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ITEM7 –MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTSOF OPERATIONS

The following discussion and analysis of our financial condition and results of operations should be read in conjunction with Item 6 - “Selected Financial Data,” our consolidated financial statements and related notes thereto, included in Item 8 - "Financial Statements and Supplementary Data", and other financial data appearing elsewhere in this report. This discussion and analysis contains forward-looking statements that involve risks, uncertainties and assumptions. Certain risks, uncertainties and other factors, including but not limited to those set forth under “Safe Harbor Statement Under the Private Securities Litigation Reform Act of 1995,” Item 1A – "Risk Factors” and elsewhere in this report, may cause actual results to differ materially from those projected in the forward-looking statements. We assume no obligation to update any of these forward-looking statements. Readers of our Annual Report on Form 10-K should therefore consider these risks and uncertainties in evaluating forward-looking statements and should not place undue reliance on forward-looking statements.

Overview

Midland States Bancorp, Inc. is a diversified financial holding company headquartered in Effingham, Illinois. Its wholly-owned banking subsidiary, Midland States Bank, has branches across Illinois and in Missouri, and provides a full range of commercial and consumer banking products and services, business equipment financing, merchant credit card services, trust and investment management, and insurance and financial planning services. As of December 31, 2020, we had $6.87 billion in assets, $5.10 billion of deposits and $621.4 million of shareholders’ equity.

Our strategic plan is focused on building a performance-based, customer-centric culture, seeking accretive acquisitions, creating revenue diversification, achieving operational excellence and maintaining a robust enterprise-wide risk management program. Over the past several years, we have grown organically and through a series of acquisitions, with an over-arching focus on enhancing shareholder value and building a platform for scalability. Most recently, in July 2019, the Company completed its acquisition of HomeStar and its wholly-owned banking subsidiary, HomeStar Bank. In February 2018, the Company completed its acquisition of Alpine and its wholly-owned banking subsidiary, Alpine Bank. Additional information on recent acquisitions is presented in Note 2 to the consolidated financial statements in Item 8 of this Form 10-K.

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Our principal lines of business include traditional community banking and wealth management. Our traditional community banking business primarily consists of commercial and retail lending and deposit taking. Our wealth management group provides a comprehensive suite of trust and wealth management products and services, and has grown to $3.48 billion of assets under administration as of December 31, 2020.

Our principal business activity has been lending to and accepting deposits from individuals, businesses, municipalities and other entities. We have derived income principally from interest charged on loans and leases and, to a lesser extent, from interest and dividends earned on investment securities. We have also derived income from noninterest sources, such as: fees received in connection with various lending and deposit services; wealth management services; commercial FHA mortgage loan servicing; residential mortgage loan originations and sales; and, from time to time, gains on sales of assets. Our principal expenses include interest expense on deposits and borrowings, operating expenses, such as salaries and employee benefits, occupancy and equipment expenses, data processing costs, professional fees and other noninterest expenses, provisions for credit losses and income tax expense.

Material Trends and Developments

Community Banking. We believe the most important trends affecting community banks in the United States over the foreseeable future will be related to heightened regulatory capital requirements, increasing regulatory burdens generally, including the implementation of the Dodd-Frank Act and the regulations promulgated and to be promulgated thereunder, and net interest margin compression. We expect that community banks will face increased competition for lower cost capital as a result of regulatory policies that may offer larger financial institutions greater access to government assistance than is available for smaller institutions, including community banks. We expect that troubled community banks will continue to face significant challenges when attempting to raise capital. We also believe that heightened regulatory capital requirements will make it more difficult for even well-capitalized, healthy community banks to grow in their communities. We believe these trends will favor community banks that have sufficient capital, a diversified business model and a strong deposit franchise, and we believe we possess these characteristics.

We also believe that increased regulatory burdens will have a significant adverse effect on smaller community banks, which often lack the personnel, experience and technology to efficiently comply with new regulations in a variety of areas in the banking industry, including in the areas of deposits, lending, compensation, information security and overdraft protection. We believe the increased costs to smaller community banks from a more complex regulatory environment, coupled with challenges in the real estate lending area, present attractive acquisition opportunities for larger community banks that have already made significant investments in regulatory compliance and risk management and can acquire and quickly integrate these smaller institutions into their existing platform. Furthermore, we believe that, as a result of our significant operational investments and our experience acquiring other institutions and quickly integrating them into our organization, we are well positioned to capitalize on the challenges facing smaller community banks.

We continue to believe we have significant opportunities for further growth through additional acquisitions of banks, branches, wealth management firms and trust departments of community banks, selective de novo opportunities, continued expansion of our wealth management operations, the hiring of commercial banking and wealth management professionals from other organizations and organic growth within our existing branch network. We also believe we have the necessary experience, management and infrastructure to take advantage of these growth opportunities.

Credit Reserves. One of our key operating objectives has been, and continues to be, maintenance of an appropriate level of reserve protection against estimated losses in our loan portfolio. In 2020, our provision for credit losses on loans was $43.1 million compared to $17.0 million in 2019 and $9.4 million in 2018.

Effective January 1, 2020, the Company adopted CECL. The CECL model requires a reporting entity to estimate credit losses expected over the “life” of an asset, or pool of assets. The estimate of expected credit losses will consider historical information, current information, and the reasonable and supportable forecasts of future events and circumstances, as well as estimates of prepayments. The allowance for credit losses ("ACL") on loans and related provision for credit losses on loans was modeled under the provisions of CECL for the twelve months ended December 31, 2020, as opposed to the incurred loss model for periods prior to January 1, 2020.

Regulatory Environment. As a result of regulatory changes, including the Dodd-Frank Act and the Basel III Rule, we expect to be subject to more restrictive capital requirements, more stringent asset concentration and growth limitations and new and potentially heightened examination and reporting requirements. We also expect to face a more challenging environment for customer loan demand due to the increased costs that could be ultimately borne by borrowers, and to incur higher costs to comply with these new regulations. This uncertain regulatory environment could have a detrimental impact on our ability to

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manage our business consistent with historical practices and cause difficulty in executing our growth plan. See Item 1A - "Risk Factors—Legal, Accounting and Compliance Risks” and Item 1 - "Business—Supervision and Regulation.”

Impact of COVID-19. The progression of the COVID-19 pandemic in the United States has had an adverse impact on our financial condition and results of operations as of and for the twelve months ended December 31, 2020, and is expected to have a complex and significant adverse impact on the economy, the banking industry and our Company in future fiscal periods, all subject to a high degree of uncertainty.

Effects on Our Market Areas. Our commercial and consumer banking products and services are delivered primarily in Illinois and Missouri, where individual and governmental responses to the COVID-19 pandemic have led to a broad curtailment of economic activity beginning March 2020. Both Illinois and Missouri were subject to stay-at-home orders and limitations on business activity beginning in March 2020, with economic and social activity reopening in a phased-in approach since May 2020. These measures have had, and current measures continue to have, a lasting impact on the economies of and the customers located in these states. Each state's reopening plans remain subject to roll back, depending on public health developments. The Bank and its branches have remained open during these orders because banking is deemed an essential business, although it has suspended lobby access at its branches since March 17, 2020, and the lobbies remain closed.

Each state has experienced a dramatic increase in unemployment levels as a result of the curtailment of business activities. According to the U.S. Bureau of Labor Statistics, the unemployment rate in Illinois (on a seasonally adjusted basis) was 4.2% in March 2020, increased to 17.2% in April 2020 and was 7.6% in December 2020 (based on preliminary estimates). The unemployment rate in Missouri (on a seasonally adjusted basis) was 3.9% in March 2020, increased to 10.2 % in April 2020 and was 5.8% in December 2020 (based on preliminary estimates), according to the U.S. Bureau of Labor Statistics.

Policy and Regulatory Developments. Federal, state and local governments and regulatory authorities have enacted and issued a range of policy responses to the COVID-19 pandemic, including the following:

•The Federal Reserve decreased the range for the federal funds target rate by 0.50% on March 3, 2020, and by another 1.0% on March 16, 2020, reaching its current range of 0.0 – 0.25%.

•On March 27, 2020, President Trump signed the CARES Act, which established a $2.0 trillion economic stimulus package, including cash payments to individuals, supplemental unemployment insurance benefits and a $349.0 billion loan program administered through the SBA, referred to as the PPP. The Bank participates as a lender in the PPP. After the initial $349.0 billion in funds for the PPP was exhausted, an additional $310.0 billion in funding for PPP loans was authorized. In addition, on December 27, 2020, President Trump signed the Consolidated Appropriations Act, 2021, a $900.0 billion COVID-19 relief package that includes an additional $284.5 billion in PPP funding, and Congress is in the process of negotiating additional stimulus bills and other actions in response to COVID-19.

•In addition, the CARES Act, as extended by the Coronovirus Response and Relief Supplemental Appropriations Act (a part of the Consolidated Appropriations Act, 2021), provides financial institutions the option to temporarily suspend certain requirements under GAAP related to TDRs for a limited period of time to account for the effects of COVID-19.

•On April 7, 2020, federal banking regulators issued a revised Interagency Statement on Loan Modifications and Reporting for Financial Institutions, which, among other things, encouraged financial institutions to work prudently with borrowers who are or may be unable to meet their contractual payment obligations because of the effects of COVID-19, and stated that institutions generally do not need to categorize COVID-19-related modifications as TDRs and that the agencies will not direct supervised institutions to automatically categorize all COVID-19 related loan modifications as TDRs.

•On April 9, 2020, the Federal Reserve announced additional measures aimed at supporting small and midsized business, as well as state and local governments impacted by COVID-19. The Federal Reserve announced the Main Street Business Lending Program, which establishes two new loan facilities intended to facilitate lending to small and midsized businesses: (1) the Main Street New Loan Facility ("MSNLF"), and (2) the Main Street Expanded Loan Facility ("MSELF"). MSNLF loans are unsecured term loans originated on or after April 8, 2020, while MSELF loans are provided as upsized tranches of existing loans originated before April 8, 2020. The combined size of the program is authorized up to $600.0 billion. The Main Street Business Lending Program terminated on January 8, 2021.

•In addition to the policy responses described above, the federal bank regulatory agencies, along with their state counterparts, have issued a stream of guidance in response to the COVID-19 pandemic and have taken a number of unprecedented steps to help banks navigate the pandemic and mitigate its impact. These include, without limitation: requiring banks to focus on business continuity and pandemic planning; adding pandemic scenarios to

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stress testing; encouraging bank use of capital buffers and reserves in lending programs; permitting certain regulatory reporting extensions; reducing margin requirements on swaps; permitting certain, otherwise prohibited, investments in investment funds; issuing guidance to encourage banks to work with customers affected by the pandemic and encourage loan workouts; and providing credit under the CRA for certain pandemic-related loans, investments and public service. Moreover, because of the need for social distancing measures, the agencies revamped the manner in which they conducted periodic examinations of their regulated institutions, including making greater use of off-site reviews. The Federal Reserve also issued guidance encouraging banking institutions to utilize its discount window for loans and intraday credit extended by its Reserve Banks to help households and businesses impacted by the pandemic and announced numerous funding facilities. The FDIC has also acted to mitigate the deposit insurance assessment effects of participating in the PPP and the Federal Reserve’s PPP Liquidity Facility and Money Market Mutual Fund Liquidity Facility.

Effects on Our Business. The COVID-19 pandemic and the specific developments referred to above have had and will continue to have a significant impact on our business. In particular, we anticipate that a significant portion of the Bank’s borrowers in the hotel, restaurant, ground transportation, long-term healthcare and retail industries will continue to endure significant economic distress, which has caused, and will continue to cause, them to draw on their existing lines of credit and adversely affect their ability to repay existing indebtedness, and is expected to adversely impact the value of collateral. These developments, together with economic conditions generally, are also expected to impact our commercial real estate portfolio, particularly with respect to real estate with exposure to these industries, our equipment leasing business and loan portfolio, our consumer loan business and loan portfolio, and the value of certain collateral securing our loans. As a result, we anticipate that our financial condition, capital levels and results of operations will be adversely affected, as described in further detail below.

Our Response. We have taken numerous steps in response to the COVID-19 pandemic, including the following:

•To protect the health and safety of our employees and customers, we instituted the following measures:

◦On March 17, 2020, we closed our banking center lobbies but continued to serve clients by appointment or through our drive-up lanes. As of December 31, 2020, our banking center lobbies remained closed.

◦On March 23, 2020, we closed our corporate offices, effectively leveraging our investments in technology to transition to working remotely. As of December 31, 2020, these offices remained closed.

•To meet the financial needs of our customers, we have instituted the following measures:

◦The Company has granted requests for payment deferrals on loans related to the impact of COVID-19 on such borrowers. At December 31, 2020, loans totaling $209.1 million are currently on deferral, the majority of which are for principal and interest for a period of 90 days. Deferrals of $82.6 million related to the hotel and motel industry and $44.1 million related to transit and ground transportation account for 61% of our deferrals at December 31, 2020. Loan deferrals decreased from $898.4 million, or 18.6% of total loans at June 30, 2020 to 4.1% at December 31, 2020. We are continuing to work with our customers to address their specific needs.

◦The Bank participates, as a lender, in the PPP and began taking applications on the first day of the program. At December 31, 2020, we had $184.4 million of PPP loans outstanding to 1,541 customers. Income recognized on PPP loans totaled $7.1 million in 2020, including loan origination fees of $5.2 million. The resulting yield of 3.99% is lower than yields on the remainder of our loan portfolio. As of December 31, 2020, $155.6 million of loans had been submitted to the SBA to process loan forgiveness, of which $93.2 million were forgiven.

Additional Factors Affecting Comparability

Each factor listed below affects the comparability of our results of operations and financial condition in 2020, 2019 and 2018, and may affect the comparability of financial information we report in future fiscal periods.

FHLB Advance Prepayments. In the fourth quarter of 2020, the Company pre-paid $114.2 million of FHLB advances with a weighted average interest rate of 2.10% and maturity dates ranging from 2021 to 2024. As a result, we paid prepayment fees of $4.9 million in that quarter.

Facilities Optimization Plan. On September 3, 2020, the Company announced a series of planned branch and corporate office reductions as part of its ongoing efforts to enhance efficiencies and financial performance. The Company closed 13 branches, or 20% of its branch network, and vacated approximately 23,000 square feet of corporate office space between September 3, 2020 and December 31, 2020. The Company estimates that the branch and corporate office reductions will result in annual cost savings of approximately $5.0 million in future periods. Additionally, the Company plans to renovate and upgrade five other branches to reduce the size of and better utilize those facilities to serve retail and commercial customers.

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These renovations and upgrades are expected to cost approximately $4.0 million. The Company estimates that these renovations and upgrades will result in annual cost savings of approximately $1.0 million beginning in 2022. As a result of this plan, we recorded $12.7 million of asset impairment on existing banking facilities and $0.8 million in other related charges. We had $4.2 million of facility-related assets classified as held for sale in other assets on the consolidated balance sheet at December 31, 2020.

In 2019, the Company closed one facility and consolidated two additional facilities as a result of the acquisition of HomeStar. In addition, the Company planned to consolidate three other existing facilities in other areas of its footprint, one of which closed in 2019 and the remaining two facilities closed in January 2020. Consequently, in 2019, the Company recorded $3.2 million of asset impairment on banking facilities to be closed.

Sale of Commercial FHA Origination Platform. On August 28, 2020, the Company announced that it had completed the sale of its commercial FHA origination platform to Dwight Capital, a nationwide mortgage banking firm headquartered in New York. The Bank continues to service Love Funding’s current servicing portfolio of approximately $3.50 billion.

Capital Raising Transactions. On September 20, 2019, the Company issued, through a private placement, $100.0 million aggregate principal amount of subordinated notes, which were structured into two tranches: $72.75 million aggregate principal amount of 5.00% Fixed-to-Floating Rate Subordinated Notes due 2029, and $27.25 million aggregate principal amount of 5.50% Fixed-to-Floating Rate Subordinated Notes due 2034. On January 13, 2020, the Company completed its offer to exchange all $100.0 million aggregate principal amount of subordinated notes for substantially identical subordinated notes that were registered under the Securities Act of 1933, in satisfaction of the Company’s obligations under a registration rights agreement entered into with the purchasers of the subordinated notes in the private placement transaction. The Company used a portion of the net proceeds from the offering to repay a $30.0 million senior term loan and is using the remaining net proceeds for general corporate purposes.

Preferred Stock Repurchase. On July 29, 2019, the Company redeemed, in whole, the shares of Series H preferred stock. The price paid by the Company for such shares was equal to $1,000 per share plus any unpaid dividends.

Recent Acquisitions. On July 17, 2019, the Company completed its acquisition of HomeStar and its wholly-owned banking subsidiary, HomeStar Bank, which operated five full-service banking centers in northern Illinois. The Company acquired $366.3 million in assets, including $211.1 million in loans, and assumed $321.7 million in deposits.

On February 28, 2018, the Company completed its acquisition of Alpine and its wholly-owned banking subsidiary, Alpine Bank, which operated 19 locations principally in and around the Rockford, Illinois area. The Company acquired $1.24 billion in assets, including $786.2 million in loans, and assumed $1.11 billion in deposits.

Purchased Loans. Our net interest margin benefits from accretion income associated with purchase accounting discounts established on the purchased loans included in our acquisitions. Effective January 1, 2020, PCI loans were reclassified as purchased credit deteriorated ("PCD") loans, and due to this change, accretion income will decrease in future periods. Our reported net interest margins for 2020, 2019 and 2018 were 3.40%, 3.69% and 3.76%, respectively. Accretion income associated with accounting discounts established on loans acquired totaled $7.7 million, $12.6 million and $13.4 million in 2020, 2019 and 2018, respectively, increasing the reported net interest margins by 13, 22,and 24 basis points for each respective period.

Results of Operations

For discussion of the results of operations for the year ended December 31, 2019 compared with the year ended December 31, 2018, refer to Item 7 of the Company’s 2019 Annual Report on Form 10-K, filed with the SEC on February 28, 2020, which is incorporated herein by reference.

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Overview. The COVID-19 pandemic, the adoption of CECL, the FHLB advance prepayments and our facilities optimization plan had a significant impact on our net income for the year ended December 31, 2020. The following table sets forth condensed income statement information of the Company for the years ended December 31, 2020, 2019 and 2018:

For the Years Ended December 31,

Income Statement Data:

Preferred stock dividends and premium amortization — 46 141

Diluted earnings per share $ 0.95 $ 2.26 $ 1.66

In 2020, we generated net income of $22.5 million, or diluted earnings per common share of $0.95, compared to net income of $55.7 million, or diluted earnings per common share of $2.26 in 2019. Earnings in 2020 declined primarily due to a $27.4 million increase in provision for credit losses, a $14.0 million decrease in noninterest income and an $8.4 million increase in noninterest expense. These results were partially offset by a $9.3 million increase in net interest income and a $7.2 million decrease in income tax expense. These are discussed in further detail below.

Net Interest Income and Margin. Our primary source of revenue is net interest income, which is the difference between interest income from interest-earning assets (primarily loans and securities) and interest expense of funding sources (primarily interest-bearing deposits and borrowings). Net interest income is influenced by many factors, primarily the volume and mix of interest-earning assets, funding sources, and interest rate fluctuations. Noninterest-bearing sources of funds, such as demand deposits and shareholders’ equity, also support earning assets. The impact of the noninterest-bearing sources of funds is captured in net interest margin, which is calculated as net interest income divided by average interest-earning assets. Net interest margin is presented on a tax-equivalent basis, which means that tax-free interest income has been adjusted to pretax-equivalent income, assuming a federal income tax rate of 21% for 2020 and 2019.

As described above, one of the factors that impacts net interest income is interest rate fluctuations. The Federal Reserve decreased the target federal funds interest rate by 25 basis points in each of August 2019, September 2019 and October 2019. In addition, in response to the COVID-19 pandemic, the Federal Reserve decreased the target federal funds interest rate by a total of 150 basis points in March 2020. These decreases impact the comparability of net interest income between 2019 and 2020.

In 2020, net interest income, on a tax-equivalent basis, was $200.9 million with a tax-equivalent net interest margin of 3.40% compared to net interest income, on a tax-equivalent basis, of $191.9 million and tax-equivalent net interest margin of 3.69% in 2019.

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Average Balance Sheet, Interest and Yield/Rate Analysis. The following table presents average balance sheet information, interest income, interest expense and the corresponding average yields earned and rates paid for the years ended December 31, 2020, 2019 and 2018. The average balances are principally daily averages and, for loans, include both performing and nonperforming balances. Interest income on loans includes the effects of discount accretion and net deferred loan origination costs accounted for as yield adjustments.

Year Ended December 31,

EARNING ASSETS:

Investment securities:

Loans:

INTEREST-BEARING LIABILITIES

NONINTEREST-BEARING LIABILITIES

(1)Interest income and average rates for tax-exempt loans and securities are presented on a tax-equivalent basis, assuming a statutory federal income tax rate of 21%. Tax-equivalent adjustments totaled $1.8 million, $2.0 million and $2.1 million for the years ended December 31, 2020, 2019 and 2018, respectively.

(2)Average loan balances include nonaccrual loans. Interest income on loans includes amortization of deferred loan fees, net of deferred loan costs.

(3)Net interest margin during the periods presented represents: (i) the difference between interest income on interest-earning assets and the interest expense on interest-bearing liabilities, divided by (ii) average interest-earning assets for the period.

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Interest Rates and Operating Interest Differential. Increases and decreases in interest income and interest expense result from changes in average balances (volume) of interest-earning assets and interest-bearing liabilities, as well as changes in average interest rates. The following table shows the effect that these factors had on the interest earned on our interest-earning assets and the interest incurred on our interest-bearing liabilities. The effect of changes in volume is determined by multiplying the change in volume by the previous period’s average rate. Similarly, the effect of rate changes is calculated by multiplying the change in average rate by the previous period’s volume. Changes which are not due solely to volume or rate have been allocated proportionally to the change due to volume and the change due to rate.

Change due to: InterestVariance Change due to: InterestVariance

(tax-equivalent basis, dollars in thousands) Volume Rate Volume Rate

INTEREST-EARNING ASSETS:

Investment securities:

Loans:

INTEREST-BEARING LIABILITIES:

Interest Income. Interest income, on a tax-equivalent basis, decreased $4.9 million to $246.7 million in 2020 as compared to 2019 primarily due to a decrease in the yields on most earning asset categories. The yield on earning assets decreased 66 basis points to 4.17% from 4.83%. The decrease in yield on earning assets was primarily due to the impact of lower market interest rates due to the Federal Reserve's decreases in the target federal funds interest rate, the impact of PPP loan yields and a reduction in accretion income associated with accounting discounts established on loans acquired, which totaled $7.7 million and $12.6 million in 2020 and 2019, respectively.

Average earning assets increased to $5.91 billion in 2020 from $5.20 billion in 2019. The increases were primarily in loans and cash investments, which increased $489.0 million and $188.2 million, respectively. During the second quarter of 2020, the Company originated and funded $313.1 million of PPP loans. Income recognized on this portfolio totaled $7.1 million in 2020, including loan origination fees of $5.2 million, resulting in a yield on PPP loans of 3.99%, which amount is lower than yields on the remainder of our loan portfolio. The increase in average loan balances was primarily the result of PPP loans and continued growth in our equipment finance loan and lease and consumer loan portfolios.

Interest Expense. Interest expense decreased $14.0 million to $45.8 million in 2020 compared to 2019. The cost of interest-bearing liabilities decreased to 1.00% in 2020 compared to 1.43% for the prior year primarily due to lower rates as a result of the Federal Reserve Bank's reduction in rates.

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Interest expense on deposits decreased to $21.5 million in 2020 from $34.2 million in 2019. The decrease was primarily due to a decrease in rates paid on deposits. Average balances of interest-bearing deposit accounts increased $353.1 million, or 10.8%, to $3.63 billion for the year ended December 31, 2020 compared to 2019. The increase in volume was primarily attributable to an increase of $311.8 million from our Insured Cash Sweep (“ICS”) product offering and from commercial customers due to PPP-related fund inflows. With the increase in these deposits, we were able to replace, in part, wholesale funds through the intentional decrease in brokered time deposits which, in addition to lower market rates, resulted in a lower average rate paid on deposits.

Interest expense on subordinated debt increased $2.3 million to $9.7 million for 2020 due primarily to the issuance of $100.0 million of subordinated debt in September 2019. The increase was partially offset by the redemption of $16.5 million of subordinated debt during the fourth quarter of 2019 and an additional $7.3 million in the first quarter of 2020. In turn, the reported cost of funds for subordinated debt decreased 47 basis points to 5.73% for 2020.

Provision for Credit Losses on Loans. The provision for credit losses on loans totaled $43.1 million in 2020 compared to $17.0 million in 2019. The higher provision for credit losses on loans was driven by higher net charge-offs, primarily in the first quarter of 2020, and by the implementation of CECL, which uses an economic forecast that now includes the impact of the COVID-19 pandemic. Continued loan growth in future periods, a decline in our current level of recoveries, a decline in our loans' credit quality, or an increase in charge-offs could result in an increase in provision expense. Additionally, with the adoption of CECL beginning on January 1, 2020, provision expense may become more volatile due to changes in CECL model assumptions or credit quality, macroeconomic factors and conditions and loan composition, which drive the allowance for credit losses on loans.

Noninterest Income. The following table sets forth the major components of our noninterest income for the years ended December 31, 2020, 2019 and 2018:

(dollars in thousands) 2020 2019 2018 Increase (decrease) Increase (decrease)

Noninterest income:

Commercial FHA revenue. On August 28, 2020, the Company announced that it had completed the sale of its commercial FHA origination platform to Dwight Capital, a nationwide mortgage banking firm headquartered in New York. The Bank continues to service Love Funding’s current servicing portfolio of approximately $3.50 billion. Commercial FHA revenue for 2020 was $6.0 million, a decrease of $9.3 million compared to 2019. The decline in revenue is attributable to the sale of the loan origination platform in August resulting in a decline in interest rate locks. Interest rate lock commitments were $199.2 million in 2020, with 47% representing loan modifications which result in lower gain premiums than new originations. In 2019, interest rate lock commitments were $307.9 million, 1% of which were loan modifications.

Residential mortgage banking revenue. Residential mortgage banking revenue for 2020 totaled $9.8 million, compared to $2.9 million in 2019. The increase was primarily attributable to an increase in production as the decrease in the 10-year treasury rate stimulated a significant increase in mortgage activity. Loans originated in 2020 totaled $321.9 million, with 59% representing refinance transactions versus purchase transactions. Loans originated during the prior year totaled $156.8 million with 33% representing refinance transactions.

Service charges on deposit accounts. Service charges on deposit accounts were $8.6 million for 2020, a decline of $2.4 million from 2019. The decrease in revenue was attributable, primarily, to a decline in overdraft-related fees due to decreased business activities as a result of COVID-19.

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Impairment of Commercial Mortgage Servicing Rights. Impairment of commercial mortgage servicing rights was $12.3 million for 2020 compared to $2.1 million for 2019. Loans serviced for others totaled $3.50 billion and $4.08 billion at December 31, 2020 and 2019, respectively. The impairment resulted from loan prepayments due to borrowers refinancing their loans in this low rate environment, coupled with a reduction in the assumed earnings rates related to escrow and replacement reserves.

Other noninterest income. The decrease of $1.2 million in other noninterest income primarily reflected a decrease in bridge loan fees from Love Funding in 2020 compared to 2019.

Noninterest Expense. The following table sets forth the major components of noninterest expense for the years ended December 31, 2020, 2019 and 2018:

(dollars in thousands) 2020 2019 2018 Increase (decrease) Increase (decrease)

Noninterest expense:

Salaries and employee benefits. Salaries and employee benefits expense for 2020 totaled $85.6 million, compared to $91.9 million in 2019. The Company employed 904 employees at December 31, 2020 compared to 1,100 employees at December 31, 2019. The reduction in staff was primarily due to a reduction of 50 full-time employee positions announced in January 2020, the sale of our commercial FHA loan origination platform in August 2020 and the closure of 13 banking facilities in December 2020. Bonus expense was less in 2020 compared to 2019 due to anticipated financial results not meeting established thresholds for these annual awards.

Occupancy and equipment expense. The $1.3 million decrease in expense was primarily due to the Company operating fewer offices in 2020 compared to 2019. The Company closed six offices in the third quarter of 2019 related to our branch network consolidation plan as a result of the HomeStar acquisition. In the third quarter of 2020, we vacated the Love Funding offices as a result of the sale of the commercial FHA loan origination platform, and in December 2020, we closed 13 branches and vacated approximately 23,000 square feet of corporate office space. At December 31, 2020, the Company operated 52 full-service banking centers.

Data processing fees. The $1.3 million increase in data processing fees during 2020, as compared to 2019, was primarily the result of our continuing investments in technology to better serve our growing customer base.

Professional fees. The $1.5 million decrease in professional fees in 2020 as compared to 2019 was primarily the result of legal and consulting expenses incurred during the second and third quarters of 2019 related to the acquisition of HomeStar.

Loss onmortgage servicing rights held for sale. The Company recognized losses of $1.7 million on mortgage servicing rights held for sale in 2020 compared to a gain of $0.5 million in 2019. Market disruption as a result of COVID-19 resulted in a decreased demand by potential acquirers and a resulting decrease in value.

Impairment on facilities optimization. In the third quarter of 2020, the Company announced it would close or consolidate 13 branches, or 20% of its branch network, and vacate approximately 23,000 square feet of corporate office space by the end of 2020. As a result of this plan, we recorded $12.8 million of asset impairment on existing banking facilities. In 2019, the Company recorded $3.6 million of asset impairment on six banking facilities related to our branch network consolidation plan as a result of the HomeStar acquisition.

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FHLB advances prepayment fees. In the fourth quarter of 2020, the Company pre-paid $114.2 million of FHLB advances with a weighted average interest rate of 2.10% and maturity dates ranging from 2021 to 2024. As a result, we paid prepayment fees of $4.9 million.

Income Tax Expense. Income tax expense was $9.5 million in 2020 compared to $16.7 million in 2019. Effective tax rates for 2020 and 2019 were 29.6% and 23.0%, respectively. The significant increase in the effective tax rates resulted from Love Funding's asset sale in the third quarter of 2020, as goodwill of $10.9 million was derecognized and was not deductible for tax purposes, generating tax expense of $3.0 million.

Financial Condition

Assets. Total assets increased to $6.87 billion at December 31, 2020, as compared to $6.09 billion at December 31, 2019.

Loans. The loan portfolio is the largest category of our assets. The following table presents the balance and associated percentage of each major category in our loan portfolio at December 31, 2020, 2019, 2018, 2017 and 2016:

As of December 31,

Loans:

Total loans increased $701.9 million to $5.10 billion at December 31, 2020 as compared to December 31, 2019. The loan growth was primarily reflected in our commercial loan portfolio, which increased $630.4 million from $1.06 billion at December 31, 2019 to $1.69 billion at December 31, 2020. At December 31, 2020, PPP loans totaled $184.4 million, all of which were included in our commercial loan portfolio. Advances on our HUD warehouse lines of credit increased $219.2 million to $273.3 million at December 31, 2020, which are included in our commercial loan portfolio. We also continued to see loan growth from our equipment financing business, which is booked in the commercial loans and lease financing portfolios. Consumer loans increased $156.0 million as a result of our relationship with GreenSky. These increases were offset in part by payoffs and repayments in the residential real estate portfolio. We anticipate that loan growth will remain slow in the future for our commercial real estate and consumer loan portfolios as a result of COVID-19 and the related decline in economic conditions in our market areas.

Outstanding loan balances increased due to new loan originations, advances on outstanding commitments and loans acquired as a result of acquisitions of other financial institutions, net of amounts received for loan payments and payoffs,

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charge-offs of loans and transfers of loans to other real estate owned. The following table shows the fair values of the loans acquired during the years presented and the net growth or attrition of the acquired loans during the periods presented:

For the Year Ended December 31,

The principal categories of our loan portfolio are discussed below:

Commercial loans. We provide a mix of variable and fixed rate commercial loans. The loans are typically made to small- and medium-sized manufacturing, wholesale, retail and service businesses for working capital needs, business expansions and farm operations. Commercial loans generally include lines of credit and loans with maturities of five years or less. The loans are generally made with business operations as the primary source of repayment, but may also include collateralization by inventory, accounts receivable and equipment, and generally include personal guarantees.

Commercial real estate loans. Our commercial real estate loans consist of both real estate occupied by the borrower for ongoing operations and non-owner occupied real estate properties. The real estate securing our existing commercial real estate loans includes a wide variety of property types, such as owner occupied offices, warehouses and production facilities, office buildings, hotels, mixed-use residential and commercial facilities, retail centers, multifamily properties and assisted living facilities. Our commercial real estate loan portfolio also includes farmland loans. Farmland loans are generally made to a borrower actively involved in farming rather than to passive investors.

Construction and land development loans. Our construction and land development loans are comprised of residential construction, commercial construction and land acquisition and development loans. Interest reserves are generally established on real estate construction loans.

Residential real estate loans. Our residential real estate loans consist of loans for the purchase of residential properties that generally do not qualify for secondary market sale.

Consumer loans. Our consumer loans include direct personal loans, indirect automobile loans, lines of credit and installment loans originated through home improvement specialty retailers and contractors. Personal loans are generally secured by automobiles, boats and other types of personal property and are made on an installment basis.

Lease financing. Our equipment leasing business provides financing leases to varying types of businesses, nationwide, for purchases of business equipment and software. The financing is secured by a first priority interest in the financed asset and generally requires monthly payments.

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The following table shows the contractual maturities of our loan portfolio and the distribution between fixed and adjustable interest rate loans at December 31, 2020:

Within One Year One Year to Five Years After Five Years

Loans:

Loan Quality

We use what we believe is a comprehensive methodology to monitor credit quality and prudently manage credit concentration within our loan portfolio. Our underwriting policies and practices govern the risk profile and credit and geographic concentration for our loan portfolio. We also have what we believe to be a comprehensive methodology to monitor these credit quality standards, including a risk classification system that identifies potential problem loans based on risk characteristics by loan type as well as the early identification of deterioration at the individual loan level.

Analysis of the Allowance for Credit Losses on Loans. The following table allocates the allowance for credit losses on loans, or the allowance, by loan category:

As of December 31,

Loans:

(1)Information presented prior to December 31, 2020 was modeled under the incurred loss model.

(2)Represents the percentage of the allowance to total loans in the respective category.

As discussed in Note 1 - Summary of Significant Accounting Policies in the accompanying notes to consolidated financial statements, our policies and procedures related to accounting for credit losses changed on January 1, 2020 in connection with the adoption of a new accounting standard update as codified in Accounting Standards Codification (“ASC”) Topic 326 (“ASC 326”) Financial Instruments - Credit Losses. The amount of the allowance represents management's best estimate of current expected credit losses on loans considering available information, from internal and external sources, relevant to assessing exposure to credit loss over the contractual term of the instrument. Relevant available information includes historical credit loss experience, current conditions and reasonable and supportable forecasts. While historical credit loss experience provides the basis for the estimation of expected credit losses, adjustments to historical loss information may be made for differences in current portfolio-specific risk characteristics, environmental conditions or other relevant factors. While management utilizes its best judgment and information available, the ultimate adequacy of our allowance accounts is dependent upon a variety of factors beyond our control, including the performance of our portfolios, the economy, changes in interest rates and the view of the regulatory authorities toward classification of assets.

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For each loan pool, we measure expected credit losses over the life of each loan utilizing a combination of models which measure (i) probability of default, which is the likelihood that loan will stop performing/default, (ii) loss given default, which is the expected loss rate for loans in default, (iii) assumed prepayment speed, which is the likelihood that a loan will prepay or pay-off prior to maturity, and (iv) exposure at default , which is the estimated outstanding principal balance of the loans upon default. We continue to evaluate our level of reserves in light of the COVID-19 pandemic.

The following table provides an analysis of the allowance for credit losses on loans, provision for credit losses on loans and net charge-offs for the years indicated:

As of and for the Year Ended December 31,

Charge-offs:

Construction and land development 376 44 — — 1

Recoveries:

Individual loans considered to be uncollectible are charged off against the allowance. Factors used in determining the amount and timing of charge-offs on loans include consideration of the loan type, length of delinquency, sufficiency of collateral value, lien priority and the overall financial condition of the borrower. Collateral value is determined using updated appraisals and/or other market comparable information. Recoveries on loans previously charged off are added to the allowance. Net charge-offs to average loans were 0.50% and 0.23% for 2020 and 2019, respectively.

Nonperforming Loans. The following table sets forth our nonperforming assets by asset categories as of the dates indicated. Nonperforming loans include nonaccrual loans, loans past due 90 days or more and still accruing interest and loans modified under troubled debt restructurings. Deferrals related to COVID-19 are not included as TDRs as of December 31, 2020. The balances of nonperforming loans reflect the net investment in these assets, including deductions for purchase discounts. Purchased credit impaired loans were not reported as nonperforming loans in periods prior to January 1, 2020. Effective January 1, 2020, PCI loans were reclassified as PCD loans as a result of the adoption of CECL, and due to this change, are included in nonperforming loans.

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As of December 31,

Nonperforming loans:

We did not recognize interest income on nonaccrual loans during the years ended December 31, 2020, 2019 and 2018 while they were in nonaccrual status. Additional interest income that we would have recognized on these loans had they been current in accordance with their original terms was $3.3 million, $2.2 million and $1.8 million during the years ended December 31, 2020, 2019 and 2018, respectively. We recognized interest income on commercial and commercial real estate loans modified under troubled debt restructurings of $70,000 in 2020, $117,000 in 2019 and $97,000 in 2018.

We utilize an asset risk classification system in compliance with guidelines established by the Federal Reserve as part of our efforts to improve asset quality. In connection with examinations of insured institutions, examiners have the authority to identify problem assets and, if appropriate, classify them. There are three classifications for problem assets: “substandard,” “doubtful,” and “loss.” Substandard assets have one or more defined weaknesses and are characterized by the distinct possibility that the insured institution will sustain some loss if the deficiencies are not corrected. Doubtful assets have the weaknesses of substandard assets with the additional characteristic that the weaknesses make collection or liquidation in full questionable and there is a high probability of loss based on currently existing facts, conditions and values. An asset classified as loss is not considered collectable and is of such little value that continuance of booking the asset is not warranted.

We use a ten grade risk rating system to categorize and determine the credit risk of our loans. Potential problem loans include loans with a risk grade of 7, which are "special mention," and loans with a risk grade of 8, which are "substandard" loans that are not considered to be nonperforming. These loans generally require more frequent loan officer contact and receipt of financial data to closely monitor borrower performance. Potential problem loans are managed and monitored regularly through a number of processes, procedures and committees, including oversight by a loan administration committee comprised of executive officers and other members of the Bank's senior management team. Additionally, the Company initiated a re-evaluation of the accuracy of loan grades assigned to its commercial loan portfolio during the second quarter of 2020. Effects as a result of the pandemic may continue, potentially resulting in additional loans being identified.

The following table presents the recorded investment of potential problem commercial loans by loan category at the dates indicated:

Commercial CommercialReal Estate Construction &Land Development

Risk Category Risk Category Risk Category

(dollars in thousands) 7 8 (1) 7 8 (1) 7 8 (1) Total

(1)Includes only those 8-rated loans that are not included in nonperforming loans.

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Commercial real estate loans with a risk rating of 7 or 8 increased to $250.2 million as of December 31, 2020, compared to $84.7 million as of December 31, 2019, primarily due to COVID-19 related loan deferral requests. As requests were evaluated, loan risk ratings were adjusted as necessary. Loan modifications related to the hotel industry totaled $82.6 million with risk rating downgrades applied to $76.7 million of those loans.

Investment Securities. Our investment strategy aims to maximize earnings while maintaining liquidity in securities with minimal credit risk. The types and maturities of securities purchased are primarily based on our current and projected liquidity and interest rate sensitivity positions.

The following table sets forth the book value and percentage of each category of investment securities at December 31, 2020, 2019 and 2018. The book value for investment securities classified as available for sale is equal to fair market value.

December 31,

Investment securities available for sale:

U.S. Treasury securities $ — — $ — — % $ 24,650 3.8 %

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The following table sets forth the book value, maturities and weighted average yields for our investment portfolio at December 31, 2020. The book value for investment securities classified as available for sale is equal to fair market value.

(dollars in thousands) BookValue % ofTotal WeightedAverageYield

Investment securities available for sale:

U.S. government sponsored entities and U.S. agency securities:

Maturing in one to five years 2,718 0.4 2.4

Maturing in five to ten years 9,903 1.5 1.0

Mortgage-backed securities - agency:

Total mortgage-backed securities - agency $ 344,577 50.9 % 2.1 %

Mortgage-backed securities - non-agency:

Maturing within one year $ 4,595 0.7 % 2.5 %

Maturing in five to ten years — — —

Maturing after ten years — — —

Total mortgage-backed securities - non-agency $ 20,744 3.1 % 2.4 %

State and municipal securities (1):

Maturing within one year $ 6,033 0.9 % 4.0 %

Total state and municipal securities $ 129,765 19.2 % 3.6 %

Corporate securities:

Maturing within one year $ 8,272 1.2 % 3.4 %

Maturing after ten years — — —

Total investment securities available for sale $ 676,711 100.0 % 2.9 %

(1)Weighted average yield for tax-exempt securities are presented on a tax-equivalent basis assuming a federal statutory income tax rate of 21%.

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The table below presents the credit ratings for our investment securities classified as available for sale, at fair value, at December 31, 2020:

AmortizedCost EstimatedFair Value Average Credit Rating

(dollars in thousands) AAA AA+/− A+/− BBB+/− <BBB− Not Rated

Investment securities available for sale:

Operating Lease Right-of-Use Asset. Operating lease ROU assets totaled $9.2 million at December 31, 2020 compared to $14.2 million at December 31, 2019. The Company terminated or impaired $4.1 million ROU assets related to its facilities optimization plan and sale of its commercial FHA origination platform.

Goodwill and Other Intangible Assets. Goodwill was $161.9 million at December 31, 2020 compared to $171.8 million at December 31, 2019. Goodwill represents the excess of consideration paid in an acquisition over the fair value of the net assets acquired. The $9.9 million decrease in 2020 primarily resulted from goodwill derecognized as a result of the sale of our commercial FHA origination platform in the third quarter of 2020.

Our other intangible assets, which consist of core deposit and trust relationship intangibles, were $28.4 million and $34.9 million at December 31, 2020 and 2019, respectively. The decrease in other intangibles was due to amortization expense of $6.5 million.

Liabilities. Total liabilities increased to $6.25 billion at December 31, 2020 compared to $5.43 billion at December 31, 2019.

Deposits. We emphasize developing total client relationships with our customers in order to increase our retail and commercial core deposit bases, which are our primary funding sources. Our deposits consist of noninterest-bearing and interest-bearing demand, savings and time deposit accounts.

Total deposits increased $556.8 million to $5.10 billion at December 31, 2020, as compared to December 31, 2019. The increase primarily resulted from organic deposit growth of $140.4 million in commercial deposits, $122.6 million in retail deposits, $154.1 million in servicing deposits and $152.7 million in our ICS product. Commercial deposit growth included increases from PPP funds deposited. The growth was partially offset by the intentional reduction of $26.7 million in brokered time deposits. At December 31, 2020, total deposits were comprised of 28.8% of noninterest-bearing demand accounts, 57.9% of interest-bearing transaction accounts and 13.3% of time deposits. At December 31, 2020, brokered time deposits totaled $23.1 million, or 0.5% of total deposits, compared to $49.7 million, or 1.1% of total deposits, at December 31, 2019.

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The following table summarizes our average deposit balances and weighted average rates for the years ended December 31, 2020, 2019 and 2018:

December 31,

Deposits

Interest-bearing:

The following table sets forth the maturity of time deposits of $250,000 or more and brokered deposits as of December 31, 2020:

Maturity Within:

Short-Term Borrowings. In addition to deposits, we use short-term borrowings, such as federal funds purchased and securities sold under agreements to repurchase, as a source of funds to meet the daily liquidity needs of our customers and fund growth in earning assets. Short-term borrowings were $69.0 million at December 31, 2020 compared to $82.0 million at December 31, 2019. The decrease was driven by customers migrating to a new deposit product. The weighted average interest rate on our short-term borrowings was 0.12% and 0.67% at December 31, 2020 and 2019, respectively.

FHLB Advances and Other Borrowings. FHLB advances and other borrowings totaled $779.2 million and $493.3 million as of December 31, 2020 and 2019, respectively. As mentioned previously, the Company pre-paid $114.2 million of FHLB advances with a weighted average interest rate of 2.10% and maturity dates ranging from 2021 to 2024. At year-end, the Company borrowed an additional $200.0 million from the FHLB as a result of advances on its HUD warehouse lines. These borrowings were at a rate of 0.25% with terms of less than 30 days. The weighted average cost of the FHLB borrowings was 1.32% at December 31, 2020.

Operating Lease Liabilities. Operating lease liabilities totaled $12.0 million at December 31, 2020 compared to $15.4 million at December 31, 2019. Operating lease obligations of $2.1 million were assumed by the buyer in the sale of our commercial FHA origination platform.

Capital Resources and Liquidity Management

Capital Resources. Shareholders’ equity is influenced primarily by earnings, dividends, issuances and redemptions of common stock and changes in accumulated other comprehensive income caused primarily by fluctuations in unrealized holding gains or losses, net of taxes, on available-for-sale investment securities.

Shareholders’ equity decreased $40.5 million to $621.4 million at December 31, 2020 as compared to December 31, 2019. The Company generated net income of $22.5 million during 2020 and had an increase in accumulated other comprehensive income of $4.0 million. Offsetting these increases to shareholders’ equity were $25.0 million of dividends to

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common shareholders and $39.6 million in common stock repurchases. In addition, the Company recorded a $7.2 million reduction to retained earnings related to the adoption of CECL effective January 1, 2020.

On August 6, 2019, the Company announced that its Board of Directors authorized the Company to repurchase up to $25.0 million of its common stock, which amount was increased to $50.0 million on March 11, 2020 by an amendment approved by the Board of Directors.On December 2, 2020, the Company announced that the Board had extended the term of the repurchase program from December 31, 2020 to December 31, 2021. At the time of the extension, the program had approximately $6.4 million of remaining repurchase authority. Stock repurchases under the program may be made from time to time on the open market, in privately negotiated transactions, or in any manner that complies with applicable securities laws, at the discretion of the Company. The timing of purchases and the number of shares repurchased under the program are dependent upon a variety of factors including price, trading volume, corporate and regulatory requirements and market condition. The repurchase program may be suspended or discontinued at any time without notice. As of December 31, 2020, $43.4 million, or 2,472,736 shares of the Company’s common stock, had been repurchased under the program.

Liquidity Management. Liquidity refers to the measure of our ability to meet the cash flow requirements of depositors and borrowers, while at the same time meeting our operating, capital and strategic cash flow needs, all at a reasonable cost. We continuously monitor our liquidity position to ensure that assets and liabilities are managed in a manner that will meet all short-term and long-term cash requirements. We manage our liquidity position to meet the daily cash flow needs of customers, while maintaining an appropriate balance between assets and liabilities to meet the return on investment objectives of our shareholders.

Integral to our liquidity management is the administration of short-term borrowings. To the extent we are unable to obtain sufficient liquidity through core deposits, we seek to meet our liquidity needs through wholesale funding or other borrowings, including our ability to borrow from the FHLB, on either a short- or long-term basis.

Securities sold under agreements to repurchase, which are classified as secured borrowings, generally mature within one to four days from the transaction date. Securities sold under agreements to repurchase are reflected at the amount of cash received in connection with the transaction, which represents the amount of the Bank’s obligation. The Bank may be required to provide additional collateral based on the fair value of the underlying securities. Investment securities with a carrying amount of $76.5 million and $87.4 million at December 31, 2020 and December 31, 2019, respectively, were pledged for securities sold under agreements to repurchase.

The Company had available lines of credit of $54.4 million and $21.6 million at December 31, 2020 and December 31, 2019, respectively, from the Federal Reserve Discount Window. The lines are collateralized by a collateral agreement with respect to a pool of commercial real estate loans totaling $68.1 million and $24.3 million at December 31, 2020 and 2019, respectively. There were no outstanding borrowings at December 31, 2020 and 2019.

The Company has the option of obtaining additional liquidity by participating in the Paycheck Protection Program Liquidity Facility (“Facility”). Under the Facility, the Company can pledge its PPP loans to the Federal Reserve Bank as collateral for available advances. PPP loans pledged as collateral to secure extensions of credit under the Facility will be valued at the principal amount of the PPP loan. No loans have been pledged under the Facility as of December 31, 2020.

At December 31, 2020, the Company had available federal funds lines of credit totaling $20.0 million, which were unused.

At December 31, 2020 and 2019, we had capacity to borrow $334.0 million and $481.0 million, respectively, from the FHLB. The Company’s advances from the FHLB are collateralized by a blanket collateral agreement of qualifying mortgage and home equity line of credit loans and certain commercial real estate loans totaling $1.86 billion and $1.94 billion at December 31, 2020 and 2019, respectively.

The Company is a corporation separate and apart from the Bank and, therefore, must provide for its own liquidity. The Company’s main source of funding is dividends declared and paid to us by the Bank. There are statutory, regulatory and debt covenant limitations that affect the ability of the Bank to pay dividends to the Company. Management believed at December 31, 2020, that these limitations will not impact our ability to meet our ongoing short-term cash obligations.

Regulatory Capital Requirements

We are subject to various regulatory capital requirements administered by the federal and state banking regulators. Failure to meet regulatory capital requirements may result in certain mandatory and possible additional discretionary actions by regulators that, if undertaken, could have a direct material effect on our financial statements. Under capital adequacy guidelines

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and the regulatory framework for “prompt corrective action”, we must meet specific capital guidelines that involve quantitative measures of our assets, liabilities and certain off-balance sheet items as calculated under regulatory accounting policies.

In December 2018, the Office of the Comptroller of the Currency, the Federal Reserve, and the FDIC approved a final rule to address changes to credit loss accounting under GAAP, including banking organizations’ implementation of CECL. The final rule provides banking organizations the option to phase in over a three-year period the day-one adverse effects on regulatory capital that may result from the adoption of the new accounting standard. In March 2020, the Office of the Comptroller of the Currency, the Federal Reserve, and the FDIC published an interim final rule to delay the estimated impact on regulatory capital stemming from the implementation of CECL. The interim final rule maintains the three-year transition option in the previous rule and provides banks the option to delay for two years an estimate of CECL’s effect on regulatory capital, relative to the incurred loss methodology’s effect on regulatory capital, followed by a three-year transition period (five-year transition option). The Company is adopting the capital transition relief over the permissible five-year period.

At December 31, 2020, the Company and the Bank exceeded the regulatory minimums and met the regulatory definition of well-capitalized.

The following table presents the Company and the Bank’s capital ratios and the minimum requirements at December 31, 2020:

Ratio Actual MinimumRegulatoryRequirements (1) WellCapitalized

Total capital (to risk-weighted assets):

Midland States Bancorp, Inc. 13.24 % 10.50 % N/A

Tier 1 capital (to risk-weighted assets):

Midland States Bancorp, Inc. 9.20 8.50 N/A

Common equity tier 1 capital (to risk-weighted assets):

Midland States Bancorp, Inc. 7.99 7.00 N/A

Tier 1 leverage (to average assets):

Midland States Bancorp, Inc. 7.50 4.00 N/A

(1)Total risk-based capital ratio, Common equity tier 1 risk-based capital ratio and Tier 1 risk-based capital ratio include the capital conservation buffer of 2.5%.

Contractual Obligations

The following table contains supplemental information regarding our total contractual obligations at December 31, 2020:

Payments Due

Securities sold under repurchase agreements 68,957 — — — 68,957

We believe that we will be able to meet our contractual obligations as they come due through the maintenance of adequate cash levels. We expect to maintain adequate cash levels through profitability, loan and securities repayment and

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maturity activity and continued deposit gathering activities. We have in place various borrowing mechanisms for both short-term and long-term liquidity needs.

Off-Balance Sheet Arrangements

We have limited off-balance sheet arrangements that have, or are reasonably likely to have, a current or future material effect on our financial condition, revenues, expenses, results of operations, liquidity, capital expenditures or capital resources.

In the normal course of business, we enter into various transactions, which, in accordance with GAAP, are not included in our consolidated balance sheets. We enter into these transactions to meet the financing needs of our customers. These transactions include commitments to extend credit and standby letters of credit, which involve, to varying degrees, elements of credit risk and interest rate risk in excess of the amounts recognized in our consolidated balance sheets. Most of these commitments mature within two years and are expected to expire without being drawn upon. Standby letters of credit are included in the determination of the amount of risk-based capital that the Company and the Bank are required to hold.

We enter into contractual loan commitments to extend credit, normally with fixed expiration dates or termination clauses, at specified rates and for specific purposes. Substantially all of our commitments to extend credit are contingent upon customers maintaining specific credit standards until the time of loan funding. We decrease our exposure to losses under these commitments by subjecting them to credit approval and monitoring procedures. We assess the credit risk associated with certain commitments to extend credit and establish a liability for probable credit losses.

Standby letters of credit are written conditional commitments issued by us to guarantee the performance of a customer to a third party. In the event that the customer does not perform in accordance with the terms of the agreement with the third party, we would be required to fund the commitment. The maximum potential amount of future payments we could be required to make is represented by the contractual amount of the commitment. If the commitment is funded, we would be entitled to seek recovery from the customer. Our policies generally require that standby letter of credit arrangements contain security and debt covenants similar to those contained in loan agreements.

We guarantee the distributions and payments for redemption or liquidation of the trust preferred securities issued by our wholly owned subsidiary business trusts to the extent of funds held by the trusts. Although this guarantee is not separately recorded, the obligation underlying the guarantee is fully reflected on our consolidated balance sheets as junior subordinated debentures held by subsidiary trusts. The junior subordinated debentures currently qualify as Tier 1 capital under the Federal Reserve capital adequacy guidelines.

Quantitative and Qualitative Disclosures About Market Risk

Market Risk. Market risk represents the risk of loss due to changes in market values of assets and liabilities. We incur market risk in the normal course of business through exposures to market interest rates, equity prices, and credit spreads. We are primarily exposed to interest rate risk as a result of offering a wide array of financial products to our customers and secondarily to price risk from investments in securities backed by mortgage loans.

Interest Rate Risk

Overview. Interest rate risk is the risk to earnings and value arising from changes in market interest rates. Interest rate risk arises from timing differences in the repricings and maturities of interest-earning assets and interest-bearing liabilities (reprice risk), changes in the expected maturities of assets and liabilities arising from embedded options, such as borrowers’ ability to prepay residential mortgage loans at any time and depositors’ ability to redeem certificates of deposit before maturity (option risk), changes in the shape of the yield curve where interest rates increase or decrease in a nonparallel fashion (yield curve risk), and changes in spread relationships between different yield curves, such as U.S. Treasuries and LIBOR (basis risk).

We actively manage interest rate risk, as changes in market interest rates may have a significant impact on reported earnings. Changes in market interest rates may result in changes in the fair market value of our financial instruments, cash flows, and net interest income. We seek to achieve consistent growth in net interest income and capital while managing volatility arising from shifts in market interest rates. Our Board of Directors’ Risk Policy and Compliance Committee oversees interest rate, as well as the establishment of risk measures, limits, and policy guidelines for managing the amount of interest rate and mortgage price risk and its effect on net interest income and capital. Responsibility for measuring and the management of interest rate risk resides with Corporate Treasury.Our Risk Policy and Compliance Committee meets quarterly to monitor the level of interest rate risk sensitivity to ensure compliance with the board of directors’ approved risk limits.

Interest rate risk management is an active process that encompasses monitoring loan and deposit flows complemented by investment and funding activities. Effective management of interest rate risk begins with understanding the dynamic

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characteristics of assets and liabilities and determining the appropriate interest rate risk posture given business forecasts, management objectives, market expectations, and policy constraints.

An asset sensitive position refers to a balance sheet position in which an increase in short-term interest rates is expected to generate higher net interest income, as rates earned on our interest-earning assets would reprice upward more quickly than rates paid on our interest-bearing liabilities, thus expanding our net interest margin. Conversely, a liability sensitive position refers to a balance sheet position in which an increase in short-term interest rates is expected to generate lower net interest income, as rates paid on our interest-bearing liabilities would reprice upward more quickly than rates earned on our interest-earning assets, thus compressing our net interest margin.

Income Simulation and Economic Value Analysis. Interest rate risk measurement is calculated and reported to the Risk Policy and Compliance Committee at least quarterly. The information reported includes period-end results and identifies any policy limits exceeded, along with an assessment of the policy limit breach and the action plan and timeline for resolution, mitigation, or assumption of the risk.

We use two approaches to model interest rate risk: Net Interest Income at Risk (“NII at Risk”) and Economic Value of Equity (“EVE”). Under NII at Risk, net interest income is modeled utilizing various assumptions for assets, liabilities, and derivatives. EVE measures the period end market value of assets minus the market value of liabilities and the change in this value as rates change. EVE is a period end measurement.

NII at risk uses net interest income simulation analysis which involves forecasting net interest earnings under a variety of scenarios including changes in the level of interest rates, the shape of the yield curve, and spreads between market interest rates. The sensitivity of net interest income to changes in interest rates is measured using numerous interest rate scenarios including shocks, gradual ramps, curve flattening, curve steepening as well as forecasts of likely interest rates scenarios. Modeling the sensitivity of net interest earnings to changes in market interest rates is highly dependent on numerous assumptions incorporated into the modeling process. To the extent that actual performance is different than what was assumed, actual net interest earnings sensitivity may be different than projected. The assumptions used in the models are our best estimates based on studies conducted by the treasury group. The treasury group uses a data warehouse to study interest rate risk at a transactional level and uses various ad-hoc reports to continuously refine assumptions. Assumptions and methodologies regarding administered rate liabilities (e.g., savings accounts, money market accounts and interest-bearing checking accounts), balance trends, and repricing relationships reflect our best estimate of expected behavior and these assumptions are reviewed periodically.

We also have longer-term interest rate risk exposure, which may not be appropriately measured by earnings sensitivity analysis. The Risk Policy and Compliance Committee uses EVE to study the impact of long-term cash flows on earnings and on capital. EVE involves discounting present values of all cash flows of on and off-balance sheet items under different interest rate scenarios. The discounted present value of all cash flows represents our EVE. The analysis requires modifying the expected cash flows in each interest rate scenario, which will impact the discounted present value. The amount of base-case measurement and its sensitivity to shifts in the yield curve allow us to measure longer-term repricing and option risk in the balance sheet.

The following table shows NII at Risk at the dates indicated:

Net Interest Income Sensitivity (Shocks)

Immediate Change in Rates

Percent change (3.1) % 2.7 % 4.9 %

Percent change (5.4) % 1.2 % 0.9 %

Percent change (4.3) % 1.4 % 2.4 %

We report NII at Risk to isolate the change in income related solely to interest-earning assets and interest-bearing liabilities. The NII at Risk results included in the table above reflect the analysis used quarterly by management. It models

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−100, +100 and +200 basis point parallel shifts in market interest rates, implied by the forward yield curve over the next twelve months. We were within Board policy limits for the +100 and +200 and the -100 basis point scenarios at December 31, 2020.

Tolerance levels for risk management require the continuing development of remediation plans to maintain residual risk within approved levels as we adjust the balance sheet. NII at Risk reported at December 31, 2020, projected that our earnings exhibited decreased sensitivity at −100 basis point scenario to changes in interest rates compared to December 31, 2019.

The following table shows EVE at the dates indicated:

Economic Value of Equity Sensitivity (Shocks)

Immediate Change in Rates

The EVE results included in the table above reflect the analysis used quarterly by management. It models immediate −100, +100 and +200 basis point parallel shifts in market interest rates.

The EVE reported at December 31, 2020 projected that as interest rates increase, the economic value of equity position will increase, and as interest rates decrease, the economic value of equity position will decrease. When interest rates rise, fixed rate assets generally lose economic value; the longer the duration, the greater the value lost. The opposite is true when interest rates fall.

We were within board policy limits for the +100 and +200 basis point scenarios at December 31, 2020 and out of compliance for the -100 basis point scenario. The Bank is reviewing strategies to bring this position into policy compliance.

Price Risk. Price risk represents the risk of loss arising from adverse movements in the prices of financial instruments that are carried at fair value and are subject to fair value accounting. We have price risk from mortgage-backed securities, derivative instruments, and equity investments.

Critical Accounting Policies and Estimates

The preparation of our consolidated financial statements in accordance with GAAP requires us to make estimates and judgments that affect our reported amounts of assets, liabilities, revenues and expenses and related disclosure of contingent assets and liabilities. We base our estimates on historical experience and on various other assumptions that are believed to be reasonable under current circumstances, results of which form the basis for making judgments about the carrying value of certain assets and liabilities that are not readily available from other sources. We evaluate our estimates on an ongoing basis. Actual results may differ from these estimates under different assumptions or conditions.

Accounting policies, as described in detail in the notes to our consolidated financial statements, are an integral part of our financial statements. A thorough understanding of these accounting policies is essential when reviewing our reported results of operations and our financial position. We believe that the critical accounting policies and estimates discussed below require us to make difficult, subjective or complex judgments about matters that are inherently uncertain. Changes in these estimates that are likely to occur from period to period, or using different estimates that we could have reasonably used in the current period, would have a material impact on our financial position, results of operations or liquidity.

Investment Securities. Investment securities generally must be classified as equity, held to maturity, available for sale or trading. The Company classifies its debt investment securities as available for sale or held to maturity at the time of purchase. Investments in stock of a publicly traded company or in mutual funds are classified as equity securities. Held-to-maturity securities are principally debt securities that we have both the positive intent and ability to hold to maturity. Trading securities

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are held primarily for sale in the near term to generate income. Securities that do not meet the definition of equity, trading or held to maturity are classified as available for sale.

The classification of investment securities is significant since it directly impacts the accounting for unrealized gains and losses on these securities. Unrealized gains and losses on equity securities and trading securities flow directly through earnings during the periods in which they arise. Trading, equity and investment securities available for sale are measured at fair value each reporting period. Unrealized gains and losses on investment securities available for sale are recorded as a separate component of shareholders’ equity (accumulated other comprehensive income or loss) and do not affect earnings until realized or it is determined that a credit loss exists. If a credit loss exists, an allowance for credit losses is recorded for the credit loss, limited by the amount that the fair value is less than the amortized cost basis. Any impairment that has not been recorded through an ACL is recorded in other comprehensive income.

The fair values of investment securities are generally determined by various pricing models. We evaluate the methodologies used to develop the resulting fair values. We perform a quarterly analysis on the pricing of investment securities to ensure that the prices represent a reasonable estimate of the fair value. Our procedures include initial and ongoing review of pricing methodologies and trends. We seek to ensure prices represent a reasonable estimate of fair value through the use of broker quotes, current sales transactions from our portfolio and pricing techniques, which are based on the net present value of future expected cash flows discounted at a rate of return market participants would require. Significant inputs used in internal pricing techniques are estimated by type of underlying collateral, estimated prepayment speeds where applicable and appropriate discount rates. As a result of this analysis, if we determine there is a more appropriate fair value, the price is adjusted accordingly.

When the level and volume of trading activity for certain securities has significantly declined or when we believe that pricing is based in part on forced liquidation or distressed sales, we estimate fair value based on a combination of pricing information and an internal model using a discounted cash flow approach. We make certain significant assumptions in addition to those discussed above related to the liquidity risk premium, specific nonperformance and default experience in the collateral underlying the security. The values resulting from each approach are weighted to derive the final fair value for each security trading in an inactive market.

The fair value of investment securities is a critical accounting estimate. Changes in fair value estimates that occur from period to period, or the use of different estimates that could have been reasonably used in the current period, could have a material impact on our financial position, results of operations or liquidity.

Allowance for Credit Losses on Loans. The allowance for credit losses on loans represents management’s estimate of all expected credit losses over the expected contractual life of our loan portfolio. The accounting policy related to the allowance for credit losses on loans is considered to be critical as this policy involves considerable subjective judgment and estimation by management. As discussed in Note 1 - Summary of Significant Accounting Policies, our policy related to the allowance for credit losses on loans changed on January 1, 2020 in connection with the adoption of CECL. The allowance for credit losses on loans is a contra-asset valuation account that is deducted from the amortized cost basis of loans to present the net amount expected to be collected. The amount of the allowance represents management's best estimate of current expected credit losses considering available information, from internal and external sources, relevant to assessing exposure to credit loss over the contractual term of the loan. Relevant available information includes historical credit loss experience, current conditions and reasonable and supportable forecasts. While historical credit loss experience provides the basis for the estimation of expected credit losses, adjustments to historical loss information may be made for differences in current portfolio-specific risk characteristics, environmental conditions or other relevant factors.

We utilize a probability of default/loss given default methodology in in combination with qualitative factors in to determine expected future credit losses for performing loans. This method, a form of migration analysis, combines the estimated probability of loans experiencing default events and the losses ultimately associated with the loans experiencing those defaults. The probability of default is the risk that the borrower will be unable or unwilling to repay its debt in full or on time. Probability of default is generally associated with financial characteristics such as inadequate cash flow to service debt, declining revenues or operating margins, high leverage, declining or marginal liquidity, and the inability to successfully implement a business plan. The loss given default component is the percentage of defaulted loan balance that is ultimately charged off. Multiplying one by the other gives the Company its loss rate, which is then applied to the loan portfolio balance to determine expected future losses. The model utilizes linear regression analysis to develop default rates based on forecasted macroeconomic variables that correlate to and are predictive of losses. The selected variables were evaluated based on regression analysis output to determine the statistical fit of the variables used to forecasted expected credit losses. Qualitative factors include items such as changes in lending policies or procedures, asset specific risks, the impact of COVID-19 on customers' operations and economic uncertainty in forward-looking forecasts.

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The allowance represents management’s best estimate, but significant downturns in circumstances relating to loan quality and economic conditions could result in a requirement for additional allowance. Likewise, an upturn in loan quality and improved economic conditions may allow a reduction in the required allowance. In either instance, unanticipated changes could have a significant impact on results of operations. The expense for credit loss recorded through earnings is the amount necessary to maintain the allowance for credit losses at the amount of expected credit losses inherent within the loans held for investment portfolio. The amount of expense and the corresponding level of allowance for credit losses for loans are based on our evaluation of the collectability of the loan portfolio based on historical loss experience, reasonable and supportable forecasts, and other significant qualitative and quantitative factors.

Goodwill. For acquisitions, we are required to record the assets acquired, including identified intangible assets such as goodwill, and the liabilities assumed at their fair value. These often involve estimates based on third party valuations, such as appraisals, or internal valuations based on discounted cash flow analyses or other valuation techniques that may include estimates of attrition, inflation, asset growth rates, or other relevant factors. The carrying value of goodwill recorded must be reviewed for impairment on an annual basis, as well as on an interim basis if events or changes indicate that the asset might be impaired. An impairment loss must be recognized for any excess of carrying value over fair value of the goodwill. The determination of fair values is based on valuations using management’s assumptions of future growth rates, future attrition, discount rates, multiples of earnings or other relevant factors. Changes in these factors, as well as downturns in economic or business conditions, could have a significant adverse impact on the carrying value of goodwill and could result in impairment losses affecting our financial statements as a whole and our banking subsidiary in which the goodwill resides.

In the second quarter of 2020, the Company performed a Step 1 impairment analysis of its goodwill, as an unprecedented decline in economic conditions triggered by the COVID-19 pandemic caused a significant decline in stock market valuations, including our stock price. These events indicated that goodwill may be impaired. As a result of the analysis, we concluded that our goodwill was not impaired. The Company performed its required annual impairment test as of August 31, 2020, accelerating its annual measurement date from the previous date of September 30. The Company concluded that its estimated fair value was greater than its book value and impairment of goodwill was not required. No events or circumstances since the August 31, 2020 annual impairment test were noted that would indicate it was more likely than not a goodwill impairment exists.

On a quarterly basis, we will continue to evaluate our qualitative assessment assumptions, which are subject to risks and uncertainties, including: (1) forecasted revenues, expenses, and cash flows; (2) current discount rates; (3) our market capitalization; (4) observable market transactions and multiples; (5) changes to the regulatory environment; and (6) the nature and amount of government support that has been and is expected to be provided in the future. A prolonged economic downturn or deterioration in the economic outlook may lead management to conclude that an interim quantitative impairment test of our goodwill is required prior to the annual impairment test conducted on August 31.

Loan Servicing Rights. On a periodic basis, the Company sells residential mortgage loans, commercial FHA mortgage loans and SBA loans in the secondary market. Loan servicing rights resulting from us retaining the right to service the loans sold are carried at the lower of the initial capitalized amount, net of accumulated amortization, or estimated fair value. Loan servicing rights are amortized in proportion to and over the period of estimated net servicing income.

The Company periodically evaluates its mortgage servicing rights asset for impairment. Impairment is assessed based on the fair value of net servicing cash flows at each reporting date using estimated prepayment speeds of the underlying loans serviced and stratifications based on the risk characteristics of the underlying loans. The fair value of our servicing rights is estimated by using a cash flow valuation model which calculates the present value of estimated future net servicing cash flows, taking into consideration expected mortgage loan prepayment rates, discount rates, servicing costs, replacement reserves and other economic factors which are estimated based on current market conditions.

Determining the fair value of our loan servicing rights for impairment assessment purposes is considered a critical accounting estimate, as it requires significant judgment and the use of subjective measurements. Changes in these estimates and assumptions are possible and may have a material impact on our financial position, results of operations or liquidity.

Deferred Income Taxes. We use the asset and liability method of accounting for income taxes as prescribed by GAAP. Under this method, deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. If current available information raises doubt as to the realization of the deferred tax assets, a valuation allowance is established. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. Accounting for deferred income taxes is a critical accounting estimate because we exercise significant judgment in evaluating the amount and timing of recognition of the resulting tax liabilities and assets. Management’s determination of the realization of deferred tax assets is based upon management’s

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judgment of various future events and uncertainties, including the timing and amount of future income, reversing temporary differences which may offset, and the implementation of various tax plans to maximize realization of the deferred tax asset. These judgments and estimates are inherently subjective and reviewed on a continual basis as regulatory and business factors change. Any reduction in estimated future taxable income may require us to record a valuation allowance against our deferred tax assets. A valuation allowance would result in additional income tax expense in such period, which would negatively affect earnings.

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ITEM 7A – QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

The quantitative and qualitative disclosures about market risk are included under Item 7 – "Management’s Discussion and Analysis of Financial Condition and Results of Operations – Quantitative and Qualitative Disclosures About Market Risk.”

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ITEM 8 – FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

Report of Independent Registered Public Accounting Firm

Shareholders and the Board of Directors of Midland States Bancorp, Inc.

Effingham, Illinois

Opinions on the Financial Statements and Internal Control over Financial Reporting

We have audited the accompanying consolidated balance sheets of Midland States Bancorp, Inc. (the "Company") as of December 31, 2020 and 2019, the related consolidated statements of income, comprehensive income, shareholders’ equity, and cash flows for each of the years in the three-year period ended December 31, 2020, and the related notes (collectively referred to as the "financial statements"). We also have audited the Company’s internal control over financial reporting as of December 31, 2020, based on criteria established in Internal Control – Integrated Framework: (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO).

In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of the Company as of December 31, 2020 and 2019, and the results of its operations and its cash flows for each of the years in the three-year period ended December 31, 2020 in conformity with accounting principles generally accepted in the United States of America. Also in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2020, based on criteria established in Internal Control – Integrated Framework: (2013) issued by COSO.

Change in Accounting Principle

As discussed in Note 1 to the financial statements, the Company changed its method for accounting for credit losses effective January 1, 2020, due to the adoption of Financial Accounting Standards Board (FASB) Accounting Standards Codification No. 326, Financial Instruments - Credit Losses (ASC 326). The Company adopted the new credit loss standard using the modified retrospective method such that prior period amounts are not adjusted and continue to be reported in accordance with previously applicable generally accepted accounting principles. The adoption of the new credit loss standard and its subsequent application is also communicated as a critical audit matter below.

Basis for Opinions

The Company’s management is responsible for these financial statements, for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management’s Annual Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on the Company’s financial statements and an opinion on the Company’s internal control over financial reporting based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) ("PCAOB") and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.

We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud, and whether effective internal control over financial reporting was maintained in all material respects.

Our audits of the financial statements included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. Our audit of

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internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions.

Definition and Limitations of Internal Control Over Financial Reporting

A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

Critical Audit Matters

The critical audit matters communicated below are matters arising from the current period audit of the financial statements that were communicated or required to be communicated to the audit committee and that: (1) relate to accounts or disclosures that are material to the financial statements and (2) involved our especially challenging, subjective, or complex judgments. The communication of critical audit matters does not alter in any way our opinion on the financial statements, taken as a whole, and we are not, by communicating the critical audit matters below, providing separate opinions on the critical audit matters or on the accounts or disclosures to which they relate.

Allowance for Credit Losses on Loans

On January 1, 2020 the Company adopted ASC 326, Financial Instruments – Credit Losses, which, among other things, modified the allowance calculation to consider expected losses over the estimated life of loans instead of incurred losses. The Company recorded a reduction to retained earnings net of tax of $7,172,000 as a cumulative-effect adjustment as a result of the adoption of the standard on January 1, 2020. See change in accounting principle explanatory paragraph above. As of December 31, 2020, the Company’s allowance for credit losses on loans was $60,443,000, and the provision for credit losses on loans was $43,149,000 for the year then ended. Refer to Notes 1 and 5 of the consolidated financial statements for information on the allowance for credit losses under CECL.

Upon adoption and in continued application of CECL, the Company employed a probability of default (“PD”) and loss given default (“LGD”) modeling approach. The estimated PD and LGD rates are applied to the estimated exposure at default (“EAD”) to calculate expected credit losses. The Company’s CECL model utilizes linear regression analysis to develop default rates based on forecasted macroeconomic variables that correlate to and are predictive of losses. The methodologies utilized to develop and implement the macroeconomic factors that drive the loss estimates in the forecasting model were complex in their use of linear regression modeling techniques. The process involved the selection of the macroeconomic variables and the evaluation of regression analysis outputs to determine the statistical fit of the macroeconomic variables used to forecast expected credit losses. The Company also developed a qualitative analysis framework to address asset specific risks, changes in economic and business conditions, the impact of COVID-19 on its customers’ operations and/or other factors that were not inherently considered by the model for each portfolio segment. Significant management judgment was required in evaluating the qualitative adjustments used in the analysis.

The audit procedures over the modeling techniques used to determine loss estimates and the selection and application of the macroeconomic variables involved a high degree of auditor judgment and required significant audit effort, including the use of more experienced audit personnel and use of our credit and valuation specialists due to its complexity. Additionally, the audit procedures over the qualitative adjustments utilized in management’s

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methodology involved challenging and subjective auditor judgment. Therefore, we identified auditing the CECL modeling techniques and qualitative risk factors as a critical audit matter.

The primary audit procedures we performed to address this critical audit matter included:

•Tested the operating effectiveness of the Company’s controls over:

◦The Company’s allowance committee’s oversight and approval of management’s application of accounting policies, and selection and implementation of PD and LGD assumptions.

◦Management’s review relating to selection and implementation of relevant macroeconomic variables and their appropriateness.

◦Management’s review over the calculation methodologies, adjustments, and validation of the allowance model.

◦The completeness and accuracy of internal data used in the loss estimation models and in the qualitative analysis framework.

◦Management’s review over the relevance and reliability of external data used in the loss estimation model and qualitative analysis framework.

◦The mathematical accuracy of the qualitative adjustments.

•Evaluated the reasonableness and appropriateness of the methodologies employed for suitability under the standard including, but not limited to, evaluating their conceptual soundness and testing the PD models and LGD assumptions and judgments in estimating expected credit losses.

•Tested the internal data used in the loss estimation model for completeness and accuracy.

•Specific to qualitative analysis we performed the following procedures, among others:

◦Assessed the appropriateness and reasonableness of the framework developed for the qualitative analysis including evaluating management’s judgments as to which factors impacted the qualitative analysis for each portfolio segment.

◦Evaluated the reasonableness and the relevance of data used in the qualitative analysis methodology.

◦Performed testing over the accuracy of inputs utilized in the calculation of qualitative analysis for each portfolio segment.

◦Tested the mathematical accuracy of the calculation of the qualitative adjustments.

Commercial FHA Servicing Rights – Determining the Fair Value

As described in Notes 1 and 8 to the consolidated financial statements, as part of its commercial mortgage banking activities, the Company holds mortgage servicing rights (“MSR’s”) resulting from the right to service loans that are sold in the secondary market. These MSR’s are carried at the lower of the initial capitalized amount, net of accumulated amortization, or estimated fair value.

Determining the fair value of the MSR is considered a critical accounting estimate, as it requires significant judgment and the use of subjective measurements. The fair value is estimated by using a cash flow valuation model that calculates the present value of estimated future net servicing cash flows, taking into consideration expected mortgage loan prepayment rates, discount rates, servicing costs, escrow and replacement reserves, and other economic factors which are estimated based on current market conditions.

We identified the fair value determination of the commercial FHA mortgage servicing rights as a critical audit matter as the valuation methodology is complex and includes assumptions and estimates over unobservable inputs which require significant judgment to evaluate. Changes in these estimates and assumptions may have a material impact on the Company’s financial position or the results of operations. Auditing these elements involved challenging auditor judgment due to the nature and extent of audit effort required to address these matters, including the extent of specialized skill or knowledge needed.

The primary audit procedures we performed to address this critical audit matter included:

•Tested the operating effectiveness of the Company’s controls over:

◦The review of the completeness and accuracy of the data that is provided to the third-party valuation firm.

◦The review and approval by management of the valuation model, including the independent review of the significant assumptions and inputs used and the concluded placement within the calculated range.

•Used a third-party valuation specialist to assist in the evaluation of the reasonableness of fair value of the commercial FHA mortgage servicing rights.

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•Tested the mathematical accuracy of the calculation.

•Tested the completeness and accuracy of the internal loan data used in the valuation model.

Crowe LLP

We have served as the Company’s auditor since 2017.

Indianapolis, Indiana

February 26, 2021

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MIDLAND STATES BANCORP, INC.

CONSOLIDATED BALANCE SHEETS

(dollars in thousands, except per share data)

December 31,

Assets

Equity securities, at fair value 9,424 5,621

Allowance for credit losses on loans (60,443) (28,028)

Operating lease right-of-use assets 9,177 14,224

Loan servicing rights, at lower of cost or fair value 39,276 53,824

Cash surrender value of life insurance policies 146,004 142,423

Liabilities and Shareholders’ Equity

Liabilities:

Deposits:

Shareholders’ Equity:

Accumulated other comprehensive income 11,431 7,442

The accompanying notes are an integral part of the consolidated financial statements.

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MIDLAND STATES BANCORP, INC.

CONSOLIDATED STATEMENTS OF INCOME

(dollars in thousands, except per share data)

Years Ended December 31,

Interest income:

Loans:

Investment securities:

Interest expense:

Provision for credit losses:

Provision for credit losses on unfunded commitments 846 — —

Provision for other credit losses 366 — —

Noninterest income:

Gain on sales of investment securities, net 1,721 674 464

Noninterest expense:

Loss (gain) on mortgage servicing rights held for sale 1,692 (490) 458

Impairment related to facilities optimization 12,847 3,577 —

FHLB advances prepayment fees 4,872 — —

Preferred stock dividends and premium amortization — 46 141

Per common share data:

Basic earnings per common share $ 0.95 $ 2.28 $ 1.69

Diluted earnings per common share $ 0.95 $ 2.26 $ 1.66

The accompanying notes are an integral part of the consolidated financial statements.

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MIDLAND STATES BANCORP, INC.

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(dollars in thousands)

Years Ended December 31,

Other comprehensive income (loss):

Investment securities available for sale:

Unrealized gains (losses) that occurred during the period 6,454 13,847 (4,845)

Provision for credit loss expense 366 — —

Cash flow hedges:

Net unrealized derivative gains on cash flow hedges 403 — —

Income tax effect (111) — —

Change in cash flow hedges, net of tax 292 — —

Other comprehensive income (loss), net of tax 3,989 9,550 (3,866)

The accompanying notes are an integral part of the consolidated financial statements.

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MIDLAND STATES BANCORP, INC.

CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY

YEARS ENDED DECEMBER 31, 2020, 2019 AND 2018

(dollars in thousands, except per share data)

Other comprehensive loss — — — — (3,866) (3,866)

Preferred dividends declared — — — (330) — (330)

Preferred stock, premium amortization (189) — — 189 — —

Common dividends declared ($0.88 per share) — — — (19,977) — (19,977)

Share-based compensation expense — — 1,533 — — 1,533

Issuance of common stock under employee benefit plans — 2 2,276 — — 2,278

Other comprehensive income — — — — 9,550 9,550

Acquisition of HomeStar Financial Group, Inc. — 4 10,335 — — 10,339

Preferred dividends declared — — — (191) — (191)

Preferred stock, premium amortization (145) — — 145 — —

Redemption of Series H preferred stock (2,636) — — — — (2,636)

Common dividends declared ($0.97 per share) — — — (23,599) — (23,599)

Common stock repurchased — (2) (4,017) — — (4,019)

Share-based compensation expense — — 2,364 — — 2,364

Issuance of common stock under employee benefit plans — 4 5,790 — — 5,794

Other comprehensive income — — — — 3,989 3,989

Common dividends declared ($1.07 per share) — — — (24,958) — (24,958)

Share-based compensation expense — — 2,175 — — 2,175

Issuance of common stock under employee benefit plans — 2 2,522 — — 2,524

The accompanying notes are an integral part of the consolidated financial statements.

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MIDLAND STATES BANCORP, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

Years Ended December 31,

Cash flows from operating activities:

Amortization of operating lease right-of-use asset 2,547 2,937 —

Increase in cash surrender value of life insurance (3,581) (3,640) (3,579)

Gain on sales of investment securities, net (1,721) (674) (464)

Gain on sales of other real estate owned (78) (185) (544)

Impairment on other real estate owned 1,390 16 301

Loss (gain) on mortgage servicing rights held for sale 1,692 (490) 458

Impairment related to facilities optimization 12,847 3,577 —

Gain on proceeds from bank-owned life insurance — — (709)

Net change in operating assets and liabilities:

Cash flows from investing activities:

Purchases of equity securities (3,345) (82) (59)

Proceeds from sales of equity securities — 105 7,733

Proceeds from sale of commercial FHA origination platform 7,502 — —

Proceeds from sales of nonmarketable equity securities — 12,684 15,099

Proceeds from sales of mortgage servicing rights held for sale — 3,288 12,994

Proceeds from sales of other real estate owned 2,225 1,647 3,879

Proceeds from settlements of bank-owned life insurance — — 1,449

Cash flows from financing activities:

FHLB advances prepayment fees 4,872 — —

Proceeds from issuance of subordinated debt, net of issuance costs — 98,265 —

Payments made on subordinated debt (7,443) (19,543) —

Subordinated debt prepayment fees 193 1,778 —

Cash dividends paid on preferred stock — (191) (330)

Redemption of preferred stock (10) (2,636) —

Net (decrease) increase in cash and cash equivalents (52,865) 180,805 (1,502)

Cash and cash equivalents:

The accompanying notes are an integral part of the consolidated financial statements.

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MIDLAND STATES BANCORP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 1 –SUMMARYOF SIGNIFICANT ACCOUNTING POLICIES

Nature of Operations

Midland States Bancorp, Inc. (the “Company,” “we,” “our,” or “us”) is a diversified financial holding company headquartered in Effingham, Illinois. Our wholly-owned banking subsidiary, Midland States Bank, has branches across Illinois and in Missouri, and provides a full range of commercial and consumer banking products and services, business equipment financing, merchant credit card services, trust and investment management services, and insurance and financial planning services.

In addition, we provided multifamily and healthcare facility Federal Housing Administration (“FHA”) financing through Love Funding Corporation, our non-bank subsidiary. On August 28, 2020, the Company announced that it had completed the sale of its commercial FHA origination platform to Dwight Capital, a nationwide mortgage banking firm headquartered in New York. The Bank continues to service Love Funding's current servicing portfolio of approximately $3.50 billion.

Our principal business activity has been lending to and accepting deposits from individuals, businesses, municipalities and other entities. We have derived income principally from interest charged on loans and, to a lesser extent, from interest and dividends earned on investment securities. We have also derived income from noninterest sources, such as: fees received in connection with various lending and deposit services; wealth management services; commercial FHA mortgage loan servicing; residential mortgage loan originations, sales and servicing; and, from time to time, gains on sales of assets. Our principal expenses include interest expense on deposits and borrowings, operating expenses, such as salaries and employee benefits, occupancy and equipment expenses, data processing costs, professional fees and other noninterest expenses, provisions for credit losses and income tax expense.

Basis of Presentation

The accompanying consolidated financial statements of the Company have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) and conform to predominant practices within the banking industry. Management of the Company has made a number of estimates and assumptions related to the reporting of assets and liabilities to prepare the consolidated financial statements in conformity with GAAP. Actual results may differ from those estimates. In the opinion of management, all adjustments, consisting of normal recurring accruals considered necessary for a fair presentation of the results of operations for annual periods presented herein, have been included. Certain reclassifications of 2019 and 2018 amounts have been made to conform to the 2020 presentation but do not have an effect on net income or shareholders’ equity.

Principles of Consolidation

The consolidated financial statements include the accounts of the parent company and its subsidiaries. All significant intercompany accounts and transactions have been eliminated. Assets held for customers in a fiduciary or agency capacity, other than trust cash on deposit with the Bank, are not assets of the Company and, accordingly, are not included in the accompanying consolidated financial statements.

Subsequent Events

Management has evaluated subsequent events for recognition and disclosure through February 26, 2021, which is the date the financial statements were available to be issued.

Business Combinations

The Company accounts for business combinations under the acquisition method of accounting in accordance with ASC 805, Business Combinations. Under the acquisition method of accounting, tangible and intangible identifiable assets acquired, liabilities assumed and any noncontrolling interests in the acquiree are recorded at fair value as of the acquisition date. The Company includes the results of operations of the acquired company in the consolidated statements of income from the date of acquisition. Transaction costs and costs to restructure the acquired company are expensed as incurred. Goodwill is recognized as the excess of the acquisition price over the estimated fair value of the net assets acquired. If the fair value of the net assets acquired is greater than the acquisition price, a bargain purchase gain is recognized and recorded in noninterest income.

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Cash and Cash Equivalents and Cash Flows

For the presentation in the accompanying consolidated statement of cash flows, cash and cash equivalents are defined as cash on hand, amounts due from banks, which includes amounts on deposit with the Federal Reserve, interest-bearing deposits with banks or other financial institutions and federal funds sold. Generally, federal funds are sold for one-day periods, but not longer than 30 days.

The following table summarizes supplemental cash flow information:

Years Ended December 31,

Supplemental disclosures of cash flow information:

Cash payments for:

Supplemental disclosures of noncash investing and financing activities:

Transfer of premises and equipment, net to assets held for sale 11,344 4,350 —

Investment Securities

The Company classifies its debt investment securities as available for sale or held to maturity at the time of purchase. Securities held to maturity are those debt instruments which the Company has the positive intent and ability to hold until maturity. Securities held to maturity are recorded at cost, adjusted for the amortization of premiums or accretion of discounts. All other debt securities are classified as available for sale. As of December 31, 2020, all investment securities were classified as available for sale. Investment securities available for sale are recorded at fair value with the unrealized gains and losses, net of the related tax effect, included in other comprehensive income. The related accumulated unrealized holding gains and losses are reported as a separate component of shareholders’ equity until realized.

Available-for-sale debt securities in an unrealized loss position are evaluated, at least quarterly, for impairment related to credit losses. The Company first assesses whether it intends to sell, or it is more likely than not that it will be required to sell, the security before recovery of its amortized cost basis. If either of the criteria regarding intent or requirement to sell is met, the security’s amortized cost basis is written down to fair value through income. For debt securities available for sale that do not meet the aforementioned criteria, the Company evaluates whether the decline in fair value has resulted from credit losses or other factors. In making this assessment, management considers the extent to which fair value is less than amortized cost, any changes to the rating of the security by a rating agency, and adverse conditions specifically related to the security, among other factors. If this assessment indicates that a credit loss exists, and the present value of cash flows expected to be collected from the security is less than the amortized cost basis, a credit loss exists and an ACL is recorded for the credit loss, limited by the amount that the fair value is less than the amortized cost basis. Any impairment that has not been recorded through an allowance for credit losses is recorded in other comprehensive income.

Changes in the allowance for credit losses are recorded as provision for, or reversal of, credit loss expense. Losses are charged against the allowance when management believes the uncollectibility of an available-for-sale security is confirmed or when either of the criteria regarding intent or requirement to sell is met.

Purchase premiums are amortized over the estimated life or to the earliest call date and purchase discounts are accreted over the estimated life of the related investment security as an adjustment to yield using the effective interest method. Unamortized premiums, unaccreted discounts, and early payment premiums are recognized in interest income upon disposition of the related security. Interest and dividend income are recognized when earned. Realized gains and losses from the sale of investment securities available for sale are determined using the specific identification method and are included in noninterest

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income. Also, when applicable, realized gains and losses are reported as a reclassification adjustment, net of tax, in other comprehensive income.

Equity Securities

Investments in stock of a publicly traded company or in mutual funds are classified as equity securities. Equity securities are recorded at fair value with unrealized gains and losses recognized in net income.

Nonmarketable Equity Securities

Nonmarketable equity securities include the Bank’s required investments in the stock of the Federal Home Loan Bank (“FHLB”) and the Federal Reserve Bank (“FRB”). The Bank is a member of the FHLB system as well as its regional FRB. Members of the FHLB are required to own a certain amount of stock based on the level of borrowings and other factors, and may invest in additional amounts. FHLB stock and FRB stock are both carried at cost, classified as a restricted security, and periodically evaluated for impairment based on ultimate recovery of par value. Both cash and stock dividends are reported as income.

Loans

Loans that management has the intent and ability to hold for the foreseeable future or until maturity or payoff are classified as portfolio loans and carried at amortized cost, i.e., the principal balance outstanding, net of purchase premiums and discounts, fair value hedge accounting adjustments, and deferred loan fees and costs. Interest income is accrued on the unpaid principal balance. Accrued interest receivable on loans totaled $19.9 million at December 31, 2020 and was reported in accrued interest receivable on the consolidated balance sheets.

Interest income on mortgage and commercial loans is discontinued and the loan is placed on nonaccrual status at the time the loan is 90 days delinquent unless the loan is well secured and in process of collection. Mortgage loans are charged off at 180 days past due, and commercial loans are charged off to the extent principal or interest is deemed uncollectible. Consumer and credit card loans continue to accrue interest until they are charged off or at an earlier date if collection of principal or interest is considered doubtful.

All interest accrued but not received for loans placed on nonaccrual is reversed against interest income. Interest received on such loans is accounted for on the cost-recovery or cash-basis method, until qualifying for return to accrual. Under the cost-recovery method, interest income is not recognized until the loan balance is reduced to zero. Under the cash-basis method, interest income is recorded when the payment is received in cash. Loans are returned to accrual status when all the principal and interest amounts contractually due are brought current and future payments are reasonably assured.

Leases. The Company provides financing leases to small businesses for purchases of business equipment. Under the direct financing method of accounting, the minimum lease payments to be received under the lease contract, together with the estimated unguaranteed residual values (approximately 3% to 15% of the cost of the related equipment), are recorded as lease receivables when the lease is signed and the leased property is delivered to the customer. The excess of the minimum lease payments and residual values over the cost of the equipment is recorded as unearned lease income. Unearned lease income is recognized over the term of the lease on a basis that results in an approximately level rate of return on the unrecovered lease investment.

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

Nonperforming Loans. A loan is considered nonperforming when it is probable that we will be unable to collect all amounts due according to the contractual terms of the loan agreement. Nonperforming loans include loans on nonaccrual status, loans past due 90 days or more and still accruing interest, and performing troubled debt restructured loans. Income from loans on nonaccrual status is recognized to the extent cash is received and when the principal balance is deemed collectible. Depending on a particular loan’s circumstances, we measure impairment based upon either the present value of expected future cash flows discounted at the effective interest rate, the observable market price, or the fair value of the collateral less estimated costs to sell if the loan is collateral dependent. A loan is considered collateral dependent when repayment is based solely on the liquidation of the collateral. Fair value, where possible, is determined by independent appraisals, typically on an annual basis. Between appraisal periods, the fair value may be adjusted based on specific events, such as if deterioration of quality of the

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collateral comes to our attention as part of our problem loan monitoring process, or if discussions with the borrower lead us to believe the last appraised value no longer reflects the actual market for the collateral. The impairment amount is charged-off to the allowance if deemed not collectible or is set up as a specific reserve.

Allowance for Credit Losses on Loans

The ACL on loans is a valuation account that is deducted from the loans’ amortized cost basis to present the net amount expected to be collected on the loans. The amount of the allowance represents management's best estimate of current expected credit losses on loans considering available information, from internal and external sources, relevant to assessing collectibility over the loans' contractual terms, adjusted for expected prepayments when appropriate. The contractual term excludes expected extensions, renewals, and modifications. unless either of the following applies: management has a reasonable expectation at the reporting date that a troubled debt restructuring will be executed with an individual borrower or the extension or renewal options are included in the original or modified contract at the reporting date and are not unconditionally cancellable by the Company.

Management estimates the allowance balance using relevant information, from internal and external sources, relating to historical credit loss experience, current conditions, and reasonable and supportable forecasts. While historical credit loss experience provides the basis for the estimation of expected credit losses, adjustments to historical loss information may be made for differences in current loan-specific risk characteristics, environmental conditions or other relevant factors. ACL on loans is measured on a collective basis and reflects impairment in groups of loans aggregated on the basis of similar risk characteristics. Loans that do not share risk characteristics are evaluated for expected credit losses on an individual basis and excluded from the collective evaluation. Expected credit losses for collateral dependent loans, including loans where the borrower is experiencing financial difficulty but foreclosure is not probable, are based on the fair value of the collateral at the reporting date, adjusted for selling costs as appropriate.

Credit loss expense related to loans reflects the totality of actions taken on all loans for a particular period including any necessary increases or decreases in the allowance related to changes in credit loss expectations associated with specific loans or pools of loans. Portions of the allowance may be allocated for specific credits; however, the entire allowance is available for any credit that, in management’s judgment, should be charged off. While management utilizes its best judgment and information available, the ultimate appropriateness of the allowance is dependent upon a variety of factors beyond our control, including the performance of our loan portfolio, the economy, changes in interest rates and the view of the regulatory authorities toward loan classifications.

In calculating the allowance for credit losses, most loans are segmented into pools based upon similar characteristics and risk profiles. Common characteristics and risk profiles may include internal credit ratings, risk ratings or classification, financial asset type, collateral type, size, industry of the borrower, historical or expected credit loss patterns, and reasonable and supportable forecast periods. For modeling purposes, our loan pools include (i) commercial, (ii) commercial real estate, (iii) construction and land development, (iv) residential real estate, (v) consumer, and (vi) lease financing. We periodically reassess each pool to ensure the loans within the pool continue to share similar characteristics and risk profiles and to determine whether further segmentation is necessary.

The table below identifies the Company’s loan portfolio segments and classes.

Segment Class

Commercial Commercial

Commercial Other

Commercial Real Estate Commercial Real Estate Non-Owner Occupied

Commercial Real Estate Owner Occupied

Multi-Family

Farmland

Construction and Land Development Construction and Land Development

Residential Real Estate Residential First Lien

Other Residential

Consumer Consumer

Consumer Other

Lease Financing Lease Financing

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For each loan pool, we measure expected credit losses over the life of each loan utilizing a combination of models which measure (i) probability of default (“PD”), which is the likelihood that loan will stop performing/default, (ii) loss given default (“LGD”), which is the expected loss rate for loans in default, (iii) assumed prepayment speed, which is the likelihood that a loan will prepay or pay-off prior to maturity, and (iv) exposure at default (“EAD”), which is the estimated outstanding principal balance of the loans upon default, including the expected funding of unfunded commitments outstanding as of the measurement date. For certain commercial loan portfolios, the PD is calculated using a transition matrix to determine the likelihood of a customer’s risk grade migrating from one specified range of risk grades to a different specified range. Expected credit losses are calculated as the product of PD (adjusted for prepayment), LGD and EAD. This methodology builds on default probabilities already incorporated into our risk grading process by utilizing pool-specific historical loss rates to calculate expected credit losses. These pool-specific historical loss rates may be adjusted for current macroeconomic assumptions, as further discussed below, and other factors such as differences in underwriting standards, portfolio mix, or when historical asset terms do not reflect the contractual terms of the financial assets being evaluated as of the measurement date. Each time we measure expected credit losses, we assess the relevancy of historical loss information and consider any necessary adjustments to address any differences in asset-specific characteristics.

The measurement of expected credit losses is impacted by loan/borrower attributes and certain macroeconomic variables. Significant loan/borrower attributes utilized in our modeling processes include, among other things, (i) origination date, (ii) maturity date, (iii) payment type, (iv) collateral type and amount, (v) current risk grade, (vi) current unpaid balance and commitment utilization rate, (vii) payment status/delinquency history and (viii) expected recoveries of previously charged-off amounts. Significant macroeconomic variables utilized in our modeling processes include, among other things, (i) US and Illinois Disposable Income and Gross Domestic Product, (ii) selected market interest rates including U.S. Treasury rates and government bond rates, among others, (iii) Consumer Price Index, (iv) commercial and residential property prices in Illinois and the US as a whole, and (v) Illinois Housing Starts and Retail Sales for the State of Illinois and US.

The probability of default and prepayment assumptions were estimated by analyzing internally-sourced data related to historical performance of each loan pool. They are adjusted to reflect the current impact of certain macroeconomic variables as well as their expected changes over a reasonable and supportable forecast period. We have determined that we are reasonably able to forecast the macroeconomic variables used in our modeling processes with an acceptable degree of confidence for a total of two years with the last twelve months of the forecast period encompassing a reversion process whereby the forecasted macroeconomic variables are reverted to their historical mean utilizing a straight line basis. The macroeconomic variables utilized as inputs in our modeling processes were subjected to a variety of analysis procedures and were selected primarily based on statistical relevancy and correlation to our historical credit losses. By reverting these modeling inputs to their historical mean and considering loan/borrower specific attributes, our models are intended to yield a measurement of expected credit losses that reflects our average historical loss rates for periods subsequent to the twelve-month reversion period. The LGD is based on historical recovery averages for each loan pool, adjusted to reflect the current impact of certain macroeconomic variables as well as their expected changes over a two-year forecast period, with the final twelve months of the forecast period encompassing a reversion process, which management considers to be both reasonable and supportable. This same forecast/reversion period is used for all macroeconomic variables used in all of our models.

Management qualitatively adjusts model results for risk factors that are not considered within our modeling processes but are nonetheless relevant in assessing the expected credit losses within our loan pools. These qualitative factor (“Q-Factor”) adjustments may increase or decrease management's estimate of expected credit losses by a calculated percentage or amount based upon the estimated level of risk. The various risks that may be considered in making Q-Factor adjustments include, among other things, the impact of (i) changes in lending policies and procedures, including changes in underwriting standards and practices for collections, write-offs, and recoveries, (ii) actual and expected changes in economic and business conditions and developments that affect the collectibility of the loan pools, (iii) changes in the nature and volume of the loan pools and in the terms of the underlying loans, (iv) changes in the experience, ability, and depth of our lending management and staff, (v) changes in volume and severity of past due financial assets, the volume of non-accrual assets, and the volume and severity of adversely classified or graded assets, (vi) changes in the quality of our credit review function, (vii) changes in the value of the underlying collateral for loans that are non-collateral dependent, (viii) the existence, growth, and effect of any concentrations of credit and (ix) other factors such as the regulatory, legal and technological environments; competition; and events such as natural disasters or health pandemics.

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

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value of the collateral at the measurement date, adjusted for estimated selling costs if satisfaction of the loan depends on the sale of the collateral. We reevaluate the fair value of collateral supporting collateral dependent loans on a quarterly basis.

Specific reserves reflect expected credit losses on loans identified for evaluation or individually considered nonperforming. These loans no longer have similar risk characteristics to collectively evaluated loans due to changes in credit risk, borrower circumstances, recognition of write-offs, or cash collections that have been fully applied to principal on the basis of nonaccrual policies. At a minimum, the population of loans subject to individual evaluation include individual loans where it is probable we will be unable to collect all amounts due, according to the original contractual terms. These include, nonaccrual loans with an effective balance greater than $500,000, accruing loans 90 days past due or greater with an effective balance greater than $100,000, specialty lending relationships and other loans as determined by management. ACL for consumer and residential loans are, primarily, determined by meaningful pools of similar loans and are evaluated on a quarterly basis.

The provision for credit losses on loans individually evaluated is recognized on the basis of the present value of expected future cash flows discounted at the effective interest rate, the fair value of collateral adjusted for estimated costs to sell, or the observable market price as of the relevant date. ACL on loans adjustments for estimated costs to sell are not appropriate when the repayment of the collateral-dependent loan is expected from the operation of the collateral.

Loans Held for Sale

Loans held for sale consist of residential and commercial FHA mortgage loans originated with the intent to sell. Loans held for sale are carried at fair value, determined individually, as of the balance sheet date. The Company believes the fair value method better reflects the economic risks associated with these loans. Fair value measurements on loans held for sale are based on quoted market prices for similar loans in the secondary market, market quotes from anticipated sales contracts and commitments, or contract prices from firm sales commitments. The changes in the fair value of loans held for sale are reflected in commercial FHA revenue and residential mortgage banking revenue on the consolidated statements of income.

Mortgage Repurchase Reserve

The Company sells residential mortgage loans to investors in the normal course of business. Residential mortgage loans sold to investors are predominantly conventional residential first lien mortgages originated under our usual underwriting procedures, and are sold on a nonrecourse basis. The Company’s agreements to sell residential mortgage loans usually require general representations and warranties on the underlying loans sold, related to credit information, loan documentation, collateral, and insurability, which if subsequently untrue or breached, could require the Company to indemnify or repurchase certain loans affected. The balance in the repurchase reserve at the balance sheet date reflects the estimated amount of potential loss the Company could incur from repurchasing a loan, as well as loss reimbursements, indemnification, and other “make whole” settlement resolutions. Refer to Note 22 in the consolidated financial statements for additional information on the mortgage repurchase reserve.

Premises and Equipment

Premises, furniture and equipment, and leasehold improvements are stated at cost less accumulated depreciation. Depreciation expense is computed principally on the straight-line method over the estimated useful lives of the assets. Leasehold improvements are amortized on a straight-line basis over the shorter of the life of the asset or the lease term. Estimated useful lives of premises and equipment range from 10 to 40 years and from 3 to 10 years, respectively. Maintenance and repairs are charged to operating expenses as incurred, while improvements that extend the useful life of assets are capitalized and depreciated over the estimated remaining life.