Mid Penn Bancorp: 5 Goals for Personal Finance and Planning
FINWARD BANCORP Management’s Discussion and Analysis of Financial Condition and Results of Operations (Form 10-K)

General


The Bancorp's earnings are dependent upon the earnings of the Bank. The Bank's
earnings are primarily dependent upon net interest margin. The net interest
margin is the difference between interest income earned on loans and investments
and interest expense paid on deposits and borrowings stated as a percentage of
average interest earning assets. The net interest margin is perhaps the clearest
indicator of a financial institution's ability to generate core earnings. Fees
and service charges, wealth management operations income, gains and losses from
the sale of assets, provisions for loan losses, income taxes and operating
expenses also affect the Bancorp's profitability.



A summary of the Bancorp's significant accounting policies are detailed in Note
1 to the Bancorp's consolidated financial statements included in this report.
Preparing financial statements in conformity with accounting principles
generally accepted in the United States of America requires management to make
estimates and assumptions that affect the reported amounts of assets,
liabilities and disclosure of contingent assets and liabilities at the date of
the financial statements and the reported amounts of revenue and expenses during
the reporting period, as well as the disclosures provided. Actual results could
differ from those estimates. Estimates associated with the allowance for loan
losses are particularly susceptible to material change in the near term.



At December 31, 2021, the Bancorp had total assets of $1.6 billion and total
deposits of $1.4 billion. The Bancorp's deposit accounts are insured up to
applicable limits by the Deposit Insurance Fund (DIF) that is administered by
the Federal Deposit Insurance Corporation (FDIC), an agency of the federal
government. At December 31, 2021, stockholders' equity totaled $156.6 million,
with book value per share at $45.00. Net income for 2021 was $15.0 million, or
$4.30 basic and diluted earnings per common share. The return on average assets
was 0.95%, while the return on average stockholders' equity was 9.61%.



RECENT DEVELOPMENTS


Acquisition of Royal Financial, Inc. On January 31, 2022, the Bancorp completed
its acquisition of Royal Financial, Inc. ("RYFL") pursuant to an Agreement and
Plan of Merger dated July 28, 2021 (the "Merger Agreement") between the Bancorp
and RYFL. Pursuant to the terms of the Merger Agreement, RYFL merged with and
into the Bancorp, with the Bancorp as the surviving corporation (the "RYFL
Merger"). Simultaneous with the RYFL Merger, Royal Savings Bank, an Illinois
state chartered savings bank and wholly-owned subsidiary of RYFL, merged with
and into the Bank, with the Bank as the surviving institution.



Under the terms of the Merger Agreement, RYFL stockholders who owned 101 or more
shares of RYFL common stock were permitted to elect to receive either 0.4609
shares of Finward common stock or $20.14 in cash, or a combination of both, for
each share of RYFL common stock owned, subject to proration and allocation
provisions such that 65% of the shares of RYFL common stock outstanding
immediately prior to the closing of the merger were converted into the right to
receive shares of Finward common stock and the remaining 35% of the outstanding
RYFL shares were converted into the right to receive cash. Stockholders holding
less than 101 shares of RYFL common stock will have the right to receive fixed
consideration of $20.14 in cash and no stock consideration for each share of
RYFL common stock.



As a result of RYFL stockholder stock and cash elections and the related
allocation and proration provisions of the Merger Agreement, Finward issued
795,423 shares of its common stock and paid cash consideration of approximately
$18.7 million in the RYFL Merger. Based on the January 28, 2022 closing price of
$47.75 per share of Finward common stock, the transaction had an implied
valuation of approximately $56.7 million. The acquisition further expanded the
Bank's banking center network in Cook County, Illinois, expanding the Bank's
full-service retail banking network to 30 banking centers.



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Financial Condition

During the year ended December 31, 2021, total assets increased by $124.5
million (8.3%), to $1.6 billion, with interest-earning assets increasing by
$125.1 million (8.9%). At December 31, 2021, interest­earning assets totaled
$1.5 billion and represented 94.0% of total assets. Loans totaled $966.7 million
and represented 63.4% of interest-earning assets, 59.6% of total assets and
67.4% of total deposits. The loan portfolio, which is the Bancorp's largest
asset, is a significant source of both interest and fee income.



                                        December 31,                       December 31,
(Dollars in thousands)                      2021                               2020
                                 Balance           % Loans          Balance           % Loans

Residential real estate        $    260,134              27.1 %        286,048              33.0 %
Home equity                          34,612               3.6 %         39,233               5.4 %
Commercial real estate              317,145              33.0 %        298,257              31.2 %
Construction and land
development                         123,822              12.9 %         93,562               9.7 %
Multifamily                          61,194               6.4 %         50,571               5.7 %
Farmland                                  -               0.0 %            215               0.0 %
Consumer                                582               0.1 %          1,025               0.1 %
Manufactured Homes                   37,887               3.9 %         24,232               1.8 %
Commercial business                 115,772              12.1 %        158,140              11.4 %
Government                            8,991               0.9 %         10,142               1.7 %
Loans receivable                    960,139             100.0 %        961,425             100.0 %
Plus:
Net deferred loans
origination costs                     6,810                              3,871
Undisbursed loan funds                 (229 )                             (150 )
Loans receivable, net of
deferred fees and costs        $    966,720                       $    965,146




                                      December 31,       December 31,
                                          2021               2020

Loans receivable to total assets               59.6 %             64.5 %
Loans receivable to earning assets             63.4 %             69.0 %
Loans receivable to total deposits             67.4 %             74.1 %




The Bancorp is primarily a portfolio lender. Mortgage banking activities
historically have been limited to the sale of fixed rate mortgage loans with
contractual maturities greater than 15 years. These loans are identified as held
for sale when originated and sold, on a loan-by-loan basis, in the secondary
market. The Bancorp will also retain fixed rate mortgage loans with a
contractual maturity greater than 15 years on a limited basis. During the twelve
months ended December 31, 2021, the Bancorp originated $153.1 million in new
fixed rate mortgage loans for sale, compared to $224.9 million during the twelve
months ended December 31, 2020. Net gains realized from the mortgage loan sales
totaled $5.3 million for the twelve months ended December 31, 2021, compared to
$7.6 million for the twelve months ended December 31, 2020. At December 31,
2021, the Bancorp had $5.0 million in loans that were classified as held for
sale, compared to $11.3 million at December 31, 2020.



In addition, the Bancorp participates in the U.S. Small Business
Administration's Paycheck Protection Program ("PPP"), a program initiated to
help small businesses maintain their workforces during the pandemic. As of
December 31, 2021, the Bancorp approved 782 applications totaling $91.5 million
for the first round, with an average loan size of approximately $117 thousand.
These loans helped local business owners retain 10,758 employees based on the
borrowers' applications. The Bancorp's SBA lender fee is averaging approximately
3.80% for the first round of the program, and fees will be earned over the life
of the associated loans. The first round of PPP closed in August of 2020. On
December 21, 2020, Congress passed the Consolidated Appropriations Act, 2021,
which included provisions for a second round of PPP funding in 2021. As of
December 31, 2021, the Bancorp approved 420 applications totaling $37.5 million
for the second round, with an average loan size of approximately $89 thousand.
These loans will help local business owners retain 4,410 employees based on the
borrowers' applications. The Bancorp's SBA lender fee is averaging approximately
5.32% for this program, and fees will be earned over the life of the associated
loans. As of December 31, 2021, the Bancorp had remaining loan balances under
the Paycheck Protection Program totaling $22.1 million.



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Non-performing loans include those loans that are 90 days or more past due and
accruing and those loans that have been placed on non-accrual status. At
December 31, 2021, all non-performing loans are also accounted for on a
non-accrual basis, except for one commercial real estate loan totaling $91
thousand, two commercial business loans totaling $49 thousand, one home equity
loan totaling $34 thousand, and one residential real estate loan totaling $31
thousand that remained accruing and more than 90 days past due.



Bancorp’s non-performing loans are summarized below:




(Dollars in thousands)
                                      December 31,       December 31,
Loan Segment                              2021               2020
Residential real estate               $       4,682     $        6,470
Home equity                                     657                505
Commercial real estate                        1,031              5,827
Construction and land development                 -                 20
Multifamily                                     455                504
Farmland                                          -                  -
Commercial business                             436              1,039
Consumer                                          -                  -
Manufactured homes                                -                  -
Government                                        -                  -
Total                                 $       7,261     $       14,365
Nonperforming loans to total loans             0.75 %             1.49 %
Nonperforming loans to total assets            0.45 %             0.96 %




Substandard loans include non-performing loans and potential problem loans, when information about possible credit problems or other conditions causes management to question the ability of such borrowers to meet debt covenants of the loan or the terms of repayment. No outstanding has been classified internally as doubtful or as a loss December 31, 2021 Where December 31, 2020.

Loans below Bancorp’s standards are summarized below:




(Dollars in thousands)
                                    December 31,       December 31,
Loan Segment                            2021               2020
Residential real estate             $       3,722     $        6,387
Home equity                                   632                495
Commercial real estate                      3,562              8,180
Construction and land development               -                  -
Multifamily                                   384                504
Farmland                                        -                  -
Commercial business                           387              1,061
Consumer                                        -                  -
Manufactured homes                              -                  -
Government                                      -                  -
Total                               $       8,687     $       16,627




In addition to identifying and monitoring non-performing and other classified
loans, management maintains a list of special mention loans. Special mention
loans represent loans management is closely monitoring due to one or more
factors that may cause the loan to become classified as substandard.



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Bancorp’s special mention loans are summarized below:




(Dollars in thousands)
                                     December 31,       December 31,
Loan Segment                             2021               2020
Residential real estate             $        2,940     $        3,539
Home equity                                    415                761
Commercial real estate                      12,011             11,983
Construction and land development            3,630              3,652
Multifamily                                    153              1,408
Farmland                                         -                  -
Commercial business                          1,915              1,341
Consumer                                         -                  -
Manufactured homes                              59                  -
Government                                       -                  -
Total                               $       21,123     $       22,684




A loan is considered impaired when, based on current information and events, it
is probable that a borrower will be unable to pay all amounts due according to
the contractual terms of the loan agreement. Typically, management does not
individually classify smaller-balance homogeneous loans, such as residential
mortgages or consumer loans, as impaired, unless they are troubled debt
restructurings.



Purchased loans acquired in a business combination are recorded at estimated
fair value on their purchase date. Purchased loans with evidence of credit
quality deterioration since origination are considered purchased credit impaired
loans. Expected future cash flows at the purchase date in excess of the fair
value of loans are recorded as interest income over the life of the loans if the
timing and amount of the future cash flows is reasonably estimable ("accretable
yield"). The difference between contractually required payments and the cash
flows expected to be collected at acquisition is referred to as the
non-accretable difference and represents probable losses in the portfolio. In
determining the acquisition date fair value of purchased credit impaired loans,
and in subsequent accounting, the Bancorp aggregates these purchased loans into
pools of loans by common risk characteristics, such as credit risk rating and
loan type. Subsequent to the purchase date, increases in cash flows over those
expected at the purchase date are recognized as interest income prospectively.
Subsequent decreases to the expected cash flows will generally result in a
provision for loan losses.



The Bancorp's impaired loans, including purchased credit impaired loans, are
summarized below:




(Dollars in thousands)
                                    December 31,       December 31,
Loan Segment                            2021               2020
Residential real estate             $       1,771     $        2,165
Home equity                                   284                353
Commercial real estate                      1,600              6,341
Construction and land development               -                  -
Multifamily                                   556                716
Farmland                                        -                  -
Commercial business                         1,597              2,246
Consumer                                        -                  -
Manufactured homes                              -                  -
Government                                      -                  -
Total                               $       5,808     $       11,821




At times, the Bancorp will modify the terms of a loan to forego a portion of
interest or principal or reduce the interest rate on the loan to a rate
materially less than market rates, or materially extend the maturity date of a
loan as part of a troubled debt restructuring. The valuation basis for the
Bancorp's troubled debt restructurings is based on the present value of expected
future cash flows; unless consistent cash flows are not present, then the fair
value of the collateral securing the loan is the basis for valuation.



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Bancorp’s distressed debt restructured loans are summarized below:




(Dollars in thousands)
                                                 December 31, 2021                                December 31, 2020
Loan Segment                        Number of Loans         Recorded Investment      Number of Loans         Recorded Investment
Residential real estate                            5       $                 342                    8       $                 614
Home equity                                        3                          83                    7                         187
Commercial real estate                             3                         747                    4                         872
Construction and land development                  -                           -                    -                           -
Multifamily                                        -                           -                    -                           -
Farmland                                           -                           -                    -                           -
Commercial business                                2                         694                    6                         448
Consumer                                           -                           -                    -                           -
Manufactured homes                                 -                           -                    -                           -
Government                                         -                           -                    -                           -
Total                                             13       $               1,866                   25       $               2,121




The decrease in nonperforming, impaired, and substandard loans as of December
31, 2021, is due to the loan sale with charge off for a single large commercial
real estate loan relationship, which operates a hotel, totaling $5,080 thousand.
Nonperforming loans at December 31, 2021, also decreased due to the removal of
various residential real estate loans from nonaccrual totaling $2,856 thousand.
Substandard loans at December 31, 2021, also decreased due to the removal of
various residential real estate loans totaling $2,665 thousand. Impaired loans
at December 31, 2021, also decreased due to the removal of eight commercial
business or commercial real estate customers with loans totaling $623 thousand
due to loan pay off or refinance. The decrease in special mention loans as of
December 31, 2021, is due to the removal of six commercial business, multifamily
or commercial real estate customers with loans totaling $2,513 thousand because
of loan risk rating change or loan pay off and the removal of various
residential real estate and home equity loans totaling $945 thousand which was
offset by the addition of seven commercial real estate or commercial business
customers with loans totaling $2,854 thousand.



At December 31, 2021, management is of the opinion that there are no loans,
except certain of those discussed above, where known information about possible
credit problems of borrowers causes management to have serious doubts as to the
ability of such borrowers to comply with the present loan repayment terms and
which will imminently result in such loans being classified as past due,
non-accrual or a troubled debt restructure. Management does not presently
anticipate that any of the non-performing loans or classified loans would
materially affect future operations, liquidity or capital resources.



The allowance for loan losses (ALL) is a valuation allowance for probable
incurred credit losses, increased by the provision for loan losses, and
decreased by charge-offs net of recoveries. A loan is charged off against the
allowance by management as a loss when deemed uncollectible, although collection
efforts continue and future recoveries may occur. The determination of the
amounts of the ALL and provisions for loan losses is based on management's
current judgments about the credit quality of the loan portfolio with
consideration given to all known relevant internal and external factors that
affect loan collectability as of the reporting date. The appropriateness of the
current period provision and the overall adequacy of the ALL are determined
through a disciplined and consistently applied quarterly process that reviews
the Bancorp's current credit risk within the loan portfolio and identifies the
required allowance for loan losses given the current risk estimates.



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The Bancorp's provision for loan losses for the
twelve months ended are summarized below:




(Dollars in thousands)

                                    December 31,      December 31,
Loan Segment                            2021              2020
Residential real estate             $         220     $         374
Home equity                                    81                53
Commercial real estate                        639             1,713
Construction and land development             714               324
Multifamily                                   222                97
Farmland                                        -                 -
Commercial business                          (377 )           1,145
Consumer                                       10                (2 )
Manufactured homes                              -                 -
Government                                      -               (17 )
Total                               $       1,509     $       3,687



Information on Bancorp charges and recoveries is summarized below:




(Dollars in thousands)                                  (unaudited)
                                                  As of December 31, 2021
Loan Segment                         Charge-off         Recoveries      Net Charge-offs
Residential real estate             $        (32 )     $         81     $             49
Home equity                                   (1 )                1                    -
Commercial real estate                      (530 )                -                 (530 )
Construction and land development              -                  -                    -
Multifamily                                    -                  -                    -
Farmland                                       -                  -                    -
Commercial business                         (158 )               36                 (122 )
Consumer                                     (29 )                8                  (21 )
Manufactured homes                             -                  -
Government                                     -                  -                    -
Total                               $       (750 )     $        126     $           (624 )




The ALL provisions take into consideration management's current judgments about
the credit quality of the loan portfolio, loan portfolio balances, changes in
the portfolio mix and local economic conditions. In determining the provision
for loan losses for the current period, management has considered risks
associated with the local economy, changes in loan balances and mix, and asset
quality.



In addition, management considers reserves that are not part of the ALL that
have been established from acquisition activity. The Bancorp acquired loans for
which there was evidence of credit quality deterioration since origination and
it was determined that it was probable that the Bancorp would be unable to
collect all contractually required principal and interest payments. At December
31, 2021, total purchased credit impaired loans nonaccretable and accretable
discount totaled $1.4 million compared to $2.1 million at December 31, 2020.
Additionally, the Bancorp has acquired loans where there was no evidence of
credit quality deterioration since origination and has marked these loans to
their fair values. As part of the fair value of loans receivable, a net fair
value discount was established for loans acquired and has a balance of $1.1
million at December 31, 2021, compared to $2.0 million at December 31, 2020.
Details on these fair value marks and the additional reserves created can be
found in Note 4, Loans Receivable.



A deferred cost reserve is maintained for the portfolio of manufactured home
loans that have been purchased. This reserve is available for use for
manufactured home loan nonperformance and costs associated with nonperformance.
If the segment performs in line with expectation, the deferred cost reserve is
paid as an origination cost to the third party originator of the loan.



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The Bancorp's allowance to total loans and
non-performing loans are summarized below:




(Dollars in thousands)
                                                December 31,       December 31,
                                                    2021               2020

Allowance for loan losses                      $       13,343     $       12,458
Total loans                                    $      966,720     $      966,578
Non-performing loans                           $        7,261     $       14,365
ALL-to-total loans                                       1.38 %             1.29 %
ALL-to-non-performing loans (coverage ratio)            183.8 %             86.7 %




The December 31, 2021, balance in the ALL account is considered adequate by
management after evaluation of the loan portfolio, past experience and current
economic and market conditions. While management may periodically allocate
portions of the allowance for specific problem loans, the whole allowance is
available for any loan charge offs that occur. The allocation of the ALL
reflects performance and growth trends within the various loan categories, as
well as consideration of the facts and circumstances that affect the repayment
of individual loans, and loans which have been pooled as of the evaluation date,
with particular attention given to non-performing loans and loans which have
been classified as substandard, doubtful or loss. Management has allocated
reserves to both performing and non-performing loans based on current
information available.



At December 31, 2021, the Bank held no balances in foreclosed real estate,
compared to $538 thousand and ten properties at December 31, 2020. During 2021,
net sales of foreclosed real estate totaled $585 thousand and net gains from the
2021 sales totaled $47 thousand.



The primary objective of the Bancorp's investment portfolio is to provide for
the liquidity needs of the Bancorp and to contribute to profitability by
providing a stable flow of dependable earnings. Funds are generally invested in
federal funds, interest bearing balances in other financial institutions, U.S.
government securities, federal agency obligations, obligations of state and
local municipalities and corporate securities. The securities portfolio, all of
which is designated as available-for-sale, totaled $526.9 million at December
31, 2021, compared to $410.7 million at December 31, 2020, an increase of $116.2
million (28.3%). The increase in the securities portfolio during the year is a
result of market value adjustments and investment of excess liquidity. At
December 31, 2021, the securities portfolio represented 34.6% of
interest-earning assets and 32.5% of total assets compared to 29.4% of
interest-earning assets and 27.4% of total assets at December 31, 2020.



From December 31, 2021, Bancorp’s two investments in trust preferred securities have “payment in kind” status. The payment-in-kind status results in a temporary delay in the payment of interest. Due to a delay in the collection of interest payments, management has placed these securities in unexpired status. AT December 31, 2021the cost base of the two non-recognition trust preferred securities totaled $2.2 million.




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Bancorp’s period-end investment portfolio and other short-term investments and inventory balances were as follows:



                                    December 31.                         December 31,
(Dollars in thousands)                  2021                                 2020
                                      Balance         % Securities        

Balance % Securities


Money market fund                  $            -               0.0 %   $       52,941              12.9 %
U.S. government sponsored
entities                                    8,669               1.6 %            7,860               1.9 %
U.S. treasury securities                      400               0.1 %                -               0.0 %
Collateralized mortgage
obligations and residential
mortgage-backed securities                184,701              35.1 %          154,736              37.7 %
Municipal securities                      332,127              63.0 %          194,203              47.3 %
Collateralized debt obligations               992               0.2 %              929               0.2 %
Total securities
available-for-sale                 $      526,889             100.0 %   $      410,669             100.0 %




                                    December 31.      December 31,          YTD
(Dollars in thousands)                  2021              2020            Change
                                      Balance            Balance             $               %

Interest bearing deposits in
other financial institutions       $       19,987     $       5,908     $    14,079           238.3 %
Fed funds sold                                464                 -             464           100.0 %
Certificates of deposit in other
financial institutions                      1,709             1,897            (188 )          -9.9 %
Federal Home Loan Bank stock                3,247             3,918            (671 )         -17.1 %



The net increase in interest-bearing deposits at other financial institutions is mainly due to the increase in customer deposits.




Deposits are a fundamental and cost-effective source of funds for lending and
other investment purposes. The Bancorp offers a variety of products designed to
attract and retain customers, with the primary focus on building and expanding
relationships.


Bancorp’s period-end deposit portfolio balances were as follows:



                           December 31,       December 31,               YTD
(Dollars in thousands)         2021               2020                 Change
                             Balance            Balance             $            %

Checking                  $      629,038     $      516,487     $ 112,551        21.8 %
Savings                          293,976            254,108        39,868        15.7 %
Money market                     271,970            246,916        25,054        10.1 %
Certificates of deposit          239,217            284,828       (45,611 )     -16.0 %
Total deposits            $    1,434,201     $    1,302,339     $ 131,862        10.1 %



The overall increase in total deposits is primarily the result of Bancorp’s efforts to maintain and grow core deposits and customer preferences for the security and liquidity of Bancorp’s deposit product offerings.




The Bancorp's borrowed funds are primarily used to fund asset growth not
supported by deposit generation. The Bancorp's end-of-period borrowing balances
were as follows:





                          December 31,       December 31,               YTD
(Dollars in thousands)        2021               2020                 Change
                            Balance            Balance            $            %

Repurchase agreements    $       14,581     $       13,711     $    870          6.3 %
Borrowed funds                        -              6,149       (6,149 )     -100.0 %
Total borrowed funds     $       14,581     $       19,860     $ (5,279 )      -26.6 %




Repurchase agreements increased as part of normal account fluctuations within
that product line. Borrowed funds decreased as FHLB advances were paid down and
matured during the year.



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Cash and capital resources


For the Bancorp, liquidity management refers to the ability to generate
sufficient cash to fund current loan demand, meet deposit withdrawals, and pay
dividends and operating expenses. Because profit and liquidity are often
conflicting objectives, management attempts to maximize the Bank's net interest
margin by making adequate, but not excessive, liquidity provisions. Furthermore,
funds are managed so that future profits will not be significantly impacted as
funding costs increase.



Changes in the liquidity position result from operating, investing and financing
activities. Cash flows from operating activities are generally the cash effects
of transactions and other events that enter into the determination of net
income. The primary investing activities include loan originations, loan
repayments, investments in interest bearing balances in financial institutions,
and the purchase, sale, and maturity of investment securities. Financing
activities focus almost entirely on the generation of customer deposits. In
addition, the Bancorp utilizes borrowings (i.e., repurchase agreements, FHLB
advances and federal funds purchased) as a source of funds.



During 2021, cash and cash equivalents increased $13.3 million compared to a
decrease of $27.3 million for 2020. During 2021, he primary sources of cash and
cash equivalents were the sale loans originated for sale, proceeds from the
maturity and paydown of securities, proceeds from the sale of securities, growth
of deposits, and proceeds from the maturity and paydown of loans receivable. The
primary uses of cash and cash equivalents were origination of loans for sale and
purchase of securities. During 2021, net cash from operating activities totaled
$17.0 million, compared to $19.7 million for 2020. The decrease in cash in-flow
from operating activities was primarily due to lower net income year over year,
lower sale of loans originated for sale, and net change in accrued expenses and
other liabilities. Net cash outflows from investing activities totaled $125.9
million during 2021, compared to outflows of $185.0 million during 2020. The
changes for the current year were primarily related to the decreased purchases
of securities and net change in loans receivable. Net cash inflows from
financing activities totaled $122.1 million in 2021, compared to net cash
inflows of $138.0 million in 2020. The increase during 2021 was primarily due to
the change in deposits. On a cash basis, the Bancorp paid dividends on common
stock of $4.3 million during 2021 and 2020. During 2021, the Bancorp's Board of
Directors maintained dividends as earnings and capital continued to be
sufficient to warrant the current dividend.



Management strongly believes that safety and soundness is enhanced by
maintaining a high level of capital. Stockholders' equity totaled $156.6 million
at December 31, 2021, compared to $151.7 million at December 31, 2020, an
increase of $4.9 million (3.2%). The increase was primarily the result of net
income of $15.0 million, offset against change in net unrealized gains of
available for sale securities of $6.2 million and dividends of $4.3 million. At
December 31, 2021, book value per share was $45.00 compared to $43.80 for 2020.



The following table shows that at December 31, 2021, the Bank’s capital exceeded all regulatory capital requirements. Dollar amounts are in millions.




(Dollars in millions)                                                                         Minimum Required To Be
                                                         Minimum Required For             Well Capitalized Under Prompt
                                Actual                 Capital Adequacy Purposes          Corrective Action Regulations
At December 31, 2021     Amount         Ratio           Amount             Ratio            Amount                Ratio
Common equity tier 1
capital to
risk-weighted assets    $   133.7          12.6 %   $         47.8              4.5 %   $          69.0                6.5 %
Tier 1 capital to
risk-weighted assets    $   133.7          12.6 %   $         63.7              6.0 %   $          85.0                8.0 %
Total capital to
risk-weighted assets    $   147.0          13.9 %   $         85.0              8.0 %   $         106.2               10.0 %
Tier 1 capital to
adjusted average
assets                  $   133.7           8.4 %   $         64.1              4.0 %   $          80.1                5.0 %




The Bancorp's ability to pay dividends to its shareholders is entirely dependent
upon the Bank's ability to pay dividends to the Bancorp. Under Indiana law, the
Bank may pay dividends from its undivided profits (generally, earnings less
losses, bad debts, taxes and other operating expenses) as is considered
expedient by the Bank's Board of Directors. However, the Bank must obtain the
approval of the Indiana Department of Financial Institutions (DFI) if the total
of all dividends declared by the Bank during the current year, including the
proposed dividend, would exceed the sum of retained net income for the year to
date plus its retained net income for the previous two years. For this purpose,
"retained net income," means net income as calculated for call report purposes,
less all dividends declared for the applicable period. An exemption from DFI
approval would require that the Bank have been assigned a composite uniform
financial institutions rating of 1 or 2 as a result of the most recent federal
or state examination; the proposed dividend would not result in a Tier 1
leverage ratio below 7.5%; and that the Bank not be subject to any corrective
action, supervisory order, supervisory agreement, or board approved operating
agreement. The aggregate amount of dividends that may be declared by the Bank in
2021, without the need for qualifying for an exemption or prior DFI approval, is
its 2021 net profits plus $21.4 million. Moreover, the FDIC and the Federal
Reserve Board may prohibit the payment of dividends if it determines that the
payment of dividends would constitute an unsafe or unsound practice in light of
the financial condition of the Bank. On November 19, 2021 the Board of Directors
of the Bancorp declared a fourth quarter dividend of $0.31 per share. The
Bancorp's fourth quarter dividend was paid to shareholders on January 7, 2022.



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Results of Operations -

Comparison of 2021 to 2020

Net income for 2021 was $15.0 million, compared to $15.9 million for 2020, a
decrease of $969 thousand (6.1%). The twelve-month earnings decrease is
primarily related to higher noninterest expense and lower noninterest income.
The earnings represent a return on average assets of 0.95% for 2021, compared to
1.12% for 2020. The return on average equity was 9.61% for 2021, compared to
11.04% for 2020.



Net interest income for 2021, was $48.6 million, an increase of $2.7 million
(5.9%) from $45.9 million for 2020. During the year, the Bancorp's interest
earning assets were negatively impacted by lower yields, while interest expense
was driven lower primarily by decreased cost of funds. The weighted-average
yield on interest-earning assets was 3.44% for 2021, compared to 3.91% for 2020.
The weighted-average cost of funds was 0.15% for 2021, compared to 0.45% for
2020. The impact of the 3.44% return on interest earning assets and the 0.15%
cost of funds resulted in a net interest spread of 3.29% for 2021, compared to a
net interest spread of 3.46% for 2020. During 2021, total interest income
decreased by $966 thousand (1.9%) while total interest expense decreased by $3.7
million (63.8%). The net interest margin was 3.29% for 2021, compared to 3.47%
for 2019. The Bancorp's tax equivalent net interest margin for 2021, was 3.51%
compared to 3.63% for 2020. Comparing the net interest margin on a tax
equivalent basis more accurately compares the returns on tax-exempt loans and
securities to those on taxable interest-earning assets.



The decrease in interest earning asset income for the year ended December 31,
2021, compared to the year ended December 31, 2020, is primarily related to
continued decreased reinvestment rates in 2021 for loans, securities, and excess
cash balances, as a result of the Federal Reserve cuts occurring in March 2020.
The decrease in interest bearing liability expense is primarily the result of
the Bancorp adjusting deposit and repurchase agreement pricing to align with the
current interest rate cycle.



The following table shows the change in non-interest income for the year ending
December 31, 2021and December 31, 2020.




(Dollars in thousands, except per
share data)                                Year Ended December 31,          

31/12/2021 vs. 31/12/2020

                                            2021              2020            $ Change            % Change
Noninterest income:
Fees and service charges                       5,388             5,161                227                4.4 %
Gain on sale of loans held-for-sale,
net                                            5,296             7,588             (2,292 )            -30.2 %
Wealth management operations                   2,375             2,138                237               11.1 %
Gain on sale of securities, net                1,987             2,348               (361 )            -15.4 %
Increase in cash value of bank owned
life insurance                                   715               708                  7                1.0 %
Gain on sale of foreclosed real
estate                                            47                78                (31 )            -39.7 %
Other                                            139               127                 12                9.4 %

Total noninterest income                      15,947            18,148             (2,201 )            -12.1 %




The increase in fees and service charges is primarily the result of the
Bancorp's efforts to provide products and services to help customers be more
successful, including debit card and ATM services. The decrease in gain on sale
of loans is the result of significant refinance activity in the prior year due
to the economic and rate environment, which resulted in more loans originated
and sold. The increase in wealth management income is the result of the
Bancorp's continued focus on expanding its wealth management line of business.
The decrease in gains on the sale of securities is a result of current market
conditions and actively managing the portfolio.



                                                                  Page 55 of 108
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The following table shows the change in non-interest expenses for the year ending
December 31, 2021and December 31, 2020.

(in thousands of dollars, except per share data) End of year the 31st of December,

31/12/2021 vs. 31/12/2020

                                                    2021              2020           $ Change               % Change

Noninterest expense:
Compensation and benefits                             24,241           22,855               1,386                  6.1 %
Occupancy and equipment                                5,537            4,933                 604                 12.2 %
Data processing                                        3,648            2,267               1,381                 60.9 %
Federal deposit insurance premiums                       861              788                  73                  9.3 %
Professional services                                  1,205              640                 565                 88.3 %
Marketing                                              1,085              732                 353                 48.2 %
Other                                                 10,059            9,421                 638                  6.8 %

Total noninterest expense                             46,636           41,636               5,000                 12.0 %




The increase in compensation and benefits is primarily the result of
management's continued focus on talent management and retention. The increase in
occupancy and equipment is primarily related to facilities improvement efforts
aimed at enhancing technology and efficiency. The increase in data processing
expense is primarily the result of increased system utilization and investment
in technological advancements such as Salesforce and nCino. The increase in
marketing expense is the result of increased marketing and rebranding
initiatives. The increase in professional services is primarily the result of
the Royal Financial acquisition. The increase in other operating expenses is
primarily the result of investments in strategic initiatives focusing on growth
of the organization, such as the acquisition of Royal Financial. The acquisition
of RYFL is discussed in Note 2 of the financial statements.



Income tax expenses for the year ended December 31, 2021, totaled $1.4 million,
compared to income tax expense of $2.8 for the year ended December 31, 2020, a
decrease of $1.4 million (49.0%). The combined effective federal and state tax
rates for the Bancorp was 8.6% for the year ended December 31, 2021, compared to
14.8% for the year ended December 31, 2020. The Bancorp's lower current period
effective tax rate is a result of a greater increase to tax preferred income
relative to earnings.


Critical accounting policies


Critical accounting policies are those accounting policies that management
believes are most important to the portrayal of the Bancorp's financial
condition and that require management's most difficult, subjective or complex
judgments. The Bancorp's most critical accounting policies are summarized below.
Other accounting policies, including those related to the fair values of
financial instruments and the status of contingencies, are summarized in Note 1
to the Bancorp's consolidated financial statements.



Valuation of Investment Securities - The fair values of securities available for
sale are determined on a recurring basis by obtaining quoted prices on
nationally recognized securities exchanges or pricing models utilizing
significant observable inputs such as matrix pricing, which is a mathematical
technique widely used in the industry to value debt securities without relying
exclusively on quoted prices for the specific securities but rather by relying
on the securities' relationship to other benchmark quoted securities. Different
judgments and assumptions used in pricing could result in different estimates of
value. In certain cases where market data is not readily available because of
lack of market activity or little public disclosure, values may be based on
unobservable inputs and classified in Level 3 of the fair value hierarchy.



At the end of each reporting period securities held in the investment portfolio
are evaluated on an individual security level for other-than-temporary
impairment in accordance with the Investments - Debt and Equity Securities Topic
of the Accounting Standards Codification. Significant judgments are required in
determining impairment, which include making assumptions regarding the estimated
prepayments, loss assumptions and the change in interest rates.



                                                                  Page 56 of 108
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We consider the following factors when determining an other-than-temporary
impairment for a security: The length of time and the extent to which the market
value has been less than amortized cost; the financial condition and near-term
prospects of the issuer; the underlying fundamentals of the relevant market and
the outlook for such market for the near future; and an assessment of whether
the Bancorp has (1) the intent to sell the debt securities or (2) more likely
than not will be required to sell the debt securities before its anticipated
market recovery. If either of these conditions is met, management will recognize
other-than-temporary impairment. If, in management's judgment, an
other-than-temporary impairment exists, the cost basis of the security will be
written down for the credit loss, and the unrealized loss will be transferred
from accumulated other comprehensive loss as an immediate reduction of current
earnings. Management will utilize an independent valuation specialist to value
securities semi-annually for other-than-temporary impairment.



Allowance for Loan Losses - The Bancorp maintains an Allowance for Loan Losses
("ALL") to absorb probable incurred credit losses that arise from the loan
portfolio. The ALL is increased by the provision for loan losses, and decreased
by charge-offs net of recoveries. The determination of the amounts of the ALL
and provisions for loan losses is based upon management's current judgments
about the credit quality of the loan portfolio with consideration given to all
known relevant internal and external factors that affect loan collectability.
The methodology used to determine the current year provision and the overall
adequacy of the ALL includes a disciplined and consistently applied quarterly
process that combines a review of the current position with a risk assessment
worksheet. Factors that are taken into consideration in the analysis include an
assessment of national and local economic trends, a review of current year loan
portfolio growth and changes in portfolio mix, and an assessment of trends for
loan delinquencies and loan charge-off activity. Particular attention is given
to non-accruing loans and accruing loans past due 90 days or more, and loans
that have been classified as substandard, doubtful, or loss. Changes in the
provision are directionally consistent with changes in observable data.



Commercial and industrial, and commercial real estate loans that exhibit credit
weaknesses and loans that have been classified as impaired are subject to an
individual review. Where appropriate, ALL allocations are made to these loans
based on management's assessment of financial position, current cash flows,
collateral values, financial strength of guarantors, industry trends, and
economic conditions. ALL allocations for homogeneous loans, such as residential
mortgage loans and consumer loans, are based on historical charge-off activity
and current delinquency trends. Management has allocated general reserves to
both performing and non-performing loans based on historical data and current
information available.



Risk factors for non-performing and internally classified loans are based on an
analysis of either the projected discounted cash flows or the estimated
collateral liquidation value for individual loans defined as substandard or
doubtful. Estimated collateral liquidation values are based on established loan
underwriting standards and adjusted for current mitigating factors on a
loan-by-loan basis. Aggregate substandard loan collateral deficiencies are
determined for residential, commercial real estate, commercial business, and
consumer loan portfolios. These deficiencies are then stated as a percentage of
the total substandard balances to determine the appropriate risk factors.



Risk factors for performing and non-classified loans are based on a weighted
average of net charge-offs for the most recent three years, which are then
stated as a percentage of average loans for the same period. Historical risk
factors are calculated for residential, commercial real estate, commercial
business, and consumer loans. The three year weighted average historical factors
are then adjusted for current subjective risks attributable to: regional and
national economic factors; loan growth and changes in loan composition;
organizational structure; composition of loan staff; loan concentrations; policy
changes and out of market lending activity.

The risk factors are applied to these types of loans to determine the
appropriate level for the ALL. Adjustments may be made to these allocations that
reflect management's judgment on current conditions, delinquency trends, and
charge-off activity. Based on the above discussion, management believes that the
ALL is currently adequate, but not excessive, given the risk inherent in the
loan portfolio.


Impact of inflation and price changes


The financial statements and related data presented herein have been prepared in
accordance with accounting principles generally accepted in the United States of
America, which require the measurement of financial position and operating
results in terms of historical dollars, without considering changes in the
relative purchasing power of money over time due to inflation. The primary
assets and liabilities of the Bancorp are monetary in nature. As a result,
interest rates have a more significant impact on the Bancorp's performance than
the effects of general levels of inflation. Interest rates do not necessarily
move in the same direction or magnitude as the prices of goods and services.

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