SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

 

FORM 10-K

(Mark One)

x

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

For the fiscal year ended December 31, 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 0-26128

 

NorthWest Indiana Bancorp

(Exact name of registrant as specified in its charter)

 

Indiana		35-1927981
(State or other jurisdiction of		(I.R.S. Employer Identification No.)
incorporation or organization)
9204 Columbia Avenue		46321
Munster, Indiana		(Zip Code)
(Address of principal executive offices)

 

(219) 836-4400

(Registrant’s telephone number, including area code)

 

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

Securities registered pursuant to Section 12(g) of the Act: Common Stock, without par value

 

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 if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of Registrant’s knowledge in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. x

 

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

 

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

Smaller Reporting Company x     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

 

Based on the average bid and ask prices for the registrant’s Common Stock at June 30, 2017, at that date, the aggregate market value of the registrant’s Common Stock held by nonaffiliates of the registrant (assuming solely for the purposes of this calculation that all directors and executive officers of the registrant are “affiliates”) was $93,491,671.

 

There were 2,868,940 shares of the registrant’s Common Stock, without par value, outstanding at February 16, 2018.

 

DOCUMENTS INCORPORATED BY REFERENCE

 

Portions of the following documents have been incorporated by reference into this Annual Report on Form 10-K:

 

1. Definitive Proxy Statement for the 2018 Annual Meeting of Shareholders. (Part III)

 

 

 

NorthWest Indiana Bancorp

Index

 

		Page Number
PART I.
	Item 1. Business	3
	Item 1A. Risk Factors	27
	Item 1B. Unresolved Staff Comments	27
	Item 2. Properties	28
	Item 3. Legal Proceedings	29
	Item 4. Mine Safety Disclosures	29
	Item 4.5 Executive Officers of the Bancorp	29
PART II.
	Item 5. Market for the Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities	31
	Item 6. Selected Financial Data	33
	Item 7. Management's Discussion and Analysis of Financial Condition and  Results of Operations	34
	Item 7A. Quantitative and Qualitative Disclosures about Market Risk	41
	Item 8. Financial Statements	42
	Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure	79
	Item 9A. Controls and Procedures	79
	Item 9B. Other Information	81
PART III.
	Item 10. Directors, Executive Officers and Corporate Governance	82
	Item 11. Executive Compensation	82
	Item 12. Security Ownership of Certain Beneficial Owners and Management  and Related Stockholder Matters	82
	Item 13. Certain Relationships and Related Transactions, and Director  Independence	82
	Item 14. Principal Accountant Fees and Services	83
PART IV.
	Item 15. Exhibits and Financial Statement Schedules	83
SIGNATURES		85
EXHIBIT INDEX		86

 

  

PART I

 

Item 1. Business

 

General

 

NorthWest Indiana Bancorp, an Indiana corporation (the “Bancorp”), was incorporated on January 31, 1994, and is the holding company for Peoples Bank SB, an Indiana savings bank (the “Bank”). The Bank is a wholly owned subsidiary of the Bancorp. The Bancorp’s business activities include being a holding company for the Bank and the Bank's wholly owned subsidiaries, as well as a holding company for NWIN Risk Management, Inc., a captive insurance company.

 

The Bank is primarily engaged in the business of attracting deposits from the general public and the origination of loans, mostly upon the security of single family residences and commercial real estate, as well as, construction loans and various types of consumer loans, commercial business loans and municipal loans, within its primary market area of Lake and Porter Counties, in Northwest Indiana. In addition, the Bancorp's Wealth Management Group provides estate and retirement planning, guardianships, land trusts, profit sharing and 401(k) retirement plans, IRA and Keogh accounts, investment agency accounts, and serves as the personal representative of estates and acts as trustee for revocable and irrevocable trusts.

 

The Bank’s deposit accounts are insured up to applicable limits by the Deposit Insurance Fund (“DIF”), which is administered by the Federal Deposit Insurance Corporation (“FDIC”), an agency of the federal government. As the holding company for the Bank, the Bancorp is subject to comprehensive examination, supervision and regulation by the Board of Governors of the Federal Reserve System (“FRB”), while the Bank is subject to comprehensive examination, supervision and regulation by both the FDIC and the Indiana Department of Financial Institutions (“DFI”). The Bank is also subject to regulation by the FRB governing reserves required to be maintained against certain deposits and other matters. The Bank is also a member of the Federal Home Loan Bank (“FHLB”) of Indianapolis, which is one of the eleven regional banks comprising the system of Federal Home Loan Banks.

 

The Bancorp maintains its corporate office at 9204 Columbia Avenue, Munster, Indiana, from which it oversees the operation of its sixteen branch locations. For further information, see “Properties.”

 

Forward-Looking Statements

 

Statements contained in this filing on Form 10-K that are not historical facts are forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. The words or phrases “would be,” “will allow,” “intends to,” “will likely result,” “are expected to,” “will continue,” “is anticipated,” “estimate,” “project,” or similar expressions are also intended to identify “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act. The Bancorp cautions readers that forward-looking statements, including without limitation those relating to the Bancorp’s future business prospects, interest income and expense, net income, liquidity, and capital needs are subject to certain risks and uncertainties that could cause actual results to differ materially from those indicated in the forward-looking statements due to a number of factors, including those set forth above in “Recent Developments” and below in “Regulation and Supervision” of this Form 10-K.

 

Lending Activities

 

General. The Bancorp’s product offerings include residential mortgage loans, construction loans, commercial real estate loans, consumer loans, commercial business loans and loans to municipalities. The Bancorp’s lending strategy stresses quality growth, product diversification, and competitive and profitable pricing. While lending efforts include both fixed and adjustable rate products, the focus has been on products with adjustable rates and/or shorter terms to maturity. It is management’s goal that all programs are marketed effectively to our primary market area.

 

 

The Bancorp is primarily a portfolio lender. Mortgage banking activities are limited to the sale of fixed rate mortgage loans with contractual maturities generally exceeding fifteen years and greater. These loans are sold, on a case-by-case basis, in the secondary market as part of the Bancorp’s efforts to manage interest rate risk. All loan sales are made to Freddie Mac or to the Federal Home Loan Bank of Indianapolis. All loans held for sale are recorded at the lower of cost or market value.

 

Under Indiana Law, an Indiana stock savings bank generally may not make any loan to a borrower or its related entities if the total of all such loans by the savings bank exceeds 15% of its unimpaired capital and unimpaired surplus (plus up to an additional 10% of unimpaired capital and unimpaired surplus, in the case of loans fully collateralized by readily marketable collateral); provided, however, that certain specified types of loans are exempted from these limitations or subject to different limitations. The maximum amount that the Bank could have loaned to one borrower and the borrower’s related entities at December 31, 2017, under the 15% of capital and surplus limitation was approximately $14,066,000. At December 31, 2017, the Bank had no loans that exceeded the regulatory limitations.

 

At December 31, 2017, there were no concentrations of loans in any type of industry that exceeded 10% of total loans that were not otherwise disclosed as a loan category.

 

Loan Portfolio. The following table sets forth selected data relating to the composition of the Bancorp’s loan portfolio by type of loan and type of collateral at the end of each of the last five years. The amounts are stated in thousands (000’s).

 

		2017				2016				2015				2014				2013
Type of loan:
Conventional real estate loans:
Construction and development		$	50,746			$	38,937			$	41,524			$	25,733			$	21,462
Loans on existing properties (1)			463,368				437,361				432,020				377,247				336,823
Consumer (2)			461				524				535				472				350
Commercial business			76,851				77,299				68,757				58,682				57,716
Government			28,785				29,529				29,062				26,019				21,470
Loans receivable (3)		$	620,211			$	583,650			$	571,898			$	488,153			$	437,821
Type of collateral:
Real estate:
1-to-4 family		$	208,910			$	205,838			$	213,756			$	189,529			$	161,663
Other dwelling units, land and commercial real estate			305,204				270,461				259,789				213,451				196,622
Consumer			321				424				461				351				212
Commercial business			76,666				76,735				68,308				58,145				56,767
Government			28,785				29,529				29,062				26,019				21,470
Loans receivable (4)		$	619,886			$	582,987			$	571,376			$	488,038			$	437,703
Average loans outstanding during the period (3)		$	602,426			$	587,119			$	522,278			$	480,404			$	436,430

 

(1)

Includes residential and commercial construction loans converted to permanent term loans and commercial real estate loans.

(2)

Includes overdrafts to deposit accounts.

(3)

Net of unearned income and net deferred loan fees.

(4)

Net of unearned income and net deferred loan fees. Does not include unsecured loans.

 

 

Loan Originations, Purchases and Sales. Set forth on the following table loan originations, purchases and sales activity for each of the last three years are shown. The amounts are stated in thousands (000’s).

 

		2017				2016				2015
Loans originated:
Conventional real estate loans:
Construction and development		$	11,510			$	7,700			$	6,566
Existing property			78,249				82,539				74,305
Refinanced			9,138				12,798				11,673
Total conventional real estate loans originated			98,897				103,037				92,544
Commercial business			238,667				238,633				228,351
Consumer			244				358				397
Total loans originated		$	337,808			$	342,028			$	321,292
Whole loans and participations purchased		$	796			$	-			$	27,978
Whole loans and participations sold		$	42,212			$	58,338			$	45,987

 

Loan Maturity Schedule. The following table sets forth certain information at December 31, 2017 regarding the dollar amount of loans in the Bancorp’s portfolio based on their contractual terms to maturity. Demand loans, loans having no schedule of repayments and no stated maturity, and overdrafts are reported as due in one year or less. Contractual principal repayments of loans do not necessarily reflect the actual term of the loan portfolio. The average life of mortgage loans is substantially less than their contractual terms because of loan prepayments and because of enforcement of due-on-sale clauses, which give the Bancorp the right to declare a loan immediately due and payable in the event, among other things, that the borrower sells the property subject to the mortgage. The amounts are stated in thousands (000’s).

 

		Maturing				After one
		within				but within				After
		one year				five years				five years				Total
Real estate		$	63,531			$	77,238			$	373,345			$	514,114
Consumer			15				422				24				461
Commercial business, and other			40,195				50,423				15,018				105,636
Total loans receivable		$	103,741			$	128,083			$	388,387			$	620,211

 

The following table sets forth the dollar amount of all loans due after one year from December 31, 2017, which have predetermined interest rates or have floating or adjustable interest rates. The amounts are stated in thousands (000’s).

 

		Predetermined				Floating or
		rates				adjustable rates				Total
Real estate		$	174,478			$	276,105			$	450,583
Consumer			446				-				446
Commercial business, and other			57,219				8,222				65,441
Total loans receivable		$	232,143			$	284,327			$	516,470

 

Lending Area. The primary lending area of the Bancorp encompasses all of Lake and Porter Counties in northwest Indiana, where a majority of loan activity is concentrated. To a lesser extent, the Bancorp also has lending activity in LaPorte, Newton and Jasper counties in Indiana, and Lake, Cook and Will counties in Illinois. The communities of Munster, Crown Point, Dyer, St. John, Merrillville, Schererville, and Cedar Lake have experienced consistent growth and, therefore, have provided the greatest lending opportunities.

 

  

Loan Origination Fees. All loan origination and commitment fees, as well as incremental direct loan origination costs, are deferred and amortized into income as yield adjustments over the contractual lives of the related loans.

 

Loan Origination Procedure. The primary sources for loan originations are referrals from commercial customers, real estate brokers and builders, solicitations by the Bancorp’s lending and retail staff, and advertising of loan programs and rates. The Bancorp employs no staff appraisers. All appraisals are performed by fee appraisers that have been approved by the Board of Directors and who meet all federal guidelines and state licensing and certification requirements.

 

Designated officers have authorities, established by the Board of Directors, to approve loans. Loans up to $2,500,000 are approved by the loan officers’ loan committee. Loans from $2,500,000 to $4,000,000 are approved by the senior officers’ loan committee. All loans in excess of $4,000,000, up to the legal lending limit of the Bank, must be approved by the Bank’s Board of Directors or its Executive Committee. (All members of the Bank’s Board of Directors and Executive Committee are also members of the Bancorp’s Board of Directors and Executive Committee, respectively.) Certain loan renewals and extensions may not require approval by the Board of Directors or the Directors of Executive Committee as long as there is no material change, credit downgrade, significant change in borrower or guarantor status, material release or change in collateral value or the eligible loan renewal or extension is not outside the current concentration limits set by the Board of Directors. In addition, all swap transactions will be subject to the approval of the SOLC and the Board of Directors or Director’s Executive Committee. The maximum in-house legal lending limit as set by the Board of Directors is the lower of 10% of the bank’s risk based capital or $6,000,000. Requests that exceed this amount will be considered on a case-by-case basis, after taking into consideration the legal lending limit, by specific Board action. Peoples Bank will not extend credit to any of its executive officers, directors, or principal shareholders or to any related interest of that person, except in compliance with the insider lending restrictions of Regulation O under the Federal Reserve Act and in an amount that, when aggregated with all other extensions of credit to that person, exceeds $500,000 unless: (1) the extension of credit has been approved in advance by a majority of the entire Board of Directors of the Bank, and (2) the interested party has abstained from participating directly or indirectly in the voting.

 

All loans secured by personal property must be covered by insurance in an amount sufficient to cover the full amount of the loan. All loans secured by real estate must be covered by insurance in an amount sufficient to cover the full amount of the loan or restore the property to its original state. First mortgage loans must be covered by a lender’s title insurance policy in the amount of the loan.

 

The Current Lending Programs

 

Residential Mortgage Loans. The primary lending activity of the Bancorp has been the granting of conventional mortgage loans to enable borrowers to purchase existing homes, refinance existing homes, or construct new homes. Conventional loans are made up to a maximum of 97% of the purchase price or appraised value, whichever is less. For loans made in excess of 80% of value, private mortgage insurance is generally required in an amount sufficient to reduce the Bancorp’s exposure to 80% or less of the appraised value of the property. Loans insured by private mortgage insurance companies can be made for up to 97% of value. During 2017, 76% of mortgage loans closed were conventional loans with borrowers having 20% or more equity in the property. This type of loan does not require private mortgage insurance because of the borrower’s level of equity investment.

 

Fixed rate loans currently originated generally conform to Freddie Mac guidelines for loans purchased under the one-to-four family program. Loan interest rates are determined based on secondary market yield requirements and local market conditions. Fixed rate mortgage loans with contractual maturities generally exceeding fifteen years and greater may be sold and/or classified as held for sale to control exposure to interest rate risk.

 

The 15 year mortgage loan program has gained wide acceptance in the Bancorp’s primary market area. As a result of the shortened maturity of these loans, this product has been priced below the comparable 20 and 30 year loan offerings. Mortgage applicants for 15 year loans tend to have a larger than normal down payment; this, coupled with the larger principal and interest payment amount, has caused the 15 year mortgage loan portfolio to consist, to a significant extent, of second time home buyers whose underwriting qualifications tend to be above average.

 

  

The Bancorp’s Adjustable Rate Mortgage Loans (“ARMs”) include offerings that reprice annually or are “Mini-Fixed.” The “Mini-Fixed” mortgage reprices annually after a one, three, five, seven or ten year period. ARM originations totaled $11.1 million for 2017 and $8.0 million for 2016. During 2017, ARMs represented 16.3% of total mortgage loan originations. The ability of the Bancorp to successfully market ARM’s depends upon loan demand, prevailing interest rates, volatility of interest rates, public acceptance of such loans and terms offered by competitors.

 

Construction Loans. Construction loans on residential properties are made primarily to individuals and contractors who are under contract with individual purchasers. These loans are personally guaranteed by the borrower. The maximum loan-to-value ratio is 89% of either the current appraised value or the cost of construction, whichever is less. Residential construction loans are typically made for periods of six months to one year.

 

Loans are also made for the construction of commercial properties. All such loans are made in accordance with well-defined underwriting standards. Generally if the loans are not owner occupied, these types of loans require proof of intent to lease and a confirmed end-loan takeout. In general, loans made do not exceed 80% of the appraised value of the property. Commercial construction loans are typically made for periods not to exceed two years or date of occupancy, whichever is less.

 

Commercial Real Estate Loans. Commercial real estate loans are typically made to a maximum of 80% of the appraised value. Such loans are generally made on an adjustable rate basis. These loans are typically made for terms of 15 to 20 years. Loans with an amortizing term exceeding 15 years normally have a balloon feature calling for a full repayment within seven to ten years from the date of the loan. The balloon feature affords the Bancorp the opportunity to restructure the loan if economic conditions so warrant. Commercial real estate loans include loans secured by commercial rental units, apartments, condominium developments, small shopping centers, owner occupied commercial/industrial properties, hospitality units and other retail and commercial developments.

 

While commercial real estate lending is generally considered to involve a higher degree of risk than single-family residential lending due to the concentration of principal in a limited number of loans and the effects of general economic conditions on real estate developers and managers, the Bancorp has endeavored to reduce this risk in several ways. In originating commercial real estate loans, the Bancorp considers the feasibility of the project, the financial strength of the borrowers and lessees, the managerial ability of the borrowers, the location of the project and the economic environment. Management evaluates the debt coverage ratio and analyzes the reliability of cash flows, as well as the quality of earnings. All such loans are made in accordance with well-defined underwriting standards and are generally supported by personal guarantees, which represent a secondary source of repayment.

 

Loans for the construction of commercial properties are generally located within an area permitting physical inspection and regular review of business records. Projects financed outside of the Bancorp’s primary lending area generally involve borrowers and guarantors who are or were previous customers of the Bancorp or projects that are underwritten according to the Bank’s underwriting standards.

 

Consumer Loans. The Bancorp offers consumer loans to individuals for personal, household or family purposes. Consumer loans are either secured by adequate collateral, or unsecured. Unsecured loans are based on the strength of the applicant’s financial condition. All borrowers must meet current underwriting standards. The consumer loan program includes both fixed and variable rate products. On a limited basis, the Bancorp purchases indirect dealer paper from various well-established businesses in its immediate banking area.

 

Home Equity Line of Credit. The Bancorp offers a fixed and variable rate revolving line of credit secured by the equity in the borrower’s home. Both products offer an interest only option where the borrower pays interest only on the outstanding balance each month. Equity lines will typically require a second mortgage appraisal and a second mortgage lender’s title insurance policy. Loans are generally made up to a maximum of 89% of the appraised value of the property less any outstanding liens.

 

  

Home Improvement Loans and Equity Loans—Fixed Term. Home improvement and equity loans are made up to a maximum of 85% of the appraised value of the improved property, less any outstanding liens. These loans are offered on both a fixed and variable rate basis with a maximum term of 240 months. All home equity loans are made on a direct basis to borrowers.

 

Commercial Business Loans. Although the Bancorp’s priority in extending various types of commercial business loans changes from time to time, the basic considerations in determining the makeup of the commercial business loan portfolio are economic factors, regulatory requirements and money market conditions. The Bancorp seeks commercial loan relationships from the local business community and from its present customers. Conservative lending policies based upon sound credit analysis governs the extension of commercial credit. The following loans, although not inclusive, are considered preferable for the Bancorp’s commercial loan portfolio: loans collateralized by liquid assets; loans secured by general use machinery and equipment; secured short-term working capital loans to established businesses secured by business assets; short-term loans with established sources of repayment and secured by sufficient equity and real estate; and unsecured loans to customers whose character and capacity to repay are firmly established.

 

Government Loans. The Bancorp is permitted to purchase non-rated municipal securities, tax anticipation notes and warrants within the local market area.

 

Non-Performing Assets, Asset Classification and Provision for Loan Losses

 

Loans are reviewed on a regular basis and are generally placed on a non-accrual status when, in the opinion of management, serious doubt exists as to the collectability of a loan. Loans are generally placed on non-accrual status when either principal or interest is 90 days or more past due. Consumer non-residential loans are generally charged off when the loan becomes over 120 days delinquent. Interest accrued and unpaid at the time a loan is placed on non-accrual status is charged against interest income. Subsequent payments are either applied to the outstanding principal balance, tax and insurance reserve or recorded as interest income, depending on the assessment of the ultimate collectability of the loan.

 

The Bancorp’s mortgage loan collection procedures provide that, when a mortgage loan is 15 days or more delinquent, the borrower will be contacted by mail and payment requested. If the delinquency continues, subsequent efforts will be made to contact the delinquent borrower. In certain instances, the Bancorp will recast the loan or grant a limited moratorium on loan payments to enable the borrower to reorganize his, her or its financial affairs. If the loan continues in a delinquent status for 120 days, the Bancorp will generally initiate foreclosure proceedings. Any property acquired as the result of foreclosure or by voluntary transfer of property made to avoid foreclosure is classified as foreclosed real estate until such time as it is sold or otherwise disposed of by the Bancorp. Foreclosed real estate is recorded at fair value at the date of foreclosure. At foreclosure, any write-down of the property is charged to the allowance for loan losses. Costs relating to improvement of property are capitalized, whereas holding costs are expensed. Valuations are periodically performed by management, and a valuation allowance is established by a charge to operations if the carrying value of a property exceeds its estimated fair value less selling costs. Subsequent gains or losses on disposition, including expenses incurred in connection with the disposition, are charged to operations. Collection procedures for consumer loans provide that when a consumer loan becomes ten days delinquent, the borrower will be contacted by mail and payment requested. If the delinquency continues, subsequent efforts will be made to contact the delinquent borrower. In certain instances, the Bancorp may grant a payment deferral. If a loan continues to be delinquent after 60 days and all collection efforts have been exhausted, the Bancorp will initiate legal proceedings. Collection procedures for commercial business loans provide that when a commercial loan becomes ten days delinquent, the borrower will be contacted by mail and payment requested. If the delinquency continues, subsequent efforts will be made to contact the delinquent borrower pursuant to the commercial loan collection policy. In certain instances, the Bancorp may grant a payment deferral or restructure the loan. Once it has been determined that collection efforts are unsuccessful, the Bancorp will initiate legal proceedings.

 

  

At December 31, 2017, the Bancorp classified five loans totaling $535 thousand as troubled debt restructurings, which involves modifying the terms of a loan to forego a portion of interest or principal or reducing the interest rate on the loan to a rate materially less than market rates, or materially extending the maturity date of a loan. The Bancorp’s troubled debt restructurings include two residential real estate loans totaling $302 thousand for which an extension in maturity and reduction in interest rate was granted, two commercial business loans totaling $52 thousand for which a reduction in principal was granted, and one commercial real estate loan totaling $181 thousand for which a reduction in interest rate and change in amortization was granted with no change to the maturity date. At December 31, 2017, all of the Bancorp’s loans classified as troubled debt restructurings are accruing loans. The valuation basis for the Bancorp’s troubled debt restructurings is based on the present value of cash flows, unless consistent cash flows are not present, then the fair value of the collateral securing the loan is the basis for valuation.

 

The following table sets forth information regarding the Bancorp’s non-performing assets as of December 31 for each period indicated. The amounts are stated in thousands (000’s).

 

		2017				2016				2015				2014				2013
Loans accounted for on a non-accrual basis:
Real estate:
Residential		$	3,858			$	4,521			$	4,172			$	2,443			$	2,526
Commercial			466				456				1,007				1,918				807
Commercial business			672				628				22				238				447
Consumer			-				-				-				-				-
Total		$	4,996			$	5,605			$	5,201			$	4,599			$	3,780
Accruing loans which are contractually past due 90 days or more:
Real estate:
Residential		$	227			$	500			$	377			$	941			$	174
Commercial			-				-				-				-				-
Commercial business			-				-				-				-				-
Consumer			-				-				-				-				-
Total		$	227			$	500			$	377			$	941			$	174
Loans that qualify as troubled debt restructurings and accruing:
Real estate:
Residential		$	302			$	-			$	-			$	-			$	491
Commercial			181				-				4,419				4,597				7,657
Commercial business			52				60				74				90				-
Consumer			-				-				-				-				-
Total		$	535			$	60			$	4,493			$	4,687			$	8,148
Total of non-accrual, 90 days past due and accruing, and restructurings		$	5,758			$	6,165			$	10,071			$	10,227			$	12,102
Ratio of non-performing loans to total assets			0.56	%			0.67	%			0.64	%			0.71	%			0.57	%
Ratio of non-performing loans to total loans			0.84	%			1.05	%			0.98	%			1.10	%			0.90	%
Foreclosed real estate		$	1,618			$	2,665			$	1,590			$	1,745			$	1,084
Ratio of foreclosed real estate to total assets			0.18	%			0.29	%			0.18	%			0.23	%			0.16	%

 

During 2017, gross interest income of $396 thousand would have been recorded on loans accounted for on a non-accrual basis if the loans had been current throughout the period. Interest on such loans included in income during the period amounted to $80 thousand.

 

  

Federal regulations require savings banks to classify their own loans and to establish appropriate general and specific allowances, subject to regulatory review. These regulations are designed to encourage management to evaluate loans on a case-by-case basis and to discourage automatic classifications. Loans classified as substandard or doubtful must be evaluated by management to determine loan loss reserves. Loans classified as loss must either be written off or reserved for by a specific allowance. Amounts reported in the general loan loss reserve are included in the calculation of the Bancorp’s total risk-based capital requirement (to the extent that the amount does not exceed 1.25% of total risk-based assets), but are not included in Tier 1 leverage ratio calculations and Tier 1 risk-based capital requirements. Loans internally classified as substandard totaled $5.9 million at December 31, 2017, compared to $6.1 million at December 31, 2016. No loans are internally classified as doubtful at December 31, 2017 or 2016. No loans were classified as loss at either December 31, 2017 or 2016. Substandard loans include non-performing loans and potential problem loans, where information about possible credit issues or other conditions causes management to question the ability of such borrowers to comply with loan covenants or repayment terms. In addition to identifying and monitoring non-performing and other classified loans, management maintains a list of watch loans. Watch loans represent loans management is closely monitoring due to one or more factors that may cause the loan to become classified. Watch loans totaled $11.7 million at December 31, 2017, compared to $10.6 million at December 31, 2016.

 

A loan is considered impaired when, based on current information and events, it is probable that a borrower will be unable to pay all amounts due according to the contractual terms of the loan agreement. At December 31, 2017, impaired loans totaled $2.5 million compared to $3.5 million at December 31, 2016. The December 31, 2017, impaired loan balances consist of fourteen commercial real estate, construction & land development, and commercial business loans totaling $1.4 million that are secured by business assets and real estate, and are personally guaranteed by the owners of the businesses. In addition, twenty-one mortgage loans totaling $462 thousand, along with forty-five purchased credit impaired mortgage loans totaling $690 thousand, have also been classified as impaired. The December 31, 2017 allowance for loan losses (“ALL”) contained $704 thousand in specific allowances for collateral deficiencies, compared to $1.2 million at December 31, 2016. The decrease in the specific allowance was primarily due to charge-off activity. Typically, management does not individually classify smaller-balance homogeneous loans, such as residential mortgages or consumer loans, as impaired, unless they are troubled debt restructurings.

 

At December 31, 2017, management is of the opinion that there are no loans, except those discussed above, where known information about possible credit problems of borrowers causes management to have serious doubts as to the ability of such borrowers to comply with the present loan repayment terms and which will imminently result in disclosure of such loans as non-accrual, past due or restructured loans. Management does not presently anticipate that any of the non-performing loans or classified loans would materially impact future operations, liquidity or capital resources.

 

For 2017, $1.2 million in provisions to the ALL were required, compared to $1.3 million for 2016 a decrease of $68 thousand or 5.4%. The ALL provision decrease is primarily a result of overall non-performing and impaired loans declining for the period. For 2017, net loan charge-offs, totaled $1.4 million, compared to $523 thousand for 2016. The net loan charge-offs for 2017 were comprised of $956 thousand in residential real estate loans, $347 thousand in commercial business loans, $60 thousand in home equity loans, and $53 thousand in consumer loans. The ALL provisions take into consideration management’s current judgments about the credit quality of the loan portfolio, loan portfolio balances, changes in the portfolio mix and local economic conditions. In determining the provision for loan losses for the current period, management has given consideration to historically elevated risks associated with the local economy, changes in loan balances and mix, and asset quality.

 

  

The ALL to total loans was 1.21% at December 31, 2017, compared to 1.32% at December 31, 2016. The decrease in the ratio was related to the overall decrease in non-performing loans and management’s current opinion on the strength of the portfolio. ALL to non-performing loans (coverage ratio) was 143.26% at December 31, 2017, compared to 126.10% at December 31, 2016. The December 31, 2017 balance in the ALL account of $7.5 million is considered adequate by management after evaluation of the loan portfolio, past experience and current economic and market conditions. While management may periodically allocate portions of the allowance for specific problem loans, the whole allowance is available for any loan charge offs that occur. The allocation of the ALL reflects performance and growth trends within the various loan categories, as well as consideration of the facts and circumstances that affect the repayment of individual loans, and loans which have been pooled as of the evaluation date, with particular attention given to non-performing loans and loans which have been classified as substandard, doubtful or loss. Management has allocated reserves to both performing and non-performing loans based on current information available.

 

The table that follows sets forth the allowance for loan losses and related ratios for the periods indicated. The amounts are stated in thousands (000’s).

 

		2017				2016				2015				2014				2013
Balance at beginning of period		$	7,698			$	6,953			$	6,361			$	7,189			$	8,421
Loans charged-off:
Real estate residential			(1,019	)			(529	)			(239	)			(311	)			(153	)
Commercial real estate			-				-				(59	)			(1,421	)			(788	)
Commercial real estate participations			-				-				-				-				(333	)
Commercial business			(386	)			-				(77	)			-				(567	)
Consumer			(71	)			(33	)			(30	)			(32	)			(16	)
Total charge-offs			(1,476	)			(562	)			(405	)			(1,764	)			(1,857	)
Recoveries:
Residential real estate			3				2				9				20				1
Commercial real estate			-				-				22				17				9
Commercial real estate participations			-				-				-				2				137
Commercial business			39				28				10				21				23
Consumer			18				9				2				1				5
Total recoveries			60				39				43				61				175
Net (charge-offs) / recoveries			(1,416	)			(523	)			(362	)			(1,703	)			(1,682	)
Provision for loan losses			1,200				1,268				954				875				450
Balance at end of period		$	7,482			$	7,698			$	6,953			$	6,361			$	7,189
ALL to loans outstanding			1.21	%			1.32	%			1.22	%			1.30	%			1.64	%
ALL to nonperforming loans			143.26	%			126.10	%			124.66	%			114.83	%			181.81	%
Net charge-offs / recoveries to average loans outstanding during the period			-0.23	%			-0.09	%			-0.07	%			-0.35	%			-0.39	%

 

The following table shows the allocation of the allowance for loan losses at December 31, for the dates indicated. The dollar amounts are stated in thousands (000’s). The percent columns represent the percentage of loans in each category to total loans.

 

		2017								2016								2015								2014								2013
		$				%				$				%				$				%				$				%				$				%
Real estate loans:
Residential			1,734				33.7				2,410				35.3				1,711				37.4				1,877				38.8				1,444				36.9
Commercial and other dwelling			4,365				49.2				4,302				46.3				4,436				45.4				3,658				43.7				4,820				44.9
Consumer loans			31				0.1				34				0.1				38				0.1				18				0.1				12				0.1
Commercial business and other			1,352				17.0				952				18.3				768				17.1				808				17.4				913				18.1
Total			7,482				100.0				7,698				100.0				6,953				100.0				6,361				100.0				7,189				100.0

 

  

Investment Activities

 

The primary objective of the investment portfolio is to provide for the liquidity needs of the Bancorp and to contribute to profitability by providing a stable flow of dependable earnings. Securities can be classified as either held-to-maturity (HTM) or available-for-sale (AFS) at the time of purchase. No securities are classified as trading or as held-to-maturity. AFS securities are those the Bancorp may decide to sell if needed for liquidity, asset-liability management or other reasons. During 2017, the Bancorp did not hold as investments any derivative instruments and was not involved in hedging activities as defined by Accounting Standards Codification Topic 815 Derivatives and Hedging. It has been the policy of the Bancorp to invest its excess cash in U.S. government agency securities, mortgage-backed securities, collateralized mortgage obligations and municipal securities. In addition, short-term funds are generally invested as interest bearing balances in financial institutions and federal funds. At December 31, 2017, the Bancorp’s investment portfolio totaled $244.5 million. In addition, the Bancorp had $357 thousand of federal funds sold, and $3.0 million in FHLB stock.

 

The table below shows the carrying values of the components of the investment securities portfolio at December 31, on the dates indicated. The amounts are stated in thousands (000’s).

 

		2017				2016				2015
Money market fund		$	476			$	222			$	525
U.S. government agencies:
Available-for-sale			3,890				16,274				17,431
Mortgage-backed securities (1):
Available-for-sale			47,314				67,533				58,259
Collateralized Mortgage Obligations (1):
Available-for-sale			85,624				50,442				60,914
Municipal Securities:
Available-for-sale			103,747				96,745				93,487
Trust Preferred Securities:
Available-for-sale			3,439				2,409				2,734
Totals		$	244,490			$	233,625			$	233,350

 

(1) Mortgage-backed securities and Collateralized Mortgage Obligations are U.S. government agency and sponsored securities.

 

The contractual maturities and weighted average yields for the U.S. government securities, agency securities, municipal securities, and trust preferred securities at December 31, 2017, are summarized in the table below. Securities not due at a single maturity date, such as mortgage-backed securities and collateralized mortgage obligations are not included in the following table. The carrying values are stated in thousands (000’s).

 

Yields presented are not on a tax-equivalent basis.

 

		Within 1 Year								1 - 5 Years								5 - 10 Years								After 10 Years
		Amount				Yield				Amount				Yield				Amount				Yield				Amount				Yield
Money market fund:		$	476				0.24	%		$	-				0.00	%		$	-				0.00	%		$	-				0.00	%
U.S. government Agencies:
AFS			-				0.00	%			1,951				1.75	%			1,940				1.86	%			-				0.00	%
Municipal Securities:
AFS			281				4.96	%			4,199				4.13	%			26,591				3.62	%			72,675				3.24	%
Trust Preferred Securities:
AFS			-				0.00	%			-				0.00	%			-				0.00	%			3,439				2.18	%
Totals		$	757				5.37	%		$	6,150				3.37	%		$	28,531				3.50	%		$	76,114				3.19	%

 

  

The Bancorp currently holds four trust preferred securities of which three of the securities’ quarterly interest payments have been placed in “payment in kind” status. Payment in kind status results in a temporary delay in the payment of interest. As a result of a delay in the collection of the interest payments, management placed these securities in non-accrual status. At December 31, 2017, the cost basis of the three trust preferred securities on non-accrual status totaled $3.5 million. One trust preferred security with a cost basis of $1.3 million remains on accrual status.

 

Sources of Funds

 

General. Deposits are the major source of the Bancorp’s funds for lending and other investment purposes. In addition to deposits, the Bancorp derives funds from maturing investment securities and certificates of deposit, dividend receipts from the investment portfolio, loan principal repayments, repurchase agreements, advances from the Federal Home Loan Bank of Indianapolis (FHLB) and other borrowings. Loan repayments are a relatively stable source of funds, while deposit inflows and outflows are significantly influenced by general interest rates and money market conditions. Borrowings may be used on a short-term basis to compensate for reductions in the availability of other sources of funds. They may also be used on a longer-term basis for general business purposes. The Bancorp uses repurchase agreements, as well as a line-of-credit and advances from the FHLB for borrowings. At December 31, 2017, the Bancorp had $11.3 million in repurchase agreements. Other borrowings totaled $20.9 million, of which $20.3 million represents FHLB advances.

 

Deposits. Retail and commercial deposits are attracted principally from within the Bancorp’s primary market area. The Bancorp offers a broad selection of deposit instruments including non-interest bearing demand accounts, interest bearing demand accounts, savings accounts, money market deposit accounts, certificate accounts and retirement savings plans. Deposit accounts vary as to terms, with the principal differences being the minimum balance required, the time period the funds must remain on deposit and the interest rate. Certificate account offerings typically range in maturity from ten days to 42 months. The deregulation of federal controls on insured deposits has allowed the Bancorp to be more competitive in obtaining funds and to be flexible in meeting the threat of net deposit outflows. The Bancorp does not obtain funds through brokers.

 

The following table presents the average daily amount of deposits and average rates paid on such deposits for the years indicated. The amounts are stated in thousands (000’s).

 

		2017								2016								2015
		Amount				Rate %				Amount				Rate %				Amount				Rate %
Noninterest bearing demand deposits		$	117,656				-			$	104,672				-			$	91,737				-
Interest bearing demand deposits			169,980				0.08				145,347				0.07				138,006				0.07
MMDA accounts			170,211				0.26				167,684				0.21				150,288				0.18
Savings accounts			131,908				0.08				124,214				0.09				105,557				0.07
Certificates of deposit			180,413				0.77				192,991				0.62				190,858				0.55
Total deposits		$	770,168				0.27			$	734,908				0.24			$	676,446				0.22

 

Maturities of time certificates of deposit and other time deposits of $100 thousand or more at December 31, 2017 are summarized as follows. The amounts are stated in thousands (000’s).

 

3 months or less		$	19,851
Over 3 months through 6 months			18,324
Over 6 months through 12 months			30,218
Over 12 months			22,654
Total		$	91,047

 

  

Borrowings. Borrowed money is used on a short-term basis to compensate for reductions in the availability of other sources of funds and is generally accomplished through repurchase agreements, as well as, through a line of credit and advances from the FHLB. Repurchase agreements generally mature within one year and are generally secured by U.S. government securities or U.S. agency securities, under the Bancorp’s control. FHLB advances with maturities ranging from one year to five years are used to fund securities and loans of comparable duration, as well as to reduce the impact that movements in short-term interest rates have on the Bancorp’s overall cost of funds. Fixed rate advances are payable at maturity, with a prepayment penalty.

 

The following tables set forth certain information regarding borrowing and repurchase agreements by the Bancorp at the end of and during the periods indicated. The amounts are stated in thousands (000’s).

 

		At December 31,
		2017				2016				2015
Repurchase agreements:
Balance		$	11,300			$	13,998			$	18,508
Securities underlying the agreements:
Ending carrying amount			18,053				23,571				23,479
Ending fair value			18,053				23,571				23,479
Weighted average rate (1)			0.91	%			0.56	%			0.45	%

 

		For year ended December 31,
		2017				2016				2015
Highest month-end balance		$	17,720			$	23,308			$	22,020
Average outstanding balance			13,734				17,755				18,003
Weighted average rate on securities sold under agreements to repurchase (2)			0.82	%			0.55	%			0.38	%

 

		At December 31,
		2017				2016				2015
Fixed rate short-term advances from the FHLB		$	6,100			$	12,000			$	10,000
Fixed rate long-term advances from the FHLB			11,000				13,100				24,100
Variable advances from the FHLB			-				-				5,000
FHLB line-of-credit			3,181				28				-
Overdrawn due from other financial institutions			600				700				393
Total borrowings		$	20,881			$	25,828			$	39,493

 

(1) The weighted average rate for each period is calculated by weighting the principal balances outstanding for the various interest rates.

(2) The weighted average rate is calculated by dividing the interest expense for the period by the average daily balances of securities sold under agreements to repurchase for the period.

 

Wealth Management Group

 

The activities of the Bancorp's Wealth Management Group provides estate and retirement planning, guardianships, land trusts, profit sharing and 401(k) retirement plans, IRA and Keogh accounts, investment agency accounts, and serves as personal representative of estates and acts as trustee for revocable and irrevocable trusts. At December 31, 2017, the market value of the Wealth Management Group’s assets totaled $306.0 million, a decrease of $13.4 million, compared to December 31, 2016.

 

Analysis of Profitability and Key Operating Ratios

 

Distribution of Assets, Liabilities and Shareholders’ Equity; Interest Rates and Interest Differential.

 

The net earnings of the Bancorp depend primarily upon the “spread” (difference) between (a) the income it receives from its loan portfolio and other investments, and (b) its cost of money, consisting principally of the interest paid on deposit accounts and on other borrowings.

 

  

The following table presents the weighted average yields on loans and securities, the weighted average cost of interest bearing deposits and other borrowings, and the interest rate spread for the year ended December 31, 2017.

 

Weighted average yield:
Securities			2.66	%
Loans receivable			4.45	%
Federal Home Loan Bank stock			4.25	%
Total interest-earning assets			3.91	%
Weighted average cost:
Deposit accounts			0.27	%
Borrowed funds			1.27	%
Total interest-bearing liabilities			0.32	%
Interest rate spread:
Weighted average yield on interest-earning assets minus the weighted average cost of interest-bearing funds			3.59	%

 

Financial Ratios and the Analysis of Changes in Net Interest Income.

 

The tables below set forth certain financial ratios of the Bancorp for the periods indicated:

 

		Year ended December 31,
		2017				2016				2015
Return on average assets			0.98	%			1.03	%			0.96	%
Return on average equity			9.90	%			10.65	%			9.90	%
Average equity-to-average assets ratio			9.94	%			9.67	%			9.70	%
Dividend payout ratio			36.76	%			34.69	%			38.50	%

 

		At December 31,
		2017				2016				2015
Total stockholders’ equity to  total assets			9.93	%			9.21	%			9.35	%

 

  

The average balance sheet amounts, the related interest income or expense, and average rates earned or paid are presented in the following table.

 

The amounts are stated in thousands (000's).

 

		Year ended December 31, 2017												Year ended December 31, 2016												Year ended December 31, 2015
						Interest												Interest												Interest
		Average				Income/				Average				Average				Income/				Average				Average				Income/				Average
		Balance				Expense				Rate				Balance				Expense				Rate				Balance				Expense				Rate
Assets:
Interest bearing balances in financial institutions		$	5,114			$	54				1.06	%		$	5,149			$	31				0.60	%		$	11,022			$	28				0.25	%
Federal funds sold			960				4				0.42				409				1				0.24				435				-				0.10
Securities			242,502				6,441				2.66				240,262				6,097				2.54				231,366				6,151				2.66
Total investments			248,576				6,499				2.61				245,820				6,129				2.49				242,823				6,179				2.54
Loans:*
Real estate mortgage loans			495,448				22,697				4.58				485,778				22,474				4.63				429,724				19,766				4.60
Commercial business loans			108,083				4,143				3.83				100,861				3,771				3.74				92,047				3,418				3.71
Consumer loans			382				19				4.97				480				24				5.00				507				19				3.75
Total loans			603,913				26,859				4.45				587,119				26,269				4.47				522,278				23,203				4.44
Total interest-earning assets			852,489				33,358				3.91				832,939				32,398				3.89				765,101				29,382				3.84
Allowance for loan losses			(7,239	)											(7,364	)											(6,625	)
Cash and due from banks			12,171												11,868												11,963
Premises and equipment			19,621												18,955												18,140
Other assets			34,036												31,617												28,782
Total assets		$	911,078											$	888,015											$	817,361
Liabilities:
Demand deposit		$	117,656			$	-				-	%		$	101,835			$	-				-	%		$	91,737			$	-				-	%
NOW accounts			169,980				129				0.08				148,184				101				0.07				138,006				101				0.07
Money market demand accounts			170,211				437				0.26				167,684				360				0.21				150,288				273				0.18
Savings accounts			131,908				110				0.08				124,214				107				0.09				105,557				77				0.07
Certificates of deposit			180,413				1,384				0.77				192,991				1,202				0.62				190,858				1,058				0.55
Total interest-bearing deposits			770,168				2,060				0.27				734,908				1,770				0.24				676,446				1,509				0.22
Borrowed funds			42,060				533				1.27				56,990				575				1.01				52,803				504				0.95
Total interest-bearing liabilities			812,228				2,593				0.32				791,898				2,345				0.30				729,249				2,013				0.28
Other liabilities			8,312												10,275												8,813
Total liabilities			820,540												802,173												738,062
Stockholders' equity			90,538												85,842												79,299
Total liabilities and stockholders' equity		$	911,078											$	888,015											$	817,361
Net interest income						$	30,765											$	30,053											$	27,369
Net interest spread											3.59	%											3.59	%											3.56	%
Net interest margin**											3.61	%											3.61	%											3.58	%

 

* Non-accruing loans have been included in the average balances.

** Net interest income divided by average interest-earning assets.

 

  

The table below sets forth certain information regarding changes in interest income and interest expense of the Bancorp for the periods indicated. For each category of interest-earning asset and interest-bearing liability, information is provided on changes attributable to: (1) changes in volume (change in volume multiplied by old rate) and (2) changes in rate (change in rate multiplied by old volume). Changes attributable to both rate and volume which cannot be segregated have been allocated proportionately to the change due to volume and the change due to rate. The amounts are stated in thousands (000's).

 

		Year Ended December 31,												Year Ended December 31,
		2017				vs.				2016				2016				vs.				2015
		Increase / (Decrease)												Increase / (Decrease)
		Due To												Due To
		Volume				Rate				Total				Volume				Rate				Total
Interest income:
Loans receivable		$	748			$	(159	)		$	589			$	2,900			$	166			$	3,066
Securities			57				280				337				232				(286	)			(54	)
Other interest-earning assets			3				30				33				(20	)			24				4
Total interest-earning assets			808				151				959				3,112				(96	)			3,016
Interest Expense:
Deposits			88				201				289				136				125				261
Borrowed Funds			(170	)			128				(42	)			41				30				71
Total interest-bearing liabilities			(82	)			329				247				177				155				332
Net change in net interest income/(expense)		$	890			$	(178	)		$	712			$	2,935			$	(251	)		$	2,684

 

  

Bank Subsidiary Activities

 

NWIN Risk Management, Inc. is a wholly owned subsidiary of the Bancorp. The subsidiary provides captive insurance for the subsidiaries of the Bancorp. At December 31, 2017, the Bancorp had an investment balance of $1.7 million in NWIN Risk Management, Inc.

 

Peoples Service Corporation, a wholly owned subsidiary of the Bank was incorporated under the laws of the State of Indiana. The subsidiary currently provides insurance and annuity investments to the Bank’s wealth management customers. At December 31, 2017, the Bank had an investment balance of $172 thousand in Peoples Service Corporation.

 

NWIN, LLC is a wholly owned subsidiary of the Bank. NWIN, LLC was incorporated under the laws of the State of Nevada as an investment subsidiary. The investment subsidiary currently holds Bank security investments, which are managed by a professional portfolio manager. In addition, the investment subsidiary is the parent of a real estate investment trust, NWIN Funding, Inc., that invests in real estate loans originated by the Bank. At December 31, 2017, the Bank had an investment balance of $330.8 million in NWIN, LLC.

 

NWIN Funding, Inc. is a subsidiary of NWIN, LLC, and was formed as an Indiana Real Estate Investment Trust (REIT). The formation of NWIN Funding, Inc. provides the Bancorp with a vehicle that may be used to raise capital utilizing portfolio mortgages as collateral, without diluting stock ownership. In addition, NWIN Funding, Inc. will receive favorable state tax treatment for income generated by its operations. At December 31, 2017, the REIT held assets of $77.4 million in real estate loans.

 

Columbia Development Company, LLC is a wholly owned subsidiary of the Bank and was incorporated under the laws of the State of Indiana. The subsidiary holds real estate properties that the Bank has acquired through the foreclosure process. At December 31, 2017, the Bank had an investment balance of $4.0 million in Columbia Development Company, LLC.

 

The consolidated financial statements include NorthWest Indiana Bancorp (the Bancorp), its wholly owned subsidiaries, Peoples Bank SB (the Bank), NWIN Risk Management, Inc, and the Bank’s wholly owned subsidiaries, Peoples Service Corporation, NWIN, LLC and Columbia Development Company, LLC. The Bancorp’s business activities include being a holding company for the Bank as well as a holding company for NWIN Risk Management, Inc. The Bancorp’s earnings are dependent upon the earnings of the Bank. All significant inter-company accounts and transactions have been eliminated in consolidation.

 

Competition

 

The Bancorp’s primary market area for deposits, loans and financial services encompasses Lake and Porter Counties, in Northwest Indiana, where all of its offices are located. Approximately ninety-two percent of the Bancorp’s business activities are within this area.

 

The Bancorp faces strong competition in its primary market area for the attraction and retention of deposits and in the origination of loans. The Bancorp’s most direct competition for deposits has historically come from commercial banks, savings associations, and credit unions located in its primary market area. Particularly in times of high interest rates, the Bancorp has had significant competition from mutual funds and other firms offering financial services. The Bancorp’s competition for loans comes principally from savings associations, commercial banks, mortgage banking companies, credit unions, insurance companies, and other institutional lenders.

 

The Bancorp competes for loans principally through the interest rates and loan fees it charges and the efficiency and quality of the services it provides borrowers and other third-party sources. It competes for deposits by offering depositors a wide variety of savings accounts, checking accounts, competitive interest rates, convenient banking center locations, drive-up facilities, automatic teller machines, tax deferred retirement programs, electronic banking, and other miscellaneous services.

 

  

The activities of the Bancorp and the Bank in the geographic market served involve competition with other banks as well as with other financial institutions and enterprises, many of which have substantially greater resources than those available to the Bancorp. In addition, non-bank financial services companies with which the Bancorp and Bank compete, while subject to regulation by the CFPB, are generally not subject to the same type of extensive regulation by the federal and state banking agencies applicable to the Bancorp and the Bank.

 

Personnel

 

As of December 31, 2017, the Bank had 185 full-time and 32 part-time employees. The employees are not represented by a collective bargaining agreement. Management believes its employee relations are good. The Bancorp has seven executive officers and has no other employees. The Bancorp’s officers also are full-time employees of the Bank, and are compensated by the Bank.

 

Regulation and Supervision

 

Bank Holding Company Regulation. As a registered bank holding company for the Bank, the Bancorp is subject to the regulation and supervision of the FRB under the Bank Holding Company Act of 1956, as amended (the "BHCA"). Bank holding companies are required to file periodic reports with and are subject to periodic examination by the FRB.

 

Under the BHCA, without the prior approval of the FRB, the Bancorp may not acquire direct or indirect control of more than 5% of the voting stock or substantially all of the assets of any company, including a bank, and may not merge or consolidate with another bank holding company. In addition, the Bancorp is generally prohibited by the BHCA from engaging in any nonbanking business unless such business is determined by the FRB to be so closely related to banking as to be a proper incident thereto. Under the BHCA, the FRB has the authority to require a bank holding company to terminate any activity or relinquish control of a nonbank subsidiary (other than a nonbank subsidiary of a bank) upon the FRB's determination that such activity or control constitutes a serious risk to the financial soundness and stability of any bank subsidiary of the bank holding company.

 

Under the Dodd-Frank Act, a bank holding company is expected to serve as a source of financial and managerial strength to its subsidiary banks. Pursuant to this requirement, a bank holding company should stand ready to use its resources to provide adequate capital funds to its subsidiary banks during periods of financial stress or adversity. This support may be required by the FRB at times when the Bancorp may not have the resources to provide it or, for other reasons, would not be inclined to provide it. Additionally, under the Federal Deposit Insurance Corporation Improvement Act of 1991 ("FDICIA"), a bank holding company is required to provide limited guarantee of the compliance by any insured depository institution subsidiary that may become "undercapitalized" (as defined in the statute) with the terms of any capital restoration plan filed by such subsidiary with its appropriate federal banking agency.

 

Savings Bank Regulation. As an Indiana stock savings bank, the Bank is subject to federal regulation and supervision by the FDIC and to state regulation and supervision by the DFI. The Bank's deposit accounts are insured by DIF, which is administered by the FDIC. The Bank is not a member of the Federal Reserve System.

 

Both federal and Indiana law extensively regulate various aspects of the banking business such as reserve requirements, truth-in-lending and truth-in-savings disclosures, equal credit opportunity, fair credit reporting, trading in securities and other aspects of banking operations. Current federal law also requires savings banks, among other things, to make deposited funds available within specified time periods.

 

Under FDICIA, insured state chartered banks are prohibited from engaging as principal in activities that are not permitted for national banks, unless: (i) the FDIC determines that the activity would pose no significant risk to the appropriate deposit insurance fund, and (ii) the bank is, and continues to be, in compliance with all applicable capital standards.

 

Branches and Acquisitions. Branching by the Bank requires the approval of the Federal Reserve and the DFI. Under current law, Indiana chartered banks may establish branches throughout the state and in other states, subject to certain limitations. Congress authorized interstate branching, with certain limitations, beginning in 1997. Indiana law authorizes an Indiana bank to establish one or more branches in states other than Indiana through interstate merger transactions and to establish one or more interstate branches through de novo branching or the acquisition of a branch. The Dodd-Frank Act permits the establishment of de novo branches in states where such branches could be opened by a state bank chartered by that state. The consent of the state is no longer required.

 

  

Transactions with Affiliates. Under Indiana law, the Bank is subject to Sections 22(h), 23A and 23B of the Federal Reserve Act, which restrict financial transactions between banks and affiliated companies, such as the Bancorp. The statute limits credit transactions between a bank and its executive officers and its affiliates, prescribes terms and conditions for bank affiliate transactions deemed to be consistent with safe and sound banking practices, and restricts the types of collateral security permitted in connection with a bank's extension of credit to an affiliate.

 

Capital Requirements. Federal regulations require FDIC insured depository institutions, including state chartered FRB member banks, to meet several minimum capital standards: (i) a common equity Tier 1 capital to risk-based assets ratio of 4.5%; (ii) a Tier 1 capital to risk-based assets ratio of 6.0%; (iii) a total capital to risk-based assets ratio of 8%; and (iv) a 4% Tier 1 capital to total assets leverage ratio. These capital requirements were effective January 1, 2015 and are the result of a final rule implementing the Basel III regulatory capital reforms and changes required by the Dodd-Frank Act.

 

As noted, the capital standards require the maintenance of common equity Tier 1 capital, Tier 1 capital and total capital to risk-weighted assets of at least 4.5%, 6% and 8%, respectively, and a leverage ratio of at least 4% Tier 1 capital. Common equity Tier 1 capital is generally defined as common shareholders’ equity and retained earnings. Tier 1 capital is generally defined as common equity Tier 1 and Additional Tier 1 capital. Additional Tier 1 capital generally includes certain noncumulative perpetual preferred stock and related surplus and minority interests in equity accounts of consolidated subsidiaries. Total capital includes Tier 1 capital (common equity Tier 1 capital plus Additional Tier 1 capital) and Tier 2 capital. Tier 2 capital is comprised of capital instruments and related surplus meeting specified requirements, and may include cumulative preferred stock and long-term perpetual preferred stock, mandatory convertible securities, intermediate preferred stock, and subordinated debt. Also included in Tier 2 capital is the allowance for loan and lease losses limited to a maximum of 1.25% of risk-weighted assets and, for institutions that have exercised an opt-out election regarding the treatment of Accumulated Other Comprehensive Income (“AOCI”), up to 45% of net unrealized gains on available-for-sale equity securities with readily determinable fair market values. Institutions that have not exercised the AOCI opt-out have AOCI incorporated into common equity Tier 1 capital (including unrealized gains and losses on available-for-sale-securities). Calculation of all types of regulatory capital is subject to deductions and adjustments specified in the regulations.

 

In determining the amount of risk-weighted assets for purposes of calculating risk-based capital ratios, assets, including certain off-balance sheet assets (e.g., recourse obligations, direct credit substitutes, and residual interests) are multiplied by a risk weight factor assigned by the regulations based on the risks believed inherent in the type of asset. Higher levels of capital are required for asset categories believed to present greater risk. For example, a risk weight of 0% is assigned to cash and U.S. government securities, a risk weight of 50% is generally assigned to prudently underwritten first lien one to four-family residential mortgages, a risk weight of 100% is assigned to commercial and consumer loans, a risk weight of 150% is assigned to certain past due loans and a risk weight of between 0% to 600% is assigned to permissible equity interests, depending on certain specified factors.

 

In addition to establishing the minimum regulatory capital requirements, the regulations limit capital distributions by the institution and certain discretionary bonus payments to management if an institution does not hold a “capital conservation buffer” consisting of 2.5% of common equity Tier 1 capital to risk-weighted assets above the amount necessary to meet its minimum risk-based capital requirements. The capital conservation buffer requirement is being phased in beginning January 1, 2016 at 0.625% of risk-weighted assets and increasing each year until fully implemented at 2.5% on January 1, 2019.

 

The FRB has authority to establish individual minimum capital requirements in appropriate cases upon a determination that an institution’s capital level is or may become inadequate in light of the particular risks or circumstances. As of December 31, 2017, the Bank met all applicable capital adequacy requirements.

 

  

Bank holding companies are generally subject to consolidated capital requirements established by the FRB. The Dodd-Frank Act required the FRB to set minimum capital levels for bank holding companies that are as stringent as those required for insured depository subsidiaries. However, under the FRB’s “Small Bank Holding Company” exemption from consolidated bank holding company capital requirements, bank holding companies and savings and loan holding companies with less than $1 billion in consolidated assets, such as the Bancorp, are exempt from consolidated regulatory capital requirements, unless the FRB determines otherwise in particular cases.

 

Federal law establishes a system of prompt corrective action to resolve the problems of undercapitalized institutions. The law requires that certain supervisory actions be taken against undercapitalized institutions, the severity of which depends on the degree of undercapitalization. The FRB has adopted regulations to implement the prompt corrective action legislation as to state member banks. An institution is deemed to be “well capitalized” if it has a total risk-based capital ratio of 10.0% or greater, a Tier 1 risk-based capital ratio of 8.0% or greater, a leverage ratio of 5.0% or greater, and a common equity Tier 1 ratio of 6.5% or greater. An institution is “adequately capitalized” if it has a total risk-based capital ratio of 8.0% or greater, a Tier 1 risk-based capital ratio of 6.0% or greater, a leverage ratio of 4.0% or greater, and a common equity Tier 1 ratio of 4.5% or greater. An institution is “undercapitalized” if it has a total risk-based capital ratio of less than 8.0%, a Tier 1 risk-based capital ratio of less than 6.0%, a leverage ratio of less than 4.0%, or a common equity Tier 1 ratio of less than 4.5%. An institution is deemed to be “significantly undercapitalized” if it has a total risk-based capital ratio of less than 6.0%, a Tier 1 risk-based capital ratio of less than 4.0%, a leverage ratio of less than 3.0%, or a common equity Tier 1 ratio of less than 3.0%. An institution is considered to be “critically undercapitalized” if it has a ratio of tangible equity (as defined in the regulations) to total assets that is equal to or less than 2.0%.

 

Subject to a narrow exception, a receiver or conservator is required to be appointed for an institution that is “critically undercapitalized” within specified time frames. The regulations also provide that a capital restoration plan must be filed with the FRB within 45 days of the date an institution is deemed to have received notice that it is “undercapitalized,” “significantly undercapitalized,” or “critically undercapitalized.” Compliance with the plan must be guaranteed by any parent holding company up to the lesser of 5% of the institution’s total assets when it was deemed to be undercapitalized or the amount necessary to achieve compliance with applicable capital requirements. In addition, numerous mandatory supervisory actions become immediately applicable to an undercapitalized institution including, but not limited to, increased monitoring by regulators and restrictions on growth, capital distributions and expansion. The FRB could also take any one of a number of discretionary supervisory actions, including the issuance of a capital directive and the replacement of senior executive officers and directors. Significantly and critically undercapitalized institutions are subject to additional mandatory and discretionary measures.

 

The following table shows that, at December 31, 2017, and December 31, 2016, the Bancorp’s capital exceeded all applicable regulatory capital requirements. The dollar amounts are in millions.

 

(Dollars in millions)																		Minimum Required To Be
										Minimum Required For								Well Capitalized Under Prompt
		Actual								Capital Adequacy Purposes								Corrective Action Regulations
At December 31, 2017		Amount				Ratio				Amount				Ratio				Amount				Ratio
Common equity tier 1 capital to risk-weighted assets		$	88.4				12.9	%		$	30.9				4.5	%			N/A				N/A
Tier 1 capital to risk-weighted assets		$	88.4				12.9	%		$	41.2				6.0	%			N/A				N/A
Total capital to risk-weighted assets		$	96.0				14.0	%		$	55.0				8.0	%			N/A				N/A
Tier 1 capital to adjusted average assets		$	88.4				9.6	%		$	36.8				4.0	%			N/A				N/A

 

(Dollars in millions)																		Minimum Required To Be
										Minimum Required For								Well Capitalized Under Prompt
		Actual								Capital Adequacy Purposes								Corrective Action Regulations
At December 31, 2016		Amount				Ratio				Amount				Ratio				Amount				Ratio
Common equity tier 1 capital to risk-weighted assets		$	82.4				13.1	%		$	28.3				4.5	%			N/A				N/A
Tier 1 capital to risk-weighted assets		$	82.4				13.1	%		$	37.8				6.0	%			N/A				N/A
Total capital to risk-weighted assets		$	90.1				14.3	%		$	50.4				8.0	%			N/A				N/A
Tier 1 capital to adjusted average assets		$	82.4				9.2	%		$	36.0				4.0	%			N/A				N/A

 

  

In addition, the following table shows that, at December 31, 2017, and December 31, 2016, the Bank’s capital exceeded all applicable regulatory capital requirements. The dollar amounts are in millions.

 

(Dollars in millions)																		Minimum Required To Be
										Minimum Required For								Well Capitalized Under Prompt
		Actual								Capital Adequacy Purposes								Corrective Action Regulations
At December 31, 2017		Amount				Ratio				Amount				Ratio				Amount				Ratio
Common equity tier 1 capital to risk-weighted assets		$	86.3				12.6	%		$	30.9				4.5	%		$	44.6				6.5	%
Tier 1 capital to risk-weighted assets		$	86.3				12.6	%		$	41.2				6.0	%		$	54.9				8.0	%
Total capital to risk-weighted assets		$	93.8				13.7	%		$	54.9				8.0	%		$	68.7				10.0	%
Tier 1 capital to adjusted average assets		$	86.3				9.4	%		$	36.7				4.0	%		$	45.8				5.0	%

 

(Dollars in millions)																		Minimum Required To Be
										Minimum Required For								Well Capitalized Under Prompt
		Actual								Capital Adequacy Purposes								Corrective Action Regulations
At December 31, 2016		Amount				Ratio				Amount				Ratio				Amount				Ratio
Common equity tier 1 capital to risk-weighted assets		$	81.2				12.9	%		$	28.4				4.5	%		$	41.0				6.5	%
Tier 1 capital to risk-weighted assets		$	81.2				12.9	%		$	37.9				6.0	%		$	50.5				8.0	%
Total capital to risk-weighted assets		$	88.9				14.1	%		$	50.5				8.0	%		$	63.1				10.0	%
Tier 1 capital to adjusted average assets		$	81.2				9.0	%		$	35.9				4.0	%		$	44.9				5.0	%

 

Banking regulators may change these capital requirements from time to time, depending on the economic outlook generally and the outlook for the banking industry. The Bancorp is unable to predict whether and when any such further capital requirements would be imposed and, if so, to what levels and on what schedule.

 

Dividend Limitations. The Bancorp is a legal entity separate and distinct from the Bank. The primary source of the Bancorp’s cash flow, including cash flow to pay dividends on the Bancorp’s Common Stock, is the payment of dividends to the Bancorp by the Bank. Under Indiana law, the Bank may pay dividends of so much of its undivided profits (generally, earnings less losses, bad debts, taxes and other operating expenses) as is considered expedient by the Bank’s Board of Directors. However, the Bank must obtain the approval of the DFI for the payment of a dividend if the total of all dividends declared by the Bank during the current year, including the proposed dividend, would exceed the sum of retained net income for the year to date plus its retained net income for the previous two years. For this purpose, “retained net income” means net income as calculated for call report purposes, less all dividends declared for the applicable period. An exemption from DFI approval would require that the Bank have been assigned a composite uniform financial institutions rating of 1 or 2 as a result of the most recent federal or state examination; the proposed dividend would not result in a Tier 1 leverage ratio below 7.5%; and that the Bank not be subject to any corrective action, supervisory order, supervisory agreement, or board approved operating agreement.

 

The FDIC has the authority to prohibit the Bank from paying dividends if, in its opinion, the payment of dividends would constitute an unsafe or unsound practice in light of the financial condition of the Bank. In addition, under FRB supervisory policy, a bank holding company generally should not maintain its existing rate of cash dividends on common shares unless (i) the organization’s net income available to common shareholders over the past year has been sufficient to fully fund the dividends and (ii) the prospective rate of earnings retention appears consistent with the organization’s capital needs, assets, quality, and overall financial condition. The FRB issued a letter dated February 24, 2009, to bank holding companies providing that it expects banks holding companies to consult with it in advance of declaring dividends that could raise safety and soundness concerns (i.e., such as when the dividend is not supported by earnings or involves a material increase in the dividend rate) and in advance of repurchasing shares of common preferred stock.

 

Federal Deposit Insurance. Deposits in the Bank are insured by the Deposit Insurance Fund of the FDIC up to a maximum amount, which is generally $250,000 per depositor, subject to aggregation rules. There is no unlimited insurance coverage for noninterest bearing transaction accounts. Rather, deposits held in noninterest bearing transaction accounts are aggregated with interest bearing deposits the owner may hold in the same ownership category, and the combined insured up to at least $250,000. The Bank is subject to deposit insurance assessments by the FDIC pursuant to its regulations establishing a risk-related deposit insurance assessment system, based on the institution’s capital levels and risk profile. Under the FDIC’s risk-based assessment system, insured institutions are assigned to one of four risk-weighted categories based on supervisory evaluations, regulatory capital levels, and certain other factors with less risky institutions paying lower assessments. An institution’s initial assessment rate depends upon the category to which it is assigned. There are also adjustments to a bank’s initial assessment rates based on levels of long-term unsecured debt, secured liabilities in excess of 25% of domestic deposits and, for certain institutions, brokered deposit levels. Pursuant to FDIC rules adopted under the Dodd-Frank Act (described below), initial assessments ranged from 5 to 35 basis points of the institution’s total assets minus its tangible equity. The Bank paid deposit insurance assessments of $293 thousand during the year ended December 31, 2017. For 2017, the deposit insurance assessment rate before applying one time credits was approximately 0.039% of insured deposits. No institution may pay a dividend if it is in default of the federal deposit insurance assessment.

 

  

The Bank is also subject to assessment for the Financing Corporation (FICO) to service the interest on its bond obligations. The amount assessed on individual institutions, including the Bank, by FICO is in addition to the amount paid for deposit insurance according to the risk-related assessment rate schedule. These assessments will continue until the FICO bonds are repaid between 2017 and 2019. During 2017, the FICO assessment rate was 0.52 basis points for each $100 of insured deposits. The Bank paid interest payment assessments of approximately $43 thousand during the year ended December 31, 2017. Future increases in deposit insurance premiums or changes in risk classification would increase the Bank’s deposit related costs.

 

Under the Dodd-Frank Act, the FDIC is authorized to set the reserve ratio for the Deposit Insurance Fund at no less than 1.35%, and must achieve the 1.35% designated reserve ratio by September 30, 2020. The FDIC must offset the effect of the increase in the minimum designated reserve ratio from 1.15% to 1.35% on insured depository institutions of less than $10 billion, and may declare dividends to depository institutions when the reserve ratio at the end of a calendar quarter is at least 1.5%, although the FDIC has the authority to suspend or limit such permitted dividend declarations. The FDIC has set the designated reserve ratio for the deposit insurance fund at 2% of estimated insured deposits, which the FDIC has established as a long-term goal.

 

Under the Dodd-Frank Act, the assessment base for deposit insurance premiums changed from adjusted domestic deposits to average consolidated total assets minus average tangible equity. Tangible equity for this purpose means Tier 1 capital. These changes went into effect in April 2011. The rate schedules set forth in the rule are scaled to the increase in the assessment base, including schedules that will go into effect when the reserve ratio reaches 1.15%, 2%, and 2.5%.

 

The schedules reduce the initial base assessment rate in each of the four risk-based pricing categories.

·

For small Risk category I banks, the rates range from 5-9 basis points.

·

The rates for small institutions in Risk Categories II, III and IV are 14, 23 and 35 basis points, respectively.

·

For large institutions and large, highly complex institutions, the rate schedule ranges from 5 to 35 basis points.

 

There are also adjustments made to the initial assessment rates based on long-term unsecured debt, depository institution debt, and brokered deposits. The FDIC also revised the assessment system for large depository institutions with over $10 billion in assets.

 

The FDIC has the authority to increase insurance assessments. A significant increase in insurance premiums would likely have an adverse effect on the operating expenses and results of operations of the Bank. Management cannot predict what insurance assessment rates will be in the future.

 

The FDIC may terminate the deposit insurance of any insured depository institution if the FDIC determines, after a hearing, that the institution has engaged or is engaging in unsafe or unsound practices, is in an unsafe and unsound condition to continue operations or has violated any applicable law, regulation, order or any condition imposed in writing by, or written agreement with, the FDIC. The FDIC may also suspend deposit insurance temporarily during the hearing process for a permanent termination of insurance if the institution has no tangible capital.

 

 

 

Federal Home Loan Bank System. The Bank is a member of the Federal Home Loan Bank of Indianapolis, which is one of eleven regional Federal Home Loan Banks. Each Federal Home Loan Bank serves as a reserve or central bank for its members within its assigned region. It is funded primarily from funds deposited by member institutions and proceeds from the sale of consolidated obligations of the Federal Home Loan Bank system. It makes loans to members (i.e., advances) in accordance with policies and procedures established by the board of trustees of the Federal Home Loan Bank. As a member, the Bank is required to purchase and maintain stock in the Federal Home Loan Bank of Indianapolis in an amount equal to the greater of 1% of its aggregate unpaid residential mortgage loans, home purchase contracts or similar obligations at the beginning of each year or 5% of our outstanding advances from the Federal Home Loan Bank. At December 31, 2017, the Bank was in compliance with this requirement.

 

At December 31, 2017, the Bancorp owned $3.0 million of stock of the Federal Home Loan Bank of Indianapolis (“FHLBI”) and had outstanding borrowings of $20.3 million from the FHLBI. The FHLBI stock entitles the Bancorp to dividends from the FHLBI. The Bancorp recognized dividend income of approximately $127 thousand in 2017. At December 31, 2017, the Bancorp’s excess borrowing capacity based on collateral from the FHLBI was $115.4 million. Generally, the loan terms from the FHLBI are better than the terms the Bancorp can receive from other sources making it cheaper to borrow money from the FHLBI.

 

Federal Reserve System. Under regulations of the FRB, the Bank is required to maintain reserves against its transaction accounts (primarily checking accounts) and non-personal money market deposit accounts. The effect of these reserve requirements is to increase the Bank’s cost of funds. The Bank is in compliance with its reserve requirements.

 

Community Reinvestment Act. Under the Community Reinvestment Act (“CRA”), the Bank has a continuing and affirmative obligation consistent with its safe and sound operation to help meet the credit needs of its entire community, including low and moderate income neighborhoods. The CRA does not establish specific lending requirements or programs for financial institutions nor does it limit an institution’s discretion to develop the types of products and services that it believes are best suited to its particular community, consistent with the CRA. The CRA requires the FDIC in connection with its examination of the Bank, to assess its record of meeting the credit needs of its community and to take that record into account in its evaluation of certain applications by the Bank. For example, the regulations specify that a bank’s CRA performance will be considered in its expansion (e.g., branching) proposals and may be the basis for approving, denying or conditioning the approval of an application. As of the date of its most recent regulatory examination, the Bank was rated “satisfactory” with respect to its CRA compliance.

 

Gramm-Leach-Bliley Act. Under the Gramm-Leach-Bliley Act ("Gramm-Leach"), bank holding companies are permitted to offer their customers virtually any type of financial service, including banking, securities underwriting, insurance (both agency and underwriting) and merchant banking. In order to engage in these new financial activities, a bank holding company must qualify and register with the FRB as a "financial holding company" by demonstrating that each of its bank subsidiaries is well capitalized, well managed and has at least a satisfactory rating under the CRA. The Bancorp has no current intention to elect to become a financial holding company under Gramm-Leach.

 

Gramm-Leach established a system of functional regulation, under which the federal banking agencies regulate the banking activities of financial holding companies, the U.S. Securities and Exchange Commission regulates their securities activities and state insurance regulators regulate their insurance activities.

 

Under Gramm-Leach, federal banking regulators adopted rules limiting the ability of banks and other financial institutions to disclose nonpublic information about consumers to nonaffiliated third parties. The rules require disclosure of privacy policies to consumers and, in some circumstances, allow consumers to prevent disclosure of certain personal information to nonaffiliated third parties. The privacy provisions of Gramm-Leach affect how consumer information is transmitted through diversified financial services companies and conveyed to outside vendors.

 

The Bancorp does not disclose any nonpublic information about any current or former customers to anyone except as permitted by law and subject to contractual confidentiality provisions which restrict the release and use of such information.

 

 

Consumer Financial Protection Bureau. The Dodd-Frank Act established the Consumer Financial Protection Bureau (“CFPB”) within the Federal Reserve, which is granted broad rulemaking, supervisory and enforcement powers under various federal consumer financial protection laws, including the Equal Credit Opportunity Act, Truth in Lending Act, Real Estate Settlement Procedures Act, Fair Credit Reporting Act, Fair Debt Collection Act, the Consumer Financial Privacy provisions of Gramm-Leach and certain other statutes. Many of the consumer financial protection functions formerly assigned to the federal banking and other designated agencies are now performed by the CFPB. The CFPB has a large budget and staff, and has the authority to implement regulations under federal consumer protection laws and enforce those laws against, and examine, financial institutions. The CFPB has examination and primary enforcement authority with respect to depository institutions with $10 billion or more in assets. Smaller institutions are subject to rules promulgated by the CFPB but continue to be examined and supervised by the federal banking regulators for consumer compliance purposes. The CFPB has the authority to prevent unfair, deceptive or abusive practice in connection with the offering of consumer financial products. Additionally, this bureau is authorized to collect fines and provide consumer restitution in the event of violations, engage in consumer financial education, track consumer complaints, request data, and promote the availability of financial services to underserved consumers and communities.

 

Moreover, the Dodd-Frank Act authorizes the CFPB to establish certain minimum standards for the origination of residential mortgages including a determination of the borrower’s ability to repay. In addition, the CFPB has published several final regulations impacting the mortgage industry, including rules related to ability-to-pay, mortgage servicing, and mortgage loan originator compensation. The ability-to-repay rule makes lenders liable if they fail to assess ability to repay under a prescribed test, but also creates a safe harbor for so-called “qualified mortgages.” Failure to comply with the ability-to-repay rule may result in possible CFPB enforcement action and special statutory damages plus actual, class action, and attorneys’ fees damages, all of which a borrower may claim in defense of a foreclosure action at any time. The Dodd-Frank Act also permits states to adopt consumer protection laws and standards that are more stringent than those adopted at the federal level and, in certain circumstances, permits state attorneys general to enforce compliance with both the state and federal laws and regulations. Federal preemption of state consumer protection law requirements, traditionally an attribute of the federal savings association charter, has also been modified by the Dodd-Frank Act and now requires a case-by-case determination of preemption by the OCC and eliminates preemption for subsidiaries of a bank. Depending on the implementation of this revised federal preemption standard, the operations of the Bank could become subject to additional compliance burdens in the states in which it operates.

 

Mortgage Reform and Anti-Predatory Lending. Title XIV of the Dodd-Frank Act, the Mortgage Reform and Anti-Predatory Lending Act, includes a series of amendments to the Truth In Lending Act with respect to mortgage loan origination standards affecting, among other things, originator compensation, minimum repayment standards and pre-payments. With respect to mortgage loan originator compensation, except in limited circumstances, an originator is prohibited from receiving compensation that varies based on the terms of the loan (other than the principal amount). The amendments to the Truth In Lending Act also prohibit a creditor from making a residential mortgage loan unless it determines, based on verified and documented information of the consumer’s financial resources, that the consumer has a reasonable ability to repay the loan. The amendments also prohibit certain pre-payment penalties and require creditors offering a consumer a mortgage loan with a pre-payment penalty to offer the consumer the option of a mortgage loan without such a penalty. In addition, the Dodd-Frank Act expands the definition of a “high-cost mortgage” under the Truth In Lending Act, and imposes new requirements on high-cost mortgages and new disclosure, reporting and notice requirements for residential mortgage loans, as well as new requirements with respect to escrows and appraisal practices.

 

Interchange Fees for Debit Cards. Under the Dodd-Frank Act, interchange fees for debit card transactions must be reasonable and proportional to the issuer’s incremental cost incurred with respect to the transaction plus certain fraud related costs. Although institutions with total assets of less than $10 billion are exempt from this requirement, competitive pressures have required smaller depository institutions to reduce fees with respect to these debit card transactions.

 

Federal Securities Law. The shares of Common Stock of the Bancorp have been registered with the SEC under the Securities Exchange Act (the “1934 Act”). The Bancorp is subject to the information, proxy solicitation, insider trading restrictions and other requirements of the 1934 Act and the rules of the SEC there under. If the Bancorp has fewer than 300 shareholders, it may deregister its shares under the 1934 Act and cease to be subject to the foregoing requirements.

 

 

Shares of Common Stock held by persons who are affiliates of the Bancorp may not be resold without registration unless sold in accordance with the resale restrictions of Rule 144 under the Securities Act of 1933. If the Bancorp meets the current public information requirements under Rule 144, each affiliate of the Bancorp who complies with the other conditions of Rule 144 (including those that require the affiliate’s sale to be aggregated with those of certain other persons) would be able to sell in the public market, without registration, a number of shares not to exceed, in any three-month period, the greater of (i) 1% of the outstanding shares of the Bancorp or (ii) the average weekly volume of trading in such shares during the preceding four calendar weeks.

 

Under the Dodd-Frank Act, the Bancorp is required to provide its shareholders an opportunity to vote on the executive compensation payable to its named executive officers and on golden parachute payments in connection with mergers and acquisitions. These votes are non-binding and advisory. At least once every six years, the Bancorp must also permit shareholders to determine on an advisory basis whether such votes should be held every one, two, or three years.

 

Other Future Legislation and Change in Regulations. Various other legislation, including proposals to expand or contract the powers of banking institutions and bank holding companies, is from time to time introduced. This legislation may change banking statutes and the operating environment of the Bancorp and the Bank in substantial and unpredictable ways. If enacted, such legislation could increase or decrease the cost of doing business, limit or expand permissible activities or affect the competitive balance among banks, savings associations, credit unions and other financial institutions. The Bancorp cannot accurately predict whether any of this potential legislation will ultimately be enacted, and, if enacted, the ultimate effect that it, or implementing regulations, would have upon the financial condition or results of operations of the Bancorp or the Bank.

 

Federal Taxation

 

For federal income tax purposes, the Bank reports its income and expenses on the accrual method of accounting. The Bancorp and the Bank file a consolidated federal income tax return for each fiscal year ending December 31.

 

State Taxation

 

The Bank is subject to Indiana’s Financial Institutions Tax (“FIT”), which is imposed at a flat rate of 7.0% on “adjusted gross income” for the taxable year beginning January 1, 2016. This rate is scheduled to decrease over the succeeding years as follows: to 6.5% for 2017 and 2018, to 6.25% for 2019, to 6.0% for 2020, to 5.5% for 2021, to 5.0% for 2022, and to 4.9% for 2023 and thereafter. “Adjusted gross income,” for purposes of FIT, begins with taxable income as defined by Section 63 of the Code and, thus, incorporates federal tax law to the extent that it affects the computation of taxable income. Federal taxable income is then adjusted by several Indiana modifications. Other applicable state taxes include generally applicable sales and use taxes plus real and personal property taxes.

 

Accounting for Income Taxes

 

At December 31, 2017, the Bancorp’s consolidated total deferred tax assets were $3.1 million and the consolidated total deferred tax liabilities were $1.5 million, resulting in a consolidated net deferred tax asset of $1.6 million, net of an $80 thousand valuation allowance. The valuation allowance of $80 thousand was provided for the state tax credit, as management does not believe these amounts will be fully utilized before statutory expiration.

 

On December 22, 2017, the Tax Cuts and Jobs Act (the "Act") was signed into law. Among other changes, the Act reduces the corporate federal income tax rate from 34% to 21% effective January 1, 2018. As a result of these changes made by the Act, the Bancorp made the determination to revalue its net deferred tax asset, as deferred tax assets and liabilities are to be measured using enacted rates expected to apply in years in which the deferred tax assets and liabilities are expected to be recovered or settled. See Note 7 – Income Taxes for additional detail related to the Act.

 

 

Item 1A. Risk Factors

 

Not applicable.

 

Item 1B. Unresolved Staff Comments

 

Not applicable.

 

 

Item 2. Properties

 

The Bancorp maintains its corporate office at 9204 Columbia Avenue, Munster, Indiana, from which it oversees the operation of the Bank’s sixteen banking locations. The Bancorp owns all of its office properties.

 

The following table sets forth additional information with respect to the Bank’s offices as of December 31, 2017. Net book value and total investment figures are for land, buildings, furniture and fixtures.

 

		Year								Approximate
		facility				Net book				square				Total
Office location		opened				value				footage				cost
9204 Columbia Avenue
Munster, IN 46321-3517			1985			$	533,799				11,640			$	3,312,298
141 W. Lincoln Highway
Schererville, IN 46375-1851			1990				555,669				9,444				2,300,457
7120 Indianapolis Blvd.
Hammond, IN 46324-2221			1979				86,366				2,600				1,005,922
1300 Sheffield
Dyer, IN 46311-1548			1976				172,824				2,100				1,018,166
7915 Taft
Merrillville, IN 46410-5242			1968				113,046				2,750				958,987
8600 Broadway
Merrillville, IN 46410-7034			1996				948,971				4,400				2,601,589
4901 Indianapolis Blvd.
East Chicago, IN 46312-3604			1995				689,087				4,300				1,808,790
1501 Lake Park Avenue
Hobart, IN 46342-6637			2000				1,722,928				6,992				3,389,661
9204 Columbia Avenue
Corporate Center Building
Munster, IN 46321-3517			2003				4,791,632				36,685				13,581,321
855 Stillwater Parkway
Crown Point, IN 46307-5361			2007				1,609,475				3,945				2,485,936
1801 W. 25th Avenue
Gary, IN 46404-3546			2008				1,419,875				2,700				2,041,453
2905 Calumet Avenue
Valparaiso, IN 46383-2645			2009				1,818,286				2,790				2,358,101
9903 Wicker Avenue
Saint John, IN 46373-9402			2010				1,415,875				2,980				2,231,357
130 Rimbach Street
Hammond, IN 46320-1710			2014				811,211				5,230				1,187,099
1900 Indianapolis Blvd.
Whiting, IN 46394-1510			2015				499,439				9,922				793,384
10688 Randolph Street
Crown Point, IN 46307-9424			2015				643,609				2,032				944,615
3927 Ridge Road
Highland, IN 46322-2258			2017				1,727,291				2,282				1,777,680

 

The Bank outsources its core processing activities to Fidelity National Information Services, Inc., or FIS Corporation located in Jacksonville, Florida. FIS provides real time services for loans, deposits, retail delivery systems, card solutions and electronic banking. Additionally, the Bank utilizes Accutech in Muncie, Indiana for its Wealth Management operations.

 

The net book value of the Bank’s property, premises and equipment totaled $19.6 million at December 31, 2017.

 

 

Item 3. Legal Proceedings

 

Not applicable

 

Item 4. Mine Safety Disclosures

 

Not applicable

 

Item 4.5 Executive Officers of the Bancorp

 

Pursuant to General Instruction G(3) of Form 10-K, the following information is included as an unnumbered item in this Part I in lieu of being included in the Bancorp’s Proxy Statement for the 2018 Annual Meeting of Shareholders:

 

The executive officers of the Bancorp are as follows:

 

Executive Officer		Age at December 31, 2017		Position
David A. Bochnowski		72		Executive Chairman
Benjamin J. Bochnowski		37		President, Chief Executive Officer
Robert T. Lowry		56		Executive Vice President, Chief Financial Officer and Treasurer
Leane E. Cerven		59		Executive Vice President, General Counsel, Corporate Secretary
Tanya A. Leetz		47		Executive Vice President, Chief Information and Technology Officer
Todd Scheub		50		Executive Vice President, Chief Banking Officer

 

The following is a description of the principal occupation and employment of the executive officers of the Bancorp during at least the past five years:

 

David A. Bochnowski, is the Executive Chairman of the Bancorp and Bank. His duties include assisting his successor in the transition into the role of Chief Executive Officer of the Company and Bank, assisting the Company and Bank with their strategic goals and budgeting process, and engaging in community and banking activities supporting the mission of the Company and Bank. He formerly served as the Chief Executive Officer for thirty-five years retiring from that position in April of 2016. He has been Chairman of the Company and Bank since 1995. He has been a director since 1977 and was the Bank’s legal counsel from 1977 to 1981. Mr. Bochnowski is the past Chairman of America’s Community Bankers, now merged with the American Bankers Association. He is a past Chairman of the American Banker Association’s Government Relations Council. He was selected by the Securities and Exchange Commission to serve on the Commission’s Advisory Council on Small and Emerging Companies. He is a former Chairman of the Indiana Department of Financial Institutions; former director of the Federal Home Loan Bank of Indianapolis, and, a former member of the Federal Reserve Thrift Advisory Council. He is a trustee and treasurer of the Munster Community Hospital, a director of the Community Health Care System, serves as Vice-Chairman of Calumet College, and serves on the board of Trustees of Valparaiso University. He is a former Chairman of the Legacy Foundation of Lake County, a former Director of One Region, a former Director of Habitat for Humanity, and a former director of the Local Initiatives Support Corporation (LISC), among others. Before joining the Bank, Mr. Bochnowski was an attorney in private practice. He holds an undergraduate Bachelor of Science and Juris Doctor degrees from Georgetown University and a Master’s Degree from Howard University. He served as an officer in the United States Army and received a Bronze Star for his service in the Vietnam conflict. Mr. Bochnowski is the father of Benjamin Bochnowski, the President and Chief Executive Officer of the Bancorp and Bank.

 

Benjamin J. Bochnowski has served as President and Chief Executive Officer of Northwest Indiana Bancorp and Peoples Bank, SB (“Peoples”) since April 2016, and has served as a director of both companies since 2014. Since joining Peoples in 2010, Mr. Bochnowski also held the position of Executive Vice President, Chief Operating Officer; prior to that, he held positions overseeing risk management and strategic planning. He earned a bachelor’s degree from the University of Michigan, followed by an MBA from ESADE business school in Barcelona, Spain. He speaks Spanish, and is a graduate of the American Bankers Association’s Stonier Graduate School of Banking with a Leadership Certificate from the Wharton School at the University of Pennsylvania. Mr. Bochnowski volunteers with the Volunteer Income Tax Assistance (VITA) Program for low-income individuals. He is a Board Member at the Legacy Foundation, One Region, and the Indiana Bankers Association; he has also been a mentor for the Entrepreneurship Bootcamp for Veterans at Purdue University. Mr. Bochnowski is the son of David A. Bochnowski, the Chairman, Chief Executive Officer of the Bancorp and the Bank.

 

 

Robert T. Lowry is Executive Vice President, Chief Financial Officer and Treasurer of the Bancorp and the Bank. He is responsible for finance, accounting, financial reporting, and risk management activities. Mr. Lowry has been with the Bank since 1985 and has previously served as the Bank’s Assistant Controller, Internal Auditor and Controller. Mr. Lowry is a Certified Public Accountant (CPA) and a Chartered Global Management Accountant (CGMA). Mr. Lowry holds a Master’s of Business Administration Degree from Indiana University and is a graduate of America’s Community Bankers National School of Banking. Mr. Lowry has taught online courses for the American Bankers Association that focused on capital and liquidity management, interest rate risk and investments. Mr. Lowry is currently serving on the board of the Food Bank of Northwest Indiana as board treasurer and chairman of the finance committee. In addition, Mr. Lowry is a volunteer for the IRS Volunteer Income Tax Assistance (VITA) program. He is a member of the American Institute of Certified Public Accountants, the Indiana CPA Society and the Financial Managers Society.

 

Leane English Cerven is Executive Vice President, General Counsel, and Corporate Secretary of the Bancorp and Bank. Ms. Cerven joined the Bancorp and the Bank in May of 2010. Prior to joining the Bancorp and the Bank, she practiced law for sixteen years in Chicago, first as an Associate Attorney with Mayer, Brown & Platt where she practiced primarily in the banking area, which included transactions involving the Resolution Trust Corporation/FDIC, corporate, international, bankruptcy, and litigation practice areas, and then as Vice President and Legal Counsel for Bank One where she practiced primarily in the commercial finance area, including secured and unsecured transactions, mergers and acquisitions, workouts, purchase of assets out of bankruptcy, international and multicurrency transactions, syndications, ESOP financings, and capital regulations. She is licensed to practice law in Indiana and Illinois. Ms. Cerven holds a Juris Doctorate degree from Valparaiso University School of Law and a Bachelor of Arts degree from the University of Minnesota, Minneapolis. She is a 2014 graduate of the American Bankers Association Stonier Graduate School of Banking, a member of the Stonier Graduate School of Banking Advisory Board, and a Stonier Capstone Advisor. She is also a member of the ABA’s Regional Banks General Counsels Group and the Society of Corporate Secretaries & Governance Professionals. Ms. Cerven is actively involved in community service and serves on the Board of Directors of South Shore Arts, the Bioethics Committees for St. Catherine’s Hospital and St. Mary’s Hospital, the Investment Committee for the Catholic Foundation of Northwest Indiana, and the Finance Council for St. Thomas More Church.

 

Tanya A. Leetz is Executive Vice President, Chief Information and Technology Officer of the Bancorp and the Bank. She is responsible for operational and technology activities. Ms. Leetz joined the Bank in 1994 and has previously served as trust administrator, management development, information systems manager, and chief operating officer. She is a Certified Information Security Manager (CISM) and Certified in Risk and Information Systems Control (CRISC). Ms. Leetz holds a Master’s Degree in Business Administration and a Bachelor of Science Degree in Financial Planning from Purdue University. She also graduated from America’s Community Bankers National School of Banking. Ms. Leetz currently serves on the Executive Committee on the Board of the Boys and Girls Clubs of Greater Northwest Indiana and is involved in other community activities. She is a member of the Information Systems Audit and Control Association and serves as an advisory member of a technology committee.

 

Todd M. Scheub is Executive Vice President, Chief Banking Officer of the Bancorp and the Bank. He is responsible for the Bank’s Wealth Management group, Retail Banking group, Marketing, Commercial, and Retail lending groups as well as the management of asset quality in the loan portfolio. Mr. Scheub joined the Bank in 1996 and has previously held positions in the commercial lending group. He provides oversight to the sales group in wealth management, retail banking, business and retail lending as well as chairing the Senior Officer’s Loan Committee. Additionally he provides oversight to the Bank’s Marketing group. He is the liaison to the operations and technology group, risk management, executive management, and the Board of Directors on all items related to the Bank’s sales groups. Mr. Scheub holds a Bachelor of Science Degree in Business and a Master’s Degree in Business Administration from Indiana University Northwest. He also graduated from America’s Community Bankers National School of Banking. Mr. Scheub is a Board Member at Campagna Academy, Frontline Foundations, and the Northwest Indiana Regional Development Company.

 

 

PART II

 

Item 5. Market for the Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

 

The Bancorp’s Common Stock is traded in the over-the-counter market and quoted on the OTC Bulletin Board. The Bancorp’s stock is not actively traded. As of February 16, 2018, the Bancorp had 2,868,940 shares of common stock outstanding and 413 stockholders of record. This does not reflect the number of persons or entities who may hold their stock in nominee or “street” name through brokerage firms. Set forth below are the high and low bid prices during each quarter for the years ended December 31, 2017 and December 31, 2016. The bid prices reflect inter-dealer prices without retail mark-up, mark-down or commission and may not necessarily represent actual transactions. Also set forth is information concerning the dividends declared by the Bancorp during the periods reported. Note 11 to the Financial Statements describes regulatory limits on the Bancorp’s ability to pay dividends.

 

												Dividends
				Per Share Prices								Declared Per
				High				Low				Common Share
Year Ended
December 31, 2017		1st Quarter		$	40.50			$	38.40			$	0.28
		2nd Quarter			41.00				39.50				0.29
		3rd Quarter			42.50				40.50				0.29
		4th Quarter			44.50				41.50				0.29
Year Ended
December 31, 2016		1st Quarter		$	31.05			$	29.30			$	0.27
		2nd Quarter			30.00				28.35				0.28
		3rd Quarter			32.50				29.00				0.28
		4th Quarter			39.87				33.00				0.28

 

 

On April 24, 2014 the Bancorp’s Board of Directors authorized a stock repurchase program to repurchase up to 50,000 shares of the Bancorp’s outstanding common stock, from time to time and subject to market conditions, on the open market or in privately negotiated transactions. The stock repurchase program does not expire and is only limited by the number of shares that can be purchased. The stock repurchase program will be reviewed annually by the Board of Directors. No shares were repurchased during the twelve months ended December 31, 2017 under the stock repurchase program.

 

								Total Number of Shares				Maximum Number of
								Purchased as Part of				Shares That May Yet
		Total Number				Average Price		Publicly Announced				Be Purchased Under
Period		of Shares Purchased				Paid per Share		Plans or Programs				the Program(1)
January 1, 2017 – January 31, 2017			-			N/A			-				48,828
February 1, 2017 – February 28, 2017			-			N/A			-				48,828
March 1, 2017 – March 31, 2017			-			N/A			-				48,828
April 1, 2017 – April 30, 2017			-			N/A			-				48,828
May 1, 2017 – May 31, 2017			-			N/A			-				48,828
June 1, 2017 – June 30, 2017			-			N/A			-				48,828
July 1, 2017 – July 31, 2017			-			N/A			-				48,828
August 1, 2017 – August 31, 2017			-			N/A			-				48,828
September 1, 2017 – September 30, 2017			-			N/A			-				48,828
October 1, 2017 – October 31, 2017			-			N/A			-				48,828
November 1, 2017 – November 30, 2017			-			N/A			-				48,828
December 1, 2017 – December 31, 2017			-			N/A			-				48,828

 

(1) The stock repurchase program was announced on April 24, 2014, whereby the Bancorp is authorized to repurchase up to 50,000 shares of the Bancorp’s common stock outstanding. There is no express expiration date for this program.

 

 

Item 6. Selected Financial Data

 

Fiscal Year Ended		December 31,				December 31,				December 31,				December 31,				December 31,
		2017				2016				2015				2014				2013
Statement of Income:
Total interest income		$	33,358			$	32,399			$	29,383			$	27,183			$	26,157
Total interest expense			2,592				2,345				2,013				1,820				1,730
Net interest income			30,766				30,054				27,370				25,363				24,427
Provision for loan losses			1,200				1,268				954				875				450
Net interest income after provision for loan losses			29,566				28,786				26,416				24,488				23,977
Noninterest income			7,752				7,613				6,850				6,074				5,359
Noninterest expense			25,488				24,709				23,616				21,015				19,821
Net noninterest expense			17,736				17,096				16,766				14,941				14,462
Income tax expenses			2,869				2,548				1,798				2,153				2,397
Net income		$	8,961			$	9,142			$	7,852			$	7,394			$	7,118
Basic earnings per common share		$	3.13			$	3.20			$	2.75			$	2.60			$	2.50
Diluted earnings per common share		$	3.13			$	3.20			$	2.75			$	2.60			$	2.50
Cash dividends declared per common share		$	1.15			$	1.11			$	1.06			$	0.97			$	0.85

 

		December 31,				December 31,				December 31,				December 31,				December 31,
		2017				2016				2015				2014				2013
Balance Sheet:
Total assets		$	927,259			$	913,626			$	864,893			$	775,044			$	693,453
Loans receivable			620,211				583,650				571,898				488,153				437,821
Investment securities			244,490				233,625				233,350				213,600				194,296
Deposits			793,004				779,771				714,875				633,946				572,893
Borrowed funds			32,181				39,826				58,001				53,906				44,929
Total stockholders' equity			92,060				84,108				80,909				76,165				66,761

 

		December 31,				December 31,				December 31,				December 31,				December 31,
		2017				2016				2015				2014				2013
Interest Rate Spread During Period:
Average effective yield on loans and investment securities			3.91	%			3.89	%			3.84	%			3.82	%			4.03	%
Average effective cost of deposits and borrowings			0.32	%			0.30	%			0.28	%			0.27	%			0.28	%
Interest rate spread			3.59	%			3.59	%			3.56	%			3.55	%			3.75	%
Net interest margin			3.61	%			3.61	%			3.58	%			3.57	%			3.77	%
Return on average assets			0.98	%			1.03	%			0.96	%			0.97	%			1.03	%
Return on average equity			9.90	%			10.65	%			9.90	%			10.14	%			10.17	%

 

		December 31,				December 31,				December 31,				December 31,				December 31,
		2017				2016				2015				2014				2013
Common equity tier 1 capital to risk-weighted assets			12.9	%			13.1	%			12.4	%			N/A				N/A
Tier 1 capital to risk-weighted assets			12.9	%			13.1	%			12.4	%			13.6	%			14.3	%
Total capital to risk-weighted assets			14.0	%			14.3	%			13.5	%			14.8	%			15.6	%
Tier 1 capital to adjusted average assets			9.6	%			9.2	%			9.0	%			9.2	%			10.0	%
Allowance for loan losses to total loans			1.21	%			1.32	%			1.22	%			1.30	%			1.64	%
Allowance for loan losses to non-performing loans			143.26	%			126.10	%			124.66	%			114.83	%			181.81	%
Non-performing loans to total loans			0.84	%			1.05	%			0.98	%			1.10	%			0.90	%
Total loan accounts			5,680				5,655				5,628				5,140				4,472
Total deposit accounts			31,080				31,175				30,968				28,955				29,861
Total branches (all full service)			16				16				16				14				12

 

 

Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations

 

General

 

The Bancorp's earnings are dependent upon the earnings of the Bank. The Bank's earnings are primarily dependent upon net interest margin. The net interest margin is the difference between interest income earned on loans and investments and interest expense paid on deposits and borrowings stated as a percentage of average interest earning assets. The net interest margin is perhaps the clearest indicator of a financial institution's ability to generate core earnings. Fees and service charges, wealth management operations income, gains and losses from the sale of assets, provisions for loan losses, income taxes and operating expenses also affect the Bancorp's profitability.

 

A summary of the Bancorp’s significant accounting policies are detailed in Note 1 to the Bancorp’s consolidated financial statements included in this report. Preparing financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period, as well as the disclosures provided. Actual results could differ from those estimates. Estimates associated with the allowance for loan losses, fair values of foreclosed real estate, loan servicing rights, investment securities, deferred tax assets, goodwill, and the status of contingencies are particularly susceptible to material change in the near term.

 

At December 31, 2017, the Bancorp had total assets of $927.3 million and total deposits of $793.0 million. The Bancorp's deposit accounts are insured up to applicable limits by the Deposit Insurance Fund (DIF) that is administered by the Federal Deposit Insurance Corporation (FDIC), an agency of the federal government. At December 31, 2017, stockholders' equity totaled $92.1 million, with book value per share at $32.14. Net income for 2017 was $9.0 million, or $3.13 basic and diluted earnings per common share. The return on average assets was 0.98%, while the return on average stockholders’ equity was 9.90%.

 

Financial Condition

 

During the year ended December 31, 2017, total assets increased by $13.6 million (1.5%), to $927.3 million, with interest-earning assets increasing by $19.2 million (2.3%). At December 31, 2017, interest-earning assets totaled $871.5 million and represented 94.0% of total assets. Loans totaled $620.2 million and represented 71.2% of interest-earning assets, 66.9% of total assets and 78.2% of total deposits. The loan portfolio, which is the Bancorp’s largest asset, is a significant source of both interest and fee income. The Bancorp’s lending strategy emphasizes quality growth, product diversification, and competitive and profitable pricing. The loan portfolio includes $208.9 million (33.7%) in residential real estate loans, $211.1 million (34.0%) in commercial real estate loans, $76.9 million (12.4%) in commercial business loans, $43.4 million (7.0%) in multifamily loans, $50.7 million (8.2%) in construction and land development loans, $28.6 million (4.6%) in government, and $461 thousand (0.1%) in consumer loans. Adjustable rate loans comprised 56.2% of total loans at year-end. During 2017, loan balances increased by $36.6 million (6.3%), with commercial real estate, construction and land development, multifamily, residential real estate and consumer balances increasing. The increase in loans during the year is the result of improving credit and economic conditions.

 

The Bancorp is primarily a portfolio lender. Mortgage banking activities historically have been limited to the sale of fixed rate mortgage loans with contractual maturities greater than 15 years. During 2017, the Bancorp sold $44.0 million in newly originated fixed rate mortgage loans, compared to $60.0 million during 2016. Net gains realized from the mortgage loan sales totaled $1.2 million for 2017, compared to $1.6 million for 2016. At December 31, 2017, the Bancorp had $1.6 million in loans that were classified as held for sale.

 

The allowance for loan losses (ALL) is a valuation allowance for probable incurred credit losses, increased by the provision for loan losses, and decreased by charge-offs net of recoveries. A loan is charged off against the allowance by management as a loss when deemed uncollectible, although collection efforts continue and future recoveries may occur. The determination of the amounts of the ALL and provisions for loan losses is based on management’s current judgments about the credit quality of the loan portfolio with consideration given to all known relevant internal and external factors that affect loan collectability as of the reporting date. The appropriateness of the current period provision and the overall adequacy of the ALL are determined through a disciplined and consistently applied quarterly process that reviews the Bancorp’s current credit risk within the loan portfolio and identifies the required allowance for loan losses given the current risk estimates.

 

 

Non-performing loans include those loans that are 90 days or more past due and those loans that have been placed on non-accrual status. Non-performing loans totaled $5.2 million at December 31, 2017, compared to $6.1 million at December 31, 2016, a decrease of $882 thousand or 14.5%. The ratio of non-performing loans to total loans was 0.84% at December 31, 2017, compared to 1.05% at December 31, 2016. The ratio of non-performing loans to total assets was 0.56% at December 31, 2017, compared to 0.67% at December 31, 2016. The decrease in the ratio of non-performing loans for 2017 is primarily the result of charge-offs to non-accruing residential real estate loans totaling $1.0 million. At December 31, 2017, all non-performing loans are also accounted for on a non-accrual basis, except for four residential real estate loans totaling $227 thousand that were classified as accruing and 90 days past due.

 

Loans, internally classified as substandard, totaled $5.9 million at December 31, 2017, compared to $6.1 million at December 31, 2016 a decrease of $199 thousand or 3.3%. The slight decrease in substandard loans is primarily due to the results of ongoing business operations related to the management of a loan portfolio and not due to one specific borrower. Substandard loans include non-performing loans and potential problem loans, where information about possible credit issues or other conditions causes management to question the ability of such borrowers to comply with loan covenants or repayment terms. No loans were internally classified as doubtful or loss at December 31, 2017 or December 31, 2016. In addition to identifying and monitoring non-performing and other classified loans, management maintains a list of watch loans. Watch loans represent loans management is closely monitoring due to one or more factors that may cause the loan to become classified as substandard. Watch loans totaled $11.7 million at December 31, 2017, compared to $10.6 million at December 31, 2016 an increase of $1.1 million or 10.4%. The increase in watch loans is primarily the result of the addition of two commercial real estate loans totaling $1.5 million.

 

A loan is considered impaired when, based on current information and events, it is probable that a borrower will be unable to pay all amounts due according to the contractual terms of the loan agreement. At December 31, 2017, impaired loans totaled $2.5 million compared to $3.5 million at December 31, 2016. The December 31, 2017, impaired loan balances consist of fourteen commercial real estate, construction & land development, and commercial business loans totaling $1.4 million that are secured by business assets and real estate, and are personally guaranteed by the owners of the businesses. In addition, twenty-one mortgage loans totaling $462 thousand, along with forty-five purchased credit impaired mortgage loans totaling $690 thousand, have also been classified as impaired. The December 31, 2017 allowance for loan losses (“ALL”) contained $704 thousand in specific allowances for collateral deficiencies, compared to $1.2 million at December 31, 2016. The decrease in the specific allowance was primarily due to charge-off activity. Typically, management does not individually classify smaller-balance homogeneous loans, such as residential mortgages or consumer loans, as impaired, unless they are troubled debt restructurings.

 

At December 31, 2017, the Bancorp classified five loans totaling $535 thousand as troubled debt restructurings, which involves modifying the terms of a loan to forego a portion of interest or principal or reducing the interest rate on the loan to a rate materially less than market rates, or materially extending the maturity date of a loan. The Bancorp’s troubled debt restructurings include two residential real estate loans totaling $302 thousand for which an extension in maturity and reduction in interest rate was granted, two commercial business loans totaling $52 thousand for which a reduction in principal was granted, and one commercial real estate loan totaling $181 thousand for which a reduction in interest rate and change in amortization was granted with no change to the maturity date. At December 31, 2017, all of the Bancorp’s loans classified as troubled debt restructurings are accruing loans. The valuation basis for the Bancorp’s troubled debt restructurings is based on the present value of cash flows, unless consistent cash flows are not present, then the fair value of the collateral securing the loan is the basis for valuation.

 

At December 31, 2017, management is of the opinion that there are no loans, except those discussed above, where known information about possible credit problems of borrowers causes management to have serious doubts as to the ability of such borrowers to comply with the present loan repayment terms and which will imminently result in such loans being classified as past due, non-accrual or a troubled debt restructure. Management does not presently anticipate that any of the non-performing loans or classified loans would materially affect future operations, liquidity or capital resources.

 

 

 

For 2017, $1.2 million in provisions to the ALL were required, compared to $1.3 million for 2016 a decrease of $68 thousand or 5.4%. The ALL provision decrease is primarily a result of overall non-performing and impaired loans declining for the period. For 2017, net loan charge-offs, totaled $1.4 million, compared to $522 thousand for 2016. The net loan charge-offs for 2017 were comprised of $956 thousand in residential real estate loans, $347 thousand in commercial business loans, $60 thousand in home equity loans, and $53 thousand in consumer loans. The ALL provisions take into consideration management’s current judgments about the credit quality of the loan portfolio, loan portfolio balances, changes in the portfolio mix and local economic conditions. In determining the provision for loan losses for the current period, management has given consideration to risks associated with the local economy, changes in loan balances and mix, and asset quality.

 

The ALL to total loans was 1.21% at December 31, 2017, compared to 1.32% at December 31, 2016. The decrease in the ratio was related to the overall decrease in non-performing loans and management’s current opinion on the strength of the portfolio. ALL to non-performing loans (coverage ratio) was 143.26% at December 31, 2017, compared to 126.10% at December 31, 2016. The December 31, 2017 balance in the ALL account of $7.5 million is considered adequate by management after evaluation of the loan portfolio, past experience and current economic and market conditions. While management may periodically allocate portions of the allowance for specific problem loans, the whole allowance is available for any loan charge offs that occur. The allocation of the ALL reflects performance and growth trends within the various loan categories, as well as consideration of the facts and circumstances that affect the repayment of individual loans, and loans which have been pooled as of the evaluation date, with particular attention given to non-performing loans and loans which have been classified as substandard, doubtful or loss. Management has allocated reserves to both performing and non-performing loans based on current information available.

 

At December 31, 2017, foreclosed real estate totaled $1.7 million, which was comprised of sixteen properties, compared to $2.7 million and twenty-six properties at December 31, 2016. During 2017, loans totaling $349 thousand were transferred into foreclosed real estate, while net sales of foreclosed real estate totaled $1.2 million. Net gains from the 2017 sales totaled $103 thousand. Market value adjustments in 2017 of $158 thousand were also made. At the end of December 2017 all of the Bancorp’s foreclosed real estate is located within its primary market area.

 

At December 31, 2017, the Bancorp's investment portfolio totaled $244.5 million and was invested as follows: 54.4% in U.S. government agency mortgage-backed securities and collateralized mortgage obligations, 42.4% in municipal securities, 1.6% in U.S. government agency debt securities, 1.4% in trust preferred securities, and 0.2% in a money market fund. During 2017, securities increased by $10.9 million (4.7%). The increase is a result of proceeds from sales, calls and maturities being reinvested in addition to market values increasing on the portfolio. In addition, at December 31, 2017, the Bancorp had $3.0 million in FHLB stock.

 

As of December 31, 2017, three of the Bancorp’s four investments in trust preferred securities are in “payment in kind” status. Payment in kind status results in a temporary delay in the payment of interest. As a result of a delay in the collection of the interest payments, management placed these securities on non-accrual status. At December 31, 2017, the cost basis of the three trust preferred securities on non-accrual status totaled $3.5 million. One trust preferred security with a cost basis of $1.3 million remains on accrual status.

 

Deposits are a fundamental and cost-effective source of funds for lending and other investment purposes. The Bancorp offers a variety of products designed to attract and retain customers, with the primary focus on building and expanding relationships. At December 31, 2017, deposits totaled $793.0 million. During 2017, deposits increased by $13.2 million (1.7%). The 2017 change in deposits was comprised of the following: certificates of deposit decreased by $1.7 million (0.9%), checking accounts increased by $20.8 million (7.2%), savings accounts increased by $2.1 million (1.6%), and money market deposit accounts (MMDA’s) decreased by $8.0 million (4.5%). Deposit balances increased for the year as a result of the continued customer preferences for liquid investments in the current low interest rate environment.

 

 

The Bancorp’s borrowed funds are primarily comprised of repurchase agreements and FHLB advances that are used to fund asset growth not supported by deposit generation. At December 31, 2017, borrowed funds totaled $20.8 million compared to $25.8 million at December 31, 2016, a decrease of $4.9 million (19.2%). Strong core deposit growth for the year reduced the need for borrowed funds. Retail repurchase agreements totaled $11.3 million at December 31, 2017, compared to $14.0 million at December 31, 2016, a decrease of $2.7 million (19.3%). FHLB advances totaled $17.1 million, decreasing $8.0 million or 20.8%. The Bancorp’s FHLB line of credit totaled $3.2 million at December 31, 2017, compared to $28 thousand at December 31, 2016. Other short-term borrowings totaled $600 thousand at December 31, 2017, compared to $700 thousand at December 31, 2016.

 

Liquidity and Capital Resources

 

For the Bancorp, liquidity management refers to the ability to generate sufficient cash to fund current loan demand, meet deposit withdrawals, and pay dividends and operating expenses. Because profit and liquidity are often conflicting objectives, management attempts to maximize the Bank’s net interest margin by making adequate, but not excessive, liquidity provisions. Furthermore, funds are managed so that future profits will not be significantly impacted as funding costs increase.

 

Changes in the liquidity position result from operating, investing and financing activities. Cash flows from operating activities are generally the cash effects of transactions and other events that enter into the determination of net income. The primary investing activities include loan originations, loan repayments, investments in interest bearing balances in financial institutions, and the purchase, sale, and maturity of investment securities. Financing activities focus almost entirely on the generation of customer deposits. In addition, the Bancorp utilizes borrowings (i.e., repurchase agreements, FHLB advances and federal funds purchased) as a source of funds.

 

During 2017, cash and cash equivalents decreased $32.4 million compared to an increase of $33.6 million for 2016. During 2017, the primary sources of cash and cash equivalents were from maturities and sales of securities, deposit originations, loan sales and repayments, FHLB advances, and cash from operating activities. The primary uses of cash and cash equivalents were loan originations, purchases of securities, FHLB advance repayments, and the payment of common stock dividends. During 2017, cash from operating activities totaled $12.3 million, compared to $10.4 million for 2016. The increase in cash from operating activities was primarily a result of an increase in clearing accounts that facilitate customer transactions. Cash outflows from investing activities totaled $47.0 million during 2017, compared to outflows of $20.4 million during 2016. The changes for the current year were related to increased loan payoffs and proceeds from sales of securities available-for-sale. Net cash inflows from financing activities totaled $2.3 million in 2017, compared to net cash inflows of $43.6 million in 2016. The decrease during 2017 was primarily due to repurchase agreements and borrowed funds decreasing. On a cash basis, the Bancorp paid dividends on common stock of $3.3 million and $3.1 million during 2017 and 2016, respectively. During 2017, the Bancorp’s Board of Directors increased dividends as earnings and capital continued to be sufficient to warrant dividend increases.

 

Management strongly believes that safety and soundness is enhanced by maintaining a high level of capital. Stockholders' equity totaled $92.1 million at December 31, 2017, compared to $84.1 million at December 31, 2016, an increase of $8.0 million (9.5%). The increase was primarily the result of net income of $9.0 million less $3.3 million in cash dividends. At December 31, 2017, book value per share was $32.14 compared to $29.41 for 2016.

 

The Bancorp is subject to risk-based capital guidelines adopted by the FRB, and the Bank is subject to risk-based capital guidelines adopted by the FDIC. As applied to the Bancorp and the Bank, the FRB and FDIC capital requirements are substantially the same. These regulations divide capital into various tiers, as described in “Recent Developments – Regulatory Capital Rules” above. The following table shows that, at December 31, 2017, the Bancorp’s capital exceeded all regulatory capital requirements. The dollar amounts are in millions.

 

 

(Dollars in millions)																		Minimum Required To Be
										Minimum Required For								Well Capitalized Under Prompt
		Actual								Capital Adequacy Purposes								Corrective Action Regulations
At December 31, 2017		Amount				Ratio				Amount				Ratio				Amount		Ratio
Common equity tier 1 capital to risk-weighted assets		$	88.4				12.9	%		$	30.9				4.5	%		N/A		N/A
Tier 1 capital to risk-weighted assets		$	88.4				12.9	%		$	41.2				6.0	%		N/A		N/A
Total capital to risk-weighted assets		$	96.0				14.0	%		$	55.0				8.0	%		N/A		N/A
Tier 1 capital to adjusted average assets		$	88.4				9.6	%		$	36.8				4.0	%		N/A		N/A

 

The following table shows that, at December 31, 2017, the Bank’s capital exceeded all regulatory capital requirements. The dollar amounts are in millions.

 

(Dollars in millions)																		Minimum Required To Be
										Minimum Required For								Well Capitalized Under Prompt
		Actual								Capital Adequacy Purposes								Corrective Action Regulations
At December 31, 2017		Amount				Ratio				Amount				Ratio				Amount				Ratio
Common equity tier 1 capital to risk-weighted assets		$	86.3				12.6	%		$	30.9				4.5	%		$	44.6				6.5	%
Tier 1 capital to risk-weighted assets		$	86.3				12.6	%		$	41.2				6.0	%		$	54.9				8.0	%
Total capital to risk-weighted assets		$	93.8				13.7	%		$	54.9				8.0	%		$	68.7				10.0	%
Tier 1 capital to adjusted average assets		$	86.3				9.4	%		$	36.7				4.0	%		$	45.8				5.0	%

 

The Bancorp’s ability to pay dividends to its shareholders is entirely dependent upon the Bank’s ability to pay dividends to the Bancorp. Under Indiana law, the Bank may pay dividends from its undivided profits (generally, earnings less losses, bad debts, taxes and other operating expenses) as is considered expedient by the Bank’s Board of Directors. However, the Bank must obtain the approval of the Indiana Department of Financial Institutions (DFI) if the total of all dividends declared by the Bank during the current year, including the proposed dividend, would exceed the sum of retained net income for the year to date plus its retained net income for the previous two years. For this purpose, “retained net income,” means net income as calculated for call report purposes, less all dividends declared for the applicable period. An exemption from DFI approval would require that the Bank have been assigned a composite uniform financial institutions rating of 1 or 2 as a result of the most recent federal or state examination; the proposed dividend would not result in a Tier 1 leverage ratio below 7.5%; and that the Bank not be subject to any corrective action, supervisory order, supervisory agreement, or board approved operating agreement. The aggregate amount of dividends that may be declared by the Bank in 2018, without the need for qualifying for an exemption or prior DFI approval, is $10.2 million plus 2018 net profits. Moreover, the FDIC and the Federal Reserve Board may prohibit the payment of dividends if it determines that the payment of dividends would constitute an unsafe or unsound practice in light of the financial condition of the Bank. On November 17, 2017, the Board of Directors of the Bancorp declared a fourth quarter dividend of $0.29 per share. The Bancorp’s fourth quarter dividend was paid to shareholders on January 9, 2018.

 

Results of Operations – Comparison of 2017 to 2016

 

Net income for 2017 was $9.0 million, compared to $9.1 million for 2016, a decrease of $181 thousand (2.0%). The decrease in net income for 2017 was the result of a revaluation of the deferred asset in relation to tax reform passed and signed into law in 2017. The earnings represent a return on average assets of 0.98% for 2017 compared to 1.03% for 2016. The return on average equity was 9.90% for 2017 compared to 10.65% for 2016.

 

Net interest income for 2017 was $30.8 million, an increase of $712 thousand (2.4%) from $30.1 million for 2016. During the year, the Bancorp’s yield on interest earning assets was positively impacted by higher yields, while interest expense was driven higher primarily by deposit account growth and an increased cost of funds. The weighted-average yield on interest-earning assets was 3.91% for 2017 compared to 3.89% for 2016. The weighted-average cost of funds was 0.32% for 2017 compared to 0.30% for 2016. The impact of the 3.91% return on interest earning assets and the 0.32% cost of funds resulted in a net interest spread of 3.59% for 2017, the same as it was for 2016. During 2017, total interest income increased by $959 thousand (3.0%) while total interest expense increased by $247 thousand (10.5%). The net interest margin was 3.61% for 2017 the same as it was 2016. The Bancorp’s tax equivalent net interest margin for 2017 was 3.84% compared to 3.85% for 2016.

 

 

During 2017, interest income from loans increased by $589 thousand (2.2%) compared to 2016. The increase in interest income from loans is a result of increased loan balances, improving credit and economic conditions. The weighted-average yield on loans outstanding was 4.45% for 2017 compared to 4.47% for 2016. Loan balances averaged $603.9 million for 2017, an increase of $16.8 million (2.9%) from $587.1 million for 2016. During 2017, interest income from securities and other interest earning assets increased by $370 thousand (6.0%) compared to 2016. The weighted-average yield on securities and other interest earning assets was 2.61% for 2017 compared to 2.49% for 2016. Securities and other interest earning assets averaged $248.6 million for 2017, up $3.0 million (1.1%) from $245.8 million for 2016.

 

Interest expense for deposits increased by $289 thousand (16.3%) during 2017 compared to 2016. The change was due to an increase in the weighted-average rate paid on deposits and increased balances. The weighted-average rate paid on deposits for 2017 was 0.27% compared to 0.24% for 2016. Total deposit balances averaged $770.2 million for 2017, an increase of $35.3 million (4.8%) from $734.9 million for 2016. Interest expense for borrowed funds decreased by $42 thousand (7.3%) during 2017 compared to 2016. The change was due to lower average balances. The weighted-average cost of borrowed funds was 1.27% for 2017 compared to 1.01% for 2016. Borrowed funds averaged $42.1 million during 2017, a decrease of $14.9 million (26.2%) from $57.0 million for 2016.

 

Noninterest income for 2017 was $7.8 million, an increase of $139 thousand (1.8%) from $7.6 million for 2016. During 2017, fees and service charges totaled $3.31 million, an increase of $401 thousand (13.8%) from $2.91 million for 2016. The increase in fees and service charges is the result of the Bancorp’s growing depository base and enhanced product offerings. Fees from Wealth Management operations totaled $1.71 million for 2017, an increase of $31 thousand (1.8%) from $1.68 million for 2016. The increase in Wealth Management income is related to growth in average assets under management and market value changes. Gains from loan sales totaled $1.2 million for the current year, a decrease of $409 thousand (25.4%), compared to $1.6 million for 2016. The decrease in gains from the sale of loans is a result of less originations for the year. Gains from the sale of securities totaled $860 thousand for the current year, an increase of $34 thousand (4.1 %) from $826 thousand for 2016. Current market conditions continue to provide opportunities to manage securities cash flows, while recognizing gains from the sales of securities. In 2017, $460 thousand from the increase in the cash value of bank owned life insurance was recorded, a decrease of $9 thousand (1.9%) compared to $469 thousand for 2016. For 2017, foreclosed real estate sales gains totaled $103 thousand, an increase of $3 thousand (3.0%) from $100 thousand for 2016. During 2017, other noninterest income totaled $107 thousand, an increase of $88 thousand (463.2%) from $19 thousand for 2016. Rental income from REO properties were the main reason for the increase in other noninterest income for 2017.

 

Noninterest expense for 2017 was $25.5 million, up $779 thousand (3.2%) from $24.7 million for 2016. During 2017, compensation and benefits totaled $14.2 million, an increase of $240 thousand (1.7%) from $14.0 million for 2016. The increase in compensation and benefits is the result of the Bancorp’s ordinary course, annual adjustments to salaries. Occupancy and equipment expense totaled $3.3 million for 2017, a decrease of $353 thousand (9.7%) compared to $3.6 million for 2016. The decrease in occupancy and equipment expense is the result of lower building operating expenses. Data processing expense totaled $1.5 million for 2017, an increase of $114 thousand (8.5%) from $1.4 million for 2016. Data processing expense has increased as a result of increased system utilization. Marketing expense related to banking products totaled $595 thousand for the year, an increase of $78 thousand (15.1%) from $517 thousand for 2016. Federal deposit insurance premiums totaled $336 thousand for 2017, a decrease of $118 thousand (26.0%) from $454 thousand for 2016. The decrease was the result of lower FDIC assessment rates. Statement and check processing expense totaled $383 thousand for the year, an increase of $10 thousand (2.7%) from $373 thousand for 2016. Professional service expense totaled $443 thousand for the year, an increase of $78 thousand (21.4%) from $365 thousand for 2016. Other expenses related to banking operations totaled $4.8 million for 2017, an increase of $730 thousand (18.0%) from $4.0 million for 2016. The increase in other operating expenses is generally related to increased loan collection efforts, increased foreclosure expenses, and an increased use of third-party services. The Bancorp’s efficiency ratio for 2017 was 66.17% compared to 65.61% for 2016. The weaker efficiency ratio is primarily the result of higher noninterest expense. The ratio is determined by dividing total noninterest expense by the sum of net interest income and total noninterest income for the period.

 

 

The Bancorp had an income tax expense for 2017 of $2.9 million compared to income tax expense of $2.5 million for 2016, an increase to expense of $321 thousand (12.6%). The combined effective federal and state tax rates for the Bancorp were 24.3% for 2017 and 21.8% for 2016. The Bancorp’s higher current period effective tax rate is a result of the revaluation of the deferred tax asset as a result of tax reform being signed into law in 2017. A valuation allowance remains for certain other state tax credits that management does not believe will be fully utilized before statutory expiration.

 

Critical Accounting Policies

 

Critical accounting policies are those accounting policies that management believes are most important to the portrayal of the Bancorp’s financial condition and that require management’s most difficult, subjective or complex judgments. The Bancorp’s most critical accounting policies are summarized below. Other accounting policies, including those related to the fair values of financial instruments and the status of contingencies, are summarized in Note 1 to the Bancorp’s consolidated financial statements.

 

Valuation of Investment Securities – The fair values of securities available for sale are determined on a recurring basis by obtaining quoted prices on nationally recognized securities exchanges or pricing models utilizing significant observable inputs such as matrix pricing, which is a mathematical technique widely used in the industry to value debt securities without relying exclusively on quoted prices for the specific securities but rather by relying on the securities’ relationship to other benchmark quoted securities. Different judgments and assumptions used in pricing could result in different estimates of value. In certain cases where market data is not readily available because of lack of market activity or little public disclosure, values may be based on unobservable inputs and classified in Level 3 of the fair value hierarchy.

 

At the end of each reporting period securities held in the investment portfolio are evaluated on an individual security level for other-than-temporary impairment in accordance with the Investments – Debt and Equity Securities Topic of the Accounting Standards Codification. Significant judgments are required in determining impairment, which include making assumptions regarding the estimated prepayments, loss assumptions and the change in interest rates.

 

We consider the following factors when determining an other-than-temporary impairment for a security: The length of time and the extent to which the market value has been less than amortized cost; the financial condition and near-term prospects of the issuer; the underlying fundamentals of the relevant market and the outlook for such market for the near future; and an assessment of whether the Bancorp has (1) the intent to sell the debt securities or (2) more likely than not will be required to sell the debt securities before its anticipated market recovery. If either of these conditions is met, management will recognize other-than-temporary impairment. If, in management’s judgment, an other-than-temporary impairment exists, the cost basis of the security will be written down for the credit loss, and the unrealized loss will be transferred from accumulated other comprehensive loss as an immediate reduction of current earnings. Management will utilize an independent valuation specialist to value securities semi-annually for other-than-temporary impairment.

 

Allowance for Loan Losses – The Bancorp maintains an Allowance for Loan Losses (ALL) to absorb probable incurred credit losses that arise from the loan portfolio. The ALL is increased by the provision for loan losses, and decreased by charge-offs net of recoveries. The determination of the amounts of the ALL and provisions for loan losses is based upon management’s current judgments about the credit quality of the loan portfolio with consideration given to all known relevant internal and external factors that affect loan collectability. The methodology used to determine the current year provision and the overall adequacy of the ALL includes a disciplined and consistently applied quarterly process that combines a review of the current position with a risk assessment worksheet. Factors that are taken into consideration in the analysis include an assessment of national and local economic trends, a review of current year loan portfolio growth and changes in portfolio mix, and an assessment of trends for loan delinquencies and loan charge-off activity. Particular attention is given to non-accruing loans and accruing loans past due 90 days or more, and loans that have been classified as substandard, doubtful, or loss. Changes in the provision are directionally consistent with changes in observable data.

 

Commercial and industrial, and commercial real estate loans that exhibit credit weaknesses and loans that have been classified as impaired are subject to an individual review. Where appropriate, ALL allocations are made to these loans based on management’s assessment of financial position, current cash flows, collateral values, financial strength of guarantors, industry trends, and economic conditions. ALL allocations for homogeneous loans, such as residential mortgage loans and consumer loans, are based on historical charge-off activity and current delinquency trends. Management has allocated general reserves to both performing and non-performing loans based on historical data and current information available.

 

 

Risk factors for non-performing and internally classified loans are based on an analysis of either the projected discounted cash flows or the estimated collateral liquidation value for individual loans defined as substandard or doubtful. Estimated collateral liquidation values are based on established loan underwriting standards and adjusted for current mitigating factors on a loan-by-loan basis. Aggregate substandard loan collateral deficiencies are determined for residential, commercial real estate, commercial business, and consumer loan portfolios. These deficiencies are then stated as a percentage of the total substandard balances to determine the appropriate risk factors.

 

Risk factors for performing and non-classified loans are based on a weighted average of net charge-offs for the most recent three years, which are then stated as a percentage of average loans for the same period. Historical risk factors are calculated for residential, commercial real estate, commercial business, and consumer loans. The three year weighted average historical factors are then adjusted for current subjective risks attributable to: regional and national economic factors; loan growth and changes in loan composition; organizational structure; composition of loan staff; loan concentrations; policy changes and out of market lending activity.

 

The risk factors are applied to these types of loans to determine the appropriate level for the ALL. Adjustments may be made to these allocations that reflect management’s judgment on current conditions, delinquency trends, and charge-off activity. Based on the above discussion, management believes that the ALL is currently adequate, but not excessive, given the risk inherent in the loan portfolio.

 

Impact of Inflation and Changing Prices

 

The financial statements and related data presented herein have been prepared in accordance with accounting principles generally accepted in the United States of America, which require the measurement of financial position and operating results in terms of historical dollars, without considering changes in the relative purchasing power of money over time due to inflation. The primary assets and liabilities of the Bancorp are monetary in nature. As a result, interest rates have a more significant impact on the Bancorp’s performance than the effects of general levels of inflation. Interest rates do not necessarily move in the same direction or magnitude as the prices of goods and services.

 

Forward-Looking Statements

 

Statements contained in this report that are not historical facts are forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. The words or phrases “would be,” “will allow,” “intends to,” “will likely result,” “are expected to,” “will continue,” “is anticipated,” “estimate,” “project,” or similar expressions are also intended to identify “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act. The Bancorp cautions readers that forward-looking statements, including without limitation, those relating to the Bancorp’s future business prospects, interest income and expense, net income, liquidity, and capital needs are subject to certain risks and uncertainties that could cause actual results to differ materially from those indicated in the forward-looking statements, due to, among other things, factors identified in this report.

 

Item 7A. Quantitative and Qualitative Disclosures about Market Risk

 

Not applicable.

 

 

Item 8. Financial Statements

 

Report of Independent Registered

Public Accounting Firm

 

To the Board of Directors and Stockholders

NorthWest Indiana Bancorp and Subsidiaries

 

Opinion on the Consolidated Financial Statements

 

We have audited the accompanying consolidated balance sheets of NorthWest Indiana Bancorp and Subsidiaries (the “Company”) as of December 31, 2017 and 2016, the related consolidated statements of income, comprehensive income, stockholders' equity, and cash flows for the years then ended, and the related notes (collectively referred to as the “consolidated financial statements”). In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of the Company as of December 31, 2017 and 2016, and the results of its operations and its cash flows for the years then ended, in conformity with accounting principles generally accepted in the United States of America.

 

We also have audited the Company’s internal control over financial reporting as of December 31, 2017, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (“PCAOB”), based on criteria established in Internal Control-Integrated Framework (2013) issued by The Committee of Sponsoring Organizations of the Treadway Commission (COSO). Our report dated February 20, 2018, expressed an unqualified opinion.

 

Basis for Opinion

 

The Company’s management is responsible for these consolidated financial statements. Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.

 

We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement, whether due to error or fraud. Our audits included performing procedures to assess the risks of material misstatement of the consolidated financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the consolidated financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. We believe that our audits provide a reasonable basis for our opinion.

 

	/s/ Plante & Moran, PLLC
	Plante & Moran, PLLC

 

We have served as the Company’s auditor since 2010.

 

Chicago, Illinois

February 20, 2018

 

 

Consolidated Balance Sheets

 

		December 31,
(Dollars in thousands)		2017				2016
ASSETS
Cash and non-interest bearing deposits in other financial institutions		$	10,529			$	15,338
Interest bearing deposits in other financial institutions			139				28,671
Federal funds sold			357				215
Total cash and cash equivalents			11,025				44,224
Certificates of deposit in other financial institutions			1,676				885
Securities available-for-sale			244,490				233,625
Loans held-for-sale			1,592				2,193
Loans receivable			620,211				583,650
Less: allowance for loan losses			(7,482	)			(7,698	)
Net loans receivable			612,729				575,952
Federal Home Loan Bank stock			3,000				3,000
Accrued interest receivable			3,262				3,086
Premises and equipment			19,559				19,287
Foreclosed real estate			1,699				2,665
Cash value of bank owned life insurance			19,355				18,895
Goodwill			2,792				2,792
Other assets			6,080				7,022
Total assets		$	927,259			$	913,626
LIABILITIES AND STOCKHOLDERS' EQUITY
Deposits:
Non-interest bearing		$	120,556			$	111,800
Interest bearing			672,448				667,971
Total			793,004				779,771
Repurchase agreements			11,300				13,998
Borrowed funds			20,881				25,828
Accrued expenses and other liabilities			10,014				9,921
Total liabilities			835,199				829,518
Stockholders' Equity:
Preferred stock, no par or stated value; 10,000,000 shares authorized, none outstanding			-				-
Common stock, no par or stated value; 10,000,000 shares authorized; shares issued:      December 31, 2017 - 2,920,545			361				361
December 31, 2016 - 2,916,195
shares outstanding:  December 31, 2017 - 2,864,507
December 31, 2016 - 2,860,157
Additional paid-in capital			4,506				4,300
Accumulated other comprehensive income (loss)			684				(1,506	)
Retained earnings			86,509				80,953
Total stockholders' equity			92,060				84,108
Total liabilities and stockholders' equity		$	927,259			$	913,626

 

See accompanying notes to consolidated financial statements.

 

 

Consolidated Statements of Income

 

(Dollars in thousands, except per share data)		Year Ended December 31,
		2017				2016
Interest income:
Loans receivable
Real estate loans		$	22,697			$	22,474
Commercial loans			4,143				3,772
Consumer loans			19				24
Total loan interest			26,859				26,270
Securities			6,434				6,097
Other interest earning assets			65				32
Total interest income			33,358				32,399
Interest expense:
Deposits			2,059				1,770
Repurchase agreements			113				98
Borrowed funds			420				477
Total interest expense			2,592				2,345
Net interest income			30,766				30,054
Provision for loan losses			1,200				1,268
Net interest income after provision for loan losses			29,566				28,786
Noninterest income:
Fees and service charges			3,311				2,910
Wealth management operations			1,711				1,680
Gain on sale of loans held-for-sale, net			1,200				1,609
Gain on sale of securities, net			860				826
Increase in cash value of bank owned life insurance			460				469
Gain on sale of foreclosed real estate			103				100
Other			107				19
Total noninterest income			7,752				7,613
Noninterest expense:
Compensation and benefits			14,219				13,979
Occupancy and equipment			3,281				3,634
Data processing			1,453				1,339
Marketing			595				517
Professional services			443				365
Statement and check processing			383				373
Federal deposit insurance premiums			336				454
Other			4,778				4,048
Total noninterest expense			25,488				24,709
Income before income tax expenses			11,830				11,690
Income tax expenses			2,869				2,548
Net income		$	8,961			$	9,142
Earnings per common share:
Basic		$	3.13			$	3.20
Diluted		$	3.13			$	3.20
Dividends declared per common share		$	1.15			$	1.11

 

See accompanying notes to consolidated financial statements.

 

 

Consolidated Statements of Comprehensive Income

 

(Dollars in thousands)		Year Ended December 31,
		2017				2016
Net income		$	8,961			$	9,142
Net change in net unrealized gains and losses on securities available-for-sale:
Unrealized gain/(loss) arising during the period			4,009				(3,551	)
Less: reclassification adjustment for gains included in net income			(860	)			(826	)
Net securities gain/(loss) during the period			3,149				(4,377	)
Tax effect			(1,070	)			1,493
Net of tax amount			2,079				(2,884	)
Net change in unrealized gain on postretirement benefit:
Termination of plan			-				(28	)
Amortization of net actuarial gain			-				-
Net loss during the period			-				(28	)
Tax effect			-				-
Net of tax amount			-				(28	)
Other comprehensive gain/(loss), net of tax			2,079				(2,912	)
Comprehensive income, net of tax		$	11,040			$	6,230

 

See accompanying notes to consolidated financial statements.

 

Consolidated Statements of Changes in Stockholders’ Equity

 

										Accumulated
						Additional				Other
		Common				Paid-in				Comprehensive				Retained				Total
(Dollars in thousands, except per share data)		Stock				Capital				(Loss)/Income				Earnings				Equity
Balance at January 1, 2016		$	361			$	4,158			$	1,406			$	74,984			$	80,909
Comprehensive income:
Net income			-				-				-				9,142				9,142
Net unrealized loss on securities available-for- sale, net of reclassification and tax effects			-				-				(2,884	)			-				(2,884	)
Termination of plan			-				-				(28	)			-				(28	)
Comprehensive income																			6,230
Stock-based compensation expense			-				142				-				-				142
Cash dividends, $1.11 per share			-				-				-				(3,173	)			(3,173	)
Balance at December 31, 2016		$	361			$	4,300			$	(1,506	)		$	80,953			$	84,108
Comprehensive income:
Net income			-				-				-				8,961				8,961
Net unrealized gain on securities available-for- sale, net of reclassification and tax effects			-				-				2,079				-				2,079
Comprehensive income																			11,040
Exercise of 500 incentive stock option shares at $28.50 per share			-				14				-				-				14
Stock-based compensation expense			-				192				-				-				192
Reclassification related to tax effect of unrealized gains			-				-				111				(111	)			-
Cash dividends, $1.15 per share			-				-				-				(3,294	)			(3,294	)
Balance at December 31, 2017		$	361			$	4,506			$	684			$	86,509			$	92,060

 

See accompanying notes to consolidated financial statements.

 

 

Consolidated Statements of Cash Flows

 

NorthWest Indiana Bancorp

Consolidated Statements of Cash Flows

 

(Dollars in thousands)		Year ended December 31,
		2017				2016
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income		$	8,961			$	9,142
Adjustments to reconcile net income to net cash provided by operating activities:
Origination of loans for sale			(42,212	)			(58,338	)
Sale of loans originated for sale			43,980				60,163
Depreciation and amortization, net of accretion			2,548				2,502
Deferred tax expense			377				125
Reclassification related to tax effect of unrealized gains			(111	)			-
Amortization of mortgage servicing rights			64				52
Stock based compensation expense			192				142
Gain on sale of securities, net			(860	)			(826	)
Gain on sale of loans held-for-sale, net			(1,200	)			(1,609	)
Gain on sale of foreclosed real estate			(103	)			(100	)
Provision for loan losses			1,200				1,268
Net change in:
Interest receivable			(176	)			(86	)
Other assets			(455	)			(858	)
Accrued expenses and other liabilities			93				(1,187	)
Total adjustments			3,337				1,248
Net cash - operating activities			12,298				10,390
CASH FLOWS FROM INVESTING ACTIVITIES:
Proceeds from maturities of certificates of deposit in other financial institutions			245				-
Purchase of certificates of deposit in other financial institutions			(1,036	)			(885	)
Proceeds from maturities and pay downs of securities available-for-sale			25,033				49,412
Proceeds from sales of securities available-for-sale			56,347				44,258
Purchase of securities available-for-sale			(89,399	)			(98,633	)
Loan participations purchased			(796	)			-
Net change in loans receivable			(37,390	)			(14,070	)
Purchase of premises and equipment, net			(1,657	)			(1,710	)
Proceeds from sale of foreclosed real estate, net			1,278				820
Change in cash value of bank owned life insurance			(460	)			(469	)
Net cash - investing activities			(47,835	)			(21,277	)
CASH FLOWS FROM FINANCING ACTIVITIES:
Change in deposits			13,233				64,896
Proceeds from FHLB advances			9,000				11,000
Repayment of FHLB advances			(17,000	)			(25,000	)
Change in other borrowed funds			355				(4,175	)
Proceeds from exercise of incentive stock options			14				-
Dividends paid			(3,264	)			(3,143	)
Net cash - financing activities			2,338				43,578
Net change in cash and cash equivalents			(33,199	)			32,691
Cash and cash equivalents at beginning of period			44,224				11,533
Cash and cash equivalents at end of period		$	11,025			$	44,224
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
Cash paid during the period for:
Interest		$	2,591			$	2,349
Income taxes			1,895				2,655
Noncash activities:
Transfers from loans to foreclosed real estate		$	349			$	1,794

 

See accompanying notes to consolidated financial statements.

 

 

Notes to Consolidated Financial Statements

Years ended December 31, 2017 and 2016

 

NOTE 1 - Summary of Significant Accounting Policies

 

Principles of Consolidation – The consolidated financial statements include NorthWest Indiana Bancorp (the “Bancorp”), its wholly-owned subsidiaries NWIN Risk Management, Inc. (a captive insurance subsidiary) and Peoples Bank SB (the “Bank”), and the Bank’s wholly owned subsidiaries, Peoples Service Corporation, NWIN, LLC, NWIN Funding, Incorporated, and Columbia Development Company, LLC. The Bancorp’s business activities include being a holding company for the Bank as well as a holding company for NWIN Risk Management, Inc. The Bancorp’s earnings are dependent upon the earnings of the Bank. Peoples Service Corporation provides insurance and annuity investments to the Bank’s wealth management customers. NWIN, LLC is located in Las Vegas, Nevada and serves as the Bank’s investment subsidiary and parent of a real estate investment trust, NWIN Funding, Inc. NWIN Funding, Inc. was formed as an Indiana Real Estate Investment Trust. The formation of NWIN Funding, Inc. provides the Bancorp with a vehicle that may be used to raise capital utilizing portfolio mortgages as collateral, without diluting stock ownership. In addition, NWIN Funding, Inc. will receive favorable state tax treatment for income generated by its operations. Columbia Development Company is a limited liability company that serves to hold certain real estate properties that are acquired through foreclosure. All significant inter-company accounts and transactions have been eliminated in consolidation.

 

Use of Estimates – Preparing financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period, as well as the disclosures provided. Actual results could differ from those estimates. Estimates associated with the allowance for loan losses, fair values of foreclosed real estate, loan servicing rights, investment securities, deferred tax assets, goodwill, and the status of contingencies are particularly susceptible to material change in the near term.

 

Concentrations of Credit Risk – The Bancorp grants residential, commercial real estate, commercial business and installment loans to customers primarily in Lake County, in northwest Indiana. The Bancorp is also an active lender in Porter County, and to a lesser extent, LaPorte, Newton, and Jasper counties in Indiana, and Lake, Cook and Will counties in Illinois. Substantially all loans are secured by specific items of collateral including residences, commercial real estate, business assets, and consumer assets. 

 

Cash Flow Reporting – For purposes of the statements of cash flows, the Bancorp considers cash on hand, noninterest bearing deposits in other financial institutions, all interest bearing deposits in other financial institutions with original maturities of 90 days or less, and federal funds sold to be cash and cash equivalents. The Bancorp reports net cash flows for customer loan and deposit transactions and short-term borrowings with maturities of 90 days or less. 

 

Certificates of deposits in other financial institutions – Certificates of deposits in other financial institutions generally mature within 5 years and are carried at cost.

 

Securities – The Bancorp classifies securities into held-to-maturity, available-for-sale, or trading categories. Held-to-maturity securities are those which management has the positive intent and the Bancorp has the ability to hold to maturity, and are reported at amortized cost. Available-for-sale securities are those the Bancorp may decide to sell if needed for liquidity, asset-liability management or other reasons. Available-for-sale securities are reported at fair value, with unrealized gains and losses reported in other comprehensive income, net of tax. At December 31, 2017, and 2016, all of the Bancorp’s securities were classified as available-for-sale. The Bancorp does not have a trading portfolio. Realized gains and losses resulting from the sale of securities recorded on the trade date are computed by the specific identification method. Interest and dividend income, adjusted by amortization of premiums or discounts on a level yield method, are included in earnings. Securities are reviewed for other-than-temporary impairment on a quarterly basis.

 

The Bancorp considers the following factors when determining an other-than-temporary impairment for a security: the length of time and the extent to which the market value has been less than amortized cost; the financial condition and near-term prospects of the issuer; the underlying fundamentals of the relevant market and the outlook for such market for the near future; and an assessment of whether the Bancorp has (1) the intent to sell the debt security or (2) it is more likely than not that the Bancorp will be required to sell the debt security before its anticipated market recovery. If either of these conditions are met, management will recognize other-than-temporary impairment. If, in management’s judgment, an other-than-temporary impairment exists, the cost basis of the security will be written down for the credit loss, and the unrealized credit loss will be transferred from accumulated other comprehensive loss as an immediate reduction of current earnings.

 

 

Loans Held-for-Sale – Mortgage loans originated and intended for sale in the secondary market are carried at the lower of aggregate cost or fair market value, as determined by outstanding commitments from investors. Net unrealized losses, if any, are recorded as a valuation allowance and charged to earnings.

 

Mortgage loans held-for-sale can be sold with servicing rights retained or released. The carrying value of mortgage loans sold is reduced by the amount allocated to the servicing rights. Gains and losses on sales of mortgage loans are based on the difference between the selling price and the carrying value of the related loan sold.

 

Loans and Loan Income – Loans that management has the intent and ability to hold for the foreseeable future or until maturity or payoff are reported at the principal balance outstanding, net of unearned interest, net deferred loan fees and costs, and an allowance for loan losses. Interest income is accrued on the unpaid principal balance. Loan origination fees, net of certain direct origination costs, are deferred and recognized in interest income using the level-yield method without anticipating prepayments. 

 

The accrual of interest income on mortgage and commercial loans is discontinued at the time the loan is 90 days delinquent unless the loan is well-secured and in process of collection. Consumer loans are typically charged-off no later than when they reach 120 days past due. Past due status is based on the contractual terms of the loan. In all cases, loans are placed on non-accrual or charged-off status at an earlier date if collection of principal or interest is considered doubtful.

 

Generally, interest accrued but not received for loans placed on non-accrual status is reversed against interest income. Interest received on such loans is accounted for on the cash-basis or cost-recovery method, until qualifying for return to accrual. Loans are returned to accrual status when all the principal and interest amounts contractually due are brought current and future payments are reasonably assured.

 

Allowance for Loan Losses – The allowance for loan losses (allowance) is a valuation allowance for probable incurred credit losses. Loan losses are charged against the allowance when management believes the uncollectibility of a loan balance is confirmed. Subsequent recoveries, if any, are credited to the allowance. Management estimates the allowance balance required using past loan loss experience, the nature and volume of the portfolio, information about specific borrower situations and estimated collateral values, economic conditions, and other factors. Allocations of the allowance may be made for specific loans, but the entire allowance is available for any loan that, in management’s judgment, should be charged-off.

 

A loan is considered impaired when, based on current information and events, it is probable that the Bancorp will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement. Factors considered by management in determining impairment include payment status, collateral value, and the probability of collecting scheduled principal and interest payments when due. Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired. Management determines the significance of payment delays and payment shortfalls on a case by case basis, taking into consideration all of the circumstances surrounding the loan and the borrower, including the length of the delay, the reasons for the delay, the borrower’s prior payment record, and the amount of the shortfall in relation to the principal and interest owed. Impairment is measured on a loan by loan basis for commercial and construction loans by either the present value of expected future cash flows discounted at the loan’s effective interest rate, the loan’s obtainable market price, or the fair value of the collateral if the loan is collateral dependent. Large groups of smaller balance homogeneous loans are collectively evaluated for impairment. Accordingly, the Bancorp does not separately identify individual consumer and residential loans for impairment disclosures.

 

Troubled Debt Restructures – A troubled debt restructuring of a loan is undertaken to improve the likelihood that the loan will be repaid in full under the modified terms in accordance with a reasonable repayment schedule. All modified loans are evaluated to determine whether the loan should be reported as a troubled debt restructure (TDR). A loan is a TDR when the Bancorp, for economic or legal reasons related to the borrower's financial difficulties, grants a concession to the borrower by modifying or renewing a loan under terms that the Bancorp would not otherwise consider. To make this determination, the Bancorp must determine whether (a) the borrower is experiencing financial difficulties and (b) the Bancorp granted the borrower a concession. This determination requires consideration of all of the facts and circumstances surrounding the modification. An overall general decline in the economy or some level of deterioration in a borrower's financial condition does not inherently mean the borrower is experiencing financial difficulties.

 

 

Some of the factors considered by management when determining whether a borrower is experiencing financial difficulties are: (1) is the borrower currently in default on any of its debts, (2) has the borrower declared or is the borrower in the process of declaring bankruptcy, and (3) absent the current modification, the borrower would likely default.

 

Federal Home Loan Bank Stock – The Bank is a member of the FHLB system. Members are required to own a certain amount of stock based on the level of borrowings and other factors, and may invest in additional amounts. FHLB stock is carried at cost, classified as a restricted security, and periodically evaluated for impairment based on ultimate recovery of par value. Both cash and stock dividends are reported as income.

 

Transfers of Financial Assets – Transfers of financial assets are accounted for as sales when control over the assets has been surrendered. Control over transferred assets is deemed to be surrendered when (1) the assets have been isolated from the Bancorp, (2) the transferee obtains the right (free of conditions that constrain it from taking advantage of the right) to pledge or exchange the transferred assets, and (3) the Bancorp does not maintain effective control over the transferred assets through an agreement to repurchase them before their maturity. 

 

Premises and Equipment – Land is carried at cost. Premises and equipment are carried at cost less accumulated depreciation. Premises and related components are depreciated using the straight-line method with useful lives ranging from 26 to 39 years. Furniture and equipment are depreciated using the straight-line method with useful lives ranging from 2 to 10 years.  

 

Foreclosed Real Estate – Assets acquired through or instead of loan foreclosure are initially recorded at fair value less estimated costs to sell when acquired, establishing a new cost basis. If fair value declines subsequent to foreclosure, a valuation allowance is recorded through expense. Operating costs after acquisition are expensed.  

 

Long-term Assets – Premises and equipment and other long-term assets are reviewed for impairment when events indicate their carrying amount may not be recoverable from future undiscounted cash flows. If impaired, the assets are recorded at fair value. 

 

Bank Owned Life Insurance – The Bancorp has purchased life insurance policies on certain key executives. In accordance with accounting for split-dollar life insurance, Bank owned life insurance is recorded at the amount that can be realized under the insurance contract at the balance sheet date, which is the cash surrender value adjusted for other charges or other amounts due that are probable at settlement.

 

Goodwill and Intangibles – The Bancorp records the assets acquired, including identified intangible assets, and the liabilities assumed in acquisitions at their fair values. These fair values often involve estimates based on third-party valuations, such as appraisals, or internal valuations based on discounted cash flow analyses or other valuation techniques that may include estimates of attrition, inflation, asset growth rates or other relevant factors. In addition, the determination of the useful lives over which an intangible asset will be amortized is subjective. Under the Financial Accounting Standards Board (FASB) Accounting Standards Codification (ASC) 350, goodwill and indefinite-lived assets recorded are reviewed for impairment on an annual basis, as well as on an interim basis if events or changes indicate that the asset might be impaired. An impairment loss is recognized for any excess of carrying value over fair value of the goodwill or the indefinite-lived intangible asset.

 

Repurchase Agreements – Substantially, all repurchase agreement liabilities represent amounts advanced by various customers that are not covered by federal deposit insurance and are secured by securities owned by the Bancorp.

 

 

Income Taxes – Income tax expense is the total of the current year income tax due or refundable and the change in deferred tax assets and liabilities. Deferred tax assets and liabilities are the expected future tax amounts for the temporary differences between carrying amounts and tax bases of assets and liabilities, computed using enacted tax rates. A valuation allowance, if needed, reduces deferred tax assets to the amount expected to be realized.  

 

At December 31, 2017 and 2016, the Bancorp evaluated tax positions taken for filing with the Internal Revenue Service and all state jurisdictions in which it operates. The Bancorp believes that income tax filing positions will be sustained under examination and does not anticipate any adjustments that would result in a material adverse effect on the Bancorp's financial condition, results of operations, or cash flows. Accordingly, the Bancorp has not recorded any reserves or related accruals for interest and penalties for uncertain tax positions at December 31, 2017 and 2016.

 

Loan Commitments and Related Financial Instruments – Financial instruments include off-balance sheet credit instruments, such as commitments to make loans and standby letters of credit, issued to meet customer financing needs. The face amount for these items represents the exposure to loss, before considering customer collateral or ability to repay. Such financial instruments are recorded when they are funded.

 

Earnings Per Common Share – Basic earnings per common share is net income divided by the weighted-average number of common shares outstanding during the period. There were no outstanding incentive stock options at December 31, 2017, however, the weighted average calculation for dilution still considers them outstanding for part of the year.

 

Comprehensive Income – Comprehensive income consists of net income and other comprehensive income. Other comprehensive income includes unrealized gains and losses on securities available-for-sale and the unrecognized gains and losses on postretirement benefits.

 

Loss Contingencies – Loss contingencies, including claims and legal actions arising in the ordinary course of business, are recorded as liabilities when the likelihood of loss is probable and an amount or range of loss can be reasonably estimated. Management does not believe such matters currently exist that will have a material effect on the financial statements.

 

Restrictions on Cash – Cash on hand or on deposit with the Federal Reserve Bank of $878 thousand and $765 thousand was required to meet regulatory reserve and clearing requirements at December 31, 2017 and 2016, respectively. These balances do not earn interest.

 

Fair Value of Financial Instruments – Fair values of financial instruments are estimated using relevant market information and other assumptions, as more fully disclosed in a separate note. Fair value estimates involve uncertainties and matters of significant judgment regarding interest rates, credit risk, prepayments and other factors, especially in the absence of broad markets for particular instruments. Changes in assumptions or in market conditions could significantly affect the estimates.

 

Operating Segments – While the Bancorp's executive management monitors the revenue streams of the various products and services, the identifiable segments are not material and operations are managed and financial performance is evaluated on a company-wide basis. Accordingly, all of the Bancorp's financial service operations are considered by management to be aggregated in one reportable operating segment.

 

Reclassification – Certain amounts appearing in the consolidated financial statements and notes thereto for the year ended December 31, 2016, may have been reclassified to conform to the December 31, 2017 presentation.

 

Trust Assets – Assets of the Bancorp’s wealth management department, other than cash on deposit at the Bancorp, are not included in these consolidated financial statements because they are not assets of the Bancorp.

 

Adoption of New Accounting Pronouncements – In May 2014, FASB issued Accounting Standards Update (ASU) No. 2014-09 and ASU 2015-14, Revenue from Contracts with Customers (Topic 606), which will supersede the current revenue recognition requirements in Topic 605, Revenue Recognition. The ASU is based on the principle that revenue is recognized to depict the transfer of goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. The ASU also requires additional disclosure about the nature, amount, timing, and uncertainty of revenue and cash flows arising from customer contracts, including significant judgments and changes in judgments and assets recognized from costs incurred to obtain or fulfill a contract. The new guidance will be effective for the Bancorp's year ending December 31, 2018 and has been adopted as of January 1, 2018. The use of the modified retrospective approach will be used for implementing this standard. Interest income is outside of the scope of the new standard and will not be impacted by the adoption of the standard. A review of the Bancorp’s noninterest income has not resulted in a change in revenue recognition since adoption, nor is revenue recognition expected to change revenue recognition prospectively in a significant way.

 

 

In January 2016, FASB issued Accounting Standards Update (ASU) No. 2016-01, Recognition and Measurement of Financial Assets and Financial Liabilities. The ASU covers various changes to the accounting, measurement, and disclosures related to certain financial instruments, including requiring equity investments to be accounted for at fair value with changes recorded through earnings, the use of the exit price when measuring fair value, and disaggregation of financial assets and liabilities by category for disclosure purposes. The new guidance will be effective for the Bancorp's year ending December 31, 2018 and was adopted on January 1, 2018. The adoption of this ASU will not have a material impact on the consolidated financial statements, as the Bancorp does not hold any equity securities with unrealized gains or losses.

 

In February 2016, FASB issued ASU No. 2016-02, Leases, which will supersede the current lease requirements in ASC 840. The ASU requires lessees to recognize a right-of-use asset and related lease liability for all leases, with a limited exception for short-term leases. Leases will be classified as either finance or operating, with the classification affecting the pattern of expense recognition in the statement of operations. Currently, leases are classified as either capital or operating, with only capital leases recognized on the balance sheet. The reporting of lease-related expenses in the statements of operations and cash flows will be generally consistent with the current guidance. The new lease guidance will be effective for the Bancorp's year ending December 31, 2019 and will be applied using a modified retrospective transition method to the beginning of the earliest period presented. Management does not believe the adoption of this update will have a material effect on the Bancorp’s consolidated financial statements, as the Bancorp does not engage in the leasing of property or in leasing of any significant furniture, fixtures, equipment, or software.

 

In March 2016, FASB issued ASU No. 2016-09: Compensation—Stock Compensation (Topic 718)—Improvements to Employee Share-Based Payment Accounting. This ASU seeks to reduce complexity in accounting standards. The areas for simplification in ASU No. 2016-09, identified through outreach for the Simplification Initiative, pre-agenda research for the Private Company Council, and the August 2014 Post-Implementation Review Report on FASB Statement No. 123(R), Share-Based Payment, involve several aspects of the accounting for share-based payment transactions, including (1) accounting for income taxes, (2) classification of excess tax benefits on the statement of cash flow, (3) forfeitures; (4) minimum statutory tax withholding requirements, (5) classification of employee taxes paid on the statement of cash flows when an employer withholds shares for tax withholding purposes:, (6) the practical expedient for estimating the expected term, and (7) intrinsic value. The Bancorp adopted this ASU during 2017.

 

In June 2016, FASB issued ASU No. 2016-13, Financial Instruments - Credit Losses: Measurement of Credit Losses on Financial Instruments. The ASU includes increased disclosures and various changes to the accounting and measurement of financial assets including the Bancorp’s loans and available-for-sale and held-to-maturity debt securities. Each financial asset presented on the balance sheet would have a unique allowance for credit losses valuation account that is deducted from the amortized cost basis to present the net carrying value at the amount expected to be collected on the financial asset. The amendments in this ASU also eliminate the probable initial recognition threshold in current GAAP and instead, reflect an entity’s current estimate of all expected credit losses using reasonable and supportable forecasts. The new credit loss guidance will be effective for the Bancorp's year ending December 31, 2020. Upon adoption, the ASU will be applied using a modified retrospective transition method to the beginning of the first reporting period in which the guidance is effective. A prospective transition approach is required for debt securities for which an other-than-temporary impairment had been recognized before the effective date. Early adoption for all institutions is permitted for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. Management is in the process of evaluating the impact adoption of this update will have on the Bancorp’s consolidated financial statements. This process of evaluation has engaged multiple areas of the Bancorp’s management in discussing loss estimation methods and the application of these methods to specific segments of the loans receivable portfolio. Given the amount of time left to adoption, the appropriateness of the loss estimation methods chosen, and the continuing development of understanding of application, additional time is needed to fully understand how this ASU will impact the Bancorp’s financial statements.

 

In January 2017, the FASB issued ASU 2017-04, Intangibles – Goodwill and Other (Topic 350): Simplifying the Test for Goodwill Impairment. This Standard simplifies the manner in which an entity is required to test goodwill for impairment by eliminating Step 2 from the goodwill impairment test. Step 2 measures a goodwill impairment loss by comparing the implied fair value of a reporting unit’s goodwill with the carrying amount of that goodwill. In computing the implied fair value of goodwill under Step 2, an entity, prior to the amendments in ASU No. 2017-04, had to perform procedures to determine the fair value at the impairment testing date of its assets and liabilities, including unrecognized assets and liabilities, in accordance with the procedure that would be required in determining the fair value of assets acquired and liabilities assumed in a business combination. However, under the amendments in this ASU, an entity should (1) perform its annual or interim goodwill impairment test by comparing the fair value of a reporting unit with its carrying amount, and (2) recognize an impairment charge for the amount by which the carrying amount exceeds the reporting unit’s fair value, with the understanding that the loss recognized should not exceed the total amount of goodwill allocated to that reporting unit. Additionally, ASU No. 2017-04 removes the requirements for any reporting unit with a zero or negative carrying amount to perform a qualitative assessment and, if it fails such qualitative test, to perform Step 2 of the goodwill impairment test. Finally, this ASU amends the Overview and Background sections of the Accounting Standards Codification as part of the FASB’s initiative to unify and improve such sections across Topics and Subtopics. The new guidance will be effective for the Company’s year ending December 31, 2020.

 

In March 2017, the FASB issued ASU 2017-08, Receivables—Nonrefundable Fees and Other Costs (Subtopic 310-20): Premium Amortization on Purchased Callable Debt Securities. This Standard amends the amortization period for certain purchased callable debt securities held at a premium. In particular, the amendments in this ASU require the premium to be amortized to the earliest call date. The amendments do not, however, require an accounting change for securities held at a discount; instead, the discount continues to be amortized to maturity. The amendments in this ASU more closely align the amortization period of premiums and discounts to expectations incorporated in market pricing on the underlying securities. In fact, in most cases, market participants price securities to the call date that produces the worst yield when the coupon is above current market rates (i.e., the security is trading at a premium), and price securities to maturity when the coupon is below market rates (i.e., the security is trading at a discount), in anticipation that the borrower will act in its economic best interest. The new guidance will be effective for the Company’s year ending December 31, 2020. Management will recognize amortization expense as dictated by the amount of premiums and the differences between maturity and call dates at the time of adoption.

 

In February 2018, the FASB issued ASU No. 2018-02, Income Statement – Reporting Comprehensive Income (Topic 220): Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income. The ASU required a reclassification from accumulated other comprehensive income to retained earnings for stranded tax effects resulting from the newly enacted federal corporate income tax rate as a result of the Tax Cuts and Jobs Act. The amount of the reclassification is the difference between the historical corporate income tax rate and the newly enacted twenty-one percent corporate income tax rate. The new guidance will be effective for the Company’s year ending December 31, 2018, however, the Company chose to early adopt the new standard for the year ending December 31, 2017, as allowed under the new standard. The amount of the reclassification for the Company was $111 thousand, as shown in the Consolidated Statement of Changes in Stockholder's Equity.

 

 

NOTE 2 – Securities

 

The estimated fair value of available-for-sale securities and the related gross unrealized gains and losses recognized in accumulated other comprehensive income (loss) were as follows:

 

		(Dollars in thousands)
						Gross				Gross				Estimated
		Cost				Unrealized				Unrealized				Fair
December 31, 2017		Basis				Gains				Losses				Value
Money market fund		$	476			$	-			$	-			$	476
U.S. government sponsored entities			3,996				-				(106	)			3,890
Collateralized mortgage obligations and residential mortgage-backed securities			134,224				170				(1,456	)			132,938
Municipal securities			100,088				3,709				(50	)			103,747
Collateralized debt obligations			4,835				-				(1,396	)			3,439
Total securities available-for-sale		$	243,619			$	3,879			$	(3,008	)		$	244,490

 

		(Dollars in thousands)
						Gross				Gross				Estimated
		Cost				Unrealized				Unrealized				Fair
December 31, 2016		Basis				Gains				Losses				Value
Money market fund		$	222			$	-			$	-			$	222
U.S. government sponsored entities			16,643				-				(369	)			16,274
Collateralized mortgage obligations and residential mortgage-backed securities			118,807				441				(1,273	)			117,975
Municipal securities			95,242				2,146				(643	)			96,745
Collateralized debt obligations			4,989				-				(2,580	)			2,409
Total securities available-for-sale		$	235,903			$	2,587			$	(4,865	)		$	233,625

 

The estimated fair value of available-for-sale securities and carrying amount, if different, at December 31, 2017 by contractual maturity were as follows. Securities not due at a single maturity date, primarily mortgage-backed securities, are shown separately. Tax-equivalent yields were calculated using the 2017 tax rate.

 

		(Dollars in thousands)
		Available-for-sale
		Estimated
		Fair				Tax-Equivalent
December 31, 2017		Value				Yield (%)
Due in one year or less		$	757				7.46
Due from one to five years			6,150				4.79
Due from five to ten years			28,531				5.21
Due over ten years			76,114				4.73
Collateralized mortgage obligations and residential mortgage-backed securities			132,938				2.57
Total		$	244,490				3.62

 

 

Sales of available-for-sale securities were as follows:

 

		(Dollars in thousands)
		December 31,				December 31,
		2017				2016
Proceeds		$	56,347			$	44,258
Gross gains			972				926
Gross losses			(112	)			(100	)

 

The tax provisions related to these net realized gains were approximately $339 thousand for 2017 and $325 thousand for 2016.

 

Accumulated other comprehensive income/(loss) balances, net of tax, related to available-for-sale securities, were as follows:

 

		(Dollars in thousands)
		Unrealized gain/(loss)
Ending balance, December 31, 2016		$	(1,506	)
Current period change			2,079
Reclassification related to tax effect of unrealized gains			111
Ending balance, December 31, 2017		$	684

 

Securities with carrying values of approximately $21.2 million and $32.4 million were pledged as of December 31, 2017 and 2016, respectively, as collateral for repurchase agreements, public funds, and for other purposes as permitted or required by law.

 

Securities with unrealized losses at December 31, 2017 and 2016 not recognized in income are as follows:

 

		(Dollars in thousands)
		Less than 12 months								12 months or longer								Total
		Estimated								Estimated								Estimated
		Fair				Unrealized				Fair				Unrealized				Fair				Unrealized
December 31, 2017		Value				Losses				Value				Losses				Value				Losses
U.S. government sponsored entities		$	-			$	-			$	3,890			$	(106	)		$	3,890			$	(106	)
Collateralized mortgage obligations and residential mortgage-backed securities			66,917				(511	)			37,003				(945	)			103,920				(1,456	)
Municipal securities			1,790				(3	)			1,815				(47	)			3,605				(50	)
Collateralized debt obligations			-				-				3,439				(1,396	)			3,439				(1,396	)
Total temporarily impaired		$	68,707			$	(514	)		$	46,147			$	(2,494	)		$	114,854			$	(3,008	)
Number of securities							40								37								77

 

		(Dollars in thousands)
		Less than 12 months								12 months or longer								Total
		Estimated								Estimated								Estimated
		Fair				Unrealized				Fair				Unrealized				Fair				Unrealized
December 31, 2016		Value				Losses				Value				Losses				Value				Losses
U.S. government sponsored entities		$	16,274			$	(369	)		$	-			$	-			$	16,274			$	(369	)
Collateralized mortgage obligations and residential mortgage-backed securities			75,931				(1,183	)			2,287				(90	)			78,218				(1,273	)
Municipal securities			20,775				(643	)			-				-				20,775				(643	)
Collateralized debt obligations			-				-				2,409				(2,580	)			2,409				(2,580	)
Total temporarily impaired		$	112,980			$	(2,195	)		$	4,696			$	(2,670	)		$	117,676			$	(4,865	)
Number of securities							97								6								103

 

 

Unrealized losses on securities have not been recognized into income because the securities are of high credit quality, have undisrupted cash flows, or have been independently evaluated for other-than-temporary impairment and appropriate write downs taken. Management has the intent and ability to hold the securities for the foreseeable future, and the decline in fair value is largely due to changes in interest rates and volatility in the securities markets. The fair values are expected to recover as the securities approach maturity.

 

NOTE 3 – Loans Receivable

 

Year end loans are summarized below:

 

(Dollars in thousands)
		December 31, 2017				December 31, 2016
Loans secured by real estate:
Residential real estate		$	172,780			$	173,365
Home equity			36,718				32,614
Commercial real estate			211,090				195,438
Construction and land development			50,746				38,937
Multifamily			43,369				36,086
Total loans secured by real estate			514,703				476,440
Consumer			460				522
Commercial business			77,122				77,513
Government			28,785				29,529
Subtotal			621,070				584,004
Less:
Net deferred loan origination fees			(130	)			(162	)
Undisbursed loan funds			(729	)			(192	)
Loans receivable		$	620,211			$	583,650

 

 

(Dollars in thousands)
		Beginning Balance				Charge-offs				Recoveries				Provisions				Ending Balance
The Bancorp's activity in the allowance for loan losses, by loan segment, is summarized below for the twelve months ended December 31, 2017:
Allowance for loan losses:
Residential real estate		$	2,111			$	(959	)		$	3			$	413			$	1,568
Home equity			299				(60	)			-				(73	)			166
Commercial real estate			3,113				-				-				12				3,125
Construction and land development			617				-				-				1				618
Multifamily			572				-				-				50				622
Consumer			34				(71	)			18				50				31
Commercial business			896				(386	)			39				749				1,298
Government			56				-				-				(2	)			54
Total		$	7,698			$	(1,476	)		$	60			$	1,200			$	7,482
The Bancorp's activity in the allowance for loan losses, by loan segment, is summarized below for the twelve months ended December 31, 2016:
Allowance for loan losses:
Residential real estate		$	1,447			$	(529	)		$	2			$	1,191			$	2,111
Home equity			263				-				-				36				299
Commercial real estate			2,986				-				-				127				3,113
Construction and land development			692				-				-				(75	)			617
Multifamily			758				-				-				(186	)			572
Consumer			38				(33	)			9				20				34
Commercial business			699				-				28				169				896
Government			70				-				-				(14	)			56
Total		$	6,953			$	(562	)		$	39			$	1,268			$	7,698

 

 

		Ending Balances
														Loans				Purchased				Loans
		Individually				Collectively								receivable				credit impaired				receivable
(Dollars in thousands)		evaluated for				evaluated for								Individually				individually				Collectively
		impairment				impairment				Loan				evaluated for				evaluated for				evaluated for
		reserves				reserves				receivables				impairment				impairment				impairment
The Bancorp's allowance for loan losses impairment evaluation and loan receivables are summarized below at December 31, 2017:
Residential real estate		$	21			$	1,547			$	172,141			$	462			$	690			$	170,989
Home equity			-				166				36,769				-				-				36,769
Commercial real estate			144				2,981				211,090				512				-				210,578
Construction and land development			-				618				50,746				134				-				50,612
Multifamily			-				622				43,368				-				-				43,368
Commercial business			539				759				76,851				724				-				76,127
Consumer			-				31				461				-				-				461
Government			-				54				28,785				-				-				28,785
Total		$	704			$	6,778			$	620,211			$	1,832			$	690			$	617,689
The Bancorp's allowance for loan losses impairment evaluation and loan receivables are summarized below at December 31, 2016:
Residential real estate		$	879			$	1,232			$	173,262			$	1,419			$	956			$	170,886
Home equity			-				299				32,575				-				-				32,575
Commercial real estate			3				3,110				195,438				322				-				195,116
Construction and land development			-				617				38,937				134				-				38,804
Multifamily			-				572				36,086				-				-				36,086
Commercial business			354				542				77,299				687				-				76,612
Consumer			-				34				524				-				-				524
Government			-				56				29,529				-				-				29,529
Total		$	1,236			$	6,462			$	583,650			$	2,562			$	956			$	580,132

 

 

The Bancorp has established a standard loan grading system to assist management, lenders and review personnel in their analysis and supervision of the loan portfolio. The use and application of theses grades by the Bancorp is uniform and conforms to regulatory definitions. The loan grading system is as follows:

 

1 – Minimal Risk

 

Borrower demonstrates exceptional credit fundamentals, including stable and predictable profit margins, strong liquidity and a conservative balance sheet with superior asset quality. Excellent cash flow coverage of existing and projected debt service. Historic and projected performance indicates borrower is able to meet obligations under almost any economic circumstances.

 

2 – Moderate risk

 

Borrower consistently internally generates sufficient cash flow to fund debt service, working assets, and some capital expenditures. Risk of default considered low.

 

3 – Above average acceptable risk

 

Borrower generates sufficient cash flow to fund debt service and some working assets and/or capital expansion needs. Profitability and key balance sheet ratios are at or slightly above peers. Current trends are positive or stable. Earnings may be level or trending down slightly or be erratic; however, positive strengths are offsetting. Risk of default is reasonable but may warrant collateral protection.

 

4 – Acceptable risk

 

Borrower generates sufficient cash flow to fund debt service, but most working asset and all capital expansion needs are provided from external sources. Profitability ratios and key balance sheet ratios are usually close to peers but one or more ratios (e.g. leverage) may be higher than peer. Earnings may be trending down over the last three years. Borrower may be able to obtain similar financing from other banks with comparable or less favorable terms. Risk of default is acceptable but requires collateral protection.

 

5 – Marginally acceptable risk

 

Borrower may exhibit excessive growth, declining earnings, strained cash flow, increasing leverage and/or weakening market position that indicate above average risk. Limited additional debt capacity, modest coverage, and average or below average asset quality, margins and market share. Interim losses and/or adverse trends may occur, but not to the level that would affect the Bank’s position. The potential for default is higher than normal but considered marginally acceptable based on prospects for improving financial performance and the strength of the collateral.

 

6 – Pass/monitor

 

The borrower has significant weaknesses resulting from performance trends or management concerns. The financial condition of the company has taken a negative turn and may be temporarily strained. Cash flow may be weak but cash reserves remain adequate to meet debt service. Management weaknesses are evident. Borrowers in this category will warrant more than the normal level of supervision and more frequent reporting.

 

7 – Special mention (watch)

 

Special mention credits are considered bankable assets with no apparent loss of principal or interest envisioned but requiring a high level of management attention. Assets in this category are currently protected but are potentially weak. These borrowers are subject to economic, industry, or management factors having an adverse impact upon their prospects for orderly service of debt. The perceived risk in continued lending is considered to have increased beyond the level where such loans would normally be granted. These assets constitute an undue and unwarranted credit risk, but not to the point of justifying a classification of Substandard.

 

8 – Substandard

 

This classification consists of loans which are inadequately protected by the current sound worth and paying capacity of the obligor or of 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. Loans are still considered collectible, but due to increased risks and defined weaknesses of the credit, some loss could be incurred in collection if the deficiencies are not corrected.

 

 

9 – Doubtful

 

This classification consists of loans where the possibility of loss is high after collateral liquidation based upon existing facts, market conditions, and value. Loss is deferred until certain important and reasonably specific pending factors which may strengthen the credit can be exactly determined. These factors may include proposed acquisitions, liquidation procedures, capital injection and receipt of additional collateral, mergers or refinancing plans.

 

Performing loans are loans that are paying as agreed and are approximately less than ninety days past due on payments of interest and principal.

 

The Bancorp's credit quality indicators are summarized below at December 31, 2017 and December 31, 2016:

 

		Credit Exposure - Credit Risk Portfolio By Creditworthiness Category
		December 31, 2017
(Dollars in thousands)		2				3				4				5				6				7				8
						Above average								Marginally								Special
Loan Segment		Moderate				acceptable				Acceptable				acceptable				Pass/monitor				mention				Substandard
Residential real estate		$	887			$	12,317			$	92,241			$	8,759			$	50,075			$	4,130			$	3,732
Home equity			-				1,065				34,871				-				250				233				350
Commercial real estate			-				2,372				79,847				81,547				40,054				6,758				512
Construction and land development			-				-				20,719				19,583				10,310				-				134
Multifamily			-				-				20,159				20,965				2,076				168				-
Commercial business			7,169				17,202				16,784				21,087				13,041				394				1,174
Consumer			-				131				330				-				-				-				-
Government			-				2,318				20,202				6,265				-				-				-
Total		$	8,056			$	35,405			$	285,153			$	158,206			$	115,806			$	11,683			$	5,902

 

		December 31, 2016
		2				3				4				5				6				7				8
						Above average								Marginally								Special
Loan Segment		Moderate				acceptable				Acceptable				acceptable				Pass/monitor				mention				Substandard
Residential real estate		$	-			$	6,069			$	94,394			$	7,085			$	57,644			$	4,015			$	4,056
Home equity			83				1,172				30,459				-				250				236				376
Commercial real estate			248				2,708				93,293				64,950				28,306				5,611				323
Construction and land development			-				439				11,355				18,913				8,097				-				134
Multifamily			-				-				17,123				16,836				1,939				188				-
Commercial business			6,315				15,044				24,754				18,786				10,653				533				1,214
Consumer			90				4				430				-				-				-				-
Government			-				955				25,474				3,100				-				-				-
Total		$	6,736			$	26,391			$	297,282			$	129,669			$	106,888			$	10,582			$	6,102

  

One commercial real estate loan and one residential real estate loan totaling $213 thousand were modified as a troubled debt restructuring during 2017. No troubled debt restructurings defaulted during 2017. All of the loans classified as troubled debt restructurings are also considered impaired. The valuation basis for the Bancorp’s troubled debt restructurings is based on the present value of cash flows, unless consistent cash flows are not present, then the fair value of the collateral securing the loan is the basis for valuation.

 

 

The Bancorp's individually evaluated impaired loans are summarized below:

 

														For the twelve months ended
		As of December 31, 2017												December 31, 2017
						Unpaid								Average				Interest
(Dollars in thousands)		Recorded				Principal				Related				Recorded				Income
		Investment				Balance				Allowance				Investment				Recognized
With no related allowance recorded:
Residential real estate		$	1,072			$	3,351			$	-			$	1,101			$	70
Commercial real estate			253				253				-				339				6
Construction and land development			134				134				-				134				-
Commercial business			184				184				-				198				10
With an allowance recorded:
Residential real estate			80				270				21				256				1
Commercial real estate			259				259				144				163				-
Construction and land development			-				-				-				-				-
Commercial business			540				540				539				492				-
Total:
Residential real estate		$	1,152			$	3,621			$	21			$	1,357			$	71
Commercial real estate		$	512			$	512			$	144			$	502			$	6
Construction & land development		$	134			$	134			$	-			$	134			$	-
Commercial business		$	724			$	724			$	539			$	690			$	10

 

														For the twelve months ended
		As of December 31, 2016												December 31, 2016
						Unpaid								Average				Interest
(Dollars in thousands)		Recorded				Principal				Related				Recorded				Income
		Investment				Balance				Allowance				Investment				Recognized
With no related allowance recorded:
Residential real estate		$	1,309			$	3,293			$	-			$	2,582			$	120
Commercial real estate			305				305				-				1,138				6
Construction and land development			134				134				-				134				-
Commercial business			212				212				-				168				4
With an allowance recorded:
Residential real estate			1,066				1,066				879				348				6
Commercial real estate			18				18				3				89				-
Construction & land development			-				-				-				-				-
Commercial business			475				475				354				324				1
Total:
Residential real estate		$	2,375			$	4,359			$	879			$	2,930			$	126
Commercial real estate		$	323			$	323			$	3			$	1,227			$	6
Construction & land development		$	134			$	134			$	-			$	134			$	-
Commercial business		$	687			$	687			$	354			$	492			$	5

  

As a result of acquisition activity, the Bancorp acquired loans for which there was evidence of credit quality deterioration since origination and it was determined that it was probable that the Bancorp would be unable to collect all contractually required principal and interest payments. At December 31, 2017, purchased credit impaired loans with unpaid principal balances totaled $2.6 million with a recorded investment of $690 thousand. At December 31, 2016, purchased credit impaired loans with unpaid principal balances totaled $2.9 million with a recorded investment of $956 thousand.

 

 

The Bancorp's age analysis of past due loans is summarized below:

 

(Dollars In thousands)		30-59 Days Past Due				60-89 Days Past Due				Greater Than 90 Days Past Due				Total Past Due				Current				Total Loans				Recorded Investments Greater than 90 Days Past Due and Accruing
December 31, 2017
Residential real estate		$	4,921			$	1,751			$	3,092			$	9,764			$	162,377			$	172,141			$	225
Home equity			295				18				234				547				36,222				36,769				2
Commercial real estate			951				96				332				1,379				209,711				211,090				-
Construction and land development			-				-				133				133				50,613				50,746				-
Multifamily			319				-				-				319				43,049				43,368				-
Commercial business			285				162				539				986				75,865				76,851				-
Consumer			1				-				-				1				460				461				-
Government			-				-				-				-				28,785				28,785				-
Total		$	6,772			$	2,027			$	4,330			$	13,129			$	607,082			$	620,211			$	227
December 31, 2016
Residential real estate		$	3,640			$	1,702			$	3,804			$	9,146			$	164,115			$	173,262			$	436
Home equity			334				73				220				626				31,949				32,575				64
Commercial real estate			208				189				323				720				194,718				195,438				-
Construction and land development			-				-				134				134				38,804				38,937				-
Multifamily			188				-				-				188				35,898				36,086				-
Commercial business			171				217				465				853				76,445				77,299				-
Consumer			-				-				-				-				524				524				-
Government			-				-				-				-				29,529				29,529				-
Total		$	4,541			$	2,181			$	4,946			$	11,668			$	571,982			$	583,650			$	500

 

The Bancorp's loans on nonaccrual status are summarized below:

 

(Dollars in thousands)

 

		December 31,				December 31,
		2017				2016
Residential real estate		$	3,509			$	4,146
Home equity			350				376
Commercial real estate			332				323
Construction and land development			133				134
Multifamily			-				-
Commercial business			672				628
Consumer			-				-
Government			-				-
Total		$	4,996			$	5,605

 

 

Note 4 – Premises and Equipment, Net

 

At year end, premises and equipment are summarized as follows:

 

		(Dollars in thousands)
		2017				2016
Cost:
Land		$	5,216			$	5,216
Buildings and improvements			23,672				22,854
Furniture and equipment			14,908				14,267
Total cost			43,796				42,337
Less accumulated depreciation			(24,237	)			(23,050	)
Premises and equipment, net		$	19,559			$	19,287

 

Depreciation expense was approximately $1.38 million and $1.35 million for 2017 and 2016, respectively.

 

Note 5 – Foreclosed Real Estate

 

At year end, foreclosed real estate is summarized below:

 

		(Dollars in thousands)
		2017				2016
Residential real estate, including home equity		$	914			$	1,810
Commercial real estate, construction & land development and other dwellings			785				855
Total		$	1,699			$	2,665

 

 

Note 6 – Goodwill and Other Intangible Assets

 

The Bancorp established a goodwill balance totaling $2.8 million with the acquisitions of First Federal Savings & Loan (First Federal) and Liberty Savings Bank (Liberty Savings). Goodwill of $2.0 million was established with the acquisition of First Federal and goodwill of $804 thousand was established with the acquisition of Liberty Savings. Goodwill is tested annually for impairment. Goodwill arising from business combinations represents the value attributable to unidentifiable intangible assets in the business acquired. The Bancorp’s goodwill relates to the value inherent in the banking industry and that value is dependent upon the ability of the Bancorp to provide quality, cost effective banking services in a competitive marketplace. If the implied fair value of goodwill is lower than its carrying amount, goodwill impairment is indicated and goodwill is written down to its implied fair value. There has not been any impairment of goodwill identified or recorded. During the second quarter of 2016, original estimates related to Liberty Savings goodwill components were adjusted. Estimates of fair values related to a pool of purchased loans were determined to be lower than originally estimated, which led to the addition of $178 thousand to goodwill. Fixed asset valuations were also determined to be higher than originally estimated, which led to a reduction of $109 thousand to goodwill. Also, the valuation of the accrued withdrawal liability for the defined benefit plan was determined to be higher than originally estimated leading to the addition of $162 thousand to goodwill. Goodwill totaled $2.8 million at December 31, 2017 and December 31, 2016.

 

In addition to goodwill, a core deposit intangible of $93 thousand for the acquisition of First Federal was established and is being amortized over 7.9 years on a straight line basis. Approximately $12 thousand of amortization was taken during the years ended December 31, 2017 and December 31, 2016. It is estimated that $12 thousand of additional amortization will occur annually from 2018 through 2021, and the remaining amount will be amortized through to the first quarter of 2022. A core deposit intangible of $471 thousand for the acquisition of Liberty Savings was established and is being amortized over 8.2 years on a straight line basis. Approximately $58 thousand of amortization was taken during the years ended December 31, 2017 and December 31, 2016. It is estimated that $58 thousand of additional amortization will occur annually from 2018 to 2022, and the remaining amount will be amortized through to the third quarter of 2023.

 

  

For the First Federal acquisition, as part of the fair value of loans receivable, a net fair value discount was established for residential real estate, including home equity lines of credit, of $1.1 million that is being accreted over 55 months on a straight line basis. Approximately $149 thousand of accretion was taken into income for the year ended December 31, 2017, compared to $217 thousand for the year ended December 31, 2016. It is estimated that $160 thousand of accretion will occur in 2018. Similarly, for the Liberty Savings acquisition, as part of the fair value of loans receivable, a net fair value discount was established for residential real estate, including home equity lines of credit, of $1.2 million that is being accreted over 44 months on a straight line basis. Approximately $307 thousand of accretion was taken into income for the year ended December 31, 2017, compared to $389 thousand of accretion was taken into income for the year ended December 31, 2016. It is estimated that $264 thousand of accretion will occur during 2018, and accretion of $44 thousand will occur during 2019.

 

For the Liberty Savings acquisition, as part of the fair value of certificates of deposit, a fair value premium was established of $124 thousand that was amortized over 17 months on a straight line basis. No amortization was taken as expense during the year ended December 31, 2017, compared to $80 thousand of amortization taken as expense during the year ended December 31, 2016.

 

Note 7 – Income Taxes

 

At year-end, components of income tax expense/(benefit) consist of the following:

 

		(Dollars in thousands)
		2017				2016
Federal:
Current		$	1,898			$	2,343
Deferred			275				(129	)
Revaluation of net deferred tax asset			517				-
State:
Current			77				80
Deferred, net of valuation allowance			102				254
Income tax expense		$	2,869			$	2,548

 

 

Effective tax rates differ from the federal statutory rate of 34% applied to income before income taxes due to the following:

 

		(Dollars in thousands)
		2017				2016
Federal statutory rate			34	%			34	%
Tax expense at statutory rate		$	4,022			$	3,975
State tax, net of federal effect			118				220
Tax exempt income			(1,302	)			(1,318	)
Bank owned life insurance			(156	)			(160	)
Captive insurance			(307	)			(179	)
Revaluation of net deferred tax asset			517				-
Other			(23	)			10
Total income tax expense		$	2,869			$	2,548

  

At December 31, the components of the net deferred tax asset recorded in the consolidated balance sheets are as follows:

 

		(Dollars in thousands)
		2017				2016
Deferred tax assets:
Bad debts		$	1,885			$	2,872
Deferred loan fees			32				60
Deferred compensation			332				503
Unrealized depreciation on securities available-for-sale, net			-				771
Net operating loss, state			290				294
Tax credits			99				98
Nonaccrual loan interest income			71				109
Share based compensation			133				126
REO writedowns			25				-
Unqualified deferred compensation plan			51				74
Other-than-temporary impairment			57				92
Accrued vacation			59				129
Impairment on land			48				71
Other			15				29
Total deferred tax assets			3,097				5,228
Deferred tax liabilities:
Depreciation			(641	)			(850	)
Prepaids			(237	)			(346	)
Mortgage servicing rights			(26	)			(51	)
Deferred stock dividends			(65	)			(97	)
Unrealized appreciation on securities available-for-sale, net			(188	)			-
Purchase accounting			(100	)			(88	)
Other			(209	)			(181	)
Total deferred tax liabilities			(1,466	)			(1,613	)
Valuation allowance			(80	)			(98	)
Net deferred tax asset		$	1,551			$	3,517

 

On December 22, 2017, the Tax Cuts and Jobs Act (the "Act") was signed into law. Among other changes, the Act reduces the corporate federal income tax rate from 34% to 21% effective January 1, 2018. As a result of these changes made by the Act, the Bancorp made the determination to revalue its net deferred tax asset, as deferred tax assets and liabilities are to be measured using enacted rates expected to apply in years in which the deferred tax assets and liabilities are expected to be recovered or settled. The revaluation of the deferred tax assets and liabilities are adjusted through income tax expense in the year the changes in tax laws are enacted. The revaluation of the net deferred tax asset resulted in additional income tax expense of $517 thousand for 2017. The $517 thousand tax expense was $628 thousand net of a tax benefit of $111 thousand relating to the other comprehensive income revaluation adjustment.

 

At December 31, 2017, the Bancorp has a state net operating loss carry forward of approximately $6.9 million which will begin to expire in 2024 if not used. The Bancorp also has a state tax credit carry forward of approximately $126 thousand which has begun to expire in 2017 and will continue to expire if not used. Management has concluded that the state net operating loss will be fully utilized and therefore no valuation allowance is necessary on the state net operating loss. A valuation allowance remains in place on the state tax credit carryforward. A valuation allowance of $80 thousand and $98 thousand was provided at December 31, 2017 and December 31, 2016, respectively, for the state tax credits.

 

  

The Bancorp qualified under provisions of the Internal Revenue Code, to deduct from taxable income a provision for bad debts in excess of the provision for such losses charged to income in the financial statements, if any. Accordingly, retained earnings at December 31, 2017 and 2016 includes, approximately $6.0 million for which no provision for federal income taxes has been made. If, in the future this portion of retained earnings is used for any purpose other than to absorb bad debt losses, federal income taxes would be imposed at the then applicable rate. The unrecorded deferred income tax liability on the above amounts was approximately $1.3 million and $2.0 million at December 31, 2017 and 2016.

 

The Bancorp had no unrecognized tax benefits at any time during 2017 or 2016 and does not anticipate any significant increase or decrease in unrecognized tax benefits during 2018. Should the accrual of any interest or penalties relative to unrecognized tax benefits be necessary, it is the Bancorp's policy to record such accruals through income tax accounts; no such accruals existed at any time during 2017 or 2016.

 

The Bancorp and its subsidiaries are subject to US Federal income tax as well as income tax of the states of Indiana and Illinois. The Bancorp is no longer subject to examination by taxing authorities for the years before 2014 for federal and 2013 for state.

 

Note 8 – Deposits

 

The aggregate amount of certificates of deposit with a balance of $250 thousand or more was approximately $29.9 million at December 31, 2017 and $24.8 million at December 31, 2016.

 

At December 31, 2017, scheduled maturities of certificates of deposit were as follows:

 

		(Dollars in thousands)
2018		$	133,265
2019			39,065
2020			9,444
2021			2,051
2022			95
Total		$	183,920

 

 

Note 9 – Borrowed Funds

 

At year end, borrowed funds are summarized below:

 

		(Dollars in thousands)
		2017				2016
Fixed rate advances from the FHLB		$	17,100			$	25,100
Line of credit at FHLB			3,181				28
Other			600				700
Total		$	20,881			$	25,828

 

At December 31, 2017, scheduled maturities of borrowed funds were as follows:

 

		(Dollars in thousands)
2018		$	9,881
2019			9,000
2020			2,000
Total		$	20,881

 

  

Repurchase agreements generally mature within one year and are secured by U.S. government and U.S. agency securities, under the Bancorp’s control. At December 31, information concerning these retail repurchase agreements is summarized below:

 

		(Dollars in thousands)
		2017				2016
Ending balance		$	11,300			$	13,998
Average balance during the year			13,734				17,755
Maximum month-end balance during the year			17,720				23,308
Securities underlying the agreements at year end:
Carrying value			18,053				23,571
Fair value			18,053				23,571
Average interest rate during the year			0.82	%			0.55	%
Average interest rate at year end			0.91	%			0.56	%

 

At December 31, advances from the Federal Home Loan Bank were as follows:

 

		(Dollars in thousands)
		2017				2016
Fixed rate advances, maturing January 2018 through June 2020 at rates from 0.97% to 2.11%; average rate: 2017 – 1.67%; 2016 – 1.40%		$	17,100			$	25,100

 

Fixed rate advances are payable at maturity, with a prepayment penalty. The advances were collateralized by mortgage loans with a carrying value totaling approximately $270.8 million and $242.7 million at December 31, 2017 and 2016, respectively. In addition to the fixed rate advances, the Bancorp maintains a $20.0 million line of credit with the Federal Home Loan Bank of Indianapolis. There was a $3.2 million balance on the line of credit at December 31, 2017 compared to $28 thousand balance on the line of credit at December 31, 2016. Other borrowings at December 31, 2017 and 2016 are comprised of reclassified bank balances.

 

Note 10 – Employees’ Benefit Plans

 

The Bancorp maintains an Employees’ Savings and Profit Sharing Plan and Trust for all employees who meet the plan qualifications. Employees are eligible to participate in the Employees’ Savings and Profit Sharing Plan and Trust on the next January 1 or July 1 following the completion of one year of employment, attaining age 18, and completion of 1,000 hours of service. The Employees’ Savings Plan feature allows employees to make pre-tax contributions to the Employees’ Savings Plan of 1% to 50% of Plan Salary, subject to limitations imposed by Internal Revenue Code section 401(k). Employees are able to begin deferring effective the first of the month following 90 days of employment. The Profit Sharing Plan and Trust feature is non-contributory on the part of the employee. Contributions to the Employees’ Profit Sharing Plan and Trust are made at the discretion of the Bancorp’s Board of Directors. Contributions for the years ended December 31, 2017 were based on 8% of the participants’ total compensation, excluding incentives, as compared to 9% for 2016. Profit sharing contributions made by the Bank and earnings credited to the employee’s account vest on the following schedule: two years of service, 40% of contributions and earnings; three years of service, 60% of contributions and earnings; four years of service, 80% of contributions and earnings; and five years of service, 100% of contributions and earnings. Participants also become 100% vested in the employer contributions and accrued earnings in their account upon their death, approved disability, or attainment of age 65 while employed at the Bank. The benefit plan expense amounted to approximately $796 thousand for 2017 and $843 thousand for 2016.

 

  

The Bancorp maintains an Unqualified Deferred Compensation Plan (the “UDC Plan”). The purpose of the UDC Plan is to provide deferred compensation to key senior management employees of the Bancorp in order to recognize their substantial contributions to the Bank and provide them with additional financial security as inducement to remain with the Bank. The Compensation Committee selects which persons shall be participants in the UDC Plan. Participants’ accounts are credited each year with an amount based on a formula involving the participant’s employer funded contributions under all qualified plans and the limitations imposed by Internal Revenue Code subsection 401(a)(17) and Code section 415. The unqualified deferred compensation plan liability at December 31, 2017 and 2016 was approximately $211 thousand and $200 thousand, respectively. The UDC Plan expense amounted to approximately $6 thousand for 2017 and $13 thousand for 2016.

 

Directors have deferred some of their fees in consideration of future payments. Fee deferrals, including interest, totaled approximately $68 thousand and $72 thousand for 2017 and 2016, respectively. The deferred fee liability at December 31, 2017 and 2016 was approximately $1.3 million and $1.4 million, respectively.

 

Note 11 – Regulatory Capital

 

The Bancorp and Bank are subject to regulatory capital requirements administered by federal banking agencies. Capital adequacy guidelines and prompt corrective action regulations involve quantitative measures of assets, liabilities, and certain off-balance-sheet items calculated under regulatory accounting practices. Capital amounts and classifications are also subject to qualitative judgments by regulators. Failure to meet various capital requirements can initiate regulatory action. Prompt corrective action regulations provide five classifications, including well capitalized, adequately capitalized, undercapitalized, significantly undercapitalized, and critically undercapitalized, although these terms are not used to represent overall financial condition. If adequately capitalized, regulatory approval is required to accept brokered deposits. If undercapitalized, capital distributions are limited, as is asset growth and expansion, and capital restoration plans are required. At December 31, 2017 and 2016, the most recent regulatory notifications categorized the Bancorp and Bank as well capitalized under the regulatory framework for prompt corrective action. There are no conditions or events since that notification that management believes have changed the Bancorp’s or the Bank’s category.

 

The following table shows that, at December 31, 2017, and December 31, 2016, the Bancorp’s capital exceeded all applicable regulatory capital requirements. The dollar amounts are in millions.

 

(Dollars in millions)																		Minimum Required To Be
										Minimum Required For								Well Capitalized Under Prompt
		Actual								Capital Adequacy Purposes								Corrective Action Regulations
At December 31, 2017		Amount				Ratio				Amount				Ratio				Amount		Ratio
Common equity tier 1 capital to risk-weighted assets		$	88.4				12.9	%		$	30.9				4.5	%		N/A		N/A
Tier 1 capital to risk-weighted assets		$	88.4				12.9	%		$	41.2				6.0	%		N/A		N/A
Total capital to risk-weighted assets		$	96.0				14.0	%		$	55.0				8.0	%		N/A		N/A
Tier 1 capital to adjusted average assets		$	88.4				9.6	%		$	36.8				4.0	%		N/A		N/A

 

(Dollars in millions)																		Minimum Required To Be
										Minimum Required For								Well Capitalized Under Prompt
		Actual								Capital Adequacy Purposes								Corrective Action Regulations
At December 31, 2016		Amount				Ratio				Amount				Ratio				Amount		Ratio
Common equity tier 1 capital to risk-weighted assets		$	82.4				13.1	%		$	28.3				4.5	%		N/A		N/A
Tier 1 capital to risk-weighted assets		$	82.4				13.1	%		$	37.8				6.0	%		N/A		N/A
Total capital to risk-weighted assets		$	90.1				14.3	%		$	50.4				8.0	%		N/A		N/A
Tier 1 capital to adjusted average assets		$	82.4				9.2	%		$	36.0				4.0	%		N/A		N/A

 

 

In addition, the following table shows that, at December 31, 2017, and December 31, 2016, the Bank’s capital exceeded all applicable regulatory capital requirements. The dollar amounts are in millions.

 

(Dollars in millions)																		Minimum Required To Be
										Minimum Required For								Well Capitalized Under Prompt
		Actual								Capital Adequacy Purposes								Corrective Action Regulations
At December 31, 2017		Amount				Ratio				Amount				Ratio				Amount				Ratio
Common equity tier 1 capital to risk-weighted assets		$	86.3				12.6	%		$	30.9				4.5	%		$	44.6				6.5	%
Tier 1 capital to risk-weighted assets		$	86.3				12.6	%		$	41.2				6.0	%		$	54.9				8.0	%
Total capital to risk-weighted assets		$	93.8				13.7	%		$	54.9				8.0	%		$	68.7				10.0	%
Tier 1 capital to adjusted average assets		$	86.3				9.4	%		$	36.7				4.0	%		$	45.8				5.0	%

 

(Dollars in millions)																		Minimum Required To Be
										Minimum Required For								Well Capitalized Under Prompt
		Actual								Capital Adequacy Purposes								Corrective Action Regulations
At December 31, 2016		Amount				Ratio				Amount				Ratio				Amount				Ratio
Common equity tier 1 capital to risk-weighted assets		$	81.2				12.9	%		$	28.4				4.5	%		$	41.0				6.5	%
Tier 1 capital to risk-weighted assets		$	81.2				12.9	%		$	37.9				6.0	%		$	50.5				8.0	%
Total capital to risk-weighted assets		$	88.9				14.1	%		$	50.5				8.0	%		$	63.1				10.0	%
Tier 1 capital to adjusted average assets		$	81.2				9.0	%		$	35.9				4.0	%		$	44.9				5.0	%

 

The Bancorp’s ability to pay dividends to its shareholders is entirely dependent upon the Bank’s ability to pay dividends to the Bancorp. Under Indiana law, the Bank may pay dividends from its undivided profits (generally, earnings less losses, bad debts, taxes and other operating expenses) as is considered expedient by the Bank’s Board of Directors. However, the Bank must obtain the approval of the Indiana Department of Financial Institutions (DFI) if the total of all dividends declared by the Bank during the current year, including the proposed dividend, would exceed the sum of retained net income for the year to date plus its retained net income for the previous two years. For this purpose, “retained net income,” means net income as calculated for call report purposes, less all dividends declared for the applicable period. An exemption from DFI approval would require that the Bank have been assigned a composite uniform financial institutions rating of 1 or 2 as a result of the most recent federal or state examination; the proposed dividend would not result in a Tier 1 leverage ratio below 7.5%; and that the Bank not be subject to any corrective action, supervisory order, supervisory agreement, or board approved operating agreement. The aggregate amount of dividends that may be declared by the Bank in 2018, without the need for qualifying for an exemption or prior DFI approval, is $10.2 million plus 2018 net profits. Moreover, the FDIC and the Federal Reserve Board may prohibit the payment of dividends if it determines that the payment of dividends would constitute an unsafe or unsound practice in light of the financial condition of the Bank. On November 17, 2017 the Board of Directors of the Bancorp declared a fourth quarter dividend of $0.29 per share. The Bancorp’s fourth quarter dividend was paid to shareholders on January 9, 2018.

 

Note 12 – Stock Based Compensation

 

The Bancorp’s 2015 Stock Option and Incentive Plan (the “Incentive Plan”), which was adopted by the Bancorp’s Board of Directors on February 17, 2015 and approved by the Bancorp’s shareholders on April 24, 2015, permits the grant of equity awards for up to 250,000 shares of common stock. Awards granted under the Incentive Plan may be in the form of incentive stock options, non-qualified stock options, restricted stock, unrestricted stock, performance shares, or performance units. The purposes of the Plan are (i) to align the personal interests of plan participants with those of the shareholders of the Bancorp, (ii) to encourage key individuals to accept or continue employment or service with the Bancorp and its subsidiaries, and (iii) to furnish incentives to such key individuals to improve operations and increase profits by providing such key individuals the opportunity to acquire common stock of the Bancorp or to receive monetary payments based on the value of such common stock. Option awards are generally granted with an exercise price equal to the market price of the Bancorp’s common stock at the date of grant. No expense was charged against income for incentive stock options during 2017 or 2016.

 

The fair value of each incentive stock option award is estimated on the date of grant using a closed form option valuation (Black-Scholes) model. Expected volatilities are based on historical volatilities of the Company’s common stock. No incentive stock options were granted during 2017 or 2016. The Bancorp uses historical data to estimate option exercise and post-vesting termination behavior. The expected term of options granted is based on historical data and represents the period of time that options granted are expected to be outstanding, which takes into account that the options are not transferable. The risk-free interest rate for the expected term of the option is based on the U.S. Treasury yield curve in effect at the time of the grant.

 

  

A summary of the Bancorp’s stock option activity for 2017 and 2016 follows:

 

		Shares				Weighted Average Exercise Price				Weighted Average Remaining Contractual Term (Years)				Aggregate Intrinsic Value
Outstanding at January 1, 2016			750			$	28.50
Granted			-				-
Exercised			-				-
Forfeited or expired			(250	)			28.50
Outstanding at end of year			500			$	28.50				1.2			$	5,175
Vested or expected to vest			500			$	28.50				1.2			$	5,175
Exercisable at December 31, 2016			500			$	28.50				1.2			$	5,175
Outstanding at January 1, 2017			500			$	28.50
Granted			-				-
Exercised			(500	)		$	28.50
Forfeited or expired			-				-
Outstanding at end of year			-			$	-				-			$	-
Vested or expected to vest			-			$	-				-			$	-
Exercisable at December 31, 2017			-			$	-				-			$	-

 

As of December 31, 2017, there were no unrecognized compensation costs related to non-vested incentive stock options granted under the Incentive Plan.

 

Restricted stock awards are generally granted with an award price equal to the market price of the Bancorp’s common stock on the award date. Restricted stock awards have been issued with a five year vesting period. Forfeiture provisions exist for personnel that separate employment before the vesting period expires. Compensation expense related to restricted stock awards is recognized over the vesting period. Total compensation cost that has been charged against income for those plans was approximately $192 thousand and $142 thousand for 2017 and 2016, respectively.

 

 

A summary of changes in the Bancorp’s non-vested restricted stock for 2017 and 2016 follows:

 

Non-vested Shares		Shares				Weighted Average Grant Date Fair Value
Non-vested at January 1, 2016			19,725			$	25.15
Granted			8,740				30.10
Vested			-				-
Forefited			-				-
Non-vested at December 31, 2016			28,465			$	26.67
Non-vested at January 1, 2017			28,465			$	26.67
Granted			4,575				39.00
Vested			(1,625	)			25.81
Forefited			(725	)			28.62
Non-vested at December 31, 2017			30,690			$	28.51

 

As of December 31, 2017, there was approximately $400 thousand of total unrecognized compensation cost related to non-vested restricted shares granted under the Incentive Plan. The cost is expected to be recognized over a weighted-average period of 2.1 years.

 

Note 13 – Earnings per Common Share

 

Earnings per common share is computed by dividing net income by the weighted-average number of common shares outstanding. A reconciliation of the numerators and denominators of the basic earnings per common share and diluted earnings per common share computations for 2017 and 2016 is presented below.

 

		2017				2016
Basic earnings per common share:
Net income available to common stockholders		$	8,960,766			$	9,141,725
Weighted-average common shares outstanding			2,863,899				2,858,556
Basic earnings per common share		$	3.13			$	3.20
Diluted earnings per common share:
Net income available to common stockholders		$	8,960,766			$	9,141,725
Weighted-average common shares outstanding			2,863,899				2,858,556
Weighted-average common and dilutive potential common shares outstanding			2,864,037				2,858,601
Diluted earnings per common share		$	3.13			$	3.20

 

 

Note 14 – Related Party Transactions

 

The Bancorp had aggregate loans outstanding to directors and executive officers (with individual balances exceeding $120 thousand) of approximately $1.7 million at December 31, 2017 and approximately $3.7 million at December 31, 2016. For the year ended December 31, 2017, the following activity occurred on these loans:

 

		(Dollars in thousands)
Aggregate balance at the beginning of the year		$	3,691
New loans			426
Repayments			(2,450	)
Aggregate balance at the end of the year		$	1,667

 

Deposits from directors and executive officers totaled approximately $4.4 million and $4.1 million at December 31, 2017 and 2016, respectively.

 

Note 15 – Commitments and Contingencies

 

The Bancorp is a party to financial instruments in the normal course of business to meet the financing needs of its customers. These financial instruments, which include commitments to make loans and standby letters of credit, are not reflected in the accompanying consolidated financial statements. Such financial instruments are recorded when they are funded.

 

The Bancorp’s exposure to credit loss in the event of non-performance by the other party to the financial instrument for commitments to originate loans and standby letters of credit is represented by the contractual amount of those instruments. Commitments generally have fixed expiration dates or other termination clauses and may require the payment of a fee. The Bancorp uses the same credit policy to make such commitments as it uses for on-balance sheet items. Since commitments to make loans may expire without being used, the amount does not necessarily represent future cash commitments.

 

The Bancorp had outstanding commitments to originate loans as follows:

 

		(Dollars in thousands)
		Fixed				Variable
		Rate				Rate				Total
December 31, 2017:
Residential real estate		$	70			$	7,678			$	7,748
Home equity			31,008				1,838				32,846
Commercial real estate			1,351				6,866				8,217
Construction and land development			8,074				21,105				29,179
Multifamily			174				322				496
Consumer			16,469				-				16,469
Commercial business			1,103				41,381				42,484
Government			-				-				-
Total		$	58,249			$	79,190			$	137,439
December 31, 2016:
Residential real estate		$	82			$	7,683			$	7,765
Home equity			25,896				2,839				28,735
Commercial real estate			1,426				5,973				7,399
Construction and land development			5,838				8,029				13,867
Multifamily			6,168				192				6,360
Consumer			15,332				-				15,332
Commercial business			1,088				41,474				42,562
Government			-				-				-
Total		$	55,830			$	66,190			$	122,020

 

The approximately $58.2 million in fixed rate commitments outstanding at December 31, 2017 had interest rates ranging from 2.99% to 10.00%, for a period not to exceed forty-five days. At December 31, 2016, fixed rate commitments outstanding of approximately $55.8 million had interest rates ranging from 2.99% to 10.00%, for a period not to exceed forty-five days. Mortgage interest rate locks with borrowers which are included with real estate commitments, were treated as derivative transactions.

 

  

Standby letters of credit are conditional commitments issued by the Bancorp to guarantee the performance of a customer to a third party. At December 31, 2017 and 2016, the Bancorp had standby letters of credit totaling approximately $9.9 million and $7.8 million, respectively which are not included in the tables above. The Bancorp evaluates each customer’s creditworthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary by the Bancorp upon extension of credit, is based on management’s credit evaluation of the borrower. Collateral obtained may include accounts receivable, inventory, property, land or other assets.

 

Note 16 – Fair Values of Financial Instruments

 

The Fair Value Measurements Topic (the “Topic”) establishes a hierarchy that requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. The Topic describes three levels of inputs that may be used to measure fair value:

 

Level 1: Quoted prices (unadjusted) for identical assets or liabilities in active markets that the entity has the ability to access as of the measurement date.

 

Level 2: Significant other observable 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.

 

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

 

The fair values of securities available for sale are determined on a recurring basis by obtaining quoted prices on nationally recognized securities exchanges or pricing models utilizing significant observable inputs such as matrix pricing, which is a mathematical technique widely used in the industry to value debt securities without relying exclusively on quoted prices for the specific securities, but rather by relying on the securities’ relationship to other benchmark quoted securities. Different judgments and assumptions used in pricing could result in different estimates of value. In certain cases where market data is not readily available because of lack of market activity or little public disclosure, values may be based on unobservable inputs and classified in Level 3 of the fair value hierarchy.

 

At the end of each reporting period, securities held in the investment portfolio are evaluated on an individual security level for other-than-temporary impairment in accordance with the Investments – Debt and Equity Securities Topic. Impairment is other-than-temporary if the decline in the fair value of the security is below its amortized cost and it is probable that all amounts due according to the contractual terms of a debt security will not be received. Significant judgments are required in determining impairment, which include making assumptions regarding the estimated prepayments, loss assumptions and the change in interest rates. The Bancorp considers the following factors when determining other-than-temporary impairment for a security: the length of time and the extent to which the market value has been less than amortized cost; the financial condition and near-term prospects of the issuer; the underlying fundamentals of the relevant market and the outlook for such market for the near future; an assessment of whether the Bancorp (1) has the intent to sell the debt securities or (2) more likely than not will be required to sell the debt securities before their anticipated market recovery. If either of these conditions are met, management will recognize other-than-temporary impairment. If, in management’s judgment, an other-than-temporary impairment exists, the cost basis of the security will be written down for the credit loss, and the unrealized loss will be transferred from accumulated other comprehensive loss as an immediate reduction of current earnings.

 

  

The Bancorp’s management utilizes a specialist to perform an other-than-temporary impairment analysis for each of its four pooled trust preferred securities. The analysis is performed semiannually on June 30 and December 31 and utilizes analytical models used to project future cash flows for the pooled trust preferred securities based on current assumptions for prepayments, default and deferral rates, and recoveries. The projected cash flows are then tested for impairment consistent with the Investments – Other Topic and the Investments – Debt and Equity Securities Topic. The other-than-temporary impairment testing compares the present value of the cash flows from quarter to quarter to determine if there is a “favorable” or “adverse” change. Other-than-temporary impairment is recorded if the projected present value of cash flows is lower than the book value of the security. To perform the semi-annual other-than-temporary impairment analysis, management utilizes current reports issued by the trustee, which contain principal and interest tests, waterfall distributions, note valuations, collection detail and credit ratings for each pooled trust preferred security. In addition, a detailed review of the performing collateral was performed. The review of the collateral began with a review of financial information provided by SNL Financial, a comprehensive database, widely used in the industry, which gathers financial data on banks and thrifts from U.S. GAAP financial statements for public companies (annual and quarterly reports on Forms 10-K and 10-Q), as well as regulatory reports for private companies, including consolidated financial statements for bank holding companies (FR Y-9C reports) and parent company-only financial statements for bank holding companies (FR Y-9LP reports) filed with the Federal Reserve and bank call reports filed with the FDIC and OCC. Using the information sources described above, for each bank and thrift examined, the following items were examined: nature of the issuer’s business, years of operating history, corporate structure, loan composition and loan concentrations, deposit mix, asset growth rates, geographic footprint and local economic environment. The issuers’ historical financial performance was reviewed and their financial ratios were compared to appropriate peer groups of regional banks or thrifts with similar asset sizes. The analysis focused on six broad categories: profitability (revenue streams and earnings quality, return on assets and shareholder’s equity, net interest margin and interest rate sensitivity), credit quality (charge-offs and recoveries, non-current loans and total non-performing assets as a percentage of total loans, loan loss reserve coverage and the adequacy of the loan loss provision), operating efficiency (noninterest expense compared to total revenue), capital adequacy (Tier-1, total capital and leverage ratios and equity capital growth), leverage (tangible equity as a percentage of tangible assets, short-term and long-term borrowings and double leverage at the holding company) and liquidity (the nature and availability of funding sources, net non-core funding dependence and quality of deposits). In addition, for publicly traded companies, stock price movements were reviewed and the market price of publicly traded debt instruments was examined. The current other-than-temporary impairment analysis indicated that the Bancorp’s four pooled trust preferred securities had no additional other-than-temporary impairment for the years ending December 31, 2017 and 2016.

 

The table below shows the credit loss roll forward for the Bancorp’s pooled trust preferred securities that have been classified with other-than-temporary impairment:

 

		(Dollars in thousands)
		Collateralized debt obligations
		other-than-temporary impairment
Ending balance, December 31, 2016		$	271
Additions not previously recognized			-
Ending balance, December 31, 2017		$	271

 

 

  

The following table contains information regarding the Bancorp’s pooled trust preferred securities as of December 31, 2017:

 

Cusip			74043CAC1				74042TAJ0				01449TAB9				01450NAC6
Deal name			PreTSL XXIV				PreTSL XXVII				Alesco IX				Alesco XVII
Class			B-1				C-1				A-2A				B
Lowest credit rating assigned			CCC				CC				BB				CCC
Number of performing banks			62				33				63				51
Number of performing insurance companies			13				7				10				n/a
Number of issuers in default			16				7				2				4
Number of issuers in deferral			2				2				1				1
Defaults & deferrals as a % of
performing collateral			26.56	%			20.06	%			2.93	%			8.11	%
Subordination:
As a % of performing collateral			23.55	%			8.35	%			53.11	%			35.58	%
As a % of performing collateral - adjusted for projected future defaults			18.67	%			1.24	%			49.64	%			31.69	%
Other-than-temporary impairment model assumptions:
Defaults:
Year 1 - issuer average			2.00	%			2.40	%			2.30	%			1.90	%
Year 2 - issuer average			2.00	%			2.40	%			2.30	%			1.90	%
Year 3 - issuer average			2.00	%			2.40	%			2.30	%			1.90	%
> 3 Years - issuer average			(1	)			(1	)			(1	)			(1	)
Discount rate - 3 month Libor, plus implicit yield spread at purchase			1.48	%			1.23	%			1.27	%			1.44	%
Recovery assumptions			(2	)			(2	)			(2	)			(2	)
Prepayments			0.00	%			0.00	%			0.00	%			0.00	%
Other-than-temporary impairment		$	41			$	132			$	36			$	62

 

(1) - Default rates > 3 years are evaluated on a issuer by issuer basis and range from 0.25% to 5.00%.

(2) - Recovery assumptions are evaluated on a issuer by issuer basis and range from 0% to 15% with a five year lag.

 

In the table above, the Bancorp’s subordination for each trust preferred security is calculated by taking the total performing collateral and subtracting the sum of the total collateral within the Bancorp’s class and the total collateral within all senior classes, and then stating this result as a percentage of the total performing collateral. This measure is an indicator of the level of collateral that can default before potential cash flow disruptions may occur. In addition, management calculates subordination assuming future collateral defaults by utilizing the default/deferral assumptions in the Bancorp’s other-than-temporary impairment analysis. Subordination assuming future default/deferral assumptions is calculated by deducting future defaults from the current performing collateral. At December 31, 2017 and 2016, management reviewed the subordination levels for each security in context of the level of current collateral defaults and deferrals within each security; the potential for additional defaults and deferrals within each security; the length of time that the security has been in “payment in kind” status; and the Bancorp’s class position within each security.

 

Management calculated the other-than-temporary impairment model assumptions based on the specific collateral underlying each individual security. The following assumption methodology was applied consistently to each of the four pooled trust preferred securities: For collateral that has already defaulted, no recovery was assumed; no cash flows were assumed from collateral currently in deferral, with the exception of the recovery assumptions. The default and recovery assumptions were calculated based on the detailed collateral review. The discount rate assumption used in the calculation of the present value of cash flows is based on the discount margin (i.e., credit spread) at the time each security was purchased using the original purchase price. The discount margin is then added to the appropriate 3-month LIBOR forward rate obtained from the forward LIBOR curve.

 

  

At December 31, 2017 and 2016, three of the trust preferred securities with a cost basis of $3.5 million have been placed in “payment in kind” status. The Bancorp’s securities that are classified as “payment in kind” are a result of not receiving the scheduled quarterly interest payments. For the securities in “payment in kind” status, management anticipates to receive the unpaid contractual interest payments from the issuer, because of the self-correcting cash flow waterfall provisions within the structure of the securities. When a tranche senior to the Bancorp’s position fails the coverage test, the Bancorp’s interest cash flows are paid to the senior tranche and recorded as a reduction of principal. The coverage test represents an over collateralization target by stating the balance of the performing collateral as a percentage of the balance of the Bancorp’s tranche, plus the balance of all senior tranches. The principal reduction in the senior tranche continues until the appropriate coverage test is passed. As a result of the principal reduction in the senior tranche, more cash is available for future payments to the Bancorp’s tranche. Consistent with the Investments – Debt and Equity Securities Topic, management considered the failure of the issuer of the security to make scheduled interest payments in determining whether a credit loss existed. Management will not capitalize the “payment in kind” interest payments to the book value of the securities and will keep these securities in non-accrual status until the quarterly interest payments resume.

 

Assets and Liabilities Measured at Fair Values on a Recurring Basis

 

There were no transfers to or from Levels 1 and 2 during the years ended December 31, 2017 and 2016. Changes in Level 3 assets are solely the result of changes in estimated fair values of securities that have been classified as level 3 during all of 2017 and 2016. Assets measured at fair value on a recurring basis are summarized below:

 

						(Dollars in thousands)
						Fair Value Measurements at December 31, 2017 Using
(Dollars in thousands)		Estimated Fair Value				Quoted Prices in Active Markets for Identical Assets (Level 1)				Significant Other Observable Inputs (Level 2)				Significant Unobservable Inputs (Level 3)
Available-for-sale debt securities:
Money market fund		$	476			$	476			$	-			$	-
U.S. government sponsored entities			3,890				-				3,890				-
Collateralized mortgage obligations and residential mortgage-backed securities			132,938				-				132,938				-
Municipal securities			103,747				-				103,747				-
Collateralized debt obligations			3,439				-				-				3,439
Total securities available-for-sale		$	244,490			$	476			$	240,575			$	3,439

 

						(Dollars in thousands)
						Fair Value Measurements at December 31, 2016 Using
(Dollars in thousands)		Estimated Fair Value				Quoted Prices in Active Markets for Identical Assets (Level 1)				Significant Other Observable Inputs (Level 2)				Significant Unobservable Inputs (Level 3)
Available-for-sale debt securities:
Money market fund		$	222			$	222			$	-			$	-
U.S. government sponsored entities			16,274				-				16,274				-
Collateralized mortgage obligations and residential mortgage-backed securities			117,975				-				117,975				-
Municipal securities			96,745				-				96,745				-
Collateralized debt obligations			2,409				-				-				2,409
Total securities available-for-sale		$	233,625			$	222			$	230,994			$	2,409

 

  

A reconciliation of available-for-sale securities, which require significant adjustment based on unobservable data, is presented below:

 

		(Dollars in thousands)
		Estimated Fair Value Measurements Using Significant Unobservable Inputs (Level 3)
		Available-for- sale securities
Beginning balance, January 1, 2016		$	2,734
Principal payments			(107	)
Total unrealized losses, included in other comprehensive income			(218	)
Transfers in and/or (out) of Level 3			-
Ending balance, December 31, 2016		$	2,409
Beginning balance, January 1, 2017		$	2,409
Principal payments			(154	)
Total unrealized gains, included in other comprehensive income			1,184
Transfers in and/or (out) of Level 3			-
Ending balance, December 31, 2017		$	3,439

 

Assets and Liabilities Measured at Fair Value on a Non-Recurring Basis

 

Assets and liabilities measured at fair value on a non-recurring basis are summarized below:

 

						(Dollars in thousands)
						Fair Value Measurements at December 31, 2017 Using
(Dollars in thousands)		Estimated Fair Value				Quoted Prices in Active Markets for Identical Assets (Level 1)				Significant Other Observable Inputs (Level 2)				Significant Unobservable Inputs (Level 3)
Impaired loans		$	1,818			$	-			$	-			$	1,818
Foreclosed real estate			1,699				-				-				1,699

 

						(Dollars in thousands)
						Fair Value Measurements at December 31, 2016 Using
(Dollars in thousands)		Estimated Fair Value				Quoted Prices in Active Markets for Identical Assets (Level 1)				Significant Other Observable Inputs (Level 2)				Significant Unobservable Inputs (Level 3)
Impaired loans		$	2,282			$	-			$	-			$	2,282
Foreclosed real estate			2,665				-				-				2,665

 

The fair value of impaired loans with specific allocations of the allowance for loan losses or loans for which charge-offs have been taken is generally based on the present value of future cash flows or, for collateral dependent loans, based on recent real estate appraisals. Appraisals may utilize a single valuation approach or a combination of approaches, including comparable sales and the income approach. The recorded investment of impaired loans was approximately $2.5 million and the related specific reserves totaled approximately $704 thousand, resulting in a fair value of impaired loans totaling approximately $1.8 million, at December 31, 2017. The recorded investment of impaired loans was approximately $3.5 million and the related specific reserves totaled approximately $1.2 million, resulting in a fair value of impaired loans totaling approximately $2.3 million, at December 31, 2016. Fair value is determined, where possible, using market prices derived from an appraisal or evaluation, which are considered to be Level 2 inputs. However, certain assumptions and unobservable inputs are often used by the appraiser, therefore, qualifying the assets as Level 3 in the fair value hierarchy. The fair value of foreclosed real estate is similarly determined by using the results of recent real estate appraisals. The numerical range of unobservable inputs for these valuation assumptions is not meaningful to this presentation.

 

  

The following table shows carrying values and related estimated fair values of financial instruments as of the dates indicated. Estimated fair values are further categorized by the inputs used to measure fair value. Items that are not financial instruments are not included.

 

		December 31, 2017								Estimated Fair Value Measurements at December 31, 2017 Using
(Dollars in thousands)		Carrying Value				Estimated Fair Value				Quoted Prices in  Active Markets for Identical Assets (Level 1)				Significant Other Observable Inputs (Level 2)				Significant Unobservable Inputs (Level 3)
Financial assets:
Cash and cash equivalents		$	11,025			$	11,025			$	11,025			$	-			$	-
Certificates of deposit in other financial institutions			1,676				1,640				-				1,640				-
Securities available-for-sale			244,490				244,490				476				240,575				3,439
Loans held-for-sale			1,592				1,625				1,625				-				-
Loans receivable, net			612,729				608,506				-				-				608,506
Federal Home Loan Bank stock			3,000				3,000				-				3,000				-
Accrued interest receivable			3,262				3,262				-				3,262				-
Financial liabilities:
Non-interest bearing deposits			120,556				120,556				120,556				-				-
Interest bearing deposits			672,448				670,967				488,528				182,439				-
Repurchase agreements			11,300				11,292				9,545				1,747				-
Borrowed funds			20,881				20,818				600				20,218				-
Accrued interest payable			42				42				-				42				-

 

		December 31, 2016								Estimated Fair Value Measurements at December 31, 2016 Using
(Dollars in thousands)		Carrying Value				Estimated Fair Value				Quoted Prices in  Active Markets for Identical Assets (Level 1)				Significant Other Observable Inputs (Level 2)				Significant Unobservable Inputs (Level 3)
Financial assets:
Cash and cash equivalents		$	45,109			$	45,109			$	45,109			$	-			$	-
Certificates of deposit in other financial institutions			885				866				-				866				-
Securities available-for-sale			233,625				233,625				222				230,994				2,409
Loans held-for-sale			2,193				2,242				2,242				-				-
Loans receivable, net			575,952				568,855				-				-				568,855
Federal Home Loan Bank stock			3,000				3,000				-				3,000				-
Accrued interest receivable			3,086				3,086				-				3,086				-
Financial liabilities:
Non-interest bearing deposits			111,800				111,800				111,800				-				-
Interest bearing deposits			667,971				667,227				482,307				184,920				-
Repurchase agreements			13,998				13,995				11,439				2,556				-
Borrowed funds			25,828				25,840				700				25,140				-
Accrued interest payable			41				41				-				41				-

 

  

The following methods were used to estimate the fair value of financial instruments presented in the preceding table for the periods ended December 31, 2017 and 2016:

 

Cash and cash equivalent carrying amounts approximate fair value. Certificates of deposits in other financial institutions carrying amounts approximate fair value (Level 2). The fair values of securities available-for-sale are obtained from broker pricing (Level 2), with the exception of collateralized debt obligations, which are valued by a third-party specialist (Level 3). Loans held-for-sale comprise residential mortgages and are priced based on values established by the secondary mortgage markets (Level 1). The estimated fair value for net loans receivable is based on estimates of the rate the Bancorp would charge for similar such loans, applied for the time period until estimated repayment, in addition to appraisals which may utilize a single valuation approach or a combination of approaches including comparable sales and the income approach (Level 3). Federal Home Loan Bank stock is estimated at book value due to restrictions that limit the sale or transfer of the security. Fair values of accrued interest receivable and payable approximate book value, as the carrying values are determined using the observable interest rate, balance, and last payment date.

 

Non-interest and interest bearing deposits, which include checking, savings, and money market deposits, are estimated to have fair values based on the amount payable as of the reporting date (Level 1). The fair value of fixed-maturity certificates of deposit (included in interest bearing deposits) are based on estimates of the rate the Bancorp would pay on similar deposits, applied for the time period until maturity (Level 2). Estimated fair values for short-term repurchase agreements, which represent sweeps from demand deposits to accounts secured by pledged securities, are estimated based on the amount payable as of the reporting date (Level 1). Longer-term repurchase agreements, with contractual maturity dates of three months or more, are based on estimates of the rate the Bancorp would pay on similar deposits, applied for the time period until maturity (Level 2). Short-term borrowings are generally only held overnight, therefore, their carrying amount is a reasonable estimate of fair value (Level 1). The fair value of FHLB Advances are estimated by discounting the future cash flows using quoted rates from the FHLB for similar advances with similar maturities (Level 2). The estimated fair value of other financial instruments, and off-balance sheet loan commitments, approximate cost and are not considered significant to this presentation.

 

  

Note 17 – Parent Company Only Statements

 

		(Dollars in thousands)
		NorthWest Indiana Bancorp
		Condensed Balance Sheets
		December 31,				December 31,
		2017				2016
Assets
Cash on deposit with Peoples Bank		$	125			$	57
Investment in Peoples Bank			89,915				82,875
Investment in NWIN Risk Management, Inc.			1,674				775
Dividends receivable from Peoples Bank			831				800
Other assets			899				775
Total assets		$	93,444			$	85,282
Liabilities and stockholders’ equity
Dividends payable		$	831			$	800
Other liabilities			553				374
Total liabilities			1,384				1,174
Common stock			361				361
Additional paid in capital			4,506				4,300
Accumulated other comprehensive income			684				(1,506	)
Retained earnings			86,509				80,953
Total stockholders’ equity			92,060				84,108
Total liabilities and stockholders’ equity		$	93,444			$	85,282

 

		(Dollars in thousands)
		NorthWest Indiana Bancorp
		Condensed Statements of Income
		Year Ended December 31,
		2017				2016
Dividends from Peoples Bank		$	3,295			$	3,520
Operating expenses			262				194
Income before income taxes and equity in undistributed income of Peoples Bank			3,033				3,326
Income tax benefit			(69	)			(54	)
Income before equity in undistributed income of Peoples Bank			3,102				3,380
Equity in undistributed
income of Peoples Bank			4,961				5,237
income of NWIN Risk Management, Inc.			898				525
Net income		$	8,961			$	9,142

 

		(Dollars in thousands)
		NorthWest Indiana Bancorp
		Condensed Statements of Cash Flows
		Year Ended December 31,
		2017				2016
Cash flows from operating activities:
Net income		$	8,961			$	9,142
Adjustments to reconcile net income to net cash provided by operating activities
Equity in undistributed net income of:
Peoples Bank			(4,961	)			(5,237	)
NWIN Risk Management, Inc.			(898	)			(525	)
Stock based compensation expense			192				142
Change in other assets			(155	)			(654	)
Change in other liabilities			179				(159	)
Total adjustments			(5,643	)			(6,433	)
Net cash - operating activities			3,318				2,709
Cash flows from investing activities:
Investment in NWIN Risk Management, Inc.			-				(250	)
Net cash - investing activities			-				(250	)
Cash flows from financing activities:
Dividends paid			(3,264	)			(3,143	)
Proceeds from issuance of common stock			14				-
Net cash - financing activities			(3,250	)			(3,143	)
Net change in cash			68				(684	)
Cash at beginning of year			57				741
Cash at end of year		$	125			$	57

 

  

Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure

 

There are no items reportable under this item.

 

Item 9A. Controls and Procedures

 

Evaluation of Disclosure Controls and Procedures

 

The Chief Executive Officer and Chief Financial Officer have evaluated the effectiveness of the design and operation of the Company’s disclosure controls and procedures, as defined in Rule 13a-15(e) promulgated under the Securities and Exchange Act of 1934, as amended, as of December 31, 2017. Based on that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that as of December 31, 2017, the Company’s disclosure controls and procedures are effective to ensure that information required to be disclosed by the Company in reports that it files or submits under the Securities Exchange Act of 1934 is recorded, processed, summarized, and reported within the time periods specified in the SEC’s rules and forms and such information is accumulated and communicated to the issuer’s management, including its principal executive and principal financial officers as appropriate to allow timely decisions regarding required disclosure.

 

There were no changes in the Company’s internal control over financial reporting during the year ended December 31, 2017, that have materially affected or are reasonably likely to affect, the Company’s internal control over financial reporting.

 

Management’s Report on Internal Control Over Financial Reporting

 

The management of the Company is responsible for establishing and maintaining adequate internal control over financial reporting, as defined in Rule 13a–15(f) under the Securities Exchange Act of 1934. The Company’s internal control over financial reporting is a process designed under the supervision of the Company’s Chief Executive Officer and Chief Financial Officer to provide reasonable assurance regarding the reliability of financial reporting and the preparation of the Company’s financial statements for external reporting purposes in accordance with U.S. generally accepted accounting principles.

 

As of December 31, 2017, management assessed the effectiveness of the Company’s internal control over financial reporting based on the framework established in the “Internal Control - Integrated Framework” issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Based on this evaluation, management has determined that the Company’s internal control over financial reporting was effective as of December 31, 2017, based on the criteria specified.

 

Plante & Moran PLLC, the independent registered public accounting firm that audited the consolidated financial statements of the Company and has issued an attestation report, included herein, on the Company’s internal control over financial reporting as of December 31, 2017.

 

 

Report of Independent Registered Public Accounting Firm

  

To the Board of Directors and Stockholders
NorthWest Indiana Bancorp and Subsidiaries

 

Opinion on Internal Controls over Financial Reporting

 

We have audited the internal control over financial reporting as of December 31, 2017 of NorthWest Indiana Bancorp and Subsidiaries (the “Company”), based on criteria established in Internal Control-Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (the “COSO framework”). In our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2017, based on criteria established in the COSO framework.

 

We also have audited the accompanying consolidated balance sheets of the Company as of December 31, 2017 and 2016, and the related consolidated statements of income, comprehensive income, stockholders' equity, and cash flows for the years then ended, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (“PCAOB”). Our report dated February 20, 2018, expresses an unqualified opinion.

 

Basis for Opinion

 

The Company's management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting included in the accompanying “Management’s Report on Internal Control Over Financial Reporting”. Our responsibility is to express an opinion on the Company's internal control over financial reporting based on our audit. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.

 

We conducted our audit in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audit also included performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.

 

  

Definition and Limitations of Internal Control over Financial Reporting

 

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

 

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

or that the degree of compliance with the policies or procedures may deteriorate.

 

	/s/ Plante & Moran, PLLC
	Plante & Moran, PLLC

 

We have served as the Company’s auditor since 2010.

 

Chicago, Illinois
February 20, 2018

 

Item 9B. Other Information

 

There are no items reportable under this item.

 

  

PART III

 

Item 10. Directors, Executive Officers and Corporate Governance

 

The information contained under the sections captioned "Proposal 1 - Election of Directors,” “Corporate Governance - Board Committees,” "Security Ownership by Certain Beneficial Owners and Management,” “Section 16(a) Beneficial Ownership Reporting Compliance" and “Corporate Governance - Code of Ethics” in the Bancorp’s definitive Proxy Statement for the 2018 Annual Meeting of Shareholders is incorporated herein by reference. Information regarding the Bancorp’s executive officers is included under Item 4.5 captioned "Executive Officers of the Bancorp" at the end of Part I hereof and is incorporated herein by reference, in accordance with General Instruction G(3) to Form 10-K and Instruction 3 to Item 401(b) of Regulation S-K.

 

Item 11. Executive Compensation

 

The information contained under the section captioned “Executive Compensation" in the Bancorp’s definitive Proxy Statement for its 2018 Annual Meeting of Shareholders is incorporated herein by reference.

 

Item 12.

Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters

 

The information contained within the Bancorp’s definitive Proxy Statement for the 2018 Annual Meeting of Shareholders, under the section captioned “Security Ownership by Certain Beneficial Owners and Management,” and the table providing information on the Bancorp’s director nominees and continuing directors in the section captioned “Proposal 1 - Election of Directors,” is incorporated herein by reference.

 

Equity Compensation Plan Information

 

The following table provides certain information as of December 31, 2017 with respect to the Bancorp’s existing equity compensation plans.

 

		Number of securities to be issued upon exercise of outstanding options,  warrants and rights				Weighted-average exercise price of outstanding options, warrants and rights				Number of securities remaining available for future issuance under equity compensation plans (excluding securities reflected in column a)
Plan Category		(a)				(b)				(c)
Equity compensation plans approved by security holders			-			$	-				225,755
Equity compensation plans not approved by security holders			-				-				-
Total			-			$	-				225,755

 

Item 13. Certain Relationships and Related Transactions, and Director Independence

 

The information contained under the sections captioned “Transactions with Related Persons” and “Corporate Governance-Director Independence,” and the information contained in the “Summary Compensation Table for 2017” under the section captioned “Executive Compensation,” in the Bancorp’s definitive Proxy Statement for its 2018 Annual Meeting of Shareholders, is incorporated herein by reference.

 

  

Item 14. Principal Accountant Fees and Services

 

The information contained under the section captioned "Independent Registered Public Accounting Firm’s Services and Fees" in the Bancorp’s definitive Proxy Statement for its 2018 Annual Meeting of Shareholders, is incorporated herein by reference.

 

PART IV

 

Item 15. Exhibits and Financial Statement Schedules

 

(a)

(1) Financial Statements:

 

The consolidated financial statements of the Bancorp are included in Part II, Item 8 of this Form 10-K.

 

(2)

Financial Statement Schedules: Not Applicable.

 

(3)

Exhibits:

 

Exhibit Number		Description
2.1		Plan of Conversion of Peoples Bank, A Federal Savings Bank, dated December 18, 1993 (incorporated herein by reference to Exhibit A to the Bancorp’s Definitive Proxy Statement/Prospectus dated March 23, 1994, as filed pursuant to Rule 424(b) under the 1933 Act on March 28, 1994).
2.3@		Agreement and Plan of Voluntary Supervisory Merger Conversion dated March 20, 2015 by and between Peoples Bank SB and Liberty Savings Bank, FSB (incorporated herein by reference to Exhibit 10.1 of the Bancorp’s Form 8-K dated March 20, 2015).
3.1		Articles of Incorporation (incorporated herein by reference to Exhibit 3(i) to the Bancorp’s Registration Statement on Form S-4 filed March 3, 1994 (File No. 33-76038)).
3.2		By-Laws of NorthWest Indiana Bancorp. (incorporated herein by reference to Exhibit 3.2 of the Bancorp’s Form 10-K for the year ended December 31, 2014).
10.1 *		Unqualified Deferred Compensation Plan for the Officers of Peoples Bank effective January 1, 2005 (incorporated herein by reference to Exhibit 10.3 of the Bancorp’s Form 10-K for the year ended December 31, 2012).
10.2 *		Amended Post 2004 Unfunded Deferred Compensation Plan for the Directors of Peoples Bank SB effective January 1, 2005 (incorporated herein by reference to Exhibit 10.5 of the Bancorp’s Form 10-K for the year ended December 31, 2012).
10.3 *		NorthWest Indiana Bancorp 2015 Stock Option and Incentive Plan (incorporated herein by reference to Exhibit 10.1 of the Bancorp’s Form 8-K dated April 24, 2015).
10.4 *		Form of Nonqualified Stock Option Agreement under the NorthWest Indiana Bancorp 2015 Stock Option and Incentive Plan (incorporated herein by reference to Exhibit 10.2 of the Bancorp’s Form 8-K dated April 24, 2015).
10.5 *		Form of Incentive Stock Option Agreement under the NorthWest Indiana Bancorp 2015 Stock Option and Incentive Plan (incorporated herein by reference to Exhibit 10.3 of the Bancorp’s Form 8-K dated April 24, 2015).
10.6 *		Form of Agreement for Restricted Stock under the NorthWest Indiana Bancorp 2015 Stock Option and Incentive Plan (incorporated herein by reference to Exhibit 10.4 of the Bancorp’s Form 8-K dated April 24, 2015).
10.7		Amended and Restated Employment Agreement, dated February 16, 2016, by and among NorthWest Indiana Bancorp, Peoples Bank SB and David A. Bochnowski (incorporated herein by reference to Exhibit 10.1 of the Bancorp’s Form 8-K dated February 26, 2016).

 

  

10.8		Employment Agreement between NorthWest Indiana Bancorp, Peoples Bank SB, and Benjamin J. Bochnowski dated August 1, 2017 (incorporated herein by reference to Exhibit 10.1 of the Bancorp’s Form 8-K dated August 4, 2017).
13		2017 Annual Report to Shareholders.
21		Subsidiaries of the Bancorp.
23.1		Plante & Moran, PLLC - Consent of Independent Registered Public Accounting Firm.
31.1		Rule 13a-14(a)/15d-14(a) Certification of Chief Executive Officer.
31.2		Rule 13a-14(a)/15d-14(a) Certification of Chief Financial Officer.
32		Section 1350 Certifications.
101		The following materials from the Bancorp’s Form 10-K for the fiscal year ended December 31, 2017, formatted in an XBRL Interactive Data File: (i) Consolidated Balance Sheets; (ii) Consolidated Statements of Income; (iii) Consolidated Statements of Comprehensive Income; (iv) Consolidated Statements of Changes in Stockholders’ Equity; (v) Consolidated Statements of Cash Flows; and (vi) Notes to Consolidated Financial Statements, with detailed tagging of notes and financial statement schedules.

 

@ – The Bancorp has omitted schedules and similar attachments to the subject agreement pursuant to Item 601(b) of Regulation S-K. The Bancorp will furnish a copy of any omitted schedule or similar attachment to the SEC upon request.

 

* - The indicated exhibit is a management contract, compensatory plan or arrangement required to be filed by Item 601 of Regulation S-K.

 

 

SIGNATURES

 

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

 

	NORTHWEST INDIANA BANCORP
	By	/s/Benjamin J. Bochnowski
	Benjamin J. Bochnowski
	President and
	Chief Executive Officer

 

Date: February 20, 2018

 

Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on February 20, 2018:

 

Signature		Title
Principal Executive Officer:
/s/Benjamin J. Bochnowski		President and
Benjamin J. Bochnowski		Chief Executive Officer
Principal Financial Officer and
Principal Accounting Officer:
/s/Robert T. Lowry		Executive Vice President,
Robert T. Lowry		Chief Financial Officer and Treasurer
The Board of Directors:
/s/David A. Bochnowski		Executive Chairman of the Board
David A. Bochnowski
/s/Edward J. Furticella		Director
Edward J. Furticella
/s/Joel Gorelick		Director
Joel Gorelick
/s/Kenneth V. Krupinski		Director
Kenneth V. Krupinski
/s/Anthony M. Puntillo		Director
Anthony M. Puntillo

/s/James L. Wieser		Director
James L. Wieser
/s/Donald P. Fesko		Director
Donald P. Fesko
/s/Amy W. Han		Director
Amy W. Han
/s/Danette Garza		Director
Danette Garza
/s/Robert E. Johnson III		Director
Robert E. Johnson III

 

 

EXHIBIT INDEX

 

Exhibit		Description
13		2017 Annual Report to Shareholders.
21		Subsidiaries of the Bancorp.
23.1		Plante & Moran, PLLC - Consent of Independent Registered Public Accounting Firm.
31.1		Rule 13a-14(a)/15d-14(a) Certification of Chief Executive Officer.
31.2		Rule 13a-14(a)/15d-14(a) Certification of Chief Financial Officer.
32		Section 1350 Certifications.
101		The following materials from the Bancorp’s Form 10-K for the fiscal year ended December 31, 2017, formatted in an XBRL Interactive Data File: (i) Consolidated Balance Sheets; (ii) Consolidated Statements of Income; (iii) Consolidated Statements of Comprehensive Income; (iv) Consolidated Statements of Changes in Stockholders’ Equity; (v) Consolidated Statements of Cash Flows; and (vi) Notes to Consolidated Financial Statements, with detailed tagging of notes and financial statement schedules.