Toggle SGML Header (+)


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

 

 

 

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

_________________

 

FORM 10-K

(Mark One)

xANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the fiscal year ended December 31, 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 (I.R.S. Employer Identification No.)
incorporation or organization)  
   
9204 Columbia Avenue 46321
Munster, Indiana (Zip Code)
(Address of principal executive offices)  

 

(219) 836-4400

(Registrant’s telephone number, including area code)

 

Securities registered pursuant to Section 12(b) of the Act: None

Securities registered pursuant to Section 12(g) of the Act: Common Stock, without par value

 

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes ¨ No x

 

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes ¨ No x

 

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 if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of Registrant’s knowledge in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. x

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. 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

 

Based on the average bid and ask prices for the registrant’s Common Stock at June 30, 2018, at that date, the aggregate market value of the registrant’s Common Stock held by nonaffiliates of the registrant (assuming solely for the purposes of this calculation that all directors and executive officers of the registrant are “affiliates”) was $98,107,924.

 

There were 3,452,199 shares of the registrant’s Common Stock, without par value, outstanding at March 4, 2019.

 

DOCUMENTS INCORPORATED BY REFERENCE

 

Portions of the following documents have been incorporated by reference into this Annual Report on Form 10-K:

 

1.Definitive Proxy Statement for the 2019 Annual Meeting of Shareholders. (Part III)

 

 

 

 

 

 

NorthWest Indiana Bancorp

Index

 

    Page
    Number
PART I.  
     
  Item 1. Business 3
     
  Item 1A. Risk Factors 29
     
  Item 1B. Unresolved Staff Comments 29
     
  Item 2. Properties 29
     
  Item 3. Legal Proceedings 30
     
  Item 4. Mine Safety Disclosures 30
     
  Item 4.5 Executive Officers of the Bancorp 30
     
PART II.  
     
  Item 5. Market for the Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities 32
     
  Item 6. Selected Financial Data 33
     
  Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations 34
     
  Item 7A. Quantitative and Qualitative Disclosures about Market Risk 45
     
  Item 8. Financial Statements 46
     
  Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure 86
     
  Item 9A. Controls and Procedures 86
     
  Item 9B. Other Information 87
     
PART III.  
     
  Item 10. Directors, Executive Officers and Corporate Governance 88
     
  Item 11. Executive Compensation 88
     
  Item 12. Security Ownership of Certain Beneficial Owners and Management  and Related Stockholder Matters 88
     
  Item 13. Certain Relationships and Related Transactions, and Director Independence 88
     
  Item 14. Principal Accountant Fees and Services 88
     
PART IV.  
     
  Item 15. Exhibits and Financial Statement Schedules 89
     
SIGNATURES 91
     
EXHIBIT INDEX  

 

 Page 2 of 91

 

  

PART I

 

Item 1. Business

 

General

 

NorthWest Indiana Bancorp, an Indiana corporation (the “Bancorp”), was incorporated on January 31, 1994, and is the holding company for Peoples Bank SB, an Indiana savings bank (the “Bank”). The Bank is a wholly owned subsidiary of the Bancorp. The Bancorp’s business activities include being a holding company for the Bank and the Bank's wholly owned subsidiaries, as well as a holding company for NWIN Risk Management, Inc., a captive insurance company.

 

The Bank is primarily engaged in the business of attracting deposits from the general public and the origination of loans, mostly upon the security of single family residences and commercial real estate, as well as, construction loans and various types of consumer loans, commercial business loans and municipal loans, within its primary market areas of Lake and Porter Counties, in Northwest Indiana, and Cook County, Illinois. In addition, the Bancorp's Wealth Management Group provides estate and retirement planning, guardianships, land trusts, profit sharing and 401(k) retirement plans, IRA and Keogh accounts, investment agency accounts, and serves as the personal representative of estates and acts as trustee for revocable and irrevocable trusts.

 

The Bank’s deposit accounts are insured up to applicable limits by the Deposit Insurance Fund (“DIF”), which is administered by the Federal Deposit Insurance Corporation (“FDIC”), an agency of the federal government. As the holding company for the Bank, the Bancorp is subject to comprehensive examination, supervision and regulation by the Board of Governors of the Federal Reserve System (“FRB”), while the Bank is subject to comprehensive examination, supervision and regulation by both the FDIC and the Indiana Department of Financial Institutions (“DFI”). The Bank is also subject to regulation by the FRB governing reserves required to be maintained against certain deposits and other matters. The Bank is also a member of the Federal Home Loan Bank (“FHLB”) of Indianapolis, which is one of the eleven regional banks comprising the system of Federal Home Loan Banks.

 

On July 26, 2018, the Bancorp completed its 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 the Bank, with the Bank as the surviving institution. 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 the Bancorp’s common stock on July 25, 2018, the transaction had an implied valuation of approximately $15.6 million. The acquisition represented the Bank’s first expansion into the South Suburban Chicagoland market, and expanded the Bank’s full-service retail banking network to 19 banking centers.

 

On January 24, 2019, the Bancorp completed its acquisition of AJS Bancorp, Inc., a Maryland corporation (“AJSB”), pursuant to an Agreement and Plan of Merger dated July 30, 2018 (the “AJSB Merger Agreement”), between the Bancorp and AJSB. Pursuant to the terms of the AJSB Merger Agreement, AJSB merged with and into the Bancorp, with the Bancorp as the surviving corporation (the “AJSB Merger”). Simultaneous with the AJSB Merger, A.J. Smith Federal Savings Bank, a federally chartered savings bank and wholly-owned subsidiary of AJSB, merged with and into the Bank, with the Bank as the surviving institution. In connection with the AJSB Merger, each AJSB stockholder holding 100 or more shares of AJSB common stock received fixed consideration of (i) 0.2030 shares of the Bancorp common stock, and (ii) $7.20 per share in cash for each outstanding share of AJSB common stock. Stockholders holding less than 100 shares of AJSB common stock received $16.00 in cash and no stock consideration for each outstanding share of AJSB common stock. Any fractional shares of Bancorp common stock that an AJSB stockholder would have otherwise received in the AJSB Merger were cashed out in the amount of such fraction multiplied by $43.01. The Bancorp issued 416,478 shares of Bancorp common stock to the former AJSB stockholders, and paid cash consideration of approximately $15.4 million. Based upon the closing price of the Bancorp’s common stock on January 23, 2019, the transaction had an implied valuation of approximately $34.2 million, which includes unallocated shares held by the AJSB Employee Stock Ownership Plan (“ESOP”), some of which were cancelled in connection with the closing to satisfy the ESOP’s outstanding loan balance. As a result of the acquisition, the Bank was able to further expand its retail banking network in the South Suburban Chicagoland market, bringing the total number of its full-service banking centers to 22.

 

The Bancorp maintains its corporate office at 9204 Columbia Avenue, Munster, Indiana, from which it oversees the operation of its twenty-two branch locations. For further information, see “Properties.”

 

Forward-Looking Statements

 

Statements contained in this filing on Form 10-K that are not historical facts are forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. The words or phrases “would be,” “will allow,” “intends to,” “will likely result,” “are expected to,” “will continue,” “is anticipated,” “estimate,” “project,” or similar expressions are also intended to identify “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act. The Bancorp cautions readers that forward-looking statements, including without limitation those relating to the Bancorp’s future business prospects, interest income and expense, net income, liquidity, and capital needs are subject to certain risks and uncertainties that could cause actual results to differ materially from those indicated in the forward-looking statements due to a number of factors, including those set forth above in “Recent Developments” and below in “Regulation and Supervision” of this Form 10-K.

 

Lending Activities

 

General. The Bancorp’s product offerings include residential mortgage loans, construction loans, commercial real estate loans, consumer loans, commercial business loans and loans to municipalities. The Bancorp’s lending strategy stresses quality growth, product diversification, and competitive and profitable pricing. While lending efforts include both fixed and adjustable rate products, the focus has been on products with adjustable rates and/or shorter terms to maturity. It is management’s goal that all programs are marketed effectively to our primary market area.

 

 Page 3 of 91

 

 

The Bancorp is primarily a portfolio lender. Mortgage banking activities are limited to the sale of fixed rate mortgage loans with contractual maturities generally exceeding fifteen years and greater. These loans are sold, on a case-by-case basis, in the secondary market as part of the Bancorp’s efforts to manage interest rate risk. All loan sales are made to Freddie Mac or to the Federal Home Loan Bank of Indianapolis. All loans held for sale are recorded at the lower of cost or market value.

 

Under Indiana Law, an Indiana stock savings bank generally may not make any loan to a borrower or its related entities if the total of all such loans by the savings bank exceeds 15% of its unimpaired capital and unimpaired surplus (plus up to an additional 10% of unimpaired capital and unimpaired surplus, in the case of loans fully collateralized by readily marketable collateral); provided, however, that certain specified types of loans are exempted from these limitations or subject to different limitations. The maximum amount that the Bank could have loaned to one borrower and the borrower’s related entities at December 31, 2018, under the 15% of capital and surplus limitation was approximately $14,686,000. At December 31, 2018, the Bank had no loans that exceeded the regulatory limitations.

 

At December 31, 2018, there were no concentrations of loans in any type of industry that exceeded 10% of total loans that were not otherwise disclosed as a loan category.

 

Loan Portfolio. The following table sets forth selected data relating to the composition of the Bancorp’s loan portfolio by type of loan and type of collateral at the end of each of the last five years. The amounts are stated in thousands (000’s).

 

   2018   2017   2016   2015   2014 
Type of loan:                         
Conventional real estate loans:                         
Construction and  development  $64,433   $50,746   $38,937   $41,524   $25,733 
Loans on existing properties (1)   569,384    463,368    437,361    432,020    377,247 
Consumer (2)   6,043    461    524    535    472 
Commercial business   103,439    76,851    77,299    68,757    58,682 
Government   21,101    28,785    29,529    29,062    26,019 
Loans receivable (3)  $764,400   $620,211   $583,650   $571,898   $488,153 
Type of collateral:                         
Real estate:                         
1-to-4 family  $268,805   $208,910   $205,838   $213,756   $189,529 
Other dwelling units, land and commercial real estate   365,012    305,204    270,461    259,789    213,451 
Consumer   5,813    321    424    461    351 
Commercial business   103,012    76,666    76,735    68,308    58,145 
Government   21,101    28,785    29,529    29,062    26,019 
Loans receivable (4)  $763,743   $619,886   $582,987   $571,376   $488,038 
                          
Average loans outstanding  during the period (3)  $684,159   $602,426   $587,119   $522,278   $480,404 

 

(1)Includes residential and commercial construction loans converted to permanent term loans and commercial real estate loans.
(2)Includes overdrafts to deposit accounts.
(3)Net of unearned income and net deferred loan fees.
(4)Net of unearned income and net deferred loan fees. Does not include unsecured loans.

 

 Page 4 of 91

 

 

Loan Originations, Purchases and Sales. Set forth on the following table loan originations, purchases and sales activity for each of the last three years are shown. The amounts are stated in thousands (000’s).

 

   2018   2017   2016 
Loans originated:               
Conventional real estate loans:               
Construction and development  $14,061   $11,510   $7,700 
Existing property   106,661    78,249    82,539 
Refinanced   5,400    9,138    12,798 
Total conventional real estate loans originated   126,122    98,897    103,037 
Commercial business   274,613    238,667    238,633 
Consumer   13,042    244    358 
Total loans originated  $413,777   $337,808   $342,028 
                
Whole loans and participations purchased  $94,600   $796   $- 
Whole loans and participations sold  $55,525   $42,212   $58,338 

 

Loan Maturity Schedule. The following table sets forth certain information at December 31, 2018 regarding the dollar amount of loans in the Bancorp’s portfolio based on their contractual terms to maturity. Demand loans, loans having no schedule of repayments and no stated maturity, and overdrafts are reported as due in one year or less. Contractual principal repayments of loans do not necessarily reflect the actual term of the loan portfolio. The average life of mortgage loans is substantially less than their contractual terms because of loan prepayments and because of enforcement of due-on-sale clauses, which give the Bancorp the right to declare a loan immediately due and payable in the event, among other things, that the borrower sells the property subject to the mortgage. The amounts are stated in thousands (000’s).

 

   Maturing   After one         
   within   but within   After     
   one year   five years   five years   Total 
Real estate  $59,812   $115,473   $458,532   $633,817 
Consumer   40    466    4,814    5,320 
Commercial business, and other   42,299    66,150    16,814    125,263 
Total loans receivable  $102,151   $182,089   $480,160   $764,400 

 

The following table sets forth the dollar amount of all loans due after one year from December 31, 2018, which have predetermined interest rates or have floating or adjustable interest rates. The amounts are stated in thousands (000’s).

 

   Predetermined   Floating or     
   rates   adjustable rates   Total 
Real estate  $222,761   $351,244   $574,005 
Consumer   5,280    -    5,280 
Commercial business, and other   71,853    11,111    82,964 
Total loans receivable  $299,894   $362,355   $662,249 

 

Lending Area. 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.

 

Loan Origination Fees. All loan origination and commitment fees, as well as incremental direct loan origination costs, are deferred and amortized into income as yield adjustments over the contractual lives of the related loans.

 

 Page 5 of 91

 

 

Loan Origination Procedure. The primary sources for loan originations are referrals from commercial customers, real estate brokers and builders, solicitations by the Bancorp’s lending and retail staff, and advertising of loan programs and rates. The Bancorp employs no staff appraisers. All appraisals are performed by fee appraisers that have been approved by the Board of Directors and who meet all federal guidelines and state licensing and certification requirements.

 

Designated officers have authorities, established by the Board of Directors, to approve loans. Loans up to $2,500,000 are approved by the loan officers’ loan committee. Loans from $2,500,000 to $4,000,000 are approved by the senior officers’ loan committee (SOLC). All loans in excess of $4,000,000, up to the legal lending limit of the Bank, must be approved by the Bank’s Board of Directors or its Executive Committee. (All members of the Bank’s Board of Directors and Executive Committee are also members of the Bancorp’s Board of Directors and Executive Committee, respectively.) Certain loan renewals and extensions may not require approval by the Board of Directors or the Executive Committee as long as there is no material change, credit downgrade, significant change in borrower or guarantor status, material release or change in collateral value or the eligible loan renewal or extension is not outside the current concentration limits set by the Board of Directors. The maximum in-house legal lending limit as set by the Board of Directors is the lower of 10% of the Bank’s risk based capital or $7,000,000. Requests that exceed this amount will be considered on a case-by-case basis, after taking into consideration the legal lending limit, by specific Board action. The Bank will not extend credit to any of its executive officers, directors, or principal shareholders or to any related interest of that person, except in compliance with the insider lending restrictions of Regulation O under the Federal Reserve Act and in an amount that, when aggregated with all other extensions of credit to that person, exceeds $500,000 unless: (1) the extension of credit has been approved in advance by a majority of the entire Board of Directors of the Bank, and (2) the interested party has abstained from participating directly or indirectly in the voting.

 

All loans secured by personal property must be covered by insurance in an amount sufficient to cover the full amount of the loan. All loans secured by real estate must be covered by insurance in an amount sufficient to cover the full amount of the loan or restore the property to its original state. First mortgage loans must be covered by a lender’s title insurance policy in the amount of the loan.

 

The Current Lending Programs

 

Residential Mortgage Loans. The primary lending activity of the Bancorp has been the granting of conventional mortgage loans to enable borrowers to purchase existing homes, refinance existing homes, or construct new homes. Conventional loans are made up to a maximum of 97% of the purchase price or appraised value, whichever is less. For loans made in excess of 80% of value, private mortgage insurance is generally required in an amount sufficient to reduce the Bancorp’s exposure to 80% or less of the appraised value of the property. Loans insured by private mortgage insurance companies can be made for up to 97% of value. During 2018, 68% of mortgage loans closed were conventional loans with borrowers having 20% or more equity in the property. This type of loan does not require private mortgage insurance because of the borrower’s level of equity investment.

 

Fixed rate loans currently originated generally conform to Freddie Mac guidelines for loans purchased under the one-to-four family program. Loan interest rates are determined based on secondary market yield requirements and local market conditions. Fixed rate mortgage loans with contractual maturities generally exceeding fifteen years and greater may be sold and/or classified as held for sale to control exposure to interest rate risk.

 

The 15 year mortgage loan program has gained wide acceptance in the Bancorp’s primary market area. As a result of the shortened maturity of these loans, this product has been priced below the comparable 20 and 30 year loan offerings. Mortgage applicants for 15 year loans tend to have a larger than normal down payment; this, coupled with the larger principal and interest payment amount, has caused the 15 year mortgage loan portfolio to consist, to a significant extent, of second time home buyers whose underwriting qualifications tend to be above average.

 

 Page 6 of 91

 

 

The Bancorp’s Adjustable Rate Mortgage Loans (“ARMs”) include offerings that reprice annually or are “Mini-Fixed.” The “Mini-Fixed” mortgage reprices annually after a one, three, five, seven or ten year period. ARM originations totaled $16.2 million for 2018 and $11.1 million for 2017. During 2018, ARMs represented 17.7% of total mortgage loan originations. The ability of the Bancorp to successfully market ARM’s depends upon loan demand, prevailing interest rates, volatility of interest rates, public acceptance of such loans and terms offered by competitors.

 

Construction Loans. Construction loans on residential properties are made primarily to individuals and contractors who are under contract with individual purchasers. These loans are personally guaranteed by the borrower. The maximum loan-to-value ratio is 89% of either the current appraised value or the cost of construction, whichever is less. Residential construction loans are typically made for periods of six months to one year.

 

Loans are also made for the construction of commercial properties. All such loans are made in accordance with well-defined underwriting standards. Generally if the loans are not owner occupied, these types of loans require proof of intent to lease and a confirmed end-loan takeout. In general, loans made do not exceed 80% of the appraised value of the property. Commercial construction loans are typically made for periods not to exceed two years or date of occupancy, whichever is less.

 

Commercial Real Estate Loans. Commercial real estate loans are typically made to a maximum of 80% of the appraised value. Such loans are generally made on an adjustable rate basis. These loans are typically made for terms of 15 to 20 years. Loans with an amortizing term exceeding 15 years normally have a balloon feature calling for a full repayment within seven to ten years from the date of the loan. The balloon feature affords the Bancorp the opportunity to restructure the loan if economic conditions so warrant. Commercial real estate loans include loans secured by commercial rental units, apartments, condominium developments, small shopping centers, owner occupied commercial/industrial properties, hospitality units and other retail and commercial developments.

 

While commercial real estate lending is generally considered to involve a higher degree of risk than single-family residential lending due to the concentration of principal in a limited number of loans and the effects of general economic conditions on real estate developers and managers, the Bancorp has endeavored to reduce this risk in several ways. In originating commercial real estate loans, the Bancorp considers the feasibility of the project, the financial strength of the borrowers and lessees, the managerial ability of the borrowers, the location of the project and the economic environment. Management evaluates the debt coverage ratio and analyzes the reliability of cash flows, as well as the quality of earnings. All such loans are made in accordance with well-defined underwriting standards and are generally supported by personal guarantees, which represent a secondary source of repayment.

 

Loans for the construction of commercial properties are generally located within an area permitting physical inspection and regular review of business records. Projects financed outside of the Bancorp’s primary lending area generally involve borrowers and guarantors who are or were previous customers of the Bancorp or projects that are underwritten according to the Bank’s underwriting standards.

 

Consumer Loans. The Bancorp offers consumer loans to individuals for personal, household or family purposes. Consumer loans are either secured by adequate collateral, or unsecured. Unsecured loans are based on the strength of the applicant’s financial condition. All borrowers must meet current underwriting standards. The consumer loan program includes both fixed and variable rate products. On a limited basis, the Bancorp purchases indirect dealer paper from various well-established businesses in its immediate banking area.

 

Home Equity Line of Credit. The Bancorp offers a fixed and variable rate revolving line of credit secured by the equity in the borrower’s home. Both products offer an interest only option where the borrower pays interest only on the outstanding balance each month. Equity lines will typically require a second mortgage appraisal and a second mortgage lender’s title insurance policy. Loans are generally made up to a maximum of 89% of the appraised value of the property less any outstanding liens.

 

Home Improvement Loans and Equity Loans—Fixed Term. Home improvement and equity loans are made up to a maximum of 85% of the appraised value of the improved property, less any outstanding liens. These loans are offered on both a fixed and variable rate basis with a maximum term of 240 months. All home equity loans are made on a direct basis to borrowers.

 

 Page 7 of 91

 

 

Commercial Business Loans. Although the Bancorp’s priority in extending various types of commercial business loans changes from time to time, the basic considerations in determining the makeup of the commercial business loan portfolio are economic factors, regulatory requirements and money market conditions. The Bancorp seeks commercial loan relationships from the local business community and from its present customers. Conservative lending policies based upon sound credit analysis governs the extension of commercial credit. The following loans, although not inclusive, are considered preferable for the Bancorp’s commercial loan portfolio: loans collateralized by liquid assets; loans secured by general use machinery and equipment; secured short-term working capital loans to established businesses secured by business assets; short-term loans with established sources of repayment and secured by sufficient equity and real estate; and unsecured loans to customers whose character and capacity to repay are firmly established.

 

Government Loans. The Bancorp is permitted to purchase non-rated municipal securities, tax anticipation notes and warrants within the local market area.

 

Non-Performing Assets, Asset Classification and Provision for Loan Losses

 

Loans are reviewed on a regular basis and are generally placed on a non-accrual status when, in the opinion of management, serious doubt exists as to the collectability of a loan. Loans are generally placed on non-accrual status when either principal or interest is 90 days or more past due. Consumer non-residential loans are generally charged off when the loan becomes over 120 days delinquent. Interest accrued and unpaid at the time a loan is placed on non-accrual status is charged against interest income. Subsequent payments are either applied to the outstanding principal balance, tax and insurance reserve or recorded as interest income, depending on the assessment of the ultimate collectability of the loan.

 

The Bancorp’s mortgage loan collection procedures provide that, when a mortgage loan is 15 days or more delinquent, the borrower will be contacted by mail and payment requested. If the delinquency continues, subsequent efforts will be made to contact the delinquent borrower. In certain instances, the Bancorp will recast the loan or grant a limited moratorium on loan payments to enable the borrower to reorganize his, her or its financial affairs. If the loan continues in a delinquent status for 120 days, the Bancorp will generally initiate foreclosure proceedings. Any property acquired as the result of foreclosure or by voluntary transfer of property made to avoid foreclosure is classified as foreclosed real estate until such time as it is sold or otherwise disposed of by the Bancorp. Foreclosed real estate is recorded at fair value at the date of foreclosure. At foreclosure, any write-down of the property is charged to the allowance for loan losses. Costs relating to improvement of property are capitalized, whereas holding costs are expensed. Valuations are periodically performed by management, and a valuation allowance is established by a charge to operations if the carrying value of a property exceeds its estimated fair value less selling costs. Subsequent gains or losses on disposition, including expenses incurred in connection with the disposition, are charged to operations. Collection procedures for consumer loans provide that when a consumer loan becomes ten days delinquent, the borrower will be contacted by mail and payment requested. If the delinquency continues, subsequent efforts will be made to contact the delinquent borrower. In certain instances, the Bancorp may grant a payment deferral. If a loan continues to be delinquent after 60 days and all collection efforts have been exhausted, the Bancorp will initiate legal proceedings. Collection procedures for commercial business loans provide that when a commercial loan becomes ten days delinquent, the borrower will be contacted by mail and payment requested. If the delinquency continues, subsequent efforts will be made to contact the delinquent borrower pursuant to the commercial loan collection policy. In certain instances, the Bancorp may grant a payment deferral or restructure the loan. Once it has been determined that collection efforts are unsuccessful, the Bancorp will initiate legal proceedings.

 

 Page 8 of 91

 

 

The following table sets forth information regarding the Bancorp’s non-performing assets as of December 31 for each period indicated. The amounts are stated in thousands (000’s).

 

   2018   2017   2016   2015   2014 
Loans accounted for on a non-accrual basis:                         
Real estate:                         
Residential  $5,405   $3,858   $4,521   $4,172   $2,443 
Commercial   695    466    456    1,007    1,918 
Commercial business   495    672    628    22    238 
Consumer   -    -    -    -    - 
Total  $6,595   $4,996   $5,605   $5,201   $4,599 
                          
Accruing loans which are contractually past due 90 days or more:                         
Real estate:                         
Residential  $172   $227   $500   $377   $941 
Commercial   -    -    -    -    - 
Commercial business   149    -    -    -    - 
Consumer   -    -    -    -    - 
Total  $321   $227   $500   $377   $941 
                          
Loans that qualify as troubled debt restructurings and accruing:                         
Real estate:                         
Residential  $598   $302   $-   $-   $- 
Commercial   1,074    181    -    4,419    4,597 
Commercial business   234    52    60    74    90 
Consumer   -    -    -    -    - 
Total  $1,906   $535   $60   $4,493   $4,687 
                          
Total of non-accrual, 90 days past due and accruing, and restructurings  $8,822   $5,758   $6,165   $10,071   $10,227 
                          
Ratio of non-performing loans to total assets   0.63%   0.56%   0.67%   0.64%   0.71%
Ratio of non-performing loans to total loans   0.90%   0.84%   1.05%   0.98%   1.10%
                          
* non-performing loans include non-accrual loans and accruing loans which are contractually past due 90 days or more
                          
Foreclosed real estate  $1,627   $1,699   $2,665   $1,590   $1,745 
Ratio of foreclosed real estate to total assets   0.15%   0.18%   0.29%   0.18%   0.23%

 

During 2018, gross interest income of $306 thousand would have been recorded on loans accounted for on a non-accrual basis if the loans had been current throughout the period. Interest on such loans included in income during the period amounted to $230 thousand.

 

Federal regulations require savings banks to classify their own loans and to establish appropriate general and specific allowances, subject to regulatory review. These regulations are designed to encourage management to evaluate loans on a case-by-case basis and to discourage automatic classifications. Loans classified as substandard or doubtful must be evaluated by management to determine loan loss reserves. Loans classified as loss must either be written off or reserved for by a specific allowance. Amounts reported in the general loan loss reserve are included in the calculation of the Bancorp’s total risk-based capital requirement (to the extent that the amount does not exceed 1.25% of total risk-based assets), but are not included in Tier 1 leverage ratio calculations and Tier 1 risk-based capital requirements.

 

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 December 31, 2018 or December 31, 2017.

 

 Page 9 of 91

 

 

The Bancorp's substandard loans are summarized below:

 

(Dollars in thousands)        
Loan Segment  December 31,
2018
   December 31,
2017
 
Residential real estate  $5,366   $3,732 
Home equity   373    350 
Commercial real estate   1,770    512 
Construction and land development   -    134 
Multifamily   -    - 
Farmland   -    - 
Commercial business   728    1,174 
Consumer   -    - 
Government   -    - 
Total  $8,237   $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)        
Loan Segment  December 31,
2018
   December 31,
2017
 
Residential real estate  $3,908   $4,130 
Home equity   657    233 
Commercial real estate   4,715    6,758 
Construction and land development   -    - 
Multifamily   149    168 
Farmland   -    - 
Commercial business   2,958    394 
Consumer   20    - 
Government   -    - 
Total  $12,407   $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.

 

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.

 

 Page 10 of 91

 

 

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

 

(Dollars in thousands)        
Loan Segment  December 31,
2018
   December 31,
2017
 
Residential real estate  $1,550   $1,152 
Home equity   264    - 
Commercial real estate   2,105    512 
Construction and land development   -    134 
Multifamily   -    - 
Farmland   -    - 
Commercial business   1,863    724 
Consumer   -    - 
Government   -    - 
Total  $5,782   $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)        
Loan Segment  December 31,
2018
   December 31,
2017
 
Residential real estate  $598   $303 
Home equity   -    - 
Commercial real estate   1,074    181 
Construction and land development   -    - 
Multifamily   -    - 
Farmland   -    - 
Commercial business   359    51 
Consumer   -    - 
Government   -    - 
Total  $2,031   $535 

 

The increase in the troubled debt restructured loans reflected in the table above for the twelve months ended December 31, 2018 was the result of a $1.1 million commercial relationship as well as eight residential or home equity loans totaling $301 thousand which were modified as part of a troubled debt restructure or renewed with cash flow difficulties. 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 twelve months ending December 31, 2018, are the result of the completion of the acquisition of First Personal as well as two large commercial relationships, one commercial real estate customer and one First Federal residential customer which were not related to the acquisition. First Personal loans totaling $612 thousand, one $523 thousand First Federal residential loan and one $464 thousand commercial real estate loan contributed to the December 31, 2018 increase in nonperforming loans. One $1.1 million commercial relationship, First Personal loans totaling $721 thousand, one $523 thousand First Federal residential loan and one $464 thousand commercial real estate loan contributed to the December 31, 2018 increase in substandard loans. First Personal loans totaling $2.8 million and one $2.1 million commercial relationship contributed to the December 31, 2018 increase in watch loans, which was offset by the payoff of one $2.3 million commercial real estate loan. First Personal purchased credit impaired loans totaling $2.3 million, one $1.1 million commercial relationship and one $464 thousand commercial real estate loan contributed to the December 31, 2018 increase in impaired loans.

 

 Page 11 of 91

 

 

The table that follows sets forth the allowance for loan losses and related ratios for the periods indicated. The amounts are stated in thousands (000’s).

 

   2018   2017   2016   2015   2014 
Balance at beginning of period  $7,482   $7,698   $6,953   $6,361   $7,189 
Loans charged-off:                         
Real estate residential   (242)   (1,019)   (529)   (239)   (311)
Commercial real estate   (119)   -    -    (59)   (1,421)
Commercial real estate participations   -    -    -    -    - 
Commercial business   (592)   (386)   -    (77)   - 
Consumer   (58)   (71)   (33)   (30)   (32)
Total charge-offs   (1,011)   (1,476)   (562)   (405)   (1,764)
Recoveries:                         
Residential real estate   1    3    2    9    20 
Commercial real estate   24    -    -    22    17 
Commercial real estate participations   -    -    -    -    2 
Commercial business   134    39    28    10    21 
Consumer   24    18    9    2    1 
Total recoveries   183    60    39    43    61 
Net (charge-offs) / recoveries   (828)   (1,416)   (523)   (362)   (1,703)
Provision for loan losses   1,308    1,200    1,268    954    875 
Balance at end of period  $7,962   $7,482   $7,698   $6,953   $6,361 
                          
ALL to loans outstanding   1.04%   1.21%   1.32%   1.22%   1.30%
ALL to nonperforming loans   115.12%   143.26%   126.10%   124.66%   114.83%
Net charge-offs / recoveries to average loans outstanding during the period   -0.12%   -0.23%   -0.09%   -0.06%   -0.35%

 

The following table shows the allocation of the allowance for loan losses at December 31, for the dates indicated. The dollar amounts are stated in thousands (000’s). The percent columns represent the percentage of loans in each category to total loans.

 

   2018   2017   2016   2015   2014 
   $   %   $   %   $   %   $   %   $   % 
Real estate loans:                                                  
Residential   1,917    35.2    1,734    33.7    2,410    35.3    1,711    37.4    1,877    38.8 
Commercial and other dwelling   4,563    47.7    4,365    49.2    4,302    46.3    4,436    45.4    3,658    43.7 
Consumer loans   82    0.7    31    0.1    34    0.1    38    0.1    18    0.1 
Commercial business and other   1,400    16.4    1,352    17.0    952    18.3    768    17.1    808    17.4 
Total   7,962    100.0    7,482    100.0    7,698    100.0    6,953    100.0    6,361    100.0 

 

 Page 12 of 91

 

 

Investment Activities

 

The primary objective of the 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. Securities can be classified as either held-to-maturity (HTM) or available-for-sale (AFS) at the time of purchase. No securities are classified as trading or as held-to-maturity. AFS securities are those the Bancorp may decide to sell if needed for liquidity, asset-liability management or other reasons. During 2018, the Bancorp did not hold as investments any derivative instruments and was not involved in hedging activities as defined by Accounting Standards Codification Topic 815 Derivatives and Hedging. It has been the policy of the Bancorp to invest its excess cash in U.S. government agency securities, mortgage-backed securities, collateralized mortgage obligations and municipal securities. In addition, short-term funds are generally invested as interest bearing balances in financial institutions and federal funds. At December 31, 2018, the Bancorp’s investment portfolio totaled $241.8 million. In addition, the Bancorp had $763 thousand of federal funds sold, and $3.5 million in FHLB stock.

 

The table below shows the carrying values of the components of the investment securities portfolio at December 31, on the dates indicated. The amounts are stated in thousands (000’s).

 

   2018   2017   2016 
Money market fund  $2,480   $476   $222 
U.S. government agencies:               
Available-for-sale   7,894    3,890    16,274 
Mortgage-backed securities (1):               
Available-for-sale   50,583    47,314    67,533 
Collateralized Mortgage Obligations (1):               
Available-for-sale   84,698    85,624    50,442 
Municipal Securities:               
Available-for-sale   94,064    103,747    96,745 
Trust Preferred Securities:               
Available-for-sale   2,049    3,439    2,409 
Totals  $241,768   $244,490   $233,625 

 

 

(1) Mortgage-backed securities and Collateralized Mortgage Obligations are U.S. government agency and sponsored securities.

 

The contractual maturities and weighted average yields for the U.S. government securities, agency securities, municipal securities, and trust preferred securities at December 31, 2018, are summarized in the table below. Securities not due at a single maturity date, such as mortgage-backed securities and collateralized mortgage obligations are not included in the following table. The carrying values are stated in thousands (000’s).

 

 Page 13 of 91

 

 

Yields presented are not on a tax-equivalent basis.

 

   Within 1 Year   1 - 5 Years   5 - 10 Years   After 10 Years 
   Amount   Yield   Amount   Yield   Amount   Yield   Amount   Yield 
Money market fund:  $2,480    2.10%  $-    0.00%  $-    0.00%  $-    0.00%
U.S. government Agencies:                                        
AFS   -    0.00%   3,866    1.80%   4,028    3.23%   -    0.00%
Municipal Securities:                                        
AFS   341    5.90%   3,832    5.02%   12,854    4.27%   77,037    4.14%
Trust Preferred Securities:                                        
AFS   -    0.00%   -    0.00%   -    0.00%   2,049    2.18%
Totals  $2,821    2.56%  $7,698    3.40%  $16,882    4.02%  $79,086    4.09%

 

The Bancorp currently holds three trust preferred securities and the securities’ quarterly interest payments have been placed in “payment in kind” status. Payment in kind status results in a temporary delay in the payment of interest. As a result of a delay in the collection of the interest payments, management placed these securities in non-accrual status. At December 31, 2018, the cost basis of the three trust preferred securities on non-accrual status totaled $3.5 million.

 

Sources of Funds

 

General. Deposits are the major source of the Bancorp’s funds for lending and other investment purposes. In addition to deposits, the Bancorp derives funds from maturing investment securities and certificates of deposit, dividend receipts from the investment portfolio, loan principal repayments, repurchase agreements, advances from the Federal Home Loan Bank of Indianapolis (FHLB) and other borrowings. Loan repayments are a relatively stable source of funds, while deposit inflows and outflows are significantly influenced by general interest rates and money market conditions. Borrowings may be used on a short-term basis to compensate for reductions in the availability of other sources of funds. They may also be used on a longer-term basis for general business purposes. The Bancorp uses repurchase agreements, as well as a line-of-credit and advances from the FHLB for borrowings. At December 31, 2018, the Bancorp had $11.6 million in repurchase agreements. Other borrowings totaled $43.0 million, all of which were FHLB advances.

 

Deposits. Retail and commercial deposits are attracted principally from within the Bancorp’s primary market area. The Bancorp offers a broad selection of deposit instruments including non-interest bearing demand accounts, interest bearing demand accounts, savings accounts, money market deposit accounts, certificate accounts and retirement savings plans. Deposit accounts vary as to terms, with the principal differences being the minimum balance required, the time period the funds must remain on deposit and the interest rate. Certificate account offerings typically range in maturity from ten days to 42 months. The deregulation of federal controls on insured deposits has allowed the Bancorp to be more competitive in obtaining funds and to be flexible in meeting the threat of net deposit outflows. The Bancorp does not obtain funds through brokers.

 

 Page 14 of 91

 

 

The following table presents the average daily amount of deposits and average rates paid on such deposits for the years indicated. The amounts are stated in thousands (000’s).

 

   2018   2017   2016 
   Amount   Rate %   Amount   Rate %   Amount   Rate % 
Noninterest bearing demand deposits  $124,866    -   $117,656    -   $104,672    - 
Interest bearing demand deposits   190,372    0.15    169,980    0.08    145,347    0.07 
MMDA accounts   157,228    0.45    170,211    0.26    167,684    0.21 
Savings accounts   144,746    0.08    131,908    0.08    124,214    0.09 
Certificates of deposit   222,267    1.21    180,413    0.77    192,991    0.62 
Total deposits  $839,479    0.45   $770,168    0.27   $734,908    0.24 

 

Maturities of time certificates of deposit and other time deposits of $100 thousand or more at December 31, 2018 are summarized as follows. The amounts are stated in thousands (000’s).

 

3 months or less  $33,847 
Over 3 months through 6 months   32,603 
Over 6 months through 12 months   36,032 
Over 12 months   28,999 
Total  $131,481 

 

Borrowings. Borrowed money is used on a short-term basis to compensate for reductions in the availability of other sources of funds and is generally accomplished through repurchase agreements, as well as, through a line of credit and advances from the FHLB. Repurchase agreements generally mature within one year and are generally secured by U.S. government securities or U.S. agency securities, under the Bancorp’s control. FHLB advances with maturities ranging from one year to five years are used to fund securities and loans of comparable duration, as well as to reduce the impact that movements in short-term interest rates have on the Bancorp’s overall cost of funds. Fixed rate advances are payable at maturity, with a prepayment penalty.

 

 Page 15 of 91

 

 

The following tables set forth certain information regarding borrowing and repurchase agreements by the Bancorp at the end of and during the periods indicated. The amounts are stated in thousands (000’s).

 

   At December 31, 
  2018   2017   2016 
Repurchase agreements:            
Balance  $11,628   $11,300   $13,998 
Securities underlying the agreements:               
Ending carrying amount   16,262    18,053    23,571 
Ending fair value   16,262    18,053    23,571 
Weighted average rate (1)   1.44%   0.91%   0.56%

 

   For year ended December 31, 
   2018   2017   2016 
Highest month-end balance  $16,672   $17,720   $23,308 
Average outstanding balance   12,754    13,734    17,755 
Weighted average rate on securities sold under agreements to repurchase (2)   1.38%   0.82%   0.55%

 

   At December 31, 
   2018   2017   2016 
Fixed rate short-term advances from the FHLB  $9,000   $6,100   $12,000 
Fixed rate long-term advances from the FHLB   14,000    11,000    13,100 
Variable advances from the FHLB   20,000    -    - 
FHLB line-of-credit   -    3,181    28 
Overdrawn due from other financial institutions   -    600    700 
Total borrowings  $43,000   $20,881   $25,828 

 

 

(1) The weighted average rate for each period is calculated by weighting the principal balances outstanding for the various interest rates.

 

(2) The weighted average rate is calculated by dividing the interest expense for the period by the average daily balances of securities sold under agreements to repurchase for the period.

 

Wealth Management Group

 

Bancorp's Wealth Management Group provides estate and retirement planning, guardianships, land trusts, profit sharing and 401(k) retirement plans, IRA and Keogh accounts, investment agency accounts, and serves as personal representative of estates and acts as trustee for revocable and irrevocable trusts. At December 31, 2018, the market value of the Wealth Management Group’s assets totaled $309.0 million, an increase of $3.0 million, compared to December 31, 2017.

 

Analysis of Profitability and Key Operating Ratios

 

Distribution of Assets, Liabilities and Shareholders’ Equity; Interest Rates and Interest Differential.

 

The net earnings of the Bancorp depend primarily upon the “spread” (difference) between (a) the income it receives from its loan portfolio and other investments, and (b) its cost of money, consisting principally of the interest paid on deposit accounts and on other borrowings.

 

The following table presents the weighted average yields on loans and securities, the weighted average cost of interest bearing deposits and other borrowings, and the interest rate spread for the year ended December 31, 2018.

 

 Page 16 of 91

 

 

Weighted average yield:     
Securities   2.85%
Loans receivable   4.71%
Federal Home Loan Bank stock   4.84%
Total interest-earning assets   4.22%
      
Weighted average cost:     
Deposit accounts   0.45%
Borrowed funds   2.25%
Total interest-bearing liabilities   0.57%
      
Interest rate spread:     
Weighted average yield on interest-earning assets minus the weighted average cost of interest-bearing funds   3.65%

 

Financial Ratios and the Analysis of Changes in Net Interest Income.

 

The tables below set forth certain financial ratios of the Bancorp for the periods indicated:

 

   Year ended December 31, 
   2018   2017   2016 
Return on average assets   0.93%   0.98%   1.03%
Return on average equity   9.88%   9.90%   10.65%
Average equity-to-average assets ratio   9.43%   9.94%   9.67%
Dividend payout ratio   37.62%   36.76%   34.69%

 

   At December 31, 
   2018   2017   2016 
Total stockholders’ equity to  total assets   9.26%   9.93%   9.21%

 

 Page 17 of 91

 

 

The average balance sheet amounts, the related interest income or expense, and average rates earned or paid are presented in the following table.

 

The amounts are stated in thousands (000's).

 

   Year ended December 31, 2018   Year ended December 31, 2017   Year ended December 31, 2016 
       Interest           Interest           Interest     
   Average   Income/   Average   Average   Income/   Average   Average   Income/   Average 
   Balance   Expense   Rate   Balance   Expense   Rate   Balance   Expense   Rate 
Assets:                                             
                                              
Interest bearing balances in financial institutions  $5,996   $167    2.79%  $5,114   $54    1.06%  $5,149   $31    0.60%
Federal funds sold   901    10    1.11    960    4    0.42    409    1    0.24 
Nontaxable Securities   91,458    3,043    3.33    94,238    3,143    3.34    96,087    3,213    3.34 
Taxable Securities   

150,048

    

3,838

    

2.56

    

148,264

    

3,298

    

2.22

    

144,175

    

2,884

    

2.00

 
Total investments   248,403    7,058    2.84    248,576    6,499    2.61    245,820    6,129    2.49 
Loans:*                                             
Real estate mortgage loans   570,980    27,091    4.74    495,448    22,697    4.58    485,778    22,474    4.63 
Commercial business loans   113,545    5,079    4.47    108,083    4,143    3.83    100,861    3,771    3.74 
Consumer loans   2,665    222    8.33    382    19    4.97    480    24    5.00 
Total loans   687,190    32,392    4.71    603,913    26,859    4.45    587,119    26,269    4.47 
Total interest-earning assets   935,593    39,450    4.22    852,489    33,358    3.91    832,939    32,398    3.89 
Allowance for loan losses   (7,512)             (7,239)             (7,364)          
Cash and due from banks   10,813              12,171              11,868           
Premises and equipment   21,835              19,621              18,955           
Other assets   41,179              34,036              31,617           
Total assets  $1,001,908             $911,078             $888,015           
                                              
Liabilities:                                             
                                              
Demand deposit  $124,866   $-    -%  $117,656   $-    -%  $101,835   $-    -%
NOW accounts   190,372    288    0.15    169,980    129    0.08    148,184    101    0.07 
Money market demand accounts   157,228    705    0.45    170,211    437    0.26    167,684    360    0.21 
Savings accounts   144,746    118    0.08    131,908    110    0.08    124,214    107    0.09 
Certificates of deposit   222,267    2,688    1.21    180,413    1,383    0.77    192,991    1,202    0.62 
Total interest-bearing deposits   839,479    3,799    0.45    770,168    2,059    0.27    734,908    1,770    0.24 
Repurchase Agreements   12,754    176    1.38    13,734    113    0.82                
Borrowed funds   44,628    1,116    2.50    28,326    420    1.48    56,990    575    1.01 
Total interest-bearing liabilities   896,861    5,091    0.57    812,228    2,592    0.32    791,898    2,345    0.30 
                                              
Other liabilities   10,587              8,312              10,275           
Total liabilities   907,448              820,540              802,173           
                                              
Stockholders' equity   94,460              90,538              85,842           
Total liabilities and stockholders' equity  $1,001,908             $911,078             $888,015           
                                              
Net interest income       $34,359             $30,766             $30,053      
Net interest spread             3.65%             3.59%             3.59%
Net interest margin**             3.67%             3.61%             3.61%

 

* Non-accruing loans have been included in the average balances.

** Net interest income divided by average interest-earning assets.

 

 Page 18 of 91

 

 

Rate/Volume Analysis

 

The table below sets forth certain information regarding changes in interest income and interest expense of the Bancorp for the periods indicated. For each category of interest-earning asset and interest-bearing liability, information is provided on changes attributable to: (1) changes in volume (change in volume multiplied by old rate) and (2) changes in rate (change in rate multiplied by old volume). Changes attributable to both rate and volume which cannot be segregated have been allocated proportionately to the change due to volume and the change due to rate. The amounts are stated in thousands (000's).

 

   Year Ended December 31,   Year Ended December 31, 
   2018   vs.   2017   2017   vs.   2016 
   Increase / (Decrease)   Increase / (Decrease) 
       Due To           Due To     
   Volume   Rate   Total   Volume   Rate   Total 
                         
Interest income:                              
Loans receivable  $3,858   $1,675   $5,533   $748   $(159)  $589 
Securities   (27)   474    447    57    280    337 
Other interest-earning assets   10    102    112    3    30    33 
Total interest-earning assets   3,841    2,251    6,092    808    151    959 
                               
Interest Expense:                              
Deposits   1,540    200    1,740    88    201    289 
                               
Borrowed Funds   242    517    759    (170)   128    (42)
Total interest-bearing liabilities   1,782     717    2,499    (82)   329    247 
                               
Net change in net interest income/(expense)  $2,059   $1,534   $3,593   $890   $(178)  $712 

 

 Page 19 of 91

 

 

Bank Subsidiary Activities

 

NWIN Risk Management, Inc. is a wholly owned subsidiary of the Bancorp. The subsidiary provides captive insurance for the subsidiaries of the Bancorp. At December 31, 2018, the Bancorp had an investment balance of $2.5 million in NWIN Risk Management, Inc.

 

Peoples Service Corporation, a wholly owned subsidiary of the Bank was incorporated under the laws of the State of Indiana. The subsidiary currently provides insurance and annuity investments to the Bank’s wealth management customers. At December 31, 2018, the Bank had an investment balance of $169 thousand in Peoples Service Corporation.

 

NWIN, LLC is a wholly owned subsidiary of the Bank. NWIN, LLC was incorporated under the laws of the State of Nevada as an investment subsidiary. The investment subsidiary currently holds Bank security investments, which are managed by a professional portfolio manager. In addition, the investment subsidiary is the parent of a real estate investment trust, NWIN Funding, Inc., that invests in real estate loans originated by the Bank. At December 31, 2018, the Bank had an investment balance of $334.5 million in NWIN, LLC.

 

NWIN Funding, Inc. is a subsidiary of NWIN, LLC, and was formed as an Indiana Real Estate Investment Trust (REIT). The formation of NWIN Funding, Inc. provides the Bancorp with a vehicle that may be used to raise capital utilizing portfolio mortgages as collateral, without diluting stock ownership. In addition, NWIN Funding, Inc. will receive favorable state tax treatment for income generated by its operations. At December 31, 2018, the REIT held assets of $70.2 million in real estate loans.

 

Columbia Development Company, LLC is a wholly owned subsidiary of the Bank and was incorporated under the laws of the State of Indiana. The subsidiary holds real estate properties that the Bank has acquired through the foreclosure process. At December 31, 2018, the Bank had an investment balance of $4.2 million in Columbia Development Company, LLC.

 

The consolidated financial statements include NorthWest Indiana Bancorp (the Bancorp), its wholly owned subsidiaries, Peoples Bank SB (the Bank), NWIN Risk Management, Inc, and the Bank’s wholly owned subsidiaries, Peoples Service Corporation, NWIN, LLC 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 dependent upon the earnings of the Bank. All significant inter-company accounts and transactions have been eliminated in consolidation.

 

Competition

 

The Bancorp’s primary market area for deposits, loans and financial services encompasses Lake and Porter Counties, in Northwest Indiana, and Cook County in northeast Illinois. All of the Bancorp’s banking centers and offices are located in its primary market area. Approximately ninety-two percent of the Bancorp’s business activities are within this area.

 

The Bancorp faces strong competition in its primary market area for the attraction and retention of deposits and in the origination of loans. The Bancorp’s most direct competition for deposits has historically come from commercial banks, savings associations, and credit unions located in its primary market area. Particularly in times of high interest rates, the Bancorp has had significant competition from mutual funds and other firms offering financial services. The Bancorp’s competition for loans comes principally from savings associations, commercial banks, mortgage banking companies, credit unions, insurance companies, and other institutional lenders.

 

The Bancorp competes for loans principally through the interest rates and loan fees it charges and the efficiency and quality of the services it provides borrowers and other third-party sources. It competes for deposits by offering depositors a wide variety of savings accounts, checking accounts, competitive interest rates, convenient banking center locations, drive-up facilities, automatic teller machines, tax deferred retirement programs, electronic banking, and other miscellaneous services.

 

 Page 20 of 91

 

 

The activities of the Bancorp and the Bank in the geographic market served involve competition with other banks as well as with other financial institutions and enterprises, many of which have substantially greater resources than those available to the Bancorp. In addition, non-bank financial services companies with which the Bancorp and Bank compete, while subject to regulation by the CFPB, are generally not subject to the same type of extensive regulation by the federal and state banking agencies applicable to the Bancorp and the Bank.

 

Personnel

 

As of December 31, 2018, the Bank had 203 full-time and 46 part-time employees. The employees are not represented by a collective bargaining agreement. Management believes its employee relations are good. The Bancorp has seven executive officers and has no other employees. The Bancorp’s officers also are full-time employees of the Bank, and are compensated by the Bank.

 

Regulation and Supervision

 

Bank Holding Company Regulation. As a registered bank holding company for the Bank, the Bancorp is subject to the regulation and supervision of the FRB under the Bank Holding Company Act of 1956, as amended (the "BHCA"). Bank holding companies are required to file periodic reports with and are subject to periodic examination by the FRB.

 

Under the BHCA, without the prior approval of the FRB, the Bancorp may not acquire direct or indirect control of more than 5% of the voting stock or substantially all of the assets of any company, including a bank, and may not merge or consolidate with another bank holding company. In addition, the Bancorp is generally prohibited by the BHCA from engaging in any nonbanking business unless such business is determined by the FRB to be so closely related to banking as to be a proper incident thereto. Under the BHCA, the FRB has the authority to require a bank holding company to terminate any activity or relinquish control of a nonbank subsidiary (other than a nonbank subsidiary of a bank) upon the FRB's determination that such activity or control constitutes a serious risk to the financial soundness and stability of any bank subsidiary of the bank holding company.

 

Under the Dodd Frank Wall Street Reform and Consumer Protection Act of 2010 (the “Dodd-Frank Act”), a bank holding company is expected to serve as a source of financial and managerial strength to its subsidiary bank(s). Pursuant to this requirement, a bank holding company should stand ready to use its resources to provide adequate capital funds to its subsidiary bank(s) during periods of financial stress or adversity. This support may be required by the FRB at times when the Bancorp may not have the resources to provide it or, for other reasons, would not be inclined to provide it. Additionally, under the Federal Deposit Insurance Corporation Improvement Act of 1991 ("FDICIA"), a bank holding company is required to provide limited guarantee of the compliance by any insured depository institution subsidiary that may become "undercapitalized" (as defined in the statute) with the terms of any capital restoration plan filed by such subsidiary with its appropriate federal banking agency.

 

Savings Bank Regulation. As an Indiana stock savings bank, the Bank is subject to federal regulation and supervision by the FDIC and to state regulation and supervision by the DFI. The Bank's deposit accounts are insured by DIF, which is administered by the FDIC. The Bank is not a member of the Federal Reserve System.

 

Both federal and Indiana law extensively regulate various aspects of the banking business such as reserve requirements, truth-in-lending and truth-in-savings disclosures, equal credit opportunity, fair credit reporting, trading in securities and other aspects of banking operations. Current federal law also requires savings banks, among other things, to make deposited funds available within specified time periods.

 

Under FDICIA, insured state chartered banks are prohibited from engaging as principal in activities that are not permitted for national banks, unless: (i) the FDIC determines that the activity would pose no significant risk to the appropriate deposit insurance fund, and (ii) the bank is, and continues to be, in compliance with all applicable capital standards.

 

Branches and Acquisitions. Branching by the Bank requires the approval of the Federal Reserve and the DFI. Under current law, Indiana chartered banks may establish branches throughout the state and in other states, subject to certain limitations. Congress authorized interstate branching, with certain limitations, beginning in 1997. Indiana law authorizes an Indiana bank to establish one or more branches in states other than Indiana through interstate merger transactions and to establish one or more interstate branches through de novo branching or the acquisition of a branch. The Dodd-Frank Act permits the establishment of de novo branches in states where such branches could be opened by a state bank chartered by that state. The consent of the state is no longer required.

 

 Page 21 of 91

 

 

Transactions with Affiliates. Under Indiana law, the Bank is subject to Sections 22(h), 23A and 23B of the Federal Reserve Act, which restrict financial transactions between banks and affiliated companies, such as the Bancorp. The statute limits credit transactions between a bank and its executive officers and its affiliates, prescribes terms and conditions for bank affiliate transactions deemed to be consistent with safe and sound banking practices, and restricts the types of collateral security permitted in connection with a bank's extension of credit to an affiliate.

 

Capital Requirements. Federal regulations require FDIC insured depository institutions, including state chartered FRB member banks, to meet several minimum capital standards: (i) a common equity Tier 1 capital to risk-based assets ratio of 4.5%; (ii) a Tier 1 capital to risk-based assets ratio of 6.0%; (iii) a total capital to risk-based assets ratio of 8%; and (iv) a 4% Tier 1 capital to total assets leverage ratio.

 

Common equity Tier 1 capital is generally defined as common shareholders’ equity and retained earnings. Tier 1 capital is generally defined as common equity Tier 1 and Additional Tier 1 capital. Additional Tier 1 capital generally includes certain noncumulative perpetual preferred stock and related surplus and minority interests in equity accounts of consolidated subsidiaries. Total capital includes Tier 1 capital (common equity Tier 1 capital plus Additional Tier 1 capital) and Tier 2 capital. Tier 2 capital is comprised of capital instruments and related surplus meeting specified requirements, and may include cumulative preferred stock and long-term perpetual preferred stock, mandatory convertible securities, intermediate preferred stock, and subordinated debt. Also included in Tier 2 capital is the allowance for loan and lease losses limited to a maximum of 1.25% of risk-weighted assets and, for institutions that have exercised an opt-out election regarding the treatment of Accumulated Other Comprehensive Income (“AOCI”), up to 45% of net unrealized gains on available-for-sale equity securities with readily determinable fair market values. Institutions that have not exercised the AOCI opt-out have AOCI incorporated into common equity Tier 1 capital (including unrealized gains and losses on available-for-sale-securities). Calculation of all types of regulatory capital is subject to deductions and adjustments specified in the regulations.

 

In determining the amount of risk-weighted assets for purposes of calculating risk-based capital ratios, assets, including certain off-balance sheet assets (e.g., recourse obligations, direct credit substitutes, and residual interests) are multiplied by a risk weight factor assigned by the regulations based on the risks believed inherent in the type of asset. Higher levels of capital are required for asset categories believed to present greater risk. For example, a risk weight of 0% is assigned to cash and U.S. government securities, a risk weight of 50% is generally assigned to prudently underwritten first lien one to four-family residential mortgages, a risk weight of 100% is assigned to commercial and consumer loans, a risk weight of 150% is assigned to certain past due loans and a risk weight of between 0% to 600% is assigned to permissible equity interests, depending on certain specified factors.

 

In addition to establishing the minimum regulatory capital requirements, the regulations limit capital distributions by the institution and certain discretionary bonus payments to management if an institution does not hold a “capital conservation buffer” consisting of 2.5% of common equity Tier 1 capital to risk-weighted assets above the amount necessary to meet its minimum risk-based capital requirements. The capital conservation buffer requirement was phased in beginning January 1, 2016 at 0.625% of risk-weighted assets, increasing each year until the buffer requirement became fully effective on January 1, 2019.

 

The FRB has authority to establish individual minimum capital requirements in appropriate cases upon a determination that an institution’s capital level is or may become inadequate in light of the particular risks or circumstances. As of December 31, 2018, the Bank met all applicable capital adequacy requirements.

 

 Page 22 of 91

 

 

Bank holding companies are generally subject to consolidated capital requirements established by the FRB. The Dodd-Frank Act 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.

 

Federal law establishes a system of prompt corrective action to resolve the problems of undercapitalized institutions. The law requires that certain supervisory actions be taken against undercapitalized institutions, the severity of which depends on the degree of undercapitalization. The FRB has adopted regulations to implement the prompt corrective action legislation as to state member banks. An institution is deemed to be “well capitalized” if it has a total risk-based capital ratio of 10.0% or greater, a Tier 1 risk-based capital ratio of 8.0% or greater, a leverage ratio of 5.0% or greater, and a common equity Tier 1 ratio of 6.5% or greater. An institution is “adequately capitalized” if it has a total risk-based capital ratio of 8.0% or greater, a Tier 1 risk-based capital ratio of 6.0% or greater, a leverage ratio of 4.0% or greater, and a common equity Tier 1 ratio of 4.5% or greater. An institution is “undercapitalized” if it has a total risk-based capital ratio of less than 8.0%, a Tier 1 risk-based capital ratio of less than 6.0%, a leverage ratio of less than 4.0%, or a common equity Tier 1 ratio of less than 4.5%. An institution is deemed to be “significantly undercapitalized” if it has a total risk-based capital ratio of less than 6.0%, a Tier 1 risk-based capital ratio of less than 4.0%, a leverage ratio of less than 3.0%, or a common equity Tier 1 ratio of less than 3.0%. An institution is considered to be “critically undercapitalized” if it has a ratio of tangible equity (as defined in the regulations) to total assets that is equal to or less than 2.0%.

 

Subject to a narrow exception, a receiver or conservator is required to be appointed for an institution that is “critically undercapitalized” within specified time frames. The regulations also provide that a capital restoration plan must be filed with the FRB within 45 days of the date an institution is deemed to have received notice that it is “undercapitalized,” “significantly undercapitalized,” or “critically undercapitalized.” Compliance with the plan must be guaranteed by any parent holding company up to the lesser of 5% of the institution’s total assets when it was deemed to be undercapitalized or the amount necessary to achieve compliance with applicable capital requirements. In addition, numerous mandatory supervisory actions become immediately applicable to an undercapitalized institution including, but not limited to, increased monitoring by regulators and restrictions on growth, capital distributions and expansion. The FRB could also take any one of a number of discretionary supervisory actions, including the issuance of a capital directive and the replacement of senior executive officers and directors. Significantly and critically undercapitalized institutions are subject to additional mandatory and discretionary measures.

 

The following table shows that, at December 31, 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 December 31, 2018  Amount   Ratio   Amount   Ratio   Amount  Ratio
Common equity tier 1 capital to risk-weighted assets  $92.8    11.6%  $36.1    4.5%  N/A  N/A
Tier 1 capital to risk-weighted assets  $92.8    11.6%  $48.2    6.0%  N/A  N/A
Total capital to risk-weighted assets  $100.8    12.6%  $64.2    8.0%  N/A  N/A
Tier 1 capital to adjusted average assets  $92.8    8.6%  $43.2    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

 

 Page 23 of 91

 

 

In addition, the following table shows that, at December 31, 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 December 31, 2018  Amount   Ratio   Amount   Ratio   Amount   Ratio 
Common equity tier 1 capital to risk-weighted assets  $89.9    11.2%  $36.2    4.5%  $52.2    6.5%
Tier 1 capital to risk-weighted assets  $89.9    11.2%  $48.2    6.0%  $64.3    8.0%
Total capital to risk-weighted assets  $97.9    12.2%  $64.3    8.0%  $80.3    10.0%
Tier 1 capital to adjusted average assets  $89.9    8.4%  $42.9    4.0%  $53.6    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%

 

In December 2017, the Basel Committee on Banking Supervision published the last version of the Basel III accord, generally referred to as “Basel IV.” The Basel Committee stated that a key objective of the revisions incorporated into the framework is to reduce excessive variability of risk-weighted assets (“RWA”), which will be accomplished by enhancing the robustness and risk sensitivity of the standardized approaches for credit risk and operational risk, which will facilitate the comparability of banks’ capital ratios; constraining the use of internally modeled approaches; and complementing the risk-weighted capital ratio with a finalized leverage ratio and a revised and robust capital floor. The leadership of the FRB, Office of the Comptroller of the Currency (“OCC”), and FDIC, who are tasked with implementing Basel IV, supported the revisions. Under the current U.S. capital rules, operational risk capital requirements and a capital floor apply only to advanced approaches institutions, and not to the Bancorp. The impact of Basel IV on the Bancorp will depend on the manner in which it is implemented by the federal banking regulators.

 

Banking regulators may change these capital requirements from time to time, depending on the economic outlook generally and the outlook for the banking industry. The Bancorp is unable to predict whether and when any such further capital requirements would be imposed and, if so, to what levels and on what schedule.

 

New Accounting Standards With Regulatory Effect. In June 2016, the Financial Accounting Standards Board (“FASB”) issued an accounting standard update, “Financial Instruments-Credit Losses (Topic 326), Measurement of Credit Losses on Financial Instruments,” which replaces the current “incurred loss” model for recognizing credit losses with an “expected loss” model referred to as the Current Expected Credit Loss (“CECL”) model. Under the CECL model, the Bancorp will be required to present certain financial assets carried at amortized cost, such as loans held for investment and held-to-maturity debt securities, at the net amount expected to be collected. The measurement of expected credit losses is to be based on information about past events, including historical experience, current conditions, and reasonable and supportable forecasts that affect the collectability of the reported amount. On December 21, 2018, the federal banking agencies approved a final rule modifying their regulatory capital rules and providing an option to phase in over a period of three years the day-one regulatory capital effects of the CECL model. The final rule also revises the agencies’ other rules to reflect the update to the accounting standards. The final rule will take effect April 1, 2019. The new CECL standard will become effective for the Bancorp for fiscal years beginning after December 15, 2019 and for interim periods within those fiscal years. The Bancorp’s management is currently evaluating the impact the CECL model will have on the Bancorp’s accounting. Additional detail around managements current efforts can be found in Note 1 to the financial statements, under ASU No. 2016-13, Financial Instruments - Credit Losses: Measurement of Credit Losses on Financial Instruments.

 

Dividend Limitations. The Bancorp is a legal entity separate and distinct from the Bank. The primary source of the Bancorp’s cash flow, including cash flow to pay dividends on the Bancorp’s Common Stock, is the payment of dividends to the Bancorp by the Bank. Under Indiana law, the Bank may pay dividends of so much of 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 DFI for the payment of a dividend 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 FDIC has the authority to prohibit the Bank from paying dividends if, in its opinion, the payment of dividends would constitute an unsafe or unsound practice in light of the financial condition of the Bank. In addition, under FRB supervisory policy, a bank holding company generally should not maintain its existing rate of cash dividends on common shares unless (i) the organization’s net income available to common shareholders over the past year has been sufficient to fully fund the dividends and (ii) the prospective rate of earnings retention appears consistent with the organization’s capital needs, assets, quality, and overall financial condition. The FRB expects bank holding companies to consult with it in advance of declaring dividends that could raise safety and soundness concerns (i.e., such as when the dividend is not supported by earnings or involves a material increase in the dividend rate) and in advance of repurchasing shares of common or preferred stock.

 

Federal Deposit Insurance. Deposits in the Bank are insured by the Deposit Insurance Fund of the FDIC up to a maximum amount, which is generally $250,000 per depositor, subject to aggregation rules. There is no unlimited insurance coverage for noninterest bearing transaction accounts. Rather, deposits held in noninterest bearing transaction accounts are aggregated with interest bearing deposits the owner may hold in the same ownership category, and the combined insured up to at least $250,000. The Bank is subject to deposit insurance assessments by the FDIC pursuant to its regulations establishing a risk-related deposit insurance assessment system, based on the institution’s capital levels and risk profile. Under the FDIC’s risk-based assessment system, insured institutions are assigned to one of four risk-weighted categories based on supervisory evaluations, regulatory capital levels, and certain other factors with less risky institutions paying lower assessments. An institution’s initial assessment rate depends upon the category to which it is assigned. There are also adjustments to a bank’s initial assessment rates based on levels of long-term unsecured debt, secured liabilities in excess of 25% of domestic deposits and, for certain institutions, brokered deposit levels. Pursuant to FDIC rules adopted under the Dodd-Frank Act (described below), initial assessments ranged from 5 to 35 basis points of the institution’s total assets minus its tangible equity. The Bank paid deposit insurance assessments of $387 thousand during the year ended December 31, 2018. For 2018, the deposit insurance assessment rate before applying one-time credits was approximately 0.051% of insured deposits. No institution may pay a dividend if it is in default of the federal deposit insurance assessment.

 

 Page 24 of 91

 

 

The Bank is also subject to assessment for the Financing Corporation (FICO) to service the interest on the FICO’s bond obligations. The amount assessed on individual institutions, including the Bank, by FICO is in addition to the amount paid for deposit insurance according to the risk-related assessment rate schedule. These assessments will continue until the FICO bonds mature in 2019. During 2018, the FICO assessment rate was 0.14 basis points for each $100 of insured deposits. The Bank paid interest payment assessments of approximately $23 thousand during the year ended December 31, 2018. Future increases in deposit insurance premiums or changes in risk classification would increase the Bank’s deposit related costs.

 

Under the Dodd-Frank Act, the FDIC is authorized to set the reserve ratio for the Deposit Insurance Fund at no less than 1.35%, and must achieve the 1.35% designated reserve ratio by September 30, 2020. The FDIC must offset the effect of the increase in the minimum designated reserve ratio from 1.15% to 1.35% on insured depository institutions of less than $10 billion, and may declare dividends to depository institutions when the reserve ratio at the end of a calendar quarter is at least 1.5%, although the FDIC has the authority to suspend or limit such permitted dividend declarations. The FDIC has set the designated reserve ratio for the deposit insurance fund at 2% of estimated insured deposits, which the FDIC has established as a long-term goal. On September 30, 2018, the DIF reserve ratio reached 1.36 percent, exceeding the statutorily required minimum reserve ratio of 1.35 percent ahead of the September 30, 2020 deadline required under the Dodd-Frank Act.

 

Under the Dodd-Frank Act, the assessment base for deposit insurance premiums is calculated as average consolidated total assets minus average tangible equity. Tangible equity for this purpose means Tier 1 capital. The rate schedules set forth in the rule governing the assessment base are scaled to the increase in the assessment base, including schedules that go into effect as the reserve ratio reaches 1.15%, 2%, and 2.5%.

 

The schedules reduce the initial base assessment rate in each of the four risk-based pricing categories.

 

·For small Risk category I banks, the rates range from 5-9 basis points.
·The rates for small institutions in Risk Categories II, III and IV are 14, 23 and 35 basis points, respectively.
·For large institutions and large, highly complex institutions, the rate schedule ranges from 5 to 35 basis points.

 

There are also adjustments made to the initial assessment rates based on long-term unsecured debt, depository institution debt, and brokered deposits. The FDIC also provides for an assessment system for large depository institutions with over $10 billion in assets.

 

The FDIC has the authority to increase insurance assessments. A significant increase in insurance premiums would likely have an adverse effect on the operating expenses and results of operations of the Bank. Management cannot predict what insurance assessment rates will be in the future.

 

The FDIC may terminate the deposit insurance of any insured depository institution if the FDIC determines, after a hearing, that the institution has engaged or is engaging in unsafe or unsound practices, is in an unsafe and unsound condition to continue operations or has violated any applicable law, regulation, order or any condition imposed in writing by, or written agreement with, the FDIC. The FDIC may also suspend deposit insurance temporarily during the hearing process for a permanent termination of insurance if the institution has no tangible capital.

 Page 25 of 91

 

 

Federal Home Loan Bank System. The Bank is a member of the Federal Home Loan Bank of Indianapolis, which is one of eleven regional Federal Home Loan Banks. Each Federal Home Loan Bank serves as a reserve or central bank for its members within its assigned region. It is funded primarily from funds deposited by member institutions and proceeds from the sale of consolidated obligations of the Federal Home Loan Bank system. It makes loans to members (i.e., advances) in accordance with policies and procedures established by the board of trustees of the Federal Home Loan Bank. As a member, the Bank is required to purchase and maintain stock in the Federal Home Loan Bank of Indianapolis in an amount equal to the greater of 1% of its aggregate unpaid residential mortgage loans, home purchase contracts or similar obligations at the beginning of each year or 5% of our outstanding advances from the Federal Home Loan Bank. At December 31, 2018, the Bank was in compliance with this requirement.

 

At December 31, 2018, the Bancorp owned $3.5 million of stock of the Federal Home Loan Bank of Indianapolis (“FHLBI”) and had outstanding borrowings of $43.0 million from the FHLBI. The FHLBI stock entitles the Bancorp to dividends from the FHLBI. The Bancorp recognized dividend income of approximately $151 thousand in 2018. At December 31, 2018, the Bancorp’s excess borrowing capacity based on collateral from the FHLBI was $118.6 million. Generally, the loan terms from the FHLBI are better than the terms the Bancorp can receive from other sources making it cheaper to borrow money from the FHLBI.

 

Federal Reserve System. Under regulations of the FRB, the Bank is required to maintain reserves against its transaction accounts (primarily checking accounts) and non-personal money market deposit accounts. The effect of these reserve requirements is to increase the Bank’s cost of funds. The Bank is in compliance with its reserve requirements.

 

Community Reinvestment Act. Under the Community Reinvestment Act (“CRA”), the Bank has a continuing and affirmative obligation consistent with its safe and sound operation to help meet the credit needs of its entire community, including low and moderate income neighborhoods. The CRA does not establish specific lending requirements or programs for financial institutions nor does it limit an institution’s discretion to develop the types of products and services that it believes are best suited to its particular community, consistent with the CRA. The CRA requires the FDIC in connection with its examination of the Bank, to assess its record of meeting the credit needs of its community and to take that record into account in its evaluation of certain applications by the Bank. For example, the regulations specify that a bank’s CRA performance will be considered in its expansion (e.g., branching) proposals and may be the basis for approving, denying or conditioning the approval of an application. As of the date of its most recent regulatory examination, the Bank was rated “satisfactory” with respect to its CRA compliance.

 

Gramm-Leach-Bliley Act. Under the Gramm-Leach-Bliley Act ("Gramm-Leach"), bank holding companies are permitted to offer their customers virtually any type of financial service, including banking, securities underwriting, insurance (both agency and underwriting) and merchant banking. In order to engage in these new financial activities, a bank holding company must qualify and register with the FRB as a "financial holding company" by demonstrating that each of its bank subsidiaries is well capitalized, well managed and has at least a satisfactory rating under the CRA. The Bancorp has no current intention to elect to become a financial holding company under Gramm-Leach.

 

Gramm-Leach established a system of functional regulation, under which the federal banking agencies regulate the banking activities of financial holding companies, the U.S. Securities and Exchange Commission regulates their securities activities and state insurance regulators regulate their insurance activities.

 

Under Gramm-Leach, federal banking regulators adopted rules limiting the ability of banks and other financial institutions to disclose nonpublic information about consumers to nonaffiliated third parties. The rules require disclosure of privacy policies to consumers and, in some circumstances, allow consumers to prevent disclosure of certain personal information to nonaffiliated third parties. The privacy provisions of Gramm-Leach affect how consumer information is transmitted through diversified financial services companies and conveyed to outside vendors.

 

The Bancorp does not disclose any nonpublic information about any current or former customers to anyone except as permitted by law and subject to contractual confidentiality provisions which restrict the release and use of such information.

 

Cybersecurity Guidelines. The federal banking agencies have adopted guidelines for establishing information security standards and cybersecurity programs for implementing safeguards under the supervision of the board of directors. These guidelines, along with related regulatory materials, increasingly focus on risk management and processes related to information technology and the use of third parties in the provision of financial services. In October 2016, the federal banking agencies issued an advance notice of proposed rulemaking on enhanced cybersecurity risk-management and resilience standards that would apply to large and interconnected banking organizations and to services provided by third parties to these firms. These enhanced standards would apply only to depository institutions and depository institution holding companies with total consolidated assets of $50 billion or more, which would not currently include the Bancorp. However, similar standards and/or regulations may be adopted or implemented by federal and state banking agencies in the future which may be applicable to community banking organizations such as the Bancorp.

 

Recent cyberattacks against banks and other financial institutions that resulted in unauthorized access to confidential customer information have prompted the federal banking regulators to issue extensive guidance on cybersecurity. Among other things, financial institutions are expected to design multiple layers of security controls to establish lines of defense and ensure that their risk management processes address the risks posed by compromised customer credentials, including security measures to authenticate customers accessing internet-based services. A financial institution also should have a robust business continuity program to recover from a cyberattack and procedures for monitoring the security of third-party service providers that may have access to nonpublic data at the institution. During 2018, the Bancorp did not discover any material cybersecurity incidents.

 

 Page 26 of 91

 

 

Consumer Financial Protection Bureau. The Dodd-Frank Act established the Consumer Financial Protection Bureau (“CFPB”) within the Federal Reserve, which is granted broad rulemaking, supervisory and enforcement powers under various federal consumer financial protection laws, including the Equal Credit Opportunity Act, Truth in Lending Act, Real Estate Settlement Procedures Act, Fair Credit Reporting Act, Fair Debt Collection Act, the Consumer Financial Privacy provisions of Gramm-Leach and certain other statutes. Many of the consumer financial protection functions formerly assigned to the federal banking and other designated agencies are now performed by the CFPB. The CFPB has a large budget and staff, and has the authority to implement regulations under federal consumer protection laws and enforce those laws against, and examine, financial institutions. The CFPB has examination and primary enforcement authority with respect to depository institutions with $10 billion or more in assets. Smaller institutions are subject to rules promulgated by the CFPB but continue to be examined and supervised by the federal banking regulators for consumer compliance purposes. The CFPB has the authority to prevent unfair, deceptive or abusive practice in connection with the offering of consumer financial products. Additionally, this bureau is authorized to collect fines and provide consumer restitution in the event of violations, engage in consumer financial education, track consumer complaints, request data, and promote the availability of financial services to underserved consumers and communities.

 

Moreover, the Dodd-Frank Act authorized the CFPB to establish certain minimum standards for the origination of residential mortgages including a determination of the borrower’s ability to repay. In addition, the CFPB has published several final regulations impacting the mortgage industry, including rules related to ability-to-pay, mortgage servicing, and mortgage loan originator compensation. The ability-to-repay rule makes lenders liable if they fail to assess ability to repay under a prescribed test, but also creates a safe harbor for so-called “qualified mortgages.” Failure to comply with the ability-to-repay rule may result in possible CFPB enforcement action and special statutory damages plus actual, class action, and attorneys’ fees damages, all of which a borrower may claim in defense of a foreclosure action at any time. The Dodd-Frank Act also permits states to adopt consumer protection laws and standards that are more stringent than those adopted at the federal level and, in certain circumstances, permits state attorneys general to enforce compliance with both the state and federal laws and regulations. Federal preemption of state consumer protection law requirements, traditionally an attribute of the federal savings association charter, also was modified by the Dodd-Frank Act and requires a case-by-case determination of preemption by the OCC and eliminates preemption for subsidiaries of a bank. Depending on the implementation of this revised federal preemption standard, the operations of the Bank could become subject to additional compliance burdens in the states in which it operates.

 

Mortgage Reform and Anti-Predatory Lending. Title XIV of the Dodd-Frank Act, the Mortgage Reform and Anti-Predatory Lending Act, includes a series of amendments to the Truth In Lending Act with respect to mortgage loan origination standards affecting, among other things, originator compensation, minimum repayment standards and pre-payments. With respect to mortgage loan originator compensation, except in limited circumstances, an originator is prohibited from receiving compensation that varies based on the terms of the loan (other than the principal amount). The amendments to the Truth In Lending Act also prohibit a creditor from making a residential mortgage loan unless it determines, based on verified and documented information of the consumer’s financial resources, that the consumer has a reasonable ability to repay the loan. The amendments also prohibit certain pre-payment penalties and require creditors offering a consumer a mortgage loan with a pre-payment penalty to offer the consumer the option of a mortgage loan without such a penalty. In addition, the Dodd-Frank Act expands the definition of a “high-cost mortgage” under the Truth In Lending Act, and imposes new requirements on high-cost mortgages and new disclosure, reporting and notice requirements for residential mortgage loans, as well as new requirements with respect to escrows and appraisal practices.

 

Interchange Fees for Debit Cards. Under the Dodd-Frank Act, interchange fees for debit card transactions must be reasonable and proportional to the issuer’s incremental cost incurred with respect to the transaction plus certain fraud related costs. Although institutions with total assets of less than $10 billion are exempt from this requirement, competitive pressures have required smaller depository institutions to reduce fees with respect to these debit card transactions.

 

Federal Securities Law. The shares of Common Stock of the Bancorp have been registered with the SEC under the Securities Exchange Act (the “1934 Act”). The Bancorp is subject to the information, proxy solicitation, insider trading restrictions and other requirements of the 1934 Act and the rules of the SEC there under. If the Bancorp has fewer than 1,200 record shareholders, it may deregister its shares under the 1934 Act and cease to be subject to the foregoing requirements.

 

 Page 27 of 91

 

 

Shares of Common Stock held by persons who are affiliates of the Bancorp may not be resold without registration unless sold in accordance with the resale restrictions of Rule 144 under the Securities Act of 1933. If the Bancorp meets the current public information requirements under Rule 144, each affiliate of the Bancorp who complies with the other conditions of Rule 144 (including those that require the affiliate’s sale to be aggregated with those of certain other persons) would be able to sell in the public market, without registration, a number of shares not to exceed, in any three-month period, the greater of (i) 1% of the outstanding shares of the Bancorp or (ii) the average weekly volume of trading in such shares during the preceding four calendar weeks.

 

Under the Dodd-Frank Act, the Bancorp is required to provide its shareholders an opportunity to vote on the executive compensation payable to its named executive officers and on golden parachute payments in connection with mergers and acquisitions. These votes are non-binding and advisory. At least once every six years, the Bancorp must also permit shareholders to determine on an advisory basis whether such votes should be held every one, two, or three years.

 

Federal Reserve Monetary Policies. The Bancorp’s earnings and growth, as well as the earnings and growth of the banking industry in general, are affected by the monetary and credit policies of monetary authorities, including the FRB. An important function of the FRB is to regulate the national supply of bank credit in order to combat recession and curb inflationary pressures. Among the instruments of monetary policy used by the FRB to implement these objectives are open market operations in U.S. government securities, changes in reserve requirements against member bank deposits, and changes in the Federal Reserve discount rate. These instruments are used in varying combinations to influence overall growth of bank loans, investments, and deposits, and may also affect interest rates charged on loans or paid for deposits. The monetary policies of the FRB have had a significant impact on the operating results of financial institutions in the past and are expected to continue to have effects in the future.

 

In view of continually changing conditions in the national economy and in money markets, as well as the effect of credit policies by monetary and fiscal authorities, including the FRB, it is difficult to predict the impact of possible future changes in interest rates, deposit levels, and loan demand, or their effect on the Bancorp’s business and earnings or on the financial condition of the Bancorp’s various customers.

 

Other Future Legislation and Change in Regulations. Various other legislation, including proposals to expand or contract the powers of banking institutions and bank holding companies, is from time to time introduced. This legislation may change banking statutes and the operating environment of the Bancorp and the Bank in substantial and unpredictable ways. If enacted, such legislation could increase or decrease the cost of doing business, limit or expand permissible activities or affect the competitive balance among banks, savings associations, credit unions and other financial institutions. The Bancorp cannot accurately predict whether any of this potential legislation will ultimately be enacted, and, if enacted, the ultimate effect that it, or implementing regulations, would have upon the financial condition or results of operations of the Bancorp or the Bank.

 

Federal Taxation

 

For federal income tax purposes, the Bank reports its income and expenses on the accrual method of accounting. The Bancorp and the Bank file a consolidated federal income tax return for each fiscal year ending December 31.

 

State Taxation

 

The Bank is subject to Indiana’s Financial Institutions Tax (“FIT”), which is imposed at a flat rate of 7.0% on “adjusted gross income”. This rate is scheduled to decrease over the succeeding years as follows: to 6.25% for 2019, to 6.0% for 2020, to 5.5% for 2021, to 5.0% for 2022, and to 4.9% for 2023 and thereafter. Additionally, the Bank is subject to Illinois state tax which is imposed at a flat rate of 9.5%. “Adjusted gross income,” for purposes of FIT, begins with taxable income as defined by Section 63 of the Internal Revenue Code of 1986, as amended (the “Code”) and, thus, incorporates federal tax law to the extent that it affects the computation of taxable income. Federal taxable income is then adjusted by several Indiana and Illinois modifications. Other applicable state taxes include generally applicable sales and use taxes plus real and personal property taxes.

 

Accounting for Income Taxes

 

At December 31, 2018, the Bancorp has consolidated total deferred tax assets of $5.2 million and consolidated total deferred tax liabilities of $1.3 million, resulting in a consolidated net deferred tax asset of $3.9 million, net of an $87 thousand valuation allowance. The valuation allowance of $87 thousand was provided for the state tax credit, as management does not believe these amounts will be fully utilized before statutory expiration.

 

On December 22, 2017, President Trump signed into law the Tax Cuts and Jobs Act of 2017 (the “TCJA”), which includes a number of provisions that impact the Bancorp, including the following:

 

·Corporate Tax Rate. The TCJA replaced the graduated corporate tax rates applicable under prior law, which imposed a maximum tax rate of 35%, with a reduced 21% flat tax rate. Although the reduced tax rate generally should be favorable to the Bancorp by resulting in increased earnings and capital, it decreased the value of our then-existing deferred tax assets effective in the fourth quarter of 2017. The effect of remeasuring deferred tax assets due to the reduction in the tax rate is a nonrecurring event that generally is not expected to have a substantial adverse impact on the Bancorp’s core earnings or capital over the long term.

 

·Employee Performance-Based Compensation. A “publicly held corporation” is not permitted to deduct compensation in excess of $1 million per year paid to certain employees. The TCJA eliminated certain exceptions to the $1 million limit applicable under prior law related to performance-based compensation under Section 162(m) of the Code, such as equity grants and cash bonuses that are paid only on the attainment of performance goals. As a result, the Bancorp’s ability to deduct certain compensation paid to our most highly compensated employees is now limited.

 

·Business Asset Expensing. The TCJA allows taxpayers to immediately expense the entire cost (instead of only 50%, as under prior law) of certain depreciable tangible property and real property improvements acquired and placed in service after September 27, 2017 and before January 1, 2023 (with an additional year for certain property). This 100% “bonus” depreciation is phased out proportionately for property placed in service on or after January 1, 2023 and before January 1, 2027 (with an additional year for certain property).

 

·Interest Expense. The TCJA limits a taxpayer’s annual deduction of business interest expense to the sum of (i) business interest income, plus (ii) 30% of “adjusted taxable income,” defined as a business’ taxable income without taking into account business interest income or expense, net operating losses, and, for 2018 through 2021, depreciation, amortization and depletion. Because the Bancorp generates significant amounts of net interest income, we do not expect to be impacted by this limitation.

 

The foregoing description of the impact of the TCJA on the Bancorp should be read in conjunction with Note 8 – Income Taxes of the notes to our Consolidated Financial Statements.

 

 Page 28 of 91

 

 

Item 1A. Risk Factors

 

Not applicable.

 

Item 1B. Unresolved Staff Comments

 

Not applicable.

 

Item 2. Properties

 

The Bancorp maintains its corporate office at 9204 Columbia Avenue, Munster, Indiana, from which it oversees the operation of the Bank’s nineteen banking locations. The Bancorp owns all of its office properties.

 

The following table sets forth additional information with respect to the Bank’s offices as of December 31, 2018. Net book value and total investment figures are for land, buildings, furniture and fixtures.

 

   Year       Approximate     
   facility   Net book   square   Total 
Office location  opened   value   footage   cost 
9204 Columbia Avenue                    
Munster, IN 46321-3517   1985   $623,711    11,640   $3,413,403 
141 W. Lincoln Highway                    
Schererville, IN 46375-1851   1990    500,487    9,444    2,311,799 
7120 Indianapolis Blvd.                    
Hammond, IN 46324-2221   1979    72,476    2,600    1,011,824 
1300 Sheffield                    
Dyer, IN 46311-1548   1976    170,882    2,100    1,042,228 
7915 Taft                    
Merrillville, IN 46410-5242   1968    94,161    2,750    970,123 
8600 Broadway                    
Merrillville, IN 46410-7034   1996    894,378    4,400    2,613,788 
4901 Indianapolis Blvd.                    
East Chicago, IN 46312-3604   1995    630,798    4,300    1,815,093 
1501 Lake Park Avenue                    
Hobart, IN 46342-6637   2000    1,678,868    6,992    3,461,658 
9204 Columbia Avenue                    
Corporate Center Building                    
Munster, IN 46321-3517   2003    4,620,526    36,685    14,020,263 
855 Stillwater Parkway                    
Crown Point, IN 46307-5361   2007    1,573,767    3,945    2,493,786 
1801 W. 25th Avenue                    
Gary, IN 46404-3546   2008    1,377,622    2,700    2,047,184 
2905 Calumet Avenue                    
Valparaiso, IN 46383-2645   2009    1,783,096    2,790    2,360,267 
9903 Wicker Avenue                    
Saint John, IN 46373-9402   2010    1,386,629    2,980    2,244,639 
130 Rimbach Street                    
Hammond, IN 46320-1710   2014    772,582    5,230    1,192,501 
1900 Indianapolis Blvd.                    
Whiting, IN 46394-1510   2015    499,248    9,922    849,666 
10688 Randolph Street                    
Crown Point, IN 46307-9424   2015    588,230    2,032    956,339 
3927 Ridge Road                    
Highland, IN 46322-2204   2017    1,633,436    2,282    1,785,492 
14701 South Ravinia Avenue                    
Orland Park, IL 60462-3100   2018    3,544,506    18,771    3,589,468 
12261 Archer Avenue                    
Lemont, IL 60439-6712   2018    1,707,070    5,473    1,736,766 
6162 South Archer Avenue                    
Chicago, IL 60438-2642   2018    671,563    3,278    689,664 

 

The Bank outsources its core processing activities to Fidelity National Information Services, Inc., or FIS Corporation located in Jacksonville, Florida. FIS provides real time services for loans, deposits, retail delivery systems, card solutions, electronic banking, and wealth management. The net book value of the Bank’s property, premises and equipment totaled $24.8 million at December 31, 2018.

 

 Page 29 of 91

 

 

Item 3. Legal Proceedings

 

Not applicable

 

Item 4. Mine Safety Disclosures

 

Not applicable

 

Item 4.5 Executive Officers of the Bancorp

 

Pursuant to General Instruction G(3) of Form 10-K, the following information is included as an unnumbered item in this Part I in lieu of being included in the Bancorp’s Proxy Statement for the 2019 Annual Meeting of Shareholders:

 

The executive officers of the Bancorp are as follows:

 

Executive Officer  

Age at

December 31,

2018

  Position
David A. Bochnowski   73   Executive Chairman
Benjamin J. Bochnowski   38   President, Chief Executive Officer
Robert T. Lowry   57   Executive Vice President, Chief Financial Officer and Treasurer
Leane E. Cerven   60   Executive Vice President, General Counsel, Corporate Secretary
Tanya A. Leetz   48   Executive Vice President, Chief Information and Technology Officer
Todd Scheub   51   Executive Vice President, Chief Banking Officer

 

The following is a description of the principal occupation and employment of the executive officers of the Bancorp during at least the past five years:

 

David A. Bochnowski, is the Executive Chairman of the Bancorp and Bank. His duties include assisting his successor in the transition into the role of Chief Executive Officer of the Company and Bank, assisting the Company and Bank with their strategic goals and budgeting process, and engaging in community and banking activities supporting the mission of the Company and Bank. He formerly served as the Chief Executive Officer for thirty-five years, retiring from that position in April of 2016. He has been Chairman of the Company and Bank since 1995. He has been a director since 1977 and was the Bank’s legal counsel from 1977 to 1981. Mr. Bochnowski is the past Chairman of America’s Community Bankers, now merged with the American Bankers Association. He is a past Chairman of the American Banker Association’s Government Relations Council. He was selected by the Securities and Exchange Commission to serve on the Commission’s Advisory Council on Small and Emerging Companies. He is a former Chairman of the Indiana Department of Financial Institutions; former director of the Federal Home Loan Bank of Indianapolis, and, a former member of the Federal Reserve Thrift Advisory Council. He is a trustee and treasurer of the Munster Community Hospital, a director of the Community Health Care System, serves as Vice-Chairman of Calumet College, and serves on the board of Trustees of Valparaiso University. He is a former Chairman of the Legacy Foundation of Lake County, a former Director of One Region, a former Director of Habitat for Humanity, and a former director of the Local Initiatives Support Corporation (LISC), among others. Before joining the Bank, Mr. Bochnowski was an attorney in private practice. He holds an undergraduate Bachelor of Science and Juris Doctor degrees from Georgetown University and a Master’s Degree from Howard University. He served as an officer in the United States Army and received a Bronze Star for his service in the Vietnam conflict. Mr. Bochnowski is the father of Benjamin Bochnowski, the President and Chief Executive Officer of the Bancorp and Bank.

 

Benjamin J. Bochnowski currently serves as President and Chief Executive Officer of the Bancorp. Mr. Bochnowski joined the Bancorp in 2010, became Executive Vice President and Chief Operating Officer of the Bancorp in 2013, was promoted to President and Chief Operating Officer in 2015, and became the Chief Executive Officer in 2016. He is a Director and member of the Executive Committee of the Indiana Bankers Association, and serves on the Membership Committee of the American Bankers Association. He also serves as the Chairman of the Board of Directors of One Region, a non-profit business organization focused on population growth. Mr. Bochnowski volunteers with the Volunteer Income Tax Assistance (VITA) Program for low-income individuals, and has been a mentor for the Entrepreneurship Boot Camp for Veterans at Purdue University.

 

 Page 30 of 91

 

 

Robert T. Lowry is Executive Vice President, Chief Financial Officer and Treasurer of the Bancorp and the Bank. He is responsible for finance, accounting, financial reporting, and risk management activities. Mr. Lowry has been with the Bank since 1985 and has previously served as the Bank’s Assistant Controller, Internal Auditor and Controller. Mr. Lowry is a Certified Public Accountant (CPA) and a Chartered Global Management Accountant (CGMA). Mr. Lowry holds a Master’s of Business Administration Degree from Indiana University and is a graduate of America’s Community Bankers National School of Banking. Mr. Lowry has taught online courses for the American Bankers Association that focused on capital and liquidity management, interest rate risk and investments. Mr. Lowry is currently serving on the board of the Food Bank of Northwest Indiana as board chairman and chair of the executive committee. In addition, Mr. Lowry is a volunteer for the IRS Volunteer Income Tax Assistance (VITA) program. He is a member of the American Institute of Certified Public Accountants, the Indiana CPA Society and the Financial Managers Society.

 

Leane English Cerven is Executive Vice President, General Counsel, and Corporate Secretary of NorthWest Indiana Bancorp and Peoples Bank SB. Ms. Cerven has been employed by the Bancorp and the Bank since 2010. Prior to joining the Bancorp and the Bank, she was Vice President and Legal Counsel for Bank One and an Associate Attorney with Mayer, Brown & Platt. She is licensed to practice law in Indiana and Illinois. Ms. Cerven holds a J.D. from Valparaiso University School of Law and a B.A. (Political Science/Spanish) from the University of Minnesota, Minneapolis. She is a 2014 graduate of the American Bankers Association Stonier Graduate School of Banking, Vice Chairman of the Stonier Graduate School of Banking Advisory Board, and a Stonier Capstone Advisor. She is also a member of the ABA’s Regional Banks General Counsels Group. She serves on the Board of South Shore Arts, the Investment Committee for Catholic Foundation for Northwest Indiana, and the Bioethics Committees for St. Catherine’s Hospital and St. Mary’s Hospital.

 

Tanya A. Leetz is Executive Vice President, Chief Information and Technology Officer of the Bancorp and the Bank. She is responsible for operational and technology activities. Ms. Leetz joined the Bank in 1994 and has previously served as trust administrator, management development, information systems manager, and chief operating officer. She is a Certified Information Security Manager (CISM) and Certified in Risk and Information Systems Control (CRISC). Ms. Leetz holds a Master’s Degree in Business Administration and a Bachelor of Science Degree in Financial Planning from Purdue University. She also graduated from America’s Community Bankers National School of Banking. Ms. Leetz currently serves on the Executive Committee on the Board of the Boys and Girls Clubs of Greater Northwest Indiana and is involved in other community activities. She is a member of the Information Systems Audit and Control Association and serves as an advisory member of a technology committee.

 

Todd M. Scheub is Executive Vice President, Chief Banking Officer of the Bancorp and the Bank. He is responsible for the Bank’s Wealth Management group, Retail Banking group, Marketing, Commercial, and Retail lending groups as well as the management of asset quality in the loan portfolio. Mr. Scheub joined the Bank in 1996 and has previously held positions in the commercial lending group. He provides oversight to the sales group in wealth management, retail banking, business and retail lending as well as chairing the Senior Officer’s Loan Committee. Additionally he provides oversight to the Bank’s Marketing group. He is the liaison to the operations and technology group, risk management, executive management, and the Board of Directors on all items related to the Bank’s sales groups. Mr. Scheub holds a Bachelor of Science Degree in Business and a Master’s Degree in Business Administration from Indiana University Northwest. He also graduated from America’s Community Bankers National School of Banking. Mr. Scheub is a Board Member at Campagna Academy, Frontline Foundations, Lake County Economic Alliance, and the Northwest Indiana Regional Development Company.

 

 Page 31 of 91

 

 

PART II

 

Item 5. Market for the Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

 

The Bancorp’s Common Stock is not listed on any national securities exchange, but rather is quoted in the over-the-market on the OTC Pink Marketplace, which is maintained by OTC Markets Group, Inc., and on the OTC Bulletin Board, which is maintained by the Financial Industry Regulatory Authority, Inc., under the symbol “NWIN.” The Bancorp’s stock is not actively traded. As of March 4, 2019, the Bancorp had 3,452,199 shares of common stock outstanding and 958 stockholders of record. This does not reflect the number of persons or entities who may hold their stock in nominee or “street” name through brokerage firms. Any over-the-counter market quotations reflect inter-dealer prices without retail mark-up, mark-down or commission and may not necessarily represent actual transactions.

   

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 during the twelve months ended December 31, 2018 under the stock repurchase program.

 

           Total Number of Shares   Maximum Number of 
           Purchased as Part of   Shares That May Yet 
   Total Number   Average Price   Publicly Announced   Be Purchased Under 
Period  of Shares Purchased   Paid per Share   Plans or Programs   the Program(1) 
January 1, 2018 – January 31, 2018   -    N/A    -    48,828 
February 1, 2018 – February 28, 2018   -    N/A    -    48,828 
March 1, 2018 – March 31, 2018   -    N/A    -    48,828 
April 1, 2018 – April 30, 2018   -    N/A    -    48,828 
May 1, 2018 – May 31, 2018   -    N/A    -    48,828 
June 1, 2018 – June 30, 2018   -    N/A    -    48,828 
July 1, 2018 – July 31, 2018   -    N/A    -    48,828 
August 1, 2018 – August 31, 2018   -    N/A    -    48,828 
September 1, 2018 – September 30, 2018   -    N/A    -    48,828 
October 1, 2018 –October 31, 2018   -    N/A    -    48,828 
November 1, 2018 – November 30, 2018   -    N/A    -    48,828 
December 1, 2018 – December 31, 2018   -    N/A    -    48,828 
    -    N/A    -    48,828 

 

(1) The stock repurchase program was announced on April 24, 2014, whereby the Bancorp is authorized to repurchase up to 50,000 shares of the Bancorp’s common stock outstanding. There is no express expiration date for this program.

 

 Page 32 of 91

 

 

Item 6. Selected Financial Data

 

Fiscal Year Ended  December 31,   December 31,   December 31,   December 31,   December 31, 
   2018   2017   2016   2015   2014 
Statement of Income:                         
                          
Total interest income  $39,450   $33,358   $32,399   $29,383   $27,183 
Total interest expense   5,091    2,592    2,345    2,013    1,820 
Net interest income   34,359    30,766    30,054    27,370    25,363 
Provision for loan losses   1,308    1,200    1,268    954    875 
Net interest income after provision for loan losses   33,051    29,566    28,786    26,416    24,488 
Noninterest income   9,099    7,752    7,613    6,850    6,074 
Noninterest expense   31,383    25,488    24,709    23,616    21,015 
Net noninterest expense   22,284    17,736    17,096    16,766    14,941 
Income tax expenses   1,430    2,869    2,548    1,798    2,153 
Net income  $9,337   $8,961   $9,142   $7,852   $7,394 
                          
Basic earnings per common share  $3.17   $3.13   $3.20   $2.75   $2.60 
Diluted earnings per common share  $3.17   $3.13   $3.20   $2.75   $2.60 
Cash dividends declared per common share  $1.19   $1.15   $1.11   $1.06   $0.97 
                          
   December 31,   December 31,   December 31,   December 31,   December 31, 
   2018   2017   2016   2015   2014 
Balance Sheet:                         
                          
Total assets  $1,096,158   $927,259   $913,626   $864,893   $775,044 
Loans receivable   764,400    620,211    583,650    571,898    488,153 
Investment securities   241,768    244,490    233,625    233,350    213,600 
Deposits   929,786    793,004    779,771    714,875    633,946 
Borrowed funds   54,628    32,181    39,826    58,001    53,906 
Total stockholders' equity   101,464    92,060    84,108    80,909    76,165 
                          
   December 31,   December 31,   December 31,   December 31,   December 31, 
   2018   2017   2016   2015   2014 
Interest Rate Spread During Period:                         
                          
Average effective yield on loans and investment securities   4.22%   3.91%   3.89%   3.84%   3.82%
Average effective cost of deposits and borrowings   0.57%   0.32%   0.30%   0.28%   0.27%
Interest rate spread   3.65%   3.59%   3.59%   3.56%   3.55%
                          
Net interest margin   3.67%   3.61%   3.61%   3.58%   3.57%
Return on average assets   0.93%   0.98%   1.03%   0.96%   0.97%
Return on average equity   9.88%   9.90%   10.65%   9.90%   10.14%

 

   December 31,   December 31,   December 31,   December 31,   December 31, 
   2018   2017   2016   2015   2014 
                     
Common equity tier 1 capital to risk-weighted assets   11.6%   12.9%   13.1%   12.4%   N/A 
Tier 1 capital to risk-weighted assets   11.6%   12.9%   13.1%   12.4%   13.6%
Total capital to risk-weighted assets   12.6%   14.0%   14.3%   13.5%   14.8%
Tier 1 capital to adjusted average assets   8.6%   9.6%   9.2%   9.0%   9.2%
                          
Allowance for loan losses to total loans   1.04%   1.21%   1.32%   1.22%   1.30%
Allowance for loan losses to non-performing loans   115.12%   143.26%   126.10%   124.66%   114.83%
Non-performing loans to total loans   0.90%   0.84%   1.05%   0.98%   1.10%
                          
Total loan accounts   6,176    5,680    5,655    5,628    5,140 
Total deposit accounts   36,039    31,080    31,175    30,968    28,955 
Total branches (all full service)   19    16    16    16    14 

 

 Page 33 of 91

 

 

Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations

 

General

 

The Bancorp's earnings are dependent upon the earnings of the Bank. The Bank's earnings are primarily dependent upon net interest margin. The net interest margin is the difference between interest income earned on loans and investments and interest expense paid on deposits and borrowings stated as a percentage of average interest earning assets. The net interest margin is perhaps the clearest indicator of a financial institution's ability to generate core earnings. Fees and service charges, wealth management operations income, gains and losses from the sale of assets, provisions for loan losses, income taxes and operating expenses also affect the Bancorp's profitability.

 

A summary of the Bancorp’s significant accounting policies are detailed in Note 1 to the Bancorp’s consolidated financial statements included in this report. Preparing financial statements in conformity with accounting principles generally accepted in the United States of America 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 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.

 

At December 31, 2018, the Bancorp had total assets of $1.1 billion and total deposits of $929.8 million. The Bancorp's deposit accounts are insured up to applicable limits by the Deposit Insurance Fund (DIF) that is administered by the Federal Deposit Insurance Corporation (FDIC), an agency of the federal government. At December 31, 2018, stockholders' equity totaled $101.5 million, with book value per share at $33.50. Net income for 2018 was $9.3 million, or $3.17 basic and diluted earnings per common share. The return on average assets was 0.93%, while the return on average stockholders’ equity was 9.88%.

 

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 institution. The acquisition represented the Bank’s first expansion into the South Suburban Chicagoland market, and expanded the Bank’s full-service retail banking network to 19 banking centers.

 

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 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.

 

Acquisition of AJS Bancorp, Inc. On January 24, 2019, the Bancorp completed its acquisition of AJS Bancorp, Inc., a Maryland corporation (“AJSB”), pursuant to an Agreement and Plan of Merger dated July 30, 2018 (the “AJSB Merger Agreement”) between the Bancorp and AJSB. Pursuant to the terms of the AJSB Merger Agreement, AJSB merged with and into the Bancorp, with the Bancorp as the surviving corporation (the “AJSB Merger”). Simultaneous with the AJSB Merger, A.J. Smith Federal Savings Bank, a federally chartered savings bank and wholly-owned subsidiary of AJSB, merged with and into the Bank, with the Bank as the surviving institution.

 

 Page 34 of 91

 

 

In connection with the AJSB Merger, each AJSB stockholder holding 100 or more shares of AJSB common stock received fixed consideration of (i) 0.2030 shares of the Bancorp common stock, and (ii) $7.20 per share in cash for each outstanding share of AJSB common stock. Stockholders holding less than 100 shares of AJSB common stock received $16.00 in cash and no stock consideration for each outstanding share of AJSB common stock. Any fractional shares of Bancorp common stock that an AJSB stockholder would have otherwise received in the AJSB Merger were cashed out in the amount of such fraction multiplied by $43.01.

 

The Bancorp issued 416,478 shares of Bancorp common stock to the former AJSB stockholders, and paid cash consideration of approximately $15.4 million. Based upon the closing price of the Bancorp’s common stock on January 23, 2019, the transaction had an implied valuation of approximately $34.2 million, which includes unallocated shares held by the AJSB Employee Stock Ownership Plan (“ESOP”), some of which were cancelled in connection with the closing to satisfy the ESOP’s outstanding loan balance. As a result of the acquisition, the Bank was able to further expand its retail banking network in the South Suburban Chicagoland market, bringing the total number of its full-service banking centers to 22.

  

Financial Condition

 

During the year ended December 31, 2018, total assets increased by $168.9 million (18.2%), to $1.1 billion, with interest-earning assets increasing by $146.9 million (16.9%). At December 31, 2018, interest-earning assets totaled $1.0 billion and represented 92.9% of total assets. Loans totaled $764.4 million and represented 75.1% of interest-earning assets, 69.7% of total assets and 82.2% of total deposits. The loan portfolio, which is the Bancorp’s largest asset, is a significant source of both interest and fee income.

 

   December 31,   December 31, 
(Dollars in thousands)  2018   2017 
   Balance   % Loans   Balance   % Loans 
                 
Residential real estate  $223,323    29.2%   172,141    27.8%
Home equity   45,483    6.0%   36,769    5.9%
Commercial real estate   253,104    33.1%   211,090    34.0%
Construction and land development   64,433    8.4%   50,746    8.2%
Multifamily   47,234    6.2%   43,368    7.0%
Farmland   240    0.0%   -    0.0%
Consumer   6,043    0.8%   461    0.1%
Commercial business   103,439    13.5%   76,851    12.4%
Government   21,101    2.8%   28,785    4.6%
Loans receivable  $764,400    100.0%  $       620,211    100.0%
                     
Adjustable rate loans / loans receivable  $437,928    57.3%  $348,559    56.2%
                     
   December 31,   December 31, 
   2018   2017 
         
Loans receivable to total assets   69.7%   66.9%
Loans receivable to earning assets   75.1%   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 twelve months ended December 31, 2018, the Bancorp originated $55.5 million in new fixed rate mortgage loans for sale, compared to $42.2 million during the twelve months ended December 31, 2017. Net gains realized from the mortgage loan sales totaled $1.6 million for the twelve months ended December 31, 2018, compared to $1.2 million for the twelve months ended December 31, 2017. At December 31, 2018, the Bancorp had $2.9 million in loans that were classified as held for sale, compared to $1.6 million at December 31, 2017.

 

 Page 35 of 91

 

 

Non-performing loans include those loans that are 90 days or more past due and accruing and those loans that have been placed on non-accrual status. At December 31, 2018, all non-performing loans are also accounted for on a non-accrual basis, except for three commercial business loans totaling $149 thousand, one residential loan totaling $122 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 summarized below:

 

(Dollars in thousands)        
Loan Segment 

December 31,

2018

  

December 31,

2017

 
Residential real estate  $5,257   $3,734 
Home equity   320    352 
Commercial real estate   695    332 
Construction and land development   -    133 
Multifamily   -    - 
Farmland   -    - 
Commercial business   644    672 
Consumer   -    - 
Government   -    - 
Total  $6,916   $5,223 
Nonperforming loans to total loans   0.90%   0.84%
Nonperforming loans to total assets   0.63%   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 December 31, 2018 or December 31, 2017.

 

The Bancorp's substandard loans are summarized below:

 

(Dollars in thousands)        
Loan Segment 

December 31,

2018

  

December 31,

2017

 
Residential real estate  $5,366   $3,732 
Home equity   373    350 
Commercial real estate   1,770    512 
Construction and land development   -    134 
Multifamily   -    - 
Farmland   -    - 
Commercial business   728    1,174 
Consumer   -    - 
Government   -    - 
Total  $8,237   $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.

 

 Page 36 of 91

 

 

The Bancorp's special mention loans are summarized below:

 

(Dollars in thousands)        
Loan Segment 

December 31,

2018

  

December 31,

2017

 
Residential real estate  $3,908   $4,130 
Home equity   657    233 
Commercial real estate   4,715    6,758 
Construction and land development   -    - 
Multifamily   149    168 
Farmland   -    - 
Commercial business   2,958    394 
Consumer   20    - 
Government   -    - 
Total  $12,407   $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.

 

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)        
Loan Segment 

December 31,

2018

  

December 31,

2017

 
Residential real estate  $1,550   $1,152 
Home equity   264    - 
Commercial real estate   2,105    512 
Construction and land development   -    134 
Multifamily   -    - 
Farmland   -    - 
Commercial business   1,863    724 
Consumer   -    - 
Government   -    - 
Total  $5,782   $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.

 

 Page 37 of 91

 

 

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

 

(Dollars in thousands)        
Loan Segment 

December 31,

2018

  

December 31,

2017

 
Residential real estate  $598   $303 
Home equity   -    - 
Commercial real estate   1,074    181 
Construction and land development   -    - 
Multifamily   -    - 
Farmland   -    - 
Commercial business   359    51 
Consumer   -    - 
Government   -    - 
Total  $2,031   $535 

 

The increase in the troubled debt restructure loans reflected in the table above for the twelve months ended December 31, 2018 was the result of a $1.1 million commercial relationship as well as eight residential or home equity loans totaling $301 thousand which were modified as part of a troubled debt restructure or renewed with cash flow difficulties. 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 twelve months ending December 31, 2018, are the result of the completion of the acquisition of First Personal as well as two commercial relationships, one commercial real estate customer and one First Federal residential customer which were all not related to the acquisition. First Personal loans totaling $612 thousand, one $523 thousand First Federal residential loan and one $464 thousand commercial real estate loan contributed to the December 31, 2018 increase in nonperforming loans. One $1.1 million commercial relationship, First Personal loans totaling $721 thousand, one $523 thousand First Federal residential loan and one $464 thousand commercial real estate loan contributed to the December 31, 2018 increase in substandard loans. First Personal loans totaling $2.8 million and one $2.1 million commercial relationship contributed to the December 31, 2018 increase in watch loans, which was offset by the payoff of one $2.3 million commercial real estate loan. First Personal purchased credit impaired loans totaling $2.3 million, one $1.1 million commercial relationship and one $464 thousand commercial real estate loan contributed to the December 31, 2018 increase in impaired loans.

 

At December 31, 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.

 

 Page 38 of 91

 

 

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

 

(Dollars in thousands)        
Loan Segment 

December 31,

2018

  

December 31,

2017

 
Residential real estate  $340   $413 
Home equity   84    (73)
Commercial real estate   305    12 
Construction and land development   138    1 
Multifamily   (150)   50 
Farmland   -    - 
Commercial business   522    749 
Consumer   85    50 
Government   (16)   (2)
Total  $1,308   $1,200 

 

The Bancorp's charge-off and recovery information is summarized below:

 

(Dollars in thousands)    
   As of December 31, 2018 
Loan Segment  Charge-off   Recoveries   Net Charge-offs 
Residential real estate  $(194)  $1   $(193)
Home equity   (48)   -    (48)
Commercial real estate   (119)   24    (95)
Construction and land development   -    -    - 
Multifamily   -    -    - 
Farmland   -    -    - 
Commercial business   (592)   134    (458)
Consumer   (58)   24    (34)
Government   -    -    - 
Total  $(1,011)  $183   $(828)

  

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.

 

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

 

(Dollars in thousands)        
  

December 31,

2018

  

December 31,

2017

 
         
Allowance for loan losses  $7,962   $7,482 
Total loans  $764,400   $620,211 
Non-performing loans  $6,916   $5,223 
ALL-to-total loans   1.04%   1.21%
ALL-to-non-performing loans (coverage ratio)   115.1%   143.3%

 

The December 31, 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.

 

 Page 39 of 91

 

 

At December 31, 2018, foreclosed real estate totaled $1.6 million, which was comprised of twenty-four properties, compared to $1.7 million and sixteen properties at December 31, 2017. During 2018, loans totaling $282 thousand were transferred into foreclosed real estate, approximately $1.3 million of foreclosed real estate resulted from the First Personal acquisition, while net sales of foreclosed real estate totaled $1.6 million. Net gains from the 2018 sales totaled $54 thousand. Market value adjustments in 2018 of $135 thousand were also made. At the end of December 2018 all of the Bancorp’s foreclosed real estate is located within its primary market area.

 

At December 31, 2018, the Bancorp's investment portfolio totaled $241.8 million and was invested as follows: 56.0% in U.S. government agency mortgage-backed securities and collateralized mortgage obligations, 38.9% in municipal securities, 3.3% in U.S. government agency debt securities, 0.8% in trust preferred securities, and 1% in a money market fund. During 2018, securities decreased by $2.7 million (1.1%). The decrease in the securities portfolio during the year is a result of market value adjustments for unrealized losses and the reallocation of funds to support loan growth. In addition, at December 31, 2018, the Bancorp had $3.5 million in FHLB stock.

 

As of December 31, 2018, the Bancorp’s three investments in trust preferred securities are in “payment in kind” status. Payment in kind status results in a temporary delay in the payment of interest. As a result of a delay in the collection of the interest payments, management placed these securities on non-accrual status. At December 31, 2018, the cost basis of the three trust preferred securities on non-accrual status totaled $3.5 million.

 

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. At December 31, 2018, deposits totaled $929.8 million. During 2018, deposits increased by $136.8 million (17.2%). The 2018 change in deposits was comprised of the following: certificates of deposit increased by $75.0 million (40.8%), checking accounts increased by $32.6 million (10.6%), savings accounts increased by $30.8 million (23.7%), and money market deposit accounts (MMDA’s) decreased by $1.6 million (1.0%). Deposit balances increased for the year as a result of the First Personal acquisition. When adjusted for the First Personal acquisition, overall deposits decreased.

 

The Bancorp’s borrowed funds are primarily comprised of repurchase agreements and FHLB advances that are used to fund asset growth not supported by deposit generation. At December 31, 2018, borrowed funds totaled $43.0 million compared to $20.8 million at December 31, 2017, an increase of $22.1 million (105.9%). Borrowed funds increased as FHLB advances were utilized for funding loan originations. Retail repurchase agreements totaled $11.6 million at December 31, 2018, compared to $11.3 million at December 31, 2017, an increase of $328 thousand (2.9%). FHLB advances totaled $43.0 million, increasing $25.9 million or 151.5%. The Bancorp did not carry a balance on the FHLB line of credit at December 31, 2018, compared to a $3.2 million balance at December 31, 2017. The Bancorp did not have any other borrowings at December 31, 2018, compared to $600 thousand at December 31, 2017.

 

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 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.

 

 Page 40 of 91

 

 

During 2018, cash and cash equivalents increased $6.1 million compared to a decrease of $33.2 million for 2017. During 2018, the primary sources of cash and cash equivalents were from the acquisition of First Personal, maturities and sales of securities, loan sales and repayments, FHLB advances, and cash from operating activities. The primary uses of cash and cash equivalents were for the purchase of First Personal, loan originations, purchases of securities, FHLB advance repayments, and the payment of common stock dividends. During 2018, cash from operating activities totaled $6.4 million, compared to $12.3 million for 2017. The decrease in cash in-flow from operating activities was primarily a result of accrued expenses and other liabilities related to the First Personal acquisition. Cash outflows from investing activities totaled $31.2 million during 2018, compared to outflows of $47.8 million during 2017. The changes for the current year were related to decreased purchases of securities and in-take of cash and cash equivalents from acquisition activity. Net cash inflows from financing activities totaled $30.9 million in 2018, compared to net cash inflows of $2.3 million in 2017. The increase during 2018 was primarily due to the increase in deposits and borrowed funds. On a cash basis, the Bancorp paid dividends on common stock of $3.4 million and $3.3 million during 2018 and 2017, respectively. During 2018, the Bancorp’s Board of Directors increased dividends as earnings and capital continued to be sufficient to warrant dividend increases.

 

Management strongly believes that safety and soundness is enhanced by maintaining a high level of capital. Stockholders' equity totaled $101.5 million at December 31, 2018, compared to $92.1 million at December 31, 2017, an increase of $9.4 million (10.2%). The increase was primarily the result of net income of $9.3 million and issuance of $6.9 million shares related to the acquisition of First Personal less $3.5 million in cash dividends and net unrealized loss of available for sale securities of $3.5 million. At December 31, 2018, book value per share was $33.50 compared to $32.14 for 2017.

 

The Bancorp is subject to risk-based capital guidelines adopted by 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 various tiers, as described in “Recent Developments – Regulatory Capital Rules” above. The following table shows that, at December 31, 2018, the Bancorp’s capital exceeded all 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 December 31, 2018  Amount   Ratio   Amount   Ratio   Amount   Ratio 
Common equity tier 1 capital to risk-weighted assets  $92.8    11.6%  $36.1    4.5%   N/A    N/A 
Tier 1 capital to risk-weighted assets  $92.8    11.6%  $48.2    6.0%   N/A    N/A 
Total capital to risk-weighted assets  $100.8    12.6%  $64.2    8.0%   N/A    N/A 
Tier 1 capital to adjusted average assets  $92.8    8.6%  $43.2    4.0%   N/A    N/A 

 

The following table shows that, at December 31, 2018, the Bank’s capital exceeded all 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 December 31, 2018  Amount   Ratio   Amount   Ratio   Amount   Ratio 
Common equity tier 1 capital to risk-weighted assets  $89.9    11.2%  $36.2    4.5%  $52.2    6.5%
Tier 1 capital to risk-weighted assets  $89.9    11.2%  $48.2    6.0%  $64.3    8.0%
Total capital to risk-weighted assets  $97.9    12.2%  $64.3    8.0%  $80.3    10.0%
Tier 1 capital to adjusted average assets  $89.9    8.4%  $42.9    4.0%  $53.6    5.0%

 

The Bancorp’s ability to pay dividends to its shareholders is entirely 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 2019, without the need for qualifying for an exemption or prior DFI approval, is $1.5 million plus 2019 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 December, 2018, the Board of Directors of the Bancorp declared a fourth quarter dividend of $0.30 per share. The Bancorp’s fourth quarter dividend was paid to shareholders on January 8, 2019.

 

 Page 41 of 91

 

 

Results of Operations –

Comparison of 2018 to 2017

 

Net income for 2018 was $9.3 million, compared to $9.0 million for 2017, an increase of $376 thousand (4.2%). The twelve-month earnings increase is related to strong loan originations as well as the effects of the merger with First Personal and the tax effects from the Tax Cuts and Jobs Act that, among other changes, reduces the corporate federal income tax rate from 34% to 21% and was effective January 1, 2018. The earnings represent a return on average assets of 0.93% for 2018 compared to 0.98% for 2017. The return on average equity was 9.88% for 2018 compared to 9.90% for 2017.

 

Net interest income for 2018 was $34.4 million, an increase of $3.6 million (11.7%) from $30.8 million for 2017. During the year, the Bancorp’s yield on interest earning assets was positively impacted by higher yields, while interest expense was driven higher primarily by deposit account growth and an increased cost of funds. The weighted-average yield on interest-earning assets was 4.22% for 2018 compared to 3.91% for 2017. The weighted-average cost of funds was 0.57% for 2018 compared to 0.32% for 2017. The impact of the 4.22% return on interest earning assets and the 0.57% cost of funds resulted in a net interest spread of 3.65% for 2018, compared to a net interest spread of 3.59% for 2017. During 2018, total interest income increased by $6.1 million (18.3%) while total interest expense increased by $2.5 million (96.4%). The net interest margin was 3.67% for 2018, compared to 3.61% for 2017. The Bancorp’s tax equivalent net interest margin for 2018 was 3.81% compared to 3.84% for 2017.

 

During 2018, interest income from loans increased by $5.5 million (20.6%) compared to 2017. The increase in interest income from loans is a result of strong loan originations as well as the effects of the merger with First Personal. The weighted-average yield on loans outstanding was 4.71% for 2018 compared to 4.45% for 2017. Loan balances averaged $687.2 million for 2018, an increase of $83.3 million (13.8%) from $603.9 million for 2017. During 2018, interest income from securities and other interest earning assets increased by $559 thousand (8.6%) compared to 2017. The weighted-average yield on securities and other interest earning assets was 2.84% for 2018 compared to 2.61% for 2017. Securities and other interest earning assets averaged $248.4 million for 2018, down $173 thousand (0.1%) from $248.6 million for 2017.

 

Interest expense for deposits increased by $1.7 million (84.5%) during 2018 compared to 2017. The change was due to an increase in the weighted-average rate paid on deposits and increased balances from the acquisition of First Personal as well as internal sales efforts. The weighted-average rate paid on deposits for 2018 was 0.45% compared to 0.27% for 2017. Total deposit balances averaged $839.5 million for 2018, an increase of $69.3 million (9.0%) from $770.2 million for 2017. Interest expense for borrowed funds increased by $696 thousand (165.7%) during 2018 compared to 2017. The change was due to strong loan originations, some of which were funded with borrowed funds. The weighted-average cost of borrowed funds was 2.25% for 2018 compared to 1.27% for 2017. Borrowed funds averaged $57.4 million during 2018, an increase of $15.3 million (35.4%) from $42.1 million for 2017.

 

Noninterest income for 2018 was $9.1 million, an increase of $1.3 million (17.4%) from $7.8 million for 2017. During 2018, fees and service charges totaled $3.9 million, an increase of $555 thousand (16.8%) from $3.3 million for 2017. The increase in fees and service charges is the result of the Bancorp’s growing depository base and enhanced product offerings. Fees from Wealth Management operations totaled $1.70 million for 2018, a decrease of $15 thousand (0.8%) from $1.70 million for 2017. Gains from loan sales totaled $1.6 million for the current year, an increase of $419 thousand (34.9%), compared to $1.2 million for 2017. The increase in gains from the sale of loans is a result of increased originations for the year. Gains from the sale of securities totaled $1.2 million for the current year, an increase of $340 thousand (39.5%) from $860 thousand for 2017. Current market conditions continue to provide opportunities to manage securities cash flows, while recognizing gains from the sales of securities. In 2018, $494 thousand from the increase in the cash value of bank owned life insurance was recorded, an increase of $34 thousand (7.4%) compared to $460 thousand for 2017. The increase in the cash value of bank owned life insurance is a result of the acquisition of First Personal. For 2018, foreclosed real estate sales gains totaled $54 thousand, an decrease of $49 thousand (47.6%) from $103 thousand for 2017. During 2018, other noninterest income totaled $170 thousand, an increase of $63 thousand (58.9%) from $107 thousand for 2017. Rental income from REO properties was the main reason for the increase in other noninterest income for 2018.

 

 Page 42 of 91

 

 

Noninterest expense for 2018 was $31.4 million, up $5.9 million (23.1%) from $25.5 million for 2017. During 2018, compensation and benefits totaled $16.4 million, an increase of $2.2 million (15.4%) from $14.2 million for 2017. The increase in compensation and benefits is the result of the Bancorp’s ordinary course, annual adjustments to salaries, as well as increases due to the acquisition of First Personal. Occupancy and equipment expense totaled $3.7 million for 2018, an increase of $372 thousand (11.3%) compared to $3.3 million for 2017. The increase in occupancy and equipment expense is the result of higher building operating expenses, as well as increases due to the acquisition of First Personal. Data processing expense totaled $2.5 million for 2018, an increase of $1.0 million (69.8%) from $1.5 million for 2017. Data processing expense has increased as a result of increased system utilization, as well as increases due to the acquisition of First Personal. Marketing expense related to banking products totaled $707 thousand for the year, an increase of $112 thousand (18.8%) from $595 thousand for 2017. The increase in marketing expense is primarily related to the acquisition of First Personal. Federal deposit insurance premiums totaled $410 thousand for 2018, an increase of $74 thousand (22.0%) from $336 thousand for 2017. The increase was primarily due to the acquisition of First Personal that resulted in a higher assessment base. Statement and check processing expense totaled $414 thousand for the year, an increase of $31 thousand (8.1%) from $383 thousand for 2017. Professional service expense totaled $713 thousand for the year, an increase of $270 thousand (60.9%) from $443 thousand for 2017. The increase in professional services was directly related to cost associated with the acquisition of First Personal. Other expenses related to banking operations totaled $6.6 million for 2018, an increase of $1.8 million (38.3%) from $4.8 million for 2017. The increase in other operating expenses is primarily related to the acquisition of First Personal and accounts for approximately $609 thousand of one-time expenses and approximately $301 thousand of ongoing expenses that make up the increase for the year ended December 31, 2018. The remainder of the increase in other noninterest expense is primarily related to a shared loss of $125 thousand from the operation of the wholly-owned subsidiary NWIN Risk Management, Inc. (a captive insurance subsidiary), as well as generally higher third party costs. The Bancorp’s efficiency ratio for 2018 was 72.21% compared to 66.17% for 2017. The weaker efficiency ratio is primarily the result of one-time costs associated with the acquisition of First Personal. The ratio is determined by dividing total noninterest expense by the sum of net interest income and total noninterest income for the period.

 

The Bancorp had an income tax expense for 2018 of $1.4 million compared to income tax expense of $2.9 million for 2017, a decrease to expense of $1.4 million (50.2%). The combined effective federal and state tax rates for the Bancorp were 13.3% for 2018 and 24.3% for 2017. The Bancorp’s lower current period effective tax rate is a result of the revaluation of the Bancorp’s net deferred tax asset during December 2017, that resulted in a one-time write down of $517 thousand that was recorded as additional income tax expense. Current period tax expense was also positively impacted by the TCJA that, among other changes, reduces the top corporate federal income tax rate from 35% to a flat rate of 21% and was effective January 1, 2018. A valuation allowance remains for certain other state tax credits that management does not believe will be fully utilized before statutory expiration.

 

Critical Accounting Policies

 

Critical accounting policies are those accounting policies that management believes are most important to the portrayal of the Bancorp’s financial condition and that require management’s most difficult, subjective or complex judgments. The Bancorp’s most critical accounting policies are summarized below. Other accounting policies, including those related to the fair values of financial instruments and the status of contingencies, are summarized in Note 1 to the Bancorp’s consolidated financial statements.

 

Valuation of Investment Securities – 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 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.

 

 Page 43 of 91

 

 

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 of the Accounting Standards Codification. Significant judgments are required in determining impairment, which include making assumptions regarding the estimated prepayments, loss assumptions and the change in interest rates.

 

We consider 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; and an assessment of whether the Bancorp has (1) the intent to sell the debt securities or (2) more likely than not will be required to sell the debt securities before its 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. Management will utilize an independent valuation specialist to value securities semi-annually for other-than-temporary impairment.

 

Allowance for Loan Losses – The Bancorp maintains an Allowance for Loan Losses (ALL) to absorb probable incurred credit losses that arise from the loan portfolio. The ALL is increased by the provision for loan losses, and decreased by charge-offs net of recoveries. The determination of the amounts of the ALL and provisions for loan losses is based upon 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. The methodology used to determine the current year provision and the overall adequacy of the ALL includes a disciplined and consistently applied quarterly process that combines a review of the current position with a risk assessment worksheet. Factors that are taken into consideration in the analysis include an assessment of national and local economic trends, a review of current year loan portfolio growth and changes in portfolio mix, and an assessment of trends for loan delinquencies and loan charge-off activity. Particular attention is given to non-accruing loans and accruing loans past due 90 days or more, and loans that have been classified as substandard, doubtful, or loss. Changes in the provision are directionally consistent with changes in observable data.

 

Commercial and industrial, and commercial real estate loans that exhibit credit weaknesses and loans that have been classified as impaired are subject to an individual review. Where appropriate, ALL allocations are made to these loans based on management’s assessment of financial position, current cash flows, collateral values, financial strength of guarantors, industry trends, and economic conditions. ALL allocations for homogeneous loans, such as residential mortgage loans and consumer loans, are based on historical charge-off activity and current delinquency trends. Management has allocated general reserves to both performing and non-performing loans based on historical data and current information available.

 

Risk factors for non-performing and internally classified loans are based on an analysis of either the projected discounted cash flows or the estimated collateral liquidation value for individual loans defined as substandard or doubtful. Estimated collateral liquidation values are based on established loan underwriting standards and adjusted for current mitigating factors on a loan-by-loan basis. Aggregate substandard loan collateral deficiencies are determined for residential, commercial real estate, commercial business, and consumer loan portfolios. These deficiencies are then stated as a percentage of the total substandard balances to determine the appropriate risk factors.

 

Risk factors for performing and non-classified loans are based on a weighted average of net charge-offs for the most recent three years, which are then stated as a percentage of average loans for the same period. Historical risk factors are calculated for residential, commercial real estate, commercial business, and consumer loans. The three year weighted average historical factors are then adjusted for current subjective risks attributable to: regional and national economic factors; loan growth and changes in loan composition; organizational structure; composition of loan staff; loan concentrations; policy changes and out of market lending activity.

 

 Page 44 of 91

 

 

The risk factors are applied to these types of loans to determine the appropriate level for the ALL. Adjustments may be made to these allocations that reflect management’s judgment on current conditions, delinquency trends, and charge-off activity. Based on the above discussion, management believes that the ALL is currently adequate, but not excessive, given the risk inherent in the loan portfolio.

 

Impact of Inflation and Changing Prices

 

The financial statements and related data presented herein have been prepared in accordance with accounting principles generally accepted in the United States of America, which require the measurement of financial position and operating results in terms of historical dollars, without considering changes in the relative purchasing power of money over time due to inflation. The primary assets and liabilities of the Bancorp are monetary in nature. As a result, interest rates have a more significant impact on the Bancorp’s performance than the effects of general levels of inflation. Interest rates do not necessarily move in the same direction or magnitude as the prices of goods and services.

 

Forward-Looking Statements

 

Statements contained in this report that are not historical facts are forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. The words or phrases “would be,” “will allow,” “intends to,” “will likely result,” “are expected to,” “will continue,” “is anticipated,” “estimate,” “project,” or similar expressions are also intended to identify “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act. The Bancorp cautions readers that forward-looking statements, including without limitation, those relating to the Bancorp’s future business prospects, interest income and expense, net income, liquidity, and capital needs are subject to certain risks and uncertainties that could cause actual results to differ materially from those indicated in the forward-looking statements, due to, among other things, factors identified in this report.

 

Item 7A. Quantitative and Qualitative Disclosures about Market Risk

 

Not applicable.

 

 Page 45 of 91

 

 

Item 8. Financial Statements

 

Report of Independent Registered

Public Accounting Firm

 

To the Board of Directors and Stockholders

NorthWest Indiana Bancorp and Subsidiaries

 

Opinion on the Consolidated Financial Statements

 

We have audited the accompanying consolidated balance sheets of NorthWest Indiana Bancorp and Subsidiaries (the “Company”) as of December 31, 2018 and 2017, the related consolidated statements of income, comprehensive income, stockholders' equity, and cash flows for the years then ended, and the related notes (collectively referred to as the “consolidated financial statements”). In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of the Company as of December 31, 2018 and 2017, and the results of its operations and its cash flows for the years then ended, in conformity with accounting principles generally accepted in the United States of America.

 

We also have audited the Company’s internal control over financial reporting as of December 31, 2018, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (“PCAOB”), based on criteria established in Internal Control-Integrated Framework (2013) issued by The Committee of Sponsoring Organizations of the Treadway Commission (COSO). Our report dated March 4, 2019, expressed an unqualified opinion.

 

Basis for Opinion

 

The Company’s management is responsible for these consolidated financial statements. Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.

 

We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement, whether due to error or fraud. Our audits included performing procedures to assess the risks of material misstatement of the consolidated financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the consolidated financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. We believe that our audits provide a reasonable basis for our opinion.

 

  /s/ Plante & Moran, PLLC  
  Plante & Moran, PLLC  

 

We have served as the Company’s auditor since 2010.

 

Chicago, Illinois

March 4, 2019 

 

 Page 46 of 91

 

 

Consolidated Balance Sheets

 

   December 31, 
(Dollars in thousands)  2018   2017 
         
ASSETS          
           
Cash and non-interest bearing deposits in other financial institutions  $13,260   $10,529 
Interest bearing deposits in other financial institutions   3,116    139 
Federal funds sold   763    357 
           
Total cash and cash equivalents   17,139    11,025 
           
Certificates of deposit in other financial institutions   2,024    1,676 
           
Securities available-for-sale   241,768    244,490 
Loans held-for-sale   2,863    1,592 
Loans receivable   764,400    620,211 
Less: allowance for loan losses   (7,962)   (7,482)
Net loans receivable   756,438    612,729 
Federal Home Loan Bank stock   3,460    3,000 
Accrued interest receivable   3,632    3,262 
Premises and equipment   24,824    19,559 
Foreclosed real estate   1,627    1,699 
Cash value of bank owned life insurance   23,142    19,355 
Goodwill   8,170    2,792 
Other assets   11,071    6,080 
           
Total assets  $1,096,158   $927,259 
         
LIABILITIES AND STOCKHOLDERS' EQUITY        
         
Deposits:          
Non-interest bearing  $127,277   $120,556 
Interest bearing   802,509    672,448 
Total   929,786    793,004 
Repurchase agreements   11,628    11,300 
Borrowed funds   43,000    20,881 
Accrued expenses and other liabilities   10,280    10,014 
           
Total liabilities   994,694    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:  December 31, 2018 - 3,029,157
                     December 31, 2017 - 2,864,507
          
Additional paid-in capital   11,927    4,867 
Accumulated other comprehensive (loss) income   (2,796)   684 
Retained earnings   92,333    86,509 
           
Total stockholders' equity   101,464    92,060 
           
Total liabilities and stockholders' equity  $1,096,158   $927,259 

 

See accompanying notes to consolidated financial statements.

 

 Page 47 of 91

 

 

Consolidated Statements of Income

 

(Dollars in thousands, except per share data)  Year Ended December 31, 
   2018   2017 
Interest income:          
Loans receivable          
Real estate loans  $27,091   $22,697 
Commercial loans   5,079    4,143 
Consumer loans   222    19 
Total loan interest   32,392    26,859 
Securities   6,881    6,434 
Other interest earning assets   177    65 
           
Total interest income   39,450    33,358 
           
Interest expense:          
Deposits   3,799    2,059 
Repurchase agreements   176    113 
Borrowed funds   1,116    420 
           
Total interest expense   5,091    2,592 
           
Net interest income   34,359    30,766 
Provision for loan losses   1,308    1,200 
           
Net interest income after provision for loan losses   33,051    29,566 
           
Noninterest income:          
Fees and service charges   3,866    3,311 
Wealth management operations   1,696    1,711 
Gain on sale of loans held-for-sale, net   1,619    1,200 
Gain on sale of securities, net   1,200    860 
Increase in cash value of bank owned life insurance   494    460 
Gain on sale of foreclosed real estate   54    103 
Other   170    107 
           
Total noninterest income   9,099    7,752 
           
Noninterest expense:          
Compensation and benefits   16,412    14,219 
Occupancy and equipment   3,653    3,281 
Data processing   2,467    1,453 
Marketing   707    595 
Professional services   713    443 
Statement and check processing   414    383 
Federal deposit insurance premiums   410    336 
Other   6,607    4,778 
           
Total noninterest expense   31,383    25,488 
           
Income before income tax expenses   10,767    11,830 
Income tax expenses   1,430    2,869 
           
Net income  $9,337   $8,961 
           
Earnings per common share:          
Basic  $3.17   $3.13 
Diluted  $3.17   $3.13 
           
Dividends declared per common share  $1.19   $1.15 

 

See accompanying notes to consolidated financial statements.

 

 Page 48 of 91

 

 

Consolidated Statements of Comprehensive Income

 

(Dollars in thousands)  Year Ended December 31, 
   2018   2017 
         
Net income  $9,337   $8,961 
           
Net change in net unrealized gains and losses on securities available-for-sale:          
Unrealized gain/(loss) arising during the period   (3,211)   4,009 
Less: reclassification adjustment for gains included in net income   (1,200)   (860)
Net securities gain/(loss) during the period   (4,411)   3,149 
Tax effect   931    (1,070)
Net of tax amount   (3,480)   2,079 
           
Comprehensive income, net of tax  $5,857   $11,040 

 

See accompanying notes to consolidated financial statements.

 

Consolidated Statements of Changes in Stockholders’ Equity

 

           Accumulated         
       Additional   Other         
   Common   Paid-in   Comprehensive   Retained   Total 
(Dollars in thousands, except per share data)  Stock   Capital   (Loss)/Income   Earnings   Equity 
                     
Balance at January 1, 2017  $-   $4,661   $(1,506)  $80,953   $84,108 
                          
Comprehensive income:                         
Net income   -    -    -    8,961    8,961 
Net unrealized loss on securities available-for-sale, net of reclassification and tax effects   -    -    2,079    -    2,079 
Comprehensive income