# EDGAR Filing Document

**Accession Number:** 0000034782
**File Stem:** 0000034782-23-000059
**Filing Date:** 2023-3
**Character Count:** 271329
**Document Hash:** 60454e1c22db169240eb0a9d08033dc7
**Contains OCR:** False
**Source Format:** 

## Filing Content

## Filing Summary
**0000034782-23-000059.hdr.sgml**: 20230310

**ACCESSION NUMBER**: 0000034782-23-000059

**CONFORMED SUBMISSION TYPE**: ARS

**PUBLIC DOCUMENT COUNT**: 1

**CONFORMED PERIOD OF REPORT**: 20221231

**FILED AS OF DATE**: 20230310

**DATE AS OF CHANGE**: 20230310

**EFFECTIVENESS DATE**: 20230310

**FILER**: 

**COMPANY DATA:**
- **COMPANY CONFORMED NAME:** 1ST SOURCE CORP
- **CENTRAL INDEX KEY:** 0000034782
- **STANDARD INDUSTRIAL CLASSIFICATION:** STATE COMMERCIAL BANKS [6022]
- **IRS NUMBER:** 351068133
- **STATE OF INCORPORATION:** IN
- **FISCAL YEAR END:** 1231

**FILING VALUES:**
- **FORM TYPE:** ARS
- **SEC ACT:** 1934 Act
- **SEC FILE NUMBER:** 000-06233
- **FILM NUMBER:** 23722557

**BUSINESS ADDRESS:**
- **STREET 1:** 100 NORTH MICHIGAN STREET
- **CITY:** SOUTH BEND
- **STATE:** IN
- **ZIP:** 46601
- **BUSINESS PHONE:** 5742352702

**MAIL ADDRESS:**
- **STREET 1:** P O BOX 1602
- **STREET 2:** P O BOX 1602
- **CITY:** SOUTH BEND
- **STATE:** IN
- **ZIP:** 46634

**FORMER COMPANY:**
- **FORMER CONFORMED NAME:** FBT BANCORP INC
- **DATE OF NAME CHANGE:** 19820818

### Attached PDF Documents

**Attachment 1:** `arssce20221231.pdf`

# 2022 ANNUAL REPORT

Source Corporation

Your partners from the Red, Paul M. Abraham, Ashley M. Adamczyk, Alexander M. Adams, Jennifer C. Addis, Nana K. Addo, Stefan H. Adkins, Erica Aguilar, Jennifer L. Allen, Constable A. Alarcon, Solis, Tona M. Albright, Amanda S. Alburne, Jamie T. Alexander, Sheila A. Alexander, Adobe P. Albrock, Brenda A. Alison, Madison L. Allman, Kristina L. Alvarado, Cristina M. Alvarez, Marie G. Alvarez, Amber B. Amor, Amber L. Anderson, Solomon L. Anderson, Margie S. Anglemyer, Gabrielle A. Anglin, Jessica M. Anglin, Tara A. Antonucci, Peter M. Balaz, Agassiz A. Bate, J. Armitage, Scott H. Armitage, Luke M. Armstrong, Angela M. Amid, Chloe T. Amid, Lane C. Arnett, Emily M. Arroyo, Stephanie A. Arsen, Helen M. Atkinson, Quentin G. Aubrey, Joseph D. Avery, Eric C. Back, Christy M. Bader, Braden A. Baer, Nick G. Balfour, Heather M. Bailey, Phileke J. Bailey, Jane L. Bais, Lisa A. Balaz, Christine L. Baldwin, John V. Ball, Jr., Kathryn A. Baliga, Angela D. Bance, Sarah M. Bance, James M. Barker, Donna M. Banks, Amy M. Barbour, Linsey Barlowski, Sharon G. Barman, Deborah A. Barton, Robert E. Bartos, Kona G. Bass, Kimberly L. Bates, Brent A. Bauer, Laurence R. Bauer, Aretas D. Bailey, Adalard D. Becht, Gina L. Beckner, Gina M. Beckstedt, Stephanie L. Baca, John D. Bedert, Debbie I. Bregis, Terri R. Belcher, Diana S. Bell, Ryan S. Bell, Stephanie A. Bell, Tristan A. Bell, Caroline M. Bellamy, Holly M. Bellegarde, Todd M. Bementer, Alec S. Berckx, Andrew J. Berckx, John M. Berckx, Kim A. Berrett, Mary A. Benson, Angeline D. Bess, Allison B. Berger, Andrew C. Bessmer, Angela M. Bessner, Stephanie Bessner, Zachary M. Best, Keenan D. Betcher, Monika K. Kutt, T. Bessell, Israel E. Bida, Carolyn H. Biggs, Amanda L. Bickowski, Barry A. Biger, Trina R. Bissborough, Alex P. Bird, Elizabeth M. Bitt, Lara L. Bixler, Kayla M. Bishop, Brian J. Bitter, S. B. B. B. B. B. B. B. B. B. B. B. B. B. B. B. B. B. B. B. B. B. B. B. B. B. B. B. B. B. B. B. B. B. B. B. B. B. B. B. B. B. B. B. B. B. B. B. B. B. B. B.

# 2022 ANNUAL REPORT

# Forbes

Best in State Bank
2022 Forbes Survey

# Forbes

Best Mid-size Employer
2021-2023 Forbes Survey

Best Employer for Diversity
2022 Forbes Survey

Best Employer for Veterans
2020-2021 Forbes Survey

# SBA

Small Business Administration

2013 - 2022 Indiana SBA Community
Lender Gold Level Award

#1 SBA Lender in our
Indiana Footprint

2019 Indiana Rural Lender of the Year

# monitor

Ranked #22 | 2022 Top 50
U.S. Bank Finance/Leasing Company

Ranked #37 | 2022 Top 100 Largest
Equipment Finance/Leasing
Companies in the U.S.

![img-0.jpeg](img-0.jpeg)

Bank Honor Roll
2019 - 2022

# ★★★★
Bauer Financial

5 Star "Superior" Rating

Highest rating possible. Based on capital
ratio, profitability/loss trend, credit quality
and CRA ratings

# CONTENTS

| Corporate Description | i |
| --- | --- |
| 2022 in Brief | i |
| Financial Highlights | ii |
| 2022 Annual Shareholders' Letter | iii |
| Services | ix |
| Locations | x |
| Shareholders' Information | xi |
| Financial Report | 1 |
| Directors and Officers | Inside Back Cover |

![img-1.jpeg](img-1.jpeg)

**Strong. Stable. Local. Personal.** We are a top-rated community bank recognized for outstanding performance and exceptional service to clients.

Staying true to our values has helped us succeed. Integrity; outstanding client service; teamwork; superior quality; and community leadership are at the heart of everything we do. We adhere to solid, basic lending principles, allowing us to maintain a strong financial standing.

![img-2.jpeg](img-2.jpeg)

# CORPORATE DESCRIPTION

1st Source Corporation is the largest locally controlled financial institution headquartered in the northern Indiana-southwestern Michigan area serving the region since 1863. While delivering a comprehensive range of consumer, commercial and digital banking services, 1st Source has distinguished itself with highly personalized services and distinctive convenience. 1st Source also provides specialized financing for solar installations throughout the U.S. and nationally for automobiles and light trucks for leasing and rental agencies, medium and heavy duty trucks and construction equipment, as well as nationally and internationally for new and pre-owned private and cargo aircraft.

The Corporation has 79 banking centers in 18 counties in Indiana, Michigan and one county in Florida, 10 1st Source Insurance offices, nine Wealth Advisory Services locations, and 19 locations nationwide for the 1st Source Specialty Finance Group. 1st Source is proud of its tradition of providing superior service to clients while playing a leadership role in the continued development of the communities it serves.

## Net Income Summary

| (000s) | 2022 | 2021 | $ Change | % Change |
| --- | --- | --- | --- | --- |
| Net interest income | $263,469 | $236,638 | $26,831 | 11.3% |
| Provision (recovery of provision) for credit losses | 13,245 | (4,303) | 17,548 | 407.8% |
| Net interest income after provision | 250,224 | 240,941 | 9,283 | 3.9% |
| Noninterest income* | 81,239 | 86,398 | (5,159) | (6.0)% |
| Noninterest expense* | 174,676 | 172,454 | 2,222 | 1.3% |
| Income before income taxes | 156,787 | 154,885 | 1,902 | 1.2% |
| Income tax expense | 36,255 | 36,328 | (73) | (0.2)% |
| Net income | 120,532 | 118,557 | 1,975 | 1.7% |
| Net income attributable to noncontrolling interests | (23) | (23) | - | - % |
| Net income available to common shareholders | $120,509 | $118,534 | $1,975 | 1.7% |

*Excludes lease/equipment depreciation

## Pre-Tax Pre-Provision Earnings (in millions)

![img-3.jpeg](img-3.jpeg)

## Net Income and Cash Dividends

![img-4.jpeg](img-4.jpeg)

## 2022 In Brief:

2022 net income was $120.51 million compared to $118.53 million earned in 2021. Diluted net income per common share for 2022 was $4.84, up from $4.70 the previous year. Return on average total assets was 1.49% compared to 1.53% a year ago. Return on average common shareholders' equity was 13.81% for 2022, compared to 13.07% for 2021. The average common shareholders' equity-to-average assets ratio for 2022 was 10.81% compared to 11.73% last year.

At year-end, total assets were $8.34 billion, up 3.00% from a year earlier. Loans and leases were $6.01 billion, up 12.44%, deposits were $6.93 billion, up 3.73% from 2021 and common shareholders' equity was $864.07 million, a decrease of 5.70% from a year earlier.

The allowance for loan and lease losses at year-end was 2.32% of total loans and leases, compared to 2.38% the prior year. The ratio of nonperforming assets to loans and leases was 0.45% for 2022, compared to 0.77% for 2021.

## Average Deposits

![img-5.jpeg](img-5.jpeg)

## Average Loans and Leases

![img-6.jpeg](img-6.jpeg)

## Loan and Lease Quality (% of Loans and Leases)

![img-7.jpeg](img-7.jpeg)

i

# FINANCIAL HIGHLIGHTS

## Earnings and Dividends

(Dollars in thousands, except per share amounts)

|  | 2022 | 2021 | 2020 | 2019 | 2018 |
| --- | --- | --- | --- | --- | --- |
| Net interest income | $263,469 | $236,638 | $225,820 | $223,866 | $213,906 |
| Provision (recovery of provision) for credit losses | 13,245 | (4,303) | 36,001 | 15,833 | 19,462 |
| Noninterest income | 91,262 | 100,092 | 103,889 | 101,130 | 97,050 |
| Noninterest expense | 184,699 | 186,148 | 187,367 | 189,009 | 186,467 |
| Net income available to common shareholders | 120,509 | 118,534 | 81,437 | 91,960 | 82,414 |
| Common cash dividends | 32,102 | 31,340 | 29,764 | 29,021 | 25,686 |
| Per common share |  |  |  |  |  |
| Diluted net income | $4.84 | $4.70 | $3.17 | $3.57 | $3.16 |
| Cash dividends | 1.26 | 1.21 | 1.13 | 1.10 | 0.96 |
| Book value | 35.04 | 37.04 | 34.93 | 32.47 | 29.56 |
| Return on average common shareholders' equity | 13.81% | 13.07% | 9.41% | 11.50% | 11.09% |
| Return on average assets | 1.49% | 1.53% | 1.14% | 1.41% | 1.34% |

## Statement of Condition

Average Balances: (Dollars in thousands)

|  | 2022 | 2021 | 2020 | 2019 | 2018 |
| --- | --- | --- | --- | --- | --- |
| Assets | $8,073,111 | $7,731,147 | $7,120,009 | $6,528,274 | $6,151,439 |
| Earning assets | 7,661,168 | 7,338,639 | 6,684,246 | 6,104,673 | 5,761,761 |
| Investments | 1,845,351 | 1,443,380 | 1,058,060 | 1,014,659 | 951,812 |
| Loans and leases | 5,566,701 | 5,437,817 | 5,463,436 | 5,000,161 | 4,755,256 |
| Allowance for loan and lease losses | 133,028 | 139,141 | 130,776 | 105,340 | 99,258 |
| Deposits | 6,711,376 | 6,342,527 | 5,736,602 | 5,276,736 | 4,963,663 |
| Interest bearing liabilities | 5,002,168 | 4,784,697 | 4,546,548 | 4,440,905 | 4,288,617 |
| Shareholders' equity | 872,721 | 906,951 | 865,278 | 799,736 | 743,173 |

### Average Common Shareholders' Equity

![img-8.jpeg](img-8.jpeg)

### Return on Average Common Shareholders' Equity (as a percent)

![img-9.jpeg](img-9.jpeg)

### Return on Average Assets (as a percent)

![img-10.jpeg](img-10.jpeg)

### Diluted Net Income Per Common Share

![img-11.jpeg](img-11.jpeg)

ii

# 2022 ANNUAL SHAREHOLDERS' LETTER

## INTRODUCTION

2022 was a good year for 1st Source in terms of net income, one much better than we had anticipated. We benefited from a widening interest rate margin between our cost of funds and our interest income due to seven rate increases by the Federal Reserve over the last year and a continuing high level of liquidity in corporate and personal deposit accounts. This was enhanced by strong loan growth which accelerated throughout the year. As the year was closing there was increasing competition for deposits and businesses and individuals increased the use of their cash.

The Federal Reserve (the Fed) did a wonderful job addressing the challenges brought on by the COVID-19 pandemic in 2020 and 2021. They used monetary policy initiatives to reduce interest rates substantially to ensure that the economy would not fall into a deep recession or depression. The Federal Government also supplied substantial fiscal stimulus to the markets in the form of the Paycheck Protection Program (PPP) forgivable loans, individual stimulus payments, and through a variety of other gift and lending programs. These achieved their intended effect and kept the economy from whipping into a negative tailspin, but those stimulus programs may have overshot their goals and created their own set of problems. Unfortunately, with people being pent up for so long, the consumer emerged wanting more goods and services just at a time when supply chains were tight to closed. This led to inflating prices, which the Fed originally identified as transitory, only to learn later that the price increases and expectations for such were building themselves into the economy. Similarly, the Russian invasion of Ukraine, the West's response with significant economic restrictions, and the war's impact on agriculture and energy costs clearly constrained the Fed's ability to affect the economy through monetary policy. It turned out that inflation was more than transitory, and the Fed responded by raising interest rates and announcing its intention to unwind its balance sheet built through its Quantitative Easing initiatives following the 2008 financial crises.

Knowing the very negative impact of high inflation on the economy, the Fed decided to move early in 2022 to curb inflationary expectations and reduce price and wage increases that could adversely affect everyone. The first rise was in March at 25 basis points. That was followed with a 50 basis point increase in May and four successive rate increases of 75 basis points each in June, July, September and November, and then finishing with a lower 50 basis point increase in December. So, for the full year, the Fed Funds Rate moved up 4.25%. Having lived through and trying to manage my own personal finances and this Bank's in the latter 1970s after wage and price controls and a series of other failed Government attempts to direct the economy and the inflationary pain of the early 1980s, I agree with the Fed's decision to tighten quickly and to stamp out increasing inflation even if it means slower economic growth and higher unemployment for a while. Everyone gets hurt by

inflation, and it can lead to catastrophic economic results in the long term. In any case, 1st Source benefited from these higher rates as deposit costs did not move as fast as interest rates charged on loans.

Obviously, the great tragedy of 2022 is the suffering the people of Ukraine are having to endure to fight for their country's right to exist. Europeans are suffering from much higher energy costs and the costs of millions of refugees seeking shelter from the ravages of the war. Also, the rising hostility with China and its continued desires to repatriate Taiwan, strains of ethnic and religious battles in the Middle East and Africa, and the belligerent nature of Kim Jong Un's military build-up all threaten the global security of which we are all beneficiaries.

At 1st Source we can't know the future, but we can build a strong balance sheet, maintain strong capital and reserves, and be prepared to handle whatever challenges the world presents. Having the right people who believe in our Mission of service and a culture built on integrity, committed to doing the right thing in the right way, and not becoming infected by human hubris, helps us prepare for a future of continued success, not next year or the year after but ten and twenty years from now. I am blessed with such people as colleagues throughout the Bank! They love our customers, and our customers love them whether they be in personal banking, business banking, specialty finance, investment or wealth management, or insurance. And these colleagues are backed up by people just as committed serving them, and through them our customers, and they are in everything from loan or deposit operations, payments, accounting, compliance, information technology, administration, legal, treasury management, card products, marketing, funds management, credit, workout, audit, loan review, buildings and ground management, digital support, call centers, the vault, human resources, training, and a host of other important but unheralded jobs. I am also blessed with a leadership team that wants to continue our 160 years of success.

![img-12.jpeg](img-12.jpeg)

*Our success is the result of a collaborative effort among all our teams.*

iii

## PERFORMANCE

In 2022 we achieved net income of $120.51 million up from $118.53 million in 2021 and earnings per share of $4.84 for 2022 versus $4.70 the year before. All the details of our earnings and their comparisons year-to-year can be found in the Form 10-K attached hereto. From an overall standpoint, the largest impact on earnings was total interest income of $293.82 million, up $39.04 million from $254.77 million the prior year while interest expense of $30.35 million was up only $12.21 million from 2021. In 2021 there was a recovery of the provision for credit losses of $4.30 million, positively impacting earnings while 2022 required a $13.25 million increase in the provision due to loan growth. This reduced income for 2022. The provision which follows the CECL model adopted in 2020 accounts for historical losses and recognizes the difficult economy that might lie ahead as well as taking into account concentration and systemic clumping risks in our portfolios. We have always believed it appropriate to plan for difficulty ahead and be prepared for it when it comes, as it surely does.

Total noninterest income was down by $8.83 million primarily due to much lower mortgage volumes while noninterest expense was down $1.45 million between 2021 and 2022.

The primary changes in our balance sheet can be found in our loan growth of $664.95 million for the year to $6.01 billion and in our deposit growth of $249.20 million to $6.93 billion. Investment securities started the year at $1.86 billion and finished the year at $1.78 billion with the difference due to market value adjustments. And, with the rising interest rates, the mark to market adjustment for “available-for-sale securities” rose to an unrealized loss of $147.69 million at the close of 2022 from $9.86 million at the end of 2021.

## PLANNING AND BUSINESS INITIATIVES

2022 marks the end of our previous three-year planning cycle and the beginning of another. We undertake a strategic planning initiative every three years setting five-year aspirational goals and then building a set of three-year objectives with the initiatives necessary to achieve them. We assume an economic scenario and a variety of alternatives, and then lay out what we expect to achieve. We are almost never right in what we predict will happen, but we plan for flexibility and keep our eye on our longer-term goals knowing we have to bob and weave as we work our way through the three years that then ensue. The last three years is a very good example of that. We never planned for an event as devastating as the pandemic became. We worked our way through the period taking advantage of opportunities and setting up programs to mitigate risks, and in the end, we achieved most of our goals both financial and otherwise.

## SUSTAINABILITY: INTERNAL AND IN THE MARKET

I would like to write that we have figured sustainability out. That is not the case, but we are working on it. We are working

to understand our carbon footprint and to do what we can to reduce it. To that end, we have undertaken a number of initiatives with varying results. Our operations staff has been working to lower our carbon footprint by reducing paper use, encouraging electronic and digital adoption of work processes, recycling waste, installing LED lighting and purchasing recycled materials. These have had positive outcomes. The use of digital systems has been designed to reduce the use of paper and takes steps out of our processes. Sometimes we are more efficient with these new systems and sometimes less so as we learn how to use them more effectively.

We have been more successful in helping clients positively impact the environment by proactively encouraging and supporting the use of sustainable energy sources. We do this as a tax equity investor and as a sustainability lender. For over five years, we have been investing in the tax equity of solar projects and financing their development and operation. This time is the minimum required to know whether our tax equity approach has worked financially. To be sure, we have earned from financing solar projects, closing 2022 with $381 million in outstanding loans. But until the close of this year, we had not yet experienced the full cycle of a tax equity investment. Just prior to year-end we achieved our first milestone. Two of our first tax equity investments were converted and we were bought out by the developer, leading to $2.2 million in additional income from those projects. We know this does not guarantee that every project in which we have invested will have a similar outcome, but it does encourage us to continue to pursue appropriate solar tax equity and finance opportunities where we can add value due to our knowledge and experience.

1st Source Bank has now funded over $100 million in tax equity investments in renewable energy projects, ending the year with $109 million invested. We are pleased to provide our clients with a streamlined financing process which includes tax equity and debt financing. We have also recently financed, as part of our solar projects, battery installations to improve their economic performance. Battery storage is a growing field with technological changes making it more important and successful in the sustainability market. We will continue to study opportunities and dimension risks as we grow this business and meet our client needs. Thus far our portfolio offsets 277,000 metric tons of carbon greenhouse emissions annually.

Our sustainable energy financing initiative supports local communities in our home markets and across the country. Two specific ways our efforts directly benefit communities are the financing of education-related projects (higher education institutions, community school systems, etc.) and community solar projects (state programs facilitated by utilities that offer solar benefits to residents, religious and civic organizations, municipalities, and small-to-large businesses). As of 2022, we have financed ten education-related projects across seven states, representing 44 megawatts of power and another 22 community solar projects across five states, representing 220 megawatts of renewable energy capacity. We view these as

iv

**SUSTAINABILITY - CONTINUED**

**PEOPLE**

great opportunities to continue to have a positive sustainability impact within communities across the United States.

In 2022, we expanded our sustainable energy financing initiative with a tax equity investment and financing of a hydroelectric facility built for the University of Notre Dame as part of its efforts to become carbon neutral. This 2.5-megawatt facility will provide an estimated 7% of Notre Dame's electrical needs and will offset 9,700 tons of carbon dioxide annually.

We are pleased with our success in these markets and will continue to look for opportunities to expand our sustainable energy portfolio. This is an important initiative we started seven years ago that has growing momentum. However, we are mindful of the fact that we are still new to these businesses, and we know there are still some hard lessons to learn.

Similarly, we have worked hard to understand the opportunity and risks in financing electric vehicles whether they be cars, light trucks, heavy duty yard tractors, construction machinery, and other work vehicles. There has been a lot of hype around this, and we do not know yet the longer-term impact of the availability of supportive infrastructure, competitive new entrants to the manufacturing and sales markets, disposition and environmental challenges around battery disposition, or the appearance of new sustainability alternatives like hydrogen. All of these have an impact on the markets and vehicle values which are hard to predict. Nonetheless, we will proceed to finance those electric vehicles that we think make sense and will work to mitigate embedded risks. Today, just over 1% of the vehicles we have financed in our auto rental and commercial leasing portfolios are electric.

In summary, we are committed to being good stewards of our environment by helping with sustainable energy development and through good energy management and recycling practices.

![img-13.jpeg](img-13.jpeg)

*Warsaw community solar array financed by 1st Source Bank. Bench made from recycled plastic lids gathered by colleagues.*

The pandemic created a whole set of challenges as people began to refocus on their families and their health. Turnover increased across the country and many people left the workforce for good. Businesses closed due to the pandemic or reduced their staffs significantly due to lower volumes of business. This was especially true in retail businesses, hospitality and entertainment. 1st Source did not close, nor did we lay people off. We continued to serve clients, and we tried to keep people working together as teams in our offices. In some cases, individuals were allowed to work from home due to their being high risk from a health standpoint. Almost all our people returned to the office by the end of 2021. Having said that, we still lost people who decided working with the public was just too stressful or who stayed home to care for their children.

Starting salaries were rising across the market to entice people back to work elsewhere and we responded to make sure we are competitive in getting the right people to join us. During the pandemic in 2021 and 2022, starting pay was raised from $12.00 an hour to $15.00 with programs put in place in our banking centers and call centers to allow increases to $18.00 relatively quickly with the achievement of specified goals. We changed our dress code from requiring coats and ties for men and professional dress for women to business casual. We increased both vacation and personal days, increased tuition reimbursements for those pursuing continuing education, expanded pay ranges, and increased our merit guideline levels. Being mindful of the stresses people were experiencing at home and in the workplace, we offered enhanced employee assistance programs and mental wellness benefits. We also developed clearer progression steps and career paths for our banking center-based employees and focused on increasing our diversity to ensure equity and inclusion across the Bank. Lastly, we continued to provide strong retirement benefits and provided increased payments to our profit-sharing plan. We will continue to look for ways to improve our competitiveness in the market and attract good people who believe in our values, being part of our long-term success, and who love being in service to others.

Developing people is critically imperative to our long-term performance. What sets us apart and is at the core of our success is understanding our purpose as a business and our Mission of service and how we deliver it in each of our individual capacities. Building knowledge and commitment to the 1st Source Way (our structured service development program), teaching managers how to be servant leaders and to coach success among those for whom they are responsible, are important components in our commitment to delivering Outstanding Client Service. Our Human Resources team and our LEAD and Lean initiatives touched over 370 colleagues in 2022. This is just a start in a continuous journey to be better and to serve better. In a world of noise, derision, fake news, and social rumor mongering, we must stay focused on and continually reinforce our values.

v

We also must look out years into the future and make sure we are bringing the right people along for future leadership. They need to be purposefully educated, tested, vetted, and experienced to be ready to step into the shoes of another who retires or transitions. And this needs to be done at all levels. Each June we commit our management team to doing a rigorous talent review analyzing all officers. In that process, we discuss individual development plans in place or needed for our colleagues' continued growth. Annually, I also review with the Board's Executive Compensation and Human Resources Committee potential needs at the Senior and Executive levels ten years out and discuss efforts to ensure continued personal growth.

This year is an example of the fruits of our multi-year effort. Andrea Short was promoted to CEO of the Bank after she returned from the Harvard Business School's Advanced Management Program. I sent one of her predecessors, Duke Jones, to the same program years ago to make sure he would be a better President. As part of her development, Andrea had previously attended the University of Chicago Booth School of Business Chicago Management Institute and Northwestern University Kellogg School of Management Executive Education classes. This customized development ensured she had the background, the education, and the experience to lead effectively at the next level. In her career here, she has demonstrated commitment to our values and to selfless leadership. The education, experience, and demonstrated values led to her promotion to Bank CEO as part of our longer-term planning. Similarly, Kevin Murphy, Chief Digital Officer, was promoted to Executive Vice President of the Bank and 1st Source Corporation after having moved through multiple jobs, divisions, and positions as part of his management experience and long-term training. He has served as Web Development Manager, Treasury Services Product Manager, Head of Electronic Banking, President of the Central Region and Chief Information Officer. As part of his development, he attended the University of Notre Dame's Executive MBA program to learn new tools and to further refine his analytical and presentational skills. He graduated Magna Cum Laude. He has also distinguished himself in leadership in the regional community serving on the Boards of the History Museum, the YMCA, The Boys and Girls Club, Holy Cross College and as Vice Chair of the Center for Hospice. Similar educational and work experiences are being developed and encouraged of officers throughout the Bank and as part of our three-year planning process. We will look for further opportunities to develop longer term leadership talent.

No matter what their training or background, our future leaders must demonstrate an innate respect and love of others, an intellectual curiosity that leads to their continual learning, a humble yet confident servant leadership attitude, mastery with demonstrable results in their areas of responsibility, and a willingness and ability to coach others. From a business perspective, they must have a true understanding of the balance between opportunity and risk in the economic equation of consumer and commercial banking, the power of frugality and paranoia in running a risk-based business that relies on

a multitude of exogenous events to ensure success and they must show they are optimistic about the future but obsessively paranoid about to what prevents us from getting to the future.

![img-14.jpeg](img-14.jpeg)

Andrea Short - President and Chief Executive Officer*

## DIVERSITY, EQUITY, AND INCLUSION (DEI)

We certainly made good progress in 2022, but after our initial successes in 2021, with colleagues who had been prepared for years, 2022 was more difficult to duplicate. It takes time to learn and master one's responsibilities and to grow to the next level. Our focus is less on the year-to-year hiring and promotion numbers and more on the substantive development of people's mastery and professionalism, giving them greater opportunities for advancement. And, of course, being the largest financial institution in our market, our success developing people, diverse and otherwise, makes us a target of everyone around us looking for people with the experiences we have provided. Turnover is always a concern but building the right population of people who master their areas of responsibility, are committed to our Mission, with shared values built on integrity, in a diverse and equitable company is more critically important to us.

We accelerated our DEI efforts in 2021 and experienced great momentum from our professional level diversity hiring and promotion goals - aggressively pursuing a larger number of internal diverse promotions. We have continued that positive momentum this year with 16% of all exempt hires and promotions among underrepresented groups. We are very intentional about our outreach efforts to attract diversity from the markets we serve and then proactively build individual development plans during the onboarding process. All exempt diversity hires and promotions are 'required' to have a development plan in place supporting their growth, full inclusion and preparation for expanded opportunities as professionals, and including management. To be successful in the long term, it is critical that we reflect the communities we serve. Also, internally we continue to educate toward a more inclusive environment that is understanding of, and managing better, our biases. We have continued our conversations around unconscious and conscious biases and are learning of

vi

**DIVERSITY, EQUITY, AND INCLUSION - CONT'D**

**HIGHLIGHTS**

the richness of our individual experiences and perspectives and how they can help us all succeed. 214 colleagues went through the diversity training program this year and we've continued regular DEI communications with diversity messaging. We also introduced DEI inclusion months, elevating the importance of this initiative across the bank. We've increased our internal DEI discussion groups and we continue to focus on training and education for all our colleagues. Collectively, they completed over 1,180 courses which included over 38,000 training modules.

In summary, we continue to grow in our diversity knowledge and experience and believe our efforts will lead to continuing improvement in the years ahead.

![img-15.jpeg](img-15.jpeg)

# **ORGANIZATION AND STRUCTURE**

We are a community bank with specific geographic markets and have organized our businesses accordingly. It is a simple model with a President responsible in each geographic market for the growth of clients, deposits, loans, and other financial products offered to individuals and businesses alike. Our products and services are delivered through banking facilities for which each President has responsibility. Credit underwriting, marketing, operational and systems support are provided by centralized services. Similarly, some product areas such as Treasury Services, Wealth Management, SBA Lending, and Insurance are centrally managed. Our specialty transportation financing businesses - auto and light truck, construction machinery, and private aircraft - are organized around verticals of similar equipment. Each is led by a President responsible for client growth, deposit and loan growth, pricing, credit quality and profitability. They are also supported by the centralized services mentioned above. This gives clear line of sight over responsibility and accountability of our leaders for their business units and their working together to balance risk with growth.

While detailed financial numbers are outlined in the Form 10-K, I did want to focus on some of our financial and other highlights from the year if for no other reason than to shine a bright light on some of the things my esteemed colleagues accomplished.

I am listing achievements made as part of our 2022 plan and for our three-year goals set in 2019 for 2022.

- • For the tenth year in a row the U.S. Small Business Administration (SBA), Indiana District, recognized 1st Source Bank with a Gold Level Award in the Community Lender category. The award honors 1st Source Bank for delivering the greatest number of SBA loans in Indiana in 2022 among Community Banks with less than \$10 billion in assets.
- • Solar financing outstandings reached \$381 million at December 31, 2022, and to date our tax equity investments reached \$109 million.
- • With 2022 proving to be one of the most difficult years in decades for investors, by keeping an eye on the longer term and working closely with clients, our Wealth Advisory team added relationships and had a positive growth in asset flows of over \$100 million. And we hired several new experts in trust and investments adding to one of the largest and most credentialed Wealth teams in the region.
- • We introduced an entirely new 1stsource.com, our website, to make it more client friendly and easier to use with enhanced frequently asked questions, more robust financial education, and more useful advisory content.
- • At the close of the year, we introduced a digital mobile account opening capability for potential new depositors increasing and improving our digital offerings.
- • Across our markets, we and our sister organization 1st Source Foundation partnered, sometimes together and sometimes separately, with our local United Ways, Junior Achievement and its Biz-Town, Boys and Girls Clubs, The Boy Scouts, Bashor Home, local and regional health care institutions, and many other not-for-profits to address the growing needs of the communities we serve. Between the Bank and the Foundation over \$3 million was contributed to deserving and successful community service organizations.
- • Our Specialty Finance Group grew to become the 37th of the top 100 finance businesses in the U.S. and 22nd of the top 50 bank equipment finance units. Of course, we are not looking to be the biggest just the best at what we do for our clients and our shareholders.
- • We were identified as the number one Community Development Lender in Indiana ranked by dollars and number two in loans made in dollar amount and as a percent of assets.
- • Three of 1st Source's Board members, Melody Birmingham, Tracy D. Graham and myself, were included in the inaugural lists of Indiana's most 250 influential people.
- • Of the over 6,750 and over \$850 million of PPP loans provided through 1st Source, 99% have been totally forgiven with less than \$1 million remaining in repayment.

vii

## CLOSING REMARKS

In closing, I want to thank my colleagues once again across the bank for their commitment to service, for living our values built on the most important: personal and corporate integrity, and for believing in our Mission of helping clients achieve security, build wealth, and realize their dreams. Thank you also to our managerial leadership for coming together to work as a team to address challenges and find solutions, and to our Board for its oversight and wise counsel. Let me also recognize a director retiring from our Board this year. He joined us as a well-respected business leader in the Elkhart market and he brought us knowledge and experience managing multimarket, multiproduct international businesses and service on public company boards. Vinod Khilnani has served on our Board since 2013 and in that time has provided sage advice as we expanded our international financing and developed our governance guidelines. He has served as the Audit, Finance and Risk Committee Chairperson, a member of the Loan and

Funds Management Committee, the Executive Compensation and Human Resources Committee, and the Governance and Nominating Committee. The Board joins me in thanking him for his commitment and leadership and we wish him Godspeed in his retirement.

Thank you to all of you as shareholders. Know we are committed to continuing to lead and manage this company for long term performance built on quality values driven by a Mission of service, making a difference in our clients' lives. Thank you for your support and we invite you to join us as a client if you have not already done so. You may open your account digitally at 1stsource.com.

Yours,

![img-0.jpeg](img-0.jpeg)

![img-1.jpeg](img-1.jpeg)

![img-2.jpeg](img-2.jpeg)

![img-3.jpeg](img-3.jpeg)

viii

# SERVICES

## PERSONAL

### Checking

### Savings

Certificates of Deposit
IRAs
Health Savings Accounts

### Loans

Personal
Automobile
Home Equity
Mortgage
Boat, RV, Motorcycle

### Trust and Estate Administration

Trust Administration
IRA/401(k) Management
Special Needs Trust
Estate Settlement
Bill Payment Services
Charitable Trust & Foundation Administration

### Wealth Advisory Services

Investment Management
Estate Planning
Charitable Strategies
Retirement Planning
Education Planning
Tax Planning
Insurance Solutions

### Private Banking

Relationship Management
Premier Convenience in Day-to-Day Banking
Deposit/Treasury Services Specialization
Mortgage Loans
Lines of Credit (secured and unsecured)
Checking

## ASSET MANAGEMENT

Traditional & Roth IRAs
Rollover Services
Mutual Funds, Stocks & Bonds

## BUSINESS

Loans & Leasing
Treasury Services
Merchant Card Services
Business 401(k) Plans
Retirement Plan Services
Renewable Energy Financing

## SPECIALTY EQUIPMENT FINANCE

Aircraft & Helicopter
Auto & Light Truck
Medium & Heavy Duty Trucks
Construction Equipment
Shuttle Bus
Step Vans
Funeral Cars
Motor Coaches

## INSURANCE

### Personal

Homeowners
Rental
Flood
Umbrella Liability Coverage
Life & Health
Disability Income
Automobile
Snowmobile
Recreational Vehicle
Boat

### Business

Commercial Auto
Commercial Property
Crime
Employment Practices
Key Man Life
Environmental Liability
General Liability
Umbrella/Excess Liability
Workers' Compensation
Crop Insurance

ix

# LOCATIONS

![img-4.jpeg](img-4.jpeg)

![img-5.jpeg](img-5.jpeg)

x

# SHAREHOLDERS' INFORMATION

## 2022 STOCK PERFORMANCE & DIVIDENDS

1st Source Corporation common stock is traded on the Over-The-Counter Market and is listed on the NASDAQ Global Select Market under the symbol "SRCE." 1st Source is also listed on the National Market System tables in many daily papers under the symbol "1stSrc."

High and low common stock prices, cash dividends paid for 2022 and book value were:

| Quarter Ended | High | Low | Cash Dividends Paid |
| --- | --- | --- | --- |
| March 31 | $52.70 | $45.78 | $0.31 |
| June 30 | 48.42 | 42.29 | 0.31 |
| September 30 | 51.29 | 42.38 | 0.32 |
| December 31 | 59.94 | 46.40 | 0.32 |

Book value per common share at December 31, 2022: $35.04

## ANNUAL MEETING OF SHAREHOLDERS

The virtual Annual Meeting of Shareholders has been called for 8:00 a.m. EDT, April 20, 2023, at www.virtualshareholdermeeting.com/SRCE2023.

Access to the annual meeting is limited to shareholders only and a control number is required to log in. If your shares are held in "street name" (that is, through a broker), you can gain access to the meeting by logging into you brokerage firm's website to link through to the meeting.

## COMMON STOCK LISTING

The NASDAQ Global Select Market
Market Symbol: "SRCE"
CUSIP #336901 10 3

## 1stsource.com

For the latest shareholder information, log on to www.1stsource.com.
Scroll to bottom of home page and click "Investor Relations."

If you would like to receive email alerts, please sign up on our website.

## TRANSFER AGENT, REGISTRAR AND DIVIDEND DISBURSING AGENT

American Stock Transfer and Trust Company
6201 15th Avenue
Brooklyn, NY 11219
(800) 937-5449

## INDEPENDENT AUDITORS

FORVIS, LLP
111 E Wayne Street
Suite 600
Fort Wayne, IN 46802

## SHAREHOLDER INQUIRIES

1st Source Corporation
Brett A. Bauer,
Chief Financial Officer
Post Office Box 1602
South Bend, IN 46634
(574) 235-2000
shareholder@1stsource.com

xi

# **UNITED STATES**
**SECURITIES AND EXCHANGE COMMISSION**
Washington, D.C. 20549
**FORM 10-K**

(Mark One)

☑ **ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**

For the fiscal year ended December 31, 2022

OR

☐ **TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**

For the transition period from __________ to __________

Commission file number 0-6233

# **1st Source Corporation**

(Exact name of registrant as specified in its charter)

**Indiana**

**35-1068133**

(State or other jurisdiction of incorporation or organization)

(I.R.S. Employer Identification No.)

**100 North Michigan Street**

South Bend, IN

**46601**

(Address of principal executive offices)

(Zip Code)

Registrant's telephone number, including area code: **(574) 235-2000**

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 - without par value | SRCE | The NASDAQ Stock Market LLC |

Securities registered pursuant to Section 12(g) of the Act: **None**

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes ☐ No ☑

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes ☐ No ☑

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

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

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, 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 has filed a report on and attestation to its management's assessment of the effectiveness of its internal control over financial reporting under Section 404(b) of the Sarbanes-Oxley Act (15 U.S.C. 7262(b)) by the registered public accounting firm that prepared or issued its audit report ☑

If securities are registered pursuant to Section 12(b) of the Act, indicate by check mark whether the financial statements of the registrant included in the filing reflect the correction of an error to previously issued financial statements. ☐

Indicate by check mark whether any of those error corrections are restatements that required a recovery analysis of incentive-based compensation received by any of the registrant's executive officers during the relevant recovery period pursuant to §240.10D-1(b). ☐

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

The aggregate market value of the voting common stock held by non-affiliates of the registrant as of June 30, 2022 was $870,592,534

The number of shares outstanding of each of the registrant's classes of stock as of February 10, 2023: Common Stock, without par value - 24,700,618 shares

# **DOCUMENTS INCORPORATED BY REFERENCE**

Portions of the 2023 Proxy Statement for the 2023 annual meeting of shareholders to be held April 20, 2023, are incorporated by reference into Part III.

1 • SRCE

2022 Form 10-K

# TABLE OF CONTENTS

| Part I |  |  |
| --- | --- | --- |
| Item 1. | Business | 3 |
| Item 1A. | Risk Factors | 9 |
| Item 1B. | Unresolved Staff Comments | 15 |
| Item 2. | Properties | 15 |
| Item 3. | Legal Proceedings | 15 |
| Item 4. | Mine Safety Disclosures | 15 |
| Part II |  |  |
| Item 5. | Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities | 16 |
| Item 6. | [Reserved] | 17 |
| Item 7. | Management's Discussion and Analysis of Financial Condition and Results of Operations | 17 |
| Item 7A. | Quantitative and Qualitative Disclosures About Market Risk | 39 |
| Item 8. | Financial Statements and Supplementary Data | 40 |
|  | Reports of Independent Registered Public Accounting Firm | 41 |
|  | Consolidated Statements of Financial Condition | 44 |
|  | Consolidated Statements of Income | 45 |
|  | Consolidated Statements of Comprehensive Income | 46 |
|  | Consolidated Statements of Shareholders' Equity | 46 |
|  | Consolidated Statements of Cash Flows | 47 |
|  | Notes to Consolidated Financial Statements | 49 |
| Item 9. | Changes in and Disagreements with Accountants on Accounting and Financial Disclosure | 89 |
| Item 9A. | Controls and Procedures | 89 |
| Item 9B. | Other Information | 89 |
| Item 9C. | Disclosure Regarding Foreign Jurisdictions that Prevent Inspections | 89 |
| Part III |  |  |
| Item 10. | Directors, Executive Officers and Corporate Governance | 90 |
| Item 11. | Executive Compensation | 90 |
| Item 12. | Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters | 90 |
| Item 13. | Certain Relationships and Related Transactions, and Director Independence | 90 |
| Item 14. | Principal Accountant Fees and Services | 90 |
| Part IV |  |  |
| Item 15. | Exhibits and Financial Statement Schedules | 91 |
| Item 16. | Form 10-K Summary | 93 |
| Signatures |  | 93 |
| Certifications |  |  |

2 • SRCE

2022 Form 10-K

# Part I

## Item 1. Business.

### 1ST SOURCE CORPORATION

1st Source Corporation, an Indiana corporation incorporated in 1971, is a bank holding company headquartered in South Bend, Indiana that provides, through its subsidiaries (collectively referred to as “1st Source”, “we”, and “our”), a broad array of financial products and services. 1st Source Bank (“Bank”), its banking subsidiary, offers commercial and consumer banking services, trust and wealth advisory services, and insurance to individual and business clients through most of our 79 banking center locations in 18 counties in Indiana and Michigan and Sarasota County in Florida. 1st Source Bank’s Specialty Finance Group, with 19 locations nationwide, offers specialized financing services for construction equipment, new and pre-owned private and cargo aircraft, and various vehicle types (cars, trucks, vans) for fleet purposes. While our lending portfolio is concentrated in certain equipment types, we serve a diverse client base. We are not dependent upon any single industry or client. At December 31, 2022, we had consolidated total assets of $8.34 billion, total loans and leases of $6.01 billion, total deposits of $6.93 billion, and total shareholders’ equity of $864.07 million.

Our principal executive office is located at 100 North Michigan Street, South Bend, Indiana 46601 and our telephone number is (574) 235-2000. Access to our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and all amendments to those reports is available, free of charge, at www.1stsource.com soon after the material is electronically filed with or furnished to the Securities and Exchange Commission (SEC). Information on our website is not incorporated by reference into this Form 10-K or our other public filings. The SEC maintains an Internet site that contains reports, proxy and information statements, and other information regarding issuers that file electronically with the SEC at www.sec.gov.

### 1ST SOURCE BANK

1st Source Bank is a wholly owned subsidiary of 1st Source Corporation that offers a broad range of consumer and commercial banking services through its lending operations, retail branches, and fee based businesses.

**Commercial, Agricultural, and Real Estate Loans** - 1st Source Bank provides commercial, small business, agricultural, and real estate loans to primarily privately owned business clients mainly located within our regional market area. Loans are made for a wide variety of general corporate purposes, including financing for industrial and commercial properties, financing for equipment, inventories and accounts receivable, and acquisition financing. Other services include commercial leasing, treasury management services and retirement planning services.

**Renewable Energy Financing** - 1st Source Bank provides financing for commercial solar projects across the contiguous United States, with a focus in the Northeast and Midwest states. 1st Source Bank’s approach provides solar developers with one-stop shop financing including construction loans, permanent loans, and tax equity investments for community solar, commercial and industrial, small utility scale, university, and municipal projects. Project sizes generally range from five megawatts to 20 megawatts.

**Consumer Services** - 1st Source Bank provides a full range of consumer banking products and services through our banking centers and at 1stsource.com. The traditional banking services include checking and savings accounts, certificates of deposits and Individual Retirement Accounts. 1st Source offers a full line of on-line and mobile banking products which includes on-line and mobile account opening, person-to-person payments, mobile deposit, outside account aggregation, money management budgeting solution and bill payment. As an added convenience, a strategically located Automated Teller Machine network serves our customers and supports the debit and credit card programs of the bank. Consumers also have the ability to obtain consumer loans, credit cards, real estate mortgage loans and home equity lines of credit in any of our banking centers or on-line. In a number of our markets, 1st Source also offers insurance products through 1st Source Insurance offices or in our banking centers. Finally, 1st Source offers a variety of financial planning, financial literacy and other consultative services to our customers.

**Trust and Wealth Advisory Services** - 1st Source Bank provides a wide range of trust, investment, agency, and custodial services for individual, corporate, and not-for-profit clients. These services include the administration of estates and personal trusts, as well as the management of investment accounts for individuals, employee benefit plans, and charitable foundations.

**Specialty Finance Group Services** - 1st Source Bank, through its Specialty Finance Group, provides a broad range of comprehensive equipment loan and lease products addressing the financing needs of a broad array of companies. This group can be broken down into four areas: construction equipment; new and pre-owned aircraft; auto and light trucks; and medium and heavy duty trucks.

Construction equipment financing includes financing of equipment (i.e., asphalt and concrete plants, bulldozers, excavators, cranes and loaders, etc.) to the construction industry. Construction equipment finance receivables generally range from $50,000 to $25 million with fixed or variable interest rates and terms of one to ten years.

3 • SRCE

2022 Form 10-K

Aircraft financing consists of financings for new and pre-owned general aviation aircraft (including helicopters) for private and corporate aircraft users, aircraft distributors and dealers, air charter operators, air cargo carriers, and other aircraft operators. For many years, on a limited and selective basis, 1st Source Bank has provided international aircraft financing, primarily in Mexico and Brazil. Aircraft finance receivables generally range from $500,000 to $25 million with fixed or variable interest rates and terms of one to ten years.

The auto and light truck division (including specialty vehicles such as step vans, vocational work trucks, motor coaches, shuttle buses and funeral cars) consists of fleet financings to automobile and light truck rental companies, commercial leasing companies, and single unit to fleet financing for users of specialty vehicles. The auto and light truck finance receivables generally range from $50,000 to $38 million with fixed or variable interest rates and terms of one to eight years.

The medium and heavy duty truck division provides fleet financing for highway tractors, medium duty trucks and trailers to the commercial trucking industry. Medium and heavy duty truck finance receivables generally range from $50,000 to $20 million with fixed or variable interest rates and terms of three to eight years.

## SPECIALTY FINANCE GROUP SUBSIDIARIES

The Specialty Finance Group also consists of separate wholly owned subsidiaries of 1st Source Bank which include: Michigan Transportation Finance Corporation, 1st Source Specialty Finance, Inc., SFG Aircraft, Inc., 1st Source Intermediate Holding, LLC, SFG Commercial Aircraft Leasing, Inc., and SFG Equipment Leasing Corporation I.

### 1ST SOURCE INSURANCE, INC.

1st Source Insurance, Inc. is a wholly owned subsidiary of 1st Source Bank that provides insurance products and services to individuals and businesses covering corporate and personal property, casualty insurance, individual and group health insurance and life insurance. 1st Source Insurance, Inc. has ten offices.

### 1ST PORTFOLIO MANAGEMENT, INC.

1st Portfolio Management, Inc. is a wholly owned subsidiary of 1st Source Bank that owns and manages certain available-for-sale investment securities.

## CONSOLIDATED VARIABLE INTEREST SUBSIDIARIES

1st Source Bank is the managing general partner in the following subsidiaries that have interests in tax-advantaged investments with third parties: 1st Source Solar 2, LLC, 1st Source Solar 3, LLC, 1st Source Solar 4, LLC, 1st Source Solar 5, LLC, 1st Source Solar 6, LLC, 1st Source Solar 7, LLC and 1st Source Solar 8, LLC.

## OTHER CONSOLIDATED SUBSIDIARIES

We have other subsidiaries that are not significant to the consolidated entity.

### 1ST SOURCE MASTER TRUST

Our unconsolidated subsidiary includes 1st Source Master Trust. This subsidiary was created for the purpose of issuing $57.00 million of trust preferred securities and lending the proceeds to 1st Source. We guarantee, on a limited basis, payments of distributions on the trust preferred securities and payments on redemption of the trust preferred securities.

## COMPETITION

The activities in which we and the Bank engage are highly competitive. Our businesses and the geographic markets we serve require us to compete with other banks, some of which are affiliated with large bank holding companies headquartered outside of our principal market. We generally compete on the basis of client service and responsiveness to client needs, available loan and deposit products, the rates of interest charged on loans and leases, the rates of interest paid for funds, other credit and service charges, the quality of services rendered, the convenience of banking facilities, and in the case of loans and leases to large commercial borrowers, relative lending limits.

In addition to competing with other banks within our primary service areas, the Bank also competes with other financial service companies, such as credit unions, industrial loan associations, securities firms, insurance companies, small loan companies, finance companies, mortgage companies, real estate investment trusts, certain governmental agencies, credit organizations, and other enterprises.

Additional competition for depositors' funds comes from United States Government securities, private issuers of debt obligations, and suppliers of other investment alternatives for depositors. Many of our non-bank competitors are not subject to the same extensive Federal and State regulations that govern bank holding companies and banks. Such non-bank competitors may, as a result, have certain advantages over us in providing some services.

4 • SRCE

2022 Form 10-K

We compete against these financial institutions by being convenient to do business with, and by taking the time to listen and understand our clients' needs. We deliver personalized, one-on-one banking through knowledgeable local members of the community always keeping the clients' best interest in mind while offering a full array of products and highly personalized services. We rely on our history and our reputation in northern Indiana dating back to 1863.

# OUR PEOPLE

At December 31, 2022, we had approximately 1,150 colleagues on a full-time equivalent basis. As a service-driven business, our long-term success depends on our people. And as the Company grows, the importance of our talent strategy has only intensified. For these reasons, we are committed to taking a multi-dimensional approach to talent and culture.

Diversity, Equity, and Inclusion - At 1st Source, we cultivate and advance diversity in all forms as part of building a strong culture, a culture in which inclusion and belonging are paramount, and where all of our colleagues strive to be open and inclusive leaders and teammates. Our culture is what unifies our colleagues across our diverse business model, ensures we are best positioned to serve our diverse clients and propels our continuous evolution.

- Since 2021, all employees have completed a series of facilitated training sessions on unconscious bias within six months of hire.
- Diversity in leadership starts with our Board of Directors and we are proud to report that five of our twelve Board Members (42%) are women or minority.
- For the sixth consecutive year, more than 21% of our new hires were diverse colleagues.
- In 2022, Forbes Magazine recognized the Company again as one of America's best employers for diversity and in 2021 as one of America's best employers for veterans. While we appreciate such recognition, our work here is never done and we are committed to continuous improvement in this area.

Training and Talent Development - We believe a critical driver of our future growth is the ability to grow leaders. We are committed to identifying and developing talent to help our colleagues accelerate their growth and achieve their career goals. We provide developmental opportunities for our colleagues at all levels through a robust set of formal and informal programs.

- 1st Source University focuses on enabling colleagues to build skills and knowledge in specific facets of our business. These educational experiences and resources include topics such as client relationships, technology, investments, compliance, leadership and management, and professional development.
- In 2022, 1st Source colleagues completed over 38,000 training modules consisting of over 1,180 different courses covering topics such as regulations, leadership development, relationship building, cybersecurity, soft skills, and unconscious bias.
- The 1st Source L.E.A.D. program is a set of immersive experiences and collaborative interactions, developing leadership capability over a fourteen-month period. The program is built around a series of best-in-class leadership principles and their application by participants as they lead their current teams.
- The Commercial Banker Development Program is a rotational program for recent college graduates designed to expose participants to fundamentals of commercial banking, including the funding and pricing of commercial loans, credit analysis and relationship sales.
- The Tuition Reimbursement Program reflects our philosophy of continuous learning and provides for reimbursement of tuition related expenses incurred through approved and accredited public and private not-for-profit institutions of higher education. In 2022, we reimbursed over $137,000 to colleagues for tuition reimbursement with an average of $3,600 per colleague who used the benefit.
- The Ivy Tech Bank Cohort Education Program was developed and made available through a partnership between 1st Source and Ivy Tech Community College to provide opportunities for obtaining a college degree among colleagues in the hourly and lower-level salaried workforce. The program was an important investment in education which then jumpstarted colleague interest in returning to school at Ivy Tech and other universities. We have moved from a low of 16 colleagues attending eight colleges and universities in the year prior to the program creation, to now almost 50 colleagues who are attending 22 different schools. Many in our first cohort of students have gone on to obtain their bachelor's degree and found success in new growth opportunities at 1st Source.

Community Engagement - Our organization is only as strong as the communities we serve. Our colleagues give their time, talent, and treasure to a wide variety of organizations in their local communities. 1st Source and our colleagues are proud to support our local schools, nonprofits, and faith groups while continuing to promote increased financial literacy through our straight talk and sound advice.

- In 2022, our colleagues donated approximately 13,000 hours to a total of 900 different organizations.
- In 2022, our colleagues contributed over $189,000 to local United Way organizations.
- In 2022, 1st Source contributed over $745,000 to over 450 deserving and successful community service organizations.

5 • SRCE

2022 Form 10-K

# REGULATION AND SUPERVISION

**General** - 1st Source and the Bank are extensively regulated under federal and state law. To the extent the following information describes statutory or regulatory provisions, it is qualified in its entirety by reference to the particular statutory and regulatory provisions. Any change in applicable laws or regulations may have a material effect on our existing and prospective business and operations. We are unable to predict the nature or the extent of the effects on our business, operations and earnings that fiscal or monetary policies, economic controls, or new federal or state legislation or regulation may have in the future.

We are a registered bank holding company under the Bank Holding Company Act of 1956, as amended (BHCA), and, as such, we are subject to regulation, supervision, and examination by the Board of Governors of the Federal Reserve System (Federal Reserve). We are required to file annual reports with the Federal Reserve and to provide the Federal Reserve such additional information as it may require.

The Bank, as an Indiana state bank and member of the Federal Reserve System, is subject to prudential supervision by the Indiana Department of Financial Institutions (DFI) and the Federal Reserve Bank of Chicago (FRB Chicago). As such, 1st Source Bank is regularly examined by and subject to regulations promulgated by the DFI and the Federal Reserve. Because the Federal Deposit Insurance Corporation (FDIC) provides deposit insurance to the Bank, we are also subject to supervision and regulation by the FDIC (even though the FDIC is not our primary Federal regulator). The Bank is also subject to regulations promulgated by the Consumer Financial Protection Bureau (CFPB) and to supervision for compliance with such regulations by the DFI and the FRB Chicago.

**Bank Holding Company Act** - Under the BHCA our activities are limited to (i) business so closely related to banking, managing, or controlling banks as to be a proper incident thereto and (ii) non-bank activities, determined by law or regulation, to be closely related to the business of banking or of managing or controlling banks. We are also subject to capital requirements applied on a consolidated basis in a form substantially similar to those required of the Bank. The BHCA also requires a bank holding company to obtain approval from the Federal Reserve before (i) acquiring or holding more than 5% voting interest in any bank or bank holding company, (ii) acquiring all or substantially all of the assets of another bank or bank holding company, or (iii) merging or consolidating with another bank holding company.

**Capital Standards** - The federal bank regulatory agencies use capital adequacy guidelines in their examination and regulation of bank holding companies and banks. If capital falls below the minimum levels established by these guidelines, a bank holding company or bank must submit an acceptable plan for achieving compliance with the capital guidelines and, until its capital sufficiently improves, will be subject to denial of applications and appropriate supervisory enforcement actions. For banks, the FDIC's prompt corrective action regulations establish five capital levels for financial institutions ('well capitalized,' 'adequately capitalized,' 'undercapitalized,' 'significantly undercapitalized,' and 'critically undercapitalized'), and impose mandatory regulatory scrutiny and limitations on institutions that are less than adequately capitalized. At December 31, 2022, the Bank was categorized as 'well capitalized,' meaning that our total risk-based capital ratio exceeded 10.00%, our Tier 1 risk-based capital ratio exceeded 8.00%, our common equity Tier 1 risk-based capital ratio exceeded 6.50%, our leverage ratio exceeded 5.00%, and we are not subject to a regulatory order, agreement, or directive to meet and maintain a specific capital level for any capital measure. The various regulatory capital requirements that we are subject to are disclosed in Part II, Item 8, Financial Statements and Supplementary Data - Note 20 of the Notes to Consolidated Financial Statements.

As of December 31, 2022, we were in compliance with all applicable regulatory capital requirements and guidelines.

In September 2019, the Federal Reserve and other federal banking agencies adopted a final rule, effective January 1, 2020, creating a community bank leverage ratio ('CBLR') for institutions with total consolidated assets of less than $10 billion and that meet other qualifying criteria. The CBLR provides for a simple measure of capital adequacy for qualifying institutions. Qualifying institutions that elect to use the CBLR framework and that maintain a leverage ratio of greater than 9% will be considered to have satisfied the generally applicable risk-based and leverage capital requirements in the regulatory agencies' capital rules and to have met the well-capitalized ratio requirements. Management reviewed the CBLR framework and has determined that 1st Source and the Bank will not elect to use the CBLR framework.

**Securities and Exchange Commission (SEC) and The NASDAQ Stock Market (NASDAQ)** - We are also subject to regulations promulgated by the SEC and certain state securities commissions for matters relating to the offering and sale of our securities. We are subject to the disclosure and regulatory requirements of the Securities Act of 1933, as amended, and the Securities Exchange Act of 1934, as amended, as administered by the SEC. We are listed on the NASDAQ Global Select Market under the trading symbol 'SRCE,' and we are subject to the rules of NASDAQ for listed companies.

6 • SRCE

2022 Form 10-K

The following table shows the estimated scheduled maturities of the portion of time deposits in U.S. offices in excess of the FDIC insurance limit and time deposits that are otherwise uninsured.

| (Dollars in thousands) |  |
| --- | --- |
| Under 3 Months | $138,892 |
| 4 - 6 Months | 70,383 |
| 7 - 12 Months | 181,961 |
| Over 12 Months | 217,415 |
| Total | $608,651 |

See Part II, Item 8, Financial Statements and Supplementary Data - Note 10 of the Notes to Consolidated Financial Statements for additional information on deposits.

## SHORT-TERM BORROWINGS

The following table shows the distribution of our short-term borrowings and the weighted average interest rates thereon at the end of each of the last two years. Also provided are the maximum amount of borrowings and the average amount of borrowings, as well as weighted average interest rates for the last two years.

| (Dollars in thousands) | Federal Funds Purchased and Securities Repurchase Agreements | Commercial Paper | Federal Home Loan Bank Advances | Other Short-Term Borrowings | Total Borrowings |
| --- | --- | --- | --- | --- | --- |
| 2022 |  |  |  |  |  |
| Balance at December 31, 2022 | $141,432 | $3,096 | $70,000 | $1,001 | $215,529 |
| Maximum amount outstanding at any month-end | 193,798 | 4,072 | 250,000 | 1,746 | 449,616 |
| Average amount outstanding | 169,600 | 3,838 | 40,123 | 1,409 | 214,970 |
| Weighted average interest rate during the year | 0.12% | 0.04% | 3.22% | - % | 0.70% |
| Weighted average interest rate for outstanding amounts at December 31, 2022 | 0.05% | 0.03% | 4.16% | - % | 1.39% |
| 2021 |  |  |  |  |  |
| Balance at December 31, 2021 | $194,727 | $3,967 | $ - | $1,333 | $200,027 |
| Maximum amount outstanding at any month-end | 210,275 | 5,141 | - | 3,007 | 218,423 |
| Average amount outstanding | 180,610 | 4,316 | - | 1,802 | 186,728 |
| Weighted average interest rate during the year | 0.06% | 0.08% | - % | - % | 0.06% |
| Weighted average interest rate for outstanding amounts at December 31, 2021 | 0.04% | 0.04% | N/A | - % | 0.04% |

## LIQUIDITY AND CAPITAL RESOURCES

**Core Deposits** - Our major source of investable funds is provided by stable core deposits consisting of all interest bearing and noninterest bearing deposits, excluding brokered certificates of deposit, listing services certificates of deposit and certain certificates of deposit over $250,000 based on established FDIC insured deposits. In 2022, average core deposits equaled 79.60% of average total assets, compared to 78.04% in 2021 and 73.64% in 2020. The effective rate of core deposits in 2022 was 0.32%, compared to 0.12% in 2021 and 0.39% in 2020.

Average noninterest bearing core deposits increased 8.27% in 2022 compared to an increase of 22.96% in 2021. These represented 31.71% of total core deposits in 2022, compared to 31.20% in 2021, and 29.20% in 2020.

**Purchased Funds** - We use purchased funds to supplement core deposits, which include certain certificates of deposit over $250,000, brokered certificates of deposit, listing services certificates of deposit, over-night borrowings, securities sold under agreements to repurchase, commercial paper, and other short-term borrowings. Purchased funds are raised from customers seeking short-term investments and are used to manage the Bank’s interest rate sensitivity. During 2022, our reliance on purchased funds decreased to 6.19% of average total assets from 6.41% in 2021.

37 • SRCE

2022 Form 10-K

**Shareholders' Equity** - Average shareholders' equity equated to 10.81% of average total assets in 2022, compared to 11.73% in 2021. Shareholders' equity was 10.36% of total assets at year-end 2022, compared to 11.32% at year-end 2021. We include unrealized gains (losses) on available-for-sale securities, net of income taxes, in accumulated other comprehensive income (loss) which is a component of shareholders' equity. While regulatory capital adequacy ratios exclude unrealized gains (losses), it does impact our equity as reported in the audited financial statements. The unrealized losses on available-for-sale securities, net of income taxes, were $147.69 million and $9.86 million at December 31, 2022 and 2021, respectively. The unrealized losses occurred as a result of changes in interest rates, market spreads and market conditions subsequent to purchase. Additionally, we do not intend to sell these investments and it is more likely than not that we will not be required to sell these investments before recovery of the amortized cost basis, which may be the maturity dates of the securities.

**Other Liquidity** - Under Indiana law governing the collateralization of public fund deposits, the Indiana Board of Depositories determines which financial institutions are required to pledge collateral based on the strength of their financial ratings. We have been informed that no collateral is required for our public fund deposits. However, the Board of Depositories could alter this requirement in the future and adversely impact our liquidity. Our potential liquidity exposure if we must pledge collateral is approximately $1.15 billion.

**Liquidity Risk Management** - The Bank's liquidity is monitored and closely managed by the Asset/Liability Management Committee (ALCO), whose members are comprised of the Bank's senior management. Asset and liability management includes the management of interest rate sensitivity and the maintenance of an adequate liquidity position. The purpose of interest rate sensitivity management is to stabilize net interest income during periods of changing interest rates.

Liquidity management is the process by which the Bank ensures that adequate liquid funds are available to meet short-term and long-term financial commitments on a timely basis. Financial institutions must maintain liquidity to meet day-to-day requirements of depositors and borrowers, take advantage of market opportunities and provide a cushion against unforeseen needs.

Liquidity of the Bank is derived primarily from core deposits, principal payments received on loans, the sale and maturity of investment securities, net cash provided by operating activities, and access to other funding sources. The most stable source of liability-funded liquidity is deposit growth and retention of the core deposit base. The principal source of asset-funded liquidity is available-for-sale investment securities, cash and due from banks, overnight investments, securities purchased under agreements to resell, and loans and interest bearing deposits with other banks maturing within one year. Additionally, liquidity is provided by repurchase agreements, and the ability to borrow from the Federal Reserve Bank (FRB) and the Federal Home Loan Bank (FHLB).

The Bank's liquidity strategy is guided by internal policies and the Interagency Policy Statement on Funding and Liquidity Risk Management. Internal guidelines consist of:

- (i) Available Liquidity (sum of short term borrowing capacity) greater than $500 million;
- (ii) Liquidity Ratio (total of net cash, short term investments and unpledged marketable assets divided by the sum of net deposits and short term liabilities) greater than 15%;
- (iii) Dependency Ratio (net potentially volatile liabilities minus short term investments divided by total earning assets minus short term investments) less than 15%; and
- (iv) Loans to Deposits Ratio less than 100%

At December 31, 2022, we were in compliance with the foregoing internal policies and regulatory guidelines.

The Bank also maintains a contingency funding plan that assesses the liquidity needs under various scenarios of market conditions, asset growth and credit rating downgrades. The plan includes liquidity stress testing which measures various sources and uses of funds under the different scenarios. The contingency plan provides for ongoing monitoring of unused borrowing capacity and available sources of contingent liquidity to prepare for unexpected liquidity needs and to cover unanticipated events that could affect liquidity.

We have borrowing sources available to supplement deposits and meet our funding needs. 1st Source Bank has established relationships with several banks to provide short term borrowings in the form of federal funds purchased. At December 31, 2022, we had no borrowings in the federal funds market. We could borrow $245.00 million in additional funds for a short time from these banks on a collective basis. As of December 31, 2022, we had $91.31 million outstanding in FHLB advances and could borrow an additional $464.70 million contingent on the FHLB activity-based stock ownership requirement. We also had no outstandings with the FRB and could borrow $444.99 million as of December 31, 2022.

38 • SRCE

2022 Form 10-K

**Interest Rate Risk Management** - ALCO monitors and manages the relationship of earning assets to interest bearing liabilities and the responsiveness of asset yields, interest expense, and interest margins to changes in market interest rates. In the normal course of business, we face ongoing interest rate risks and uncertainties. We may utilize interest rate swaps to partially manage the primary market exposures associated with the interest rate risk related to underlying assets, liabilities, and anticipated transactions.

A hypothetical change in net interest income was modeled by calculating an immediate 200 basis point (2.00%) and 100 basis point (1.00%) increase and a 100 basis point (1.00%) decrease in interest rates across all maturities. The following table shows the aggregate hypothetical impact to pre-tax net interest income.

| Basis Point Interest Rate Change | Percentage Change in Net Interest Income |  |  |  |
| --- | --- | --- | --- | --- |
|  | December 31, 2022 |  | December 31, 2021 |  |
|  | 12 Months | 24 Months | 12 Months | 24 Months |
| Up 200 | (2.32)% | 2.99% | 0.34% | 7.00% |
| Up 100 | (1.15)% | 1.52% | (0.51)% | 2.86% |
| Down 100 | (2.39)% | (5.10)% | (3.22)% | (8.00)% |

The earnings simulation model excludes the earnings dynamics related to how fee income and noninterest expense may be affected by changes in interest rates. Actual results may differ materially from those projected. The use of this methodology to quantify the market risk of the balance sheet should not be construed as an endorsement of its accuracy or the accuracy of the related assumptions.

At December 31, 2022 and 2021, the impact of these hypothetical fluctuations in interest rates on our derivative holdings was not significant, and, as such, separate disclosure is not presented. We manage the interest rate risk related to mortgage loan commitments by entering into contracts for future delivery of loans with outside parties. See Part II, Item 8, Financial Statements and Supplementary Data - Note 18 of the Notes to Consolidated Financial Statements.

**Commitments and Contractual Obligations** - In the ordinary course of operations, we enter into certain contractual obligations. Such obligations include customer deposits, the funding of operations through debt issuances as well as operating leases for the rent of premises and equipment. Additionally, we routinely enter into contracts for services that may require payment to be provided in the future and may contain penalty clauses for early termination of the contract. Further discussion of commitments and contractual obligations is included in Part II, Item 8, Financial Statements and Supplementary Data - Notes 10, 11, 12 and 18 of the Notes to Consolidated Financial Statements.

We also enter into derivative contracts under which we are required to either receive cash from, or pay cash to, counterparties depending on changes in interest rates. Derivative contracts are carried at fair value on the consolidated balance sheet with the fair value representing the net present value of expected future cash receipts or payments based on market interest rates as of the balance sheet date. The fair value of the contracts changes daily as market interest rates change. Further discussion of derivative contracts is included in Part II, Item 8, Financial Statements and Supplementary Data - Note 19 of the Notes to Consolidated Financial Statements.

#### OFF-BALANCE SHEET ARRANGEMENTS

Assets under management and assets under custody are held in fiduciary or custodial capacity for our clients. In accordance with U.S. generally accepted accounting principles, these assets are not included on our balance sheet.

We are also party to financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of our clients. These financial instruments include commitments to extend credit and standby letters of credit. Further discussion of these commitments is included in Part II, Item 8, Financial Statements and Supplementary Data - Note 18 of the Notes to Consolidated Financial Statements.

#### **Item 7A. Quantitative and Qualitative Disclosures about Market Risk.**

For information regarding Quantitative and Qualitative Disclosures about Market Risk, see Part II, Item 7, Management's Discussion and Analysis of Financial Condition and Results of Operations, Interest Rate Risk Management.

39 • SRCE

2022 Form 10-K

# **Item 8. Financial Statements and Supplementary Data.**

# Index to Consolidated Financial Statements

|  | Page |
| --- | --- |
| Reports of FORVIS, LLP, Independent Registered Public Accounting Firm (FORVIS, LLP, Fort Wayne, Indiana, Auditor Firm ID: 686) | 41 |
| Consolidated Statements of Financial Condition | 44 |
| Consolidated Statements of Income | 45 |
| Consolidated Statements of Comprehensive Income | 46 |
| Consolidated Statements of Shareholders' Equity | 46 |
| Consolidated Statements of Cash Flows | 47 |
| Notes to Consolidated Financial Statements | 48 |

40 • SRCE

2022 Form 10-K

# Report of Independent Registered Public Accounting Firm

To the Shareholders, Board of Directors and Audit, Finance and Risk Committee

## *Opinion on the Consolidated Financial Statements*

We have audited the accompanying consolidated statements of financial condition of 1st Source Corporation (Company) as of December 31, 2022 and 2021, the related consolidated statements of income, comprehensive income (loss), shareholders' equity and cash flows for each of the years in the three-year period ended December 31, 2022, and the related notes (collectively referred to as the financial statements). In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of the Company as of December 31, 2022 and 2021, and the results of its operations and its cash flows for each of the years in the three-year period ended December 31, 2022, in conformity with accounting principles generally accepted in the United States of America.

We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the Company's internal control over financial reporting as of December 31, 2022, based on criteria established in *Internal Control-Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO)* and our report dated February 16, 2023, expressed an unqualified opinion thereon.

## *Basis for Opinion*

These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on the Company's financial statements based on our audits.

We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.

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

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

## *Critical Audit Matters*

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

## *Allowance for Loan and Lease Losses*

As described in Note 5 to the consolidated financial statements, the Company's consolidated allowance for loan and lease losses (ALLL) was $139.27 million at December 31, 2022. The Company also describes in Note 1 of the consolidated financial statements the 'Allowance for Loan and Lease Losses' accounting policy around this estimate. The ALLL is an estimate of current expected credit losses in the loan and lease portfolio. The determination of the allowance for loan and lease losses requires significant judgment reflecting the Company's best estimate of expected future losses for the loan's entire contractual term adjusted for expected payments when appropriate.

41 • SRCE

2022 Form 10-K

This assessment is made on a loan pool basis in most instances, with the expected credit losses estimates by using a combination of models that measures the probability of default, probability of attrition, loss given defaults and exposure at default. The assessments of probability of default and probability of attrition are based on internal data that relates to the historical performance of each loan pool over a complete economic cycle. Adjustments were then applied, if needed, to reflect the current impact of macroeconomic variables and to account for other expected changes that could occur in the future. These assumptions are analyzed for a reasonable and supportable forecast period, after which, the forecasted macroeconomic assumptions reverted to their historical average, using a rational and systematic basis. The loss given default is based on an analysis of historical recoveries for each loan pool, with adjustments to reflect the current impact of macroeconomic variables and to account for other expected changes that could occur in the future, if considered necessary. The exposure at default was estimated by using a transitional matrix that estimates the average percentage of the loan balance that remains at the time of default. Additional qualitative adjustments were applied in certain circumstances, to account for other factors not evaluated in the initial model. In certain instances, loans were evaluated on an individual basis due to the management's conclusion that they exhibited unique risk characteristics which prevented them from being similar to the identified loan pools.

The primary reason for our determination that the allowance for loan losses is a critical audit matter is that auditing the estimated allowance for loan losses involved significant judgment and high degree of subjectivity, due to the number of relevant assumptions and the nature of the qualitative factor adjustments. Areas that contained subjectivity in evaluating management's estimate, included evaluating management's assessment of current and expected economic conditions and other environmental factors, evaluating assumptions utilized in determining cohort loss rates, probability of default and loss given default, evaluating the adequacy of specific allowances associated with individually evaluated loans and assessing the appropriateness of loan grades.

Our audit procedures related to the estimated allowance for loan losses at December 31, 2022, included:

- Testing the design and operating effectiveness of internal controls, including those related to technology, over the ALLL, the establishment of qualitative adjustments for current and expected conditions, grading and risk classification of loans and establishment of specific reserves on individually evaluated loans and management's review controls over the ALLL balance as a whole including attending internal Company Credit Policy Committee meetings and Audit Committee discussions and analysis.
- Testing clerical and computational accuracy of the formulas within the calculation.
- Testing of completeness and accuracy of the information and reports utilized in the ALLL, including reports used in management review controls over the ALLL.
- Evaluating the precision of management review of the adequacy of the ALLL.
- Evaluating the current and expected qualitative adjustments, including assessing the basis for the adjustments and the reasonableness of the significant assumptions including growth in gross domestic product, unemployment rates, housing market trends, commodity prices, and inflation rates.
- Evaluating the forecast adjustment, including assessing that it is reasonable and supportable.
- Evaluating significant assumptions utilized in the probability of default/loss given default model including probability of default run-out frequency, length, and look-back period and loss given default months of delay, look-back period and loss horizon.
- Evaluating significant assumptions utilized in the cohort model including look-back period, months of delay, and loss horizon.
- Evaluating the relevance and reliability of data and assumptions.
- Testing of the loan review function and the accuracy of loan grades determined. Specifically, utilizing internal professionals to assist us in evaluating the appropriateness of loan grades and to assess the reasonableness of specific impairments on loans.
- Evaluating the overall reasonableness of qualitative factors and the appropriateness of their direction and magnitude and the Company's support for the direction and magnitude compared to previous years.
- Evaluating credit quality indicators such as trends in delinquencies, nonaccruals, charge-offs, and loan grades.
- Identifying fields in the various loan systems that defined the loan pools and tested the design and operating effectiveness of internal controls surrounding the input and maintenance of those fields.

/s/ FORVIS, LLP (Formerly, BKD, LLP)

We have served as the Company's auditor since 2015

Fort Wayne, Indiana

February 16, 2023

42 • SRCE

2022 Form 10-K

# Report of Independent Registered Public Accounting Firm

To the Shareholders, Board of Directors and Audit, Finance and Risk Committee

## *Opinion on the Internal Control over Financial Reporting*

We have audited 1st Source Corporation's (Company) internal control over financial reporting as of December 31, 2022, based on criteria established in *Internal Control - Integrated Framework: (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO)*.

In our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2022, based on criteria established in *Internal Control - Integrated Framework: (2013) issued by COSO*.

We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) ('PCAOB'), the consolidated financial statements of the Company as of December 31, 2022 and 2021, and for each of the three years in the period ended December 31, 2022 and our report dated February 16, 2023, expressed an unqualified opinion on those financial statements.

## *Basis for Opinion*

The Company's management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management Report on Internal Control Over Financial Reporting. Our responsibility is to express an opinion on the Company's internal control over financial reporting based on our audit.

We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.

We conducted our audit in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects.

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

## *Definitions and Limitations of Internal Control over Financial Reporting*

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

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

/s/ FORVIS, LLP (Formerly, BKD, LLP)

Fort Wayne, Indiana February 16, 2023

43 • SRCE

2022 Form 10-K

## CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION

| December 31 (Dollars in thousands) | 2022 | 2021 |
| --- | --- | --- |
| ASSETS |  |  |
| Cash and due from banks | $84,703 | $54,420 |
| Federal funds sold and interest bearing deposits with other banks | 38,094 | 470,767 |
| Investment securities available-for-sale | 1,775,128 | 1,863,041 |
| Other investments | 25,293 | 27,189 |
| Mortgages held for sale | 3,914 | 13,284 |
| Loans and leases, net of unearned discount: |  |  |
| Commercial and agricultural | 812,031 | 918,712 |
| Solar | 381,163 | 348,302 |
| Auto and light truck | 808,117 | 603,775 |
| Medium and heavy duty truck | 313,862 | 259,740 |
| Aircraft | 1,077,722 | 898,401 |
| Construction equipment | 938,503 | 754,273 |
| Commercial real estate | 943,745 | 929,341 |
| Residential real estate and home equity | 584,737 | 500,590 |
| Consumer | 151,282 | 133,080 |
| Total loans and leases | 6,011,162 | 5,346,214 |
| Allowance for loan and lease losses | (139,268) | (127,492) |
| Net loans and leases | 5,871,894 | 5,218,722 |
| Equipment owned under operating leases, net | 31,700 | 48,433 |
| Net premises and equipment | 44,773 | 47,038 |
| Goodwill and intangible assets | 83,907 | 83,926 |
| Accrued income and other assets | 380,010 | 269,469 |
| Total assets | $8,339,416 | $8,096,289 |
| LIABILITIES |  |  |
| Deposits: |  |  |
| Noninterest-bearing demand | $1,998,151 | $2,052,981 |
| Interest-bearing deposits: |  |  |
| Interest-bearing demand | 2,591,464 | 2,455,580 |
| Savings | 1,198,191 | 1,286,367 |
| Time | 1,140,459 | 884,137 |
| Total interest-bearing deposits | 4,930,114 | 4,626,084 |
| Total deposits | 6,928,265 | 6,679,065 |
| Short-term borrowings: |  |  |
| Federal funds purchased and securities sold under agreements to repurchase | 141,432 | 194,727 |
| Other short-term borrowings | 74,097 | 5,300 |
| Total short-term borrowings | 215,529 | 200,027 |
| Long-term debt and mandatorily redeemable securities | 46,555 | 71,251 |
| Subordinated notes | 58,764 | 58,764 |
| Accrued expenses and other liabilities | 166,537 | 117,718 |
| Total liabilities | 7,415,650 | 7,126,825 |
| SHAREHOLDERS' EQUITY |  |  |
| Preferred stock; no par value |  |  |
| Authorized 10,000,000 shares; none issued or outstanding | - | - |
| Common stock; no par value |  |  |
| Authorized 40,000,000 shares; issued 28,205,674 shares at December 31, 2022 and 2021 | 436,538 | 436,538 |
| Retained earnings | 694,862 | 603,787 |
| Cost of common stock in treasury (3,543,388 shares at December 31, 2022 and 3,466,162 shares at December 31, 2021) | (119,642) | (114,209) |
| Accumulated other comprehensive loss | (147,690) | (9,861) |
| Total shareholders' equity | 864,068 | 916,255 |
| Noncontrolling interests | 59,698 | 53,209 |
| Total equity | 923,766 | 969,464 |
| Total liabilities and equity | $8,339,416 | $8,096,289 |

The accompanying notes are a part of the consolidated financial statements.

44 • SRCE

2022 Form 10-K

## CONSOLIDATED STATEMENTS OF INCOME

| Year Ended December 31 (Dollars in thousands, except per share amounts) | 2022 | 2021 | 2020 |
| --- | --- | --- | --- |
| Interest income: |  |  |  |
| Loans and leases | $263,894 | $235,031 | $242,772 |
| Investment securities, taxable | 26,294 | 17,767 | 18,080 |
| Investment securities, tax-exempt | 1,049 | 601 | 895 |
| Other | 2,579 | 1,373 | 1,284 |
| Total interest income | 293,816 | 254,772 | 263,031 |
| Interest expense: |  |  |  |
| Deposits | 25,231 | 12,276 | 30,459 |
| Short-term borrowings | 1,497 | 115 | 517 |
| Subordinated notes | 3,550 | 3,267 | 3,367 |
| Long-term debt and mandatorily redeemable securities | 69 | 2,476 | 2,868 |
| Total interest expense | 30,347 | 18,134 | 37,211 |
| Net interest income | 263,469 | 236,638 | 225,820 |
| Provision (recovery of provision) for credit losses | 13,245 | (4,303) | 36,001 |
| Net interest income after provision for credit losses | 250,224 | 240,941 | 189,819 |
| Noninterest income: |  |  |  |
| Trust and wealth advisory | 23,107 | 23,782 | 21,114 |
| Service charges on deposit accounts | 12,146 | 10,589 | 9,485 |
| Debit card | 18,052 | 18,125 | 14,983 |
| Mortgage banking | 4,122 | 11,822 | 15,674 |
| Insurance commissions | 6,703 | 7,247 | 7,025 |
| Equipment rental | 12,274 | 16,647 | 23,380 |
| (Losses) gains on investment securities available-for-sale | (184) | (680) | 279 |
| Other | 15,042 | 12,560 | 11,949 |
| Total noninterest income | 91,262 | 100,092 | 103,889 |
| Noninterest expense: |  |  |  |
| Salaries and employee benefits | 105,110 | 105,808 | 101,556 |
| Net occupancy | 10,728 | 10,524 | 10,276 |
| Furniture and equipment | 5,448 | 5,977 | 6,541 |
| Data processing | 22,375 | 19,877 | 19,147 |
| Depreciation - leased equipment | 10,023 | 13,694 | 20,203 |
| Professional fees | 7,280 | 8,676 | 6,317 |
| FDIC and other insurance | 3,625 | 2,677 | 2,606 |
| Business development and marketing | 5,823 | 8,013 | 4,157 |
| Other | 14,287 | 10,902 | 16,564 |
| Total noninterest expense | 184,699 | 186,148 | 187,367 |
| Income before income taxes | 156,787 | 154,885 | 106,341 |
| Income tax expense | 36,255 | 36,328 | 24,880 |
| Net income | 120,532 | 118,557 | 81,461 |
| Net (income) loss attributable to noncontrolling interests | (23) | (23) | (24) |
| Net income available to common shareholders | $120,509 | $118,534 | $81,437 |
| Basic net income per common share | $4.84 | $4.70 | $3.17 |
| Diluted net income per common share | $4.84 | $4.70 | $3.17 |

The accompanying notes are a part of the consolidated financial statements.

45 • SRCE

2022 Form 10-K

## CONSOLIDATED STATEMENTS OF COMPREHENSIVE (LOSS) INCOME

| Year Ended December 31 (Dollars in thousands) | 2022 | 2021 | 2020 |
| --- | --- | --- | --- |
| Net income | $120,532 | $118,557 | $81,461 |
| Other comprehensive (loss) income: |  |  |  |
| Unrealized (depreciation) appreciation of investment securities available-for-sale | (181,237) | (37,867) | 17,666 |
| Reclassification adjustment for realized losses (gains) included in net income | 184 | 680 | (279) |
| Income tax effect | 43,224 | 8,955 | (4,188) |
| Other comprehensive (loss) income, net of tax | (137,829) | (28,232) | 13,199 |
| Comprehensive (loss) income | (17,297) | 90,325 | 94,660 |
| Comprehensive (income) loss attributable to noncontrolling interests | (23) | (23) | (24) |
| Comprehensive (loss) income available to common shareholders | $(17,320) | $90,302 | $94,636 |

The accompanying notes are a part of the consolidated financial statements.

## CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY

| (Dollars in thousands, except per share amounts) | 1st Source Corporation Shareholders |  |  |  |  |  |  |  |
| --- | --- | --- | --- | --- | --- | --- | --- | --- |
|  | Preferred Stock | Common Stock | Retained Earnings | Cost of Common Stock in Treasury | Accumulated Other Comprehensive Income (Loss), Net | Total Shareholders' Equity | Noncontrolling Interests | Total Equity |
| Balance at January 1, 2020 | $ - | $436,538 | $463,269 | $(76,702) | $5,172 | $828,277 | $20,359 | $848,636 |
| Cumulative-effect adjustment | - | - | (2,552) | - | - | (2,552) | - | (2,552) |
| Balance at January 1, 2020, adjusted | - | 436,538 | 460,717 | (76,702) | 5,172 | 825,725 | 20,359 | 846,084 |
| Net income | - | - | 81,437 | - | - | 81,437 | 24 | 81,461 |
| Other comprehensive income | - | - | - | - | 13,199 | 13,199 | - | 13,199 |
| Issuance of 46,089 common shares under stock based compensation awards | - | - | 962 | 877 | - | 1,839 | - | 1,839 |
| Cost of 166,446 shares of common stock acquired for treasury | - | - | - | (6,415) | - | (6,415) | - | (6,415) |
| Common stock dividend ($1.13 per share) | - | - | (28,940) | - | - | (28,940) | - | (28,940) |
| Contributions from noncontrolling interests | - | - | - | - | - | - | 24,098 | 24,098 |
| Distributions to noncontrolling interests | - | - | - | - | - | - | (656) | (656) |
| Balance at December 31, 2020 | $ - | $436,538 | $514,176 | $(82,240) | $18,371 | $886,845 | $43,825 | $930,670 |
| Net income | - | - | 118,534 | - | - | 118,534 | 23 | 118,557 |
| Other comprehensive loss | - | - | - | - | (28,232) | (28,232) | - | (28,232) |
| Issuance of 63,527 common shares under stock based compensation awards | - | - | 1,547 | 1,167 | - | 2,714 | - | 2,714 |
| Cost of 713,132 shares of common stock acquired for treasury | - | - | - | (33,136) | - | (33,136) | - | (33,136) |
| Common stock dividend ($1.21 per share) | - | - | (30,470) | - | - | (30,470) | - | (30,470) |
| Contributions from noncontrolling interests | - | - | - | - | - | - | 10,358 | 10,358 |
| Distributions to noncontrolling interests | - | - | - | - | - | - | (997) | (997) |
| Balance at December 31, 2021 | $ - | $436,538 | $603,787 | $(114,209) | $(9,861) | $916,255 | $53,209 | $969,464 |
| Net income | - | - | 120,509 | - | - | 120,509 | 23 | 120,532 |
| Other comprehensive loss | - | - | - | - | (137,829) | (137,829) | - | (137,829) |
| Issuance of 72,593 common shares under stock based compensation awards | - | - | 1,762 | 1,403 | - | 3,165 | - | 3,165 |
| Cost of 149,819 shares of common stock acquired for treasury | - | - | - | (6,836) | - | (6,836) | - | (6,836) |
| Common stock dividend ($1.26 per share) | - | - | (31,196) | - | - | (31,196) | - | (31,196) |
| Contributions from noncontrolling interests | - | - | - | - | - | - | 7,700 | 7,700 |
| Distributions to noncontrolling interests | - | - | - | - | - | - | (1,234) | (1,234) |
| Balance at December 31, 2022 | $ - | $436,538 | $694,862 | $(119,642) | $(147,690) | $864,068 | $59,698 | $923,766 |

The accompanying notes are a part of the consolidated financial statements.

46 • SRCE

2022 Form 10-K

## CONSOLIDATED STATEMENTS OF CASH FLOWS

| Year Ended December 31 (Dollars in thousands) | 2022 | 2021 | 2020 |
| --- | --- | --- | --- |
| Operating activities: |  |  |  |
| Net income | $120,532 | $118,557 | $81,461 |
| Adjustments to reconcile net income to net cash provided by operating activities: |  |  |  |
| Provision (recovery of provision) for credit losses | 13,245 | (4,303) | 36,001 |
| Depreciation of premises and equipment | 4,596 | 5,093 | 5,673 |
| Depreciation of equipment owned and leased to others | 10,023 | 13,694 | 20,203 |
| Stock-based compensation | 3,587 | 4,214 | 3,293 |
| Amortization of investment securities premiums and accretion of discounts, net | 3,951 | 6,684 | 6,057 |
| Amortization of mortgage servicing rights | 1,287 | 2,117 | 2,361 |
| Mortgage servicing rights (recoveries) impairments | - | (812) | 812 |
| Amortization of right of use assets | 3,181 | 3,095 | 2,842 |
| Deferred income taxes | (9,461) | 15,396 | (24,160) |
| Losses (gains) on investment securities available-for-sale | 184 | 680 | (279) |
| Originations of loans held for sale, net of principal collected | (86,185) | (261,558) | (330,991) |
| Proceeds from the sales of loans held for sale | 97,166 | 268,226 | 351,039 |
| Net gains on sale of loans held for sale | (1,611) | (7,067) | (12,656) |
| Net gains on sale of other real estate and repossessions | (410) | (672) | (138) |
| Change in interest receivable | (6,987) | 2,482 | (1,117) |
| Change in interest payable | 4,115 | (2,111) | (9,923) |
| Change in other assets | 413 | 17,757 | 12,782 |
| Change in other liabilities | 21,910 | (14,990) | 10,293 |
| Other | (4,006) | 279 | 940 |
| Net change in operating activities | 175,530 | 166,761 | 154,493 |
| Investing activities: |  |  |  |
| Proceeds from sales of investment securities available-for-sale | 23,795 | 99,208 | 8,403 |
| Proceeds from maturities and paydowns of investment securities available-for-sale | 206,426 | 336,364 | 443,617 |
| Purchases of investment securities available-for-sale | (327,496) | (1,145,697) | (597,296) |
| Net change in partnership investments | (18,292) | (24,897) | (54,981) |
| Net change in other investments | 1,896 | 240 | 985 |
| Loans sold or participated to others | 57,473 | 54,623 | 17,462 |
| Proceeds from principal payments on direct finance leases | 58,654 | 40,751 | 54,771 |
| Net change in loans and leases | (784,355) | 36,414 | (489,477) |
| Net change in equipment owned under operating leases | 6,710 | 2,913 | 26,414 |
| Purchases of premises and equipment | (2,380) | (2,886) | (2,850) |
| Proceeds from disposal of premises and equipment | 49 | 129 | 23 |
| Purchases of bank owned life insurance policies | (10,000) | - | - |
| Proceeds from sales of other real estate and repossessions | 2,648 | 4,279 | 10,271 |
| Net change in investing activities | (784,872) | (598,559) | (582,658) |

47 • SRCE

2022 Form 10-K

| Financing activities: |  |  |  |
| --- | --- | --- | --- |
| Net change in demand deposits and savings accounts | (7,122) | 1,016,257 | 1,069,843 |
| Net change in time deposits | 256,322 | (283,220) | (481,141) |
| Net change in short-term borrowings | 15,502 | 49,386 | 4,748 |
| Proceeds from issuance of long-term debt | - | - | 10,000 |
| Payments on long-term debt | (25,530) | (13,460) | (2,905) |
| Stock issued under stock purchase plans | 252 | 90 | 39 |
| Acquisition of treasury stock | (6,836) | (33,136) | (6,415) |
| Net contributions from (distributions to) noncontrolling interests | 6,466 | 9,361 | 23,442 |
| Cash dividends paid on common stock | (32,102) | (31,340) | (29,764) |
| Net change in financing activities | 206,952 | 713,938 | 587,847 |
| Net change in cash and cash equivalents | (402,390) | 282,140 | 159,682 |
| Cash and cash equivalents, beginning of year | 525,187 | 243,047 | 83,365 |
| Cash and cash equivalents, end of year | $122,797 | $525,187 | $243,047 |
| Supplemental Information: |  |  |  |
| Non-cash transactions: |  |  |  |
| Loans transferred to other real estate and repossessions | $1,811 | $2,440 | $4,317 |
| Common stock matching contribution to Employee Stock Ownership and Profit Sharing Plan | 683 | 715 | 622 |
| Right of use assets obtained in exchange for lease obligation | 2,027 | 1,344 | 2,612 |
| Cash paid for: |  |  |  |
| Interest | $26,233 | $20,245 | $47,134 |
| Income taxes | 23,258 | 15,360 | 13,461 |

The accompanying notes are a part of the consolidated financial statements.

48 • SRCE

2022 Form 10-K

# NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

## Note 1 - Accounting Policies

1st Source Corporation is a bank holding company headquartered in South Bend, Indiana that provides, through its subsidiaries (collectively referred to as “1st Source” or “the Company”), a broad array of financial products and services. 1st Source Bank (“Bank”), its banking subsidiary, offers commercial and consumer banking services, trust and wealth advisory services, and insurance to individual and business clients. The following is a summary of significant accounting policies followed in the preparation of the consolidated financial statements.

**Basis of Presentation** - The financial statements consolidate 1st Source, its subsidiaries (principally the Bank) and any variable interest entities (“VIEs”) for which the Company has concluded it has significant involvement in and the ability to direct the activities that impact the entity’s economic performance. All significant intercompany balances and transactions have been eliminated. For purposes of the parent company only financial information presented in Note 22, investments in subsidiaries are carried at equity in the underlying net assets.

**Use of Estimates in the Preparation of Financial Statements** - Financial statements prepared in accordance with U.S. generally accepted accounting principles (GAAP) require the Company to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of income and expenses during the reporting period. Actual results could differ from those estimates.

**Business Combinations** - Business combinations are accounted for under the purchase method of accounting. Under the purchase method, assets and liabilities of the business acquired are recorded at their estimated fair values as of the date of acquisition with any excess of the cost of the acquisition over the fair value of the net tangible and intangible assets acquired recorded as goodwill. Results of operations of the acquired business are included in the income statement from the date of acquisition.

**Cash Flows** - For purposes of the consolidated and parent company only statements of cash flows, the Company considers cash and due from banks, federal funds sold and interest bearing deposits with other banks with original maturities of three months or less as cash and cash equivalents.

**Securities** - Securities that the Company has the ability and positive intent to hold to maturity are classified as investment securities held-to-maturity. Held-to-maturity investment securities, when present, are carried at amortized cost. As of December 31, 2022 and 2021, the Company held no securities classified as held-to-maturity. Securities that may be sold in response to, or in anticipation of, changes in interest rates and resulting prepayment risk, or for other factors, are classified as available-for-sale and are carried at fair value. Unrealized gains and losses on debt securities are reported, net of applicable taxes, as a separate component of accumulated other comprehensive income (loss) in shareholders’ equity. Unrealized gains and losses on equity securities are reflected, net of applicable taxes, in earnings.

For available-for-sale securities in an unrealized loss position, the Company first assesses whether it intends to sell, or it is more likely than not that it will be required to sell the security before recovery of its amortized cost basis. If either of these criteria regarding intent or requirement to sell is met, the security’s amortized cost basis is written down to fair value in Other Income on the Consolidated Statements of Income. For debt securities that do not meet the aforementioned criteria, the Company evaluates whether the decline in fair value has resulted from credit losses or other factors. In making this assessment, management considers the extent to which fair value is less than amortized cost, nature of the security, the underlying collateral, and the financial condition of the issuer, among other factors. If this assessment indicates a credit loss exists, the present value of cash flows expected to be collected from the security are compared to the amortized cost basis of the security. If the present value of the cash flows expected to be collected is less than the amortized cost basis, a credit loss exists and an allowance for available-for-sale securities losses is recorded for the credit loss, limited by the amount that the fair value is less than the amortized cost basis. Any impairment that has not been recorded through an allowance for available-for-sale securities losses is recognized in other comprehensive income.

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

Debt and equity securities that are purchased and held principally for the purpose of selling them in the near term are classified as trading account securities and are carried at fair value with unrealized gains and losses reported in earnings. Realized gains and losses on the sales of all securities are reported in earnings and computed using the specific identification cost basis.

49 • SRCE

2022 Form 10-K

Other investments consist of shares of Federal Home Loan Bank of Indianapolis (FHLBI) and Federal Reserve Bank stock. As restricted member stocks, these investments are carried at cost. Both cash and stock dividends received on the stocks are reported as income. Quarterly, the Company reviews its investment in FHLBI for impairment. Factors considered in determining impairment are: history of dividend payments; determination of cause for any net loss; adequacy of capital; and review of the most recent financial statements. As of December 31, 2022 and 2021, it was determined that the Company's investment in FHLBI stock is appropriately valued at cost, which equates to par value. In addition, other investments include interest bearing deposits with other banks with original maturities of greater than three months. These investments are in denominations, including accrued interest, that are fully insured by the FDIC.

**Loans and Leases** - Loans are stated at the principal amount outstanding, net of unamortized deferred loan origination fees and costs and net of unearned income. Interest income is accrued as earned based on unpaid principal balances. Origination fees and direct loan and lease origination costs are deferred, and the net amount amortized to interest income over the estimated life of the related loan or lease. Loan commitment fees are deferred and amortized into other income over the commitment period.

Direct financing leases are carried at the aggregate of lease payments plus estimated residual value of the leased property, net of unamortized deferred lease origination fees and costs and unearned income. Only those costs incurred as a direct result of closing a lease transaction are capitalized and all initial direct costs are expensed immediately. Interest income on direct financing leases is recognized over the term of the lease to achieve a constant periodic rate of return on the outstanding investment.

Accrued interest is included in Accrued Income and Other Assets on the Consolidated Statements of Financial Condition. The accrual of interest on loans and leases is discontinued when a loan or lease becomes contractually delinquent for 90 days, or when an individual analysis of a borrower's credit worthiness indicates a credit should be placed on nonperforming status, except for residential mortgage loans and consumer loans that are well secured and in the process of collection. Residential mortgage loans are placed on nonaccrual at the time the loan is placed in foreclosure. When interest accruals are discontinued, interest credited to income in the current year is reversed and interest accrued in the prior year is charged to the allowance for loan and lease losses. However, in some cases, the Company may elect to continue the accrual of interest when the net realizable value of collateral is sufficient to cover the principal and accrued interest. When a loan or lease is classified as nonaccrual and the future collectability of the recorded loan or lease balance is doubtful, collections on interest and principal are applied as a reduction to principal outstanding. Loans are returned to accrual status when all principal and interest amounts contractually due are brought current and future payments are reasonably assured, which is typically evidenced by a sustained repayment performance of at least six months.

Loans and leases that have been modified and economic concessions have been granted to borrowers who have experienced financial difficulties are considered a troubled debt restructuring (TDR). These concessions typically result from the Company's loss mitigation activities and may include reductions in the interest rate, payment extensions, forgiveness of principal, forbearance or other actions. Certain TDRs are classified as nonperforming at the time of restructuring and typically are returned to performing status after considering the borrower's sustained repayment performance for a reasonable period of at least six months.

When the Company modifies loans and leases in a TDR, it evaluates any possible impairment based on the present value of expected future cash flows, discounted at the contractual interest rate of the original loan or lease agreement, or uses the current fair value of the collateral, less selling costs for collateral dependent loans. If the Company determines that the value of the modified loan is less than the recorded investment in the loan (net of previous charge-offs, deferred loan fees or costs and unamortized premium or discount), impairment is recognized through an allowance for loan and lease losses estimate or a charge-off to the allowance for loan and lease losses. In periods subsequent to modification, the Company evaluates all TDRs, including those that have payment defaults, for possible impairment and recognizes impairment through the allowance for loan and lease losses.

The Company sells mortgage loans to the Government National Mortgage Association (GNMA) in the normal course of business and retains the servicing rights. The GNMA programs under which the loans are sold allow the Company to repurchase individual delinquent loans that meet certain criteria from the securitized loan pool. At its option, and without GNMA's prior authorization, the Company may repurchase a delinquent loan for an amount equal to 100% of the remaining principal balance on the loan. Once the Company has the unconditional ability to repurchase a delinquent loan, the Company is deemed to have regained effective control over the loan and the Company is required to recognize the loan on its balance sheet and record an offsetting liability, regardless of its intent to repurchase the loan. At December 31, 2022 and 2021, residential real estate portfolio loans included $1.00 million and $1.33 million, respectively, of loans available for repurchase under the GNMA optional repurchase programs with the offsetting liability recorded within Other Short-term Borrowings on the Consolidated Statements of Financial Position.

**Mortgage Banking Activities** - Loans held for sale are composed of performing one-to-four family residential mortgage loans originated for resale. Mortgage loans originated with the intent to sell are carried at fair value.

50 • SRCE

2022 Form 10-K

The Company recognizes the rights to service mortgage loans for others as separate assets, whether the servicing rights are acquired through a separate purchase or through the sale of originated loans with servicing rights retained. The Company allocates a portion of the total proceeds of a mortgage loan to servicing rights based on the relative fair value. These assets are amortized as reductions of mortgage servicing fee income over the estimated servicing period in proportion to the estimated servicing income to be received. The balance of MSRs is located in Accrued Income and Other Assets on the Consolidated Statements of Financial Condition and the gains and losses on the sale of MSRs are recognized in Noninterest Income on the Consolidated Statements of Income in the period in which such rights are sold.

MSRs are evaluated for impairment at each reporting date. For purposes of impairment measurement, MSRs are stratified based on the predominant risk characteristics of the underlying servicing, principally by loan type. If temporary impairment exists within a tranche, a valuation allowance is established through a charge to income equal to the amount by which the carrying value exceeds the fair value. If it is later determined all or a portion of the temporary impairment no longer exists for a particular tranche, the valuation allowance is reduced through a recovery of income.

MSRs are also reviewed for permanent impairment. Permanent impairment exists when recoverability of a recorded valuation allowance is determined to be remote considering historical and projected interest rates, prepayments, and loan pay-off activity. When this situation occurs, the unrecoverable portion of the valuation allowance is applied as a direct write-down to the carrying value of the MSRs. Unlike a valuation allowance, a direct write-down permanently reduces the carrying value of the MSRs and the valuation allowance, precluding subsequent recoveries.

As part of mortgage banking operations, the Company enters into commitments to originate loans whereby the interest rate on these loans is determined prior to funding (“rate lock commitments”). Similar to loans held for sale, the fair value of rate lock commitments is subject to change primarily due to changes in interest rates. Under the Company’s risk management policy, these fair values are hedged primarily by selling forward contracts on agency securities at the time the interest rate locks are issued to the customers. The rate lock commitments on mortgage loans intended to be sold and the related hedging instruments are recorded at fair value with changes in fair value recorded in current earnings.

#### **Allowance for Credit Losses:**

**Loans and leases** - Accrued interest on loans and leases is excluded from the calculation of the allowance for credit losses due to the Company’s charge-off policy to reverse accrued interest on nonperforming loans against interest income in a timely manner. Expected credit losses on net investments in leases, including any unguaranteed residual asset, are included in the allowance for loan and lease losses.

**Allowance for Loan and Lease Losses** - Effective January 1, 2020, the allowance for credit losses is established for current expected credit losses on the Company’s loan and lease portfolio. Prior to January 1, 2020, the allowance was established based on an incurred loss model. It is the Company’s policy to maintain the allowance at a level believed to be adequate to absorb estimated credit losses within its portfolio of loans and leases. The determination of the allowance requires significant judgment to estimate credit losses measured on a collective pool basis when similar risk characteristics exist, and for loans evaluated individually. In determining the allowance, the Company estimates expected future losses for the loan’s entire contractual term adjusted for expected payments when appropriate. The allowance estimate considers relevant available information, from internal and external sources relating to the historical loss experience, current conditions, and reasonable and supportable forecasts for the Company’s outstanding loan and lease balances. The allowance is an estimation that reflects management’s evaluation of expected losses related to the Company’s financial assets measured at amortized cost. To ensure that the allowance is maintained at an adequate level, a detailed analysis is performed on a quarterly basis and an appropriate provision is made to adjust the allowance.

The Company categorizes its loan portfolios into nine segments based on similar risk characteristics. Loans within each segment are collectively evaluated using either: 1) a cohort cumulative loss rate methodology (“cohort”) or, 2) the probability of default (“PD”)/loss given default (“LGD”) methodology (PD/LGD).

The cohort methodology is applied to ungraded portfolios, portfolios where receipt of financial statements is generally less timely, and portfolios where there are numerous small dollar accounts that are credit scored. Loans are broken out by internal risk rating (loan grade) bands: 1-6 and 7-12 (special attention). For ungraded portfolios, there is only one pool. The cohort methodology has a steady state assumption; qualitative adjustments capture any differences that may exist between the current and historical conditions.

51 • SRCE

2022 Form 10-K

The PD/LGD methodology is applied to graded portfolios due to the quantitative nature of the Company's risk rating system and is consistent with the Company's definition of risk, downgrading a credit where and when appropriate and recognizing losses in a timely manner. Loans are broken out by risk rating (loan grade) bands: 1-3, 4-6, 7-8, and 9-12. The amortized cost loan balances (rather than counts) are used for determining the transition and default probabilities. The Company uses risk rating bands as the active state to track the movement of loans through the transition matrix. The transition frequency is quarterly. Default is defined as the point at which a loan is placed on non-accrual status. In addition, a charge-off is assumed to be a default (i.e. a loan goes from accruing to charge-off, without ever being on non-accrual status). The PD is the cumulative probability of default estimated by use of a transition matrix (based on a Markov transition matrix methodology) which captures the migration of a loan from one risk rating band to another. The LGD is the ratio of loss relative to the exposure (amortized cost) at default.

The current expected credit loss methodology has a factor for reasonable and supportable forecasts. Generally, reasonable and supportable forecasts are for two years or less and have a reversion period of a similar duration, reverting expected credit losses to a level that is consistent with our historical loss experience. Forecast adjustments are added via basis points for the cohort methodology. For the PD/LGD methodology, adjustments to the probability of default factor are applied through forecast adjustments to the PD factor used as the baseline transition matrix runout, thus impacting the historical loss ratio. The Company developed its reasonable and supportable forecasts using relevant data including, but not limited to, growth in gross domestic product, unemployment rates, housing market trends, commodity prices, inflation, and other factors associated with credit losses on the financial statements.

For both the cohort and the PD/LGD methodologies, the Company uses qualitative adjustments to capture differences that may exist between the current and historical conditions. Qualitative factors include but are not limited to current market risk assessment by industry, recent loss experience in particular segments of the portfolios, movement in equipment values collateralizing specialized industry portfolios, concentrations of credit risk, delinquencies, trends in volume, experience and depth of relationship managers and division management, and the effects of changes in lending policies and practices, including changes in quality of the loan and lease origination, servicing and risk management process.

Loans which exhibit different risk characteristics than the pool are evaluated individually for impairment. Loans evaluated individually are not included in the collective evaluation. These loans can be identified from a variety of sources including delinquency, non-accrual status and troubled debt restructurings (TDRs). The scope may include accruing loans that exhibit risk characteristics which differ from their pool or non-performing loans with risk characteristics not similar to other special attention loans in their pool. Individual reserves are determined based on an analysis of the loan's expected future cash flows, the loan's observable market value, or the fair value of the collateral less costs to sell. When foreclosure is probable, impairment is determined based on the collateral's fair value less costs to sell. As a practical expedient, fair value less costs to sell may be used when developing the estimate of credit losses. Similarly, for a going concern analysis, a discounted cash method may be used.

**Liability for Credit Losses on Unfunded Loan Commitments** - The liability for credit losses on commitments to originate loans and standby letters of credit is included in Accrued Expenses and Other Liabilities on the Consolidated Statements of Financial Condition. Expected credit losses are estimated over the contractual period in which the Company is exposed to credit risk via a contractual obligation unless the obligation is unconditionally cancellable by the Company. The liability for credit losses on unfunded loan commitments is adjusted as a provision for credit losses in Other Noninterest Expense on the Consolidated Statements of Income. The estimate includes consideration of the likelihood that funding will occur and an estimate of expected credit losses on commitments expected to be funded over its estimated useful life. Because business processes and credit risks associated with unfunded credit commitments are essentially the same as for loans, the Company utilizes similar processes to estimate its liability for unfunded credit commitments.

52 • SRCE

2022 Form 10-K

**Equipment Owned Under Operating Leases** - As a lessor, the Company finances various types of construction equipment, medium and heavy duty trucks, automobiles and other equipment under leases classified as operating leases. The equipment underlying the operating leases is reported at cost, net of accumulated depreciation, on the Consolidated Statements of Financial Condition. These operating lease arrangements require the lessee to make a fixed monthly rental payment over a specified lease term generally ranging from three years to seven years. Revenue consists of the contractual lease payments and is recognized on a straight-line basis over the lease term and reported in Noninterest Income on the Consolidated Statements of Income. Leased assets are depreciated on a straight-line method over the lease term to the estimate of the equipment's fair market value at lease termination, also referred to as 'residual' value. The depreciation of these operating lease assets is reported in Noninterest Expense on the Consolidated Statements of Income. For automobile leases, fair value is based upon published industry market guides. For other equipment leases, fair value may be based upon observable market prices, third-party valuations, or prices received on sales of similar assets at the end of the lease term. These residual values are reviewed annually to ensure the recorded amount does not exceed the fair market value at the lease termination. At the end of the lease, the operating lease asset is either purchased by the lessee or returned to the Company. The Company is responsible for the payment of personal property taxes which is reported in Other Expense on the Consolidated Statements of Income. The lessee is responsible for reimbursing the Company for personal property taxes which is reported in Other Income on the Consolidated Statements of Income. The Company excludes sales taxes and other similar taxes from being reported as lease revenue with an associated expense.

**Lease Commitments** - The Company leases certain banking center locations, office space, land and billboards. In determining whether a contract contains a lease, the Company examines the contract to ensure an asset was specifically identified and that the Company has control of use over the asset. To determine whether a lease is classified as operating or finance, the Company performs an economic life test on all building leases with greater than a twenty years term. Further, the Company performs a fair value test to identify any leases that have a present value of future lease payments over the lease term that is greater than 90% of the fair value of the building. The Company only capitalizes leases with an initial lease liability of $2,000 or greater.

At lease inception, the Company determines the lease term by adding together the minimum lease term and all optional renewal periods that it is reasonably certain to renew. The Company determines this on each lease by considering all relevant contract-based, asset-based, market-based, and entity-based economic factors. Generally, the exercise of lease renewal options is at the Company's sole discretion. The lease term is used to determine whether a lease is operating or finance and is used to calculate straight-line rent expense. Additionally, the depreciable life of leasehold improvements is limited by the expected lease term.

Operating lease rentals are expensed on a straight-line basis over the life of the lease beginning on the date the Company takes possession of the property. Rent expense and variable lease costs are included in Net Occupancy Expense on the Consolidated Statements of Income. Included in variable lease costs are leases with rent escalations based on recent financial indices, such as the Consumer Price Index, where the Company initially measures lease payments using the index on the commencement date and records future changes in rent payments resulting from changes in the index to variable costs in the period the changes occur. Certain leases require the Company to pay common area maintenance, real estate taxes, insurance and other operating expenses associated with the leases premises. These expenses are classified in Net Occupancy Expense on the Consolidated Statements of Income, consistent with similar costs for owned locations. There are no residual value guarantees, restrictions or covenants imposed by leases.

The Company accounts for lease and nonlease components together as a single lease component by class of underlying asset. Operating lease obligations with an initial term longer than 12 months are recorded with a right of use asset and a lease liability on the Consolidated Statements of Financial Condition.

The discount rate used in determining the lease liability and related right of use asset is based upon what would be obtained by the Company for similar loans as an incremental rate as of the date of origination or renewal.

**Other Real Estate** - Other real estate acquired through partial or total satisfaction of nonperforming loans is included in Other Assets on the Consolidated Statements of Financial Condition and recorded at fair value less anticipated selling costs based upon the property's appraised value at the date of transfer, with any difference between the fair value of the property less cost to sell, and the carrying value of the loan charged to the allowance for loan and lease losses or other income, if a positive adjustment. Subsequent fair value write-downs or write-ups, to the extent of previous write-downs, property maintenance costs, and gains or losses recognized upon the sale of other real estate are recognized in Noninterest Expense on the Consolidated Statements of Income. Gains or losses resulting from the sale of other real estate are recognized on the date of sale. As of December 31, 2022 and 2021, other real estate had carrying values of $0.10 million and $0.00 million, respectively, and is included in Other Assets on the Consolidated Statements of Financial Condition.

53 • SRCE

2022 Form 10-K

**Repossessed Assets** - Repossessed assets may include fixtures and equipment, inventory and receivables, aircraft, construction equipment, and vehicles acquired from business banking and specialty finance activities. Repossessed assets are included in Other Assets on the Consolidated Statements of Financial Condition at fair value of the equipment or vehicle less estimated selling costs. At the time of repossession, the recorded amount of the loan or lease is written down to the fair value of the equipment or vehicle by a charge to the allowance for loan and lease losses or other income, if a positive adjustment. Subsequent fair value write-downs or write-ups, to the extent of previous write-downs, equipment maintenance costs, and gains or losses recognized upon the sale of repossessions are recognized in Noninterest Expense on the Consolidated Statements of Income. Gains or losses resulting from the sale of repossessed assets are recognized on the date of sale. Repossessed assets totaled $0.33 million and $0.86 million, as of December 31, 2022 and 2021, respectively, and are included in Other Assets on the Consolidated Statements of Financial Condition.

**Premises and Equipment** - Premises and equipment are stated at cost, less accumulated depreciation and amortization. The provision for depreciation is computed by the straight-line method, primarily with useful lives ranging from three years to 31.5 years. Maintenance and repairs are charged to expense as incurred, while improvements, which extend the useful life, are capitalized and depreciated over the estimated remaining life.

**Goodwill and Intangibles** - Goodwill represents the excess of the cost of businesses acquired over the fair value of the net assets acquired. Other intangible assets represent purchased assets that also lack physical substance but can be distinguished from goodwill because of contractual or other legal rights or because the asset is capable of being sold or exchanged either on its own or in combination with a related contract, asset, or liability. Goodwill is reviewed for impairment at least annually or on an interim basis if an event occurs or circumstances change that would more likely than not reduce the carrying amount. Goodwill is allocated into two reporting units. Fair value for each reporting unit is estimated using stock price multiples or earnings before interest, tax, depreciation and amortization (EBITDA) multiples. Intangible assets that have finite lives are amortized over their estimated useful lives and are subject to impairment testing. All of the Company's other intangible assets have finite lives and are amortized on a straight-line basis over varying periods not exceeding twenty-five years.

The Company has historically evaluated goodwill for impairment during the fourth quarter of each year, with financial data as of September 30. During the first quarter of 2021, management determined that the deterioration in general economic conditions as a result of the COVID-19 pandemic and responses thereto represented a triggering event prompting an evaluation of goodwill impairment. The Company performed impairment analyses in each quarter of 2021. In 2022, management determined conditions no longer represented a triggering event requiring quarterly analyses and returned to its historical practice of evaluating goodwill during the fourth quarter of the year. Based on the analyses performed each quarter of 2021 and the fourth quarter of 2022, the Company determined that goodwill was not impaired.

**Partnership Investments** - The Company accounts for its investments in partnerships for which it owns less than fifty percent and has the ability to exercise significant influence over the partnership on the equity method. The Company accounts for its investments in partnerships for which it does not have the ability to exercise significant influence at fair value less impairment, if any, or cost less any impairment if the fair value is not readily determinable. The Company has elected to use the practical expedient to estimate fair value of an investment in an investment company using the net asset value of its partnership interest. The Company uses the hypothetical liquidation book value (HLBV) method for equity investments when the liquidation rights and priorities as defined by an equity investment agreement differ from what is reflected by the underlying percentage ownership interests. The HLBV method is commonly applied to equity investments in the renewable energy industry, where the economic benefits corresponding to an equity investment may vary at different points in time and/or are not directly linked to an investor's ownership percentage. A calculation is prepared at each balance sheet date to determine the amount that the Company would receive if an equity investment entity were to liquidate all of its assets (as valued in accordance with GAAP) and distribute that cash to the investors based on the contractually defined liquidation priorities. The difference between the calculated liquidation distribution amounts at the beginning and the end of the reporting period, after adjusting for capital contributions and distributions, is 1st Source's share of the earnings or losses from the equity investment for the period. Investments in partnerships are included in Other Assets on the Consolidated Statements of Financial Condition. The balances as of December 31, 2022 and 2021 were $137.15 million and $95.05 million, respectively.

**Short-Term Borrowings** - Short-term borrowings consist of Federal funds purchased, securities sold under agreements to repurchase, commercial paper, Federal Home Loan Bank notes, and borrowings from non-affiliated banks. Federal funds purchased, securities sold under agreements to repurchase, and other short-term borrowings mature within one day to 365 days of the transaction date. Commercial paper matures within seven days to 270 days. Other short-term borrowings on the Consolidated Statements of Financial Condition include the Company's liability related to mortgage loans available for repurchase under GNMA optional repurchase programs.

Securities purchased under agreements to resell and securities sold under agreements to repurchase are treated as collateralized financing transactions and are recorded at the amounts at which the securities were acquired or sold plus accrued interest. The fair value of collateral either received from or provided to a third-party is continually monitored and additional collateral obtained or requested to be returned to the Company as deemed appropriate.

54 • SRCE

2022 Form 10-K

**Revenue Recognition** - The Company recognizes revenues as they are earned based on contractual terms, as transactions occur, or as services are provided and collectability is reasonably assured. The Company’s principal source of revenue is interest income from loans and leases and investment securities. The Company also earns noninterest income from various banking and financial services offered primarily through 1st Source Bank and its subsidiaries.

**Interest Income** - The largest source of revenue for the Company is interest income which is primarily recognized on an accrual basis according to nondiscretionary formulas in written contracts, such as loan and lease agreements or investment securities contracts.

**Noninterest Income** - The Company earns noninterest income through a variety of financial and transaction services provided to corporate and consumer clients such as trust and wealth advisory, deposit account, debit card, mortgage banking, insurance, and equipment rental services. Revenue is recorded for noninterest income based on the contractual terms for the service or transaction performed. In certain circumstances, noninterest income is reported net of associated expenses.

**Trust and Wealth Advisory Fees** - Trust and wealth advisory fees are recognized on the accrual basis.

**Income Taxes** - 1st Source and its subsidiaries file a consolidated Federal income tax return. The provision for income taxes is based upon income in the consolidated financial statements, rather than amounts reported on the income tax return. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized as income or expense in the period that includes the enactment date. A valuation allowance, if needed, reduces deferred tax assets to the expected amount most likely to be realized. Realization of deferred tax assets is dependent upon the generation of a sufficient level of future taxable income and recoverable taxes paid in prior years. Although realization is not assured, the Company believes it is more likely than not that all of the deferred tax assets will be realized.

The Company uses the deferral method of accounting on investments that generate investment tax credits. Under this method, the investment tax credits are recognized as a reduction to the related asset. The expense on certain qualified affordable housing investments is included in Income Tax Expense on the Consolidated Statements of Income.

Positions taken in the tax returns may be subject to challenge by the taxing authorities upon examination. Uncertain tax positions are initially recognized in the financial statements when it is more likely than not the position will be sustained upon examination by the tax authorities. Such tax positions are both initially and subsequently measured as the largest amount of tax benefit that is greater than 50% likely of being realized upon settlement with the tax authority, assuming full knowledge of the position and all relevant facts. The Company provides for interest and, in some cases, penalties on tax positions that may be challenged by the taxing authorities. Interest expense is recognized beginning in the first period that such interest would begin accruing. Penalties are recognized in the period that the Company claims the position in the tax return. Interest and penalties on income tax uncertainties are classified within Income Tax Expense on the Consolidated Statements of Income.

**Net Income Per Common Share** - Earnings per share is computed using the two-class method. Basic earnings per common share is computed by dividing net income available to common shareholders by the weighted-average number of shares of common stock outstanding, excluding participating securities. Diluted earnings per common share is computed by using the weighted-average number of shares determined for the basic earnings per share calculation plus the dilutive effect of stock compensation using the treasure stock method.

**Stock-Based Employee Compensation** - The Company recognizes stock-based compensation as compensation cost on the Consolidated Statements of Income based on their fair values on the measurement date, which, for its purposes, is the date of grant. The Company recognizes forfeitures as they occur.

**Segment Information** - 1st Source has one principal business segment, commercial banking. While our chief decision makers monitor the revenue streams of various products and services, the identifiable segments’ operations are managed and financial performance is evaluated on a company-wide basis. Accordingly, all of the Company’s financial service operations are considered to be aggregated in one reportable operating segment.

55 • SRCE

2022 Form 10-K

**Derivative Financial Instruments** - The Company occasionally enters into derivative financial instruments as part of its interest rate risk management strategies. These derivative financial instruments consist primarily of interest rate swaps. All derivative instruments are recorded on the Consolidated Statements of Financial Condition, as either an asset or liability, at their fair value. The accounting for the gain or loss resulting from the change in fair value depends on the intended use of the derivative. For a derivative used to hedge changes in fair value of a recognized asset or liability, or an unrecognized firm commitment, the gain or loss on the derivative will be recognized in earnings together with the offsetting loss or gain on the hedged item. This results in an earnings impact only to the extent that the hedge is ineffective in achieving offsetting changes in fair value. If it is determined that the derivative instrument is not highly effective as a hedge, hedge accounting is discontinued and the adjustment to fair value of the derivative instrument is recorded in earnings. For a derivative used to hedge changes in cash flows associated with forecasted transactions, the gain or loss on the effective portion of the derivative will be deferred, and reported as accumulated other comprehensive income, a component of shareholders' equity, until such time the hedged transaction affects earnings. For derivative instruments not accounted for as hedges, changes in fair value are recognized in noninterest income/expense on the Consolidated Statements of Income. Deferred gains and losses from derivatives that are terminated and were in a cash flow hedge are amortized over the shorter of the original remaining term of the derivative or the remaining life of the underlying asset or liability.

**Fair Value Measurements** - The Company records certain assets and liabilities at fair value. Fair value is defined as the 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. Securities available for sale, mortgage loans held for sale, and derivative instruments are carried at fair value on a recurring basis. Fair value measurements are also utilized to determine the initial value of certain assets and liabilities, to perform impairment assessments, and for disclosure purposes. The Company uses quoted market prices and observable inputs to the maximum extent possible when measuring fair value. In the absence of quoted market prices, various valuation techniques are utilized to measure fair value. When possible, observable market data for identical or similar financial instruments are used in the valuation. When market data is not available, fair value is determined using valuation models that incorporate management's estimates of the assumptions a market participant would use in pricing the asset or liability.

Fair value measurements are classified within one of three levels based on the observability of the inputs used to determine fair value, as follows:

Level 1 - The valuation is based on quoted prices in active markets for identical instruments.

Level 2 - The valuation is based on observable inputs such as quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active, and model-based valuation techniques for which all significant assumptions are observable in the market.

Level 3 - The valuation is based on unobservable inputs that are supported by minimal or no market activity and that are significant to the fair value of the instrument. Level 3 valuations are typically performed using pricing models, discounted cash flow methodologies, or similar techniques that incorporate management's own estimates of assumptions that market participants would use in pricing the instrument, or valuations that require significant management judgment or estimation.

**Reclassifications** - Certain amounts in the prior periods consolidated financial statements have been reclassified to conform with the current year presentation. These reclassifications had no effect on total assets, shareholders' equity or net income as previously reported.

56 • SRCE

2022 Form 10-K

## Note 2 - Recent Accounting Pronouncements

**Fair Value Measurements:** In June 2022, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) No. 2022-03 “*Fair Value Measurements (Topic 820): Fair Value Measurement of Equity Securities Subject to Contractual Sale Restrictions.*” These amendments clarify that a contractual restriction on the sale of an equity security is not considered part of the unit of account of the equity security and, therefore, is not considered in measuring fair value. This guidance is effective for public business entities for fiscal years, including interim periods within those fiscal years, beginning after December 15, 2023. Early adoption is permitted. The Company has assessed ASU 2022-03 and does not expect it to have a material impact on its accounting and disclosures.

**Financial Instruments-Credit Losses:** In March 2022, the FASB issued ASU No. 2022-02 “*Financial Instruments-Credit Losses (Topic 326): Troubled Debt Restructurings and Vintage Disclosures.*” These amendments eliminate the TDR recognition and measurement guidance and, instead, require that an entity evaluate (consistent with the accounting for other loan modifications) whether the modification represents a new loan or a continuation of an existing loan. The amendments also enhance existing disclosure requirements and introduce new requirements related to certain modifications of receivables made to borrowers experiencing financial difficulty. Additionally, these amendments require that an entity disclose current-period gross write-offs by year of origination for financing receivables and net investment in leases within the scope of Subtopic 326-20. The guidance is effective for entities that have adopted ASU 2016-13 for fiscal years beginning after December 15, 2022, including interim periods within those fiscal years. These amendments should be applied prospectively. If an entity elects to early adopt ASU 2022-02 in an interim period, the guidance should be applied as of the beginning of the fiscal year that includes the interim period. An entity may elect to early adopt the amendments about TDRs and related disclosure enhancements separately from the amendments related to vintage disclosures. The Company adopted ASU 2022-02 on January 1, 2023 and it did not have a material impact on its accounting and disclosures.

**Reference Rate Reform:** In March 2020, the FASB issued ASU No. 2020-04 “*Reference Rate Reform (Topic 848): Facilitation of the Effects of Reference Rate Reform on Financial Reporting.*” These amendments provide temporary optional guidance to ease the potential burden in accounting for reference rate reform. The ASU provides optional expedients and exceptions for applying generally accepted accounting principles to contract modifications and hedging relationships, subject to meeting certain criteria, that reference LIBOR or another reference rate expected to be discontinued. It is intended to help stakeholders during the global market-wide reference rate transition period. In January 2021, the FASB issued ASU 2021-01 which clarifies that certain optional expedients and exceptions in Topic 848 for contract modifications and hedge accounting apply to derivatives that are affected by the discounting transition. In December of 2022, the FASB issued ASU No. 2022-06 which extended the period of time prepares can utilize the reference rate reform relief guidance in Topic 848. The guidance ensures the relief in Topic 848 covers the period of time during which a significant number of modifications may take place and the ASU defers the sunset date of Topic 848 from December 31, 2022 to December 31, 2024. The Company continues to implement its transition plan towards cessation of LIBOR and the modification of its loans and other financial instruments with attributes that are either directly or indirectly influenced by LIBOR. The Company expects to utilize the LIBOR transition relief allowed under ASU 2020-04, ASU 2021-01 and ASU 2022-06, as applicable, and does not expect such adoption to have a material impact on its accounting and disclosures. The Company will continue to assess the impact as the reference rate transition progresses.

57 • SRCE

2022 Form 10-K

### Note 3 - Investment Securities Available-For-Sale

The following table shows investment securities available-for-sale.

| (Dollars in thousands) | Amortized Cost | Gross Unrealized Gains | Gross Unrealized Losses | Fair Value |
| --- | --- | --- | --- | --- |
| December 31, 2022 |  |  |  |  |
| U.S. Treasury and Federal agencies securities | $1,090,743 | $ - | $(92,145) | $998,598 |
| U.S. States and political subdivisions securities | 130,670 | 591 | (8,499) | 122,762 |
| Mortgage-backed securities - Federal agencies | 730,672 | 60 | (93,674) | 637,058 |
| Corporate debt securities | 16,486 | - | (355) | 16,131 |
| Foreign government securities | 600 | - | (21) | 579 |
| Total investment securities available-for-sale | $1,969,171 | $651 | $(194,694) | $1,775,128 |
| December 31, 2021 |  |  |  |  |
| U.S. Treasury and Federal agencies securities | $1,093,780 | $3,244 | $(13,018) | $1,084,006 |
| U.S. States and political subdivisions securities | 95,700 | 1,130 | (1,129) | 95,701 |
| Mortgage-backed securities - Federal agencies | 663,441 | 4,745 | (8,459) | 659,727 |
| Corporate debt securities | 22,510 | 499 | - | 23,009 |
| Foreign government securities | 600 | - | (2) | 598 |
| Total investment securities available-for-sale | $1,876,031 | $9,618 | $(22,608) | $1,863,041 |

Amortized cost excludes accrued interest receivable which is included in Accrued Income and Other Assets on the Consolidated Statements of Financial Condition. At December 31, 2022 and 2021, accrued interest receivable on investment securities available for sale was $5.98 million and $4.80 million, respectively.

At December 31, 2022, the residential mortgage-backed securities held by the Company consisted primarily of GNMA, FNMA and FHLMC pass-through certificates which are guaranteed by those respective agencies of the United States government (Government Sponsored Enterprise, GSEs).

The Company did not hold any marketable equity securities at December 31, 2022 and 2021.

The following table shows the contractual maturities of investments in debt securities available-for-sale at December 31, 2022. Expected maturities will differ from contractual maturities, because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.

| (Dollars in thousands) | Amortized Cost | Fair Value |
| --- | --- | --- |
| Due in one year or less | $63,325 | $62,318 |
| Due after one year through five years | 1,112,166 | 1,016,225 |
| Due after five years through ten years | 21,835 | 18,204 |
| Due after ten years | 41,173 | 41,323 |
| Mortgage-backed securities | 730,672 | 637,058 |
| Total debt securities available-for-sale | $1,969,171 | $1,775,128 |

58 • SRCE

2022 Form 10-K

The following table summarizes gross unrealized losses and fair value by investment category and age. At December 31, 2022, the Company's available-for-sale securities portfolio consisted of 745 securities, 690 of which were in an unrealized loss position.

| (Dollars in thousands) | Less than 12 Months |  | 12 months or Longer |  | Total |  |
| --- | --- | --- | --- | --- | --- | --- |
|  | Fair Value | Unrealized Losses | Fair Value | Unrealized Losses | Fair Value | Unrealized Losses |
| December 31, 2022 |  |  |  |  |  |  |
| U.S. Treasury and Federal agencies securities | $164,481 | $(6,299) | $834,117 | $(85,846) | $998,598 | $(92,145) |
| U.S. States and political subdivisions securities | 57,592 | (2,126) | 38,834 | (6,373) | 96,426 | (8,499) |
| Mortgage-backed securities - Federal agencies | 198,469 | (13,482) | 426,989 | (80,192) | 625,458 | (93,674) |
| Corporate debt securities | 16,132 | (355) | - | - | 16,132 | (355) |
| Foreign government securities | 484 | (16) | 95 | (5) | 579 | (21) |
| Total debt securities available-for-sale | $437,158 | $(22,278) | $1,300,035 | $(172,416) | $1,737,193 | $(194,694) |
| December 31, 2021 |  |  |  |  |  |  |
| U.S. Treasury and Federal agencies securities | $789,536 | $(10,728) | $84,191 | $(2,290) | $873,727 | $(13,018) |
| U.S. States and political subdivisions securities | 39,585 | (980) | 4,875 | (149) | 44,460 | (1,129) |
| Mortgage-backed securities - Federal agencies | 454,413 | (7,312) | 35,232 | (1,147) | 489,645 | (8,459) |
| Corporate debt securities | - | - | - | - | - | - |
| Foreign government securities | 598 | (2) | - | - | 598 | (2) |
| Total debt securities available-for-sale | $1,284,132 | $(19,022) | $124,298 | $(3,586) | $1,408,430 | $(22,608) |

The Company does not consider available-for-sale securities with unrealized losses at December 31, 2022 to be experiencing credit losses and recognized no resulting allowance for credit losses. The Company does not intend to sell these investments and it is more likely than not that the Company will not be required to sell these investments before recovery of the amortized cost basis, which may be the maturity dates of the securities. The unrealized losses occurred as a result of changes in interest rates, market spreads and market conditions subsequent to purchase.

The following table shows the gross realized gains and losses from the available-for-sale debt securities portfolio. Realized gains and losses of all securities are computed using the specific identification cost basis.

| (Dollars in thousands) | 2022 | 2021 | 2020 |
| --- | --- | --- | --- |
| Gross realized gains | $ - | $221 | $285 |
| Gross realized losses | (184) | (901) | (6) |
| Net realized (losses) gains | $(184) | $(680) | $279 |

At December 31, 2022 and 2021, investment securities with carrying values of $282.87 million and $351.13 million, respectively, were pledged as collateral for security repurchase agreements and for other purposes.

#### Note 4 - Loan and Lease Financings

Total loans and leases outstanding were recorded net of unearned income and deferred loan fees and costs at December 31, 2022 and 2021, and totaled $6.01 billion and $5.35 billion, respectively. At December 31, 2022 and 2021, net deferred loan and lease costs (fees) were $2.00 million and $(0.09) million, respectively. At December 31, 2022 and 2021, there were $0.01 million and $2.71 million, respectively, in deferred loan fees related to Paycheck Protection Program (PPP) loans. Accrued interest receivable on loans and leases at December 31, 2022 and 2021 was $18.75 million and $12.94 million, respectively.

In the ordinary course of business, the Company has extended loans to certain directors, executive officers, and principal shareholders of equity securities of 1st Source and to their affiliates. In the opinion of management, these loans are made on substantially the same terms, including interest rates and collateral, as those prevailing at the time for comparable transactions with persons not related to the Company and did not involve more than the normal risk of collectability, or present other unfavorable features. The loans are consistent with sound banking practices and within applicable regulatory and lending limitations. The aggregate dollar amounts of these loans were $12.53 million and $14.05 million at December 31, 2022 and 2021, respectively. During 2022, $0.45 million of new loans and other additions were made and $1.97 million of repayments and other reductions occurred.

59 • SRCE

2022 Form 10-K

The Company evaluates loans and leases for credit quality at least annually but more frequently if certain circumstances occur (such as material new information which becomes available and indicates a potential change in credit risk). The Company uses two methods to assess credit risk: loan or lease credit quality grades and credit risk classifications. The purpose of the loan or lease credit quality grade is to document the degree of risk associated with individual credits as well as inform management of the degree of risk in the portfolio taken as a whole. Credit risk classifications are used to categorize loans by degree of risk and to designate individual or committee approval authorities for higher risk credits at the time of origination. Credit risk classifications include categories for: Acceptable, Marginal, Special Attention, Special Risk, Restricted by Policy, Regulated and Prohibited by Law.

All loans and leases, except residential real estate and home equity loans and consumer loans, are assigned credit quality grades on a scale from 1 to 12 with grade 1 representing superior credit quality. The criteria used to assign grades to extensions of credit that exhibit potential problems or well-defined weaknesses are primarily based upon the degree of risk and the likelihood of orderly repayment, and their effect on our safety and soundness. Loans or leases graded 7 or weaker are considered “special attention” credits and, as such, relationships in excess of $250,000 are reviewed quarterly as part of management’s evaluation of the appropriateness of the allowance for loan and lease losses. Grade 7 credits are defined as “watch” and contain greater than average credit risk and are monitored to limit our exposure to increased risk; grade 8 credits are “special mention” and, following regulatory guidelines, are defined as having potential weaknesses that deserve management’s close attention. Credits that exhibit well-defined weaknesses and a distinct possibility of loss are considered “classified” and are graded 9 through 12 corresponding to the regulatory definitions of “substandard” (grades 9 and 10) and the more severe “doubtful” (grade 11) and “loss” (grade 12). For residential real estate and home equity and consumer loans, credit quality is based on the aging status of the loan and by payment activity. Nonperforming loans are those loans which are on nonaccrual status or are 90 or more past due.

Below is a summary of the Company’s loan and lease portfolio segments and a discussion of the risk characteristics relevant to each portfolio segment.

*Commercial and agricultural* - loans are to entities within the Company’s local market communities. Loans are for business or agri-business purposes and include working capital lines of credit secured by accounts receivable and inventory that are generally renewable annually and term loans secured by equipment with amortizations based on the expected life of the underlying collateral, generally three to seven years. These loans are typically further supported by personal guarantees. Commercial exposure is to a wide range of industries and services. Risks in this sector are also varied and are most impacted by general economic conditions. Risk mitigants include appropriate underwriting and monitoring and, when appropriate, government guarantees, including SBA and FSA. This portfolio sector also includes PPP loans, which are fully guaranteed by the SBA. There were no PPP originations during 2022 and PPP loan originations during 2021 amounted to $261.46 million. As of December 31, 2022 and 2021, PPP loan balances were $0.90 million and $73.08 million, respectively, which is net of an unearned discount of $0.01 million and $2.71 million, respectively.

*Solar* - loans are for the purpose of financing solar related projects and may include construction draw notes, operating loans, letters of credit and may entail a tax equity structure. Collateral in a multi-state area includes tangible assets of the borrower, assignment of intangible assets including power purchase agreements, and pledges of permits and licenses. Financing is provided to qualified borrowers throughout the continental United States with an emphasis on the region east of the Rocky Mountains.

*Auto and light truck* - loans are secured by vehicles and borrowers are nationwide. The portfolio consists of multiple industries: auto rental, auto leasing and specialty vehicle which includes bus, funeral car and step van. Borrowers in the auto rental segment are primarily independent auto rental entities with on-airport and off-airport locations, and some insurance replacement business. Loan terms are relatively short, generally eighteen months, but up to four years. Auto leasing customers lease to businesses and the Company takes assignment of the lease stream and places its lien on the vehicles. Terms are generally longer than the auto rental sector, three to seven years and match the underlying leases. Risks include economic risks and collateral risks, principally used vehicle values. Specialty vehicle loans are also of longer duration, generally six years but up to 104 months for new motor coaches. The bus segment is secured primarily by shuttle buses and motor coaches, the step van segment is secured by step vans and the funeral car segment is secured by hearses and limousines. Risks include lack of well-established mechanisms for disposition of collateral, such as auctions that are key to disposition of autos. Loans in the portfolio generally carry personal guarantees.

*Medium and heavy duty truck* - loans and full-service truck leases are secured by heavy-duty trucks, commonly Class 8 trucks, and are generally personally guaranteed. In addition to economic risks, collateral risk is significant. Financing is generally at full cost, plus additional expenditures to get the vehicle operational, such as taxes, insurance and fees. It takes three to four years of debt amortization to reach an equity position in the collateral.

60 • SRCE

2022 Form 10-K

*Aircraft* - loans are to domestic and foreign borrowers with the domestic segment further divided into two pools: 1) personal and business use, and 2) dealers and operators. The Company’s focus for the foreign sector is Latin America, principally Mexico and Brazil. Loans are primarily secured by new and used business jets and helicopters, with appropriate advances, amortizations of ten to fifteen years, and are generally guaranteed by individuals. The most significant risk in the Aircraft portfolio is collateral risk - volatility in underlying values and maintenance concerns. The portfolio is subject to national and global economic risks.

*Construction equipment* - loans are to borrowers throughout the country secured by specific equipment. The borrowers include highway and road builders, asphalt producers and pavers, suppliers of aggregate products, site developers, frac sand operations, general construction equipment dealers and operators, and crane rental entities. Generally, loans include personal guarantees. The construction equipment industry is heavily dependent on the U.S. economy and the global economy. Market growth is reliant on investments from public and private sectors into urbanization and infrastructure projects.

*Commercial real estate* - loans are generally to entities within the local market communities served by the Company with advances generally within regulatory guidelines. Historically, the Company’s exposure to commercial real estate had been primarily to the less risky owner-occupied segment although growth in recent years has been in the non-owner-occupied segment which now accounts for slightly less than half of the portfolio. The non-owner-occupied segment includes hotels, apartment complexes and warehousing facilities. There is limited exposure to construction loans. Many commercial real estate loans carry personal guarantees. Additional risks in the commercial real estate portfolio stem from geographical concentration in northern Indiana and southwest Michigan and general economic conditions.

*Residential real estate and home equity* - loans predominantly include one-to-four family mortgages to borrowers in the Company’s local market communities and are appropriately underwritten and secured by residential real estate.

*Consumer* - loans are to individuals in the Company’s local markets and auto loans are generally secured by personal vehicles and appropriately underwritten.

61 • SRCE

2022 Form 10-K

The following table shows the amortized cost of loans and leases, segregated by portfolio segment, credit quality rating and year of origination as of December 31, 2022.

| (Dollars in thousands) | Term Loans and Leases by Origination Year |  |  |  |  |  | Revolving Loans | Revolving Loans Converted to Term | Total |
| --- | --- | --- | --- | --- | --- | --- | --- | --- | --- |
|  | 2022 | 2021 | 2020 | 2019 | 2018 | Prior |  |  |  |
| Commercial and agricultural |  |  |  |  |  |  |  |  |  |
| Grades 1-6 | $159,317 | $107,232 | $71,365 | $35,874 | $17,192 | $13,860 | $370,553 | $ - | $775,393 |
| Grades 7-12 | 4,491 | 5,934 | 60 | 2,094 | 1,644 | 1,040 | 21,375 | - | 36,638 |
| Total commercial and agricultural | 163,808 | 113,166 | 71,425 | 37,968 | 18,836 | 14,900 | 391,928 | - | 812,031 |
| Solar |  |  |  |  |  |  |  |  |  |
| Grades 1-6 | 109,393 | 113,276 | 35,660 | 72,652 | 18,518 | 20,654 | - | - | 370,153 |
| Grades 7-12 | - | - | 1,091 | 5,678 | 701 | 3,540 | - | - | 11,010 |
| Total Solar | 109,393 | 113,276 | 36,751 | 78,330 | 19,219 | 24,194 | - | - | 381,163 |
| Auto and light truck |  |  |  |  |  |  |  |  |  |
| Grades 1-6 | 521,399 | 155,508 | 62,063 | 32,975 | 10,946 | 3,476 | - | - | 786,367 |
| Grades 7-12 | 5,972 | 3,366 | 5,836 | 2,836 | 1,792 | 1,948 | - | - | 21,750 |
| Total auto and light truck | 527,371 | 158,874 | 67,899 | 35,811 | 12,738 | 5,424 | - | - | 808,117 |
| Medium and heavy duty truck |  |  |  |  |  |  |  |  |  |
| Grades 1-6 | 158,296 | 66,533 | 43,711 | 31,980 | 10,053 | 3,274 | - | - | 313,847 |
| Grades 7-12 | - | - | - | - | - | 15 | - | - | 15 |
| Total medium and heavy duty truck | 158,296 | 66,533 | 43,711 | 31,980 | 10,053 | 3,289 | - | - | 313,862 |
| Aircraft |  |  |  |  |  |  |  |  |  |
| Grades 1-6 | 438,481 | 273,726 | 213,661 | 57,379 | 31,085 | 35,012 | 3,687 | - | 1,053,031 |
| Grades 7-12 | 12,962 | 4,253 | 6,190 | - | - | 1,286 | - | - | 24,691 |
| Total aircraft | 451,443 | 277,979 | 219,851 | 57,379 | 31,085 | 36,298 | 3,687 | - | 1,077,722 |
| Construction equipment |  |  |  |  |  |  |  |  |  |
| Grades 1-6 | 475,854 | 213,349 | 106,409 | 59,204 | 17,834 | 4,593 | 23,310 | 2,754 | 903,307 |
| Grades 7-12 | 20,709 | 7,757 | 2,483 | 1,878 | 313 | 32 | 583 | 1,441 | 35,196 |
| Total construction equipment | 496,563 | 221,106 | 108,892 | 61,082 | 18,147 | 4,625 | 23,893 | 4,195 | 938,503 |
| Commercial real estate |  |  |  |  |  |  |  |  |  |
| Grades 1-6 | 271,526 | 164,173 | 121,685 | 97,470 | 102,271 | 168,391 | 251 | - | 925,767 |
| Grades 7-12 | 1,532 | 1,716 | 7,824 | 5,789 | 47 | 1,070 | - | - | 17,978 |
| Total commercial real estate | 273,058 | 165,889 | 129,509 | 103,259 | 102,318 | 169,461 | 251 | - | 943,745 |
| Residential real estate and home equity |  |  |  |  |  |  |  |  |  |
| Performing | 115,154 | 100,690 | 97,205 | 34,498 | 6,864 | 81,653 | 142,724 | 4,115 | 582,903 |
| Nonperforming | - | 131 | 693 | - | - | 725 | 180 | 105 | 1,834 |
| Total residential real estate and home equity | 115,154 | 100,821 | 97,898 | 34,498 | 6,864 | 82,378 | 142,904 | 4,220 | 584,737 |
| Consumer |  |  |  |  |  |  |  |  |  |
| Performing | 74,258 | 34,619 | 12,924 | 7,375 | 2,977 | 692 | 18,098 | - | 150,943 |
| Nonperforming | 148 | 65 | 49 | 53 | 12 | 12 | - | - | 339 |
| Total consumer | $74,406 | $34,684 | $12,973 | $7,428 | $2,989 | $704 | $18,098 | $ - | $151,282 |

62 • SRCE

2022 Form 10-K

The following table shows the amortized cost of loans and leases, segregated by portfolio segment, credit quality rating and year of origination as of December 31, 2021.

| (Dollars in thousands) | Term Loans and Leases by Origination Year |  |  |  |  |  | Revolving Loans | Revolving Loans Converted to Term | Total |
| --- | --- | --- | --- | --- | --- | --- | --- | --- | --- |
|  | 2021 | 2020 | 2019 | 2018 | 2017 | Prior |  |  |  |
| Commercial and agricultural |  |  |  |  |  |  |  |  |  |
| Grades 1-6 | $233,512 | $123,947 | $60,744 | $55,231 | $32,545 | $20,184 | $364,460 | $ - | $890,623 |
| Grades 7-12 | 4,682 | 194 | 3,667 | 2,373 | 2,004 | 484 | 14,685 | - | 28,089 |
| Total commercial and agricultural | 238,194 | 124,141 | 64,411 | 57,604 | 34,549 | 20,668 | 379,145 | - | 918,712 |
| Solar |  |  |  |  |  |  |  |  |  |
| Grades 1-6 | 159,244 | 42,073 | 81,593 | 18,979 | 34,889 | 3,780 | - | - | 340,558 |
| Grades 7-12 | - | 1,138 | 5,882 | 724 | - | - | - | - | 7,744 |
| Total Solar | 159,244 | 43,211 | 87,475 | 19,703 | 34,889 | 3,780 | - | - | 348,302 |
| Auto and light truck |  |  |  |  |  |  |  |  |  |
| Grades 1-6 | 331,105 | 122,709 | 72,580 | 24,965 | 11,814 | 901 | - | - | 564,074 |
| Grades 7-12 | 10,828 | 11,752 | 7,467 | 3,859 | 4,876 | 919 | - | - | 39,701 |
| Total auto and light truck | 341,933 | 134,461 | 80,047 | 28,824 | 16,690 | 1,820 | - | - | 603,775 |
| Medium and heavy duty truck |  |  |  |  |  |  |  |  |  |
| Grades 1-6 | 92,252 | 68,354 | 57,967 | 23,210 | 12,419 | 5,265 | - | - | 259,467 |
| Grades 7-12 | - | - | - | - | - | 273 | - | - | 273 |
| Total medium and heavy duty truck | 92,252 | 68,354 | 57,967 | 23,210 | 12,419 | 5,538 | - | - | 259,740 |
| Aircraft |  |  |  |  |  |  |  |  |  |
| Grades 1-6 | 384,895 | 290,897 | 85,916 | 45,848 | 47,025 | 29,435 | 4,844 | - | 888,860 |
| Grades 7-12 | 1,141 | 649 | - | 4,670 | 454 | 2,627 | - | - | 9,541 |
| Total aircraft | 386,036 | 291,546 | 85,916 | 50,518 | 47,479 | 32,062 | 4,844 | - | 898,401 |
| Construction equipment |  |  |  |  |  |  |  |  |  |
| Grades 1-6 | 314,044 | 201,032 | 109,029 | 47,693 | 13,501 | 5,031 | 18,937 | 4,594 | 713,861 |
| Grades 7-12 | 26,650 | 8,709 | 1,983 | 797 | 80 | - | - | 2,193 | 40,412 |
| Total construction equipment | 340,694 | 209,741 | 111,012 | 48,490 | 13,581 | 5,031 | 18,937 | 6,787 | 754,273 |
| Commercial real estate |  |  |  |  |  |  |  |  |  |
| Grades 1-6 | 230,701 | 150,144 | 146,374 | 141,838 | 126,642 | 112,243 | 391 | - | 908,333 |
| Grades 7-12 | 218 | 5,921 | 7,159 | 491 | 6,208 | 1,011 | - | - | 21,008 |
| Total commercial real estate | 230,919 | 156,065 | 153,533 | 142,329 | 132,850 | 113,254 | 391 | - | 929,341 |
| Residential real estate and home equity |  |  |  |  |  |  |  |  |  |
| Performing | 105,345 | 114,682 | 41,185 | 9,706 | 11,720 | 89,646 | 122,281 | 4,555 | 499,120 |
| Nonperforming | - | - | - | 13 | 421 | 655 | 293 | 88 | 1,470 |
| Total residential real estate and home equity | 105,345 | 114,682 | 41,185 | 9,719 | 12,141 | 90,301 | 122,574 | 4,643 | 500,590 |
| Consumer |  |  |  |  |  |  |  |  |  |
| Performing | 58,866 | 24,307 | 17,031 | 8,284 | 2,263 | 697 | 21,378 | - | 132,826 |
| Nonperforming | 37 | 107 | 43 | 30 | 33 | 4 | - | - | 254 |
| Total consumer | $58,903 | $24,414 | $17,074 | $8,314 | $2,296 | $701 | $21,378 | $ - | $133,080 |

63 • SRCE

2022 Form 10-K

The following table shows the amortized cost of loans and leases, segregated by portfolio segment, with delinquency aging and nonaccrual status.

| (Dollars in thousands) | Current | 30-59 Days Past Due | 60-89 Days Past Due | 90 Days or More Past Due and Accruing | Total Accruing Loans | Nonaccrual | Total Financing Receivables |
| --- | --- | --- | --- | --- | --- | --- | --- |
| December 31, 2022 |  |  |  |  |  |  |  |
| Commercial and agricultural | $810,223 | $944 | $ - | $ - | $811,167 | $864 | $812,031 |
| Solar | 381,163 | - | - | - | 381,163 | - | 381,163 |
| Auto and light truck | 793,610 | 353 | 1 | - | 793,964 | 14,153 | 808,117 |
| Medium and heavy duty truck | 313,845 | - | 2 | - | 313,847 | 15 | 313,862 |
| Aircraft | 1,075,865 | 223 | 1,063 | - | 1,077,151 | 571 | 1,077,722 |
| Construction equipment | 932,603 | 431 | - | - | 933,034 | 5,469 | 938,503 |
| Commercial real estate | 940,516 | - | - | - | 940,516 | 3,229 | 943,745 |
| Residential real estate and home equity | 582,053 | 562 | 288 | 49 | 582,952 | 1,785 | 584,737 |
| Consumer | 150,328 | 416 | 199 | 5 | 150,948 | 334 | 151,282 |
| Total | $5,980,206 | $2,929 | $1,553 | $54 | $5,984,742 | $26,420 | $6,011,162 |
| December 31, 2021 |  |  |  |  |  |  |  |
| Commercial and agricultural | $916,659 | $ - | $ - | $ - | $916,659 | $2,053 | $918,712 |
| Solar | 348,302 | - | - | - | 348,302 | - | 348,302 |
| Auto and light truck | 579,605 | - | - | - | 579,605 | 24,170 | 603,775 |
| Medium and heavy duty truck | 259,467 | - | - | - | 259,467 | 273 | 259,740 |
| Aircraft | 894,092 | 1,130 | 2,530 | - | 897,752 | 649 | 898,401 |
| Construction equipment | 745,870 | 1,313 | - | - | 747,183 | 7,090 | 754,273 |
| Commercial real estate | 926,345 | - | - | - | 926,345 | 2,996 | 929,341 |
| Residential real estate and home equity | 498,854 | 212 | 54 | 245 | 499,365 | 1,225 | 500,590 |
| Consumer | 132,464 | 332 | 30 | 4 | 132,830 | 250 | 133,080 |
| Total | $5,301,658 | $2,987 | $2,614 | $249 | $5,307,508 | $38,706 | $5,346,214 |

Interest income for the years ended December 31, 2022, 2021, and 2020, would have increased by approximately $2.68 million, $2.62 million, and $3.49 million, respectively, if the nonaccrual loans and leases had earned interest at their full contract rate.

64 • SRCE

2022 Form 10-K

The following table shows the number of loans and leases classified as troubled debt restructurings (TDRs) during 2022, 2021 and 2020, by portfolio segment, as well as the recorded investment as of December 31. The classification between nonperforming and performing is shown at the time of modification. Modification programs focused on extending maturity dates or modifying payment patterns with most TDRs experiencing a combination of concessions. The modifications did not result in the contractual forgiveness of principal or interest. The TDRs during 2020 were the result of issues that predated the COVID-19 pandemic. There was no modifications during 2022, one modification during 2021, and two modification during 2020 that resulted in an interest rate reduction below market rate. Consequently, the financial impact of the modifications was immaterial.

| (Dollars in thousands) | 2022 |  | 2021 |  | 2020 |  |
| --- | --- | --- | --- | --- | --- | --- |
|  | Number of Modifications | Recorded Investment | Number of Modifications | Recorded Investment | Number of Modifications | Recorded Investment |
| Performing TDRs: |  |  |  |  |  |  |
| Commercial and agricultural | - | $ - | - | $ - | - | $ - |
| Solar | - | - | - | - | - | - |
| Auto and light truck | - | - | - | - | - | - |
| Medium and heavy duty truck | - | - | - | - | - | - |
| Aircraft | - | - | - | - | - | - |
| Construction equipment | - | - | - | - | - | - |
| Commercial real estate | - | - | - | - | - | - |
| Residential real estate and home equity | - | - | - | - | - | - |
| Consumer | - | - | - | - | - | - |
| Total performing TDR modifications | - | - | - | - | - | - |
| Nonperforming TDRs: |  |  |  |  |  |  |
| Commercial and agricultural | - | - | - | - | - | - |
| Solar | - | - | - | - | - | - |
| Auto and light truck | - | - | - | - | - | - |
| Medium and heavy duty truck | - | - | - | - | - | - |
| Aircraft | - | - | - | - | 1 | 828 |
| Construction equipment | - | - | 1 | 5,729 | 1 | 9,905 |
| Commercial real estate | - | - | - | - | - | - |
| Residential real estate and home equity | - | - | - | - | - | - |
| Consumer | - | - | - | - | - | - |
| Total nonperforming TDR modifications | - | - | 1 | 5,729 | 2 | 10,733 |
| Total TDR modifications | - | $ - | 1 | $5,729 | 2 | $10,733 |

There was one nonperforming construction equipment TDR with a recorded investment of $3.07 million which had a payment default within the twelve months following modification for the year ended December 31, 2022, no TDRs which had payment defaults within the twelve months following modification for the year ended December 31, 2021, and one nonperforming commercial and agricultural TDR with a recorded investment of $0.41 million which had a payment default within the twelve months following modification during the year ended December 31, 2020.

The classification between nonperforming and performing is shown at the time of modification. Default occurs when a loan or lease is 90 days or more past due under the modified terms or transferred to nonaccrual.

The following table shows the recorded investment of loans and leases classified as troubled debt restructurings as of December 31.

| Year Ended December 31 (Dollars in thousands) | 2022 | 2021 |
| --- | --- | --- |
| Performing TDRs | $ - | $319 |
| Nonperforming TDRs | 3,640 | 6,742 |
| Total TDRs | $3,640 | $7,061 |

65 • SRCE

2022 Form 10-K

## Note 5 - Allowance for Credit Losses

### Allowance for Loan and Lease Losses

The methodology used to estimate the appropriate level of the allowance for loan and lease losses is described in Note 1, under the heading “Allowance for Credit Losses.” The allowance for loan and lease losses at December 31, 2022 and 2021, represents the Company’s current estimate of lifetime credit losses inherent in the loan and lease portfolio. The following table shows the changes in the allowance for loan and lease losses, segregated by portfolio segment, for each of the three years ended December 31.

| (Dollars in thousands) | Commercial and agricultural | Solar | Auto and light truck | Medium and heavy duty truck | Aircraft | Construction equipment | Commercial real estate | Residential real estate and home equity | Consumer | Total |
| --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- |
| 2022 |  |  |  |  |  |  |  |  |  |  |
| Balance, beginning of year | $15,409 | $6,585 | $19,624 | $6,015 | $33,628 | $19,673 | $19,691 | $5,084 | $1,783 | $127,492 |
| Charge-offs | 625 | - | 118 | - | - | 1,114 | 538 | 284 | 730 | 3,409 |
| Recoveries | 56 | - | 417 | - | 785 | 17 | 45 | 160 | 460 | 1,940 |
| Net charge-offs (recoveries) | 569 | - | (299) | - | (785) | 1,097 | 493 | 124 | 270 | 1,469 |
| Provision (recovery of provision) | (205) | 632 | (1,289) | 1,551 | 6,680 | 5,463 | (1,767) | 1,518 | 662 | 13,245 |
| Balance, end of year | $14,635 | $7,217 | $18,634 | $7,566 | $41,093 | $24,039 | $17,431 | $6,478 | $2,175 | $139,268 |
| 2021 |  |  |  |  |  |  |  |  |  |  |
| Balance, beginning of year | $16,680 | $5,549 | $28,926 | $6,400 | $34,053 | $19,166 | $22,758 | $5,374 | $1,748 | $140,654 |
| Charge-offs | 2,930 | - | 7,797 | - | - | 856 | - | 228 | 712 | 12,523 |
| Recoveries | 812 | - | 1,316 | - | 687 | 473 | 19 | 16 | 341 | 3,664 |
| Net charge-offs (recoveries) | 2,118 | - | 6,481 | - | (687) | 383 | (19) | 212 | 371 | 8,859 |
| Provision (recovery of provision) | 847 | 1,036 | (2,821) | (385) | (1,112) | 890 | (3,086) | (78) | 406 | (4,303) |
| Balance, end of year | $15,409 | $6,585 | $19,624 | $6,015 | $33,628 | $19,673 | $19,691 | $5,084 | $1,783 | $127,492 |
| 2020 |  |  |  |  |  |  |  |  |  |  |
| Balance, beginning of year | $20,926 | $2,745 | $14,400 | $4,612 | $31,058 | $14,120 | $18,350 | $3,609 | $1,434 | $111,254 |
| Impact of ASC 326 adoption | (939) | 284 | (1,303) | 2,414 | 484 | 372 | (649) | 1,688 | 233 | 2,584 |
| Adjusted balance, beginning of year | 19,987 | 3,029 | 13,097 | 7,026 | 31,542 | 14,492 | 17,701 | 5,297 | 1,667 | 113,838 |
| Charge-offs | 903 | - | 7,107 | 15 | 855 | 4,090 | 37 | 74 | 893 | 13,974 |
| Recoveries | 663 | - | 499 | 18 | 1,800 | 1,415 | 58 | 33 | 303 | 4,789 |
| Net charge-offs (recoveries) | 240 | - | 6,608 | (3) | (945) | 2,675 | (21) | 41 | 590 | 9,185 |
| Provision (recovery of provision) | (3,067) | 2,520 | 22,437 | (629) | 1,566 | 7,349 | 5,036 | 118 | 671 | 36,001 |
| Balance, end of year | $16,680 | $5,549 | $28,926 | $6,400 | $34,053 | $19,166 | $22,758 | $5,374 | $1,748 | $140,654 |

The allowance for loan and lease losses increased year-over-year in 2022 as most portfolio segments experienced loan growth along with an adjustment to forecast due to increased risk during the forecast period attributable to a weakened domestic GDP outlook, persistent inflation, markedly higher interest rates and continued geopolitical uncertainty. Allowance increases were offset by a sizeable decline in the highly reserved bus segment of the auto and light truck portfolio due to continued pay downs and the removal of multiple qualitative adjustments specific to the segment. The bus segment was severely impacted by the pandemic and experienced sizeable credit losses in each of the previous two years. Credit quality within the bus segment is stabilizing with minimal delinquency and minimal new special attention activity in 2022. The year-over-year decline in reserves experienced in 2021 was due to improvements in credit quality attributable in large part to government stimulus payments which provided much needed relief to the Company’s customers during the pandemic.

*Commercial and agricultural* - the decline in loan balances year-over-year was primarily attributable to PPP debt forgiveness along with a modest decline in core business balances. The allowance was flat year-over-year as lowly reserved PPP loans were offset by core business loans which carry higher reserves. Credit quality is stable.

*Solar* - allowance increased due to loan growth offset by a reduction in qualitative adjustments given stable credit quality and no loss history since portfolio inception.

*Auto and light truck* - allowance decreased due to declining balances and reduced qualitative adjustments in the highly reserved bus segment, partially offset by strong loan growth in the core auto rental and leasing segments which carry lower loss ratios.

*Medium and heavy duty truck* - allowance increased due to loan growth. Credit quality metrics continued to be relatively strong for this portfolio.

66 • SRCE

2022 Form 10-K

*Aircraft* - the allowance was principally impacted by strong loan growth in both the domestic and foreign aircraft segments. Credit quality metrics remain stable, offset by heightened economic and political concerns related to foreign loans. The Company has historically carried a higher allowance in this portfolio due to risk volatility.

*Construction equipment* - allowance increase was driven by strong loan growth during the year.

*Commercial real estate* - the allowance decrease was a result of the removal of qualitative adjustments related to the COVID-19 pandemic during the year, primarily in the hotel segment, offset by modest loan growth in the portfolio.

*Residential real estate and home equity* - increased allowance due to forecast adjustments and loan growth.

*Consumer* - the segment saw an increase in allowance due to forecast adjustments and loan growth.

#### Economic Outlook

As of December 31, 2022, the most significant economic factors impacting the Company’s loan portfolios was a weakened domestic growth outlook, exacerbated by persistent inflation, higher interest rates and the protracted war in Ukraine and resultant increased geopolitical uncertainty. The forecast considers global and domestic impacts from these factors as well as other key economic factors such as changes in unemployment, commodity prices, and the housing market which may impact the Company’s clients. The Company’s assumption was that economic growth will be weak in 2023 and exhibit below trend growth during 2024 with inflation slowly moving back towards the 2% Federal Reserve target rate resulting in an adverse impact on the loan and lease portfolio over the next two years.

As a result of geopolitical risk and economic uncertainty, the Company’s future loss estimates may vary considerably from the December 31, 2022 assumptions.

#### Liability for Credit Losses on Unfunded Loan Commitments

The liability for credit losses inherent in unfunded loan commitments is included in Accrued Expenses and Other Liabilities on the Consolidated Statements of Financial Condition. The following table shows the changes in the liability for credit losses on unfunded loan commitments for each of the three years ended December 31.

| (Dollars in thousands) | 2022 | 2021 | 2020 |
| --- | --- | --- | --- |
| Balance, beginning of year | $4,196 | $4,499 | $3,172 |
| Impact of ASC 326 adoption | - | - | 777 |
| Adjusted balance, beginning of year | 4,196 | 4,499 | 3,949 |
| Provision (recovery of provision) | 1,420 | (303) | 550 |
| Balance, end of year | $5,616 | $4,196 | $4,499 |

#### Note 6 - Lease Investments

As a lessor, the Company’s loan and lease portfolio includes direct finance leases, which are included in Commercial and Agricultural, Solar, Auto and Light Truck, Medium and Heavy Duty Truck, Aircraft, and Construction Equipment on the Consolidated Statements of Financial Condition. The Company also finances various types of construction equipment, medium and heavy duty trucks, automobiles and other equipment under leases classified as operating leases, which are included in Equipment Owned Under Operating Leases, Net, on the Consolidated Statements of Financial Condition.

The following table shows the components of the investment in direct finance and operating leases as of December 31.

| (Dollars in thousands) | 2022 | 2021 |
| --- | --- | --- |
| Direct finance leases: |  |  |
| Minimum lease payments | $224,816 | $172,017 |
| Estimated unguaranteed residual values | - | - |
| Less: Unearned income | (50,633) | (22,552) |
| Net investment in direct finance leases | $174,183 | $149,465 |
| Operating leases: |  |  |
| Gross investment in operating leases | $60,999 | $95,046 |
| Accumulated depreciation | (29,299) | (46,613) |
| Net investment in operating leases | $31,700 | $48,433 |

67 • SRCE

2022 Form 10-K

The following table shows future minimum lease payments due from clients on direct finance and operating leases at December 31, 2022.

| (Dollars in thousands) | Direct Finance Leases | Operating Leases |
| --- | --- | --- |
| 2023 | $48,011 | $9,192 |
| 2024 | 32,764 | 5,526 |
| 2025 | 31,472 | 3,071 |
| 2026 | 25,890 | 1,489 |
| 2027 | 23,221 | 599 |
| Thereafter | 63,458 | 223 |
| Total | $224,816 | $20,100 |

To mitigate the risk of loss, the Company seeks to diversify both the type of equipment leased and the industries in which the lessees participate. In addition, a portion of the Company's leases are terminal rental adjustment clause or 'TRAC' leases where the lessee effectively guarantees the full residual value through a rental adjustment at the end of term or those where partial value is guaranteed ('split-TRAC'), which has a limited residual risk. Under a split-TRAC structure, the limited residual risk would be satisfied first by the net sale proceeds of the leased asset. The lessee's at-risk portion, or top risk, is satisfied last and is subject to repayment as additional rent, if the TRAC amount is not satisfied by the net sale proceeds. The carrying amount of residual assets covered by residual value guarantees was $29.65 million and $27.33 million at December 31, 2022 and December 31, 2021, respectively.

The following table shows interest income recognized from direct finance lease payments and operating lease equipment rental income and related depreciation expense.

| (Dollars in thousands) | 2022 | 2021 | 2020 |
| --- | --- | --- | --- |
| Direct finance leases: |  |  |  |
| Interest income on lease receivable | $9,008 | $6,634 | $8,258 |
| Operating leases: |  |  |  |
| Income related to lease payments | $12,274 | $16,647 | $23,380 |
| Depreciation expense | 10,023 | 13,694 | 20,203 |

Income related to reimbursements from lessees for personal property tax on operating leased equipment for the years ended December 31, 2022, 2021 and 2020 were $0.35 million, $0.46 million and $0.61 million, respectively. Expense related to personal property tax payments on operating leased equipment for the year ended December 31, 2022, 2021 and 2020 were $0.35 million, $0.46 million and $0.61 million, respectively.

During the year ended December 31, 2022, the Company recorded impairment charges of $0.06 million. The impairment charges were recorded as a result of the annual review of operating lease residual values and was recognized in Depreciation - Leased Equipment on the Consolidated Statements of Income.

#### Note 7 - Premises and Equipment

The following table shows premises and equipment as of December 31.

| (Dollars in thousands) | 2022 | 2021 |
| --- | --- | --- |
| Land | $15,500 | $15,500 |
| Buildings and improvements | 61,860 | 61,257 |
| Furniture and equipment | 40,404 | 39,418 |
| Total premises and equipment | 117,764 | 116,175 |
| Accumulated depreciation and amortization | (72,991) | (69,137) |
| Net premises and equipment | $44,773 | $47,038 |

Depreciation and amortization of properties and equipment totaled $4.60 million in 2022, $5.09 million in 2021, and $5.67 million in 2020.

#### Note 8 - Mortgage Servicing Rights

The unpaid principal balance of residential mortgage loans serviced for third parties was $848.96 million at December 31, 2022, compared to $883.90 million at December 31, 2021, and $838.45 million at December 31, 2020.

68 • SRCE

2022 Form 10-K

Amortization expense on MSRs is expected to total $0.67 million, $0.58 million, $0.50 million, $0.42 million, and $0.36 million in 2023, 2024, 2025, 2026, and 2027, respectively. Projected amortization excludes the impact of future asset additions or disposals.

The following table shows changes in the carrying value of MSRs and the associated valuation allowance.

| (Dollars in thousands) | 2022 | 2021 |
| --- | --- | --- |
| Mortgage servicing rights: |  |  |
| Balance at beginning of year | $4,671 | $4,616 |
| Additions | 753 | 2,172 |
| Amortization | (1,287) | (2,117) |
| Sales | - | - |
| Carrying value before valuation allowance at end of year | 4,137 | 4,671 |
| Valuation allowance: |  |  |
| Balance at beginning of year | - | (812) |
| Impairment recoveries | - | 812 |
| Balance at end of year | $ - | $ - |
| Net carrying value of mortgage servicing rights at end of year | $4,137 | $4,671 |
| Fair value of mortgage servicing rights at end of year | $8,007 | $5,640 |

At December 31, 2022, the fair value of MSRs exceeded the carrying value reported on the Consolidated Statements of Financial Condition by $3.87 million. This difference represents increases in the fair value of certain MSRs that could not be recorded above cost basis.

Funds held in trust at 1st Source for the payment of principal, interest, taxes and insurance premiums applicable to mortgage loans being serviced for others, were approximately $8.57 million and $13.76 million at December 31, 2022 and December 31, 2021, respectively. Mortgage loan contractual servicing fees, including late fees and ancillary income, were $2.79 million, $3.17 million, and $3.13 million for 2022, 2021, and 2020, respectively. Mortgage loan contractual servicing fees are included in Mortgage Banking Income on the Consolidated Statements of Income.

#### Note 9 - Intangible Assets and Goodwill

At December 31, 2022, intangible assets consisted of goodwill of $83.87 million and other intangible assets of $0.04 million, which was net of accumulated amortization of $0.10 million. At December 31, 2021, intangible assets consisted of goodwill of $83.87 million and other intangible assets of $0.06 million, which was net of accumulated amortization of $0.08 million. Intangible asset amortization was $0.02 million, $0.02 million, and $0.02 million for 2022, 2021, and 2020, respectively. Amortization on other intangible assets is expected to total $0.02 million, $0.02 million, $0.00 million, $0.00 million, and $0.00 million in 2023, 2024, 2025, 2026, and 2027, respectively.

The following table shows a summary of other intangible assets as of December 31.

| (Dollars in thousands) | 2022 | 2021 |
| --- | --- | --- |
| Other intangibles: |  |  |
| Gross carrying amount | $146 | $146 |
| Less: accumulated amortization | (106) | (86) |
| Net carrying amount | $40 | $60 |

#### Note 10 - Deposits

The aggregate amount of certificates of deposit of $250,000 or more and other time deposits of $250,000 or more outstanding at December 31, 2022 and 2021 was $600.37 million and $290.89 million, respectively.

The following table shows the amount of certificates of deposit of $250,000 or more and other time deposits of $250,000 or more outstanding at December 31, 2022, by time remaining until maturity.

| (Dollars in thousands) |  |
| --- | --- |
| Under 3 months | $149,632 |
| 4 - 6 months | 71,595 |
| 7 - 12 months | 175,229 |
| Over 12 months | 203,911 |
| Total | $600,367 |

69 • SRCE

2022 Form 10-K

The following table shows scheduled maturities of time deposits, including both private and public funds, at December 31, 2022.

| (Dollars in thousands) |  |
| --- | --- |
| 2023 | $796,947 |
| 2024 | 154,656 |
| 2025 | 82,635 |
| 2026 | 51,355 |
| 2027 | 33,229 |
| Thereafter | 21,637 |
| Total | $1,140,459 |

#### Note 11 - Borrowed Funds and Mandatorily Redeemable Securities

The following table shows the details of long-term debt and mandatorily redeemable securities as of December 31, 2022 and 2021.

| (Dollars in thousands) | 2022 | 2021 |
| --- | --- | --- |
| Federal Home Loan Bank borrowings (1.04% - 2.80%) | $21,315 | $44,150 |
| Mandatorily redeemable securities | 17,905 | 20,598 |
| Other long-term debt | 7,335 | 6,503 |
| Total long-term debt and mandatorily redeemable securities | $46,555 | $71,251 |

Annual maturities of long-term debt outstanding at December 31, 2022, for the next five years and thereafter beginning in 2023, are as follows: $3.16 million; $12.29 million; $1.25 million; $11.14 million; $0.68 million; and $18.04 million.

At December 31, 2022, the Federal Home Loan Bank borrowings represented a source of funding for community economic development activities, agricultural loans and general funding for the bank and consisted of eight fixed rate notes with maturities ranging from 2023 to 2026. These notes were collateralized by $29.73 million of certain real estate loans.

Mandatorily redeemable securities as of December 31, 2022 and 2021, of $17.91 million and $20.60 million, respectively reflected the “book value” shares under the 1st Source Executive Incentive Plan. See Note 16 - Stock Based Compensation (Stock Award Plans) for additional information. Dividends paid on these shares and changes in book value per share are recorded as Other interest expense on the Consolidated Statements of Income. Total interest expense recorded for 2022, 2021, and 2020 was $(0.35) million, $1.79 million, and $2.14 million, respectively. Negative interest expense recognized during 2022 was due to a decrease in book value per share during the year.

The following table shows the details of short-term borrowings as of December 31, 2022 and 2021.

| (Dollars in thousands) | 2022 |  | 2021 |  |
| --- | --- | --- | --- | --- |
|  | Amount | Weighted Average Rate | Amount | Weighted Average Rate |
| Federal funds purchased | $ - | - % | $ - | - % |
| Securities sold under agreements to repurchase | 141,432 | 0.05 | 194,727 | 0.05 |
| Commercial paper | 3,096 | 0.03 | 3,967 | 0.04 |
| Federal Home Loan Bank advances | 70,000 | 4.16 | - | - |
| Other short-term borrowings | 1,001 | - | 1,333 | - |
| Total short-term borrowings | $215,529 | 1.39% | $200,027 | 0.05% |

#### Note 12 - Variable Interest Entities

A variable interest entity (VIE) is a partnership, limited liability company, trust or other legal entity that meets any one of the following criteria:

- The entity does not have sufficient equity to conduct its activities without additional subordinated financial support from another party.
- The entity’s investors lack the power to direct the activities that most significantly affect the entity’s economic performance.
- The entity’s at-risk holders do not have the obligation to absorb the losses or the right to receive residual returns.

70 • SRCE

2022 Form 10-K

- The voting rights of some investors are not proportional to their economic interests in the entity, and substantially all of the entity’s activities involve, or are conducted on behalf of, investors with disproportionately few voting rights.

The Company is involved in various entities that are considered to be VIEs. The Company’s investments in VIEs are primarily related to investments promoting affordable housing, community development and renewable energy sources. Some of these tax-advantaged investments support the Company’s regulatory compliance with the Community Reinvestment Act. The Company’s investments in these entities generate a return primarily through the realization of federal and state income tax credits and other tax benefits, such as tax deductions from operating losses of the investments, over specified time periods. These tax credits are recognized as a reduction of tax expense or, for investments qualifying as investment tax credits, as a reduction to the related investment asset. The Company recognized federal and state income tax credits related to its affordable housing and community development tax-advantaged investments in tax expense of $2.06 million, $2.02 million and $1.72 million for the years ended December 31, 2022, 2021 and 2020, respectively. The Company also recognized $9.83 million, $3.53 million and $31.08 million of investment tax credits for the years ended December 31, 2022, 2021 and 2020, respectively.

The Company is not required to consolidate VIEs in which it has concluded it does not have a controlling financial interest, and thus is not the primary beneficiary. In such cases, the Company does not have both the power to direct the entities’ most significant activities and the obligation to absorb losses or the right to receive benefits that could potentially be significant to the VIEs. As a limited partner in these operating partnerships, we are allocated credits and deductions associated with the underlying properties. The Company has determined that it is not the primary beneficiary of these investments because the general partners have the power to direct activities that most significantly influence the economic performance of their respective partnerships.

The Company’s investments in these unconsolidated VIEs are carried in Other Assets on the Consolidated Statements of Financial Condition. The Company’s unfunded capital and other commitments related to these unconsolidated VIEs are generally carried in Other Liabilities on the Consolidated Statements of Financial Condition. The Company’s maximum exposure to loss from these unconsolidated VIEs include the investment recorded on the Consolidated Statements of Financial Condition, net of unfunded capital commitments, and previously recorded tax credits which remain subject to recapture by taxing authorities based on compliance features required to be met at the project level. While the Company believes potential losses from these investments are remote, the maximum exposure was determined by assuming a scenario where the community-based business, housing projects and renewable energy projects completely fail and do not meet certain taxing authority compliance requirements resulting in recapture of the related tax credits.

The following table provides a summary of investments in affordable housing, community development and renewable energy VIEs that the Company has not consolidated as of December 31, 2022 and 2021.

| (Dollars in thousands) | 2022 | 2021 |
| --- | --- | --- |
| Investment carrying amount | $70,887 | $35,968 |
| Unfunded capital and other commitments | 64,520 | 29,670 |
| Maximum exposure to loss | 45,020 | 50,319 |

The Company is required to consolidate VIEs in which it has concluded it has significant involvement in and the ability to direct the activities that impact the entity’s economic performance. The Company is the managing general partner of entities to which it shares interest in tax-advantaged investments with a third party. At December 31, 2022 and 2021, approximately $66.26 million and $59.08 million, respectively, of the Company’s assets and $0.00 million and $0.00 million, respectively, of its liabilities included on the Consolidated Statements of Financial Condition were related to tax-advantaged investment VIEs which the Company has consolidated. The assets of the consolidated VIE are reported in Other Assets, the liabilities are reported in Other Liabilities and the non-controlling interest is reported in Equity on the Consolidated Statements of Financial Condition. The assets of a particular VIE are the primary source of funds to settle its obligations. The creditors of the VIE do not have recourse to the general credit of the Company. The Company’s exposure to the consolidated VIE is generally limited to the carrying value of its variable interest plus any related tax credits previously recognized.

71 • SRCE

2022 Form 10-K

Additionally, the Company sponsors one trust, 1st Source Master Trust (Capital Trust) of which 100% of the common equity is owned by the Company. The Capital Trust was formed in 2007 for the purpose of issuing corporation-obligated mandatorily redeemable capital securities (the capital securities) to third-party investors and investing the proceeds from the sale of the capital securities solely in junior subordinated debenture securities of the Company (the subordinated notes). The subordinated notes held by the Capital Trust are the sole assets of the Capital Trust. The Capital Trust qualifies as a variable interest entity for which the Company is not the primary beneficiary and therefore reported in the financial statements as an unconsolidated subsidiary. The junior subordinated debentures are reflected as subordinated notes on the Consolidated Statements of Financial Condition with the corresponding interest distributions reflected as Interest Expense on the Consolidated Statements of Income. The common shares issued by the Capital Trust are included in Other Assets on the Consolidated Statements of Financial Condition.

Distributions on the capital securities issued by the Capital Trust are payable quarterly at a rate per annum equal to the interest rate being earned by the Capital Trust on the subordinated notes held by the Capital Trust. The capital securities are subject to mandatory redemption, in whole or in part, upon repayment of the subordinated notes. The Company has entered into agreements which, taken collectively, fully and unconditionally guarantee the capital securities subject to the terms of each of the guarantees. The capital securities held by the Capital Trust qualify as Tier 1 capital under Federal Reserve Board guidelines.

The following table shows subordinated notes at December 31, 2022.

| (Dollars in thousands) | Amount of Subordinated Notes | Interest Rate | Maturity Date |
| --- | --- | --- | --- |
| June 2007 issuance (1) | $41,238 | 7.22% | 6/15/2037 |
| August 2007 issuance (2) | 17,526 | 6.25% | 9/15/2037 |
| Total | $58,764 |  |  |

(1) Fixed rate through life of debt.

(2) 3-Month LIBOR +1.48% through remaining life of debt.

### Note 13 - Earnings Per Share

Earnings per common share is computed using the two-class method. Basic earnings per common share is computed by dividing net income available to common shareholders by the weighted-average number of common shares outstanding during the applicable period, excluding outstanding participating securities. Participating securities include non-vested restricted stock awards. Non-vested restricted stock awards are considered participating securities to the extent the holders of these securities receive non-forfeitable dividends at the same rate as holders of common stock. Diluted earnings per common share is computed using the weighted-average number of shares determined for the basic earnings per common share computation plus the dilutive effect of stock compensation using the treasury stock method.

Stock options, where the exercise price was greater than the average market price of the common shares, were excluded from the computation of diluted earnings per common share because the result would have been antidilutive. No stock options were considered antidilutive as of December 31, 2022, 2021 and 2020.

The following table presents a reconciliation of the number of shares used in the calculation of basic and diluted earnings per common share for the three years ending December 31.

| (Dollars in thousands - except per share amounts) | 2022 | 2021 | 2020 |
| --- | --- | --- | --- |
| Distributed earnings allocated to common stock | $31,095 | $30,369 | $28,859 |
| Undistributed earnings allocated to common stock | 88,419 | 87,237 | 52,044 |
| Net earnings allocated to common stock | 119,514 | 117,606 | 80,903 |
| Net earnings allocated to participating securities | 995 | 928 | 534 |
| Net income allocated to common stock and participating securities | $120,509 | $118,534 | $81,437 |
| Weighted average shares outstanding for basic earnings per common share | 24,687,324 | 25,038,127 | 25,525,154 |
| Dilutive effect of stock compensation | - | - | - |
| Weighted average shares outstanding for diluted earnings per common share | 24,687,324 | 25,038,127 | 25,525,154 |
| Basic earnings per common share | $4.84 | $4.70 | $3.17 |
| Diluted earnings per common share | $4.84 | $4.70 | $3.17 |

72 • SRCE

2022 Form 10-K

#### Note 14 - Accumulated Other Comprehensive Loss

The following table presents reclassifications out of accumulated other comprehensive loss related to unrealized gains and losses on available-for-sale securities for the two years ending December 31.

| (Dollars in thousands) | 2022 | 2021 | Affected Line Item in the Statements of Income |
| --- | --- | --- | --- |
| Realized losses included in net income | $(184) | $(680) | (Losses) gains on investment securities available-for-sale |
|  | (184) | (680) | Income before income taxes |
| Tax effect | 43 | 160 | Income tax expense |
| Net of tax | $(141) | $(520) | Net income |

#### Note 15 - Employee Benefit Plans

The 1st Source Corporation Employee Stock Ownership and Profit Sharing Plan (as amended, the “Plan”) includes an employee stock ownership component, which is designed to invest in and hold 1st Source common stock, and a 401(k) plan component, which holds all Plan assets not invested in 1st Source common stock. The Plan encourages diversification of investments with opportunities to change investment elections and contribution levels.

Employees are eligible to participate in the Plan the first of the month following 90 days of employment. The Company matches dollar for dollar on the first 4% of deferred compensation, plus 50 cents on the dollar of the next 2% deferrals. The Company will also contribute to the Plan an amount designated as a fixed 2% employer contribution. The amount of fixed contribution is equal to two percent of the participant’s eligible compensation. Additionally, each year the Company may, in its sole discretion, make a discretionary profit sharing contribution. As of December 31, 2022 and 2021, there were 730,151 and 751,447 shares, respectively, of 1st Source Corporation common stock held in relation to employee benefit plans.

The Company contributions are allocated among the participants on the basis of compensation. Each participant’s account is credited with cash and/or shares of 1st Source common stock based on that participant’s compensation earned during the year. After completing 5 years of service in which they worked at least 1,000 hours per year, a participant will be completely vested in the Company’s contribution. An employee is always 100% vested in their deferral. Plan participants are entitled to receive distributions from their Plan accounts in-service and upon termination of service, retirement, or death.

Contribution expense for the years ended December 31, 2022, 2021, and 2020, amounted to $6.22 million, $6.31 million, and $5.70 million, respectively.

#### Note 16 - Stock Based Compensation

As of December 31, 2022, the Company had four active stock-based employee compensation plans. These plans include three executive stock award plans, the Executive Incentive Plan (EIP), the Restricted Stock Award Plan (RSAP), the Strategic Deployment Incentive Plan (SDP); and the Employee Stock Purchase Plan (ESPP). The 2011 Stock Option Plan was approved by the shareholders on April 21, 2011 but the Company had not made any grants through December 31, 2022. These stock-based employee compensation plans were established to help retain and motivate key employees. All of the plans have been approved by the shareholders of 1st Source Corporation. The Executive Compensation and Human Resources Committee (the “Committee”) of the 1st Source Corporation Board of Directors has sole authority to select the employees, establish the awards to be issued, and approve the terms and conditions of each award under the stock-based compensation plans.

Stock-based compensation to employees is recognized as compensation cost on the Consolidated Statements of Income based on their fair values on the measurement date, which, for 1st Source, is the date of grant. Stock-based compensation expense is recognized ratably over the requisite service period for all awards. The total fair value of share awards vested was $4.08 million during 2022, $3.45 million in 2021, and $2.67 million in 2020.

73 • SRCE

2022 Form 10-K

The following table shows the combined summary of activity regarding active stock option and stock award plans.

|  | Shares Available for Grant | Non-Vested Stock Awards Outstanding |  |
| --- | --- | --- | --- |
|  |  | Number of Shares | Weighted-Average Grant-Date Fair Value |
| Balance, January 1, 2020 | 664,502 | 218,991 | $29.60 |
| Shares authorized - 2020 EIP | 60,233 | - | - |
| Granted | (147,576) | 147,576 | 37.41 |
| Stock awards vested | - | (74,203) | 28.95 |
| Forfeited | 49 | (870) | 31.82 |
| Balance, December 31, 2020 | 577,208 | 291,494 | 33.71 |
| Shares authorized - 2021 EIP | 62,369 | - | - |
| Granted | (79,072) | 79,072 | 36.22 |
| Stock awards vested | - | (92,622) | 32.53 |
| Forfeited | 250 | (3,798) | 32.12 |
| Balance, December 31, 2021 | 560,755 | 274,146 | 34.86 |
| Shares authorized - 2022 EIP | 287,503 | - | - |
| Granted | (127,198) | 127,198 | 40.44 |
| Stock awards vested | - | (97,640) | 34.92 |
| Forfeited | 9,131 | (15,179) | 36.53 |
| Balance, December 31, 2022 | 730,191 | 288,525 | $37.03 |

**Stock Option Plans** - Incentive stock option plans include the 2011 Stock Option Plan (the “2011 Plan”).

Each award from the plan is evidenced by an award agreement that specifies the option price, the duration of the option, the number of shares to which the option pertains, and such other provisions as the Committee determines. The option price is equal to the fair market value of a share of 1st Source Corporation’s common stock on the date of grant. Options granted expire at such time as the Committee determines at the date of grant and in no event does the exercise period exceed a maximum of ten years. Upon merger, consolidation, or other corporate consolidation in which 1st Source Corporation is not the surviving corporation, as defined in the plans, all outstanding options immediately vest.

There were zero stock options exercised during 2022, 2021 or 2020. All shares issued in connection with stock option exercises and non-vested stock awards are issued from available treasury stock.

No stock-based compensation expense related to stock options was recognized in 2022, 2021 or 2020.

The fair value of each option on the date of grant is estimated using the Black-Scholes option pricing model. Expected volatility is based on the historical volatility estimated over a period equal to the expected life of the options. In estimating the fair value of stock options under the Black-Scholes valuation model, separate groups of employees that have similar historical exercise behavior are considered separately. The expected life of the options granted is derived based on past experience and represents the period of time that options granted are expected to be outstanding.

**Stock Award Plans** - Incentive stock award plans include the EIP, the SDP and the RSAP. The EIP is administered by the Committee. Awards under the EIP and SDP include “book value” shares and “market value” shares of common stock. These shares are awarded annually based on weighted performance criteria and generally vest over a period of five years. The EIP book value shares may only be sold to 1st Source and such sale is mandatory in the event of death, retirement, disability, or termination of employment. The RSAP is designed for key employees. Awards under the RSAP are made to employees recommended by the Chief Executive Officer and approved by the Committee. Shares granted under the RSAP vest over a period of up to ten years and vesting is based upon meeting certain various criteria, including continued employment with 1st Source.

Stock-based compensation expense relating to the EIP, SDP and RSAP totaled $3.59 million in 2022, $4.21 million in 2021, and $3.29 million in 2020. The total income tax benefit recognized in the accompanying Consolidated Statements of Income related to stock-based compensation was $0.83 million in 2022, $0.99 million in 2021, and $0.77 million in 2020. Unrecognized stock-based compensation expense related to non-vested stock awards (EIP/SDP/RSAP) was $7.90 million at December 31, 2022. At such date, the weighted-average period over which this unrecognized expense was expected to be recognized was 3.11 years.

The fair value of non-vested stock awards for the purposes of recognizing stock-based compensation expense is market price of the stock on the measurement date, which, for the Company’s purposes is the date of the award.

74 • SRCE

2022 Form 10-K

**Employee Stock Purchase Plan** - The Company offers an ESPP for substantially all employees with at least two years of service on the effective date of an offering under the plan. Eligible employees may elect to purchase any dollar amount of stock, so long as such amount does not exceed 25% of their base rate of pay and the aggregate stock accrual rate for all offerings does not exceed $25,000 in any calendar year. The purchase price for shares offered is the lower of the closing market bid price for the offering date or the average market bid price for the five business days preceding the offering date. The purchase price and premium/(discount) to the actual market closing price on the offering date for the 2022, 2021, and 2020 offerings were $46.78 (-0.34%), $49.98 (-0.42%), and $34.35 (1.78%), respectively. Payment for the stock is made through payroll deductions over the offering period, and employees may discontinue the deductions at any time and exercise the option or take the funds out of the program. The most recent offering began June 1, 2022 and runs through June 1, 2024, with $209,200 in stock value to be purchased at $46.78 per share.

#### Note 17 - Income Taxes

The following table shows the composition of income tax expense.

| Year Ended December 31 (Dollars in thousands) | 2022 | 2021 | 2020 |
| --- | --- | --- | --- |
| Current: |  |  |  |
| Federal | $38,779 | $16,346 | $42,411 |
| State | 6,937 | 4,586 | 6,629 |
| Total current | 45,716 | 20,932 | 49,040 |
| Deferred: |  |  |  |
| Federal | (7,936) | 14,206 | (21,865) |
| State | (1,525) | 1,190 | (2,295) |
| Total deferred | (9,461) | 15,396 | (24,160) |
| Total provision | $36,255 | $36,328 | $24,880 |

The following table shows the reasons for the difference between income tax expense and the amount computed by applying the statutory federal income tax rate (21%) to income before income taxes.

| Year Ended December 31 (Dollars in thousands) | 2022 |  | 2021 |  | 2020 |  |
| --- | --- | --- | --- | --- | --- | --- |
|  | Amount | Percent of Pretax Income | Amount | Percent of Pretax Income | Amount | Percent of Pretax Income |
| Statutory federal income tax | $32,925 | 21.0% | $32,526 | 21.0% | $22,332 | 21.0% |
| (Decrease) increase in income taxes resulting from: |  |  |  |  |  |  |
| Tax-exempt interest income | (504) | (0.3) | (373) | (0.2) | (439) | (0.4) |
| State taxes, net of federal income tax benefit | 4,275 | 2.7 | 4,563 | 2.9 | 3,424 | 3.2 |
| Other | (441) | (0.3) | (388) | (0.2) | (437) | (0.4) |
| Total | $36,255 | 23.1% | $36,328 | 23.5% | $24,880 | 23.4% |

The tax expense related to (losses) gains on investment securities available-for-sale for the years 2022, 2021, and 2020 was approximately $(39,000), $(164,000), and $67,000, respectively.

75 • SRCE

2022 Form 10-K

The following table shows the composition of deferred tax assets and liabilities as of December 31, 2022 and 2021.

| (Dollars in thousands) | 2022 | 2021 |
| --- | --- | --- |
| Deferred tax assets: |  |  |
| Allowance for credit losses | $33,237 | $32,431 |
| Operating lease liability | 4,728 | 5,145 |
| Accruals for employee benefits | 3,752 | 3,837 |
| Capitalized loan costs | - | 15 |
| Net unrealized losses on securities available-for-sale | 46,353 | 3,128 |
| Other | 426 | 1,015 |
| Total deferred tax assets | 88,496 | 45,571 |
| Deferred tax liabilities: |  |  |
| Differing depreciable bases in premises and leased equipment | 7,373 | 10,796 |
| Right of use assets - leases | 5,037 | 5,315 |
| Differing bases in assets related to acquisitions | 4,305 | 4,219 |
| Tax advantaged partnerships | 3,823 | 9,502 |
| Other | 245 | 713 |
| Total deferred tax liabilities | 20,783 | 30,545 |
| Net deferred tax asset | $67,713 | $15,026 |

No valuation allowance for deferred tax assets was recorded at December 31, 2022 and 2021 as the Company believes it is more likely than not that all of the deferred tax assets will be realized. Additionally, the tax credit carryforward generated in 2020 was fully utilized in 2021.

Tax years that remain open and subject to audit include the federal 2019-2022 years and the Indiana 2019-2022 years. The Company does not anticipate a significant change in the amount of uncertain tax positions within the next 12 months.

#### Note 18 - Contingent Liabilities, Commitments, and Financial Instruments with Off-Balance-Sheet Risk

**Contingent Liabilities** - 1st Source and its subsidiaries are defendants in various legal proceedings arising in the normal course of business. In the opinion of management, based upon present information including the advice of legal counsel, the ultimate resolution of these proceedings will not have a material effect on the Company's consolidated financial position or results of operations.

1st Source Bank sells residential mortgage loans to Fannie Mae as well as FHA-insured, USDA-insured and VA-guaranteed loans in Ginnie Mae mortgage-backed securities. Additionally, the Bank has sold loans on a service released basis to various other financial institutions in the past. The agreements under which the Bank sells these mortgage loans contain various representations and warranties regarding the acceptability of loans for purchase. On occasion, the Bank may be required to indemnify the loan purchaser for credit losses on loans that were later deemed ineligible for purchase or may be required to repurchase a loan. Both circumstances are collectively referred to as 'repurchases.'

The Company's liability for repurchases, included in Accrued Expenses and Other Liabilities on the Consolidated Statements of Financial Condition, was $0.17 million and $0.22 million as of December 31, 2022 and 2021, respectively. The mortgage repurchase liability represents the Company's best estimate of the loss that it may incur. The estimate is based on specific loan repurchase requests and a historical loss ratio with respect to origination dollar volume. Because the level of mortgage loan repurchase losses are dependent on economic factors, investor demand strategies and other external conditions that may change over the life of the underlying loans, the level of liability for mortgage loan repurchase losses is difficult to estimate and requires considerable management judgment.

**Lease Commitments** - The Company and its subsidiaries are obligated under operating leases for certain office premises and equipment.

The following table shows operating lease right of use assets and operating lease liabilities as of December 31.

| (Dollars in thousands) | Statement of Financial Condition classification | 2022 | 2021 |
| --- | --- | --- | --- |
| Operating lease right of use assets | Accrued income and other assets | $20,916 | $22,071 |
| Operating lease liabilities | Accrued expenses and other liabilities | $19,634 | $21,364 |

76 • SRCE

2022 Form 10-K

The following table shows the components of operating leases expense for the year ended December 31.

| (Dollars in thousands) | Statement of Income classification | 2022 | 2021 | 2020 |
| --- | --- | --- | --- | --- |
| Operating lease cost | Net occupancy expense | $3,527 | $3,480 | $3,472 |
| Short-term lease cost | Net occupancy expense | 18 | 20 | 8 |
| Variable lease cost (recovery of cost) | Net occupancy expense | 8 | - | (30) |
| Total operating lease cost |  | $3,553 | $3,500 | $3,450 |

The following table shows future minimum rental commitments for all noncancellable operating leases with an initial term longer than 12 months for the next five years and thereafter.

| (Dollars in thousands) |  |
| --- | --- |
| 2023 | $3,862 |
| 2024 | 3,281 |
| 2025 | 2,913 |
| 2026 | 2,620 |
| 2027 | 2,091 |
| Thereafter | 6,398 |
| Total lease payments | 21,165 |
| Less: imputed interest | (1,531) |
| Present value of operating lease liabilities | $19,634 |

The following table shows the weighted average remaining operating lease term, the weighted average discount rate and supplemental Consolidated Statement of Cash Flows information for operating leases at December 31.

| (Dollars in thousands) | 2022 | 2021 | 2020 |
| --- | --- | --- | --- |
| Weighted average remaining lease term | 9.33 years | 9.31 years | 10.17 years |
| Weighted average discount rate | 1.85% | 1.75% | 1.80% |
| Cash paid for amounts included in the measurement of lease liabilities: |  |  |  |
| Operating cash flows from operating leases | $4,298 | $4,006 | $3,794 |

There were no new significant leases that had not yet commenced as of December 31, 2022.

**Financial Instruments with Off-Balance-Sheet Risk** - To meet the financing needs of our clients, 1st Source and its subsidiaries are parties to financial instruments with off-balance-sheet risk in the normal course of business. These off-balance-sheet financial instruments include commitments to originate and sell loans and standby letters of credit. The instruments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the Consolidated Statements of Financial Condition.

Financial instruments, whose contract amounts represent credit risk as of December 31, were as follows:

| (Dollars in thousands) | 2022 | 2021 |
| --- | --- | --- |
| Amounts of commitments: |  |  |
| Loan commitments to extend credit | $1,234,866 | $1,148,984 |
| Standby letters of credit | $18,055 | $24,657 |
| Commercial and similar letters of credit | $2,368 | $8,531 |

The Company's exposure to credit loss in the event of nonperformance by the other party to the financial instruments for loan commitments and standby letters of credit is represented by the dollar amount of those instruments. The Company uses the same credit policies and collateral requirements in making commitments and conditional obligations as it does for on-balance-sheet instruments.

Loan commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. The Company grants mortgage loan commitments to borrowers subject to normal loan underwriting standards. The interest rate risk associated with these loan commitments is managed by entering into contracts for future deliveries of loans.

77 • SRCE

2022 Form 10-K

Standby letters of credit are conditional commitments issued to guarantee the performance of a client to a third party. The credit risk involved in and collateral obtained when issuing standby letters of credit are essentially the same as those involved in extending loan commitments to clients. Standby letters of credit generally have terms ranging from two months to one year.

Commercial letters of credit are issued specifically to facilitate commerce and typically result in the commitment being drawn on when the underlying transaction is consummated between the customer and the third party. Commercial letters of credit generally have terms ranging from two months to six months.

#### Note 19 - Derivative Financial Instruments

Commitments to originate residential mortgage loans held for sale and forward commitments to sell residential mortgage loans are considered derivative instruments. See Note 18 for further information.

The Company has certain interest rate derivative positions that are not designated as hedging instruments. Derivative assets and liabilities are recorded at fair value on the Consolidated Statements of Financial Condition and do not take into account the effects of master netting agreements. Master netting agreements allow the Company to settle all derivative contracts held with a single counterparty on a net basis, and to offset net derivative positions with related collateral, where applicable. These derivative positions relate to transactions in which the Company enters into an interest rate swap with a client while at the same time entering into an offsetting interest rate swap with another financial institution. In connection with each transaction, the Company agrees to pay interest to the client on a notional amount at a variable interest rate and receive interest from the client on the same notional amount at a fixed interest rate. At the same time, the Company agrees to pay another financial institution the same fixed interest rate on the same notional amount and receive the same variable interest rate on the same notional amount. The transaction allows the client to effectively convert a variable rate loan to a fixed rate. Because the terms of the swaps with the customers and the other financial institution offset each other, with the only difference being counterparty credit risk, changes in the fair value of the underlying derivative contracts are not materially different and do not significantly impact the Company's results of operations.

The following table shows the amounts of non-hedging derivative financial instruments at December 31, 2022 and 2021.

| (Dollars in thousands) | Notional or contractual amount | Asset derivatives |  | Liability derivatives |  |
| --- | --- | --- | --- | --- | --- |
|  |  | Statement of Financial Condition classification | Fair value | Statement of Financial Condition classification | Fair value |
| Interest rate swap contracts | $881,600 | Other assets | $24,838 | Other liabilities | $25,307 |
| Loan commitments | 2,638 | Mortgages held for sale | 67 | N/A | - |
| Forward contracts - mortgage loan | 3,750 | Mortgages held for sale | 24 | N/A | - |
| Total - December 31, 2022 | $887,988 |  | $24,929 |  | $25,307 |
| Interest rate swap contracts | $1,064,721 | Other assets | $20,735 | Other liabilities | $21,172 |
| Loan commitments | 15,086 | Mortgages held for sale | 452 | N/A | - |
| Forward contracts - mortgage loan | 22,000 | N/A | - | Mortgages held for sale | 11 |
| Total - December 31, 2021 | $1,101,807 |  | $21,187 |  | $21,183 |

The following table shows the amounts included on the Consolidated Statements of Income for non-hedging derivative financial instruments at December 31, 2022, 2021 and 2020.

| (Dollars in thousands) | Statement of Income classification | Gain (loss) |  |  |
| --- | --- | --- | --- | --- |
|  |  | 2022 | 2021 | 2020 |
| Interest rate swap contracts | Other expense | $(32) | $591 | $(650) |
| Interest rate swap contracts | Other income | 83 | 410 | 879 |
| Loan commitments | Mortgage banking | (385) | (1,035) | 1,302 |
| Forward contracts - mortgage loan | Mortgage banking | 35 | 279 | (252) |
| Total |  | $(299) | $245 | $1,279 |

78 • SRCE

2022 Form 10-K

The following table shows the offsetting of financial assets and derivative assets at December 31, 2022 and 2021.

| (Dollars in thousands) | Gross Amounts of Recognized Assets | Gross Amounts Offset in the Statement of Financial Condition | Net Amounts of Assets Presented in the Statement of Financial Condition | Gross Amounts Not Offset in the Statement of Financial Condition |  | Net Amount |
| --- | --- | --- | --- | --- | --- | --- |
|  |  |  |  | Financial Instruments | Cash Collateral Received |  |
| December 31, 2022 |  |  |  |  |  |  |
| Interest rate swaps | $24,838 | $ - | $24,838 | $ - | $25,295 | $(457) |
| December 31, 2021 |  |  |  |  |  |  |
| Interest rate swaps | $24,436 | $3,701 | $20,735 | $ - | $ - | $20,735 |

The following table shows the offsetting of financial liabilities and derivative liabilities at December 31, 2022 and 2021.

| (Dollars in thousands) | Gross Amounts of Recognized Liabilities | Gross Amounts Offset in the Statement of Financial Condition | Net Amounts of Liabilities Presented in the Statement of Financial Condition | Gross Amounts Not Offset in the Statement of Financial Condition |  | Net Amount |
| --- | --- | --- | --- | --- | --- | --- |
|  |  |  |  | Financial Instruments | Cash Collateral Pledged |  |
| December 31, 2022 |  |  |  |  |  |  |
| Interest rate swaps | $25,307 | $ - | $25,307 | $ - | $ - | $25,307 |
| Repurchase agreements | 141,432 | - | 141,432 | 141,432 | - | - |
| Total | $166,739 | $ - | $166,739 | $141,432 | $ - | $25,307 |
| December 31, 2021 |  |  |  |  |  |  |
| Interest rate swaps | $24,873 | $3,701 | $21,172 | $20,498 | $ - | $674 |
| Repurchase agreements | 194,727 | - | 194,727 | 194,727 | - | - |
| Total | $219,600 | $3,701 | $215,899 | $215,225 | $ - | $674 |

If a default in performance of any obligation of a repurchase or derivative agreement occurs, each party will set-off property held, or loan indebtedness owing, in respect of transactions against obligations owing in respect of any other transactions. At December 31, 2022 and December 31, 2021, repurchase agreements had a remaining contractual maturity of $138.08 million and $191.47 million in overnight and $3.35 million and $3.26 million in up to 30 days, respectively and were collateralized by U.S. Treasury and Federal agencies securities.

## Note 20 - Regulatory Matters

The Company is subject to various regulatory capital requirements administered by the Federal banking agencies. Failure to meet minimum capital requirements can result in certain mandatory and possible additional discretionary actions by regulators that, if undertaken, could have a material effect on the Company's financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Company must meet specific capital guidelines that involve quantitative measures of assets, liabilities, and certain off-balance-sheet items as calculated under regulatory accounting practices. Capital amounts and classification are subject to qualitative judgments by the regulators about components, risk weightings, and other factors.

Quantitative measures established by regulation to ensure capital adequacy require the Company to maintain minimum amounts and ratios of total capital, Tier 1 capital, and common equity Tier 1 capital to risk-weighted assets and of Tier 1 capital to average assets. The Company believes that it meets all capital adequacy requirements to which it is subject.

The most recent notification from the Federal bank regulators categorized 1st Source Bank, the largest of its subsidiaries, as 'well capitalized' under the regulatory framework for prompt corrective action. To be categorized as 'well capitalized' the Bank must maintain minimum total risk-based, Tier 1 risk-based, common equity Tier 1 risk-based, and Tier 1 leverage ratios as set forth in the table below. There are no conditions or events since that notification that the Company believes will have changed the institution's category.

79 • SRCE

2022 Form 10-K

As discussed in Note 12, the capital securities held by the Capital Trusts qualify as Tier 1 capital under Federal Reserve Board guidelines. The following table shows the actual and required capital amounts and ratios for 1st Source Corporation and 1st Source Bank as of December 31, 2022 and 2021.

| (Dollars in thousands) | Actual |  | Minimum Capital Adequacy |  | Minimum Capital Adequacy with Capital Buffer |  | To Be Well Capitalized Under Prompt Corrective Action Provisions |  |
| --- | --- | --- | --- | --- | --- | --- | --- | --- |
|  | Amount | Ratio | Amount | Ratio | Amount | Ratio | Amount | Ratio |
| 2022 |  |  |  |  |  |  |  |  |
| Total Capital (to Risk-Weighted Assets): |  |  |  |  |  |  |  |  |
| 1st Source Corporation | $1,137,984 | 16.10% | $565,314 | 8.00% | $741,975 | 10.50% | $706,643 | 10.00% |
| 1st Source Bank | 1,060,292 | 15.01 | 565,119 | 8.00 | 741,718 | 10.50 | 706,398 | 10.00 |
| Tier 1 Capital (to Risk-Weighted Assets): |  |  |  |  |  |  |  |  |
| 1st Source Corporation | 1,048,955 | 14.84 | 423,986 | 6.00 | 600,647 | 8.50 | 565,314 | 8.00 |
| 1st Source Bank | 971,294 | 13.75 | 423,839 | 6.00 | 600,439 | 8.50 | 565,119 | 8.00 |
| Common Equity Tier 1 Capital (to Risk-Weighted Assets): |  |  |  |  |  |  |  |  |
| 1st Source Corporation | 932,257 | 13.19 | 317,989 | 4.50 | 494,650 | 7.00 | 459,318 | 6.50 |
| 1st Source Bank | 911,596 | 12.90 | 317,879 | 4.50 | 494,479 | 7.00 | 459,159 | 6.50 |
| Tier 1 Capital (to Average Assets): |  |  |  |  |  |  |  |  |
| 1st Source Corporation | 1,048,955 | 12.63 | 332,287 | 4.00 | N/A | N/A | 415,359 | 5.00 |
| 1st Source Bank | 971,294 | 11.70 | 332,125 | 4.00 | N/A | N/A | 415,156 | 5.00 |
| 2021 |  |  |  |  |  |  |  |  |
| Total Capital (to Risk-Weighted Assets): |  |  |  |  |  |  |  |  |
| 1st Source Corporation | $1,034,605 | 16.76% | $493,751 | 8.00% | $648,048 | 10.50% | $617,189 | 10.00% |
| 1st Source Bank | 969,228 | 15.71 | 493,412 | 8.00 | 647,603 | 10.50 | 616,765 | 10.00 |
| Tier 1 Capital (to Risk-Weighted Assets): |  |  |  |  |  |  |  |  |
| 1st Source Corporation | 956,783 | 15.50 | 370,313 | 6.00 | 524,611 | 8.50 | 493,751 | 8.00 |
| 1st Source Bank | 891,458 | 14.45 | 370,059 | 6.00 | 524,250 | 8.50 | 493,412 | 8.00 |
| Common Equity Tier 1 Capital (to Risk-Weighted Assets): |  |  |  |  |  |  |  |  |
| 1st Source Corporation | 846,573 | 13.72 | 277,735 | 4.50 | 432,032 | 7.00 | 401,173 | 6.50 |
| 1st Source Bank | 838,248 | 13.59 | 277,544 | 4.50 | 431,735 | 7.00 | 400,897 | 6.50 |
| Tier 1 Capital (to Average Assets): |  |  |  |  |  |  |  |  |
| 1st Source Corporation | 956,783 | 11.89 | 321,925 | 4.00 | N/A | N/A | 402,407 | 5.00 |
| 1st Source Bank | 891,458 | 11.08 | 321,821 | 4.00 | N/A | N/A | 402,277 | 5.00 |

The Bank was not required to maintain noninterest bearing cash balances with the Federal Reserve Bank as of December 31, 2022 and 2021.

Dividends that may be paid by a subsidiary bank to the parent company are subject to certain legal and regulatory limitations and also may be affected by capital needs, as well as other factors.

Due to the Company's mortgage activities, 1st Source Bank is required to maintain minimum net worth capital requirements established by various governmental agencies. 1st Source Bank's net worth requirements are governed by the Department of Housing and Urban Development and GNMA. As of December 31, 2022, 1st Source Bank met its minimum net worth capital requirements.

#### **Note 21 - Fair Value Measurements**

The Company determines the fair values of its financial instruments based on the fair value hierarchy, which requires an entity to maximize the use of quoted prices and observable inputs and to minimize the use of unobservable inputs when measuring fair value. The Company elected fair value accounting for mortgages held for sale and for its best-efforts forward sales commitments. The Company economically hedges its mortgages held for sale at the time the interest rate locks are issued to the customers. The Company believes the election for mortgages held for sale will reduce certain timing differences and better match changes in the value of these assets with changes in the value of the derivatives or best-efforts forward sales commitments. At December 31, 2022 and 2021, all mortgages held for sale are carried at fair value.

80 • SRCE

2022 Form 10-K

The following table shows the differences between fair value carrying amount of mortgages held for sale measured at fair value and the aggregate unpaid principal amount the Company is contractually entitled to receive at maturity on December 31, 2022 and 2021.

| (Dollars in thousands) | Fair value carrying amount | Aggregate unpaid principal | Excess of fair value carrying amount over (under) unpaid principal |
| --- | --- | --- | --- |
| December 31, 2022 |  |  |  |
| Mortgages held for sale reported at fair value: |  |  |  |
| Total Loans | $3,914 | $3,766 | $148 (1) |
| December 31, 2021 |  |  |  |
| Mortgages held for sale reported at fair value: |  |  |  |
| Total Loans | $13,284 | $12,456 | $828 (1) |

(1) The excess of fair value carrying amount over (under) unpaid principal is included in mortgage banking income and includes changes in fair value at and subsequent to funding and gains and losses on the related loan commitment prior to funding.

### ***Financial Instruments on Recurring Basis:***

The following is a description of the valuation methodologies used for financial instruments measured at fair value on a recurring basis:

Investment securities available-for-sale are valued primarily by a third-party pricing agent. Prices supplied by the independent pricing agent, as well as their pricing methodologies and assumptions, are reviewed by the Company for reasonableness and to ensure such prices are aligned with market levels. In general, the Company's investment securities do not possess a complex structure that could introduce greater valuation risk. The portfolio mainly consists of traditional investments including U.S. Treasury and Federal agencies securities, Federal agency mortgage pass-through securities, and general obligation and revenue municipal bonds. Pricing for such instruments is fairly generic and is easily obtained. On a quarterly basis, prices supplied by the pricing agent are validated by comparison to prices obtained from other third party sources for a material portion of the portfolio.

The valuation policy and procedures for Level 3 fair value measurements of available-for-sale debt securities are decided through collaboration between management of the Corporate Accounting and Funds Management departments. The changes in fair value measurement for Level 3 securities are analyzed on a periodic basis under a collaborative framework with the aforementioned departments. The methodology and variables used for input are derived from the combination of observable and unobservable inputs. The unobservable inputs are determined through internal assumptions that may vary from period to period due to external factors, such as market movement and credit rating adjustments.

Both the market and income valuation approaches are implemented using the following types of inputs:

- • U.S. treasuries are priced using the market approach and utilizing live data feeds from active market exchanges for identical securities.
- • Government-sponsored agency debt securities and corporate bonds are primarily priced using available market information through processes such as benchmark curves, market valuations of like securities, sector groupings and matrix pricing.
- • Other government-sponsored agency securities, mortgage-backed securities and some of the actively traded REMICs and CMOs, are primarily priced using available market information including benchmark yields, prepayment speeds, spreads and volatility of similar securities.
- • State and political subdivisions are largely grouped by characteristics, i.e., geographical data and source of revenue in trade dissemination systems. Since some securities are not traded daily and due to other grouping limitations, active market quotes are often obtained using benchmarking for like securities. Local direct placement municipal securities, with very little market activity, are priced using an appropriate market yield curve which incorporates a credit spread assumption.

Mortgages held for sale and the related loan commitments and forward contracts (economic hedges) are valued by a third party pricing agent. Prices supplied by the independent pricing agent, as well as their pricing methodologies, are reviewed by the Company for reasonableness and to ensure such prices are aligned with market values. On a quarterly basis, prices supplied by the pricing agent are validated by comparison to the prices obtained from other third party sources.

81 • SRCE

2022 Form 10-K

Interest rate swap positions, both assets and liabilities, are valued by a third-party pricing agent using an income approach and utilizing models that use as their basis readily observable market parameters. This valuation process considers various factors including interest rate yield curves, time value and volatility factors. Validation of third-party agent valuations is accomplished by comparing those values to the Company’s swap counterparty valuations. Management believes an adjustment is required to “mid-market” valuations for derivatives tied to its performing loan portfolio to recognize the imprecision and related exposure inherent in the process of estimating expected credit losses as well as velocity of deterioration evident with systemic risks embedded in these portfolios. Any change in the mid-market derivative valuation adjustment will be recognized immediately through the Consolidated Statements of Income.

The following table shows the balance of assets and liabilities measured at fair value on a recurring basis.

| (Dollars in thousands) | Level 1 | Level 2 | Level 3 | Total |
| --- | --- | --- | --- | --- |
| December 31, 2022 |  |  |  |  |
| Assets: |  |  |  |  |
| Investment securities available-for-sale: |  |  |  |  |
| U.S. Treasury and Federal agencies securities | $573,679 | $424,919 | $ - | $998,598 |
| U.S. States and political subdivisions securities | - | 121,298 | 1,464 | 122,762 |
| Mortgage-backed securities - Federal agencies | - | 637,058 | - | 637,058 |
| Corporate debt securities | - | 16,131 | - | 16,131 |
| Foreign government and other securities | - | 579 | - | 579 |
| Total debt securities available-for-sale | 573,679 | 1,199,985 | 1,464 | 1,775,128 |
| Mortgages held for sale | - | 3,914 | - | 3,914 |
| Accrued income and other assets (interest rate swap agreements) | - | 24,838 | - | 24,838 |
| Total | $573,679 | $1,228,737 | $1,464 | $1,803,880 |
| Liabilities: |  |  |  |  |
| Accrued expenses and other liabilities (interest rate swap agreements) | $ - | $25,307 | $ - | $25,307 |
| Total | $ - | $25,307 | $ - | $25,307 |
| December 31, 2021 |  |  |  |  |
| Assets: |  |  |  |  |
| Investment securities available-for-sale: |  |  |  |  |
| U.S. Treasury and Federal agencies securities | $561,950 | $522,056 | $ - | $1,084,006 |
| U.S. States and political subdivisions securities | - | 93,852 | 1,849 | 95,701 |
| Mortgage-backed securities - Federal agencies | - | 659,727 | - | 659,727 |
| Corporate debt securities | - | 23,009 | - | 23,009 |
| Foreign government and other securities | - | 598 | - | 598 |
| Total debt securities available-for-sale | 561,950 | 1,299,242 | 1,849 | 1,863,041 |
| Mortgages held for sale | - | 13,284 | - | 13,284 |
| Accrued income and other assets (interest rate swap agreements) | - | 20,735 | - | 20,735 |
| Total | $561,950 | $1,333,261 | $1,849 | $1,897,060 |
| Liabilities: |  |  |  |  |
| Accrued expenses and other liabilities (interest rate swap agreements) | $ - | $21,172 | $ - | $21,172 |
| Total | $ - | $21,172 | $ - | $21,172 |

82 • SRCE

2022 Form 10-K

The following table shows the changes in Level 3 assets and liabilities measured at fair value on a recurring basis.

| (Dollars in thousands) | U.S. States and political subdivisions securities |
| --- | --- |
| Beginning balance January 1, 2022 | $1,849 |
| Total gains or losses (realized/unrealized): |  |
| Included in earnings | - |
| Included in other comprehensive income | (135) |
| Purchases | 3,000 |
| Issuances | - |
| Sales | - |
| Settlements | - |
| Maturities | (3,250) |
| Transfers into Level 3 | - |
| Transfers out of Level 3 | - |
| Ending balance December 31, 2022 | $1,464 |
| Beginning balance January 1, 2021 | $2,152 |
| Total gains or losses (realized/unrealized): |  |
| Included in earnings | - |
| Included in other comprehensive income | (15) |
| Purchases | - |
| Issuances | - |
| Sales | - |
| Settlements | - |
| Maturities | (288) |
| Transfers into Level 3 | - |
| Transfers out of Level 3 | - |
| Ending balance December 31, 2021 | $1,849 |

There were no gains or losses for the period included in earnings attributable to the change in unrealized gains or losses relating to assets and liabilities still held at December 31, 2022 or 2021.

The following table shows the valuation methodology and unobservable inputs for Level 3 assets and liabilities measured at fair value on a recurring basis.

| (Dollars in thousands) | Fair value | Valuation Methodology | Unobservable Inputs | Range of Inputs | Weighted Average |
| --- | --- | --- | --- | --- | --- |
| December 31, 2022 |  |  |  |  |  |
| Debt securities available-for-sale |  |  |  |  |  |
| Direct placement municipal securities | $1,464 | Discounted cash flows | Credit spread assumption | 0.22% - 4.09% | 3.49% |
| December 31, 2021 |  |  |  |  |  |
| Debt securities available-for-sale |  |  |  |  |  |
| Direct placement municipal securities | $1,849 | Discounted cash flows | Credit spread assumption | 0.04% - 2.31% | 1.58% |

#### ***Financial Instruments on Non-recurring Basis:***

The Company may be required, from time to time, to measure certain other financial assets at fair value on a non-recurring basis in accordance with GAAP. These adjustments to fair value usually result from application of lower of cost or market accounting or impairment charges of individual assets.

83 • SRCE

2022 Form 10-K

The Credit Policy Committee (CPC), a management committee, is responsible for overseeing the valuation processes and procedures for Level 3 measurements of impaired loans, other real estate and repossessions. The CPC reviews these assets on a quarterly basis to determine the accuracy of the observable inputs, generally third-party appraisals, auction values, values derived from trade publications and data submitted by the borrower, and the appropriateness of the unobservable inputs, generally discounts due to current market conditions and collection issues. The CPC establishes discounts based on asset type and valuation source; deviations from the standard are documented. The discounts are reviewed periodically, annually at a minimum, to determine they remain appropriate. Consideration is given to current trends in market values for the asset categories and gain and losses on sales of similar assets. The Loan and Funds Management Committee of the Board of Directors is responsible for overseeing the CPC.

Discounts vary depending on the nature of the assets and the source of value. Aircraft are generally valued using quarterly trade publications adjusted for engine time, condition, maintenance programs, discounted by 10%. Likewise, autos are valued using current auction values, discounted by 10%; medium and heavy duty trucks are valued using trade publications and auction values, discounted by 15%. Construction equipment is generally valued using trade publications and auction values, discounted by 20%. Real estate is valued based on appraisals or evaluations, discounted by 20% at a minimum with higher discounts for property in poor condition or property with characteristics which may make it more difficult to market. Commercial loans subject to borrowing base certificates are generally discounted by 20% for receivables and 40% - 75% for inventory with higher discounts when monthly borrowing base certificates are not required or received.

Collateral-dependent impaired loans and related write-downs are based on the fair value of the underlying collateral if repayment is expected solely from the collateral. Collateral values are reviewed quarterly and estimated using customized discounting criteria, appraisals and dealer and trade magazine quotes which are used in a market valuation approach. In accordance with fair value measurements, only impaired loans for which an allowance for loan loss has been established based on the fair value of collateral require classification in the fair value hierarchy. As a result, only a portion of the Company's impaired loans are classified in the fair value hierarchy.

The Company has established MSRs valuation policies and procedures based on industry standards and to ensure valuation methodologies are consistent and verifiable. MSRs and related adjustments to fair value result from application of lower of cost or fair value accounting. For purposes of impairment, MSRs are stratified based on the predominant risk characteristics of the underlying servicing, principally by loan type. The fair value of each tranche of the servicing portfolio is estimated by calculating the present value of estimated future net servicing cash flows, taking into consideration actual and expected mortgage loan prepayment rates, discount rates, servicing costs, and other economic factors. Prepayment rates and discount rates are derived through a third-party pricing agent. Changes in the most significant inputs, including prepayment rates and discount rates, are compared to the changes in the fair value measurements and appropriate resolution is made. A fair value analysis is also obtained from an independent third-party agent and compared to the internal valuation for reasonableness. MSRs do not trade in an active, open market with readily observable prices and though sales of MSRs do occur, precise terms and conditions typically are not readily available and the characteristics of the Company's servicing portfolio may differ from those of any servicing portfolios that do trade.

Other real estate is based on the fair value of the underlying collateral less expected selling costs. Collateral values are estimated primarily using appraisals and reflect a market value approach. Fair values are reviewed quarterly and new appraisals are obtained annually. Repossessions are similarly valued.

For assets measured at fair value on a nonrecurring basis the following represents impairment charges (recoveries) recognized on these assets during the year ended December 31, 2022 and 2021, respectively: collateral-dependent impaired loans - $0.00 million and $2.76 million; MSRs - $0.00 million and $(0.81) million; repossessions - $0.00 million and $0.27 million, and other real estate - $0.00 million and $0.06 million.

84 • SRCE

2022 Form 10-K

The following table shows the carrying value of assets measured at fair value on a non-recurring basis.

| (Dollars in thousands) | Level 1 | Level 2 | Level 3 | Total |
| --- | --- | --- | --- | --- |
| December 31, 2022 |  |  |  |  |
| Collateral-dependent impaired loans | $ - | $ - | $ - | $ - |
| Accrued income and other assets (mortgage servicing rights) | - | - | 4,137 | 4,137 |
| Accrued income and other assets (repossessions) | - | - | 327 | 327 |
| Accrued income and other assets (other real estate) | - | - | 104 | 104 |
| Total | $ - | $ - | $4,568 | $4,568 |
| December 31, 2021 |  |  |  |  |
| Collateral-dependent impaired loans | $ - | $ - | $571 | $571 |
| Accrued income and other assets (mortgage servicing rights) | - | - | 4,671 | 4,671 |
| Accrued income and other assets (repossessions) | - | - | 861 | 861 |
| Accrued income and other assets (other real estate) | - | - | - | - |
| Total | $ - | $ - | $6,103 | $6,103 |

The following table shows the valuation methodology and unobservable inputs for Level 3 assets and liabilities measured at fair value on a non-recurring basis.

| (Dollars in thousands) | Carrying Value | Fair Value | Valuation Methodology | Unobservable Inputs | Range of Inputs | Weighted Average |
| --- | --- | --- | --- | --- | --- | --- |
| December 31, 2022 |  |  |  |  |  |  |
| Collateral-dependent impaired loans | $ - | $ - | Collateral based measurements including appraisals, trade publications, and auction values | Discount for lack of marketability and current conditions | 0% - 0% | 0% |
| Mortgage servicing rights | 4,137 | 8,007 | Discounted cash flows | Constant prepayment rate (CPR) | 7.6% - 9.6% | 8.2% |
|  |  |  |  | Discount rate | 11.4% - 14.2% | 11.5% |
| Repossessions | 327 | 370 | Appraisals, trade publications and auction values | Discount for lack of marketability | 2% - 9% | 7% |
| Other real estate | 104 | 104 | Appraisals | Discount for lack of marketability | 0% - 0% | 0% |
| December 31, 2021 |  |  |  |  |  |  |
| Collateral-dependent impaired loans | $571 | $571 | Collateral based measurements including appraisals, trade publications, and auction values | Discount for lack of marketability and current conditions | 20% - 90% | 43.1% |
| Mortgage servicing rights | 4,671 | 5,640 | Discounted cash flows | Constant prepayment rate (CPR) | 11.8% - 18.5% | 16.4% |
|  |  |  |  | Discount rate | 8.6% - 11.5% | 8.8% |
| Repossessions | 861 | 942 | Appraisals, trade publications and auction values | Discount for lack of marketability | 0% - 21% | 2% |
| Other real estate | - | - | Appraisals | Discount for lack of marketability | 0% - 0% | 0% |

GAAP requires disclosure of the fair value of financial assets and financial liabilities, including those financial assets and financial liabilities that are not measured and reported at fair value on a recurring or non-recurring basis.

85 • SRCE

2022 Form 10-K

The following table shows the fair values of the Company's financial instruments.

| (Dollars in thousands) | Carrying or Contract Value | Fair Value | Level 1 | Level 2 | Level 3 |
| --- | --- | --- | --- | --- | --- |
| December 31, 2022 |  |  |  |  |  |
| Assets: |  |  |  |  |  |
| Cash and due from banks | $84,703 | $84,703 | $84,703 | $ - | $ - |
| Federal funds sold and interest bearing deposits with other banks | 38,094 | 38,094 | 38,094 | - | - |
| Investment securities, available-for-sale | 1,775,128 | 1,775,128 | 573,679 | 1,199,985 | 1,464 |
| Other investments | 25,293 | 25,293 | 25,293 | - | - |
| Mortgages held for sale | 3,914 | 3,914 | - | 3,914 | - |
| Loans and leases, net of allowance for loan and lease losses | 5,871,894 | 5,712,972 | - | - | 5,712,972 |
| Mortgage servicing rights | 4,137 | 8,007 | - | - | 8,007 |
| Accrued interest receivable | 24,747 | 24,747 | - | 24,747 | - |
| Interest rate swaps | 24,838 | 24,838 | - | 24,838 | - |
| Liabilities: |  |  |  |  |  |
| Deposits | $6,928,265 | $6,909,392 | $5,787,806 | $1,121,586 | $ - |
| Short-term borrowings | 215,529 | 215,529 | 139,079 | 76,450 | - |
| Long-term debt and mandatorily redeemable securities | 46,555 | 45,111 | - | 45,111 | - |
| Subordinated notes | 58,764 | 51,398 | - | 51,398 | - |
| Accrued interest payable | 5,999 | 5,999 | - | 5,999 | - |
| Interest rate swaps | 25,307 | 25,307 | - | 25,307 | - |
| Off-balance-sheet instruments * | - | 108 | - | 108 | - |
| December 31, 2021 |  |  |  |  |  |
| Assets: |  |  |  |  |  |
| Cash and due from banks | $54,420 | $54,420 | $54,420 | $ - | $ - |
| Federal funds sold and interest bearing deposits with other banks | 470,767 | 470,767 | 470,767 | - | - |
| Investment securities, available-for-sale | 1,863,041 | 1,863,041 | 561,950 | 1,299,242 | 1,849 |
| Other investments | 27,189 | 27,189 | 27,189 | - | - |
| Mortgages held for sale | 13,284 | 13,284 | - | 13,284 | - |
| Loans and leases, net of allowance for loan and lease losses | 5,218,722 | 5,269,551 | - | - | 5,269,551 |
| Mortgage servicing rights | 4,671 | 5,640 | - | - | 5,640 |
| Accrued interest receivable | 17,760 | 17,760 | - | 17,760 | - |
| Interest rate swaps | 20,735 | 20,735 | - | 20,735 | - |
| Liabilities: |  |  |  |  |  |
| Deposits | $6,679,065 | $6,680,163 | $5,794,928 | $885,235 | $ - |
| Short-term borrowings | 200,027 | 200,027 | 192,801 | 7,226 | - |
| Long-term debt and mandatorily redeemable securities | 71,251 | 71,305 | - | 71,305 | - |
| Subordinated notes | 58,764 | 58,553 | - | 58,553 | - |
| Accrued interest payable | 1,885 | 1,885 | - | 1,885 | - |
| Interest rate swaps | 21,172 | 21,172 | - | 21,172 | - |
| Off-balance-sheet instruments * | - | 364 | - | 364 | - |

\* Represents estimated cash outflows required to currently settle the obligations at current market rates.

These estimates do not reflect any premium or discount that could result from offering for sale at one time the Company's entire holdings of a particular financial instrument. These estimates are subjective in nature and require considerable judgment to interpret market data. Accordingly, the estimates presented herein are not necessarily indicative of the amounts the Company could realize in a current market exchange, nor are they intended to represent the fair value of the Company as a whole. The use of different market assumptions and/or estimation methodologies may have a material effect on the estimated fair value amounts. The fair value estimates presented herein are based on pertinent information available to management as of the respective balance sheet date. Although the Company is not aware of any factors that would significantly affect the estimated fair value amounts, such amounts have not been comprehensively revalued since the presentation dates, and therefore, estimates of fair value after the balance sheet date may differ significantly from the amounts presented herein.

86 • SRCE

2022 Form 10-K

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