Loans

Loans that management intends to hold until maturity are reported at their outstanding principal balance adjusted for unearned income, charge-offs, the allowance for loan losses, any unamortized deferred fees or costs on originated loans, and unamortized premiums or discounts on purchased loans.

For loans recorded at cost, interest income is accrued based on the unpaid principal balance. Loan origination fees, net of certain direct origination costs, as well as premiums and discounts, are deferred and amortized as a level yield adjustment over the respective term of the loan.

Categories of loans include:



	September 30, 2016			December 31, 2015
Commercial loans
Commercial and industrial	$	107,250		$	102,000
Owner-occupied commercial real estate	45,540			44,462
Investor commercial real estate	12,752			16,184
Construction	56,391			45,898
Single tenant lease financing	571,972			374,344
Total commercial loans	793,905			582,888
Consumer loans
Residential mortgage	200,889			214,559
Home equity	37,849			43,279
Other consumer	163,158			108,312
Total consumer loans	401,896			366,150
Total commercial and consumer loans	1,195,801			949,038
Deferred loan origination costs and premiums and discounts on purchased loans	3,131			4,821
Total loans	1,198,932			953,859
Allowance for loan losses	(10,561		)	(8,351		)
Net loans	$	1,188,371		$	945,508

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

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

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

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

Construction: Construction loans are secured by real estate and improvements and are made to assist in the construction of new structures, which may include commercial (retail, industrial, office, multi-family) properties or single family residential properties offered for sale by the builder. These loans generally finance a variety of project costs, including land, site preparation, construction, closing and soft costs and interim financing needs. The cash flows of builders, while initially predictable, may fluctuate with market conditions, and the value of the collateral securing these loans may be subject to fluctuations based on general economic changes.

Single Tenant Lease Financing: These loans are made to property owners of real estate subject to long term lease arrangements with single tenant operators. The real estate is typically operated by regionally, nationally or globally branded businesses. The loans are underwritten based on the financial strength of the borrower, characteristics of the real estate, cash flows generated from the lease arrangements and the financial strength of the tenant. Similar to the other loan portfolio segments, management monitors and evaluates these loans based on borrower and tenant financial performance, collateral value, industry trends and other risk grade criteria.

Residential Mortgage: With respect to residential loans that are secured by 1-4 family residences and are generally owner occupied, the Company typically establishes a maximum loan-to-value ratio and requires private mortgage insurance if that ratio is exceeded. Repayment of these loans is primarily dependent on the financial circumstances of the borrowers, which can be impacted by economic conditions in their market areas such as unemployment levels. Repayment can also be impacted by changes in residential property values. Risk is mitigated by the fact that the loans are of smaller individual amounts and spread over a large number of borrowers in geographically diverse locations throughout the country.

Home Equity: Home equity loans and lines of credit are typically secured by a subordinate interest in 1-4 family residences. The properties securing the Company's home equity portfolio segment are generally geographically diverse as the Company offers these products on a nationwide basis. Repayment of home equity loans and lines of credit may be impacted by changes in property values on residential properties and unemployment levels, among other economic conditions and financial circumstances in the market.

Other Consumer: These loans primarily consist of consumer loans and credit cards. Consumer loans may be secured by consumer assets such as horse trailers or recreational vehicles. Some consumer loans are unsecured, such as small installment loans, home improvement loans and certain lines of credit. Repayment of consumer loans is primarily dependent upon the personal income of the borrowers, which can be impacted by economic conditions in their market areas such as unemployment levels. Risk is mitigated by the fact that the loans are of smaller individual amounts and spread over a large number of borrowers in geographically diverse locations throughout the country.

Allowance for Loan Losses Methodology

Company policy is designed to maintain an adequate allowance for loan losses (“ALLL”). The portfolio is segmented by loan type, and the required ALLL for types of performing homogeneous loans which do not have a specific reserve is determined by applying a factor based on average historical losses, adjusted for current economic factors and portfolio trends. Management believes the historical loss experience methodology is appropriate in the current economic environment as it captures loss rates that are comparable to the current period being analyzed. Management adds qualitative factors for observable trends, changes in internal practices, changes in delinquencies and impairments, and external factors. Observable factors include changes in the composition and size of portfolios, as well as loan terms or concentration levels. The Company evaluates the impact of internal changes such as management and staff experience levels or modification to loan underwriting processes. Delinquency trends are scrutinized for both volume and severity of past due, nonaccrual, or classified loans as well as any changes in the value of underlying collateral. Finally, the Company considers the effect of other external factors such as national, regional, and local economic and business conditions, as well as competitive, legal, and regulatory requirements. Loans that are considered to be impaired are evaluated to determine the need for a specific allowance by applying at least one of three methodologies: present value of future cash flows; fair value of collateral less costs to sell; or the loan’s observable market price. All troubled debt restructurings (“TDR”) are considered impaired loans. Loans evaluated for impairment are removed from other pools to prevent double-counting. Accounting Standards Codification (“ASC”) Topic 310, Receivables, requires that impaired loans be measured based on the present value of expected future cash flows discounted at the loans’ effective interest rates or the fair value of the underlying collateral less costs to sell and allows existing methods for recognizing interest income.

Provision for Loan Losses

A provision for estimated losses on loans is charged to income based upon management’s evaluation of the potential losses. Such an evaluation, which includes a review of all loans for which full repayment may not be reasonably assured, considers, among other matters, the estimated net realizable value of the underlying collateral, as applicable, economic conditions, loan loss experience, and other factors that are particularly susceptible to changes that could result in a material adjustment in the near term. While management attempts to use the best information available in making its evaluations, future allowance adjustments may be necessary if economic conditions change substantially from the assumptions used in making the evaluations.

Policy for Charging Off Loans

The Company’s policy is to charge off a loan at any point in time when it no longer can be considered a bankable asset, meaning collectible within the parameters of policy. A secured loan is generally charged down to the estimated fair value of the collateral, less costs to sell, no later than when it is 120 days past due as to principal or interest. An unsecured loan generally is charged off no later than when it is 180 days past due as to principal or interest. A home improvement loan generally is charged off no later than when it is 90 days past due as to principal or interest.

The following tables present changes in the balance of the ALLL during the three and nine month periods ended September 30, 2016 and 2015.



	Three Months Ended September 30, 2016
	Commercial and industrial			Owner-occupied commercial real estate			Investor commercial real estate			Construction		Single tenant lease financing		Residential mortgage			Home equity			Other consumer			Total
Allowance for loan losses:
Balance, beginning of period	$	1,834		$	461		$	171		$	555	$	5,059	$	781		$	121		$	1,034		$	10,016
Provision (credit) charged to expense	1,174			(5		)	(7		)	37		832		(67		)	(15		)	255			2,204
Losses charged off	(1,582		)	—			—			—		—		—			—			(155		)	(1,737		)
Recoveries	—			—			—			—		—		2			4			72			78
Balance, end of period	$	1,426		$	456		$	164		$	592	$	5,891	$	716		$	110		$	1,206		$	10,561



	Nine Months Ended September 30, 2016
	Commercial and industrial			Owner-occupied commercial real estate			Investor commercial real estate			Construction		Single tenant lease financing		Residential mortgage			Home equity			Other consumer			Total
Allowance for loan losses:
Balance, beginning of period	$	1,367		$	476		$	212		$	500	$	3,931	$	896		$	125		$	844		$	8,351
Provision (credit) charged to expense	1,641			(20		)	(48		)	92		1,960		(75		)	8			516			4,074
Losses charged off	(1,582		)	—			—			—		—		(134		)	(33		)	(369		)	(2,118		)
Recoveries	—			—			—			—		—		29			10			215			254
Balance, end of period	$	1,426		$	456		$	164		$	592	$	5,891	$	716		$	110		$	1,206		$	10,561



	Three Months Ended September 30, 2015
	Commercial and industrial		Owner-occupied commercial real estate		Investor commercial real estate			Construction		Single tenant lease financing		Residential mortgage			Home equity			Other consumer			Total
Allowance for loan losses:
Balance, beginning of period	$	1,201	$	439	$	261		$	227	$	3,093	$	933		$	157		$	762		$	7,073
Provision (credit) charged to expense	29		16		(31		)	129		429		(132		)	(1		)	15			454
Losses charged off	—		—		—			—		—		(14		)	—			(62		)	(76		)
Recoveries	—		—		—			—		—		130			—			90			220
Balance, end of period	$	1,230	$	455	$	230		$	356	$	3,522	$	917		$	156		$	805		$	7,671



	Nine Months Ended September 30, 2015
	Commercial and industrial		Owner-occupied commercial real estate		Investor commercial real estate			Construction		Single tenant lease financing		Residential mortgage			Home equity			Other consumer			Total
Allowance for loan losses:
Balance, beginning of period	$	920	$	345	$	261		$	330	$	2,061	$	985		$	207		$	691		$	5,800
Provision (credit) charged to expense	310		110		(531		)	26		1,461		(284		)	(51		)	159			1,200
Losses charged off	—		—		—			—		—		(185		)	—			(351		)	(536		)
Recoveries	—		—		500			—		—		401			—			306			1,207
Balance, end of period	$	1,230	$	455	$	230		$	356	$	3,522	$	917		$	156		$	805		$	7,671

The following tables present the recorded investment in loans based on portfolio segment and impairment method as of September 30, 2016, and December 31, 2015.



	September 30, 2016
	Commercial and industrial		Owner-occupied commercial real estate		Investor commercial real estate		Construction		Single tenant lease financing		Residential mortgage		Home equity		Other consumer		Total
Loans:
Ending balance: collectively evaluated for impairment	$	107,250	$	45,540	$	12,752	$	56,391	$	571,972	$	198,871	$	37,849	$	162,976	$	1,193,601
Ending balance: individually evaluated for impairment	—		—		—		—		—		2,018		—		182		2,200
Ending balance	$	107,250	$	45,540	$	12,752	$	56,391	$	571,972	$	200,889	$	37,849	$	163,158	$	1,195,801
Allowance for loan losses:
Ending balance: collectively evaluated for impairment	$	1,426	$	456	$	164	$	592	$	5,891	$	716	$	110	$	1,206	$	10,561
Ending balance: individually evaluated for impairment	—		—		—		—		—		—		—		—		—
Ending balance	$	1,426	$	456	$	164	$	592	$	5,891	$	716	$	110	$	1,206	$	10,561



	December 31, 2015
	Commercial and industrial		Owner-occupied commercial real estate		Investor commercial real estate		Construction		Single tenant lease financing		Residential mortgage		Home equity		Other consumer		Total
Loans:
Ending balance: collectively evaluated for impairment	$	102,000	$	44,462	$	16,184	$	45,898	$	374,344	$	213,426	$	43,279	$	108,163	$	947,756
Ending balance: individually evaluated for impairment	—		—		—		—		—		1,133		—		149		1,282
Ending balance	$	102,000	$	44,462	$	16,184	$	45,898	$	374,344	$	214,559	$	43,279	$	108,312	$	949,038
Allowance for loan losses:
Ending balance: collectively evaluated for impairment	$	1,367	$	476	$	212	$	500	$	3,931	$	896	$	125	$	844	$	8,351
Ending balance: individually evaluated for impairment	—		—		—		—		—		—		—		—		—
Ending balance	$	1,367	$	476	$	212	$	500	$	3,931	$	896	$	125	$	844	$	8,351

The Company utilizes a risk grading matrix to assign a risk grade to each of its commercial loans. In the third quarter 2016, the Company updated its risk grading matrix to improve precision within the “Pass” risk grades. Commercial loans are now graded on a scale of 1 to 10, whereas commercial loans were previously graded on a scale of 1 to 9. This update to the risk grading matrix did not have an impact on the ALLL. The following table illustrates the risk ratings utilized as of September 30, 2016 and December 31, 2015.



Rating	September 30, 2016	December 31, 2015
Pass	Grade 1-6	Grade 1-5
Special Mention	Grade 7	Grade 6
Substandard	Grade 8	Grade 7
Doubtful	Grade 9	Grade 8
Loss	Grade 10	Grade 9

A description of the general characteristics of the ten risk grades is as follows:


•	“Pass” (Grades 1-6) - Higher quality loans that do not fit any of the other categories described below.


•	“Special Mention” (Grade 7) - Loans that possess some credit deficiency or potential weakness which deserve close attention.


•	“Substandard” (Grade 8) - Loans that possess a defined weakness or weaknesses that jeopardize the liquidation of the debt. Loans characterized by the distinct possibility that the institution will sustain some loss if the deficiencies are not corrected. Loans that are inadequately protected by the current net worth and paying capacity of the obligor or of the collateral pledged, if any.

•

“Doubtful” (Grade 9) - Such loans have been placed on nonaccrual status and may be heavily dependent upon collateral possessing a value that is difficult to determine or based upon some near-term event which lacks clear certainty. These loans have all of the weaknesses of those classified as Substandard; however, based on existing conditions, these weaknesses make full collection of the principal balance highly improbable.


•	“Loss” (Grade 10) - Loans that are considered uncollectible and of such little value that continuing to carry them as assets is not warranted.

Nonaccrual Loans

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

The following tables present the credit risk profile of the Company’s commercial and consumer loan portfolios based on rating category and payment activity as of September 30, 2016 and December 31, 2015.



	September 30, 2016
	Commercial and industrial		Owner-occupied commercial real estate		Investor commercial real estate		Construction		Single tenant lease financing		Total
Rating:
1-6 Pass	$	106,482	$	45,529	$	12,752	$	56,391	$	571,972	$	793,126
7 Special Mention	243		—		—		—		—		243
8 Substandard	525		11		—		—		—		536
9 Doubtful	—		—		—		—		—		—
Total	$	107,250	$	45,540	$	12,752	$	56,391	$	571,972	$	793,905



	September 30, 2016
	Residential mortgage		Home equity		Other consumer		Total
Performing	$	199,864	$	37,849	$	163,050	$	400,763
Nonaccrual	1,025		—		108		1,133
Total	$	200,889	$	37,849	$	163,158	$	401,896



	December 31, 2015
	Commercial and industrial		Owner-occupied commercial real estate		Investor commercial real estate		Construction		Single tenant lease financing		Total
Rating:
1-5 Pass	$	95,589	$	43,913	$	14,746	$	45,599	$	374,344	$	574,191
6 Special Mention	2,006		535		—		299		—		2,840
7 Substandard	4,405		14		1,438		—		—		5,857
8 Doubtful	—		—		—		—		—		—
Total	$	102,000	$	44,462	$	16,184	$	45,898	$	374,344	$	582,888



	December 31, 2015
	Residential mortgage		Home equity		Other consumer		Total
Performing	$	214,456	$	43,279	$	108,248	$	365,983
Nonaccrual	103		—		64		167
Total	$	214,559	$	43,279	$	108,312	$	366,150

The following tables present the Company’s loan portfolio delinquency analysis as of September 30, 2016 and December 31, 2015.



	September 30, 2016
	30-59 Days Past Due		60-89 Days Past Due		90 Days or More Past Due		Total Past Due		Current		Total Commercial and Consumer Loans		Non- accrual Loans		Total Loans 90 Days or More Past Due and Accruing
Commercial and industrial	$	257	$	—	$	—	$	257	$	106,993	$	107,250	$	—	$	—
Owner-occupied commercial real estate	—		—		—		—		45,540		45,540		—		—
Investor commercial real estate	—		—		—		—		12,752		12,752		—		—
Construction	—		—		—		—		56,391		56,391		—		—
Single tenant lease financing	—		—		—		—		571,972		571,972		—		—
Residential mortgage	—		—		991		991		199,898		200,889		1,025		—
Home equity	—		—		—		—		37,849		37,849		—		—
Other consumer	232		35		—		267		162,891		163,158		108		—
Total	$	489	$	35	$	991	$	1,515	$	1,194,286	$	1,195,801	$	1,133	$	—



	December 31, 2015
	30-59 Days Past Due		60-89 Days Past Due		90 Days or More Past Due		Total Past Due		Current		Total Commercial and Consumer Loans		Non- accrual Loans		Total Loans 90 Days or More Past Due and Accruing
Commercial and industrial	$	29	$	—	$	—	$	29	$	101,971	$	102,000	$	—	$	—
Owner-occupied commercial real estate	—		—		—		—		44,462		44,462		—		—
Investor commercial real estate	—		—		—		—		16,184		16,184		—		—
Construction	—		—		—		—		45,898		45,898		—		—
Single tenant lease financing	—		—		—		—		374,344		374,344		—		—
Residential mortgage	300		23		45		368		214,191		214,559		103		—
Home equity	20		—		—		20		43,259		43,279		—		—
Other consumer	116		12		—		128		108,184		108,312		64		—
Total	$	465	$	35	$	45	$	545	$	948,493	$	949,038	$	167	$	—

Impaired Loans

A loan is designated as impaired, in accordance with the impairment accounting guidance, when, based on current information or events, it is probable that the Company will be unable to collect all amounts due (principal and interest) according to the contractual terms of the loan agreement. Payments with delays generally not exceeding 90 days outstanding are not considered impaired. Certain nonaccrual and substantially all delinquent loans more than 90 days past due may be considered to be impaired. Generally, loans are placed on nonaccrual status at 90 days past due and accrued interest is reversed against earnings, unless the loan is well-secured and in the process of collection. The accrual of interest on impaired and nonaccrual loans is discontinued when, in management’s opinion, the borrower may be unable to meet payments as they become due.

Impaired loans include nonperforming loans as well as loans modified in TDRs where concessions have been granted to borrowers experiencing financial difficulties. These concessions could include a reduction in the interest rate on the loan, payment extensions, forgiveness of principal, forbearance, or other actions intended to maximize collection.

ASC Topic 310, Receivables, requires that impaired loans be measured based on the present value of expected future cash flows discounted at the loans’ effective interest rates or the fair value of the underlying collateral, less costs to sell, and allows existing methods for recognizing interest income.

The following table presents the Company’s impaired loans as of September 30, 2016 and December 31, 2015. The Company had no impaired loans with a specific valuation allowance as of September 30, 2016 or December 31, 2015.



	September 30, 2016						December 31, 2015
	Recorded Balance		Unpaid Principal Balance		Specific Allowance		Recorded Balance		Unpaid Principal Balance		Specific Allowance
Loans without a specific valuation allowance
Residential mortgage	$	2,018	$	2,130	$	—	$	1,133	$	1,154	$	—
Other consumer	182		237		—		149		178		—
Total	2,200		2,367		—		1,282		1,332		—
Total impaired loans	$	2,200	$	2,367	$	—	$	1,282	$	1,332	$	—

The table below presents average balances and interest income recognized for impaired loans during the three and nine month periods ended September 30, 2016 and September 30, 2015.



	Three Months Ended				Nine Months Ended				Three Months Ended				Nine Months Ended
	September 30, 2016								September 30, 2015
	Average Balance		Interest Income		Average Balance		Interest Income		Average Balance		Interest Income		Average Balance		Interest Income
Loans without a specific valuation allowance
Investor commercial real estate	$	—	$	—	$	—	$	—	$	—	$	—	$	28	$	2
Residential mortgage	1,876		2		1,478		6		1,146		3		1,105		7
Other consumer	167		1		153		5		254		3		197		9
Total	2,043		3		1,631		11		1,400		6		1,330		18
Loans with a specific valuation allowance
Commercial and industrial	$	3,524	$	—	$	1,568	$	—	$	—	$	—	$	—	$	—
Residential mortgage	—		—		—		—		—		—		20		—
Other consumer	—		—		—		—		—		—		18		1
Total	3,524		—		1,568		—		—		—		38		1
Total impaired loans	$	5,567	$	3	$	3,199	$	11	$	1,400	$	6	$	1,368	$	19

As of September 30, 2016 and December 31, 2015, the Company had less than $0.1 million and $0.0 million, respectively, in residential mortgage other real estate owned. There were $0.8 million and less than $0.1 million of loans at September 30, 2016 and December 31, 2015, respectively, in the process of foreclosure.