10-Q 1 gabc-2018630x10q.htm 10-Q Document
UNITED STATES
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 June 30, 2018
 
Commission File Number 001-15877
 
German American Bancorp, Inc.
(Exact name of registrant as specified in its charter)
Indiana
 
35-1547518
(State or other jurisdiction of
 
(I.R.S. Employer
incorporation or organization)
 
Identification No.)
 
711 Main Street, Jasper, Indiana 47546
(Address of Principal Executive Offices and Zip Code)
 
Registrant’s telephone number, including area code: (812) 482-1314
 
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
 
YES   x      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 during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).
 
YES   x      NO ¨
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company:
Large accelerated filer x
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.
¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act): 
YES   ¨      NO x
 
Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.
Class
 
Outstanding at August 1, 2018
Common Shares, no par value
 
22,968,078


CAUTION REGARDING FORWARD-LOOKING STATEMENTS AND ASSOCIATED RISKS
 
Information included in or incorporated by reference in this Quarterly Report on Form 10-Q, our other filings with the Securities and Exchange Commission (the “SEC”) and our press releases or other public statements, contains or may contain “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995. Please refer to the discussions of our forward-looking statements and associated risks in our Annual Report on Form 10-K for the year ended December 31, 2017, in Item 1, “Business – Forward-Looking Statements and Associated Risks” and our discussion of risk factors in Item 1A, “Risk Factors” of that Annual Report on Form 10-K, as updated from time to time in our subsequent SEC filings, including by Item 2 of Part I of this Report (“Management’s Discussion and Analysis of Financial Condition and Results of Operations”) at the conclusion of that Item 2 under the heading “Forward-Looking Statements and Associated Risks.”

2

*****
 
INDEX
 
PART I.            FINANCIAL INFORMATION
 
 
 
Item 1.
Unaudited Financial Statements
 
 
 
 
Consolidated Balance Sheets – June 30, 2018 and December 31, 2017
 
 
 
 
Consolidated Statements of Income – Three Months Ended June 30, 2018 and 2017
 
 
 
 
Consolidated Statements of Income – Six Months Ended June 30, 2017 and 2016
 
 
 
 
Consolidated Statements of Comprehensive Income – Three and Six Months Ended June 30, 2018 and 2017
 
 
 
 
Consolidated Statements of Cash Flows – Six Months Ended June 30, 2018 and 2017
 
 
 
 
Notes to Consolidated Financial Statements – June 30, 2018
 
 
 
Item 2.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
 
 
 
Item 3.
Quantitative and Qualitative Disclosures About Market Risk
 
 
 
Item 4. 
Controls and Procedures
 
 
 
PART II.           OTHER INFORMATION
 
 
 
Item 1.
Legal Proceedings
 
 
 
Item 1A.
Risk Factors
 
 
 
Item 2.
Unregistered Sales of Equity Securities and Use of Proceeds
 
 
 
Item 3.
Defaults Upon Senior Securities
 
 
 
Item 4.
Mine Safety Disclosures
 
 
 
Item 5.
Other Information
 
 
 
Item 6.
Exhibits
 
 
 
SIGNATURES

3

PART  I.         FINANCIAL INFORMATION
Item 1.           Financial Statements
GERMAN AMERICAN BANCORP, INC.
CONSOLIDATED BALANCE SHEETS
(unaudited, dollars in thousands except share and per share data)
 
 
June 30,
2018
 
December 31,
2017
ASSETS
 
 

 
 

Cash and Due from Banks
 
$
60,244

 
$
58,233

Federal Funds Sold and Other Short-term Investments
 
11,038

 
12,126

Cash and Cash Equivalents
 
71,282

 
70,359

 
 
 
 
 
Securities Available-for-Sale, at Fair Value
 
739,481

 
740,641

Other Investments
 
353

 
353

 
 
 
 
 
Loans Held-for-Sale, at Fair Value
 
9,552

 
6,719

 
 
 
 
 
Loans
 
2,321,845

 
2,145,019

Less: Unearned Income
 
(3,335
)
 
(3,381
)
Allowance for Loan Losses
 
(15,637
)
 
(15,694
)
Loans, Net
 
2,302,873

 
2,125,944

 
 
 
 
 
Stock in FHLB of Indianapolis and Other Restricted Stock, at Cost
 
13,048

 
13,048

Premises, Furniture and Equipment, Net
 
66,641

 
54,246

Other Real Estate
 
40

 
54

Goodwill
 
60,913

 
54,058

Intangible Assets
 
5,065

 
2,102

Company Owned Life Insurance
 
46,655

 
46,385

Accrued Interest Receivable and Other Assets
 
28,641

 
30,451

TOTAL ASSETS
 
$
3,344,544

 
$
3,144,360

 
 
 
 
 
LIABILITIES
 
 

 
 

Non-interest-bearing Demand Deposits
 
$
629,724

 
$
606,134

Interest-bearing Demand, Savings, and Money Market Accounts
 
1,611,583

 
1,490,033

Time Deposits
 
360,133

 
387,885

Total Deposits
 
2,601,440

 
2,484,052

 
 
 
 
 
FHLB Advances and Other Borrowings
 
354,803

 
275,216

Accrued Interest Payable and Other Liabilities
 
17,761

 
20,521

TOTAL LIABILITIES
 
2,974,004

 
2,779,789

 
 
 
 
 
SHAREHOLDERS’ EQUITY
 
 

 
 

Preferred Stock, no par value; 500,000 shares authorized, no shares issued
 
—

 
—

Common Stock, no par value, $1 stated value; 45,000,000 shares authorized
 
22,968

 
22,934

Additional Paid-in Capital
 
165,917

 
165,288

Retained Earnings
 
194,994

 
178,969

Accumulated Other Comprehensive Loss
 
(13,339
)
 
(2,620
)
TOTAL SHAREHOLDERS’ EQUITY
 
370,540

 
364,571

TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY
 
$
3,344,544

 
$
3,144,360

End of period shares issued and outstanding
 
22,967,898

 
22,934,403






See accompanying notes to consolidated financial statements.

4

GERMAN AMERICAN BANCORP, INC.
CONSOLIDATED STATEMENTS OF INCOME
(unaudited, dollars in thousands except per share data)
 

Three Months Ended 
June 30,
 

2018

2017
INTEREST INCOME

 


 

Interest and Fees on Loans

$
26,308


$
22,602

Interest on Federal Funds Sold and Other Short-term Investments

54


27

Interest and Dividends on Securities:

 


 

Taxable

2,962


2,702

Non-taxable

2,209


2,070

TOTAL INTEREST INCOME

31,533


27,401








INTEREST EXPENSE

 


 

Interest on Deposits

2,848


1,626

Interest on FHLB Advances and Other Borrowings

1,216


962

TOTAL INTEREST EXPENSE

4,064


2,588








NET INTEREST INCOME

27,469


24,813

Provision for Loan Losses

1,220


350

NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES

26,249


24,463








NON-INTEREST INCOME

 


 

Trust and Investment Product Fees

1,677


1,350

Service Charges on Deposit Accounts

1,643


1,478

Insurance Revenues

1,696


1,744

Company Owned Life Insurance

260


480

Interchange Fee Income

1,714


1,156

Other Operating Income

913


630

Net Gains on Sales of Loans

905


959

Net Gains on Securities

74


—

TOTAL NON-INTEREST INCOME

8,882


7,797








NON-INTEREST EXPENSE

 


 

Salaries and Employee Benefits

12,019


11,460

Occupancy Expense

1,811


1,570

Furniture and Equipment Expense

716


654

FDIC Premiums

238


232

Data Processing Fees

1,398


1,044

Professional Fees

1,361


913

Advertising and Promotion

857


630

Intangible Amortization

306


242

Other Operating Expenses

3,002


2,251

TOTAL NON-INTEREST EXPENSE

21,708


18,996








Income before Income Taxes

13,423


13,264

Income Tax Expense

2,326


3,425

NET INCOME

$
11,097


$
9,839








Basic Earnings per Share

$
0.48


$
0.43

Diluted Earnings per Share

$
0.48


$
0.43








Dividends per Share

$
0.15


$
0.13

 

See accompanying notes to consolidated financial statements.

5

GERMAN AMERICAN BANCORP, INC.
CONSOLIDATED STATEMENTS OF INCOME
(unaudited, dollars in thousands except per share data)
 
 
Six Months Ended
June 30,
 
 
2018
 
2017
INTEREST INCOME
 
 

 
 

Interest and Fees on Loans
 
$
50,258

 
$
44,864

Interest on Federal Funds Sold and Other Short-term Investments
 
110

 
54

Interest and Dividends on Securities:
 


 


Taxable
 
5,960

 
5,421

Non-taxable
 
4,350

 
4,095

TOTAL INTEREST INCOME
 
60,678

 
54,434

 
 
 
 
 
INTEREST EXPENSE
 
 

 
 

Interest on Deposits
 
5,131

 
3,069

Interest on FHLB Advances and Other Borrowings
 
2,468

 
1,827

TOTAL INTEREST EXPENSE
 
7,599

 
4,896

 
 
 
 
 
NET INTEREST INCOME
 
53,079

 
49,538

Provision for Loan Losses
 
1,570

 
850

NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES
 
51,509

 
48,688

 
 
 
 
 
NON-INTEREST INCOME
 
 

 
 

Trust and Investment Product Fees
 
3,450

 
2,593

Service Charges on Deposit Accounts
 
3,114

 
2,962

Insurance Revenues
 
4,626

 
4,384

Company Owned Life Insurance
 
572

 
734

Interchange Fee Income
 
3,196

 
2,179

Other Operating Income
 
1,517

 
1,487

Net Gains on Sales of Loans
 
1,555

 
1,646

Net Gains on Securities
 
344

 
—

TOTAL NON-INTEREST INCOME
 
18,374

 
15,985

 
 
 
 
 
NON-INTEREST EXPENSE
 
 

 
 

Salaries and Employee Benefits
 
24,145

 
22,904

Occupancy Expense
 
3,555

 
3,119

Furniture and Equipment Expense
 
1,381

 
1,287

FDIC Premiums
 
475

 
471

Data Processing Fees
 
2,525

 
2,055

Professional Fees
 
2,232

 
1,716

Advertising and Promotion
 
1,558

 
1,408

Intangible Amortization
 
512

 
495

Other Operating Expenses
 
5,780

 
4,577

TOTAL NON-INTEREST EXPENSE
 
42,163

 
38,032

 
 
 
 
 
Income before Income Taxes
 
27,720

 
26,641

Income Tax Expense
 
4,810

 
7,246

NET INCOME
 
$
22,910

 
$
19,395

 
 
 
 
 
Basic Earnings per Share
 
$
1.00

 
$
0.85

Diluted Earnings per Share
 
$
1.00

 
$
0.85

 
 
 
 
 
Dividends per Share
 
$
0.30

 
$
0.26



See accompanying notes to consolidated financial statements.

6

GERMAN AMERICAN BANCORP, INC.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(unaudited, dollars in thousands)
 
 
 
Three Months Ended
June 30,
 
 
2018
 
2017
 
 
 
 
 
NET INCOME
 
$
11,097

 
$
9,839

 
 
 
 
 
Other Comprehensive Income (Loss):
 
 

 
 

Unrealized Gains (Losses) on Securities:
 
 

 
 

Unrealized Holding Gain (Loss)Arising During the Period
 
(1,840
)
 
10,133

Reclassification Adjustment for Gains Included in Net Income
 
(74
)
 
—

Tax Effect
 
413

 
(3,567
)
Net of Tax
 
(1,501
)
 
6,566

 
 
 
 
 
Total Other Comprehensive Income (Loss)
 
(1,501
)
 
6,566

 
 
 
 
 
COMPREHENSIVE INCOME
 
$
9,596

 
$
16,405

 

 
 




 
 
Six Months Ended
June 30,
 
 
2018
 
2017
 
 
 
 
 
NET INCOME
 
$
22,910

 
$
19,395

 
 
 
 
 
Other Comprehensive Income (Loss):
 
 

 
 

Unrealized Gains (Losses) on Securities:
 
 

 
 

Unrealized Holding Gain (Loss) Arising During the Period
 
(13,292
)
 
16,312

Reclassification Adjustment for Gains Included in Net Income
 
(344
)
 
—

Tax Effect
 
2,917

 
(5,748
)
Net of Tax
 
(10,719
)
 
10,564

 
 
 
 
 
Total Other Comprehensive Income (Loss)
 
(10,719
)
 
10,564

 
 
 
 
 
COMPREHENSIVE INCOME
 
$
12,191

 
$
29,959










See accompanying notes to consolidated financial statements.

7

GERMAN AMERICAN BANCORP, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited, dollars in thousands)
 
 
Six Months Ended 
June 30,
 
 
2018
 
2017
CASH FLOWS FROM OPERATING ACTIVITIES
 
 

 
 

Net Income
 
$
22,910

 
$
19,395

Adjustments to Reconcile Net Income to Net Cash from Operating Activities:
 
 

 
 

Net Amortization on Securities
 
1,793

 
1,669

Depreciation and Amortization
 
2,601

 
2,317

Loans Originated for Sale
 
(65,071
)
 
(57,304
)
Proceeds from Sales of Loans Held-for-Sale
 
63,710

 
64,286

Provision for Loan Losses
 
1,570

 
850

Gain on Sale of Loans, net
 
(1,555
)
 
(1,646
)
Gain on Securities, net
 
(344
)
 
—

Gain on Sales of Other Real Estate and Repossessed Assets
 
(13
)
 
(7
)
Loss (Gain) on Disposition and Donation of Premises and Equipment
 
(36
)
 
2

Increase in Cash Surrender Value of Company Owned Life Insurance
 
(521
)
 
(759
)
Equity Based Compensation
 
562

 
637

Change in Assets and Liabilities:
 
 

 
 

Interest Receivable and Other Assets
 
2,924

 
(196
)
Interest Payable and Other Liabilities
 
90

 
(751
)
Net Cash from Operating Activities
 
28,620

 
28,493

 
 
 
 
 
CASH FLOWS FROM INVESTING ACTIVITIES
 
 

 
 

Proceeds from Maturity of Securities Available-for-Sale
 
37,481

 
40,792

Proceeds from Sales of Securities Available-for-Sale
 
17,515

 
—

Purchase of Securities Available-for-Sale
 
(68,923
)
 
(56,941
)
Purchase of Loans
 
—

 
(59
)
Proceeds from Sales of Loans
 
6,000

 
—

Loans Made to Customers, net of Payments Received
 
(66,922
)
 
(43,297
)
Proceeds from Sales of Other Real Estate
 
54

 
190

Property and Equipment Expenditures
 
(8,862
)
 
(3,302
)
Proceeds from Sales of Property and Equipment
 
40

 
—

Acquire Bank Branches
 
41,392

 
—

Net Cash from Investing Activities
 
(42,225
)
 
(62,617
)
 
 
 
 
 
CASH FLOWS FROM FINANCING ACTIVITIES
 
 

 
 

Change in Deposits
 
(58,239
)
 
13,909

Change in Short-term Borrowings
 
89,640

 
(18,851
)
Advances in Long-term Debt
 
35,000

 
50,000

Repayments of Long-term Debt
 
(45,089
)
 
(25,804
)
Issuance (Retirement) of Common Stock
 
101

 
(29
)
Dividends Paid
 
(6,885
)
 
(5,880
)
Net Cash from Financing Activities
 
14,528

 
13,345

 
 
 
 
 
Net Change in Cash and Cash Equivalents
 
923

 
(20,779
)
Cash and Cash Equivalents at Beginning of Year
 
70,359

 
64,816

Cash and Cash Equivalents at End of Period
 
$
71,282

 
$
44,037

 
 
 
 
 
Cash Paid During the Period for
 
 

 
 

Interest
 
$
7,641

 
$
4,913

Income Taxes
 
2,150

 
7,239

 
 
 
 
 
Supplemental Non Cash Disclosures
 
 

 
 

Loans Transferred to Other Real Estate
 
$
27

 
$
1,230




See accompanying notes to consolidated financial statements.

8

GERMAN AMERICAN BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
June 30, 2018
(unaudited, dollars in thousands except share and per share data)

  
NOTE 1 – Basis of Presentation
 
German American Bancorp, Inc. operates primarily in the banking industry. The accounting and reporting policies of German American Bancorp, Inc. and its subsidiaries (hereinafter collectively referred to as the "Company") conform to U.S. generally accepted accounting principles. Certain information and footnote disclosures normally included in financial statements prepared in accordance with U.S. generally accepted accounting principles have been condensed or omitted. All adjustments which are, in the opinion of management, necessary for a fair presentation of the results for the periods reported have been included in the accompanying unaudited consolidated financial statements, and all such adjustments are of a normal recurring nature. It is suggested that these consolidated financial statements and notes be read in conjunction with the financial statements and notes thereto in the Company's Annual Report on Form 10-K for the year ended December 31, 2017. Certain items included in the prior period financial statements were reclassified to conform to the current presentation. There was no effect on net income or total shareholders' equity based on these reclassifications.

NOTE 2 - Revenue Recognition

In May 2014, the Financial Accounting Standards Board (the "FASB") issued ASU No. 2014-09, Revenue from Contracts with Customers (Topic 606). On January 1, 2018, the Company adopted ASU 2014-09 and all subsequent amendments to the ASU that modified Topic 606. Topic 606 creates a single framework for recognizing revenue from contracts with customers that fall within its scope and revises when it is appropriate to recognize a gain (loss) from the transfer of nonfinancial assets. Since the guidance does not apply to revenue associated with financial instruments, the new guidance did not have a material impact on revenue most closely associated with financial instruments, including interest income and expense. The majority of the Company's revenues are from financial instruments and are not within the scope of Topic 606. The Company completed its overall assessment of revenue streams and related contracts, including service charges on deposit accounts, interchange income, and trust and investment brokerage fees. Based on the assessment, the Company concluded that ASU 2014-09 did not materially change the method in which the Company currently recognizes revenue for these revenue streams. The Company also completed its evaluation of certain costs related to these revenue streams to determine whether certain revenue streams should be reported gross versus net of certain expenses. Based on its evaluation, the Company determined that the classification of certain debit card related costs should change and now be reported as expenses versus contra-revenue. This reclassification change resulted in an immaterial impact to both revenue and expense. The Company adopted ASU 2014-09 and its related amendments utilizing the modified retrospective approach. Since there was no net income impact upon adoption of this guidance, a cumulative adjustment to retained earnings was not deemed necessary. Consistent with the modified retrospective approach, the Company did not adjust prior period amounts for the debit card costs noted above.

A description of the Company's revenue streams accounted for under Topic 606 follows:

Service Charges on Deposit Accounts: The Company earns fees from its deposit customers for transaction-based, account maintenance, and overdraft services. Transaction-based fees, which include services such as stop payment charges and statement rendering, are recognized at the time the transaction is executed (the point in time the Company fills the customer's request). Account maintenance fees, which relate primarily to monthly maintenance, are earned over the course of a month, representing the period over which the Company satisfies the performance obligation. Overdraft fees are recognized at the point in time that the overdraft occurs.

Interchange Fee Income: The Company earns interchange fees from debit/credit cardholder transactions conducted through various payment networks. Interchange fees from cardholder transactions represent a percentage of the underlying transaction value and are recognized daily, concurrently with the transaction processing services provided to the cardholder.

Trust and Investment Product Fees: The Company earns trust and investment brokerage fees from its contracts with trust and brokerage customers to manage assets for investment and/or to transact their accounts. These fees are primarily earned over time as the Company provides the contracted monthly or quarterly services and are generally assessed based on the market value of assets under management at month-end. Fees that are transaction based, including trade execution services, are recognized at the point in time that the transaction is executed (trade date).

Insurance Revenues: The Company earns insurance revenue from commissions derived from the sale of personal and corporate property and casualty insurance products. These commissions are primarily earned over time as the Company provides the contracted insurance product to customers.


9

GERMAN AMERICAN BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
June 30, 2018
(unaudited, dollars in thousands except share and per share data

NOTE 2 - Revenue Recognition (continued)

The following table presents non-interest income, segregated by revenue streams in-scope and out-of-scope of Topic 606, for the three and six months ended June 30, 2018 and 2017. Trust and investment product fees are included in the trust and investment advisory services segment while insurance revenues are included in the insurance segment. All other revenue streams are primarily included in the banking segment.
 
 
Three Months Ended
 
 
June 30,
Non-interest Income
 
2018
 
2017
   In-Scope of Topic 606:
 
 
 
 
      Trust and Investment Product Fees
 
$
1,677

 
$
1,350

      Service Charges on Deposit Accounts
 
1,643

 
1,478

      Insurance Revenues
 
1,696

 
1,744

      Interchange Fee Income
 
1,714

 
1,156

      Other Operating Income
 
442

 
387

   Non-interest Income (in-scope of Topic 606)
 
7,172

 
6,115

   Non-interest Income (out-of-scope of Topic 606)
 
1,710

 
1,682

Total Non-interest Income
 
$
8,882

 
$
7,797


 
 
Six Months Ended
 
 
June 30,
Non-interest Income
 
2018
 
2017
   In-Scope of Topic 606:
 
 
 
 
      Trust and Investment Product Fees
 
$
3,450

 
$
2,593

      Service Charges on Deposit Accounts
 
3,114

 
2,962

      Insurance Revenues
 
4,626

 
4,384

      Interchange Fee Income
 
3,196

 
2,179

      Other Operating Income
 
820

 
731

   Non-interest Income (in-scope of Topic 606)
 
15,206

 
12,849

   Non-interest Income (out-of-scope of Topic 606)
 
3,168

 
3,136

Total Non-interest Income
 
$
18,374

 
$
15,985




10

GERMAN AMERICAN BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
June 30, 2018
(unaudited, dollars in thousands except share and per share data)

NOTE 3 – Per Share Data
 
The computation of Basic Earnings per Share and Diluted Earnings per Share are as follows:
 
 
Three Months Ended 
June 30,
 
 
2018
 
2017
Basic Earnings per Share:
 
 

 
 

Net Income
 
$
11,097

 
$
9,839

Weighted Average Shares Outstanding
 
22,968,178

 
22,929,426

Basic Earnings per Share
 
$
0.48

 
$
0.43

 
 
 
 
 
Diluted Earnings per Share:
 
 

 
 

Net Income
 
$
11,097

 
$
9,839

 
 
 
 
 
Weighted Average Shares Outstanding
 
22,968,178

 
22,929,426

Potentially Dilutive Shares, Net
 
—

 
—

Diluted Weighted Average Shares Outstanding
 
22,968,178

 
22,929,426

Diluted Earnings per Share
 
$
0.48

 
$
0.43

         
For the three months ended June 30, 2018 and 2017, there were no anti-dilutive shares.

 
 
Six Months Ended 
June 30,
 
 
2018
 
2017
Basic Earnings per Share:
 
 

 
 

Net Income
 
$
22,910

 
$
19,395

Weighted Average Shares Outstanding
 
22,954,367

 
22,919,094

Basic Earnings per Share
 
$
1.00

 
$
0.85

 
 
 
 
 
Diluted Earnings per Share:
 
 

 
 

Net Income
 
$
22,910

 
$
19,395

 
 
 
 
 
Weighted Average Shares Outstanding
 
22,954,367

 
22,919,094

Potentially Dilutive Shares, Net
 
—

 
—

Diluted Weighted Average Shares Outstanding
 
22,954,367

 
22,919,094

Diluted Earnings per Share
 
$
1.00

 
$
0.85


For the six months ended June 30, 2018 and 2017, there were no anti-dilutive shares.


11

GERMAN AMERICAN BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
June 30, 2018
(unaudited, dollars in thousands except share and per share data)

NOTE 4 – Securities 

The amortized cost, unrealized gross gains and losses recognized in accumulated other comprehensive income (loss), and fair value of Securities Available-for-Sale at June 30, 2018 and December 31, 2017, were as follows:
Securities Available-for-Sale: 
 
Amortized
Cost
 
Gross
Unrealized
Gains
 
Gross
Unrealized
Losses
 
 Fair
Value
 
 
 

 
 

 
 

 
 

June 30, 2018
 
 

 
 

 
 

 
 

Obligations of State and Political Subdivisions
 
$
277,135

 
$
3,732

 
$
(2,030
)
 
$
278,837

MBS/CMO - Residential
 
478,983

 
57

 
(18,396
)
 
460,644

Total
 
$
756,118

 
$
3,789

 
$
(20,426
)
 
$
739,481

 
 
 
 
 
 
 
 
 
December 31, 2017
 
 

 
 

 
 

 
 

Obligations of State and Political Subdivisions
 
$
267,437

 
$
6,733

 
$
(861
)
 
$
273,309

MBS/CMO - Residential
 
476,205

 
416

 
(9,289
)
 
467,332

Total
 
$
743,642

 
$
7,149

 
$
(10,150
)
 
$
740,641

 
   
All mortgage-backed securities in the above table (identified above and throughout this Note 4 as "MBS/CMO - Residential") are residential mortgage-backed securities and guaranteed by government sponsored entities.

Equity securities that do not have readily determinable fair values are included as "Other Investments" on the Consolidated Balance Sheet, are carried at historical cost and are evaluated for impairment on a periodic basis.  The Company's equity securities consist of one non-controlling investment in a single banking organization at June 30, 2018 and December 31, 2017. The original investment totaled $1,350 and other-than-temporary impairment was previously recorded totaling $997. When a decline in fair value below cost is deemed to be other-than-temporary, the unrealized loss must be recognized as a charge to earnings.

The amortized cost and fair value of securities at June 30, 2018 by contractual maturity are shown below. Expected maturities may differ from contractual maturities because some issuers have the right to call or prepay certain obligations with or without call or prepayment penalties. Mortgage-backed Securities are not due at a single maturity date and are shown separately in the table below.
Securities Available-for-Sale:
 
Amortized
Cost
 
Fair
Value
 
 
 
 
 
Due in one year or less
 
$
2,588

 
$
2,602

Due after one year through five years
 
21,074

 
21,560

Due after five years through ten years
 
75,427

 
76,655

Due after ten years
 
178,046

 
178,020

MBS/CMO - Residential
 
478,983

 
460,644

Total
 
$
756,118

 
$
739,481

  

Proceeds from the Sales of Securities are summarized below:
 
 
Three Months Ended
 
Three Months Ended
 
 
June 30, 2018
 
June 30, 2017
 
 
 
 
 
Proceeds from Sales
 
$
10,220

 
$
—

Gross Gains on Sales
 
74

 
—

Income Taxes on Gross Gains
 
16

 
—


12

GERMAN AMERICAN BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
June 30, 2018
(unaudited, dollars in thousands except share and per share data

NOTE 4 - Securities (continued)

 
 
Six Months Ended
 
Six Months Ended
 
 
June 30, 2018
 
June 30, 2017
 
 
 
 
 
Proceeds from Sales
 
$
17,515

 
$
—

Gross Gains on Sales
 
344

 
—

Income Taxes on Gross Gains
 
73

 
—

    
The carrying value of securities pledged to secure repurchase agreements, public and trust deposits, and for other purposes as required by law was $206,633 and $165,404 as of June 30, 2018 and December 31, 2017, respectively.

Below is a summary of securities with unrealized losses as of June 30, 2018 and December 31, 2017, presented by length of time the securities have been in a continuous unrealized loss position:
 
 
Less than 12 Months
 
12 Months or More
 
Total
June 30, 2018
 
Fair
Value
 
Unrealized
Loss
 
Fair
Value
 
Unrealized
Loss
 
Fair
Value
 
Unrealized
Loss
 
 
 
 
 
 
 
 
 
 
 
 
 
Obligations of State and Political Subdivisions
 
$
71,937

 
$
(1,096
)
 
$
23,735

 
$
(934
)
 
$
95,672

 
$
(2,030
)
MBS/CMO - Residential
 
226,405

 
(6,454
)
 
226,703

 
(11,942
)
 
453,108

 
(18,396
)
Total
 
$
298,342

 
$
(7,550
)
 
$
250,438

 
$
(12,876
)
 
$
548,780

 
$
(20,426
)
 
 
Less than 12 Months
 
12 Months or More
 
Total
December 31, 2017
 
Fair
Value
 
Unrealized
Loss
 
Fair
Value
 
Unrealized
Loss
 
Fair
Value
 
Unrealized
Loss
 
 
 
 
 
 
 
 
 
 
 
 
 
Obligations of State and Political Subdivisions
 
$
33,230

 
$
(237
)
 
$
24,161

 
$
(624
)
 
$
57,391

 
$
(861
)
MBS/CMO - Residential
 
172,354

 
(2,048
)
 
250,520

 
(7,241
)
 
422,874

 
(9,289
)
Total
 
$
205,584

 
$
(2,285
)
 
$
274,681

 
$
(7,865
)
 
$
480,265

 
$
(10,150
)

Securities are written down to fair value when a decline in fair value is not considered temporary. In estimating other-than-temporary losses, management considers many factors, including: (1) the length of time and the extent to which the fair value has been less than cost, (2) the financial condition and near-term prospects of the issuer, (3) whether the market decline was affected by macroeconomic conditions, and (4) whether the Company has the intent to sell the debt security or more likely than not will be required to sell the debt security before its anticipated recovery.  The Company does not intend to sell or expect to be required to sell these securities, and the decline in fair value is largely due to changes in market interest rates. Therefore, the Company does not consider these securities to be other-than-temporarily impaired. All mortgage-backed securities and collateralized mortgage obligations (MBS/CMO - Residential) in the Company’s portfolio are guaranteed by government sponsored entities, are investment grade, and are performing as expected.
 
NOTE 5 – Derivatives

The Company executes interest rate swaps with commercial banking customers to facilitate their respective risk management strategies. The notional amounts of these interest rate swaps and the offsetting counterparty derivative instruments were $86.7 million at June 30, 2018 and $87.8 million at December 31, 2017. These interest rate swaps are simultaneously hedged by offsetting interest rate swaps that the Company executes with a third party, such that the Company minimizes its net risk exposure resulting from such transactions with approved, reputable, independent counterparties with substantially matching terms. The agreements are considered stand alone derivatives and changes in the fair value of derivatives are reported in earnings as non-interest income.  

Credit risk arises from the possible inability of counterparties to meet the terms of their contracts. The Company’s exposure is limited to the replacement value of the contracts rather than the notional, principal or contract amounts. There are provisions in the agreements with the counterparties that allow for certain unsecured credit exposure up to an agreed threshold. Exposures in excess of the agreed thresholds are collateralized. In addition, the Company minimizes credit risk through credit approvals, limits, and monitoring procedures.


13

GERMAN AMERICAN BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
June 30, 2018
(unaudited, dollars in thousands except share and per share data)

NOTE 5 - Derivatives (continued)

The following table reflects the fair value hedges included in the Consolidated Balance Sheets as of:
 
 
June 30, 2018
 
December 31, 2017
 
 
Notional
Amount
 
Fair Value
 
Notional
Amount
 
Fair Value
Included in Other Assets:
 
 

 
 

 
 

 
 

Interest Rate Swaps
 
$
86,739

 
$
2,845

 
$
87,788

 
$
1,564

 
 
 
 
 
 
 
 
 
Included in Other Liabilities:
 
 

 
 

 
 

 
 

Interest Rate Swaps
 
$
86,739

 
$
2,797

 
$
87,788

 
$
1,633


The following table presents the effect of derivative instruments on the Consolidated Statements of Income for the periods presented:
 
 
Three Months Ended
June 30,
 
Six Months Ended
June 30,
 
 
2018
 
2017
 
2018
 
2017
Interest Rate Swaps:
 
 

 
 

 
 
 
 
Included in Other Operating Income
 
$
26

 
$
—

 
$
116

 
$
348


NOTE 6 – Loans
 
Loans were comprised of the following classifications at June 30, 2018 and December 31, 2017: 
 
 
June 30,
2018
 
December 31,
2017
Commercial:
 
 

 
 

Commercial and Industrial Loans and Leases
 
$
518,299

 
$
486,668

Commercial Real Estate Loans
 
986,486

 
926,729

Agricultural Loans
 
352,308

 
333,227

Retail:
 
 

 
 

Home Equity Loans
 
169,456

 
152,187

Consumer Loans
 
71,859

 
67,475

Residential Mortgage Loans
 
223,437

 
178,733

Subtotal
 
2,321,845

 
2,145,019

Less: Unearned Income
 
(3,335
)
 
(3,381
)
Allowance for Loan Losses
 
(15,637
)
 
(15,694
)
Loans, Net
 
$
2,302,873

 
$
2,125,944


As further described in Note 14, during 2018 the Company acquired loans with a fair value of $117,619 as part of a branch acquisition. This was made up of loans with an acquired balance of $120,499, net of $2,880 of fair value discounts at date of acquisition. At June 30, 2018, the remaining carrying amount of such loans totaled $115,713, which is included in the table above. This amount is made up of loans with a remaining balance of $118,517 net of remaining fair value discounts of $2,804. No loans with deteriorated credit quality were acquired as part of the branch acquisition described in Note 14.


14

GERMAN AMERICAN BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
June 30, 2018
(unaudited, dollars in thousands except share and per share data)

NOTE 6 - Loans (continued)

The following tables present the activity in the allowance for loan losses by portfolio class for the three months ended June 30, 2018 and 2017:
June 30, 2018
 
Commercial and Industrial
Loans and Leases
 
Commercial Real Estate Loans
 
Agricultural
Loans
 
Home Equity Loans
 
Consumer Loans
 
Residential Mortgage Loans
 
Unallocated
 
Total
Beginning Balance
 
$
3,603

 
$
4,622

 
$
4,825

 
$
272

 
$
316

 
$
327

 
$
495

 
$
14,460

Provision for Loan Losses
 
(44
)
 
335

 
753

 
86

 
107

 
19

 
(36
)
 
1,220

Recoveries
 
4

 
5

 
—

 
8

 
68

 
29

 
—

 
114

Loans Charged-off
 
—

 
(4
)
 
—

 
—

 
(144
)
 
(9
)
 
—

 
(157
)
Ending Balance
 
$
3,563

 
$
4,958

 
$
5,578

 
$
366

 
$
347

 
$
366

 
$
459

 
$
15,637


June 30, 2017
 
Commercial and Industrial
Loans and Leases
 
Commercial Real Estate Loans
 
Agricultural
Loans
 
Home Equity Loans
 
Consumer Loans
 
Residential Mortgage Loans
 
Unallocated
 
Total
Beginning Balance
 
$
3,612

 
$
5,696

 
$
4,361

 
$
299

 
$
244

 
$
348

 
$
606

 
$
15,166

Provision for Loan Losses
 
62

 
(259
)
 
468

 
16

 
54

 
19

 
(10
)
 
350

Recoveries
 
7

 
34

 
—

 
2

 
67

 
8

 
—

 
118

Loans Charged-off
 
(9
)
 
(155
)
 
—

 
(17
)
 
(111
)
 
(22
)
 
—

 
(314
)
Ending Balance
 
$
3,672

 
$
5,316

 
$
4,829

 
$
300

 
$
254

 
$
353

 
$
596

 
$
15,320


The following tables present the activity in the allowance for loan losses by portfolio class for the six months ended June 30, 2018 and 2017:
June 30, 2018
 
Commercial and Industrial
Loans and Leases
 
Commercial Real Estate Loans
 
Agricultural
Loans
 
Home Equity Loans
 
Consumer Loans
 
Residential Mortgage Loans
 
Unallocated
 
Total
Beginning Balance
 
$
4,735

 
$
4,591

 
$
4,894

 
$
330

 
$
298

 
$
343

 
$
503

 
$
15,694

Provision for Loan Losses
 
323

 
360

 
684

 
42

 
204

 
1

 
(44
)
 
1,570

Recoveries
 
5

 
11

 
—

 
10

 
157

 
31

 
—

 
214

Loans Charged-off
 
(1,500
)
 
(4
)
 
—

 
(16
)
 
(312
)
 
(9
)
 
—

 
(1,841
)
Ending Balance
 
$
3,563

 
$
4,958

 
$
5,578

 
$
366

 
$
347

 
$
366

 
$
459

 
$
15,637


June 30, 2017
 
Commercial and Industrial
Loans and Leases
 
Commercial Real Estate Loans
 
Agricultural
Loans
 
Home Equity Loans
 
Consumer Loans
 
Residential Mortgage Loans
 
Unallocated
 
Total
Beginning Balance
 
$
3,725

 
$
5,452

 
$
4,094

 
$
283

 
$
235

 
$
329

 
$
690

 
$
14,808

Provision for Loan Losses
 
(53
)
 
19

 
735

 
33

 
172

 
38

 
(94
)
 
850

Recoveries
 
9

 
39

 
—

 
2

 
127

 
35

 
—

 
212

Loans Charged-off
 
(9
)
 
(194
)
 
—

 
(18
)
 
(280
)
 
(49
)
 
—

 
(550
)
Ending Balance
 
$
3,672

 
$
5,316

 
$
4,829

 
$
300

 
$
254

 
$
353

 
$
596

 
$
15,320


In determining the adequacy of the allowance for loan loss, general allocations are made for pools of loans, including non-classified loans, homogeneous portfolios of consumer and residential real estate loans, and loans within certain industry categories believed to present unique risk of loss. General allocations of the allowance are primarily made based on historical averages for loan losses for these portfolios, judgmentally adjusted for current economic factors and portfolio trends.


15

GERMAN AMERICAN BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
June 30, 2018
(unaudited, dollars in thousands except share and per share data)

NOTE 6 - Loans (continued)

Loan impairment is reported when full repayment under the terms of the loan is not expected. This methodology is used for all loans, including loans acquired with deteriorated credit quality if such loans perform worse than what was expected at the time of acquisition. For purchased loans, the assessment is made at the time of acquisition as well as over the life of the loan. If a loan is impaired, a portion of the allowance is allocated so that the loan is reported net, at the present value of estimated future cash flows using the loan’s existing rate, or at the fair value of collateral if repayment is expected solely from the collateral. Commercial and industrial loans, commercial real estate loans, and agricultural loans are evaluated individually for impairment. Smaller balance homogeneous loans are evaluated for impairment in total. Such loans include real estate loans secured by one-to-four family residences and loans to individuals for household, family and other personal expenditures. Individually evaluated loans on non-accrual are generally considered impaired. Impaired loans, or portions thereof, are charged off when deemed uncollectible.

Specific allocations on impaired loans are determined by comparing the loan balance to the present value of expected cash flows or expected collateral proceeds. Allocations are also applied to categories of loans not considered individually impaired but for which the rate of loss is expected to be greater than historical averages, including non-performing consumer or residential real estate loans. Such allocations are based on past loss experience and information about specific borrower situations and estimated collateral values.

The following tables present the balance in the allowance for loan losses and the recorded investment in loans by portfolio class and based on impairment method as of June 30, 2018 and December 31, 2017:
June 30, 2018
 
Total
 
Commercial and Industrial
Loans and Leases
 
Commercial Real Estate Loans
 
Agricultural Loans
 
Home Equity Loans
 
Consumer Loans
 
Residential Mortgage Loans
 
Unallocated
Allowance for Loan Losses:
 
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 

Ending Allowance Balance Attributable to Loans:
 
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 

Individually Evaluated for Impairment
 
$
1,372

 
$
233

 
$
1,139

 
$
—

 
$
—

 
$
—

 
$
—

 
$
—

Collectively Evaluated for Impairment
 
14,228

 
3,327

 
3,790

 
5,578

 
366

 
347

 
361

 
459

Acquired with Deteriorated Credit Quality
 
37

 
3

 
29

 
—

 
—

 
—

 
5

 
—

Total Ending Allowance Balance
 
$
15,637

 
$
3,563

 
$
4,958

 
$
5,578

 
$
366

 
$
347

 
$
366

 
$
459


 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Loans:
 
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 

Loans Individually Evaluated for Impairment
 
$
9,897

 
$
3,840

 
$
6,057

 
$
—

 
$
—

 
$
—

 
$
—

 
n/m(2)

Loans Collectively Evaluated for Impairment
 
2,313,658

 
515,126

 
977,762

 
355,566

 
170,141

 
72,045

 
223,018

 
n/m(2)

Loans Acquired with Deteriorated Credit Quality
 
7,776

 
783

 
5,174

 
951

 
—

 
—

 
868

 
n/m(2)

Total Ending Loans Balance(1)
 
$
2,331,331

 
$
519,749

 
$
988,993

 
$
356,517

 
$
170,141

 
$
72,045

 
$
223,886

 
n/m(2)

 
 
(1)Total recorded investment in loans includes $9,486 in accrued interest.
(2)n/m = not meaningful

16

GERMAN AMERICAN BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
June 30, 2018
(unaudited, dollars in thousands except share and per share data)

NOTE 6 - Loans (continued)

December 31, 2017
 
Total
 
Commercial and Industrial
Loans and Leases
 
Commercial Real Estate Loans
 
Agricultural Loans
 
Home Equity Loans
 
Consumer Loans
 
Residential Mortgage Loans
 
Unallocated
Allowance for Loan Losses:
 
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 

Ending Allowance Balance Attributable to Loans:
 
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 

Individually Evaluated for Impairment
 
$
2,228

 
$
1,399

 
$
829

 
$
—

 
$
—

 
$
—

 
$
—

 
$
—

Collectively Evaluated for Impairment
 
13,455

 
3,333

 
3,759

 
4,894

 
330

 
298

 
338

 
503

Acquired with Deteriorated Credit Quality
 
11

 
3

 
3

 
—

 
—

 
—

 
5

 
—

Total Ending Allowance Balance
 
$
15,694

 
$
4,735

 
$
4,591

 
$
4,894

 
$
330

 
$
298

 
$
343

 
$
503


 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Loans:
 
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 

Loans Individually Evaluated for Impairment
 
$
11,633

 
$
5,918

 
$
5,552

 
$
163

 
$
—

 
$
—

 
$
—

 
n/m(2)

Loans Collectively Evaluated for Impairment
 
2,133,752

 
481,152

 
917,036

 
336,849

 
152,757

 
67,647

 
178,311

 
n/m(2)

Loans Acquired with Deteriorated Credit Quality
 
9,117

 
988

 
6,452

 
789

 
—

 
—

 
888

 
n/m(2)

Total Ending Loans Balance(1)
 
$
2,154,502

 
$
488,058

 
$
929,040

 
$
337,801

 
$
152,757

 
$
67,647

 
$
179,199

 
n/m(2)

 
(1)Total recorded investment in loans includes $9,483 in accrued interest.
(2)n/m = not meaningful 

The following tables present loans individually evaluated for impairment by class of loans as of June 30, 2018 and December 31, 2017:
June 30, 2018
 
Unpaid Principal Balance(1)
 
 Recorded Investment
 
Allowance for Loan Losses Allocated
With No Related Allowance Recorded:
 
 

 
 

 
 

Commercial and Industrial Loans and Leases
 
$
1,135

 
$
1,139

 
$
—

Commercial Real Estate Loans
 
1,203

 
1,177

 
—

Agricultural Loans
 
663

 
538

 
—

Subtotal
 
3,001

 
2,854

 
—

With An Allowance Recorded:
 
 

 
 

 


Commercial and Industrial Loans and Leases
 
2,923

 
2,706

 
236

Commercial Real Estate Loans
 
5,265

 
5,079

 
1,168

Agricultural Loans
 
—

 
—

 
—

Subtotal
 
8,188

 
7,785

 
1,404

Total
 
$
11,189

 
$
10,639

 
$
1,404

 
 
 
 
 
 
 
Loans Acquired With Deteriorated Credit Quality With No Related Allowance Recorded (Included in the Total Above)
 
$
663

 
$
538

 
$
—

Loans Acquired With Deteriorated Credit Quality With An Additional Allowance Recorded (Included in the Total Above)
 
$
410

 
$
204

 
$
32

   
(1) Unpaid Principal Balance is the remaining contractual principal payments gross of partial charge-offs and discounts.


17

GERMAN AMERICAN BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
June 30, 2018
(unaudited, dollars in thousands except share and per share data)

NOTE 6 - Loans (continued)

December 31, 2017
 
Unpaid Principal Balance(1)
 
 Recorded Investment
 
Allowance for Loan Losses Allocated
With No Related Allowance Recorded:
 
 

 
 

 
 

Commercial and Industrial Loans and Leases
 
$
1,205

 
$
1,166

 
$
—

Commercial Real Estate Loans
 
1,812

 
1,495

 
—

Agricultural Loans
 
919

 
749

 
—

Subtotal
 
3,936

 
3,410

 
—

With An Allowance Recorded:
 
 

 
 

 
 

Commercial and Industrial Loans and Leases
 
4,804

 
4,763

 
1,402

Commercial Real Estate Loans
 
4,489

 
4,465

 
832

Agricultural Loans
 
—

 
—

 
—

Subtotal
 
9,293

 
9,228

 
2,234

Total
 
$
13,229

 
$
12,638

 
$
2,234

 
 
 
 
 
 
 
Loans Acquired With Deteriorated Credit Quality With No Related Allowance Recorded (Included in the Total Above)
 
$
1,255

 
$
797

 
$
—

Loans Acquired With Deteriorated Credit Quality With An Additional Allowance Recorded (Included in the Total Above)
 
$
252

 
$
208

 
$
6

    
(1) Unpaid Principal Balance is the remaining contractual principal payments gross of partial charge-offs and discounts.
 
The following tables present the average balance and related interest income of loans individually evaluated for impairment by class of loans for the three month period ended June 30, 2018 and 2017:
June 30, 2018
 
Average Recorded
Investment
 
Interest Income Recognized
 
Cash Basis
Recognized
With No Related Allowance Recorded:
 
 

 
 

 
 

Commercial and Industrial Loans and Leases
 
$
1,142

 
$
13

 
$
—

Commercial Real Estate Loans
 
1,180

 
13

 
—

Agricultural Loans
 
546

 
—

 
—

Subtotal
 
2,868

 
26

 
—

With An Allowance Recorded:
 
 

 
 

 
 

Commercial and Industrial Loans and Leases
 
2,690

 
1

 
—

Commercial Real Estate Loans
 
5,130

 
6

 
—

Agricultural Loans
 
—

 
—

 
—

Subtotal
 
7,820

 
7

 
—

Total
 
$
10,688

 
$
33

 
$
—

 
 
 
 
 
 
 
Loans Acquired With Deteriorated Credit Quality With No Related Allowance Recorded (Included in the Total Above)
 
$
546

 
$
—

 
$
—

Loans Acquired With Deteriorated Credit Quality With An Additional Allowance Recorded (Included in the Total Above)
 
$
207

 
$
7

 
$
—



18

GERMAN AMERICAN BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
June 30, 2018
(unaudited, dollars in thousands except share and per share data)

NOTE 6 - Loans (continued)

June 30, 2017
 
Average Recorded
Investment
 
Interest Income Recognized
 
Cash Basis
Recognized
With No Related Allowance Recorded:
 
 

 
 

 
 

Commercial and Industrial Loans and Leases
 
$
150

 
$
2

 
$
1

Commercial Real Estate Loans
 
1,124

 
26

 
26

Agricultural Loans
 
496

 
19

 
16

Subtotal
 
1,770

 
47

 
43

With An Allowance Recorded:
 
 

 
 

 
 

Commercial and Industrial Loans and Leases
 
65

 
1

 
—

Commercial Real Estate Loans
 
795

 
4

 
—

Agricultural Loans
 
727

 
—

 
—

Subtotal
 
1,587

 
5

 
—

Total
 
$
3,357

 
$
52

 
$
43

 
 
 
 
 
 
 
Loans Acquired With Deteriorated Credit Quality With No Related Allowance Recorded (Included in the Total Above)
 
$
245

 
$
25

 
$
25

Loans Acquired With Deteriorated Credit Quality With An Additional Allowance Recorded (Included in the Total Above)
 
$
712

 
$
4

 
$
—


The following tables present the average balance and related interest income of loans individually evaluated for impairment by class of loans for the six month period ended June 30, 2018 and 2017:
June 30, 2018
 
Average Recorded
Investment
 
Interest Income Recognized
 
Cash Basis
Recognized
With No Related Allowance Recorded:
 
 

 
 

 
 

Commercial and Industrial Loans and Leases
 
$
1,163

 
$
26

 
$
1

Commercial Real Estate Loans
 
1,294

 
26

 
6

Agricultural Loans
 
623

 
—

 
—

Subtotal
 
3,080

 
52

 
7

With An Allowance Recorded:
 
 

 
 

 
 

Commercial and Industrial Loans and Leases
 
3,487

 
2

 
—

Commercial Real Estate Loans
 
4,876

 
9

 
—

Agricultural Loans
 
—

 
—

 
—

Subtotal
 
8,363

 
11

 
—

Total
 
$
11,443

 
$
63

 
$
7

 
 
 
 
 
 
 
Loans Acquired With Deteriorated Credit Quality With No Related Allowance Recorded (Included in the Total Above)
 
$
548

 
$
—

 
$
—

Loans Acquired With Deteriorated Credit Quality With An Additional Allowance Recorded (Included in the Total Above)
 
$
211

 
$
11

 
$
—


19

GERMAN AMERICAN BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
June 30, 2018
(unaudited, dollars in thousands except share and per share data)

NOTE 6 - Loans (continued)

June 30, 2017
 
Average Recorded
Investment
 
Interest Income Recognized
 
Cash Basis
Recognized
With No Related Allowance Recorded:
 
 

 
 

 
 

Commercial and Industrial Loans and Leases
 
$
83

 
$
2

 
$
2

Commercial Real Estate Loans
 
823

 
30

 
29

Agricultural Loans
 
607

 
24

 
16

Subtotal
 
1,513

 
56

 
47

With An Allowance Recorded:
 
 

 
 

 
 

Commercial and Industrial Loans and Leases
 
84

 
2

 
1

Commercial Real Estate Loans
 
1,609

 
10

 
6

Agricultural Loans
 
612

 
—

 
—

Subtotal
 
2,305

 
12

 
7

Total
 
$
3,818

 
$
68

 
$
54

 
 
 
 
 
 
 
Loans Acquired With Deteriorated Credit Quality With No Related Allowance Recorded (Included in the Total Above)
 
$
311

 
$
25

 
$
25

Loans Acquired With Deteriorated Credit Quality With An Additional Allowance Recorded (Included in the Total Above)
 
$
721

 
$
11

 
$
7


All classes of loans, including loans acquired with deteriorated credit quality, are generally placed on non-accrual status when scheduled principal or interest payments are past due for 90 days or more or when the borrower’s ability to repay becomes doubtful. For purchased loans, the determination is made at the time of acquisition as well as over the life of the loan. Uncollected accrued interest for each class of loans is reversed against income at the time a loan is placed on non-accrual. Interest received on such loans is accounted for on the cash-basis or cost-recovery method, until qualifying for return to accrual. All classes of loans are returned to accrual status when all the principal and interest amounts contractually due are brought current and future payments are reasonably assured. Loans are typically charged-off at 180 days past due, or earlier if deemed uncollectible. Exceptions to the non-accrual and charge-off policies are made when the loan is well secured and in the process of collection.

The following tables present the recorded investment in non-accrual loans and loans past due 90 days or more still on accrual by class of loans as of June 30, 2018 and December 31, 2017:
 
 
Non-Accrual Loans
 
Loans Past Due 90 Days
or More & Still Accruing
 
 
June 30,
 
December 31,
 
June 30,
 
December 31,
 
 
2018
 
2017
 
2018
 
2017
Commercial and Industrial Loans and Leases
 
$
2,701

 
$
4,753

 
$
455

 
$
—

Commercial Real Estate Loans
 
4,966

 
4,618

 
93

 
474

Agricultural Loans
 
538

 
748

 
—

 
268

Home Equity Loans
 
94

 
199

 
—

 
—

Consumer Loans
 
47

 
286

 
—

 
—

Residential Mortgage Loans
 
607

 
487

 
—

 
—

Total
 
$
8,953

 
$
11,091

 
$
548

 
$
742

Loans Acquired With Deteriorated Credit Quality (Included in the Total Above)
 
$
600

 
$
866

 
$
—

 
$
—



20

GERMAN AMERICAN BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
June 30, 2018
(unaudited, dollars in thousands except share and per share data)

NOTE 6 - Loans (continued)

The following tables present the aging of the recorded investment in past due loans by class of loans as of June 30, 2018 and December 31, 2017:
June 30, 2018
 
Total
 
30-59 Days Past Due
 
60-89 Days Past Due
 
90 Days or More Past Due
 
Total
Past Due
 
Loans Not Past Due
Commercial and Industrial Loans and Leases
 
$
519,749

 
$
4,438

 
$
178

 
$
1,073

 
$
5,689

 
$
514,060

Commercial Real Estate Loans
 
988,993

 
485

 
532

 
2,266

 
3,283

 
985,710

Agricultural Loans
 
356,517

 
616

 
1,313

 
—

 
1,929

 
354,588

Home Equity Loans
 
170,141

 
500

 
127

 
94

 
721

 
169,420

Consumer Loans
 
72,045

 
496

 
77

 
47

 
620

 
71,425

Residential Mortgage Loans
 
223,886

 
3,054

 
560

 
407

 
4,021

 
219,865

Total(1)
 
$
2,331,331

 
$
9,589

 
$
2,787

 
$
3,887

 
$
16,263

 
$
2,315,068

Loans Acquired With Deteriorated Credit Quality (Included in the Total Above)
 
$
7,776

 
$
60

 
$
71

 
$
26

 
$
157

 
$
7,619

Loans Acquired in Current Year
      (Included in the Total Above)
 
$
115,960

 
$
106

 
$
17

 
$
—

 
$
123

 
$
115,837

 
(1)Total recorded investment in loans includes $9,486 in accrued interest.

December 31, 2017
 
Total
 
30-59 Days Past Due
 
60-89 Days Past Due
 
90 Days or More Past Due
 
Total
Past Due
 
Loans Not Past Due
Commercial and Industrial Loans and Leases
 
$
488,058

 
$
209

 
$
1,365

 
$
905

 
$
2,479

 
$
485,579

Commercial Real Estate Loans
 
929,040

 
1,229

 
1,650

 
677

 
3,556

 
925,484

Agricultural Loans
 
337,801

 
27

 
—

 
268

 
295

 
337,506

Home Equity Loans
 
152,757

 
366

 
93

 
199

 
658

 
152,099

Consumer Loans
 
67,647

 
246

 
97

 
286

 
629

 
67,018

Residential Mortgage Loans
 
179,199

 
2,850

 
1,247

 
261

 
4,358

 
174,841

Total(1)
 
$
2,154,502

 
$
4,927

 
$
4,452

 
$
2,596

 
$
11,975

 
$
2,142,527

Loans Acquired With Deteriorated Credit Quality (Included in the Total Above)
 
$
9,117

 
$
342

 
$
74

 
$
27

 
$
443

 
$
8,674

 
(1)Total recorded investment in loans includes $9,483 in accrued interest.

Troubled Debt Restructurings:
 
In certain instances, the Company may choose to restructure the contractual terms of loans. A troubled debt restructuring occurs when the Bank grants a concession to the borrower that it would not otherwise consider due to a borrower’s financial difficulty.   In order to determine whether a borrower is experiencing financial difficulty, an evaluation is performed of the probability that the borrower will be in payment default on any of its debt in the foreseeable future without modification. This evaluation is performed under the Company’s internal underwriting policy. The Company uses the same methodology for loans acquired with deteriorated credit quality as for all other loans when determining whether the loan is a troubled debt restructuring.
 
During the three and six months ended June 30, 2018, there were no loans modified as a troubled debt restructuring. During the three months ended June 30, 2017, there was one loan modified as a troubled debt restructuring. During the six months ended June 30, 2017, there was two loans modified as troubled debt restructurings.


21

GERMAN AMERICAN BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
June 30, 2018
(unaudited, dollars in thousands except share and per share data)

NOTE 6 - Loans (continued)

The following tables present the recorded investment of troubled debt restructurings by class of loans as of June 30, 2018 and December 31, 2017:
June 30, 2018
 
Total
 
Performing
 
Non-Accrual(1)
Commercial and Industrial Loans and Leases
 
$
190

 
$
123

 
$
67

Commercial Real Estate Loans
 
—

 
—

 
—

Total
 
$
190

 
$
123

 
$
67

December 31, 2017
 
Total
 
Performing
 
Non-Accrual(1)
Commercial and Industrial Loans and Leases
 
$
258

 
$
125

 
$
133

Commercial Real Estate Loans
 
24

 
24

 
—

Total
 
$
282

 
$
149

 
$
133

 
 
(1)The non-accrual troubled debt restructurings are included in the Non-Accrual Loan table presented on a previous page.
 
The Company had not committed to lending any additional amounts as of June 30, 2018 and December 31, 2017 to customers with outstanding loans that are classified as troubled debt restructurings.

The following tables present loans by class modified as troubled debt restructurings that occurred during the three months ending June 30, 2018 and 2017:
June 30, 2018
 
Number of Loans
 
Pre-Modification Outstanding Recorded Investment
 
Post-Modification Outstanding Recorded Investment
Commercial and Industrial Loans and Leases
 
—

 
$
—

 
$
—

Commercial Real Estate Loans
 
—

 
—

 
—

Total
 
—

 
$
—

 
$
—

       
The troubled debt restructurings described above increased the allowance for loan losses by $0 and resulted in charge-offs of $0 during the three months ending June 30, 2018.
June 30, 2017
 
Number of Loans
 
Pre-Modification Outstanding Recorded Investment
 
Post-Modification Outstanding Recorded Investment
Commercial and Industrial Loans and Leases
 
1

 
$
127

 
$
127

Commercial Real Estate Loans
 
—

 
—

 
—

Total
 
1

 
$
127

 
$
127

         
The troubled debt restructurings described above increased the allowance for loan losses by $8 and resulted in charge-offs of $0 during the three months ending June 30, 2017.

The following tables present loans by class modified as troubled debt restructurings that occurred during the six months ending June 30, 2018 and 2017:
June 30, 2018
 
Number of Loans
 
Pre-Modification Outstanding Recorded Investment
 
Post-Modification Outstanding Recorded Investment
Commercial and Industrial Loans and Leases
 
—

 
$
—

 
$
—

Commercial Real Estate Loans
 
—

 
—

 
—

Total
 
—

 
$
—

 
$
—

       
The troubled debt restructurings described above increased the allowance for loan losses by $0 and resulted in charge-offs of $0 during the six months ending June 30, 2018.

22

GERMAN AMERICAN BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
June 30, 2018
(unaudited, dollars in thousands except share and per share data)

NOTE 6 - Loans (continued)

June 30, 2017
 
Number of Loans
 
Pre-Modification Outstanding Recorded Investment
 
Post-Modification Outstanding Recorded Investment
Commercial and Industrial Loans and Leases
 
1

 
$
127

 
$
127

Commercial Real Estate Loans
 
1

 
28

 
28

Total
 
2

 
$
155

 
$
155

         
The troubled debt restructurings described above increased the allowance for loan losses by $10 and resulted in charge-offs of $0 during the six months ending June 30, 2017.

Additionally, there were no loans modified as troubled debt restructurings for which there was a payment default within twelve months following the modification during the three and six months ending June 30, 2018 and 2017.

A loan is considered to be in payment default once it is 30 days contractually past due under the modified terms.

Credit Quality Indicators:

The Company categorizes loans into risk categories based on relevant information about the ability of borrowers to service their debt such as: current financial information, historical payment experience, credit documentation, public information, and current economic trends, among other factors. The Company classifies loans as to credit risk by individually analyzing loans. This analysis includes commercial and industrial loans, commercial real estate loans, and agricultural loans with an outstanding balance greater than $250. This analysis is typically performed on at least an annual basis. The Company uses the following definitions for risk ratings:
 
Special Mention. Loans classified as special mention have a potential weakness that deserves management’s close attention. If left uncorrected, these potential weaknesses may result in deterioration of the repayment prospects for the loan or of the institution’s credit position at some future date.
 
Substandard. Loans classified as substandard are inadequately protected by the current net worth and paying capacity of the obligor or of the collateral pledged, if any. Loans so classified have a well-defined weakness or weaknesses that jeopardize the liquidation of the debt. They are characterized by the distinct possibility that the institution will sustain some loss if the deficiencies are not corrected.
 
Doubtful. Loans classified as doubtful have all the weaknesses inherent in those classified as substandard, with the added characteristic that the weaknesses make collection or liquidation in full, on the basis of currently existing facts, conditions, and values, highly questionable and improbable.
 
Loans not meeting the criteria above that are analyzed individually as part of the above described process are considered to be pass rated loans. Based on the most recent analysis performed, the risk category of loans by class of loans is as follows:
June 30, 2018
 
Pass
 
Special Mention
 
Substandard
 
Doubtful
 
Total
Commercial and Industrial Loans and Leases
 
$
499,876

 
$
4,247

 
$
15,626

 
$
—

 
$
519,749

Commercial Real Estate Loans
 
960,045

 
14,248

 
14,700

 
—

 
988,993

Agricultural Loans
 
323,339

 
20,427

 
12,751

 
—

 
356,517

Total
 
$
1,783,260

 
$
38,922

 
$
43,077

 
$
—

 
$
1,865,259

Loans Acquired With Deteriorated Credit Quality (Included in the Total Above)
 
$
2,552

 
$
1,597

 
$
2,759

 
$
—

 
$
6,908

Loans Acquired in Current Year
      (Included in the Total Above)
 
$
52,771

 
$
—

 
$
—

 
$
—

 
$
52,771



23

GERMAN AMERICAN BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
June 30, 2018
(unaudited, dollars in thousands except share and per share data)

NOTE 6 - Loans (continued)

December 31, 2017
 
Pass
 
Special Mention
 
Substandard
 
Doubtful
 
Total
Commercial and Industrial Loans and Leases
 
$
462,212

 
$
7,901

 
$
17,945

 
$
—

 
$
488,058

Commercial Real Estate Loans
 
894,027

 
18,037

 
16,976

 
—

 
929,040

Agricultural Loans
 
304,032

 
27,288

 
6,481

 
—

 
337,801

Total
 
$
1,660,271

 
$
53,226

 
$
41,402

 
$
—

 
$
1,754,899

Loans Acquired With Deteriorated Credit Quality (Included in the Total Above)
 
$
2,604

 
$
1,647

 
$
3,978

 
$
—

 
$
8,229

    
The Company considers the performance of the loan portfolio and its impact on the allowance for loan losses. For home equity, consumer and residential mortgage loan classes, the Company also evaluates credit quality based on the aging status of the loan, which was previously presented, and by payment activity.  The following table presents the recorded investment in home equity, consumer and residential mortgage loans based on payment activity as of June 30, 2018 and December 31, 2017:
June 30, 2018
 
Home Equity Loans
 
Consumer Loans
 
Residential Mortgage Loans
Performing
 
$
170,047

 
$
71,998

 
$
223,279

Nonperforming
 
94

 
47

 
607

Total
 
$
170,141

 
$
72,045

 
$
223,886

Loans Acquired With Deteriorated Credit Quality
(Included in the Total Above)
 
$
—

 
$
—

 
$
868


December 31, 2017
 
Home Equity Loans
 
Consumer Loans
 
Residential Mortgage Loans
Performing
 
$
152,558

 
$
67,361

 
$
178,712

Nonperforming
 
199

 
286

 
487

Total
 
$
152,757

 
$
67,647

 
$
179,199

Loans Acquired With Deteriorated Credit Quality
(Included in the Total Above)
 
$
—

 
$
—

 
$
888

 

The Company has 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. The recorded investment of those loans is as follows: 
 
 
June 30, 2018
 
December 31, 2017
 
 
 
 
 
Commercial and Industrial Loans
 
$
783

 
$
988

Commercial Real Estate Loans
 
5,174

 
6,452

Agricultural Loans
 
951

 
789

Residential Mortgage Loans
 
868

 
888

Total
 
$
7,776

 
$
9,117

 
 
 

 
 

Carrying Amount, Net of Allowance
 
$
7,739

 
$
9,106

 

24

GERMAN AMERICAN BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
June 30, 2018
(unaudited, dollars in thousands except share and per share data)

NOTE 6 - Loans (continued)

Accretable yield, or income expected to be collected, is as follows:
 
 
2018
 
2017
 
 
 
 
 
Balance at April 1
 
$
2,739

 
$
2,790

New Loans Purchased
 
—

 
—

Accretion of Income
 
(140
)
 
(240
)
Reclassifications from Non-accretable Difference
 
65

 
155

Charge-off of Accretable Yield
 
(97
)
 
—

Balance at June 30
 
$
2,567

 
$
2,705

    
For those purchased loans disclosed above, the Company did not increase the allowance for loan losses during the three months ended June 30, 2018 and 2017. The Company reversed allowance for loan losses of $3 and $56 during the three months ended June 30, 2018 and 2017.
 
 
2018
 
2017
 
 
 
 
 
Balance at January 1
 
$
2,734

 
$
2,521

New Loans Purchased
 
—

 
—

Accretion of Income
 
(221
)
 
(282
)
Reclassifications from Non-accretable Difference
 
151

 
466

Charge-off of Accretable Yield
 
(97
)
 
—

Balance at June 30
 
$
2,567

 
$
2,705

 
For those purchased loans disclosed above, the Company increased the allowance for loan losses by $30 and $11 during the six months ended June 30, 2018 and 2017. The Company reversed allowance for loan losses of $3 and $56 during the six months ended June 30, 2018 and 2017.
    
The carrying amount of consumer mortgage loans secured by residential real estate properties for which formal foreclosure proceedings are in process according to local requirements of the applicable jurisdiction totaled $0 as of June 30, 2018 and $14 as of December 31, 2017.
   
NOTE 7 – Repurchase Agreements Accounted for as Secured Borrowings

Repurchase agreements are short-term borrowings included in FHLB Advances and Other Borrowings and mature overnight and continuously. Repurchase agreements, which were secured by mortgage-backed securities, totaled $35,039 and $41,499 as of June 30, 2018 and December 31, 2017, respectively. Risk could arise when the collateral pledged to a repurchase agreement declines in fair value. The Company minimizes risk by consistently monitoring the value of the collateral pledged. At the point in time where the collateral has declined in fair value, the Company is required to provide additional collateral based on the value of the underlying securities.

NOTE 8 – Segment Information
 
The Company’s operations include three primary segments: core banking, trust and investment advisory services, and insurance operations. The core banking segment involves attracting deposits from the general public and using such funds to originate consumer, commercial and agricultural, commercial and agricultural real estate, and residential mortgage loans, primarily in the Company’s local markets. The core banking segment also involves the sale of residential mortgage loans in the secondary market. The trust and investment advisory services segment involves providing trust, investment advisory, and brokerage services to customers. The insurance segment offers a full range of personal and corporate property and casualty insurance products, primarily in the Company’s banking subsidiary’s local markets.
 

25

GERMAN AMERICAN BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
June 30, 2018
(unaudited, dollars in thousands except share and per share data)

NOTE 8 - Segment Information (continued)

The core banking segment is comprised by the Company’s banking subsidiary, German American Bank, which operated through 58 banking offices at June 30, 2018. Net interest income from loans and investments funded by deposits and borrowings is the primary revenue for the core-banking segment. The trust and investment advisory services segment’s revenues are comprised primarily of fees generated by the trust operations of the Company's banking subsidiary and by German American Investment Services, Inc. These fees are derived by providing trust, investment advisory, and brokerage services to its customers. The insurance segment primarily consists of German American Insurance, Inc., which provides a full line of personal and corporate insurance products. Commissions derived from the sale of insurance products are the primary source of revenue for the insurance segment.

The following segment financial information has been derived from the internal financial statements of the Company which are used by management to monitor and manage financial performance. The accounting policies of the three segments are the same as those of the Company. The evaluation process for segments does not include holding company income and expense. Holding company amounts are the primary differences between segment amounts and consolidated totals, and are reflected in the column labeled “Other” below, along with amounts to eliminate transactions between segments.
 

Core
Banking

Trust and Investment Advisory Services

Insurance

Other

Consolidated Totals
Three Months Ended

 


 


 


 


 

June 30, 2018

 


 


 





 

Net Interest Income

$
27,672


$
(1
)

$
3


$
(205
)

$
27,469

Net Gains on Sales of Loans

905


—


—


—


905

Net Gains on Securities

74


—


—


—


74

Trust and Investment Product Fees

—


1,677


—


—


1,677

Insurance Revenues

5


2


1,689


—


1,696

Noncash Items:













 

Provision for Loan Losses

1,220


—


—


—


1,220

Depreciation and Amortization

1,316


1


21


64


1,402

Income Tax Expense (Benefit)

2,487


96


13


(270
)

2,326

Segment Profit (Loss)

11,478


269


30


(680
)

11,097

Segment Assets at June 30, 2018

3,346,765


1,886


11,013


(15,120
)

3,344,544

 

 

Core
Banking

Trust and Investment Advisory Services

Insurance

Other

Consolidated Totals
Three Months Ended

 


 


 


 


 

June 30, 2017

 


 


 


 


 

Net Interest Income

$
24,999


$
1


$
2


$
(189
)

$
24,813

Net Gains on Sales of Loans

959


—


—


—


959

Net Gains on Securities

—


—


—


—


—

Trust and Investment Product Fees

1


1,350


—


(1
)

1,350

Insurance Revenues

12


8


1,724


—


1,744

Noncash Items:

 


 


 


 


 

Provision for Loan Losses

350


—


—


—


350

Depreciation and Amortization

1,103


4


19


64


1,190

Income Tax Expense (Benefit)

3,615


49


48


(287
)

3,425

Segment Profit (Loss)

9,791


66


74


(92
)

9,839

Segment Assets at December 31, 2017

3,142,096


1,987


10,078


(9,801
)

3,144,360



26

GERMAN AMERICAN BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
June 30, 2018
(unaudited, dollars in thousands except share and per share data)

NOTE 8 - Segment Information (continued)

 
 
Core
Banking
 
Trust and Investment Advisory Services
 
Insurance
 
Other
 
Consolidated Totals
Six Months Ended
 
 

 
 

 
 

 
 

 
 

June 30, 2018
 
 

 
 

 
 

 
 
 
 

Net Interest Income
 
$
53,462

 
$
2

 
$
5

 
$
(390
)
 
$
53,079

Net Gains on Sales of Loans
 
1,555

 
—

 
—

 
—

 
1,555

Net Gains on Securities
 
344

 
—

 
—

 
—

 
344

Trust and Investment Product Fees
 
2

 
3,448

 
—

 
—

 
3,450

Insurance Revenues
 
6

 
4

 
4,616

 
—

 
4,626

Noncash Items:
 
 
 
 
 
 
 
 
 
 

Provision for Loan Losses
 
1,570

 
—

 
—

 
—

 
1,570

Depreciation and Amortization
 
2,431

 
2

 
40

 
128

 
2,601

Income Tax Expense (Benefit)
 
4,731

 
232

 
334

 
(487
)
 
4,810

Segment Profit (Loss)
 
22,240

 
654

 
969

 
(953
)
 
22,910

Segment Assets at June 30, 2018
 
3,346,765

 
1,886

 
11,013

 
(15,120
)
 
3,344,544


 
 
Core
Banking
 
Trust and Investment Advisory Services
 
Insurance
 
Other
 
Consolidated Totals
Six Months Ended
 
 

 
 

 
 

 
 

 
 

June 30, 2017
 
 

 
 

 
 

 
 
 
 

Net Interest Income
 
$
49,908

 
$
2

 
$
4

 
$
(376
)
 
$
49,538

Net Gains on Sales of Loans
 
1,646

 
—

 
—

 
—

 
1,646

Net Gains on Securities
 
—

 
—

 
—

 
—

 
—

Trust and Investment Product Fees
 
2

 
2,594

 
—

 
(3
)
 
2,593

Insurance Revenues
 
14

 
13

 
4,357

 
—

 
4,384

Noncash Items:
 
 
 
 
 
 
 
 
 
 

Provision for Loan Losses
 
850

 
—

 
—

 
—

 
850

Depreciation and Amortization
 
2,144

 
7

 
38

 
128

 
2,317

Income Tax Expense (Benefit)
 
7,237

 
83

 
475

 
(549
)
 
7,246

Segment Profit (Loss)
 
18,756

 
110

 
747

 
(218
)
 
19,395

Segment Assets at December 31, 2017
 
3,142,096

 
1,987

 
10,078

 
(9,801
)
 
3,144,360


NOTE 9 – Stock Repurchase Plan
 
On April 26, 2001, the Company announced that its Board of Directors approved a stock repurchase program for up to 911,631 of the outstanding shares of common stock of the Company. Shares may be purchased from time to time in the open market and in large block privately negotiated transactions. The Company is not obligated to purchase any shares under the program, and the program may be discontinued at any time before the maximum number of shares specified by the program are purchased. The Board of Directors established no expiration date for this program. As of June 30, 2018, the Company had purchased 502,447 shares under the program. No shares were purchased under the program during the three or six months ended June 30, 2018 and 2017.


27

GERMAN AMERICAN BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
June 30, 2018
(unaudited, dollars in thousands except share and per share data)

NOTE 10 – Equity Plans and Equity Based Compensation
 
The Company maintains three equity incentive plans under which stock options, restricted stock, and other equity incentive awards can be granted. At June 30, 2018, the Company has reserved 386,754 shares of common stock for the purpose of issuance pursuant to outstanding and future grants of options, restricted stock, and other equity awards to officers, directors and other employees of the Company. 
 
For the three and six months ended June 30, 2018 and 2017, the Company granted no options.  The Company recorded no stock compensation expense applicable to options during the three and six months ended June 30, 2018 and 2017 because all outstanding options were fully vested prior to 2007.  In addition, there was no unrecognized option expense. 
 
During the periods presented, awards of long-term incentives were granted in the form of restricted stock.  Awards that were granted to management under a management incentive plan were granted in tandem with cash credit entitlements (typically in the form of 60% restricted stock grants and 40% cash credit entitlements). The management and employee restricted stock grants and tandem cash credit entitlements awarded will vest in three equal installments of 33.3% with the first annual vesting on December 5th of the year of the grant and on December 5th of the next two succeeding years.  Awards that were granted to directors as additional retainer for their services do not include any cash credit entitlement. These director restricted stock grants are subject to forfeiture in the event that the recipient of the grant does not continue in service as a director of the Company through December 5th of the year after grant or does not satisfy certain meeting attendance requirements, at which time they generally vest 100 percent. For measuring compensation costs, restricted stock awards are valued based upon the market value of the common shares on the date of grant. During the three months ended June 30, 2018 and 2017, the Company granted awards of 450 and 210 shares of restricted stock, respectively. During the six months ended June 30, 2018 and 2017, the Company granted awards of 35,310 and 38,100 shares of restricted stock, respectively. Total unvested restricted stock awards at June 30, 2018 and December 31, 2017 were 79,801 and 46,306, respectively.

The following table presents expense recorded for restricted stock and cash entitlements as well as the related tax information for the periods presented:
 

Three Months Ended
June 30,
 

2018

2017







Restricted Stock Expense

$
383


$
342

Cash Entitlement Expense

172


181

Tax Effect

(145
)

(205
)
Net of Tax

$
410


$
318

 
 
Six Months Ended
June 30,
 
 
2018
 
2017
 
 
 
 
 
Restricted Stock Expense
 
$
661

 
$
649

Cash Entitlement Expense
 
342

 
340

Tax Effect
 
(262
)
 
(388
)
Net of Tax
 
$
741

 
$
601

    
Unrecognized expense associated with the restricted stock grants and cash entitlements totaled $2,822 and $2,739 as of June 30, 2018 and 2017, respectively.
 
The Company maintains an Employee Stock Purchase Plan whereby eligible employees have the option to purchase the Company’s common stock at a discount. The purchase price of the shares under this Plan has been set at 95% of the fair market value of the Company’s common stock as of the last day of the plan year. The plan provided for the purchase of up to 750,000 shares of common stock, which the Company may obtain by purchases on the open market or from private sources, or by issuing authorized but unissued common shares. At June 30, 2018, there were 557,203 shares available for future issuance under this plan. Funding for the purchase of common stock is from employee and Company contributions. 

28

GERMAN AMERICAN BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
June 30, 2018
(unaudited, dollars in thousands except share and per share data)

NOTE 10 - Equity Plans and Equity Based Compensation (continued)

There was no expense recorded for the employee stock purchase plan during the three and six months ended June 30, 2018 and 2017. There was no unrecognized compensation expense as of June 30, 2018 and 2017 for the Employee Stock Purchase Plan.
 
NOTE 11 – Fair Value
 
Fair value is the exchange price that would be received for an asset or paid to transfer a liability (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. There are three levels of inputs that may be used to measure fair values:
 
Level 1: Quoted prices (unadjusted) for identical assets or liabilities in active markets that the entity has the ability to access as of the measurement date.
 
Level 2: Significant other observable inputs other than Level 1 prices such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data.

Level 3: Significant unobservable inputs that reflect a reporting entity’s own assumptions about the assumptions that market participants would use in pricing an asset or liability.
 
The Company used the following methods and significant assumptions to estimate the fair value of each type of financial instrument:

Investment Securities and Other Investments: The fair values for investment securities and other investments are determined by quoted market prices, if available (Level 1). For investment securities and other investments where quoted prices are not available, fair values are calculated based on market prices of similar investment securities and other investments (Level 2). For investment securities and other investments where quoted prices or market prices of similar investment securities and other investments are not available, fair values are calculated using discounted cash flows or other market indicators (Level 3). Level 3 pricing is obtained from a third-party based upon similar trades that are not traded frequently without adjustment by the Company. At June 30, 2018, the Company held $5.5 million in Level 3 securities which consist of $5.2 million of non-rated Obligations of State and Political Subdivisions and $353 thousand of equity securities that are not actively traded. Absent the credit rating, significant assumptions must be made such that the credit risk input becomes an unobservable input and thus these investment securities and other investments are reported by the Company in a Level 3 classification.
 
Derivatives: The fair values of derivatives are based on valuation models using observable market data as of the measurement date (Level 2).
 
Impaired Loans: Fair values for impaired collateral dependent loans are generally based on appraisals obtained from licensed real estate appraisers and in certain circumstances includes consideration of offers obtained to purchase properties prior to foreclosure. Appraisals for commercial real estate generally use three methods to derive value: cost, sales or market comparison and income approach. The cost method bases value in the cost to replace the current property. Value of market comparison approach evaluates the sales price of similar properties in the same market area. The income approach considers net operating income generated by the property and an investor's required return. Adjustments are routinely made in the appraisal process by the independent appraisers to adjust for differences between the comparable sales and income data available. Comparable sales adjustments are based on known sales prices of similar type and similar use properties and duration of time that the property has been on the market to sell. Such adjustments made in the appraisal process are typically significant and result in a Level 3 classification of the inputs for determining fair value.
 
Appraisals for both collateral-dependent impaired loans and other real estate owned 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 the Company. Once received, a member of the Company’s Risk Management Area reviews the assumptions and approaches utilized in the appraisal. In determining the value of impaired collateral dependent loans and other real estate owned, significant unobservable inputs may be used which include: physical condition of comparable properties sold, net operating income generated by the property and investor rates of return.
 

29

GERMAN AMERICAN BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
June 30, 2018
(unaudited, dollars in thousands except share and per share data)

NOTE 11 - Fair Value (continued)

Other Real Estate: Nonrecurring adjustments to certain commercial and residential real estate properties classified as other real estate (ORE) are measured at the lower of carrying amount or fair value, less costs to sell. Fair values are generally based on third party appraisals of the property utilizing similar techniques as discussed above for Impaired Loans, resulting in a Level 3 classification. In cases where the carrying amount exceeds the fair value, less costs to sell, impairment loss is recognized.

Loan Servicing Rights: On a quarterly basis, loan servicing rights are evaluated for impairment based upon the fair value of the rights as compared to carrying amount resulting in a Level 2 classification. The valuation model utilizes interest rate, prepayment speed, and default rate assumptions that market participants would use in estimating future net servicing income and that can be validated against available market data.

Loans Held-for-Sale: The fair values of loans held for sale are determined by using quoted prices for similar assets, adjusted for specific attributes of that loan resulting in a Level 2 classification.

Assets and Liabilities Measured on a Recurring Basis
 
Assets and liabilities measured at fair value on a recurring basis, including financial assets and liabilities for which the Company has elected the fair value option, are summarized below:
 
 
Fair Value Measurements at June 30, 2018 Using
 
 
Quoted Prices in Active Markets for Identical Assets (Level 1)
 
Significant Other Observable Inputs (Level 2)
 
Significant
Unobservable Inputs (Level 3)
 
Total
Obligations of State and Political Subdivisions
 
$
—

 
$
273,670

 
$
5,167

 
$
278,837

MBS/CMO - Residential
 
—

 
460,644

 
—

 
460,644

Equity Securities
 
—

 
—

 
353

 
353

Total Securities and Other Investments
 
$
—

 
$
734,314

 
$
5,520

 
$
739,834

 
 
 
 
 
 
 
 
 
Loans Held-for-Sale
 
$
—

 
$
9,552

 
$
—

 
$
9,552

 
 
 
 
 
 
 
 
 
Derivative Assets
 
$
—

 
$
2,845

 
$
—

 
$
2,845

 
 
 
 
 
 
 
 
 
Mortgage Servicing Rights
 
$
—

 
$
1,052

 
$
—

 
$
1,052

 
 
 
 
 
 
 
 
 
Derivative Liabilities
 
$
—

 
$
2,797

 
$
—

 
$
2,797



30

GERMAN AMERICAN BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
June 30, 2018
(unaudited, dollars in thousands except share and per share data)

NOTE 11 - Fair Value (continued)

 
 
Fair Value Measurements at December 31, 2017 Using
 
 
Quoted Prices in Active Markets for Identical Assets (Level 1)
 
Significant Other Observable Inputs (Level 2)
 
Significant
Unobservable  Inputs (Level 3)
 
Total
Obligations of State and Political Subdivisions
 
$
—

 
$
267,660

 
$
5,649

 
$
273,309

MBS/CMO - Residential
 
—

 
467,332

 
—

 
467,332

Equity Securities
 
—

 
—

 
353

 
353

Total Securities and Other Investments
 
$
—

 
$
734,992

 
$
6,002

 
$
740,994

 
 
 
 
 
 
 
 
 
Loans Held-for-Sale
 
$
—

 
$
6,719

 
$
—

 
$
6,719

 
 
 
 
 
 
 
 
 
Derivative Assets
 
$
—

 
$
1,564

 
$
—

 
$
1,564

 
 
 
 
 
 
 
 
 
Mortgage Servicing Rights
 
$
—

 
$
547

 
$
—

 
$
547

 
 
 
 
 
 
 
 
 
Derivative Liabilities
 
$
—

 
$
1,633

 
$
—

 
$
1,633

    
There were no transfers between Level 1 and Level 2 for the periods ended June 30, 2018 and December 31, 2017.
 
At June 30, 2018, the aggregate fair value of the Loans Held-for-Sale was $9,552. Aggregate contractual principal balance was $9,377 with a difference of $175.  At December 31, 2017, the aggregate fair value of the Loans Held-for-Sale was $6,719. Aggregate contractual principal balance was $6,576 with a difference of $143.

The tables below present a reconciliation of all assets measured at fair value on a recurring basis using significant unobservable inputs (Level 3) for the three and six months ended June 30, 2018 and 2017:
 
 
Obligations of State and Political Subdivisions
 
Equity Securities
 
 
2018
 
2017
 
2018
 
2017
 
 
 
 
 
 
 
 
 
Balance of Recurring Level 3 Assets at April 1
 
$
5,171

 
$
6,447

 
$
353

 
$
353

Total Gains or Losses Included in Other Comprehensive Income
 
(4
)
 
17

 
—

 
—

Maturities / Calls
 
—

 
—

 
—

 
—

Purchases
 
—

 
—

 
—

 
—

Balance of Recurring Level 3 Assets at June 30
 
$
5,167

 
$
6,464

 
$
353

 
$
353

 

Obligations of State and Political Subdivisions

Equity Securities
 

2018

2017

2018

2017













Balance of Recurring Level 3 Assets at January 1

$
5,649


$
7,295


$
353


$
353

Total Gains or Losses Included in Other Comprehensive Income

(22
)

34


—


—

Maturities / Calls

(460
)

(865
)

—


—

Purchases

—


—


—


—

Balance of Recurring Level 3 Assets at June 30

$
5,167


$
6,464


$
353


$
353

      
Of the total gain/loss for the three and six months ended June 30, 2018 ($4) and ($22) was attributable to other changes in fair value, respectively. Of the total gain/loss for the three and six months ended June 30, 2017, $17 and $34 was attributable to other changes in fair value, respectively.
 

31

GERMAN AMERICAN BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
June 30, 2018
(unaudited, dollars in thousands except share and per share data)

NOTE 11 - Fair Value (continued)

Assets and Liabilities Measured on a Non-Recurring Basis
 
Assets and liabilities measured at fair value on a non-recurring basis are summarized below:
 
 
Fair Value Measurements at June 30, 2018 Using
 
 
Quoted Prices in Active Markets for Identical Assets (Level 1)
 
Significant Other Observable Inputs (Level 2)
 
Significant Unobservable 
Inputs (Level 3)
 
Total
Assets:
 
 

 
 

 
 

 
 

Impaired Loans
 
 

 
 

 
 

 
 

Commercial and Industrial Loans
 
$
—

 
$
—

 
$
2,468

 
$
2,468

Commercial Real Estate Loans
 
—

 
—

 
3,741

 
3,741

 
 
 
Fair Value Measurements at December 31, 2017 Using
 
 
Quoted Prices in Active Markets for Identical Assets (Level 1)
 
Significant Other Observable Inputs (Level 2)
 
Significant Unobservable 
Inputs (Level 3)
 
Total
Assets:
 
 

 
 

 
 

 
 

Impaired Loans
 
 

 
 

 
 

 
 

Commercial and Industrial Loans
 
$
—

 
$
—

 
$
3,354

 
$
3,354

Commercial Real Estate Loans
 
—

 
—

 
3,438

 
3,438


Impaired loans, which are measured for impairment using the fair value of the collateral for collateral dependent loans, had a carrying amount of $7,581 with a valuation allowance of $1,372, resulting in an increase to the provision for loan losses of $191 for the three months ended June 30, 2018 and a decrease to the provision for loan losses of $856 for the six months ended June 30, 2018. For the three months ended June 30, 2017, impaired loans resulted in a decrease to the provision for loan losses of $273 and an increase to the provision for loan losses of $5 for the six months ended June 30, 2017. Impaired loans, which are measured for impairment using the fair value of the collateral for collateral dependent loans, had a carrying amount of $9,020 with a valuation allowance of $2,228, resulting in an increase to the provision for loan losses of $1,973 for the year ended December 31, 2017.
 
There was no Other Real Estate carried at fair value less costs to sell at June 30, 2018. No charge to earnings was included in the three and six months ended June 30, 2018 and 2017. There was no Other Real Estate carried at fair value less costs to sell at December 31, 2017. No charge to earnings was included in the year ended December 31, 2017.

The following table presents quantitative information about Level 3 fair value measurements for financial instruments measured at fair value on a non-recurring basis at June 30, 2018 and December 31, 2017:
June 30, 2018
 
Fair Value

Valuation Technique(s)

Unobservable Input(s)

Range (Weighted Average)

 








Impaired Loans - Commercial and Industrial Loans
 
$
2,468

 
Sales comparison approach
 
Adjustment for physical condition of comparable properties sold
 
0%-100%
(89%)
Impaired Loans - Commercial Real Estate Loans
 
$
3,741


Sales comparison approach

Adjustment for physical condition of comparable properties sold

17%-76%
(46%)


32

GERMAN AMERICAN BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
June 30, 2018
(unaudited, dollars in thousands except share and per share data)

NOTE 11 - Fair Value (continued)

December 31, 2017
 
Fair Value
 
Valuation Technique(s)
 
Unobservable Input(s)
 
Range (Weighted Average)
 
 
 
 
 
 
 
 
 
Impaired Loans - Commercial and Industrial Loans
 
$
3,354

 
Sales comparison approach
 
Adjustment for physical condition of comparable properties sold
 
0%-95%
(84%)
Impaired Loans - Commercial Real Estate Loans
 
$
3,438

 
Sales comparison approach
 
Adjustment for physical condition of comparable properties sold
 
30%-76%
(47%)
     
The carrying amounts and estimated fair values of the Company’s financial instruments not previously presented are provided in the tables below for the periods ending June 30, 2018 and December 31, 2017. Not all of the Company’s assets and liabilities are considered financial instruments, and therefore are not included in the tables. Because no active market exists for a significant portion of the Company’s financial instruments, fair value estimates were based on subjective judgments, and therefore cannot be determined with precision. In accordance with the adoption of ASU 2016-01, the table below for June 30, 2018, presents the fair values measured using an exit price notion. The fair value of loans as of December 31, 2017 was measured using an entrance price notion.
 
 
 
 
Fair Value Measurements at
June 30, 2018 Using
 
 
Carrying Value
 
Level 1
 
Level 2
 
Level 3
 
Total
Financial Assets:
 
 

 
 

 
 

 
 

 
 

Cash and Short-term Investments
 
$
71,282

 
$
60,244

 
$
11,038

 
$
—

 
$
71,282

Loans, Net
 
2,296,664

 
—

 
—

 
2,259,096

 
2,259,096

FHLB Stock and Other Restricted Stock
 
13,048

 
N/A

 
N/A

 
N/A

 
N/A

Accrued Interest Receivable
 
13,395

 
—

 
3,809

 
9,586

 
13,395

Financial Liabilities:
 
 

 
 

 
 

 
 

 
 

Demand, Savings, and Money Market Deposits
 
(2,241,307
)
 
(2,241,307
)
 
—

 
—

 
(2,241,307
)
Time Deposits
 
(360,133
)
 
—

 
(358,646
)
 
—

 
(358,646
)
Short-term Borrowings
 
(223,139
)
 
—

 
(223,139
)
 
—

 
(223,139
)
Long-term Debt
 
(131,664
)
 
—

 
(118,614
)
 
(8,459
)
 
(127,073
)
Accrued Interest Payable
 
(1,016
)
 
—

 
(940
)
 
(76
)
 
(1,016
)
 
 
 
 
Fair Value Measurements at
December 31, 2017 Using
 
 
Carrying Value
 
Level 1
 
Level 2
 
Level 3
 
Total
Financial Assets:
 
 

 
 

 
 

 
 

 
 

Cash and Short-term Investments
 
$
70,359

 
$
48,467

 
$
16,349

 
$
—

 
$
64,816

Loans, Net
 
2,119,152

 
—

 
—

 
2,120,154

 
2,120,154

FHLB Stock and Other Restricted Stock
 
13,048

 
N/A

 
N/A

 
N/A

 
N/A

Accrued Interest Receivable
 
13,258

 
—

 
3,574

 
9,684

 
13,258

Financial Liabilities:
 
 

 
 

 
 

 
 

 
 

Demand, Savings, and Money Market Deposits
 
(2,096,167
)
 
(1,096,167
)
 
—

 
—

 
(1,096,167
)
Time Deposits
 
(387,885
)
 
—

 
(388,640
)
 
—

 
(388,640
)
Short-term Borrowings
 
(133,499
)
 
—

 
(133,499
)
 
—

 
(133,499
)
Long-term Debt
 
(141,717
)
 
—

 
(129,366
)
 
(11,052
)
 
(140,418
)
Accrued Interest Payable
 
(1,058
)
 
—

 
(1,042
)
 
(16
)
 
(1,058
)
 

33

GERMAN AMERICAN BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
June 30, 2018
(unaudited, dollars in thousands except share and per share data)

NOTE 12 - Other Comprehensive Income (Loss)

The tables below summarize the changes in accumulated other comprehensive income (loss) by component for the three and six months ended June 30, 2018 and 2017, net of tax:
June 30, 2018

Unrealized Gains and Losses on Available-for-Sale Securities

Postretirement Benefit Items

Total










Beginning Balance at April 1, 2018

$
(11,553
)

$
(285
)

$
(11,838
)
Other Comprehensive Income (Loss) Before Reclassification

(1,443
)

—


(1,443
)
Amounts Reclassified from Accumulated Other Comprehensive Income (Loss)

(58
)

—


(58
)
Net Current Period Other Comprehensive Income (Loss)

(1,501
)

—


(1,501
)
Ending Balance at June 30, 2018

$
(13,054
)

$
(285
)

$
(13,339
)

June 30, 2018

Unrealized Gains and Losses on Available-for-Sale Securities

Postretirement Benefit Items

Total










Beginning Balance at January 1, 2018

$
(2,335
)

$
(285
)

$
(2,620
)
Other Comprehensive Income (Loss) Before Reclassification

(10,448
)

—


(10,448
)
Amounts Reclassified from Accumulated Other Comprehensive Income (Loss)

(271
)

—


(271
)
Net Current Period Other Comprehensive Income (Loss)

(10,719
)

—


(10,719
)
Ending Balance at June 30, 2018

$
(13,054
)

$
(285
)

$
(13,339
)

June 30, 2017
 
Unrealized Gains and Losses on Available-for-Sale Securities
 
Postretirement Benefit Items
 
Total
 
 
 
 
 
 
 
Beginning Balance at April 1, 2017
 
$
(2,314
)
 
$
(92
)
 
$
(2,406
)
Other Comprehensive Income (Loss) Before Reclassification
 
6,566

 
—

 
6,566

Amounts Reclassified from Accumulated Other Comprehensive Income (Loss)
 
—

 
—

 
—

Net Current Period Other Comprehensive Income (Loss)
 
6,566

 
—

 
6,566

Ending Balance at June 30, 2017
 
$
4,252

 
$
(92
)
 
$
4,160


34

GERMAN AMERICAN BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
June 30, 2018
(unaudited, dollars in thousands except share and per share data)

NOTE 12 - Other Comprehensive Income (Loss) (continued)

June 30, 2017
 
Unrealized Gains and Losses on Available-for-Sale Securities
 
Postretirement Benefit Items
 
Total
 
 
 
 
 
 
 
Beginning Balance at January 1, 2017
 
$
(6,312
)
 
$
(92
)
 
$
(6,404
)
Other Comprehensive Income (Loss) Before Reclassification
 
10,564

 
—

 
10,564

Amounts Reclassified from Accumulated Other Comprehensive Income (Loss)
 
—

 
—

 
—

Net Current Period Other Comprehensive Income (Loss)
 
10,564

 
—

 
10,564

Ending Balance at June 30, 2017
 
$
4,252

 
$
(92
)
 
$
4,160


The tables below summarize the classifications out of accumulated other comprehensive income (loss) by component for the three and six months ended June 30, 2018 and 2017:
Details about Accumulated Other Comprehensive Income (Loss) Components

Amount Reclassified From Accumulated Other Comprehensive Income (Loss)

Affected Line Item in the Statement Where Net Income is Presented






Unrealized Gains and Losses on Available-for-Sale Securities

$
74


Net Gains on Securities


(16
)

Income Tax Expense
 

58


Net of Tax






Total Reclassifications for the Three Months Ended June 30, 2018

$
58


 

Details about Accumulated Other Comprehensive Income (Loss) Components

Amount Reclassified From Accumulated Other Comprehensive Income (Loss)

Affected Line Item in the Statement Where Net Income is Presented






Unrealized Gains and Losses on Available-for-Sale Securities

$
344


Net Gains on Securities
 

(73
)

Income Tax Expense
 

271


Net of Tax






Total Reclassifications for the Six Months Ended June 30, 2018

$
271


 

Details about Accumulated Other Comprehensive Income (Loss) Components
 
Amount Reclassified From Accumulated Other Comprehensive Income (Loss)
 
Affected Line Item in the Statement Where Net Income is Presented
 
 
 
 
 
Unrealized Gains and Losses on Available-for-Sale Securities
 
$
—

 
Net Gains on Securities
 
 
—

 
Income Tax Expense
 
 
—

 
Net of Tax
 
 
 
 
 
Total Reclassifications for the Three Months Ended June 30, 2017
 
$
—

 
 


35

GERMAN AMERICAN BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
June 30, 2018
(unaudited, dollars in thousands except share and per share data)

NOTE 12 - Other Comprehensive Income (Loss) (continued)

Details about Accumulated Other Comprehensive Income (Loss) Components
 
Amount Reclassified From Accumulated Other Comprehensive Income (Loss)
 
Affected Line Item in the Statement Where Net Income is Presented
 
 
 
 
 
Unrealized Gains and Losses on Available-for-Sale Securities
 
$
—

 
Net Gains on Securities
 
 
—

 
Income Tax Expense
 
 
—

 
Net of Tax
 
 
 
 
 
Total Reclassifications for the Six Months Ended June 30, 2017
 
$
—

 
 

NOTE 13 - Newly Issued Accounting Pronouncements
 
In January 2016, the FASB amended existing guidance (ASU 2016-01, Financial Instruments - Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities) that requires equity investments (except those accounted for under the equity method of accounting, or those that result in consolidation of the investee) to be measured at fair value with changes in fair value recognized in net income. Also, it requires public business entities to use the exit price notion when measuring the fair value of financial instruments for disclosure purposes. It requires separate presentation of financial assets and financial liabilities by measurement category and form of financial asset (i.e., securities or loans and receivables). It eliminates the requirement for public business entities to disclose the method(s) and significant assumptions used to estimate the fair value for financial instruments measured at amortized cost. These amendments are effective for public business entities for fiscal years beginning after December 15, 2017, including interim periods within that reporting period. The Company notes that the impact of adoption is to carry the equity security at fair value or at cost, less impairment when fair value is not readily determinable, with observable price changes being recognized in earnings. The Company adopted ASU 2016-01 on January 1, 2018 and no adjustment to the single equity security was performed upon adoption. Also, upon adoption of ASU 2016-01, this equity security is no longer classified as available-for-sale. For additional information on this equity security, see Note 4 - Securities. Per ASU 2016-01 guidance, the Company reported the fair value of financial instruments based upon an exit price notion for June 30, 2018. For additional information, see Note 11 - Fair Value.

In August 2016, the FASB issued ASU (ASU No. 2016-15, Statement of Cash Flows (Topic 320): Classification of Certain Cash Receipts and Cash Payments) to address the diversity in how certain cash receipts and cash payments are presented and classified in the statement of cash flows including the following:
•
Debt Prepayment or Debt Extinguishment Costs;
•
Settlement of Zero-Coupon Bonds or Debt with Coupon Interest Rates That Are Insignificant in Relation to the Effective Interest Rate;
•
Contingent Consideration payments Made Soon After a Business Combination;
•
Proceeds From the Settlement of Insurance Claims;
•
Proceeds From the Settlement of BOLI and COLI Policies;
•
Distributions Received From Equity Method Investees;
•
Beneficial Interests in Securitization Transactions; and
•
Application of the Predominance Principle.
These amendments are effective for public business entities beginning January 1, 2018. The Company adopted ASU 2016-15 on January 1, 2018 and there was no material impact on the Company's Consolidated Statements of Cash Flows.

In March 2017, the FASB amended existing guidance (ASU No. 2017-07, Compensation - Retirement Benefits (Topic 715)) to improve the presentation of net periodic pension cost and net periodic postretirement benefit cost. The amendments require that an employer report the service cost component in the same line item or items as other compensation costs arising from services rendered by the pertinent employees during the period. The other components of net benefit costs are required to be presented in the income statement separately from the service cost component and outside a subtotal of income from operations, if one is presented. The amendments are effective for public business entities beginning January 1, 2018. The Company adopted ASU 2017-07 on January 1, 2018 and there was no material impact on the Company's Consolidated Statements of Income.


36

GERMAN AMERICAN BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
June 30, 2018
(unaudited, dollars in thousands except share and per share data)

NOTE 13 - Newly Issued Accounting Pronouncements (continued)


In February 2016, the FASB amended existing guidance (ASU No. 2016-02, Leases (Topic 842)) that requires lessees recognize the following for all leases (with the exception of short-term leases) at the commencement date (1) A lease liability, which is a lessee’s obligation to make lease payments arising from a lease, measured on a discounted basis; and (2) A right-of-use asset, which is an asset that represents the lessee’s right to use, or control the use of, a specified asset for the lease term. Under the new guidance, lessor accounting is largely unchanged. Certain targeted improvements were made to align, where necessary, lessor accounting with the lessee accounting model and Topic 606, Revenue from Contracts with Customers. These amendments are effective for public business entities for fiscal years beginning after December 15, 2018, including interim periods within that reporting period. Based on our leases outstanding as of June 30, 2018, the Company does not expect this new guidance to have a material impact on the consolidated results of operation. However as a result of this new guidance, the Company anticipates an estimated increase in its Consolidated Balance Sheet of approximately $6,000. This impact will vary based on the Company's future decisions to enter into new lease agreements or exit/renew current lease agreements prior to the date of implementation.

In June 2016, the FASB issued guidance (ASU No. 2016-13, Financial Instruments - Credit Losses (Topic 326)) to replace the incurred loss model with an expected loss model, which is referred to as the current expected credit loss (CECL) model. The CECL model is applicable to the measurement of credit losses on financial assets measured at amortized cost, including loan receivables, held-to-maturity debt securities, and reinsurance receivables. It also applies to off-balance sheet credit exposures not accounted for as insurance (loan commitments, standby letters of credit, financial guarantees, and other similar instruments) and net investments in leases recognized by a lessor. This standard will be effective for public business entities for fiscal years beginning after December 15, 2019, including interim periods within that reporting period.

The transition to the new standard will be applied as follows:
•
For debt securities with other-than-temporary impairment (OTTI), the guidance will be applied prospectively.
•
Existing purchased credit impaired (PCI) assets will be grandfathered and classified as purchased credit deteriorated (PCD) assets at the date of adoption. The asset will be grossed up for the allowance for expected credit losses for all PCD assets at the date of adoption and will continue to recognize the noncredit discount in interest income based on the yield of such assets as of the adoption date. Subsequent changes in expected credit losses will be recorded through the allowance.
•
For all other assets within the scope of CECL, a cumulative-effect adjustment will be recognized in retained earnings as of the beginning of the first reporting period in which the guidance is effective.

The Company has formed a CECL committee that is assessing data and system needs in order to evaluate the impact of adopting the new guidance. The Company expects to recognize a one-time cumulative adjustment to the allowance for loan losses as of the beginning of the first reporting period in which the new standard is effective, but cannot estimate the amount at this time.

NOTE 14 – Business Combinations

Branch Acquisition
On May 18, 2018, German American Bank completed the acquisition of five branch locations of First Financial Bancorp (formerly branch locations of Mainsource Financial Group, Inc. prior to its merger with First Financial Bancorp on April 1, 2018) and certain related assets, and the assumption by German American Bank of certain related liabilities. Four of the branches are located in Columbus, Indiana, and one in Greensburg, Indiana. At the time of closing, German American Bank acquired approximately $175.3 million in deposits and approximately $117.6 million in loans associated with the five bank branches. The premium paid on deposits by German American Bank was approximately $7.4 million. The premium is subject to adjustment to reflect increases or decreases in the deposit balances during the six month period following the closing date. German American Bank also has the ability, under certain circumstances, to put loans back to First Financial Bancorp’s bank subsidiary during such six month period. The Company accounted for the transaction under the acquisition method of accounting, which means that the acquired assets and liabilities were recorded at fair value at the date of acquisition. The fair value estimates included in these financial statements are based on preliminary valuations. The Company expects that final valuation estimates will be completed during the year ending December 31, 2018.

This branch acquisition was consistent with the Company's strategy to continue building its regional presence in Southern Indiana. The acquisition offers the Company the opportunity to increase profitability by introducing existing products and services to the acquired customer base as well as add new customers in the expanded region.

37

GERMAN AMERICAN BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
June 30, 2018
(unaudited, dollars in thousands except share and per share data)

NOTE 14 - Business Combinations (continued)

In accordance with ASC 805, the Company has expensed approximately $632 of direct acquisition costs and recorded $6.9 million of goodwill and $3.5 million of intangible assets. The intangible assets are related to core deposits and are being amortized over 8 years. For tax purposes, goodwill totaling $6.9 million is tax deductible and will be amortized over 15 years. The following table summarizes the fair value of the total cash received as part of the branch acquisition as well as the fair value of identifiable assets acquired and liabilities assumed as of the effective date of the transaction.
Total Cash Received from First Financial
 
$
40,637

 
 
 
Recognized Amounts of Identifiable Assets Acquired and Liabilities Assumed:
 
 
     Cash
 
$
755

     Loans
 
117,604

     Premises, Furniture & Equipment
 
5,666

     Intangible Assets
 
3,475

     Accrued Interest Receivable and Other Assets
 
780

     Deposits - Non-interest Bearing
 
(39,607
)
     Deposits - Interest Bearing
 
(136,096
)
     Accrued Interest Payable and Other Liabilities
 
(69
)
 
 
 
     Total Identifiable Net Assets
 
$
(47,492
)
 
 
 
Goodwill
 
$
6,855


Pending Bank Acquisition
On May 22, 2018, the Company entered into a definitive agreement to acquire First Security, Inc. ("First Security") through the merger of First Security with and into the Company (the “Merger”). Immediately following completion of the Merger, First Security’s subsidiary bank, First Security Bank, Inc., will be merged with and into the Company’s subsidiary bank, German American Bank. First Security, based in Owensboro, Kentucky, operates 11 retail banking offices through First Security Bank, Inc., in Owensboro, Bowling Green, Franklin and Lexington, Kentucky and in Evansville and Newburgh, Indiana. At March 31, 2018, First Security had total assets of approximately $586 million, total loans of approximately $409 million, and total deposits of approximately $458 million.

Under terms of the definitive agreement, each record holder of First Security common stock (other than shares held by dissenting stockholders and shares held by the First Security, Inc. 401k and Employee Stock Ownership Plan (the "KSOP")) will receive (a) 0.7982 shares of the Company’s common stock in a tax-free exchange for each share of First Security common stock, plus (b) a cash payment of $12.00 for each share of First Security common stock. The KSOP, as a record holder of shares of First Security common stock, will receive, for each share of First Security common stock then held by the KSOP, a cash payment equal to $40.00. Any option to acquire a share of First Security common stock outstanding at the closing of the Merger will be cancelled in exchange for a cash payment equal to (x) $40.00, less (y) the applicable exercise price, and less (z) any withholding taxes. The cash payment per outstanding share (including each KSOP share) and per outstanding option described above are also subject to reduction in the event the "Effective Time Book Value" (as defined in and calculated pursuant to the definitive agreement) of First Security falls below certain thresholds at the time of closing of the Merger.

Based on First Security's number of shares of common stock currently outstanding, the Company expects to issue approximately 2.0 million shares of its common stock, and pay approximately $31 million in cash, in exchange for all of the issued and outstanding shares of common stock of First Security (including those held by the KSOP) and in cancellation of all outstanding options to acquire First Security common stock.

Consummation of the Merger is subject to approval by federal and state banking regulatory authorities, approval by the shareholders of First Security and certain other closing conditions. Assuming such approvals are timely secured, the Company expects that the Merger will be completed effective October 1, 2018.

This pending bank acquisition will be consistent with the Company's strategy to build a regional presence in central and western Kentucky. The acquisition offers the Company the opportunity to increase profitability by introducing existing products and services to the acquired customer base as well as add new customers in the expanded region.

38


Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

GERMAN AMERICAN BANCORP, INC.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
 
German American Bancorp, Inc., is a NASDAQ-traded (symbol: GABC) financial services holding company based in Jasper, Indiana. German American Bancorp, Inc., through its banking subsidiary German American Bank, operates 58 banking offices in 20 contiguous southern Indiana counties and one northern Kentucky county. Prior to April 1, 2018, German American Bank was known as German American Bancorp. The Company also owns an investment brokerage subsidiary (German American Investment Services, Inc.) and a full line property and casualty insurance agency (German American Insurance, Inc.).
 
Throughout this Management’s Discussion and Analysis, as elsewhere in this Report, when we use the term “Company,” we will usually be referring to the business and affairs (financial and otherwise) of German American Bancorp, Inc. and its subsidiaries and affiliates as a whole. Occasionally, we will refer to the term “parent company” or “holding company” when we mean to refer to only German American Bancorp, Inc.

This section presents an analysis of the consolidated financial condition of the Company as of June 30, 2018 and December 31, 2017 and the consolidated results of operations for the three and six months ended June 30, 2018 and 2017. This discussion should be read in conjunction with the consolidated financial statements and other financial data presented elsewhere herein and with the financial statements and other financial data, as well as the Management’s Discussion and Analysis of Financial Condition and Results of Operations, included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2017.

MANAGEMENT OVERVIEW

This updated discussion should be read in conjunction with the Management Overview that was included in our Management’s Discussion and Analysis of Financial Condition and Results of Operations in the Company’s Annual Report on Form 10-K for the year ended December 31, 2017.

Net income for the quarter ended June 30, 2018 totaled $11,097,000, or $0.48 per diluted share, an improvement on a per share basis of 12%, compared to net income of $9,839,000, or $0.43 per diluted share for the quarter ended June 30, 2017. Net income for the first half of 2018 totaled $22,910,000, or $1.00 per diluted share, an increase of 18% on a per share basis, compared to net income of $19,395,000, or $0.85 per diluted share for the six months ended June 30, 2017.

The second quarter and first half of 2018 net income was positively impacted by lower federal income tax rates that became effective January 1, 2018 as a result of the Tax Act (as discussed and defined below). The lower federal income tax rates had a positive impact of approximately $0.06 per share during the second quarter of 2018 and $0.13 per share for the first six months of 2018.

On December 22, 2017, the U.S. government enacted comprehensive tax reform legislation commonly referred to as the Tax Cuts and Jobs Act of 2017 (the “Tax Act”). Among other things, the Tax Act includes significant changes to the U.S. corporate income tax system, including: reducing the federal corporate rate from 35% to 21%; modifying the rules regarding limitations on certain deductions for executive compensation; introducing a capital investment deduction in certain circumstances; placing certain limitations on the interest deduction; and modifying the rules regarding the usability of net operating losses.

On May 18, 2018, German American Bank completed the acquisition of five branch locations of First Financial Bancorp (formerly branch locations of Mainsource Financial Group, Inc. prior to its merger with First Financial Bancorp on April 1, 2018) and certain related assets, and the assumption by German American Bank of certain related liabilities. Four of the branches are located in Columbus, Indiana, and one in Greensburg, Indiana. At the time of closing, German American Bank acquired approximately $175.3 million in deposits and approximately $117.6 million in loans associated with the five bank branches. The premium paid on deposits by German American Bank was approximately $7.4 million. The premium is subject to adjustment to reflect increases or decreases in the deposit balances during the six month period following the closing date. German American Bank also has the ability, under certain circumstances, to put loans back to First Financial Bancorp’s bank subsidiary during such six month period.

On May 22, 2018, the Company entered into a definitive agreement to acquire First Security, Inc. ("First Security") through the merger of First Security with and into the Company (the “Merger”). Immediately following completion of the Merger, First Security’s subsidiary bank, First Security Bank, Inc., will be merged with and into the Company’s subsidiary bank, German American Bank. First Security, based in Owensboro, Kentucky, operates 11 retail banking offices, through First Security Bank, Inc., in Owensboro, Bowling Green, Franklin and Lexington, Kentucky and in Evansville and Newburgh, Indiana. As of March

39


31, 2018, First Security had total assets of approximately $586 million, total loans of approximately $409 million, and total deposits of approximately $458 million.

Based on First Security's number of shares of common stock currently outstanding, the Company expects to issue approximately 2.0 million shares of its common stock, and pay approximately $31 million in cash, in exchange for all of the issued and outstanding shares of common stock of First Security and in cancellation of all outstanding options to acquire First Security common stock.

Consummation of the Merger is subject to approval by federal and state banking regulatory authorities, approval by the shareholders of First Security and certain other closing conditions. Assuming such approvals are timely secured, the Company expects that the Merger will be completed effective October 1, 2018. For further information regarding this pending acquisition, see Note 14 (Business Combinations) in the Notes to the Consolidated Financial Statements included in Item 1 of this Report.

CRITICAL ACCOUNTING POLICIES AND ESTIMATES

The financial condition and results of operations for the Company presented in the Consolidated Financial Statements, accompanying Notes to the Consolidated Financial Statements, and selected financial data appearing elsewhere within this Report, are, to a large degree, dependent upon the Company’s accounting policies. The selection of and application of these policies involve estimates, judgments, and uncertainties that are subject to change. The critical accounting policies and estimates that the Company has determined to be the most susceptible to change in the near term relate to the determination of the allowance for loan losses, the valuation of securities available for sale, income tax expense, and the valuation of goodwill and other intangible assets.

Allowance for Loan Losses

The Company maintains an allowance for loan losses to cover probable incurred credit losses at the balance sheet date. Loan losses are charged against the allowance when management believes the uncollectibility of a loan balance is confirmed. Subsequent recoveries, if any, are credited to the allowance. Allocations of the allowance may be made for specific loans, but the entire allowance is available for any loan that, in management’s judgment, should be charged-off. A provision for loan losses is charged to operations based on management’s periodic evaluation of the necessary allowance balance. Evaluations are conducted at least quarterly and more often if deemed necessary. The ultimate recovery of all loans is susceptible to future market factors beyond the Company’s control.
 
The Company has an established process to determine the adequacy of the allowance for loan losses. The determination of the allowance is inherently subjective, as it requires significant estimates, including the amounts and timing of expected future cash flows on impaired loans, estimated losses on other classified loans and pools of homogeneous loans, and consideration of past loan loss experience, the nature and volume of the portfolio, information about specific borrower situations and estimated collateral values, economic conditions, and other factors, all of which may be susceptible to significant change. The allowance consists of two components of allocations, specific and general. These two components represent the total allowance for loan losses deemed adequate to cover losses inherent in the loan portfolio.
 
Commercial and agricultural loans are subject to a standardized grading process administered by an internal loan review function. The need for specific reserves is considered for credits identified as impaired when: (a) the customer’s cash flow or net worth appears insufficient to repay the loan; (b) the loan has been criticized in a regulatory examination; (c) the loan is on non-accrual; or (d) other reasons where the ultimate collectability of the loan is in question, or the loan characteristics require special monitoring. Specific allowances are established in cases where management has identified significant conditions or circumstances related to an individual credit that we believe indicates the loan is impaired.

Specific allocations on impaired loans are determined by comparing the loan balance to the present value of expected cash flows or expected collateral proceeds. Allocations are also applied to categories of loans not considered individually impaired but for which the rate of loss is expected to be greater than historical averages, including non-performing consumer or residential real estate loans. Such allocations are based on past loss experience and information about specific borrower situations and estimated collateral values.

General allocations are made for commercial and agricultural loans that are graded as substandard based on migration analysis techniques to determine historical average losses for similar types of loans. General allocations are also made for other pools of loans, including non-classified loans, homogeneous portfolios of consumer and residential real estate loans, and loans within certain industry categories believed to present unique risk of loss. General allocations of the allowance are primarily made based on historical averages for loan losses for these portfolios, judgmentally adjusted for economic, external and internal factors and portfolio trends. Economic factors include evaluating changes in international, national, regional and local economic and business conditions that affect the collectability of the loan portfolio. Internal factors include evaluating changes in lending policies and

40


procedures; changes in the nature and volume of the loan portfolio; and changes in experience, ability and depth of lending management and staff. In setting our external and internal factors we also consider the overall level of the allowance for loan losses to total loans; our allowance coverage as compared to similar size bank holding companies; and regulatory requirements.

Due to the imprecise nature of estimating the allowance for loan losses, the Company’s allowance for loan losses includes a minor unallocated component. The unallocated component of the allowance for loan losses incorporates the Company’s judgmental determination of inherent losses that may not be fully reflected in other allocations, including factors such as economic uncertainties, lending staff quality, industry trends impacting specific portfolio segments, and broad portfolio quality trends.  Therefore, the ratio of allocated to unallocated components within the total allowance may fluctuate from period to period.

Securities Valuation
 
Securities available-for-sale are carried at fair value, with unrealized holding gains and losses reported separately in accumulated other comprehensive income (loss), net of tax. The Company obtains market values from a third party on a monthly basis in order to adjust the securities to fair value. Equity securities that do not have readily determinable fair values are carried at cost, less impairment with observable price changes being recognized in earnings. Additionally, when securities are deemed to be other than temporarily impaired, a charge will be recorded through earnings; therefore, future changes in the fair value of securities could have a significant impact on the Company’s operating results. In determining whether a market value decline is other than temporary, management considers the reason for the decline, the extent of the decline, the duration of the decline and whether the Company intends to sell or believes it will be required to sell the securities prior to recovery.  As of June 30, 2018, gross unrealized gains on the securities available-for-sale portfolio totaled approximately $3,789,000 and gross unrealized losses totaled approximately $20,426,000.  

Income Tax Expense
 
Income tax expense involves estimates related to the valuation allowance on deferred tax assets and loss contingencies related to exposure from tax examinations presumed to occur.
 
A valuation allowance reduces deferred tax assets to the amount management believes is more likely than not to be realized. In evaluating the realization of deferred tax assets, management considers the likelihood that sufficient taxable income of appropriate character will be generated within carry-back and carry-forward periods, including consideration of available tax planning strategies. Tax-related loss contingencies, including assessments arising from tax examinations and tax strategies, are recorded as liabilities when the likelihood of loss is probable and an amount or range of loss can be reasonably estimated. In considering the likelihood of loss, management considers the nature of the contingency, the progress of any examination or related protest or appeal, the views of legal counsel and other advisors, experience of the Company or other enterprises in similar matters, if any, and management’s intended response to any assessment.

Goodwill and Other Intangible Assets

Goodwill resulting from business combinations represents the excess of the purchase price over the fair value of the net assets of businesses acquired. Goodwill resulting from business combinations is generally determined as the excess of the fair value of the consideration transferred, plus the fair value of any noncontrolling interests in the acquiree, over the fair value of the net assets acquired and liabilities assumed as of the acquisition date. Goodwill and intangible assets acquired in a purchase business combination and determined to have an indefinite useful life are not amortized, but tested for impairment at least annually. The Company has selected December 31 as the date to perform the annual impairment test. Intangible assets with definite useful lives are amortized over their estimated useful lives to their estimated residual values. Goodwill is the only intangible asset with an indefinite life on the Company’s balance sheet.
 
Other intangible assets consist of core deposit and acquired customer relationship intangible assets. They are initially measured at fair value and then are amortized over their estimated useful lives, which range from 6 to 10 years.

RESULTS OF OPERATIONS

Net Income:

Net income for the quarter ended June 30, 2018 totaled $11,097,000, or $0.48 per share, an increase of 12% on a per share basis compared with the second quarter 2017 net income of $9,839,000, or $0.43 per share. The second quarter of 2018 net income was positively impacted by lower federal income tax rates that became effective January 1, 2018, as a result of the Tax Act. The lower federal income tax rates had a positive impact of approximately $0.06 per share during the second quarter of 2018.

41



Net income for the six months ended June 30, 2018 totaled $22,910,000, or $1.00 per share, an increase of 18% on a per share basis compared with the first half of 2017 net income of $19,395,000, or $0.85 per share. The first half of 2018 net income was positively impacted by approximately $0.13 per share due to the lower federal income tax rates.

Net Interest Income:
 
Net interest income is the Company’s single largest source of earnings, and represents the difference between interest and fees realized on earning assets, less interest paid on deposits and borrowed funds. Several factors contribute to the determination of net interest income and net interest margin, including the volume and mix of earning assets, interest rates, and income taxes. Many factors affecting net interest income are subject to control by management policies and actions. Factors beyond the control of management include the general level of credit and deposit demand, Federal Reserve Board monetary policy, and changes in tax laws.

The following table summarizes net interest income (on a tax-equivalent basis) for the three months ended June 30, 2018 and 2017. For tax-equivalent adjustments, an effective tax rate of 21% was used for the three months ended June 30, 2018 and 35% was used for the three months ended June 30, 2017(1).
 

Average Balance Sheet
(Tax-equivalent basis / dollars in thousands)
 

Three Months Ended
June 30, 2018

Three Months Ended
June 30, 2017
 

Principal Balance

Income / Expense

Yield / Rate

Principal Balance

Income / Expense

Yield / Rate
ASSETS

 


 


 


 


 


 

Federal Funds Sold and Other
Short-term Investments

$
12,939


$
54


1.68
%

$
13,268


$
27


0.79
%
Securities:

 


 


 


 





 

Taxable

475,107


2,962


2.49
%

481,556


2,702


2.24
%
Non-taxable

276,260


2,796


4.05
%

261,798


3,185


4.87
%
Total Loans and Leases(2)

2,229,972


26,394


4.75
%

2,011,518


22,780


4.54
%
TOTAL INTEREST EARNING ASSETS

2,994,278


32,206


4.31
%

2,768,140


28,694


4.15
%
Other Assets

246,589


 


 


218,038


 


 

Less: Allowance for Loan Losses

(14,776
)

 


 


(15,433
)

 


 

TOTAL ASSETS

$
3,226,091


 


 


$
2,970,745


 


 




















LIABILITIES AND SHAREHOLDERS’ EQUITY

 


 


 


 


 


 

Interest-bearing Demand, Savings
and Money Market Deposits

$
1,560,838


$
1,597


0.41
%

$
1,446,994


$
939


0.26
%
Time Deposits

417,585


1,251


1.20
%

360,938


687


0.76
%
FHLB Advances and Other Borrowings

238,775


1,216


2.04
%

233,197


962


1.65
%
TOTAL INTEREST-BEARING LIABILITIES

2,217,198


4,064


0.74
%

2,041,129


2,588


0.51
%
Demand Deposit Accounts

625,158


 


 


560,763


 


 

Other Liabilities

18,538


 


 


21,818


 


 

TOTAL LIABILITIES

2,860,894


 


 


2,623,710


 


 

Shareholders’ Equity

365,197


 


 


347,035


 


 

TOTAL LIBABILITIES AND SHAREHOLDERS' EQUITY

$
3,226,091


 


 


$
2,970,745


 


 




















COST OF FUNDS

 


 


0.54
%

 


 


0.37
%
NET INTEREST INCOME

 


$
28,142





 


$
26,106


 

NET INTEREST MARGIN

 


 


3.77
%

 


 


3.78
%
 
(1) 
Effective tax rates were determined as though interest earned on the Company’s investments in municipal bonds and loans was fully taxable.
(2) 
Loans held-for-sale and non-accruing loans have been included in average loans.

Net interest income increased $2,656,000, or 11%, for the quarter ended June 30, 2018 compared with the same quarter of 2017.  The net interest margin represents tax-equivalent net interest income expressed as a percentage of average earning assets. The tax equivalent net interest margin was 3.77% for the second quarter of 2018 compared to 3.78% during the second quarter of 2017. The tax equivalent yield on earning assets totaled 4.31% during the quarter ended June 30, 2018 compared to 4.15% in the same

42


period of 2017, while the cost of funds (expressed as a percentage of average earning assets) totaled 0.54% during the quarter ended June 30, 2018 compared to 0.37% in the same period of 2017.

The increased level of net interest income during the second quarter of 2018 compared with the second quarter of 2017 was driven primarily by a higher level of average earning assets and an improved net interest margin (excluding the impact of lower federal tax rates on the net interest margin). The increased level of average earning assets in the second quarter of 2018 was driven by organic loan growth from the Company's existing branch footprint combined with growth related to the branch acquisition completed during the quarter.

The net interest margin during the second quarter of 2018 when compared with the second quarter of 2017 was positively impacted by an improvement in loan yields driven by higher short-term market interest rates while a decrease in the amount of accretion on loan discounts on acquired loans, an increase in the cost of funds and the decline in federal income tax rates in 2018 compared with 2017 negatively impacted the net interest margin. Accretion of loan discounts on acquired loans contributed approximately 7 basis points to the net interest margin on an annualized basis in the second quarter of 2018 compared with 10 basis points in the second quarter of 2017. The Company's cost of funds increased approximately 17 basis points in the second quarter of 2018 compared with the second quarter of 2017. The higher cost of funds was largely attributable to an increase in short-term market interest rates over the past several quarters. The lower federal income tax rates during the second quarter of 2018 had an approximately 9 basis point negative impact on the Company's net interest margin and earning asset yield.

The following table summarizes net interest income (on a tax-equivalent basis) for the six months ended June 30, 2018 and 2017. For tax-equivalent adjustments, an effective tax rate of 21% was used for the six months ended June 30, 2018 and 35% was used for the six months ended June 30, 2017(1).
 
 
Average Balance Sheet
(Tax-equivalent basis / dollars in thousands)
 
 
Six Months Ended
June 30, 2018
 
Six Months Ended
June 30, 2017
 
 
Principal Balance
 
Income / Expense
 
Yield / Rate
 
Principal Balance
 
Income / Expense
 
Yield / Rate
ASSETS
 
 

 
 

 
 

 
 

 
 

 
 

Federal Funds Sold and Other
Short-term Investments
 
$
10,760

 
$
110

 
2.06
%
 
$
12,913

 
$
54

 
0.83
%
Securities:
 
 

 
 

 
 

 
 

 
 
 
 

Taxable
 
478,037

 
5,960

 
2.49
%
 
480,720

 
5,421

 
2.26
%
Non-taxable
 
274,435

 
5,507

 
4.01
%
 
256,924

 
6,300

 
4.90
%
Total Loans and Leases(2)
 
2,185,087

 
50,425

 
4.65
%
 
1,993,283

 
45,220

 
4.57
%
TOTAL INTEREST EARNING ASSETS
 
2,948,319

 
62,002

 
4.23
%
 
2,743,840

 
56,995

 
4.18
%
Other Assets
 
240,825

 
 

 
 

 
219,923

 
 

 
 

Less: Allowance for Loan Losses
 
(15,323
)
 
 

 
 

 
(15,220
)
 
 

 
 

TOTAL ASSETS
 
$
3,173,821

 
 

 
 

 
$
2,948,543

 
 

 
 

 
 
 
 
 
 
 
 
 
 
 
 
 
LIABILITIES AND SHAREHOLDERS’ EQUITY
 
 

 
 

 
 

 
 

 
 

 
 

Interest-bearing Demand, Savings
and Money Market Deposits
 
$
1,525,298

 
$
2,872

 
0.38
%
 
$
1,416,341

 
$
1,677

 
0.24
%
Time Deposits
 
408,044

 
2,259

 
1.12
%
 
380,935

 
1,392

 
0.74
%
FHLB Advances and Other Borrowings
 
250,713

 
2,468

 
1.98
%
 
230,009

 
1,827

 
1.60
%
TOTAL INTEREST-BEARING LIABILITIES
 
2,184,055

 
7,599

 
0.70
%
 
2,027,285

 
4,896

 
0.49
%
Demand Deposit Accounts
 
605,405

 
 

 
 

 
559,345

 
 

 
 

Other Liabilities
 
19,969

 
 

 
 

 
20,570

 
 

 
 

TOTAL LIABILITIES
 
2,809,429

 
 

 
 

 
2,607,200

 
 

 
 

Shareholders’ Equity
 
364,392

 
 

 
 

 
341,343

 
 

 
 

TOTAL LIBABILITIES AND SHAREHOLDERS' EQUITY
 
$
3,173,821

 
 

 
 

 
$
2,948,543

 
 

 
 

 
 
 
 
 
 
 
 
 
 
 
 
 
COST OF FUNDS
 
 

 
 

 
0.52
%
 
 

 
 

 
0.36
%
NET INTEREST INCOME
 
 

 
$
54,403

 
 
 
 

 
$
52,099

 
 

NET INTEREST MARGIN
 
 

 
 

 
3.71
%
 
 

 
 

 
3.82
%
   
(1) 
Effective tax rates were determined as though interest earned on the Company’s investments in municipal bonds and loans was fully taxable.
(2) 
Loans held-for-sale and non-accruing loans have been included in average loans.

43


Net interest income increased $3,541,000, or 7%, for the six months ended June 30, 2018 compared with the same period of 2017.  The increased level of net interest income during the first half of 2018 compared with the first half of 2017 was driven primarily by a higher level of average earning assets and an improved net interest margin (excluding the impact of lower federal tax rates on the net interest margin). The increased level of average earning assets during 2018 was largely driven by organic loan growth from the Company's existing branch footprint and to a lesser degree from growth related to the branch acquisition completed during the second quarter.

The tax equivalent net interest margin was 3.71% for the first six months of 2018 compared to 3.82% during the same period of 2017. The tax equivalent yield on earning assets totaled 4.23% during the six months ended June 30, 2018 compared to 4.18% in the same period of 2017, while the cost of funds (expressed as a percentage of average earning assets) totaled 0.52% during the six months ended June 30, 2018 compared to 0.36% in the same period of 2017. The increased yield on earning assets and the increase in the cost of funds during 2018 were both impacted by increased short-term market interest rates.

Accretion of loan discounts on acquired loans contributed approximately 5 basis points to the net interest margin on an annualized basis in the first half of 2018 and 14 basis points in the same period of 2017. The lower federal income tax rates during the first half of 2018 had an approximately 9 basis point negative impact on the Company's net interest margin and earning asset yield.

Provision for Loan Losses:

The Company provides for loan losses through regular provisions to the allowance for loan losses. The provision is affected by net charge-offs on loans and changes in specific and general allocations of the allowance. During the quarter ended June 30, 2018, the provision for loan losses totaled $1,220,000 compared with a $350,000 provision for loan losses during the second quarter of 2017. The provision for loan losses represented approximately 22 basis points and 7 basis points of average loans on an annualized basis in the second quarter of 2018 and 2017, respectively.

The provision for loan losses totaled $1,570,000 for the six months ended June 30, 2018, an increase of $720,000, or 85%, compared to the provision of $850,000 during the six months ended June 30, 2017. During the first half of 2018, the provision for loan loss represented approximately 14 basis points of average loans on an annualized basis compared with 9 basis points of average loans on an annualized basis during the first half of 2017. The level of provision during all periods presented was done in accordance with the Company's standard methodology for determining the adequacy of its allowance for loan loss.

Net charge-offs totaled $43,000 or 1 basis point on an annualized basis of average loans outstanding during the three months ended June 30, 2018, compared with $196,000 or 4 basis points on an annualized basis of average loans outstanding during the same period of 2017. The Company realized net charge-offs of $1,627,000 or 15 basis points on an annualized basis of average loans outstanding during the six months ended June 30, 2018, compared with net charge-offs of $338,000 or 3 basis points on an annualized basis of average loans outstanding during the same period of 2017. The increase in net charge-offs during the first half of 2018 was primarily attributable to a partial charge-off on a single commercial lending relationship in the first quarter of 2018 that was downgraded during the fourth quarter of 2017.

The provision for loan losses made during each of the three and six month periods ended June 30, 2018 was made at a level deemed necessary by management to absorb changes in estimated, probable incurred losses in the loan portfolio. A detailed evaluation of the adequacy of the allowance for loan losses is completed quarterly by management, the results of which are used to determine provision for loan losses. Management estimates the allowance balance required using past loan loss experience, the nature and volume of the portfolio, information about specific borrower situations and estimated collateral values, economic conditions, and other factors.

44


Non-interest Income:

During the quarter ended June 30, 2018, non-interest income totaled $8,882,000, an increase of $1,085,000, or 14%, compared with the second quarter of 2017.
Non-interest Income
(dollars in thousands)

Three Months
Ended June 30,

Change From
Prior Period


 
 
 

Amount

Percent
 

2018

2017

Change

Change
Trust and Investment Product Fees

$
1,677


$
1,350


$
327


24
 %
Service Charges on Deposit Accounts

1,643


1,478


165


11

Insurance Revenues

1,696


1,744


(48
)

(3
)
Company Owned Life Insurance

260


480


(220
)

(46
)
Interchange Fee Income

1,714


1,156


558


48

Other Operating Income

913


630


283


45

Subtotal

7,903


6,838


1,065


16

Net Gains on Sales of Loans

905


959


(54
)

(6
)
Net Gains on Securities

74


—


74


n/m(1)

Total Non-interest Income

$
8,882


$
7,797


$
1,085


14

(1) 
n/m=not meaningful  
        
Trust and investment product fees increased $327,000, or 24%, during the second quarter of 2018 compared with the second quarter of 2017. Increased assets under management in the Company's wealth advisory group contributed to this increase in trust and investment product fees.

Interchange fees increased $558,000, or 48%, during the second quarter of 2018 compared with the second quarter of 2017. The increase during the second quarter of 2018 compared with the second quarter of 2017 was attributable to increased card utilization by customers and to the adoption of the new revenue recognition standard effective January 1, 2018. While the adoption of the standard did not have a significant impact on the Company's financial results, the recording of revenue gross versus net of certain expenses, in accordance with the standard, did result in the reclassification of some expenses associated with the interchange fee revenue during the second quarter of 2018. The reclassification of this expense for the second quarter of 2018 totaled $389,000.

Other operating income increased $283,000, or 45%, during the quarter ended June 30, 2018 compared with the second quarter of 2017. The increase in the second quarter of 2018 compared with with the second quarter of 2017 was largely attributable to increased merchant card services revenue.

During the six months ended June 30, 2018, non-interest income totaled $18,374,000, an increase of $2,389,000, or 15%, compared with the first half of 2017.
Non-interest Income
(dollars in thousands)
 
Six Months
Ended June 30,
 
Change From
Prior Period
 
 
 
 
 
 
Amount
 
Percent
 
 
2018
 
2017
 
Change
 
Change
Trust and Investment Product Fees
 
$
3,450

 
$
2,593

 
$
857

 
33
 %
Service Charges on Deposit Accounts
 
3,114

 
2,962

 
152

 
5

Insurance Revenues
 
4,626

 
4,384

 
242

 
6

Company Owned Life Insurance
 
572

 
734

 
(162
)
 
(22
)
Interchange Fee Income
 
3,196

 
2,179

 
1,017

 
47

Other Operating Income
 
1,517

 
1,487

 
30

 
2

Subtotal
 
16,475

 
14,339

 
2,136

 
15

Net Gains on Sales of Loans
 
1,555

 
1,646

 
(91
)
 
(6
)
Net Gains on Securities
 
344

 
—

 
344

 
n/m(1)

Total Non-interest Income
 
$
18,374

 
$
15,985

 
$
2,389

 
15

(1) 
n/m=not meaningful  

Trust and investment product fees increased $857,000, or 33%, during the first half of 2018 compared with the first half of 2017. The increase was primarily attributable to fees generated from increased assets under management in the Company's wealth advisory group.

45


Insurance revenues increased $242,000, or 6%, during the first half of 2018 compared with the first half of 2017. The increase during 2018 was primarily due to increased contingency revenue. Contingency revenue during 2018 totaled $1,218,000 compared with $992,000 during 2017. The fluctuation in contingency revenue is a normal course of business variance and is reflective of claims and loss experience with insurance carriers that the Company represents through its property and casualty insurance agency. Typically, the majority of contingency revenue is recognized during the first quarter of the year.

Interchange fees increased $1,017,000, or 47%, during the first half of 2018 compared with 2017. The increase during 2018 compared with 2017 was attributable to increased card utilization by customers and to the adoption of the new revenue recognition standard effective January 1, 2018. While the adoption of the standard did not have a significant impact on the Company's financial results, the recording of revenue gross versus net of certain expenses, in accordance with the standard, did result in the reclassification of some expenses associated with the interchange fee revenue during the first half of 2018. The reclassification of this expense for the six months ended June 30, 2018 totaled $700,000.

During the first half of 2018, the Company realized a net gain on the sale of securities of $344,000 related to the sale of $17.2 million of securities compared with no gains on sales of securities during the first half of 2017.

Non-interest Expense:

During the quarter ended June 30, 2018, non-interest expense totaled $21,708,000, an increase of $2,712,000, or 14%, compared with the second quarter of 2017. The second quarter of 2018 included acquisition related expenses that were of a non-recurring nature of approximately $904,000 for the five-branch acquisition that closed on May 18, 2018 and the pending acquisition of First Security, Inc. that was also announced in May 2018.
Non-interest Expense
(dollars in thousands)

Three Months
Ended June 30,

Change From
Prior Period


 
 
 

Amount

Percent
 

2018

2017

Change

Change
Salaries and Employee Benefits

$
12,019


$
11,460


$
559


5
%
Occupancy, Furniture and Equipment Expense

2,527


2,224


303


14

FDIC Premiums

238


232


6


3

Data Processing Fees

1,398


1,044


354


34

Professional Fees

1,361


913


448


49

Advertising and Promotion

857


630


227


36

Intangible Amortization

306


242


64


26

Other Operating Expenses

3,002


2,251


751


33

Total Non-interest Expense

$
21,708


$
18,996


$
2,712


14

        
Salaries and benefits increased $559,000, or 5%, during the quarter ended June 30, 2018 compared with the second quarter of 2017. The increase in salaries and benefits during the second quarter of 2018 compared with the second quarter of 2017 was primarily attributable to an increased number of full-time equivalent employees.

Occupany, furniture and equipment expense increased $303,000, or 14%, during the second quarter of 2018 compared with the second quarter of 2017. The increase during the second quarter of 2018 compared to the second quarter of 2017 was primarily due to operating costs related to the acquisition of the five banking branches in the Columbus and Greensburg, Indiana markets as well as other facilities the Company has placed into service over the past several quarters.

Data processing fees increased $354,000, or 34%, during the second quarter of 2018 compared to the second quarter of 2017. The increase during the second quarter of 2018 was largely related to conversion costs associated with the aforementioned branch acquisition.

Professional fees increased $448,000, or 49%, during the second quarter of 2018 compared with the second quarter of 2017. The increase during the second quarter of 2018 was largely related to professional fees associated with the the five-branch acquisition that closed on May 18, 2018 and the pending acquisition of First Security, Inc. that was also announced in May 2018.

Advertising and promotion expense increased $227,000, or 36%, during the second quarter of 2018 compared with the second quarter of 2017. The increase during the second quarter of 2018 was the result of the branch acquisition completed during the second quarter of 2018 and increased contributions throughout the Company's market areas.


46


Other operating expenses increased $751,000, or 33%, during the second quarter of 2018 compared with the second quarter of 2017. The increase in the second quarter of 2018 was largely attributable to the adoption of the revenue recognition standard effective January 1, 2018. The reclassification of expense in accordance with the standard for the second quarter of 2018 totaled $389,000.

During the six months ended June 30, 2018, non-interest expense totaled $42,163,000, an increase of $4,131,000, or 11%, compared with the first half of 2017. The first half of 2018 included acquisition related expenses that were of a non-recurring nature of approximately $1,090,000 for the five-branch acquisition that closed on May 18, 2018 and the pending acquisition of First Security, Inc. that was also announced in May 2018.
Non-interest Expense
(dollars in thousands)
 
Six Months
Ended June 30,
 
Change From
Prior Period
 
 
 
 
 
 
Amount
 
Percent
 
 
2018
 
2017
 
Change
 
Change
Salaries and Employee Benefits
 
$
24,145

 
$
22,904

 
$
1,241

 
5
%
Occupancy, Furniture and Equipment Expense
 
4,936

 
4,406

 
530

 
12

FDIC Premiums
 
475

 
471

 
4

 
1

Data Processing Fees
 
2,525

 
2,055

 
470

 
23

Professional Fees
 
2,232

 
1,716

 
516

 
30

Advertising and Promotion
 
1,558

 
1,408

 
150

 
11

Intangible Amortization
 
512

 
495

 
17

 
3

Other Operating Expenses
 
5,780

 
4,577

 
1,203

 
26

Total Non-interest Expense
 
$
42,163

 
$
38,032

 
$
4,131

 
11


Salaries and benefits increased $1,241,000, or 5%, during the six months ended June 30, 2018 compared with the same period of 2017. The increase in salaries and benefits during 2018 compared with 2017 was primarily attributable to an increased number of full-time equivalent employees.

Occupany, furniture and equipment expense increased $530,000, or 12%, during the first half of 2018 compared with 2017. The increase during 2018 compared with 2017 was primarily due to operating costs related to facilities the Company has placed into service over the past several quarters and to the acquisition of the five banking branches in the Columbus and Greensburg, Indiana markets.

Data processing fees increased $470,000, or 23%, during the first six months of 2018 compared with 2017. The increase during 2018 was largely related to conversion costs associated with the aforementioned branch acquisition.

Professional fees increased $516,000, or 30%, during the first half of 2018 compared with 2017. The increase during 2018 was largely related to professional fees associated with the the five-branch acquisition that closed on May 18, 2018 and the pending acquisition of First Security, Inc. that was also announced in May 2018.

Other operating expenses increased $1,203,000, or 26%, during the first half of 2018 compared with the first half of 2017. The increase in 2018 was largely attributable to the adoption of the revenue recognition standard effective January 1, 2018, The reclassification of expense in accordance with the standard for the six months ended June 30, 2018, totaled $700,000.

Income Taxes:

The Company’s effective income tax rate was 17.3% and 25.8%, respectively, during the three months ended June 30, 2018 and 2017. The Company’s effective income tax rate was 17.4% and 27.2%, respectively, during the six months ended June 30, 2018 and 2017. The effective tax rate in all periods presented was lower than the blended statutory rate resulting primarily from the Company’s tax-exempt investment income on securities, loans and company-owned life insurance, income tax credits generated from affordable housing projects, and income generated by subsidiaries domiciled in a state with no state or local income tax.

During the quarter ended June 30, 2018, the Company recorded a provision for income tax expense of $2,326,000 compared with a provision for income tax expense of $3,425,000 in the second quarter of 2017. During the six months ended June 30, 2018, the Company recorded a provision for income tax expense of $4,810,000 compared with a provision for income tax expense of $7,246,000 in the first half of 2017. The provision for income tax and the effective tax rate was positively impacted during the second quarter and first half of 2018 by the reduction of federal income tax rates from a statutory rate of 35% to 21% effective January 1, 2018 related to the federal tax reform legislation enacted during the fourth quarter of 2017.

47


FINANCIAL CONDITION

Total assets for the Company increased to $3.345 billion at June 30, 2018, representing an increase of $200.2 million, or 13% on an annualized basis, compared with December 31, 2017. The increase in total assets was driven by the acquisition of a five-branch network in the Columbus and Greensburg, Indiana markets, as well as organic loan growth.

At June 30, 2018, total loans increased $176.8 million, or 16% on an annualized basis, compared with December 31, 2017. At June 30, 2018, the loans acquired as a part of the branch acquisition, which closed on May 18, 2018, totaled $115.8 million. At June 30, 2018, total loans, excluding those acquired as a part of the branch acquisition, increased $61.0 million, or approximately 6% on an annualized basis, compared with December 31, 2017.

The increase in total loans during the first half of 2018, excluding those acquired as a part of the branch acquisition, was driven by an increase of approximately $6.0 million, or 3% on an annualized basis, of commercial and industrial loans, an increase of $35.0 million, or 8% on an annualized basis, of commercial real estate loans, an increase of $16.8 million, or 10% on an annualized basis, of agricultural loans and an increase of $3.2 million, or 2% on annualized basis, of retail loans.
End of Period Loan Balances:
(dollars in thousands)
 
June 30,
2018
 
December 31,
2017
 
Current Period Change
Commercial and Industrial Loans and Leases
 
$
518,299

 
$
486,668

 
$
31,631

Commercial Real Estate Loans
 
986,486

 
926,729

 
59,757

Agricultural Loans
 
352,308

 
333,227

 
19,081

Home Equity and Consumer Loans
 
241,315

 
219,662

 
21,653

Residential Mortgage Loans
 
223,437

 
178,733

 
44,704

Total Loans
 
$
2,321,845

 
$
2,145,019

 
$
176,826


The following table indicates the breakdown of the allowance for loan losses for the periods indicated (dollars in thousands):
 
 
June 30,
2018
 
December 31,
2017
Commercial and Industrial Loans and Leases
 
$
3,563

 
$
4,735

Commercial Real Estate Loans
 
4,958

 
4,591

Agricultural Loans
 
5,578

 
4,894

Home Equity and Consumer Loans
 
713

 
628

Residential Mortgage Loans
 
366

 
343

Unallocated
 
459

 
503

 
 
 
 
 
Total Allowance for Loan Loss
 
$
15,637

 
$
15,694


The Company’s allowance for loan losses totaled $15.6 million at June 30, 2018 compared to $15.7 million at December 31, 2017. The allowance for loan losses represented 0.67% of period-end loans at June 30, 2018 compared with 0.73% of period-end loans at December 31, 2017. From time to time, the Company has acquired loans through bank and branch acquisitions with the most recent being a branch acquisition in the second quarter of 2018. Under acquisition accounting treatment, loans acquired are recorded at fair value which includes a credit risk component, and therefore the allowance on loans acquired is not carried over from the seller. The Company held a net discount on acquired loans of $9.6 million as of June 30, 2018 and $7.6 million at December 31, 2017.


48


The following is an analysis of the Company’s non-performing assets at June 30, 2018 and December 31, 2017:
Non-performing Assets:
(dollars in thousands)
 
June 30,
2018
 
December 31,
2017
Non-accrual Loans
 
$
8,953

 
$
11,091

Past Due Loans (90 days or more)
 
534

 
719

Total Non-performing Loans
 
9,487

 
11,810

Other Real Estate
 
40

 
54

Total Non-performing Assets
 
$
9,527

 
$
11,864

 
 
 
 
 
Restructured Loans
 
$
123

 
$
149

 
 
 
 
 
Non-performing Loans to Total Loans
 
0.41
%
 
0.55
%
Allowance for Loan Loss to Non-performing Loans
 
164.83
%
 
132.89
%

The following tables present non-accrual loans and loans past due 90 days or more still on accrual by class of loans:
 
 
Non-Accrual Loans
 
Loans Past Due 90 Days
or More & Still Accruing
 
 
June 30,
2018
 
December 31,
2017
 
June 30,
2018
 
December 31,
2017
Commercial and Industrial Loans and Leases
 
$
2,701

 
$
4,753

 
$
443

 
$
—

Commercial Real Estate Loans
 
4,966

 
4,618

 
91

 
471

Agricultural Loans
 
538

 
748

 
—

 
248

Home Equity Loans
 
94

 
199

 
—

 
—

Consumer Loans
 
47

 
286

 
—

 
—

Residential Mortgage Loans
 
607

 
487

 
—

 
—

Total
 
$
8,953

 
$
11,091

 
$
534

 
$
719


Non-performing assets totaled $9.5 million at June 30, 2018 compared to $11.9 million of non-performing assets at December 31, 2017. Non-performing assets represented 0.28% of total assets at June 30, 2018 compared to 0.38% of total assets at December 31, 2017. Non-performing loans totaled $9.5 million at June 30, 2018 compared to $11.8 million at December 31, 2017. Non-performing loans represented 0.41% of total loans at June 30, 2018 compared to 0.55% at December 31, 2017. The decline in non-performing assets during the first half of 2018 was largely attributable to a partial charge-off on a single commercial lending relationship that was downgraded during the fourth quarter of 2017.

Loan impairment is reported when repayment under the terms of the loan is not expected.  If a loan is impaired, a portion of the allowance is specifically allocated so that the loan is reported net, at the present value of estimated future cash flows using the loan’s existing rate, or at the fair value of collateral if repayment is expected solely from the collateral. Commercial and industrial loans, commercial real estate loans, and agricultural loans are evaluated individually for impairment. Smaller balance homogeneous loans are evaluated for impairment in total. Such loans include real estate loans secured by one-to-four family residences and loans to individuals for household, family and other personal expenditures. Individually evaluated loans on non-accrual are generally considered impaired. Impaired loans, or portions thereof, are charged off when deemed uncollectible.

Total deposits increased $117.4 million, or 9% on an annualized basis, as of June 30, 2018 compared with December 31, 2017. The increase in total deposits during the first half of 2018 compared with year-end 2017 was largely driven by the previously discussed branch acquisition. At June 30, 2018, the deposits acquired as a part of the branch acquisition totaled approximately $122.7 million.
End of Period Deposit Balances:
(dollars in thousands)
 
June 30,
2018
 
December 31,
2017
 
Current Period Change
Non-interest-bearing Demand Deposits
 
$
629,724

 
$
606,134

 
$
23,590

Interest-bearing Demand, Savings, & Money Market Accounts
 
1,611,583

 
1,490,033

 
121,550

Time Deposits < $100,000
 
190,179

 
198,646

 
(8,467
)
Time Deposits of $100,000 or more
 
169,954

 
189,239

 
(19,285
)
Total Deposits
 
$
2,601,440

 
$
2,484,052

 
$
117,388


49


Capital Resources:

As of June 30, 2018, shareholders’ equity increased by $5.9 million to $370.5 million compared with $364.6 million at year-end 2017. The increase in shareholders' equity was primarily attributable to an increase of $16.0 million in retained earnings partially offset by a decline in accumulated other comprehensive income primarily related to the decrease in value of the Company's available-for-sale securities portfolio. Shareholders’ equity represented 11.1% of total assets at June 30, 2018 and 11.6% of total assets at December 31, 2017. Shareholders’ equity included $66.0 million of goodwill and other intangible assets at June 30, 2018 compared to $56.2 million of goodwill and other intangible assets at December 31, 2017. The increase in goodwill and other intangible assets resulted from the previously discussed branch acquisition.

Federal banking regulations provide guidelines for determining the capital adequacy of bank holding companies and banks. These guidelines provide for a more narrow definition of core capital and assign a measure of risk to the various categories of assets. The Company is required to maintain minimum levels of capital in proportion to total risk-weighted assets and off-balance sheet exposures.

 As of January 1, 2015, the Company and its subsidiary bank adopted the new Basel III regulatory capital framework. The adoption of this new framework modified the regulatory capital calculations, minimum capital levels and well-capitalized thresholds and added the new Common Equity Tier 1 capital ratio. Additionally, under the new rules, in order to avoid limitations on capital distributions, including dividend payments, the Company is required to maintain a capital conservation buffer above the adequately capitalized regulatory capital ratios. The capital conservation buffer is being phased in from 0.00% in 2015 to 2.50% in 2019. For June 30, 2018, the capital conservation buffer was 1.875% and for December 31, 2017, the capital conservation buffer was 1.25%. At June 30, 2018, the capital levels for the Company and its subsidiary bank remained well in excess of of the minimum amounts needed for capital adequacy purposes and the bank's capital levels met the necessary requirements to be considered well-capitalized.

The table below presents the Company’s consolidated and the subsidiary bank's capital ratios under regulatory guidelines:
 
 
6/30/2018
Ratio
 
12/31/2017
Ratio
 
Minimum for Capital Adequacy Purposes
 
Well-Capitalized Guidelines
Total Capital (to Risk Weighted Assets)
 
 
 
 
 
 
 
 
Consolidated
 
12.91
%
 
13.62
%
 
8.00
%
 
N/A

Bank
 
11.67
%
 
12.29
%
 
8.00
%
 
10.00
%
Tier 1 (Core) Capital (to Risk Weighted Assets)
 
 
 
 
 
 
 
 
Consolidated
 
12.33
%
 
12.99
%
 
6.00
%
 
N/A

Bank
 
11.08
%
 
11.66
%
 
6.00
%
 
8.00
%
Common Tier 1, (CET 1) Capital Ratio (to Risk Weighted Assets)
 
 
 
 
 
 
 
 
Consolidated
 
11.91
%
 
12.55
%
 
4.50
%
 
N/A

Bank
 
11.08
%
 
11.66
%
 
4.50
%
 
6.50
%
Tier 1 Capital (to Average Assets)
 
 
 
 
 
 
 
 
Consolidated
 
10.38
%
 
10.71
%
 
4.00
%
 
N/A

Bank
 
9.34
%
 
9.63
%
 
4.00
%
 
5.00
%

Under the the final rules provided for by Basel III, accumulated other comprehensive income ("AOCI") was to be included in a banking organization's Common Equity Tier 1 capital. The final rules allowed community banks to make a one-time election not to include the additional components of AOCI in regulatory capital and instead use the existing treatment under the general risk-based capital rules that excludes most AOCI components from regulatory capital. The Company elected, in its March 31, 2015 regulatory filings (Call Report and FR Y-9), to opt-out and continue the existing treatment of AOCI for regulatory capital purposes.

Liquidity:

The Consolidated Statement of Cash Flows details the elements of changes in the Company’s consolidated cash and cash equivalents. Total cash and cash equivalents increased $923,000 during the six months ended June 30, 2018 ending at $71.3 million.  During the six months ended June 30, 2018, operating activities resulted in net cash inflows of $28.6 million. Investing activities resulted in net cash outflows of $42.2 million during the six months ended June 30, 2018.  Financing activities resulted in net cash inflows for the six months ended June 30, 2018 of $14.5 million.

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The parent company is a corporation separate and distinct from its bank and other subsidiaries. The Company uses funds at the parent-company level to pay dividends to its shareholders, to acquire or make other investments in other businesses or their securities or assets, to repurchase its stock from time to time, and for other general corporate purposes including debt service. The parent company does not have access at the parent-company level to the deposits and certain other sources of funds that are available to its bank subsidiary to support its operations. Instead, the parent company has historically derived most of its revenues from dividends paid to the parent company by its bank subsidiary. The Company’s banking subsidiary is subject to statutory restrictions on its ability to pay dividends to the parent company. The parent company has in recent years supplemented the dividends received from its subsidiaries with borrowings. As of June 30, 2018, the parent company had approximately $21.5 million of cash and cash equivalents available to meet its cash flow needs.

FORWARD-LOOKING STATEMENTS AND ASSOCIATED RISKS
 
The Company from time to time in its oral and written communications makes statements relating to its expectations regarding the future. These types of statements are considered “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995. The Company may include forward-looking statements in filings with the Securities and Exchange Commission (“SEC”), such as this Form 10-Q, in other written materials, and in oral statements made by senior management to analysts, investors, representatives of the media, and others. Such forward looking statements can include statements about the Company’s net interest income or net interest margin; its adequacy of allowance for loan losses, levels of provisions for loan losses, and the quality of the Company’s loans, investment securities and other assets; simulations of changes in interest rates; expected results from mergers with or acquisitions of other businesses; litigation results; tax estimates and recognition; dividend policy; parent company cash resources and cash requirements, and parent company capital resources; estimated cost savings, plans and objectives for future operations; and expectations about the Company’s financial and business performance and other business matters as well as economic and market conditions and trends. They often can be identified by the use of words like “plan,” “expect,” “can,” “might,” “may,” “will,” “would,” “could,” “should,” “intend,” “project,” “estimate,” “believe” or “anticipate,” or similar expressions.
 
Forward-looking statements speak only as of the date they are made, and the Company undertakes no obligation to update any forward-looking statement to reflect events or circumstances after the date on which the forward-looking statement is made.
 
Readers are cautioned that, by their nature, all forward-looking statements are based on assumptions and are subject to risks, uncertainties, and other factors. Actual results may differ materially and adversely from the expectations of the Company that are expressed or implied by any forward-looking statement. The discussions in this Item 2 list some of the factors that could cause the Company’s actual results to vary materially from those expressed or implied by any forward-looking statements. Other risks, uncertainties, and factors that could cause the Company’s actual results to vary materially from those expressed or implied by any forward-looking statement include the unknown future direction of interest rates and the timing and magnitude of any changes in interest rates; changes in competitive conditions; the introduction, withdrawal, success and timing of asset/liability management strategies or of mergers and acquisitions and other business initiatives and strategies; changes in customer borrowing, repayment, investment and deposit practices; changes in fiscal, monetary and tax policies; changes in financial and capital markets; deterioration in general economic conditions, either nationally or locally, resulting in, among other things, credit quality deterioration; capital management activities, including possible future sales of new securities, or possible repurchases or redemptions by the Company of outstanding debt or equity securities; risks of expansion through acquisitions and mergers, such as unexpected credit quality problems of the acquired loans or other assets, unexpected attrition of the customer base of the acquired institution or branches, and difficulties in integration of the acquired operations; factors driving impairment charges on investments; the impact, extent and timing of technological changes; potential cyber-attacks, information security breaches and other criminal activities; litigation liabilities, including related costs, expenses, settlements and judgments, or the outcome of matters before regulatory agencies, whether pending or commencing in the future; actions of the Federal Reserve Board; changes in accounting principles and interpretations; the expected impact of U.S. tax regulations passed in December 2017; potential increases of federal deposit insurance premium expense, and possible future special assessments of FDIC premiums, either industry wide or specific to the Company’s banking subsidiary; actions of the regulatory authorities under the Dodd-Frank Wall Street Reform and Consumer Protection Act (the "Dodd-Frank Act") and the Federal Deposit Insurance Act and other possible legislative and regulatory actions and reforms; impacts resulting from possible amendments or revisions to the Dodd-Frank Act and the regulations promulgated thereunder, or to Consumer Financial Protection Bureau rules and regulations; and the continued availability of earnings and excess capital sufficient for the lawful and prudent declaration and payment of cash dividends. Such statements reflect our views with respect to future events and are subject to these and other risks, uncertainties and assumptions relating to the operations, results of operations, growth strategy and liquidity of the Company. Readers are cautioned not to place undue reliance on these forward-looking statements.
 

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Investors should consider these risks, uncertainties, and other factors, in addition to those mentioned by the Company in its Annual Report on Form 10-K for its fiscal year ended December 31, 2017, and other SEC filings from time to time, when considering any forward-looking statement.


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Item 3. Quantitative and Qualitative Disclosures About Market Risk
 
The Company’s exposure to market risk is reviewed on a regular basis by the Asset/Liability Committee and Boards of Directors of the parent company and its subsidiary bank. Primary market risks which impact the Company’s operations are liquidity risk and interest rate risk.

The liquidity of the parent company is dependent upon the receipt of dividends from its subsidiary bank, which is subject to certain regulatory limitations. The Bank’s source of funding is predominately core deposits, maturities of securities, repayments of loan principal and interest, federal funds purchased, securities sold under agreements to repurchase and borrowings from the Federal Home Loan Bank.

The Company monitors interest rate risk by the use of computer simulation modeling to estimate the potential impact on its net interest income under various interest rate scenarios, and by estimating its static interest rate sensitivity position. Another method by which the Company’s interest rate risk position can be estimated is by computing estimated changes in its net portfolio value (“NPV”). This method estimates interest rate risk exposure from movements in interest rates by using interest rate sensitivity analysis to determine the change in the NPV of discounted cash flows from assets and liabilities. NPV represents the market value of portfolio equity and is equal to the estimated market value of assets minus the estimated market value of liabilities.

Computations for measuring both net interest income and NPV are based on a number of assumptions, including the relative levels of market interest rates and prepayments in mortgage loans and certain types of investments. These computations do not contemplate any actions management may undertake in response to changes in interest rates, and should not be relied upon as indicative of actual results. In addition, certain shortcomings are inherent in the method of computing both net interest income and NPV. Should interest rates remain or decrease below current levels, the proportion of adjustable rate loans could decrease in future periods due to refinancing activity. In the event of an interest rate change, prepayment levels would likely be different from those assumed in the modeling. Lastly, the ability of many borrowers to repay their adjustable rate debt may decline during a rising interest rate environment.

The Company from time to time utilizes derivatives to manage interest rate risk. Management continuously evaluates the merits of such interest rate risk products but does not anticipate the use of such products to become a major part of the Company’s risk management strategy.

The table below provides an assessment of the risk to net interest income over the next 12 months in the event of a sudden and sustained 1% and 2% increase and decrease in prevailing interest rates (dollars in thousands).

Interest Rate Sensitivity as of June 30, 2018 - Net Interest Income
 
 
Net Interest Income
 
 
 
 
 
 
 
Changes in Rates
 
Amount

 
% Change

 
+2%
 
$
112,918

 
(3.37
)%
 
+1%
 
114,916

 
(1.66
)%
 
Base
 
116,853

 
—

 
-1%
 
113,941

 
(2.49
)%
 
-2%
 
104,948

 
(10.19
)%
 
 
The above table is a measurement of the Company’s net interest income at risk, assuming a static balance sheet as of June 30, 2018 and instantaneous parallel changes in interest rates. The Company also monitors interest rate risk under other scenarios including a more gradual movement in market interest rates. This type of scenario can at times produce different modeling results in measuring interest rate risk sensitivity.

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The table below provides an assessment of the risk to NPV in the event of a sudden and sustained 1% and 2% increase and decrease in prevailing interest rates (dollars in thousands).
   
Interest Rate Sensitivity as of June 30, 2018 - Net Portfolio Value
 
 
Net Portfolio Value
 
 Net Portfolio Value as a % of Present Value of Assets
Changes in Rates
 
Amount
 
% Change
 
NPV Ratio
 
Change
 
 
 
 
 
 
 
 
 
+2%
 
$
446,183

 
(8.85
)%
 
14.36
%
 
(62) b.p.

+1%
 
469,958

 
(3.99
)%
 
14.74
%
 
(24) b.p.

Base
 
489,493

 
—

 
14.98
%
 
—

-1%
 
478,871

 
(2.17
)%
 
14.36
%
 
(62) b.p.

-2%
 
434,299

 
(11.28
)%
 
12.80
%
 
(218) b.p.

 
This Item 3 includes forward-looking statements. See “Forward-looking Statements and Associated Risks” included in Part I, Item 2 of this Report for a discussion of certain factors that could cause the Company’s actual exposure to market risk to vary materially from that expressed or implied above. These factors include possible changes in economic conditions; interest rate fluctuations, competitive product and pricing pressures within the Company’s markets; and equity and fixed income market fluctuations. Actual experience may also vary materially to the extent that the Company’s assumptions described above prove to be inaccurate.

Item 4.  Controls and Procedures
 
As of June 30, 2018, the Company carried out an evaluation, under the supervision and with the participation of its principal executive officer and principal financial officer, of the effectiveness of the design and operation of its disclosure controls and procedures. Based on this evaluation, the Company’s principal executive officer and principal financial officer concluded that the Company’s disclosure controls and procedures were, as of that date, effective in timely alerting them to material information required to be included in the Company’s periodic reports filed with the Securities and Exchange Commission. There are inherent limitations to the effectiveness of systems of disclosure controls and procedures, including the possibility of human error and the circumvention or overriding of the controls and procedures. Accordingly, even effective systems of disclosure controls and procedures can provide only reasonable assurances of achieving their control objectives.

There was no change in the Company’s internal control over financial reporting that occurred during the Company’s second fiscal quarter of 2018 that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.


54


PART II. OTHER INFORMATION

Item 1.   Legal Proceedings

There are no pending legal proceedings, other than litigation incidental to the ordinary business of the Company, of a material nature to which the Company is a party or of which any of its properties are subject.

Item 1A.  Risk Factors

There have been no material changes to the risk factors previously disclosed in German American Bancorp, Inc.'s Annual Report on Form 10-K for the year ended December 31, 2017.

Item 2.   Unregistered Sales of Equity Securities and Use of Proceeds
 
Issuer Purchases of Equity Securities
The following table sets forth information regarding the Company’s purchases of its common shares during each of the three months ended June 30, 2018.
Period
 
Total Number
of Shares (or Units) Purchased
 
Average Price Paid Per Share (or Unit)
 
Total Number of Shares
(or Units) Purchased as Part of Publicly Announced Plans or Programs
 
Maximum Number
(or Approximate Dollar Value) of Shares (or Units) that
May Yet Be Purchased under the Plans or Programs (1)
April 2018
 
—

 
—

 
—

 
409,184

May 2018
 
—

 
—

 
—

 
409,184

June 2018
 
—

 
—

 
—

 
409,184


(1) On April 26, 2001, the Company announced that its Board of Directors had approved a stock repurchase program for up to 911,631 of its outstanding common shares, of which the Company had purchased 502,447 common shares through June 30, 2018 (both such numbers adjusted for subsequent stock dividends). The Board of Directors established no expiration date for this program. The Company purchased no shares under this program during the quarter ended June 30, 2018.


Item 3.   Defaults Upon Senior Securities

None.

Item 4.   Mine Safety Disclosures

Not applicable.

Item 5.   Other Information

None.


55


Item 6.      Exhibits
 
The following exhibits are included with this Report or incorporated herein by reference.
 
Exhibit No.
 
Description
 
 
 
 
 
 
 

 

 
 
 
 
 
101+
 
The following materials from German American Bancorp, Inc.’s Form 10-Q Report for the quarterly period ended June 30, 2018, formatted in XBRL: (i) the Consolidated Balance Sheets, (ii) the Consolidated Statements of Income, (iii)  the Consolidated Statements of Comprehensive Income, (iv) the Consolidated Statements of Cash Flows, and (v) the Notes to Consolidated Financial Statements.
 
Note: No long-term debt instrument issued by the Registrant exceeds 10% of consolidated total assets or is registered. In accordance with paragraph 4 (iii) of Item 601(b) of Regulation S-K, the Registrant will furnish the Securities and Exchange Commission copies of long-term debt instruments and related agreements upon request.

*Exhibits that are filed with this Report (other than through incorporation by reference to other disclosures or exhibits) are indicated by a double asterisk.
 
+Pursuant to Rule 406T of Regulation S-T, the Interactive Data Files on Exhibit 101 hereto are furnished and not deemed filed or part of a registration statement or prospectus for purposes of Sections 11 and 12 of the Securities Act of 1933, as amended, and are deemed not filed for purposes of Section 18 of the Securities Exchange Act of 1934, as amended, and otherwise are not subject to liability under those sections.


56


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.
 
 
GERMAN AMERICAN BANCORP, INC.
 
 
Date: August 9, 2018
By: /s/Mark A. Schroeder
 
Mark A. Schroeder
 
Chairman and Chief Executive Officer
 
(Principal Executive Officer)
 
 
Date: August 9, 2018
By: /s/Bradley M. Rust
 
Bradley M. Rust
 
Executive Vice President and Chief Financial Officer
 
(Principal Financial and Accounting Officer)


57