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EX-32 - EXHIBIT 32 - MUTUALFIRST FINANCIAL INCv471129_ex32.htm
EX-31.2 - EXHIBIT 31.2 - MUTUALFIRST FINANCIAL INCv471129_ex31-2.htm
EX-31.1 - EXHIBIT 31.1 - MUTUALFIRST FINANCIAL INCv471129_ex31-1.htm

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q

 

x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
  For the quarterly period ended June 30, 2017
  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 000-27905

 

MutualFirst Financial, Inc.
(Exact name of registrant as specified in its charter)

 

Maryland   35-2085640
(State or other jurisdiction of incorporation or organization)   (I.R.S. Employer Identification No.)
     
110 E. Charles Street, Muncie, Indiana   47305-2419
(Address of principal executive offices)   (Zip Code)

 

Registrant’s telephone number, including area code: (765) 747-2800

 

Securities registered pursuant to Section 12(b) of the Act:

 

Title of each class Name of each exchange on which registered
Common Stock, par value $.01 per share Nasdaq Global Market

 

Securities Registered Pursuant to Section 12(g) of the Act:

None

 

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

 

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 x

 

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 x No ¨

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted 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 and post such files). Yes x No ¨

 

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

 

Large accelerated filer  ¨ Accelerated filer  x Non-accelerated filer  ¨ Smaller reporting company  ¨
    (Do not check if smaller
    reporting company)

Emerging growth company  ¨

 

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

 

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

 

Indicate the number of shares outstanding of each of the registrant’s classes of common stock as of the latest practicable date. As of August 7, 2017, there were 7,381,394 shares of the registrant’s common stock outstanding. 

 

 

 

 

  

MutualFirst Financial, Inc.

Form 10-Q Quarterly Report for the Period Ended June 30, 2017

Table of Contents

 

  Page
  Number
PART I – FINANCIAL INFORMATION  
     
Item 1. Financial Statements  
  Consolidated Condensed Balance Sheets 1
  Consolidated Condensed Statements of Income 2
  Consolidated Condensed Statements of Comprehensive Income 3
  Consolidated Condensed Statement of Stockholders’ Equity 4
  Consolidated Condensed Statements of Cash Flows 5
  Notes to Unaudited Consolidated Condensed Financial Statements 7
     
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations 31
     
Item 3. Quantitative and Qualitative Disclosures about Market Risk 44
     
Item 4. Controls and Procedures 45
     
PART II – OTHER INFORMATION  
     
Item 1. Legal Proceedings 45
     
Item 1A. Risk Factors 45
     
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds 46
     
Item 3. Defaults Upon Senior Securities 46
     
Item 4. Mine Safety Disclosure 46
     
Item 5. Other Information 46
     
Item 6. Exhibits 47
     
Signature Page 49
   
Exhibits 50

 

 

 

  

MutualFirst Financial, Inc.

Consolidated Condensed Balance Sheets
(In Thousands, Except Share and Per Share Data)

  

   June 30,   December 31, 
   2017   2016 
   (Unaudited)     
Assets          
Cash and due from banks  $6,998   $8,503 
Interest-bearing demand deposits   18,170    18,357 
Cash and cash equivalents   25,168    26,860 
Interest-bearing time deposits   2,046    993 
Investment securities available for sale (carried at fair value)   256,642    249,913 
Loans held for sale   8,796    4,063 
Loans, net of allowance for loan losses of $12,426 and $12,382, at June 30, 2017 and December 31, 2016, respectively   1,171,927    1,157,120 
Premises and equipment, net   20,886    21,200 
Federal Home Loan Bank stock   11,183    10,925 
Deferred tax asset, net   10,800    12,037 
Cash value of life insurance   52,155    51,594 
Goodwill   1,800    1,800 
Other real estate owned and repossessed assets   709    1,199 
Other assets   13,837    15,429 
Total assets  $1,575,949   $1,553,133 
           
Liabilities and Stockholders' Equity          
Liabilities          
Deposits          
Noninterest-bearing  $187,173   $178,046 
Interest-bearing   985,812    975,336 
Total deposits   1,172,985    1,153,382 
Federal Home Loan Bank advances   235,991    240,591 
Other borrowings   4,211    4,189 
Other liabilities   16,436    14,933 
Total liabilities   1,429,623    1,413,095 
           
Commitments and Contingencies          
           
Stockholders' Equity          
Common stock, $.01 par value          
Authorized - 20,000,000 shares          
Issued and outstanding - 7,344,233 and 7,324,233 shares at June 30, 2017 and December 31, 2016, respectively   73    73 
Additional paid-in capital   74,303    74,164 
Retained earnings   71,809    67,055 
Accumulated other comprehensive income (loss)   141    (1,254)
Total stockholders' equity   146,326    140,038 
Total liabilities and stockholders' equity  $1,575,949   $1,553,133 

 

See notes to consolidated condensed financial statements

 

  1

 

  

MutualFirst Financial, Inc.

Consolidated Condensed Statements of Income
(Unaudited)

(In Thousands, Except Share and Per Share Data)

 

   Three Months Ended   Six Months Ended 
   June 30,   June 30, 
   2017   2016   2017   2016 
Interest and Dividend Income                    
Loans receivable  $12,753   $11,515   $25,002   $22,735 
Investment securities   1,745    1,610    3,466    3,299 
Federal Home Loan Bank stock   117    111    231    216 
Deposits with financial institutions   37    22    62    42 
Total interest and dividend income   14,652    13,258    28,761    26,292 
                     
Interest Expense                    
Deposits   1,634    1,283    3,100    2,568 
Federal Home Loan Bank advances   883    897    1,769    1,792 
Other   48    91    92    183 
Total interest expense   2,565    2,271    4,961    4,543 
                     
Net Interest Income   12,087    10,987    23,800    21,749 
Provision for loan losses   300    150    500    350 
Net Interest Income After Provision for Loan Losses   11,787    10,837    23,300    21,399 
                     
Non-interest Income                    
Service fee income   1,714    1,528    3,114    2,902 
Net realized gain on sales of available for sale securities   279    652    408    770 
Commissions   1,318    1,404    2,514    2,503 
Net gains on sales of loans   945    1,407    1,715    2,347 
Net servicing fees   96    78    197    148 
Increase in cash value of life insurance   288    306    560    590 
Loss on sale of other real estate and repossessed assets   (75)   (188)   (21)   (217)
Other income   105    706    307    847 
Total non-interest income   4,670    5,893    8,794    9,890 
                     
Non-interest Expenses                    
Salaries and employee benefits   6,534    6,660    13,260    13,151 
Net occupancy expenses   763    601    1,572    1,247 
Equipment expenses   438    484    865    971 
Data processing fees   541    492    1,095    981 
ATM and debit card expenses   410    356    828    736 
Deposit insurance   168    225    381    459 
Professional fees   408    380    804    850 
Advertising and promotion   303    269    614    696 
Software subscriptions and maintenance   567    549    1,136    1,029 
Other real estate and repossessed assets   33    14    80    86 
Other expenses   1,052    1,210    1,988    2,450 
Total non-interest expenses   11,217    11,240    22,623    22,656 
                     
Income Before Income Tax   5,240    5,490    9,471    8,633 
Income tax expense   1,342    1,333    2,367    2,111 
Net Income Available to Common Shareholders  $3,898   $4,157   $7,104   $6,522 
                     
Earnings Per Common Share                    
Basic  $0.53   $0.56   $0.97   $0.87 
Diluted  $0.52   $0.55   $0.95   $0.86 
Dividends Per Common Share  $0.16   $0.14   $0.32   $0.28 

 

See notes to consolidated condensed financial statements

 

  2

 

  

MutualFirst Financial, Inc.

Consolidated Condensed Statements of Comprehensive Income
(Unaudited)

(In Thousands)

 

   Three Months Ended   Six Months Ended 
   June 30,   June 30, 
   2017   2016   2017   2016 
Net Income  $3,898   $4,157   $7,104   $6,522 
Other Comprehensive Income                    
Net unrealized holding gain on securities available for sale   1,802    2,452    2,517    5,866 
Reclassification adjustment for realized gains included in net income   (279)   (652)   (408)   (770)
Net unrealized loss on derivative used for cash flow hedges   -    (3)   -    (28)
    1,523    1,797    2,109    5,068 
Income tax expense related to other comprehensive income   (519)   (610)   (714)   (1,729)
Other comprehensive income, net of tax   1,004    1,187    1,395    3,339 
Comprehensive Income  $4,902   $5,344   $8,499   $9,861 

 

See notes to consolidated condensed financial statements

 

  3

 

 

MutualFirst Financial, Inc.

Consolidated Condensed Statement of Changes in Stockholders’ Equity
For the Period Ended June 30, 2017

(Unaudited)

(In Thousands, Except Share and Per Share Data)

 

   Common
Stock
   Additional
Paid-in Capital
   Retained
Earnings
   Accumulated Other
Comprehensive Income
(Loss)
   Total 
Balances December 31, 2016  $73   $74,164   $67,055   $(1,254)  $140,038 
Net income             7,104         7,104 
Other comprehensive income, net of taxes                  1,395    1,395 
Stock options, exercised        139              139 
Cash dividends, common stock ($.32 per share)             (2,350)        (2,350)
Balances June 30, 2017  $73   $74,303   $71,809   $141   $146,326 

  

See notes to consolidated condensed financial statements

 

  4

 

 

MutualFirst Financial, Inc.

Consolidated Condensed Statements of Cash Flows
(Unaudited)

(In Thousands, Except Share and Per Share Data)

 

   Six Months Ended June 30, 
   2017   2016 
Operating Activities          
Net income  $7,104   $6,522 
Items not requiring cash          
Provision for loan losses   500    350 
Depreciation and amortization   2,290    2,543 
Deferred income tax   524    158 
Increase in cash value of life insurance   (560)   (590)
Loans originated for sale   (54,702)   (64,176)
Proceeds from sales of loans held for sale   51,538    63,724 
Net gain on sale of loans   (1,715)   (2,347)
Net gain on sale of securities, available for sale   (408)   (770)
Loss on sale of other real estate and repossessed assets   21    217 
Change in          
Interest receivable and other assets   1,009    (551)
Interest payable and other liabilities   (377)   293 
Other adjustments   (8)   70 
Net cash provided by operating activities   5,216    5,443 
           
Investing Activities          
Net change in interest-bearing time deposits   (1,053)   (980)
Purchases of securities, available for sale   (34,401)   (28,801)
Proceeds from maturities and paydowns of securities, available for sale   13,326    17,741 
Proceeds from sales of securities, available for sale   18,365    29,901 
Purchase of Federal Home Loan Bank stock   (258)   (158)
Net change in loans   (16,415)   (28,628)
Purchases of premises and equipment   (415)   (1,690)
Proceeds from real estate owned sales   649    1,471 
Proceeds from sale of real estate held for investment   502    - 
Proceeds from bank owned life insurance   -    1,121 
Gain on bank owned life insurance   -    (346)
Proceeds from sale of premises and equipment   -    65 
Net cash used in investing activities   (19,700)   (10,304)
           
Financing Activities          
Net change in          
Noninterest-bearing, interest-bearing demand and savings deposits   13,511    14,714 
Certificates of deposit   6,092    (9,595)
Proceeds from FHLB advances   164,200    129,900 
Repayments of FHLB advances   (168,800)   (111,700)
Net repayments other borrowings   -    (379)
Cash dividends   (2,350)   (2,093)
Stock options exercised   139    976 
Stock repurchased   -    (4,354)
Net cash provided by financing activities   12,792    17,469 
Net Change in Cash and Cash Equivalents   (1,692)   12,608 
Cash and Cash Equivalents, Beginning of Period   26,860    20,915 
Cash and Cash Equivalents, End of Period  $25,168   $33,523 
           
Additional Cash Flows Information          
Interest paid  $4,802   $4,492 
Income tax paid   1,000    400 
Transfers from loans to foreclosed assets   168    816 
Mortgage servicing rights capitalized   146    204 
Purchase of securities, due to broker   1,970    3,766 

 

See notes to consolidated condensed financial statements

 

  5

 

  

MutualFirst Financial, Inc.

Notes to Consolidated Financial Statements

(Unaudited)

(In Thousands, Except Share and Per Share Data)

 

Note 1:  Basis of Presentation

 

The consolidated condensed financial statements include the accounts of MutualFirst Financial, Inc. (MutualFirst or the “Company”), its wholly owned subsidiaries, MFBC Statutory Trust, MutualFirst Risk Management, Inc., Mutual Risk Advisors, Inc., and MutualBank, an Indiana commercial bank (“Mutual” or the “Bank”), Mutual’s wholly owned subsidiaries, First MFSB Corporation, Mishawaka Financial Services, Summit Service Corp. and the wholly owned subsidiary of Summit Service Corp., Summit Mortgage Inc. (“Summit”), Mutual Federal Investment Company (“MFIC”), and MFIC majority owned subsidiary, Mutual Federal REIT, Inc. All significant inter-company accounts and transactions have been eliminated in consolidation. These companies conform to accounting principles generally accepted in the United States of America and reporting practices followed by the banking industry. The more significant of the policies are described below.

 

Certain information and note disclosures normally included in the Company’s annual financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted. These consolidated condensed financial statements should be read in conjunction with the consolidated financial statements and notes thereto included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2016, filed with the Securities and Exchange Commission on March 16, 2017.

 

The interim consolidated condensed financial statements at and for the three and six months ended June 30, 2017 and 2016, have not been audited by independent accountants, but in the opinion of management, reflect all adjustments (which include only normal recurring adjustments) necessary to present fairly the financial position, results of operations and cash flows for such periods. The results of operations for the period are not necessarily indicative of the results to be expected for the full year.

 

The Consolidated Condensed Balance Sheet of the Company as of December 31, 2016 has been derived from the Audited Consolidated Balance Sheet of the Company as of that date.

 

Note 2: Earnings Per Share

 

Earnings per share were computed as follows:

 

   Three Months Ended June 30, 
   2017   2016 
   Net
Income
   Weighted-
Average
Shares
   Per-Share
Amount
   Net
Income
   Weighted-
Average
Shares
   Per-Share
Amount
 
Basic Earnings Per Share                              
Net income  $3,898    7,344,233   $0.53   $4,157    7,453,333   $0.56 
Effect of Dilutive Securities                              
Stock options        143,256              142,955      
Diluted Earnings Per Share                              
Net income available and assumed conversions  $3,898    7,487,489   $0.52   $4,157    7,596,288   $0.55 

 

   Six Months Ended June 30, 
   2017   2016 
   Net
Income
   Weighted-
Average
Shares
   Per-Share
Amount
   Net
Income
   Weighted-
Average
Shares
   Per-Share
Amount
 
Basic Earnings Per Share                              
Net income  $7,104    7,338,377   $0.97   $6,522    7,459,871   $0.87 
Effect of Dilutive Securities                              
Stock options        145,641              146,213      
Diluted Earnings Per Share                              
Net income available and assumed conversions  $7,104    7,484,018   $0.95   $6,522    7,606,084   $0.86 

 

  6

 

  

As of June 30, 2017 and 2016, the exercise price for all options was lower than the average market price of the common shares.

 

Note 3: Impact of Accounting Pronouncements

 

In March 2017, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2017-08, Receivables-Nonrefundable Fees and Other Costs (Subtopic 310-20): Premium Amortization on Purchased Callable Debt Securities. The ASU shortens the amortization period for certain callable debt securities held at a premium and requires the premium to be amortized to the earliest call date. However, the amendments do not require an accounting change for securities held at a discount; the discount continues to be amortized to maturity. The amendments are effective for annual periods beginning after December 15, 2018, including interim periods within those annual periods. Early adoption is permitted. The Company early adopted this ASU in the first quarter of 2017 and it did not have a material impact on the Company’s consolidated financial statements.

 

In January 2017, the FASB issued ASU 2017-04, Intangibles-Goodwill and Other (Topic 350)-Simplifying the Test for Goodwill Impairment. These amendments eliminate Step 2 from the goodwill impairment test. The amendments also eliminate the requirements for any reporting unit with a zero or negative carrying amount to perform a qualitative assessment and, if it fails that qualitative test, to perform Step 2 of the goodwill impairment test. An entity still has the option to perform the qualitative assessment for a reporting unit to determine if the quantitative impairment test is necessary. The guidance is effective for annual or any interim goodwill impairment tests in fiscal years beginning after December 15, 2019. Early adoption is permitted for interim goodwill impairment tests performed on testing dates after January 1, 2017. ASU 2017-04 should be adopted on a prospective basis. The Company has assessed ASU 2017-04 and does not expect it to have a material impact on its accounting and disclosures.

 

In January 2017, the FASB issued ASU 2017-01, Business Combinations (Topic 805)-Clarifying the Definition of a Business. ASU 2017-01 provides amendments to clarify the definition of a business and affect all companies and other reporting organizations that must determine whether they have acquired or sold a business. The amendments are intended to help companies and other organizations evaluate whether transactions should be accounted for as acquisitions (or disposals) of assets or businesses. The guidance is effective for public business entities for fiscal years beginning after December 15, 2017, and interim periods within those fiscal years and should be applied prospectively as of the beginning of the period of adoption. Early adoption is permitted under certain circumstances. The Company has assessed ASU 2017-01 and does not expect it to have a material impact on its accounting and disclosures.

 

In August 2016, the FASB issued ASU 2016-15, Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts and Cash Payments. The ASU is intended to address diversity in how certain cash receipts and cash payments are presented and classified in the statement of cash flows by specifically addressing eight specific areas. The amendments are effective for the Company for annual and interim periods beginning in the first quarter of 2018. Early adoption is permitted, including adoption in an interim period. The Company is currently evaluating the effects that this ASU will have on its financial statements, specifically the Statement of Cash Flows, and does not expect these effects to be material.

 

In June 2016, the Financial Accounting Standards Board (FASB) issued ASU 2016-13, Financial Instruments-Credit Losses (Topic 326): Measurement of Credit Losses on Financial Statements. Topic 326 amends guidance on reporting credit losses for assets held at amortized cost basis and available for sale debt securities. The ASU is intended to provide financial statement users with useful information about the expected credit losses on financial instruments and other commitments to extend credit.

 

·The ASU requires financial assets measured at amortized cost (primarily loans) be presented at the amount net of a valuation allowance for credit losses, and that the income statement include the measurement of credit losses for newly recognized financial assets as well as changes in expected losses on previously recognized financial assets. The provisions of this ASU does not specify the method for measuring expected credit losses, and an entity is allowed to apply methods that reasonably reflect its expectations of the credit loss estimate. The new model will be based on relevant information including past events, historical experience, current conditions, and reasonable and supportive forecasts that affect the collectability of the asset. The provisions of this ASU differ from current U.S. generally accepted accounting principles (“GAAP”) in that current U.S. GAAP generally delays recognition of the full amount of credit losses until the loss is probable of occurring.
·This ASU requires that credit losses on available-for-sale debt securities be presented as an allowance rather than as a write-down.

 

This ASU will be effective for the Company for interim and annual periods beginning in the first quarter of 2020. Earlier adoption is permitted beginning in the first quarter of 2019. The Company is in the evaluation stage for this ASU in order to determine the most appropriate method of implementation and all resources and data (both current and historical) needed.

 

In March 2016, the FASB issued ASU 2016-09, Compensation–Stock Compensation: Improvements to Employee Share-Based Payment Accounting. The amendments are intended to improve the accounting for employee share-based payments and affect all organizations that issue share-based payment awards to their employees. This Update includes amendments that currently apply, or may apply in the future, to the Company related to the following: (1) accounting for the difference between the deduction for tax purposes and the amount of compensation cost recognized for financial reporting purposes; (2) classification of excess tax benefits on the statement of cash flows; (3) accounting for forfeitures; (4) accounting for awards partially settled in cash in excess of the employer’s minimum statutory tax withholding requirements; and (5) classification of employee taxes paid on the statement of cash flows when an employer withholds shares for tax-withholding purposes. The amendments in this Update were effective for the Company for annual and interim periods beginning in the first quarter 2017. The ASU provides separate transition provisions for each of the amendments. Initial adoption of this ASU in 2017 did not have a material impact on the Company.

 

  7

 

  

In February 2016, the FASB issued ASU 2016-02, Leases. The objective of the amendment is to establish the principles that lessees and lessors shall apply to report useful information to users of financial statements about the amount, timing, and uncertainty of cash flows arising from a lease. These changes will increase transparency among companies by recognizing lease assets and liabilities on the balance sheet and disclosing additional information about lease arrangements. The amendments in this update are effective for annual and interim periods beginning in the first quarter of 2019. The Company has operating leases in place for some locations as well as equipment and is in the early stages of evaluating the potential impact of adopting this amendment.

 

In January 2016, the FASB issued ASU 2016-01, Financial Instruments-Overall: Recognition and Measurement of Financial Assets and Financial Liabilities. The amendments in this Update require: (1) all equity investments to be measured at fair value with changes in the fair value recognized through net income (other than those accounted for under equity method of accounting or those that result in consolidation of the investee); (2) an entity to present separately in other comprehensive income the portion of the total change in the fair value of a liability resulting from a change in the instrument-specific credit risk when the entity has elected to measure the liability at fair value in accordance with the fair value option for financial instruments; and (3) eliminates the requirement to disclose the method(s) and significant assumptions used to estimate the fair value that is required to be disclosed for financial instruments measured at amortized cost on the balance sheet for public business entities. The new guidance is effective for the Company for annual and interim periods beginning in the first quarter of 2018. Current evaluation would indicate that the primary area impacted by the amendments of this ASU will be our investment in Federal Home Loan Bank stock, which is an equity security and does not have a readily determinable fair value. See Note 1 - Significant Accounting Policies, “Federal Home Loan Bank Stock” for information regarding the Company’s investment. The adoption of ASU 2016-01 is not anticipated to have a material effect on the Company’s consolidated financial statements.

 

Note 4: Investment Securities

 

The amortized costs and approximate fair values, together with gross unrealized gains and losses on securities, are in the tables below. All mortgage-backed securities and collateralized mortgage obligations held as of June 30, 2017 and December 31, 2016 were guaranteed by government sponsored entities, government corporations or federal agencies.

 

   June 30, 2017 
   Amortized
Cost
   Gross
Unrealized
Gains
   Gross
Unrealized
Losses
   Fair Value 
Available for Sale Securities                    
Mortgage-backed securities  $77,050   $508   $(862)  $76,696 
Collateralized mortgage obligations   76,717    246    (704)   76,259 
Municipal obligations   85,246    2,779    (556)   87,469 
Corporate obligations   17,395    71    (1,248)   16,218 
Total investment securities  $256,408   $3,604   $(3,370)  $256,642 

 

   December 31, 2016 
   Amortized
Cost
   Gross
Unrealized
Gains
   Gross
Unrealized
Losses
   Fair Value 
Available for Sale Securities                    
Mortgage-backed securities  $92,871   $802   $(1,156)  $92,517 
Collateralized mortgage obligations   68,621    269    (843)   68,047 
Municipal obligations   77,474    1,716    (1,508)   77,682 
Corporate obligations   12,822    78    (1,233)   11,667 
Total investment securities  $251,788   $2,865   $(4,740)  $249,913 

 

  8

 

  

The amortized cost and fair value of securities available for sale at June 30, 2017, by contractual maturity, are shown below. Expected maturities will differ from contractual maturities because issuers may have the right to call or prepay obligations with or without call or prepayment penalties.

 

   Available for Sale 
Description Securities  Amortized Cost   Fair Value 
Security obligations due          
Within one year  $160   $160 
One to five years   5,057    5,086 
Five to ten years   23,978    24,774 
After ten years   73,446    73,667 
    102,641    103,687 
Mortgage-backed securities   77,050    76,696 
Collateralized mortgage obligations   76,717    76,259 
Totals  $256,408   $256,642 

 

Proceeds from sales of securities available for sale for the three and six months ended June 30, 2017 were $12.7 million and $18.4 million, respectively. For the three and six months ended June 30, 2016, proceeds from sales of securities available for sale were $26.0 million and $29.9 million, respectively. Gross gains were recognized on the sales for the three and six months ended June 30, 2017 of $279,000 and $408,000, respectively. Gross gains of $701,000 and $819,000 were recognized, for the three and six months ended June 30, 2016. There were no gross losses recognized on the sales of securities for the three and six months ended June 30, 2017, respectively. Gross losses of $49,000 for the three and six months ended June 30, 2016, were also recognized on those sales.

 

Certain investments in debt securities are reported in the financial statements at an amount less than their historical cost. Total fair value of these investments at June 30, 2017 and December 31, 2016 was $115.9 million and $143.8 million, respectively, which was approximately 45.2 percent and 57.6 percent, respectively, of the Company’s investment portfolio at those dates.

 

Based on our evaluation of available evidence, including recent changes in market interest rates, management believes the fair value for the securities at less than historical cost for the periods presented, are temporary.

 

Should the impairment of any of these securities become other than temporary, the cost basis of the investment will be reduced and the resulting loss recognized in net income in the period the other-than-temporary impairment is identified.

 

During the first six months of 2017 and 2016, the Bank determined that its security holdings had no other-than-temporary impairment.

 

  9

 

  

The following tables show the gross unrealized losses and fair value of the Company’s investments, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position at June 30, 2017 and December 31, 2016:

 

   June 30, 2017 
   Less than 12 Months   12 Months or More   Total 
   Fair
Value
   Unrealized
Losses
   Fair
Value
   Unrealized
Losses
   Fair
Value
   Unrealized
Losses
 
Available for Sale                              
Mortgage-backed securities  $50,104   $(862)  $-   $-   $50,104   $(862)
Collateralized mortgage obligations   35,441    (558)   4,326    (146)   39,767    (704)
Municipal obligations   18,752    (555)   159    (1)   18,911    (556)
Corporate obligations   4,548    (2)   2,588    (1,246)   7,136    (1,248)
Total temporarily impaired securities  $108,845   $(1,977)  $7,073   $(1,393)  $115,918   $(3,370)

 

   December 31, 2016 
   Less than 12 Months   12 Months or More   Total 
   Fair
Value
   Unrealized
Losses
   Fair
Value
   Unrealized
Losses
   Fair
Value
   Unrealized
Losses
 
Available for Sale                              
Mortgage-backed securities  $58,056   $(1,156)  $-   $-   $58,056   $(1,156)
Collateralized mortgage obligations   41,769    (683)   4,688    (160)  $46,457   $(843)
Municipal obligations   31,907    (1,507)   337    (1)   32,244    (1,508)
Corporate obligations   -    -    7,076    (1,233)   7,076    (1,233)
Total temporarily impaired securities  $131,732   $(3,346)  $12,101   $(1,394)  $143,833   $(4,740)

 

Mortgage-Backed Securities (MBS) and Collateralized Mortgage Obligations (CMO)

 

The unrealized losses on the Company’s investment in MBSs and CMOs were caused by interest rate changes. The Company expects to recover the amortized cost basis over the term of the securities. Because (1) the decline in market value is attributable to changes in interest rates and not credit quality, (2) the Company does not intend to sell the investments and (3) it is more likely than not the Company will not be required to sell the investments before recovery of their amortized cost bases, which may be at maturity, the Company does not consider any of these investments to be other-than-temporarily impaired at June 30, 2017.

 

Municipals

 

The unrealized losses on the Company’s investments in securities of state and political subdivisions were caused by changes in interest rates.  The contractual terms of those investments do not permit the issuer to settle the securities at a price less than the par value of the investments.  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. The Company does not consider any of these investment securities to be other-than-temporarily impaired at June 30, 2017.

 

Corporate Obligations

 

The Company’s unrealized losses on investments in corporate obligations primarily relates to two investments in pooled trust preferred securities. The unrealized losses were primarily caused by (1) a decrease in performance and regulatory capital resulting from exposure to subprime mortgages and (2) a sector downgrade by industry analysts.

 

Other-Than-Temporary Impairment (OTTI)

 

Upon acquisition of a security, the Company decides whether it is within the scope of the accounting guidance for beneficial interests in securitized financial assets or whether it will be evaluated for impairment under the accounting guidance for investments in debt and equity securities.

 

The accounting guidance for beneficial interests in securitized financial assets provides incremental impairment guidance for a subset of the debt securities within the scope of the guidance for investments in debt and equity securities. For securities that are a beneficial interest in securitized financial assets, the Company uses the beneficial interests in securitized financial asset impairment model. For securities that are not a beneficial interest in securitized financial assets, the Company uses debt and equity securities impairment accounting model.

 

  10

 

  

The Company conducts periodic reviews to identify and evaluate each investment security to determine whether an other-than-temporary impairment has occurred. Economic models are used to determine whether an other-than-temporary impairment has occurred on these securities. While all securities are considered, the securities primarily impacted by other-than-temporary impairment testing are private-label mortgage-backed securities and trust preferred securities.

 

MutualFirst Financial uses market-based yield indicators as a baseline for determining appropriate discount rates, and then adjusts the resulting discount rates on the basis of its credit and structural analysis of specific trust preferred securities. The primary focus is on the returns a fixed income investor would require in order to allocate capital on a risk adjusted basis. There is currently little demand for pooled trust preferred securities; however, the Company looks principally to market yields for stand-alone trust preferred securities issued by banks, thrifts and insurance companies for which there is an active and liquid market. The next step is to make a series of adjustments to reflect the differences that exist between these products (both credit and structural) and, most importantly, to reflect idiosyncratic credit performance differences (both actual and projected) between these products and the underlying collateral in the specific trust preferred security. Importantly, as part of the analysis described above, MutualFirst considers the fact that structured instruments frequently exhibit leverage not present in stand-alone instruments, and makes adjustments as necessary to reflect this additional risk.

 

  11

 

 

Pooled Trust Preferred Securities. The Company has invested in pooled trust preferred securities. At June 30, 2017, the current book balance of our pooled trust preferred securities was $3.8 million. The original par value of these securities was $4.0 million. All pooled trust preferred securities owned were performing as agreed in the first six months of 2017. All pooled trust preferred securities owned by the Company are exempt from the Volcker Rule.

 

The following table provides additional information related to the Company’s investment in pooled trust preferred securities as of June 30, 2017:

 

Deal Name  Class  Original
Par
   Book
Value
   Fair
Value
   Unrealized
loss
   Realized
Losses 
YTD
   Lowest
Current
Rating
  Number of
Banks /
Insurance
Cos.
Currently
Performing
   Total
Number
of Banks
and
Insurance
Cos. In
Issuance
(Unique)
   Actual
Deferrals/
Defaults
(as a % of
original
collateral)
   Total
Projected
Defaults
 (as a % of
performing
collateral)
(1)
   Excess
subordination
(after taking
into account
best estimate
of future
deferrals/
 defaults) (2)
 
   (Dollars in Thousands)
Alesco Preferred Funding IX  Aa3  $1,000   $920   $563   $(357)  $-   CCC-   44    49    4.20%   9.55%   54.52%
U.S. Capital Funding I  B3   3,000    2,914    2,025    (889)   -   Caa1   29    33    7.95%   6.19%   12.69%
      $4,000   $3,834   $2,588   $(1,246)  $-                             

 

 

(1)A 10% recovery is applied to all projected defaults by depository institutions. A 15% recovery is applied to all projected defaults by insurance companies. No recovery is applied to current defaults.
(2)Excess subordination represents the additional defaults in excess of both current and projected defaults that the CDO can absorb before the bond experiences any credit impairment. Excess subordinated percentage is calculated by (a) determining what percentage of defaults a deal can experience before the bond has credit impairment, and (b) subtracting from this default breakage percentage both total current and expected future default percentages.

 

  12

 

 

Note 5: Loans and Allowance

 

Classes of loans at June 30, 2017 and December 31, 2016 include:

 

   June 30,   December 31, 
   2017   2016 
Real estate          
Commercial  $298,801   $302,577 
Commercial construction and development   29,008    22,453 
Consumer closed end first mortgage   467,802    478,848 
Consumer open end and junior liens   70,572    71,222 
Total real estate loans   866,183    875,100 
Other loans          
Consumer loans          
Auto   18,675    18,939 
Boat/RVs   158,556    141,602 
Other   5,605    5,892 
Commercial and industrial   139,145    131,103 
Total other loans   321,981    297,536 
Total loans   1,188,164    1,172,636 
Undisbursed loans in process   (9,753)   (8,691)
Unamortized deferred loan costs, net   5,942    5,557 
Allowance for loan losses   (12,426)   (12,382)
Net loans  $1,171,927   $1,157,120 

 

The risk characteristics of each loan portfolio segment are as follows:

 

Commercial

 

Real estate

 

These loans are viewed primarily as cash flow loans and secondarily as loans secured by real estate. Commercial real estate lending typically involves higher loan principal amounts and the repayment of these loans is generally dependent on the successful operation of the property securing the loan or the business conducted on the property securing the loan. Commercial real estate loans may be more adversely affected by conditions in the real estate markets or in the general economy. The properties securing the Company’s commercial real estate portfolio are diverse in terms of type and geographic location. Management monitors and evaluates commercial real estate loans based on collateral, geography and risk grade criteria. As a general rule, the Company avoids financing single purpose projects unless other underwriting factors are present to help mitigate risk. In addition, management tracks the level of owner-occupied commercial real estate loans versus non-owner occupied loans.

 

Construction and Development

 

Construction loans are underwritten utilizing feasibility studies, independent appraisal reviews, sensitivity analyses of absorption and lease rates and financial analyses of the developers and property owners. Construction loans are generally based on estimates of costs and value associated with the complete project. These estimates may be inaccurate. Construction loans often involve the disbursement of substantial funds with repayment substantially dependent on the success of the ultimate project. Sources of repayment for these types of loans may be pre-committed permanent loans from approved long-term lenders, sales of developed property or an interim loan commitment from the Company until permanent financing is obtained. These loans are closely monitored by on-site inspections and are considered to have higher risks than other real estate loans due to their ultimate repayment being sensitive to interest rate changes, governmental regulation of real property, general economic conditions and the availability of long-term financing.

 

Commercial and Industrial

 

Commercial loans are primarily based on the identified cash flows of the borrower and secondarily on the underlying collateral provided by the borrower. The cash flows of borrowers, however, may not be as expected and the collateral securing these loans may fluctuate in value. Most commercial loans are secured by the assets being financed or other business assets such as accounts receivable or inventory and may incorporate a personal guarantee; however, some loans may be made on an unsecured basis. In the case of loans secured by accounts receivable, the availability of funds for the repayment of these loans may be substantially dependent on the ability of the borrower to collect amounts due from its customers.

 

  13

 

  

Consumer Real Estate and Other Consumer Loans

 

With respect to residential loans that are secured by consumer closed end first mortgages and are primarily owner occupied, the Company generally establishes a maximum loan-to-value ratio and requires PMI if that ratio is exceeded. Consumer open end and junior lien loans are typically secured by a subordinate interest in 1-4 family residences, and other consumer loans are secured by consumer assets such as automobiles or recreational vehicles. Some consumer loans are unsecured such as small installment loans and certain lines of credit. Repayment of these loans is primarily dependent on the personal income of the borrowers, which can be impacted by economic conditions in their market areas such as unemployment levels. Repayment can also be impacted by changes in property values on residential properties. Risk is mitigated by the fact that the loans are of smaller individual amounts and spread over a large number of borrowers.

 

Nonaccrual Loans and Past Due Loans

 

Loans are considered past due if the required principal and interest payments have not been received as of the date such payments were due. Loans are placed on non-accrual status when, in management’s opinion, the borrower may be unable to meet payment obligations as they become due, as well as when required by regulatory provisions, but never greater than 90 days past due.

 

All interest accrued but not collected for loans that are placed on nonaccrual status or charged off is reversed against interest income. The interest on these loans is accounted for on the cash-basis or cost-recovery method, until qualifying for return to accrual status. Loans are returned to accrual status when all the principal and interest amounts contractually due are brought current and future payments are reasonably assured and generally only after six months of satisfactory performance.

 

Nonaccrual loans, segregated by class of loans, as of June 30, 2017 and December 31, 2016 are as follows:

 

   June 30,   December 31, 
   2017   2016 
Real estate          
Commercial  $1,199   $912 
Commercial construction and development   -    - 
Consumer closed end first mortgage   1,679    3,626 
Consumer open end and junior liens   238    335 
Consumer loans          
Auto   4    5 
Boat/RVs   342    224 
Other   10    24 
Commercial and industrial   39    18 
Total nonaccrual loans  $3,511   $5,144 

 

  14

 

 

An age analysis of the Company’s past due loans, segregated by class of loans, as of June 30, 2017 and December 31, 2016 are as follows:

 

   June 30, 2017 
   30-59
Days
Past
Due
   60-89
Days
Past
Due
   90 Days
or More
Past
Due
   Total
Past
Due
   Current   Total
Loans
Receivable
   Total
Loans 90
Days
Past Due
and
Accruing
 
Real estate                                   
Commercial  $614   $11   $1,081   $1,706   $297,095   $298,801   $- 
Commercial construction and development   157    -    -    157    28,851    29,008    - 
Consumer closed end first mortgage   3,603    380    1,500    5,483    462,319    467,802    24 
Consumer open end and junior liens   243    76    200    519    70,053    70,572    - 
Consumer loans                                   
Auto   48    19    2    69    18,606    18,675    - 
Boat/RVs   805    336    156    1,297    157,259    158,556    - 
Other   55    15    13    83    5,522    5,605    3 
Commercial and industrial   230    4    37    271    138,874    139,145    - 
Total  $5,755   $841   $2,989   $9,585   $1,178,579   $1,188,164   $27 

 

   December 31, 2016 
   30-59
Days
Past
Due
   60-89
Days
Past
Due
   90 Days
or More
Past
Due
   Total
Past
Due
   Current   Total
Loans
Receivable
   Total
Loans 90
Days
Past Due
and
Accruing
 
Real estate                                   
Commercial  $854   $142   $785   $1,781   $300,796   $302,577   $- 
Commercial construction and development   -    -    -    -    22,453    22,453    - 
Consumer closed end first mortgage   6,789    1,554    3,675    12,018    466,830    478,848    237 
Consumer open end and junior liens   512    166    304    982    70,240    71,222    - 
Consumer loans                                   
Auto   103    25    5    133    18,806    18,939    - 
Boat/RVs   1,376    305    213    1,894    139,708    141,602    - 
Other   89    26    13    128    5,764    5,892    - 
Commercial and industrial   497    32    8    537    130,566    131,103    - 
Total  $10,220   $2,250   $5,003   $17,473   $1,155,163   $1,172,636   $237 

 

  15

 

  

Impaired Loans

 

Loans are considered impaired in accordance with the impairment accounting guidance (ASC 310-10-35-16), when, based on current information and events, it is probable the Company will be unable to collect all amounts due from the borrower in accordance with the contractual terms of the loan. Impaired loans include nonperforming loans but also include loans modified in troubled debt restructurings where concessions have been granted to borrowers experiencing financial difficulties. These concessions could include a reduction in the interest rate on the loan, payment extensions, forgiveness of principal, forbearance or other actions intended to maximize collection.

 

Interest on impaired loans is recorded based on the performance of the loan. All interest received on impaired loans that are on nonaccrual status is accounted for on the cash-basis method until qualifying for return to accrual status. Interest is accrued per the contract for impaired loans that are performing.

 

The following tables present impaired loans as of and for the three and six month periods ended June 30, 2017 and 2016 and as of and for the year ended December 31, 2016.

 

   June 30, 2017 
   Recorded
Balance
   Unpaid
Principal
Balance
   Specific
Allowance
   Average
Investment in
Impaired
Loans -
QTD
   Average
Investment in
Impaired
Loans -
YTD
   Interest
Income
Recognized
- QTD
   Interest
Income
Recognized
- YTD
 
Loans without a specific valuation
allowance
                                   
Real estate                                   
Commercial  $809   $809   $-   $811   $763   $-   $- 
Commercial construction and development   761    761    -    776    792    8    17 
Consumer closed end first mortgage   781    781    -    1,315    1,499    -    - 
Commercial and industrial   172    172    -    176    179    1    3 
                                    
Loans with a specific valuation allowance                                   
Real estate                                   
Commercial   214    214    100    214    214    -    - 
                                    
Total                                   
Real estate                                   
Commercial  $1,023   $1,023   $100   $1,025   $977   $-   $- 
Commercial construction and development  $761   $761   $-   $776   $792   $8   $17 
Consumer closed end first mortgage  $781   $781   $-   $1,315   $1,499   $-   $- 
Commercial and industrial  $172   $172   $-   $176   $179   $1   $3 
                                    
Total  $2,737   $2,737   $100   $3,292   $3,447   $9   $20 

 

  16

 

 

   December 31, 2016 
   Recorded
Balance
   Unpaid
Principal
Balance
   Specific
Allowance
   Average
Investment
in
Impaired
Loans
   Interest
Income
Recognized
 
Loans without a specific valuation allowance                         
Real estate                         
Commercial  $665   $665   $-   $2,207   $68 
Commercial construction and development   822    822    -    874    40 
Consumer closed end first mortgage   1,869    1,869    -    1,328    - 
Consumer open end and junior liens   -    -    -    193    - 
Commercial and industrial   187    187    -    204    1 
                          
Loans with a specific valuation allowance                         
Real estate                         
Commercial   214    214    100    416    - 
                          
Total                         
Real estate                         
Commercial  $879   $879   $100   $2,623   $68 
Commercial construction and development  $822   $822   $-   $874   $40 
Consumer closed end first mortgage  $1,869   $1,869   $-   $1,328   $- 
Consumer open end and junior liens  $-   $-   $-   $193   $- 
Commercial and industrial  $187   $187   $-   $204   $1 
                          
Total  $3,757   $3,757   $100   $5,222   $109 

 

  17

 

 

   June 30, 2016 
   Recorded
Balance
   Unpaid
Principal
Balance
   Specific
Allowance
   Average
Investment
in
Impaired
Loans -
QTD
   Average
Investment
in
Impaired
Loans -
YTD
   Interest
Income
Recognized
- QTD
   Interest
Income
Recognized
- YTD
 
Loans without a specific valuation
allowance
                                   
Real estate                                   
Commercial  $2,896   $2,896   $-   $3,022   $3,080   $24   $48 
Commercial construction and development   853    853    -    856    907    9    21 
Consumer closed end first mortgage   1,126    1,126    -    1,126    1,126    -    - 
Consumer open end and junior liens   -    -    -    243    322    -    - 
Commercial and industrial   200    200    -    205    208    -    - 
                                    
Loans with a specific valuation allowance                                   
Real estate                                   
Commercial   410    410    100    464    534    -    - 
                                    
Total                                   
Real estate                                   
Commercial  $3,306   $3,306   $100   $3,486   $3,614   $24   $48 
Commercial construction and development  $853   $853   $-   $856   $907   $9   $21 
Consumer closed end first mortgage  $1,126   $1,126   $-   $1,126   $1,126   $-   $- 
Consumer open end and junior liens  $-   $-   $-   $243   $322   $-   $- 
Commercial and industrial  $200   $200   $-   $205   $208   $-   $- 
                                    
Total  $5,485   $5,485   $100   $5,916   $6,177   $33   $69 

 

  18

 

 

The following information presents the credit risk profile of the Company’s loan portfolio based on rating category and payment activity as of June 30, 2017.

 

Commercial Loan Grades

 

Definition of Loan Grades. Loan grades are numbered 1 through 8. Grades 1-4 are "pass" credits, grade 5 [Special Mention] loans are "criticized" assets, and grades 6 [Substandard], 7 [Doubtful] and 8 [Loss] are "classified" assets. The use and application of these grades by the Bank conform to the Bank's policy and regulatory definitions.

 

Pass. Pass credits are loans in grades prime through fair. These are at least considered to be credits with acceptable risks and would be granted in the normal course of lending operations.

 

Special Mention. Special mention credits have potential weaknesses that deserve management’s close attention. If left uncorrected, these potential weaknesses may result in deterioration of the repayment prospects for the credits or in the Bank’s credit position at some future date. If weaknesses cannot be identified, classifying as special mention is not appropriate. Special mention credits are not adversely classified and do not expose the Bank to sufficient risk to warrant an adverse classification. No apparent loss of principal or interest is expected.

 

Substandard. Substandard credits are inadequately protected by the current sound worth and paying capacity of the obligor or by the collateral pledged. Financial statements normally reveal some or all of the following:  poor trends, lack of earnings and cash flow, excessive debt, lack of liquidity, and the absence of creditor protection. Credits so classified must have a well-defined weakness, or weaknesses that jeopardize the liquidation of the debt. They are characterized by the distinct possibility that the Bank will sustain some loss if the deficiencies are not corrected.

 

Doubtful. A doubtful extension of credit has all the weaknesses inherent in a substandard asset with the added characteristic that the weaknesses make collection or liquidation in full, on the basis of currently existing facts, conditions, and values, highly questionable and improbable. The possibility of loss is extremely high, but because of certain important and reasonably specific pending factors that may work to the advantage and strengthening of the asset, its classification as an estimated loss is deferred until its more exact status may be determined. Pending factors include proposed merger, acquisition, or liquidation procedures, capital injection, perfecting liens on additional collateral, and refinancing plans. Doubtful classification for an entire credit should be avoided when collection of a specific portion appears highly probable with the adequately secured portion graded Substandard.  

  

Retail Loan Grades

 

Pass. Pass credits are loans that are currently performing as agreed and are not troubled debt restructurings.

 

Special Mention. Special mention credits have potential weaknesses that deserve management’s close attention. If left uncorrected, these potential weaknesses may result in deterioration of the repayment prospects for the credits or in the Bank’s credit position at some future date. If weaknesses cannot be identified, classifying as special mention is not appropriate. Special mention credits are not adversely classified and do not expose the Bank to sufficient risk to warrant an adverse classification. No apparent loss of principal or interest is expected.

 

Substandard. Substandard credits are loans that have reason to be considered to have a weakness and placed on non-accrual. This would include all retail loans over 90 days and troubled debt restructurings.

 

As of June 30, 2017, special mention commercial loans increased as management determined that a few credits had potential weaknesses deserving management’s close attention. All of these credits were performing as agreed as of June 30, 2017.

 

  19

 

  

   June 30, 2017 
   Commercial   Consumer     
   Pass   Special
Mention
   Substandard   Doubtful   Pass   Special
Mention
   Substandard   Total 
Real estate                                        
Commercial  $288,365   $7,285   $3,128   $23               $298,801 
Commercial construction and development   27,841    406    761    -                   29,008 
Consumer closed end first mortgage                      $464,234   $-   $3,568    467,802 
Consumer open end and junior liens                       70,286    -    286    70,572 
                                         
Other loans                                        
Consumer loans                                        
Auto                       18,668    -    7    18,675 
Boat/RVs                       158,160    -    396    158,556 
Other                       5,565    -    40    5,605 
Commercial and industrial   130,745    8,313    87    -                   139,145 
   $446,951   $16,004   $3,976   $23   $716,913   $-   $4,297   $1,188,164 

 

   December 31, 2016 
   Commercial   Consumer     
   Pass   Special
Mention
   Substandard   Doubtful   Pass   Special
Mention
   Substandard   Total 
Real estate                                        
Commercial  $295,548   $3,705   $3,297   $27              $302,577 
Commercial construction and development   21,782    254    417    -                   22,453 
Consumer closed end first mortgage                      $473,329   $-   $5,519    478,848 
Consumer open end and junior liens                       70,769    -    453    71,222 
                                         
Other loans                                        
Consumer loans                                        
Auto                       18,931    -    8    18,939 
Boat/RVs                       141,294    -    308    141,602 
Other                       5,859    -    33    5,892 
Commercial and industrial   128,436    2,513    154    -                   131,103 
   $445,766   $6,472   $3,868   $27   $710,182   $-   $6,321   $1,172,636 

 

  20

 

  

Allowance for Loan Losses.

 

We maintain an allowance for loan losses to absorb losses inherent in the loan portfolio. The allowance is based on ongoing, quarterly assessments of the estimated losses inherent in the loan portfolio.  Our methodology for assessing the appropriateness of the allowance consists of several key elements, including the general allowance and specific allowances for identified problem loans and portfolio segments.  In addition, the allowance incorporates the results of measuring impaired loans as provided in FASB ASC 310, Receivables.  These accounting standards prescribe the measurement methods, income recognition and disclosures related to impaired loans. The general allowance is calculated by applying loss factors to outstanding loans based on the internal risk evaluation of such loans or pools of loans. Changes in risk evaluations of both performing and nonperforming loans affect the amount of the general allowance. Loss factors are based on our historical loss experience as well as on significant factors that, in management’s judgment, affect the collectability of the portfolio as of the evaluation date.

 

The appropriateness of the allowance is reviewed by management based upon its evaluation of then-existing economic and business conditions affecting our key lending areas and other conditions, such as credit quality trends (including trends in non-performing loans expected to result from existing conditions), collateral values, loan volumes and concentrations, specific industry conditions within portfolio segments and recent loss experience in particular segments of the portfolio that existed as of the balance sheet date and the impact that such conditions were believed to have had on the collectability of the loan.  Senior management reviews these conditions quarterly in discussions with our senior credit officers.  To the extent that any of these conditions is evidenced by a specifically identifiable problem credit or portfolio segment as of the evaluation date, management’s estimate of the effect of such condition may be reflected as a specific allowance applicable to such credit or portfolio segment.  Where any of these conditions is not evidenced by a specifically identifiable problem credit or portfolio segment as of the evaluation date, management’s evaluation of the loss related to this condition is reflected in the general allowance for loan losses.  The evaluation of the inherent loss with respect to these conditions is subject to a higher degree of uncertainty because they are not identified with specific problem credits or portfolio segments.

 

The allowance for loan losses is based on estimates of losses inherent in the loan portfolio.  Actual losses can vary significantly from the estimated amounts.  Our methodology as described permits adjustments to any loss factor used in the computation of the general allowance in the event that, in management’s judgment, significant factors which affect the collectability of the portfolio as of the evaluation date are not reflected in the loss factors.  By assessing the probable incurred losses inherent in the loan portfolio on a quarterly basis, we are able to adjust specific and inherent loss estimates based upon any more recent information that has become available.  

 

The following table details activity in the allowance for loan losses by portfolio segment for the three and six month periods ended June 30, 2017 and 2016, respectively. Allocation of a portion of the allowance to one category of loans does not preclude its availability to absorb losses in other segments.

 

   Three Months Ended June 30, 2017 
   Commercial   Mortgage   Consumer   Total 
Allowance for loan losses:                    
Balance, beginning of period  $7,397   $2,279   $2,706   $12,382 
Provision charged to expense   144    24    132    300 
Losses charged off   (12)   (84)   (206)   (302)
Recoveries   6    4    36    46 
Balance, end of period  $7,535   $2,223   $2,668   $12,426 

 

   Six Months Ended June 30, 2017 
   Commercial   Mortgage   Consumer   Total 
Allowance for loan losses:                    
Balance, beginning of year  $7,358   $2,303   $2,721   $12,382 
Provision charged to expense   176    41    283    500 
Losses charged off   (12)   (129)   (410)   (551)
Recoveries   13    8    74    95 
Balance, end of period  $7,535   $2,223   $2,668   $12,426 

 

  21

 

  

   Three Months Ended June 30, 2016 
   Commercial   Mortgage   Consumer   Total 
Allowance for loan losses:                    
Balance, beginning of period  $7,208   $2,629   $2,833   $12,670 
Provision charged to expense   (49)   23    176    150 
Losses charged off   (29)   (64)   (200)   (293)
Recoveries   2    1    74    77 
Balance, end of period  $7,132   $2,589   $2,883   $12,604 

 

   Six Months Ended June 30, 2016 
   Commercial   Mortgage   Consumer   Total 
Allowance for loan losses:                    
Balance, beginning of year  $7,090   $2,683   $2,868   $12,641 
Provision charged (credited) to expense   71    85    194    350 
Losses charged off   (33)   (184)   (338)   (555)
Recoveries   4    5    159    168 
Balance, end of period  $7,132   $2,589   $2,883   $12,604 

 

The following tables provide a breakdown of the allowance for loan losses and loan portfolio balances by segment as of June 30, 2017 and 2016, and December 31, 2016.

 

   June 30, 2017 
   Commercial   Mortgage   Consumer   Total 
Allowance balances                    
Individually evaluated for impairment  $100   $-   $-   $100 
Collectively evaluated for impairment   7,435    2,223    2,668    12,326 
Total allowance for loan losses  $7,535   $2,223   $2,668   $12,426 
Loan balances                    
Individually evaluated for impairment  $1,956   $781   $-   $2,737 
Collectively evaluated for impairment   464,998    467,021    253,408    1,185,427 
Gross loans  $466,954   $467,802   $253,408   $1,188,164 

 

   June 30, 2016 
   Commercial   Mortgage   Consumer   Total 
Allowance balances                    
Individually evaluated for impairment  $100   $-   $-   $100 
Collectively evaluated for impairment   7,032    2,589    2,883    12,504 
Total allowance for loan losses  $7,132   $2,589   $2,883   $12,604 
Loan balances                    
Individually evaluated for impairment  $4,359   $1,126   $-   $5,485 
Collectively evaluated for impairment   396,225    484,122    227,973    1,108,320 
Gross loans  $400,584   $485,248   $227,973   $1,113,805 

 

  22

 

  

   December 31, 2016 
   Commercial   Mortgage   Consumer   Total 
Allowance balances                    
Individually evaluated for impairment  $100   $-   $-   $100 
Collectively evaluated for impairment   7,258    2,303    2,721    12,282 
Total allowance for loan losses  $7,358   $2,303   $2,721   $12,382 
Loan balances                    
Individually evaluated for impairment  $1,888   $1,869   $-   $3,757 
Collectively evaluated for impairment   454,245    476,979    237,655    1,168,879 
Gross loans  $456,133   $478,848   $237,655   $1,172,636 

 

Management’s general practice is to proactively charge down loans individually evaluated for impairment to the fair value of the underlying collateral.

 

For all loan portfolio segments except consumer real estate and other consumer loans, the Company promptly charges-off loans, or portions thereof, when available information confirms that specific loans are uncollectible based on information that includes, but is not limited to, (1) the deteriorating financial condition of the borrower, (2) declining collateral values, and/or (3) legal action, including bankruptcy, that impairs the borrower’s ability to adequately meet its obligations. For impaired loans that are considered to be solely collateral dependent, a partial charge-off is recorded when a loss has been confirmed by an updated appraisal or other appropriate valuation of the collateral.

 

The Company charges-off consumer real estate and other consumer loans, or portions thereof, when the Company reasonably determines the amount of the loss. The Company adheres to timeframes established by applicable regulatory guidance which provides for the charge-down of 1-4 family first and junior lien mortgages to the net realizable value less costs to sell when the loan is 180 days past due, charge-off of unsecured open-end loans when the loan is 180 days past due, and charge-down to the net realizable value when other secured loans are 120 days past due. Loans at these respective delinquency thresholds for which the Company can clearly document that the loan is both well-secured and in the process of collection, such that collection will occur regardless of delinquency status, need not be charged-off.

 

 

Troubled Debt Restructurings

 

Certain categories of impaired loans include loans that have been modified in a troubled debt restructuring; that involves granting economic concessions to borrowers who have experienced financial difficulties. These concessions typically result from our loss mitigation activities and could include reductions in the interest rate, payment extensions, forgiveness of principal, forbearance or other actions. Modifications of terms for our loans and their inclusion as troubled debt restructurings are based on individual facts and circumstances.

 

When we modify loans in a troubled debt restructuring, we evaluate any possible impairment similar to other impaired loans based on the present value of expected future cash flows, discounted at the contractual interest rate of the original loan agreement, or we use the current fair value of the collateral, less selling costs for collateral dependent loans. If we determine 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 a specific reserve or a charge-off to the allowance.

 

Loans retain their accrual status at the time of their modification. As a result, if a loan is on nonaccrual at the time it is modified, it stays as nonaccrual until a period of satisfactory performance, generally six months, is obtained. If a loan is on accrual at the time of the modification, the loan is evaluated to determine if the collection of principal and interest is reasonably assured and generally stays on accrual.

 

At June 30, 2017, the Company had loans that were modified in troubled debt restructurings. The modification of terms of such loans included one or a combination of the following: an extension of maturity or a reduction of the stated interest rate.

 

  23

 

  

The following tables describe troubled debts restructured during the three and six month periods ended June 30, 2017 and 2016:

 

   Three Months Ended 
   June 30, 2017   June 30, 2016 
   No. of
Loans
   Pre-
Modification
Recorded
Balance
   Post-
Modification
Recorded
Balance
   No. of
Loans
   Pre-
Modification
Recorded
Balance
   Post-
Modification
Recorded
Balance
 
Real estate                              
Consumer closed end first mortgage   3   $119   $121    4   $134   $141 
Consumer open end and junior liens   1    3    3    -    -    - 
                               
Other loans                              
Consumer loans                              
Boat/RVs   -    -    -    1    8    8 

 

   Six Months Ended 
   June 30, 2017   June 30, 2016 
   No. of
Loans
   Pre-
Modification
Recorded
Balance
   Post-
Modification
Recorded
Balance
   No. of
Loans
   Pre-
Modification
Recorded
Balance
   Post-
Modification
Recorded
Balance
 
Real estate                              
Consumer closed end first mortgage   4    184    188    9    554    569 
Consumer open end and junior liens   1    3    3    -    -    - 
                               
Other loans                              
Consumer loans                              
Auto   -    -    -    1    4    4 
Boat/RVs   -    -    -    3    56    56 
Commercial and industrial   1    72    72    1    83    83 

 

The impact on the allowance for loan losses was insignificant as a result of these modifications.

 

  24

 

  

Newly restructured loans by type for the three and six months ended June 30, 2017 and 2016 are as follows:

 

   Three Months Ended June 30, 2017 
   Rate   Term   Combination   Total
Modification
 
Real estate                    
Consumer closed end first mortgage  $-   $-   $121   $121 
Consumer open end and junior liens   -    3    -    3 

 

   Three Months Ended June 30, 2016 
   Rate   Term   Combination   Total
Modification
 
Real estate                    
Consumer closed end first mortgage  $-   $47   $94   $141 
                     
Other loans                    
Consumer loans                    
Boat/RVs   -    -    8    8 

 

   Six Months Ended June 30, 2017 
   Rate   Term   Combination   Total
Modification
 
Real Estate                    
Consumer closed end first mortgage  $-   $-   $188   $188 
Consumer open end and junior liens   -    3    -    3 
Commercial and industrial   -    72    -    72 

 

   Six Months Ended June 30, 2016 
   Rate   Term   Combination   Total
Modification
 
Real Estate                    
Consumer closed end first mortgage  $-   $47   $522   $569 
                     
Other loans                    
Consumer loans                    
Auto   -    -    4    4 
Boat/RVs   -    48    8    56 
Commercial and industrial   -    83    -    83 

 

There were no defaults on loans modified as troubled debt restructurings made in the three and six months ended June 30, 2017 and 2016. Defaults are defined as any loans that become 90 days past due.

 

At June 30, 2017, the Company had residential real estate held for sale as a result of foreclosure totaling $326,000 and real estate in the process of foreclosure of $1.2 million. As of June 30, 2017, the Company also held $383,000 in other repossessed assets, such as autos, boats, RVs and horse trailers.

 

  25

 

  

Note 6: Derivative Financial Instruments

 

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 Balance Sheet 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 Consolidated Statements of Income. The notional amount of customer-facing swaps as of June 30, 2017 and December 31, 2016 was approximately $14.4 million and $14.6 million, respectively.

 

The following table shows the amounts of derivative financial instruments at June 30, 2017 and December 31, 2016.

 

   Asset Derivatives
      Fair Value      Fair Value 
   Balance Sheet  June 30,   December 31,   Balance Sheet  June 30,   December 31, 
   Location  2017   2016   Location  2017   2016 
Derivatives not designated as hedging instruments:                      
Interest rate contracts  Other assets  $461   $553   Other liabilities  $461   $553 

 

  26

 

  

Note 7: Accumulated Other Comprehensive Income (Loss)

 

The components of accumulated other comprehensive income (loss), included in stockholders’ equity, are as follows:

 

   June 30,   December 31, 
   2017   2016 
Net unrealized gain (loss) on securities available-for-sale  $234   $(1,875)
Net unrealized gain relating to defined benefit plan liability   30    30 
    264    (1,845)
Tax benefit (expense)   (123)   591 
Net of tax amount  $141   $(1,254)

 

The following table presents the reclassification adjustments out of accumulated other comprehensive income that were included in net income in the Consolidated Statements of Income for the three and six months ended June 30, 2017 and 2016.

 

   Amount Reclassified from
Accumulated Other
Comprehensive Income For
the Three Months Ended
    
   June 30,    
Details about Accumulated Other
Comprehensive Income Components
  2017   2016   Affected Line Item in the Statements of
Income
Realized gains on available-for-sale securities             
Realized securities gains reclassified into income  $279   $652   Total non-interest income - net realized gains on sale of available-for-sale securities
Related income tax expense   (95)   (222)  Income tax expense
              
Total reclassifications for the period, net of tax  $184   $430    

 

   Amount Reclassified from
Accumulated Other
Comprehensive Income For
the Six Months Ended
    
   June 30,    
Details about Accumulated Other
Comprehensive Income Components
  2017   2016   Affected Line Item in the Statements of
Income
Realized gains on available-for-sale securities             
Realized securities gains reclassified into income  $408   $770   Total non-interest income - net realized gains on sale of available-for-sale securities
Related income tax expense   (139)   (262)  Income tax expense
              
Total reclassifications for the period, net of tax  $269   $508    

 

  27

 

  

Note 8: Fair Values of Financial Instruments

 

Fair value is 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. Fair value measurements must maximize the use of observable inputs and minimize the use of unobservable inputs. There is a hierarchy of three levels of inputs that may be used to measure fair value:

 

Level 1Quoted prices in active markets for identical assets or liabilities

 

Level 2Observable inputs other than Level 1 prices, such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities

 

Level 3Unobservable inputs supported by little or no market activity and are significant to the fair value of the assets or liabilities

 

Items Measured at Fair Value on a Recurring Basis

 

Following is a description of the valuation methodologies and inputs used for instruments measured at fair value on a recurring basis and recognized in the accompanying comparative balance sheet, as well as the general classification of such instruments pursuant to the valuation hierarchy.

 

Available-for-Sale Securities

 

Where quoted market prices are available in an active market, securities are classified within Level 1 of the valuation hierarchy. The Company uses a third-party provider to provide market prices on its securities. Pooled trust preferred securities prices are evaluated by a third party. Level 1 securities include marketable equity securities. If quoted market prices are not available, then fair values are estimated by using pricing models, quoted prices of securities with similar characteristics or discounted cash flows. Level 2 securities include mortgage-backed, collateralized mortgage obligations, small business administration, marketable equity, municipal, federal agency and certain corporate obligation securities. In certain cases where Level 1 or Level 2 inputs are not available, securities are classified within Level 3 of the hierarchy and include certain corporate obligation securities.

 

Third party vendors compile prices from various sources and may apply such techniques as matrix pricing to determine the value of identical or similar investment securities (Level 2). Matrix pricing is a mathematical technique widely used in the banking industry to value investment securities without relying exclusively on quoted prices for specific investment securities but rather relying on investment securities relationship to other benchmark quoted investment securities. Any investment security not valued based upon the methods above are considered Level 3.

 

The following table presents the fair value measurements of assets measured on a recurring basis and level within the ASC 820 fair value hierarchy.

 

       Fair Value Measurements Using 
   Fair Value   Level 1   Level 2   Level 3 
June 30, 2017                    
Mortgage-backed securities  $76,696   $-   $76,696   $- 
Collateralized mortgage obligations   76,259    -    76,259    - 
Municipal obligations   87,469    -    87,469    - 
Corporate obligations   16,218    -    13,630    2,588 
Available-for-sale securities  $256,642   $-   $254,054   $2,588 

 

       Fair Value Measurements Using 
   Fair Value   Level 1   Level 2   Level 3 
December 31, 2016                    
Mortgage-backed securities  $92,517   $-   $92,517   $- 
Collateralized mortgage obligations   68,047    -    68,047    - 
Municipal obligations   77,682    -    77,682    - 
Corporate obligations   11,667    -    9,079    2,588 
Available-for-sale securities  $249,913   $-   $247,325   $2,588 

 

The following is a reconciliation of the beginning and ending balances for the three and six months ended June 30, 2017 and 2016 of recurring fair value measurements recognized in the accompanying balance sheets using significant unobservable (Level 3) inputs:

 

  28

 

  

   Three Months Ended   Six Months Ended 
   June 30,   June 30, 
   2017   2016   2017   2016 
Beginning balance  $2,588   $2,534   $2,588   $2,534 
Total realized and unrealized gains (losses)                    
Included in net income   -    -    -    - 
Included in other comprehensive income (loss)   -    -    -    - 
Purchases, issuances and settlements   -    -    -    - 
Ending balance  $2,588   $2,534   $2,588   $2,534 
Total gains for the period included in net income attributable to the change in unrealized gains or losses related to assets still held at the reporting date  $-   $-   $-   $- 

 

 

Items Measured at Fair Value on a Non-Recurring Basis

 

From time to time, certain assets may be recorded at fair value on a non-recurring basis. These non-recurring fair value adjustments typically are a result of the application of lower of cost or fair value accounting or a write-down occurring during the period. The following is a description of the valuation methodologies used for certain assets that are recorded at fair value.

 

The following table presents quantitative information about unobservable inputs used in recurring and nonrecurring Level 3 fair value measurements:

 

June 30, 2017  Fair Value   Valuation Technique  Unobservable Inputs  Range 
Trust Preferred Securities  $2,588   Discounted cash flow  Discount rate   7.0 - 8.0%
           Constant prepayment rate   2.0%
           Cumulative projected prepayments   40.0%
           Probability of default   1.7 - 2.2%
           Projected cures given deferral   0 - 15.0%
           Loss severity   32.5 - 38.7%

 

December 31, 2016  Fair Value   Valuation Technique  Unobservable Inputs  Range 
Trust Preferred Securities  $2,588   Discounted cash flow  Discount rate   7.0 - 8.0
           Constant prepayment rate   2.0%
           Cumulative projected prepayments   40.0%
           Probability of default   1.7 - 2.2%
           Projected cures given deferral   0 - 15.0%
           Loss severity   32.5 - 38.7%

 

The following methods and assumptions were used to estimate the fair value of all other financial instruments recognized in the accompanying balance sheets at amounts other than fair value:

 

Cash and Cash Equivalents - The fair value of cash and cash-equivalents approximates carrying value.

 

Interest Bearing Time Deposits – The fair value of interest bearing time deposits approximates carrying value.

 

Loans Held For Sale - Fair values are based on quoted market prices.

 

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Loans - The fair value for loans is estimated using discounted cash flow analyses using interest rates currently being offered for loans with similar terms to borrowers of similar credit quality.

 

FHLB Stock - Fair value of FHLB stock is based on the price at which it may be resold to the FHLB.

 

Interest Receivable/Payable - The fair values of interest receivable/payable approximate carrying values.

 

Deposits - The fair values of noninterest-bearing, interest-bearing demand and savings accounts are equal to the amount payable on demand at the balance sheet date. Fair values for fixed-rate certificates of deposit are estimated using a discounted cash flow calculation that applies interest rates currently being offered on certificates to a schedule of aggregated expected monthly maturities on such time deposits.

 

FHLB Advances - The fair value of these borrowings is estimated using a discounted cash flow calculation, based on current rates for similar debt for periods comparable to the remaining terms to maturity of these advances.

 

Other Borrowings - The fair value of these borrowings is estimated using discounted cash flow analyses using interest rates for similar financial instruments.

 

Off-Balance Sheet Commitments - Commitments include commitments to purchase and originate mortgage loans, commitments to sell mortgage loans, and standby letters of credit and are generally of a short-term nature. The fair values of such commitments are based on fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements and the counterparties’ credit standing. The fair value of these instruments is insignificant.

 

The estimated fair values of the Company’s financial instruments not carried at fair value in the consolidated balance sheets as of the dates noted below are as follows:

 

           Fair Value Measurements Using 
June 30, 2017  Carrying
Amount
   Fair Value   Level 1   Level 2   Level 3 
Assets                         
Cash and cash equivalents  $25,168   $25,168   $25,168   $-   $- 
Interest-bearing time deposits   2,046    2,046    2,046    -    - 
Loans held for sale   8,796    8,905    -    8,905    - 
Loans, net   1,171,927    1,160,935    -    -    1,160,935 
FHLB stock   11,183    11,183    -    11,183    - 
Interest receivable   4,664    4,664    -    4,664    - 
Liabilities                         
Deposits   1,172,985    1,172,919    794,153    -    378,766 
FHLB advances   235,991    235,705    -    235,705    - 
Other borrowings   4,211    4,363    -    4,363    - 
Interest payable   510    510    -    510    - 

 

           Fair Value Measurements Using 
December 31, 2016  Carrying
Amount
   Fair Value   Level 1   Level 2   Level 3 
Assets                         
Cash and cash equivalents  $26,860   $26,860   $26,860   $-   $- 
Interest-bearing time deposits   993    993    993    -    - 
Loans held for sale   4,063    4,094    -    4,094    - 
Loans, net   1,157,120    1,139,450    -    -    1,139,450 
FHLB stock   10,925    10,925    -    10,925    - 
Interest receivable   4,629    4,629    -    4,629    - 
Liabilities                         
Deposits   1,153,382    1,152,030    779,577    -    372,453 
FHLB advances   240,591    239,866    -    239,866    - 
Other borrowings   4,189    4,189    -    4,189    - 
Interest payable   350    350    -    350    - 

 

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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operation

 

The following should be read in conjunction with the Management’s Discussion and Analysis in Item 7 of the Company’s Annual Report on Form 10-K for the year ended December 31, 2016, which was filed with the SEC on March 16, 2017.

 

MutualFirst is a Maryland corporation and a bank holding company headquartered in Muncie, Indiana, with banking operations in Allen, Delaware, Elkhart, Grant, Kosciusko, Randolph, St. Joseph and Wabash counties in Indiana. It owns MutualBank, an Indiana commercial bank with 27 full-service branches in Indiana, trust offices in Fishers and Crawfordsville, Indiana and a loan origination office in New Buffalo, Michigan. MutualBank’s wholly owned subsidiary, Summit Service Corp, owns Summit Mortgage, a mortgage banking company located in Ft. Wayne, Indiana. The Company is subject to examination, supervision and regulation by the Federal Reserve Board (FRB), and the Bank is subject to regulation, supervision and examination by the Indiana Department of Financial Institutions (IDFI) and the Federal Deposit Insurance Corporation (FDIC).

 

Our principal business consists of attracting retail and commercial deposits from the general public and businesses, including some brokered deposits, and investing those funds primarily in loans secured by consumer closed end first mortgages and consumer open end and junior liens on owner-occupied, one- to four-family residences, a variety of other consumer loans, loans secured by commercial real estate, commercial construction and development and commercial and industrial loans. Funds not invested in loans generally are invested in investment securities, including mortgage-backed, mortgage-related, and municipal. We also obtain funds from FHLB advances and other borrowings.

 

Our results of operations depend primarily on the level of our net interest income, which is the difference between interest income on interest-earning assets, such as loans and investment securities, and interest expense on interest-bearing liabilities, primarily deposits and borrowings. The structure of our interest-earning assets versus the structure of interest-bearing liabilities, along with the shape of the yield curve, has a direct impact on our net interest income. Historically, our interest-earning assets have been longer term in nature (i.e., fixed-rate loans) and interest-bearing liabilities have been shorter term (i.e., certificates of deposit, regular savings accounts, etc.). This structure would impact net interest income favorably in a decreasing rate environment, assuming a normally shaped yield curve, as the rates on interest-bearing liabilities would decrease more rapidly than rates on interest-earning assets. Conversely, in an increasing rate environment, assuming a normally shaped yield curve, net interest income would be impacted unfavorably as rates on interest-earning assets would increase at a slower rate than rates on interest-bearing liabilities.

 

Second quarter Highlights. At June 30, 2017, we had $1.6 billion in assets, $1.2 billion in net loans, $1.2 billion in deposits and $146.3 million in stockholders’ equity. The Company’s total risk-based capital ratio at June 30, 2017 was 13.3%, exceeding the 10.0% requirement for a well-capitalized institution. Tangible common equity, as a percentage of tangible assets, increased to 9.2% as of June 30, 2017 compared to 8.9% and 9.2% at both December 31, 2016 and June 30, 2016, respectively. For the quarter ended June 30, 2017, net income was $3.9 million, or $0.52 diluted earnings per common share, compared with net income of $4.2 million, or $0.55 diluted earnings per common share for the quarter ended June 30, 2016.

 

Financial highlights as of and for the three and the six months ended June 30, 2017 included:

 

·Commercial loan balances increased $10.5 million, or 9.2% on an annualized basis in the second quarter of 2017.
·Non-real estate consumer loan balances increased $13.1 million, or 30.8% on an annualized basis, in the second quarter of 2017.
·Tangible common equity to total assets was 9.17% and tangible book value per common share was $19.65 as of June 30, 2017 compared to tangible common equity to total assets of 8.89% and tangible book value per common share of $18.82 as of December 31, 2016.
·Net interest income for the second quarter of 2017 increased by $374,000 on a linked quarter basis and increased by $1.1 million compared to the second quarter of 2016.
·Provision for loan losses increased $100,000 in the second quarter of 2017 compared to the linked quarter and increased $150,000 compared to the second quarter of 2016.
·Net interest margin was 3.29% for the second quarter of 2017 compared to 3.21% in the first quarter of 2017 and 3.16% in the second quarter of 2016. Tax equivalent net interest margin was 3.39% for the second quarter of 2017 compared to 3.32% in the first quarter of 2017 and 3.25% in the second quarter of 2016.
·Non-interest income in the second quarter of 2017 increased by $546,000 on a linked quarter basis and decreased by $1.2 million when compared to the second quarter of 2016.
·Non-interest expense decreased in the second quarter of 2017 by $189,000 on a linked quarter basis and decreased by $23,000 when compared to the second quarter of 2016.
·The efficiency ratio was 66.9% in the second quarter 2017 compared to 66.6% in the second quarter of 2016.

 

The Management’s Discussion and Analysis in Item 7 of the Company’s Annual Report on Form 10-K for the year ended December 31, 2016, contains a summary of our management’s strategic plan for 2015-2019. The financial highlights of our strategic progress during the quarter include:

 

·Commercial and non-real estate consumer lending was 54.7% of the lending portfolio as of June 30, 2017 compared to 53.1% at December 31, 2016.
·Core deposits were 67.7% of total deposits as of June 30, 2017 the same as December 31, 2016.
·Commission income from wealth and investment services decreased $86,000 during the second quarter 2017 compared to the same period in 2016 and increased $11,000 during the first six months of 2017 compared to the same period in 2016.

 

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Critical Accounting Policies

 

Note 1 to the Consolidated Financial Statements in Item 8 of the Form 10-K for the year ended December 31, 2016 contains a summary of the Company’s significant accounting policies. Certain of these policies are important to the portrayal of the Company’s financial condition, since they require management to make difficult, complex or subjective judgments, some of which may relate to matters that are inherently uncertain. Management believes that its critical accounting policies include determining the allowance for loan losses, the valuation of foreclosed assets, mortgage servicing rights, valuation of intangible assets and securities, deferred tax asset and income tax accounting.

 

Allowance for Loan Losses. The allowance for loan losses is a significant estimate that can and does change based on management’s assumptions about specific borrowers and current general economic and business conditions, among other factors. A worsening or protracted economic decline would increase the likelihood of additional losses due to credit and market risk and could create the need for additional loss reserves. Management reviews the adequacy of the allowance for loan losses on at least a quarterly basis. The evaluation by management includes consideration of past loss experience, changes in the composition of the loan portfolio, the current condition and amount of loans outstanding, identified problem loans and the probability of collecting all amounts due.

 

Foreclosed Assets. Foreclosed assets are carried at the lower of cost or fair value less estimated selling costs. Management estimates the fair value of the properties based on current appraisal information. Fair value estimates are particularly susceptible to significant changes in the economic environment, market conditions, and real estate market. A worsening or protracted economic decline would increase the likelihood of a decline in property values and could create the need to write down the properties through current operations.

 

Mortgage Servicing Rights. Mortgage servicing rights (“MSRs”) associated with loans originated and sold, where servicing is retained, are capitalized and included in other assets in the consolidated balance sheet. The value of the capitalized servicing rights represents the fair value of the right to service loans in the portfolio. Critical accounting policies for MSRs relate to the initial valuation and subsequent impairment tests. The methodology used to determine the valuation of MSRs requires the development and use of a number of estimates, including anticipated principal amortization and prepayments of that principal balance. Events that may significantly affect the estimates used are changes in interest rates, mortgage loan prepayment speeds and the payment performance of the underlying loans. The carrying value of the MSRs is periodically reviewed for impairment based on a determination of fair value. For purposes of measuring impairment, the servicing rights are compared to a valuation prepared based on a discounted cash flow methodology, utilizing current prepayment speeds and discount rates. Impairment, if any, is recognized through a valuation allowance and is recorded as a reduction in loan servicing fee income.

 

Goodwill and Intangible Assets. MutualFirst periodically assesses the impairment of its goodwill and the recoverability of its core deposit intangible. Impairment is the condition that exists when the carrying amount exceeds its implied fair value. If actual external conditions and future operating results differ from MutualFirst’s judgments, impairment and/or increased amortization charges may be necessary to reduce the carrying value of these assets to the appropriate value.

 

Securities. Under FASB Codification Topic 320 (ASC 320), Investments-Debt and Equity Securities, investment securities must be classified as held-to-maturity, available-for-sale or trading. Management determines the appropriate classification at the time of purchase. The classification of securities is significant since it directly impacts the accounting for unrealized gains and losses on securities. Debt securities are classified as held-to-maturity and carried at amortized cost when management has the positive intent and the Company has the ability to hold the securities to maturity. Securities not classified as held-to-maturity are classified as available-for-sale and are carried at fair value, with the unrealized holding gains and losses, net of tax, reported in other comprehensive income and do not affect earnings until realized.

 

The fair values of the Company’s securities are generally determined by reference to quoted prices from reliable independent sources utilizing observable inputs. Certain of the Company’s fair values of securities are determined using models whose significant value drivers or assumptions are unobservable and are significant to the fair value of the securities. These models are utilized when quoted prices are not available for certain securities or in markets where trading activity has slowed or ceased. When quoted prices are not available and are not provided by third party pricing services, management judgment is necessary to determine fair value. As such, fair value is determined using discounted cash flow analysis models, incorporating default rates, estimation of prepayment characteristics and implied volatilities.

 

The Company evaluates all securities on a quarterly basis, and more frequently when economic conditions warrant additional evaluations, for determining if an other-than-temporary impairment (“OTTI”) exists pursuant to guidelines established in ASC 320. In evaluating the possible impairment of securities, consideration is given to the length of time and the extent to which the fair value has been less than cost, the financial condition and near-term prospects of the issuer, and the ability and intent of the Company to retain its investment in the issuer for a period of time sufficient to allow for any anticipated recovery in fair value. In analyzing an issuer’s financial condition, the Company may consider whether the securities are issued by the federal government or its agencies or government sponsored agencies, whether downgrades by bond rating agencies have occurred, and the results of reviews of the issuer’s financial condition.

 

If management determines that an investment experienced an OTTI, management must then determine the amount of the OTTI to be recognized in earnings. If management does not intend to sell the security and it is more likely than not that the Company will not be required to sell the security before recovery of its amortized cost basis less any current period loss, the OTTI will be separated into the amount representing the credit loss and the amount related to all other factors. The amount of OTTI related to the credit loss is determined based on the present value of cash flows expected to be collected and is recognized in earnings. The amount of the OTTI related to other factors will be recognized in other comprehensive income, net of applicable taxes. The previous amortized cost basis less the OTTI recognized in earnings will become the new amortized cost basis of the investment. If management intends to sell the security or more likely than not will be required to sell the security before recovery of its amortized cost basis less any current period credit loss, the OTTI will be recognized in earnings equal to the entire difference between the investment’s amortized cost basis and its fair value at the balance sheet date. Any subsequent recoveries related to the value of these securities are recorded as an unrealized gain (as other comprehensive income (loss) in stockholders’ equity) and not recognized in income until the security is ultimately sold.

 

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The Company from time to time may dispose of an impaired security in response to asset/liability management decisions, future market movements, business plan changes, or if the net proceeds can be reinvested at a rate of return that is expected to recover the loss within a reasonable period of time.

 

Deferred Tax Asset. The Company has evaluated its deferred tax asset to determine if it is more likely than not that the asset will be utilized in the future. The Company’s most recent evaluation has determined that, except for the amounts represented by the valuation allowance in Note 15 to the Consolidated Financial Statements in Item 8 of the Form 10-K for the year ended December 31, 2016, the Company will more likely than not be able to utilize the remaining deferred tax asset. As of year-end 2016, the Company had generated average annual positive pre-tax pre-provision earnings of $16.4 million, or 1.1% of pre-tax pre-provision ROA over the previous five years. This level of earnings, if maintained in the future, would be sufficient to utilize portions of the operating losses, tax credit carryforwards and temporary tax differences over the allowable periods. The analysis as of June 30, 2017, supports no additional valuation reserve is needed.

 

The valuation allowances established is the result of net operating losses for state franchise tax purposes totaling $23.0 million. See Note 15 to the Consolidated Financial Statements in Item 8 of the Form 10-K for the year ended December 31, 2016.

 

Income Tax Accounting. We file a consolidated federal income tax return. The provision for income taxes is based upon income in our consolidated financial statements, rather than amounts reported on our income tax return. Deferred tax assets and liabilities are recognized for 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 of a change in tax rates on our deferred tax assets and liabilities is recognized as income or expense in the period that includes the enactment date.

 

Forward-Looking Statements

 

This Form 10-Q contains and our future filings with the SEC, Company press releases, other public pronouncements, stockholder communications and oral statements made by or with the approval of an authorized executive officer, will contain “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995. You can identify these forward-looking statements through our use of words such as “may,” “will,” “anticipate,” “assume,” “should,” “indicate,” “would,” “believe,” “contemplate,” “expect,” “estimate,” “continue,” “plan,” “project,” “could,” “intend,” “target” and other similar words and expressions of the future. These forward-looking statements include, but are not limited to: (i) statements of our goals, intentions and expectations; (ii) statements regarding our business plans, prospects, growth and operating strategies; (iii) statements regarding the asset quality of our loan and investment portfolios; and (iv) estimates of our risks and future costs and benefits. These forward-looking statements are based on current beliefs and expectations of our management and are inherently subject to significant business, economic and competitive uncertainties and contingencies, many of which are beyond our control. In addition, these forward-looking statements are subject to assumptions with respect to future business strategies and decisions that are subject to change. The Company does not undertake and specifically declines any obligation to publicly release the result of any revisions that may be made to any forward-looking statements to reflect events or circumstances after the date of such statements or to reflect the occurrence of unanticipated events.

 

The following factors, among others, could cause actual results to differ materially from the anticipated results or other expectations expressed in the forward-looking statements: (i) the credit risks of lending activities, including changes in the level and trend of loan delinquencies and write-offs and changes in our allowance for loan losses and provision for loan losses that may be impacted by deterioration in the housing and commercial real estate markets; (ii) changes in general economic conditions, either nationally or in our market areas; (iii) changes in the levels of general interest rates and the relative differences between short- and long-term interest rates, deposit interest rates, our net interest margin and funding sources; (v) fluctuations in the demand for loans, the number of unsold homes, land and other properties and fluctuations in real estate values in our market areas; (vi) decreases in the secondary market for the sale of loans that we originate; (vii) results of examinations of us by the IDFI, FDIC, FRB or other regulatory authorities, including the possibility that any such regulatory authority may, among other things, require us to increase our reserve for loan losses, write-down assets, change our regulatory capital position or affect our ability to borrow funds or maintain or increase deposits, which could adversely affect our liquidity and earnings; (viii) legislative or regulatory changes that adversely affect our business including the effect of Dodd-Frank Wall Street Reform and Consumer Protection Act (the Dodd-Frank Act”), changes in regulatory policies and principles, or the interpretation of regulatory capital or other rules, including changes that increase our capital requirements; (ix) our ability to attract and retain deposits; (x) increases in premiums for deposit insurance; (xi) management’s assumptions in determining the adequacy of the allowance for loan losses; (xii) our ability to control operating costs and expenses; (xiii) the use of estimates in determining fair value of certain of our assets, which estimates may prove to be incorrect and result in significant declines in valuation; (xiv) difficulties in reducing risks associated with the loans on our balance sheet; (xv) staffing fluctuations in response to product demand or the implementation of corporate strategies that affect our workforce and potential associated charges; (xvi) a failure or security breach in the computer systems on which we depend; (xvii) our ability to retain key members of our senior management team; (xviii) costs and effects of litigation, including settlements and judgments; (xix) our ability to successfully integrate into our operations any assets, liabilities, customers, systems, and management personnel we may in the future acquire and our ability to realize related revenue synergies and cost savings within expected time frames or at all and any goodwill charges related thereto; (xx) increased competitive pressures among financial services companies; (xxi) changes in consumer spending, borrowing and savings habits; (xxii) the availability of resources to address changes in laws, rules, or regulations or to respond to regulatory actions; (xxiii) adverse changes in the securities markets; (xxiv) inability of key third-party providers to perform their obligations to us; (xv) changes in accounting policies and practices, as may be adopted by the financial institution regulatory agencies, the Public Company Accounting Oversight Board or the Financial Accounting Standards Board; and (xvi) other economic, competitive, governmental, regulatory, and technological factors affecting our operations, pricing, products and services and the other risks described elsewhere in this report.

 

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The Company wishes to advise readers that these factors could affect the Company's financial performance and could cause the Company's actual results for future periods to differ materially from any opinions or statements expressed with respect to future periods in any current statements. 

 

Financial Condition

 

General. Total assets at June 30, 2017 were $1.6 billion, reflecting a $22.8 million increase since December 31, 2016, primarily as a result of a $14.8 million increase in net loans. Total liabilities as of June 30, 2017 were $1.4 billion, an increase of $16.5 million compared to December 31, 2016, primarily due to a $19.6 million increase in deposits. Total stockholders’ equity increased to $146.3 million, an increase of $6.3 million compared to December 31, 2016 primarily due to an increase in retained earnings of $4.8 million.

 

Loans. Our gross loan portfolio, excluding loans held for sale, increased $15.5 million at June 30, 2017 to $1.2 billion. The following table reflects the changes in the gross amount of loans, excluding loans held for sale, by type during the six month period:

 

   June 30,   December 31,   Amount   Percent 
   2017   2016   Change   Change 
                 
Real estate                    
Commercial  $298,801   $302,577   $(3,776)   (1.25)%
Commercial construction and development   29,008    22,453    6,555    29.19 
Consumer closed end first mortgage   467,802    478,848    (11,046)   (2.31)
Consumer open end and junior liens   70,572    71,222    (650)   (0.91)
Total real estate loans   866,183    875,100    (8,917)   (1.02)
                     
Consumer loans                    
Auto   18,675    18,939    (264)   (1.39)
Boat/RV   158,556    141,602    16,954    11.97 
Other   5,605    5,892    (287)   (4.87)
Total consumer other   182,836    166,433    16,403    9.86 
Commercial and industrial   139,145    131,103    8,042    6.13 
Total other loans   321,981    297,536    24,445    8.22 
                     
Total Gross Loans  $1,188,164   $1,172,636   $15,528    1.32%

 

The Company’s strategy to increase commercial and consumer loans remains a primary focus as we continued to see growth in these areas during the first six months of 2017 as commercial and non-real estate consumer loans grew by $27.2 million. We continue to seek to provide sound commercial borrowers opportunities for new loans to meet their growing demands, refinance loans currently served by other financial institutions and build relationships with commercial clients in our footprint. The increase in the commercial and other consumer portfolios was partially offset by an $11.7 million decrease in the consumer real estate portfolios during the period. The Company continues to sell longer term fixed-rate mortgage loans to reduce related interest rate risk.

 

Delinquencies and Non-performing Assets. As of June 30, 2017, our total loans delinquent 30-to-89 days were $6.6 million or 0.6% of total loans, down from $12.5 million or 1.1% of total loans at the year-end of 2016. This was primarily due to a decrease in delinquency on consumer mortgage and other consumer loans.

 

At June 30, 2017, our non-performing assets totaled $4.2 million or 0.27% of total assets, compared to $6.6 million or 0.42% of total assets at December 31, 2016. This $2.3 million, or 35.5% decrease was primarily due to a reduction in consumer mortgage loans and foreclosed assets.

 

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The table below sets forth the amounts and categories of non-performing assets at the dates indicated.

 

   June 30,   December 31,   Amount   Percent 
   2017   2016   Change   Change 
                 
Non-accruing loans  $3,511   $5,144   $(1,633)   (31.75)%
Accruing loans delinquent 90 days   27    237    (210)   (88.61)
Foreclosed assets   709    1,199    (490)   (40.87)
Total  $4,247   $6,580   $(2,333)   (35.46)%

 

The Company continues to diligently monitor and write down loans that appear to have irreversible weakness. The Company works to ensure possible problem loans have been identified and steps have been taken to reduce loss by restructuring loans to improve cash flow or by increasing collateral. In addition to the decrease in non-performing assets, the Company has seen improvement during the first six months of 2017 in total classified assets. Total classified assets decreased by 20.6% from $11.4 million at December 31, 2016 to $9.1 million at June 30, 2017 due to improvements in the economy in the local communities we serve and the sales of foreclosed assets.

 

At June 30, 2017, foreclosed real estate totaled $326,000 compared to $718,000 at December 31, 2016. The Company has seen a decrease in this area as overall real estate owned sales volumes are up and the number of foreclosures is down. At June 30, 2017, all foreclosed real estate owned was in consumer real estate. As of June 30, 2017, the Company also held $383,000 in other repossessed assets, such as autos, boats, RVs and horse trailers.

 

Allowance for Loan Losses. Allowance for loan losses was constant at $12.4 million as of June 30, 2017 compared to December 31, 2016. Net charge-offs in the first six months of 2017 were $456,000, or 0.08% of total loans on an annualized basis, compared to $387,000, or 0.07% of total loans on an annualized basis in the first six months of 2016. The allowance for loan losses to non-performing loans as of June 30, 2017 was 351.2% compared to 230.1% as of December 31, 2016. The allowance for loan losses to total loans as of June 30, 2017 was 1.05% compared to 1.06% as of December 31, 2016. Non-performing loans to total loans at June 30, 2017 were 0.30% compared to 0.46% at December 31, 2016. Non-performing assets to total assets were 0.27% at June 30, 2017 compared to 0.42% at December 31, 2016.

 

Deposits. Deposits increased by $19.6 million in the first six months of 2017. The increase in deposits was a result of an increase in core deposits of $13.5 million and $6.1 million in certificates of deposit. Core deposits are currently 67.7% of the Bank’s total deposits as of June 30, 2017.

 

   June 30, 2017   December 31, 2016 
   Amount   Weighted
Average
Rate
   Amount   Weighted
Average
Rate
 
                 
Type of Account:                    
Non-interest Checking  $187,173    0.00%  $178,046    0.00%
Interest-bearing NOW   300,341    0.42    292,977    0.27 
Savings   138,207    0.01    136,314    0.01 
Money Market   168,432    0.31    173,305    0.26 
Certificates of Deposit   378,832    1.28    372,740    1.19 
Total  $1,172,985    0.57%  $1,153,382    0.49%

 

Borrowings. Total borrowings decreased to $240.2 million at June 30, 2017, down $4.6 million, or 1.9%, since year-end 2016 primarily due to a $4.6 million decrease in FHLB advances. Other borrowings, a subordinated debenture, remained constant at $4.2 million at June 30, 2017.

 

The Company acquired $5.0 million of issuer trust preferred securities in the 2008 acquisition of MFB Corp., which had a net balance of $4.2 million at June 30, 2017 due to the purchase accounting adjustment in the acquisition. These securities mature 30 years from the date of issuance, or September 15, 2035. The securities bear a rate of interest of the prevailing three-month LIBOR rate plus 170 basis points. The Company has the right to redeem the trust preferred securities, in whole or in part, without penalty.

 

Stockholders’ Equity. Stockholders’ equity was $146.3 million at June 30, 2017, an increase of $6.3 million from December 31, 2016. The increase was primarily due to net income available to common shareholders of $7.1 million, an increase in accumulated other comprehensive income of $1.4 million and an increase of $139,000 due to exercises of stock options. These increases were partially offset by cash dividends on common stock of $2.4 million for the first six months of 2017. The Company’s tangible book value per common share as of June 30, 2017 increased to $19.65 compared to $18.82 as of December 31, 2016 and the tangible common equity ratio increased to 9.17% as of June 30, 2017 compared to 8.89% as of December 31, 2016. The Company’s and the Bank’s risk-based capital ratios were well in excess of “well-capitalized” levels as defined by all regulatory standards as of June 30, 2017.

 

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Comparison of Results of Operations for the Three Months Ended June 30, 2017 and 2016.

 

General. Net income for the three months ended June 30, 2017 was $3.9 million, or $0.52 diluted earnings per common share compared to net income of $4.2 million, or $0.55 diluted earnings per common share for the three months ended June 30, 2016. Annualized return on average assets was 0.99% and annualized return on average tangible common equity was 10.92% for the second quarter of 2017 compared to 1.10% and 12.01% respectively, for the same period of last year. 

 

Net Interest Margin and Average Balance Sheet. The following table presents the Company’s average balance sheet, interest income/interest expense, and the average rate as a percent of average earning assets for the periods indicated. All average balances are daily average balances. Non-accruing loans have been included in the table as loans carrying a zero yield.

 

   Three Months Ended 
   June 30, 2017   June 30, 2016 
   Average
Outstanding
Balance
   Interest
Earned/Paid
   Average
Yield/Rate
   Average
Outstanding
Balance
   Interest
Earned/Paid
   Average
Yield/Rate
 
Interest-Earning Assets:                              
Interest -bearing deposits  $24,059   $37    0.62%  $28,136   $22    0.31%
Investment securities, available for sale (1):                              
MBS/CMO   159,559    977    2.45    176,550    1,029    2.33 
Other   93,956    768    3.27    73,245    581    3.17 
Loans receivable   1,182,502    12,753    4.31    1,103,832    11,515    4.17 
Stock in FHLB of Indianapolis   11,183    117    4.18    10,492    111    4.23 
Total interest-earning assets (1)   1,471,259    14,652    3.98    1,392,255    13,258    3.81 
Non-interest earning assets, net of allowance for loan losses and unrealized gain/loss   98,254              113,340           
Total assets  $1,569,513             $1,505,595           
                               
Interest-Bearing Liabilities:                              
Demand and NOW accounts  $308,047    298    0.39   $278,588    169    0.24 
Savings deposits   139,766    4    0.01    137,029    4    0.01 
Money market accounts   166,272    126    0.30    169,114    110    0.26 
Certificate accounts   387,138    1,206    1.25    343,554    1,000    1.16 
Total deposits   1,001,223    1,634    0.65    928,285    1,283    0.55 
Borrowings   220,004    931    1.69    233,592    988    1.69 
Total interest-bearing liabilities   1,221,227    2,565    0.84    1,161,877    2,271    0.78 
Non-interest bearing deposit accounts   187,791              187,223           
Other liabilities   15,664              15,610           
Total liabilities   1,424,682              1,364,710           
Stockholders' equity   144,831              140,885           
Total liabilities and stockholders' equity  $1,569,513             $1,505,595           
                               
Net earning assets  $250,032             $230,378           
Net interest income       $12,087             $10,987      
Net interest rate spread (3)             3.14%             3.03%
Net interest margin (3)             3.29%             3.16%
Net interest margin, tax equivalent (2) (3)             3.39%             3.25%
Average interest-earning assets to average interest-bearing liabilities   120.47%             119.83%          

 

(1) Average balance of securities is computed based on the average of the historical amortized cost balances without the effects of the fair value adjustments.

(2) Tax equivalent margin is calculated by taking non-taxable interest and grossing up by 34% applicable tax rate.

(3) Ratios for the three month periods have been annualized.

 

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Interest Income. Total interest income increased $1.4 million, or 10.5%, to $14.7 million during the three months ended June 30, 2017 from $13.3 million during the same period in 2016. The increase was a result of an increase of $79.0 million in average interest-earning assets due to an increase in the average loan portfolio of $78.7 million and an increase of seventeen basis points in the average interest rate on average interest-earning assets for the quarter ended June 30, 2017 compared to the same period in 2016.

 

Interest Expense. Interest expense increased $294,000, or 12.9%, to $2.6 million during the three months ended June 30, 2017. The primary reason for this increase was an increase of $59.4 million in average interest-bearing liabilities. This was due to an increase in average interest-bearing deposits of $72.9 million partially offset by a decrease in borrowings of $13.6 million. The average rate paid for interest-bearing liabilities increased by six basis points for the three months ended June 30, 2017 compared to the same period in 2016.

 

Net Interest Income and Net Interest Margin. Net interest income before the provision for loan losses increased $1.1 million for the quarter ended June 30, 2017 compared to the same period in 2016. The increase in net interest income was primarily a result of an increase of $79.0 million in average interest earning assets, due to an increase of $78.7 million in average loans. This increase was also aided by a thirteen basis point increase in net interest margin to 3.29%, while the tax equivalent margin increased fourteen basis points. The increase in the margin was the result of average interest earning assets, primarily loans, repricing upward faster than average interest bearing liabilities due to increases in the federal funds rate. For more information on our asset/liability management especially as it relates to interest rate risk, see “Item 7A - Quantitative and Qualitative Disclosures About Market Risk” in the Form 10-K for the year ended December 31, 2016.

 

Provision for Loan Losses. Provision for loan losses in the second quarter of 2017 was $300,000 compared to $150,000 during last year’s comparable period. The increase was due to management’s ongoing evaluation of the adequacy of the allowance for loan losses, which was partially attributable to an increasing loan portfolio and a consistently low level in net charge offs of $256,000, or 0.09% of loans on an annualized basis, in the second quarter of 2017 compared to net charge offs of $216,000, or 0.08% of loans on an annualized basis, in the second quarter of 2016.

 

Non-Interest Income. Non-interest income for the second quarter of 2017 was $4.7 million, a decrease of $1.2 million compared to the second quarter of 2016.

 

   Three Months Ended June 30,   Amount   Percent 
   2017   2016   Change   Change 
Service fee income  $1,714   $1,528   $186    12.17%
Net realized gain on sale of securities   279    652    (373)   (57.21)
Commissions   1,318    1,404    (86)   (6.13)
Net gains on sales of loans   945    1,407    (462)   (32.84)
Net servicing fees   96    78    18    23.08 
Increase in cash surrender value of life insurance   288    306    (18)   (5.88)
Loss on sale of other real estate and repossessed assets   (75)   (188)   113    (60.11)
Other income   105    706    (601)   (85.13)
Total  $4,670   $5,893   $(1,223)   (20.75)%

 

Decreases in non-interest income included a decrease of $601,000 in other income primarily due to a gain on bank owned life insurance of $346,000 due to a death and a $200,000 gain on sale of an interest in a low income housing property in the second quarter of 2016 that was not repeated in 2017. Net gain on sale of loans decreased $462,000 as mortgage originations slowed compared to the second quarter of 2016. Gain on sale of investments decreased $373,000 as the Company took advantage of a decline in longer term interest rates in the second quarter of 2016 to reposition approximately $16.9 million of the investment portfolio which was not fully repeated in 2017. These decreases were partially offset by an increase of $186,000 on deposit service fee income as interchange income has increased due to increased debit card activity.

 

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Non-Interest Expense. Non-interest expenses decreased $23,000, to $11.2 million, for the second quarter of 2017.

 

   Three Months Ended June 30,   Amount   Percent 
   2017   2016   Change   Change 
Salaries and employee benefits  $6,534   $6,660   $(126)   (1.89)%
Net occupancy expenses   763    601    162    26.96 
Equipment expenses   438    484    (46)   (9.50)
Data processing fees   541    492    49    9.96 
ATM and debit card expense   410    356    54    15.17 
Deposit insurance   168    225    (57)   (25.33)
Professional fees   408    380    28    7.37 
Advertising and promotion   303    269    34    12.64 
Software subscriptions and maintenance   567    549    18    3.28 
Other real estate and repossessed assets   33    14    19    135.71 
Other expenses   1,052    1,210    (158)   (13.06)
Total  $11,217   $11,240   $(23)   (0.20)%

 

The decrease was primarily due to a decrease of $126,000 in salaries and benefits due to lower health insurance costs, lower mortgage originator commissions, and savings from branch closures compared to the second quarter of 2016. Other expenses also declined by $158,000 primarily due to a decline in intangible amortization and savings from branch closures in the first quarter of 2017. The decreases were offset by an increase of $162,000 in occupancy expense due to a loss of rental income from an office building sold in the fourth quarter of 2016 and an increase of $54,000 in ATM/debit card expense due to EMV card issuances and increased transaction charges.

 

Income Tax Expense. The effective tax rate for the second quarter of 2017 was 25.6% compared to 24.3% in the same quarter of 2016. The slight increase was due to increased taxable income as a percentage of total income.

 

Comparison of Results of Operations for the Six Months Ended June 30, 2017 and 2016.

 

General. Net income available to common shareholders for the six months ended June 30, 2017 was $7.1 million, or $0.95 diluted earnings per common share compared to net income available to common shareholders of $6.5 million, or $0.86 diluted earnings per common share for the six months ended June 30, 2016. Annualized return on average assets was 0.91% and annualized return on average tangible common equity was 10.09% for the first six months of 2017 compared to 0.87% and 9.48% respectively, for the same period of last year.

 

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Net Interest Margin and Average Balance Sheet. The following table presents the Company’s average balance sheet, interest income/interest expense, and the average rate as a percent of average earning assets for the periods indicated. All average balances are daily average balances. Non-accruing loans have been included in the table as loans carrying a zero yield.

 

   Six Months Ended 
   June 30, 2017   June 30, 2016 
   Average
Outstanding
Balance
   Interest
Earned/Paid
   Average
Yield/Rate
   Average
Outstanding
Balance
   Interest
Earned/Paid
   Average
Yield/Rate
 
Interest-Earning Assets:                              
Interest -bearing deposits  $22,742   $62    0.55%  $26,175   $42    0.32%
Investment securities, available for sale (1):                              
MBS/CMO   160,364    1,976    2.46    182,119    2,165    2.38 
Other   92,767    1,490    3.21    71,223    1,134    3.18 
Loans receivable