10-Q


UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C.  20549
 
FORM 10-Q/A
(Amendment No. 1)
 
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2015
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 0-13368
 
FIRST MID-ILLINOIS BANCSHARES, INC.
(Exact name of Registrant as specified in its charter)
 
Delaware
37-1103704
(State or other jurisdiction of
(I.R.S. employer identification no.)
incorporation or organization)
 
 
1421 Charleston Avenue,
 
Mattoon, Illinois
61938
(Address of principal executive offices)
(Zip code)
 
(217) 234-7454
(Registrant's telephone number, including area code)

Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes [X]  No [  ]

Indicate by check mark whether the Registrant has submitted electronically and posted on its corporate website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (Section 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes [X ]  No [  ]

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

Large accelerated filer [  ]
 
Accelerated filer [X]
 
Non-accelerated filer [  ]
(Do not check if a smaller reporting company)
Smaller reporting company [  ]
 

Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Act).  [  ] Yes  [X] No

As of November 6, 2015, 8,426,176 common shares, $4.00 par value, were outstanding.




EXPLANATORY NOTE
First Mid-Illinois Bancshares, Inc. (the “Company”) is filing this amendment on Form 10-Q/A (this “Form 10-Q/A”) to amend the Company’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2015 (the “Original Form 10-Q”), as originally filed with the U.S. Securities and Exchange Commission on November 9, 2015. This Form 10-Q/A is being filed solely to amend an inadvertent error in reporting (i) the number of shares of the Company’s common shares, $4.00 par value (the “Common Stock”), outstanding as of November 6, 2015 on the cover page of the Original Form 10-Q and (ii) the number of shares of Common Stock issued as of September 30, 2015 in the Condensed Consolidated Balance Sheets included in Item 1 of Part I of the Original Form 10-Q.
Specifically, the amount of Common Stock issued and outstanding as of November 6, 2015 reported on the cover page of the Original Form 10-Q inadvertently included treasury shares that were issued but not outstanding, and the number of shares of Common Stock issued as of September 30, 2015 reported in Item 1 of Part I of the Original Form 10-Q inadvertently excluded those treasury shares. As reflected in this Form 10-Q/A, the number of shares of Common Stock issued and outstanding as of November 6, 2015, as reflected on the cover page hereof, was 8,426,176 and the number of shares of Common Stock issued as of September 30, 2015, as reflected in Item 1 of Part I hereof, was 8,970,114.
The incorrect number of shares issued was also included in Exhibit 101 to the Original Form 10-Q containing the Company’s Extensible Business Reporting Language (“XBRL”) materials for the period ended September 30, 2015. This Form 10-Q/A also amends Item 6 of Part II of the Original Form 10-Q by including Exhibit 101 containing the Company’s XBRL materials for the period ended September 30, 2015 with the corrected number of shares issued.
This Form 10-Q/A speaks as of the date of filing of the Original Form 10-Q and does not reflect any events that may have occurred after that date. Except as specifically noted above, this Form 10-Q/A does not modify or update the financial results or disclosures in the Original Form 10-Q.






PART I

ITEM 1.  FINANCIAL STATEMENTS
 
 
 
First Mid-Illinois Bancshares, Inc.
 
 
 
Condensed Consolidated Balance Sheets
(Unaudited)
 
 
(In thousands, except share data)
September 30, 2015
 
December 31, 2014
Assets
 
 
 
Cash and due from banks:
 
 
 
Non-interest bearing
$
41,077

 
$
40,716

Interest bearing
173,894

 
10,520

Federal funds sold
492

 
494

Cash and cash equivalents
215,463

 
51,730

Certificates of deposit investments
12,930

 

Investment securities:
 

 
 

Available-for-sale, at fair value
490,556

 
377,856

Held-to-maturity, at amortized cost (estimated fair value of $50,030 and $53,937 at September 30, 2015 and December 31, 2014, respectively)
49,105

 
53,650

Loans held for sale
1,346

 
1,958

Loans
1,235,403

 
1,060,448

Less allowance for loan losses
(14,228
)
 
(13,682
)
Net loans
1,221,175

 
1,046,766

Interest receivable
7,620

 
6,828

Other real estate owned
320

 
263

Premises and equipment, net
31,582

 
27,352

Goodwill, net
39,768

 
25,753

Intangible assets, net
7,594

 
1,844

Other assets
14,569

 
13,103

Total assets
$
2,092,028

 
$
1,607,103

Liabilities and Stockholders’ Equity
 

 
 

Deposits:
 

 
 

Non-interest bearing
$
331,206

 
$
222,116

Interest bearing
1,400,654

 
1,049,961

Total deposits
1,731,860

 
1,272,077

Securities sold under agreements to repurchase
108,499

 
121,869

Interest payable
381

 
285

FHLB borrowings
20,000

 
20,000

Junior subordinated debentures
20,620

 
20,620

Dividends payable
1,100

 
530

Other liabilities
5,759

 
6,806

Total liabilities
1,888,219

 
1,442,187

Stockholders’ Equity:
 

 
 

Convertible preferred stock, no par value; authorized 1,000,000 shares; issued 5,500 shares in 2015 and 2014
27,400

 
27,400

Common stock, $4 par value; authorized 18,000,000 shares; issued 8,970,114 shares in 2015 and 7,529,815 shares in 2014
37,880

 
32,119

Additional paid-in capital
79,033

 
55,607

Retained earnings
70,135

 
61,956

Deferred compensation
3,086

 
3,329

Accumulated other comprehensive income (loss)
1,861

 
(875
)
Less treasury stock at cost, 548,642 shares in 2015 and 496,497 shares in 2014
(15,586
)
 
(14,620
)
Total stockholders’ equity
203,809

 
164,916

Total liabilities and stockholders’ equity
$
2,092,028

 
$
1,607,103


See accompanying notes to unaudited condensed consolidated financial statements.
First Mid-Illinois Bancshares, Inc.
 
 
 
Condensed Consolidated Statements of Income (unaudited)
 
(In thousands, except per share data)
Three months ended September 30,
 
Nine months ended September 30,
 
2015
 
2014
 
2015
 
2014
Interest income:
 
 
 
 
 
 
 
Interest and fees on loans
$
12,198

 
$
11,391

 
$
34,974

 
$
33,242

Interest on investment securities
2,682

 
2,392

 
7,473

 
7,460

Interest on certificates of deposit investments
6

 

 
6

 

Interest on deposits with other financial institutions
57

 
24

 
101

 
67

Total interest income
14,943

 
13,807

 
42,554

 
40,769

Interest expense:
 

 
 

 
 

 
 

Interest on deposits
645

 
586

 
1,690

 
1,778

Interest on securities sold under agreements to repurchase
14

 
11

 
43

 
33

Interest on FHLB borrowings
155

 
78

 
465

 
211

Interest on other borrowings
1

 

 
14

 
1

Interest on subordinated debentures
132

 
130

 
390

 
385

Total interest expense
947

 
805

 
2,602

 
2,408

Net interest income
13,996

 
13,002

 
39,952

 
38,361

Provision for loan losses
481

 
44

 
889

 
495

Net interest income after provision for loan losses
13,515

 
12,958

 
39,063

 
37,866

Other income:
 

 
 

 
 

 
 

Trust revenues
795

 
813

 
2,575

 
2,594

Brokerage commissions
329

 
265

 
913

 
748

Insurance commissions
459

 
448

 
1,568

 
1,447

Service charges
1,536

 
1,412

 
4,003

 
3,909

Securities gains, net
1

 
(20
)
 
231

 
714

Mortgage banking revenue, net
172

 
185

 
549

 
441

ATM / debit card revenue
1,200

 
958

 
3,224

 
2,933

Other
517

 
341

 
1,282

 
1,087

Total other income
5,009

 
4,402

 
14,345

 
13,873

Other expense:
 

 
 

 
 

 
 

Salaries and employee benefits
6,522

 
6,216

 
18,875

 
18,323

Net occupancy and equipment expense
2,424

 
2,056

 
6,329

 
6,319

Net other real estate owned (income) expense
(1
)
 
41

 

 
23

FDIC insurance
236

 
199

 
641

 
604

Amortization of intangible assets
155

 
162

 
466

 
487

Stationery and supplies
180

 
152

 
475

 
480

Legal and professional
660

 
514

 
1,842

 
1,753

Marketing and donations
296

 
246

 
790

 
755

Other
2,410

 
1,504

 
5,498

 
4,520

Total other expense
12,882

 
11,090

 
34,916

 
33,264

Income before income taxes
5,642

 
6,270

 
18,492

 
18,475

Income taxes
1,979

 
2,355

 
6,634

 
6,924

Net income
3,663

 
3,915

 
11,858

 
11,551

Dividends on preferred shares
550

 
1,105

 
1,650

 
3,313

Net income available to common stockholders
$
3,113

 
$
2,810

 
$
10,208

 
$
8,238


3



First Mid-Illinois Bancshares, Inc.
 
 
 
Condensed Consolidated Statements of Income (unaudited) (continued)
 

 
 
(In thousands, except per share data)
Three months ended September 30,
 
Nine months ended September 30,
 
2015
 
2014
 
2015
 
2014
Per share data:
 

 
 

 
 

 
 

Basic net income per common share available to common stockholders
$
0.37

 
$
0.48

 
$
1.35

 
$
1.40

Diluted net income per common share available to common stockholders
$
0.37

 
$
0.47

 
$
1.33

 
$
1.38

Cash dividends declared per common share

 

 
0.29

 
0.26

See accompanying notes to unaudited condensed consolidated financial statements.

4



First Mid-Illinois Bancshares, Inc.
 
 
 
 
 
 
 
Condensed Consolidated Statements of Comprehensive Income (unaudited)
 
 
 
(in thousands)
Three months ended September 30,
 
Nine months ended September 30,
 
2015
 
2014
 
2015
 
2014
Net income
$
3,663

 
$
3,915

 
$
11,858

 
$
11,551

Other Comprehensive Income
 

 
 

 
 

 
 

Unrealized gains on available-for-sale securities, net of taxes of $(1,709) and $(1,073) for three months ended September 30, 2015 and 2014, respectively and $(1,662) and $(4,605) for nine months ended September 30, 2015 and 2014, respectively.
2,676

 
1,679

 
2,601

 
7,209

Amortized holding losses on held-to-maturity securities transferred from available-for-sale, net of taxes of $(51) and $540 for three months ended September 30, 2015 and 2014, respectively and $(176) and $540 for nine months ended September 30, 2015 and 2014, respectively.
80

 
(844
)
 
276

 
(844
)
Less: reclassification adjustment for realized (gains) losses included in net income net of taxes of $0 and $(8) for three months ended September 30, 2015 and 2014, respectively and $90 and $278 for nine months ended September 30, 2015 and 2014, respectively.
(1
)
 
12

 
(141
)
 
(436
)
Other comprehensive income, net of taxes
2,755

 
847

 
2,736

 
5,929

Comprehensive income
$
6,418

 
$
4,762

 
$
14,594

 
$
17,480


See accompanying notes to unaudited condensed consolidated financial statements.



5



First Mid-Illinois Bancshares, Inc.
 
Condensed Consolidated Statements of Cash Flows (unaudited)
Nine months ended September 30,
(In thousands)
2015
 
2014
Cash flows from operating activities:
 
 
 
Net income
$
11,858

 
$
11,551

Adjustments to reconcile net income to net cash provided by operating activities:
 

 
 

Provision for loan losses
889

 
495

Depreciation, amortization and accretion, net
2,908

 
3,010

Stock-based compensation expense
264

 
312

Gains on investment securities, net
(231
)
 
(714
)
(Gain) loss on sales of other real property owned, net
(32
)
 
41

Loss on write down of fixed assets
166

 
85

Gains on sale of loans held for sale, net
(586
)
 
(455
)
Increase in accrued interest receivable
(298
)
 
(362
)
(Decrease) increase in accrued interest payable
(29
)
 
34

Origination of loans held for sale
(43,106
)
 
(33,125
)
Proceeds from sale of loans held for sale
44,304

 
32,414

Increase in other assets
(2,327
)
 
(1,961
)
Decrease in other liabilities
(1,500
)
 
(861
)
Net cash provided by operating activities
12,280

 
10,464

Cash flows from investing activities:
 

 
 

Purchases of certificates of deposit investments
(12,930
)
 

Proceeds from sales of securities available-for-sale
9,453

 
75,618

Proceeds from maturities of securities available-for-sale
55,057

 
48,889

Proceeds from maturities of securities held-to-maturity
10,000

 

Purchases of securities available-for-sale
(168,820
)
 
(55,399
)
Purchases of securities held-to-maturity
(10,000
)
 

Net increase in loans
(23,068
)
 
(57,421
)
Purchases of premises and equipment
(1,380
)
 
(989
)
Proceeds from sales of other real property owned
113

 
524

Cash received related to acquisition, net of cash and cash equivalents acquired
279,468

 

Net cash provided by investing activities
137,893

 
11,222

Cash flows from financing activities:
 
 
 

Net increase in deposits
6,136

 
11,224

Decrease in repurchase agreements
(17,167
)
 
(31,121
)
Proceeds from FHLB advances
5,000

 
5,000

Repayment of FHLB advances
(5,000
)
 
(10,000
)
Proceeds from other borrowings
2,000

 
1,000

Repayment of other borrowings
(2,000
)
 
(1,000
)
Proceeds from issuance of common stock
28,165

 
493

Conversion of preferred stock

 
(5
)
Purchase of treasury stock
(1,041
)
 
(1,650
)
Dividends paid on preferred stock
(1,001
)
 
(2,024
)
Dividends paid on common stock
(1,532
)
 
(1,133
)
Net cash provided by (used in) financing activities
13,560

 
(29,216
)
Increase (decrease) in cash and cash equivalents
163,733

 
(7,530
)
Cash and cash equivalents at beginning of period
51,730

 
65,102

Cash and cash equivalents at end of period
$
215,463

 
$
57,572


6



First Mid-Illinois Bancshares, Inc.
 
Condensed Consolidated Statements of Cash Flows (unaudited) (continued)
Nine months ended September 30,
(In thousands)
2015
 
2014
 
 
 
 
Supplemental disclosures of cash flow information
 
 
 
Cash paid during the period for:
 
 
 
Interest
$
2,506

 
$
2,374

Income taxes
6,961

 
6,685

Supplemental disclosures of noncash investing and financing activities
 

 
 

Securities transferred from available-for-sale to held-to-maturity

 
53,594

Loans transferred to other real estate owned
167

 
344

Dividends reinvested in common stock
597

 
576

Net tax benefit related to option and deferred compensation plans
85

 
101


See accompanying notes to unaudited condensed consolidated financial statements.

7



Notes to Condensed Consolidated Financial Statements
(unaudited)

Note 1 --  Basis of Accounting and Consolidation

The unaudited condensed consolidated financial statements include the accounts of First Mid-Illinois Bancshares, Inc. (“Company”) and its wholly-owned subsidiaries:  First Mid-Illinois Bank & Trust, N.A. (“First Mid Bank”), Mid-Illinois Data Services, Inc. (“MIDS”) and The Checkley Agency, Inc. doing business as First Mid Insurance Group (“First Mid Insurance”).  All significant intercompany balances and transactions have been eliminated in consolidation.   The financial information reflects all adjustments which, in the opinion of management, are necessary for a fair presentation of the results of the interim periods ended September 30, 2015 and 2014, and all such adjustments are of a normal recurring nature.  Certain amounts in the prior year’s consolidated financial statements have been reclassified to conform to the September 30, 2015 presentation and there was no impact on net income or stockholders’ equity.  The results of the interim period ended September 30, 2015 are not necessarily indicative of the results expected for the year ending December 31, 2015. The Company operates as a one-segment entity for financial reporting purposes.

The 2014 year-end consolidated balance sheet data was derived from audited financial statements, but does not include all disclosures required by accounting principles generally accepted in the United States of America.

The unaudited condensed consolidated financial statements have been prepared in accordance with the instructions to Form 10-Q and Article 10 of Regulation S-X and do not include all of the information required by U.S. generally accepted accounting principles (“GAAP”) for complete financial statements and related footnote disclosures although the Company believes that the disclosures made are adequate to make the information not misleading.  These financial statements should be read in conjunction with the consolidated financial statements and notes thereto included in the Company’s 2014 Annual Report on Form 10-K.

Website

The Company maintains a website at www.firstmid.com. All periodic and current reports of the Company and amendments to these reports filed with the Securities and Exchange Commission (“SEC”) can be accessed, free of charge, through this website as soon as reasonably practicable after these materials are filed with the SEC.

Branch Purchase and Assumption Agreement

On January 30, 2015, First Mid Bank, a wholly-owned subsidiary of the Company, entered into a Purchase and Assumption Agreement (the “Purchase Agreement”) with Old National Bank, a national banking association having its principal office in Evansville, Indiana, pursuant to which First Mid Bank purchased certain assets and assume certain liabilities of 12 branch offices of Old National Bank in Southern Illinois (the “ONB Branches”). Pursuant to the terms of the Purchase Agreement, First Mid Bank agreed to assume certain deposit liabilities and to acquire certain loans, as well as cash, real property, furniture, and other fixed operating assets associated with the ONB Branches. The book value of loan and deposit balances assumed was approximately $156 million and $453 million, respectively. First Mid Bank also agreed to assume certain leases, and entered into certain subleases, relating to the ONB Branches. The completion of the Purchase was subject to regulatory approval required by the Office of the Comptroller of the Currency and normal customary closing conditions, including First Mid Bank, in conjunction with the Company, obtaining financing in connection with the acquisition. Following satisfaction of these conditions, First Mid Bank and Old National Bank closed the acquisition on August 14, 2015.

Capital Raise

On June 18, 2015, the Company entered into a securities purchase agreement with a limited number of institutional investors to sell, and accepted from certain other accredited investors, including certain directors of the Company, subscriptions for, an aggregate total of 1,392,859 newly issued shares of the Company's common stock at a purchase price of $21.00 per share, for an aggregate gross purchase price of approximately $29,250,039 (the "Offering"). The Offering closed on June 19, 2015. The Company used the net proceeds of the Offering to provide capital support for the purchase of the ONB Branches and for general corporate purposes.






8



Rights Agreement

On January 21, 2015, the Company entered into an Amendment No. 1 to the Rights Agreement (the "Rights Agreement"), dated as of September 22, 2009, by and between the Company and Computershare Trust Company, N.A., as rights agent. This amendment accelerated the expiration of the Company's common stock purchase rights (the “Rights”) from 5:00 p.m., Mattoon, Illinois time, on September 22, 2019, to 5:00 p.m., Mattoon, Illinois time, on January 21, 2015, and had the effect of terminating the Rights Agreement on that date. At the time of the termination of the Rights Agreement, all of the Rights distributed to holders of the Company's common stock pursuant to the Rights Agreement expired.

NASDAQ Listing

On May 12, 2014, the Company's common stock began trading on The NASDAQ Stock Market under the ticker "FMBH." Prior to the listing of the Company's common stock on NASDAQ, the common stock was traded on the OTC Bulletin Board.

Stock Plans

At the Annual Meeting of Stockholders held May 23, 2007, the stockholders approved the First Mid-Illinois Bancshares, Inc. 2007 Stock Incentive Plan (“SI Plan”).  The SI Plan was implemented to succeed the Company’s 1997 Stock Incentive Plan, which had a ten-year term that expired October 21, 2007. The SI Plan is intended to provide a means whereby directors, employees, consultants and advisors of the Company and its subsidiaries may sustain a sense of proprietorship and personal involvement in the continued development and financial success of the Company and its subsidiaries, thereby advancing the interests of the Company and its stockholders.  Accordingly, directors and selected employees, consultants and advisors may be provided the opportunity to acquire shares of common stock of the Company on the terms and conditions established in the SI Plan.

On September 27, 2011, the Board of Directors passed a resolution relating to the SI Plan whereby they authorized and approved the Executive Long-Term Incentive Plan (“LTIP”). The LTIP was implemented to provide methodology for granting Stock Awards and Stock Unit Awards to select senior executives of the Company or any Subsidiary.

A maximum of 300,000 shares of common stock may be issued under the SI Plan.  As of September 30, 2015, the Company had awarded 59,500 shares as stock options under the SI plan.  There were no stock options awarded in 2015 or 2014. The Company awarded 16,604 shares as Stock Unit Awards and 14,770 as 50% Stock Awards and 50% Stock Unit Awards during 2015 and 2014, respectively, under the SI plan.

Convertible Preferred Stock

Series B Convertible Preferred Stock.  During 2009, the Company sold to certain accredited investors including directors, executive officers, and certain major customers and holders of the Company’s common stock, $24,635,000, in the aggregate, of a newly authorized series of its preferred stock designated as Series B 9% Non-Cumulative Perpetual Convertible Preferred Stock (the “Series B Preferred Stock”). The Series B Preferred Stock had an issue price of $5,000 per share and no par value per share.  The Series B Preferred Stock was issued in a private placement exempt from registration pursuant to Regulation D of the Securities Act of 1933, as amended.

On September 23, 2014, the Board of Directors of the Company approved the mandatory conversion of all of the Company's issued and outstanding 4,926 shares of Series B Preferred Stock into shares of the Company’s common stock. On September 24, 2014, notices were sent to the shareholders of the Series B Preferred Stock regarding the mandatory conversion. On November 17, 2014, the Company completed the mandatory conversion. The conversion ratio for each share of the Preferred Stock was computed by dividing $5,000 (the issuance price per share of the Series B Preferred Stock) by $21.62 (then current conversion price). The conversion ratio, therefore, was 231.267 shares of the Company's common stock for each share of Series B Preferred Stock. This resulted in the issuance of approximately 1,139,195 shares of common stock in the aggregate. As a result of the conversion, dividends ceased to accrue on the Series B Preferred Stock and certificates for shares of Series B Preferred Stock only represent the right to receive the appropriate number of shares of common stock, together with net accrued but unpaid dividends on the Preferred Stock, and cash in lieu of fractional share interests.







9



Series C Convertible Preferred Stock.  On February 11, 2011, the Company accepted from certain accredited investors, including directors, executive officers, and certain major customers and holders of the Company’s common stock (collectively, the “Investors”), subscriptions for the purchase of $27,500,000, in the aggregate, of a newly authorized series of preferred stock designated as Series C 8% Non-Cumulative Perpetual Convertible Preferred Stock (the “Series C Preferred Stock”). As of February 11, 2011, $11,010,000 of the Series C Preferred Stock had been issued and sold by the Company to certain Investors.  On March 2, 2011, three investors subsequently completed the required bank regulatory process and an additional $2,750,000 of Series C Preferred Stock was issued and sold by the Company to these investors. On May 13, 2011, four additional investors received the required bank regulatory approval and an additional $5,490,000 of Series C Preferred Stock was issued and sold by the Company to these investors. On June 28, 2012, the final $8,250,000 of the Company’s Series C Preferred Stock was issued and sold by the Company to Investors following their receipt of the required bank regulatory approval, for a total of $27,500,000 of outstanding Series C Preferred Stock. All of the Series C Preferred Stock subscribed for by investors has been issued.

The Series C Preferred Stock has an issue price of $5,000 per share and no par value per share.  The Series C Preferred Stock was issued in a private placement exempt from registration pursuant to Regulation D of the Securities Act of 1933, as amended.

The Series C Preferred Stock pays non-cumulative dividends semiannually in arrears, when, as and if authorized by the Board of Directors of the Company, at a rate of 8% per year.  Holders of the Series C Preferred Stock will have no voting rights, except with respect to certain fundamental changes in the terms of the Series C Preferred Stock and certain other matters.  In addition, if dividends on the Series C Preferred Stock are not paid in full for four dividend periods, whether consecutive or not, the holders of the Series C Preferred Stock, acting as a class with any other of the Company’s securities having similar voting rights, including the Company’s Series B Preferred Stock, will have the right to elect two directors to the Company’s Board of Directors.  The terms of office of these directors will end when the Company has paid or set aside for payment full semi-annual dividends for four consecutive dividend periods.

Each share of the Series C Preferred Stock may be converted at any time at the option of the holder into shares of the Company’s common stock.  The number of shares of common stock into which each share of the Series C Preferred Stock is convertible is the $5,000 liquidation preference per share divided by the Conversion Price of $20.29.  The Conversion Price is subject to adjustment from time to time pursuant to the terms of the Series C Certificate of Designation.  If at the time of conversion, there are any authorized, declared and unpaid dividends with respect to a converted share of Series C Preferred Stock, the holder will receive cash in lieu of the dividends, and a holder will receive cash in lieu of fractional shares of common stock following conversion.

After May 13, 2016 the Company may, at its option but subject to the Company’s receipt of any required prior approvals from the Board of Governors of the Federal Reserve System or any other regulatory authority, redeem the Series C Preferred Stock.  Any redemption will be in exchange for cash in the amount of $5,000 per share, plus any authorized, declared and unpaid dividends, without accumulation of any undeclared dividends.

The Company also has the right at any time after May 13, 2016 to require the conversion of all (but not less than all) of the Series C Preferred Stock into shares of common stock if, on the date notice of mandatory conversion is given to holders, (a) the tangible book value per share of the Company’s common stock equals or exceeds 115% of the tangible book value per share of the Company’s common stock at December 31, 2010, and (b) the NASDAQ Bank Index (denoted by CBNK:IND) equals or exceeds 115% of the NASDAQ Bank Index at December 31, 2010.  “Tangible book value per share of our common stock” at any date means the result of dividing the Company’s total common stockholders equity at that date, less the amount of goodwill and intangible assets, determined in accordance with U.S. generally accepted accounting principles, by the number of shares of common stock then outstanding, net of any shares held in the treasury. The tangible book value of the Company’s common stock at December 31, 2010 was $9.38, and 115% of this amount is approximately $10.79. The NASDAQ Bank Index value at December 31, 2010 was 1,847.35 and 115% of this amount is approximately 2,124.45. The tangible book value of the Company’s common stock at September 30, 2015 was $15.32 and the NASDAQ Bank Index value at September 30, 2015 was 2,770.27.


10



Accumulated Other Comprehensive Income

The components of accumulated other comprehensive income included in stockholders’ equity as of September 30, 2015 and December 31, 2014 are as follows (in thousands):
 
Unrealized Gain (Loss) on
Securities
 
Securities with Other-Than-Temporary Impairment Losses
 
Total
September 30, 2015
 
 
 
 
 
Net unrealized gains on securities available-for-sale
$
4,967

 
$

 
$
4,967

Unamortized losses on held-to-maturity securities transferred from available-for-sale
(876
)
 

 
(876
)
Securities with other-than-temporary impairment losses

 
(1,042
)
 
(1,042
)
Tax benefit
(1,594
)
 
406

 
(1,188
)
Balance at September 30, 2015
$
2,497

 
$
(636
)
 
$
1,861

December 31, 2014
 
 
 
 
 
Net unrealized gains on securities available-for-sale
$
2,829

 
$

 
$
2,829

Unamortized losses on held-to-maturity securities transferred from available-for-sale
(1,328
)
 

 
(1,328
)
Securities with other-than-temporary impairment losses

 
(2,936
)
 
(2,936
)
Tax benefit (expense)
(586
)
 
1,146

 
560

Balance at December 31, 2014
$
915

 
$
(1,790
)
 
$
(875
)


Amounts reclassified from accumulated other comprehensive income and the affected line items in the statements of income during the nine months ended September 30, 2015 and 2014, were as follows (in thousands):
 
Amounts Reclassified from Other Comprehensive Income
 
Affected Line Item in the Statements of Income
 
2015
 
2014
 
Unrealized gains on available-for-sale securities
$
231

 
714

 
Securities gains, net
 
 
 
 
 
(Total reclassified amount before tax)
 
(90
)
 
(278
)
 
Income taxes
Total reclassifications out of accumulated other comprehensive income
$
141

 
$
436

 
Net reclassified amount


See “Note 3 – Investment Securities” for more detailed information regarding unrealized losses on available-for-sale securities.


11



Adoption of New Accounting Guidance

Accounting Standards Update 2014-09, Revenue from Contracts with Customers (Topic 606): Revenue from Contracts with Customers ("ASU 2014-09"). In May 2014, FASB issued ASU 2014-09 which creates a new topic in the FASB Accounting Standards Codification(R) ("ASC"), Topic 606. In addition to superseding and replacing nearly all existing U.S. GAAP revenue recognition guidance, including industry-specific guidance, ASU 2014-09 establishes a new control-based revenue recognition model, changes the basis for deciding when revenue is recognized over time or at a point in time, provides new and more detailed guidance on specific topics and expands and improves disclosures about revenue. In addition, ASU 2014-09 adds a new Subtopic to the ASC, Other Assets and Deferred Costs: Contracts with Customers ("ASC 340-40"), to provide guidance on costs related to obtaining a contract with a customer and costs incurred in fulfilling a contract with a customer that are not in the scope of another ASC Topic. The new guidance does not apply to certain contracts within the scope of other ASC Topics, such as lease contracts, insurance contracts, financing arrangements, financial instruments, guarantee other than product or service warranties, and non-monetary exchanges between entities in the same line of business to facilitate sales to customers. The amendments are effective for annual periods and interim periods within those annual periods beginning after December 15, 2016. In August 2015, FASB issued ASU 2015-14, Revenue from Contracts with Customers (Topic 606)-Deferral of the Effective Date which provides a one year deferral of ASU 2014-09. The adoption of this guidance is not expected to have a material impact on the Company’s financial statements.

Accounting Standards Update 2014-11, Transfers and Servicing (Topic 860): Repurchase-to-Maturity Transactions, Repurchase Financings, and Disclosures ("ASU 2014-11"). In June 2014, FASB issued ASU 2014-11 which changes the accounting for repurchase-to-maturity transactions and repurchase financing arrangements to secured borrowing accounting. ASU 2014-11 also requires enhanced disclosures about repurchase agreements and other similar transactions. The accounting changes in this update are effective for the first interim or annual period beginning after December 31, 2014. The disclosure for transactions accounted for as a sale is effective for the first interim or annual period beginning on or after December 15, 2014; the disclosure for transactions accounted for as secured borrowings is required to be presented for annual periods after December 15, 2014, and interim periods after March 15, 2015. Early application is not permitted. The adoption of this amendment did not have a material effect on the Company's financial statements.

12



Note 2 -- Earnings Per Share

Basic net income per common share available to common stockholders is calculated as net income less preferred stock dividends divided by the weighted average number of common shares outstanding.  Diluted net income per common share available to common stockholders is computed using the weighted average number of common shares outstanding, increased by the assumed conversion of the Company’s convertible preferred stock and the Company’s stock options, unless anti-dilutive.

The components of basic and diluted net income per common share available to common stockholders for the three and nine-month period ended September 30, 2015 and 2014 were as follows:

 
Three months ended September 30,
 
Nine months ended September 30,
 
2015
 
2014
 
2015
 
2014
Basic Net Income per Common Share
 
 
 
 
 
 
 
Available to Common Stockholders:
 
 
 
 
 
 
 
Net income
$
3,663,000

 
$
3,915,000

 
$
11,858,000

 
$
11,551,000

Preferred stock dividends
(550,000
)
 
(1,105,000
)
 
(1,650,000
)
 
(3,313,000
)
Net income available to common stockholders
$
3,113,000

 
$
2,810,000

 
$
10,208,000

 
$
8,238,000

Weighted average common shares outstanding
8,421,397
 
5,881,681
 
7,553,468
 
5,881,974
Basic earnings per common share
$
0.37

 
$
0.48

 
$
1.35

 
$
1.40

Diluted Net Income per Common Share
 
 
 
 
 
 
 
Available to Common Stockholders:
 
 
 
 
 
 
 
Net income available to common stockholders
$
3,113,000

 
$
2,810,000

 
$
10,208,000

 
$
8,238,000

Effect of assumed preferred stock conversion
550,000

 
1,105,000

 
1,650,000

 
3,313,000

Net income applicable to diluted earnings per share
$
3,663,000

 
$
3,915,000

 
$
11,858,000

 
$
11,551,000

Weighted average common shares outstanding
8,421,397

 
5,881,681

 
7,553,468

 
5,881,974

Dilutive potential common shares:
 
 
 
 
 
 
 
Restricted stock awarded
7,788

 
9,892

 
7,788

 
9,892

Assumed conversion of preferred stock
1,355,348

 
2,494,569

 
1,355,348

 
2,494,642

Dilutive potential common shares
1,363,136

 
2,504,461

 
1,363,136

 
2,504,534

Diluted weighted average common shares outstanding
9,784,533

 
8,386,142

 
8,916,604

 
8,386,508

Diluted earnings per common share
$
0.37

 
$
0.47

 
$
1.33

 
$
1.38



The following shares were not considered in computing diluted earnings per share for the three and nine-month periods ended September 30, 2015 and 2014 because they were anti-dilutive:
 
Three months ended September 30,
 
Nine months ended September 30,
 
2015
 
2014
 
2015
 
2014
Stock options to purchase shares of common stock
45,500

 
128,750

 
45,500

 
128,750






13



Note 3 -- Investment Securities

The amortized cost, gross unrealized gains and losses and estimated fair values for available-for-sale and held-to-maturity securities by major security type at September 30, 2015 and December 31, 2014 were as follows (in thousands):
 
Amortized Cost
 
Gross Unrealized Gains
 
Gross Unrealized (Losses)
 
Fair Value
September 30, 2015
 
 
 
 
 
 
 
Available-for-sale:
 
 
 
 
 
 
 
U.S. Treasury securities and obligations of U.S. government corporations & agencies
$
127,239

 
$
368

 
$
(156
)
 
$
127,451

Obligations of states and political subdivisions
95,354

 
2,354

 
(207
)
 
97,501

Mortgage-backed securities: GSE residential
256,836

 
3,156

 
(551
)
 
259,441

Trust preferred securities
3,167

 

 
(1,042
)
 
2,125

Other securities
4,035

 
35

 
(32
)
 
4,038

Total available-for-sale
$
486,631

 
$
5,913

 
$
(1,988
)
 
$
490,556

Held-to-maturity:
 
 
 
 
 
 
 
U.S. Treasury securities and obligations of U.S. government corporations & agencies
$
49,105

 
$
931

 
$
(6
)
 
$
50,030

 
 
 
 
 
 
 
 
December 31, 2014
 
 
 
 
 
 
 
Available-for-sale:
 
 
 
 
 
 
 
U.S. Treasury securities and obligations of U.S. government corporations & agencies
$
101,224

 
$
91

 
$
(1,358
)
 
$
99,957

Obligations of states and political subdivisions
75,589

 
2,608

 
(113
)
 
78,084

Mortgage-backed securities: GSE residential
193,814

 
2,548

 
(961
)
 
195,401

Trust preferred securities
3,300

 

 
(2,936
)
 
364

Other securities
4,036

 
26

 
(12
)
 
4,050

Total available-for-sale
$
377,963

 
$
5,273

 
$
(5,380
)
 
$
377,856

Held-to-maturity:
 
 
 
 
 
 
 
U.S. Treasury securities and obligations of U.S. government corporations & agencies
$
53,650

 
$
299

 
$
(12
)
 
$
53,937



During the third quarter of 2014, management evaluated its available-for-sale portfolio and transferred obligations of U.S. government corporations & agencies securities with a fair value of $53.6 million from available-for-sale to held-to-maturity to reduce price volatility. Management determined it has both the intent and ability to hold these securities to maturity. Transfers of investment securities into the held-to-maturity category from available-for-sale are made at fair value on the date of transfer. There were no gains or losses recognized as a result of this transfer. The related $1.4 million of unrealized holding loss that was included in the transfer is retained in the carrying value of the held-to-maturity securities and in other comprehensive income net of deferred taxes. These amounts are being amortized into net interest income over the remaining life of the related securities as a yield adjustment, resulting in no impact on future net income.

Trust preferred securities represent one trust preferred pooled security issued by First Tennessee Financial (“FTN”). The unrealized loss of this security, which has a remaining maturity of twenty-two years, is primarily due to its long-term nature, a lack of demand or inactive market for the security, and concerns regarding the underlying financial institutions that have issued the trust preferred security. See the heading “Trust Preferred Securities” for further information regarding this security.






14



Realized gains and losses resulting from sales of securities were as follows during the nine months ended September 30, 2015 and 2014 (in thousands):
 
September 30,
2015
 
September 30,
2014
Gross gains
$
231

 
$
1,451

Gross losses

 
(737
)

The following table indicates the expected maturities of investment securities classified as available-for-sale presented at fair value, and held-to-maturity presented at amortized cost, at September 30, 2015 and the weighted average yield for each range of maturities (dollars in thousands):
 
One year or less
 
After 1 through 5 years
 
After 5 through 10 years
 
After ten years
 
Total
Available-for-sale:
 
 
 
 
 
 
 
 
 
U.S. Treasury securities and obligations of U.S. government corporations and agencies
$
85,648

 
$
41,803

 
$

 
$

 
$
127,451

Obligations of state and political subdivisions
5,669

 
44,125

 
47,278

 
429

 
97,501

Mortgage-backed securities: GSE residential
795

 
210,986

 
47,660

 

 
259,441

Trust preferred securities

 

 

 
2,125

 
2,125

Other securities

 
3,977

 

 
61

 
4,038

Total available-for-sale investments
$
92,112

 
$
300,891

 
$
94,938

 
$
2,615

 
$
490,556

Weighted average yield
1.74
%
 
2.39
%
 
2.80
%
 
1.46
%
 
2.32
%
Full tax-equivalent yield
1.90
%
 
2.73
%
 
3.90
%
 
1.72
%
 
2.73
%
Held to Maturity:
 
 
 
 
 
 
 
 
 
U.S. Treasury securities and obligations of U.S. government corporations and agencies
$
29,647

 
$
14,585

 
$
4,873

 
$

 
$
49,105

Weighted average yield
2.11
%
 
2.11
%
 
2.53
%
 
%
 
2.15
%
Full tax-equivalent yield
2.11
%
 
2.11
%
 
2.53
%
 
%
 
2.15
%


The weighted average yields are calculated on the basis of the amortized cost and effective yields weighted for the scheduled maturity of each security. Tax-equivalent yields have been calculated using a 35% tax rate.  With the exception of obligations of the U.S. Treasury and other U.S. government agencies and corporations, there were no investment securities of any single issuer, the book value of which exceeded 10% of stockholders' equity at September 30, 2015.

Investment securities carried at approximately $363 million and $330 million at September 30, 2015 and December 31, 2014, respectively, were pledged to secure public deposits and repurchase agreements and for other purposes as permitted or required by law.


15



The following table presents the aging of gross unrealized losses and fair value by investment category as of September 30, 2015 and December 31, 2014 (in thousands):
 
Less than 12 months
 
12 months or more
 
Total
 
Fair
Value
 
Unrealized
Losses
 
Fair
Value
 
Unrealized
Losses
 
Fair
Value
 
Unrealized
Losses
September 30, 2015
 
 
 
 
 
 
 
 
 
 
 
Available-for-sale:
 
 
 
 
 
 
 
 
 
 
 
U.S. Treasury securities and obligations of U.S. government corporations and agencies
$
22,215

 
$
(31
)
 
$
28,973

 
$
(125
)
 
$
51,188

 
$
(156
)
Obligations of states and political subdivisions
10,444

 
(145
)
 
1,185

 
(62
)
 
11,629

 
(207
)
Mortgage-backed securities: GSE residential
18,219

 
(86
)
 
21,001

 
(465
)
 
39,220

 
(551
)
Trust preferred securities

 

 
2,125

 
(1,042
)
 
2,125

 
(1,042
)
Other securities
1,968

 
(32
)
 

 

 
1,968

 
(32
)
Total
$
52,846

 
$
(294
)
 
$
53,284

 
$
(1,694
)
 
$
106,130

 
$
(1,988
)
Held-to-maturity:
 
 
 
 
 
 
 
 
 
 
 
U.S. Treasury securities and obligations of U.S. government corporations and agencies
$
4,994

 
$
(6
)
 
$

 
$

 
$
4,994

 
$
(6
)
December 31, 2014
 

 
 

 
 

 
 

 
 

 
 

Available-for-sale:
 
 
 
 
 
 
 
 
 
 
 
U.S. Treasury securities and obligations of U.S. government corporations and agencies
$
7,289

 
$
(46
)
 
$
75,030

 
$
(1,312
)
 
$
82,319

 
$
(1,358
)
Obligations of states and political subdivisions
3,586

 
(19
)
 
4,416

 
(94
)
 
8,002

 
(113
)
Mortgage-backed securities: GSE residential
19,565

 
(159
)
 
37,224

 
(802
)
 
56,789

 
(961
)
Trust preferred securities

 

 
364

 
(2,936
)
 
364

 
(2,936
)
Other securities

 

 
1,988

 
(12
)
 
1,988

 
(12
)
Total
$
30,440

 
$
(224
)
 
$
119,022

 
$
(5,156
)
 
$
149,462

 
$
(5,380
)
Held-to-maturity:
 
 
 
 
 
 
 
 
 
 
 
U.S. Treasury securities and obligations of U.S. government corporations and agencies
$
4,853

 
$
(12
)
 
$

 
$

 
$
4,853

 
$
(12
)

U.S. Treasury Securities and Obligations of U.S. Government Corporations and Agencies. At September 30, 2015, there were six available-for sale U.S. Treasury securities and obligations of U.S. government corporations and agencies with a fair value of $28,973,000 and unrealized losses of $125,000 in a continuous unrealized loss position for twelve months or more. At December 31, 2014 there were sixteen available-for-sale U.S. Treasury securities and obligations of U.S. government corporations and agencies with a fair value of $75,030,000 and unrealized losses of $1,312,000 in a continuous unrealized loss position for twelve months or more. At September 30, 2015 and December 31, 2014 there were no held-to-maturity U.S. Treasury securities and obligations of U.S. government corporations and agencies in a continuous unrealized loss position for twelve months or more.

Obligations of states and political subdivisions.  At September 30, 2015 there were two obligations of states and political subdivisions with a fair value of $1,185,000 and unrealized losses of $62,000 in a continuous unrealized loss position for twelve months or more. At December 31, 2014, there were ten obligations of states and political subdivisions with a fair value of $4,416,000 and unrealized losses of $94,000 in a continuous unrealized loss position for twelve months or more.

Mortgage-backed Securities: GSE Residential. At September 30, 2015 there were seven mortgage-backed securities with a fair value of $21,001,000 and unrealized losses of $465,000 in a continuous unrealized loss position for twelve months or more. At December 31, 2014, there were eleven mortgage-backed securities with a fair value of $37,224,000 and unrealized losses of $802,000 in a continuous unrealized loss position for twelve months or more.





16




Trust Preferred Securities. At September 30, 2015, there was one trust preferred security with a fair value of $2,125,000 and unrealized loss of $1,042,000 in a continuous unrealized loss position for twelve months or more. At December 31, 2014, there was one trust preferred security with a fair value of $364,000 and unrealized loss of $2,936,000 in a continuous unrealized loss position for twelve months or more. The unrealized loss was primarily due to the long-term nature of the trust preferred security, a lack of demand or inactive market for the security, the impending change to the regulatory treatment of these securities, and concerns regarding the underlying financial institutions that have issued the trust preferred securities.
The Company recorded no other-than-temporary impairment (OTTI) for these securities during 2015 or 2014.   Because it is not more-likely-than-not that the Company will be required to sell the remaining security before recovery of its new, lower amortized cost basis, which may be maturity, the Company does not consider the remainder of the investment to be other-than-temporarily impaired at September 30, 2015. However, future downgrades or additional deferrals and defaults in this security, could result in additional OTTI and consequently, have a material impact on future earnings.

Following are the details for the currently impaired trust preferred security (in thousands):
 
Book
Value
 
Market Value
 
Unrealized Gains (Losses)
 
Other-than-
temporary
Impairment
Recorded To-date
PreTSL XXVIII
$
3,167

 
$
2,125

 
$
(1,042
)
 
$
(1,111
)


Other securities. At September 30, 2015 and December 31, 2014, there were no corporate bonds in a continuous unrealized loss position for twelve months or more.

The Company does not believe any other individual unrealized loss as of September 30, 2015 represents OTTI. However, given the continued disruption in the financial markets, the Company may be required to recognize OTTI losses in future periods with respect to its available for sale investment securities portfolio. The amount and timing of any additional OTTI will depend on the decline in the underlying cash flows of the securities. Should the impairment of any of these securities become other-than-temporary, the cost basis of the investment will be reduced and the resulting loss recognized in the period the other-than-temporary impairment is identified.

Other-than-temporary Impairment. Upon acquisition of a security, the Company determines whether it is within the scope of the accounting guidance for investments in debt and equity securities or whether it must be evaluated for impairment under the accounting guidance for beneficial interests in securitized financial assets.

The Company conducts periodic reviews to evaluate its investment securities to determine whether OTTI has occurred. While all securities are considered, the securities primarily impacted by OTTI evaluation are pooled trust preferred securities. For the pooled trust preferred security currently in the investment portfolio, an extensive review is conducted to determine if any additional OTTI has occurred. The Company utilizes an independent third-party to perform the OTTI evaluation. The Company's management reviews the assumption inputs and methodology with the third-party to obtain an understanding of them and determine if they are appropriate for the evaluation. Economic models are used to project future cash flows for the security based on current assumptions for discount rate, prepayments, default and deferral rates and recoveries. These assumptions are determined based on the structure of the issuance, the specific collateral underlying the security, historical performance of trust preferred securities and general state of the economy. The OTTI test compares the present value of the cash flows from quarter to quarter to determine if there has been an adverse change which could indicate additional OTTI.

The discount rate assumption used in the cash flow model is equal to the current yield used to accrete the beneficial interest. The Company’s current trust preferred security investment has a floating rate coupon of 3-month LIBOR plus 90 basis points. Since the estimate of 3-month LIBOR is based on the forward curve on the measurement date, and is therefore variable, the discount assumption for this security is a range of projected coupons over the expected life of the security.

The Company considers the likelihood that issuers will prepay their securities which changes the amount of expected cash flows. Factors such as the coupon rates of collateral, economic conditions and regulatory changes, such as the Dodd-Frank Act and Basel III, are considered.


17



The trust preferred security includes collateral issued by financial institutions and insurance companies. To identify bank issuers with a high risk of near term default or deferral, a credit model developed by the third-party is utilized that scores each bank issuer based on 29 different ratios covering capital adequacy, asset quality, earnings, liquidity, the Texas Ratio, and sensitivity to interest rates. To account for longer term bank default risk not captured by the credit model, it is assumed that banks will default at a rate of 2% annually for the first two years of the cash flow projection, and 36 basis points in each year thereafter. To project defaults for insurance issuers, each issuer’s credit rating is mapped to its idealized default rate, which is AM Best’s estimate of the historical default rate for insurance companies with that rating.

Lastly, it is assumed that trust preferred securities issued by banks that have already failed will have no recoveries, and that banks projected to default will have recoveries of 10%. Additionally, the 10% recovery assumption, incorporates the potential for cures by banks that are currently in deferral.

If the Company determines that a given pooled trust preferred security position will be subject to a write-down or loss, the Company records the expected credit loss as a charge to earnings.

Credit Losses Recognized on Investments. As described above, the Company’s investment in trust preferred security has experienced fair value deterioration due to credit losses but is not otherwise other-than-temporarily impaired. The following table provides information about the trust preferred security for which only a credit loss was recognized in income and other losses are recorded in other comprehensive income (loss) for the nine months ended September 30, 2015 and 2014 (in thousands).

 
Accumulated Credit Losses
 
September 30, 2015
 
September 30, 2014
Credit losses on trust preferred securities held
 
 
 
Beginning of period
$
1,111

 
$
1,111

Additions related to OTTI losses not previously recognized

 

Reductions due to sales / (recoveries)

 

Reductions due to change in intent or likelihood of sale

 

Additions related to increases in previously recognized OTTI losses

 

Reductions due to increases in expected cash flows

 

End of period
$
1,111

 
$
1,111





18



Note 4 – Loans and Allowance for Loan Losses

Loans are stated at the principal amount outstanding net of unearned discounts, unearned income and allowance for loan losses.  Unearned income includes deferred loan origination fees reduced by loan origination costs and is amortized to interest income over the life of the related loan using methods that approximated the effective interest rate method.  Interest on substantially all loans is credited to income based on the principal amount outstanding. A summary of loans at September 30, 2015 and December 31, 2014 follows (in thousands):
 
September 30,
2015
 
December 31,
2014
Construction and land development
$
33,426

 
$
21,627

Agricultural real estate
120,431

 
110,158

1-4 Family residential properties
234,273

 
179,886

Multifamily residential properties
54,961

 
53,129

Commercial real estate
378,665

 
380,173

Loans secured by real estate
821,756

 
744,973

Agricultural loans
65,520

 
68,225

Commercial and industrial loans
296,334

 
223,633

Consumer loans
44,041

 
15,118

All other loans
11,202

 
8,736

Gross loans
1,238,853

 
1,060,685

Less:
 

 
 

Net deferred loan fees, premiums and discounts
3,450

 
237

Allowance for loan losses
14,228

 
13,682

Net loans
$
1,221,175

 
$
1,046,766



Loans expected to be sold are classified as held for sale in the consolidated financial statements and are recorded at the lower of aggregate cost or market value, taking into consideration future commitments to sell the loans. These loans are primarily for 1-4 family residential properties. The balance of loans held for sale, excluded from the balances above, were $1,346,000 and $1,958,000 at September 30, 2015 and December 31, 2014, respectively.

Most of the Company’s business activities are with customers located within central Illinois.  At September 30, 2015, the Company’s loan portfolio included $186.0 million of loans to borrowers whose businesses are directly related to agriculture. Of this amount, $154.8 million was concentrated in other grain farming. Total loans to borrowers whose businesses are directly related to agriculture increased $7.5 million from $178.5 million at December 31, 2014 while loans concentrated in other grain farming decreased $0.3 million from $155.1 million at December 31, 2014 due to seasonal paydowns based upon timing of cash flow requirements.  While the Company adheres to sound underwriting practices, including collateralization of loans, any extended period of low commodity prices, drought conditions, significantly reduced yields on crops and/or reduced levels of government assistance to the agricultural industry could result in an increase in the level of problem agriculture loans and potentially result in loan losses within the agricultural portfolio.

In addition, the Company has $60.5 million of loans to motels and hotels.  The performance of these loans is dependent on borrower specific issues as well as the general level of business and personal travel within the region.  While the Company adheres to sound underwriting standards, a prolonged period of reduced business or personal travel could result in an increase in nonperforming loans to this business segment and potentially in loan losses. The Company also has $106.9 million of loans to lessors of non-residential buildings and $68.0 million of loans to lessors of residential buildings and dwellings.

The structure of the Company’s loan approval process is based on progressively larger lending authorities granted to individual loan officers, loan committees, and ultimately the Board of Directors.  Outstanding balances to one borrower or affiliated borrowers are limited by federal regulation; however, limits well below the regulatory thresholds are generally observed.  The vast majority of the Company’s loans are to businesses located in the geographic market areas served by the Company’s branch bank system.  Additionally, a significant portion of the collateral securing the loans in the portfolio is located within the Company’s primary geographic footprint.  In general, the Company adheres to loan underwriting standards consistent with industry guidelines for all loan segments.


19



The Company’s lending can be summarized into the following primary areas:

Commercial Real Estate Loans.  Commercial real estate loans are generally comprised of loans to small business entities to purchase or expand structures in which the business operations are housed, loans to owners of real estate who lease space to non-related commercial entities, loans for construction and land development, loans to hotel operators, and loans to owners of multi-family residential structures, such as apartment buildings.  Commercial real estate loans are underwritten based on historical and projected cash flows of the borrower and secondarily on the underlying real estate pledged as collateral on the debt.  For the various types of commercial real estate loans, minimum criteria have been established within the Company’s loan policy regarding debt service coverage while maximum limits on loan-to-value and amortization periods have been defined.  Maximum loan-to-value ratios range from 65% to 80% depending upon the type of real estate collateral, while the desired minimum debt coverage ratio is 1.20x. Amortization periods for commercial real estate loans are generally limited to twenty years. The Company’s commercial real estate portfolio is well below the thresholds that would designate a concentration in commercial real estate lending, as established by the federal banking regulators.

Commercial and Industrial Loans. Commercial and industrial loans are primarily comprised of working capital loans used to purchase inventory and fund accounts receivable that are secured by business assets other than real estate.  These loans are generally written for one year or less. Also, equipment financing is provided to businesses with these loans generally limited to 80% of the value of the collateral and amortization periods limited to seven years. Commercial loans are often accompanied by a personal guaranty of the principal owners of a business.  Like commercial real estate loans, the underlying cash flow of the business is the primary consideration in the underwriting process.  The financial condition of commercial borrowers is monitored at least annually with the type of financial information required determined by the size of the relationship.  Measures employed by the Company for businesses with higher risk profiles include the use of government-assisted lending programs through the Small Business Administration and U.S. Department of Agriculture.

Agricultural and Agricultural Real Estate Loans. Agricultural loans are generally comprised of seasonal operating lines to cash grain farmers to plant and harvest corn and soybeans and term loans to fund the purchase of equipment.  Agricultural real estate loans are primarily comprised of loans for the purchase of farmland.  Specific underwriting standards have been established for agricultural-related loans including the establishment of projections for each operating year based on industry developed estimates of farm input costs and expected commodity yields and prices.  Operating lines are typically written for one year and secured by the crop. Loan-to-value ratios on loans secured by farmland generally do not exceed 65% and have amortization periods limited to twenty five years.  Federal government-assistance lending programs through the Farm Service Agency are used to mitigate the level of credit risk when deemed appropriate.

Residential Real Estate Loans. Residential real estate loans generally include loans for the purchase or refinance of residential real estate properties consisting of one-to-four units and home equity loans and lines of credit.  The Company sells the vast majority of its long-term fixed rate residential real estate loans to secondary market investors.  The Company also releases the servicing of these loans upon sale.  The Company retains all residential real estate loans with balloon payment features.  Balloon periods are limited to five years. Residential real estate loans are typically underwritten to conform to industry standards including criteria for maximum debt-to-income and loan-to-value ratios as well as minimum credit scores.  Loans secured by first liens on residential real estate held in the portfolio typically do not exceed 80% of the value of the collateral and have amortization periods of twenty five years or less. The Company does not originate subprime mortgage loans.

Consumer Loans. Consumer loans are primarily comprised of loans to individuals for personal and household purposes such as the purchase of an automobile or other living expenses.  Minimum underwriting criteria have been established that consider credit score, debt-to-income ratio, employment history, and collateral coverage.  Typically, consumer loans are set up on monthly payments with amortization periods based on the type and age of the collateral.

Other Loans. Other loans consist primarily of loans to municipalities to support community projects such as infrastructure improvements or equipment purchases.  Underwriting guidelines for these loans are consistent with those established for commercial loans with the additional repayment source of the taxing authority of the municipality.









20



Allowance for Loan Losses

The allowance for loan losses represents the Company’s best estimate of the reserve necessary to adequately account for probable losses existing in the current portfolio. The provision for loan losses is the charge against current earnings that is determined by the Company as the amount needed to maintain an adequate allowance for loan losses. In determining the adequacy of the allowance for loan losses, and therefore the provision to be charged to current earnings, the Company relies predominantly on a disciplined credit review and approval process that extends to the full range of the Company’s credit exposure.  The review process is directed by the overall lending policy and is intended to identify, at the earliest possible stage, borrowers who might be facing financial difficulty.  Once identified, the magnitude of exposure to individual borrowers is quantified in the form of specific allocations of the allowance for loan losses.  The Company considers collateral values and guarantees in the determination of such specific allocations. Additional factors considered by the Company in evaluating the overall adequacy of the allowance include historical net loan losses, the level and composition of nonaccrual, past due and troubled debt restructurings, trends in volumes and terms of loans, effects of changes in risk selection and underwriting standards or lending practices, lending staff changes, concentrations of credit, industry conditions and the current economic conditions in the region where the Company operates. The Company estimates the appropriate level of allowance for loan losses by separately evaluating large impaired loans, large adversely classified loans and nonimpaired loans.

Impaired loans
The Company individually evaluates certain loans for impairment.  In general, these loans have been internally identified via the Company’s loan grading system as credits requiring management’s attention due to underlying problems in the borrower’s business or collateral concerns.  This evaluation considers expected future cash flows, the value of collateral and also other factors that may impact the borrower’s ability to make payments when due.  For loans greater than $250,000 in the commercial, commercial real estate, agricultural, agricultural real estate segments, impairment is individually measured each quarter using one of three alternatives: (1) the present value of expected future cash flows discounted at the loan’s effective interest rate; (2) the loan’s observable market price, if available; or (3) the fair value of the collateral less costs to sell for collateral dependent loans and loans for which foreclosure is deemed to be probable. A specific allowance is assigned when expected cash flows or collateral do not justify the carrying amount of the loan. The carrying value of the loan reflects reductions from prior charge-offs.

Adversely classified loans
A detailed analysis is also performed on each adversely classified (substandard or doubtful rated) borrower with an aggregate, outstanding balance greater than $250,000. This analysis includes commercial, commercial real estate, agricultural, and agricultural real estate borrowers who are not currently identified as impaired but pose sufficient risk to warrant in-depth review. Estimated collateral shortfalls are then calculated with allocations for each loan segment based on the five-year historical average of collateral shortfalls adjusted for environmental factors including changes in economic conditions, changes in credit policies or underwriting standards, and changes in the level of credit risk associated with specific industries and markets. Because the economic and business climate in any given industry or market, and its impact on any given borrower, can change rapidly, the risk profile of the loan portfolio is periodically assessed and adjusted when appropriate. Consumer loans are evaluated for adverse classification based primarily on the Uniform Retail Credit Classification and Account Management Policy established by the federal banking regulators. Classification standards are generally based on delinquency status, collateral coverage, bankruptcy and the presence of fraud.

Non-classified and Watch loans
For loans, in all segments of the portfolio, that are considered to possess levels of risk commensurate with a pass rating, management establishes base loss estimations which are derived from historical loss experience.  Use of a five-year historical loss period eliminates the effect of any significant losses that can be attributed to a single event or borrower during a given reporting period. The base loss estimations for each loan segment are adjusted after consideration of several environmental factors influencing the level of credit risk in the portfolio. In addition, loans rated as watch are further segregated in the commercial / commercial real estate and agricultural / agricultural real estate segments. These loans possess potential weaknesses that, if unchecked, may result in deterioration to the point of becoming a problem asset.  Due to the elevated risk inherent in these loans, an allocation of twice the adjusted base loss estimation of the applicable loan segment is determined appropriate.

Due to weakened economic conditions during recent years, the Company established allocations for each of the loan segments at levels above the base loss estimations. Some of the economic factors included the potential for reduced cash flow for commercial operating loans from reduction in sales or increased operating costs, decreased occupancy rates for commercial buildings, reduced levels of home sales for commercial land developments, the uncertainty regarding grain prices and increased operating costs for farmers, and increased levels of unemployment and bankruptcy impacting consumer’s ability to pay. Each of these economic uncertainties was taken into consideration in developing the level of the reserve.

21



The Company has not materially changed any aspect of its overall approach in the determination of the allowance for loan losses.  However, on an on-going basis the Company continues to refine the methods used in determining management’s best estimate of the allowance for loan losses.

The following tables present the balance in the allowance for loan losses and the recorded investment in loans based on portfolio segment and impairment method for the three and nine-months ended September 30, 2015 and 2014 and for the year ended December 31, 2014 (in thousands):

 
Commercial/ Commercial Real Estate
 
Agricultural/ Agricultural Real Estate
 
Residential 
Real Estate
 
Consumer
 
Unallocated
 
Total
Three months ended September 30, 2015
 
 
 
 
 
 
 
 
 
 
Allowance for loan losses:
 
 
 
 
 
 
 
 
 
 
 
Balance, beginning of period
$
11,294

 
$
1,312

 
$
731

 
$
382

 
$
212

 
$
13,931

Provision charged to expense
84

 
84

 
97

 
305

 
(89
)
 
481

Losses charged off
(174
)
 

 
(24
)
 
(72
)
 

 
(270
)
Recoveries
47

 

 

 
39

 

 
86

Balance, end of period
$
11,251

 
$
1,396

 
$
804

 
$
654

 
$
123

 
$
14,228

Ending balance:
 

 
 

 
 

 
 

 
 

 
 

Individually evaluated for impairment
$
148

 
$

 
$

 
$
194

 
$

 
$
342

Collectively evaluated for impairment
$
11,103

 
$
1,396

 
$
804

 
$
460

 
$
123

 
$
13,886

Three months ended September 30, 2014
 
 

 
 

 
 

 
 

 
 

Allowance for loan losses:
 

 
 

 
 

 
 

 
 

 
 

Balance, beginning of period
$
10,771

 
$
524

 
$
757

 
$
368

 
$
1,261

 
$
13,681

Provision charged to expense
(267
)
 
775

 
87

 
58

 
(609
)
 
44

Losses charged off
(22
)
 

 
(30
)
 
(81
)
 

 
(133
)
Recoveries
66

 
1

 
4

 
42

 

 
113

Balance, end of period
$
10,548

 
$
1,300

 
$
818

 
$
387

 
$
652

 
$
13,705

Ending balance:
 

 
 

 
 

 
 

 
 

 
 

Individually evaluated for impairment
$
293

 
$

 
$
14

 
$

 
$

 
$
307

Collectively evaluated for impairment
$
10,255

 
$
1,300

 
$
804

 
$
387

 
$
652

 
$
13,398

Nine months ended September 30, 2015
 
 
 
 
 
 
 
 
 
 
Allowance for loan losses:
 
 
 
 
 
 
 
 
 
 
 
Balance, beginning of year
$
10,914

 
$
1,360

 
$
790

 
$
386

 
$
232

 
$
13,682

Provision charged to expense
319

 
35

 
77

 
567

 
(109
)
 
889

Losses charged off
(245
)
 

 
(64
)
 
(432
)
 

 
(741
)
Recoveries
263

 
1

 
1

 
133

 

 
398

Balance, end of period
$
11,251

 
$
1,396

 
$
804

 
$
654

 
$
123

 
$
14,228

Ending balance:
 

 
 

 
 

 
 

 
 

 
 

Individually evaluated for impairment
$
148

 
$

 
$

 
$
194

 
$

 
$
342

Collectively evaluated for impairment
$
11,103

 
$
1,396

 
$
804

 
$
460

 
$
123

 
$
13,886

Loans:
 

 
 

 
 

 
 

 
 

 
 

Ending balance
$
772,388

 
$
185,275

 
$
234,761

 
$
44,325

 
$

 
$
1,236,749

Ending balance:
 

 
 

 
 

 
 

 
 

 
 

Individually evaluated for impairment
$
1,248

 
$

 
$
411

 
$
224

 
$

 
$
1,883

Collectively evaluated for impairment
$
771,140

 
$
185,275

 
$
234,350

 
$
44,101

 
$

 
$
1,234,866


22



 
 
Commercial/ Commercial Real Estate
 
Agricultural/ Agricultural Real Estate
 
Residential  Real Estate
 
Consumer
 
Unallocated
 
Total
Nine months ended September 30, 2014
 
 
 
 
 
 
 
 
 
 
Allowance for loan losses:
 
 
 
 
 
 
 
 
 
 
 
Balance, beginning of year
$
10,646

 
$
533

 
$
771

 
$
377

 
$
922

 
$
13,249

Provision charged to expense
(192
)
 
765

 
98

 
94

 
(270
)
 
495

Losses charged off
(54
)
 

 
(75
)
 
(186
)
 

 
(315
)
Recoveries
148

 
2

 
24

 
102

 

 
276

Balance, end of period
$
10,548

 
$
1,300

 
$
818

 
$
387

 
$
652

 
$
13,705

Ending balance:
 

 
 

 
 

 
 

 
 

 
 

Individually evaluated for impairment
$
293

 
$

 
$
14

 
$

 
$

 
$
307

Collectively evaluated for impairment
$
10,255

 
$
1,300

 
$
804

 
$
387

 
$
652

 
$
13,398

Loans:
 

 
 

 
 

 
 

 
 

 
 

Ending balance
$
667,656

 
$
169,309

 
$
188,521

 
$
15,522

 
$

 
$
1,041,008

Ending balance:
 

 
 

 
 

 
 

 
 

 
 

Individually evaluated for impairment
$
3,473

 
$

 
$
225

 
$

 
$

 
$
3,698

Collectively evaluated for impairment
$
664,183

 
$
169,309

 
$
188,296

 
$
15,522

 
$

 
$
1,037,310

Year ended December 31, 2014
 

 
 

 
 

 
 

 
 

 
 

Allowance for loan losses:
 

 
 

 
 

 
 

 
 

 
 

Balance, beginning of year
$
10,646

 
$
533

 
$
771

 
$
377

 
$
922

 
$
13,249

Provision charged to expense
192

 
825

 
135

 
167

 
(690
)
 
629

Losses charged off
(86
)
 

 
(140
)
 
(311
)
 

 
(537
)
Recoveries
162

 
2

 
24

 
153

 

 
341

Balance, end of year
$
10,914

 
$
1,360

 
$
790

 
$
386

 
$
232

 
$
13,682

Ending balance:
 

 
 

 
 

 
 

 
 

 
 

Individually evaluated for impairment
$
263

 
$

 
$

 
$

 
$

 
$
263

Collectively evaluated for impairment
$
10,651

 
$
1,360

 
$
790

 
$
386

 
$
232

 
$
13,419

Loans:
 

 
 

 
 

 
 

 
 

 
 

Ending balance
$
684,552

 
$
178,091

 
$
184,661

 
$
15,102

 
$

 
$
1,062,406

Ending balance:
 

 
 

 
 

 
 

 
 

 
 

Individually evaluated for impairment
$
3,301

 
$

 
$

 
$

 
$

 
$
3,301

Collectively evaluated for impairment
$
681,251

 
$
178,091

 
$
184,661

 
$
15,102

 
$

 
$
1,059,105




23



Consistent with regulatory guidance, charge-offs on all loan segments are taken when specific loans, or portions thereof, are considered uncollectible. The Company’s policy is to promptly charge these loans off in the period the uncollectible loss is reasonably determined.

For all loan portfolio segments except 1-4 family residential properties and consumer, the Company promptly charges-off loans, or portions thereof, when available information confirms that specific loans are uncollectible based on information that includes, but is not limited to, (1) the deteriorating financial condition of the borrower, (2) declining collateral values, and/or (3) legal action, including bankruptcy, that impairs the borrower’s ability to adequately meet its obligations. For impaired loans that are considered to be solely collateral dependent, a partial charge-off is recorded when a loss has been confirmed by an updated appraisal or other appropriate valuation of the collateral.

The Company charges-off 1-4 family residential and consumer loans, or portions thereof, when the Company reasonably determines the amount of the loss. The Company adheres to timeframes established by applicable regulatory guidance which provides for the charge-down of 1-4 family first and junior lien mortgages to the net realizable value less costs to sell when the loan is 180 days past due, charge-off of unsecured open-end loans when the loan is 180 days past due, and charge down to the net realizable value when other secured loans are 120 days past due. Loans at these respective delinquency thresholds for which the Company can clearly document that the loan is both well-secured and in the process of collection, such that collection will occur regardless of delinquency status, need not be charged off.

Credit Quality

The Company categorizes loans into risk categories based on relevant information about the ability of borrowers to service their debt such as:  current financial information, historical payment experience, collateral support, credit documentation, public information, and current economic trends, among other factors. The Company analyzes loans individually by classifying the loans as to credit risk. This analysis is performed on a continuous basis. The Company uses the following definitions for risk ratings:

Watch. Loans classified as watch have a potential weakness that deserves management’s close attention.  If left uncorrected, these potential weaknesses may result in deterioration of the repayment prospects for the loan or of the institution’s credit position at some future date.

Substandard. Loans classified as substandard are inadequately protected by the current sound-worthiness and paying capacity of the obligor or of the collateral pledged, if any.  Loans so classified have a well-defined weakness or weaknesses that jeopardize the liquidation of the debt. They are characterized by the distinct possibility that the institution will sustain some loss if the deficiencies are not corrected.

Doubtful. Loans classified as doubtful have all the weaknesses inherent in those classified as substandard, with the added characteristic that the weaknesses make collection or liquidation in full, on the basis of currently existing factors, conditions and values, highly questionable and improbable.

Loans not meeting the criteria above that are analyzed individually as part of the above described process are considered pass rated loans.


24



The following tables present the credit risk profile of the Company’s loan portfolio based on rating category and payment activity as of September 30, 2015 and December 31, 2014 (in thousands):

 
Construction &
Land Development
 
Agricultural Real Estate
 
1-4 Family Residential
Properties
 
Multifamily Residential
Properties
 
2015
 
2014
 
2015
 
2014
 
2015
 
2014
 
2015
 
2014
Pass
$
33,241

 
$
20,842

 
$
115,928

 
$
107,976

 
$
229,991

 
$
177,764

 
$
54,363

 
$
52,793

Watch

 

 
2,231

 
1,036

 
2,591

 
1,187

 
246

 

Substandard
148

 
785

 
2,155

 
1,181

 
2,195

 
2,970

 
323

 
336

Doubtful

 

 

 

 

 

 

 

Total
$
33,389

 
$
21,627

 
$
120,314

 
$
110,193

 
$
234,777

 
$
181,921

 
$
54,932

 
$
53,129


 
Commercial Real Estate (Nonfarm/Nonresidential)
 
Agricultural Loans
 
Commercial & Industrial Loans
 
Consumer Loans
 
2015
 
2014
 
2015
 
2014
 
2015
 
2014
 
2015
 
2014
Pass
$
355,085

 
$
357,873

 
$
64,298

 
$
67,619

 
$
289,991

 
$
218,193

 
$
43,031

 
$
15,105

Watch
21,622

 
18,817

 
255

 

 
4,810

 
4,647

 
30

 
9

Substandard
1,199

 
2,914

 
1,043

 
679

 
534

 
940

 
243

 
4

Doubtful

 

 

 

 

 

 

 

Total
$
377,906

 
$
379,604

 
$
65,596

 
$
68,298

 
$
295,335

 
$
223,780

 
$
43,304

 
$
15,118


 
All Other Loans
 
Total Loans
 
2015
 
2014
 
2015
 
2014
Pass
$
11,196

 
$
8,736

 
$
1,197,124

 
$
1,026,901

Watch

 

 
31,785

 
25,696

Substandard

 

 
7,840

 
9,809

Doubtful

 

 

 

Total
$
11,196

 
$
8,736

 
$
1,236,749

 
$
1,062,406


25



The following table presents the Company’s loan portfolio aging analysis at September 30, 2015 and December 31, 2014 (in thousands):
 
30-59 days Past Due
 
60-89 days Past Due
 
90 Days
or More Past Due
 
Total
Past Due
 
Current
 
Total Loans Receivable
 
Total Loans > 90 days & Accruing
September 30, 2015
 
 
 
 
 
 
 
 
 
 
 
 
 
Construction and land development
$

 
$

 
$

 
$

 
$
33,389

 
$
33,389

 
$

Agricultural real estate

 

 
106

 
106

 
120,208

 
120,314

 

1-4 Family residential properties
980

 
534

 
103

 
1,617

 
233,160

 
234,777

 

Multifamily residential properties

 

 

 

 
54,932

 
54,932

 

Commercial real estate
77

 
185

 
527

 
789

 
377,117

 
377,906

 

Loans secured by real estate
1,057

 
719

 
736

 
2,512

 
818,806

 
821,318

 

Agricultural loans
10

 
222

 

 
232

 
65,364

 
65,596

 

Commercial and industrial loans
409

 
191

 
127

 
727

 
294,608

 
295,335

 

Consumer loans
112

 
14

 
5

 
131

 
43,173

 
43,304

 

All other loans

 

 

 

 
11,196

 
11,196

 

Total loans
$
1,588

 
$
1,146

 
$
868

 
$
3,602

 
$
1,233,147

 
$
1,236,749

 
$

December 31, 2014
 

 
 

 
 

 
 

 
 

 
 

 
 

Construction and land development
$
297

 
$
25

 
$

 
$
322

 
$
21,305

 
$
21,627

 
$

Agricultural real estate

 

 

 

 
110,193

 
110,193

 

1-4 Family residential properties
201

 
224

 
385

 
810

 
181,111

 
181,921

 

Multifamily residential properties

 

 

 

 
53,129

 
53,129

 

Commercial real estate
60

 
32

 
945

 
1,037

 
378,567

 
379,604

 

Loans secured by real estate
558

 
281

 
1,330

 
2,169

 
744,305

 
746,474

 

Agricultural loans
16

 
20

 

 
36

 
68,262

 
68,298

 

Commercial and industrial loans
228

 
10

 
98

 
336

 
223,444

 
223,780

 

Consumer loans
331

 
10

 
5

 
346

 
14,772

 
15,118

 

All other loans

 

 

 

 
8,736

 
8,736

 

Total loans
$
1,133

 
$
321

 
$
1,433

 
$
2,887

 
$
1,059,519

 
$
1,062,406

 
$



Impaired Loans

Within all loan portfolio segments, loans are considered impaired when, based on current information and events, it is probable the Company will be unable to collect all amounts due from the borrower in accordance with the contractual terms of the loan. The entire balance of a loan is considered delinquent if the minimum payment contractually required to be made is not received by the specified due date. Impaired loans, excluding certain troubled debt restructured loans, are placed on nonaccrual status. Impaired loans include nonaccrual loans and loans modified in troubled debt restructurings where concessions have been granted to borrowers experiencing financial difficulties.  These concessions could include a reduction in the interest rate on the loan, payment extensions, forgiveness of principal, forbearance or other actions intended to maximize collection. It is the Company’s policy to have any restructured loans which are on nonaccrual status prior to being modified remain on nonaccrual status until, in the opinion of management, the financial position of the borrower indicates there is no longer any reasonable doubt as to the timely collection of interest or principal. If the restructured loan is on accrual status prior to being modified, the loan is reviewed to determine if the modified loan should remain on accrual status.

The Company’s policy is to discontinue the accrual of interest income on all loans for which principal or interest is ninety days past due.  The accrual of interest is discontinued earlier when, in the opinion of management, there is reasonable doubt as to the timely collection of interest or principal.  Once interest accruals are discontinued, accrued but uncollected interest is charged against current year income. Subsequent receipts on non-accrual loans are recorded as a reduction of principal, and interest income is recorded only after principal recovery is reasonably assured. Interest on loans determined to be troubled debt restructurings is recognized on an accrual basis in accordance with the restructured terms if the loan is in compliance with the modified terms.  Nonaccrual loans are returned to accrual status when, in the opinion of management, the financial position of

26



the borrower indicates there is no longer any reasonable doubt as to the timely collection of interest or principal. The Company requires a period of satisfactory performance of not less than six months before returning a nonaccrual loan to accrual status.

The following tables present impaired loans as of September 30, 2015 and December 31, 2014 (in thousands):

 
September 30, 2015
 
December 31, 2014
 
Recorded
Balance
 
Unpaid Principal Balance
 
Specific Allowance
 
Recorded
Balance
 
Unpaid Principal Balance
 
Specific Allowance
Loans with a specific allowance:
 
 
 
 
 
 
 
 
 
 
 
Construction and land development
$
148

 
$
713

 
$
20

 
$
785

 
$
2,960

 
$
43

Agricultural real estate

 

 

 

 

 

1-4 Family residential properties
411

 
411

 

 
67

 
134

 

Multifamily residential properties
323

 
323

 

 

 

 

Commercial real estate
532

 
603

 
29

 
472

 
986

 
136

Loans secured by real estate
1,414

 
2,050

 
49

 
1,324

 
4,080

 
179

Agricultural loans

 

 

 

 

 

Commercial and industrial loans
246

 
380

 
99

 
83

 
181

 
84

Consumer loans
223

 
223

 
194

 

 

 

All other loans

 

 

 

 

 

Total loans
$
1,883

 
$
2,653

 
$
342

 
$
1,407

 
$
4,261

 
$
263

Loans without a specific allowance:
 

 
 

 
 

 
 

 
 

 
 

Construction and land development
$

 
$

 
$

 
$

 
$

 
$

Agricultural real estate
25

 
29

 

 
73

 
235

 

1-4 Family residential properties
742

 
1,067

 

 
1,156

 
2,866

 

Multifamily residential properties

 

 

 

 

 

Commercial real estate
242

 
242

 

 
1,640

 
3,808

 

Loans secured by real estate
1,009

 
1,338

 

 
2,869

 
6,909

 

Agricultural loans

 

 

 

 

 

Commercial and industrial loans
599

 
762

 

 
249

 
933

 

Consumer loans
20

 
29

 

 
15

 
60

 

All other loans

 

 

 

 

 

Total loans
$
1,628

 
$
2,129

 
$

 
$
3,133

 
$
7,902

 
$

Total loans:
 

 
 

 
 

 
 

 
 

 
 

Construction and land development
$
148

 
$
713

 
$
20

 
$
785

 
$
2,960

 
$
43

Agricultural real estate
25

 
29

 

 
73

 
235

 

1-4 Family residential properties
1,153

 
1,478

 

 
1,223

 
3,000

 

Multifamily residential properties
323

 
323

 

 

 

 

Commercial real estate
774

 
845

 
29

 
2,112

 
4,794

 
136

Loans secured by real estate
2,423

 
3,388

 
49

 
4,193

 
10,989

 
179

Agricultural loans

 

 

 

 

 

Commercial and industrial loans
845

 
1,142

 
99

 
332

 
1,114

 
84

Consumer loans
243

 
252

 
194

 
15

 
60

 

All other loans

 

 

 

 

 

Total loans
$
3,511

 
$
4,782

 
$
342

 
$
4,540

 
$
12,163

 
$
263


27



The following tables present average recorded investment and interest income recognized on impaired loans for the three and nine-month periods ended September 30, 2015 and 2014 (in thousands):
 
For the three months ended
 
September 30, 2015
 
September 30, 2014
 
Average Investment
in Impaired Loans
 
Interest Income Recognized
 
Average Investment
in Impaired Loans
 
Interest Income Recognized
Construction and land development
$
148

 
$

 
$
817

 
$

Agricultural real estate
25

 

 
34

 

1-4 Family residential properties
1,160

 
2

 
1,129

 
5

Multifamily residential properties
326

 

 

 

Commercial real estate
777

 
1

 
2,349

 
1

Loans secured by real estate
2,436

 
3

 
4,329

 
6

Commercial and industrial loans
1,157

 
3

 
653

 

Consumer loans
296

 
1

 
35

 

Total loans
$
3,889

 
$
7

 
$
5,017

 
$
6

 
For the nine months ended
 
September 30, 2015
 
September 30, 2014
 
Average Investment
in Impaired Loans
 
Interest Income Recognized
 
Average Investment
in Impaired Loans
 
Interest Income Recognized
Construction and land development
$
148

 
$

 
$
1,004

 
$

Agricultural real estate
92

 
2

 
35

 

1-4 Family residential properties
1,197

 
11

 
1,156

 
12

Multifamily residential properties
328

 

 

 

Commercial real estate
784

 
2

 
2,379

 
2

Loans secured by real estate
2,549

 
15

 
4,574

 
14

Commercial and industrial loans
1,293

 
6

 
696

 

Consumer loans
308

 
2

 
39

 
1

Total loans
$
4,150

 
$
23

 
$
5,309

 
$
15



The amount of interest income recognized by the Company within the periods stated above was due to loans modified in a troubled debt restructuring that remained on accrual status.  The balance of loans modified in a troubled debt restructuring included in the impaired loans stated above that were still accruing was $0 of Farm loans, $339,000 of 1-4 Family residential properties, $36,000 of commercial real estate, $149,000 of commercial & industrial loans and $20,000 of consumer loans at September 30, 2015 and $345,000 of 1-4 family residential properties, $38,000 commercial real estate and $12,000 of consumer loans at September 30, 2014. For the nine months ended September 30, 2015 and 2014, the amount of interest income recognized using a cash-basis method of accounting during the period that the loans were impaired was not material.



28



Non Accrual Loans

The following table presents the Company’s recorded balance of nonaccrual loans as September 30, 2015 and December 31, 2014 (in thousands). This table excludes purchased impaired loans and performing troubled debt restructurings.
 
September 30,
2015
 
December 31,
2014
Construction and land development
$
148

 
$
785

Agricultural real estate
25

 
29

1-4 Family residential properties
814

 
878

Multifamily residential properties
323

 

Commercial real estate
738

 
2,074

Loans secured by real estate
2,048

 
3,766

Commercial and industrial loans
696

 
332

Consumer loans
223

 
7

Total loans
$
2,967

 
$
4,105


Interest income that would have been recorded under the original terms of such nonaccrual loans totaled $49,000 and $44,000 for the nine months ended September 30, 2015 and 2014, respectively.


Troubled Debt Restructuring

The balance of troubled debt restructurings ("TDRs") at September 30, 2015 and December 31, 2014 was $1.8 million and $2.9 million, respectively.  Approximately $313,000 and $234,000 in specific reserves have been established with respect to these loans as of September 30, 2015 and December 31, 2014, respectively. As troubled debt restructurings, these loans are included in nonperforming loans and are classified as impaired which requires that they be individually measured for impairment. The modification of the terms of these loans included one or a combination of the following: a reduction of stated interest rate of the loan; an extension of the maturity date and change in payment terms; or a permanent reduction of the recorded investment in the loan. The following table presents the Company’s recorded balance of troubled debt restructurings at September 30, 2015 and December 31, 2014 (in thousands).
Troubled debt restructurings:
September 30,
2015
 
December 31,
2014
Construction and land development
$
148

 
$
785

Agricultural real estate

 
44

1-4 Family residential properties
460

 
503

Commercial real estate
288

 
1,283

Loans secured by real estate
896

 
2,615

Commercial and industrial loans
649

 
236

Consumer loans
243

 
9

Total
$
1,788

 
$
2,860

Performing troubled debt restructurings:
 

 
 

Agricultural real estate
$

 
$
44

1-4 Family residential properties
339

 
$
345

Commercial real estate
36

 
37

Loans secured by real estate
375

 
426

Commercial and industrial loans
149

 

Consumer loans
20

 
9

Total
$
544

 
$
435





29



The following table presents loans modified as TDRs during the nine months ended September 30, 2015 and 2014, as a result of various modified loan factors (in thousands):
 
September 30, 2015
 
September 30, 2014
 
Number of Modifications
 
Recorded Investment
 
Type of Modifications
 
Number of Modifications
 
Recorded Investment
 
Type of Modifications
Farm Loans

 

 

 

 
$

 
 
1-4 Family residential properties
4

 
61

 
(b)(c)
 
3

 
$
248

 
(c)
Commercial real estate
1

 
34

 
(b)(c)
 
1

 
501

 
(b)(c)
Loans secured by real estate
5

 
95

 
 
 
4

 
749

 
 
Commercial and industrial loans
4

 
507

 
(b)(c)
 

 

 

Consumer Loans
3

 
237

 
(b)(c)
 

 

 

Total
12

 
$
839

 
 
 
4

 
$
749

 
 

Type of modifications:
(a) Reduction of stated interest rate of loan
(b) Change in payment terms
(c) Extension of maturity date

A loan is considered to be in payment default once it is 90 days past due under the modified terms.  There were no loans modified as troubled debt restructurings during the prior twelve months that experienced defaults during the nine months ended September 30, 2015 or the year ended December 31, 2014.


Note 5 -- Goodwill and Intangible Assets

The Company has goodwill from business combinations, intangible assets from branch acquisitions, and identifiable intangible assets assigned to core deposit relationships and customer lists of the Insurance agency.

The following table presents gross carrying value and accumulated amortization by major intangible asset class as of September 30, 2015 and December 31, 2014 (in thousands):

 
September 30, 2015
December 31, 2014
 
Gross Carrying Value
Accumulated Amortization
Gross Carrying Value
Accumulated Amortization
Goodwill not subject to amortization (effective 1/1/02)
$
43,528

$
3,760

$
29,513

$
3,760

Intangibles from branch acquisition
3,015

3,015

3,015

3,015

Core deposit intangibles
15,202

7,608

8,986

7,142

Other Intangibles
1,904

1,904

1,904

1,904

 
$
63,649

$
16,287

$
43,418

$
15,821



Goodwill of $14 million was recorded for the acquisition of twelve Old National Bank Branches during the third quarter of 2015. The goodwill consists largely of the synergies and economies of scale expected from combining the operations of the Company and the ONB Branches. All of the goodwill was assigned to the banking segment of the Company. The Company expects this goodwill to be fully deductible for tax purposes.









30




The following table provides a reconciliation of the purchase price paid for the Branches and the amount of goodwill recorded (in thousands):
Purchase price
 
$
15,892

Less purchase accounting adjustments:
 
 
     Fair value of loans
$
3,377

 
     Fair value of premises and equipment
125

 
     Fair value of time deposits
837

 
     Core deposit intangible
(6,216
)
 
 
 
(1,877
)
Resulting goodwill from acquisition
 
$
14,015


Total amortization expense for the nine months ended September 30, 2015 and 2014 was as follows (in thousands):

 
September 30,
 
2015

2014

Intangibles from branch acquisition
$

$

Core deposit intangibles
466

487

Other Intangibles


 
$
466

$
487


Aggregate amortization expense for the current year and estimated amortization expense for each of the five succeeding years is shown in the table below (in thousands):
Aggregate amortization expense:
 
     For period 01/01/15-09/30/15
$
466

 
 
Estimated amortization expense:
 
     For period 10/01/15-12/31/15
$
410

     For year ended 12/31/16
$
1,389

     For year ended 12/31/17
$
1,139

     For year ended 12/31/18
$
1,010

     For year ended 12/31/19
$
896

     For year ended 12/31/20
$
750



In accordance with the provisions of SFAS No. 142,Goodwill and Other Intangible Assets,” codified within ASC 350, the Company performed testing of goodwill for impairment as of September 30, 2015 and determined that, as of that date, goodwill was not impaired. Management also concluded that the remaining amounts and amortization periods were appropriate for all intangible assets.


Note 6 -- Repurchase Agreements and Other Borrowings

Securities sold under agreements to repurchase were $108.5 million at September 30, 2015, a decrease of $13.4 million from $121.9 million at December 31, 2014. The decrease during the first nine months of 2015 was primarily due to declines in balances of a few customers due to changes in cash flow needs for their businesses. All of the transactions have overnight maturities.




31



The right of setoff for a repurchase agreement resembles a secured borrowing, whereby the collateral pledged by the Company would be used to settle the fair value of the repurchase agreement should the Company be in default (e.g., declare bankruptcy), the Company could cancel the repurchase agreement (i.e., cease payment of principal and interest), and attempt collection on the amount of collateral value in excess of the repurchase agreement fair value. The collateral is held by a third party financial institution in the counterparty's custodial account. The counterparty has the right to sell or repledge the investment securities. For government entity repurchase agreements, the collateral is held by the Company in a segregated custodial account under a tri-party agreement. The Company is required by the counterparty to maintain adequate collateral levels. In the event the collateral fair value falls below stipulated levels, the Company will pledge additional securities. The Company closely monitors collateral levels to ensure adequate levels are maintained, while mitigating the potential of over-collateralization in the event of counterparty default. Repurchase agreements by class of collateral pledged are as follows (in thousands):
 
September 30, 2015
US Treasury securities and obligations of U.S. government corporations & agencies
$
82,206

Mortgage-backed securities: GSE: residential
26,293

Total
$
108,499


FHLB borrowings remained the same at $20 million for September 30, 2015 and December 31, 2014. At September 30, 2015 the advances were as follows:
$5 million advance with a 10-year maturity, at 4.58%, due July 14, 2016, one year lockout, callable quarterly
$5 million advance with a 6-year maturity, at 2.30%, due August 24, 2020
$5 million advance with a 7-year maturity, at 2.55% due October 1, 2021
$5 million advance with a 8-year maturity, at 2.40% due January 9, 2023


Note 7 -- Fair Value of Assets and Liabilities

Fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date.  Fair value measurements must maximize the use of observable inputs and minimize the use of unobservable inputs.  There is a hierarchy of three levels of inputs that may be used to measure fair value:
Level 1
Valuations for assets and liabilities traded in active exchange markets, such as the New York Stock Exchange.  Valuations are obtained from readily available pricing sources for market transactions involving identical assets or liabilities.
Level 2
Valuations for assets and liabilities traded in less active dealer or broker markets.  Valuations are obtained from third party pricing services for identical or comparable assets or liabilities which use observable inputs other than Level 1 prices, such as quoted prices for similar assets or liabilities; quoted prices in active markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities.
Level 3
Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities.


Following is a description of the inputs and valuation methodologies used for assets measured at fair value on a recurring basis and recognized in the accompanying balance sheets, as well as the general classification of such assets pursuant to the valuation hierarchy.









32



Available-for-Sale Securities. The fair value of available-for-sale securities is determined by various valuation methodologies.  Where quoted market prices are available in an active market, securities are classified within Level 1. If quoted market prices are not available, then fair values are estimated by using quoted prices of securities with similar characteristics or independent asset pricing services and pricing models, the inputs of which are market-based or independent sources of market parameters, including but not limited to, yield curves, interest rates, volatilities, prepayments, defaults, cumulative loss projections and cash flows.  Such securities are classified in Level 2 of the valuation hierarchy. In certain cases where Level 1 or Level 2 inputs are not available, securities are classified within Level 3 of the hierarchy and include subordinated tranches of collateralized mortgage obligations and investments in trust preferred securities.

Fair value determinations for Level 3 measurements of securities are the responsibility of the Treasury function of the Company.  The Company contracts with a pricing specialist to generate fair value estimates on a monthly basis.  The Treasury function of the Company challenges the reasonableness of the assumptions used and reviews the methodology to ensure the estimated fair value complies with accounting standards generally accepted in the United States, analyzes the changes in fair value and compares these changes to internally developed expectations and monitors these changes for appropriateness.

The trust preferred securities are collateralized debt obligation securities that are backed by trust preferred securities issued by banks, thrifts, and insurance companies. The market for these securities at September 30, 2015 is not active and markets for similar securities are also not active. The inactivity was evidenced first by a significant widening of the bid-ask spread in the brokered markets in which trust preferred securities trade and then by a significant decrease in the volume of trades relative to historical levels. The new issue market is also inactive and will continue to be, as a result of the Dodd-Frank Act’s elimination of trust preferred securities from Tier 1 capital for certain holding companies. There are currently very few market participants who are willing and or able to transact for these securities. The market values for these securities are very depressed relative to historical levels.

Given conditions in the debt markets today and the absence of observable transactions in the secondary and new issue markets, we determined:

The few observable transactions and market quotations that are available are not reliable for purposes of determining fair value at September 30, 2015,

An income valuation approach technique (present value technique) that maximizes the use of relevant observable inputs and minimizes the use of unobservable inputs will be equally or more representative of fair value than the market approach valuation technique used at prior measurement dates, and

The trust preferred securities held by the Company will be classified within Level 3 of the fair value hierarchy because we determined that significant adjustments are required to determine fair value at the measurement date.


33



The following table presents the Company’s assets that are measured at fair value on a recurring basis and the level within the fair value hierarchy in which the fair value measurements fall as of September 30, 2015 and December 31, 2014 (in thousands):
 
 
 
Fair Value Measurements Using
 
 
 
Fair Value
 
Quoted Prices in Active Markets for Identical Assets (Level 1)
 
Significant Other Observable Inputs (Level 2)
 
Significant
Unobservable Inputs
(Level 3)
September 30, 2015
 
 
 
 
 
 
 
Available-for-sale securities:
 
 
 
 
 
 
 
U.S. Treasury securities and obligations of U.S. government corporations and agencies
$
127,451

 
$

 
$
127,451

 
$

Obligations of states and political subdivisions
97,501

 

 
97,501

 

Mortgage-backed securities
259,441

 

 
259,441

 

Trust preferred securities
2,125

 

 

 
2,125

Other securities
4,038

 
62

 
3,976

 

Total available-for-sale securities
$
490,556

 
$
62

 
$
488,369

 
$
2,125

December 31, 2014
 
 
 
 
 
 
 
Available-for-sale securities:
 
 
 
 
 
 
 
U.S. Treasury securities and obligations of U.S. government corporations and agencies
$
99,957

 
$

 
$
99,957

 
$

Obligations of states and political subdivisions
78,084

 

 
78,084

 

Mortgage-backed securities
195,401

 

 
195,401

 

Trust preferred securities
364

 

 

 
364

Other securities
4,050

 
55

 
3,995

 

Total available-for-sale securities
$
377,856

 
$
55

 
$
377,437

 
$
364


The change in fair value of assets measured on a recurring basis using significant unobservable inputs (Level 3) for the nine months ended September 30, 2015 and 2014 is summarized as follows (in thousands):

 
 
Trust Preferred Securities
 
 
September 30, 2015
 
September 30, 2014
Beginning balance
 
$
364

 
$
191

Transfers into Level 3
 

 

Transfers out of Level 3
 

 

Total gains or losses:
 
 
 
 
Included in net income
 

 

Included in other comprehensive income
 
1,894

 
474

Purchases, issuances, sales and settlements:
 
 

 
 
Purchases
 

 

Issuances
 

 

Sales
 

 

Settlements
 
(133
)
 
(203
)
Ending balance
 
$
2,125

 
$
462

Total gains or losses for the period included in net income attributable to the change in unrealized gains or losses related to assets and liabilities still held at the reporting date
 
$

 
$



34



Following is a description of the valuation methodologies used for assets measured at fair value on a nonrecurring basis and recognized in the accompanying balance sheets, as well as the general classification of such assets pursuant to the valuation hierarchy.

Impaired Loans (Collateral Dependent). Loans for which it is probable that the Company will not collect all principal and interest due according to contractual terms are measured for impairment.  Allowable methods for determining the amount of impairment and estimating fair value include using the fair value of the collateral for collateral dependent loans.

If the impaired loan is identified as collateral dependent, then the fair value method of measuring the amount of impairment is utilized. This method requires obtaining a current independent appraisal of the collateral and applying a discount factor to the value. Impaired loans that are collateral dependent are classified within Level 3 of the fair value hierarchy when impairment is determined using the fair value method.

Management establishes a specific allowance for impaired loans that have an estimated fair value that is below the carrying value. The total carrying amount of loans for which a change in specific allowance has occurred as of September 30, 2015 was $478,000 and a fair value of $165,000 resulting in specific loss exposures of $313,000.

When there is little prospect of collecting principal or interest, loans, or portions of loans, may be charged-off to the allowance for loan losses.  Losses are recognized in the period an obligation becomes uncollectible.  The recognition of a loss does not mean that the loan has absolutely no recovery or salvage value, but rather that it is not practical or desirable to defer writing off the loan even though partial recovery may be affected in the future.

Foreclosed Assets Held For Sale. Other real estate owned acquired through loan foreclosure are initially recorded at fair value less costs to sell when acquired, establishing a new cost basis. The adjustment at the time of foreclosure is recorded through the allowance for loan losses. Due to the subjective nature of establishing the fair value when the asset is acquired, the actual fair value of the other real estate owned or foreclosed asset could differ from the original estimate. If it is determined that fair value declines subsequent to foreclosure, a valuation allowance is recorded through noninterest expense. Operating costs associated with the assets after acquisition are also recorded as noninterest expense. Gains and losses on the disposition of other real estate owned and foreclosed assets are netted and posted to other noninterest expense. The total carrying amount of other real estate owned as of September 30, 2015 was $320,000. Other real estate owned included in the total carrying amount and measured at fair value on a nonrecurring basis during the period amounted to $51,000.

The following table presents the fair value measurement of assets measured at fair value on a nonrecurring basis and the level within the fair value hierarchy in which the fair value measurements fall at September 30, 2015 and December 31, 2014 (in thousands):
 
Fair Value Measurements Using
 
 
 
Fair Value
 
Quoted Prices in Active Markets for Identical Assets (Level 1)
 
Significant Other Observable Inputs (Level 2)
 
Significant
Unobservable Inputs
(Level 3)
September 30, 2015
 
 
 
 
 
 
 
Impaired loans (collateral dependent)
$
165

 
$

 
$

 
$
165

Foreclosed assets held for sale
51

 

 

 
51

December 31, 2014
 

 
 

 
 

 
 

Impaired loans (collateral dependent)
$
1,313

 
$

 
$

 
$
1,313



35



Sensitivity of Significant Unobservable Inputs

The following is a discussion of the sensitivity of significant unobservable inputs, the interrelationships between those inputs and other unobservable inputs used in recurring fair value measurement and of how those inputs might magnify or mitigate the effect of changes in the unobservable inputs on the fair value measurement.

Trust Preferred Securities. The significant unobservable inputs used in the fair value measurement of the Company’s trust preferred securities are offered quotes and comparability adjustments.  Significant increases (decreases) in any of those inputs in isolation would result in a significantly lower (higher) fair value measurement.  Generally, changes in either of those inputs will not affect the other input.

The following table presents quantitative information about unobservable inputs used in recurring and nonrecurring Level 3 fair value measurements other than goodwill (in thousands).
 
Fair Value at September 30, 2015
 
Valuation Technique
 
Unobservable Inputs
 
Range (Weighted Average)
Trust Preferred Securities
$
2,125

 
Discounted cash flow
 
Discount rate
 
12.3%

 
 
Constant prepayment rate (1)
 
1.3%
 
 
 
Cumulative projected prepayments
 
23.7%

 
 
Probability of default
 
0.4%

 
 
Projected cures given deferral
 
100.0%

 
 
Loss severity
 
96.8%

 
 
Impaired loans (collateral dependent)
$
165

 
Third party valuations
 
Discount to reflect realizable value
 
0
%
-
40%
(
20%
)
Foreclosed assets held for sale
 
$
51

 
Third party valuations
 
Discount to reflect realizable value less estimated selling costs
 
0
%
-
40%
(
35%
)

 
Fair Value at December 31, 2014
 
Valuation Technique
 
Unobservable Inputs
 
Range (Weighted Average)
Trust Preferred Securities
$
364

 
Discounted cash flow
 
Discount rate
 
11.6%
 
 
 
Constant prepayment rate (1)
 
1.3%
 
 
 
Cumulative projected prepayments
 
24.4%
 
 
 
Probability of default
 
0.1%
 
 
 
Projected cures given deferral
 
100.0%
 
 
 
Loss severity
 
97.4%
 
 
 
Impaired loans (collateral dependent)
$
1,313

 
Third party valuations
 
Discount to reflect realizable value
 
0
%
-
40%
(
20%
)

(1)
Every five years



36



Other. The following methods were used to estimate the fair value of all other financial instruments recognized in the accompanying balance sheets at amounts other than fair value.

Cash and Cash Equivalents, Federal Funds Sold, Interest Receivable and Federal Reserve and Federal Home Loan Bank Stock
The carrying amount approximates fair value.

Certificates of Deposit Investments
The fair value of certificates of deposit investments is estimated using a discounted cash flow calculation that applies the rates currently offered for deposits of similar remaining maturities.

Held-to-Maturity Securities
Fair Value is based on quoted market prices, if available. If a quoted market price is not available, fair value is estimated using quoted market prices for similar securities.

Loans Held for Sale
Loans expected to be sold are classified as held for sale and are recorded at the lower of aggregate cost or market
value.

Loans
For loans with floating interest rates, it is assumed that the estimated fair values generally approximate the carrying amount balances.  Fixed rate loans have been valued using a discounted present value of projected cash flow. The discount rate used in these calculations is the current rate at which similar loans would be made to borrowers with similar credit ratings and for the same remaining maturities.  The carrying amount of accrued interest approximates its fair value.

Deposits
Deposits include demand deposits, savings accounts, NOW accounts and certain money market deposits. The carrying amount of these deposits approximates fair value. The fair value of fixed-maturity time deposits is estimated using a discounted cash flow calculation that applies the rates currently offered for deposits of similar remaining maturities.

Securities Sold Under Agreements to Repurchase
The fair value of securities sold under agreements to repurchased is estimated using a discounted cash flow calculation that applies the rates currently offered for deposits of similar remaining maturities.

Interest Payable
The carrying amount approximates fair value.

Junior Subordinated Debentures, Federal Home Loan Bank Borrowings and Other Borrowings
Rates currently available to the Company for debt with similar terms and remaining maturities are used to estimate the fair value of existing debt.


37



The following tables present estimated fair values of the Company’s financial instruments at September 30, 2015 and December 31, 2014 in accordance with FAS 107-1 and APB 28-1, codified with ASC 805 (in thousands):

 
Carrying
Amount
 
Fair
Value
 
Level 1
 
Level 2
 
Level 3
September 30, 2015
 
 
 
 
 
 
 
 
 
Financial Assets
 
 
 
 
 
 
 
 
 
Cash and due from banks
$
214,971

 
$
214,971

 
$
214,971

 
$

 
$

Federal funds sold
492

 
492

 
492

 

 

Certificates of deposit investments
12,930

 
12,952

 

 
12,952

 

Available-for-sale securities
490,556

 
490,556

 
62

 
488,369

 
2,125

Held-to-maturity securities
49,105

 
50,030

 

 
50,030

 

Loans held for sale
1,346

 
1,346

 

 
1,346

 

Loans net of allowance for loan losses
1,221,175

 
1,232,704

 

 

 
1,232,704

Interest receivable
7,620

 
7,620

 

 
7,620

 

Federal Reserve Bank stock
2,272

 
2,272

 

 
2,272

 

Federal Home Loan Bank stock
3,391

 
3,391

 

 
3,391

 

Financial Liabilities
 

 
 

 
 

 
 

 
 

Deposits
$
1,731,860

 
$
1,731,984

 
$

 
$
1,475,955

 
$
256,029

Securities sold under agreements to repurchase
108,499

 
108,526

 

 
108,526

 

Interest payable
381

 
381

 

 
381

 

Federal Home Loan Bank borrowings
20,000

 
20,698

 

 
20,698

 

Junior subordinated debentures
20,620

 
12,557

 

 
12,557

 

December 31, 2014
 
 
 
 
 
 
 
 
 
Financial Assets
 
 
 
 
 
 
 
 
 
Cash and due from banks
$
51,236

 
$
51,236

 
$
51,236

 
$

 
$

Federal funds sold
494

 
494

 
494

 

 

Available-for-sale securities
377,856

 
377,856

 
55

 
377,437

 
364

Held-to-maturity securities
53,650

 
53,937

 

 
53,937

 

Loans held for sale
1,958

 
1,958

 

 
1,958

 

Loans net of allowance for loan losses
1,046,766

 
1,051,110

 

 

 
1,051,110

Interest receivable
6,828

 
6,828

 

 
6,828

 

Federal Reserve Bank stock
1,522

 
1,522

 

 
1,522

 

Federal Home Loan Bank stock
3,391

 
3,391

 

 
3,391

 

Financial Liabilities
 

 
 

 
 
 
 
 
 
Deposits
$
1,272,077

 
$
1,272,358

 
$

 
$
1,053,800

 
$
218,558

Securities sold under agreements to repurchase
121,869

 
121,870

 

 
121,870

 

Interest payable
285

 
285

 

 
285

 

Federal Home Loan Bank borrowings
20,000

 
20,541

 

 
20,541

 

Junior subordinated debentures
20,620

 
12,528

 

 
12,528

 



38



Note 8 -- Business Combination

On August 14, 2015, First Mid-Illinois Bank completed the acquisition of twelve Illinois bank branches ("ONB Branches") from Old National Bank, a national banking association having its principal office in Evansville, Indiana. The acquisition expanded First Mid Bank's service area into Southern Illinois and provided a stable source of core deposits. Pursuant to the terms of the Branch Purchase and Assumption Agreement, dated January 30, 2015, as amended, by and between First Mid Bank and Old National Bank, First Mid Bank, among other matters, assumed certain deposit liabilities and acquired certain loans, as well as cash, real property, furniture, and other fixed operating assets associated with the ONB Branches. The deposit and loan balances assumed were approximately $453 million and $156 million at book value, respectively. First Mid Bank also assumed certain leases, and entered into certain subleases, related to the ONB Branches.

First Mid Bank agreed to pay Old National Bank the sum of: (i) a deposit premium of 3.6% on the amount of deposit accounts of the ONB Branches, other than brokered deposits and municipal deposits, which equated to approximately $15.9 million, (ii) $500,000, representing the fixed deposit premium related to the municipal deposits of the Branches, (iii) the principal amount of the loans being purchased, plus the accrued but unpaid interest, (iv) the aggregate net book value of the other assets purchased including facilities of approximately $4.5 million, and (v) the aggregate amount of cash on hand of $2.7 million as of the closing. The acquisition was settled by Old National Bank paying cash of approximately $276.8 million to First Mid Bank for the difference between these amounts and the total deposits assumed.

The purchase was accounted for under the acquisition method in accordance with Accounting Standards Codification (“ASC”) 805, “Business Combinations,” and accordingly the assets and liabilities were recorded at their fair values on the date of acquisition. The following table summarizes the estimated fair values of assets acquired and liabilities assumed at the date of acquisition (in thousands).
 
 
Acquired
Book Value
Fair Value Adjustments
As Recorded by
First Mid Bank
Assets
 
 
 
     Cash
279,468


279,468

     Loans
155,774

(3,377
)
152,397

     Premises and equipment
4,547

(125
)
4,422

     Goodwill

14,015

14,015

     Core deposit intangible

6,216

6,216

     Other assets
1,433


1,433

              Total assets acquired
$
441,222

$
16,729

$
457,951

Liabilities
 
 
 
     Deposits
$
452,810

$
837

$
453,647

     Securities sold under agreements to repurchase
3,797


3,797

     Other liabilities
507


507

              Total liabilities assumed
$
457,114

$
837

$
457,951

  

The Company has recognized approximately $1.1 million of costs related to completion of the acquisition during the first nine months of 2015. These acquisition costs are included in legal and professional and other expense. The difference between the fair value and acquired value of the purchased loans of $3,377,000 is being accreted to interest income over the remaining term of the loans. The difference between the fair value and acquired value of the assumed time deposits of $837,000 is being amortized to interest expense over the remaining term of the time deposits. The core deposit intangible asset, with a fair value of $6,216,000, will be amortized on an accelerated basis over its estimated life of ten years.








39





The following unaudited pro forma condensed combined financial information presents the results of operations of the Company, including the effects of the purchase accounting adjustments and acquisition expenses, had the acquisition taken place at the beginning of the period (in thousands):

 
Three months ended
Nine months ended
 
September 30,
September 30,
 
2015
2014
2015
2014
Net interest income
$
16,953

$
15,842

$
47,627

$
45,685

Provision for loan losses
522

96

1,012

651

Non-interest income
6,811

6,283

19,750

19,515

Non-interest expense
15,615

14,178

42,873

42,524

  Income before income taxes
7,627

7,851

23,492

22,025

Income tax expense
2,674

2,909

8,384

8,167

   Net income
$
4,953

$
4,942

$
15,108

$
13,858

Dividends on preferred shares
550

1,105

1,650

3,313

Net income available to common stockholders
$
4,403

$
3,837

$
13,458

$
10,545

 
 
 
 
 
Earnings per share
 
 
 
 
   Basic
$
0.52

$
0.65

$
1.78

$
1.79

   Diluted
$
0.51

$
0.59

$
1.69

$
1.65

 
 
 
 
 
Basic weighted average shares outstanding
8,421,397

5,881,681

7,553,468

5,881,973

Diluted weighted average shares outstanding
9,784,533

8,386,142

8,916,604

8,386,507


The unaudited pro forma condensed combined financial statements do not reflect any anticipated cost savings and revenue enhancements. Accordingly, the pro forma results of operations of the Company as of and after the business combination may not be indicative of the results that actually would have occurred if the combination had been in effect during the periods presented or of the results that may be attained in the future.



40



ITEM 2.   MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS


The following discussion and analysis is intended to provide a better understanding of the consolidated financial condition and results of operations of the Company and its subsidiaries as of, and for the three and nine-month periods ended September 30, 2015 and 2014.  This discussion and analysis should be read in conjunction with the consolidated financial statements, related notes and selected financial data appearing elsewhere in this report.

Forward-Looking Statements

This report may contain certain forward-looking statements, such as discussions of the Company’s pricing and fee trends, credit quality and outlook, liquidity, new business results, expansion plans, anticipated expenses and planned schedules. The Company intends such forward-looking statements to be covered by the safe harbor provisions for forward-looking statements contained in the Private Securities Litigation Reform Act of 1955. Forward-looking statements, which are based on certain assumptions and describe future plans, strategies and expectations of the Company, are identified by use of the words “believe,” ”expect,” ”intend,” ”anticipate,” ”estimate,” ”project,” or similar expressions. Actual results could differ materially from the results indicated by these statements because the realization of those results is subject to many risks and uncertainties, including those described in Item 1A-“Risk Factors” and other sections of the Company’s Annual Report on Form 10-K and the Company’s other filings with the SEC, and changes in interest rates, general economic conditions and those in the Company’s market area, legislative/regulatory changes, monetary and fiscal policies of the U.S. Government, including policies of the U.S. Treasury and the Federal Reserve Board, the quality or composition of the loan or investment portfolios and the valuation of the investment portfolio, the Company’s success in raising capital and effecting and integrating acquisitions, demand for loan products, deposit flows, competition, demand for financial services in the Company’s market area and accounting principles, policies and guidelines. Furthermore, forward-looking statements speak only as of the date they are made. Except as required under the federal securities laws or the rules and regulations of the SEC, we do not undertake any obligation to update or review any forward-looking information, whether as a result of new information, future events or otherwise. Further information concerning the Company and its business, including  a discussion of these and additional factors that could materially affect the Company’s financial results, is included in the Company’s 2014 Annual Report on Form 10-K under the headings “Item 1. Business" and “Item 1A. Risk Factors."



Overview

This overview of management’s discussion and analysis highlights selected information in this document and may not contain all of the information that is important to you. For a more complete understanding of trends, events, commitments, uncertainties, liquidity, capital resources, and critical accounting estimates which have an impact on the Company’s financial condition and results of operations you should carefully read this entire document.

Net income was $11,858,000 and $11,551,000 for the nine months ended September 30, 2015 and 2014, respectively. Diluted net income per common share available to common stockholders was $1.33 and $1.38 for the nine months ended September 30, 2015 and 2014. The following table shows the Company’s annualized performance ratios for the nine months ended September 30, 2015 and 2014, compared to the performance ratios for the year ended December 31, 2014:
 
Nine months ended
 
Year ended
 
September 30,
2015
 
September 30,
2014
 
December 31,
2014
Return on average assets
0.92
%
 
0.97
%
 
0.97
%
Return on average common equity
8.86
%
 
10.76
%
 
10.34
%
Average equity to average assets
10.58
%
 
9.85
%
 
9.94
%


Total assets were $2.09 billion at September 30, 2015, compared to $1.61 billion as of December 31, 2014. From December 31, 2014 to September 30, 2015, cash and interest bearing deposits increased $163.7 million, net loan balances increased $174.4 million and investment securities increased $108.2 million. The increase in investment securities balance was primarily due to purchases of obligations of U.S. government corporations and agencies securities and mortgage-backed securities during the first nine months of 2015. Net loan balances were $1.22 billion at September 30, 2015, from $1.05 billion

41



at December 31, 2014. The increase in loan balances was primarily due to $152 million loans acquired in the ONB Branch acquisition and an increase in commercial and industrial loans offset by a decline in commercial real estate loans.
 
Net interest margin, defined as net interest income divided by average interest-earning assets, was 3.30% for the nine months ended September 30, 2015, down from 3.43% for the same period in 2014. This decrease was primarily due to a greater decline in investment and loan yields than funding costs. Net interest income before the provision for loan losses was $40.0 million compared to net interest income of $38.4 million for the same period in 2014.

Total non-interest income of $14.3 million increased $472,000 or 3.40% from $13.9 million for the same period last year. Mortgage banking income increased from $441,000 for the the first nine months of of 2014 to $549,000 for the first nine months of this year as refinance activity and new purchase activity has increased due to lower mortgage rates. Insurance revenues also increased due to more income received from insurance carriers based on previous year claim experience. Gains on the sale of securities were $231,000 for the nine months ended September 30, 2015 compared to $714,000 for the same period last year.

Total non-interest expense of $34.9 million decreased $1,652,000 or 5.0% from $33.3 million for the same period last year primarily due to expenses incurred to complete the acquisition of the twelve ONB Branches.

Following is a summary of the factors that contributed to the changes in net income (in thousands):
 
Change in Net Income
2015 versus 2014
 
Three months ended September 30,
 
Nine months ended September 30,
Net interest income
$
994

 
$
1,591

Provision for loan losses
(437
)
 
(394
)
Other income, including securities transactions
607

 
472

Other expenses
(1,792
)
 
(1,652
)
Income taxes
376

 
290

Increase in net income
$
(252
)
 
$
307


Credit quality is an area of importance to the Company. Total nonperforming loans were $3.5 million at September 30, 2015, compared to $4.8 million at September 30, 2014 and $4.5 million at December 31, 2014. See the discussion under the heading “Loan Quality and Allowance for Loan Losses” for a detailed explanation of these balances. Repossessed asset balances totaled $320,000 at September 30, 2015 compared to $352,000 on September 30, 2014 and $263,000 on December 31, 2014. The Company’s provision for loan losses for the nine months ended September 30, 2015 and 2014 was $889,000 and $495,000, respectively.  Total loans past due 30 days or more were 0.29% of loans at September 30, 2015 compared to 0.31% at September 30, 2014, and 0.27% of loans at December 31, 2014.  At September 30, 2015, the composition of the loan portfolio remained similar to the same period last year. Loans secured by both commercial and residential real estate comprised approximately 66.4% of the loan portfolio as of September 30, 2015 and 70.3% as of December 31, 2014.

The Company’s capital position remains strong and the Company has consistently maintained regulatory capital ratios above the “well-capitalized” standards. The Company’s Tier 1 capital to risk weighted assets ratio calculated under the regulatory risk-based capital requirements at September 30, 2015 and 2014 and December 31, 2014 was 13.84%, 14.54% and 14.42%, respectively. The Company’s total capital to risk weighted assets ratio calculated under the regulatory risk-based capital requirements at September 30, 2015 and 2014 and December 31, 2014 was 14.88%, 15.75% and 15.60%, respectively. The primary reason for the decrease in these ratios was completion of the acquisition of twelve ONB Branches which increased risk-weighted assets by approximately $227 million offset by completion of a private placement capital raise completed during the second quarter of 2015 which resulted in an increase in common stockholder's equity of approximately $29.3 million.

The Company’s liquidity position remains sufficient to fund operations and meet the requirements of borrowers, depositors, and creditors. The Company maintains various sources of liquidity to fund its cash needs. See the discussion under the heading “Liquidity” for a full listing of sources and anticipated significant contractual obligations.

The Company enters into financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments include lines of credit, letters of credit and other commitments to extend credit.  The total outstanding commitments at September 30, 2015 and 2014 were $302 million and $235 million,

42



respectively.  The increase in 2015 was primarily due to additional outstanding commitments resulting from the acquisition of the twelve ONB Branches.


Federal Deposit Insurance Corporation Insurance Coverage. As an FDIC-insured institution, First Mid Bank is required to pay deposit insurance premium assessments to the FDIC.  A number of developments with respect to the FDIC insurance system have affected recent results.

On February 27, 2009, the FDIC adopted a final rule setting initial base assessment rates beginning April 1, 2009, at 12 to 45 basis points and, due to extraordinary circumstances, extended the period of the restoration plan to increase the deposit insurance fund to seven years. Also on February 27, 2009, the FDIC issued final rules on changes to the risk-based assessment system which imposes rates based on an institution’s risk to the deposit insurance fund. The new rates increased the range of annual risk based assessment rates from 5 to 7 basis points to 7 to 24 basis points. The final rules both increase base assessment rates and incorporate additional assessments for excess reliance on brokered deposits and FHLB advances. This new assessment took effect April 1, 2009. The Company expensed $574,000 and $537,000 for this assessment during the first nine months of 2015 and 2014, respectively.

In addition to its insurance assessment, each insured bank was subject to quarterly debt service assessments in connection with bonds issued by a government corporation that financed the federal savings and loan bailout.  The Company expensed $67,000 and $66,000 during the first nine months of 2015 and 2014, respectively, for this assessment.


Basel III. In September 2010, the Basel Committee on Banking Supervision proposed higher global minimum capital standards, including a minimum Tier 1 common capital ratio and additional capital and liquidity requirements. On July 2, 2013, the Federal Reserve Board approved a final rule to implement these reforms and changes required by the Dodd-Frank Act. This final rule was subsequently adopted by the OCC and the FDIC.

As included in the proposed rule of June 2012, the final rule includes new risk-based capital and leverage ratios, which will be phased in from 2015 to 2019, and refines the definition of what constitutes “capital” for purposes of calculating those ratios. The new minimum capital level requirements applicable to the Company and First Mid Bank beginning in 2015 are: (i) a new common equity Tier 1 capital ratio of 4.5%; (ii) a Tier 1 capital ratio of 6%; (iii) a total capital ratio of 8%; and (iv) a Tier 1 leverage ratio of 4%. The rule also establishes a “capital conservation buffer” of 2.5% above the new regulatory minimum capital requirements, which must consist entirely of common equity Tier 1 capital and would result in the following minimum ratios: (i) a common equity Tier 1 capital ratio of 7.0%, (ii) a Tier 1 capital ratio of 8.5%, and (iii) a total capital ratio of 10.5%. The new capital conservation buffer requirement will be phased in beginning in January 2016 at 0.625% of risk weighted assets and will increase by that amount each year until fully implemented in January 2019. An institution will be subject to limitations on paying dividends, engaging in share repurchases and paying discretionary bonuses if its capital level falls below the buffer amount.

The final rule also makes three changes to the proposed rule of June 2012 that impact the Company. First, the proposed rule would have required banking organizations to include accumulated other comprehensive income (“AOCI”) in common equity tier 1 capital. AOCI includes accumulated unrealized gains and losses on certain assets and liabilities that have not been included in net income. Under existing general risk-based capital rules, most components of AOCI are not included in a banking organization's regulatory capital calculations. The final rule allows community banking organizations to make a one-time election not to include these additional components of AOCI in regulatory capital and instead use the existing treatment under the general risk-based capital rules that excludes most AOCI components from regulatory capital.

Second, the proposed rule would have modified the risk-weight framework applicable to residential mortgage exposures to require banking organizations to divide residential mortgage exposure into two categories in order to determine the applicable risk weight. The final rule, however, retains the existing treatment for residential mortgage exposures under the general risk-based capital rules.

Third, the proposed rule would have required banking organizations with total consolidated assets of less than $15 billion as of December 31, 2009, such as the Company, to phase out over ten years any trust preferred securities and cumulative perpetual preferred securities from its Tier 1 capital regulatory capital. The final rule, however, permanently grandfathers into Tier 1 capital of depository institution holding companies with total consolidated assets of less than $15 billion as of December 31, 2009 any trust preferred securities or cumulative perpetual preferred stock issued before May 19, 2010.

See discussion under the heading "Capital Resources" for a description of the Company's and First Mid Bank's risk-based capital.



43




Critical Accounting Policies and Use of Significant Estimates

The Company has established various accounting policies that govern the application of U.S. generally accepted accounting principles in the preparation of the Company’s financial statements. The significant accounting policies of the Company are described in the footnotes to the consolidated financial statements included in the Company’s 2014 Annual Report on Form 10-K. Certain accounting policies involve significant judgments and assumptions by management that have a material impact on the carrying value of certain assets and liabilities; management considers such accounting policies to be critical accounting policies. The judgments and assumptions used by management are based on historical experience and other factors, which are believed to be reasonable under the circumstances. Because of the nature of the judgments and assumptions made by management, actual results could differ from these judgments and assumptions, which could have a material impact on the carrying values of assets and liabilities and the results of operations of the Company.

Allowance for Loan Losses. The Company believes the allowance for loan losses is the critical accounting policy that requires the most significant judgments and assumptions used in the preparation of its consolidated financial statements. An estimate of potential losses inherent in the loan portfolio are determined and an allowance for those losses is established by considering factors including historical loss rates, expected cash flows and estimated collateral values. In assessing these factors, the Company use organizational history and experience with credit decisions and related outcomes. The allowance for loan losses represents the best estimate of losses inherent in the existing loan portfolio. The allowance for loan losses is increased by the provision for loan losses charged to expense and reduced by loans charged off, net of recoveries. The Company evaluates the allowance for loan losses quarterly. If the underlying assumptions later prove to be inaccurate based on subsequent loss evaluations, the allowance for loan losses is adjusted.

The Company estimates the appropriate level of allowance for loan losses by separately evaluating impaired and nonimpaired loans. A specific allowance is assigned to an impaired loan when expected cash flows or collateral do not justify the carrying amount of the loan. The methodology used to assign an allowance to a nonimpaired loan is more subjective. Generally, the allowance assigned to nonimpaired loans is determined by applying historical loss rates to existing loans with similar risk characteristics, adjusted for qualitative factors including the volume and severity of identified classified loans, changes in economic conditions, changes in credit policies or underwriting standards, and changes in the level of credit risk associated with specific industries and markets. Because the economic and business climate in any given industry or market, and its impact on any given borrower, can change rapidly, the risk profile of the loan portfolio is continually assessed and adjusted when appropriate. Notwithstanding these procedures, there still exists the possibility that the assessment could prove to be significantly incorrect and that an immediate adjustment to the allowance for loan losses would be required.

Other Real Estate Owned. Other real estate owned acquired through loan foreclosure is initially recorded at fair value less costs to sell when acquired, establishing a new cost basis. The adjustment at the time of foreclosure is recorded through the allowance for loan losses. Due to the subjective nature of establishing the fair value when the asset is acquired, the actual fair value of the other real estate owned or foreclosed asset could differ from the original estimate. If it is determined that fair value temporarily declines subsequent to foreclosure, a valuation allowance is recorded through noninterest expense. Operating costs associated with the assets after acquisition are also recorded as noninterest expense. Gains and losses on the disposition of other real estate owned and foreclosed assets are netted and posted to other noninterest expense.

Investment in Debt and Equity Securities. The Company classifies its investments in debt and equity securities as either held-to-maturity or available-for-sale in accordance with Statement of Financial Accounting  Standards (SFAS) No. 115, “Accounting for Certain Investments in Debt and Equity Securities,” which was codified into ASC 320. Securities classified as held-to-maturity are recorded at cost or amortized cost. Available-for-sale securities are carried at fair value. Fair value calculations are based on quoted market prices when such prices are available. If quoted market prices are not available, estimates of fair value are computed using a variety of techniques, including extrapolation from the quoted prices of similar instruments or recent trades for thinly traded securities, fundamental analysis, or through obtaining purchase quotes. Due to the subjective nature of the valuation process, it is possible that the actual fair values of these investments could differ from the estimated amounts, thereby affecting the financial position, results of operations and cash flows of the Company. If the estimated value of investments is less than the cost or amortized cost, the Company evaluates whether an event or change in circumstances has occurred that may have a significant adverse effect on the fair value of the investment. If such an event or change has occurred and the Company determines that the impairment is other-than-temporary, a further determination is made as to the portion of impairment that is related to credit loss. The impairment of the investment that is related to the credit loss is expensed in the period in which the event or change occurred. The remainder of the impairment is recorded in other comprehensive income.



44



Deferred Income Tax Assets/Liabilities. The Company’s net deferred income tax asset arises from differences in the dates that items of income and expense enter into our reported income and taxable income. Deferred tax assets and liabilities are established for these items as they arise. From an accounting standpoint, deferred tax assets are reviewed to determine if they are realizable based on the historical level of taxable income, estimates of future taxable income and the reversals of deferred tax liabilities. In most cases, the realization of the deferred tax asset is based on future profitability. If the Company were to experience net operating losses for tax purposes in a future period, the realization of deferred tax assets would be evaluated for a potential valuation reserve.

Additionally, the Company reviews its uncertain tax positions annually under FASB Interpretation No. 48 (FIN No. 48), “Accounting for Uncertainty in Income Taxes,” codified within ASC 740. An uncertain tax position is recognized as a benefit only if it is "more likely than not" that the tax position would be sustained in a tax examination, with a tax examination being presumed to occur. The amount actually recognized is the largest amount of tax benefit that is greater than 50% likely to be recognized on examination. For tax positions not meeting the "more likely than not" test, no tax benefit is recorded. A significant amount of judgment is applied to determine both whether the tax position meets the "more likely than not" test as well as to determine the largest amount of tax benefit that is greater than 50% likely to be recognized. Differences between the position taken by management and that of taxing authorities could result in a reduction of a tax benefit or increase to tax liability, which could adversely affect future income tax expense.

Impairment of Goodwill and Intangible Assets. Core deposit and customer relationships, which are intangible assets with a finite life, are recorded on the Company’s balance sheets. These intangible assets were capitalized as a result of past acquisitions and are being amortized over their estimated useful lives of up to 15 years. Core deposit intangible assets, with finite lives will be tested for impairment when changes in events or circumstances indicate that its carrying amount may not be recoverable. Core deposit intangible assets were tested for impairment as of September 30, 2015 as part of the goodwill impairment test and no impairment was identified.

As a result of the Company’s acquisition activity, goodwill, an intangible asset with an indefinite life, is reflected on the balance sheets. Goodwill is evaluated for impairment annually, unless there are factors present that indicate a potential impairment, in which case, the goodwill impairment test is performed more frequently than annually.

Fair Value Measurements. The fair value of a financial instrument is defined as the amount at which the instrument could be exchanged in a current transaction between willing parties, other than in a forced or liquidation sale. The Company estimates the fair value of a financial instrument using a variety of valuation methods. Where financial instruments are actively traded and have quoted market prices, quoted market prices are used for fair value. When the financial instruments are not actively traded, other observable market inputs, such as quoted prices of securities with similar characteristics, may be used, if available, to determine fair value. When observable market prices do not exist, the Company estimates fair value. The Company’s valuation methods consider factors such as liquidity and concentration concerns. Other factors such as model assumptions, market dislocations, and unexpected correlations can affect estimates of fair value. Imprecision in estimating these factors can impact the amount of revenue or loss recorded.

SFAS No. 157, “Fair Value Measurements”, which was codified into ASC 820, establishes a framework for measuring the fair value of financial instruments that considers the attributes specific to particular assets or liabilities and establishes a three-level hierarchy for determining fair value based on the transparency of inputs to each valuation as of the fair value measurement date. The three levels are defined as follows:

Level 1 — quoted prices (unadjusted) for identical assets or liabilities in active markets.

Level 2 — inputs include quoted prices for similar assets and liabilities in active markets, quoted prices of identical or similar assets or liabilities in markets that are not active, and inputs that are observable for the asset or liability, either directly or indirectly, for substantially the full term of the financial instrument.

Level 3 — inputs that are unobservable and significant to the fair value measurement.

At the end of each quarter, the Company assesses the valuation hierarchy for each asset or liability measured. From time to time, assets or liabilities may be transferred within hierarchy levels due to changes in availability of observable market inputs to measure fair value at the measurement date. Transfers into or out of hierarchy levels are based upon the fair value at the beginning of the reporting period. A more detailed description of the fair values measured at each level of the fair value hierarchy can be found in Note 6 – Fair Value of Assets and Liabilities.



45



Results of Operations

Net Interest Income

The largest source of revenue for the Company is net interest income. Net interest income represents the difference between total interest income earned on earning assets and total interest expense paid on interest-bearing liabilities.  The amount of interest income is dependent upon many factors, including the volume and mix of earning assets, the general level of interest rates and the dynamics of changes in interest rates.  The cost of funds necessary to support earning assets varies with the volume and mix of interest-bearing liabilities and the rates paid to attract and retain such funds.  The Company’s average balances, interest income and expense and rates earned or paid for major balance sheet categories are set forth for the three and nine months ended September 30, 2015 and 2014 in the following table (dollars in thousands):

46



 
 
 
 
 
 
 
 
 
 
 
 
 
Three months ended September 30, 2015
 
Three months ended September 30, 2014
 
Average
Balance
 
Interest
 
Average
Rate
 
Average
Balance
 
Interest
 
Average
Rate
ASSETS
 
 
 
 
 
 
 
 
 
 
 
Interest-bearing deposits with other financial institutions
$
114,673

 
$
57

 
0.20
%
 
$
39,470

 
$
24

 
0.24
%
Federal funds sold
492

 

 
%
 
495

 

 
%
Certificates of deposit investments
2,769

 
6

 
0.86
%
 

 

 
%
Investment securities
 

 
 

 
 

 
 

 
 

 
 

Taxable
410,710

 
1,959

 
1.91
%
 
365,547

 
1,808

 
1.98
%
Tax-exempt (1)
89,329

 
723

 
3.24
%
 
69,338

 
584

 
3.37
%
Loans (2)(3)(4)
1,151,089

 
12,198

 
4.20
%
 
1,033,991

 
11,391

 
4.37
%
Total earning assets
1,769,062

 
14,943

 
3.35
%
 
1,508,841

 
13,807

 
3.63
%
Cash and due from banks
39,234

 
 

 
 

 
31,644

 
 

 
 

Premises and equipment
29,524

 
 

 
 

 
27,847

 
 

 
 

Other assets
55,271

 
 

 
 

 
44,233

 
 

 
 

Allowance for loan losses
(14,059
)
 
 

 
 

 
(13,715
)
 
 

 
 

Total assets
$
1,879,032

 
 

 
 

 
$
1,598,850

 
 

 
 

LIABILITIES AND STOCKHOLDERS’ EQUITY
 
 
 
 
 
 
 
 
 
 
 
Interest-bearing deposits
 

 
 

 
 

 
 

 
 

 
 

Demand deposits
$
710,850

 
$
190

 
0.11
%
 
$
564,749

 
$
168

 
0.12
%
Savings deposits
301,340

 
100

 
0.13
%
 
278,420

 
94

 
0.13
%
Time deposits
224,488

 
355

 
0.63
%
 
234,187

 
324

 
0.55
%
Securities sold under agreements to repurchase
114,346

 
14

 
0.05
%
 
98,944

 
11

 
0.04
%
FHLB advances
23,043

 
155

 
2.67
%
 
12,174

 
78

 
2.54
%
Fed Funds Purchased
332

 
1

 
1.19
%
 

 

 
%
Junior subordinated debt
20,620

 
132

 
2.54
%
 
20,620

 
130

 
2.50
%
Other debt

 

 
%
 

 

 
%
Total interest-bearing liabilities
1,395,019

 
947

 
0.27
%
 
1,209,094

 
805

 
0.26
%
Non interest-bearing demand deposits
275,726

 
 

 
 

 
220,855

 
 

 
 

Other liabilities
7,247

 
 

 
 

 
11,165

 
 

 
 

Stockholders' equity
201,040

 
 

 
 

 
157,736

 
 

 
 

Total liabilities & equity
$
1,879,032

 
 

 
 

 
$
1,598,850

 
 

 
 

Net interest income
 

 
$
13,996

 
 

 
 

 
$
13,002

 
 

Net interest spread
 

 
 

 
3.08
%
 
 

 
 

 
3.37
%
Impact of non-interest bearing funds
 

 
 

 
0.05
%
 
 

 
 

 
0.05
%
Net yield on interest- earning assets
 

 
 

 
3.13
%
 
 

 
 

 
3.42
%
 
 
 
 
 
 
 
 
 
 
 
 
(1) The tax-exempt income is not recorded on a tax equivalent basis.
 
 
 
 
 
 
(2) Nonaccrual loans have been included in the average balances.
 
 
 
 
 
 
(3) Net of unaccreted discount related to loans acquired
 
 
 
 
 
 
(4) Includes loans held for sale.
 
 
 
 
 
 

47



 
Nine months ended September 30, 2015
 
Nine months ended September 30, 2014
 
Average
Balance
 
Interest
 
Average
Rate
 
Average
Balance
 
Interest
 
Average
Rate
Assets
 
 
 
 
 
 
 
 
 
 
 
Interest-bearing deposits with other financial institutions
$
61,770

 
$
101

 
0.22
%
 
$
35,940

 
$
67

 
0.25
%
Federal funds sold
493

 

 
0.10
%
 
496

 

 
0.10
%
Certificates of deposit investments
933

 
6

 
0.80
%
 

 

 
%
Investment securities:
 

 
 

 
 

 
 

 
 

 
 

Taxable
385,598

 
5,476

 
1.89
%
 
379,164

 
5,725

 
2.01
%
Tax-exempt (1)
83,311

 
1,997

 
3.20
%
 
68,209

 
1,735

 
3.39
%
Loans (2)
1,084,184

 
34,974

 
4.31
%
 
1,010,767

 
33,242

 
4.40
%
Total earning assets
1,616,289

 
42,554

 
3.52
%
 
1,494,576

 
40,769

 
3.65
%
Cash and due from banks
36,675

 
 

 
 

 
34,626

 
 

 
 

Premises and equipment
27,997

 
 

 
 

 
28,006

 
 

 
 

Other assets
44,489

 
 

 
 

 
45,268

 
 

 
 

Allowance for loan losses
(13,990
)
 
 

 
 

 
(13,595
)
 
 

 
 

Total assets
$
1,711,460

 
 

 
 

 
$
1,588,881

 
 

 
 

Liabilities and Stockholders' Equity
 
 
 
 
 
 
 
 
Interest-bearing deposits
 

 
 

 
 

 
 

 
 

 
 

Demand deposits
$
617,543

 
$
518

 
0.11
%
 
$
557,811

 
$
517

 
0.12
%
Savings deposits
290,048

 
293

 
0.14
%
 
283,527

 
280

 
0.13
%
Time deposits
210,332

 
879

 
0.56
%
 
230,405

 
981

 
0.57
%
Securities sold under agreements to repurchase
116,443

 
43

 
0.05
%
 
94,026

 
33

 
0.05
%
FHLB advances
24,231

 
465

 
2.57
%
 
12,747

 
211

 
2.22
%
Fed Funds Purchased
190

 
1

 
%
 
22

 

 
0.50
%
Junior subordinated debt
20,620

 
390

 
2.53
%
 
20,620

 
385

 
2.49
%
Other debt
630

 
13

 
2.66
%
 
136

 
1

 
1.21
%
Total interest-bearing liabilities
1,280,037

 
2,602

 
0.27
%
 
1,199,294

 
2,408

 
0.27
%
Non interest-bearing demand deposits
242,421

 
 

 
 

 
224,396

 
 

 
 

Other liabilities
7,920

 
 

 
 

 
8,629

 
 

 
 

Stockholders' equity
181,082

 
 

 
 

 
156,562

 
 

 
 

Total liabilities & equity
$
1,711,460

 
 

 
 

 
$
1,588,881

 
 

 
 

Net interest income
 

 
$
39,952

 
 

 
 

 
$
38,361

 
 

Net interest spread
 

 
 

 
3.25
%
 
 

 
 

 
3.38
%
Impact of non-interest bearing funds
 

 
 

 
0.05
%
 
 

 
 

 
0.05
%
Net yield on interest- earning assets
 

 
 

 
3.30
%
 
 

 
 

 
3.43
%

(1) The tax-exempt income is not recorded on a tax equivalent basis.
(2) Nonaccrual loans and loans held for sale are included in the average balances. Balances are net of unaccreted discount related to loans acquired.


48



Changes in net interest income may also be analyzed by segregating the volume and rate components of interest income and
interest expense.  The following table summarizes the approximate relative contribution of changes in average volume and interest rates to changes in net interest income for the three and nine-months ended September 30, 2015, compared to the same periods in 2014 (in thousands):
 
Three months ended September 30, 2015 compared to 2014 Increase / (Decrease)
 
Nine months ended September 30,
2015 compared to 2014
Increase / (Decrease)
 
Total
Change
 
Volume (1)
 
Rate (1)
 
Total
Change
 
Volume (1)
 
Rate (1)
Earning Assets:
 
 
 
 
 
 
 
 
 
 
 
Interest-bearing deposits
$
33

 
$
60

 
$
(27
)
 
$
34

 
$
48

 
$
(14
)
Federal funds sold

 

 

 

 

 

Certificates of deposit investments
6

 

 
6

 
6

 

 
6

Investment securities:
 

 
 

 
 

 
 

 
 

 
 

Taxable
151

 
515

 
(364
)
 
(249
)
 
146

 
(395
)
Tax-exempt (2)
139

 
163

 
(24
)
 
262

 
367

 
(105
)
Loans (3)
807

 
3,218

 
(2,411
)
 
1,732

 
2,771

 
(1,039
)
Total interest income
1,136

 
3,956

 
(2,820
)
 
1,785

 
3,332

 
(1,547
)
Interest-Bearing Liabilities:
 

 
 

 
 

 
 

 
 

 
 

Interest-bearing deposits
 

 
 

 
 

 
 

 
 

 
 

Demand deposits
22

 
102

 
(80
)
 
1

 
64

 
(63
)
Savings deposits
6

 
6

 

 
13

 
3

 
10

Time deposits
31

 
(76
)
 
107

 
(102
)
 
(85
)
 
(17
)
Securities sold under agreements to repurchase
3

 
1

 
2

 
10

 
10

 

FHLB advances
77

 
73

 
4

 
254

 
216

 
38

Junior subordinated debt
2

 

 
2

 
5

 

 
5

Other debt

 

 

 
12

 
9

 
3

Total interest expense
142

 
106

 
36

 
194

 
218

 
(24
)
Net interest income
$
994

 
$
3,850

 
$
(2,856
)
 
$
1,591

 
$
3,114

 
$
(1,523
)

(1) Changes attributable to the combined impact of volume and rate have been allocated proportionately to the change due to volume and the change due to rate.
(2) The tax-exempt income is not recorded on a tax-equivalent basis.
(3) Nonaccrual loans have been included in the average balances.


Net interest income increased $1.6 million, or 4.1%, to $40.0 million for the nine months ended September 30, 2015, from $38.4 million for the same period in 2014. Net interest income increased primarily due to the growth in average earning assets. The net interest margin decreased primarily due to the decline in earning asset yields from the higher amount of interest bearing deposits or short-term liquidity from the acquisition and declines in loan and investment yields.

For the nine months ended September 30, 2015, average earning assets increased by $121.7 million, or 8.1%, and average interest-bearing liabilities increased $80.7 million or 6.7%, compared with average balances for the same period in 2014. The changes in average balances for these periods are shown below:

Average interest-bearing deposits held by the Company increased $25.8 million or 71.9%.
Average federal funds sold decreased $3,000 or 0.6%.
Average certificates of deposits investments increased $933,000 or 100.0%
Average loans increased by $73.4 million or 7.3%.
Average securities increased by $21.5 million or 4.8%.
Average deposits increased by $46.2 million or 4.3%.
Average securities sold under agreements to repurchase increased by $22.4 million or 23.8%.
Average borrowings and other debt increased by $12.1 million or 36.2%.
Net interest margin decreased to 3.30% for the first nine months of 2015 from 3.43% for the first nine months of 2014.

49





To compare the tax-exempt yields on interest-earning assets to taxable yields, the Company also computes non-GAAP net interest income on a tax equivalent basis (TE) where the interest earned on tax-exempt securities is adjusted to an amount comparable to interest subject to normal income taxes assuming a federal tax rate of 35% (referred to as the tax equivalent adjustment). The year-to-date net yield on interest-earning assets (TE) was 3.40% and 3.52% for the first nine months of 2015 and 2014, respectively. The TE adjustments to net interest income for the nine months ended September 30, 2015 and 2014 were $1,188,000 and $1,064,000, respectively.


Provision for Loan Losses

The provision for loan losses for the nine months ended September 30, 2015 and 2014 was $889,000 and $495,000, respectively.  The increase in provision expense was due to greater net charge-offs and an increase in loan balances. Net charge-offs were $343,000 for the nine months ended September 30, 2015 compared to $39,000 during the same period in 2014.  Nonperforming loans were $3.5 million and $4.8 million as of September 30, 2015 and 2014, respectively.   For information on loan loss experience and nonperforming loans, see discussion under the “Nonperforming Loans” and “Loan Quality and Allowance for Loan Losses” sections below.


Other Income

An important source of the Company’s revenue is other income.  The following table sets forth the major components of other income for the three and nine-months ended September 30, 2015 and 2014 (in thousands):
 
Three months ended September 30,
 
Nine months ended September 30,
 
2015
 
2014
 
$ Change
 
2015
 
2014
 
$ Change
Trust revenues
$
795

 
$
813

 
$
(18
)
 
$
2,575

 
$
2,594

 
$
(19
)
Brokerage commissions
329

 
265

 
64

 
913

 
748

 
165

Insurance commissions
459

 
448

 
11

 
1,568

 
1,447

 
121

Service charges
1,536

 
1,412

 
124

 
4,003

 
3,909

 
94

Security gains, net
1

 
(20
)
 
21

 
231

 
714

 
(483
)
Mortgage banking revenue, net
172

 
185

 
(13
)
 
549

 
441

 
108

ATM / debit card revenue
1,200

 
958

 
242

 
3,224

 
2,933

 
291

Other
517

 
341

 
176

 
1,282

 
1,087

 
195

Total other income
$
5,009

 
$
4,402

 
$
607

 
$
14,345

 
$
13,873

 
$
472


Following are explanations of the changes in these other income categories for the three months ended September 30, 2015 compared to the same period in 2014:

Trust revenues decreased $18,000 or 2.2% to $795,000 from $813,000. Trust assets, at market value, were $815.0 million at September 30, 2015 compared to $743.8 million at September 30, 2014.

Revenues from brokerage increased $64,000 or 24.2% to $329,000 from $265,000 due to an increase in the number of brokerage accounts from new business development efforts.

Insurance commissions increased $11,000 or 2.5% to $459,000 from $448,000 due to an increase in commissions received during 2015 compared to 2014.

Fees from service charges increased $124,000 or 8.8% to $1,536,000 from $1,412,000 for the three months ended September 30, 2015 and 2014 primarily due to additional service charge income from the ONB branches acquired during the third quarter of 2015.

The sale of securities during the three months ended September 30, 2015 resulted in net securities gains of $1,000 compared to losses of $20,000 during the three months ended September 30, 2014.



50






Mortgage banking income decreased $13,000 or 7.0% to $172,000 from $185,000. Loans sold balances were as follows:

$14.7 million (representing 123 loans) for the three months ended of September 30, 2015
$12.7 million (representing 103 loans) for the three months ended of September 30, 2014

First Mid Bank generally releases the servicing rights on loans sold into the secondary market.

Revenue from ATMs and debit cards increased $242,000 or 25.3% to $1,200,000 from $958,000 due the addition of ONB branches and an increase in electronic transactions.

Other income increased $176,000 or 51.6% to $517,000 from $341,000 due to the other income from the ONB branches acquired during the third quarter of 2015 and an increase in merchant card processing fees for the quarter.


Following are explanations of the changes in these other income categories for the nine months September 30, 2015 compared to the same period in 2014:

Trust revenues decreased $19,000 or 0.7% to $2,575,000 from $2,594,000. Trust assets, at market value, were $815.0 million at September 30, 2015 compared to $743.8 million at September 30, 2014.

Revenues from brokerage increased $165,000 or 22.1% to $913,000 from $748,000 due to an increase in the number of brokerage accounts from new business development efforts.

Insurance commissions increased $121,000 or 8.4% to $1,568,000 from $1,447,000 due to an increase in contingency income received from carriers based on claims experience and an increase in commission and fee income received during 2015 compared to 2014.

Fees from service charges increased $94,000 or 2.4% to $4,003,000 from $3,909,000 for the nine months ended September 30, 2015 and 2014 primarily due to an increase the additional income from the ONB branches acquired in the third quarter of 2015.

The sale of securities during the nine months ended September 30, 2015 resulted in net securities gains of $231,000 compared to $714,000 during the nine months ended September 30, 2014.

Mortgage banking income increased $108,000 or 24.5% to $549,000 from $441,000. Loans sold balances were as follows:

$43.7 million (representing 348 loans) for the nine months ended of September 30, 2015
$32.0 million (representing 264 loans) for the nine months months ended of September 30, 2014

First Mid Bank generally releases the servicing rights on loans sold into the secondary market.

Revenue from ATMs and debit cards increased $291,000 or 9.9% to $3,224,000 from $2,933,000 due to the ONB Branches acquired in the third quarter of 2015 and an increase in electronic transactions and incentives received from VISA.

Other income increased $195,000 or 17.9% to $1,282,000 from $1,087,000 due to income from the ONB branches acquired during the third quarter of 2015 and an increase in merchant card processing fees.








51




Other Expense

The major categories of other expense include salaries and employee benefits, occupancy and equipment expenses and other operating expenses associated with day-to-day operations.  The following table sets forth the major components of other expense for the three and nine-months ended September 30, 2015 and 2014 (in thousands):
 
Three months ended September 30,
 
Nine months ended September 30,
 
2015
 
2014
 
$ Change
 
2015
 
2014
 
$ Change
Salaries and employee benefits
$
6,522

 
$
6,216

 
$
306

 
$
18,875

 
$
18,323

 
$
552

Net occupancy and equipment expense
2,424

 
2,056

 
368

 
6,329

 
6,319

 
10

Net other real estate owned expense (income)
(1
)
 
41

 
(42
)
 

 
23

 
(23
)
FDIC insurance
236

 
199

 
37

 
641

 
604

 
37

Amortization of intangible assets
155

 
162

 
(7
)
 
466

 
487

 
(21
)
Stationery and supplies
180

 
152

 
28

 
475

 
480

 
(5
)
Legal and professional
660

 
514

 
146

 
1,842

 
1,753

 
89

Marketing and donations
296

 
246

 
50

 
790

 
755

 
35

Other operating expenses
2,410

 
1,504

 
906

 
5,498

 
4,520

 
978

Total other expense
$
12,882

 
$
11,090

 
$
1,792

 
$
34,916

 
$
33,264

 
$
1,652


Following are explanations for the changes in these other expense categories for the three months ended September 30, 2015 compared to the same period in 2014:

Salaries and employee benefits, the largest component of other expense, increased $306,000 to $6,522,000 from $6,216,000.  The increase was primarily due to the addition of 84 employees with the acquisition of twelve ONB branches. There were 499 and 397 full-time equivalent employees at September 30, 2015 and 2014, respectively.

Occupancy and equipment expense increased $368,000 or 17.9% to $2,424,000 from $2,056,000. This increase was primarily due to increases in rent and depreciation expenses related to the acquisition of twelve ONB Branches.

Net other real estate owned expense decreased $42,000 or 102.4% to $(1,000) from $41,000. The decrease in 2015 was primarily due to less losses on properties sold during 2015 compared to properties sold in 2014.

Expense for amortization of intangible assets decreased $7,000 or 4.3% to $155,000 from $162,000 for the nine months ended September 30, 2015 and 2014, respectively. The decrease in intangible amortization expense in 2015 was due to less amortization expense for core deposit intangibles in 2015 compared to 2014.

Other operating expenses increased $906,000 or 60.2% to $2,410,000 in 2015 from $1,504,000 in 2014 primarily due to expenses incurred to complete the acquisition of twelve ONB Branches during the third quarter of 2015 compared to 2014.

On a net basis, all other categories of operating expenses increased $224,000 or 24.6% to $1,136,000 in 2015 from $912,000 in 2014.  The increase was primarily due to an increase in professional expenses.

Following are explanations for the changes in these other expense categories for the nine months ended September 30, 2015 compared to the same period in 2014:

Salaries and employee benefits, the largest component of other expense, increased $552,000 to $18,875,000 from $18,323,000.  The increase was primarily due to the addition of 84 employees with the acquisition of twelve ONB branches. Other contributing factors are merit increases in 2015 for continuing employees, an increase in incentive compensation expense and number of employees added during 2015. There were 499 and 397 full-time equivalent employees at September 30, 2015 and 2014, respectively.

Occupancy and equipment expense increased $10,000 or 0.2% to $6,329,000 from $6,319,000. This increase was primarily due to increases in rent and depreciation expenses related to the acquisition of twelve ONB Branches during the third quarter of 2015.

52




Net other real estate owned expense decreased $23,000 or 100.0% to $0 from $23,000. The decrease in 2015 was primarily due to less losses on properties sold during 2015 compared to properties sold in 2014.

Expense for amortization of intangible assets decreased $21,000 or 4.3% to $466,000 from $487,000 for the nine months ended September 30, 2015 and 2014, respectively. The decrease in intangible amortization expense in 2015 was due to less amortization expense for core deposit intangibles in 2015 compared to 2014.

Other operating expenses increased $978,000 or 21.6% to $5,498,000 in 2015 from $4,520,000 in 2014 primarily due to expenses incurred to complete the acquisition of twelve ONB Branches during the third quarter of 2015.

On a net basis, all other categories of operating expenses increased $119,000 or 4.0% to $3,107,000 in 2015 from $2,988,000 in 2014.  The increase was due to increases in marketing and promotion expenses and legal and professional expenses.


Income Taxes

Total income tax expense amounted to $6.6 million (35.9% effective tax rate) for the nine months ended September 30, 2015, compared to $6.9 million (37.5% effective tax rate) for the same period in 2014. The decline in effective tax rate for 2015 is primarily due to a reduction in the Company's state tax rate, from 9.5% to 7.75% beginning January 1, 2015.

The Company files U.S. federal and state of Illinois income tax returns.  The Company is no longer subject to U.S. federal or state income tax examinations by tax authorities for years before 2012.



53



Analysis of Balance Sheets

Securities

The Company’s overall investment objectives are to insulate the investment portfolio from undue credit risk, maintain adequate liquidity, insulate capital against changes in market value and control excessive changes in earnings while optimizing investment performance.  The types and maturities of securities purchased are primarily based on the Company’s current and projected liquidity and interest rate sensitivity positions.

The following table sets forth the amortized cost of the available-for-sale and held-to-maturity securities as of September 30, 2015 and December 31, 2014 (dollars in thousands):
 
September 30, 2015
 
December 31, 2014
 
Amortized
Cost
 
Weighted
Average
Yield
 
Amortized
Cost
 
Weighted
Average
Yield
U.S. Treasury securities and obligations of U.S. government corporations and agencies
$
176,344

 
1.68
%
 
$
154,874

 
1.72
%
Obligations of states and political subdivisions
95,354

 
3.25
%
 
75,589

 
3.33
%
Mortgage-backed securities: GSE residential
256,836

 
2.44
%
 
193,814

 
2.48
%
Trust preferred securities
3,167

 
1.24
%
 
3,300

 
1.14
%
Other securities
4,035

 
1.28
%
 
4,036

 
1.20
%
Total securities
$
535,736

 
2.32
%
 
$
431,613

 
2.33
%


At September 30, 2015, the Company’s investment portfolio increased by $104.1 million from December 31, 2014 primarily due to purchases of obligations of U.S. government corporations and agencies securities and mortgage-backed securitiesas the company deploys the excess cash received in the acquisition of the ONB Branches.  When purchasing investment securities, the Company considers its overall liquidity and interest rate risk profile, as well as the adequacy of expected returns relative to the risks assumed.

The table below presents the credit ratings as of September 30, 2015 for certain investment securities (in thousands):

 
Amortized Cost
 
Estimated Fair Value
 
Average Credit Rating of Fair Value at June 30, 2015 (1)
 
 
 
AAA
 
AA +/-
 
A +/-
 
BBB +/-
 
< BBB -
 
Not rated
Available-for-sale:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
U.S. Treasury securities and obligations of U.S. government corporations and agencies
$
127,239

 
$
127,451

 
$
349

 
$
127,102

 
$

 
$

 
$

 
$

Obligations of state and political subdivisions
95,354

 
97,501

 
4,626

 
74,909

 
17,135

 


 

 
831

Mortgage-backed securities (2)
256,836

 
259,441

 

 

 

 

 

 
259,441

Trust preferred securities
3,167

 
2,125

 

 

 

 
2,125

 

 

Other securities
4,035

 
4,038

 

 
2,009

 
1,968

 

 

 
61

Total available-for-sale
$
486,631

 
$
490,556

 
$
4,975

 
$
204,020

 
$
19,103

 
$
2,125

 
$

 
$
260,333

Held-to-maturity:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
U.S. Treasury securities and obligations of U.S. government corporations and agencies
$
49,105

 
$
50,030

 
$

 
$
50,030

 
$

 
$

 
$

 
$


(1) Credit ratings reflect the lowest current rating assigned by a nationally recognized credit rating agency.

(2) Mortgage-backed securities include mortgage-backed securities (MBS) and collateralized mortgage obligation (CMO) issues from the following government sponsored enterprises: FHLMC, FNMA, GNMA and FHLB. While MBS and CMOs are no longer explicitly rated by credit rating agencies, the industry recognizes that they are backed by agencies which have an implied government guarantee.

54



The trust preferred securities is one trust preferred pooled security issued by FTN Financial Securities Corp. (“FTN”). The following table contains information regarding the trust preferred security as of September 30, 2015:

Deal name
 
PreTSL XXVIII

Class
 
Mezzanine C-1

Book value
 
$
3,167,000

Fair value
 
$
2,125,000

Unrealized gains/(losses)
 
$
(1,042,000
)
Other-than-temporary impairment recorded in earnings
 
$
1,111,000

Lowest credit rating assigned
 
CCC

Number of performing banks
 
34

Number of issuers in default
 
8

Number of issuers in deferral
 
2

Original collateral
 
$
360,850,000

Actual defaults & deferrals as a % of original collateral
 
15.1
%
Remaining collateral
 
$
340,712,000

Actual defaults & deferrals as a % of remaining collateral
 
16.0
%
Expected defaults & deferrals as a % of remaining collateral
 
41.2
%
Estimated incremental defaults required to break yield
 
$
65,766,000

Performing collateral
 
$
287,395,000

Current balance of class
 
$
34,852,000

Subordination
 
$
268,853,000

Excess subordination
 
$
10,797,000

Excess subordination as a % of remaining performing collateral
 
3.8
%
Discount rate (1)
 
1.62%-4.29%

Expected defaults & deferrals as a % of remaining collateral (2)
 
2% / .36

Recovery assumption (3)
 
10
%
Prepayment assumption (4)
 
1
%

(1) The discount rate for floating rate bonds is a compound interest formula based on the LIBOR forward curve for each payment date

(2) 2% annually for 2 years and 36 basis points annually thereafter

(3) With 2 year lag

(4) Additional assumptions regarding prepayments:
Banks with more than $15 billion in total assets as of 12/31/2009:
(a) For fixed rate TruPS, all securities will be called in one year
(b) For floating rate TruPS, (1) all securities with spreads greater than 250 bps will be called in one year (2) all securities with spreads between 150 bps and 250 bps will be called at a rate of 5% annually (3) all securities with spreads less than 150 bps will be called at a rate of 1% annually
Banks with less than $15 billion in total assets as of 12/31/2009:
(a) For fixed rate TruPS, (1) all securities with coupons greater than 8% that were issued by healthy banks with the capacity to prepay will be called in one year (2) All remaining fixed rate securities will be called at a rate of 1% annually
(b) For floating rate TruPs, all securities will be called at a rate of 1% annually


55



The trust preferred pooled security is a Collateralized Debt Obligation (“CDOs”) backed by a pool of debt securities issued by financial institutions. The collateral consists of trust-preferred securities and subordinated debt securities issued by banks, bank holding companies and insurance companies. Performing collateral is the amount of remaining collateral less the balances of collateral in deferral or default. Subordination is the amount of performing collateral in excess of the current balance of a specified class and all classes senior to the specified class.  Excess subordination is the amount that the performing collateral balance exceeds the current outstanding balance of the specific class, plus all senior classes. It is a static measure of credit enhancement, but does not incorporate all of the structural elements of the security deal. This amount can also be impacted by future defaults and deferrals, deferring balances that cure or redemptions of securities by issuers. A negative excess subordination indicates that the current performing collateral of the security would be insufficient to pay the current principal balance of the class notes after all of the senior classes’ notes were paid. However, the performing collateral balance excludes the collateral of issuers currently deferring their interest payments. Because these issuers are expected to resume payment in the future (within five years of the first deferred interest period), a negative excess subordination does not necessarily mean a class note holder will not receive a greater than projected or even full payment of cash flow at maturity.

At September 30, 2015 and 2014 the Company was receiving “payment in kind” (“PIK”) in lieu of cash interest on its trust preferred security investment as and to the extent described below. The Company’s use of “PIK” does not indicate that additional securities have been issued in satisfaction of any outstanding obligation; rather, it indicates that a coverage test of a class or tranche directly senior to the class in question has failed and interest received on the PIK note is being capitalized, which means the principal balance is being increased. Once the coverage test is met, the capitalized interest will be paid in cash and current cash interest payments will resume.

The Company’s trust preferred security investment allows, under the terms of the issue, for issuers to defer interest for up to five consecutive years. After five years, if not cured, the security is considered to be in default and the trustee may demand payment in full of principal and accrued interest. Issuers are also considered to be in default in the event of the failure of the issuer or a subsidiary. The structuring of the trust preferred security provides for a waterfall approach to absorbing losses whereby lower classes or tranches are initially impacted and more senior tranches are only impacted after lower tranches can no longer absorb losses. Likewise, the waterfall approach also applies to principal and interest payments received, as senior tranches have priority over lower tranches in the receipt of payments. Both deferred and defaulted issuers are considered non-performing, and the trustee calculates, on a quarterly basis, certain coverage tests prior to the payment of cash interest to owners of the various tranches of the securities. The coverage tests are compared to an over-collateralization target that states the balance of performing collateral as a percentage of the tranche balance plus the balance of all senior tranches. The tests must show that performing collateral is sufficient to meet requirements for the senior tranches, both in terms of cash flow and collateral value, before cash interest can be paid to subordinate tranches. As a result of the cash flow waterfall provisions within the structure of the security, when a senior tranche fails its coverage test, all of the cash flows that would have been paid to lower tranches are paid to the senior tranche and recorded as a reduction of the senior tranches’ principal. This principal reduction in the senior tranche continues until the coverage test of the senior tranche is passed or the principal of the tranche is paid in full. For so long as the cash flows are being diverted to the senior tranches, the amount of interest due and payable to the subordinate tranches is capitalized and recorded as an increase in the principal value of the tranche. The Company’s trust preferred security investment is in the mezzanine tranche or class which is subordinate to more senior tranches of the issue. The Company is receiving PIK for this security due to failure of the required senior tranche coverage tests described. This security is projected to remain in PIK status for approximately two more quarters.

The impact of payment of PIK to subordinate tranches is to strengthen the position of the senior tranches by reducing the senior tranches’ principal balances relative to available collateral and cash flow.  The impact to the subordinate tranches is to increase principal balances, decrease cash flow, and increase credit risk to the tranches receiving the PIK. The risk to holders of a security of a tranche in PIK status is that the remaining total cash flow will not be sufficient to repay all principal and capitalized interest related to the investment.

During the fourth quarter of 2010, after analysis of the expected future cash flows and the timing of resumed interest payments, the Company determined that placing the trust preferred security on non-accrual status was the most prudent course of action. The Company stopped all accrual of interest and ceased to capitalize any PIK to the principal balance of the security.  The Company intends to keep the security on non-accrual status until the scheduled interest payments resume on a regular basis and any previously recorded PIK has been paid. The PIK status of the securities, among other factors, indicates potential other-than-temporary impairment (“OTTI”) and accordingly, the Company has performed further detailed analysis of the investments cash flows and the credit conditions of the underlying issuers. This analysis incorporates, among other things, the waterfall provisions and any resulting PIK status of these securities to determine if cash flow will be sufficient to pay all principal and interest due to the investment tranche held by the Company.  


56



See discussion below and Note 3 – Investment Securities in the notes to the financial statements for more detail regarding this analysis. Based on this analysis, the Company believes the amortized costs recorded for the trust preferred security investment accurately reflects the position of the security at September 30, 2015 and December 31, 2014.

Other-than-temporary Impairment of Securities

Declines in the fair value, or unrealized losses, of all available for sale investment securities, are reviewed to determine whether the losses are either a temporary impairment or OTTI. Temporary adjustments are recorded when the fair value of a security fluctuates from its historical cost. Temporary adjustments are recorded in accumulated other comprehensive income, and impact the Company’s equity position. Temporary adjustments do not impact net income. A recovery of available for sale security prices also is recorded as an adjustment to other comprehensive income for securities that are temporarily impaired, and results in a positive impact to the Company’s equity position.

OTTI is recorded when the fair value of an available for sale security is less than historical cost, and it is probable that all contractual cash flows will not be collected. Investment securities are evaluated for OTTI on at least a quarterly basis. In conducting this assessment, the Company evaluates a number of factors including, but not limited to:

how much fair value has declined below amortized cost;
how long the decline in fair value has existed;
the financial condition of the issuers;
contractual or estimated cash flows of the security;
underlying supporting collateral;
past events, current conditions and forecasts;
significant rating agency changes on the issuer; and
the Company’s intent and ability to hold the security for a period of time sufficient to allow for any anticipated recovery in fair value.

If the Company intends to sell the security or if it is more likely than not the Company will be required to sell the security before recovery of its amortized cost basis, the entire amount of OTTI is recorded to noninterest income, and therefore, results in a negative impact to net income. Because the available for sale securities portfolio is recorded at fair value, the conclusion as to whether an investment decline is other-than-temporarily impaired, does not significantly impact the Company’s equity position, as the amount of the temporary adjustment has already been reflected in accumulated other comprehensive income/loss.

If the Company does not intend to sell the security and it is not more-likely-than-not it will be required to sell the security before recovery of its amortized cost basis, only the amount related to credit loss is recognized in earnings.  In determining the portion of OTTI that is related to credit loss, the Company compares the present value of cash flows expected to be collected from the security with the amortized cost basis of the security. The remaining portion of OTTI, related to other factors, is recognized in other comprehensive earnings, net of applicable taxes.

The term “other-than-temporary” is not intended to indicate that the decline is permanent, but indicates that the prospects for a near-term recovery of value are not necessarily favorable, or that there is a general lack of evidence to support a realizable value equal to or greater than the carrying value of the investment. See Note 3 -- Investment Securities in the Notes to Condensed Consolidated Financial Statements (unaudited) for a discussion of the Company’s evaluation and subsequent charges for OTTI.


57



Loans

The loan portfolio (net of unearned interest) is the largest category of the Company’s earning assets.  The following table summarizes the composition of the loan portfolio, including loans held for sale, as of September 30, 2015 and December 31, 2014 (in thousands):
 
September 30, 2015
 
% Outstanding
Loans
 
December 31, 2014
 
% Outstanding
Loans
Construction and land development
$
33,389

 
2.7
%
 
$
21,627

 
2.0
%
Agricultural real estate
120,314

 
9.7
%
 
110,193

 
10.4
%
1-4 Family residential properties
234,777

 
19.0
%
 
181,921

 
17.1
%
Multifamily residential properties
54,932

 
4.4
%
 
53,129

 
5.0
%
Commercial real estate
377,906

 
30.6
%
 
379,604

 
35.8
%
Loans secured by real estate
821,318

 
66.4
%
 
746,474

 
70.3
%
Agricultural loans
65,596

 
5.3
%
 
68,298

 
6.4
%
Commercial and industrial loans
295,335

 
23.9
%
 
223,780

 
21.1
%
Consumer loans
43,304

 
3.5
%
 
15,118

 
1.4
%
All other loans
11,196

 
0.9
%
 
8,736

 
0.8
%
Total loans
$
1,236,749

 
100.0
%
 
$
1,062,406

 
100.0
%


Overall net loans increased $174.3 million, or 16.41%.  The increase was primarily due to loans added in the acquisition of twelve ONB Branches and increases in commercial and industrial loans offset by a decline in commercial real estate loans.  The balance of real estate loans held for sale, included in the balances shown above, amounted to $1,346,000 and $1,958,000 as of September 30, 2015 and December 31, 2014, respectively.

Commercial and commercial real estate loans generally involve higher credit risks than residential real estate and consumer loans. Because payments on loans secured by commercial real estate or equipment are often dependent upon the successful operation and management of the underlying assets, repayment of such loans may be influenced to a great extent by conditions in the market or the economy. The Company does not have any sub-prime mortgages or credit card loans outstanding which are also generally considered to be higher credit risk.

The following table summarizes the loan portfolio geographically by branch region as of September 30, 2015 and December 31, 2014 (dollars in thousands):
 
September 30, 2015
 
December 31, 2014
 
Principal
balance
 
% Outstanding
Loans
 
Principal
balance
 
% Outstanding
loans
Central region
378,505

 
30.5
%
 
368,484

 
34.7
%
Sullivan region
149,549

 
12.1
%
 
153,731

 
14.5
%
Decatur region
286,343

 
23.2
%
 
256,241

 
24.1
%
Peoria region
161,202

 
13.0
%
 
166,056

 
15.6
%
Highland region
110,715

 
9.0
%
 
117,894

 
11.1
%
Southern region
150,435

 
12.2
%
 

 
%
Total all regions
$
1,236,749

 
100.0
%
 
$
1,062,406

 
100.0
%


Loans are geographically dispersed among these regions located in central and southern Illinois. While these regions have experienced some economic stress during 2015 and 2014, the Company does not consider these locations high risk areas since these regions have not experienced the significant declines in real estate values seen in some other areas in the United States.





58




The Company does not have a concentration, as defined by the regulatory agencies, in construction and land development loans or commercial real estate loans as a percentage of total risk-based capital for the periods shown above. At September 30, 2015 and December 31, 2014, the Company did have industry loan concentrations in excess of 25% of total risk-based capital in the following industries (dollars in thousands):
 
September 30, 2015
 
December 31, 2014
 
Principal
balance
 
% Outstanding
Loans
 
Principal
balance
 
% Outstanding
Loans
Other grain farming
$
154,824

 
12.52
%
 
$
155,136

 
14.60
%
All Other General Merchandise Stores (1)
41,732

 
3.37
%
 
46,169

 
4.35
%
Lessors of non-residential buildings
106,896

 
8.64
%
 
96,508

 
9.08
%
Lessors of residential buildings & dwellings
68,018

 
5.50
%
 
65,781

 
6.19
%
Hotels and motels
60,496

 
4.89
%
 
56,546

 
5.32
%

(1) Not a concentration as of September 30, 2015, but shown for comparative purposes due to concentration at December 31, 2014.

The Company had no further industry loan concentrations in excess of 25% of total risk-based capital.

The following table presents the balance of loans outstanding as of September 30, 2015, by contractual maturities (in thousands):
 
Maturity (1)
 
One year
or less(2)
 
Over 1 through
5 years
 
Over
5 years
 
Total
Construction and land development
$
30,325

 
$
2,222

 
$
842

 
$
33,389

Agricultural real estate
6,304

 
53,252

 
60,758

 
120,314

1-4 Family residential properties
19,704

 
83,109

 
131,964

 
234,777

Multifamily residential properties
5,710

 
18,802

 
30,420

 
54,932

Commercial real estate
34,605

 
239,354

 
103,947

 
377,906

Loans secured by real estate
96,648

 
396,739

 
327,931

 
821,318

Agricultural loans
49,386

 
15,603

 
607

 
65,596

Commercial and industrial loans
129,467

 
116,408

 
49,460

 
295,335

Consumer loans
3,415

 
26,484

 
13,405

 
43,304

All other loans
1,604

 
2,000

 
7,592

 
11,196

Total loans
$
280,520

 
$
557,234

 
$
398,995

 
$
1,236,749


(1) Based upon remaining contractual maturity.
(2) Includes demand loans, past due loans and overdrafts.

As of September 30, 2015, loans with maturities over one year consisted of approximately $845.6 million in fixed rate loans and approximately $110.6 million in variable rate loans.  The loan maturities noted above are based on the contractual provisions of the individual loans.  The Company has no general policy regarding renewals and borrower requests, which are handled on a case-by-case basis.



59



Nonperforming Loans and Nonperforming Other Assets

Nonperforming loans include: (a) loans accounted for on a nonaccrual basis; (b) accruing loans contractually past due ninety days or more as to interest or principal payments; and (c) loans not included in (a) and (b) above which are defined as “troubled debt restructurings”. Repossessed assets include primarily repossessed real estate and automobiles.

The Company’s policy is to discontinue the accrual of interest income on any loan for which principal or interest is ninety days past due.  The accrual of interest is discontinued earlier when, in the opinion of management, there is reasonable doubt as to the timely collection of interest or principal.  Once interest accruals are discontinued, accrued but uncollected interest is charged against current year income. Subsequent receipts on non-accrual loans are recorded as a reduction of principal, and interest income is recorded only after principal recovery is reasonably assured. Nonaccrual loans are returned to accrual status when, in the opinion of management, the financial position of the borrower indicates there is no longer any reasonable doubt as to the timely collection of interest or principal.

Restructured loans are loans on which, due to deterioration in the borrower’s financial condition, the original terms have been modified in favor of the borrower or either principal or interest has been forgiven. Repossessed assets represent property acquired as the result of borrower defaults on loans. These assets are recorded at estimated fair value, less estimated selling costs, at the time of foreclosure or repossession.  Write-downs occurring at foreclosure are charged against the allowance for loan losses. On an ongoing basis, properties are appraised as required by market indications and applicable regulations. Write-downs for subsequent declines in value are recorded in non-interest expense in other real estate owned along with other expenses related to maintaining the properties.

The following table presents information concerning the aggregate amount of nonperforming loans and repossessed assets at September 30, 2015 and December 31, 2014 (in thousands):
 
September 30,
2015
 
December 31,
2014
Nonaccrual loans
$
2,967

 
$
4,105

Restructured loans which are performing in accordance with revised terms
544

 
435

Total nonperforming loans
3,511

 
4,540

Repossessed assets
320

 
263

Total nonperforming loans and repossessed assets
$
3,831

 
$
4,803

Nonperforming loans to loans, before allowance for loan losses
0.33
%
 
0.43
%
Nonperforming loans and repossessed assets to loans, before allowance for loan losses
0.36
%
 
0.45
%

The $1,138,000 decrease in nonaccrual loans during 2015 resulted from the net of $1,429,000 of loans put on nonaccrual status, offset by $2,416,000 of loans becoming current or paid-off, $74,000 of loans transferred to other real estate and 77,000 of loans charged off. The following table summarizes the composition of nonaccrual loans (in thousands):
 
September 30, 2015
 
December 31, 2014
 
Balance
 
% of Total
 
Balance
 
% of Total
Construction and land development
$
148

 
5.0
%
 
$
785

 
19.1
%
Agricultural real estate
25

 
0.8
%
 
29

 
0.7
%
1-4 Family residential properties
814

 
27.4
%
 
878

 
21.4
%
Multifamily Residential properties
323

 
10.9
%
 

 
%
Commercial real estate
738

 
24.9
%
 
2,074

 
50.5
%
Loans secured by real estate
2,048

 
69.0
%
 
3,766

 
91.7
%
Commercial and industrial loans
696

 
23.5
%
 
332

 
8.1
%
Consumer loans
223

 
7.5
%
 
7

 
0.2
%
Total loans
$
2,967

 
100.0
%
 
$
4,105

 
100.0
%


Interest income that would have been reported if nonaccrual and restructured loans had been performing totaled $49,000 and $44,000 for the nine months ended September 30, 2015 and 2014, respectively.

60



The $57,000 increase in repossessed assets during the first nine months of 2015 resulted from the net of $178,000 of additional assets repossessed and $114,000 of repossessed assets sold, and a $7,000 write-down of one repossessed asset. The following table summarizes the composition of repossessed assets (in thousands):
 
September 30, 2015
 
December 31, 2014
 
Balance
 
% of Total
 
Balance
 
% of Total
Construction and land development
$
200

 
62.5
%
 
$
201

 
76.4
%
1-4 family residential properties
120

 
37.5
%
 
62

 
23.6
%
Total repossessed collateral
$
320

 
100.0
%
 
$
263

 
100.0
%


Repossessed assets sold during the first nine months of 2015 resulted in net gains of $33,000, of which $32,000 was related to real estate asset sales and $1,000 was related to other repossessed assets. Repossessed assets sold during 2014 resulted in net gains of $41,000, all of which was related to real estate asset sales.


Loan Quality and Allowance for Loan Losses

The allowance for loan losses represents management’s estimate of the reserve necessary to adequately account for probable losses existing in the current portfolio. The provision for loan losses is the charge against current earnings that is determined by management as the amount needed to maintain an adequate allowance for loan losses.  In determining the adequacy of the allowance for loan losses, and therefore the provision to be charged to current earnings, management relies predominantly on a disciplined credit review and approval process that extends to the full range of the Company’s credit exposure.  The review process is directed by overall lending policy and is intended to identify, at the earliest possible stage, borrowers who might be facing financial difficulty.  Once identified, the magnitude of exposure to individual borrowers is quantified in the form of specific allocations of the allowance for loan losses.  Management considers collateral values and guarantees in the determination of such specific allocations.  Additional factors considered by management in evaluating the overall adequacy of the allowance include historical net loan losses, the level and composition of nonaccrual, past due and renegotiated loans, trends in volumes and terms of loans, effects of changes in risk selection and underwriting standards or lending practices, lending staff changes, concentrations of credit, industry conditions and the current economic conditions in the region where the Company operates.

Given the current state of the economy, management did assess the impact of the recession on each category of loans and adjusted historical loss factors for more recent economic trends. Management utilizes a five-year loss history as one of several components in assessing the probability of inherent future losses. Given the continued weakened economic conditions, management also increased its allocation to various loan categories for economic factors during 2015 and 2014. Some of the economic factors include the potential for reduced cash flow for commercial operating loans from reduction in sales or increased operating costs, decreased occupancy rates for commercial buildings, reduced levels of home sales for commercial land developments, the uncertainty regarding grain prices, drought conditions and increased operating costs for farmers, and increased levels of unemployment and bankruptcy impacting consumer’s ability to pay. Each of these economic uncertainties was taken into consideration in developing the level of the reserve. Management considers the allowance for loan losses a critical accounting policy.

Management recognizes there are risk factors that are inherent in the Company’s loan portfolio.  All financial institutions face risk factors in their loan portfolios because risk exposure is a function of the business.  The Company’s operations (and therefore its loans) are concentrated in east central Illinois, an area where agriculture is the dominant industry.  Accordingly, lending and other business relationships with agriculture-based businesses are critical to the Company’s success. At September 30, 2015, the Company’s loan portfolio included $186.0 million of loans to borrowers whose businesses are directly related to agriculture. Of this amount, $154.8 million was concentrated in other grain farming. Total loans to borrowers whose businesses are directly related to agriculture increased $7.5 million from $178.5 million at December 31, 2014 while loans concentrated in other grain farming decreased $0.3 million from $155.1 million at December 31, 2014.  

While the Company adheres to sound underwriting practices, including collateralization of loans, any extended period of low commodity prices, drought conditions, significantly reduced yields on crops and/or reduced levels of government assistance to the agricultural industry could result in an increase in the level of problem agriculture loans and potentially result in loan losses within the agricultural portfolio.


61



In addition, the Company has $60.5 million of loans to motels and hotels.  The performance of these loans is dependent on borrower specific issues as well as the general level of business and personal travel within the region.  While the Company adheres to sound underwriting standards, a prolonged period of reduced business or personal travel could result in an increase in nonperforming loans to this business segment and potentially in loan losses. The Company also has $106.9 million of loans to lessors of non-residential buildings and $68.0 million of loans to lessors of residential buildings and dwellings.

The structure of the Company’s loan approval process is based on progressively larger lending authorities granted to individual loan officers, loan committees, and ultimately the Board of Directors.  Outstanding balances to one borrower or affiliated borrowers are limited by federal regulation; however, limits well below the regulatory thresholds are generally observed.  The vast majority of the Company’s loans are to businesses located in the geographic market areas served by the Company’s branch bank system.  Additionally, a significant portion of the collateral securing the loans in the portfolio is located within the Company’s primary geographic footprint.  In general, the Company adheres to loan underwriting standards consistent with industry guidelines for all loan segments.

The Company minimizes credit risk by adhering to sound underwriting and credit review policies.  Management and the board of directors of the Company review these policies at least annually.  Senior management is actively involved in business development efforts and the maintenance and monitoring of credit underwriting and approval.  The loan review system and controls are designed to identify, monitor and address asset quality problems in an accurate and timely manner.  On a quarterly basis, the board of directors and management review the status of problem loans and determine a best estimate of the allowance.  In addition to internal policies and controls, regulatory authorities periodically review asset quality and the overall adequacy of the allowance for loan losses.


62



Analysis of the allowance for loan losses as of September 30, 2015 and 2014, and of changes in the allowance for the three and nine month periods ended September 30, 2015 and 2014, is as follows (dollars in thousands):

 
Three months ended September 30,
 
Nine months ended September 30,
 
2015
 
2014
 
2015
 
2014
Average loans outstanding, net of unearned income
$
1,151,089

 
$
1,033,991

 
$
1,084,184

 
$
1,010,767

Allowance-beginning of period
13,931

 
13,681

 
13,682

 
13,249

Charge-offs:
 
 
 
 
 
 
 
Real estate-mortgage
23

 
41

 
122

 
110

Commercial, financial & agricultural
175

 
11

 
187

 
19

Installment
4

 
1

 
258

 
18

Other
68

 
80

 
174

 
168

Total charge-offs
270

 
133

 
741

 
315

Recoveries:
 

 
 

 
 

 
 

Real estate-mortgage
2

 
62

 
178

 
109

Commercial, financial & agricultural
45

 
9

 
87

 
65

Installment
5

 
4

 
21

 
19

Other
34

 
38

 
112

 
83

Total recoveries
86

 
113

 
398

 
276

Net charge-offs (recoveries)
184

 
20

 
343

 
39

Provision for loan losses
481

 
44

 
889

 
495

Allowance-end of period
$
14,228

 
$
13,705

 
$
14,228

 
$
13,705

Ratio of annualized net charge-offs to average loans
0.06
%
 
0.01
%
 
0.13
%
 
0.01
%
Ratio of allowance for loan losses to loans outstanding (less unearned interest at end of period)
1.15
%
 
1.32
%
 
1.15
%
 
1.32
%
Ratio of allowance for loan losses to nonperforming loans
405
%
 
284
%
 
405
%
 
284
%


The ratio of allowance for loan losses to loans outstanding was 1.15% as of September 30, 2015 compared to 1.32% as of September 30, 2014. The decrease in the ratio is primarily due to $152 million of additional loans added from the ONB Branch acquisition that were all performing loans. Therefore no additional provision for loan losses was recorded for these loans. The ratio of the allowance for loan losses to nonperforming loans is 405% as of September 30, 2015 compared to 284% as of September 30, 2014.  The increase in this ratio is primarily due to the decline in nonperforming loans to $3.5 million at September 30, 2015 from $4.8 million at September 30, 2014. During the first nine months of 2015, the Company had net charge offs of $343,000 compared to net charge offs of $39,000 in 2014. There was significant charge off of one commercial loan of $149,000 and was one significant charge off of one consumer loan of $251,000 during the first nine months of 2015. There were no significant charge offs during the first nine months of 2014.


63



Deposits

Funding of the Company’s earning assets is substantially provided by a combination of consumer, commercial and public fund deposits.  The Company continues to focus its strategies and emphasis on retail core deposits, the major component of funding sources.  The following table sets forth the average deposits and weighted average rates for the nine months ended September 30, 2015 and 2014 and for the year ended December 31, 2014 (dollars in thousands):
 
Nine Months Ended September 30, 2015
 
Nine months ended September 30, 2014
 
Year ended December 31, 2014
 
Average
Balance
 
Weighted
Average
Rate
 
Average
Balance
 
Weighted
Average
Rate
 
Average
Balance
 
Weighted
Average
Rate
Demand deposits:
 
 
 
 
 
 
 
 
 
 
 
Non-interest-bearing
$
242,421

 
%
 
$
224,396

 
%
 
$
223,505

 
%
Interest-bearing
617,543

 
0.11
%
 
557,811

 
0.12
%
 
559,168

 
0.12
%
Savings
290,048

 
0.14
%
 
283,527

 
0.13
%
 
281,185

 
0.13
%
Time deposits
210,332

 
0.56
%
 
230,405

 
0.57
%
 
229,763

 
0.56
%
Total average deposits
$
1,360,344

 
0.17
%
 
$
1,296,139

 
0.18
%
 
$
1,293,621

 
0.18
%


The following table sets forth the high and low month-end balances for the nine months ended September 30, 2015 and 2014 and for the year ended December 31, 2014 (in thousands):
 
Nine months ended
September 30, 2015
 
Nine months ended September 30, 2014
 
Year ended
December 31, 2014
High month-end balances of total deposits
$
1,741,079

 
$
1,305,825

 
$
1,305,825

Low month-end balances of total deposits
1,266,199

 
1,279,569

 
1,265,058



During the first nine months of 2015, the average balance of deposits increased by $66.7 million from the average balance for the year ended December 31, 2014. Average non-interest bearing deposits increased by $18.9 million, average interest bearing balances increased by $58.4 million, savings account balances increased $8.9 million and balances of time deposits decreased $19.4 million due to higher rate customer CDs that matured and were not renewed and brokered CDs that were not replaced. These increases were primarily the result of deposit balances acquired in acquisition of twelve ONB Branches.

Balances of time deposits of $100,000 or more include time deposits maintained for public fund entities and consumer time deposits. The following table sets forth the maturity of time deposits of $100,000 or more at September 30, 2015 and December 31, 2014 (in thousands):

 
September 30, 2015
 
December 31, 2014
3 months or less
$
35,518

 
$
35,604

Over 3 through 6 months
10,871

 
15,270

Over 6 through 12 months
18,563

 
21,710

Over 12 months
27,961

 
25,861

Total
$
92,913

 
$
98,445




64



Repurchase Agreements and Other Borrowings

Securities sold under agreements to repurchase are short-term obligations of First Mid Bank.  First Mid Bank collateralizes these obligations with certain government securities that are direct obligations of the United States or one of its agencies.  First Mid Bank offers these retail repurchase agreements as a cash management service to its corporate customers.  Other borrowings consist of Federal Home Loan Bank (“FHLB”) advances, federal funds purchased, loans (short-term or long-term debt) that the Company has outstanding and junior subordinated debentures.

Information relating to securities sold under agreements to repurchase and other borrowings as of September 30, 2015 and December 31, 2014 is presented below (dollars in thousands):
 
September 30, 2015
 
December 31, 2014
Securities sold under agreements to repurchase
$
108,499

 
$
121,869

Federal Home Loan Bank advances:
 

 
 

Fixed term – due in one year or less
5,000

 

Fixed term – due after one year
15,000

 
20,000

Junior subordinated debentures
20,620

 
20,620

Total
$
149,119

 
$
162,489

Average interest rate at end of period
0.95
%
 
0.54
%
Maximum outstanding at any month-end:
 
 
 
Securities sold under agreements to repurchase
$
122,022

 
$
121,869

Federal Home Loan Bank advances:
 

 
 

Fixed term – due in one year or less
10,000

 
10,000

Fixed term – due after one year
20,000

 
20,000

Debt:
 

 
 

Debt due in one year or less
2,000

 

Junior subordinated debentures
20,620

 
20,620

Averages for the period (YTD):
 

 
 

Securities sold under agreements to repurchase
$
116,443

 
$
97,478

Federal funds purchased
190

 
16

Federal Home Loan Bank advances:
 

 
 
Fixed term – due in one year or less
5,641

 
1,520

Fixed term – due after one year
18,590

 
13,055

Debt:
 

 
 

Loans due in one year or less
630

 
101

Junior subordinated debentures
20,620

 
20,620

Total
$
162,114

 
$
132,790

Average interest rate during the period
0.34
%
 
0.30
%


Securities sold under agreements to repurchase decreased $13.4 million during the first nine months of 2015 primarily due to the seasonal declines in balances of various customers. FHLB advances represent borrowings by First Mid Bank to economically fund loan demand.  









65



At September 30, 2015 the fixed term advances consisted of $20 million as follows:

$5 million advance with a 10-year maturity, at 4.58%, due July 14, 2016, one year lockout, callable quarterly
$5 million advance with a 6-year maturity, at 2.30%, due August 24, 2020
$5 million advance with a 7-year maturity, at 2.55% due October 1, 2021
$5 million advance with a 8-year maturity, at 2.40% due January 9, 2023

The Company is party to a revolving credit agreement with The Northern Trust Company in the amount of $15 million. The balance on this line of credit was $0 as of September 30, 2015. This loan was renewed on April 17, 2015 for one year as a revolving credit agreement with a maximum available balance of $15 million. The interest rate is floating at 2.25% over the federal funds rate (2.38% at September 30, 2015). The loan is unsecured and subject to a borrowing agreement containing requirements for the Company and First Mid Bank, including requirements for operating and capital ratios. The Company and its subsidiary bank were in compliance with the then existing covenants at September 30, 2015 and 2014 and December 31, 2014.

On February 27, 2004, the Company completed the issuance and sale of $10 million of floating rate trust preferred securities through First Mid-Illinois Statutory Trust I (“Trust I”), a statutory business trust and wholly-owned unconsolidated subsidiary of the Company, as part of a pooled offering.  The Company established Trust I for the purpose of issuing the trust preferred securities. The $10 million in proceeds from the trust preferred issuance and an additional $310,000 for the Company’s investment in common equity of Trust I, a total of $10,310 000, was invested in junior subordinated debentures of the Company.  The underlying junior subordinated debentures issued by the Company to Trust I mature in 2034, bear interest at three-month London Interbank Offered Rate (“LIBOR”) plus 280 basis points (3.14% and 3.09% at September 30, 2015 and December 31, 2014), reset quarterly, and are callable at par, at the option of the Company, quarterly. The Company used the proceeds of the offering for general corporate purposes.

On April 26, 2006, the Company completed the issuance and sale of $10 million of fixed/floating rate trust preferred securities through First Mid-Illinois Statutory Trust II (“Trust II”), a statutory business trust and wholly-owned unconsolidated subsidiary of the Company, as part of a pooled offering.  The Company established Trust II for the purpose of issuing the trust preferred securities. The $10 million in proceeds from the trust preferred issuance and an additional $310,000 for the Company’s investment in common equity of Trust II, a total of $10,310 000, was invested in junior subordinated debentures of the Company.  The underlying junior subordinated debentures issued by the Company to Trust II mature in 2036, bore interest at a fixed rate of 6.98% paid quarterly until June 15, 2011 and then converted to floating rate (LIBOR plus 160 basis points) after June 15, 2011 (1.94% and 1.84% at and September 30, 2015 and December 31, 2014, respectively). The net proceeds to the Company were used for general corporate purposes, including the Company’s acquisition of Mansfield Bancorp, Inc. in 2006.

The trust preferred securities issued by Trust I and Trust II are included as Tier 1 capital of the Company for regulatory capital purposes.  On March 1, 2005, the Federal Reserve Board adopted a final rule that allows the continued limited inclusion of trust preferred securities in the calculation of Tier 1 capital for regulatory purposes.  The final rule provided a five-year transition period, ending September 30, 2010, for application of the revised quantitative limits. On March 17, 2009, the Federal Reserve Board adopted an additional final rule that delayed the effective date of the new limits on inclusion of trust preferred securities in the calculation of Tier 1 capital until March 31, 2012. The application of the revised quantitative limits did not and is not expected to have a significant impact on its calculation of Tier 1 capital for regulatory purposes or its classification as well-capitalized. The Dodd-Frank Act, signed into law July 21, 2010, removes trust preferred securities as a permitted component of a holding company’s Tier 1 capital after a three-year phase-in period beginning January 1, 2013 for larger holding companies. For holding companies with less than $15 billion in consolidated assets, existing issues of trust preferred securities are grandfathered and not subject to this new restriction. Similarly, the final rule implementing the Basel III reforms allows holding companies with less than $15 billion in consolidated assets as of December 31, 2009 to continue to count toward Tier 1 capital any trust preferred securities issued before May 19, 2010. New issuances of trust preferred securities, however would not count as Tier 1 regulatory capital.

In addition to requirements of the Dodd-Frank Act discussed above, the act also required the federal banking agencies to adopt rules that prohibit banks and their affiliates from engaging in proprietary trading and investing in and sponsoring certain unregistered investment companies (defined as hedge funds and private equity funds). This rule is generally referred to as the “Volcker Rule.” On December 10, 2013, the federal banking agencies issued final rules to implement the prohibitions required by the Volcker Rule. Following the publication of the final rule, and in reaction to concerns in the banking industry regarding the adverse impact the final rule’s treatment of certain collateralized debt instruments has on community banks, the federal banking agencies approved an interim final rule to permit banking entities to retain interests in certain collateralized debt

66



obligations backed primarily by trust preferred securities. Under the interim final rule, the agencies permit the retention of an interest in or sponsorship of covered funds by banking entities under $15 billion in assets if (1) the collateralized debt obligation was established and issued prior to May 19, 2010, (2) the banking entity reasonably believes that the offering proceeds received by the collateralized debt obligation were invested primarily in qualifying trust preferred collateral, and (3) the banking entity’s interests in the collateralized debt obligation was acquired on or prior to December 10, 2013.  Although the Volcker Rule impacts many large banking entities, the Company does not currently anticipate that the Volcker Rule will have a material effect on the operations of the Company or First Mid Bank.


Interest Rate Sensitivity

The Company seeks to maximize its net interest margin while maintaining an acceptable level of interest rate risk.  Interest rate risk can be defined as the amount of forecasted net interest income that may be gained or lost due to changes in the interest rate environment, a variable over which management has no control. Interest rate risk, or sensitivity, arises when the maturity or repricing characteristics of interest-bearing assets differ significantly from the maturity or repricing characteristics of interest-bearing liabilities. The Company monitors its interest rate sensitivity position to maintain a balance between rate sensitive assets and rate sensitive liabilities.  This balance serves to limit the adverse effects of changes in interest rates.  The Company’s asset liability management committee (ALCO) oversees the interest rate sensitivity position and directs the overall allocation of funds.

In the banking industry, a traditional way to measure potential net interest income exposure to changes in interest rates is through a technique known as “static GAP” analysis which measures the cumulative differences between the amounts of assets and liabilities maturing or repricing at various intervals. By comparing the volumes of interest-bearing assets and liabilities that have contractual maturities and repricing points at various times in the future, management can gain insight into the amount of interest rate risk embedded in the balance sheet.


67



The following table sets forth the Company’s interest rate repricing GAP for selected maturity periods at September 30, 2015 (dollars in thousands):
 
Rate Sensitive Within
 
Fair Value
 
1 year
 
1-2 years
 
2-3 years
 
3-4 years
 
4-5 years
 
Thereafter
 
Total
 
Interest-earning assets:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Federal funds sold and other interest-bearing deposits
$
174,386

 
$

 
$

 
$

 
$

 
$

 
$
174,386

 
$
174,386

Certificates of deposit investments
$
12,681

 
$
249

 
$

 
$

 
$

 
$

 
$
12,930

 
$
12,952

Taxable investment securities
62

 
349

 
5,021

 
36,705

 
57,279

 
342,744

 
442,160

 
443,085

Nontaxable investment securities

 
459

 
1,026

 
416

 
1,898

 
93,702

 
97,501

 
97,501

Loans
548,351

 
213,108

 
187,185

 
112,814

 
92,739

 
82,552

 
1,236,749

 
1,248,278

Total
$
735,480


$
214,165


$
193,232


$
149,935


$
151,916


$
518,998


$
1,963,726


$
1,976,202

Interest-bearing liabilities:
 
 
 

 
 

 
 

 
 

 
 

 
 

 
 

Savings and NOW accounts
$
196,947

 
$
42,460

 
$
44,154

 
$
62,790

 
$
64,742

 
$
384,914

 
$
796,007

 
$
796,006

Money market accounts
311,848

 
3,096

 
3,182

 
4,128

 
4,214

 
22,275

 
348,743

 
348,743

Other time deposits
182,657

 
32,122

 
22,062

 
9,332

 
8,577

 
1,154

 
255,904

 
256,029

Short-term borrowings/debt
108,499

 

 

 

 

 

 
108,499

 
108,526

Long-term borrowings/debt
25,620

 

 

 

 
5,000

 
10,000

 
40,620

 
33,255

Total
$
825,571

 
$
77,678

 
$
69,398

 
$
76,250

 
$
82,533

 
$
418,343

 
$
1,549,773

 
$
1,542,559

Rate sensitive assets – rate sensitive liabilities
$
(90,091
)
 
$
136,487

 
$
123,834

 
$
73,685

 
$
69,383

 
$
110,655

 
$
413,953

 
 

Cumulative GAP
$
(90,091
)
 
$
46,396

 
$
170,230

 
$
243,915

 
$
313,298

 
$
413,953

 
 

 
 

Cumulative amounts as % of total Rate sensitive assets
(4.6
)%
 
7.0
%
 
6.3
%
 
3.8
%
 
3.5
%
 
5.1
%
 
 
 
 
Cumulative Ratio
(4.6
)%
 
2.4
%
 
8.7
%
 
12.4
%
 
16.0
%
 
21.1
%
 
 
 
 


The static GAP analysis shows that at September 30, 2015, the Company was liability sensitive, on a cumulative basis, through the twelve-month time horizon. This indicates that future increases in interest rates could have an adverse effect on net interest income.

There are several ways the Company measures and manages the exposure to interest rate sensitivity, including static GAP analysis.  The Company’s ALCO also uses other financial models to project interest income under various rate scenarios and prepayment/extension assumptions consistent with First Mid Bank’s historical experience and with known industry trends.  ALCO meets at least monthly to review the Company’s exposure to interest rate changes as indicated by the various techniques and to make necessary changes in the composition terms and/or rates of the assets and liabilities.  The Company is currently experiencing downward pressure on asset yields resulting from the extended period of historically low interest rates and heightened competition for loans. A continuation of this environment could result in a decline in interest income and the net interest margin.

68






Capital Resources

At September 30, 2015, the Company’s stockholders' equity had increased $38.9 million, or 23.6%, to $203.8 million from $164.9 million as of December 31, 2014. The increase resulted primarily from the private placement capital raise completed during the second quarter of 2015 which resulted in an additional common equity of $29.3 million. Also during the first nine months of 2015, net income contributed $11.9 million to equity before the payment of dividends to stockholders. The change in market value of available-for-sale investment securities increased stockholders' equity by $2.7 million, net of tax and additional purchases of treasury stock (52,145 shares at an average cost of $19.37 per share) decreased stockholders’ equity by approximately $1 million.

The Company is subject to various regulatory capital requirements administered by the federal banking agencies.  Bank holding companies follow minimum regulatory requirements established by the Board of Governors of the Federal Reserve System (“Federal Reserve System”), and First Mid Bank follows similar minimum regulatory requirements established for national banks by the Office of the Comptroller of the Currency (“OCC”).  Failure to meet minimum capital requirements can initiate certain mandatory and possibly additional discretionary action by regulators that, if undertaken, could have a direct material effect on the Company’s financial statements. Quantitative measures established by regulatory capital standards to ensure capital adequacy require the the Company and its subsidiary bank to maintain a minimum capital amounts and ratios (set forth in the table below). Management believes that, as of September 30, 2015 and December 31, 2014, the Company and First Mid Bank met all capital adequacy requirements.

To be categorized as well-capitalized, total risk-based capital, Tier 1 risk-based capital, common equity Tier 1 risk-based capital and Tier 1 leverage ratios must be maintained as set forth in the following table (dollars in thousands):

69



 
Actual
 
Required Minimum For Capital Adequacy Purposes
 
To Be Well-Capitalized Under Prompt Corrective Action Provisions
 
Amount
 
Ratio
 
Amount
 
Ratio
 
Amount
 
Ratio
September 30, 2015
 
 
 
 
 
 
 
 
 
 
 
Total Capital (to risk-weighted assets)
 
 
 
 
 
 
 
 
 
 
 
Company
$
202,743

 
14.88
%
 
$
108,982

 
> 8.00%
 
N/A

 
N/A
First Mid Bank
193,666

 
14.30

 
108,312

 
> 8.00
 
$
135,391

 
> 10.00%
Tier 1 Capital (to risk-weighted assets)
 

 
 

 
 

 
 
 
 

 
 
Company
188,515

 
13.84

 
81,737

 
> 6.00
 
N/A

 
N/A
First Mid Bank
179,438

 
13.25

 
81,234

 
> 6.00
 
108,312

 
> 8.00
Common Equity Tier 1 Capital (to risk-weighted assets)
 
 

 
 
 
 

 
 
Company
141,115

 
10.36

 
61,302

 
> 4.50
 
N/A

 
N/A
First Mid Bank
179,438

 
13.25

 
60,926

 
> 4.50
 
88,004

 
> 6.50
Tier 1 Capital (to average assets)
 

 
 

 
 

 
 
 
 

 
 
Company
188,515

 
10.21

 
73,824

 
> 4.00
 
N/A

 
N/A
First Mid Bank
179,438

 
9.76

 
73,535

 
> 4.00
 
91,919

 
> 5.00
December 31, 2014
 

 
 

 
 
 
 
 
 

 
 
Total Capital (to risk-weighted assets)
 

 
 

 
 

 
 
 
 

 
 
Company
$
180,678

 
15.60
%
 
$
92,675

 
> 8.00%
 
N/A

 
N/A
First Mid Bank
172,991

 
15.02

 
92,110

 
> 8.00
 
$
115,137

 
> 10.00%
Tier 1 Capital (to risk-weighted assets)
 

 
 
 
 

 
 
 
 

 
 
Company
166,996

 
14.42

 
46,338

 
> 4.00
 
N/A

 
N/A
First Mid Bank
159,309

 
13.84

 
46,055

 
> 4.00
 
69,082

 
> 6.00
Tier 1 Capital (to average assets)
 

 
 

 
 

 
 
 
 

 
 
Company
166,996

 
10.52

 
63,493

 
> 4.00
 
N/A

 
N/A
First Mid Bank
159,309

 
10.08

 
63,210

 
> 4.00
 
79,012

 
> 5.00



The Company's risk-weighted assets, capital and capital ratios for September 30, 2015 are computed in accordance with Basel III capital rules which were effective January 1, 2015. Prior periods are computed following previous rules. See heading "Basel III" in the Overview section of this report for a more detailed description of the Basel III rules. As of September 30, 2015, both the Company and First Mid Bank had capital ratios above the required minimums for regulatory capital adequacy,  and First Mid Bank had capital ratios that qualified it for treatment as well-capitalized under the regulatory framework for prompt corrective action with respect to banks.  The decrease in capital ratios from December 31, 2014 is primarily due to additional assets from the acquisition partially offset by the capital raise completed by the Company during the second quarter of 2015.


Stock Plans

Participants may purchase Company stock under the following four plans of the Company: the Deferred Compensation Plan, the First Retirement and Savings Plan, the Dividend Reinvestment Plan, and the SI Plan.  For more detailed information on these plans, refer to the Company’s Annual Report on Form 10-K for the year ended December 31, 2014.

At the Annual Meeting of Stockholders held May 23, 2007, the stockholders approved the SI Plan.  The SI Plan was implemented to succeed the Company’s 1997 Stock Incentive Plan, which had a ten-year term that expired October 21, 2007. The SI Plan is intended to provide a means whereby directors, employees, consultants and advisors of the Company and its Subsidiaries may sustain a sense of proprietorship and personal involvement in the continued development and financial success of the Company and its Subsidiaries, thereby advancing the interests of the Company and its stockholders.  Accordingly, directors and selected employees, consultants and advisors may be provided the opportunity to acquire shares of Common Stock of the Company on the terms and conditions established in the SI Plan.

On September 27, 2011, the Board of Directors passed a resolution relating to the SI Plan whereby they authorized and approved the Executive Long-Term Incentive Plan (“LTIP”). The LTIP was implemented to provide methodology for granting Stock Awards and Stock Unit Awards to select senior executives of the Company or any Subsidiary.

A maximum of 300,000 shares of common stock may be issued under the SI Plan.  As of September 30, 2015, the Company had awarded 59,500 shares as stock options under the SI plan. There were no stock options granted in 2015 or 2014.  The Company awarded 16,604 shares and 14,770 shares during 2015 and 2014, respectively, as 50% Stock Awards and 50% Stock Unit Awards under the SI plan.
 

Stock Repurchase Program

Since August 5, 1998, the Board of Directors has approved repurchase programs pursuant to which the Company may repurchase a total of approximately $76.7 million of the Company’s common stock.  The repurchase programs approved by the Board of Directors are as follows:

On August 5, 1998, repurchases of up to 3%, or $2 million, of the Company’s common stock.
In March 2000, repurchases up to an additional 5%, or $4.2 million of the Company’s common stock.
In September 2001, repurchases of $3 million of additional shares of the Company’s common stock.
In August 2002, repurchases of $5 million of additional shares of the Company’s common stock.
In September 2003, repurchases of $10 million of additional shares of the Company’s common stock.
On April 27, 2004, repurchases of $5 million of additional shares of the Company’s common stock.
On August 23, 2005, repurchases of $5 million of additional shares of the Company’s common stock.
On August 22, 2006, repurchases of $5 million of additional shares of the Company’s common stock.
On February 27, 2007, repurchases of $5 million of additional shares of the Company’s common stock.
On November 13, 2007, repurchases of $5 million of additional shares of the Company’s common stock.
On December 16, 2008, repurchases of $2.5 million of additional shares of the Company’s common stock.
On May 26, 2009, repurchases of $5 million of additional shares of the Company’s common stock.
On February 22, 2011, repurchases of $5 million of additional shares of the Company’s common stock.
On November 13, 2012, repurchases of $5 million of additional shares of the Company's common stock.
On November 19, 2013, repurchases of $5 million additional shares of the Company's common stock.
On October 28, 2014, repurchases of $5 million additional shares of the Company's common stock.



70



During the nine months ended September 30, 2015, the Company repurchased 52,145 shares at a total cost of approximately $1,041,000. Since 1998, the Company has repurchased a total of 2,041,892 shares at a total price of approximately $69,509,000.  As of September 30, 2015, the Company is authorized per all repurchase programs to purchase $7,198,000 in additional shares.


Liquidity

Liquidity represents the ability of the Company and its subsidiaries to meet all present and future financial obligations arising in the daily operations of the business.  Financial obligations consist of the need for funds to meet extensions of credit, deposit withdrawals and debt servicing.  The Company’s liquidity management focuses on the ability to obtain funds economically through assets that may be converted into cash at minimal costs or through other sources. The Company’s other sources of cash include overnight federal fund lines, Federal Home Loan Bank advances, deposits of the State of Illinois, the ability to borrow at the Federal Reserve Bank of Chicago, and the Company’s operating line of credit with The Northern Trust Company.  Details for the sources include:

First Mid Bank has $35 million available in overnight federal fund lines, including $10 million from U.S. Bank, N.A., $10 million from Wells Fargo Bank, N.A. and $15 million from The Northern Trust Company.  Availability of the funds is subject to First Mid Bank meeting minimum regulatory capital requirements for total capital to risk-weighted assets and Tier 1 capital to total average assets.  As of September 30, 2015, First Mid Bank met these regulatory requirements.

First Mid Bank can borrow from the Federal Home Loan Bank as a source of liquidity.  Availability of the funds is subject to the pledging of collateral to the Federal Home Loan Bank.  Collateral that can be pledged includes one-to-four family residential real estate loans and securities.  At September 30, 2015, the excess collateral at the FHLB would support approximately $126.0 million of additional advances.

First Mid Bank is a member of the Federal Reserve System and can borrow funds provided that sufficient collateral is pledged.

In addition, as of September 30, 2015, the Company had a revolving credit agreement in the amount of $15 million with The Northern Trust Company with an outstanding balance of $0 million and $15 million in available funds.  This loan was renewed on April 17, 2015 for one year as a revolving credit agreement. The interest rate is floating at 2.25% over the federal funds rate. The loan is unsecured and subject to a borrowing agreement containing requirements for the Company and First Mid Bank, including requirements for operating and capital ratios. The Company and its subsidiary bank were in compliance with the then existing covenants at September 30, 2015 and 2014 and December 31, 2014.

Management continues to monitor its expected liquidity requirements carefully, focusing primarily on cash flows from:

lending activities, including loan commitments, letters of credit and mortgage prepayment assumptions;
deposit activities, including seasonal demand of private and public funds;
investing activities, including prepayments of mortgage-backed securities and call provisions on U.S. Treasury and government agency securities; and
operating activities, including scheduled debt repayments and dividends to stockholders.















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The following table summarizes significant contractual obligations and other commitments at September 30, 2015 (in thousands):
 
Total
 
Less than
1 year
 
1-3 years
 
3-5 years
 
More than
5 years
Time deposits
$
255,904

 
$
175,525

 
$
56,722

 
$
22,400

 
$
1,257

Debt
20,620

 

 

 

 
20,620

Other borrowings
128,499

 
113,499

 
15,000

 

 

Operating leases
44,333

 
2,375

 
4,543

 
3,792

 
33,623

Supplemental retirement
732

 
100

 
200

 
132

 
300

 
$
450,088

 
$
291,499

 
$
76,465

 
$
26,324

 
$
55,800


For the nine months ended September 30, 2015, net cash of $12.3 million, 137.9 million and $13.6 million was provided from operating activities, investing activities, and financing activities, respectively. In total, cash and cash equivalents increased by $163.7 million since year-end 2014.


Off-Balance Sheet Arrangements

First Mid Bank enters into financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of its customers.  These financial instruments include lines of credit, letters of credit and other commitments to extend credit.  Each of these instruments involves, to varying degrees, elements of credit, interest rate and liquidity risk in excess of the amounts recognized in the consolidated balance sheets.  The Company uses the same credit policies and requires similar collateral in approving lines of credit and commitments and issuing letters of credit as it does in making loans. The exposure to credit losses on financial instruments is represented by the contractual amount of these instruments. However, the Company does not anticipate any losses from these instruments.

The off-balance sheet financial instruments whose contract amounts represent credit risk at September 30, 2015 and December 31, 2014 were as follows (in thousands):
 
September 30, 2015
 
December 31, 2014
Unused commitments and lines of credit:
 
 
 
Commercial real estate
$
39,175

 
$
32,927

Commercial operating
162,790

 
133,884

Home equity
33,070

 
23,285

Other
59,434

 
47,498

Total
$
294,469

 
$
237,594

Standby letters of credit
$
7,465

 
$
5,193


The increase in 2015 was primarily due to additional outstanding commitments resulting from the acquisition of the twelve ONB Branches. Commitments to originate credit represent approved commercial, residential real estate and home equity loans that generally are expected to be funded within ninety days.  Lines of credit are agreements by which the Company agrees to provide a borrowing accommodation up to a stated amount as long as there is no violation of any condition established in the loan agreement.  Both commitments to originate credit and lines of credit generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since many of the lines and some commitments are expected to expire without being drawn upon, the total amounts do not necessarily represent future cash requirements.

Standby letters of credit are conditional commitments issued by the Company to guarantee the financial performance of customers to third parties.  Standby letters of credit are primarily issued to facilitate trade or support borrowing arrangements and generally expire in one year or less.  The credit risk involved in issuing letters of credit is essentially the same as that involved in extending credit facilities to customers.  The maximum amount of credit that would be extended under letters of credit is equal to the total off-balance sheet contract amount of such instrument.


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ITEM 3.  QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

There has been no material change in the market risk faced by the Company since December 31, 2014.  For information regarding the Company’s market risk, refer to the Company’s Annual Report on Form 10-K for the year ended December 31, 2014.


ITEM 4.  CONTROLS AND PROCEDURES

The Company’s management, with the participation of the Company’s Chief Executive Officer and Chief Financial Officer, evaluated the effectiveness of the Company’s “disclosure controls and procedures” (as such term is defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act), as of the end of the period covered by this report.  Based on such evaluation, such officers have concluded that, as of the end of the period covered by this report, the Company’s disclosure controls and procedures are effective.  Further, there have been no changes in the Company’s internal control over financial reporting during the last fiscal quarter that have materially affected or that are reasonably likely to affect materially the Company’s internal control over financial reporting.



PART II

ITEM 1.
LEGAL PROCEEDINGS

None.


ITEM 1A.  RISK FACTORS

Various risks and uncertainties, some of which are difficult to predict and beyond the Company’s control, could negatively impact the Company.  As a financial institution, the Company is exposed to interest rate risk, liquidity risk, credit risk, operational risk, risks from economic or market conditions, and general business risks among others.  Adverse experience with these or other risks could have a material impact on the Company’s financial condition and results of operations, as well as the value of its common stock.  See the risk factors and “Supervision and Regulation” described in the Company’s Annual Report on Form 10-K for the year ended December 31, 2014 and in the Company's Quarterly Report on Form 10-Q for the quarter ended June 30, 2015.


ITEM 2.
UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
ISSUER PURCHASES OF EQUITY SECURITIES
Period
(a) Total Number of Shares Purchased
 
(b) Average Price Paid per Share
 
(c) Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs
 
(d) Approximate Dollar Value of Shares that May Yet Be Purchased Under the Plans or Programs
July 1, 2015 - July 31, 2015
0
 
$0.00
 
0
 
$
7,276,000

August 1, 2015 - August 31, 2015
3,600
 
$21.74
 
3,600
 
$
7,198,000

September 1, 2015 - September 30, 2015
1
 
$17.00
 
1
 
$
7,198,000

Total
3,601
 
$19.37
 
3,601
 
$
7,198,000


See heading “Stock Repurchase Program” for more information regarding stock purchases.



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ITEM 3.
DEFAULTS UPON SENIOR SECURITIES

None.

ITEM 4.
MINE SAFETY DISCLOSURES

Not applicable.

ITEM 5.
OTHER INFORMATION

None.

ITEM 6.
EXHIBITS

The exhibits required by Item 601 of Regulation S-K and filed herewith are listed in the Exhibit Index that follows the Signature Page and that immediately precedes the exhibits filed.


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SIGNATURES



Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.




FIRST MID-ILLINOIS BANCSHARES, INC.
(Registrant)

Date:  December 16, 2015


Joseph R. Dively
President and Chief Executive Officer

Michael L. Taylor
Chief Financial Officer






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Exhibit Index to Quarterly Report on Form 10-Q/A
Exhibit Number
Description and Filing or Incorporation Reference
2.1
First Amendment to Branch Purchase and Assumption Agreement between First Mid-Illinois Bank & Trust, N.A. and Old National Bank, dated August 14, 2015 (incorporated by reference to Exhibit 2.2 to the Company's Current Report on Form 8-K/A filed October 23, 2015).
 
 
4.1
The Registrant agrees to furnish to the Commission, upon request, a copy of each instrument with respect to issues of long-term debt involving a total amount which does not exceed 10% of the total assets of the Registrant and its subsidiaries on a consolidated basis
 
 
11.1
Statement re:  Computation of Earnings Per Share (Filed herewith on page 14)
 
 
31.1
Certification pursuant to section 302 of the Sarbanes-Oxley Act of 2002
 
 
31.2
Certification pursuant to section 302 of the Sarbanes-Oxley Act of 2002
 
 
32.1
Certification pursuant to 18 U.S.C. section 1350, as adopted pursuant to section 906 of the Sarbanes-Oxley Act of 2002
 
 
32.2
Certification pursuant to 18 U.S.C. section 1350, as adopted pursuant to section 906 of the Sarbanes-Oxley Act of 2002
 
 
101 *
The following materials from the Company’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2015, formatted in XBRL (Extensible Business Reporting Language): (i) the Consolidated Balance Sheets at September 30, 2015 and December 31, 2014, (ii) the Consolidated Statements of Income for the three and nine months ended September 30, 2015 and 2014, (iii) the Consolidated Statements of Cash Flows for the nine months ended September 30, 2015 and 2014, and (iv) the Notes to Consolidated Financial Statements.

* Exhibit 101 is being filed solely to correct the number of shares issued as of September 30, 2015 as described in the Explanatory Note to this Form 10-Q/A.


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