Companies: 10,796     total market cap: A$199.289 T
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First Merchants Corporation
FRME
#4358
Rank
A$3.63 B
Marketcap
๐Ÿ‡บ๐Ÿ‡ธ United States
Country
A$57.33
Share price
-0.66%
Change (1 day)
7.62%
Change (1 year)
๐Ÿฆ Banks๐Ÿ’ณ Financial services
Categories
  1. First Merchants Corporation
  2. Quarterly Reports (10-Q)
  3. Financial Year FY2021 Q1

First Merchants Corporation - 10-Q quarterly report FY2021 Q1


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FORM 10-Q
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
___________________

☒ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE

SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended March 31, 2021
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 0-17071

FIRST MERCHANTS CORPORATION
(Exact name of registrant as specified in its charter)

Indiana                                                                            35-1544218
(State or other jurisdiction of                                   (I.R.S. Employer
incorporation or organization)                               Identification No.)

200 East Jackson Street, Muncie, IN                  47305-2814
(Address of principal executive offices)                   (Zip code)

(Registrant’s telephone number, including area code): (765) 747-1500

Not Applicable
(Former name, former address and former fiscal year,
if changed since last report)

Securities registered pursuant to Section 12(b) of the Act:
Title of Each ClassTrading Symbol(s)Name of each exchange on which registered
Common Stock, $0.125 stated value per shareFRMENasdaq Global Select Market

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 ☒   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 (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes ☒   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
☐
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 ☒

As of May 3, 2021, there were 54,371,549 outstanding common shares of the registrant.
1
Table of Contents
TABLE OF CONTENTS

FIRST MERCHANTS CORPORATION

Page No.
3
Item 1. 
 
4
 
5
 
6
 
7
 
8
 
9
Item 2.
38
Item 3.
53
Item 4.
54
   
 
Item 1.
55
Item 1A.
55
Item 2.
55
Item 3.
55
Item 4.
55
Item 5.
55
Item 6.
56
57
2
Table of Contents
GLOSSARY OF DEFINED TERMS

FIRST MERCHANTS CORPORATION

ACLAllowance for Credit Losses
AmeriborThe American interbank offered rate, a potential replacement for LIBOR, is a benchmark interest rate calculated as a volume-weighted average of the daily transactions in overnight unsecured loans on the American Financial Exchange, LLC, a self-regulated electronic exchange for direct lending by American banks and financial institutions.
ASCAccounting Standards Codification
ASUAccounting Standards Update
BankFirst Merchants Bank, a wholly-owned subsidiary of the Corporation
CARES ActCoronavirus Aid, Relief and Economic Security Act
CECL
Current expected credit losses
CET1Common Equity Tier 1
CorporationFirst Merchants Corporation
COVID-192019 novel coronavirus disease, which was declared a pandemic by the World Health Organization on March 11, 2020.
Economic Impact PaymentsEconomic stimulus payments of up to $1,200 per adult and $500 per child, subject to eligibility requirements and certain limitations, as established under the CARES Act and distributed by the IRS.
ESPPEmployee Stock Purchase Plan
FASBFinancial Accounting Standards Board
FDICFederal Deposit Insurance Corporation
Federal ReserveBoard of Governors of the Federal Reserve System
FHLBFederal Home Loan Bank
FOMCFederal Open Market Committee, the monetary policymaking body of the Federal Reserve System.
FTEFully taxable equivalent
GAAPU.S. Generally Accepted Accounting Principles
IRSInternal Revenue Service
OREOOther real estate owned
PPPPaycheck Protection Program, which was established by the CARES Act and implemented by the Small Business Administration to provide small business loans.
RSARestricted Stock Awards
TEFRATax Equity and Fiscal Responsibility Act


3
Table of Contents
PART I. FINANCIAL INFORMATION
ITEM 1. CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
(table dollar amounts in thousands, except share data)


CONSOLIDATED CONDENSED BALANCE SHEETS
March 31,
2021		December 31,
2020
(Unaudited)
ASSETS  
Cash and cash equivalents$187,901 $192,896 
Interest-bearing deposits392,806 392,305 
Investment securities available for sale2,405,568 1,919,119 
Investment securities held to maturity, net of allowance for credit losses of $245 and $0 (fair value of $1,318,780 and $1,280,293)
1,295,289 1,227,668 
Loans held for sale4,430 3,966 
Loans9,318,228 9,243,174 
Less: Allowance for credit losses - loans 1
(201,082)(130,648)
Net loans9,117,146 9,112,526 
Premises and equipment109,432 111,062 
Federal Home Loan Bank stock28,736 28,736 
Interest receivable54,662 53,948 
Goodwill543,918 543,918 
Other intangibles27,618 28,975 
Cash surrender value of life insurance293,766 292,745 
Other real estate owned604 940 
Tax asset, deferred and receivable40,163 12,340 
Other assets127,027 146,066 
TOTAL ASSETS$14,629,066 $14,067,210 
LIABILITIES  
Deposits:  
Noninterest-bearing$2,494,891 $2,298,138 
Interest-bearing9,456,889 9,063,472 
Total Deposits11,951,780 11,361,610 
Borrowings:  
Securities sold under repurchase agreements185,721 177,102 
Federal Home Loan Bank advances359,337 389,430 
Subordinated debentures and other borrowings118,439 118,380 
Total Borrowings663,497 684,912 
Interest payable4,020 3,287 
Other liabilities203,913 141,756 
Total Liabilities12,823,210 12,191,565 
COMMITMENTS AND CONTINGENT LIABILITIES
STOCKHOLDERS' EQUITY
Cumulative Preferred Stock, $1,000 par value, $1,000 liquidation value:
  
Authorized - 600 shares
  
Issued and outstanding - 125 shares
125 125 
Common Stock, $0.125 stated value:
  
Authorized - 100,000,000 shares
  
Issued and outstanding - 53,953,723 and 53,922,359 shares
6,744 6,740 
Additional paid-in capital1,007,300 1,005,366 
Retained earnings755,877 788,578 
Accumulated other comprehensive income35,810 74,836 
Total Stockholders' Equity1,805,856 1,875,645 
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY$14,629,066 $14,067,210 

1 Beginning January 1, 2021, the calculation is based on the current expected credit loss methodology. Prior to January 1, 2021, the calculation is based on the incurred loss methodology. See additional details in NOTE 1. GENERAL of these Notes to Consolidated Condensed Financial Statement.


See NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS.
4
Table of Contents
PART I. FINANCIAL INFORMATION
ITEM 1. CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
(table dollar amounts in thousands, except share data)


CONSOLIDATED CONDENSED STATEMENTS OF INCOME
(Unaudited)
Three Months Ended
March 31,
 20212020
INTEREST INCOME  
Loans receivable:
Taxable$85,105 $96,652 
Tax exempt5,339 5,315 
Investment securities: 
Taxable6,695 7,631 
Tax exempt12,385 9,335 
Deposits with financial institutions114 575 
Federal Home Loan Bank stock178 299 
Total Interest Income109,816 119,807 
INTEREST EXPENSE  
Deposits6,200 21,748 
Federal funds purchased2 111 
Securities sold under repurchase agreements87 352 
Federal Home Loan Bank advances1,442 1,774 
Subordinated debentures and other borrowings1,657 1,945 
Total Interest Expense9,388 25,930 
NET INTEREST INCOME100,428 93,877 
Provision for credit losses - loans— 19,752 
NET INTEREST INCOME AFTER PROVISION FOR CREDIT LOSSES100,428 74,125 
OTHER INCOME  
Service charges on deposit accounts5,264 5,970 
Fiduciary and wealth management fees6,422 5,985 
Card payment fees4,367 5,907 
Net gains and fees on sales of loans3,986 3,363 
Derivative hedge fees317 1,939 
Other customer fees368 398 
Increase in cash surrender value of life insurance1,189 1,360 
Gains on life insurance benefits147 — 
Net realized gains on sales of available for sale securities1,799 4,612 
Other income232 265 
Total Other Income24,091 29,799 
OTHER EXPENSES  
Salaries and employee benefits38,811 39,243 
Net occupancy6,491 5,801 
Equipment5,030 4,344 
Marketing1,124 1,443 
Outside data processing fees4,244 4,199 
Printing and office supplies283 387 
Intangible asset amortization1,357 1,514 
FDIC assessments1,368 1,523 
Other real estate owned and foreclosure expenses734 505 
Professional and other outside services2,543 2,258 
Other expenses4,113 4,954 
Total Other Expenses66,098 66,171 
INCOME BEFORE INCOME TAX58,421 37,753 
Income tax expense8,952 3,490 
NET INCOME AVAILABLE TO COMMON STOCKHOLDERS$49,469 $34,263 
Per Share Data:  
Basic Net Income Available to Common Stockholders$0.92 $0.63 
Diluted Net Income Available to Common Stockholders$0.91 $0.62 
Cash Dividends Paid$0.26 $0.26 
Average Diluted Shares Outstanding (in thousands)54,134 54,918 


See NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS.

5
Table of Contents
PART I. FINANCIAL INFORMATION
ITEM 1. CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
(table dollar amounts in thousands, except share data)


CONSOLIDATED CONDENSED STATEMENTS OF COMPREHENSIVE INCOME
(Unaudited)
Three Months Ended
March 31,
20212020
Net income$49,469 $34,263 
Other comprehensive income (loss):
     Unrealized gains/losses on securities available-for-sale:
Unrealized holding gain (loss) arising during the period(47,911)38,435 
Reclassification adjustment for losses (gains) included in net income(1,799)(4,612)
Tax effect10,439 (7,102)
Net of tax(39,271)26,721 
     Unrealized gain/loss on cash flow hedges:
Unrealized holding gain (loss) arising during the period58 (1,314)
Reclassification adjustment for losses (gains) included in net income252 125 
Tax effect(65)250 
Net of tax245 (939)
      Total other comprehensive income (loss), net of tax(39,026)25,782 
Comprehensive income$10,443 $60,045 


See NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS.

6
Table of Contents
PART I. FINANCIAL INFORMATION
ITEM 1. CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
(table dollar amounts in thousands, except share data)


CONSOLIDATED CONDENSED STATEMENTS OF STOCKHOLDERS’ EQUITY
(Unaudited)


Three Months Ended March 31, 2021
PreferredCommon StockAdditionalAccumulated
Other
SharesAmountSharesAmountPaid in
Capital		Retained
Earnings		Comprehensive
Income		Total
Balances, December 31, 2020125 $125 53,922,359 $6,740 $1,005,366 $788,578 $74,836 $1,875,645 
Cumulative effect of ASC 326 adoption(68,040)(68,040)
Balance, January 1, 2021125 $125 53,922,359 $6,740 $1,005,366 1005366$720,538 $74,836 $1,807,605 
Comprehensive income:
Net income— — — — — 49,469 — 49,469 
Other comprehensive loss, net of tax — — — — — — (39,026)(39,026)
Cash dividends on common stock ($.26 per share)
— — — — — (14,130)— (14,130)
Share-based compensation— — 4,285 1 1,189 — — 1,190 
Stock issued under employee benefit plans— — 3,929 — 144 — — 144 
Stock issued under dividend reinvestment and
stock purchase plan		— — 9,117 1 442 — — 443 
Stock options exercised— — 14,300 2 169 — — 171 
Restricted shares withheld for taxes— — (267)— (10)— — (10)
Balances, March 31, 2021
125 $125 53,953,723 $6,744 $1,007,300 $755,877 $35,810 $1,805,856 


Three Months Ended March 31, 2020
PreferredCommon StockAdditionalAccumulated
Other
SharesAmountSharesAmountPaid in
Capital		Retained
Earnings		Comprehensive
Loss		Total
Balances, December 31, 2019125 $125 55,368,482 $6,921 $1,054,997 $696,520 $27,874 $1,786,437 
Comprehensive income:       
Net income— — — — — 34,263 — 34,263 
Other comprehensive income, net of tax — — — — — — 25,782 25,782 
Cash dividends on common stock ($.26 per share)
— — — — — (14,265)— (14,265)
Repurchases of common stock— — (1,634,437)(204)(55,708)— — (55,912)
Share-based compensation— — 3,332 — 1,220 — — 1,220 
Stock issued under dividend reinvestment and
stock purchase plan		— — 15,710 2 426 — — 428 
Stock options exercised— — 1,050 — 7 — — 7 
Balances, March 31. 2020
125 $125 53,754,137 $6,719 $1,000,942 $716,518 $53,656 $1,777,960 


See NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS.




7
Table of Contents
PART I. FINANCIAL INFORMATION
ITEM 1. CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
(table dollar amounts in thousands, except share data)


CONSOLIDATED CONDENSED STATEMENTS OF CASH FLOWS (Unaudited)
 Three Months Ended
 March 31, 2021March 31, 2020
Cash Flow From Operating Activities:  
Net income$49,469 $34,263 
Adjustments to reconcile net income to net cash provided by operating activities:  
Provision for loan losses— 19,752 
Depreciation and amortization2,748 2,674 
Change in deferred taxes(3,079)(7,662)
Share-based compensation1,190 1,220 
Loans originated for sale(111,558)(163,378)
Proceeds from sales of loans held for sale114,383 170,307 
Gains on sales of loans held for sale(3,289)(2,931)
Gains on sales of securities available for sale(1,799)(4,612)
Increase in cash surrender of life insurance(1,189)(1,360)
Gains on life insurance benefits(147)— 
Change in interest receivable(714)1,412 
Change in interest payable733 992 
Other adjustments6,062 20,816 
Net cash provided by operating activities52,810 71,493 
Cash Flows from Investing Activities:  
Net change in interest-bearing deposits(501)(14,681)
Purchases of: 
Securities available for sale(597,901)(87,499)
Securities held to maturity(135,098)(126,759)
Proceeds from sales of securities available for sale48,016 96,558 
Proceeds from maturities of: 
Securities available for sale80,114 45,621 
Securities held to maturity66,361 49,912 
Net change in loans(72,704)(148,882)
Proceeds from the sale of other real estate owned495 303 
Proceeds from life insurance benefits315 — 
Other adjustments(2,285)(3,672)
Net cash used in investing activities(613,188)(189,099)
Cash Flows from Financing Activities:  
Net change in :  
Demand and savings deposits620,609 109,276 
Certificates of deposit and other time deposits(30,439)(78,748)
Borrowings8,678 180,060 
Repayment of borrowings(30,093)(72,710)
Cash dividends on common stock(14,130)(14,265)
Stock issued under employee benefit plans144 — 
Stock issued under dividend reinvestment and stock purchase plans443 428 
Stock options exercised171 7 
Repurchase of common stock— (55,912)
Net cash provided by financing activities555,383 68,136 
Net Change in Cash and Cash Equivalents(4,995)(49,470)
Cash and Cash Equivalents, January 1192,896 177,201 
Cash and Cash Equivalents, March 31
$187,901 $127,731 
Additional cash flow information:  
Interest paid$8,655 $24,938 
Loans transferred to other real estate owned44 761 
Fixed assets transferred to other real estate owned1,167 — 
Non-cash investing activities using trade date accounting66,558 44,362 
ROU assets obtained in exchange for new operating lease liabilities386 79 


See NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS.
8
Table of Contents
PART I. FINANCIAL INFORMATION
ITEM 1. NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
(table dollar amounts in thousands, except share data)
(Unaudited)



NOTE 1 
GENERAL
Financial Statement Preparation

The Consolidated Condensed Balance Sheet of the Corporation as of December 31, 2020, has been derived from the audited consolidated balance sheet of the Corporation as of that date. Certain information and note disclosures normally included in the Corporation’s annual financial statements, prepared in accordance with accounting principles generally accepted in the United States of America, have been condensed or omitted. These consolidated condensed financial statements should be read in conjunction with the consolidated financial statements and notes thereto included in the Corporation’s Annual Report on Form 10-K for the year ended December 31, 2020 filed with the Securities and Exchange Commission. The results of operations for the three months ended March 31, 2021, are not necessarily indicative of the results to be expected for the year. Reclassifications have been made to prior financial statements to conform to the current financial statement presentation. These reclassifications had no effect on net income. Material estimates that are particularly susceptible to significant change relate to the determination of the allowance for credit losses and fair value of financial instruments. The uncertainties related to the coronavirus disease 2019 ("COVID-19") could cause significant changes to these estimates compared to what was known at the time these financial statements were prepared.

Significant Accounting Policies

The significant accounting policies followed by the Corporation and its wholly-owned subsidiaries for interim financial reporting are consistent with the accounting policies followed for annual financial reporting, with the exception of the Corporation's adoption of ASC 326 as described below under the heading "Recent Accounting Changes Adopted In 2021." The Corporation revised certain accounting policies and implemented certain accounting policy elections, related to the adoption of ASC 326 which are described below. All adjustments, which are of a normal recurring nature and are in the opinion of management necessary for a fair statement of the results for the periods reported, have been included in the accompanying Consolidated Condensed Financial Statements.

The Corporation adopted FASB Accounting Standards Update (ASU) No. 2016-13, Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments ("CECL") on January 1, 2021. CECL replaces the previous "incurred loss" model for measuring credit losses, which encompassed allowances for current known and inherent losses within the portfolio, with an "expected loss" model for measuring credit losses, which encompasses allowances for losses expected to be incurred over the life of the portfolio. The new CECL model requires the measurement of all expected credit losses for financial assets measured at amortized cost and certain off-balance sheet credit exposures based on historical experiences, current conditions, and reasonable and supportable forecasts. CECL also requires enhanced disclosures related to the significant estimates and judgments used in estimating credit losses, as well as credit quality and underwriting standards of an organization's portfolio. In addition, CECL includes certain changes to the accounting for investment securities available for sale depending on whether management intends to sell the securities or believes that it is more likely than not they will be required to sell.

As of the adoption and day one measurement date of January 1, 2021, the Corporation recorded a one-time cumulative-effect adjustment to retained earnings, net of income taxes, on the consolidated balance sheet of $68.0 million. The allowance increased 57 percent from December 31, 2020, or $74.1 million, because it covered expected credit losses over the life of the loan portfolio, which approximates four years, and it included an allowance on all purchased loans that were previously excluded from the allowance for loan losses calculation. CECL also requires the establishment of a reserve for potential losses from unfunded commitments that is recorded in other liabilities, separate from allowance for credit losses, which was approximately $20.5 million. An allowance for credit losses of $245,000 was recorded on the state and municipal securities classified as held to maturity based on applying the long-term historical credit loss rate, as published by Moody’s, for similarly rated securities. The following table details the impact of the adoption of CECL on the Corporation's balance sheet as of January 1, 2021.

December 31, 2020Impact of CECL AdoptionJanuary 1, 2021 Post-CECL Adoption
Assets:
Held to maturity securities1,227,668 (245)1,227,423 
Loans9,243,174 4,776 9,247,950 
Allowance for credit losses - Loans(130,648)(74,055)(204,703)
Net loans9,112,526 (69,279)9,043,247 
Tax asset, deferred and receivable12,340 21,984 34,324 
Liabilities:
Allowance for credit losses on unfunded loan commitments— 20,500 20,500 
Stockholder's Equity:
Retained Earnings788,578 (68,040)720,538 
— 


9
Table of Contents
PART I. FINANCIAL INFORMATION
ITEM 1. NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
(table dollar amounts in thousands, except share data)
(Unaudited)



Allowance for credit losses on investment securities available for sale – for investment securities available for sale in an unrealized loss position, the Corporation 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 criteria regarding intent or requirement to sell is met, the security’s amortized cost basis is written down to fair value through income. For investment securities available for sale that do not meet the aforementioned criteria, the Corporation evaluates whether the decline in fair value has resulted from credit losses or other factors. In making this assessment, the Corporation 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, limited by the amount that the fair value is less than the amortized cost basis. Unrealized losses that have not been recorded through an allowance for credit losses are recognized in other comprehensive income. Adjustments to the allowance for credit losses are reported in the income statement as a component of the provision for credit loss. The Corporation has made the accounting policy election to exclude accrued interest receivable on investment securities available for sale from the estimate of credit losses. Investment securities available for sale are charged off against the allowance or, in the absence of any allowance, written down through the income statement when deemed uncollectible or when either of the aforementioned criteria regarding intent or requirement to sell is met. The Corporation did not record an allowance for credit losses on its investment securities available for sale as the unrealized losses were attributable to changes in interest rates, not credit quality.

Allowance for credit losses on investment securities held to maturity ("ACL - Investments") – the ACL - Investments is a contra asset-valuation account that is deducted from the amortized cost basis of investment securities held to maturity to present the net amount expected to be collected. Investment securities held to maturity are charged off against the ACL - Investments when deemed uncollectible. Adjustments to the ACL - Investments are reported in the income statement as a component of the provision for credit loss. The Corporation measures expected credit losses on held to maturity debt securities on a collective basis by major security type with each type sharing similar risk characteristics, and considers historical credit loss information that is adjusted for current conditions and reasonable and supportable forecasts. The Corporation has made the accounting policy election to exclude accrued interest receivable on investment securities held to maturity from the estimate of credit losses. With regard to U.S. Government-sponsored agency and mortgage-backed securities, all these securities are issued by a U.S. government-sponsored entity and have an implicit or explicit government guarantee. With regard to securities issued by states and municipalities and other investment securities held to maturity, management considers (1) issuer bond ratings, (2) the financial condition of the issuer, (3) historical loss rates for given bond ratings, and (4) whether issuers continue to make timely principal and interest payments under the contractual terms of the securities. Historical loss rates associated with securities having similar grades as those in the Corporation's portfolio have generally not been significant. Furthermore, as of March 31, 2021, there were no past due principal and interest payments associated with these securities. An allowance for credit losses of $245,000 was recorded on the state and municipal securities classified as held to maturity based on applying the long-term historical credit loss rate, as published by Moody’s, for similarly rated securities.

Purchased Credit Deteriorated (“PCD”) – the Corporation has purchased loans, some of which have experienced more than insignificant credit deterioration since origination. PCD loans are recorded at the amount paid. An allowance for credit losses is determined using the same methodology as other loans held for investment. The initial allowance for credit losses determined on a collective basis is allocated to individual loans. The sum of the loan’s purchase price and allowance for credit losses becomes its initial amortized cost basis. The difference between the initial amortized cost basis and the par value of the loan is the noncredit discount or premium, which is amortized into interest income over the life of the loan. Subsequent changes to the allowance for credit losses are recorded through the provision for credit losses.

Allowance for Credit Losses - Loans ("ACL - Loans") - the ACL - Loans is a valuation account that is deducted from the loans’ amortized cost basis to present the net amount expected to be collected on loans over the contractual term. Loans are charged off against the allowance when the uncollectibility of the loan is confirmed. Expected recoveries do not exceed the aggregate of amounts previously charged off and expected to be charged off. Adjustments to the ACL- Loans are reported in the income statement as a component of provision for credit loss. The Corporation has made the accounting policy election to exclude accrued interest receivable on loans from the estimate of credit losses. Further information regarding the policies and methodology used to estimate the ACL - Loans is detailed in NOTE 3. LOANS AND ALLOWANCE of these Notes to Consolidated Condensed Financial Statements.

Allowance for Credit Losses – Off-Balance Sheet Credit Exposures – the allowance for credit losses on off-balance sheet credit exposures is a liability account representing expected credit losses over the contractual period for which the Corporation is exposed to credit risk resulting from a contractual obligation to extend credit. No allowance is recognized if the Corporation has the unconditional right to cancel the obligation. Off-balance sheet credit exposures primarily consist of amounts available under outstanding lines of credit and letters of credit. For the period of exposure, the estimate of expected credit losses considers both the likelihood that funding will occur and the amount expected to be funded over the estimated remaining life of the commitment or other off-balance sheet exposure. The likelihood and expected amount of funding are based on historical utilization rates. The amount of the allowance represents management’s best estimate of expected credit losses on commitments expected to be funded over the contractual life of the commitment. The allowance for off-balance sheet credit exposures is adjusted through the income statement as a component of provision for credit loss.
10
Table of Contents
PART I. FINANCIAL INFORMATION
ITEM 1. NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
(table dollar amounts in thousands, except share data)
(Unaudited)



Impact of COVID-19

On January 30, 2020, the World Health Organization (“WHO”) announced that the outbreak of COVID-19 constituted a public health emergency of international concern. On March 11, 2020, WHO declared COVID-19 to be a global pandemic and, on March 13, 2020, the President of the United States declared the COVID-19 outbreak a national emergency. The health concerns relating to the COVID-19 outbreak and related governmental actions taken to reduce the spread of the virus have significantly impacted the global economy (including the states and local economies in which the Corporation operates), disrupted supply chains, lowered equity market valuations, and created significant volatility and disruption in financial markets. The outbreak has resulted in authorities implementing numerous measures to try to contain the virus, such as travel bans and restrictions, quarantines, shelter in place or total lock-down orders and business limitations and shutdowns. As a result of the shelter in place mandates in effect beginning early in the second quarter of 2020, commercial activity throughout our geographic footprint, as well as nationally, decreased significantly during 2020 and 2021. These containment measures have significantly contributed to rising unemployment and negatively impacted consumer and business spending. Although most states have reopened, albeit under limited capacities and under other social distancing restrictions, commercial activity has not returned to the levels existing prior to the outbreak of the pandemic. While multiple COVID-19 vaccines are now broadly available and vaccination rates are steadily increasing, it is too early to know how effective vaccinations will be in mitigating the adverse social and economic effects of the pandemic. Moreover, certain states and localities have recently experienced significant increases in the number of individuals diagnosed with COVID-19, which, in certain cases, is causing government officials to reinstitute activity restrictions. In addition, variant strains of the COVID-19 virus have appeared, further complicating efforts of the medical community and federal, state and local governments in response to the pandemic.

The continued impact of COVID-19 on the Corporation will depend on numerous factors and future developments that are highly uncertain and cannot be predicted with confidence. It is unknown how long the COVID-19 pandemic will last, or when restrictions on individuals and businesses will be fully lifted and businesses and their employees will be able to resume normal activities. Additional information may emerge regarding new developments with COVID-19 and additional actions may be taken by federal, state and local governments to contain COVID-19 or treat its impact. Changes in the behavior of customers, businesses and their employees as a result of COVID-19 pandemic, including social distancing practices, even after formal restrictions have been lifted and vaccination rates have increased, are also unknown. As a result of COVID-19 and the actions taken to contain it or reduce its impact, we may experience changes in the demand for our products and services, changes in the value of collateral securing outstanding loans, reductions in the credit quality of borrowers and the inability of borrowers to repay loans in accordance with their terms. Our commercial and consumer customers are experiencing varying degrees of financial distress, which is expected to continue in 2021, especially if positive cases increase and economic shutdowns continue. These and similar factors and events may have substantial negative effects on the business, financial condition and results of operations of the Corporation and its customers.

Guidance on Non-TDR Loan Modifications due to COVID-19

On March 22, 2020, a statement was issued by the Bank’s banking regulators and titled the “Interagency Statement on Loan Modifications and Reporting for Financial Institutions Working with Customers Affected by the Coronavirus” (the “Interagency Statement”) that encourages financial institutions to work prudently with borrowers who are or may be unable to meet their contractual payment obligations due to the effects of COVID-19. Additionally, Section 4013 of the CARES Act further provides that a qualified loan modification is exempt by law from classification as a troubled debt restructure as defined by GAAP, from the period beginning March 1, 2020 until the earlier of December 31, 2020 or the date that is 60 days after the date on which the national emergency concerning the COVID-19 outbreak under the National Emergencies Act (50 U.S.C. 1601 et seq.) terminates. The Interagency Statement was subsequently revised on April 7, 2020 to clarify the interaction of the original guidance with Section 4013 of the CARES Act, as well as setting forth the banking regulators’ views on consumer protection considerations. In accordance with such guidance, the Bank has offered short-term modifications made in response to COVID-19 to borrowers who were current and otherwise not past due. These included short-term, 180 days or less, modifications in the form of payment deferrals, fee waivers, extensions of repayment terms, or other delays in payment that are insignificant. The CAA, as described above, extended the expiration date for COVID-related loan modifications exempt from troubled debt restructuring classification until the earlier of January 1, 2022, or 60 days after the termination of the national emergency. Details of the Corporation's modifications are included in the "LOAN QUALITY" section of Management’s Discussion and Analysis of Financial Condition and Results of Operations included on this Form 10-Q.

Recent Accounting Changes Adopted In 2021

The Corporation continually monitors potential accounting pronouncements and the following pronouncements have been deemed to have the most applicability to the Corporation's financial statements:

FASB Accounting Standards Updates No. 2016-13, Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments
Summary - The FASB issued Accounting Standards Update (ASU) No. 2016-13, Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments. This new guidance replaces the previous "incurred loss" model for measuring credit losses with an "expected life of loan loss" model, referred to as the CECL model.

Under the CECL model, certain financial assets carried at amortized cost, such as loans held for investment and held-to-maturity debt securities, are required to be presented at the net amount expected to be collected. The measurement of expected credit losses is based on information about past events, including historical experience, current conditions, and reasonable and supportable forecasts that affect the collectability of the reported amount. This measurement takes place at the time the financial asset is first added to the balance sheet and periodically thereafter. This differs significantly from the “incurred loss” model, which delayed recognition until it is probable a loss had been incurred.
11
Table of Contents
PART I. FINANCIAL INFORMATION
ITEM 1. NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
(table dollar amounts in thousands, except share data)
(Unaudited)



The Corporation developed models that satisfy the requirements of the new standard which are governed by a system of internal controls and a cross-functional working group consisting of accounting, finance, and credit administration personnel. The loan portfolio was pooled into ten loan segments with similar risk characteristics for which the probability of default/loss given default methodology was applied. The Corporation utilized a one-year economic forecast period then reverted to historical macroeconomic levels for the remaining life of the portfolio. A baseline macroeconomic scenario, along with other scenarios, were used to develop a range of estimated credit losses for which to determine the best estimate within.

The ASU was effective for SEC filers for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2019. Pursuant to the CARES Act and the related joint statement of federal banking regulators (which also became effective as of March 27, 2020), and consistent with guidance from the SEC and FASB, the Corporation elected to delay implementation of ASU No. 2016-13, which was set to expire on December 31, 2020. However, the CAA (as discussed above) extended the temporary relief from CECL compliance to the earlier of the first day of the fiscal year that begins after the date on which the national emergency concerning COVID-19 terminates, or January 1, 2022. The Corporation elected to delay implementation of CECL following the approval of the CARES Act and, with the enactment of the CAA, the Corporation elected to adopt CECL on January 1, 2021. This allows the Corporation to utilize the CECL standard for the entire year of 2021, while its 2020 financial statements were prepared under the incurred loss model.

As of the adoption and day one measurement date of January 1, 2021, the Corporation recorded a one-time cumulative-effect adjustment to retained earnings, net of income taxes, on the consolidated balance sheet of $68.0 million. The allowance increased 57 percent from December 31, 2020, or $74.1 million, because it covered expected credit losses over the life of the loan portfolio, which approximates four years, and it included an allowance on all purchased loans that were previously excluded from the allowance for loan losses calculation. CECL also requires the establishment of a reserve for potential losses from unfunded commitments that is recorded in other liabilities, separate from allowance for credit losses, which was approximately $20.5 million. An allowance for credit losses of $245,000 was recorded on the state and municipal securities classified as held to maturity based on applying the long-term historical credit loss rate, as published by Moody’s, for similarly rated securities.

FASB Accounting Standards Updates No. 2019-11 - Codification Improvements to (Topic 326): Financial Instruments - Credit Losses
Summary - The FASB issued ASU No. 2019-11, Codification Improvements to Topic 326, Financial Instruments - Credit Losses in order to address issues raised by stakeholders during the implementation of ASU No. 2016-13, Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses of Financial Instruments.

Among other narrow-scope improvements, the new ASU clarifies guidance around how to report expected recoveries. “Expected recoveries” describes a situation in which an organization recognizes a full or partial write-off of the amortized cost basis of a financial asset, but then later determines that the amount written off, or a portion of that amount, will in fact be recovered. While applying the credit losses standard, stakeholders questioned whether expected recoveries were permitted on assets that had already shown credit deterioration at the time of purchase (also known as PCD assets). In response to this question, the ASU permits organizations to record expected recoveries on PCD assets. In addition to other narrow technical improvements, the ASU also reinforces existing guidance that prohibits organizations from recording negative allowances for available-for-sale debt securities.

The ASU includes effective dates and transition requirements that vary depending on whether or not an entity has already adopted ASU No. 2016-13. As discussed above, pursuant to the CARES Act, the Corporation elected to defer the adoption of CECL. Additionally, the 2021 Consolidated Appropriations Act ("CAA"), signed into law on December 27, 2020, amended the CARES Act by extending the temporary relief from CECL compliance to the earlier of the first day of the fiscal year that begins after the date on which the national emergency concerning COVID-19 terminates, or January 1, 2022. The Corporation elected to delay implementation of CECL following the approval of the CARES Act and, with the enactment of the CAA, the Corporation elected to adopt CECL on January 1, 2021. The adoption of this standard did not have a significant effect on the Corporation’s consolidated financial statements or disclosures.


12
Table of Contents
PART I. FINANCIAL INFORMATION
ITEM 1. NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
(table dollar amounts in thousands, except share data)
(Unaudited)



Accounting Standards Update No. 2019-12 - Income Taxes (Topic 740): Simplifying the Accounting for Income Taxes
Summary - The FASB issued ASU No. 2019-12, Income Taxes (Topic 740): Simplifying the Accounting for Income Taxes, which is expected to reduce cost and complexity related to the accounting for income taxes.

The ASU removes specific exceptions to the general principles in Topic 740 in Generally Accepted Accounting Principles (GAAP). It eliminates the need for an organization to analyze whether the following apply in a given period:
•    Exception to the incremental approach for intraperiod tax allocation;
•    Exceptions to accounting for basis differences when there are ownership changes in foreign investments; and
•    Exception in interim period income tax accounting for year-to-date losses that exceed anticipated losses.

The ASU also improves financial statement preparers’ application of income tax-related guidance and simplifies GAAP for:
•    Franchise taxes that are partially based on income;
•    Transactions with a government that result in a step up in the tax basis of goodwill
•    Separate financial statements of legal entities that are not subject to tax; and
•    Enacted changes in tax laws in interim periods.

The ASU is part of the FASB’s simplification initiative to make narrow-scope simplifications and improvements to accounting standards through a series of short-term projects. For public business entities, the ASU is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2020. Early adoption of the ASU was permitted. The Corporation adopted this standard on January 1, 2021 and adoption of this standard did not have a significant effect on the Corporation's consolidated financial statements or disclosures.

New Accounting Pronouncements Not Yet Adopted

FASB Accounting Standards Updates - No. 2020-04 - Reference Rate Reform (Topic 848): Facilitation of the Effects of Reference Rate Reform on Financial Reporting
Summary - The FASB issued ASU No. 2020-04 to provide temporary optional guidance to ease the potential burden in accounting for reference rate reform. LIBOR and other interbank offered rates are widely used benchmarks or reference rates in the United States and globally. Trillions of dollars in loans, derivatives, and other financial contracts reference LIBOR, the benchmark interest rate banks use to make short-term loans to each other. With global capital markets expected to move away from LIBOR and other interbank offered rates and move toward rates that are more observable or transaction based and less susceptible to manipulation, the FASB launched a broad project in late 2018 to address potential accounting challenges expected to arise from the transition. The new guidance provides optional expedients and exceptions for applying generally accepted accounting principles to contract modifications and hedging relationships, subject to meeting certain criteria, that reference LIBOR or another reference rate expected to be discontinued. The ASU is intended to help stakeholders during the global market-wide reference rate transition period.

Entities may apply this ASU as of the beginning of an interim period that includes the March 12, 2020 issuance date of the ASU, through December 31, 2022. The Corporation expects to adopt the practical expedients included in the ASU prior to December 31, 2022. The Corporation is implementing a transition plan to identify and modify its loans and other financial instruments with attributes that are either directly or indirectly influenced by LIBOR. The Corporation is assessing ASU 2020-04 and its impact on the Corporation's transition away from LIBOR for its loans and other financial instruments.

FASB Accounting Standards Updates - Accounting Standards Update No. 2021-01 - Reference Rate Reform (Topic 848): Scope
Summary - The FASB has published ASU 2021-01, Reference Rate Reform. ASU 2021-01 clarifies that certain optional expedients and exceptions in Topic 848 for contract modifications and hedge accounting apply to derivatives that are affected by the discounting transition. The ASU also amends the expedients and exceptions in Topic 848 to capture the incremental consequences of the scope clarification and to tailor the existing guidance to derivative instruments affected by the discounting transition.

An entity may elect to apply the amendments in this Update on a full retrospective basis as of any date from the beginning of an interim period that includes or is subsequent to March 12, 2020, or on a prospective basis to new modifications from any date within an interim period that includes or is subsequent to the date of the issuance of a final Update, up to the date that financial statements are available to be issued.

If an entity elects to apply any of the amendments in this Update for an eligible hedging relationship, any adjustments as a result of those elections must be reflected as of the date the entity applies the election.

The amendments in this Update do not apply to contract modifications made after December 31, 2022, new hedging relationships entered into after December 31, 2022, and existing hedging relationships evaluated for effectiveness in periods after December 31, 2022, except for hedging relationships existing as of December 31, 2022, that apply certain optional expedients in which the accounting effects are recorded through the end of the hedging relationship (including periods after December 31, 2022). The Corporation is assessing ASU 2021-01 and its impact on the Corporation's transition away from LIBOR for its loans and other financial instruments.
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Table of Contents
PART I. FINANCIAL INFORMATION
ITEM 1. NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
(table dollar amounts in thousands, except share data)
(Unaudited)



NOTE 2

INVESTMENT SECURITIES

The following table summarizes the amortized cost, gross unrealized gains and losses and approximate fair value of investment securities available for sale as of March 31, 2021 and December 31, 2020.

 Amortized
Cost		Gross Unrealized
Gains		Gross Unrealized
Losses		Fair
Value
Available for sale at March 31, 2021    
U.S. Treasury$1,000 $— $— $1,000 
U.S. Government-sponsored agency securities11,504 40 163 11,381 
State and municipal1,301,378 67,438 2,654 1,366,162 
U.S. Government-sponsored mortgage-backed securities1,025,660 13,550 16,347 1,022,863 
Corporate obligations4,031 153 22 4,162 
Total available for sale$2,343,573 $81,181 $19,186 $2,405,568 

 Amortized
Cost		Gross Unrealized
Gains		Gross Unrealized
Losses		Fair
Value
Available for sale at December 31, 2020    
U.S. Government-sponsored agency securities$2,380 $50 $— $2,430 
State and municipal1,168,711 89,420 246 1,257,885 
U.S. Government-sponsored mortgage-backed securities632,267 22,505 103 654,669 
Corporate obligations4,031 104 — 4,135 
Total available for sale$1,807,389 $112,079 $349 $1,919,119 


The following table summarizes the amortized cost, gross unrealized gains and losses, approximate fair value and allowance for credit losses on investment securities held to maturity as of March 31, 2021 and December 31, 2020.

Amortized
Cost		Allowance for Credit LossesNet Carrying AmountGross Unrealized
Gains		Gross Unrealized
Losses		Fair
Value
Held to maturity at March 31, 2021    
U.S. Government-sponsored agency securities$60,676 $— $60,676 $1 $1,553 59,124 
State and municipal624,553 245 624,308 23,154 3,389 644,318 
U.S. Government-sponsored mortgage-backed securities608,805 — 608,805 11,849 6,816 613,838 
Foreign investment1,500 — 1,500 — — 1,500 
Total held to maturity$1,295,534 $245 $1,295,289 $35,004 $11,758 $1,318,780 


Amortized
Cost		Allowance for Credit LossesNet Carrying AmountGross Unrealized
Gains		Gross Unrealized
Losses		Fair
Value
Held to maturity at December 31, 2020    
U.S. Government-sponsored agency securities$31,087 $— $31,087 $10 $113 $30,984 
State and municipal619,927 — 619,927 34,978 32 654,873 
U.S. Government-sponsored mortgage-backed securities575,154 — 575,154 17,889 107 592,936 
Foreign investment1,500 — 1,500 — — 1,500 
Total held to maturity$1,227,668 $— $1,227,668 $52,877 $252 $1,280,293 


Accrued interest on investment securities available for sale and held to maturity of $20.6 million are included in the Interest Receivable line on the Corporation's Consolidated Condensed Balance Sheets. The total amount of accrued interest is excluded from the amortized cost of available for sale and held to maturity securities presented above.


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PART I. FINANCIAL INFORMATION
ITEM 1. NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
(table dollar amounts in thousands, except share data)
(Unaudited)



In determining the allowance for credit losses on investment securities available for sale that are in an unrealized loss position, the Corporation 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 criteria regarding intent or requirement to sell is met, the security’s amortized cost basis is written down to fair value through the income statement. For investment securities available for sale that do not meet the aforementioned criteria, the Corporation evaluates whether the decline in fair value has resulted from credit losses or other factors. In making this assessment, the Corporation 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 for the credit loss, limited by the amount that the fair value is less than the amortized cost basis. Unrealized losses that have not been recorded through an allowance for credit losses is recognized in other comprehensive income. Adjustments to the allowance are reported in the income statement as a component of the provision for credit loss. The Corporation has made the accounting policy election to exclude accrued interest receivable on investment securities available for sale from the estimate of credit losses. Investment securities available for sale are charged off against the allowance or, in the absence of any allowance, written down through the income statement when deemed uncollectible or when either of the aforementioned criteria regarding intent or requirement to sell is met. The Corporation did not record an allowance for credit losses on its investment securities available for sale as the unrealized losses were attributable to changes in interest rates, not credit quality.

The allowance for credit losses on investment securities held to maturity is a contra asset-valuation account that is deducted from the amortized cost basis of investment securities held to maturity to present the net amount expected to be collected. Investment securities held to maturity are charged off against the allowance when deemed uncollectible. Adjustments to the allowance are reported in the income statement as a component of the provision for credit loss. The Corporation measures expected credit losses on investment securities held to maturity on a collective basis by major security type with each type sharing similar risk characteristics, and considers historical credit loss information that is adjusted for current conditions and reasonable and supportable forecasts. The Corporation has made the accounting policy election to exclude accrued interest receivable on investment securities held to maturity from the estimate of credit losses. With regard to U.S. Government-sponsored agency and mortgage-backed securities, all these securities are issued by a U.S. government-sponsored entity and have an implicit or explicit government guarantee; therefore, no allowance for credit losses has been recorded for these securities.. With regard to securities issued by states and municipalities and other investment securities held to maturity, management considers (1) issuer bond ratings, (2) historical loss rates for given bond ratings, (3) the financial condition of the issuer, and (4) whether issuers continue to make timely principal and interest payments under the contractual terms of the securities. Historical loss rates associated with securities having similar grades as those in the Corporation's portfolio have been insignificant. Furthermore, as of March 31, 2021, there were no past due principal and interest payments associated with these securities. An allowance for credit losses of $245,000 was recorded on the state and municipal securities classified as held to maturity based on applying the long-term historical credit loss rate, as published by Moody’s, for similarly rated securities.

On a quarterly basis, the Corporation monitors the credit quality of investment securities held to maturity through the use of credit ratings. The following table summarizes the amortized cost of investment securities held to maturity at March 31, 2021, aggregated by credit quality indicator.

Held to Maturity
State and municipalOtherTotal
Credit Rating:
Aaa$48,689 $60,676 $109,365 
Aa184,954 — 84,954 
Aa2107,436 — 107,436 
Aa372,969 — 72,969 
A165,578 — 65,578 
A219,074 — 19,074 
A31,065 — 1,065 
Baa2528 — 528 
Non-rated224,260 610,305 834,565 
Total$624,553 $670,981 $1,295,534 


The following table details activity in the allowance for credit losses on investment securities held to maturity during the three months ended March 31, 2021.

State and municipal
Allowance for Credit Losses:
Balance, December 31, 2020$— 
Impact of adopting ASC 326245 
Provision for credit loss— 
Securities charged off— 
Recoveries on securities— 
Balance, March 31, 2021$245 
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PART I. FINANCIAL INFORMATION
ITEM 1. NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
(table dollar amounts in thousands, except share data)
(Unaudited)



The following tables summarize, as of March 31, 2021 and December 31, 2020, investment securities available for sale in an unrealized loss position for which an allowance for credit losses has not been recorded, aggregated by security type and length of time in a continuous unrealized loss position.

Less than 12 Months12 Months or LongerTotal
Fair
Value		Gross
Unrealized
Losses		Fair
Value		Gross
Unrealized
Losses		Fair
Value		Gross
Unrealized
Losses
Investment securities available for sale at March 31, 2021
U.S. Government-sponsored agency securities$9,837 $163 $— $— $9,837 $163 
State and municipal172,655 2,654 — — 172,655 2,654 
U.S. Government-sponsored mortgage-backed securities606,498 16,347 — — 606,498 16,347 
Corporate obligations978 22 — — 978 22 
Total investment securities available for sale$789,968 $19,186 $— $— $789,968 $19,186 


 
Less than 12 Months12 Months or LongerTotal
Fair
Value		Gross
Unrealized
Losses		Fair
Value		Gross
Unrealized
Losses		Fair
Value		Gross
Unrealized
Losses
Investment securities available for sale at December 31, 2020
State and municipal$5,368 $246 $— $— $5,368 $246 
U.S. Government-sponsored mortgage-backed securities9,651 103 — — 9,651 103 
Total investment securities available for sale$15,019 $349 $— $— $15,019 $349 


Certain investment securities available for sale are reported in the financial statements at an amount less than their historical cost as indicated in the table below.
March 31, 2021December 31, 2020
Investments available for sale reported at less than historical cost:  
Historical cost$809,154 $15,368 
Fair value789,968 15,019 
Gross unrealized losses$19,186 $349 
Percent of the Corporation's investments available for sale21.4 %0.5 %


In determining the fair value of the investment securities portfolio, the Corporation utilizes a third party for portfolio accounting services, including market value input, for those securities classified as Level I and Level II in the fair value hierarchy.  The Corporation has obtained an understanding of what inputs are being used by the vendor in pricing the portfolio and how the vendor classified these securities based upon these inputs.  From these discussions, the Corporation’s management is comfortable that the classifications are proper.  The Corporation has gained trust in the data for two reasons:  (a) independent spot testing of the data is conducted by the Corporation through obtaining market quotes from various brokers on a periodic basis; and (b) actual gains or loss resulting from the sale of certain securities has proven the data to be accurate over time.   Fair value of securities classified as Level 3 in the valuation hierarchy was determined using a discounted cash flow model that incorporated market estimates of interest rates and volatility in markets that have not been active.

U.S. Government-Sponsored Mortgage-Backed Securities
The unrealized losses on the Corporation's investment in mortgage-backed securities were a result of interest rate changes. The Corporation expects to recover the amortized cost basis over the term of the securities. Because the decline in market value is attributable to changes in interest rates and not credit quality, and because the Corporation does not intend to sell the investments and it is not more likely than not that the Corporation will be required to sell the investments before recovery of their amortized cost basis, which may be maturity. As noted in the table above, the mortgage-backed securities portfolio contains unrealized losses of $16.3 million on fifty-five securities in the available for sale portfolio. All these securities are issued by a government-sponsored entity.

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PART I. FINANCIAL INFORMATION
ITEM 1. NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
(table dollar amounts in thousands, except share data)
(Unaudited)



State and Municipal Securities, U.S. Government-Sponsored Agency Securities and Corporate Obligation Securities 
The unrealized losses on the Corporation's investments in securities of state and political subdivisions, U.S. Government-Sponsored Agency securities and corporate obligations were caused by interest rate increases. 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 Corporation does not intend to sell the investments and it is not more likely than not that the Corporation will be required to sell the investments before recovery of their amortized cost basis, which may be maturity. As noted in the table above, the state and municipal securities portfolio contains unrealized losses of $2.7 million on one hundred eight securities in the available for sale portfolio. The U.S. government-sponsored agency securities portfolio contains unrealized losses of $163,000 on two securities in the available for sale portfolio. The corporate obligation securities portfolio contains unrealized losses of $22,000 on one security in the available for sale portfolio.
The amortized cost and fair value of investment securities available for sale and held to maturity at March 31, 2021 and December 31, 2020, by contractual maturity are shown below. Expected maturities will differ from contractual maturities because issuers may have the right to call or prepay obligations with or without call or prepayment penalties. Securities not due at a single maturity are shown separately.

 Available for SaleHeld to Maturity
 Amortized CostFair ValueAmortized CostFair Value
Maturity Distribution at March 31, 2021    
Due in one year or less$2,062 $2,071 $9,056 $9,068 
Due after one through five years4,781 4,960 23,116 24,084 
Due after five through ten years92,598 96,882 151,103 154,819 
Due after ten years1,218,472 1,278,792 503,454 516,971 
 1,317,913 1,382,705 686,729 704,942 
U.S. Government-sponsored mortgage-backed securities1,025,660 1,022,863 608,805 613,838 
Total investment securities$2,343,573 $2,405,568 $1,295,534 $1,318,780 
 
 
Available for SaleHeld to Maturity
Amortized CostFair ValueAmortized CostFair Value
Maturity Distribution at December 31, 2020    
Due in one year or less$1,349 $1,353 $9,712 $9,755 
Due after one through five years5,545 5,764 22,241 23,190 
Due after five through ten years70,777 75,223 115,408 121,333 
Due after ten years1,097,451 1,182,110 505,153 533,079 
 1,175,122 1,264,450 652,514 687,357 
U.S. Government-sponsored mortgage-backed securities632,267 654,669 575,154 592,936 
Total investment securities$1,807,389 $1,919,119 $1,227,668 $1,280,293 
 

Securities with a carrying value of approximately $999.2 million and $890.0 million were pledged at March 31, 2021 and December 31, 2020, respectively, to secure certain deposits and securities sold under repurchase agreements, and for other purposes as permitted or required by law.

The book value of securities sold under agreements to repurchase amounted to $178.2 million at March 31, 2021 and $167.3 million at
December 31, 2020.

Gross gains on the sales and redemptions of investment securities available for sale for the three months ended March 31, 2021 and 2020 are shown below.
Three Months Ended
March 31,
20212020
Sales and redemptions of investment securities available for sale:  
Gross gains$2,076 $4,612 
Gross losses277 — 
Net gains on sales and redemptions of investment securities available for sale$1,799 $4,612 

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PART I. FINANCIAL INFORMATION
ITEM 1. NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
(table dollar amounts in thousands, except share data)
(Unaudited)




NOTE 3

LOANS AND ALLOWANCE

Loan Portfolio and Credit Quality

The Corporation's primary lending focus is small business and middle market commercial, commercial real estate and residential real estate, which results in portfolio diversification. The following tables show the composition of the loan portfolio and credit quality characteristics by collateral classification, excluding loans held for sale. Loans held for sale at March 31, 2021 and December 31, 2020, were $4.4 million and $4.0 million, respectively.

The following table illustrates the composition of the Corporation’s loan portfolio by loan class for the periods indicated:
March 31, 2021December 31, 2020
Commercial and industrial loans$2,876,212 $2,776,699 
Agricultural land, production and other loans to farmers245,631 281,884 
Real estate loans:
Construction541,224 484,723 
Commercial real estate, non-owner occupied2,178,832 2,220,949 
Commercial real estate, owner occupied950,038 958,501 
Residential1,239,925 1,234,741 
Home equity482,229 508,259 
Individuals' loans for household and other personal expenditures126,387 129,479 
Public finance and other commercial loans677,750 647,939 
Loans$9,318,228 $9,243,174 

As of March 31, 2021, the Corporation had $741.7 million of Paycheck Protection Program ("PPP") loans compared to the December 31, 2020 balance of $667.1 million. PPP loans are included in the commercial and industrial loan class. Additional details of the PPP are included in The CARES Act and the Paycheck Protection Program section of the "COVID-19 UPDATE" section of Management’s Discussion and Analysis of Financial Condition and Results of Operations included on this Form 10-Q.

Credit Quality
As part of the ongoing monitoring of the credit quality of the Corporation's loan portfolio, management tracks certain credit quality indicators including trends related to: (i) the level of criticized commercial loans, (ii) net charge-offs, (iii) non-performing loans, (iv) covenant failures and (v) the general national and local economic conditions.

The Corporation utilizes a risk grading of pass, special mention, substandard, doubtful and loss to assess the overall credit quality of large commercial loans. All large commercial credit grades are reviewed at a minimum of once a year for pass grade loans. Loans with grades below pass are reviewed more frequently depending on the grade. A description of the general characteristics of these grades is as follows:

•Pass - Loans that are considered to be of acceptable credit quality.

•Special Mention - Loans which possess some credit deficiency or potential weakness, which deserves close attention. If left uncorrected, these potential weaknesses may result in deterioration of the repayment prospects for the asset or in the Corporation's credit position at some future date. Special mention assets are not adversely classified and do not expose the Corporation to sufficient risk to warrant adverse classification.

•Substandard - A substandard loan is inadequately protected by the current net worth and paying capacity of the obligor or of the collateral pledged, if any. Assets so classified have a well-defined weakness that jeopardizes the liquidation of the debt. They are characterized by the distinct possibility that the Corporation will sustain some loss if the deficiencies are not corrected.

•Doubtful - Loans that have all of the weaknesses of those classified as Substandard. However, based on currently existing facts, conditions and values, these weaknesses make full collection of principal highly questionable and improbable.

•Loss – Loans that are considered uncollectible and of such little value that continuing to carry them as an asset is not warranted. Loans will be classified as Loss when it is neither practical or desirable to defer writing off or reserving all or a portion of a basically worthless asset, even though partial recovery may be possible at some time in the future.


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PART I. FINANCIAL INFORMATION
ITEM 1. NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
(table dollar amounts in thousands, except share data)
(Unaudited)



The following tables summarize the risk grading of the Corporation’s loan portfolio by loan class and by year of origination for the years indicated. Consumer loans are not risk graded. For the purposes of this disclosure the consumer loans are classified in the following manner: loans that are less than 30 days past due are Pass, loans 30-89 days past due are Special Mention and loans greater than 89 days past due are Substandard. The entire balance of a loan is considered delinquent if the minimum payment contractually required to be made is not received by the specified due date. Loans that evidenced deterioration of credit quality since origination and it was probable, at acquisition, that all contractually required payments would not be collected are included in the applicable categories below. Outstanding loan balances as of March 31, 2021 with an origination year of 2021 and 2020 include PPP loans of $293.1 million and $448.6 million, respectively.

Term Loans (amortized cost basis by origination year)
20212020201920182017PriorRevolving loans amortized cost basisTotal
Commercial and industrial loans
Pass$451,747 $1,101,622 $265,685 $121,416 $47,101 $64,093 $634,146 $2,685,810 
Special Mention7,735 50,704 1,421 7,435 2,306 2,326 29,255 101,182 
Substandard1,891 4,946 6,319 606 469 1,394 73,595 89,220 
Total Commercial and industrial loans$461,373 $1,157,272 $273,425 $129,457 $49,876 $67,813 $736,996 $2,876,212 
Agricultural land, production and other loans to farmers
Pass22,570 58,620 26,146 11,864 8,821 49,646 45,626 223,293 
Special Mention151 621 186 2,151 — 3,347 8,824 15,280 
Substandard— 4,116 64 125 717 877 1,159 7,058 
Total Agricultural land, production and other loans to farmers$22,721 $63,357 $26,396 $14,140 $9,538 $53,870 $55,609 $245,631 
Real estate loans:
Construction
Pass60,800 208,852 165,903 68,816 3,104 1,945 17,184 526,604 
Special Mention— 10,118 — 63 — — 30 10,211 
Substandard4,391 — — — — 18 — 4,409 
Total Construction$65,191 $218,970 $165,903 $68,879 $3,104 $1,963 $17,214 $541,224 
Commercial real estate, non-owner occupied
Pass93,726 933,226 275,343 225,971 141,947 196,284 25,454 1,891,951 
Special Mention9,544 169,291 13,242 990 — 112 1,250 194,429 
Substandard238 38,545 24,741 11,585 7,840 9,503 — 92,452 
Total Commercial real estate, non-owner occupied$103,508 $1,141,062 $313,326 $238,546 $149,787 $205,899 $26,704 $2,178,832 
Commercial real estate, owner occupied
Pass51,710 481,355 122,017 57,531 60,587 89,802 39,729 902,731 
Special Mention45 10,174 2,606 1,646 2,242 1,178 149 18,040 
Substandard5,079 19,107 154 2,179 723 1,979 — 29,221 
Loss46 — — — — — — 46 
Total Commercial real estate, owner occupied$56,880 $510,636 $124,777 $61,356 $63,552 $92,959 $39,878 $950,038 
Residential
Pass171,109 398,112 148,457 101,627 88,700 314,130 3,873 1,226,008 
Special Mention349 982 — 588 82 1,313 93 3,407 
Substandard485 3,152 518 1,355 372 4,628 — 10,510 
Total Residential$171,943 $402,246 $148,975 $103,570 $89,154 $320,071 $3,966 $1,239,925 
Home equity
Pass2,673 20,032 2,577 2,930 1,786 5,085 442,166 477,249 
Special Mention— 91 — — — 59 2,588 2,738 
Substandard403 151 — 13 129 195 1,351 2,242 
Total Home Equity$3,076 $20,274 $2,577 $2,943 $1,915 $5,339 $446,105 $482,229 
Individuals' loans for household and other personal expenditures
Pass16,786 38,678 24,201 18,482 4,383 7,550 15,996 126,076 
Special Mention— 68 75 35 8 33 4 223 
Substandard— 1 87 — — — — 88 
Total Individuals' loans for household and other personal expenditures$16,786 $38,747 $24,363 $18,517 $4,391 $7,583 $16,000 $126,387 
Public finance and other commercial loans
Pass21,613 191,808 128,844 39,837 130,856 151,403 13,389 677,750 
Total Public finance and other commercial loans$21,613 $191,808 $128,844 $39,837 $130,856 $151,403 $13,389 $677,750 
Loans$923,091 $3,744,372 $1,208,586 $677,245 $502,173 $906,900 $1,355,861 $9,318,228 
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PART I. FINANCIAL INFORMATION
ITEM 1. NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
(table dollar amounts in thousands, except share data)
(Unaudited)



December 31, 2020
Commercial
Pass		Commercial
Special
Mention		Commercial SubstandardCommercial
Doubtful		Commercial LossConsumer PerformingConsumer
Non-Performing		Total
Commercial and industrial loans$2,562,077 $117,503 $97,119 $— $— $— $— $2,776,699 
Agricultural production financing and other loans to farmers243,991 26,835 9,885 — — 1,173 — 281,884 
Real estate Loans:
Construction446,846 10,445 5,549 — — 21,763 120 484,723 
Commercial real estate, non-owner occupied1,979,827 160,304 80,818 — — — — 2,220,949 
Commercial real estate, owner occupied907,566 17,641 33,294 — — 958,501 
Residential199,338 2,261 7,058 — — 1,020,687 5,397 1,234,741 
Home equity12,714 — 989 — — 492,999 1,557 508,259 
Individuals' loans for household and other personal expenditures— — — — — 129,440 39 129,479 
Public finance and other commercial loans647,939 — — — — — — 647,939 
Loans$7,000,298 $334,989 $234,712 $— $— $1,666,062 1666062$7,113 $9,243,174 


At March 31, 2021, 30-59 Days Past Due loans totaled $55.6 million, an increase of $36.0 million from December 31, 2020. The primary increase was in the commercial real estate, non-owner occupied segment and is related to four relationships. Three of the relationships are multi-family units totaling $24.1 million and the fourth relationship is a hotel totaling $21.0 million. At March 31, 2021, the 60-89 Days Past Due category totaled $3.0 million, a decrease of $8.2 million from December 31, 2020. The primary decrease was related to a $5.0 million commercial and industrial loan that was current as of March 31, 2021. The 90 Days or More Past Due bucket totaled $47.4 million at March 31, 2021, an increase of $5.4 million from December 31, 2020. The primary increase was related to a $13.0 million nursing home loan within the commercial real estate, non-owner occupied segment, that was current at December 31, 2020, but has moved into the 90+ Days Past Due bucket. This was offset by a $3.7 million loan within the same segment that was 90+ Days Past Due at December 31, 2020, but has since paid off. The tables below show a past due aging of the Corporation’s loan portfolio, by loan class, for the years indicated:
March 31, 2021
Current30-59 Days
Past Due		60-89 Days
Past Due		90 Days or More Past DueTotalLoans > 90 Days or More Past Due
And Accruing
Commercial and industrial loans$2,870,436 $4,545 $19 $1,212 $2,876,212 $— 
Agricultural land, production and other loans to farmers244,403 114 — 1,114 245,631 — 
Real estate loans:
Construction540,648 560 — 16 541,224 — 
Commercial real estate, non-owner occupied2,094,103 45,942 434 38,353 2,178,832 — 
Commercial real estate, owner occupied946,423 792 1,096 1,727 950,038 1,032 
Residential1,234,473 1,582 377 3,493 1,239,925 — 
Home equity477,927 1,906 1,010 1,386 482,229 60 
Individuals' loans for household and other personal expenditures126,075 181 42 89 126,387 1 
Public finance and other commercial loans677,750 — — — 677,750 — 
Loans$9,212,238 $55,622 $2,978 $47,390 $9,318,228 $1,093 


December 31, 2020
Current30-59 Days
Past Due		60-89 Days
Past Due		90 Days or More Past DueTotalLoans > 90 Days or More Past Due
And Accruing
Commercial and industrial loans$2,761,473 $5,866 $6,571 $2,789 $2,776,699 $594 
Agricultural land, production and other loans to farmers280,615 146 226 897 281,884 — 
Real estate loans:— 
Construction484,706 — 17 — 484,723 — 
Commercial real estate, non-owner occupied2,184,681 2,525 2,109 31,634 2,220,949 — 
Commercial real estate, owner occupied951,561 4,854 180 1,906 958,501 — 
Residential1,226,779 3,269 1,429 3,264 1,234,741 133 
Home equity503,596 2,644 559 1,460 508,259 19 
Individuals' loans for household and other personal expenditures129,049 334 96 — 129,479 — 
Public finance and other commercial loans647,939 — — — 647,939 — 
Loans$9,170,399 $19,638 $11,187 $41,950 $9,243,174 $746 


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PART I. FINANCIAL INFORMATION
ITEM 1. NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
(table dollar amounts in thousands, except share data)
(Unaudited)



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. All unpaid accrued interest is reversed against earnings when considered uncollectible and at the time accrual is discontinued. Payments subsequently received on non-accrual 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 Corporation’s non-accrual loans by loan class for the periods indicated:

March 31, 2021December 31, 2020
Non-Accrual LoansNon-Accrual Loans with no Allowance for Credit LossesNon-Accrual Loans
Commercial and industrial loans$1,671 $786 $2,329 
Agricultural land, production and other loans to farmers1,220 561 1,012 
Real estate loans:
Construction18 — 123 
Commercial real estate, non-owner occupied44,143 1,853 46,316 
Commercial real estate, owner occupied1,760 1,513 3,040 
Residential6,336 835 6,517 
Home equity2,650 — 2,095 
Individuals' loans for household and other personal expenditures125 — 39 
Loans$57,923 $5,548 $61,471 


There was no interest income recognized on non-accrual loans for the three months ended March 31, 2021 and 2020, 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.

The following table presents the amortized cost basis of collateral dependent loans, which are individually evaluated to determine expected credit losses:
March 31, 2021
Commercial Real EstateResidential Real EstateOtherTotal Allowance on Collateral Dependent Loans
Commercial and industrial loans$— $— $2,202 $2,202 $— 
Agricultural land, production and other loans to farmers780 — — 780 — 
Real estate loans:
Commercial real estate, non-owner occupied45,188 — — 45,188 5,561 
Commercial real estate, owner occupied3,539 — — 3,539 — 
Residential— 3,113 — 3,113 356 
Home equity— 452 — 452 77 
Individuals' loans for household and other personal expenditures— — 2 2 — 
Loans$49,507 $3,565 $2,204 $55,276 $5,994 



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PART I. FINANCIAL INFORMATION
ITEM 1. NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
(table dollar amounts in thousands, except share data)
(Unaudited)



As detailed in NOTE 1. GENERAL of these Notes to Consolidated Condensed Financial Statements, the Bank's banking regulators issued guidance in March 2020 encouraging financial institutions to work prudently with borrowers who are or may be unable to meet their contractual payment obligations due to the effects of COVID-19. Additionally, Section 4013 of the CARES Act had further provided that a qualified loan modification is exempt by law from classification as a troubled debt restructure as defined by GAAP, from the period beginning March 1, 2020 until the earlier of December 31, 2020 or the date that is 60 days after the date on which the national emergency concerning the COVID-19 outbreak under the National Emergencies Act (50 U.S.C. 1601 et seq.) terminates. In accordance with that guidance, the Bank has offered short-term modifications made in response to COVID-19 to borrowers who were current and otherwise not past due. These included short-term, 180 days or less, modifications in the form of payment deferrals, fee waivers, extensions of repayment terms, or other delays in payment that are insignificant. The Consolidated Appropriations Act, 2021 extended the expiration date for COVID-related loan modifications exempt from troubled debt restructuring classification until the earlier of January 1, 2022, or 60 days after the termination of the national emergency. Details of the Corporation's modifications are included in the "LOAN QUALITY" section of Management’s Discussion and Analysis of Financial Condition and Results of Operations included on this Form 10-Q.

In certain loan restructuring situations, the Corporation may grant a concession to a debtor experiencing financial difficulty, resulting in a troubled debt restructuring. A concession is deemed to be granted when, as a result of the restructuring, the Corporation does not expect to collect all original amounts due, including interest accrued at the original contract rate. If the payment of principal at original maturity is primarily dependent on the value of collateral, the current value of the collateral is considered in determining whether the principal will be repaid.

The following tables summarize troubled debt restructures in the Corporation's loan portfolio that occurred during the three months ended March 31, 2021. No troubled debt restructures in the Corporation's loan portfolio occurred in the three months ended March 31, 2020.

Three Months Ended March 31, 2021
Pre- Modification Recorded BalanceTerm ModificationRate ModificationCombinationPost - Modification Recorded BalanceNumber of Loans
Commercial and industrial $348 $348 $— $— $348 2
Real estate loans:
Residential6253831261186277
Total$973 $731 $126 $118 $975 9

Loans secured by 1- 4 family residential real estate made up 64 percent of the post-modification balances of the troubled debt restructured loans that occurred during the three months ending March 31, 2021.

The following tables summarize troubled debt restructures that occurred during the twelve months ended March 31, 2021 and 2020, that subsequently defaulted during the period indicated and remained in default at period end. For purposes of this schedule, a loan is considered in default if it is 30-days or more past due.
Three Months Ended March 31, 2021
Number of LoansRecorded Balance
Real estate loans:  
Residential5 $197 
Home equity1 91 
Individuals' loans for household and other personal expenditures1 2 
Total7 $290 


Three Months Ended March 31, 2020
Number of LoansRecorded Balance
Real estate loans:  
Residential1 $22 
Total1 $22 


Commercial troubled debt restructured loans risk graded special mention, substandard, doubtful and loss are individually evaluated for apparent loss and may result in a specific reserve allocation in the allowance for credit loss. Commercial troubled debt restructures that aren't individually evaluated for a specific reserve are included in the calculation of allowance for credit losses through the loan segment loss analysis.

For all consumer loan modifications, an evaluation to identify if a troubled debt restructure has occurred is performed prior to making the modification. Any subsequent deterioration is addressed through the charge-off process or through a specific reserve allocation included in the allowance for credit loss. Consumer troubled debt restructures that are not individually evaluated for a specific reserve are included in the calculation of the allowance for credit losses through the loan segment loss analysis. Consumer loans secured by residential real estate properties for which formal foreclosure proceedings are in process totaled $3.3 million and $507,000 at March 31, 2021 and March 31, 2020, respectively.

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PART I. FINANCIAL INFORMATION
ITEM 1. NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
(table dollar amounts in thousands, except share data)
(Unaudited)



Allowance for Credit Losses on Loans

The Allowance for Credit Losses on Loans ("ACL - Loans") is a valuation account that is deducted from the amortized cost basis of loans to present the net amount expected to be collected on loans over the contractual term. The ACL - Loans is adjusted by the provision for credit losses, which is reported in earnings, and reduced by charge offs for loans, net or recoveries. Provision for credit losses on loans reflects the totality of actions taken on all loans for a particular period including any necessary increases or decreases in the allowance related to changes in credit loss expectations associated with specific loans or pools of loans. Loans are charged off against the allowance when the uncollectibility of the loan is confirmed. Expected recoveries do not exceed the aggregate of amounts previously charged off and expected to be charged off.

The allowance represents the Corporation’s best estimate of current expected credit losses on loans using relevant available information, from internal and external sources, related to past events, current conditions, and reasonable and supportable forecasts. Historical credit loss experience provides the basis for the estimation of expected credit losses. The current expected credit loss ("CECL") calculation is performed and evaluated quarterly and losses are estimated over the expected life of the loan. The level of the allowance for credit losses is believed to be adequate to absorb all expected future losses inherent in the loan portfolio at the measurement date.

In calculating the allowance for credit losses, the loan portfolio was pooled into ten loan segments with similar risk characteristics. Common characteristics include the type or purpose of the loan, underlying collateral and historical/expected credit loss patterns. In developing the loan segments, the Corporation analyzed the degree of correlation in how loans within each portfolio respond when subjected to varying economic conditions and scenarios as well as other portfolio stress factors.

The expected credit losses are measured over the life of each loan segment utilizing the Probability of Default / Loss Given Default methodology combined with economic forecast models to estimate the current expected credit loss inherent in the loan portfolio. This approach is also leveraged to estimate the expected credit losses associated with unfunded loan commitments incorporating expected utilization rates.

The Corporation sub-segmented certain commercial portfolios by risk level and certain consumer portfolios by delinquency status where appropriate. The Corporation utilized a four-quarter reasonable and supportable economic forecast period followed by a six-quarter, straight-line reversion period to the historical macroeconomic mean for the remaining life of the loans. Econometric modeling was performed using historical default rates and a selection of economic forecast scenarios published by Moody’s to develop a range of estimated credit losses for which to determine the best credit loss estimate within. Macroeconomic factors utilized in the modeling process include the national unemployment rate, BBB US corporate index, CRE price index and the home price index.

The Corporation qualitatively adjusts model results for risk factors that are not inherently considered in the quantitative modeling process, but are nonetheless relevant in assessing the expected credit losses within the loan portfolio. These adjustments may increase or decrease the estimate of expected credit losses based upon the assessed level of risk for each qualitative factor. The various risks that may be considered in making qualitative adjustments include, among other things, the impact of (i) changes in the nature and volume of the loan portfolio, (ii) changes in the existence, growth and effect of any concentrations in credit, (iii) changes in lending policies and procedures, including changes in underwriting standards and practices for collections, write-offs, and recoveries, (iv) changes in the quality of the credit review function, (v) changes in the experience, ability and depth of lending management and staff, and (vi) other environmental factors such as regulatory, legal and technological considerations, as well as competition.

In some cases, management may determine that an individual loan exhibits unique risk characteristics which differentiate the loan from other loans within the loan segments. In such cases, the loans are evaluated for expected credit losses on an individual basis and excluded from the collective evaluation. Specific reserve allocations of the allowance for credit losses are determined by analyzing the borrower’s ability to repay amounts owed, collateral deficiencies, the relative risk grade of the loan and economic conditions affecting the borrower’s industry, among other things. A loan is considered to be collateral dependent when, based upon management's assessment, the borrower is experiencing financial difficulty and repayment is expected to be provided substantially through the operation or sale of the collateral. In such cases, expected credit losses are based on the fair value of the collateral at the measurement date, adjusted for estimated selling costs if satisfaction of the loan depends on the sale of the collateral. The fair value of collateral supporting collateral dependent loans is evaluated on a quarterly basis.

No allowance for credit losses has been recognized for PPP loans as such loans are fully guaranteed by the Small Business Administration ("SBA").

The risk characteristics of the Corporation’s portfolio segments are as follows:

Commercial
Commercial lending is 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. Most commercial loans are secured by the tangible assets being financed such as equipment or real estate or other business assets such as accounts receivable or inventory and may incorporate a personal guarantee. Other loans may be unsecured, secured but under-collateralized or otherwise made on the basis of the enterprise value of an organization. In the case of loans secured by accounts receivable, the availability of funds for the repayment of these loans may be substantially dependent on the ability of the borrower to collect amounts due from its customers.

Commercial real estate
Commercial real estate loans are viewed primarily as cash flow loans and secondarily as loans secured by real estate. Commercial real estate lending typically involves higher loan principal amounts and the repayment of these loans is generally dependent on the successful operation of the property securing the loan or the business conducted on the property securing the loan. The Corporation monitors commercial real estate loans based on collateral and risk grade criteria, as well as the levels of owner-occupied versus non-owner occupied loans.
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PART I. FINANCIAL INFORMATION
ITEM 1. NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
(table dollar amounts in thousands, except share data)
(Unaudited)



Construction
Construction loans are underwritten utilizing a combination of tools and techniques including feasibility and market studies, independent appraisals and appraisal reviews, absorption and interest rate sensitivity analysis as well as the financial analysis of the developer and all guarantors. Construction loans are monitored by either in house or third party inspectors limiting advances to a percentage of costs or stabilized project value. These loans frequently involve the disbursement of significant funds with the repayment dependent upon the successful completion and, where necessary, the future stabilization of the project. The predominant inherent risk of this portfolio is associated with the borrower's ability to successfully complete a project on time, within budget and stabilize the projected as originally projected.

Consumer and Residential
With respect to residential loans that are secured by 1-4 family residences, which are typically owner occupied, the Corporation generally establishes a maximum loan-to-value ratio and requires private mortgage insurance if that ratio is exceeded. Home equity loans are secured by a subordinate interest in 1-4 family residences, and consumer loans are secured by consumer assets such as automobiles or recreational vehicles. Some consumer loans, such as small installment loans and certain lines of credit, are unsecured. Repayment of these loans is primarily dependent on the personal income and credit rating of the borrowers and can also be impacted by changes in property values. Risk is mitigated by the fact that the loans are of smaller individual amounts and spread over a large number of borrowers.

The following tables summarize changes in the allowance for credit losses by loan segment for the three months ended March 31, 2021:

Three Months Ended March 31, 2021
CommercialCommercial Real EstateConstructionConsumerResidentialConsumer & ResidentialTotal
Allowance for credit losses
Balances, December 31, 2020$47,115 $51,070 $— $9,648 $22,815 $— $130,648 
Credit risk reclassifications— (10,284)10,284 (9,648)(22,815)32,463 — 
Balances, December 31, 2020 after reclassifications47,115 40,786 10,284 — — 32,463 130,648 
Impact of adopting ASC 32620,024 34,925 8,805 — — 10,301 74,055 
Balances, January 1, 2021 Post-ASC 326 adoption67,139 75,711 19,089 — — 42,764 204,703 
Provision for credit losses(932)(1,701)1,095 — — 1,538 — 
Recoveries on loans188 164 — — — 342 694 
Loans charged off(673)(3,313)(2)— — (327)(4,315)
Balances, March 31, 2021$65,722 $70,861 $20,182 $— $— $44,317 $201,082 


Allowance for Loan Losses under prior GAAP ("Incurred Loss Model")

Prior to the adoption of ASU No. 2016-13, Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments on January 1, 2021, the Corporation maintained an allowance for loan losses in accordance with the incurred loss model as disclosed in the Corporation's 2020 Annual Report on Form 10-K.

The following tables summarize changes in the allowance for loan losses by loan segment for the three months ended March 31, 2020:
Three Months Ended March 31, 2020
 CommercialCommercial
Real Estate		ConsumerResidentialTotal
Allowance for loan losses:    
Balances, December 31, 2019$32,902 $28,778 $4,035 $14,569 $80,284 
Provision for losses5,701 9,194 1,924 2,933 19,752 
Recoveries on loans443 118 42 70 673 
Loans charged off(615)(183)(249)(208)(1,255)
Balances, March 31, 2020$38,431 $37,907 $5,752 $17,364 $99,454 



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PART I. FINANCIAL INFORMATION
ITEM 1. NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
(table dollar amounts in thousands, except share data)
(Unaudited)



The table below shows the Corporation’s allowance for loan losses under the incurred loss model and loan portfolio by loan segment as of the periods indicated.
 December 31, 2020
 CommercialCommercial
Real Estate		ConsumerResidentialTotal
Allowance Balances:     
Individually evaluated for impairment$223 $12,246 $— $432 $12,901 
Collectively evaluated for impairment46,892 38,824 9,648 22,383 117,747 
Total Allowance for Loan Losses$47,115 $51,070 $9,648 $22,815 $130,648 
Loan Balances:     
Individually evaluated for impairment$1,258 $51,605 $2 $3,291 $56,156 
Collectively evaluated for impairment3,505,863 3,805,808 129,477 1,739,709 9,180,857 
Loans acquired with deteriorated credit quality577 5,584 — — 6,161 
Loans$3,507,698 $3,862,997 $129,479 $1,743,000 $9,243,174 


The following tables show the composition of the Corporation’s impaired loans, related allowance under the incurred loss model and interest income recognized while impaired by loan class as of the periods indicated:
 December 31, 2020
 Unpaid
Principal
Balance		Recorded
Investment		Related
Allowance
Impaired loans with no related allowance:   
Commercial and industrial loans$1,059 $991 $— 
Real estate Loans:
Commercial real estate, non-owner occupied4,958 4,694 — 
Commercial real estate, owner occupied 2,125 1,310 — 
Residential957 816 — 
Individuals' loans for household and other personal expenditures2 2 — 
Total$9,101 $7,813 $— 
Impaired loans with related allowance:   
Commercial and industrial loans$268 $268 $223 
Agricultural land, production and other loans to farmers640 562 3 
Real estate Loans:  
Commercial real estate, non-owner occupied44,016 43,715 11,686 
Commercial real estate, owner occupied2,061 1,323 557 
Residential2,041 2,014 352 
Home equity487 461 80 
Total$49,513 $48,343 $12,901 
Total Impaired Loans$58,614 $56,156 $12,901 


 Three Months Ended March 31, 2020
 Average
Recorded Investment		Interest
Income Recognized
Impaired loans with no related allowance:  
Commercial and industrial loans$905 $— 
Real estate Loans:
Construction1,015 — 
Commercial and farmland6,852 37 
Residential59 1 
Individuals' loans for household and other personal expenditures3 — 
Total$8,834 $38 
Impaired loans with related allowance:
Real estate Loans:
Commercial and farmland$2,400 $— 
Residential2,180 19 
Home equity393 3 
Total$4,973 $22 
Total Impaired Loans$13,807 $60 

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PART I. FINANCIAL INFORMATION
ITEM 1. NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
(table dollar amounts in thousands, except share data)
(Unaudited)



Off-Balance Sheet Arrangements, Commitments And Contingencies

In the normal course of business, the Corporation has entered into off-balance sheet financial instruments which include commitments to extend credit and standby letters of credit. Commitments to extend credit are usually the result of lines of credit granted to existing borrowers under agreements that the total outstanding indebtedness will not exceed a specific amount during the term of the indebtedness. Typical borrowers are commercial concerns that use lines of credit to supplement their treasury management functions, and thus their total outstanding indebtedness may fluctuate during any time period based on the seasonality of their business and the resultant timing for their cash flows. Other typical lines of credit are related to home equity loans granted to customers. Commitments to extend credit generally have fixed expiration dates or other termination clauses that may require a fee.

Standby letters of credit are generally issued on behalf of an applicant (the Corporation’s customer) to a specifically named beneficiary and are the result of a particular business arrangement that exists between the applicant and the beneficiary. Standby letters of credit have fixed expiration dates and are usually for terms of two years or less unless terminated beforehand due to criteria specified in the standby letter of credit. The standby letter of credit would permit the beneficiary to obtain payment from the Corporation under certain prescribed circumstances. Subsequently, the Corporation would seek reimbursement from the applicant pursuant to the terms of the standby letter of credit.

The Corporation typically follows the same credit policies and underwriting practices when making these commitments as it does for on-balance sheet instruments. Each customer’s creditworthiness is typically evaluated on a case-by-case basis, and the amount of collateral obtained, if any, is based on management’s credit evaluation of the customer. Collateral held varies but may include cash, real estate, marketable securities, accounts receivable, inventory, equipment and personal property.

The contractual amounts of these commitments are not reflected in the consolidated financial statements and only amounts drawn upon would be reflected in the future. Since many of the commitments are expected to expire without being drawn upon, the contractual amounts do not necessarily represent future cash requirements. However, should the commitments be drawn upon and should the Corporation’s customers default on their resulting obligation to the Corporation, the maximum exposure to credit loss, without consideration of collateral, is represented by the contractual amount of those commitments.

Financial instruments with off-balance sheet risk were as follows:
March 31, 2021December 31, 2020
Amounts of commitments:
Loan commitments to extend credit$3,657,931 $3,443,514 
Standby letters of credit$33,610 $29,555 


The adoption of the CECL methodology for measuring credit losses, as discussed more fully in the Allowance for Credit Loss on Loans section of this Note, and in NOTE 1. GENERAL of these Notes to Consolidated Condensed Financial Statements, increased the opening balance of our accrual for off-balance sheet commitments at adoption by $20.5 million, which is reported in Other Liabilities as of March 31, 2021 in the CONSOLIDATED CONDENSED BALANCE SHEETS.

The following table details activity in the allowance for credit losses on off-balance sheet commitments:
Three Months Ended
March 31, 2021
Balances, December 31, 2020$— 
Impact of adopting ASC 32620,500 
Provision for credit losses— 
Balances, March 31, 2021$20,500 


NOTE 4

OTHER INTANGIBLES

Core deposit intangibles are recorded on the acquisition date of an entity. The carrying basis and accumulated amortization of recognized core deposit intangibles are noted below.

March 31, 2021December 31, 2020
Gross carrying amount$102,396 $102,396 
Accumulated amortization(74,778)(73,421)
Total core deposit intangibles$27,618 $28,975 


26
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PART I. FINANCIAL INFORMATION
ITEM 1. NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
(table dollar amounts in thousands, except share data)
(Unaudited)



The core deposit intangibles are being amortized primarily on an accelerated basis over their estimated useful lives, generally over a period of ten years. Intangible asset amortization expense for the three months ended March 31, 2021 was $1.4 million compared to $1.5 million for the three months ended March 31, 2020. Estimated future amortization expense is summarized as follows:
Amortization Expense
2021$4,072 
20225,027 
20234,827 
20244,241 
20253,526 
After 20255,925 
$27,618 


NOTE 5

DERIVATIVE FINANCIAL INSTRUMENTS

Risk Management Objective of Using Derivatives

The Corporation is exposed to certain risks arising from both its business operations and economic conditions.  The Corporation principally manages its exposures to a wide variety of business and operational risks through management of its core business activities. The Corporation manages economic risks, including interest rate, liquidity, and credit risk, primarily by managing the amount, sources, and duration of its assets and liabilities and through the use of derivative financial instruments.  Specifically, the Corporation enters into derivative financial instruments to manage exposures that arise from business activities that result in the receipt or payment of future known and uncertain cash amounts, the value of which are determined by interest rates.  The Corporation’s derivative financial instruments are used to manage differences in the amount, timing, and duration of the Corporation’s known or expected cash payments principally related to certain variable-rate liabilities.  The Corporation also has derivatives that are a result of a service the Corporation provides to certain qualifying customers, and, therefore, are not used to manage interest rate risk in the Corporation’s assets or liabilities.  The Corporation manages a matched book with respect to its derivative instruments offered as a part of this service to its customers in order to minimize its net risk exposure resulting from such transactions.

Cash Flow Hedges of Interest Rate Risk

The Corporation’s objectives in using interest rate derivatives are to add stability to interest expense and to manage its exposure to interest rate movements. To accomplish these objectives, the Corporation primarily uses interest rate swaps and interest rate caps as part of its interest rate risk management strategy.  Interest rate swaps designated as cash flow hedges involve the payment of fixed amounts to a counterparty in exchange for the Corporation receiving variable payments over the life of the agreements without exchange of the underlying notional amount. Interest rate caps designated as cash flow hedges involve the receipt of variable amounts from a counterparty if interest rates rise above the strike rate on the contract in exchange for an up-front premium. As of March 31, 2021 and December 31, 2020, the Corporation had four interest rate swaps with a notional amount of $60.0 million that were designated as cash flow hedges.

The effective portion of changes in the fair value of derivatives designated and that qualify as cash flow hedges is recorded in accumulated other comprehensive income and is subsequently reclassified into earnings in the period that the hedged forecasted transaction affects earnings. During the first quarter of 2021, $26.0 million of the interest rate swaps were used to hedge the variable cash outflows (LIBOR-based) associated with existing trust preferred securities when the outflows converted from a fixed rate to variable rate in September 2012.  In addition, $10.0 million of interest rate swaps were used to hedge the variable cash outflows (LIBOR-based) associated with one Federal Home Loan Bank advances. Finally, the remaining $24.0 million of interest rate swaps were used to hedge the variable cash outflows (Ameribor-based) associated with a brokered deposit originated in December 2020. The ineffective portion of the change in fair value of the derivatives is recognized directly in earnings. During the three months ended March 31, 2021 and 2020, the Corporation did not recognize any ineffectiveness.

Amounts reported in accumulated other comprehensive income related to derivatives will be reclassified to interest expense as interest payments are made on the Corporation's variable-rate liabilities. During the next twelve months, the Corporation expects to reclassify $1.0 million from accumulated other comprehensive income to interest expense.

Non-designated Hedges

The Corporation does not use derivatives for trading or speculative purposes.  Derivatives not designated as hedges are not speculative and result from a service the Corporation provides to certain customers. The Corporation executes interest rate swaps with commercial banking customers to facilitate their respective risk management strategies.  Those interest rate swaps are simultaneously hedged by offsetting interest rate swaps that the Corporation executes with a third party, such that the Corporation minimizes its net risk exposure resulting from such transactions.  As the interest rate swaps associated with this program do not meet the strict hedge accounting requirements, changes in the fair value of both the customer swaps and the offsetting swaps are recognized directly in earnings.  As of March 31, 2021 and December 31, 2020, the notional amount of customer-facing swaps was approximately $972.7 million and $985.0 million, respectively.  These amounts are offset with third party counterparties, as described above.
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ITEM 1. NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
(table dollar amounts in thousands, except share data)
(Unaudited)



Fair Values of Derivative Instruments on the Balance Sheet

The table below presents the fair value of the Corporation’s derivative financial instruments, as well as their classification on the Balance Sheet, as of March 31, 2021, and December 31, 2020.
 Asset DerivativesLiability Derivatives
 March 31, 2021December 31, 2020March 31, 2021December 31, 2020
 Balance
Sheet
Location		Fair
Value		Balance
Sheet
Location		Fair
Value		Balance
Sheet
Location		Fair
Value		Balance
Sheet
Location		Fair
Value
Derivatives designated as hedging instruments:        
Interest rate contractsOther Assets$— Other Assets$— Other Liabilities$1,708 Other Liabilities$2,018 
Derivatives not designated as hedging instruments:        
Interest rate contractsOther Assets$48,576 Other Assets$74,335 Other Liabilities$48,576 Other Liabilities$74,335 



The amount of gain (loss) recognized in other comprehensive income is included in the table below for the periods indicated.
Derivatives in Cash Flow Hedging RelationshipsAmount of Gain (Loss) Recognized in Other Comprehensive Income on Derivative
 (Effective Portion)
Three Months Ended
March 31, 2021March 31, 2020
Interest Rate Products$58 $(1,314)


Effect of Derivative Instruments on the Income Statement

The Corporation did not recognize any gains or losses from derivative financial instruments in the Consolidated Condensed Statements of Income for the three months ended March 31, 2021 and 2020.

The amount of gain (loss) reclassified from other comprehensive income into income is included in the table below for the periods indicated.
Derivatives Designated as
Hedging Instruments under
FASB ASC 815-10		Location of Gain (Loss)
Recognized Income on
Derivative		Amount of Gain (Loss) Reclassed from Other Comprehensive Income into Income (Effective Portion)
Three Months Ended
March 31, 2021		Three Months Ended
March 31, 2020
Interest rate contractsInterest Expense$(252)$(125)

The Corporation’s exposure to credit risk occurs because of nonperformance by its counterparties.  The counterparties approved by the Corporation are usually financial institutions, which are well capitalized and have credit ratings through Moody’s and/or Standard & Poor’s at or above investment grade.  The Corporation’s control of such risk is through quarterly financial reviews, comparing mark-to-market values with policy limitations, credit ratings and collateral pledging.

Credit-risk-related Contingent Features

The Corporation has agreements with certain of its derivative counterparties that contain a provision where if the Corporation fails to maintain its status as a well or adequately capitalized institution, then the Corporation could be required to terminate or fully collateralize all outstanding derivative contracts. Additionally, the Corporation has agreements with certain of its derivative counterparties that contain a provision where if the Corporation defaults on any of its indebtedness, including default where repayment of the indebtedness has not been accelerated by the lender, then the Corporation could also be declared in default on its derivative obligations. As of March 31, 2021, the termination value of derivatives in a net liability position related to these agreements was $36.7 million. As of March 31, 2021, the Corporation has minimum collateral posting thresholds with certain of its derivative counterparties and has posted collateral of $62.8 million. While the Corporation did not breach any of these provisions as of March 31, 2021, if it had, the Corporation could have been required to settle its obligations under the agreements at their termination value.
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(table dollar amounts in thousands, except share data)
(Unaudited)



NOTE 6 

DISCLOSURES ABOUT FAIR VALUE OF ASSETS AND LIABILITIES

The Corporation used fair value measurements to record fair value adjustments to certain assets and liabilities and to determine fair value disclosures. The accounting guidance defines fair value, establishes a framework for measuring fair value and expands disclosures about fair value measurements.  ASC 820 applies only when other guidance requires or permits assets or liabilities to be measured at fair value; it does not expand the use of fair value in any new circumstances.

As defined in ASC 820, fair value is the price to sell an asset or transfer a liability in an orderly transaction between market participants. It represents an exit price at the measurement date. Market participants are buyers and sellers, who are independent, knowledgeable, and willing and able to transact in the principal (or most advantageous) market for the asset or liability being measured. Current market conditions, including imbalances between supply and demand, are considered in determining fair value. The Corporation values its assets and liabilities in the principal market where it sells the particular asset or transfers the liability with the greatest volume and level of activity. In the absence of a principal market, the valuation is based on the most advantageous market for the asset or liability (i.e., the market where the asset could be sold or the liability transferred at a price that maximizes the amount to be received for the asset or minimizes the amount to be paid to transfer the liability).

Valuation inputs refer to the assumptions market participants would use in pricing a given asset or liability. Inputs can be observable or unobservable. Observable inputs are those assumptions which market participants would use in pricing the particular asset or liability. These inputs are based on market data and are obtained from a source independent of the Corporation. Unobservable inputs are assumptions based on the Corporation’s own information or estimate of assumptions used by market participants in pricing the asset or liability. Unobservable inputs are based on the best and most current information available on the measurement date. All inputs, whether observable or unobservable, are ranked in accordance with a prescribed fair value hierarchy which gives the highest ranking to quoted prices (unadjusted) in active markets for identical assets or liabilities (Level 1) and the lowest ranking to unobservable inputs for which there is little or no market activity (Level 3). Fair values for assets or liabilities classified as Level 2 are based on one or a combination of the following factors: (i) quoted prices for similar assets; (ii) observable inputs for the asset or liability, such as interest rates or yield curves; or (iii) inputs derived principally from or corroborated by observable market data. The level in the fair value hierarchy within which the fair value measurement in its entirety falls is determined based on the lowest level input that is significant to the fair value measurement in its entirety. The Corporation considers an input to be significant if it drives 10 percent or more of the total fair value of a particular asset or liability.

RECURRING MEASUREMENTS

Assets and liabilities are considered to be measured at fair value on a recurring basis if fair value is measured regularly (i.e., daily, weekly, monthly or quarterly). Recurring valuation occurs at a minimum on the measurement date. Assets and liabilities are considered to be measured at fair value on a nonrecurring basis if the fair value measurement of the instrument does not necessarily result in a change in the amount recorded on the balance sheet. Generally, nonrecurring valuation is the result of the application of other accounting pronouncements which require assets or liabilities to be assessed for impairment or recorded at the lower of cost or fair value. The fair value of assets or liabilities transferred in or out of Level 3 is measured on the transfer date, with any additional changes in fair value subsequent to the transfer considered to be realized or unrealized gains or losses.

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

Investment Securities

Where quoted prices are available in an active market, securities are classified within Level 1 of the valuation hierarchy. The Corporation currently has no securities classified within Level 1 of the hierarchy. Where significant observable inputs, other than Level 1 quoted prices, are available, securities are classified within Level 2 of the valuation hierarchy. Level 2 securities include U.S. treasury securities, government-sponsored agency and mortgage-backed securities, state and municipal securities and corporate obligations securities. In certain cases where Level 1 or Level 2 inputs are not available, securities are classified within Level 3 of the hierarchy and include state and municipal securities, government-sponsored mortgage-backed securities and corporate obligations securities. Level 3 fair value for securities was determined using a discounted cash flow model that incorporated market estimates of interest rates and volatility in markets that have not been active.

Third party vendors compile prices from various sources and may apply such techniques as matrix pricing to determine the value of identical or similar investment securities (Level 2). Matrix pricing is a mathematical technique widely used in the banking industry to value investment securities without relying exclusively on quoted prices for specific investment securities but rather relying on the investment securities’ relationship to other benchmark quoted investment securities. Any investment security not valued based upon the methods above are considered Level 3.


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(table dollar amounts in thousands, except share data)
(Unaudited)



Interest Rate Derivative Agreements

See information regarding the Corporation’s interest rate derivative products in NOTE 5. DERIVATIVE FINANCIAL INSTRUMENTS of these Notes to Consolidated Condensed Financial Statements.

The following table presents the fair value measurements of assets and liabilities recognized in the accompanying balance sheets measured at fair value on a recurring basis and the level within the ASC 820 fair value hierarchy in which the fair value measurements fall at March 31, 2021, and December 31, 2020.
  Fair Value Measurements Using:
March 31, 2021Fair ValueQuoted Prices in Active Markets for Identical Assets
(Level 1)		Significant Other
Observable Inputs
(Level 2)		Significant
Unobservable
Inputs
(Level 3)
Available for sale securities:    
U.S. Treasury$1,000 $— $1,000 $— 
U.S. Government-sponsored agency securities11,381 — 11,381 — 
State and municipal1,366,162 — 1,364,051 2,111 
U.S. Government-sponsored mortgage-backed securities1,022,863 — 1,022,859 4 
Corporate obligations4,162 — 4,131 31 
Interest rate swap asset48,576 — 48,576 — 
Interest rate swap liability50,284 — 50,284 — 
  Fair Value Measurements Using:
December 31, 2020Fair ValueQuoted Prices in
Active Markets for
Identical Assets
(Level 1)		Significant Other Observable Inputs
(Level 2)		Significant
Unobservable
Inputs
(Level 3)
Available for sale securities:    
U.S. Government-sponsored agency securities$2,430 $— $2,430 $— 
State and municipal1,257,885 — 1,255,441 2,444 
U.S. Government-sponsored mortgage-backed securities654,669 — 654,665 4 
Corporate obligations4,135 — 4,104 31 
Interest rate swap asset74,335 — 74,335 — 
Interest rate swap liability76,353 — 76,353 — 


There were no gains or losses included in earnings that were attributable to the changes in unrealized gains or losses related to assets or
liabilities held at March 31, 2021 or December 31, 2020.

Level 3 Reconciliation

The following is a reconciliation of the beginning and ending balances of recurring fair value measurements recognized in the accompanying
balance sheets using significant unobservable Level 3 inputs for the three months ended March 31, 2021 and 2020.
 Available for Sale Securities
Three Months Ended
 March 31, 2021March 31, 2020
Balance at beginning of the period$2,479 $2,893 
Included in other comprehensive income(60)(20)
Principal payments(273)(344)
Ending balance $2,146 $2,529 


Transfers Between Levels

There were no transfers in or out of Level 3 for the three months ended March 31, 2021 and 2020.
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(Unaudited)


Nonrecurring Measurements

Following is a description of valuation methodologies used for instruments measured at fair value on a non-recurring basis and recognized in the accompanying balance sheets, as well as the general classification of such instruments pursuant to the valuation hierarchy for March 31, 2021, and December 31, 2020.
  Fair Value Measurements Using
March 31, 2021Fair ValueQuoted Prices in
Active Markets for
Identical Assets
(Level 1)		Significant Other
Observable
Inputs
(Level 2)		Significant Unobservable
Inputs
(Level 3)
Collateral dependent loans$40,698 $— $— $40,698 
Other real estate owned185 — — 185 
  Fair Value Measurements Using
December 31, 2020Fair ValueQuoted Prices in
Active Markets for
Identical Assets
(Level 1)		Significant Other
Observable
 Inputs
(Level 2)		Significant Unobservable
Inputs
(Level 3)
Impaired loans (collateral dependent)$37,250 $— $— $37,250 
Other real estate owned544 — — 544 

Impaired Loans (collateral dependent)

Loans for which it is probable that the Corporation will not collect all principal and interest due according to contractual terms are measured for impairment. Allowable methods for determining the amount of impairment include estimating fair value of the collateral for collateral dependent loans. If the impaired loan is identified as collateral dependent, then the fair value method of measuring the amount of impairment is utilized. This method requires obtaining a current independent appraisal of the collateral and applying a discount factor to the value. A portion of the allowance for loan losses is allocated to impaired loans if the value of such loans is deemed to be less than the unpaid balance. If these allocations cause the allowance for loan losses to increase, such increase is reported as a component of the provision for loan losses. Loan losses are charged against the allowance when management believes the uncollectability of the loan is confirmed. During 2020 and 2021, certain impaired loans were partially charged off or re-evaluated. Impaired loans that are collateral dependent are classified within Level 3 of the fair value hierarchy when impairment is determined using the fair value method.

Other Real Estate Owned

The fair value for impaired loans and other real estate owned is measured based on the value of the collateral securing those loans or real estate and is determined using several methods. The fair value of real estate is generally determined 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 discounted 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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(Unaudited)



Unobservable (Level 3) Inputs

The following table presents quantitative information about unobservable inputs used in recurring and nonrecurring Level 3 fair value measurements, other than goodwill, at March 31, 2021 and December 31, 2020.
March 31, 2021Fair ValueValuation TechniqueUnobservable InputsRange (Weighted-Average)
State and municipal securities$2,111 Discounted cash flowMaturity/Call date
1 month to 15 years
   US Muni BQ curve
A- to BBB-
   Discount rate
2% - 4%
Weighted-average coupon
4%
Corporate obligations and U.S. Government-sponsored mortgage-backed securities$35 Discounted cash flowRisk free rate
3 month LIBOR
   plus premium for illiquidity
plus 200bps
Weighted-average coupon
—%
Collateral dependent loans$40,698 Collateral based measurementsDiscount to reflect current market conditions and ultimate collectability
 0% - 10%
  Weighted-average discount by loan balance
4%
Other real estate owned$185 AppraisalsDiscount to reflect current market conditions
0% - 72%
Weighted-average discount of other real estate owned balance
39%
December 31, 2020Fair ValueValuation TechniqueUnobservable InputsRange (Weighted-Average)
State and municipal securities$2,444 Discounted cash flowMaturity/Call date
1 month to 15 years
   US Muni BQ curve
A- to BBB-
   Discount rate
2% - 4%
Weighted-average coupon
4%
Corporate obligations and U.S Government-sponsored mortgage-backed securities$35 Discounted cash flowRisk free rate
3 month LIBOR
   plus premium for illiquidity
plus 200bps
Weighted-average coupon
—%
Impaired loans (collateral dependent)$37,250 Collateral based measurementsDiscount to reflect current market conditions and ultimate collectability
0% - 10%
Weighted-average discount by loan balance
6%
   
Other real estate owned$544 AppraisalsDiscount to reflect current market conditions
0% - 30%
Weighted-average discount of other real estate owned balance
26%


The following is a discussion of the sensitivity of significant unobservable inputs, the interrelationships between those inputs and other unobservable inputs used in recurring fair value measurement and how those inputs might magnify or mitigate the effect of changes in the unobservable inputs on the fair value measurement.

State and Municipal Securities, Corporate Obligations and U.S. Government-sponsored Mortgage-Backed Securities

The significant unobservable inputs used in the fair value measurement of the Corporation's state and municipal securities, corporate obligations and U.S. Government-sponsored mortgage-backed securities are premiums for unrated securities and marketability discounts. Significant increases or decreases in either of those inputs in isolation would result in a significantly lower or higher fair value measurement. Generally, changes in either of those inputs will not affect the other input.

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(table dollar amounts in thousands, except share data)
(Unaudited)



Fair Value of Financial Instruments

The following table presents estimated fair values of the Corporation’s financial instruments and the level within the fair value hierarchy in which the fair value measurements fall at March 31, 2021, and December 31, 2020.
March 31, 2021
 Quoted Prices in Active Markets
for Identical
Assets		Significant
Other
Observable
Inputs		Significant Unobservable
Inputs
 Carrying Amount(Level 1)(Level 2)(Level 3)
Assets:    
Cash and cash equivalents$187,901 $187,901 $— $— 
Interest-bearing deposits392,806 392,806 — — 
Investment securities available for sale2,405,568 — 2,403,422 2,146 
Investment securities held to maturity1,295,289 — 1,299,944 18,836 
Loans held for sale4,430 — 4,430 — 
Loans9,117,146 — — 9,168,023 
Federal Home Loan Bank stock28,736 — 28,736 — 
Interest rate swap asset48,576 — 48,576 — 
Interest receivable54,662 — 54,662 — 
Liabilities:    
Deposits$11,951,780 $11,103,474 $847,398 $— 
Borrowings:  
Securities sold under repurchase agreements185,721 — 185,716 — 
Federal Home Loan Bank advances359,337 — 366,179 — 
Subordinated debentures and other borrowings118,439 — 108,124 — 
Interest rate swap liability50,284 — 50,284 — 
Interest payable4,020 — 4,020 — 
December 31, 2020
 Quoted Prices in Active Markets
for Identical
Assets		Significant
Other
Observable
Inputs		Significant Unobservable
Inputs
 Carrying Amount(Level 1)(Level 2)(Level 3)
Assets:    
Cash and cash equivalents$192,896 $192,896 $— $— 
Interest-bearing deposits392,305 392,305 — — 
Investment securities available for sale1,919,119 — 1,916,640 2,479 
Investment securities held to maturity1,227,668 — 1,260,815 19,478 
Loans held for sale3,966 — 3,966 — 
Loans9,112,526 — — 9,191,628 
Federal Home Loan Bank stock28,736 — 28,736 — 
Interest rate swap asset74,335 — 74,335 — 
Interest receivable53,948 — 53,948 — 
Liabilities:    
Deposits$11,361,610 $10,482,865 $878,257 $— 
Borrowings:    
Securities sold under repurchase agreements177,102 — 177,097 — 
Federal Home Loan Bank advances389,430 — 399,991 — 
Subordinated debentures and other borrowings118,380 — 108,439 — 
Interest rate swap liability76,353 — 76,353 — 
Interest payable3,287 — 3,287 — 

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(Unaudited)



NOTE 7

TRANSFERS ACCOUNTED FOR AS SECURED BORROWINGS

The collateral pledged for all repurchase agreements that are accounted for as secured borrowings as of March 31, 2021 and December 31, 2020 were:
March 31, 2021
Remaining Contractual Maturity of the Agreements
Overnight and ContinuousUp to 30 Days30-90 DaysGreater Than 90 DaysTotal
U.S. Government-sponsored mortgage-backed securities$184,067 $— $1,654 $— $185,721 
December 31, 2020
Remaining Contractual Maturity of the Agreements
Overnight and ContinuousUp to 30 Days30-90 DaysGreater Than 90 DaysTotal
U.S. Government-sponsored mortgage-backed securities$175,449 $— $1,653 $— $177,102 


NOTE 8 
ACCUMULATED OTHER COMPREHENSIVE INCOME (LOSS)
The following table summarizes the changes in the balances of each component of accumulated other comprehensive income (loss), net of tax, as of March 31, 2021 and 2020:
Accumulated Other Comprehensive Income (Loss)
Unrealized Gains (Losses) on Securities Available for SaleUnrealized Gains (Losses) on Cash Flow HedgesUnrealized Gains (Losses) on Defined Benefit PlansTotal
Balance at December 31, 2020$87,988 $(1,594)$(11,558)$74,836 
Other comprehensive income (loss) before reclassifications(37,850)46 — (37,804)
Amounts reclassified from accumulated other comprehensive income(1,421)199 — (1,222)
Period change(39,271)245 — (39,026)
Balance at March 31, 2021$48,717 $(1,349)$(11,558)$35,810 
Balance at December 31, 2019$38,872 $(1,141)$(9,857)$27,874 
Other comprehensive income (loss) before reclassifications30,364 (1,038)— 29,326 
Amounts reclassified from accumulated other comprehensive income(3,643)99 — (3,544)
Period change26,721 (939)— 25,782 
Balance at March 31, 2020$65,593 $(2,080)$(9,857)$53,656 



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(table dollar amounts in thousands, except share data)
(Unaudited)



The following table presents the reclassification adjustments out of accumulated other comprehensive income (loss) that were included in net income in the Consolidated Condensed Statements of Income for the three months ended March 31, 2021 and 2020.
Amount Reclassified from Accumulated Other Comprehensive Income (Loss) For the Three Months Ended March 31,
Details about Accumulated Other Comprehensive Income (Loss) Components20212020Affected Line Item in the Statements of Income
Unrealized gains (losses) on available for sale securities (1)
Realized securities gains reclassified into income$1,799 $4,612 Other income - net realized gains on sales of available for sale securities
Related income tax expense(378)(969)Income tax expense
$1,421 $3,643 
Unrealized gains (losses) on cash flow hedges (2)
Interest rate contracts$(252)$(125)Interest expense - subordinated debentures and term loans
Related income tax benefit53 26 Income tax expense
$(199)$(99)
Total reclassifications for the period, net of tax$1,222 $3,544 

(1) For additional detail related to unrealized gains (losses) on available for sale securities and related amounts reclassified from accumulated other comprehensive income see NOTE 2. INVESTMENT SECURITIES of these Notes to Consolidated Condensed Financial Statements.
(2) For additional detail related to unrealized gains (losses) on cash flow hedges and related amounts reclassified from accumulated other comprehensive income see NOTE 5. DERIVATIVE FINANCIAL INSTRUMENTS of these Notes to Consolidated Condensed Financial Statements.

NOTE 9

SHARE-BASED COMPENSATION

Stock options and RSAs have been issued to directors, officers and other management employees under the Corporation's 2009 Long-term Equity Incentive Plan, the 2019 Long-term Equity Incentive Plan, and the Equity Compensation Plan for Non-Employee Directors. The stock options, which have a ten year life, become 100 percent vested based on time ranging from one year to two years and are fully exercisable when vested. Option exercise prices equal the Corporation's common stock closing price on NASDAQ on the date of grant. The RSAs issued to employees and non-employee directors provide for the issuance of shares of the Corporation's common stock at no cost to the holder and generally vest after 3 years.  The RSAs vest only if the employee is actively employed by the Corporation on the vesting date and, therefore, any unvested shares are forfeited.  For non-employee directors, the RSAs vest only if the non-employee director remains as an active board member on the vesting date and, therefore, any unvested shares are forfeited. The RSAs for employees and non-employee directors are either immediately vested at retirement, disability or death, or, continue to vest after retirement, disability or death, depending on the plan under which the shares were granted.

The Corporation’s 2019 ESPP provides eligible employees of the Corporation and its subsidiaries an opportunity to purchase shares of common stock of the Corporation through quarterly offerings financed by payroll deductions. The price of the stock to be paid by the employees shall be equal to 85 percent of the average of the closing price of the Corporation’s common stock on each trading day during the offering period. However, in no event shall such purchase price be less than the lesser of an amount equal to 85 percent of the market price of the Corporation’s stock on the offering date or an amount equal to 85 percent of the market value on the date of purchase. Common stock purchases are made quarterly and are paid through advance payroll deductions up to a calendar year maximum of $25,000.

Compensation expense related to unvested share-based awards is recorded by recognizing the unamortized grant date fair value of these awards over the remaining service periods of those awards, with no change in historical reported fair values and earnings.  Awards are valued at fair value in accordance with provisions of share-based compensation guidance and are recognized on a straight-line basis over the service periods of each award. To complete the exercise of vested stock options, RSA’s and ESPP options, the Corporation generally issues new shares from its authorized but unissued share pool. Share-based compensation for the three months ended March 31, 2021 was $1,190,000 compared to $1,220,000 for the three months ended March 31, 2020. Share-based compensation has been recognized as a component of salaries and benefits expense in the accompanying Consolidated Condensed Statements of Income.

Share-based compensation expense recognized in the Consolidated Condensed Statements of Income is based on awards ultimately expected to vest and is reduced for estimated forfeitures. Share-based compensation guidance requires forfeitures to be estimated at the time of grant and revised, if necessary, in subsequent periods, if actual forfeitures differ from those estimates. Pre-vesting forfeitures were estimated to be approximately 0.5 percent for the three months ended March 31, 2021, based on historical experience.
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(Unaudited)



The following table summarizes the components of the Corporation's share-based compensation awards recorded as an expense and the income tax benefit of such awards.
Three Months Ended
March 31,
 20212020
Stock and ESPP Options  
Pre-tax compensation expense$75 $41 
Income tax expense (benefit)(72)— 
Stock and ESPP option expense, net of income taxes$3 $41 
Restricted Stock Awards  
Pre-tax compensation expense$1,115 $1,179 
Income tax expense (benefit)(237)(257)
Restricted stock awards expense, net of income taxes$878 $922 
Total Share-Based Compensation  
Pre-tax compensation expense$1,190 $1,220 
Income tax expense (benefit)(309)(257)
Total share-based compensation expense, net of income taxes$881 $963 


As of March 31, 2021, unrecognized compensation expense related to RSAs was $8.4 million and is expected to be recognized over a weighted-average period of 2.01 years. The Corporation did not have any unrecognized compensation expense related to stock options as of March 31, 2021.

Stock option activity under the Corporation's stock option plans as of March 31, 2021 and changes during the three months ended March 31, 2021, were as follows:
 Number of
Shares		Weighted-Average Exercise PriceWeighted Average Remaining
Contractual Term
(in Years)		Aggregate
Intrinsic
Value
Outstanding at January 1, 2021
45,800 $15.00   
Exercised(14,300)$11.97   
Outstanding March 31, 2021
31,500 $16.37 2.06$949,155 
Vested and Expected to Vest at March 31, 202131,500 $16.37 2.06$949,155 
Exercisable at March 31, 202131,500 $16.37 2.06$949,155 


The aggregate intrinsic value in the table above represents the total pre-tax intrinsic value (the difference between the Corporation's closing stock price on the last trading day of the first three months of 2021 and the exercise price, multiplied by the number of in-the-money options) that would have been received by the option holders had all option holders exercised their stock options on March 31, 2021.  The amount of aggregate intrinsic value will change based on the fair market value of the Corporation's common stock.

The aggregate intrinsic value of stock options exercised during the three months ended March 31, 2021 and 2020 was $453,000 and $36,000, respectively. Cash receipts of stock options exercised during this same period were $171,000 and $7,000, respectively.

The following table summarizes information on unvested RSAs outstanding as of March 31, 2021:
 Number of SharesWeighted-Average
Grant Date Fair Value
Unvested RSAs at January 1, 2021
357,883 $36.30 
Granted66,913 $42.39 
Vested(4,285)$42.15 
Forfeited(1,650)$32.21 
Unvested RSAs at March 31, 2021
418,861 $37.23 


The grant date fair value of ESPP options was estimated to be approximately $75,000 at the beginning of the January 1, 2021 quarterly offering period. The ESPP options vested during the three months ending March 31, 2021, leaving no unrecognized compensation expense related to unvested ESPP options at March 31, 2021.
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PART I. FINANCIAL INFORMATION
ITEM 1. NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
(table dollar amounts in thousands, except share data)
(Unaudited)



NOTE 10

INCOME TAX

The following table summarizes the major components creating differences between income taxes at the federal statutory and the effective tax rate recorded in the consolidated statements of income for the three months ended March 31, 2021 and 2020:
Three Months Ended
March 31,
 20212020
Reconciliation of Federal Statutory to Actual Tax Expense:  
Federal statutory income tax at 21%$12,268 $7,928 
Tax-exempt interest income(3,706)(3,022)
Share-based compensation(59)— 
Tax-exempt earnings and gains on life insurance(281)(286)
Tax credits(73)(61)
CARES Act - NOL carryback rate differential— (1,178)
State Income Tax702 86 
Other101 23 
Actual Tax Expense$8,952 $3,490 
Effective Tax Rate15.3 %9.2 %


NOTE 11
NET INCOME PER SHARE
Basic net income per share is computed by dividing net income by the weighted-average shares outstanding during the reporting period. Diluted net income per share is computed by dividing net income by the combination of the weighted-average shares outstanding during the reporting period and all potentially dilutive common shares. Potentially dilutive common shares include stock options and RSAs issued under the Corporation's share-based compensation plans. Potentially dilutive common shares are excluded from the computation of diluted earnings per share in the periods where the effect would be antidilutive.

The following table reconciles basic and diluted net income per share for the three months ended March 31, 2021 and 2020.
 Three Months Ended March 31,
 20212020
 Net IncomeWeighted-Average SharesPer Share
Amount		Net IncomeWeighted-Average SharesPer Share
Amount
Net income available to common stockholders$49,469 53,930,200 $0.92 $34,263 54,732,073 $0.63 
Effect of potentially dilutive stock options and restricted stock awards203,422  185,687  
Diluted net income per share$49,469 54,133,622 $0.91 $34,263 54,917,760 $0.62 
For the three months ended March 31, 2021 and 2020, there were no stock options with an option price greater than the average market price of the common shares.


NOTE 12
GENERAL LITIGATION AND REGULATORY EXAMINATIONS

The Corporation is subject to claims and lawsuits that arise primarily in the ordinary course of business. Additionally, the Corporation is subject to periodic examinations by various regulatory agencies. It is the general opinion of management that the disposition or ultimate resolution of such claims, lawsuits, and examinations will not have a material adverse effect on the consolidated financial position, results of operations and cash flow of the Corporation.


NOTE 13
SUBSEQUENT EVENT

On April 1, 2021, the Bank closed its acquisition of Hoosier Trust Company, an Indiana trust company (“Hoosier”), pursuant to which Hoosier merged with and into the Bank. The consideration paid to the shareholders of Hoosier at closing was $3,225,000 in cash.
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PART I: FINANCIAL INFORMATION
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

ITEM 2.  MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
FORWARD-LOOKING STATEMENTS

From time to time, we include forward-looking statements in our oral and written communication. We may include forward-looking statements in filings with the Securities and Exchange Commission, such as this Quarterly Report on Form 10-Q, in other written materials and in oral statements made by senior management to analysts, investors, representatives of the media and others. We intend these forward-looking statements to be covered by the safe harbor provisions for forward-looking statements contained in the Private Securities Litigation Reform Act of 1995, and we are including this statement for purposes of these safe harbor provisions. Forward-looking statements can often be identified by the use of words like “believe”, “continue”, “pattern”, “estimate”, “project”, “intend”, “anticipate”, “expect” and similar expressions or future or conditional verbs such as “will”, “would”, “should”, “could”, “might”, “can”, “may”, or similar expressions. These forward-looking statements include:

•statements of the Corporation's goals, intentions and expectations;
•statements regarding the Corporation's business plan and growth strategies;
•statements regarding the asset quality of the Corporation's loan and investment portfolios; and
•estimates of the Corporation's risks and future costs and benefits.

These forward-looking statements are subject to significant risks, assumptions and uncertainties, including, among other things, the following important factors which could affect the actual outcome of future events:

•fluctuations in market rates of interest and loan and deposit pricing, which could negatively affect our net interest margin, asset valuations and expense expectations;
•adverse changes in the economy, which might affect our business prospects and could cause credit-related losses and expenses;
•the severity and duration of the COVID-19 pandemic and its impact on general economic and financial market conditions and our business, results of operations, and financial condition;
•adverse developments in our loan and investment portfolios;
•our participation as a lender in the PPP;
•competitive factors in the banking industry, such as the trend towards consolidation in our market;
•changes in the banking legislation or the regulatory requirements of federal and state agencies applicable to bank holding companies and banks like our affiliate bank;
•acquisitions of other businesses by us and integration of such acquired businesses;
•our ability to implement and comply with the Settlement Agreement and Agreed Order entered into with the United States Department of Justice ("DOJ") related to our fair lending practices;
•changes in market, economic, operational, liquidity, credit and interest rate risks associated with our business; and
•the continued availability of earnings and excess capital sufficient for the lawful and prudent declaration and payment of cash dividends.

Because of these and other uncertainties, our actual future results may be materially different from the results indicated by these forward-looking statements. In addition, our past results of operations do not necessarily indicate our anticipated future results.

CRITICAL ACCOUNTING POLICIES
Generally accepted accounting principles are complex and require us to apply significant judgments to various accounting, reporting and disclosure matters. We must use assumptions and estimates to apply those principles where actual measurement is not possible or practical. For a complete discussion of our significant accounting policies, see “Notes to the Consolidated Financial Statements” in our Annual Report on Form 10-K for the year ended December 31, 2020. Certain policies are considered critical because they are highly dependent upon subjective or complex judgments, assumptions and estimates. Changes in such estimates may have a significant impact on the financial statements. The uncertainties related to COVID-19 could cause significant changes to these estimates compared to what was known at the time these financial statements were prepared.

We believe there have been no significant changes during the three months ended March 31, 2021 to the items that we disclosed as our critical accounting policies and estimates in Management’s Discussion and Analysis of Financial Condition and Results of Operations in our Annual Report on Form 10-K for the year ended December 31, 2020, with the exception of the adoption of Accounting Standards Update (ASU) No. 2016-13, Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments ("CECL") on January 1, 2021. Certain accounting policies were revised and certain accounting policy elections were implemented, related to the adoption of CECL.


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PART I: FINANCIAL INFORMATION
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

CECL replaces the previous "incurred loss" model for measuring credit losses, which encompassed allowances for current known and inherent losses within the portfolio, with an "expected loss" model for measuring credit losses, which encompasses allowances for losses expected to be incurred over the life of the portfolio. The new CECL model requires the measurement of all expected credit losses for financial assets measured at amortized cost and certain off-balance sheet credit exposures based on historical experiences, current conditions, and reasonable and supportable forecasts. CECL also requires enhanced disclosures related to the significant estimates and judgments used in estimating credit losses, as well as credit quality and underwriting standards of an organization's portfolio. In addition, CECL includes certain changes to the accounting for investment securities available for sale depending on whether management intends to sell the securities or believes that it is more likely than not they will be required to sell. See NOTE 1. GENERAL, NOTE 2. INVESTMENT SECURITIES and NOTE 3. LOANS AND ALLOWANCE of the Notes to Consolidated Condensed Financial Statements of this Quarterly Report on Form 10-Q for details of the accounting policy changes related to the adoption of CECL.
BUSINESS SUMMARY

First Merchants Corporation (the “Corporation”) is a financial holding company headquartered in Muncie, Indiana and was organized in September 1982. The Corporation’s Common Stock is traded on NASDAQ’s Global Select Market System under the symbol FRME. The Corporation has one full-service bank charter, First Merchants Bank (the “Bank”), which opened for business in Muncie, Indiana, in March 1893. The Bank also operates First Merchants Private Wealth Advisors (a division of First Merchants Bank).  The Bank includes 125 banking locations in Indiana, Illinois, Ohio and Michigan. In addition to its traditional branch network, the Corporation offers comprehensive electronic and mobile delivery channels to its customers. The Corporation’s business activities are currently limited to one significant business segment, which is community banking.

Through the Bank, the Corporation offers a broad range of financial services, including accepting time, savings and demand deposits; making consumer, commercial, agri-business and real estate mortgage loans; providing personal and corporate trust services; offering full-service brokerage and private wealth management; and providing letters of credit, repurchase agreements and other corporate services.

COVID-19 UPDATE

The COVID-19 pandemic continued to impact the Corporation’s operations during the quarter ended March 31, 2021. While most states have eased restrictive measures and vaccination rates are steadily increasing, uncertainty remains about the ultimate duration of the pandemic and the timing and strength of the economic recovery. As the pandemic has evolved, we continue to support our customers by providing assistance to those affected by the pandemic, including by working with borrowers who are or may be unable to meet their contractual payment obligations due to the effects of COVID-19 and by originating loans under the Paycheck Protection Program (“PPP”).

The CARES Act and the Paycheck Protection Program
As previously reported, the Coronavirus Aid, Relief and Economic Security Act (the “CARES Act”) was signed into law in March 2020, providing an approximately $2 trillion stimulus package. For small businesses, eligible nonprofits and certain others, the CARES Act established the PPP, a lending program administered by the Small Business Administration (“SBA”) that is intended to incentivize participants to retain their employees by providing them with loans that are fully guaranteed by the U.S. government and subject to forgiveness if program guidelines are met. The PPP was later extended and modified by the Paycheck Protection Program and Health Care Enhancement Act in April 2020 and the Paycheck Protection Program Flexibility Act in June 2020, with PPP funding under this initial round expiring on August 8, 2020.

In December 2020, the Economic Aid to Hard-Hit Small Businesses, Nonprofits, and Venues Act was signed into law as part of the Consolidated Appropriations Act, 2021 (the “CAA”). In addition to direct stimulus payments and other aid, this Act provided for a second round of PPP loans through March 31, 2021, and included the establishment of PPP second draw loans. Certain borrowers that had obtained a PPP loan in 2020 (a “first draw PPP loan”) became eligible in January 2021 to apply for a “second draw PPP loan” on generally the same terms and conditions as their first draw loans. The eligibility requirements for a second draw PPP loan, however, are much narrower than the eligibility requirements for a first draw PPP loan. More recently, the American Rescue Plan Act of 2021 was signed into law on March 11, 2021, providing additional funds for the PPP and expanding certain PPP eligibility requirements. Further, on March 30, 2021, the PPP Extension Act of 2021 (was signed into law, providing applicants two additional months (through May 31, 2021) to apply for a first draw or second draw PPP loan and giving the SBA until June 30, 2021 to process loan applications.

Having actively participated in assisting its customers with applications for resources through the first round of the PPP during 2020, the Bank is also participating in the second round that commenced in January 2021. Loans under the program earn interest at a fixed rate of 1 percent and the vast majority of the Bank’s first round PPP loans have two-year maturities. The second round PPP loans have five-year maturities. The Bank anticipates that the majority of these loans will ultimately be forgiven, in whole or in part, by the SBA in accordance with the terms of the program. As of March 31, 2021, the Bank had over 4,700 PPP loans representing $741.7 million, which is net of $18.6 million of deferred processing fee income and costs. The weighted-average deferred processing fee on PPP loans was approximately 3.44 percent and is recognized over the term of the loan. If a loan is forgiven by the SBA or paid off by the borrower prior to maturity, any unamortized portion of the fee will be recognized immediately. During the three months ended March 31, 2021, the Corporation recognized interest income on PPP loans of $1.7 million and $7.6 million of PPP loan related deferred processing fee income as a yield adjustment.



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PART I: FINANCIAL INFORMATION
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Loan Modifications and Troubled Debt Restructures
As previously reported, the Bank's banking regulators issued guidance in March 2020 encouraging financial institutions to work prudently with borrowers who are or may be unable to meet their contractual payment obligations due to the effects of COVID-19. Additionally, Section 4013 of the CARES Act had further provided that a qualified loan modification is exempt by law from classification as a troubled debt restructure as defined by GAAP, from the period beginning March 1, 2020 until the earlier of December 31, 2020 or the date that is 60 days after the date on which the national emergency concerning the COVID-19 outbreak under the National Emergencies Act (50 U.S.C. 1601 et seq.) terminates. In accordance with that guidance, the Bank has offered short-term modifications made in response to COVID-19 to borrowers who were current and otherwise not past due. These included short-term, 180 days or less, modifications in the form of payment deferrals, fee waivers, extensions of repayment terms, or other delays in payment that are insignificant. The CAA, as described above, extended the expiration date for COVID-related loan modifications exempt from troubled debt restructuring classification until the earlier of January 1, 2022, or 60 days after the termination of the national emergency. As of March 31, 2021, $65.1 million in loan balances remained in deferral. Details of the modifications are included in the "LOAN QUALITY" section of this Management's Discussion and Analysis of Financial Condition and Results of Operations.

CECL Implementation
Accounting Standards Update No. 2016-13, Financial Instruments - Credit Losses (Topic 326): Measurement of Credit losses on Financial Instruments ("CECL") had an original adoption date of January 1, 2020, which included a day 1 measurement date of January 1, 2020. Pursuant to the CARES Act, which created an optional deferral of the CECL adoption date, and the related joint statement of federal banking regulators (which also became effective in March 2020), and consistent with guidance from the SEC and FASB, the Corporation elected to delay implementation of ASU No. 2016-13, the optional deferral of which was set to expire on December 31, 2020. However, the CAA amended the CARES Act by extending the temporary relief from CECL compliance to the earlier of the first day of the fiscal year that begins after the date on which the national emergency concerning COVID-19 terminates, or January 1, 2022. The Corporation elected to delay implementation of CECL following the approval of the CARES Act and, with the enactment of the CAA, the Corporation elected to delay adoption of CECL to January 1, 2021. As a result of the Corporation’s election, its 2020 financial statements have been prepared under the incurred loss model and its 2021 financial statements have been prepared under the CECL model.

Regulatory Capital
As part of a March 27, 2020 joint statement of federal banking regulators, an interim final rule that allowed banking organizations to mitigate the effects of the CECL accounting standard on their regulatory capital was announced. Banking organizations could elect to mitigate the estimated cumulative regulatory capital effects of CECL for up to two years. This two-year delay was to be in addition to the three-year transition period that federal banking regulators had already made available. While the CAA provided for a further extension of the mandatory adoption of CECL to the earlier of the first day of the fiscal year that begins after the date on which the national emergency concerning COVID-19 terminates, or January 1, 2022, the federal banking regulators have elected to not provide a similar extension to the two year mitigation period applicable to regulatory capital effects. Instead, the federal banking regulators require that, in order to utilize the additional two-year delay, banking organizations must have adopted the CECL standard no later than December 31, 2020, as required by the CARES Act.

As discussed above, the Corporation elected to delay implementation of ASU No. 2016-13 until January 1, 2021 and, as a result, will recognize the implementation effects of CECL on its regulatory capital over a three-year transition period. Beginning on January 1, 2021, the Corporation phased in 25 percent of the deferred capital impact of CECL, with an additional 25 percent to be phased in at the beginning of the following three years, resulting in the impact being fully phased in on January 1, 2024.

RESULTS OF OPERATIONS

The Corporation reported first quarter 2021 net income of $49.5 million, compared to $34.3 million during the first quarter of 2020. Diluted earnings per share for the first quarter 2021 totaled $0.91 per share, compared to $0.62 per diluted share during the same period in 2020.

As of March 31, 2021, total assets equaled $14.6 billion, an increase of $561.9 million, or 4.0 percent, from December 31, 2020. The Corporation's total loan portfolio increased $75.5 million from December 31, 2020. As of March 31, 2021, the Corporation had $741.7 million of PPP loans, an increase of $74.6 million from the December 31, 2020 balance of $667.1 million. PPP loans are included in the commercial and industrial loan class, which was the largest loan class increase since December 31, 2020. Additionally, other loan classes that experienced large increases from December 31, 2020 were real estate construction and public finance and other commercial loans. The largest loan classes that experienced a decrease from December 31, 2020 were commercial real estate, non-owner occupied and agricultural land, production and other loans to farmers. Additional details of the changes in the Corporation's loans are discussed within NOTE 3. LOANS AND ALLOWANCE of the Notes to Consolidated Condensed Financial Statements of this Quarterly Report on Form 10-Q, and the "LOAN QUALITY AND PROVISION FOR CREDIT LOSSES ON LOANS" section of this Management's Discussion and Analysis of Financial Condition and Results of Operations.

Total investment securities increased $554.1 million from December 31, 2020 as the excess liquidity from deposit growth was used to invest in the bond portfolio, which was offset by a decline in net unrealized gains on the available for sale portfolio of $49.7 million. The net decrease in unrealized gains from December 31, 2020 to March 31, 2021 is primarily due to changes in interest rates. The longer term points on the yield curve have increased since year-end which decreases the fair value of securities held in the portfolio. Additionally, the overall increase in investment securities was also offset by the Corporation's adoption of CECL, which resulted in an allowance for credit loss of $245,000 recorded at adoption on the state and municipal securities in the held to maturity portfolio. Additional details of the changes in the Corporation's investment securities portfolio are discussed within NOTE 2. INVESTMENT SECURITIES of the Notes to Consolidated Condensed Financial Statements of this Quarterly Report on Form 10-Q.


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PART I: FINANCIAL INFORMATION
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The Corporation’s allowance for credit losses - loans totaled $201.1 million as of March 31, 2021 and equaled 2.16 percent of total loans. The Corporation adopted the current expected credit losses ("CECL") model for calculating the allowance for credit losses on January 1, 2021. CECL replaces the previous "incurred loss" model for measuring credit losses, which encompassed allowances for current known and inherent losses within the portfolio, with an "expected loss" model for measuring credit losses, which encompasses allowances for losses expected to be incurred over the life of the portfolio. The new CECL model requires the measurement of all expected credit losses for financial assets measured at amortized cost and certain off-balance sheet credit exposures based on historical experiences, current conditions, and reasonable and supportable forecasts. CECL also requires enhanced disclosures related to the significant estimates and judgments used in estimating credit losses, as well as credit quality and underwriting standards of an organization's portfolio. The impact of the adoption was an increase to the Allowance for Credit Losses - Loans of $74.1 million. Additional details of the Allowance methodology and credit quality of the loan portfolio are discussed within NOTE 3. LOANS AND ALLOWANCE of the Notes to Consolidated Condensed Financial Statements of this Quarterly Report on Form 10-Q and within the “LOAN QUALITY AND PROVISION FOR CREDIT LOSSES ON LOANS” section of this Management’s Discussion and Analysis of Financial Condition and Results of Operations.

The Corporation did not recognize any provision expense during the three months ended March 31, 2021, compared to provision expense of $19.8 million during the same period of the prior year. Net charge-offs in the first quarter of 2021 were $3.6 million, compared to net charge-offs of $582,000 during the same period of 2020. For the three months ended March 31, 2021, there were three individual charge-offs greater than $500,000 that totaled $3.2 million, and for the three months ended March 31, 2020, there were not any charge-offs greater than $500,000. Non-accrual loans totaled $57.9 million, a decrease of $3.5 million from December 31, 2020, resulting in a coverage ratio of 347.2 percent..

The Corporation's net tax asset, deferred and receivable increased $27.8 million from December 31, 2020. As a result of the CECL adoption on January 1, 2021, the cumulative effect of adoption resulted in a deferred tax asset of $22.0 million. Additionally, the decrease in unrealized gains on available for sale investment securities resulted in a $10.4 million decline in the deferred tax liability. Both, the increase in deferred tax asset from CECL adoption and the decrease in deferred tax liability related to unrealized gains on available for sale investment securities, increase the net deferred tax asset.

The Corporation's other assets decreased $19.0 million from December 31, 2020. The Corporation's derivative asset (recorded in other assets) and derivative liability (recorded in other liabilities) related to interest rate contracts decreased $25.8 million and $26.1 million, respectively, from December 31, 2020. The decreases in valuations are due to a lower total notional balance and higher yield curve rates across the entire term point spectrum. The higher interest rates are the result of higher inflation expectations resulting from surging consumer demand observed in the market place.

As of March 31, 2021, total deposits equaled $12.0 billion, an increase of $590.2 million from December 31, 2020. The Corporation experienced increases from December 31, 2020 in demand and savings accounts of $424.7 million and $195.9 million, respectively. A portion of the increase is due to PPP loans that have remained on deposit, in addition to consumer Economic Impact Payments from the IRS that have also remained on deposit. Offsetting these increases were decreases in certificates of deposit and brokered deposits of $23.0 million and $7.5 million, respectively, from December 31, 2020. The low interest rate environment has resulted in customers moving funds from maturing time deposit products into non-maturity products due to similar rates offered for both products.

Total borrowings decreased $21.4 million as of March 31, 2021, compared to December 31, 2020. Federal Home Loan Bank advances decreased $30.1 million compared to December 31, 2020 as the Corporation utilized excess liquidity from deposit growth to pay off maturing advances. Offsetting this decrease was an increase in securities sold under repurchase agreements of $8.6 million.

The Corporation's other liabilities as of March 31, 2021 increased $62.2 million compared to December 31, 2020. As part of the CECL adoption on January 1, 2021, the Corporation recorded a $20.5 million allowance for credit losses on off-balance sheet credit exposures as a liability account representing expected credit losses over the contractual period for which the Corporation is exposed to credit risk resulting from a contractual obligation to extend credit. The Corporation also accrued $72.7 million of trade date accounting related to investment securities purchases as of March 31, 2021, of which, the accrual was $6.2 million as of December 31, 2020. Additionally, as noted above, the derivative hedge liability decreased $26.1 million from December 31, 2020.

The Corporation was able to maintain all regulatory capital ratios in excess of the regulatory definition of “well-capitalized.” Details of the Stock Repurchase Program and regulatory capital ratios are discussed within the “CAPITAL” section of this Management’s Discussion and Analysis of Financial Condition and Results of Operations.
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PART I: FINANCIAL INFORMATION
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

NET INTEREST INCOME

Net interest income is the most significant component of our earnings, comprising 81 percent of revenues for the three months ended March 31, 2021. Net interest income and margin are influenced by many factors, primarily the volume and mix of earning assets, funding sources, and interest rate fluctuations. Other factors include the level of accretion income on purchased loans, prepayment risk on mortgage and investment-related assets, and the composition and maturity of earning assets and interest-bearing liabilities. Loans typically generate more interest income than investment securities with similar maturities. Funding from customer deposits generally cost less than wholesale funding sources. Factors such as general economic activity, Federal Reserve Board monetary policy, and price volatility of competing alternative investments, can also exert significant influence on our ability to optimize the mix of assets and funding and the net interest income and margin.

Net interest income is the excess of interest received from earning assets over interest paid on interest-bearing liabilities. For analytical purposes, net interest income is also presented on an FTE basis in the tables that follow to reflect what tax-exempt assets would need to yield in order to achieve the same after-tax yield as a taxable asset. The federal statutory rate of 21 percent was used for all periods, adjusted for the TEFRA interest disallowance applicable to certain tax-exempt obligations. The FTE analysis portrays the income tax benefits associated with tax-exempt assets and helps to facilitate a comparison between taxable and tax-exempt assets. Management 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. Therefore, management believes these measures provide useful information for both management and investors by allowing them to make peer comparisons.

Net interest margin, on a tax equivalent basis, decreased 23 basis points to 3.23 percent for three months ended March 31, 2021 compared to 3.46 percent for the same period in 2020. Average earning assets for the three months ended March 31, 2021 increased $1.7 billion compared to the same period in 2020, and was primarily attributable to an increase in loans and investment securities of $709.9 million and $739.6 million, respectively. Since the beginning of the PPP in April 2020, the Bank has originated over $1.2 billion of PPP loans, which averaged $660.7 million in the first quarter of 2021. The increase in the investment securities portfolio was the result of excess liquidity generated from growth in deposits being used to invest in the bond portfolio.

In the first quarter of 2021, FTE asset yields decreased 86 basis points compared to the same period in 2020. This decrease was primarily a result of the FOMC's interest rate decreases of 50 basis points on March 3, 2020 and 100 basis points on March 16, 2020 at the Committee's special meetings related to COVID-19, and the decline in one-month LIBOR from March 31, 2020 to March 31, 2021 of 88 basis points. The PPP loans originated were recorded at an interest rate of only 1 percent, but the Corporation also recognized fee income of $7.6 million during the first quarter of 2021, which is included in interest income, and had a positive impact to net interest margin of 13 basis points.

The Corporation recognized fair value accretion income on purchased loans, which is included in interest income, of $4.7 million, which accounted for 6 basis points of net interest margin in the first quarter of 2021. Comparatively, the Corporation recognized $3.5 million of accretion income for the first quarter of 2020, or 12 basis points of net interest margin.

Interest costs decreased 78 basis points, contributing to a 8 basis point FTE decrease in net interest spread as compared to the same period in 2020. Interest costs have decreased as management aggressively moved deposit rates down in tandem with a decline in wholesale funding rates. Interest-bearing deposit and borrowing costs for the three months ended March 31, 2021 of 0.27 percent and 1.89 percent, respectively, decreased from 1.06 percent and 2.24 percent, respectively, during the same period in 2020.
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PART I: FINANCIAL INFORMATION
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following tables presents the Corporation’s average balance sheet, interest income/interest expense, and the average rate as a percent of average earning assets/liabilities for the three months ended March 31, 2021, and 2020.
(Dollars in Thousands)Three Months Ended
March 31, 2021March 31, 2020
Average BalanceInterest
 Income /
Expense		Average
Rate		Average BalanceInterest
 Income /
Expense		Average
Rate
Assets: 
Interest-bearing deposits$441,254 $114 0.10 %$159,859 $575 1.44 %
Federal Home Loan Bank stock28,736 178 2.48 28,737 299 4.16 
Investment Securities: (1)
Taxable1,494,008 6,695 1.79 1,368,546 7,631 2.23 
Tax-Exempt (2)
1,822,899 15,677 3.44 1,208,717 11,816 3.91 
Total Investment Securities3,316,907 22,372 2.70 2,577,263 19,447 3.02 
Loans held for sale16,139 156 3.87 17,217 193 4.48 
Loans: (3)
Commercial6,876,818 69,174 4.02 6,235,336 76,952 4.94 
Real Estate Mortgage975,262 9,286 3.81 870,654 10,402 4.78 
Installment674,307 6,489 3.85 759,614 9,105 4.79 
Tax-Exempt (2)
693,895 6,758 3.90 643,750 6,728 4.18 
Total Loans9,236,421 91,863 3.98 8,526,571 103,380 4.85 
Total Earning Assets13,023,318 114,527 3.52 %11,292,430 123,701 4.38 %
Net unrealized gain on securities available for sale55,658 48,656 
Allowance for credit losses(204,353)(81,160)
Cash and cash equivalents165,774 159,757 
Premises and equipment110,992 113,812 
Other assets1,093,350 1,039,743 
Total Assets$14,244,739 $12,573,238 
Liabilities:
Interest-bearing deposits:
Interest-bearing deposits$4,616,988 $3,709 0.32 %$3,589,240 $8,276 0.92 %
Money market deposits2,086,322 835 0.16 1,535,844 3,783 0.99 
Savings deposits1,660,528 476 0.11 1,425,054 1,827 0.51 
Certificates and other time deposits859,334 1,180 0.55 1,666,642 7,862 1.89 
Total Interest-bearing Deposits9,223,172 6,200 0.27 8,216,780 21,748 1.06 
Borrowings675,117 3,188 1.89 748,185 4,182 2.24 
Total Interest-bearing Liabilities9,898,289 9,388 0.38 8,964,965 25,930 1.16 
Noninterest-bearing deposits2,344,746 1,669,493 
Other liabilities161,272 122,362 
Total Liabilities12,404,307 10,756,820 
Stockholders' Equity1,840,432 1,816,418 
Total Liabilities and Stockholders' Equity$14,244,739 9,388 $12,573,238 25,930 
Net Interest Income (FTE)$105,139 $97,771 
Net Interest Spread (FTE) (4)
3.14 %3.22 %
Net Interest Margin (FTE):
Interest Income (FTE) / Average Earning Assets3.52 %4.38 %
Interest Expense / Average Earning Assets0.29 %0.92 %
Net Interest Margin (FTE) (5)
3.23 %3.46 %
(1) Average balance of securities is computed based on the average of the historical amortized cost balances without the effects of the fair value adjustments. Annualized amounts are computed utilizing a 30/360 day basis.
(2) Tax-exempt securities and loans are presented on a fully taxable equivalent basis, using a marginal tax rate of 21 percent for 2021 and 2020. These totals equal $4,711 and $3,894 for the three months ended March 31, 2021 and 2020, respectively.
(3) Non-accruing loans have been included in the average balances.
(4) Net Interest Spread (FTE) is interest income expressed as a percentage of average earning assets minus interest expense expressed as a percentage of average interest-bearing liabilities.
(5) Net Interest Margin (FTE) is interest income expressed as a percentage of average earning assets minus interest expense expressed as a percentage of average earning assets.

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PART I: FINANCIAL INFORMATION
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

NON-INTEREST INCOME

Non-interest income totaled $24.1 million for the quarter ended March 31, 2021, a $5.7 million, or 19.2 percent decline from the first quarter of 2020. Customer-specific line items accounted for $2.8 million of the decrease driven by lower derivative hedge fees and the impact of the Durbin Amendment adoption on card payment fees. Additionally, net realized gains on the sales of available for sale securities decreased $2.8 million in the first quarter of 2021 when compared to the same period in 2020.
NON-INTEREST EXPENSE

Non-interest expense totaled $66.1 million for the first quarter of 2021 and remained consistent with the first quarter of 2020 expense total of $66.2 million. The largest increases in the comparative first quarter periods were in net occupancy and equipment costs, which primarily resulted from additional expenses incurred to continue established social distancing and cleaning protocols resulting from the COVID-19 pandemic. The largest offsetting decrease, when comparing first quarter of 2021 to first quarter of 2020, was in customer-related travel and entertainment, which was also caused by COVID-19 pandemic.

INCOME TAXES

Income tax expense for the three months ended March 31, 2021 was $8,952,000 on pre-tax net income of $58,421,000.  For the same period in 2020, income tax expense was $3,490,000 on pre-tax net income of $37,753,000. The effective income tax rate was 15.3 percent for the first quarter of 2021 and 9.2 percent for the first quarter of 2020.

The lower effective income tax rate for the comparative period ended March 31, 2020 was driven by two factors. First, an abnormally high level of loan provision expense as a result of the economic impact of the COVID-19 pandemic reduced taxable income, and when coupled with an increase in tax-exempt income, the benefit of non-taxable income increased. Secondly, the CARES Act provided for the carryback of certain federal net operating losses to a prior period with a rate differential between the 2020 statutory rate of 21 percent and the rate in effect during the carryback year.

The detailed reconciliation of federal statutory to actual tax expense is shown in NOTE 10. INCOME TAX of the Notes to Consolidated Condensed Financial Statements of this Quarterly Report on Form 10-Q.
CAPITAL

Stockholders' Equity
The Corporation adopted the current expected credit losses ("CECL") model for calculating the allowance for credit losses on January 1, 2021. CECL replaces the previous "incurred loss" model for measuring credit losses, which encompassed allowances for current known and inherent losses within the portfolio, with an "expected loss" model for measuring credit losses, which encompasses allowances for losses expected to be incurred over the life of the portfolio. As of the adoption and day one measurement date of January 1, 2021, the Corporation recorded a one-time cumulative-effect adjustment to retained earnings, net of income taxes, of $68.0 million. See additional details of the Corporation's CECL adoption in NOTE 3. LOANS AND ALLOWANCE of the Notes to Consolidated Condensed Financial Statements of this Quarterly Report on Form 10-Q.

Stock Repurchase Program
On September 3, 2019, the Board of Directors of the Corporation approved a stock repurchase program of up to 3 million shares of the Corporation's outstanding common stock; provided, however, that the total aggregate investment in shares repurchased under the program was not to exceed $75 million. On a share basis, the amount of common stock subject to the repurchase program represented approximately 5 percent of the Corporation's outstanding shares. During the first quarter of 2020, the Corporation repurchased 1,634,437 of its common shares for $55.9 million at an average price of $34.21, which resulted in the aggregate investment in share repurchases of $75.0 million, the maximum allowable under the plan. As such, the September 2019 program terminated upon its own terms following the repurchases.

On January 27, 2021, the Board of Directors of the Corporation approved a stock repurchase program of up to 3,333,000 shares of the Corporation's outstanding common stock; provided, however, that the total aggregate investment in shares repurchased under the program may not exceed $100,000,000. On a share basis, the amount of common stock subject to the repurchase program represents approximately 6 percent of the Corporation's outstanding shares. The Corporation has not made any repurchases under the January 2021 program as of March 31, 2021.

Regulatory Capital
Capital adequacy is an important indicator of financial stability and performance. The Corporation and the Bank are subject to various regulatory capital requirements administered by the federal banking agencies and are assigned to a capital category. The assigned capital category is largely determined by four ratios that are calculated according to the regulations: total risk-based capital, tier 1 risk-based capital, CET1, and tier 1 leverage ratios. The ratios are intended to measure capital relative to assets and credit risk associated with those assets and off-balance sheet exposures of the entity. The capital category assigned to an entity can also be affected by qualitative judgments made by regulatory agencies about the risk inherent in the entity's activities that are not part of the calculated ratios.


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PART I: FINANCIAL INFORMATION
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

There are five capital categories defined in the regulations, ranging from well capitalized to critically undercapitalized. Classification of a bank in any of the undercapitalized categories can result in actions by regulators that could have a material effect on a bank's operations. Quantitative measures established by regulation to ensure capital adequacy require the Bank to maintain minimum amounts and ratios of total and tier 1 capital to risk-weighted assets, and of tier 1 capital to average assets, or leverage ratio, all of which are calculated as defined in the
regulations. Banks with lower capital levels are deemed to be undercapitalized, significantly undercapitalized or critically undercapitalized, depending on their actual levels. The appropriate federal regulatory agency may also downgrade a bank to the next lower capital category upon a determination that the bank is in an unsafe or unsound practice. Banks are required to monitor closely their capital levels and to notify their appropriate regulatory agency of any basis for a change in capital category.

Basel III was effective for the Corporation on January 1, 2015 and requires the Corporation and the Bank to maintain the minimum capital and
leverage ratios as defined in the regulation and as illustrated in the table below, which capital to risk-weighted asset ratios include a 2.5 percent capital conservation buffer. Under Basel III, in order to avoid limitations on capital distributions, including dividends, the Corporation must hold a 2.5 percent capital conservation buffer above the adequately capitalized CET1 to risk-weighted assets ratio (which buffer is reflected in the required ratios below). Under Basel III, the Corporation and Bank elected to opt-out of including accumulated other comprehensive income in regulatory capital. As of March 31, 2021, the Bank met all capital adequacy requirements to be considered well capitalized under the fully phased-in Basel III capital rules. There is no threshold for well capitalized status for bank holding companies.

As part of a March 27, 2020 joint statement of federal banking regulators, an interim final rule that allowed banking organizations to mitigate the effects of the CECL accounting standard on their regulatory capital was announced. Banking organizations could elect to mitigate the estimated cumulative regulatory capital effects of CECL for up to two years. This two-year delay was to be in addition to the three-year transition period that federal banking regulators had already made available. While the CAA provided for a further extension of the mandatory adoption of CECL to the earlier of the first day of the fiscal year that begins after the date on which the national emergency concerning COVID-19 terminates, or January 1, 2022, the federal banking regulators have elected to not provide a similar extension to the two year mitigation period applicable to regulatory capital effects. Instead, the federal banking regulators require that, in order to utilize the additional two-year delay, banking organizations must have adopted the CECL standard no later than December 31, 2020, as required by the CARES Act.

The Corporation elected to delay implementation of ASU No. 2016-13 until January 1, 2021 and, as a result, will recognize the implementation effects of CECL on its regulatory capital over a three-year transition period. Beginning on January 1, 2021, the Corporation phased in 25 percent of the deferred capital impact of CECL, with an additional 25 percent to be phased in at the beginning of the following three years, resulting in the impact being fully phased in on January 1, 2024.

The Corporation's and Bank's actual and required capital ratios as of March 31, 2021 and December 31, 2020 were as follows:
Prompt Corrective Action Thresholds
 ActualBasel III Minimum Capital RequiredWell Capitalized
March 31, 2021AmountRatioAmountRatioAmountRatio
Total risk-based capital to risk-weighted assets
First Merchants Corporation$1,487,455 14.33 %$1,090,253 10.50 %N/AN/A
First Merchants Bank1,404,801 13.49 1,093,668 10.50 $1,041,589 10.00 %
Tier 1 capital to risk-weighted assets
First Merchants Corporation$1,291,394 12.44 %$882,586 8.50 %N/AN/A
First Merchants Bank1,273,339 12.22 885,350 8.50 $833,271 8.00 %
CET1 capital to risk-weighted assets
First Merchants Corporation$1,244,967 11.99 %$726,835 7.00 %N/AN/A
First Merchants Bank1,273,339 12.22 729,112 7.00 $677,033 6.50 %
Tier 1 capital to average assets
First Merchants Corporation$1,291,394 9.41 %$548,791 4.00 %N/AN/A
First Merchants Bank1,273,339 9.31 546,920 4.00 $683,650 5.00 %
Prompt Corrective Action Thresholds
 ActualBasel III Minimum Capital RequiredWell Capitalized
December 31, 2020AmountRatioAmountRatioAmountRatio
Total risk-based capital to risk-weighted assets
First Merchants Corporation$1,475,551 14.36 %$1,079,015 10.50 %N/AN/A
First Merchants Bank1,412,805 13.70 1,082,430 10.50 $1,030,886 10.00 %
Tier 1 capital to risk weighted assets
First Merchants Corporation$1,282,070 12.48 %$873,488 8.50 %N/AN/A
First Merchants Bank1,283,922 12.45 876,253 8.50 $824,708 8.00 %
CET1 capital to risk-weighted assets
First Merchants Corporation$1,235,702 12.02 %$719,343 7.00 %N/AN/A
First Merchants Bank1,283,922 12.45 721,620 7.00 $670,076 6.50 %
Tier 1 capital to average assets
First Merchants Corporation$1,282,070 9.57 %$536,123 4.00 %N/AN/A
First Merchants Bank1,283,922 9.59 535,279 4.00 $669,098 5.00 %


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PART I: FINANCIAL INFORMATION
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

On April 9, 2020, federal banking regulators issued an interim final rule to modify the Basel III regulatory capital rules applicable to banking organizations to allow those organizations participating in the PPP to neutralize the regulatory capital effects of participating in the program. The interim final rule, which became effective April 13, 2020, clarifies that PPP loans receive a zero percent risk weight for purposes of determining risk-weighted assets and the CET1, Tier 1 and Total Risk-Based capital ratios. At March 31, 2021, risk-weighted assets included $741.7 million of PPP loans at a zero risk weight. Additionally, in order to facilitate use of the PPPL Facility, the agencies have clarified that banking organizations, including the Corporation and the Bank, are allowed to neutralize the regulatory effects of PPP covered loans on the risk-based capital ratios, as well as PPP covered loans pledged under the PPPL Facility on the leverage capital ratios. The Bank has until June 30, 2021 to access funds under the PPPL Facility, unless further extended by the Federal Reserve and the Department of the Treasury. At March 31, 2021 and December 31, 2020, the Corporation did not have an outstanding balance with the PPPL Facility; therefore there were no adjustments to the leverage ratio for PPP loans.

Management believes that all of the above capital ratios are meaningful measurements for evaluating the safety and soundness of the Corporation. Traditionally, the banking regulators have assessed bank and bank holding company capital adequacy based on both the amount and the composition of capital, the calculation of which is prescribed in federal banking regulations. The Federal Reserve focuses its assessment of capital adequacy on a component of Tier 1 capital known as CET1. Because the Federal Reserve has long indicated that voting common shareholders' equity (essentially Tier 1 risk-based capital less preferred stock and non-controlling interest in subsidiaries) generally should be the dominant element in Tier 1 risk-based capital, this focus on CET1 is consistent with existing capital adequacy categories. Tier I regulatory capital consists primarily of total stockholders’ equity and subordinated debentures issued to business trusts categorized as qualifying borrowings, less non-qualifying intangible assets and unrealized net securities gains or losses.
March 31, 2021December 31, 2020
(Dollars in thousands, except per share amounts)First Merchants CorporationFirst Merchants BankFirst Merchants CorporationFirst Merchants Bank
Total Risk-Based Capital
Total Stockholders' Equity (GAAP)$1,805,856 $1,836,502 $1,875,645 $1,926,269 
Adjust for Accumulated Other Comprehensive (Income) Loss (1)
(35,810)(38,532)(74,836)(77,687)
Less: Preferred Stock(125)(125)(125)(125)
Add: Qualifying Capital Securities46,427 — 46,368 — 
Less: Disallowed Goodwill and Intangible Assets(563,889)(563,441)(564,982)(564,535)
Add: Modified CECL Transition Amount40,314 40,314 — — 
Less: Disallowed Deferred Tax Assets(1,379)(1,379)— — 
Total Tier 1 Capital (Regulatory)1,291,394 1,273,339 1,282,070 1,283,922 
Qualifying Subordinated Debentures65,000 — 65,000 — 
Allowance for Loan Losses Includible in Tier 2 Capital131,061 131,462 128,481 128,883 
Total Risk-Based Capital (Regulatory)$1,487,455 $1,404,801 $1,475,551 $1,412,805 
Net Risk-Weighted Assets (Regulatory)$10,383,360 $10,415,888 $10,276,333 $10,308,855 
Average Assets (Regulatory)$13,719,785 $13,672,992 $13,403,065 $13,381,969 
Total Risk-Based Capital Ratio (Regulatory)14.33 %13.49 %14.36 %13.70 %
Tier 1 Capital to Risk-Weighted Assets12.44 %12.22 %12.48 %12.45 %
Tier 1 Capital to Average Assets9.41 %9.31 %9.57 %9.59 %
CET1 Capital Ratio
Total Tier 1 Capital (Regulatory)$1,291,394 $1,273,339 $1,282,070 $1,283,922 
Less: Qualified Capital Securities(46,427)— (46,368)— 
CET1 Capital (Regulatory)$1,244,967 $1,273,339 $1,235,702 $1,283,922 
Net Risk-Weighted Assets (Regulatory)$10,383,360 $10,415,888 $10,276,333 $10,308,855 
CET1 Capital Ratio (Regulatory)11.99 %12.22 %12.02 %12.45 %


(1) Includes net unrealized gains or losses on available for sale securities, net gains or losses on cash flow hedges, and amounts resulting from the application of the applicable accounting guidance for defined benefit and other postretirement plans.


Additionally, management believes the following tables are also meaningful when considering performance measures of the Corporation. Non-GAAP financial measures such as tangible common equity to tangible assets, return on average tangible capital and return on average tangible assets are important measures of the strength of the Corporation's capital and ability to generate earnings on tangible common equity invested by our shareholders. These non-GAAP measures provide useful supplemental information and may assist investors in analyzing the
Corporation’s financial position without regard to the effects of intangible assets and preferred stock. Disclosure of these measures also allows analysts and banking regulators to assess our capital adequacy on these same bases.

Because these measures are not defined in GAAP or federal banking regulations, they are considered non-GAAP financial measures. Non-GAAP financial measures have inherent limitations, are not required to be uniformly applied, and are not audited. Although these non-GAAP financial measures are frequently used by investors to evaluate a company, they have limitations as analytical tools, and should not be considered in isolation, or as a substitute for analyses of results as reported under GAAP.

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PART I: FINANCIAL INFORMATION
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The Corporation had a strong capital position as evidenced by the tangible common equity to tangible assets ratio of 8.78 percent at March 31, 2021, and 9.65 percent at December 31, 2020.
Tangible Common Equity to Tangible Assets (non-GAAP)
(Dollars in thousands, except per share amounts)March 31, 2021December 31, 2020
Total Stockholders' Equity (GAAP)$1,805,856 $1,875,645 
Less: Cumulative preferred stock (GAAP)(125)(125)
Less: Intangible assets (GAAP)(571,536)(572,893)
Tangible common equity (non-GAAP)$1,234,195 $1,302,627 
Total assets (GAAP)$14,629,066 $14,067,210 
Less: Intangible assets (GAAP)(571,536)(572,893)
Tangible assets (non-GAAP)$14,057,530 $13,494,317 
Stockholders' Equity to Assets (GAAP)12.34 %13.33 %
Tangible common equity to tangible assets (non-GAAP)8.78 %9.65 %
Tangible common equity (non-GAAP)$1,234,195 $1,302,627 
Plus: Tax Benefit of intangibles (non-GAAP)5,710 5,989 
Tangible common equity, net of tax (non-GAAP)$1,239,905 $1,308,616 
Common Stock outstanding53,954 53,922 
Book Value (GAAP)$33.47 $34.78 
Tangible book value - common (non-GAAP)$22.98 $24.27 


The following table details and reconciles tangible earnings per share, return on tangible capital and tangible assets to traditional GAAP measures for the three months ended March 31, 2021 and 2020.
Three Months Ended March 31,
(Dollars in thousands, except per share amounts)20212020
Average goodwill (GAAP)$543,919 $543,919 
Average core deposit intangible (GAAP)28,427 34,335 
Average deferred tax on CDI (GAAP)(5,877)(7,129)
Intangible adjustment (non-GAAP)$566,469 $571,125 
Average stockholders' equity (GAAP)$1,840,432 $1,816,418 
Average cumulative preferred stock (GAAP)(125)(125)
Intangible adjustment (non-GAAP)(566,469)(571,125)
Average tangible capital (non-GAAP)$1,273,838 $1,245,168 
Average assets (GAAP)$14,244,739 $12,573,238 
Intangible adjustment (non-GAAP)(566,469)(571,125)
Average tangible assets (non-GAAP)$13,678,270 $12,002,113 
Net income available to common stockholders (GAAP)$49,469 $34,263 
CDI amortization, net of tax (GAAP)1,072 1,197 
Tangible net income available to common stockholders (non-GAAP)$50,541 $35,460 
Per Share Data:  
Diluted net income available to common stockholders (GAAP)$0.91 $0.62 
Diluted tangible net income available to common stockholders (non-GAAP)$0.93 $0.65 
Ratios:  
Return on average GAAP capital (ROE)10.75 %7.55 %
Return on average tangible capital15.87 %11.39 %
Return on average assets (ROA)1.39 %1.09 %
Return on average tangible assets1.48 %1.18 %


Return on average tangible capital is tangible net income available to common stockholders (annualized) expressed as a percentage of average tangible capital.  Return on average tangible assets is tangible net income available to common stockholders (annualized) expressed as a percentage of average tangible assets.
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PART I: FINANCIAL INFORMATION
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

LOAN QUALITY AND PROVISION FOR CREDIT LOSSES ON LOANS

The Corporation’s primary lending focus is small business and middle market commercial, commercial real estate and residential real estate, which results in portfolio diversification.  Commercial loans are individually underwritten and judgmentally risk rated.  They are periodically monitored and prompt corrective actions are taken on deteriorating loans.  Consumer loans are typically underwritten with statistical decision-making tools and are managed throughout their life cycle on a portfolio basis.

Loan Quality

The quality of the loan portfolio and the amount of non-performing loans may increase or decrease as a result of acquisitions, organic portfolio growth, problem loan recognition and resolution through collections, sales or charge-offs. The performance of any loan can be affected by external factors such as economic conditions, or internal factors specific to a particular borrower, such as the actions of a customer's internal management.

At March 31, 2021, non-performing loans totaled $58.6 million, a decrease of $6.1 million from December 31, 2020. Loans not accruing interest income totaled $57.9 million at March 31, 2021, a decrease of $3.6 million from December 31, 2020. The decrease in the non- accrual loan balance was attributed to partial charge-offs related to three loans. Two of the loans are in the senior living sector with remaining balances, net of specific reserves, totaling $23.4 million and the third is a medical office building with a remaining loan balance of $164,000.

Other real estate owned and repossessions, totaling $604,000 at March 31, 2021, decreased $336,000 from December 31, 2020. For other real estate owned, current appraisals are obtained to determine fair value as management continues to aggressively market these real estate assets.

According to guidance set forth in ASC 326-20-35, loans that no longer exhibit similar risk characteristics are evaluated individually to determine if there is a need for a specific reserve. Commercial loans under $500,000 and consumer loans, with the exception of troubled debt restructures, are not individually evaluated. The determination for individual evaluation is made based on current information or events that may suggest it is probable that not all amounts due of principal and interest, according to the contractual terms of the loan agreement, will be substantially collected.

The Corporation's non-performing assets plus accruing loans 90 days or more delinquent and individually evaluated loans are presented in the table below.
(Dollars in Thousands)March 31, 2021December 31, 2020
Non-Performing Assets:  
Non-accrual loans$57,923 $61,471 
Renegotiated loans655 3,240 
Non-performing loans (NPL)58,578 64,711 
OREO and Repossessions604 940 
Non-performing assets (NPA)59,182 65,651 
Loans 90-days or more delinquent and still accruing1,093 746 
NPAs and loans 90-days or more delinquent$60,275 $66,397 


The non-accrual balances in the table above include troubled debt loan restructures totaling $1.8 million and $1.7 million as of March 31, 2021 and December 31, 2020, respectively.

The composition of non-performing assets plus accruing loans 90-days or more delinquent is reflected in the following table.
(Dollars in Thousands)March 31, 2021December 31, 2020
Non-performing assets and loans 90-days or more delinquent:  
Commercial and industrial loans$1,671 $2,923 
Agricultural land, production and other loans to farmers1,220 1,012 
Real estate loans: 
Construction330 435 
Commercial real estate, non-owner occupied44,239 47,548 
Commercial real estate, owner occupied2,792 3,040 
Residential7,185 9,034 
Home equity2,710 2,350 
Individuals' loans for household and other personal expenditures128 55 
Non-performing assets and loans 90-days or more delinquent:$60,275 $66,397 
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PART I: FINANCIAL INFORMATION
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

On March 22, 2020, a statement was issued by the Bank's banking regulators and titled the “Interagency Statement on Loan Modifications and Reporting for Financial Institutions Working with Customers Affected by the Coronavirus” (the "Interagency Statement") that encourages financial institutions to work prudently with borrowers who are or may be unable to meet their contractual payment obligations due to the effects of COVID-19. Additionally, Section 4013 of the CARES Act further provides that a qualified loan modification is exempt by law from classification as a troubled debt restructure as defined by GAAP, from the period beginning March 1, 2020 until the earlier of December 31, 2020 or the date that is 60 days after the date on which the national emergency concerning the COVID-19 outbreak under the National Emergencies Act (50 U.S.C. 1601 et seq.) terminates. The Interagency Statement was subsequently revised on April 7, 2020 to clarify the interaction of the original guidance with Section 4013 of the CARES Act, as well as setting forth the banking regulators’ views on consumer protection considerations. In accordance with such guidance, the Bank has offered short-term modifications made in response to COVID-19 to borrowers who were current and otherwise not past due. These included short-term, 180 days or less, modifications primarily in the form of payment deferrals. Modifications in the form of fee waivers, extensions of repayment terms, or other delays in payment that are insignificant were also made.

On December 27, 2020, a $900 billion COVID-19 relief package, as passed by the U.S. Congress, was signed into law as part of the 2021 Consolidated Appropriations Act (the “CAA”) that provides federal government funding through the end of its 2021 fiscal year. In addition to delivering direct stimulus payments to certain individuals, an increase in unemployment insurance benefits, an extension of the eviction moratorium, relief to the healthcare industry, and additional aid to various other businesses, the COVID-19-related provisions of the CAA provide for (i) an additional $284 billion in funding for the PPP, through March 31, 2021, and the establishment of PPP second draw loans, (ii) an extension of the temporary delay for implementation of the CECL accounting standard, and (iii) further suspension of the troubled debt restructure assessment and reporting requirements for financial institutions under GAAP. Certain borrowers that had obtained a PPP loan in 2020 (a “first draw PPP loan”) became eligible on January 19, 2021 to apply for a “second draw PPP loan” on generally the same terms and conditions as their first draw loans. However, the eligibility requirements for a second draw PPP loan are much narrower than the eligibility requirements for a first draw PPP loan. The following table summarizes modifications that remained in deferment as of March 31, 2021.
March 31, 2021
Recorded BalanceNumber of Loans
Commercial and industrial loans$13,984 11 
Real estate loans:
Construction4,360 1 
Commercial real estate, non-owner occupied43,530 10 
Commercial real estate, owner occupied1,865 6 
Residential1,026 8 
Individuals' loans for household and other personal expenditures291 13 
Total$65,056 49 


Of the loans still in deferment at March 31, 2021 as indicated in the table above, $46.6 million, or 72 percent of the balance, were in the hotel industry. Although the Corporation believes its underwriting and loan review procedures are appropriate for the various kinds of loans it makes, its results of operations and financial condition could be adversely affected in the event the quality of its loan portfolio declines. Deterioration in the economic environment including residential and commercial real estate values may result in increased levels of loan delinquencies and credit losses.

Provision and Allowance for Credit Losses on Loans

The Corporation adopted FASB Accounting Standards Update (ASU) No. 2016-13, Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments ("CECL") on January 1, 2021. CECL replaces the previous "incurred loss" model with an "expected loss" model of measuring credit losses, which encompasses allowances for losses expected to be incurred over the life of the portfolio. The new CECL model requires the measurement of all expected credit losses for financial assets measured at amortized cost based on historical experiences, current conditions and reasonable and supportable forecasts. CECL also requires enhanced disclosures related to the significant estimates and judgments used in estimating credit losses, as well as credit quality and underwriting standards of an organization's portfolio.

The CECL allowance is maintained through the provision for loan losses, which is a charge against earnings. Based on management’s judgment as to the appropriate level of the allowance for loan losses, the amount provided in any period may be greater or less than net loan losses for the same period. The determination of the provision amount and the adequacy of the allowance in any period is based on management’s continuing review and evaluation of the loan portfolio.

The Corporation’s total loan balance increased $75.1 million from December 31, 2020 to $9.3 billion at March 31, 2021. PPP loans accounted for $741.7 million of the total loan balance at March 31, 2021. At March 31, 2021, the allowance for credit losses totaled $201.1 million, which represents an increase of $70.4 million from December 31, 2020. The allowance increase was primarily due to the day one cumulative effect adjustment related to the adoption of CECL. As a percent of loans, the allowance for credit losses was 2.16 percent at March 31, 2021 compared to 1.41 percent at December 31, 2020. The allowance for credit losses as a percentage of total loans less PPP loans was 2.34 percent as of March 31, 2021. The Bank anticipates that a majority of the PPP loans will ultimately be forgiven, in whole or in part, by the SBA as, in accordance with the terms of the PPP, the loans are fully guaranteed by the SBA.

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

There was no provision for credit losses for the three months ended March 31, 2021 compared to $19.8 million for the same period of 2020. The first quarter 2020 provision reflected an increase in the reserve related to the estimated impact on the economy and the credit quality of our loan portfolio due to the emerging COVID-19 pandemic. The Corporation adopted CECL effective January 1, 2021 and recorded a day one cumulative effect adjustment which increased the Allowance for Credit Losses for Loans to $204.7 million. Net charge-offs lowered the allowance to $201.1 million. The Corporation deems this estimate for loan portfolio credit exposure as appropriate, thus there was no related provision in the first quarter 2021.

Net charge-offs totaling $3.6 million and $582,000, respectively, were recognized for the three months ended March 31, 2021 and March 31, 2020. For the three months ended March 31, 2021, there were three individual charge-offs greater than $500,000 that totaled $3.2 million, and for the three months ended March 31, 2020, there were not any charge-offs greater than $500,000. There have been no individual recoveries greater than $500,000 for either reporting period. The distribution of the net charge-offs (recoveries) for the three months ended March 31, 2021 and 2020 are reflected in the following table:
Three Months Ended March 31,
(Dollars in Thousands)20212020
Net charge-offs (Recoveries):  
Commercial and industrial loans$484 $129 
Agricultural land, production and other loans to farmers1 43 
Real estate loans:
Construction2 (37)
Commercial real estate, non-owner occupied2,511 19 
Commercial real estate, owner occupied638 83 
Residential72 (7)
Home equity(165)145 
Individuals' loans for household and other personal expenditures78 207 
Total net charge-offs$3,621 $582 


Management continually evaluates the commercial loan portfolio by including consideration of specific borrower cash flow analysis and estimated collateral values, types and amounts on non-performing loans, past and anticipated loan loss experience, changes in the composition of the loan portfolio, and the current condition and amount of loans outstanding. The determination of the provision for loan losses in any period is based on management’s continuing review and evaluation of the loan portfolio, and its judgment as to the impact of current economic conditions on the portfolio.

LIQUIDITY

Liquidity management is the process by which the Corporation ensures that adequate liquid funds are available for the holding company and its subsidiaries. These funds are necessary in order to meet financial commitments on a timely basis. These commitments include withdrawals by depositors, funding credit obligations to borrowers, paying dividends to stockholders, paying operating expenses, funding capital expenditures, and maintaining deposit reserve requirements. Liquidity is monitored and closely managed by the asset/liability committee.

The Corporation’s liquidity is dependent upon the receipt of dividends from the Bank, which is subject to certain regulatory limitations and access to other funding sources.  Liquidity of the Bank is derived primarily from core deposit growth, principal payments received on loans, the sale and maturity of investment securities, net cash provided by operating activities, and access to other funding sources.

The principal source of asset-funded liquidity is investment securities classified as available for sale, the market values of which totaled $2.4 billion at March 31, 2021, an increase of $486.4 million, or 25.4 percent, from December 31, 2020.  Securities classified as held to maturity that are maturing within a short period of time can also be a source of liquidity. Securities classified as held to maturity and that are maturing in one year or less totaled $9.1 million at March 31, 2021. In addition, other types of assets such as cash and interest-bearing deposits with other banks, federal funds sold and loans maturing within one year are sources of liquidity.

The most stable source of liability-funded liquidity for both the long-term and short-term is deposit growth and retention in the core deposit base.  Federal funds purchased and securities sold under agreements to repurchase are also considered a source of liquidity. In addition, FHLB advances are utilized as a funding source.  At March 31, 2021, total borrowings from the FHLB were $359.3 million The Bank has pledged certain mortgage loans and investments to the FHLB. The total available remaining borrowing capacity from the FHLB at March 31, 2021 was $714.6 million.

The Corporation and the Bank receive outside credit ratings from Moody's. Both the Corporation and the Bank currently have Issuer Ratings of Baa1 with a Rating Outlook of Stable. Additionally, the Bank has a Baseline Credit Assessment Rating of a3. Management considers these ratings to be indications of a sound capital base and strong liquidity and believes that these ratings would help ensure the ready marketability of its commercial paper. Because of the Corporation's and Bank's current levels of long-term debt, management believes it could generate additional liquidity from various sources should the need arise.
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Table of Contents
PART I: FINANCIAL INFORMATION
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The required payments related to operating leases and borrowings at March 31, 2021 are as follows:
(Dollars in Thousands)Remaining
2021		20222023202420252026 and
after		ASC 805 fair value adjustments at acquisitionTotal
Operating leases$2,729 $3,544 $3,141 $3,070 $2,837 $7,750 $— $23,071 
Securities sold under repurchase agreements185,721 — — — — — — 185,721 
Federal Home Loan Bank advances25,072 75,097 115,097 10,097 25,097 108,877 — 359,337 
Subordinated debentures and other borrowings— — — — — 122,012 (3,573)118,439 
Total$213,522 $78,641 $118,238 $13,167 $27,934 $238,639 $(3,573)$686,568 


Also, in the normal course of business, the Bank is a party to a number of other off-balance sheet activities that contain credit, market and operational risk that are not reflected in whole or in part in our consolidated financial statements.  These activities primarily consist of traditional off-balance sheet credit-related financial instruments such as loan commitments and standby letters of credit.

Summarized credit-related financial instruments at March 31, 2021 are as follows:
(Dollars in Thousands)March 31, 2021
Amounts of commitments: 
Loan commitments to extend credit$3,657,931 
Standby and commercial letters of credit33,610 
 $3,691,541 


Since many of the commitments are expected to expire unused or be only partially used, the total amount of unused commitments in the preceding table does not necessarily represent future cash requirements.

INTEREST SENSITIVITY AND DISCLOSURE ABOUT MARKET RISK

Asset/Liability management has been an important factor in the Corporation's ability to record consistent earnings growth through periods of interest rate volatility and product deregulation. Management and the Board of Directors monitor the Corporation's liquidity and interest sensitivity positions at regular meetings to review how changes in interest rates may affect earnings.  Decisions regarding investment and the pricing of loan and deposit products are made after analysis of reports designed to measure liquidity, rate sensitivity, the Corporation’s exposure to changes in net interest income given various rate scenarios and the economic and competitive environments.

It is the objective of the Corporation to monitor and manage risk exposure to net interest income caused by changes in interest rates.  It is the goal of the Corporation’s Asset/Liability management function to provide optimum and stable net interest income. To accomplish this, management uses two asset liability tools. GAP/Interest Rate Sensitivity Reports and Net Interest Income Simulation Modeling are constructed, presented and monitored quarterly. Management believes that the Corporation's liquidity and interest sensitivity position at March 31, 2021, remained adequate to meet the Corporation’s primary goal of achieving optimum interest margins while avoiding undue interest rate risk.

Net interest income simulation modeling, or earnings-at-risk, measures the sensitivity of net interest income to various interest rate movements. The Corporation's asset liability process monitors simulated net interest income under three separate interest rate scenarios; base, rising and falling. Estimated net interest income for each scenario is calculated over a twelve-month horizon. The immediate and parallel changes to the base case scenario used in the model are presented below. The interest rate scenarios are used for analytical purposes and do not necessarily represent management's view of future market movements. Rather, these are intended to provide a measure of the degree of volatility interest rate movements may introduce into the earnings of the Corporation.

The base scenario is highly dependent on numerous assumptions embedded in the model, including assumptions related to future interest rates. While the base sensitivity analysis incorporates management's best estimate of interest rate and balance sheet dynamics under various market rate movements, the actual behavior and resulting earnings impact will likely differ from that projected. For certain assets, the base simulation model captures the expected prepayment behavior under changing interest rate environments. Assumptions and methodologies regarding the interest rate or balance behavior of indeterminate maturity products, such as savings, money market, interest-bearing and demand deposits, reflect management's best estimate of expected future behavior. Historical retention rate assumptions are applied to non-maturity deposits for modeling purposes.


51
Table of Contents
PART I: FINANCIAL INFORMATION
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The comparative rising 200 basis points and falling 100 basis points scenarios below, as of March 31, 2021 and December 31, 2020, assume further interest rate changes in addition to the base simulation discussed above. These changes are immediate and parallel changes to the base case scenario. In the current rate environment, many drivers are at or near historical lows due to the FOMC's rate reductions in March 2020 in response to COVID-19.

Results for the rising 200 basis points, and falling 100 basis points interest rate scenarios are listed below based upon the Corporation’s rate sensitive assets and liabilities at March 31, 2021 and December 31, 2020. The change from the base scenario represents cumulative net interest income over a twelve-month time horizon. Balance sheet assumptions used for the base scenario are the same for the rising and falling simulations.


March 31, 2021December 31, 2020
Rising 200 basis points from base case3.9%5.9 %
Falling 100 basis points from base case(0.5)%0.7 %


EARNING ASSETS

The following table presents the earning asset mix as of March 31, 2021 and December 31, 2020. Earning assets increased by $630.1 million during the three months ended March 31, 2021.   

Total investment securities increased $554.1 million from December 31, 2020 as excess liquidity from deposit growth was used to invest in the bond portfolio, which was offset by a decline in net unrealized gains on the available for sale portfolio of $49.7 million. The net decrease in unrealized gains from December 31, 2020 to March 31, 2021 is primarily due the changes in interest rates. The longer term points on the yield curve have increased since year-end which decreases the fair value of securities held in the portfolio. Additionally, the overall increase in investment securities was also offset by the Corporation's adoption of CECL, which resulted in an allowance for credit loss of $245,000 recorded at adoption on the state and municipal securities in the held to maturity portfolio. Additional details of the changes in the Corporation's investment securities portfolio are discussed within NOTE 2. INVESTMENT SECURITIES of the Notes to Consolidated Condensed Financial Statements of this Quarterly Report on Form 10-Q.

Loans and loans held for sale increased $75.5 million from December 31, 2020. As of March 31, 2021, the Corporation had $741.7 million of PPP loans, an increase of $74.6 million from the December 31, 2020 balance of $667.1 million. PPP loans are included in the commercial and industrial loan class, which was the largest loan class increase since December 31, 2020. Additionally, other loan classes that experienced large increases from December 31, 2020 were real estate construction and public finance and other commercial loans. The largest loan classes that experienced a decrease from December 31, 2020 were commercial real estate, non-owner occupied and agricultural land, production and other loans to farmers. Additional details of the changes in the Corporation's loan portfolio are discussed within NOTE 3. LOANS AND ALLOWANCE of the Notes to Consolidated Condensed Financial Statements of this Quarterly Report on Form 10-Q.
(Dollars in Thousands)March 31, 2021December 31, 2020
Interest-bearing deposits$392,806 $392,305 
Investment securities available for sale2,405,568 1,919,119 
Investment securities held to maturity, net of allowance for credit losses of $245,000 as of March 31, 20211,295,289 1,227,668 
Loans held for sale4,430 3,966 
Loans9,318,228 9,243,174 
Federal Home Loan Bank stock28,736 28,736 
Total$13,445,057 $12,814,968 

OTHER

The Securities and Exchange Commission maintains a web site that contains reports, proxy and information statements and other information regarding registrants that file electronically with the Commission, including the Corporation, and that address is (http://www.sec.gov).

52
Table of Contents
PART I: FINANCIAL INFORMATION
ITEM 3. QUANTITATIVE AND QUALITATIVE
DISCLOSURES ABOUT MARKET RISK

ITEM 3.  QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

The information required under this item is included as part of Management’s Discussion and Analysis of Financial Condition and Results of Operations, under the headings “LIQUIDITY” and “INTEREST SENSITIVITY AND DISCLOSURE ABOUT MARKET RISK”.
53
Table of Contents
PART I: FINANCIAL INFORMATION
ITEM 4. CONTROLS AND PROCEDURES

ITEM 4.  CONTROLS AND PROCEDURES

At the end of the period covered by this report, we carried out an evaluation, under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures. Based upon that evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures are effective. Disclosure controls and procedures are controls and procedures that are designed to ensure that information required to be disclosed in our reports filed or submitted under the Securities Exchange Act of 1934 are recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms.

There have been no changes in the Corporation’s internal control over financial reporting identified in connection with the evaluation discussed above that occurred during the Corporation’s last fiscal quarter that have materially affected, or are reasonably likely to materially affect, the Corporation’s internal control over financial reporting.

54
Table of Contents
PART II: OTHER INFORMATION
ITEM 1., ITEM 1A., ITEM 2., ITEM 3., ITEM 4. AND ITEM 5.
(table dollar amounts in thousands, except share data)
ITEM 1.  LEGAL PROCEEDINGS

There are no pending legal proceedings, other than litigation incidental to the ordinary business of the Corporation or its subsidiaries, of a material nature to which the Corporation or its subsidiaries is a party or of which any of their properties are subject. Further, there are no material legal proceedings in which any director, officer, principal shareholder, or affiliate of the Corporation, or any associate of any such director, officer or principal shareholder, is a party, or has a material interest, adverse to the Corporation or any of its subsidiaries.

None of the routine legal proceedings, individually or in the aggregate, in which the Corporation or its affiliates are involved are expected to have a material adverse impact on the financial position or the results of operations of the Corporation.

ITEM 1A.  RISK FACTORS

There have been no material changes to the risk factors previously disclosed in the Corporation’s Annual Report on Form 10-K for the year ended December 31, 2020.

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

a. None

b. None

c. Issuer Purchases of Equity Securities

The following table presents information relating to our purchases of equity securities during the three months ended March 31, 2021.
Period
Total Number
of Shares
Purchased (1)
Average
Price Paid
per Share		Total Number of Shares
Purchased as part of Publicly announced Plans or Programs
Maximum Number of Shares
that may yet be Purchased
Under the Plans or Programs (2)
January, 2021267 $40.82 — 3,333,000 
February, 2021— $— — 3,333,000 
March, 2021— $— — 3,333,000 

(i) The shares repurchased were pursuant to net settlement by employees in satisfaction of income tax withholding obligations incurred through the vesting of the Corporation's restricted stock awards.

(2) On January 27, 2021, the Board of Directors of the Corporation approved a stock repurchase program of up to 3,333,000 shares of the Corporation's outstanding common stock; provided, however, that the total aggregate investment in shares repurchased under the program may not exceed $100,000,000. The program does not have an expiration date. However, it may be discontinued by the Board at any time.


ITEM 3.  DEFAULTS UPON SENIOR SECURITIES

None

ITEM 4.  MINE SAFETY DISCLOSURES

Not Applicable 

ITEM 5.  OTHER INFORMATION

a. None

b. None

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Table of Contents

PART II: OTHER INFORMATION
ITEM 6. EXHIBITS

ITEM 6.  EXHIBITS
 
Exhibit No:Description of Exhibits:
3.1
3.2
4.1
4.2
4.3
4.4
4.5
4.6
10.1
31.1
31.2
32
101.INSInline XBRL Instance Document - the instance document does not appear in the Interactive Data File because its XBRL tags are embedded within the Inline XBRL document (2)
101.SCHInline XBRL Taxonomy Extension Schema Document (2)
101.CALInline XBRL Taxonomy Extension Calculation Linkbase Document (2)
101.DEFInline XBRL Taxonomy Extension Definition Linkbase Document (2)
101.LABInline XBRL Taxonomy Extension Label Linkbase Document (2)
101.PREInline XBRL Taxonomy Extension Presentation Linkbase Document (2)
104Cover Page Interactive Data File (formatted as Inline XBRL and included in Exhibit 101)
(1) Management contract or compensatory plan.
 (2) Filed herewith.
 (3) Furnished herewith.


56
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SIGNATURES

Pursuant to the requirements 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 Merchants Corporation
(Registrant)
May 10, 2021
by /s/ Mark K. Hardwick
Mark K. Hardwick
Chief Executive Officer
(Principal Executive Officer)
May 10, 2021
by /s/ Michele M. Kawiecki
Michele M. Kawiecki
Executive Vice President, Chief Financial Officer
(Principal Financial and Accounting Officer)

57

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