Document


UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
FORM 10-Q
 
(Mark One)
þ
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the Quarterly Period ended September 30, 2018
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 001-35750 
First Internet Bancorp
(Exact Name of Registrant as Specified in Its Charter)
Indiana
 
20-3489991
(State or Other Jurisdiction of
Incorporation or Organization)
 
(I.R.S. Employer
Identification No.)
 
 
 
11201 USA Parkway
Fishers, IN
 
46037
(Address of Principal Executive Offices)
 
(Zip Code)
 
(317) 532-7900
 
 
(Registrant’s Telephone Number, Including Area Code)
 
 
 
 
 
(Former Name, Former Address and Former Fiscal Year,
if Changed Since Last Report)
 
  
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 þ No ¨
 
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes þ No ¨
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.
Large Accelerated Filer ¨
Accelerated Filer þ
Non-accelerated Filer ¨ 
Smaller Reporting Company ¨
Emerging growth company ¨
 

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

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ No þ
 
As of November 2, 2018, the registrant had 10,181,675 shares of common stock issued and outstanding.




Cautionary Note Regarding Forward-Looking Statements
  
This Quarterly Report on Form 10-Q contains “forward-looking statements” within the meaning of the federal securities laws. These statements are not historical facts, but rather statements based on the current expectations of First Internet Bancorp and its consolidated subsidiaries (“we,” “our,” “us” or the “Company”) regarding its business strategies, intended results and future performance. Forward-looking statements are generally preceded by terms such as “anticipate,” “believe,” “can,” “estimate,” “expect,” “intend,” “may,” “plan,” “should” and similar expressions. Such statements are subject to certain risks and uncertainties including: general economic conditions, whether national or regional, and conditions in the lending markets in which we participate that may have an adverse effect on the demand for our loans and other products; our credit quality and related levels of nonperforming assets and loan losses, and the value and salability of the real estate that we own or that is the collateral for our loans; failures or breaches of or interruptions in the communication and information systems on which we rely to conduct our business that could reduce our revenues, increase our costs or lead to disruptions in our business; our plans to grow our commercial real estate, commercial and industrial, public finance and healthcare finance loan portfolios which may carry greater risks of non-payment or other unfavorable consequences; our dependence on capital distributions from First Internet Bank of Indiana (the “Bank”); results of examinations of us by our regulators, including the possibility that our regulators may, among other things, require us to increase our allowance for loan losses or to write-down assets; changing bank regulatory conditions, policies or programs, whether arising as new legislation or regulatory initiatives, that could lead to restrictions on activities of banks generally, or the Bank in particular; more restrictive regulatory capital requirements; increased costs, including deposit insurance premiums; regulation or prohibition of certain income producing activities or changes in the secondary market for loans and other products; changes in market rates and prices that may adversely impact the value of securities, loans, deposits and other financial instruments and the interest rate sensitivity of our balance sheet; our liquidity requirements being adversely affected by changes in our assets and liabilities; the effect of legislative or regulatory developments, including changes in laws concerning taxes, banking, securities, insurance and other aspects of the financial services industry; competitive factors among financial services organizations, including product and pricing pressures and our ability to attract, develop and retain qualified banking professionals; execution of future acquisition, reorganization or disposition transactions including without limitation, the related time and costs of implementing such transactions, integrating operations as part of these transactions and possible failures to achieve expected gains, revenue growth and/or expense savings and other anticipated benefits from such transactions; changes in applicable tax laws; the growth and profitability of noninterest or fee income being less than expected; the loss of any key members of senior management; the effect of changes in accounting policies and practices, as may be adopted by the Financial Accounting Standards Board (the “FASB”), the Securities and Exchange Commission (the “SEC”), the Public Company Accounting Oversight Board (the “PCAOB”) and other regulatory agencies; and the effect of fiscal and governmental policies of the United States federal government. Additional factors that may affect our results include those discussed in our most recent Annual Report on Form 10-K under the heading “Risk Factors” and in other reports filed with the SEC. We caution readers not to place undue reliance on any such forward-looking statements, which speak only as of the date made. The factors listed above could affect our financial performance and could cause our actual results for future periods to differ materially from any opinions or statements expressed with respect to future periods in any current statements.
Except as required by law, we do not undertake, and specifically disclaim 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 anticipated or unanticipated events.


i



PART I

ITEM 1.
FINANCIAL STATEMENTS 

First Internet Bancorp
Condensed Consolidated Balance Sheets
(Amounts in thousands except share data)
 
 
September 30, 2018
 
December 31, 2017
 
 
(Unaudited)
 
 
Assets
 
 

 
 

Cash and due from banks
 
$
3,517

 
$
4,539

Interest-bearing deposits
 
82,273

 
43,442

Total cash and cash equivalents
 
85,790

 
47,981

Securities available-for-sale, at fair value (amortized cost of $491,726 and $481,357 in 2018 and 2017, respectively)
 
468,997

 
473,275

Securities held-to-maturity, at amortized cost (fair value of $19,510 and $19,083 in 2018 and 2017, respectively)
 
20,200

 
19,209

Loans held-for-sale (includes $23,493 and $23,571 at fair value in 2018 and 2017, respectively)
 
23,493

 
51,407

Loans
 
2,493,622

 
2,091,193

Allowance for loan losses
 
(16,704
)
 
(14,970
)
Net loans
 
2,476,918

 
2,076,223

Accrued interest receivable
 
14,472

 
11,944

Federal Home Loan Bank of Indianapolis stock
 
22,050

 
19,575

Cash surrender value of bank-owned life insurance
 
35,819

 
35,105

Premises and equipment, net
 
10,041

 
10,058

Goodwill
 
4,687

 
4,687

Other real estate owned
 
5,041

 
5,041

Accrued income and other assets
 
35,410

 
13,182

Total assets
 
$
3,202,918

 
$
2,767,687

Liabilities and Shareholders’ Equity
 
 

 
 

Liabilities
 
 

 
 

Noninterest-bearing deposits
 
$
42,750

 
$
44,686

Interest-bearing deposits
 
2,403,814

 
2,040,255

Total deposits
 
2,446,564

 
2,084,941

Advances from Federal Home Loan Bank
 
425,160

 
410,176

Subordinated debt, net of unamortized discounts and debt issuance costs of $1,163 and $1,274 in 2018 and 2017, respectively
 
33,837

 
36,726

Accrued interest payable
 
887

 
311

Accrued expenses and other liabilities
 
8,730

 
11,406

Total liabilities
 
2,915,178

 
2,543,560

Commitments and Contingencies
 


 


Shareholders’ Equity
 
 

 
 

Preferred stock, no par value; 4,913,779 shares authorized; issued and outstanding - none
 

 

Voting common stock, no par value; 45,000,000 shares authorized; 10,181,675 and 8,411,077 shares issued and outstanding in 2018 and 2017, respectively
 
227,454

 
172,043

Nonvoting common stock, no par value; 86,221 shares authorized; issued and outstanding - none
 

 

Retained earnings
 
74,733

 
57,103

Accumulated other comprehensive loss
 
(14,447
)
 
(5,019
)
Total shareholders’ equity
 
287,740

 
224,127

Total liabilities and shareholders’ equity
 
$
3,202,918

 
$
2,767,687


See Notes to Condensed Consolidated Financial Statements

1



First Internet Bancorp
Condensed Consolidated Statements of Income – Unaudited
(Amounts in thousands except share and per share data)
 
 
Three Months Ended
 
Nine Months Ended
 
 
September 30, 2018
 
September 30, 2017
 
September 30, 2018
 
September 30, 2017
Interest Income
 
 

 
 

 
 
 
 

Loans
 
$
26,019

 
$
18,922

 
$
71,833

 
$
49,494

Securities – taxable
 
2,659

 
2,582

 
7,703

 
7,515

Securities – non-taxable
 
698

 
697

 
2,109

 
2,090

Other earning assets
 
847

 
493

 
1,973

 
960

Total interest income
 
30,223

 
22,694

 
83,618

 
60,059

Interest Expense
 
 

 
 

 
 
 
 

Deposits
 
11,650

 
6,594

 
29,146

 
16,617

Other borrowed funds
 
2,603

 
1,909

 
7,626

 
4,820

Total interest expense
 
14,253

 
8,503

 
36,772

 
21,437

Net Interest Income
 
15,970

 
14,191

 
46,846

 
38,622

Provision for Loan Losses
 
888

 
1,336

 
2,405

 
3,693

Net Interest Income After Provision for Loan Losses
 
15,082

 
12,855

 
44,441

 
34,929

Noninterest Income
 
 

 
 

 
 
 
 

Service charges and fees
 
236

 
226

 
697

 
657

Mortgage banking activities
 
1,402

 
2,535

 
4,577

 
6,306

Gain on sale of loans
 

 

 
414

 

Other
 
356

 
374

 
1,025

 
1,039

Total noninterest income
 
1,994

 
3,135


6,713

 
8,002

Noninterest Expense
 
 

 
 

 
 
 
 

Salaries and employee benefits
 
5,704

 
5,197

 
17,436

 
15,463

Marketing, advertising and promotion
 
601

 
741

 
1,925

 
1,803

Consulting and professional services
 
709

 
897

 
2,193

 
2,474

Data processing
 
368

 
247

 
913

 
729

Loan expenses
 
241

 
262

 
738

 
724

Premises and equipment
 
1,244

 
1,080

 
3,689

 
3,058

Deposit insurance premium
 
441

 
375

 
1,386

 
990

Other
 
737

 
602

 
2,164

 
1,781

Total noninterest expense
 
10,045

 
9,401


30,444

 
27,022

Income Before Income Taxes
 
7,031

 
6,589

 
20,710

 
15,909

Income Tax Provision
 
743

 
1,694

 
2,386

 
4,181

Net Income
 
$
6,288

 
$
4,895


$
18,324

 
$
11,728

Income Per Share of Common Stock
 
 

 
 

 
 
 
 

Basic
 
$
0.61

 
$
0.72

 
$
1.99

 
$
1.76

Diluted
 
$
0.61

 
$
0.71

 
$
1.98

 
$
1.75

Weighted-Average Number of Common Shares Outstanding
 
 

 
 

 
 
 
 

Basic
 
10,261,967

 
6,834,011

 
9,230,149

 
6,656,160

Diluted
 
10,273,766

 
6,854,614

 
9,250,839

 
6,683,379

Dividends Declared Per Share
 
$
0.06

 
$
0.06

 
$
0.18

 
$
0.18


See Notes to Condensed Consolidated Financial Statements

2



First Internet Bancorp
Condensed Consolidated Statements of Comprehensive Income – Unaudited
(Amounts in thousands)
 
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
 
2018
 
2017
 
2018
 
2017
Net income
 
$
6,288

 
$
4,895

 
$
18,324

 
$
11,728

Other comprehensive income
 
 
 
 
 
 
 
 
Net unrealized holding (losses) gains on securities available-for-sale recorded within other comprehensive income before income tax
 
(3,063
)
 
1,231

 
(12,301
)
 
6,287

Reclassification adjustment for losses realized
 

 
8

 

 
8

Net unrealized holding gains on cash flow hedging derivatives recorded within other comprehensive income tax
 
1,366

 

 
408

 

Other comprehensive (loss) income before income tax
 
(1,697
)
 
1,239

 
(11,893
)
 
6,295

Income tax (benefit) provision
 
(1,328
)
 
483

 
(3,528
)
 
2,062

Other comprehensive (loss) income
 
(369
)
 
756

 
(8,365
)
 
4,233

Comprehensive income
 
$
5,919

 
$
5,651

 
$
9,959

 
$
15,961

 
 See Notes to Condensed Consolidated Financial Statements

3



First Internet Bancorp
Condensed Consolidated Statement of Shareholders’ Equity - Unaudited
Nine Months Ended September 30, 2018
(Amounts in thousands except per share data)
 
 
Voting and
Nonvoting
Common
Stock
 
Retained
Earnings
 
Accumulated
Other
Comprehensive
Loss
 
Total
Shareholders’
Equity
Balance, January 1, 2018
 
$
172,043

 
$
57,103

 
$
(5,019
)
 
$
224,127

Impact of adoption of new accounting standards (1)
 

 
1,063

 
(1,063
)
 

Net income
 

 
18,324

 

 
18,324

Other comprehensive loss
 

 

 
(8,365
)
 
(8,365
)
Dividends declared ($0.18 per share)
 

 
(1,757
)
 

 
(1,757
)
Net cash proceeds from common stock issuance
 
54,334

 

 

 
54,334

Recognition of the fair value of share-based compensation
 
1,257

 

 

 
1,257

Deferred stock rights and restricted stock units issued in lieu of cash dividends payable on outstanding deferred stock rights and restricted stock units
 
30

 

 

 
30

Common stock redeemed for the net settlement of share-based awards
 
(210
)
 

 

 
(210
)
Balance, September 30, 2018
 
$
227,454

 
$
74,733

 
$
(14,447
)
 
$
287,740


(1) Represents the impact of adopting Accounting Standards Update (“ASU”) 2018-02 and ASU 2016-01. ASU 2018-02 increased retained earnings and accumulated other comprehensive loss by $1.1 million. ASU 2016-01 decreased retained earnings and accumulated other comprehensive loss by $0.1 million. See Note 12 to the condensed consolidated financial statements for more information.
 
See Notes to Condensed Consolidated Financial Statements

4



First Internet Bancorp
Condensed Consolidated Statements of Cash Flows – Unaudited
(Amounts in thousands)
 
 
Nine Months Ended September 30,
 
 
2018
 
2017
Operating Activities
 
 

 
 

Net income
 
$
18,324

 
$
11,728

Adjustments to reconcile net income to net cash provided by operating activities:
 
 

 
 

Depreciation and amortization
 
4,262

 
3,876

Increase in cash surrender value of bank-owned life insurance
 
(714
)
 
(661
)
Provision for loan losses
 
2,405

 
3,693

Share-based compensation expense
 
1,257

 
787

Loss (gain) from sale of available-for-sale securities
 

 
8

Loans originated for sale
 
(282,527
)
 
(302,887
)
Proceeds from sale of loans
 
287,556

 
317,170

Gain on loans sold
 
(5,201
)
 
(5,876
)
Gain on sale of other real estate owned
 
(105
)
 

Decrease (increase) in fair value of loans held-for-sale
 
250

 
(519
)
(Gain) loss on derivatives
 
(100
)
 
89

Net change in accrued income and other assets
 
(149
)
 
(2,310
)
Net change in accrued expenses and other liabilities
 
(1,924
)
 
1,530

Net cash provided by operating activities
 
23,334

 
26,628

Investing Activities
 
 
 
 
Net loan activity, excluding purchases
 
(274,507
)
 
(629,541
)
Proceeds from sale of other real estate owned
 
332

 
30

Net change in interest-bearing time deposits
 

 
250

Maturities and calls of securities available-for-sale
 
48,938

 
50,165

Proceeds from sale of securities available-for-sale
 

 
9,192

Purchase of securities available-for-sale
 
(65,289
)
 
(90,306
)
Purchase of securities held-to-maturity
 
(1,000
)
 
(2,550
)
Purchase of Federal Home Loan Bank of Indianapolis stock
 
(2,475
)
 
(10,665
)
Purchase of bank-owned life insurance
 

 
(10,000
)
Purchase of premises and equipment
 
(1,161
)
 
(821
)
Loans purchased
 
(132,041
)
 
(42,345
)
Net proceeds from sale of portfolio loans
 
25,717

 
26,679

Other investing activities
 
(10,166
)
 

Net cash used in investing activities
 
(411,652
)
 
(699,912
)
Financing Activities
 
 
 
 
Net increase in deposits
 
361,623

 
534,161

Cash dividends paid
 
(1,620
)
 
(1,283
)
Repayment of subordinated debt
 
(3,000
)
 

Proceeds from advances from Federal Home Loan Bank
 
225,000

 
447,000

Repayment of advances from Federal Home Loan Bank
 
(210,000
)
 
(271,805
)
Net proceeds from common stock issuance
 
54,334

 
51,636

Other, net
 
(210
)
 
(173
)
Net cash provided by financing activities
 
426,127

 
759,536

Net Increase in Cash and Cash Equivalents
 
37,809

 
86,252

Cash and Cash Equivalents, Beginning of Period
 
47,981

 
39,452

Cash and Cash Equivalents, End of Period
 
$
85,790

 
$
125,704

Supplemental Disclosures
 
 
 
 
Cash paid during the period for interest
 
$
36,196

 
$
21,312

Cash paid during the period for taxes
 
360

 
2,922

Loans transferred to other real estate owned
 
227

 
648

Cash dividends declared, paid in subsequent period
 
611

 
504

Securities purchased during the period, settled in subsequent period
 

 
1,158

Transfer of other equity investments from securities available-for-sale to other assets in accordance with adoption of ASU 2016-01
 
2,932

 

See Notes to Condensed Consolidated Financial Statements

5



First Internet Bancorp
Notes to Condensed Consolidated Financial Statements – Unaudited
(Table amounts in thousands except share and per share data)
  
Note 1:        Basis of Presentation
 
The accompanying unaudited condensed consolidated financial statements have been prepared in conformity with U.S. generally accepted accounting principles (“GAAP”) for interim financial information and pursuant to the rules and regulations of the U.S. Securities and Exchange Commission (“SEC”). Accordingly, they do not include all of the information or footnotes necessary for a complete presentation of financial condition, results of operations, or cash flows in accordance with GAAP. In our opinion, all adjustments (consisting only of normal recurring adjustments) necessary for a fair presentation have been included. The results of operations for the three and nine months ended September 30, 2018 are not necessarily indicative of the results expected for the year ending December 31, 2018 or any other period. The September 30, 2018 condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and notes included in the First Internet Bancorp Annual Report on Form 10-K for the year ended December 31, 2017.
 
The preparation of the condensed consolidated financial statements in conformity with GAAP requires management to make estimates, judgments, or assumptions that could have a material effect on the carrying value of certain assets and liabilities. These estimates, judgments, and assumptions affect the amounts reported in the condensed consolidated financial statements and the disclosures provided. The determination of the allowance for loan losses, valuations and impairments of investment securities, and the accounting for income tax expense are highly dependent upon management’s estimates, judgments, and assumptions where changes in any of these could have a significant impact on the financial statements.

The condensed consolidated financial statements include the accounts of First Internet Bancorp (the “Company”), its wholly-owned subsidiary, First Internet Bank of Indiana (the “Bank”), and the Bank’s three wholly-owned subsidiaries, First Internet Public Finance Corp., JKH Realty Services, LLC and SPF15, Inc. All significant intercompany accounts and transactions have been eliminated in consolidation.
 
The Company is subject to claims and lawsuits that arise primarily in the ordinary course of business. It is the opinion of management that the disposition or ultimate resolution of such claims and lawsuits will not have a material adverse effect on the consolidated financial position, results of operations, and cash flows of the Company.
 
Certain reclassifications have been made to the 2017 financial statements to conform to the presentation of the 2018 financial statements. These reclassifications had no effect on net income.



    




6



Note 2:        Earnings Per Share
 
Earnings per share of common stock are based on the weighted-average number of basic shares and dilutive shares outstanding during the period.
 
The following is a reconciliation of the weighted-average common shares for the basic and diluted earnings per share computations for the three and nine months ended September 30, 2018 and 2017
 
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
 
2018
 
2017
 
2018
 
2017
Basic earnings per share
 
 

 
 

 
 
 
 
Net income
 
$
6,288

 
$
4,895

 
$
18,324

 
$
11,728

Weighted-average common shares
 
10,261,967

 
6,834,011

 
9,230,149

 
6,656,160

Basic earnings per common share
 
$
0.61

 
$
0.72

 
$
1.99

 
$
1.76

Diluted earnings per share
 
 

 
 

 
 

 
 

Net income
 
$
6,288

 
$
4,895

 
$
18,324

 
$
11,728

Weighted-average common shares
 
10,261,967

 
6,834,011

 
9,230,149

 
6,656,160

Dilutive effect of warrants
 

 


 

 
8,094

Dilutive effect of equity compensation
 
11,799

 
20,603

 
20,690

 
19,125

     Weighted-average common and incremental shares
 
10,273,766

 
6,854,614

 
9,250,839

 
6,683,379

Diluted earnings per common share
 
$
0.61

 
$
0.71

 
$
1.98

 
$
1.75

  
Note 3:         Securities
 
The following tables summarize securities available-for-sale and securities held-to-maturity as of September 30, 2018 and December 31, 2017.
 
 
September 30, 2018
 
 
Amortized
 
Gross Unrealized
 
Fair
 
 
Cost
 
Gains
 
Losses
 
Value
Securities available-for-sale
 
 

 
 

 
 

 
 

U.S. Government-sponsored agencies
 
$
115,176

 
$
20

 
$
(2,436
)
 
$
112,760

Municipal securities
 
97,160

 
39

 
(6,119
)
 
91,080

Mortgage-backed securities
 
237,703

 
33

 
(12,044
)
 
225,692

Asset-backed securities
 
5,003

 

 
(43
)
 
4,960

Corporate securities
 
36,684

 
41

 
(2,220
)
 
34,505

Total available-for-sale
 
$
491,726

 
$
133

 
$
(22,862
)
 
$
468,997

 
 
September 30, 2018
 
 
Amortized
 
Gross Unrealized
 
Fair
 
 
Cost
 
Gains
 
Losses
 
Value
Securities held-to-maturity
 
 

 
 

 
 

 
 

Municipal securities
 
$
10,159

 
$

 
$
(640
)
 
$
9,519

Corporate securities
 
10,041

 
24

 
(74
)
 
9,991

Total held-to-maturity
 
$
20,200

 
$
24

 
$
(714
)
 
$
19,510


7



 
 
December 31, 2017
 
 
Amortized
 
Gross Unrealized
 
Fair
 
 
Cost
 
Gains
 
Losses
 
Value
Securities available-for-sale
 
 

 
 

 
 

 
 

U.S. Government-sponsored agencies
 
$
133,424

 
$
531

 
$
(765
)
 
$
133,190

Municipal securities
 
97,370

 
366

 
(1,359
)
 
96,377

Mortgage-backed securities
 
215,452

 
15

 
(5,747
)
 
209,720

Asset-backed securities
 
5,000

 
9

 

 
5,009

Corporate securities
 
27,111

 
103

 
(1,167
)
 
26,047

Other securities
 
3,000

 

 
(68
)
 
2,932

Total available-for-sale
 
$
481,357

 
$
1,024

 
$
(9,106
)
 
$
473,275

 
 
December 31, 2017
 
 
Amortized
 
Gross Unrealized
 
Fair
 
 
Cost
 
Gains
 
Losses
 
Value
Securities held-to-maturity
 
 

 
 

 
 

 
 

Municipal securities
 
$
10,164

 
$
40

 
$
(357
)
 
$
9,847

Corporate securities
 
9,045

 
191

 

 
9,236

Total held-to-maturity
 
$
19,209

 
$
231

 
$
(357
)
 
$
19,083


The carrying value of securities at September 30, 2018 is shown below by their contractual maturity date. Actual maturities will differ because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.
 
 
Available-for-Sale
 
 
Amortized
Cost
 
Fair
Value
One to five years
 
$
425

 
$
403

Five to ten years
 
63,004

 
61,057

After ten years
 
185,591

 
176,885

 
 
249,020

 
238,345

Mortgage-backed securities
 
237,703

 
225,692

Asset-backed securities
 
5,003

 
4,960

Total
 
$
491,726

 
$
468,997

 
 
Held-to-Maturity
 
 
Amortized
Cost
 
Fair
Value
Five to ten years
 
$
14,286

 
$
13,956

After ten years
 
5,914

 
5,554

Total
 
$
20,200

 
$
19,510


There were no gross gains or losses resulting from sales of available-for-sale securities during the three and nine months ended September 30, 2018 and gross losses of $0.0 million for the three and nine months ended September 30, 2017.
 
Certain investments in debt securities are reported in the condensed consolidated financial statements at an amount less than their historical cost. The total fair value of these investments at September 30, 2018 and December 31, 2017 was $466.6 million and $354.6 million, which was approximately 96% and 72%, respectively, of the Company’s available-for-sale and held-to-maturity securities portfolios. These declines resulted primarily from fluctuations in market interest rates after purchase. Management believes the declines in fair value for these securities are temporary. Should the impairment of any of these securities become other than temporary, the cost basis of the investment will be reduced with the resulting loss recognized in net income in the period the other-than-temporary impairment (“OTTI”) is identified.


8



U. S. Government-Sponsored Agencies, Municipal Securities and Corporate Securities

The unrealized losses on the Company’s investments in securities issued by U.S. Government-sponsored agencies, municipal organizations and corporate entities were caused by interest rate changes. The contractual terms of those investments do not permit the issuer to settle the securities at a price less than the amortized cost bases of the investments. Because the Company does not intend to sell the investments and it is not likely that the Company will be required to sell the investments before recovery of their amortized cost bases, which may be upon maturity, the Company does not consider those investments to be other-than-temporarily impaired at September 30, 2018.
 
Mortgage-Backed Securities
 
The unrealized losses on the Company’s investments in mortgage-backed securities were caused by interest rate changes. The Company expects to recover the amortized cost bases over the term of the securities. Because the Company does not intend to sell the investments and it is not likely that the Company will be required to sell the investments before recovery of their amortized cost bases, which may be upon maturity, the Company does not consider those investments to be other-than-temporarily impaired at September 30, 2018.

 
 
September 30, 2018
 
 
Less Than 12 Months
 
12 Months or Longer
 
Total
 
 
Fair
Value
 
Unrealized
Losses
 
Fair
Value
 
Unrealized
Losses
 
Fair
Value
 
Unrealized
Losses
Securities available-for-sale
 
 

 
 

 
 

 
 

 
 

 
 

U.S. Government-sponsored agencies
 
$
75,589

 
$
(1,019
)
 
$
31,049

 
$
(1,417
)
 
$
106,638

 
$
(2,436
)
Municipal securities
 
30,647

 
(1,292
)
 
56,008

 
(4,827
)
 
86,655

 
(6,119
)
Mortgage-backed securities
 
55,063

 
(1,061
)
 
167,901

 
(10,983
)
 
222,964

 
(12,044
)
Asset-backed securities
 
4,960

 
(43
)
 

 

 
4,960

 
(43
)
Corporate securities
 
9,548

 
(33
)
 
19,813

 
(2,187
)
 
29,361

 
(2,220
)
Total
 
$
175,807

 
$
(3,448
)
 
$
274,771

 
$
(19,414
)
 
$
450,578

 
$
(22,862
)
 
 
September 30, 2018
 
 
Less Than 12 Months
 
12 Months or Longer
 
Total
 
 
Fair
Value
 
Unrealized
Losses
 
Fair
Value
 
Unrealized
Losses
 
Fair
Value
 
Unrealized
Losses
Securities held-to-maturity
 
 

 
 

 
 

 
 

 
 

 
 

Municipal securities
 
$
9,519

 
$
(640
)
 
$

 
$

 
$
9,519

 
$
(640
)
Corporate securities
 
6,467

 
(74
)
 

 

 
6,467

 
(74
)
Total
 
$
15,986

 
$
(714
)
 
$

 
$

 
$
15,986

 
$
(714
)

 
 
 
December 31, 2017
 
 
Less Than 12 Months
 
12 Months or Longer
 
Total
 
 
Fair
Value
 
Unrealized
Losses
 
Fair
Value
 
Unrealized
Losses
 
Fair
Value
 
Unrealized
Losses
Securities available-for-sale
 
 

 
 

 
 

 
 

 
 

 
 

U.S. Government-sponsored agencies
 
$
30,194

 
$
(256
)
 
$
22,824

 
$
(509
)
 
$
53,018

 
$
(765
)
Municipal securities
 
5,638

 
(77
)
 
57,128

 
(1,282
)
 
62,766

 
(1,359
)
Mortgage-backed securities
 
29,542

 
(251
)
 
177,266

 
(5,496
)
 
206,808

 
(5,747
)
Corporate securities
 
1,852

 
(148
)
 
18,981

 
(1,019
)
 
20,833

 
(1,167
)
Other securities
 

 

 
2,932

 
(68
)
 
2,932

 
(68
)
Total
 
$
67,226

 
$
(732
)
 
$
279,131

 
$
(8,374
)
 
$
346,357

 
$
(9,106
)

9



 
 
December 31, 2017
 
 
Less Than 12 Months
 
12 Months or Longer
 
Total
 
 
Fair
Value
 
Unrealized
Losses
 
Fair
Value
 
Unrealized
Losses
 
Fair
Value
 
Unrealized
Losses
Securities held-to-maturity
 
 

 
 

 
 

 
 

 
 

 
 

Municipal securities
 
$
8,255

 
$
(357
)
 
$

 
$

 
$
8,255

 
$
(357
)
Total
 
$
8,255

 
$
(357
)
 
$

 
$

 
$
8,255

 
$
(357
)

There were no amounts reclassified from accumulated other comprehensive loss to the condensed consolidated statements of income during the three and nine months ended September 30, 2018. Amounts reclassified from accumulated other comprehensive loss and the affected line items in the condensed consolidated statements of income during the three and nine months ended September 30, 2017 were as follows:

Details About Accumulated Other Comprehensive Loss Components
 
Amounts Reclassified from
Accumulated Other Comprehensive Loss for the
 
Affected Line Item in the
Statements of Income
 
Three Months Ended September 30, 2017
 
Nine Months Ended September 30, 2017
 
Realized gains and losses on securities available-for-sale
 
 

 
 

 
 
Loss realized in earnings
 
$
(8
)
 
$
(8
)
 
Other
Total reclassified amount before tax
 
(8
)
 
(8
)
 
Income Before Income Taxes
Tax benefit
 
(3
)
 
(3
)
 
Income Tax Provision
Total reclassifications out of accumulated other comprehensive loss
 
$
(5
)
 
$
(5
)
 
Net Income


Note 4:        Loans
 
Loans that management intends to hold until maturity are reported at their outstanding principal balance adjusted for unearned income, charge-offs, the allowance for loan losses, any unamortized deferred fees or costs on originated loans, and unamortized premiums or discounts on purchased loans.
 
For loans recorded at cost, interest income is accrued based on the unpaid principal balance. Loan origination fees, net of certain direct origination costs, as well as premiums and discounts, are deferred and amortized as a level yield adjustment over the respective term of the loan.
 

10



Categories of loans include:
 
 
September 30, 2018
 
December 31, 2017
Commercial loans
 
 

 
 

Commercial and industrial
 
$
105,489

 
$
122,940

Owner-occupied commercial real estate
 
93,568

 
75,768

Investor commercial real estate
 
5,595

 
7,273

Construction
 
38,228

 
49,213

Single tenant lease financing
 
883,372

 
803,299

Public finance
 
610,858

 
438,341

Healthcare finance
 
89,525

 
31,573

Total commercial loans
 
1,826,635

 
1,528,407

Consumer loans
 
 
 
 
Residential mortgage
 
362,574

 
299,935

Home equity
 
28,713

 
30,554

Other consumer
 
270,567

 
227,533

Total consumer loans
 
661,854

 
558,022

Total commercial and consumer loans
 
2,488,489

 
2,086,429

Deferred loan origination costs and premiums and discounts on purchased loans
 
5,133

 
4,764

Total loans
 
2,493,622

 
2,091,193

Allowance for loan losses
 
(16,704
)
 
(14,970
)
Net loans
 
$
2,476,918

 
$
2,076,223

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

Commercial and Industrial: Commercial and industrial loans’ sources of repayment are primarily based on the identified cash flows of the borrower and secondarily on the underlying collateral provided by the borrower. The cash flows of borrowers, however, may not be as expected, and the collateral securing these loans may fluctuate in value. Loans are made for working capital, equipment purchases, or other purposes. Most commercial and industrial loans are secured by the assets being financed and may incorporate a personal guarantee. This portfolio segment is generally concentrated in Central Indiana and adjacent markets and the greater Phoenix, Arizona market.

Owner-Occupied Commercial Real Estate: The primary source of repayment is the cash flow from the ongoing operations and activities conducted by the borrower, or an affiliate of the borrower, who owns the property. This portfolio segment is generally concentrated in the Central Indiana and adjacent markets and the greater Phoenix, Arizona market and its loans are often secured by manufacturing and service facilities, as well as office buildings.

Investor Commercial Real Estate: These loans are underwritten primarily based on the cash flow expected to be generated from the property and are secondarily supported by the value of the real estate. These loans typically incorporate a personal guarantee. This portfolio segment generally involves higher loan principal amounts, and the repayment of these loans is generally dependent on the successful operation of the property securing the loan or the business conducted on the property securing the loan. Investor commercial real estate loans may be more adversely affected by conditions in the real estate markets, changing industry dynamics, or the overall health of the general economy. The properties securing the Company’s investor commercial real estate portfolio tend to be diverse in terms of property type and are typically located in the state of Indiana and markets adjacent to Indiana. Management monitors and evaluates commercial real estate loans based on property financial performance, collateral value, guarantor strength, and other risk grade criteria. As a general rule, the Company avoids financing special use projects or properties outside of its designated market areas unless other underwriting factors are present to mitigate these additional risks.


11



Construction: Construction loans are secured by real estate and improvements and are made to assist in the construction of new structures, which may include commercial (retail, industrial, office, multi-family) properties or single family residential properties offered for sale by the builder. These loans generally finance a variety of project costs, including land, site preparation, construction, closing and soft costs and interim financing needs. The cash flows of builders, while initially predictable, may fluctuate with market conditions, and the value of the collateral securing these loans may be subject to fluctuations based on general economic changes. This portfolio segment is generally concentrated in Central Indiana.
Single Tenant Lease Financing: These loans are made to property owners of real estate subject to long-term lease arrangements with single tenant operators. The real estate is typically operated by regionally, nationally or globally branded businesses.  The loans are underwritten based on the financial strength of the borrower, characteristics of the real estate, cash flows generated from the lease arrangements and the financial strength of the tenant.  Similar to the other loan portfolio segments, management monitors and evaluates these loans based on borrower and tenant financial performance, collateral value, industry trends and other risk grade criteria.

Public Finance: These loans are made to governmental and not-for-profit entities to provide both tax-exempt and taxable loans for a variety of purposes including: short term cash-flow needs; debt refinancing; economic development; quality of life projects; infrastructure improvements; and equipment financing. The primary sources of repayment for public finance loans include pledged revenue sources including but not limited to: general obligations; property taxes; income taxes; tax increment revenue; utility revenue; gaming revenues; sales tax; and pledged general revenue. Certain loans may also include an additional collateral pledge of mortgaged property or a security interest in financed equipment. Public finance loans have been completed primarily in the Midwest, with plans to continue expanding nationwide.

Healthcare Finance: These loans are made to healthcare providers, primarily dentists, for refinancing or acquiring practices, refinancing or acquiring owner-occupied commercial real estate, and equipment purchases. The sources of repayment for these loans are primarily based on the identified cash flows of the borrower (including ongoing operations and activities conducted by the borrower, or an affiliate of the borrower, who owns the property) and secondarily on the underlying collateral provided by the borrower. This portfolio segment is generally concentrated in the Western United States with plans to expand nationwide.

Residential Mortgage: With respect to residential loans that are secured by 1-4 family residences and are generally owner occupied, the Company typically establishes a maximum loan-to-value ratio and requires private mortgage insurance if that ratio is exceeded. Repayment of these loans is primarily dependent on the financial circumstances of the borrowers, which can be impacted by economic conditions in their market areas such as unemployment levels. Repayment can also be impacted by changes in residential property values. Risk is mitigated by the fact that the loans are of smaller individual amounts and spread over a large number of borrowers in geographically diverse locations throughout the country.
Home Equity: Home equity loans and lines of credit are typically secured by a subordinate interest in 1-4 family residences. The properties securing the Company's home equity portfolio segment are generally geographically diverse as the Company offers these products on a nationwide basis. Repayment of these loans and lines of credit is primarily dependent on the financial circumstances of the borrowers and may be impacted by changes in unemployment levels and property values on residential properties, among other economic conditions in the market.
Other Consumer: These loans primarily consist of consumer loans and credit cards. Consumer loans may be secured by consumer assets such as horse trailers or recreational vehicles. Some consumer loans are unsecured, such as small installment loans, home improvement loans and certain lines of credit. Repayment of consumer loans is primarily dependent upon the personal income of the borrowers, which can be impacted by economic conditions in their market areas such as unemployment levels. Risk is mitigated by the fact that the loans are of smaller individual amounts and spread over a large number of borrowers in geographically diverse locations throughout the country.

12



Allowance for Loan Losses Methodology
 
Company policy is designed to maintain an adequate allowance for loan losses (“ALLL”). The portfolio is segmented by loan type, and the required ALLL for types of performing homogeneous loans which do not have a specific reserve is determined by applying a factor based on average historical losses, adjusted for current economic factors and portfolio trends. Management believes the historical loss experience methodology is appropriate in the current economic environment as it captures loss rates that are comparable to the current period being analyzed. Management adds qualitative factors for observable trends, changes in internal practices, changes in delinquencies and impairments, and external factors. Observable factors include changes in the composition and size of portfolios, as well as loan terms or concentration levels. The Company evaluates the impact of internal changes such as management and staff experience levels or modification to loan underwriting processes. Delinquency trends are scrutinized for both volume and severity of past due, nonaccrual, or classified loans as well as any changes in the value of underlying collateral. Finally, the Company considers the effect of other external factors such as national, regional, and local economic and business conditions, as well as competitive, legal, and regulatory requirements. Loans that are considered to be impaired are evaluated to determine the need for a specific allowance by applying at least one of three methodologies: present value of future cash flows; fair value of collateral less costs to sell; or the loan’s observable market price. All troubled debt restructurings (“TDR”) are considered impaired loans. Loans evaluated for impairment are removed from other pools to prevent double-counting. Accounting Standards Codification (“ASC”) Topic 310, Receivables, requires that impaired loans be measured based on the present value of expected future cash flows discounted at the loans’ effective interest rates or the fair value of the underlying collateral less costs to sell and allows existing methods for recognizing interest income.
 
Provision for Loan Losses
 
A provision for estimated losses on loans is charged to income based upon management’s evaluation of the potential losses. Such an evaluation, which includes a review of all loans for which full repayment may not be reasonably assured, considers, among other matters, the estimated net realizable value of the underlying collateral, as applicable, economic conditions, loan loss experience, and other factors that are particularly susceptible to changes that could result in a material adjustment in the near term. While management attempts to use the best information available in making its evaluations, future allowance adjustments may be necessary if economic conditions change substantially from the assumptions used in making the evaluations.
 
Policy for Charging Off Loans
 
The Company’s policy is to charge off a loan at any point in time when it no longer can be considered a bankable asset, meaning collectible within the parameters of policy. A secured loan is generally charged down to the estimated fair value of the collateral, less costs to sell, no later than when it is 120 days past due as to principal or interest. An unsecured loan generally is charged off no later than when it is 180 days past due as to principal or interest. A home improvement loan generally is charged off no later than when it is 90 days past due as to principal or interest.


13



The following tables present changes in the balance of the ALLL during the three and nine months ended September 30, 2018 and 2017

 
Three Months Ended September 30, 2018
Allowance for loan losses:
Balance, Beginning of Period
 
Provision (Credit) Charged to Expense
 
Losses
Charged Off
 
Recoveries
 
Balance,
End of Period
Commercial and industrial
$
1,364

 
$
(51
)
 
$
(6
)
 
$

 
$
1,307

Owner-occupied commercial real estate
889

 
69

 

 

 
958

Investor commercial real estate
67

 
(5
)
 

 

 
62

Construction
295

 
(54
)
 

 

 
241

Single tenant lease financing
8,294

 
186

 

 

 
8,480

Public finance
1,372

 
82

 

 

 
1,454

Healthcare finance
676

 
249

 

 

 
925

Residential mortgage
909

 
68

 

 
1

 
978

Home equity
54

 
(5
)
 

 
5

 
54

Other consumer
2,133

 
349

 
(330
)
 
93

 
2,245

Total
$
16,053

 
$
888

 
$
(336
)
 
$
99

 
$
16,704



 
Nine Months Ended September 30, 2018
Allowance for loan losses:
Balance, Beginning of Period
 
Provision (Credit) Charged to Expense
 
Losses
Charged Off
 
Recoveries
 
Balance,
End of Period
Commercial and industrial
$
1,738

 
$
(428
)
 
$
(6
)
 
$
3

 
$
1,307

Owner-occupied commercial real estate
803

 
155

 

 

 
958

Investor commercial real estate
85

 
(23
)
 

 

 
62

Construction
423

 
(182
)
 

 

 
241

Single tenant lease financing
7,872

 
608

 

 

 
8,480

Public finance
959

 
495

 

 

 
1,454

Healthcare finance
313

 
612

 

 

 
925

Residential mortgage
956

 
27

 
(9
)
 
4

 
978

Home equity
70

 
(28
)
 

 
12

 
54

Other consumer
1,751

 
1,169

 
(881
)
 
206

 
2,245

Total
$
14,970

 
$
2,405

 
$
(896
)
 
$
225

 
$
16,704



14



 
Three Months Ended September 30, 2017
Allowance for loan losses:
Balance, Beginning of Period
 
Provision (Credit) Charged to Expense
 
Losses
Charged Off
 
Recoveries
 
Balance,
End of Period
Commercial and industrial
$
1,525

 
$
361

 
$
(205
)
 
$

 
$
1,681

Owner-occupied commercial real estate
716

 
89

 

 

 
805

Investor commercial real estate
109

 
(22
)
 

 

 
87

Construction
395

 
38

 

 

 
433

Single tenant lease financing
7,403

 
281

 

 

 
7,684

Public finance
362

 
201

 

 

 
563

Healthcare finance
28

 
95

 

 

 
123

Residential mortgage
991

 
81

 
(116
)
 
2

 
958

Home equity
80

 
(6
)
 

 
1

 
75

Other consumer
1,585

 
218

 
(211
)
 
86

 
1,678

Total
$
13,194

 
$
1,336

 
$
(532
)
 
$
89

 
$
14,087



 
Nine Months Ended September 30, 2017
Allowance for loan losses:
Balance, Beginning of Period
 
Provision (Credit) Charged to Expense
 
Losses
Charged Off
 
Recoveries
 
Balance,
End of Period
Commercial and industrial
$
1,352

 
$
465

 
$
(205
)
 
$
69

 
$
1,681

Owner-occupied commercial real estate
582

 
223

 

 

 
805

Investor commercial real estate
168

 
(81
)
 

 

 
87

Construction
544

 
(111
)
 

 

 
433

Single tenant lease financing
6,248

 
1,436

 

 

 
7,684

Public finance

 
563

 

 

 
563

Healthcare finance

 
123

 

 

 
123

Residential mortgage
754

 
316

 
(116
)
 
4

 
958

Home equity
102

 
(48
)
 

 
21

 
75

Other consumer
1,231

 
807

 
(604
)
 
244

 
1,678

Total
$
10,981

 
$
3,693

 
$
(925
)
 
$
338

 
$
14,087



15



The following tables present the recorded investment in loans based on portfolio segment and impairment method as of September 30, 2018 and December 31, 2017
 
Loans
 
Allowance for Loan Losses
September 30, 2018
Ending Balance:  
Collectively Evaluated for Impairment
 
Ending Balance:  
Individually Evaluated for Impairment
 
Ending Balance
 
Ending Balance:  
Collectively Evaluated for Impairment
 
Ending Balance:  
Individually Evaluated for Impairment
 
Ending Balance
Commercial and industrial
$
97,540

 
$
7,949

 
$
105,489

 
$
1,307

 
$

 
$
1,307

Owner-occupied commercial real estate
92,089

 
1,479

 
93,568

 
958

 

 
958

Investor commercial real estate
5,595

 

 
5,595

 
62

 

 
62

Construction
38,228

 

 
38,228

 
241

 

 
241

Single tenant lease financing
883,372

 

 
883,372

 
8,480

 

 
8,480

Public finance
610,858

 

 
610,858

 
1,454

 

 
1,454

Healthcare finance
89,525

 

 
89,525

 
925

 

 
925

Residential mortgage
361,995

 
579

 
362,574

 
978

 

 
978

Home equity
28,713

 

 
28,713

 
54

 

 
54

Other consumer
270,456

 
111

 
270,567

 
2,245

 

 
2,245

Total
$
2,478,371

 
$
10,118

 
$
2,488,489

 
$
16,704

 
$

 
$
16,704

 
Loans
 
Allowance for Loan Losses
December 31, 2017
Ending Balance:  
Collectively Evaluated for Impairment
 
Ending Balance:  
Individually Evaluated for Impairment
 
Ending Balance
 
Ending Balance:  
Collectively Evaluated for Impairment
 
Ending Balance:  
Individually Evaluated for Impairment
 
Ending Balance
Commercial and industrial
$
119,054

 
$
3,886

 
$
122,940

 
$
1,738

 
$

 
$
1,738

Owner-occupied commercial real estate
75,761

 
7

 
75,768

 
803

 

 
803

Investor commercial real estate
7,273

 

 
7,273

 
85

 

 
85

Construction
49,213

 

 
49,213

 
423

 

 
423

Single tenant lease financing
803,299

 

 
803,299

 
7,872

 

 
7,872

Public finance
438,341

 

 
438,341

 
959

 

 
959

Healthcare finance
31,573

 

 
31,573

 
313

 

 
313

Residential mortgage
298,796

 
1,139

 
299,935

 
956

 

 
956

Home equity
30,471

 
83

 
30,554

 
70

 

 
70

Other consumer
227,443

 
90

 
227,533

 
1,751

 

 
1,751

Total
$
2,081,224

 
$
5,205

 
$
2,086,429

 
$
14,970

 
$

 
$
14,970



16



The Company utilizes a risk grading matrix to assign a risk grade to each of its commercial loans. A description of the general characteristics of the risk grades is as follows:
 
“Pass” - Higher quality loans that do not fit any of the other categories described below.

“Special Mention” - Loans that possess some credit deficiency or potential weakness, which deserve close attention.

“Substandard” - Loans that possess a defined weakness or weaknesses that jeopardize the liquidation of the debt. Loans characterized by the distinct possibility that the institution will sustain some loss if the deficiencies are not corrected. Loans that are inadequately protected by the current net worth and paying capacity of the obligor or of the collateral pledged, if any.

“Doubtful” - Such loans have been placed on nonaccrual status and may be heavily dependent upon collateral possessing a value that is difficult to determine or based upon some near-term event that lacks clear certainty. These loans have all of the weaknesses of those classified as Substandard; however, based on existing conditions, these weaknesses make full collection of the principal balance highly improbable.

“Loss” - Loans that are considered uncollectible and of such little value that continuing to carry them as assets is not warranted.

Nonaccrual Loans
 
Any loan which becomes 90 days delinquent or for which the full collection of principal and interest may be in doubt will be considered for nonaccrual status. At the time a loan is placed on nonaccrual status, all accrued but unpaid interest will be reversed from interest income. Placing the loan on nonaccrual status does not relieve the borrower of the obligation to repay interest. A loan placed on nonaccrual status may be restored to accrual status when all delinquent principal and interest has been brought current, and the Company expects full payment of the remaining contractual principal and interest.

17




The following tables present the credit risk profile of the Company’s commercial and consumer loan portfolios based on rating category and payment activity as of September 30, 2018 and December 31, 2017
 
September 30, 2018
 
Pass
 
Special Mention
 
Substandard
 
Total
Commercial and industrial
$
95,573

 
$
1,967

 
$
7,949

 
$
105,489

Owner-occupied commercial real estate
90,571

 
1,518

 
1,479

 
93,568

Investor commercial real estate
5,595

 

 

 
5,595

Construction
38,228

 

 

 
38,228

Single tenant lease financing
877,825

 
5,547

 

 
883,372

Public finance
610,858

 

 

 
610,858

Healthcare finance
89,525

 

 

 
89,525

Total commercial loans
$
1,808,175

 
$
9,032

 
$
9,428

 
$
1,826,635

 
September 30, 2018
 
Performing
 
Nonaccrual
 
Total
Residential mortgage
$
362,395

 
$
179

 
$
362,574

Home equity
28,713

 

 
28,713

Other consumer
270,506

 
61

 
270,567

Total consumer loans
$
661,614

 
$
240

 
$
661,854

 
December 31, 2017
 
Pass
 
Special Mention
 
Substandard
 
Total
Commercial and industrial
$
113,840

 
$
5,203

 
$
3,897

 
$
122,940

Owner-occupied commercial real estate
72,995

 
2,766

 
7

 
75,768

Investor commercial real estate
7,273

 

 

 
7,273

Construction
49,213

 

 

 
49,213

Single tenant lease financing
796,307

 
6,992

 

 
803,299

Public finance
438,341

 

 

 
438,341

Healthcare finance
31,573

 

 

 
31,573

Total commercial loans
$
1,509,542

 
$
14,961

 
$
3,904

 
$
1,528,407

 
December 31, 2017
 
Performing
 
Nonaccrual
 
Total
Residential mortgage
$
299,211

 
$
724

 
$
299,935

Home equity
30,471

 
83

 
30,554

Other consumer
227,501

 
32

 
227,533

Total consumer loans
$
557,183

 
$
839

 
$
558,022

  

18



The following tables present the Company’s loan portfolio delinquency analysis as of September 30, 2018 and December 31, 2017

 
 
September 30, 2018
 
 
30-59
Days
Past Due
 
60-89
Days
Past Due
 
90 Days 
or More
Past Due
 
Total 
Past Due
 
Current
 
Total
Loans
 
Non-
accrual
Loans
 
Total Loans
90 Days or
More Past
Due and
Accruing
Commercial and industrial
 
$

 
$

 
$

 
$

 
$
105,489

 
$
105,489

 
$

 
$

Owner-occupied commercial real estate
 

 

 

 

 
93,568

 
93,568

 

 

Investor commercial real estate
 

 

 

 

 
5,595

 
5,595

 

 

Construction
 

 

 

 

 
38,228

 
38,228

 

 

Single tenant lease financing
 

 

 

 

 
883,372

 
883,372

 

 

Public finance
 

 

 

 

 
610,858

 
610,858

 

 

Healthcare finance
 

 

 

 

 
89,525

 
89,525

 

 

Residential mortgage
 

 
98

 

 
98

 
362,476

 
362,574

 
179

 

Home equity
 

 

 

 

 
28,713

 
28,713

 

 

Other consumer
 
250

 
153

 
44

 
447

 
270,120

 
270,567

 
61

 
16

Total
 
$
250

 
$
251

 
$
44

 
$
545

 
$
2,487,944

 
$
2,488,489

 
$
240

 
$
16

 
 
December 31, 2017
 
 
30-59
Days
Past Due
 
60-89
Days
Past Due
 
90 Days 
or More
Past Due
 
Total 
Past Due
 
Current
 
Total
Loans
 
Non-
accrual
Loans
 
Total Loans
90 Days or
More Past
Due and
Accruing
Commercial and industrial
 
$

 
$
10

 
$

 
$
10

 
$
122,930

 
$
122,940

 
$

 
$

Owner-occupied commercial real estate
 

 

 

 

 
75,768

 
75,768

 

 

Investor commercial real estate
 

 

 

 

 
7,273

 
7,273

 

 

Construction
 

 

 

 

 
49,213

 
49,213

 

 

Single tenant lease financing
 

 

 

 

 
803,299

 
803,299

 

 

Public finance
 

 

 

 

 
438,341

 
438,341

 

 

Healthcare finance
 

 

 

 

 
31,573

 
31,573

 

 

Residential mortgage
 

 
23

 
560

 
583

 
299,352

 
299,935

 
724

 

Home equity
 

 

 
83

 
83

 
30,471

 
30,554

 
83

 

Other consumer
 
299

 
110

 
6

 
415

 
227,118

 
227,533

 
32

 

Total
 
$
299

 
$
143

 
$
649

 
$
1,091

 
$
2,085,338

 
$
2,086,429

 
$
839

 
$


Impaired Loans
 
A loan is designated as impaired, in accordance with the impairment accounting guidance, when, based on current information or events, it is probable that the Company will be unable to collect all amounts due (principal and interest) according to the contractual terms of the loan agreement. Payments with delays generally not exceeding 90 days outstanding are not considered impaired. Certain nonaccrual and substantially all delinquent loans more than 90 days past due may be considered to be impaired. Generally, loans are placed on nonaccrual status at 90 days past due and accrued interest is reversed against earnings, unless the loan is well-secured and in the process of collection. The accrual of interest on impaired and nonaccrual loans is discontinued when, in management’s opinion, the borrower may be unable to meet payments as they become due.
 
Impaired loans include nonperforming loans as well as loans modified in troubled debt restructurings where concessions have been granted to borrowers experiencing financial difficulties. These concessions could include a reduction in the interest rate on the loan, payment extensions, forgiveness of principal, forbearance, or other actions intended to maximize collection.

19



 
ASC Topic 310, Receivables, requires that impaired loans be measured based on the present value of expected future cash flows discounted at the loans’ effective interest rates or the fair value of the underlying collateral, less costs to sell, and allows existing methods for recognizing interest income.
 
The following table presents the Company’s impaired loans as of September 30, 2018 and December 31, 2017
 
 
September 30, 2018
 
December 31, 2017
 
 
Recorded
Balance
 
Unpaid
Principal
Balance
 
Specific
Allowance
 
Recorded
Balance
 
Unpaid
Principal
Balance
 
Specific
Allowance
Loans without a specific valuation allowance
 
 

 
 

 
 

 
 

 
 

 
 

Commercial and industrial
 
$
7,949

 
$
7,949

 
$

 
$
3,886

 
$
3,886

 
$

Owner-occupied commercial real estate
 
1,479

 
1,479

 

 
7

 
7

 

Residential mortgage
 
579

 
579

 

 
1,139

 
1,144

 

Home equity
 

 

 

 
83

 
83

 

Other consumer
 
111

 
160

 

 
90

 
143

 

Total impaired loans
 
$
10,118

 
$
10,167

 
$

 
$
5,205

 
$
5,263

 
$

 
The table below presents average balances and interest income recognized for impaired loans during the three and nine months ended September 30, 2018 and 2017.
 
 
Three Months Ended
 
Nine Months Ended
 
Three Months Ended
 
Nine Months Ended
 
 
September 30, 2018
 
September 30, 2017
 
 
Average
Balance
 
Interest
Income
 
Average
Balance
 
Interest
Income
 
Average
Balance
 
Interest
Income
 
Average
Balance
 
Interest
Income
Loans without a specific valuation allowance
 
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 

Commercial and industrial
 
$
7,233

 
$
561

 
$
5,430

 
$
723

 
$
3,941

 
$
71

 
$
2,157

 
$
71

Owner-occupied commercial real estate
 
1,249

 
75

 
553

 
82

 
4

 

 
1

 

Residential mortgage
 
573

 

 
768

 

 
1,690

 
7

 
1,673

 
7

Home equity
 
62

 

 
76

 

 

 

 

 

Other consumer
 
104

 
1

 
110

 
1

 
93

 
2

 
113

 
2

Total
 
9,221

 
637

 
6,937

 
806

 
5,728

 
80

 
3,944

 
80

Loans with a specific valuation allowance
 
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 

Commercial and industrial
 

 

 

 
$

 
50

 

 
46

 

Total
 

 

 

 

 
50

 

 
46

 

Total impaired loans
 
$
9,221

 
$
637

 
$
6,937

 
$
806

 
$
5,778

 
$
80

 
$
3,990

 
$
80


The Company had $0.6 million in residential mortgage other real estate owned as of September 30, 2018 and had $0.6 million in residential mortgage other real estate owned as of December 31, 2017. There were no loans in the process of foreclosure at September 30, 2018 and $0.2 million of loans in the process of foreclosure at December 31, 2017.

Troubled Debt Restructurings (“TDRs”)
 
The loan portfolio includes TDRs, which are loans that have been modified to grant economic concessions to borrowers who have experienced financial difficulties. These concessions typically result from loss mitigation efforts and could include reductions in the interest rate, payment extensions, forgiveness of principal, forbearance, or other actions. Certain TDRs are classified as nonperforming at the time of restructuring and typically are returned to performing status after considering the borrower’s sustained repayment performance for a reasonable period, generally not less than six consecutive months.
 
When loans are modified in a TDR, any possible impairment similar to other impaired loans is evaluated based on the present value of expected future cash flows, discounted at the contractual interest rate of the original loan agreement, or using the current fair value of the collateral, less selling costs for collateral dependent loans. If it is determined that the value of the modified loan is less than the recorded balance of the loan, impairment is recognized through a specific allowance or charge-off to the allowance. In periods subsequent to modification, all TDRs, including those that have payment defaults, are evaluated for possible impairment, and impairment is recognized through the allowance.
 

20



In the course of working with troubled borrowers, the Company may choose to restructure the contractual terms of certain loans in an effort to work out an alternative payment schedule with the borrower in order to optimize the collectability of the loan. Any loan modification is reviewed by the Company to identify whether a TDR has occurred when the Company grants a concession to the borrower that it would not otherwise consider based on economic or legal reasons related to a borrower’s financial difficulties. Terms may be modified to fit the ability of the borrower to repay in line with its current financial status or the loan may be restructured to secure additional collateral and/or guarantees to support the debt, or a combination of the two.

There were no loans classified as new TDRs during the three and nine months ended September 30, 2018. There were no new loans classified as new TDRs during the three months ended September 30, 2017 and two commercial and industrial loans classified as new TDRs during the nine months ended September 30, 2017 with a pre-modification and post-modification outstanding recorded investment of $1.8 million. The Company did not allocate a specific allowance for those loans as of September 30, 2017. The modifications consisted of maturity date amendments and certain other term modifications.
 

Note 5:        Premises and Equipment
 
The following table summarizes premises and equipment at September 30, 2018 and December 31, 2017.
 
 
September 30,
2018
 
December 31,
2017
Land
 
$
2,500

 
$
2,500

Building and improvements
 
6,175

 
6,427

Furniture and equipment
 
9,024

 
7,610

Less: accumulated depreciation
 
(7,658
)
 
(6,479
)
Total
 
$
10,041

 
$
10,058

  
Note 6:        Goodwill        
 
As of September 30, 2018 and December 31, 2017, the carrying amount of goodwill was $4.7 million. There have been no changes in the carrying amount of goodwill for the periods ended September 30, 2018 and December 31, 2017.  Goodwill is tested for impairment on an annual basis as of August 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 August 31, 2018 annual impairment test that would suggest it was more likely than not goodwill impairment existed.
 
Note 7:        Subordinated Debt
 
In June 2013, the Company issued a subordinated debenture (the “2021 Debenture”) in the principal amount of $3.0 million. The 2021 Debenture bore a fixed interest rate of 8.00% per year, payable quarterly, and was scheduled to mature on June 28, 2021. The 2021 Debenture could be repaid, without penalty, at any time after June 28, 2016. The Company repaid the 2021 Debenture in full in June 2018.
 
In connection with the 2021 Debenture, the Company also issued a warrant to purchase up to 48,750 shares of common stock at an initial per share exercise price equal to $19.33. The warrant became exercisable on June 28, 2014. On May 4, 2017, the Company issued a net amount of 15,915 shares of common stock pursuant to an exercise by the holder of a warrant to purchase 48,750 shares of common stock at a price of $19.33 per share. The holder satisfied the exercise price by instructing the Company to withhold 32,835 of the shares of common stock in accordance with the warrant’s cashless exercise feature.

In October 2015, the Company entered into a term loan in the principal amount of $10.0 million, evidenced by a term note due 2025 (the “2025 Note”). The 2025 Note bears a fixed interest rate of 6.4375% per year, payable quarterly, and is scheduled to mature on October 1, 2025. The 2025 Note is an unsecured subordinated obligation of the Company and may be repaid, without penalty, on any interest payment date on or after October 15, 2020. The 2025 Note is intended to qualify as Tier 2 capital under regulatory guidelines.


21



In September 2016, the Company issued $25.0 million aggregate principal amount of 6.0% Fixed-to-Floating Rate Subordinated Notes due 2026 (the “2026 Notes”) in a public offering. The 2026 Notes initially bear a fixed interest rate of 6.00% per year to, but excluding September 30, 2021, and thereafter a floating rate equal to the then-current three-month LIBOR rate plus 485 basis points. All interest on the 2026 Notes is payable quarterly. The 2026 Notes are scheduled to mature on September 30, 2026. The 2026 Notes are unsecured subordinated obligations of the Company and may be repaid, without penalty, on any interest payment date on or after September 30, 2021. The 2026 Notes are intended to qualify as Tier 2 capital under regulatory guidelines.

The following table presents the principal balance and unamortized discount and debt issuance costs for the 2021 Debenture, the 2025 Note and the 2026 Notes as of September 30, 2018 and December 31, 2017.
 
September 30, 2018
 
December 31, 2017
 
Principal
 
Unamortized Discount and Debt Issuance Costs
 
Principal
 
Unamortized Discount and Debt Issuance Costs
2021 Debenture
$

 
$

 
$
3,000

 
$

2025 Note
10,000

 
(168
)
 
10,000

 
(186
)
2026 Notes
25,000

 
(995
)
 
25,000

 
(1,088
)
Total
$
35,000

 
$
(1,163
)
 
$
38,000

 
$
(1,274
)

Note 8:        Benefit Plans
 
Employment Agreement
 
The Company has entered into an employment agreement with its Chief Executive Officer that provides for the continuation of salary and certain benefits for a specified period of time under certain conditions. Under the terms of the agreement, these payments could occur in the event of a termination of employment by us without “cause”, by him for “good reason” or in connection with a “change in control,” each as defined in the agreement, along with other specific conditions.
 
2013 Equity Incentive Plan
 
The 2013 Equity Incentive Plan (the “2013 Plan”) authorizes the issuance of 750,000 shares of the Company’s common stock in the form of equity-based awards to employees, directors, and other eligible persons.  Under the terms of the 2013 Plan, the pool of shares available for issuance may be used for available types of equity awards under the 2013 Plan, which includes stock options, stock appreciation rights, restricted stock awards, stock unit awards, and other share-based awards.  All employees, consultants, and advisors of the Company or any subsidiary, as well as all non-employee directors of the Company, are eligible to receive awards under the 2013 Plan.

The Company recorded $0.3 million and $1.3 million of share-based compensation expense for the three and nine months ended September 30, 2018, respectively, related to awards made under the 2013 Plan. The Company recorded $0.3 million and $0.8 million of share-based compensation expense for the three and nine months ended September 30, 2017, respectively, related to awards made under the 2013 Plan.

The following table summarizes the status of the 2013 Plan awards as of September 30, 2018, and activity for the nine months ended September 30, 2018.
 
Restricted Stock Units
 
Weighted-Average Grant Date Fair Value Per Share
 
Restricted Stock Awards
 
Weighted-Average Grant Date Fair Value Per Share
 
Deferred Stock Units
 
Weighted-Average Grant Date Fair Value Per Share
Nonvested at December 31, 2017
72,765

 
$
27.91

 
3,333

 
$
24.44

 

 
$

   Granted
41,334

 
40.69

 
11,294

 
38.75

 
4

 
37.23

   Vested
(34,241
)
 
26.06

 
(11,395
)
 
37.21

 
(4
)
 
37.23

   Forfeited
(4,477
)
 
34.57

 

 

 

 

Nonvested at September 30, 2018
75,381

 
$
35.36

 
3,232

 
$
31.37

 

 
$



22



At September 30, 2018, the total unrecognized compensation cost related to nonvested awards was $2.1 million with a weighted-average expense recognition period of 2.0 years.

Directors Deferred Stock Plan
 
Until January 1, 2014, the Company had a practice granting awards under a stock compensation plan for members of the Board of Directors (“Directors Deferred Stock Plan”). The Company reserved 180,000 shares of common stock that could have been issued pursuant to the Directors Deferred Stock Plan. The Directors Deferred Stock Plan provided directors the option to elect to receive up to 100% of their annual retainer in either common stock or deferred stock rights. Deferred stock rights were to be settled in common stock following the end of the deferral period payable on the basis of one share of common stock for each deferred stock right.
 
The following table summarizes the status of deferred stock rights related to the Directors Deferred Stock Plan for the nine months ended September 30, 2018.
 
 
Deferred Stock Rights
Outstanding, beginning of period
 
82,995

Granted
 
394

Exercised
 

Outstanding, end of period
 
83,389


All deferred stock rights granted during the 2018 period were additional rights issued in lieu of cash dividends payable on outstanding deferred stock rights.

Note 9:        Fair Value of Financial Instruments
 
ASC Topic 820, Fair Value Measurement, defines fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. ASC Topic 820 also specifies a fair value hierarchy which requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. The standard describes three levels of inputs that may be used to measure fair value:

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

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

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

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

Available-for-Sale Securities
 
Where quoted market prices are available in an active market, securities are classified within Level 1 of the valuation hierarchy. Level 1 securities include highly liquid mutual funds. If quoted market prices are not available, then fair values are estimated by using pricing models, quoted prices of securities with similar characteristics or discounted cash flows.
 
Level 2 securities include U.S. Government-sponsored agencies, municipal securities, mortgage and asset-backed securities and certain corporate securities. Matrix pricing is a mathematical technique widely used in the banking industry to value investment securities without relying exclusively on quoted prices for specific investment securities but also on the investment securities’ relationship to other benchmark quoted investment securities.
 

23



In certain cases where Level 1 or Level 2 inputs are not available, securities are classified within Level 3 of the hierarchy. Fair values are calculated using discounted cash flows. Discounted cash flows are calculated based off of the anticipated future cash flows updated to incorporate loss severities. Rating agency and industry research reports as well as default and deferral activity are reviewed and incorporated into the calculation. The Company did not own any securities classified within Level 3 of the hierarchy as of September 30, 2018 or December 31, 2017.

Loans Held-for-Sale (mandatory pricing agreements)

The fair value of loans held-for-sale is determined using quoted prices for similar assets, adjusted for specific attributes of that loan (Level 2).
 
Forward Contracts

The fair values of forward contracts on to-be-announced securities are determined using quoted prices in active markets, or benchmarked thereto (Level 1).
 
Interest Rate Lock Commitments
 
The fair values of interest rate lock commitments (“IRLCs”) are determined using the projected sale price of individual loans based on changes in market interest rates, projected pull-through rates (the probability that an IRLC will ultimately result in an originated loan), the reduction in the value of the applicant’s option due to the passage of time, and the remaining origination costs to be incurred based on management’s estimate of market costs (Level 3).


24



The following tables present the fair value measurements of assets and liabilities recognized in the accompanying condensed consolidated balance sheets measured at fair value on a recurring basis and the level within the fair value hierarchy in which the fair value measurements fall at September 30, 2018 and December 31, 2017.
 
 
 
 
September 30, 2018
Fair Value Measurements Using
 
 
Fair
Value
 
Quoted Prices
in Active Markets for Identical Assets
(Level 1)
 
Significant
Other
Observable
Inputs
(Level 2)
 
Significant
Unobservable
Inputs
(Level 3)
U.S. Government-sponsored agencies
 
$
112,760

 
$

 
$
112,760

 
$

Municipal securities
 
91,080

 

 
91,080

 

Mortgage-backed securities
 
225,692

 

 
225,692

 

Asset-backed securities
 
4,960

 

 
4,960

 

Corporate securities
 
34,505

 

 
34,505

 

Total available-for-sale securities
 
468,997

 

 
468,997

 

Loans held-for-sale (mandatory pricing agreements)
 
23,493

 

 
23,493

 

Interest rate swap assets
 
8,032

 

 
8,032

 

Interest rate swap liabilities
 
(72
)
 

 
(72
)
 

Forward contracts
 
127

 
127

 

 

IRLCs
 
383

 

 

 
383

 
 
 
 
December 31, 2017
Fair Value Measurements Using
 
 
Fair
Value
 
Quoted Prices
in Active Markets for Identical Assets
(Level 1)
 
Significant
Other
Observable
Inputs
(Level 2)
 
Significant
Unobservable
Inputs
(Level 3)
U.S. Government-sponsored agencies
 
$
133,190

 
$

 
$
133,190

 
$

Municipal securities
 
96,377

 

 
96,377

 

Mortgage-backed securities
 
209,720

 

 
209,720

 

Asset-backed securities
 
5,009

 

 
5,009

 

Corporate securities
 
26,047

 

 
26,047

 

Other securities
 
2,932

 
2,932

 

 

Total available-for-sale securities
 
473,275

 
2,932

 
470,343

 

Loans held-for-sale (mandatory pricing agreements)
 
23,571

 

 
23,571

 

Interest rate swaps
 
(271
)
 

 
(271
)
 

Forward contracts
 
(80
)
 
(80
)
 

 

IRLCs
 
551

 

 

 
551



25



The following tables reconcile the beginning and ending balances of recurring fair value measurements recognized in the accompanying condensed consolidated balance sheets using significant unobservable (Level 3) inputs for the three and nine months ended September 30, 2018 and 2017.
 
 
Three Months Ended
 
 
Interest Rate Lock Commitments
Balance, July 1, 2018
 
$
724

Total realized losses
 
 
Included in net income
 
(341
)
Balance, September 30, 2018
 
$
383

 
 
 
Balance, July 1, 2017
 
$
652

Total realized gains
 
 
Included in net income
 
135

Balance, September 30, 2017
 
$
787



 
 
Nine Months Ended
 
 
Interest Rate Lock Commitments
Balance, January 1, 2018
 
$
551

Total realized losses
 
 

Included in net income
 
(168
)
Balance, September 30, 2018
 
$
383

 
 
 
Balance, January 1, 2017
 
$
610

Total realized gains
 
 
Included in net income
 
177

Balance, September 30, 2017
 
$
787

 
 
 Significant Unobservable (Level 3) Inputs
 
The following tables present quantitative information about significant unobservable inputs used in recurring and Level 3 fair value measurements other than goodwill.

 
 
Fair Value at
September 30, 2018
 
Valuation
Technique
 
Significant Unobservable
Inputs
 
Range
IRLCs
 
$
383

 
Discounted cash flow
 
Loan closing rates
 
38% - 100%
 
 
Fair Value at
December 31, 2017
 
Valuation
Technique
 
Significant Unobservable
Inputs
 
Range
IRLCs
 
$
551

 
Discounted cash flow
 
Loan closing rates
 
39% - 100%

The following methods were used to estimate the fair value of all other financial instruments recognized in the accompanying condensed consolidated balance sheets at amounts other than fair value.
 
Cash and Cash Equivalents
 
For these instruments, the carrying amount is a reasonable estimate of fair value.
 
Interest-Bearing Time Deposits
 
The fair value of these financial instruments approximates carrying value.
 

26



Securities Held-to-Maturity
 
Fair values are determined by using models that are based on security-specific details, as well as relevant industry and economic factors. The most significant of these inputs are quoted market prices, and interest rate spreads on relevant benchmark securities.
 
Loans Held-for-Sale (best efforts pricing agreements)
 
The fair value of these loans approximates carrying value.

Loans
 
The fair value of loans as of September 30, 2018 was impacted by the adoption of Accounting Standards Update 2016-01, which is discussed further in Note 12 of the consolidated financial statements. In accordance with Accounting Standards Update 2016-01, the fair value of loans are estimated on an exit price basis incorporating discounts for credit, liquidity and marketability factors. This is not comparable with the fair values disclosed for December 31, 2017, which were based on an entrance price basis. For that date, fair values of variable rate loans that reprice frequently and with no significant change in credit risk were based on carrying values. The fair value of other loans as of that date were estimated by discounted cash flow analysis, which used interest rates then being offered for loans with similar terms to borrowers of similar credit quality.
 
Accrued Interest Receivable
 
The fair value of these financial instruments approximates carrying value.
 
Federal Home Loan Bank of Indianapolis Stock
 
The fair value approximates carrying value.
 
Deposits 
The fair value of noninterest-bearing and interest-bearing demand deposits, savings and money market accounts approximates carrying value. The fair value of fixed maturity certificates of deposit and brokered deposits are estimated using rates currently offered for deposits of similar remaining maturities.

Advances from Federal Home Loan Bank
 
The fair value of fixed rate advances is estimated using rates currently available for advances with similar remaining maturities. The carrying value of variable rate advances approximates fair value.
 
Subordinated Debt
 
The fair value of the Company’s publicly traded subordinated debt is obtained from quoted market prices. The fair value of the Company’s remaining subordinated debt is estimated using discounted cash flow analysis, based on current borrowing rates for similar types of debt instruments.

 Accrued Interest Payable
 
The fair value of these financial instruments approximates carrying value.

Commitments
 
The fair value of commitments to extend credit are based on fees currently charged to enter into similar agreements with similar maturities and interest rates. The Company determined that the fair value of commitments was zero based on the contractual value of outstanding commitments at each of September 30, 2018 and December 31, 2017.
  

27



The following tables present the carrying value and estimated fair value of all financial assets and liabilities at September 30, 2018 and December 31, 2017.
 
 
September 30, 2018
Fair Value Measurements Using
 
 
Carrying
Amount
 
Fair Value
 
Quoted Prices
In Active
Market for
Identical Assets
(Level 1)
 
Significant
Other
Observable
Inputs
(Level 2)
 
Significant
Unobservable
Inputs
(Level 3)
Cash and cash equivalents
 
$
85,790

 
$
85,790

 
$
85,790

 
$

 
$

Securities held-to-maturity
 
20,200

 
19,510

 

 
19,510

 

Net loans
 
2,476,918

 
2,347,403

 

 

 
2,347,403

Accrued interest receivable
 
14,472

 
14,472

 
14,472

 

 

Federal Home Loan Bank of Indianapolis stock
 
22,050

 
22,050

 

 
22,050

 

Deposits
 
2,446,564

 
2,423,037

 
663,012

 

 
1,760,025

Advances from Federal Home Loan Bank
 
425,160

 
414,668

 

 
414,668

 

Subordinated debt
 
33,837

 
35,877

 
25,630

 
10,247

 

Accrued interest payable
 
887

 
887

 
887

 

 

 
 
December 31, 2017
Fair Value Measurements Using
 
 
Carrying
Amount
 
Fair Value
 
Quoted Prices
In Active
Market for
Identical
Assets
(Level 1)
 
Significant
Other
Observable
Inputs
(Level 2)
 
Significant
Unobservable
Inputs
(Level 3)
Cash and cash equivalents
 
$
47,981

 
$
47,981

 
$
47,981

 
$

 
$

Securities held-to-maturity
 
19,209

 
19,083

 

 
19,083

 

Loans held-for-sale (best efforts pricing agreements)
 
27,836

 
27,836

 

 
27,836

 

Net loans
 
2,076,223

 
2,036,575

 

 

 
2,036,575

Accrued interest receivable
 
11,944

 
11,944

 
11,944

 

 

Federal Home Loan Bank of Indianapolis stock
 
19,575

 
19,575

 

 
19,575

 

Deposits
 
2,084,941

 
2,057,708

 
688,800

 

 
1,368,908

Advances from Federal Home Loan Bank
 
410,176

 
397,950

 

 
397,950

 

Subordinated debt
 
36,726

 
39,972

 
26,520

 
13,452

 

Accrued interest payable
 
311

 
311

 
311

 

 

 
Note 10:        Mortgage Banking Activities

The Company’s residential real estate lending business originates mortgage loans for customers and typically sells a majority of the originated loans into the secondary market. For most of the mortgages it sells in the secondary market, the Company hedges its mortgage banking pipeline by entering into forward contracts for the future delivery of mortgage loans to third party investors and entering into IRLCs with potential borrowers to fund specific mortgage loans that will be sold into the secondary market. To facilitate the hedging of the loans, the Company has elected the fair value option for loans originated and intended for sale in the secondary market under mandatory pricing agreements. Changes in the fair value of loans held-for-sale, IRLCs and forward contracts are recorded in the mortgage banking activities line item within noninterest income.  Refer to Note 11 for further information on derivative financial instruments. 

28




During the three months ended September 30, 2018 and 2017, the Company originated mortgage loans held-for-sale of $104.1 million and $107.8 million, respectively, and sold $102.8 million and $118.3 million of mortgage loans, respectively, into the secondary market. During the nine months ended September 30, 2018 and 2017, the Company originated mortgage loans held-for-sale of $282.5 million and $302.9 million, respectively, and sold $287.6 million and $317.2 million of mortgage loans, respectively, into the secondary market. Additionally, during the nine months ended September 30, 2018, the Company sold $25.2 million of portfolio mortgage loans to an investor, resulting in a gain of $0.4 million.

The following table presents the components of income from mortgage banking activities for the three and nine months ended September 30, 2018 and 2017.
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2018
 
2017
 
2018
 
2017
Gain on loans sold
$
1,622

 
$
2,453

 
$
4,787

 
$
5,876

(Loss) gain resulting from the change in fair value of loans held-for-sale
(168
)
 
(6
)
 
(250
)
 
519

(Loss) gain resulting from the change in fair value of derivatives
(52
)
 
88

 
40

 
(89
)
Net revenue from mortgage banking activities
$
1,402

 
$
2,535

 
$
4,577

 
$
6,306


Fluctuations in interest rates and changes in IRLC and loan volume within the mortgage banking pipeline may cause volatility in the fair value of loans held-for-sale and the fair value of derivatives used to hedge the mortgage banking pipeline.

Note 11:        Derivative Financial Instruments
 
The Company uses derivative financial instruments to help manage exposure to interest rate risk and the effects that changes in interest rates may have on net income and the fair value of assets and liabilities. The Company enters into interest rate swap agreements as part of its asset/liability management strategy to help manage its interest rate risk position. Additionally, the Company enters into forward contracts for the future delivery of mortgage loans to third party investors and enters into IRLCs with potential borrowers to fund specific mortgage loans that will be sold into the secondary market. The forward contracts are entered into in order to economically hedge the effect of changes in interest rates resulting from the Company’s commitment to fund the loans.
 
The Company entered into various interest rate swap agreements designated and qualifying as accounting hedges during the reported periods. Designating an interest rate swap as an accounting hedge allows the Company to recognize gains and losses, less any ineffectiveness, in the income statement within the same period that the hedged item affects earnings. The Company includes the gain or loss on the hedged items in the same line item as the offsetting loss or gain on the related interest rate swaps. For derivative instruments that are designated and qualify as cash flow hedges, any gains or losses related to changes in fair value are recorded in accumulated other comprehensive loss, net of tax. The fair value of interest rate swaps with a positive fair value are reported in accrued income and other assets in the condensed consolidated balance sheets while interest rate swaps with a negative fair value are reported in accrued expenses and other liabilities in the condensed consolidated balance sheets.

The IRLCs and forward contracts are not designated as accounting hedges, and are recorded at fair value with changes in fair value reflected in noninterest income on the condensed consolidated statements of income. The fair value of derivative instruments with a positive fair value are reported in accrued income and other assets in the condensed consolidated balance sheets while derivative instruments with a negative fair value are reported in accrued expenses and other liabilities in the condensed consolidated balance sheets.

The following table presents amounts that were recorded on the condensed consolidated balance sheets related to cumulative basis adjustments for interest rate swap derivatives designated as fair value accounting hedges as of September 30, 2018 and December 31, 2017.  



29



 
 
Carrying amount of the hedged asset
 
Cumulative amount of fair value hedging adjustment included in the carrying amount of the hedged assets
Line item in the condensed consolidated balance sheets in which the hedged item is included
 
September 30, 2018
 
December 31, 2017
 
September 30, 2018
 
December 31, 2017
Loans
 
$
366,948

 
$
91,653

 
$
(5,152
)
 
$
263

Securities available-for-sale (1)
 
159,215

 
92,230

 
(2,339
)
 
8

(1) These amounts include the amortized cost basis of closed portfolios used to designate hedging relationships in which the hedged item
is the last layer expected to be remaining at the end of the hedging relationship. At September 30, 2018 and December 31, 2017, the amounts of the designated hedged items were $88.2 million and $50.0 million, respectively.

The following tables present a summary of interest rate swap derivatives designated as fair value accounting hedges of fixed-rate receivables used in the Company’s asset/liability management activities at September 30, 2018 and December 31, 2017, identified by the underlying interest rate-sensitive instruments.

September 30, 2018
 
Notional
 
Weighted Average Remaining Maturity
 
 
 
Weighted-Average Ratio
Instruments Associated With
 
Value
 
(years)
 
Fair Value
 
Receive
 
Pay
Loans
 
$
338,242

 
6.6
 
$
5,193

 
3 month LIBOR
 
2.84
%
Securities available-for-sale
 
88,200

 
5.4
 
2,359

 
3 month LIBOR
 
2.54
%
Total at September 30, 2018
 
$
426,442

 
6.4
 
$
7,552

 
3 month LIBOR
 
2.78
%

December 31, 2017
 
Notional
 
Weighted Average Remaining Maturity
 
 
 
Weighted-Average Ratio
Instruments Associated With
 
Value
 
(years)
 
Fair Value
 
Receive
 
Pay
Loans
 
$
91,135

 
7.9
 
$
(263
)
 
3 month LIBOR
 
2.44
%
Securities available-for-sale
 
50,000

 
6.8
 
(8
)
 
3 month LIBOR
 
2.33
%
Total at December 31, 2017
 
$
141,135

 
7.5
 
$
(271
)
 
3 month LIBOR
 
2.41
%

The following table presents a summary of interest rate swap derivatives designated as cash flow accounting hedges of variable-rate liabilities used in the Company’s asset/liability management activities at September 30, 2018. There were no interest rate swap derivatives designated as cash flow accounting hedges at December 31, 2017.

September 30, 2018
 
Notional
 
Weighted Average Remaining Maturity
 
 
 
Weighted-Average Ratio
Cash Flow Hedges
 
Value
 
(years)
 
Fair Value
 
Receive
 
Pay
Interest rate swaps
 
$
50,000

 
9.7
 
$
234

 
3 month LIBOR
 
3.01
%
Interest rate swaps
 
80,000

 
5.2
 
174

 
1 month LIBOR
 
2.86
%

These derivative financial instruments were entered into for the purpose of managing the interest rate risk of certain assets. At September 30, 2018, the Company received $8.0 million of cash collateral from counterparties as security for their obligations related to these swap transactions. At December 31, 2017, the Company pledged $0.7 million of cash collateral to counterparties as security for its obligations related to these interest rate swap transactions. Collateral posted and received is dependent on the market valuation of the underlying hedges.





30



The following table presents the notional amount and fair value of interest rate swaps, IRLCs and forward contracts utilized by the Company at September 30, 2018 and December 31, 2017.

 
 
September 30, 2018
 
December 31, 2017
 
 
Notional
Amount
 
Fair
Value
 
Notional
Amount
 
Fair
Value
Asset Derivatives
 
 

 
 

 
 

 
 

Derivatives designated as hedging instruments
 
 
 
 
 
 
 
 
Interest rate swaps associated with loans
 
$
300,654

 
$
5,265

 
$
17,900

 
$
3

Interest rate swaps associated with securities available-for-sale
 
88,200

 
2,359

 

 

Interest rate swaps associated with liabilities
 
130,000

 
408

 

 

Derivatives not designated as hedging instruments
 
 

 
 

 
 

 
 

IRLCs
 
26,658

 
383

 
26,394

 
551

Forward contracts
 
30,500

 
127

 

 

Total contracts
 
$
576,012

 
$
8,542

 
$
44,294

 
$
554

Liability Derivatives
 
 
 
 
 
 
 
 
Derivatives designated as hedging instruments
 
 
 
 
 
 
 
 
Interest rate swaps associated with loans
 
$
37,588

 
$
(72
)
 
$
73,235

 
$
(266
)
Interest rate swaps associated with securities available-for-sale
 

 

 
50,000

 
(8
)
Derivatives not designated as hedging instruments
 
 
 
 
 
 
 
 
Forward contracts
 

 

 
51,124

 
(80
)
Total contracts
 
$
37,588

 
$
(72
)
 
$
174,359

 
$
(354
)

The fair value of interest rate swaps were estimated using a discounted cash flow method that incorporates current market interest rates as of the balance sheet date. Fair values of IRLCs and forward contracts were estimated using changes in mortgage interest rates form the date the Company entered into the IRLC and the balance sheet date.

The following table presents the effects of the Company’s cash flow hedge relationships on the condensed consolidated statements of comprehensive income during the three and nine months ended September 30, 2018.

 
 
Amount of Gain Recognized in Other Comprehensive Income
 
 
Three Months Ended
 
Nine Months Ended
 
 
September 30, 2018
 
September 30, 2018
 
 
 
 
 
Interest rate swap agreements
 
$
1,366

 
$
408
 

The following table summarizes the periodic changes in the fair value of derivatives not designated as hedging instruments on the condensed consolidated statements of income for the three and nine months ended September 30, 2018 and 2017.

 
 
Amount of gain / (loss) recognized in the three months ended
 
Amount of gain / (loss) recognized in the nine months ended
 
 
September 30, 2018
 
September 30, 2017
 
September 30, 2018
 
September 30, 2017
Asset Derivatives
 
 

 
 

 
 

 
 

Derivatives not designated as hedging instruments
 
 

 
 

 
 

 
 

IRLCs
 
$
(341
)
 
$
135

 
$
(168
)
 
$
177

Forward contracts
 
289

 
(47
)
 
208

 
(266
)
  
The following table presents the effects of the Company’s interest rate swap agreements on the condensed consolidated statements of income during the three and nine months ended September 30, 2018 and 2017.

31




Line item in the condensed consolidated statements of income
 
Three Months Ended
 
Nine Months Ended
 
September 30, 2018
 
September 30, 2017
 
September 30, 2018
 
September 30, 2017
Interest income
 
 
 
 
 
 
 
 
Loans
 
$
13

 
$

 
$
30

 
$

Securities - taxable
 
(45
)
 

 
(121
)
 

Securities - non-taxable
 
1

 

 
19

 

Total interest income
 
(31
)
 

 
(72
)
 

Interest expense
 
 

 
 

 
 

 
 

Deposits
 
39

 

 
39

 

Other borrowed funds
 
86

 

 
101

 

Total interest expense
 
125

 

 
140

 

Net interest income
 
$
(156
)
 
$

 
$
(212
)
 
$



Note 12:     Recent Accounting Pronouncements

ASU 2014-09, Revenue from Contracts with Customers (Topic 606) (May 2014)

On January 1, 2018, the Company adopted this update, as subsequently amended, which (i) creates a single framework for recognizing revenue from contracts with customers that fall within its scope and (ii) revises when it is appropriate to recognize a gain (loss) for the transfer of nonfinancial assets, such as OREO. The majority of the Company’s revenues comes from interest income and other sources, including loans, leases, securities, and derivatives that are outside the scope of ASC 606. The Company’s services that fall within the scope of ASC 606 are presented within noninterest income and are recognized as revenue as the Company satisfies its obligation to the customer. Our services within the scope of ASC 606 include deposit service charges on deposits, interchange income and the sale of OREO. Our revenue within the scope of ASC 606 is minimal and the adoption of this update did not have a material impact on the condensed consolidated statements of income.

ASU 2016-01, Financial Instruments - Overall (Subtopic 825-10) - Recognition and Measurement of Financial Assets and Financial Liabilities (January 2016)

The purpose of this update is to improve the recognition and measurement of financial instruments by requiring equity investments to be measured at fair value with changes in fair value recognized in net income; requiring public business entities to use the exit price notion when measuring the fair value of financial instruments for disclosure purposes; requiring separate presentation of financial assets and financial liabilities by measurement category and form of financial asset on the balance sheet or the accompanying notes to the financial statements; eliminating the requirement for public business entities to disclose the method(s) and significant assumptions used to estimate the fair value that is required to be disclosed for financial instruments measured and amortized at cost on the balance sheet; and requiring a reporting organization to present separately in other comprehensive income the portion of the total change in the fair value of a liability resulting option for financial instruments. This update is effective for annual periods and interim periods within those periods beginning after December 15, 2017. The amendments should be applied by means of a cumulative-effect adjustment to the balance sheet as of the beginning of the fiscal year of adoption. The amendments related to equity securities without readily determinable fair values (including disclosure requirements) should be applied prospectively to equity investments that exist as of the date of adoption. In February 2018, the FASB issued ASU 2018-03, which includes technical corrections and improvements to clarify the guidance in ASU 2016-01. The Company adopted ASU 2016-01 on January 1, 2018, and it did not have a material impact on fair value disclosures and other disclosure requirements.


32



ASU 2016-02, Leases (Topic 842) (February 2016)

In February 2016, the FASB amended its standards with respect to the accounting for leases. The amended standard serves to replace all current GAAP guidance on this topic and requires that an operating lease be recognized by the lessee on the balance sheet as a “right-of-use” asset along with a corresponding liability representing the rent obligation. Key aspects of current lessor accounting remain unchanged from existing guidance. This standard is expected to result in an increase to assets and liabilities recognized and, therefore, increase risk-weighted assets for regulatory capital purposes. The amended standard requires the use of the modified retrospective transition approach for existing leases that have not expired before the date of initial application and will become effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2018. Earlier adoption of the amended standard is permitted. The Company does not expect to early adopt and is currently in the process of fully evaluating the amendments on the condensed consolidated financial statements and will subsequently implement updated processes and accounting policies as deemed necessary. The overall impact of the new standard on the Company’s financial condition, results of operations and regulatory capital is not yet determinable. In July 2018, the FASB issued ASU 2018-10 and ASU 2018-11, which include improvements to the codification to clarify recognizing leases and the transitioning to the amended standard.

ASU 2016-13, Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments (June 2016)

The main objective of this update is to provide financial statement users with more decision-useful information about the expected credit losses on financial instruments and other commitments to extend credit held by a reporting entity at each reporting date. To achieve this objective, the amendments in this update replace the incurred loss impairment methodology in current GAAP with a methodology that reflects expected credit losses and requires consideration of a broader range of reasonable and supportable information to inform credit loss estimates.

The amendments affect entities holding financial assets that are not accounted for at fair value through net income. The amendments affect loans, debt securities, off-balance-sheet credit exposures, and any other financial assets not excluded from the scope that have the contractual right to receive cash. The amendments in this update affect an entity to varying degrees depending on the credit quality of the assets held by the entity, their duration, and how the entity applies current GAAP. There is diversity in practice in applying the incurred loss methodology, which means that before transition some entities may be more aligned under current GAAP than others to the new measure of expected credit losses. The following describes the main provisions of this update.

Assets Measured at Amortized Cost: The amendments in this update require a financial asset (or a group of financial assets) measured at amortized cost basis to be presented at the net amount expected to be collected. The allowance for credit losses is a valuation account that is deducted from the amortized cost basis of the financial asset(s) to present the net carrying value at the amount expected to be collected on the financial asset. The income statement reflects the measurement of credit losses for newly recognized financial assets, as well as the expected increases or decreases of credit losses that have taken place during the period. The measurement of expected credit losses is based on relevant information about past events, including historical experience, current conditions, and reasonable and supportable forecasts that affect the collectability of the reported amount. An entity must use judgment in determining the relevant information and estimation methods that are appropriate in its circumstances.

Available-for-Sale Debt Securities: Credit losses relating to available-for-sale debt securities should be recorded through an allowance for credit losses. Available-for-sale accounting recognizes that value may be realized either through collection of contractual cash flows or through sale of the security. Therefore, the amendments limit the amount of the allowance for credit losses to the amount by which fair value is below amortized cost because the classification as available-for-sale is premised on an investment strategy that recognizes that the investment could be sold at fair value, if cash collection would result in the realization of an amount less than fair value.


33



For public business entities that are SEC filers, the amendments in this update are effective for fiscal years beginning after December 15, 2019, including interim periods within those fiscal years. All entities may adopt the amendments in this update earlier as of the fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. An entity will apply the amendments in this update through a cumulative-effect adjustment to retained earnings as of the beginning of the first reporting period in which the guidance is effective (that is, a modified-retrospective approach). A prospective transition approach is required for debt securities for which an other-than-temporary impairment had been recognized before the effective date. The effect of a prospective transition approach is to maintain the same amortized cost basis before and after the effective date of this update.

The Company does not expect to early adopt and is currently evaluating the impact of the amendments on the Company’s condensed consolidated financial statements. The Company currently cannot determine or reasonably quantify the impact of the adoption of the amendments due to the complexity and extensive changes. The Company intends to develop processes and procedures during the next year to ensure it is fully compliant with the amendments at adoption date. The Company has formed an implementation committee and has begun evaluating the data needed for implementation as well as considering appropriate methodologies.

ASU 2018-02 - Income Statement - Reporting Comprehensive Income (Topic 820): Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income (February 2018)

The amendments in this update allow a reclassification from accumulated other comprehensive income to retained earnings for stranded tax effects resulting from the Tax Cuts and Jobs Act of 2017 (the “Tax Act”). Consequently, the amendments eliminate the stranded tax effects resulting from the Tax Act and will improve the usefulness of information reported to financial statement users. However, because the amendments only relate to the reclassification of the income tax effects of the Tax Act, the underlying guidance that requires that the effect of a change in tax laws or rates be included in income from continuing operations is not affected. The amendments in this update also require certain disclosures about stranded tax effects.

The amendments in this update are effective for all entities for fiscal years beginning after December 15, 2018, and interim periods within those fiscal years. Early adoption is permitted, including adoption in any interim period for public business entities for reporting periods for which the financial statements have not yet been issued. The amendments in this update should be applied either in the period of adoption or retrospectively to each period (or periods) in which the effect of the change in the U.S. federal corporate income tax rate in the Tax Act is recognized. The Company elected to early adopt this update as of January 1, 2018. The adoption of the guidance resulted in a cumulative-effect adjustment that increased retained earnings and increased AOCI in the nine months ended September 30, 2018.


34



ASU 2018-05 - Income Taxes (Topic 740): Amendments to SEC Paragraphs Pursuant to SEC Staff Accounting Bulletin No. 118 (March 2018)

The amendments in this update provide additional clarification on accounting for the Tax Act’s effects. In accordance with Staff Accounting Bulletin 118, entities that elect to record provisional amounts must base them on reasonable estimates and may adjust those amounts for a period of up to one year after the December 22, 2017 enactment date. Entities also need to consider the effect of the Tax Act when they estimate their annual effective tax rate in the first quarter and project the deferred tax effects of expected year-end temporary differences. In addition to applying the new corporate tax rate, an entity will need to consider whether it has elected to reflect global intangible low-taxed income as a period cost or as part of deferred taxes. As the Company has substantially completed the accounting for the net deferred tax asset revaluation, this update is not expected to have a material impact on the condensed consolidated financial statements.

ASU 2018-07 - Compensation - Stock Compensation (Topic 718): Improvements to Nonemployee Share-Based Payment Accounting (June 2018)

The amendments in this update simplify the accounting for share-based payments granted to nonemployees for goods and services. Under the ASU, most of the guidance on such payments to nonemployees would be aligned with the requirements for share-based payments granted to employees. This guidance is effective for public companies for fiscal years, and interim fiscal periods within those fiscal years, beginning after December 15, 2018. The Company has evaluated this update and it is not expected to have a material impact on the condensed consolidated financial statements.

ASU 2018-13 - Fair Value Measurement (Topic 820): Disclosure Framework - Changes to the Disclosure Requirements for Fair Value Measurement (August 2018)

The amendments in this update modify the disclosure requirements on fair value measurements in Topic 820. This ASU eliminates the requirements to disclose the amount of and reasons for transfers between Level 1 and Level 2 of the fair value hierarchy, the policy for timing of transfers between levels and the valuation processes for Level 3 fair value measurements. In addition, this ASU requires entities that calculate net asset value to disclose the timing of liquidation of an investee’s assets and the date when restrictions from redemption might lapse only if the investee has communicated the timing to the entity or announced the timing publicly. This ASU also added new requirements, which include the disclosure of the changes in unrealized gains and losses for the period included in other comprehensive income for recurring Level 3 fair value measurements held at the end of the reporting period and the range and weighted average of significant unobservable inputs used to develop Level 3 fair value measurements. The amendments in this ASU are effective for public companies for fiscal years, and interim fiscal periods within those fiscal years, beginning after December 15, 2019. Early adoption is permitted. The Company is currently evaluating the impact of the amendment on the Company’s condensed consolidated financial statements.


35



ITEM 2.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
 
The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our condensed consolidated financial statements and related notes appearing elsewhere in this report. This discussion and analysis includes certain forward-looking statements that involve risks, uncertainties, and assumptions. You should review the “Risk Factors” section of our Annual Report on Form 10-K for the year ended December 31, 2017 for a discussion of important factors that could cause actual results to differ materially from the results described in or implied by such forward-looking statements. See also “Cautionary Note Regarding Forward-Looking Statements” at the beginning of this report.
 
Overview
 
First Internet Bancorp (“we,” “our,” “us,” or the “Company”) is a bank holding company that conducts its business activities through its wholly-owned subsidiary, First Internet Bank of Indiana, an Indiana chartered bank (the “Bank”). The Bank was the first state-chartered, Federal Deposit Insurance Corporation (“FDIC”) insured Internet bank and commenced banking operations in 1999. The Company was incorporated under the laws of the State of Indiana on September 15, 2005. On March 21, 2006, we consummated a plan of exchange by which we acquired all of the outstanding shares of the Bank.

The Bank has three wholly-owned subsidiaries, First Internet Public Finance Corp., which was organized in early 2017 and provides a range of public and municipal finance lending and leasing products to governmental entities throughout the United States and acquires securities issued by state and local governments and other municipalities, JKH Realty Services, LLC, which manages other real estate owned (“OREO”) properties as needed and SPF15, Inc, which was formed to acquire and hold real estate.

We offer a wide range of commercial, small business, consumer and municipal banking products and services. We conduct our consumer and small business deposit operations primarily through online channels on a nationwide basis and have no traditional branch offices. Our residential mortgage products are offered nationwide primarily through an online direct-to-consumer platform and are supplemented with Central Indiana-based mortgage and construction lending. Our consumer lending products are primarily originated on a nationwide basis over the Internet as well as through relationships with dealerships and financing partners.

Our commercial banking products and services are delivered through a relationship banking model and include commercial real estate (“CRE”) banking, commercial and industrial (“C&I”) banking, public finance, healthcare finance and commercial deposits and treasury management. Through our CRE team, we offer single tenant lease financing on a nationwide basis in addition to traditional investor commercial real estate and construction loans primarily within Central Indiana and adjacent markets. To meet the needs of commercial borrowers and depositors located primarily in Central Indiana, Phoenix, Arizona and adjacent markets, our C&I banking team provides credit solutions such as lines of credit, term loans, owner-occupied commercial real estate loans and corporate credit cards. Our public finance team, established in early 2017, provides a range of public and municipal lending and leasing products to government entities on a nationwide basis. Healthcare finance was established in the second quarter of 2017 in conjunction with our strategic partnership with Lendeavor, Inc., a San Francisco-based technology-enabled lender to healthcare practices, and provides lending for healthcare practice finance or acquisition, acquiring or refinancing owner-occupied commercial real estate and equipment purchases. Initial efforts within healthcare finance have primarily focused on the West Coast with plans to expand nationwide. Our commercial deposits and treasury management team works with the other commercial teams to provide deposit products and treasury management services to our commercial and municipal lending customers as well as pursues commercial deposit opportunities in business segments where we have no credit relationships.


36



Results of Operations

The following table presents a summary of the Company’s financial performance for the last five completed fiscal quarters and the nine months ended September 30, 2018 and 2017.
(dollars in thousands except for per share data)
Three Months Ended
 
Nine Months Ended
September 30,
2018
 
June 30,
2018
 
March 31,
2018
 
December 31,
2017
 
September 30,
2017
 
September 30,
2018
 
September 30,
2017
Income Statement Summary:
 
 
 
 
 
 
 
 
 
 
 
 
 
Net interest income
$
15,970

 
$
15,461

 
$
15,415

 
$
15,360

 
$
14,191

 
$
46,846

 
$
38,622

Provision for loan losses
888

 
667

 
850

 
1,179

 
1,336

 
2,405

 
3,693

Noninterest income
1,994

 
2,177

 
2,542

 
2,539

 
3,135

 
6,713

 
8,002

Noninterest expense
10,045

 
10,182

 
10,217

 
9,701

 
9,401

 
30,444

 
27,022

Income tax provision
743

 
781

 
862

 
3,521

 
1,694

 
2,386

 
4,181

Net income
$
6,288

 
$
6,008

 
$
6,028

 
$
3,498

 
$
4,895

 
$
18,324

 
$
11,728

Per Share Data:
 
 
 
 
 
 
 
 
 
 
 
 
 
Earnings per share - basic
$
0.61

 
$
0.67

 
$
0.71

 
$
0.41

 
$
0.72

 
$
1.99

 
$
1.76

Earnings per share - diluted
$
0.61

 
$
0.67

 
$
0.71

 
$
0.41

 
$
0.71

 
$
1.98

 
$
1.75

Dividends declared per share
$
0.06

 
$
0.06

 
$
0.06

 
$
0.06

 
$
0.06

 
$
0.18

 
$
0.18

Book value per common share
$
28.26

 
$
27.71

 
$
26.60

 
$
26.65

 
$
26.26

 
$
28.26

 
$
26.26

Tangible book value per common share 1
$
27.80

 
$
27.25

 
$
26.05

 
$
26.09

 
$
25.70

 
$
27.80

 
$
25.70

Common shares outstanding
10,181,675

 
10,181,675

 
8,450,925

 
8,411,077

 
8,411,077

 
10,181,675

 
8,411,077

Average common shares outstanding:
 
 
 
 
 
 
 
 
 
 
 
 
 
Basic
10,261,967

 
8,909,913

 
8,499,196

 
8,490,951

 
6,834,011

 
9,230,149

 
6,656,160

Diluted
10,273,766

 
8,919,460

 
8,542,363

 
8,527,599

 
6,854,614

 
9,250,839

 
6,683,379

Performance Ratios:
 
 
 
 
 
 
 
 
 
 
 
 
 
Return on average assets
0.79
%
 
0.82
%
 
0.87
%
 
0.52
%
 
0.78
%
 
0.83
%
 
0.71
%
Return on average shareholders’ equity
8.75
%
 
10.11
%
 
10.96
%
 
6.23
%
 
11.20
%
 
9.83
%
 
9.61
%
Return on average tangible common equity 1
8.89
%
 
10.31
%
 
11.19
%
 
6.37
%
 
11.51
%
 
10.02
%
 
9.89
%
Net interest margin
2.06
%
 
2.17
%
 
2.26
%
 
2.35
%
 
2.31
%
 
2.16
%
 
2.41
%
Net interest margin - FTE 1,2
2.23
%
 
2.33
%
 
2.41
%
 
2.59
%
 
2.52
%
 
2.32
%
 
2.57
%
Noninterest expense to average assets
1.27
%
 
1.40
%
 
1.47
%
 
1.45
%
 
1.50
%
 
1.37
%
 
1.64
%
Capital Ratios:
 
 
 
 
 
 
 
 
 
 
 
 
 
Total shareholders’ equity to assets
8.98
%
 
9.05
%
 
7.85
%
 
8.10
%
 
8.39
%
 
8.98
%
 
8.39
%
Tangible common equity to tangible assets ratio 1
8.85
%
 
8.92
%
 
7.70
%
 
7.94
%
 
8.22
%
 
8.85
%
 
8.22
%
Tier 1 leverage ratio
9.40
%
 
9.93
%
 
8.17
%
 
8.45
%
 
8.86
%
 
9.40
%
 
8.86
%
Common equity tier 1 capital ratio
13.14
%
 
13.54
%
 
11.42
%
 
11.43
%
 
11.93
%
 
13.14
%
 
11.93
%
Tier 1 capital ratio
13.14
%
 
13.54
%
 
11.42
%
 
11.43
%
 
11.93
%
 
13.14
%
 
11.93
%
Total risk-based capital ratio
15.38
%
 
15.85
%
 
14.01
%
 
14.07
%
 
14.67
%
 
15.38
%
 
14.67
%

1 This information represents a non-GAAP financial measure. See the “Reconciliation of Non-GAAP Financial Measures” for a reconciliation of these measures to their most directly comparable GAAP measures.
2 On a fully-taxable equivalent (“FTE”) basis assuming a 21% tax rate in 2018 and a 35% tax rate in 2017. Net interest income is adjusted to reflect income from assets such as municipal loans and securities that are exempt from Federal income taxes.   This is to recognize the income tax savings that facilitates a comparison between taxable and tax-exempt assets.  The Company believes that it is a standard practice in the banking industry to present net interest margin and net interest income on a fully-taxable equivalent basis as these measures provide useful information to make peer comparisons.


37



During the third quarter 2018, net income was $6.3 million, or $0.61 per diluted share, compared to third quarter 2017 net income of $4.9 million, or $0.71 per diluted share, representing an increase in net income of $1.4 million, or 28.5%. During the nine months ended September 30, 2018, net income was $18.3 million, or $1.98 per diluted share, compared to net income of $11.7 million, or $1.75 per diluted share, for the nine months ended September 30, 2017, resulting in an increase in net income of $6.6 million, or 56.2%. The comparability of diluted earnings per share between the third quarter 2018 and the third quarter 2017 as well as the nine months ended September 30, 2018 and the nine months ended September 30, 2017 is impacted by the effect on average diluted shares outstanding resulting from the Company’s issuance of 1,897,500 shares of common stock issued through an underwritten public offering in September 2017 and the issuance of 1,730,750 shares of common stock issued through an underwritten public offering in June 2018.

The increase in net income in the third quarter 2018 compared to the third quarter 2017 was due primarily to a $1.8 million, or 12.5%, increase in net interest income, a $1.0 million, or 56.1%, decrease in income tax provision and a $0.4 million, or 33.5%, decrease in provision for loan losses, partially offset by a $1.1 million, or 36.4%, decrease in noninterest income and a $0.6 million, or 6.9%, increase in noninterest expense.

The increase in net income in the nine months ended September 30, 2018 compared to the nine months ended September 30, 2017 was due primarily to an $8.2 million, or 21.3%, increase in net interest income, a $1.8 million, or 42.9%, decrease in income tax expense and a $1.3 million, or 34.9%, decrease in provision for loan losses, partially offset by a $3.4 million, or 12.7%, increase in noninterest expense and a $1.3 million, or 16.1%, decrease in noninterest income.

During the third quarter 2018, return on average assets (“ROAA”) and return on average shareholders’ equity (“ROAE”) were 0.79% and 8.75%, respectively, compared to 0.78% and 11.20%, respectively, for the third quarter 2017. During the nine months ended September 30, 2018, ROAA and ROAE were 0.83% and 9.83%, respectively, compared to 0.71% and 9.61%, respectively, for the nine months ended September 30, 2017. The decline in ROAE during the third quarter 2018 compared to the third quarter 2017 was a result of the Company’s growth in average shareholders’ equity of $111.7 million, or 64.4%, which outpaced net income growth. The increase in average shareholders’ equity was due primarily to the equity offerings completed in September 2017 and June 2018, which resulted in net proceeds to the Company of $51.6 million and$54.3 million, respectively.



38



Consolidated Average Balance Sheets and Net Interest Income Analyses
 
For the periods presented, the following tables provide the average balances of interest-earning assets and interest-bearing liabilities and the related yields and cost of funds. The tables do not reflect any effect of income taxes except for net interest margin - FTE as discussed below. Balances are based on the average of daily balances. Nonaccrual loans are included in average loan balances.
(dollars in thousands)
 
Three Months Ended
 
 
September 30, 2018
 
June 30, 2018
 
September 30, 2017
 
 
Average Balance
 
Interest /Dividends
 
Yield /Cost
 
Average Balance
 
Interest /Dividends
 
Yield /Cost
 
Average Balance
 
Interest /Dividends
 
Yield /Cost
Assets
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Interest-earning assets
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Loans, including
loans held-for-sale
 
$
2,462,209

 
$
26,019

 
4.19
%
 
$
2,295,970

 
$
23,699

 
4.14
%
 
$
1,818,379

 
$
18,922

 
4.13
%
Securities - taxable
 
389,880

 
2,659

 
2.71
%
 
386,207

 
2,556

 
2.65
%
 
410,630

 
2,582

 
2.49
%
Securities - non-taxable
 
94,020

 
698

 
2.95
%
 
94,506

 
700

 
2.97
%
 
97,243

 
697

 
2.84
%
Other earning assets
 
131,306

 
847

 
2.56
%
 
79,346

 
461

 
2.33
%
 
108,547

 
493

 
1.80
%
Total interest-earning assets
 
3,077,415

 
30,223

 
3.90
%
 
2,856,029

 
27,416

 
3.85
%
 
2,434,799

 
22,694

 
3.70
%
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Allowance for loan losses
 
(16,312
)
 
 
 
 
 
(15,782
)
 
 
 
 
 
(13,657
)
 
 
 
 
Noninterest-earning assets
 
87,127

 
 
 
 
 
81,293

 
 
 
 
 
71,609

 
 
 
 
Total assets
 
$
3,148,230

 
 
 
 
 
$
2,921,540

 
 
 
 
 
$
2,492,751

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Liabilities
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Interest-bearing liabilities
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Interest-bearing demand deposits
 
$
87,102

 
$
133

 
0.61
%
 
$
93,599

 
$
145

 
0.62
%
 
$
88,633

 
$
122

 
0.55
%
Regular savings accounts
 
51,557

 
147

 
1.13
%
 
55,273

 
158

 
1.15
%
 
42,308

 
97

 
0.91
%
Money market accounts
 
527,715

 
2,206

 
1.66
%
 
571,398

 
2,130

 
1.50
%
 
440,293

 
1,187

 
1.07
%
Certificates and brokered deposits
 
1,702,098

 
9,164

 
2.14
%
 
1,416,775

 
6,793

 
1.92
%
 
1,268,709

 
5,188

 
1.62
%
Total interest-bearing deposits
 
2,368,472

 
11,650

 
1.95
%
 
2,137,045

 
9,226

 
1.73
%
 
1,839,943

 
6,594

 
1.42
%
Other borrowed funds
 
439,412

 
2,603

 
2.35
%
 
492,068

 
2,729

 
2.22
%
 
431,738

 
1,909

 
1.75
%
Total interest-bearing liabilities
 
2,807,884

 
14,253

 
2.01
%
 
2,629,113

 
11,955

 
1.82
%
 
2,271,681

 
8,503

 
1.49
%
Noninterest-bearing deposits
 
44,921

 
 
 
 
 
44,524

 
 
 
 
 
35,094

 
 
 
 
Other noninterest-bearing liabilities
 
10,218

 
 
 
 
 
9,438

 
 
 
 
 
12,517

 
 
 
 
Total liabilities
 
2,863,023

 
 
 
 
 
2,683,075

 
 
 
 
 
2,319,292

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Shareholders’ equity
 
285,207

 
 
 
 
 
238,465

 
 
 
 
 
173,459

 
 
 
 
Total liabilities and shareholders’ equity
 
$
3,148,230

 
 
 
 
 
$
2,921,540

 
 
 
 
 
$
2,492,751

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Net interest income
 
 
 
$
15,970

 
 
 
 
 
$
15,461

 
 
 
 
 
$
14,191

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Interest rate spread 1
 
 
 
 
 
1.89
%
 
 
 
 
 
2.03
%
 
 
 
 
 
2.21
%
Net interest margin 2
 
 
 
 
 
2.06
%
 
 
 
 
 
2.17
%
 
 
 
 
 
2.31
%
Net interest margin FTE 3
 
 
 
 
 
2.23
%
 
 
 
 
 
2.33
%
 
 
 
 
 
2.52
%
1 Yield on total interest-earning assets minus cost of total interest-bearing liabilities
2 Net interest income divided by total average interest-earning assets (annualized)
3 On an FTE basis assuming a 21% tax rate in 2018 and a 35% tax rate in 2017. Net interest income is adjusted to reflect income from assets such as municipal loans and securities that are exempt from Federal income taxes.   This is to recognize the income tax savings that facilitates a comparison between taxable and tax-exempt assets.  The Company believes that it is a standard practice in the banking industry to present net interest margin and net interest income on a fully-taxable equivalent basis as these measures provide useful information to make peer comparisons. Net interest margin-FTE represents a non-GAAP financial measure. See the “Reconciliation of Non-GAAP Financial Measures” for a reconciliation of these measures to their most directly comparable GAAP measures.


39



(dollars in thousands)
 
Nine Months Ended
 
 
September 30, 2018
 
September 30, 2017
 
 
Average Balance
 
Interest /Dividends
 
Yield /Cost
 
Average Balance
 
Interest /Dividends
 
Yield /Cost
Assets
 
 
 
 
 
 
 
 
 
 
 
 
Interest-earning assets
 
 
 
 
 
 
 
 
 
 
 
 
Loans, including loans held-for-sale
 
$
2,311,374

 
$
71,833

 
4.16
%
 
$
1,577,526

 
$
49,494

 
4.19
%
Securities - taxable
 
388,513

 
7,703

 
2.65
%
 
399,284

 
7,515

 
2.52
%
Securities - non-taxable
 
94,744

 
2,109

 
2.98
%
 
95,348

 
2,090

 
2.93
%
Other earning assets
 
105,210

 
1,973

 
2.51
%
 
74,208

 
960

 
1.73
%
Total interest-earning assets
 
2,899,841

 
83,618

 
3.86
%
 
2,146,366

 
60,059

 
3.74
%
 
 
 
 
 
 
 
 
 
 
 
 
 
Allowance for loan losses
 
(15,770
)
 
 
 
 
 
(12,451
)
 
 
 
 
Noninterest-earning assets
 
81,638

 
 
 
 
 
65,949

 
 
 
 
Total assets
 
$
2,965,709

 
 
 
 
 
$
2,199,864

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Liabilities
 
 
 
 
 
 
 
 
 
 
 
 
Interest-bearing liabilities
 
 
 
 
 
 
 
 
 
 
 
 
Interest-bearing demand deposits
 
$
90,564

 
$
401

 
0.59
%
 
$
89,869

 
$
368

 
0.55
%
Regular savings accounts
 
54,245

 
462

 
1.14
%
 
35,113

 
210

 
0.80
%
Money market accounts
 
553,692

 
6,228

 
1.50
%
 
394,581

 
2,799

 
0.95
%
Certificates and brokered deposits
 
1,506,000

 
22,055

 
1.96
%
 
1,109,858

 
13,240

 
1.59
%
Total interest-bearing deposits
 
2,204,501

 
29,146

 
1.77
%
 
1,629,421

 
16,617

 
1.36
%
Other borrowed funds
 
457,807

 
7,626

 
2.23
%
 
364,738

 
4,820

 
1.77
%
Total interest-bearing liabilities
 
2,662,308

 
36,772

 
1.85
%
 
1,994,159

 
21,437

 
1.44
%
Noninterest-bearing deposits
 
44,477

 
 
 
 
 
33,164

 
 
 
 
Other noninterest-bearing liabilities
 
9,762

 
 
 
 
 
9,311

 
 
 
 
Total liabilities
 
2,716,547

 
 
 
 
 
2,036,634

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Shareholders’ equity
 
249,162

 
 
 
 
 
163,230

 
 
 
 
Total liabilities and shareholders’ equity
 
$
2,965,709

 
 
 
 
 
$
2,199,864

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Net interest income
 
 
 
$
46,846

 
 
 
 
 
$
38,622

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Interest rate spread 1
 
 
 
 
 
2.01
%
 
 
 
 
 
2.30
%
Net interest margin 2
 
 
 
 
 
2.16
%
 
 
 
 
 
2.41
%
Net interest margin - FTE 3
 
 
 
 
 
2.32
%
 
 
 
 
 
2.57
%
1 Yield on total interest-earning assets minus cost of total interest-bearing liabilities
2 Net interest income divided by total average interest-earning assets (annualized)
3 On an FTE basis assuming a 21% tax rate in 2018 and a 35% tax rate in 2017. Net interest income is adjusted to reflect income from assets such as municipal loans and securities that are exempt from Federal income taxes.   This is to recognize the income tax savings that facilitates a comparison between taxable and tax-exempt assets.  The Company believes that it is a standard practice in the banking industry to present net interest margin and net interest income on a fully-taxable equivalent basis as these measures provide useful information to make peer comparisons. Net interest margin-FTE represents a non-GAAP financial measure. See the “Reconciliation of Non-GAAP Financial Measures” for a reconciliation of these measures to their most directly comparable GAAP measures.


40



Rate/Volume Analysis 

The following table illustrates the impact of changes in the volume of interest-earning assets and interest-bearing liabilities and interest rates on net interest income for the periods indicated. The change in interest not due solely to volume or rate has been allocated in proportion to the absolute dollar amounts of the change in each. 
(dollars in thousands)
 
Three Months Ended September 30, 2018 vs. June 30, 2018 Due to Changes in
 
Three Months Ended September 30, 2018 vs. September 30, 2017 Due to Changes in
 
Nine Months Ended September 30, 2018 vs. September 30, 2017 Due to Changes in
 
 
Volume
 
Rate
 
Net
 
Volume
 
Rate
 
Net
 
Volume
 
Rate
 
Net
Interest income
 
 

 
 

 
 

 
 
 
 
 
 
 
 

 
 

 
 

Loans, including loans held-for-sale
 
$
1,988

 
$
332

 
$
2,320

 
$
6,817

 
$
280

 
$
7,097

 
$
22,932

 
$
(593
)
 
$
22,339

Securities – taxable
 
30

 
73

 
103

 
(630
)
 
707

 
77

 
(292
)
 
480

 
188

Securities – non-taxable
 
(1
)
 
(1
)
 
(2
)
 
(98
)
 
99

 
1

 
(21
)
 
40

 
19

Other earning assets
 
336

 
50

 
386

 
118

 
236

 
354

 
487

 
526

 
1,013

Total
 
2,353

 
454

 
2,807

 
6,207

 
1,322

 
7,529

 
23,106

 
453

 
23,559

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Interest expense
 
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 

Interest-bearing deposits
 
1,115

 
1,309

 
2,424

 
2,199

 
2,857

 
5,056

 
6,757

 
5,772

 
12,529

Other borrowed funds
 
(909
)
 
783

 
(126
)
 
34

 
660

 
694

 
1,390

 
1,416

 
2,806

Total
 
206

 
2,092

 
2,298

 
2,233

 
3,517

 
5,750

 
8,147

 
7,188

 
15,335

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Increase (decrease) in net interest income
 
$
2,147

 
$
(1,638
)
 
$
509

 
$
3,974

 
$
(2,195
)
 
$
1,779

 
$
14,959

 
$
(6,735
)
 
$
8,224

 

Net interest income for the third quarter 2018 was $16.0 million, an increase of $1.8 million, or 12.5%, compared to $14.2 million for the third quarter 2017. The increase in net interest income was the result of a $7.5 million, or 33.2%, increase in total interest income to $30.2 million for the third quarter 2018 from $22.7 million for the third quarter 2017. The increase in total interest income was partially offset by a $5.8 million, or 67.6%, increase in total interest expense to $14.3 million for the third quarter 2018 from $8.5 million for the third quarter 2017.

Net interest income for the nine months ended September 30, 2018 was $46.8 million, an increase of $8.2 million, or 21.3%, compared to $38.6 million for the nine months ended September 30, 2017. The increase in net interest income was the result of a $23.6 million, or 39.2%, increase in total interest income to $83.6 million for the nine months ended September 30, 2018 from $60.1 million for the nine months ended September 30, 2017. The increase in total interest income was partially offset by a $15.3 million, or 71.5%, increase in total interest expense to $36.8 million for the nine months ended September 30, 2018 from $21.4 million for the nine months ended September 30, 2017.

The increase in total interest income from the third quarter 2018 compared to the third quarter 2017 was due primarily to an increase in interest earned on loans resulting from an increase of $643.8 million, or 35.4%, in the average balance of loans, including loans held-for-sale and an an increase of 6 basis points (“bps”) in the yield on loans, including loans held-for-sale. The increase in average loan balances was driven by growth in the public finance, single tenant lease financing, healthcare finance and consumer loan portfolios. All loan portfolios experienced an increase in yields, which drove the overall increase in the yield earned on loans. The average balance of securities decreased $24.0 million, or 4.7%, and the yield earned on the securities portfolio increased 19 bps for the third quarter 2018 compared to the third quarter 2017.

The increase in total interest income from the nine months ended September 30, 2018 compared to the nine months ended September 30, 2017 was due primarily to an increase in interest earned on loans resulting from an increase of $733.8 million, or 46.5%, in the average balance of loans, including loans held-for-sale, partially offset by a decline of 3 bps in the yield on loans, including loans held-for-sale. The increase in average loan balances was driven by growth in the public finance, single tenant lease financing, residential mortgage, healthcare finance and consumer loan portfolios. While most loan categories experienced an increase in yields, the overall portfolio declined due primarily to the proportion of growth coming from the public finance loan portfolio, which generally has lower tax-exempt interest rates. The average balance of securities decreased $11.4 million, or 2.3%, and the yield earned on the securities portfolio increased 11 bps for the nine months ended September 30, 2018 compared to the nine months ended September 30, 2017.

The increase in total interest expense for the third quarter 2018 compared to the third quarter 2017 was driven primarily by an increase of $528.5 million, or 28.7%, in the average balance of interest-bearing deposits for the third quarter 2018 compared to the third quarter 2017, as well as a 53 bp increase in the cost of funds related to interest-bearing deposits. The increase in the

41



cost of interest-bearing deposits was due primarily to a $433.4 million, or 34.2%, increase in average certificates and brokered deposit balances and a 52 bp increase in the related costs of those deposits. Additionally, the increase in the cost of interest-bearing deposits was impacted by an $87.4 million, or 19.9%, increase in average money market account balances and a 59 bp increase in the related cost of these deposits. The increase in the costs of funds related to money market accounts and certificates and brokered deposits was due primarily to increases in interest rates as the Federal Reserve increased its benchmark Fed Funds target rate 100 bps from September 30, 2017 through September 30, 2018.

Interest expense related to other borrowed funds also contributed to the increase in total interest expense due to a $7.7 million, or 1.8%, increase in the average balance of other borrowed funds for the third quarter 2018 compared to the third quarter 2017. The increase in the interest expense of other borrowed funds was due primarily to the cost of funds related to Federal Home Loan Bank advances increasing 70 bps, as both short and long-term interest rates were higher in the third quarter 2018 compared to third quarter 2017.

The increase in total interest expense for the nine months ended September 30, 2018 compared to the nine months ended September 30, 2017 was driven primarily by an increase of $575.1 million, or 35.3%, in the average balance of interest-bearing deposits for the nine months ended September 30, 2018 compared to the nine months ended September 30, 2017, as well as a 41 bp increase in the cost of funds related to interest-bearing deposits. The increase in the cost of interest-bearing deposits was due primarily to a $396.1 million, or 35.7%, increase in average certificates and brokered deposit balances and a 37 bp increase in the related cost of those deposits. Additionally, the increase in the cost of interest-bearing deposits was impacted by a $159.1 million, or 40.3%, increase in average money market account balances and a 55 bp increase in the related cost of these deposits. The increase in the costs of funds related to money market accounts and certificates and brokered deposits was due to increases in interest rates as the Federal Reserve increased its benchmark Fed Funds target rate 150 bps from January 1, 2017 through September 30, 2018.

Interest expense related to other borrowed funds also contributed to the increase in total interest expense due to a $93.1 million, or 25.5%, increase in the average balance of other borrowed funds for the nine months ended September 30, 2018 compared to the nine months ended September 30, 2017, as well as an increase of 46 bps in the cost of other borrowed funds. The average balance of other borrowed funds increased due primarily to the average balance of Federal Home Loan Bank advances, which increased $94.0 million, or 28.7%, in the nine months ended September 30, 2018 compared to the nine months ended September 30, 2017. Additionally, the cost of funds related to Federal Home Loan Bank advances increased 64 bps, as both short and long-term interest rates were higher for the nine months ended September 30, 2018 compared to the nine months ended September 30, 2017.

Net interest margin (“NIM”) was 2.06% for the third quarter 2018 compared to 2.31% for the third quarter 2017. The decrease in NIM for the third quarter 2018 compared to the third quarter 2017 was driven primarily by an increase of 52 bps in the cost of interest-bearing liabilities, partially offset by an increase of 20 bps in the yield earned on interest-earning assets. On a fully-taxable equivalent basis, NIM was 2.23% for the third quarter 2018 compared to 2.52% for the third quarter 2017. The decline of 29 bps in the fully-taxable equivalent NIM was also impacted by the reduction in the federal corporate tax rate from 35% to 21%, effective January 1, 2018.

NIM was 2.16% for the nine months ended September 30, 2018 compared to 2.41% for the nine months ended September 30, 2017. The decline in NIM for the nine months ended September 30, 2018 compared to the nine months ended September 30, 2017 was driven primarily by an increase of 41 bps in the cost of interest-bearing liabilities, partially offset by a 12 bp increase in the yield earned on interest-earning assets. On a fully-taxable equivalent basis, NIM was 2.32% for the nine months ended September 30, 2018, compared to 2.57% for the nine months ended September 30, 2017. The decline of 25 bps in the fully-taxable equivalent NIM was also impacted by the reduction in the federal corporate tax rate from 35% to 21%, effective January 1, 2018.


42



Noninterest Income

The following table presents noninterest income for the last five completed fiscal quarters and the nine months ended September 30, 2018 and 2017.
(dollars in thousands)
Three Months Ended
 
Nine Months Ended
 
September 30,
2018
 
June 30,
2018
 
March 31,
2018
 
December 31,
2017
 
September 30,
2017
 
September 30,
2018
 
September 30,
2017
Service charges and fees
$
236

 
$
231

 
$
230

 
$
231

 
$
226

 
$
697

 
$
657

Mortgage banking activities
1,402

 
1,597

 
1,578

 
1,530

 
2,535

 
4,577

 
6,306

Gain on sale of loans

 

 
414

 
395

 

 
414

 

Other
356

 
349

 
320

 
383

 
374

 
1,025

 
1,039

Total noninterest income
$
1,994

 
$
2,177

 
$
2,542

 
$
2,539

 
$
3,135

 
$
6,713

 
$
8,002


During the third quarter 2018, noninterest income was $2.0 million, representing a decrease of $1.1 million, or 36.4%, compared to $3.1 million for the third quarter 2017. The decrease was due to a decrease of $1.1 million, or 44.7%, in revenue from mortgage banking activities. The decrease in mortgage banking revenue was due to declines in both mortgage originations and gain on sale margins.

During the nine months ended September 30, 2018, noninterest income was $6.7 million, a decrease of $1.3 million, or 16.1%, from the nine months ended September 30, 2017. The decrease was due to a $1.7 million, or 27.4%, decrease in revenue from mortgage banking activities, partially offset by a $0.4 million increase in gain on sale of loans sold. The decrease in mortgage banking revenue was due to a decline in mortgage originations. During the nine months ended September 30, 2018, the Company completed two sales of single tenant lease financing loans, which resulted in the gain of $0.4 million, while no loan sale transactions were completed during the nine months ended September 30, 2017.

Noninterest Expense

The following table presents noninterest expense for the last five completed fiscal quarters and the nine months ended September 30, 2018 and 2017.
(dollars in thousands)
Three Months Ended
 
Nine Months Ended
 
September 30,
2018
 
June 30,
2018
 
March 31,
2018
 
December 31,
2017
 
September 30,
2017
 
September 30,
2018
 
September 30,
2017
Salaries and employee benefits
$
5,704

 
$
5,827

 
$
5,905

 
$
5,701

 
$
5,197

 
$
17,436

 
$
15,463

Marketing, advertising and promotion
601

 
608

 
716

 
590

 
741

 
1,925

 
1,803

Consulting and professional services
709

 
633

 
851

 
617

 
897

 
2,193

 
2,474

Data processing
368

 
282

 
263

 
242

 
247

 
913

 
729

Loan expenses
241

 
260

 
237

 
303

 
262

 
738

 
724

Premises and equipment
1,244

 
1,231

 
1,214

 
1,125

 
1,080

 
3,689

 
3,058

Deposit insurance premium
441

 
480

 
465

 
420

 
375

 
1,386

 
990

Other
737

 
861

 
566

 
703

 
602

 
2,164

 
1,781

Total noninterest expense
$
10,045

 
$
10,182

 
$
10,217

 
$
9,701

 
$
9,401

 
$
30,444

 
$
27,022


Noninterest expense for the third quarter 2018 was $10.0 million, compared to $9.4 million for the third quarter 2017. The increase of $0.6 million, or 6.9%, compared to the third quarter 2017 was due primarily to increases of $0.5 million in salaries and employee benefits, $0.2 million in premises and equipment, $0.1 million in other expenses, and $0.1 million in data processing expenses, partially offset by decreases of $0.2 million in consulting and professional fees and $0.1 million in marketing, advertising and promotion expenses. The increase in salaries and employee benefits primarily resulted from personnel growth, generally in higher skill positions, and increases in employee compensation. The increase in premises and equipment was due primarily to higher software expense. The increase in other expenses was due primarily to repairs and maintenance expenses related to commercial OREO. The decrease in consulting and professional fees was due primarily to a decrease in legal expenses. The decrease in marketing, advertising and promotion expenses was due primarily to lower mortgage lead generation costs.


43



Noninterest expense for the nine months ended September 30, 2018 was $30.4 million, compared to $27.0 million for the nine months ended September 30, 2017. The increase of $3.4 million, or 12.7%, compared to the nine months ended September 30, 2017 was due primarily to an increase of $2.0 million in salaries and employee benefits, an increase of $0.6 million in premises and equipment, an increase of $0.4 million in deposit insurance premium, an increase of $0.4 million in other expenses and an increase of $0.2 million in data processing expense, partially offset by a decrease of $0.3 million in consulting and professional services. The increase in salaries and employee benefits primarily resulted from personnel growth, generally in higher skill positions, increases in employee compensation, benefits and higher equity compensation expense, including $0.2 million of non-recurring accelerated vesting recognition, but partially offset by a decrease in incentive compensation. The increase in premises and equipment was due primarily to software expenses. The increase in deposit insurance premium was due primarily to the Company’s year-over-year asset growth of 21.6%, as the FDIC uses annual asset growth as a component of its calculation to determine the cost of FDIC deposit insurance. The increase in other expenses was due primarily to lower operating income and repairs and maintenance expenses related to commercial OREO. The decrease in consulting and professional fees was due primarily to a decrease in legal expenses.

Income tax provision was $0.7 million for the third quarter 2018, resulting in an effective tax rate of 10.6%, compared to $1.7 million and an effective tax rate of 25.7% for the third quarter 2017. Income tax provision was $2.4 million for the nine months ended September 30, 2018, resulting in an effective tax rate of 11.5%, compared to $4.2 million and an effective tax rate of 26.3% for the nine months ended September 30, 2017. The decrease in the effective tax rate during the third quarter 2018 and the nine months ended September 30, 2018 was due primarily to the Tax Cuts and Jobs Act of 2017 which, among other things, reduced the corporate federal income tax rate from 35% in 2017 to 21% in 2018. Additionally, the lower effective tax rate in both the three and nine months ended September 30, 2018 was due to an increase in the average balance of tax-exempt earning assets resulting from growth in the public finance loan portfolio.

Financial Condition

The following table presents summary balance sheet data for the last five completed fiscal quarters.
(dollars in thousands)
 
 
 
 
 
 
 
 
 
 
Balance Sheet Data:
 
September 30,
2018
 
June 30,
2018
 
March 31,
2018
 
December 31,
2017
 
September 30,
2017
Total assets
 
$
3,202,918

 
$
3,115,773

 
$
2,862,728

 
$
2,767,687

 
$
2,633,422

Loans
 
2,493,622

 
2,374,035

 
2,209,405

 
2,091,193

 
1,868,487

Total securities
 
489,197

 
480,025

 
482,858

 
492,484

 
511,680

Loans held-for-sale
 
23,493

 
20,672

 
17,067

 
51,407

 
45,487

Noninterest-bearing deposits
 
42,750

 
44,671

 
47,678

 
44,686

 
33,734

Interest-bearing deposits
 
2,403,814

 
2,349,613

 
2,129,443

 
2,040,255

 
1,963,294

Total deposits
 
2,446,564

 
2,394,284

 
2,177,121

 
2,084,941

 
1,997,028

Advances from Federal Home Loan Bank
 
425,160

 
390,167

 
413,173

 
410,176

 
365,180

Total shareholders’ equity
 
287,740

 
282,087

 
224,824

 
224,127

 
220,867


Total assets increased $435.2 million, or 15.7%, to $3.2 billion at September 30, 2018 compared to $2.8 billion at December 31, 2017. Balance sheet expansion during the first nine months of 2018 was funded primarily by deposit growth of $361.6 million, or 17.3% and supplemented by growth in total shareholders’ equity of $63.6 million, or 28.4%. This funding was generally deployed to support loan growth of $402.4 million, or 19.2%.

Loan Portfolio Analysis

The following table presents a detailed listing of the Company’s loan portfolio for the last five completed fiscal quarters.

44



(dollars in thousands)
September 30,
2018
 
June 30,
2018
 
March 31,
2018
 
December 31,
2017
 
September 30,
2017
Commercial loans
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Commercial and industrial
$
105,489

 
4.2
%
 
$
107,394

 
4.5
%
 
$
119,893

 
5.4
%
 
$
122,940

 
5.9
%
 
$
122,587

 
6.5
%
Owner-occupied commercial real estate
93,568

 
3.8
%
 
86,068

 
3.6
%
 
81,998

 
3.7
%
 
75,768

 
3.6
%
 
75,986

 
4.1
%
Investor commercial real estate
5,595

 
0.2
%
 
6,185

 
0.3
%
 
6,273

 
0.3
%
 
7,273

 
0.4
%
 
7,430

 
0.4
%
Construction
38,228

 
1.5
%
 
46,769

 
2.0
%
 
47,013

 
2.1
%
 
49,213

 
2.4
%
 
50,367

 
2.7
%
Single tenant lease financing
883,372

 
35.4
%
 
863,981

 
36.4
%
 
834,335

 
37.8
%
 
803,299

 
38.4
%
 
783,918

 
41.9
%
Public finance
610,858

 
24.5
%
 
566,184

 
23.8
%
 
481,923

 
21.8
%
 
438,341

 
21.0
%
 
269,347

 
14.4
%
Healthcare finance
89,525

 
3.6
%
 
65,605

 
2.8
%
 
48,891

 
2.2
%
 
31,573

 
1.5
%
 
12,363

 
0.7
%
Total commercial loans
1,826,635

 
73.3
%
 
1,742,186

 
73.4
%
 
1,620,326

 
73.3
%
 
1,528,407

 
73.2
%
 
1,321,998

 
70.7
%
Consumer loans
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Residential mortgage
362,574

 
14.5
%
 
337,143

 
14.2
%
 
318,298

 
14.4
%
 
299,935

 
14.3
%
 
291,382

 
15.6
%
Home equity
28,713

 
1.2
%
 
28,826

 
1.2
%
 
29,296

 
1.3
%
 
30,554

 
1.5
%
 
31,236

 
1.7
%
Other consumer
270,567

 
10.8
%
 
260,164

 
11.0
%
 
236,185

 
10.7
%
 
227,533

 
10.8
%
 
220,920

 
11.8
%
Total consumer loans
661,854

 
26.5
%
 
626,133

 
26.4
%
 
583,779

 
26.4
%
 
558,022

 
26.6
%
 
543,538

 
29.1
%
Net deferred loan origination costs and premiums and discounts on purchased loans
5,133

 
0.2
%
 
5,716

 
0.2
%
 
5,300

 
0.3
%
 
4,764

 
0.2
%
 
2,951

 
0.2
%
Total loans
2,493,622

 
100.0
%
 
2,374,035

 
100.0
%
 
2,209,405

 
100.0
%
 
2,091,193

 
100.0
%
 
1,868,487

 
100.0
%
Allowance for loan losses
(16,704
)
 
 
 
(16,053
)
 
 
 
(15,560
)
 
 
 
(14,970
)
 
 
 
(14,087
)
 
 
Net loans
$
2,476,918

 
 
 
$
2,357,982

 
 
 
$
2,193,845

 
 
 
$
2,076,223

 
 
 
$
1,854,400

 
 

Total loans were $2.5 billion as of September 30, 2018, an increase of $402.4 million, or 19.2%, compared to December 31, 2017. The growth in commercial loan balances was positively impacted by production in public finance as balances increased $172.5 million, or 39.4%, compared to December 31, 2017. Production in single tenant lease financing remained solid as balances increased $80.1 million, or 10.0%, compared to December 31, 2017. Additionally, healthcare finance balances increased $58.0 million, or 183.6%, during the first nine months of 2018. The growth in consumer loans was primarily driven by the Company’s residential mortgage portfolio and other consumer loan portfolio, which increased $62.6 million, or 20.9%, and $43.0 million, or 18.9%, respectively, compared to December 31, 2017. The growth in the other consumer loans portfolio was driven primarily by production in trailer and recreational vehicle loans.

The Company completed two sales of single tenant lease financing loans during the nine months ended September 30, 2018. The sales, totaling $25.2 million in the aggregate, resulted in a $0.4 million gain. Loan sales provide the Company an additional strategy to manage balance sheet growth and capital while providing additional liquidity and further diversifying revenue channels.


45



Asset Quality

Nonperforming loans are comprised of nonaccrual loans and loans 90 days past due and accruing. Nonperforming assets include nonperforming loans, OREO and other nonperforming assets, which consist of repossessed assets. The following table provides a detailed listing of the Company’s nonperforming assets for the last five completed fiscal quarters.
(dollars in thousands)
September 30,
2018
 
June 30,
2018
 
March 31,
2018
 
December 31,
2017
 
September 30,
2017
Nonaccrual loans
 
 
 
 
 
 
 
 
 
Commercial loans:
 
 
 
 
 
 
 
 
 
Commercial and industrial
$

 
$

 
$

 
$

 
$
1,845

Total commercial loans

 

 

 

 
1,845

Consumer loans:
 
 
 
 
 
 
 
 
 
Residential mortgage
179

 
161

 
495

 
724

 
775

Home equity

 
83

 
83

 
83

 

Other consumer
61

 
41

 
81

 
32

 
40

Total consumer loans
240

 
285

 
659

 
839

 
815

Total nonaccrual loans
240

 
285

 
659

 
839

 
2,660

 
 
 
 
 
 
 
 
 
 
Past Due 90 days and accruing loans
 
 
 
 
 
 
 
 
 
Consumer loans:
 
 
 
 
 
 
 
 
 
Other consumer
16

 

 

 

 
2

Total consumer loans
16

 

 

 

 
2

Total past due 90 days and accruing loans
16

 

 

 

 
2

 
 
 
 
 
 
 
 
 
 
Total nonperforming loans
256

 
285

 
659

 
839

 
2,662

 
 
 
 
 
 
 
 
 
 
Other real estate owned
 
 
 
 
 
 
 
 
 
Investor commercial real estate
4,488

 
4,488

 
4,488

 
4,488

 
4,488

Residential mortgage
553

 
553

 
553

 
553

 
648

Total other real estate owned
5,041

 
5,041

 
5,041

 
5,041

 
5,136

 
 
 
 
 
 
 
 
 
 
Other nonperforming assets
7

 
9

 
10

 
12

 
57

 
 
 
 
 
 
 
 
 
 
Total nonperforming assets
$
5,304

 
$
5,335

 
$
5,710

 
$
5,892

 
$
7,855

 
 
 
 
 
 
 
 
 
 
Total nonperforming loans to total loans
0.01
%
 
0.01
%
 
0.03
%
 
0.04
%
 
0.14
%
Total nonperforming assets to total assets
0.17
%
 
0.17
%
 
0.21
%
 
0.21
%
 
0.30
%
Allowance for loan losses to total loans
0.67
%
 
0.68
%
 
0.70
%
 
0.72
%
 
0.75
%
Allowance for loan losses to nonperforming loans
6,525.0
%
 
5,632.6
%
 
2,361.2
%
 
1,784.3
%
 
529.2
%

Troubled Debt Restructurings

The following table provides a summary of troubled debt restructurings for the last five completed fiscal quarters.
(dollars in thousands)
September 30,
2018
 
June 30,
2018
 
March 31,
2018
 
December 31,
2017
 
September 30,
2017
Troubled debt restructurings – nonaccrual
$

 
$

 
$

 
$

 
$
1,845

Troubled debt restructurings – performing
$
450

 
$
457

 
$
464

 
$
473

 
$
480

Total troubled debt restructurings
$
450

 
$
457

 
$
464

 
$
473

 
$
2,325

 

46



The decrease of $0.6 million, or 10.0%, in total nonperforming assets as of September 30, 2018 compared to December 31, 2017 was due primarily to a decrease of $0.5 million, or 75.3%, in residential mortgage nonaccrual loans related to one nonaccrual loan that was transferred to OREO and subsequently sold during the first quarter 2018 and one nonaccrual loan that was paid in full during the second quarter 2018. Total nonperforming loans declined $0.6 million, or 69.5%, to $0.3 million as of September 30, 2018 compared to $0.8 million as of December 31, 2017. The ratio of nonperforming loans to total loans decreased to 0.01% as of September 30, 2018 compared to 0.04% as of December 31, 2017. The ratio of nonperforming assets to total assets decreased slightly to 0.17% as of September 30, 2018 compared to 0.21% as of December 31, 2017 due primarily to the increase in total assets and decrease in nonperforming assets during the period.

As of September 30, 2018 and December 31, 2017, the Company had one commercial property in OREO with a carrying value of $4.5 million. This property consists of two buildings which are residential units adjacent to a university campus. Improvements to the property have been made in collaboration with the university and the property continues to be occupied. As of September 30, 2018 and December 31, 2017, the Company had residential mortgage OREO of $0.6 million.

Allowance for Loan Losses 

The following table provides a rollforward of the allowance for loan losses for the last five completed fiscal quarters and the nine months ended September 30, 2018 and 2017.
(dollars in thousands)
Three Months Ended
 
Nine Months Ended
 
September 30,
2018
 
June 30,
2018
 
March 31,
2018
 
December 31,
2017
 
September 30,
2017
 
September 30,
2018
 
September 30,
2017
Balance, beginning of period
$
16,053

 
$
15,560

 
$
14,970

 
$
14,087

 
$
13,194

 
$
14,970

 
$
10,981

Provision charged to expense
888

 
667

 
850

 
1,179

 
1,336

 
2,405

 
3,693

Losses charged off
(336
)
 
(254
)
 
(305
)
 
(357
)
 
(532
)
 
(896
)
 
(925
)
Recoveries
99

 
80

 
45

 
61

 
89

 
225

 
338

Balance, end of period
$
16,704

 
$
16,053

 
$
15,560

 
$
14,970

 
$
14,087

 
$
16,704

 
$
14,087

 
 
 
 
 
 
 
 
 
 
 
 
 
 
Net charge-offs to average loans
0.04
%
 
0.03
%
 
0.05
%
 
0.06
%
 
0.10
%
 
0.04
%
 
0.05
%

The allowance for loan losses was $16.7 million as of September 30, 2018, compared to $15.0 million as of December 31, 2017. The increase of $1.7 million, or 11.6%, was due primarily to the growth in single tenant lease financing, public finance, healthcare finance, residential mortgage and other consumer loan balances. During the third quarter 2018, the Company recorded net charge-offs of $0.2 million, compared to net charge-offs of $0.4 million during the third quarter 2017. The net charge-offs for the third quarter 2018 were primarily driven by charge-offs in other consumer loans. The net charge-offs for the third quarter 2017 were primarily driven by charge-offs in other consumer loans and commercial and industrial loans. During the nine months ended September 30, 2018, the Company recorded net charge-offs of $0.7 million, compared to net charge-offs of $0.6 million during the nine months ended September 30, 2017. The net charge-offs for the nine months ended September 30, 2018 and September 30, 2017 were primarily driven by charge-offs in other consumer loans.

The allowance for loan losses as a percentage of total loans decreased to 0.67% as of September 30, 2018, compared to 0.72% as of December 31, 2017. The decline in the allowance as a percentage of total loans was due primarily to the continued growth in the public finance portfolio, as well as growth in the residential mortgage portfolio, as these loan categories generally have lower loss reserve factors than other loan types. Additionally, the decrease in commercial and industrial loan balances contributed to the decline in the allowance ratio, as these loans have the highest loss reserve factor. Due to the combination of growth in the allowance for loan losses and the decrease in nonaccrual loans, the allowance for loan losses as a percentage of nonperforming loans increased to 6,525.0% as of September 30, 2018, compared to 1,784.3% as of December 31, 2017.


47



Investment Securities

The following tables present the amortized cost and approximate fair value of our investment portfolio by security type for the last five completed fiscal quarters.   
(dollars in thousands)
 
 
 
 
 
 
 
 
 
Amortized Cost
September 30,
2018
 
June 30,
2018
 
March 31,
2018
 
December 31,
2017
 
September 30,
2017
Securities available-for-sale
 
 
 
 
 
 
 
 
 
U.S. Government-sponsored agencies
$
115,176

 
$
122,162

 
$
128,175

 
$
133,424

 
$
138,730

Municipal securities
97,160

 
97,230

 
97,299

 
97,370

 
97,439

Mortgage-backed securities
237,703

 
225,756

 
219,295

 
215,452

 
224,311

Asset-backed securities
5,003

 
5,003

 
5,000

 
5,000

 
9,949

Corporate securities
36,684

 
29,627

 
29,630

 
27,111

 
27,114

Other securities

 

 

 
3,000

 
3,000

Total available-for-sale
491,726

 
479,778

 
479,399

 
481,357

 
500,543

Securities held-to-maturity
 
 
 
 
 
 
 
 
 
Municipal securities
10,159

 
10,161

 
10,163

 
10,164

 
10,166

Corporate securities
10,041

 
9,042

 
9,043

 
9,045

 
9,046

Total held-to-maturity
20,200

 
19,203

 
19,206

 
19,209

 
19,212

Total securities
$
511,926

 
$
498,981

 
$
498,605

 
$
500,566

 
$
519,755

(dollars in thousands)
 
 
 
 
 
 
 
 
 
Approximate Fair Value
September 30,
2018
 
June 30,
2018
 
March 31,
2018
 
December 31,
2017
 
September 30,
2017
Securities available-for-sale
 
 
 
 
 
 
 
 
 
U.S. Government-sponsored agencies
$
112,760

 
$
120,232

 
$
127,334

 
$
133,190

 
$
138,499

Municipal securities
91,080

 
92,824

 
93,227

 
96,377

 
95,435

Mortgage-backed securities
225,692

 
215,383

 
210,122

 
209,720

 
219,579

Asset-backed securities
4,960

 
4,983

 
5,009

 
5,009

 
10,000

Corporate securities
34,505

 
27,400

 
27,960

 
26,047

 
26,004

Other securities

 

 

 
2,932

 
2,951

Total available-for-sale
468,997

 
460,822

 
463,652

 
473,275

 
492,468

Securities held-to-maturity
 
 
 
 
 
 
 
 
 
Municipal securities
9,519

 
9,675

 
9,743

 
9,847

 
9,832

Corporate securities
9,991

 
9,052

 
9,166

 
9,236

 
9,239

Total held-to-maturity
19,510

 
18,727

 
18,909

 
19,083

 
19,071

Total securities
$
488,507

 
$
479,549

 
$
482,561

 
$
492,358

 
$
511,539


The approximate fair value of investment securities available-for-sale decreased $4.3 million, or 0.9%, to $469.0 million as of September 30, 2018, compared to $473.3 million as of December 31, 2017. The decrease was due primarily to decreases of $20.4 million in U.S. Government-sponsored agencies, $5.3 million in municipal securities and $2.9 million in other securities, partially offset by an increase of $16.0 million in mortgage-backed securities and $8.5 million in corporate securities. The decrease in U.S. Government-sponsored agencies was due primarily to principal amortization and prepayments. The decrease in the approximate fair value of municipal securities was primarily caused by interest rate changes. The decline in other securities was due to the reclassification of a mutual fund with a readily determinable fair value to other assets in accordance with the adoption of ASU 2016-01. The increase in mortgage-backed securities was driven by purchases as excess liquidity was deployed, partially offset by market value declines due to interest rate changes. Additional liquidity was also used to purchase corporate securities during 2018. As of September 30, 2018, the Company had securities with an amortized cost basis of $20.2 million designated as held-to-maturity compared to $19.2 million as of December 31, 2017.


48



Other Assets

During the third quarter 2018, the Bank’s subsidiary, SPF15, Inc., acquired several parcels of land consisting of approximately 3.3 acres located in Fishers, Indiana for approximately $10.2 million, inclusive of acquisition costs. Pursuant to a Land Acquisition Agreement among SPF15, Inc. (“SPF15”), the City of Fishers, Indiana (the “City”), and its Redevelopment Commission (the “RDC”), among others, the City has agreed to reimburse SPF15 for the purchase price and other specified land acquisition costs on or before December 31, 2018. Upon the City reimbursing SPF15, SPF15 will transfer the property to the RDC, or upon request from the City, a third party in connection with the development of the property. SPF15 will be reimbursed for closing costs or fees (other than its own legal fees) resulting from such transfer(s). The Company is currently exploring the possibility of developing a portion of the land for its future use.

Deposits  

The following table presents the composition of the Company’s deposit base for the last five completed fiscal quarters.
(dollars in thousands)
 
September 30,
2018
 
June 30,
2018
 
March 31,
2018
 
December 31,
2017
 
September 30,
2017
Noninterest-bearing deposits
 
$
42,750

 
1.7
%
 
$
44,671

 
1.9
%
 
$
47,678

 
2.2
%
 
$
44,686

 
2.1
%
 
$
33,734

 
1.7
%
Interest-bearing demand deposits
 
94,681

 
3.9
%
 
91,748

 
3.8
%
 
99,006

 
4.5
%
 
94,674

 
4.5
%
 
89,748

 
4.5
%
Savings accounts
 
47,033

 
1.9
%
 
48,897

 
2.1
%
 
60,176

 
2.8
%
 
49,939

 
2.4
%
 
49,913

 
2.5
%
Money market accounts
 
478,548

 
19.6
%
 
582,565

 
24.3
%
 
592,113

 
27.2
%
 
499,501

 
24.0
%
 
499,160

 
25.0
%
Certificates of deposits
 
1,252,690

 
51.2
%
 
1,231,438

 
51.4
%
 
1,185,176

 
54.4
%
 
1,319,488

 
63.3
%
 
1,300,952

 
65.1
%
Brokered deposits
 
530,862

 
21.7
%
 
394,965

 
16.5
%
 
192,972

 
8.9
%
 
76,653

 
3.7
%
 
23,521

 
1.2
%
Total deposits
 
$
2,446,564

 
100.0
%
 
$
2,394,284

 
100.0
%
 
$
2,177,121

 
100.0
%
 
$
2,084,941

 
100.0
%
 
$
1,997,028

 
100.0
%
   
Total deposits increased $361.6 million, or 17.3%, to $2.4 billion as of September 30, 2018, compared to approximately $2.1 billion as of December 31, 2017. This increase was due primarily to an increase of $454.2 million, or 592.6%, in brokered deposits, partially offset by decreases of $66.8 million, or 5.1%, in certificates of deposits, $21.0 million, or 4.2%, in money market accounts and $2.9 million, or 5.8%, in savings accounts. A portion of the increase in brokered deposits and decrease in certificates of deposits was partially due to $160.5 million of public fund deposits originated through an investment advisor who manages fixed income portfolios for municipalities being reclassified from certificates of deposits to brokered deposits per regulatory guidance in the first quarter 2018. Additionally, brokered certificates of deposit were used as a funding source, as interest rates in the brokered market were lower than in the institutional and commercial markets in which the Company competes for deposits. The Company also used brokered money market deposits in the third quarter 2018 that were effectively converted to long-term funding with interest rate swaps to manage long-term interest rate risk. The decrease in money market accounts was due primarily to the loss of one large customer. This was a situation where another bank was extremely aggressive in going after the customer and at a certain level, it did not make good business sense to match the extremely high rate the customer was offered.

Recent Equity Stock Offerings

In June 2018, the Company completed an underwritten public offering of 1,730,750 shares of its common stock at a price of $33.25 per share. The Company received net proceeds of approximately $54.3 million after deducting underwriting discounts and commissions and offering expenses.

In September 2017, the Company completed an underwritten public offering of 1,897,500 shares of its common stock at a price of $29.00 per share. The Company received net proceeds of approximately $51.6 million after deducting underwriting discounts and commissions and offering expenses.

Regulatory Capital Requirements

The Company and the Bank are subject to various regulatory capital requirements administered by state and federal banking agencies. Capital adequacy guidelines and, additionally for banks, prompt corrective action regulations, involve quantitative measures of assets, liabilities, and certain off-balance-sheet items calculated under regulatory accounting practices. Capital amounts and classifications are also subject to qualitative judgments by regulators about components, risk weighting and other factors.

The Basel III Capital Rules became effective for the Company and the Bank on January 1, 2015, subject to a phase-in period for certain provisions. Quantitative measures established by the Basel III Capital Rules to ensure capital adequacy require

49



the maintenance of minimum amounts and ratios of Common Equity Tier 1 capital, Tier 1 capital and Total capital, as defined in the regulations, to risk-weighted assets, and of Tier 1 capital to adjusted quarterly average assets (“Leverage Ratio”).

When fully phased in on January 1, 2019, the Basel III Capital Rules will require the Company and the Bank to maintain: 1) a minimum ratio of Common Equity Tier 1 capital to risk-weighted assets of 4.5%, plus a 2.5% “capital conservation buffer” (resulting in a minimum ratio of Common Equity Tier 1 capital to risk-weighted assets of 7.0% upon full implementation); 2) a minimum ratio of Tier 1 capital to risk-weighted assets of 6.0%, plus the capital conservation buffer (resulting in a minimum Tier 1 capital ratio of 8.5% upon full implementation); 3) a minimum ratio of Total capital to risk-weighted assets of 8.0%, plus the capital conservation buffer (resulting in a minimum Total capital ratio of 10.5% upon full implementation); and 4) a minimum Leverage Ratio of 4.0%.

The implementation of the capital conservation buffer began on January 1, 2016 at the 0.625% level and will be phased in over a four-year period increasing by increments of that amount on each subsequent January 1 until it reaches 2.5% on January 1, 2019. The capital conservation buffer is designed to absorb losses during periods of economic stress. Failure to maintain the minimum Common Equity Tier 1 capital ratio plus the capital conservation buffer will result in potential restrictions on a banking institution’s ability to pay dividends, repurchase stock and/or pay discretionary compensation to its employees.

The following tables present actual and required capital ratios as of September 30, 2018 and December 31, 2017 for the Company and the Bank under the Basel III Capital Rules. The minimum required capital amounts presented include the minimum required capital levels as of September 30, 2018 and December 31, 2017 based on the phase-in provisions of the Basel III Capital Rules and the minimum required capital levels as of January 1, 2019 when the Basel III Capital Rules have been fully phased-in. Capital levels required to be considered well capitalized are based upon prompt corrective action regulations, as amended to reflect the changes under the Basel III Capital Rules.
 
Actual
 
Minimum Capital Required - Basel III Phase-In Schedule
 
Minimum Capital Required - Basel III Fully Phased-In
 
Minimum Required to be Considered Well Capitalized
(dollars in thousands)
Capital Amount
 
Ratio
 
Capital Amount
 
Ratio
 
Capital Amount
 
Ratio
 
Capital Amount
 
Ratio
As of September 30, 2018:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Common equity tier 1 capital to risk-weighted assets
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Consolidated
$
297,500

 
13.14
%
 
$
144,283

 
6.38
%
 
$
158,428

 
7.00
%
 
N/A

 
N/A

Bank
266,218

 
11.78
%
 
144,015

 
6.38
%
 
158,134

 
7.00
%
 
$
146,839

 
6.50
%
Tier 1 capital to risk-weighted assets
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Consolidated
297,500

 
13.14
%
 
178,231

 
7.88
%
 
192,377

 
8.50
%
 
N/A

 
N/A

Bank
266,218

 
11.78
%
 
177,901

 
7.88
%
 
192,020

 
8.50
%
 
180,724

 
8.00
%
Total capital to risk-weighted assets
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Consolidated
348,041

 
15.38
%
 
223,496

 
9.88
%
 
237,642

 
10.50
%
 
N/A

 
N/A

Bank
282,922

 
12.52
%
 
223,082

 
9.88
%
 
237,201

 
10.50
%
 
225,905

 
10.00
%
Leverage ratio
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Consolidated
297,500

 
9.40
%
 
126,533

 
4.00
%
 
126,533

 
4.00
%
 
N/A

 
N/A

Bank
266,218

 
8.42
%
 
126,398

 
4.00
%
 
126,398

 
4.00
%
 
157,998

 
5.00
%

50



 
Actual
 
Minimum Capital Required - Basel III Phase-In Schedule
 
Minimum Capital Required - Basel III Fully Phased-In
 
Minimum Required to be Considered Well Capitalized
(dollars in thousands)
Capital Amount
 
Ratio
 
Capital Amount
 
Ratio
 
Capital Amount
 
Ratio
 
Capital Amount
 
Ratio
As of December 31, 2017:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Common equity tier 1 capital to risk-weighted assets
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Consolidated
$
224,407

 
11.43
%
 
$
112,866

 
5.75
%
 
$
137,402

 
7.00
%
 
N/A

 
N/A

Bank
223,288

 
11.40
%
 
112,672

 
5.75
%
 
137,166

 
7.00
%
 
$
127,368

 
6.50
%
Tier 1 capital to risk-weighted assets
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Consolidated
224,407

 
11.43
%
 
142,309

 
7.25
%
 
166,845

 
8.50
%
 
N/A

 
N/A

Bank
223,288

 
11.40
%
 
142,064

 
7.25
%
 
166,558

 
8.50
%
 
156,761

 
8.00
%
Total capital to risk-weighted assets
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Consolidated
276,103

 
14.07
%
 
181,566

 
9.25
%
 
206,102

 
10.50
%
 
N/A

 
N/A

Bank
238,258

 
12.16
%
 
181,255

 
9.25
%
 
205,748

 
10.50
%
 
195,951

 
10.00
%
Leverage ratio
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Consolidated
224,407

 
8.45
%
 
106,196

 
4.00
%
 
106,196

 
4.00
%
 
N/A

 
N/A

Bank
223,288

 
8.42
%
 
106,059

 
4.00
%
 
106,059

 
4.00
%
 
132,574

 
5.00
%

Shareholders’ Dividends

The Company’s Board of Directors declared a cash dividend of $0.06 per share of common stock payable October 15, 2018 to shareholders of record as of September 28, 2018. The Company expects to continue to pay cash dividends on a quarterly basis; however, the declaration and amount of any future cash dividends will be subject to the sole discretion of the Board of Directors and will depend upon many factors, including its results of operations, financial condition, capital requirements, regulatory and contractual restrictions (including with respect to the Company’s outstanding subordinated debt), business strategy and other factors deemed relevant by the Board of Directors.

As of September 30, 2018, the Company had $35.0 million principal amount of subordinated debt outstanding pursuant to the 2025 Note and the 2026 Notes. The agreements that govern our outstanding subordinated debt prohibit the Company from paying any dividends on its common stock or making any other distributions to shareholders at any time when there shall have occurred, and be continuing to occur, an event of default under the applicable agreement. If an event of default were to occur and the Company did not cure it, the Company would be prohibited from paying any dividends or making any other distributions to shareholders or from redeeming or repurchasing any common stock.

Capital Resources

While the Company believes it has sufficient liquidity and capital resources to meet its cash and capital expenditure requirements for at least the next twelve months, including any cash dividends it may pay, the Company intends to continue pursuing its growth strategy, which may require additional capital. If the Company is unable to secure such capital at favorable terms, its ability to execute its growth strategy could be adversely affected.

Liquidity

Liquidity management is the process used by the Company to manage the continuing flow of funds necessary to meet its financial commitments on a timely basis and at a reasonable cost while also maintaining safe and sound operations. Liquidity, represented by cash and investment securities, is a product of the Company’s operating, investing and financing activities. The primary sources of funds are deposits, principal and interest payments on loans and investment securities, maturing loans and investment securities, access to wholesale funding sources and collateralized borrowings. While scheduled payments and maturities of loans and investment securities are relatively predictable sources of funds, deposit flows are greatly influenced by interest rates, general economic conditions and competition. Therefore, the Company supplements deposit growth and enhances interest rate risk management through borrowings and wholesale funding, which are generally advances from the Federal Home Loan Bank and brokered deposits.


51



The Company maintains cash and investment securities that qualify as liquid assets to maintain adequate liquidity to ensure safe and sound operations and meet its financial commitments. At September 30, 2018, on a consolidated basis, the Company had $554.8 million in cash and cash equivalents and investment securities available-for-sale and $23.5 million in loans held-for-sale that were generally available for its cash needs. The Company can also generate funds from wholesale funding sources and collateralized borrowings. At September 30, 2018, the Bank had the ability to borrow an additional $586.6 million from the Federal Home Loan Bank, the Federal Reserve and correspondent bank Fed Funds lines of credit.

The Company is a separate legal entity from the Bank and must provide for its own liquidity. In addition to its operating expenses, the Company is responsible for paying any dividends declared to its common shareholders and interest and principal on outstanding debt. The Company’s primary sources of funds are cash maintained at the holding company level and dividends from the Bank, the payment of which is subject to regulatory limits. At September 30, 2018, the Company, on an unconsolidated basis, had $62.2 million in cash generally available for its cash needs, which is in excess of its current annual regular shareholder dividend and operating expenses.
 
The Company uses its sources of funds primarily to meet ongoing financial commitments, including withdrawals by depositors, credit commitments to borrowers, operating expenses and capital expenditures. At September 30, 2018, approved outstanding loan commitments, including unused lines of credit and standby letters of credit, amounted to $183.7 million. Certificates of deposits and brokered deposits scheduled to mature in one year or less at September 30, 2018 totaled $805.6 million. Generally, the Company believes that a majority of maturing deposits will remain with the Bank.

Management is not aware of any other events or regulatory requirements that, if implemented, are likely to have a material effect on either the Company’s or the Bank’s liquidity.


52



Reconciliation of Non-GAAP Financial Measures

This Management’s Discussion and Analysis contains financial information determined by methods other than in accordance with GAAP. Non-GAAP financial measures, specifically tangible common equity, tangible assets, average tangible common equity, tangible book value per common share, return on average tangible common equity and the tangible common equity to tangible assets ratio, net interest income - FTE and net interest margin - FTE are used by the Company’s management to measure the strength of its capital and analyze profitability, including its ability to generate earnings on tangible capital invested by its shareholders. The Company also believes that it is a standard practice in the banking industry to present net interest margin and net income on a fully-taxable equivalent basis as those measures provide useful information for peer comparisons. Although the Company believes these non-GAAP financial 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 financial measures that may be presented by other companies. Reconciliations of these non-GAAP financial measures to the most directly comparable GAAP financial measures are included in the following table for the last five completed fiscal quarters and the nine months ended September 30, 2018 and 2017.

(dollars in thousands, except share and per share data)
Three Months Ended
 
Nine Months Ended
September 30,
2018
 
June 30,
2018
 
March 31,
2018
 
December 31,
2017
 
September 30,
2017
 
September 30,
2018
 
September 30,
2017
Total equity - GAAP
$
287,740

 
$
282,087

 
$
224,824

 
$
224,127

 
$
220,867

 
$
287,740

 
$
220,867

Adjustments:
 
 
 
 
 
 
 
 
 
 
 
 
 
     Goodwill
(4,687
)
 
(4,687
)
 
(4,687
)
 
(4,687
)
 
(4,687
)
 
(4,687
)
 
(4,687
)
Tangible common equity
$
283,053

 
$
277,400

 
$
220,137

 
$
219,440

 
$
216,180

 
$
283,053

 
$
216,180

 
 
 
 
 
 
 
 
 
 
 
 
 
 
Total assets - GAAP
$
3,202,918

 
$
3,115,773

 
$
2,862,728

 
$
2,767,687

 
$
2,633,422

 
$
3,202,918

 
$
2,633,422

Adjustments:
 
 
 
 
 
 
 
 
 
 
 
 
 
     Goodwill
(4,687
)
 
(4,687
)
 
(4,687
)
 
(4,687
)
 
(4,687
)
 
(4,687
)
 
(4,687
)
Tangible assets
$
3,198,231

 
$
3,111,086

 
$
2,858,041

 
$
2,763,000

 
$
2,628,735

 
$
3,198,231

 
$
2,628,735

 
 
 
 
 
 
 
 
 
 
 
 
 
 
Total common shares outstanding
10,181,675

 
10,181,675

 
8,450,925

 
8,411,077

 
8,411,077

 
10,181,675

 
8,411,077

 
 
 
 
 
 
 
 
 
 
 
 
 
 
Book value per common share
$
28.26

 
$
27.71

 
$
26.60

 
$
26.65

 
$
26.26

 
$
28.26

 
$
26.26

Effect of goodwill
(0.46
)
 
(0.46
)
 
(0.55
)
 
(0.56
)
 
(0.56
)
 
(0.46
)
 
(0.56
)
Tangible book value per common share
$
27.80

 
$
27.25

 
$
26.05

 
$
26.09

 
$
25.70

 
$
27.80

 
$
25.70

 
 
 
 
 
 
 
 
 
 
 
 
 
 
Total shareholders’ equity to assets ratio
8.98
 %
 
9.05
 %
 
7.85
 %
 
8.10
 %
 
8.39
 %
 
8.98
 %
 
8.39
 %
Effect of goodwill
(0.13
)%
 
(0.13
)%
 
(0.15
)%
 
(0.16
)%
 
(0.17
)%
 
(0.13
)%
 
(0.17
)%
Tangible common equity to tangible assets ratio
8.85
 %
 
8.92
 %
 
7.70
 %
 
7.94
 %
 
8.22
 %
 
8.85
 %
 
8.22
 %
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Total average equity - GAAP
$
285,207

 
$
238,465

 
$
223,131

 
$
222,670

 
$
173,459

 
$
249,162

 
$
163,230

Adjustments:
 
 
 
 
 
 
 
 
 
 
 
 
 
     Average goodwill
(4,687
)
 
(4,687
)
 
(4,687
)
 
(4,687
)
 
(4,687
)
 
(4,687
)
 
(4,687
)
Average tangible common equity
$
280,520

 
$
233,778

 
$
218,444

 
$
217,983

 
$
168,772

 
$
244,475

 
$
158,543

 
 
 
 
 
 
 
 
 
 
 
 
 
 
Return on average shareholders’ equity
8.75
 %
 
10.11
 %
 
10.96
 %
 
6.23
 %
 
11.20
 %
 
9.83
 %
 
9.61
 %
Effect of goodwill
0.14
 %
 
0.20
 %
 
0.23
 %
 
0.14
 %
 
0.31
 %
 
0.19
 %
 
0.28
 %
Return on average tangible common equity
8.89
 %
 
10.31
 %
 
11.19
 %
 
6.37
 %
 
11.51
 %
 
10.02
 %
 
9.89
 %

53



(dollars in thousands, except share and per share data)
Three Months Ended
 
Nine Months Ended
September 30,
2018
 
June 30,
2018
 
March 31,
2018
 
December 31,
2017
 
September 30,
2017
 
September 30,
2018
 
September 30,
2017
Total interest income
$
30,223

 
$
27,416

 
$
25,979

 
$
20,971

 
$
22,694

 
$
83,618

 
$
60,059

Adjustments:
 
 
 
 
 
 
 
 
 
 
 
 
 
Fully-taxable equivalent adjustments 1
1,351

 
1,164

 
1,018

 
1,555

 
1,280

 
3,533

 
2,586

Total interest income - FTE
$
31,574

 
$
28,580

 
$
26,997

 
$
22,526

 
$
23,974

 
$
87,151

 
$
62,645

 
 
 
 
 
 
 
 
 
 
 
 
 
 
Net interest income
$
15,970

 
$
15,461

 
$
15,415

 
$
15,360

 
$
14,191

 
$
46,846

 
$
38,622

Adjustments:
 
 
 
 
 
 
 
 
 
 
 
 
 
Fully-taxable equivalent adjustments 1
1,351

 
1,164

 
1,018

 
1,555

 
1,280

 
3,533

 
2,586

Net interest income - FTE
$
17,321

 
$
16,625

 
$
16,433

 
$
16,915

 
$
15,471

 
$
50,379

 
$
41,208

 
 
 
 
 
 
 
 
 
 
 
 
 
 
Net interest margin
2.06
%
 
2.17
%
 
2.26
%
 
2.35
%
 
2.31
%
 
2.16
%
 
2.41
%
Effect of fully-taxable equivalent adjustments 1
0.17
%
 
0.16
%
 
0.15
%
 
0.24
%
 
0.21
%
 
0.16
%
 
0.16
%
Net interest margin - FTE
2.23
%
 
2.33
%
 
2.41
%
 
2.59
%
 
2.52
%
 
2.32
%
 
2.57
%

1 Assuming a 21% tax rate in 2018 and a 35% tax rate in 2017


Critical Accounting Policies and Estimates
 
There have been no material changes in the Company’s critical accounting policies or estimates from those disclosed in its Annual Report on Form 10-K for the year ended December 31, 2017.
 
Recent Accounting Pronouncements
 
Refer to Note 12 of the condensed consolidated financial statements.

Off-Balance Sheet Arrangements
 
In the ordinary course of business, the Company enters into financial transactions to extend credit, interest rate swaps and forms of commitments that may be considered off-balance sheet arrangements. Interest rate swaps are arranged to receive hedge accounting treatment and are classified as either fair value or cash flow hedges. Fair value hedges are purchased to convert certain fixed rate assets to floating rate. Cash flow hedges are used to convert certain variable rate liabilities into fixed rate liabilities. At September 30, 2018 and December 31, 2017, the Company had interest rate swaps with notional amounts of $556.4 million and $141.1 million, respectively. Additionally, we enter into forward contracts relating to our mortgage banking business to hedge the exposures we have from commitments to extend new residential mortgage loans to our customers and from our mortgage loans held-for-sale. At September 30, 2018 and December 31, 2017, the Company had commitments to sell residential real estate loans of $30.5 million and $51.1 million, respectively. These contracts mature in less than one year. Refer to Note 11 to the Company’s condensed consolidated financial statements for additional information about derivative financial instruments.

ITEM 3.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
 
Market risk is the risk of loss arising from adverse changes in the fair value of financial instruments due to changes in interest rates, foreign exchange rates and equity prices. The primary source of market risk for the Company is interest rate risk. Interest rate risk is the risk to earnings and the value of the Company’s equity resulting from changes in market interest rates and arises in the normal course of business to the extent that there are timing and volume differences between the amount of interest-earning assets and the amount of interest-bearing liabilities that are prepaid, withdrawn, re-priced or mature in specified periods. The Company seeks to achieve consistent growth in net interest income and equity while managing volatility arising from shifts in market interest rates.
The Company monitors its interest rate risk position using income simulation models and economic value of equity (“EVE”) sensitivity analysis that capture both short-term and long-term interest rate risk exposure. Income simulation involves forecasting net interest income (“NII”) under a variety of interest rate scenarios. The Company uses EVE sensitivity analysis to understand the impact of changes in interest rates on long-term cash flows, income and capital. EVE is calculated by discounting the cash flows for all balance sheet instruments under different interest-rate scenarios. Modeling the sensitivity of NII and EVE to changes

54



in market interest rates is highly dependent on the assumptions incorporated into the modeling process. The Company continually reviews and refines the assumptions used in its interest rate risk modeling.
Presented below is the estimated impact on the Company’s NII and EVE position as of September 30, 2018, assuming parallel shifts in interest rates:
 
% Change from Base Case for Parallel Changes in Rates
 
-100 Basis Points
 
+50 Basis Points
 
+100 Basis Points
 
+200 Basis Points
NII - Year 1
0.29
%
 
0.98
 %
 
2.02
 %
 
3.67
 %
NII - Year 2
1.06
%
 
3.22
 %
 
5.14
 %
 
8.55
 %
EVE
9.15
%
 
(4.72
)%
 
(9.51
)%
 
(18.51
)%

The Company’s objective is to manage the balance sheet with a bias toward asset sensitivity while simultaneously balancing the potential earnings impact of this strategy. A “risk-neutral” position refers to the absence of a strong bias toward either asset or liability sensitivity. An “asset sensitive” position refers to when the characteristics of the balance sheet are expected to generate higher net interest income when interest rates, primarily short-term rates, increase as rates earned on interest-earning assets would reprice upward more quickly or in greater quantities than rates paid on interest-bearing liabilities would reprice.  A “liability sensitive” position refers to when the characteristics of the balance sheet are expected to generate lower net interest income when short-term interest rates increase as rates paid on interest-bearing liabilities would reprice upward more quickly or in greater quantities than rates earned on interest-earning assets.

ITEM 4.
CONTROLS AND PROCEDURES
 
Evaluation of Disclosure Controls and Procedures
 
The Company maintains disclosure controls and procedures that are designed to provide reasonable assurance that information required to be disclosed in reports that it files or submits under the Securities Exchange Act of 1934, as amended (the “Exchange Act”), is recorded, processed, summarized, and reported within the time period specified in the SEC’s rules and forms. These controls and procedures are also designed to provide reasonable assurance that such information is accumulated and communicated to management, including the principal executive and principal financial officers, as appropriate, to allow timely decisions regarding required disclosures. In designing and evaluating disclosure controls and procedures, the Company has recognized that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives. Management is required to apply judgment in evaluating its controls and procedures.
 
The Company performed an evaluation under the supervision and with the participation of management, including the principal executive and principal financial officers, to assess the effectiveness of the design and operation of its disclosure controls and procedures under the Exchange Act. Based on that evaluation, the principal executive and principal financial officers concluded that the disclosure controls and procedures were effective at a reasonable assurance level as of September 30, 2018.
 
Changes in Internal Control Over Financial Reporting
 
There has been no change in the Company’s internal control over financial reporting during the three months ended September 30, 2018 that has materially affected, or is reasonably likely to materially affect, its internal control over financial reporting.

55



PART II
 
ITEM 1.
LEGAL PROCEEDINGS
 
Neither we nor any of our subsidiaries are party to any material legal proceedings. From time to time, the Bank is a party to legal actions arising from its normal business activities.
 
ITEM 1A.
RISK FACTORS
 
There have been no material changes to the risk factors previously disclosed in Part I, Item 1A, of the Company’s Annual Report on Form 10-K for the year ended December 31, 2017.
ITEM 2.
UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
 
None.

ITEM 3.
DEFAULTS UPON SENIOR SECURITIES
 
None.
 
ITEM 4.
MINE SAFETY DISCLOSURES
 
Not Applicable.
 
ITEM 5.
OTHER INFORMATION

None.
 
ITEM 6.
EXHIBITS
 
Unless otherwise indicated, all documents incorporated into this quarterly report on Form 10-Q by reference to a document filed with the SEC pursuant to the Exchange Act are located under SEC file number 1-35750.

Exhibit No.
 
Description
 
Method of Filing
 
Articles of Incorporation of First Internet Bancorp (incorporated by reference to Exhibit 3.1 to registration statement on Form 10 filed November 30, 2012)
 
Incorporated by Reference
 
Amended and Restated Bylaws of First Internet Bancorp as amended March 18, 2013 (incorporated by reference to Exhibit 3.2 to annual report on Form 10-K for the year ended December 31, 2012)
 
Incorporated by Reference
 
 
Filed Electronically
 
 
Filed Electronically
 
 
Filed Electronically
101.INS
 
XBRL Instance Document
 
Filed Electronically
101.SCH
 
XBRL Taxonomy Extension Schema
 
Filed Electronically
101.CAL
 
XBRL Taxonomy Extension Calculation Linkbase
 
Filed Electronically
101.DEF
 
XBRL Taxonomy Extension Definition Linkbase
 
Filed Electronically
101.LAB
 
XBRL Taxonomy Extension Label Linkbase
 
Filed Electronically
101.PRE
 
XBRL Taxonomy Extension Presentation Linkbase
 
Filed Electronically


56



SIGNATURES
 
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
 
 
 
FIRST INTERNET BANCORP
 
 
 
Date: November 9, 2018
By
/s/ David B. Becker
 
 
David B. Becker,
Chairman, President and Chief Executive Officer
(on behalf of Registrant)
 
 
 
Date: November 9, 2018
By
/s/ Kenneth J. Lovik
 
 
Kenneth J. Lovik,
Executive Vice President and Chief Financial Officer (principal financial officer)

 

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