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ITEM 1A. RISK FACTORS

In addition to the other information in this Annual Report on Form 10-K, stockholders or prospective investors should carefully consider the following risk factors:

Risks Relating to General Economic Conditions

A continued downturn in the general economic or business conditions, nationally or in markets where our business is concentrated, could have an adverse effect on our business, results of operations and financial condition.

Our success depends upon the business activity, population, employment rates, income levels, deposits and real estate activity in our markets in northern and central Indiana. Although our customers’ business and financial interests may extend well beyond these market areas, adverse economic conditions that affect these market areas could reduce our growth rate, diminish the ability of our customers to repay their loans to us, decrease the value of any collateral securing our loans and generally adversely affect our financial condition and results of operations. Moreover, because of our geographic concentration, we are less able than other regional or national financial institutions to diversify our credit risks across multiple markets.

In general, business activity, employment rates, income levels and other measures of economic activity have been negatively affected by the COVID-19 pandemic. The speed and strength of any economic recovery from the pandemic is subject to a high degree of uncertainty, but is expected to be affected by further developments in the pandemic, including the scope of federal and state governmental policies, the success of vaccination efforts and other matters, as described in further detail below.

The COVID-19 pandemic is having an adverse impact on our business and results of operations, and could have an adverse impact on our financial condition or capital levels, any of which could be material.

The COVID-19 pandemic has had a significant economic impact on the communities in which we operate, our borrowers and depositors, and the national economy generally, including a general curtailment of business activity and increased levels of unemployment in our Indiana markets. We expect this impact could continue to be volatile, and last for a significant and indeterminate period. These developments have adversely affected our business and results of operations, and we believe they could adversely impact our financial condition and capital levels, the amounts of which cannot be determined and could be material. In particular, certain of our borrowers and depositors are in or have exposure to industries, such as hotel and accommodations, entertainment and recreation and full-service restaurants, which have reduced or suspended operations. Any continued decrease, or delayed recovery, in economic activity as a result of COVID-19 could have a negative adverse impact on certain of our borrowers and their financial condition, which could impact their ability to meet their financial obligations and could result in elevated levels of delinquencies, defaults, foreclosures and loan losses. See “Note 26 – COVID-19 and Current Economic Conditions” for additional information.

In addition, the COVID-19 pandemic could have a material impact on our operations. We rely upon our third-party vendors to conduct business and to process, record and monitor transactions. If any of these vendors are unable to continue to provide us with these services, it could negatively impact our ability to serve our customers. Furthermore, the outbreak could negatively impact our employees and customers’ ability to engage in banking and other financial transactions and could create widespread business continuity issues for us. We also could be adversely affected if key personnel or a significant number of employees were to become unavailable due to the effects and restrictions of a COVID-19 outbreak in our market areas.

The pandemic has also increased our exposure to related business risks, including the following:

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Interest rate shifts may reduce net interest income and otherwise negatively impact our financial condition and results of operations.

Shifts in short-term interest rates may reduce net interest income, which is the principal component of our earnings. Net interest income is the difference between the amounts received by us on our interest bearing assets and the interest paid by us on our interest bearing liabilities. When interest rates rise, the rate of interest we pay on our liabilities may rise more quickly than the rate of interest that we receive on our interest bearing assets, which may cause our profits to decrease. Conversely, when interest rates fall our interest bearing assets reprice more quickly than our interest bearing liabilities, given our asset-sensitive balance sheet, which may cause our net interest income to decrease. The impact on earnings is more adverse when the slope of the yield curve flattens, i.e. when short-term interest rates increase more than corresponding changes in long-term interest rates or when long-term interest rates decrease more than corresponding changes in short-term interest rates.

Interest rate increases often result in larger payment requirements for our borrowers, which increases the potential for default. At the same time, the marketability of the underlying property may be adversely affected by any reduced demand resulting from higher interest rates. In a declining interest rate environment, there may be an increase in prepayments on the loans as borrowers refinance their mortgages at lower rates.

Changes in interest rates also can affect the value of loans, securities and other assets. An increase in interest rates that adversely affects the ability of borrowers to pay the principal or interest on loans may lead to an increase in nonperforming assets and a reduction of income recognized, which could have a material adverse effect on our results of operations and cash flows. Thus, an increase in the amount of nonperforming assets would have an adverse impact on net interest income.

The Federal Reserve Bank has lowered the target fed funds rate range to 0.00%-0.25%, and short-term interest rates have remained at historically low levels for a prolonged period. As a result, we have experienced, and expect to continue to experience, net interest margin compression, which negatively affects our net interest income and results of operations.

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Risks Relating to Our Business

If we do not effectively manage our credit risk, we may experience increased levels of nonperforming loans, charge offs and delinquencies, which could require further increases in our provision for loan losses.

There are risks inherent in making any loan, including risks inherent in dealing with individual borrowers, risks of nonpayment, risks resulting from uncertainties as to the future value of collateral and risks resulting from changes in economic and industry conditions. In general, these risks have increased as a result of the COVID-19 pandemic, which has disrupted business trends that we evaluate when making credit decisions, and changed the short- and long-term outlook for businesses and individuals in our markets. We cannot assure you that our loan application approval procedures, use of loan concentration limits, credit monitoring, use of independent reviews of outstanding loans or other procedures will reduce these credit risks. If the overall economic climate in the United States, generally, and our market areas, specifically, does not perform in the manner we expect, or even if it does, our borrowers may experience difficulties in repaying their loans, and the level of nonperforming loans, charge-offs and delinquencies could rise and require increases in the provision for loan losses, which would cause our net income and return on equity to decrease.

If our allowance for loan losses is not sufficient to absorb losses that may occur in our loan portfolio, our financial condition and liquidity could suffer.

We establish our allowance for loan losses and maintain it at a level considered adequate by management to absorb probable incurred loan losses that are inherent in the portfolio. The allowance contains provisions for probable incurred losses that have been identified relating to specific borrowing relationships, as well as probable losses inherent in the loan portfolio and credit undertakings that are not specifically identified. Additions to the allowance for loan losses, which are charged to earnings through the provision for loan losses, are determined based on a variety of factors, including an analysis of the loan portfolio, historical loss experience and an evaluation of current economic conditions in our market areas. The actual amount of loan losses is affected by changes in economic, operating and other conditions within our markets, which may be beyond our control, and such losses may exceed current estimates.

At December 31, 2020, our allowance for loan losses as a percentage of total loans was 1.32% and as a percentage of total nonperforming loans was 507%. Because of the nature of our loan portfolio and our concentration in commercial and industrial loans, which tend to be larger loans, the movement of a small number of loans to nonperforming status can have a significant impact on these ratios. Although management believes that the allowance for loan losses is adequate to absorb probable losses on any existing loans, we cannot predict loan losses with certainty and we cannot assure you that our allowance for loan losses will prove sufficient to cover actual loan losses in the future. Loan losses in excess of our reserves may adversely affect our business, results of operations and financial condition.

Commercial and industrial loans make up a significant portion of our loan portfolio.

Commercial and industrial loans were $1.791 billion, or approximately 38.5% of our total loan portfolio, as of December 31, 2020. Commercial and industrial loans are often larger and involve greater risks than other types of lending. Because payments on such loans are often dependent on the successful operation of the borrower involved, repayment of such loans is often more sensitive than other types of loans to adverse conditions in the general economy. For example, decreased economic activity as a result of the COVID-19 pandemic has adversely affected commercial and industrial loans, and we expect this trend to continue for certain portions of our loan portfolio, depending on the strength and speed of economic recovery and other factors.

Our commercial and industrial loans are primarily made based on the identified cash flow of the borrower and secondarily on the underlying collateral provided by the borrower. Most often, this collateral is accounts receivable, inventory, machinery or real estate. Whenever practical, we require a personal guarantee on commercial and industrial loans. Credit support provided by the borrower for most of these loans and the probability of repayment is based on the liquidation of the pledged collateral and enforcement of a personal guarantee, if any exists. As a result, 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. The collateral securing other loans may depreciate over time, may be difficult to appraise and may fluctuate in value based on the success of the business. Due to the larger average size of each commercial loan as compared with other loans such as residential loans, as well as collateral that is generally less readily-marketable, losses incurred on a small number of commercial loans could adversely affect our business, results of operations and growth prospects.

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Our loan portfolio includes commercial real estate loans, which involve risks specific to real estate value.

Commercial real estate loans were $1.895 billion, or approximately 40.7% of our total loan portfolio as of December 31, 2020. The market value of real estate can fluctuate significantly in a short period of time as a result of market conditions in the geographic area in which the real estate is located, and, as a general matter, these values have been significantly and negatively affected by the COVID-19 pandemic.

Although a significant portion of such loans are secured by real estate as a secondary form of collateral, these developments and any future adverse developments affecting real estate values in one or more of our markets could increase the credit risk associated with our loan portfolio. Additionally, real estate lending typically involves higher loan principal amounts and the repayment of the loans generally is dependent, in large part, on sufficient income from the properties securing the loans to cover operating expenses and debt service. Economic events or governmental regulations outside of the control of the borrower or lender could negatively impact the future cash flow and market values of the affected properties.

If the loans that are collateralized by real estate become troubled and the value of the real estate has been significantly impaired, then we may not be able to recover the full contractual amount of principal and interest that we anticipated at the time of originating the loan, which could cause us to increase our provision for loan losses and adversely affect our operating results and financial condition.

Our loan portfolio has a notable concentration in agri-business, which has a higher level of uncontrolled risk.

Our agri-business loans, which totaled $429.6 million, or approximately 9.2% of our total loan portfolio as of December 31, 2020, are subject to risks outside of our or the borrower’s control. These risks, specific to the agricultural industry, include decreases in livestock and crop prices, increases in labor and seed prices, increase in stockpiles of agricultural commodities, the strength of the U.S. dollar, the potential impact of tariffs on commodities and the nature of climate and weather conditions. To the extent these or other factors affect the performance or financial condition of our agri-business borrowers, our results of operations and financial performance could suffer.

Our consumer loans generally have a higher degree of risk of default than our other loans.

At December 31, 2020, consumer loans totaled $103.6 million, or 2.2% of our total loan portfolio. Consumer loans typically have shorter terms and lower balances with higher yields as compared to commercial loans, but generally carry higher risks of default. Consumer loan collections are dependent on the borrower’s continuing financial stability, and thus are more likely to be affected by adverse personal circumstances. Furthermore, the application of various federal and state laws, including bankruptcy and insolvency laws, may limit the amount which can be recovered on these loans.

Nonperforming assets take significant time to resolve and adversely affect our results of operations and financial condition and could result in further losses in the future.

Our nonperforming assets adversely affect our net income in various ways. We do not record interest income on nonaccrual loans or other real estate owned, which adversely affects our net income and returns on assets and equity, increases our loan administration costs and adversely affects our efficiency ratio. When we take collateral in foreclosure and similar proceedings, we are required to mark the collateral to its current fair market value at the time of transfer, which may result in a loss. These nonperforming loans and other real estate owned also increase our risk profile and our regulatory capital requirements may increase in light of such risks. The resolution of nonperforming assets requires significant time commitments from management and can be detrimental to the performance of their other responsibilities. If we experience increases in nonperforming loans and other nonperforming assets, our net interest income and provision expense may be negatively impacted and our loan administration costs could increase, each of which could have an adverse effect on our net income and related ratios, such as return on assets and equity.

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Liquidity risks could affect operations and jeopardize our business, results of operations and financial condition.

Liquidity is essential to our business. An inability to raise funds through deposits, borrowings, the sale of loans and other sources could have a substantial, negative effect on our liquidity. Our primary sources of funds consist of deposits, cash from operations and investment maturities and sales. Additional liquidity is provided by brokered deposits, CD Option of IntraFi Network Deposits (“CD Option”, formerly known as CDARS), American Financial Exchange overnight borrowings, IntraFi Network’s insured cash sweep program, as well as our ability to borrow from federal funds lines at correspondent banks, the Federal Reserve and the Federal Home Loan Bank (the “FHLB”). Our access to funding sources in amounts adequate to finance or capitalize our activities or on terms that are acceptable to us could be impaired by factors that affect us directly or the financial services industry or economy in general, such as disruptions in the financial markets or negative views and expectations about the prospects for the financial services industry. In addition, increased competition with the largest banks for retail deposits may impact our ability to raise funds through deposits and could have a negative effect on our liquidity.

During the last recession, the financial services industry and the credit markets generally were materially and adversely affected by significant declines in asset values and historically depressed levels of liquidity. The liquidity issues were also particularly acute for regional and community banks, as many of the larger financial institutions curtailed their lending to regional and community banks to reduce their exposure to the risks of other banks. In addition, many of the larger correspondent lenders reduced or even eliminated federal funds lines for their correspondent customers. Furthermore, regional and community banks generally have less access to the capital markets than national and super-regional banks because of their smaller size and limited analyst coverage. Any decline in available funding could adversely impact our ability to originate loans, invest in securities, meet our expenses, pay dividends to our stockholders, or fulfill obligations such as repaying our borrowings or meeting deposit withdrawal demands, any of which could have a material adverse impact on our liquidity, business, results of operations and financial condition.

Any action or steps to change coverages or eliminate Indiana’s Public Deposit Insurance Fund could require us to find alternative, higher-cost funding sources to replace public fund deposits or to provide for collateralization of these deposits.

Approximately 23% of our deposits are concentrated in public funds from a small number of municipalities and government agencies located in the Bank’s geographic footprint. A shift in funding away from public fund deposits would impact liquidity availability and could increase our cost of funds, as the alternate funding sources, such as brokered certificates of deposit, can be higher-cost, are less favorable deposits and could require additional collateral to be pledged. The inability to maintain these public funds on deposit could result in a material adverse effect on the Bank’s liquidity and could materially impact our ability to grow and remain profitable.

Declines in asset values may result in impairment charges and adversely affect the value of our investments, financial performance and capital.

We maintain an investment portfolio that includes, but is not limited to, mortgage-backed securities and municipal securities. The market value of investments may be affected by factors other than the underlying performance of the servicer of the securities or the mortgages underlying the securities, such as ratings downgrades, the effects of the COVID-19 pandemic on the financial condition of state and local governments, adverse changes in the business climate and a lack of liquidity in the secondary market for certain investment securities. On a quarterly basis, we evaluate investments and other assets for impairment indicators. We may be required to record additional impairment charges if our investments suffer a decline in value that is considered other-than-temporary. If we determine that a significant impairment has occurred, we would be required to charge against earnings the credit-related portion of the other-than-temporary impairment, which could have a material adverse effect on our results of operations in the periods in which the write-offs occur.

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We may be adversely impacted by the discontinuance of LIBOR as a short-term interest rate utilized for loans and other financing agreements.

In July 2017, the Financial Conduct Authority (the authority that regulates LIBOR) announced it intends to stop compelling banks to submit rates for the calculation of LIBOR after 2021. The Alternative Reference Rates Committee ("ARRC") has proposed that the Secured Overnight Financing Rate ("SOFR") is the rate that represents best practice as the alternative to USD-LIBOR for use in derivatives and other financial contracts that are currently indexed to USD-LIBOR. ARRC has proposed a paced market transition plan to SOFR from USD-LIBOR and organizations are currently working on industry wide and company-specific transition plans as it relates to derivatives and cash markets exposed to USD-LIBOR. The Company has material contracts that are indexed to USD-LIBOR and is monitoring this activity and evaluating the related risks. This includes identifying outstanding USD-LIBOR-based loans without ARRC recommended fallback language, internal training and education, and working with our core provider to ensure proper integration once an alternative reference is implemented. Management is also monitoring ARRC publications for best practices.

Risks Relating to Our Corporate Strategy

We may need to raise additional capital in the future to achieve our growth plans, but that capital may not be available when it is needed.

We are required by federal and state regulatory authorities to maintain adequate levels of capital to support our operations. Accordingly, we may need to raise additional capital to support our future growth plans. Our ability to raise additional capital depends on conditions in the capital markets, economic conditions and a number of other factors, including investor perceptions regarding the banking industry, market conditions and governmental activities, and on our financial condition and performance. Accordingly, we cannot make assurances of our ability to raise additional capital, if needed, on terms acceptable to us. If we cannot raise additional capital when needed, our financial condition and our ability to further expand our operations through internal growth or acquisitions could be materially impaired.

We may experience difficulties in managing our growth, and our growth strategy involves risks that may negatively impact our net income.

In addition to our continuing expansion in Indianapolis and larger cities in Northern Indiana, we may expand into additional communities or attempt to strengthen our position in our current markets through opportunistic acquisitions of all or part of other financial institutions, or by opening new branches in or within two hours of our contiguous geographic footprint. To the extent that we undertake acquisitions or new branch openings, we are likely to experience the effects of higher operating expenses relative to operating income from the new operations, which may have an adverse effect on our levels of reported net income, return on average equity and return on average assets. Other effects of engaging in such growth strategies may include potential diversion of our management’s time and attention and general disruption to our business.

To the extent that we grow through acquisitions and branch openings, we cannot assure you that we will be able to adequately and profitably manage this growth. Acquiring other banks and businesses will involve similar risks to those commonly associated with branching but may also involve additional risks, including:

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We face intense competition in all phases of our business from other banks and financial institutions.

The banking and financial services business in our market is highly competitive. Our competitors include large national, regional and local community banks, credit unions, Fintech and nonbank financial service providers, securities and brokerage companies, mortgage companies, insurance companies, finance companies, money market mutual funds and farm credit services. Many of these competitors are not subject to the same operating costs or regulatory restrictions as we are and are able to provide customers with a feasible alternative to traditional banking services.

Increased competition in our market may also result in a decrease in the amounts of our loans and deposits, reduced spreads between loan rates and deposit rates or loan terms that are more favorable to the borrower. Any of these results could have a material adverse effect on our ability to grow and remain profitable. If increased competition causes us to significantly discount the interest rates we offer on loans or increase the amount we pay on deposits, our net interest income could be adversely impacted. If increased competition causes us to relax our underwriting standards, we could be exposed to higher losses from lending activities. Moreover, we rely on deposits to be a low-cost source of funding, and a loss in our deposit base could cause us to incur higher funding costs.

Additionally, many of our competitors are much larger in total assets and capitalization, have greater access to capital markets, possess larger lending limits and offer a broader range of financial services than we can offer.

Attractive acquisition opportunities may not be available to us in the future.

We expect that other banking and financial service companies, many of which have significantly greater resources than us, will compete with us in acquiring other financial institutions if we pursue such acquisitions. This competition could increase prices for potential acquisitions that we believe are attractive. Also, acquisitions are subject to various regulatory approvals. If we fail to receive the appropriate regulatory approvals, we will not be able to consummate an acquisition that we believe is in our best interests. Among other things, our regulators consider our capital, liquidity, profitability, regulatory compliance and levels of goodwill and intangibles when considering acquisition and expansion proposals. Any acquisition could be dilutive to our earnings and stockholders’ equity per share of our common stock.

Risks Relating to Regulation, Tax and Accounting

We may be materially and adversely affected by the highly regulated environment in which we operate.

We are subject to extensive federal and state regulation, supervision and examination. A more detailed description of the primary federal and state banking laws and regulations that affect us is contained in the section of this Annual Report on Form 10-K captioned “Supervision and Regulation.” Banking regulations are primarily intended to protect depositors’ funds, FDIC funds, customers and the banking system as a whole, rather than our shareholders. These regulations affect our lending practices, capital structure, investment practices, dividend policy and growth, among other things.

As a bank holding company, we are subject to extensive regulation and supervision and undergo periodic examinations by our regulators, who have extensive discretion and authority to prevent or remedy unsafe or unsound practices or violations of law by banks and bank holding companies. Failure to comply with applicable laws, regulations or policies could result in sanctions by regulatory agencies, civil monetary penalties and/or damage to our reputation, which could have a material adverse effect on us. Although we have policies and procedures designed to mitigate the risk of any such violations, there can be no assurance that such violations will not occur.

The laws, regulations, rules, standards, policies and interpretations governing us are constantly evolving and may change significantly over time. For example, on July 21, 2010, the Dodd-Frank Act was signed into law, which significantly changed the regulation of financial institutions and the financial services industry. The Dodd-Frank Act, together with the regulations to be developed thereunder, includes provisions affecting large and small financial institutions alike, including several provisions that affect how community banks, thrifts and small bank and thrift holding companies will be regulated. In addition, the Federal Reserve, in recent years, has adopted numerous new regulations addressing banks’ overdraft and mortgage lending practices. Further, the CFPB was recently established, with broad powers to supervise and enforce consumer protection laws, and additional consumer protection legislation and regulatory activity is anticipated in the near future.

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In addition, in July 2013, the U.S. federal banking authorities approved the implementation of the Basel III Rule, defined previously. The Basel III Rule is applicable to all U.S. banks that are subject to minimum capital requirements as well as to bank and saving and loan holding companies, other than “small bank holding companies” (generally bank holding companies with consolidated assets of less than $3 billion).

These provisions, as well as any other aspects of current or proposed regulatory or legislative changes to laws applicable to the financial industry, may impact the profitability of our business activities and may change certain of our business practices, including our ability to offer new products, obtain financing, attract deposits, make loans and achieve satisfactory interest spreads and could expose us to additional costs, including increased compliance costs. Although we are currently compliant with the Basel III Rule, these changes also may require us to invest significant management attention and resources to make any necessary changes to operations in order to comply and could therefore also materially and adversely affect our business, financial condition and results of operations.

Monetary policies and regulations of the Federal Reserve could adversely affect our business, financial condition and results of operations.

In addition to being affected by general economic conditions, our earnings and growth are affected by the policies of the Federal Reserve. An important function of the Federal Reserve is to regulate the money supply and credit conditions. Among the instruments used by the Federal Reserve to implement these objectives are open market operations in U.S. government securities, adjustments of the discount rate and changes in reserve requirements against bank deposits. These instruments are used in varying combinations to influence overall economic growth and the distribution of credit, bank loans, investments and deposits. Their use also affects interest rates charged on loans or paid on deposits. Declining federal funds rate lowers short-term rates and the interest earned from floating rate loans. The bank may not be able to lower deposit rates fast enough to offset the effect of declining short-term rates on loan interest income.

The monetary policies and regulations of the Federal Reserve have had a significant effect on the operating results of commercial banks in the past and are expected to continue to do so in the future. The effects of such policies upon our business, financial condition and results of operations cannot be predicted.

We may be adversely affected by changes in U.S. tax laws and regulations.

Any change in federal or state tax laws or regulations, including any increase in the federal corporate income tax rate from the current level of 21%, could negatively affect our business and results of operations, including as a result of our income tax expense and any impact to the profitability of our loan customers.

We are required to maintain capital to meet regulatory requirements, and, if we fail to maintain sufficient capital, whether due to losses, an inability to raise additional capital or otherwise, our financial condition, liquidity and results of operations, as well as our ability to maintain regulatory compliance, would be adversely affected.

The Company, on a consolidated basis, and the Bank, on a stand-alone basis, must meet certain regulatory capital requirements and maintain sufficient liquidity. We face significant capital and other regulatory requirements as a financial institution, which were heightened with the implementation of the Basel III Rule and the phase-in of capital conservation buffer requirement. Our ability to raise additional capital depends on conditions in the capital markets, economic conditions and a number of other factors, including investor perceptions regarding the banking industry, market conditions and governmental activities and on our financial condition and performance. Accordingly, we cannot assure you that we will be able to raise additional capital if needed or on terms acceptable to us. If we fail to maintain capital to meet regulatory requirements, our financial condition, liquidity and results of operations would be materially and adversely affected.

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We may be subject to a higher consolidated effective tax rate if there is a change in tax laws relating to LCB Investments II, Inc. or if LCB Funding, Inc. fails to qualify as a real estate investment trust.

The Bank holds certain investment securities in its wholly owned subsidiary LCB Investments II, Inc., which is incorporated in Nevada. Pursuant to the State of Indiana’s current tax laws and regulations, we are not subject to Indiana income tax for income earned through that subsidiary. If there are changes in Indiana’s tax laws or interpretations thereof requiring us to pay state taxes for income generated by LCB Investments II, Inc., the resulting tax consequences could increase our effective tax rate or cause us to have a tax liability for prior years.

The Bank also holds certain commercial real estate loans, residential real estate loans and other loans in a real estate investment trust through LCB Investments II, Inc., which is incorporated in Maryland. Qualification as a real estate investment trust involves application of specific provisions of the Internal Revenue Code relating to various asset tests. If LCB Funding, Inc. fails to meet any of the required provisions for real estate investment trusts, it could no longer qualify as a real estate investment trust and the resulting tax consequences would increase our effective tax rate or cause us to have a tax liability for prior years.

Our accounting policies and methods are the basis for how we prepare our consolidated financial statements and how we report our financial condition and results of operations, and they require management to make estimates about matters that are inherently uncertain.

Our accounting policies and methods are fundamental to how we record and report our financial condition and results of operations. Our management must exercise judgment in selecting and applying many of these accounting policies and methods in order to ensure they comply with GAAP and reflect management’s judgment as to the most appropriate manner in which to record and report our financial condition and results of operations. In some cases, management must select the accounting policy or method to apply from two or more alternatives, any of which might be reasonable under the circumstances. The application of that chosen accounting policy or method might result in the Company reporting different amounts than would have been reported under a different alternative. If management’s estimates or assumptions are incorrect, the Company may experience material losses.

Management has identified two accounting policies as being “critical” to the presentation of the Company’s financial condition and results of operations because they require management to make particularly subjective and complex judgments about matters that are inherently uncertain and because of the likelihood that materially different amounts would be reported under different conditions or using different assumptions. These critical accounting policies relate to: (1) the allowance for loan losses and (2) determining the fair value and possible other-than-temporary impairment of investment securities available-for-sale. Because of the inherent uncertainty of these estimates, no assurance can be given that the application of alternative policies or methods might not result in the reporting of different amounts of the fair value of securities available-for-sale, or the allowance for loan losses and, accordingly, net income.

From time to time, the FASB and the SEC change the financial accounting and reporting standards or the interpretation of those standards that govern the preparation of our external financial statements. These changes are beyond our control, can be difficult to predict and could materially impact how we report our financial condition and results of operations. Changes in these standards are continuously occurring, and given the current economic environment, more drastic changes may occur. The implementation of such changes could have a material adverse effect on our financial condition and results of operations.

We may experience increases to, and volatility in, the balance of the allowance for credit losses and related provision expense due to the adoption of the CECL methodology.

We will adopt CECL, effective as of January 1, 2021, following the delayed adoption period permitted by the CARES Act and extended by the Consolidated Appropriations Act, 2021. The CECL methodology differs substantially from the incurred loss methodology previously used in that it is forward looking, requiring measurement to occur when a financial asset is first added to the balance sheet and periodically thereafter. These measurements require significant use of management judgments as well as forward- looking information and forecasts. Any failure of these judgments or forecasts to be correct could negatively affect our results of operations and financial condition.

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Risks Relating to our Operations

Our ability to attract and retain management and key personnel and any damage to our reputation may affect future growth and earnings.

Much of our success and growth has been influenced strongly by our ability to attract and retain management experienced in banking and financial services and familiar with the communities in our market areas. Our ability to retain the executive officers, management teams, branch managers and loan officers at the Bank will continue to be important to the successful implementation of our strategy. It is also critical, as we grow, to be able to attract and retain qualified additional management and loan officers with the appropriate level of experience and knowledge about our market areas to implement our community-based operating strategy. The unexpected loss of services of any key management personnel, or the inability to recruit and retain qualified personnel in the future, could have an adverse effect on our business, results of operations and financial condition.

In addition, our business depends on earning and maintaining the trust of our customers and communities. Harm to our reputation could arise from numerous sources, including employee misconduct, compliance failures, litigation or our failure to deliver appropriate levels of service. If any events or circumstances occur which could undermine our reputation, there can be no assurance that the additional costs and expenses we may incur as a result would not have an adverse impact on our business.

We have a continuing need to adapt to technological change and we may not have the resources to effectively implement new technology.

The financial services industry is constantly undergoing rapid technological changes with frequent introductions of new technology-driven products and services. In addition to better serving customers, the effective use of technology increases efficiency and enables financial institutions to reduce costs. Our future success will depend in part upon our ability to address the needs of our customers by using technology to provide products and services that will satisfy customer demands for convenience as well as to create additional efficiencies in our operations as we continue to grow and expand our market areas. Many of our larger competitors have substantially greater resources to invest in technological improvements. As a result, they may be able to offer additional or superior products to those that we will be able to offer, which would put us at a competitive disadvantage. Accordingly, we cannot provide assurances that we will be able to effectively implement new technology-driven products and services or be successful in marketing such products and services to our customers.

The Company’s information systems may experience an interruption or breach in security and cyber-attacks, all of which could have a material adverse effect on the Company’s business.

The Company relies heavily on internal and outsourced technologies, communications, and information systems to conduct its business. Additionally, in the normal course of business, the Company collects, processes and retains sensitive and confidential information regarding our customers. As the Company’s reliance on technology has increased, so have the potential risks of a technology-related operation interruption (such as disruptions in the Company’s core provider, general ledger, deposit, loan, digital banking or other systems) or the occurrence of a cyber-attack (such as unauthorized access to the Company’s systems). These risks have increased for all financial institutions as new technologies, the use of the Internet and telecommunications technologies (including mobile devices) to conduct financial and other business transactions and the increased sophistication and activities of organized crime, perpetrators of fraud, hackers, terrorists and others have increased. In addition to cyber-attacks or other security breaches involving the theft of sensitive and confidential information, hackers recently have engaged in attacks against financial institutions, particularly denial of service attacks, which are designed to disrupt key business services, such as customer-facing web sites and social engineering attacks that could influence an employee of the Company to click on a link that downloads malware or ransomware to the Company’s system. The Company is not able to anticipate or implement effective preventive measures against all security breaches of these types, especially because the techniques used change frequently and because attacks can originate from a wide variety of sources. In addition, it is possible that we may not be able to detect security breaches on a timely basis, or at all, which could increase the costs and risks associated with any such breach.

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The Company also faces risks related to cyber-attacks and other security breaches in connection with credit card and debit card transactions that typically involve the transmission of sensitive information regarding the Company’s customers through various third parties, including merchant acquiring banks, payment processors, payment card networks and its processors. Some of these parties have in the past been the target of security breaches and cyber-attacks, and because the transactions involve third parties and environments such as the point of sale that the Company does not control or secure, future security breaches or cyber-attacks affecting any of these third parties could impact the Company through no fault of its own, and in some cases it may have exposure and suffer losses for breaches or attacks relating to them. In addition, the Company offers its customers protection against fraud and certain losses for unauthorized use of debit cards in order to stay competitive with other financial institutions. Offering such protection exposes the Company to losses that could adversely affect its business, financial condition and results of operations. Further cyber-attacks or other breaches in the future, whether affecting the Company or others, could intensify consumer concern and regulatory focus and result in reduced use of payment cards and increased costs, all of which could have a material adverse effect on the Company’s business. To the extent we are involved in any future cyber-attacks or other breaches, the Company’s reputation could be affected, which could also have a material adverse effect on the Company’s business, financial condition or results of operations.

We are subject to certain operational risks, including, but not limited to, customer or employee fraud and data processing system failures and errors.

Employee errors and misconduct could subject us to financial losses or regulatory sanctions and seriously harm our reputation. Misconduct by our employees could include hiding their own unauthorized activities from us, improper or unauthorized activities on behalf of our customers or improper use of confidential information. It is not always possible to prevent employee errors and misconduct, and the precautions we take to prevent and detect this activity may not be effective in all cases. Employee errors could also subject us to financial claims for negligence, among others.

In addition, as a bank, we are susceptible to fraudulent activity that may be committed against us, third parties or our clients, which may result in financial losses or increased costs to us or our clients, disclosure or misuse of our information or our client information, misappropriation of assets, privacy breaches against our clients, litigation or damage to our reputation. Such fraudulent activity may take many forms, including check fraud, electronic fraud, wire fraud, phishing, social engineering and other dishonest acts. For example, as previously disclosed, in the third quarter of 2019, the Bank discovered potentially fraudulent activity by a former treasury management client involving multiple banks. In the context of resulting bankruptcy proceedings involving the former client, the debtors have stated that, based on their investigation, which is ongoing, they believe that they hold claims and causes of action against the Bank. We cannot predict what legal claims, if any, will be made against the Bank. See "Management's Discussion and Analysis of Financial Condition and Results of Operations-Results of Operations-Noninterest Expense" for additional information.

We maintain a system of internal controls and insurance coverage to mitigate operational risks, including data processing system failures and errors, cyber-attacks, and customer or employee fraud. Should our internal controls fail to prevent or detect an occurrence, or if any resulting loss is not insured or exceeds applicable insurance limits, it could have a material adverse effect on our business, results of operations and financial condition.

ITEM 1B. UNRESOLVED STAFF COMMENTS

We have no unresolved SEC staff comments.

ITEM 2. PROPERTIES

The Company is headquartered in the main office building of the Bank at 202 E. Center Street, Warsaw, Indiana 46580. The Company operates in 57 locations, 51 of which are owned by the Bank and six of which are leased from third parties.

None of the Company’s real property assets are the subject of any material encumbrances.

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ITEM 3. LEGAL PROCEEDINGS

There are no material pending legal proceedings, other than ordinary routine litigation incidental to the business of the Company, to which Lakeland Financial or the Bank is a party or to which any of their property is subject.

ITEM 4. MINE SAFETY DISCLOSURES

Not applicable.

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PART II

ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES

The quarterly high and low closing prices for the Company’s common stock and the cash dividends declared and paid on that common stock are set forth in the table below.

Cash Cash

High* Low* Dividend High* Low* Dividend

The common stock of the Company was first quoted on The Nasdaq Stock Market under the symbol “LKFN” on August 14, 1997. Currently, the Company’s common stock is listed for trading on the Nasdaq Global Select Market under the symbol “LKFN.” On February 17, 2021, the Company had approximately 327 stockholders of record.

The Company paid dividends on its common stock as set forth in the table above. The Company’s ability to pay dividends to stockholders is largely dependent upon the dividends it receives from the Bank, and the Bank is subject to regulatory limitations on the amount of cash dividends it may pay. See “Supervision and Regulation – Dividend Payments” for additional information.

Equity Compensation Plan Information

The table below sets forth the following information as of December 31, 2020 for (i) all compensation plans previously approved by the Company’s stockholders and (ii) all compensation plans not previously approved by the Company’s stockholders:

(a) the number of securities to be issued upon the exercise of outstanding options, warrants and rights;

(b) the weighted-average exercise price of such outstanding options, warrants and rights; and

(c) other than securities to be issued upon the exercise of such outstanding options, warrants and rights, the number of securities remaining available for future issuance under the plans.

EQUITY COMPENSATION PLAN INFORMATION

Number of securities

remaining available

Number of securities to be Weighted-average for future issuance

issued upon exercise of exercise price of under equity

Plan category outstanding options outstanding options compensation plans

Equity compensation plans approved by security holders(1) — $ — 590,460

Equity compensation plans not approved by security holders — — —

(1) Lakeland Financial Corporation 2017 Equity Incentive Plan was adopted on April 12, 2017 by the board of directors.

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STOCK PRICE PERFORMANCE GRAPH

The graph below compares the cumulative total return of the Company, the Nasdaq Market Index, and the SNL U.S. Bank Nasdaq Index.

Period Ending

The above returns assume that $100 invested on December 31, 2015 and that all dividends were reinvested.

ISSUER PURCHASES OF EQUITY SECURITIES

On January 8, 2019, the Company's board of directors approved a share repurchase program, under which the Company is authorized to repurchase, from time to time as the Company deems appropriate, shares of the Company's common stock with an aggregate purchase price of up to $30 million. Repurchases may be made in the open market, through block trades or otherwise, and in privately negotiated transactions. The repurchase program expired on December 31, 2019, and it was reauthorized and extended through January 21, 2021 by the Company’s board of directors on January 14, 2020. As extended, the repurchase program has an aggregate purchase price cap of $30 million. The repurchase program does not obligate the Company to repurchase any dollar amount or number of shares, and the program may be extended, modified, suspended or discontinued at any time.

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Share repurchases under the repurchase plan were suspended in March of 2020 with $20 million of authorization remaining available under the plan. No shares were repurchased under the plan during the fourth quarter of 2020. The Company continues to evaluate the share repurchase program pursuant to its previously established criteria for execution.

The following table provides information about purchases by the Company and its affiliates during the quarter ended December 31, 2020 of equity securities that are registered by the Company pursuant to Section 12 of the Exchange Act:

Maximum Number (or

Total Number of Appropriate Dollar

Shares Purchased as Value) of Shares that

Part of Publicly May Yet Be Purchased

Total Number of Average Price Announced Plans or Under the Plans or

Period Shares Purchased Paid per Share Programs Programs (1)

The shares purchased during the quarter were held as treasury stock and credited to the deferred share accounts of ten non-employee directors under the Company’s directors’ deferred compensation plan.

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ITEM 6. SELECTED FINANCIAL DATA

The following selected financial data as of the year-end for each of the five years in the five-year period ended December 31, 2020 has been derived from the Company’s Consolidated Financial Statements and the results of operations for each such period. This financial data should be read in conjunction with the Consolidated Financial Statements included in this Annual Report on Form 10-K.

Ending period balances

Average balances

Income statement data

Per share data *

Basic net income per common share $ 3.31 $ 3.40 $ 3.18 $ 2.28 $ 2.08

Cash dividends declared per common share 1.20 1.16 1.00 0.85 0.73

Key ratios

Asset Quality

Other Data

* Share and per share data has been adjusted for a 3-for-2 stock split on July 25, 2016 in the form of a stock dividend on August 5, 2016.

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ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

OVERVIEW

Net income in 2020 was $84.3 million, down 3.1% from $87.0 million in 2019 and up 4.9% from $80.4 million in 2018.

Diluted net income per common share was $3.30 in 2020, $3.38 in 2019 and $3.13 in 2018. Return on average total assets was 1.55% in 2020 versus 1.76% in 2019 and 1.69% in 2018. Return on average total equity was 13.51% in 2020 versus 15.47% in 2019 and 16.51% in 2018. The dividend payout ratio, with respect to diluted earnings per share, was 36.36% in 2020, 34.32% in 2019 and 31.95% in 2018. The average equity to average assets ratio was 11.51% in 2020 compared to 11.38% in 2019 and 10.24% in 2018.

Net income in 2020 was positively impacted by an $8.0 million increase in net interest income and a $1.8 million increase in noninterest income. Offsetting these positive impacts were an $11.5 million increase in the provision for loan losses and a $1.8 million increase in noninterest expense.

Net income in 2019 was $87.0 million, up 8.3% from $80.4 million in 2018 and up 51.8% from $57.3 million in 2017. Diluted net income per common share was $3.38 in 2019, $3.13 in 2018 and $2.23 in 2017. Return on average total assets was 1.76% in 2019 versus 1.69% in 2018 and 1.29% in 2017. Return on average total equity was 15.47% in 2019 versus 16.51% in 2018 and 12.72% in 2017. The dividend payout ratio, with respect to diluted earnings per share, was 34.32% in 2019, 31.95% in 2018 and 38.12% in 2017. The average equity to average assets ratio was 11.38% in 2019 compared to 10.24% in 2018 and 10.15% in 2017.

Net income in 2019 was positively impacted by a $4.7 million increase in noninterest income, a $3.8 million increase in net interest income and a $3.2 million decrease in the provision for loan losses. Offsetting these positive impacts was a $3.2 million increase in noninterest expense.

Total assets were $5.830 billion as of December 31, 2020 versus $4.947 billion as of December 31, 2019, an increase of $883.7 million or 17.9%. This increase was primarily due to a $572.6 million increase in net loans, an increase in short-term investments of $144.7 million and a $126.6 million increase in available-for-sale investment securities. Total average assets increased $482.9 million primarily due to average loans increasing $449.9 million in 2020, and a $30.4 million increase in available-for-sale investment securities.

CRITICAL ACCOUNTING POLICIES

Certain of the Company’s accounting policies are important to the portrayal of the Company’s financial condition, since they require management to make difficult, complex or subjective judgments, some of which may relate to matters that are inherently uncertain. Estimates associated with these policies are susceptible to material changes as a result of changes in facts and circumstances. Some of the facts and circumstances which could affect these judgments include changes in interest rates, in the performance of the economy or in the financial condition of borrowers. Management believes that its critical accounting policies include determining the allowance for loan losses and the valuation and other-than-temporary impairment of investment securities.

Allowance for Loan Losses

The Company maintains an allowance for loan losses to provide for probable incurred credit losses. Loan losses are charged against the allowance when management believes that the principal is uncollectable. Subsequent recoveries, if any, are credited to the allowance. Allocations of the allowance are made for specific loans and for pools of similar types of loans, although the entire allowance is available for any loan that, in management’s judgment, should be charged against the allowance. A provision for loan losses is taken based on management’s ongoing evaluation of the appropriate allowance balance. A formal evaluation of the adequacy of the loan loss allowance is conducted monthly. The ultimate recovery of all loans is susceptible to future market factors beyond the Company’s control.

The level of loan loss provision is influenced by growth in the overall loan portfolio, emerging market risk, emerging concentration risk, commercial loan focus and large credit concentration, new industry lending activity, general economic conditions and historical loss analysis. In addition, management gives consideration to changes in the allocation for specific watch list credits in determining the appropriate level of the loan loss provision. Furthermore, management’s overall view on credit quality is a factor in the determination of the provision.

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The determination of the appropriate allowance is inherently subjective, as it requires significant estimates by management. The Company has an established process to determine the adequacy of the allowance for loan losses that generally includes consideration of the following factors: changes in the nature and volume of the loan portfolio, overall portfolio quality and current economic conditions that may affect the borrowers’ ability to repay. Consideration is not limited to these factors although they represent the most commonly cited factors. With respect to specific allocation levels for individual credits, management considers the current valuation of collateral and the amounts and timing of expected future cash flows as the primary measures. Management also considers trends in adversely classified loans based upon an ongoing review of those credits. With respect to pools of similar loans, allocations are assigned based upon historical experience subject to a floor, unless the rate of loss is expected to be greater than historical losses as noted below. A detailed analysis is performed on loans that are classified but determined not to be impaired which incorporates different scenarios where the risk that the borrower will be unable or unwilling to repay its debt in full or on time is combined with an estimate of loss in the event the borrower cannot pay to develop non-specific allocations for such loan pools. These allocations may be adjusted based on the other factors cited above. An appropriate level of general allowance for pooled loans is determined by portfolio segment using historical loss percentages subject to a floor, supplemented with other environmental factors based on the risks present for each portfolio segment. These factors include consideration of the following: levels of, and trends in, delinquencies and impaired loans; trends in volume and terms of loans; effects of any changes in risk selection and underwriting standards; other changes in lending policies, procedure, and practices; experience, ability, and depth of lending management and other relevant staff; national and local economic trends and conditions; industry conditions; and effects of changes in credit concentrations. It is also possible that the following could affect the overall process: social, political, economic and terrorist events or activities. All of these factors are susceptible to change, which may be significant. As a result of this detailed process, the allowance results in two forms of allocations, specific and general. These two components represent the total allowance for loan losses deemed adequate to cover probable losses inherent in the loan portfolio.

Commercial loans are subject to a dual standardized grading process administered by the credit administration function. These grade assignments are performed independent of each other and a consensus is reached by credit administration and the loan review officer. Specific allowances are established in cases where management has identified significant conditions or circumstances related to an individual credit that indicate the loan is impaired. Considerations with respect to specific allocations for these individual credits include, but are not limited to, the following: (a) does the customer’s cash flow or net worth appear insufficient to repay the loan; (b) is there adequate collateral to repay the loan; (c) has the loan been criticized in a regulatory examination; (d) is the loan impaired; (e) are there other reasons where the ultimate collectability of the loan is in question; or (f) are there unique loan characteristics that require special monitoring.

Allocations are also applied to categories of loans considered not to be individually impaired, but for which the rate of loss is expected to be consistent with or greater than historical averages. Such allocations are based on past loss experience and information about specific borrower situations and estimated collateral values. In addition, general allocations are made for other pools of loans, including non-classified loans. These general pooled loan allocations are performed for portfolio segments of commercial and industrial, commercial real estate and multi-family, agri-business and agricultural, other commercial, consumer 1-4 family mortgage and other consumer loans, and loans within certain industry categories believed to present unique risk of loss. General allocations of the allowance are primarily made based on a three-year historical average for loan losses for these portfolios, subject to a floor, and are adjusted for economic factors and portfolio trends.

Due to the imprecise nature of estimating the allowance for loan losses, the Company’s allowance for loan losses includes an unallocated component. The unallocated component of the allowance for loan losses incorporates the Company’s judgmental determination of inherent losses that may not be fully reflected in other allocations, including factors such as the level of classified credits, economic uncertainties, industry trends impacting specific portfolio segments, broad portfolio quality trends and trends in the composition of the Company’s large commercial loan portfolio and related large dollar exposures to individual borrowers.

Valuation and Other-Than-Temporary Impairment of Available-for-Sale 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, which utilize significant observable inputs such as matrix pricing. This 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. The fair value of certain securities is determined using unobservable inputs, primarily observable inputs of similar securities.

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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 current accounting guidance. Impairment is other-than-temporary if the decline in the fair value of the security is below its amortized cost and it is probable that all amounts due according to the contractual terms of a debt security will not be received.

Significant judgments are required in determining impairment, which includes making assumptions regarding the estimated prepayments, loss assumptions and the change in interest rates.

We consider the following factors when determining other-than-temporary impairment for a security or investment:

● the financial condition and near-term prospects of the issuer;

The assessment of whether a decline exists that is other-than-temporary, involves a high degree of subjectivity and judgment and is based on the information available to management at a point in time. If, in management’s judgment, other-than-temporary impairment exists, the cost basis of the security will be written down to the computed net present value, and the unrealized loss will be transferred from accumulated other comprehensive loss as an immediate reduction of current earnings (as if the loss had been realized in the period of other-than-temporary impairment).

RESULTS OF OPERATIONS

Overview

In 2020 and 2019, the Company continued to grow loans and deposits organically, in its geographic footprint of northern Indiana and in central Indiana in the Indianapolis market. In addition, during 2020 the Company was an active participant in the PPP. The Company had 50 branches as of December 31, 2020. The Company’s profitability has been positively impacted by growth in loans and deposits. In addition, asset quality has remained stable. The core banking contributions to noninterest income of interest rate swap, mortgage banking, loan and wealth management fee income increased in 2020. Overall, expense growth has reflected our continued investment in people, technology and our branch infrastructure. The outlook for 2021 includes plans for continued organic loan and deposit growth, a disciplined credit philosophy, continued investment in the Company in the form of staff additions, continued expansion in our geographic footprint, and continued investments in customer- facing technology and cybersecurity risk management tools.

Selected income statement information for the years ended December 31, 2020, 2019 and 2018 is presented in the following table.

Income Statement Summary:

Other Data:

Net charge-offs (recoveries) to average loans 0.09 % 0.03 % 0.13 %

Net interest margin excluding PPP loans (3) 3.19 % 3.38 % 3.43 %

Noninterest income to total revenue 22.32 % 22.49 % 21.04 %

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(1) Noninterest expense/Net interest income plus Noninterest income.

The Company believes that providing non-GAAP financial measures provides investors with information useful to understanding the company's financial performance. A reconciliation of these non-GAAP financial measures is provided below (dollars in thousands, except per share data).

Year Ended

Dec. 31, Dec. 31, Dec. 31,

Plus: Deferred tax assets related to goodwill 1,176 1,181 1,191

Tangible Book Value Per Common Share $ 25.70 $ 23.19 $ 20.47

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The impact of the Paycheck Protection Program on Net Interest Margin FTE is provided below (dollars in thousands)

Year Ended

Dec. 31, Dec. 31, Dec. 31,

Less: Average Balance of PPP Loans 376,785 — —

Less: PPP Loan Income (12,832) — —

Adjusted Earning Asset Yield, net of PPP Impact 3.80 % 4.67 % 4.50 %

Less: Average Balance of PPP Loans 376,785 — —

Less: PPP Cost of Funds (956) — —

Adjusted Cost of Funds, net of PPP Impact 0.61 % 1.29 % 1.07 %

Net Interest Margin FTE, net of PPP Impact 3.19 % 3.38 % 3.43 %

Net Income

Net income was $84.3 million in 2020, a decrease of $2.7 million, or 3.1%, versus net income of $87.0 million in 2019. The decrease in net income from 2019 to 2020 was primarily due to an increase in the provision for loan losses of $11.5 million, or 356.6%, as well as an increase of $1.8 million, or 2.0%, in noninterest expense. Net interest income increased $8.0 million, or 5.1%, and noninterest income increased $1.8 million, or 4.1%. Net interest income for 2020 included $12.8 million in PPP interest and fee income. And unamortized PPP fee income was $6.3 million at December 31, 2020. The increase in provision for loan losses was driven by the potential negative impact to the Company’s borrowers due to the economic impact of the COVID-19 pandemic.

Net income was $87.0 million in 2019, an increase of $6.6 million, or 8.3%, versus net income of $80.4 million in 2018. The increase in net income from 2018 to 2019 was primarily due to the increase in noninterest income of $4.7 million, or 11.6%. In addition, net interest income increased $3.8 million, or 2.5%, to $155.0 million versus $151.3 million in 2018 and the provision for loan losses decreased $3.2 million, or 49.5%. Noninterest expense increased by $3.2 million, or 3.7% and income tax expense increased $1.8 million, or 9.7%.

Net Interest Income

The following table presents a three-year average balance sheet and, for each major asset and liability category, its related interest income and yield or its expense and rate for the years ended December 31, 2020, 2019 and 2018.

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THREE YEAR AVERAGE BALANCE SHEET AND NET INTEREST ANALYSIS

Earning Assets

Loans:

Investments: (1)

Nonearning Assets

Premises and equipment 60,492 59,147 56,842

Interest Bearing Liabilities

Time deposits:

Noninterest Bearing Liabilities

Interest Margin Recap

(3) Nonaccrual loans are included in the average balance of taxable loans.

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The following table shows fluctuations in net interest income attributable to changes in the average balances of assets and liabilities and the yields earned or rates paid for the years ended December 31.

NET INTEREST INCOME – RATE/VOLUME ANALYSIS (fully tax equivalent basis, dollars in thousands)

Attributable to Total Attributable to Total

Volume Rate Change Volume Rate Change

Interest Income (2)

Loans:

Investments:

Interest Expense

Time deposits:

Long-term borrowings and

Net interest income increased by $8.0 million to $163.0 million in 2020 compared to 2019, primarily due to a $528.1 million, or 11.3%, increase in average earning assets, driven by a $469.0 million increase in average commercial loans. The yield on average earning assets decreased 90 basis points to 3.77% in 2020 from 4.67% in 2019. The growth in average commercial loans was driven by $376.8 million in average PPP loans. Average core loan growth, with excludes PPP loans, was $73.2 million, or 1.8%. The net interest margin decreased to 3.19% in 2020 versus 3.38% in 2019, driven by the Federal Reserve Bank decreasing the target Federal Funds Rate by 225 basis points since the second half of 2019, inclusive of two emergency cuts during March 2020, in response to the COVID-19 pandemic. The net interest margin decreased to 3.38% in 2019 versus 3.43% in 2018, due to higher costs on average interest bearing liabilities, which offset an increase in the yield of earning assets during 2019.

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Growth in the commercial loan portfolio accounted for most of the growth in loans, as well as total earning assets, during both 2020 and 2019 and positively impacted total interest income. Management believes that the growth in the loan portfolio unrelated to the PPP loan program will likely continue in a measured and prudent fashion as a result of our continued strategic focus on commercial and industrial lending, as well as commercial real estate lending. Loan growth, excluding PPP loans, was slower in 2020 and 2019 as compared to prior years due to a slowdown in demand for manufacturing and industrial loans. The utilization of commercial lines of credit has dropped in 2020 and 2019 due to softened loan demand to 43% at December 31, 2020 from 46% at December 31, 2019 and 49% at December 31, 2018. Management believes its organic growth strategy of continued expansion in its current geographic footprint and in Indianapolis will provide continued loan growth opportunities. During 2020 growth in average loans of $449.9 million, growth in available-for-sale investment securities of $30.4 million and growth in short-term investments and interest bearing deposits of $47.8 was funded through an increase in deposits. Average demand deposits increased $365.8 million in 2020 and average interest bearing deposit accounts increased $42.3 million. The increase in deposits for 2020 resulted from excess liquidity on our customers’ balance sheets resulting from a combination of PPP loans, stimulus payments and an increase in the savings rate as a result from the health crisis and economic downturn.

The Company’s net interest margin decreased 19 basis points to 3.19% for 2020 compared to 3.38% for 2019. The lower margin in 2020 was impacted by lower yields on loans and securities, partially offset by a lower cost of funds. The Federal Reserve Bank decreased the target Federal Funds Rate by 225 basis points since the second half of 2019, including two Federal Reserve Bank emergency cuts to the Federal Funds Rate during March 2020. The two emergency cuts in March reduced the Federal Funds Rate by 150 basis points and brought the Federal Funds Rate back to the zero-bound range of 0.00% to 0.25%.

Provision for Loan Losses

On December 27, 2020, President Trump signed into law the Consolidated Appropriations Act, 2021. This law extended relief for troubled debt restructurings and provided the opportunity to further delay CECL adoption originally provided under the CARES Act. The Company elected to defer adoption of CECL until January 1, 2021. The Company recorded a provision for loan losses of $14.8 million in 2020 compared to $3.2 million in 2019 and $6.4 million in 2018. The higher provision in 2020 was driven by the potential negative impact to the company’s borrowers as a result of the economic conditions resulting from the COVID-19 pandemic. The Company’s allowance for loan losses as of December 31, 2020 was $61.4 million compared to $50.7 million as of December 31, 2019 and $48.5 million as of December 31, 2018. The allowance for loan losses represented 1.32% of total loans as of December 31, 2020 versus 1.25% at December 31, 2019 and 1.24% at December 31, 2018. The company’s loan loss reserve to total loans excluding PPP loans was 1.45% at December 31, 2020. PPP loans are guaranteed by the United States SBA and have not been allocated for within the allowance for loan losses. Net charge-offs of $4.0 million, or 0.09% of average loans, and net charge-offs of $1.0 million, or 0.03% of average loans, were recorded in 2020 and 2019, respectively. The Company’s management continues to monitor the adequacy of the provision based on loan levels, asset quality, economic conditions including the impact of the COVID-19 pandemic and other factors that may influence the assessment of the collectability of loans.

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Noninterest Income

The following table presents changes in the components of noninterest income for the years ended December 31.

% Change From

Prior Year

Noninterest income to total revenue 22.3 % 22.5 % 21.0 %

Noninterest income was $46.8 million in 2020 versus $45.0 million in 2019, an increase of $1.8 million, or 4.1%. The increase was primarily driven by a $3.4 million increase in interest rate swap fees generated from commercial lending transactions, as well as a $2.3 million increase in mortgage banking income. Noninterest income was also positively impacted by increases in wealth advisory fees due to continued growth of client relationships. Offsetting these increases was a decrease in service charges on deposit accounts driven primarily by lower treasury management fees as well as reduced levels of overdraft fee income.

Noninterest income was $45.0 million in 2019 versus $40.3 million in 2018, an increase of $4.7 million, or 11.6%. The increase was primarily driven by a $2.0 million increase in other income related to $1.2 million of swap fees generated from commercial lending transactions, as well as $846,000 in life insurance proceeds on bank owned life insurance policies. Noninterest income was also positively impacted by increases in bank owned life insurance income, loan and service fees, mortgage banking income, and wealth advisory and brokerage fees due to continued growth of client relationships. Offsetting the increases was a decrease in service charges on deposit accounts driven by lower treasury management fees from a single commercial treasury management relationship. This relationship contributed $4.5 million to services charges on deposit accounts during 2019. The related treasury management activity was terminated and the revenue will not recur in future periods.

Noninterest Expense

The following table presents changes in the components of noninterest expense for the years ended December 31.

% Change From

Prior Year

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Noninterest expense was $91.2 million in 2020 versus $89.4 million in 2019, an increase of $1.8 million, or 2.0%. Data processing fees increased $1.5 million in 2020 primarily due to the Company’s continued investment in customer focused, technology-based solutions and ongoing cybersecurity and data management enhancements. FDIC insurance and other regulatory fees increased $1.1 million due to the expiration of insurance assessment credits. Professional fees increased by $670,000 primarily due to higher legal expenses, increased fees to accounting firms and professional fees for innovative project implementations. Salaries and employee benefits increased primarily due to an increase in staffing in revenue producing and risk management areas as well as higher health insurance expenses. Offsetting these increases were decreases in corporate and business development as the COVID-19 pandemic forced the cancellation and postponement of events, in-person trainings and face-to-face customer and prospect meetings due to COVID-19 safety protocols. The Company spent approximately $640,000 since the pandemic began on personal protective equipment, protective barriers and enhanced social distancing measures for the safety of bank customers and employees.

Noninterest expense was $89.4 million in 2019 versus $86.2 million in 2018, an increase of $3.2 million, or 3.7%. Salaries and employee benefits increased by $1.1 million primarily due to an increase in staffing in revenue producing and risk management areas as well as normal merit increases. Professional fees increased due to higher legal expenses and increased utilization of accounting firms for outsourced services. Data processing fees also increased during 2019 primarily due to the Company’s continued investment in customer focused, technology-based solutions and ongoing cybersecurity and data management enhancements. Offsetting these increases were decreases in FDIC insurance and other regulatory fees as well as decreases in corporate and business development. In the third quarter of 2019, the FDIC announced that due to the Deposit Insurance Fund reserve ratio exceeding 1.38%, banks with consolidated assets of less than $10 billion would be receiving credits against their deposit insurance assessments. The bank’s $1.1 million credit was applied as a reduction of FDIC assessments commencing with the payment of the second quarter assessment paid in September 2019 and were fully utilized by the end of the first quarter of 2020.

As previously disclosed, in the third quarter of 2019, the Bank discovered potentially fraudulent activity by a former treasury management client involving multiple banks. The former client subsequently filed several related bankruptcy cases, captioned In re Interlogic Outsourcing, Inc. et al., which are pending in the United States Bankruptcy Court for the Western District of Michigan. The Bank and the other banks are currently subject to document and information requests in these bankruptcy cases and other related bankruptcy cases. The debtors have also requested the examinations of various current and former bank employees as part of the debtors’ investigation. On February 5, 2021, the former client and the other debtors in related bankruptcy cases filed a joint disclosure statement and a joint plan for liquidation with the bankruptcy court. In those documents, the debtors state that they have been investigating causes of action against various banks and other parties involved with the former customer, including the Bank. The debtors stated that, based on their investigation, which is ongoing, they believe that they hold claims and causes of action against the Bank. We cannot predict what legal claims, if any, will be made against the Bank. Based on current information, we have determined that a loss is neither probable nor estimable at this time, and the Bank intends to vigorously defend itself if any claim is filed.

Income Taxes

The Company recognized income tax expense in 2020 of $19.5 million, compared to $20.3 million in 2019 and $18.5 million in 2018. The effective tax rate in 2020 was 18.8% compared to 18.9% in 2019, and 18.7% in 2018. For a detailed analysis of the Company’s income taxes see Note 13 – Income Taxes.

FINANCIAL CONDITION

Overview

Total assets of the Company were $5.830 billion as of December 31, 2020, an increase of $883.7 million, or 17.9%, when compared to $4.947 billion as of December 31, 2019. Total loans increased by $583.3 million, or 14.3%, to $4.649 billion at December 31, 2020 from $4.066 billion at December 31, 2019. PPP loans originated during 2020 were $570.5 million and $412.0 remained outstanding at December 31, 2020. Cash and cash equivalents increased by $150.5 million and available-for-sale securities increased by $126.6 million. Funding for the loan and investment growth came from a $903.0 million increase in total deposits as well as a $53.8 million increase in retained earnings, offset by an $84.5 million decrease in total borrowings. The Company used wholesale funding, including brokered deposits and FHLB advances, to provide liquidity for loan growth and to help maintain its desired interest rate risk position. During 2020, reliance on wholesale funding decreased as a result of strong core deposit growth.

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Uses of Funds

Investment Portfolio

The amortized cost and the fair value of securities as of December 31, 2020, 2019 and 2018 were as follows:

Amortized Fair Amortized Fair Amortized Fair

Securities available for sale:

U.S. Treasury securities $ — $ — $ — $ — $ 994 $ 987

At year-end 2020, 2019 and 2018, there were no holdings of securities of any one issuer, other than the U.S. government, government agencies and government sponsored agencies, in an amount greater than 10% of stockholders’ equity. See Note 2 – Securities for more information on these investments.

Purchases of securities available-for-sale totaled $216.5 million in 2020, $129.5 million in 2019 and $126.6 million in 2018. Growth of the investment portfolio during the past three years serves to provide liquidity for the Company and provide longer duration as an offset to the short duration of the loan portfolio. The Company targets investment securities as a percentage of total assets in a range from 11% - 14%. During the fourth quarter of 2020, the Company deployed excess liquidity to the investment portfolio in the amount of $100.0 million. Securities sales totaled $8.0 million in 2020, $57.1 million in 2019 and $15.3 million in 2018. Paydowns from prepayments and scheduled payments of $90.4 million, $53.0 million and $42.8 million were received in 2020, 2019 and 2018, and the amortization of premiums, net of the accretion of discounts, was $4.0 million, $3.9 million and $3.2 million, respectively. Maturities and calls of securities totaled $7.6 million, $14.8 million and $11.0 million in 2020, 2019 and 2018, respectively. No other- than-temporary impairment was recognized in 2020, 2019 or 2018. The investment portfolio is managed to provide for an appropriate balance between liquidity, credit risk and investment return and to limit the Company’s exposure to risk to an acceptable level.

The weighted average yields and maturity distribution for the securities portfolio at December 31, 2020, were as follows:

Within After One After Five Years Over Ten

One Year Within Five Years Within Ten years Years

Fair Fair Fair Fair

The Company does not trade or invest in or sponsor certain unregistered investment companies defined as hedge funds and private equity funds in the Volcker Rule.

Real Estate Mortgage Loans Held For Sale

Real estate mortgages held for sale increased by $6.7 million to $11.2 million at December 31, 2020 from $4.5 million at December 31, 2019 as a result of strong mortgage refinancing demand in response to the low interest rate environment. This asset category is subject to a high degree of variability depending on, among other things, recent mortgage loan rates and the timing of loan sales into the secondary market. The Company generally sells almost all of the mortgage loans it originates on the secondary market. Proceeds from sales totaled $114.2 million in 2020, $64.8 million in 2019 and $51.7 million in 2018.

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Loan Portfolio

The loan portfolio by class as of December 31, 2020, 2019, 2018, 2017 and 2016 was as follows:

Commercial and industrial loans:

Commercial real estate and multi-family residential loans:

Agri-business and agricultural loans:

Consumer 1-4 family mortgage loans:

The ratio of loans to total loans by portfolio segment as of December 31, 2020, 2019, 2018, 2017 and 2016 was as follows:

In 2020, net loan balances increased by $572.6 million to $4.588 billion, which excludes approximately $117.6 million in loans originated for sale. PPP loans of $412.0 million are included in non-working capital loans of commercial and industrial loans. In 2019, net loan balances increased by $148.9 million to $4.015 billion, which excludes approximately $66.0 million in loans originated for sale. In 2018, net loan balances increased by $95.0 million to $3.866 billion, which excludes approximately $49.8 million in loans originated for sale and $316,000 transferred to other real estate in 2018.

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The mix of loan types within the Company’s portfolio continued a trend toward a higher percentage of the total loan portfolio being in commercial loans. This higher percentage of commercial loans to the total portfolio was a result of the Company’s long standing strategic plan that is focused on organic expansion and growth in commercial loans. Commercial and industrial loans together with owner-occupied commercial real estate loans represent 52.4% and 49.2% of total loans as of December 31, 2020 and 2019, respectively. The owner-occupied commercial real estate loans tend to represent the real estate holding of our commercial and industrial loan customers. Another significant loan segment are loans to the agri-business sector, which has resulted in the Company becoming one of the largest agricultural lenders in the State of Indiana.

The residential construction and land development loans class included construction loans totaling $7.2 million, $8.1 million, $12.5 million, $10.0 million and $11.4 million as of December 31, 2020, 2019, 2018, 2017 and 2016. Declines in consumer loans during 2020 resulted from paydowns due to borrower excess liquidity generated from mortgage refinancing activity. The Bank generally sells conforming mortgage loans which it originates on the secondary market. These loans generally represent mortgage loans that are made to clients with long-term or substantial relationships with the Bank on terms consistent with secondary market requirements. The loan classifications are based on the nature of the loans as of the loan origination date. There were no foreign loans included in the loan portfolio for the periods presented.

Repricing opportunities of the loan portfolio occur either according to predetermined float rate indices, adjustable rate schedules included in the related loan agreements or upon maturity of each principal payment. The following table indicates the scheduled maturities of the loan portfolio as of December 31, 2020:

Commercial

Real Estate

and Agri-business Consumer

Commercial and Multi-family and Other 1-4 Family Other

At maturity, credits are reviewed and, if renewed, are renewed at rates and conditions that prevail at the time of maturity.

Based upon the table above, all loans due after one year which have a predetermined interest rate and loans due after one year which have floating or adjustable interest rates as of December 31, 2020 amounted to $1.611 billion and $1.655 billion, respectively.

Paycheck Protection Program

As of December 31, 2020, 900 loans with an aggregate principal amount of $142 million, representing 37% of the 2,409 total PPP loans originated with an aggregate amount of $570.5 million, were forgiven during the fourth quarter. In addition, the Company had submitted an additional 10% of the total PPP loans originated in 2020, totaling $159.3 million, to the Small Business Administration (SBA) for forgiveness as of year-end. As of February 17, 2021, 1,527, or 63%, of the total PPP loans originated in 2020 totaling $232.7 million, were forgiven and $198.1 million, or 35%, had been submitted to the SBA for forgiveness. Additionally, the Company has started accepting, submitting and funding loan applications for the second round of PPP loans. As of February 17, 2021, the Company had received 776 applications for second round PPP loans totaling $133.7 million. Of these applications, 531, or 68%, had been approved by the SBA and 56, or 7%, were submitted and awaiting SBA approval. PPP round two loans totaling $104.0 million have been approved by the SBA and an additional $13.2 million in PPP loans have been submitted to the SBA for approval.

During the third quarter, the Company began to process PPP loan forgiveness applications for its customers and in November 2020, the SBA began to approve forgiveness applications. In addition, the Bank has engaged a third-party Fintech technology partner to assist the bank and its customers to automate the forgiveness application process. This application will also be used for the second round of PPP loan originations and forgiveness. Most of the PPP loans are for existing customers and 51% of the number of PPP loans are for amounts less than $50,000. As of December 31, 2020, the Bank has submitted 1,145 loan forgiveness applications to the SBA in the amount of $300 million, which represented 48% of total PPP loans originated. The SBA has approved forgiveness for 900 loans in the amount of $142 million.

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Bank Owned Life Insurance

Bank owned life insurance increased by $11.4 million to $95.2 million at December 31, 2020 and by $6.7 million to $83.8 million at December 31, 2019 from $77.1 million at December 31, 2018. The increases during 2020 and 2019 were primarily due to the purchase of additional life insurance policies on officers of the Bank. Bank owned life insurance provides investment income from the securities the life insurance is invested in and offsets benefit plan expenses.

Sources of Funds

The average daily deposits and borrowings together with the average rates paid on those deposits and borrowings for the years ended December 31, 2020, 2019 and 2018 are summarized in the following table:

% Balance Change

(dollars in thousands) Balance Rate Balance Rate Balance Rate 2020 2019

Savings and transaction accounts:

Time deposits:

Time deposits as of December 31, 2020 will mature as follows:

(dollars in thousands) or more or less Total Total

Deposits

Total deposits increased by $903.0 million to $5.037 billion, comparing December 31, 2020 to December 31, 2019. The growth in deposits consisted of $1.002 billion in core deposit growth offset by a decrease of $98.5 million in brokered deposits. Total deposit growth was led by an increase of $664.3 million in commercial deposits. In addition, retail deposits increased by $301.9 million while public funds deposits increased by $35.3 million. The growth in deposits in 2020 resulted primarily from increased deposit balances from new and existing customers, as well as a decreased utilization of brokered deposits. Deposit growth was impacted by excess liquidity on customer balance sheets resulting from PPP loans, due to both economic stimulus payments made to retail customers and an increase in savings rates. Core deposit growth enabled the Company to reduce reliance on public funds and wholesale funding during 2020.

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Total deposits increased by $89.8 million to $4.134 billion, comparing December 31, 2019 to December 31, 2018. The growth in deposits consisted of $141.1 million in core deposit growth offset by a decrease of $51.4 million in brokered deposits. Total deposit growth was led by an increase of $200.6 million in commercial deposits. In addition, retail deposits increased by $28.9 million while public funds deposits decreased by $88.4 million. The growth in deposits in 2019 resulted from increased deposit balances from new and existing customers, as well as a decreased utilization of brokered deposits. Core deposit growth enabled the Company to reduce reliance on wholesale funding during 2019.As previously noted, 23% of the Company’s deposit base is attributable to public fund entities which primarily represent customers in the Company’s geographic footprint. A shift in funding away from public fund deposits could require the Company to execute alternative funding plans under the Contingency Funding Plan discussed in further detail under “Liquidity Risk” below. The following table presents total deposits by portfolio segment as of December 31, 2020, 2019 and 2018:

FHLB Advances and Other Borrowings

During 2020, average total short-term borrowings decreased by $27.0 million to $34.3 million, primarily due to lower short-term FHLB borrowings. Ending balances of short-term and miscellaneous borrowings decreased $159.5 million during 2020 to $10.5 million. The decrease was due to the payoff of outstanding short-term FHLB borrowings. During 2020, the Company utilized $10.5 million of its holding company $30.0 million revolving line of credit in connect with its share repurchase activity. Short-term FHLB borrowings are used to fund short-term balance sheet growth due to the flexible nature of the financial instrument and allows the Company to prudently lend to commercial or retail borrowers when opportunities are presented. Average total long-term borrowings increased by $31.5 million to $62.3 million, primarily due to a $75.0 million long-term FHLB borrowing and the repayment of the Company’s subordinated debentures in December 2019.

During 2019, average total short-term borrowings decreased by $54.5 million to $61.3 million, primarily due to the discontinuance of securities sold under agreements to repurchase products in 2019. In addition, on December 30, 2019, the Company redeemed $30.0 million of subordinated debentures priced at three-month LIBOR plus 305 basis points. Ending balances of total short- term borrowings decreased $75.6 million during 2019 to $170.0 million, due to decreases in securities sold under agreements to repurchase.

Capital

The Company believes that a strong, appropriately managed capital position is critical to long-term earnings and continuing growth in loans. Capital is used primarily to fund continued organic loan growth and to support dividends per share to shareholders. The Company had a total risk-based capital ratio of 14.7%, a Tier I risk-based capital ratio of 13.4% and a common Tier 1 risk-based capital ratio of 13.4% as of December 31, 2020. These ratios met or exceeded the Federal Reserve Bank’s “well-capitalized” minimums of 10.0%, 8.0% and 6.5%, respectively. The Company also had a Tier 1 leverage ratio of 10.9% and a tangible equity ratio of 11.2%. See Note 16 – Capital Requirements for more information.

The ability to maintain these ratios is a function of the balance between net income and a prudent dividend policy. Total stockholders’ equity increased by 9.9% to $657.2 million as of December 31, 2020 from $598.1 million as of December 31, 2019. The Company earned $84.3 million in 2020 and $87.0 million in 2019. The Company declared cash dividends of $1.20 per share in 2020, which decreased equity by $30.6 million. The Company declared cash dividends of $1.16 per share in 2019, which decreased equity by $29.7 million. The change in accumulated other comprehensive income was due to changes in the fair values of available-for-sale securities and the defined benefit pension which increased equity by $15.7 million in 2020 compared to an increase of $18.3 million in 2019. The impact to equity due to other comprehensive income is not included in regulatory capital. In addition, during 2020 the

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Company repurchased 289,101 shares of its common stock for $10.0 million. Share repurchases under the repurchase plan were suspended in March of 2020 with $20.0 million of authorization remaining under the plan.

RISK MANAGEMENT

Overview

The Company, with the oversight of the Corporate Risk Committee of the Board, has developed a company-wide risk management program intended to help identify, manage and mitigate the various business risks the Company is exposed to. Following is a discussion addressing the risks identified as most significant to the Company – Credit, Liquidity, Interest Rate and Market Risk. Item 7A. includes additional discussion about market risk.

Credit Risk

Credit risk represents the risk of loss arising from an obligor’s inability or failure to meet contractual payment or performance terms. Our primary credit risks result from lending and to a lesser extent, investment activities.

Investment Portfolio

The Company’s investment portfolio consists of government agencies and municipal bonds subject to an investment security policy that is approved annually by the Board. During 2020, purchases in the securities portfolio consisted of primarily municipal bonds, agency securities and mortgage-backed securities. As of December 31, 2020, the Company’s investment in U.S government sponsored mortgage-backed securities represented approximately 43% of total securities consisting of Collateralized Mortgage Obligations, Commercial Mortgage-Backed Securities and mortgage pools issued by Ginnie Mae, Fannie Mae and Freddie Mac. Ginnie Mae, Fannie Mae and Freddie Mac securities are each guaranteed by their respective agencies as to principal and interest. All mortgage securities purchased by the Company in 2020 were within risk tolerances for price, prepayment, extension and original life risk characteristics contained in the Company’s investment policy. Municipal securities represent 52% of total securities as of December 31, 2020 and were rated investment grade at the time of purchase and continue to be rated investment grade. The Company uses analytics provided by its third party portfolio advisor to evaluate and monitor credit risk for all investments on a quarterly basis. Based upon these analytics as of December 31, 2020, the securities in the available-for-sale portfolio had approximately a 3.1 year effective duration. The analysis indicated a negative 11.87% change in market value in the event of a 300 basis point upward, instantaneous rate shock and an approximate positive 2.85% change in market value in the event of a 100 basis point downward, instantaneous rate shock. As of December 31, 2020, all mortgage-backed securities were performing in a manner consistent with management’s ALCO modeled expectations at time of purchase.

Loan Portfolio

The Company has a relatively high percentage of commercial and commercial real estate loans extended to businesses with a broad range of revenue and within a wide variety of industries. Traditionally, this type of lending may have more credit risk than other types of lending because of the size and diversity of the credits. The Company manages this risk by utilizing conservative credit structures, by adjusting its pricing to the perceived risk of each individual credit and by diversifying the portfolio by customer, product, industry and market area and by obtaining loan guarantees.

There were no loan concentrations within industries, which exceeded ten percent of total loans, except commercial real estate and manufacturing. Commercial real estate was $1.895 billion, or 40.7%, of total loans and manufacturing was $510.8 million, or 11.0%, of total loans at December 31, 2020. The Company’s in-house lending limit was raised from $30.0 million to $40.0 million during 2020. Manufacturing loans are included in the commercial and industrial loans total and are well diversified by industry. Agri- business and agricultural loans represent 9.2% of total loans as of December 31, 2020 and are not concentrated to any agricultural sector. Nearly all of the Bank’s commercial, industrial, agricultural real estate mortgage, real estate construction mortgage and consumer loans are made within its geographic market areas and to diverse industries.

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The following is a summary of nonperforming loans as of December 31, 2020, 2019, 2018, 2017 and 2016.

Commercial and industrial loans

Past due accruing loans (90 days or more) $ — $ — $ — $ — $ —

Commercial real estate and multi-family residential loans

Past due accruing loans (90 days or more) — — — — —

Agri-business and agricultural loans

Past due accruing loans (90 days or more) — — — — —

Other commercial loans

Past due accruing loans (90 days or more) — — — — —

Nonaccrual loans(1) — — — — —

Subtotal nonperforming loans — — — — —

Consumer 1-4 family mortgage loans

Past due accruing loans (90 days or more) 116 45 — 6 53

Other consumer loans

Past due accruing loans (90 days or more) — — — — —

Nonaccrual loans(1) — 17 — 235 —

Subtotal nonperforming loans — 17 — 235 —

(1) Includes nonaccrual troubled debt restructured loans.

Nonperforming assets of the Company include nonperforming loans (as indicated above), nonaccrual investments and other real estate owned and repossessions, the total of which amounted to $12.4 million and $19.0 million at December 31, 2020 and 2019, respectively. Nonperforming loans decreased by $6.6 million during 2020, due primarily to a $3.7 million charge-off resulting from a single commercial manufacturing borrower and due to paydowns of existing nonaccrual loans. As of December 31, 2020, management believed that there were no significant foreseeable losses relating to nonperforming assets, except as discussed below.

Loans for which the borrower appears to be unable or unwilling to repay its debt in full or on time and the collateral is insufficient to cover all principal and accrued interest, will be reclassified as nonperforming loans to the extent they are unsecured, on or before the date when the loan becomes 90 days delinquent, with the exception of small dollar other consumer loans which are not placed on nonaccrual status since these loans are charged-off when they have been delinquent from 90 to 180 days, and when the related collateral, if any, is not sufficient to offset the indebtedness. When a loan is classified as a nonaccrual loan, interest on the loan is no longer accrued, all unpaid accrued interest is reversed and interest income is subsequently recorded only to the extent cash payments are received. Accrual status is resumed when all contractually due payments are brought current and future payments are reasonably assured.

A loan is impaired when full payment under the original loan terms is not expected. Impairment is evaluated in total for smaller-balance loans of similar nature not in nonaccrual or troubled debt restructured status such as residential mortgage, consumer, and credit card loans, and on an individual loan basis for other loans. If a loan is impaired, a portion of the allowance may be allocated so that the loan is reported, net, at the present value of estimated future cash flow or at the fair value of collateral if repayment is expected solely from the collateral.

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Total nonperforming loans were $12.1 million, or 0.26% of total loans, at year end 2020 versus $18.7 million, or 0.46% of total loans, at year end 2019. There were 39 loans totaling $20.2 million classified as impaired as of December 31, 2020 versus 54 loans totaling $27.8 million at the end of 2019. The decrease in impaired loans during 2020 resulted primarily from a $3.7 million charge-off resulting from a single commercial manufacturing borrower as well as payments received on impaired credits.

Loans renegotiated as troubled debt restructurings are those loans for which either the contractual interest rate has been reduced below market rates and/or other concessions to market terms are granted to the borrower because of a deterioration in the financial condition of the borrower which results in the inability of the borrower to meet the terms of the loan.

As of December 31, 2020, there were 31 loans totaling $11.7 million renegotiated as troubled debt restructurings of which $5.5 million were modified in 2020. Of these loans, $6.5 million were included in nonaccrual loans in the previous table and the remaining $5.2 million were performing under their modified terms. The increase in troubled debt restructurings during 2020 resulted primarily from the addition of a single commercial relationship. As of December 31, 2019, there were 35 loans totaling $9.1 million renegotiated as troubled debt restructurings of which $35,000 were modified in 2019. Of these loans, $3.2 million were included in nonaccrual loans in the previous table and the remaining $5.9 million were performing under their modified terms. The Company has no commitments to lend additional funds to any of the borrowers.

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The following is a summary of the loan loss experience for the years ended December 31, 2020, 2019, 2018, 2017 and 2016.

Loans charged-off:

Agri-business and agricultural loans — — — — —

Other commercial loans — — — — —

Recoveries of loans previously charged-off:

Agri-business and agricultural loans — 8 42 23 19

Other commercial loans — — — — —

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The following is a summary of the allocation for loan losses as of December 31, 2020, 2019, 2018, 2017 and 2016.

Allocated allowance for loan losses:

At December 31, 2020, the allowance for loan losses was 1.32% of total loans outstanding, versus 1.25% of total loans outstanding at December 31, 2019. The allowance for loan losses was 1.45% of total loans outstanding, excluding PPP loans of $412.0 million, as of December 31, 2020. This reflects a more comparable ratio to prior periods, as PPP loans are fully guaranteed by the SBA and have not been allocated for within the allowance for loan losses calculation. Management believes the allowance for loan losses is at a level commensurate with the overall risk exposure of the loan portfolio. However, if economic conditions fail to recover or continue to deteriorate due to the COVID-19 pandemic, certain borrowers may experience difficulty and the level of nonperforming loans, charge-offs and delinquencies could rise and require increases in the allowance for loan losses. The process of identifying probable incurred credit losses is a subjective process. Therefore, the Company maintains a general allowance to cover probable incurred credit losses within the entire portfolio. The methodology management uses to determine the adequacy of the loan loss reserve includes the considerations below.

Loans are charged against the allowance for loan losses when management believes that the principal is uncollectible. Subsequent recoveries, if any, are credited to the allowance. The allowance is an amount that management believes will be adequate to absorb probable incurred credit losses relating to specifically identified loans based on an evaluation of the loans by management, as well as other probable incurred losses inherent in the loan portfolio. The evaluations take into consideration such factors as changes in the nature and volume of the loan portfolio, overall portfolio quality, review of specific problem loans and current economic conditions that may affect the borrower’s ability to repay. Management also considers trends in adversely classified loans based upon a monthly review of those credits. An appropriate level of general allowance is determined after considering the following factors: changes in the nature and volume of the loan portfolio, overall portfolio quality and current economic conditions that may affect the borrowers’ ability to repay. Consideration is not limited to these factors although they represent the most commonly cited factors. Federal regulations require insured institutions to classify their own assets on a regular basis. The regulations provide for three categories of classified loans: Substandard, Doubtful and Loss. The regulations also contain a Special Mention category. Special Mention is defined as loans that do not currently expose an insured institution to a sufficient degree of risk to warrant classification as Substandard, Doubtful or Loss but do possess credit deficiencies or potential weaknesses deserving management’s close attention. The Company’s policy is to establish a specific allowance for loan losses for any assets where management has identified conditions or circumstances that indicate an asset is impaired. If an asset or portion thereof is classified as loss, the Company’s policy is to either establish specific allowances for loan losses in the amount of 100% of the portion of the asset classified loss or charge-off such amount.

At December 31, 2020, on the basis of management’s review of the loan portfolio, the Company had 96 credits totaling $286.1 million on the classified loan list versus 103 credits totaling $180.2 million on December 31, 2019. The increase in classified loans during 2020 reflects the challenges some of the Company’s borrowers are experiencing, particularly in the hotel and entertainment industries. As of December 31, 2020, the Company had $251.9 million of assets classified as Special Mention, $34.3 million classified as Substandard, $0 classified as Doubtful and $0 classified as Loss as compared to $96.6 million, $84.6 million, $0 and $0, respectively, at December 31, 2019. The balances reported in Note 4 – Allowance for Loan Losses and Credit Quality include deferred fees and costs.

Included in the classified loan amounts for December 31, 2020 above were the following troubled debt restructured loans: 12 mortgage loans totaling $1.1 million with total allocations of $220,000 and 12 commercial loans totaling $8.9 million with total allocations of $4.1 million. Included in the classified loan amounts for December 31, 2019 above were the following troubled debt

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restructured loans: 17 mortgage loans totaling $1.1 million with total allocations of $247,000, and 18 commercial loans totaling $8.0 million with total allocations of $2.3 million.

In accordance with Section 4013 of the CARES Act, loan deferrals granted to customers that resulted from the impact of COVID-19 and who were not past due at the time of deferral were not considered trouble debt restructurings as of December 31, 2020. This provision was extended to January 1, 2022 under the Consolidated Appropriations Act, 2021. Management continues to monitor these deferrals and has adequately considered these credits in the December 31, 2020 allowance for loan losses balance.

As of February 17, 2021, nine borrowers with loans outstanding of $20.8 million were in their second deferral period and 11 borrowers with loans outstanding of $40.2 million were in their third deferral period, most of which were additional 90-day deferrals. Additionally, 14 borrowers with loans outstanding of $26.6 million were in their fourth-deferral period. Of the fourth deferral borrowers, two represented 89% of the fourth deferral population and were commercial real estate nonowner occupied loans supported by adequate collateral and personal guarantors and consist of loans to the hotel and accommodation industry.

The company’s retail loan portfolio is comprised of 1-4 family mortgage loans, home equity lines of credit and other direct and indirect installment loans. A third-party vendor manages the company’s retail and commercial credit card program and the company does not have any balance sheet exposure with respect to this program except for nominal recourse on limited commercial card accounts.

Total Loan Deferrals

Peak % change from

(in millions)

% of Total Loan Portfolio 16 % 15 % 2 % 2 % NA

Total Commercial Loan Deferrals

Peak % change from

(in millions)

% of Commercial Loan Portfolio 18 % 16 % 2 % 2 % NA

Total Retail Loan Deferrals

Peak % change from

Amount $ 7 $ 6 $ 3 $ 2 (71) %

(in millions)

% of Retail Loan Portfolio 2 % 1 % 1 % 1 % NA

Allowance estimates are developed by management taking into account actual loss experience, subject to a floor, adjusted for current economic conditions. Allowance estimates are considered a prudent measurement of the risk in the Company’s loan portfolio and are applied to individual loans based on loan type. In accordance with the incurred loan loss reserve accounting guidance, the allowance is provided for losses that have been incurred as of the balance sheet date and is based on past events and current economic conditions and does not include the effects of expected losses on specific loans or groups of loans that are related to future events or

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expected changes in economic conditions. For a more thorough discussion of the allowance for loan losses methodology see the Critical Accounting Policies section of this Item 7.

The allowance for loan losses increased 21.2%, or $10.7 million, from $50.7 million at December 31, 2019 to $61.4 million at December 31, 2020 due to the increased risk in the loan portfolio resulting from the impact of COVID-19 on the economy. Pooled loan allocations increased $12.3 million from $37.9 million at December 31, 2019 to $50.2 million at December 31, 2020, which was primarily due to management’s view of current credit quality, the current economic environment, the impacts of COVID-19 and loan growth. The unallocated component of the allowance for loan losses was $3.1 million at December 31, 2020, which increased from $2.3 million reported at December 31, 2019, and increased primarily due to the high level of uncertainty that exists regarding near term economic conditions. The unallocated component of the allowance for loan losses incorporates the Company’s judgmental determination of inherent losses that may not be fully reflected in other allocations, including factors such as the level of classified credits, economic uncertainties, industry trends impacting specific portfolio segments, broad portfolio quality trends and trends in the composition of the Company’s large commercial loan portfolio and related large dollar exposures to individual borrowers.

The Company has experienced growth in total loans over the last several years with growth of $583.3 million, or 14.3%, from December 31, 2019 to December 31, 2020 including $412.0 million in PPP loans, and $151.1 million, or 3.9%, from December 31, 2018 to December 31, 2019. The concentration of this loan growth was in the commercial loan portfolio, which can result in overall asset quality being influenced by a small number of credits. Management has historically considered growth and portfolio composition when determining loan loss allocations. Management believes that it is prudent to continue to provide for loan losses in a manner consistent with its historical approach due to the loan growth described above and current economic conditions.

Prior to the pandemic, economic conditions in the Company’s markets were stable. During the last nine months some industries have performed well during the pandemic, while others have not. The Company is actively monitoring industries and borrowers impacted by the pandemic. As of March 31, 2020 the initial review identified approximately 19% of the total loan portfolio and included the following industries with their respective percentage of the loan portfolio: recreational vehicle - 4%, nursing home and assisted living - 4%, hotel and accommodations - 2%, self-storage units - 2%, automotive, boating, trailer and truck - 2%, transportation and trucking contractors - 1%, C&I building construction - 1%, restaurants - 2% and entertainment and recreation - 1%. The Company expanded the universe of industries and clients under review to significantly broaden the scope of the semi-annual Loan Portfolio Meetings, in addition to actively working with borrowers on COVID-19 related loan deferral requests. The Company’s December 31, 2020 list of industries under review represents approximately 3.3%, or $141 million, of the total loan portfolio, excluding PPP loans. The current list of industries under review, along with their respective percentage of the loan portfolio, is hotel and accommodations – 2.3%, entertainment and recreation – 0.6% and full-service restaurants – 0.4%, for a total of 3.3% of the total loan portfolio. The Company has no direct exposure to oil and gas and limited exposure to retail shopping centers. The Company’s continued growth strategy promotes diversification among industries, as well as continued focus on enforcement of a strong credit environment and a disciplined approach in loan work-out situations.

Liquidity Risk

Liquidity risk arises from the possibility that the Company may not be able to satisfy current or future financial commitments or may become unduly reliant on alternative funding sources. Liquidity is monitored and closely managed by the ALCO Committee.

Management maintains a liquidity position that it believes will adequately provide funding for loan demand and deposit run- off that may occur in the normal course of business. The liquidity structure is expressly detailed in the Company’s Contingency Funding Plan, which is discussed below. The Company relies on a number of different sources in order to meet these potential liquidity demands. The primary sources are increases in deposit accounts and cash flows from loan payments and the securities portfolio. The cash flow from the securities portfolio is expected to provide approximately $126.4 million of potential contingent funding in 2021.

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The Company has approval of $2.774 billion in secondary funding sources available as of December 31, 2020, of which $90.0 million was utilized. The Company had $350.0 million of availability in federal funds lines with eleven correspondent banks, none of which was drawn on as of December 31, 2020. The Company has Board approval to borrow up to $800.0 million at the FHLB, but, given the Company’s current collateral structure and outstanding borrowings as of December 31, 2020, the Company could have only borrowed up to $317.3 million under this authority based on utilization of $75.0 million of advances at December 31, 2020. The Company also has additional collateral that could be pledged to the FHLB of $191.8 million as of December 31, 2020 to generate additional liquidity. Further, the Company had available capacity at the Federal Reserve Bank of Chicago of up to $490.4 million given its current collateral structure at the Federal Reserve Bank discount window program and the terms of these facilities at December 31, 2020, with no balances outstanding at December 31, 2020. During 2020 the Company also completed the actions required to activate participation in the Federal Reserve Bank’s Paycheck Protection Program Liquidity Facility (PPPLF); however, of the $412.0 million in eligible PPP loans there were no PPP loans pledged to the PPPLF as of December 31, 2020. The Company also has established relationships in the brokered time deposit and brokered money market sectors, as well as the IntraFi Network CD Option One-Way Buy program, to access these funds when desired with settlement of funds in one to two weeks’ time. Additionally, during 2020 the Bank entered into agreements with IntraFi Network relative to their Insured Cash Sweep One-Way Buy program. As of December 31, 2020, the total amount available to the Bank via this program was $100.0 million, of which $10.0 million was drawn on. The Bank is also a member of the American Financial Exchange (AFX) where overnight fed funds purchased can be obtained from other banks on the Exchange that have approved the Bank for an unsecured, overnight line. These funds are only available if the approving banks have an ‘offer’ out to sell that day. As of December 31, 2020, the total amount approved for Lake City Bank via AFX banks was $394.0 million and none was outstanding at year end.

The Company had all of its securities in the available-for-sale portfolio at December 31, 2020, allowing the Company maximum flexibility to sell securities to meet funding demands. Management believes the majority of the securities in the available- for-sale portfolio are of high quality and marketable. Approximately 48% of this portfolio is comprised of U.S. government agency securities or mortgage-backed securities directly or indirectly backed by the U.S. government. In addition, the Company has historically sold the majority of its originated mortgage loans on the secondary market to reduce interest rate risk and to create an additional source of funding.

The Company has a formalized Contingency Funding Plan (“CFP”). The Board and management recognize the importance of liquidity during times of normal operations and in times of stress. The CFP was developed to ensure that the multiple liquidity sources available to the Company are readily available. The CFP specifically considers liquidity at the Bank and the Company level. The CFP identifies the potential funding sources at the Bank level, which includes the FHLB, the Federal Reserve Bank, brokered deposits, one-way buy products via the IntraFi Network (CD Option and ICS) and Fed Funds. The CFP also addresses the Bank’s ability to liquidate its securities portfolio. The CFP funding sources at the Holding Company level include a holding company committed line of credit, as well as the ability to transfer securities from the investment subsidiary of the Bank to the Company. The Company’s committed line of credit has availability up to $30.0 million, of which $10.5 million was drawn up as of December 31, 2020. The line of credit was subsequently repaid in January of 2021.

Further, the CFP identifies CFP team members and expressly details their respective roles. Potential risk scenarios are identified and the plan includes multiple scenarios, including short-term and long-term funding crisis situations. Under the long-term funding crisis, two additional scenarios are identified: a moderate risk scenario and a highly stressed scenario. The CFP details the responsibilities and the actions to be taken by the CFP team under each scenario. Quarterly reports to management and the Board under the CFP include an early warning indicator matrix and pro forma cash flows for the various scenarios.

The following table discloses information on the maturity of the Company’s contractual long-term obligations as of December 31, 2020.

Payments Due by Period

One year After 5

(dollars in thousands) Total or less 1-3 years 3-5 years years

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During the normal course of business, the Company becomes a party to financial instruments with off-balance sheet risk in order to meet the financing needs of its customers. These financial instruments include commitments to make loans and open-ended revolving lines of credit. The Company follows the same credit policy (including requiring collateral, if deemed appropriate) to make such commitments as it follows for those loans that are recorded in its financial statements.

The Company’s exposure to credit losses in the event of nonperformance is represented by the contractual amount of the commitments. Management does not expect any significant losses as a result of these commitments. Off-balance sheet transactions are more fully discussed in Note 18 – Commitments, Off-Balance Sheet Risks and Contingencies.

The following table discloses information on the maturity of the Company’s commitments.

Amount of Commitment Expiration Per Period

Total

Amount One year Over one

(dollars in thousands) Committed or less year

Interest Rate Risk

Interest rate risk is the risk that the estimated fair value of the Company’s assets, liabilities and derivative financial instruments will decline as a result of changes in interest rates or financial market volatility, or that net income will be significantly reduced by interest rate changes.

Interest rate risk represents the Company’s primary market risk exposure. The Company does not have material exposure to foreign currency exchange risk and does not maintain a trading portfolio. The Corporate Risk Committee of the Board annually reviews and approves the ALCO policy and the Derivatives and Hedging policy used to manage interest rate risk. These policies set guidelines for balance sheet structure, which are designed to protect the Company from the impact that interest rate changes could have on net income, but it does not necessarily indicate the effect on future net interest income. Given the Company’s mix of interest bearing liabilities and interest bearing assets on December 31, 2020 and using changes in the interest rate environment over a one-year period, the net interest margin could be expected to decline in a falling interest rate environment and increase in a rising interest rate environment. Earnings can also be affected by the monetary and fiscal policies of the U.S. Government and its agencies, particularly the Federal Reserve Board.

During 2020 the Federal Reserve Board’s Federal Open Market Committee (“FOMC”) reduced interest rates by a combined 150 basis points on two different occasions in March. The effect of these combined decreases lowered the target federal funds rate back to the zero-bound range of 0% - .25%. At the FOMC meeting in December 2020 rates were left unchanged. At that time the Committee was more optimistic in regards to the economy than reported with their previously issued economic projections, but did continue to clearly state that the path of the economy will depend significantly on the course of the COVID-19 virus and pandemic. The updated economic projections released at the December meeting project no rate changes in 2021, 2022 and 2023; conversely, the longer run Fed median forecast for the federal funds rate was left unchanged at 2.50%. The combined result of the decrease in the yield on earning assets offset by a decrease in the cost of funding earning assets led to decrease in the net interest margin from 3.38% for 2019 to 3.19% for 2020 given the Company’s asset sensitive balance sheet. The Company’s yield on earning assets decreased 90 basis points during 2020. Contributing to this decrease was the full year impact of the combined 75 basis point FOMC rate decrease made during the second half of 2019 and the 150 basis point decrease made in March 2020. The commercial loan portfolio represents 90% of the total loan portfolio. Approximately 62% of the commercial loan portfolio are variable rate loans which are primarily indexed to 30 day LIBOR, prime and FHLB indices. The rate paid on deposit accounts and purchased funds decreased 76 basis points for 2020 mainly due to decreased rates paid on public fund accounts, including transactional accounts and time deposit accounts, as these accounts are typically more sensitive to interest rates. Deposit rates also decreased due to the rates paid on various other transactional and time deposit accounts due to the Company’s proactive reduced pricing structure implemented early in 2020 to offset the FOMC easing. The realized decrease in the rate paid on deposit accounts and purchased funds was benefited by an increase in the average balance of non-interest bearing demand deposit accounts for 2020 verses 2019, which was largely influenced by PPP loan proceeds deposited into borrower checking and savings accounts at the Bank as well as an overall increase in the savings rate.

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Future changes in the net interest margin will be dependent upon multiple factors including further actions by the FOMC during 2021 in response to the COVID-19 pandemic, economic conditions and geopolitical concerns, the results of any of the new administration’s changes to economic policy and laws, competitive pressures in the various markets served, and changes in the structure of the balance sheet as a result of changes in customer demands for products and services. In general, we expect loans to reprice quicker than deposits in a rising and falling rate environment as quantified in the sensitivity to market rates table in Item 7A.

The effects of price changes and inflation can vary substantially for most financial institutions. While management believes that inflation affects the growth of total assets, it believes that it is difficult to assess the overall impact. Management believes this to be the case due to the fact that generally neither the timing nor the magnitude of the inflationary changes in the consumer price index (“CPI”) coincides with changes in interest rates. The price of one or more of the components of the CPI may fluctuate considerably and thereby influence the overall CPI without having a corresponding effect on interest rates or upon the cost of those goods and services normally purchased by the Company. In years of high inflation and high interest rates, intermediate and long-term interest rates tend to increase, thereby adversely impacting the market values of investment securities, mortgage loans and other long-term fixed rate loans. In addition, higher short-term interest rates caused by inflation tend to increase the cost of funds. In other years, the reverse situation may occur.

ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Market Risk

The Company’s primary market risk exposure is interest rate risk. The Company does not have a material exposure to foreign currency exchange rate risk and does not maintain a trading portfolio.

The following table provides information regarding the Company’s financial instruments that are sensitive to changes in interest rates. For loans, securities and liabilities with contractual maturities, the table presents principal cash flows and related weighted-average interest rates by contractual maturities, as well as the Company’s assumptions relative to the impact of interest-rate fluctuations on the prepayment of certain commercial, residential and home equity loans and mortgage-backed securities. Core deposits such as noninterest bearing deposits, interest bearing checking, savings and money market deposits that have no contractual maturity, are shown based on management’s judgment and historical experience that indicates some portion of the balances are retained over time. Weighted-average variable rates are based upon rates existing at the reporting date.

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Principal/Notional Amount Maturing in:

Fair

Value

Rate sensitive assets:

Rate sensitive liabilities:

Cumulative rate sensitivity ratio

The Company utilizes computer modeling software to stress test the balance sheet under a wide variety of interest rate scenarios. The model quantifies the income impact of changes in customer preference for products, basis risk between the assets and the liabilities that support them and the risk inherent in different yield curves as well as other factors. The ALCO committee reviews these possible outcomes and makes loan, investment and deposit decisions that maintain reasonable balance sheet structure in light of potential interest rate movements. It is the objective of the Company to monitor and manage risk exposure to net interest income caused by changes in interest rates. It is the goal of the Company’s asset/liability 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, which are constructed, presented and monitored quarterly. Management believes that the Company’s liquidity and interest sensitivity position at December 31, 2020, remained adequate to meet the Company’s primary goal of achieving optimum interest margins while avoiding undue interest rate risk. The Company places a greater level of credence in net interest income simulation modeling. The GAP/Interest Rate Sensitivity Report is believed by the Company’s management to have two major shortfalls. The GAP/Interest Rate Sensitivity Report fails to precisely gauge how often an interest rate sensitive product reprices, nor is it able to measure the magnitude of potential future rate movements. Although management does not consider GAP ratios in planning, the information can be used in a general fashion to look at asset and liability mismatches. The Company’s cumulative repricing GAP ratio as of December 31, 2020 for the next 12 months using a scenario in which interest rates remained unchanged was a negative 0.99% of earning assets.

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LKFN US Equity

LKFN · 10-K · period ended 2020-12-31

ITEM 1A. RISK FACTORS

ITEM 1B. UNRESOLVED STAFF COMMENTS

ITEM 2. PROPERTIES

ITEM 3. LEGAL PROCEEDINGS

ITEM 4. MINE SAFETY DISCLOSURES

ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES

ITEM 6. SELECTED FINANCIAL DATA

ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

LKFN US Equity☆

LKFN · 10-K · period ended 2020-12-31

ITEM 1A. RISK FACTORS

ITEM 1B. UNRESOLVED STAFF COMMENTS

ITEM 2. PROPERTIES

ITEM 3. LEGAL PROCEEDINGS

ITEM 4. MINE SAFETY DISCLOSURES

ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES

ITEM 6. SELECTED FINANCIAL DATA

ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

LKFN US Equity