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INDEPENDENT BANK CORP /MI/ - Quarter Report: 2018 March (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 March 31, 2018

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, smaller reporting company or an emerging growth company.
 
Large accelerated filer ☐ Accelerated filer ☒ Non-accelerated filer ☐ Smaller reporting company ☐ Emerging growth company  ☐

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to section 13(a) of the Exchange Act.  Yes ☐  No ☐

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
 
24,106,711
Class
 
Outstanding at May 2, 2018
 


INDEPENDENT BANK CORPORATION AND SUBSIDIARIES

INDEX

   
Number(s)
PART I -
Financial Information
 
Item 1.
3
 
4
 
5
 
6
 
7
 
8-54
Item 2.
55-77
Item 3.
78
Item 4.
78
     
PART II -
Other Information
 
Item 1A
79
Item 2.
79
Item 6.
80
 
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;
·
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.
 
In addition, factors that may cause actual results to differ from expectations regarding the April 1, 2018 acquisition of TCSB Bancorp, Inc. include, but are not limited to, the reaction to the transaction of the companies’ customers, employees and counterparties; customer disintermediation; inflation; expected synergies, cost savings and other financial benefits of the transaction might not be realized within the expected timeframes or might be less than projected; credit and interest rate risks associated with the parties' respective businesses, customers, borrowings, repayment, investment, and deposit practices; general economic conditions, either nationally or in the market areas in which the parties operate or anticipate doing business, are less favorable than expected; new regulatory or legal requirements or obligations; and other risks.
 
The risk factors disclosed in Part I – Item 1A of our Annual Report on Form 10-K for the year ended December 31, 2017, 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

   
March 31,
2018
   
December 31,
2017
 
   
(unaudited)
 
   
(In thousands, except share
amounts)
 
Assets
               
Cash and due from banks
 
$
29,126
   
$
36,994
 
Interest bearing deposits
   
13,250
     
17,744
 
Cash and Cash Equivalents
   
42,376
     
54,738
 
Interest bearing deposits - time
   
1,738
     
2,739
 
Equity securities at fair value
   
301
     
-
 
Trading securities
   
-
     
455
 
Securities available for sale
   
489,119
     
522,925
 
Federal Home Loan Bank and Federal Reserve Bank stock, at cost
   
15,543
     
15,543
 
Loans held for sale, carried at fair value
   
34,148
     
39,436
 
Loans
               
Commercial
   
857,417
     
853,260
 
Mortgage
   
888,910
     
849,530
 
Installment
   
325,108
     
316,027
 
Total Loans
   
2,071,435
     
2,018,817
 
Allowance for loan losses
   
(23,071
)
   
(22,587
)
Net Loans
   
2,048,364
     
1,996,230
 
Other real estate and repossessed assets
   
1,647
     
1,643
 
Property and equipment, net
   
38,809
     
39,149
 
Bank-owned life insurance
   
54,353
     
54,572
 
Deferred tax assets, net
   
13,715
     
15,089
 
Capitalized mortgage loan servicing rights
   
17,783
     
15,699
 
Other intangibles
   
1,500
     
1,586
 
Accrued income and other assets
   
33,723
     
29,551
 
Total Assets
 
$
2,793,119
   
$
2,789,355
 
                 
Liabilities and Shareholders' Equity
               
Deposits
               
Non-interest bearing
 
$
774,046
   
$
768,333
 
Savings and interest-bearing checking
   
1,100,505
     
1,064,391
 
Reciprocal
   
63,012
     
50,979
 
Time
   
377,663
     
374,872
 
Brokered time
   
115,175
     
141,959
 
Total Deposits
   
2,430,401
     
2,400,534
 
Other borrowings
   
27,847
     
54,600
 
Subordinated debentures
   
35,569
     
35,569
 
Accrued expenses and other liabilities
   
31,385
     
33,719
 
Total Liabilities
   
2,525,202
     
2,524,422
 
                 
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: 21,374,816 shares at March 31, 2018 and 21,333,869 shares at December 31, 2017
   
324,517
     
324,986
 
Accumulated deficit
   
(48,098
)
   
(54,054
)
Accumulated other comprehensive loss
   
(8,502
)
   
(5,999
)
Total Shareholders’ Equity
   
267,917
     
264,933
 
Total Liabilities and Shareholders’ Equity
 
$
2,793,119
   
$
2,789,355
 
 
See notes to interim condensed consolidated financial statements (unaudited)
 
3

INDEPENDENT BANK CORPORATION AND SUBSIDIARIES
Condensed Consolidated Statements of Operations

   
Three months ended
March 31,
 
   
2018
     
2017
 
    (unaudited)  
    (In thousands, except
 per share amounts)
 
Interest Income
             
Interest and fees on loans
 
$
23,353
     
$
19,858
 
Interest on securities
                 
Taxable
   
2,635
       
2,754
 
Tax-exempt
   
479
       
455
 
Other investments
   
330
       
312
 
Total Interest Income
   
26,797
       
23,379
 
Interest Expense
                 
Deposits
   
2,287
       
1,443
 
Other borrowings and subordinated debentures
   
574
       
470
 
Total Interest Expense
   
2,861
       
1,913
 
Net Interest Income
   
23,936
       
21,466
 
Provision for loan losses
   
315
       
(359
)
Net Interest Income After Provision for Loan Losses
   
23,621
       
21,825
 
Non-interest Income
                 
Service charges on deposit accounts
   
2,905
       
3,009
 
Interchange income
   
2,246
       
1,922
 
Net gains (losses) on assets
                 
Mortgage loans
   
2,571
       
2,571
 
Securities
   
(173
)
     
27
 
Mortgage loan servicing, net
   
2,221
       
825
 
Other
   
1,943
       
1,985
 
Total Non-interest Income
   
11,713
       
10,339
 
Non-interest Expense
                 
Compensation and employee benefits
   
14,468
       
14,147
 
Occupancy, net
   
2,264
       
2,142
 
Data processing
   
1,878
       
1,937
 
Furniture, fixtures and equipment
   
967
       
977
 
Communications
   
680
       
683
 
Loan and collection
   
677
       
413
 
Interchange expense
   
598
       
283
 
Advertising
   
441
       
506
 
Legal and professional
   
378
       
437
 
FDIC deposit insurance
   
230
       
198
 
Merger related expenses
   
174
       
-
 
Credit card and bank service fees
   
96
       
191
 
Other
   
1,284
       
1,655
 
Total Non-interest Expense
   
24,135
       
23,569
 
Income Before Income Tax
   
11,199
       
8,595
 
Income tax expense
   
2,038
       
2,621
 
Net Income
 
$
9,161
     
$
5,974
 
Net Income Per Common Share
                 
Basic
 
$
0.43
     
$
0.28
 
Diluted
 
$
0.42
     
$
0.28
 
Dividends Per Common Share
                 
Declared
 
$
0.15
     
$
0.10
 
Paid
 
$
0.15
     
$
0.10
 
 
See notes to interim condensed consolidated financial statements (unaudited)
 
4

INDEPENDENT BANK CORPORATION AND SUBSIDIARIES
Condensed Consolidated Statements of Comprehensive Income
 
   
Three months ended
March 31,
 
   
2018
   
2017
 
   
(unaudited)
 
   
(In thousands)
 
             
Net income
 
$
9,161
   
$
5,974
 
Other comprehensive income (loss), before tax
               
Securities available for sale
               
Unrealized gains (losses) arising during period
   
(3,865
)
   
3,623
 
Change in unrealized gains for which a portion of other than temporary impairment has been recognized in earnings
   
(1
)
   
(22
)
Reclassification adjustments for (gains) losses included in earnings
   
19
     
(106
)
Unrealized gains (losses) recognized in other comprehensive income (loss) on securities available for sale
   
(3,847
)
   
3,495
 
Income tax expense (benefit)
   
(808
)
   
1,223
 
Unrealized gains (losses)recognized in other comprehensive income (loss) on securities available for sale, net of tax
   
(3,039
)
   
2,272
 
Derivative instruments
               
Unrealized gain arising during period
   
684
     
-
 
Reclassification adjustment for income recognized in earnings
   
(6
)
   
-
 
Unrealized gains recognized in other comprehensive income (loss) on derivative instruments
   
678
     
-
 
Income tax expense
   
142
     
-
 
Unrealized gains recognized in other comprehensive income (loss) on derivative instruments, net of tax
   
536
     
-
 
Other comprehensive income (loss)
   
(2,503
)
   
2,272
 
Comprehensive income
 
$
6,658
   
$
8,246
 
 
See notes to interim condensed consolidated financial statements (unaudited)
 
5

INDEPENDENT BANK CORPORATION AND SUBSIDIARIES
Condensed Consolidated Statements of Cash Flows

   
Three months ended March 31,
 
   
2018
   
2017
 
   
(unaudited - In thousands)
 
Net Income
 
$
9,161
   
$
5,974
 
Adjustments to Reconcile Net Income to Net Cash From Operating Activities
               
Proceeds from sales of loans held for sale
   
92,607
     
81,681
 
Disbursements for loans held for sale
   
(84,748
)
   
(80,777
)
Net increase in other liabilities held for sale
   
-
     
717
 
Provision for loan losses
   
315
     
(359
)
Deferred income tax expense
   
2,039
     
2,451
 
Deferred loan fees and costs
   
(638
)
   
(931
)
Net depreciation, amortization of intangible assets and premiums and accretion of discounts on securities, loans and interest bearing deposits - time
   
1,819
     
1,279
 
Net gains on mortgage loans
   
(2,571
)
   
(2,571
)
Net gains (losses) on securities
   
173
     
(27
)
Net (gains) losses on other real estate and repossessed assets
   
(290
)
   
11
 
Share based compensation
   
407
     
432
 
Increase in accrued income and other assets
   
(5,675
)
   
(1,272
)
Decrease in accrued expenses and other liabilities
   
(5,711
)
   
(3,229
)
Total Adjustments
   
(2,273
)
   
(2,595
)
Net Cash From Operating Activities
   
6,888
     
3,379
 
Cash Flow Used in Investing Activities
               
Proceeds from the sale of securities available for sale
   
22,277
     
6,152
 
Proceeds from maturities, prepayments and calls of securities available for sale
   
34,067
     
50,075
 
Purchases of securities available for sale
   
(23,637
)
   
(45,673
)
Proceeds from the maturity of interest bearing deposits - time
   
1,000
     
251
 
Net increase in portfolio loans (loans originated, net of principal payments)
   
(68,611
)
   
(61,003
)
Proceeds from the sale of portfolio loans
   
16,460
     
-
 
Net increase in payment plan receivables and other assets held for sale
   
-
     
(1,438
)
Proceeds from bank-owned life insurance
   
474
     
523
 
Proceeds from the sale of other real estate and repossessed assets
   
608
     
238
 
Capital expenditures
   
(921
)
   
(680
)
Net Cash Used in Investing Activities
   
(18,283
)
   
(51,555
)
Cash Flow From (Used in) Financing Activities
               
Net increase in total deposits
   
29,867
     
37,340
 
Net decrease in other borrowings
   
(6,753
)
   
-
 
Proceeds from Federal Home Loan Bank Advances
   
40,000
     
-
 
Payments of Federal Home Loan Bank Advances
   
(60,000
)
   
-
 
Dividends paid
   
(3,206
)
   
(2,133
)
Proceeds from issuance of common stock
   
13
     
25
 
Share based compensation withholding obligation
   
(888
)
   
(427
)
Net Cash From (Used in) Financing Activities
   
(967
)
   
34,805
 
Net Decrease in Cash and Cash Equivalents
   
(12,362
)
   
(13,371
)
Cash and Cash Equivalents at Beginning of Period
   
54,738
     
83,194
 
Cash and Cash Equivalents at End of Period
 
$
42,376
   
$
69,823
 
Cash paid during the period for
               
Interest
 
$
2,656
   
$
1,622
 
Income taxes
   
-
     
140
 
Transfers to other real estate and repossessed assets
   
322
     
502
 
Purchase of securities available for sale not yet settled
   
3,220
     
6,046
 
 
See notes to interim condensed consolidated financial statements (unaudited)
 
6

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

   
Three months ended
March 31,
 
   
2018
   
2017
 
   
(unaudited)
 
   
(In thousands)
 
             
Balance at beginning of period
 
$
264,933
   
$
248,980
 
Cumulative effect of change in accounting
   
-
     
352
 
Balance at beginning of period, as adjusted
   
264,933
     
249,332
 
Net income
   
9,161
     
5,974
 
Cash dividends declared
   
(3,206
)
   
(2,133
)
Issuance of common stock
   
13
     
25
 
Share based compensation
   
407
     
432
 
Share based compensation withholding obligation
   
(888
)
   
(427
)
Net change in accumulated other comprehensive loss, net of related tax effect
   
(2,503
)
   
2,272
 
Balance at end of period
 
$
267,917
   
$
255,475
 
 
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, 2017 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 March 31, 2018 and December 31, 2017, and the results of operations for the three-month periods ended March 31, 2018 and 2017.  The results of operations for the three-month period ended March 31, 2018, 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 valuation of capitalized mortgage loan servicing rights and the valuation of deferred tax assets.  Refer to our 2017 Annual Report on Form 10-K for a disclosure of our accounting policies.

2.
New Accounting Standards

In February 2016, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2016-02, “Leases  (Topic 842)”.  This ASU amends existing guidance related to the accounting for leases. These amendments, among other things, require 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.  Based on a review of our operating leases that we currently have in place we do not expect a material change in the recognition, measurement and presentation of lease expense or impact on cash flow.  While the primary impact will be the recognition of certain operating leases on our Condensed Consolidated Statements of Financial Condition this impact is not expected to be material.

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 securities available for sale, 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 began evaluating this ASU in 2016 and have formed a committee that includes personnel from various areas of Independent Bank (the “Bank”) that meets regularly to discuss the implementation of the ASU.  We are currently in the process of gathering data and reviewing loss methodologies and have engaged third party resources that will assist us in the implementation of this ASU.  While we have not yet determined what the impact will be on our consolidated operating results or financial condition by the nature of the implementation of an expected loss model compared to an incurred loss approach, we would expect our allowance for loan losses (“AFLL”) to increase under this ASU.
 
8

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

In August 2017, the FASB issued ASU 2017-12, “Derivatives and Hedging (Topic 815), Targeted Improvements to Accounting for Hedging Activities”.  This new ASU amends the hedge accounting model in Topic 815 to enable entities to better portray the economics of their risk management activities in the financial statements and enhance the transparency and understandability of hedge results. The amendments expand an entity’s ability to hedge nonfinancial and financial risk components and reduce complexity in fair value hedges of interest rate risk. The guidance eliminates the requirement to separately measure and report hedge ineffectiveness and generally requires the entire change in the fair value of a hedging instrument to be presented in the same income statement line as the hedged item. The guidance also eases certain documentation and assessment requirements and modifies the accounting for components excluded from the assessment of hedge effectiveness.  This amended guidance is effective for us on January 1, 2019, and given our current level of derivatives designated as hedges is not expected to 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)”, (“ASU 2014-09”). 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.  We adopted this ASU using the modified retrospective approach with no material impact to our accumulated deficit at January 1, 2018.  Financial instruments for the most part and related contractual rights and obligations which are the sources of the majority of our operating revenue are excluded from the scope of this amended guidance.  Those operating revenue streams that are included in the scope of this amended guidance were not materially impacted.  Results for reporting periods beginning after January 1, 2018 are presented under this ASU while prior period amounts continue to be reported in accordance with legacy GAAP.  The impact of the adoption of this ASU on our Condensed Consolidated Statements of Operations for the three month period ending March 31, 2018 is summarized in the table below.  In addition, see note #17 for further discussion on our accounting policies for operating revenue streams that are included in the scope of this amended guidance.

The impact of the adoption of ASU 2014-09 on our Condensed Consolidated Statement of Operations for the three months ending March 31, 2018 follows:

       
As Reported
     
Under
Legacy GAAP
     
Impact of
ASU 2014-09
  
   
(In thousands)
 
                   
Non-interest income - Interchange income
 
$
2,246
   
$
1,938
   
$
308
(1)
                         
                         
Non-interest expense - interchange expense
  $
598
    $
290
     
308
(1)
Impact on net income
                 
$
-
 
 
(1)
Represents certain costs charged by payment networks that were previously netted against interchange income.
 
9

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, require 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, require public business entities to use the exit price notion when measuring the fair value of financial instruments for disclosure purposes, require separate presentation of financial assets and financial liabilities by measurement category and form of financial asset and eliminate 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 was effective for us on January 1, 2018.  The adoption of this of this ASU did not have a material impact on our consolidated operating results or financial condition.  As a result of the adoption of this ASU our equity securities previously classified as trading securities are now classified as equity securities at fair value on our March 31, 2018 Condensed Consolidated Statement of Financial Condition.  In addition, this amended guidance impacted certain fair value disclosure items (see note #12).

In January 2017, the FASB issued ASU 2017-01, “Business Combinations (Topic 805), Clarifying the Definition of a Business”.  This new ASU clarifies the definition of a business with the objective of adding guidance to assist entities with evaluating whether transactions should be accounted for as acquisitions (or disposals) of assets or businesses which distinction determines whether goodwill is recorded or not. This amended guidance was effective for us on January 1, 2018, and did not have a material impact on our consolidated operating results or financial condition.

In January 2017, the FASB issued ASU 2017-4, “Intangibles – Goodwill and Other (Topic 350), Simplifying the Test for Goodwill Impairment”.  This new ASU amends the requirement that entities compare the implied fair value of goodwill with its carrying amount as part of step 2 of the goodwill impairment test. As a result, entities should perform their annual or interim goodwill impairment test by comparing the fair value of a reporting unit with its carrying amount and recognize an impairment if the carrying amount exceeds the reporting unit’s fair value. This amended guidance is effective for us on January 1, 2020 with early application permitted. Due to our pending acquisition (see note #16) and expectations this ASU will be relevant to us in 2018 we elected to adopt this amended guidance as of January 1, 2018. The adoption of this ASU did not have a material impact on our consolidated operating results or financial condition.

In February 2018, the FASB issued ASU 2018-02, ‘‘Income Statement – Reporting Comprehensive Income (Topic 220), Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income’’. This new ASU allows a reclassification from accumulated other comprehensive income to retained earnings for stranded tax effects resulting from the Tax Cuts and Jobs Act. As a result, this amended guidance eliminates the stranded tax effects resulting from the Tax Cuts and Jobs Act and will improve the usefulness of information reported to financial statement users. This amended guidance is effective for us on January 1, 2019, with early application permitted in any period for which financial statements have not yet been issued.  We elected to adopt this amended guidance during the fourth quarter of 2017 and it resulted in a $0.04 million reclassification between accumulated other comprehensive loss and accumulated deficit.
 
10

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

3.
Securities

Securities available for sale consist of the following:

 
Amortized
   
Unrealized
     
   
Cost
   
Gains
   
Losses
   
Fair Value
 
   
(In thousands)
 
March 31, 2018
                       
U.S. Treasury
 
$
600
   
$
-
   
$
1
   
$
599
 
U.S. agency
   
24,067
     
15
     
146
     
23,936
 
U.S. agency residential mortgage-backed
   
138,270
     
925
     
1,951
     
137,244
 
U.S. agency commercial mortgage-backed
   
10,218
     
1
     
274
     
9,945
 
Private label mortgage-backed
   
28,690
     
397
     
636
     
28,451
 
Other asset backed
   
90,559
     
165
     
197
     
90,527
 
Obligations of states and political subdivisions
   
154,194
     
336
     
2,707
     
151,823
 
Corporate
   
41,954
     
139
     
344
     
41,749
 
Trust preferred
   
2,931
     
-
     
121
     
2,810
 
Foreign government
   
2,078
     
-
     
43
     
2,035
 
Total
 
$
493,561
   
$
1,978
   
$
6,420
   
$
489,119
 
                                 
December 31, 2017
                               
U.S. Treasury
 
$
898
   
$
-
   
$
-
   
$
898
 
U.S. agency
   
25,667
     
82
     
67
     
25,682
 
U.S. agency residential mortgage-backed
   
137,785
     
1,116
     
983
     
137,918
 
U.S. agency commercial mortgage-backed
   
9,894
     
36
     
170
     
9,760
 
Private label mortgage-backed
   
29,011
     
428
     
330
     
29,109
 
Other asset backed
   
93,811
     
202
     
115
     
93,898
 
Obligations of states and political subdivisions
   
174,073
     
755
     
1,883
     
172,945
 
Corporate
   
47,365
     
578
     
90
     
47,853
 
Trust preferred
   
2,929
     
-
     
127
     
2,802
 
Foreign government
   
2,087
     
-
     
27
     
2,060
 
Total
 
$
523,520
   
$
3,197
   
$
3,792
   
$
522,925
 
 
11

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)
 
                                     
March 31, 2018
                                   
U.S. Treasury
 
$
599
   
$
1
   
$
-
   
$
-
   
$
599
   
$
1
 
U.S. agency
   
13,958
     
101
     
5,556
     
45
     
19,514
     
146
 
U.S. agency residential mortgage-backed
   
44,450
     
877
     
31,930
     
1,074
     
76,380
     
1,951
 
U.S. agency commercial mortgage-backed
   
5,775
     
82
     
4,025
     
192
     
9,800
     
274
 
Private label mortgage- backed
   
15,248
     
349
     
4,263
     
287
     
19,511
     
636
 
Other asset backed
   
37,043
     
97
     
13,897
     
100
     
50,940
     
197
 
Obligations of states and political subdivisions
   
85,527
     
1,323
     
33,654
     
1,384
     
119,181
     
2,707
 
Corporate
   
21,244
     
237
     
3,893
     
107
     
25,137
     
344
 
Trust preferred
   
-
     
-
     
2,810
     
121
     
2,810
     
121
 
Foreign government
   
481
     
18
     
1,554
     
25
     
2,035
     
43
 
Total
 
$
224,325
   
$
3,085
   
$
101,582
   
$
3,335
   
$
325,907
   
$
6,420
 
                                                 
December 31, 2017
                                               
U.S. agency
 
$
5,466
   
$
26
   
$
5,735
   
$
41
   
$
11,201
   
$
67
 
U.S. agency residential mortgage-backed
   
22,198
     
229
     
40,698
     
754
     
62,896
     
983
 
U.S. agency commercial mortgage-backed
   
2,181
     
34
     
3,994
     
136
     
6,175
     
170
 
Private label mortgage-backed
   
11,390
     
92
     
4,396
     
238
     
15,786
     
330
 
Other asset backed
   
20,352
     
40
     
16,648
     
75
     
37,000
     
115
 
Obligations of states and political subdivisions
   
76,574
     
936
     
28,246
     
947
     
104,820
     
1,883
 
Corporate
   
14,440
     
33
     
3,943
     
57
     
18,383
     
90
 
Trust preferred
   
-
     
-
     
2,802
     
127
     
2,802
     
127
 
Foreign government
   
489
     
10
     
1,571
     
17
     
2,060
     
27
 
Total
 
$
153,090
   
$
1,400
   
$
108,033
   
$
2,392
   
$
261,123
   
$
3,792
 

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 (loss).
 
12

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

U.S. Treasury, U.S. agency, U.S. agency residential mortgage-backed securities and U.S. agency commercial mortgage backed securities — at March 31, 2018, we had one U.S. Treasury, 43 U.S. agency, 134 U.S. agency residential mortgage-backed and 18 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 March 31, 2018, we had 27 of this type of security whose fair value is less than amortized cost. Unrealized losses are primarily due to credit spread widening and increases in interest rates since their acquisition.

Two private label mortgage-backed securities (included in the securities discussed further below) were 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 these two securities whose fair value is less than amortized cost.  See further discussion below.

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 March 31, 2018, we had 103 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 March 31, 2018, we had 382 municipal securities whose fair value is less than amortized cost. The unrealized losses are primarily due to wider benchmark pricing spreads and increases in interest rates since acquisition. Tax exempt securities have been negatively impacted by lower federal tax rates signed into law in December, 2017. 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 March 31, 2018, we had 26 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.

Trust preferred securities — at March 31, 2018, 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.
 
13

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

Two of the three securities are rated by two major rating agencies as investment grade while 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 $0.9 million as of March 31, 2018, continues to have satisfactory credit metrics and make interest payments.

The following table breaks out our trust preferred securities in further detail as of March 31, 2018 and December 31, 2017:

   
March 31, 2018
   
December 31, 2017
 
   
Fair
Value
   
Net
Unrealized
Loss
   
Fair
Value
   
Net
Unrealized
Loss
 
   
(In thousands)
 
                         
Trust preferred securities
                       
Rated issues
 
$
1,875
   
$
(56
)
 
$
1,860
   
$
(69
)
Unrated issues
   
935
     
(65
)
   
942
     
(58
)
 
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.

Foreign government — at March 31, 2018, we had two foreign government securities whose fair value is less than amortized cost. The unrealized losses are primarily due to 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.

We recorded no credit related OTTI charges in our Condensed Consolidated Statements of Operations related to securities available for sale during the three month periods ended March 31, 2018 and 2017, respectively.

At March 31, 2018, 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)
 
                         
Fair value
 
$
996
   
$
921
   
$
58
   
$
1,975
 
Amortized cost
   
853
     
756
     
-
     
1,609
 
Non-credit unrealized loss
   
-
     
-
     
-
     
-
 
Unrealized gain
   
143
     
165
     
58
     
366
 
Cumulative credit related OTTI
   
757
     
457
     
380
     
1,594
 
 
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 March 31, 2018.  The original amortized cost (current amortized cost excluding cumulative credit related OTTI) 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.
 
14

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

A roll forward of credit losses recognized in earnings on securities available for sale follows:

   
Three months ended
March 31,
 
   
2018
   
2017
 
   
(In thousands)
 
Balance at beginning of period
 
$
1,594
   
$
1,594
 
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
 
$
1,594
   
$
1,594
 
 
The amortized cost and fair value of securities available for sale at March 31, 2018, by contractual maturity, follow:

   
Amortized
Cost
   
Fair
Value
 
   
(In thousands)
 
Maturing within one year
 
$
27,598
   
$
27,580
 
Maturing after one year but within five years
   
76,940
     
76,334
 
Maturing after five years but within ten years
   
68,816
     
67,803
 
Maturing after ten years
   
52,470
     
51,235
 
     
225,824
     
222,952
 
U.S. agency residential mortgage-backed
   
138,270
     
137,244
 
U.S. agency commercial mortgage-backed
   
10,218
     
9,945
 
Private label mortgage-backed
   
28,690
     
28,451
 
Other asset backed
   
90,559
     
90,527
 
Total
 
$
493,561
   
$
489,119
 
 
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 three month periods ending March 31, follows:

         
Realized
 
   
Proceeds
   
Gains
   
Losses
 
   
(In thousands)
 
2018
 
$
22,277
   
$
76
   
$
95
 
2017
   
6,152
     
106
     
-
 
 
Certain preferred stocks have been classified as equity securities at fair value in our Condensed Consolidated Statement of Financial Condition beginning  on January 1, 2018.  Previously these preferred stocks were classified as trading securities.  See note #2.  During the three months ended March 31, 2018 and 2017 we recognized losses on these preferred stocks of $0.154 million and $0.079 million, respectively, that are included in net gains (losses) on securities in the Condensed Consolidated Statements of Operations.  These amounts relate to preferred stock still held at each respective period end.
 
15

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 March 31, follows:
 
   
Commercial
   
Mortgage
   
Installment
   
Subjective
Allocation
   
Total
 
   
(In thousands)
 
2018
                             
Balance at beginning of period
 
$
5,595
   
$
8,733
   
$
864
   
$
7,395
   
$
22,587
 
Additions (deductions)
                                       
Provision for loan losses
   
(135
)
   
147
     
69
     
234
     
315
 
Recoveries credited to the allowance
   
606
     
180
     
228
     
-
     
1,014
 
Loans charged against the allowance
   
(40
)
   
(439
)
   
(366
)
   
-
     
(845
)
Balance at end of period
 
$
6,026
   
$
8,621
   
$
795
   
$
7,629
   
$
23,071
 
                                         
2017
                                       
Balance at beginning of period
 
$
4,880
   
$
8,681
   
$
1,011
   
$
5,662
   
$
20,234
 
Additions (deductions)
                                       
Provision for loan losses
   
(61
)
   
(699
)
   
133
     
268
     
(359
)
Recoveries credited to the allowance
   
404
     
486
     
239
     
-
     
1,129
 
Loans charged against the allowance
   
(135
)
   
(359
)
   
(472
)
   
-
     
(966
)
Balance at end of period
 
$
5,088
   
$
8,109
   
$
911
   
$
5,930
   
$
20,038
 
 
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
   
Subjective
Allocation
   
Total
 
   
(In thousands)
 
March 31, 2018
                             
Allowance for loan losses
                             
Individually evaluated for impairment
 
$
739
   
$
5,345
   
$
248
   
$
-
   
$
6,332
 
Collectively evaluated for impairment
   
5,287
     
3,276
     
547
     
7,629
     
16,739
 
Total ending allowance balance
 
$
6,026
   
$
8,621
   
$
795
   
$
7,629
   
$
23,071
 
                                         
Loans
                                       
Individually evaluated for impairment
 
$
8,348
   
$
51,830
   
$
3,891
           
$
64,069
 
Collectively evaluated for impairment
   
851,338
     
840,396
     
322,094
             
2,013,828
 
Total loans recorded investment
   
859,686
     
892,226
     
325,985
             
2,077,897
 
Accrued interest included in recorded investment
   
2,269
     
3,316
     
877
             
6,462
 
Total loans
 
$
857,417
   
$
888,910
   
$
325,108
           
$
2,071,435
 
                                         
December 31, 2017
                                       
Allowance for loan losses
                                       
Individually evaluated for impairment
 
$
837
   
$
5,725
   
$
277
   
$
-
   
$
6,839
 
Collectively evaluated for impairment
   
4,758
     
3,008
     
587
     
7,395
     
15,748
 
Total ending allowance balance
 
$
5,595
   
$
8,733
   
$
864
   
$
7,395
   
$
22,587
 
                                         
Loans
                                       
Individually evaluated for impairment
 
$
8,420
   
$
53,179
   
$
3,945
           
$
65,544
 
Collectively evaluated for impairment
   
847,140
     
799,629
     
313,005
             
1,959,774
 
Total loans recorded investment
   
855,560
     
852,808
     
316,950
             
2,025,318
 
Accrued interest included in recorded investment
   
2,300
     
3,278
     
923
             
6,501
 
Total loans
 
$
853,260
   
$
849,530
   
$
316,027
           
$
2,018,817
 
 
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)
 
March 31, 2018
                 
Commercial
                 
Income producing - real estate
 
$
-
   
$
-
   
$
-
 
Land, land development and construction - real estate
   
-
     
-
     
-
 
Commercial and industrial
   
-
     
439
     
439
 
Mortgage
                       
1-4 family
   
-
     
4,213
     
4,213
 
Resort lending
   
-
     
762
     
762
 
Home equity - 1st lien
   
-
     
309
     
309
 
Home equity - 2nd lien
   
-
     
301
     
301
 
Purchased loans
   
-
     
-
     
-
 
Installment
                       
Home equity - 1st lien
   
-
     
150
     
150
 
Home equity - 2nd lien
   
-
     
241
     
241
 
Boat lending
   
-
     
66
     
66
 
Recreational vehicle lending
   
-
     
14
     
14
 
Other
   
-
     
134
     
134
 
Total recorded investment
 
$
-
   
$
6,629
   
$
6,629
 
Accrued interest included in recorded investment
 
$
-
   
$
-
   
$
-
 
December 31, 2017
                       
Commercial
                       
Income producing - real estate
 
$
-
   
$
30
   
$
30
 
Land, land development and construction - real estate
   
-
     
9
     
9
 
Commercial and industrial
   
-
     
607
     
607
 
Mortgage
                       
1-4 family
   
-
     
5,130
     
5,130
 
Resort lending
   
-
     
1,223
     
1,223
 
Home equity - 1st lien
   
-
     
326
     
326
 
Home equity - 2nd lien
   
-
     
316
     
316
 
Purchased loans
   
-
     
-
     
-
 
Installment
                       
Home equity - 1st lien
   
-
     
141
     
141
 
Home equity - 2nd lien
   
-
     
159
     
159
 
Boat lending
   
-
     
100
     
100
 
Recreational vehicle lending
   
-
     
25
     
25
 
Other
   
-
     
118
     
118
 
Total recorded investment
 
$
-
   
$
8,184
   
$
8,184
 
Accrued interest included in recorded investment
 
$
-
   
$
-
   
$
-
 
 
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)
 
March 31, 2018
                                   
Commercial
                                   
Income producing - real estate
 
$
-
   
$
-
   
$
-
   
$
-
   
$
304,709
   
$
304,709
 
Land, land development and construction - real estate
   
-
     
-
     
-
     
-
     
51,382
     
51,382
 
Commercial and industrial
   
41
     
8
     
-
     
49
     
503,546
     
503,595
 
Mortgage
                                               
1-4 family
   
2,598
     
443
     
4,213
     
7,254
     
665,487
     
672,741
 
Resort lending
   
85
     
-
     
762
     
847
     
86,582
     
87,429
 
Home equity - 1st lien
   
61
     
264
     
309
     
634
     
37,191
     
37,825
 
Home equity - 2nd lien
   
334
     
254
     
301
     
889
     
59,598
     
60,487
 
Purchased loans
   
9
     
1
     
-
     
10
     
33,734
     
33,744
 
Installment
                                               
Home equity - 1st lien
   
174
     
-
     
150
     
324
     
8,497
     
8,821
 
Home equity - 2nd lien
   
157
     
59
     
241
     
457
     
8,411
     
8,868
 
Boat lending
   
156
     
8
     
66
     
230
     
134,383
     
134,613
 
Recreational vehicle lending
   
30
     
24
     
14
     
68
     
98,489
     
98,557
 
Other
   
124
     
61
     
134
     
319
     
74,807
     
75,126
 
Total recorded investment
 
$
3,769
   
$
1,122
   
$
6,190
   
$
11,081
   
$
2,066,816
   
$
2,077,897
 
Accrued interest included in recorded investment
 
$
46
   
$
17
   
$
-
   
$
63
   
$
6,399
   
$
6,462
 
                                                 
December 31, 2017
                                               
Commercial
                                               
Income producing - real estate
 
$
-
   
$
-
   
$
30
   
$
30
   
$
290,466
   
$
290,496
 
Land, land development and construction - real estate
   
9
     
-
     
-
     
9
     
70,182
     
70,191
 
Commercial and industrial
   
60
     
-
     
44
     
104
     
494,769
     
494,873
 
Mortgage
                                               
1-4 family
   
1,552
     
802
     
5,130
     
7,484
     
625,638
     
633,122
 
Resort lending
   
713
     
-
     
1,223
     
1,936
     
88,620
     
90,556
 
Home equity - 1st lien
   
308
     
38
     
326
     
672
     
34,689
     
35,361
 
Home equity - 2nd lien
   
353
     
155
     
316
     
824
     
58,834
     
59,658
 
Purchased loans
   
7
     
-
     
-
     
7
     
34,104
     
34,111
 
Installment
                                               
Home equity - 1st lien
   
90
     
11
     
141
     
242
     
9,213
     
9,455
 
Home equity - 2nd lien
   
217
     
94
     
159
     
470
     
9,001
     
9,471
 
Boat lending
   
59
     
36
     
100
     
195
     
129,777
     
129,972
 
Recreational vehicle lending
   
28
     
20
     
25
     
73
     
92,737
     
92,810
 
Other
   
275
     
115
     
118
     
508
     
74,734
     
75,242
 
Total recorded investment
 
$
3,671
   
$
1,271
   
$
7,612
   
$
12,554
   
$
2,012,764
   
$
2,025,318
 
Accrued interest included in recorded investment
 
$
43
   
$
22
   
$
-
   
$
65
   
$
6,436
   
$
6,501
 
 
19

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

Impaired loans are as follows:
 
   
March 31,
2018
   
December 31,
2017
 
Impaired loans with no allocated allowance
 
(In thousands)
 
TDR
 
$
382
   
$
349
 
Non - TDR
   
164
     
175
 
Impaired loans with an allocated allowance
               
TDR - allowance based on collateral
   
1,988
     
2,482
 
TDR - allowance based on present value cash flow
   
61,261
     
62,113
 
Non - TDR - allowance based on collateral
   
-
     
148
 
Total impaired loans
 
$
63,795
   
$
65,267
 
                 
Amount of allowance for loan losses allocated
               
TDR - allowance based on collateral
 
$
533
   
$
684
 
TDR - allowance based on present value cash flow
   
5,799
     
6,089
 
Non - TDR - allowance based on collateral
   
-
     
66
 
Total amount of allowance for loan losses allocated
 
$
6,332
   
$
6,839
 
 
20

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

Impaired loans by class  are as follows (1):

   
March 31, 2018
   
December 31, 2017
 
   
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
 
$
-
   
$
-
   
$
-
   
$
-
   
$
-
   
$
-
 
Land, land development & construction-real estate
   
-
     
-
     
-
     
-
     
-
     
-
 
Commercial and industrial
   
515
     
541
     
-
     
524
     
549
     
-
 
Mortgage
                                               
1-4 family
   
35
     
476
     
-
     
2
     
469
     
-
 
Resort lending
   
-
     
-
     
-
     
-
     
-
     
-
 
Home equity - 1st lien
   
-
     
-
     
-
     
-
     
-
     
-
 
Home equity - 2nd lien
   
-
     
-
     
-
     
-
     
-
     
-
 
Installment
                                               
Home equity - 1st lien
   
1
     
94
     
-
     
1
     
69
     
-
 
Home equity - 2nd lien
   
-
     
-
     
-
     
-
     
-
     
-
 
Boat lending
   
-
     
-
     
-
     
-
     
-
     
-
 
Recreational vehicle lending
   
-
     
-
     
-
     
-
     
-
     
-
 
Other
   
-
     
17
     
-
     
-
     
-
     
-
 
     
551
     
1,128
     
-
     
527
     
1,087
     
-
 
With an allowance recorded:
                                               
Commercial
                                               
Income producing - real estate
   
5,178
     
5,158
     
344
     
5,195
     
5,347
     
347
 
Land, land development & construction-real estate
   
156
     
155
     
5
     
166
     
194
     
9
 
Commercial and industrial
   
2,499
     
2,556
     
390
     
2,535
     
2,651
     
481
 
Mortgage
                                               
1-4 family
   
35,885
     
37,464
     
3,248
     
36,848
     
38,480
     
3,454
 
Resort lending
   
15,579
     
15,607
     
2,044
     
15,978
     
16,046
     
2,210
 
Home equity - 1st lien
   
154
     
160
     
36
     
173
     
236
     
43
 
Home equity - 2nd lien
   
177
     
212
     
17
     
178
     
213
     
18
 
Installment
                                               
Home equity - 1st lien
   
1,622
     
1,738
     
106
     
1,667
     
1,804
     
108
 
Home equity - 2nd lien
   
1,761
     
1,778
     
114
     
1,793
     
1,805
     
140
 
Boat lending
   
1
     
5
     
1
     
1
     
5
     
1
 
Recreational vehicle lending
   
87
     
87
     
5
     
90
     
90
     
5
 
Other
   
419
     
443
     
22
     
393
     
418
     
23
 
     
63,518
     
65,363
     
6,332
     
65,017
     
67,289
     
6,839
 
Total
                                               
Commercial
                                               
Income producing - real estate
   
5,178
     
5,158
     
344
     
5,195
     
5,347
     
347
 
Land, land development & construction-real estate
   
156
     
155
     
5
     
166
     
194
     
9
 
Commercial and industrial
   
3,014
     
3,097
     
390
     
3,059
     
3,200
     
481
 
Mortgage
                                               
1-4 family
   
35,920
     
37,940
     
3,248
     
36,850
     
38,949
     
3,454
 
Resort lending
   
15,579
     
15,607
     
2,044
     
15,978
     
16,046
     
2,210
 
Home equity - 1st lien
   
154
     
160
     
36
     
173
     
236
     
43
 
Home equity - 2nd lien
   
177
     
212
     
17
     
178
     
213
     
18
 
Installment
                                               
Home equity - 1st lien
   
1,623
     
1,832
     
106
     
1,668
     
1,873
     
108
 
Home equity - 2nd lien
   
1,761
     
1,778
     
114
     
1,793
     
1,805
     
140
 
Boat lending
   
1
     
5
     
1
     
1
     
5
     
1
 
Recreational vehicle lending
   
87
     
87
     
5
     
90
     
90
     
5
 
Other
   
419
     
460
     
22
     
393
     
418
     
23
 
Total
 
$
64,069
   
$
66,491
   
$
6,332
   
$
65,544
   
$
68,376
   
$
6,839
 
                                                 
Accrued interest included in recorded investment
 
$
274
                   
$
277
                 
 
(1)
There were no impaired purchased mortgage loans at March 31, 2018 or December 31, 2017.
 
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 March 31, follows (1):
 
   
2018
   
2017
 
   
Average
Recorded
Investment
   
Interest
Income
Recognized
   
Average
Recorded
Investment
   
Interest
Income
Recognized
 
With no related allowance recorded
 
(In thousands)
 
Commercial
                       
Income producing - real estate
 
$
-
   
$
-
   
$
444
   
$
-
 
Land, land development & construction-real estate
   
-
     
-
     
16
     
-
 
Commercial and industrial
   
520
     
4
     
1,171
     
-
 
Mortgage
                               
1-4 family
   
19
     
6
     
2
     
4
 
Resort lending
   
-
     
-
     
-
     
-
 
Home equity - 1st lien
   
-
     
-
     
-
     
-
 
Home equity - 2nd lien
   
-
     
-
     
-
     
-
 
Installment
                               
Home equity - 1st lien
   
1
     
2
     
-
     
1
 
Home equity - 2nd lien
   
-
     
-
     
-
     
-
 
Boat lending
   
-
     
-
     
-
     
-
 
Recreational vehicle lending
   
-
     
-
     
-
     
-
 
Other
   
-
     
-
     
-
     
-
 
     
540
     
12
     
1,633
     
5
 
With an allowance recorded
                               
Commercial
                               
Income producing - real estate
   
5,187
     
68
     
7,739
     
105
 
Land, land development & construction-real estate
   
161
     
2
     
203
     
2
 
Commercial and industrial
   
2,517
     
32
     
4,099
     
35
 
Mortgage
                               
1-4 family
   
36,367
     
458
     
40,900
     
464
 
Resort lending
   
15,779
     
164
     
16,795
     
161
 
Home equity - 1st lien
   
164
     
2
     
235
     
2
 
Home equity - 2nd lien
   
178
     
2
     
254
     
2
 
Installment
                               
Home equity - 1st lien
   
1,645
     
29
     
1,939
     
34
 
Home equity - 2nd lien
   
1,777
     
27
     
2,362
     
35
 
Boat lending
   
1
     
-
     
1
     
-
 
Recreational vehicle lending
   
89
     
1
     
108
     
1
 
Other
   
406
     
6
     
385
     
7
 
     
64,271
     
791
     
75,020
     
848
 
Total
                               
Commercial
                               
Income producing - real estate
   
5,187
     
68
     
8,183
     
105
 
Land, land development & construction-real estate
   
161
     
2
     
219
     
2
 
Commercial and industrial
   
3,037
     
36
     
5,270
     
35
 
Mortgage
                               
1-4 family
   
36,386
     
464
     
40,902
     
468
 
Resort lending
   
15,779
     
164
     
16,795
     
161
 
Home equity - 1st lien
   
164
     
2
     
235
     
2
 
Home equity - 2nd lien
   
178
     
2
     
254
     
2
 
Installment
                               
Home equity - 1st lien
   
1,646
     
31
     
1,939
     
35
 
Home equity - 2nd lien
   
1,777
     
27
     
2,362
     
35
 
Boat lending
   
1
     
-
     
1
     
-
 
Recreational vehicle lending
   
89
     
1
     
108
     
1
 
Other
   
406
     
6
     
385
     
7
 
Total
 
$
64,811
   
$
803
   
$
76,653
   
$
853
 

(1)
There were no impaired purchased mortgage loans during the three month periods ended March 31, 2018 and 2017, respectively.
 
22

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

Cash receipts on impaired loans on non-accrual status are generally applied to the principal balance.

Troubled debt restructurings follow:

   
March 31, 2018
 
   
Commercial
   
Retail (1)
   
Total
 
   
(In thousands)
 
Performing TDRs
 
$
7,880
   
$
52,022
   
$
59,902
 
Non-performing TDRs(2)
   
275
     
3,454
(3) 
   
3,729
 
Total
 
$
8,155
   
$
55,476
   
$
63,631
 

   
December 31, 2017
 
   
Commercial
   
Retail (1)
   
Total
 
   
(In thousands)
 
Performing TDRs
 
$
7,748
   
$
52,367
   
$
60,115
 
Non-performing TDRs(2)
   
323
     
4,506
(3) 
   
4,829
 
Total
 
$
8,071
   
$
56,873
   
$
64,944
 

(1)
Retail loans include mortgage and installment portfolio segments.
(2)
Included in non-performing loans table above.
(3)
Also includes loans on non-accrual at the time of modification until six payments are received on a timely basis.
 
We allocated $6.3 million and $6.8 million of specific reserves to customers whose loan terms have been modified in troubled debt restructurings as of March 31, 2018 and December 31, 2017, respectively.

During the three months ended March 31, 2018 and 2017, 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.
 
23

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

Loans that have been classified as troubled debt restructurings during the three-month periods ended March 31 follow(1):

   
Number of
Contracts
   
Pre-modification
Recorded
Balance
   
Post-modification
Recorded
Balance
 
   
(Dollars in thousands)
 
2018
                 
Commercial
                 
Income producing - real estate
   
1
   
$
67
   
$
67
 
Land, land development & construction-real estate
   
-
     
-
     
-
 
Commercial and industrial
   
3
     
434
     
434
 
Mortgage
                       
1-4 family
   
3
     
228
     
211
 
Resort lending
   
-
     
-
     
-
 
Home equity - 1st lien
   
-
     
-
     
-
 
Home equity - 2nd lien
   
-
     
-
     
-
 
Installment
                       
Home equity - 1st lien
   
3
     
98
     
99
 
Home equity - 2nd lien
   
1
     
61
     
61
 
Boat lending
   
-
     
-
     
-
 
Recreational vehicle lending
   
-
     
-
     
-
 
Other
   
1
     
35
     
32
 
Total
   
12
   
$
923
   
$
904
 
                         
2017
                       
Commercial
                       
Income producing - real estate
   
-
   
$
-
   
$
-
 
Land, land development & construction-real estate
   
-
     
-
     
-
 
Commercial and industrial
   
3
     
133
     
133
 
Mortgage
                       
1-4 family
   
1
     
17
     
17
 
Resort lending
   
1
     
189
     
189
 
Home equity - 1st lien
   
-
     
-
     
-
 
Home equity - 2nd lien
   
-
     
-
     
-
 
Installment
                       
Home equity - 1st lien
   
2
     
34
     
37
 
Home equity - 2nd lien
   
2
     
45
     
46
 
Boat lending
   
-
     
-
     
-
 
Recreational vehicle lending
   
-
     
-
     
-
 
Other
   
-
     
-
     
-
 
Total
   
9
   
$
418
   
$
422
 

(1)
There were no purchased mortgage loans classified as troubled debt restructurings during the three month periods ended March 31, 2018 and 2017, respectively.

The troubled debt restructurings described above for 2018 decreased the allowance for loan losses by $0.03 million and resulted in zero charge offs while the troubled debt restructurings described above for 2017 increased the allowance for loan losses by $0.05 million and resulted in zero charge offs.
 
24

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

There were no troubled debt restructurings that subsequently defaulted within twelve months following the modification during the three months ended March 31, 2018 and 2017.

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

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-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, and (d) 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. These ratings include 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. Our doubtful rating includes a sub classification for a loss rate other than 50% (which is the standard doubtful loss rate).  These ratings include 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.
 
25

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)
 
March 31, 2018
                             
Income producing - real estate
 
$
303,189
   
$
1,225
   
$
295
   
$
-
   
$
304,709
 
Land, land development and construction - real estate
   
48,916
     
2,466
     
-
     
-
     
51,382
 
Commercial and industrial
   
466,289
     
27,389
     
9,478
     
439
     
503,595
 
Total
 
$
818,394
   
$
31,080
   
$
9,773
   
$
439
   
$
859,686
 
Accrued interest included in total
 
$
2,122
   
$
103
   
$
44
   
$
-
   
$
2,269
 
                                         
December 31, 2017
                                       
Income producing - real estate
 
$
288,869
   
$
1,293
   
$
304
   
$
30
   
$
290,496
 
Land, land development and construction - real estate
   
70,122
     
60
     
-
     
9
     
70,191
 
Commercial and industrial
   
463,570
     
28,351
     
2,345
     
607
     
494,873
 
Total
 
$
822,561
   
$
29,704
   
$
2,649
   
$
646
   
$
855,560
 
Accrued interest included in total
 
$
2,198
   
$
94
   
$
8
   
$
-
   
$
2,300
 

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.
 
26

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)
 
March 31, 2018
                                     
800 and above
   
$
68,918
   
$
9,759
   
$
6,990
   
$
7,107
   
$
7,862
   
$
100,636
 
750-799
     
279,211
     
35,228
     
17,235
     
23,504
     
17,462
     
372,640
 
700-749
     
154,631
     
21,334
     
8,177
     
16,633
     
7,891
     
208,666
 
650-699
     
91,118
     
11,740
     
2,970
     
7,336
     
423
     
113,587
 
600-649
     
25,015
     
2,963
     
1,226
     
2,609
     
-
     
31,813
 
550-599
     
15,341
     
2,486
     
418
     
1,470
     
-
     
19,715
 
500-549
     
8,755
     
749
     
480
     
1,102
     
-
     
11,086
 
Under 500
     
2,905
     
266
     
180
     
377
     
-
     
3,728
 
Unknown
     
26,847
     
2,904
     
149
     
349
     
106
     
30,355
 
Total
   
$
672,741
   
$
87,429
   
$
37,825
   
$
60,487
   
$
33,744
   
$
892,226
 
Accrued interest included in total
   
$
2,400
   
$
370
   
$
165
   
$
283
   
$
98
   
$
3,316
 
                                                   
December 31, 2017
                                                 
800 and above
   
$
70,540
   
$
11,625
   
$
6,169
   
$
7,842
   
$
7,983
   
$
104,159
 
750-799
     
265,907
     
36,015
     
16,561
     
24,126
     
17,651
     
360,260
 
700-749
     
146,302
     
22,099
     
7,317
     
15,012
     
7,937
     
198,667
 
650-699
     
83,695
     
12,145
     
2,793
     
7,420
     
426
     
106,479
 
600-649
     
25,087
     
3,025
     
1,189
     
2,512
     
-
     
31,813
 
550-599
     
15,136
     
2,710
     
518
     
1,118
     
-
     
19,482
 
500-549
     
9,548
     
1,009
     
397
     
1,156
     
-
     
12,110
 
Under 500
     
2,549
     
269
     
260
     
385
     
-
     
3,463
 
Unknown
     
14,358
     
1,659
     
157
     
87
     
114
     
16,375
 
Total
   
$
633,122
   
$
90,556
   
$
35,361
   
$
59,658
   
$
34,111
   
$
852,808
 
Accrued interest included in total
   
$
2,361
   
$
371
   
$
157
   
$
294
   
$
95
   
$
3,278
 
 
(1)
Credit scores have been updated within the last twelve months.
 
27

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

     
Installment(1)
 
     
Home
Equity
1st Lien
   
Home
Equity
2nd Lien
   
Boat Lending
   
Recreational
Vehicle
Lending
   
Other
   
Total
 
     
(In thousands)
       
March 31, 2018
                                     
800 and above
   
$
829
   
$
636
   
$
17,303
   
$
17,684
   
$
5,808
   
$
42,260
 
750-799
     
1,739
     
1,731
     
75,796
     
56,527
     
28,221
     
164,014
 
700-749
     
1,713
     
1,900
     
30,043
     
18,801
     
21,211
     
73,668
 
650-699
     
1,679
     
1,963
     
8,556
     
4,178
     
9,247
     
25,623
 
600-649
     
1,500
     
1,231
     
2,006
     
907
     
2,376
     
8,020
 
550-599
     
862
     
1,137
     
577
     
308
     
806
     
3,690
 
500-549
     
444
     
164
     
243
     
107
     
440
     
1,398
 
Under 500
     
40
     
76
     
32
     
5
     
142
     
295
 
Unknown
     
15
     
30
     
57
     
40
     
6,875
     
7,017
 
Total
   
$
8,821
   
$
8,868
   
$
134,613
   
$
98,557
   
$
75,126
   
$
325,985
 
Accrued interest included in total
   
$
32
   
$
38
   
$
331
   
$
248
   
$
228
   
$
877
 
                                                   
December 31, 2017
                                                 
800 and above
   
$
815
   
$
825
   
$
15,531
   
$
16,754
   
$
7,060
   
$
40,985
 
750-799
     
1,912
     
1,952
     
73,251
     
52,610
     
28,422
     
158,147
 
700-749
     
1,825
     
2,142
     
28,922
     
17,993
     
20,059
     
70,941
 
650-699
     
1,840
     
2,036
     
9,179
     
4,270
     
9,258
     
26,583
 
600-649
     
1,567
     
1,065
     
2,052
     
754
     
2,402
     
7,840
 
550-599
     
950
     
1,028
     
640
     
305
     
871
     
3,794
 
500-549
     
499
     
303
     
281
     
83
     
475
     
1,641
 
Under 500
     
32
     
88
     
57
     
6
     
194
     
377
 
Unknown
     
15
     
32
     
59
     
35
     
6,501
     
6,642
 
Total
   
$
9,455
   
$
9,471
   
$
129,972
   
$
92,810
   
$
75,242
   
$
316,950
 
Accrued interest included in total
   
$
39
   
$
43
   
$
346
   
$
254
   
$
241
   
$
923
 
 
(1)
Credit scores have been updated within the last twelve months.

Foreclosed residential real estate properties included in other real estate and repossessed assets on our Condensed Consolidated Statements of Financial Condition totaled $1.5 million and $1.6 million at March 31, 2018 and December 31, 2017, 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 $0.8 million at March 31, 2018 and December 31, 2017, respectively.

In March 2018, we sold $16.5 million of single-family residential fixed and adjustable rate mortgage loans servicing retained to another financial institution and recognized a gain on sale of $0.05 million.  These mortgage loans were all on properties located in Ohio, had a weighted average interest rate of 3.59% and were sold primarily for asset/liability management purposes.
 
28

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

5.    Shareholders’ Equity and Earnings Per Common Share

On January 22, 2018, 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, 2018.  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.  We did not repurchase any shares of common stock during the three months ended March 31, 2018.

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

   
Three Months Ended
March 31,
 
   
2018
   
2017
 
   
(In thousands, except
per share data)
 
Net income
 
$
9,161
   
$
5,974
 
                 
Weighted average shares outstanding (1)
   
21,365
     
21,308
 
Effect of stock options
   
135
     
152
 
Stock units for deferred compensation plan for non-employee directors
   
125
     
119
 
Performance share units
   
49
     
60
 
Weighted average shares outstanding for calculation of diluted earnings per share
   
21,674
     
21,639
 
                 
Net income per common share
               
Basic (1)
 
$
0.43
   
$
0.28
 
Diluted
 
$
0.42
   
$
0.28
 

(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 common share because they were anti-dilutive were zero for the three month periods ended March 31, 2018 and 2017, respectively.
 
6.          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.
 
29

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:
 
   
March 31, 2018
 
   
Notional
Amount
   
Average
Maturity
(years)
   
Fair
Value
 
   
(Dollars in thousands)
 
Cash flow hedge designation
                 
Pay-fixed interest rate swap agreements
 
$
15,000
     
3.4
   
$
426
 
Interest rate cap agreements
   
45,000
     
3.3
     
1,474
 
   
$
60,000
     
3.3
   
$
1,900
 
No hedge designation
                       
Rate-lock mortgage loan commitments
 
$
42,159
     
0.1
   
$
958
 
Mandatory commitments to sell mortgage loans
   
61,743
     
0.1
     
(123
)
Pay-fixed interest rate swap agreements - commercial
   
80,449
     
6.2
     
1,348
 
Pay-variable interest rate swap agreements - commercial
   
80,449
     
6.2
     
(1,348
)
Pay-variable interest rate swap agreements
   
10,000
     
0.4
     
-
 
Purchased options
   
3,119
     
3.2
     
229
 
Written options
   
3,119
     
3.2
     
(229
)
Total
 
$
281,038
     
3.8
   
$
835
 

   
December 31, 2017
 
   
Notional
Amount
   
Average
Maturity
(years)
   
Fair
Value
 
   
(Dollars in thousands)
 
Cash flow hedge designation
                 
Pay-fixed interest rate swap agreements
 
$
15,000
     
3.7
   
$
245
 
Interest rate cap agreements
   
45,000
     
3.5
     
976
 
    $ 60,000       3.6     $ 1,221  
No hedge designation
                       
Rate-lock mortgage loan commitments
 
$
25,032
     
0.1
   
$
530
 
Mandatory commitments to sell mortgage loans
   
56,127
     
0.1
     
37
 
Pay-fixed interest rate swap agreements - commercial
   
75,990
     
6.2
     
292
 
Pay-variable interest rate swap agreements - commercial
   
75,990
     
6.2
     
(292
)
Purchased options
   
3,119
     
3.5
     
322
 
Written options
   
3,119
     
3.5
     
(322
)
Total
 
$
239,377
     
4.1
   
$
567
 
 
30

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

We use variable-rate and short-term fixed-rate (less than 12 months) debt obligations to fund a portion of our balance sheet, which exposes us to variability in interest rates. To meet our asset/liability management objectives, we may periodically enter into derivative financial instruments to mitigate exposure to fluctuations in cash flows resulting from changes in interest rates (“Cash Flow Hedges”).  Cash Flow Hedges included certain pay-fixed interest rate swaps and interest rate cap agreements.  Pay-fixed interest rate swaps convert the variable-rate cash flows on debt obligations to fixed-rates.  Under interest-rate cap agreements, we will receive cash if interest rates rise above a predetermined level. As a result, we effectively have variable-rate debt with an established maximum rate. We pay an upfront premium on interest rate caps which is recognized in earnings in the same period in which the hedged item affects earnings.  Unrecognized premiums from interest rate caps aggregated to $0.9 million at both March 31, 2018 and December 31, 2017, respectively.

We record the fair value of Cash Flow Hedges in accrued income and other assets and accrued expenses and other liabilities on our Condensed Consolidated Statements of Financial Condition.  On an ongoing basis, we adjust our Condensed Consolidated Statements of Financial Condition to reflect the then current fair value of Cash Flow Hedges.  The related gains or losses are reported in other comprehensive income or loss and are subsequently reclassified into earnings, as a yield adjustment in the same period in which the related interest on the hedged items (variable-rate debt obligations) affect earnings.  It is anticipated that approximately $0.29 million, of unrealized gains on Cash Flow Hedges at March 31, 2018 will be reclassified to earnings over the next twelve months.  To the extent that the Cash Flow Hedges are not effective, the ineffective portion of the Cash Flow Hedges is immediately recognized in interest expense.  The maximum term of the Cash Flow Hedge at March 31, 2018 is 3.7 years.

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 in our Condensed Consolidated Statements of Operations.  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.

We currently offer 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 noted as commercial in the table above with no hedge designation relate to this program.

We have also entered into a pay-variable interest rate swap agreement unrelated to the commercial loan program noted above.  While we have not designated this swap agreement as an accounting hedge the use of this hedge has the expectation to turn certain short-term fixed rate debt into short-term variable rate debt.  The change in the swap agreement fair value will be recorded in earnings in our Condensed Consolidated Statement of Operations.
 
31

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

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:

 
Asset Derivatives
 
Liability Derivatives
 
 
March 31,
2018
 
December 31,
2017
 
March 31,
2018
 
December 31,
2017
 
 
Balance
 Sheet
 Location
 
Fair
Value
 
 Balance
 Sheet
 Location
 
Fair
Value
 
 Balance
 Sheet
 Location
 
Fair
Value
 
 Balance
 Sheet
 Location
 
Fair
Value
 
 
(In thousands)
 
                               
Derivatives designated as hedging instruments
                               
Pay-fixed interest rate swap agreements
Other assets
 
$
426
 
Other assets
 
$
245
 
Other liabilities
 
$
-
 
Other liabilities
 
$
-
 
Interest rate cap agreements
Other assets
   
1,474
 
Other assets
   
976
 
Other liabilities
   
-
 
Other liabilities
   
-
 
       
1,900
       
1,221
       
-
       
-
 
Derivatives not designated as hedging instruments
                                       
Rate-lock mortgage loan commitments
Other assets
   
958
 
Other assets
   
530
 
Other liabilities
   
-
 
Other liabilities
   
-
 
Mandatory commitments to sell mortgage loans
Other assets
   
-
 
Other assets
   
37
 
Other liabilities
   
123
 
Other liabilities
   
-
 
Pay-fixed interest rate swap agreements - commercial
Other assets
   
1,526
 
Other assets
   
631
 
Other liabilities
   
178
 
Other liabilities
   
339
 
Pay-variable interest rate swap agreements - commercial
Other assets
   
178
 
Other assets
   
339
 
Other liabilities
   
1,526
 
Other liabilities
   
631
 
Pay-variable interest rate swap agreements
Other assets
   
-
 
Other assets
   
-
 
Other liabilities
   
-
 
Other liabilities
   
-
 
Purchased options
Other assets
   
229
 
Other assets
   
322
 
Other liabilities
   
-
 
Other liabilities
   
-
 
Written options
Other assets
   
-
 
Other assets
   
-
 
Other liabilities
   
229
 
Other liabilities
   
322
 
       
2,891
       
1,859
       
2,056
       
1,292
 
Total derivatives
   
$
4,791
     
$
3,080
     
$
2,056
     
$
1,292
 
 
32

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

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

Three Month Periods Ended March 31,
 
   
Gain
Recognized in
Other
Comprehensive
Income (Loss)
(Effective Portion)
 
 Location of
 Gain (Loss)
 Reclassified
 from
 Accumulated
 Other
 Comprehensive
 Loss into
 Income
 (Effective
 
Gain (Loss)
Reclassified from
Accumulated Other
Comprehensive
Loss into Income
(Effective Portion)
 
 Location of
 Gain (Loss)
 Recognized
 
Gain (Loss)
Recognized
in Income (1)
 
   
2018
   
2017
 
 Portion)
 
2018
   
2017
 
 in Income (1)
 
2018
   
2017
 
   
(In thousands)
 
Cash Flow Hedges
                                       
Interest rate cap agreements
 
$
513
   
$
-
 
Interest expense
 
$
7
   
$
-
 
Interest expense
 
$
-
   
$
-
 
Pay-fixed interest rate swap agreements
   
171
     
-
 
Interest expense
   
(1
)
   
-
 
Interest expense
   
12
     
-
 
Total
 
$
684
   
$
-
     
$
6
   
$
-
     
$
12
   
$
-
 
                                               
No hedge designation
                                             
Rate-lock mortgage loan commitments
                                 
Net gains on on mortage loans
 
$
428
   
$
371
 
Mandatory commitments to sell mortgage loans
                           
Net gains on on mortage loans
   
(160
)
   
(796
)
Pay-fixed interest rate swap agreements - commercial
                                 
Interest income
   
1,056
     
110
 
Pay-variable interest rate swap agreements - commercial
                                 
Interest income
   
(1,056
)
   
(110
)
Pay-variable interest rate  swap agreements
                                 
Interest expense
   
-
     
-
 
Purchased options
                                 
Interest expense
   
(93
)
   
69
 
Written options
                                 
Interest expense
   
93
     
(69
)
Total
                                          
$
268
   
$
(425
)
 
(1)
For cash flow hedges, this location and amount refers to the ineffective portion.
 
33

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

7.  Intangible Assets

The following table summarizes intangible assets, net of amortization:

   
March 31, 2018
   
December 31, 2017
 
   
Gross
Carrying
Amount
   
Accumulated
Amortization
   
Gross
Carrying
Amount
   
Accumulated
Amortization
 
   
(In thousands)
 
                         
Amortized intangible assets - core deposits
 
$
6,118
   
$
4,618
   
$
6,118
   
$
4,532
 


Amortization of other intangibles has been estimated through 2022 in the following table.
   
(In thousands)
 
       
Nine months ending December 31, 2018
 
$
260
 
2019
   
346
 
2020
   
346
 
2021
   
346
 
2022
   
202
 
Total
 
$
1,500
 

8.  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 0.5 million shares of common stock as of March 31, 2018.  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 March 31, 2018. 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 the three month periods ended March 31, 2018 and 2017, pursuant to our long-term incentive plan, we granted 0.04 million and 0.05 million shares of restricted stock, respectively and 0.02 million and 0.02 million performance stock units (“PSU”), respectively to certain officers.  Except for 0.002 million shares of restricted stock issued in 2018 that vest ratably over three years, 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.

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 0.002 million shares during each three month period ended March 31, of 2018 and 2017 and expensed their value during those same periods.
 
34

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

Total compensation expense recognized for grants pursuant to our long-term incentive plan was $0.4 million during each three month period ended March 31, 2018 and 2017.  The corresponding tax benefit relating to this expense was $0.1 million for each period. Total expense recognized for non-employee director share based payments was $0.05 million and $0.04 million during the three months ended March 31, 2018 and 2017, respectively. The corresponding tax benefit relating to this expense was $0.01 million for each period.

At March 31, 2018, the total expected compensation cost related to non-vested restricted stock and PSUs not yet recognized was $3.0 million.  The weighted-average period over which this amount will be recognized is 2.3 years.

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, 2018
   
176,055
   
$
5.24
             
Granted
   
-
                     
Exercised
   
(3,800
)
   
3.39
             
Forfeited
   
-
                     
Expired
   
-
                     
Outstanding at March 31, 2018
   
172,255
   
$
5.28
     
3.8
   
$
3,035
 
                               
Vested and expected to vest at March 31, 2018
   
172,255
   
$
5.28
     
3.8
   
$
3,035
 
Exercisable at March 31, 2018
   
172,255
   
$
5.28
     
3.8
   
$
3,035
 

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

   
Number
of Shares
   
Weighted-
Average
Grant Date
Fair Value
 
Outstanding at January 1, 2018
   
290,527
   
$
15.88
 
Granted
   
64,406
     
23.58
 
Vested
   
(95,036
)
   
13.14
 
Forfeited
   
(6,028
)
   
17.70
 
Outstanding at March 31, 2018
   
253,869
   
$
18.82
 
 
Certain information regarding options exercised during the periods follows:

   
Three Months Ended
March 31,
 
   
2018
   
2017
 
   
(In thousands)
 
Intrinsic value
 
$
78
   
$
279
 
Cash proceeds received
 
$
13
   
$
66
 
Tax benefit realized
 
$
16
   
$
98
 
 
35

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

9.  Income Tax

Income tax expense was $2.0 million and $2.6 million during the three months ended March 31, 2018 and 2017, respectively.  On December 22, 2017, "H.R. 1" (also known as the "Tax Cuts and Jobs Act") was signed into law.  H.R. 1, among other things, reduced the federal corporate income tax rate to 21% effective January 1, 2018 from 35% during 2017.

Our actual federal income tax expense is different than the amount computed by applying our statutory income tax rate to our income before income tax primarily due to tax-exempt interest income and tax-exempt income from the increase in the cash surrender value on life insurance.  In addition, the first quarters of 2018 and 2017, include reductions of $0.2 million and $0.1 million, respectively, of income tax expense related to impact of the excess value of stock awards that vested and stock options that were exercised as compared to the initial fair values that were expensed.

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 March 31, 2018 and 2017, that the realization of substantially all of our deferred tax assets continues to be more likely than not.

At both March 31, 2018 and December 31, 2017, we had approximately $0.7 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 2018.

10.  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 March 31, 2018, the Bank had positive undivided profits of $27.1 million.  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.

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 interim condensed 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 March 31, 2018 and December 31, 2017, 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 1.875% and 1.25% added to the minimum ratio for adequately capitalized institutions for 2018 and 2017, respectively and 0.625% will be added each subsequent year until fully phased in during 2019.  This capital conservation buffer is not reflected in the table that follows.  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.
 
36

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)
 
March 31, 2018
                                   
Total capital to risk-weighted assets
                                   
Consolidated
 
$
318,837
     
15.24
%
 
$
167,402
     
8.00
%
 
NA
   
NA
 
Independent Bank
   
301,081
     
14.40
     
167,291
     
8.00
   
$
209,114
     
10.00
%
                                                 
Tier 1 capital to risk-weighted assets
                                               
Consolidated
 
$
294,755
     
14.09
%
 
$
125,551
     
6.00
%
 
NA
   
NA
 
Independent Bank
   
276,999
     
13.25
     
125,468
     
6.00
   
$
167,291
     
8.00
%
                                                 
Common equity tier 1 capital to risk-weighted assets
                                               
Consolidated
 
$
260,255
     
12.44
%
 
$
94,164
     
4.50
%
 
NA
   
NA
 
Independent Bank
   
276,999
     
13.25
     
94,101
     
4.50
   
$
135,924
     
6.50
%
                                                 
Tier 1 capital to average assets
                                               
Consolidated
 
$
294,755
     
10.64
%
 
$
110,783
     
4.00
%
 
NA
   
NA
 
Independent Bank
   
276,999
     
10.01
     
110,726
     
4.00
   
$
138,408
     
5.00
%
 
                                               
December 31, 2017
                                               
Total capital to risk-weighted assets
                                               
Consolidated
 
$
312,163
     
15.16
%
 
$
164,782
     
8.00
%
 
NA
   
NA
 
Independent Bank
   
290,188
     
14.10
     
164,675
     
8.00
   
$
205,843
     
10.00
%
                                                 
Tier 1 capital to risk-weighted assets
                                               
Consolidated
 
$
288,451
     
14.00
%
 
$
123,586
     
6.00
%
 
NA
   
NA
 
Independent Bank
   
266,476
     
12.95
     
123,506
     
6.00
   
$
164,675
     
8.00
%
                                                 
Common equity tier 1 capital to risk-weighted assets
                                               
Consolidated
 
$
255,934
     
12.43
%
 
$
92,690
     
4.50
%
 
NA
   
NA
 
Independent Bank
   
266,476
     
12.95
     
92,630
     
4.50
   
$
133,798
     
6.50
%
 
                                               
Tier 1 capital to average assets
                                               
Consolidated
 
$
288,451
     
10.57
%
 
$
109,209
     
4.00
%
 
NA
   
NA
 
Independent Bank
   
266,476
     
9.78
     
109,041
     
4.00
   
$
136,301
     
5.00
%
 

NA - Not applicable
 
37

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

The components of our regulatory capital are as follows:

   
Consolidated
   
Independent Bank
 
   
March 31,
2018
   
December 31,
2017
   
March 31,
2018
   
December 31,
2017
 
   
(In thousands)
 
Total shareholders' equity
 
$
267,917
   
$
264,933
   
$
276,646
   
$
269,481
 
Add (deduct)
                               
Accumulated other comprehensive (gain) loss for regulatory purposes
   
2,705
     
201
     
2,705
     
201
 
Intangible assets
   
(1,500
)
   
(1,269
)
   
(1,500
)
   
(1,269
)
Disallowed deferred tax assets
   
(8,867
)
   
(7,931
)
   
(852
)
   
(1,937
)
Common equity tier 1 capital
   
260,255
     
255,934
     
276,999
     
266,476
 
Qualifying trust preferred securities
   
34,500
     
34,500
     
-
     
-
 
Disallowed deferred tax assets
   
-
     
(1,983
)
   
-
     
-
 
Tier 1 capital
   
294,755
     
288,451
     
276,999
     
266,476
 
Allowance for loan losses and allowance for unfunded lending  commitments limited to 1.25% of  total risk-weighted assets
   
24,082
     
23,712
     
24,082
     
23,712
 
Total risk-based capital
 
$
318,837
   
$
312,163
   
$
301,081
   
$
290,188
 

11.  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.
 
38

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 (equity securities at fair value, 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 and US Treasuries in our securities available for sale portfolio.  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, obligations of states and political subdivisions, trust preferred securities, corporate securities and foreign government securities.

Loans held for saleThe fair value of mortgage loans held for sale is based on agency cash window loan 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 March 31, 2018 and December 31, 2017, 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 estateAt 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, which is part of non-interest expense - other 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.
 
39

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, or a member of our Collateral Evaluation Department (for commercial properties), or a member of our Special Assets/ORE Group (for residential 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 residential 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 Level 3.  Management evaluates the third party valuation for reasonableness each quarter as part of our financial reporting control processes.

DerivativesThe fair value of rate-lock mortgage loan commitments is based on agency cash window loan pricing for comparable assets and the fair value of 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 and interest rate cap agreements are derived from proprietary models which utilize current market data.  The 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).
 
40

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)
 
March 31, 2018:
                       
Measured at Fair Value on a Recurring Basis
                       
Assets
                       
Equity securities at fair value
 
$
301
   
$
301
   
$
-
   
$
-
 
Securities available for sale
                               
U.S. Treasury
   
599
     
599
     
-
     
-
 
U.S. agency
   
23,936
     
-
     
23,936
     
-
 
U.S. agency residential mortgage-backed
   
137,244
     
-
     
137,244
     
-
 
U.S. agency commercial mortgage-backed
   
9,945
     
-
     
9,945
     
-
 
Private label mortgage-backed
   
28,451
     
-
     
28,451
     
-
 
Other asset backed
   
90,527
     
-
     
90,527
     
-
 
Obligations of states and political subdivisions
   
151,823
     
-
     
151,823
     
-
 
Corporate
   
41,749
     
-
     
41,749
     
-
 
Trust preferred
   
2,810
     
-
     
2,810
     
-
 
Foreign government
   
2,035
     
-
     
2,035
     
-
 
Loans held for sale
   
34,148
     
-
     
34,148
     
-
 
Capitalized mortgage loan servicing rights
   
17,783
     
-
     
-
     
17,783
 
Derivatives (1)
   
4,791
     
-
     
4,791
     
-
 
Liabilities
                               
Derivatives (2)
   
2,056
     
-
     
2,056
     
-
 
                                 
Measured at Fair Value on a Non-recurring basis:
                               
Assets
                               
Impaired loans (3)
                               
Commercial
                               
Income producing - real estate
   
302
     
-
     
-
     
302
 
Land, land development & construction-real estate
   
3
     
-
     
-
     
3
 
Commercial and industrial
   
874
     
-
     
-
     
874
 
Mortgage
                               
1-4 family
   
276
     
-
     
-
     
276
 
Other real estate (4)
                               
Mortgage
                               
1-4 family
   
35
     
-
     
-
     
35
 
Resort lending
   
136
     
-
     
-
     
136
 

(1)
Included in accrued income and other assets
(2)
Included in accrued expenses and other liabilities
(3)
Only includes impaired loans with specific loss allocations based on collateral value.
(4)
Only includes other real estate with subsequent write downs to fair value.
 
41

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, 2017:
                       
Measured at Fair Value on a Recurring Basis:
                       
Assets
                       
Trading securities
 
$
455
   
$
455
   
$
-
   
$
-
 
Securities available for sale
                               
U.S. Treasury
   
898
     
898
     
-
     
-
 
U.S. agency
   
25,682
     
-
     
25,682
     
-
 
U.S. agency residential mortgage-backed
   
137,918
     
-
     
137,918
     
-
 
U.S. agency commercial mortgage-backed
   
9,760
     
-
     
9,760
     
-
 
Private label mortgage-backed
   
29,109
     
-
     
29,109
     
-
 
Other asset backed
   
93,898
     
-
     
93,898
     
-
 
Obligations of states and political subdivisions
   
172,945
     
-
     
172,945
     
-
 
Corporate
   
47,853
     
-
     
47,853
     
-
 
Trust preferred
   
2,802
     
-
     
2,802
     
-
 
Foreign government
   
2,060
     
-
     
2,060
     
-
 
Loans held for sale
   
39,436
     
-
     
39,436
     
-
 
Capitalized mortgage loan servicing rights
   
15,699
     
-
     
-
     
15,699
 
Derivatives (1)
   
3,080
     
-
     
3,080
     
-
 
Liabilities
                               
Derivatives (2)
   
1,292
     
-
     
1,292
     
-
 
                                 
Measured at Fair Value on a Non-recurring basis:
                               
Assets
                               
Impaired loans (3)
                               
Commercial
                               
Income producing - real estate
   
274
     
-
     
-
     
274
 
Land, land development & construction-real estate
   
9
     
-
     
-
     
9
 
Commercial and industrial
   
1,051
     
-
     
-
     
1,051
 
Mortgage
                               
1-4 family
   
339
     
-
     
-
     
339
 
Resort lending
   
207
     
-
     
-
     
207
 
Other real estate (4)
                               
Mortgage
                               
1-4 family
   
186
     
-
     
-
     
186
 
Resort lending
   
65
     
-
     
-
     
65
 

(1)
Included in accrued income and other assets
(2)
Included in accrued expenses and other liabilities
(3)
Only includes impaired loans with specific loss allocations based on collateral value.
(4)
Only includes other real estate with subsequent write downs to fair value.

There were no transfers between Level 1 and Level 2 during the three months ended March 31, 2018 and 2017.
 
42

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 three-Month Periods
Ended March 31 for Items Measured at Fair Value
Pursuant to Election of the Fair Value Option
 
   
Net Gains (Losses)
on Assets
   
Mortgage
   
Total
Change
in Fair
Values
Included
in Current
 
   
Securities
   
Mortgage
Loans
   
Loan
Servicing, net
   
Period
Earnings
 
   
(In thousands)
 
2018
                       
Equity securities at fair value
 
$
(154
)
 
$
-
   
$
-
   
$
(154
)
Loans held for sale
   
-
     
(153
)
   
-
     
(153
)
Capitalized mortgage loan servicing rights
   
-
     
-
     
1,029
     
1,029
 
                                 
2017
                               
Trading securities
 
$
(79
)
 
$
-
   
$
-
   
$
(79
)
Loans held for sale
   
-
     
581
     
-
     
581
 
Capitalized mortgage loan servicing rights
   
-
     
-
     
(264
)
   
(264
)

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 month periods ended March 31, 2018 and 2017 relating to assets measured at fair value on a non-recurring basis:

·
Loans which are measured for impairment using the fair value of collateral for collateral dependent loans had a carrying amount of $2.0 million, with a valuation allowance of $0.5 million at March 31, 2018, and had a carrying amount of $2.6 million, with a valuation allowance of $0.7 million at December 31, 2017.  The provision for loan losses included in our results of operations relating to impaired loans was an expense of $0.1 million and $0.3 million during the three month periods ended March 31, 2018 and 2017, respectively.
·
Other real estate, which is measured using the fair value of the property, had a carrying amount of $0.2 million which is net of a valuation allowance of $0.1 million at March 31, 2018, and a carrying amount of $0.3 million, which is net of a valuation allowance of $0.1 million, at December 31, 2017. An additional charge relating to other real estate measured at fair value of $0.02 million and $0.02 million was included in our results of operations during the three month periods ended March 31, 2018 and 2017, respectively.
 
43

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

A reconciliation for all assets and (liabilities) measured at fair value on a recurring basis using significant unobservable inputs (Level 3) follows:

   
Capitalized Mortgage
Loan Servicing Rights
 
   
Three Months Ended
March 31,
 
   
2018
   
2017
 
   
(In thousands)
 
Beginning balance
 
$
15,699
   
$
-
 
Change in accounting
   
-
     
14,213
 
Beginning balance, as adjusted
   
15,699
     
14,213
 
Total gains (losses) realized and unrealized:
               
Included in results of operations
   
1,029
     
(264
)
Included in other comprehensive income (loss)
   
-
     
-
 
Purchases, issuances, settlements, maturities and calls
   
1,055
     
778
 
Transfers in and/or out of Level 3
   
-
     
-
 
Ending balance
 
$
17,783
   
$
14,727
 
                 
Amount of total gains (losses) for the period included in earnings attributable to the change in unrealized gains (losses) relating to assets and liabilities still held at March 31
 
$
1,029
   
$
(264
)

The fair value of our capitalized mortgage loan servicing rights has been determined based on a valuation model used by an independent third party as discussed above.  The significant unobservable inputs used in the fair value measurement of the capitalized mortgage loan servicing rights are discount rate, cost to service, ancillary income and float rate.  Significant changes in all four of these assumptions in isolation would result in significant changes to the value of our capitalized mortgage loan servicing rights.  Quantitative information about our Level 3 fair value measurements measured on a recurring basis follows:

   
Asset
Fair
Value
 
Valuation
Technique
 
Unobservable
Inputs
 
Range
   
Weighted
Average
 
   
(In thousands)
               
March 31, 2018
                       
Capitalized mortgage loan servicing rights
 
$
17,783
 
Present value of net
 
Discount rate
 
10.00% to 13.00 %
     
10.14
%
         
servicing revenue
 
Cost to service
 
$ 66 to $216
   
$
81
 
               
Ancillary income
 
20 to 36
     
23
 
               
Float rate
 
2.70% to 2.70 %
     
2.70
%
                              
December 31, 2017
                             
Capitalized mortgage loan servicing rights
 
$
15,699
 
Present value of net
 
Discount rate
 
9.88% to 11.00 %
     
10.11
%
         
servicing revenue
 
Cost to service
 
$ 66 to $216
   
$
81
 
               
Ancillary income
 
20 to 36
     
23
 
               
Float rate
 
2.24% to 2.24 %
     
2.24
%
 
44

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
 
Range
 
Weighted
Average
 
   
(In thousands)
 
 
         
March 31, 2018
         
 
         
Impaired loans
                         
Commercial
 
$
1,179
 
Sales comparison approach
 
Adjustment for differences between comparable sales
  (32.5)% to 25.0%     (3.9 )%
Mortgage
   
276
 
Sales comparison approach
 
Adjustment for differences between comparable sales
  (30.9) to 77.9     7.0  
                           
Other real estate
           
 
           
Mortgage
   
171
 
Sales comparison approach
 
Adjustment for differences between comparable sales
  (33.0) to 44.5     (2.0 )
                           
December 31, 2017
           
 
           
Impaired loans
           
 
           
Commercial
   
1,334
 
Sales comparison approach
 
Adjustment for differences between comparable sales
  (32.5)% to 25.0%     (4.5 )%
Mortgage
   
546
 
Sales comparison approach
 
Adjustment for differences between comparable sales
  (21.1) to 34.1     (2.7 )
                           
Other real estate
           
 
           
Mortgage
   
251
 
Sales comparison approach
 
Adjustment for differences between comparable sales
  (33.0) to 44.5     (1.0 )

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
                 
March 31, 2018
 
$
34,148
   
$
691
   
$
33,457
 
December 31, 2017
   
39,436
     
844
     
38,592
 

12.
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.
 
45

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

As discussed in note #2, we adopted ASU 2016-02 as of January 1, 2018.  This new ASU requires entities to use the exit price notion when measuring the fair value of financial instruments for disclosure purposes. All of estimated fair values of our financial instruments in the table below at March 31, 2018 have used this exit price notion.   In addition, except as discussed below in the net loans and loans held for sale section, all of our financial assets and liabilities have historically been valued using an exit price notion.  This new ASU also removes the requirement to disclose the methods and significant assumptions used to estimate the fair value of financial instruments measured at amortized cost.  The methods and significant assumptions for those financial instruments measured at amortized cost disclosed below are presented for fair values at December 31, 2017.

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.  Equity securities at fair value, trading securities and U.S. Treasury securities available for sale are classified as Level 1 while all other securities available for sale are classified as Level 2 as described in note #11.

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 at December 31, 2017 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 #11. Loans held for sale are classified as Level 2 as described in note #11.

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.

Derivative financial instruments:  The fair value of rate-lock mortgage loan commitments is based on agency cash window loan pricing for comparable assets, the fair value of mandatory commitments to sell mortgage loans is based on mortgage backed security pricing for comparable assets, the fair value of interest rate swap and interest rate cap agreements is derived from proprietary models which utilize current market data 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 #11.
 
46

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

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 time deposits 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.
 
47

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)
 
March 31, 2018
                             
Assets
                             
Cash and due from banks
 
$
29,126
   
$
29,126
   
$
29,126
   
$
-
   
$
-
 
Interest bearing deposits
   
13,250
     
13,250
     
13,250
     
-
     
-
 
Interest bearing deposits - time
   
1,738
     
1,738
     
-
     
1,738
     
-
 
Equity securities at fair value
   
301
     
301
     
301
     
-
     
-
 
Securities available for sale
   
489,119
     
489,119
     
599
     
488,520
     
-
 
Federal Home Loan Bank and Federal Reserve Bank Stock
   
15,543
   
NA
   
NA
   
NA
   
NA
 
Net loans and loans held for sale
   
2,082,512
     
2,060,458
     
-
     
34,148
     
2,026,310
 
Accrued interest receivable
   
8,909
     
8,909
     
-
     
2,535
     
6,374
 
Derivative financial instruments
   
4,791
     
4,791
     
-
     
4,791
     
-
 
                                         
Liabilities
                                       
Deposits with no stated maturity (1)
 
$
1,891,343
   
$
1,891,343
   
$
1,891,343
   
$
-
   
$
-
 
Deposits with stated maturity (1)
   
539,058
     
534,832
     
-
     
534,832
     
-
 
Other borrowings
   
27,847
     
27,981
     
-
     
27,981
     
-
 
Subordinated debentures
   
35,569
     
31,248
     
-
     
31,248
     
-
 
Accrued interest payable
   
1,097
     
1,097
     
48
     
1,049
     
-
 
Derivative financial instruments
   
2,056
     
2,056
     
-
     
2,056
     
-
 
                                         
December 31, 2017
                                       
Assets
                                       
Cash and due from banks
 
$
36,994
   
$
36,994
   
$
36,994
   
$
-
   
$
-
 
Interest bearing deposits
   
17,744
     
17,744
     
17,744
     
-
     
-
 
Interest bearing deposits - time
   
2,739
     
2,740
     
-
     
2,740
     
-
 
Trading securities
   
455
     
455
     
455
     
-
     
-
 
Securities available for sale
   
522,925
     
522,925
     
898
     
522,027
     
-
 
Federal Home Loan Bank and Federal Reserve Bank Stock
   
15,543
   
NA
   
NA
   
NA
   
NA
 
Net loans and loans held for sale
   
2,035,666
     
1,962,937
     
-
     
39,436
     
1,923,501
 
Accrued interest receivable
   
8,609
     
8,609
     
1
     
2,192
     
6,416
 
Derivative financial instruments
   
3,080
     
3,080
     
-
     
3,080
     
-
 
                                         
Liabilities
                                       
Deposits with no stated maturity (1)
 
$
1,845,716
   
$
1,845,716
   
$
1,845,716
   
$
-
   
$
-
 
Deposits with stated maturity (1)
   
554,818
     
551,489
     
-
     
551,489
     
-
 
Other borrowings
   
54,600
     
54,918
     
-
     
54,918
     
-
 
Subordinated debentures
   
35,569
     
29,946
     
-
     
29,946
     
-
 
Accrued interest payable
   
892
     
892
     
48
     
844
     
-
 
Derivative financial instruments
   
1,292
     
1,292
     
-
     
1,292
     
-
 

(1)
Deposits with no stated maturity include reciprocal deposits with a recorded book balance of $16.8 million and $13.0 million at March 31, 2018 and December 31, 2017, respectively. Deposits with a stated maturity include reciprocal deposits with a recorded book balance of $46.2 million and $38.0 million March 31, 2018 and December 31, 2017, respectively.
 
48

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

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.

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.

13.
Contingent Liabilities

In the fourth quarter of 2016, we reached a tentative settlement regarding litigation initiated against the Bank in Wayne County, Michigan Circuit Court. The Court issued a preliminary approval of this settlement in the first quarter of 2017 and a final approval of this settlement in January 2018. This litigation concerned the Bank’s checking account transaction sequencing during a period from February 2009 to June 2011. Under the terms of the settlement, we agreed to pay $2.2 million and we are also responsible for class notification costs and certain other expenses which are estimated to total approximately $0.1 million. The $2.2 million was paid in January 2018. We recorded a $2.3 million expense in the fourth quarter of 2016 for this settlement. Although, we deny any liability associated with this matter and believe we have meritorious defenses to the allegations in the complaint, given the costs and uncertainty of litigation, we determined that this settlement was in the best interests of the organization.

We are also involved in various other 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 insignificant.  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). 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.
 
49

NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
(unaudited)
 
In connection with the sale of Mepco Finance Corporation (Mepco) (see note #15), we agreed to contractually indemnify the purchaser from certain losses it may incur, including as a result of its failure to collect certain receivables it purchased as part of the business as well as breaches of representations and warranties we made in the sale agreement, subject to various limitations. We have not accrued any liability related to these indemnification requirements in our March 31, 2018 Condensed Consolidated Statement of Financial Condition because we believe the likelihood of having to pay any amount as a result of these indemnification obligations is remote. However, if the purchaser is unable to collect the receivables it purchased from Mepco or otherwise encounters difficulties in operating the business, it is possible it could make one or more claims against us pursuant to the sale agreement. In that event, we may incur expenses in defending any such claims and/or amounts paid to such purchaser to resolve such claims. As of March 31, 2018 these receivables balances had declined to $8.2 million and to date the purchaser has made no claims for indemnification.

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, Ginnie Mae and the FHLB). 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 of $0.01 million and $0.03 million for the three month periods ended March 31, 2018 and 2017, respectively. The reserve for loss reimbursements on sold mortgage loans totaled $0.7 million at both March 31, 2018 and December 31, 2017, 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. 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.
 
50

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

14.
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
   
Unrealized
Gains on
Cash Flow
Hedges
   
Total
 
   
(In thousands)
 
For the three months ended March 31,
                       
2018
                       
Balances at beginning of period
 
$
(470
)
 
$
(5,798
)
 
$
269
   
$
(5,999
)
Other comprehensive income (loss) before reclassifications
   
(3,054
)
   
-
     
541
     
(2,513
)
Amounts reclassified from AOCL
   
15
     
-
     
(5
)
   
10
 
Net current period other comprehensive income (loss)
   
(3,039
)
   
-
     
536
     
(2,503
)
Balances at end of period
 
$
(3,509
)
 
$
(5,798
)
 
$
805
   
$
(8,502
)
                                 
2017
                               
Balances at beginning of period
 
$
(3,310
)
 
$
(5,798
)
 
$
-
   
$
(9,108
)
Cumulative effect of change in accounting
   
300
     
-
     
-
     
300
 
Balances at beginning of period, as adjusted
   
(3,010
)
   
(5,798
)
   
-
     
(8,808
)
Other comprehensive income before reclassifications
   
2,341
     
-
     
-
     
2,341
 
Amounts reclassified from AOCL
   
(69
)
   
-
     
-
     
(69
)
Net current period other comprehensive income
   
2,272
     
-
     
-
     
2,272
 
Balances at end of period
 
$
(738
)
 
$
(5,798
)
 
$
-
   
$
(6,536
)

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. Release of material disproportionate tax effects from other comprehensive income to earnings is done by the portfolio method whereby the effects will remain in AOCL as long as we carry a more than insubstantial portfolio of securities available for sale.
 
51

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

A summary of reclassifications out of each component of AOCL for the three months ended March 31 follows:
AOCL Component
 
Amount
Reclassified
From
AOCL
 
 Affected Line Item in Condensed
 Consolidated Statements of Operations
   
(In thousands)
   
2018
        
Unrealized losses on securities available for sale
        
   
$
(19
)
 Net gains (losses) on securities
     
-
 
 Net impairment loss recognized in earnings
     
(19
)
 Total reclassifications before tax
     
(4
)
 Income tax expense
   
$
(15
)
 Reclassifications, net of tax
             
Unrealized gains on cash flow hedges
          
   
$
(6
)
 Interest expense
     
(1
)
 Income tax expense
   
$
(5
)
 Reclassification, net of tax
             
   
$
(10
)
 Total reclassifications for the period, net of tax
             
2017
          
Unrealized gains on securities available for sale
          
   
$
106
 
 Net gains on securities
     
-
 
 Net impairment loss recognized in earnings
     
106
 
 Total reclassifications before tax
     
37
 
 Income tax expense
   
$
69
 
 Reclassifications, net of tax

15.
Mepco Sale

On December 30, 2016, Mepco executed an Asset Purchase Agreement (the “APA”) with Seabury Asset Management LLC (“Seabury”). Pursuant to the terms of the APA, we sold our payment plan processing business, payment plan receivables, and certain other assets to Seabury, who also assumed certain liabilities of Mepco.

This transaction closed on May 18, 2017, with an effective date of May 1, 2017. As a result of the closing, Mepco sold $33.1 million of net payment plan receivables, $0.5 million of commercial loans, $0.2 million of furniture and equipment and $1.6 million of other assets to Seabury, who also assumed $2.0 million of specified liabilities. We received cash totaling $33.4 million and recorded no gain or loss in 2017 as the assets were sold and the liabilities were assumed at book value.
 
52

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

16.
Recent Acquisition

Effective April 1, 2018, we completed the acquisition of all of the issued and outstanding shares of common stock of TCSB Bancorp, Inc. (‘‘TCSB’’) and merged TCSB into Independent Bank Corporation (“IBCP”), with IBCP as the surviving corporation (the ‘‘Merger’’).  On that same date we also consolidated Traverse City State Bank, TCSB’s wholly-owned subsidiary bank, into the Independent Bank (with the Independent Bank as the surviving institution).  Under the terms of the merger agreement we issued 2.71 million shares of common stock and 0.19 million stock options with a fair value of approximately $64.5 million to the shareholders and option holders of TCSB.  As the transaction did not occur until April 1, 2018, it was not practical to complete the purchase accounting adjustments for inclusion in these Notes to Interim Condensed Consolidated Financial Statements.  We will record this acquisition and related purchase accounting adjustments in the second quarter of 2018.

Our 2018 non-interest expenses include $0.2 million of costs incurred during the three months ended March, 31, 2018 related to the Merger. As of March 31, 2018, prior to any fair value related adjustments, TCSB Bancorp, Inc. had total assets of $343.8 million, total loans of $301.8 million, total deposits of $288.1 million, and total shareholders’ equity of $34.7 million.

17.
Revenue from Contracts with Customers

We account for revenue in accordance with ASC Topic 606, Revenue from Contracts with Customers, which we adopted on January 1, 2018, using the modified retrospective method (see note #2). We derive the majority of our revenue from financial instruments and their related contractual rights and obligations which  for the most part are excluded from the scope of ASU 2014-09.  These sources of revenue that are excluded from the scope of this amended guidance include interest income, net gains on mortgage loans, net gains (losses) on securities, mortgage loan servicing, net and bank owned life insurance and were approximately 82.2% and 79.5% of total revenues at March 31, 2018 and 2017, respectively.

Material sources of revenue that are included in the scope of ASC Topic 606 include service charges on deposits, other deposit related income, interchange income and investment and insurance commissions and are discussed in the following paragraphs.  Generally these sources of revenue are earned at the time the service is delivered or over the course of a monthly period and do not result in any contract asset or liability balance at any given period end.  As a result, there were no contract assets or liabilities recorded as of March 31, 2018.

Service charges on deposit accounts and other deposit related income: Revenues are earned on depository accounts for commercial and retail customers and include fees for transaction-based, account maintenance and overdraft services. Transaction-based fees, which includes services such as ATM use fees, stop payment charges and ACH fees are recognized at the time the transaction is executed as that is the time we fulfill our customer’s request.  Account maintenance fees, which includes monthly maintenance services are earned over the course of a month representing the period over which the performance obligation is satisfied. Our obligation for overdraft services is satisfied at the time of the overdraft.

Interchange income: Interchange income primarily includes debit card interchange and network revenues.  Debit card interchange and network revenues are earned on debit card transactions conducted through payment networks such as MasterCard and NYCE. Interchange income is recognized concurrently with the delivery of services on a daily basis. Interchange and network revenues are presented gross of interchange expenses, which are presented separately as a component of non-interest expense.
 
53

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

Investment and insurance commissions:  Investment and insurance commissions include fees and commissions from asset management, custody, recordkeeping, investment advisory and other services provided to our customers. Revenue is recognized on an accrual basis at the time the services are performed and are generally based on either the market value of the assets managed or the services provided.  We have an agent relationship with a third party provider of these services and net certain direct costs charged by the third party provider associated with providing these services to our customers.

Net (gains) losses other real estate and repossessed assets:  We record a gain or loss from the sale of other real estate when control of the property transfers to the buyer, which generally occurs at the time of an executed deed.  If we were to finance the sale of other real estate to the buyer, we would assess whether the buyer is committed to perform their obligations under the contract and whether collectability of the transaction is probable.  Once these criteria are met, the other real estate asset would be derecognized and the gain or loss on sale would be recorded upon the transfer of control of the property to the buyer.  There were no other real estate properties sold during the three months ending March 31, 2018 that were financed by us.

Disaggregation of our revenue sources by attribute for the three months ending March 31, 2018 follows:

   
Service
Charges
on Deposits
   
Other
Deposit
Related
Income
   
Interchange
Income
   
Investment
and
Insurance
Commissions
   
Total
 
   
(In thousands)
 
Retail
                             
Overdraft fees
 
$
1,972
                     
$
1,972
 
Account service charges
   
500
                       
500
 
ATM fees
         
$
345
                 
345
 
Other
           
207
                 
207
 
Business
                                   
Overdraft fees
   
365
                         
365
 
Account service charges
   
68
                         
68
 
ATM fees
           
8
                 
8
 
Other
           
129
                 
129
 
Interchange income
                 
$
2,246
           
2,246
 
Asset management revenue
                         
$
271
     
271
 
Transaction based revenue
                           
167
     
167
 
                                         
Total
 
$
2,905
   
$
689
   
$
2,246
   
$
438
   
$
6,278
 
                                         
Reconciliation to Condensed Consolidated Statement of Operations:
                 
Non-interest income - other:
                                       
Other deposit related income
                                 
$
689
 
Investment and insurance commissions
                             
438
 
Bank owned life insurance
                                   
256
 
Other
                                   
560
 
Total
                                 
$
1,943
 
 
54

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 (“IBCP”), 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 2017 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 2018, albeit at an uneven pace.  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.

Recent Developments. On December 22, 2017, "H.R. 1" (also known as the "Tax Cuts and Jobs Act") was signed into law.  H.R. 1, among other things, reduced the federal corporate income tax rate to 21% effective January 1, 2018.  As a result, we concluded that our deferred tax assets, net (“DTA”) had to be remeasured. Our DTA represents expected corporate tax benefits anticipated to be realized in the future.  The reduction in the federal corporate income tax rate reduces these anticipated future benefits.  The remeasurement of our DTA at December 31, 2017 resulted in a reduction of these net assets and a corresponding increase in income tax expense of $6.0 million that was recorded in the fourth quarter of 2017.

On December 4, 2017, we entered into an Agreement and Plan of Merger with TCSB Bancorp, Inc. ("TCSB") (the "Merger Agreement") providing for a business combination of IBCP and TCSB.  On April 1, 2018, TCSB was merged with and into IBCP, with IBCP as the surviving corporation (the "Merger").  In connection with the Merger, on April 1, 2018, IBCP consolidated Traverse City State Bank, TCSB's wholly-owned subsidiary bank, with and into Independent Bank (with Independent Bank as the surviving institution).

We paid aggregate Merger consideration of approximately $64.5 million in IBCP common stock or stock options for all of the shares of TCSB common stock and TCSB stock options issued and outstanding immediately before the effective time of the Merger.

At March 31, 2018, TCSB had $343.8 million of total assets, $301.8 million of loans, $288.1 million of deposits and $34.7 million of shareholders’ equity ($31.9 million of tangible common equity).  TCSB reported a net income of $0.03 million in the first quarter of 2018.  The TCSB first quarter 2018 results were adversely impacted due to $1.0 million of merger expenses.  We expect the Merger to have a significant impact on our second quarter 2018 results because of the inclusion of their operations for the first time that quarter and merger related expenses.
 
55

Regulation. On July 2, 2013, the Federal Reserve Board 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 ratably over a four-year period that began in 2016.  In 2018, 1.875% is being added to the minimum ratio for adequately capitalized institutions.  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 (now 6.375% in 2018).  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.  As of March 31, 2018 and December 31, 2017 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 first quarter of 2018 as compared to 2017.

Results of Operations

Summary.  We recorded net income of $9.2 million during the three months ended March 31, 2018, compared to net income of $6.0 million during the three months ended March 31, 2017. The increase in net income is primarily due to increases in net interest income and non-interest income and a decrease in income tax expense that were partially offset by increases in the provision for loan losses and non-interest expense.


Key performance ratios
     
   
Three months
ended March 31,
 
   
2018
   
2017
 
Net income (annualized) to
           
Average assets
   
1.34
%
   
0.95
%
Average common shareholders’ equity
   
14.04
     
9.63
 
                 
Net income per common share
               
Basic
 
$
0.43
   
$
0.28
 
Diluted
   
0.42
     
0.28
 
 
56

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.

Net interest income totaled $23.9 million during the first quarter of 2018, which represents a $2.5 million, or 11.5% increase, from the comparable quarter one year earlier.  The increase in net interest income in 2018 compared to 2017 primarily reflects a two basis point increase in our tax equivalent net interest income as a percent of average interest-earning assets (the “net interest margin”) as well as an increase in average interest-earning assets.

Total average interest-earning assets were $2.61 billion in the first quarter of 2018 compared to $2.37 billion in the year ago quarter.  Partially offsetting the growth in net interest income was a decline in net recoveries of interest on loans on non-accrual or previously charged-off to $0.18 million in the first quarter of 2018 compared to $0.50 million in the year ago quarter.

The increase in average interest-earning assets primarily reflects loan growth utilizing funds from increases in deposits and borrowed funds.  The increase in the net interest margin reflects a change in the mix of average-interest earning assets (higher percentage of loans) as well as increases in short-term market interest rates.

Our net interest income is also adversely impacted by our level of non-accrual loans.  In the first quarter of 2018 non-accrual loans averaged $7.5 million compared to $11.6 million in the first quarter of 2017.
 
57

Average Balances and Tax Equivalent Rates


   
Three Months Ended
March 31,
 
   
2018
   
2017
 
   
Average
Balance
   
Interest
   
Rate (2)
   
Average
Balance
   
Interest
   
Rate (2)
 
   
(Dollars in thousands)
 
Assets
                                   
Taxable loans
 
$
2,060,720
   
$
23,339
     
4.57
%
 
$
1,685,936
   
$
19,824
     
4.75
%
Tax-exempt loans (1)
   
2,127
     
18
     
3.43
     
4,067
     
52
     
5.19
 
Taxable securities
   
422,254
     
2,635
     
2.50
     
521,407
     
2,754
     
2.11
 
Tax-exempt securities (1)
   
78,345
     
603
     
3.08
     
78,044
     
698
     
3.58
 
Interest bearing cash
   
32,901
     
82
     
1.01
     
66,708
     
113
     
0.69
 
Other investments
   
15,543
     
248
     
6.47
     
15,543
     
199
     
5.19
 
Interest Earning Assets
   
2,611,890
     
26,925
     
4.15
     
2,371,705
     
23,640
     
4.02
 
Cash and due from banks
   
32,135
                     
33,790
                 
Other assets, net
   
132,961
                     
153,992
                 
Total Assets
 
$
2,776,986
                   
$
2,559,487
                 
                                                 
Liabilities
                                               
Savings and interest- bearing checking
 
$
1,094,981
     
551
     
0.20
   
$
1,047,114
     
283
     
0.11
 
Time deposits
   
564,282
     
1,736
     
1.25
     
482,188
     
1,160
     
0.98
 
Other borrowings
   
64,890
     
574
     
3.59
     
45,004
     
470
     
4.24
 
Interest Bearing Liabilities
   
1,724,153
     
2,861
     
0.67
     
1,574,306
     
1,913
     
0.49
 
Non-interest bearing deposits
   
758,643
                     
704,551
                 
Other liabilities
   
29,606
                     
29,064
                 
Shareholders’ equity
   
264,584
                     
251,566
                 
Total liabilities and shareholders’ equity
 
$
2,776,986
                   
$
2,559,487
                 
                                                 
Net Interest Income
         
$
24,064
                   
$
21,727
         
                                                 
Net Interest Income as a Percent of Average Interest Earning Assets
                   
3.71
%
                   
3.69
%
 

(1)
Interest on tax-exempt loans and securities is presented on a fully tax equivalent basis assuming a marginal tax rate of 21% in 2018 and 35% in 2017.
(2)
Annualized
 
58

Reconciliation of Net Interest Margin, Fully Taxable Equivalent ("FTE")

   
Three Months Ended
March 31,
 
   
2018
   
2017
 
   
(Dollars in thousands)
 
Net interest income
 
$
23,936
   
$
21,466
 
Add:  taxable equivalent adjustment
   
128
     
261
 
Net interest income - taxable equivalent
 
$
24,064
   
$
21,727
 
Net interest margin (GAAP) (1)
   
3.69
%
   
3.67
%
Net interest margin (FTE) (1)
   
3.71
%
   
3.69
%
 

(1)
Annualized

Provision for loan losses.  The provision for loan losses was an expense of $0.3 million and a credit of $0.4 million in the first quarters of 2018 and 2017, 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 first quarter of 2018.

Non-interest income.  Non-interest income is a significant element in assessing our results of operations. Non-interest income totaled $11.5 million and $10.3 million during the first three months of 2018 and 2017, respectively. We adopted Financial Accounting Standards Board Accounting Standards Update 2014-09 “Revenue from Contracts with Customers (Topic 606)” (“ASU 2014-09”) on January 1, 2018, using the modified retrospective method.  Although ASU 2014-09 did not have any impact on our January 1, 2018 shareholders’ equity or first quarter 2018 net income, it did result in a classification change in non-interest income and non-interest expense as compared to the prior year period.  Specifically, in the first quarter of 2018, interchange income and interchange expense each increased by $0.3 million, due to classification changes under ASU 2014-09 (also see notes #2 and #17 to the Condensed Consolidated Financial Statements included within this report).
 
59

The components of non-interest income are as follows:

Non-Interest Income

   
Three months ended
March 31,
 
   
2018
   
2017
 
   
(In thousands)
 
Service charges on deposit accounts
 
$
2,905
   
$
3,009
 
Interchange income
   
2,246
     
1,922
 
Net gains (losses) on assets
               
Mortgage loans
   
2,571
     
2,571
 
Securities
   
(173
)
   
27
 
Mortgage loan servicing, net
   
2,221
     
825
 
Investment and insurance commissions
   
438
     
468
 
Bank owned life insurance
   
256
     
253
 
Other
   
1,249
     
1,264
 
Total non-interest income
 
$
11,713
   
$
10,339
 

Service charges on deposit accounts totaled $2.9 million in the first quarter of 2018, a decrease of $0.1 million from the comparable period in 2017.  This decrease was principally due to a decline in treasury management fees due in part to an increase in crediting rates to customers (as a result of increased interest rates).

Interchange income totaled $2.2 million in the first quarter of 2018 compared to $1.9 million in the year ago period.  As discussed above, most of the first quarter 2018 increase in interchange income was due to a reclassification pursuant to ASU 2014-09.  Transaction volume increased 3.4% year-over-year and interchange revenue per transaction was relatively unchanged.

Net gains on mortgage loans were $2.6 million in both the first quarters of 2018 and 2017.   Mortgage loan sales totaled $106.3 million in the first quarter of 2018 compared to $79.7 million in the first quarter of 2017.  Mortgage loans originated totaled $159.0 million in the first quarter of 2018 compared to $158.1 million in the comparable quarter of 2017.

During the last quarter of 2016 and the first half of 2017, we significantly expanded our mortgage-banking operations by adding new employees and opening new loan production offices (Ann Arbor, Brighton, Dearborn, Grosse Pointe, Traverse City and Troy, Michigan and Columbus and Fairlawn, Ohio). This business expansion has accelerated the growth of portfolio mortgage loans and mortgage loans serviced for others, leading to increased mortgage loan interest income and mortgage loan servicing revenue.  However, this expansion has also increased non-interest expenses, particularly compensation and employee benefits and occupancy.  In addition, due to higher interest rates, mortgage loan refinance volume has declined on an industry-wide basis.  It is important to our future results of operations that we effectively and successfully manage this business expansion.
 
60

Mortgage Loan Activity
     
   
Three months ended
March 31,
 
   
2018
   
2017
 
   
(Dollars in thousands)
 
Mortgage loans originated
 
$
158,967
   
$
158,081
 
Mortgage loans sold
   
106,343
     
79,691
 
Net gains on mortgage loans
   
2,571
     
2,571
 
Net gains as a percentage of mortgage loans sold  (“Loan Sales Margin”)
   
2.42
%
   
3.23
%
Fair value adjustments included in the Loan Sales Margin
   
0.11
%
   
0.20
%

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 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 these fair value accounting adjustments, the Loan Sales Margin would have been 2.31% and 3.03% in the first quarters of 2018 and 2017, respectively. In 2018, our Loan Sales Margin contracted due primarily to competitive factors.  In general, as overall industry-wide mortgage loan origination levels drop, pricing becomes more competitive. The changes in the fair value accounting adjustments are primarily due to changes in the amount of commitments to originate mortgage loans for sale during each period.

We recorded net gains (losses) on securities of approximately $(0.17) million and $0.03 million in the first quarters of 2018 and 2017, respectively.  The first quarter 2018 net losses on securities are due primarily to a decline in the fair value of equity securities of $0.15 million. First quarter 2018 securities sales of $22.3 million resulted in a small net loss of $0.02 million.  The first quarter 2017 net gains on securities were due primarily to sales of $6.2 million that resulted in net gains of $0.11 million that were partially offset by a $0.08 million decline in the fair value of trading securities.

We recorded no net impairment losses in either the first quarter of 2018 or 2017, for other than temporary impairment of securities available for sale.  (See “Securities.”)
 
61


Mortgage loan servicing generated income of $2.2 million and $0.8 million in the first quarters of 2018 and 2017, respectively.  This activity is summarized in the following table:

   
Three Months Ended
 
   
March 31, 2018
   
March 31, 2017
 
Mortgage loan servicing:
 
(Dollars in thousands)
 
Revenue, net
 
$
1,192
   
$
1,089
 
Fair value change due to price
   
1,458
     
145
 
Fair value change due to pay-downs
   
(429
)
   
(409
)
Total
 
$
2,221
   
$
825
 

The significant variance in the fair value change due to price relates primarily to the rise in mortgage loan interest rates in the first quarter of 2018.  That increase reduced projected prepayment rates for mortgage loans serviced for others, leading to an increase in fair value.

Activity related to capitalized mortgage loan servicing rights is as follows:

Capitalized Mortgage Loan Servicing Rights
 
   
Three months ended
March 31,
 
   
2018
   
2017
 
   
(In thousands)
 
Balance at beginning of period
 
$
15,699
   
$
13,671
 
Change in accounting
   
-
     
542
 
Balance at beginning of period, as adjusted
 
$
15,699
   
$
14,213
 
Originated servicing rights capitalized
   
1,055
     
778
 
Change in fair value
   
1,029
     
(264
)
Balance at end of period
 
$
17,783
   
$
14,727
 

At March 31, 2018 we were servicing approximately $1.86 billion in mortgage loans for others on which servicing rights have been capitalized. This servicing portfolio had a weighted average coupon rate of 4.16% and a weighted average service fee of approximately 25.9 basis points. Capitalized mortgage loan servicing rights (recorded at fair value) at March 31, 2018 totaled $17.8 million, representing approximately 95.6 basis points on the related amount of mortgage loans serviced for others.

Investment and insurance commissions were relatively unchanged in the first quarter of 2018 as compared to the year ago period.

We earned $0.26 million and $0.25 million in the first quarters of 2018 and 2017, respectively, principally as a result of increases in the cash surrender value of our separate account bank owned life insurance.  Our separate account is primarily invested in agency mortgage-backed securities and managed by a third-party. 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 $54.4 million and $54.6 million at March 31, 2018 and December 31, 2017, respectively.  The reduction in the cash surrender value of our bank owned life insurance during the first quarter of 2018 was due to the receipt of cash on a death claim that was partially offset by net earnings credits.
 
62

Other non-interest income was relatively unchanged and totaled $1.25 million and $1.26 million during the first quarters of 2018 and 2017, respectively.

Non-interest expense.  Non-interest expense is an important component of our results of operations. We strive to efficiently manage our cost structure.

Non-interest expense totaled $23.9 million in the first quarter of 2018 compared to $23.6 million in the year ago period. The components of non-interest expense are as follows:

Non-Interest Expense
     
   
Three months ended
March 31,
 
   
2018
   
2017
 
   
(In thousands)
 
Compensation
 
$
9,118
   
$
9,672
 
Performance-based compensation
   
2,595
     
1,993
 
Payroll taxes and employee benefits
   
2,755
     
2,482
 
Compensation and employee benefits
   
14,468
     
14,147
 
Occupancy, net
   
2,264
     
2,142
 
Data processing
   
1,878
     
1,937
 
Furniture, fixtures and equipment
   
967
     
977
 
Communications
   
680
     
683
 
Loan and collection
   
677
     
413
 
Interchange expense
   
598
     
283
 
Advertising
   
441
     
506
 
Legal and professional
   
378
     
437
 
FDIC deposit insurance
   
230
     
198
 
Merger related expenses
   
174
     
--
 
Supplies
   
165
     
172
 
Credit card and bank service fees
   
96
     
191
 
Amortization of intangible assets
   
86
     
87
 
Provision for loss reimbursement on sold loans
   
11
     
31
 
Costs (recoveries) related to unfunded lending commitments
   
(114
)
   
110
 
Net (gains) losses on other real estate and repossessed assets
   
(290
)
   
11
 
Other
   
1,426
     
1,244
 
Total non-interest expense
 
$
24,135
   
$
23,569
 

Compensation and employee benefits expenses, in total, increased by $0.3 million, or 2.3%, in the first quarter of 2018, as compared to the year ago period.

Compensation expense decreased by $0.6 million, or 5.7%.  This year-over-year decrease was primarily due to the following factors:  a $0.2 million increase in the amount of compensation that was deferred as direct loan origination costs in the first quarter of 2018 and $0.3 million of additional one-time compensation costs associated with the initial expansion of our mortgage banking operations that were incurred in the first quarter of 2017. Average full-time equivalent employees (“FTEs”) increased by 3.2, or 0.4%, during the first quarter of 2018 compared to the year ago quarter, as additional personnel added due to the expansion of our mortgage-banking operations were largely offset by a decline in employees in our payment plan processing business that was sold in May 2017.
 
63

Performance-based compensation increased by $0.6 million in 2018 due primarily to a higher accrual (increased by $0.3 million) for anticipated incentive compensation for salaried employees based on our forecasted 2018 performance as compared to goals, as well as a $0.3 million bonus that was paid to hourly employees in the first quarter of 2018.

Payroll taxes and employee benefits increased $0.3 million in 2018 due primarily to higher payroll taxes, workers’ compensation insurance costs and 401(k) plan costs (the employee match was increased to 4% of eligible compensation in 2018 compared to 3% in 2017).

Occupancy, net, increased $0.1 million, or 5.7%, in the first quarter of 2018 compared to 2017 primarily because of the additional loan production offices opened as described above and higher snow removal costs.

Data processing expense decreased $0.1 million, or 3.0%, in the first quarter of 2018 compared to the year earlier period due primarily to 2017 including expenses related to our payment processing business that was sold in May 2017.

Furniture, fixtures and equipment, communications, advertising and supplies expenses were all relatively unchanged in the first quarter of 2018 as compared to the year earlier period.

Loan and collection expenses primarily reflect costs related to lending activities, including the management and collection of non-performing loans and other problem credits. These expenses increased by $0.3 million in the first quarter of 2018 compared to the year ago quarter, as the first quarter of 2017 included a $0.2 million recovery of previously incurred costs related to a commercial loan relationship.

Interchange expense increased by $0.3 million in the first quarter of 2018 compared to the year ago quarter due primarily to the impact of the implementation of ASU 2014-09 on January 1, 2018.  Prior to the first quarter of 2018, certain processing costs were being netted against interchange income.  As described above, under ASU 2014-09 these costs are no longer being netted against interchange income but instead are being reported as part of interchange expense.

Legal and professional fees decreased by $0.06 million in the first quarter of 2018 compared to the year ago quarter due primarily to a decline in co-sourced internal audit costs and the sale of our payment processing business in May 2017.

FDIC deposit insurance expense increased by $0.03 million in the first quarter of 2018 compared to the year ago quarter due primarily to the growth in our total assets.

Merger related expenses totaled $0.2 million in the first quarter of 2018 and primarily represent professional fees incurred related to the TCSB Merger.  (See “Recent Developments.” above.)

Credit card and bank service fees decreased by $0.1 million in the first quarter of 2018 as compared to the year earlier period primarily due to the sale of our payment plan processing business in May 2017.
 
64

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 $1.5 million and $1.6 million at March 31, 2018 and December 31, 2017, respectively. See note #7 to the Condensed Consolidated Financial Statements for a schedule of future amortization of intangible assets.  However, this category of non-interest expense will increase in the second quarter of 2018 due to the TCSB Merger.

The provision for loss reimbursement on sold loans was an expense of $0.01 million and $0.03 million in the first quarters of 2018 and 2017, respectively, and represents our estimate of incurred losses related to mortgage loans that we have sold to investors (primarily Fannie Mae, Freddie Mac, Ginnie Mae and the Federal Home Loan Bank of Indianapolis [“FHLB”]).  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 $0.68 million and $0.67 million at March 31, 2018 and December 31, 2017, respectively. This reserve is included in accrued expenses and other liabilities in our Condensed Consolidated Statements of Financial Condition. 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.

The changes in cost 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.

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.  The $0.3 million net gain in the first quarter of 2018 primarily relates to the sale of single-family homes and reflects generally increasing housing prices in our markets.

Other non-interest expenses increased by $0.2 million in the first quarter of 2018 compared to the year ago quarter due primarily to higher travel and meeting costs and increased directors fees (due to the addition of one director).

Income tax expense.  We recorded an income tax expense of $2.0 million and $2.6 million in the first quarters of 2018 and 2017, respectively.  As described earlier under “Recent Developments” our statutory federal corporate income tax rate was reduced to 21% (from 35%) effective on January 1, 2018.

Our actual federal income tax expense is different than the amount computed by applying our statutory income tax rate to our income before income tax primarily due to tax-exempt interest income and tax-exempt income from the increase in the cash surrender value on life insurance.  In addition, the first quarters of 2018 and 2017, include reductions of $0.2 million and $0.1 million, respectively, of income tax expense related to impact of the excess value of stock awards that vested and stock options that were exercised as compared to the initial fair values that were expensed.
 
65

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 March 31, 2018 and 2017 and at December 31, 2017, that the realization of substantially all of our deferred tax assets continues to be more likely than not.
 
Financial Condition

Summary.  Our total assets increased by $3.8 million during the first three months of 2018.  Loans, excluding loans held for sale ("Portfolio Loans"), totaled $2.07 billion at March 31, 2018, an increase of $52.6 million, or 2.6%, from December 31, 2017.  (See "Portfolio Loans and asset quality.")

Deposits totaled $2.43 billion at March 31, 2018, compared to $2.40 billion at December 31, 2017.  The $29.9 million increase in total deposits during the period is primarily due to growth in savings and interest-bearing checking 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, asset-backed securities, corporate securities, trust preferred securities and foreign government securities (that are denominated in U.S. dollars). 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
                       
March 31, 2018
 
$
493,561
   
$
1,978
   
$
6,420
   
$
489,119
 
December 31, 2017
   
523,520
     
3,197
     
3,792
     
522,925
 
 
Securities available for sale declined $33.8 million during the first quarter of 2018.  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 (loss).  We recorded no impairment losses related to other than temporary impairment on securities available for sale in either the first quarter of 2018 or 2017.
 
66

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

   
Three months ended
March 31,
 
   
2018
   
2017
 
   
(In thousands)
 
       
Proceeds
 
$
22,277
   
$
6,152
 
                 
Gross gains
 
$
76
   
$
106
 
Gross losses
   
(95
)
   
-
 
Net impairment charges
   
-
     
-
 
Fair value adjustments
   
(154
)
   
(79
)
Net gains (losses)
 
$
(173
)
 
$
27
 

Portfolio Loans and asset quality.  In addition to the communities served by our Bank branch and loan production office 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 March 2018, we sold $16.5 million of single-family residential fixed and adjustable rate mortgage loans servicing retained to another financial institution and recognized a gain on sale of $0.05 million.  These mortgage loans were all on properties located in Ohio, had a weighted average interest rate of 3.59% and were sold primarily for asset/liability management purposes.

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.

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 conventional and fixed rate jumbo mortgage loans as Portfolio Loans, while 15- and 30-year fixed-rate non-jumbo mortgage loans are generally sold to mitigate exposure to changes in interest rates. (See “Non-interest income.”) Due primarily to the expansion of our mortgage-banking activities and a change in mix in our mortgage loan originations, we are now originating and putting into Portfolio Loans more fixed rate mortgage loans than as compared to past periods.  These fixed rate mortgage loans generally have terms from 15 to 30 years, do not have prepayment penalties and expose us to more interest rate risk.  To date, our interest rate risk profile has not changed significantly.  However, we are carefully monitoring this change in the composition of our Portfolio Loans and the impact of potential future changes in interest rates on our changes in market value of portfolio equity and changes in net interest income. (See “Asset/liability management.”).  As a result, we have added and may continue to add some longer-term borrowings, may utilize derivatives (interest rate swaps and interest rate caps) to manage interest rate risk and may begin to attempt to sell fixed rate jumbo mortgage loans in the future.
 
67

A summary of our Portfolio Loans follows:

   
March 31,
2018
   
December 31,
2017
 
   
(In thousands)
 
Real estate(1)
           
Residential first mortgages
 
$
690,288
   
$
672,592
 
Residential home equity and other junior mortgages
   
143,037
     
136,560
 
Construction and land development
   
133,852
     
143,188
 
Other(2)
   
547,314
     
538,880
 
Consumer
   
306,757
     
291,091
 
Commercial
   
245,845
     
231,786
 
Agricultural
   
4,342
     
4,720
 
Total loans
 
$
2,071,435
   
$
2,018,817
 
 

(1)
Includes both residential and non-residential commercial loans secured by real estate.
(2)
Includes loans secured by multi-family residential and non-farm, non-residential property.


Non-performing assets(1)
           
   
March 31,
2018
   
December 31,
2017
 
   
(Dollars in thousands)
 
Non-accrual loans
 
$
6,629
   
$
8,184
 
Loans 90 days or more past due and still accruing interest
   
--
     
--
 
Total non-performing loans
   
6,629
     
8,184
 
Other real estate and repossessed assets
   
1,647
     
1,643
 
Total non-performing assets
 
$
8,276
   
$
9,827
 
As a percent of Portfolio Loans
               
Non-performing loans
   
0.32
%
   
0.41
%
Allowance for loan losses
   
1.11
     
1.12
 
Non-performing assets to total assets
   
0.30
     
0.35
 
Allowance for loan losses as a percent of non-performing loans
   
348.03
     
275.99
 
 
(1)
Excludes loans classified as “troubled debt restructured” that are not past due.
 
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Troubled debt restructurings ("TDR")
 
                   
   
March 31, 2018
 
   
Commercial
   
Retail (1)
   
Total
 
   
(In thousands)
 
Performing TDR's
 
$
7,880
   
$
52,022
   
$
59,902
 
Non-performing TDR's(2)
   
275
     
3,454
(3) 
   
3,729
 
Total
 
$
8,155
   
$
55,476
   
$
63,631
 
 
   
December 31, 2017
 
   
Commercial
   
Retail
   
Total
 
   
(In thousands)
 
Performing TDR's
 
$
7,748
   
$
52,367
   
$
60,115
 
Non-performing TDR's(2)
   
323
     
4,506
(3)     
4,829
 
Total
 
$
8,071
   
$
56,873
   
$
64,944
 

(1)
Retail loans include mortgage and installment portfolio segments.
(2)
Included in non-performing loans table above.
(3)
Also includes loans on non-accrual at the time of modification until six payments are received on a timely basis.

Non-performing loans decreased by $1.6 million, or 19.0%, during the first quarter of 2018 due principally to decreases in non-performing commercial loans and mortgage loans. These declines primarily reflect reduced levels of new loan defaults as well as loan charge-offs, pay-offs, negotiated transactions, and the migration of loans into other real estate. In general, stable economic conditions in our market areas, as well as our collection and resolution efforts, have resulted in a 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 $59.9 million, or 2.9% of total Portfolio Loans, and $60.1 million, or 3.0% of total Portfolio Loans, at March 31, 2018 and December 31, 2017, respectively. The decrease in the amount of performing TDRs in the first quarter of 2018 primarily reflects pay downs and payoffs.

Other real estate and repossessed assets were essentially unchanged and totaled $1.6 million at both March 31, 2018 and December 31, 2017.

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 0.03% (as a result of net recoveries) on an annualized basis in the first quarter of 2018 compared to a negative 0.04% in the first quarter of 2017.  The dollar amount of loan net recoveries was essentially unchanged in the first quarter of 2018 as compared to the year-ago period.
 
69

Allowance for loan losses
 
   
Three months ended
March 31,
 
   
2018
   
2017
 
   
Loans
   
Unfunded
Commitments
   
Loans
   
Unfunded
Commitments
 
   
(Dollars in thousands)
 
Balance at beginning of period
 
$
22,587
   
$
1,125
   
$
20,234
   
$
650
 
Additions (deductions)
                               
Provision for loan losses
   
315
     
-
     
(359
)
   
-
 
Recoveries credited to allowance
   
1,014
     
-
     
1,129
     
-
 
Loans charged against the allowance
   
(845
)
   
-
     
(966
)
   
-
 
Additions included in non-interest expense
   
-
     
(114
)
   
-
     
110
 
Balance at end of period
 
$
23,071
   
$
1,011
   
$
20,038
   
$
760
 
                                 
Net loans charged against the allowance to average Portfolio Loans
   
(0.03
)%
           
(0.04
)%
       


Allocation of the Allowance for Loan Losses
           
   
March 31,
2018
   
December 31,
2017
 
   
(In thousands)
 
Specific allocations
 
$
6,332
   
$
6,839
 
Other adversely rated commercial loans
   
1,865
     
1,228
 
Historical loss allocations
   
7,245
     
7,125
 
Additional allocations based on subjective factors
   
7,629
     
7,395
 
Total
 
$
23,071
   
$
22,587
 

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 AFLL 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 AFLL 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 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.

The allowance for loan losses increased $0.5 million to $23.1 million at March 31, 2018 from $22.6 million at December 31, 2017 and was equal to 1.11% of total Portfolio Loans at March 31, 2018 compared to 1.12% at December 31, 2017.

Three of the four components of the allowance for loan losses outlined above increased in the first quarter of 2018. The allowance for loan losses related to specific loans decreased $0.5 million in 2018 due primarily to a decline in the balance of individually impaired loans and lower loss given default rates as well as charge-offs.  The allowance for loan losses related to other adversely rated commercial loans increased $0.6 million in 2018 primarily due to an increase in the balance of such loans included in this component to $35.3 million at March 31, 2018 from $27.2 million at December 31, 2017 and $11.6 million at March 31, 2017.  Approximately two-thirds of the year-over-year increase of $23.7 million was in the earliest watch stage (7-rated commercial loans), all of the loans representing the increase are current  and at the present time, no significant loss is expected on any of these credits. The allowance for loan losses related to historical losses increased $0.1 million during 2018 due principally to loan growth.  The allowance for loan losses related to subjective factors increased $0.2 million during 2018 primarily due to loan growth.
 
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By comparison, three of the four components of the allowance for loan losses outlined above increased in the first quarter of 2017. The allowance for loan losses related to specific loans decreased $1.5 million in 2017 due primarily to a decline in the balance of individually impaired loans as well as charge-offs.  In particular, we received a full payoff in March 2017 on a commercial loan that had a specific reserve of $1.2 million at December 31, 2016. The allowance for loan losses related to other adversely rated commercial loans increased $0.1 million in 2017 primarily due to slight upward adjustments in our probability of default and expected loss rates that were partially offset by a decrease in the balance of such loans included in this component to $11.6 million at March 31, 2017 from $11.8 million at December 31, 2016. The allowance for loan losses related to historical losses increased $0.9 million during 2017 due principally to slight upward adjustments in our probability of default and expected loss rates for commercial loans, an additional component of approximately $0.5 million added for loans secured by commercial real estate due primarily to emerging risks in this sector (such as retail store closings and potential overdevelopment in certain markets) and loan growth. We also extended our historical lookback period to be more representative of the probability of default and account for infrequent migration events and extremely low levels of watch credits.  The allowance for loan losses related to subjective factors increased $0.3 million during 2017 primarily due to loan growth.

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 $2.43 billion and $2.40 billion at March 31, 2018 and December 31, 2017, respectively.  The $29.9 million increase in deposits in the first quarter of 2018 is primarily due to growth in savings and interest-bearing checking deposit account balances.  Reciprocal deposits totaled $63.0 million and $51.0 million at March 31, 2018 and December 31, 2017, 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 March 31, 2018, we had approximately $536.0 million of uninsured deposits. A reduction in core deposits would likely increase our need to rely on wholesale funding sources.
 
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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 primarily of federal funds purchased and advances from the FHLB, totaled $27.8 million and $54.6 million at March 31, 2018 and December 31, 2017, 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 March 31, 2018, our use of such wholesale funding sources (including reciprocal deposits) amounted to approximately $206.0 million, or 8.4% 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, and Brokered CDs may be difficult for us to retain or replace at attractive rates as they mature. 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.  During the first quarters of 2018 and 2017, we entered into $11.3 million and $9.8 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 $0.10 million and $0.05 million of fee income related to these transactions during the first quarters of 2018 and 2017, respectively. See note #6 to the Condensed Consolidated Financial Statements included within this report for more information on our derivative financial instruments.

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, federal funds purchased borrowing facilities with other banks, and access to the capital markets (for Brokered CDs).
 
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At March 31, 2018, we had $426.3 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, $1.89 billion of our deposits at March 31, 2018, 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 highly liquid or short-term assets) to total assets, short-term liability dependence and basic surplus (defined as quick assets less volatile liabilities to total assets). Policy limits have been established for our various liquidity measurements and are monitored on a quarterly 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 $17.0 million as of March 31, 2018 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
           
   
March 31,
2018
   
December 31,
2017
 
   
(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
   
324,517
     
324,986
 
Accumulated deficit
   
(48,098
)
   
(54,054
)
Accumulated other comprehensive loss
   
(8,502
)
   
(5,999
)
Total shareholders’ equity
   
267,917
     
264,933
 
Total capitalization
 
$
302,417
   
$
299,433
 

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.
 
74

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 March 31, 2018 and December 31, 2017. 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 increased to $267.9 million at March 31, 2018 from $264.9 million at December 31, 2017 due primarily to our net income that was partially offset by an increase in our accumulated other comprehensive loss and by a dividend that we paid. Our tangible common equity (“TCE”) totaled $266.4 million and $263.3 million, respectively, at those same dates. Our ratio of TCE to tangible assets was 9.54% and 9.45% at March 31, 2018 and December 31, 2017, respectively.  TCE and the ratio of TCE to tangible assets are non-GAAP measures.  TCE represents total common equity less intangible assets.

In January 2018, our Board of Directors authorized a share repurchase plan.  Under the terms of the 2018 share repurchase plan, we are authorized to buy back up to 5% of our outstanding common stock.    This repurchase plan is authorized to last through December 31, 2018.  We did not repurchase any shares during the first quarter of 2018.

We pay a quarterly cash dividend on our common stock.  These dividends totaled $0.15 per share and $0.10 per share in the first quarters of 2018 and 2017, respectively.    We generally favor a dividend payout ratio between 30% and 50% of net income.

As of March 31, 2018 and December 31, 2017, our Bank (and holding company) continued to meet the requirements to be considered “well-capitalized” under federal regulatory standards (also see note #10 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 assets and liabilities 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.
 
75

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.

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)
 
March 31, 2018
                       
200 basis point rise
 
$
410,900
     
(3.86
)%
 
$
102,300
     
1.29
%
100 basis point rise
   
424,200
     
(0.75
)
   
102,400
     
1.39
 
Base-rate scenario
   
427,400
     
-
     
101,000
     
-
 
100 basis point decline
   
409,000
     
(4.31
)
   
96,500
     
(4.46
)
                                 
December 31, 2017
                               
200 basis point rise
 
$
409,200
     
(1.23
)%
 
$
99,100
     
2.27
%
100 basis point rise
   
417,100
     
0.68
     
98,600
     
1.75
 
Base-rate scenario
   
414,300
     
-
     
96,900
     
-
 
100 basis point decline
   
386,400
     
(6.73
)
   
91,600
     
(5.47
)
 

(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.
 
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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”). Certain equity securities, securities available for sale, loans held for sale, derivatives and capitalized mortgage loan servicing rights 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 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 #11 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.
 
 Litigation Matters

The aggregate amount we have accrued for losses we consider probable as a result of 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 insignificant.  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). 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 AFLL, capitalized mortgage loan servicing rights, 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.  There have been no material changes to our critical accounting policies as disclosed in our Annual Report on Form 10-K for the year ended December 31, 2017.
 
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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 March 31, 2018, have concluded that, as of such date, our disclosure controls and procedures were effective.

(b)
Changes in Internal Controls.

During the quarter ended March 31, 2018, 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.
 
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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, 2017.

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 first quarter of 2018, the Company issued 703 shares of common stock to non-employee directors on a current basis and 1,682 shares of common stock to the trust for distribution to directors on a deferred basis.  The shares were issued in January 2018, at prices of $22.35 per share and $22.70 per share, representing aggregate fees of $0.05 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 March 31, 2018:

Period
 
Total Number of
Shares Purchased (1)
   
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
 
January 2018
   
36,722
   
$
23.80
     
--
     
1,066,693
 
February 2018
   
29,245
   
$
23.15
     
--
     
1,066,693
 
March 2018
   
--
     
--
     
--
     
1,066,693
 
Total
   
65,967
   
$
23.51
     
--
     
1,066,693
 

(1)
Represents (i) 28,639 shares of our common stock purchased in the open market by the Independent Bank Corporation Employee Stock Ownership Trust as part of our employee stock ownership plan, and (ii) 37,328 shares withheld from the shares that would otherwise have been issued to certain officers in order to satisfy tax withholding obligations resulting from vesting of restricted stock.
 
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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:
 
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).
 
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).
 
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
May 4, 2018
 
By
/s/ Robert N. Shuster
       
Robert N. Shuster, Principal Financial Officer
         
Date
May 4, 2018
 
 By
/s/ James J. Twarozynski
       
James J. Twarozynski, Principal Accounting Officer
 
 
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