SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
☒ ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2020
☐ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from __________to_________
Commission file number 0-17071
FIRST MERCHANTS CORPORATION
(Exact name of registrant as specified in its charter)
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
200 East Jackson Street, Muncie, IN 47305-2814
(Address of principal executive offices) (Zip code)
Registrant’s telephone number, including area code: (765)747-1500
(Former name, former address and former fiscal year,
if changed since last report)
Securities registered pursuant to Section 12(b) of the Act:
|Title of Each Class||Trading Symbol(s)||Name of each exchange on which registered|
|Common Stock, $0.125 stated value per share||FRME||Nasdaq Global Select Market|
Securities registered pursuant to Section 12(g) of the Act: None
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes ☒ No ☐
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes ☐ No ☒
Indicate by check mark whether the registrant(1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ☒ No ☐
Indicate by check mark whether the registrant has submitted electronically every interactive data file required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files) Yes ☒ No ☐
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.
Large Accelerated Filer
Smaller Reporting Company
Emerging Growth Company
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐
Indicate by check mark whether the registrant has filed a report on and attestation to its management’s assessment of the effectiveness of its internal control over financial reporting under Section 404(b) of the Sarbanes-Oxley Act (15 U.S.C.7262(b)) by the registered public accounting firm that prepared or issued its audit report. ☒
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes ☐ No ☒
The aggregate market value (not necessarily a reliable indication of the price at which more than a limited number of shares would trade) of the voting stock held by non-affiliates of the registrant was $1,483,142,000 as of the last business day of the registrant's most recently completed second fiscal quarter (June 30, 2020).
As of February 23, 2021 there were 54,347,186 outstanding common shares, without par value, of the registrant.
DOCUMENTS INCORPORATED BY REFERENCE
|Documents||Part of Form 10-K into which incorporated|
|Portions of the Registrant’s Definitive||Part III (Items 10 through 14)|
|Proxy Statement for Annual Meeting of|
|Shareholders to be held May 11, 2021|
FIRST MERCHANTS CORPORATION
GLOSSARY OF DEFINED TERMS
FIRST MERCHANTS CORPORATION
|Arlington Bank||The Arlington Bank, which was acquired by the Corporation on May 19, 2017|
|ASC||Accounting Standards Codification|
|AOCI||Accumulated Other Comprehensive Income|
|Bank||First Merchants Bank, a wholly-owned subsidiary of the Corporation|
|BHC Act||Bank Holding Company Act of 1956|
|CARES Act||Coronavirus Aid, Relief and Economic Security Act|
FASB Accounting Standards Update No. 2016-13, Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments
|CET1||Common Equity Tier 1|
|CFPB||Consumer Financial Protection Bureau|
|CMT||Constant Maturity Treasury|
|CAA||The 2021 Consolidated Appropriations Act, signed into law on December 27, 2020, provided the annual funding for the federal government and also contained several rules giving further COVID-19 relief|
|Corporation||First Merchants Corporation|
|COVID-19||2019 novel coronavirus disease, which was declared a pandemic by the World Health Organization on March 11, 2020.|
|Dodd-Frank Act||Dodd-Frank Wall Street Reform and Consumer Protection Act|
|Economic Impact Payments||Economic stimulus payments of up to $1,200 per adult and $500 per child, subject to eligibility requirements and certain limitations, as established under the CARES Act and distributed by the IRS.|
|ERISA||Employee Retirement Income Security Act of 1974 |
|ESPP||Employee Stock Purchase Plan|
|FASB||Financial Accounting Standards Board|
|FDIC||Federal Deposit Insurance Corporation|
|FDICIA||Federal Deposit Insurance Corporation Improvement Act of 1991|
|Federal Reserve||Board of Governors of the Federal Reserve System|
|FHLB||Federal Home Loan Bank|
|FTE||Fully taxable equivalent|
|GAAP||Accounting Principles Generally Accepted in the United States of America|
|IAB||Independent Alliance Banks, Inc., which was acquired by the Corporation on July 14, 2017|
|Indiana DFI||Indiana Department of Financial Institutions|
|Interagency Statement||Interagency Statement on Loan Modifications and Reporting for Financial Institutions Working with Customers Affected by the Coronavirus issued by banking regulators on March 22, 2020|
|MBT||MBT Financial Corp., which was acquired by the Corporation on September 1, 2019|
|OCC||Office of the Comptroller of the Currency|
|OREO||Other real estate owned|
|RSA||Restricted Stock Awards|
|PPP||Paycheck Protection Program, which was established by the CARES Act and implemented by the Small Business Administration to provide small business loans.|
|PPPLF||Paycheck Protection Program Liquidity Facility, which was established by the Federal Reserve.|
|Sarbanes-Oxley Act||Sarbanes-Oxley Act of 2002|
|Savings Plan||The First Merchants Corporation Retirement and Income Savings Plan|
|SEC||Securities and Exchange Commission|
|TCJA||Tax Cuts and Jobs Act, which was enacted by the U.S. Government on December 22, 2017|
|TEFRA||Tax Equity and Fiscal Responsibility Act. The TEFRA disallowance reduces the amount of interest expense an entity may deduct for the purpose of carrying tax-free investment securities.|
|Treasury||U.S. Department of Treasury|
|USI||USI Insurance Services, LLC|
The Corporation from time to time includes forward-looking statements in its oral and written communication. The Corporation may include forward-looking statements in filings with the SEC, such as its Annual Reports on Form 10-K and its Quarterly Reports on Form 10-Q, in other written materials and oral statements made by senior management to analysts, investors, representatives of the media and others. The Corporation intends these forward-looking statements to be covered by the safe harbor provisions for forward-looking statements contained in the Private Securities Litigation Reform Act of 1995, and the Corporation is including this statement for purposes of these safe harbor provisions. Forward-looking statements can often be identified by the use of words like “believe”, “continue”, “pattern”, “estimate”, “project”, “intend”, “anticipate”, “expect” and similar expressions or future or conditional verbs such as “will”, “would”, “should”, “could”, “might”, “can”, “may” or similar expressions. These forward-looking statements include:
•statements of the Corporation’s goals, intentions and expectations;
•statements regarding the Corporation’s business plan and growth strategies;
•statements regarding the asset quality of the Corporation’s loan and investment portfolios; and
•estimates of the Corporation’s risks and future costs and benefits.
These forward-looking statements are subject to significant risks, assumptions and uncertainties, including, among other things, those discussed in Item 1A, “RISK FACTORS”.
Because of these and other uncertainties, the Corporation’s actual future results may be materially different from the results indicated by these forward-looking statements. In addition, the Corporation’s past results of operations do not necessarily indicate its future results.
ITEM 1. BUSINESS
The Corporation is a financial holding company headquartered in Muncie, Indiana and was organized in September 1982. The Corporation’s Common Stock is traded on the Nasdaq Global Select Market under the symbol FRME. The Corporation has one full-service bank charter, First Merchants Bank, which opened for business in Muncie, Indiana, in March 1893. The Bank also operates First Merchants Private Wealth Advisors (a division of First Merchants Bank). The Bank includes 124 banking locations in Indiana, Ohio, Michigan and Illinois. In addition to its branch network, the Corporation offers comprehensive electronic and mobile delivery channels to its customers. The Corporation’s business activities are currently limited to one significant business segment, which is community banking.
Through the Bank, the Corporation offers a broad range of financial services, including accepting time, savings and demand deposits; making consumer, commercial, agri-business and real estate mortgage loans; providing personal and corporate trust services; offering full-service brokerage and private wealth management; and providing letters of credit, repurchase agreements and other corporate services.
All inter-company transactions are eliminated during the preparation of consolidated financial statements.
As of December 31, 2020, the Corporation had consolidated assets of $14.1 billion, consolidated deposits of $11.4 billion and stockholders’ equity of $1.9 billion.
As of December 31, 2020, the Corporation and its subsidiaries had 1,907 full-time equivalent employees. Our stated mission to be the most responsive, knowledgeable, and high performing bank requires a dedicated and talented team of colleagues to succeed. Our employees prepare, every day, to deliver a customer and colleague experience that grows the Corporation. We seek to attract, retain and develop a team of diverse, committed colleagues who are capable of delivering a whole-bank delivery approach. And, we promote a work culture of development, growth, internal promotion and career pathing.
Best Places to Work / Employer of Choice: Winning Best Places to Work in at least three of our four operating states over the past three years, we constantly strive to be an employer of choice. Onboarding, training, talent assessment and development, career conversations, development planning and a culture of pride in high performance help us achieve employer of choice status. Trust, respect, integrity and commitment are at the core of our success.
Employee Engagement: Our biennial Employee Engagement Survey is conducted by a third party vendor for confidentiality and anonymity for increased candid feedback. Results show consistently strong employee engagement with over 87 percent of our employees considered to be “highly engaged.” Our response rates are high (83 percent) with the survey results providing valuable feedback that helps managers promote work satisfaction and high contribution.
Education Assistance: First Merchants offers an education assistance program that supports full- and part-time colleagues as they seek degree programs that will help them advance their careers. From 2018-2020, 144 employees participated in the Education Assistance program with a total investment of approximately $639,000.
Corporate Training: Leveraging a blend of custom designed / internally built training programs and external development resources, First Merchants employees are trained and prepared to perform confidently with role-based training and training focused on topics such as privacy, fair banking and many other industry specific topics and regulations. Our training completion rates are very high related to required development (99 percent completion, due only to leaves of absence) and our Learning Management System (LMS) archives all development in the Corporation. This creates transcripts and a system to further enhance development.
Diversity Equity and Inclusion: We believe in attracting, retaining and promoting a diverse workforce. 2020 marked the beginning of several Diversity Equity and Inclusion ("DEI") initiatives aimed at promoting the career growth and engagement of all First Merchants employees. Our largest employee resource group (First Women Connections) expanded as it continues to promote the careers of women in the Corporation. The creation of a DEI Employee Council is attended by nearly 100 employees every two weeks and the formation of a DEI Steering Committee was established to provide clear direction and set priorities around our efforts to further our successes of our increasingly diverse organization.
Talent Assessment, Succession Planning and Career Path: Nearly 1,000 of our employees participated in our annual Calibration Process (9 Box Talent Assessment) with the goal of ensuring employees are held to the same high standards across the Corporation and to identify specific development action planning to help retain employees with high potential and performance, increase job satisfaction and high productivity. Talent calibration supports succession and career planning for the Corporation.
The Corporation makes its Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended, available on its website at https://www.firstmerchants.com without charge, as soon as reasonably practicable, after such reports are electronically filed with, or furnished to, the Securities and Exchange Commission. The SEC maintains an internet site that contains reports, proxy and information statements, and other information regarding issuers that file electronically with the SEC, including the Corporation. Those filings are accessible on the SEC’s website at http://www.sec.gov.
ACQUISITION AND DIVESTITURE POLICY
The Corporation anticipates that it will continue its policy of geographic expansion of its banking business through the acquisition of banks whose operations are consistent with its banking philosophy. Management routinely explores opportunities to acquire financial institutions and other financial services-related businesses and to enter into strategic alliances to expand the scope of its services and its customer base. Future acquisitions and divestitures will be driven by a disciplined financial evaluation process and will be consistent with the Corporation's strategy of community banking, client relationships and consistent quality earnings. As with previous acquisitions, the consideration paid in future acquisitions may be in the form of cash or First Merchants common stock, or a combination thereof. The amount and structure of such consideration is based on reasonable growth, synergies and economies of scale and a thorough analysis of the impact on both long- and short-term financial results. Acquisitions typically involve the payment of a premium over book and market values, and, therefore, some dilution of our tangible book value and net income per share may occur in connection with any future transaction. The Corporation's ability to engage in certain merger or acquisition transactions, whether or not any regulatory approval is required, will be dependent upon the Corporation's bank regulators' views at the time as to the capital levels, quality of management and the Corporation's overall condition and their assessment of a variety of other factors. Certain merger or acquisition transactions, including those involving the acquisition of a depository institution or the assumption of the deposits of any depository institution, require formal approval from various bank regulatory authorities, which will be subject to a variety of factors and considerations.
On September 1, 2019, the Corporation acquired 100 percent of MBT. MBT was headquartered in Monroe, Michigan and had 20 banking centers serving the Monroe market. Pursuant to the merger agreement, each MBT shareholder received 0.275 shares of the Corporation's common stock for each outstanding share of MBT common stock held. The Corporation issued approximately 6.4 million shares of common stock, which was valued at approximately $229.9 million. Details of the MBT acquisition can be found in NOTE 2. ACQUISITIONS of the Notes to Consolidated Financial Statements included in Item 8 of this Annual Report on Form 10-K.
On November 21, 2016, the Corporation purchased 495,112 shares, or 12.1 percent, of IAB's outstanding common stock from an IAB shareholder for $19.8 million, or $40.00 per share. On July 14, 2017, the Corporation acquired the remaining shares of IAB common stock. IAB was headquartered in Fort Wayne, Indiana and had 16 banking centers serving the Fort Wayne market. Pursuant to the merger agreement, each IAB shareholder received 1.653 shares of the Corporation's common stock for each outstanding share of IAB common stock held. The Corporation issued approximately 6.0 million shares of common stock. The transaction value for the remaining shares of common stock, not owned by the Corporation, was approximately $238.8 million, resulting in a total purchase price of $258.6 million.
On May 19, 2017, the Corporation acquired 100 percent of Arlington Bank. Arlington Bank was headquartered in Columbus, Ohio and had 3 banking centers serving the Columbus, Ohio market. Pursuant to the merger agreement, each Arlington Bank shareholder received 2.7245 shares of the Corporation's common stock for each outstanding share of Arlington Bank common stock held. The Corporation issued approximately 2.1 million shares of common stock, which was valued at approximately $82.6 million.
The Bank is located in Indiana, Ohio, Michigan and Illinois counties where other financial services companies provide similar banking services. The Bank faces substantial competition in all areas of our operations from a variety of different competitors, many of which are larger and have more financial resources. Such competitors primarily include national, regional and internet banks within the various markets in which the Bank operates, though the Bank also competes with smaller community banks that seek to offer similar service levels. The Bank also faces competition from many other types of institutions, including, without limitation savings and loans associations, credit unions, finance companies, brokerage firms, insurance companies, and other financial intermediaries.
The financial services industry is becoming even more competitive as a result of legislative, regulatory and technological changes and continued consolidation. Banks, securities firms and insurance companies can operate as affiliates under the umbrella of a financial holding company, which can offer virtually any type of financial service, including banking, securities underwriting, insurance (both agency and underwriting) and merchant banking. Also, technology has lowered barriers to enter and made it possible for nonbanks to offer products and services traditionally provided by banks, such as automatic transfer and automatic payment systems. Many of our nonbank competitors have fewer regulatory constraints and may have lower cost structures. Additionally, due to their size, many competitors may be able to achieve economies of scale and, as a result, may offer broader range of products and services as well as better pricing for those products and services than we can. Finally, the Bank's competitors may choose to offer lower loan interest rates and pay higher deposit rates.
The Bank believes that the most important criteria to their targeted clients when selecting a bank is the customer's desire to receive exceptional and personal customer service while being able to enjoy convenient access to a broad array of financial products. Additionally, when presented with a choice, the Bank believes that many of their targeted clients prefer to deal with an institution that favors local decision making as opposed to where many important decisions regarding a client's financial affairs are made outside the local community.
REGULATION AND SUPERVISION OF FIRST MERCHANTS CORPORATION AND SUBSIDIARIES
The Corporation and its subsidiaries are subject to extensive regulation under federal and state laws. The regulatory framework is intended primarily for the protection of depositors, federal deposit insurance funds and the banking system as a whole and not for the protection of shareholders and creditors. Significant elements of the laws and regulations applicable to the Corporation and its subsidiaries are described below. The description is qualified in its entirety by reference to the full text of the statues, regulations and policies that are described. Also, such statutes, regulations and policies are continually under review by Congress and state legislatures and federal and state regulatory agencies. A change in statutes, regulations or regulatory policies applicable to the Corporation and its subsidiaries could have a material effect on the Corporation's business, financial condition or results of operations.
Bank Holding Company Regulation
The Corporation is registered as a bank holding company and has elected to be a financial holding company. It is subject to the supervision of, and regulation by the Board of Governors of the Federal Reserve under the BHC Act, as amended. Bank holding companies are required to file periodic reports with and are subject to periodic examination by the Federal Reserve. The Federal Reserve has issued regulations under the BHC Act requiring a bank holding company to serve as a source of financial and managerial strength to the Bank. Thus, it is the policy of the Federal Reserve that a bank holding company should stand ready to use its resources to provide adequate capital funds to the Bank during periods of financial stress or adversity. Additionally, under the FDICIA, a bank holding company is required to guarantee the compliance of any subsidiary bank that may become “undercapitalized” (as defined in the FDICIA section of this Form 10-K) with the terms of any capital restoration plan filed by such subsidiary with its appropriate federal banking agency. Under the BHC Act, the Federal Reserve has the authority to require a bank holding company to terminate any activity or relinquish control of a non-bank subsidiary (other than a non-bank subsidiary of a bank) upon the determination that such activity constitutes a serious risk to the financial stability of any bank subsidiary.
The BHC Act requires the Corporation to obtain the prior approval of the Federal Reserve before:
•acquiring direct or indirect control or ownership of any voting shares of any bank or bank holding company if, after such acquisition, the bank holding company will directly or indirectly own or control more than 5 percent of the voting shares of the bank or bank holding company;
•merging or consolidating with another bank holding company; or
•acquiring substantially all of the assets of any bank.
The BHC Act generally prohibits bank holding companies that have not become financial holding companies from (i) engaging in activities other than banking or managing or controlling banks or other permissible subsidiaries, and (ii) acquiring or retaining direct or indirect control of any company engaged in the activities other than those activities determined by the Federal Reserve to be closely related to banking or managing or controlling banks.
Capital Adequacy Guidelines for Bank Holding Companies (Basel III)
The Corporation and the Bank are subject to certain risk-based capital and leverage ratio requirements under the Basel III capital rules adopted by United States banking regulators. These rules implement the Basel III international regulatory capital standards in the United States, as well as certain provisions of the Dodd-Frank Act.
The Basel III rules require the Corporation and the Bank to maintain minimum ratios of common equity tier 1 capital (“CET1”), tier 1 capital, and total capital to total risk-weighted assets, and of tier 1 capital to average total assets, all of which are calculated as defined in the regulations. Basel III specifies that CET1 consists of common stock instruments (that meet the Basel III eligibility criteria), retained earnings, accumulated other comprehensive income and CET1 minority interest. Basel III also defines CET1 narrowly by requiring that most adjustments to regulatory capital measures be made to CET1, and not to the other components of capital. Tier 1 capital consists of CET1 and "Additional Tier 1 Capital" instruments meeting the specified requirements of Basel III.
Under Basel III, in order to avoid limitations on capital distributions, including dividends, the Corporation must hold a capital conservation buffer of 2.50 percent above the adequately capitalized CET1, tier 1 and total capital to risk-weighted assets ratios.
Specifically, Basel III requires the Corporation and the Bank to maintain:
•a minimum ratio of CET1 to risk-weighted assets of a least 4.5 percent, plus the 2.5 percent capital conservation buffer effectively resulting in a minimum ratio of CET1 to risk-weighted assets of at least 7.0 percent;
•a minimum ratio of Tier 1 capital to risk-weighted assets of at least 6.0 percent, plus the 2.5 percent capital conservation buffer effectively resulting in a minimum Tier 1 capital ratio of 8.5 percent;
•a minimum ratio of total capital (Tier 1 plus Tier 2 capital) to risk-weighted assets of at least 8.0 percent, plus the 2.5 percent capital conservation buffer effectively resulting in a minimum total capital ratio of 10.5 percent; and
•a minimum leverage ratio of 4.0 percent, calculated as the ratio of Tier 1 capital to adjusted average consolidated assets.
Basel III also provides for a “countercyclical capital buffer” that is applicable to only certain covered institutions and is not expected to have any current applicability to the Corporation or the Bank.
The aforementioned capital conservation buffer is designed to absorb losses during periods of economic stress. Banking institutions with risk-weighted capital ratios above the minimum but below the conservation buffer will face limitations on the payment of dividends, common stock repurchases and discretionary cash payments to executive officers based on the amount of the shortfall.
Basel III provides for a number of deductions from and adjustments to CET1. These include, for example, the requirement that mortgage servicing rights, deferred tax assets dependent upon future taxable income and significant investments in non-consolidated financial entities be deducted from CET1 to the extent that any one such category exceeds 10 percent of CET1 or all such categories in the aggregate exceed 15 percent of CET1. Under Basel III, the Corporation and the Bank made a one-time election to filter out certain AOCI components.
Basel III permits banks with less than $15 billion in assets to continue to treat trust preferred securities as Tier 1 capital. This treatment is permanently grandfathered as Tier 1 capital even if the Corporation should ever exceed $15 billion in assets due to organic growth. Should the Corporation exceed $15 billion in assets as the result of a merger or acquisition, then the Tier 1 treatment of its outstanding trust preferred securities will be phased out, but those securities will still be treated as Tier 2 capital. Basel III permits banks with less than $250 billion in assets to choose to continue excluding unrealized gains and losses on certain securities holdings for purposes of calculating regulatory capital. The rules limit a banking organization’s capital distributions and certain discretionary bonus payments if the banking organization does not hold a “capital conservation buffer” consisting of a specified amount of CET1 capital in addition to the amount necessary to meet its minimum risk-based capital requirements.
Historically, the regulation and monitoring of a bank and bank holding company's liquidity has been addressed as a supervisory matter, without minimum required formulaic measures. The Basel III liquidity framework requires banks and bank holding companies to measure their liquidity against specific liquidity tests that, although similar in some respects to liquidity measures historically applied by banks and regulators for management and supervisory purposes, is now required by regulation. One test, referred to as the liquidity coverage ratio, is designed to ensure that the banking entity maintains an adequate level of unencumbered high-quality liquid assets equal to the entity’s expected net cash outflow for a 30-day time horizon (or, if greater, 25% of its expected total cash outflow) under an acute liquidity stress scenario. The other test, referred to as the net stable funding ratio ("NSFR"), is designed to promote more medium- and long-term funding of the assets and activities of banking entities over a one-year time horizon. These requirements are expected to incent banking entities to increase their holdings of U.S. Treasury securities and other sovereign debt as a component of assets and increase the use of long-term debt as a funding source. However, the federal banking agencies have not proposed rules implementing the Basel III liquidity framework and have not determined to what extent they will apply to U.S. banks that are not large, internationally active banks.
On April 9, 2020, federal banking regulators issued an interim final rule to modify the Basel III regulatory capital rules applicable to banking organizations to allow those organizations participating in the Paycheck Protection Program (“PPP”) established under the Coronavirus Aid, Relief and Economic Security Act (the “CARES Act”) to neutralize the regulatory capital effects of participating in the program. The interim final rule, which became effective April 13, 2020, clarifies that PPP loans receive a zero percent risk weight for purposes of determining risk-weighted assets and the CET1, Tier 1 and Total Risk-Based capital ratios. At December 31, 2020, risk-weighted assets included $667.1 million of PPP loans at a zero risk weight. Additionally, in order to facilitate use of the Paycheck Protection Program Liquidity Facility, which provides Federal Reserve Bank loans to eligible financial institutions such as the Bank to fund PPP loans (the “PPPL Facility”), the agencies clarified that banking organizations, including the Corporation and the Bank, are allowed to neutralize the regulatory effects of PPP covered loans on the risk-based capital ratios, as well as PPP covered loans pledged under the PPPL Facility on the leverage capital ratios. At December 31, 2020, the Corporation did not have an outstanding balance with the PPPL Facility; therefore, there were no adjustments to the leverage ratio for PPP loans. See “- COVID-19, The CARES Act and Related Legislative and Regulatory Actions” below for additional information.
The following are the Corporation’s regulatory capital ratios as of December 31, 2020:
| ||Corporation||Basel III Minimum Capital Required|
|Total risk-based capital to risk-weighted assets||14.36 ||%||10.50 ||%|
|Tier 1 capital to risk-weighted assets||12.48 ||%||8.50 ||%|
|Common equity tier 1 capital to risk-weighted assets||12.02 ||%||7.00 ||%|
|Tier 1 capital to average assets||9.57 ||%||4.00 ||%|
Impact of CECL Implementation on Regulatory Capital
As discussed in NOTE 1. NATURE OF OPERATIONS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES of the Notes to Consolidated Financial Statements of this Annual Report on Form 10-K, the FASB issued the “current expected credit losses” (“CECL”) accounting standard in 2016 to address concerns relating to the ability to record credit losses that are expected, but do not yet meet the “probable” threshold by replacing the current “incurred loss” model for recognizing credit losses with an “expected life of loan loss” model referred to as the CECL model. While the original implementation date of the CECL model was January 1, 2020, the CARES Act and a related joint statement of federal banking regulators provided financial institutions with optional temporary relief from having to comply with implementation of the CECL standard. This temporary relief was set to expire on December 31, 2020. However, the 2021 Consolidated Appropriations Act (the “CAA”), which was signed into law on December 27, 2020, amended the CARES Act by extending the temporary relief from CECL compliance to the earlier of the first day of the fiscal year that begins after the date on which the national emergency concerning COVID-19 terminates or January 1, 2022. The Corporation had elected to delay implementation of CECL following the approval of the CARES Act and, with the enactment of the CAA, the Corporation has elected to further delay adoption of CECL to January 1, 2021. This will allow the Corporation to utilize the CECL standard for the entire year of adoption.
As part of a March 27, 2020 joint statement of federal banking regulators, an interim final rule that allows banking organizations to mitigate the effects of the CECL accounting standard on their regulatory capital was announced. Banking organizations can elect to mitigate the estimated cumulative regulatory capital effects of CECL for up to two years. This two-year delay is in addition to the three-year transition period that federal banking regulators had already made available. While the Corporation has elected to delay implementation of ASU No. 2016-13 as described above, it expects to take advantage of the additional time permitted by this interim final rule, which will largely delay the effects of CECL on its regulatory capital through December 31, 2022. Beginning on January 1, 2023, the Corporation will be required to phase in 25 percent of the previously deferred estimated capital impact of CECL, with an additional 25 percent to be phased in at the beginning of each subsequent year until fully phased in by January 1, 2026. Under the interim final rule, the amount of adjustments to regulatory capital that can be deferred until the phase-in period includes both the initial impact of our adoption of CECL, and 25 percent of subsequent changes in our allowance for credit losses during each quarter following implementation of CECL until December 31, 2022.
The Bank is subject to the primary regulatory oversight, supervision and examination of the FDIC and the Indiana DFI. These agencies have the authority to issue cease-and-desist orders if they determine that activities of the Bank regularly represent an unsafe and unsound banking practice or a violation of law. Federal law extensively regulates various aspects of the banking business such as reserve requirements, truth-in-lending and truth-in-savings disclosures, equal credit opportunity, fair credit reporting, trading in securities and other aspects of banking operations. Current federal law also requires banks, among other things, to make deposited funds available within specified time periods.
The Consumer Financial Protection Bureau (“CFPB”), an independent federal agency created under the Dodd-Frank Act, was granted broad rulemaking, supervisory and enforcement powers under various federal consumer financial protection laws, primarily with authority over banks and their affiliates with assets of more than $10 billion. The quarter ended December 31, 2019 was the fourth consecutive quarter that the Bank reported assets exceeding $10 billion. As a result, effective as of the beginning of the second quarter of 2020, the Bank and its affiliates became subject to CFPB supervisory and enforcement authority. See “- Dodd-Frank Wall Street Reform and Consumer Protection Act” and “- Consumer Financial Protection” below for additional information.
Bank Capital Requirements
Capital adequacy is an important indicator of financial stability and performance. The Corporation and the Bank are subject to various regulatory capital requirements administered by the federal banking agencies including, in the case of both the Bank and the Corporation, the Basel III requirements discussed above under “- Capital Adequacy Guidelines for Bank Holding Companies (Basel III)” and, in the case of the Bank, the “prompt corrective action” requirements discussed below under “- FDIC Improvement Act of 1991 (FDICIA).” Under the regulations, a capital category is assigned to the regulated entity, which is largely determined by four ratios that are calculated according to the applicable regulations: total risk-based capital, tier 1 risk-based capital, common equity tier 1 capital, and tier 1 leverage ratios. The ratios are intended to measure capital relative to assets and credit risk associated with those assets and off-balance sheet exposures of the entity. The capital category assigned to an entity can also be affected by qualitative judgments made by regulatory agencies about the risk inherent in the entity's activities that are not part of the calculated ratios.
There are five capital categories defined in the regulations, ranging from “well capitalized” to “critically undercapitalized”. Classification of a bank in any of the undercapitalized categories can result in actions by regulators that could have a material effect on a bank's operations. Quantitative measures established by regulation to ensure capital adequacy require the Bank to maintain minimum amounts and ratios of total, tier 1 and common equity tier 1 capital to risk-weighted assets, and of tier 1 capital to average assets, or leverage ratio, all of which are calculated as defined in the regulations. Banks with lower capital levels are deemed to be “undercapitalized”, “significantly undercapitalized” or “critically undercapitalized”, depending on their actual levels. The appropriate federal regulatory agency may also downgrade a bank to the next lower capital category upon a determination that the bank is in an unsafe or unsound practice. Banks are required to monitor closely their capital levels and to notify their appropriate regulatory agency of any basis for a change in capital category.
FDIC Improvement Act of 1991 (FDICIA)
The FDICIA requires, among other things, federal bank regulatory authorities to take “prompt corrective action” with respect to banks, which do not meet minimum capital requirements. For these purposes, FDICIA establishes five capital tiers: well capitalized, adequately capitalized, undercapitalized, significantly undercapitalized and critically undercapitalized. The FDIC has adopted regulations to implement the prompt corrective action provisions of FDICIA.
The "prompt corrective action" regulations require the following for well capitalized status:
• a minimum CET1 risk-based capital ratio of a least 6.5 percent;
• a minimum tier 1 risk-based capital ratio of at least 8.0 percent;
• a minimum total risk-based capital ratio of at least 10.0 percent; and
• a minimum leverage ratio of 5.0 percent.
The FDICIA generally prohibits a depository institution from making any capital distributions (including payment of a dividend) or paying any management fee to its parent holding company if the depository institution would thereafter be “undercapitalized.” “Undercapitalized” banks are subject to growth limitations and are required to submit a capital restoration plan. A bank’s compliance with such plan is required to be guaranteed by the bank’s parent holding company. If an “undercapitalized” bank fails to submit an acceptable plan, it is treated as if it is significantly undercapitalized. “Significantly undercapitalized” banks are subject to various requirements and restrictions, including an order by the FDIC to sell sufficient voting stock to become "adequately capitalized", requirements to reduce total assets and cease receipt of deposits from correspondent banks, and restrictions on compensation of executive officers. “Critically undercapitalized” institutions may not, beginning 60 days after becoming “critically undercapitalized,” make any payment of principal or interest on certain subordinated debt, extend credit for a highly leveraged transaction, or enter into any transaction outside the ordinary course of business. In addition, “critically undercapitalized” institutions are subject to appointment of a receiver or conservator.
As of December 31, 2020, the Bank was “well capitalized” based on the “prompt corrective action” ratios described above. It should be noted that a bank’s capital category is determined solely for the purpose of applying the FDIC’s “prompt corrective action” regulations and that the capital category may not constitute an accurate representation of the bank’s overall financial condition or prospects.
Dodd-Frank Wall Street Reform and Consumer Protection Act
The Dodd-Frank Act has had a broad impact on the financial services industry, including significant regulatory and compliance changes. Although most of the required regulations of the Dodd-Frank Act have been promulgated and implemented (or are being implemented over time), there are additional regulations yet to be finalized by the authorized federal agencies. The changes resulting from the Dodd-Frank Act have impacted the profitability of the Corporation’s business activities, required changes to certain business practices, and imposed more stringent capital, liquidity and leverage requirements, and, when fully implemented, may further adversely affect our business. Among other things, the Dodd-Frank Act has resulted, and in the future will likely result, in:
•increases to the cost of the Corporation’s operations due to greater regulatory oversight, supervision and examination of banks and bank holding companies, including higher deposit insurance premiums;
•limitations on the Corporation’s ability to raise additional capital through the use of trust preferred securities, as new issuances of these securities may no longer be included as Tier 1 capital;
•reduced flexibility for the Corporation to generate or originate certain revenue-producing assets based on increased regulatory capital standards;
•limitations on the Corporation’s ability to expand consumer product and service offerings due to stricter consumer protection laws and regulations; and
•as the Corporation's assets now exceed $10 billion, compliance with the Durbin Amendment has resulted in a material reduction of interchange fee income paid by merchants when debit cards are used as payment.
The Economic Growth, Regulatory Relief, and Consumer Protection Act (the “Economic Growth Act”), which was enacted in May 2018, repealed or modified several provisions of the Dodd-Frank Act. In particular, the asset threshold at which banks are subject to annual company-run stress tests were increased from $10 billion to $250 billion under the Economic Growth Act. As a result, the Corporation and the Bank will not be subject to the Dodd-Frank Act stress testing requirements.
The Corporation’s management continues to take the steps necessary to minimize the adverse impact of the Dodd-Frank Act on its business, financial condition and results of operation.
Under the Durbin Amendment to the Dodd-Frank Act, the Federal Reserve adopted rules establishing standards for assessing whether the interchange fees that may be charged with respect to certain electronic debit transactions are "reasonable and proportional" to the costs incurred by issuers for processing such transactions.
Interchange fees, or "swipe" fees, are charges that merchants pay the Bank and other card-issuing banks for processing electronic payment transactions. Federal Reserve rules applicable to financial institutions that have assets of $10 billion or more provide that the maximum permissible interchange fee for an electronic debit transaction is the sum of 21 cents per transaction and 5 basis points multiplied by the value of the transaction. An upward adjustment of no more than 1 cent to the issuer's debit card interchange fee is allowed if the card issuer develops and implements policies and procedures reasonably designed to achieve certain fraud-prevention standards. The Federal Reserve also has rules governing routing and exclusivity that require issuers to offer two unaffiliated networks for routing transactions on each debit or prepaid product.
As the Corporation's assets exceeded $10 billion, compliance with the Durbin Amendment began July 1, 2020. For the last six months of 2020, compliance with the Durbin Amendment resulted in a material reduction of interchange fee income paid by merchants when debit cards were used as a source of payment.
The Volcker Rule, which was adopted under the Dodd-Frank Act, places certain limitations on the trading activity of insured depository institutions and their affiliates subject to certain exceptions. The restricted trading activity includes purchasing or selling certain types of securities or instruments in order to benefit from short-term price movements or to realize short-term profits. Exceptions to the Volcker Rule include trading in certain U.S. Government or other municipal securities and trading conducted (i) in certain capacities as a broker or other agent, or as a fiduciary on behalf of customers, (ii) to satisfy a debt previously contracted, (iii) pursuant to repurchase and securities lending agreements, and (iv) in risk-mitigating hedging activities. The Volcker Rule also prohibits banking institutions from having an ownership interest in a hedge fund or private equity fund.
A banking entity that engages in proprietary trading (which excludes the exceptions discussed above) or covered fund-related activities or investments, and has total consolidated assets of more than $10 billion for two years, must implement and maintain a compliance program that meets certain minimum requirements and must also maintain certain documentation with respect to covered fund activities, in each case, as described in the Volcker Rule. While the Corporation’s total consolidated assets first exceeded $10 billion during the quarter ended March 31, 2019, the Volcker Rule has not had, and is not expected to have, a material impact on the Corporation or the Bank.
The Bank’s deposit accounts are currently insured by the Deposit Insurance Fund of the FDIC. The insurance benefit generally covers up to a maximum of $250,000 per separately insured depositor. As an FDIC-insured bank, the Bank is subject to deposit insurance premiums and assessments to maintain the Deposit Insurance Fund. The Bank’s deposit insurance premium assessment rate depends on the asset and supervisory categories to which it is assigned. The FDIC has authority to raise or lower assessment rates on insured banks in order to achieve statutorily required reserve ratios in the Deposit Insurance Fund and to impose special additional assessments.
Deposit insurance assessments are based on average consolidated total assets minus average tangible equity. Under the FDIC's risk-based assessment system, insured institutions with a least $10 billion in assets, such as the Bank, are assessed on the basis of a scoring system that combine the institution's regulatory ratings and certain financial measures. The scoring system assesses risk measures to produce two scores, a performance score and a loss severity score, that will be combined and converted to an initial assessment rate.
The performance score measures an institution's financial performance and its ability to withstand stress. The loss severity score quantifies the relative magnitude of potential losses to the FDIC in the event of an institution's failure. Once the performance and loss severity scores are calculated, those scores are converted to a total score. An institution with a total score of 30 or less will pay the minimum base assessment rate, and an institution with a total score of 90 or more will pay the maximum initial base assessment rate. For total scores between 30 and 90, initial base assessment rates will rise at an increasing rate as the total score increases.
The FDIC may also terminate deposit insurance upon a finding that the institution has engaged in unsafe and unsound practices, is in an unsafe or unsound condition to continue operations, or has violated any applicable law, regulation, rule, order or condition imposed by the FDIC.
The Corporation's principal source of funds for dividend payments to shareholders is dividends received from the Bank. Banking regulations limit the maximum amount of dividends that a bank may pay without requesting prior approval of regulatory agencies. Under these regulations, the amount of dividends that may be paid in any calendar year is limited to the bank’s retained income (as defined under the regulations) for the current year plus those for the previous two years, subject to the capital requirements described above. As of December 31, 2020, the amount available for dividends from the Corporation’s subsidiaries (both banking and non-banking), without prior regulatory approval or notice, was $207,182,000.
Under FDIC regulations, no FDIC-insured depository institution can accept brokered deposits unless it (i) is well capitalized, or (ii) is adequately capitalized and received a waiver from the FDIC. In addition, these regulations prohibit any depository institution that is not well capitalized from (a) paying an interest rate on deposits in excess of 75 basis points over certain prevailing market rates or (b) offering “pass through” deposit insurance on certain employee benefit plan accounts unless it provides certain notice to affected depositors. The Corporation and the Bank were well capitalized as of December 31, 2020.
Consumer Financial Protection
The Bank is subject to a number of federal and state consumer protection laws that govern its relationship with customers. These laws include, but are not limited to:
•the Equal Credit Opportunity Act (prohibiting discrimination on the basis of race, religion or other prohibited factors in the extension of credit);
•the Fair Credit Reporting Act (governing the provision of consumer information to credit reporting agencies and the use of consumer information);
•the Truth-In-Lending Act (governing disclosures of credit terms to consumer borrowers);
•the Truth-in-Savings Act (which requires disclosure of deposit terms to consumers);
•the Electronic Funds Transfer Act (governing automatic deposits to and withdrawals from deposit accounts and customers’ rights and liabilities arising from the use of automated teller machines and other electronic banking services);
•the Fair Debt Collection Act (governing the manner in which consumer debts may be collected by collection agencies);
•the Right to Financial Privacy Act (which imposes a duty to maintain the confidentiality of consumer financial records and prescribes procedures for complying with administrative subpoenas of financial records);
•the Home Mortgage Disclosure Act and Regulation C, requiring financial institutions to provide certain information about home mortgage and refinanced loans; and
•the respective state-law counterparts to the above laws, as applicable, as well as state usury laws and laws regarding unfair and deceptive acts and practices.
Violations of applicable consumer protection laws can result in significant potential liability from litigation brought by customers, including actual damages, restitution and attorneys’ fees. Federal bank regulators, state attorneys general and state and local consumer protection agencies may also seek to enforce consumer protection requirements and obtain these and other remedies, including regulatory sanctions, customer rescission rights, action by the state and local attorneys general in each jurisdiction in which we operate and civil money penalties. Failure to comply with consumer protection requirements may also result in the Corporation’s failure to obtain any required bank regulatory approval for merger or acquisition transactions that it may wish to pursue or prohibition from engaging in such transactions even if approval is not required. The CFPB, an independent federal agency created under the Dodd-Frank Act, was granted broad rulemaking, supervisory and enforcement powers under various federal consumer financial protection laws, primarily with authority over banks and their affiliates with assets of more than $10 billion. As stated previously, with its assets having exceeded $10 billion for four consecutive quarters, the Bank and its affiliates became subject to CFPB supervisory and enforcement authority effective as of the beginning of the second quarter of 2020.
The consumer protection provisions of the Dodd-Frank Act and the examination, supervision and enforcement of those laws and implementing regulations by the CFPB have created a more complex environment for consumer finance regulation. The CFPB has significant authority to implement and enforce federal consumer finance laws, including the Truth in Lending Act, the Equal Credit Opportunity Act and new requirements for financial services products provided for in the Dodd-Frank Act, as well as the authority to identify and prohibit unfair, deceptive or abusive acts and practices. The review of products and practices to prevent such acts and practices is a continuing focus of the CFPB, and of banking regulators more broadly. The ultimate impact of this heightened scrutiny is uncertain but could result in changes to pricing, practices, products and procedures. It could also result in increased costs related to regulatory oversight, supervision and examination, additional remediation efforts and possible penalties. In addition, the Dodd-Frank Act provides the CFPB with broad supervisory, examination and enforcement authority over various consumer financial products and services, including the ability to require reimbursements and other payments to customers for alleged legal violations and to impose significant penalties, as well as injunctive relief that prohibits lenders from engaging in allegedly unlawful practices. The CFPB also has the authority to obtain cease and desist orders providing for affirmative relief or monetary penalties. The Dodd-Frank Act does not prevent states from adopting stricter consumer protection standards. State regulation of financial products and potential enforcement actions could also adversely affect our business, financial condition or results of operations.
Community Reinvestment Act
The Community Reinvestment Act of 1977 (the “CRA”) requires depository institutions to assist in meeting the credit needs of their market areas consistent with safe and sound banking practice. Under the CRA, each depository institution is required to help meet the credit needs of its market areas by, among other things, providing credit to low- and moderate-income individuals and communities. These factors are also considered in evaluating mergers, acquisitions and applications to open a branch or facility. The applicable federal regulators regularly conduct CRA examinations to assess the performance of financial institutions and assign one of four ratings to the institution’s records of meeting the credit needs of its community. These ratings are outstanding, satisfactory, needs to improve or substantial noncompliance. During its last examination, a rating of satisfactory was received by the Bank.
The federal banking regulators adopted rules that limit the ability of banks and other financial institutions to disclose non-public information about consumers to nonaffiliated third parties. These limitations require disclosure of privacy policies to consumers and, in some circumstances, allow consumers to prevent disclosure of certain personal information to a nonaffiliated third party. These regulations affect how consumer information is transmitted through diversified financial companies and conveyed to outside vendors.
The Bank is also subject to regulatory guidelines establishing standards for safeguarding customer information. These guidelines describe the federal banking agencies’ expectations for the creation, implementation and maintenance of an information security program, which would include administrative, technical and physical safeguards appropriate to the size and complexity of the institution and the nature and scope of its activities. The standards set forth in the guidelines are intended to ensure the security and confidentiality of customer records and information, protect against any anticipated threats or hazards to the security or integrity of such records and protect against unauthorized access to or use of such records or information that could result in substantial harm or inconvenience to any customer.
Anti-Money Laundering and the USA Patriot Act
A major focus of governmental policy on financial institutions in recent years has been aimed at combating money laundering and terrorist financing. The USA Patriot Act of 2001 (the “USA Patriot Act”) substantially broadened the scope of United States anti-money laundering laws and regulations by imposing significant new compliance and due diligence obligations on financial institutions, creating new crimes and penalties and expanding the extra-territorial jurisdiction of the United States.
The Bank Secrecy Act (the “BSA”) requires financial institutions to develop policies, procedures, and practices to prevent and deter money laundering, and mandates that every bank have a written, board-approved program that is reasonably designed to assure and monitor compliance with the BSA. In addition, banks are required to adopt a customer identification program as part of its BSA compliance program, and are required to file Suspicious Activity Reports when they detect certain known or suspected violations of federal law or suspicious transactions related to a money laundering activity or a violation of the BSA. The Bank is also required to (1) identify and verify, subject to certain exceptions, the identity of the beneficial owners of all legal entity customers at the time a new account is opened, and (2) include, in its anti-money laundering program, risk-based procedures for conducting ongoing customer due diligence, which are to include procedures that: (a) assist in understanding the nature and purpose of customer relationships for the purpose of developing a customer risk profile, and (b) require ongoing monitoring to identify and report suspicious transactions and, on a risk basis, to maintain and update customer information.
Failure of a financial institution to maintain and implement adequate programs to combat money laundering and terrorist financing, or to comply with all of the relevant laws or regulations, could have serious legal and reputational consequences for the institution, including causing applicable bank regulatory authorities not to approve merger or acquisition transactions when regulatory approval is required or to prohibit such transactions even if approval is not required.
Office of Foreign Assets Control Regulation
The United States has imposed economic sanctions that affect transactions with designated foreign countries, nationals and others which are administered by the U.S. Treasury Department Office of Foreign Assets Control. Failure to comply with these sanctions could have serious legal and reputational consequences, including causing applicable bank regulatory authorities not to approve merger or acquisition transactions when regulatory approval is required or to prohibit such transactions even if approval is not required.
COVID-19, The CARES Act and Related Legislative and Regulatory Actions
Impact of COVID-19
On January 30, 2020, the World Health Organization (“WHO”) announced that the outbreak of COVID-19 constituted a public health emergency of international concern. On March 11, 2020, WHO declared COVID-19 to be a global pandemic and, on March 13, 2020, the President of the United States declared the COVID-19 outbreak a national emergency. The health concerns relating to the COVID-19 outbreak and related governmental actions taken to reduce the spread of the virus have significantly impacted the global economy (including the states and local economies in which the Corporation operates), disrupted supply chains, lowered equity market valuations, and created significant volatility and disruption in financial markets. The outbreak has resulted in authorities implementing numerous measures to try to contain the virus, such as travel bans and restrictions, quarantines, shelter in place or total lock-down orders and business limitations and shutdowns. As a result of the shelter in place mandates in effect beginning early in the second quarter of 2020, commercial activity throughout our geographic footprint, as well as nationally, decreased significantly during 2020. Most states have reopened, albeit under limited capacities and under other social distancing restrictions; however, commercial activity has not returned to the levels existing prior to the outbreak of the pandemic. Such measures have significantly contributed to rising unemployment and negatively impacted consumer and business spending. As a result, the demand for the Corporation’s products and services has been, and will continue to be, significantly impacted.
The continued impact of COVID-19 on the Corporation will depend on numerous factors and future developments that are highly uncertain and cannot be predicted with confidence. It is unknown how long the COVID-19 pandemic will last, or when restrictions on individuals and businesses will be fully lifted and businesses and their employees will be able to resume normal activities. Additional information may emerge regarding the severity of COVID-19 and additional actions may be taken by federal, state and local governments to contain COVID-19 or treat its impact. Changes in the behavior of customers, businesses and their employees as a result of COVID-19 pandemic, including social distancing practices, even after formal restrictions have been lifted and vaccination rates have increased, are also unknown. As a result of COVID-19 and the actions taken to contain it or reduce its impact, we may experience changes in the demand for our products and services, changes in the value of collateral securing outstanding loans, reductions in the credit quality of borrowers and the inability of borrowers to repay loans in accordance with their terms. Our commercial and consumer customers are experiencing varying degrees of financial distress, which is expected to continue in 2021, especially if positive cases increase and economic shutdowns continue. These and similar factors and events may have substantial negative effects on the business, financial condition and results of operations of the Corporation and its customers. While we expect nearly every industry to have some impact from COVID-19, some industries will be impacted more than others. In particular, senior living, hotel and accommodations, and restaurants and food service have been the most affected by COVID-19 and account for approximately 7 percent of total loans.
We have taken deliberate actions to ensure that we have the balance sheet strength to serve our clients and communities, including increases in liquidity and managing our assets and liabilities in order to maintain a strong capital position. Additionally, in response to the COVID-19 pandemic, we have taken a number of actions to offer various forms of support to our customers, employees and communities that have experienced impacts from this development. The Corporation contributed approximately $1 million to non-profit organizations in our communities on the front lines of fighting the COVID-19 pandemic. In response to social distancing protocols, we have modified office locations by installing protective barriers, required the use of personal protective equipment and incurred additional cleaning and janitorial expense to disinfect banking centers and office locations, which cost $1.5 million. Additionally, we have enhanced mobile and online services, such as increased mobile deposit limits, to allow more transactions to be completed outside the banking centers. We have also provided customer alerts focused on COVID-19 scams and fraud education and prevention.
The CARES Act and the Paycheck Protection Program
On March 27, 2020, the Coronavirus Aid, Relief and Economic Security Act (the “CARES Act”) was signed into law, providing an approximately $2 trillion stimulus package that includes direct payments to individual taxpayers, economic stimulus to significantly impacted industry sectors, emergency funding for hospitals and providers, small business loans, increased unemployment benefits, and a variety of tax incentives.
For small businesses, eligible nonprofits and certain others, the CARES Act established a Paycheck Protection Program (“PPP”), which is administered by the Small Business Administration (“SBA”). On April 24, 2020, the Paycheck Protection Program and Health Care Enhancement Act was enacted. Among other things, this legislation amends the initial CARES Act program by raising the appropriation level for PPP loans from $349 billion to $670 billion. The PPP was further modified on June 5, 2020 with the adoption of the Paycheck Protection Program Flexibility Act (the Flexibility Act), which extended the maturity date for PPP loans from two years to five years for loans disbursed on or after the date of enactment of the Flexibility Act. For PPP loans disbursed prior to such enactment, the Flexibility Act permits the borrower and lender to mutually agree to extend the term of the loan to five years. The Bank has actively participated in assisting its customers with applications for resources through the program. PPP loans earn interest at a fixed rate of 1 percent and primarily have a two-year term. The Bank anticipates that the majority of these loans will ultimately be forgiven, in whole or in part, by the SBA in accordance with the terms of the program. Under the terms of the PPP, the loans are fully guaranteed by the SBA. As discussed below under “The 2021 Consolidated Appropriations Act ("CAA"),” an additional $284 billion in funding has been made available under the PPP, with authority to make loans under the program being extended through March 31, 2021. During 2021, the Bank plans to offer additional PPP loans as authorized under the CAA.
Loan Modifications and Troubled Debt Restructures
On March 22, 2020, a statement was issued by the Bank's banking regulators and titled the “Interagency Statement on Loan Modifications and Reporting for Financial Institutions Working with Customers Affected by the Coronavirus” (the "Interagency Statement") that encourages financial institutions to work prudently with borrowers who are or may be unable to meet their contractual payment obligations due to the effects of COVID-19. Additionally, Section 4013 of the CARES Act further provides that a qualified loan modification is exempt by law from classification as a troubled debt restructure as defined by GAAP, from the period beginning March 1, 2020 until the earlier of December 31, 2020 or the date that is 60 days after the date on which the national emergency concerning the COVID-19 outbreak under the National Emergencies Act (50 U.S.C. 1601 et seq.) terminates. The Interagency Statement was subsequently revised on April 7, 2020 to clarify the interaction of the original guidance with Section 4013 of the CARES Act, as well as setting forth the banking regulators’ views on consumer protection considerations. As provided under the CAA (see below), qualified loan modifications will continue to be exempt from classification as a troubled debt restructure until the earlier of 60 days after the national emergency termination date or January 1, 2022. In accordance with such guidance, the Bank has offered and will continue to offer short-term modifications made in response to COVID-19 to borrowers who were current and otherwise not past due. These have included and will continue to include short-term, 180 days or less, modifications in the form of payment deferrals, fee waivers, extensions of repayment terms, or other delays in payment that are insignificant.
The CARES Act, the CAA and certain actions by federal banking regulators have resulted in modifications to, or delays in implementation of, various regulatory capital rules applicable to banking organizations. See “- Capital Adequacy Guidelines for Bank Holding Companies (Basel III)” above for additional information.
The 2021 Consolidated Appropriations Act
On December 27, 2020, a $900 billion COVID-19 relief package, as passed by the U.S. Congress, was signed into law as part of the 2021 Consolidated Appropriations Act (“CAA”) that provides federal government funding through the end of its 2021 fiscal year. In addition to delivering direct stimulus payments to certain individuals, an increase in unemployment insurance benefits, an extension of the eviction moratorium, relief to the healthcare industry, and additional aid to various other businesses, the COVID-19-related provisions of the CAA provide for (i) an additional $284 billion in funding for the Paycheck Protection Program (“PPP”), through March 31, 2021, (ii) an extension of the temporary delay for implementation of the CECL accounting standard, and (iii) further suspension of the troubled debt restructure assessment and reporting requirements for financial institutions under GAAP.
The Corporation and the Bank are subject to the Federal Reserve Act, which restricts financial transactions between banks and affiliated companies. The statute limits credit transactions between banks, affiliated companies and its executive officers and its affiliates. The statute prescribes terms and conditions for bank affiliate transactions deemed to be consistent with safe and sound banking practices. It also restricts the types of collateral security permitted in connection with the bank’s extension of credit to an affiliate. Additionally, all transactions with an affiliate must be on terms substantially the same or at least as favorable to the institution as those prevailing at the time for comparable transactions with non-affiliated parties.
The earnings of financial institutions are also affected by general economic conditions and prevailing interest rates, both domestic and foreign, and by the monetary and fiscal policies of the United States Government and its various agencies, particularly the Federal Reserve. The Federal Reserve regulates the supply of credit in order to influence general economic conditions, primarily through open market operations in United States Government obligations, varying the discount rate on financial institution borrowings, varying reserve requirements against financial institution deposits, and restricting certain borrowings by financial institutions and their subsidiaries. The monetary policies of the Federal Reserve have had a significant effect on the operating results of the Bank in the past and are expected to continue to do so in the future.
Additional legislation and administrative actions affecting the banking industry may be considered by the United States Congress, state legislatures and various regulatory agencies, including those referred to above. It cannot be predicted with certainty whether such legislation or administrative action will be enacted or the extent to which the banking industry, the Corporation or the Bank would be affected.
The following tables set forth statistical data on the Corporation and its subsidiaries.
DISTRIBUTION OF ASSETS, LIABILITIES AND STOCKHOLDERS’ EQUITY; INTEREST RATES AND INTEREST DIFFERENTIAL
The daily average balance sheet amounts, the related interest income or interest expense, and average rates earned or paid are presented in the following table:
| ||Average Balance||Interest|
|(Dollars in Thousands)||2020||2019||2018|
|Assets:|| || || || || |
|Interest-bearing deposits||$||319,686 ||$||938 ||0.29 ||%||$||211,683 ||$||4,225 ||2.00 ||%||$||110,232 ||$||2,241 ||2.03 ||%|
|Federal Home Loan Bank stock||28,736 ||1,042 ||3.63 ||25,645 ||1,370 ||5.34 ||24,538 ||1,234 ||5.03 |
Investment Securities: (1)
|Taxable||1,282,827 ||24,440 ||1.91 ||1,101,247 ||27,815 ||2.53 ||841,203 ||21,597 ||2.57 |
|1,440,913 ||53,596 ||3.72 ||987,006 ||40,070 ||4.06 ||762,623 ||32,290 ||4.23 |
|Total investment securities||2,723,740 ||78,036 ||2.87 ||2,088,253 ||67,885 ||3.25 ||1,603,826 ||53,887 ||3.36 |
|Loans held for sale||18,559 ||781 ||4.21 ||18,402 ||780 ||4.24 ||11,425 ||540 ||4.73 |
|Commercial||6,755,215 ||286,773 ||4.25 ||5,631,146 ||306,139 ||5.44 ||5,143,576 ||274,302 ||5.33 |
|Real estate mortgage||889,083 ||40,002 ||4.50 ||811,188 ||37,782 ||4.66 ||733,709 ||33,549 ||4.57 |
|Installment||718,815 ||30,708 ||4.27 ||701,459 ||38,071 ||5.43 ||640,310 ||34,110 ||5.33 |
|669,483 ||27,194 ||4.06 ||527,995 ||22,238 ||4.21 ||468,751 ||18,813 ||4.01 |
|Total loans||9,051,155 ||385,458 ||4.26 ||7,690,190 ||405,010 ||5.27 ||6,997,771 ||361,314 ||5.16 |
|Total earning assets||12,123,317 ||465,474 ||3.84 ||%||10,015,771 ||478,490 ||4.78 ||%||8,736,367 ||418,676 ||4.79 ||%|
|Net unrealized gain (loss) on securities available for sale||59,639 ||17,676 ||(14,790)|
|Allowance for loan losses||(110,963)||(81,000)||(77,444)|
|Cash and cash equivalents||200,366 ||142,857 ||131,925 |
|Premises and equipment||113,642 ||99,343 ||94,567 |
|Other assets||1,080,268 ||896,673 ||818,432 |
|Total Assets||$||13,466,269 ||$||11,091,320 ||$||9,689,057 |
|Interest-bearing deposit accounts||$||4,009,566 ||$||20,239 ||0.50 ||%||$||3,070,861 ||$||33,921 ||1.10 ||%||$||2,319,081 ||$||17,577 ||0.76 ||%|
|Money market deposit accounts||1,769,478 ||7,810 ||0.44 ||1,300,064 ||14,111 ||1.09 ||1,097,762 ||6,721 ||0.61 |
|Savings deposits||1,534,069 ||3,641 ||0.24 ||1,242,468 ||9,464 ||0.76 ||1,065,031 ||5,230 ||0.49 |
|Certificates and other time deposits||1,346,967 ||20,050 ||1.49 ||1,673,292 ||34,089 ||2.04 ||1,514,271 ||22,014 ||1.45 |
|Total interest-bearing deposits||8,660,080 ||51,740 ||0.60 ||7,286,685 ||91,585 ||1.26 ||5,996,145 ||51,542 ||0.86 |
|Borrowings||768,238 ||14,641 ||1.91 ||644,729 ||17,160 ||2.66 ||718,061 ||17,545 ||2.44 |
|Total interest-bearing liabilities||9,428,318 ||66,381 ||0.70 ||7,931,414 ||108,745 ||1.37 ||6,714,206 ||69,087 ||1.03 |
|Noninterest-bearing deposits||2,068,026 ||1,495,949 ||1,573,337 |
|Other liabilities||144,790 ||94,342 ||57,653 |
|Total Liabilities||11,641,134 ||9,521,705 ||8,345,196 |
|Stockholders' Equity||1,825,135 ||1,569,615 ||1,343,861 |
|Total Liabilities and Stockholders' Equity||$||13,466,269 ||66,381 ||$||11,091,320 ||108,745 ||$||9,689,057 ||69,087 |
|Net Interest Income (FTE)||$||399,093 ||$||369,745 ||$||349,589 |
Net Interest Spread (FTE) (4)
|3.14 ||%||3.41 ||%||3.76 ||%|
|Net Interest Margin (FTE):|
|Interest Income (FTE) / Average Earning Assets||3.84 ||%||4.78 ||%||4.79 ||%|
|Interest Expense / Average Earning Assets||0.55 ||%||1.09 ||%||0.79 ||%|
Net Interest Margin (FTE) (5)
|3.29 ||%||3.69 ||%||4.00 ||%|
(1) Average balance of securities is computed based on the average of the historical amortized cost balances without the effects of the fair value adjustment.
(2) Tax-exempt securities and loans are presented on a fully taxable equivalent basis, using a marginal tax rate of 21 percent for 2020, 2019 and 2018. These totals equal $16,966, $13,085 and $10,732, respectively.
(3) Non-accruing loans have been included in the average balances.
(4) Net Interest Spread (FTE) is interest income expressed as a percentage of average earning assets minus interest expense expressed as a percentage of average interest-bearing liabilities.
(5) Net Interest Margin (FTE) is interest income expressed as a percentage of average earning assets minus interest expense expressed as a percentage of average earning assets.
ANALYSIS OF CHANGES IN NET INTEREST INCOME
The following table presents net interest income components on a tax-equivalent basis and reflects changes between periods attributable to movement in either the average balance or average interest rate for both earning assets and interest-bearing liabilities. The volume differences were computed as the difference in volume between the current and prior year multiplied by the interest rate from the prior year. The interest rate changes were computed as the difference in rate between the current and prior year multiplied by the volume from the prior year. Volume and rate variances have been allocated on the basis of the absolute relationship between volume variances and rate variances.
| ||2020 Compared to 2019|
Increase (Decrease) Due To
|2019 Compared to 2018|
Increase (Decrease) Due To
|2018 Compared to 2017|
Increase (Decrease) Due To
|(Dollars in Thousands, Fully Taxable Equivalent Basis)||Volume||Rate||Total||Volume||Rate||Total||Volume||Rate||Total|
|Interest Income:|| || || |
|Interest-bearing deposits||$||1,467 ||$||(4,754)||$||(3,287)||$||2,026 ||$||(42)||$||1,984 ||$||450 ||$||1,055 ||$||1,505 |
|Federal Home Loan Bank stock||151 ||(479)||(328)||57 ||79 ||136 ||168 ||172 ||340 |
|Investment securities||18,895 ||(8,744)||10,151 ||15,799 ||(1,801)||13,998 ||8,551 ||(5,044)||3,507 |
|Loans held for sale||7 ||(6)||1 ||301 ||(61)||240 ||190 ||(112)||78 |
|Loans||65,095 ||(84,648)||(19,553)||35,993 ||7,463 ||43,456 ||56,084 ||24,996 ||81,080 |
|Totals||85,615 ||(98,631)||(13,016)||54,176 ||5,638 ||59,814 ||65,443 ||21,067 ||86,510 |
|Interest Expense:|| || || |
|Interest-bearing deposit accounts||8,341 ||(22,023)||(13,682)||6,779 ||9,565 ||16,344 ||2,509 ||9,251 ||11,760 |
|Money market deposit accounts||3,951 ||(10,252)||(6,301)||1,423 ||5,967 ||7,390 ||540 ||3,393 ||3,933 |
|Savings deposits||1,832 ||(7,655)||(5,823)||983 ||3,251 ||4,234 ||239 ||4,257 ||4,496 |
|Certificates and other time deposits||(5,896)||(8,143)||(14,039)||2,504 ||9,571 ||12,075 ||2,061 ||5,486 ||7,547 |
|Borrowings||2,911 ||(5,430)||(2,519)||(1,877)||1,492 ||(385)||1,185 ||2,554 ||3,739 |
|Totals||11,139 ||(53,503)||(42,364)||9,812 ||29,846 ||39,658 ||6,534 ||24,941 ||31,475 |
|Change in net interest income (fully taxable equivalent basis)||$||74,476 ||$||(45,128)||29,348 ||$||44,364 ||$||(24,208)||20,156 ||$||58,909 ||$||(3,874)||55,035 |
|Tax equivalent adjustment using marginal rate of 21% for 2020, 2019 and 2018|| || ||(3,881)||(2,353)||6,538 |
|Change in net interest income|| || ||$||25,467 ||$||17,803 ||$||61,573 |
Management evaluates securities for other-than-temporary-impairment ("OTTI") at least on a quarterly basis, and more frequently when economic or market conditions warrant such an evaluation.
In determining OTTI, management considers many factors, including: (1) the length of time and the extent to which the fair value has been less than cost, (2) the financial condition and near term prospects of the issuer, (3) whether the market decline was affected by macroeconomic conditions, and (4) whether the Corporation has the intent to sell the debt security or more likely than not, will be required to sell the debt security before its anticipated recovery. The assessment of whether an other-than-temporary decline exists involves a high degree of subjectivity and judgment and is based on the information available to management at a point in time.
When OTTI occurs, the amount of OTTI recognized in the income statement depends on whether the Corporation intends to sell the security or it is more likely than not that the Corporation will be required to sell the security before recovery of its amortized cost basis, less any recognized credit loss. If the intent is to sell, or it is more likely than not that the Corporation will be required to sell the security before recovery of its amortized cost basis, less any recognized credit loss, the OTTI shall be recognized in earnings equal to the entire difference between the investment’s amortized cost basis, less any recognized credit loss, and its fair value at the balance sheet date. If the intent is not to sell the security and it is not more likely than not that the Corporation will be required to sell the security before the recovery of its amortized cost basis less any recognized credit loss, the OTTI has been separated into the amount representing the credit loss and the amount related to all other factors. The amount of the total OTTI related to the credit loss is determined based on the present value of cash flows expected to be collected and is recognized in earnings. The amount of the total OTTI related to other factors is recognized in other comprehensive income, net of applicable income taxes. The previous amortized cost basis less the OTTI recognized in earnings becomes the new amortized cost basis of the investment.
The Corporation’s management has evaluated all securities with unrealized losses for OTTI as of December 31, 2020 and concluded no OTTI existed in 2020.
In determining the fair value of the investment securities portfolio, the Corporation utilizes a third party for portfolio accounting services, including market value input, for those securities classified as Level I and Level II in the fair value hierarchy. The Corporation has obtained an understanding of what inputs are being used by the vendor in pricing the portfolio and how the vendor classified these securities based upon these inputs. From these discussions, the Corporation’s management is comfortable that the classifications are proper. The Corporation has gained trust in the data for two reasons: (a) independent spot testing of the data is conducted by the Corporation through obtaining market quotes from various brokers on a periodic basis; and (b) actual gains or loss resulting from the sale of certain securities has proven the data to be accurate over time. Fair value of securities classified as Level 3 in the valuation hierarchy were determined using a discounted cash flow model that incorporated market estimates of interest rates and volatility in markets that have not been active.
The amortized cost, gross unrealized gains, gross unrealized losses and approximate fair value of the investment securities at the dates indicated were:
| ||Amortized Cost||Gross Unrealized Gains||Gross Unrealized Losses||Fair Value|
|Available for sale at December 31, 2020|
|U.S. Government-sponsored agency securities||$||2,380 ||$||50 ||$||— ||$||2,430 |
|State and municipal||1,168,711 ||89,420 ||246 ||1,257,885 |
|U.S. Government-sponsored mortgage-backed securities||632,267 ||22,505 ||103 ||654,669 |
|Corporate obligations||4,031 ||104 ||— ||4,135 |
|Total available for sale||1,807,389 ||112,079 ||349 ||1,919,119 |
|Held to maturity at December 31, 2020|| |
|U.S. Government-sponsored agency securities||31,087 ||10 ||113 ||30,984 |
|State and municipal||619,927 ||34,978 ||32 ||654,873 |
|U.S. Government-sponsored mortgage-backed securities||575,154 ||17,889 ||107 ||592,936 |
|Foreign investment||1,500 ||— ||— ||1,500 |
|Total held to maturity||1,227,668 ||52,877 ||252 ||1,280,293 |
|Total Investment Securities||$||3,035,057 ||$||164,956 ||$||601 ||$||3,199,412 |
|Amortized Cost||Gross Unrealized Gains||Gross Unrealized Losses||Fair Value|
|Available for sale at December 31, 2019|| || || || |
|U.S. Government-sponsored agency securities||$||38,529 ||$||346 ||$||— ||$||38,875 |
|State and municipal||859,511 ||41,092 ||807 ||899,796 |
|U.S. Government-sponsored mortgage-backed securities||842,349 ||10,378 ||1,404 ||851,323 |
|Corporate obligations||31 ||— ||— ||31 |
|Total available for sale||1,740,420 ||51,816 ||2,211 ||1,790,025 |
|Held to maturity at December 31, 2019|| |
|U.S. Government-sponsored agency securities||15,619 ||1 ||37 ||15,583 |
|State and municipal||354,115 ||15,151 ||107 ||369,159 |
|U.S. Government-sponsored mortgage-backed securities||434,804 ||6,921 ||401 ||441,324 |
|Foreign investment||1,500 ||— ||— ||1,500 |
|Total held to maturity||806,038 ||22,073 ||545 ||827,566 |
|Total Investment Securities||$||2,546,458 ||$||73,889 ||$||2,756 ||$||2,617,591 |
|Amortized Cost||Gross Unrealized Gains||Gross Unrealized Losses||Fair Value|
|Available for sale at December 31, 2018|| || || || |
|U.S. Government-sponsored agency securities||$||13,493 ||$||92 ||$||3 ||$||13,582 |
|State and municipal||605,994 ||5,995 ||5,854 ||606,135 |
|U.S. Government-sponsored mortgage-backed securities||530,209 ||634 ||8,396 ||522,447 |
|Corporate obligations||31 ||— ||— ||31 |
|Total available for sale||1,149,727 ||6,721 ||14,253 ||1,142,195 |
|Held to maturity at December 31, 2018|| || || || |
|U.S. Government-sponsored agency securities||22,618 ||— ||545 ||22,073 |
|State and municipal||197,909 ||2,858 ||872 ||199,895 |
|U.S. Government-sponsored mortgage-backed securities||268,860 ||713 ||3,323 ||266,250 |
|Foreign investment||1,000 ||— ||1 ||999 |
|Total held to maturity||490,387 ||3,571 ||4,741 ||489,217 |
|Total Investment Securities||$||1,640,114 ||$||10,292 ||$||18,994 ||$||1,631,412 |
The cost and yield for Federal Home Loan Bank stock is included in the table below.
|(Dollars in Thousands)||Cost||Yield||Cost||Yield||Cost||Yield|
|Federal Home Loan Bank stock||$||28,736 ||3.6 ||%||$||28,736 ||4.8 ||%||$||24,588 ||5.0 ||%|
|Total||$||28,736 ||3.6 ||%||$||28,736 ||4.8 ||%||$||24,588 ||5.0 ||%|
The Corporation’s Federal Home Loan Bank stock is primarily in the Federal Home Loan Bank of Indianapolis and it continued to produce sufficient financial results to pay dividends.
There were no issuers included in the investment security portfolio at December 31, 2020, 2019 or 2018 where the aggregate carrying value of any one issuer exceeded 10 percent of the Corporation's stockholders' equity at those dates. The term "issuer" excludes the U.S. Government and its sponsored agencies and corporations.
The maturity distribution and average yields for the securities portfolio at December 31, 2020 were:
| ||Within 1 Year||1-5 Years||5-10 Years|
|(Dollars in Thousands)||Amount|
|Securities available for sale December 31, 2020|| || || || || || |
|U.S. Government-sponsored agency securities||$||878 ||1.9 ||%||$||1,552 ||2.0 ||%||$||— ||— ||%|
|State and municipal||475 ||5.9 ||%||4,212 ||4.3 ||%||71,119 ||3.6 ||%|
|Corporate obligations||— ||— ||%||— ||— ||%||4,104 ||5.0 ||%|
|$||1,353 ||3.3 ||%||$||5,764 ||3.7 ||%||$||75,223 ||3.7 ||%|
| ||Due After Ten Years|
Sponsored Mortgage - Backed
|U.S. Government-sponsored agency securities||$||— ||— ||%||$||— ||— ||%||$||2,430 ||2.0 ||%|
|State and municipal||1,182,079 ||3.6 ||%||— ||— ||%||1,257,885 ||3.6 ||%|
|U.S. Government-sponsored mortgage-backed securities||— ||— ||%||654,669 ||2.2 ||%||654,669 ||2.2 ||%|
|Corporate obligations||31 ||— ||%||— ||— ||%||4,135 ||5.0 ||%|
|$||1,182,110 ||3.6 ||%||$||654,669 ||2.2 ||%||$||1,919,119 ||3.1 ||%|
| ||Within 1 Year||1-5 Years||5-10 Years|
|(Dollars in Thousands)||Amount|
|Securities held to maturity at December 31, 2020|| || || || || || |
|U.S. Government-sponsored agency securities||$||100 ||1.9 ||%||$||— ||— ||%||$||30,987 ||1.0 ||%|
|State and municipal||9,612 ||4.1 ||%||20,741 ||4.4 ||%||84,421 ||4.0 ||%|
|Foreign investment||— ||— ||%||1,500 ||2.9 ||%||— ||— ||%|
|$||9,712 ||4.1 ||%||$||22,241 ||4.3 ||%||$||115,408 ||3.2 ||%|
| ||Due After Ten Years|
Sponsored Mortgage - Backed