Midland States Bancorp (MSBI) 10-Q 2019 Q2 Quarterly report

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

☒ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended June 30, 2019

☐ 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 001-35272

MIDLAND STATES BANCORP, INC.

(Exact name of registrant as specified in its charter)

Illinois	37-1233196
(State of other jurisdiction of incorporation or organization)	(I.R.S. Employer Identification No.)

1201 Network Centre Drive Effingham, IL	62401
(Address of principal executive offices)	(Zip Code)

(217) 342-7321

(Registrant’s telephone number, including area code)

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, $0.01 par value	MSBI	Nasdaq Global Select Market

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. ⌧ Yes ◻ No

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). ⌧ Yes ◻ No

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.

Large accelerated filer ⌧	Accelerated filer ◻	Non-accelerated filer ◻	Smaller reporting company ☐
Emerging growth company ☐

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ◻

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). ☐ Yes ⌧ No

As of July 31, 2019, the Registrant had 24,363,400 shares of outstanding common stock, $0.01 par value.

MIDLAND STATES BANCORP, INC.

TABLE OF CONTENTS

		Page
PART I. FINANCIAL INFORMATION
Item 1.	Financial Statements:
	Consolidated Balance Sheets at June 30, 2019 (Unaudited) and December 31, 2018	2
	Consolidated Statements of Income (Unaudited) for the three and six months ended June 30, 2019 and 2018	3
	Consolidated Statements of Comprehensive Income (Unaudited) for the three and six months ended June 30, 2019 and 2018	4
	Consolidated Statements of Shareholders’ Equity (Unaudited) for the three and six months ended June 30, 2019 and 2018	5
	Consolidated Statements of Cash Flows (Unaudited) for the six months ended June 30, 2019 and 2018	6
	Notes to Consolidated Financial Statements (Unaudited)	6
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	36
Item 3.	Quantitative and Qualitative Disclosures about Market Risk	55
Item 4.	Controls and Procedures	55
PART II. OTHER INFORMATION
Item 1.	Legal Proceedings	55
Item 1A.	Risk Factors	55
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	56
Item 6.	Exhibits	57
SIGNATURES

1

PART I – FINANCIAL INFORMATION

ITEM 1 – FINANCIAL STATEMENTS

MIDLAND STATES BANCORP, INC.

CONSOLIDATED BALANCE SHEETS

(dollars in thousands, except per share data)

	June 30,		December 31,
	2019		2018
	(unaudited)
Assets
Cash and due from banks	$	244,239	$	210,780
Federal funds sold		1,176		2,920
Cash and cash equivalents		245,415		213,700
Investment securities available for sale, at fair value		609,657		657,451
Equity securities, at fair value		3,369		3,334
Loans		4,073,527		4,137,551
Allowance for loan losses		(25,925)		(20,903)
Total loans, net		4,047,602		4,116,648
Loans held for sale, at fair value		22,143		30,401
Premises and equipment, net		94,824		94,840
Operating lease right-of-use asset		10,226		—
Other real estate owned		3,797		3,483
Nonmarketable equity securities		43,175		42,472
Accrued interest receivable		15,509		16,560
Mortgage servicing rights, at lower of cost or fair value		54,191		53,447
Mortgage servicing rights held for sale		159		3,545
Intangible assets		33,893		37,376
Goodwill		164,673		164,673
Cash surrender value of life insurance policies		140,593		138,783
Accrued income taxes receivable		2,032		8,809
Deferred tax assets, net		—		1,251
Other assets		54,797		50,900
Total assets	$	5,546,055	$	5,637,673
Liabilities and Shareholders’ Equity
Liabilities:
Deposits:
Noninterest-bearing	$	902,286	$	972,164
Interest-bearing		3,108,921		3,102,006
Total deposits		4,011,207		4,074,170
Short-term borrowings		113,844		124,235
FHLB advances and other borrowings		582,387		640,631
Subordinated debt		94,215		94,134
Trust preferred debentures		48,041		47,794
Accrued interest payable		5,455		4,855
Deferred tax liabilities, net		3,869		—
Operating lease liabilities		10,719		—
Other liabilities		36,430		43,329
Total liabilities		4,906,167		5,029,148
Shareholders’ Equity:
Preferred stock, Series H, $2 par value; $1,000 per share liquidation value; 2,636 shares authorized, issued and outstanding at June 30, 2019 and December 31, 2018		2,684		2,781
Common stock, $0.01 par value; 40,000,000 shares authorized; 23,897,038 and 23,751,798 shares issued and outstanding at June 30, 2019 and December 31, 2018, respectively		239		238
Capital surplus		477,412		473,833
Retained earnings		152,387		133,781
Accumulated other comprehensive income (loss)		7,166		(2,108)
Total shareholders’ equity		639,888		608,525
Total liabilities and shareholders’ equity	$	5,546,055	$	5,637,673

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

2

MIDLAND STATES BANCORP, INC.

CONSOLIDATED STATEMENTS OF INCOME—(UNAUDITED)

(dollars in thousands, except per share data)

	Three Months Ended					Six Months Ended
	June 30,					June 30,
	2019			2018		2019		2018
Interest income:
Loans:
Taxable	$	53,021		$	50,699	$	104,903	$	91,730
Tax exempt		918			802		1,892		1,269
Loans held for sale		451			295		750		723
Investment securities:
Taxable		3,606			3,756		7,289		6,399
Tax exempt		1,061			1,235		2,127		2,251
Nonmarketable equity securities		597			482		1,218		881
Federal funds sold and cash investments		982			1,014		1,889		1,535
Total interest income		60,636			58,283		120,068		104,788
Interest expense:
Deposits		8,437			5,005		15,800		9,122
Short-term borrowings		210			116		447		240
FHLB advances and other borrowings		3,541			2,582		7,388		4,453
Subordinated debt		1,514			1,514		3,028		3,028
Trust preferred debentures		857			780		1,727		1,474
Total interest expense		14,559			9,997		28,390		18,317
Net interest income		46,077	���		48,286		91,678		86,471
Provision for loan losses		4,076			1,854		7,319		3,860
Net interest income after provision for loan losses		42,001			46,432		84,359		82,611
Noninterest income:
Wealth management revenue		5,504			5,316		10,457		9,395
Commercial FHA revenue		4,917			326		8,187		3,656
Residential mortgage banking revenue		611			2,116		1,445		3,534
Service charges on deposit accounts		2,639			2,693		5,159		4,660
Interchange revenue		3,010			2,929		5,690		4,974
Gain (loss) on sales of investment securities, net		14			(70)		14		(5)
(Loss) gain on sales of other real estate owned		(12)			166		54		473
Other income		2,904			2,371		5,656		5,662
Total noninterest income		19,587			15,847		36,662		32,349
Noninterest expense:
Salaries and employee benefits		21,134			23,467		43,173		51,862
Occupancy and equipment		4,500			4,708		9,332		8,960
Data processing		4,987			5,106		9,878		9,585
FDIC insurance		367			539		802		1,087
Professional		2,410			3,195		4,483		6,944
Marketing		1,118			1,411		2,352		2,617
Communications		677			741		1,348		2,317
Loan expense		616			552		976		1,076
Other real estate owned		101			166		194		256
Amortization of intangible assets		1,673			1,576		3,483		3,251
(Gain) loss on mortgage servicing rights held for sale		(515)			188		(515)		188
Other expense		3,126			4,803		5,785		7,808
Total noninterest expense		40,194			46,452		81,291		95,951
Income before income taxes		21,394			15,827		39,730		19,009
Income taxes		5,039			3,045		9,393		4,421
Net income		16,355			12,782		30,337		14,588
Preferred stock dividends and premium amortization		34			36		68		72
Net income available to common shareholders	$	16,321		$	12,746	$	30,269	$	14,516
Per common share data:
Basic earnings per common share	$	0.67		$	0.53	$	1.25	$	0.64
Diluted earnings per common share	$	0.67		$	0.52	$	1.24	$	0.63
Weighted average common shares outstanding		24,081,777			23,815,436		24,040,032		22,365,927
Weighted average diluted common shares outstanding		24,303,211			24,268,111		24,254,612		22,817,472

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

3

MIDLAND STATES BANCORP, INC.

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME—(UNAUDITED)

(dollars in thousands)

	Three Months Ended				Six Months Ended
	June 30,				June 30,
	2019		2018		2019		2018
Net income	$	16,355	$	12,782	$	30,337	$	14,588
Other comprehensive income (loss):
Investment securities available for sale:
Unrealized gains (losses) that occurred during the period		5,098		(2,252)		12,806		(5,589)
Reclassification adjustment for realized net (gains) losses on sales of investment securities included in net income		(14)		70		(14)		5
Income tax effect		(1,398)		595		(3,518)		1,519
Change in investment securities available for sale, net of tax		3,686		(1,587)		9,274		(4,065)
Other comprehensive income (loss), net of tax		3,686		(1,587)		9,274		(4,065)
Total comprehensive income	$	20,041	$	11,195	$	39,611	$	10,523

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

4

MIDLAND STATES BANCORP, INC.

CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY—(UNAUDITED)

(dollars in thousands, except per share data)

									Accumulated
									other		Total
	Preferred		Common		Capital		Retained		comprehensive		shareholders'
	stock		stock		surplus		earnings		income (loss)		equity
For the three months ended June 30, 2019:
Balances, March 31, 2019	$	2,733	$	238	$	475,811	$	141,906	$	3,480	$	624,168
Net income		—		—		—		16,355		—		16,355
Other comprehensive income		—		—		—		—		3,686		3,686
Common dividends declared ($0.2425 per share)		—		—		—		(5,840)		—		(5,840)
Preferred dividends declared		—		—		—		(83)		—		(83)
Preferred stock, premium amortization		(49)		—		—		49		—		—
Share-based compensation expense		—		—		493		—		—		493
Issuance of common stock under employee benefit plans		—		1		1,108		—		—		1,109
Balances, June 30, 2019	$	2,684	$	239	$	477,412	$	152,387	$	7,166	$	639,888
For the six months ended June 30, 2019:
Balances, December 31, 2018	$	2,781	$	238	$	473,833	$	133,781	$	(2,108)	$	608,525
Net income		—		—		—		30,337		—		30,337
Other comprehensive income		—		—		—		—		9,274		9,274
Common dividends declared ($0.4850 per share)		—		—		—		(11,663)		—		(11,663)
Preferred dividends declared		—		—		—		(165)		—		(165)
Preferred stock, premium amortization		(97)		—		—		97		—		—
Share-based compensation expense		—		—		1,339		—		—		1,339
Issuance of common stock under employee benefit plans		—		1		2,240		—		—		2,241
Balances, June 30, 2019	$	2,684	$	239	$	477,412	$	152,387	$	7,166	$	639,888
For the three months ended June 30, 2018:
Balances, March 31, 2018	$	2,923	$	236	$	470,937	$	112,009	$	(720)	$	585,385
Net income		—		—		—		12,782		—		12,782
Other comprehensive loss		—		—		—		—		(1,587)		(1,587)
Common dividends declared ($0.22 per share)		—		—		—		(5,233)		—		(5,233)
Preferred dividends declared		—		—		—		(83)		—		(83)
Preferred stock, premium amortization		(47)		—		—		47		—		—
Share-based compensation expense		—		—		398		—		—		398
Issuance of common stock under employee benefit plans		—		1		872		—		—		873
Balances, June 30, 2018	$	2,876	$	237	$	472,207	$	119,522	$	(2,307)	$	592,535
For the six months ended June 30, 2018:
Balances, December 31, 2017	$	2,970	$	191	$	330,148	$	114,478	$	1,758	$	449,545
Net income		—		—		—		14,588		—		14,588
Other comprehensive loss		—		—		—		—		(4,065)		(4,065)
Common dividends declared ($0.44 per share)		—		—		—		(9,472)		—		(9,472)
Preferred dividends declared		—		—		—		(166)		—		(166)
Preferred stock, premium amortization		(94)		—		—		94		—		—
Share-based compensation expense		—		—		831		—		—		831
Acquisition of Alpine Bancorporation, Inc.		—		45		139,876		—		—		139,921
Issuance of common stock under employee benefit plans		—		1		1,352		—		—		1,353
Balances, June 30, 2018	$	2,876	$	237	$	472,207	$	119,522	$	(2,307)	$	592,535

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

5

MIDLAND STATES BANCORP, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS—(UNAUDITED)

(dollars in thousands)

	Six Months Ended
	June 30,
	2019		2018
Cash flows from operating activities:
Net income	$	30,337	$	14,588
Adjustments to reconcile net income to net cash provided by operating activities:
Provision for loan losses		7,319		3,860
Depreciation on premises and equipment		3,186		3,083
Amortization of intangible assets		3,483		3,251
Amortization of operating lease right-of-use asset		1,353		—
Share-based compensation expense		1,339		831
Increase in cash surrender value of life insurance		(1,810)		(1,737)
Investment securities amortization, net		1,925		1,814
(Gain) loss on sales of investment securities, net		(14)		5
Gain on sales of other real estate owned		(54)		(473)
Impairment of other real estate owned		16		126
Origination of loans held for sale		(233,845)		(251,501)
Proceeds from sales of loans held for sale		248,704		269,899
Gain on loans sold and held for sale		(7,563)		(5,372)
Loss on disposals of premises and equipment		9		—
Amortization of mortgage servicing rights		1,353		1,671
(Recapture) impairment of mortgage servicing rights		(534)		633
(Gain) loss on mortgage servicing rights held for sale		(515)		188
Net change in operating assets and liabilities:
Accrued interest receivable		1,051		1,329
Accrued interest payable		600		667
Accrued income taxes receivable		8,209		3,789
Operating lease liabilities		(1,483)		—
Other assets		(3,308)		(8,994)
Other liabilities		(6,210)		(640)
Net cash provided by operating activities		53,548		37,017
Cash flows from investing activities:
Investment securities available for sale:
Purchases		(32,539)		(59,031)
Sales		28,465		16,869
Maturities and payments		62,680		71,483
Equity securities:
Purchases		(31)		(29)
Sales		105		7,733
Net decrease (increase) in loans		59,998		(86,122)
Proceeds from sale of premises and equipment		31		183
Purchases of premises and equipment		(3,210)		(4,087)
Proceeds from sales of mortgage servicing rights held for sale		3,288		13,101
Purchases of nonmarketable equity securities		(10,271)		(14,045)
Sales of nonmarketable equity securities		9,568		6,601
Proceeds from sales of other real estate owned		1,274		3,226
Net cash acquired in acquisition		—		36,153
Net cash provided by (used in) investing activities		119,358		(7,965)
Cash flows from financing activities:
Net decrease in deposits		(62,963)		(82,362)
Net decrease in short-term borrowings		(10,391)		(41,590)
Proceeds from FHLB borrowings		295,000		657,000
Payments made on FHLB borrowings		(350,393)		(491,257)
Payments made on other borrowings		(2,857)		(1,429)
Cash dividends paid on preferred stock		(165)		(166)
Cash dividends paid on common stock		(11,663)		(9,472)
Proceeds from issuance of common stock under employee benefit plans		2,241		1,353
Net cash (used in) provided by financing activities		(141,191)		32,077
Net increase in cash and cash equivalents		31,715		61,129
Cash and cash equivalents:
Beginning of period		213,700		215,202
End of period	$	245,415	$	276,331
Supplemental disclosures of cash flow information:
Cash payments for:
Interest paid on deposits and borrowed funds	$	27,790	$	17,111
Income tax paid (net of refunds)		612		528
Supplemental disclosures of noncash investing and financing activities:
Transfer of loans to other real estate owned	$	1,719	$	765
Transfer of mortgage servicing rights at lower of cost or market to mortgage servicing rights held for sale		—		3,649

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

6

MIDLAND STATES BANCORP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(UNAUDITED)

Note 1 – Business Description

Midland States Bancorp, Inc. (the “Company,” “we,” “our,” or “us”) is a diversified financial holding company headquartered in Effingham, Illinois. Its wholly owned banking subsidiary, Midland States Bank (the “Bank”), has branches across Illinois and in Missouri, and provides a full range of commercial and consumer banking products and services, business equipment finance, merchant credit card services, trust and investment management, and insurance and financial planning services. In addition, multifamily and healthcare facility Federal Housing Administration (“FHA”) financing is provided through Love Funding Corporation (“Love Funding”), our non-bank subsidiary.

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; residential mortgage loan originations, sales and servicing; and, from time to time, gains on sales of assets. Our income sources also include Love Funding’s commercial FHA loan origination and servicing income. 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 loan losses and income tax expense.

Note 2 – Basis of Presentation and Summary of Significant Accounting Policies

Basis of Presentation

The consolidated financial statements of the Company are unaudited and should be read in conjunction with the consolidated financial statements and related notes contained in the Company’s Annual Report on Form 10-K for the year ended December 31, 2018, filed with the Securities and Exchange Commission (the “SEC”) on February 28, 2019. The consolidated financial statements have been prepared in accordance with the accounting principles generally accepted in the United States of America (“GAAP”) and conform to predominant practices within the banking industry. A discussion of these policies can be found in Note 1 – Summary of Significant Accounting Policies included in the Company's 2018 Annual Report on Form 10-K. There has been one change to our significant accounting policies since December 31, 2018, which is described below. 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 the interim periods presented herein, have been included. Certain reclassifications of 2018 amounts have been made to conform to the 2019 presentation. Management has evaluated subsequent events for potential recognition or disclosure. Operating results for the three and six months ended June 30, 2019 are not necessarily indicative of the results that may be expected for the year ending December 31, 2019 or any other period.

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 unaudited consolidated financial statements.

Accounting Guidance Adopted in 2019

FASB ASU 2016-02, “Leases (Topic 842)” – In February 2016, the FASB issued ASU No. 2016-02, “Leases (Topic 842),” which requires lessees to recognize leases on-balance sheet and to disclose key information about leasing arrangements. Topic 842 was subsequently amended by ASU No. 2018-10, “Codification Improvements to Topic 842, Leases;” and ASU No. 2018-11, “Targeted Improvements.” The new standard established a right-of-use (“ROU”) model, that requires a lessee to recognize ROU assets and lease liabilities on the balance sheet for all leases with a term longer than 12 months. Under the new guidance, leases are classified as either finance or operating, with classification

7

affecting the pattern and classification of expense recognition in the statement of income. The Company adopted the new standard on January 1, 2019, and used the effective date as our date of initial application.

A modified retrospective adoption approach is required, applying the new standard to all existing leases in effect at the adoption date and new leases going forward. Consequently, financial information will not be updated and the disclosures required under the new standard will not be provided for dates and periods prior to January 1, 2019. This update also allows lessors to not separate non-lease components from the associated lease component if certain conditions are met.  The Company elected the “package of practical expedients” permitted by ASU 2018-11, which allows us not to reassess under the new standard our prior conclusions about lease identification, lease classification and initial direct costs.

The new standard also provides practical expedients for ongoing accounting. The Company elected the short-term lease recognition exemption for our office equipment leases. This means, for those leases that qualify, we did recognize ROU assets or lease liabilities, and this includes not recognizing ROU assets or lease liabilities for existing short-term leases of those assets in transition.

At the adoption date, the Company reported increased assets and liabilities of approximately $12.1 million on its consolidated balance sheet as a result of recognizing ROU assets and lease liabilities related to non-cancelable operating lease agreements for office space. The adoption of this guidance did not have a material effect to its consolidated statement of income.

Accounting Guidance Issued But Not Yet Adopted

FASB ASU 2016-13, “Financial Instruments – Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments” – In June 2016, the FASB issued ASU No. 2016-13, “Financial Instruments – Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments (“CECL”).” The objective of this update is to improve financial reporting by providing timelier recording of credit losses on loans and other financial instruments held by financial institutions and other organizations. The ASU requires an organization to measure all expected credit losses for financial assets held at the reporting date based on historical experience, current conditions, and reasonable and supportable forecasts. Financial institutions and other organizations will use forward-looking information to better understand their credit loss estimates. For public companies that are filers with the SEC, this update is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2019. As previously disclosed, the Company has established a cross-functional governance structure, which oversees overall strategy for implementation of Topic 326. Additionally, a working group was formed and has developed a project plan focused on understanding the ASU, researching issues, data requirements, technology solutions and future state processes. The project plan is targeting the model validation completion by a third party during the third quarter of 2019, with parallel processing of our existing allowance for loan loss model with CECL prior to implementation during the third and fourth quarters of 2019. The working group has identified 12 distinct loan portfolios for which a model has been developed and internally validated. The Company continues to focus on researching and resolving interpretive accounting issues in the ASU, contemplating various related accounting policies, developing processes and related controls and considering various reporting disclosures. The Company also continues to believe that the adoption of the standard will result in an overall increase in the allowance for loan losses to cover credit losses over the estimated life of the financial assets. However, the magnitude of the increase in its allowance for loan losses at the adoption date will depend upon the nature and characteristics of the portfolio at the adoption date, as well as macroeconomic conditions and forecasts at that time. 

FASB ASU No. 2018-13, “Fair Value Measurement (Topic 820): Disclosure Framework – Changes to the Disclosure Requirements for Fair Value Measurement” – In August 2018, the FASB issued ASU No. 2018-13 to improve the disclosure requirements on fair value measurements. The amendment removes certain disclosures required by Topic 820 related to transfers between Level 1 and Level 2 of the fair value hierarchy; the policy for timing of transfers between levels; the valuation processes for Level 3 fair value measurements. The update also adds certain disclosure requirements related to changes in unrealized gains and losses for the period included in other comprehensive income for recurring Level 3 fair value measurements held at the end of the reporting period and the range and weighted average of significant unobservable inputs used to develop Level 3 fair value measurements. For certain unobservable inputs, an entity may disclose other quantitative information in lieu of the weighted average if the entity determines that other quantitative information would be a more reasonable and rational method to reflect the distribution of unobservable inputs used to develop Level 3 fair value measurements. The amendments in this update become effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2019, with early adoption

8

permitted. The Company is currently evaluating the impact of adopting the new guidance on its consolidated financial statements, but it is not expected to have a material impact.

Note 3 – Acquisitions

Alpine Bancorporation, Inc.

On February 28, 2018, the Company completed its acquisition of Alpine Bancorporation, Inc. (“Alpine”) and its banking subsidiary, Alpine Bank & Trust Co. (“Alpine Bank”), which operated 19 locations in northern Illinois. In the aggregate, the Company acquired Alpine for consideration valued at approximately $173.2 million, which consisted of approximately $33.3 million in cash and the issuance of 4,463,200 shares of the Company’s common stock. The acquisition was accounted for under the acquisition method of accounting. Accordingly, the Company recognized amounts for identifiable assets acquired and liabilities assumed at their estimated acquisition date fair values, while $22.4 million of transaction and integration costs associated with the acquisition were expensed as incurred. As of February 28, 2019, the Company finalized its valuation of all assets acquired liabilities assumed in its acquisition of Alpine, resulting in no material change to acquisition accounting adjustments.

Note 4 – Investment Securities

Investment securities as of June 30, 2019 and December 31, 2018 were as follows:

	June 30, 2019
			Gross		Gross
	Amortized		unrealized		unrealized		Fair
(dollars in thousands)	cost		gains		losses		value
Available for sale securities
Government sponsored entity debt securities	$	74,286	$	589	$	—	$	74,875
Agency mortgage-backed securities		294,432		3,126		196		297,362
State and municipal securities		138,181		5,559		11		143,729
Corporate securities		92,874		1,251		434		93,691
Total available for sale securities	$	599,773	$	10,525	$	641	$	609,657
Equity securities							$	3,369

	December 31, 2018
			Gross		Gross
	Amortized		unrealized		unrealized		Fair
(dollars in thousands)	cost		gains		losses		value
Available for sale securities
U.S. Treasury securities	$	25,018	$	—	$	368	$	24,650
Government sponsored entity debt securities		76,554		17		887		75,684
Agency mortgage-backed securities		329,690		371		3,756		326,305
State and municipal securities		156,795		3,282		815		159,262
Corporate securities		72,302		383		1,135		71,550
Total available for sale securities	$	660,359	$	4,053	$	6,961	$	657,451
Equity securities							$	3,334

Unrealized losses and fair values for investment securities available for sale as of June 30, 2019 and December 31, 2018, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position, are summarized as follows:

	June 30, 2019
	Less than 12 Months				12 Months or more				Total
	Fair		Unrealized		Fair		Unrealized		Fair		Unrealized
(dollars in thousands)	value		loss		value		loss		value		loss
Available for sale securities
Government sponsored entity debt securities	$	—	$	—	$	—	$	—	$	—	$	—
Agency mortgage-backed securities		25,257		30		40,366		166		65,623		196
State and municipal securities		836		4		3,348		7		4,184		11
Corporate securities		18,053		287		6,390		147		24,443		434
Total available for sale securities	$	44,146	$	321	$	50,104	$	320	$	94,250	$	641

9

	December 31, 2018
	Less than 12 Months				12 Months or more				Total
	Fair		Unrealized		Fair		Unrealized		Fair		Unrealized
(dollars in thousands)	value		loss		value		loss		value		loss
Available for sale securities
U.S. Treasury securities	$	5,012	$	1	$	19,638	$	367	$	24,650	$	368
Government sponsored entity debt securities		51,717		195		23,223		692		74,940		887
Agency mortgage-backed securities		139,115		528		126,561		3,228		265,676		3,756
State and municipal securities		15,791		146		27,692		669		43,483		815
Corporate securities		32,616		575		8,535		560		41,151		1,135
Total available for sale securities	$	244,251	$	1,445	$	205,649	$	5,516	$	449,900	$	6,961

For all of the above investment securities, the unrealized losses are generally due to changes in interest rates and unrealized losses are considered to be temporary as the fair value is expected to recover as the securities approach maturity date.

We evaluate securities for other-than-temporary impairment (“OTTI”) on a quarterly basis, at a minimum, and more frequently when economic or market concerns warrant such evaluation. In estimating OTTI losses, we consider the severity and duration of the impairment; the financial condition and near-term prospects of the issuer, which for debt securities considers external credit ratings and recent downgrades; and the intent and ability of the Company to hold the security for a period of time sufficient for a recovery in value.

At June 30, 2019, 51 investment securities available for sale had unrealized losses with aggregate depreciation of 0.68% from their amortized cost basis. The unrealized losses relate principally to the fluctuations in the current interest rate environment. In analyzing an issuer’s financial condition, we consider whether the securities are issued by the federal government or its agencies and whether downgrades by bond rating agencies have occurred. The Company does not have the intent to sell and it is not more likely than not that it will be required to sell a security in an unrealized loss position prior to recovery in value; therefore, the Company does not consider these securities to be other than temporarily impaired at June 30, 2019.

For the three and six months ended June 30, 2019 and 2018, the Company did not recognize OTTI losses on its investment securities.

The following is a summary of the amortized cost and fair value of the available-for-sale investment securities, by maturity, at June 30, 2019. Expected maturities may differ from contractual maturities in mortgage-backed securities because the mortgages underlying the securities may be prepaid without penalties. The maturities of all other available-for-sale investment securities are based on final contractual maturity.

	Amortized		Fair
(dollars in thousands)	cost		value
Available for sale securities
Within one year	$	47,428	$	47,545
After one year through five years		79,332		81,206
After five years through ten years		152,041		155,775
After ten years		26,540		27,769
Mortgage-backed securities		294,432		297,362
Total available for sale securities	$	599,773	$	609,657

Proceeds from the sale of securities available for sale were $28.5 million for both the three and six months ended June 30, 2019. Gross realized gains and gross realized losses from the sale of securities available for sale were $126,000 and $190,000, respectively, for both the three and six months ended June 30, 2019.

Proceeds from the sale of securities available for sale were $15.3 million and $16.9 million for the three and six months ended June 30, 2018, respectively. Gross realized gains from the sale of securities available for sale were $8,000 and $73,000 for the three and six months ended June 30, 2018, respectively. Gross realized losses from the sale of securities available for sale were $25,000 for both the three and six months ended June 30, 2018.

Proceeds from the sale of equity securities were $105,000 for the three and six months ended June 30, 2019.

10

Gross realized gains from the sale of equity securities were $78,000 for the three and six months ended June 30, 2019. There were no gross realized losses from the sale of equity securities for the three and six months ended June 30, 2019. During the three and six months ended June 30, 2019, the Company recognized net unrealized losses of $30,000 and net unrealized gains of $37,000, respectively, on equity securities, which was recorded as other income in the consolidated statements of income.

Proceeds from the sale of equity securities were $7.7 million for the three and six months ended June 30, 2018. Gross realized losses from the sale of equity securities were $53,000 for the three and six months ended June 30, 2018. There were no gross realized gains from the sale of equity securities for the three and six months ended June 30, 2018. During the three and six months ended June 30, 2018, the Company recognized net unrealized losses of $18,000 and net unrealized gains of $93,000, respectively, on equity securities, which was recorded as other income in the consolidated statements of income.

Note 5 – Loans

The following table presents total loans outstanding by portfolio, which includes non-purchased credit impaired (“Non-PCI”) loans and purchased credit impaired (“PCI”) loans, as of June 30, 2019 and December 31, 2018:

	June 30, 2019						December 31, 2018
	Non-PCI		PCI				Non-PCI		PCI
(dollars in thousands)	Loans		Loans (1)		Total		Loans		Loans (1)		Total
Commercial	$	848,587	$	2,974	$	851,561	$	806,027	$	4,857	$	810,884
Commercial real estate		1,508,683		15,686		1,524,369		1,619,903		19,252		1,639,155
Construction and land development		244,188		6,226		250,414		223,898		8,331		232,229
Total commercial loans		2,601,458		24,886		2,626,344		2,649,828		32,440		2,682,268
Residential real estate		544,061		8,345		552,406		569,289		8,759		578,048
Consumer		595,728		1,240		596,968		611,408		1,776		613,184
Lease financing		297,809		—		297,809		264,051		—		264,051
Total loans	$	4,039,056	$	34,471	$	4,073,527	$	4,094,576	$	42,975	$	4,137,551

(1) The unpaid principal balance for PCI loans totaled $45.0 million and $56.9 million as of June 30, 2019 and December 31, 2018, respectively.

Total loans include net deferred loan fees of $3.0 million and $11.6 million at June 30, 2019 and December 31, 2018, respectively, and unearned income of $34.2 million and $29.2 million within the lease financing portfolio at June 30, 2019 and December 31, 2018, respectively.

At June 30, 2019 and December 31, 2018, the Company had commercial and residential loans held for sale totaling $22.1 million and $30.4 million, respectively. During the three and six months ended June 30, 2019, the Company sold commercial and residential real estate loans with proceeds totaling $149.4 million and $248.7 million, respectively, and sold commercial and residential real estate loans with proceeds totaling $115.9 million and $269.9 million for the comparable periods in 2018, respectively.

The aggregate loans outstanding to the directors, executive officers, principal shareholders and their affiliates totaled $24.5 million and $26.5 million at June 30, 2019 and December 31, 2018, respectively. During the three and six months ended June 30, 2019, there were $1.6 million and $3.1 million of new loans and other additions, respectively, while repayments and other reductions totaled $643,000 and $5.1 million, respectively.

Credit Quality Monitoring

The Company maintains loan policies and credit underwriting standards as part of the process of managing credit risk. These standards include making loans generally within the Company’s four main regions, which include eastern, northern and southern Illinois and the St. Louis metropolitan area. Our equipment leasing business provides financing to business customers across the country.

The Company has a loan approval process involving underwriting and individual and group loan approval authorities to consider credit quality and loss exposure at loan origination. The loans in the Company’s commercial loan portfolio are risk rated at origination based on the grading system set forth below. All loan authority is based on the aggregate credit to a borrower and its related entities. All loans in the commercial loan portfolio have an assigned relationship manager, and most borrowers provide periodic financial and operating information that allows the

11

relationship managers to stay abreast of credit quality during the life of the loans. The risk ratings of loans in the commercial loan portfolio are reassessed at least annually, with loans below an acceptable risk rating reassessed more frequently and reviewed by various individuals within the Company at least quarterly.

The Company’s consumer loan portfolio is primarily comprised of both secured and unsecured loans that are relatively small and are evaluated at origination on a centralized basis against standardized underwriting criteria. The ongoing measurement of credit quality of the consumer loan portfolio is largely done on an exception basis. If payments are made on schedule, as agreed, then no further monitoring is performed. However, if delinquency occurs, the delinquent loans are turned over to the Company’s Consumer Collections Group for resolution. Credit quality for the entire consumer loan portfolio is measured by the periodic delinquency rate, nonaccrual amounts and actual losses incurred.

The Company maintains a centralized independent loan review function that monitors the approval process and ongoing asset quality of the loan portfolio, including the accuracy of loan grades. The Company also maintains an independent appraisal review function that participates in the review of all appraisals obtained by the Company.

Credit Quality Indicators

The Company uses a ten grade risk rating system to monitor the ongoing credit quality of its commercial loan portfolio. These loan grades rank the credit quality of a borrower by measuring liquidity, debt capacity, and coverage and payment behavior as shown in the borrower’s financial statements. The risk grades also measure the quality of the borrower’s management and the repayment support offered by any guarantors.

The Company considers all loans with Risk Grades of 1 – 6 as acceptable credit risks and structures and manages such relationships accordingly. Periodic financial and operating data combined with regular loan officer interactions are deemed adequate to monitor borrower performance. Loans with Risk Grades of 7 are considered “watch credits” and the frequency of loan officer contact and receipt of financial data is increased to stay abreast of borrower performance. Loans with Risk Grades of 8 – 10 are considered problematic and require special care. Further, loans with Risk Grades of 7 – 10 are managed and monitored regularly through a number of processes, procedures and committees, including oversight by a loan administration committee comprised of executive and senior management of the Company, which includes highly structured reporting of financial and operating data, intensive loan officer intervention and strategies to exit, as well as potential management by the Company’s Special Assets Group. Loans not graded in the commercial loan portfolio are monitored by aging status and payment activity.

The following table presents the recorded investment of the commercial loan portfolio (excluding PCI loans) by risk category as of June 30, 2019 and December 31, 2018:

	June 30, 2019								December 31, 2018
			Commercial		Construction						Commercial		Construction
			Real		and Land						Real		and Land
(dollars in thousands)	Commercial		Estate		Development		Total		Commercial		Estate		Development		Total
Acceptable credit quality	$	796,947	$	1,403,625	$	238,050	$	2,438,622	$	748,296	$	1,536,127	$	218,798	$	2,503,221
Special mention		22,391		23,284		2,491		48,166		35,103		15,306		3,448		53,857
Substandard		21,086		53,152		884		75,122		14,139		46,976		—		61,115
Substandard – nonaccrual		8,163		28,622		1,312		38,097		8,489		21,494		1,171		31,154
Doubtful		—		—		—		—		—		—		—		—
Not graded		—		—		1,451		1,451		—		—		481		481
Total (excluding PCI)	$	848,587	$	1,508,683	$	244,188	$	2,601,458	$	806,027	$	1,619,903	$	223,898	$	2,649,828

12

The Company evaluates the credit quality of its other loan portfolio based primarily on the aging status of the loan and payment activity. Accordingly, loans on nonaccrual status, loans past due 90 days or more and still accruing interest, and loans modified under troubled debt restructurings are considered to be impaired for purposes of credit quality evaluation. The following table presents the recorded investment of our other loan portfolio (excluding PCI loans) based on the credit risk profile of loans that are performing and loans that are impaired as of June 30, 2019 and December 31, 2018:

	June 30, 2019								December 31, 2018
	Residential				Lease				Residential				Lease
(dollars in thousands)	Real Estate		Consumer		Financing		Total		Real Estate		Consumer		Financing		Total
Performing	$	535,528	$	595,339	$	296,776	$	1,427,643	$	562,019	$	610,839	$	263,094	$	1,435,952
Impaired		8,533		389		1,033		9,955		7,270		569		957		8,796
Total (excluding PCI)	$	544,061	$	595,728	$	297,809	$	1,437,598	$	569,289	$	611,408	$	264,051	$	1,444,748

Impaired Loans

Impaired loans include loans on nonaccrual status, loans past due 90 days or more and still accruing interest and loans modified under troubled debt restructurings. Impaired loans at June 30, 2019 and December 31, 2018 do not include $34.5 million and $43.0 million, respectively, of PCI loans. The risk of credit loss on acquired loans was recognized as part of the fair value adjustment at the acquisition date.

There was no interest income recognized on nonaccrual loans during the three and six months ended June 30, 2019 and 2018 while the loans were in nonaccrual status. Additional interest income that would have been recorded on nonaccrual loans had they been current in accordance with their original terms was $666,000 and $1.3 million for the three and six months ended June 30, 2019, respectively, and $346,000 and $846,000 for the three and six months ended June 30, 2018, respectively. The Company recognized interest income on commercial and commercial real estate loans modified under troubled debt restructurings of $29,000 and $61,000 for the three and six months ended June 30, 2019, respectively, and $28,000 and $58,000 for the comparable periods in 2018, respectively.

The following table presents impaired loans (excluding PCI loans) by portfolio and related valuation allowance as of June 30, 2019 and December 31, 2018:

	June 30, 2019						December 31, 2018
			Unpaid		Related				Unpaid		Related
	Recorded		Principal		Valuation		Recorded		Principal		Valuation
(dollars in thousands)	Investment		Balance		Allowance		Investment		Balance		Allowance
Impaired loans with a valuation allowance:
Commercial	$	7,863	$	8,380	$	5,311	$	7,945	$	8,102	$	4,448
Commercial real estate		13,616		14,235		4,395		7,496		13,844		523
Construction and land development		109		155		12		171		171		54
Residential real estate		5,174		5,915		668		4,055		4,662		554
Consumer		379		427		34		428		444		45
Lease financing		494		494		262		766		766		361
Total impaired loans with a valuation allowance		27,635		29,606		10,682		20,861		27,989		5,985
Impaired loans with no related valuation allowance:
Commercial		915		3,991		—		983		4,392		—
Commercial real estate		16,967		23,739		—		16,372		16,921		—
Construction and land development		1,251		1,253		—		1,136		1,136		—
Residential real estate		3,359		3,639		—		3,215		3,516		—
Consumer		10		12		—		141		145		—
Lease financing		539		538		—		191		191		—
Total impaired loans with no related valuation allowance		23,041		33,172		—		22,038		26,301		—
Total impaired loans:
Commercial		8,778		12,371		5,311		8,928		12,494		4,448
Commercial real estate		30,583		37,974		4,395		23,868		30,765		523
Construction and land development		1,360		1,408		12		1,307		1,307		54
Residential real estate		8,533		9,554		668		7,270		8,178		554
Consumer		389		439		34		569		589		45
Lease financing		1,033		1,032		262		957		957		361
Total impaired loans (excluding PCI)	$	50,676	$	62,778	$	10,682	$	42,899	$	54,290	$	5,985

13

The difference between a loan’s recorded investment and the unpaid principal balance represents: (1) a partial charge-off resulting from a confirmed loss due to the value of the collateral securing the loan being below the loan’s principal balance and management’s assessment that the full collection of the loan balance is not likely and/or (2) payments received on nonaccrual loans that are fully applied to principal on the loan’s recorded investment as compared to being applied to principal and interest on the unpaid customer principal and interest balance. The difference between the recorded investment and the unpaid principal balance on loans was $12.1 million and $11.4 million at June 30, 2019 and December 31, 2018, respectively.

The average balance of impaired loans (excluding PCI loans) and interest income recognized on impaired loans during the three months ended June 30, 2019 and 2018 are included in the table below:

	Three Months Ended June 30,
	2019				2018
			Interest Income				Interest Income
	Average		Recognized		Average		Recognized
	Recorded		While on		Recorded		While on
(dollars in thousands)	Investment		Impaired Status		Investment		Impaired Status
Impaired loans with a valuation allowance:
Commercial	$	8,007	$	7	$	1,229	$	7
Commercial real estate		9,435		23		2,589		21
Construction and land development		111		—		100		1
Residential real estate		5,236		8		4,167		10
Consumer		395		—		166		—
Lease financing		494		—		447		—
Total impaired loans with a valuation allowance		23,678		38		8,698		39
Impaired loans with no related valuation allowance:
Commercial		937		—		864		—
Commercial real estate		21,313		—		15,876		—
Construction and land development		1,252		1		711		—
Residential real estate		3,367		3		2,360		2
Consumer		10		1		20		—
Lease financing		538		—		321		—
Total impaired loans with no related valuation allowance		27,417		5		20,152		2
Total impaired loans:
Commercial		8,944		7		2,093		7
Commercial real estate		30,748		23		18,465		21
Construction and land development		1,363		1		811		1
Residential real estate		8,603		11		6,527		12
Consumer		405		1		186		—
Lease financing		1,032		—		768		—
Total impaired loans (excluding PCI)	$	51,095	$	43	$	28,850	$	41

14

The average balance of impaired loans (excluding PCI loans) and interest income recognized on impaired loans during the six months ended June 30, 2019 and 2018 are included in the table below:

	Six Months Ended June 30,
	2019				2018
			Interest Income				Interest Income
	Average		Recognized		Average		Recognized
	Recorded		While on		Recorded		While on
(dollars in thousands)	Investment		Impaired Status		Investment		Impaired Status
Impaired loans with a valuation allowance:
Commercial	$	8,448	$	13	$	1,279	$	17
Commercial real estate		9,381		50		2,769		41
Construction and land development		119		—		101		2
Residential real estate		5,264		19		4,173		21
Consumer		413		—		175		—
Lease financing		494		—		447		—
Total impaired loans with a valuation allowance		24,119		82		8,944		81
Impaired loans with no related valuation allowance:
Commercial		955		—		888		—
Commercial real estate		21,512		—		16,138		—
Construction and land development		1,261		1		725		—
Residential real estate		3,379		5		2,381		2
Consumer		11		1		21		—
Lease financing		538		—		321		—
Total impaired loans with no related valuation allowance		27,656		7		20,474		2
Total impaired loans:
Commercial		9,403		13		2,167		17
Commercial real estate		30,893		50		18,907		41
Construction and land development		1,380		1		826		2
Residential real estate		8,643		24		6,554		23
Consumer		424		1		196		—
Lease financing		1,033		—		768		—
Total impaired loans (excluding PCI)	$	51,776	$	89	$	29,418	$	83

The aging status of the recorded investment in loans by portfolio (excluding PCI loans) as of June 30, 2019 and December 31, 2018 were as follows:

	Accruing
	30-59		60-89		Past Due
	Days		Days		90 Days				Total				Total
(dollars in thousands)	Past Due		Past Due		or More		Nonaccrual		Past Due		Current		Loans
June 30, 2019
Commercial	$	3,828	$	2,777	$	—	$	8,163	$	14,768	$	833,819	$	848,587
Commercial real estate		1,489		1,501		—		28,622		31,612		1,477,071		1,508,683
Construction and land development		—		—		—		1,312		1,312		242,876		244,188
Residential real estate		544		643		—		7,831		9,018		535,043		544,061
Consumer		5,456		3,774		4		338		9,572		586,156		595,728
Lease financing		1,112		430		302		731		2,575		295,234		297,809
Total (excluding PCI)	$	12,429	$	9,125	$	306	$	46,997	$	68,857	$	3,970,199	$	4,039,056
December 31, 2018
Commercial	$	4,013	$	2,581	$	4	$	8,489	$	15,087	$	790,940	$	806,027
Commercial real estate		1,667		945		149		21,494		24,255		1,595,648		1,619,903
Construction and land development		989		—		85		1,171		2,245		221,653		223,898
Residential real estate		1,292		728		566		5,894		8,480		560,809		569,289
Consumer		5,211		2,533		51		388		8,183		603,225		611,408
Lease financing		4,322		932		206		751		6,211		257,840		264,051
Total (excluding PCI)	$	17,494	$	7,719	$	1,061	$	38,187	$	64,461	$	4,030,115	$	4,094,576

Troubled Debt Restructurings

Loans modified as TDRs for commercial and commercial real estate loans generally consist of allowing commercial borrowers to defer scheduled principal payments and make interest only payments for a specified period of time at the stated interest rate of the original loan agreement or lower payments due to a modification of the loans’

15

contractual terms. TDRs that continue to accrue interest and are greater than $50,000 are individually evaluated for impairment on a quarterly basis, and transferred to nonaccrual status when it is probable that any remaining principal and interest payments due on the loan will not be collected in accordance with the contractual terms of the loan. TDRs that subsequently default are individually evaluated for impairment at the time of default. The allowance for loan losses on TDRs totaled $412,000 and $557,000 as of June 30, 2019 and December 31, 2018, respectively. The Company had no unfunded commitments in connection with TDRs at June 30, 2019 and December 31, 2018.

The Company’s TDRs are identified on a case-by-case basis in connection with the ongoing loan collection processes. The following table presents TDRs by loan portfolio (excluding PCI loans) as of June 30, 2019 and December 31, 2018:

	June 30, 2019						December 31, 2018
(dollars in thousands)	Accruing (1)		Non-accrual (2)		Total		Accruing (1)		Non-accrual (2)		Total
Commercial	$	615	$	386	$	1,001	$	435	$	406	$	841
Commercial real estate		1,961		10,695		12,656		2,225		9,103		11,328
Construction and land development		48		174		222		51		—		51
Residential real estate		702		1,467		2,169		810		853		1,663
Consumer		47		—		47		130		—		130
Lease financing		—		—		—		—		—		—
Total loans (excluding PCI)	$	3,373	$	12,722	$	16,095	$	3,651	$	10,362	$	14,013

(1) These loans are still accruing interest.

(2) These loans are included in non-accrual loans in the preceding tables.

The following table presents a summary of loans by portfolio that were restructured during the three and six months ended June 30, 2019 and the loans by portfolio that were modified as TDRs within the previous twelve months that subsequently defaulted during the three and six months ended June 30, 2019:

	Commercial Loan Portfolio						Other Loan Portfolio
			Commercial		Construction		Residential
			Real		and Land		Real				Lease
(dollars in thousands)	Commercial		Estate		Development		Estate		Consumer		Financing		Total
For the three months ended June 30, 2019
Troubled debt restructurings:
Number of loans		1		—		—		2		—		—		3
Pre-modification outstanding balance	$	249	$	—	$	—	$	106	$	—	$	—	$	355
Post-modification outstanding balance		249		—		—		109		—		—		358
Troubled debt restructurings that subsequently defaulted
Number of loans		—		—		—		—		—		—		—
Recorded balance	$	—	$	—	$	—	$	—	$	—	$	—	$	—
For the six months ended June 30, 2019
Troubled debt restructurings:
Number of loans		1		3		1		9		2		—		16
Pre-modification outstanding balance	$	—	$	1,924	$	62	$	330	$	15	$	—	$	2,331
Post-modification outstanding balance		249		1,838		16		324		16		—		2,443
Troubled debt restructurings that subsequently defaulted
Number of loans		—		—		1		—		—		—		1
Recorded balance	$	—	$	—	$	43	$	—	$	—	$	—	$	43

16

The following table presents a summary of loans by portfolio that were restructured during the three and six months ended June 30, 2018 and the loans by portfolio that were modified as TDRs within the previous twelve months that subsequently defaulted during the three and six months ended June 30, 2018:

	Commercial Loan Portfolio						Other Loan Portfolio
			Commercial		Construction		Residential
			Real		and Land		Real				Lease
(dollars in thousands)	Commercial		Estate		Development		Estate		Consumer		Financing		Total
For the three months ended June 30, 2018:
Troubled debt restructurings:
Number of loans		1		—		—		3		4		—		8
Pre-modification outstanding balance	$	23	$	—	$	—	$	212	$	19	$	—	$	254
Post-modification outstanding balance		22		—		—		207		19		—		248
Troubled debt restructurings that subsequently defaulted
Number of loans		—		—		—		—		—		—		—
Recorded balance	$	—	$	—	$	—	$	—	$	—	$	—	$	—
For the six months ended June 30, 2018:
Troubled debt restructurings:
Number of loans		1		—		—		3		4		—		8
Pre-modification outstanding balance	$	23	$	—	$	—	$	212	$	19	$	—	$	254
Post-modification outstanding balance		22		—		—		207		19		—		248
Troubled debt restructurings that subsequently defaulted
Number of loans		—		—		—		—		—		—		—
Recorded balance	$	—	$	—	$	—	$	—	$	—	$	—	$	—

Purchased Credit Impaired Loans

The Company has purchased loans for which there was, at acquisition, evidence of deterioration of credit quality since origination and it was probable, at acquisition, that all contractually required payments would not be collected.

Accretable yield of PCI loans, or income expected to be collected, was as follows:

	Three Months Ended				Six Months Ended
	June 30,				June 30,
(dollars in thousands)	2019		2018		2019		2018
Balance, at beginning of period	$	11,063	$	7,630	$	12,240	$	5,732
New loans purchased – Alpine acquisition		—		—		—		1,245
Accretion		(1,937)		(1,190)		(3,013)		(2,351)
Other adjustments (including maturities, charge-offs and impact of changes in timing of expected cash flows)		194		(181)		88		479
Reclassification from non-accretable		1,079		5		1,084		1,159
Balance, at end of period	$	10,399	$	6,264	$	10,399	$	6,264

Accretion recorded as loan interest income totaled $1.9 million and $3.0 million during the three and six months ended June 30, 2019, respectively, and $1.2 million and $2.4 million for the comparable periods in 2018, respectively.

Allowance for Loan Losses

The Company’s loan portfolio is principally comprised of commercial, commercial real estate, construction and land development, residential real estate and consumer loans and lease financing receivables. The principal risks to each category of loans are as follows:

Commercial – The principal risk of commercial loans is that these loans are primarily made based on the identified cash flow of the borrower and secondarily on the collateral underlying the loans. Most often, this collateral consists of accounts receivable, inventory and equipment. Inventory and equipment may depreciate over time, may be difficult to appraise and may fluctuate in value based on the success of the business. If the cash flow from business operations is reduced, the borrower’s ability to repay the loan may be impaired. As such, repayment of such loans is often more sensitive than other types of loans to adverse conditions in the general economy.

17

Commercial real estate – As with commercial loans, repayment of commercial real estate loans is often dependent on the borrower’s ability to make repayment from the cash flow of the commercial venture. While commercial real estate loans are collateralized by the borrower’s underlying real estate, foreclosure on such assets may be more difficult than with other types of collateralized loans because of the possible effect the foreclosure would have on the borrower’s business, and property values may tend to be partially based upon the value of the business situated on the property.

Construction and land development – Construction and land development lending involves additional risks not generally present in other types of lending because funds are advanced upon the estimated future value of the project, which is uncertain prior to its completion and at the time the loan is made, and costs may exceed realizable values in declining real estate markets. Moreover, if the estimate of the value of the completed project proves to be overstated or market values or rental rates decline, the collateral may prove to be inadequate security for the repayment of the loan. Additional funds may also be required to complete the project, and the project may have to be held for an unspecified period of time before a disposition can occur.

Residential real estate – The principal risk to residential real estate lending is associated with residential loans not sold into the secondary market. In such cases, the value of the underlying property may have deteriorated as a result of a change in the residential real estate market, and the borrower may have little incentive to repay the loan or continue living in the property. Additionally, in areas with high vacancy rates, reselling the property without substantial loss may be difficult.

Consumer – The repayment of consumer loans is typically dependent on the borrower remaining employed through the life of the loan, as well as the possibility that the collateral underlying the loan, if applicable, may not be adequately maintained by the borrower.

Lease financing – Our financing leases are primarily for business equipment leased to varying types of businesses, nationwide, for the purchase of business equipment and software. If the cash flow from business operations is reduced, the business’s ability to repay may become impaired.

18

The following table represents, by loan portfolio, a summary of changes in the allowance for loan losses for the three and six months ended June 30, 2019 and 2018:

	Commercial Loan Portfolio						Other Loan Portfolio
			Commercial		Construction		Residential
			Real		and Land		Real				Lease
(dollars in thousands)	Commercial		Estate		Development		Estate		Consumer		Financing		Total
Changes in allowance for loan losses for the three months ended June 30, 2019:
Balance, beginning of period	$	9,545	$	6,617	$	398	$	2,424	$	2,137	$	1,970	$	23,091
Provision for loan losses		558		2,262		(85)		174		326		841		4,076
Charge-offs		(2)		(269)		—		(223)		(465)		(691)		(1,650)
Recoveries		14		29		3		49		221		92		408
Balance, end of period	$	10,115	$	8,639	$	316	$	2,424	$	2,219	$	2,212	$	25,925
Changes in allowance for loan losses for the six months ended June 30, 2019:
Balance, beginning of period	$	9,524	$	4,723	$	372	$	2,041	$	2,154	$	2,089	$	20,903
Provision for loan losses		676		4,207		(22)		688		655		1,115		7,319
Charge-offs		(114)		(327)		(44)		(376)		(1,021)		(1,150)		(3,032)
Recoveries		29		36		10		71		431		158		735
Balance, end of period	$	10,115	$	8,639	$	316	$	2,424	$	2,219	$	2,212	$	25,925
Changes in allowance for loan losses for the three months ended June 30, 2018:
Balance, beginning of period	$	5,902	$	5,485	$	328	$	2,504	$	1,309	$	2,176	$	17,704
Provision for loan losses		1,224		(310)		157		279		522		(18)		1,854
Charge-offs		(1,120)		(99)		—		(103)		(349)		(473)		(2,144)
Recoveries		197		301		20		62		147		105		832
Balance, end of period	$	6,203	$	5,377	$	505	$	2,742	$	1,629	$	1,790	$	18,246
Changes in allowance for loan losses for the six months ended June 30, 2018:
Balance, beginning of period	$	5,256	$	5,044	$	518	$	2,750	$	1,344	$	1,519	$	16,431
Provision for loan losses		1,791		197		(58)		18		826		1,086		3,860
Charge-offs		(1,145)		(259)		—		(139)		(783)		(959)		(3,285)
Recoveries		301		395		45		113		242		144		1,240
Balance, end of period	$	6,203	$	5,377	$	505	$	2,742	$	1,629	$	1,790	$	18,246

19

The following table represents, by loan portfolio, details regarding the balance in the allowance for loan losses and the recorded investment in loans as of June 30, 2019 and December 31, 2018 by impairment evaluation method:

	Commercial Loan Portfolio						Other Loan Portfolio
			Commercial		Construction		Residential
			Real		and Land		Real				Lease
(dollars in thousands)	Commercial		Estate		Development		Estate		Consumer		Financing		Total
June 30, 2019:
Allowance for loan losses:
Loans individually evaluated for impairment	$	5,242	$	4,361	$	—	$	294	$	—	$	235	$	10,132
Loans collectively evaluated for impairment		69		34		12		374		34		27		550
Non-impaired loans collectively evaluated for impairment		4,788		3,481		304		1,349		1,992		1,950		13,864
Loans acquired with deteriorated credit quality (1)		16		763		—		407		193		—		1,379
Total allowance for loan losses	$	10,115	$	8,639	$	316	$	2,424	$	2,219	$	2,212	$	25,925
Recorded investment (loan balance):
Impaired loans individually evaluated for impairment	$	8,175	$	30,286	$	1,251	$	4,926	$	—	$	792	$	45,430
Impaired loans collectively evaluated for impairment		603		297		109		3,607		389		241		5,246
Non-impaired loans collectively evaluated for impairment		839,809		1,478,100		242,828		535,528		595,339		296,776		3,988,380
Loans acquired with deteriorated credit quality (1)		2,974		15,686		6,226		8,345		1,240		—		34,471
Total recorded investment (loan balance)	$	851,561	$	1,524,369	$	250,414	$	552,406	$	596,968	$	297,809	$	4,073,527
December 31, 2018:
Allowance for loan losses:
Loans individually evaluated for impairment	$	4,405	$	476	$	48	$	233	$	—	$	330	$	5,492
Loans collectively evaluated for impairment		43		47		6		321		45		31		493
Non-impaired loans collectively evaluated for impairment		4,971		3,356		318		1,051		1,926		1,728		13,350
Loans acquired with deteriorated credit quality (1)		105		844		—		436		183		—		1,568
Total allowance for loan losses	$	9,524	$	4,723	$	372	$	2,041	$	2,154	$	2,089	$	20,903
Recorded investment (loan balance):
Impaired loans individually evaluated for impairment	$	8,520	$	23,431	$	1,249	$	3,929	$	5	$	668	$	37,802
Impaired loans collectively evaluated for impairment		408		437		58		3,341		564		289		5,097
Non-impaired loans collectively evaluated for impairment		797,099		1,596,035		222,591		562,019		610,839		263,094		4,051,677
Loans acquired with deteriorated credit quality (1)		4,857		19,252		8,331		8,759		1,776		—		42,975
Total recorded investment (loan balance)	$	810,884	$	1,639,155	$	232,229	$	578,048	$	613,184	$	264,051	$	4,137,551

(1) Loans acquired with deteriorated credit quality were originally recorded at fair value at the acquisition date and the risk of credit loss was recognized at that date based on estimates of expected cash flows.

Note 6 – Premises and Equipment, Net

A summary of premises and equipment as of June 30, 2019 and December 31, 2018 is as follows:

	June 30,		December 31,
(dollars in thousands)	2019		2018
Land	$	20,231	$	20,231
Buildings and improvements		78,782		76,141
Furniture and equipment		30,194		29,858
Total		129,207		126,230
Accumulated depreciation		(34,383)		(31,390)
Premises and equipment, net	$	94,824	$	94,840

Depreciation expense of $1.6 million and $3.2 million was recorded for the three and six months ended June 30, 2019, respectively, and $1.6 million and $3.1 million for the comparable periods in 2018, respectively.

20

Note 7 – Leases

The Company determines if a lease is present at the inception of an agreement. Operating leases are capitalized at commencement and are discounted using the Company’s FHLB borrowing rate for a similar term borrowing unless the lease defines an implicit rate within the contract. For operating leases existing prior to January 1, 2019, the rate for the remaining lease term as of January 1, 2019 was used.

The ROU assets represent the Company’s right to use an underlying asset for the lease term and lease liabilities represent the obligation to make lease payments arising from the lease. Operating lease ROU assets and operating lease liabilities are recognized on the lease commencement date based on the present value of lease payments over the lease term. No significant judgments or assumptions were involved in developing the estimated operating lease liabilities as the Company’s operating lease liabilities largely represent future rental expenses associated with operating leases and the borrowing rates are based on publicly available interest rates.

The Company has operating leases for banking centers and operating facilities. Our leases have remaining lease terms of 2 months to 13 years, some of which may include options to extend the lease terms for up to an additional 5 years. The options to extend are included if they are reasonably certain to be exercised.

As of June 30, 2019, operating lease ROU assets totaled $10.2 million and operating lease liabilities totaled $10.7 million.

Information related to operating leases for the three and six months ended June 30, 2019 was as follows:

	Three Months Ended			Six Months Ended
(dollars in thousands)	June 30, 2019			June 30, 2019
Operating lease cost	$	706		$	1,415
Operating cash flows from leases		742			1,483
Right-of-use assets obtained in exchange for lease obligations		181			12,281
Weighted average remaining lease term		5.9 years			5.9 years
Weighted average discount rate		3.12	%		3.12	%

The projected minimum rental payments under the terms of the leases as of June 30, 2019 were as follows:

(dollars in thousands)	Amount
Year ending December 31:
2019 remaining	$	1,143
2020		2,382
2021		2,229
2022		2,119
2023		1,594
Thereafter		2,322
Total future minimum lease payments		11,789
Less imputed interest		(1,070)
Total operating lease liabilities	$	10,719

21

Note 8 – Mortgage Servicing Rights

The Company serviced commercial FHA mortgage loans for others with unpaid principal balances of approximately $4.03 billion and $3.98 billion at June 30, 2019 and December 31, 2018, respectively. Changes in our commercial FHA mortgage servicing rights were as follows for the three and six months ended June 30, 2019 and 2018:

	Three Months Ended				Six Months Ended
	June 30,				June 30,
(dollars in thousands)	2019		2018		2019		2018
Mortgage servicing rights:
Balance, beginning of period	$	55,787	$	56,039	$	56,252	$	55,714
Originated servicing		1,350		911		1,563		1,912
Amortization		(675)		(682)		(1,353)		(1,358)
Balance, end of period		56,462		56,268		56,462		56,268
Valuation allowances:
Balance, beginning of period		2,830		3,387		2,805		3,254
Additions		—		500		25		633
Reductions		(559)		—		(559)		—
Balance, end of period		2,271		3,887		2,271		3,887
Mortgage servicing rights, net	$	54,191	$	52,381	$	54,191	$	52,381
Fair value:
At beginning of period	$	52,957	$	52,652	$	53,447	$	52,460
At end of period	$	54,191	$	52,381	$	54,191	$	52,381

The following table is a summary of key assumptions, representing both general economic and other published information and the weighted average characteristics of the commercial portfolio, used in the valuation of servicing rights at June 30, 2019 and December 31, 2018. Assumptions used in the prepayment rate consider many factors as appropriate, including lockouts, balloons, prepayment penalties, interest rate ranges, delinquencies and geographic location. The discount rate is based on an average pre-tax internal rate of return utilized by market participants in pricing the servicing portfolio. Significant increases or decreases in any one of these assumptions would result in a significantly lower or higher fair value measurement.

					Remaining
	Servicing		Interest		Years to	Prepayment		Servicing		Discount
(dollars in thousands)	Fee		Rate		Maturity	Rate		Cost		Rate
June 30, 2019:
Commercial FHA mortgage loans	0.12	%	3.68	%	29.9	8.21	%	$	1,000	10 - 14	%
December 31, 2018:
Commercial FHA mortgage loans	0.13	%	3.67	%	30.1	8.24	%	$	1,000	10 - 14	%

We recognize revenue from servicing commercial FHA and residential mortgages as earned based on the specific contractual terms. This revenue, along with amortization of and changes in impairment on servicing rights, is reported in commercial FHA revenue and residential mortgage banking revenue in the consolidated statements of income. Mortgage servicing rights do not trade in an active market with readily observable prices. The fair value of mortgage servicing rights and their sensitivity to changes in interest rates is influenced by the mix of the servicing portfolio and characteristics of each segment of the portfolio. The Company’s servicing portfolio consists of the distinct portfolios of government-insured residential and commercial mortgages and conventional residential mortgages. 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, cost to service, contractual servicing fee income, ancillary income, late fees, replacement reserves and other economic factors that are determined based on current market conditions.

At June 30, 2019 and December 31, 2018, the Company serviced residential mortgage loans for others with unpaid principal balances of approximately $58.6 million and $897.6 million, respectively. During the three and six months ended June 30, 2019, the Company sold mortgage servicing rights held for sale of zero and $3.3 million, respectively, and sold mortgage servicing rights held for sale of $2.7 million and $12.9 million for the comparable periods in 2018, respectively. At June 30, 2019, total residential mortgage servicing rights of $159,000 are reflected in the consolidated balance sheet as mortgage servicing rights held for sale.

22

Note 9 – Goodwill and Intangible Assets

At June 30, 2019 and December 31, 2018, goodwill totaled $164.7 million.

The following table summarizes the carrying amount of goodwill by segment at both June 30, 2019 and December 31, 2018.

(dollars in thousands)	Goodwill
Banking	$	149,035
Commercial FHA origination and servicing		10,892
Wealth management		4,746
Total goodwill	$	164,673

The Company’s intangible assets, consisting of core deposit and customer relationship intangibles, as of June 30, 2019 and December 31, 2018 are summarized as follows:

	June 30, 2019						December 31, 2018
	Gross						Gross
	Carrying		Accumulated				Carrying		Accumulated
(dollars in thousands)	Amount		Amortization		Total		Amount		Amortization		Total
Core deposit intangibles	$	52,712	$	(27,691)	$	25,021	$	52,712	$	(24,803)	$	27,909
Customer relationship intangibles		13,771		(4,899)		8,872		13,771		(4,304)		9,467
Total intangible assets	$	66,483	$	(32,590)	$	33,893	$	66,483	$	(29,107)	$	37,376

Amortization of intangible assets was $1.7 million and $3.5 million for the three and six months ended June 30, 2019, respectively, and $1.6 million and $3.3 million for the comparable periods in 2018, respectively.

Note 10 – Derivative Instruments

As part of the Company’s overall management of interest rate sensitivity, the Company utilizes derivative instruments to minimize significant, unanticipated earnings fluctuations caused by interest rate volatility, including interest rate lock commitments, forward commitments to sell mortgage-backed securities and interest rate swap contracts.

Interest Rate Lock Commitments / Forward Commitments to Sell Mortgage-Backed Securities

The Company issues interest rate lock commitments on originated fixed-rate commercial and residential real estate loans to be sold. The interest rate lock commitments and loans held for sale are hedged with forward contracts to sell mortgage-backed securities. The fair value of the interest rate lock commitments and forward contracts to sell mortgage-backed securities are included in other assets or other liabilities in the consolidated balance sheets. Changes in the fair value of derivative financial instruments are recognized in commercial FHA revenue and residential mortgage banking revenue in the consolidated statements of income.

The following table summarizes the interest rate lock commitments and forward commitments to sell mortgage-backed securities held by the Company, their notional amount and estimated fair values at June 30, 2019 and December 31, 2018:

	Notional Amount				Fair Value Gain
	June 30,		December 31,		June 30,		December 31,
(dollars in thousands)	2019		2018		2019		2018
Derivative Instruments (included in Other Assets):
Interest rate lock commitments	$	183,562	$	264,710	$	3,791	$	4,492
Forward commitments to sell mortgage-backed securities		183,280		276,871		—		—
Total	$	366,842	$	541,581	$	3,791	$	4,492

	Notional Amount				Fair Value Loss
	June 30,		December 31,		June 30,		December 31,
(dollars in thousands)	2019		2018		2019		2018
Derivative Instruments (included in Other Liabilities):
Forward commitments to sell mortgage-backed securities	$	—	$	54	$	—	$	—

23

During the three and six months ended June 30, 2019, the Company recognized net losses of $2.0 million and $701,000, respectively, on derivative instruments in commercial FHA revenue and residential mortgage banking revenue in the consolidated statements of income.

During the three and six months ended June 30, 2018, the Company recognized net losses of $2.0 million and $2.1 million, respectively, on derivative instruments in commercial FHA revenue and residential mortgage banking revenue in the consolidated statements of income.

Interest Rate Swap Contracts

The Company entered into interest rate swap contracts sold to commercial customers who wish to modify their interest rate sensitivity. These swaps are offset by contracts simultaneously purchased by the Company from other financial dealer institutions with mirror-image terms. Because of the mirror-image terms of the offsetting contracts, in addition to collateral provisions which mitigate the impact of non-performance risk, changes in the fair value subsequent to initial recognition have a minimal effect on earnings. These derivative contracts do not qualify for hedge accounting.

The notional amounts of these customer derivative instruments and the offsetting counterparty derivative instruments were $9.2 million and $9.5 million at June 30, 2019 and December 31, 2018, respectively. The fair value of the customer derivative instruments and the offsetting counterparty derivative instruments was $286,000 and $145,000 at June 30, 2019 and December 31, 2018, respectively, which are included in other assets and other liabilities, respectively, on the consolidated balance sheets.

Note 11 – Deposits

The following table summarizes the classification of deposits as of June 30, 2019 and December 31, 2018:

	June 30,		December 31,
(dollars in thousands)	2019		2018
Noninterest-bearing demand	$	902,286	$	972,164
Interest-bearing:
Checking		1,009,023		1,002,275
Money market		732,573		862,171
Savings		442,017		442,132
Time		925,308		795,428
Total deposits	$	4,011,207	$	4,074,170

Note 12 – Short-Term Borrowings

The following table presents the distribution of short-term borrowings and related weighted average interest rates as of June 30, 2019 and December 31, 2018:

	Repurchase Agreements
	June 30,			December 31,
(dollars in thousands)	2019			2018
Outstanding at period-end	$	113,844		$	124,235
Average amount outstanding		128,058			138,135
Maximum amount outstanding at any month end		138,907			173,387
Weighted average interest rate:
During period		0.70	%		0.51	%
End of period		0.68	%		0.71	%

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 $128.8 million and $132.2 million at June 30, 2019 and December 31, 2018, respectively, were pledged for securities sold under agreements to repurchase.

The Company had lines of credit of $50.9 million and $56.8 million at June 30, 2019 and December 31, 2018, respectively, from the Federal Reserve Discount Window. The lines are collateralized by a collateral agreement with

24

respect to a pool of commercial real estate loans totaling $60.0 million and $67.6 million at June 30, 2019 and December 31, 2018, respectively. There were no outstanding borrowings at June 30, 2019 and December 31, 2018.

At June 30, 2019, the Company had available federal funds lines of credit totaling $45.0 million. These lines of credit were unused at June 30, 2019.

Note 13 – FHLB Advances and Other Borrowings

The following table summarizes our Federal Home Loan Bank (“FHLB”) advances and other borrowings as of June 30, 2019 and December 31, 2018:

	June 30,		December 31,
(dollars in thousands)	2019		2018
Midland States Bancorp, Inc.
Term loan - variable interest rate equal to LIBOR plus 2.25%, which was 4.75% and 4.63% at June 30, 2019 and December 31, 2018, respectively, – maturing May 25, 2020	$	29,989	$	32,840
Series G redeemable preferred stock - 181 shares at $1,000 per share		181		181
Midland States Bank
FHLB advances – fixed rate, fixed term of $22.3 million and $87.7 million, at rates averaging 2.37% and 2.35% at June 30, 2019 and December 31, 2018, respectively – maturing through February 2023 and putable fixed rate of $530.0 million and $520.0 million at rates averaging 2.24% and 2.09% at June 30, 2019 and December 31, 2018, respectively – maturing through August 2025 with call provisions through August 2021		552,217		607,610
Total FHLB advances and other borrowings	$	582,387	$	640,631

In May 2017, the Company entered into a loan agreement with another bank for a revolving line of credit in the original principal amount of up to $10.0 million and a term loan in the original principal amount of $40.0 million. The term loan matures on May 25, 2020 and has a variable rate of interest equal to one-month LIBOR plus 2.25%. Beginning September 1, 2018, the Company was required to make quarterly principal and interest payments on the term loan of $1.4 million with the remaining principal and any unpaid interest due at maturity. The loan is unsecured with a negative pledge of shares of the Bank’s common stock. The loan agreement contains financial covenants that require the Company to maintain a minimum total capital to risk-weighted assets ratio, a minimum adjusted loan loss reserves to nonperforming loans ratio, a minimum fixed charge coverage ratio and a maximum percentage of nonperforming assets to tangible capital. At June 30, 2019, the Company was in compliance with each of these financial covenants.

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 approximately $2.01 billion and $2.22 billion at June 30, 2019 and December 31, 2018, respectively.

25

Note 14 – Earnings Per Share

Earnings per share are calculated utilizing the two-class method. Basic earnings per share are calculated by dividing the sum of distributed earnings to common shareholders and undistributed earnings allocated to common shareholders by the weighted average number of common shares outstanding. Diluted earnings per share are calculated by dividing the sum of distributed earnings to common shareholders and undistributed earnings allocated to common shareholders by the weighted average number of shares adjusted for the dilutive effect of common stock awards. The diluted earnings per share computation for the three and six months ended June 30, 2019 and 2018 excluded antidilutive stock options of 96,837 and 31,259, respectively, because the exercise prices of these stock options exceeded the average market prices of the Company’s common shares for those respective periods. Presented below are the calculations for basic and diluted earnings per common share for the three and six months ended June 30, 2019 and 2018:

	Three Months Ended				Six Months Ended
		June 30,			June 30,
(dollars in thousands, except per share data)	2019		2018		2019		2018
Net income	$	16,355	$	12,782	$	30,337	$	14,588
Preferred dividends declared		(83)		(83)		(165)		(166)
Preferred stock, premium amortization		49		47		97		94
Net income available to common shareholders		16,321		12,746		30,269		14,516
Common shareholder dividends		(5,791)		(5,201)		(11,567)		(9,409)
Unvested restricted stock award dividends		(49)		(32)		(96)		(63)
Undistributed earnings to unvested restricted stock awards		(85)		(44)		(150)		(31)
Undistributed earnings to common shareholders	$	10,396	$	7,469	$	18,456	$	5,013
Basic
Distributed earnings to common shareholders	$	5,791	$	5,201	$	11,567	$	9,409
Undistributed earnings to common shareholders		10,396		7,469		18,456		5,013
Total common shareholders earnings, basic	$	16,187	$	12,670	$	30,023	$	14,422
Diluted
Distributed earnings to common shareholders	$	5,791	$	5,201	$	11,567	$	9,409
Undistributed earnings to common shareholders		10,396		7,469		18,456		5,013
Total common shareholders earnings		16,187		12,670		30,023		14,422
Add back:
Undistributed earnings reallocated from unvested restricted stock awards		1		1		1		1
Total common shareholders earnings, diluted	$	16,188	$	12,671	$	30,024	$	14,423
Weighted average common shares outstanding, basic		24,081,777		23,815,436		24,040,032		22,365,927
Options		221,434		452,675		214,580		451,545
Weighted average common shares outstanding, diluted		24,303,211		24,268,111		24,254,612		22,817,472
Basic earnings per common share	$	0.67	$	0.53	$	1.25	$	0.64
Diluted earnings per common share		0.67		0.52		1.24		0.63

26

Note 15 – Fair Value of Financial Instruments

Fair value is defined as the exchange price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date reflecting assumptions that a market participant would use when pricing an asset or liability. The hierarchy uses three levels of inputs to measure the fair value of assets and liabilities as follows:

● Level 1: Unadjusted quoted prices for identical assets or liabilities traded in active markets.

● Level 2: Significant other observable inputs other than Level 1, including quoted prices for similar assets and liabilities in active markets, quoted prices in less active markets, or other observable inputs that can be corroborated by observable market data.

● Level 3: Significant unobservable inputs that reflect a company’s own assumptions about the assumptions that market participants would use in pricing an asset or liability.

Assets and liabilities measured and recorded at fair value, including financial assets for which the Company has elected the fair value option, on a recurring and nonrecurring basis as of June 30, 2019 and December 31, 2018, are summarized below:

	June 30, 2019
			Quoted prices
			in active		Significant
			markets		other		Significant
			for identical		observable		unobservable
			assets		inputs		inputs
(dollars in thousands)	Total		(Level 1)		(Level 2)		(Level 3)
Assets and liabilities measured at fair value on a recurring basis:
Assets
Investment securities available for sale:
Government sponsored entity debt securities	$	74,875	$	—	$	74,875	$	—
Agency mortgage-backed securities		297,362		—		297,362		—
State and municipal securities		143,729		—		143,729		—
Corporate securities		93,691		—		92,756		935
Equity securities		3,369		—		3,369		—
Loans held for sale		22,143		—		22,143		—
Interest rate lock commitments		3,791		—		3,791		—
Interest rate swap contracts		286		—		286		—
Total	$	639,246	$	—	$	638,311	$	935
Liabilities
Interest rate swap contracts	$	286	$	—	$	286	$	—
Assets measured at fair value on a non-recurring basis:
Mortgage servicing rights	$	54,191	$	—	$	—	$	54,191
Mortgage servicing rights held for sale		159		159		—		—
Impaired loans		13,170		—		10,842		2,328
Other real estate owned		47		—		47		—
Assets held for sale		1,297		—		1,297		—

27

	December 31, 2018
			Quoted prices
			in active		Significant
			markets		other		Significant
			for identical		observable		unobservable
			assets		inputs		inputs
(dollars in thousands)	Total		(Level 1)		(Level 2)		(Level 3)
Assets and liabilities measured at fair value on a recurring basis:
Assets
Investment securities available for sale:
U.S. Treasury securities	$	24,650	$	24,650	$	—	$	—
Government sponsored entity debt securities		75,684		—		75,684		—
Agency mortgage-backed securities		326,305		—		326,305		—
State and municipal securities		159,262		—		159,262		—
Corporate securities		71,550		—		69,627		1,923
Equity securities		3,334		—		3,334		—
Loans held for sale		30,401		—		30,401		—
Interest rate lock commitments		4,492		—		4,492		—
Interest rate swap contracts		145		—		145		—
Total	$	695,823	$	24,650	$	669,250	$	1,923
Liabilities
Interest rate swap contracts	$	145	$	—	$	145	$	—
Assets measured at fair value on a non-recurring basis:
Mortgage servicing rights	$	53,447	$	—	$	—	$	53,447
Mortgage servicing rights held for sale		3,545		3,545		—		—
Impaired loans		11,238		—		9,226		2,012
Other real estate owned		1,439		—		1,439		—
Assets held for sale		1,687		—		1,687		—

The following table presents gains (losses) recognized on assets measured on a non-recurring basis for the three and six months ended June 30, 2019 and 2018:

	Three Months Ended				Six Months Ended
	June 30,				June 30,
(dollars in thousands)	2019		2018		2019		2018
Mortgage servicing rights	$	559	$	(500)	$	534	$	(633)
Mortgage servicing rights held for sale		515		(188)		515		(188)
Impaired loans		(1,252)		(2,041)		(2,233)		(2,916)
Other real estate owned		—		(126)		(16)		(126)
Total loss on assets measured on a nonrecurring basis	$	(178)	$	(2,855)	$	(1,200)	$	(3,863)

The following table presents activity for assets measured at fair value on a recurring basis using significant unobservable inputs (Level 3) for the three and six months ended June 30, 2019 and 2018:

	Three Months Ended				Six Months Ended
	June 30,				June 30,
(dollars in thousands)	2019		2018		2019		2018
Balance, beginning of period	$	1,930	$	4,787	$	1,923	$	4,779
Total realized in earnings (1)		20		63		42		119
Total unrealized in other comprehensive income		5		562		12		562
Net settlements (principal and interest)		(1,020)		(55)		(1,042)		(103)
Balance, end of period	$	935	$	5,357	$	935	$	5,357

(1) Amounts included in interest income from investment securities taxable in the consolidated statements of income.

28

The following table presents quantitative information about significant unobservable inputs used in fair value measurements of non-recurring assets (Level 3) at June 30, 2019:

Non-recurring		Fair Value	Valuation	Unobservable
fair value measurements		(dollars in thousands)	technique	input / assumptions	Range (weighted average)
Mortgage servicing rights	$	54,191	Discounted cash flow	Prepayment speed	8.00% - 18.00% (8.21%)
				Discount rate	10.00% - 27.00% (11.03%)
Impaired loans	$	2,328	Fair value of collateral	Discount for type of property,	4.32% - 8.00% (5.51%)
				age of appraisal and current status

The following table presents quantitative information about significant unobservable inputs used in fair value measurements of non-recurring assets (Level 3) at December 31, 2018:

Non-recurring		Fair Value	Valuation	Unobservable
fair value measurements		(dollars in thousands)	technique	input / assumptions	Range (weighted average)
Mortgage servicing rights	$	53,447	Discounted cash flow	Prepayment speed	8.00% - 18.00% (8.24%)
				Discount rate	10.00% - 27.00% (11.12%)
Impaired loans	$	2,012	Fair value of collateral	Discount for type of property,	5.00% - 7.26% (5.26%)
				age of appraisal and current status

Mortgage Servicing Rights. In accordance with GAAP, the Company must record impairment charges on mortgage servicing rights on a non-recurring basis when the carrying value exceeds the estimated fair value. 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. The determination of fair value of servicing rights relies upon Level 3 inputs. The fair value of mortgage servicing rights was $54.2 million and $53.4 million at June 30, 2019 and December 31, 2018, respectively.

Impaired loans. Impaired loans are measured and recorded at fair value on a non-recurring basis. All of our nonaccrual loans and restructured loans are considered impaired and are reviewed individually for the amount of impairment, if any. Most of our loans are collateral dependent and, accordingly, we measure impaired loans based on the estimated fair value of such collateral. The fair value of each loan’s collateral is generally based on estimated market prices from an independently prepared appraisal, which is then adjusted for the cost related to liquidating such collateral; such valuation inputs result in a nonrecurring fair value measurement that is categorized as a Level 2 measurement. When adjustments are made to an appraised value to reflect various factors such as the age of the appraisal or known changes in the market or the collateral, such valuation inputs are considered unobservable and the fair value measurement is categorized as a Level 3 measurement. The impaired loans categorized as Level 3 also include unsecured loans and other secured loans whose fair values are based significantly on unobservable inputs such as the strength of a guarantor, cash flows discounted at the effective loan rate, and management’s judgment.

ASC Topic 825, Financial Instruments, requires disclosure of the estimated fair value of certain financial instruments and the methods and significant assumptions used to estimate such fair values. Additionally, certain financial instruments and all nonfinancial instruments are excluded from the applicable disclosure requirements.

The Company has elected the fair value option for newly originated residential and commercial loans held for sale. These loans are intended for sale and are hedged with derivative instruments. We have elected the fair value option to mitigate accounting mismatches in cases where hedge accounting is complex and to achieve operational simplification.

29

The following table presents the difference between the aggregate fair value and the aggregate remaining principal balance for loans for which the fair value option has been elected as of June 30, 2019 and December 31, 2018:

	June 30, 2019						December 31, 2018
	Aggregate				Contractual		Aggregate				Contractual
(dollars in thousands)	fair value		Difference		principal		fair value		Difference		principal
Residential loans held for sale	$	7,198	$	364	$	6,834	$	8,121	$	484	$	7,637
Commercial loans held for sale		14,945		301		14,644		22,280		595		21,685
Total loans held for sale	$	22,143	$	665	$	21,478	$	30,401	$	1,079	$	29,322

The following table presents the amount of gains (losses) from fair value changes included in income before income taxes for financial assets carried at fair value for the three and six months ended June 30, 2019 and 2018:

	Three Months Ended				Six Months Ended
	June 30,				June 30,
(dollars in thousands)	2019		2018		2019		2018
Residential loans held for sale	$	38	$	168	$	(19)	$	60
Commercial loans held for sale		34		260		(294)		25
Total loans held for sale	$	72	$	428	$	(313)	$	85

The following tables are a summary of the carrying values and fair value estimates of certain financial instruments as of June 30, 2019 and December 31, 2018:

	June 30, 2019
					Quoted prices
					in active		Significant
					markets		other		Significant
					for identical		observable		unobservable
	Carrying				assets		inputs		inputs
(dollars in thousands)	Amount		Fair Value		(Level 1)		(Level 2)		(Level 3)
Assets
Cash and due from banks	$	244,239	$	244,239	$	244,239	$	—	$	—
Federal funds sold		1,176		1,176		1,176		—		—
Investment securities available for sale		609,657		609,657		—		608,722		935
Equity securities		3,369		3,369		—		3,369		—
Nonmarketable equity securities		43,175		43,175		—		43,175		—
Loans, net		4,047,602		4,056,912		—		4,056,912		—
Loans held for sale		22,143		22,143		—		22,143		—
Accrued interest receivable		15,509		15,509		—		15,509		—
Interest rate lock commitments		3,791		—		—		3,791		—
Interest rate swap contracts		286		—		—		286		—
Liabilities
Deposits	$	4,011,207	$	4,016,503	$	—	$	4,016,503	$	—
Short-term borrowings		113,844		113,844		—		113,844		—
FHLB and other borrowings		582,387		594,404		—		594,404		—
Subordinated debt		94,215		93,761		—		93,761		—
Trust preferred debentures		48,041		55,218		—		55,218		—
Accrued interest payable		5,455		5,455		—		5,455		—
Interest rate swap contracts		286		—		—		286		—

30

	December 31, 2018
					Quoted prices
					in active		Significant
					markets		other		Significant
					for identical		observable		unobservable
	Carrying				assets		inputs		inputs
(dollars in thousands)	Amount		Fair Value		(Level 1)		(Level 2)		(Level 3)
Assets
Cash and due from banks	$	210,780	$	210,780	$	210,780	$	—	$	—
Federal funds sold		2,920		2,920		2,920		—		—
Investment securities available for sale		660,785		660,785		24,650		634,212		1,923
Nonmarketable equity securities		42,472		42,472		—		42,472		—
Loans, net		4,116,648		4,091,438		—		—		4,091,438
Loans held for sale		30,401		30,401		—		30,401		—
Accrued interest receivable		16,560		16,560		—		16,560		—
Interest rate lock commitments		4,492		4,492		—		4,492		—
Interest rate swap contracts		145		145		—		145		—
Liabilities
Deposits	$	4,074,170	$	4,069,098	$	—	$	4,069,098	$	—
Short-term borrowings		124,235		124,235		—		124,235		—
FHLB and other borrowings		640,631		641,050		—		641,050		—
Subordinated debt		94,134		91,926		—		91,926		—
Trust preferred debentures		47,794		56,805		—		56,805		—
Accrued interest payable		4,855		4,855		—		4,855		—
Interest rate swap contracts		145		145		—		145		—

Note 16 – Commitments, Contingencies and Credit Risk

In the normal course of business, there are outstanding various contingent liabilities such as claims and legal actions, which are not reflected in the consolidated financial statements. No material losses are anticipated as a result of these actions or claims.

We are a party to financial instruments with off-balance-sheet risk in the normal course of business to meet the financing needs of our customers. These financial instruments include commitments to extend credit and standby letters of credit. Those instruments involve, to varying degrees, elements of credit risk in excess of the amount recognized in the balance sheet. The contract amounts of those instruments reflect the extent of involvement we have in particular classes of financial instruments.

Our exposure to credit loss in the event of nonperformance by the other party to the financial instrument for commitments to extend credit and standby letters of credit is represented by the contractual amount of those instruments. The Bank used the same credit policies in making commitments and conditional obligations as it does for on-balance sheet instruments. The commitments are principally tied to variable rates. Loan commitments as of June 30, 2019 and December 31, 2018 were as follows:

	June 30,		December 31,
(dollars in thousands)	2019		2018
Commitments to extend credit	$	761,832	$	663,555
Financial guarantees – standby letters of credit		127,135		142,859

The Company establishes a mortgage repurchase liability to reflect management’s estimate of losses on loans for which the Company could have a repurchase obligation based on the volume of loans sold in 2019 and years prior, borrower default expectations, historical investor repurchase demand and appeals success rates, and estimated loss severity. Loans repurchased from investors are initially recorded at fair value, which becomes the Company’s new accounting basis. Any difference between the loan’s fair value and the outstanding principal amount is charged or credited to the mortgage repurchase liability, as appropriate. Subsequent to repurchase, such loans are carried in loans receivable. As a result of make-whole requests and loan repurchases, the Company incurred losses totaling $9,000 and $20,000 for the three and six months ended June 30, 2018, respectively. There were no losses as a result of make-whole requests and loan repurchases for the three and six months ended June 30, 2019. The liability for unresolved repurchase demands totaled $289,000 and $492,000 at June 30, 2019 and December 31, 2018, respectively.

31

Note 17 – Segment Information

Our business segments are defined as Banking, Commercial FHA Origination and Servicing, Wealth Management, and Other. The reportable business segments are consistent with the internal reporting and evaluation of the principle lines of business of the Company. The banking segment provides a wide range of financial products and services to consumers and businesses, including commercial, commercial real estate, mortgage and other consumer loan products; commercial equipment leasing; mortgage loan sales and servicing; letters of credit; various types of deposit products, including checking, savings and time deposit accounts; merchant services; and corporate treasury management services. The commercial FHA origination and servicing segment provides for the origination and servicing of government sponsored mortgages for multifamily and healthcare facilities. The wealth management segment consists of trust and fiduciary services, brokerage and retirement planning services. The other segment includes the operating results of the parent company, our captive insurance business unit, and the elimination of intercompany transactions.

Selected business segment financial information as of and for the three and six months ended June 30, 2019 and 2018 were as follows:

			Commercial FHA
			Origination and		Wealth
(dollars in thousands)	Banking		Servicing		Management		Other		Total
Three Months Ended June 30, 2019
Net interest income (expense)	$	48,930	$	(138)	$	—	$	(2,715)	$	46,077
Provision for loan losses		4,076		—		—		—		4,076
Noninterest income		9,025		5,116		5,504		(58)		19,587
Noninterest expense		33,809		3,004		3,772		(391)		40,194
Income before income taxes		20,070		1,974		1,732		(2,382)		21,394
Income taxes (benefit)		5,132		551		197		(841)		5,039
Net income (loss)	$	14,938	$	1,423	$	1,535	$	(1,541)	$	16,355
Total assets	$	5,478,515	$	88,320	$	19,398	$	(40,178)	$	5,546,055
Six Months Ended June 30, 2019
Net interest income (expense)	$	97,448	$	(314)	$	—	$	(5,456)	$	91,678
Provision for loan losses		7,319		—		—		—		7,319
Noninterest income		17,965		8,354		10,457		(114)		36,662
Noninterest expense		69,180		5,815		7,019		(723)		81,291
Income (loss) before income taxes (benefit)		38,914		2,225		3,438		(4,847)		39,730
Income taxes (benefit)		10,107		622		337		(1,673)		9,393
Net income (loss)	$	28,807	$	1,603	$	3,101	$	(3,174)	$	30,337
Total assets	$	5,478,515	$	88,320	$	19,398	$	(40,178)	$	5,546,055

			Commercial FHA
			Origination and		Wealth
(dollars in thousands)	Banking		Servicing		Management		Other		Total
Three Months Ended June 30, 2018
Net interest income (expense)	$	51,050	$	(95)	$	—	$	(2,669)	$	48,286
Provision for loan losses		1,854		—		—		—		1,854
Noninterest income		5,681		447		5,316		4,403		15,847
Noninterest expense		38,216		4,718		3,257		261		46,452
Income (loss) before income taxes (benefit)		16,661		(4,366)		2,059		1,473		15,827
Income taxes (benefit)		5,201		(1,402)		151		(905)		3,045
Net income (loss)	$	11,460	$	(2,964)	$	1,908	$	2,378	$	12,782
Total assets	$	5,780,313	$	94,481	$	17,171	$	(161,365)	$	5,730,600
Six Months Ended June 30, 2018
Net interest income (expense)	$	91,766	$	(58)	$	—	$	(5,237)	$	86,471
Provision for loan losses		3,860		—		—		—		3,860
Noninterest income		14,698		3,968		9,395		4,288		32,349
Noninterest expense		82,582		8,256		5,643		(530)		95,951
Income (loss) before income taxes (benefit)		20,022		(4,346)		3,752		(419)		19,009
Income taxes (benefit)		6,580		(995)		292		(1,456)		4,421
Net income (loss)	$	13,442	$	(3,351)	$	3,460	$	1,037	$	14,588
Total assets	$	5,780,313	$	94,481	$	17,171	$	(161,365)	$	5,730,600

32

1

Note 18 – Related Party Transactions

The Company utilizes the services of a company to act as a general manager for the construction of new facilities. A member of our board of directors is a substantial shareholder of this company and currently serves as its Chairman. During the three and six months ended June 30, 2019, the Company paid $325,000 and $535,000, respectively, to this company for work on various projects, which was approved in accordance with the Company’s related party transaction policy.

Note 19 – Revenue From Contracts with Customers

On January 1, 2018, the Company adopted ASU No. 2014-09 “Revenue from Contracts with Customers” (Topic 606) and all subsequent ASUs that modified Topic 606. As stated in “Note 2 – Basis of Presentation and Summary of Significant Accounting Policies,” the implementation of the new standard did not have a material impact on the measurement or recognition of revenue. Since the impact of applying the standard was determined to be immaterial, the Company did not record a cumulative effect adjustment to beginning retained earnings on January 1, 2018. Results for reporting periods beginning after January 1, 2018 are presented under Topic 606, while prior period amounts were not adjusted and continue to be reported in accordance with previous GAAP.

Topic 606 does not apply to revenue associated with financial instruments, including revenue from loans and investment securities. In addition, certain noninterest income streams such as commercial FHA revenue, residential mortgage banking revenue and gain on sales of investment securities, net are also not in scope of the new guidance. Topic 606 is applicable to noninterest income streams such as wealth management revenue, service charges on deposit accounts, interchange revenue, gain on sales of other real estate owned, and certain other noninterest income streams. The recognition of revenue associated with these noninterest income streams did not change significantly from current practice upon adoption of Topic 606. The noninterest income streams considered in-scope by Topic 606 are discussed below.

Wealth Management Revenue

Wealth management revenue is primarily comprised of fees earned from the management and administration of trusts and other customer assets. The Company also earns investment advisory fees through its SEC registered investment advisory subsidiary. The Company’s performance obligation in both of these instances is generally satisfied over time and the resulting fees are recognized monthly, based upon the month-end market value of the assets under management and contractually determined fee schedules. Payment is generally received a few days after month end through a direct charge to each customer’s account. The Company does not earn performance-based incentives. Optional services such as real estate sales and tax return preparation services are also available to existing trust and asset management customers. The Company’s performance obligation for these transactional-based services is generally satisfied, and related revenue recognized, at a point in time (i.e., as incurred). Payment is received shortly after services are rendered. Fees generated from transactions executed by the Company’s third party broker dealer are remitted by them to the Company on a monthly basis for that month’s transactional activity.

Service Charges on Deposit Accounts

Service charges on deposit accounts consist of fees received under depository agreements with customers to provide access to deposited funds, serve as custodian of deposited funds, and when applicable, pay interest on deposits. These service charges primarily include non-sufficient fund fees and other account related service charges. Non-sufficient fund fees are earned when a depositor presents an item for payment in excess of available funds, and the Company, at its discretion, provides the necessary funds to complete the transaction. The Company generates other account related service charge revenue by providing depositors proper safeguard and remittance of funds as well as by delivering optional services for depositors, such as check imaging or treasury management, that are performed upon the depositor’s request. The Company’s performance obligation for the proper safeguard and remittance of funds, monthly account analysis and any other monthly service fees is generally satisfied, and the related revenue recognized, over the period in which the service is provided. Payment for service charges on deposit accounts is typically received immediately or in the following month through a direct charge to a customer’s account.

33

Interchange Revenue

Interchange revenue includes debit / credit card income and ATM user fees. Card income is primarily comprised of interchange fees earned for standing ready to authorize and providing settlement on card transactions processed through the MasterCard interchange network. The levels and structure of interchange rates are set by MasterCard and can vary based on cardholder purchase volumes. Interchange fees from cardholder transactions represent a percentage of the underlying transaction value and are recognized daily, concurrently with completion of the Company’s performance obligation, the transaction processing services provided to the cardholder. Payment is typically received immediately or in the following month. ATM fees are primarily generated when a Company cardholder withdraws funds from a non-Company ATM or a non-Company cardholder withdraws funds from a Company ATM. The Company satisfies its performance obligation for each transaction at the point in time when the ATM withdrawal is processed.

Gain on Sales of Other Real Estate Owned

The Company records a gain or loss from the sale of other real estate owned (“OREO”) when control of the property transfers to the buyer, which generally occurs at the time of an executed deed. When the Company finances the sale of OREO to a buyer, the Company assesses whether the buyer is committed to perform their obligations under the contract and whether collectability of the transaction price is probable. Once these criteria are met, the OREO asset is derecognized and the gain or loss on sale is recorded upon transfer of control of the property to the buyer. In determining the gain or loss on the sale, the Company adjusts the transaction price and related gain or loss on sale if a significant financing component is present.

Other Noninterest Income

The other noninterest income revenue streams within the scope of Topic 606 consist of merchant services revenue, safe deposit box rentals, wire transfer fees, paper statement fees, check printing commissions, and other noninterest related fees. Revenue from the Company’s merchant services business consists principally of transaction and account management fees charged to merchants for the electronic processing of transactions. These fees are net of interchange fees paid to the credit card issuing bank, card company assessments, and revenue sharing amounts. Account management fees are considered earned at the time the merchant’s transactions are processed or other services are performed. Fees related to the other components of other noninterest income within the scope of Topic 606 are largely transactional based, and therefore, the Company’s performance obligation is satisfied and related revenue recognized, at the point in time the customer uses the selected service to execute a transaction.

The following presents noninterest income, segregated by revenue streams in-scope and out-of-scope of Topic 606, for the three and six months ended June 30, 2019 and 2018.

	Three Months Ended				Six Months Ended
	June 30,				June 30,
(dollars in thousands)	2019		2018		2019		2018
Noninterest income - in-scope of Topic 606
Wealth management revenue:
Trust management/administration fees	$	4,082	$	4,322	$	7,699	$	7,441
Investment advisory fees		539		495		1,068		960
Investment brokerage fees		232		286		451		550
Other		651		213		1,239		444
Service charges on deposit accounts:
Nonsufficient fund fees		1,801		1,991		3,555		3,441
Other		838		702		1,604		1,219
Interchange revenues		3,010		2,929		5,690		4,974
Other income:
Merchant services revenue		389		460		764		798
Other		788		687		1,606		1,747
Noninterest income - out-of-scope of Topic 606		7,257		3,762		12,986		10,775
Total noninterest income	$	19,587	$	15,847	$	36,662	$	32,349

34

Contract Balances

A contract asset balance occurs when an entity performs a service for a customer before the customer pays consideration (resulting in a contract receivable) or before payment is due (resulting in a contract asset). A contract liability balance is an entity’s obligation to transfer a service to a customer for which the entity has already received payment (or payment is due) from the customer. The Company’s noninterest revenue streams are largely based on transactional activity, or standard month-end revenue accruals such as asset management fees based on month-end market values. Consideration is often received immediately or shortly after the Company satisfies its performance obligation and revenue is recognized. The Company does not typically enter into long-term revenue contracts with customers, and therefore, does not experience significant contract balances. As of June 30, 2019 and December 31, 2018, the Company did not have any significant contract balances.

Contract Acquisition Costs

In connection with the adoption of Topic 606, an entity is required to capitalize, and subsequently amortize into expense, certain incremental costs of obtaining a contract with a customer if these costs are expected to be recovered. The incremental costs of obtaining a contract are those costs that an entity incurs to obtain a contract with a customer that it would not have incurred if the contract had not been obtained (for example, sales commission). The Company utilizes the practical expedient which allows entities to immediately expense contract acquisition costs when the asset that would have resulted from capitalizing these costs would have been amortized in one year or less. Upon adoption of Topic 606, the Company did not capitalize any contract acquisition costs.

Note 20 – Subsequent Events

Acquisition of HomeStar Financial Group, Inc. – Completed on July 17, 2019

On July 17, 2019, the Company completed its acquisition of HomeStar Financial Group, Inc. (“HomeStar”), and its wholly owned subsidiary, HomeStar Bank and Financial Services, which operates 5 full-service banking centers in northern Illinois, for total consideration of $11.4 million, consisting of $1.0 million in cash and 405,000 shares of the Company’s common stock. The Company has not yet determined the estimated acquisition date fair values for identifiable assets acquired and liabilities assumed. As of June 30, 2019, HomeStar had approximately $370.4 million in assets, $219.5 million in loans and $321.8 million in deposits. The Company anticipates there will be goodwill and core deposit intangibles recorded with this acquisition.

Redemption of Fixed Rate Non-Voting Perpetual Non-Cumulative Preferred Stock, Series H

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

Stock Repurchase Program

On August 6, 2019, the Board of Directors also approved a stock repurchase program that authorizes the Company to repurchase up to $25.0 million of its common stock. Stock repurchases under the program may be made from time to time on the open market, in privately negotiated transactions, or in any other manner that complies with applicable securities laws, at the discretion of the Company. The program will be in effect until June 30, 2020, with the timing of purchases and the number of shares repurchased under the program dependent upon a variety of factors including price, trading volume, corporate and regulatory requirements and market conditions. The repurchase program may be suspended or discontinued at any time without notice.

35

Item 2 – Management’s Discussion and Analysis of Financial Condition and Results of Operations

The following discussion explains our financial condition and results of operations as of and for the three and six months ended June 30, 2019. Annualized results for this interim period may not be indicative of results for the full year or future periods. The following discussion and analysis should be read in conjunction with the consolidated financial statements and related notes presented elsewhere in this report and our Annual Report on Form 10-K for the year ended December 31, 2018, filed with the SEC on February 28, 2019.

In addition to the historical information contained herein, this Form 10-Q includes “forward-looking statements” within the meaning of such term in the Private Securities Litigation Reform Act of 1995. These statements are subject to many risks and uncertainties, including changes in interest rates and other general economic, business and political conditions, including changes in the financial markets; changes in business plans as circumstances warrant; risks related to mergers and acquisitions and the integration of acquired businesses; and other risks detailed from time to time in filings made by the Company with the SEC. Readers should note that the forward-looking statements included herein are not a guarantee of future events, and that actual events may differ materially from those made in or suggested by the forward-looking statements. Forward-looking statements generally can be identified by the use of forward-looking terminology such as “will,” “propose,” “may,” “plan,” “seek,” “expect,” “intend,” “estimate,” “anticipate,” “believe,” or “continue,” or similar terminology. Any forward-looking statements presented herein are made only as of the date of this document, and we do not undertake any obligation to update or revise any forward-looking statements to reflect changes in assumptions, the occurrence of unanticipated events, or otherwise.

Significant Transactions

Each item listed below materially affects the comparability of our results of operations for the three and six months ended June 30, 2019 and 2018, and our financial condition as of June 30, 2019 and December 30, 2018, and may affect the comparability of financial information we report in future fiscal periods.

Recent Acquisitions. On February 28, 2018, the Company acquired Alpine for total consideration valued at approximately $173.2 million. Consideration transferred by the Company consisted of $33.3 million in cash and 4,463,200 shares of common stock. All identifiable assets acquired and liabilities assumed were adjusted to fair value as of February 28, 2018, and the results of Alpine’s operations have been included in the consolidated statements of income beginning on that date. Intangible assets recognized as a result of the transaction consisted of $66.0 million in goodwill, $6.3 million in customer relationship intangibles and $21.1 million in core deposit intangibles.

Purchased Loans.  Our net interest margin benefits from favorable changes in expected cash flows on our PCI loans and from accretion income associated with purchase accounting discounts established on the non-PCI loans included in our acquisitions. Our reported net interest margin for the three months ended June 30, 2019 and 2018 was 3.76% and 3.91%, respectively. Accretion income associated with accounting discounts established on loans acquired totaled $3.4 million and $5.5 million for the three months ended June 30, 2019 and 2018, respectively, increasing the reported net interest margin by 25 and 40 basis points for each respective period. The reported net interest margin for the six months ended June 30, 2019 and 2018 was 3.75% and 3.81%, respectively. Accretion income associated with purchase accounting discounts established on loans acquired totaled $5.9 million and $7.4 million for the six months ended June 30, 2019 and 2018, respectively, increasing the reported net interest margin by 21 and 29 points for each respective period.

Results of Operations

Net Interest Income. 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 a pretax-equivalent income, assuming a federal income tax rate of 21% for the three and six months ended June 30, 2019 and 2018.

36

As described above, one of the factors that impact net interest income is interest rate fluctuations. The Federal Reserve implemented quarterly interest rate increases in 2018, with the last increase of 25 basis points in December 2018. These increases impact the comparability of net interest income between 2018 and 2019 as further discussed below. The Federal Reserve has not changed interest rates in the first half of 2019.

During the three months ended June 30, 2019, net interest income (on a tax-equivalent basis) was $46.6 million as compared to $48.8 million for the comparative prior year quarter. The tax-equivalent net interest margin was 3.76% for the second quarter of 2019 compared to 3.91% in the second quarter of 2018.

During the six months ended June 30, 2019, we generated $92.7 million of net interest income (on a tax-equivalent basis), which was an increase of $5.3 million, or 6.11%, from $87.4 million during the six months ended June 30, 2018. The tax-equivalent net interest margin was 3.75% for the first six months of 2019 compared to 3.81% for the first six months of 2018.

Average Balance Sheet, Interest and Yield/Rate Analysis. The following tables present average balance sheet information, interest income, interest expense and the corresponding average yields earned and rates paid for the three and six months ended June 30, 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.

	Three Months Ended June 30,
	2019						2018
	Average		Interest		Yield /		Average		Interest		Yield /
(tax-equivalent basis, dollars in thousands)	Balance		& Fees		Rate		Balance		& Fees		Rate
EARNING ASSETS:
Federal funds sold and cash investments	$	162,110	$	982	2.43	%	$	227,499	$	1,014	1.79	%
Investment securities:
Taxable investment securities		488,341		3,606	2.95			555,053		3,756	2.71
Investment securities exempt from federal income tax (1)		148,605		1,344	3.62			175,964		1,564	3.55
Total securities		636,946		4,950	3.11			731,017		5,320	2.91
Loans:
Loans (2)		3,979,705		53,021	5.34			3,880,427		50,699	5.24
Loans exempt from federal income tax (1)		107,015		1,161	4.35			102,531		1,015	3.97
Total loans		4,086,720		54,182	5.32			3,982,958		51,714	5.21
Loans held for sale		40,177		451	4.50			31,220		295	3.79
Nonmarketable equity securities		44,217		597	5.42			38,872		482	4.97
Total earning assets		4,970,170	$	61,162	4.94	%		5,011,566	$	58,825	4.71	%
Noninterest-earning assets		618,023						639,864
Total assets	$	5,588,193					$	5,651,430
INTEREST-BEARING LIABILITIES:
Checking and money market deposits	$	1,735,198	$	3,306	0.76	%	$	1,822,290	$	1,925	0.42	%
Savings deposits		450,185		225	0.20			465,478		190	0.16
Time deposits		749,806		3,779	2.02			660,089		1,835	1.12
Brokered deposits		172,471		1,127	2.62			210,959		1,055	2.00
Total interest-bearing deposits		3,107,660		8,437	1.09			3,158,816		5,005	0.64
Short-term borrowings		120,859		210	0.70			120,794		116	0.38
FHLB advances and other borrowings		607,288		3,541	2.34			573,107		2,582	1.81
Subordinated debt		94,196		1,514	6.43			94,035		1,514	6.44
Trust preferred debentures		47,982		857	7.17			47,488		780	6.59
Total interest-bearing liabilities		3,977,985	$	14,559	1.47	%		3,994,240	$	9,997	1.00	%
NONINTEREST-BEARING LIABILITIES
Noninterest-bearing deposits		921,115						1,025,308
Other noninterest-bearing liabilities		60,363						47,229
Total noninterest-bearing liabilities		981,478						1,072,537
Shareholders’ equity		628,730						584,653
Total liabilities and shareholders’ equity	$	5,588,193					$	5,651,430
Net interest income / net interest margin (3)			$	46,603	3.76	%			$	48,828	3.91	%

(1) Interest income and average rates for tax-exempt loans and securities are presented on a tax-equivalent basis, assuming a federal income tax rate of 21%. Tax-equivalent adjustments totaled $526,000 and $541,000 for the three months ended June 30, 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.

37

	Six Months Ended June 30,
	2019						2018
	Average		Interest		Yield /		Average		Interest		Yield /
(tax-equivalent basis, dollars in thousands)	Balance		& Fees		Rate		Balance		& Fees		Rate
EARNING ASSETS:
Federal funds sold and cash investments	$	157,122	$	1,889	2.42	%	$	183,133	$	1,535	1.69	%
Investment securities:
Taxable investment securities		494,472		7,289	2.95			486,458		6,399	2.63
Investment securities exempt from federal income tax (1)		151,333		2,693	3.56			153,640		2,850	3.71
Total securities		645,805		9,982	3.09			640,098		9,249	2.89
Loans:
Loans (2)		3,999,991		104,903	5.29			3,648,407		91,730	5.07
Loans exempt from federal income tax (1)		107,699		2,395	4.48			83,426		1,606	3.88
Total loans		4,107,690		107,298	5.27			3,731,833		93,336	5.04
Loans held for sale		35,511		750	4.26			36,003		723	4.05
Nonmarketable equity securities		44,248		1,218	5.55			36,892		881	4.82
Total earning assets		4,990,376	$	121,137	4.90	%		4,627,959	$	105,724	4.61	%
Noninterest-earning assets		618,507						588,592
Total assets	$	5,608,883					$	5,216,551
INTEREST-BEARING LIABILITIES
Checking and money market deposits	$	1,774,319	$	6,683	0.76	%	$	1,702,919	$	3,576	0.42	%
Savings deposits		449,682		445	0.20			405,302		351	0.17
Time deposits		701,460		6,481	1.86			612,507		3,285	1.08
Brokered deposits		175,396		2,191	2.52			197,685		1,910	1.95
Total interest-bearing deposits		3,100,857		15,800	1.03			2,918,413		9,122	0.63
Short-term borrowings		128,058		447	0.70			134,671		240	0.36
FHLB advances and other borrowings		640,087		7,388	2.33			531,567		4,453	1.69
Subordinated debt		94,176		3,028	6.43			94,014		3,028	6.44
Trust preferred debentures		47,915		1,727	7.27			47,431		1,474	6.27
Total interest-bearing liabilities		4,011,093	$	28,390	1.43	%		3,726,096	$	18,317	0.99	%
NONINTEREST-BEARING LIABILITIES
Noninterest-bearing deposits		920,156						904,409
Other noninterest-bearing liabilities		56,124						44,012
Total noninterest-bearing liabilities		976,280						948,421
Shareholders’ equity		621,510						542,034
Total liabilities and shareholders’ equity	$	5,608,883					$	5,216,551
Net interest income / net interest margin (3)			$	92,747	3.75	%			$	87,407	3.81	%

(1) Interest income and average rates for tax-exempt loans and securities are presented on a tax-equivalent basis, assuming a federal income tax rate of 21%. Tax-equivalent adjustments totaled $1.1 million and $936,000 for the six months ended June 30, 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.

38

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.

	Three Months Ended June 30, 2019						Six Months Ended June 30, 2019
	Compared with						Compared with
	Three Months Ended June 30, 2018						Six Months Ended June 30, 2018
	Change due to:				Interest		Change due to:				Interest
(tax-equivalent basis, dollars in thousands)	Volume		Rate		Variance		Volume		Rate		Variance
EARNING ASSETS:
Federal funds sold and cash investments	$	(343)	$	311	$	(32)	$	(265)	$	619	$	354
Investment securities:
Taxable investment securities		(472)		322		(150)		112		778		890
Investment securities exempt from federal income tax		(245)		25		(220)		(42)		(115)		(157)
Total securities		(717)		347		(370)		70		663		733
Loans:
Loans		1,310		1,012		2,322		9,030		4,143		13,173
Loans exempt from federal income tax		47		99		146		503		286		789
Total loans		1,357		1,111		2,468		9,533		4,429		13,962
Loans held for sale		93		63		156		(10)		37		27
Nonmarketable equity securities		69		46		115		189		148		337
Total earning assets	$	459	$	1,878	$	2,337	$	9,517	$	5,896	$	15,413
INTEREST-BEARING LIABILITIES:
Checking and money market deposits	$	(128)	$	1,509	$	1,381	$	210	$	2,897	$	3,107
Savings deposits		(7)		42		35		41		53		94
Time deposits		351		1,593		1,944		650		2,546		3,196
Brokered deposits		(222)		294		72		(247)		528		281
Total interest-bearing deposits		(6)		3,438		3,432		654		6,024		6,678
Short-term borrowings		—		94		94		(17)		224		207
FHLB advances and other borrowings		177		782		959		1,081		1,854		2,935
Subordinated debt		3		(3)		—		5		(5)		—
Trust preferred debentures		8		69		77		16		237		253
Total interest-bearing liabilities	$	182	$	4,380	$	4,562	$	1,739	$	8,334	$	10,073
Net interest income	$	277	$	(2,502)	$	(2,225)	$	7,778	$	(2,438)	$	5,340

Interest Income. The $2.5 million, or 4.8%, increase in interest income on loans (on a tax-equivalent basis) for the second quarter of 2019 was primarily due to a 2.6% increase in the average balance of loans outstanding combined with an 11 basis point increase in the average yield. The increase in the average balance of loans outstanding was primarily due to growth in commercial loans, construction and land development loans, and lease financings. The increase in the average yield on loans was mainly due to the impact of higher market interest rates. Accretion income associated with accounting discounts established on loans acquired totaled $3.4 million and $5.5 million for the three months ended June 30, 2019 and 2018, respectively, increasing the reported net interest margin by 25 and 40 basis points for each respective period.

For the six months ended June 30, 2019, the $14.0 million, or 15.0%, increase in interest income on loans was primarily due to a 10.1% increase in the average balance of loans outstanding combined with a 23 basis point increase in the average yield. The average balance increase was primarily due to a full six month effect of loans added from Alpine in February 2018. The reported yield on total loans for the six months ended June 30, 2019 and 2018 was 5.27% and 5.04%, respectively. The increase in the average yield on loans was mainly due to the impact of higher rates on new and renewed loans as compared to the same period last year. Accretion income associated with purchase accounting discounts established on loans acquired totaled $5.9 million and $7.4 million for the six months ended June 30, 2019 and 2018, respectively, increasing the reported net interest margin by 21 and 29 basis points for each respective period.

39

Interest income on our investment securities portfolio on a tax-equivalent basis decreased $0.4 million for the three months ended June 30, 2019 compared to the prior year period, which was mainly attributable to decreases in the average balance of investment securities of 12.9%, partially offset by a 20 basis point increase in the average yield. The decrease in average balance was primarily attributable to the liquidation of the securities in the U.S. Treasury portfolio, which were reinvested in other assets, including corporate securities and loans, as well as a higher level of paydowns of agency mortgage backed securities and municipal securities during the second quarter of 2019. The increase in the average yield was driven by higher market rates.

For the six months ended June 30, 2019, the $0.7 million, or 7.9%, increase in interest income on our investment securities portfolio on a tax-equivalent basis was primarily attributable to a 20 basis point increase in the average yield. The increase in the rate was driven by higher market rates.

Interest Expense. Interest expense on interest-bearing liabilities increased $4.6 million to $14.6 million for the second quarter of 2019, and $10.1 million to $28.4 million for the six months ended June 30, 2019.

Interest expense on deposits increased to $8.4 million for the three months ended June 30, 2019 from $5.0 million for the comparable period in 2018. The $3.4 million, or 68.6%, increase in interest expense on deposits for the second quarter of 2019 was primarily due to a 45 basis point increase in the average rate paid. The increase in the average rates paid was primarily due to the impact of market competition.

For the six month period June 30, 2019, the $6.7 million, or 73.2%, increase in interest expense on deposits was mainly attributable to a 40 basis point increase in the average rate paid coupled with the average balance of deposits increasing 6.3%. The increase in the average rates paid were primarily due to market competition. The increases in the average balance of deposits reflected the addition of $770.2 million of interest-bearing deposits from Alpine in February 2018.

Interest expense on borrowings increased to $6.1 million for the three months ended June 30, 2019 as compared to $5.0 million for the comparable period in 2018. The $1.1 million increase in interest expense on borrowings for the three months ended June 30, 2019 was primarily due to the impact of higher market interest rates on new FHLB advances and our variable rate trust preferred debentures combined with the expanded usage of FHLB advances as a short-term and long-term funding source.

For the six months ended June 30, 2019, the $3.4 million increase in interest expense on borrowings to $12.6 million from $9.2 million for the first six months of 2018 was primarily attributable to the impact of higher market interest rates on new FHLB advances and the addition of $18.1 million of FHLB advances assumed from Alpine.

Provision for Loan Losses. The provision for loan losses totaled $4.1 million and $1.9 million for the three months ended June 30, 2019 and 2018, respectively. The increase in provision for loan losses was primarily driven by an increase in specific reserves on a credit placed on nonaccrual in the second quarter of 2019.

The provision for loan losses totaled $7.3 million and $3.9 million for the six months ended June 30, 2019 and 2018, respectively. The increase in provision for loan losses was primarily attributable to an increase in specific reserves on two credits placed on nonaccrual and a downgrade of one commercial real estate loan and one residential real estate loan during the first half of 2019.

40

Noninterest Income. The following table sets forth the major components of our noninterest income for the three and six months ended June 30, 2019 and 2018:

	Three Months Ended						Six Months Ended
	June 30,				Increase		June 30,				Increase
(dollars in thousands)	2019		2018		(decrease)		2019		2018		(decrease)
Noninterest income:
Wealth management revenue	$	5,504	$	5,316	$	188	$	10,457	$	9,395	$	1,062
Commercial FHA revenue		4,917		326		4,591		8,187		3,656		4,531
Residential mortgage banking revenue		611		2,116		(1,505)		1,445		3,534		(2,089)
Service charges on deposit accounts		2,639		2,693		(54)		5,159		4,660		499
Interchange revenue		3,010		2,929		81		5,690		4,974		716
Gain (loss) on sales of investment securities, net		14		(70)		84		14		(5)		19
(Loss) gain on sales of other real estate owned		(12)		166		(178)		54		473		(419)
Other income		2,904		2,371		533		5,656		5,662		(6)
Total noninterest income	$	19,587	$	15,847	$	3,740	$	36,662	$	32,349	$	4,313

Wealth management revenue. Noninterest income from our wealth management business increased $1.1 million for the six months ended June 30, 2019, primarily due to an increase in trust fees and the addition of $1.0 billion of wealth management assets under administration from the Alpine acquisition in February 2018.

Commercial FHA revenue. The $4.6 million increase in commercial FHA revenue for the three months ended June 30, 2019 is attributable to an increase in gain premiums, partially offset by lower loan costs. Interest rate lock commitments increased to $42.2 million in the second quarter of 2019 from $11.1 million for the comparable period in 2018. Included in the increase of commercial FHA revenue was a $0.6 million recapture of mortgage servicing rights in the second quarter of 2019 as compared to $0.5 million of impairment in the second quarter of 2018.

For the six months ended June 30, 2019, the $4.5 million increase in commercial FHA revenue was driven by an increase in gain premiums, partially offset by lower loan costs as compared to the first half of 2018. Interest rate lock commitments increased to $106.7 million from $91.5 million for the six months ended June 30, 2019 and 2018, respectively. Included in the increase was a $0.6 million recapture of mortgage servicing rights in the first half of 2019 as compared to $0.6 million of impairment for the comparable period in 2018.

Residential mortgage banking revenue. The decrease of $1.5 million of residential mortgage banking revenue for the three months ended June 30, 2019 was primarily attributable to a decrease in servicing fees as a result of the reduction of residential mortgage loans serviced for others due to the sale of residential mortgage servicing rights during 2018 and the first quarter of 2019 and a decline in closed production and interest rate lock commitments that were due in part to a smaller loan production team as compared to the three months ended June 30, 2018.

For the six months ended June 30, 2019, the decrease of $2.1 million of residential mortgage banking revenue was primarily attributable to a decrease in servicing fees as a result of the reduction of residential mortgage loans serviced for others due to the sale of residential mortgage servicing rights during 2018 and the first quarter of 2019 and a decline in closed production and interest rate lock commitments that were due in part to a smaller loan production team as compared to the first half of 2018.

41

Noninterest Expense. The following table sets forth the major components of noninterest expense for the three and six months ended June 30, 2019 and 2018:

	Three Months Ended						Six Months Ended
	June 30,				Increase		June 30,				Increase
(dollars in thousands)	2019		2018		(decrease)		2019		2018		(decrease)
Noninterest expense:
Salaries and employee benefits	$	21,134	$	23,467	$	(2,333)	$	43,173	$	51,862	$	(8,689)
Occupancy and equipment		4,500		4,708		(208)		9,332		8,960		372
Data processing		4,987		5,106		(119)		9,878		9,585		293
FDIC insurance		367		539		(172)		802		1,087		(285)
Professional		2,410		3,195		(785)		4,483		6,944		(2,461)
Marketing		1,118		1,411		(293)		2,352		2,617		(265)
Communications		677		741		(64)		1,348		2,317		(969)
Loan expense		616		552		64		976		1,076		(100)
Other real estate owned		101		166		(65)		194		256		(62)
Amortization of intangible assets		1,673		1,576		97		3,483		3,251		232
(Gain) loss on mortgage servicing rights held for sale		(515)		188		(703)		(515)		188		(703)
Other		3,126		4,803		(1,677)		5,785		7,808		(2,023)
Total noninterest expense	$	40,194	$	46,452	$	(6,258)	$	81,291	$	95,951	$	(14,660)

Salaries and employee benefits. The $2.3 million decrease in salaries and employee benefits expense during the three months ended June 30, 2019 as compared to the same period in 2018 was primarily driven by a decrease in average full-time equivalent employees after the integration of Alpine into the Bank in the third quarter of 2018.

For the six months ended June 30, 2019, the $8.7 million decrease in salaries and employee benefits was mainly due to the incurrence of Alpine acquisition expenses of change in control payments, severance costs and other benefit-related expenses in the first half of 2018.

Professional fees. For the six months ended June 30, 2019, the $2.5 million decrease in professional fees was primarily due to the decrease in professional fees incurred on various technology and other integration projects related to the Alpine acquisition.

Other noninterest expense. The decrease in other noninterest expense of $1.7 million and $2.0 million for the three and six months ended June 30, 2019, respectively, as compared to the same periods in 2018 was primarily due to certain nonrecurring items that impacted expense levels during the second quarter and first half of 2018.

Income Tax Expense. Income tax expense was $5.0 million and $3.0 million for the three months ended June 30, 2019 and 2018, respectively. The effective tax rate increased to 23.6% for the second quarter of 2019 as compared to 19.2% for the second quarter of 2018. The effective tax rate in the second quarter of 2019 was negatively impacted by the state deferred tax assets and liabilities adjusted as a result of a decreased tax rate.

Income tax expense was $9.4 million and $4.4 million for the six months ended June 30, 2019 and 2018, respectively. The increase of the effective tax rate to 23.6% for the first half of 2019 as compared to 23.3% for the first half of 2018 was primarily due to the negative impact of the BOLI death benefit recorded in 2018.

42

Financial Condition

Assets. Total assets decreased to $5.55 billion at June 30, 2019, as compared to $5.64 billion at December 31, 2018.

Loans. The loan portfolio is the largest category of our assets. At June 30, 2019, total loans were $4.07 billion. The following table shows loans by non-PCI and PCI loan category as of June 30, 2019 and December 31, 2018:

	June 30, 2019						December 31, 2018
	Non-PCI		PCI				Non-PCI		PCI
(dollars in thousands)	Loans		Loans		Total		Loans		Loans		Total
Commercial	$	848,587	$	2,974	$	851,561	$	806,027	$	4,857	$	810,884
Commercial real estate		1,508,683		15,686		1,524,369		1,619,903		19,252		1,639,155
Construction and land development		244,188		6,226		250,414		223,898		8,331		232,229
Total commercial loans		2,601,458		24,886		2,626,344		2,649,828		32,440		2,682,268
Residential real estate		544,061		8,345		552,406		569,289		8,759		578,048
Consumer		595,728		1,240		596,968		611,408		1,776		613,184
Lease financing		297,809		—		297,809		264,051		—		264,051
Total loans	$	4,039,056	$	34,471	$	4,073,527	$	4,094,576	$	42,975	$	4,137,551

Loans decreased $64.0 million to $4.07 billion at June 30, 2019 as compared to December 31, 2018. The decrease in loans was primarily due to several large loan payoffs and principal reductions in the commercial real estate portfolio in addition to payoffs and payments in the residential real estate and consumer portfolio during the first six months of 2019. These decreases were partially offset by organic loan growth primarily from our commercial equipment finance business.

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 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 first priority interest in the financed asset and generally require monthly payments.

43

The following table shows the contractual maturities of our loan portfolio and the distribution between fixed and adjustable interest rate loans at June 30, 2019:

	June 30, 2019
	Within One Year				One Year to Five Years				After Five Years
			Adjustable				Adjustable				Adjustable
(dollars in thousands)	Fixed Rate		Rate		Fixed Rate		Rate		Fixed Rate		Rate		Total
Loans:
Commercial	$	31,134	$	259,011	$	338,291	$	69,864	$	115,192	$	38,069	$	851,561
Commercial real estate		194,061		75,981		784,195		182,278		60,661		227,193		1,524,369
Construction and land development		9,191		73,197		41,459		121,222		158		5,187		250,414
Total commercial loans		234,386		408,189		1,163,945		373,364		176,011		270,449		2,626,344
Residential real estate		5,382		7,234		21,675		40,030		197,346		280,739		552,406
Consumer		4,650		3,721		573,741		14,444		389		23		596,968
Lease financing		7,254		—		262,517		—		28,038		—		297,809
Total loans	$	251,672	$	419,144	$	2,021,878	$	427,838	$	401,784	$	551,211	$	4,073,527

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, 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. In addition to our allowance for loan losses, our purchase discounts on acquired loans provide additional protections against credit losses.

Discounts on PCI Loans. PCI loans are loans that have evidence of credit deterioration since origination and for which it is probable at the date of acquisition that we will not collect all contractually required principal and interest payments. These loans are recorded at estimated fair value on their purchase date without a carryover of the related allowance for loan losses. At June 30, 2019 and December 31, 2018, we had PCI loans totaling $34.5 million and $43.0 million, respectively. The decrease in PCI loans was primarily driven by a loan pay off and a loan transferred to OREO.

In determining the fair value of purchased credit-impaired loans at acquisition, we first determine the contractually required payments due, which represent the total undiscounted amount of all uncollected principal and interest payments, adjusted for the effect of estimated prepayments. We then estimate the undiscounted cash flows we expect to collect. We incorporate several key assumptions to estimate cash flows expected to be collected, including probability of default rates, loss given default assumptions and the amount and timing of prepayments. We calculate fair value by discounting the estimated cash flows we expect to collect using an observable market rate of interest, when available, adjusted for factors that a market participant would consider in determining fair value. We have aggregated certain credit-impaired loans acquired in the same transaction into pools based on common risk characteristics. A pool is accounted for as one asset with a single composite interest rate and an aggregate fair value and expected cash flows.

The difference between contractually required payments due and the cash flows expected to be collected, considering the impact of prepayments, is referred to as the nonaccretable difference. The nonaccretable difference, which is neither accreted into income nor recorded on our consolidated balance sheet, reflects estimated future credit losses expected to be incurred over the life of the loans. The excess of cash flows expected to be collected over the estimated fair value of PCI loans is referred to as the accretable yield. This amount is not recorded on our consolidated balance sheet, but is accreted into interest income over the remaining life of the loans or pool of loans, using the effective yield method. The outstanding customer balance for PCI loans totaled $45.0 million and $56.9 million as of June 30, 2019 and December 31, 2018, respectively.

Subsequent to acquisition, we periodically evaluate our estimates of cash flows expected to be collected. These evaluations, performed quarterly, require the continued use of key assumptions and estimates, similar to the initial estimate of fair value. Subsequent changes in the estimated cash flows expected to be collected may result in changes in the accretable yield and nonaccretable difference or reclassifications between accretable yield and the nonaccretable difference. Decreases in expected cash flows due to further credit deterioration will result in an impairment charge to the provision for loan losses, resulting in an increase to the allowance for loan losses and a reclassification from accretable yield to nonaccretable difference. Increases in expected cash flows due to credit improvements will result in an increase

44

in the accretable yield through a reclassification from the nonaccretable difference or as a reduction in the allowance for loan losses to the extent established on specific pools subsequent to acquisition. The adjusted accretable yield is recognized in interest income over the remaining life of the loan, or pool of loans.

The following table shows changes in the accretable yield for PCI loans for the three and six months ended June 30, 2019 and 2018:

	Three Months Ended				Six Months Ended
	June 30,				June 30,
(dollars in thousands)	2019		2018		2019		2018
Balance, beginning of period	$	11,063	$	7,630	$	12,240	$	5,732
New loans purchased - Alpine acquisition		—		—		—		1,245
Accretion		(1,937)		(1,190)		(3,013)		(2,351)
Other adjustments (including maturities, charge-offs, and impact of changes in timing of expected cash flows)		194		(181)		88		479
Reclassification from non-accretable		1,079		5		1,084		1,159
Balance, end of period	$	10,399	$	6,264	$	10,399	$	6,264

As of June 30, 2019, the balance of accretable discounts on our PCI loan portfolio was $10.4 million compared to $12.2 million at December 31, 2018. We may not accrete the full amount of these discounts into interest income in future periods if the assets to which these discounts are applied do not perform according to our current expectations.

We have also recorded accretable discounts in purchase accounting for loans that are not considered PCI loans. Similar to the way in which we employ the fair value methodology for PCI loans, we consider expected prepayments and estimate the amount and timing of undiscounted cash flows in order to determine the accretable discount for non-PCI loans. Such discounts are accreted into income on a level yield basis.

Analysis of the Allowance for Loan Losses. The following table allocates the allowance for loan losses, or the allowance, by loan category:

	June 30, 2019				December 31, 2018
(dollars in thousands)	Book Value		% (1)		Book Value		% (1)
Loans:
Commercial	$	10,115	1.19	%	$	9,524	1.17	%
Commercial real estate		8,639	0.57			4,723	0.29
Construction and land development		316	0.13			372	0.16
Total commercial loans		19,070	0.73			14,619	0.55
Residential real estate		2,424	0.44			2,041	0.35
Consumer		2,219	0.37			2,154	0.35
Lease financing		2,212	0.74			2,089	0.79
Total allowance for loan losses	$	25,925	0.64		$	20,903	0.51

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

The allowance and the balance of nonaccretable discounts represent our estimate of probable and reasonably estimable credit losses inherent in loans held for investment as of the respective balance sheet date. We assess the appropriateness of our allowance for non-PCI loans separately from our allowance for PCI loans.

The allowance for loan losses was $25.9 million at June 30, 2019 compared to $20.9 million at December 31, 2018. The increase in the allowance at June 30, 2019 compared to December 31, 2018 was mainly attributable to an increase in specific reserves on two credits placed on nonaccrual and the downgrade of one commercial real estate loan and one residential real estate loan during the six months ended of 2019.

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. Charge-offs are generally taken on loans once the impairment is determined to be other-than-temporary. Recoveries on loans previously charged off are added to the allowance. Net charge-offs to average loans were 0.12% and 0.11% for the three and six months ended June 30, 2019, respectively, as compared to 0.13% for the year ended December 31, 2018.

45

Allowance for non-PCI loans. Our methodology for assessing the appropriateness of the allowance for non-PCI loans includes a general allowance for performing loans, which are grouped based on similar characteristics, and a specific allowance for individual impaired loans or loans considered by management to be in a high-risk category. General allowances are established based on a number of factors, including historical loss rates, an assessment of portfolio trends and conditions, accrual status and economic conditions.

For commercial and commercial real estate loans, a specific allowance may be assigned to individual loans based on an impairment analysis. Loans are considered impaired when it is probable that we will be unable to collect all amounts due according to the contractual terms of the loan agreement. The amount of impairment is based on an analysis of the most probable source of repayment, including the present value of the loan's expected future cash flows and the estimated market value or the fair value of the underlying collateral. Interest income on impaired loans is accrued as earned, unless the loan is placed on nonaccrual status.

Allowance for PCI loans. PCI loans are recorded at their estimated fair value at the date of acquisition, with the estimated fair value including a component for estimated credit losses. An allowance related to PCI loans may be recorded subsequent to acquisition if a PCI loan pool experiences a decrease in expected cash flows as compared to the expected cash flows projected in the previous quarter. Loans considered to be uncollectible are initially charged off against the specific loan pool’s non-accretable difference. When the pool’s non-accretable difference has been fully utilized, uncollectible amounts are charged off against the corresponding allowance.

The following table shows our allowance by loan portfolio and by non-PCI and PCI loans as of June 30, 2019 and December 31, 2018:

	June 30, 2019						December 31, 2018
	Non-PCI		PCI				Non-PCI		PCI
(dollars in thousands)	Loans		Loans		Total		Loans		Loans		Total
Loans:
Commercial	$	10,099	$	16	$	10,115	$	9,419	$	105	$	9,524
Commercial real estate		7,876		763		8,639		3,879		844		4,723
Construction and land development		316		—		316		372		—		372
Total commercial loans		18,291		779		19,070		13,670		949		14,619
Residential real estate		2,017		407		2,424		1,605		436		2,041
Consumer		2,026		193		2,219		1,971		183		2,154
Lease financing		2,212		—		2,212		2,089		—		2,089
Total allowance for loan losses	$	24,546	$	1,379	$	25,925	$	19,335	$	1,568	$	20,903

Provision for Loan Losses. In determining the allowance and the related provision for loan losses, we consider three principal elements: (i) valuation allowances based upon probable losses identified during the review of impaired commercial, commercial real estate, and construction and land development loans, (ii) allocations, by loan classes, on loan portfolios based on historical loan loss experience and qualitative factors, and (iii) valuation allowances on PCI loan pools based on decreases in expected cash flows. Provisions for loan losses are charged to operations to adjust the total allowance to a level deemed appropriate by us.

46

The following table provides an analysis of the allowance for loan losses, provision for loan losses and net charge-offs for the three and six months ended June 30, 2019 and 2018:

	As of and for the						As of and for the
	Three Months Ended						Six Months Ended
	June 30,						June 30,
(dollars in thousands)	2019			2018			2019			2018
Balance, beginning of period	$	23,091		$	17,704		$	20,903		$	16,431
Charge-offs:
Commercial		2			1,120			114			1,145
Commercial real estate		269			99			327			259
Construction and land development		—			—			44			—
Residential real estate		223			103			376			139
Consumer		465			349			1,021			783
Lease financing		691			473			1,150			959
Total charge-offs		1,650			2,144			3,032			3,285
Recoveries:
Commercial		14			197			29			301
Commercial real estate		29			301			36			395
Construction and land development		3			20			10			45
Residential real estate		49			62			71			113
Consumer		221			147			431			242
Lease financing		92			105			158			144
Total recoveries		408			832			735			1,240
Net charge-offs		1,242			1,312			2,297			2,045
Provision for loan losses		4,076			1,854			7,319			3,860
Balance, end of period	$	25,925		$	18,246		$	25,925		$	18,246
Gross loans, end of period	$	4,073,527		$	4,095,811		$	4,073,527		$	4,095,811
Average loans	$	4,086,720		$	3,982,958		$	4,107,690		$	3,731,833
Net charge-offs to average loans		0.12	%		0.13	%		0.11	%		0.11	%
Allowance to total loans		0.64	%		0.45	%		0.64	%		0.45	%

Impaired Loans. The following table sets forth our nonperforming assets by asset categories as of the dates indicated. Impaired loans include nonaccrual loans, loans past due 90 days or more and still accruing interest and loans modified under troubled debt restructurings. The balances of impaired loans reflect the net investment in these assets, including deductions for purchase discounts. PCI loans are excluded from nonperforming status because we expect to fully collect their new carrying values, which reflect significant purchase discounts. If our expectation of reasonably estimable future cash flows from PCI loans deteriorates, the loans may be classified as nonaccrual loans and interest income will not be recognized until the timing and amount of future cash flows can be reasonably estimated.

	June 30,			December 31,
(dollars in thousands)	2019			2018
Impaired loans:
Commercial	$	8,778		$	8,928
Commercial real estate		30,583			23,868
Construction and land development		1,360			1,307
Residential real estate		8,533			7,270
Consumer		389			569
Lease financing		1,033			957
Total impaired loans		50,676			42,899
Other real estate owned, non-guaranteed		3,797			3,000
Nonperforming assets	$	54,473		$	45,899
Impaired loans to total loans		1.24	%		1.04	%
Nonperforming assets to total assets		0.98	%		0.81	%

We did not recognize interest income recognized on nonaccrual loans during the three and six months ended June 30, 2019 and 2018 while the loans were in nonaccrual status. Additional interest income that would have been recorded on nonaccrual loans had they been current in accordance with their original terms was $666,000 and $1.3 million for the three and six months ended June 30, 2019, respectively, and $346,000 and $846,000 for the three and six months ended June 30, 2018, respectively. The Company recognized interest income on commercial and commercial real estate loans modified under troubled debt restructurings of $29,000 and $61,000 for the three and six months ended

47

June 30, 2019, respectively, and $28,000 and $58,000 for the comparable periods in 2018, respectively.

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 impaired. 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.

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

					Commercial				Construction &
	Commercial				Real Estate				Land Development
	Risk Category				Risk Category				Risk Category
(dollars in thousands)	7		8 (1)		7		8 (1)		7		8 (1)		Total
June 30, 2019	$	22,164	$	20,697	$	23,284	$	51,378	$	2,491	$	884	$	120,898
December 31, 2018		34,857		12,956		14,934		45,263		3,448		—		111,458

(1) Includes only those 8-rated loans that are not included in impaired 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 June 30, 2019 and December 31, 2018. The book value for investment securities classified as available for sale and equity securities is equal to fair market value.

	June 30, 2019				December 31, 2018
	Book		% of		Book		% of
(dollars in thousands)	Value		Total		Value		Total
Available for sale securities
U.S. Treasury securities	$	—	—	%	$	24,650	3.7	%
Government sponsored entity debt securities		74,875	12.2			75,684	11.5
Agency mortgage-backed securities		297,362	48.5			326,305	49.4
State and municipal securities		143,729	23.5			159,262	24.1
Corporate securities		93,691	15.3			71,550	10.8
Total investment securities, available for sale, at fair value		609,657	99.5			657,451	99.5
Equity securities		3,369	0.5			3,334	0.5
Total investment securities, at fair value	$	613,026	100.0	%	$	660,785	100.0	%

48

The following table sets forth the book value, maturities and weighted average yields for our investment portfolio at June 30, 2019. The book value for investment securities classified as available for sale is equal to fair market value.

	June 30, 2019
			% of Total		Weighted
	Book		Investment		Average
(dollars in thousands)	Value		Securities		Yield
Investment securities, available for sale:
Government sponsored entity debt securities:
Maturing within one year	$	28,658	4.7	%	2.4	%
Maturing in one to five years		33,321	5.4		2.4
Maturing in five to ten years		12,480	2.0		2.6
Maturing after ten years		416	0.1		2.6
Total government sponsored entity debt securities	$	74,875	12.2	%	2.4	%
Agency mortgage-backed securities:
Maturing within one year	$	3,462	0.5	%	2.8	%
Maturing in one to five years		266,417	43.5		2.8
Maturing in five to ten years		24,248	4.0		2.8
Maturing after ten years		3,235	0.5		3.0
Total agency mortgage-backed securities	$	297,362	48.5	%	2.8	%
State and municipal securities (1):
Maturing within one year	$	14,874	2.4	%	3.6	%
Maturing in one to five years		42,822	7.0		4.3
Maturing in five to ten years		58,680	9.6		4.4
Maturing after ten years		27,353	4.5		4.1
Total state and municipal securities	$	143,729	23.5	%	4.2	%
Corporate securities:
Maturing within one year	$	4,013	0.7	%	3.6	%
Maturing in one to five years		5,063	0.8		3.6
Maturing in five to ten years		84,615	13.8		5.2
Maturing after ten years		—	—		—
Total corporate securities	$	93,691	15.3	%	5.0	%
Total investment securities, available for sale	$	609,657	99.5	%	3.4	%
Equity securities:
No stated maturity	$	3,369	0.5	%	2.5	%
Total investment securities and equity securities	$	613,026	100.0	%	3.4	%

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

The table below presents the credit ratings at June 30, 2019 at fair value for our investment securities classified as available for sale.

	June 30, 2019
	Amortized		Estimated		Average Credit Rating
(dollars in thousands)	Cost		Fair Value		AAA		AA+/−		A+/−		BBB+/−		<BBB−		Not Rated
Investment securities available for sale:
Government sponsored entity debt securities	$	74,286	$	74,875	$	—	$	74,875	$	—	$	—	$	—	$	—
Agency mortgage-backed securities		294,432		297,362		5,394		291,968		—		—		—		—
State and municipal securities		138,181		143,729		27,844		89,558		9,304		6,116		488		10,419
Corporate securities		92,874		93,691		—		—		9,557		43,228		7,260		33,646
Total investment securities, available for sale	$	599,773	$	609,657	$	33,238	$	456,401	$	18,861	$	49,344	$	7,748	$	44,065

Cash and Cash Equivalents. Cash and cash equivalents increased $31.7 million to $245.4 million as of June 30, 2019 compared to December 31, 2018. This increase was primarily due to cash flows from investing activities and operating activities totaling $119.4 million and $53.5 million, respectively. These increases were offset in part by cash flows used in financing activities of $141.2 million. Cash flows provided by investing activities primarily consisted of a

49

$60.0 million decrease in loans offset in part by $32.5 million in purchases of investments securities available for sale and $10.3 million in purchases of nonmarketable equity securities. Cash flows provided by operating activities primarily reflected $30.3 million of net income and $248.7 million of proceeds received from sales of loans held for sale exceeding $233.8 million in originations of loans held for sale. Cash used in financing activities primarily reflected $350.4 million of payments made on FHLB borrowings, which exceeded proceeds received from FHLB borrowings.

Operating Lease Right-of-Use Asset. We adopted ASU 2016-02, Leases (Topic 842) on January 1, 2019, which required the recognition of operating lease ROU assets. Operating lease ROU assets represent the lessee’s right to use, or control the use of, specified assets for the lease term. Operating lease ROU assets are recognized based on the present value of lease payments over the lease term. Operating lease ROU totaled $10.2 million at June 30, 2019.

Liabilities. Total liabilities decreased to $4.91 billion at June 30, 2019 compared to $5.03 billion at December 31, 2018.

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.

The following table summarizes our average deposit balances and weighted average rates for the three months ended June 30, 2019 and 2018:

	June 30, 2019				June 30, 2018
			Weighted				Weighted
	Average		Average		Average		Average
(dollars in thousands)	Balance		Rate		Balance		Rate
Deposits:
Noninterest-bearing demand	$	921,115	—		$	1,025,308	—
Interest-bearing:
Checking		990,413	0.60	%		1,001,628	0.23	%
Money market		744,785	0.99			820,662	0.66
Savings		450,186	0.20			465,478	0.16
Time, less than $250,000		650,125	1.97			576,245	1.10
Time, $250,000 and over		99,680	2.33			83,844	1.21
Time, brokered		172,471	2.62			210,959	2.00
Total interest-bearing	$	3,107,660	1.09	%	$	3,158,816	0.64	%
Total deposits	$	4,028,775	0.84	%	$	4,184,124	0.48	%

The following table sets forth the maturity of time deposits of $250,000 or more and brokered time deposits as of June 30, 2019:

	June 30, 2019
	Maturity Within:
	Three		Three to Six		Six to 12		After 12
(dollars in thousands)	Months or Less		Months		Months		Months		Total
Time, $250,000 and over	$	12,565	$	7,045	$	51,564	$	34,450	$	105,624
Time, brokered		54,111		44,876		27,208		13,777		139,972
Total	$	66,676	$	51,921	$	78,772	$	48,227	$	245,596

Total deposits decreased $63.0 million to $4.01 billion at June 30, 2019, as compared to December 31, 2018. This decrease primarily resulted from an intentional reduction of $111.7 million in brokered money market deposits and brokered time deposits. At June 30, 2019, total deposits were comprised of 22.5% noninterest-bearing demand accounts, 54.4% interest-bearing transaction accounts and 23.1% of time deposits. At June 30, 2019, brokered time deposits totaled $140.0 million, or 3.5% of total deposits, compared to $161.6 million, or 4.0% of total deposits, at December 31, 2018.

Operating Lease Liabilities. The adoption of ASU 2016-02, Leases (Topic 842) on January 1, 2019 also required the recognition of operating lease liabilities. Operating lease liabilities represent a lessee’s obligation to make lease payments arising from a lease, measured on a discounted basis. Operating lease liabilities totaled $10.7 million at June 30, 2019.

50

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 increased $31.4 million to $639.9 million at June 30, 2019 as compared to December 31, 2018. The increase in shareholders’ equity was due primarily to $9.3 million increase in accumulated other comprehensive income and $30.3 million of net income, partially offset by $11.7 million of declared dividends to common shareholders.

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 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 $128.8 million and $132.2 million at June 30, 2019 and December 31, 2018, respectively, were pledged for securities sold under agreements to repurchase.

The Company had lines of credit of $50.9 million and $56.8 million at June 30, 2019 and December 31, 2018, 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 $60.0 million and $67.6 million at June 30, 2019 and December 31, 2018, respectively. There were no outstanding borrowings at June 30, 2019 and December 31, 2018.

At June 30, 2019, the Company had available federal funds lines of credit totaling $45.0 million. These lines of credit were unused at June 30, 2019.

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 believes 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 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.

51

At June 30, 2019, the Company and the Bank exceeded the regulatory minimums and the Bank met the regulatory definition of well-capitalized based on the most recent regulatory notification.

The following table presents the Company and the Bank’s capital ratios and the minimum requirements at June 30, 2019:

			Fully Phased-In
			Guidelines		Well
Ratio	Actual		Minimum (1)		Capitalized
Total risk-based capital ratio
Midland States Bancorp, Inc.	13.49	%	10.50	%	N/A
Midland States Bank	13.22		10.50		10.00	%
Common equity Tier 1 risk-based capital ratio
Midland States Bancorp, Inc.	9.38		7.00		N/A
Midland States Bank	12.63		7.00		6.50
Tier 1 risk-based capital ratio
Midland States Bancorp, Inc.	10.85		8.50		N/A
Midland States Bank	12.63		8.50		8.00
Tier 1 leverage ratio
Midland States Bancorp, Inc.	9.27		4.00		N/A
Midland States Bank	10.80		4.00		5.00

(1) As of January 1, 2019, the capital conservation buffer was fully phased in at 2.5%.

Contractual Obligations

The following table contains supplemental information regarding our total contractual obligations at June 30, 2019:

	Payments Due
	Less than		One to		Three to		More than
(dollars in thousands)	One Year		Three Years		Five Years		Five Years		Total
Deposits without a stated maturity	$	3,085,899	$	—	$	—	$	—	$	3,085,899
Time deposits		573,659		323,850		27,798		1		925,308
Securities sold under repurchase agreements		113,844		—		—		—		113,844
FHLB advances and other borrowings		35,374		26,629		410,384		110,000		582,387
Operating lease obligations		2,080		4,056		2,905		1,678		10,719
Subordinated debt		—		—		—		94,215		94,215
Trust preferred debentures		—		—		—		48,041		48,041
Total contractual obligations	$	3,810,856	$	354,535	$	441,087	$	253,935	$	4,860,413

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

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 have identified two primary sources of market risk: interest rate risk and price risk.

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).

52

Our board of directors established broad policy limits with respect to interest rate risk. Our Enterprise Risk Committee (“ERC”) establishes specific operating guidelines within the parameters of the board of directors’ policies. In general, we seek to minimize the impact of changing interest rates on net interest income and the economic values of assets and liabilities. Our ERC 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 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 ERC 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.

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

	Net Interest Income Sensitivity
	Immediate Change in Rates
(dollars in thousands)	-100			+100			+200
June 30, 2019:
Dollar change	$	(9,352)		$	2,503		$	2,851
Percent change		(5.1)	%		1.4	%		1.6	%
December 31, 2018:
Dollar change	$	(8,497)		$	2,694		$	4,623
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 −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 basis point scenarios at June 30, 2019. The Bank, at June 30, 2019 has exceeded the established tolerance level for the −100 basis point sensitivity. Tolerance levels for risk management require the development of remedial plans to maintain residual risk within approved levels. NII at Risk

53

reported at June 30, 2019, projects that our earnings exhibit increased sensitivity to changes in interest rates compared to December 31, 2018.

The following table shows EVE at the dates indicated:

	Economic Value of Equity Sensitivity
	Immediate Change in Rates
(dollars in thousands)	-100			+100			+200
June 30, 2019:
Dollar change	$	(81,442)		$	45,031		$	63,750
Percent change		(15.1)	%		8.4	%		11.9	%
December 31, 2018:
Dollar change	$	(80,035)		$	40,599		$	69,461
Percent change		(12.7)	%		6.4	%		11.0	%

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.

We were within board policy limits for the +100 and +200 basis point scenarios at June 30, 2019.

In September 2018, the Federal Reserve increased the range for the Federal Funds Target Rate, which led to an increase in the magnitude of the declining rate scenario to 100 basis points from the prior −50 basis point floor. Tolerance levels for risk management require the development of remediation plans to maintain residual risk within tolerance if simulation modeling demonstrates that a parallel 100 basis point increase or 100 basis point decrease in interest rates over the twelve months would adversely affect net interest income over the same period by more than the tolerance level. The Bank, at June 30, 2019 has exceeded the established tolerance level for the −100 basis point sensitivity.

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 subject to fair value accounting. We have price risk from equity investments and investments in securities backed by mortgage loans.

54

Item 3 – Quantitative and Qualitative Disclosures About Market Risk

The quantitative and qualitative disclosures about market risk are included under “Item 2 – Management’s Discussion and Analysis of Financial Condition and Results of Operations – Quantitative and Qualitative Disclosures About Market Risk”.

Item 4 – Controls and Procedures

Evaluation of disclosure controls and procedures. The Company’s management, including our President and Chief Executive Officer and our Chief Financial Officer, have evaluated the effectiveness of our “disclosure controls and procedures” (as defined in Rule 13a-15(e) under the Securities Exchange Act of 1934 (“Exchange Act”)), as of the end of the period covered by this report. Based on such evaluation, our President and Chief Executive Officer and our Chief Financial Officer have concluded that, as of the end of such period, the Company’s disclosure controls and procedures were effective as of that date to provide reasonable assurance that the information required to be disclosed by the Company in the reports it files or submits under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the rules and forms of the SEC and that information required to be disclosed by the Company in the reports it files or submits under the Exchange Act is accumulated and communicated to the Company’s management, including its President and Chief Executive Officer and its Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure.

Changes in internal control over financial reporting. There have not been any changes in the Company’s internal control over financial reporting (as such term is defined in Rule 13a-15(f) under the Exchange Act) during the fiscal quarter to which this report relates that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

Part II – Other Information

Item 1 – Legal Proceedings

In the normal course of business, we are named or threatened to be named as a defendant in various lawsuits, none of which we expect to have a material effect on the Company. However, given the nature, scope and complexity of the extensive legal and regulatory landscape applicable to our business (including laws and regulations governing consumer protection, fair lending, fair labor, privacy, information security, anti-money laundering and anti-terrorism), we, like all banking organizations, are subject to heightened legal and regulatory compliance and litigation risk. There are no material pending legal proceedings to which the Company or any of its subsidiaries is a party or of which any of their property is the subject.

Item 1A – Risk Factors

There have been no material changes from the risk factors previously disclosed in the “Risk Factors” section included in our Annual Report on Form 10-K for the year ended December 31, 2018.

55

Item 2 – Unregistered Sales of Equity Securities and Use of Proceeds

Issuer Purchases of Equity Securities

The following table sets forth information regarding the Company’s repurchase of shares of its outstanding common stock during the second quarter of 2019.

				Total		Maximum
				Number of		Number of
	Total	Average		Shares Purchased		Shares that May
	Number	Price		as Part of Publicly		Yet Be Purchased
	of Shares	Paid Per		Announced Plans		Under the Plans
Period	Purchased (1)	Share		or Programs		or Programs
April 1 - 30, 2019	1,152	$	25.49	-		-
May 1 - 31, 2019	2,829		27.10	-		-
June 1 - 30, 2019	461		26.33	-		-
Total	4,442	$	26.60	-	���	-

__________________________________

(1) Represents shares of the Company’s common stock repurchased under the employee stock purchase program and/or shares withheld to satisfy tax withholding obligations upon the vesting of awards of restricted stock. These shares were purchased pursuant to the terms of the applicable plan and not pursuant to a publicly announced repurchase plan or program.

56

Item 6 – Exhibits

Exhibit No.	Description
10.1	Midland States Bancorp, Inc. 2019 Long-Term Incentive Plan (incorporated by reference to Exhibit 4.6 of the Company’s Registration Statement on Form S-8 (File No. 333-231323) filed with the SEC on May 9, 2019)
10.2	Form of Incentive Stock Option Award Agreement under the Midland States Bancorp, Inc. 2019 Long-Term Incentive Plan (incorporated by reference to Exhibit 4.7 of the Company’s Registration Statement on Form S-8 (File No. 333-231323) filed with the SEC on May 9, 2019)
10.3	Form of Nonqualified Stock Option Award Agreement under the Midland States Bancorp, Inc. 2019 Long-Term Incentive Plan (incorporated by reference to Exhibit 4.8 of the Company’s Registration Statement on Form S-8 (File No. 333-231323) filed with the SEC on May 9, 2019)
10.4	Form of Restricted Stock Unit Award Agreement under the Midland States Bancorp, Inc. 2019 Long-Term Incentive Plan (incorporated by reference to Exhibit 4.9 of the Company’s Registration Statement on Form S-8 (File No. 333-231323) filed with the SEC on May 9, 2019)
10.5	Form of Restricted Stock Award Agreement under the Midland States Bancorp, Inc. 2019 Long-Term Incentive Plan (incorporated by reference to Exhibit 4.10 of the Company’s Registration Statement on Form S-8 (File No. 333-231323) filed with the SEC on May 9, 2019)
10.6	Amended and Restated Midland States Bancorp, Inc. Employee Stock Purchase Plan (Amended and Restated May 3, 2019) (incorporated by reference to Exhibit 4.11 of the Company’s Registration Statement on Form S-8 (File No. 333-231323) filed with the SEC on May 9, 2019)
31.1	Chief Executive Officer’s Certification required by Rule 13(a)-14(a) – filed herewith.
31.2	Chief Financial Officer’s Certification required by Rule 13(a)-14(a) – filed herewith.
32.1	Chief Executive Officer Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 – filed herewith.
32.2	Chief Financial Officer Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 – filed herewith.
101	Financial information from the Company’s Quarterly Report on Form 10-Q for the quarterly period ended June 30, 2019, formatted in iXBRL (Inline eXtensible Business Reporting Language): (i) Consolidated Balance Sheets; (ii) Consolidated Statements of Income; (iii) Consolidated Statements of Comprehensive Income; (iv) Consolidated Statements of Shareholders’ Equity; (v) Consolidated Statements of Cash Flows; and (vi) Notes to Consolidated Financial Statements – filed herewith.

57

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

	Midland States Bancorp, INC.
Date: August 7, 2019	By:	/s/	Jeffrey G. Ludwig
			Jeffrey G. Ludwig
			President and Chief Executive Officer
			(Principal Executive Officer)
Date: August 7, 2019	By:	/s/	Stephen A. Erickson
			Stephen A. Erickson
			Chief Financial Officer
			(Principal Financial and Accounting Officer)

58