UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q

 

(Mark One)

☑			QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the Quarterly Period ended June 30, 2023

OR

☐			TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the Transition Period From ________ to ________.

 

Commission File Number 001-35750 

First Internet Bancorp
(Exact Name of Registrant as Specified in Its Charter)

Indiana						20-3489991
(State or Other Jurisdiction of Incorporation or Organization)						(I.R.S. Employer Identification No.)
8701 East 116th Street Fishers, IN						46038
(Address of Principal Executive Offices)						(Zip Code)

			(317) 532-7900
			(Registrant’s Telephone Number, Including Area Code)

Securities registered pursuant to Section 12(b) of the Act:

Title of each class

Trading Symbols

Name of each exchange on which registered

Common Stock, without par value

INBK

The Nasdaq Stock Market LLC

6.0% Fixed to Floating Subordinated Notes due 2029

INBKZ

The Nasdaq Stock Market LLC

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes þ No ¨

 

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes þ No ¨

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.

Large Accelerated Filer ¨			Accelerated Filer þ
Non-accelerated Filer ¨			Smaller Reporting Company ☐
Emerging growth company ☐

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ☐ No þ

 

As of August 4, 2023, the registrant had 8,717,407 shares of common stock issued and outstanding.

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Cautionary Note Regarding Forward-Looking Statements

  

This Quarterly Report on Form 10-Q contains forward-looking statements within the meaning of the federal securities laws. These statements are not historical facts, but rather statements based on the current expectations of First Internet Bancorp and its consolidated subsidiaries (the “Company,” “we,” “our,” or “us”) regarding our business strategies, intended results and future performance, including without limitation statements concerning the financial condition, results of operations, trends in lending policies and loan programs, plans and prospective business partnerships, objectives, future performance and business of the Company. Forward-looking statements are generally preceded by terms such as “acquire”, “anticipate,” “attempt,” “believe,” “can,” “continue,” “could,” “differentiate,” “diversify,” “driving,” “effort,” “emerging,” “estimate,” “expect,” “grow,” “increase,” “intend,” “likely,” “may,” “objective,” “optimistic,” “pending,” “plan,” “position,” “potential,” “preliminary,” “remain,” “retain,” “should,” “succeed,” “will,” “win,” “would” or other similar expressions. Such statements are subject to certain risks and uncertainties, including without limitation: changes in market rates and prices that may adversely impact the value of securities, loans, deposits and other financial instruments and the interest rate sensitivity of our balance sheet; changing bank regulatory conditions, policies or programs, whether arising as a result of new legislation or regulatory initiatives, that could lead to restrictions on activities of banks generally or First Internet Bank (the “Bank”) in particular; more restrictive regulatory capital requirements; increased costs, including deposit insurance premiums; other general economic conditions, whether national or regional, and conditions in the lending markets in which we participate that may have an adverse effect on the demand for our loans and other products; our credit quality and related levels of nonperforming assets and credit losses, and the value and salability of the real estate that is the collateral for our loans; failures or breaches of or interruptions in the communication and information systems on which we rely to conduct our business that could reduce our revenues, increase our costs or lead to disruptions in our business; our dependence on capital distributions from the Bank; results of examinations of us by our regulators, including the possibility that our regulators may, among other things, require us to increase our allowance for credit losses or to write-down assets; regulation or prohibition of certain income producing activities or changes in the secondary market for loans and other products; our liquidity requirements being adversely affected by changes in our assets and liabilities; the effect of legislative or regulatory developments, including changes in laws concerning taxes, banking, securities, insurance and other aspects of the financial services industry; competitive factors among financial services organizations, including product and pricing pressures and our ability to attract, develop and retain qualified banking professionals; the growth and profitability of noninterest or fee income being less than expected; the loss of any key members of senior management; the effect of changes in accounting policies and practices, as may be adopted by the Financial Accounting Standards Board, the Securities and Exchange Commission (the “SEC”), the Public Company Accounting Oversight Board and other regulatory agencies; and the effect of fiscal and governmental policies of the United States federal government. Additional factors that may affect our results include those discussed in this Quarterly Report on Form 10-Q and our most recent Annual Report on Form 10-K under the heading “Risk Factors” and in other reports filed with the SEC. We caution readers not to place undue reliance on any such forward-looking statements, which speak only as of the date made. The factors listed above could affect our financial performance and could cause our actual results for future periods to differ materially from any opinions or statements expressed with respect to future periods in any current statements.

Except as required by law, we do not undertake, and specifically disclaim any obligation, to publicly release the result of any revisions that may be made to any forward-looking statements to reflect events or circumstances after the date of such statements or to reflect the occurrence of anticipated or unanticipated events.

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PART I

ITEM 1.    FINANCIAL STATEMENTS 

First Internet Bancorp

Condensed Consolidated Balance Sheets

(Amounts in thousands except share data)

						June 30, 2023						December 31, 2022
						(Unaudited)
Assets
Cash and due from banks						$	9,503					$	17,426
Interest-bearing deposits						456,128						239,126
Total cash and cash equivalents						465,631						256,552
Securities available-for-sale, at fair value (amortized cost of $424,891 and $436,183 in 2023 and 2022, respectively)						379,394						390,384
Securities held-to-maturity, at amortized cost, net of allowance for credit losses (fair value of $208,643 and $168,483 in 2023 and 2022, respectively)						230,605						189,168
Loans held-for-sale (includes $9,110 at fair value in 2022)						32,001						21,511
Loans						3,646,832						3,499,401
Allowance for credit losses - loans						(36,058)						(31,737)
Net loans						3,610,774						3,467,664
Accrued interest receivable						24,101						21,069
Federal Home Loan Bank of Indianapolis stock						28,350						28,350
Cash surrender value of bank-owned life insurance						40,357						39,859
Premises and equipment, net						73,525						72,711
Goodwill						4,687						4,687
Servicing asset, at fair value						8,252						6,255
Other real estate owned						106						—
Accrued income and other assets						49,266						44,894
Total assets						$	4,947,049					$	4,543,104
Liabilities and Shareholders’ Equity
Liabilities
Noninterest-bearing deposits						$	119,291					$	175,315
Interest-bearing deposits						3,735,017						3,265,930
Total deposits						3,854,308						3,441,245
Advances from Federal Home Loan Bank						614,931						614,928
Subordinated debt, net of unamortized debt issuance costs of $2,316 and $2,468 in 2023 and 2022, respectively						104,684						104,532
Accrued interest payable						3,338						2,913
Accrued expenses and other liabilities						15,456						14,512
Total liabilities						4,592,717						4,178,130
Commitments and Contingencies
Shareholders’ Equity
Preferred stock, no par value; 4,913,779 shares authorized; issued and outstanding - none						—						—
Voting common stock, no par value; 45,000,000 shares authorized; 8,774,507 and 9,065,883 shares issued and outstanding in 2023 and 2022, respectively						186,545						192,935
Nonvoting common stock, no par value; 86,221 shares authorized; issued and outstanding - none						—						—
Retained earnings						200,973						205,675
Accumulated other comprehensive loss						(33,186)						(33,636)
Total shareholders’ equity						354,332						364,974
Total liabilities and shareholders’ equity						$	4,947,049					$	4,543,104

See Notes to Condensed Consolidated Financial Statements

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First Internet Bancorp

Condensed Consolidated Statements of Income – Unaudited

(Amounts in thousands except share and per share data)

						Three Months Ended												Six Months Ended
						June 30, 2023						June 30, 2022						June 30, 2023						June 30, 2022
Interest Income
Loans						$	46,906					$	32,415					$	90,749					$	65,603
Securities – taxable						3,835						2,567						7,441						4,788
Securities – non-taxable						860						328						1,658						577
Other earning assets						6,521						796						10,307						1,172
Total interest income						58,122						36,106						110,155						72,140
Interest Expense
Deposits						34,676						6,408						61,946						12,505
Other borrowed funds						5,301						4,018						10,490						8,205
Total interest expense						39,977						10,426						72,436						20,710
Net Interest Income						18,145						25,680						37,719						51,430
Provision for Credit Losses 1						1,698						1,185						11,113						1,976
Net Interest Income After Provision for Credit Losses						16,447						24,495						26,606						49,454
Noninterest Income
Service charges and fees						218						281						427						597
Loan servicing revenue						850						620						1,635						1,205
Loan servicing asset revaluation						(358)						(470)						(413)						(767)
Mortgage banking activities						—						1,710						76						3,583
Gain on sale of loans						4,868						1,952						8,929						5,797
Other						293						221						663						719
Total noninterest income						5,871						4,314						11,317						11,134
Noninterest Expense
Salaries and employee benefits						10,706						10,832						22,500						20,710
Marketing, advertising and promotion						705						920						1,549						1,676
Consulting and professional services						711						1,197						1,637						3,122
Data processing						520						490						1,179						939
Loan expenses						1,072						693						3,049						2,275
Premises and equipment						2,661						2,419						5,438						4,959
Deposit insurance premium						936						287						1,479						568
Other						1,359						1,147						2,793						2,516
Total noninterest expense						18,670						17,985						39,624						36,765
Income (Loss) Before Income Taxes						3,648						10,824						(1,701)						23,823
Income Tax (Benefit) Provision						(234)						1,279						(2,566)						3,069
Net Income						$	3,882					$	9,545					$	865					$	20,754
Income Per Share of Common Stock
Basic						$	0.44					$	0.99					$	0.10					$	2.14
Diluted						$	0.44					$	0.99					$	0.10					$	2.13
Weighted-Average Number of Common Shares Outstanding
Basic						8,903,213						9,600,383						8,963,308						9,694,729
Diluted						8,908,180						9,658,689						8,980,262						9,764,232
Dividends Declared Per Share						$	0.06					$	0.06					$	0.12					$	0.12

1Beginning January 1, 2023, the allowance calculation is based on the CECL methodology. Prior to January 1, 2023, the allowance calculation was based on the incurred loss methodology.

See Notes to Condensed Consolidated Financial Statements

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First Internet Bancorp

Condensed Consolidated Statements of Comprehensive Income – Unaudited

(Amounts in thousands except per share data)

						Three Months Ended June 30,												Six Months Ended June 30,
						2023						2022						2023						2022
Net income						$	3,882					$	9,545					$	865					$	20,754
Other comprehensive (loss) income
Securities available-for-sale
Net unrealized holding (losses) gains recorded within other comprehensive (loss) income before income tax						(4,810)						(15,395)						302						(33,276)
Income tax (benefit) provision						(1,107)						(4,186)						63						(8,263)
Net effect on other comprehensive (loss) income						(3,703)						(11,209)						239						(25,013)
Securities held-to-maturity
Reclassification of securities from available-for-sale to held-to-maturity						—						—						—						(5,402)
Amortization of net unrealized holding losses on securities transferred from available-for-sale to held-to-maturity						206						193						364						312
Income tax provision (benefit)						49						(23)						95						(1,272)
Net effect on other comprehensive income (loss)						157						216						269						(3,818)
Cash flow hedges
Net unrealized holding gains (losses) on cash flow hedging derivatives recorded within other comprehensive income (loss) before income tax						2,094						4,944						(76)						14,278
Income tax provision (benefit)						481						1,840						(18)						5,158
Net effect on other comprehensive income (loss)						1,613						3,104						(58)						9,120
Total other comprehensive (loss) income						(1,933)						(7,889)						450						(19,711)
Comprehensive income						$	1,949					$	1,656					$	1,315					$	1,043

 

 See Notes to Condensed Consolidated Financial Statements

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First Internet Bancorp

Condensed Consolidated Statements of Changes in Shareholders’ Equity - Unaudited

Six Months Ended June 30, 2023 and 2022

(Amounts in thousands except per share data)

						Voting and Nonvoting Common Stock						Retained Earnings						Accumulated Other Comprehensive Loss						Total Shareholders’ Equity
Balance, January 1, 2023						$	192,935					$	205,675					$	(33,636)					$	364,974
Impact of adoption of new accounting standards 1						—						(4,491)						—						(4,491)
Net Income						—						865						—						865
Other comprehensive income						—						—						450						450
Dividends declared ($0.12 per share)						—						(1,076)						—						(1,076)
Recognition of the fair value of share-based compensation						487						—						—						487
Repurchased shares of common stock (364,691)						(6,774)						—						—						(6,774)
Deferred stock rights and restricted stock units issued in lieu of cash dividends payable on outstanding deferred stock rights and restricted stock units						3						—						—						3
Common stock redeemed for the net settlement of share-based awards						(106)						—						—						(106)
Balance, June 30, 2023						$	186,545					$	200,973					$	(33,186)					$	354,332
Balance, January 1, 2022						$	218,946					$	172,431					$	(11,039)					$	380,338
Net income						—						20,754						—						20,754
Other comprehensive loss						—						—						(19,711)						(19,711)
Dividends declared ($0.12 per share)						—						(1,174)						—						(1,174)
Recognition of the fair value of share-based compensation						1,534						—						—						1,534
Repurchase of common stock (398,167)						(16,240)						—						—						(16,240)
Deferred stock rights and restricted stock units issued in lieu of cash dividends payable on outstanding deferred stock rights and restricted stock units						10						—						—						10
Common stock redeemed for the net settlement of share-based awards						(179)						—						—						(179)
Balance, June 30, 2022						$	204,071					$	192,011					$	(30,750)					$	365,332

1 Reflects the impact of adopting Accounting Standards Update (“ASU”) 2016-13.

See Notes to Condensed Consolidated Financial Statements

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First Internet Bancorp

Condensed Consolidated Statements of Changes in Shareholders’ Equity - Unaudited

Three Months Ended June 30, 2023 and 2022

(Amounts in thousands except per share data)

						Voting and Nonvoting Common Stock						Retained Earnings						Accumulated Other Comprehensive Loss						Total Shareholders’ Equity
Balance April 1, 2023						$	189,202					$	197,623					$	(31,253)					$	355,572
Net income						—						3,882						—						3,882
Other comprehensive loss						—						—						(1,933)						(1,933)
Dividends declared ($0.06 per share)						—						(532)						—						(532)
Recognition of the fair value of share-based compensation						115						—						—						115
Repurchased shares of common stock (85,000)						(2,745)						—						—						(2,745)
Excise tax on repurchase of common stock						(27)						—						—						(27)
Balance, June 30, 2023						$	186,545					$	200,973					$	(33,186)					$	354,332
Balance April 1, 2022						$	214,473					$	183,043					$	(22,861)					$	374,655
Net income						—						9,545						—						9,545
Other comprehensive loss						—						—						(7,889)						(7,889)
Dividends declared ($0.06 per share)						—						(577)						—						(577)
Recognition of the fair value of share-based compensation						895						—						—						895
Repurchase of common stock (294,464)						(11,123)						—						—						(11,123)
Deferred stock rights and restricted stock units issued in lieu of cash dividends payable on outstanding deferred stock rights and restricted stock units						5						—						—						5
Common stock redeemed for the net settlement of share-based awards						(179)						—						—						(179)
Balance, June 30, 2022						$	204,071					$	192,011					$	(30,750)					$	365,332

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First Internet Bancorp

Condensed Consolidated Statements of Cash Flows – Unaudited

(Amounts in thousands except per share data)

						Six Months Ended June 30,
						2023						2022
Operating Activities
Net income						$	865					$	20,754
Adjustments to reconcile net income to net cash used in operating activities:
Depreciation and amortization						2,918						4,604
Increase in cash surrender value of bank-owned life insurance						(498)						(469)
Provision for credit losses 1						11,113						1,976
Share-based compensation expense						487						1,534
Loans originated for sale						(170,112)						(311,268)
Proceeds from sale of loans						166,469						335,226
Gain on loans sold						(9,400)						(9,736)
Decrease in fair value of loans held-for-sale						143						149
Gain (loss) on derivatives						368						(2,546)
Loan servicing asset revaluation						413						767
Net change in accrued income and other assets						(4,985)						16,183
Net change in accrued expenses and other liabilities						(2,625)						(5,173)
Net cash (used in) provided by operating activities						(4,844)						52,001
Investing Activities
Net loan activity, excluding purchases						(37,490)						(11,665)
Proceeds from sale of other real estate owned						—						1,188
Maturities and calls of securities available-for-sale						25,446						52,397
Purchase of securities available-for-sale						(14,863)						(10,133)
Maturities and calls of securities held-to-maturity						11,332						2,309
Purchase of securities held-to-maturity						(49,443)						(31,782)
Redemption of Federal Home Loan Bank of Indianapolis stock						—						431
Purchase of premises and equipment						(3,132)						(12,634)
Loans purchased						(118,813)						(197,514)
Net proceeds from sale of portfolio loans						—						14,466
Other investing activities						(2,094)						374
Net cash used in investing activities						(189,057)						(192,563)
Financing Activities
Net increase (decrease) in deposits						410,951						(26,858)
Cash dividends paid						(1,091)						(1,168)
Repurchase of common stock						(6,774)						(16,240)
Proceeds from advances from Federal Home Loan Bank						220,000						220,000
Repayment of advances from Federal Home Loan Bank						(220,000)						(270,000)
Other, net						(106)						(179)
Net cash provided by (used in) financing activities						402,980						(94,445)
Net Increase (Decrease) in Cash and Cash Equivalents						209,079						(235,007)
Cash and Cash Equivalents, Beginning of Period						256,552						442,960
Cash and Cash Equivalents, End of Period						$	465,631					$	207,953
Supplemental Disclosures
Cash paid during the period for interest						72,013						20,722
Cash paid during the period for taxes						818						1,892
Loans transferred to other real estate owned						106						—
Loans transferred to held-for-sale from portfolio						—						14,049
Cash dividends declared, paid in subsequent period						526						564
Securities purchased during the period, settled in subsequent period						2,632						—
Transfer of available-for-sale mortgage-backed securities to held-to-maturity mortgage-backed securities at fair value						—						96,220

1Beginning January 1, 2023, the allowance calculation is based on the CECL methodology. Prior to January 1, 2023, the allowance calculation was based on the incurred loss methodology.

See Notes to Condensed Consolidated Financial Statements

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First Internet Bancorp

Notes to Condensed Consolidated Financial Statements – Unaudited

(Table amounts in thousands except share and per share data)

  

Note 1:        Basis of Presentation

 

The accompanying unaudited condensed consolidated financial statements have been prepared in conformity with U.S. generally accepted accounting principles (“GAAP”) for interim financial information and pursuant to the rules and regulations of the U.S. Securities and Exchange Commission (“SEC”). Accordingly, they do not include all of the information or footnotes necessary for a complete presentation of financial condition, results of operations, changes in shareholders’ equity, or cash flows in accordance with GAAP. In our opinion, all adjustments (consisting only of normal recurring adjustments) necessary for a fair presentation have been included. The results of operations for the three and six months ended June 30, 2023 are not necessarily indicative of the results expected for the year ending December 31, 2023 or any other period. The June 30, 2023 condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and notes included in the First Internet Bancorp Annual Report on Form 10-K for the year ended December 31, 2022.

 

The preparation of the condensed consolidated financial statements in conformity with GAAP requires management to make estimates, judgments, or assumptions that could have a material effect on the carrying value of certain assets and liabilities. These estimates, judgments, and assumptions affect the amounts reported in the condensed consolidated financial statements and the disclosures provided. The determination of the allowance for credit losses, income taxes, valuations and impairments of investment securities and goodwill, as well as fair value measurements of derivatives and loans held-for-sale are highly dependent upon management’s estimates, judgments, and assumptions, and changes in any of these could have a significant impact on the condensed consolidated financial statements.

The condensed consolidated financial statements include the accounts of First Internet Bancorp (the “Company”), its wholly owned subsidiary, First Internet Bank of Indiana (the “Bank”), and the Bank’s three wholly owned subsidiaries, First Internet Public Finance Corp., JKH Realty Services, LLC and SPF15, Inc. All significant intercompany accounts and transactions have been eliminated in consolidation.

 

The Company is subject to claims and lawsuits that arise primarily in the ordinary course of business. It is the opinion of management that the disposition or ultimate resolution of such claims and lawsuits will not have a material adverse effect on the consolidated financial position, results of operations, and cash flows of the Company.

Other than the adoption of new accounting standards, the Company has not changed its significant accounting and reporting policies from those disclosed in the Company’s Form 10-K for the year ended December 31, 2022.

Adoption of new accounting standards

ASU 2016 - 13

On January 1, 2023, the Company adopted ASU 2016-03 Financial Instruments - Credit losses (“ASC 326”): Measurement of Credit Losses on Financial Instruments, as amended, which replaces the incurred loss methodology with an expected credit loss (“CECL”) methodology. The CECL estimate is applicable to financial assets measured at amortized cost, including loan receivables and held-to-maturity debt securities. It also applies to off-balance sheet credit exposures, including loan commitments, standby letters of credit, financial guarantees and other similar instruments. Additionally, ASC 326 resulted in changes to the accounting for available-for-sale and held-to-maturity debt securities.

The Company adopted ASC 326 for all financial assets measured at amortized cost, available for sale securities and off-balance sheet credit exposures. Results for reporting periods beginning after January 1, 2023 are presented under ASC 326, while prior period amounts continue to be reported in accordance with previously applicable U.S. GAAP. The Company recorded a net decrease to retained earnings of $4.5 million as of January 1, 2023 for the cumulative effect of adopting ASC 326. The net adjustment to allowance for credit losses (“ACL”) includes $2.3 million related to loans, $1.9 million related to off-balance sheet credit exposures and $0.3 million related to held-to-maturity debt securities.

ACL - Available-For-Sale (“AFS”) Debt Securities

For AFS debt securities in an unrealized loss position, the Company first assesses whether it intends to sell, or it is more likely than not that it will be required to sell, the security before recovery of its amortized cost basis. If either of the

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criteria regarding intent or requirement to sell is met, the security’s amortized cost basis is written down to fair value through income. For AFS debt securities that do not meet the aforementioned criteria, the Company evaluates whether the decline in fair value has resulted from credit losses or other factors, such as interest rates or market conditions. In making this assessment, management considers the extent to which fair value is less than amortized cost, any changes to the rating of the security by a rating agency and adverse conditions specifically related to the security, among other factors. If this assessment indicates that a credit loss exists, the present value of cash flows expected to be collected from the security are compared to the amortized cost basis of the security. If the present value of cash flows expected to be collected is less than the amortized cost basis, a credit loss exists and an allowance for credit losses is recorded. Changes in the ACL are recorded as a provision for, or recovery of, credit loss expense. Losses are charged against the allowance when management believes that uncollectibility of an AFS debt security is confirmed or when either of the criteria regarding intent or requirement to sell is met.

Accrued interest receivable on AFS debt securities totaled $2.0 million at June 30, 2023 and is excluded from the estimate of credit losses. The Company made the policy election to exclude accrued interest from the amortized cost basis of AFS debt securities and report accrued interest separately on the condensed consolidated balance sheet.

ACL - Held-To-Maturity (“HTM”) Debt Securities

Management measures expected credit losses on HTM debt securities on a collective basis by major security type. Accrued interest receivable on HTM debt securities totaled $1.0 million at June 30, 2023 and is excluded from the estimate of credit losses. The Company made the accounting policy election to not measure an ACL for accrued interest. Accrued interest deemed uncollectible will be written off through interest income. The HTM securities portfolio includes municipal securities, residential mortgage-backed-securities, commercial mortgage-backed securities and corporate securities. All residential and commercial mortgage-backed securities are U.S. government issued or sponsored and substantially all municipal and corporate securities are rated investment grade or above.

The estimate of expected credit losses considers historical credit loss information that is adjusted for current conditions and reasonable and supportable forecasts. At the time of adoption, the estimated reserve was $0.3 million.

ACL - Loans

The ACL for loans represents management's estimate of all expected credit losses over the expected life of the Company’s existing loan portfolio. Management estimates the ACL balance using relevant available information about the collectability of cash flows, from internal and external sources, including historical information relating to past events, current conditions, and reasonable and supportable forecasts of future economic conditions. When the Company is unable to forecast future economic events, management may revert to historical information.

Accrued interest receivable on loans totaled $19.3 million and is excluded from the estimate of credit losses. The Company made the accounting policy election to not measure an ACL for accrued interest receivable. Accrued interest deemed uncollectible will be written off through interest income.

ACL - Loans - Collectively Evaluated

The ACL is measured on a collective pool basis when similar risk characteristics exist. The Company has identified the following portfolio segments in the table below.

The Company utilized a discounted cash flow (“DCF”) method to estimate the quantitative portion of the allowance for credit losses for loans evaluated on a collective pooled basis. For each segment, a loss driver analysis was performed in order to identify loss drivers and create a regression model for use in forecasting cash flows.

In creating the DCF model, the Company has established a one-year reasonable and supportable forecast period with a one-year straight line reversion to the long-term historical average. Due to its minimal loss history, the Company elected to use peer data for a more reasonable calculation.

Key inputs into the DCF model include loan-level detail, including the amortized cost basis of individual loans, payment structure, loss history, and forecasted loss drivers. The Company utilizes a third party to provide economic forecasts under various scenarios, which are assessed quarterly considering the scenarios in the context of the current economic environment and loss risk.

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Expected credit losses are estimated over the contractual term of the loans and adjusted for prepayments when appropriate. The contractual term excludes extensions, renewals, and modifications unless the extension or renewal options are included in the original or modified contract at the reporting date and are not unconditionally cancellable by the Company.

Additional key assumptions in the DCF model include the probability of default (“PD”), loss given default (“LGD”), and prepayment/curtailment rates. The Company utilizes the model-driven PD and a LGD derived from a method referred to as Frye Jacobs. The Frye Jacobs method is a mathematical formula that traces the relationship between LGD and PD over time and projects the LGD based on the level of PD forecasted. In all cases, the Frye Jacobs method is utilized to calculate LGDs during the forecast period, reversion period and long-term historical average. Prepayment and curtailment rates were calculated through third party analysis of the Company’s own data.

Qualitative factors for the DCF and weighted-average remaining maturity methodologies include the following:

•Changes in lending policies and procedures, including changes in underwriting standards and collections, charge-offs and recovery practices

•Changes in international, national, regional and local conditions

•Changes in the nature and volume of the portfolio and terms of loans

•Changes in the experience, depth and ability of lending management

•Changes in the volume and severity of past due loans and other similar conditions

•Changes in the quality of the organization’s loan review system

•Changes in the value of underlying collateral for collateral dependent loans

•The existence and effect of any concentrations of credit and changes in the levels of such concentrations

•The effect of other external factors (i.e. competition, legal and regulatory requirements) on the level of estimated credit losses

ACL - Loans - Individually Evaluated

Loans that do not share risk characteristics are evaluated on an individual basis and are excluded from the collective evaluation. The Company has determined that any loans which have been placed on nonaccrual status will be individually evaluated. Individual analysis will establish a specific reserve for loans, if necessary. Specific reserves on nonaccrual loans are typically based on management’s best estimate of the fair value of collateral securing these loans, adjusted for selling costs as necessary.

ACL - Off-Balance Sheet Credit Exposures

The Company estimates expected credit losses over the contractual period in which the Company is exposed to credit risk via a contractual obligation to extend credit, unless that obligation is unconditionally cancellable by the Company. The ACL for off-balance sheet credit exposure is recorded as a liability and adjusted as a provision for credit loss expense. The estimate includes consideration of the likelihood that funding will occur and an estimate of expected credit losses on commitments expected to be funded over its estimated life. Funding rates are based on a historical analysis of the Company’s portfolio, while estimates of credit losses are determined using the same loss rates as funded loans.

Regulatory Capital

As permitted by the federal banking regulatory agencies, the Company has elected the option to delay the impact of the day one adoption of ASC 326. Refer to “Item 2. Regulatory Capital Requirements” for details of the phase-in transition adjustments.

Modified Loans to Borrowers Experiencing Financial Difficulty

Concurrent with the adoption of ASU 2016-03, the Company adopted ASU 2022-02 “Financial Instruments-Credit Losses (ASC 326): Troubled Debt Restructurings and Vintage Disclosures,” as amended. The update eliminated the accounting guidance for troubled debt restructurings (“TDRs”) by creditors, while enhancing disclosure requirements for certain loan refinancings and restructurings by creditors when a borrower is experiencing financial difficulty.

    

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Note 2:        Earnings Per Share

 

Earnings per share of common stock are based on the weighted-average number of basic shares and dilutive shares outstanding during the period.

 

The following is a reconciliation of the weighted-average common shares for the basic and diluted earnings per share computations for the three and six months ended June 30, 2023 and 2022. 

(dollars in thousands, except per share data)						Three Months Ended June 30,												Six Months Ended June 30,
						2023						2022						2023						2022
Basic earnings per share
Net income						$	3,882					$	9,545					$	865					$	20,754
Weighted-average common shares						8,903,213						9,600,383						8,963,308						9,694,729
Basic earnings per common share						$	0.44					$	0.99					$	0.10					$	2.14
Diluted earnings per share
Net income						$	3,882					$	9,545					$	865					$	20,754
Weighted-average common shares						8,903,213						9,600,383						8,963,308						9,694,729
Dilutive effect of equity compensation						4,967						58,306						16,954						69,503
Weighted-average common and incremental shares						8,908,180						9,658,689						8,980,262						9,764,232
Diluted earnings per common share 1						$	0.44					$	0.99					$	0.10					$	2.13

1 Potential dilutive common shares are excluded from the computation of diluted EPS in the periods where the effect would be antidilutive. Excluded from the computation of diluted EPS were weighted-average antidilutive shares totaling 79,313 and 35,033 for the three and six months ended June 30, 2023, respectively. Excluded from the computation of diluted EPS were weighted-average antidilutive shares totaling 5,560 and 1,198 for the three and six months ended June 30, 2022, respectively.

  

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Note 3:         Securities

 

The following tables summarize securities available-for-sale and securities held-to-maturity as of June 30, 2023 and December 31, 2022.

						June 30, 2023
						Amortized						Gross Unrealized												Fair
(in thousands)						Cost						Gains						Losses						Value
Securities available-for-sale
U.S. Government-sponsored agencies						$	41,024					$	130					$	(1,680)					$	39,474
Municipal securities						68,931						413						(2,135)						67,209
Agency mortgage-backed securities - residential 1						239,263						—						(35,122)						204,141
Agency mortgage-backed securities - commercial						16,311						—						(1,420)						14,891
Private label mortgage-backed securities - residential						14,749						—						(1,334)						13,415
Asset-backed securities						1,000						—						—						1,000
Corporate securities						43,613						44						(4,393)						39,264
Total available-for-sale						$	424,891					$	587					$	(46,084)					$	379,394

						June 30, 2023
						Amortized Cost						Gross Unrealized												Fair Value						Allowance for Credit Losses						Net Carrying Value
(in thousands)												Gains						Losses
Securities held-to-maturity
Municipal securities						$	13,916					$	—					$	(966)					$	12,950					$	(3)					$	13,913
Mortgage-backed securities - residential						169,186						—						(15,593)						153,593						—						169,186
Mortgage-backed securities - commercial						5,795						—						(1,244)						4,551						—						5,795
Corporate securities						42,044						—						(4,495)						37,549						(333)						41,711
Total held-to-maturity						$	230,941					$	—					$	(22,298)					$	208,643					$	(336)					$	230,605

1 Includes $0.4 million of additional premium related to terminated interest rate swaps associated with agency mortgage-backed securities - residential as of June 30, 2023.

Accrued interest receivable on AFS and HTM securities at June 30, 2023 was $2.0 million and $1.0 million, respectively, and is included in accrued interest receivable on the condensed consolidated balance sheet. The Company elected to exclude all accrued interest receivable from securities when estimating credit losses.

Over 97% of mortgage-backed securities (including both AFS and HTM) held by the Company are issued by U.S. government-sponsored entities and agencies. These securities are either explicitly or implicitly guaranteed by the U.S. government and have a long history of no credit losses; therefore, the Company did not record an ACL on these securities.

Additionally, the Company evaluated credit impairment for individual AFS securities that are in an unrealized loss position and determined that the unrealized losses are unrelated to credit quality and are primarily attributable to changes in interest rates and volatility in the financial markets. As the Company does not intend to sell the AFS securities that are in an unrealized loss position, and it is unlikely that it will be required to sell these securities before recovery of their amortized cost basis, the Company did not record an ACL on these securities.

In accordance with the adoption of ASC 326, the Company also evaluated its HTM securities that are in an unrealized loss position and considered issuer bond ratings, historical loss rates for bond ratings and economic forecasts. As a result, the Company recorded in an initial ACL in retained earnings of $0.3 million on January 1, 2023. The Company reevaluated these securities at June 30, 2023 and determined no additional ACL was necessary.

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						December 31, 2022
						Amortized						Gross Unrealized												Fair
(in thousands)						Cost						Gains						Losses						Value
Securities available-for-sale
U.S. Government-sponsored agencies						$	35,606					$	—					$	(1,797)					$	33,809
Municipal securities						68,958						458						(2,140)						67,276
Agency mortgage-backed securities - residential 1						252,066						—						(36,974)						215,092
Agency mortgage-backed securities - commercial						17,142						—						(1,302)						15,840
Private label mortgage-backed securities - residential						11,777						—						(1,322)						10,455
Asset-backed securities						5,000						—						(40)						4,960
Corporate securities						45,634						35						(2,717)						42,952
Total available-for-sale						$	436,183					$	493					$	(46,292)					$	390,384

						December 31, 2022
						Amortized						Gross Unrealized												Fair
(in thousands)						Cost						Gains						Losses						Value
Securities held-to-maturity
Municipal securities						$	13,946					$	—					$	(1,114)					$	12,832
Agency mortgage-backed securities - residential						121,853						—						(15,112)						106,741
Agency mortgage-backed securities - commercial						5,818						—						(1,266)						4,552
Corporate securities						47,551						—						(3,193)						44,358
Total held-to-maturity						$	189,168					$	—					$	(20,685)					$	168,483

1 Includes $0.5 million of additional premium related to terminated interest rate swaps associated with agency mortgage-backed securities - residential as of December 31, 2022.

The carrying value of securities at June 30, 2023 is shown below by their contractual maturity date. Actual maturities will differ because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.

						Available-for-Sale
(in thousands)						Amortized Cost						Fair Value
Within one year						$	569					$	563
One to five years						32,459						32,565
Five to ten years						47,959						44,817
After ten years						72,581						68,002
						153,568						145,947
Agency mortgage-backed securities - residential						239,263						204,141
Agency mortgage-backed securities - commercial						16,311						14,891
Private label mortgage-backed securities - residential						14,749						13,415
Asset-backed securities						1,000						1,000
Total						$	424,891					$	379,394

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						Held-to-Maturity
(in thousands)						Amortized Cost						Fair Value
Within one year						$	495					$	486
One to five years						5,798						5,580
Five to ten years						44,203						39,557
After ten years						5,464						4,876
						55,960						50,499
Agency mortgage-backed securities - residential						169,186						153,593
Agency mortgage-backed securities - commercial						5,795						4,551
Total						$	230,941					$	208,643

There were no gross gains or losses resulting from the sale of available-for-sale securities during the three and six months ended June 30, 2023 and June 30, 2022, respectively.

Certain investments in debt securities are reported in the condensed consolidated financial statements at an amount less than their historical cost. The total fair value of these investments at June 30, 2023 and December 31, 2022 was $542.0 million and $527.4 million, which was approximately 92% and 94%, respectively, of the Company’s AFS and HTM securities portfolios. As of June 30, 2023, the Company’s security portfolio consisted of 477 securities, of which 462 were in an unrealized loss position. As of December 31, 2022, the Company’s security portfolio consisted of 445 securities, of which 434 were in an unrealized loss position. The unrealized losses are related to the categories noted below.

U. S. Government-Sponsored Agencies, Municipal Securities and Corporate Securities

The unrealized losses on the Company’s investments in securities issued by U.S. Government-sponsored agencies, municipal organizations and corporate entities were caused primarily by interest rate changes. The contractual terms of those investments do not permit the issuer to settle the securities at a price less than the amortized cost basis of the investments. The Company does not intend to sell the investments and it is not likely that the Company will be required to sell the investments before recovery of their amortized cost basis, which may be upon maturity. As of June 30, 2023, the unrealized losses occurred as a result of changes in interest rates, market spreads and market conditions subsequent to purchase.

 

Agency Mortgage-Backed and Private Label Mortgage-Backed Securities

 

The unrealized losses on the Company’s investments in agency mortgage-backed and private label mortgage-backed securities were caused primarily by interest rate changes. The Company expects to recover the amortized cost basis over the terms of the securities. The Company does not intend to sell the investments and it is not likely that the Company will be required to sell the investments before recovery of their amortized cost basis, which may be upon maturity. As of June 30, 2023, the unrealized losses occurred as a result of changes in interest rates, market spreads and market conditions subsequent to purchase.

The following tables show the securities portfolio’s gross unrealized losses and fair value, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position at June 30, 2023 and December 31, 2022.

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						June 30, 2023
						Less Than 12 Months												12 Months or Longer												Total
(in thousands)						Fair Value						Unrealized Losses						Fair Value						Unrealized Losses						Fair Value						Unrealized Losses
Securities available-for-sale
U.S. Government-sponsored agencies						$	3,819					$	(13)					$	28,895					$	(1,667)					$	32,714					$	(1,680)
Municipal securities						1,454						(59)						39,935						(2,076)						41,389						(2,135)
Agency mortgage-backed securities- residential						5,489						(361)						198,652						(34,761)						204,141						(35,122)
Agency mortgage-backed securities- commercial						—						—						14,891						(1,420)						14,891						(1,420)
Private label mortgage-backed securities - residential						3,642						(87)						9,773						(1,247)						13,415						(1,334)
Corporate securities						8,523						(1,036)						18,643						(3,357)						27,166						(4,393)
Total						$	22,927					$	(1,556)					$	310,789					$	(44,528)					$	333,716					$	(46,084)

						December 31, 2022
						Less Than 12 Months												12 Months or Longer												Total
(in thousands)						Fair Value						Unrealized Losses						Fair Value						Unrealized Losses						Fair Value						Unrealized Losses
Securities available-for-sale
U.S. Government-sponsored agencies						$	29,668					$	(1,008)					$	4,141					$	(789)					$	33,809					$	(1,797)
Municipal securities						39,557						(1,766)						4,778						(374)						44,335						(2,140)
Agency mortgage-backed securities - residential						170,026						(29,690)						45,066						(7,284)						215,092						(36,974)
Agency mortgage-backed securities - commercial						10,560						(926)						5,280						(376)						15,840						(1,302)
Private label mortgage-backed securities						2,445						(330)						8,010						(992)						10,455						(1,322)
Asset-backed securities						4,960						(40)						—						—						4,960						(40)
Corporate securities						21,568						(1,452)						13,239						(1,265)						34,807						(2,717)
Total						$	278,784					$	(35,212)					$	80,514					$	(11,080)					$	359,298					$	(46,292)

						December 31, 2022
						Less Than 12 Months												12 Months or Longer												Total
(in thousands)						Fair Value						Unrealized Losses						Fair Value						Unrealized Losses						Fair Value						Unrealized Losses
Securities held-to-maturity
Municipal securities						$	8,160					$	(661)					$	4,258					$	(453)					$	12,418					$	(1,114)
Agency mortgage-backed securities - residential						68,408						(8,848)						38,332						(6,264)						106,740						(15,112)
Agency mortgage-backed securities - commercial						4,552						(1,266)						—						—						4,552						(1,266)
Corporate securities						36,866						(2,685)						7,492						(508)						44,358						(3,193)
Total						$	117,986					$	(13,460)					$	50,082					$	(7,225)					$	168,068					$	(20,685)

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The following table summarizes ratings for the Company’s HTM portfolio issued by state and political subdivisions and other securities as of June 30, 2023.

						Held-to-Maturity
(in thousands)						State and Municipal						Other						Total
Aaa/AAA						$	8,671					$	—					$	8,671
Aa1/AA+						1,266						—						1,266
Aa2/AA						1,540						—						1,540
A1/A+						1,794						—						1,794
A2/A						645						—						645
A3/A-						—						9,514						9,514
Baa1/BBB+						—						9,500						9,500
Baa2/BBB						—						8,500						8,500
Baa3/BBB-						—						12,530						12,530
Ba1/BB+						—						2,000						2,000
Not Rated 1						—						174,981						174,981
Total						$	13,916					$	217,025					$	230,941

1 HTM agency mortgage-backed securities - commercial and residential are listed under Other securities as not rated.

There were no amounts reclassified from accumulated other comprehensive loss to the condensed consolidated statements of income during the three and six months ended June 30, 2023.

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Note 4:        Loans

Loan balances as of June 30, 2023 and December 31, 2022 are summarized in the table below. Categories of loans include:

(in thousands)						June 30, 2023						December 31, 2022
Commercial loans
Commercial and industrial						$	112,423					$	126,108
Owner-occupied commercial real estate						59,564						61,836
Investor commercial real estate						137,504						93,121
Construction						192,453						181,966
Single tenant lease financing						947,466						939,240
Public finance						575,541						621,032
Healthcare finance						245,072						272,461
Small business lending						170,550						123,750
Franchise finance						390,479						299,835
Total commercial loans						2,831,052						2,719,349
Consumer loans
Residential mortgage						396,154						383,948
Home equity						24,375						24,712
Other consumer loans						352,124						324,598
Total consumer loans						772,653						733,258
Total commercial and consumer loans						3,603,705						3,452,607
Net deferred loan origination fees/costs and premiums/discounts on purchased loans and other1						43,127						46,794
Total loans						3,646,832						3,499,401
Allowance for credit losses						(36,058)						(31,737)
Net loans						$	3,610,774					$	3,467,664

1 Includes carrying value adjustments of $30.5 million and $32.5 million related to terminated interest rate swaps associated with public finance loans as of June 30, 2023 and December 31, 2022, respectively. 

Risk characteristics of each loan portfolio segment are as follows:

Commercial and Industrial: Commercial and industrial loans’ sources of repayment are primarily based on the identified cash flows of the borrower and secondarily on the underlying collateral provided by the borrower. The cash flows of borrowers, however, may not be as expected, and the collateral securing these loans may fluctuate in value. Loans are made for working capital, equipment purchases, or other purposes. Most commercial and industrial loans are secured by the assets being financed and may incorporate a personal guarantee. This portfolio segment is generally concentrated in the Midwest and Southwest regions of the United States.

Owner-Occupied Commercial Real Estate: The primary source of repayment is the cash flow from the ongoing operations and activities conducted by the borrower, or an affiliate of the borrower, who owns the property. This portfolio segment is generally concentrated in the Midwest and Southwest regions of the United States and its loans are often secured by manufacturing and service facilities, as well as office buildings.

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Investor Commercial Real Estate: These loans are underwritten primarily based on the cash flow expected to be generated from the property and are secondarily supported by the value of the real estate. These loans typically incorporate a personal guarantee from the primary sponsor or sponsors. This portfolio segment generally involves larger loan amounts with repayment primarily dependent on the successful leasing and operation of the property securing the loan or the business conducted on the property securing the loan. Investor commercial real estate loans may be more adversely affected by changing economic conditions in the real estate markets, industry dynamics or the overall health of the local economy where the property is located. The properties securing the Company’s investor commercial real estate portfolio tend to be diverse in terms of property type and are generally located in the Midwest and Southwest regions of the United States. Management monitors and evaluates commercial real estate loans based on property financial performance, collateral value, guarantor strength, economic and industry conditions together with other risk grade criteria. As a general rule, the Company avoids financing special use projects unless other underwriting factors are present to mitigate these additional risks.

Construction: Construction loans are secured by land and related improvements and are made to assist in the construction of new structures, which may include commercial (retail, industrial, office, and multi-family) properties, land development for residential properties or single family residential properties offered for sale by the builder. These loans generally finance a variety of project costs, including land, site preparation, architectural services, construction, closing and soft costs and interim financing needs. The cash flows of builders, while initially predictable, may fluctuate with market conditions, and the value of the collateral securing these loans may be subject to fluctuations based on general economic changes. This portfolio segment is generally concentrated in the Midwest and Southwest regions of the United States.

Single Tenant Lease Financing: These loans are made on a nationwide basis to property owners of real estate subject to long-term lease arrangements with single tenant operators. The real estate is typically operated by regionally, nationally or globally branded businesses. The loans are underwritten based on the financial strength of the borrower, characteristics of the real estate, cash flows generated from the lease arrangements and the financial strength of the tenant. Similar to the other loan portfolio segments, management monitors and evaluates these loans based on borrower and tenant financial performance, collateral value, industry trends and other risk grade criteria.

Public Finance: These loans are made on a nationwide basis to governmental and not-for-profit entities to provide both tax-exempt and taxable loans for a variety of purposes including: short-term cash-flow needs; debt refinancing; economic development; quality of life projects; infrastructure improvements; renewable energy projects; and equipment financing. The primary sources of repayment for public finance loans include pledged revenue sources including but not limited to: general obligations; property taxes; income taxes; tax increment revenue; utility revenue; gaming revenues; sales tax; and pledged general revenue. Certain loans may also include an additional collateral pledge of mortgaged property or a security interest in financed equipment.

Healthcare Finance: These loans are made on a nationwide basis to healthcare providers, primarily dentists, for practice acquisition financing or refinancing that occasionally includes owner-occupied commercial real estate and equipment purchases. The sources of repayment are primarily based on the identified cash flows from operations of the borrower and related entities and secondarily on the underlying collateral provided by the borrower.

Small Business Lending: These loans are made on a nationwide basis to small businesses and generally carry a partial guaranty from the U.S. Small Business Administration (“SBA”) under its 7(a) loan program. We generally sell the government guaranteed portion of SBA loans into the secondary market while retaining the non-guaranteed portion of the loan and the servicing rights. Loans in the small business lending portfolio have sources of repayment that are primarily based on the identified cash flows of the borrower and secondarily on any underlying collateral provided by the borrower. Loans may, but do not always, have a collateral shortfall. For SBA loans where the guaranteed portion is retained, the SBA guaranty provides a tertiary source of repayment to the Bank in event of borrower default. Cash flows of borrowers, however, may not be as expected and collateral securing these loans may fluctuate in value. Loans are made for a broad array of purposes including, but not limited to, providing operating cash flow, funding ownership changes, and facilitating equipment purchases.

Franchise Finance: These loans are made on a nationwide basis through our partnership with ApplePie Capital, which through their deep relationships with franchise brands provides franchisees with financing options for new franchise units, recapitalization, expansion, equipment and working capital. The sources of repayment are either based on identified cash flows from existing operations of the borrower or pro forma cash flow for new franchise locations.

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Residential Mortgage: With respect to residential loans that are secured by 1-to-4 family residences and are generally owner occupied, the Bank typically establishes a maximum loan-to-value ratio and requires private mortgage insurance if that ratio is exceeded. Repayment of these loans is primarily dependent on the financial circumstances of the borrowers, which can be impacted by economic conditions in their market areas such as unemployment levels. Repayment can also be impacted by changes in residential property values. Risk is mitigated by the fact that the loans are of smaller individual amounts and spread over a large number of borrowers in geographically diverse locations throughout the country.

Home Equity: Home equity loans and lines of credit are typically secured by a subordinate interest in 1-to-4 family residences. The properties securing the home equity portfolio segment are generally geographically diverse as the Bank offered these products on a nationwide basis. Repayment of these loans and lines of credit is primarily dependent on the financial circumstances of the borrowers and may be impacted by changes in unemployment levels and property values on residential properties, among other economic conditions in the market.

Other Consumer: These loans primarily consist of consumer loans and credit cards. Consumer loans may be secured by consumer assets such as horse trailers or recreational vehicles. Some consumer loans are unsecured, such as small installment loans, home improvement loans and certain lines of credit. Repayment of consumer loans is primarily dependent upon the personal income of the borrowers, which can be impacted by economic conditions in their market areas such as unemployment levels. Risk is mitigated by the fact that the loans are of smaller individual amounts and spread over a large number of borrowers in geographically diverse locations throughout the country.

Allowance for Credit Losses (“ACL”) Methodology

The ACL for loans represents management's estimate of all expected credit losses over the expected life of the Company’s existing loan portfolio. Management estimates the ACL balance using relevant available information about the collectability of cash flows, from internal and external sources, including historical information relating to past events, current conditions, and reasonable and supportable forecasts of future economic conditions. When the Company is unable to forecast future economic events, management may revert to historical information.

The Company's methodologies incorporate a one-year reasonable and supportable forecast period with a one-year straight line reversion to the long-term historical average.

The ACL methodology may also consider other adjustments to address changes in conditions, trends, and circumstances such as local industry changes that could have a significant impact on the risk profile of the loan portfolio and provide for adjustments that may not be reflected and/or captured in the historical loss data. These factors include: lending policies, imprecision in forecasting future economic conditions, loan profile, lending staff, problem loan trends, loan review, collateral, credit concentration, or other internal and external factors.

The Company also includes qualitative adjustments to the allowance based on factors and considerations that have not otherwise been fully accounted for. Qualitative adjustments include, but are not limited to:

•Changes in lending policies and procedures, including changes in underwriting standards and collections, charge-offs and recovery practices

•Changes in international, national, regional and local conditions

•Changes in the nature and volume of the portfolio and terms of loans

•Changes in the experience, depth and ability of lending management

•Changes in the volume and severity of past due loans and other similar conditions

•Changes in the quality of the organization’s loan review system

•Changes in the value of underlying collateral for collateral dependent loans

•The existence and effect of any concentrations of credit and changes in the levels of such concentrations

•The effect of other external factors (i.e. competition, legal and regulatory requirements) on the level of estimated credit losses

The ACL is measured on a collective or pool basis when similar risk characteristics exist. The Company segments its portfolio generally by Federal Financial Institutions Examination Council ("FFIEC") Call Report codes that align with its lines of business. Additional sub-segmentation may be utilized to identify groups of loans with unique risk characteristics relative to the rest of the portfolio.

18

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Loans that do not share similar risk characteristics are evaluated on an individual basis. These evaluations are typically performed on loans with a deteriorated internal risk rating. The allowance for credit loss is determined based on several methods, including estimating the fair value of the underlying collateral or the present value of expected cash flows.

The Company relies on a third-party platform that offers multiple methodologies to measure historical life-of-loan losses.

Modified Loans to Borrowers Experiencing Financial Difficulty

The Company may make modifications to certain loans in order to alleviate temporary difficulties in the borrower’s financial condition and/or constraints on the borrower’s ability to repay the loan, and to minimize potential losses to the Company. Modifications may include changes in the amortization terms of the loan, reductions in interest rates, acceptance of interest only payments, and/or reductions to the outstanding loan balance. Such loans are typically placed on nonaccrual status when there is doubt concerning the full repayment of principal and interest or the loan has been delinquent for a period of 90 days or more. These loans may be returned to accrual status when all contractual amounts past due have been brought current, and the borrower’s performance under the modified terms of the loan agreement and the ultimate collectability of all contractual amounts due under the modified terms is no longer in doubt. The Company typically measures the ACL on modified loans to borrowers experiencing financial difficulty on an individual basis when the loans are deemed to no longer share risk characteristics that are similar with other loans in the portfolio. The determination of the ACL for these loans is based on a discounted cash flow approach for both those measured collectively and individually, unless the loan is deemed collateral dependent, which requires measurement of the ACL based on the estimated expected fair value of the underlying collateral, less costs to sell. GAAP requires the Company to make certain disclosures related to these loans, including certain types of modifications, as well as how such loans have performed since their modifications.

Provision for Credit Losses

 

A provision for estimated losses on loans is charged to income based upon management’s evaluation of the potential losses. Such an evaluation, which includes a review of all loans for which full repayment may not be reasonably assured, considers, among other matters, the estimated net realizable value of the underlying collateral, as applicable, economic conditions, loan loss experience, and other factors that are particularly susceptible to changes that could result in a material adjustment in the near term. While management attempts to use the best information available in making its evaluations, future allowance adjustments may be necessary if economic conditions change substantially from the assumptions used in making the evaluations.

 

Policy for Charging Off Loans

 

The Company’s policy is to charge off a loan at any point in time when it no longer can be considered a bankable asset, meaning collectible within the parameters of policy. A secured loan is generally charged down to the estimated fair value of the collateral, less costs to sell, no later than when it is 120 days past due as to principal or interest. An unsecured loan generally is charged off no later than when it is 180 days past due as to principal or interest. A home improvement loan generally is charged off no later than when it is 90 days past due as to principal or interest.

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The following tables present changes in the balance of the ACL during the three and six months ended June 30, 2023. 

(in thousands)			Three Months Ended June 30, 2023
Allowance for credit losses:			Balance, Beginning of Period												(Credit) Provision Charged to Expense						Losses Charged Off						Recoveries						Balance, End of Period
Commercial and industrial			$	1,437											$	195					$	—					$	217					$	1,849
Owner-occupied commercial real estate			712												77						—						—						789
Investor commercial real estate			1,276												140						—						—						1,416
Construction			1,551												389						—						—						1,940
Single tenant lease financing			10,273												(303)						—						—						9,970
Public finance			1,570												(61)						—						—						1,509
Healthcare finance			3,695												(1,249)						(25)						—						2,421
Small business lending			2,340												1,599						(1,358)						37						2,618
Franchise finance			4,672												143						(331)						—						4,484
Residential mortgage			2,561												(12)						—						1						2,550
Home equity			254												(32)						—						2						224
Other consumer loans			6,538												(133)						(150)						33						6,288
Total			$	36,879											$	753					$	(1,864)					$	290					$	36,058

(in thousands)			Six Months Ended June 30, 2023
Allowance for credit losses:			Balance, Beginning of Period						Adoption of CECL						(Credit) Provision Charged to Expense						Losses Charged Off						Recoveries						Balance, End of Period
Commercial and industrial			$	1,711					$	(120)					$	7,005					$	(6,965)					$	218					$	1,849
Owner-occupied commercial real estate			651						62						76						—						—						789
Investor commercial real estate			1,099						(191)						508						—						—						1,416
Construction			2,074						(435)						301						—						—						1,940
Single tenant lease financing			10,519						(346)						(203)						—						—						9,970
Public finance			1,753						(135)						(109)						—						—						1,509
Healthcare finance			2,997						1,034						(1,585)						(25)						—						2,421
Small business lending			2,168						334						1,493						(1,417)						40						2,618
Franchise finance			3,988						(313)						1,140						(331)						—						4,484
Residential mortgage			1,559						406						582						—						3						2,550
Home equity			69						133						19						—						3						224
Other consumer loans			3,149						2,533						899						(383)						90						6,288
Total			$	31,737					$	2,962					$	10,126					$	(9,121)					$	354					$	36,058

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Prior to the adoption of ASU 2016-13 on January 1, 2023, the Company calculated the allowance for loan losses using the incurred loss methodology. The following table presents the activity in the allowance for loan losses by segment for the three and six months ended June 30, 2022.

(in thousands)			Three Months Ended June 30, 2022
Allowance for loan losses:			Balance, Beginning of Period						(Credit) Provision Charged to Expense						Losses Charged Off						Recoveries						Balance, End of Period
Commercial and industrial			$	1,979					$	47					$	—					$	—					$	2,026
Owner-occupied commercial real estate			626						77						—						—						703
Investor commercial real estate			405						216						—						—						621
Construction			1,766						(59)						—						—						1,707
Single tenant lease financing			9,971						(259)						—						—						9,712
Public finance			1,783						67						—						—						1,850
Healthcare finance			5,510						(748)						—						—						4,762
Small business lending			1,435						519						—						2						1,956
Franchise finance			1,437						844						—						—						2,281
Residential mortgage			731						406						—						1						1,138
Home equity			65						(145)						—						134						54
Other consumer loans			2,189						202						(128)						80						2,343
Tax refund advance loans			354						18						(372)						—						—
Total			$	28,251					$	1,185					$	(500)					$	217					$	29,153

(in thousands)			Six Months Ended June 30, 2022
Allowance for loan losses:			Balance, Beginning of Period						(Credit) Provision Charged to Expense						Losses Charged Off						Recoveries						Balance, End of Period
Commercial and industrial			$	1,891					$	135					$	—					$	—					$	2,026
Owner-occupied commercial real estate			742						(39)						—						—						703
Investor commercial real estate			328						293						—						—						621
Construction			1,612						95						—						—						1,707
Single tenant lease financing			10,385						(1,904)						—						1,231						9,712
Public finance			1,776						74						—						—						1,850
Healthcare finance			5,940						(1,178)						—						—						4,762
Small business lending			1,387						630						(80)						19						1,956
Franchise finance			1,083						1,198						—						—						2,281
Residential mortgage			643						493						—						2						1,138
Home equity			64						(146)						—						136						54
Other consumer loans			1,990						465						(291)						179						2,343
Tax refund advance loans			—						1,860						(1,860)						—						—
Total			$	27,841					$	1,976					$	(2,231)					$	1,567					$	29,153

In addition to the ACL, the Company established a reserve for off-balance sheet commitments, classified in other liabilities, as required by the adoption of the CECL methodology for measuring credit losses. This reserve is maintained at a level management believes to be sufficient to absorb losses arising from unfunded loan commitments. The day one entry for off-balance sheet commitments resulted in a reserve of $2.5 million. The adequacy of the reserve for unfunded commitments is determined quarterly based on methodology similar to the methodology for determining the ACL. The following table details activity in the provision for credit losses on off-balance sheet commitments for the three months ended June 30, 2023.

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(dollars in thousands)						Balance March 31, 2023												Provision for credit losses						Balance June 30, 2023
Off-balance sheet commitments
Commercial loans
Commercial and industrial						$	149											$	39					$	188
Owner-occupied commercial real estate						8												—						8
Investor commercial real estate						48												(28)						20
Construction						2,154												743						2,897
Healthcare finance						2												(2)						—
Small business lending						—												242						242
Total commercial loans						2,361												994						3,355
Consumer loans
Residential mortgage						113												(54)						59
Home equity						62												1						63
Other consumer						10												4						14
Total consumer loans						185												(49)						136
Total allowance for off-balance sheet commitments						$	2,546											$	945					$	3,491

The following table details activity in the provision for credit losses on off-balance sheet commitments for the six months ended June 30, 2023.

(dollars in thousands)						Pre-ASC 326 Adoption						Impact of ASC 326 Adoption						Provision for credit losses						Balance June 30, 2023
Off-balance sheet commitments
Commercial loans
Commercial and industrial						$	—					$	110					$	78					$	188
Owner-occupied commercial real estate						—						—						8						8
Investor commercial real estate						—						9						11						20
Construction						—						2,193						704						2,897
Healthcare finance						—						2						(2)						—
Small business lending						—						—						242						242
Total commercial loans						—						2,314						1,041						3,355
Consumer loans
Residential mortgage						—						127						(68)						59
Home equity						—						52						11						63
Other consumer						—						11						3						14
Total consumer loans						—						190						(54)						136
Total allowance for off-balance sheet commitments						$	—					$	2,504					$	987					$	3,491

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The following table presents the recorded investment in loans based on portfolio segment and impairment method as of December 31, 2022. 

(in thousands)			Loans																		Allowance for Loan Losses
December 31, 2022			Ending Balance:   Collectively Evaluated for Impairment						Ending Balance:   Individually Evaluated for Impairment						Ending Balance						Ending Balance:   Collectively Evaluated for Impairment						Ending Balance:   Individually Evaluated for Impairment						Ending Balance
Commercial and industrial			$	116,307					$	9,801					$	126,108					$	1,660					$	51					$	1,711
Owner-occupied commercial real estate			60,266						1,570						61,836						651						—						651
Investor commercial real estate			93,121						—						93,121						1,099						—						1,099
Construction			181,966						—						181,966						2,074						—						2,074
Single tenant lease financing			939,240						—						939,240						10,519						—						10,519
Public finance			621,032						—						621,032						1,753						—						1,753
Healthcare finance			272,461						—						272,461						2,997						—						2,997
Small business lending1			113,699						10,051						123,750						1,465						703						2,168
Franchise finance			299,835						—						299,835						3,988						—						3,988
Residential mortgage			380,272						3,676						383,948						1,559						—						1,559
Home equity			24,683						29						24,712						69						—						69
Other consumer			324,581						17						324,598						3,149						—						3,149
Total			$	3,427,463					$	25,144					$	3,452,607					$	30,983					$	754					$	31,737

1 Balance is partially guaranteed by the U.S. government.

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The Company utilizes a risk grading matrix to assign a risk grade to each of its commercial loans. A description of the general characteristics of the risk grades is as follows:

 

•“Pass” - Higher quality loans that do not fit any of the other categories described below.

•“Special Mention” - Loans that possess some credit deficiency or potential weakness, which deserve close attention.

•“Substandard” - Loans that possess a defined weakness or weaknesses that jeopardize the liquidation of the debt. Loans characterized by the distinct possibility that the institution will sustain some loss if the deficiencies are not corrected. Loans that are inadequately protected by the current net worth and paying capacity of the obligor or of the collateral pledged, if any.

•“Doubtful” - Such loans have been placed on nonaccrual status and may be heavily dependent upon collateral possessing a value that is difficult to determine or based upon some near-term event that lacks clear certainty. These loans have all of the weaknesses of those classified as Substandard; however, based on existing conditions, these weaknesses make full collection of the principal balance highly improbable.

•“Loss” - Loans that are considered uncollectible and of such little value that continuing to carry them as assets is not warranted.

The Company does not risk grade its consumer loans. It classifies them as either performing or nonperforming. Below is a description of those classifications:

•“Performing” - Loans that are accruing and full collection of principal and interest is expected.

•“Nonperforming” - Loans that are 90 days delinquent or for which the full collection of principal and interest may be in doubt.

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The following tables present the credit risk profile of the Company’s commercial and consumer loan portfolios by loan class and by year of origination for the years indicated based on rating category and payment activity as of June 30, 2023. 

			June 30, 2023
			Term Loans (amortized cost basis by origination year)																																				Revolving loans amortized cost basis			Revolving loans converted to term
(in thousands)			2023						2022						2021						2020						2019						Prior															Total
Commercial and industrial
Pass			$	9,599					$	32,980					$	15,583					$	2,582					$	12,672					$	9,598					$	28,056		$	—					$	111,070
Special Mention			—						34						890						—						—						—						429			—						1,353
Substandard			—						—						—						—						—						—						—			—						—
Doubtful			—						—						—						—						—						—						—			—						—
Total Commercial and      industrial			9,599						33,014						16,473			—			2,582						12,672						9,598						28,485			—						112,423
Gross charge-offs			—						—						6,914						—						51						—						—			—						6,965
Owner-occupied commercial real estate
Pass			409						11,404						9,140						6,697						5,867						13,217						—			—						46,734
Special Mention			827						—						—						8,511						—						2,087						—			—						11,425
Substandard			—						—						—						—						—						1,405						—			—						1,405
Doubtful			—						—						—						—						—						—						—			—						—
Total owner-occupied      commercial real estate			1,236						11,404						9,140						15,208						5,867						16,709						—			—						59,564
Investor commercial real estate
Pass			4,953						35,893						24,569						9,989						48,312						5,945						—			—						129,661
Special Mention			—						—						—						—						—						7,843						—			—						7,843
Substandard			—						—						—						—						—						—						—			—						—
Doubtful			—						—						—						—						—						—						—			—						—
Total investor commercial real      estate			4,953						35,893						24,569						9,989						48,312						13,788						—			—						137,504
Construction
Pass			2,086						104,985						41,960						38,589						—						815						3,372			—						191,807
Special Mention			—						—						646						—						—						—						—			—						646
Substandard			—						—						—						—						—						—						—			—						—
Doubtful			—						—						—						—						—						—						—			—						—
Total construction			2,086						104,985						42,606						38,589						—						815						3,372			—						192,453
Single tenant lease financing
Pass			36,534						228,614						97,500						70,880						146,126						365,317						—			—						944,971
Special Mention			—						—						—						—						—						2,495						—			—						2,495
Substandard			—						—						—						—						—						—						—			—						—
Doubtful			—						—						—						—						—						—						—			—						—
Total single tenant lease      financing			36,534						228,614						97,500						70,880						146,126						367,812						—			—						947,466
Public finance
Pass			2,396						54,105						31,950						7,640						46,505						430,665						—			—						573,261
Special Mention			—						—						—						—						—						2,280						—			—						2,280
Substandard			—						—						—						—						—						—						—			—						—
Doubtful			—						—						—						—						—						—						—			—						—
Total public finance			2,396						54,105						31,950						7,640						46,505						432,945						—			—						575,541

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			June 30, 2023
			Term Loans (amortized cost basis by origination year)																																				Revolving loans amortized cost basis			Revolving loans converted to term
(in thousands)			2023						2022						2021						2020						2019						Prior															Total
Healthcare finance
Pass			—						—						10,908						137,660						69,275						25,942						—			—						243,785
Special Mention			—						—						—						—						1,287						—						—			—						1,287
Substandard			—						—						—						—						—						—						—			—						—
Doubtful			—						—						—						—						—						—						—			—						—
Total healthcare finance			—						—						10,908						137,660						70,562						25,942						—			—						245,072
Gross charge-offs			—						—						—						—						25						—						—			—						25
Small business lending 1
Pass			60,406						47,213						16,579						15,227						4,890						13,885						3,540			—						161,740
Special Mention			—						1,223						123						1,361						1,108						1,098						399			—						5,312
Substandard			—						780						28						1,697						793						56						144			—						3,498
Doubtful			—						—						—						—						—						—						—			—						—
Total small business lending			60,406						49,216						16,730						18,285						6,791						15,039						4,083			—						170,550
Gross charge-offs			—						—						60						1,358						—						—						—			—						1,418
Franchise finance
Pass			103,670						224,752						61,755						—						—						—						—			—						390,177
Special Mention			—						—						302						—						—						—						—			—						302
Substandard			—						—						—						—						—						—						—			—						—
Doubtful			—						—						—						—						—						—						—			—						—
Total franchise finance			103,670						224,752						62,057						—						—						—						—			—						390,479
Gross charge-offs			—						331						—						—						—						—						—			—						331
Consumer loans
Residential mortgage
Payment performance
Performing			8,966						192,725						97,832						33,590						12,224						49,825						—			—						395,162
Nonperforming			—						235						—						74						—						683						—			—						992
Total residential mortgage			8,966						192,960						97,832						33,664						12,224						50,508						—			—						396,154
Home equity
Payment performance
Performing			1,413						2,372						360						487						176						631						17,639			1,297						24,375
Nonperforming			—						—						—						—						—						—						—			—						—
Total home equity			1,413						2,372						360						487						176						631						17,639			1,297						24,375
Other consumer
Payment performance
Performing			60,418						115,827						46,881						29,747						30,286						68,085						779			—						352,023
Nonperforming			—						63						—						6						18						15						—			—						102
Total other consumer			60,418						115,889						46,881						29,753						30,304						68,100						779			—						352,124
Gross charge-offs			58						50						19						12						107						136						—			—						382
Total Loans			$	291,677					$	1,053,204					$	457,006					$	364,737					$	379,539					$	1,001,887					$	54,358		$	1,297					$	3,603,705
Total gross charge-offs			$	58					$	381					$	6,993					$	1,370					$	183					$	136					$	—		$	—					$	9,121

1 Balance in “Substandard” is partially guaranteed by the U.S. government.

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The following tables present the credit risk profile of the Company’s commercial and consumer loan portfolios based on rating category and payment activity as of December 31, 2022. 

			December 31, 2022
(in thousands)			Pass						Special Mention						Substandard																		Total
Commercial and industrial			$	114,934					1,373						$	9,801																	$	126,108
Owner-occupied commercial real estate			50,721						9,546						1,569																		61,836
Investor commercial real estate			93,121						—						—																		93,121
Construction			180,768						1,198						—																		181,966
Single tenant lease financing			936,207						3,033						—																		939,240
Public finance			618,752						2,280						—																		621,032
Healthcare finance			271,085						1,376						—																		272,461
Small business lending 1			107,885						5,814						10,051																		123,750
Franchise finance			299,241						594						—																		299,835
Total loans			$	2,672,714					$	25,214					$	21,421																	$	2,719,349

1 Balance in “Substandard” is partially guaranteed by the U.S. government.

			December 31, 2022
(in thousands)			Performing						Nonaccrual						Total
Residential mortgage			$	382,900					$	1,048					$	383,948
Home equity			24,712						—						24,712
Other consumer			324,581						17						324,598
Total consumer loans			$	732,193					$	1,065					$	733,258

The following tables present the Company’s loan portfolio delinquency analysis as of June 30, 2023 and December 31, 2022. 

						June 30, 2023
(in thousands)						30-59 Days Past Due						60-89 Days Past Due						90 Days  or More Past Due						Total  Past Due						Current						Total Loans
Commercial and industrial						$	20					$	—					$	—					$	20					$	112,403					$	112,423
Owner-occupied commercial real estate						—						—						—						—						59,564						59,564
Investor commercial real estate						—						—						—						—						137,504						137,504
Construction						—						—						—						—						192,453						192,453
Single tenant lease financing						—						—						—						—						947,466						947,466
Public finance						—						—						—						—						575,541						575,541
Healthcare finance						—						—						—						—						245,072						245,072
Small business lending1						270						28						1,677						1,975						168,575						170,550
Franchise finance						—						—						—						—						390,479						390,479
Residential mortgage						705						291						235						1,231						394,923						396,154
Home equity						—						—						—						—						24,375						24,375
Other consumer						114						39						17						170						351,954						352,124
Total						$	1,109					$	358					$	1,929					$	3,396					$	3,600,309					$	3,603,705

1 Balance is partially guaranteed by the U.S. government.

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						December 31, 2022
(in thousands)						30-59 Days Past Due						60-89 Days Past Due						90 Days  or More Past Due						Total  Past Due						Current						Total Loans
Commercial and industrial						$	81					$	—					$	51					$	132					$	125,976					$	126,108
Owner-occupied commercial real estate						—						—						—						—						61,836						61,836
Investor commercial real estate						—						—						—						—						93,121						93,121
Construction						—						1,198						—						1,198						180,768						181,966
Single tenant lease financing						—						—						—						—						939,240						939,240
Public finance						—						—						—						—						621,032						621,032
Healthcare finance						—						—						—						—						272,461						272,461
Small business lending1						57						—						3,485						3,542						120,208						123,750
Franchise Finance						313						—						—						313						299,522						299,835
Residential mortgage						—						283						185						468						383,480						383,948
Home equity						—						—						—						—						24,712						24,712
Other consumer						91						10						—						101						324,497						324,598
Total						$	542					$	1,491					$	3,721					$	5,754					$	3,446,853					$	3,452,607

1 Balance is partially guaranteed by the U.S. government.

Loans are reclassified to a non-accruing status when, in management’s judgment, the collateral value and financial condition of the borrower do not justify accruing interest. At the time the accrual is discontinued, all unpaid accrued interest is reversed against earnings. Interest income accrued in prior years, if any, is charged to the allowance for credit losses. Payments subsequently received on nonaccrual loans are applied to principal. A loan is returned to accrual status when principal and interest are no longer past due and collectability is probable, typically after a minimum of six consecutive months of performance.

The following table summarizes the Company’s nonaccrual loans and loans past due 90 days or more and still accruing by loan class for the periods indicated:

						June 30, 2023																		December 31, 2022
(in thousands)						Nonaccrual Loans						Nonaccrual Loans with no Allowance for Credit Losses						Total Loans 90 Days or More Past Due and Accruing						Nonaccrual Loans						Nonaccrual Loans with no Allowance for Loan Losses						Total Loans 90 Days or More Past Due and Accruing
Commercial and industrial						$	—					$	—					$	—					$	51					$	—					$	—
Owner-occupied commercial real estate						1,405						1,405						—						1,570						1,570						—
Small business lending1						3,729						2,205						—						4,764						2,766						—
Residential mortgage						992						992						—						1,048						1,048						79
Other consumer						101						101						—						17						17						—
Total loans						$	6,227					$	4,703					$	—					$	7,450					$	5,401					$	79

1 Balance is partially guaranteed by the U.S. government.

There was $69 thousand and $78 thousand in interest income recognized on nonaccrual loans for the six months ended June 30, 2023 and June 30, 2022, respectively.

Determining fair value for collateral dependent loans requires obtaining a current independent appraisal of the collateral and applying a discount factor, which includes selling costs if applicable, to the value. The fair value of real estate is generally based on appraisals by qualified licensed appraisers. The appraisers typically determine the value of the real estate by utilizing an income or market valuation approach. If an appraisal is not available, the fair value may be determined by using a cash flow analysis. Fair value on other collateral such as business assets is typically ascertained by assessing, either singularly or some combination of, asset appraisals, accounts receivable aging reports, inventory listings and/or customer financial statements. Both appraised values and values based on borrower’s financial information are discounted as considered appropriate based on age and quality of the information and current market conditions.

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The following table presents the amortized cost basis of collateral dependent loans, which are individually evaluated to determine expected credit losses as of June 30, 2023,

						June 30, 2023
(in thousands)						Commercial Real Estate						Residential Real Estate						Other						Total						Allowance on Collateral Dependent Loans
Commercial and industrial						$	—					$	—					$	—					$	—					$	—
Owner-occupied commercial real estate						—						—						1,406						1,406						—
Small business lending1						1,598						1,626						398						3,622						633
Residential mortgage						—						992						—						992						—
Other consumer loans						—						—						101						101						—
Total loans						$	1,598					$	2,618					$	1,905					$	6,121					$	633

1 Balance is partially guaranteed by the U.S. government.

The following table presents the Company’s impaired loans as of December 31, 2022.

						December 31, 2022
(in thousands)						Recorded Balance						Unpaid Principal Balance						Specific Allowance
Loans without a specific valuation allowance
Commercial and industrial						$	9,750					$	9,750					$	—
Owner-occupied commercial real estate						1,570						1,779						—
Small business lending						8,184						8,705						—
Residential mortgage						3,676						3,835						—
Home equity						29						29						—
Other consumer loans						17						36						—
Total						23,226						24,134						—
Loans with a specific valuation allowance
Commercial and industrial						51						51						51
Small business lending 1						1,867						1,867						703
Total						1,918						1,918						754
Total impaired loans						$	25,144					$	26,052					$	754

1 Balance is partially guaranteed by the U.S. government.

The table below presents average balances and interest income recognized for impaired loans during the three and six months ended June 30, 2022.

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						Three Months Ended												Six Months Ended
						June 30, 2022												June 30, 2022
(in thousands)						Average Balance						Interest Income						Average Balance						Interest Income
Loans without a specific valuation allowance
Owner-occupied commercial real estate						$	2,461					$	—					$	2,884					$	—
Small business lending						867						—						848						—
Residential mortgage						3,667						25						3,470						33
Home equity						15						—						14						—
Other consumer loans						9						—						9						—
Total						7,019						25						7,225						33
Loans with a specific valuation allowance
Commercial and industrial						$	390					$	—					508						—
Single tenant lease financing						546						—						820						—
Healthcare finance						901						28						909						45
Small business lending						1,674						—						1,504						—
Total						3,511						28						3,741						45
Total impaired loans						$	10,530					$	53					$	10,966					$	78

1 Balance is partially guaranteed by the U.S. government.

The Company had $0.1 million in other real estate owned (“OREO”) as of June 30, 2023, which consisted of one residential mortgage property. The Company did not have any OREO as of December 31, 2022. There were two loans totaling $0.4 million and one loan totaling $0.1 million in the process of foreclosure at June 30, 2023 and December 31, 2022, respectively.

Loan Modifications to Borrowers Experiencing Financial Difficulty

 

In January 2023, the Company adopted ASU 2022-02, “Financial Instruments - Credit Losses (Topic 326): Troubled Debt restructurings and Vintage Disclosures” (“ASU 2022-02”), which eliminated the accounting guidance for troubled debt restructurings (“TDRs”) while enhancing disclosure requirements for certain loan refinancing and restructurings by creditors when a borrower is experiencing financial difficulty. This guidance was applied on a prospective basis. Upon adoption of this guidance, the Company no longer establishes a specific reserve for modifications to borrowers experiencing financial difficulty. Instead, these modifications are included in their respective loan pool and a historical loss rate is applied to the current loan balance to arrive at the quantitative baseline portion of the ACL.

Modifications to borrowers experiencing financial difficulty may include interest rate reductions, principal or interest forgiveness, forbearances, term extensions and other actions intended to minimize loss and to avoid foreclosure or repossession of collateral. The Company did not have any loan modifications made to borrowers experiencing financial difficulty during the three and six months ended June 30, 2023.

There were no loans classified as new TDRs during the three months ended June 30, 2022. There was one portfolio residential mortgage loan classified as a new TDR during the six months ended June 30, 2022 with a pre-modification and post-modification outstanding recorded investment of $0.7 million. The Company did not allocate a specific allowance for that loan as of June 30, 2022. The modifications consisted of interest-only payments for a period of time. There were no performing TDRs that had payment defaults within the twelve months following modification during the three and six months ended June 30, 2022, respectively.

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Note 5:        Premises and Equipment

 

The following table summarizes premises and equipment at June 30, 2023 and December 31, 2022.

(in thousands)						June 30, 2023						December 31, 2022
Land						$	5,598					$	5,598
Construction in process						81						714
Right of use leased asset						114						206
Building and improvements						60,524						57,505
Furniture and equipment						19,921						19,585
Less: accumulated depreciation						(12,713)						(10,897)
Total						$	73,525					$	72,711

  

Note 6:        Goodwill        

 

As of June 30, 2023 and December 31, 2022, the carrying amount of goodwill was $4.7 million. There have been no changes in the carrying amount of goodwill for the three and six months ended June 30, 2023 or June 30, 2022. Goodwill is assessed for impairment annually as of August 31, or more frequently if events occur or circumstances change that indicate an impairment may exist. When assessing goodwill for impairment, first, a qualitative assessment can be made to determine whether it is more likely than not that the estimated fair value of a reporting unit is less than its estimated carrying value. If the results of the qualitative assessment are not conclusive, a quantitative goodwill test is performed. Alternatively, a quantitative goodwill test can be performed without performing a qualitative assessment.

In March 2023, the closure of two large regional banks resulted in market volatility and a significant decline in regional bank stock prices, including our stock price. This triggering event indicated that goodwill may be impaired and resulted in us performing a goodwill impairment assessment as of May 31, 2023. The estimated fair value of the reporting unit exceeded the net carrying value, and therefore no goodwill impairment existed as of that date.

Note 7:        Servicing Asset

Activity for the servicing asset and the related changes in fair value for the three and six months ended June 2023 and 2022 are shown in the table below.

						Three Months Ended
(in thousands)						June 30, 2023						June 30, 2022
Balance, beginning of period						$	7,312					$	5,249
Additions:
Originated and purchased servicing						1,298						566
Subtractions
Paydowns:						(528)						(353)
Changes in fair value due to changes in valuation inputs or assumptions used in       the valuation model						170						(117)
Loan servicing asset revaluation						$	(358)					$	(470)
Balance, end of period						$	8,252					$	5,345

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						Six Months Ended
(in thousands)						June 30, 2023						June 30, 2022
Balance, beginning of period						$	6,255					$	4,702
Additions:
Originated and purchased servicing						2,410						1,410
Subtractions
Paydowns:						(867)						(609)
Changes in fair value due to changes in valuation inputs or assumptions used in       the valuation model						454						(158)
Loan servicing asset revaluation						$	(413)					$	(767)
Balance, end of period						$	8,252					$	5,345

Loans serviced for others are not included in the condensed consolidated balance sheets. The unpaid principal balances of these loans serviced for others as of June 30, 2023 and December 31, 2022 are shown in the table below.

(in thousands)						June 30, 2023						December 31, 2022
Loan portfolios serviced for:
SBA guaranteed loans						$	397,908					$	318,194
Total						$	397,908					$	318,194

Loan servicing revenue totaled $0.9 million and $1.6 million for the three and six months ended June 30, 2023, respectively, and $0.6 million and $1.2 million for the three and six months ended June 30, 2022, respectively. Loan servicing asset revaluation, which represents the change in fair value of the servicing asset, resulted in a $0.4 million and $0.4 million downward valuation for the three and six months ended June 30, 2023, respectively, and a $0.5 million and $0.8 million downward valuation for the three and six months ended June 30, 2022, respectively.

The fair value of servicing rights is highly sensitive to changes in underlying assumptions. Though fluctuations in prepayment speeds and changes in secondary market premiums generally have the most substantial impact on the fair value of servicing rights, other influencing factors include changing economic conditions, changes to the discount rate assumption and the weighted average life of the servicing portfolio. Measurement of fair value is limited to the conditions existing and the assumptions used as of a particular point in time; however, those assumptions may change over time. Refer to Note 11 - Fair Value of Financial Instruments for further details.

Note 8:        Subordinated Debt

 

In June 2019, the Company issued $37.0 million aggregate principal amount of 6.0% Fixed-to-Floating Rate Subordinated Notes due 2029 (the “2029 Notes”) in a public offering. The 2029 Notes initially bear a fixed interest rate of 6.0% per year to, but excluding, June 30, 2024, and thereafter a floating rate equal to the then-current benchmark rate (initially three-month LIBOR rate) plus 4.11%. All interest on the 2029 Notes is payable quarterly. The 2029 Notes are scheduled to mature on June 30, 2029. The 2029 Notes are unsecured subordinated obligations of the Company and may be repaid, without penalty, on any interest payment date on or after June 30, 2024. The 2029 Notes are intended to qualify as Tier 2 capital under regulatory guidelines.

In October 2020, the Company entered into a term loan in the principal amount of $10.0 million, evidenced by a term note due 2030 (the “2030 Note”). The 2030 Note initially bears a fixed interest rate of 6.0% per year to, but excluding, November 1, 2025 and thereafter at a floating rate equal to the then-current benchmark rate (initially the then current three-month term SOFR plus 5.795%). The 2030 Note is scheduled to mature on November 1, 2030. The 2030 Note is an unsecured subordinated obligation of the Company and may be repaid, without penalty, on any interest payment date on or after November 1, 2025. The 2030 Note is intended to qualify as Tier 2 capital under regulatory guidelines. The Company used the net proceeds from the issuance of the 2030 Note to redeem a subordinated term note that had been entered into in October 2015.

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In August 2021, the Company issued $60.0 million aggregate principal amount of 3.75% Fixed-to-Floating Rate Subordinated Notes due 2031 (the “2031 Notes”) in a private placement. The 2031 Notes initially bear a fixed interest rate of 3.75% per year to, but excluding, September 1, 2026, and thereafter a floating rate equal to the then-current benchmark rate (initially three-month Term SOFR plus 3.11%). The 2031 Notes are scheduled to mature on September 1, 2031. The 2031 Notes are unsecured subordinated obligations of the Company and may be repaid, without penalty, on any interest payment date on or after September 1, 2026. The 2031 Notes are intended to qualify as Tier 2 capital under regulatory guidelines. The Company used a portion of the net proceeds from the issuance of the 2031 Notes to redeem subordinated notes issued by the Company in 2016. Pursuant to the terms of a Registration Rights Agreement between the Company and the initial purchasers of the 2031 Notes, the Company offered to exchange the 2031 Notes for subordinated notes that are registered under the Securities Act of 1933, as amended, and have substantially the same terms as the 2031 Notes. On December 30, 2021, we completed an exchange of $59.3 million principal amount of the unregistered 2031 Notes for registered 2031 Notes in satisfaction of our obligations under the registration rights agreement. Holders of $0.7 million of unregistered 2031 Notes did not participate in the exchange.

The following table presents the principal balance and unamortized debt issuance costs for the 2029 Notes, the 2030 Note, and the 2031 Notes as of June 30, 2023 and December 31, 2022.

			June 30, 2023												December 31, 2022
(in thousands)			Principal						Unamortized Debt Issuance Costs						Principal						Unamortized Debt Issuance Costs
2029 Notes			$	37,000					$	(941)					$	37,000					$	(1,020)
2030 Notes			10,000						(172)						10,000						(184)
2031 Notes			60,000						(1,203)						60,000						(1,264)
Total			$	107,000					$	(2,316)					$	107,000					$	(2,468)

Note 9:        Benefit Plans

 

Employment Agreements

 

The Company is party to certain employment agreements with each of its Chief Executive Officer, President and Chief Operating Officer and Executive Vice President and Chief Financial Officer. The employment agreements each provide for annual base salaries and annual bonuses, if any, as determined from time to time by the Compensation Committee of our Board of Directors. The annual bonuses are to be determined with reference to the achievement of annual performance objectives established by the Compensation Committee. The agreements also provide that each of the Chief Executive Officer, President and Chief Operating Officer and Executive Vice President and Chief Financial Officer, may be awarded additional compensation, benefits, or consideration as the Compensation Committee may determine.

The agreements also provide for the continuation of salary and certain other benefits for a specified period of time upon termination of employment under certain circumstances, including resignation for “good reason,” termination by the Company without “cause” at any time or any termination of employment within twelve months following a “change in control,” along with other specific conditions.

 

2022 Equity Incentive Plan

The First Internet Bancorp 2022 Equity Incentive Plan (the “2022 Plan”) was approved by our Board of Directors and ratified by our shareholders on May 16, 2022. The 2022 Plan permits awards of incentive and non-statutory stock options, stock appreciation rights, restricted stock awards, stock unit awards, performance awards and other stock-based awards. All employees, consultants, and advisors of the Company or any subsidiary, as well as all non-employee directors of the Company, are eligible to receive awards under the 2022 Plan. The 2022 Plan initially authorized the issuance of 400,000 new shares of the Company’s common stock plus all shares of common stock that remained available for future grants under the First Internet Bancorp 2013 Equity Incentive Plan (the “2013 Plan”).

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Award Activity Under 2022 Plan

The Company recorded less than $0.1 million of share-based compensation expense for the three and six months ended June 30, 2023, related to stock-based awards under the 2022 Plan.

The following table summarizes the stock-based award activity under the 2022 Plan for the six months ended June 30, 2023.

			Restricted Stock Units						Weighted-Average Grant Date Fair Value Per Share						Restricted Stock Awards						Weighted-Average Grant Date Fair Value Per Share						Deferred Stock Units						Weighted-Average Grant Date Fair Value Per Share
Unvested at December 31, 2022			—						$	—					3,558						$	36.84					—						$	—
Granted			72,354						24.61						30,030						11.18						—						—
Cancelled/Forfeited			—						—						—						—						—						—
Vested			—						—						(3,558)						36.85						—						—
Unvested at June 30, 2023			72,354						$	24.61					30,030						$	11.18					—						$	—

At June 30, 2023, the total unrecognized compensation cost related to unvested stock-based awards under the 2022 Plan was $2.8 million with a weighted-average expense recognition period of 2.0 years.

2013 Equity Incentive Plan

 

The 2013 Plan authorized the issuance of 750,000 shares of the Company’s common stock in the form of stock-based awards to employees, directors, and other eligible persons. Although outstanding stock-based awards under the 2013 Plan remain in place according to their terms, our authority to grant new awards under the 2013 Plan terminated upon shareholder approval of the 2022 Plan.

Award Activity Under 2013 Plan

The Company recorded less than $0.1 million and $0.5 million of share-based compensation expense for the three and six months ended June 30, 2023, related to stock-based awards under the 2013 Plan. The Company recorded $0.9 million and $1.5 million of share-based compensation expense for the three and six months ended June 30, 2022, related to stock-based awards under the 2013 Plan.

The following table summarizes the stock-based award activity under the 2013 Plan for the six months ended June 30, 2023.

			Restricted Stock Units						Weighted-Average Grant Date Fair Value Per Share						Restricted Stock Awards						Weighted-Average Grant Date Fair Value Per Share						Deferred Stock Units						Weighted-Average Grant Date Fair Value Per Share
Unvested at December 31, 2022			101,734						$	35.93					—						$	—					—						$	—
Granted			—						—						—						—						—						—
Cancelled/Forfeited			(278)						27.56						—						—						—						—
Vested			(35,808)						31.87						—						—						—						—
Unvested at June 30, 2023			65,648						$	38.18					—						$	—					—						$	—

At June 30, 2023, the total unrecognized compensation cost related to unvested stock-based awards under the 2013 Plan was $1.0 million with a weighted-average expense recognition period of 1.4 years.

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Directors Deferred Stock Plan

 

Until January 2014, the Company had a practice of granting awards under a stock compensation plan for members of the Board of Directors (“Directors Deferred Stock Plan”). The Company reserved 180,000 shares of common stock that could have been issued pursuant to the Directors Deferred Stock Plan. The plan provided directors the option to elect to receive up to 100% of their annual retainer in either common stock or deferred stock rights. Deferred stock rights were to be settled in common stock following the end of the deferral period payable on the basis of one share of common stock for each deferred stock right.

 

The following table summarizes the status of deferred stock rights related to the Directors Deferred Stock Plan for the six months ended June 30, 2023.

						Deferred Stock Rights
Outstanding, beginning of period						40,414
Granted						201
Outstanding, end of period						40,615

All deferred stock rights granted during the 2023 period were additional rights issued in lieu of cash dividends payable on outstanding deferred stock rights.

Note 10:        Commitments and Credit Risk

 

In the normal course of business, the Company makes various commitments to extend credit which are not reflected in the accompanying condensed consolidated financial statements. At June 30, 2023 and December 31, 2022, the Company had outstanding loan commitments totaling approximately $544.8 million and $485.4 million, respectively.

Capital Commitments

Capital expenditures were made in connection with the construction of the building where our corporate headquarters is located, along with an attached parking garage. The Company entered into construction-related contracts. As of June 30, 2023, the project was completed at a total cost of $67.2 million. There are no remaining capital commitments left at June 30, 2023.

Note 11:        Fair Value of Financial Instruments

 

ASC Topic 820, Fair Value Measurement, defines fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. ASC Topic 820 also specifies a fair value hierarchy which requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. The standard describes three levels of inputs that may be used to measure fair value:

Level 1    Quoted prices in active markets for identical assets or liabilities

Level 2    Observable inputs other than Level 1 prices, such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities

Level 3    Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities

Following is a description of the valuation methodologies and inputs used for assets measured at fair value on a recurring basis and recognized in the accompanying condensed consolidated balance sheets, as well as the general classification of such assets pursuant to the valuation hierarchy.

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Available-for-Sale Securities

 

Where quoted market prices are available in an active market, securities are classified within Level 1 of the valuation hierarchy. Level 1 securities include highly liquid mutual funds. If quoted market prices are not available, then fair values are estimated by using pricing models, quoted prices of securities with similar characteristics or discounted cash flows.

 

Level 2 securities include U.S. Government-sponsored agencies, municipal securities, mortgage and asset-backed securities and corporate securities. Matrix pricing is a mathematical technique widely used in the banking industry to value investment securities.

 

In certain cases where Level 1 or Level 2 inputs are not available, securities are classified within Level 3 of the hierarchy. Fair values are calculated using discounted cash flows. Discounted cash flows are calculated based off of the anticipated future cash flows updated to incorporate loss severities. Rating agency and industry research reports as well as default and deferral activity are reviewed and incorporated into the calculation. The Company did not own any securities classified within Level 3 of the hierarchy as of June 30, 2023 or December 31, 2022.

Loans Held-for-Sale (mandatory pricing agreements)

The fair value of loans held-for-sale is determined using quoted prices for similar assets, adjusted for specific attributes of that loan (Level 2).

Servicing Asset

Fair value is based on a loan-by-loan basis taking into consideration the origination to maturity dates of the loans, the current age of the loans and the remaining term to maturity. The valuation methodology utilized for the servicing asset begins with generating estimated future cash flows for each servicing asset based on their unique characteristics and market-based assumptions for prepayment speeds and costs to service. The present value of the future cash flows is then calculated utilizing market-based discount rate assumptions (Level 3).

Interest Rate Swap Agreements

The fair values of interest rate swap agreements are estimated using current market interest rates as of the balance sheet date and calculated using discounted cash flows that are observable or that can be corroborated by observable market data (Level 2).

Forward Contracts

The fair values of forward contracts on to-be-announced securities are determined using quoted prices in active markets or benchmarked thereto (Level 1).

 

Interest Rate Lock Commitments

 

The fair values of IRLCs are determined using the projected sale price of individual loans based on changes in market interest rates, projected pull-through rates (the probability that an IRLC will ultimately result in an originated loan), the reduction in the value of the applicant’s option due to the passage of time, and the remaining origination costs to be incurred based on management’s estimate of market costs (Level 3).

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The following tables present the fair value measurements of assets and liabilities recognized in the accompanying condensed consolidated balance sheets measured at fair value on a recurring basis and the level within the fair value hierarchy in which the fair value measurements fall at June 30, 2023 and December 31, 2022.

												June 30, 2023  Fair Value Measurements Using
(in thousands)						Fair Value						Quoted Prices in Active Markets for Identical Assets (Level 1)						Significant Other Observable Inputs (Level 2)						Significant Unobservable Inputs (Level 3)
U.S. Government-sponsored agencies						$	39,474					$	—					$	39,474					$	—
Municipal securities						67,209						—						67,209						—
Agency mortgage-backed securities - residential						204,141						—						204,141						—
Agency mortgage-backed securities - commercial						14,891						—						14,891						—
Private label mortgage-backed securities - residential						13,415						—						13,415						—
Asset-backed securities						1,000						—						1,000						—
Corporate securities						39,264						—						39,264						—
Total available-for-sale securities						$	379,394					$	—					$	379,394					$	—
Servicing asset						8,252						—						—						8,252
Interest rate swap agreements						8,395						—						8,395						—

												December 31, 2022 Fair Value Measurements Using
(in thousands)						Fair Value						Quoted Prices in Active Markets for Identical Assets (Level 1)						Significant Other Observable Inputs (Level 2)						Significant Unobservable Inputs (Level 3)
U.S. Government-sponsored agencies						$	33,809					$	—					$	33,809					$	—
Municipal securities						67,276						—						67,276						—
Agency mortgage-backed securities - residential						215,092						—						215,092						—
Agency mortgage-backed securities - commercial						15,840						—						15,840						—
Private label mortgage-backed securities - residential						10,455						—						10,455						—
Asset-backed securities						4,960						—						4,960						—
Corporate securities						42,952						—						42,952						—
Total available-for-sale securities						$	390,384					$	—					$	390,384					$	—
Loans held-for-sale (mandatory pricing agreements)						9,110						—						9,110						—
Servicing asset						6,255						—						—						6,255
Interest rate swap agreements						8,645						—						8,645						—
Forward contracts						97						97						—						—
IRLCs						133						—						—						133

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The following tables reconcile the beginning and ending balances of recurring fair value measurements recognized in the accompanying condensed consolidated balance sheets using significant unobservable (Level 3) inputs for the three and six months ended June 30, 2023 and 2022.

												Three Months Ended
(in thousands)												Servicing Asset						Interest Rate Lock Commitments
Balance, April 1, 2023												$	7,312					$	—
Total realized gains
Additions:
Originated and purchased servicing												1,298						—
Subtractions:
Paydowns												(528)						—
Change in fair value												170						—
Balance, June 30, 2023												$	8,252					$	—
Balance as of April 1, 2022												$	5,249					$	(88)
Total realized gains
Additions:
Originated and purchased servicing												566						—
Subtractions:
Paydowns												(353)						—
Change in fair value												(117)						550
Balance, June 30, 2022												$	5,345					$	462

												Six Months Ended
(in thousands)												Servicing Asset						Interest Rate Lock Commitments
Balance, January 1, 2023												$	6,255					$	133
Total realized gains
Additions:
Originated and purchased servicing												2,410						—
Subtractions:
Paydowns												(867)						—
Change in fair value												454						(133)
Balance, June 30, 2023												$	8,252					$	—
Balance as of January 1, 2022												$	4,702					$	718
Total realized gains
Additions:
Originated and purchased servicing												1,410						—
Subtractions:
Paydowns												(609)						—
Change in fair value												(158)						(256)
Balance, June 30, 2022												$	5,345					$	462

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The following describes the valuation methodologies and inputs used for assets measured at fair value on a nonrecurring basis, as well as the general classification of such assets pursuant to the valuation hierarchy.

Collateral Dependent Loans

Loans for which it is probable that the Company will not collect all principal and interest due according to contractual terms are measured for impairment. The amount of impairment may be determined based on the fair value of the underlying collateral, less costs to sell, the estimated present value of future cash flows or the loan’s observable market price.

If the impaired loan is identified as collateral dependent, the fair value of the underlying collateral, less costs to sell, is used to measure impairment. This method requires obtaining a current independent appraisal of the collateral and applying a discount factor to the value. If the impaired loan is not collateral dependent, the Company utilizes a discounted cash flow analysis to measure impairment.

Impaired loans with a specific valuation allowance based on the value of the underlying collateral or a discounted cash flow analysis are classified as Level 3 assets.

The following table presents the fair value measurements of assets and liabilities recognized in the accompanying condensed consolidated balance sheets measured at fair value on a nonrecurring basis and the level within the fair value hierarchy in which the fair value measurement falls at June 30, 2023 and December 31, 2022.

												June 30, 2023
(in thousands)												Fair Value Measurements Using
						Fair Value						Quoted Prices in Active Markets for Identical Assets (Level 1)						Significant Other Observable Inputs (Level 2)						Significant Unobservable Inputs (Level 3)
Collateral dependent loans						$	891					$	—					$	—					$	891

												December 31, 2022
(in thousands)												Fair Value Measurements Using
						Fair Value						Quoted Prices in Active Markets for Identical Assets (Level 1)						Significant Other Observable Inputs (Level 2)						Significant Unobservable Inputs (Level 3)
Impaired loans						$	1,164					$	—					$	—					$	1,164

 Significant Unobservable (Level 3) Inputs

 

The following tables present quantitative information about unobservable inputs used in recurring and nonrecurring Level 3 fair value measurements.

(dollars in thousands)

Fair Value at June 30, 2023

Valuation Technique

Significant Unobservable Inputs

Range

Weighted-Average Range

Collateral dependent loans

$

891

Fair value of collateral

Discount for type of property and current market conditions

10% - 25%

21%

Servicing asset

8,252

Discounted cash flow

Prepayment speeds Discount rate

0% - 25% 14%

11.4% 14%

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(dollars in thousands)						Fair Value at December 31, 2022						Valuation Technique						Significant Unobservable Inputs						Range						Weighted-Average Range
Impaired loans						$	1,164					Fair value of collateral						Discount for type of property and current market conditions						0% - 25%						20%
IRLCs						133						Discounted cash flow						Loan closing rates						31% - 100%						89%
Servicing asset						6,255						Discounted cash flow						Prepayment speeds Discount rate						0% - 25% 14%						14.6% 14%

The following methods were used to estimate the fair value of all other financial instruments recognized in the accompanying condensed consolidated balance sheets at amounts other than fair value.

 

Cash and Cash Equivalents

 

For these instruments, the carrying amount is a reasonable estimate of fair value.

 

Securities Held-to-Maturity

 

Where quoted market prices are available in an active market, securities are classified within Level 1 of the valuation hierarchy. Level 1 securities include highly liquid mutual funds. If quoted market prices are not available, then fair values are estimated by using pricing models, quoted prices of securities with similar characteristics or discounted cash flows.

 

Level 2 securities include agency mortgage-backed securities - residential, municipal securities and corporate securities. Matrix pricing is a mathematical technique widely used in the banking industry to value investment securities.

 

In certain cases where Level 1 or Level 2 inputs are not available, securities are classified within Level 3 of the hierarchy. Fair values are calculated using discounted cash flows. Discounted cash flows are calculated based off of the anticipated future cash flows updated to incorporate loss severities. Rating agency and industry research reports as well as default and deferral activity are reviewed and incorporated into the calculation. The Company did not own any securities classified within Level 3 of the hierarchy as of June 30, 2023 or December 31, 2022.

Loans Held-for-Sale (best efforts pricing agreements)

 

The fair value of these loans approximates carrying value.

Loans

 

The fair value of loans is estimated on an exit price basis incorporating discounts for credit, liquidity and marketability factors.

 

Accrued Interest Receivable

 

The fair value of these financial instruments approximates carrying value.

 

Federal Home Loan Bank of Indianapolis Stock

 

The fair value of this financial instrument approximates carrying value.

 

Deposits 

The fair value of noninterest-bearing and interest-bearing demand deposits, savings and money market accounts approximates carrying value. The fair value of fixed maturity certificates of deposit and brokered deposits are estimated using rates currently offered for deposits of similar remaining maturities.

40

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Advances from Federal Home Loan Bank

 

The fair value of fixed rate advances is estimated using rates currently available for advances with similar remaining maturities. The carrying value of variable rate advances approximates fair value.

 

Subordinated Debt

 

The fair value of the Company’s publicly traded subordinated debt is obtained from quoted market prices. The fair value of the Company’s remaining subordinated debt is estimated using discounted cash flow analysis, based on current borrowing rates for similar types of debt instruments.

 Accrued Interest Payable

 

The fair value of these financial instruments approximates carrying value.

Commitments

 

The fair value of commitments to extend credit are based on fees currently charged to enter into similar agreements with similar maturities and interest rates. The Company determined that the fair value of commitments was zero based on the contractual value of outstanding commitments at each of June 30, 2023 and December 31, 2022.

  

The following tables present the carrying value and estimated fair value of all financial assets and liabilities that are not measured at fair value on a recurring basis at June 30, 2023 and December 31, 2022.

						June 30, 2023 Fair Value Measurements Using
(in thousands)						Carrying Amount						Fair Value						Quoted Prices In Active Market for Identical Assets (Level 1)						Significant Other Observable Inputs (Level 2)						Significant Unobservable Inputs (Level 3)
Cash and cash equivalents						$	465,631					$	465,631					$	465,631					$	—					$	—
Securities held-to-maturity, net						230,605						208,643						—						208,643						—
Loans held-for-sale (best efforts pricing agreements)						32,001						32,001						—						32,001						—
Net loans						3,610,774						3,409,661						—						—						3,409,661
Accrued interest receivable						24,101						24,101						24,101						—						—
Federal Home Loan Bank of Indianapolis stock						28,350						28,350						—						28,350						—
Deposits						3,854,308						3,838,133						1,779,148						—						2,058,985
Advances from Federal Home Loan Bank						614,931						598,932						—						598,932						—
Subordinated debt						104,684						99,700						29,600						70,100						—
Accrued interest payable						3,338						3,338						3,338						—						—

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						December 31, 2022 Fair Value Measurements Using
(in thousands)						Carrying Amount						Fair Value						Quoted Prices In Active Market for Identical Assets (Level 1)						Significant Other Observable Inputs (Level 2)						Significant Unobservable Inputs (Level 3)
Cash and cash equivalents						$	256,552					$	256,552					$	256,552					$	—					$	—
Securities held-to-maturity						189,168						168,483						—						168,483						—
Loans held-for-sale (best efforts pricing agreements)						12,401						12,401						—						12,401						—
Net loans						3,467,664						3,225,845						—						—						3,225,845
Accrued interest receivable						21,069						21,069						21,069						—						—
Federal Home Loan Bank of Indianapolis stock						28,350						28,350						—						28,350						—
Deposits						3,441,245						3,415,390						1,974,344						—						1,441,046
Advances from Federal Home Loan Bank						614,928						596,455						—						596,455						—
Subordinated debt						104,532						102,669						32,560						70,109						—
Accrued interest payable						2,913						2,913						2,913						—						—

 

Note 12:        Mortgage Banking Activities

The Bank’s residential real estate lending business originated mortgage loans for customers and typically sold a majority of the originated loans into the secondary market. For most of the mortgages sold in the secondary market, the Bank hedged its mortgage banking pipeline by entering into forward contracts for the future delivery of mortgage loans to third party investors and entering into IRLCs with potential borrowers to fund specific mortgage loans that would be sold into the secondary market. To facilitate the hedging of the loans, the Bank elected the fair value option for loans originated and intended for sale in the secondary market under mandatory pricing agreements. Changes in the fair value of loans held-for-sale, IRLCs and forward contracts are recorded in the mortgage banking activities line item within noninterest income. Refer to Note 13 for further information on derivative financial instruments. 

During the three months ended June 30, 2023, the Company originated no mortgage loans held-for-sale and sold $3.1 million of mortgage loans into the secondary market. During the three months ended June 30, 2022, the Company originated $105.9 million of mortgage loans held-for-sale and sold $107.9 million of mortgage loans into the secondary market. During the six months ended June 30, 2023 and 2022, the Company originated mortgage loans held-for-sale of $36.3 million and $258.2 million, respectively, and sold $46.5 million and $270.3 million of mortgage loans, respectively, into the secondary market.

The following table presents the components of income from mortgage banking activities for the three and six months ended June 30, 2023 and 2022.

			Three Months Ended June 30,												Six Months Ended June 30,
(in thousands)			2023						2022						2023						2022
Gain on loans sold			$	—					$	1,878					$	471					$	3,940
Gain (loss) resulting from the change in fair value of loans held-for-sale			—						340						(143)						(149)
Loss resulting from the change in fair value of derivatives			—						(508)						(252)						(208)
Net revenue from mortgage banking activities			$	—					$	1,710					$	76					$	3,583

Fluctuations in interest rates and changes in IRLC and loan volume within the mortgage banking pipeline may cause volatility in the fair value of loans held-for-sale and the fair value of derivatives used to hedge the mortgage banking pipeline.

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Note 13:        Derivative Financial Instruments

 

The Company uses derivative financial instruments to help manage exposure to interest rate risk and the effects that changes in interest rates may have on net income and the fair value of assets and liabilities. The Company enters into interest rate swap agreements as part of its asset/liability management strategy to help manage its interest rate risk position. Additionally, the Company entered into forward contracts for the future delivery of mortgage loans to third-party investors and entered into IRLCs with potential borrowers to fund specific mortgage loans that were sold into the secondary market. The forward contracts were entered into in order to economically hedge the effect of changes in interest rates resulting from the Company’s commitment to fund the loans.

 

The Company had various interest rate swap agreements designated and qualifying as accounting hedges during the reported periods. Designating an interest rate swap as an accounting hedge allows the Company to recognize gains and losses in the condensed consolidated statements of income within the same period that the hedged item affects earnings. The Company includes the gain or loss on the hedged items in the same line item as the offsetting loss or gain on the related interest rate swaps. For derivative instruments that are designated and qualify as cash flow hedges, any gains or losses related to changes in fair value are recorded in accumulated other comprehensive loss, net of tax. The fair value of interest rate swaps with a positive fair value are reported in accrued income and other assets in the condensed consolidated balance sheets, while interest rate swaps with a negative fair value are reported in accrued expenses and other liabilities in the condensed consolidated balance sheets.

The IRLCs and forward contracts are not designated as accounting hedges and are recorded at fair value with changes in fair value reflected in noninterest income on the condensed consolidated statements of income. The fair value of derivative instruments with a positive fair value are reported in accrued income and other assets in the condensed consolidated balance sheets, while derivative instruments with a negative fair value are reported in accrued expenses and other liabilities in the condensed consolidated balance sheets.

The following table presents amounts that were recorded on the condensed consolidated balance sheets related to cumulative basis adjustments for interest rate swap derivatives designated as fair value accounting hedges as of June 30, 2023 and December 31, 2022.

(in thousands)						Carrying amount of the hedged asset												Cumulative amount of fair value hedging adjustment included in the carrying amount of the hedged assets
Line item in the condensed consolidated balance sheets in which the hedged item is included						June 30, 2023						December 31, 2022						June 30, 2023						December 31, 2022
Securities available-for-sale 1						$	68,935					$	68,963					$	(1,914)					$	(2,088)

1 These amounts include the amortized cost basis of closed portfolios used to designate hedging relationships in which the hedged item is the last layer expected to be remaining at the end of the hedging relationship. The designated hedged items were $50.0 million at both June 30, 2023 and December 31, 2022.

The following tables present a summary of interest rate swap derivatives designated as fair value accounting hedges of fixed-rate receivables used in the Company’s asset/liability management activities at June 30, 2023 and December 31, 2022, identified by the underlying interest rate-sensitive instruments.

(dollars in thousands)   June 30, 2023						Notional Value						Weighted- Average Remaining Maturity (years)												Weighted-Average Ratio
Instruments Associated With																		Fair Value						Receive						Pay
Securities available-for-sale						$	50,000					1.3						$	1,919					3-month LIBOR						2.33		%
Total at June 30, 2023						$	50,000					1.3						$	1,919					3-month LIBOR						2.33		%

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(dollars in thousands) December 31, 2022						Notional Value						Weighted- Average Remaining Maturity (years)												Weighted-Average Ratio
Instruments Associated With																		Fair Value						Receive						Pay
Securities available-for-sale						$	50,000					1.8						$	2,093					3-month LIBOR						2.33		%
Total swap portfolio at December 31, 2022						$	50,000					1.8						$	2,093					3-month LIBOR						2.33		%

In March 2021, the Company terminated the last layer of interest rate swaps associated with available-for-sale agency mortgage-backed securities - residential, which resulted in swap termination payments to counterparties totaling $1.9 million. The corresponding fair value hedging adjustment was allocated pro-rata to the underlying hedged securities and is being amortized over the remaining lives of the designated securities. Amortization expense totaling less than $0.1 million and $0.1 million was recognized as a reduction to interest income on securities for the three and six months ended June 30, 2023 and 2022, respectively.

In June 2020, the Company terminated all fair value hedging relationships associated with loans, which resulted in swap termination payments to counterparties totaling $46.1 million. The corresponding loan fair value hedging adjustment as of the date of termination is being amortized over the remaining lives of the designated loans, which have a weighted average term to maturity of 10.8 years as of June 30, 2023. Amortization expense totaling $1.0 million and $2.0 million for the three and six months ended June 30, 2023, respectively, and $1.1 million and $2.1 million for the three and six months ended June 30 2022 respectively, related to these previously terminated fair value hedges was recognized as a reduction to interest income on loans.

The following tables present a summary of interest rate swap derivatives designated as cash flow accounting hedges of variable-rate liabilities used in the Company’s asset/liability management activities at June 30, 2023 and December 31, 2022.

(dollars in thousands)   June 30, 2023						Notional Value						Weighted- Average Remaining Maturity (years)												Weighted-Average Ratio
Cash Flow Hedges																		Fair Value						Receive						Pay
Interest rate swaps						$	110,000					3.6						$	5,395					3-month LIBOR						2.88		%
Interest rate swaps						60,000						0.1						197						1-month LIBOR						2.88		%
Interest rate swaps						40,000						0.9						884						Fed Funds Effective						2.78		%

(dollars in thousands) December 31, 2022						Notional Value						Weighted- Average Remaining Maturity (years)												Weighted-Average Ratio
Cash Flow Hedges																		Fair Value						Receive						Pay
Interest rate swaps						$	110,000					4.1						$	4,787					3-month LIBOR						2.88		%
Interest rate swaps						60,000						0.6						735						1-month LIBOR						2.88		%
Interest rate swaps						40,000						1.4						1,030						Fed Funds Effective						2.78		%

These derivative financial instruments were entered into for the purpose of managing the interest rate risk of certain assets and liabilities. The Company received $8.3 million and $7.7 million of cash collateral from counterparties as security for their obligations related to these swap transactions at June 30, 2023 and December 31, 2022. The Company had no pledged cash collateral as of June 30, 2023 and December 31, 2022 to counterparties on interest rate swap agreements as security for its obligations related to these agreements. Collateral posted and received is dependent on the market valuation of the underlying hedges.

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The following table presents the notional amount and fair value of interest rate swaps, IRLCs and forward contracts utilized by the Company at June 30, 2023 and December 31, 2022.

						June 30, 2023												December 31, 2022
(in thousands)						Notional Amount						Fair Value						Notional Amount						Fair Value
Asset Derivatives
Derivatives designated as hedging instruments
Interest rate swaps associated with securities available-for-sale						$	50,000					$	1,919					$	50,000					$	2,093
Interest rate swaps associated with liabilities						210,000						6,476						210,000						6,552
Derivatives not designated as hedging instruments
IRLCs						—						—						14,862						133
Forward contracts						—						—						17,000						97
Total contracts						$	260,000					$	8,395					$	291,862					$	8,875

The fair value of interest rate swaps was estimated using a discounted cash flow method that incorporates current market interest rates as of the balance sheet date. Fair values of IRLCs and forward contracts were estimated using changes in mortgage interest rates from the date the Company entered into the IRLC and the balance sheet date.

The following table presents the effects of the Company’s cash flow hedge relationships on the condensed consolidated statements of comprehensive income during the three and six months ended June 30, 2023 and 2022.

						Amount of Gain Recognized in Other Comprehensive Loss in The Three Months Ended																														Amount of (Loss) Gain Recognized in Other Comprehensive Income (Loss) in The Six Months Ended
(in thousands)						June 30, 2023						June 30, 2022																								June 30, 2023						June 30, 2022
Interest rate swap agreements						$	2,094					$	4,944																							$	(76)					$	14,278

The following table summarizes the periodic changes in the fair value of derivatives not designated as hedging instruments on the condensed consolidated statements of income for the three and six months ended June 30, 2023 and 2022.

						Amount of Gain / (Loss) Recognized in the Three Months Ended												Amount of Gain / (Loss) Recognized in the Six Months Ended
(in thousands)						June 30, 2023						June 30, 2022						June 30, 2023						June 30, 2022
Asset Derivatives
Derivatives not designated as hedging instruments
IRLCs						$	—					$	550					$	—					$	—
Forward contracts						—						—						—						43
Liability Derivatives
Derivatives not designated as hedging instruments
IRLCs						$	—					$	—					$	(133)					$	(252)
Forward contracts						—						(1,059)						(119)						—

  

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The following table presents the effects of the Company’s interest rate swap agreements on the condensed consolidated statements of operations during the three and six months ended June 30, 2023 and 2022.

(in thousands) Line item in the condensed consolidated statements of operations						Three Months Ended												Six Months Ended
						June 30, 2023						June 30, 2022						June 30, 2023						June 30, 2022
Interest income
Securities - taxable						$	—					$	—					$	—					$	—
Securities - non-taxable						354						(174)						648						(435)
Total interest income						354						(174)						648						(435)
Interest expense
Deposits						(539)						509						(957)						1,179
Other borrowed funds						(595)						491						(1,117)						1,187
Total interest expense						(1,134)						1,000						(2,074)						2,366
Net interest income						$	1,488					$	(1,174)					$	2,722					$	(2,801)

Note 14:     Accumulated Other Comprehensive Loss

The components of accumulated other comprehensive loss, included in shareholders' equity, for the six months ended June 30, 2023 and 2022, respectively, are presented in the table below.

(in thousands)						Unrealized Losses On Debt Securities						Unrealized Losses On Debt Securities Transferred From Available-For-Sale To Held-To-Maturity						Cash Flow Hedges						Total
Balance, January 1, 2023						$	(35,831)					$	(3,519)					$	5,714					$	(33,636)
Other comprehensive income (loss) before reclassifications from accumulated other comprehensive loss before tax						302						—						(76)						226
Reclassifications from accumulated other comprehensive loss to earnings before tax						—						364						—						364
Other comprehensive gain (loss) before tax						302						364						(76)						590
Income tax provision (benefit)						63						95						(18)						140
Other comprehensive income (loss) - net of tax						239						269						(58)						450
Balance, June 30, 2023						$	(35,592)					$	(3,250)					$	5,656					$	(33,186)
Balance, January 1, 2022						$	(2,555)					$	—					$	(8,484)					$	(11,039)
Other comprehensive (loss) income before reclassifications from accumulated other comprehensive loss before tax						(33,276)						(5,402)						14,278						(24,400)
Reclassifications from accumulated other comprehensive loss to earnings before tax						—						312						—						312
Other comprehensive (loss) gain before tax						(33,276)						(5,090)						14,278						(24,088)
Income tax (benefit) provision						(8,263)						(1,272)						5,158						(4,377)
Other comprehensive (loss) income - net of tax						(25,013)						(3,818)						9,120						(19,711)
Balance, June 30, 2022						$	(27,568)					$	(3,818)					$	636					$	(30,750)

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The components of accumulated other comprehensive loss, included in stockholders' equity, for the three months ended June 30, 2023 and 2022, respectively, are presented in the table below.

(in thousands)						Unrealized Losses On Debt Securities						Unrealized Losses On Debt Securities Transferred From Available-For-Sale To Held-To-Maturity						Cash Flow Hedges						Total
Balance, April 1, 2023						$	(31,889)					$	(3,407)					$	4,043					$	(31,253)
Other comprehensive (loss) income before reclassifications from accumulated other comprehensive loss before tax						(4,810)						—						2,094						(2,716)
Reclassifications from accumulated other comprehensive loss to earnings before tax						—						206						—						206
Other comprehensive (loss) gain before tax						(4,810)						206						2,094						(2,510)
Income tax (benefit) provision						(1,107)						49						481						(577)
Other comprehensive (loss) income - net of tax						(3,703)						157						1,613						(1,933)
Balance, June 30, 2023						$	(35,592)					$	(3,250)					$	5,656					$	(33,186)
Balance, April 1, 2022						$	(16,359)					$	(4,034)					$	(2,468)					$	(22,861)
Other comprehensive (loss) income before reclassifications from accumulated other comprehensive loss before tax						(15,395)						—						4,944						(10,451)
Reclassifications from accumulated other comprehensive loss to earnings before tax						—						193						—						193
Other comprehensive (loss) gain before tax						(15,395)						193						4,944						(10,258)
Income tax (benefit) provision						(4,186)						(23)						1,840						(2,369)
Other comprehensive (loss) income - net of tax						(11,209)						216						3,104						(7,889)
Balance, June 30, 2022						$	(27,568)					$	(3,818)					$	636					$	(30,750)

Details About Accumulated Other Comprehensive Loss Components						Amounts Reclassified from Accumulated Other Comprehensive Loss for the												Amounts Reclassified from Accumulated Other Comprehensive Income (Loss) for the												Affected Line Item in the Statements of Operations
						Three Months Ended June 30, 2023						Three Months Ended June 30, 2022						Six Months Ended June 30, 2023						Six Months Ended June 30, 2022
Reclassifications from accumulated other comprehensive loss to earnings before tax						$	(206)					(193)						$	(364)					$	(312)					Interest income
Total amount reclassified before tax						(206)						(193)						(364)						(312)						Income (loss) before income taxes
Tax benefit						(49)						(44)						(95)						(71)						Income tax (benefit) provision
Total reclassifications from accumulated other comprehensive loss						$	(157)					$	(149)					$	(269)					$	(241)					Net income (loss)

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Note 15:     Recent Accounting Pronouncements

ASU 2016-13 - Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments (June 2016)

The main objective of this update is to provide financial statement users with more decision-useful information about the expected credit losses on financial instruments and other commitments to extend credit held by a reporting entity at each reporting date. To achieve this objective, the amendments in this update replace the incurred loss impairment methodology in current GAAP with a methodology that reflects expected credit losses and requires consideration of a broader range of reasonable and supportable information to inform credit loss estimates.

The amendments affect entities holding financial assets that are not accounted for at fair value through net income. The amendments affect loans, debt securities, off-balance-sheet credit exposures, and any other financial assets not excluded from the scope that have the contractual right to receive cash. The amendments in this update affect an entity to varying degrees depending on the credit quality of the assets held by the entity, their duration, and how the entity applies current GAAP. There is diversity in practice in applying the incurred loss methodology, which means that before transition some entities may be more aligned under current GAAP than others to the new measure of expected credit losses. The following describes the main provisions of this update.

•Assets Measured at Amortized Cost: The amendments in this update require a financial asset (or a group of financial assets) measured at amortized cost basis to be presented at the net amount expected to be collected. The allowance for credit losses is a valuation account that is deducted from the amortized cost basis of the financial asset(s) to present the net carrying value at the amount expected to be collected on the financial asset. The statements of income reflect the measurement of credit losses for newly recognized financial assets, as well as the expected increase or decrease of credit losses that have taken place during the period. The measurement of expected credit losses is based on relevant information about past events, including historical experience, current conditions, and reasonable and supportable forecasts that affect the collectability of the reported amount. An entity must use judgment in determining the relevant information and estimation methods that are appropriate in its circumstances.

•Available-for-Sale Debt Securities: Credit losses relating to available-for-sale debt securities should be recorded through an allowance for credit losses. Available-for-sale accounting recognizes that value may be realized either through collection of contractual cash flows or through sale of the security. Therefore, the amendments limit the amount of the allowance for credit losses to the amount by which fair value is below amortized cost because the classification as available-for-sale is premised on an investment strategy that recognizes that the investment could be sold at fair value if cash collection would result in the realization of an amount less than fair value.

•In May 2019, the FASB issued ASU 2019-05 - Financial Instruments - Credit Losses (Topic 326) - Targeted Transition Relief. This ASU allows an option for preparers to irrevocably elect the fair value option, on an instrument-by-instrument basis, for eligible financial assets measured at amortized cost basis upon adoption of the credit losses standard. This increases the comparability of financial statement information provided by institutions that otherwise would have reported similar financial instruments using different measurement methodologies, potentially decreasing costs for financial statement preparers while providing more useful information to investors and other users.

The Company formed a current expected credit losses (“CECL”) working group that discussed implementation matters related to the completeness and accuracy of historical data, model development and corporate governance documentation. The new allowance model estimates credit losses over the expected life of the portfolio and includes a qualitative framework to account for drivers of losses that the quantitative model does not capture. The CECL working group discussed results from parallel model runs for each portfolio segment, assumptions related to unfunded commitments and economic forecast factors. Model validation was completed by an independent third party in the fourth quarter 2022.

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The ASU allows for several different methods of calculating the Allowance for Credit Losses (“ACL”) and based on its analysis of observable data, the Company determined the discounted cash flow method to be the most appropriate for all its loan segments.

The Company adopted this guidance on January 1, 2023 and recorded a $3.0 million pre-tax one-time cumulative effect adjustment to the ACL in retained earnings on the consolidated balance sheet as of the beginning of 2023, as is required in the guidance. In addition, the Company recorded a one-time $2.5 million pre-tax cumulative effect adjustment to the allowance for unfunded commitments in retained earnings on the consolidated balance sheet.

The qualitative impact of the new accounting standard is directed by many of the same factors that impacted the previous methodology for calculating the ACL, including but not limited to, quality and experience of staff, changes in the value of collateral, concentrations of credit in loan types or industries and changes to lending policies. In addition, the Company also uses reasonable and supportable forecasts. Examples of this are regression analyses of data from the Federal Open Market Committee quarterly economic projections for change in real GDP, housing price index and national unemployment.

The following table presents the impact of the adoption of ASC 326 as of January 1, 2023:

						January 1, 2023
(dollars in thousands)						Pre-ASC 326 Adoption						Impact of ASC 326 Adoption						As Reported Under ASC 326
Assets:
Commercial loans
Commercial and industrial						$	1,711					$	(120)					$	1,591
Owner-occupied commercial real estate						651						62						713
Investor commercial real estate						1,099						(191)						908
Construction						2,074						(435)						1,639
Single tenant lease financing						10,519						(346)						10,173
Public finance						1,753						(135)						1,618
Healthcare finance						2,997						1,034						4,031
Small business lending						2,168						334						2,502
Franchise finance						3,988						(313)						3,675
Total commercial loans						26,960						(110)						26,850
Consumer loans
Residential mortgage						1,559						406						1,965
Home equity						69						133						202
Other consumer						3,149						2,533						5,682
Total consumer loans						4,777						3,072						7,849
Total allowance for credit losses						$	31,737					$	2,962					$	34,699
Liabilities:
Liability for off-balance sheet credit exposures						$	—					$	2,504					$	2,504

The Company also performed an assessment to determine if an allowance for credit loss was needed for available-for-sale and held-to-maturity securities. The Company analyzed available-for-sale securities investment securities that were in an unrealized loss position as of January 1, 2023 and determined the decline in fair value for those securities was not related to credit, but rather related to changes in interest rates and general market conditions. As such, no ACL was recorded for available-for-sale securities. The Company analyzed held-to-maturity securities and recorded a $0.3 million one-time cumulative adjustment to the allowance in retained earnings.

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ASU 2020-04 - Reference Rate Reform (Topic 848): Facilitation of the Effects of Reference Rate Reform on     Financial Reporting (March 2020) and ASU 2022-06 - Deferral of sunset Date of Topic 848

In March 2020, FASB issued ASU 2020-04 to ease the potential burden in accounting for the transition away from the LIBOR on financial reporting. The ASU provides optional expedients and exceptions for applying GAAP to contract modification and hedge accounting relationships. The guidance is effective March 12, 2020 through December 31, 2024. The Company believes the adoption of this guidance will not have a material impact on the condensed consolidated financial statements.

ASU 2022-02 - Financial Instruments - Credit Losses (Topic 326): Troubled Debt Restructurings and Vintage Disclosures (March 2022)

In March 2022, the FASB issued ASU No. 2022-02, Financial Instruments - Credit Losses (Topic 326): Troubled Debt Restructurings and Vintage Disclosures. This ASU eliminates the separate recognition and measurement guidance for Troubled Debt Restructurings ("TDRs") by creditors. The elimination of the TDR guidance may be adopted prospectively for loan modifications after adoption or on a modified retrospective basis, which would also apply to loans previously modified, resulting in a cumulative effect adjustment to retained earnings in the period of adoption for changes in the allowance for credit losses. The ASU requires an entity to disclose current-period gross write-offs by year of origination for financing receivables within the scope of Subtopic 326-20. This guidance is effective on January 1, 2023, with early adoption permitted. Using a prospective approach, the Company adopted this guidance on January 1, 2023 and it did not have a material impact on the condensed consolidated financial statements.

ITEM 2.    MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our condensed consolidated financial statements and related notes appearing elsewhere in this report. This discussion and analysis includes certain forward-looking statements that involve risks, uncertainties, and assumptions. You should review the “Risk Factors” sections of this report and our Annual Report on Form 10-K for the year ended December 31, 2022 for a discussion of important factors that could cause actual results to differ materially from the results described in or implied by such forward-looking statements. See also “Cautionary Note Regarding Forward-Looking Statements” at the beginning of this report.

 

Overview

 

    First Internet Bancorp is a financial holding company headquartered in Fishers, Indiana that conducts its primary business activities through its wholly-owned subsidiary, First Internet Bank of Indiana, an Indiana chartered bank. The Bank was the first state-chartered, Federal Deposit Insurance Corporation (“FDIC”) insured Internet bank and commenced banking operations in 1999. First Internet Bancorp was incorporated under the laws of the State of Indiana on September 15, 2005. On March 21, 2006, we consummated a plan of exchange by which we acquired all of the outstanding shares of the Bank.

    The Bank has three wholly-owned subsidiaries: First Internet Public Finance Corp., an Indiana corporation that provides a range of public and municipal finance lending and leasing products to governmental entities throughout the United States and acquires securities issued by state and local governments and other municipalities; JKH Realty Services, LLC, a Delaware limited liability company that manages other real estate owned properties as needed; and SPF15, Inc., an Indiana corporation that owns real estate used primarily for the Bank’s principal office.

We offer a wide range of commercial, small business, consumer and municipal banking products and services. We conduct our consumer and small business deposit operations primarily through digital channels on a nationwide basis and have no traditional branch offices. Our consumer lending products are primarily originated on a nationwide basis through relationships with dealerships and financing partners.

Our commercial banking products and services are delivered through a relationship banking model and include commercial and industrial (“C&I”), construction and investor commercial real estate, single tenant lease financing, public finance, healthcare finance, small business lending, franchise finance and commercial deposits and treasury management. Our C&I team provides credit solutions such as lines of credit, term loans, owner-occupied commercial real estate loans and

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corporate credit cards on a regional basis to commercial borrowers primarily in the Midwest and Southwest regions of the United States. We primarily offer construction and investor commercial real estate loans in the Midwest and Southwest regions of the Untied States and single tenant lease financing on a nationwide basis. Our public finance team provides a range of public and municipal lending and leasing products to government entities on a nationwide basis. Our healthcare finance team was established in conjunction with our strategic partnership with Provide, Inc. (formerly known as Lendeavor, Inc.), a San Francisco-based technology-enabled lender to healthcare practices, which provided lending on a nationwide basis for healthcare practice finance or acquisition, acquisition or refinancing of owner-occupied commercial real estate and equipment purchases. In the third quarter 2021, Provide was acquired by a super-regional financial institution. Subsequent to Provide being acquired, the acquiring institution has retained most, if not all, of Provide’s loan origination activity and our healthcare finance loan balances have declined. Our franchise finance business was established in July 2021 in conjunction with our business relationship with ApplePie Capital, a financial technology (“fintech”) company that specializes in providing financing to franchisees in various industry segments. Our commercial deposits and treasury management team works with the other commercial teams to provide deposit products and treasury management services to our commercial and municipal lending customers as well as pursues commercial deposit opportunities in business segments where we have no credit relationships.

We believe that we differentiate ourselves from larger financial institutions by providing a full suite of services to emerging small businesses and entrepreneurs on a nationwide basis. We are one of the fastest-growing lenders in the Small Business Administration (“SBA”) 7(a) program, closing more than $155.4 million in SBA 7(a) loans during 2022 and ranking in the top 30 SBA 7(a) lenders for the SBA’s 2022 fiscal year. During the six months ended June 30, 2023, we closed more than $199.5 million in SBA 7(a) loans, and currently rank in the top 10 SBA 7(a) lenders for the SBA’s 2023 fiscal year-to-date. We also offer a top-ranked small business checking account product to our country’s entrepreneurs. We continue to scale up this business with the goal of driving increased earnings and profitability in future periods.

We also offer payment, deposit, card and lending products and services through fintech partnerships, which we plan to grow in future periods. With the rapid evolution of technology that enables consumers and small businesses to manage their finances digitally, fintechs are addressing a significantly growing marketplace. Fintechs have created robust digital offerings, unburdened by legacy technology architecture, to address growing customer expectations. Through partnerships with selected fintechs, we believe our ability to win and retain consumer and small business relationships will be significantly enhanced. Furthermore, we believe partnering with select fintechs will allow us to further diversify our revenue sources, acquire lower-cost deposits and pursue additional asset generation capabilities.

As of June 30, 2023, the Company had consolidated assets of $4.9 billion, consolidated deposits of $3.9 billion and stockholders’ equity of $354.3 million.

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Results of Operations

During the second quarter 2023, net income was $3.9 million, or $0.44 diluted earnings per share, compared to second quarter 2022 net income of $9.5 million, or $0.99 diluted earnings per share, representing a decrease in net income of $5.7 million, or 59.3%, and a decrease in diluted earnings per share of $0.55, or 55.6%. During the six months ended June 30, 2023, net income was $0.9 million, or $0.10 per diluted share, compared to the six months ended June 30, 2022 net income of $20.8 million, or $2.13 per diluted share, resulting in a decrease in net income of $19.9 million, or 95.8%.

The $5.7 million decrease in net income for the second quarter 2023 compared to the second quarter 2022 was due primarily to a decrease of $7.5 million, or 29.3%, in net interest income, an increase of $0.7 million, or 3.8%, in noninterest expense and an increase of $0.5 million, or 43.3%, in provision for credit losses, partially offset by an increase of $1.6 million, or 36.1%, in noninterest income and a decrease of $1.5 million, or 118.3%, in income tax expense.

The decrease in net income for the six months ended June 30, 2023 compared to the six months ended June 30, 2022 was due primarily to a $13.7 million, or 26.7%, decrease in net interest income, a $9.1 million, or 462.4%, increase in provision for credit losses and a $2.9 million, or 7.8%, increase in noninterest expense, partially offset by a $5.6 million, or 183.6%, decrease in income tax expense and a $0.2 million, or 1.6%, increase in noninterest income.

Due to the steep decline in consumer mortgage volumes and the negative outlook for consumer mortgage lending over the next several years, the Company decided to exit its consumer mortgage business during the first quarter 2023. This included its nationwide digital direct-to-consumer mortgage platform that originated residential loans for sale in the secondary market, as well as its local traditional consumer mortgage and construction-to-permanent business. In connection with this decision, the Company recognized $3.1 million of mortgage operations and exit costs during the first quarter 2023, which primarily drove the increase in noninterest expense compared to the six months ended June 30, 2022.

The Company also recognized $0.1 million of mortgage banking revenue during the six months ended June 30, 2023, down from $3.6 million in the six months ended June 30, 2022, as it immediately began winding down its existing pipeline following the decision to exit the business.

Additionally, during the six months ended June 30, 2023, the Company recognized a partial charge-off of $6.9 million related to a commercial and industrial participation loan with a balance of $9.8 million, prior to the partial charge-off, that was moved to nonaccrual status late in the first quarter 2023. This action contributed to the increase in the provision for credit losses as compared to the six months ended June 30, 2022. The Company received payment for the remaining balance of the participation loan during the second quarter 2023.

During the second quarter 2023, return on average assets (“ROAA”), return on average shareholders’ equity (“ROAE”), and return on average tangible common equity (“ROATCE”) were 0.32%, 4.35%, and 4.40%, respectively, compared to 0.93%, 10.23%, and 10.36%, respectively, for the second quarter 2022. During the six months ended June 30, 2023, ROAA, ROAE and ROATCE were 0.04%, 0.48%, and 0.49%, respectively, compared to 1.01%, 11.09%, and 11.23%, respectively, for the six months ended June 30, 2022.

During the second quarter 2022, the Company paid a $0.5 million discretionary inflation bonus to certain employees, recognized accelerated equity compensation expense of $0.3 million related to several retirements and incurred $0.1 million of acquisition-related expenses. Excluding these items, adjusted net income for the second quarter 2022 was $10.3 million and adjusted diluted earnings per share was $1.06. Additionally, for the second quarter 2022, adjusted ROAA, adjusted ROAE and adjusted ROATCE were 1.00%, 11.01% and 11.15%, respectively.

Excluding the impact of exiting consumer mortgage and the partial charge-off, adjusted net income for the six months ended June 30, 2023 was $8.7 million and adjusted diluted earnings per share was $0.97. Additionally, for the six months ended June 30, 2023, adjusted ROAA, adjusted ROAE and adjusted ROATCE were 0.37%, 4.85% and 4.92%, respectively.

During the six months ended June 30, 2022, the Company recognized a nonrecurring consulting fee associated with a special project of $0.9 million, paid a $0.5 million discretionary inflation bonus to certain employees, recognized accelerated equity compensation expense of $0.3 million related to several retirements and incurred acquisition-related expenses of $0.3 million. Excluding these items, adjusted net income for the six months ended June 30, 2022 was $22.3 million and adjusted diluted earnings per share was $2.28. Additionally, for the six months ended June 30, 2022, adjusted ROAA, adjusted ROAE and adjusted ROATCE were 1.08%, 11.92% and 12.07%, respectively.

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Refer to the “Reconciliation of Non-GAAP Financial Measures” section of Part I, Item 2 of this report, Management’s Discussion and Analysis of Financial Condition and Results of Operations for additional information.

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Consolidated Average Balance Sheets and Net Interest Income Analyses

 

For the periods presented, the following tables provide the average balances of interest-earning assets and interest-bearing liabilities and the related yields and cost of funds. The tables do not reflect any effect of income taxes except for net interest margin - FTE, as discussed below. Balances are based on the average of daily balances. Nonaccrual loans are included in average loan balances.

						Three Months Ended
						June 30, 2023																		March 31, 2023																		June 30, 2022
(dollars in thousands)						Average Balance						Interest /Dividends						Yield /Cost						Average Balance						Interest /Dividends						Yield /Cost						Average Balance						Interest /Dividends						Yield /Cost
Assets
Interest-earning assets
Loans, including loans held-for-sale						$	3,656,146					$	46,906					5.15		%				$	3,583,218					$	43,843					4.96		%				$	3,019,891					$	32,415					4.31		%
Securities - taxable						531,040						3,835						2.90		%				511,923						3,606						2.86		%				543,422						2,567						1.89		%
Securities - non-taxable						73,142						860						4.72		%				73,347						798						4.41		%				76,974						328						1.71		%
Other earning assets						511,295						6,521						5.12		%				331,294						3,786						4.63		%				322,302						796						0.99		%
Total interest-earning assets						4,771,623						58,122						4.89		%				4,499,782						52,033						4.69		%				3,962,589						36,106						3.65		%
Allowance for credit losses - loans						(36,671)																		(35,075)																		(28,599)
Noninterest-earning assets						192,760																		182,449																		163,875
Total assets						$	4,927,712																	$	4,647,156																	$	4,097,865
Liabilities
Interest-bearing liabilities
Interest-bearing demand deposits						$	359,969					$	1,509					1.68		%				$	333,642					$	900					1.09		%				$	348,274					$	466					0.54		%
Savings accounts						29,915						64						0.86		%				38,482						82						0.86		%				66,657						68						0.41		%
Money market accounts						1,274,453						12,314						3.88		%				1,377,600						12,300						3.62		%				1,427,665						1,921						0.54		%
BaaS - brokered deposits						22,918						230						4.03		%				14,741						138						3.80		%				71,234						154						0.87		%
Certificates and brokered deposits						2,025,831						20,559						4.07		%				1,647,504						13,850						3.41		%				1,104,592						3,799						1.38		%
Total interest-bearing deposits						3,713,086						34,676						3.75		%				3,411,969						27,270						3.24		%				3,018,422						6,408						0.85		%
Other borrowed funds						719,577						5,301						2.95		%				719,499						5,189						2.92		%				583,553						4,018						2.76		%
Total interest-bearing liabilities						4,432,663						39,977						3.62		%				4,131,468						32,459						3.19		%				3,601,975						10,426						1.16		%
Noninterest-bearing deposits						117,496																		134,988																		108,980
Other noninterest-bearing liabilities						19,241																		17,427																		12,636
Total liabilities						4,569,400																		4,283,883																		3,723,591
Shareholders’ equity						358,312																		363,273																		374,274
Total liabilities and shareholders’ equity						$	4,927,712																	$	4,647,156																	$	4,097,865
Net interest income												$	18,145																	$	19,574																	$	25,680
Interest rate spread 1																		1.27%																		1.50%																		2.49		%
Net interest margin 2																		1.53%																		1.76%																		2.60		%
Net interest margin - FTE 3																		1.64%																		1.89%																		2.74		%

1 Yield on total interest-earning assets minus cost of total interest-bearing liabilities.

2 Net interest income divided by total average interest-earning assets (annualized).

3 On an FTE basis assuming a 21% tax rate. Net interest income is adjusted to reflect income from assets such as municipal loans and securities that are exempt from Federal income taxes. This is to recognize the income tax savings that facilitates a comparison between taxable and tax-exempt assets. The Company believes that it is a standard practice in the banking industry to present net interest margin and net interest income on a fully-taxable equivalent basis, as these measures provide useful information to make peer comparisons. Net interest margin - FTE represents a non-GAAP financial measure. See “Reconciliation of Non-GAAP Financial Measures” for a reconciliation of this measure to its most directly comparable GAAP measure.

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						Six Months Ended
						June 30, 2023																		June 30, 2022
(dollars in thousands)						Average Balance						Interest /Dividends						Yield /Cost						Average Balance						Interest /Dividends						Yield /Cost
Assets
Interest-earning assets
Loans, including loans held-for-sale						$	3,619,883					$	90,749					5.06		%				$	2,998,085					$	65,603					4.41		%
Securities - taxable						521,533						7,441						2.88		%				555,533						4,788						1.74		%
Securities - non-taxable						73,244						1,658						4.56		%				78,952						577						1.47		%
Other earning assets						421,793						10,307						4.93		%				388,760						1,172						0.61		%
Total interest-earning assets						4,636,453						110,155						4.79		%				4,021,330						72,140						3.62		%
Allowance for credit losses - loans						(35,877)																		(28,288)
Noninterest-earning assets						187,633																		163,026
Total assets						$	4,788,209																	$	4,156,068
Liabilities
Interest-bearing liabilities
Interest-bearing demand deposits						$	346,878					$	2,409					1.40		%				$	333,361					$	878					0.53		%
Savings accounts						34,175						145						0.86		%				63,653						121						0.38		%
Money market accounts						1,325,741						24,614						3.74		%				1,440,976						3,425						0.48		%
BaaS - brokered deposits						18,852						368						3.94		%				41,836						160						0.77		%
Certificates and brokered deposits						1,837,713						34,410						3.78		%				1,164,949						7,921						1.37		%
Total interest-bearing deposits						3,563,359						61,946						3.51		%				3,044,775						12,505						0.83		%
Other borrowed funds						719,538						10,490						2.94		%				601,274						8,205						2.75		%
Total interest-bearing liabilities						4,282,897						72,436						3.41		%				3,646,049						20,710						1.15		%
Noninterest-bearing deposits						126,194																		110,605
Other noninterest-bearing liabilities						18,339																		21,910
Total liabilities						4,427,430																		3,778,564
Shareholders’ equity						360,779																		377,504
Total liabilities and shareholders’ equity						$	4,788,209																	$	4,156,068
Net interest income												$	37,719																	$	51,430
Interest rate spread 1																		1.38%																		2.47%
Net interest margin 2																		1.64%																		2.58%
Net interest margin - FTE 3																		1.76%																		2.71%

1 Yield on total interest-earning assets minus cost of total interest-bearing liabilities.

2 Net interest income divided by total average interest-earning assets (annualized).

3 On an FTE basis assuming a 21% tax rate. Net interest income is adjusted to reflect income from assets such as municipal loans and securities that are exempt from Federal income taxes. This is to recognize the income tax savings that facilitates a comparison between taxable and tax-exempt assets. The Company believes that it is a standard practice in the banking industry to present net interest margin and net interest income on a fully-taxable equivalent basis, as these measures provide useful information to make peer comparisons. Net interest margin - FTE represents a non-GAAP financial measure. See “Reconciliation of Non-GAAP Financial Measures” for a reconciliation of this measure to its most directly comparable GAAP measure.

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Rate/Volume Analysis 

The following table illustrates the impact of changes in the volume of interest-earning assets and interest-bearing liabilities and interest rates on net interest income for the periods indicated. The change in interest not due solely to volume or rate has been allocated in proportion to the absolute dollar amounts of the change in each. 

						Three Months Ended June 30, 2023 vs. March 31, 2023 Due to Changes in																		Three Months Ended June 30, 2023 vs. June 30, 2022 Due to Changes in																		Six Months Ended June 30, 2023 vs. June 30, 2022 Due to Changes in
(in thousands)						Volume						Rate						Net						Volume						Rate						Net						Volume						Rate						Net
Interest income
Loans, including loans held-for-sale						$	1,063					$	2,000					$	3,063					$	7,528					$	6,963					$	14,491					$	14,699					$	10,447					$	25,146
Securities – taxable						167						62						229						(397)						1,665						1,268						(856)						3,509						2,653
Securities – non-taxable						(15)						77						62						(114)						646						532						(126)						1,207						1,081
Other earning assets						2,289						446						2,735						706						5,019						5,725						109						9,026						9,135
Total						3,504						2,585						6,089						7,723						14,293						22,016						13,826						24,189						38,015
Interest expense
Interest-bearing deposits						2,661						4,745						7,406						1,786						26,482						28,268						2,477						46,964						49,441
Other borrowed funds						1						111						112						990						293						1,283						1,691						594						2,285
Total						2,662						4,856						7,518						2,776						26,775						29,551						4,168						47,558						51,726
Increase (decrease) in net interest income						$	842					$	(2,271)					$	(1,429)					$	4,947					$	(12,482)					$	(7,535)					$	9,658					$	(23,369)					$	(13,711)

Net interest income for the second quarter 2023 was $18.1 million, a decrease of $7.5 million, or 29.3%, compared to $25.7 million for the second quarter 2022. The decrease in net interest income was the result of a $29.6 million, or 283.4%, increase in total interest expense to $40.0 million for the second quarter 2023 from $10.4 million for the second quarter 2022, partially offset by a $22.0 million, or 61.0%, increase in total interest income to $58.1 million for the second quarter 2023 from $36.1 million for the second quarter 2022.

Net interest income for the six months ended June 30, 2023 was $37.7 million, a decrease of $13.7 million, or 26.7%, compared to $51.4 million for the six months ended June 30, 2022. The decrease in net interest income was the result of a $51.7 million, or 249.8%, increase in total interest expense to $72.4 million for the six months ended June 30, 2023 from $20.7 million for the six months ended June 30, 2022. The increase in total interest expense was partially offset by a $38.0 million, or 52.7%, increase in total interest income to $110.2 million for the six months ended June 30, 2023 from $72.1 million for the six months ended June 30, 2022.

The increase in total interest income for the second quarter 2023 compared to second quarter 2022 was due primarily to a $14.5 million, or 44.7%, increase in interest earned on loans, $5.7 million, or 719.2%, increase in income from other earning assets and a $1.8 million, or 62.2%, increase in interest earned on securities. The increase in income from loans was due primarily to an 84 bp increase in the yield earned on loans, as well as an increase of $636.3 million, or 21.1%, in the average balance of loans compared to the second quarter 2022. The yield earned on other earning assets increased 413 bps and the average balance of other earning assets increased $189.0 million, or 58.6%. The increase in the average balance of other earning assets was due primarily to higher cash balances. The average balance of securities decreased $16.2 million, or 2.6%, while the yield earned on the securities portfolio increased 125 bps for the second quarter 2023 compared to the second quarter 2022. The increase in the yields earned on loans, other earning assets and securities was due to the continued rise in interest rates during 2023. The yield on funded portfolio originations was 8.42% in the second quarter 2023, an increase of 366 bps compared to the second quarter 2022.

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The increase in total interest income for the six months ended June 30, 2023 compared to the six months ended June 30, 2022 was due primarily to an increase in interest earned on loans resulting from an increase of 65 bps in the yield on loans, including loans held-for-sale, as well as an increase of $621.8 million, or 20.7%, in the average balance of loans, including loans held-for-sale. The yield on other earning assets increased 432 bps and the average balance of other earning assets increased $33.0 million, or 8.5%. In addition, the average balance of securities decreased $39.7 million, or 6.3%, and the yield earned on the securities portfolio increased 138 bps for the six months ended June 30, 2023 compared to the six months ended June 30, 2022. The increase in the yields earned on loans, other earning assets and securities was due to the continued rise in interest rates during 2023. The yield on funded portfolio originations was 8.0% for the six months ended June 30, 2023, an increase of 314 bps compared to the six months ended June 30, 2022.

The increase in total interest expense for the second quarter 2023 compared to the second quarter 2022 was due primarily to increases of $16.8 million, or 441.2%, in interest expense associated with certificates and brokered deposits, $10.4 million, or 541.0%, in interest expense associated with money market accounts, $1.3 million, or 31.9%, in interest expense associated with other borrowed funds and $1.0 million, or 223.8%, in interest expense associated with interest-bearing demand deposits. The increase in interest expense related to certificates and brokered deposits was driven by an increase of 269 bps in the cost of these deposits, as well as an increase of $921.2 million, or 83.4%, in the average balance of these deposits. The increase in the average balance of these deposits was driven by strong consumer and small business demand for certificates of deposits in 2023, as well as the funding of brokered deposits throughout 2023 to supplement on-balance sheet liquidity. The increase in interest expense related to money market accounts was driven primarily by an increase of 334 bps in the cost of these deposits, partially offset by a decrease in the average balance of these deposits of $153.2 million, or 10.7%. The increase in interest expense related to other borrowed funds was due primarily to additional long-term FHLB advances in the second half of 2022 at rates lower than market deposit costs, as the cost of the borrowed funds increased only 19 bps while the average balance increased 23.3%. The increase in interest expense related to interest-bearing demand deposits was due primarily to a 114 bp increase in the cost of these deposits, as well as an increase of $11.7 million, or 3.4%, in the average balance of these deposits. The increase in the overall cost of deposits was due primarily to the continued rise in interest rates during 2023. Beginning in March 2022, the Federal Reserve has increased the Fed Funds rate 5.00% through June 30, 2023, which has impacted pricing of the Company’s deposit products.

The increase in total interest expense for the six months ended June 30, 2023 compared to the six months ended June 30, 2022 was due primarily to increases of $26.5 million, or 334.4%, in interest expense associated with certificates and brokered deposits, $21.2 million, or 618.7%, in interest expense associated with money market accounts, $2.3 million, or 395.4%, in interest expense associated with other borrowed funds and $1.5 million, or 174.4%, in interest expense associated with interest-bearing demand deposits. The increase in interest expense related to certificates and brokered deposits was driven by an increase of 241 bps in the cost of these deposits, as well as an increase of 672.8 million, or 57.8%, in the average balance of these deposits. The increase in the average balance of these deposits was driven by strong consumer and small business demand for certificates of deposits in 2023, as well as the funding of brokered deposits throughout 2023 to supplement on-balance sheet liquidity. The increase in interest expense related to money market accounts was driven primarily by an increase of 326 bps in the cost of these deposits, partially offset by a decrease of $115.2 million, or 8.0%, in the average balance of these deposits. The increase in interest expense related to other borrowed funds was due primarily to additional long-term FHLB advances in the second half of 2022 at rates lower than market deposit costs, as the cost of the borrowed funds increased only 19 bps while the average balance increased 19.7%. The increase in interest expense related to interest-bearing demand deposits was due primarily to an 87 bp increase in the cost of these deposits, as well as an increase of $13.5 million, or 4.1%, in the average balance of these deposits. The increase in the overall cost of deposits was due primarily to the continued rise in interest rates during 2023. Beginning in March 2022, the Federal Reserve has increased the Fed Funds rate 5.00% through June 30, 2023, which has impacted pricing of the Company’s deposit products.

Overall, the cost of total interest-bearing liabilities for the second quarter 2023 increased 246 bps to 3.62% from 1.16% for the second quarter 2022. The cost of total interest-bearing liabilities for the six months ended June 30, 2023 increased 226 bps to 3.41% from 1.15% for the six months ended June 30, 2022. The increase in the cost of funds for both the three and six months ended June 30, 2023 reflects the rapid rise in interest rates in 2023.

Net interest margin (“NIM”) was 1.53% for the second quarter 2023 compared to 2.60% for the second quarter 2022, a decrease of 107 bps. On a fully-taxable equivalent (“FTE”) basis, NIM was 1.64% for the second quarter 2023 compared to 2.74% for the second quarter 2022, a decrease of 110 bps. NIM was 1.64% for the six months ended June 30, 2023 compared to 2.58% for the six months ended June 30, 2022, a decrease of 94 bps. FTE NIM was 1.76% for the six months ended June 30, 2023 compared to 2.71% for the six months ended June 30, 2022, a decrease of 95 bps.

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The decrease in both the three and six months ended June 30, 2023 NIM and FTE NIM compared to the three and six months ended June 30, 2022 reflects the increase in the cost of interest-bearing liabilities, partially offset by the increase in earning asset yields noted above.

Noninterest Income

The following table presents noninterest income for the last five completed fiscal quarters and the six months ended June 30, 2023 and 2022.

			Three Months Ended																														Six Months Ended
(in thousands)			June 30, 2023						March 31, 2023						December 31, 2022						September 30, 2022						June 30, 2022						June 30, 2023						June 30, 2022
Service charges and fees			$	218					$	209					$	226					$	248					$	281					$	427					$	597
Loan servicing revenue			850						785						715						653						620						1,635						1,205
Loan servicing asset revaluation			(358)						(55)						(539)						(333)						(470)						(413)						(767)
Mortgage banking activities			—						76						1,010						871						1,710						76						3,583
Gain on sale of loans			4,868						4,061						2,862						2,713						1,952						8,929						5,797
Other			293						370						1,533						164						221						663						719
Total noninterest income			$	5,871					$	5,446					$	5,807					$	4,316					$	4,314					$	11,317					$	11,134

During the second quarter 2023, noninterest income was $5.9 million, representing an increase of $1.6 million, or 36.1%, compared to $4.3 million for the second quarter 2022. The increase in noninterest income was due primarily to increases in gain on sale of loans and net servicing revenue, partially offset by a decrease in revenue from mortgage banking activities. The increase of $2.9 million, or 149.4%, in gain on sale of loans was due to an increase in the volume of U.S. Small Business Administration (“SBA”) 7(a) guaranteed loan sales. The increase of $0.3 million, or 228.0%, in net servicing revenue reflects the growth in the Company’s SBA servicing portfolio, as origination volume has increased over the past year. The decrease in mortgage banking revenue was due to the Company’s exit from the mortgage business in the first quarter 2023.

During the six months ended June 30, 2023, noninterest income was $11.3 million, an increase of $0.2 million, or 1.6%, compared to $11.1 million for the six months ended June 30, 2022. The modest increase in noninterest income was due primarily to increases in gain on sale of loans and net loan servicing revenue, partially offset by a decrease in mortgage banking activities. The increase of $3.1 million, or 54.0%, in gain on sale of loans was due to an increase in the volume of SBA 7(a) guaranteed loan sales. The increase in net loan servicing revenue was due to growth in the balance of the Company’s SBA 7(a) servicing portfolio, as well as slower prepayment speeds in first six months of 2023 compared to first six months of 2022. The decrease in mortgage banking revenue was due to the Company’s exit from the mortgage business in the first quarter 2023.

Noninterest Expense

The following table presents noninterest expense for the last five completed fiscal quarters and the six months ended June 30, 2023 and 2022.

			Three Months Ended																														Six Months Ended
(in thousands)			June 30, 2023						March 31, 2023						December 31, 2022						September 30, 2022						June 30, 2022						June 30, 2023						June 30, 2022
Salaries and employee benefits			$	10,706					$	11,794					$	10,404					$	10,439					$	10,832					$	22,500					$	20,710
Marketing, advertising and promotion			705						844						837						1,041						920						1,549						1,676
Consulting and professional services			711						926						914						790						1,197						1,637						3,122
Data processing			520						659						567						483						490						1,179						939
Loan expenses			1,072						1,977						1,018						1,142						693						3,049						2,275
Premises and equipment			2,661						2,777						2,921						2,808						2,419						5,438						4,959
Deposit insurance premium			936						543						355						229						287						1,479						568
Other			1,359						1,434						1,497						1,063						1,147						2,793						2,516
Total noninterest expense			$	18,670					$	20,954					$	18,513					$	17,995					$	17,985					$	39,624					$	36,765

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Noninterest expense for the second quarter 2023 was $18.7 million, compared to $18.0 million for the second quarter 2022. The increase of $0.7 million, or 3.8%, was due primarily to a $0.6 million increase in deposit insurance premium and a $0.4 million increase in loan expenses, partially offset by a decrease of $0.5 million in consulting and professional fees. The second quarter 2022 includes a $0.5 million discretionary inflation bonus paid to certain employees and $0.3 million of accelerated equity compensation expense related to several retirements. Excluding these items, salaries and employee benefits increased $0.7 million due primarily to increased headcount and higher incentive compensation in small business lending. The increase in deposit insurance premium was due primarily to year-over-year asset growth and changes in the composition of the loans and deposit portfolios. The increase in loan expenses was due primarily to servicing fees related to franchise finance loans. The decrease in consulting and professional fees was due primarily to lower legal fees.

Noninterest expense for the six months ended June 30, 2023 was $39.6 million, compared to $36.8 million for the six months ended June 30, 2022. The increase of $2.8 million, or 7.8%, was due primarily to increases of $1.8 million in salaries and benefits, $0.9 million in deposit insurance premium, $0.8 million in loan expenses and $0.5 million in premises and equipment, partially offset by a $1.5 million decrease in consulting and professional fees. During the six months ended June 30, 2022, the Company paid a $0.5 million discretionary inflation bonus to certain employees and recognized accelerated equity compensation expense of $0.3 million related to several retirements. Excluding these items, salaries and employee benefits increased $2.6 million. The increase in salaries and employee benefits was due primarily to mortgage exit costs, such as severance, as well as an increase in headcount and higher incentive compensation in small business lending. The increase in loan expenses was due primarily to mortgage exit costs and accrued contract expenses. The increase in deposit insurance premium was due mainly to asset growth, as well as the composition of loans and deposits. The increase in premises and equipment was due mainly to increases in software maintenance and building maintenance. The decrease in consulting and professional fees was due primarily to consulting fees related to a special project that occurred in the first quarter of 2022, as well as lower legal fees in 2023.

The Company recorded an income tax benefit of $0.2 million for the second quarter 2023, compared to an income tax provision of $1.3 million for the second quarter 2022 and an effective tax rate of 11.8%. The Company recorded an income tax benefit of $2.6 million for the six months ended June 30, 2023, compared to an income tax provision of $3.1 million, or an effective tax rate of 12.9%, for the six months ended June 30, 2022. The income tax benefits recognized during 2023 reflect the impact of the partial charge-off of the commercial and industrial participation loan, as well as the benefit of tax exempt income relative to stated pre-tax income.

Financial Condition

The following table presents summary balance sheet data for the last five completed fiscal quarters.

(in thousands)
Balance Sheet Data:						June 30, 2023						March 31, 2023						December 31, 2022						September 30, 2022						June 30, 2022
Total assets						$	4,947,049					$	4,721,319					$	4,543,104					$	4,264,424					$	4,099,806
Loans						3,646,832						3,607,242						3,499,401						3,255,906						3,082,127
Total securities						609,999						606,594						579,552						584,622						610,602
Loans held-for-sale						32,001						18,144						21,511						23,103						31,580
Noninterest-bearing deposits						119,291						140,449						175,315						142,875						126,153
Interest-bearing deposits						3,735,017						3,481,841						3,265,930						3,049,769						3,025,948
Total deposits						3,854,308						3,622,290						3,441,245						3,192,644						3,152,101
Advances from Federal Home Loan Bank						614,931						614,929						614,928						589,926						464,925
Total shareholders’ equity						354,332						355,572						364,974						360,857						365,332

Total assets increased $403.9 million, or 8.9%, to $4.9 billion at June 30, 2023 compared to $4.5 billion at December 31, 2022. The increase was due primarily to increases in loan and cash balances, and was funded by growth in deposit balances of $413.0 million, or 12.0%.

As of June 30, 2023, total shareholders’ equity was $354.3 million, a decrease of $10.6 million, or 3.0%, compared to December 31, 2022. The decrease in retained earnings was due primarily to stock repurchase activity and the day 1 CECL adjustment, partially offset by a decrease in accumulated other comprehensive loss. Tangible common equity totaled $349.6 million as of June 30, 2023, representing a decrease of $10.6 million, or 3.0%, compared to December 31, 2022. The ratio of total shareholders’ equity to total assets decreased to 7.16% as of June 30, 2023 from 8.03% as of December 31, 2022, and the ratio of tangible common equity to tangible assets decreased to 7.07% as of June 30, 2023 from 7.94% as of December 31, 2022.

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Book value per common share increased 0.3% to $40.38 as of June 30, 2023 from $40.26 as of December 31, 2022. Tangible book value per share increased 0.3% to $39.85 as of June 30, 2023 from $39.74 as of December 31, 2022. The slight increase in both book value per common share and tangible book value per share reflects the effect of stock repurchase activity during the year, partially offset by declines in total shareholders’ equity and tangible common equity. Refer to the “Reconciliation of Non-GAAP Financial Measures” section of Part I, Item 2 of this report, Management’s Discussion and Analysis of Financial Condition and Results of Operations for additional information.

    

Loan Portfolio Analysis

    The following table presents a summary of the Company’s loan portfolio for the last five completed fiscal quarters.

(dollars in thousands)			June 30, 2023												March 31, 2023												December 31, 2022												September 30, 2022												June 30, 2022
Commercial loans
Commercial and industrial			$	112,423					3.1		%				$	113,198					3.1		%				$	126,108					3.6		%				$	104,780					3.2		%				$	110,540					3.6		%
Owner-occupied commercial real estate			59,564						1.6		%				59,643						1.7		%				61,836						1.8		%				58,615						1.8		%				61,277						2.0		%
Investor commercial real estate			137,504						3.8		%				142,174						3.9		%				93,121						2.7		%				91,021						2.8		%				52,648						1.7		%
Construction			192,453						5.3		%				158,147						4.4		%				181,966						5.2		%				139,509						4.3		%				143,475						4.7		%
Single tenant lease financing			947,466						25.9		%				952,533						26.4		%				939,240						26.8		%				895,302						27.4		%				867,181						28.1		%
Public finance			575,541						15.8		%				604,898						16.8		%				621,032						17.7		%				614,139						18.9		%				613,759						19.9		%
Healthcare finance			245,072						6.7		%				256,670						7.1		%				272,461						7.8		%				293,686						9.0		%				317,180						10.3		%
Small business lending			170,550						4.7		%				136,382						3.8		%				123,750						3.5		%				113,001						3.5		%				102,724						3.3		%
Franchise finance			390,479						10.6		%				382,161						10.6		%				299,835						8.6		%				225,012						6.8		%				168,942						5.5		%
Total commercial loans			2,831,052						77.5		%				2,805,806						77.8		%				2,719,349						77.7		%				2,535,065						77.7		%				2,437,726						79.1		%
Consumer loans
Residential mortgage			396,154						10.9		%				392,062						10.9		%				383,948						11.0		%				337,565						10.4		%				281,124						9.1		%
Home equity			24,375						0.7		%				26,160						0.7		%				24,712						0.7		%				22,114						0.7		%				19,928						0.6		%
Other consumer			352,124						9.7		%				338,133						9.4		%				324,598						9.3		%				312,512						9.7		%				292,955						9.6		%
Total consumer loans			772,653						21.3		%				756,355						21.0		%				733,258						21.0		%				672,191						20.8		%				594,007						19.3		%
Net deferred loan origination costs, premiums and discounts on purchased loans and other 1			43,127						1.2		%				45,081						1.2		%				46,794						1.3		%				48,650						1.5		%				50,394						1.6		%
Total loans			3,646,832						100.0		%				3,607,242						100.0		%				3,499,401						100.0		%				3,255,906						100.0		%				3,082,127						100.0		%
Allowance for credit losses 2			(36,058)												(36,879)												(31,737)												(29,866)												(29,153)
Net loans			$	3,610,774											$	3,570,363											$	3,467,664											$	3,226,040											$	3,052,974

1 Includes carrying value adjustments of $30.5 million, $31.5 million, $32.5 million, $33.9 million and $35.4 million related to terminated interest rate swaps associated with public finance loans as of June 30, 2023, March 31, 2023, December 31, 2022, September 30, 2022 and June 30, 2022, respectively. 

2 Beginning January 1, 2023, the allowance calculation is based on the CECL methodology. Prior to January 1, 2023, the allowance calculation was based on the incurred loss methodology.

Total loans were $3.6 billion as of June 30, 2023, an increase of $147.4 million, or 4.2%, compared to December 31, 2022. Total commercial loan balances were $2.8 billion as of June 30, 2023, up $111.7 million, or 4.1%, from December 31, 2022. Total consumer loan balances were $772.7 million as of June 30, 2023, an increase of $39.4 million, or 5.4%, compared to December 31, 2022. Compared to December 31, 2022, the increase in commercial loan balances was driven by growth in franchise finance and small business lending, as well as combined growth in investor commercial real estate and construction balances. The increase was partially offset by a decrease in public finance, as well as continued runoff in healthcare finance. The increase in consumer loans was due to higher balances in the recreational vehicles and trailers loan portfolios, in addition to funded residential mortgages and draws on construction/perm loans that were in the pipeline prior to exiting the business.

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Asset Quality

Nonperforming loans are comprised of nonaccrual loans and loans 90 days past due and accruing. Nonperforming assets include nonperforming loans, other real estate owned and other nonperforming assets, which consist of repossessed assets. The following table provides a summary of the Company’s nonperforming assets for the last five completed fiscal quarters.

(dollars in thousands)			June 30, 2023						March 31, 2023						December 31, 2022						September 30, 2022						June 30, 2022
Nonaccrual loans
Commercial loans:
Commercial and industrial			$	—					$	2,836					$	51					$	350					$	350
Owner-occupied commercial real estate			1,405						1,441						1,570						1,622						1,661
Single tenant lease financing			—						—						—						—						—
Small business lending 1			3,729						3,797						4,764						2,958						1,297
Total commercial loans			5,134						8,074						6,385						4,930						3,308
Consumer loans:
Residential mortgage			992						1,006						1,048						1,073						1,201
Home equity			—						—						—						—						14
Other consumer			101						141						17						3						4
Total consumer loans			1,093						1,147						1,065						1,076						1,219
Total nonaccrual loans			6,227						9,221						7,450						6,006						4,527
Past Due 90 days and accruing loans
Consumer loans:
Residential mortgage			—						—						79						—						—
Total consumer loans			—						—						79						—						—
Total past due 90 days and accruing loans			—						—						79						—						—
Total nonperforming loans			6,227						9,221						7,529						6,006						4,527
Other real estate owned
Residential mortgage			106						106						—						—						—
Total other real estate owned			106						106						—						—						—
Other nonperforming assets			64						19						42						—						23
Total nonperforming assets			$	6,397					$	9,346					$	7,571					$	6,006					$	4,550
Total nonperforming loans to total loans 2			0.17		%				0.26		%				0.22		%				0.18		%				0.15		%
Total nonperforming assets to total assets 2			0.13		%				0.20		%				0.17		%				0.14		%				0.11		%
Allowance for credit losses to total loans			0.99		%				1.02		%				0.91		%				0.92		%				0.95		%
Nonaccrual loans to total loans			0.17		%				0.26		%				0.22		%				0.18		%				0.15		%
Allowance for credit losses to nonperforming loans 2			579.1		%				400.0		%				426.0		%				497.3		%				644.0		%

1 Balance of loans are partially guaranteed by the U.S. government.

2 Includes the impact of nonperforming small business lending loans, which are guaranteed by the U.S. government.

Total nonperforming loans decreased $1.3 million, or 17.3%, to $6.2 million as of June 30, 2023 compared to $7.5 million as of December 31, 2022 due primarily to payoffs in small business lending. Total nonperforming assets decreased $1.2 million, or 15.5%, to $6.4 million as of June 30, 2023, compared to $7.6 million as of December 31, 2022, due primarily to the payoff activity discussed above, partially offset by an increase in OREO. As of June 30, 2023, the Company had one residential mortgage property in OREO with a carrying value of $0.1 million. As of December 31, 2022, the Company did not own any OREO.

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Troubled Debt Restructurings

With the adoption ASU 2022-02, effective January 1, 2023, TDR accounting was eliminated. Total TDRs as of December 31, 2022 were $5.5 million. There were two portfolio residential mortgage loans and one small business lending loan classified as new TDRs during the twelve months ended December 31, 2022 with pre-modification and post-modification balances totaling $1.6 million. The following table provides a summary of troubled debt restructurings.

(in thousands)			June 30, 2023						March 31, 2023						December 31, 2022						September 30, 2022						June 30, 2022
Troubled debt restructurings – nonaccrual			$	—					$	—					$	2,864					$	2,342					$	2,389
Troubled debt restructurings – performing			—						—						2,658						2,410						2,425
Total troubled debt restructurings			$	—					$	—					$	5,522					$	4,752					$	4,814

 

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Allowance for Credit Losses - Loans

The following table provides a rollforward of the allowance for credit losses for the last five completed fiscal quarters and the six months ended June 30, 2023 and 2022.

			Three Months Ended																														Six Months Ended
(dollars in thousands)			June 30, 2023						March 31, 2023						December 31, 2022						September 30, 2022						June 30, 2022						June 30, 2023						June 30, 2022
Balance, beginning of period, December 31, 2022			$	36,879					$	31,737					$	29,866					$	29,153					$	28,251					$	31,737					$	27,841
Adoption of ASU 2016-13 (CECL)			—						2,962						—						—						—						2,962						—
Balance, beginning of period			36,879						34,699						29,866						29,153						28,251						34,699						27,841
Provision charged to expense			753						9,373						2,109						892						1,185						10,126						1,976
Losses charged off
Commercial and industrial			—						6,965						—						—						—						6,965						—
Healthcare finance			25						—						—						—						—						25						—
Small business lending			1,358						60						192						130						—						1,418						80
Franchise finance			331						—						—						—						—						331						—
Other consumer			150						232						101						106						128						382						291
Tax refund advance loans			—						—						—						—						372						—						1,860
Total losses charged off			1,864						7,257						293						236						500						9,121						2,231
Recoveries
Commercial and industrial			217						1						3						2						—						218						—
Single tenant lease financing			—						—						—						—						—						—						1,231
Small business lending			37						3						7						3						2						40						19
Residential mortgage			1						2						2						1						1						3						2
Home equity			2						1						2						1						134						3						136
Other consumer			33						57						41						50						80						90						179
Total recoveries			290						64						55						57						217						354						1,567
Balance, end of period			$	36,058					$	36,879					$	31,737					$	29,866					$	29,153					$	36,058					$	29,153
Net charge-offs			$	1,574					$	7,193					$	238					$	179					$	283					$	8,767					$	664
Net charge-offs (recoveries) to average loans (annualized)
Commercial and industrial			(0.46		%)				27.16		%				0.00		%				0.00		%				0.00		%				13.74		%				0.00		%
Single tenant lease financing			0.00		%				0.00		%				0.00		%				0.00		%				0.00		%				0.00		%				(0.29		%)
Healthcare finance			0.02		%				0.00		%				0.00		%				0.00		%				0.00		%				0.02		%				0.00		%
Small business lending			1.50		%				0.15		%				0.14		%				0.14		%				0.00		%				1.69		%				0.11		%
Franchise finance			0.17		%				0.00		%				0.00		%				0.00		%				0.00		%				0.18		%				0.00		%
Total commercial net charge-offs (recoveries)			0.10		%				1.02		%				0.01		%				0.01		%				0.00		%				0.61		%				(0.10		%)
Residential mortgage			0.00		%				0.00		%				0.00		%				0.00		%				0.00		%				0.00		%				0.00		%
Home equity			(0.02		%)				(0.02		%)				(0.01		%)				(0.01		%)				(1.42		%)				(0.02		%)				(1.48		%)
Other consumer			0.21		%				0.36		%				0.18		%				0.20		%				0.30		%				0.28		%				0.34		%
Tax refund advance loans			0.00		%				0.00		%				0.00		%				0.00		%				23.55		%				0.00		%				12.89		%
Total consumer net charge-offs			0.03		%				0.09		%				0.01		%				0.01		%				0.11		%				0.08		%				0.71		%
Total net charge-offs to average loans			0.17		%				0.82		%				0.03		%				0.02		%				0.04		%				0.49		%				0.05		%

    The allowance for credit losses (“ACL”) was $36.1 million as of June 30, 2023, compared to $31.7 million as of December 31, 2022. The increase in the ACL reflects the day one current expected credit losses (“CECL”) adjustment of $3.0 million, as well as overall growth in the loan portfolio and changes in certain economic forecasts that impacted quantitative

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factors for certain portfolios. The ACL as a percentage of total loans was 0.99% at June 30, 2023, compared to 0.91%, at December 31, 2022. The ACL as a percentage of nonperforming loans increased to 579.1% as of June 30, 2023, compared to 426.0% as of December 31, 2022, due to the increase in the ACL, as well as the decline in nonperforming loans.

Net charge-offs of $1.6 million were recognized during the second quarter 2023, resulting in net charge-offs to average loans of 0.17%, compared to net charge-offs to average loans of 0.04% for the second quarter 2022. The increase in net charge-offs was due primarily to an increase in charge-offs in small business loans and a charge off of one franchise finance loan.

During the six months ended June 30, 2023, the Company recorded net charge-offs of $8.8 million, compared to net charge-offs of $0.7 million during the six months ended June 30, 2022. The increase in net charge-offs for the six months ended June 30, 2023 was driven primarily by a $6.9 million partial charge-off of a C&I participation loan that was placed on nonaccrual status and subsequently charged off during the first quarter 2023, as well as the increase in charge-offs in small business loans and a charge-off of one franchise finance loan discussed above and a recovery in single tenant lease financing in the first quarter 2022. These were offset by $1.9 million of charge-offs related to tax refund advance loans in 2022.

The provision for credit losses in the second quarter 2023 was $1.7 million, compared to $1.2 million for the second quarter 2022. The increase in provision for the second quarter 2023 was driven primarily by the increase in net charge-offs and an increase in the reserve for unfunded commitments, partially offset by the positive impact of economic forecasts on certain portfolios.

Investment Securities Portfolio

The following tables present the amortized cost and approximate fair value of our investment portfolio by security type for the last five completed fiscal quarters.   

(in thousands)
Amortized Cost			June 30, 2023						March 31, 2023						December 31, 2022						September 30, 2022						June 30, 2022
Securities available-for-sale
U.S. Government-sponsored agencies			$	41,024					$	38,675					$	35,606					$	38,197					$	41,542
Municipal securities			68,931						69,243						68,958						71,156						71,264
Agency mortgage-backed securities - residential			239,263						249,795						252,066						259,568						265,196
Agency mortgage-backed securities - commercial			16,311						16,739						17,142						17,825						23,312
Private label mortgage-backed securities - residential			14,749						11,445						11,777						12,320						13,259
Asset-backed securities			1,000						5,000						5,000						5,000						5,000
Corporate securities			43,613						45,623						45,634						44,644						42,655
Total available-for-sale			424,891						436,520						436,183						448,710						462,228
Securities held-to-maturity, net
Municipal securities			13,913						13,932						13,946						13,957						13,969
Agency mortgage-backed securities - residential			169,186						146,809						121,853						123,718						117,749
Agency mortgage-backed securities - commercial			5,795						5,806						5,818						5,828						5,838
Corporate securities			41,711						44,214						47,551						47,554						47,557
Total held-to-maturity, net			230,605						210,761						189,168						191,057						185,113
Total securities			$	655,496					$	647,281					$	625,351					$	639,767					$	647,341

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(in thousands)
Approximate Fair Value			June 30, 2023						March 31, 2023						December 31, 2022						September 30, 2022						June 30, 2022
Securities available-for-sale
U.S. Government-sponsored agencies			$	39,474					$	37,047					$	33,809					$	36,329					$	40,003
Municipal securities			67,209						68,636						67,276						63,537						67,923
Agency mortgage-backed securities - residential			204,141						216,752						215,092						219,191						237,546
Agency mortgage-backed securities - commercial			14,891						15,530						15,840						16,522						22,207
Private label mortgage-backed securities - residential			13,415						10,275						10,455						11,041						12,479
Asset-backed securities			1,000						4,998						4,960						4,884						4,897
Corporate securities			39,264						42,595						42,952						42,061						40,434
Total available-for-sale			379,394						395,833						390,384						393,565						425,489
Securities held-to-maturity
Municipal securities			12,950						13,144						12,832						12,668						13,356
Agency mortgage-backed securities - residential			153,593						133,267						106,741						107,570						109,054
Agency mortgage-backed securities - commercial			4,551						4,703						4,552						4,686						5,048
Corporate securities			37,549						41,349						44,358						45,053						46,561
Total held-to-maturity			208,643						192,463						168,483						169,977						174,019
Total securities			$	588,037					$	588,296					$	558,867					$	563,542					$	599,508

The approximate fair value of available-for-sale investment securities decreased $11.0 million, or 2.8%, to $379.4 million as of June 30, 2023, compared to $390.4 million as of December 31, 2022. The decrease was due primarily to decreases of $11.0 million in agency mortgage-backed securities - residential, $4.0 million in asset-backed securities and $3.7 million in corporate securities, partially offset by increases of $5.7 million in U.S. Government-sponsored agencies and $3.0 million in private label mortgage-backed securities - residential. The decrease was caused primarily by principal paydowns outpacing new purchase activity for certain available-for-sale portfolios.

Accrued Income and Other Assets

    Accrued income and other assets increased $4.4 million, or 9.7%, to $49.3 million at June 30, 2023 compared to $44.9 million at December 31, 2022. The increase was primarily related to an increase of $3.5 million in deferred tax assets and $1.4 million in fund investments, partially offset by a decrease of $0.5 million in derivative assets.

Accrued Expenses and Other Liabilities

    Accrued expenses and other liabilities increased $0.9 million, or 6.5%, to $15.5 million at June 30, 2023, compared to $14.5 million at December 31, 2022. The increase was due primarily to increases of $3.5 million in the reserve for unfunded commitments and $2.4 million in other accrued expenses, partially offset by decreases of $2.1 million in other liabilities, $1.5 million in accrued salary and benefits and $1.2 million in accrued taxes.

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Deposits  

The following table presents the composition of the Company’s deposit base for the last five completed fiscal quarters.

(dollars in thousands)						June 30, 2023												March 31, 2023												December 31, 2022												September 30, 2022												June 30, 2022
Noninterest-bearing deposits						$	119,291					3.1		%				$	140,449					3.9		%				$	175,315					5.1		%				$	142,635					4.5		%				$	126,153					4.0		%
Interest-bearing demand deposits						398,899						10.3		%				351,641						9.7		%				335,611						9.8		%				337,765						10.6		%				350,551						11.1		%
Savings accounts						28,239						0.7		%				32,762						0.9		%				44,819						1.3		%				52,228						1.6		%				65,365						2.1		%
Money market accounts						1,232,719						32.0		%				1,254,013						34.6		%				1,418,599						41.2		%				1,378,087						43.2		%				1,363,424						43.3		%
BaaS - brokered deposits						25,549						0.7		%				25,725						0.7		%				13,607						0.4		%				96,287						3.0		%				194,133						6.2		%
Certificates of deposits						1,366,409						35.5		%				1,170,094						32.3		%				874,490						25.4		%				773,040						24.2		%				800,598						25.3		%
Brokered deposits						683,202						17.7		%				647,606						17.9		%				578,804						16.8		%				412,602						12.9		%				251,877						8.0		%
Total deposits						$	3,854,308					100.0		%				$	3,622,290					100.0		%				$	3,441,245					100.0		%				$	3,192,644					100.0		%				$	3,152,101					100.0		%

   

Total deposits increased $413.1 million, or 12.0%, to $3.9 billion as of June 30, 2023, compared to $3.4 billion as of December 31, 2022. This increase was due primarily to increases of $491.9 million, or 56.3%, in certificates of deposits, $104.4 million, or 18.0%, in brokered deposits, $63.3 million, or 18.9%, in interest-bearing demand deposits and $11.9 million, or 87.8%, in BaaS - brokered deposits, partially offset by decreases of $185.9 million, or 13.1%, in money market accounts, $56.0 million, or 32.0%, in noninterest-bearing deposits and $16.6 million, or 37.0%, in savings accounts. The increase in certificates of deposits and brokered deposits was due primarily to strong consumer and small business demand for certificates of deposits in 2023, as well as the funding of brokered deposits throughout 2023 to supplement on-balance sheet liquidity. The increase in interest-bearing demand deposits was due primarily to growth in BaaS deposits. The decrease in money market accounts was due primarily to certain customer activity that can be periodically volatile, as well as certain higher-cost relationships that were exited during 2023. The decline in noninterest-bearing deposits was due primarily to drawdowns from commercial real estate development and construction clients contributing equity to projects the Company is financing.

Uninsured deposit balances represented 24% of total deposits at June 30, 2023, down from 33% at December 31, 2022. These balances include Indiana-based municipal deposits, which are insured by the Indiana Board for Depositories, as well as larger balance accounts under contractual agreements that only allow withdrawal under certain conditions. After subtracting these types of deposits, the adjusted uninsured deposit balance decreases to 18%, down from 24% as of December 31, 2022.

Recent Debt Offerings

    In August 2021, the Company issued $60.0 million aggregate principal amount of 3.75% Fixed-to-Floating Rate Subordinated Notes due 2031 (the “2031 Notes”) in a private placement. The 2031 Notes initially bear a fixed interest rate of 3.75% per year to, but excluding, September 1, 2026, and thereafter a floating rate equal to the then-current benchmark rate (initially three-month Term SOFR plus 3.11%). The 2031 Notes are scheduled to mature on September 1, 2031. The 2031 Notes are unsecured subordinated obligations of the Company and may be repaid, without penalty, on any interest payment date on or after September 1, 2026. The 2031 Notes are intended to qualify as Tier 2 capital under regulatory guidelines. Pursuant to the terms of a Registration Rights Agreement between the Company and the initial purchasers of the 2031 Notes, the Company offered to exchange the 2031 Notes for subordinated notes that are registered under the Securities Act of 1933, as amended, and have substantially the same terms as the 2031 Notes. On December 30, 2021, the Company completed an exchange of $59.3 million principal amount of the unregistered 2031 Notes for registered 2031 Notes in satisfaction of its obligations under the registration rights agreement. Holders of $0.7 million of unregistered 2031 Notes did not participate in the exchange.

Regulatory Capital Requirements

The Company and the Bank are subject to various regulatory capital requirements administered by state and federal banking agencies. Capital adequacy guidelines and, additionally for banks, prompt corrective action regulations, involve quantitative measures of assets, liabilities, and certain off-balance-sheet items calculated under regulatory accounting practices. Capital amounts and classifications are also subject to qualitative judgments by regulators about components, risk weighting and other factors.

The Basel III Capital Rules became effective for the Company and the Bank on January 1, 2015, subject to a phase-in period for certain provisions. Quantitative measures established by the Basel III Capital Rules to ensure capital adequacy require the maintenance of minimum amounts and ratios of Common Equity Tier 1 capital, Tier 1 capital and Total capital, as defined in the regulations, to risk-weighted assets, and of Tier 1 capital to adjusted quarterly average assets (“Leverage Ratio”).

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The Basel III Capital Rules were fully phased in on January 1, 2019 and require the Company and the Bank to maintain: 1) a minimum ratio of Common Equity Tier 1 capital to risk-weighted assets of 4.5%, plus a 2.5% “capital conservation buffer” (resulting in a minimum ratio of Common Equity Tier 1 capital to risk-weighted assets of 7.0%); 2) a minimum ratio of Tier 1 capital to risk-weighted assets of 6.0%, plus the capital conservation buffer (resulting in a minimum Tier 1 capital ratio of 8.5%); 3) a minimum ratio of Total capital to risk-weighted assets of 8.0%, plus the capital conservation buffer (resulting in a minimum Total capital ratio of 10.5%); and 4) a minimum Leverage Ratio of 4.0%.

The capital conservation buffer is designed to absorb losses during periods of economic stress. Failure to maintain the minimum Common Equity Tier 1 capital ratio plus the capital conservation buffer will result in potential restrictions on a banking institution’s ability to pay dividends, repurchase stock and/or pay discretionary compensation to its employees.

The following tables present actual and required capital ratios as of June 30, 2023 and December 31, 2022 for the Company and the Bank under the Basel III Capital Rules. The minimum required capital amounts presented include the minimum required capital levels as of June 30, 2023 and December 31, 2022, which are based on the Basel III Capital Rules. Capital levels required to be considered well capitalized are based upon prompt corrective action regulations, as amended to reflect the changes under the Basel III Capital Rules.

As permitted by the federal banking regulatory agencies, the Company has elected the option to delay the impact of the day one adoption of ASC 326. The transition adjustments of $4.5 million will be phased into the regulatory capital calculations over a three-year period, with 25% of the adjustment recognized in 2023, 50% of the adjustment recognized in 2024, 75% of the adjustment recognized in 2025 and 100% of the adjustment recognized in 2026.

			Actual																		Minimum Capital Required - Basel III												Minimum Required to be Considered Well Capitalized
(dollars in thousands)			Capital Amount						Ratio																		Capital Amount						Ratio						Capital Amount						Ratio
As of June 30, 2023:
Common equity tier 1 capital to risk-weighted assets
Consolidated			$	378,819					10.10		%																$	262,422					7.00		%				N/A						N/A
Bank			463,429						12.39		%																261,755						7.00		%				$	243,058					6.50		%
Tier 1 capital to risk-weighted assets
Consolidated			378,819						10.10		%																318,655						8.50		%				N/A						N/A
Bank			463,429						12.39		%																317,845						8.50		%				299,148						8.00		%
Total capital to risk-weighted assets
Consolidated			520,019						13.87		%																393,633						10.50		%				N/A						N/A
Bank			499,945						13.37		%																392,632						10.50		%				373,936						10.00		%
Leverage ratio
Consolidated			378,819						7.63		%																198,515						4.00		%				N/A						N/A
Bank			463,429						9.35		%																198,171						4.00		%				247,714						5.00		%

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			Actual																		Minimum Capital Required - Basel III												Minimum Required to be Considered Well Capitalized
(dollars in thousands)			Capital Amount						Ratio																		Capital Amount						Ratio						Capital Amount						Ratio
As of December 31, 2022:
Common equity tier 1 capital to risk-weighted assets
Consolidated			$	390,150					10.93		%																$	249,795					7.00		%				N/A						N/A
Bank			466,257						13.10		%																249,191						7.00		%				$	231,392					6.50		%
Tier 1 capital to risk-weighted assets
Consolidated			390,150						10.93		%																303,323						8.50		%				N/A						N/A
Bank			466,257						13.10		%																302,590						8.50		%				284,790						8.00		%
Total capital to risk-weighted assets
Consolidated			526,419						14.75		%																374,693						10.50		%				N/A						N/A
Bank			497,994						13.99		%																373,787						10.50		%				355,988						10.00		%
Leverage ratio
Consolidated			390,150						9.06		%																172,330						4.00		%				N/A						N/A
Bank			466,257						10.84		%																172,093						4.00		%				215,116						5.00		%

Shareholders’ Dividends

The Company’s Board of Directors declared a cash dividend of $0.06 per share of common stock payable July 17, 2023 to shareholders of record as of June 30, 2023. The Company expects to continue to pay cash dividends on a quarterly basis; however, the declaration and amount of any future cash dividends will be subject to the sole discretion of the Board of Directors and will depend upon many factors, including the Company’s results of operations, financial condition, capital requirements, regulatory and contractual restrictions (including with respect to the Company’s outstanding subordinated debt), business strategy and other factors deemed relevant by the Board of Directors.

As of June 30, 2023, the Company had $107.0 million principal amount of subordinated debt outstanding evidenced by the 2029 Notes, 2030 Note and 2031 Notes. The agreements that govern our outstanding subordinated debt prohibit the Company from paying any dividends on its common stock or making any other distributions to shareholders at any time when there shall have occurred, and be continuing to occur, an event of default under the applicable agreement. If an event of default were to occur and the Company did not cure it, the Company would be prohibited from paying any dividends or making any other distributions to shareholders or from redeeming or repurchasing any common stock.

Capital Resources

The Company believes it has sufficient liquidity and capital resources to meet its cash and capital expenditure requirements for the next twelve months and longer. The Company may explore strategic alternatives, including additional asset, deposit or revenue generation channels that complement our small business, commercial and consumer banking platforms, which may require additional capital. If the Company is unable to secure such capital at favorable terms, its ability to take advantage of such opportunities could be adversely affected.

In October 2021, the Company’s Board of Directors approved a stock repurchase program authorizing the repurchase of up to $30.0 million, which was subsequently increased to $35.0 million, of our outstanding common stock from time to time on the open market or in privately negotiated transactions. The stock repurchase authorization was scheduled to expire on December 31, 2022. Under this program, the Company repurchased 855,956 shares of common stock through December 19, 2022, at an average price of $36.31, for a total investment of $31.1 million.

In December 2022, the Company’s Board of Directors approved a new stock repurchase program authorizing the repurchase of up to $25.0 million of the Company’s outstanding stock from time to time on the open market or in privately negotiated transactions. The stock repurchase program is scheduled to expire on December 31, 2023, and replaces the stock repurchase program mentioned above. Under this program, the Company repurchased 411,188 shares of common stock through June 30, 2023, at an average price of $19.07, for a total investment of $7.8 million.

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Various factors determine the amount and timing of our share repurchases, including our capital requirements, organic growth and other strategic opportunities, economic and market conditions (including the trading price of our stock), and regulatory and legal considerations. See Part II, Item 2, of this report for information regarding recent repurchase activity and our remaining authority under the program.

Liquidity

Liquidity management is the process used by the Company to manage the continuing flow of funds necessary to meet its financial commitments on a timely basis and at a reasonable cost while also maintaining safe and sound operations. Liquidity, represented by cash and investment securities, is a product of the Company’s operating, investing and financing activities. The primary sources of funds are deposits, principal and interest payments on loans and investment securities, maturing loans and investment securities, access to wholesale funding sources and collateralized borrowings. While scheduled payments and maturities of loans and investment securities are relatively predictable sources of funds, deposit flows are greatly influenced by interest rates, general economic conditions and competition. Therefore, the Company supplements deposit growth and enhances interest rate risk management through borrowings and wholesale funding, which are generally advances from the Federal Home Loan Bank and brokered deposits.

The Company holds cash and investment securities that qualify as liquid assets to maintain adequate liquidity to ensure safe and sound operations and meet its financial commitments. At June 30, 2023, on a consolidated basis, the Company had $845.0 million in cash and cash equivalents and investment securities available-for-sale and $32.0 million in loans held-for-sale that were generally available for its cash needs. The Company can also generate funds from wholesale funding sources and collateralized borrowings. At June 30, 2023, the Bank had the ability to borrow an additional $729.2 million from the FHLB, the Federal Reserve and correspondent bank Fed Funds lines of credit, which when combined with cash balances, totaled $1.2 billion and represented 127% of adjusted uninsured deposit balances.

The Company is a separate legal entity from the Bank and must provide for its own liquidity. In addition to its operating expenses, the Company is responsible for paying any dividends declared to its common shareholders and interest and principal on outstanding debt. The Company’s primary sources of funds are cash maintained at the holding company level and dividends from the Bank, the payment of which is subject to regulatory limits. At June 30, 2023, the Company, on an unconsolidated basis, had $12.3 million in cash generally available for its cash needs, which is in excess of its current annual regular shareholder dividend and operating expenses.

 

The Company uses its sources of funds primarily to meet ongoing financial commitments, including withdrawals by depositors, credit commitments to borrowers, operating expenses and capital expenditures. At June 30, 2023, approved outstanding loan commitments, including unused lines of credit and standby letters of credit, amounted to $544.8 million. Certificates of deposits and brokered deposits scheduled to mature in one year or less at June 30, 2023 totaled $1.1 billion.

Management is not aware of any other events or regulatory requirements that, if implemented, are likely to have a material effect on either the Company’s or the Bank’s liquidity.

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Reconciliation of Non-GAAP Financial Measures

This Management’s Discussion and Analysis contains financial information determined by methods other than in accordance with GAAP. Non-GAAP financial measures, specifically tangible common equity, tangible assets, tangible book value per common share, tangible common equity to tangible assets, average tangible common equity, return on average tangible common equity, total interest income - FTE, net interest income - FTE, net interest margin - FTE, adjusted total revenue, adjusted noninterest income, adjusted noninterest expense, adjusted income (loss) before income taxes, adjusted income tax (benefit) provision, adjusted net income, adjusted diluted earnings (loss) per share, adjusted return on average assets, adjusted return on average shareholders’ equity and adjusted return on average tangible common equity are used by the Company’s management to measure the strength of its capital and analyze profitability, including its ability to generate earnings on tangible capital invested by its shareholders. The Company also believes that it is a standard practice in the banking industry to present total interest income, net interest income and net interest margin on a fully-taxable equivalent basis, as those measures provide useful information for peer comparisons. Although the Company believes these non-GAAP financial measures provide a greater understanding of its business, they should not be considered a substitute for financial measures determined in accordance with GAAP, nor are they necessarily comparable to non-GAAP financial measures that may be presented by other companies. Reconciliations of these non-GAAP financial measures to the most directly comparable GAAP financial measures are included in the following table for the last five completed fiscal quarters and the six months ended June 30, 2023 and 2022.

(dollars in thousands, except share and per share data)			Three Months Ended																														Six Months Ended
			June 30, 2023						March 31, 2023						December 31, 2022						September 30, 2022						June 30, 2022						June 30, 2023						June 30, 2022
Total equity - GAAP			$	354,332					$	355,572					$	364,974					$	360,857					$	365,332					$	354,332					$	365,332
Adjustments:
Goodwill			(4,687)						(4,687)						(4,687)						(4,687)						(4,687)						(4,687)						(4,687)
Tangible common equity			$	349,645					$	350,885					$	360,287					$	356,170					$	360,645					$	349,645					$	360,645
Total assets - GAAP			$	4,947,049					$	4,721,319					$	4,543,104					$	4,264,424					$	4,099,806					$	4,947,049					$	4,099,806
Adjustments:
Goodwill			(4,687)						(4,687)						(4,687)						(4,687)						(4,687)						(4,687)						(4,687)
Tangible assets			$	4,942,362					$	4,716,632					$	4,538,417					$	4,259,737					$	4,095,119					$	4,942,362					$	4,095,119
Common shares outstanding			8,774,507						8,943,477						9,065,883						9,290,885						9,404,000						8,774,507						9,404,000
Book value per common share			$	40.38					$	39.76					$	40.26					$	38.84					$	38.85					$	40.38					$	38.85
Effect of goodwill			(0.53)						(0.53)						(0.52)						(0.50)						(0.50)						(0.53)						(0.50)
Tangible book value per common share			$	39.85					$	39.23					$	39.74					$	38.34					$	38.35					$	39.85					$	38.35
Total shareholders’ equity to assets			7.16		%				7.53		%				8.03		%				8.46		%				8.91		%				7.16		%				8.91		%
Effect of goodwill			(0.09		%)				(0.09		%)				(0.09		%)				(0.10		%)				(0.10		%)				(0.09		%)				(0.10		%)
Tangible common equity to tangible assets			7.07		%				7.44		%				7.94		%				8.36		%				8.81		%				7.07		%				8.81		%
Total average equity - GAAP			$	358,312					$	363,273					$	364,657					$	371,303					$	374,274					$	360,779					$	377,504
Adjustments:
Average goodwill			(4,687)						(4,687)						(4,687)						(4,687)						(4,687)						(4,687)						(4,687)
Average tangible common equity			$	353,625					$	358,586					$	359,970					$	366,616					$	369,587					$	356,092					$	372,817
Return on average shareholders’ equity			4.35		%				(3.37		%)				6.91		%				9.01		%				10.23		%				0.48		%				11.09		%
Effect of goodwill			0.05		%				(0.04		%)				0.09		%				0.12		%				0.13		%				0.01		%				0.14		%
Return on average tangible common equity			4.40		%				(3.41		%)				7.00		%				9.13		%				10.36		%				0.49		%				11.23		%

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(dollars in thousands, except share and per share data)			Three Months Ended																														Six Months Ended
			June 30, 2023						March 31, 2023						December 31, 2022						September 30, 2022						June 30, 2022						June 30, 2023						June 30, 2022
Total interest income			$	58,122					$	52,033					$	45,669					$	36,034					$	36,106					$	110,155					$	72,140
Adjustments:
Fully-taxable equivalent adjustments 1			1,347						1,383						1,384						1,314						1,377						2,731						2,691
Total interest income - FTE			$	59,469					$	53,416					$	47,053					$	37,348					$	37,483					$	112,886					$	74,831
Net interest income			$	18,145					$	19,574					$	21,669					$	25,750					$	25,680					$	37,719					$	51,430
Adjustments:
Fully-taxable equivalent adjustments 1			1,347						1,383						1,384						1,314						1,377						2,731						2,691
Net interest income - FTE			$	19,492					$	20,957					$	23,053					$	27,064					$	27,057					$	40,450					$	54,121
Net interest margin			1.53		%				1.76		%				2.09		%				2.40		%				2.60		%				1.64		%				2.58		%
Effect of fully-taxable equivalent adjustments 1			0.11		%				0.13		%				0.13		%				0.13		%				0.14		%				0.12		%				0.13		%
Net interest margin - FTE			1.64		%				1.89		%				2.22		%				2.53		%				2.74		%				1.76		%				2.71		%
1 Assuming a 21% tax rate

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(dollars in thousands, except share and per share data)						Three Months Ended																														Six Months Ended
						June 30, 2023						March 31, 2023						December 31, 2022						September 30, 2022						June 30, 2022						June 30, 2023						June 30, 2022
Total Revenue- GAAP						$	24,016					$	25,020					$	27,476					$	28,310					$	29,994					$	49,036					$	62,564
Adjustments:
Mortgage-related revenue						—						(65)						—						—						—						—						—
Adjusted total revenue						$	24,016					$	24,955					$	27,476					$	28,310					$	29,994					$	49,036					$	62,564
Noninterest income - GAAP						$	5,871					$	5,446					$	5,807					$	4,316					$	4,314					$	11,317					$	11,134
Adjustments:
Mortgage-related revenue						—						(65)						—						—						—						(65)						—
Adjusted noninterest income						$	5,871					$	5,381					$	5,807					$	4,316					$	4,314					$	11,252					$	11,134
Noninterest expense - GAAP						$	18,670					$	20,954					$	18,513					$	17,995					$	17,985					$	39,624					$	36,765
Adjustments:
Mortgage-related costs						—						(3,052)						—						—						—						(3,052)						—
Acquisition-related expenses						—						—						—						—						(103)						—						(273)
Nonrecurring consulting fee						—						—						—						—						—						—						—
Write-down of Software						—						—						—						(125)						—						—						(875)
Discretionary inflation bonus						—						—						—						—						(531)						—						(531)
Accelerated equity compensation						—						—						—						—						(289)						—						(289)
Adjusted noninterest expense						$	18,670					$	17,902					$	18,513					$	17,870					$	17,062					$	36,572					$	34,797
Income (loss) before income taxes - GAAP						$	3,648					$	(5,349)					$	6,854					$	9,423					$	10,824					$	(1,701)					$	23,823
Adjustments:1
Mortgage-related revenue						—						(65)						—						—						—						(65)						—
Mortgage-related costs						—						3,052						—						—						—						3,052						—
Partial charge-off of C&I participation loan						—						6,914						—						—						—						6,914						—
Acquisition-related expenses						—						—						—						—						103						—						273
Nonrecurring consulting fee						—						—						—						—						—						—						875
Write-down of Software						—						—						—						125						—						—						—
Discretionary inflation bonus						—						—						—						—						531						—						531
Accelerated equity compensation						—						—						—						—						289						—						289
Adjusted income before income taxes						$	3,648					$	4,552					$	6,854					$	9,548					$	11,747					$	8,200					$	25,791
Income tax (benefit) provision - GAAP						$	(234)					$	(2,332)					$	503					$	987					$	1,279					$	(2,566)					$	3,069
Adjustments:1
Mortgage-related revenue						—						(14)						—						—						—						(14)						—
Mortgage-related costs						—						641						—						—						—						641						—
Partial charge-off of C&I participation loan						—						1,452						—						—						—						1,452						—
Acquisition-related expenses						—						—						—						—						21						—						57
Nonrecurring consulting fee						—						—						—						—						—						—						184
Write-down of Software						—						—						—						26						—						—						—
Discretionary inflation bonus						—						—						—						—						112						—						112
Accelerated equity compensation						—						—						—						—						61						—						61
Adjusted income tax (benefit) provision						$	(234)					$	(253)					$	503					$	1,013					$	1,473					$	(487)					$	3,483
1 Assuming a 21% tax rate

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(dollars in thousands, except share and per share data)						Three Months Ended																														Six Months Ended
						June 30, 2023						March 31, 2023						December 31, 2022						September 30, 2022						June 30, 2022						June 30, 2023						June 30, 2022
Net income (loss) - GAAP						$	3,882					$	(3,017)					$	6,351					$	8,436					$	9,545					$	865					$	20,754
Adjustments:
Mortgage-related revenue						—						(51)						—						—						—						(51)						—
Mortgage-related costs						—						2,411						—						—						—						2,411						—
Partial charge-off of C&I participation loan						—						5,462						—						—						—						5,462						—
Acquisition-related expenses						—						—						—						—						82						—						216
Nonrecurring consulting fee						—						—						—						—						—						—						691
Write-down of Software						—						—						—						99						—						—						—
Discretionary inflation bonus						—						—						—						—						419						—						419
Accelerated equity compensation						—						—						—						—						228						—						228
Adjusted net income						$	3,882					$	4,805					$	6,351					$	8,535					$	10,274					$	8,687					$	22,308
Diluted average common shares outstanding						8,908,180						9,024,072						9,343,533						9,525,855						9,658,689						8,980,262						9,764,232
Diluted earnings (loss) per share - GAAP						$	0.44					$	(0.33)					$	0.68					$	0.89					$	0.99					$	0.10					$	2.13
Adjustments:
Mortgage-related revenue						—						(0.01)						—						—						—						(0.01)						—
Mortgage-related costs						—						0.27						—						—						—						0.27						—
Effect of partial charge-off of C&I participation loan						—						0.60						—						—						—						0.61						—
Effect of acquisition-related expenses						—						—						—						—						0.01						—						0.02
Effect of nonrecurring consulting fee						—						—						—						—						—						—						0.07
Effect of write-down of software						—						—						—						0.01						—						—						—
Effect of discretionary inflation bonus						—						—						—						—						0.04						—						0.04
Effect of accelerated equity compensation						—						—						—						—						0.02						—						0.02
Adjusted diluted earnings per share						$	0.44					$	0.53					$	0.68					$	0.90					$	1.06					$	0.97					$	2.28
Return on average assets						0.32		%				(0.26		%)				0.59		%				0.82		%				0.93		%				0.04		%				1.01		%
Effect of mortgage-related revenue						0.00		%				0.00		%				0.00		%				0.00		%				0.00		%				0.00		%				0.00		%
Effect of mortgage-related costs						0.00		%				0.21		%				0.00		%				0.00		%				0.00		%				0.10		%				0.00		%
Effect of partial charge-off of C&I participation loan						0.00		%				0.48		%				0.00		%				0.00		%				0.00		%				0.23		%				0.00		%
Effect of acquisition-related expenses						0.00		%				0.00		%				0.00		%				0.00		%				0.01		%				0.00		%				0.01		%
Effect of nonrecurring consulting fee						0.00		%				0.00		%				0.00		%				0.00		%				0.00		%				0.00		%				0.03		%
Effect of write-down of software						0.00		%				0.00		%				0.00		%				0.01		%				0.00		%				0.00		%				0.00		%
Effect of discretionary inflation bonus						0.00		%				0.00		%				0.00		%				0.00		%				0.04		%				0.00		%				0.02		%
Effect of accelerated equity compensation						0.00		%				0.00		%				0.00		%				0.00		%				0.02		%				0.00		%				0.01		%
Adjusted return on average assets						0.32		%				0.43		%				0.59		%				0.83		%				1.00		%				0.37		%				1.08		%
Return on average shareholders' equity						4.35		%				(3.37		%)				6.91		%				9.01		%				10.23		%				0.48		%				11.09		%
Effect of mortgage-related revenue						0.00		%				(0.06		%)				0.00		%				0.00		%				0.00		%				(0.03		%)				0.00		%

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(dollars in thousands, except share and per share data)						Three Months Ended																														Six Months Ended
						June 30, 2023						March 31, 2023						December 31, 2022						September 30, 2022						June 30, 2022						June 30, 2023						June 30, 2022
Effect of mortgage-related costs						0.00		%				2.69		%				0.00		%				0.00		%				0.00		%				1.35		%				0.00		%
Effect of partial charge-off of C&I participation loan						0.00		%				6.10		%				0.00		%				0.00		%				0.00		%				3.05		%				0.00		%
Effect of acquisition-related expenses						0.00		%				0.00		%				0.00		%				0.00		%				0.09		%				0.00		%				0.12		%
Effect of nonrecurring consulting fee						0.00		%				0.00		%				0.00		%				0.00		%				0.00		%				0.00		%				0.37		%
Effect of write-down of software						0.00		%				0.00		%				0.00		%				0.11		%				0.00		%				0.00		%				0.00		%
Effect of discretionary inflation bonus						0.00		%				0.00		%				0.00		%				0.00		%				0.45		%				0.00		%				0.22		%
Effect of accelerated equity compensation						0.00		%				0.00		%				0.00		%				0.00		%				0.24		%				0.00		%				0.12		%
Adjusted return on average shareholders' equity						4.35		%				5.36		%				6.91		%				9.12		%				11.01		%				4.85		%				11.92		%
Return on average tangible common equity						4.40		%				(3.41		%)				7.00		%				9.13		%				10.36		%				0.49		%				11.23		%
Effect of mortgage-related revenue						0.00		%				(0.06		%)				0.00		%				0.00		%				0.00		%				(0.03		%)				0.00		%
Effect of mortgage-related costs						0.00		%				2.73		%				0.00		%				0.00		%				0.00		%				1.37		%				0.00		%
Effect of partial charge-off of C&I participation loan						0.00		%				6.18		%				0.00		%				0.00		%				0.00		%				3.09		%				0.00		%
Effect of acquisition-related expenses						0.00		%				0.00		%				0.00		%				0.00		%				0.09		%				0.00		%				0.12		%
Effect of nonrecurring consulting fee						0.00		%				0.00		%				0.00		%				0.00		%				0.00		%				0.00		%				0.37		%
Effect of write-down of software						0.00		%				0.00		%				0.00		%				0.11		%				0.00		%				0.00		%				0.00		%
Effect of discretionary inflation bonus						0.00		%				0.00		%				0.00		%				0.00		%				0.45		%				0.00		%				0.23		%
Effect of accelerated equity compensation						0.00		%				0.00		%				0.00		%				0.00		%				0.25		%				0.00		%				0.12		%
Adjusted return on average tangible common equity						4.40		%				5.44		%				7.00		%				9.24		%				11.15		%				4.92		%				12.07		%

Critical Accounting Policies and Estimates

 

There have been changes in the Company’s critical accounting policies or estimates from those disclosed in its Annual Report on Form 10-K for the year ended December 31, 2022. Refer to Note 1 Basis of Presentation for further details.

 

Recent Accounting Pronouncements

 

Refer to Note 15 to the condensed consolidated financial statements.

Off-Balance Sheet Arrangements

 

In the ordinary course of business, the Company enters into financial transactions to extend credit, interest rate swap agreements and forms of commitments that may be considered off-balance sheet arrangements. Interest rate swaps are arranged to receive hedge accounting treatment and are classified as either fair value or cash flow hedges. Fair value hedges are purchased to convert certain fixed rate assets to floating rate. Cash flow hedges are used to convert certain variable rate liabilities into fixed rate liabilities. At both June 30, 2023 and December 31, 2022, the Company had interest rate swaps with notional amounts of $260.0 million. Additionally, prior to the Company’s decision to exit its consumer mortgage business in the first quarter 2023, we entered into forward contracts related to our mortgage banking business to hedge the exposures we have from commitments to extend new residential mortgage loans to our customers and from our mortgage loans held-for-sale. At June 30, 2023, the company did not have any commitments to sell residential real estate loans. At December 31, 2022, the Company had commitments to sell residential real estate loans of $17.0 million. Refer to Note 13 to the condensed consolidated financial statements for additional information about derivative financial instruments.

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ITEM 3.    QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

     Market risk is the risk of loss arising from adverse changes in the fair value of financial instruments due to changes in interest rates, foreign exchange rates and equity prices. The primary source of market risk for the Company is interest rate risk, which can be defined as the risk to earnings and the value of our equity resulting from changes in market interest rates. Interest rate risk arises in the normal course of business to the extent that there are timing and volume differences between the amount of interest-earning assets and the amount of interest-bearing liabilities that are prepaid, withdrawn, re-priced or mature in specified periods. We seek to achieve consistent growth in net interest income and equity while managing volatility arising from shifts in market interest rates.

We monitor the Company’s interest rate risk position using income simulation models and economic value of equity (“EVE”) sensitivity analysis that capture both short-term and long-term interest rate risk exposure. Income simulation involves forecasting net interest income (“NII”) under a variety of interest rate scenarios. We use EVE sensitivity analysis to understand the impact of changes in interest rates on long-term cash flows, income and capital. EVE is calculated by discounting the cash flows for all balance sheet instruments under different interest-rate scenarios. Modeling the sensitivity of NII and EVE to changes in market interest rates is highly dependent on the assumptions incorporated into the modeling process, especially those pertaining to non-maturity deposit accounts. These assumptions are reviewed and refined on an ongoing basis by the Company. We continually model our NII and EVE positions with various interest rate scenarios and assumptions of future balance sheet composition. We utilize implied forward rates as its base case scenario which reflects market expectations for rate increases over the next 24 months. Presented below is the estimated impact on our NII and EVE position as of June 30, 2023, assuming a static balance sheet and instantaneous parallel shifts in interest rates:

			% Change from Base Case for Instantaneous Parallel Changes in Rates
			Implied Forward Curve -200 Basis Points						Implied Forward Curve -100 Basis Points						Base Implied Forward Curve						Implied Forward Curve +50 Basis Points						Implied Forward Curve +100 Basis Points
NII - Year 1			20.51		%				11.57		%				N/A						(4.26		%)				(8.63		%)
NII - Year 2			51.54		%				40.44		%				26.30		%				19.90		%				12.59		%
EVE			27.06		%				17.46		%				N/A						(7.48		%)				(15.13		%)

To supplement the instantaneous rate shocks required by regulatory guidance, we also calculate our interest rate risk position assuming a gradual change in market interest rates. This gradual change is commonly referred to as a “rate ramp” and evenly allocates a change in interest rates over a specified time period.

Presented below is the estimated impact on the Company’s NII and EVE position as of June 30, 2023, assuming a static balance sheet and gradual parallel shifts in interest rates:

			% Change from Base Case for Gradual Changes in Rates
			Implied Forward Curve -200 Basis Points						Implied Forward Curve -100 Basis Points						Base Implied Forward Curve						Implied Forward Curve +50 Basis Points						Implied Forward Curve +100 Basis Points
NII - Year 1			8.82		%				4.77		%				N/A						(2.37		%)				(4.67		%)
NII - Year 2			50.49		%				39.76		%				26.30		%				19.18		%				11.22		%
EVE			23.91		%				15.28		%				N/A						(7.72		%)				(15.44		%)

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The NII and EVE figures presented in the tables above are reflective of a static balance sheet, and do not incorporate either balance sheet growth or contraction, or strategies to increase net interest income while managing volatility arising from shifts in market interest rates. As such, it is likely that actual results will differ from what is presented in the tables above. Balance sheet strategies to achieve such objectives may include:

•Increasing the proportion of low-duration or variable-rate loans to total loans, including organic growth in small business, construction or C&I lending, and declines in longer-term loan portfolios

•Selling longer-term fixed rate loans

•Increasing the proportion of lower cost non-maturity deposits to total deposits

•Extending the duration of wholesale funding

•Executing derivative strategies to synthetically extend liabilities or shorten asset duration

•Repositioning the investment portfolio to manage its duration

ITEM 4.    CONTROLS AND PROCEDURES

 

Evaluation of Disclosure Controls and Procedures

 

The Company maintains disclosure controls and procedures that are designed to provide reasonable assurance that information required to be disclosed in reports that it files or submits under the Securities Exchange Act of 1934, as amended (the “Exchange Act”), is recorded, processed, summarized, and reported within the time period specified in the SEC’s rules and forms. These controls and procedures are also designed to provide reasonable assurance that such information is accumulated and communicated to management, including the principal executive and principal financial officers, as appropriate, to allow timely decisions regarding required disclosures. In designing and evaluating disclosure controls and procedures, the Company has recognized that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives. Management is required to apply judgment in evaluating its controls and procedures.

 

The Company performed an evaluation under the supervision and with the participation of management, including the principal executive and principal financial officers, to assess the effectiveness of the design and operation of its disclosure controls and procedures under the Exchange Act. Based on that evaluation, our management, including our principal executive officer and principal financial officer, concluded that our disclosure controls and procedures were effective at a reasonable assurance level as of June 30, 2023.

Changes in Internal Control over Financial Reporting

 

There has been no change in the Company’s internal control over financial reporting during the quarter ended June 30, 2023 that has materially affected, or is reasonably likely to materially affect, its internal control over financial reporting.

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PART II

 

ITEM 1.    LEGAL PROCEEDINGS

 

Neither we nor any of our subsidiaries are party to any material legal proceedings. From time to time, the Bank is a party to legal actions arising from its normal business activities.

 

ITEM 1A.    RISK FACTORS

 

The following represents a material change in our risk factors from those previously disclosed in Part I, Item 1A, of our Annual Report on Form 10-K for the year ended December 31, 2022.

Recent negative developments in the banking industry could adversely affect our current and future business operations and financial condition.

The recent bank failures and related negative media attention have caused significant market trading volatility among publicly traded bank and financial holding companies, particularly for regional and community banks. These developments have negatively impacted customer confidence in smaller banks, which could prompt customers to move their deposits to larger financial institutions. Further, competition for and costs of deposits have similarly increased, putting pressure on net interest margin. While we have taken actions to improve our costs of funds, there is no guarantee that such actions will be successful or sufficient in the current or future market.

We also anticipate increased regulatory scrutiny – in the course of routine examinations and otherwise – and new regulations directed towards banks of similar size to the Bank designed to respond to recent negative developments in the banking industry, all of which may increase our costs of doing business and reduce our profitability. Among other things, there may be increased focus by both regulators and investors on deposit composition, the level of uninsured deposits, brokered deposits, unrealized losses in securities portfolios, liquidity, CRE composition and concentration, capital and general oversight and control of the foregoing. The Bank could face increased scrutiny or be viewed as higher risk by regulators and/or the investor community, which could negatively affect our future results of operations and financial condition.

ITEM 2.    UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

 

Repurchases of Common Stock

In December 2022, the Company’s Board of Directors approved a stock repurchase program authorizing the repurchase of up to $25.0 million of the Company’s outstanding stock from time to time on the open market or in privately negotiated transactions. The stock repurchase program is scheduled to expire on December 31, 2023. Under this program, the Company has repurchased 411,188 shares of common stock through June 30, 2023, at an average price of $19.07, for a total investment of $7.8 million.

The following table presents information with respect to purchases of the Company’s common stock made by or on behalf of the Company or any “affiliated purchaser,” as defined in Rule 10b-18(a)(3), during the second quarter 2023.

			Total Number of Shares Purchased						Average Price Paid Per Share						Total Number of Shares Purchased As Part of Publicly Announced Programs						Approximate Dollar Value Of Shares That May Yet Be Purchased Under The Program
April 1, 2023 - April 30, 2023			38,000						$	16.01					38,000						$	19,294
May 1, 2023 - May 31, 2023			88,000						$	11.61					88,000						$	18,272
June 1, 2023 - June 30, 2023			77,000						$	14.48					77,000						$	17,157
Total			203,000												203,000

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Limitations on the Payment of Dividends

The ability of the Company to make capital distributions, including paying dividends and repurchasing shares, depends upon our receipt of dividends from the Bank. The ability of the Bank to pay dividends is limited by state and federal laws and regulations, including the requirement for the Bank to obtain the prior approval of the Indiana Department of Financial Institutions (“DFI”) before paying a dividend that, together with other dividends it has paid during a calendar year, would exceed the sum of its net income for the year to date combined with its retained net income for the previous two years. The ability of the Bank to pay dividends is further affected by the requirement to maintain adequate capital pursuant to applicable capital adequacy guidelines and regulations, and it is generally prohibited from paying any dividends if, following payment thereof, it would be undercapitalized. Notwithstanding the availability of funds for dividends, the FDIC and the DFI may prohibit the payment of dividends by the Bank if either or both determine such payment would constitute an unsafe or unsound practice. In addition, under the Basel III Capital Rules, institutions that seek the freedom to pay dividends have to maintain 2.5% in Common Equity Tier 1 Capital attributable to the capital conservation buffer.

ITEM 3.    DEFAULTS UPON SENIOR SECURITIES

 

None.

 

ITEM 4.    MINE SAFETY DISCLOSURES

 

Not Applicable.

 

ITEM 5.    OTHER INFORMATION

None.

 

ITEM 6.    EXHIBITS 

Exhibit No.

Description

Method of Filing

3.1

Amended and Restated Articles of Incorporation of First Internet Bancorp (incorporated by reference to Exhibit 3.1 to current report on Form 8-K filed May 21, 2020)

Incorporated by Reference

3.2

Amended and Restated Bylaws of First Internet Bancorp (incorporated by reference to Exhibit 3.2 to current report on Form 8-K filed May 21, 2020)

Incorporated by Reference

10.1

Form of Non-Employee Director Restricted Stock Award Agreement Under 2022 Equity Incentive Plan *

Filed Electronically

31.1

Rule 13a-14(a)/15d-14(a) Certification of Chief Executive Officer

Filed Electronically

31.2

Rule 13a-14(a)/15d-14(a) Certification of Chief Financial Officer

Filed Electronically

32.1

Section 1350 Certifications

Filed Electronically

101

Inline XBRL Instance Document (does not appear in the Interactive Data File because XBRL tags are embedded within the Inline XBRL document)

Filed Electronically

101.SCH

Inline XBRL Taxonomy Extension Schema

Filed Electronically

101.CAL

Inline XBRL Taxonomy Extension Calculation Linkbase

Filed Electronically

101.DEF

Inline XBRL Taxonomy Extension Definition Linkbase

Filed Electronically

101.LAB

Inline XBRL Taxonomy Extension Label Linkbase

Filed Electronically

101.PRE

Inline XBRL Taxonomy Extension Presentation Linkbase

Filed Electronically

104

Cover Page Interactive Data File (formatted as Inline XBRL and contained in Exhibit 101)

Filed Electronically

*Management contract, compensatory plan or arrangement required to be filed as an exhibit.

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SIGNATURES

 

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

 

						FIRST INTERNET BANCORP
8/8/2023			By			/s/ David B. Becker
						David B. Becker, Chairman and Chief Executive Officer (on behalf of Registrant)
8/8/2023			By			/s/ Kenneth J. Lovik
						Kenneth J. Lovik, Executive Vice President and Chief Financial Officer (principal financial officer)

 

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