10-Q 1 form10q.htm 10-Q
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C.  20549

FORM 10-Q

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED September 30, 2019

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.

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

Title of each Class
  
Trading Symbol
  
Name of each exchange which registered
Common stock, no par value
  
IBCP
  
The Nasdaq Stock Market, LLC

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, 22,481,485 as of October 31, 2019.

INDEPENDENT BANK CORPORATION AND SUBSIDIARIES

INDEX

 
Number(s)
PART I -
 Financial Information  
Item 1.
3
 
4
 
5
 
6
 
7
 
8-68
Item 2.
69-91
Item 3.
92
Item 4.
92

   
PART II
Other Information
  
Item 1A
93
Item 2.
93
Item 6.
94

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.  The risk factors disclosed in Part I – Item 1A of our Annual Report on Form 10-K for the year ended December 31, 2018, 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.

Part I - Item1.
 INDEPENDENT BANK CORPORATION AND SUBSIDIARIES
 

Condensed Consolidated Statements of Financial Condition

   
September 30,
2019
    
December 31,
2018
  
   
(unaudited)
  

  
(In thousands, except share amounts)
Assets
  
Cash and due from banks
  
$
38,662
    
$
23,350
  
Interest bearing deposits
    
43,755
      
46,894
  
Cash and Cash Equivalents
    
82,417
      
70,244
  
Interest bearing deposits - time
    
499
      
595
  
Equity securities at fair value
    
-
      
393
  
Securities available for sale
    
439,592
      
427,926
  
Federal Home Loan Bank and Federal Reserve Bank stock, at cost
    
18,359
      
18,359
  
Loans held for sale, carried at fair value
    
87,358
      
44,753
  
Loans held for sale, carried at lower of cost or fair value
    
36,622
      
41,471
  
Loans
                
Commercial
    
1,189,017
      
1,144,481
  
Mortgage
    
1,070,035
      
1,042,890
  
Installment
    
463,394
      
395,149
  
Total Loans
    
2,722,446
      
2,582,520
  
Allowance for loan losses
    
(26,148
)
    
(24,888
)
Net Loans
    
2,696,298
      
2,557,632
  
Other real estate and repossessed assets, net
    
1,789
      
1,299
  
Property and equipment, net
    
37,424
      
38,777
  
Bank-owned life insurance
    
55,412
      
55,068
  
Deferred tax assets, net
    
2,773
      
5,779
  
Capitalized mortgage loan servicing rights, carried at fair value
    
16,906
      
21,400
  
Other intangibles
    
5,598
      
6,415
  
Goodwill
    
28,300
      
28,300
  
Accrued income and other assets
    
41,490
      
34,870
  
Total Assets
  
$
3,550,837
    
$
3,353,281
  
                 
Liabilities and Shareholders’ Equity
  
Deposits
                
Non-interest bearing
  
$
883,138
    
$
879,549
  
Savings and interest-bearing checking
    
1,178,695
      
1,194,865
  
Reciprocal
    
416,200
      
182,072
  
Time
    
374,579
      
385,981
  
Brokered time
    
199,700
      
270,961
  
Total Deposits
    
3,052,312
      
2,913,428
  
Other borrowings
    
63,974
      
25,700
  
Subordinated debentures
    
39,439
      
39,388
  
Accrued expenses and other liabilities
    
54,867
      
35,771
  
Total Liabilities
    
3,210,592
      
3,014,287
  
Commitments and contingent liabilities
                
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: 22,480,748 shares at September 30, 2019 and 23,579,725 shares at December 31, 2018
    
351,839
      
377,372
  
Accumulated deficit
    
(8,221
)
    
(28,270
)
Accumulated other comprehensive loss
    
(3,373
)
    
(10,108
)
Total Shareholders’ Equity
    
340,245
      
338,994
  
Total Liabilities and Shareholders’ Equity
  
$
3,550,837
    
$
3,353,281
  

See notes to interim condensed consolidated financial statements (unaudited)

INDEPENDENT BANK CORPORATION AND SUBSIDIARIES
Condensed Consolidated Statements of Operations

   
Three months ended
September 30,
    
Nine months ended
September 30,
  
   
2019
    
2018
    
2019
    
2018
  
   
(unaudited)
    
(unaudited)
  
   
(In thousands, except per share amounts)
  
                   
Interest Income
                        
Interest and fees on loans
  
$
34,226
    
$
31,000
    
$
100,743
    
$
84,027
  
Interest on securities
                                
Taxable
    
2,771
      
2,737
      
8,811
      
8,092
  
Tax-exempt
    
319
      
412
      
1,017
      
1,335
  
Other investments
    
495
      
303
      
1,449
      
898
  
Total Interest Income
    
37,811
      
34,452
      
112,020
      
94,352
  
Interest Expense
                                
Deposits
    
6,236
      
3,976
      
17,938
      
9,472
  
Other borrowings and subordinated debentures
    
703
      
779
      
2,211
      
2,267
  
Total Interest Expense
    
6,939
      
4,755
      
20,149
      
11,739
  
Net Interest Income
    
30,872
      
29,697
      
91,871
      
82,613
  
Provision for loan losses
    
(271
)
    
(53
)
    
1,045
      
912
  
Net Interest Income After Provision for Loan Losses
    
31,143
      
29,750
      
90,826
      
81,701
  
Non-interest Income
                                
Service charges on deposit accounts
    
2,883
      
3,166
      
8,323
      
9,166
  
Interchange income
    
2,785
      
2,486
      
7,744
      
7,236
  
Net gains (losses) on assets
                                
Mortgage loans
    
5,677
      
2,745
      
13,590
      
8,571
  
Securities
    
-
      
93
      
304
      
(71
)
Mortgage loan servicing, net
    
(1,562
)
    
1,212
      
(4,684
)
    
4,668
  
Other
    
2,492
      
2,134
      
6,862
      
6,294
  
Total Non-interest Income
    
12,275
      
11,836
      
32,139
      
35,864
  
Non-interest Expense
                                
Compensation and employee benefits
    
16,673
      
16,169
      
48,955
      
46,506
  
Occupancy, net
    
2,161
      
2,233
      
6,797
      
6,667
  
Data processing
    
2,282
      
2,051
      
6,597
      
6,180
  
Furniture, fixtures and equipment
    
1,023
      
1,043
      
3,058
      
3,029
  
Communications
    
733
      
727
      
2,219
      
2,111
  
Interchange expense
    
891
      
715
      
2,332
      
1,974
  
Loan and collection
    
714
      
531
      
1,976
      
1,900
  
Advertising
    
636
      
594
      
1,935
      
1,578
  
Legal and professional
    
541
      
477
      
1,281
      
1,311
  
FDIC deposit insurance
    
13
      
270
      
723
      
750
  
Merger related expenses
    
-
      
98
      
-
      
3,354
  
Other
    
2,181
      
1,832
      
6,557
      
5,276
  
Total Non-interest Expense
    
27,848
      
26,740
      
82,430
      
80,636
  
Income Before Income Tax
    
15,570
      
14,846
      
40,535
      
36,929
  
Income tax expense
    
3,125
      
2,921
      
7,979
      
7,026
  
Net Income
  
$
12,445
    
$
11,925
    
$
32,556
    
$
29,903
  
Net Income Per Common Share
                                
Basic
  
$
0.55
    
$
0.49
    
$
1.41
    
$
1.29
  
Diluted
  
$
0.55
    
$
0.49
    
$
1.40
    
$
1.27
  

See notes to interim condensed consolidated financial statements (unaudited)

INDEPENDENT BANK CORPORATION AND SUBSIDIARIES
Condensed Consolidated Statements of Comprehensive Income

   
Three months ended
September 30,
    
Nine months ended
September 30,
  
   
2019
    
2018
    
2019
    
2018
  
   
(unaudited - In thousands)
  
             
Net income
  
$
12,445
    
$
11,925
    
$
32,556
    
$
29,903
  
Other comprehensive income (loss)
                                
Securities available for sale
                                
Unrealized gains (losses) arising during period
    
1,567
      
(1,157
)
    
10,851
      
(6,220
)
Change in unrealized losses for which a portion of other than temporary impairment has been recognized in earnings
    
(53
)
    
(14
)
    
(55
)
    
(17
)
Reclassification adjustments for (gains) losses included in earnings
    
-
      
-
      
(137
)
    
45
  
Unrealized gains (losses) recognized in other comprehensive income (loss) on securities available for sale
    
1,514
      
(1,171
)
    
10,659
      
(6,192
)
Income tax expense (benefit)
    
318
      
(246
)
    
2,238
      
(1,300
)
Unrealized gains (losses) recognized in other comprehensive income (loss) on securities available for sale, net of tax
    
1,196
      
(925
)
    
8,421
      
(4,892
)
Derivative instruments
                                
Unrealized gain (loss) arising during period
    
(72
)
    
389
      
(1,740
)
    
1,400
  
Reclassification adjustment for income recognized in earnings
    
(102
)
    
(73
)
    
(393
)
    
(132
)
Unrealized gains (losses) recognized in other comprehensive income (loss) on derivative instruments
    
(174
)
    
316
      
(2,133
)
    
1,268
  
Income tax expense (benefit)
    
(36
)
    
66
      
(447
)
    
266
  
Unrealized gains (losses) recognized in other comprehensive income (loss) on derivative instruments, net of tax
    
(138
)
    
250
      
(1,686
)
    
1,002
  
Other comprehensive income (loss)
    
1,058
      
(675
)
    
6,735
      
(3,890
)
Comprehensive income
  
$
13,503
    
$
11,250
    
$
39,291
    
$
26,013
  

See notes to interim condensed consolidated financial statements (unaudited)

INDEPENDENT BANK CORPORATION AND SUBSIDIARIES
Condensed Consolidated Statements of Cash Flows

   
Nine months ended September 30,
  
   
2019
    
2018
  
   
(unaudited - In thousands)
  
Net Income
  
$
32,556
    
$
29,903
  
Adjustments to Reconcile Net Income to Net Cash From Operating Activities
                
Proceeds from the sale of equity securities at fair value
    
560
      
-
  
Proceeds from sales of loans held for sale
    
422,557
      
351,486
  
Disbursements for loans held for sale
    
(451,572
)
    
(343,462
)
Provision for loan losses
    
1,045
      
912
  
Deferred income tax expense
    
1,216
      
6,972
  
Deferred loan fees and costs
    
(3,122
)
    
(3,681
)
Net depreciation, amortization of intangible assets and premiums and accretion of discounts on securities, loans and interest bearing deposits - time
    
4,427
      
4,560
  
Net gains on mortgage loans
    
(13,590
)
    
(8,571
)
Net (gains) losses on securities
    
(304
)
    
71
  
Share based compensation
    
1,348
      
1,293
  
Increase in accrued income and other assets
    
(2,149
)
    
(16,925
)
Increase (decrease) in accrued expenses and other liabilities
    
13,088
      
(1,930
)
Total Adjustments
    
(26,496
)
    
(9,275
)
Net Cash From Operating Activities
    
6,060
      
20,628
  
Cash Flow Used in Investing Activities
                
Proceeds from the sale of securities available for sale
    
44,305
      
31,445
  
Proceeds from maturities, prepayments and calls of securities available for sale
    
110,517
      
125,275
  
Purchases of securities available for sale
    
(123,238
)
    
(71,067
)
Proceeds from the sale of interest bearing deposits - time
    
-
      
2,474
  
Proceeds from the maturity of interest bearing deposits - time
    
100
      
3,728
  
Purchase of Federal Reserve Bank Stock
    
-
      
(2,034
)
Net increase in portfolio loans (loans originated, net of principal payments)
    
(213,116
)
    
(272,084
)
Proceeds from the sale of portfolio loans
    
50,516
      
27,577
  
Acquisition of TCSB Bancorp Inc., less cash received
    
-
      
23,516
  
Proceeds from bank-owned life insurance
    
470
      
474
  
Proceeds from the sale of other real estate and repossessed assets
    
1,438
      
1,777
  
Capital expenditures
    
(2,587
)
    
(2,812
)
Net Cash Used in Investing Activities
    
(131,595
)
    
(131,731
)
Cash Flow From Financing Activities
                
Net increase in total deposits
    
138,884
      
110,400
  
Net increase in other borrowings
    
18,355
      
18,903
  
Proceeds from Federal Home Loan Bank Advances
    
57,000
      
1,202,000
  
Payments of Federal Home Loan Bank Advances
    
(37,143
)
    
(1,210,197
)
Dividends paid
    
(12,507
)
    
(10,446
)
Proceeds from issuance of common stock
    
282
      
202
  
Repurchase of common stock
    
(26,284
)
    
-
  
Share based compensation withholding obligation
    
(879
)
    
(1,327
)
Net Cash From Financing Activities
    
137,708
      
109,535
  
Net Increase (Decrease) in Cash and Cash Equivalents
    
12,173
      
(1,568
)
Cash and Cash Equivalents at Beginning of Period
    
70,244
      
54,738
  
Cash and Cash Equivalents at End of Period
  
$
82,417
    
$
53,170
  
Cash paid during the period for
                
Interest
  
$
20,185
    
$
11,168
  
Income taxes
    
5,934
      
120
  
Operating leases
    
1,692
      
-
  
Transfers to other real estate and repossessed assets
    
1,901
      
960
  
Purchase of securities available for sale not yet settled
    
3,075
      
1,000
  
Securitization of portfolio loans
    
29,790
      
-
  
Right of use assets obtained in exchange for lease obligations
    
7,767
      
-
  
Transfer of loans to held for sale
    
36,622
      
27,577
  

See notes to interim condensed consolidated financial statements (unaudited)

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


     
Common
Stock
          
Accumulated
Deficit
    
Accumulated
Other
Comprehensive
Loss
    
Total
Shareholders’
Equity
  
   
(Dollars in thousands, except per share amounts)
  
Balances at July 1, 2019
  
$
351,894
    
$
(16,617
)
  
$
(4,431
)
  
$
330,846
  
Net income, three months ended September 30, 2019
    
-
      
12,445
      
-
      
12,445
  
Cash dividends declared, $.18 per share
    
-
      
(4,049
)
    
-
      
(4,049
)
Repurchase of 25,000 shares of common stock
    
(502
)
    
-
      
-
      
(502
)
Issuance of 1,900 shares of common stock
    
-
      
-
      
-
      
-
  
Share based compensation (issuance of 5,991 shares of common stock)
    
460
      
-
      
-
      
460
  
Share based compensation withholding obligation (withholding of 919 shares of common stock)
    
(13
)
    
-
      
-
      
(13
)
Other comprehensive income
    
-
      
-
      
1,058
      
1,058
  
Balances at September 30, 2019
  
$
351,839
    
$
(8,221
)
  
$
(3,373
)
  
$
340,245
  
Balances at July 1, 2018
  
$
389,196
    
$
(42,899
)
  
$
(9,214
)
  
$
337,083
  
Net income, three months ended September 30, 2018
    
-
      
11,925
      
-
      
11,925
  
Cash dividends declared, $.15 per share
    
-
      
(3,623
)
    
-
      
(3,623
)
Issuance of 8,340 shares of common stock
    
55
      
-
      
-
      
55
  
Share based compensation (issuance of zero shares of common stock)
    
445
      
-
      
-
      
445
  
Share based compensation withholding obligation (withholding of 382 shares of common stock)
    
(6
)
    
-
      
-
      
(6
)
Other comprehensive loss
    
-
      
-
      
(675
)
    
(675
)
Balances at September 30, 2018
  
$
389,690
    
$
(34,597
)
  
$
(9,889
)
  
$
345,204
  
Balances at January 1, 2019
  
$
377,372
    
$
(28,270
)
  
$
(10,108
)
  
$
338,994
  
Net income, nine months ended September 30, 2019
    
-
      
32,556
      
-
      
32,556
  
Cash dividends declared, $.54 per share
    
-
      
(12,507
)
    
-
      
(12,507
)
Repurchase of 1,204,688 shares of common stock
    
(26,284
)
    
-
      
-
      
(26,284
)
Issuance of 70,299 shares of common stock
    
282
      
-
      
-
      
282
  
Share based compensation (issuance of 92,617 shares of common stock)
    
1,348
      
-
      
-
      
1,348
  
Share based compensation withholding obligation (withholding of 57,205 shares of common stock)
    
(879
)
    
-
      
-
      
(879
)
Other comprehensive income
    
-
      
-
      
6,735
      
6,735
  
Balances at September 30, 2019
  
$
351,839
    
$
(8,221
)
  
$
(3,373
)
  
$
340,245
  
Balances at January 1, 2018
  
$
324,986
    
$
(54,054
)
  
$
(5,999
)
  
$
264,933
  
Net income, nine months ended September 30, 2018
    
-
      
29,903
      
-
      
29,903
  
Cash dividends declared, $.45 per share
    
-
      
(10,446
)
    
-
      
(10,446
)
Acquisition of TCSB Bancorp, Inc.
    
64,536
      
-
      
-
      
64,536
  
Issuance of 113,548 shares of common stock
    
202
      
-
      
-
      
202
  
Share based compensation (issuance of 81,919 shares of common stock)
    
1,293
      
-
      
-
      
1,293
  
Share based compensation withholding obligation (withholding of 87,767 shares of common stock)
    
(1,327
)
    
-
      
-
      
(1,327
)
Other comprehensive loss
    
-
      
-
      
(3,890
)
    
(3,890
)
Balances at September 30, 2018
  
$
389,690
    
$
(34,597
)
  
$
(9,889
)
  
$
345,204
  

See notes to interim condensed consolidated financial statements (unaudited)

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, 2018 included in our Annual Report on Form 10-K.

In our opinion, the accompanying unaudited condensed consolidated financial statements contain all the adjustments necessary to present fairly our consolidated financial condition as of September 30, 2019 and December 31, 2018, and the results of operations for the three and nine-month periods ended September 30, 2019 and 2018.  The results of operations for the three and nine-month periods ended September 30, 2019, 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 and the valuation of capitalized mortgage loan servicing rights.  Refer to our 2018 Annual Report on Form 10-K for a disclosure of our accounting policies.

2.
New Accounting Standards

In June 2016, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“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:

•
Replaces the existing incurred loss impairment guidance and establishes a single allowance framework for financial assets carried at amortized cost, which will reflect our estimate of credit losses over the full remaining expected life of the financial assets and will consider expected future changes in macroeconomic conditions.
•
Eliminates existing guidance for purchase credit impaired (“PCI”) loans, and requires recognition of the nonaccretable difference as an increase to the allowance for expected credit losses on financial assets purchased with more than insignificant credit deterioration since origination, which will be offset by an increase in the recorded investment of the related loans.
•
Requires inclusion of expected recoveries, limited to the cumulative amount of prior write-offs, when estimating the allowance for credit losses for in scope financial assets (including collateral dependent assets).
•
Amends existing impairment guidance for securities available for sale to incorporate an allowance, which will allow for reversals of credit impairments in the event that the credit of an issuer improves. Credit losses on securities available for sale are limited to the amount of the decline in fair value regardless of what the credit loss model would show for impairment.
•
Generally requires a cumulative-effect adjustment to retained earnings as of the beginning of the reporting period of adoption.
•
Is effective for us on January 1, 2020.

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

We began evaluating this ASU in 2016 and established a company-wide, cross-discipline governance structure, which provides implementation oversight. We continue to test and refine our current expected credit loss models that satisfy the requirements of this ASU. Oversight and testing, as well as efforts to meet expanded disclosure requirements, will extend through the remainder of 2019.  We expect that the allowance related to our loans will increase as it will cover credit losses over the full remaining expected life of the portfolio. We currently intend to estimate losses over approximately a two year forecast period using the Federal Open Market Committee median economic projections (which are typically published in March of each year) as well as considering other economic forecast sources, and then revert to longer term historical loss experience to estimate losses over more extended periods. We currently expect the increase in the allowance for loan losses to be in the range of $9.0 million to $11.0 million, primarily driven by the longer contractual maturities of our mortgage and consumer installment loan segments.  This estimated range is based on our September 30, 2019 loan portfolio and currently available economic forecasts. The mid-point of the range utilizes a two year forecast period and a two year reversion period. This estimated range also includes a qualitative adjustment to the allowance for loan losses. In addition, we currently expect this ASU to increase the allowance for losses related to unfunded loan commitments between $0.5 million and $1.5 million.  These estimates are subject to further refinement based on continuing reviews, testing, enhancements and approvals of models, methodologies and judgments. The ultimate impact will depend upon the nature and characteristics of our loan portfolio at the adoption date, the macroeconomic conditions and forecasts at that date, further regulatory or accounting guidance and other management judgments.  We currently do not expect to record any allowance for loss on available for sale securities. The ultimate impact will depend upon the nature and characteristics of our securities available for sale (including issuer specific matters) at the adoption date, the macroeconomic conditions and forecasts at that date, and other management judgments.

In August 2018, the FASB issued ASU 2018-13, ‘‘Fair Value Measurement (Topic 820), Disclosure Framework – Changes to the Disclosure Requirements for Fair Value Measurement’’. This new ASU amends disclosure requirements in Topic 820 to eliminate, add and modify certain disclosure requirements for fair value measurements as part of its disclosure framework project. The amended guidance eliminates the requirements to disclose the amount of and reasons for transfers between Level 1 and Level 2 of the fair value hierarchy, the entity’s policy for the timing of transfers between levels of the fair value hierarchy and the entity’s valuation processes for Level 3 fair value measurements. The amended guidance adds the requirements to disclose the changes in unrealized gains and losses for the period included in other comprehensive income (loss) for recurring Level 3 fair value measurements of instruments held at the end of the reporting period and for recurring and nonrecurring Level 3 fair value measurements, the range and weighted average used to develop significant unobservable inputs and how the weighted average was calculated, with certain exceptions. This amended guidance is effective for us on January 1, 2020, and is not expected to have a material impact on our consolidated operating results or financial condition.

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

In February 2016, the FASB issued ASU 2016-02, “Leases (Topic 842)”.  This ASU amends existing guidance related to the accounting for leases. These amendments, among other things, 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 was effective for us on January 1, 2019 and did not have a material impact on our consolidated operating results or financial condition.  Based on 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.  The primary impact was the recognition of certain operating leases on our Condensed Consolidated Statements of Financial Condition which resulted in the recording of right of use (“ROU”) assets and offsetting lease liabilities each totaling approximately $7.7 million at January 1, 2019.  See note #16.

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 was effective for us on January 1, 2019, and did not have a material impact on our consolidated operating results or financial condition.

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)
  
September 30, 2019
                        
U.S. agency
  
$
15,145
    
$
153
    
$
15
    
$
15,283
  
U.S. agency residential mortgage-backed
    
146,128
      
1,806
      
214
      
147,720
  
U.S. agency commercial mortgage-backed
    
11,182
      
155
      
18
      
11,319
  
Private label mortgage-backed
    
31,195
      
686
      
55
      
31,826
  
Other asset backed
    
94,799
      
185
      
199
      
94,785
  
Obligations of states and political subdivisions
    
99,352
      
1,880
      
93
      
101,139
  
Corporate
    
32,444
      
1,237
      
3
      
33,678
  
Trust preferred
    
1,966
      
-
      
146
      
1,820
  
Foreign government
    
2,020
      
4
      
2
      
2,022
  
Total
  
$
434,231
    
$
6,106
    
$
745
    
$
439,592
  
                                 
December 31, 2018
                                
U.S. agency
  
$
20,198
    
$
9
    
$
193
    
$
20,014
  
U.S. agency residential mortgage-backed
    
124,777
      
817
      
1,843
      
123,751
  
U.S. agency commercial mortgage-backed
    
5,909
      
1
      
184
      
5,726
  
Private label mortgage-backed
    
29,735
      
321
      
637
      
29,419
  
Other asset backed
    
83,481
      
86
      
248
      
83,319
  
Obligations of states and political subdivisions
    
130,244
      
257
      
2,946
      
127,555
  
Corporate
    
34,866
      
29
      
586
      
34,309
  
Trust preferred
    
1,964
      
-
      
145
      
1,819
  
Foreign government
    
2,050
      
-
      
36
      
2,014
  
Total
  
$
433,224
    
$
1,520
    
$
6,818
    
$
427,926
  

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)
  
                                     
September 30, 2019
                                    
U.S. agency
  
$
2,189
    
$
4
    
$
2,888
    
$
11
    
$
5,077
    
$
15
  
U.S. agency residential mortgage-backed
    
26,084
      
33
      
16,902
      
181
      
42,986
      
214
  
U.S. agency commercial mortgage-backed
    
1,987
      
12
      
882
      
6
      
2,869
      
18
  
Private label mortgage- backed
    
5,636
      
6
      
612
      
49
      
6,248
      
55
  
Other asset backed
    
23,926
      
100
      
11,487
      
99
      
35,413
      
199
  
Obligations of states and political subdivisions
    
14,457
      
37
      
4,362
      
56
      
18,819
      
93
  
Corporate
    
285
      
2
      
999
      
1
      
1,284
      
3
  
Trust preferred
    
900
      
100
      
920
      
46
      
1,820
      
146
  
Foreign government
    
-
      
-
      
1,519
      
2
      
1,519
      
2
  
Total
  
$
75,464
    
$
294
    
$
40,571
    
$
451
    
$
116,035
    
$
745
  
                                                 
December 31, 2018
                                                
U.S. agency
  
$
7,150
    
$
46
    
$
11,945
    
$
147
    
$
19,095
    
$
193
  
U.S. agency residential mortgage-backed
    
18,374
      
180
      
48,184
      
1,663
      
66,558
      
1,843
  
U.S. agency commercial mortgage-backed
    
566
      
3
      
5,094
      
181
      
5,660
      
184
  
Private label mortgage-backed
    
8,273
      
57
      
16,145
      
580
      
24,418
      
637
  
Other asset backed
    
53,043
      
160
      
10,235
      
88
      
63,278
      
248
  
Obligations of states and political subdivisions
    
25,423
      
262
      
80,701
      
2,684
      
106,124
      
2,946
  
Corporate
    
17,758
      
343
      
9,222
      
243
      
26,980
      
586
  
Trust preferred
    
939
      
61
      
880
      
84
      
1,819
      
145
  
Foreign government
    
-
      
-
      
2,014
      
36
      
2,014
      
36
  
Total
  
$
131,526
    
$
1,112
    
$
184,420
    
$
5,706
    
$
315,946
    
$
6,818
  

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. agency, U.S. agency residential mortgage-backed securities and U.S. agency commercial mortgage backed securities — at September 30, 2019, we had 26 U.S. agency, 98 U.S. agency residential mortgage-backed and eight U.S. agency commercial mortgage-backed securities whose fair market value is less than amortized cost. The unrealized losses are largely attributed to increases in interest rates since acquisition and widening spreads to Treasury bonds. As management does not intend to liquidate these securities and it is more likely than not that we will not be required to sell these securities prior to recovery of these unrealized losses, no declines are deemed to be other than temporary.

Private label mortgage backed securities — at September 30, 2019, we had 12 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 (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. 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 September 30, 2019, we had 40 other asset backed securities whose fair value is less than amortized cost. The unrealized losses are primarily due to credit spread widening and increases in interest rates since acquisition. As management does not intend to liquidate these securities and it is more likely than not that we will not be required to sell these securities prior to recovery of these unrealized losses, no declines are deemed to be other than temporary.

Obligations of states and political subdivisions — at September 30, 2019, we had 59 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. As management does not intend to liquidate these securities and it is more likely than not that we will not be required to sell these securities prior to recovery of these unrealized losses, no declines are deemed to be other than temporary.

Corporate — at September 30, 2019, we had two 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.

13
NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
(unaudited)

Trust preferred securities — at September 30, 2019, we had two trust preferred securities whose fair value is less than amortized cost. Both of our trust preferred securities are single issue securities issued by a trust subsidiary of a bank holding company. The pricing of trust preferred securities has suffered from credit spread widening. One of the securities is rated by a major rating agency 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 $0.90 million as of September 30, 2019, continues to have satisfactory credit metrics and make interest payments. As management does not intend to liquidate this security and it is more likely than not that we will not be required to sell this security prior to recovery of the unrealized loss, this decline is not deemed to be other than temporary.
 
Foreign government — at September 30, 2019, we had one foreign government security whose fair value is less than amortized cost. The unrealized loss is primarily due to increases in interest rates since acquisition. As management does not intend to liquidate this security and it is more likely than not that we will not be required to sell this security prior to recovery of this unrealized loss, this decline is not 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 and nine month periods ended September 30, 2019 and 2018, respectively.

At September 30, 2019, two private label mortgage-backed securities had credit related OTTI and are summarized as follows:

   
Senior
Security
    
Super
Senior
Security
    
Total
  
   
(In thousands)
  
                   
Fair value
  
$
645
    
$
647
    
$
1,292
  
Amortized cost
    
552
      
479
      
1,031
  
Non-credit unrealized loss
    
-
      
-
      
-
  
Unrealized gain
    
93
      
168
      
261
  
Cumulative credit related OTTI
    
757
      
457
      
1,214
  


Both of these securities are receiving principal and interest payments similar to principal reductions in the underlying collateral and have unrealized gains at September 30, 2019. 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
September 30,
    
Nine months ended
September 30,
  
   
2019
    
2018
    
2019
    
2018
  
   
(In thousands)
    
(In thousands)
  
Balance at beginning of period
  
$
1,594
    
$
1,594
    
$
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
    
-
      
-
      
-
      
-
  
Reduction(1)
    
(380
)
    
-
      
(380
)
    
-
  
Balance at end of period
  
$
1,214
    
$
1,594
    
$
1,214
    
$
1,594
  

(1)During the third quarter of 2019 one security with previously recorded OTTI was settled and balance is now zero.

The amortized cost and fair value of securities available for sale at September 30, 2019, by contractual maturity, follow:

   
Amortized
Cost
    
Fair
Value
  
   
(In thousands)
  
Maturing within one year
  
$
13,331
    
$
13,347
  
Maturing after one year but within five years
    
53,809
      
54,524
  
Maturing after five years but within ten years
    
47,726
      
49,239
  
Maturing after ten years
    
36,061
      
36,832
  
     
150,927
      
153,942
  
U.S. agency residential mortgage-backed
    
146,128
      
147,720
  
U.S. agency commercial mortgage-backed
    
11,182
      
11,319
  
Private label mortgage-backed
    
31,195
      
31,826
  
Other asset backed
    
94,799
      
94,785
  
Total
  
$
434,231
    
$
439,592
  

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

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

         
Realized
  
   
Proceeds
    
Gains (1)
    
Losses
  
   
(In thousands)
  
2019
  
$
44,305
    
$
169
    
$
32
  
2018
  
$
31,445
    
$
81
    
$
126
  

(1)
2018 excludes a $0.144 million gain on the sale of 1,000 VISA class B shares.

15
NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
(unaudited)

Certain preferred stocks which were all sold during the first quarter of 2019 had been classified as equity securities at fair value in our Condensed Consolidated Statement of Financial Condition.  During the nine months ended September 30, 2019 and 2018 we recognized gains (losses) on these preferred stocks of $0.167 million and $(0.170) million, respectively, that are included in net gains (losses) on securities in the Condensed Consolidated Statements of Operations.  Zero and $(0.170) million of these gains (losses) during the nine months ended September 30, 2019 and 2018, respectively relate to preferred stock still held at each respective period end.

4.
Loans

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

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

   
Commercial
    
Mortgage
    
Installment
    
Subjective
Allocation
    
Total
  
   
(In thousands)
  
2019
                              
Balance at beginning of period
  
$
8,121
    
$
8,062
    
$
1,293
    
$
8,427
    
$
25,903
  
Additions (deductions)
                                        
Provision for loan losses
    
(810
)
    
83
      
289
      
167
      
(271
)
Recoveries credited to the allowance
    
1,215
      
235
      
202
      
-
      
1,652
  
Loans charged against the allowance
    
(303
)
    
(397
)
    
(436
)
    
-
      
(1,136
)
Balance at end of period
  
$
8,223
    
$
7,983
    
$
1,348
    
$
8,594
    
$
26,148
  
                                         
2018
                                        
Balance at beginning of period
  
$
6,073
    
$
8,296
    
$
848
    
$
8,287
    
$
23,504
  
Additions (deductions)
                                        
Provision for loan losses
    
(907
)
    
415
      
(25
)
    
464
      
(53
)
Recoveries credited to the allowance
    
1,418
      
192
      
298
      
-
      
1,908
  
Loans charged against the allowance
    
(225
)
    
(448
)
    
(285
)
    
-
      
(958
)
Balance at end of period
  
$
6,359
    
$
8,455
    
$
836
    
$
8,751
    
$
24,401
  

16
NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
(unaudited)

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

   
Commercial
    
Mortgage
    
Installment
    
Subjective Allocation
    
Total
  
   
(In thousands)
  
2019
                              
Balance at beginning of period
  
$
7,090
    
$
7,978
    
$
895
    
$
8,925
    
$
24,888
  
Additions (deductions)
                                        
Provision for loan losses
    
85
      
270
      
1,021
      
(331
)
    
1,045
  
Recoveries credited to the allowance
    
1,720
      
786
      
603
      
-
      
3,109
  
Loans charged against the allowance
    
(672
)
    
(1,051
)
    
(1,171
)
    
-
      
(2,894
)
Balance at end of period
  
$
8,223
    
$
7,983
    
$
1,348
    
$
8,594
    
$
26,148
  
                                         
2018
                                        
Balance at beginning of period
  
$
5,595
    
$
8,733
    
$
864
    
$
7,395
    
$
22,587
  
Additions (deductions)
                                        
Provision for loan losses
    
(1,404
)
    
778
      
182
      
1,356
      
912
  
Recoveries credited to the allowance
    
2,458
      
549
      
761
      
-
      
3,768
  
Loans charged against the allowance
    
(290
)
    
(1,605
)
    
(971
)
    
-
      
(2,866
)
Balance at end of period
  
$
6,359
    
$
8,455
    
$
836
    
$
8,751
    
$
24,401
  

17
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)
  
September 30, 2019
                              
Allowance for loan losses:
                              
Individually evaluated for impairment
  
$
871
    
$
4,610
    
$
297
    
$
-
    
$
5,778
  
Collectively evaluated for impairment
    
7,352
      
3,373
      
1,051
      
8,594
      
20,370
  
Loans acquired with deteriorated credit quality
    
-
      
-
      
-
      
-
      
-
  
Total ending allowance for loan losses balance
  
$
8,223
    
$
7,983
    
$
1,348
    
$
8,594
    
$
26,148
  
                                         
Loans
                                        
Individually evaluated for impairment
  
$
7,776
    
$
42,590
    
$
3,223
            
$
53,589
  
Collectively evaluated for impairment
    
1,182,825
      
1,031,163
      
460,973
              
2,674,961
  
Loans acquired with deteriorated credit quality
    
1,421
      
582
      
329
              
2,332
  
Total loans recorded investment
    
1,192,022
      
1,074,335
      
464,525
              
2,730,882
  
Accrued interest included in recorded investment
    
3,005
      
4,300
      
1,131
              
8,436
  
Total loans
  
$
1,189,017
    
$
1,070,035
    
$
463,394
            
$
2,722,446
  
                                         
December 31, 2018
                                        
Allowance for loan losses:
                                        
Individually evaluated for impairment
  
$
1,305
    
$
4,799
    
$
206
    
$
-
    
$
6,310
  
Collectively evaluated for impairment
    
5,785
      
3,179
      
689
      
8,925
      
18,578
  
Loans acquired with deteriorated credit quality
    
-
      
-
      
-
      
-
      
-
  
Total ending allowance for loan losses balance
  
$
7,090
    
$
7,978
    
$
895
    
$
8,925
    
$
24,888
  
                                         
Loans
                                        
Individually evaluated for impairment
  
$
8,697
    
$
46,394
    
$
3,370
            
$
58,461
  
Collectively evaluated for impairment
    
1,137,586
      
1,000,038
      
392,460
              
2,530,084
  
Loans acquired with deteriorated credit quality
    
1,609
      
555
      
349
              
2,513
  
Total loans recorded investment
    
1,147,892
      
1,046,987
      
396,179
              
2,591,058
  
Accrued interest included in recorded investment
    
3,411
      
4,097
      
1,030
              
8,538
  
Total loans
  
$
1,144,481
    
$
1,042,890
    
$
395,149
            
$
2,582,520
  

18
NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
(unaudited)

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

   
90+ and
Still
Accruing
    
Non-
Accrual
    
Total Non-
Performing
Loans
  
   
(In thousands)
        
September 30, 2019
                  
Commercial
                  
Income producing - real estate
  
$
-
    
$
-
    
$
-
  
Land, land development and construction - real estate
    
-
      
654
      
654
  
Commercial and industrial
    
-
      
87
      
87
  
Mortgage
                        
1-4 family
    
-
      
3,873
      
3,873
  
Resort lending
    
-
      
227
      
227
  
Home equity - 1st lien
    
-
      
208
      
208
  
Home equity - 2nd lien
    
-
      
665
      
665
  
Installment
                        
Home equity - 1st lien
    
-
      
125
      
125
  
Home equity - 2nd lien
    
-
      
269
      
269
  
Boat lending
    
-
      
378
      
378
  
Recreational vehicle lending
    
-
      
2
      
2
  
Other
    
-
      
161
      
161
  
Total recorded investment
  
$
-
    
$
6,649
    
$
6,649
  
Accrued interest included in recorded investment
  
$
-
    
$
-
    
$
-
  
December 31, 2018
                        
Commercial
                        
Income producing - real estate
  
$
-
    
$
-
    
$
-
  
Land, land development and construction - real estate
    
-
      
-
      
-
  
Commercial and industrial
    
-
      
2,123
      
2,123
  
Mortgage
                        
1-4 family
    
5
      
4,332
      
4,337
  
Resort lending
    
-
      
755
      
755
  
Home equity - 1st lien
    
-
      
159
      
159
  
Home equity - 2nd lien
    
-
      
419
      
419
  
Installment
                        
Home equity - 1st lien
    
-
      
178
      
178
  
Home equity - 2nd lien
    
-
      
226
      
226
  
Boat lending
    
-
      
166
      
166
  
Recreational vehicle lending
    
-
      
7
      
7
  
Other
    
-
      
204
      
204
  
Total recorded investment
  
$
5
    
$
8,569
    
$
8,574
  
Accrued interest included in recorded investment
  
$
-
    
$
-
    
$
-
  

19
NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
(unaudited)

An aging analysis of loans by class follows:

   
Loans Past Due
    
Loans not
    
Total
  
   
30-59 days
    
60-89 days
    
90+ days
    
Total
    
Past Due
    
Loans
  
   
(In thousands)
  
September 30, 2019
                                    
Commercial
                                    
Income producing - real estate
  
$
44
    
$
-
    
$
-
    
$
44
    
$
424,472
    
$
424,516
  
Land, land development and construction - real estate
    
-
      
-
      
-
      
-
      
102,227
      
102,227
  
Commercial and industrial
    
483
      
26
      
-
      
509
      
664,770
      
665,279
  
Mortgage
                                                
1-4 family
    
3,098
      
973
      
1,359
      
5,430
      
841,658
      
847,088
  
Resort lending
    
703
      
81
      
93
      
877
      
69,949
      
70,826
  
Home equity - 1st lien
    
87
      
101
      
79
      
267
      
37,069
      
37,336
  
Home equity - 2nd lien
    
765
      
344
      
231
      
1,340
      
117,745
      
119,085
  
Installment
                                                
Home equity - 1st lien
    
83
      
19
      
10
      
112
      
5,871
      
5,983
  
Home equity - 2nd lien
    
118
      
3
      
166
      
287
      
4,832
      
5,119
  
Boat lending
    
625
      
49
      
140
      
814
      
205,526
      
206,340
  
Recreational vehicle lending
    
92
      
33
      
2
      
127
      
152,904
      
153,031
  
Other
    
233
      
85
      
104
      
422
      
93,630
      
94,052
  
Total recorded investment
  
$
6,331
    
$
1,714
    
$
2,184
    
$
10,229
    
$
2,720,653
    
$
2,730,882
  
Accrued interest included in recorded investment
  
$
65
    
$
17
    
$
-
    
$
82
    
$
8,354
    
$
8,436
  
                                                 
December 31, 2018
                                                
Commercial
                                                
Income producing - real estate
  
$
44
    
$
-
    
$
-
    
$
44
    
$
388,729
    
$
388,773
  
Land, land development and construction - real estate
    
-
      
-
      
-
      
-
      
84,458
      
84,458
  
Commercial and industrial
    
1,538
      
-
      
-
      
1,538
      
673,123
      
674,661
  
Mortgage
                                                
1-4 family
    
1,608
      
194
      
4,882
      
6,684
      
833,760
      
840,444
  
Resort lending
    
252
      
-
      
755
      
1,007
      
80,774
      
81,781
  
Home equity - 1st lien
    
176
      
-
      
159
      
335
      
38,909
      
39,244
  
Home equity - 2nd lien
    
446
      
100
      
419
      
965
      
84,553
      
85,518
  
Installment
                                                
Home equity - 1st lien
    
200
      
55
      
197
      
452
      
6,985
      
7,437
  
Home equity - 2nd lien
    
111
      
24
      
226
      
361
      
6,683
      
7,044
  
Boat lending
    
316
      
295
      
166
      
777
      
169,117
      
169,894
  
Recreational vehicle lending
    
28
      
21
      
7
      
56
      
125,780
      
125,836
  
Other
    
241
      
131
      
204
      
576
      
85,392
      
85,968
  
Total recorded investment
  
$
4,960
    
$
820
    
$
7,015
    
$
12,795
    
$
2,578,263
    
$
2,591,058
  
Accrued interest included in recorded investment
  
$
44
    
$
11
    
$
-
    
$
55
    
$
8,483
    
$
8,538
  

20
NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
(unaudited)

Impaired loans are as follows:

   
September 30,
2019
    
December 31,
2018
  
Impaired loans with no allocated allowance for loan losses
  
(In thousands)
  
Troubled debt restructurings (“TDR”)
  
$
-
    
$
-
  
Non - TDR
    
1,144
      
-
  
Impaired loans with an allocated allowance for loan losses
                
TDR - allowance based on collateral
    
1,129
      
2,787
  
TDR - allowance based on present value cash flow
    
49,094
      
53,258
  
Non - TDR - allowance based on collateral
    
1,969
      
2,145
  
Total impaired loans
  
$
53,336
    
$
58,190
  
                 
Amount of allowance for loan losses allocated
                
TDR - allowance based on collateral
  
$
230
    
$
769
  
TDR - allowance based on present value cash flow
    
4,865
      
4,849
  
Non - TDR - allowance based on collateral
    
683
      
692
  
Total amount of allowance for loan losses allocated
  
$
5,778
    
$
6,310
  

21
NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
(unaudited)

Impaired loans by class  are as follows:

   
September 30, 2019
    
December 31, 2018
  
   
Recorded
Investment
    
Unpaid
Principal
Balance
    
Related
Allowance
For Loan
Losses
    
Recorded
Investment
    
Unpaid
Principal
Balance
    
Related
Allowance
For Loan
Losses
  
With no related allowance for loan losses recorded:
  
(In thousands)
        
Commercial
                                    
Income producing - real estate
  
$
-
    
$
-
    
$
-
    
$
-
    
$
-
    
$
-
  
Land, land development & construction-real estate
    
654
      
734
      
-
      
-
      
-
      
-
  
Commercial and industrial
    
-
      
-
      
-
      
-
      
-
      
-
  
Mortgage
                                                
1-4 family
    
490
      
774
      
-
      
3
      
474
      
-
  
Resort lending
    
-
      
-
      
-
      
-
      
-
      
-
  
Home equity - 1st lien
    
-
      
-
      
-
      
-
      
-
      
-
  
Home equity - 2nd lien
    
-
      
-
      
-
      
-
      
-
      
-
  
Installment
                                                
Home equity - 1st lien
    
-
      
-
      
-
      
1
      
122
      
-
  
Home equity - 2nd lien
    
-
      
15
      
-
      
-
      
-
      
-
  
Boat lending
    
-
      
5
      
-
      
-
      
5
      
-
  
Recreational vehicle lending
    
-
      
-
      
-
      
-
      
-
      
-
  
Other
    
-
      
24
      
-
      
-
      
15
      
-
  
     
1,144
      
1,552
      
-
      
4
      
616
      
-
  
With an allowance for loan losses recorded:
                                                
Commercial
                                                
Income producing - real estate
  
$
5,859
    
$
5,837
      
619
      
4,770
      
4,758
      
303
  
Land, land development & construction-real estate
    
113
      
113
      
25
      
290
      
289
      
35
  
Commercial and industrial
    
1,150
      
1,244
      
227
      
3,637
      
3,735
      
967
  
Mortgage
                                                
1-4 family
    
29,521
      
31,657
      
3,164
      
32,842
      
34,427
      
2,859
  
Resort lending
    
11,741
      
11,949
      
1,197
      
13,328
      
13,354
      
1,927
  
Home equity - 1st lien
    
190
      
219
      
49
      
65
      
64
      
4
  
Home equity - 2nd lien
    
648
      
657
      
200
      
156
      
155
      
9
  
Installment
                                                
Home equity - 1st lien
    
1,219
      
1,395
      
77
      
1,440
      
1,524
      
89
  
Home equity - 2nd lien
    
1,406
      
1,417
      
116
      
1,471
      
1,491
      
92
  
Boat lending
    
140
      
177
      
37
      
-
      
-
      
-
  
Recreational vehicle lending
    
49
      
50
      
3
      
79
      
79
      
4
  
Other
    
409
      
477
      
64
      
379
      
406
      
21
  
     
52,445
      
55,192
      
5,778
      
58,457
      
60,282
      
6,310
  
Total
                                                
Commercial
                                                
Income producing - real estate
    
5,859
      
5,837
      
619
      
4,770
      
4,758
      
303
  
Land, land development & construction-real estate
    
767
      
847
      
25
      
290
      
289
      
35
  
Commercial and industrial
    
1,150
      
1,244
      
227
      
3,637
      
3,735
      
967
  
Mortgage
                                                
1-4 family
    
30,011
      
32,431
      
3,164
      
32,845
      
34,901
      
2,859
  
Resort lending
    
11,741
      
11,949
      
1,197
      
13,328
      
13,354
      
1,927
  
Home equity - 1st lien
    
190
      
219
      
49
      
65
      
64
      
4
  
Home equity - 2nd lien
    
648
      
657
      
200
      
156
      
155
      
9
  
Installment
                                                
Home equity - 1st lien
    
1,219
      
1,395
      
77
      
1,441
      
1,646
      
89
  
Home equity - 2nd lien
    
1,406
      
1,432
      
116
      
1,471
      
1,491
      
92
  
Boat lending
    
140
      
182
      
37
      
-
      
5
      
-
  
Recreational vehicle lending
    
49
      
50
      
3
      
79
      
79
      
4
  
Other
    
409
      
501
      
64
      
379
      
421
      
21
  
Total
  
$
53,589
    
$
56,744
    
$
5,778
    
$
58,461
    
$
60,898
    
$
6,310
  
Accrued interest included in recorded investment
  
$
253
                    
$
271
                  

22
NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
(unaudited)

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

   
2019
    
2018
  
   
Average
Recorded
Investment
    
Interest
Income
Recognized
    
Average
Recorded
Investment
    
Interest
Income
Recognized
  
With no related allowance for loan losses recorded:
  
(In thousands)
  
Commercial
                        
Income producing - real estate
  
$
-
    
$
-
    
$
-
    
$
-
  
Land, land development & construction-real estate
    
327
      
5
      
2,402
      
-
  
Commercial and industrial
    
-
      
-
      
425
      
7
  
Mortgage
                                
1-4 family
    
552
      
7
      
121
      
9
  
Resort lending
    
-
      
-
      
-
      
-
  
Home equity - 1st lien
    
-
      
-
      
-
      
-
  
Home equity - 2nd lien
    
-
      
-
      
-
      
-
  
Installment
                                
Home equity - 1st lien
    
-
      
-
      
1
      
1
  
Home equity - 2nd lien
    
-
      
-
      
-
      
-
  
Boat lending
    
-
      
-
      
-
      
-
  
Recreational vehicle lending
    
-
      
-
      
-
      
-
  
Other
    
-
      
1
      
-
      
-
  
     
879
      
13
      
2,949
      
17
  
With an allowance for loan losses recorded:
                                
Commercial
                                
Income producing - real estate
    
5,867
      
68
      
4,968
      
64
  
Land, land development & construction-real estate
    
202
      
3
      
153
      
3
  
Commercial and industrial
    
1,534
      
16
      
2,264
      
24
  
Mortgage
                                
1-4 family
    
29,966
      
420
      
34,731
      
458
  
Resort lending
    
12,067
      
171
      
14,276
      
161
  
Home equity - 1st lien
    
158
      
1
      
67
      
1
  
Home equity - 2nd lien
    
601
      
8
      
157
      
2
  
Installment
                                
Home equity - 1st lien
    
1,242
      
27
      
1,545
      
27
  
Home equity - 2nd lien
    
1,420
      
20
      
1,679
      
24
  
Boat lending
    
86
      
2
      
1
      
-
  
Recreational vehicle lending
    
50
      
1
      
83
      
1
  
Other
    
443
      
3
      
406
      
5
  
     
53,636
      
740
      
60,330
      
770
  
Total
                                
Commercial
                                
Income producing - real estate
    
5,867
      
68
      
4,968
      
64
  
Land, land development & construction-real estate
    
529
      
8
      
2,555
      
3
  
Commercial and industrial
    
1,534
      
16
      
2,689
      
31
  
Mortgage
                                
1-4 family
    
30,518
      
427
      
34,852
      
467
  
Resort lending
    
12,067
      
171
      
14,276
      
161
  
Home equity - 1st lien
    
158
      
1
      
67
      
1
  
Home equity - 2nd lien
    
601
      
8
      
157
      
2
  
Installment
                                
Home equity - 1st lien
    
1,242
      
27
      
1,546
      
28
  
Home equity - 2nd lien
    
1,420
      
20
      
1,679
      
24
  
Boat lending
    
86
      
2
      
1
      
-
  
Recreational vehicle lending
    
50
      
1
      
83
      
1
  
Other
    
443
      
4
      
406
      
5
  
Total
  
$
54,515
    
$
753
    
$
63,279
    
$
787
  

23
NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
(unaudited)

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

   
2019
    
2018
  
   
Average
Recorded
Investment
    
Interest
Income
Recognized
    
Average
Recorded
Investment
    
Interest
Income
Recognized
  
With no related allowance for loan losses recorded:
  
(In thousands)
  
Commercial
                        
Income producing - real estate
  
$
-
    
$
-
    
$
-
    
$
-
  
Land, land development & construction-real estate
    
164
      
5
      
1,201
      
-
  
Commercial and industrial
    
-
      
-
      
472
      
20
  
Mortgage
                                
1-4 family
    
365
      
9
      
70
      
18
  
Resort lending
    
-
      
-
      
-
      
-
  
Home equity - 1st lien
    
-
      
-
      
-
      
-
  
Home equity - 2nd lien
    
-
      
-
      
-
      
-
  
Installment
                                
Home equity - 1st lien
    
-
      
-
      
1
      
5
  
Home equity - 2nd lien
    
-
      
-
      
-
      
-
  
Boat lending
    
-
      
-
      
-
      
-
  
Recreational vehicle lending
    
-
      
-
      
-
      
-
  
Other
    
-
      
1
      
-
      
1
  
     
529
      
15
      
1,744
      
44
  
With an allowance for loan losses recorded:
                                
Commercial
                                
Income producing - real estate
    
5,306
      
214
      
5,077
      
202
  
Land, land development & construction-real estate
    
246
      
7
      
157
      
7
  
Commercial and industrial
    
2,406
      
52
      
2,391
      
90
  
Mortgage
                                
1-4 family
    
31,273
      
1,280
      
35,549
      
1,347
  
Resort lending
    
12,607
      
493
      
15,027
      
475
  
Home equity - 1st lien
    
125
      
4
      
115
      
4
  
Home equity - 2nd lien
    
479
      
14
      
167
      
5
  
Installment
                                
Home equity - 1st lien
    
1,328
      
70
      
1,595
      
81
  
Home equity - 2nd lien
    
1,446
      
61
      
1,728
      
76
  
Boat lending
    
68
      
2
      
1
      
-
  
Recreational vehicle lending
    
65
      
2
      
86
      
3
  
Other
    
437
      
14
      
406
      
18
  
     
55,786
      
2,213
      
62,299
      
2,308
  
Total
                                
Commercial
                                
Income producing - real estate
    
5,306
      
214
      
5,077
      
202
  
Land, land development & construction-real estate
    
410
      
12
      
1,358
      
7
  
Commercial and industrial
    
2,406
      
52
      
2,863
      
110
  
Mortgage
                                
1-4 family
    
31,638
      
1,289
      
35,619
      
1,365
  
Resort lending
    
12,607
      
493
      
15,027
      
475
  
Home equity - 1st lien
    
125
      
4
      
115
      
4
  
Home equity - 2nd lien
    
479
      
14
      
167
      
5
  
Installment
                                
Home equity - 1st lien
    
1,328
      
70
      
1,596
      
86
  
Home equity - 2nd lien
    
1,446
      
61
      
1,728
      
76
  
Boat lending
    
68
      
2
      
1
      
-
  
Recreational vehicle lending
    
65
      
2
      
86
      
3
  
Other
    
437
      
15
      
406
      
19
  
Total
  
$
56,315
    
$
2,228
    
$
64,043
    
$
2,352
  

24
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.

TDRs follow:

   
September 30, 2019
  
   
Commercial
    
Retail (1)
    
Total
  
   
(In thousands)
  
Performing TDRs
  
$
6,947
    
$
40,873
    
$
47,820
  
Non-performing TDRs(2)
    
46
      
2,357
(3) 
    
2,403
  
Total
  
$
6,993
    
$
43,230
    
$
50,223
  
                         
   
December 31, 2018
  
   
Commercial
    
Retail (1)
    
Total
  
   
(In thousands)
  
Performing TDRs
  
$
6,460
    
$
46,627
    
$
53,087
  
Non-performing TDRs(2)
    
74
      
2,884
(3) 
    
2,958
  
Total
  
$
6,534
    
$
49,511
    
$
56,045
  

(1)
Retail loans include mortgage and installment loan 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 $5.1 million and $5.6 million of specific reserves to customers whose loan terms have been modified in troubled debt restructurings as of September 30, 2019 and December 31, 2018, respectively.

During the nine months ended September 30, 2019 and 2018, 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.

25
NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
(unaudited)

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

   
Number of
Contracts
    
Pre-modification
Recorded
Balance
    
Post-modification
Recorded
Balance
  
   
(Dollars in thousands)
  
2019
                  
Commercial
                  
Income producing - real estate
    
-
    
$
-
    
$
-
  
Land, land development & construction-real estate
    
-
      
-
      
-
  
Commercial and industrial
    
2
      
137
      
137
  
Mortgage
                        
1-4 family
    
1
      
198
      
202
  
Resort lending
    
-
      
-
      
-
  
Home equity - 1st lien
    
-
      
-
      
-
  
Home equity - 2nd lien
    
3
      
75
      
75
  
Installment
                        
Home equity - 1st lien
    
1
      
28
      
28
  
Home equity - 2nd lien
    
-
      
-
      
-
  
Boat lending
    
-
      
-
      
-
  
Recreational vehicle lending
    
-
      
-
      
-
  
Other
    
-
      
-
      
-
  
Total
    
7
    
$
438
    
$
442
  
                         
2018
                        
Commercial
                        
Income producing - real estate
    
-
    
$
-
    
$
-
  
Land, land development & construction-real estate
    
-
      
-
      
-
  
Commercial and industrial
    
1
      
24
      
24
  
Mortgage
                        
1-4 family
    
3
      
609
      
609
  
Resort lending
    
1
      
115
      
114
  
Home equity - 1st lien
    
-
      
-
      
-
  
Home equity - 2nd lien
    
-
      
-
      
-
  
Installment
                        
Home equity - 1st lien
    
1
      
15
      
15
  
Home equity - 2nd lien
    
1
      
20
      
21
  
Boat lending
    
-
      
-
      
-
  
Recreational vehicle lending
    
-
      
-
      
-
  
Other
    
-
      
-
      
-
  
Total
    
7
    
$
783
    
$
783
  

26
NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
(unaudited)

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

   
Number of
Contracts
    
Pre-modification
Recorded
Balance
    
Post-modification
Recorded
Balance
  
   
(Dollars in thousands)
  
2019
                  
Commercial
                  
Income producing - real estate
    
2
    
$
1,329
    
$
1,329
  
Land, land development & construction-real estate
    
-
      
-
      
-
  
Commercial and industrial
    
3
      
186
      
186
  
Mortgage
                        
1-4 family
    
3
      
985
      
988
  
Resort lending
    
-
      
-
      
-
  
Home equity - 1st lien
    
-
      
-
      
-
  
Home equity - 2nd lien
    
3
      
75
      
75
  
Installment
                        
Home equity - 1st lien
    
3
      
77
      
79
  
Home equity - 2nd lien
    
4
      
111
      
112
  
Boat lending
    
-
      
-
      
-
  
Recreational vehicle lending
    
-
      
-
      
-
  
Other
    
-
      
-
      
-
  
Total
    
18
    
$
2,763
    
$
2,769
  
                         
2018
                        
Commercial
                        
Income producing - real estate
    
1
    
$
67
    
$
67
  
Land, land development & construction-real estate
    
-
      
-
      
-
  
Commercial and industrial
    
6
      
611
      
611
  
Mortgage
                        
1-4 family
    
7
      
903
      
889
  
Resort lending
    
1
      
115
      
114
  
Home equity - 1st lien
    
-
      
-
      
-
  
Home equity - 2nd lien
    
-
      
-
      
-
  
Installment
                        
Home equity - 1st lien
    
6
      
203
      
205
  
Home equity - 2nd lien
    
3
      
113
      
114
  
Boat lending
    
-
      
-
      
-
  
Recreational vehicle lending
    
-
      
-
      
-
  
Other
    
2
      
76
      
73
  
Total
    
26
    
$
2,088
    
$
2,073
  

The troubled debt restructurings described above for 2019 increased the allowance for loan losses by $0.04 million and resulted in zero charge offs during the three months ended September 30, 2019, and increased the allowance for loan losses by $0.09 million and resulted in zero charge offs during the nine months ended September 30, 2019.

The troubled debt restructurings described above for 2018 decreased the allowance for loan losses by $0.01 million and resulted in zero charge offs during the three months ended September 30, 2018, and decreased the allowance by $0.004 million and resulted in zero charge offs during the nine months ended September 30, 2018.

27
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 and nine months periods ended September 30, 2019 and 2018.

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.

28
NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
(unaudited)

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

   
Commercial
  
   
Non-watch
1-6
    
Watch
7-8
    
Substandard
Accrual
9
    
Non-
Accrual
10-11
    
Total
  
               
(In thousands)
              
September 30, 2019
                              
Income producing - real estate
  
$
408,132
    
$
15,619
    
$
765
    
$
-
    
$
424,516
  
Land, land development and construction - real estate
    
93,563
      
8,010
      
-
      
654
      
102,227
  
Commercial and industrial
    
604,311
      
59,425
      
1,456
      
87
      
665,279
  
Total
  
$
1,106,006
    
$
83,054
    
$
2,221
    
$
741
    
$
1,192,022
  
Accrued interest included in total
  
$
2,713
    
$
284
    
$
8
    
$
-
    
$
3,005
  
                                         
December 31, 2018
                                        
Income producing - real estate
 
$
 375,142
    
$
 13,387
    
$
 200
    
$
 44
    
$
 388,773
  
Land, land development and construction - real estate
    
76,120
      
8,328
      
-
      
10
      
84,458
  
Commercial and industrial
    
631,345
      
35,469
      
5,577
      
2,270
      
674,661
  
Total
  
$
1,082,607
    
$
57,184
    
$
5,777
    
$
2,324
    
$
1,147,892
  
Accrued interest included in total
  
$
3,107
    
$
174
    
$
130
    
$
-
    
$
3,411
  

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.

29
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
    
Total
  
   
(In thousands)
  
September 30, 2019
                              
800 and above
  
$
101,927
    
$
11,151
    
$
6,165
    
$
12,177
    
$
131,420
  
750-799
    
385,243
      
31,372
      
16,300
      
52,564
      
485,479
  
700-749
    
204,241
      
15,323
      
9,209
      
32,897
      
261,670
  
650-699
    
84,458
      
7,612
      
3,747
      
13,168
      
108,985
  
600-649
    
30,819
      
2,241
      
668
      
4,196
      
37,924
  
550-599
    
16,410
      
1,171
      
663
      
1,881
      
20,125
  
500-549
    
10,972
      
620
      
330
      
1,072
      
12,994
  
Under 500
    
3,718
      
80
      
254
      
372
      
4,424
  
Unknown
    
9,300
      
1,256
      
-
      
758
      
11,314
  
Total
  
$
847,088
    
$
70,826
    
$
37,336
    
$
119,085
    
$
1,074,335
  
Accrued interest included in total
  
$
3,327
    
$
343
    
$
166
    
$
464
    
$
4,300
  
                                         
December 31, 2018
                                        
800 and above
  
$
94,492
    
$
10,898
    
$
6,784
    
$
8,838
    
$
121,012
  
750-799
    
384,344
      
36,542
      
17,303
      
38,295
      
476,484
  
700-749
    
202,440
      
17,282
      
9,155
      
23,249
      
252,126
  
650-699
    
91,847
      
9,945
      
3,987
      
8,681
      
114,460
  
600-649
    
34,342
      
3,088
      
959
      
3,359
      
41,748
  
550-599
    
13,771
      
1,867
      
427
      
1,236
      
17,301
  
500-549
    
8,439
      
106
      
418
      
826
      
9,789
  
Under 500
    
2,533
      
143
      
98
      
381
      
3,155
  
Unknown
    
8,236
      
1,910
      
113
      
653
      
10,912
  
Total
  
$
840,444
    
$
81,781
    
$
39,244
    
$
85,518
    
$
1,046,987
  
Accrued interest included in total
  
$
3,079
    
$
363
    
$
199
    
$
456
    
$
4,097
  

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

30
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)
  
September 30, 2019
                                    
800 and above
  
$
380
    
$
219
    
$
29,581
    
$
24,296
    
$
7,140
    
$
61,616
  
750-799
    
1,104
      
1,265
      
120,085
      
90,692
      
35,671
      
248,817
  
700-749
    
1,323
      
1,123
      
42,869
      
29,990
      
25,052
      
100,357
  
650-699
    
1,399
      
1,104
      
10,536
      
5,560
      
10,324
      
28,923
  
600-649
    
934
      
678
      
1,783
      
1,692
      
2,762
      
7,849
  
550-599
    
526
      
457
      
808
      
617
      
735
      
3,143
  
500-549
    
299
      
208
      
455
      
145
      
748
      
1,855
  
Under 500
    
18
      
50
      
223
      
39
      
156
      
486
  
Unknown
    
-
      
15
      
-
      
-
      
11,464
      
11,479
  
Total
  
$
5,983
    
$
5,119
    
$
206,340
    
$
153,031
    
$
94,052
    
$
464,525
  
Accrued interest included in total
  
$
21
    
$
16
    
$
467
    
$
350
    
$
277
    
$
1,131
  
                                                 
December 31, 2018
                                                
800 and above
  
$
555
    
$
235
    
$
20,767
    
$
20,197
    
$
6,272
    
$
48,026
  
750-799
    
1,502
      
1,642
      
100,191
      
74,154
      
31,483
      
208,972
  
700-749
    
1,582
      
1,682
      
35,455
      
24,890
      
24,369
      
87,978
  
650-699
    
1,606
      
1,217
      
10,581
      
4,918
      
9,840
      
28,162
  
600-649
    
996
      
1,272
      
1,657
      
992
      
2,751
      
7,668
  
550-599
    
759
      
658
      
652
      
453
      
838
      
3,360
  
500-549
    
384
      
229
      
286
      
225
      
651
      
1,775
  
Under 500
    
51
      
6
      
266
      
7
      
218
      
548
  
Unknown
    
2
      
103
      
39
      
-
      
9,546
      
9,690
  
Total
  
$
7,437
    
$
7,044
    
$
169,894
    
$
125,836
    
$
85,968
    
$
396,179
  
Accrued interest included in total
  
$
28
    
$
25
    
$
403
    
$
311
    
$
263
    
$
1,030
  

(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 $1.2 million at both September 30, 2019 and December 31, 2018, respectively.  Retail mortgage loans secured by residential real estate properties for which formal foreclosure proceedings are in process according to local requirements totaled $0.2 million and $0.3 million at September 30, 2019 and December 31, 2018, respectively.

During the first quarter of 2019, we sold $40.6 million, of residential adjustable rate mortgage loans servicing released (classified on the Condensed Consolidated Statements of Financial Condition as held for sale, carried at the lower of cost or fair value at December 31, 2018) to another financial institution and recognized a gain on sale of $0.01 million.  During the first quarter of 2019 we also securitized $29.8 million, of portfolio residential fixed rate mortgage loans servicing retained with Freddie Mac and recognized a gain on sale of $0.53 million.  During the third quarter of 2019, we sold $9.9 million of residential fixed and adjustable rate portfolio mortgage loans servicing retained to another financial institution and recognized a gain on sale of $0.07 million.  During the third quarter of 2019 we also transferred $36.6 million, of portfolio residential fixed rate mortgage loans to loans held for sale, carried at the lower of cost or fair value.  At the time of transfer and at September 30, 2019 the fair value of these loans exceeded their cost.  During the fourth quarter of 2019 these loans were securitized servicing retained with Freddie Mac and we recognized a gain on sale of approximately $1.0 million. These transactions were done primarily for asset/liability management purposes.

31
NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
(unaudited)

During the first and third quarters of 2018, we sold $16.5 million and $11.1 million, respectively, of residential fixed and adjustable rate portfolio mortgage loans servicing retained to another financial institution and recognized a gain (loss) on sale of $0.05 million and ($0.01) million, respectively.  These mortgage loans were sold primarily for asset/liability management purposes.

Purchase Credit Impaired (“PCI”) Loans

Loans acquired in a business combination are recorded at estimated fair value on their purchase date with no carryover of the related allowance for loan losses. In determining the estimated fair value of purchased loans, we consider a number of factors including, among others, the remaining life of the acquired loans, estimated prepayments, estimated loss ratios, estimated value of the underlying collateral, and net present value of cash flows expected to be received. Purchased loans are accounted for in accordance with guidance for certain loans acquired in a transfer (ASC 310-30), when the loans have evidence of credit deterioration since origination and it is probable at the date of acquisition that the acquirer will not collect all contractually required principal and interest payments. The difference between contractually required payments and the cash flows expected to be collected at acquisition is referred to as the non-accretable difference. Subsequent decreases to the expected cash flows will generally result in a provision for loan losses. Subsequent increases in expected cash flows will result in a reversal of the provision for loan losses to the extent of prior charges and then an adjustment to accretable yield, which would have a positive impact on interest income.

As a result of our acquisition of TCSB Bancorp, Inc. (“TCSB”) (see note #17) we purchased loans for which there was, at acquisition, evidence of deterioration of credit quality since origination and it was probable, at acquisition, that all contractually required payments would not be collected. For these loans that meet the criteria of ASC 310-30 treatment, the carrying amount was as follows:

   
September 30,
2019
    
December 31,
2018
  
   
(In thousands)
  
Commercial
  
$
1,421
    
$
1,609
  
Mortgage
    
582
      
555
  
Installment
    
329
      
349
  
Total carrying amount
    
2,332
      
2,513
  
Allowance for loan losses
    
-
      
-
  
Carrying amount, net of allowance for loan losses
  
$
2,332
    
$
2,513
  

32
NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
(unaudited)

The accretable difference on PCI loans is the difference between the expected cash flows and the net present value of expected cash flows with such difference accreted into earnings using the effective yield method over the term of the loans. Accretion recorded as loan interest income is included in the table below.  Accretable yield of PCI loans, or income expected to be collected follows:

   
Three months ended
September 30,
    
Nine months ended
September 30,
  
   
2019
    
2018
    
2019
    
2018
  
   
(unaudited)
    
(unaudited)
  
   
(In thousands)
    
(In thousands)
  
                         
Balance at beginning of period
  
$
749
    
$
533
    
$
462
    
$
-
  
New loans purchased
    
-
      
-
      
-
      
568
  
Accretion recorded as loan interest income
    
(56
)
    
(32
)
    
(134
)
    
(67
)
Reclassification from (to) nonaccretable difference
    
-
      
-
      
365
      
-
  
Displosals/other adjustments
    
-
      
-
      
-
      
-
  
Balance at end of period
  
$
693
    
$
501
    
$
693
    
$
501
  

5.
Shareholders’ Equity and Earnings Per Common Share

In December, 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, 2019.  In May 2019, we completed the repurchase of 5% of our outstanding common shares.  In June 2019, our Board of Directors authorized a 300,000 share expansion of the 2019 repurchase plan.  We expect to accomplish any remaining repurchases through open market transactions, though we could execute repurchases through other means, such as privately negotiated transactions.  The timing and amount of any share repurchases will depend on a variety of factors, including, among others, securities law restrictions, the trading price of our common stock, regulatory requirements, potential alternative uses for capital, and our financial performance. The Repurchase Plan does not obligate us to acquire any particular amount of common stock, and it may be modified or suspended at any time at our discretion. We expect to fund any repurchases from cash on hand.  During the nine month periods ended September 30, 2019 and 2018 repurchases were made totaling 1,204,688 shares and zero shares of common stock, respectively for an aggregate purchase price of $26.3 million and zero, respectively.

33
NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
(unaudited)

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

   
Three Months Ended
September 30,
    
Nine Months Ended
September 30,
  
   
2019
    
2018
    
2019
    
2018
  
   
(In thousands, except per share data)
  
Net income
  
$
12,445
    
$
11,925
    
$
32,556
    
$
29,903
  
                                 
Weighted average shares outstanding (1)
    
22,486
      
24,149
      
23,033
      
23,218
  
Stock units for deferred compensation plan for non-employee directors
    
132
      
129
      
131
      
126
  
Effect of stock options
    
110
      
182
      
116
      
180
  
Performance share units
    
42
      
55
      
39
      
52
  
Weighted average shares outstanding for calculation of diluted earnings per share
    
22,770
      
24,515
      
23,319
      
23,576
  
                                 
Net income per common share
                                
Basic (1)
  
$
0.55
    
$
0.49
    
$
1.41
    
$
1.29
  
Diluted
  
$
0.55
    
$
0.49
    
$
1.40
    
$
1.27
  
 
(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 and nine month periods ended September 30, 2019 and 2018, 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.

34
NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
(unaudited)
 
Our derivative financial instruments according to the type of hedge in which they are designated follows:

   
September 30, 2019
  
   
Notional
Amount
    
Average
Maturity
(years)
    
Fair
Value
  
   
(Dollars in thousands)
  
                   
Fair value hedge designation - Pay-fixed interest rate swap agreements
  
$
7,117
      
9.6
    
$
(391
)
                         
Cash flow hedge designation
                        
Pay-fixed interest rate swap agreements
  
$
25,000
      
1.8
    
$
(220
)
Interest rate cap agreements
    
150,000
      
2.8
      
318
  
Total
  
$
175,000
      
2.7
    
$
98
  
                         
No hedge designation
                        
Rate-lock mortgage loan commitments
  
$
79,446
      
0.1
    
$
2,051
  
Mandatory commitments to sell mortgage loans
    
137,315
      
0.1
      
(27
)
Pay-fixed interest rate swap agreements - commercial
    
141,427
      
5.4
      
(4,849
)
Pay-variable interest rate swap agreements - commercial
    
141,427
      
5.4
      
4,849
  
Purchased options
    
3,088
      
1.8
      
125
  
Written options
    
3,028
      
1.8
      
(124
)
Total
  
$
505,731
      
3.1
    
$
2,025
  

   
December 31, 2018
  
   
Notional
Amount
    
Average
Maturity
(years)
    
Fair
Value
  
   
(Dollars in thousands)
  
Cash flow hedge designation
                  
Pay-fixed interest rate swap agreements
  
$
25,000
      
2.6
    
$
280
  
Interest rate cap agreements
    
150,000
      
3.6
      
2,245
  
Total
  
$
175,000
      
3.5
    
$
2,525
  
                         
No hedge designation
                        
Rate-lock mortgage loan commitments
  
$
32,473
      
0.1
    
$
687
  
Mandatory commitments to sell mortgage loans
    
57,583
      
0.1
      
(383
)
Pay-fixed interest rate swap agreements - commercial
    
94,451
      
5.5
      
405
  
Pay-variable interest rate swap agreements - commercial
    
94,451
      
5.5
      
(405
)
Purchased options
    
3,095
      
2.5
      
116
  
Written options
    
3,095
      
2.5
      
(116
)
Total
  
$
285,148
      
3.7
    
$
304
  

35
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 Condensed Consolidated Statements of Financial Condition, 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 $2.4 million at September 30, 2019 and $2.7 million at December 31, 2018.

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 $0.03 million, of unrealized losses on Cash Flow Hedges at September 30, 2019 will be reclassified to earnings over the next twelve months.  The maximum term of the Cash Flow Hedge at September 30, 2019 is 4.0 years.

Beginning in the second quarter of 2019 we entered into a pay-fixed interest rate swap to protect a portion of the fair value of a certain fixed rate commercial loan commitment (“Fair Value Hedge”).  As a result, changes in the fair value of the pay-fixed interest rate swap is expected to offset changes in the fair value of the fixed rate commercial loan commitment due to fluctuations in interest rates.  We record the fair value of Fair Value Hedges in accrued income and other assets and accrued expenses and other liabilities on our Condensed Consolidated Statements of Financial Condition.  The hedged item (fixed rate commercial loan commitment) is also recorded at fair value which offsets the adjustment to the Fair Value Hedge.  On an ongoing basis, we adjust our Condensed Consolidated Statements of Financial Condition to reflect the then current fair value of both the Fair Value Hedge and the hedged item.  The related gains or losses are reported in non-interest income – other in our Condensed Consolidated Statements of Operations.

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.

36
NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
(unaudited)

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.

In prior periods we offered to our deposit customers an equity linked time deposit product (“Altitude CD”).  The Altitude CD was 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.

37
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:

Fair Values of Derivative Instruments

   
Asset Derivatives
    
Liability Derivatives
  
   
September 30,
2019
  
December 31,
2018
    
September 30,
2019
  
December 31,
2018
  

 
 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
  
$
-
  
Other assets
  
$
280
    
Other liabilities
  
$
611
  
Other liabilities
  
$
-
  
Interest rate cap agreements
  
Other assets
    
318
  
Other assets
    
2,245
    
Other liabilities
    
-
  
Other liabilities
    
-
  
         
318
        
2,525
          
611
        
-
  
Derivatives not designated as hedging instruments
                                            
Rate-lock mortgage loan commitments
  
Other assets
    
2,051
  
Other assets
    
687
    
Other liabilities
    
-
  
Other liabilities
    
-
  
Mandatory commitments to sell mortgage loans
  
Other assets
    
-
  
Other assets
    
-
    
Other liabilities
    
27
  
Other liabilities
    
383
  
Pay-fixed interest rate swap agreements - commercial
  
Other assets
    
23
  
Other assets
    
1,116
    
Other liabilities
    
4,872
  
Other liabilities
    
711
  
Pay-variable interest rate swap agreements - commercial
  
Other assets
    
4,872
  
Other assets
    
711
    
Other liabilities
    
23
  
Other liabilities
    
1,116
  
Purchased options
  
Other assets
    
125
  
Other assets
    
116
    
Other liabilities
    
-
  
Other liabilities
    
-
  
Written options
  
Other assets
    
-
  
Other assets
    
-
    
Other liabilities
    
124
  
Other liabilities
    
116
  
          7,071
         2,630
           5,046
         2,326
  
Total derivatives
      
$
7,389
      
$
5,155
        
$
5,657
      
$
2,326
  

38
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 September 30,
  
   
Gain (Loss)
Recognized in
Other
Comprehensive
Income (Loss)
(Effective Portion)
  
 Location of
 Gain
 Reclassified
 from
 Accumulated
 Other
 Comprehensive
 Loss into
 Income
 (Effective
  
Gain
Reclassified from
Accumulated Other
Comprehensive
Loss into Income
(Effective Portion)
  
 Location of
 Gain (Loss)
 Recognized
  
Gain (Loss)
Recognized
in Income (1)
  
   
2019
    
2018
  
 Portion)
  
2019
    
2018
  
 in Income (1)
  
2019
    
2018
  
   
(In thousands)
  
Fair Value Hedges                                            
Pay-fixed interest rate swap agreements
                          
Non-interest income-other
  
$
(188
)
  
$
-
  
Cash Flow Hedges                                                    
Interest rate cap agreements
  
$
(37
)
  
$
297
  
Interest expense
  
$
88
    
$
67
  
Interest expense
  
$
-
    
$
-
  
Pay-fixed interest rate swap agreements
    
(35
)
    
92
  
Interest expense
    
14
      
6
  
Interest expense
    
-
      
16
  
Total
  
$
(72
)
  
$
389
      
$
102
    
$
73
      
$
-
    
$
16
  
                                                     
No hedge designation
                                                    
Rate-lock mortgage loan commitments
                                  
Net gains on mortgage loans
  
$
(96
)
  
$
(318
)
Mandatory commitments to sell mortgage loans
                                  
Net gains on mortgage loans
    
307
      
415
  
Pay-fixed interest rate swap agreements - commercial
                                  
Interest income
    
(1,670
)
    
407
  
Pay-variable interest rate swap agreements - commercial
                                  
Interest income
    
1,670
      
(407
)
Purchased options
                                  
Interest income
    
(46
)
    
(45
)
Written options
                                  
Interest income
    
46
      
45
  
Total
                                           
$
211
    
$
97
  

(1)
For cash flow hedges, this location and amount refers to the ineffective portion.

39
NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
(unaudited)

Nine Month Periods Ended September 30,
  
   
Gain (Loss)
Recognized in
Other
Comprehensive
Income (Loss)
(Effective Portion)
  
 Location of
 Gain
 Reclassified
 from
 Accumulated
 Other
 Comprehensive
 Loss into
 Income
 (Effective
  
Gain
Reclassified from
Accumulated Other
Comprehensive
Loss into Income
(Effective Portion)
  
 Location of
 Gain (Loss)
 Recognized
  
Gain (Loss)
Recognized
in Income (1)
  
   
2019
    
2018
  
 Portion)
  
2019
    
2018
  
 in Income (1)
  
2019
    
2018
  
   
(In thousands)
  
Fair Value Hedges                                            
Pay-fixed interest rate swap agreements
                          
Non-interest income-other
  
$
(391
)
  
$
-
  
Cash Flow Hedges                                                    
Interest rate cap agreements
  
$
(1,311
)
  
$
1,054
  
Interest expense
  
$
321
    
$
119
  
Interest expense
  
$
-
    
$
-
  
Pay-fixed interest rate swap agreements
    
(429
)
    
346
  
Interest expense
    
72
      
13
  
Interest expense
    
-
      
4
  
Total
  
$
(1,740
)
  
$
1,400
      
$
393
    
$
132
      
$
-
    
$
4
  
                                                     
No hedge designation
                                                    
Rate-lock mortgage loan commitments
                                  
Net gains on mortgage loans
  
$
1,364
    
$
354
  
Mandatory commitments to sell mortgage loans
                                  
Net gains on mortgage loans
    
356
      
145
  
Pay-fixed interest rate swap agreements - commercial
                                  
Interest income
    
(5,254
)
    
1,950
  
Pay-variable interest rate swap agreements - commercial
                                  
Interest income
    
5,254
      
(1,950
)
Purchased options
                                  
Interest expense
    
9
      
(144
)
Written options
                                  
Interest expense
    
(8
)
    
144
  
Total
                                           
$
1,721
    
$
499
  

(1)
For cash flow hedges, this location and amount refers to the ineffective portion.

40
NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
(unaudited)

7.
Goodwill and other Intangibles

The following table summarizes intangible assets, net of amortization:

   
September 30, 2019
    
December 31, 2018
  
   
Gross
Carrying
Amount
    
Accumulated
Amortization
    
Gross
Carrying
Amount
    
Accumulated
Amortization
  
   
(In thousands)
  
                         
Amortized intangible assets - core deposits
  
$
11,916
    
$
6,318
    
$
11,916
    
$
5,501
  
Unamortized intangible assets - goodwill
  
$
28,300
            
$
28,300
          

A summary of estimated core deposit intangible amortization at September 30, 2019 follows:

   
(In thousands)
  
       
Three months ending December 31, 2019
  
$
272
  
2020
    
1,020
  
2021
    
970
  
2022
    
785
  
2023
    
547
  
2024 and thereafter
    
2,004
  
Total
  
$
5,598
  

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 September 30, 2019.  The non-employee director stock purchase plan permits the issuance of additional share based payments for up to 0.2 million shares of common stock as of September 30, 2019. 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.

A summary of restricted stock and performance stock units (“PSU”) granted pursuant to our long-term incentive plan follows:

   
Three Months Ended
September 30,
    
Nine Months Ended
September 30,
  
   
2019
    
2018
    
2019
    
2018
  
       
Restricted stock
    
8,000
      
-
      
64,267
      
53,420
  
PSU
    
-
      
-
      
22,016
      
19,986
  

Except for 0.008 million shares of restricted stock issued during the third quarter of 2019 and 0.002 million shares of restricted stock issued during the first quarters of 2019 and 2018  that vest ratably over three years, the shares of restricted stock and PSUs shown in the above table 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.

41
NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
(unaudited)

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 0.008 million and 0.007 million shares during the nine month periods ended September 30, 2019 and 2018, respectively, pursuant to this plan and expensed their value during those same periods.

Total compensation expense recognized for grants pursuant to our long-term incentive plan was $0.4 million and $1.2 million during the three and nine month periods ended September 30, 2019, respectively, and was $0.4 million and $1.1 million during the same periods in 2018, respectively.  The corresponding tax benefit relating to this expense was $0.1 million and $0.2 million for the three and nine month periods ended September 30, 2019, respectively and $0.1 million and $0.2 million for the same periods in 2018. Total expense recognized for non-employee director share based payments was $0.06 million and $0.18 million during the three and nine month periods ended September 30, 2019, respectively, and was $0.05 million and $0.16 million during the same periods in 2018, respectively.  The corresponding tax benefit relating to this expense was $0.01 million and $0.04 million for the three and nine month periods ended September 30, 2019, respectively and $0.01 million and $0.03 million during the same periods in 2018.

At September 30, 2019, the total expected compensation cost related to non-vested restricted stock and PSUs not yet recognized was $2.5 million.  The weighted-average period over which this amount will be recognized is 1.9 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, 2019
    
211,421
    
$
6.48
              
Granted
    
-
                      
Exercised
    
(70,299
)
    
9.98
              
Forfeited
    
-
                      
Expired
    
(1,116
)
    
22.35
              
Outstanding at September 30, 2019
    
140,006
    
$
4.60
      
3.2
    
$
2,340
  
Vested and expected to vest at September 30, 2019
    
140,006
    
$
4.60
      
3.2
    
$
2,340
  
Exercisable at September 30, 2019
    
140,006
    
$
4.60
      
3.2
    
$
2,340
  

42
NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
(unaudited)

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, 2019
    
258,419
    
$
19.00
  
Granted
    
86,283
      
22.87
  
Vested
    
(85,978
)
    
14.57
  
Forfeited
    
(12,998
)
    
22.85
  
Outstanding at September 30, 2019
    
245,726
    
$
21.72
  

Certain information regarding options exercised during the periods follows:

   
Three Months Ended
September 30,
    
Nine Months Ended
September 30,
  
   
2019
    
2018
    
2019
    
2018
  
   
(In thousands)
  
Intrinsic value
  
$
32
    
$
153
    
$
868
    
$
1,827
  
Cash proceeds received
  
$
6
    
$
58
    
$
701
    
$
1,042
  
Tax benefit realized
  
$
6
    
$
32
    
$
182
    
$
384
  

9.
Income Tax

Income tax expense was $3.1 million and $2.9 million during the three month periods ended September 30, 2019 and 2018, respectively and $8.0 million and $7.0 million during the nine months ended September 30, 2019 and 2018, respectively.  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 three and nine month periods ending September 30, 2019 include reductions of $0.01 million and $0.18 million, respectively, of income tax expense related to the 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.  These amounts during the same periods in 2018 were $0.01 million and $0.33 million, respectively.

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 September 30, 2019, September 30, 2018 and December 31, 2018 that the realization of substantially all of our deferred tax assets continues to be more likely than not.

At both September 30, 2019 and December 31, 2018, we had approximately $0.6 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 2019.

43
NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
(unaudited)

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 September 30, 2019, the Bank had positive undivided profits of $38.3 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 September 30, 2019 and December 31, 2018, 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.

44
NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
(unaudited)

Our actual capital amounts and ratios follow (1):

   
Actual
    
Minimum for
Adequately Capitalized
Institutions
    
Minimum for
Well-Capitalized
Institutions
  
   
Amount
    
Ratio
    
Amount
    
Ratio
    
Amount
    
Ratio
  
   
(Dollars in thousands)
  
                                     
September 30, 2019
                                    
Total capital to risk-weighted assets
                                    
Consolidated
  
$
369,923
      
13.39
%
  
$
221,065
      
8.00
%
  
NA
    
NA
  
Independent Bank
    
352,432
      
12.76
      
220,984
      
8.00
    
$
276,230
      
10.00
%
                                                 
Tier 1 capital to risk-weighted assets
                                                
Consolidated
  
$
342,138
      
12.38
%
  
$
165,799
      
6.00
%
  
NA
    
NA
  
Independent Bank
    
324,647
      
11.75
      
165,738
      
6.00
    
$
220,984
      
8.00
%
                                                 
Common equity tier 1 capital to risk-weighted assets
                                                
Consolidated
  
$
303,923
      
11.00
%
  
$
124,349
      
4.50
%
  
NA
    
NA
  
Independent Bank
    
324,647
      
11.75
      
124,304
      
4.50
    
$
179,550
      
6.50
%
                                                 
Tier 1 capital to average assets
                                                
Consolidated
  
$
342,138
      
9.93
%
  
$
137,762
      
4.00
%
  
NA
    
NA
  
Independent Bank
    
324,647
      
9.43
      
137,736
      
4.00
    
$
172,170
      
5.00
%
                                                 
December 31, 2018
                                                
Total capital to risk-weighted assets
                                                
Consolidated
  
$
371,603
      
14.25
%
  
$
208,572
      
8.00
%
  
NA
    
NA
  
Independent Bank
    
337,227
      
12.94
      
208,456
      
8.00
    
$
260,569
      
10.00
%
                                                 
Tier 1 capital to risk-weighted assets
                                                
Consolidated
  
$
345,419
      
13.25
%
  
$
156,429
      
6.00
%
  
NA
    
NA
  
Independent Bank
    
311,043
      
11.94
      
156,342
      
6.00
    
$
208,456
      
8.00
%
                                                 
Common equity tier 1 capital to risk-weighted assets
                                                
Consolidated
  
$
307,255
      
11.79
%
  
$
117,322
      
4.50
%
  
NA
    
NA
  
Independent Bank
    
311,043
      
11.94
      
117,256
      
4.50
    
$
169,370
      
6.50
%
                                                 
Tier 1 capital to average assets
                                                
Consolidated
  
$
345,419
      
10.47
%
  
$
131,930
      
4.00
%
  
NA
    
NA
  
Independent Bank
    
311,043
      
9.44
      
131,778
      
4.00
    
$
164,723
      
5.00
%

(1)
These ratios do not reflect a capital conservation buffer of 2.50% and 1.875% at September 30, 2019 and December 31, 2018, respectively.
NA - Not applicable

45
NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
(unaudited)

The components of our regulatory capital are as follows:

   
Consolidated
    
Independent Bank
  
   
September 30,
2019
    
December 31,
2018
    
September 30,
2019
    
December 31,
2018
  
   
(In thousands)
  
Total shareholders’ equity
  
$
340,245
    
$
338,994
    
$
360,969
    
$
341,496
  
Add (deduct)
                                
Accumulated other comprehensive (income) loss for regulatory purposes
    
(2,424
)
    
4,311
      
(2,424
)
    
4,311
  
Goodwill and other intangibles
    
(33,898
)
    
(34,715
)
    
(33,898
)
    
(34,715
)
Disallowed deferred tax assets
    
-
      
(1,335
)
    
-
      
(49
)
Common equity tier 1 capital
    
303,923
      
307,255
      
324,647
      
311,043
  
Qualifying trust preferred securities
    
38,215
      
38,164
      
-
      
-
  
Tier 1 capital
    
342,138
      
345,419
      
324,647
      
311,043
  
Allowance for loan losses and allowance for unfunded lending commitments limited to 1.25% of total risk-weighted assets
    
27,785
      
26,184
      
27,785
      
26,184
  
Total risk-based capital
  
$
369,923
    
$
371,603
    
$
352,432
    
$
337,227
  

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.

46
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 or available for sale) are classified as Level 1 of the valuation hierarchy.  Level 1 securities include certain preferred stocks included in our equity securities at fair value for which there are quoted prices in active markets (at December 31, 2018).  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 sale:  The fair value of mortgage loans held for sale, carried at fair value is based on agency cash window loan pricing for comparable assets (recurring Level 2) and the fair value of mortgage loans held for sale, carried at the lower of cost or fair value (December 31, 2018) is based on a quoted sales price (non-recurring Level 1).  The fair value of Loans held for sale, carried at the lower of cost or fair value at September 30, 2019 exceeded their cost and therefore were carried at cost and not included in the table that follows.

Impaired loans with specific loss allocations based on collateral value:  From 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 for loan losses represent loans for which the fair value of the expected repayments or collateral exceed the recorded investments in such loans. At September 30, 2019 and December 31, 2018, 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.

47
NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
(unaudited)

Other real estate:  At the time of acquisition, other real estate is recorded at fair value, less estimated costs to sell, which becomes the property’s new basis. Subsequent write-downs to reflect declines in value since the time of acquisition may occur from time to time and are recorded in net (gains) losses on other real estate and repossessed assets, 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.

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 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.

Derivatives:  The 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).

48
NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
(unaudited)

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

         
Fair Value Measurements Using
  
   
Fair Value
Measure-
ments
    
Quoted
Prices
in Active
Markets
for
Identical
Assets
(Level 1)
    
Significant
Other
Observable
Inputs
(Level 2)
    
Significant
Un-
observable
Inputs
(Level 3)
  
   
(In thousands)
  
September 30, 2019:
                        
Measured at Fair Value on a Recurring Basis
                        
Assets
                        
Securities available for sale
                        
U.S. agency
  
$
15,283
    
$
-
    
$
15,283
    
$
-
  
U.S. agency residential mortgage-backed
    
147,720
      
-
      
147,720
      
-
  
U.S. agency commercial mortgage-backed
    
11,319
      
-
      
11,319
      
-
  
Private label mortgage-backed
    
31,826
      
-
      
31,826
      
-
  
Other asset backed
    
94,785
      
-
      
94,785
      
-
  
Obligations of states and political subdivisions
    
101,139
      
-
      
101,139
      
-
  
Corporate
    
33,678
      
-
      
33,678
      
-
  
Trust preferred
    
1,820
      
-
      
1,820
      
-
  
Foreign government
    
2,022
      
-
      
2,022
      
-
  
Loans held for sale, carried at fair value
    
87,358
      
-
      
87,358
      
-
  
Capitalized mortgage loan servicing rights
    
16,906
      
-
      
-
      
16,906
  
Derivatives (1)
    
7,389
      
-
      
7,389
      
-
  
Liabilities
                                
Derivatives (2)
    
5,657
      
-
      
5,657
      
-
  
                                 
Measured at Fair Value on a Non-recurring Basis:
                                
Assets
                                
Impaired loans (3)
                                
Commercial
                                
Income producing - real estate
    
115
      
-
      
-
      
115
  
Land, land development & construction-real estate
    
87
      
-
      
-
      
87
  
Commercial and industrial
    
706
      
-
      
-
      
706
  
Mortgage
                                
1-4 family
    
666
      
-
      
-
      
666
  
Resort lending
    
60
      
-
      
-
      
60
  
Home equity - 1st lien
    
83
      
-
      
-
      
83
  
Home equity - 2nd lien
    
199
      
-
      
-
      
199
  
Installment
                                
Home equity - 1st lien
    
9
      
-
      
-
      
9
  
Home equity - 2nd lien
    
70
      
-
      
-
      
70
  
Boat lending
    
103
      
-
      
-
      
103
  
Recreational vehicle lending
    
1
      
-
      
-
      
1
  
Other
    
86
      
-
      
-
      
86
  
Other real estate (4)
                                
Mortgage
                                
1-4 family
    
23
      
-
      
-
      
23
  
Home equity - 2nd lien
    
57
      
-
      
-
      
57
  

(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.

49
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, 2018:
                        
Measured at Fair Value on a Recurring Basis
                        
Assets
                        
Equity securities at fair value
  
$
393
    
$
393
    
$
-
    
$
-
  
Securities available for sale
                                
U.S. agency
    
20,014
      
-
      
20,014
      
-
  
U.S. agency residential mortgage-backed
    
123,751
      
-
      
123,751
      
-
  
U.S. agency commercial mortgage-backed
    
5,726
      
-
      
5,726
      
-
  
Private label mortgage-backed
    
29,419
      
-
      
29,419
      
-
  
Other asset backed
    
83,319
      
-
      
83,319
      
-
  
Obligations of states and political subdivisions
    
127,555
      
-
      
127,555
      
-
  
Corporate
    
34,309
      
-
      
34,309
      
-
  
Trust preferred
    
1,819
      
-
      
1,819
      
-
  
Foreign government
    
2,014
      
-
      
2,014
      
-
  
Loans held for sale, carried at fair value
    
44,753
      
-
      
44,753
      
-
  
Capitalized mortgage loan servicing rights
    
21,400
      
-
      
-
      
21,400
  
Derivatives (1)
    
5,155
      
-
      
5,155
      
-
  
Liabilities
                                
Derivatives (2)
    
2,326
      
-
      
2,326
      
-
  
                                 
Measured at Fair Value on a Non-recurring Basis:
                                
Assets
                                
Loans held for sale, carried at the lower of cost or fair value
    
41,471
      
41,471
      
-
      
-
  
Impaired loans (3)
                                
Commercial
                                
Income producing - real estate
    
217
      
-
      
-
      
217
  
Land, land development & construction-real estate
    
106
      
-
      
-
      
106
  
Commercial and industrial
    
2,243
      
-
      
-
      
2,243
  
Mortgage
                                
1-4 family
    
333
      
-
      
-
      
333
  
Resort lending
    
572
      
-
      
-
      
572
  
Other real estate (4)
                                
Mortgage
                                
1-4 family
    
95
      
-
      
-
      
95
  
Home equity - 2nd lien
    
59
      
-
      
-
      
59
  

(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 nine months ended September 30, 2019 and 2018.

50
NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
(unaudited)

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

   
Changes in Fair Values for the Nine-Month Periods
Ended September 30 for Items Measured at Fair Value
Pursuant to Election of the Fair Value Option
  
   
Net Gains (Losses)
on Assets
    
Mortgage
    
Total
Change
in Fair
Values
Included
in Current
  
   
Securities
    
Mortgage
Loans
    
Loan
Servicing, net
    
Period
Earnings
  
   
(In thousands)
  
2019
                        
Equity securities at fair value
  
$
167
    
$
-
    
$
-
    
$
167
  
Loans held for sale
    
-
      
822
      
-
      
822
  
Capitalized mortgage loan servicing rights
    
-
      
-
      
(9,258
)
    
(9,258
)
                                 
2018
                                
Equity securities at fair value
  
$
(170
)
  
$
-
    
$
-
    
$
(170
)
Loans held for sale
    
-
      
(120
)
    
-
      
(120
)
Capitalized mortgage loan servicing rights
    
-
      
-
      
694
      
694
  

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

The following represent impairment charges recognized during the three and nine month periods ended September 30, 2019 and 2018 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 $2.2 million, which is net of a valuation allowance of $0.9 million at September 30, 2019, and had a carrying amount of $3.5 million, which is net of a valuation allowance of $1.5 million at December 31, 2018.  The provision for loan losses included in our results of operations relating to impaired loans was a net expense of $0.5 million and $0.1 million for the three month periods ending September 30, 2019 and 2018, respectively, and a net expense of $0.8 million and $0.5 million for the nine month periods ending September 30, 2019 and 2018, respectively.

•
Other real estate, which is measured using the fair value of the property, had a carrying amount of $0.1 million which is net of a valuation allowance of $0.1 million at September 30, 2019, and a carrying amount of $0.2 million, which is net of a valuation allowance of $0.1 million, at December 31, 2018. Charges included in our results of operations relating to other real estate measured at fair value were $0.07 million and $0.08 million during the three and nine month periods ended September 30, 2019, and were $0.04 million during each of the three and nine month periods ended September 30, 2018.

51
NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
(unaudited)

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

   
Capitalized Mortgage Loan Servicing Rights
  
   
Three Months Ended
September 30,
    
Nine Months Ended
September 30,
  
   
2019
    
2018
    
2019
    
2018
  
   
(In thousands)
    
(In thousands)
  
Beginning balance
  
$
17,894
    
$
21,848
    
$
21,400
    
$
15,699
  
Total gains (losses) realized and unrealized:
                                
Included in results of operations
    
(3,145
)
    
(198
)
    
(9,258
)
    
694
  
Included in other comprehensive income (loss)
    
-
      
-
      
-
      
-
  
Purchases, issuances, settlements, maturities and calls
    
2,157
      
1,501
      
4,764
      
6,758
  
Transfers in and/or out of Level 3
    
-
      
-
      
-
      
-
  
Ending balance
  
$
16,906
    
$
23,151
    
$
16,906
    
$
23,151
  

                               
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 September 30
  
$
(3,145
)
  
$
(198
)
  
$
(9,258
)
  
$
694
  

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, float rate and prepayment 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)
                    
September 30, 2019
                        
Capitalized mortgage loan servicing rights
  
$
16,906
  
Present value of net
  
Discount rate
  
10.00% to 13.00
%
    
10.14
%
         
servicing revenue
  
Cost to service
  
$
63 to $216
    
$
80
  
               
Ancillary income
  
20 to 36
      
22
  
               
Float rate
    
1.50
%
    
1.50
%
               
Prepayment rate
  
7.01% to 29.80
%
    
16.08
%
December 31, 2018
                              
Capitalized mortgage loan servicing rights
  
$
21,400
  
Present value of net
  
Discount rate
  
10.00% to 13.00
%
    
10.15
%
         
servicing revenue
  
Cost to service
  
$
68 to $216
    
$
81
  
               
Ancillary income
  
20 to 36
      
23
  
               
Float rate
    
2.57
%
    
2.57
%
               
Prepayment rate
  
6.68% to 78.78
%
    
10.54
%

52
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)
                  
September 30, 2019
                      
Impaired loans
        

 

         
Commercial
  
$
908
  
Sales comparison approach
  
Adjustment for differences between comparable sales
  
(48.0)% to 6.3
%
  
(12.3
)%

   

 

 
           
Mortgage and Installment(1)
    
1,277
  
Sales comparison approach
  
Adjustment for differences between comparable sales
  
(61.4) to 65.2
    
(6.8
)

                         
Other real estate
        
 
           
Mortgage
     80  
Sales comparison approach
  
Adjustment for differences between comparable sales
  
(36.4) to 16.3
    
(20.3
)
                           
December 31, 2018
                          
Impaired loans
        
 
           
Commercial(2)
   $
2,566
  
Sales comparison approach
  
Adjustment for differences between comparable sales
  
(32.5)% to 60.0
%
  
(1.9
)%
         
               
Mortgage
     905
 
Sales comparison approach
  
Adjustment for differences between comparable sales
  
(40.1) to 25.6
    
0.7
  
                           
Other real estate
        
 
           
Mortgage
    
154
   Sales comparison approach  
Adjustment for differences between comparable sales
  
0.0 to 34.1
    
11.2
  

(1)
In addition to the valuation techniques and unobservable inputs discussed above, at September 30, 2019 certain impaired collateral dependent installment loans totaling approximately $0.2 million are secured by collateral other than real estate.  For the majority of these loans, we apply internal discount rates to industry valuation guides.
(2)
In addition to the valuation techniques and unobservable inputs discussed above, at December 31, 2018, we had an impaired collateral dependent commercial relationship that totaled $0.7 million that was secured by collateral other than real estate. Collateral securing this relationship primarily included accounts receivable, inventory and cash at December 31, 2018. Valuation techniques at December 31, 2018, included discounting financial statement values for each particular asset type. Discount rates used ranged from 20% to 80% of stated values at December 31, 2018.

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

   
Aggregate
Fair Value
    
Difference
    
Contractual
Principal
  
   
(In thousands)
  
Loans held for sale
                  
September 30, 2019
  
$
87,358
    
$
2,079
    
$
85,279
  
December 31, 2018
    
44,753
      
1,257
      
43,496
  

53
NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
(unaudited)

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.

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.

54
NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
(unaudited)

The estimated recorded book balances and fair values follow:


        
   
Fair Value Using
  
   
Recorded
Book
Balance
    
Fair Value
    
Quoted
Prices
in Active
Markets
for
Identical
Assets
(Level 1)
    
Significant
Other
Observable
Inputs
(Level 2)
    
Significant
Un-
observable
Inputs
(Level 3)
  
   
(In thousands)
  
September 30, 2019
                              
Assets
                              
Cash and due from banks
  
$
38,662
    
$
38,662
    
$
38,662
    
$
-
    
$
-
  
Interest bearing deposits
    
43,755
      
43,755
      
43,755
      
-
      
-
  
Interest bearing deposits - time
    
499
      
500
      
-
      
500
      
-
  
Securities available for sale
    
439,592
      
439,592
      
-
      
439,592
      
-
  
Federal Home Loan Bank and Federal Reserve Bank Stock
    
18,359
    
NA
    
NA
    
NA
    
NA
  
Net loans and loans held for sale
    
2,820,278
      
2,841,484
      
-
      
125,013
      
2,716,471
  
Accrued interest receivable
    
10,480
      
10,480
      
1
      
1,995
      
8,484
  
Derivative financial instruments
    
7,389
      
7,389
      
-
      
7,389
      
-
  
                                         
Liabilities
                                        
Deposits with no stated maturity (1)
  
$
2,429,013
    
$
2,429,013
    
$
2,429,013
    
$
-
    
$
-
  
Deposits with stated maturity (1)
    
623,299
      
623,916
      
-
      
623,916
      
-
  
Other borrowings
    
63,974
      
63,930
      
-
      
63,930
      
-
  
Subordinated debentures
    
39,439
      
32,427
      
-
      
32,427
      
-
  
Accrued interest payable
    
1,610
      
1,610
      
100
      
1,510
      
-
  
Derivative financial instruments
    
5,657
      
5,657
      
-
      
5,657
      
-
  
                                         
December 31, 2018
                                        
Assets
                                        
Cash and due from banks
  
$
23,350
    
$
23,350
    
$
23,350
    
$
-
    
$
-
  
Interest bearing deposits
    
46,894
      
46,894
      
46,894
      
-
      
-
  
Interest bearing deposits - time
    
595
      
594
      
-
      
594
      
-
  
Equity securities at fair value
    
393
      
393
      
393
      
-
      
-
  
Securities available for sale
    
427,926
      
427,926
      
-
      
427,926
      
-
  
Federal Home Loan Bank and Federal Reserve Bank Stock
    
18,359
    
NA
    
NA
    
NA
    
NA
  
Net loans and loans held for sale
    
2,643,856
      
2,606,256
      
41,471
      
44,753
      
2,520,032
  
Accrued interest receivable
    
10,164
      
10,164
      
22
      
1,789
      
8,353
  
Derivative financial instruments
    
5,155
      
5,155
      
-
      
5,155
      
-
  
                                         
Liabilities
                                        
Deposits with no stated maturity (1)
  
$
2,197,494
    
$
2,197,494
    
$
2,197,494
    
$
-
    
$
-
  
Deposits with stated maturity (1)
    
715,934
      
711,312
      
-
      
711,312
      
-
  
Other borrowings
    
25,700
      
25,706
      
-
      
25,706
      
-
  
Subordinated debentures
    
39,388
      
35,021
      
-
      
35,021
      
-
  
Accrued interest payable
    
1,646
      
1,646
      
114
      
1,532
      
-
  
Derivative financial instruments
    
2,326
      
2,326
      
-
      
2,326
      
-
  

(1)
Deposits with no stated maturity include reciprocal deposits with a recorded book balance of $367.180 million and $123.080 million at September 30, 2019 and December 31, 2018, respectively. Deposits with a stated maturity include reciprocal deposits with a recorded book balance of $49.020 million and $58.992 million at September 30, 2019 and December 31, 2018, respectively.
 
55
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.
Contingencies

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

56
NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
(unaudited)

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 Federal Home Loan Bank of Indianapolis). 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 $0.03 million and $0.05 million for the three month periods ended September 30, 2019 and 2018, respectively and an expense of $0.18 million and $0.08 million for the nine month periods ended September 30, 2019 and 2018, respectively. The reserve for loss reimbursements on sold mortgage loans totaled $0.85 million and $0.78 million at September 30, 2019 and December 31, 2018, 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.

We own 12,566 shares of VISA Class B common stock. At the present time, these shares can only be sold to other Class B shareholders. As a result, there has generally been limited transfer activity in private transactions between buyers and sellers. Given the limited activity that we have become aware of  and the continuing uncertainty regarding the likelihood, ultimate timing and eventual exchange rate for Class B shares into Class A shares, we continue to carry these shares at zero, representing cost basis less impairment. However, given the current conversion ratio of 1.6228 to Class A shares and the closing price of VISA Class A shares on October 17, 2019 of $177.94 per share, our 12,566 Class B shares would have a current “value” of approximately $3.6 million. We continue to monitor Class B trading activity and the status of the resolution of certain litigation matters at VISA that would trigger the conversion of Class B common shares into Class A common shares that would have no trading restrictions.

57
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
(Losses) on
Cash Flow
Hedges
    
Total
  
   
(In thousands)
  
For the three months ended September 30,
                        
2019
                        
Balances at beginning of period
  
$
3,040
    
$
(5,798
)
  
$
(1,673
)
  
$
(4,431
)
Other comprehensive income (loss) before reclassifications
    
1,196
      
-
      
(58
)
    
1,138
  
Amounts reclassified from AOCL
    
-
      
-
      
(80
)
    
(80
)
Net current period other comprehensive income (loss)
    
1,196
      
-
      
(138
)
    
1,058
  
Balances at end of period
  
$
4,236
    
$
(5,798
)
  
$
(1,811
)
  
$
(3,373
)
                                 
2018
                                
Balances at beginning of period
  
$
(4,437
)
  
$
(5,798
)
  
$
1,021
    
$
(9,214
)
Other comprehensive income (loss) before reclassifications
    
(925
)
    
-
      
307
      
(618
)
Amounts reclassified from AOCL
    
-
      
-
      
(57
)
    
(57
)
Net current period other comprehensive income (loss)
    
(925
)
    
-
      
250
      
(675
)
Balances at end of period
  
$
(5,362
)
  
$
(5,798
)
  
$
1,271
    
$
(9,889
)
                                 
For the nine months ended September 30,
                                
2019
                                
Balances at beginning of period
  
$
(4,185
)
  
$
(5,798
)
  
$
(125
)
  
$
(10,108
)
Other comprehensive income (loss) before reclassifications
    
8,529
      
-
      
(1,376
)
    
7,153
  
Amounts reclassified from AOCL
    
(108
)
    
-
      
(310
)
    
(418
)
Net current period other comprehensive income (loss)
    
8,421
      
-
      
(1,686
)
    
6,735
  
Balances at end of period
  
$
4,236
    
$
(5,798
)
  
$
(1,811
)
  
$
(3,373
)
                                 
2018
                                
Balances at beginning of period
  
$
(470
)
  
$
(5,798
)
  
$
269
    
$
(5,999
)
Other comprehensive income (loss) before reclassifications
    
(4,928
)
    
-
      
1,106
      
(3,822
)
Amounts reclassified from AOCL
    
36
      
-
      
(104
)
    
(68
)
Net current period other comprehensive income (loss)
    
(4,892
)
    
-
      
1,002
      
(3,890
)
Balances at end of period
  
$
(5,362
)
  
$
(5,798
)
  
$
1,271
    
$
(9,889
)

58
NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
(unaudited)

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 inconsequential portfolio of securities available for sale.

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

AOCL Component
  
Amount
Reclassified
From
AOCL
  
 Affected Line Item in Condensed
 Consolidated Statements of Operations
   
(In thousands)
    
2019
         
Unrealized gains (losses) on securities available for sale
         
   
$
-
  
Net gains (losses) on securities
     
-
  
Net impairment loss recognized in earnings
     
-
  
Total reclassifications before tax
     
-
  
Income tax expense
   
$
-
  
Reclassifications, net of tax
             
Unrealized gains (losses) on cash flow hedges
           
   
$
(102
)
Interest expense
     
(22
)
Income tax expense
   
$
(80
)
Reclassification, net of tax
             
   
$
80
  
Total reclassifications for the period, net of tax
             
2018
           
Unrealized gains (losses) on securities available for sale
           
   
$
-
  
Net gains (losses) on securities
     
-
  
Net impairment loss recognized in earnings
     
-
  
Total reclassifications before tax
     
-
  
Income tax expense
   
$
-
  
Reclassifications, net of tax
             
Unrealized gains (losses) on cash flow hedges
           
   
$
(73
)
Interest expense
     
(16
)
Income tax expense
   
$
(57
)
Reclassification, net of tax
             
   
$
57
  
Total reclassifications for the period, net of tax

59
NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
(unaudited)

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

AOCL Component
  
Amount
Reclassified
From
AOCL
  
 Affected Line Item in Condensed
 Consolidated Statements of Operations
   
(In thousands)
    
2019
         
Unrealized gains (losses) on securities available for sale
         
   
$
137
  
 Net gains (losses) on securities
     
-
  
 Net impairment loss recognized in earnings
     
137
  
 Total reclassifications before tax
     
29
  
 Income tax expense
   
$
108
  
 Reclassifications, net of tax
             
Unrealized gains (losses) on cash flow hedges
           
   
$
(393
)
 Interest expense
     
(83
)
 Income tax expense
   
$
(310
)
 Reclassification, net of tax
             
   
$
418
  
 Total reclassifications for the period, net of tax
             
2018
           
Unrealized gains (losses) on securities available for sale
           
   
$
(45
)
 Net gains (losses) on securities
     
-
  
 Net impairment loss recognized in earnings
     
(45
)
 Total reclassifications before tax
     
(9
)
 Income tax expense
   
$
(36
)
 Reclassifications, net of tax
             
Unrealized gains (losses) on cash flow hedges
           
   
$
(132
)
 Interest expense
     
(28
)
 Income tax expense
   
$
(104
)
 Reclassification, net of tax
             
   
$
68
  
 Total reclassifications for the period, net of tax

15.
Revenue from Contracts with Customers

We account for revenue in accordance with ASC Topic 606, Revenue from Contracts with Customers. 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 this topic.  These sources of revenue that are excluded from the scope of this topic 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 84.7% and 83.1% of total revenues at September 30, 2019 and 2018, respectively.

60
NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
(unaudited)

Material sources of revenue that are included in the scope of this topic include service charges on deposit accounts, 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 September 30, 2019 and December 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.

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 on 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 and nine month periods ending September 30, 2019 and 2018 that were financed by us.

61
NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
(unaudited)

Disaggregation of our revenue sources by attribute follows:

Three months ending September 30, 2019
   
Service
Charges
on Deposit
Accounts
    
Other
Deposit
Related
Income
    
Interchange
Income
    
Investment
and
Insurance
Commissions
    
Total
  
   
(In thousands)
  
Retail
                              
Overdraft fees
  
$
1,970
    
$
-
    
$
-
    
$
-
    
$
1,970
  
Account service charges
    
552
      
-
      
-
      
-
      
552
  
ATM fees
    
-
      
373
      
-
      
-
      
373
  
Other
    
-
      
240
      
-
      
-
      
240
  
Business
                                        
Overdraft fees
    
361
      
-
      
-
      
-
      
361
  
Account service charges
    
-
      
-
      
-
      
-
      
-
  
ATM fees
    
-
      
9
      
-
      
-
      
9
  
Other
    
-
      
91
      
-
      
-
      
91
  
Interchange income
    
-
      
-
      
2,785
      
-
      
2,785
  
Asset management revenue
    
-
      
-
      
-
      
292
      
292
  
Transaction based revenue
    
-
      
-
      
-
      
158
      
158
  
                                         
Total
  
$
2,883
    
$
713
    
$
2,785
    
$
450
    
$
6,831
  
                                         
Reconciliation to Condensed Consolidated Statement of Operations:
                  
Non-interest income - other:
                                        
Other deposit related income
                                  
$
713
  
Investment and insurance commissions
                              
450
  
Bank owned life insurance
                                    
301
  
Other
                                    
1,028
  
Total
                                  
$
2,492
  

62
NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
(unaudited)

Three months ending September 30, 2018
   
Service
Charges
on Deposit
Accounts
    
Other
Deposit
Related
Income
    
Interchange
Income
    
Investment
and
Insurance
Commissions
    
Total
  
   
(In thousands)
  
Retail
                              
Overdraft fees
  
$
2,161
    
$
-
    
$
-
    
$
-
    
$
2,161
  
Account service charges
    
519
      
-
      
-
      
-
      
519
  
ATM fees
    
-
      
374
      
-
      
-
      
374
  
Other
    
-
      
219
      
-
      
-
      
219
  
Business
                                        
Overdraft fees
    
408
      
-
      
-
      
-
      
408
  
Account service charges
    
78
      
-
      
-
      
-
      
78
  
ATM fees
    
-
      
10
      
-
      
-
      
10
  
Other
    
-
      
124
      
-
      
-
      
124
  
Interchange income
    
-
      
-
      
2,486
      
-
      
2,486
  
Asset management revenue
    
-
      
-
      
-
      
274
      
274
  
Transaction based revenue
    
-
      
-
      
-
      
239
      
239
  
                                         
Total
  
$
3,166
    
$
727
    
$
2,486
    
$
513
    
$
6,892
  
                                         
Reconciliation to Condensed Consolidated Statement of Operations:
                  
Non-interest income - other:
                                        
Other deposit related income
                                  
$
727
  
Investment and insurance commissions
                              
513
  
Bank owned life insurance
                                    
237
  
Other
                                    
657
  
Total
                                  
$
2,134
  

63
NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
(unaudited)

Nine months ending September 30, 2019
   
Service
Charges
on Deposit
Accounts
    
Other
Deposit
Related
Income
    
Interchange
Income
    
Investment
and
Insurance
Commissions
    
Total
  
   
(In thousands)
  
Retail
                              
Overdraft fees
  
$
5,582
    
$
-
    
$
-
    
$
-
    
$
5,582
  
Account service charges
    
1,609
      
-
      
-
      
-
      
1,609
  
ATM fees
    
-
      
1,041
      
-
      
-
      
1,041
  
Other
    
-
      
703
      
-
      
-
      
703
  
Business
                                        
Overdraft fees
    
1,123
      
-
      
-
      
-
      
1,123
  
Account service charges
    
9
      
-
      
-
      
-
      
9
  
ATM fees
    
-
      
26
      
-
      
-
      
26
  
Other
    
-
      
309
      
-
      
-
      
309
  
Interchange income
    
-
      
-
      
7,744
      
-
      
7,744
  
Asset management revenue
    
-
      
-
      
-
      
823
      
823
  
Transaction based revenue
    
-
      
-
      
-
      
374
      
374
  
                                         
Total
  
$
8,323
    
$
2,079
    
$
7,744
    
$
1,197
    
$
19,343
  
                                         
Reconciliation to Condensed Consolidated Statement of Operations:
                  
Non-interest income - other:
                                        
Other deposit related income
                                  
$
2,079
  
Investment and insurance commissions
                              
1,197
  
Bank owned life insurance
                                    
813
  
Other
                                    
2,773
  
Total
                                  
$
6,862
  

64
NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
(unaudited)

Nine months ending September 30, 2018
   
Service
Charges
on Deposit
Accounts
    
Other
Deposit
Related
Income
    
Interchange
Income
    
Investment
and
Insurance
Commissions
    
Total
  
   
(In thousands)
  
Retail
                              
Overdraft fees
  
$
6,177
    
$
-
    
$
-
    
$
-
    
$
6,177
  
Account service charges
    
1,607
      
-
      
-
      
-
      
1,607
  
ATM fees
    
-
      
1,077
      
-
      
-
      
1,077
  
Other
    
-
      
656
      
-
      
-
      
656
  
Business
                                        
Overdraft fees
    
1,153
      
-
      
-
      
-
      
1,153
  
Account service charges
    
229
      
-
      
-
      
-
      
229
  
ATM fees
    
-
      
26
      
-
      
-
      
26
  
Other
    
-
      
399
      
-
      
-
      
399
  
Interchange income
    
-
      
-
      
7,236
      
-
      
7,236
  
Asset management revenue
    
-
      
-
      
-
      
826
      
826
  
Transaction based revenue
    
-
      
-
      
-
      
608
      
608
  
                                         
Total
  
$
9,166
    
$
2,158
    
$
7,236
    
$
1,434
    
$
19,994
  
                                         
Reconciliation to Condensed Consolidated Statement of Operations:
                  
Non-interest income - other:
                                        
Other deposit related income
                                  
$
2,158
  
Investment and insurance commissions
                              
1,434
  
Bank owned life insurance
                                    
713
  
Other
                                    
1,989
  
Total
                                  
$
6,294
  

16.  Leases

We have operating leases, primarily relating to certain office facilities, some of which include renewal options and escalation clauses.  Certain leases also include both lease components (fixed payments including rent, taxes and insurance costs) and non-lease components (common area or other maintenance costs) which are accounted for as a single lease component as we have elected the practical expedient to group lease and non-lease components for all leases.  Most of our leases include one or more options to renew. The exercise of lease renewal options is typically at our sole discretion and are included in our ROU assets and lease liabilities if they are reasonably certain of exercise.  As most of our leases do not provide an implicit rate, we use our incremental borrowing rate based on the information available at the lease commencement date in determining the present value of the lease payments.

The cost components of our operating leases follows:

   
Three Months
Ended
    
Nine Months
Ended
  
   
September 30, 2019
  
   
(In thousands)
  
Operating lease cost
  
$
565
    
$
1,692
  
Variable lease cost
    
43
      
115
  
Short-term lease cost
    
4
      
14
  
Total
  
$
612
    
$
1,821
  

65
NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
(unaudited)

Variable lease costs consist primarily of taxes, insurance, and common area or other maintenance costs for our leased facilities.

Supplemental balance sheet information related to our operating leases follows:

   
September 30, 2019
  
   
(In thousands)
  
Lease right of use asset (1)
  
$
6,244
  
Lease liabilities (2)
  
$
6,257
  
         
Weighted average remaining lease term (years)
    
5.50
  
Weighted average discount rate
    
3.2
%

(1)
Included in Accrued income and other assets in our Condensed Consolidated Statements of Financial Condition.
(2)
Included in Accrued expenses and other liabilities in our Condensed Consolidated Statements of Financial Condition.

Maturity analysis of our lease liabilities at September 30, 2019 based on required contractual payments follows:

   
(In thousands)
  
       
Three months ending December 31, 2019
  
$
543
  
2020
    
1,790
  
2021
    
1,269
  
2022
    
963
  
2023
    
925
  
2024 and thereafter
    
1,381
  
Total lease payments
    
6,871
  
Less imputed interest
    
(614
)
Total
  
$
6,257
  

66
NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
(unaudited)

17.  Recent Acquisition

Effective April 1, 2018, we completed the acquisition of all of the issued and outstanding shares of common stock of TCSB through a merger of 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 Independent Bank (with Independent Bank as the surviving institution).  Under the terms of the merger agreement each holder of TCSB common stock received 1.1166 shares of IBCP common stock plus cash in lieu of fractional shares totaling $0.005 million.  TCSB option holders had their options converted into IBCP stock options.  As a result 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.  The fair value of common stock and stock options issued as the consideration paid for TCSB was determined using the closing price of our common stock on the acquisition date.  This acquisition was accounted for under the acquisition method of accounting.  Accordingly, we recognized amounts for identifiable assets acquired and liabilities assumed at their estimated acquisition date fair values.  TCSB results of operations are included in our results beginning April 1, 2018.

The following table reflects our final valuation of the assets acquired and liabilities assumed:

   
(In thousands)
  
Cash and cash equivalents
  
$
23,521
  
Interest bearing deposits - time
    
4,054
  
Securities available for sale
    
6,066
  
Federal Home Loan Bank stock
    
778
  
Loans, net
    
295,799
  
Property and equipement, net
    
1,067
  
Capitalized mortgage loan servicing rights
    
3,047
  
Accrued income and other assets
    
3,362
  
Other intangibles (1)
    
5,798
  
Total assets acquired
    
343,492
  
         
Deposits
    
287,710
  
Other borrowings
    
14,345
  
Subordinated debentures
    
3,768
  
Accrued expenses and other liabilities
    
1,429
  
Total liabilities assumed
    
307,252
  
Net assets acquired
    
36,240
  
Goodwill
    
28,300
  
Purchase price (fair value of consideration)
  
$
64,540
  

(1)
Relates to core deposit intangibles (see note #7).

67
NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
(unaudited)

Management views the disclosed fair values presented above to be final as the one-year measurement period for finalizing acquisition-date fair values has expired.  During this measurement period we had one adjustment to our acquisition date fair values.  During the third quarter of 2018, goodwill was reduced by $0.7 million (to $28.3 million) related to the collection of a TCSB acquired loan that had been charged off in full prior to the Merger.  Because of the status of the collection activities related to this loan at the time of the Merger, we determined that this transaction was a measurement period adjustment and reduced goodwill accordingly.

Goodwill related to this acquisition will not be deductible for tax purposes and consists largely of synergies and cost savings resulting from the combining of the operations of TCSB into ours as well as expansion into a new market.

The estimated fair value of the core deposit intangible was $5.8 million and is being amortized over an estimated useful life of 10 years.

The fair value of net assets acquired includes fair value adjustments to certain receivables that were not considered impaired as of the acquisition date. The fair value adjustments were determined using discounted contractual cash flows.  However, we believe that all contractual cash flows related to these financial instruments will be collected.  As such, these receivables were not considered impaired at the acquisition date and were not subject to the guidance relating to purchased credit impaired loans which have shown evidence of credit deterioration since origination.  Receivables acquired that are not subject to these requirements included non-impaired customer receivables with a fair value and gross contractual amounts receivable of $292.9 million and $298.6 million on the date of acquisition.

68
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 2018 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.  We also have two loan production offices in Ohio (Columbus and Fairlawn).  As a result, our success depends to a great extent upon the economic conditions in Michigan’s Lower Peninsula.

Recent Developments. 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). See note #17.

It is against this backdrop that we discuss our results of operations and financial condition in the third quarter and first nine months of 2019 as compared to 2018.

Results of Operations

Summary.  We recorded net income of $12.4 million and $11.9 million, respectively, during the three months ended September 30, 2019 and 2018.  The increase in 2019 third quarter results as compared to 2018 reflects increases in net interest income and non-interest income as well as a decrease in the provision for loan losses that were partially offset by increases in non-interest expense and income tax expense.

We recorded net income of $32.6 million and $29.9 million, respectively, during the nine months ended September 30, 2019 and 2018.  The increase in 2019 year-to-date results as compared to 2018 is due to an increase in net interest income that was partially offset by a decrease in non-interest income and by increases in the provision for loan losses, non-interest expense and income tax expense.

69
Key performance ratios

   
Three months ended
 September 30,

Nine months ended
September 30,
  
   
2019
    
2018
    
2019
    
2018
  
Net income (annualized) to
                        
Average assets
    
1.42
%
    
1.46
%
    
1.28
%
    
1.30
%
Average common shareholders’ equity
    
14.64
      
13.83
      
12.84
      
12.73
  
                                 
Net income per common share
                                
Basic
  
$
0.55
    
$
0.49
    
$
1.41
    
$
1.29
  
Diluted
    
0.55
      
0.49
      
1.40
      
1.27
  

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 or interest-rate risk, in particular, can adversely impact our net interest income.

Our net interest income totaled $30.9 million during the third quarter of 2019, an increase of $1.2 million, or 4.0% from the year-ago period.  This increase primarily reflects a $246.9 million increase in average interest-earning assets that was partially offset by a 15 basis point decrease in our tax equivalent net interest income as a percent of average interest-earning assets (the “net interest margin”).

For the first nine months of 2019, net interest income totaled $91.9 million, an increase of $9.3 million, or 11.2% from 2018.  This increase primarily reflects a $336.8 million increase in average interest-earning assets that was partially offset by a three basis point decrease in our net interest margin.

Interest and fees on loans include $0.4 million and $1.1 million for the third quarter and first nine months of 2019, respectively, and include $0.6 million and $1.2 million for the third quarter and first nine months of 2018, respectively, of accretion of the discount recorded on loans acquired in the Merger.

The increase in average interest-earning assets primarily reflects loan growth utilizing funds from increases in deposits and borrowed funds as well as the impact of the Merger (for the year-to-date comparative periods).  The decrease in the net interest margin reflects the impact of lower market interest rates and a flattening of the yield curve during 2019.

Our net interest income is also adversely impacted by our level of non-accrual loans.  In the third quarter and first nine months of 2019 non-accrual loans averaged $6.9 million and $8.1 million, respectively, compared to $9.2 million and $8.1 million, respectively for the same periods in 2018.  In addition, in the third quarter and first nine months of 2019 we had net (charge-offs)/recoveries of $0.23 million and $0.66 million, respectively, of unpaid interest on loans placed on or taken off non-accrual during each period or on loans previously charged-off compared to net (charge-offs)/recoveries of $(0.01) million and $0.35 million, respectively, during the same periods in 2018.

70
Average Balances and Tax Equivalent Rates

 
 

    
Three Months Ended
September 30,
    
2019
    
2018
Average
Balance
    
Interest
    
Rate (2)
    
Average
Balance
    
Interest
    
Rate (2)
 
  
(Dollars in thousands)
  
Assets
                                    
Taxable loans
  
$
2,779,132
    
$
34,151
      
4.89
%
  
$
2,543,712
    
$
30,936
      
4.84
%
Tax-exempt loans (1)
    
7,412
      
94
      
5.03
      
6,590
      
81
      
4.88
  
Taxable securities
    
371,157
      
2,771
      
2.99
      
379,985
      
2,737
      
2.88
  
Tax-exempt securities (1)
    
52,098
      
400
      
3.07
      
62,964
      
518
      
3.29
  
Interest bearing cash
    
56,923
      
229
      
1.60
      
27,477
      
66
      
0.95
  
Other investments
    
18,359
      
266
      
5.75
      
17,493
      
237
      
5.38
  
Interest Earning Assets
    
3,285,081
      
37,911
      
4.60
      
3,038,221
      
34,575
      
4.53
  
Cash and due from banks
    
34,598
                      
35,874
                  
Other assets, net
    
163,617
                      
173,508
                  
Total Assets
  
$
3,483,296
                    
$
3,247,603
                  
 
                                                
Liabilities
                                                
Savings and interest- bearing checking
  
$
1,487,820
      
2,818
      
0.75
    
$
1,241,868
      
1,223
      
0.39
  
Time deposits
    
658,426
      
3,418
      
2.06
      
664,098
      
2,753
      
1.64
  
Other borrowings
    
72,887
      
703
      
3.83
      
80,939
      
779
      
3.82
  
Interest Bearing Liabilities
    
2,219,133
      
6,939
      
1.24
      
1,986,905
      
4,755
      
0.95
  
Non-interest bearing deposits
    
877,088
                      
884,003
                  
Other liabilities
    
49,913
                      
34,697
                  
Shareholders’ equity
    
337,162
                      
341,998
                  
Total liabilities and shareholders’ equity
  
$
3,483,296
                    
$
3,247,603
                  
 
                                                
Net Interest Income
          
$
30,972
                    
$
29,820
          
 
                                                
Net Interest Income as a Percent of Average Interest Earning Assets
                    
3.76
%
                    
3.91
%

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

71
Average Balances and Tax Equivalent Rates

   
Nine Months Ended
September 30,
  
   
2019
    
2018
  
   
Average
Balance
    
Interest
    
Rate (2)
    
Average
Balance
    
Interest
    
Rate (2)
  
Assets
  
(Dollars in thousands)
  
Taxable loans
  
$
2,695,435
    
$
100,513
      
4.98
%
  
$
2,350,883
    
$
83,881
      
4.77
%
Tax-exempt loans (1)
    
7,856
      
291
      
4.95
      
5,221
      
185
      
4.74
  
Taxable securities
    
384,291
      
8,811
      
3.06
      
400,957
      
8,092
      
2.69
  
Tax-exempt securities (1)
    
52,794
      
1,275
      
3.22
      
70,155
      
1,680
      
3.19
  
Interest bearing cash
    
51,260
      
655
      
1.71
      
29,502
      
214
      
0.97
  
Other investments
    
18,359
      
794
      
5.78
      
16,457
      
684
      
5.56
  
Interest Earning Assets
    
3,209,995
      
112,339
      
4.67
      
2,873,175
      
94,736
      
4.40
  
Cash and due from banks
    
34,032
                      
33,204
                  
Other assets, net
    
166,037
                      
159,844
                  
Total Assets
  
$
3,410,064
                    
$
3,066,223
                  
 
                                                
Liabilities
                                                
Savings and interest- bearing checking
  
$
1,421,114
      
7,787
      
0.73
    
$
1,193,388
      
2,785
      
0.31
  
Time deposits
    
670,479
      
10,151
      
2.02
      
611,103
      
6,687
      
1.46
  
Other borrowings
    
72,233
      
2,211
      
4.09
      
82,253
      
2,267
      
3.68
  
Interest Bearing Liabilities
    
2,163,826
      
20,149
      
1.24
      
1,886,744
      
11,739
      
0.83
  
Non-interest bearing deposits
    
862,929
                      
833,283
                  
Other liabilities
    
44,323
                      
32,177
                  
Shareholders’ equity
    
338,986
                      
314,019
                  
Total liabilities and shareholders’ equity
  
$
3,410,064
                    
$
3,066,223
                  
 
                                                
Net Interest Income
          
$
92,190
                    
$
82,997
          
 
                                                
Net Interest Income as a Percent of Average Interest Earning Assets
                    
3.83
%
                    
3.86
%

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

72
Reconciliation of Non-GAAP Financial Measures

   
Three Months Ended
September 30,
    
Nine Months Ended
September 30,
  
   
2019
    
2018
    
2019
    
2018
  
   
(Dollars in thousands)
  
Net Interest Margin, Fully Taxable Equivalent (“FTE”)
                        
                         
Net interest income
  
$
30,872
    
$
29,697
    
$
91,871
    
$
82,613
  
Add:  taxable equivalent adjustment
    
100
      
123
      
319
      
384
  
Net interest income - taxable equivalent
  
$
30,972
    
$
29,820
    
$
92,190
    
$
82,997
  
Net interest margin (GAAP) (1)
    
3.74
%
    
3.88
%
    
3.82
%
    
3.84
%
Net interest margin (FTE) (1)
    
3.76
%
    
3.91
%
    
3.83
%
    
3.86
%

(1) Annualized.

Provision for loan losses.  The provision for loan losses was a credit of $0.3 million and $0.1 million during the three months ended September 30, 2019 and 2018, respectively. During the nine-month periods ended September 30, 2019 and 2018, the provision was an expense of $1.0 million and $0.9 million, respectively. The provision reflects our assessment of the allowance for loan losses taking into consideration factors such as loan growth, loan mix, levels of non-performing and classified loans and loan net charge-offs.  While we use relevant information to recognize losses on loans, additional provisions for related losses may be necessary based on changes in economic conditions, customer circumstances and other credit risk factors.  See “Portfolio Loans and asset quality” for a discussion of the various components of the allowance for loan losses and their impact on the provision for loan losses in the third quarter and first nine months of 2019.

Non-interest income.  Non-interest income is a significant element in assessing our results of operations. Non-interest income totaled $12.3 million during the third quarter of 2019 compared to $11.8 million in 2018.  For the first nine months of 2019 non-interest income totaled $32.1 million compared to $35.9 million for the first nine months of 2018.

73
The components of non-interest income are as follows:

Non-Interest Income
   
Three months ended
September 30,
    
Nine months ended
September 30,
  

 
2019
    
2018
    
2019
    
 2018
  
   
(In thousands)
  
Service charges on deposit accounts
  
$
2,883
    
$
3,166
    
$
8,323
    
$
9,166
  
Interchange income
    
2,785
      
2,486
      
7,744
      
7,236
  
Net gains (losses) on assets:
                                
Mortgage loans
    
5,677
      
2,745
      
13,590
      
8,571
  
Securities
    
--
      
93
      
304
      
(71
)
Mortgage loan servicing, net
    
(1,562
)
    
1,212
      
(4,684
)
    
4,668
  
Investment and insurance commissions
    
450
      
513
      
1,197
      
1,434
  
Bank owned life insurance
    
301
      
237
      
813
      
713
  
Other
    
1,741
      
1,384
      
4,852
      
4,147
  
Total non-interest income
  
$
12,275
    
$
11,836
    
$
32,139
    
$
35,864
  

Service charges on deposit accounts decreased on both a comparative quarterly and year-to-date basis in 2019 as compared to 2018.  These decreases were principally due to a decrease in non-sufficient funds occurrences.

Interchange income increased on both a comparative quarterly and year-to-date basis in 2019 as compared to 2018 due primarily to an increase in debit card transaction volume as well as the timing of the receipt of a volume incentive from our debit card brand partner.  In 2019 this volume incentive ($0.2 million) was received in the third quarter; however, in 2018, the comparable volume incentive was not received until the fourth quarter.

Net gains on mortgage loans increased from 2018 on both a quarterly and a year to date basis. Mortgage loan activity is summarized as follows:

Mortgage Loan Activity

   
Three months ended
September 30,
    
Nine months ended
September 30,
  
   
2019
    
2018
    
2019
    
2018
  
   
(Dollars in thousands)
  
Mortgage loans originated
  
$
329,461
    
$
231,849
    
$
708,621
    
$
617,080
  
Mortgage loans sold
    
204,058
      
148,730
      
490,219
      
370,372
  
Net gains on mortgage loans
    
5,677
      
2,745
      
13,590
      
8,571
  
Net gains as a percent of mortgage loans sold (“Loan Sales Margin”)
    
2.78
%
    
1.85
%
    
2.77
%
    
2.31
%
Fair value adjustments included in the Loan Sales Margin
    
0.22
      
(0.26
)
    
0.48
      
0.10
  

The increase in mortgage loans originated is due primarily to lower interest rates spurring higher mortgage loan refinance volumes. Mortgage loans sold increased due to a higher mix of salable loans in our origination volumes, the rise in mortgage loan refinance activity and some portfolio mortgage loan sales that were completed during 2019. These factors resulted in net gains on mortgage loans increasing in 2019 as compared to 2018.

74
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.

Our Loan Sales Margin is impacted by several factors including competition and the manner in which the loan is sold. Net gains on mortgage loans are also impacted by recording fair value accounting adjustments.  Excluding the aforementioned fair value accounting adjustments, the Loan Sales Margin would have been 2.56% and 2.11% in the third quarters of 2019 and 2018, respectively and 2.29% and 2.21% for the comparative 2019 and 2018 year-to-date periods, respectively.  The increase in the Loan Sales Margin (excluding fair value adjustments) in 2019 was generally due to a widening of primary-to-secondary market pricing spreads due to competitive factors throughout the mortgage banking industry (lower mortgage loan interest rates and an increase in refinance volume). The changes in the fair value accounting adjustments are primarily due to changes in the amount of commitments to originate mortgage loans for sale.

Net gains (losses) on securities were relatively nominal for the comparative quarterly periods.  We recorded a net gain of $0.3 million and a net loss of $0.1 million on securities for the first nine months of 2019 and 2018, respectively.  We recorded no net impairment losses in either 2019 or 2018 for other than temporary impairment of securities available for sale.  See “Securities” below and note #3 to the Condensed Consolidated Financial Statements.

Mortgage loan servicing, net, generated a loss of $1.6 million and income of $1.2 million in the third quarters of 2019 and 2018, respectively. For the first nine months of 2019, mortgage loan servicing, net, generated a loss of $4.7 million as compared to income of $4.7 million in 2018. The significant variances in mortgage loan servicing, net are primarily due to changes in the fair value of capitalized mortgage loan servicing rights associated with changes in mortgage loan interest rates (a decline in 2019 as compared to an increase in 2018) and expected future prepayment levels.  This activity is summarized in the following table:

   
Three Months Ended
    
Nine Months Ended
  
   
9/30/2019
    
9/30/2018
    
9/30/2019
    
9/30/2018
  
Mortgage loan servicing, net:
  
(In thousands)
  
Revenue, net
  
$
1,583
    
$
1,410
    
$
4,574
    
$
3,974
  
Fair value change due to price
    
(2,163
)
    
610
      
(7,036
)
    
2,586
  
Fair value change due to pay-downs
    
(982
)
    
(808
)
    
(2,222
)
    
(1,892
)
Total
  
$
(1,562
)
  
$
1,212
    
$
(4,684
)
  
$
4,668
  
 
75
Activity related to capitalized mortgage loan servicing rights is as follows:
 
Capitalized Mortgage Loan Servicing Rights
   
Three months ended
September 30,
    
Nine months ended
September 30,
  
   
2019
    
2018
    
2019
    
2018
  
   
(In thousands)
  
Balance at beginning of period
  
$
17,894
    
$
21,848
    
$
21,400
    
$
15,699
  
Servicing rights acquired
    
-
      
-
      
-
      
3,047
  
Originated servicing rights capitalized
    
2,157
      
1,501
      
4,764
      
3,711
  
Change in fair value
    
(3,145
)
    
(198
)
    
(9,258
)
    
694
  
Balance at end of period
  
$
16,906
    
$
23,151
    
$
16,906
    
$
23,151
  
 
At September 30, 2019 we were servicing approximately $2.48 billion in mortgage loans for others on which servicing rights have been capitalized. This servicing portfolio had a weighted average coupon rate of 4.25% and a weighted average service fee of approximately 25.8 basis points. Capitalized mortgage loan servicing rights at September 30, 2019 totaled $16.9 million, representing approximately 68.2 basis points on the related amount of mortgage loans serviced for others.

Investment and insurance commissions represent revenues generated on the sale or management of investments and insurance for our customers.  These revenues were relatively comparable on a quarterly basis, but declined on a year-to-date basis in 2019 as compared to 2018.  The year-to-date decline in 2019 was primarily due to slower sales in the first quarter of 2019, principally reflecting market volatility and uncertainty.

Income from bank owned life insurance (“BOLI”) increased on both a comparative quarterly and year-to-date basis in 2019 compared to 2018 reflecting a higher crediting rate on our cash surrender value. Our BOLI separate account is primarily invested in agency mortgage-backed securities. The crediting rate (on which the earnings are based) reflects the performance of the separate account.  The total cash surrender value of our BOLI was $55.4 million and $55.1 million at September 30, 2019 and December 31, 2018, respectively.

Other non-interest income increased on both a comparative quarterly and year-to-date basis in 2019 compared to 2018, due primarily to increases in fees on interest rate swaps, merchant processing, and credit cards. The year-to-date increase in 2019 compared to 2018 is also due to $0.38 million of recoveries recorded in the first quarter of 2019 on TCSB loans that had been charged-off prior to the Merger.

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 increased by $1.1 million to $27.8 million and by $1.8 million to $82.4 million during the three- and nine-month periods ended September 30, 2019, respectively, compared to the same periods in 2018.

76
The components of non-interest expense are as follows:

Non-Interest Expense
   
Three months ended
September 30,
    
Nine months ended
September 30,
  
   
2019
    
2018
    
2019
    
2018
  
   
(In thousands)
  
                         
Compensation
  
$
10,327
    
$
9,582
    
$
30,993
    
$
28,086
  
Performance-based compensation
    
3,214
      
3,305
      
7,730
      
9,238
  
Payroll taxes and employee benefits
    
3,132
      
3,282
      
10,232
      
9,182
  
Compensation and employee benefits
    
16,673
      
16,169
      
48,955
      
46,506
  
Occupancy, net
    
2,161
      
2,233
      
6,797
      
6,667
  
Data processing
    
2,282
      
2,051
      
6,597
      
6,180
  
Furniture, fixtures and equipment
    
1,023
      
1,043
      
3,058
      
3,029
  
Interchange expense
    
891
      
715
      
2,332
      
1,974
  
Communications
    
733
      
727
      
2,219
      
2,111
  
Loan and collection
    
714
      
531
      
1,976
      
1,900
  
Advertising
    
636
      
594
      
1,935
      
1,578
  
Legal and professional
    
541
      
477
      
1,281
      
1,311
  
Amortization of intangible assets
    
272
      
295
      
817
      
676
  
FDIC deposit insurance
    
13
      
270
      
723
      
750
  
Supplies
    
163
      
173
      
474
      
516
  
Costs (recoveries) related to unfunded lending commitments
    
154
      
71
      
341
      
(6
)
Credit card and bank service fees
    
100
      
108
      
300
      
310
  
Provision for loss reimbursement on sold loans
    
33
      
47
      
179
      
78
  
Net (gains) losses on other real estate and repossessed assets
    
52
      
(325
)
    
(27
)
    
(619
)
Merger related expenses
    
--
      
98
      
--
      
3,354
  
Other
    
1,407
      
1,463
      
4,473
      
4,321
  
Total non-interest expense
  
$
27,848
    
$
26,740
    
$
82,430
    
$
80,636
  

Compensation and employee benefits expenses, in total, increased $0.5 million on a quarterly comparative basis and increased $2.4 million for the first nine months of 2019 compared to the same periods in 2018.

Compensation expense increased by $0.7 million and $2.9 million in the third quarter and first nine months of 2019, respectively, compared to the same periods in 2018.  The quarterly and year-to-date comparative increase in 2019 is primarily due to salary increases that were predominantly effective on January 1, 2019 and growth in the number of full-time equivalent employees.  The year-to-date comparative increase in 2019 also reflects the impact of the Merger.

Performance-based compensation decreased by $0.1 million and $1.5 million in the third quarter and first nine months of 2019, respectively, versus the same periods in 2018, due primarily to relative comparative changes in the accrual for anticipated incentive compensation based on our estimated full-year performance as compared to goals.

77
Payroll taxes and employee benefits decreased by $0.2 million and increased by $1.1 million in the third quarter and first nine months of 2019, respectively, compared to the same periods in 2018.  The quarterly comparative decrease is due primarily to a decline in health care costs.  The year-to-date comparative increase is due primarily to increases in health care costs (due to increased claims in the first six months of 2019), payroll taxes and workers’ compensation insurance costs.

Occupancy, net, furniture, fixtures and equipment, communications, legal and professional, supplies, and credit card and bank service fees expenses were all relatively unchanged on a comparative quarterly and year-to-date basis in 2019 as compared to 2018.

Data processing expenses increased on both a comparative quarterly and year-to-date basis in 2019 as compared to 2018.  These increases were due primarily to several new products or services implemented in 2019 as well as increases in mobile-banking related costs (due to higher usage) and certain software licensing costs (due principally to more users).

Interchange expense primarily represents our third-party cost to process debit card transactions.  This cost increased in 2019 on both a comparative quarterly and year-to-date basis as compared to 2018 due principally to an increase in transaction volume.

Loan and collection expenses reflect costs related to new lending activity as well as the management and collection of non-performing loans and other problem credits.  The increased expenses in 2019 as compared to 2018 primarily reflects lower recoveries of previously incurred collection expenses on non-performing and previously charged-off loans.

Total advertising expenses increased in 2019 on both a comparative quarterly and year-to-date basis as compared to 2018 due primarily to an increase in outdoor (billboard) advertising.

The amortization of intangible assets relates to the Merger and prior 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 $5.6 million and $6.4 million at September 30, 2019 and December 31, 2018, respectively. See note #7 to the Condensed Consolidated Financial Statements for a schedule of future amortization of intangible assets.

FDIC deposit insurance expense decreased in 2019 on a comparative quarterly basis and was relatively unchanged on a year-to-date basis. This quarterly decrease is related to the use of our Small Bank Assessment Credit (the “Assessment Credit”).  After the application of the Assessment Credit against the Company’s June 30, 2019 FDIC deposit insurance expense billing, approximately $0.4 million of Assessment Credit remains available to offset future expense.  Absent the use of the Assessment Credit, FDIC deposit insurance expense would be higher in 2019 due primarily to growth in our total assets.

The changes in cost (recoveries) 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.

78
The provision for loss reimbursement on sold loans was an expense of $0.03 million and $0.18 million in the third quarter and first nine months of 2019, respectively, compared to an expense of $0.05 million and $0.08 million in the third quarter and first nine months of 2018, respectively. This provision 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).  The small expense provisions in 2019 and 2018 are primarily due to growth in the balance of loans serviced for investors.  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 $0.85 million and $0.78 million at September 30, 2019 and December 31, 2018, respectively. This reserve is included in accrued expenses and other liabilities in our Condensed Consolidated Statements of Financial Condition.

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 gains in 2018 were primarily related to the sale of several residential properties.

Merger related expenses totaled $0.1 million and $3.4 million for the third quarter and first nine months of 2018, respectively.  These expenses included our investment banking fees, certain accounting and legal costs, various contract termination fees, data processing conversion costs, payments made on officer change-in-control contracts, and employee severance costs.

Other non-interest expenses were relatively unchanged in 2019 on a comparative quarterly basis and increased on a year-to-date basis as compared to 2018 due primarily to an increase in deposit account/debit card fraud costs.

Income tax expense.  We recorded an income tax expense of $3.1 million and $8.0 million in the third quarter and the first nine months of 2019, respectively. This compares to an income tax expense of $2.9 million and $7.0 million in the third quarter and the first nine months of 2018, respectively.

Our actual 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, tax-exempt income from the increase in the cash surrender value on life insurance, and differences in the value of stock awards that vest and stock options that are 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 September 30, 2019 and 2018 and at December 31, 2018, that the realization of substantially all of our deferred tax assets continues to be more likely than not.

79
Financial Condition

Summary.  Our total assets increased by $197.6 million during the first nine months of 2019.  Loans, excluding loans held for sale (“Portfolio Loans”), totaled $2.72 billion at September 30, 2019, an increase of $139.9 million, or 5.4%, from December 31, 2018.  (See “Portfolio Loans and asset quality.”)

Deposits totaled $3.05 billion at September 30, 2019, compared to $2.91 billion at December 31, 2018.  The $138.9 million increase in total deposits during the period is due primarily to growth in reciprocal deposits.

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
                        
September 30, 2019
  
$
434,231
    
$
6,106
    
$
745
    
$
439,592
  
December 31, 2018
    
433,224
      
1,520
      
6,818
      
427,926
  

Securities available for sale increased $11.7 million during the first nine months of 2019.  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 of the first nine months of 2019 or 2018.

80
Sales of securities were as follows (See “Non-interest income.”):

   
Nine months ended
September 30,
  
   
2019
    
2018
  
   
(In thousands)
  
             
Proceeds
  
$
44,305
    
$
31,445
  
                 
Gross gains
  
$
169
    
$
225
  
Gross losses
    
(32
)
    
(126
)
Net impairment charges
    
--
      
-
  
Fair value adjustments
    
167
      
(170
)
Net gains (losses)
  
$
304
    
$
(71
)

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.

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 continue to sell some fixed rate jumbo and other  portfolio mortgage loans in the future.

81
A summary of our Portfolio Loans follows:

   
September 30,
2019
    
December 31,
2018
  
   
(In thousands)
  
Real estate(1)
            
Residential first mortgages
  
$
821,531
    
$
811,719
  
Residential home equity and other junior mortgages
    
173,099
      
177,574
  
Construction and land development
    
220,822
      
180,286
  
Other(2)
    
721,042
      
707,347
  
Consumer
    
451,025
      
379,607
  
Commercial
    
330,073
      
319,058
  
Agricultural
    
4,854
      
6,929
  
Total loans
  
$
2,722,446
    
$
2,582,520
  

(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)

   
September 30,
2019
    
December 31,
2018
  
   
(Dollars in thousands)
  
Non-accrual loans
  
$
7,124
    
$
9,029
  
Loans 90 days or more past due and still accruing interest
    
--
      
5
  
Less - government guaranteed loans
    
(475
)
    
(460
)
Total non-performing loans
    
6,649
      
8,574
  
Other real estate and repossessed assets
    
1,789
      
1,299
  
Total non-performing assets
  
$
8,438
    
$
9,873
  
As a percent of Portfolio Loans
                
Non-performing loans
    
0.24
%
    
0.33
%
Allowance for loan losses
    
0.96
      
0.96
  
Non-performing assets to total assets
    
0.24
      
0.29
  
Allowance for loan losses as a percent of non-performing loans
    
393.26
      
290.27
  


(1)
Excludes loans classified as “troubled debt restructured” that are not past due.

82
Troubled debt restructurings (“TDR”)
   
September 30, 2019
  
   
Commercial
    
Retail (1)
    
Total
  
   
(In thousands)
  
Performing TDR’s
  
$
6,947
    
$
40,873
    
$
47,820
  
Non-performing TDR’s (2)
    
46
      
2,357
(3) 
    
2,403
  
Total
  
$
6,993
    
$
43,230
    
$
50,223
  

   
December 31, 2018
  
   
Commercial
    
Retail (1)
    
Total
  
   
(In thousands)
  
Performing TDR’s
  
$
6,460
    
$
46,627
    
$
53,087
  
Non-performing TDR’s (2)
    
74
      
2,884
(3) 
    
2,958
  
Total
  
$
6,534
    
$
49,511
    
$
56,045
  

(1)
Retail loans include mortgage and installment loan segments.
(2)
Included in non-performing assets 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 $1.9 million during the first nine months of 2019 due principally to a decline in non-performing commercial and mortgage loans. This decline primarily reflects 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 $47.8 million, or 1.8% of total Portfolio Loans, and $53.1 million, or 2.1% of total Portfolio Loans, at September 30, 2019 and December 31, 2018, respectively. The decrease in the amount of performing TDRs in the first nine months of 2019 primarily reflects pay downs and payoffs.

Other real estate and repossessed assets totaled $1.8 million and $1.3 million at September 30, 2019 and December 31, 2018, respectively. This increase is primarily due to the addition of a $0.6 million commercial office building located in Grand Rapids, Michigan during the second quarter of 2019.

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.

83
We had loan net recoveries in both the first nine months of 2019 and 2018 due primarily to recoveries on previously charged-off commercial loans.  The following tables reflect activity in and the allocation of the allowance for loan losses (“AFLL”).

Allowance for loan losses
   
Nine months ended
September 30,
  
   
2019
    
2018
  
   
Loans
    
Unfunded
Commitments
    
Loans
    
Unfunded
Commitments
  
   
(Dollars in thousands)
  
Balance at beginning of period
  
$
24,888
    
$
1,296
    
$
22,587
    
$
1,125
  
Additions (deductions)
                                
Provision for loan losses
    
1,045
      
-
      
912
      
-
  
Recoveries credited to allowance
    
3,109
      
-
      
3,768
      
-
  
Loans charged against the allowance
    
(2,894
)
    
-
      
(2,866
)
    
-
  
Additions included in non-interest expense
    
-
      
341
      
-
      
(6
)
Balance at end of period
  
$
26,148
    
$
1,637
    
$
24,401
    
$
1,119
  
 
                                
Net loans charged against the allowance to average Portfolio Loans
    
(0.01
)%
            
(0.04
)%
        

Allocation of the Allowance for Loan Losses
   
September 30,
2019
    
December 31,
2018
  
   
(In thousands)
  
Specific allocations
  
$
5,779
    
$
6,310
  
Other adversely rated commercial loans
    
3,022
      
1,861
  
Historical loss allocations
    
8,752
      
7,792
  
Additional allocations based on subjective factors
    
8,595
      
8,925
  
Total
  
$
26,148
    
$
24,888
  

Some loans will not be repaid in full. Therefore, an 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 AFLL increased $1.3 million to $26.1 million at September 30, 2019 from $24.9 million at December 31, 2018 and was equal to 0.96% of total Portfolio Loans at both September 30, 2019 and December 31, 2018, respectively.

During the first quarter of 2019, we deployed a third-party software solution (we previously used spreadsheet software) to assist in the determination of our AFLL.  This new third-party software will also assist us in moving to the expected loss framework that is required to be implemented on January 1, 2020.  Although the use of this new third-party software did not have any material impact on our overall AFLL, it did result in some classification shifts from the AFLL related to subjective factors into the AFLL related to historical losses as the new software model allowed us to capture longer historical look-back periods (previously this was being captured in the subjective portion of the AFLL).

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Two of the four components of the AFLL outlined above increased during the first nine months of 2019. The AFLL related to specific loans decreased $0.5 million during the first nine months of 2019 due primarily to a $4.9 million decline in the amount of such loans.  The AFLL related to other adversely rated commercial loans increased $1.2 million during the first nine months of 2019, primarily due to an increase in the balance of such loans included in this component to $67.2 million at September 30, 2019 from $44.7 million at December 31, 2018.  The increase in other adversely rated commercial loans was primarily in early watch credit categories and these loans are largely performing.  We do not believe that we will experience any significant loan losses as a result of this rise in other adversely rated commercial loans.  The AFLL related to historical losses increased $1.0 million during the first nine months of 2019, and the AFLL related to subjective factors decreased $0.3 million during the first nine months of 2019, due in part to the classification shifts discussed above, as well as loan growth, for the AFLL related to historical losses.

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 $3.05 billion and $2.91 billion at September 30, 2019 and December 31, 2018, respectively.  The $138.9 million increase in deposits during the first nine months of 2019 is primarily due to growth in reciprocal deposits.  Reciprocal deposits totaled $416.2 million and $182.1 million at September 30, 2019 and December 31, 2018, 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.  The significant increase in reciprocal deposits is due in part to an automated sweep product that we introduced in mid-2018 as well as the marketing and sales efforts of our treasury management team.

We cannot be sure that we will be able to maintain our current level of core deposits. In particular, those deposits that are uninsured may be susceptible to outflow. At September 30, 2019, we had approximately $554.3 million of uninsured deposits. A reduction in core deposits would likely increase our need to rely on wholesale funding sources.

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.

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Other borrowings, comprised primarily of advances from the FHLB and federal funds sold, totaled $64.0 million and $25.7 million at September 30, 2019 and December 31, 2018, respectively.
 
As described above, we utilize wholesale funding, including federal funds purchased, FHLB borrowings and Brokered CDs to augment our core deposits and fund a portion of our assets. At September 30, 2019, our use of such wholesale funding sources (including reciprocal deposits) amounted to approximately $679.9 million, or 21.8% of total funding (deposits and all 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 nine months of 2019 and 2018, we entered into $55.4 million and $16.6 million (aggregate notional amounts), respectively, of interest rate swaps with commercial loan customers, which were offset with interest rate swaps that the Bank entered into with a broker-dealer. We recorded $0.7 million and $0.4 million of fee income related to these transactions during the first nine months of 2019 and 2018, 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).
 
At September 30, 2019, we had $508.1 million of time deposits that mature in the next 12 months. Historically, a majority of these maturing time deposits are renewed by our customers. Additionally, $2.43 billion of our deposits at September 30, 2019, 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.

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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 and our ability to issue Brokered CDs.

We also believe that the available cash on hand at the parent company (including time deposits) of approximately $16.3 million as of September 30, 2019 provides sufficient liquidity resources at the parent company to meet operating expenses, to make interest payments on the subordinated debentures, and to pay projected cash dividends on our common stock.

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

Capitalization
   
September 30,
2019
    
December 31,
2018
  
   
(In thousands)
  
Subordinated debentures
  
$
39,439
    
$
39,388
  
Amount not qualifying as regulatory capital
    
(1,224
)
    
(1,224
)
Amount qualifying as regulatory capital
    
38,215
      
38,164
  
Shareholders’ equity
                
Common stock
    
351,839
      
377,372
  
Accumulated deficit
    
(8,221
)
    
(28,270
)
Accumulated other comprehensive loss
    
(3,373
)
    
(10,108
)
Total shareholders’ equity
    
340,245
      
338,994
  
Total capitalization
  
$
378,460
    
$
377,158
  

We currently have four special purpose entities with $38.2 million of outstanding cumulative trust preferred securities as of September 30, 2019.  These special purpose entities issued common securities and provided cash to our parent company that in turn issued subordinated debentures to these special purpose entities equal to the trust preferred securities and common securities. The subordinated debentures represent the sole asset of the special purpose entities. The common securities and subordinated debentures are included in our Condensed Consolidated Statements of Financial Condition.

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The FRB has issued rules regarding trust preferred securities as a component of the Tier 1 capital of bank holding companies. The aggregate amount of trust preferred securities (and certain other capital elements) are limited to 25 percent of Tier 1 capital elements, net of goodwill (net of any associated deferred tax liability). The amount of trust preferred securities and certain other elements in excess of the limit can be included in Tier 2 capital, subject to restrictions. At the parent company, all of these securities qualified as Tier 1 capital at September 30, 2019 and December 31, 2018.

Common shareholders’ equity increased to $340.2 million at September 30, 2019, from $339.0 million at December 31, 2018, due primarily to our net income and a decrease in our accumulated other comprehensive loss that were partially offset by share repurchases and cash dividend payments. Our tangible common equity (“TCE”) totaled $306.3 million and $304.3 million, respectively, at those same dates. Our ratio of TCE to tangible assets was 8.71% and 9.17% at September 30, 2019, and December 31, 2018, respectively.  TCE and the ratio of TCE to tangible assets are non-GAAP measures.  TCE represents total common equity less goodwill and other intangible assets.

In December 2018, our Board of Directors authorized a 2019 share repurchase plan.  Under the terms of the original 2019 share repurchase plan, we were authorized to buy back up to 5% of our outstanding common stock.  In June 2019, our Board of Directors supplemented the 2019 share repurchase plan and authorized the repurchase of up to 300,000 additional common shares. The 2019 share repurchase plan is authorized to last through December 31, 2019.  During the first nine months of 2019, the Company repurchased 1,204,688 shares at a weighted average purchase price of $21.82 per share (including 25,000 shares at a weighted average purchase price of $20.09 per share in the third quarter of 2019).

We pay a quarterly cash dividend on our common stock.  These dividends totaled $0.18 per share in each of the first, second and third quarters of 2019 and $0.15 per share in each of the comparable quarters in 2018.    We generally favor a dividend payout ratio between 30% and 50% of net income.

As of September 30, 2019 and December 31, 2018, 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.

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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)
  
September 30, 2019
                        
200 basis point rise
  
$
447,100
      
1.02
%
  
$
125,300
      
1.54
%
100 basis point rise
    
455,900
      
3.00
      
124,800
      
1.13
  
Base-rate scenario
    
442,600
      
-
      
123,400
      
-
  
100 basis point decline
    
387,700
      
(12.40
)
    
119,500
      
(3.16
)
                                 
December 31, 2018
                                
200 basis point rise
  
$
481,100
      
(3.37
)%
  
$
126,200
      
3.27
%
100 basis point rise
    
495,400
      
(0.50
)
    
124,800
      
2.13
  
Base-rate scenario
    
497,900
      
-
      
122,200
      
-
  
100 basis point decline
    
482,800
      
(3.03
)
    
119,600
      
(2.13
)

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

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

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

We utilize fair value measurements to record fair value adjustments to certain financial instruments and to determine fair value disclosures. FASB ASC topic 820 differentiates between those assets and liabilities required to be carried at fair value at every reporting period (“recurring”) and those assets and liabilities that are only required to be adjusted to fair value under certain circumstances (“nonrecurring”). Certain equity securities (at December 31, 2018), securities available for sale, loans held for sale, carried at fair value, 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 fair value 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.

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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 and capitalized mortgage loan servicing rights 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, 2018.

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Item 3.

Quantitative and Qualitative Disclosures about Market Risk

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

Item 4.

Controls and Procedures

(a)
Evaluation of Disclosure Controls and Procedures.

With the participation of management, our chief executive officer and chief financial officer, after evaluating the effectiveness of our disclosure controls and procedures (as defined in Exchange Act Rules 13a – 15(e) and 15d – 15(e)) for the period ended September 30, 2019, have concluded that, as of such date, our disclosure controls and procedures were effective.

(b)
Changes in Internal Controls.

During the quarter ended September 30, 2019, 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, 2018.

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

The Company maintains a Deferred Compensation and Stock Purchase Plan for Non-Employee Directors (the “Plan”) pursuant to which non-employee directors can elect to receive shares of the Company’s common stock in lieu of fees otherwise payable to the director for his or her service as a director.  A director can elect to receive shares on a current basis or to defer receipt of the shares, in which case the shares are issued to a trust to be held for the account of the director and then generally distributed to the director after his or her retirement from the Board.  Pursuant to this Plan, during the third quarter of 2019, the Company issued 722 shares of common stock to non-employee directors on a current basis and 2,065 shares of common stock to the trust for distribution to directors on a deferred basis.  These shares were issued on July 1, 2019 representing aggregate fees of $0.06 million. The shares on a current basis were issued at a price of $21.79 per share and the shares on a deferred basis were issued at a price of $19.61 per share, representing 90% of the fair value of the shares on the credit date.  The price per share was the consolidated closing bid price per share of the Company’s common stock as of the date of issuance, as determined in accordance with NASDAQ Marketplace Rules.  The Company issued the shares pursuant to an exemption from registration under Section 4(2) of the Securities Act of 1933 due to the fact that the issuance of the shares was made on a private basis pursuant to the Plan.

The following table shows certain information relating to repurchases of common stock for the three-months ended September 30, 2019:

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
  
July 2019
    
--
    
$
--
      
--
      
299,298
  
August 2019
    
25,919
      
20.09
      
25,000
      
274,298
  
September 2019
    
--
      
--
      
--
      
274,298
  
Total
    
25,919
    
$
20.09
      
25,000
      
274,298
  

(1)
August includes 919 shares withheld from the shares that would otherwise have been issued to certain officers in order to satisfy tax withholding obligations resulting from the vesting of restricted stock as well as satisfy tax withholding obligations and stock option exercise price resulting from the exercise of stock options.

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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
November 1, 2019
  
By
/s/ Robert N. Shuster
       
Robert N. Shuster, Principal Financial Officer
         
Date
November 1, 2019
  
By
/s/ James J. Twarozynski
       
James J. Twarozynski, Principal Accounting Officer


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