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INDEPENDENT BANK CORP /MI/ - Quarter Report: 2016 September (Form 10-Q)


SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C.  20549

FORM 10-Q

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED September 30, 2016

Commission file number   0-7818
 
INDEPENDENT BANK CORPORATION
(Exact name of registrant as specified in its charter)

Michigan
 
38-2032782
(State or jurisdiction of Incorporation or Organization)
 
 (I.R.S. Employer Identification Number)

4200 East Beltline, Grand Rapids, Michigan  49525 
(Address of principal executive offices)

(616) 527-5820
(Registrant's telephone number, including area code)

NONE
Former name, address and fiscal year, if changed since last report.

Indicate by check mark whether the registrant (1) has filed all documents and reports required to be filed by Sections 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.         
YES ☒    NO ☐
 
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).
YES   ☒       NO   ☐  

Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, non-accelerated filer or smaller reporting company.
Large accelerated filer ☐
Accelerated filer  ☒
Non-accelerated filer  ☐
Smaller reporting company  ☐

Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
YES     ☐   NO   ☒        

Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date.

Common stock, no par value
 
21,245,536
Class
 
Outstanding at November 2, 2016
 


INDEPENDENT BANK CORPORATION AND SUBSIDIARIES
 
INDEX

   
Number(s)
PART I -
Financial Information
 
Item 1.
3
 
4
 
5
 
6
 
7
 
8-59
Item 2.
60-86
Item 3.
87
Item 4.
87
     
PART II -
Other Information
 
Item 1A
88
Item 2.
88
Item 6.
89
 
1

FORWARD-LOOKING STATEMENTS

Statements in this report that are not statements of historical fact, including statements that include terms such as “will,” “may,” “should,” “believe,” “expect,” “forecast,” “anticipate,” “estimate,” “project,” “intend,” “likely,” “optimistic” and “plan” and statements about future or projected financial and operating results, plans, projections, objectives, expectations, and intentions, are forward-looking statements. Forward-looking statements include, but are not limited to, descriptions of plans and objectives for future operations, products or services; projections of our future revenue, earnings or other measures of economic performance; forecasts of credit losses and other asset quality trends; statements about our business and growth strategies; and expectations about economic and market conditions and trends. These forward-looking statements express our current expectations, forecasts of future events, or long-term goals. They are based on assumptions, estimates, and forecasts that, although believed to be reasonable, may turn out to be incorrect. Actual results could differ materially from those discussed in the forward-looking statements for a variety of reasons, including:

economic, market, operational, liquidity, credit, and interest rate risks associated with our business;
economic conditions generally and in the financial services industry, particularly economic conditions within Michigan and the regional and local real estate markets in which our bank operates;
the failure of assumptions underlying the establishment of, and provisions made to, our allowance for loan losses;
the failure of assumptions underlying our estimate of probable incurred losses from vehicle service contract payment plan counterparty contingencies, including our assumptions regarding future cancellations of vehicle service contracts, the value to us of collateral that may be available to recover funds due from our counterparties, and our ability to enforce the contractual obligations of our counterparties to pay amounts owing to us;
increased competition in the financial services industry, either nationally or regionally;
our ability to achieve loan and deposit growth;
volatility and direction of market interest rates;
the continued services of our management team; and
implementation of new legislation, which may have significant effects on us and the financial services industry.

This list provides examples of factors that could affect the results described by forward-looking statements contained in this report, but the list is not intended to be all-inclusive. The risk factors disclosed in Part I – Item 1A of our Annual Report on Form 10-K for the year ended December 31, 2015, as updated by any new or modified risk factors disclosed in Part II – Item 1A of any subsequently filed Quarterly Report on Form 10-Q, include all known risks our management believes could materially affect the results described by forward-looking statements in this report. However, those risks may not be the only risks we face. Our results of operations, cash flows, financial position, and prospects could also be materially and adversely affected by additional factors that are not presently known to us that we currently consider to be immaterial, or that develop after the date of this report. We cannot assure you that our future results will meet expectations. While we believe the forward-looking statements in this report are reasonable, you should not place undue reliance on any forward-looking statement. In addition, these statements speak only as of the date made. We do not undertake, and expressly disclaim, any obligation to update or alter any statements, whether as a result of new information, future events, or otherwise, except as required by applicable law.
 
2

Part I - Item 1. 
INDEPENDENT BANK CORPORATION AND SUBSIDIARIES
Condensed Consolidated Statements of Financial Condition
 
     
   
September 30,
2016
   
December 31,
2015
 
   
(unaudited)
 
   
(In thousands, except share
amounts)
 
Assets
 
Cash and due from banks
 
$
38,610
   
$
54,260
 
Interest bearing deposits
   
75,706
     
31,523
 
Cash and Cash Equivalents
   
114,316
     
85,783
 
Interest bearing deposits - time
   
7,233
     
11,866
 
Trading securities
   
152
     
148
 
Securities available for sale
   
603,112
     
585,484
 
Federal Home Loan Bank and Federal Reserve Bank stock, at cost
   
15,507
     
15,471
 
Loans held for sale, carried at fair value
   
38,008
     
27,866
 
Loans
               
Commercial
   
784,976
     
748,398
 
Mortgage
   
522,833
     
498,036
 
Installment
   
268,357
     
234,017
 
Payment plan receivables
   
31,188
     
34,599
 
Total Loans
   
1,607,354
     
1,515,050
 
Allowance for loan losses
   
(22,043
)
   
(22,570
)
Net Loans
   
1,585,311
     
1,492,480
 
Other real estate and repossessed assets
   
4,989
     
7,150
 
Property and equipment, net
   
40,375
     
43,103
 
Bank-owned life insurance
   
53,779
     
54,402
 
Deferred tax assets, net
   
32,156
     
39,635
 
Capitalized mortgage loan servicing rights
   
11,048
     
12,436
 
Vehicle service contract counterparty receivables, net
   
2,608
     
7,229
 
Other intangibles
   
2,019
     
2,280
 
Accrued income and other assets
   
27,706
     
23,733
 
Total Assets
 
$
2,538,319
   
$
2,409,066
 
                 
Liabilities and Shareholders' Equity
 
Deposits
               
Non-interest bearing
 
$
725,166
   
$
659,793
 
Savings and interest-bearing checking
   
1,009,354
     
988,174
 
Reciprocal
   
46,636
     
50,207
 
Time
   
425,804
     
387,789
 
Total Deposits
   
2,206,960
     
2,085,963
 
Other borrowings
   
11,527
     
11,954
 
Subordinated debentures
   
35,569
     
35,569
 
Vehicle service contract counterparty payables
   
538
     
797
 
Accrued expenses and other liabilities
   
32,823
     
23,691
 
Total Liabilities
   
2,287,417
     
2,157,974
 
                 
Shareholders’ Equity
               
Preferred stock, no par value, 200,000 shares authorized;  none issued or outstanding
   
-
     
-
 
Common stock, no par value, 500,000,000 shares authorized; issued and outstanding: 21,227,974 shares at September 30, 2016 and 22,251,373 shares at December 31, 2015
   
323,303
     
339,462
 
Accumulated deficit
   
(69,386
)
   
(82,334
)
Accumulated other comprehensive loss
   
(3,015
)
   
(6,036
)
Total Shareholders’ Equity
   
250,902
     
251,092
 
Total Liabilities and Shareholders’ Equity
 
$
2,538,319
   
$
2,409,066
 

See notes to interim condensed consolidated financial statements (unaudited)
 
3

INDEPENDENT BANK CORPORATION AND SUBSIDIARIES
Condensed Consolidated Statements of Operations

   
Three months ended
September 30,
   
Nine months ended
September 30,
 
   
2016
   
2015
   
2016
   
2015
 
   
(unaudited)
   
(unaudited)
 
   
(In thousands, except per share amounts)
 
Interest Income
                       
Interest and fees on loans
 
$
18,597
   
$
17,869
   
$
55,361
   
$
52,859
 
Interest on securities
                               
Taxable
   
2,537
     
1,901
     
7,261
     
5,528
 
Tax-exempt
   
330
     
228
     
860
     
667
 
Other investments
   
281
     
295
     
884
     
922
 
Total Interest Income
   
21,745
     
20,293
     
64,366
     
59,976
 
Interest Expense
                               
Deposits
   
1,254
     
987
     
3,520
     
2,961
 
Other borrowings
   
493
     
465
     
1,455
     
1,382
 
Total Interest Expense
   
1,747
     
1,452
     
4,975
     
4,343
 
Net Interest Income
   
19,998
     
18,841
     
59,391
     
55,633
 
Provision for loan losses
   
(175
)
   
(244
)
   
(1,439
)
   
(1,037
)
Net Interest Income After Provision for Loan Losses
   
20,173
     
19,085
     
60,830
     
56,670
 
Non-Interest Income
                               
Service charges on deposit accounts
   
3,281
     
3,294
     
9,164
     
9,261
 
Interchange income
   
1,943
     
2,169
     
5,797
     
6,551
 
Net gains (losses) on assets
                               
Mortgage loans
   
3,556
     
1,812
     
7,727
     
5,735
 
Securities
   
(45
)
   
45
     
302
     
97
 
Mortgage loan servicing, net
   
858
     
(556
)
   
(454
)
   
476
 
Title insurance fees
   
319
     
281
     
860
     
874
 
Net gain on branch sale
   
-
     
1,193
     
-
     
1,193
 
Other
   
1,796
     
1,881
     
5,701
     
5,881
 
Total Non-Interest Income
   
11,708
     
10,119
     
29,097
     
30,068
 
Non-Interest Expense
                               
Compensation and employee benefits
   
13,031
     
12,029
     
36,912
     
35,605
 
Data processing
   
1,971
     
2,001
     
6,008
     
5,958
 
Occupancy, net
   
1,919
     
1,940
     
5,982
     
6,399
 
Furniture, fixtures and equipment
   
990
     
998
     
2,939
     
2,915
 
Communications
   
670
     
754
     
2,280
     
2,184
 
Loan and collection
   
568
     
816
     
1,964
     
2,938
 
Advertising
   
455
     
406
     
1,410
     
1,338
 
Legal and professional
   
420
     
519
     
1,178
     
1,352
 
FDIC deposit insurance
   
187
     
350
     
852
     
1,044
 
Interchange expense
   
276
     
279
     
809
     
859
 
Credit card and bank service fees
   
203
     
197
     
588
     
602
 
Net (gains) losses on other real estate and repossessed assets
   
263
     
5
     
98
     
(173
)
Provision for loss reimbursement on sold loans
   
45
     
(35
)
   
30
     
(59
)
Costs related to unfunded lending commitments
   
73
     
26
     
6
     
46
 
Vehicle service contract counterparty contingencies
   
(39
)
   
30
     
(10
)
   
89
 
Other
   
1,497
     
1,564
     
4,423
     
4,512
 
Total Non-Interest Expense
   
22,529
     
21,879
     
65,469
     
65,609
 
Income Before Income Tax
   
9,352
     
7,325
     
24,458
     
21,129
 
Income tax expense
   
2,979
     
2,278
     
7,547
     
6,682
 
Net Income
 
$
6,373
   
$
5,047
   
$
16,911
   
$
14,447
 
Net Income Per Common Share
                               
Basic
 
$
0.30
   
$
0.22
   
$
0.79
   
$
0.63
 
Diluted
 
$
0.30
   
$
0.22
   
$
0.78
   
$
0.62
 
Dividends Per Common Share
                               
Declared
 
$
0.08
   
$
0.06
   
$
0.24
   
$
0.18
 
Paid
 
$
0.08
   
$
0.06
   
$
0.24
   
$
0.18
 

See notes to interim condensed consolidated financial statements (unaudited)
 
4

INDEPENDENT BANK CORPORATION AND SUBSIDIARIES
Condensed Consolidated Statements of Comprehensive Income

   
Three months ended
September 30,
   
Nine months ended
September 30,
 
   
2016
   
2015
   
2016
   
2015
 
   
(unaudited)
   
(unaudited)
 
   
(In thousands)
   
(In thousands)
 
                         
Net income
 
$
6,373
   
$
5,047
   
$
16,911
   
$
14,447
 
Other comprehensive income, before tax
                               
Securities available for sale
                               
Unrealized gains arising during period
   
451
     
1,366
     
4,899
     
1,830
 
Change in unrealized gains for which a portion of other than temporary impairment has been recognized in earnings
   
(24
)
   
10
     
47
     
-
 
Reclassification adjustments for gains included in earnings
   
(15
)
   
-
     
(298
)
   
(75
)
Unrealized gains recognized in other comprehensive
income on securities available for sale
   
412
     
1,376
     
4,648
     
1,755
 
Income tax expense
   
144
     
482
     
1,627
     
615
 
Unrealized gains recognized in other comprehensive
income on available for sale securities, net of tax
   
268
     
894
     
3,021
     
1,140
 
Other comprehensive income
   
268
     
894
     
3,021
     
1,140
 
Comprehensive income
 
$
6,641
   
$
5,941
   
$
19,932
   
$
15,587
 

See notes to interim condensed consolidated financial statements (unaudited)
 
5

INDEPENDENT BANK CORPORATION AND SUBSIDIARIES
Condensed Consolidated Statements of Cash Flows

   
Nine months ended September 30,
 
   
2016
   
2015
 
   
(unaudited - In thousands)
 
Net Income
 
$
16,911
   
$
14,447
 
Adjustments to Reconcile Net Income to Net Cash From Operating Activities
               
Proceeds from sales of loans held for sale
   
222,610
     
227,381
 
Disbursements for loans held for sale
   
(225,025
)
   
(223,446
)
Provision for loan losses
   
(1,439
)
   
(1,037
)
Deferred federal income tax expense
   
8,726
     
7,210
 
Deferred loan fees
   
(1,634
)
   
(1,189
)
Depreciation, amortization of intangible assets and premiums and accretion of discounts on securities, loans and interest bearning deposits - time
   
3,831
     
3,345
 
Net gains on mortgage loans
   
(7,727
)
   
(5,735
)
Net gains on securities
   
(302
)
   
(97
)
Net (gains) losses on other real estate and repossessed assets
   
98
     
(173
)
Vehicle service contract counterparty contingencies
   
(10
)
   
89
 
Share based compensation
   
1,200
     
1,153
 
Gain on branch sale
   
-
     
(1,193
)
Net gain on sale of fixed assets
   
(2
)
   
(152
)
Increase in accrued income and other assets
   
(5,540
)
   
(359
)
Increase (decrease) in accrued expenses and other liabilities
   
1,409
     
(684
)
Total Adjustments
   
(3,805
)
   
5,113
 
Net Cash From Operating Activities
   
13,106
     
19,560
 
Cash Flow Used in Investing Activities
               
Proceeds from the sale of securities available for sale
   
56,451
     
11,786
 
Proceeds from the maturity of securities available for sale
   
32,590
     
25,458
 
Principal payments received on securities available for sale
   
117,513
     
94,333
 
Purchases of securities available for sale
   
(213,839
)
   
(195,623
)
Purchases of interest bearing deposits - time
   
-
     
(4,100
)
Proceeds from the maturity of interest bearing deposits - time
   
4,613
     
4,576
 
Purchase of Federal Reserve Bank stock
   
(407
)
   
(272
)
Redemption of Federal Reserve Bank stock
   
371
     
391
 
Redemption of Federal Home Loan Bank stock
   
-
     
4,514
 
Net increase in portfolio loans (loans originated, net of principal payments)
   
(73,673
)
   
(56,407
)
Purchase of portfolio loans
   
(15,000
)
   
-
 
Net cash paid in branch sale
   
-
     
(7,229
)
Proceeds from the collection of vehicle service contract counterparty receivables
   
4,671
     
255
 
Proceeds from the sale of other real estate and repossessed assets
   
3,854
     
5,619
 
Proceeds from life insurance
   
2,235
     
-
 
Proceeds from the sale of property and equipment
   
23
     
490
 
Capital expenditures
   
(1,717
)
   
(2,925
)
Net Cash Used in Investing Activities
   
(82,315
)
   
(119,134
)
Cash Flow From Financing Activities
               
Net increase in total deposits
   
120,997
     
145,313
 
Net increase (decrease) in other borrowings
   
5
     
(1
)
Payments of Federal Home Loan Bank Advances
   
(432
)
   
(399
)
Net decrease in vehicle service contract counterparty payables
   
(259
)
   
(27
)
Dividends paid
   
(5,149
)
   
(4,118
)
Proceeds from issuance of common stock
   
61
     
103
 
Repurchase of common stock
   
(16,854
)
   
(9,025
)
Share based compensation withholding obligation
   
(627
)
   
(1,091
)
Net Cash From Financing Activities
   
97,742
     
130,755
 
Net Increase in Cash and Cash Equivalents
   
28,533
     
31,181
 
Cash and Cash Equivalents at Beginning of Period
   
85,783
     
74,016
 
Cash and Cash Equivalents at End of Period
 
$
114,316
   
$
105,197
 
Cash paid during the period for
               
Interest
 
$
4,811
   
$
4,302
 
Income taxes
   
437
     
229
 
Transfers to other real estate and repossessed assets
   
1,791
     
2,843
 
Transfer of payment plan receivables to vehicle service contract counterparty receivables
   
40
     
431
 
Purchase of securities available for sale not yet settled
   
7,440
     
7,717
 

See notes to interim condensed consolidated financial statements (unaudited)
 
6

INDEPENDENT BANK CORPORATION AND SUBSIDIARIES
Condensed Consolidated Statements of Shareholders' Equity

   
Nine months ended
September 30,
 
   
2016
   
2015
 
   
(unaudited)
 
   
(In thousands)
 
             
Balance at beginning of period
 
$
251,092
   
$
250,371
 
Cumulative effect of change in accounting principle
   
1,247
     
-
 
Balance at beginning of period, as adjusted
   
252,339
     
250,371
 
Net income
   
16,911
     
14,447
 
Cash dividends declared
   
(5,149
)
   
(4,118
)
Issuance of common stock
   
61
     
103
 
Share based compensation
   
1,200
     
1,153
 
Share based compensation withholding obligation
   
(627
)
   
(1,091
)
Repurchase of common stock
   
(16,854
)
   
(9,025
)
Net change in accumulated other comprehensive loss, net of related tax effect
   
3,021
     
1,140
 
Balance at end of period
 
$
250,902
   
$
252,980
 

See notes to interim condensed consolidated financial statements (unaudited)
 
7

NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)

1.
Preparation of Financial Statements

The condensed consolidated financial statements have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission. Certain information and note disclosures normally included in annual financial statements prepared in accordance with U.S. generally accepted accounting principles (“GAAP”) have been condensed or omitted pursuant to those rules and regulations, although we believe that the disclosures made are adequate to make the information not misleading.  The unaudited condensed consolidated financial statements should be read in conjunction with the audited consolidated financial statements and notes for the year ended December 31, 2015 included in our Annual Report on Form 10-K.

In our opinion, the accompanying unaudited condensed consolidated financial statements contain all the adjustments necessary to present fairly our consolidated financial condition as of September 30, 2016 and December 31, 2015, and the results of operations for the three and nine-month periods ended September 30, 2016 and 2015.  The results of operations for the three and nine-month periods ended September 30, 2016, are not necessarily indicative of the results to be expected for the full year.  Certain reclassifications have been made in the prior period financial statements to conform to the current period presentation.  Our critical accounting policies include the determination of the allowance for loan losses, the determination of vehicle service contract counterparty contingencies, the valuation of originated mortgage loan servicing rights and the valuation of deferred tax assets.  Refer to our 2015 Annual Report on Form 10-K for a disclosure of our accounting policies.

2.
New Accounting Standards

In June 2014, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2014-12, “Compensation – Stock Compensation (Topic 718) – Accounting for Share-Based Payments When the Terms of an Award Provide That a Performance Target Could Be Achieved After the Requisite Service Period”.  This ASU amends existing guidance related to the accounting for share-based payments when the terms of an award provide that a performance target could be achieved after the requisite service period. These amendments require that a performance target that affects vesting and that could be achieved after the requisite service period be treated as a performance condition.  The total amount of compensation cost recognized during and after the requisite service period should reflect the number of awards that are expected to vest and should be adjusted to reflect those awards that ultimately vest. The requisite service period ends when the employee can cease rendering service and still be eligible to vest in the award if the performance target is achieved. This amended guidance became effective for us on January 1, 2016, and did not have a material impact on our consolidated operating results or financial condition.

In May 2014, the FASB issued ASU 2014-09, “Revenue from Contracts with Customers (Topic 606)”. This ASU supersedes and replaces nearly all existing revenue recognition guidance, including industry-specific guidance, establishes a new control-based revenue recognition model, changes the basis for deciding when revenue is recognized over time or at a point in time, provides new and more detailed guidance on specific topics and expands and improves disclosures about revenue. In addition, this ASU specifies the accounting for some costs to obtain or fulfill a contract with a customer.  This amended guidance is effective for us on January 1, 2018, and is not expected to have a material impact on our consolidated operating results or financial condition.
 
8

NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
(unaudited)

In January 2016, the FASB issued ASU 2016-01, “Financial Instruments – Overall (Subtopic 825-10) – Recognition and Measurement of Financial Assets and Financial Liabilities”.  This ASU amends existing guidance related to the accounting for certain financial assets and liabilities. These amendments, among other things, requires equity investments (except those accounted for under the equity method of accounting, or those that result in consolidation of the investee) to be measured at fair value with changes in fair value recognized in net income, requires public business entities to use the exit price notion when measuring the fair value of financial instruments for disclosure purposes, requires separate presentation of financial assets and financial liabilities by measurement category and form of financial asset and eliminates 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 at amortized cost. This amended guidance is effective for us on January 1, 2018, and is not expected to have a material impact on our consolidated operating results or financial condition.

In February 2016, the FASB issued ASU 2016-02, “Leases (Topic 842)”.  This ASU amends existing guidance related to the accounting for leases. These amendments, among other things, requires lessees to account for most leases on the balance sheet while recognizing expense on the income statement in a manner similar to existing guidance.  For lessors the guidance modifies the classification criteria and the accounting for sales-type and direct finance leases. This amended guidance is effective for us on January 1, 2019, and is not expected to have a material impact on our consolidated operating results or financial condition.

In March 2016, the FASB issued ASU 2016-09, “Compensation – Stock Compensation (718) Improvements to Employee Share-Based Payment Accounting”.  This ASU amends existing guidance in an effort to simplify certain aspects of accounting for share-based payments. The areas for simplification in this ASU include income tax consequences, classification of awards as either equity or liabilities and classification on the statement of cash flows.  This amended guidance is effective for us on January 1, 2017, with early adoption permitted.  We adopted this amended guidance during the second quarter of 2016 using a modified retrospective approach.  The impact of this adoption was to adjust our January 1, 2016 Condensed Consolidated Statement of Financial Position to reflect cumulative effect adjustments as follows:

   
January 1,
2016
Originally
Presented
   
Cumulative
Retrospective
Adjustments
   
January 1,
2016
Adjusted
 
   
(Dollars in thousands)
 
                   
Deferred tax assets
 
$
39,635
   
$
1,247
   
$
40,882
 
Total assets
 
$
2,409,066
   
$
1,247
   
$
2,410,313
 
Common stock
 
$
339,462
   
$
62
   
$
339,524
 
Accumulated deficit
 
$
(82,334
)
 
$
1,185
   
$
(81,149
)
Total Shareholders’ Equity
 
$
251,092
   
$
1,247
   
$
252,339
 
Total Liabilities and Shareholders’ Equity
 
$
2,409,066
   
$
1,247
   
$
2,410,313
 
 
9

NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
(unaudited)

The adjustments above reflect the recording of $1.23 million of unrealized excess benefits on share based compensation and $0.06 million (impact to equity of $0.02 million after consideration of deferred taxes)  for the impact of making an accounting policy election to account for forfeitures as they occur.  After January 1, 2016, excess tax benefits or deficiencies resulting from share-based payments will be recognized as tax benefit or expense when they occur.  Tax benefits of zero and $0.3 million were recorded during the three and nine month periods ended September 30, 2016, respectively as a result of share awards vesting during the periods.  In addition, we have elected to apply the  amendments related to the presentation of excess tax benefits in the statement of cash flows on a prospective basis.

In June 2016, the FASB issued ASU 2016-13, “Financial Instruments — Credit Losses (Topic 326), Measurement of Credit Losses on Financial Instruments”.  This ASU significantly changes how entities will measure credit losses for most financial assets and certain other instruments that are not measured at fair value through net income.  This ASU will replace today’s “incurred loss” approach with an “expected loss” model for instruments measured at amortized cost. For available-for-sale debt securities, allowances will be recorded rather than reducing the carrying amount as is done under the current other-than-temporary impairment model. This ASU also simplifies the accounting model for purchased credit-impaired debt securities and loans. This amended guidance is effective for us on January 1, 2020.  We have not yet determined what the impact will be on our consolidated operating results or financial condition.

3.
Securities

Securities available for sale consist of the following:

   
Amortized
   
Unrealized
       
   
Cost
   
Gains
   
Losses
   
Fair Value
 
   
(In thousands)
 
September 30, 2016
                       
U.S. agency
 
$
29,482
   
$
508
   
$
41
   
$
29,949
 
U.S. agency residential mortgage-backed
   
168,233
     
1,857
     
132
     
169,958
 
U.S. agency commercial mortgage-backed
   
13,694
     
214
     
16
     
13,892
 
Private label mortgage-backed
   
33,482
     
374
     
278
     
33,578
 
Other asset backed
   
142,058
     
435
     
305
     
142,188
 
Obligations of states and political subdivisions
   
156,539
     
2,115
     
665
     
157,989
 
Corporate
   
50,787
     
792
     
124
     
51,455
 
Trust preferred
   
2,921
     
-
     
471
     
2,450
 
Foreign government
   
1,635
     
18
     
0
     
1,653
 
Total
 
$
598,831
   
$
6,313
   
$
2,032
   
$
603,112
 
                                 
December 31, 2015
                               
U.S. agency
 
$
47,283
   
$
309
   
$
80
   
$
47,512
 
U.S. agency residential mortgage-backed
   
195,055
     
1,584
     
583
     
196,056
 
U.S. agency commercial mortgage-backed
   
34,017
     
94
     
83
     
34,028
 
Private label mortgage-backed
   
5,061
     
161
     
319
     
4,903
 
Other asset backed
   
117,431
     
54
     
581
     
116,904
 
Obligations of states and political subdivisions
   
145,193
     
941
     
1,150
     
144,984
 
Corporate
   
38,895
     
9
     
290
     
38,614
 
Trust preferred
   
2,916
     
-
     
433
     
2,483
 
Total
 
$
585,851
   
$
3,152
   
$
3,519
   
$
585,484
 
 
10

NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
(unaudited)

Our investments’ gross unrealized losses and fair values aggregated by investment type and length of time that individual securities have been at a continuous unrealized loss position follows:

   
Less Than Twelve Months
   
Twelve Months or More
   
Total
 
   
Fair Value
   
Unrealized
Losses
   
Fair Value
   
Unrealized
Losses
   
Fair Value
   
Unrealized
Losses
 
   
(In thousands)
 
                                     
September 30, 2016
                                   
U.S. agency
 
$
1,604
   
$
3
   
$
8,147
   
$
38
   
$
9,751
   
$
41
 
U.S. agency residential mortgage-backed
   
22,982
     
48
     
19,099
     
84
     
42,081
     
132
 
U.S. agency commercial mortgage-backed
   
3,455
     
14
     
257
     
2
     
3,712
     
16
 
Private label mortgage- backed
   
12,202
     
18
     
1,429
     
260
     
13,631
     
278
 
Other asset backed
   
22,147
     
96
     
16,998
     
209
     
39,145
     
305
 
Obligations of states and political subdivisions
   
17,853
     
91
     
15,203
     
574
     
33,056
     
665
 
Corporate
   
3,776
     
14
     
2,892
     
110
     
6,668
     
124
 
Trust preferred
   
-
     
-
     
2,450
     
471
     
2,450
     
471
 
Total
 
$
84,019
   
$
284
   
$
66,475
   
$
1,748
   
$
150,494
   
$
2,032
 
                                                 
December 31, 2015
                                               
U.S. agency
 
$
12,164
   
$
47
   
$
6,746
   
$
33
   
$
18,910
   
$
80
 
U.S. agency residential mortgage-backed
   
57,538
     
316
     
23,340
     
267
     
80,878
     
583
 
U.S. agency commercial mortgage-backed
   
16,747
     
60
     
2,247
     
23
     
18,994
     
83
 
Private label mortgage- backed
   
-
     
-
     
3,393
     
319
     
3,393
     
319
 
Other asset backed
   
102,660
     
434
     
5,189
     
147
     
107,849
     
581
 
Obligations of states and political subdivisions
   
52,493
     
597
     
12,240
     
553
     
64,733
     
1,150
 
Corporate
   
30,550
     
290
     
-
     
-
     
30,550
     
290
 
Trust preferred
   
-
     
-
     
2,483
     
433
     
2,483
     
433
 
Total
 
$
272,152
   
$
1,744
   
$
55,638
   
$
1,775
   
$
327,790
   
$
3,519
 

Our portfolio of securities available for sale is reviewed quarterly for impairment in value. In performing this review management considers (1) the length of time and extent that fair value has been less than cost, (2) the financial condition and near term prospects of the issuer, (3) the impact of changes in market interest rates on the market value of the security and (4) an assessment of whether we intend to sell, or it is more likely than not that we will be required to sell, a security in an unrealized loss position before recovery of its amortized cost basis. For securities that do not meet the aforementioned recovery criteria, the amount of impairment recognized in earnings is limited to the amount related to credit losses, while impairment related to other factors is recognized in other comprehensive income.
 
11

NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
(unaudited)

U.S. agency, U.S. agency residential mortgage-backed securities and U.S. agency commercial mortgage backed securities — at September 30, 2016, we had 21 U.S. agency, 59 U.S. agency residential mortgage-backed and seven U.S. agency commercial mortgage-backed securities whose fair market value is less than amortized cost. The unrealized losses are largely attributed to increases in interest rates since acquisition and widening spreads to Treasury bonds. As management does not intend to liquidate these securities and it is more likely than not that we will not be required to sell these securities prior to recovery of these unrealized losses, no declines are deemed to be other than temporary.

Private label mortgage backed securities — at September 30, 2016, we had 24 of this type of security whose fair value is less than amortized cost.  The unrealized losses are primarily attributed to four securities purchased prior to 2016.  Two of these four securities have an impairment in excess of 10% and three of these holdings have been impaired for more than 12 months.  The unrealized losses are largely attributable to credit spread widening on these four securities since their acquisition.

These four securities are receiving principal and interest payments. Most of these transactions are pass-through structures, receiving pro rata principal and interest payments from a dedicated collateral pool. The nonreceipt of interest cash flows is not expected and thus not presently considered in our discounted cash flow methodology discussed below.

These four private label mortgage-backed securities are reviewed for other than temporary impairment (“OTTI”) utilizing a cash flow projection. The cash flow analysis forecasts cash flow from the underlying loans in each transaction and then applies these cash flows to the bonds in the securitization.  Our cash flow analysis forecasts complete recovery of our cost basis for all four of these securities whose fair value is less than amortized cost.

As management does not intend to liquidate these securities and it is more likely than not that we will not be required to sell these securities prior to recovery of these unrealized losses, no other declines discussed above are deemed to be other than temporary.

Other asset backed — at September 30, 2016, we had 70 other asset backed securities whose fair value is less than amortized cost. The unrealized losses are primarily due to credit spread widening and increases in interest rates since acquisition.  As management does not intend to liquidate these securities and it is more likely than not that we will not be required to sell these securities prior to recovery of these unrealized losses, no declines are deemed to be other than temporary.

Obligations of states and political subdivisions — at September 30, 2016, we had 100 municipal securities whose fair value is less than amortized cost.  The unrealized losses are primarily due to increases in interest rates since acquisition.  One of these securities has an impairment in excess of 10%.  As management does not intend to liquidate these securities and it is more likely than not that we will not be required to sell these securities prior to recovery of these unrealized losses, no declines are deemed to be other than temporary.

Corporate — at September 30, 2016, we had seven corporate securities whose fair value is less than amortized cost. The unrealized losses are primarily due to credit spread widening and increases in interest rates since acquisition.  As management does not intend to liquidate these securities and it is more likely than not that we will not be required to sell these securities prior to recovery of these unrealized losses, no declines are deemed to be other than temporary.
 
12

NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
(unaudited)

Trust preferred securities — at September 30, 2016, we had three trust preferred securities whose fair value is less than amortized cost. All of our trust preferred securities are single issue securities issued by a trust subsidiary of a bank holding company. The pricing of trust preferred securities has suffered from credit spread widening.

One of the three securities is rated by two major rating agencies as investment grade, while one (a Bank of America issuance) is rated below investment grade by two major rating agencies and the other one is non-rated. The non-rated issue is a relatively small bank and was never rated. The issuer of this non-rated trust preferred security, which had a total amortized cost of $1.0 million and total fair value of $0.7 million as of September 30, 2016, continues to have satisfactory credit metrics and make interest payments.

The following table breaks out our trust preferred securities in further detail as of September 30, 2016 and December 31, 2015:

   
September 30, 2016
   
December 31, 2015
 
   
Fair
Value
   
Net
Unrealized
Loss
   
Fair
Value
   
Net
Unrealized
Loss
 
   
(In thousands)
 
                         
Trust preferred securities
                       
Rated issues
 
$
1,735
   
$
(186
)
 
$
1,690
   
$
(226
)
Unrated issues
   
715
     
(285
)
   
793
     
(207
)

As management does not intend to liquidate these securities and it is more likely than not that we will not be required to sell these securities prior to recovery of these unrealized losses, no declines are deemed to be other than temporary.

We recorded no credit related OTTI charges in our Condensed Consolidated Statements of Operations related to securities available for sale during the three or nine month periods ended September 30, 2016 and 2015, respectively.

At September 30, 2016, three private label mortgage-backed securities had credit related OTTI and are summarized as follows:

   
Senior
Security
   
Super
Senior
Security
   
Senior
Support
Security
   
Total
 
   
(In thousands)
 
                         
As of September 30, 2016
                       
Fair value
 
$
1,346
   
$
1,135
   
$
75
   
$
2,556
 
Amortized cost
   
1,303
     
1,064
     
-
     
2,367
 
Non-credit unrealized loss
   
-
     
-
     
-
     
-
 
Unrealized gain
   
43
     
71
     
75
     
189
 
Cumulative credit related OTTI
   
757
     
457
     
380
     
1,594
 
                                 
Credit related OTTI recognized in our Condensed
                               
Consolidated Statements of Operations
                               
For the three months ended September 30,
                               
2016
 
$
-
   
$
-
   
$
-
   
$
-
 
2015
   
-
     
-
     
-
     
-
 
For the nine months ended September 30,
                               
2016
   
-
     
-
     
-
     
-
 
2015
   
-
     
-
     
-
     
-
 
 
13

NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
(unaudited)

Each of these securities is receiving principal and interest payments similar to principal reductions in the underlying collateral.  All three of these securities have unrealized gains at September 30, 2016.  The original amortized cost for each of these securities has been permanently adjusted downward for previously recorded credit related OTTI.  The unrealized loss (based on original amortized cost) for these securities is now less than previously recorded credit related OTTI amounts.

A roll forward of credit losses recognized in earnings on securities available for sale for the three and nine month periods ending September 30, follows:

   
Three months ended
September 30,
   
Nine months ended
September 30,
 
   
2016
   
2015
   
2016
   
2015
 
   
(In thousands)
   
(In thousands)
 
Balance at beginning of period
 
$
1,844
   
$
1,844
   
$
1,844
   
$
1,844
 
Additions to credit losses on securities for which no previous OTTI was recognized
   
-
     
-
     
-
     
-
 
Increases to credit losses on securities for which OTTI was previously recognized
   
-
     
-
     
-
     
-
 
Balance at end of period
 
$
1,844
   
$
1,844
   
$
1,844
   
$
1,844
 

The amortized cost and fair value of securities available for sale at September 30, 2016, by contractual maturity, follow:

   
Amortized
Cost
   
Fair
Value
 
   
(In thousands)
 
Maturing within one year
 
$
23,706
   
$
23,753
 
Maturing after one year but within five years
   
86,673
     
87,599
 
Maturing after five years but within ten years
   
63,799
     
64,784
 
Maturing after ten years
   
67,186
     
67,360
 
     
241,364
     
243,496
 
U.S. agency residential mortgage-backed
   
168,233
     
169,958
 
U.S. agency commercial mortgage-backed
   
13,694
     
13,892
 
Private label residential mortgage-backed
   
33,482
     
33,578
 
Other asset backed
   
142,058
     
142,188
 
Total
 
$
598,831
   
$
603,112
 

The actual maturity may differ from the contractual maturity because issuers may have the right to call or prepay obligations with or without call or prepayment penalties.

Gains and losses realized on the sale of securities available for sale are determined using the specific identification method and are recognized on a trade-date basis.  A summary of proceeds from the sale of securities available for sale and gains and losses for the nine month periods ending September 30, follows:

   
Proceeds
   
Realized
Gains
   
Losses
 
   
(In thousands)
 
2016
 
$
56,451
   
$
350
   
$
52
 
2015
   
11,786
     
75
     
-
 

During 2016 and 2015, our trading securities consisted of various preferred stocks.  During the first nine months of 2016 and 2015, we recognized gains on trading securities of $0.004 million and $0.022 million, respectively, that are included in net gains on securities in the Condensed Consolidated Statements of Operations.  Both of these amounts relate to gains recognized on trading securities still held at each respective period end.
 
14

NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
(unaudited)

4.
Loans

Our assessment of the allowance for loan losses is based on an evaluation of the loan portfolio, recent loss experience, current economic conditions and other pertinent factors.

An analysis of the allowance for loan losses by portfolio segment for the three months ended September 30, follows:

   
Commercial
   
Mortgage
   
Installment
   
Payment
Plan
Receivables
   
Subjective
Allocation
   
Total
 
   
(In thousands)
 
2016
                                   
Balance at beginning of period
 
$
6,039
   
$
9,956
   
$
1,139
   
$
52
   
$
5,526
   
$
22,712
 
Additions (deductions)
                                               
Provision for loan losses
   
(153
)
   
(247
)
   
208
     
-
     
17
     
(175
)
Recoveries credited to allowance
   
474
     
195
     
236
     
-
     
-
     
905
 
Loans charged against the allowance
   
(365
)
   
(561
)
   
(473
)
   
-
     
-
     
(1,399
)
Balance at end of period
 
$
5,995
   
$
9,343
   
$
1,110
   
$
52
   
$
5,543
   
$
22,043
 
                                                 
2015
                                               
Balance at beginning of period
 
$
6,707
   
$
11,465
   
$
1,461
   
$
65
   
$
4,888
   
$
24,586
 
Additions (deductions)
                                               
Provision for loan losses
   
(26
)
   
(47
)
   
(49
)
   
(5
)
   
(117
)
   
(244
)
Recoveries credited to allowance
   
637
     
286
     
250
     
-
     
-
     
1,173
 
Loans charged against the allowance
   
(190
)
   
(379
)
   
(342
)
   
-
     
-
     
(911
)
Balance at end of period
 
$
7,128
   
$
11,325
   
$
1,320
   
$
60
   
$
4,771
   
$
24,604
 
 
15

NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
(unaudited)

An analysis of the allowance for loan losses by portfolio segment for the nine months ended September 30, follows:

   
Commercial
   
Mortgage
   
Installment
   
Payment
Plan
Receivables
   
Subjective
Allocation
   
Total
 
   
(In thousands)
       
2016
                                   
Balance at beginning of period
 
$
5,670
   
$
10,391
   
$
1,181
   
$
56
   
$
5,272
   
$
22,570
 
Additions (deductions)
                                               
Provision for loan losses
   
(1,220
)
   
(885
)
   
399
     
(4
)
   
271
     
(1,439
)
Recoveries credited to allowance
   
1,944
     
871
     
808
     
-
     
-
     
3,623
 
Loans charged against the allowance
   
(399
)
   
(1,034
)
   
(1,278
)
   
-
     
-
     
(2,711
)
Balance at end of period
 
$
5,995
   
$
9,343
   
$
1,110
   
$
52
   
$
5,543
   
$
22,043
 
                                                 
2015
                                               
Balance at beginning of period
 
$
5,445
   
$
13,444
   
$
1,814
   
$
64
   
$
5,223
   
$
25,990
 
Additions (deductions)
                                               
Provision for loan losses
   
479
     
(881
)
   
(179
)
   
(4
)
   
(452
)
   
(1,037
)
Recoveries credited to allowance
   
1,722
     
843
     
853
     
-
     
-
     
3,418
 
Loans charged against the allowance
   
(518
)
   
(2,081
)
   
(1,168
)
   
-
     
-
     
(3,767
)
Balance at end of period
 
$
7,128
   
$
11,325
   
$
1,320
   
$
60
   
$
4,771
   
$
24,604
 
 
16

NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
(unaudited)

Allowance for loan losses and recorded investment in loans by portfolio segment follows:

   
Commercial
   
Mortgage
   
Installment
   
Payment
Plan
Receivables
   
Subjective
Allocation
   
Total
 
   
(In thousands)
 
September 30, 2016
                                   
Allowance for loan losses
                                   
Individually evaluated for impairment
 
$
3,325
   
$
6,717
   
$
333
   
$
-
   
$
-
   
$
10,375
 
Collectively evaluated for impairment
   
2,670
     
2,626
     
777
     
52
     
5,543
     
11,668
 
Total ending allowance balance
 
$
5,995
   
$
9,343
   
$
1,110
   
$
52
   
$
5,543
   
$
22,043
 
                                                 
Loans
                                               
Individually evaluated for impairment
 
$
16,087
   
$
60,891
   
$
5,101
   
$
-
           
$
82,079
 
Collectively evaluated for impairment
   
770,642
     
464,234
     
263,973
     
31,188
             
1,530,037
 
Total loans recorded investment
   
786,729
     
525,125
     
269,074
     
31,188
             
1,612,116
 
Accrued interest included in recorded investment
   
1,753
     
2,292
     
717
     
-
             
4,762
 
Total loans
 
$
784,976
   
$
522,833
   
$
268,357
   
$
31,188
           
$
1,607,354
 
                                                 
December 31, 2015
                                               
Allowance for loan losses
                                               
Individually evaluated for impairment
 
$
2,708
   
$
7,818
   
$
457
   
$
-
   
$
-
   
$
10,983
 
Collectively evaluated for impairment
   
2,962
     
2,573
     
724
     
56
     
5,272
     
11,587
 
Total ending allowance balance
 
$
5,670
   
$
10,391
   
$
1,181
   
$
56
   
$
5,272
   
$
22,570
 
                                                 
Loans
                                               
Individually evaluated for impairment
 
$
16,868
   
$
66,375
   
$
5,888
   
$
-
           
$
89,131
 
Collectively evaluated for impairment
   
733,399
     
433,931
     
228,827
     
34,599
             
1,430,756
 
Total loans recorded investment
   
750,267
     
500,306
     
234,715
     
34,599
             
1,519,887
 
Accrued interest included in recorded investment
   
1,869
     
2,270
     
698
     
-
             
4,837
 
Total loans
 
$
748,398
   
$
498,036
   
$
234,017
   
$
34,599
           
$
1,515,050
 
 
17

NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
(unaudited)

Loans on non-accrual status and past due more than 90 days (“Non-performing Loans”) follow:

   
90+ and
Still
Accruing
   
Non-
Accrual
   
Total Non-
Performing
Loans
 
   
(In thousands)
 
September 30, 2016
                 
Commercial
                 
Income producing - real estate
 
$
-
   
$
658
   
$
658
 
Land, land development and construction - real estate
   
-
     
211
     
211
 
Commercial and industrial
   
-
     
2,517
     
2,517
 
Mortgage
                       
1-4 family
   
-
     
4,429
     
4,429
 
Resort lending
   
-
     
1,624
     
1,624
 
Home equity - 1st lien
   
-
     
273
     
273
 
Home equity - 2nd lien
   
-
     
353
     
353
 
Purchased loans
   
-
     
-
     
-
 
Installment
                       
Home equity - 1st lien
   
-
     
96
     
96
 
Home equity - 2nd lien
   
-
     
249
     
249
 
Loans not secured by real estate
   
-
     
384
     
384
 
Other
   
-
     
3
     
3
 
Payment plan receivables
                       
Full refund
   
-
     
-
     
-
 
Partial refund
   
-
     
4
     
4
 
Other
   
-
     
-
     
-
 
Total recorded investment
 
$
-
   
$
10,801
   
$
10,801
 
Accrued interest included in recorded investment
 
$
-
   
$
-
   
$
-
 
December 31, 2015
                       
Commercial
                       
Income producing - real estate
 
$
-
   
$
1,027
   
$
1,027
 
Land, land development and construction - real estate
   
49
     
401
     
450
 
Commercial and industrial
   
69
     
2,028
     
2,097
 
Mortgage
                       
1-4 family
   
-
     
4,744
     
4,744
 
Resort lending
   
-
     
1,094
     
1,094
 
Home equity - 1st lien
   
-
     
187
     
187
 
Home equity - 2nd lien
   
-
     
147
     
147
 
Purchased loans
   
-
     
2
     
2
 
Installment
                       
Home equity - 1st lien
   
-
     
106
     
106
 
Home equity - 2nd lien
   
-
     
443
     
443
 
Loans not secured by real estate
   
-
     
421
     
421
 
Other
   
-
     
2
     
2
 
Payment plan receivables
                       
Full refund
   
-
     
2
     
2
 
Partial refund
   
-
     
2
     
2
 
Other
   
-
     
1
     
1
 
Total recorded investment
 
$
118
   
$
10,607
   
$
10,725
 
Accrued interest included in recorded investment
 
$
2
   
$
-
   
$
2
 
 
18

NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
(unaudited)

An aging analysis of loans by class follows:

   
Loans Past Due
   
Loans not
   
Total
 
   
30-59 days
   
60-89 days
   
90+ days
   
Total
   
Past Due
   
Loans
 
   
(In thousands)
 
September 30, 2016
                                   
Commercial
                                   
Income producing - real estate
 
$
-
   
$
-
   
$
541
   
$
541
   
$
273,461
   
$
274,002
 
Land, land development and construction - real estate
   
-
     
-
     
133
     
133
     
53,836
     
53,969
 
Commercial and industrial
   
105
     
116
     
457
     
678
     
458,080
     
458,758
 
Mortgage
                                               
1-4 family
   
2,180
     
1,461
     
4,429
     
8,070
     
285,892
     
293,962
 
Resort lending
   
1,975
     
-
     
1,624
     
3,599
     
103,597
     
107,196
 
Home equity - 1st lien
   
107
     
-
     
273
     
380
     
27,542
     
27,922
 
Home equity - 2nd lien
   
226
     
73
     
353
     
652
     
52,882
     
53,534
 
Purchased loans
   
7
     
1
     
-
     
8
     
42,503
     
42,511
 
Installment
                                               
Home equity - 1st lien
   
474
     
179
     
96
     
749
     
13,079
     
13,828
 
Home equity - 2nd lien
   
133
     
72
     
249
     
454
     
15,064
     
15,518
 
Loans not secured by real estate
   
291
     
114
     
384
     
789
     
236,376
     
237,165
 
Other
   
10
     
4
     
3
     
17
     
2,546
     
2,563
 
Payment plan receivables
                                               
Full refund
   
258
     
70
     
-
     
328
     
10,035
     
10,363
 
Partial refund
   
506
     
313
     
4
     
823
     
14,041
     
14,864
 
Other
   
159
     
40
     
-
     
199
     
5,762
     
5,961
 
Total recorded investment
 
$
6,431
   
$
2,443
   
$
8,546
   
$
17,420
   
$
1,594,696
   
$
1,612,116
 
Accrued interest included in recorded investment
 
$
67
   
$
28
   
$
-
   
$
95
   
$
4,667
   
$
4,762
 
                                                 
December 31, 2015
                                               
Commercial
                                               
Income producing - real estate
 
$
203
   
$
209
   
$
647
   
$
1,059
   
$
305,155
   
$
306,214
 
Land, land development and construction - real estate
   
-
     
-
     
252
     
252
     
44,231
     
44,483
 
Commercial and industrial
   
785
     
16
     
151
     
952
     
398,618
     
399,570
 
Mortgage
                                               
1-4 family
   
1,943
     
640
     
4,744
     
7,327
     
269,880
     
277,207
 
Resort lending
   
307
     
-
     
1,094
     
1,401
     
114,619
     
116,020
 
Home equity - 1st lien
   
50
     
-
     
187
     
237
     
22,327
     
22,564
 
Home equity - 2nd lien
   
439
     
54
     
147
     
640
     
50,618
     
51,258
 
Purchased loans
   
9
     
1
     
2
     
12
     
33,245
     
33,257
 
Installment
                                               
Home equity - 1st lien
   
315
     
107
     
106
     
528
     
16,707
     
17,235
 
Home equity - 2nd lien
   
231
     
149
     
443
     
823
     
19,727
     
20,550
 
Loans not secured by real estate
   
567
     
83
     
421
     
1,071
     
193,680
     
194,751
 
Other
   
15
     
3
     
2
     
20
     
2,159
     
2,179
 
Payment plan receivables
                                               
Full refund
   
492
     
62
     
2
     
556
     
21,294
     
21,850
 
Partial refund
   
415
     
228
     
2
     
645
     
5,834
     
6,479
 
Other
   
110
     
3
     
1
     
114
     
6,156
     
6,270
 
Total recorded investment
 
$
5,881
   
$
1,555
   
$
8,201
   
$
15,637
   
$
1,504,250
   
$
1,519,887
 
Accrued interest included in recorded investment
 
$
53
   
$
17
   
$
2
   
$
72
   
$
4,765
   
$
4,837
 
 
19

NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
(unaudited)

Impaired loans are as follows:

   
September 30,
2016
   
December 31,
2015
 
Impaired loans with no allocated allowance
 
(In thousands)
 
TDR
 
$
541
   
$
2,518
 
Non - TDR
   
133
     
203
 
Impaired loans with an allocated allowance
               
TDR - allowance based on collateral
   
3,472
     
4,810
 
TDR - allowance based on present value cash flow
   
76,701
     
81,002
 
Non - TDR - allowance based on collateral
   
902
     
260
 
Non - TDR - allowance based on present value cash flow
   
-
     
-
 
Total impaired loans
 
$
81,749
   
$
88,793
 
                 
Amount of allowance for loan losses allocated
               
TDR - allowance based on collateral
 
$
1,710
   
$
2,436
 
TDR - allowance based on present value cash flow
   
8,361
     
8,471
 
Non - TDR - allowance based on collateral
   
304
     
76
 
Non - TDR - allowance based on present value cash flow
   
-
     
-
 
Total amount of allowance for loan losses allocated
 
$
10,375
   
$
10,983
 
 
20

NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
(unaudited)

Impaired loans by class  are as follows (1):

   
September 30, 2016
   
December 31, 2015
 
   
Recorded
Investment
   
Unpaid
Principal
Balance
   
Related
Allowance
   
Recorded
Investment
   
Unpaid
Principal
Balance
   
Related
Allowance
 
With no related allowance recorded:
 
(In thousands)
       
Commercial
                                   
Income producing - real estate
 
$
541
   
$
787
   
$
-
   
$
641
   
$
851
   
$
-
 
Land, land development & construction-real estate
   
133
     
709
     
-
     
818
     
1,393
     
-
 
Commercial and industrial
   
-
     
-
     
-
     
1,245
     
1,241
     
-
 
Mortgage
                                               
1-4 family
   
1
     
305
     
-
     
23
     
183
     
-
 
Resort lending
   
-
     
-
     
-
     
-
     
-
     
-
 
Home equity - 1st lien
   
-
     
-
     
-
     
-
     
-
     
-
 
Home equity - 2nd lien
   
-
     
-
     
-
     
-
     
-
     
-
 
Installment
                                               
Home equity - 1st lien
   
-
     
67
     
-
     
-
     
76
     
-
 
Home equity - 2nd lien
   
-
     
-
     
-
     
-
     
-
     
-
 
Loans not secured by real estate
   
-
     
-
     
-
     
-
     
-
     
-
 
Other
   
-
     
-
     
-
     
-
     
-
     
-
 
     
675
     
1,868
     
-
     
2,727
     
3,744
     
-
 
With an allowance recorded:
                                               
Commercial
                                               
Income producing - real estate
   
7,813
     
7,951
     
561
     
8,377
     
9,232
     
516
 
Land, land development & construction-real estate
   
389
     
391
     
67
     
1,690
     
1,778
     
296
 
Commercial and industrial
   
7,211
     
7,566
     
2,697
     
4,097
     
4,439
     
1,896
 
Mortgage
                                               
1-4 family
   
43,038
     
44,922
     
4,173
     
47,792
     
49,808
     
5,132
 
Resort lending
   
17,295
     
17,327
     
2,488
     
18,148
     
18,319
     
2,662
 
Home equity - 1st lien
   
239
     
244
     
32
     
168
     
172
     
9
 
Home equity - 2nd lien
   
318
     
400
     
24
     
244
     
325
     
15
 
Installment
                                               
Home equity - 1st lien
   
2,108
     
2,223
     
105
     
2,364
     
2,492
     
143
 
Home equity - 2nd lien
   
2,461
     
2,480
     
191
     
2,929
     
2,951
     
271
 
Loans not secured by real estate
   
530
     
566
     
37
     
587
     
658
     
42
 
Other
   
2
     
2
     
-
     
8
     
8
     
1
 
     
81,404
     
84,072
     
10,375
     
86,404
     
90,182
     
10,983
 
Total
                                               
Commercial
                                               
Income producing - real estate
   
8,354
     
8,738
     
561
     
9,018
     
10,083
     
516
 
Land, land development & construction-real estate
   
522
     
1,100
     
67
     
2,508
     
3,171
     
296
 
Commercial and industrial
   
7,211
     
7,566
     
2,697
     
5,342
     
5,680
     
1,896
 
Mortgage
                                               
1-4 family
   
43,039
     
45,227
     
4,173
     
47,815
     
49,991
     
5,132
 
Resort lending
   
17,295
     
17,327
     
2,488
     
18,148
     
18,319
     
2,662
 
Home equity - 1st lien
   
239
     
244
     
32
     
168
     
172
     
9
 
Home equity - 2nd lien
   
318
     
400
     
24
     
244
     
325
     
15
 
Installment
                                               
Home equity - 1st lien
   
2,108
     
2,290
     
105
     
2,364
     
2,568
     
143
 
Home equity - 2nd lien
   
2,461
     
2,480
     
191
     
2,929
     
2,951
     
271
 
Loans not secured by real estate
   
530
     
566
     
37
     
587
     
658
     
42
 
Other
   
2
     
2
     
-
     
8
     
8
     
1
 
Total
 
$
82,079
   
$
85,940
   
$
10,375
   
$
89,131
   
$
93,926
   
$
10,983
 
                                                 
Accrued interest included in recorded investment
 
$
330
                   
$
338
                 
 
(1)
There were no impaired payment plan receivables or purchased mortgage loans at September 30, 2016 or December 31, 2015
 
21

NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
(unaudited)

Average recorded investment in and interest income earned on impaired loans by class for the three month periods ending September 30, follows (1):

   
2016
   
2015
 
   
Average
Recorded
Investment
   
Interest
Income
Recognized
   
Average
Recorded
Investment
   
Interest
Income
Recognized
 
With no related allowance recorded:
 
(In thousands)
 
Commercial
                       
Income producing - real estate
 
$
551
   
$
-
   
$
5,133
   
$
45
 
Land, land development & construction-real estate
   
133
     
-
     
932
     
14
 
Commercial and industrial
   
-
     
-
     
1,922
     
68
 
Mortgage
                               
1-4 family
   
12
     
3
     
24
     
3
 
Resort lending
   
-
     
-
     
-
     
-
 
Home equity - 1st lien
   
-
     
-
     
-
     
-
 
Home equity - 2nd lien
   
-
     
-
     
-
     
-
 
Installment
                               
Home equity - 1st lien
   
-
     
3
     
-
     
-
 
Home equity - 2nd lien
   
-
     
-
     
-
     
-
 
Loans not secured by real estate
   
-
     
-
     
-
     
-
 
Other
   
-
     
-
     
-
     
-
 
     
696
     
6
     
8,011
     
130
 
With an allowance recorded:
                               
Commercial
                               
Income producing - real estate
   
8,000
     
111
     
14,655
     
154
 
Land, land development & construction-real estate
   
1,117
     
3
     
1,993
     
2
 
Commercial and industrial
   
7,145
     
69
     
6,431
     
37
 
Mortgage
                               
1-4 family
   
44,256
     
470
     
49,706
     
554
 
Resort lending
   
17,372
     
161
     
18,414
     
163
 
Home equity - 1st lien
   
241
     
2
     
157
     
2
 
Home equity - 2nd lien
   
280
     
6
     
185
     
-
 
Installment
                               
Home equity - 1st lien
   
2,140
     
34
     
2,474
     
47
 
Home equity - 2nd lien
   
2,585
     
37
     
2,999
     
47
 
Loans not secured by real estate
   
536
     
9
     
645
     
10
 
Other
   
4
     
-
     
10
     
-
 
     
83,676
     
902
     
97,669
     
1,016
 
Total
                               
Commercial
                               
Income producing - real estate
   
8,551
     
111
     
19,788
     
199
 
Land, land development & construction-real estate
   
1,250
     
3
     
2,925
     
16
 
Commercial and industrial
   
7,145
     
69
     
8,353
     
105
 
Mortgage
                               
1-4 family
   
44,268
     
473
     
49,730
     
557
 
Resort lending
   
17,372
     
161
     
18,414
     
163
 
Home equity - 1st lien
   
241
     
2
     
157
     
2
 
Home equity - 2nd lien
   
280
     
6
     
185
     
-
 
Installment
                               
Home equity - 1st lien
   
2,140
     
37
     
2,474
     
47
 
Home equity - 2nd lien
   
2,585
     
37
     
2,999
     
47
 
Loans not secured by real estate
   
536
     
9
     
645
     
10
 
Other
   
4
     
-
     
10
     
-
 
Total
 
$
84,372
   
$
908
   
$
105,680
   
$
1,146
 

(1)
There were no impaired payment plan receivables or purchased mortgage loans during the three month periods ended September 30, 2016 and 2015, respectively.
 
22

NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
(unaudited)
 
Average recorded investment in and interest income earned on impaired loans by class for the nine month periods ending September 30, follows (1):

   
2016
   
2015
 
   
Average
Recorded
Investment
   
Interest
Income
Recognized
   
Average
Recorded
Investment
   
Interest
Income
Recognized
 
With no related allowance recorded:
 
(In thousands)
 
Commercial
                       
Income producing - real estate
 
$
632
   
$
2
   
$
5,490
   
$
170
 
Land, land development & construction-real estate
   
405
     
7
     
986
     
57
 
Commercial and industrial
   
616
     
21
     
2,345
     
195
 
Mortgage
                               
1-4 family
   
12
     
9
     
18
     
5
 
Resort lending
   
-
     
-
     
15
     
-
 
Home equity - 1st lien
   
-
     
-
     
-
     
-
 
Home equity - 2nd lien
   
-
     
-
     
-
     
-
 
Installment
                               
Home equity - 1st lien
   
-
     
4
     
-
     
1
 
Home equity - 2nd lien
   
4
     
-
     
-
     
-
 
Loans not secured by real estate
   
-
     
-
     
-
     
-
 
Other
   
-
     
-
     
-
     
-
 
     
1,669
     
43
     
8,854
     
428
 
With an allowance recorded:
                               
Commercial
                               
Income producing - real estate
   
8,153
     
318
     
13,752
     
452
 
Land, land development & construction-real estate
   
1,352
     
29
     
2,351
     
35
 
Commercial and industrial
   
5,929
     
151
     
7,304
     
117
 
Mortgage
                               
1-4 family
   
45,728
     
1,447
     
51,078
     
1,644
 
Resort lending
   
17,705
     
480
     
18,523
     
507
 
Home equity - 1st lien
   
223
     
6
     
159
     
6
 
Home equity - 2nd lien
   
231
     
11
     
154
     
6
 
Installment
                               
Home equity - 1st lien
   
2,233
     
118
     
2,582
     
141
 
Home equity - 2nd lien
   
2,723
     
122
     
3,086
     
147
 
Loans not secured by real estate
   
557
     
28
     
669
     
29
 
Other
   
5
     
-
     
11
     
1
 
     
84,839
     
2,710
     
99,669
     
3,085
 
Total
                               
Commercial
                               
Income producing - real estate
   
8,785
     
320
     
19,242
     
622
 
Land, land development & construction-real estate
   
1,757
     
36
     
3,337
     
92
 
Commercial and industrial
   
6,545
     
172
     
9,649
     
312
 
Mortgage
                               
1-4 family
   
45,740
     
1,456
     
51,096
     
1,649
 
Resort lending
   
17,705
     
480
     
18,538
     
507
 
Home equity - 1st lien
   
223
     
6
     
159
     
6
 
Home equity - 2nd lien
   
231
     
11
     
154
     
6
 
Installment
                               
Home equity - 1st lien
   
2,233
     
122
     
2,582
     
142
 
Home equity - 2nd lien
   
2,727
     
122
     
3,086
     
147
 
Loans not secured by real estate
   
557
     
28
     
669
     
29
 
Other
   
5
     
-
     
11
     
1
 
Total
 
$
86,508
   
$
2,753
   
$
108,523
   
$
3,513
 

(1)
There were no impaired payment plan receivables or purchased mortgage loans during the nine month periods ended September 30, 2016 and 2015, respectively.
 
23

NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
(unaudited)

Our average investment in impaired loans was approximately $84.4 million and $105.7 million for the three-month periods ended September 30, 2016 and 2015, respectively and $86.5 million and $108.5 million for the nine-month periods ended September 30, 2016 and 2015, respectively.  Cash receipts on impaired loans on non-accrual status are generally applied to the principal balance.  Interest income recognized on impaired loans during the three months ending September 30, 2016 and 2015, was approximately $0.9 million and $1.1 million, respectively and was approximately $2.8 million and $3.5 million during the nine months ending September 30, 2016 and 2015, respectively.

Troubled debt restructurings follow:

   
September 30, 2016
 
   
Commercial
   
Retail
     
Total
 
   
(In thousands)
 
Performing TDRs
 
$
12,642
   
$
62,299
     
$
74,941
 
Non-performing TDRs(1)
   
2,352
     
3,421
 
(2) 
   
5,773
 
Total
 
$
14,994
   
$
65,720
     
$
80,714
 

  December 31, 2015  
  Commercial    
Retail
     
Total
 
 
(In thousands)
 
Performing TDRs
 
$
13,318
   
$
68,194
     
$
81,512
 
Non-performing TDRs(1)
   
3,041
     
3,777
 
(2) 
   
6,818
 
Total
 
$
16,359
   
$
71,971
     
$
88,330
 
 
(1)
Included in non-performing loans table above.
(2)
Also includes loans on non-accrual at the time of modification until six payments are received on a timely basis.

We allocated $10.1 million and $10.9 million of specific reserves to customers whose loan terms have been modified in troubled debt restructurings as of September 30, 2016 and December 31, 2015, respectively.

During the nine months ended September 30, 2016 and 2015, the terms of certain loans were modified as troubled debt restructurings. The modification of the terms of such loans generally included one or a combination of the following: a reduction of the stated interest rate of the loan; an extension of the maturity date at a stated rate of interest lower than the current market rate for new debt with similar risk; or a permanent reduction of the recorded investment in the loan.

Modifications involving a reduction of the stated interest rate of the loan have generally been for periods ranging from 9 months to 36 months but have extended to as much as 480 months in certain circumstances. Modifications involving an extension of the maturity date have generally been for periods ranging from 1 month to 60 months but have extended to as much as 230 months in certain circumstances.
 
24

NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
(unaudited)

Loans that have been classified as troubled debt restructurings during the three-month periods ended September 30 follow(1):

   
Number of
Contracts
   
Pre-modification
Recorded
Balance
   
Post-modification
Recorded
Balance
 
   
(Dollars in thousands)
 
2016
                 
Commercial
                 
Income producing - real estate
   
2
   
$
180
   
$
180
 
Land, land development & construction-real estate
   
-
     
-
     
-
 
Commercial and industrial
   
2
     
175
     
158
 
Mortgage
                       
1-4 family
   
2
     
204
     
207
 
Resort lending
   
-
     
-
     
-
 
Home equity - 1st lien
   
-
     
-
     
-
 
Home equity - 2nd lien
   
2
     
77
     
78
 
Installment
                       
Home equity - 1st lien
   
2
     
82
     
85
 
Home equity - 2nd lien
   
1
     
7
     
7
 
Loans not secured by real estate
   
1
     
34
     
34
 
Other
   
-
     
-
     
-
 
Total
   
12
   
$
759
   
$
749
 
                         
2015
                       
Commercial
                       
Income producing - real estate
   
-
   
$
-
   
$
-
 
Land, land development & construction-real estate
   
-
     
-
     
-
 
Commercial and industrial
   
1
     
48
     
26
 
Mortgage
                       
1-4 family
   
3
     
343
     
344
 
Resort lending
   
-
     
-
     
-
 
Home equity - 1st lien
   
-
     
-
     
-
 
Home equity - 2nd lien
   
-
     
-
     
-
 
Installment
                       
Home equity - 1st lien
   
-
     
-
     
-
 
Home equity - 2nd lien
   
-
     
-
     
-
 
Loans not secured by real estate
   
1
     
19
     
19
 
Other
   
-
     
-
     
-
 
Total
   
5
   
$
410
   
$
389
 

(1)
There were no payment plan receivables or purchased mortgage loans classified as troubled debt restructurings during the three month periods ended September 30, 2016 and 2015, respectively.
 
25

NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
(unaudited)

Loans that have been classified as troubled debt restructurings during the nine-month periods ended September 30 follow(1):

   
Number of
Contracts
   
Pre-modification
Recorded
Balance
   
Post-modification
Recorded
Balance
 
   
(Dollars in thousands)
 
2016
                 
Commercial
                 
Income producing - real estate
   
4
   
$
290
   
$
290
 
Land, land development & construction-real estate
   
-
     
-
     
-
 
Commercial and industrial
   
6
     
1,933
     
1,916
 
Mortgage
                       
1-4 family
   
5
     
396
     
470
 
Resort lending
   
1
     
116
     
117
 
Home equity - 1st lien
   
1
     
107
     
78
 
Home equity - 2nd lien
   
2
     
77
     
78
 
Installment
                       
Home equity - 1st lien
   
6
     
141
     
145
 
Home equity - 2nd lien
   
5
     
133
     
136
 
Loans not secured by real estate
   
2
     
46
     
46
 
Other
   
-
     
-
     
-
 
Total
   
32
   
$
3,239
   
$
3,276
 
                         
2015
                       
Commercial
                       
Income producing - real estate
   
2
   
$
229
   
$
234
 
Land, land development & construction-real estate
   
-
     
-
     
-
 
Commercial and industrial
   
4
     
301
     
273
 
Mortgage
                       
1-4 family
   
9
     
1,373
     
1,189
 
Resort lending
   
1
     
313
     
309
 
Home equity - 1st lien
   
-
     
-
     
-
 
Home equity - 2nd lien
   
-
     
-
     
-
 
Installment
                       
Home equity - 1st lien
   
5
     
190
     
164
 
Home equity - 2nd lien
   
3
     
58
     
58
 
Loans not secured by real estate
   
2
     
19
     
25
 
Other
   
-
     
-
     
-
 
Total
   
26
   
$
2,483
   
$
2,252
 

(1)
There were no payment plan receivables or purchased mortgage loans classified as troubled debt restructurings during the nine month periods ended September 30, 2016 and 2015, respectively.

The troubled debt restructurings described above for 2016 increased the allowance for loan losses by $0.34 million and resulted in charge offs of $0.02 million during the three months ended September 30, 2016, and increased the allowance by $0.69 million and resulted in charge offs of $0.02 million during the nine months ended September 30, 2016.

The troubled debt restructurings described above for 2015 decreased the allowance for loan losses by $0.05 million and resulted in zero charge offs during the three months ended September 30, 2015, and increased the allowance by $0.05 million and resulted in zero charge offs during the nine months ended September 30, 2015.
 
26

NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
(unaudited)

Loans that have been classified as troubled debt restructurings during the past twelve months and that have subsequently defaulted during the three-month periods ended September 30 follow:

   
Number of
Contracts
   
Recorded
Balance
 
   
(Dollars in thousands)
 
2016
           
Commercial
           
Income producing - real estate
   
-
   
$
-
 
Land, land development & construction-real estate
   
-
     
-
 
Commercial and industrial
   
-
     
-
 
Mortgage
               
1-4 family
   
-
     
-
 
Resort lending
   
-
     
-
 
Home equity - 1st lien
   
-
     
-
 
Home equity - 2nd lien
   
-
     
-
 
Installment
               
Home equity - 1st lien
   
-
     
-
 
Home equity - 2nd lien
   
-
     
-
 
Loans not secured by real estate
   
-
     
-
 
Other
   
-
     
-
 
     
-
   
$
-
 
                 
2015
               
Commercial
               
Income producing - real estate
   
-
   
$
-
 
Land, land development & construction-real estate
   
-
     
-
 
Commercial and industrial
   
-
     
-
 
Mortgage
               
1-4 family
   
1
     
54
 
Resort lending
   
-
     
-
 
Home equity - 1st lien
   
-
     
-
 
Home equity - 2nd lien
   
-
     
-
 
Installment
               
Home equity - 1st lien
   
-
     
-
 
Home equity - 2nd lien
   
-
     
-
 
Loans not secured by real estate
   
-
     
-
 
Other
   
-
     
-
 
     
1
   
$
54
 
 
27

NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
(unaudited)

Loans that have been classified as troubled debt restructurings during the past twelve months and that have subsequently defaulted during the nine-month periods ended September 30 follow:

   
Number of
Contracts
   
Recorded
Balance
 
   
(Dollars in thousands)
 
2016
           
Commercial
           
Income producing - real estate
   
-
   
$
-
 
Land, land development & construction-real estate
   
-
     
-
 
Commercial and industrial
   
-
     
-
 
Mortgage
               
1-4 family
   
-
     
-
 
Resort lending
   
-
     
-
 
Home equity - 1st lien
   
-
     
-
 
Home equity - 2nd lien
   
-
     
-
 
Installment
               
Home equity - 1st lien
   
-
     
-
 
Home equity - 2nd lien
   
-
     
-
 
Loans not secured by real estate
   
-
     
-
 
Other
   
-
     
-
 
     
-
   
$
-
 
                 
2015
               
Commercial
               
Income producing - real estate
   
-
   
$
-
 
Land, land development & construction-real estate
   
-
     
-
 
Commercial and industrial
   
2
     
157
 
Mortgage
               
1-4 family
   
1
     
54
 
Resort lending
   
-
     
-
 
Home equity - 1st lien
   
-
     
-
 
Home equity - 2nd lien
   
-
     
-
 
Installment
               
Home equity - 1st lien
   
-
     
-
 
Home equity - 2nd lien
   
-
     
-
 
Loans not secured by real estate
   
1
     
4
 
Other
   
-
     
-
 
     
4
   
$
215
 

A loan is considered to be in payment default generally once it is 90 days contractually past due under the modified terms.

There were no troubled debt restructurings that subsequently defaulted during the three and nine months ended September 30, 2016.

The troubled debt restructurings that subsequently defaulted described above for 2015 decreased the allowance for loan losses by $0.01 million and resulted in zero charge offs during the three months ended September 30, 2015 and had no impact on the allowance for loan losses and resulted in zero charge offs during the nine months ended September 30, 2015.
 
28

NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
(unaudited)

In order to determine whether a borrower is experiencing financial difficulty, we perform an evaluation of the probability that the borrower will be in payment default on any of its debt in the foreseeable future without the modification. This evaluation is performed under our internal underwriting policy.

Credit Quality Indicators – As part of our on on-going monitoring of the credit quality of our loan portfolios, we track certain credit quality indicators including (a) weighted-average risk grade of commercial loans, (b) the level of classified commercial loans, (c) credit scores of mortgage and installment loan borrowers, (d) financial performance of certain counterparties for payment plan receivables and (e) delinquency history and non-performing loans.

For commercial loans, we use a loan rating system that is similar to those employed by state and federal banking regulators. Loans are graded on a scale of 1 to 12. A description of the general characteristics of the ratings follows:

Rating 1 through 6: These loans are generally referred to as our “non-watch” commercial credits that include very high or exceptional credit fundamentals through acceptable credit fundamentals.

Rating 7 and 8: These loans are generally referred to as our “watch” commercial credits. This rating includes loans to borrowers that exhibit potential credit weakness or downward trends. If not checked or cured these trends could weaken our asset or credit position. While potentially weak, no loss of principal or interest is envisioned with these ratings.

Rating 9: These loans are generally referred to as our “substandard accruing” commercial credits. This rating includes loans to borrowers that exhibit a well-defined weakness where payment default is probable and loss is possible if deficiencies are not corrected. Generally, loans with this rating are considered collectible as to both principal and interest primarily due to collateral coverage.

Rating 10 and 11: These loans are generally referred to as our “substandard - non-accrual” and “doubtful” commercial credits. This rating includes loans to borrowers with weaknesses that make collection of debt in full, on the basis of current facts, conditions and values at best questionable and at worst improbable. All of these loans are placed in non-accrual.

Rating 12: These loans are generally referred to as our “loss” commercial credits. This rating includes loans to borrowers that are deemed incapable of repayment and are charged-off.
 
29

NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
(unaudited)

The following table summarizes loan ratings by loan class for our commercial loan segment:

   
Commercial
 
   
Non-watch
1-6
   
Watch
7-8
   
Substandard
Accrual
9
   
Non-
Accrual
10-11
   
Total
 
               
(In thousands)
             
September 30, 2016
                             
Income producing - real estate
 
$
268,940
   
$
4,000
   
$
404
   
$
658
   
$
274,002
 
Land, land development and construction - real estate
   
53,559
     
199
     
-
     
211
     
53,969
 
Commercial and industrial
   
439,036
     
10,727
     
6,478
     
2,517
     
458,758
 
Total
 
$
761,535
   
$
14,926
   
$
6,882
   
$
3,386
   
$
786,729
 
Accrued interest included in total
 
$
1,676
   
$
56
   
$
21
   
$
-
   
$
1,753
 
                                         
December 31, 2015
                                       
Income producing - real estate
 
$
296,898
   
$
6,866
   
$
1,423
   
$
1,027
   
$
306,214
 
Land, land development and construction - real estate
   
40,844
     
2,995
     
243
     
401
     
44,483
 
Commercial and industrial
   
371,357
     
19,502
     
6,683
     
2,028
     
399,570
 
Total
 
$
709,099
   
$
29,363
   
$
8,349
   
$
3,456
   
$
750,267
 
Accrued interest included in total
 
$
1,729
   
$
108
   
$
32
   
$
-
   
$
1,869
 

For each of our mortgage and installment segment classes, we generally monitor credit quality based on the credit scores of the borrowers. These credit scores are generally updated semi-annually.
 
30

NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
  (unaudited)

The following tables summarize credit scores by loan class for our mortgage and installment loan segments:
 
   
Mortgage (1)
 
   
1-4 Family
   
Resort
Lending
   
Home
Equity
1st Lien
   
Home
Equity
2nd Lien
   
Purchased
Loans
        
Total
   
   
(In thousands)
 
September 30, 2016
                                   
800 and above
 
$
32,310
   
$
12,054
   
$
5,590
   
$
8,288
   
$
4,816
   
$
63,058
 
750-799
   
88,959
     
38,472
     
9,551
     
19,103
     
26,721
     
182,806
 
700-749
   
60,455
     
30,934
     
5,052
     
11,278
     
10,831
     
118,550
 
650-699
   
53,748
     
13,530
     
3,690
     
8,259
     
-
     
79,227
 
600-649
   
27,848
     
6,218
     
1,365
     
3,342
     
-
     
38,773
 
550-599
   
15,413
     
2,467
     
738
     
1,542
     
-
     
20,160
 
500-549
   
7,955
     
871
     
484
     
1,246
     
-
     
10,556
 
Under 500
   
5,097
     
596
     
172
     
244
     
-
     
6,109
 
Unknown
   
2,177
     
2,054
     
1,280
     
232
     
143
     
5,886
 
Total
 
$
293,962
   
$
107,196
   
$
27,922
   
$
53,534
   
$
42,511
   
$
525,125
 
Accrued interest included in total
 
$
1,386
   
$
473
   
$
104
   
$
210
   
$
119
   
$
2,292
 
                                                 
December 31, 2015
                                               
800 and above
 
$
28,760
   
$
13,943
   
$
4,374
   
$
7,696
   
$
2,310
   
$
57,083
 
750-799
   
78,802
     
40,888
     
7,137
     
17,405
     
23,283
     
167,515
 
700-749
   
56,519
     
31,980
     
4,341
     
11,022
     
6,940
     
110,802
 
650-699
   
51,813
     
17,433
     
3,203
     
7,691
     
-
     
80,140
 
600-649
   
27,966
     
4,991
     
1,467
     
3,684
     
-
     
38,108
 
550-599
   
16,714
     
3,070
     
1,027
     
1,918
     
-
     
22,729
 
500-549
   
10,610
     
1,051
     
572
     
1,295
     
-
     
13,528
 
Under 500
   
4,708
     
554
     
244
     
265
     
-
     
5,771
 
Unknown
   
1,315
     
2,110
     
199
     
282
     
724
     
4,630
 
Total
 
$
277,207
   
$
116,020
   
$
22,564
   
$
51,258
   
$
33,257
   
$
500,306
 
Accrued interest included in total
 
$
1,396
   
$
477
   
$
87
   
$
196
   
$
114
   
$
2,270
 
 
(1)
Credit scores have been updated within the last twelve months.
 
31

NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
(unaudited)

   
Installment(1)
 
   
Home
Equity
1st Lien
   
Home
Equity
2nd Lien
   
Loans not
Secured by
Real Estate
   
Other
   
Total
 
   
(In thousands)
 
September 30, 2016
                             
800 and above
 
$
1,373
   
$
1,953
   
$
51,471
   
$
108
   
$
54,905
 
750-799
   
3,031
     
3,558
     
110,667
     
680
     
117,936
 
700-749
   
2,170
     
2,872
     
43,616
     
812
     
49,470
 
650-699
   
2,690
     
3,244
     
18,322
     
522
     
24,778
 
600-649
   
2,193
     
1,668
     
4,080
     
281
     
8,222
 
550-599
   
1,310
     
1,348
     
1,690
     
52
     
4,400
 
500-549
   
895
     
631
     
1,126
     
48
     
2,700
 
Under 500
   
134
     
233
     
309
     
25
     
701
 
Unknown
   
32
     
11
     
5,884
     
35
     
5,962
 
Total
 
$
13,828
   
$
15,518
   
$
237,165
   
$
2,563
   
$
269,074
 
Accrued interest included in total
 
$
58
   
$
57
   
$
582
   
$
20
   
$
717
 
                                         
December 31, 2015
                                       
800 and above
 
$
1,792
   
$
1,782
   
$
44,254
   
$
58
   
$
47,886
 
750-799
   
4,117
     
5,931
     
86,800
     
531
     
97,379
 
700-749
   
2,507
     
3,899
     
34,789
     
694
     
41,889
 
650-699
   
3,508
     
4,182
     
16,456
     
499
     
24,645
 
600-649
   
2,173
     
2,153
     
4,979
     
200
     
9,505
 
550-599
   
1,800
     
1,346
     
1,997
     
109
     
5,252
 
500-549
   
1,056
     
855
     
1,170
     
61
     
3,142
 
Under 500
   
223
     
370
     
385
     
23
     
1,001
 
Unknown
   
59
     
32
     
3,921
     
4
     
4,016
 
Total
 
$
17,235
   
$
20,550
   
$
194,751
   
$
2,179
   
$
234,715
 
Accrued interest included in total
 
$
78
   
$
83
   
$
520
   
$
17
   
$
698
 

(1)
Credit scores have been updated within the last twelve months.

Mepco Finance Corporation (“Mepco”) is a wholly-owned subsidiary of our Bank that operates a vehicle service contract payment plan business throughout the United States. See Note #14 for more information about Mepco’s business. As of September 30, 2016, approximately 33.2% of Mepco’s outstanding payment plan receivables relate to programs in which a third party insurer or risk retention group is obligated to pay Mepco the full refund owing upon cancellation of the related service contract (including with respect to both the portion funded to the service contract seller and the portion funded to the administrator). These receivables are shown as “Full Refund” in the table below. Another approximately 47.7% of Mepco’s outstanding payment plan receivables as of September 30, 2016, relate to programs in which a third party insurer or risk retention group is obligated to pay Mepco the refund owing upon cancellation only with respect to the unearned portion previously funded by Mepco to the administrator (but not to the service contract seller). These receivables are shown as “Partial Refund” in the table below. The balance of Mepco’s outstanding payment plan receivables relate to programs in which there is no insurer or risk retention group that has any contractual liability to Mepco for any portion of the refund amount. These receivables are shown as “Other” in the table below. For each class of our payment plan receivables we monitor financial information on the counterparties as we evaluate the credit quality of this portfolio.
 
32

NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
(unaudited)

The following table summarizes credit ratings of insurer or risk retention group counterparties by class of payment plan receivable:

   
Payment Plan Receivables
 
   
Full
Refund
   
Partial
Refund
   
Other
   
Total
 
   
(In thousands)
 
September 30, 2016
                       
AM Best rating
                       
A+
 
$
-
   
$
8
   
$
-
   
$
8
 
A
   
1,094
     
13,696
     
-
     
14,790
 
A-
   
977
     
1,110
     
3,458
     
5,545
 
B+
   
-
     
-
     
2,502
     
2,502
 
Not rated
   
8,292
     
50
     
1
     
8,343
 
Total
 
$
10,363
   
$
14,864
   
$
5,961
   
$
31,188
 
                                 
December 31, 2015
                               
AM Best rating
                               
A+
 
$
-
   
$
6
   
$
-
   
$
6
 
A
   
2,712
     
5,203
     
-
     
7,915
 
A-
   
3,418
     
1,177
     
6,265
     
10,860
 
Not rated
   
15,720
     
93
     
5
     
15,818
 
Total
 
$
21,850
   
$
6,479
   
$
6,270
   
$
34,599
 

Although Mepco has contractual recourse against various counterparties for refunds owing upon cancellation of vehicle service contracts, see Note #14 below regarding certain risks and difficulties associated with collecting these refunds.

Foreclosed residential real estate properties included in other real estate and repossessed assets on our Condensed Consolidated Statements of Financial Condition totaled $1.8 million and $2.8 million at September 30, 2016 and December 31, 2015, respectively.  Retail mortgage loans secured by residential real estate properties for which formal foreclosure proceedings are in process according to local requirements totaled $0.4 million and $1.1 million at  September 30, 2016 and December 31, 2015, respectively.

5.
Segments

Our reportable segments are based upon legal entities.  We currently have two reportable segments:  Independent Bank (“IB” or “Bank”) and Mepco.  These business segments are also differentiated based on the products and services provided.  We evaluate performance based principally on net income (loss) of the respective reportable segments.

In the normal course of business, our IB segment provides funding to our Mepco segment through an intercompany line of credit priced at the prime rate of interest as published in the Wall Street Journal. Our IB segment also provides certain administrative services to our Mepco segment which are reimbursed at an agreed upon rate. These intercompany transactions are eliminated upon consolidation. The only other material intersegment balances and transactions are investments in subsidiaries at the parent entities and cash balances on deposit at our IB segment.
 
33

NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
(unaudited)

A summary of selected financial information for our reportable segments follows:

   
IB
   
Mepco
   
Other(1)
   
Elimination(2)
   
Total
 
   
(In thousands)
 
Total assets
                             
September 30, 2016
 
$
2,476,795
   
$
50,032
   
$
286,672
   
$
(275,180
)
 
$
2,538,319
 
December 31, 2015
   
2,340,566
     
57,208
     
286,936
     
(275,644
)
   
2,409,066
 
                                         
For the three months ended September 30,
                                 
2016
                                       
Interest income
 
$
20,731
   
$
1,014
   
$
5
   
$
(5
)
 
$
21,745
 
Net interest income
   
19,409
     
880
     
(291
)
   
0
     
19,998
 
Provision for loan losses
   
(176
)
   
1
     
0
     
0
     
(175
)
Income (loss) before income tax
   
9,811
     
(29
)
   
(406
)
   
(24
)
   
9,352
 
Net income (loss)
   
6,665
     
(20
)
   
(256
)
   
(16
)
   
6,373
 
                                         
2015
                                       
Interest income
 
$
18,973
   
$
1,320
   
$
20
   
$
(20
)
 
$
20,293
 
Net interest income
   
17,964
     
1,115
     
(238
)
   
-
     
18,841
 
Provision for loan losses
   
(238
)
   
(6
)
   
-
     
-
     
(244
)
Income (loss) before income tax
   
7,961
     
(254
)
   
(358
)
   
(24
)
   
7,325
 
Net income (loss)
   
5,455
     
(168
)
   
(224
)
   
(16
)
   
5,047
 
                                         
For the nine months ended September 30,
                                 
2016
                                       
Interest income
 
$
61,190
   
$
3,176
   
$
22
   
$
(22
)
 
$
64,366
 
Net interest income
   
57,500
     
2,727
     
(836
)
   
-
     
59,391
 
Provision for loan losses
   
(1,436
)
   
(3
)
   
-
     
-
     
(1,439
)
Income (loss) before income tax
   
25,971
     
(339
)
   
(1,103
)
   
(71
)
   
24,458
 
Net income (loss)
   
17,834
     
(225
)
   
(652
)
   
(46
)
   
16,911
 
                                         
2015
                                       
Interest income
 
$
55,895
   
$
4,081
   
$
60
   
$
(60
)
 
$
59,976
 
Net interest income
   
52,864
     
3,468
     
(699
)
   
-
     
55,633
 
Provision for loan losses
   
(1,032
)
   
(5
)
   
-
     
-
     
(1,037
)
Income (loss) before income tax
   
23,063
     
(766
)
   
(1,097
)
   
(71
)
   
21,129
 
Net income (loss)
   
15,623
     
(437
)
   
(693
)
   
(46
)
   
14,447
 
 

(1)
Includes amounts relating to our parent company.
(2)
Includes parent company's investment in subsidiaries and cash balances maintained at subsidiary.
 
6.
Shareholders’ Equity and Earnings Per Common Share

On January 21, 2016, our Board of Directors authorized a share repurchase plan (the “Repurchase Plan”) to buy back up to 5% of our outstanding common stock through December 31, 2016.  On April 26, 2016 our Board of Directors authorized a $5.0 million expansion of the Repurchase Plan. We expect to accomplish the repurchases through open market transactions, though we could affect repurchases through other means, such as privately negotiated transactions.  The timing and amount of any share repurchases will depend on a variety of factors, including, among others, securities law restrictions, the trading price of our common stock, regulatory requirements, potential alternative uses for capital, and our financial performance. The Repurchase Plan does not obligate us to acquire any particular amount of common stock, and it may be modified or suspended at any time at our discretion. We expect to fund any repurchases from cash on hand.  During the nine months ended September 30, 2016, we repurchased 1,153,136 shares of common stock for an aggregate purchase price of $16.9 million leaving $4.4 million to be repurchased under the Repurchase Plan.
 
34

NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
(unaudited)

On November 15, 2011, we entered into a Tax Benefits Preservation Plan (the "Preservation Plan") with our stock transfer agent, American Stock Transfer & Trust Company. Our Board of Directors adopted the Preservation Plan in an effort to protect the value to our shareholders of our ability to use deferred tax assets such as net operating loss carry forwards to reduce potential future federal income tax obligations. Under federal tax rules, this value could be lost in the event we experienced an "ownership change," as defined in Section 382 of the Internal Revenue Code. The Preservation Plan attempts to protect this value by reducing the likelihood that we will experience such an ownership change by discouraging any person who is not already a 5% shareholder from becoming a 5% shareholder (with certain limited exceptions).

On November 15, 2011, our Board of Directors declared a dividend of one preferred share purchase right (a "Right") for each outstanding share of our common stock under the terms of the Preservation Plan. The dividend is payable to the holders of common stock outstanding as of the close of business on November 15, 2011, or outstanding at any time thereafter but before the earlier of a "Distribution Date" and the date the Preservation Plan terminates. Each Right entitles the registered holder to purchase from us 1/1000 of a share of our Series C Junior Participating Preferred Stock, no par value per share ("Series C Preferred Stock"). Each 1/1000 of a share of Series C Preferred Stock has economic and voting terms similar to those of one whole share of common stock. The Rights are not exercisable and generally do not become exercisable until a person or group has acquired, subject to certain exceptions and conditions, beneficial ownership of 4.99% or more of the outstanding shares of common stock. At that time, each Right will generally entitle its holder to purchase securities of the Company at a discount of 50% to the current market price of the common stock. However, the Rights owned by the person acquiring beneficial ownership of 4.99% or more of the outstanding shares of common stock would automatically be void. The significant dilution that would result is expected to deter any person from acquiring beneficial ownership of 4.99% or more and thereby triggering the Rights.

To date, none of the Rights have been exercised or have become exercisable because no unpermitted 4.99% or more change in the beneficial ownership of the outstanding common stock has occurred. The Rights will generally expire on the earlier to occur of the close of business on November 15, 2016, and certain other events described in the Preservation Plan, including such date as our Board of Directors determines that the Preservation Plan is no longer necessary for its intended purposes.  On October 25, 2016, the Board of Directors took affirmative action to not renew the Preservation Plan, which will expire on November 15, 2016.
 
35

NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
(unaudited)

A reconciliation of basic and diluted net income per common share follows:

   
Three Months Ended
September 30,
   
Nine Months Ended
September 30,
 
   
2016
   
2015
   
2016
   
2015
 
   
(In thousands, except per share amounts)
 
             
Net income
 
$
6,373
   
$
5,047
   
$
16,911
   
$
14,447
 
                                 
Weighted average shares outstanding (1)
   
21,232
     
22,673
     
21,421
     
22,852
 
Effect of stock options
   
149
     
118
     
150
     
120
 
Stock units for deferred compensation plan for non-employee directors
   
116
     
112
     
115
     
111
 
Restricted stock units
   
-
     
230
     
46
     
283
 
Performance share units
   
52
     
-
     
42
     
-
 
Weighted average shares outstanding for calculation of diluted earnings per share
   
21,549
     
23,133
     
21,774
     
23,366
 
                                 
Net income per common share
                               
Basic (1)
 
$
0.30
   
$
0.22
   
$
0.79
   
$
0.63
 
Diluted
 
$
0.30
   
$
0.22
   
$
0.78
   
$
0.62
 

(1)
Basic net income per common share includes weighted average common shares outstanding during the period and participating share awards.
 
Weighted average stock options outstanding that were not considered in computing diluted net income per share because they were anti-dilutive totaled 0.03 million for both three-month periods ended September 30, 2016 and 2015, respectively and totaled 0.03 million for both nine-month periods ended September 30, 2016 and 2015, respectively.

7.
Derivative Financial Instruments

We are required to record derivatives on our Condensed Consolidated Statements of Financial Condition as assets and liabilities measured at their fair value.  The accounting for increases and decreases in the value of derivatives depends upon the use of derivatives and whether the derivatives qualify for hedge accounting.
 
36

NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
(unaudited)

Our derivative financial instruments according to the type of hedge in which they are designated follows:

   
September 30, 2016
 
   
Notional
Amount
   
Average
Maturity
(years)
   
Fair
Value
 
   
(Dollars in thousands)
 
No hedge designation
                 
Rate-lock mortgage loan commitments
 
$
31,760
     
0.1
   
$
1,163
 
Mandatory commitments to sell mortgage loans
   
67,672
     
0.1
     
(283
)
Pay-fixed interest rate swap agreements
   
48,623
     
8.8
     
(2,009
)
Pay-variable interest rate swap agreements
   
48,623
     
8.8
     
2,009
 
Purchased options
   
3,119
     
4.8
     
216
 
Written options
   
3,119
     
4.8
     
(216
)
Total
 
$
202,916
     
4.4
   
$
880
 

   
December 31, 2015
 
   
Notional
Amount
   
Average
Maturity
(years)
   
Fair
Value
 
   
(Dollars in thousands)
 
No hedge designation
                 
Rate-lock mortgage loan commitments
 
$
20,581
     
0.1
   
$
550
 
Mandatory commitments to sell mortgage loans
   
46,320
     
0.1
     
69
 
Pay-fixed interest rate swap agreements
   
27,587
     
8.0
     
(497
)
Pay-variable interest rate swap agreements
   
27,587
     
8.0
     
497
 
Purchased options
   
2,098
     
5.7
     
122
 
Written options
   
2,098
     
5.7
     
(122
)
Total
 
$
126,271
     
3.7
   
$
619
 

Certain financial derivative instruments have not been designated as hedges. The fair value of these derivative financial instruments has been recorded on our Condensed Consolidated Statements of Financial Condition and is adjusted on an ongoing basis to reflect their then current fair value. The changes in fair value of derivative financial instruments not designated as hedges are recognized in our Condensed Consolidated Statements of Operations.

In the ordinary course of business, we enter into rate-lock mortgage loan commitments with customers (“Rate-Lock Commitments”).  These commitments expose us to interest rate risk.  We also enter into mandatory commitments to sell mortgage loans (“Mandatory Commitments”) to reduce the impact of price fluctuations of mortgage loans held for sale and Rate-Lock Commitments.  Mandatory Commitments help protect our loan sale profit margin from fluctuations in interest rates. The changes in the fair value of Rate-Lock Commitments and Mandatory Commitments are recognized currently as part of net gains on mortgage loans.  We obtain market prices on Mandatory Commitments and Rate-Lock Commitments.  Net gains on mortgage loans, as well as net income may be more volatile as a result of these derivative instruments, which are not designated as hedges.
 
37

NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
(unaudited)

During 2015, we began offering to our deposit customers an equity linked time deposit product (“Altitude CD”).  The Altitude CD is a time deposit that provides the customer a guaranteed return of principal at maturity plus a potential equity return (a written option), while we receive a like stream of funds based on the equity return (a purchased option).  The written and purchased options will generally move in opposite directions resulting in little or no net impact on our Condensed Consolidated Statements of Operations.  All of the written and purchased options in the table above relate to this Altitude CD product.

We have a program that allows commercial loan customers to lock in a fixed rate for a longer period of time than we would normally offer for interest rate risk reasons.  We will enter into a variable rate commercial loan and an interest rate swap agreement with a customer and then enter into an offsetting interest rate swap agreement with an unrelated party.  The interest rate swap agreement fair values will generally move in opposite directions resulting in little or no net impact on our Condensed Consolidated Statements of Operations.  All of the interest rate swap agreements in the table above relate to this program.

The following tables illustrate the impact that the derivative financial instruments discussed above have on individual line items in the Condensed Consolidated Statements of Financial Condition for the periods presented:

Fair Values of Derivative Instruments
 
 
Asset Derivatives
 
Liability Derivatives
 
 
September 30,
2016
 
December 31,
2015
 
September 30,
2016
 
December 31,
2015
 
Balance
Sheet
Location
 
Fair
Value
 
Balance
Sheet
Location
 
Fair
Value
 
Balance
Sheet
Location
 
Fair
Value
 
Balance
Sheet
Location
 
Fair
Value
 
 
(In thousands)
 
Derivatives not designated as hedging instruments
                               
Rate-lock mortgage loan commitments
Other assets
 
$
1,163
 
Other assets
 
$
550
 
Other liabilities
 
$
-
 
Other liabilities
 
$
-
 
Mandatory commitments to sell mortgage loans
Other assets
   
-
 
Other assets
   
69
 
Other liabilities
   
283
 
Other liabilities
   
-
 
Pay-fixed interest rate swap agreements
Other assets
   
-
 
Other assets
   
-
 
Other liabilities
   
2,009
 
Other liabilities
   
497
 
Pay-variable interest rate swap agreements
Other assets
   
2,009
 
Other assets
   
497
 
Other liabilities
   
-
 
Other liabilities
   
-
 
Purchased options
Other assets
   
216
 
Other assets
   
122
 
Other liabilities
   
-
 
Other liabilities
   
-
 
Written options
Other assets
   
-
 
Other assets
   
-
 
Other liabilities
   
216
 
Other liabilities
   
122
 
Total derivatives
   
$
3,388
     
$
1,238
     
$
2,508
     
$
619
 
 
38

NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
(unaudited)

The effect of derivative financial instruments on the Condensed Consolidated Statements of Operations follows:

   
Gain (Loss) Recognized in Income
 
     
 Location of Gain (Loss) 
 
Three Month
Periods Ended
September 30,
   
Nine Month
Periods Ended
September 30,
 
 
 Recognized in Income
 
2016
   
2015
   
2016
   
2015
 
         
(In thousands)
 
No hedge designation
                           
Rate-lock mortgage loan commitments
 
Net gains on mortgage loans
 
$
264
   
$
281
   
$
613
   
$
386
 
Mandatory commitments to sell mortgage loans
 
Net gains on mortgage loans
   
94
     
(745
)
   
(352
)
   
(225
)
Pay-fixed interest rate swap agreements
 
Interest income
   
196
     
(452
)
   
(1,512
)
   
(492
)
Pay-variable interest rate swap agreements
 
Interest income
   
(196
)
   
452
     
1,512
     
492
 
Purchased options
 
Interest expense
   
13
     
126
     
94
     
126
 
Written options
 
Interest expense
   
(13
)
   
(126
)
   
(94
)
   
(126
)
Total
     
$
358
   
$
(464
)
 
$
261
   
$
161
 

8.
Intangible Assets

The following table summarizes intangible assets, net of amortization:

   
September 30, 2016
   
December 31, 2015
 
   
Gross
Carrying
Amount
   
Accumulated
Amortization
   
Gross
Carrying
Amount
   
Accumulated
Amortization
 
   
(In thousands)
 
                         
Amortized intangible assets - core deposits
 
$
6,118
   
$
4,099
   
$
6,118
   
$
3,838
 

Amortization of other intangibles has been estimated through 2021 and thereafter in the following table.

   
(In thousands)
 
       
Three months ending December 31, 2016
 
$
86
 
2017
   
346
 
2018
   
346
 
2019
   
346
 
2020
   
346
 
2021 and thereafter
   
549
 
Total
 
$
2,019
 
 
39

NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
(unaudited)

9.
Share Based Compensation

We maintain share based payment plans that include a non-employee director stock purchase plan and a long-term incentive plan that permits the issuance of share based compensation, including stock options and non-vested share awards. The long-term incentive plan, which is shareholder approved, permits the grant of additional share based awards for up to 0.2 million shares of common stock as of September 30, 2016.  The non-employee director stock purchase plan permits the issuance of additional share based payments for up to 0.2 million shares of common stock as of September 30, 2016. Share based awards and payments are measured at fair value at the date of grant and are expensed over the requisite service period. Common shares issued upon exercise of stock options come from currently authorized but unissued shares.

During each first quarter period of 2016 and 2015, pursuant to our long-term incentive plan, we granted 0.07 million shares of restricted stock and 0.03 million performance stock units (“PSU”) to certain officers.  The shares of restricted stock and PSUs cliff vest after a period of three years.  The performance feature of the PSUs is based on a comparison of our total shareholder return over the three year period starting on the grant date to the total shareholder return over that period for a banking index of our peers.  In addition, we issued 0.02 million PSUs and 0.01 million shares of restricted stock to certain officers and employees during the third quarter of 2016.  The PSUs cliff vest after four and five year periods and the restricted stock cliff vests after one and four year periods.

Our directors may elect to receive a portion of their quarterly cash retainer fees in the form of common stock (either on a current basis or on a deferred basis pursuant to the non-employee director stock purchase plan referenced above). Shares equal in value to that portion of each director’s fees that he or she has elected to receive in stock are issued each quarter and vest immediately.  We issued 0.006 million shares and 0.004 million shares to directors during the first nine months of 2016 and 2015, respectively and expensed their value during those same periods.

Total compensation expense recognized for grants pursuant to our long-term incentive plan was $0.3 million and $1.1 million during the three and nine month periods ended September 30, 2016, respectively, and was $0.4 million and $1.1 million during the same periods in 2015, respectively.  The corresponding tax benefit relating to this expense was $0.1 million and $0.4 million for the three and nine month periods ended September 30, 2016, respectively and $0.1 million and $0.4 million for the same periods in 2015. Total expense recognized for non-employee director share based payments was $0.03 million and $0.09 million during the three and nine month periods ended September 30, 2016, respectively, and was $0.02 million and $0.05 million during the same periods in 2015, respectively.  The corresponding tax benefit relating to this expense was $0.01 million and $0.03 million for the three and nine month periods ended September 30, 2016, respectively and $0.01 million and $0.02 million during the same respective periods in 2015.

At September 30, 2016, the total expected compensation cost related to non-vested stock options, restricted stock and PSUs not yet recognized was $2.2 million.  The weighted-average period over which this amount will be recognized is 2.2 years.
 
40

NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
(unaudited)

A summary of outstanding stock option grants and related transactions follows:

 
Number of
Shares
   
Average
Exercise
Price
   
Weighted-
Average
Remaining
Contractual
Term (Years)
   
Aggregated
Intrinsic
Value
 
                     
(In thousands)
 
Outstanding at January 1, 2016
   
235,596
   
$
4.94
             
Granted
   
-
                     
Exercised
   
(16,912
)
   
3.78
             
Forfeited
   
(664
)
   
6.42
             
Expired
   
(2,300
)
   
3.54
             
Outstanding at September 30, 2016
   
215,720
   
$
5.04
     
5.33
   
$
2,544
 
                                 
Vested and expected to vest at September 30, 2016
   
215,720
   
$
5.04
     
5.33
   
$
2,544
 
Exercisable at September 30, 2016
   
215,720
   
$
5.04
     
5.33
   
$
2,544
 

A summary of outstanding non-vested restricted stock, restricted stock units and PSUs and related transactions follows:

   
Number
of Shares
   
Weighted-
Average
Grant Date
Fair Value
 
Outstanding at January 1, 2016
   
261,981
   
$
11.29
 
Granted
   
121,660
     
15.05
 
Vested
   
(107,795
)
   
7.92
 
Forfeited
   
(4,924
)
   
13.24
 
Outstanding at September 30, 2016
   
270,922
   
$
14.28
 

Certain information regarding options exercised during the periods follows:

   
Three Months Ended
September 30,
   
Nine Months Ended
September 30,
 
   
2016
   
2015
   
2016
   
2015
 
                         
Intrinsic value
 
$
9
   
$
71
   
$
186
   
$
314
 
Cash proceeds received
 
$
5
   
$
23
   
$
64
   
$
105
 
Tax benefit realized
 
$
3
   
$
25
   
$
65
   
$
110
 
 
41

NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
(unaudited)

10.
Income Tax

Income tax expense was $3.0 million and $2.3 million during the three month periods ended September 30, 2016 and 2015, respectively and $7.5 million and $6.7 million during the nine months ended September 30, 2016 and 2015, respectively.   As described in note #2, we adopted ASU 2016-09, “Compensation – Stock Compensation (718) Improvements to Employee Share-Based Payment Accounting” during the second quarter of 2016 which now requires us to recognize for book purposes either income tax expense or benefit relating to excess deficiencies/benefits relating to share-based compensation.  Included in income tax expense for the three and nine month periods ended September 30, 2016 are tax benefits of zero and $0.3 million, respectively due to the vesting of certain share-based compensation grants and the exercise of stock options during the respective periods.

We assess whether a valuation allowance should be established against our deferred tax assets based on the consideration of all available evidence using a “more likely than not” standard.  The ultimate realization of this asset is primarily based on generating future income.  We concluded at both September 30, 2016 and 2015, that the realization of substantially all of our deferred tax assets continues to be more likely than not.

We did maintain a valuation allowance against our deferred tax assets of approximately $1.1 million at both September 30, 2016 and December 31, 2015. This valuation allowance on our deferred tax assets primarily relates to state income taxes at our Mepco segment.  In this instance, we determined that the future realization of these particular deferred tax assets was not more likely than not.  This conclusion was primarily based on the uncertainty of Mepco’s future earnings attributable to particular states (given the various apportionment criteria) and the significant reduction in the size of Mepco’s business.

At both September 30, 2016 and December 31, 2015, we had approximately $1.0 million, of gross unrecognized tax benefits.  We do not expect the total amount of unrecognized tax benefits to significantly increase or decrease during the balance of 2016.

11.
Regulatory Matters

Capital guidelines adopted by federal and state regulatory agencies and restrictions imposed by law limit the amount of cash dividends our Bank can pay to us. Under these guidelines, the amount of dividends that may be paid in any calendar year is limited to the Bank’s current year net profits, combined with the retained net profits of the preceding two years. Further, the Bank cannot pay a dividend at any time that it has negative undivided profits.  As of September 30, 2016, the Bank had positive undivided profits of $8.7 million.  We can request regulatory approval for a return of capital from the Bank to the parent company. During the first quarters of 2016 and 2015, we requested regulatory approval for returns of capital from the Bank to the parent company of  $18.0 million and $18.5 million, respectively.  These return of capital requests were approved by our banking regulators on February 24, 2016 and February 13, 2015, respectively and the Bank returned these amounts to the parent company on February 25, 2016 and February 17, 2015, respectively.  It is not our intent to have dividends paid in amounts that would reduce the capital of our Bank to levels below those which we consider prudent and in accordance with guidelines of regulatory authorities.
 
42

NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
(unaudited)

We are also subject to various regulatory capital requirements. The prompt corrective action regulations establish quantitative measures to ensure capital adequacy and require minimum amounts and ratios of total, Tier 1, and common equity Tier 1 capital to risk-weighted assets and Tier 1 capital to average assets. Failure to meet minimum capital requirements can result in certain mandatory, and possibly discretionary, actions by regulators that could have a material effect on our consolidated financial statements. Under capital adequacy guidelines, we must meet specific capital requirements that involve quantitative measures as well as qualitative judgments by the regulators. The most recent regulatory filings as of September 30, 2016 and December 31, 2015, categorized our Bank as well capitalized. Management is not aware of any conditions or events that would have changed the most recent Federal Deposit Insurance Corporation (“FDIC”) categorization.

On July 2, 2013, the Federal Reserve approved a final rule that establishes an integrated regulatory capital framework (the “New Capital Rules”). The rule implements in the United States the Basel III regulatory capital reforms from the Basel Committee on Banking Supervision and certain changes required by the Dodd-Frank Act.  In general, under the New Capital Rules, minimum requirements have increased for both the quantity and quality of capital held by banking organizations. Consistent with the international Basel framework, the New Capital Rules include a new minimum ratio of common equity Tier 1 capital to risk-weighted assets of 4.5% and a common equity Tier 1 capital conservation buffer of 2.5% of risk-weighted assets that applies to all supervised financial institutions.  The capital conservation buffer began to phase in on January 1, 2016 with 0.625% added to the minimum ratio for adequately capitalized institutions for 2016.  To avoid limits on capital distributions and certain discretionary bonus payments we must meet the minimum ratio for adequately capitalized institutions plus the phased in buffer.  The rule also raises the minimum ratio of Tier 1 capital to risk-weighted assets from 4% to 6% and includes a minimum leverage ratio of 4% for all banking organizations.  As to the quality of capital, the New Capital Rules emphasize common equity Tier 1 capital, the most loss-absorbing form of capital, and implement strict eligibility criteria for regulatory capital instruments. The New Capital Rules also change the methodology for calculating risk-weighted assets to enhance risk sensitivity.  The New Capital Rules became effective for us on January 1, 2015.
 
43

NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
(unaudited)

Our actual capital amounts and ratios follow:

   
Actual
   
Minimum for
Adequately Capitalized
Institutions
   
Minimum for
Well-Capitalized
Institutions
 
   
Amount
   
Ratio
   
Amount
   
Ratio
   
Amount
   
Ratio
 
   
(Dollars in thousands)
 
                                     
September 30, 2016
                                   
Total capital to risk-weighted assets
                                   
Consolidated
 
$
281,310
     
16.05
%
 
$
140,243
     
8.00
%
 
NA
   
NA
 
Independent Bank
   
269,578
     
15.39
     
140,116
     
8.00
     
175,145
     
10.00
%
                                                 
Tier 1 capital to risk-weighted assets
                                               
Consolidated
 
$
259,279
     
14.79
%
 
$
105,182
     
6.00
%
 
NA
   
NA
 
Independent Bank
   
247,615
     
14.14
     
105,087
     
6.00
     
140,116
     
8.00
%
                                                 
Common equity tier 1 capital to risk-weighted assets
                                               
Consolidated
 
$
233,631
     
13.33
%
 
$
78,886
     
4.50
%
 
NA
   
NA
 
Independent Bank
   
247,615
     
14.14
     
78,815
     
4.50
     
113,844
     
6.50
%
                                                 
Tier 1 capital to average assets
                                               
Consolidated
 
$
259,279
     
10.56
%
 
$
98,174
     
4.00
%
 
NA
   
NA
 
Independent Bank
   
247,615
     
10.09
     
98,116
     
4.00
     
122,645
     
5.00
%
                                                 
December 31, 2015
                                               
Total capital to risk-weighted assets
                                               
Consolidated
 
$
278,170
     
16.65
%
 
$
133,668
     
8.00
%
 
NA
   
NA
 
Independent Bank
   
261,894
     
15.69
     
133,514
     
8.00
   
$
166,893
     
10.00
%
                                                 
Tier 1 capital to risk-weighted assets
                                               
Consolidated
 
$
257,050
     
15.38
%
 
$
100,251
     
6.00
%
 
NA
   
NA
 
Independent Bank
   
240,867
     
14.43
     
100,136
     
6.00
   
$
133,514
     
8.00
%
                                                 
Common equity tier 1 capital to risk-weighted assets
                                               
Consolidated
 
$
239,271
     
14.32
%
 
$
75,188
     
4.50
%
 
NA
   
NA
 
Independent Bank
   
240,867
     
14.43
     
75,102
     
4.50
   
$
108,480
     
6.50
%
                                                 
Tier 1 capital to average assets
                                               
Consolidated
 
$
257,050
     
10.91
%
 
$
94,217
     
4.00
%
 
NA
   
NA
 
Independent Bank
   
240,867
     
10.23
     
94,145
     
4.00
   
$
117,682
     
5.00
%
 

NA - Not applicable
 
44

NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
(unaudited)

The components of our regulatory capital are as follows:

   
Consolidated
   
Independent Bank
 
   
September 30,
2016
   
December 31,
2015
   
September 30,
2016
   
December 31,
2015
 
   
(In thousands)
 
Total shareholders' equity
 
$
250,902
   
$
251,092
   
$
263,762
   
$
259,947
 
Add (deduct)
                               
Accumulated other comprehensive (income) loss for regulatory purposes
   
(2,783
)
   
238
     
(2,782
)
   
238
 
Intangible assets
   
(1,211
)
   
(912
)
   
(1,211
)
   
(912
)
Disallowed deferred tax assets
   
(13,277
)
   
(11,147
)
   
(12,154
)
   
(18,406
)
Common equity tier 1 capital
   
233,631
     
239,271
     
247,615
     
240,867
 
Qualifying trust preferred securities
   
34,500
     
34,500
     
-
     
-
 
Disallowed deferred tax assets
   
(8,852
)
   
(16,721
)
   
-
     
-
 
Tier 1 capital
   
259,279
     
257,050
     
247,615
     
240,867
 
Allowance for loan losses and allowance for unfunded lending commitments limited to 1.25% of total risk-weighted assets
   
22,031
     
21,120
     
21,963
     
21,027
 
Total risk-based capital
 
$
281,310
   
$
278,170
   
$
269,578
   
$
261,894
 

12.
Fair Value Disclosures

FASB ASC topic 820 defines fair value as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. FASB ASC topic 820 also establishes 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: Valuation is based upon quoted prices for identical instruments traded in active markets. Level 1 instruments include securities traded on active exchange markets, such as the New York Stock Exchange, as well as U.S. Treasury securities that are traded by dealers or brokers in active over-the-counter markets.

Level 2:  Valuation is based upon quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active, and model-based valuation techniques for which all significant assumptions are observable in the market. Level 2 instruments include securities traded in less active dealer or broker markets.

Level 3:  Valuation is generated from model-based techniques that use at least one significant assumption not observable in the market. These unobservable assumptions reflect estimates of assumptions that market participants would use in pricing the asset or liability. Valuation techniques include use of option pricing models, discounted cash flow models and similar techniques.
 
45

NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
(unaudited)

We used the following methods and significant assumptions to estimate fair value:

Securities:  Where quoted market prices are available in an active market, securities (trading or available for sale) are classified as Level 1 of the valuation hierarchy.  Level 1 securities include certain preferred stocks included in our trading portfolio for which there are quoted prices in active markets.  If quoted market prices are not available for the specific security, then fair values are estimated by (1) using quoted market prices of securities with similar characteristics, (2) matrix pricing, which is a mathematical technique used widely in the industry to value debt securities without relying exclusively on quoted prices for specific securities but rather by relying on the securities’ relationship to other benchmark quoted prices, or (3) a discounted cash flow analysis whose significant fair value inputs can generally be verified and do not typically involve judgment by management. These securities are classified as Level 2 of the valuation hierarchy and primarily include agency securities, private label mortgage-backed securities, other asset backed securities, municipal securities, trust preferred securities, corporate securities and foreign government securities.

Loans held for sale:  The fair value of mortgage loans held for sale is based on mortgage backed security pricing for comparable assets (recurring Level 2).
 
Impaired loans with specific loss allocations based on collateral valueFrom time to time, certain loans are considered impaired and an allowance for loan losses is established. Loans for which it is probable that payment of interest and principal will not be made in accordance with the contractual terms of the loan agreement are considered impaired. We measure our investment in an impaired loan based on one of three methods: the loan’s observable market price, the fair value of the collateral or the present value of expected future cash flows discounted at the loan’s effective interest rate. Those impaired loans not requiring an allowance represent loans for which the fair value of the expected repayments or collateral exceed the recorded investments in such loans. At September 30, 2016 and December 31, 2015, all of our impaired loans were evaluated based on either the fair value of the collateral or the present value of expected future cash flows discounted at the loan’s effective interest rate. When the fair value of the collateral is based on an appraised value or when an appraised value is not available we record the impaired loan as nonrecurring Level 3.  These appraisals may utilize a single valuation approach or a combination of approaches including comparable sales and the income approach. Adjustments are routinely made in the appraisal process by the independent appraisers to adjust for differences between the comparable sales and income data available. Such adjustments can be significant and thus will typically result in a Level 3 classification of the inputs for determining fair value.

Other real estate:  At the time of acquisition, other real estate is recorded at fair value, less estimated costs to sell, which becomes the property’s new basis. Subsequent write-downs to reflect declines in value since the time of acquisition may occur from time to time and are recorded in net (gains) losses on other real estate and repossessed assets in the Condensed Consolidated Statements of Operations. The fair value of the property used at and subsequent to the time of acquisition is typically determined by a third party appraisal of the property.  These appraisals may utilize a single valuation approach or a combination of approaches including comparable sales and the income approach. Adjustments are routinely made in the appraisal process by the independent appraisers to adjust for differences between the comparable sales and income data available. Such adjustments can be significant and typically result in a Level 3 classification of the inputs for determining fair value.
 
46

NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
(unaudited)

Appraisals for both collateral-dependent impaired loans and other real estate are performed by certified general appraisers (for commercial properties) or certified residential appraisers (for residential properties) whose qualifications and licenses have been reviewed and verified by us.  Once received, an independent third party (for commercial properties over $0.25 million) or a member of our Collateral Evaluation Department (for commercial properties under $0.25 million) or a member of our Special Assets Group (for retail properties) reviews the assumptions and approaches utilized in the appraisal as well as the overall resulting fair value in comparison with independent data sources such as recent market data or industry-wide statistics.   We compare the actual selling price of collateral that has been sold to the most recent appraised value of our properties to determine what additional adjustment, if any, should be made to the appraisal value to arrive at fair value.  For commercial and retail properties we typically discount an appraisal to account for various factors that the appraisal excludes in its assumptions.  These additional discounts generally do not result in material adjustments to the appraised value.

Capitalized mortgage loan servicing rights:  The fair value of capitalized mortgage loan servicing rights is based on a valuation model used by an independent third party that calculates the present value of estimated net servicing income. The valuation model incorporates assumptions that market participants would use in estimating future net servicing income. Certain model assumptions are generally unobservable and are based upon the best information available including data relating to our own servicing portfolio, reviews of mortgage servicing assumption and valuation surveys and input from various mortgage servicers and, therefore, are recorded as nonrecurring Level 3.  Management evaluates the third party valuation for reasonableness each quarter as part of our financial reporting control processes.

Derivatives:  The fair value of rate-lock mortgage loan commitments and mandatory commitments to sell mortgage loans is based on mortgage backed security pricing for comparable assets (recurring Level 2).  The fair value of interest rate swap agreements is based on a discounted cash flow analysis whose significant fair value inputs can generally be observed in the market place and do not typically involve judgment by management (recurring Level 2).  The fair value of purchased and written options is based on prices of financial instruments with similar characteristics and do not typically involve judgment by management (recurring Level 2).
 
47

NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
(unaudited)

Assets and liabilities measured at fair value, including financial assets for which we have elected the fair value option, were as follows:

         
Fair Value Measurements Using
 
   
Fair Value
Measure-
ments
   
Quoted
Prices
in Active
Markets
for
Identical
Assets
(Level 1)
   
Significant
Other
Observable
Inputs
(Level 2)
   
Significant
Un-
observable
Inputs
(Level 3)
 
   
(In thousands)
 
September 30, 2016:
                       
Measured at Fair Value on a Recurring Basis:
                       
Assets
                       
Trading securities
 
$
152
   
$
152
   
$
-
   
$
-
 
Securities available for sale
                               
U.S. agency
   
29,949
     
-
     
29,949
     
-
 
U.S. agency residential mortgage-backed
   
169,958
     
-
     
169,958
     
-
 
U.S. agency commercial mortgage-backed
   
13,892
     
-
     
13,892
     
-
 
Private label mortgage-backed
   
33,578
     
-
     
33,578
     
-
 
Other asset backed
   
142,188
     
-
     
142,188
     
-
 
Obligations of states and political subdivisions
   
157,989
     
-
     
157,989
     
-
 
Corporate
   
51,455
     
-
     
51,455
     
-
 
Trust preferred
   
2,450
     
-
     
2,450
     
-
 
Foreign government
   
1,653
     
-
     
1,653
     
-
 
Loans held for sale
   
38,008
     
-
     
38,008
     
-
 
Derivatives (1)
   
3,388
     
-
     
3,388
     
-
 
Liabilities
                               
Derivatives (2)
   
2,508
     
-
     
2,508
     
-
 
                                 
Measured at Fair Value on a Non-recurring basis:
                               
Assets
                               
Capitalized mortgage loan servicing rights (3)
   
10,678
     
-
     
-
     
10,678
 
Impaired loans (4)
                               
Commercial
                               
Income producing - real estate
   
262
     
-
     
-
     
262
 
Land, land development & construction-real estate
   
172
     
-
     
-
     
172
 
Commercial and industrial
   
1,558
     
-
     
-
     
1,558
 
Mortgage
                               
1-4 Family
   
368
     
-
     
-
     
368
 
Other real estate (5)
                               
Commercial
                               
Income producing - real estate (6)
   
2,963
     
-
     
2,963
     
-
 
Land, land development & construction-real estate
   
176
     
-
     
-
     
176
 
Mortgage
                               
1-4 Family
   
25
     
-
     
-
     
25
 
Resort lending
   
30
     
-
     
-
     
30
 

(1)
Included in accrued income and other assets
(2)
Included in accrued expenses and other liabilities
(3)
Only includes servicing rights that are carried at fair value due to recognition of a valuation allowance.
(4)
Only includes impaired loans with specific loss allocations based on collateral value.
(5)
Only includes other real estate with subsequent write downs to fair value.
(6)
Level 2 valuation is based on sales price at an auction subsequent to September 30, 2016.
 
48

NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
(unaudited)

         
Fair Value Measurements Using
 
   
Fair Value
Measure-
ments
   
Quoted
Prices
in Active
Markets
for
Identical
Assets
(Level 1)
   
Significant
Other
Observable
Inputs
(Level 2)
   
Significant
Un-
observable
Inputs
(Level 3)
 
   
(In thousands)
 
December 31, 2015:
                       
Measured at Fair Value on a Recurring Basis:
                       
Assets
                       
Trading securities
 
$
148
   
$
148
   
$
-
   
$
-
 
Securities available for sale
                               
U.S. agency
   
47,512
     
-
     
47,512
     
-
 
U.S. agency residential mortgage-backed
   
196,056
     
-
     
196,056
     
-
 
U.S. agency commercial mortgage-backed
   
34,028
     
-
     
34,028
     
-
 
Private label mortgage-backed
   
4,903
     
-
     
4,903
     
-
 
Other asset backed
   
116,904
     
-
     
116,904
     
-
 
Obligations of states and political subdivisions
   
144,984
     
-
     
144,984
     
-
 
Corporate
   
38,614
     
-
     
38,614
     
-
 
Trust preferred
   
2,483
     
-
     
2,483
     
-
 
Loans held for sale
   
27,866
     
-
     
27,866
     
-
 
Derivatives (1)
   
1,238
     
-
     
1,238
     
-
 
Liabilities
                               
Derivatives (2)
   
619
     
-
     
619
     
-
 
                                 
Measured at Fair Value on a Non-recurring basis:
                               
Assets
                               
Capitalized mortgage loan servicing rights (3)
   
8,481
     
-
     
-
     
8,481
 
Impaired loans (4)
                               
Commercial
                               
Income producing - real estate
   
711
     
-
     
-
     
711
 
Land, land development & construction-real estate
   
40
     
-
     
-
     
40
 
Commercial and industrial
   
1,257
     
-
     
-
     
1,257
 
Mortgage
                               
1-4 Family
   
421
     
-
     
-
     
421
 
Resort lending
   
129
     
-
     
-
     
129
 
Other real estate (5)
                               
Commercial
                               
Land, land development & construction-real estate
   
639
     
-
     
-
     
639
 
Commercial and industrial
   
165
     
-
     
-
     
165
 
Mortgage
                               
1-4 Family
   
26
     
-
     
-
     
26
 
Resort lending
   
107
     
-
     
-
     
107
 
Home equity - 1st lien
   
14
     
-
     
-
     
14
 
Installment
                               
Home equity - 1st lien
   
36
     
-
     
-
     
36
 

(1)
Included in accrued income and other assets
(2)
Included in accrued expenses and other liabilities
(3)
Only includes servicing rights that are carried at fair value due to recognition of a valuation allowance.
(4)
Only includes impaired loans with specific loss allocations based on collateral value.
(5)
Only includes other real estate with subsequent write downs to fair value.

There were no transfers between Level 1 and Level 2 during the nine months ended September 30, 2016 and 2015.
 
49

NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
(unaudited)

Changes in fair values for financial assets which we have elected the fair value option for the periods presented were as follows:

   
Changes in Fair Values for the Nine-Month
Periods Ended September 30 for Items Measured at
Fair Value Pursuant to Election of the Fair Value Option
 
   
2016
   
2015
 
   
Net Gains (Losses)
on Assets
   
Total
Change
in Fair
Values
Included
in Current
Period
   
Net Gains (Losses)
on Assets
   
Total
Change
in Fair
Values
Included
in Current
Period
 
   
Securities
   
Loans
   
Earnings
   
Securities
   
Loans
   
Earnings
 
 
(In thousands)
 
Trading securities
 
$
4
   
$
-
   
$
4
   
$
22
   
$
-
   
$
22
 
Loans held for sale
   
-
     
612
     
612
     
-
     
311
     
311
 

For those items measured at fair value pursuant to our election of the fair value option, interest income is recorded within the Condensed Consolidated Statements of Operations based on the contractual amount of interest income earned on these financial assets and dividend income is recorded based on cash dividends received.

The following represent impairment charges recognized during the three and nine month periods ended September 30, 2016 and 2015 relating to assets measured at fair value on a non-recurring basis:
 
Capitalized mortgage loan servicing rights, whose individual strata are measured at fair value, had a carrying amount of $10.7 million which is net of a valuation allowance of $4.7 million at September 30, 2016 and had a carrying amount of $8.5 million which is net of a valuation allowance of $3.3 million at December 31, 2015.  A recovery (charge) of $0.6 million and $(1.5) million was included in our results of operations for the three and nine month periods ending September 30, 2016, respectively and $(0.9) million and $(0.3) million during the same periods in 2015.
Loans which are measured for impairment using the fair value of collateral for collateral dependent loans, had a carrying amount of $4.4 million, with a valuation allowance of $2.0 million at September 30, 2016 and had a carrying amount of $5.1 million, with a valuation allowance of $2.5 million at December 31, 2015.  The provision for loan losses included in our results of operations relating to impaired loans was a net expense of $0.1 million and $1.0 million for the three month periods ending September 30, 2016 and 2015, respectively, and a net expense of $0.3 million and $1.9 million for the nine month periods ending September 30, 2016 and 2015, respectively.
Other real estate, which is measured using the fair value of the property, had a carrying amount of $3.2 million which is net of a valuation allowance of $0.6 million at September 30, 2016 and a carrying amount of $1.0 million which is net of a valuation allowance of $1.7 million at December 31, 2015.  An additional charge relating to other real estate measured at fair value of $0.37 million and $0.41 million was included in our results of operations during the three and nine month periods ended September 30, 2016, respectively and $0.03 million and $0.30 million during the same periods in 2015.

We had no assets or liabilities measured at fair value on a recurring basis that used significant unobservable inputs (Level 3) during the nine months ended September 30, 2016 and 2015.
 
50

NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
(unaudited)

Quantitative information about Level 3 fair value measurements measured on a non-recurring basis follows:

   
Asset
Fair
Value
 
Valuation
Technique
 
Unobservable
Inputs
 
Weighted
Average
 
   
(In thousands)
         
September 30, 2016
                 
Capitalized mortgage loan servicing rights
 
$
10,678
 
Present value of net servicing revenue
 
Discount rate
   
10.06
%
           
Cost to service
 
$
82
 
               
Ancillary income
   
24
 
               
Float rate
   
1.18
%
Impaired loans
               
Commercial (1)
   
1,787
 
Sales comparison approach
 
Adjustment for differences between comparable sales
   
(2.4
)%
Mortgage
   
368
 
Sales comparison approach
 
Adjustment for differences between comparable sales
   
(10.2
)
Other real estate
               
Commercial
   
176
 
Sales comparison approach
 
Adjustment for differences between comparable sales
   
(22.5
)
Mortgage and installment
   
55
 
Sales comparison approach
 
Adjustment for differences between comparable sales
   
4.6
 
                       
December 31, 2015
                     
Capitalized mortgage loan servicing rights
 
$
8,481
 
Present value of net servicing revenue
 
Discount rate
   
10.04
%
           
Cost to service
 
$
80
 
               
Ancillary income
   
24
 
               
Float rate
   
1.73
%
Impaired loans
                     
 
Commercial (1)
   
1,605
 
Sales comparison approach
 
Adjustment for differences between comparable sales
   
(2.1
)%
         
Income approach
  Capitalization rate    
9.3
 
Mortgage
   
550
 
Sales comparison approach
 
Adjustment for differences between comparable sales
   
0.7
 
Other real estate
               
Commercial
   
804
 
Sales comparison approach
 
Adjustment for differences between comparable sales
   
(3.9
)
Mortgage and installment
   
183
 
Sales comparison approach
 
Adjustment for differences between comparable sales
   
75.6
 
 

(1)
In addition to the valuation techniques and unobservable inputs discussed above, at September 30, 2016 and December 31, 2015, we had an impaired collateral dependent commercial relationship that totaled $0.2 million and $0.4 million, respectively that was primarily secured by collateral other than real estate.  Collateral securing this relationship primarily included machinery and equipment and inventory at September 30, 2016 and December 31, 2015.  Valuation techniques at September 30, 2016 and December 31, 2015, included appraisals and discounting restructuring firm valuations based on estimates of value recovery of each particular asset type.  Discount rates used ranged from 0% to 100% of stated values.
 
51

NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
(unaudited)

The following table reflects the difference between the aggregate fair value and the aggregate remaining contractual principal balance outstanding for loans held for sale for which the fair value option has been elected for the periods presented.

   
Aggregate
Fair Value
   
Difference
   
Contractual
Principal
 
   
(In thousands)
 
Loans held for sale
                 
September 30, 2016
 
$
38,008
   
$
1,326
   
$
36,682
 
December 31, 2015
   
27,866
     
714
     
27,152
 

13.
Fair Values of Financial Instruments

Most of our assets and liabilities are considered financial instruments. Many of these financial instruments lack an available trading market and it is our general practice and intent to hold the majority of our financial instruments to maturity. Significant estimates and assumptions were used to determine the fair value of financial instruments. These estimates are subjective in nature, involving uncertainties and matters of judgment, and therefore, fair values may not be a precise estimate. Changes in assumptions could significantly affect the estimates.

Estimated fair values have been determined using available data and methodologies that are considered suitable for each category of financial instrument. For instruments with adjustable interest rates which reprice frequently and without significant credit risk, it is presumed that estimated fair values approximate the recorded book balances.

Cash and due from banks and interest bearing deposits:  The recorded book balance of cash and due from banks and interest bearing deposits approximate fair value and are classified as Level 1.

Interest bearing deposits - time:  Interest bearing deposits - time have been valued based on a model using a benchmark yield curve plus a base spread and are classified as Level 2.

Securities:  Financial instrument assets actively traded in a secondary market have been valued using quoted market prices.  Trading securities are classified as Level 1 while securities available for sale are classified as Level 2 as described in Note #12.

Federal Home Loan Bank and Federal Reserve Bank Stock:  It is not practicable to determine the fair value of FHLB and FRB Stock due to restrictions placed on transferability.

Net loans and loans held for sale:  The fair value of loans is calculated by discounting estimated future cash flows using estimated market discount rates that reflect credit and interest-rate risk inherent in the loans and do not necessarily represent an exit price.  Loans are classified as Level 3.  Impaired loans are valued at the lower of cost or fair value as described in Note #12.  Loans held for sale are classified as Level 2 as described in Note #12.

Accrued interest receivable and payable:  The recorded book balance of accrued interest receivable and payable approximate fair value and are classified at the same Level as the asset and liability they are associated with.
 
52

NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
(unaudited)

Derivative financial instruments:  The fair value of rate-lock mortgage loan commitments and mandatory commitments to sell mortgage loans is based on mortgage backed security pricing for comparable assets, the fair value of interest rate swap agreements is based on a discounted cash flow analysis whose significant fair value inputs can generally be observed in the market place and do not typically involve judgment by management and the fair value of purchased and written options is based on prices of financial instruments with similar characteristics and do not typically involve judgment by management. Each of these instruments has been classified as Level 2 as described in Note #12.

Deposits:  Deposits without a stated maturity, including demand deposits, savings, NOW and money market accounts, have a fair value equal to the amount payable on demand.  Each of these instruments is classified as Level 1.  Deposits with a stated maturity, such as certificates of deposit have generally been valued based on the discounted value of contractual cash flows using a discount rate approximating current market rates for liabilities with a similar maturity resulting in a Level 2 classification.

Other borrowings:  Other borrowings have been valued based on the discounted value of contractual cash flows using a discount rate approximating current market rates for liabilities with a similar maturity resulting in a Level 2 classification.

Subordinated debentures:  Subordinated debentures have generally been valued based on a quoted market price of similar instruments resulting in a Level 2 classification.
 
53

NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
(unaudited)

The estimated recorded book balances and fair values follow:

               
Fair Value Using
 
   
Recorded
Book
Balance
   
Fair Value
   
Quoted
Prices
in Active
Markets
for
Identical
Assets
(Level 1)
   
Significant
Other
Observable
Inputs
(Level 2)
   
Significant
Un-
observable
Inputs
(Level 3)
 
   
(In thousands)
 
September 30, 2016
                             
Assets
                             
Cash and due from banks
 
$
38,610
   
$
38,610
   
$
38,610
   
$
-
   
$
-
 
Interest bearing deposits
   
75,706
     
75,706
     
75,706
     
-
     
-
 
Interest bearing deposits - time
   
7,233
     
7,272
     
-
     
7,272
     
-
 
Trading securities
   
152
     
152
     
152
     
-
     
-
 
Securities available for sale
   
603,112
     
603,112
     
-
     
603,112
     
-
 
Federal Home Loan Bank and Federal
                                       
Reserve Bank Stock
   
15,507
   
NA
   
NA
   
NA
   
NA
 
Net loans and loans held for sale
   
1,623,319
     
1,601,113
     
-
     
38,008
     
1,563,105
 
Accrued interest receivable
   
6,973
     
6,973
     
2
     
2,438
     
4,533
 
Derivative financial instruments
   
3,388
     
3,388
     
-
     
3,388
     
-
 
                                         
Liabilities
                                       
Deposits with no stated maturity (1)
 
$
1,743,864
   
$
1,743,864
   
$
1,743,864
   
$
-
   
$
-
 
Deposits with stated maturity (1)
   
463,096
     
462,297
     
-
     
462,297
     
-
 
Other borrowings
   
11,527
     
12,702
     
-
     
12,702
     
-
 
Subordinated debentures
   
35,569
     
22,223
     
-
     
22,223
     
-
 
Accrued interest payable
   
630
     
630
     
17
     
613
     
-
 
Derivative financial instruments
   
2,508
     
2,508
     
-
     
2,508
     
-
 
                                         
December 31, 2015
                                       
Assets
                                       
Cash and due from banks
 
$
54,260
   
$
54,260
   
$
54,260
   
$
-
   
$
-
 
Interest bearing deposits
   
31,523
     
31,523
     
31,523
     
-
     
-
 
Interest bearing deposits - time
   
11,866
     
11,858
     
-
     
11,858
     
-
 
Trading securities
   
148
     
148
     
148
     
-
     
-
 
Securities available for sale
   
585,484
     
585,484
     
-
     
585,484
     
-
 
Federal Home Loan Bank and Federal
                                       
Reserve Bank Stock
   
15,471
   
NA
   
NA
   
NA
   
NA
 
Net loans and loans held for sale
   
1,520,346
     
1,472,613
     
-
     
27,866
     
1,444,747
 
Accrued interest receivable
   
6,565
     
6,565
     
5
     
1,969
     
4,591
 
Derivative financial instruments
   
1,238
     
1,238
     
-
     
1,238
     
-
 
                                         
Liabilities
                                       
Deposits with no stated maturity (1)
 
$
1,659,743
   
$
1,659,743
   
$
1,659,743
   
$
-
   
$
-
 
Deposits with stated maturity (1)
   
426,220
     
423,776
     
-
     
423,776
     
-
 
Other borrowings
   
11,954
     
13,448
     
-
     
13,448
     
-
 
Subordinated debentures
   
35,569
     
23,069
     
-
     
23,069
     
-
 
Accrued interest payable
   
466
     
466
     
21
     
445
     
-
 
Derivative financial instruments
   
619
     
619
     
-
     
619
     
-
 

(1)
Deposits with no stated maturity include reciprocal deposits with a recorded book balance of $9.3 million and $11.8 million at September 30, 2016 and December 31, 2015, respectively.  Deposits with a stated maturity include reciprocal deposits with a recorded book balance of $37.3 million and $38.4 million at September 30, 2016 and December 31, 2015, respectively.

The fair values for commitments to extend credit and standby letters of credit are estimated to approximate their aggregate book balance, which is nominal and therefore are not disclosed.
 
54

NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
(unaudited)

Fair value estimates are made at a specific point in time, based on relevant market information and information about the financial instrument. These estimates do not reflect any premium or discount that could result from offering for sale the entire holdings of a particular financial instrument.

Fair value estimates are based on existing on- and off-balance sheet financial instruments without attempting to estimate the value of anticipated future business, the value of future earnings attributable to off-balance sheet activities and the value of assets and liabilities that are not considered financial instruments.

Fair value estimates for deposit accounts do not include the value of the core deposit intangible asset resulting from the low-cost funding provided by the deposit liabilities compared to the cost of borrowing funds in the market.

14.
Contingent Liabilities

We are involved in various litigation matters in the ordinary course of business. At the present time, we do not believe any of these matters will have a significant impact on our consolidated financial position or results of operations. The aggregate amount we have accrued for losses we consider probable as a result of these litigation matters is immaterial. However, because of the inherent uncertainty of outcomes from any litigation matter, we believe it is reasonably possible we may incur losses in addition to the amounts we have accrued. At this time, we estimate the maximum amount of additional losses that are reasonably possible is approximately $1.0 million. However, because of a number of factors, including the fact that certain of these litigation matters are still in their early stages, this maximum amount may change in the future.

The litigation matters described in the preceding paragraph primarily include claims that have been brought against us for damages, but do not include litigation matters where we seek to collect amounts owed to us by third parties (such as litigation initiated to collect delinquent loans or vehicle service contract counterparty receivables). These excluded, collection-related matters may involve claims or counterclaims by the opposing party or parties, but we have excluded such matters from the disclosure contained in the preceding paragraph in all cases where we believe the possibility of us paying damages to any opposing party is remote. Risks associated with the likelihood that we will not collect the full amount owed to us, net of reserves, are disclosed elsewhere in this report.

Our Mepco segment conducts its payment plan business activities across the United States. Mepco acquires the payment plans from companies (which we refer to as Mepco’s “counterparties”) at a discount from the face amount of the payment plan. Each payment plan (which are classified as payment plan receivables in our Condensed Consolidated Statements of Financial Condition) permits a consumer to purchase a vehicle service contract by making installment payments, generally for a term of 12 to 30 months, to the sellers of those contracts (one of the “counterparties”). Mepco thereafter collects the payments from consumers. In acquiring the payment plan, Mepco generally funds a portion of the cost to the seller of the service contract and a portion of the cost to the administrator of the service contract. The administrator, in turn, pays the necessary contractual liability insurance policy (“CLIP”) premium to the insurer or risk retention group.
 
55

NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
(unaudited)

Consumers are allowed to voluntarily cancel the service contract at any time and are generally entitled to receive a refund from the administrator of the unearned portion of the service contract at the time of cancellation. As a result, while Mepco does not owe any refund to the consumer, it also does not have any recourse against the consumer for nonpayment of a payment plan and therefore does not evaluate the creditworthiness of the individual consumer. If a consumer stops making payments on a payment plan or exercises the right to voluntarily cancel the service contract, the service contract seller and administrator are each obligated to refund to Mepco the amount necessary to make Mepco whole as a result of its funding of the service contract. In addition, the insurer or risk retention group that issued the CLIP for the service contract often guarantees all or a portion of the refund to Mepco. See Note #4 above for a breakdown of Mepco’s payment plan receivables by the level of recourse Mepco has against various counterparties.

Upon the cancellation of a service contract and the completion of the billing process to the counterparties for amounts due to Mepco, there is a decrease in the amount of “payment plan receivables” and an increase in the amount of “vehicle service contract counterparty receivables” until such time as the amount due from the counterparty is collected. These amounts represent funds actually due to Mepco from its counterparties for cancelled service contracts. Mepco is currently in the process of working to recover these receivables, primarily through negotiated settlements with the counterparties.  In some cases, Mepco requires collateral or guaranties by the principals of the counterparties to secure these refund obligations; however, this is generally only the case when no insurance company is involved to guarantee the repayment obligation of the seller and administrator counterparties. In most cases, there is no collateral to secure the counterparties’ refund obligations to Mepco, but Mepco has the contractual right to offset unpaid refund obligations against amounts Mepco would otherwise be obligated to fund to the counterparties. In addition, even when collateral is involved, the refund obligations of these counterparties are not fully secured. Mepco incurs losses when it is unable to fully recover funds owed to it by counterparties upon cancellation of the underlying service contracts. The sudden failure of one of Mepco’s major counterparties (an insurance company, administrator, or seller/dealer) could expose us to significant losses.

When counterparties do not honor their contractual obligations to Mepco to repay funds, we recognize estimated losses. Mepco pursues collection (including commencing legal action if necessary) of funds due to it under its various contracts with counterparties.  Mepco has had to initiate litigation against certain counterparties, including third party insurers, to collect amounts owed to Mepco as a result of those parties' dispute of their contractual obligations to Mepco.  During the first quarter of 2016, we settled our last significant remaining litigation matter with certain of Mepco’s counterparties.  This settlement resulted in our receipt of a cash payment of $4.0 million on March 31, 2016.  This settlement also resulted in our receipt of an interest-bearing promissory note from one of Mepco’s counterparties for $1.5 million with monthly payments scheduled over a five-year period beginning in May 2016.  Due to the lack of any payment history and limited financial information on this counterparty, we established a full reserve on this promissory note as of March 31, 2016.  A full reserve on the remaining balance ($1.39 million) on this note was maintained at September 30, 2016.   This counterparty has made the first six required monthly payments on the note.  As a longer-term payment history is developed on this note, we will continue to evaluate the need for all or any part of a reserve. Vehicle service contract counterparty receivables, net totaled $2.6 million as of September 30, 2016 compared to $7.2 million as of December 31, 2015.  Expense/(credit) related to vehicle service contract counterparty contingencies included in non-interest expense totaled $(0.039) million and $0.030 million for the three month periods ended September 30, 2016 and 2015, respectively and totaled $(0.010) million and $0.089 million for the nine month periods ended September 30, 2016 and 2015, respectively.  These charges (recoveries) are being classified in non-interest expense because they are associated with a default or potential default of a contractual obligation under our counterparty contracts as opposed to loss on the administration of the payment plan itself.
 
56

NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
(unaudited)
 
Our estimate of probable incurred losses from vehicle service contract counterparty contingencies requires a significant amount of judgment because a number of factors can influence the amount of loss that we may ultimately incur. These factors include our estimate of future cancellations of vehicle service contracts, our evaluation of collateral that may be available to recover funds due from our counterparties, and our assessment of the amount that may ultimately be collected from counterparties in connection with their contractual obligations.  We apply a rigorous process, based upon historical payment plan activity and past experience, to estimate probable incurred losses and quantify the necessary reserves for our vehicle service contract counterparty contingencies, but there can be no assurance that our modeling process will successfully identify all such losses.

We believe our assumptions regarding the collection of vehicle service contract counterparty receivables are reasonable, and we based them on our good faith judgments using data currently available. We also believe the current amount of reserves we have established and the vehicle service contract counterparty contingencies expense that we have recorded are appropriate given our estimate of probable incurred losses at the applicable Condensed Consolidated Statement of Financial Condition date. However, because of the uncertainty surrounding the numerous and complex assumptions made, actual losses could exceed the charges we have taken to date.

The provision for loss reimbursement on sold loans represents our estimate of incurred losses related to mortgage loans that we have sold to investors (primarily Fannie Mae, Freddie Mac and Ginnie Mae). Since we sell mortgage loans without recourse, loss reimbursements only occur in those instances where we have breached a representation or warranty or other contractual requirement related to the loan sale.  The provision for loss reimbursement on sold loans was an expense (credit) of $0.05 million and $(0.04) million for the three months ended September 30, 2016 and 2015, respectively and $0.03 million and $(0.06) million for the nine month periods ended September 30, 2016 and 2015, respectively.  The small expenses in 2016 are primarily due to establishing specific reserves for pending loss reimbursement claims.  The small credit provisions in 2015 are due primarily to the settlements of certain loss reimbursement claims at slightly lower amounts than what had been specifically reserved for at the end of the respective previous period.  The reserve for loss reimbursements on sold mortgage loans totaled $0.6 million and $0.5 million at September 30, 2016 and December 31, 2015, respectively. This reserve is included in accrued expenses and other liabilities in our Condensed Consolidated Statements of Financial Condition. This reserve is based on an analysis of mortgage loans that we have sold which are further categorized by delinquency status, loan to value, and year of origination. The calculation includes factors such as probability of default, probability of loss reimbursement (breach of representation or warranty) and estimated loss severity. The reserve levels at September 30, 2016 and December 31, 2015 also reflect the resolution of the mortgage loan origination years of 2000 to 2008 with Fannie Mae and Freddie Mac.  We believe that the amounts that we have accrued for incurred losses on sold mortgage loans are appropriate given our analyses.  However, future losses could exceed our current estimate.
 
57

NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
(unaudited)

15.
Accumulated Other Comprehensive Loss (“AOCL”)

A summary of changes in AOCL follows:

   
Unrealized
Gains
(Losses) on
Securities
Available
for Sale
   
Dispropor-
tionate
Tax Effects
from
Securities
Available
for Sale
   
Total
 
For the three months ended September 30,
                 
2016
                 
Balances at beginning of period
 
$
2,515
   
$
(5,798
)
 
$
(3,283
)
Other comprehensive income before reclassifications
   
278
     
-
     
278
 
Amounts reclassified from AOCL
   
(10
)
   
-
     
(10
)
Net current period other comprehensive income
   
268
     
-
     
268
 
Balances at end of period
 
$
2,783
   
$
(5,798
)
 
$
(3,015
)
                         
2015
                       
Balances at beginning of period
 
$
408
   
$
(5,798
)
 
$
(5,390
)
Other comprehensive income before reclassifications
   
894
     
-
     
894
 
Amounts reclassified from AOCL
   
-
     
-
     
-
 
Net current period other comprehensive income
   
894
     
-
     
894
 
Balances at end of period
 
$
1,302
   
$
(5,798
)
 
$
(4,496
)
                         
For the nine months ended September 30,
                       
2016
                       
Balances at beginning of period
 
$
(238
)
 
$
(5,798
)
 
$
(6,036
)
Other comprehensive income before reclassifications
   
3,215
     
-
     
3,215
 
Amounts reclassified from AOCL
   
(194
)
   
-
     
(194
)
Net current period other comprehensive income
   
3,021
     
-
     
3,021
 
Balances at end of period
 
$
2,783
   
$
(5,798
)
 
$
(3,015
)
                         
2015
                       
Balances at beginning of period
 
$
162
   
$
(5,798
)
 
$
(5,636
)
Other comprehensive income before reclassifications
   
1,189
     
-
     
1,189
 
Amounts reclassified from AOCL
   
(49
)
   
-
     
(49
)
Net current period other comprehensive income
   
1,140
     
-
     
1,140
 
Balances at end of period
 
$
1,302
   
$
(5,798
)
 
$
(4,496
)

The disproportionate tax effects from securities available for sale arose due to tax effects of other comprehensive income (“OCI”) in the presence of a valuation allowance against our deferred tax assets and a pretax loss from operations.  Generally, the amount of income tax expense or benefit allocated to operations is determined without regard to the tax effects of other categories of income or loss, such as OCI. However, an exception to the general rule is provided when, in the presence of a valuation allowance against deferred tax assets, there is a pretax loss from operations and pretax income from other categories in the current period.  In such instances, income from other categories must offset the current loss from operations, the tax benefit of such offset being reflected in operations.
 
58

NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
(unaudited)

A summary of reclassifications out of each component of AOCL for the three months ended September 30 follows:

AOCL Component
 
Amount
Reclassified
From
AOCL
 
Affected Line Item in Condensed
Consolidated Statements of Operations
   
(In thousands)
   
2016
        
Unrealized gains on securities available for sale
        
   
$
15
 
Net gains on securities
     
-
 
Net impairment loss recognized in earnings
     
15
 
Total reclassifications before tax
     
5
 
Income tax expense
   
$
10
 
Reclassifications, net of tax
             
2015
          
Unrealized gains on securities available for sale
          
   
$
-
 
Net gains on securities
     
-
 
Net impairment loss recognized in earnings
     
-
 
Total reclassifications before tax
     
-
 
Income tax expense
   
$
-
 
Reclassifications, net of tax

A summary of reclassifications out of each component of AOCL for the nine months ended September 30 follows:

AOCL Component
 
Amount
Reclassified
From
AOCL
 
Affected Line Item in Condensed
Consolidated Statements of Operations
   
(In thousands)
   
2016
        
Unrealized gains on securities available for sale
        
   
$
298
 
Net gains on securities
     
-
 
Net impairment loss recognized in earnings
     
298
 
Total reclassifications before tax
     
104
 
Income tax expense
   
$
194
 
Reclassifications, net of tax
             
2015
          
Unrealized gains on securities available for sale
          
   
$
75
 
Net gains on securities
     
-
 
Net impairment loss recognized in earnings
     
75
 
Total reclassifications before tax
     
26
 
Income tax expense
   
$
49
 
Reclassifications, net of tax
 
59

ITEM 2.

Management’s Discussion and Analysis
of Financial Condition and Results of Operations

Introduction. The following section presents additional information to assess the financial condition and results of operations of Independent Bank Corporation, its wholly-owned bank, Independent Bank (the "Bank"), and their subsidiaries. This section should be read in conjunction with the Condensed Consolidated Financial Statements. We also encourage you to read our 2015 Annual Report on Form 10-K filed with the U.S. Securities and Exchange Commission ("SEC"). That report includes a list of risk factors that you should consider in connection with any decision to buy or sell our securities.

Overview. We provide banking services to customers located primarily in Michigan’s Lower Peninsula.  As a result, our success depends to a great extent upon the economic conditions in Michigan’s Lower Peninsula. At times, we have experienced a difficult economy in Michigan. Economic conditions in Michigan began to show signs of improvement during 2010.  Generally, these improvements have continued into 2016, albeit at an uneven pace.  There has been an overall decline in the unemployment rate as well as generally improving housing prices and other related statistics (such as home sales and new building permits).  In addition, since early- to mid-2009, we have seen an improvement in our asset quality metrics. In particular, since early 2012, we have generally experienced a decline in non-performing assets, lower levels of new loan defaults, and reduced levels of loan net charge-offs.

Regulation. On July 2, 2013, the Federal Reserve Board (the "FRB") approved a final rule that establishes an integrated regulatory capital framework (the "New Capital Rules"). The rule implements in the United States the Basel III regulatory capital reforms from the Basel Committee on Banking Supervision and certain changes required by the 2010 Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”).  In general, under the New Capital Rules, minimum requirements have increased for both the quantity and quality of capital held by banking organizations. Consistent with the international Basel framework, the New Capital Rules include a new minimum ratio of common equity tier 1 capital to risk-weighted assets of 4.5% and a common equity tier 1 capital conservation buffer of 2.5% of risk-weighted assets that applies to all supervised financial institutions. The 2.5% capital conservation buffer is being phased in over a four-year period beginning in 2016 with 0.625% added to the minimum ratio for adequately capitalized institutions for 2016 and each subsequent year until being fully phased in during 2019.  To avoid limits on capital distributions and certain discretionary bonus payments we must meet the minimum ratio for adequately capitalized institutions plus the phased in buffer.  The rule also raises the minimum ratio of tier 1 capital to risk-weighted assets from 4% to 6% and includes a minimum leverage ratio of 4% for all banking organizations. As to the quality of capital, the New Capital Rules emphasize common equity tier 1 capital, the most loss-absorbing form of capital, and implements strict eligibility criteria for regulatory capital instruments. The New Capital Rules also change the methodology for calculating risk-weighted assets to enhance risk sensitivity.  Under the New Capital Rules our existing trust preferred securities are grandfathered as qualifying regulatory capital. We were subject to the New Capital Rules beginning on January 1, 2015, and as of September 30, 2016 and December 31, 2015 we exceeded all of the capital ratio requirements of the New Capital Rules.

It is against this backdrop that we discuss our results of operations and financial condition in the third quarter and first nine months of 2016 as compared to 2015.
 
60

Results of Operations

Summary.  We recorded net income of $6.4 million and $5.0 million, respectively, during the three months ended September 30, 2016 and 2015.  The increase in net income on a comparative quarterly basis is due primarily to increases in net interest income and non-interest income that were partially offset by increases in non-interest expense and income tax expense.

We recorded net income of $16.9 million and $14.4 million, respectively, during the nine months ended September 30, 2016 and 2015.  The increase in net income on a comparative year-to-date basis is due primarily to an increase in net interest income and decreases in the provision for loan losses (a higher credit) and in non-interest expense that were partially offset by a decrease in non-interest income and an increase in income tax expense.

Key performance ratios

   
Three months ended 
September 30,
   
Nine months ended
September 30,
 
   
2016
   
2015
   
2016
   
2015
 
Net income (annualized) to
                       
Average assets
   
1.02
%
   
0.86
%
   
0.92
%
   
0.84
%
Average common shareholders’ equity
   
10.20
     
7.84
     
9.19
     
7.59
 
                                 
Net income per common share
                               
Basic
 
$
0.30
   
$
0.22
   
$
0.79
   
$
0.63
 
Diluted
   
0.30
     
0.22
     
0.78
     
0.62
 

Net interest income.  Net interest income is the most important source of our earnings and thus is critical in evaluating our results of operations. Changes in our net interest income are primarily influenced by our level of interest-earning assets and the income or yield that we earn on those assets and the manner and cost of funding our interest-earning assets. Certain macro-economic factors can also influence our net interest income such as the level and direction of interest rates, the difference between short-term and long-term interest rates (the steepness of the yield curve) and the general strength of the economies in which we are doing business. Finally, risk management plays an important role in our level of net interest income. The ineffective management of credit risk and interest-rate risk in particular can adversely impact our net interest income.

Our net interest income totaled $20.0 million during the third quarter of 2016, an increase of $1.2 million, or 6.1% from the year-ago period.  The quarterly increase in net interest income in 2016 compared to 2015 primarily reflects a $182.3 million increase in average interest-earning assets that was partially offset by a seven basis point decrease in our tax equivalent net interest income as a percent of average interest-earning assets (the “net interest margin”).

For the first nine months of 2016, net interest income totaled $59.4 million, an increase of $3.8 million, or 6.8% from 2015. The year-to-date increase in net interest income in 2016 compared to 2015 primarily reflects a $169.4 million increase in average interest-earning assets that was partially offset by a four basis point decrease in our net interest margin.
 
61

The decline in our net interest margin is primarily due to the prolonged low interest rate environment that has pushed our average yield on loans lower as well as a slight increase in our cost of funds (caused primarily by a higher mix and slightly higher average interest rate on time deposits).

Interest rates have generally been at extremely low levels since 2008 due primarily to the FRB’s monetary policies and its efforts to stimulate the U.S. economy.  This very low interest rate environment has generally had an adverse impact on our net interest margin.   Based on recent announcements by the FRB, short-term interest rates are expected to remain extremely low until at least late-2016 or 2017.  Given the repricing characteristics of our interest-earning assets and interest-bearing liabilities (and our level of non-interest bearing demand deposits), we would expect that our net interest margin will generally benefit on a long-term basis from rising interest rates.

Our net interest income is also adversely impacted by our level of non-accrual loans.  In the third quarter and first nine months of 2016 non-accrual loans averaged $10.7 million and $10.6 million, respectively compared to $12.9 million and $13.7 million, respectively for the same periods in 2015.  In addition, in the third quarter and first nine months of 2016 we had net recoveries of $0.07 million and $0.75 million, respectively, of accrued and unpaid interest on loans placed on or taken off non-accrual or previously charged-off during each period compared to net recoveries of $0.16 million and $0.34 million, respectively, during the same periods in 2015.
 
62

Average Balances and Tax Equivalent Rates

   
Three Months Ended
September 30,
 
    2016     2015  
   
Average
Balance
   
Interest
   
Rate (3)
   
Average
Balance
   
Interest
   
Rate (3)
 
   
(Dollars in thousands)
 
Assets (1)
                                   
Taxable loans
 
$
1,613,189
   
$
18,562
     
4.59
%
 
$
1,470,529
   
$
17,834
     
4.83
%
Tax-exempt loans (2)
   
3,492
     
53
     
6.04
     
3,740
     
54
     
5.73
 
Taxable securities
   
534,319
     
2,537
     
1.90
     
520,805
     
1,901
     
1.46
 
Tax-exempt securities (2)
   
58,694
     
507
     
3.46
     
33,104
     
347
     
4.19
 
Interest bearing cash
   
69,603
     
86
     
0.49
     
68,972
     
70
     
0.40
 
Other investments
   
15,347
     
195
     
5.05
     
15,231
     
225
     
5.86
 
Interest Earning Assets
   
2,294,644
     
21,940
     
3.81
     
2,112,381
     
20,431
     
3.85
 
Cash and due from banks
   
34,565
                     
45,477
                 
Other assets, net
   
152,793
                     
164,253
                 
Total Assets
 
$
2,482,002
                   
$
2,322,111
                 
                                                 
Liabilities
                                               
Savings and interest-bearing checking
 
$
1,014,201
     
284
     
0.11
   
$
990,229
     
266
     
0.11
 
Time deposits
   
438,504
     
970
     
0.88
     
371,501
     
721
     
0.77
 
Other borrowings
   
47,227
     
493
     
4.15
     
47,769
     
465
     
3.86
 
Interest Bearing Liabilities
   
1,499,932
     
1,747
     
0.46
     
1,409,499
     
1,452
     
0.41
 
Non-interest bearing deposits
   
706,282
                     
633,305
                 
Other liabilities
   
27,110
                     
23,844
                 
Shareholders’ equity
   
248,678
                     
255,463
                 
 
                                               
Total liabilities and shareholders’ equity
 
$
2,482,002
                   
$
2,322,111
                 
                                                 
Net Interest Income
         
$
20,193
                   
$
18,979
         
                                               
Net Interest Income as a Percent of Average Interest Earning Assets
                   
3.51
%
                   
3.58
%
 

(1)
All domestic.
(2)
Interest on tax-exempt loans and securities is presented on a fully tax equivalent basis assuming a marginal tax rate of 35%
(3)
Annualized
 
63

Average Balances and Tax Equivalent Rates

   
Nine Months Ended
September 30,
 
    2016     2015  
   
Average
Balance
   
Interest
   
Rate (3)
   
Average
Balance
   
Interest
   
Rate (3)
 
   
(Dollars in thousands)
 
Assets (1)
                                   
Taxable loans
 
$
1,577,758
   
$
55,255
     
4.67
%
 
$
1,446,857
   
$
52,736
     
4.87
%
Tax-exempt loans (2)
   
3,564
     
163
     
6.11
     
4,097
     
189
     
6.17
 
Taxable securities
   
532,576
     
7,261
     
1.82
     
518,906
     
5,528
     
1.42
 
Tax-exempt securities (2)
   
50,286
     
1,320
     
3.50
     
32,790
     
1,021
     
4.15
 
Interest bearing cash
   
75,121
     
292
     
0.52
     
64,913
     
194
     
0.40
 
Other investments
   
15,456
     
592
     
5.12
     
17,772
     
728
     
5.48
 
Interest Earning Assets
   
2,254,761
     
64,883
     
3.84
     
2,085,335
     
60,396
     
3.87
 
Cash and due from banks
   
38,069
                     
44,829
                 
Other assets, net
   
157,570
                     
167,849
                 
Total Assets
 
$
2,450,400
                   
$
2,298,013
                 
                                                 
Liabilities
                                               
Savings and interest-bearing checking
 
$
1,018,727
     
831
     
0.11
   
$
988,594
     
792
     
0.11
 
Time deposits
   
435,146
     
2,689
     
0.83
     
373,235
     
2,169
     
0.78
 
Other borrowings
   
47,405
     
1,455
     
4.10
     
47,930
     
1,382
     
3.86
 
Interest Bearing Liabilities
   
1,501,278
     
4,975
     
0.44
     
1,409,759
     
4,343
     
0.41
 
Non-interest bearing deposits
   
677,645
                     
609,192
                 
Other liabilities
   
25,612
                     
24,581
                 
Shareholders’ equity
   
245,865
                     
254,481
                 
                                               
Total liabilities and shareholders’ equity
 
$
2,450,400
                   
$
2,298,013
                 
                                                 
Net Interest Income
         
$
59,908
                   
$
56,053
         
                                                 
Net Interest Income as a Percent of Average Interest Earning Assets
                   
3.55
%
                   
3.59
%
 

(1)
All domestic.
(2)
Interest on tax-exempt loans and securities is presented on a fully tax equivalent basis assuming a marginal tax rate of 35%
(3)
Annualized
 
64

Provision for loan losses.  The provision for loan losses was a credit of approximately $0.2 million during both the three months ended September 30, 2016 and 2015. During the nine-month periods ended September 30, 2016 and 2015, the provision was a credit of $1.4 million and $1.0 million, respectively. The provision reflects our assessment of the allowance for loan losses taking into consideration factors such as loan mix, levels of non-performing and classified loans and loan net charge-offs.  While we use relevant information to recognize losses on loans, additional provisions for related losses may be necessary based on changes in economic conditions, customer circumstances and other credit risk factors.  See “Portfolio Loans and asset quality” for a discussion of the various components of the allowance for loan losses and their impact on the provision for loan losses in the third quarter and first nine months of 2016.

Non-interest income.  Non-interest income is a significant element in assessing our results of operations. We regard net gains on mortgage loans as a recurring source of revenue but they are quite cyclical and thus can be volatile.

Non-interest income totaled $11.7 million during the three months ended September 30, 2016, an increase of $1.6 million from the comparable period in 2015.  For the first nine months of 2016 non-interest income totaled $29.1 million, a $1.0 million decrease from the comparable period in 2015.  The components of non-interest income are as follows:

Non-Interest Income

   
Three months ended
September 30,
   
Nine months ended
September 30,
 
 
 
2016
   
2015
    2016     2015  
 
(In thousands)
 
Service charges on deposit accounts
 
$
3,281
   
$
3,294
   
$
9,164
   
$
9,261
 
Interchange income
   
1,943
     
2,169
     
5,797
     
6,551
 
Net gains (losses) on assets:
                               
Mortgage loans
   
3,556
     
1,812
     
7,727
     
5,735
 
Securities
   
(45
)
   
45
     
302
     
97
 
Mortgage loan servicing, net
   
858
     
(556
)
   
(454
)
   
476
 
Investment and insurance commissions
   
427
     
447
     
1,278
     
1,380
 
Bank owned life insurance
   
282
     
304
     
870
     
979
 
Title insurance fees
   
319
     
281
     
860
     
874
 
Gain on branch sale
   
-
     
1,193
     
-
     
1,193
 
Other
   
1,087
     
1,130
     
3,553
     
3,522
 
Total non-interest income
 
$
11,708
   
$
10,119
   
$
29,097
   
$
30,068
 

Service charges on deposit accounts declined slightly on both a comparative quarterly and year-to-date basis in 2016 as compared to 2015.  Over the last few years, such service charges have been decreasing, principally due to a decline in non-sufficient funds (“NSF”) occurrences and related NSF fees. We believe the long-term decline in NSF occurrences is due to our customers managing their finances more closely and having real-time access to deposit account information through electronic channels allowing them to reduce NSF activity and avoid the associated fees.

Interchange income decreased on both a comparative quarterly and year-to-date basis in 2016 as compared to 2015.  The decrease in interchange income in 2016 as compared to 2015 primarily results from lower incentives under our Debit Brand Agreement with MasterCard.  In addition, although transaction volume increased 1.8% year-over-year, interchange revenue per transaction declined by 5.3%, primarily due to a higher mix of debit (PIN-based) versus credit (signature-based) transactions.
 
65

Net gains on mortgage loans increased on both a quarterly and a year to date basis. Mortgage loan activity is summarized as follows:

Mortgage Loan Activity

   
Three months ended
September 30,
   
Nine months ended
September 30,
 
   
2016
   
2015
   
2016
   
2015
 
   
(Dollars in thousands)
 
Mortgage loans originated
 
$
123,124
   
$
79,648
   
$
288,592
   
$
260,744
 
Mortgage loans sold
   
89,349
     
71,063
     
215,494
     
221,957
 
Net gains on the sale of mortgage loans
   
3,556
     
1,812
     
7,727
     
5,735
 
Net gains as a percent of mortgage loans sold (“Loan Sales Margin”)
   
3.98
%
   
2.55
%
   
3.59
%
   
2.58
%
Fair value adjustments included in the Loan Sales Margin
   
0.55
     
(0.05
)
   
0.40
     
0.21
 

The increases in mortgage loan originations  in 2016 as compared to 2015 are due primarily to a decrease in mortgage loan interest rates during parts of 2016 that resulted in an increase in  mortgage loan refinance volumes as well as an improving housing market which has resulted in an increase in purchase money mortgage origination volume.

Net gains as a percentage of mortgage loans sold (our “Loan Sales Margin”) are impacted by several factors including competition and the manner in which the loan is sold.  Net gains on mortgage loans are also impacted by recording fair value accounting adjustments. Excluding the aforementioned fair value accounting adjustments, the Loan Sales Margin would have been 3.43% and 2.60% in the third quarters of 2016 and 2015, respectively and 3.19% and 2.37% for the comparative 2016 and 2015 year-to-date periods, respectively. The increase in the Loan Sales Margin (excluding fair value adjustments) in 2016 was generally due to a widening of primary-to-secondary market pricing spreads as well as a higher content of government (FHA and VA) mortgage loan sales, which generally have higher profit margins than conventional mortgage loan sales. The changes in the fair value accounting adjustments are primarily due to changes in the amount of commitments to originate mortgage loans for sale.  Because of recent increases in longer-term interest rates and competitive factors, we do not expect the significant increase in the Loan Sales Margin that we have experienced in the first nine months of 2016 to continue into the last quarter of 2016 or into 2017.

The volume of loans sold is dependent upon our ability to originate mortgage loans as well as the demand for fixed-rate obligations and other loans that we choose to not put into portfolio because of our established interest-rate risk parameters. (See “Portfolio Loans and asset quality.”) Net gains on mortgage loans are also dependent upon economic and competitive factors as well as our ability to effectively manage exposure to changes in interest rates and thus can often be a volatile part of our overall revenues.

Net securities (losses) gains totaled $(0.045) million and $0.302 million during the three and nine months ended September 30, 2016, respectively, and $0.045 million and $0.097 million for the respective comparable periods in 2015.  The third quarter 2016 securities net losses were due primarily to a $0.06 million decrease in the fair value of trading securities. The year-to-date 2016 securities net gains were due primarily to the sale of $56.5 million of investments.  The third quarter 2015 securities net gains were due to an increase in the fair value of our trading securities.  The 2015 year-to-date securities net gains were due to the sale of $11.8 million of investments and an increase in the fair value of our trading securities.  We recorded no net impairment losses in 2016 or 2015 for other than temporary impairment of securities available for sale.  (See “Securities.”)
 
66

Mortgage loan servicing generated income of $0.9 million and a loss of $0.5 million in the third quarter and first nine months of 2016, respectively, compared to a loss of $0.6 million and income of $0.5 million in the third quarter and first nine months of 2015, respectively. These variances are primarily due to changes in the valuation allowance on and the amortization of capitalized mortgage loan servicing rights. The period end valuation allowance is based on the valuation of the mortgage loan servicing portfolio.  Activity related to capitalized mortgage loan servicing rights is as follows:

Capitalized Mortgage Loan Servicing Rights

   
Three months ended
September 30,
   
Nine months ended
September 30,
 
   
2016
   
2015
   
2016
   
2015
 
   
(In thousands)
 
Balance at beginning of period
 
$
10,331
   
$
12,535
   
$
12,436
   
$
12,106
 
Originated servicing rights capitalized
   
896
     
678
     
2,153
     
2,128
 
Amortization
   
(799
)
   
(700
)
   
(2,065
)
   
(2,259
)
Change in valuation allowance
   
620
     
(883
)
   
(1,476
)
   
(345
)
Balance at end of period
 
$
11,048
   
$
11,630
   
$
11,048
   
$
11,630
 
                                 
Valuation allowance at end of period
 
$
4,748
   
$
4,118
   
$
4,748
   
$
4,118
 

At September 30, 2016 we were servicing approximately $1.64 billion in mortgage loans for others on which servicing rights have been capitalized. This servicing portfolio had a weighted average coupon rate of 4.24% and a weighted average service fee of approximately 25.5 basis points. Remaining capitalized mortgage loan servicing rights at September 30, 2016 totaled $11.0 million, representing approximately 67 basis points on the related amount of mortgage loans serviced for others. The capitalized mortgage loan servicing had an estimated fair market value of $11.1 million at September 30, 2016.

Investment and insurance commissions represent revenues generated on the sale or management of investments and insurance for our customers.  These revenues were relatively unchanged on a quarterly basis and declined slightly on a year-to-date basis in 2016 as compared to 2015, due primarily to open sales representative positions that were not filled until the second quarter of 2016.

Income from bank owned life insurance declined on both a comparative quarterly and year-to-date basis in 2016 compared to 2015 reflecting a lower average crediting rate on our cash surrender value. Our separate account is primarily invested in agency mortgage-backed securities and managed by PIMCO. The crediting rate (on which the earnings are based) reflects the performance of the separate account.  The total cash surrender value of our bank owned life insurance was $53.8 million and $54.4 million at September 30, 2016 and December 31, 2015, respectively.
 
67

Title insurance fees were slightly higher on a comparative quarterly basis and relatively unchanged on a year-to-date basis in 2016 as compared to 2015.  The amount of title insurance fees is primarily a function of the level of mortgage loans that we originated.

Third quarter and year-to-date 2015 results include a net gain of $1.2 million on the sale of our Midland, Michigan branch.

Other non-interest income was relatively unchanged on both a comparative quarterly and year-to-date basis in 2016 compared to 2015.

Non-interest expense.  Non-interest expense is an important component of our results of operations. We strive to efficiently manage our cost structure and management is focused on a number of initiatives to reduce and contain non-interest expenses.

Non-interest expense increased by $0.65 million to $22.5 million and decreased by $0.1 million to $65.5 million during the three- and nine-month periods ended September 30, 2016, respectively, compared to the same periods in 2015.
 
68

The components of non-interest expense are as follows:

Non-Interest Expense

   
Three months ended
September 30,
 
Nine months ended
September 30,
 
 
 
2016
   
 2015
   
2016
   
2015
 
      (in thousands)  
Compensation
 
$
8,546
   
$
8,419
   
$
24,948
   
$
24,880
 
Performance-based compensation
   
2,174
     
1,572
     
5,374
     
4,604
 
Payroll taxes and employee benefits
   
2,311
     
2,038
     
6,590
     
6,121
 
Compensation and employee benefits
   
13,031
     
12,029
     
36,912
     
35,605
 
Data processing
   
1,971
     
2,001
     
6,008
     
5,958
 
Occupancy, net
   
1,919
     
1,940
     
5,982
     
6,399
 
Furniture, fixtures and equipment
   
990
     
998
     
2,939
     
2,915
 
Communications
   
670
     
754
     
2,280
     
2,184
 
Loan and collection
   
568
     
816
     
1,964
     
2,938
 
Advertising
   
455
     
406
     
1,410
     
1,338
 
Legal and professional fees
   
420
     
519
     
1,178
     
1,352
 
FDIC deposit insurance
   
187
     
350
     
852
     
1,044
 
Interchange expense
   
276
     
279
     
809
     
859
 
Credit card and bank service fees
   
203
     
197
     
588
     
602
 
Supplies
   
178
     
190
     
551
     
619
 
Amortization of intangible assets
   
86
     
86
     
260
     
260
 
Net (gains) losses on other real estate and repossessed assets
   
263
     
5
     
98
     
(173
)
Provision for loss reimbursement on sold loans
   
45
     
(35
)
   
30
     
(59
)
Costs related to unfunded lending commitments
   
73
     
26
     
6
     
46
 
Vehicle service contract counterparty contingencies
   
(39
)    
30
     
(10
)
   
89
 
Other
   
1,233
     
1,288
     
3,612
     
3,633
 
Total non-interest expense
 
$
22,529
   
$
21,879
   
$
65,469
   
$
65,609
 

Compensation and employee benefits expenses, in total, increased $1.0 million, or 8.3%, on a quarterly comparative basis and increased $1.3 million, or 3.7%, for the first nine months of 2016 compared to the same periods in 2015.

Compensation expense increased by $0.1 million, or 1.5%, and by $0.1 million, or 0.3%, in the third quarter and first nine months of 2016, respectively, compared to the same periods in 2015.  Average full-time equivalent employees (“FTEs”) were higher by approximately 1.4% and lower by approximately 0.7% during the third quarter and first nine months of 2016, respectively, compared to the year ago periods.  On a year-to-date basis, the impact of the slight decline in the average FTE level was offset by merit raises granted in 2016.

Performance-based compensation increased by $0.6 million and by $0.8 million in the third quarter and first nine months of 2016, respectively, compared to the same periods in 2015, due primarily to a higher accrual for anticipated incentive compensation based on our estimated 2016 performance as compared to goals.
 
69

Payroll taxes and employee benefits increased by $0.3 million and $0.5 million in the third quarter and first nine months of 2016, respectively, compared to the same periods in 2015.  The quarterly increase is due primarily to increases in medical insurance and employee training costs as well as a higher employer 401(k) contribution.  The year-to-date increase is due primarily to a higher employer 401(k) contribution and increased employee training costs.  The increased employee training costs primarily relate to a new sales training program implemented in 2016.

Data processing expenses were relatively unchanged in the third quarter and first nine months of 2016, respectively, compared to the same periods in 2015.  A decline in software amortization expense was offset by the cost of new services added with our core data processing vendor or other outside service providers.

Occupancy, net, was relatively unchanged and decreased by $0.4 million in the third quarter and first nine months of 2016, respectively, compared to the same periods in 2015.  The year-to-date decline is primarily due to decreases in utility costs and real estate property taxes (which reflect fewer properties owned due to sales or other dispositions) and lower lease costs for our Mepco Finance Corporation (“Mepco”) Chicago office due to relocating to smaller space in the fourth quarter of 2015.

Furniture, fixtures and equipment expenses were relatively unchanged on both a comparative quarterly and year-to-date basis.

Communications expenses declined by $0.1 million and increased by $0.1 million in the third quarter and first nine months of 2016, respectively, compared to the same periods in 2015.  The year-to-date increase in 2016 is due primarily to mailing costs for a new checking account program.

Loan and collection expenses primarily reflect costs related to the management and collection of non-performing loans and other problem credits. These expenses have further declined in 2016, which primarily reflects the overall year-over-year decrease in non-performing assets and watch credits. (See “Portfolio Loans and asset quality.”)

Advertising expenses increased slightly on both a quarterly and year-to-date basis in 2016 as compared to 2015, due primarily to the cost of a new checking account acquisition program.

Legal and professional fees decreased on both a comparative quarterly and year-to-date basis due primarily to a decline in legal fees at Mepco because of the resolution (in the first quarter of 2016) of counterparty litigation associated with collection matters.

FDIC deposit insurance decreased on both a comparative quarterly and year-to-date basis due primarily to a decline in our premium rate during the third quarter of 2016.  At June 30, 2016, the FDIC Deposit Insurance Fund reserve ratio reached 1.15%, which triggered a new assessment method and generally lower deposit insurance premiums for banks with less than $10 billion in assets.

Interchange expense primarily represents our third-party cost to process debit card transactions.  This cost has declined slightly on both a comparative quarterly and year-to-date basis due primarily to the decline in debit card transaction revenue described above.
 
70

Credit card and bank service fees were essentially unchanged on both a comparative quarterly and year-to-date basis as the number of payment plans being serviced by Mepco in 2016 compared to 2015 was relatively stable.

Supplies expenses decreased on both a comparative quarterly and year-to-date basis due primarily to declines at Mepco associated with the outsourcing of its mailroom operations.

The amortization of intangible assets primarily relates to branch acquisitions and the amortization of the deposit customer relationship value, including core deposit value, which was acquired in connection with those acquisitions. We had remaining unamortized intangible assets of $2.0 million and $2.3 million at September 30, 2016 and December 31, 2015, respectively. See Note #8 to the Condensed Consolidated Financial Statements for a schedule of future amortization of intangible assets.

Net (gains) losses on other real estate and repossessed assets primarily represent the gain or loss on the sale or additional write downs on these assets subsequent to the transfer of the asset from our loan portfolio. This transfer occurs at the time we acquire the collateral that secured the loan. At the time of acquisition, the other real estate or repossessed asset is valued at fair value, less estimated costs to sell, which becomes the new basis for the asset. Any write-downs at the time of acquisition are charged to the allowance for loan losses.  In general, greater stability in real estate prices during the last few years (with several markets even experiencing price increases) has resulted in modest losses or gains on the sale of other real estate.  We recorded net losses of $0.263 million and $0.098 million in the third quarter and first nine months of 2016, respectively, as compared to a net loss of $0.005 million and a net gain of $0.173 million, respectively, recorded in the same periods in 2015.  The net losses in 2016 primarily reflect a $0.36 million write-down in the third quarter on a group of commercial income-producing properties that were sold at auction.  We expect to close on this sale ($3.0 million balance in other real estate at September 30, 2016) in the fourth quarter of 2016.

The provision for loss reimbursement on sold loans was an expense of $0.045 million and $0.030 million in the third quarter and first nine months of 2016, respectively, compared to a credit of $0.035 million and a credit of $0.059 million in the third quarter and first nine months of 2015, respectively. This provision represents our estimate of incurred losses related to mortgage loans that we have sold to investors (primarily Fannie Mae, Freddie Mac and Ginnie Mae).  The small expenses in 2016 are primarily due to establishing specific reserves for pending loss reimbursement claims.  The small credit provisions in 2015 are due primarily to the settlements of certain loss reimbursement claims at slightly lower amounts than what had been specifically reserved for at the end of the respective previous period.  Since we sell mortgage loans without recourse, loss reimbursements only occur in those instances where we have breached a representation or warranty or other contractual requirement related to the loan sale.  The reserve for loss reimbursements on sold mortgage loans totaled $0.560 million and $0.530 million at September 30, 2016 and December 31, 2015, respectively. This reserve is included in accrued expenses and other liabilities in our Condensed Consolidated Statements of Financial Condition. This reserve is based on an analysis of mortgage loans that we have sold which are further categorized by delinquency status, loan to value, and year of origination. The calculation includes factors such as probability of default, probability of loss reimbursement (breach of representation or warranty) and estimated loss severity. The reserve levels at September 30, 2016 and December 31, 2015 also reflect the resolution of the mortgage loan origination years of 2000 to 2008 with Fannie Mae and Freddie Mac.  We believe that the amounts that we have accrued for incurred losses on sold mortgage loans are appropriate given our analyses.  However, future losses could exceed our current estimate.
 
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The changes in costs related to unfunded lending commitments are primarily impacted by changes in the amounts of such commitments to originate portfolio loans as well as (for commercial loan commitments) the grade (pursuant to our loan rating system) of such commitments.

Our estimate of probable incurred losses from vehicle service contract counterparty contingencies requires a significant amount of judgment because a number of factors can influence the amount of loss that we may ultimately incur. These factors include our estimate of future cancellations of vehicle service contracts, our evaluation of collateral that may be available to recover funds due from our counterparties, and our assessment of the amount that may ultimately be collected from counterparties in connection with their contractual obligations. We apply a rigorous process, based upon historical payment plan activity and past experience, to estimate probable incurred losses and quantify the necessary reserves for our vehicle service contract counterparty contingencies, but there can be no assurance that our modeling process will successfully identify all such losses.

In particular, as noted in our Risk Factors included in Part I - Item 1A of our Annual Report on Form 10-K for the year ended December 31, 2015, Mepco has had to initiate litigation against certain counterparties, including third party insurers, to collect amounts owed to Mepco as a result of those parties' dispute of their contractual obligations to Mepco.  During the first quarter of 2016, we settled our last significant remaining litigation matter with certain of Mepco’s counterparties.  This settlement resulted in our receipt of a cash payment of $4.0 million on March 31, 2016.  This settlement also resulted in our receipt of an interest-bearing promissory note from one of Mepco’s counterparties for $1.5 million with monthly payments scheduled over a five-year period beginning in May 2016.  Due to the lack of any payment history and limited financial information on this counterparty, we established a full reserve on this promissory note as of March 31, 2016.  A full reserve on the remaining balance ($1.39 million) on this note was maintained at September 30, 2016.   This counterparty has made the first six required monthly payments on the note.  As a longer-term payment history is developed on this note, we will continue to evaluate the need for all or any part of a reserve.  Vehicle service contract counterparty receivables, net totaled $2.6 million as of September 30, 2016 compared to $7.2 million as of December 31, 2015.

In addition, see Note #14 to the Condensed Consolidated Financial Statements included within this report for more information about Mepco's business, certain risks and difficulties we currently face with respect to that business, and reserves we have established (through vehicle service contract counterparty contingencies expense) for losses related to the business.

Other non-interest expenses were relatively unchanged in the third quarter and first nine months of 2016, respectively, compared to the same periods in 2015.

Income tax expense.  We recorded an income tax expense of $3.0 million and $7.5 million in the third quarter and the first nine months of 2016, respectively. This compares to an income tax expense of $2.3 million and $6.7 million in the third quarter and the first nine months of 2015, respectively.
 
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The second quarter and first nine months of 2016 included a $0.3 million income tax benefit resulting from the adoption of Financial Accounting Standards Board Accounting Standards Update 2016-09 “Compensation – Stock Compensation (718) Improvements to Employee Share-Based Payment Accounting” (“ASU 2016-09”). See Note #2 to the Condensed Consolidated Financial Statements.

Our actual federal income tax expense is different than the amount computed by applying our statutory federal income tax rate to our pre-tax income primarily due to tax-exempt interest income and tax-exempt income from the increase in the cash surrender value on life insurance.

We assess whether a valuation allowance should be established against our deferred tax assets based on the consideration of all available evidence using a “more likely than not” standard.  The ultimate realization of this asset is primarily based on generating future income.  We concluded at both September 30, 2016 and 2015, that the realization of substantially all of our deferred tax assets continues to be more likely than not.

We did maintain a valuation allowance against our deferred tax assets of approximately $1.1 million at both September 30, 2016 and December 31, 2015. This valuation allowance on our deferred tax assets primarily relates to state income taxes at our Mepco segment.  In this instance, we determined that the future realization of these particular deferred tax assets was not more likely than not.  This conclusion was primarily based on the uncertainty of Mepco’s future earnings attributable to particular states (given the various apportionment criteria) and the significant reduction in the size of Mepco’s business.

Business Segments.  Our reportable segments are based upon legal entities.  We currently have two reportable segments:  Independent Bank and Mepco.  These business segments are also differentiated based on the products and services provided.  We evaluate performance based principally on net income (loss) of the respective reportable segments.

The following table presents net income (loss) by business segment.

Business Segments

   
Three months ended
September 30,
   
Nine months ended
September 30,
 
   
2016
   
2015
   
2016
   
2015
 
   
(in thousands)
 
Independent Bank
 
$
6,665
   
$
5,455
   
$
17,834
   
$
15,623
 
Mepco
   
(20
)
   
(168
)
   
(225
)
   
(437
)
Other(1)
   
(256
)
   
(224
)
   
(652
)
   
(693
)
Elimination
   
(16
)
   
(16
)
   
(46
)
   
(46
)
Net income (loss)
 
$
6,373
   
$
5,047
   
$
16,911
   
$
14,447
 

(1)
Includes amounts relating to our parent company.

The increase in third quarter net income at Independent Bank in 2016 compared to 2015 is primarily due to increases in net interest income and non-interest income that were partially offset by increases in non-interest expense and income tax expense. The increase in year-to-date net income at Independent Bank in 2016 compared to 2015 is primarily due to an increase in net interest income and decreases in the provision for loan losses (a higher credit) and in non-interest expense that were partially offset by a decrease in non-interest income and an increase in income tax expense.  (See “Net interest income,” “Provision for loan losses,” “Non-interest income,” “Non-interest expense,” “Income tax expense,” and “Portfolio Loans and asset quality.”)
 
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The improvement in Mepco’s results in 2016 compared to 2015 is primarily due to a decrease in non-interest expenses that was partially offset by a decrease in net interest income as a result of a decline in year-over-year average payment plan receivables.  All of Mepco’s funding is provided by Independent Bank through an intercompany loan (that is eliminated in consolidation).  The rate on this intercompany loan is based on the Prime Rate (currently 3.50%). Mepco might not be able to obtain such favorable funding costs on its own in the open market.

Financial Condition

Summary.  Our total assets increased by $129.3 million during the first nine months of 2016 due primarily to increases in cash and cash equivalents, securities available for sale and loans.  Loans, excluding loans held for sale ("Portfolio Loans"), totaled $1.61 billion at September 30, 2016, an increase of $92.3 million, or 6.1%, from December 31, 2015.  (See "Portfolio Loans and asset quality.")

Deposits totaled $2.21 billion at September 30, 2016, compared to $2.09 billion at December 31, 2015.  The $121.0 million increase in total deposits during the period is primarily due to growth in checking, savings and time deposit account balances.

Securities.  We maintain diversified securities portfolios, which include obligations of U.S. government-sponsored agencies, securities issued by states and political subdivisions, residential and commercial mortgage-backed securities, collateralized loan obligations, asset-backed securities, corporate securities and trust preferred securities. We regularly evaluate asset/liability management needs and attempt to maintain a portfolio structure that provides sufficient liquidity and cash flow. Except as discussed below, we believe that the unrealized losses on securities available for sale are temporary in nature and are expected to be recovered within a reasonable time period. We believe that we have the ability to hold securities with unrealized losses to maturity or until such time as the unrealized losses reverse. (See “Asset/liability management.”)

Securities

         
Unrealized 
     
 
Amortized
Cost
   
Gains
   
Losses
 
Fair
Value
 
    (In thousands)  
Securities available for sale
                       
September 30, 2016
 
$
598,831
   
$
6,313
   
$
2,032
   
$
603,112
 
December 31, 2015
   
585,851
     
3,152
     
3,519
     
585,484
 

In the first quarter of 2016, we initiated the use of Pacific Investment Management Company LLC (“PIMCO”) to manage an approximately $150 million segment of our securities available for sale.  This segment of our securities available for sale has a similar risk-weighting and duration as our remaining portfolio.
 
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Securities available for sale increased by $17.6 million during the first nine months of 2016 due primarily to increases in private label mortgage-backed securities, asset-backed securities, corporate securities and municipal securities. The securities were purchased to utilize a portion of the funds generated from the increase in total deposits. (See “Deposits” and “Liquidity and capital resources.”)

Our portfolio of securities available for sale is reviewed quarterly for impairment in value. In performing this review, management considers (1) the length of time and extent that fair value has been less than cost, (2) the financial condition and near term prospects of the issuer, (3) the impact of changes in market interest rates on the market value of the security and (4) an assessment of whether we intend to sell, or it is more likely than not that we will be required to sell, a security in an unrealized loss position before recovery of its amortized cost basis. For securities that do not meet these recovery criteria, the amount of impairment recognized in earnings is limited to the amount related to credit losses, while impairment related to other factors is recognized in other comprehensive income or loss.

Sales of securities were as follows (See “Non-interest income.”):

    Nine months ended
September 30,
 
    2016     2015  
     
(In thousands)
 
Proceeds
 
$
56,451
   
$
11,786
 
                 
Gross gains
 
$
350
   
$
75
 
Gross losses
   
(52
)    
-
 
Net impairment charges
   
-
     
-
 
Fair value adjustments
   
4
     
22
 
Net gains
 
$
302
   
$
97
 

Portfolio Loans and asset quality.  In addition to the communities served by our Bank branch network, our principal lending markets also include nearby communities and metropolitan areas. Subject to established underwriting criteria, we also may participate in commercial lending transactions with certain non-affiliated banks and make whole loan purchases from other financial institutions. In August 2016, we purchased $14.8 million of single-family residential fixed rate mortgage loans from another Michigan-based financial institution.  These mortgage loans were all on properties located in Michigan, had a weighted average interest rate (after a 0.25% servicing fee) of 3.65% and a weighted average remaining contractual maturity of 332 months. In December 2015, we purchased $32.6 million of single-family residential fixed rate jumbo mortgage loans from another Michigan-based financial institution.  These mortgage loans were all on properties located in Michigan, had a weighted average interest rate (after a 0.25% servicing fee) of 3.94% and a weighted average remaining contractual maturity of 344 months.

The senior management and board of directors of our Bank retain authority and responsibility for credit decisions and we have adopted uniform underwriting standards. Our loan committee structure and the loan review process attempt to provide requisite controls and promote compliance with such established underwriting standards. However, there can be no assurance that our lending procedures and the use of uniform underwriting standards will prevent us from incurring significant credit losses in our lending activities.
 
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We generally retain loans that may be profitably funded within established risk parameters. (See “Asset/liability management.”) As a result, we may hold adjustable-rate mortgage loans as Portfolio Loans, while 15- and 30-year, fixed-rate obligations are generally sold to mitigate exposure to changes in interest rates. (See “Non-interest income.”)

Non-performing assets(1)
           
   
September 30,
2016
   
December 31,
2015
 
   
(Dollars in thousands)
 
Non-accrual loans
 
$
10,801
   
$
10,607
 
Loans 90 days or more past due and still accruing interest
   
-
     
116
 
Total non-performing loans
   
10,801
     
10,723
 
Other real estate and repossessed assets
   
4,989
     
7,150
 
Total non-performing assets
 
$
15,790
   
$
17,873
 
As a percent of Portfolio Loans
               
Non-performing loans
   
0.67
%
   
0.71
%
Allowance for loan losses
   
1.37
     
1.49
 
Non-performing assets to total assets
   
0.62
     
0.74
 
Allowance for loan losses as a percent of non-performing loans
   
204.08
     
210.48
 

 
(1)
Excludes loans classified as “troubled debt restructured” that are not past due and vehicle service contract counterparty receivables, net.
 
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Troubled debt restructurings ("TDR")

 
September 30, 2016
 
 
Commercial
   
Retail
   
Total
 
    (In thousands)          
Performing TDR's
 
$
12,642
   
$
62,299
   
$
74,941
 
Non-performing TDR's(1)
   
2,352
     
3,421
 (2) 
   
5,773
 
Total
 
$
14,994
   
$
65,720
   
$
80,714
 
 
 
December 31, 2015        
 
  Commercial    
Retail
   
Total
 
 
(In thousands)
 
Performing TDR's
 
$
13,318
   
$
68,194
   
$
81,512
 
Non-performing TDR's(1)
   
3,041
     
3,777
 (2) 
   
6,818
 
Total
 
$
16,359
   
$
71,971
   
$
88,330
 

(1)
Included in non-performing assets table above.
(2)
Also includes loans on non-accrual at the time of modification until six payments are received on a timely basis.

Non-performing loans increased by $0.08 million, or 0.7%, during the first nine months of 2016 due principally to an increase in non-performing mortgage loans that was largely offset by declines in non-performing commercial and consumer installment loans.  In general, improving economic conditions in our market areas, as well as our collection and resolution efforts, have resulted in a generally stable or downward trend in non-performing loans.  However, we are still experiencing some loan defaults, particularly related to commercial loans secured by income-producing property and mortgage loans secured by resort/vacation property.

Non-performing loans exclude performing loans that are classified as troubled debt restructurings (“TDRs”). Performing TDRs totaled $74.9 million, or 4.7% of total Portfolio Loans, and $81.5 million, or 5.4% of total Portfolio Loans, at September 30, 2016 and December 31, 2015, respectively. The decrease in the amount of performing TDRs in the first nine months of 2016 primarily reflects a decline in retail loan TDRs.

Other real estate and repossessed assets totaled $5.0 million at September 30, 2016, compared to $7.2 million at December 31, 2015. This decrease is primarily the result of sales of other real estate being in excess of the migration of non-performing loans secured by real estate into other real estate as the foreclosure process is completed.

We will place a loan that is 90 days or more past due on non-accrual, unless we believe the loan is both well secured and in the process of collection. Accordingly, we have determined that the collection of the accrued and unpaid interest on any loans that are 90 days or more past due and still accruing interest is probable.

The ratio of loan net charge-offs to average Portfolio Loans was a negative 0.08% (as a result of net recoveries) on an annualized basis in the first nine months of 2016 compared to 0.03% in the first nine months of 2015.  The $1.3 million decline in loan net charge-offs is primarily due to declines in commercial loan and mortgage loan net charge-offs.  The overall decrease in loan net charge-offs primarily reflects a year-over-year reduction in non-performing loans and improvement in collateral liquidation values.
 
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Allowance for loan losses

   
Nine months ended
September 30,
 
   
2016
   
2015
 
   
Loans
   
Unfunded
Commitments
   
Loans
   
Unfunded
Commitments
 
   
(Dollars in thousands)
 
Balance at beginning of period
 
$
22,570
   
$
652
   
$
25,990
   
$
539
 
Additions (deductions)
                               
Provision for loan losses
   
(1,439
)
   
-
     
(1,037
)
   
-
 
Recoveries credited to allowance
   
3,623
     
-
     
3,418
     
-
 
Loans charged against the allowance
   
(2,711
)
   
-
     
(3,767
)
   
-
 
Additions (deductions) included in non-interest expense
   
-
     
6
     
-
     
46
 
Balance at end of period
 
$
22,043
   
$
658
   
$
24,604
   
$
585
 
                                 
Net loans charged against the allowance to average Portfolio Loans (annualized)
   
(0.08
)%
           
0.03
%
       

Allocation of the Allowance for Loan Losses

   
September 30,
2016
   
December 31,
2015
 
   
(In thousands)
 
Specific allocations
 
$
10,375
   
$
10,983
 
Other adversely rated commercial loans
   
559
     
1,053
 
Historical loss allocations
   
5,566
     
5,262
 
Additional allocations based on subjective factors
   
5,543
     
5,272
 
Total
 
$
22,043
   
$
22,570
 

Some loans will not be repaid in full. Therefore, an allowance for loan losses (“AFLL”) is maintained at a level which represents our best estimate of losses incurred. In determining the AFLL and the related provision for loan losses, we consider four principal elements: (i) specific allocations based upon probable losses identified during the review of the loan portfolio, (ii) allocations established for other adversely rated commercial loans, (iii) allocations based principally on historical loan loss experience, and (iv) additional allowances based on subjective factors, including local and general economic business factors and trends, portfolio concentrations and changes in the size and/or the general terms of the loan portfolios.
 
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The first AFLL element (specific allocations) reflects our estimate of probable incurred losses based upon our systematic review of specific loans. These estimates are based upon a number of factors, such as payment history, financial condition of the borrower, discounted collateral exposure and discounted cash flow analysis. Impaired commercial, mortgage and installment loans are allocated allowance amounts using this first element. The second AFLL element (other adversely rated commercial loans) reflects the application of our commercial loan rating system. This rating system is similar to those employed by state and federal banking regulators. Commercial loans that are rated below a certain predetermined classification are assigned a loss allocation factor for each loan classification category that is based upon a historical analysis of both the probability of default and the expected loss rate (“loss given default”). The lower the rating assigned to a loan or category, the greater the allocation percentage that is applied. The third AFLL element (historical loss allocations) is determined by assigning allocations to higher rated (“non-watch credit”) commercial loans using a probability of default and loss given default similar to the second AFLL element and to homogenous mortgage and installment loan groups based upon borrower credit score and portfolio segment.  For homogenous mortgage and installment loans a probability of default for each homogenous pool is calculated by way of credit score migration.  Historical loss data for each homogenous pool coupled with the associated probability of default is utilized to calculate an expected loss allocation rate.  The fourth AFLL element (additional allocations based on subjective factors) is based on factors that cannot be associated with a specific credit or loan category and reflects our attempt to ensure that the overall allowance for loan losses appropriately reflects a margin for the imprecision necessarily inherent in the estimates of expected credit losses. We consider a number of subjective factors when determining this fourth element, including local and general economic business factors and trends, portfolio concentrations and changes in the size, mix and the general terms of the overall loan portfolio.

Increases in the AFLL are recorded by a provision for loan losses charged to expense. Although we periodically allocate portions of the AFLL to specific loans and loan portfolios, the entire AFLL is available for incurred losses. We generally charge-off commercial, homogenous residential mortgage and installment loans and payment plan receivables when they are deemed uncollectible or reach a predetermined number of days past due based on product, industry practice and other factors. Collection efforts may continue and recoveries may occur after a loan is charged against the AFLL.

While we use relevant information to recognize losses on loans, additional provisions for related losses may be necessary based on changes in economic conditions, customer circumstances and other credit risk factors.

Mepco’s allowance for losses is determined in a similar manner as discussed above, and primarily takes into account historical loss experience and other subjective factors deemed relevant to Mepco’s payment plan business. Estimated incurred losses associated with Mepco’s outstanding vehicle service contract payment plans are included in the provision for loan losses. Mepco recorded a $0.003 million credit and a $0.005 million credit in the first nine months of 2016 and 2015, respectively, for its provision for loan losses.  Mepco’s allowance for loan losses totaled $0.060 million and $0.063 million at September 30, 2016 and December 31, 2015, respectively. Mepco has established procedures for vehicle service contract payment plan servicing, administration and collections, including the timely cancellation of the vehicle service contract, in order to protect our position in the event of payment default or voluntary cancellation by the customer. Mepco has also established procedures to attempt to prevent and detect fraud since the payment plan origination activities and initial customer contacts are done entirely through unrelated third parties (vehicle service contract administrators and sellers or automobile dealerships). However, there can be no assurance that the aforementioned risk management policies and procedures will prevent us from the possibility of incurring significant credit or fraud related losses in this business segment. The estimated incurred losses described in this paragraph should be distinguished from the possible losses we may incur from counterparties failing to pay their obligations to Mepco.  See Note #14 to the Condensed Consolidated Financial Statements included within this report.
 
79

The allowance for loan losses decreased $0.53 million to $22.04 million at September 30, 2016 from $22.57 million at December 31, 2015 and was equal to 1.37% of total Portfolio Loans at September 30, 2016 compared to 1.49% at December 31, 2015. Two of the four components of the allowance for loan losses outlined above declined in the first nine months of 2016. The allowance for loan losses related to specific loans decreased $0.61 million in 2016 due primarily to a $7.0 million decline in the balance of individually impaired loans as well as charge-offs. The allowance for loan losses related to other adversely rated commercial loans decreased $0.49 million in 2016 primarily due to a decrease in the balance of such loans included in this component to $13.8 million at September 30, 2016 from $27.8 million at December 31, 2015. The allowance for loan losses related to historical losses increased $0.30 million during 2016 due principally to loan growth. The allowance for loan losses related to subjective factors increased $0.27 million during 2016 also primarily due to overall growth of the loan portfolio.

Deposits and borrowings.  Historically, the loyalty of our customer base has allowed us to price deposits competitively, contributing to a net interest margin that compares favorably to our peers. However, we still face a significant amount of competition for deposits within many of the markets served by our branch network, which limits our ability to materially increase deposits without adversely impacting the weighted-average cost of core deposits.

To attract new core deposits, we have implemented various account acquisition strategies as well as branch staff sales training. Account acquisition initiatives have historically generated increases in customer relationships. Over the past several years, we have also expanded our treasury management products and services for commercial businesses and municipalities or other governmental units and have also increased our sales calling efforts in order to attract additional deposit relationships from these sectors. We view long-term core deposit growth as an important objective. Core deposits generally provide a more stable and lower cost source of funds than alternative sources such as short-term borrowings. (See “Liquidity and capital resources.”)

Deposits totaled $2.21 billion and $2.09 billion at September 30, 2016 and December 31, 2015, respectively.  The $121.0 million increase in deposits during the first nine months of 2016 is due to growth in checking, savings and time deposit account balances.  Reciprocal deposits totaled $46.6 million and $50.2 million at September 30, 2016 and December 31, 2015, respectively.  These deposits represent demand, money market and time deposits from our customers that have been placed through Promontory Interfinancial Network’s Insured Cash Sweep® service and Certificate of Deposit Account Registry Service®.  These services allow our customers to access multi-million dollar FDIC deposit insurance on deposit balances greater than the standard FDIC insurance maximum.

We cannot be sure that we will be able to maintain our current level of core deposits. In particular, those deposits that are uninsured may be susceptible to outflow. At September 30, 2016, we had approximately $572.4 million of uninsured deposits. A reduction in core deposits would likely increase our need to rely on wholesale funding sources.
 
80

We have also implemented strategies that incorporate using federal funds purchased, other borrowings and Brokered CDs to fund a portion of our interest-earning assets. The use of such alternate sources of funds supplements our core deposits and is also an integral part of our asset/liability management efforts.

Other borrowings, comprised almost entirely of advances from the Federal Home Loan Bank (the “FHLB”), totaled $11.5 million and $12.0 million at September 30, 2016 and December 31, 2015, respectively.

As described above, we utilize wholesale funding, including FHLB borrowings and Brokered CDs to augment our core deposits and fund a portion of our assets. At September 30, 2016, our use of such wholesale funding sources (including reciprocal deposits) amounted to approximately $58.2 million, or 2.6% of total funding (deposits and total borrowings, excluding subordinated debentures). Because wholesale funding sources are affected by general market conditions, the availability of such funding may be dependent on the confidence these sources have in our financial condition and operations. The continued availability to us of these funding sources is not certain. Our liquidity may be constrained if we are unable to renew our wholesale funding sources or if adequate financing is not available in the future at acceptable rates of interest or at all.  Our financial performance could also be affected if we are unable to maintain our access to funding sources or if we are required to rely more heavily on more expensive funding sources. In such case, our net interest income and results of operations could be adversely affected.

We historically employed derivative financial instruments to manage our exposure to changes in interest rates. We discontinued the active use of derivative financial instruments during 2008.  We began to again utilize interest-rate swaps in 2014, relating to our commercial lending activities.  During the first nine months of 2016 and 2015, we entered into $23.0 million and $16.6 million (aggregate notional amounts), respectively, of interest rate swaps with commercial loan customers, which were offset with interest rate swaps that the Bank entered into with a broker-dealer. We recorded $0.4 million and $0.3 million of fee income related to these transactions during each of the first nine month periods of 2016 and 2015, respectively.

Liquidity and capital resources. Liquidity risk is the risk of being unable to timely meet obligations as they come due at a reasonable funding cost or without incurring unacceptable losses. Our liquidity management involves the measurement and monitoring of a variety of sources and uses of funds. Our Condensed Consolidated Statements of Cash Flows categorize these sources and uses into operating, investing and financing activities. We primarily focus our liquidity management on maintaining adequate levels of liquid assets (primarily funds on deposit with the FRB and certain securities available for sale) as well as developing access to a variety of borrowing sources to supplement our deposit gathering activities and provide funds for purchasing securities available for sale or originating Portfolio Loans as well as to be able to respond to unforeseen liquidity needs.

Our primary sources of funds include our deposit base, secured advances from the FHLB, a federal funds purchased borrowing facility with another commercial bank, and access to the capital markets (for Brokered CDs).
 
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At September 30, 2016, we had $324.1 million of time deposits that mature in the next 12 months. Historically, a majority of these maturing time deposits are renewed by our customers. Additionally, $1.74 billion of our deposits at September 30, 2016, were in account types from which the customer could withdraw the funds on demand. Changes in the balances of deposits that can be withdrawn upon demand are usually predictable and the total balances of these accounts have generally grown or have been stable over time as a result of our marketing and promotional activities. However, there can be no assurance that historical patterns of renewing time deposits or overall growth or stability in deposits will continue in the future.

We have developed contingency funding plans that stress test our liquidity needs that may arise from certain events such as an adverse change in our financial metrics (for example, credit quality or regulatory capital ratios). Our liquidity management also includes periodic monitoring that measures quick assets (defined generally as short-term assets with maturities less than 30 days and loans held for sale) to total assets, short-term liability dependence and basic surplus (defined as quick assets compared to short-term liabilities). Policy limits have been established for our various liquidity measurements and are monitored on a monthly basis. In addition, we also prepare cash flow forecasts that include a variety of different scenarios.

We believe that we currently have adequate liquidity at our Bank because of our cash and cash equivalents, our portfolio of securities available for sale, our access to secured advances from the FHLB, our ability to issue Brokered CDs and our improved financial metrics.

We also believe that the available cash on hand at the parent company (including time deposits) of approximately $11.5 million as of September 30, 2016 provides sufficient liquidity resources at the parent company to meet operating expenses, to make interest payments on the subordinated debentures and to pay a cash dividend on our common stock for the foreseeable future.

Effective management of capital resources is critical to our mission to create value for our shareholders. In addition to common stock, our capital structure also currently includes cumulative trust preferred securities.

Capitalization
           
   
September 30,
2016
   
December 31,
2015
 
   
(In thousands)
 
Subordinated debentures
 
$
35,569
   
$
35,569
 
Amount not qualifying as regulatory capital
   
(1,069
)
   
(1,069
)
Amount qualifying as regulatory capital
   
34,500
     
34,500
 
Shareholders’ equity
               
Common stock
   
323,303
     
339,462
 
Accumulated deficit
   
(69,386
)
   
(82,334
)
Accumulated other comprehensive loss
   
(3,015
)
   
(6,036
)
Total shareholders’ equity
   
250,902
     
251,092
 
Total capitalization
 
$
285,402
   
$
285,592
 

We currently have three special purpose entities with $34.5 million of outstanding cumulative trust preferred securities.  These special purpose entities issued common securities and provided cash to our parent company that in turn issued subordinated debentures to these special purpose entities equal to the trust preferred securities and common securities. The subordinated debentures represent the sole asset of the special purpose entities. The common securities and subordinated debentures are included in our Condensed Consolidated Statements of Financial Condition.
 
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The FRB has issued rules regarding trust preferred securities as a component of the Tier 1 capital of bank holding companies. The aggregate amount of trust preferred securities (and certain other capital elements) are limited to 25 percent of Tier 1 capital elements, net of goodwill (net of any associated deferred tax liability). The amount of trust preferred securities and certain other elements in excess of the limit can be included in Tier 2 capital, subject to restrictions. At the parent company, all of these securities qualified as Tier 1 capital at September 30, 2016 and December 31, 2015. Although the Dodd-Frank Act further limited Tier 1 treatment for trust preferred securities, those new limits did not apply to our outstanding trust preferred securities.  Further, the New Capital Rules grandfathered the treatment of our trust preferred securities as qualifying regulatory capital.

Common shareholders’ equity decreased slightly to $250.9 million at September 30, 2016 from $251.1 million at December 31, 2015 due primarily to share repurchases and dividends paid that were partially offset by our net income in the first nine months of 2016 and a decline in our accumulated other comprehensive loss.

We resumed a quarterly cash dividend on our common stock of six cents per share in May 2014 and continued to pay regular quarterly dividends at that amount through August 2015.  In October 2016 and 2015, our Board of Directors increased the quarterly cash dividend on our common stock to ten cents and eight cents per share, respectively.

For the past several years, the Bank had negative “undivided profits” (i.e. a retained deficit). Under Michigan banking regulations, the Bank was not permitted to pay a dividend when it had a retained deficit.  We can request regulatory approval for a return of capital from the Bank to the parent company. During the first quarter of 2016, we requested regulatory approval for an $18.0 million return of capital from the Bank to the parent company.  This return of capital request was approved by our banking regulators on February 24, 2016 and the Bank returned $18.0 million of capital to the parent company on February 25, 2016.  In the second quarter of 2016, the Bank returned to a positive retained earnings position.  At September 30, 2016, the Bank had retained earnings of $8.7 million.  In October 2016, the Bank paid a $5.0 million dividend to the parent company.  Also see Note #11 to the Condensed Consolidated Financial Statements included within this report.

On January 21, 2016, our Board of Directors authorized a share repurchase plan.  Under the terms of the 2016 share repurchase plan, we are authorized to buy back up to 5% of our outstanding common stock.    The repurchase plan is authorized to last through December 31, 2016.  We intend and expect to accomplish the repurchases through open market transactions, though we could effect repurchases through other means, such as privately negotiated transactions.  The timing and amount of any share repurchases will depend on a variety of factors, including, among others, securities law restrictions, the trading price of our common stock, other regulatory requirements, potential alternative uses for capital, and our financial performance. The repurchase program does not obligate us to acquire any particular amount of common stock, and it may be modified or suspended at any time at our discretion.  On April 26, 2016 our Board of Directors authorized a $5.0 million expansion of this repurchase plan. Through October 31, 2016, we repurchased 1,153,136 shares of our common stock pursuant to this plan at an average price of $14.62 per share leaving $4.4 million remaining under this repurchase plan.
 
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As of September 30, 2016 and December 31, 2015, our Bank (and holding company) continued to meet the requirements to be considered “well-capitalized” under federal regulatory standards (also see Note #11 to the Condensed Consolidated Financial Statements included within this report).

Asset/liability management.  Interest-rate risk is created by differences in the cash flow characteristics of our assets and liabilities. Options embedded in certain financial instruments, including caps on adjustable-rate loans as well as borrowers’ rights to prepay fixed-rate loans, also create interest-rate risk.

Our asset/liability management efforts identify and evaluate opportunities to structure our statement of financial condition in a manner that is consistent with our mission to maintain profitable financial leverage within established risk parameters. We evaluate various opportunities and alternate asset/liability management strategies carefully and consider the likely impact on our risk profile as well as the anticipated contribution to earnings. The marginal cost of funds is a principal consideration in the implementation of our asset/liability management strategies, but such evaluations further consider interest-rate and liquidity risk as well as other pertinent factors. We have established parameters for interest-rate risk. We regularly monitor our interest-rate risk and report at least quarterly to our board of directors.

We employ simulation analyses to monitor our interest-rate risk profile and evaluate potential changes in our net interest income and market value of portfolio equity that result from changes in interest rates. The purpose of these simulations is to identify sources of interest-rate risk. The simulations do not anticipate any actions that we might initiate in response to changes in interest rates and, accordingly, the simulations do not provide a reliable forecast of anticipated results. The simulations are predicated on immediate, permanent and parallel shifts in interest rates and generally assume that current loan and deposit pricing relationships remain constant. The simulations further incorporate assumptions relating to changes in customer behavior, including changes in prepayment rates on certain assets and liabilities.
 
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Changes in Market Value of Portfolio Equity and Net Interest Income

Change in Interest
Rates
 
Market Value
Of Portfolio
Equity(1)
   
Percent
Change
   
Net Interest
Income(2)
   
Percent
Change
 
   
(Dollars in thousands)
 
September 30, 2016
                       
200 basis point rise
 
$
387,000
     
11.50
%
 
$
85,700
     
7.93
%
100 basis point rise
   
372,400
     
7.29
     
83,000
     
4.53
 
Base-rate scenario
   
347,100
     
-
     
79,400
     
-
 
100 basis point decline
   
314,500
     
(9.39
)
   
74,700
     
(5.92
)
                                 
December 31, 2015
                               
200 basis point rise
 
$
419,600
     
8.42
%
 
$
80,700
     
6.32
%
100 basis point rise
   
407,300
     
5.25
     
78,700
     
3.69
 
Base-rate scenario
   
387,000
     
-
     
75,900
     
-
 
100 basis point decline
   
356,500
     
(7.88
)
   
72,000
     
(5.14
)
 

(1)
Simulation analyses calculate the change in the net present value of our assets and liabilities, including debt and related financial derivative instruments, under parallel shifts in interest rates by discounting the estimated future cash flows using a market-based discount rate. Cash flow estimates incorporate anticipated changes in prepayment speeds and other embedded options.
(2)
Simulation analyses calculate the change in net interest income under immediate parallel shifts in interest rates over the next twelve months, based upon a static statement of financial condition, which includes debt and related financial derivative instruments, and do not consider loan fees.

Accounting standards update. See Note #2  to  the Condensed Consolidated Financial Statements included elsewhere in this report for details on recently issued accounting pronouncements and their impact on our financial statements.

Fair valuation of financial instruments.  Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) topic 820 - “Fair Value Measurements and Disclosures” (“FASB ASC topic 820”) defines fair value as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date.

We utilize fair value measurements to record fair value adjustments to certain financial instruments and to determine fair value disclosures. FASB ASC topic 820 differentiates between those assets and liabilities required to be carried at fair value at every reporting period (“recurring”) and those assets and liabilities that are only required to be adjusted to fair value under certain circumstances (“nonrecurring”). Trading securities, securities available-for-sale, loans held for sale, and derivatives are financial instruments recorded at fair value on a recurring basis. Additionally, from time to time, we may be required to record at fair value other financial assets on a nonrecurring basis, such as loans held for investment, capitalized mortgage loan servicing rights and certain other assets. These nonrecurring fair value adjustments typically involve application of lower of cost or market accounting or write-downs of individual assets. See Note #12 to the Condensed Consolidated Financial Statements included within this report for a complete discussion on our use of fair valuation of financial instruments and the related measurement techniques.
 
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 Litigation Matters

We are involved in various litigation matters in the ordinary course of business. At the present time, we do not believe any of these matters will have a significant impact on our consolidated financial position or results of operations. The aggregate amount we have accrued for losses we consider probable as a result of these litigation matters is immaterial. However, because of the inherent uncertainty of outcomes from any litigation matter, we believe it is reasonably possible we may incur losses in addition to the amounts we have accrued.  At this time, we estimate the maximum amount of additional losses that are reasonably possible is approximately $1.0 million.  However, because of a number of factors, including the fact that certain of these litigation matters are still in their early stages, this maximum amount may change in the future.

The litigation matters described in the preceding paragraph primarily include claims that have been brought against us for damages, but do not include litigation matters where we seek to collect amounts owed to us by third parties (such as litigation initiated to collect delinquent loans or vehicle service contract counterparty receivables). These excluded, collection-related matters may involve claims or counterclaims by the opposing party or parties, but we have excluded such matters from the disclosure contained in the preceding paragraph in all cases where we believe the possibility of us paying damages to any opposing party is remote. Risks associated with the likelihood that we will not collect the full amount owed to us, net of reserves, are disclosed elsewhere in this report.

 Critical Accounting Policies

Our accounting and reporting policies are in accordance with accounting principles generally accepted in the United States of America and conform to general practices within the banking industry. Accounting and reporting policies for the allowance for loan losses, capitalized mortgage loan servicing rights, vehicle service contract payment plan counterparty contingencies, and income taxes are deemed critical since they involve the use of estimates and require significant management judgments. Application of assumptions different than those that we have used could result in material changes in our consolidated financial position or results of operations.  During the first quarter of 2016, we dropped the assessment of other than temporary impairment of securities available for sale as a critical accounting policy as we do not believe that this assessment will have a material impact on our consolidated financial position or results of operations.  There have been no other material changes to our critical accounting policies as disclosed in our Annual Report on Form 10-K for the year ended December 31, 2015.
 
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Item 3.

Quantitative and Qualitative Disclosures about Market Risk

See applicable disclosures set forth in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in Item 2 under the caption “Asset/liability management.”

Item 4.

Controls and Procedures

(a)
Evaluation of Disclosure Controls and Procedures.

With the participation of management, our chief executive officer and chief financial officer, after evaluating the effectiveness of our disclosure controls and procedures (as defined in Exchange Act Rules 13a – 15(e) and 15d – 15(e)) for the period ended September 30, 2016, have concluded that, as of such date, our disclosure controls and procedures were effective.

(b)
Changes in Internal Controls.

During the quarter ended September 30, 2016, there were no changes in our internal control over financial reporting that materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
 
87

Part II

Item 1A. 
Risk Factors

There have been no material changes to the risk factors disclosed in Item 1A. Risk Factors of our Annual Report on Form 10-K for the year ended December 31, 2015.

Item 2. 
Unregistered Sales of Equity Securities and Use of Proceeds

The Company maintains a Deferred Compensation and Stock Purchase Plan for Non-Employee Directors (the "Plan") pursuant to which non-employee directors can elect to receive shares of the Company's common stock in lieu of fees otherwise payable to the director for his or her service as a director.  A director can elect to receive shares on a current basis or to defer receipt of the shares, in which case the shares are issued to a trust to be held for the account of the director and then generally distributed to the director after his or her retirement from the Board.  Pursuant to this Plan, during the third quarter of 2016, the Company issued 652 shares of common stock to non-employee directors on a current basis and 1,325 shares of common stock to the trust for distribution to directors on a deferred basis.  The shares were issued on July 1, 2016, at a price of $14.51 per share, representing aggregate fees of $0.03 million.   The price per share was the consolidated closing bid price per share of the Company's common stock as of the date of issuance, as determined in accordance with NASDAQ Marketplace Rules.  The Company issued the shares pursuant to an exemption from registration under Section 4(2) of the Securities Act of 1933 due to the fact that the issuance of the shares was made on a private basis pursuant to the Plan.

The following table shows certain information relating to repurchases of common stock for the three-months ended September 30, 2016:

Period
 
Total Number of
Shares Purchased
   
Average Price
Paid Per Share
   
Total Number of
Shares Purchased
as Part of a
Publicly
Announced Plan
   
Remaining
Number of
Shares Authorized
for Purchase
Under the Plan(1)
 
July 2016
   
93,271
   
$
14.41
     
93,271
     
-
 
August 2016
   
-
     
-
     
-
     
-
 
September 2016
   
-
     
-
     
-
     
-
 
Total
   
93,271
   
$
14.41
     
93,271
     
-
 

(1)
Plus an additional $4.4 million.
 
88

Item 6.  
Exhibits
 
(a)
The following exhibits (listed by number corresponding to the Exhibit Table as Item 601 in Regulation S-K) are filed with this report:
  31.1
Certificate of the Chief Executive Officer of Independent Bank Corporation pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 (18 U.S.C. 1350).
31.2
Certificate of the Chief Financial Officer of Independent Bank Corporation pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 (18 U.S.C. 1350).
32.1
Certificate of the Chief Executive Officer of Independent Bank Corporation pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (18 U.S.C. 1350).
Certificate of the Chief Financial Officer of Independent Bank Corporation pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (18 U.S.C. 1350).
101. INS Instance Document
 
101. SCH XBRL Taxonomy Extension Schema Document
101. CAL XBRL Taxonomy Extension Calculation Linkbase Document
101. DEF XBRL Taxonomy Extension Definition Linkbase Document
101. LAB XBRL Taxonomy Extension Label Linkbase Document
101. PRE XBRL Taxonomy Extension Presentation Linkbase Document
 
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SIGNATURES

Pursuant to the requirements 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.

Date
 
        November 3, 2016
 
By
/s/ Robert N. Shuster
     
Robert N. Shuster, Principal Financial Officer
       
Date
 
        November 3, 2016
 
By
/s/ James J. Twarozynski
     
James J. Twarozynski, Principal Accounting Officer
 
 
90