Toggle SGML Header (+)


Section 1: 10-Q (FORM 10-Q)

 

 

 

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

FORM 10-Q

 

(Mark One)

xQuarterly report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934.

 

For the quarterly period ended September 30, 2018 or

 

¨Transition report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934.

 

For the transition period from               to              

 

Commission File Number: 0-26128

 

NorthWest Indiana Bancorp

(Exact name of registrant as specified in its charter)

 

Indiana   35-1927981
(State or other jurisdiction of incorporation   (I.R.S. Employer Identification Number)
or organization)    

 

9204 Columbia Avenue    
Munster, Indiana   46321
(Address of principal executive offices)   (ZIP code)

 

Registrant's telephone number, including area code: (219) 836-4400

 

N/A
(Former name, former address and former fiscal year, if changed since last report)

 

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 every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files).

Yes x    No ¨

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer”, “accelerated filer”, “smaller reporting company”, and “emerging growth company” in Rule 12b-2 of the Exchange Act:

Large accelerated filer ¨ Accelerated filer x Non-accelerated filer ¨

Smaller Reporting Company x 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

 

There were 3,029,157 shares of the registrant’s Common Stock, without par value, outstanding at November 2, 2018.

 

 

 

 

 

 

NorthWest Indiana Bancorp

Index

 

    Page
    Number
PART I. Financial Information  
     
Item 1. Unaudited Financial Statements and Notes 1
     
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations 22
     
Item 3. Quantitative and Qualitative Disclosures about Market Risk 35
     
Item 4. Controls and Procedures 35
     
PART II. Other Information 36
   
SIGNATURES 37
   
EXHIBITS  
31.1 Rule 13a-14(a)/15d-14(a) Certification of Chief Executive Officer  
31.2 Rule 13a-14(a)/15d-14(a) Certification of Chief Financial Officer  
32.1 Section 1350 Certifications  
101 XBRL Interactive Data File  

 

 

 

 

NorthWest Indiana Bancorp

Consolidated Balance Sheets

  

   September 30,     
(Dollars in thousands)  2018   December 31, 
   (unaudited)   2017 
ASSETS          
           
Cash and non-interest bearing deposits in other financial institutions  $9,990   $10,529 
Interest bearing deposits in other financial institutions   2,576    139 
Federal funds sold   1,398    357 
           
Total cash and cash equivalents   13,964    11,025 
           
Certificates of deposit in other financial institutions   3,754    1,676 
           
Securities available-for-sale   238,071    244,490 
Loans held-for-sale   4,483    1,592 
Loans receivable   742,232    620,211 
Less: allowance for loan losses   (7,749)   (7,482)
Net loans receivable   734,483    612,729 
Federal Home Loan Bank stock   3,236    3,000 
Accrued interest receivable   3,560    3,262 
Premises and equipment   24,868    19,559 
Foreclosed real estate   2,125    1,699 
Cash value of bank owned life insurance   23,007    19,355 
Goodwill   8,170    2,792 
Other assets   13,353    6,080 
           
Total assets  $1,073,074   $927,259 
           
LIABILITIES AND STOCKHOLDERS' EQUITY          
           
Deposits:          
Non-interest bearing  $134,449   $120,556 
Interest bearing   768,307    672,448 
Total   902,756    793,004 
Repurchase agreements   12,585    11,300 
Borrowed funds   48,314    20,881 
Accrued expenses and other liabilities   12,932    10,014 
           
Total liabilities   976,587    835,199 
           
Stockholders' Equity:          
Preferred stock, no par or stated value; 10,000,000 shares authorized, none outstanding   -    - 
Common stock, no par or stated value; 10,000,000 shares authorized;
shares issued and outstanding: September 30, 2018 - 3,029,157
   -    - 
     December 31, 2017 - 2,864,507          
Additional paid-in capital   11,877    4,867 
Accumulated other comprehensive income/(loss)   (5,992)   684 
Retained earnings   90,602    86,509 
           
Total stockholders' equity   96,487    92,060 
           
Total liabilities and stockholders' equity  $1,073,074   $927,259 

 

See accompanying notes to consolidated financial statements.

 

 1 

 

 

NorthWest Indiana Bancorp

Consolidated Statements of Income

(unaudited)

 

   Three Months Ended   Nine Months Ended 
(Dollars in thousands)  September 30,   September 30, 
   2018   2017   2018   2017 
Interest income:                    
Loans receivable                    
Real estate loans  $7,189   $5,773   $19,240   $16,800 
Commercial loans   1,266    1,050    3,457    3,116 
Consumer loans   97    5    106    15 
Total loan interest   8,552    6,828    22,803    19,931 
Securities   1,709    1,585    5,127    4,801 
Other interest earning assets   74    18    134    49 
                     
Total interest income   10,335    8,431    28,064    24,781 
                     
Interest expense:                    
Deposits   1,018    518    2,531    1,475 
Repurchase agreements   47    31    124    80 
Borrowed funds   254    110    682    281 
                     
Total interest expense   1,319    659    3,337    1,836 
                     
Net interest income   9,016    7,772    24,727    22,945 
Provision for loan losses   312    165    950    722 
                     
Net interest income after provision for loan losses   8,704    7,607    23,777    22,223 
                     
Noninterest income:                    
Fees and service charges  $991   $843   $2,830   $2,404 
Wealth management operations   414    459    1,253    1,267 
Gain on sale of securities, net   151    213    1,155    758 
Gain on sale of loans held-for-sale, net   451    412    1,021    883 
Increase in cash value of bank owned life insurance   130    119    358    349 
Gain on sale of foreclosed real estate, net   54    2    154    95 
Other   32    27    104    64 
Total noninterest income  $2,223   $2,075   $6,875   $5,820 
                     
Noninterest expense:                    
Compensation and benefits  $4,669   $4,094   $12,045   $10,847 
Occupancy and equipment   829    845    2,524    2,542 
Data processing   1,012    364    2,076    1,092 
Marketing   223    135    523    469 
Federal deposit insurance premiums   91    84    250    242 
Other   2,233    1,403    5,512    4,061 
Total noninterest expense  $9,057   $6,925   $22,930   $19,253 
                     
Income before income tax expenses   1,870    2,757    7,722    8,790 
Income tax expenses   245    509    1,025    1,715 
                     
Net income  $1,625   $2,248   $6,697   $7,075 
                     
Earnings per common share:                    
Basic  $0.54   $0.78   $2.29   $2.47 
Diluted  $0.54   $0.78   $2.29   $2.47 
                     
Dividends declared per common share  $0.30   $0.29   $0.89   $0.87 

 

See accompanying notes to consolidated financial statements.

 

 2 

 

 

NorthWest Indiana Bancorp

Consolidated Statements of Comprehensive Income

(unaudited)

 

   Three Months Ended   Nine Months Ended 
(Dollars in thousands)  September 30,   September 30, 
   2018   2017   2018   2017 
                 
Net income  $1,625   $2,248   $6,697   $7,075 
                     
Net change in net unrealized gains and losses on securities available-for-sale:                    
Unrealized gains/(losses) arising during the period   (2,071)   747    (7,301)   4,193 
Less: reclassification adjustment for gains included in net income   (151)   (213)   (1,155)   (758)
Net securities gain/(loss) during the period   (2,222)   534    (8,456)   3,435 
Tax effect   467    (183)   1,780    (1,169)
Net of tax amount   (1,755)   351    (6,676)   2,266 
                     
Comprehensive income/(loss), net of tax  $(130)  $2,599   $21   $9,341 

 

See accompanying notes to consolidated financial statements.

 

NorthWest Indiana Bancorp

Consolidated Statements of Changes in Stockholders' Equity

(unaudited)

 

   Three Months Ended   Nine Months Ended 
(Dollars in thousands)  September 30,   September 30, 
   2018   2017   2018   2017 
                 
Balance at beginning of period  $90,577   $89,308   $92,060   $84,108 
                     
Comprehensive income:                    
Net income   1,625    2,248    6,697    7,075 
Net unrealized gains/(losses) on securities available-for-sale, net of reclassifications and tax effects   (1,755)   351    (6,676)   2,266 
Comprehensive income, net of tax   (130)   2,599    21    9,341 
                     
Stock based compensation expense   50    51    154    142 
Net surrender value of restricted stock awards   (27)   -    (72)   - 
Issuance of 161,875 shares at $42.80 per share, for acquisition of First Personal Financial Corporation   6,928    -    6,928    - 
Cash dividends   (911)   (831)   (2,604)   (2,464)
                     
Balance at end of period  $96,487   $91,127   $96,487   $91,127 

 

See accompanying notes to consolidated financial statements.

 

 3 

 

 

NorthWest Indiana Bancorp

Consolidated Statements of Cash Flows

(unaudited)

 

   Nine Months Ended 
(Dollars in thousands)  September 30, 
   2018   2017 
CASH FLOWS FROM OPERATING ACTIVITIES:          
Net income  $6,697   $7,075 
Adjustments to reconcile net income to net cash provided by/(used in) operating activities:          
Origination of loans for sale   (41,823)   (31,599)
Sale of loans originated for sale   39,953    32,659 
Depreciation and amortization, net of accretion   1,902    1,906 
Amortization of mortgage servicing rights   48    48 
Stock based compensation expense   154    142 
Net surrender value of restricted stock awards   (72)   - 
Gain on sale of securities, net   (1,155)   (758)
Gain on sale of loans held-for-sale, net   (1,021)   (883)
Gain on sale of foreclosed real estate, net   (154)   (95)
Provision for loan losses   950    722 
Net change in:          
Interest receivable   (298)   65 
Other assets   (345)   (538)
Accrued expenses and other liabilities   (2,544)   372 
Total adjustments   (4,405)   2,041 
Net cash - operating activities   2,292    9,116 
           
CASH FLOWS FROM INVESTING ACTIVITIES:          
Proceeds from maturities of certificates of deposits in other financial institutions   1,150    - 
Proceeds from maturities and pay downs of securities available-for-sale   17,747    18,887 
Proceeds from sales of securities available-for-sale   29,049    48,063 
Purchase of securities available-for-sale   (48,464)   (73,503)
Loan participations purchased   -    (362)
Net change in loans receivable   (28,385)   (25,260)
Purchase of Federal Home Loan Bank Stock   (17)   - 
Purchase of premises and equipment, net   (624)   (1,373)
Proceeds from sale of foreclosed real estate, net   1,273    902 
Cash and cash equivalents from acquisition activity   26,950    - 
Cash paid for acquisition   (8,689)   - 
Change in cash value of bank owned life insurance   (358)   (349)
Net cash - investing activities   (10,368)   (32,995)
           
CASH FLOWS FROM FINANCING ACTIVITIES:          
Net change in deposits   (15,180)   (22,211)
Proceeds from FHLB advances   62,000    7,000 
Repayment of FHLB advances   (44,000)   (8,000)
Change in other borrowed funds   10,718    18,541 
Dividends paid   (2,523)   (2,432)
Net cash - financing activities   11,015    (7,102)
Net change in cash and cash equivalents   2,939    (30,981)
Cash and cash equivalents at beginning of period   11,025    45,109 
Cash and cash equivalents at end of period  $13,964   $14,128 
           
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:          
Cash paid during the period for:          
Interest  $3,258   $1,832 
Income taxes   1,080    1,355 
Acquisition activity:          
Fair value of assets acquired, including cash and cash equivalents  $137,449   $- 
Value of goodwill and other intangible assets   8,481    - 
Fair value of liabilities assumed   130,313    - 
Cash paid for acquisition   8,689    - 
Issuance of common stock for acquisition   6,928    - 
Noncash activities:          
Transfers from loans to foreclosed real estate  $253   $51 

 

See accompanying notes to consolidated financial statements.

 

 4 

 

 

NorthWest Indiana Bancorp

Notes to Consolidated Financial Statements

 

Note 1 - Basis of Presentation

 

The consolidated financial statements include the accounts of NorthWest Indiana Bancorp (the “Bancorp” or “NWIN”), its wholly-owned subsidiaries NWIN Risk Management, Inc. (a captive insurance subsidiary) and Peoples Bank SB (the “Bank”), and the Bank’s wholly-owned subsidiaries, Peoples Service Corporation, NWIN, LLC, NWIN Funding, Incorporated, and Columbia Development Company, LLC. The Bancorp’s business activities include being a holding company for the Bank as well as a holding company for NWIN Risk Management, Inc. The Bancorp’s earnings are primarily dependent upon the earnings of the Bank. The accompanying unaudited consolidated financial statements were prepared in accordance with instructions for Form 10-Q and, therefore, do not include all disclosures required by U.S. generally accepted accounting principles for complete presentation of consolidated financial statements. In the opinion of management, the consolidated financial statements contain all adjustments necessary to present fairly the consolidated balance sheets of the Bancorp as of September 30, 2018 and December 31, 2017, and the consolidated statements of income, comprehensive income, and changes in stockholders’ equity for the three and nine months ended September 30, 2018 and 2017 and consolidated statements of cash flows for the nine months ended September 30, 2018 and 2017. The income reported for the nine month period ended September 30, 2018 is not necessarily indicative of the results to be expected for the full year.

 

Note 2 - Use of Estimates

 

Preparing financial statements in conformity with U.S. generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenue and expenses during the reporting period, as well as the disclosures provided. Actual results could differ from those estimates. Estimates associated with the allowance for loan losses, fair values of foreclosed real estate, loan servicing rights, investment securities, deferred tax assets, goodwill, and the status of contingencies are particularly susceptible to material change in the near term.

 

Note 3 - Acquisition Activity

 

On July 26, 2018, the Bancorp completed its previously announced acquisition of First Personal Financial Corp., a Delaware corporation (“First Personal”) pursuant to an Agreement and Plan of Merger dated February 20, 2018 (the “First Personal Merger Agreement”) between NWIN and First Personal. Pursuant to the terms of the First Personal Merger Agreement, First Personal merged with and into NWIN, with NWIN as the surviving corporation (the “First Personal Merger”). Simultaneous with the First Personal Merger, First Personal Bank, an Illinois state chartered commercial bank and wholly-owned subsidiary of First Personal, merged with and into Peoples Bank SB (“Peoples Bank”), with Peoples Bank as the surviving bank.

 

In connection with the First Personal Merger, each First Personal stockholder holding 100 or more shares of First Personal common stock received fixed consideration of (i) 0.1246 shares of NWIN common stock, and (ii) $6.67 per share in cash for each outstanding share of First Personal’s common stock. Stockholders holding less than 100 shares of First Personal common stock received $12.12 in cash and no stock consideration for each outstanding share of First Personal common stock. Any fractional shares of NWIN common stock that a First Personal stockholder would have otherwise received in the First Personal Merger were cashed out in the amount of such fraction multiplied by $42.95.

 

NWIN issued a total of 161,875 shares of NWIN common stock to the former First Personal stockholders, and paid cash consideration of approximately $8.7 million. Based upon the closing price of NWIN common stock on July 25, 2018, the transaction had an implied valuation of approximately $15.6 million.

 

As of the closing date of the First Personal Merger, First Personal reported total assets of $138.9 million, total loans of $98.0 million, and total deposits of $125.1 million. Additionally, upon the closing of the merger the three former First Personal Bank branches in Cook County, Illinois became branches of Peoples Bank, thereby expanding the Peoples Bank branch network into Illinois.

 

Consideration paid for the First Personal acquisition included $8.7 million of cash and the issuance of $6.9 million of NWIN stock in exchange for First Personal common stock. Based on preliminary valuations of the fair value of tangible and intangible assets acquired and liabilities assumed, which are based on assumptions that are subject to change, the First Personal acquisition added assets with fair values of approximately $140.5 million, including loans with a fair market value of approximately 94.6 million, and liabilities with a fair market value of approximately $130.3 million, including deposits with a fair market value of approximately $124.9 million. The amount of consideration paid, less the net fair value of assets and liabilities, resulted in goodwill of $5.4 million.

 

 5 

 

 

Final estimates of fair value on the date of acquisition have not been finalized yet. Prior to the end of the one year measurement period for finalizing the purchase price allocation, if information becomes available which would indicate adjustments are required to the purchase price allocation, such adjustments will be included in the purchase price allocation prospectively. If any adjustments are made to the preliminary assumptions (provisional amounts), disclosures will be made in the notes to the financial statements of the amounts recorded in the current period earnings by line item that have been recorded in previous reporting periods if the adjustments to the provisional amounts had been recognized as of the acquisition date.

 

On July 30, 2018, NorthWest Indiana Bancorp entered into an Agreement and Plan of Merger (the “AJSB Merger Agreement”) with AJS Bancorp, Inc., a Maryland corporation (“AJSB”). Pursuant to the AJSB Merger Agreement, AJSB will merge with and into NWIN, with NWIN as the surviving corporation (the “AJSB Merger”). Simultaneously with the AJSB Merger, A.J. Smith Federal Savings Bank, a federally chartered savings bank and wholly-owned subsidiary of AJSB (“ AJS Bank”), will merge with and into Peoples Bank SB, with Peoples Bank as the surviving bank.

 

The boards of directors of each of NWIN and AJSB have approved the AJSB Merger and the AJSB Merger Agreement. Subject to the approval of the AJSB Merger by AJSB’s stockholders, regulatory approvals, and other customary closing conditions, the parties anticipate completing the AJSB Merger early in the first quarter of 2019.

 

Upon completion of the AJSB Merger, each AJSB stockholder who holds 100 or more shares of AJSB common stock will have the right to receive fixed consideration of (i) 0.2030 shares of NWIN common stock, and (ii) $7.20 per share in cash for each outstanding share of AJSB’s common stock, subject to adjustment as provided in the AJSB Merger Agreement. Stockholders holding less than 100 shares of AJSB common stock will have the right to receive $16.00 in cash and no stock consideration for each outstanding share of AJSB common stock.

 

AJSB has a home office and two branch offices in Cook County, Illinois. As of September 30, 2018, AJS Bank reported total assets of $182.9 million, total loans of $96.8 million, and total deposits of $153.5 million. The combined bank is expected to have approximately $1.3 billion in total assets, $839.0 million in total loans, and $1.1 billion in deposits. The acquisition will further expand the Bank’s banking center network in Cook County, Illinois.

  

Note 4 – Securities

 

The estimated fair value of available-for-sale securities and the related gross unrealized gains and losses recognized in accumulated other comprehensive income were as follows:

 

   (Dollars in thousands) 
       Gross   Gross   Estimated 
   Cost   Unrealized   Unrealized   Fair 
September 30, 2018  Basis   Gains   Losses   Value 
Money market fund  $2,018   $-   $-   $2,018 
U.S. government sponsored entities   9,997    -    (229)   9,768 
Collateralized mortgage obligations and residential mortgage-backed securities   137,628    7    (4,965)   132,670 
Municipal securities   92,519    446    (1,549)   91,416 
Collateralized debt obligations   3,494    -    (1,295)   2,199 
Total securities available-for-sale  $245,656   $453   $(8,038)  $238,071 

 

   (Dollars in thousands) 
       Gross   Gross   Estimated 
   Cost   Unrealized   Unrealized   Fair 
December 31, 2017  Basis   Gains   Losses   Value 
Money market fund  $476   $-   $-   $476 
U.S. government sponsored entities   3,996    -    (106)   3,890 
Collateralized mortgage obligations and residential mortgage-backed securities   134,224    170    (1,456)   132,938 
Municipal securities   100,088    3,709    (50)   103,747 
Collateralized debt obligations   4,835    -    (1,396)   3,439 
Total securities available-for-sale  $243,619   $3,879   $(3,008)  $244,490 

 

The estimated fair value of available-for-sale debt securities at September 30, 2018, by contractual maturity, were as follows. Securities not due at a single maturity date, primarily collateralized mortgage obligations and residential mortgage-backed securities, are shown separately.

 

 6 

 

 

   (Dollars in thousands) 
   Available-for-sale 
   Estimated     
   Fair   Tax-Equivalent 
September 30, 2018  Value   Yield (%) 
Due in one year or less  $2,689    5.48 
Due from one to five years   8,580    3.18 
Due from five to ten years   16,972    4.03 
Due over ten years   77,160    4.09 
           
Collateralized mortgage obligations and residential mortgage-backed securities   132,670    2.76 
Total  $      238,071    3.32 

 

Sales of available-for-sale securities were as follows for the nine months ended:

 

   (Dollars in thousands) 
   September 30,   September 30, 
   2018   2017 
         
Proceeds  $29,049   $48,063 
Gross gains   1,159    848 
Gross losses   (4)   (90)

 

Accumulated other comprehensive income/(loss) balances, net of tax, related to available-for-sale securities, were as follows:

 

   (Dollars in thousands) 
   Unrealized
gain/(loss)
 
Ending balance, December 31, 2017  $684 
Current period change   (6,676)
Ending balance, September 30, 2018  $(5,992)

 

Securities with carrying values of approximately $13.4 million and $21.2 million were pledged as of September 30, 2018 and December 31, 2017, respectively, as collateral for repurchase agreements, public funds, and for other purposes as permitted or required by law.

 

Securities with gross unrealized losses at September 30, 2018 and December 31, 2017 not recognized in income are as follows:

 

   (Dollars in thousands) 
   Less than 12 months   12 months or longer   Total 
   Estimated       Estimated       Estimated     
   Fair   Unrealized   Fair   Unrealized   Fair   Unrealized 
September 30, 2018  Value   Losses   Value   Losses   Value   Losses 
U.S. government sponsored entities  $3,812   $(185)  $5,956   $(44)  $9,768   $(229)
Collateralized mortgage obligations and residential mortgage-backed securities   61,506    (3,133)   70,448    (1,832)   131,954    (4,965)
Municipal securities   1,683    (177)   51,144    (1,372)   52,827    (1,549)
Collateralized debt obligations   -    -    2,199    (1,295)   2,199    (1,295)
Total temporarily impaired  $67,001   $(3,495)  $129,747   $(4,543)  $196,748   $(8,038)
Number of securities        52         128         180 

 

   (Dollars in thousands) 
   Less than 12 months   12 months or longer   Total 
   Estimated       Estimated       Estimated     
   Fair   Unrealized   Fair   Unrealized   Fair   Unrealized 
December 31, 2017  Value   Losses   Value   Losses   Value   Losses 
U.S. government sponsored entities  $-   $-   $3,890   $(106)  $3,890   $(106)
Collateralized mortgage obligations and residential mortgage-backed securities   66,917    (511)   37,003    (945)   103,920    (1,456)
Municipal securities   1,790    (3)   1,815    (47)   3,605    (50)
Collateralized debt obligations   -    -    3,439    (1,396)   3,439    (1,396)
Total temporarily impaired  $68,707   $(514)  $46,147   $(2,494)  $114,854   $(3,008)
Number of securities        40         37         77 

 

Unrealized losses on securities have not been recognized into income because the securities are of high credit quality or have undisrupted cash flows. Management has the intent and ability to hold those securities for the foreseeable future, and the decline in fair value is largely due to changes in interest rates and volatility in securities markets. The fair values are expected to recover as the securities approach maturity.

 

 7 

 

  

Note 5 - Loans Receivable

 

Loans receivable are summarized below:

 

(Dollars in thousands)

   September 30, 2018   December 31, 2017 
Loans secured by real estate:          
Residential real estate   221,054    172,780 
Home equity   43,175    36,718 
Commercial real estate   243,304    211,090 
Construction and land development   54,755    50,746 
Farmland   242    - 
Multifamily   45,752    43,369 
Total loans secured by real estate   608,282    514,703 
Consumer   5,633    460 
Commercial business   102,820    77,122 
Government   25,763    28,785 
Subtotal   742,498    621,070 
Less:          
Net deferred loan origination fees   (188)   (130)
Undisbursed loan funds   (78)   (729)
Loans receivable  $742,232   $620,211 

 

 8 

 

 

(Dollars in thousands)  Beginning Balance   Charge-offs   Recoveries   Provisions   Ending Balance 
                     
The Bancorp's activity in the allowance for loan losses, by loan segment, is summarized below for the three months ended September 30, 2018:
                          
Allowance for loan losses:                         
Residential real estate  $1,523   $(30)   -   $82   $1,575 
Home equity   183    -    -    10    193 
Commercial real estate   3,170    -    22    48    3,240 
Construction and land development   611    -    -    (32)   579 
Multifamily   607    -    -    (150)   457 
Farmland   4    -    -    (1)   3 
Consumer   36    (19)   8    298    323 
Commercial business   1,264    -    8    61    1,333 
Government   50    -    -    (4)   46 
Total  $7,448   $(49)  $38   $312   $7,749 
                          
The Bancorp's activity in the allowance for loan losses, by loan segment, is summarized below for the three months ended September 30, 2017:
                          
Allowance for loan losses:                         
Residential real estate  $1,561   $(10)  $3   $17   $1,571 
Home equity   76    (35)   -    41    82 
Commercial real estate   2,890    -    -    28    2,918 
Construction and land development   600    -    -    (30)   570 
Multifamily   501    -    -    40    541 
Farmland   -    -    -    -    - 
Consumer   30    (29)   7    22    30 
Commercial business   1,357    (120)   5    49    1,291 
Government   58    -    -    (2)   56 
Total  $7,073   $(194)  $15   $165   $7,059 
                          
The Bancorp's activity in the allowance for loan losses, by loan segment, is summarized below for the nine months ended September 30, 2018:
                          
Allowance for loan losses:                         
Residential real estate  $1,568   $(136)  $-   $143   $1,575 
Home equity   166    (24)   -    51    193 
Commercial real estate   3,125    (119)   24    210    3,240 
Construction and land development   618    -    -    (39)   579 
Multifamily   622    -    -    (165)   457 
Farmland   -    -    -    3    3 
Consumer   31    (41)   17    316    323 
Commercial business   1,298    (529)   125    439    1,333 
Government   54    -    -    (8)   46 
Total  $7,482   $(849)  $166   $950   $7,749 
                          
The Bancorp's activity in the allowance for loan losses, by loan segment, is summarized below for the nine months ended September 30, 2017:
                          
Allowance for loan losses:                         
Residential real estate  $2,111   $(913)  $3   $370   $1,571 
Home equity   299    (60)   -    (157)   82 
Commercial real estate   3,113    -    -    (195)   2,918 
Construction and land development   617    -    -    (47)   570 
Multifamily   572    -    -    (31)   541 
Consumer   34    (59)   11    44    30 
Commercial business   896    (365)   22    738    1,291 
Government   56    -    -    -    56 
Total  $7,698   $(1,397)  $36   $722   $7,059 

 

 9 

 

 

The Bancorp's impairment analysis is summarized below:

 

   Ending Balances 
(Dollars in thousands)  Individually
evaluated for
impairment
reserves
  

Collectively
evaluated for

impairment

reserves

   Loan receivables  

Individually
evaluated for

impairment

  

Purchased credit
impaired
individually

evaluated for

impairment

   Collectively
evaluated for
impairment
 
                         
The Bancorp's allowance for loan losses impairment evaluation and loan receivables are summarized below at September 30, 2018:
                               
Residential real estate  $20   $1,555   $220,862   $536   $1,095   $219,231 
Home equity   9    184    43,234    147    123    42,964 
Commercial real estate   278    2,962    243,304    1,804    1,605    239,895 
Construction and land development   -    579    54,755    -    -    54,755 
Multifamily   -    457    45,752    -    -    45,752 
Farmland   -    3    242    -    -    242 
Consumer   -    323    5,633    -    -    5,633 
Commercial business   69    1,264    102,687    473    1,436    100,778 
Government   -    46    25,763    -    -    25,763 
Total  $376   $7,373   $742,232   $2,960   $4,259   $735,013 
                               
The Bancorp's allowance for loan losses impairment evaluation and loan receivables are summarized below at December 31, 2017:
                         
Residential real estate  $21   $1,547   $172,141   $462   $690   $170,989 
Home equity   -    166    36,769    -    -    36,769 
Commercial real estate   144    2,981    211,090    512    -    210,578 
Construction and land development   -    618    50,746    134    -    50,612 
Multifamily   -    622    43,368    -    -    43,368 
Farmland   -    -    -    -    -    - 
Consumer   -    31    461    -    -    461 
Commercial business   539    759    76,851    724    -    76,127 
Government   -    54    28,785    -    -    28,785 
Total  $704   $6,778   $620,211   $1,832   $690   $617,689 

 

The Bancorp's credit quality indicators are summarized below at September 30, 2018 and December 31, 2017:

 

   Credit Exposure - Credit Risk Portfolio By Creditworthiness Category 
   September 30, 2018 
(Dollars in thousands)  2   3   4   5   6   7   8     
Loan Segment  Moderate   Above average
acceptable
   Acceptable   Marginally
acceptable
   Pass/monitor   Special
mention
   Substandard   Total 
Residential real estate  $143   $55,619   $99,366   $8,920   $47,779   $4,685   $4,350   $220,862 
Home equity   108    4,552    37,472    -    126    544    432    43,234 
Commercial real estate   -    6,133    80,598    102,712    46,018    5,972    1,871    243,304 
Construction and land development   -    330    22,127    22,895    9,403    -    -    54,755 
Multifamily   -    574    19,575    23,686    1,763    154    -    45,752 
Farmland   -    -    -    -    242    -    -    242 
Commercial business   9,872    22,398    22,229    31,540    12,724    3,144    780    102,687 
Consumer   794    3,007    678    221    913    20    -    5,633 
Government   -    2,111    18,707    4,945    -    -    -    25,763 
Total  $10,917   $94,724   $300,752   $194,919   $118,968   $14,519   $7,433   $742,232 

 

   December 31, 2017 
   2   3   4   5   6   7   8     
Loan Segment  Moderate   Above average
acceptable
   Acceptable   Marginally
acceptable
   Pass/monitor   Special
mention
   Substandard   Total 
Residential real estate  $887   $12,317   $92,241   $8,759   $50,075   $4,130   $3,732   $172,141 
Home equity   -    1,065    34,871    -    250    233    350    36,769 
Commercial real estate   -    2,372    79,847    81,547    40,054    6,758    512    211,090 
Construction and land development   -    -    20,719    19,583    10,310    -    134    50,746 
Multifamily   -    -    20,159    20,965    2,076    168    -    43,368 
Farmland   -    -    -    -    -    -    -    - 
Commercial business   7,169    17,202    16,784    21,087    13,041    394    1,174    76,851 
Consumer   -    131    330    -    -    -    -    461 
Government   -    2,318    20,202    6,265    -    -    -    28,785 
Total  $8,056   $35,405   $285,153   $158,206   $115,806   $11,683   $5,902   $620,211 

 

The Bancorp has established a standard loan grading system to assist management, lenders and review personnel in their analysis and supervision of the loan portfolio. The use and application of these grades by the Bancorp is uniform and conforms to regulatory definitions. The loan grading system is as follows:

 

1 – Minimal Risk

 

Borrower demonstrates exceptional credit fundamentals, including stable and predictable profit margins, strong liquidity and a conservative balance sheet with superior asset quality. Excellent cash flow coverage of existing and projected debt service. Historic and projected performance indicates borrower is able to meet obligations under almost any economic circumstances.

 

2 – Moderate risk

 

Borrower consistently internally generates sufficient cash flow to fund debt service, working assets, and some capital expenditures. Risk of default considered low.

 

3 – Above average acceptable risk

 

Borrower generates sufficient cash flow to fund debt service and some working assets and/or capital expansion needs. Profitability and key balance sheet ratios are at or slightly above peers. Current trends are positive or stable. Earnings may be level or trending down slightly or be erratic; however, positive strengths are offsetting. Risk of default is reasonable but may warrant collateral protection.

 

4 – Acceptable risk

 

Borrower generates sufficient cash flow to fund debt service, but most working asset and all capital expansion needs are provided from external sources. Profitability ratios and key balance sheet ratios are usually close to peers but one or more ratios (e.g. leverage) may be higher than peer. Earnings may be trending down over the last three years. Borrower may be able to obtain similar financing from other banks with comparable or less favorable terms. Risk of default is acceptable but requires collateral protection.

 

 10 

 

 

5 – Marginally acceptable risk

 

Borrower may exhibit excessive growth, declining earnings, strained cash flow, increasing leverage and/or weakening market position that indicate above average risk. Limited additional debt capacity, modest coverage, and average or below average asset quality, margins and market share. Interim losses and/or adverse trends may occur, but not to the level that would affect the Bank’s position. The potential for default is higher than normal but considered marginally acceptable based on prospects for improving financial performance and the strength of the collateral.

 

6 – Pass/monitor

 

The borrower has significant weaknesses resulting from performance trends or management concerns. The financial condition of the company has taken a negative turn and may be temporarily strained. Cash flow may be weak but cash reserves remain adequate to meet debt service. Management weaknesses are evident. Borrowers in this category will warrant more than the normal level of supervision and more frequent reporting.

 

7 – Special mention (watch)

 

Special mention credits are considered bankable assets with no apparent loss of principal or interest envisioned but requiring a high level of management attention. Assets in this category are currently protected but are potentially weak. These borrowers are subject to economic, industry, or management factors having an adverse impact upon their prospects for orderly service of debt. The perceived risk in continued lending is considered to have increased beyond the level where such loans would normally be granted. These assets constitute an undue and unwarranted credit risk, but not to the point of justifying a classification of Substandard.

 

8 – Substandard

 

This classification consists of loans which are inadequately protected by the current sound worth and paying capacity of the obligor or of the collateral pledged. Financial statements normally reveal some or all of the following: poor trends, lack of earnings and cash flow, excessive debt, lack of liquidity, and the absence of creditor protection. Loans are still considered collectible, but due to increased risks and defined weaknesses of the credit, some loss could be incurred in collection if the deficiencies are not corrected.

 

Performing loans are loans that are paying as agreed and are approximately less than ninety days past due on payments of interest and principal.

 

During the first nine months of 2018, three commercial business loans totaling $355 thousand, three commercial real estate loans totaling $935 thousand, two residential real estate loans totaling $114 thousand and five home equity loans totaling $149 thousand were modified as a troubled debt restructuring. No troubled debt restructurings have subsequently defaulted during the periods presented. All of the loans classified as troubled debt restructurings are also considered impaired. The valuation basis for the Bancorp’s troubled debt restructurings is based on the present value of cash flows, unless consistent cash flows are not present, then the fair value of the collateral securing the loan is the basis for valuation.

 

 11 

 

 

The Bancorp's individually evaluated impaired loans are summarized below:

 

               For the nine months ended 
   As of September 30, 2018   September 30, 2018 
(Dollars in thousands)  Recorded
Investment
  

Unpaid Principal

Balance

   Related Allowance   Average Recorded
Investment
   Interest Income
Recognized
 
With no related allowance recorded:                         
Residential real estate  $1,518   $3,922   $-   $1,208   $61 
Home equity   212    219    -    87    1 
Commercial real estate   2,772    3,471    -    1,114    46 
Construction and land development   -    -    -    67    - 
Multifamily   -    -    -    -    - 
Farmland   -    -    -    -    - 
Commercial business   1,831    2,091    -    651    20 
Consumer   -    -    -    -    - 
Government   -    -    -    -    - 
                          
With an allowance recorded:                         
Residential real estate   113    113    20    114    4 
Home equity   58    58    9    29    - 
Commercial real estate   637    637    278    280    3 
Construction and land development   -    -    -    -    - 
Multifamily   -    -    -    -    - 
Farmland   -    -    -    -    - 
Commercial business   78    78    69    159    1 
Consumer   -    -    -    -    - 
Government   -    -    -    -    - 
                          
Total:                         
Residential real estate  $1,631   $4,035   $20   $1,322   $65 
Home equity  $270   $277   $9   $116   $1 
Commercial real estate  $3,409   $4,108   $278   $1,394   $49 
Construction & land development  $-   $-   $-   $67   $- 
Multifamily  $-   $-   $-   $-   $- 
Farmland  $-   $-   $-   $-   $- 
Commercial business  $1,909   $2,169   $69   $810   $21 
Consumer  $-   $-   $-   $-   $- 
Government  $-   $-   $-   $-   $- 

 

               For the nine months ended 
   As of December 31, 2017   September 30, 2017 
(Dollars in thousands)  Recorded
Investment
  

Unpaid Principal

Balance

   Related Allowance   Average Recorded
Investment
   Interest Income
Recognized
 
With no related allowance recorded:                         
Residential real estate  $1,072   $3,351   $-   $1,302   $48 
Home equity   -    -    -    -    - 
Commercial real estate   253    253    -    361    4 
Construction and land development   134    134    -    134    - 
Multifamily   -    -    -    -    - 
Commercial business   184    184    -    201    3 
                          
With an allowance recorded:                         
Residential real estate   80    270    21    300    1 
Home equity   -    -    -    -    - 
Commercial real estate   259    259    144    139    - 
Construction & land development   -    -    -    -    - 
Multifamily   -    -    -    -    - 
Commercial business   540    540    539    481    4 
                          
Total:                         
Residential real estate  $1,152   $3,621   $21   $1,602   $49 
Home equity  $-   $-   $-   $-   $- 
Commercial real estate  $512   $512   $144   $500   $4 
Construction & land development  $134   $134   $-   $134   $- 
Commercial business  $724   $724   $539   $682   $7 

 

As a result of acquisition activity, the Bancorp acquired loans for which there was evidence of credit quality deterioration since origination and it was determined that it was probable that the Bancorp would be unable to collect all contractually required principal and interest payments. At September 30, 2018, total purchased credit impaired loans with unpaid principal balances totaled $7.6 million with a recorded investment of $4.3 million. At December 31, 2017, purchased credit impaired loans with unpaid principal balances totaled $2.6 million with a recorded investment of $690 thousand.

 

 12 

 

 

The Bancorp's age analysis of past due loans is summarized below:

 

(Dollars in thousands)  30-59 Days Past
Due
   60-89 Days Past
Due
   Greater Than 90
Days Past Due
   Total Past Due   Current   Total Loans   Recorded
Investments
Greater than 90
Days Past Due
and Accruing
 
September 30, 2018                                   
Residential real estate  $2,329   $1,518   $3,942   $7,789   $213,073   $220,862   $885 
Home equity   225    183    164    572    42,662    43,234    50 
Commercial real estate   -    352    680    1,032    242,272    243,304    - 
Construction and land development   -    -    -    -    54,755    54,755    - 
Multifamily   -    154    -    154    45,598    45,752    - 
Farmland   -    -    -    -    242    242    - 
Commercial business   1,397    184    207    1,788    100,899    102,687    - 
Consumer   52    20    -    72    5,561    5,633    - 
Government   -    -    -    -    25,763    25,763    - 
Total  $4,003   $2,411   $4,993   $11,407   $730,825   $742,232   $935 
                                    
December 31, 2017                                   
Residential real estate  $4,921   $1,751   $3,092   $9,764   $162,377   $172,141   $225 
Home equity   295    18    234    547    36,222    36,769    2 
Commercial real estate   951    96    332    1,379    209,711    211,090    - 
Construction and land development   -    -    133    133    50,613    50,746    - 
Multifamily   319    -    -    319    43,049    43,368    - 
Farmland   -    -    -    -    -    -    - 
Commercial business   285    162    539    986    75,865    76,851    - 
Consumer   1    -    -    1    460    461    - 
Government   -    -    -    -    28,785    28,785    - 
Total  $6,772   $2,027   $4,330   $13,129   $607,082   $620,211   $227 

 

The Bancorp's loans on nonaccrual status are summarized below:

 

(Dollars in thousands) 

   September 30,
2018
   December 31,
2017
 
Residential real estate  $3,861   $3,509 
Home equity   328    350 
Commercial real estate   768    332 
Construction and land development   -    133 
Multifamily   -    - 
Farmland   -    - 
Commercial business   514    672 
Consumer   -    - 
Government   -    - 
Total  $5,471   $4,996 

 

For the acquisitions of First Federal Savings & Loan (“First Federal”), Liberty Savings Bank (“Liberty Savings”), and First Personal Bank (“First Personal”), as part of the fair value of loans receivable, a net fair value discount was established for loans as summarized below:

 

(dollars in thousands)  First Federal   Liberty Savings   First Personal 
  Net fair value
discount
   Accretable period
in months
   Net fair value
discount
   Accretable period
in months
   Net fair value
discount
   Accretable period
 in months
 
Residential real estate  $1,100    55   $1,200    44   $948    56 
Home equity   -    -    -    -    51    50 
Commercial real estate   -    -    -    -    208    56 
Construction and land development   -    -    -    -    1    30 
Multifamily   -    -    -    -    11    48 
Consumer   -    -    -    -    146    50 
Commercial business   -    -    -    -    348    24 
Purchased credit impaired loans   -    -    -    -    424    32 
Total  $1,100        $1,200        $2,137      

 

Accretable yield, or income collected for the nine months ended September 30, is as follows:

 

(dollars in thousands)  First Federal   Liberty Savings   First Personal   Total 
2017  $112   $239   $-   $351 
2018   105    200    114                419 

 

Accretable yield, or income expected to be collected is as follows:

 

(dollars in thousands)  First Federal   Liberty Savings   First Personal   Total 
Remainder 2018  $33   $65   $157   $255 
2019   22    43    627    692 
2020   -    -    554    554 
2021   -    -    335    335 
2022   -    -    283    283 
2023   -    -    67    67 
Total  $55   $108   $2,023   $            2,186 

 

 13 

 

 

Note 6 - Foreclosed Real Estate

 

Foreclosed real estate at period-end is summarized below:

 

   (Dollars in thousands) 
   September 30, 2018   December 31, 2017 
Residential real estate  $1,311   $914 
Commercial real estate   126    97 
Construction and land development   468    468 
Commercial business   220    220 
Total  $2,125   $1,699 

 

Note 7 – Intangibles and Acquisition Related Accounting

 

The Bancorp established a goodwill balance totaling $8.2 million with the acquisitions of First Personal, First Federal and Liberty Savings. Goodwill of $5.4 million, $2.0 million, and $804 thousand were established with the acquisition of First Personal, First Federal, and Liberty Savings, respectively. Goodwill is tested annually for impairment. Goodwill arising from business combinations represents the value attributable to unidentifiable intangible assets in the business acquired. The Bancorp’s goodwill relates to the value inherent in the banking industry and that value is dependent upon the ability of the Bancorp to provide quality, cost effective banking services in a competitive marketplace. If the implied fair value of goodwill is lower than its carrying amount, goodwill impairment is indicated and goodwill is written down to its implied fair value. There has not been any impairment of goodwill identified or recorded. Goodwill totaled $8.2 million and $2.8 million as of September 30, 2018 and December 31, 2017, respectively.

 

In addition to goodwill, a core deposit intangible of $93 thousand for the acquisition of First Federal was established and is being amortized over 7.9 years on a straight line basis. A core deposit intangible of $471 thousand for the acquisition of Liberty Savings was established and is being amortized over 8.2 years on a straight line basis. A core deposit intangible of $3.0 million for the acquisition of First Personal was established and is being amortized over 6.4 years on a straight line basis. The table below summarizes the annual amortization:

 

(dollars in thousands)  First Federal   Liberty Savings   First Personal   Total 
Current period  $8   $38   $79   $125 
Remainder 2018   4    20    119    143 
2019   12    58    475    545 
2020   12    58    475    545 
2021   12    58    475    545 
2022   1    58    475    534 
2023   -    38    475    513 
2024   -    -    470    470 
Total  $49   $328   $3,043   $             3,420 

 

For the First Personal acquisition, as part of the fair value of certificates of deposit, a fair value premium was established of $133 thousand that is being amortized over 8 months on a straight line basis. Approximately $32 thousand of amortization was taken as expense during the nine months ended September 30, 2018. It is estimated that an additional $48 thousand of amortization will occur during 2018 and an additional $53 thousand of amortization will occur during 2019.

 

As part of the First Personal acquisition, the Bancorp acquired First Personal Statutory Trust I. NWIN guarantees the payment of distributions on the trust preferred securities issued by First Personal Statutory Trust I. First Personal Statutory Trust I issued $4.124 million in trust preferred securities in May 2004. The trust preferred securities carry a variable rate of interest priced at the three-month LIBOR plus 275 basis points, payable quarterly and maturing on June 17, 2034. Proceeds from the issuance of these securities were used to purchase junior subordinated debentures with the same financial terms as the trust preferred securities issued by First Personal Statutory Trust I. Management of the Bancorp has determined that the continued maintenance of the trust preferred securities issued by First Personal Statutory Trust I and the corresponding junior subordinated debentures are unnecessary to the Bancorp’s ongoing operations. As a result, the Bancorp’s board of directors has approved the redemption of the junior subordinated debentures, which also will result in the trustee of the First Personal Statutory Trust I redeeming all $4.124 million of the trust preferred securities. The junior subordinated debentures and trust preferred securities will be redeemed on or before December 31, 2018, and therefore, the fair value of the trust preferred securities approximated their carrying value.

 

Note 8 - Concentrations of Credit Risk

 

The primary lending area of the Bancorp encompasses Lake County in northwest Indiana and Cook County in northeast Illinois, where collectively a majority of loan activity is concentrated. The Bancorp is also an active lender in Porter County, and to a lesser extent, LaPorte, Newton and Jasper counties in Indiana; and Lake and Will counties in Illinois. Substantially all loans are secured by specific items of collateral including residences, commercial real estate, land development, business assets and consumer assets.

 

 14 

 

 

Note 9 - Earnings per Share

 

Earnings per common share is computed by dividing net income by the weighted-average number of common shares outstanding. A reconciliation of the numerators and denominators of the basic and diluted earnings per common share computations for the three and nine months ended September 30, 2018 and 2017 are as follows:

 

   Three Months Ended   Nine Months Ended 
(Dollars in thousands, except per share data)  September 30,   September 30, 
   2018   2017   2018   2017 
Basic earnings per common share:                    
Net income as reported  $1,625   $2,248   $6,697   $7,075 
Weighted average common shares outstanding   3,029,369    2,864,007    2,922,271    2,863,806 
Basic earnings per common share  $0.54   $0.78   $2.29   $2.47 
Diluted earnings per common share:                   
Net income as reported  $1,625   $2,248   $6,697   $7,075 
Weighted average common shares outstanding   3,029,369    2,864,007    2,922,271    2,863,806 
Add: Dilutive effect of assumed stock option exercises   -    155    -    147 
Weighted average common and dilutive potential common shares outstanding   3,029,369    2,864,162    2,922,271    2,863,953 
Diluted earnings per common share  $0.54   $0.78   $2.29   $2.47 

 

Note 10 - Stock Based Compensation

 

The Bancorp’s 2015 Stock Option and Incentive Plan (the Plan), which was adopted by the Bancorp’s Board of Directors on February 27, 2015 and approved by the Bancorp’s shareholders on April 24, 2015, permits the grant of equity awards for up to 250,000 shares of common stock. Awards granted under the Plan may be in the form of incentive stock options, non-qualified stock options, restricted stock, unrestricted stock, performance shares, or performance units.

 

As required by the Stock Compensation Topic, companies are required to record compensation cost for stock options and awards provided to employees in return for employment service. For the nine months ended September 30, 2018, stock based compensation expense of $154 thousand was recorded, compared to $142 thousand for the nine months ended September 30, 2017. It is anticipated that current outstanding unvested awards will result in additional compensation expense of approximately $441 thousand through 2022 with an additional $50 thousand in 2018, $184 thousand in 2019, $150 thousand in 2020, $54 thousand in 2021 and $3 thousand in 2022.

 

There were no incentive stock options granted during the first nine months of 2018 or 2017. When options are granted, the cost is measured at the fair value of the options when granted, and this cost is expensed over the employment service period, which is normally the vesting period of the options or awards. At September 30, 2018, there were no outstanding incentive stock options.

 

There were 4,433 shares of restricted stock granted during the first nine months of 2018 compared to 4,575 shares granted during the first nine months of 2017. Restricted stock awards are issued with an award price equal to the market price of the Bancorp’s common stock on the award date and vest between three and five years after the grant date. Forfeiture provisions exist for personnel that separate employment before the vesting period expires. A summary of restricted stock activity under the Bancorp’s incentive stock option and incentive plans described above for the year ended December 31, 2017 and nine months ended September 30, 2018 follows:

 

       Weighted 
       Average 
       Grant 
       Date 
Non-vested Shares  Shares   Fair Value 
Non-vested at January 1, 2017   28,465   $26.67 
Granted   4,575    39.00 
Vested   (1,625)   25.81 
Forfeited   (725)   28.62 
Non-vested at December 31, 2017   30,690   $28.51 
           
Non-vested at January 1, 2018   30,690   $28.51 
Granted   4,433    43.50 
Vested   (7,700)   22.64 
Forfeited   -    - 
Non-vested at September 30, 2018   27,423   $32.58 

 

 15 

 

 

Note 11 – Change in Accounting Principles

 

In May 2014, FASB issued Accounting Standards Update (ASU) No. 2014-09 and ASU 2015-14, Revenue from Contracts with Customers (Topic 606), superseding the current revenue recognition requirements in Topic 605, Revenue Recognition. The ASU is based on the principle that revenue is recognized to depict the transfer of goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. The ASU also requires additional disclosure about the nature, amount, timing, and uncertainty of revenue and cash flows arising from customer contracts, including significant judgments and changes in judgments and assets recognized from costs incurred to obtain or fulfill a contract. The new guidance is effective for the Bancorp's year ending December 31, 2018 and has been adopted as of January 1, 2018. The use of the modified retrospective approach has been used for implementing this standard. Interest income is outside of the scope of the new standard and was not impacted by the adoption of the standard. Management mapped noninterest income accounts to their associated income streams and applied the five step model to identify the contract, identify the performance obligations in the contract, determine the total transaction price, allocate the transaction price to each performance obligation, and ensure revenue is recognized when the performance obligation is satisfied. A review of the Bancorp’s noninterest income has not resulted in a change in revenue recognition since adoption.

 

In January 2016, FASB issued Accounting Standards Update (ASU) No. 2016-01, Recognition and Measurement of Financial Assets and Financial Liabilities. The ASU covers various changes to the accounting, measurement, and disclosures related to certain financial instruments, including requiring equity investments to be accounted for at fair value with changes recorded through earnings, the use of the exit price when measuring fair value, and disaggregation of financial assets and liabilities by category for disclosure purposes. The new guidance is effective for the Bancorp's year ending December 31, 2018 and was adopted on January 1, 2018. The adoption of this ASU has not had a material impact on the consolidated financial statements, as the Bancorp does not hold any equity securities with unrealized gains or losses. The new reporting requirements have been incorporated into the fair value of financial instruments table and disclosures.

 

In March 2016, FASB issued ASU No. 2016-09: Compensation—Stock Compensation (Topic 718)—Improvements to Employee Share-Based Payment Accounting. This ASU seeks to reduce complexity in accounting standards. The areas for simplification in ASU No. 2016-09, identified through outreach for the Simplification Initiative, pre-agenda research for the Private Company Council, and the August 2014 Post-Implementation Review Report on FASB Statement No. 123(R), Share-Based Payment, involve several aspects of the accounting for share-based payment transactions, including (1) accounting for income taxes, (2) classification of excess tax benefits on the statement of cash flow, (3) forfeitures; (4) minimum statutory tax withholding requirements, (5) classification of employee taxes paid on the statement of cash flows when an employer withholds shares for tax withholding purposes, (6) the practical expedient for estimating the expected term, and (7) intrinsic value. The Bancorp adopted this ASU during 2017, and the adoption of this ASU has not had a material impact on the consolidated financial statements.

 

Note 12 - Upcoming Accounting Standards

 

In February 2016, FASB issued ASU No. 2016-02, Leases, which will supersede the current lease requirements in ASC 840. The ASU requires lessees to recognize a right-of-use asset and related lease liability for all leases, with a limited exception for short-term leases. Leases will be classified as either finance or operating, with the classification affecting the pattern of expense recognition in the statement of operations. Currently, leases are classified as either capital or operating, with only capital leases recognized on the balance sheet. The reporting of lease-related expenses in the statements of operations and cash flows will be generally consistent with the current guidance. The new lease guidance will be effective for the Bancorp's year ending December 31, 2019 and will be applied using a modified retrospective transition method to the beginning of the earliest period presented. Management does not believe the adoption of this update will have a material effect on the Bancorp’s consolidated financial statements, as the Bancorp does not engage in the leasing of property or in leasing of any significant furniture, fixtures, equipment, or software.

 

 16 

 

 

In June 2016, FASB issued ASU No. 2016-13, Financial Instruments - Credit Losses: Measurement of Credit Losses on Financial Instruments. The ASU includes increased disclosures and various changes to the accounting and measurement of financial assets including the Bancorp’s loans and available-for-sale and held-to-maturity debt securities. Each financial asset presented on the balance sheet would have a unique allowance for credit losses valuation account that is deducted from the amortized cost basis to present the net carrying value at the amount expected to be collected on the financial asset. The amendments in this ASU also eliminate the probable initial recognition threshold in current GAAP and instead, reflect an entity’s current estimate of all expected credit losses using reasonable and supportable forecasts. The new credit loss guidance will be effective for the Bancorp's year ending December 31, 2020. Upon adoption, the ASU will be applied using a modified retrospective transition method to the beginning of the first reporting period in which the guidance is effective. A prospective transition approach is required for debt securities for which an other-than-temporary impairment had been recognized before the effective date. Early adoption for all institutions is permitted for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. Management is in the process of evaluating the impact adoption of this update will have on the Bancorp’s consolidated financial statements. This process of evaluation has engaged multiple areas of the Bancorp’s management in discussing loss estimation methods and the application of these methods to specific segments of the loans receivable portfolio. Given the amount of time left to adoption, the appropriateness of the loss estimation methods chosen, and the continuing development of understanding of application, additional time is needed to fully understand how this ASU will impact the Bancorp’s financial statements.

 

In January 2017, the FASB issued ASU 2017-04, Intangibles – Goodwill and Other (Topic 350): Simplifying the Test for Goodwill Impairment. This Standard simplifies the manner in which an entity is required to test goodwill for impairment by eliminating Step 2 from the goodwill impairment test. Step 2 measures a goodwill impairment loss by comparing the implied fair value of a reporting unit’s goodwill with the carrying amount of that goodwill. In computing the implied fair value of goodwill under Step 2, an entity, prior to the amendments in ASU No. 2017-04, had to perform procedures to determine the fair value at the impairment testing date of its assets and liabilities, including unrecognized assets and liabilities, in accordance with the procedure that would be required in determining the fair value of assets acquired and liabilities assumed in a business combination. However, under the amendments in this ASU, an entity should (1) perform its annual or interim goodwill impairment test by comparing the fair value of a reporting unit with its carrying amount, and (2) recognize an impairment charge for the amount by which the carrying amount exceeds the reporting unit’s fair value, with the understanding that the loss recognized should not exceed the total amount of goodwill allocated to that reporting unit. Additionally, ASU No. 2017-04 removes the requirements for any reporting unit with a zero or negative carrying amount to perform a qualitative assessment and, if it fails such qualitative test, to perform Step 2 of the goodwill impairment test. Finally, this ASU amends the Overview and Background sections of the Accounting Standards Codification as part of the FASB’s initiative to unify and improve such sections across Topics and Subtopics. The new guidance will be effective for the Company’s year ending December 31, 2020.

 

In March 2017, the FASB issued ASU 2017-08, Receivables—Nonrefundable Fees and Other Costs (Subtopic 310-20): Premium Amortization on Purchased Callable Debt Securities. This Standard amends the amortization period for certain purchased callable debt securities held at a premium. In particular, the amendments in this ASU require the premium to be amortized to the earliest call date. The amendments do not, however, require an accounting change for securities held at a discount; instead, the discount continues to be amortized to maturity. The amendments in this ASU more closely align the amortization period of premiums and discounts to expectations incorporated in market pricing on the underlying securities. In fact, in most cases, market participants price securities to the call date that produces the worst yield when the coupon is above current market rates (i.e., the security is trading at a premium), and price securities to maturity when the coupon is below market rates (i.e., the security is trading at a discount), in anticipation that the borrower will act in its economic best interest. The new guidance will be effective for the Company’s year ending December 31, 2020. Management will recognize amortization expense as dictated by the amount of premiums and the differences between maturity and call dates at the time of adoption.

 

Note 13 - Fair Value

 

The Fair Value Measurements Topic establishes a hierarchy that requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. The Topic describes three levels of inputs that may be used to measure fair value:

 

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.

  

 17 

 

 

The fair values of securities available-for-sale are determined on a recurring basis by obtaining quoted prices on nationally recognized securities exchanges or pricing models utilizing significant observable inputs such as matrix pricing, which is a mathematical technique widely used in the industry to value debt securities without relying exclusively on quoted prices for the specific securities but rather by relying on the securities’ relationship to other benchmark quoted securities. Different judgments and assumptions used in pricing could result in different estimates of value. In certain cases where market data is not readily available because of a lack of market activity or little public disclosure, values may be based on unobservable inputs and classified in Level 3 of the fair value hierarchy.

 

At the end of each reporting period, securities held in the investment portfolio are evaluated on an individual security level for other-than-temporary impairment in accordance with the Investments – Debt and Equity Securities Topic. Impairment is other-than-temporary if the decline in the fair value is below its amortized cost and it is probable that all amounts due according to the contractual terms of a debt security will not be received. Significant judgments are required in determining impairment, which include making assumptions regarding the estimated prepayments, loss assumptions and the change in interest rates. The Bancorp considers the following factors when determining an other-than-temporary impairment for a security: the length of time and the extent to which the market value has been less than amortized cost; the financial condition and near-term prospects of the issuer; the underlying fundamentals of the relevant market and the outlook for such market for the near future; an assessment of whether the Bancorp (1) has the intent to sell the debt securities or (2) more likely than not will be required to sell the debt securities before their anticipated market recovery. If either of these conditions is met, management will recognize other-than-temporary impairment. If, in management’s judgment, an other-than-temporary impairment exists, the cost basis of the security will be written down for the credit loss, and the unrealized loss will be transferred from accumulated other comprehensive loss as an immediate reduction of current earnings.

 

The Bancorp’s management utilizes a specialist to perform an other-than-temporary impairment analysis for each of its pooled trust preferred securities. The analysis is performed annually during December and utilizes analytical models used to project future cash flows for the pooled trust preferred securities based on current assumptions for prepayments, default and deferral rates, and recoveries. The projected cash flows are then tested for impairment consistent with the Investments – Other Topic and the Investments – Debt and Equity Securities Topic. The other-than-temporary impairment testing compares the present value of the cash flows from quarter to quarter to determine if there is a “favorable” or “adverse” change. Other-than-temporary impairment is recorded if the projected present value of cash flows is lower than the book value of the security. To perform the annual other-than-temporary impairment analysis, management utilizes current reports issued by the trustee, which contain principal and interest tests, waterfall distributions, note valuations, collection detail and credit ratings for each pooled trust preferred security. In addition, a detailed review of the performing collateral was performed. Based on current market conditions and a review of the trustee reports, management performed an analysis of the pooled trust preferred securities and no additional impairment was taken at December 31, 2017. During the second quarter of 2018, upon management review, the Bancorp decided to review for trust preferred security impairment annually, a change from semi-annual review previously disclosed. A specialist will be used to review all pooled trust preferred securities again at December 31, 2018.

 

The table below shows the credit loss roll forward on a year-to-date basis for the Bancorp’s pooled trust preferred securities that have been classified with other-than-temporary impairment:

 

   Collateralized 
   debt obligations 
   other-than-temporary 
(Dollars in thousands)  impairment 
Ending balance, December 31, 2017  $271 
Additions not previously recognized   - 
Ending balance, September 30, 2018  $271 

 

At September 30, 2018, trust preferred securities with a cost basis of $3.5 million continue to be in “payment in kind” status. These trust preferred securities classified as “payment in kind” are a result of not receiving the scheduled quarterly interest payments. For these trust preferred securities in “payment in kind” status, management anticipates to receive the unpaid contractual interest payments from the issuer, because of the self-correcting cash flow waterfall provisions within the structure of the securities. When a tranche senior to the Bancorp’s position fails the coverage test, the Bancorp’s interest cash flows are paid to the senior tranche and recorded as a reduction of principal. The coverage test represents an over collateralization target by stating the balance of the performing collateral as a percentage of the balance of the Bancorp’s tranche, plus the balance of all senior tranches. The principal reduction in the senior tranche continues until the appropriate coverage test is passed. As a result of the principal reduction in the senior tranche, more cash is available for future payments to the Bancorp’s tranche. Consistent with the Investments – Debt and Equity Securities Topic, management considered the failure of the issuer of the security to make scheduled interest payments in determining whether a credit loss existed. Management will not capitalize the “payment in kind” interest payments to the book value of the securities and will keep these securities in non-accrual status until the quarterly interest payments resume on a consistent basis.

  

 18 

 

 

Assets and Liabilities Measured at Fair Value on a Recurring Basis

 

There were no transfers to or from Levels 1 and 2 during the nine months ended September 30, 2018. Assets measured at fair value on a recurring basis are summarized below:

 

       Fair Value Measurements at September 30, 2018 Using 
(Dollars in thousands)  Estimated
Fair
Value
   Quoted Prices in
Active Markets
for Identical
Assets
(Level 1)
   Significant Other
Observable
Inputs
(Level 2)
   Significant
Unobservable
Inputs
(Level 3)
 
Available-for-sale debt securities:                    
Money market fund  $2,018   $2,018   $-   $- 
U.S. government sponsored entities   9,768    -    9,768    - 
Collateralized mortgage obligations and  residential mortgage-backed securities   132,670    -    132,670    - 
Municipal securities   91,416    -    91,416    - 
Collateralized debt obligations   2,199    -    -    2,199 
Total securities available-for-sale  $238,071   $2,018   $233,854   $2,199 

 

       Fair Value Measurements at December 31, 2017 Using 
(Dollars in thousands)  Estimated
Fair
Value
   Quoted Prices in
Active Markets
for Identical
Assets
(Level 1)
   Significant Other
Observable
Inputs
(Level 2)
   Significant
Unobservable
Inputs
(Level 3)
 
Available-for-sale debt securities:                    
Money market fund  $476   $476   $-   $- 
U.S. government sponsored entities   3,890    -    3,890    - 
Collateralized mortgage obligations and  residential mortgage-backed securities   132,938    -    132,938    - 
Municipal securities   103,747    -    103,747    - 
Collateralized debt obligations   3,439    -    -    3,439 
Total securities available-for-sale  $244,490   $476   $240,575   $3,439 

 

A roll forward of available-for-sale securities, which require significant adjustment based on unobservable data, are presented in the following table:

 

(Dollars in thousands)  Estimated Fair Value
Measurements Using
Significant Unobservable
Inputs (Level 3)
 
   Available-for-
sale securities
 
Beginning balance, January 1, 2017  $2,409 
Principal payments   (154)
Total unrealized gains, included in other comprehensive income   1,184 
Transfers in and/or (out) of Level 3   - 
Ending balance, December 31, 2017  $3,439 
      
Beginning balance, January 1, 2018  $3,439 
Principal payments   (38)
Total unrealized gains, included in other comprehensive income   101 
Sale out of Level 3   (1,303)
Ending balance, September 30, 2018  $2,199 

 

 19 

 

 

Assets measured at fair value on a non-recurring basis are summarized below:

 

       (Dollars in thousands) 
       Fair Value Measurements at September 30, 2018 Using 
(Dollars in thousands)  Estimated
Fair
Value
   Quoted Prices in
Active Markets
for Identical
Assets
(Level 1)
   Significant Other
Observable
Inputs
(Level 2)
   Significant
Unobservable
Inputs
(Level 3)
 
Impaired loans  $6,843   $     -   $       -   $6,843 
Foreclosed real estate   2,125    -    -    2,125 

 

       (Dollars in thousands) 
       Fair Value Measurements at December 31, 2017 Using 
(Dollars in thousands)  Estimated
Fair
Value
   Quoted Prices in
Active Markets
for Identical
Assets
(Level 1)
   Significant Other
Observable
Inputs
(Level 2)
   Significant
Unobservable
Inputs
(Level 3)
 
Impaired loans  $1,818   $     -   $      -   $1,818 
Foreclosed real estate   1,699    -    -    1,699 

 

The fair value of impaired loans with specific allocations of the allowance for loan losses or loans for which charge-offs have been taken is generally based on a present value of cash flows or, for collateral dependent loans, based on recent real estate appraisals. Appraisals may utilize a single valuation approach or a combination of approaches including comparable sales and the income approach. The recorded investment in impaired loans was approximately $7.2 million and the related specific reserves totaled approximately $376 thousand, resulting in a fair value of impaired loans totaling approximately $6.8 million, at September 30, 2018. The recorded investment of impaired loans was approximately $2.5 million and the related specific reserves totaled approximately $704 thousand, resulting in a fair value of impaired loans totaling approximately $1.8 million, at December 31, 2017. Fair value is determined, where possible, using market prices derived from an appraisal or evaluation, which are considered to be Level 2 inputs. However, certain assumptions and unobservable inputs are often used by the appraiser, therefore, qualifying the assets as Level 3 in the fair value hierarchy. The fair value of foreclosed real estate is similarly determined by using the results of recent real estate appraisals. The numerical range of unobservable inputs for these valuation assumptions is not meaningful to this presentation.

 

The following table shows carrying values and related estimated fair values of financial instruments as of the dates indicated. Estimated fair values are further categorized by the inputs used to measure fair value. Items that are not financial instruments are not included.

 

   September 30, 2018   Estimated Fair Value Measurements at September 30, 2018 Using 
(Dollars in thousands)  Carrying
Value
   Estimated
Fair Value
   Quoted Prices in
 Active Markets for
Identical Assets
(Level 1)
   Significant
Other Observable
Inputs
(Level 2)
   Significant
Unobservable
Inputs
(Level 3)
 
Financial assets:                         
Cash and cash equivalents  $13,964   $13,964   $13,964   $-   $- 
Certificates of deposit in other financial institutions   3,754    3,673    -    3,673    - 
Securities available-for-sale   238,071    238,071    2,018    233,854    2,199 
Loans held-for-sale   4,483    4,566    4,566    -    - 
Loans receivable, net   734,483    717,640    -    -    717,640 
Federal Home Loan Bank stock   3,236    3,236    -    3,236    - 
Accrued interest receivable   3,560    3,560    -    3,560    - 
                          
Financial liabilities:                         
Non-interest bearing deposits   134,449    134,449    134,449    -    - 
Interest bearing deposits   768,307    765,232    514,311    250,921    - 
Repurchase agreements   12,585    12,580    10,823    1,757    - 
Borrowed funds   48,314    48,698    13,766    34,932    - 
Interest rate swap agreements   111    111    -    111    - 
Accrued interest payable   110    110    -    110    - 

 

 20 

 

 

   December 31, 2017   Estimated Fair Value Measurements at December 31, 2017 Using 
(Dollars in thousands)  Carrying
Value
   Estimated
Fair Value
   Quoted Prices in
 Active Markets for
Identical Assets
(Level 1)
   Significant
Other Observable
Inputs
(Level 2)
   Significant
Unobservable
Inputs
(Level 3)
 
Financial assets:                         
Cash and cash equivalents  $11,025   $11,025   $11,025   $-   $- 
Certificates of deposit in other financial institutions   1,676    1,640    -    1,640    - 
Securities available-for-sale   244,490    244,490    476    240,575    3,439 
Loans held-for-sale   1,592    1,625    1,625    -    - 
Loans receivable, net   612,729    608,506    -    -    608,506 
Federal Home Loan Bank stock   3,000    3,000    -    3,000    - 
Accrued interest receivable   3,262    3,262    -    3,262    - 
                          
Financial liabilities:                         
Non-interest bearing deposits   120,556    120,556    120,556    -    - 
Interest bearing deposits   672,448    670,967    488,528    182,439    - 
Repurchase agreements   11,300    11,292    9,545    1,747    - 
Borrowed funds   20,881    20,818    600    20,218    - 
Accrued interest payable   42    42    -    42    - 

 

The following methods were used to estimate the fair value of financial instruments presented in the preceding table for the period ended September 30, 2018:

 

Cash and cash equivalents carrying amounts approximate fair value. Certificates of deposit in other financial institutions carrying amounts approximate fair value (Level 2).The fair values of securities available-for-sale are obtained from broker pricing (Level 2), with the exception of collateralized debt obligations, which are valued by a third-party specialist (Level 3). Loans held-for-sale comprise residential mortgages and are priced based on values established by the secondary mortgage markets (Level 1). The estimated fair value for net loans receivable is based on an exit price basis incorporating discounts for credit, liquidity, and marketability factors (Level 3). This is not comparable with the fair values disclosed for December 31, 2017, which were based on estimates of the rate the Bancorp would charge for similar such loans, applied for the time period until estimated repayment, in addition to appraisals which may utilize a single valuation approach or a combination of approaches including comparable sales and the income approach. Federal Home Loan Bank stock is estimated at book value due to restrictions that limit the sale or transfer of the security. Fair value of accrued interest receivable and payable approximates book value, as the carrying values are determined using the observable interest rate, balance, and last payment date.

 

Non-interest and interest bearing deposits, which include checking, savings, and money market deposits, are estimated to have fair values based on the amount payable as of the reporting date (Level 1). The fair value of fixed-maturity certificates of deposit (included in interest bearing deposits) are based on estimates of the rate the Bancorp would pay on similar deposits, applied for the time period until maturity (Level 2). Estimated fair values for short-term repurchase agreements, which represent sweeps from demand deposits to accounts secured by pledged securities, are estimated based on the amount payable as of the reporting date (Level 1). Longer-term repurchase agreements, with contractual maturity dates of quarter or more, are based on estimates of the rate the Bancorp would pay on similar deposits, applied for the time period until maturity (Level 2). Short-term borrowings are generally only held overnight, therefore, their carrying amount is a reasonable estimate of fair value (Level 1). The fair value of FHLB Advances (included in borrowed funds) are estimated by discounting the future cash flows using quoted rates from the FHLB for similar advances with similar maturities (Level 2). The estimated fair value of other financial instruments, and off-balance sheet loan commitments, approximate cost and are not considered significant to this presentation.

 

The following methods were used to estimate the fair value of financial instruments presented in the preceding table for the period ended December 31, 2017:

 

Cash and cash equivalent carrying amounts approximate fair value. Certificates of deposit in other financial institutions carrying amounts approximate fair value (Level 2). The fair values of securities available-for-sale are obtained from broker pricing (Level 2), with the exception of collateralized debt obligations, which are valued by a third-party specialist (Level 3). Loans held-for-sale comprise residential mortgages and are priced based on values established by the secondary mortgage markets (Level 1). The estimated fair value for net loans receivable is based on estimates of the rate the Bancorp would charge for similar such loans, applied for the time period until estimated repayment, in addition to appraisals which may utilize a single valuation approach or a combination of approaches including comparable sales and the income approach (Level 3). Federal Home Loan Bank stock is estimated at book value due to restrictions that limit the sale or transfer of the security. Fair values of accrued interest receivable and payable approximate book value, as the carrying values are determined using the observable interest rate, balance, and last payment date.

  

 21 

 

 

Non-interest and interest bearing deposits, which include checking, savings, and money market deposits, are estimated to have fair values based on the amount payable as of the reporting date (Level 1). The fair value of fixed-maturity certificates of deposit (included in interest bearing deposits) are based on estimates of the rate the Bancorp would pay on similar deposits, applied for the time period until maturity (Level 2). Estimated fair values for short-term repurchase agreements, which represent sweeps from demand deposits to accounts secured by pledged securities, are estimated based on the amount payable as of the reporting date (Level 1). Longer-term repurchase agreements, with contractual maturity dates of three months or more, are based on estimates of the rate the Bancorp would pay on similar deposits, applied for the time period until maturity (Level 2). Short-term borrowings are generally only held overnight, therefore, their carrying amount is a reasonable estimate of fair value (Level 1). The fair value of FHLB Advances are estimated by discounting the future cash flows using quoted rates from the FHLB for similar advances with similar maturities (Level 2). The estimated fair value of other financial instruments, and off-balance sheet loan commitments, approximate cost and are not considered significant to this presentation.

   

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

 

Summary

 

NorthWest Indiana Bancorp (the “Bancorp”) is a financial holding company registered with the Board of Governors of the Federal Reserve System. Peoples Bank SB (“the Bank”), an Indiana savings bank, and NWIN Risk Management, Inc., a captive insurance company, are wholly-owned subsidiaries of the Bancorp. The Bancorp has no other business activity other than being a holding company for the Bank and NWIN Risk Management, Inc. The following management’s discussion and analysis presents information concerning our financial condition as of September 30, 2018, as compared to December 31, 2017, and the results of operations for the quarter and nine months ending September 30, 2018, and September 30, 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.

 

At September 30, 2018, the Bancorp had total assets of $1.1 billion, total loans receivable of $742.2 million and total deposits of $902.8 million. Stockholders' equity totaled $96.5 million or 8.99% of total assets, with a book value per share of $31.85. Net income for the quarter ended September 30, 2018, was $1.6 million, or $0.54 earnings per common share for both basic and diluted calculations. For the quarter ended September 30, 2018, the return on average assets (ROA) was 0.62%, while the return on average stockholders’ equity (ROE) was 6.70%. Net income for the nine months ended September 30, 2018, was $6.7 million, or $2.29 earnings per common share for both basic and diluted calculations. For the nine months ended September 30, 2018, the ROA was 0.92%, while the ROE was 9.56%.

 

Recent Developments

 

Acquisition of First Personal Financial Corp. On July 26, 2018, the Bancorp completed its previously announced acquisition of First Personal Financial Corp., a Delaware corporation (“First Personal”) pursuant to an Agreement and Plan of Merger dated February 20, 2018 (the “First Personal Merger Agreement”) between the Bancorp and First Personal. Pursuant to the terms of the First Personal Merger Agreement, First Personal merged with and into the Bancorp, with the Bancorp as the surviving corporation (the “First Personal Merger”). Simultaneous with the First Personal Merger, First Personal Bank, an Illinois state chartered commercial bank and wholly-owned subsidiary of First Personal, merged with and into Peoples Bank SB, with Peoples Bank as the surviving bank.

 

In connection with the First Personal Merger, each First Personal stockholder holding 100 or more shares of First Personal common stock received fixed consideration of (i) 0.1246 shares of Bancorp common stock, and (ii) $6.67 per share in cash for each outstanding share of First Personal common stock. Stockholders holding less than 100 shares of First Personal common stock received $12.12 in cash and no stock consideration for each outstanding share of First Personal common stock. Any fractional shares of Bancorp common stock that a First Personal stockholder would have otherwise received in the First Personal Merger were cashed out in the amount of such fraction multiplied by $42.95.

 

The Bancorp issued a total of approximately 161,875 shares of Bancorp common stock to the former First Personal stockholders, and paid cash consideration of approximately $8.7 million. Based upon the closing price of Bancorp’s common stock on July 25, 2018, the transaction had an implied valuation of approximately $15.6 million.

 

 22 

 

 

Merger Agreement with AJS Bancorp, Inc. On July 30, 2018, the Bancorp entered into an Agreement and Plan of Merger (the “AJSB Merger Agreement”) with AJS Bancorp, Inc., a Maryland corporation (“AJSB”). Pursuant to the AJSB Merger Agreement, AJSB will merge with and into NWIN, with NWIN as the surviving corporation (the “AJSB Merger”). Simultaneously with the AJSB Merger, A.J. Smith Federal Savings Bank, a federally chartered savings bank and wholly-owned subsidiary of AJSB (“ AJS Bank”), will merge with and into Peoples Bank SB, with Peoples Bank as the surviving bank.

 

The boards of directors of each of NWIN and AJSB have approved the AJSB Merger and the AJSB Merger Agreement. Subject to the approval of the AJSB Merger by AJSB’s stockholders, regulatory approvals, and other customary closing conditions, the parties anticipate completing the AJSB Merger early in the first quarter of 2019.

 

Upon completion of the AJSB Merger, each AJSB stockholder who holds 100 or more shares of AJSB common stock will have the right to receive fixed consideration of (i) 0.2030 shares of NWIN common stock, and (ii) $7.20 per share in cash for each outstanding share of AJSB’s common stock, subject to adjustment as provided in the AJSB Merger Agreement. Stockholders holding less than 100 shares of AJSB common stock will have the right to receive $16.00 in cash and no stock consideration for each outstanding share of AJSB common stock. In lieu of any fractional shares of NWIN common stock, NWIN will distribute an amount in cash equal to such fraction multiplied by the volume-weighted average per share closing price of a share of NWIN common stock as quoted on the OTC Pink Marketplace during the fifteen consecutive trading days preceding the second business day prior to the closing of the AJSB Merger. Based upon the closing price of the Bancorp’s common stock of $43.00 on July 30, 2018, the transaction had an implied valuation of approximately $34.6 million.

 

Financial Condition

 

During the nine months ended September 30, 2018, total assets increased by $145.8 million (15.7%), with interest-earning assets increasing by $124.3 million (14.3%). At September 30, 2018, interest-earning assets totaled $995.8 million compared to $871.5 million at December 31, 2017. Earning assets represented 92.8% of total assets at September 30, 2018 and 94.0% of total assets at December 31, 2017. The increase in total assets and interest earning assets for the nine months was the result of the completion of the acquisition of First Personal as well as internally generated growth.

 

Net loans receivable totaled $734.5 million at September 30, 2018, compared to $612.7 million at December 31, 2017. The loan portfolio, which is the Bancorp’s largest asset, is the primary source of both interest and fee income. The Bancorp’s lending strategy emphasizes quality loan growth, product diversification, and competitive and profitable pricing.

 

The Bancorp’s end-of-period loan balances were as follows:

 

   September 30,         
   2018   December 31, 
(Dollars in thousands)  (unaudited)   2017 
   Balance   % Loans   Balance   % Loans 
                 
Residential real estate  $220,862    29.8%  $172,141    27.8%
Home equity   43,234    5.8%   36,769    5.9%
Commercial real estate   243,304    32.8%   211,090    34.0%
Construction and land development   54,755    7.4%   50,746    8.2%
Multifamily   45,752    6.2%   43,368    7.0%
Farmland   242    0.0%   -    0.0%
Consumer   5,633    0.8%   461    0.1%
Commercial business   102,687    13.8%   76,851    12.4%
Government   25,763    3.4%   28,785    4.6%
Loans receivable  $742,232    100.0%  $620,211    100.0%
                     
Adjustable rate loans / loans receivable  $417,367    56.2%  $348,559    56.2%

 

   September 30,     
   2018   December 31, 
   (unaudited)   2017 
         
Loans receivable to total assets   69.2%   66.9%
Loans receivable to earning assets   74.5%   71.2%
Loans receivable to total deposits   82.2%   78.2%

 

The Bancorp is primarily a portfolio lender. Mortgage banking activities historically have been limited to the sale of fixed rate mortgage loans with contractual maturities greater than 15 years. These loans are identified as held for sale when originated and sold, on a loan-by-loan basis, in the secondary market. The Bancorp will also retain fixed rate mortgage loans with a contractual maturity greater than 15 years on a limited basis. During the nine months ended September 30, 2018, the Bancorp originated $41.8 million in new fixed rate mortgage loans for sale, compared to $31.6 million during the nine months ended September 30, 2017. Net gains realized from the mortgage loan sales totaled $1.0 million for the nine months ended September 30, 2018, compared to $883 thousand for the nine months ended September 30, 2017. At September 30, 2018, the Bancorp had $4.5 million in loans that were classified as held for sale, compared to $1.6 million at December 31, 2017.

 

 23 

 

 

Non-performing loans include those loans that are 90 days or more past due and those loans that have been placed on non-accrual status. At September 30, 2018, all non-performing loans are also accounted for on a non-accrual basis, except for six residential real estate loans totaling $885 thousand and one home equity loan totaling $50 thousand that remained accruing and more than 90 days past due.

 

The Bancorp's nonperforming loans are loans that are more than 90 days past due and those loans that have been placed on non-accrual status and are summarized below:

 

(Dollars in thousands)  (unaudited)     
Loan Segment  September 30,
2018
   December 31,
2017
 
Residential real estate  $4,746   $3,734 
Home equity   378    352 
Commercial real estate   768    332 
Construction and land development   -    133 
Multifamily   -    - 
Farmland   -    - 
Commercial business   514    672 
Consumer   -    - 
Government   -    - 
Total  $6,406   $5,223 
Nonperforming loans to total loans   0.86%   0.84%
Nonperforming loans to total assets   0.60%   0.56%

 

Substandard loans include non-performing loans and potential problem loans, where information about possible credit issues or other conditions causes management to question the ability of such borrowers to comply with loan covenants or repayment terms. No loans were internally classified as doubtful or loss at September 30, 2018 or December 31, 2017.

 

The Bancorp's substandard loans are summarized below:

 

(Dollars in thousands)  (unaudited)     
Loan Segment  September 30,
2018
   December 31,
2017
 
Residential real estate  $4,350   $3,732 
Home equity   432    350 
Commercial real estate   1,871    512 
Construction and land development   -    134 
Multifamily   -    - 
Farmland   -    - 
Commercial business   780    1,174 
Consumer   -    - 
Government   -    - 
Total  $7,433   $5,902 

 

In addition to identifying and monitoring non-performing and other classified loans, management maintains a list of special mention loans. Special mention loans represent loans management is closely monitoring due to one or more factors that may cause the loan to become classified as substandard.

 

The Bancorp's special mention loans are summarized below:

 

(Dollars in thousands)  (unaudited)     
Loan Segment  September 30,
2018
   December 31,
2017
 
Residential real estate  $4,685   $4,130 
Home equity   544    233 
Commercial real estate   5,972    6,758 
Construction and land development   -    - 
Multifamily   154    168 
Farmland   -    - 
Commercial business   3,144    394 
Consumer   20    - 
Government   -    - 
Total  $14,519   $11,683 

 

A loan is considered impaired when, based on current information and events, it is probable that a borrower will be unable to pay all amounts due according to the contractual terms of the loan agreement. Typically, management does not individually classify smaller-balance homogeneous loans, such as residential mortgages or consumer loans, as impaired, unless they are troubled debt restructurings.

 

 24 

 

 

Purchased loans acquired in a business combination are recorded at estimated fair value on their purchase date. Purchased loans with evidence of credit quality deterioration since origination are considered purchased credit impaired loans. Expected future cash flows at the purchase date in excess of the fair value of loans are recorded as interest income over the life of the loans if the timing and amount of the future cash flows is reasonably estimable (“accretable yield”). The difference between contractually required payments and the cash flows expected to be collected at acquisition is referred to as the non-accretable difference and represents probable losses in the portfolio. In determining the acquisition date fair value of purchased credit impaired loans, and in subsequent accounting, the Bancorp aggregates these purchased loans into pools of loans by common risk characteristics, such as credit risk rating and loan type. Subsequent to the purchase date, increases in cash flows over those expected at the purchase date are recognized as interest income prospectively. Subsequent decreases to the expected cash flows will generally result in a provision for loan losses.

 

The Bancorp's impaired loans, including purchased credit impaired loans, are summarized below:

 

(Dollars in thousands)  (unaudited)     
Loan Segment  September 30,
2018
   December 31,
2017
 
Residential real estate  $1,631   $1,152 
Home equity   270    - 
Commercial real estate   3,409    512 
Construction and land development   -    134 
Multifamily   -    - 
Farmland   -    - 
Commercial business   1,909    724 
Consumer   -    - 
Government   -    - 
Total  $7,219   $2,522 

 

At times, the Bancorp will modify the terms of a loan to forego a portion of interest or principal or reduce the interest rate on the loan to a rate materially less than market rates, or materially extend the maturity date of a loan as part of a troubled debt restructuring. The valuation basis for the Bancorp’s troubled debt restructurings is based on the present value of expected future cash flows; unless consistent cash flows are not present, then the fair value of the collateral securing the loan is the basis for valuation.

 

The Bancorp's troubled debt restructured loans are summarized below:

 

(Dollars in thousands)  (unaudited)     
Loan Segment  September 30,
2018
   December 31,
2017
 
Residential real estate  $412   $303 
Home equity   147    - 
Commercial real estate   1,103    181 
Construction and land development   -    - 
Multifamily   -    - 
Farmland   -    - 
Commercial business   394    51 
Consumer   -    - 
Government   -    - 
Total  $2,056   $535 

 

The increase in the troubled debt restructure loans reflected in the table above for the nine months ended September 30, 2018 was the result of a $1.1 million commercial relationship as well as a $129 thousand commercial business loan which were modified as part of a troubled debt restructure or renewed with cash flow difficulties. These restructurings along with seven residential real estate and home equity restructurings all contributed to the increase in impaired loans. The $1.1 million relationship was classified as substandard and remains in accrual status.

 

The increase in the nonperforming, substandard, special mention, and impaired loans reflected in the tables above for the nine months ending September 30, 2018, are the result of the completion of the acquisition of First Personal as well as two large commercial relationships and one commercial customer which were all not related to the acquisition. One $531 thousand commercial real estate loan and First Personal loans totaling $761 thousand contributed to the September 30, 2018 increase in nonperforming loans. One large $1.1 million commercial relationship, one $531 thousand commercial real estate loan and First Personal loans totaling $761 thousand contributed to the September 30, 2018 increase in substandard loans. One $2.1 million commercial relationship and First Personal loans totaling $4.1 million contributed to the September 30, 2018 increase in watch loans, which was offset by the payoff of one $2.3 million commercial real estate loan. One large $1.1 million commercial relationship, one $531 thousand commercial real estate loan, and First Personal purchased credit impaired loans totaling $4.0 million contributed to the September 30, 2018 increase in impaired loans.

 

 25 

 

 

At September 30, 2018, management is of the opinion that there are no loans, except certain of those discussed above, where known information about possible credit problems of borrowers causes management to have serious doubts as to the ability of such borrowers to comply with the present loan repayment terms and which will imminently result in such loans being classified as past due, non-accrual or a troubled debt restructure. Management does not presently anticipate that any of the non-performing loans or classified loans would materially affect future operations, liquidity or capital resources.

 

The allowance for loan losses (ALL) is a valuation allowance for probable incurred credit losses, increased by the provision for loan losses, and decreased by charge-offs net of recoveries. A loan is charged-off against the allowance by management as a loss when deemed uncollectible, although collection efforts continue and future recoveries may occur. The determination of the amounts of the ALL and provisions for loan losses is based on management’s current judgments about the credit quality of the loan portfolio with consideration given to all known relevant internal and external factors that affect loan collectability as of the reporting date. The appropriateness of the current period provision and the overall adequacy of the ALL are determined through a disciplined and consistently applied quarterly process that reviews the Bancorp’s current credit risk within the loan portfolio and identifies the required allowance for loan losses given the current risk estimates.

 

The Bancorp's provision for loan losses for the nine months ended are summarized below:

 

(Dollars in thousands) 

   (unaudited)     
Loan Segment  September 30,
2018
   September 30,
2017
 
Residential real estate  $143   $370 
Home equity   51    (157)
Commercial real estate   210    (195)
Construction and land development   (39)   (47)
Multifamily   (165)   (31)
Farmland   3    - 
Commercial business   439    44 
Consumer   316    738 
Government   (8)   - 
Total  $950   $722 

 

The Bancorp's charge-off and recovery information for the nine months ended is summarized below:

 

(Dollars in thousands)  (unaudited) 
   As of September 30, 2018 
Loan Segment  Charge-off   Recoveries   Net Charge-offs 
Residential real estate  $(136)  $-   $(136)
Home equity   (24)   -    (24)
Commercial real estate   (119)   24    (95)
Construction and land development   -    -    - 
Multifamily   -    -    - 
Farmland   -    -    - 
Commercial business   (529)   125    (404)
Consumer   (41)   17    (24)
Government   -    -    - 
Total  $(849)  $166   $(683)

 

The ALL provisions take into consideration management’s current judgments about the credit quality of the loan portfolio, loan portfolio balances, changes in the portfolio mix and local economic conditions. In determining the provision for loan losses for the current period, management has considered risks associated with the local economy, changes in loan balances and mix, and asset quality.

 

 26 

 

 

The Bancorp's allowance to total loans and non-performing loans are summarized below:

 

(Dollars in thousands)  (unaudited)     
   September 30,
2018
   December 31,
2017
 
         
Allowance for loan losses  $7,749   $7,482 
Total loans  $742,232   $620,211 
Non-performing loans  $6,406   $5,223 
ALL-to-total loans   1.04%   1.21%
ALL-to-non-performing loans (coverage ratio)   121.0%   143.3%

 

The September 30, 2018 balance in the ALL account is considered adequate by management after evaluation of the loan portfolio, past experience and current economic and market conditions. While management may periodically allocate portions of the allowance for specific problem loans, the whole allowance is available for any loan charge offs that occur. The allocation of the ALL reflects performance and growth trends within the various loan categories, as well as consideration of the facts and circumstances that affect the repayment of individual loans, and loans which have been pooled as of the evaluation date, with particular attention given to non-performing loans and loans which have been classified as substandard, doubtful or loss. Management has allocated reserves to both performing and non-performing loans based on current information available.

 

At September 30, 2018, foreclosed real estate totaled $2.1 million, which was comprised of twenty-seven properties, compared to $1.7 million and nineteen properties at December 31, 2017. The increase in foreclosed real estate is the result of the addition of $1.2 million, which was comprised of twenty properties, from the acquisition of First Personal. Net gains from the sale of foreclosed real estate totaled $154 thousand for the nine months ended September 30, 2018. At the end of September 2018 all of the Bancorp’s foreclosed real estate is located within its primary market area, which has been expanded into the Cook County, Illinois and Chicagoland metropolitan area with the acquisition of First Personal.

 

The primary objective of the Bancorp’s investment portfolio is to provide for the liquidity needs of the Bancorp and to contribute to profitability by providing a stable flow of dependable earnings. Funds are generally invested in federal funds, interest bearing balances in other financial institutions, U.S. government securities, federal agency obligations, obligations of state and local municipalities and corporate securities. The securities portfolio, all of which is designated as available-for-sale, totaled $238.1 million at September 30, 2018, compared to $244.5 million at December 31, 2017, a decrease of $6.4 million (2.6%). The decrease in the securities portfolio during the year is a result of market value adjustments for unrealized losses and the reallocation of $5.0 million of funds to support loan growth. At September 30, 2018, the securities portfolio represented 23.9% of interest-earning assets and 22.2% of total assets compared to 28.1% of interest-earning assets and 26.4% of total assets at December 31, 2017.

 

The Bancorp’s end-of-period investment portfolio and other short-term investments and stock balances were as follows:

 

   September 30,         
   2018   December 31, 
(Dollars in thousands)  (unaudited)   2017 
   Balance   % Securities   Balance   % Securities 
                 
Money market fund  $2,018    0.8%  $476    0.2%
U.S. government sponsored entities   9,768    4.1%   3,890    1.6%
Collateralized mortgage obligations and residential mortgage-backed securities   132,670    55.7%   132,938    54.4%
Municipal securities   91,416    38.4%   103,747    42.4%
Collateralized debt obligations   2,199    1.0%   3,439    1.4%
Total securities available-for-sale  $238,071    100.0%  $244,490    100.0%

 

   September 30,             
   2018   December 31,   YTD 
(Dollars in thousands)  (unaudited)   2017   Change 
   Balance   Balance   $   % 
                 
Interest bearing deposits in other financial institutions  $2,576   $139   $2,437    1753.2%
Fed funds sold   1,398    357    1,041    291.6%
Certificates of deposit in other financial institutions   3,754    1,676    2,078    124.0%
Federal Home Loan Bank stock   3,236    3,000    236    7.9%

 

The net increase in interest bearing deposits in other financial institutions, certificates of deposit, and in fed funds sold is primarily the result of timing of liquidity needs. The increase in Federal Home Loan Bank stock corresponds to stock ownership requirements based on borrowing needs. The increase in certificate of deposits in other financial institutions is the result of First Personal merger.

 

 27 

 

 

Deposits are a fundamental and cost-effective source of funds for lending and other investment purposes. The Bancorp offers a variety of products designed to attract and retain customers, with the primary focus on building and expanding relationships.

 

The Bancorp’s end-of-period deposit portfolio balances were as follows:

 

   September 30,             
   2018   December 31,   YTD 
(Dollars in thousands)  (unaudited)   2017   Change 
   Balance   Balance   $   % 
                 
Checking  $339,176   $309,023   $30,153    9.8%
Savings   161,357    129,702    31,655    24.4%
Money market   148,227    170,359    (22,132)   -13.0%
Certificates of deposit   253,996    183,920    70,076    38.1%
Total deposits  $902,756   $793,004   $109,752    13.8%

 

The overall increase in total deposits is a result of the acquisition of First Personal. When adjusted for the First Personal acquisition, overall deposits decreased during the period ended September 30, 2018. This decrease reflects the cyclical nature and timing of municipality money market deposits.

 

The Bancorp’s borrowed funds are primarily used to fund asset growth not supported by deposit generation. The Bancorp’s end-of-period borrowing balances were as follows:

 

   September 30,             
   2018   December 31,   YTD 
(Dollars in thousands)  (unaudited)   2017   Change 
   Balance   Balance   $   % 
                 
Repurchase agreements  $12,585   $11,300   $1,285    11.4%
Borrowed funds   48,314    20,881    27,433    131.4%
Total borrowed funds  $60,899   $32,181   $28,718    89.2%

 

Repurchase agreements increased as part of normal account fluctuations within that product line. Borrowed funds increased as FHLB advances were utilized for funding purposes.

 

Liquidity and Capital Resources

 

For the Bancorp, liquidity management refers to the ability to generate sufficient cash to fund current loan demand, meet deposit withdrawals, and pay dividends and operating expenses. Because profit and liquidity are often conflicting objectives, management attempts to maximize the Bank’s net interest margin by making adequate, but not excessive, liquidity provisions. Furthermore, funds are managed so that future profits will not be significantly impacted as funding costs increase.

 

Changes in the liquidity position result from operating, investing and financing activities. Cash flows from operating activities are generally the cash effects of transactions and other events that enter into the determination of net income. The primary investing activities include loan originations, loan repayments, investments in interest bearing balances in other financial institutions, and the purchase, sale, and maturity of investment securities. Financing activities focus almost entirely on the generation of customer deposits. In addition, the Bancorp utilizes borrowings (i.e., repurchase agreements, FHLB advances and federal funds purchased) as a source of funds.

 

During the nine months ended September 30, 2018, cash and cash equivalents increased by $2.9 million compared to a $31.0 million decrease for the nine months ended September 30, 2017. The primary sources of cash and cash equivalents were sales of loans originated for sale, proceeds from maturities, pay downs, calls, and sales of available-for-sale securities, proceeds from FHLB advances, and additional borrowings. The primary uses of cash and cash equivalents were loan originations, the purchase of securities, and the repayment of FHLB advances. Cash provided by operating activities totaled $2.3 million for the nine months ended September 30, 2018, compared to cash provided of $9.1 million for the nine month period ended September 30, 2017. The decrease in cash from operating activities was primarily a result of an increase in loans originated for sale offset by the sale of loans originated for sale and accrued expenses and other liabilities. Cash outflows from investing activities totaled $10.4 million for the current period, compared to cash outflows of $33.0 million for the nine months ended September 30, 2017. Cash outflows from investing activities for the current nine months were primarily related to the origination of loans receivable and purchases of securities, offset by the sale and maturities for securities available-for-sale, and cash used for the acquisition of First Personal. Net cash inflows from financing activities totaled $11.0 million during the current period compared to net cash outflows of $7.1 million for the nine months ended September 30, 2017. The net cash inflows from financing activities were primarily a result of proceeds from FHLB advances and increased borrowing. On a cash basis, the Bancorp paid dividends on common stock of $2.5 million for the nine months ended September 30, 2018 and $2.4 million for the nine months ended September 30, 2017.

 

 28 

 

 

At September 30, 2018, outstanding commitments to fund loans totaled $185.3 million. Approximately 51.4% of the commitments were at variable rates. Standby letters of credit, which are conditional commitments issued by the Bancorp to guarantee the performance of a customer to a third party, totaled $10.2 million at September 30, 2018. Management believes that the Bancorp has sufficient cash flow and borrowing capacity to fund all outstanding commitments and letters of credit, while maintaining proper levels of liquidity.

 

Management strongly believes that maintaining a high level of capital enhances safety and soundness. During the nine months ended September 30, 2018, stockholders' equity increased by $4.4 million (4.8%). During the nine months ended September 30, 2018, stockholders’ equity was primarily increased by net income of $6.7 million and the issuance of 161,875 shares for $6.9 million as part of the acquisition of First Personal. Decreasing stockholders’ equity was the declaration of $2.6 million in cash dividends and a decrease to net unrealized gains (losses) on securities available-for-sale of $6.7 million. On April 24, 2014 the Bancorp’s Board of Directors authorized a stock repurchase program to repurchase up to 50,000 shares of the Bancorp’s outstanding common stock, from time to time and subject to market conditions, on the open market or in privately negotiated transactions. The stock repurchase program does not expire and is only limited by the number of shares that can be purchased. The stock repurchase program will be reviewed annually by the Board of Directors. No shares were repurchased under the program during the first nine months of 2018 or 2017. During 2018, 7,700 restricted stock shares vested under the program outlined in Note 10 of the financial statements, of which 1,658 of these shares were withheld in the form of a net surrender to cover the withholding tax obligations of the vesting employees. The repurchase of these surrendered shares is considered outside of the scope of the formal stock repurchase program.

 

The Bancorp is subject to risk-based capital guidelines adopted by the Board of Governors of the Federal Reserve System (the FRB), and the Bank is subject to risk-based capital guidelines adopted by the FDIC. As applied to the Bancorp and the Bank, the FRB and FDIC capital requirements are substantially the same. These regulations divide capital into multiple tiers. The first tier (Common Equity Tier 1 Capital) includes common shareholders’ equity, after deductions for various items including goodwill and certain other intangible assets, and after certain other adjustments. Common Equity Tier 1 Capital also includes accumulated other comprehensive income (for organizations that do not make opt-out elections). The next tier (Tier 1 Capital) is comprised of Common Equity Tier 1 Capital plus other qualifying capital instruments such as perpetual noncumulative preferred stock and junior subordinated debt issued to trusts, and other adjustments. The third tier (Tier 2 Capital) includes instruments such as subordinated debt that have a minimum original maturity of at least five years and are subordinated to the claims of depositors and general creditors, total capital minority interest not included in Tier 1 Capital, and limited amounts of the allowance for loan losses, less applicable regulatory adjustments and deductions. The Bancorp and the Bank are required to maintain a Common Equity Tier 1 Capital ratio of 4.5%, a Tier 1 Capital ratio of 6%, and a Total Capital ratio (comprised of Tier 1 Capital plus Tier 2 Capital) of 8%. In addition, the capital regulations provide for a minimum leverage ratio (Tier 1 capital to adjusted average assets) of 4%.

 

The Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 required the FRB to set minimum capital levels for bank holding companies that are as stringent as those required for insured depository subsidiaries. However, under the FRB’s “Small Bank Holding Company” exemption from consolidated bank holding company capital requirements, bank holding companies and savings and loan holding companies with less than $3 billion in consolidated assets, such as the Bancorp, are exempt from consolidated regulatory capital requirements, unless the FRB determines otherwise in particular cases.

 

During the nine months ended September 30, 2018, the Bancorp’s and Bank’s regulatory capital ratios continued to be negatively impacted by regulatory requirements regarding collateralized debt obligations. The regulatory requirements state that for collateralized debt obligations that have been downgraded below investment grade by the rating agencies, increased risk based asset weightings are required. The Bancorp currently holds pooled trust preferred securities with a cost basis of $3.5 million. These investments currently have ratings that are below investment grade. As a result, approximately $18.9 million of risk-based assets are generated by the trust preferred securities in the Bancorp’s and Bank’s total risk based capital calculation.

 

 29 

 

 

The following table shows that, at September 30, 2018, and December 31, 2017, the Bancorp’s capital exceeded all applicable regulatory capital requirements. The dollar amounts are in millions.

 

(Dollars in millions)                  Minimum Required To Be
           Minimum Required For   Well Capitalized Under Prompt
   Actual   Capital Adequacy Purposes   Corrective Action Regulations
At September 30, 2018  Amount   Ratio   Amount   Ratio   Amount  Ratio
Common equity tier 1 capital to risk-weighted assets  $89.1    11.3%  $35.6    4.5%  N/A  N/A
Tier 1 capital to risk-weighted assets  $89.1    11.3%  $47.5    6.0%  N/A  N/A
Total capital to risk-weighted assets  $96.8    12.2%  $63.3    8.0%  N/A  N/A
Tier 1 capital to adjusted average assets  $89.1    8.6%  $41.3    4.0%  N/A  N/A

 

(Dollars in millions)                  Minimum Required To Be
           Minimum Required For   Well Capitalized Under Prompt
   Actual   Capital Adequacy Purposes   Corrective Action Regulations
At December 31, 2017  Amount   Ratio   Amount   Ratio   Amount  Ratio
Common equity tier 1 capital to risk-weighted assets  $88.4    12.9%  $30.9    4.5%  N/A  N/A
Tier 1 capital to risk-weighted assets  $88.4    12.9%  $41.2    6.0%  N/A  N/A
Total capital to risk-weighted assets  $96.0    14.0%  $55.0    8.0%  N/A  N/A
Tier 1 capital to adjusted average assets  $88.4    9.6%  $36.8    4.0%  N/A  N/A

 

In addition, the following table shows that, at September 30, 2018, and December 31, 2017, the Bank’s capital exceeded all applicable regulatory capital requirements. The dollar amounts are in millions.

 

(Dollars in millions)                  Minimum Required To Be 
           Minimum Required For   Well Capitalized Under Prompt 
   Actual   Capital Adequacy Purposes   Corrective Action Regulations 
At September 30, 2018  Amount   Ratio   Amount   Ratio   Amount   Ratio 
Common equity tier 1 capital to risk-weighted assets  $86.3    10.9%  $35.6    4.5%  $51.4    6.5%
Tier 1 capital to risk-weighted assets  $86.3    10.9%  $47.5    6.0%  $63.3    8.0%
Total capital to risk-weighted assets  $94.1    11.9%  $63.3    8.0%  $79.1    10.0%
Tier 1 capital to adjusted average assets  $86.3    8.4%  $41.0    4.0%  $51.3    5.0%

 

(Dollars in millions)                  Minimum Required To Be 
           Minimum Required For   Well Capitalized Under Prompt 
   Actual   Capital Adequacy Purposes   Corrective Action Regulations 
At December 31, 2017  Amount   Ratio   Amount   Ratio   Amount   Ratio 
Common equity tier 1 capital to risk-weighted assets  $86.3    12.6%  $30.9    4.5%  $44.6    6.5%
Tier 1 capital to risk-weighted assets  $86.3    12.6%  $41.2    6.0%  $54.9    8.0%
Total capital to risk-weighted assets  $93.8    13.7%  $54.9    8.0%  $68.7    10.0%
Tier 1 capital to adjusted average assets  $86.3    9.4%  $36.7    4.0%  $45.8    5.0%

 

The Bancorp’s ability to pay dividends to its shareholders is primarily dependent upon the Bank’s ability to pay dividends to the Bancorp. Under Indiana law, the Bank may pay dividends from its undivided profits (generally, earnings less losses, bad debts, taxes and other operating expenses) as is considered expedient by the Bank’s Board of Directors. However, the Bank must obtain the approval of the Indiana Department of Financial Institutions (DFI) if the total of all dividends declared by the Bank during the current year, including the proposed dividend, would exceed the sum of retained net income for the year to date plus its retained net income for the previous two years. For this purpose, “retained net income,” means net income as calculated for call report purposes, less all dividends declared for the applicable period. An exemption from DFI approval would require that the Bank have been assigned a composite uniform financial institutions rating of 1 or 2 as a result of the most recent federal or state examination; the proposed dividend would not result in a Tier 1 leverage ratio below 7.5%; and that the Bank not be subject to any corrective action, supervisory order, supervisory agreement, or board approved operating agreement. The aggregate amount of dividends that may be declared by the Bank in 2018, without the need for qualifying for an exemption or prior DFI approval, is $10.2 million plus 2018 net profits. Moreover, the FDIC and the Federal Reserve Board may prohibit the payment of dividends if it determines that the payment of dividends would constitute an unsafe or unsound practice in light of the financial condition of the Bank. On August 31, 2018 the Board of Directors of the Bancorp declared a third quarter dividend of $0.30 per share. The Bancorp’s third quarter dividend was paid to shareholders on October 9, 2018.

 

Results of Operations - Comparison of the Quarter Ended September 30, 2018 to the Quarter Ended September 30, 2017

 

For the three months ended September 30, 2018, the Bancorp reported net income of $1.6 million, compared to net income of $2.2 million for the quarter ended September 30, 2017, a decrease of $623 thousand (27.7%). For the quarter, the ROA was 0.62%, compared to 0.98% for the quarter ended September 30, 2017. The ROE was 6.70% for the quarter ended September 30, 2018, compared to 9.82% for the quarter ended September 30, 2017.

 

 30 

 

 

Net interest income for the quarter ended September 30, 2018 was $9.0 million, an increase of $1.2 million (16.0%), compared to $7.8 million for the quarter ended September 30, 2017. The weighted-average yield on interest-earning assets was 4.26% for the quarter ended September 30, 2018, compared to 3.94% for the quarter ended September 30, 2017. The weighted-average cost of funds for the quarter ended September 30, 2018 was 0.56% compared to 0.32% for the quarter ended September 30, 2017. The impact of the 4.26% return on interest earning assets and the 0.56% cost of funds resulted in an interest rate spread of 3.69% for the current quarter, an increase from the 3.61% spread for the quarter ended September 30, 2017. The net interest margin on earning assets was 3.72% for the three months ended September 30, 2018 and 3.63% for the three months ended September 30, 2017. On a tax equivalent basis, the Bancorp’s net interest margin was 3.92% for the three months ended September 30, 2018, compared to 3.86% for the three months ended September 30, 2017. Comparing the net interest margin on a tax equivalent basis more accurately compares the returns on tax-exempt loans and securities to those on taxable interest-earning assets.

 

Information relating to the average consolidated balance sheet and the yield on average earning assets and cost of average liabilities for the periods indicated are in the following table. Dividing the related interest, on an annualized basis, by the average balance of assets or liabilities drives the disclosed rates. Average balances are derived from daily balances.

 

Quarter-to-Date                        
(Dollars in thousands)  Average Balances, Interest, and Rates 
   September 30, 2018   September 30, 2017 
   Average
Balance
   Interest   Rate (%)   Average
Balance
   Interest   Rate (%)</