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EX-32 - EXHIBIT 32 - MUTUALFIRST FINANCIAL INCtv484493_ex32.htm
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EX-23 - EXHIBIT 23 - MUTUALFIRST FINANCIAL INCtv484493_ex23.htm
EX-21 - EXHIBIT 21 - MUTUALFIRST FINANCIAL INCtv484493_ex21.htm
EX-14 - EXHIBIT 14 - MUTUALFIRST FINANCIAL INCtv484493_ex14.htm
EX-10.16 - EXHIBIT 10.16 - MUTUALFIRST FINANCIAL INCtv484493_ex10-16.htm

 

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-K

 

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 000-27905

 

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

  

Maryland   35-2085640
(State or other jurisdiction of incorporation or organization)   (I.R.S. Employer Identification No.)
     
110 E. Charles Street, Muncie, Indiana   47305-2400
(Address of principal executive offices)   (Zip Code)

 

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

 

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

 

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

 

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

None

 

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

 

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

 

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

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x     No ¨

 

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§ 229.405 of this chapter) 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. ¨

 

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

 

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

 

The aggregate market value of the voting and non-voting common equity held by non-affiliates, computed by reference to the last sale price of such stock on the Nasdaq Global Market as of June 30, 2017, the last business day of the registrant’s most recently completed second fiscal quarter, was approximately $189.0 million. (The exclusion from such amount of the market value of the shares owned by any person shall not be deemed an admission by the registrant that such person is an affiliate of the registrant.)

 

Indicate the number of shares outstanding of each of the registrant’s classes of common stock as of the latest practicable date. As of March 15, 2018, there were 8,574,922 shares of the registrant’s common stock outstanding.

 

DOCUMENTS INCORPORATED BY REFERENCE

 

PART III of Form 10-K-Portions of registrant’s Proxy Statement for its 2018 Annual Meeting of Stockholders.

 

 

 

   

 

 

MutualFirst Financial, Inc.

 

Form 10-K Annual Report for the Year Ended December 31, 2017 

Table of Contents

 

    Page
Number
Part I    
     
Item 1 Business 3
     
Item 1A Risk Factors 33
     
Item 1B Unresolved Staff Comments 45
     
Item 2 Properties 45
     
Item 3 Legal Proceedings 45
     
Item 4 Mine Safety Disclosure 45
     
Part II    
     
Item 5 Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities 46
     
Item 6 Selected Financial Data 48
     
Item 7 Management’s Discussion and Analysis of Financial Condition and Results of Operations 51
     
Item 7A Quantitative and Qualitative Disclosures About Market Risk 72
     
Item 8 Financial Statements and Supplementary Data 75
     
Item 9 Changes in and Disagreements with Accountants in Accounting and Financial Disclosure 127
     
Item 9A Controls and Procedures 127
     
Item 9B Other Information 131
     
Part III    
     
Item 10 Directors, Executive Officers and Corporate Governance 131
     
Item 11 Executive Compensation 132
     
Item 12 Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters 132
     
Item 13 Certain Relationships and Related Transactions, and Director Independence 133
     
Item 14 Principal Accountant Fees and Services 133
     
Part IV    
     
Item 15 Exhibits and Financial Statement Schedules 134
     
SIGNATURES   137
     
EXHIBIT INDEX   139

 

   

 

 

Item 1.Business

 

General

 

MutualFirst Financial, Inc., a Maryland corporation (“MutualFirst” or the “Company”), is the sole owner of MutualBank (“MutualBank” or the “Bank”). The Bank is an Indiana commercial bank regulated by the Indiana Department of Financial Institutions (“IDFI”) and the Federal Deposit Insurance Corporation (“FDIC”). MutualFirst is a bank holding company subject to regulation by the Board of Governors of the Federal Reserve System (“FRB”). The words “we,” “our” and “us” in this Form 10-K refer to MutualFirst and MutualBank on a consolidated basis, unless indicated otherwise herein.

 

At December 31, 2017, we had total assets of $1.6 billion, loans of $1.2 billion, deposits of $1.2 billion and stockholders’ equity of $150.3 million. Our executive offices are located at 110 E. Charles Street, Muncie, Indiana 47305-2400. Our common stock is traded on the Nasdaq Global Market under the symbol “MFSF.” For more general information about our business, and other 2017 material transactions and results, see “Item 7 - Management’s Discussion and Analysis of Financial Condition and Results of Operation - Overview and Significant Events in 2017.”

 

Forward-Looking Statements

 

This Form 10-K contains, and our future filings with the SEC, Company press releases, other public pronouncements, stockholder communications and oral statements made by or with the approval of an authorized executive officer, will contain “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995. You can identify these forward-looking statements through our use of words such as “may,” “will,” “anticipate,” “assume,” “should,” “indicate,” “would,” “believe,” “contemplate,” “expect,” “estimate,” “continue,” “plan,” “project,” “could,” “intend,” “target” and other similar words and expressions of the future. These forward-looking statements include, but are not limited to:

 

·statements of our goals, intentions and expectations;

 

·statements regarding our business plans, prospects, growth and operating strategies;

 

·statements regarding the asset quality of our loan and investment portfolios; and

 

·estimates of our risks and future costs and benefits.

 

These forward-looking statements are based on current beliefs and expectations of our management and are inherently subject to significant business, economic and competitive uncertainties and contingencies, many of which are beyond our control. In addition, these forward-looking statements are subject to assumptions with respect to future business strategies and decisions that are subject to change.

 

The following factors, among others, could cause actual results to differ materially from the anticipated results or other expectations expressed in the forward-looking statements:

 

·the credit risks of lending activities, including changes in the level and trend of loan delinquencies and write-offs and changes in our allowance for loan losses and provision for loan losses that may be impacted by deterioration in the housing and commercial real estate markets;

 

·changes in general economic conditions, either nationally or in our market areas;

 

·changes in the monetary and fiscal policies of the U.S. Government, including policies of the Treasury and the FRB;

 

·changes in the levels of general interest rates and the relative differences between short- and long-term interest rates, deposit interest rates, our net interest margin and funding sources;

 

·fluctuations in the demand for loans, the number of unsold homes, land and other properties and fluctuations in real estate values in our market areas;

 

 3 

 

 

·expected cost savings, synergies and other benefits from our merger and acquisition activities, including the merger with Universal, might not be realized within the anticipated time frames or at all, and costs or difficulties relating to integration matters, including but not limited to customer and employee retention, might be greater than expected;

 

·decreases in the secondary market for the sale of loans that we originate;

 

·results of examinations of us by the IDFI, FDIC, FRB or other regulatory authorities, including the possibility that any such regulatory authority may, among other things, require us to increase our allowance for loan losses, write-down assets, change our regulatory capital position or affect our ability to borrow funds or maintain or increase deposits, which could adversely affect our liquidity and earnings;

 

·legislative or regulatory changes that adversely affect our business, including the effect of Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”), changes in regulatory policies and principles, changes in regulatory capital requirements or the interpretation of regulatory capital or other rules;

 

·our ability to attract and retain deposits;

 

·increases in premiums for deposit insurance;

 

·management’s assumptions in determining the adequacy of the allowance for loan losses;

 

·our ability to control operating costs and expenses;

 

·the use of estimates in determining fair value of certain assets, which estimates may prove to be incorrect and result in significant losses due to declines in valuation;

 

·difficulties in reducing risks associated with the loans on our balance sheet;

 

·staffing fluctuations in response to product demand or the implementation of corporate strategies that affect our workforce and potential associated charges;

 

·a failure or security breach in the computer systems (or the third-party vendors who provide such services) on which we depend;

 

·our ability to retain members of our senior management team;

 

·costs and effects of litigation, including settlements and judgments;

 

·increased competitive pressures among financial services companies;

 

·changes in consumer spending, borrowing and savings habits;

 

·the availability of resources to address changes in laws, rules, or regulations or to respond to regulatory actions;

 

·adverse changes in the securities markets;

 

·changes in our ability and the cost to access the capital markets;

 

·inability of key third-party providers to perform their obligations to us;

 

·changes in tax legislation and accounting policies and practices, as may be adopted by the financial institution regulatory agencies, the Public Company Accounting Oversight Board or the Financial Accounting Standards Board; and

 

·other economic, competitive, governmental, regulatory, and technological factors affecting our operations, pricing, products and services and the other risks described elsewhere in this Form 10-K.

 

Some of these and other factors are discussed in “Item 1A-Risk Factors” and elsewhere in this Form 10-K. Certain of these developments could have an adverse impact on our financial position and results of operations.

 

 4 

 

 

Any of these forward-looking statements are based upon management’s beliefs and assumptions at the time they are made. We undertake no obligation to publicly update or revise any forward-looking statements included in this Form 10-K or to update the reasons why actual results could differ from those contained in such statements, whether as a result of new information, future events or otherwise. In light of these risks, uncertainties and assumptions, the forward-looking statements discussed in this Form 10-K might not occur, and you should not put undue reliance on any forward-looking statements.

 

The Company does not undertake and specifically declines any obligation to publicly release the result of any revisions that may be made to any forward-looking statements to reflect events or circumstances after the date of such statements or to reflect the occurrence of unanticipated events.

 

Market Area

 

We are a community-oriented bank offering a variety of financial services to meet the needs of the communities we serve. We are headquartered in Muncie, Indiana and offer our financial services through 27 full service retail financial center offices in Allen, Delaware, Elkhart, Grant, Kosciusko, Randolph, St. Joseph and Wabash counties in Indiana. MutualBank also has wealth management offices in Fishers and Crawfordsville, Indiana and a loan origination office in New Buffalo, Michigan. The Bank has a subsidiary, Summit Mortgage, Inc., that operates a mortgage brokerage firm in Fort Wayne, Indiana. In addition, we originate residential mortgage and commercial loans in the counties contiguous to those counties. We also originate indirect consumer loans throughout Indiana and contiguous states as described in “Lending Activities - Other Consumer Lending.”

 

The market areas where MutualBank operates in Indiana have historically experienced an unemployment rate that exceeded the federal and state unemployment rates, however in last two years the rate in our market areas was reduced to below the state and federal rates. At the end of 2017, the unemployment rate (not seasonally adjusted) was 3.9% at the federal level and 3.1% at the state level, compared to 4.5% and 4.0% at the end of 2016 at the federal and state level, respectively. Our footprint had an unemployment rate of 2.9% and 3.9% at year-end 2017 and 2016, respectively.

 

As of February 28, 2018, we will be providing services in Greene, Hamilton, Jackson, Johnson, Knox, Lawrence and Monroe counties in Indiana with the acquisition of Universal Bancorp.

 

Competition

 

We face strong competition from other banks, credit unions, mortgage bankers and finance companies in originating commercial, real estate and other loans and in attracting deposits. Our wealth management division faces strong competition from other banks, brokerage firms, financial advisers and trust companies. We attract deposits primarily through our financial center network. Competition for deposits comes principally from local banks and credit unions, but also comes from the availability of other investment opportunities, including mutual funds. We compete for deposits by offering superior service and a variety of deposit accounts at competitive rates. We also offer alternative investment products through a broker/dealer.

 

Internet Website and Information

 

The Company maintains a website at www.bankwithmutual.com - “About Us – Investor Relations.” The information contained on that website is not included as part of or incorporated by reference into this Form 10-K. The Company’s filings with the SEC are available on that website and also are available on the SEC website at sec.gov - “Search for Company Filings.”

 

 5 

 

 

Lending Activities

 

General. Our loans carry either a fixed- or an adjustable-rate of interest. At December 31, 2017, our net loan portfolio totaled $1.2 billion, which constituted 73.5% of our total assets. Our net loan portfolio, excluding loans held for sale, increased by 1.0% in 2017, primarily due to increased commercial and non- real estate consumer loans; however, that increase was partially reduced by a decrease in consumer mortgage loans aided by the selling of $18.5 million of consumer residential mortgage loans in the fourth quarter of 2017.

 

Aggregate credit exposures to borrowers of up to $1.0 million may be approved by certain individual commercial loan officers. Aggregate exposures in excess of $1.0 million, but not in excess of $2.0 million, may be approved by the combined authority of two officers that have loan authority up to $1.0 million individually. Aggregate exposures between $2.0 million, but no more than $5.0 million, may be approved by a majority vote of the Loan Committee. All aggregate exposures in excess of $5.0 million must be approved by the Board of Directors. Commercial Banking Officers may advance additional credit exposure for a commercial loan relationship requiring Board approval up to the lesser of: 10% of the existing previously approved credit exposure to the client, or $100,000. Any additional exposure approved under the 10% Rule must be approved by the Senior Vice President of Commercial Banking, or his designee, and reported to the appropriate Loan Committee during the next meeting.

 

Major Loan Customers. At December 31, 2017, the maximum amount that we could lend to any one borrower and the borrower’s related entities was approximately $21.9 million. At December 31, 2017, our five largest lending relationships were with commercial borrowers and constituted an aggregate of $73.4 million in loans and commitments issued, or 6.3% of our $1.2 billion gross loan portfolio, with $67.4 million in loans outstanding. As of December 31, 2017, our largest lending relationship to a single borrower or group of related borrowers consisted of five loans with a total commitment of $18.9 million, with a $16.0 million outstanding balance at year-end. These loans are secured primarily by commercial real estate and were in compliance with loan terms as of December 31, 2017.

 

Our next four largest relationships consist of $15.6 million in loans and commitments secured primarily by commercial real estate with $13.3 million outstanding; $13.2 million in loans and commitments issued and outstanding which is secured by commercial real estate; $13.1 million in loans and commitments issued secured by commercial real estate with $12.3 million outstanding; and $12.6 million in loans and commitments issued and outstanding which is secured primarily by commercial real estate. As of December 31, 2017, all loans within these relationships were performing as agreed.

 

 6 

 

 

The following table presents information concerning the composition of our loan portfolio in dollar amounts and in percentages as of the dates indicated.

 

   December 31, 
   2017   2016   2015   2014   2013 
   Amount   Percent   Amount   Percent   Amount   Percent   Amount   Percent   Amount   Percent 
   (Dollars in thousands) 
Real estate                                                  
Commercial  $318,684    26.75%  $302,577    25.71%  $236,895    21.75%  $198,019    19.25%  $200,817    20.24%
Commercial construction and development   28,164    2.36    22,453    1.91    15,744    1.45    33,102    3.22    13,321    1.34 
Consumer closed end first mortgage   448,820(1)   37.68    482,911(2)   41.04    497,442(3)   45.66    523,203(4)   50.87    533,160(5)   53.74 
Consumer open end and junior liens   69,477    5.83    71,222    6.05    70,990    6.52    71,073    6.91    69,354    6.99 
Total real estate loans   865,145    72.62    879,163    74.71    821,071    75.38    825,397    80.25    816,652    82.31 
                                                   
Other loans                                                  
Consumer loans                                                  
Auto   19,640    1.65    18,939    1.61    15,480    1.42    14,712    1.43    14,856    1.50 
Boat/RV   169,238    14.21    141,602    12.03    123,621    11.35    94,761    9.21    79,419    8.01 
Other   6,188    0.52    5,892    0.51    6,171    0.56    5,184    0.51    5,766    0.58 
Total consumer other   195,066    16.38    166,433    14.15    145,272    13.33    114,657    11.15    100,041    10.09 
Commercial and industrial   131,079    11.00    131,103    11.14    123,043    11.29    88,474    8.60    75,402    7.60 
Total other loans   326,145    27.38    297,536    25.29    268,315    24.62    203,131    19.75    175,443    17.69 
                                                   
Total loans receivable, gross   1,191,290    100.00%   1,176,699    100.00%   1,089,386    100.00%   1,028,528    100.00%   992,095    100.00%
                                                   
Undisbursed loans in process   (13,071)        (8,691)        (7,432)        (9,285)        (13,346)     
Unamortized deferred loan costs, net   6,503         5,557         4,882         3,583         2,517      
Allowance for loan losses   (12,387)        (12,382)        (12,641)        (13,168)        (13,412)     
Total loans receivable, net  $1,172,335        $1,161,183        $1,074,195        $1,009,658        $967,854      

 

 

(1) Includes loans held for sale of $4.6 million.

(2) Includes loans held for sale of $4.1 million.

(3) Includes loans held for sale of $6.0 million.

(4) Includes loans held for sale of $6.1 million.

(5) Includes loans held for sale of $1.9 million.

 

 7 

 

The following table shows the composition of our loan portfolio by fixed- and adjustable-rate at the dates indicated.

 

   December 31, 
   2017   2016   2015   2014   2013 
   Amount   Percent   Amount   Percent   Amount   Percent   Amount   Percent   Amount   Percent 
   (Dollars in thousands) 
Fixed-Rate Loans                                                  
Real estate                                                  
Commercial  $44,896    3.77%  $66,898    5.69%  $72,263    6.63%  $85,230    8.29%  $88,031    8.87%
Commercial construction and development   1,709    0.14    1,962    0.17    4,732    0.43    3,941    0.38    2,833    0.29 
Consumer closed end first mortgage   347,514(1)   29.17    371,111(2)   31.54    381,372(3)   35.01    392,441(4)   38.16    398,541(5)   40.17 
Consumer open end and junior liens   19,939    1.67    22,116    1.88    17,106    1.57    19,479    1.89    22,990    2.32 
Total real estate loans   414,058    34.75    462,087    39.28    475,473    43.64    501,091    48.72    512,395    51.65 
                                                   
Consumer   193,281    16.23    164,483    13.98    143,171    13.14    112,295    10.92    97,422    9.82 
Commercial and industrial   48,253    4.05    52,932    4.50    61,702    5.66    43,378    4.22    32,369    3.26 
Total fixed-rate loans   655,592    55.03    679,502    57.76    680,346    62.44    656,764    63.86    642,186    64.73 
                                                   
Adjustable-Rate Loans                                                  
Real estate                                                  
Commercial   273,788    22.98    235,679    20.03    164,632    15.12    112,789    10.97    112,786    11.37 
Commercial construction and development   26,455    2.22    20,491    1.73    11,012    1.02    29,161    2.83    10,488    1.06 
Consumer closed end first mortgage   101,306    8.51    111,800    9.50    116,070    10.65    130,762    12.71    134,619    13.57 
Consumer open end and junior liens   49,538    4.16    49,106    4.17    53,884    4.95    51,594    5.02    46,364    4.67 
Total real estate loans   451,087    37.87    417,076    35.43    345,598    31.74    324,306    31.53    304,257    30.67 
                                                   
Consumer   1,785    0.15    1,950    0.17    2,101    0.19    2,362    0.23    2,619    0.26 
Commercial and industrial   82,826    6.95    78,171    6.64    61,341    5.63    45,096    4.38    43,033    4.34 
Total adjustable-rate loans   535,698    44.97    497,197    42.24    409,040    37.56    371,764    36.14    349,909    35.27 
                                                   
Total loans receivable, gross   1,191,290    100.00%   1,176,699    100.00%   1,089,386    100.00%   1,028,528    100.00%   992,095    100.00%
                                                   
Undisbursed loans in process   (13,071)        (8,691)        (7,432)        (9,285)        (13,346)     
Unamortized deferred loan costs, net   6,503         5,557         4,882         3,583         2,517      
Allowance for loan losses   (12,387)        (12,382)        (12,641)        (13,168)        (13,412)     
Total loans receivable, net  $1,172,335        $1,161,183        $1,074,195        $1,009,658        $967,854      

 

 

(1) Includes loans held for sale of $4.6 million.

(2) Includes loans held for sale of $4.1 million.

(3) Includes loans held for sale of $6.0 million.

(4) Includes loans held for sale of $6.1 million.

(5) Includes loans held for sale of $1.9 million.

 

 8 

 

 

The following schedule illustrates the contractual maturity of our loan portfolio at December 31, 2017. Mortgages that have adjustable or renegotiable interest rates are shown as maturing in the period during which the contract is due. The total amount of loans due after December 31, 2018 that have predetermined interest rates is $621.2 million, and the total amount of loans due after such date which have floating or adjustable interest rates is $439.6 million. The schedule does not reflect the effects of possible prepayments or enforcement of due-on-sale clauses.

 

   Real Estate                         
   Consumer Closed
End First
Mortgage(1)
   Consumer Open
End
and Junior Liens
   Commercial   Construction
and
Development
   Consumer   Commercial
Business
   Total 
   Amount   WAR(3)   Amount   WAR(3)   Amount   WAR(3)   Amount   WAR(3)   Amount   WAR(3)   Amount   WAR(3)   Amount   WAR(3) 
   (Dollars in thousands) 
Due During Years Ending December 31,                                                                      
2018(2)  $4,848    4.13%  $232    6.45%  $39,127    5.09%  $12,039    5.06%  $2,457    7.03%  $67,170    4.88%  $125,873    4.98%
2019   1,091    4.59    408    6.61    11,050    4.58    989    4.50    2,509    6.31    14,873    4.45    30,920    4.68 
2020   3,311    3.87    298    7.23    3,964    4.85    12,700    4.31    5,387    5.47    8,628    4.14    34,288    4.49 
2021 & 2022   11,698    3.54    2,857    6.02    17,519    4.53    417    4.45    21,609    5.29    20,140    4.90    74,240    4.75 
2023 & 2024   11,541    3.47    3,246    5.49    11,674    4.76    -    -    12,204    6.20    5,567    4.72    44,232    4.87 
2025 to 2039   261,381    3.74    62,436    4.80    205,349    4.48    2,019    5.24    150,900    5.72    14,201    4.86    696,286    4.51 
2040 & after   150,373    3.98    -    -    30,001    4.31    -    -    -    -    500    5.90    180,874    4.04 
Total  $444,243    3.82%  $69,477    4.91%  $318,684    4.56%  $28,164    4.71%  $195,066    5.72%  $131,079    4.78%  $1,186,713    4.52%

 

 

(1) Does not include mortgage loans held for sale.

(2) Includes demand loans, loans having no stated maturity and overdraft loans.

(3) Weighted Average Rate

 

 9 

 

  

 

Consumer Closed End First Mortgages. We originate loans secured by first mortgages on owner-occupied, one- to four-family residences in our market areas for purchase, refinance, home equity and construction purposes. At December 31, 2017, these loans totaled $448.8 million, or 37.7% of our gross loan portfolio.

 

We generally underwrite and document our one- to four-family loans based on the loan applicant’s employment and credit history and the appraised value of the subject property, consistent with secondary market standards or other prudent underwriting guidelines. For loans with a loan-to-value ratio in excess of 80%, we generally require private mortgage insurance to reduce our exposure to 80%. Properties securing our one- to four-family loans are appraised or evaluated consistent with regulatory requirements and prudent lending principles. Origination and servicing practices include perfection of our lien position and appropriate monitoring of insurance and tax payments.

 

We generally underwrite and document our one- to four-family first lien position home equity loans based on the loan applicant's employment, credit history and the appraised value of the subject property, consistent with prudent underwriting guidelines.  Nearly all first lien home equity loans have a maximum loan-to-value of 80% at origination.  Exceptions would be limited to work-out loan circumstances. Properties securing our one- to four-family loans are appraised or evaluated consistent with regulatory requirements and prudent lending principles.

 

We originate consumer first mortgage one- to four-family loans on either a fixed- or adjustable-rate basis, and generally maintain a tax or insurance escrow account for these loans. Our pricing strategy for mortgage loans includes setting interest rates that are competitive with the secondary market and other local financial institutions and are consistent with our internal needs. Adjustable-rate mortgage or ARM loans are offered with initial fixed rate terms between one and 10 years. After the initial period, the interest rate for each ARM loan adjusts annually for the remainder of the term of the loan using a margin over the standard one-year treasury index. During fiscal 2017, we originated $10.8 million of one- to four-family ARM loans and $176.4 million of one- to four-family fixed-rate mortgage loans. By way of comparison, during fiscal 2016, we originated $14.8 million of one- to four-family ARM loans and $219.7 million of one- to four-family fixed-rate mortgage loans.

 

Fixed-rate loans secured by one- to four-family residences have contractual maturities of up to 30 years and are generally fully amortizing, with payments due monthly. A majority of loans with fixed-rate maturities in excess of 15 years are sold on the secondary market. Some loans are retained if their terms meet current portfolio needs consistent with balance sheet objectives. These retained loans normally remain outstanding, however, for a substantially shorter period of time because of home sales, refinancing and other prepayments. A significant change in interest rates could alter considerably the average life of a residential loan in our portfolio. Our one- to four-family loans are generally not assumable, do not contain prepayment penalties and do not permit negative amortization of principal. Most are written using underwriting guidelines that make them readily saleable in the secondary market. At December 31, 2017, our fixed-rate one- to four-family mortgage loan portfolio totaled $347.5 million, or 29.2% of our gross loan portfolio.

 

Our one- to four-family residential ARM loans are fully amortizing loans with contractual maturities of up to 30 years, with payments due monthly. Our ARM loans generally provide for specific minimum and maximum interest rates, with a lifetime cap and floor, and a periodic adjustment on the interest rate over the rate in effect on the date of origination. As a consequence of using caps, the interest rates on these loans may not be as rate sensitive as our cost of funds. In order to remain competitive in our market areas, we sometimes originate ARM loans at initial rates below the fully indexed rate. ARM loans generally pose different credit risks than fixed-rate loans, primarily because as interest rates rise, the borrower’s required payments increase, which may increase the potential for default. Our payment history for ARM loans has not been substantially different from fixed rate loans. See “Asset Quality - Non-performing Assets” and “Classified Assets.” At December 31, 2017, our one- to four-family ARM loan portfolio totaled $101.3 million, or 8.5% of our gross loan portfolio.

 

 10 

 

 

Construction-permanent loans on one- to four-family residential properties are obtained through referral business with builders, from walk-in customers and through referrals from realtors and architects. The applicant must submit complete plans, specifications and costs of the project to be constructed, which, along with an independent appraisal, are used to determine the value of the subject property. Loans are based on the lesser of the current appraised value and/or the cost of construction, including the land and the building. We generally conduct regular inspections of the construction project being financed. Residential construction loans are done with one closing for both the construction period and the long-term financing. Loans are generally granted with a construction period between six and 12 months. During the construction phase, the borrower generally pays interest only on a monthly basis, and the loan is automatically converted to amortizing payments upon completion of the construction. Single family construction loans with loan-to-value ratios over 80% usually require private mortgage insurance.

 

Consumer Open End and Junior Liens. At December 31, 2017, our consumer loans on residential properties, including home equity lines of credit and subordinate home improvement loans, totaled $69.5 million, or 5.8% of our gross loan portfolio. Unused home equity lines of credit totaled $87.1 million at December 31, 2017. These loans may be originated in amounts, together with the amount of the existing first mortgage, of up to 100% of the value of the property securing the loan. The term to maturity on our home equity and home improvement loans may be up to 15 years. Most home equity lines of credit have a maximum term to maturity of 20 years and require a minimum monthly payment based on the outstanding loan balance per month, which amount may be re-borrowed at any time. A limited number of home equity lines of credit are approved with monthly payments of accrued interest only. Other consumer loan terms vary according to the type of collateral, length of contract and creditworthiness of the borrower.

 

Commercial Real Estate Lending. We offer a variety of commercial real estate (CRE) loans for acquisition and renovation. These loans are secured by the real estate and improvements financed, and the collateral ranges from industrial and commercial buildings to churches, office buildings and multi-family housing complexes. We also have a limited amount of farm loans. At December 31, 2017, commercial real estate loans, including multi-family, totaled $318.7 million, or 26.8% of our gross loan portfolio.

 

Our loans secured by commercial real estate are originated with either a fixed or adjustable interest rate. The interest rate on adjustable-rate loans is based on a variety of indices, generally determined through negotiation with the borrower. Loan-to-value ratios on our commercial real estate loans typically do not exceed 80% of the appraised value, as of origination, of the property securing the loan. These loans typically require monthly payments, may not be fully amortizing and generally have maximum amortizations of 20 years. Loans with amortizations over 20 years require a loan-to-value ratio of 75% or less.

 

Loans secured by commercial real estate are underwritten based on the income-producing potential of the property and the financial strength of the borrower. For income-producing properties, net operating income must be sufficient to cover the payments related to the outstanding debt. Owner-occupied CRE loans are underwritten based on the borrower’s ability to generate cash flow sufficient to repay the loan. We may require personal guarantees of the borrowers in addition to the real estate as collateral for such loans. We also generally require an assignment of rents or leases in order to be assured that the cash flow from the real estate can be used to repay the debt. Appraisals on properties securing commercial real estate loans are performed by qualified independent appraisers approved by MutualBank’s Board of Directors, consistent with regulatory requirements. See “Loan Originations, Purchases, Sales and Repayments” in this Item 1. In order to monitor the adequacy of cash flows on CRE loans, the borrower is required to provide periodic financial information for loans in excess of $250,000.

 

Loans secured by commercial real estate are generally larger and involve a greater degree of credit risk than one- to four-family residential mortgage loans. Commercial real estate loans typically involve large balances to single borrowers or groups of related borrowers. Because payments on loans secured by commercial real estate are often dependent on the successful operation or management of the properties, repayment of such loans may be subject to adverse conditions in the real estate market or the economy. If the cash flow from the project is reduced, or if leases are not obtained or renewed, the borrower’s ability to repay the loan may be impaired. See “Asset Quality - Non-performing Assets” in this Item 1.

 

 11 

 

 

Construction and Development Lending. MutualBank makes a variety of commercial loans for the purpose of construction or development of commercial real estate.

 

Existing residential development loans are typically provided on property located within our market areas and are granted to developers and builders with previous borrowing experience with MutualBank. Financing of a development may include funding of land acquisition and development costs for lots as well as individual construction loans for speculative or pre-sold homes. New activity in residential development and construction lending has been limited by economic conditions for the past several years. We also provide construction-permanent financing for owner-occupied commercial properties for our business customers in our market areas as well as some income-producing property to established borrowers. We have a limited number of commercial real estate development loans. At December 31, 2017, we had $28.2 million in construction and development loans outstanding, representing 2.4% of our gross loan portfolio.

 

Loans financing land development may include funding the acquisition of the land, the infrastructure and lot sales. Development loans are secured by real estate and repaid through proceeds from the sale of lots. The maximum loan amount should not exceed 75% of the appraised value and projected lot sales should show full payout within 24-36 months of each phase being financed. Where the development loan is to be repaid through lot sales to third parties, the loan should be paid in full when no more than 80% of the lots in the phase or development are sold. Release payments should not be less than 85% of the net sales proceeds, or 125% of the original committed amount per lot, whichever is greater.

 

Construction financing must be supported by prints and specs, and an appraisal by an approved appraiser. Construction draws must be supported by a detailed list of work completed, and where appropriate, lien waivers from all contractors. All construction loans should have a maturity date with a written end financing commitment. We also provide end financing to qualified borrowers. Our maximum advance on residential pre-sold and owner occupied commercial loans is 80% of appraised value.

 

Because of the uncertainties inherent in estimating construction and development costs and the market for the project upon completion, there is risk inherent in the accuracy of estimated total loan funds required to complete a project, the related loan-to-value ratios and the likelihood of ultimate success of the project. These loans also involve many of the same risks discussed above regarding commercial real estate loans and tend to be more sensitive to general economic conditions than many other types of loans. Economic conditions in our market could cause borrowers to be unable to repay development loans due to reduced ability to market the properties consistent with original pro-forma estimates. However, we have seen stabilization in our markets which is reflected in the continued decrease in non-performing assets.

 

Other Consumer Lending. Consumer loans, other than those secured by real estate, generally have shorter terms to maturity and carry higher rates of interest than residential mortgage loans. This reduces our exposure to interest rate risk on these loans. In addition, consumer loan products help to expand and create stronger ties to our customer base by increasing the number of customer relationships and providing cross-marketing opportunities. We offer a variety of secured consumer loans, including auto, boat and recreational vehicle loans, and loans secured by savings deposits. We also offer credit cards and unsecured consumer loans. We originate consumer loans both in our market area through our financial centers and throughout Indiana as well as making consumer loans to customers residing in contiguous states through our indirect lending program. We employ credit scoring models for these types of consumer loan applications. These models evaluate credit and application attributes, with a review of the borrower’s employment and credit history and an assessment of the borrower’s ability to repay the loan. Consumer loans may entail greater risk than one- to four-family residential mortgage loans, especially consumer loans secured by rapidly depreciable assets, such as automobiles, boats and recreational vehicles. In these cases, any repossessed collateral for a defaulted loan may not provide an adequate source of repayment of the outstanding loan balance. As a result, consumer loan collections are dependent on the borrower’s continuing financial stability and, thus, are more likely to be adversely affected by economic downturn, job loss, divorce, illness or personal bankruptcy. At December 31, 2017, our consumer loan portfolio, excluding real estate secured loans, totaled $195.1 million, or 16.4% of our gross loan portfolio.

 

 12 

 

 

At December 31, 2017, auto loans totaled $19.6 million, or 1.7% of our gross loan portfolio. Auto loans may be written for up to six years and usually have a fixed rate of interest. Loan-to-value ratios are up to 100% of the MSRP or 120% of invoice for new autos and 110% of value on used cars, based on valuation from official used car guides. Loans for boats and recreational vehicles totaled $169.2 million at December 31, 2017, or 14.2% of our gross loan portfolio. Approximately $162.4 million of other consumer loans at December 31, 2017 had been originated indirectly through dealers and retailers. We generally buy indirect auto, boat and recreational vehicle loans on a rate basis, paying the dealer a cash payment for loans with an interest rate in excess of the rate we require. This premium is amortized over the remaining life of the loan. As specified in written agreements with these dealers, prepayments or delinquencies are charged to future amounts owed to that dealer, with no dealer reserve or other guarantee of payment if the dealer stops doing business with us.

 

Commercial Business Lending. At December 31, 2017, commercial business loans totaled $131.1 million, or 11.0% of our gross loan portfolio. Most of our commercial business loans have been extended to finance businesses in our market area. Credit accommodations extended include lines of credit for working capital needs, term loans to purchase capital goods and real estate, development lending to foster residential, business and community growth and agricultural lending for inventory and equipment financing.

 

Our commercial business lending policy includes credit file documentation and analysis of the borrower’s background, capacity to repay the loan, the adequacy of the borrower’s capital and collateral as well as an evaluation of other conditions affecting the borrower. Analysis of the borrower’s past, present and future cash flows also is an important aspect of our credit analysis. We may obtain personal guarantees on our commercial business loans. Nonetheless, these loans are believed to carry higher credit risk than residential loans. Unlike residential mortgage loans, commercial business loans are typically made on the basis of the borrower’s ability to make repayment from the cash flow of the borrower’s business. As a result, the availability of funds for the repayment of commercial business loans may substantially depend on the success of the business itself (which, in turn, often depends in part upon general economic conditions). Our commercial business loans are usually secured by business assets. However, the collateral securing the loans may depreciate over time, may be difficult to appraise and may fluctuate in value based on the success of the business.

 

The terms of loans extended on the security of machinery and equipment are based on the projected useful life of the machinery and equipment, generally not to exceed seven years. Lines of credit generally are available to borrowers for up to 12 months and may be renewed by us after an annual review of current financial information.

 

We issue a few financial-based standby letters of credit which are offered at competitive rates and terms and are generally on a secured basis. We continue to expand our volume of commercial business loans.

 

Loan Originations, Purchases, Sales and Repayments. We originate loans through referrals from real estate brokers and builders, our marketing efforts, our existing and walk-in customers, and through our subsidiary, Summit Mortgage, Inc. Historically, we have originated many of our non-real estate consumer loans through relationships with dealerships in Indiana. While we originate adjustable-rate and fixed-rate loans, our ability to originate loans depends upon customer demand for loans in our market areas. Demand is affected by local competition, interest rate environment and general market conditions. During the last several years, due to low market rates of interest, our dollar volume of fixed-rate, one- to four-family loans has exceeded the dollar volume of the same type of adjustable-rate loans. As part of our interest rate risk management efforts, we typically sell our fixed rate, one- to four-family residential loans, with terms equal to or greater than 15 years, on the secondary market. We have occasionally purchased adjustable rate one- to four-family residential and commercial real estate loans. In periods of economic uncertainty, the ability of financial institutions, including us, to originate or purchase large dollar volumes of loans may be substantially reduced or restricted, with a resultant decrease in interest income.

 

 13 

 

 

The Company originates consumer loans, other than loans secured by real estate, in Indiana and contiguous states through our indirect lending program. The indirect lending consumer portfolio consists of loans for autos, boats and recreational vehicles.

 

During the year ended December 31, 2017, we sold $134.4 million of one- to four-family mortgage loans on the secondary market to Freddie Mac (“FHLMC”), Federal Home Loan Bank of Indianapolis (“FHLBI”) and other investors. As part of our interest rate risk management, the Company chose to sell these loans and recognized a gain on sale of $3.9 million. Servicing was retained on all loans originated through MutualBank but not through our subsidiary, Summit Mortgage.

 

The following table shows our loan origination, purchase, sale and repayment activities for the years indicated.

 

 14 

 

 

   Year Ended December 31, 
   2017   2016   2015 
   (Dollars in thousands) 
Originations by type               
Adjustable rate               
Real estate               
Commercial  $43,783   $57,026   $28,565 
Commercial construction and development   1,827    190    1,505 
Consumer closed end first mortgage   10,833    14,790    11,372 
Consumer open end and junior liens   15,002    16,732    15,512 
Non-real-estate               
Consumer   143    266    1,047 
Commercial and industrial   3,629    6,609    5,767 
Total adjustable-rate   75,217    95,613    63,768 
Fixed Rate               
Real estate               
Commercial   3,488    13,412    3,201 
Commercial construction and development   171    10    1,000 
Consumer closed end first mortgage   176,414    219,714    204,393 
Consumer open end and junior liens   3,536    3,263    3,891 
Non-real-estate               
Consumer   75,750    64,446    67,117 
Commercial and industrial   11,413    11,163    26,870 
Total fixed-rate   270,772    312,008    306,472 
Total loans originated   345,989    407,621    370,240 
                
Purchases               
Real estate               
Consumer closed end first mortgage   225    183    144 
Total loans purchased   225    183    144 
                
Total additions   346,214    407,804    370,384 
                
Sales and Repayments               
Sales               
Real estate               
Consumer closed end first mortgage   134,367    152,067    145,437 
Total loans sold   134,367    152,067    145,437 
                
Principal repayments   195,457    168,956    162,342 
                
Total reductions   329,824    321,023    307,779 
                
Increase (decrease) in other items, net   (5,752)   2,135    2,081 
                
Net increase  $10,638   $88,916   $64,686 

 

 15 

 

 

Asset Quality

 

Collection Procedures. When a borrower fails to make a payment on a mortgage loan on or before the default date, a late charge and delinquency notice is mailed. All delinquent accounts are reviewed by a loss mitigation counselor, who attempts to cure the delinquency by contacting the borrower once the loan is 30 days past due. If the loan becomes 30 days delinquent, the loss mitigation counselor will generally contact the borrower by phone or send a letter to the borrower in order to identify the reason for the delinquency. Once the loan becomes 60 days delinquent, the borrower is asked to pay the delinquent amount in full or establish an acceptable repayment plan to bring the loan current. Prior to foreclosure, a drive-by inspection is made to determine the condition of the property. If the account becomes 120 days delinquent, and an acceptable repayment plan has not been agreed upon, a collection officer will generally refer the account to legal counsel, with instructions to prepare a notice of intent to foreclose. The notice of intent to foreclose allows the borrower up to 30 days to bring the account current. During this 30-day period, the loss mitigation counselor may accept a repayment plan from the borrower that would bring the account current prior to foreclosure.

 

For consumer loans, a similar collection process is followed, with the initial written contact being made once the loan is 20 days past due.

 

Commercial loan relationships exceeding $250,000 are reviewed on a regular basis by the commercial credit department.  Larger relationships are monitored through a system of internal and external loan review.  All relationships that are deemed to warrant special attention are monitored at least quarterly.  Individual commercial officers maintain communication with borrowers and recommend action plans to a Loan Quality Review committee which meets monthly to discuss credits graded Special Mention or worse.  The Asset Classification committee meets quarterly and establishes specific allocations, based on appraisals or discounted cash flow analysis, for relationships that are deemed to be under-collateralized and at risk of non-payment.  Collection and loss mitigation efforts are a cooperative effort between the Commercial Loan Department and the Risk Management Division.

 

Delinquent Loans. The following table sets forth, as of December 31, 2017, the amounts and categories of delinquent loans that were still accruing interest.

 

   Accruing Loans Delinquent For 
   30 to 59 Days   60 to 89 Days 
   (Dollars in thousands) 
Real estate          
Commercial  $2,171   $3,311 
Commercial construction and development   -    - 
Consumer closed end first mortgage   5,914    1,198 
Consumer open end and junior liens   517    119 
Consumer loans   1,695    356 
Commercial and industrial   276    10 
Total  $10,573   $4,994 
Total as a percent of total loans   0.9%   0.4%

 

As of December 31, 2016, total delinquent loans that were still accruing interest 30 to 59 days and 60 to 89 days were $10.1 million, or 0.9% of our gross loan portfolio, and $2.2 million, or 0.2% of our gross loan portfolio, respectively. See Note 5 of the Notes to Consolidated Financial Statements in Item 8 of this Form 10-K for additional information about our past due loans.

 

 16 

 

 

Non-performing Assets. The table below sets forth the amounts and categories of non-performing assets at the dates indicated. Generally, loans are placed on non-accrual status when the loan becomes more than 90 days delinquent or sooner when collection of interest becomes doubtful. At December 31, 2017, we had troubled debt restructurings totaling $2.4 million, $1.0 million of which were included in non-accruing loans. Troubled debt restructurings involve forgiving a portion of interest or principal or making other adjustments to assist a borrower who is unable to meet the original terms of the loan. These restructurings are included in non-accruing loans until they perform according to the modified terms for six months. Then, if continued payments under the modified terms are deemed probable, and it is anticipated all principal will be recovered, they are removed from non-accrual status. Foreclosed assets include assets acquired in settlement of loans.

 

   December 31, 
   2017   2016   2015   2014   2013 
   (Dollars in thousands) 
Non-accruing loans(1):                         
Real estate:                         
Commercial real estate  $1,107   $912   $2,356   $2,023   $1,349 
Commercial construction and development   -    -    -    209    1,103 
Consumer closed end first mortgage   3,409    3,626    3,592    3,499    4,057 
Consumer open end and junior liens   309    335    783    658    421 
Total real estate loans   4,825    4,873    6,731    6,389    6,930 
                          
Other loans:                         
Consumer   236    253    148    218    361 
Commercial and industrial   159    18    25    605    1,109 
Total other loans   395    271    173    823    1,470 
Total non-accruing loans   5,220    5,144    6,904    7,212    8,400 
                          
Accruing loans delinquent 90 days or more:                         
Real estate:                         
Consumer closed end first mortgage   31    237    267    226    175 
Consumer open end and junior liens   -    -    -    -    13 
Total   31    237    267    226    188 
                          
Total nonperforming loans   5,251    5,381    7,171    7,438    8,588 
                          
Other real estate owned and repossessed assets:                         
Real estate:                         
Commercial real estate   -    215    62    1,366    2,477 
Construction and development        -    974    34    1,699 
Consumer closed end first mortgage   251    502    906    1,429    3,974 
Other loans:                         
Consumer   331    481    513    476    283 
Commercial business   151    -    -    -    - 
Total   733    1,198    2,455    3,305    8,433 
                          
Total non-performing assets  $5,984   $6,579   $9,626   $10,743   $17,021 
Total as a percentage of total assets   0.38%   0.42%   0.65%   0.75%   1.22%

 

 

(1) Includes non-performing troubled debt restructurings.

 

For the year ended December 31, 2017, gross interest income that would have been recorded had these non-accruing loans been current in accordance with their original terms amounted to $242,000. The amount included in interest income on these loans for the year ended December 31, 2017, was $148,000.

 

 17 

 

 

See Item 7 –“ Management’s Discussion and Analysis of Financial Condition and Results of Operation - Financial Condition at December 31, 2017 Compared to December 31, 2016 - Delinquencies and Non-performing Assets” for more information on our nonperforming assets.

 

Classified Assets. Our regulators require that we classify loans and other assets, such as debt and equity securities considered to be of lesser quality, as “substandard,” “doubtful” or “loss.” An asset is considered “substandard” if it is inadequately protected by the current net worth and paying capacity of the obligor or of the collateral pledged, if any. “Substandard” assets include those characterized by the “distinct possibility” that the insured institution will sustain “some loss” if the deficiencies are not corrected. Assets classified as “doubtful” have all of the weaknesses inherent in those classified “substandard,” with the added characteristic that the weaknesses present make “collection or liquidation in full,” on the basis of currently existing facts, conditions, and values, “highly questionable and improbable.” Assets classified as “loss” are those considered “uncollectible” and of such little value that their continuance as assets without the establishment of a specific loss reserve is not warranted.

 

When an insured institution classifies problem assets as either substandard or doubtful, it may establish general allowances for loan losses in an amount deemed prudent by management and approved by the board of directors. General allowances represent loss allowances that have been established to recognize the inherent risk associated with lending activities, but which, unlike specific allowances, have not been allocated to particular problem assets. When an insured institution classifies problem assets as “loss,” it is required either to establish a specific allowance for losses equal to 100% of that portion of the asset so classified or to charge off such amount. Our determination as to the classification of our assets and the amount of our valuation allowances is subject to review by our regulators, which may order the establishment of additional general or specific loss allowances.

 

In connection with the filing of the Bank’s periodic reports in accordance with our classification of assets policy, we regularly review the problem assets in our portfolio to determine whether any assets require classification in accordance with applicable regulations. On the basis of management’s review, at December 31, 2017, we had classified $17.3 million of the Bank’s assets as substandard or doubtful; $733,000 in other real estate owned and repossessed assets and $16.6 million in substandard loans. The total amount classified represented 11.5% of our stockholders’ equity and 1.1% of our assets at December 31, 2017, compared to 8.1% and 0.7%, respectively, at December 31, 2016. See Note 5 of the Notes to Consolidated Financial Statements in Item 8 of this Form 10-K for additional information about our classified assets and credit risk profile of our loan portfolio.

 

Provision for Loan Losses. We recorded a provision for loan losses during the year ended December 31, 2017 of $1.2 million, compared to $850,000 for the year ended December 31, 2016 and $125,000 for the year ended December 31, 2015. The provision for loan losses increased in 2017 primarily due to an increase in the loan portfolio, excluding loans held for sale, of $10.6 million, or 0.9% over the last year, in combination with an increase in net charge-offs. The loan mix has contributed to the increase in provision with commercial and non-real estate consumer loans making up 57.0% of the loan portfolio at the end of 2017 compared to 53.2% as of the end of 2016. Net charge-offs for 2017 equaled $1.2 million, or 0.10% of total average loans compared to $1.1 million, or 0.10% of total average loans in 2016. The provision for loan losses is charged to income to bring our allowance for loan losses to a level deemed appropriate by management based on the factors discussed below under “Allowance for Loan Losses.”

 

Allowance for Loan Losses. We maintain an allowance for loan losses to absorb losses inherent in the loan portfolio. The allowance is based on ongoing, quarterly assessments of the estimated losses inherent in the loan portfolio. Our methodology for assessing the appropriateness of the allowance consists of several key elements, including the general allowance and specific allowances for identified problem loans and portfolio segments. In addition, the allowance incorporates the results of measuring impaired loans as provided in FASB ASC 310, Receivables. These accounting standards prescribe the measurement methods, income recognition and disclosures related to impaired loans. See Note 5 of the Notes to Consolidated Financial Statements contained in Item 8 of this Form 10-K.

 

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The general allowance is calculated by applying loss factors to outstanding loans based on the internal risk evaluation of such loans or pools of loans. Changes in risk evaluations of both performing and nonperforming loans affect the amount of the general allowance. Loss factors are based on our historical loss experience as well as on significant factors that, in management’s judgment, affect the collectability of the portfolio as of the evaluation date.

 

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

 

The allowance for loan losses is based on estimates of losses inherent in the loan portfolio. Actual losses can vary significantly from the estimated amounts. Our methodology, as described, permits adjustments to any loss factor used in the computation of the general allowance in the event that, in management’s judgment, significant factors which affect the collectability of the portfolio as of the evaluation date are not reflected in the loss factors. By assessing the probable incurred losses inherent in the loan portfolio on a quarterly basis, we are able to adjust specific and inherent loss estimates based upon any more recent information that has become available. Although the economy is stabilizing in the communities we serve and unemployment rates have improved compared to recent years, management has concluded that our allowance for loan losses should be greater than historical loss experience and specifically identified losses might otherwise indicate. This is while we continue to wait for the market to fully recover and partially due to the increase in higher risk loans like consumer and commercial, as a percentage of total loans.

 

At December 31, 2017, our allowance for loan losses was $12.4 million, or 1.05% of the total loan portfolio, and approximately 235.9% of total non-performing loans. Our allowance for loan losses balance increased 0.04% from December 31, 2016. Assessing the adequacy of the allowance for loan losses is inherently subjective as it requires making material estimates, including the amount and timing of future cash flows expected to be received on impaired loans that are susceptible to significant change. In the opinion of management, the allowance, when taken as a whole, is adequate to absorb reasonable estimated loan losses inherent in our loan portfolio.

 

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The following table sets forth an analysis of our allowance for loan losses.

 

   December 31, 
   2017   2016   2015   2014   2013 
   (Dollars in thousands) 
Balance at beginning of period  $12,382   $12,641   $13,168   $13,412   $16,038 
                          
Charge-offs:                         
Commercial   161    274    104    289    2,713 
Mortgage   284    420    643    572    886 
Consumer   967    788    640    1,021    940 
Total charge-offs   1,412    1,482    1,387    1,882    4,539 
                          
Recoveries:                         
Commercial   24    85    498    499    69 
Mortgage   13    25    34    31    273 
Consumer   160    263    203    258    271 
Total recoveries   197    373    735    788    613 
                          
Net charge-offs   1,215    1,109    652    1,094    3,926 
Provisions charged to operations   1,220    850    125    850    1,300 
Balance at end of period  $12,387   $12,382   $12,641   $13,168   $13,412 
                          
Ratio of net charge-offs during the period to average loans outstanding during the period   0.10%   0.10%   0.06%   0.11%   0.40%
                          
Allowance as a percentage of non-performing loans   235.90%   230.99%   176.28%   177.04%   156.15%
                          
Allowance as a percentage of total loans (end of period)   1.05%   1.06%   1.17%   1.30%   1.37%

 

Investment Activities

 

MutualBank may invest in various types of liquid assets, including United States Treasury obligations, securities of various federal agencies, including callable agency securities, securities of state and political subdivisions, certain certificates of deposit of insured banks and savings institutions, certain bankers’ acceptances, repurchase agreements and federal funds. It also may invest in investment grade commercial paper and corporate debt securities and certain mutual funds.

 

The Chief Financial Officer is responsible for the management of our investment portfolio, subject to the direction and guidance of the Asset and Liability Management Committee and the Board of Directors. The Chief Financial Officer considers various factors when making decisions, including the marketability, maturity and tax consequences of the proposed investment. The maturity structure of investments will be affected by various market conditions, including the current and anticipated slope of the yield curve, the level of interest rates, the trend of new deposit inflows, and the anticipated demand for funds via deposit withdrawals and loan originations and purchases.

 

The objectives of our investment portfolio are to provide liquidity when loan demand is high, to assist in maintaining earnings when loan demand is low and to maximize earnings while satisfactorily managing risk, including credit risk, reinvestment risk, liquidity risk and interest rate risk. See “Item 7A - Quantitative and Qualitative Disclosures About Market Risk”.

 

Our investment securities currently consist of U.S. Agency securities, mortgage-backed securities, collateralized mortgage obligations, municipal securities and corporate obligations. Our mortgage-backed securities portfolio currently consists of securities issued under government-sponsored agency programs. See Note 4 of the Notes to Consolidated Financial Statements contained in Item 8 of this Form 10-K.

 

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While mortgage-backed securities carry a reduced credit risk as compared to whole loans, these securities remain subject to the risk that a fluctuating interest rate environment, along with other factors like the geographic distribution of the underlying mortgage loans, may alter the prepayment rate of the mortgage loans and affect both the prepayment speed and value of the securities.

 

Although the Bank has not had a trading portfolio in recent history, we are permitted by the Board of Directors to have a trading portfolio of up to $5.0 million and to trade up to $2.0 million in these securities at any one time. At December 31, 2017, however, we did not have a trading portfolio. See Note 4 of the Notes to Consolidated Financial Statements contained in Item 8 of this Form 10-K.

 

A majority of MutualBank’s investment portfolio is under the management of its wholly owned subsidiary, Mutual Federal Investment Company. Mutual Federal Investment Company, a Nevada corporation, holds, services, manages and invests that portion of the Bank’s investment portfolio as may be transferred from time to time by the Bank to Mutual Federal Investment Company. Mutual Federal Investment Company’s investment policy, for the most part, mirrors that of the Bank’s. Mutual Federal Investment Company has hired a third-party investment advisor to manage its securities portfolio, subject to the oversight of its Board of Directors. At December 31, 2017, MutualBank had $277.4 million in consolidated investment securities carried at fair value. The portfolio is comprised of available for sale securities. At that date, Mutual Federal Investment Company managed $261.3 million of the total available for sale portfolio.

 

The following table sets forth the composition of our investment and mortgage-related securities portfolio and our other investments at the dates indicated. As of December 31, 2017, our investment securities portfolio did not contain securities of any issuer with an aggregate book value in excess of 10% of our equity capital, excluding those issued by the United States Government, its agencies or government sponsored entities.

 

   December 31, 
   2017   2016   2015 
   Amortized
Cost
   Fair
Value
   Amortized
Cost
   Fair
Value
   Amortized
Cost
   Fair
Value
 
   (Dollars in thousands) 
Investment securities available for sale:                              
Mortgage-backed securities  $68,335   $67,798   $92,871   $92,517   $106,524   $107,838 
Collateralized mortgage obligations   88,488    87,250    68,621    68,047    84,976    84,652 
Municipal obligations   107,060    110,495    77,474    77,682    54,427    57,188 
Corporate obligations   12,966    11,835    12,822    11,667    12,805    11,460 
Total securities available for sale   276,849    277,378    251,788    249,913    258,732    261,138 
                               
Investment in limited partnerships   227    N/A    327    N/A    427    N/A 
Federal Home Loan Bank stock   11,183    N/A    10,925    N/A    10,482    N/A 
Total investments  $288,259   $277,378   $263,040   $249,913   $269,641   $261,138 

 

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The following table indicates, as of December 31, 2017, the composition and contractual maturities of our investment securities, excluding Federal Home Loan Bank (“FHLB”) stock.

 

   Due In         
   Less Than
1 year
   1 to 5
Years
   5 to 10
Years
   Over
10 Years
   Total
Investment Securities
 
   Amortized   Amortized   Amortized   Amortized   Amortized   Fair 
   Cost   Cost   Cost   Cost   Cost   Value 
   (Dollars in thousands) 
Available for sale:                              
Mortgage-backed securities  $-   $1,419   $7,050   $59,866   $68,335   $67,798 
Collateralized mortgage obligations   -    -    -    88,488    88,488    87,250 
Municipal obligations   160    501    19,500    86,899    107,060    110,495 
Corporate obligations   -    4,500    4,544    3,922    12,966    11,835 
   $160   $6,420   $31,094   $239,175   $276,849   $277,378 
                               
Weighted average yield   7.00%   2.95%   3.21%   2.70%   2.77%     

 

MutualBank conducts periodic reviews to identify and evaluate each investment security to determine whether an other-than-temporary impairment (“OTTI”) has occurred. Economic models are used to determine whether an other-than-temporary impairment has occurred on these securities. While all securities are considered, the securities primarily impacted by other-than-temporary impairment testing are private-label mortgage-backed securities and trust preferred securities. During the years ended December 31, 2017, 2016 and 2015 we did not recognize any OTTI on our investments. No securities in the portfolio were non-performing as of December 31, 2017. The remaining two trust preferred securities were priced using a discounted cash flow analysis as of December 31, 2017.

 

The Bank’s trust preferred securities valuation was prepared by an independent third party. Their approach for determining fair value involved several steps including: (1) a detailed credit and structural evaluation of each piece of collateral in the trust preferred securities; (2) collateral performance projections for each piece of collateral in the trust preferred security; (3) terms of the trust preferred structure, as laid out in the indenture; and (4) discounted cash flow modeling.

 

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

 

The default and recovery probabilities for each piece of collateral were formed based on the evaluation of the collateral credit and a review of historical industry default data and current/near-term operating conditions. For collateral that has already defaulted, the Company assumed no recovery. For collateral that was in deferral, the Company assumed a recovery of 10% of par for banks, thrifts or other depository institutions, and 15% of par for insurance companies. Although the Company conservatively assumed that the majority of the deferring collateral continues to defer and eventually defaults, we also recognize there is a possibility that some deferring collateral may become current at some point in the future.

 

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Pooled Trust Preferred Securities. The Bank has invested in pooled trust preferred securities. At December 31, 2017, the current book balance of our pooled trust preferred securities was $3.9 million. The original par value of these securities was $4.0 million. All pooled trust preferred securities owned were performing as agreed during 2017. As of May 2017, current Moody’s rated these bonds as Aa3 for Alesco Preferred Funding IX and Ba2 for U.S. Capital Funding I. All pooled trust preferred securities owned by the Bank are exempt from the Volcker Rule.

 

The following table provides additional information related to the Bank’s investment in trust preferred securities as of December 31, 2017.

 

Deal Name  Class  Original
Par
   Book
Value
   Fair Value   Unrealized
Loss
   Realized
Losses
2017
   Lowest
Ratings
  Number of
Banks /
Insurance
Cos.
Currently
Performing
   Total
Number
of Banks
and
Insurance
Cos. In
Issuance
(Unique)
   Actual
Deferrals/
Defaults
(as a % of
original
collateral)
   Total
Projected
Defaults
 (as a % of
performing
collateral)
(1)
   Excess
subordination
(after taking
into account
best estimate
of future
deferrals/
 defaults) (2)
 
   (Dollars in Thousands)
Alesco Preferred Funding IX  Aa3  $1,000   $922   $599   $(322)  $-   CCC-   45    48    2.85%   8.23%   53.61%
U.S. Capital Funding I  B3   3,000    3,000    2,122    (878)   -   Caa1   26    30    7.95%   5.92%   12.29%
      $4,000   $3,922   $2,721   $(1,200)  $-                             

 

 

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

 

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Sources of Funds

 

General. Our sources of funds are deposits, borrowings, payment of principal and interest on loans, interest earned on or maturation of other investment securities and funds provided from operations.

 

Deposits. We offer deposit accounts to consumers and businesses having a wide range of interest rates and terms. Our deposits consist of savings deposit accounts, NOW and demand accounts and certificates of deposit. We solicit deposits in our market areas as well as online through our internet banking product. The Bank participates in services through the Certificate of Deposit Account Registry Service (“CDARS”) and Insured Cash Sweep (“ICS”) deposit services. All ICS and CDARs deposit accounts are classified as brokered deposits. The Bank both purchases CDARS and ICS deposits and participates in reciprocal CDARS and ICS deposit services for our customers. We primarily rely on competitive pricing policies, marketing and customer service to attract and retain these deposits. Occasionally we will accept brokered deposits from a deposit broker. At December 31, 2017, our brokered deposits totaled $92.8 million, or 7.7% of total deposits, with an average interest rate of 1.34% and a 0.65 year weighted-average maturity.

 

The flow of deposits is influenced significantly by general economic conditions, changes in money market and prevailing interest rates, and competition. The variety of our deposit accounts has allowed us to be competitive in obtaining funds and to respond to changes in consumer demand. We have become more susceptible to short-term fluctuations in deposit flows, as customers have continued to deposit in short-term products while rates remain low. We try to manage the pricing of our deposits in keeping with our asset/liability management, liquidity and profitability objectives, subject to competitive factors. Based on our experience, we believe that our deposits are relatively stable sources of funds. Our ability to attract and maintain these deposits and the rates paid on those deposits has been and will continue to be affected significantly by economic and market conditions.

 

The FRB requires all depository institutions to maintain non-interest bearing reserves at specified levels against their transaction accounts, primarily checking, NOW and Super NOW checking accounts. At December 31, 2017, we were in compliance with these reserve requirements.

 

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The following table sets forth the dollar amount of deposits in the various types of deposit programs we offered at the dates indicated.

 

   December 31, 
   2017   2016   2015 
   Amount   Percent
of Total
   Amount   Percent
of Total
   Amount   Percent
of Total
 
   (Dollars in thousands) 
Transactions and savings deposits:                              
Noninterest bearing accounts  $194,134    16.15%  $178,046    15.44%  $179,542    16.45%
Savings accounts   138,348    11.51    136,314    11.82    131,578    12.06 
Interest-bearing NOW and demand accounts   330,821    27.52    292,977    25.40    267,089    24.47 
Money market accounts   167,574    13.94    173,305    15.03    162,551    14.89 
 Total non-certificates   830,877    69.12    780,642    67.69    740,760    67.87 
                               
Certificates:                              
   0.00 -1.99%   302,734    25.19    312,498    27.09    305,517    27.99 
   2.00 -3.99%   68,423    5.69    60,240    5.22    45,052    4.13 
   4.00 -5.99%   -    0.00    2    0.00    53    0.01 
 Total certificates   371,157    30.88    372,740    32.31    350,622    32.13 
Total deposits  $1,202,034    100.00%  $1,153,382    100.00%  $1,091,382    100.00%

 

The following table shows rate and maturity information for our certificates of deposit as of December 31, 2017.

 

   0.00 -
1.99%
   2.00 -
3.99%
   4.00 -
5.99%
   Total   Percent
of Total
 
   (Dollars in thousands) 
Certificate accounts maturing in quarter ending:                    
March 31, 2018  $68,499   $761   $-   $69,260    18.65%
June 30, 2018   52,500    193    -    52,693    14.20 
September 30, 2018   29,831    168    -    29,999    8.08 
December 31, 2018   20,184    3    -    20,187    5.44 
March 31, 2019   8,939    1    -    8,940    2.41 
June 30, 2019   15,359    -    -    15,359    4.14 
September 30, 2019   14,571    114    -    14,685    3.96 
December 31, 2019   14,791    5,144    -    19,935    5.37 
March 31, 2020   16,236    445    -    16,681    4.49 
June 30, 2020   22,742    3,296    -    26,038    7.02 
September 30, 2020   7,346    4,806    -    12,152    3.27 
December 31, 2020   4,055    11,967    -    16,022    4.32 
Thereafter   27,681    41,525    -    69,206    18.65 
Total  $302,734   $68,423   $-   $371,157    100.00%
                          
Percent of total  $81.56%   18.44%   -%   100.00%     

 

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The following table indicates, as of December 31, 2017, the amount of our certificates of deposit and other deposits by time remaining until maturity.

 

   Maturity 
   3 Months
or Less
   Over 3 to
6 Months
   Over 6 to
12 Months
   Over
12 Months
   Total 
   (Dollars in thousands) 
Certificates of deposit less than $100,000  $20,561   $27,251   $25,442   $103,584   $176,838 
Certificates of deposit of $100,000 or more   12,347    14,711    16,543    70,089    113,690 
Brokered deposits   32,959    9,908    7,894    20,109    70,870 
Public Funds (1)   3,393    823    307    5,236    9,759 
Total Certificates of deposit  $69,260   $52,693   $50,186   $199,018   $371,157 

 

 

(1) Deposits from governmental and other public entities.

 

Borrowings. We also utilize borrowings as a source of funds, especially when they are less costly than deposits and can be invested at a positive interest rate spread, when we desire additional capacity to fund loan demand or when they meet our asset/liability management goals. Our borrowings historically have consisted of advances from the FHLB of Indianapolis. See Note 12 of the Notes to Consolidated Financial Statements contained in Item 8 of this Form 10-K.

 

We may obtain advances from the FHLB of Indianapolis upon the pledging of certain collateral. These advances may be made pursuant to several different credit programs, each of which has its own interest rate, range of maturities and call features. At December 31, 2017 we had $217.2 million in FHLB advances outstanding. Based on current collateral levels, we could borrow an additional $51.4 million from the FHLB at prevailing interest rates. In order to have access to FHLB advances, we are required to own stock in the FHLB of Indianapolis. At December 31, 2017, we had $11.2 million in that stock.

 

We also are authorized to borrow from the Federal Reserve Bank of Chicago’s “discount window.” We have never borrowed from the Federal Reserve Bank and currently do not have any assets pledged to them for borrowing.

 

The Bank also has three fed fund lines totaling $40 million. There was no outstanding balance on any of these lines as of December 31, 2017.

 

The Company acquired $5.0 million of issuer trust preferred securities in the 2008 acquisition of another financial institution. The net balance of these securities as of December 31, 2017 was $4.2 million due to the purchase accounting adjustment made at the time of the acquisition. The securities bore a fixed rate of interest of 6.22% for the first five years, resetting quarterly thereafter at the prevailing three-month LIBOR rate plus 170 basis points. The Company has had the right to redeem the trust preferred securities, in whole or in part, without penalty, since September 15, 2010. These securities mature on September 15, 2035.

 

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The following table sets forth, for the years indicated, the maximum month-end balance and average balance of FHLB advances and other borrowings.

 

   Year Ended December 31, 
   2017   2016   2015 
   (Dollars in thousands) 
Maximum Balance:               
FHLB advances  $240,591   $243,817   $225,617 
Other borrowings   4,232    10,312    10,181 
                
Average Balance:               
FHLB advances  $221,932   $230,329   $198,854 
Other borrowings   4,211    8,421    9,875 

 

The following table sets forth certain information as to our borrowings at the dates indicated.

 

   December 31, 
   2017   2016   2015 
   (Dollars in thousands) 
FHLB advances  $217,163   $240,591   $225,617 
Other borrowings   4,232    4,189    9,458 
Total borrowings  $221,395   $244,780   $235,075 
                
Weighted average interest rate of FHLB advances   1.72%   1.53%   1.52%
Weighted average interest rate of other borrowings(1)   3.29%   2.66%   3.17%

 

 

(1) Our other borrowings include subordinated debt as of December 31, 2017.

 

Trust and Financial Services

 

MutualWealth and MutualFinancial are the wealth management and brokerage divisions of the Bank that provide a variety of fee-based financial services, including trust and estate administration, investment management services, life insurance, broker advisory services, retirement plan administration and private banking services, in our market areas. Trust services are provided to both individual and corporate customers, including personal trust and agency accounts, employee benefit plans and corporate bond trustee accounts. These activities provide a significant source of fee income to the Company and in 2017 constituted 27.8% of the Company’s non-interest income.

 

Subsidiary and Other Activities

 

The Company, as a bank holding company that has elected to be treated as a financial holding company, is allowed to engage in activities and invest in subsidiaries as authorized by Federal law and the regulations of the FRB. At December 31, 2017, the Company had an active captive insurance company, MutualFirst Risk Management, Inc. and another subsidiary, Mutual Risk Advisors, an information security consulting firm.

 

As an Indiana commercial bank, MutualBank is allowed to invest in subsidiaries as authorized by Indiana law and the IDFI. Under federal law and FDIC regulations, those subsidiaries generally may engage as principal only in activities that are permissible for national bank subsidiaries, unless the Bank receives FDIC approval to engage in other activities permitted by Indiana law and the IDFI. Activities engaged in as agent, including insurance agency activities, are not subject to this limitation.

 

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At December 31, 2017, MutualBank had an active investment subsidiary, Mutual Federal Investment Company, which is a Nevada corporation that holds and manages a portion of MutualBank’s investment portfolio. As of December 31, 2017, the market value of securities managed was $261.3 million. Mutual Federal Investment Company has one active subsidiary, Mutual Federal REIT, Inc., which is a Maryland corporation holding approximately $45.6 million in consumer closed end first mortgage loans.

 

The Bank had one other active subsidiary as of December 31, 2017. Summit Service Corporation which controls the 100% wholly owned active subsidiary, Summit Mortgage, Inc., which is an Indiana corporation that originates and sells consumer closed end first mortgage loans. As of December 31, 2017, Summit Mortgage had $4.2 million in loans held for sale.

 

Employees

 

At December 31, 2017, we had a total of 390 full-time and 32 part-time employees. Our employees are not represented by any collective bargaining group. Management considers its employee relations to be good.

 

How We Are Regulated

 

MutualFirst Financial is a financial holding company subject to FRB regulation, and MutualBank is an Indiana commercial bank subject to regulation by the IDFI and the FDIC. The Dodd-Frank Act created the Consumer Financial Protection Bureau (“CFPB”), which has authority to promulgate regulations intended to protect consumers with respect to financial products and services, including those provided by the Bank, and to restrict unfair, deceptive or abusive conduct by providers of consumer financial products and services. The FDIC examines the Bank for compliance with these regulations. As a public company, the Company is subject to the regulation and reporting requirements of the SEC.

 

Set forth below is a brief description of certain laws and regulations that apply to us. This description, as well as other descriptions of laws and regulations contained in this Form 10-K, is not complete and is qualified in its entirety by reference to the applicable laws and regulations.

 

Legislation is introduced from time to time in the United States Congress and the Indiana General Assembly that may affect our operations. In addition, the regulations governing the Company and the Bank may be amended from time to time by the IDFI, FDIC, CFPB, FRB or SEC, as appropriate. Any legislative or regulatory changes in the future, including those resulting from the Dodd-Frank Act, could adversely affect our operations and financial condition.

 

MutualFirst Financial. MutualFirst Financial is a bank holding company that has elected to be treated as a financial holding company. MutualFirst is required to register and file reports with the FRB and is subject to regulation and examination by the FRB, including requirements that the Company serve as a source of financial and managerial strength for the Bank, particularly if the Bank is in financial distress. In addition, the FRB has enforcement authority over the Company and any of its non-bank subsidiaries. The Company’s direct activities and those of its non-bank subsidiaries are subject to FRB regulation and must be activities permissible for a bank holding company, or for a financial holding company (generally securities and insurance activities). The Company must obtain FRB approval to acquire substantially all the assets of another bank or bank holding company or to merge with another bank holding company. In addition, the Company must obtain FRB authorization to control more than 5% of the shares of any other bank or bank holding company and may not own more than 5% of any other entity engaged in activities not permitted for the Company. The IDFI also has certain oversight authority over the Company, including acquisitions of banks and bank holding companies. The FRB imposes consolidated capital requirements on the Company. See “- Regulatory Capital Requirements.”

 

MutualBank. As an Indiana commercial bank, MutualBank is subject to regulation, examination and supervision by the IDFI. Indiana and Federal laws regulate many aspects of the Bank’s operations including branching, dividends, interest and fees collected, anti-money laundering activities, confidentiality of customer information, credit card operations, corporate governance, mergers and purchase and assumption transactions, insurance activities, securities investments, real estate investments, trust operations, lending activities, subsidiary operations and required capital levels. Under Indiana law, Indiana banks may have parity authority with national banks.

 

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To fund its operations, the IDFI has established a schedule for the assessment of supervisory fees for all Indiana financial institutions. These supervisory fees are computed based on the Bank’s total assets and trust assets and increase if the Bank experiences financial distress. The IDFI also charges fees for certain applications and other filings.

 

FDIC Regulation and Insurance of Accounts. As a state-chartered, non-member bank, MutualBank is subject to regulation, examination and supervision by the FDIC. The FDIC does not assess fees for its examination and supervision of the Bank. The FDIC oversees the Bank’s operations under federal law, regulations and policies, including consumer compliance laws, and ensures that the Bank operates in a safe and sound manner. It regulates the Bank’s branching, transactions with affiliates (including the Company) and loans to insiders. Under FDIC regulations, the Bank generally is prohibited from acquiring or owning any equity investments impermissible for national banks and from engaging as principal in activities that are not permitted for national banks without FDIC approval. During examinations, the FDIC may require the Bank to establish additional reserves for loan losses, which would decrease the Company’s net income. The FDIC has adopted guidelines establishing safety and soundness standards on such matters as loan underwriting and documentation, asset quality, earnings standards, internal controls and audit systems, interest rate risk exposure and compensation and other employee benefits. Any institution that fails to comply with these standards must submit a compliance plan.

 

The Bank’s deposits are insured up to the applicable limits by the FDIC, and such insurance is backed by the full faith and credit of the United States Government. The basic deposit insurance level is $250,000 per each separately insured depositor, as defined in FDIC regulations. As insurer, the FDIC imposes deposit insurance premiums and is authorized to conduct examinations of and to require reporting by FDIC-insured institutions. Our deposit insurance premiums for the year ended December 31, 2017 were $724,000. The FDIC’s premium rates may increase due to strains on the FDIC deposit insurance fund resulting from the cost of bank failures. Also, if the Bank’s regulatory capital or supervisory ratings deteriorate, these deposit insurance premiums may increase.

 

In accordance with the Dodd-Frank Act, the FDIC has issued regulations setting insurance premium assessments based on an institution's total assets minus its Tier 1 capital instead of its deposits. The Bank’s FDIC premiums are based on its supervisory ratings and certain financial ratios. Federal law requires that the reserve ratio of the FDIC deposit insurance fund be at least 1.35% by September 2020, and the FDIC has established a plan to meet that requirement.

 

The FDIC may prohibit the Bank from engaging in any activity that it determines by regulation or order to pose a serious risk to the deposit insurance fund and may terminate our deposit insurance if it determines that we have engaged in unsafe or unsound practices or are in an unsafe or unsound condition.

 

Regulatory Capital Requirements. Both MutualFirst and MutualBank are required to maintain a minimum level of regulatory capital. The FRB and the FDIC have established capital standards for the Company and the Bank. The FRB and the FDIC also may impose capital requirements in excess of these standards on individual institutions on a case-by-case basis. See “Item 7 - Management’s Discussion and Analysis of Financial Condition and Results of Operation - Capital Resources” for information on the Company’s and the Bank’s compliance with these capital requirements.

 

The current capital regulations of the FRB and FDIC became effective at the beginning of 2015 (with some changes phased in over several years). The capital regulations establish required minimum ratio for common equity Tier 1 (“CET1”) capital, Tier 1 capital and total capital and the minimum leverage ratio; establish risk-weightings for assets and certain off-balance sheet items for purposes of the risk-based capital ratios; require an additional capital conservation buffer over the minimum risk-based capital ratios; and define what qualifies as capital for purposes of meeting the capital requirements.

 

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The minimum capital ratios are: (1) a CET1 capital ratio of 4.5% of risk-weighted assets; (2) a Tier 1 capital ratio of 6.0% of risk-weighted assets; (3) a total capital ratio of 8.0% of risk-weighted assets; and (4) a leverage ratio (the ratio of Tier 1 capital to average total adjusted assets) of 4.0%. CET1 generally consists of common stock; retained earnings; accumulated other comprehensive income (“AOCI”) except in the case of banking organizations that have elected to exclude AOCI from regulatory capital, as discussed below; and certain minority interests; all subject to applicable regulatory adjustments and deductions.

 

There are a number of changes in what constitutes regulatory capital compared to earlier regulations, subject to transition periods. These changes include the phasing-out of certain instruments as qualifying capital. Mortgage servicing and deferred tax assets over designated percentages of CET1 are deducted from capital. In addition, Tier 1 capital includes AOCI, which includes all unrealized gains and losses on available for sale debt and equity securities. Because of our asset size, we had the one-time option of deciding in the first quarter of 2015 whether to permanently opt-out of the inclusion of unrealized gains and losses on available for sale debt and equity securities in our capital calculations. We made the decision to opt out.

 

The capital regulations changed in the risk-weighting of certain assets to better reflect credit risk and other risk exposure compared to earlier regulations. These changes include a 150% risk weight (up from 100%) for certain high volatility commercial real estate acquisition, development and construction loans and for non-residential mortgage loans that are 90 days past due or otherwise in nonaccrual status; a 20% (up from 0%) credit conversion factor for the unused portion of a commitment with an original maturity of one year or less that is not unconditionally cancellable (set at 0%); and a 250% risk weight (up from 100%) for mortgage servicing and deferred tax assets that are not deducted from capital.

 

In addition to the minimum CET1, Tier 1 and total capital ratios, the capital regulations require a capital conservation buffer consisting of additional CET1 capital greater than 2.5% of risk-weighted assets above the required minimum risk-based in order to avoid limitations on paying dividends, engaging in share repurchases and paying discretionary bonuses. The phase-in of the capital conservation buffer requirement began on January 1, 2016, when a buffer greater than 0.625% of risk-weighted assets was required, which amount increases each year until the buffer requirement is fully implemented on January 1, 2019.

 

Under the FDIC’s prompt corrective action standards, in order to be considered well-capitalized, the Bank must have a ratio of CET1 capital to risk-weighted assets of 6.5%, a ratio of Tier 1 capital to risk-weighted assets of 8%, a ratio of total capital to risk-weighted assets of 10%, and a leverage ratio of 5%; and in order to be considered adequately capitalized, it must have the minimum capital ratios described above. To be considered well-capitalized a bank holding company must have, on a consolidated basis, at least a Tier 1 risk-based capital ratio of 8% and a total risk-based capital ratio of 10% and not be subject to a higher enforceable individualized capital requirement.

 

Limitations on Dividends and Other Capital Distributions. The Company’s major source of funds consists of dividends from the Bank. The ability of the Bank to pay dividends depends on its earnings and capital levels and may be limited by FDIC or IDFI regulations, directives or orders, or by the capital conservation buffer requirements. In addition, under Indiana law, the Bank may pay dividends from undivided profits; however, in some circumstances it may be required to obtain IDFI approval of a dividend if the total dividends declared during the current year, including the proposed dividend, exceeds net income for the current year and retained net income for the prior two years, which excludes dividends paid during those years. The approval from IDFI is not required if the Bank meets exemption guidelines that mandate minimums for examination ratings and the Tier 1 leverage capital ratio, and the Bank is not subject to corrective action or supervisory order agreements. Since the Bank became regulated by the IDFI, it has been exempt from the pre-approval requirements. It is the Bank’s policy to maintain a strong capital position, so, in times of financial or economic distress, the Bank will be less likely to pay dividends to the Company.

 

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The ability of the Company to pay dividends to its stockholders is primarily dependent on the receipt of dividends from the Bank. Under Maryland law, the Company cannot pay cash dividends if it would render the Company unable to pay its debts or would be insolvent (unless they are paid from recent earnings).

 

The FRB has issued a policy statement on the payment of cash dividends by bank holding companies, which expresses the FRB’s view that a bank holding company should pay cash dividends only to the extent that its net income for the past year is sufficient to cover both the cash dividends and a rate of earnings retention that is consistent with the holding company’s capital needs, asset quality and overall financial condition. The FRB also indicated that it would be inappropriate for a company experiencing serious financial problems to borrow funds to pay dividends. Furthermore, a bank holding company may be prohibited from paying any dividends if the holding company’s bank subsidiary is not adequately capitalized. The payment of dividends by a bank or a bank holding company can also be restricted under the capital conversation buffer requirements in the capital regulations.

 

A bank holding company is required to give the FRB prior written notice of any purchase or redemption of its outstanding equity securities if the gross consideration for the purchase or redemption, when combined with the net consideration paid for all such purchases or redemptions during the preceding 12 months, is equal to 10% or more of the company’s consolidated net worth. The FRB may disapprove such a purchase or redemption if it determines that the proposal would constitute an unsafe or unsound practice or would violate any law, regulation, FRB order, or any condition imposed by, or written agreement with, the FRB. This notification requirement does not apply to any company that meets the well-capitalized standard for bank holding companies, is well-managed, and is not subject to any unresolved supervisory issues.

 

Federal Securities Laws. The common stock of the Company is registered with the SEC under the Securities Exchange Act of 1934, as amended (the “Exchange Act”). Therefore, the Company is subject to the reporting, information disclosure, proxy solicitation, insider trading limits and other requirements imposed on public companies by the SEC under the Exchange Act. This includes limits on sales of stock by certain insiders and the filing of insider ownership reports with the SEC. The SEC and Nasdaq have adopted regulations under the Sarbanes-Oxley Act of 2002 that apply to the Company as a Nasdaq-traded, public company, which seek to improve corporate governance, provide enhanced penalties for financial reporting improprieties and improve the reliability of disclosures in SEC filings.

 

Federal Taxation

 

General. We are subject to federal income taxation in the same general manner as other corporations, with some exceptions discussed below. The following discussion of federal taxation is intended only to summarize certain pertinent federal income tax matters and is not a comprehensive description of the tax rules applicable to us. MutualFirst’s federal income tax returns have been closed without audit by the IRS through its year ended December 31, 2013. MutualFirst and MutualBank will file a consolidated federal income tax return for fiscal year 2017.

 

Tax Cuts and Jobs Act (“Tax Act”). The Tax Act was enacted on December 22, 2017 reducing the Company’s federal corporate tax rate from 34% to 21%, effective January 1, 2018. At December 31, 2017, the Company has substantially completed its accounting for the tax effects of enactment of the Tax Act. For deferred tax assets and liabilities, amounts were remeasured based on the rates expected to reverse in the future, which is now 21%. Based on this new law, we recorded an additional tax expense of $2.0 million due to the revaluation of the company’s deferred tax asset. The Company continues to analyze certain aspects of the Tax Act and further refinements are possible, which could potentially affect the measurement of these balances or potentially give rise to new deferred tax amounts. We do not expect these adjustments to materially impact our financial statements.

 

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Taxable Distributions and Recapture. Prior to 1998, bad debt reserves created prior to the year ended December 31, 1997 were subject to recapture into taxable income if MutualBank failed to meet certain thrift asset and definitional tests. Federal legislation eliminated these thrift recapture rules. However, under current law, pre-1988 reserves remain subject to recapture should MutualBank make certain non-dividend distributions or cease to maintain a bank charter.

 

Minimum Tax. For tax years beginning after December 31, 2017, corporate alternative minimum tax is repealed. The prior year minimum tax credit is continued to be allowed to offset the taxpayer’s regular tax liability for any tax year. For tax years beginning after 2017 and before 2022, the prior year minimum tax credit would be refundable in an amount equal to 50% (100% for tax years beginning in 2021) of the excess of the credit for the tax year over the amount of the credit allowable for the year against regular tax liability. MutualBank has $1.4 million available as minimum tax credits for carryover, as of December 31, 2017.

 

Corporate Dividends-Received Deduction. MutualFirst may eliminate from its income dividends received from MutualBank as a wholly owned subsidiary of MutualFirst if it elects to file a consolidated return with MutualBank. The corporate dividends-received deduction is 100% or 80%, in the case of dividends received from corporations with which a corporate recipient does not file a consolidated tax return, depending on the level of stock ownership of the payer of the dividend. Corporations which own less than 20% of the stock of a corporation distributing a dividend may deduct 70% of dividends received or accrued on their behalf.

 

State Taxation

 

MutualBank is subject to Indiana’s financial institutions tax, which is imposed at a flat rate as of December 31, 2017, of 6.5% on “adjusted gross income” apportioned to Indiana. “Adjusted gross income,” for purposes of the financial institutions tax, begins with taxable income as defined by Section 63 of the Internal Revenue Code and 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 including only considering members of the combined group which have Indiana nexus. Indiana legislature started reducing the financial institutions tax from 8.5% to 6.5% in 0.5% increments over a four year period that commenced in 2014. The full rate reduction to 4.9% will be phased in fully by 2023.

 

Other applicable state taxes include generally applicable sales and use taxes plus real and personal property taxes. The Company is subject to a Michigan business tax on apportioned capital employed in the state of Michigan. The Company also files the Pennsylvania Bank & Trust Company shares and loans tax report.  Ultimately, this tax is based on apportioned adjusted capital in the state of Pennsylvania.

 

Internet Website

 

We maintain a website with the address of www.bankwithmutual.com. The information contained on our website is not included as a part of, or incorporated by reference into, this Annual Report on Form 10-K. This Annual Report on Form 10-K and our other reports, proxy statements and other information, including earnings press releases, filed with the SEC are available on that website through a link to the SEC’s website at “About Us - Investor Relations - SEC Filings.” For more information regarding access to these filings on our website, please contact our Corporate Secretary, MutualFirst Financial, Inc., 110 E. Charles Street, Muncie, Indiana, 47305-2400; telephone number (765) 747-2800.

 

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Item 1A. Risk Factors

 

The following are certain risk factors that could impact our business, financial results and results of operations. Investing in our common stock involves risks, including those described below. These risk factors should be considered by prospective and current investors in our common stock when evaluating the disclosures in this Annual Report on Form 10-K (particularly the forward-looking statements). These risk factors could cause actual results and conditions to differ materially from those projected in forward-looking statements. If any of the events in the following risks actually occur, or if additional risks and uncertainties not presently known to us or that we believe are immaterial do materialize, then our business, financial condition or results of operations could be materially adversely impacted. In addition, the trading price of our common stock could decline due to any of the events described in these risks.

 

The previous economic recession was severe in our primary market area of northern and east central Indiana, which is not a high growth market. A return of recessionary conditions could result in increases in our level of non-performing loans and/or reduce demand for our products and services, which could have an adverse effect on our results of operations.

 

Our business activities and earnings are affected by general business conditions in the United States and in our local market area. These conditions are impacted by changes to short-term and long-term interest rates, inflation, unemployment levels, monetary supply, consumer confidence and spending, fluctuations in both debt and equity capital markets, and the strength of the economy in the United States generally and in our primary market area in particular. The economy continues to recover from the recent most severe recession, which caused high unemployment levels, declining real estate values and eroded consumer confidence. The recession also reduced demand for commercial business and real estate loans in our local market. Declines in real estate values and other effects of the recession impacted household and corporate incomes, impairing the ability of our borrowers to repay their loans in accordance with their terms and increasing our non-performing loans, loan charge-offs, provisions for loan losses and foreclosures.

 

Substantially all of our loans are located in northern and east central Indiana, which was impacted by the recession more severely than the national average. Our primary market area, which consists of Allen, Delaware, Elkhart, Grant, Kosciusko, Randolph, St. Joseph and Wabash counties in Indiana and Berrien county in Michigan, has experienced limited population growth of 0.64% from 2000 through 2010. This data from the census bureau reflects population increases in our northern region market of 2.02% compared to the reduction in population of our central region of (3.04%). Unemployment levels in our market areas in Indiana historically have been above the state and federal averages but have been below the state and federal level over the last two years. According to data published by the Bureau of Labor Statistics of the United States Department of Labor, the national unemployment rate for the United States at December 31, 2017 was 3.9% (not seasonally adjusted) compared to an average rate of 3.9% (not seasonally adjusted) for our market areas in Indiana. See “Item 1 - Business - Market Area.”

 

A return of recessionary conditions in the domestic and international credit markets may significantly affect the markets in which we do business, the value of our loans and investments, and our ongoing operations, costs and profitability. Declines in real estate values and sales volumes and an increase in unemployment levels may result in higher than expected loan delinquencies and a decline in demand for our products and services. These negative events may cause us to incur losses and may adversely affect our capital, liquidity, and financial condition. Stock prices for financial institution holding companies, including MutualFirst, would be expected to decline substantially, and it would be significantly more difficult to raise capital or borrow in the debt markets.

 

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Combining the Company and Universal Bancorp, which was completed during the first quarter 2018, may be more difficult, costly or time consuming than expected, and the anticipated benefits and cost savings of the merger may not be realized.

 

The success of the merger, including anticipated benefits and cost savings, will depend, in part, on our ability to successfully combine the businesses of MutualFirst and Universal. To realize these anticipated benefits and cost savings, after the completion of the merger, we expect to integrate Universal’s business into our own. It is possible that the integration process could result in the loss of key employees, the disruption of each company’s ongoing businesses or inconsistencies in standards, controls, procedures and policies that adversely affect our ability to maintain relationships with clients, customers, depositors and employees or to achieve the anticipated benefits and cost savings of the merger. If we experience difficulties with the integration process, the anticipated benefits of the merger may not be realized fully or at all or may take longer to realize than expected. As with any merger of financial institutions, there also may be business disruptions that cause us and/or Universal to lose customers or cause customers to remove their accounts from MutualFirst and/or Universal and move their business to competing financial institutions. Integration efforts between the two companies will also divert management attention and resources. These integration matters could have an adverse effect on each of Universal and MutualFirst during this transition period and on us for an undetermined period after completion of the merger. In addition, the actual cost savings of the merger could be less than anticipated.

 

A substantial portion of our assets consist of various types of loans that carry varying levels of credit and interest rate risk and that are sensitive to changes in the local and national economies.

 

Loans Secured by Residential Property. At December 31, 2017, $518.3 million, or 43.5% of our total loan portfolio, was secured by one- to four-family residential property, including loans held for sale and home equity loans and home equity lines of credit. This type of lending is generally sensitive to regional and local economic conditions that impact the ability of borrowers to meet their loan payment obligations. Although we continue to see recovery in the market areas we serve, the decline in residential real estate values as a result of the last downturn in the Indiana housing markets has reduced the value of the real estate collateral securing these types of loans and increased the risk that we could incur losses if borrowers default on their loans. In addition, borrowers seeking to sell their homes may find that they cannot sell their properties for an amount equal to or greater than the unpaid principal loan balance. These potential negative events may cause us to incur losses, adversely affect our capital and liquidity and damage our financial condition and business operations.

 

Commercial Real Estate, Construction and Development and Commercial Business Loans. At December 31, 2017, $478.0 million, or 40.1% of our total loan portfolio, consisted of commercial real estate, construction and development and commercial business loans to small and mid-sized businesses, predominantly in our primary market area, which are the types of businesses that have a heightened vulnerability to local economic conditions. At December 31, 2017, our loan portfolio included $28.2 million of commercial construction and development loans, $318.7 million of commercial real estate loans and $131.1 million of commercial business loans compared to $22.5 million, $302.6 million and $131.1 million for construction and development, commercial real estate and business loans, respectively, at December 31, 2016. Because we have seen growth in the credit risk of the portfolio in 2017 primarily due to the increased percentage of our total loan portfolio in these types of loans, a decline in property values and other market impacts could lead to an increase in non-performing loans. See “Item 1 - Business of MutualBank - Asset Quality - Non-Performing Assets.”

 

The credit risk related to these types of loans is considered to be greater than the risk related to one- to four-family residential loans because the repayment of commercial real estate loans and commercial business loans typically is dependent on the successful operation and income stream of the borrowers’ business and the real estate securing the loans as collateral, which can be significantly affected by economic conditions. Any delinquent payments or the failure to repay these loans would hurt our earnings. Additionally, commercial loans typically involve larger loan balances to single borrowers or groups of related borrowers compared to residential real estate loans. Several of our commercial borrowers have more than one commercial real estate or business loan outstanding with us. Consequently, an adverse development with respect to one loan or one credit relationship can expose us to significantly greater risk of loss compared to an adverse development with respect to any one- to four-family residential mortgage loan. Finally, if we foreclose on a commercial real estate loan, our holding period for the collateral, if any, is typically longer than a one- to four-family residential property because there are fewer potential purchasers of the collateral. If loans that are collateralized by real estate become troubled and the value of the real estate has been significantly impaired, then we may not be able to recover the full contractual amount of principal and interest that we anticipated at the time we originated the loan, which could require us to increase our provision for loan losses and adversely affect our operating results and financial condition.

 

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Other Consumer Loans. At December 31, 2017, $195.0 million, or 16.4% of our total loan portfolio consisted of consumer loans, of which $19.6 million consisted of automobile loans, $169.2 million consisted of boat/RV loans and $6.2 million consisted of other consumer loans, including unsecured lines of credit. Generally, we consider these types of loans to involve a higher degree of risk compared to mortgage loans on one- to four-family, owner-occupied residential properties, particularly in the case of loans that are secured by rapidly depreciable assets, such as automobiles. In these cases, any repossessed collateral for a defaulted loan may not provide an adequate source of repayment of the outstanding loan balance. Although our indirect loans, which totaled $176.7 million at December 31, 2017, were underwritten by a third party using our guidelines, they were primarily originated to customers outside of our normal lending area which presents greater risks than other types of lending activities. As a result of this portfolio of consumer loans, it may become necessary to increase the level of our provision for loan losses, which could negatively impact our earnings and financial condition.

 

Adjustable Rate Loans. At December 31, 2017, $535.7 million, or 45.0% of our total loan portfolio consisted of adjustable rate loans. Borrowers with adjustable rate loans are exposed to increased monthly payments when the related interest rate adjusts upward under the terms of the loan to the rate computed in accordance with the applicable index and margin. Any rise in prevailing market interest rates may result in increased payments for borrowers who have adjustable-rate loans, increasing the possibility of default. Borrowers seeking to avoid these increased monthly payments by refinancing their loans may no longer be able to find available replacement loans at comparable or lower interest rates. In addition, declining real estate prices may prevent refinancing or a sale of the property, because borrowers have insufficient equity in the real estate. These events, alone or in combination, may contribute to higher delinquency rates and negatively impact our earnings.

 

If our allowance for loan losses is not sufficient to cover actual loan losses or our non-performing assets increase, our earnings will suffer. Increases in our provision for loan losses adversely impact our earnings and operations.

 

We make various assumptions and judgments about the collectability of our loan portfolio, including the creditworthiness of our borrowers and the value of the real estate and other assets serving as collateral. In determining the amount of the allowance for loan losses, we review our loans and our loss and delinquency experience and evaluate current economic conditions. Management recognizes that significant new growth in loan portfolios, new loan products and the refinancing of existing loans can result in portfolios comprised of unseasoned loans that may not perform in a historical or projected manner. If our assumptions are incorrect, our allowance for loan losses may not be sufficient to cover actual losses, resulting in additions to our allowance. Additions to our allowance decrease our net income. Our regulators periodically review our allowance for loan losses and may require us to recognize additions to the allowance based on their judgments about information available to them at the time of their review. These increases in our allowance for loan losses or loan charge-offs may have a material adverse effect on our financial condition and results of operations. Our allowance for loan losses was 1.05% of gross loans and 235.90% of non-performing loans at December 31, 2017, compared to 1.06% of gross loans and 230.99% of non-performing loans at December 31, 2016 and 1.17% of gross loans and 176.28% of non-performing loans at December 31, 2015.

 

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At December 31, 2017, our non-performing assets (which consist of non-accrual loans, loans 90 days delinquent and still accruing, non-accrual troubled debt restructurings, foreclosed real estate and other repossessed assets) totaled $6.0 million, which was a decrease of $600,000, or a 9.0% reduction in non-performing assets from December 31, 2016. This decrease reflects improved economic conditions within our market areas. Our non-performing assets adversely affect our net income in various ways. We do not record interest income on non-accrual loans or real estate owned. We must reserve for estimated credit losses, which are established through a current period charge to the provision for loan losses, and from time to time, if appropriate, we must write down the value of properties in our real estate owned (“REO”) portfolio to reflect changing market values. Additionally, there are legal fees associated with the resolution of problem assets as well as carrying costs including taxes, insurance and maintenance related to our REO. Further, the resolution of non-performing assets requires the active involvement of management, potentially distracting them from the overall supervision of our operations and other income-producing activities.

 

During 2017, we recorded a provision for loan losses of $1.2 million compared to $850,000 in 2016 and $125,000 in 2015. We also recorded net loan charge-offs of $1.2 million in 2017, compared to $1.1 million in 2016 and $652,000 million in 2015. During 2017, we experienced an increase in net charge-offs in addition to an increase in our loan portfolio of $10.6 million. This combination increased our need to add to our allowance for loan loss to support the existing loan portfolio mix with commercial and non-real estate consumer loans making up 57.0% of the loan portfolio at the end of 2017 compared to 53.2% at the end of 2016. We did not experience declining trends in the housing, real estate and local business markets; however, if that would return, we would expect increased levels of delinquencies and credit losses to return, which would adversely impact our financial condition and results of operations.

 

Changes in interest rates could adversely affect our results of operations and financial condition.

 

Our results of operations and financial condition are affected significantly by changes in interest rates. Our results of operations depend substantially on our net interest income, which is the difference between the interest income we earn on our interest-earning assets, such as loans and securities, and the interest expense we pay on our interest-bearing liabilities, such as deposits and borrowings. Because interest-bearing liabilities generally reprice or mature more quickly than interest-earning assets, an increase in interest rates generally would tend to result in a decrease in net interest income.

 

Changes in interest rates also may affect the average life of loans and mortgage-related securities. Decreases in interest rates or continuing low interest rates can result in increased prepayments of loans and mortgage-related securities, as borrowers refinance to reduce their borrowing costs. Under these circumstances, we have been and continue to be subject to reinvestment risk to the extent that we are unable to reinvest the cash received from such prepayments at rates that are comparable to the rates on existing loans and securities. Additionally, increases in interest rates may decrease loan demand and make it more difficult for borrowers to repay adjustable-rate loans. Also, increases in interest rates may extend the life of fixed-rate assets, which could limit the funds we have available to reinvest in higher-yielding alternatives, and may result in customers withdrawing certificates of deposit early so long as the early withdrawal penalty is less than the interest they could receive as a result of the higher market interest rates.

 

Changes in interest rates also affect the current fair value of our interest-earning securities portfolio. Generally, the value of securities moves inversely with changes in interest rates. At December 31, 2017, the fair value of our portfolio of available for sale securities totaled $277.4 million. Gross unrealized gains on these securities totaled $4.1 million, while gross unrealized losses on these securities totaled $3.5 million, resulting in a net unrealized gain of $529,000 at December 31, 2017.

 

At December 31, 2017, our interest rate risk analysis indicated that our net portfolio value would decrease by 10.4% if there was an instantaneous parallel 200 basis point increase in market interest rates. See the “Management’s Discussion and Analysis of Financial Condition and Results of Operation - Asset/Liability Management.”

 

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Our strategies to modify our interest rate risk profile may be difficult to implement.

 

Our asset/liability management strategies are designed to minimize our interest rate risk sensitivity. One such strategy is to increase the amount of adjustable rate and/or short-term assets. The Bank offers adjustable rate loan products as a means to achieve this strategy. The recent availability of lower rates on fixed-rate loans has generally created a decrease in borrower demand for adjustable rate assets. Additionally, these adjustable-rate assets may prepay. Despite this, at December 31, 2017, 45.0% of our loan portfolio consisted of adjustable-rate loans, compared to 42.2% at December 31, 2016.

 

We also are managing our liabilities to moderate our interest rate risk sensitivity. Customer demand is primarily for short-term certificates of deposit and transaction accounts. Using short-term liabilities to fund long-term, fixed-rate assets will increase the interest rate sensitivity of any financial institution. When needed, we are utilizing FHLB advances agreements to mitigate the impact of customer demand by lengthening the maturities of these advances or entering into longer term repurchase agreements, depending on liquidity or investment opportunities.

 

FHLB advances are entered into as liquidity is needed or to fund assets that provide for a spread considered sufficient by management. If we are unable to originate adjustable rate assets at favorable rates or fund loan originations or securities purchases with long-term advances or structured borrowings, we may have difficulty executing this asset/liability management strategy and/or it may result in a reduction in profitability.

 

OTTI charges in our investment securities portfolio could result in losses and adversely affect our continuing operations. Our securities portfolio may be negatively impacted by fluctuations in market value and interest rates, which may have an adverse effect on our financial condition.

 

Our securities portfolio may be impacted by fluctuations in market value, potentially reducing accumulated other comprehensive income and/or earnings, which may materially adversely affect our stockholders’ equity, regulatory capital and continuing operations. Fluctuations in market value may be caused by decreases in interest rates, lower market prices for securities and limited investor demand, as well as the default rates of specific financial institutions whose securities provide the underlying collateral for these securities and changes in credit risk based on the condition of the issuer. The valuation of our investment securities also is influenced by the implementation of Securities and Exchange Commission and Financial Accounting Standards Board guidance on fair value accounting, which requires us to report our available for sale securities at their estimated fair value. Our stockholders’ equity is periodically adjusted by the amount of change in the estimated fair value of the available for sale securities, net of taxes. At December 31, 2017, the change in unrealized gains on securities available for sale from the level at December 31, 2016 was an increase of $2.4 million. When OTTI is present, the market environment more likely than not limits our ability to mitigate our exposure to valuation changes in these securities by selling them.

 

Our securities portfolio is evaluated for OTTI on at least a quarterly basis. If this evaluation shows impairment to the actual or projected cash flows associated with one or more securities, a potential loss to earnings may occur. We have not recorded any OTTI since 2011. As of December 31, 2017, we have no securities that are deemed impaired.

 

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If our investments in real estate are not properly valued or sufficiently reserved for to cover actual losses, or if we are required to increase our valuation reserves, our earnings could be reduced.

 

We obtain updated valuations in the form of appraisals and broker price opinions when a loan has been foreclosed and the property taken in as REO, and at certain other times during the assets holding period. Our net book value (“NBV”) in the loan at the time of foreclosure and thereafter is compared to the updated market value of the foreclosed property less estimated selling costs (fair value). A charge-off is recorded for any excess in the asset’s NBV over its fair value. If our valuation process is incorrect, the fair value of our investments in real estate may not be sufficient to recover our NBV in such assets, resulting in the need for additional charge-offs. Additional material charge-offs to our investments in real estate could have a material adverse effect on our financial condition and results of operations. Our regulators periodically review our REO and may require us to recognize further charge-offs. Any increase in our charge-offs, as required by our regulator, may have a material adverse effect on our financial condition and results of operations.

 

We face risks related to covenants in our loan sales to investors and secondary mortgage market conditions.

 

Our agreements with investors to sell our loans generally contain covenants that require us to repurchase loans under certain circumstances, including some delinquencies, or to return premiums paid by those investors if the loans are paid off early. If we are required to repurchase sold loans under these covenants, they may be deemed troubled loans, with the potential for charge-offs and/or loss provision changes, which could impact our earnings and asset quality ratios adversely. The Bank was not required to repurchase any loans from investors during 2017 or 2016.

 

Our ability to sell loans on the secondary mortgage market is impacted by interest rate changes and investor demand or expected return. If this market becomes less liquid, we may not be able to rely as much on loan sales to reduce our interest rate and credit risk.

 

We use estimates in determining the fair value of certain assets, such as mortgage servicing rights (“MSRs”). If our estimates prove to be incorrect, we may be required to write down the value of these assets which could adversely affect our earnings.

 

We sell a portion of our one- to four-family loans in the secondary market. We generally retain the right to service these loans through the Bank. At December 31, 2017, the book value of our MSRs was $1.5 million. We use a financial model that uses, wherever possible, quoted market prices to value our MSRs. This model is complex and also uses assumptions related to interest and discount rates, prepayment speeds, delinquency and foreclosure rates and ancillary fee income. Valuations are highly dependent upon the reasonableness of our assumptions and the predictability of the relationships that drive the results of the model. The primary risk associated with MSRs is that they will lose a substantial portion of their value as a result of higher than anticipated prepayments occasioned by declining interest rates. Conversely, these assets generally increase in value in a rising interest rate environment to the extent that prepayments are slower than anticipated. If prepayment speeds increase more than estimated or delinquency and default levels are higher than anticipated we may be required to write down the value of our MSRs which could have a material adverse effect on our net income and capital levels. The Company obtains independent valuations at least semi-annually to determine if impairment in the asset exists.

 

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Declining economic conditions may adversely impact the fees generated by our asset management and trust business.

 

To the extent our asset management and trust clients and their assets become adversely impacted by weak economic and stock market conditions, they may choose to withdraw the assets managed by us and/or the value of their assets may decline. Our asset management revenues are based on the value of the assets we manage. If our clients withdraw assets or the value of their assets decline, our revenues from these activities may be adversely affected. These fees totaled $4.0 million and $3.9 million in 2017 and 2016, respectively.

 

We face significant operational and reputational risks. As a community bank, maintaining our reputation in our market area is critical to the success of our business, and the failure to do so may materially adversely affect our performance. Our business may be adversely affected by an increasing prevalence of fraud and other financial crimes impacting the banking industry.

 

We are a community bank, and our reputation is one of the most valuable components of our business.  A key component of our business strategy is to rely on our reputation for customer service and knowledge of local markets to expand our presence by capturing new business opportunities from existing and prospective customers in our current market and contiguous areas.  As such, we strive to conduct our business in a manner that enhances our reputation. This is done, in part, by recruiting, hiring and retaining employees who share our core values of being an integral part of the communities we serve, delivering superior service to our customers and caring about our customers and associates.  We operate in many different financial service businesses and rely on the ability of our employees and systems to process a significant number of transactions. Operational risk is the risk of loss from operations, including fraud by employees or outside persons, employees’ execution of incorrect or unauthorized transactions, data processing and technology errors or hacking and breaches of internal control systems. If our reputation is negatively affected, by the actions of our employees, by our inability to conduct our operations in a manner that is appealing to current or prospective customers, or otherwise, our business and, therefore, our operating results may be materially adversely affected. Our loans to businesses and individuals and our deposit relationships and related transactions are subject to exposure to the risk of loss due to fraud and other financial crimes. Nationally, reported incidents of fraud and other financial crimes have increased. We have experienced an increase in losses due to apparent fraud and other financial crimes. Our policies and procedures designed to prevent such losses may not prevent all such losses. The Company continues to evaluate and implement new technologies; including, but not limited to, systems such as anti-skimming devices, new card technology, and monitoring systems that help to limit these types of instances.

 

Strong competition within our market area may limit our growth and profitability.

 

Competition in the banking and financial services industry is intense. In our market area, we compete with commercial banks, savings institutions, mortgage brokerage firms, credit unions, finance companies, mutual funds, insurance companies and brokerage and investment banking firms operating locally and elsewhere. Many of these competitors have national name recognition, greater resources and lending limits than we do and may offer certain services or prices for services that we do not or cannot provide. Our profitability depends upon our continued ability to successfully compete in our market.

 

The financial services industry could become even more competitive as a result of new legislative, regulatory and technological changes and continued consolidation. Banks, securities firms and insurance companies can merge under the umbrella of a bank holding company, which can offer virtually any type of financial service, including banking, securities underwriting, insurance (both agency and underwriting) and merchant banking. Also, technology has lowered barriers to entry and made it possible for non-banks to offer products and services traditionally provided by banks, such as automatic transfer and automatic payment systems. Many of our competitors have fewer regulatory constraints and may have lower cost structures. Additionally, due to their size, many competitors may be able to achieve economies of scale and, as a result, may offer a broader range of products and services as well as better pricing for those products and services than we can.

 

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A tightening of credit markets and liquidity risk could impair our ability to fund operations and jeopardize our financial condition.

 

Liquidity is essential to our business. A tightening of the credit markets and the inability to obtain adequate funding to replace deposits and fund continued loan growth may affect asset growth, our earnings capability and capital levels negatively. We rely on a number of different sources in order to meet our potential liquidity demands. Our primary sources of liquidity are increases in deposit accounts, including brokered deposits, as well as cash flows from loan payments and our securities portfolio. Borrowings, especially from the FHLB and repurchase agreements, also provide us with a source of funds to meet liquidity demands. An inability to raise funds through deposits, borrowings, the sale of loans and other sources could have a substantial negative effect on our liquidity. Our access to funding sources in amounts adequate to finance our activities or on terms that are acceptable to us could be impaired by factors that affect us specifically, or the financial services industry or economy in general. Factors that could detrimentally impact our access to liquidity sources include adverse regulatory action against us or a decrease in the level of our business activity as a result of a downturn in the markets in which our loans are concentrated. Our ability to borrow also could be impaired by factors that are not specific to us, such as a disruption in the financial markets, negative views and expectations about the prospects for the financial services industry in light of the recent turmoil faced by banking organizations or continued deterioration in credit markets.

 

Our core deposit premium could be deemed partially or fully impaired in the future, which would reduce our earnings and the values of that intangible asset.

 

At December 31, 2017, we had a core deposit premium of $71,000, due mainly to our 2008 acquisition of another financial institution. We also expect to record a core deposit premium in 2018 in connection with the merger with Universal. Under GAAP, we are required to periodically assess the value of this intangible asset based on a number of factors to determine if there is partial or full impairment. The factors taken into consideration include the market price of our stock, the net present value of our assets and liabilities and valuation information for similar financial institutions. This evaluation involves a substantial amount of judgment. If actual conditions underlying the factors differ from our assessment, the core deposit intangible could be subjected to faster amortization or partial or complete impairment, which would reduce the value of this asset and reduce our earnings, perhaps materially.

 

We currently hold a significant amount of bank-owned life insurance.

 

At December 31, 2017, we held $90.5 million of bank-owned life insurance or BOLI on key employees and executives, with a cash surrender value of $52.7 million. These policies are maintained to informally fund various benefit plans. The eventual repayment of the cash surrender value is subject to the ability of the various insurance companies to pay death benefits or to return the cash surrender value to us if needed for liquidity purposes. We continually monitor the financial strength of the various companies with whom we carry these policies. However, any one of these companies could experience a decline in financial strength, which could impair its ability to pay benefits or return our cash surrender value. If we need to liquidate these policies for liquidity purposes, we would be subject to taxation on the increase in cash surrender value and penalties for early termination, both of which would adversely impact earnings.

 

We may not be able to fully realize our deferred tax asset.

 

At December 31, 2017, we had a $7.5 million deferred income tax asset based on differences between the financial statement amounts and tax bases of assets and liabilities and reflecting mainly an allowance for loan loss timing difference and business tax and AMT carryover. The value of our deferred income tax benefit is reviewed regularly under various forecasts and assumptions, including anticipated levels of taxable net income, to determine the likelihood of realizing the benefit. If actual results or subsequent forecasts differ from our current judgments, to the extent that it becomes more likely than not that this benefit will not be fully realized, we would have to write down this asset, which would negatively impact results of operations and reduce our asset size.

 

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Transactions between the Company and its insurance subsidiary MutualFirst Risk Management, Inc. (the “Captive”), may be subject to certain IRS responsibilities and penalties.

 

The Captive is a Nevada-based, wholly-owned insurance subsidiary of the Company that provides property and casualty insurance coverage to the Company and the Bank as well as to 14 other third-party insurance captives for which insurance may not be available or economically feasible.  The Treasury Department of the United States and the IRS by way of Notice 2016-66 have stated that transactions believed similar in nature to transactions between the Company and the Captive may have the potential for tax avoidance or evasion and may be deemed by the IRS as an abusive tax structure subject to significant penalties, interest and possible criminal prosecution.

 

If our investment in the FHLB of Indianapolis becomes impaired, our earnings and stockholders’ equity could decrease.

 

At December 31, 2017, we owned $11.2 million in FHLB of Indianapolis stock. We are required to own this stock to be a member of and to obtain advances from our FHLB. This stock is not marketable and can only be redeemed by our FHLB. The most recent stock buyback initiated by FHLB was in 2015. Our FHLB’s financial condition is linked, in part, to the eleven other members of the FHLB System and to accounting rules and asset quality risks that could materially lower their capital, which would cause our FHLB stock to be deemed impaired, resulting in a decrease in our earnings and assets.

 

Changes in laws and regulations and the cost of regulatory compliance with new laws and regulations may adversely affect our operations and our income.

 

The Bank and the Company are subject to extensive regulation, supervision and examination by federal and state regulators, which have extensive discretion in connection with their supervisory and enforcement activities, including the ability to impose restrictions on a bank’s operations, reclassify assets, determine the adequacy of a bank’s allowance for loan losses and determine the level of deposit insurance premiums assessed. Because our business is highly regulated, the applicable laws and regulations are subject to frequent change. Any change in these laws, regulations and oversight, whether in the form of regulatory policy, new regulations or legislation or additional deposit insurance premiums, could have a material impact on our operations. See “Item 1 - How We Are Regulated.”

 

In response to the last financial crisis, Congress took actions that are intended to strengthen confidence and encourage liquidity in financial institutions, and the FDIC has taken actions to increase insurance coverage on deposit accounts. The Dodd-Frank Act created the CFPB.

 

The CFPB has examination and primary enforcement authority with respect to depository institutions with $10 billion or more in assets, their service providers and certain non-depository entities such as debt collectors and consumer reporting agencies. In the case of banks, such as the Bank, with total assets of less than $10 billion, this examination and enforcement authority is held by the institution’s primary federal banking regulator (the FDIC, in the case of the Bank).

 

The CFPB has finalized a number of significant rules that could have a significant impact on our business and the financial services industry more generally. In particular, the CFPB has adopted rules impacting nearly every aspect of the lifecycle of a residential mortgage loan. The CFPB has also issued guidance which could significantly affect the automotive financing industry by subjecting indirect auto lenders, such as the Bank, to regulation as creditors under the Equal Credit Opportunity Act, which would make indirect auto lenders monitor and control certain credit policies and procedures undertaken by auto dealers.

 

In the last economic downturn, federal and state banking regulators were active in responding to concerns and trends identified in examinations and have issued many formal enforcement orders requiring capital ratios in excess of regulatory requirements. The FDIC and IDFI regulate the activities in which the Bank may engage primarily for the protection of depositors and not for the protection or benefit of stockholders. In addition, new laws and regulations may increase our costs of regulatory compliance and of doing business and otherwise affect our operations. New laws and regulations may significantly affect the markets in which we do business, the markets for and value of our loans and investments, the fees we can charge and our ongoing operations, costs and profitability. Regulatory changes regarding card interchange fee income do not currently apply to us but could change in the future. Further, legislative proposals limiting our rights as a creditor could result in credit losses or increased expense in pursuing our remedies as a creditor.

 

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Increases in deposit insurance premiums and special FDIC assessments will negatively impact our earnings.

 

The Dodd-Frank Act established 1.35% of total insured deposits as the minimum reserve ratio for the FDIC Deposit Insurance Fund effective September 30, 2020. The FDIC adopted a plan under which it will meet this ratio by the statutory deadline and has reached a 1.28% as of September 30, 2017. The FDIC must offset the requirement that the minimum reserve ratio to reach 1.35% on institutions with assets less than $10 billion. To implement the offset requirement, FDIC regulations require that institutions with assets of $10 billion or more pay a surcharge during a temporary period and smaller institutions will receive credits whenever the reserve ratio reaches 1.38%. The FDIC has not announced how it will implement this offset. In addition to the statutory minimum ratio, the FDIC must set a designated reserve ratio or DRR, which may exceed the statutory minimum. The FDIC has set 2.0% as the DRR.

 

As required by the Dodd-Frank Act, the FDIC has adopted final regulations under which insurance premiums are based on an institution's total assets minus its tangible equity instead of its deposits. Since the implementation of these changes, we have seen a decline in our deposit insurance premiums. The insurance costs were $724,000, $788,000 and $897,000 for the years ended December 31, 2017, 2016 and 2015, respectively. Our future deposit insurance premiums may increase if the FDIC determines that it will not meet the required or anticipated minimum reserve ratios discussed, which could have a negative impact on our earnings.

 

Our accounting policies and methods impact how we report our financial condition and results of operations. Application of these policies and methods may require management to make estimates about matters that are uncertain.

 

Our accounting policies and methods are fundamental to how we record and report our financial condition and results of operations.  Our management must exercise judgment in selecting and applying many of these accounting policies and methods so they comply with generally accepted accounting principles and reflect management’s judgment of the most appropriate manner to report our financial condition and results of operations.  In some cases, management must select the accounting policy or method to apply from two or more alternatives, any of which might be reasonable under the circumstances yet might result in our reporting materially different amounts than would have been reported under a different alternative.  These accounting policies are critical to presenting our financial condition and results of operations. They may require management to make difficult, subjective or complex judgments about matters that are uncertain.  Materially different amounts could be reported under different conditions or using different assumptions.

 

Our controls and procedures may be ineffective.

 

We regularly review and update our internal controls, disclosure controls and procedures and corporate governance policies and procedures. As a result, we may incur increased costs to maintain and improve our controls and procedures. Any system of controls, however well designed and operated, is based in part on certain assumptions and can provide only reasonable, not absolute, assurances that the objectives of the system are met. Any failure or circumvention of our controls or procedures or failure to comply with regulations related to controls and procedures could have a material adverse effect on our business, results of operations or financial condition.

 

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System failure or breaches of our network security could subject us to increased operating costs as well as litigation and other liabilities.

 

The computer systems and network infrastructure we use could be vulnerable to unforeseen problems. Our operations are dependent upon our ability to protect our computer equipment against damage from physical theft, fire, power loss, telecommunications failure or a similar catastrophic event, as well as from security breaches, denial of service attacks, viruses, worms and other disruptive problems caused by hackers. Any damage or failure that causes an interruption in our operations could have a material adverse effect on our financial condition and results of operations. Computer break-ins, phishing and other disruptions could jeopardize the security of information stored in and transmitted through our computer systems and network infrastructure, which may result in significant liability to us and cause existing and potential customers to refrain from doing business with us. Although we, with the help of third-party service providers, intend to continue to implement security technology and establish operational procedures to prevent such damage, there can be no assurance that these security measures will be successful. Though the third-party vendors providing key components of our business infrastructure have been carefully chosen by us, we cannot control their actions, and their failures may impact the Bank’s ability to provide services to its customers and cause us to incur significant expense. In addition, advances in computer capabilities, new discoveries in the field of cryptography or other developments could result in a compromise or breach of the algorithms we and our third-party service providers use to encrypt and protect customer transaction data. A failure of such security measures could have a material adverse effect on our reputation, financial condition and results of operations.

 

We may elect or be compelled to seek additional capital in the future, but that capital may not be available when it is needed or on terms acceptable to us.

 

We are required by federal regulatory authorities to maintain adequate levels of capital to support our operations. In addition, we may elect to raise more capital to support our business or to finance acquisitions, if any, or we may otherwise elect or be required to raise additional capital. Should we be required by regulatory authorities to raise additional capital, we may seek to do so through the issuance of, among other things, our common stock or preferred stock. The issuance of additional shares of common stock or convertible securities to new stockholders would be dilutive to our current stockholders.

 

Our ability to raise additional capital, if needed, will depend on conditions in the capital markets, economic conditions and a number of other factors, many of which are outside our control, and on our financial performance. Accordingly, we cannot assure you of our ability to raise additional capital if needed or on terms acceptable to us. If we cannot raise additional capital when needed, or if the terms of such a capital raise are not advantageous, it may have a material adverse effect on our financial condition, results of operations and prospects.

 

There may be future sales of additional common stock or preferred stock or other dilution of our equity, which may adversely affect the market price of our common stock.

 

We are not restricted from issuing additional common stock or preferred stock, including any securities that are convertible into or exchangeable for, or that represent the right to receive, common stock or preferred stock or any substantially similar securities. The market value of our common stock could decline as a result of sales by us of a large number of shares of common stock or preferred stock or similar securities in the market or the perception that such sales could occur.

 

Our board of directors is authorized to allow us to issue additional common stock, as well as classes or series of preferred stock, generally without any action on the part of the stockholders. In addition, the board has the power, generally without stockholder approval, to set the terms of any such classes or series of preferred stock that may be issued, including voting rights, dividend rights and preferences over the common stock with respect to dividends or upon the liquidation, dissolution or winding-up of our business and other terms. If we issue additional preferred stock in the future that has a preference over the common stock with respect to the payment of dividends or upon liquidation, dissolution or winding-up, or if we issue additional preferred stock with voting rights that dilute the voting power of the common stock, the rights of holders of the common stock or the market value of the common stock could be adversely affected.

 

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Anti-takeover provisions could negatively impact our stockholders.

 

Provisions in our charter and bylaws, the corporate law of the State of Maryland and federal regulations could delay, defer or prevent a third party from acquiring us, despite the possible benefit to our stockholders, or otherwise adversely affect the market price of any class of our equity securities, including our common stock. These provisions include: a prohibition on voting shares of common stock beneficially owned in excess of 10% of total shares outstanding, supermajority voting requirements for certain business combinations with any person who beneficially owns more than 10% of our outstanding common stock; the election of directors to staggered terms of three years; advance notice requirements for nominations for election to our board of directors and for proposing matters that stockholders may act on at stockholder meetings, a requirement that only directors may fill a vacancy in our board of directors, supermajority voting requirements to remove any of our directors and the other provisions of our charter. Our charter also authorizes our board of directors to issue preferred stock, and preferred stock could be issued as a defensive measure in response to a takeover proposal. In addition, pursuant to federal and state laws and regulations, as a general matter, no person or company, acting individually or in concert with others, may acquire more than 10% of our common stock without prior approval from our regulators.

 

These provisions may discourage potential takeover attempts, discourage bids for our common stock at a premium over market price or adversely affect the market price of, and the voting and other rights of the holders of, our common stock. These provisions could also discourage proxy contests and make it more difficult for holders of our common stock to elect directors other than the candidates nominated by our board of directors.

 

The voting limitation provision in our charter could limit your voting rights as a holder of our common stock.

 

Our charter provides that any person or group who acquires beneficial ownership of our common stock in excess of 10% of the outstanding shares may not vote the excess shares. Accordingly, if you acquire beneficial ownership of more than 10% of the outstanding shares of our common stock, your voting rights with respect to the common stock will not be commensurate with your economic interest in the Company.

 

We rely on dividends from MutualBank for substantially all of the Company’s revenue.

 

MutualFirst’s primary source of revenue is dividends from the Bank. In certain instances, the IDFI must be notified of dividends made from the Bank to the Company and may choose to limit Bank dividends. If the Bank is unable to pay dividends, MutualFirst may not be able to service its debt, pay its other obligations or pay dividends on the Company’s common stock, which could have a material adverse impact on our financial condition or the value of your investment in our common stock.

 

Our common stock trading volume may not provide adequate liquidity for investors.

 

Our common stock is listed on the Nasdaq Global Market. However, the average daily trading volume in our common stock is less than that of many larger financial services companies. A public trading market having the desired depth, liquidity and orderliness depends on the presence of a sufficient number of willing buyers and sellers for our common stock at any given time. This presence is impacted by general economic and market conditions and investors’ views of our Company. Because our trading volume is limited, any significant sales of our shares could cause a decline in the price of our common stock.

 

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Our directors and executive officers have the ability to influence stockholder actions in a manner that may be adverse to the personal investment objectives of our stockholders.

 

As of December 31, 2017, our directors and executive officers as a group beneficially owned 1,605,356 shares, or 21.1%, of our common stock (including immediately exercisable options for 205,000 shares). In addition, our employee stock ownership and 401(k) plan controlled 5.5% of our common stock on that date. In addition, as of December 31, 2017, 58,003 shares were reserved under our current stock benefit plan for future awards for our directors, officers and employees. Due to this significant collective ownership of or control over our common stock, our directors and executive officers may be able to influence the outcome of director elections or block significant transactions, such as a merger or acquisition, or any other matter that might otherwise be favored by other stockholders and could prevent any stockholder action requiring a supermajority vote under our articles of incorporation.

 

Item 1B. Unresolved Staff Comments

 

Not applicable.

 

Item 2. Properties

 

At December 31, 2017 we had 27 full service offices. During 2017 we closed four of the full-service offices throughout our footprint. Our offices are located within east central and northern Indiana. At December 31, 2017, we owned our home office in Muncie, Indiana and all but two of our financial center offices. We lease offices in central and northern Indiana for our trust and brokerage services, financial center offices in Fort Wayne and Mishawaka, Indiana and loan origination offices in northwestern Indiana and southwest Michigan. The net book value of our investment in premises and leaseholds was approximately $18.8 million at December 31, 2017. We believe that our current facilities are adequate to meet our present and immediately foreseeable needs. See Note 7 of the Notes to Consolidated Financial Statements contained in Item 8 of this Form 10-K.

 

Item 3. Legal Proceedings

 

From time to time, we are involved as plaintiff or defendant in various legal actions arising in the normal course of business. We do not anticipate incurring any material liability as a result of such litigation. We are not a party to any pending legal proceedings that we believe would have a material adverse effect on our financial condition, results of operations or cash flows.

 

Item 4. Mine Safety Disclosure

 

Not applicable.

 

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PART II

 

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

 

The common stock of MutualFirst Financial, Inc. is traded under the symbol “MFSF” on the Nasdaq Global Market. The table below shows the high and low closing prices for our common stock for the periods indicated. This information was provided by the Nasdaq.

 

   Stock Price   Dividends 
   High   Low   per Share 
2017 Quarters:            
First Quarter (ended 03/31/17)  $33.55   $29.75   $0.16 
Second Quarter (ended 06/30/17)  $36.25   $31.25   $0.16 
Third Quarter (ended 09/30/17)  $38.65   $32.75   $0.16 
Fourth Quarter (ended 12/31/17)  $40.35   $36.55   $0.18 
                
2016 Quarters:               
First Quarter (ended 03/31/16)  $26.13   $22.75   $0.14 
Second Quarter (ended 06/30/16)  $28.20   $24.82   $0.14 
Third Quarter (ended 09/30/16)  $28.90   $27.10   $0.14 
Fourth Quarter (ended 12/31/16)  $34.90   $26.50   $0.16 

 

At December 31, 2017, there were 7,389,394 shares of common stock outstanding and approximately 3,300 common stockholders of record.

 

Our common stock cash dividend payout policy is continually reviewed by management and the Board of Directors. During 2017, the Company paid total common stock dividends of $0.66 per share, up from $0.58 per share in 2016. The Company intends to continue its policy of paying quarterly cash dividends and hopes to continue to pay dividends at least at the same level as in 2017. However, future common stock dividend payments will depend upon a number of factors, including capital requirements, regulatory limitations, the Company’s financial condition, results of operations, debt service on Company borrowings and the Bank’s ability to pay dividends to the Company. The Company relies significantly upon dividends from the Bank to accumulate earnings for payment of cash dividends to our common stockholders.

 

Information regarding our equity compensation plans is included in Part III, Item 12 of this Form 10-K.

 

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Shareholder Performance Graph Presentation

 

The following graph and related discussion are being furnished solely to accompany this Annual Report on Form 10-K pursuant to Item 201(e) of Regulation S-K and shall not be deemed to be “soliciting materials” or to be “filed” with the SEC (other than as provided in Item 201) nor shall this information be incorporated by reference into any future filing under the Securities Act or the Exchange Act, whether made before or after the date hereof and irrespective of any general incorporation language contained therein, except to the extent that the Company specifically incorporates it by reference into a filing.

 

The following graph shows a comparison of stockholder return on MutualFirst Financial Inc.’s common stock with the cumulative total returns for: 1) the Nasdaq Composite® (U.S.) Index; and 2) the SNL U.S. Bank and Thrift Index, which was compiled by SNL Financial LC of Charlottesville, Virginia. The graph assumes an initial investment of $100 and reinvestment of dividends. The graph is historical only and may not be indicative of possible future performance.

 

 

   Period Ending 
Index  12/31/12   12/31/13   12/31/14   12/31/15   12/31/16   12/31/17 
Mutual First Financial, Inc.   100.00    152.28    197.66    228.83    312.13    370.50 
NASDAQ Composite Index   100.00    140.12    160.78    171.97    187.22    242.71 
SNL U.S. Bank and Thrift Index   100.00    136.92    152.85    155.94    196.86    231.49 

 

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Item 6. Selected Financial and Other Data

 

SELECTED CONSOLIDATED FINANCIAL AND OTHER DATA

 

The following information is only a summary and you should read it in conjunction with our consolidated financial statements and accompanying notes contained in Item 8 of this Form 10-K. Balances have been updated to reflect the adoption of ASU 2014-01 in January 2015.

 

   At or For the Year Ended December 31, 
   2017   2016   2015   2014   2013 
   (Dollars in thousands) 
Selected Financial Condition Data:                         
Total assets  $1,588,932   $1,553,133   $1,478,265   $1,423,423   $1,391,405 
Cash and cash equivalents   27,341    26,860    20,915    29,575    25,285 
Loans, net   1,167,758    1,157,120    1,068,204    1,003,518    965,966 
Investment securities                         
Available for sale, at fair value   277,378    249,913    261,138    260,806    264,348 
Total deposits   1,202,034    1,153,382    1,091,382    1,079,320    1,113,084 
Total borrowings   221,395    244,780    235,075    202,616    153,818 
Total stockholders' equity   150,282    140,038    137,025    126,752    110,629 
                          
Selected Operations Data:                         
Total interest income  $58,868   $53,802   $51,776   $51,178   $51,667 
Total interest expense   10,611    9,247    8,803    8,923    11,224 
Net interest income   48,257    44,555    42,973    42,255    40,443 
Provision for loan losses   1,220    850    125    850    1,300 
Net interest income after provision for loan losses   47,037    43,705    42,848    41,405    39,143 
                          
Service fee income   6,584    6,124    5,947    5,995    5,989 
Gain on sale of loans and investment securities   4,595    5,784    4,612    2,162    1,687 
Other non-interest income   6,897    7,514    6,580    6,728    6,387 
Total non-interest income   18,076    19,422    17,139    14,885    14,063 
                          
Salaries and employee benefits   27,229    27,427    25,526    23,560    22,492 
Other expenses   18,776    18,073    17,621    17,818    17,195 
Total non-interest expenses   46,005    45,500    43,147    41,378    39,687 
Income before income taxes   19,108    17,627    16,840    14,912    13,519 
Income tax expense   6,793    4,386    4,578    3,866    4,136 
Net income   12,315    13,241    12,262    11,046    9,383 
Preferred stock dividends and accretion   -    -    -    -    1,257 
Net income available to common stockholders  $12,315   $13,241   $12,262   $11,046   $8,126 

 

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Quarter Ended  Interest Income   Interest
Expense
   Net Interest
Income
   Provision for
Loan Losses
   Net Income
Available to
Common
Shareholders
   Basic Earnings Per
Common Share
   Diluted Earnings
Per Common Share
 
                             
2017                                   
March 31  $14,109   $2,396   $11,713   $200   $3,206   $0.44   $0.43 
June 30   14,652    2,565    12,087    300    3,898    0.53    0.52 
September 30   15,026    2,762    12,264    370    3,751    0.51    0.50 
December 31   15,081    2,888    12,193    350    1,460    0.20    0.19 
                                    
Total  $58,868   $10,611   $48,257   $1,220   $12,315   $1.67   $1.64 
                                    
2016                                   
March 31  $13,034   $2,272   $10,762   $200   $2,365   $0.32   $0.31 
June 30   13,258    2,271    10,987    150    4,157    0.56    0.55 
September 30   13,567    2,330    11,237    250    3,482    0.48    0.47 
December 31   13,943    2,374    11,569    250    3,237    0.44    0.43 
                                    
Total  $53,802   $9,247   $44,555   $850   $13,241   $1.79   $1.76 
                                    
2015                                   
March 31  $12,683   $2,165   $10,518   $-   $2,481   $0.34   $0.33 
June 30   12,731    2,191    10,540    -    3,218    0.44    0.43 
September 30   13,049    2,233    10,816    -    3,225    0.44    0.43 
December 31   13,313    2,214    11,099    125    3,338    0.45    0.44 
                                    
Total  $51,776   $8,803   $42,973   $125   $12,262   $1.66   $1.62 

 

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Reconciliation of Non-GAAP Financial Measures

 

The annual report on Form 10-K contains financial information determined by methods other than in accordance with U.S. generally accepted accounting principles (“GAAP”). Non-GAAP financial measures, specifically tangible common equity, tangible assets, tangible book value per common share and return on average tangible common equity are used by management to measure the strength of its capital and its ability to generate earnings on tangible capital invested by its shareholders. Although the Company believes these non-GAAP measures provide a greater understanding of its business, they should not be considered a substitute for financial measures determined in accordance with GAAP, nor are they necessarily comparable to non-GAAP performance measures that may be presented by other companies. Reconciliations of these non-GAAP financial measures to the most directly compared GAAP financial measures are included in the following table.

 

   December 31, 
   2017   2016   2015 
Total Stockholders' Equity (GAAP)  $150,282   $140,038   $137,025 
Less: Intangible Assets   1,927    2,191    2,611 
Tangible common equity (non-GAAP)  $148,355   $137,847   $134,414 
                
Total assets (GAAP)  $1,588,932   $1,553,133   $1,478,265 
Less: Intangible Assets   1,927    2,191    2,611 
Tangible assets (non-GAAP)  $1,587,005   $1,550,942   $1,475,654 
                
Tangible common equity to tangible assets (non-GAAP)   9.35%   8.89%   9.11%
                
Book value per common share (GAAP)  $20.34   $19.12   $18.46 
Less: Effect of Intangible Assets   0.26    0.30    0.35 
Tangible book value per common share (non-GAAP)  $20.08   $18.82   $18.11 
                
Return on average stockholders' equity (GAAP)   8.40%   9.40%   9.29%
Add: Effect of Intangible Assets   0.12    0.16    0.20 
Return on average tangible common equity (non-GAAP)   8.52%   9.56%   9.49%
                
Total tax free interest income (GAAP)               
Loans receivable  $424   $443   $355 
Investment securities   2,752    2,193    1,541 
Total tax free interest income  $3,176   $2,636   $1,896 
Total tax free interest income, gross (at 34% tax rate)  $4,812   $3,994   $2,873 
                
Net interest margin (GAAP)               
Net interest income (GAAP)  $48,257   $44,555   $42,973 
Add: Tax effect tax free interest income at 34% tax rate   1,636    1,358    977 
Net interest income (non-GAAP)   49,893    45,913    43,950 
Divided by: Average interest-earning assets   1,473,968    1,405,326    1,336,622 
Net interest margin, tax equivalent   3.38%   3.27%   3.29%
                
Effective income tax rate   35.6%   24.9%   27.2%
Less: Effect on net deferred tax asset revaluation   10.5    -    - 
Adjusted effective income tax rate   25.1%   24.9%   27.2%
                
Ratio Summary:               
Return on average equity (ROE)   8.40%   9.40%   9.29%
Return on average tangible common equity   8.52%   9.56%   9.49%
Return on average assets (ROA)   0.78%   0.87%   0.85%
Tangible common equity to tangible assets   9.35%   8.89%   9.11%
Net interest margin, tax equivalent   3.38%   3.27%   3.29%

 

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Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operation

 

Overview and Significant Events in 2017

 

MutualFirst is a Maryland corporation and a bank holding company headquartered in Muncie, Indiana, with operations in Allen, Delaware, Elkhart, Grant, Kosciusko, Randolph, St. Joseph and Wabash counties in Indiana. It owns MutualBank, an Indiana commercial bank with 27 financial centers in Indiana, trust offices in Fishers and Crawfordsville, Indiana and a loan origination office in New Buffalo, Michigan. MutualFirst also owns MutualFirst Risk Management, a captive insurance company based in Nevada and Mutual Risk Advisors, an information security consulting firm based in Indiana.

 

MutualBank is an Indiana commercial bank subject to regulation, supervision and examination by the IDFI and the FDIC. MutualFirst is a bank holding company subject to examination, supervision and regulation by the FRB, which is subjected to regulatory capital requirements similar to those imposed on the Bank. For more details on these regulations see “Item 1. Business – How We Are Regulated.”

 

At December 31, 2017, we had $1.6 billion in assets, $1.2 billion in loans, $1.2 billion in deposits and $150.3 million in stockholders’ equity. The Company’s total risk-based capital ratio at December 31, 2017 was 13.5%, exceeding the 10.0% requirement for a well-capitalized institution. The ratio of average tangible common equity increased to 9.35% as of year-end 2017 compared to 8.89% at year-end 2016. For the year ended December 31, 2017, net income available to common shareholders was $12.3 million, or $1.67 per basic and $1.64 per diluted share, compared with net income available to common shareholders of $13.2 million, or $1.79 per basic and $1.76 per diluted share for 2016. The details of our 2017 performance are set forth below and in our Consolidated Audited Financial Statements contained in Item 8 of this Form 10-K.

 

Key aspects of our 2017 operations include:

 

·Commercial loan balances increased $21.8 million, or 4.8% in 2017.
·Non-real estate consumer loan balances increased $28.6 million, or 17.2% in 2017.
·Mortgage loans sold in 2017 of $134.4 million decreased compared to mortgage loans sold in 2016 of $152.1 million.
·Deposits increased $48.7 million, or 4.2% in 2017.
·Tangible book value per common share was $20.08 as of December 31, 2017 compared to $18.82 as of December 31, 2016.
·Net interest income increased $3.7 million in 2017 compared to 2016.
·Net interest margin for 2017 was 3.27% compared to 3.17% in 2016. Tax equivalent net interest margin was 3.38% for 2017 compared to 3.27% in 2016.
·Provision for loan losses increased by $370,000 to $1.2 million in 2017 compared to $850,000 in 2016.
·Non-interest income decreased $1.3 million in 2017 compared to 2016.
·Non-interest expense increased $505,000 in 2017 compared to 2016.

 

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

 

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MutualWealth is the wealth management division of the Bank providing a variety of fee-based financial services, including trust, investment, insurance, broker advisory, retirement plan and private banking services, in the Bank’s market area. MutualWealth produces non-interest income for the Bank that is tied primarily to the market value of the portfolios being managed. As of December 31, 2017, MutualWealth had $614.5 million of fiduciary assets and generated $4.0 million in commission income during 2017.

 

MutualFinancial Services is the brokerage division of the Bank providing a variety of fee-based financial services related to securities and investment transactions. MutualFinancial Services produces non-interest income for the Bank that is tied primarily to the volume of the transactions being processed. During 2017, MutualFinancial Services generated $893,000 in commission income.

 

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

 

The Company continues to reduce the impact of interest rate changes on its net interest income by shortening the term of its interest-earning assets to better match the terms of our interest-bearing liabilities and by selling long-term fixed rate loans and increasing the term of certain liabilities. See “Item 7A - Quantitative and Qualitative Disclosures About Market Risk - Asset and Liability Management and Market Risk” in this Form 10-K. It has been the Company’s strategic objective to change the repricing structure of its interest-earning assets from longer term to shorter term to better match the structure of our interest-bearing liabilities and therefore reduce the impact interest rate changes have on our net interest income. Strategies employed to accomplish this objective have been to increase the originations of variable rate commercial loans and shorter term consumer loans and to sell longer term mortgage loans. The percentage of non-residential consumer and commercial loans to total loans has increased from 52.9% at the end of 2016 to 56.5% as of December 31, 2017. We continued to see improvements in our markets during 2017 and made significant progress toward achieving our strategic target loan mix. On the liability side of the balance sheet, the Company is employing strategies intended to increase the balance of core deposit accounts, such as low cost checking and money market accounts. The percentage of core deposits to total deposits remained fairly consistent throughout the year. These are ongoing strategies that are dependent on current market conditions and competition. The Company lengthens the term to maturity of FHLB advances when advantageous to lengthen repricing of the liability side of the balance sheet in order to reduce interest rate risk exposure.

 

During 2017, in keeping with our strategic objective to reduce interest rate risk exposure, the Company also sold $134.4 million of long-term fixed rate loans, which reduced potential earning assets and therefore had a negative impact on net interest income. This was offset, in the short term, by recognizing a gain on the sale of these loans of $3.9 million.

 

Recent Accounting Standards

 

For discussion of recent accounting standards, please see Note 2: Impact of Accounting Pronouncements to our Consolidated Financial Statements in Item 8 of this Form 10-K.

 

Critical Accounting Policies

 

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

 

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The determination of the adequacy of the allowance for loan losses is based on estimates that are particularly susceptible to significant changes in the economic environment and market conditions. A worsening or protracted economic decline would increase the likelihood of additional losses due to credit and market risk and could create the need for additional loss reserves.

 

Allowance for Loan Losses. The allowance for loan losses is a significant estimate that can and does change based on management’s assumptions about specific borrowers and current general economic and business conditions, among other factors. Management reviews the adequacy of the allowance for loan losses on at least a quarterly basis. The evaluation by management includes consideration of past loss experience, changes in the composition of the loan portfolio, the current condition and amount of loans outstanding, identified problem loans and the probability of collecting all amounts due.

 

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

 

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

 

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

 

Goodwill is tested for impairment on an annual basis as of December 31, or whenever events or changes in circumstances indicate the carrying amount of goodwill exceeds its implied fair value. No events or changes in circumstances have occurred since the annual impairment test that would suggest is was more likely than not goodwill impairment existed.

 

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

 

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

 

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

 

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

 

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

 

Deferred Tax Asset. The Company has evaluated its deferred tax asset to determine if it is more likely than not that the asset will be utilized in the future. The Company’s most recent evaluation has determined that, except for the amounts represented by the valuation allowance as discussed below, the Company will more likely than not be able to utilize the remaining deferred tax asset. The Company has generated average positive pre-tax pre-provision earnings of $17.3 million, or 1.2% of pre-tax pre-provision ROA over the previous five years. These earnings would be sufficient to utilize portions of the operating losses, tax credit carryforwards and temporary tax differences over the allowable periods. The analysis supports no additional valuation reserve is needed.

 

The valuation allowance established is the result of net operating losses for state franchise tax purposes totaling $17.9 million. See Note 15 of the Notes to Consolidated Financial Statements contained in Item 8 of this Form 10-K.

 

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Income Tax Accounting. We file a consolidated federal income tax return. The provision for income taxes is based upon income in our consolidated financial statements, rather than amounts reported on our income tax return. Deferred tax assets and liabilities are recognized for future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect of a change in tax rates on our deferred tax assets and liabilities is recognized as income or expense in the period that includes the enactment date.

 

The Tax Cuts and Jobs Act (“Tax Act”) was enacted on December 22, 2017 reducing the Company’s federal corporate tax rate from 34% to 21%, effective January 1, 2018. At December 31, 2017, the Company has substantially completed its accounting for the tax effects of enactment of the Tax Act. For deferred tax assets and liabilities, amounts were remeasured based on the rates expected to reverse in the future, which is now 21%. Based on this new law, we recorded an additional tax expense of $2.0 million due to the revaluation of the company’s deferred tax asset.

 

Management Strategy

 

Our strategy is to operate as an independent, business- and retail- oriented financial institution dedicated to serving customers in our market area. Our commitment is to provide a broad range of products and services to meet the needs of our customers. As part of this commitment, we are looking to increase our emphasis on commercial business products and services. We also operate a fully interactive transactional website that also allows consumers to open accounts. In addition, we are continually looking at cost-effective ways to expand our market area. Financial highlights of our strategy have included:

 

Broadening Loan Portfolio Diversification. We continue to work toward diversifying our loan portfolio to reduce our reliance on any one type of loan. Approximately 52.9% of our loan portfolio consisted of loans other than consumer real estate loans at the end of 2016. At the end of 2017, that percentage had increased to 56.5%, reflecting an increase of $50.4 million in our commercial and non-residential consumer loan portfolios.

 

Continuing as a Leading One- to Four-Family Lender in Indiana. We are one of the largest originators of one- to four-family residential loans in our market area. During 2017, we originated $187.2 million of one- to four-family residential first mortgage loans. While the last economic downturn decreased real estate values, we have seen a stabilization and slight increase in our market areas which is leading to an increase in purchase activity as rates have remained low.

 

Increasing Market Share and Changing Mix of Deposits. We continue to be focused on growth of core deposits, as deposits grew $48.7 million in 2017.

 

Expanding Wealth Management Presence. We continue to focus on leveraging our operations in the markets in which we serve. Total fiduciary balances remained consistent with that of year-end 2016. Commission income (non-interest income) generated by these relationships during 2017 totaled $4.0 million.

 

Financial Condition at December 31, 2017 Compared to December 31, 2016

 

General. Total assets at year-end 2017 were $1.6 billion, reflecting a $35.8 million increase during the year, primarily due to the increase in the investment portfolio of $27.5 million and the $14.0 million, or 1.2% increase in the gross loan portfolio, excluding loans held for sale. Average interest-earning assets increased $68.7 million, or 4.9%, to $1.5 billion at December 31, 2017 from $1.4 billion at December 31, 2016. Average interest-bearing liabilities increased by $42.2 million, or 3.6% to $1.2 billion at year-end 2017 from $1.2 billion at year-end 2016 reflecting an increase in total deposits. Average stockholders’ equity increased by $5.7 million, or 4.0%, during 2017.

 

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Cash and Investments. Cash and investments increased $28.8 million from $277.8 million at year-end 2016 to $306.6 million at year-end 2017. The details of our cash and investments are as follows:

 

   At December 31,   Amount   Percent 
   2017   2016   Change   Change 
   (Dollars in thousands) 
Cash  $8,763   $8,503   $260    3.06%
Interest-bearing demand deposits   18,578    18,357    221    1.20 
Interest-bearing time deposits   1,853    993    860    86.61 
Securities available for sale (fair value)   277,378    249,913    27,465    10.99 
Total  $306,572   $277,766   $28,806    10.37%

 

At December 31, 2017, our investment portfolio consisted of $155.0 million in government-sponsored agency and government-sponsored entity mortgage-backed securities and collateralized mortgage obligations, $110.5 million in municipal securities and $11.8 million in corporate obligations. At December 31, 2017, these securities had gross unrealized gains of $4.1 million and gross unrealized losses of $3.5 million, of which $1.2 million was primarily due to unrealized losses on trust preferred securities. We have the ability to hold the trust preferred securities until maturity and believe that we will be able to collect the adjusted amortized cost basis of the securities. See Note 4 of the Notes to Consolidated Financial Statements in Item 8 of this Form 10-K for additional information about our investment securities.

 

Loans. Our gross loan portfolio, excluding loans held for sale, increased $14.1 million remaining consistent at approximately $1.2 billion at year-end 2017 and 2016. The following table reflects the changes in the gross amount of loans, excluding loans held for sale, by type during 2017:

 

   At December 31,   Amount   Percent 
   2017   2016   Change   Change 
   (Dollars in thousands) 
Real estate                    
Commercial  $318,684   $302,577   $16,107    5.32%
Commercial construction and development   28,164    22,453    5,711    25.44 
Consumer closed end first mortgage   444,243    478,848    (34,605)   (7.23)
Consumer open end and junior liens   69,477    71,222    (1,745)   (2.45)
Total real estate loans   860,568    875,100    (14,532)   (1.66)
                     
Consumer loans                    
Auto   19,640    18,939    701    3.70 
Boat/RV   169,238    141,602    27,636    19.52 
Other   6,188    5,892    296    5.02 
Total consumer other   195,066    166,433    28,633    17.20 
Commercial and industrial   131,079    131,103    (24)   (0.02)
Total other loans   326,145    297,536    28,609    9.62 
Total loans  $1,186,713   $1,172,636   $14,077    1.20%

 

The Bank made significant progress in its strategy to increase commercial and consumer loans as we increased the commercial portfolio by $21.8 million and the non-residential consumer portfolio by $28.6 million during 2017. We actively seek out opportunities to provide financing for new and growing commercial borrowers, as well as refinancing to sound commercial borrowers currently served by other financial institutions. The increase in the commercial and consumer portfolios was offset by selling $134.4 million of consumer residential mortgage loans including an $18.5 million portfolio mortgage loan sale during the period and a decline in residential mortgage loan originations as rates are starting to slowly increase. The Bank continues to sell longer term fixed-rate mortgage loans to reduce related interest rate risk.

 

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Delinquencies and Non-performing Assets. As of December 31, 2017, our total loans delinquent 30-to-89 days was $15.6 million, or 1.3% of total loans, compared to $12.3 million, or 1.1% of total loans, at the end of 2016.

 

At December 31, 2017, our non-performing assets totaled $6.0 million, or 0.38% of total assets, compared to $6.6 million, or 0.42% of total assets, at December 31, 2016. This $596,000, or 9.1%, decrease was due to a decrease in non-performing loans primarily in the consumer residential mortgage loan portfolio. The table below sets forth the amounts and categories of non-performing assets in our loan portfolio at the dates indicated.

 

   At December 31,   Amount   Percent 
   2017   2016   Change   Change 
   (Dollars in thousands) 
Non-accruing loans  $5,220   $5,144   $76    1.48%
Accruing loans delinquent 90 days or more   31    237    (206)   (86.92)
Other real estate owned and repossessed assets   733    1,199    (466)   (38.87)
Total  $5,984   $6,580   $(596)   (9.06)%

 

Our non-performing assets decreased in 2017 primarily due to a decrease of $466,000 in other real estate owned and repossessed assets from $6.5 million at December 31, 2016 to $6.0 million at December 31, 2017. The Bank continues to diligently monitor and write down loans that appear to have irreversible weakness. The Bank works to ensure possible problem loans have been identified and steps have been taken to reduce loss by restructuring loans to improve cash flow or by increasing collateral. Total classified assets increased by 51.8% from $11.4 million at December 31, 2016 to $17.3 million at December 31, 2017. The increase in total classified loans was primarily the result of a $4.9 million increase in commercial and industrial loans classified as substandard credits. These credits were performing as agreed as of December 31, 2017.

 

At December 31, 2017, foreclosed real estate totaled $251,000. All foreclosed real estate properties were one- to four-family residential properties within our footprint. The Bank has seen improvement in this portfolio as market values have stabilized, which has decreased the number of new foreclosures and assisted in our sale of existing commercial and residential properties. All foreclosed real estate is currently for sale. At the end of 2017, the Bank also held $482,000 in other repossessed assets, such as autos, boats, RVs and horse trailers.

 

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Allowance for Loan Loss. Allowance for loan losses increased $5,000 from $12.4 million at December 31, 2016 to $12.4 million December 31, 2017 as reflected below:

 

   Year Ended December 31, 
   2017   2016 
   (Dollars in thousands) 
Balance at beginning of period  $12,382   $12,641 
Charge-offs   1,412    1,482 
Recoveries   197    373 
Net charge-offs   1,215    1,109 
Provisions charged to operations   1,220    850 
Balance at end of period  $12,387   $12,382 
           
Ratio of net charge-offs during the period to average loans outstanding during the period   0.10%   0.10%
           
Allowance as a percentage of non-performing loans   235.90%   230.99%
Allowance as a percentage of total loans (end of period)   1.05%   1.06%

 

Specific loan loss allocation related to loans that have been individually evaluated for impairment remained unchanged throughout the year, and general loan loss reserves have increased $5,000 as the non-performing loans and classified assets have remained consistent from 2016 to 2017. Net charge-offs for the year 2017 were $1.2 million, or 0.10% of average loans on an annualized basis, compared to $1.1 million, or 0.10% of average loans, for 2016. As of December 31, 2017, the allowance for loan losses as a percentage of loans receivable and non-performing loans was 1.05% and 235.9%, respectively, compared to 1.06% and 230.1%, respectively, at December 31, 2016. Allowance for loan losses as a percentage of loans receivable decreased primarily due to an increase in the total loan portfolio. Allowance for loan losses as a percentage of non-performing loans increased due to the decrease in non-performing loans as of December 31, 2017. The increase in the allowance was primarily due to management’s ongoing evaluation of the loan portfolio conditions in our market areas.

 

Other Assets. Other material changes in our assets during 2017 include a decrease in deferred tax asset of $4.5 million primarily due to the revaluation and write down of the deferred tax asset to reflect the signing of the Tax Cuts and Jobs Act that resulted in an increase in income tax expense of $2.0 million in the fourth quarter of 2017 due to the reduction in the federal corporate income tax rate to 21%, effective January 1, 2018. The decrease in deferred tax asset was also due to the change in and utilization of temporary differences such as change in securities available for sale, the use of tax credit carryovers and other temporary differences.

 

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Deposits. Total deposits increased $48.7 million to $1.2 billion at year-end 2017 compared to $1.2 billion at year-end 2016, primarily due to increased interest-bearing NOW accounts and non-interest checking accounts, as reflected in the table below, with corresponding weighted average rates as of the same date. The changes reflected below are consistent with the Bank’s strategy to grow and strengthen core deposit relationships.

 

   At December 31,         
   2017   2016         
   Amount   Weighted
Average
Rate
   Amount   Weighted
Average
Rate
   Amount
Change
   Percent
Change
 
   (Dollars in thousands)         
Type of Account:                        
Non-interest Checking  $194,134    0.00%  $178,046    0.00%  $16,088    9.04%
Interest-bearing NOW   330,821    0.52    292,977    0.27    37,844    12.92 
Savings   138,348    0.01    136,314    0.01    2,034    1.49 
Money Market   167,574    0.46    173,305    0.26    (5,731)   (3.31)
Certificates of Deposit   371,157    1.42    372,740    1.19    (1,583)   (0.42)
Total  $1,202,034    0.65%  $1,153,382    0.49%  $48,652    4.22%

 

Borrowings. Total borrowings decreased $23.4 million, or 9.6%, to $221.4 million at year-end 2017 primarily due to a $23.4 million decrease in FHLB advances due to increases in total deposits. Other borrowings, increased $43,000 to $4.2 million at year-end 2017.

 

The Company acquired $5.0 million of issuer trust preferred securities in a 2008 acquisition of another financial institution, which had a net balance of $4.2 million at December 31, 2017 due to the purchase accounting adjustment in the acquisition. These securities mature 30 years from the date of issuance or September 15, 2035. The securities bore a variable rate based quarterly at the prevailing three-month LIBOR rate plus 170 basis points, which was 3.29%. The Company has had the right to redeem the trust preferred securities, in whole or in part, without penalty, since September 2010.

 

Stockholders’ Equity. Stockholders’ equity was $150.3 million as of December 31, 2017, an increase of $10.2 million from December 31, 2016. The increase was primarily due to net income available to common shareholders of $12.3 million and an increase of $1.2 million due to exercises of stock options. These increases were partially offset by cash dividends of $4.9 million. The Company’s tangible book value per common share as of December 31, 2017 increased to $20.08 compared to $18.82 as of December 31, 2016 and the tangible common equity ratio increased to 9.35% as of December 31, 2017 compared to 8.89% as of December 31, 2016. The Company and the Bank’s risk-based capital ratios were well in excess of “well-capitalized” levels as defined by all regulatory standards as of December 31, 2017.

 

Financial Condition at December 31, 2016 Compared to December 31, 2015

 

General. Total assets at year-end 2016 were $1.6 billion, reflecting a $74.9 million increase during the year, primarily due to the $89.2 million, or 8.2% increase in the gross loan portfolio, excluding loans held for sale. Average interest-earning assets increased $68.7 million, or 5.1%, to $1.4 billion at December 31, 2016 from $1.3 billion at December 31, 2015. Average interest-bearing liabilities increased by $46.8 million, or 4.1% to $1.2 billion at year-end 2016 from $1.1 billion at year-end 2015 reflecting an increase in FHLB advances. Average stockholders’ equity increased by $8.9 million, or 6.7%, during 2016.

 

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Cash and Investments. Cash and investments decreased from $282.1 million at year-end 2015 to $277.8 million at year-end 2016. The details of our cash and investments are as follows:

 

   At December 31,   Amount   Percent 
   2016   2015   Change   Change 
   (Dollars in thousands) 
Cash  $8,503   $8,610   $(107)   (1.24)%
Interest-bearing demand deposits   18,357    12,305    6,052    49.18 
Interest-bearing time deposits   993    -    993    0.00 
Securities available for sale (fair value)   249,913    261,138    (11,225)   (4.30)
Total  $277,766   $282,053   $(4,287)   (1.52)%

 

At December 31, 2016, our investment portfolio consisted of $160.5 million in government-sponsored agency and government-sponsored entity mortgage-backed securities and collateralized mortgage obligations, $77.7 million in municipal securities and $11.7 million in corporate obligations. At December 31, 2016, these securities had gross unrealized gains of $2.8 million and gross unrealized losses of $4.7 million, of which $3.5 million was primarily due to unrealized losses associated with the increase in treasury rates near the end of the year. We have the ability to hold the trust preferred securities until maturity and believe that we will be able to collect the adjusted amortized cost basis of the securities. See Note 4 of the Notes to Consolidated Financial Statements in Item 8 of this Form 10-K for additional information about our investment securities.

 

Loans. Our gross loan portfolio, excluding loans held for sale, increased to $1.2 billion at year-end 2016 from $1.1 billion at year-end 2015. The following table reflects the changes in the gross amount of loans, excluding loans held for sale, by type during 2016:

 

   At December 31,   Amount   Percent 
   2016   2015   Change   Change 
   (Dollars in thousands) 
Real estate                    
Commercial  $302,577   $236,895   $65,682    27.73%
Commercial construction and development   22,453    15,744    6,709    42.61 
Consumer closed end first mortgage   478,848    491,451    (12,603)   (2.56)
Consumer open end and junior liens   71,222    70,990    232    0.33 
Total real estate loans   875,100    815,080    60,020    7.36 
                     
Consumer loans                    
Auto   18,939    15,480    3,459    22.34 
Boat/RV   141,602    123,621    17,981    14.55 
Other   5,892    6,171    (279)   (4.52)
Total consumer other   166,433    145,272    21,161    14.57 
Commercial and industrial   131,103    123,043    8,060    6.55 
Total other loans   297,536    268,315    29,221    10.89 
Total loans  $1,172,636   $1,083,395   $89,241    8.24%

 

The Bank made significant progress in its strategy to increase commercial and consumer loans as we increased the commercial portfolio by $80.5 million and the non-residential consumer portfolio by $21.2 million during 2016. We actively seek out opportunities to provide financing for new and growing commercial borrowers, as well as refinancing to sound commercial borrowers currently served by other financial institutions. The increase in the commercial and consumer portfolios was partially offset by the decrease in one- to four-family loans during the period. We increased our purchase loan activity while also allowing consumers to refinance their mortgage loans; however, we are starting to see those activities slow down as rates are starting to slowly increase. The Bank continues to sell longer term fixed-rate mortgage loans to reduce related interest rate risk.

 

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Delinquencies and Non-performing Assets. As of December 31, 2016, our total loans delinquent 30-to-89 days was $12.3 million, or 1.1% of total loans, compared to $12.0 million, or 1.1% of total loans, at the end of 2015.

 

At December 31, 2016, our non-performing assets totaled $6.6 million, or 0.42% of total assets, compared to $9.6 million, or 0.65% of total assets, at December 31, 2015. This $3.0 million, or 31.7%, decrease was due to a decrease in non-performing loans primarily in the commercial real estate portfolio. The table below sets forth the amounts and categories of non-performing assets in our loan portfolio at the dates indicated.

 

   At December 31,   Amount   Percent 
   2016   2015   Change   Change 
   (Dollars in thousands) 
Non-accruing loans  $5,144   $6,904   $(1,760)   (25.49)%
Accruing loans delinquent 90 days or more   237    267    (30)   (11.24)
Other real estate owned and repossessed assets   1,199    2,456    (1,257)   (51.18)
Total  $6,580   $9,627   $(3,047)   (31.65)%

 

Our non-performing assets decreased in 2016 as local economic conditions improved. The Bank continues to diligently monitor and write down loans that appear to have irreversible weakness. The Bank works to ensure possible problem loans have been identified and steps have been taken to reduce loss by restructuring loans to improve cash flow or by increasing collateral. In addition to the decrease in non-performing assets, the Company has seen significant improvement during the year in total classified assets. Total classified assets decreased by 33.9% from $17.5 million at December 31, 2015 to $11.4 million at December 31, 2016.

 

At December 31, 2016, foreclosed real estate totaled $718,000 and consisted of primarily one- to four-family residential properties within our footprint. The Bank has seen improvement in this portfolio as market values have stabilized, which has decreased the number of new foreclosures and assisted in our sale of existing commercial and residential properties. At December 31, 2016, the Bank had 10 foreclosed residential properties with a book value totaling $552,000. All foreclosed real estate is currently for sale. At the end of 2016, the Bank also held $481,000 in other repossessed assets, such as autos, boats, RVs and horse trailers.

 

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Allowance for Loan Loss. Allowance for loan losses decreased $259,000 from $12.6 million at December 31, 2015 to $12.4 million December 31, 2016 as reflected below:

 

   Year Ended December 31, 
   2016   2015 
   (Dollars in thousands) 
Balance at beginning of period  $12,641   $13,168 
Charge-offs   1,482    1,387 
Recoveries   373    735 
Net charge-offs   1,109    652 
Provisions charged to operations   850    125 
Balance at end of period  $12,382   $12,641 
           
Ratio of net charge-offs during the period to average loans outstanding during the period   0.10%   0.06%
           
Allowance as a percentage of non-performing loans   230.99%   176.28%
Allowance as a percentage of total loans (end of period)   1.06%   1.17%

 

Specific loan loss allocation related to loans that have been individually evaluated for impairment remained unchanged throughout the year, and general loan loss reserves have decreased $259,000 as the non-performing loans and classified assets have improved. Net charge-offs for the year 2016 were $1.1 million, or 0.10% of average loans on an annualized basis, compared to $652,000, or 0.06% of average loans, for 2015. As of December 31, 2016, the allowance for loan losses as a percentage of loans receivable and non-performing loans was 1.06% and 230.1%, respectively, compared to 1.17% and 176.3%, respectively, at December 31, 2015. Allowance for loan losses as a percentage of loans receivable decreased primarily due to an increase in the total loan portfolio. Allowance for loan losses as a percentage of non-performing loans increased due to the decrease in non-performing loans as of December 31, 2016. The decrease in the allowance was primarily due to management’s ongoing evaluation of the loan portfolio conditions in our market areas.

 

Other Assets. Other material changes in our assets during 2016 include a decrease in premises and equipment of $9.8 million primarily due to the sale of an office building, we owned and occupied, in December 2016 and the closing of several financial centers locations that will be finalized in the first quarter of 2017. These transactions produced a $426,000 gain and a $215,000 loss, respectively, in 2016.

 

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Deposits. Total deposits increased $62.0 million to $1.2 billion at year-end 2016 compared to $1.1 billion at year-end 2015, primarily due to increased interest-bearing checking accounts and certificates of deposit, as reflected in the table below, with corresponding weighted average rates as of the same date. The changes reflected below are consistent with the Bank’s strategy to grow and strengthen core deposit relationships.

 

   At December 31,         
   2016   2015         
   Amount   Weighted
Average
Rate
   Amount   Weighted
Average
Rate
   Amount
Change
   Percent
Change
 
   (Dollars in thousands)         
Type of Account:                        
Non-interest Checking  $178,046    0.00%  $179,542    0.00%  $(1,496)   (0.83)%
Interest-bearing NOW   292,977    0.27    267,089    0.23    25,888    9.69 
Savings   136,314    0.01    131,578    0.01    4,736    3.60 
Money Market   173,305    0.26    162,551    0.20    10,754    6.62 
Certificates of Deposit   372,740    1.19    350,622    1.14    22,118    6.31 
Total  $1,153,382    0.49%  $1,091,382    0.45%  $62,000    5.68%

 

Borrowings. Total borrowings increased $9.7 million, or 4.1%, to $244.8 million at year-end 2016 primarily due to a $15.0 million increase in FHLB advances to fund increases in the loan portfolio. Other borrowings, decreased $5.3 million to $4.2 million at year-end 2016 due to pre-payment of a holding company note with FTN, leaving outstanding a subordinate debenture.

 

The Company acquired $5.0 million of issuer trust preferred securities in a 2008 acquisition of another financial institution, which had a net balance of $4.2 million at December 31, 2016 due to the purchase accounting adjustment in the acquisition. These securities mature 30 years from the date of issuance or September 15, 2035. The securities bore a variable rate based quarterly at the prevailing three-month LIBOR rate plus 170 basis points, which was 2.66%. The Company has had the right to redeem the trust preferred securities, in whole or in part, without penalty, since September 2010.

 

Stockholders’ Equity. Stockholders’ equity was $140.0 million as of December 31, 2016, an increase of $3.0 million from December 31, 2015. The increase was primarily due to net income available to common shareholders of $13.2 million and an increase of $976,000 due to exercises of stock options. These increases were partially offset by cash dividends of $4.3 million and stock repurchases of $4.4 million. The Company’s tangible book value per common share as of December 31, 2016 increased to $18.81 compared to $18.11 as of December 31, 2015 and the tangible common equity ratio decreased to 8.89% as of December 31, 2016 compared to 9.11% as of December 31, 2015. The Company and the Bank’s risk-based capital ratios were well in excess of “well-capitalized” levels as defined by all regulatory standards as of December 31, 2016.

 

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Average Balances and Net Interest Margin

 

The following table presents for the periods indicated the total dollar amount of interest income from average interest-earning assets and the resultant yields, as well as the interest expense on average interest-bearing liabilities, expressed both in dollars and rates. All average balances are daily average balances. Non-accruing loans have been included in the table as loans carrying a zero yield.

 

   Year ended December 31, 
   2017   2016   2015 
   Average
Outstanding
Balance
   Interest
Earned/Paid