UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
FORM 10-K
 
(Mark One)
þ
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the Fiscal Year Ended December 31, 2013
 
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 001-35750
 
 
First Internet Bancorp
 
 
(Exact Name of Registrant as Specified in its Charter)
 
 
Indiana
 
20-348991
(State or other jurisdiction of
 
(I.R.S. Employer
incorporation or organization)
 
Identification No.)
 
 
 
8888 Keystone Crossing, Suite 1700
 
 
Indianapolis, Indiana
 
46240
(Address of principal executive offices)
 
(Zip Code)
 
(317) 532-7900
(Registrant’s telephone number, including area code)
 
Securities registered pursuant to Section 12(b) of the Act:                 Common Stock, without par value
 
Securities registered pursuant to Section 12(g) of the Act:                 None
 
Indicate by check mark whether the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act of 1933.                                                                                                                                                 Yes ¨ No þ
 
Indicate by check mark whether the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934.                                                                                                                       Yes ¨ No þ
 
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act 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 þ    No ¨
 
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or such shorter period that the registrant was required to submit and post such files).    Yes þ No ¨
 
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.                                           þ
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company (as defined in Rule 12b-2 of the Exchange Act).
 
Large Accelerated Filer ¨
Accelerated Filer ¨
 
 
Non-accelerated Filer ¨ (Do not check if a smaller reporting company)
Smaller Reporting Company þ
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ No þ
 
The aggregate market value of common stock held by non-affiliates of the registrant as of June 28, 2013, the last business day of the registrant’s most recently completed second fiscal quarter, was approximately $53.39 million, based on the closing sale price for the registrant’s common stock on that date. For purposes of determining this number, all officers and directors of the registrant are considered to be affiliates of the registrant. This number is provided only for the purpose of this report and does not represent an admission by either the registrant or any such person as to the status of such person.
 
As of March 28, 2014, the registrant had 4,449,619 shares of common stock issued and outstanding.
 
Documents Incorporated By Reference
 
Portions of our Proxy Statement for the annual meeting of shareholders to be held on May 19, 2014 are incorporated by reference in Part III.
 
 
 
Forward-Looking Statements
  
This annual report on Form 10-K contains "forward-looking statements" within the meaning of the federal securities laws.  These statements are not historical facts, rather statements based on First Internet Bancorp’s (“we,” “our,” “us” or the “Company”) current expectations regarding its business strategies, intended results and future performance. Forward-looking statements are generally preceded by terms such as “expects,” “believes,” “anticipates,” “intends” and similar expressions. Such statements are subject to certain risks and uncertainties including: failures or interruptions in our information systems; growth in our commercial lending activities; declines in market values of our investments; technological obsolescence; our possible need for additional capital resources in the future; competition; loss of key members of management; fluctuations in interest rates; inadequate allowance for loan losses; risks relating to consumer lending; our dependence on capital distributions from the First Internet Bank of Indiana (the "Bank"); our ability to maintain growth in our mortgage lending business; a decline in the mortgage loan markets or real estate markets; risks associated with the regulation of financial institutions; and changes in regulatory capital requirements. Additional factors that may affect our results include those discussed in this report under the heading “Risk Factors” and in other reports filed with the Securities and Exchange Commission (the "SEC"). The Company cautions readers not to place undue reliance on any such forward-looking statements, which speak only as of the date made. The factors listed above could affect the Company’s financial performance and could cause the Company’s actual results for future periods to differ materially from any opinions or statements expressed with respect to future periods in any current statements.
 
Except as required by law, the Company does not undertake, and specifically disclaims any obligation, to publicly release the result of any revisions that may be made to any forward-looking statements to reflect events or circumstances after the date of such statements or to reflect the occurrence of anticipated or unanticipated events.
 
 
(i)

 
PART I
 
Item 1. Business
  
General
 
                First Internet Bancorp is a bank holding company that conducts its business activities through its wholly-owned subsidiary, First Internet Bank, an Indiana chartered bank. The Bank was the first state-chartered, FDIC-insured Internet bank. We offer a full complement of products and services on a nationwide basis. We conduct our deposit operations primarily over the Internet and have no branch offices.
 
                The Bank commenced banking operations in 1999 and grew organically in the consumer market in its early years by adding new customers, products and capabilities through its Internet-based platform. The Company was incorporated under the laws of the State of Indiana on September 15, 2005. On March 21, 2006, we consummated a plan of exchange by which we acquired all of the outstanding shares of the Bank. In 2007, we acquired Indianapolis-based Landmark Financial Corporation. The acquisition merged Landmark Savings Bank, FSB, into the Bank. The Landmark acquisition added a turnkey retail mortgage lending operation that we then expanded on a nationwide basis through our Internet platform. Since then, we have added commercial real estate (CRE) lending, including a nationwide credit tenant lease financing program, and commercial and industrial (C&I) lending, including asset based lending and business banking/treasury management services to meet the needs of high-quality, under-served commercial borrowers and depositors. Our commercial banking activities are highly dependent on establishing and maintaining strong relationships with our business customers.
 
As of December 31, 2013, we had total assets of $802.34  million, total liabilities of $711.43  million, and shareholders’ equity of $90.91 million.
 
Our principal office is located at 8888 Keystone Crossing, Suite 1700, Indianapolis, Indiana 46240. Our website is www.firstinternetbancorp.com.
 
Business Strategies
 
Our business model is significantly different from that of a typical community bank. We do not have a conventional brick and mortar branch system; rather, we operate through our scalable Internet banking platform. The market area for our residential real estate lending, consumer lending, and deposit gathering activities is the entire United States. We also offer credit tenant lease financing on a nationwide basis. Our other commercial lending activities, including CRE loans and C&I loans, corporate credit cards and corporate treasury management services, are offered by our commercial banking team to businesses primarily within a one hundred mile radius of our corporate headquarters. The commercial banking market in central Indiana is primarily composed of larger regional and community banks. We have no significant customer concentrations within our loan portfolio.
 
Performance
 
Growth.  Total assets have increased 59.00% from $504.62 million at December 31, 2009 to $802.34 million at December 31, 2013. This increase was driven by strong organic growth. During the same time period, total net loans increased from $305.44 million to $495.73 million and deposits increased from $411.63 million to $673.10 million, increases of 62.30% and 63.52%, respectively. Our sustained growth profile is the result of our flexible and highly scalable Internet banking strategy that allows us to target a broad reach of customers across 50 states. Additionally, key strategic commercial banking hires have enabled us to further expand our product offerings on both a local and national basis. At December 31, 2013, CRE and C&I loans comprised 39.82% of the loan portfolio, excluding residential mortgage loans held for sale, compared to 7.73% at December 31, 2009.
 
Earnings Trend.  We have generated positive net income for the last four years.  Net income amounted to $4.59 million for the year ended December 31, 2013.
  
Asset Quality.  At December 31, 2013, our nonperforming assets to total assets was 0.90% and our allowance for loan losses to total loans receivable was 1.09%. We have maintained a high quality loan portfolio due to our emphasis on a strong credit culture, conservative underwriting standards, and a diverse national and local customer base.
 
 
1

 
Strategic Focus
 
We operate on a national basis through our scalable Internet banking platform to gather deposits and offer residential mortgage and consumer lending products rather than relying on a conventional brick and mortar branch system. We also conduct commercial banking and related activities, primarily on a local basis. Our overriding strategic focus is enhancing franchise and shareholder value. We believe the continued creation of franchise and shareholder value will be driven by profitable growth in consumer and commercial banking, effective underwriting, strong asset quality and efficient technology-driven operations.
 
                National Focus on Deposit and Consumer Banking Growth. Our first product offerings were basic deposit accounts, certificates of deposit, electronic bill pay and credit cards. Within 90 days of opening, we had accounts with consumers in all 50 states. Over the years, we added secured consumer loans, lines of credit, home equity loans and single-family mortgages. Our footprint for deposit gathering and these consumer lending activities is the entire nation. With the use of our Internet-based technology platform, we do not face geographic boundaries that traditional banks must overcome for customer acquisition. Armed with smart phones and tablet computers, our customers can access our online banking system, bill pay, and remote deposit capture 24 hours a day, seven days a week, on a real time basis. In addition, we have seven dedicated banking specialists who can service customer needs via telephone, email or online chat. We intend to continue to expand our deposit base by leveraging technology and marketing. The average size of our customers' checking account at December 31, 2013 was $13,000, nearly four times the national average.
 
                Commercial Banking Growth. Over the past three years, we have diversified our operations by adding commercial banking to complement our consumer platform. We offer CRE loans, credit tenant leases, C&I loans, including asset based lending and corporate credit cards to commercial businesses. Our commercial lending teams consist of seasoned commercial bankers, most of whom have had extensive careers with larger money center, super-regional or regional banks. These lenders have developed long-term, core relationships with a consistent base of commercial borrowers. During 2013, we introduced a treasury management product to capture the deposit side of these commercial relationships. We are continuing to develop new products and services for this market that will produce additional loan interest income as well as non-interest income. We also intend to grow and expand our commercial banking platform by hiring additional seasoned loan officers and relationship managers.  In October 2013, we added asset based lending to our commercial offerings and in January 2014, we opened a loan production office in our existing Tempe, Arizona location.
 
                Experience. Our management team and our Board of Directors are integral to our success. Our management team and Board of Directors are led by David B. Becker, the founder of First Internet Bank of Indiana. Mr. Becker is a seasoned business executive and entrepreneur with over three decades of management experience in the financial services and financial technology space, and has served as our Chief Executive Officer since 2005. Mr. Becker has been the recipient of numerous business awards, including Ernst & Young Entrepreneur of the Year in 2002, and is an inductee to the Central Indiana Business Hall of Fame. Our Chief Financial Officer, Kay E. Whitaker, brings over 20 years of experience in the financial services industry, most recently as the CFO of Central Indiana Community Foundation (“CICF”) from 2007 to 2012. At CICF, Ms. Whitaker provided financial oversight for 800 philanthropic funds and 165 investment accounts across multiple portfolios, and was named 2012 CFO of the Year in the not-for-profit sector by the Indianapolis Business Journal. Ms. Whitaker also brings over 15 years of accounting experience with PriceWaterhouseCoopers focused on financial institutions. The senior management team is complemented by a dedicated Board of Directors with a wide range of experience from careers in financial services, legal, regulatory, and industrial services.
 
The leaders of our lending teams and members of their staff are highly seasoned, career bankers who bring deep banking knowledge and relationships from regional, super-regional or money center banks. Our management team has a wealth of banking knowledge from a wide variety of backgrounds which gives us significant market insight and allows us to leverage their comprehensive, long-term customer relationships. We organize our lending teams as follows: Commercial and Industrial, Commercial Real Estate, Consumer, and Mortgage Banking. The C&I team has twelve members and the CRE team has eight members. The Consumer team has four lenders and the Residential Mortgage Banking team has 26 loan producers and 34 support staff. We will continue to search for seasoned bankers who can add new lending verticals and sources of noninterest income.
  
                Profitability. We intend to continue to leverage our technology, our long-term commercial relationships and our noninterest income sources to drive profitability. As we continue to grow, we believe that our model will produce a better efficiency ratio than more traditional community banks, with a goal of higher returns on assets and equity.
 
 
2

 
                Maintain Asset Quality, Diversified Loan Portfolio and Effective Underwriting. We place an emphasis on our strong credit culture and strict underwriting standards of diverse loan products to maintain our excellent credit quality. Our loan portfolio is diversified with a low level of construction loans. At December 31, 2013, the loan portfolio consisted of 28.70% CRE, 11.12% C&I, 21.68% consumer, and 38.50% residential real estate loans. Our Chief Credit Officer has approximately twenty-five years of experience with a major regional bank and joined us in August 2012. Our Compliance Officer has approximately thirty years of banking and compliance experience.
 
                Efficiency Through Technology. To date, we have pursued growth in a prudent and disciplined fashion. We will continue to monitor our efficiency ratio and intend to invest in and utilize technology to compete more effectively as we grow in the future. Through our online account access services, augmented by our team of dedicated banking specialists, we can satisfy all of the needs of our retail and commercial customers in an efficient manner. Our data processing systems run on a “real-time” basis, unlike many banks that run a “batch system”, so customers benefit from an up-to-the-minute picture of their financial position-particularly our commercial customers, who complete numerous transactions in a single day. 
 
Scalable Platform.  We believe we have built a scalable banking infrastructure based upon technology rather than a branch network, and that our Internet banking processes are capable of supporting continued growth while improving operational efficiencies. We believe our support team has the ability to meet our consumer loan and deposit base growth without significant additional hires.
 
Expand Market Share Through Disciplined Acquisition Strategy.  We may expand on an opportunistic basis, primarily as a means of securing additional asset generation.
 
Lending Activities
 
Residential Mortgage Lending.  We offer first-lien residential mortgage loans in 50 states and second-lien (home equity) loans as well as home equity lines of credit in 47 states. We offer loans for homebuyers (purchase money) as well as existing homeowners who wish to refinance their current loans. The low interest rate environment in recent years has made refinancing an attractive opportunity for homeowners. Approximately 70% of the loans we originated in 2013 were refinances. We have increased the proportion of purchase money loans leveraging our existing technology platform, as this will provide a reliable stream of business in a rising rate environment.
 
We attract credit-worthy loan applicants through disciplined online lead generation efforts and through repeat business from past customers. We track our acquisition costs vigilantly and discontinue any lead sources that are not contributing to a positive margin. We use customer relationship management tools to track prospects and identify the most likely sales opportunities on which to focus our efforts. For 2013, the weighted average credit score of our mortgage customer was 772 at the time of origination.
 
We currently sell the vast majority of our conforming conventional (fixed rate) loans to the secondary market and thereby avoid the potential interest rate risk of these loans. We retain variable rate non-conforming (jumbo) loans in our portfolio. As rates rise, we will have the opportunity to retain conforming conventional loans on an opportunistic basis.
 
We also actively promote home equity loans and lines of credit through our Internet channel, leveraging our robust yet easy-to-use customer-facing toolset. We continue to expand our efforts to complement our first-lien product.
 
Consumer Lending.  While we offer consumer loans and credit cards through our website to a nationwide consumer base, the majority of our consumer loans have been acquired through indirect dealer networks, primarily horse trailers and recreational vehicles (RVs). In recent years, we expanded our recreational product dealer network and implemented a new loan origination system to improve the customer experience and document tracking.
  
Commercial Real Estate (CRE) Lending. We have a team of eight full-time employees in CRE lending, most with large regional bank experience. We expect that the majority of our CRE loans will be in office, retail, industrial, single family residential development and construction, and multi-family loans in the Midwest, with credit tenant lease financing on a nationwide basis. While many banks in Central Indiana must address legacy problem CRE loans in their portfolios, we are in a position to meet pent-up demand from qualified borrowers.  At December 31, 2013, $142.43 million, or 28.70% of our loan portfolio consisted of CRE loans.
 
We believe our CRE portfolio will continue its growth in two ways: (1) regionally, in more traditional short and intermediate-term financing arrangements supporting local developers and conventional property types (office, retail, multi-family, industrial, residential development & construction) as well as (2) nationally, where we will concentrate on longer term financing of properties occupied by single tenants committed to long-term leases with borrowers providing significant cash equity in relation to the debt structured.
 
 
3

 
Commercial and Industrial (C&I) Lending. Historically, we only originated C&I loans occasionally as a result of referrals we received from customers and third parties. We began focusing on C&I loan originations in the Central Indiana area in late 2011. In 2013, we expanded our commercial lending capabilities by beginning a new division that offers asset based lending services.  Operating under the name First Internet Bank Business Capital, the new division provides working capital to small-to-medium sized companies.  The asset based lending group provides revolving lines of credit backed by accounts receivable and inventory as well as term loans backed by real estate and equipment.
 
We currently have a C&I team of twelve full-time employees, most with large regional bank experience and strong local relationships. The recent increase in our C&I lending activity is intended to further diversify our lending portfolio and increase opportunities for new business. In addition to commercial loan originations, C&I lending activity can result in new deposits, including fee income from treasury management products, and opportunities to cross-sell other products such as residential mortgage loans and consumer home equity and installment loans. New C&I customers (and their advisors) also serve as referral sources for additional new business opportunities.  In order to attract deposits from C&I borrowers (which diversifies our deposit mix and reduces our cost of funds) and to enhance our non-interest income, we began offering expanded online account access and treasury management service capabilities during 2013.  In 2013, commercial deposits grew to $16.17 million.
 
Loan Portfolio Analysis
 
(dollars in thousands)
 
December 31,
 
 
 
2013
 
2012
 
2011
 
2010
 
2009
 
Real estate loans:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Residential
 
$
191,007
 
38.50
%
$
128,815
 
36.34
%
$
143,452
 
43.24
%
$
106,729
 
35.30
%
$
80,781
 
26.02
%
Commercial
 
 
142,429
 
28.70
%
 
84,918
 
23.95
%
 
43,507
 
13.11
%
 
19,563
 
6.47
%
 
20,212
 
6.51
%
Total real estate loans
 
 
333,436
 
67.20
%
 
213,733
 
60.29
%
 
186,959
 
56.35
%
 
126,292
 
41.77
%
 
100,993
 
32.53
%
Commercial loans
 
 
55,168
 
11.12
%
 
14,271
 
4.03
%
 
2,063
 
0.62
%
 
4,919
 
1.63
%
 
3,779
 
1.22
%
Consumer loans
 
 
107,562
 
21.68
%
 
126,486
 
35.68
%
 
142,783
 
43.03
%
 
171,122
 
56.60
%
 
205,702
 
66.25
%
 
 
 
496,166
 
100.00
%
 
354,490
 
100.00
%
 
331,805
 
100.00
%
 
302,333
 
100.00
%
 
310,474
 
100.00
%
Less:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Net deferred loan fees,
    premiums and discounts
 
 
4,987
 
 
 
 
3,671
 
 
 
 
3,421
 
 
 
 
4,057
 
 
 
 
5,062
 
 
 
Allowance for losses
 
 
(5,426)
 
 
 
 
(5,833)
 
 
 
 
(5,656)
 
 
 
 
(6,845)
 
 
 
 
(10,097)
 
 
 
Total net loans
 
$
495,727
 
 
 
$
352,328
 
 
 
$
329,570
 
 
 
$
299,545
 
 
 
$
305,439
 
 
 
   
Loan Maturities
 
The following table shows the contractual maturity distribution intervals of the outstanding loans in our portfolio as of December 31, 2013.
 
(dollars in thousands)
 
Real Estate
 
 
 
 
 
 
 
 
 
 
 
 
Residential
 
Commercial
 
Commercial
 
Consumer
 
Total
 
Amounts due in:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
One year or less
 
$
8,011
 
$
12,086
 
$
8,620
 
$
2,017
 
$
30,734
 
More than one to two years
 
 
7,904
 
 
1,576
 
 
939
 
 
1,392
 
$
11,811
 
More than two to three years
 
 
2,158
 
 
11,952
 
 
6,163
 
 
4,659
 
$
24,932
 
More than three to five years
 
 
661
 
 
37,011
 
 
11,746
 
 
15,070
 
$
64,488
 
More than five to ten years
 
 
1,088
 
 
73,686
 
 
27,700
 
 
69,402
 
$
171,876
 
More than ten to fifteen years
 
 
4,675
 
 
5,397
 
 
—
 
 
15,022
 
$
25,094
 
More than fifteen years
 
 
166,510
 
 
721
 
 
—
 
 
—
 
$
167,231
 
Total
 
$
191,007
 
$
142,429
 
$
55,168
 
$
107,562
 
$
496,166
 
 
 
4

 
Fixed vs. Adjustable Rate Loans
 
The following table shows the distribution of the outstanding loans in our portfolio between those with variable or floating interest rates and those with fixed or predetermined interest rates as of December 31, 2013.
 
(dollars in thousands)
 
Due after December 31, 2013
 
 
 
Fixed
 
Adjustable
 
Total
 
Real estate loans:
 
 
 
 
 
 
 
 
 
 
Residential
 
$
16,070
 
$
174,937
 
$
191,007
 
Commercial
 
 
101,454
 
 
40,975
 
$
142,429
 
Total real estate loans
 
 
117,524
 
 
215,912
 
$
333,436
 
Commercial loans
 
 
43,499
 
 
11,669
 
$
55,168
 
Consumer loans
 
 
106,431
 
 
1,131
 
$
107,562
 
Total loans
 
$
267,454
 
$
228,712
 
$
496,166
 

Loan Activity
 
The following table shows loan activity for the years ended December 31, 2013 and 2012.
 
(dollars in thousands)
 
Year ended December 31,
 
 
 
2013
 
2012
 
Total loans at beginning of period:
 
$
354,490
 
$
331,805
 
 
 
 
 
 
 
 
 
Loans originated:
 
 
 
 
 
 
 
Real estate loans:
 
 
 
 
 
 
 
Residential
 
 
22,235
 
 
4,775
 
Commercial
 
 
62,242
 
 
35,861
 
Commercial loans
 
 
21,236
 
 
7,467
 
Consumer loans
 
 
16,741
 
 
24,572
 
Total loans originated
 
 
122,454
 
 
72,675
 
 
 
 
 
 
 
 
 
Loans Purchased(1):
 
 
 
 
 
 
 
Real estate loans:
 
 
 
 
 
 
 
Residential
 
 
59,254
 
 
—
 
Commercial
 
 
—
 
 
8,877
 
Commercial loans
 
 
21,892
 
 
—
 
Consumer loans
 
 
—
 
 
—
 
Total loans purchased
 
 
81,146
 
 
8,877
 
 
 
 
 
 
 
 
 
Add (Deduct):
 
 
 
 
 
 
 
Principal repayments
 
 
(60,149)
 
 
(52,055)
 
Net other
 
 
(1,775)
 
 
(6,812)
 
 
 
 
 
 
 
 
 
Net loan activity
 
 
141,676
 
 
22,685
 
Total loans at end of period
 
$
496,166
 
$
354,490
 
 
 
(1) Excludes premiums paid or discounts received.
 
 
 
5

 
Nonperforming Assets
 
Loans are reviewed at least quarterly and any loan whose collectability is doubtful is placed on nonaccrual status. Loans are placed on nonaccrual status when either principal or interest is 90 days or more past due, unless, in the judgment of management, the loan is well collateralized and in the process of collection. Interest accrued and unpaid at the time a loan is placed on nonaccrual status is charged against interest income. Subsequent payments are either applied to the outstanding principal balance or recorded as interest income, depending on the assessment of the ultimate collectability of the loan. Restructured loans include troubled debt restructurings that involved forgiving a portion of interest or principal or making loans at a rate materially less than the market rate to borrowers whose financial condition had deteriorated. Foreclosed and repossessed assets include assets acquired in the settlement of loans. The following table sets forth the amounts and categories of nonperforming assets in our portfolio as of the dates indicated.
  
(dollars in thousands)
 
December 31,
 
 
 
2013
 
2012
 
2011
 
2010
 
2009
 
Nonaccrual loans(1):
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Real estate loans:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Residential
 
$
630
 
$
1,389
 
$
876
 
$
2,841
 
$
3,388
 
Commercial
 
 
1,054
 
 
2,362
 
 
7,523
 
 
3,593
 
 
5,186
 
Total real estate loans
 
 
1,684
 
 
3,751
 
 
8,399
 
 
6,434
 
 
8,574
 
Commercial loans
 
 
—
 
 
—
 
 
—
 
 
1,539
 
 
—
 
Consumer loans
 
 
150
 
 
155
 
 
224
 
 
683
 
 
1,726
 
Total nonaccrual loans
 
 
1,834
 
 
3,906
 
 
8,623
 
 
8,656
 
 
10,300
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Accruing loans past due 90 days or more:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Real estate loans:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Residential
 
 
—
 
 
450
 
 
75
 
 
—
 
 
47
 
Commercial
 
 
—
 
 
—
 
 
—
 
 
900
 
 
—
 
Total real estate loans
 
 
—
 
 
450
 
 
75
 
 
900
 
 
47
 
Commercial loans
 
 
—
 
 
—
 
 
—
 
 
—
 
 
—
 
Consumer loans
 
 
18
 
 
21
 
 
56
 
 
30
 
 
72
 
Total accruing loans past due 90 days or more
 
 
18
 
 
471
 
 
131
 
 
930
 
 
119
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Total nonperforming loans
 
 
1,852
 
 
4,377
 
 
8,754
 
 
9,586
 
 
10,419
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Real estate owned:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Residential
 
 
368
 
 
265
 
 
448
 
 
591
 
 
126
 
Commercial
 
 
4,013
 
 
3,401
 
 
1,064
 
 
1,616
 
 
—
 
Total real estate owned
 
 
4,381
 
 
3,666
 
 
1,512
 
 
2,207
 
 
126
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Other nonperforming assets
 
 
956
 
 
2,253
 
 
3,113
 
 
5,118
 
 
2,164
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Total nonperforming assets
 
 
7,189
 
 
10,296
 
 
13,379
 
 
16,911
 
 
12,709
 
Troubled debt restructurings not included in nonaccruals
 
 
1,243
 
 
1,412
 
 
1,086
 
 
360
 
 
—
 
Troubled debt restructurings and total
    nonperforming assets
 
$
8,432
 
$
11,708
 
$
14,465
 
$
17,271
 
$
12,709
 
 
 (1) Includes nonperforming troubled debt restructurings.
 
6

 
(dollars in thousands)
 
December 31,
 
 
 
2013
 
 
2012
 
 
2011
 
 
2010
 
 
2009
 
Troubled debt restructurings:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Real estate loans:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Residential – Accruing
 
$
1,054
 
 
$
1,092
 
 
$
817
 
 
$
360
 
 
$
—
 
Residential – Non-accruing
 
 
27
 
 
 
29
 
 
 
285
 
 
 
—
 
 
 
—
 
Commercial – Non-accruing
 
 
—
 
 
 
510
 
 
 
510
 
 
 
—
 
 
 
—
 
Total real estate loans
 
 
1,081
 
 
 
1,631
 
 
 
1,612
 
 
 
360
 
 
 
—
 
Commercial loans
 
 
—
 
 
 
—
 
 
 
—
 
 
 
—
 
 
 
—
 
Consumer loans – Accruing
 
 
189
 
 
 
319
 
 
 
269
 
 
 
—
 
 
 
—
 
Consumer loans – Non-accruing
 
 
—
 
 
 
20
 
 
 
89
 
 
 
—
 
 
 
—
 
Total troubled debt restructurings
 
$
1,270
 
 
$
1,970
 
 
$
1,970
 
 
$
360
 
 
$
—
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Total nonperforming loans to total loans
 
 
0.37
%
 
 
1.23
%
 
 
2.64
%
 
 
3.17
%
 
 
3.36
%
Total nonperforming assets to total assets
 
 
0.90
%
 
 
1.62
%
 
 
2.29
%
 
 
3.36
%
 
 
2.52
%
Total nonperforming assets and troubled debt
     restructurings to total assets
 
 
1.05
%
 
 
1.84
%
 
 
2.47
%
 
 
3.43
%
 
 
2.52
%
 
Classified Loans
 
(dollars in thousands)
 
December 31,
 
 
 
2013
 
2012
 
Special Mention loans
 
$
3,456
 
$
2,032
 
Substandard loans
 
 
1,054
 
 
2,467
 
Doubtful loans
 
 
—
 
 
—
 
Total classified loans
 
$
4,510
 
$
4,499
 
 
Delinquencies
 
(dollars in thousands)
 
December 31,
 
 
 
2013
 
2012
 
 
 
30-59 Days
Past Due
 
60-89 Days
Past Due
 
90+ Days
Past Due
 
30-59 Days
Past Due
 
60-89 Days
Past Due
 
90+ Days 
Past Due
 
Real estate loans:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Residential
 
$
122
 
$
—
 
$
603
 
$
130
 
$
5
 
$
1,555
 
Commercial
 
 
—
 
 
—
 
 
955
 
 
—
 
 
—
 
 
2,362
 
Total real estate loans
 
 
122
 
 
—
 
 
1,558
 
 
130
 
 
5
 
 
3,917
 
Commercial loans
 
 
—
 
 
—
 
 
—
 
 
—
 
 
—
 
 
—
 
Consumer loans
 
 
484
 
 
45
 
 
84
 
 
1,025
 
 
148
 
 
122
 
Total
 
$
606
 
$
45
 
$
1,642
 
$
1,155
 
$
153
 
$
4,039
 

Allocation of Allowance for Loan Losses
 
The determination of the allowance for loan losses and the related provision is one of our critical accounting policies that is subject to significant estimates, as previously discussed. The current level of the allowance for loan losses is a result of management’s assessment of the risks within the portfolio based on the information obtained through the credit evaluation process. The Company utilizes a risk-rating system on non-homogenous CRE and C&I loans that includes regular credit reviews to identify and quantify the risk in the commercial portfolio. Management conducts quarterly reviews of the entire loan portfolio and evaluates the need to establish allowances on the basis of these reviews.
 
 
7

 
Management actively monitors asset quality and, when appropriate, charges off loans against the allowance for loan losses. Although management believes it uses the best information available to make determinations with respect to the allowance for loan losses, future adjustments may be necessary if economic conditions differ substantially from the economic conditions in the assumptions used to determine the size of the allowance for loan losses.
 
The following tables reflect the allowance for loan losses and its allocations for the periods indicated.
 
(dollars in thousands)
 
December 31,
 
 
 
2013
 
2012
 
2011
 
 
 
 
 
 
% of  Total
 
% of  Total
 
 
 
 
% of  Total
 
% of  Total
 
 
 
 
% of  Total
 
% of  Total
 
 
 
Amount
 
ALLL
 
Loans
 
Amount
 
ALLL
 
Loans
 
Amount
 
ALLL
 
Loans
 
Real estate loans:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Residential
 
$
1,219
 
22.47
%
38.50
%
$
1,149
 
19.70
%
36.34
%
$
1,099
 
19.43
%
43.24
%
Commercial
 
 
2,517
 
46.39
%
28.70
%
 
3,107
 
53.27
%
23.95
%
 
2,485
 
43.93
%
13.11
%
Commercial loans
 
 
819
 
15.09
%
11.12
%
 
371
 
6.36
%
4.03
%
 
333
 
5.89
%
0.62
%
Consumer loans
 
 
871
 
16.05
%
21.68
%
 
1,206
 
20.67
%
35.68
%
 
1,739
 
30.75
%
43.03
%
Total allowance for
    loan losses
 
$
5,426
 
100.00
%
100.00
%
$
5,833
 
100.00
%
100.00
%
$
5,656
 
100.00
%
100.00
%
 
(dollars in thousands)
 
December 31,
 
 
 
2010
 
2009
 
 
 
Amount
 
% of Total
ALLL
 
% of Total
Loans
 
Amount
 
% of Total
ALLL
 
% of Total
Loans
 
Real estate loans:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Residential
 
$
2,135
 
31.19
%
35.30
%
$
765
 
7.58
%
26.02
%
Commercial
 
 
1,292
 
18.88
%
6.47
%
 
4,232
 
41.91
%
6.51
%
Commercial loans
 
 
608
 
8.88
%
1.63
%
 
79
 
0.78
%
1.22
%
Consumer loans
 
 
2,810
 
41.05
%
56.60
%
 
5,021
 
49.73
%
66.25
%
Total allowance for
    loan losses
 
$
6,845
 
100.00
%
100.00
%
$
10,097
 
100.00
%
100.00
%
 
 
8

 
Loan Loss Experience
 
The following table reflects activity in the allowance for loan losses for the periods indicated and selected related statistics.
 
(dollars in thousands)
 
Fiscal Year Ended
December 31,
 
 
 
2013
 
 
2012
 
 
2011
 
 
2010
 
 
2009
 
Allowance at beginning of period:
 
$
5,833
 
 
$
5,656
 
 
$
6,845
 
 
$
10,097
 
 
$
4,616
 
Provision for loan losses
 
 
324
 
 
 
2,852
 
 
 
2,440
 
 
 
927
 
 
 
11,564
 
Charge offs:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Real estate loans:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Residential
 
 
(164)
 
 
 
(509)
 
 
 
(811)
 
 
 
(1,158)
 
 
 
(1,402)
 
Commercial
 
 
(238)
 
 
 
(1,464)
 
 
 
(698)
 
 
 
(445)
 
 
 
(294)
 
Commercial loans
 
 
—
 
 
 
—
 
 
 
(612)
 
 
 
(61)
 
 
 
(10)
 
Consumer loans
 
 
(810)
 
 
 
(1,438)
 
 
 
(2,296)
 
 
 
(3,399)
 
 
 
(5,297)
 
Total charge-offs
 
 
(1,212)
 
 
 
(3,411)
 
 
 
(4,417)
 
 
 
(5,063)
 
 
 
(7,003)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Recoveries:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Real estate loans:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Residential
 
 
98
 
 
 
148
 
 
 
141
 
 
 
121
 
 
 
102
 
Commercial
 
 
—
 
 
 
—
 
 
 
—
 
 
 
17
 
 
 
—
 
Commercial loans
 
 
70
 
 
 
75
 
 
 
19
 
 
 
—
 
 
 
—
 
Consumer loans
 
 
313
 
 
 
513
 
 
 
628
 
 
 
746
 
 
 
818
 
Total recoveries
 
 
481
 
 
 
736
 
 
 
788
 
 
 
884
 
 
 
920
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Net charge-offs
 
 
(731)
 
 
 
(2,675)
 
 
 
(3,629)
 
 
 
(4,179)
 
 
 
(6,083)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Allowance at end of period
 
$
5,426
 
 
$
5,833
 
 
$
5,656
 
 
$
6,845
 
 
$
10,097
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Allowance to nonperforming loans
 
 
292.98
%
 
 
133.26
%
 
 
64.61
%
 
 
71.41
%
 
 
96.91
%
Allowance to total loans
    outstanding at end of period
 
 
1.09
%
 
 
1.65
%
 
 
1.70
%
 
 
2.26
%
 
 
3.25
%
Net charge-offs to average loans
    outstanding during period
 
 
(0.17)
%
 
 
(0.69)
%
 
 
(1.05)
%
 
 
(1.35)
%
 
 
(1.85)
%
 
Underwriting Procedures and Standards
 
Loan Approval Procedures and Authority.  Our lending activities follow written, non-discriminatory policies with loan approval limits approved by the Board of Directors. Loan officers have underwriting and approval authorization of varying amounts based on their years of experience in the lending field. Additionally, based on the amount of the loan, multiple signatures and or approvals are required. Our Chief Credit Officer has approval limits on individual loans up to $8 million and pool purchases up to $40 million. Per the Company’s policy, the maximum the Bank could lend to any one borrower at December 31, 2013 was $10.0 million.
 
Our goal is to have a well-diversified and balanced loan portfolio. In order to manage our loan portfolio risk, we establish concentration limits by borrower, product type, maturity, loan structure, industry and geography. To supplement our internal loan review resources, we have engaged an independent third-party loan review group, which together represent our internal loan review function. Responsibility for loan underwriting, compliance and document monitoring reside with the compliance function and loan operations function.
 
 
9

 
Residential Real Estate Loans.  Residential real estate loans generally include loans for the purchase or refinance of residential real estate properties consisting of 1-4 units and home equity loans and lines of credit.  We currently sell substantially all of the long-term fixed rate residential real estate loans that we originate to secondary market investors. We also release the servicing of these loans upon sale. Loan servicing includes collecting and remitting loan payments, accounting for principal and interest, contacting delinquent mortgagors, supervising foreclosures and property dispositions in the event of unremedied defaults, making certain insurance and tax payments on behalf of the borrowers and generally administering the loans. We typically retain all adjustable rate residential real estate loans that exceed the government maximum loan amount (which is currently $417,000) and also loans with balloon payment features in our portfolio.  Balloon periods are up to a maximum of 15 years.  Qualified Mortgage Rules went into effect in January 2014 and we discontinued offering balloon loans.  Loans secured by first liens on residential real estate held in the portfolio typically do not exceed 80% of the value of the collateral, are adjustable rate and have amortization periods of thirty years or less.
 
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. Our underwriting focuses on appraised value of the collateral as well as the applicant’s ability to repay the loan from his or her employment and from other sources.  We verify an applicant’s credit information using third-party records and tax returns through the IRS.
 
Additionally, our residential mortgage underwriters use a third party product to assess the risk of the loan transaction for both the collateral and applicant. The product helps us identify suspicious mortgage loans and analyzes the property and neighborhood characteristics for each transaction.  From the date of application to the date of closing, all of an applicant’s credit activity is monitored.  All appraisals are reviewed by our collateral underwriter, who is an Indiana state certified appraiser.  The collateral underwriter has several third party products that help assess the quality of the appraisal, the comparables chosen, and the value determination.
 
We do not offer, and have never offered, “subprime loans” (loans that generally target borrowers with weakened credit histories typically characterized by payment delinquencies, previous charge-offs, judgments, bankruptcies, or borrowers with questionable repayment capacity as evidenced by low credit scores or high debt-burden ratios).
 
Consumer Loans.  Consumer loans are primarily comprised of loans and credit cards. The majority of our consumer loans are horse trailer and recreational vehicle loans, underwritten by our staff for buyers whose applications were sent to us through a dealer network.  Minimum underwriting criteria have been established that consider credit score, debt-to-income ratio, employment history, the advance percentage and collateral coverage.  Typically, consumer loans are set up on monthly payments with amortization periods based on the type and age of the collateral.
 
Commercial Real Estate Loans.  Traditional CRE loans are 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, and loans to owners of multi-family residential structures, such as apartment buildings.  CRE loans are underwritten primarily based on historical and projected cash flows of the borrower and secondarily on the appraised value of the underlying real estate pledged as collateral on the debt. Credit tenant lease financing targets individual and institutional real estate investors purchasing commercial properties subject to long-term leasing arrangements with national or regional tenants.  These transactions are typically longer term in nature given longer contractual lease periods and reliability of the cash flow from financially strong tenants.  For the various types of commercial real estate loans, minimum criteria have been established within our 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 40% to 85% depending upon the type of real estate collateral, while the desired minimum debt coverage ratio is 1.20x.  CRE loans represented 28.70% of our loan portfolio at December 31, 2013.
 
The Bank's CRE loan portfolio is closely monitored on an ongoing basis by the completion of annual reviews requiring site inspections, periodic financial statement updates from the borrower, property rent rolls, guarantor tax returns and personal financial statements, payment history reviews, and evidence of ongoing insurance renewals and property tax payments.
 
Commercial and Industrial Loans.  C&I loans focus on the entire business relationship and consist of loans for business expansion as well as 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 three years or less. Also, new equipment financing is provided to businesses with these loans generally limited to 90% of the value of the collateral and amortization periods limited to seven years. C&I loans are often accompanied by a personal guaranty of the principal owners of a business. As with CRE loans, the underlying cash flow on a historic and projected basis of the business is the primary consideration in the underwriting process, with a desired minimum debt coverage ratio of 1.20x. We also assess the management’s operational effectiveness, level of equity invested in the business and customer relationships. We also consider relevant economic and industry factors, as well as competitor and supplier information relating to the applicant’s business.  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.  We address the needs of businesses with higher risk profiles through the use of government-assisted lending programs through the Small Business Administration. We determine the loan structure after evaluating what is appropriate for the specific situation and establish monitoring mechanisms for going forward.
 
 
10

 
Deposit Activities and Other Sources of Funds
 
We obtain deposits through the ACH network (direct deposit as well as customer-directed transfers of funds from outside financial institutions), remote and mobile deposit capture, mailed checks, wire transfers, and a deposit-taking ATM network. We do not currently solicit brokered deposits, although we had approximately $17.8 million and $18.3 million in brokered time deposits at December 31, 2013 and 2012, respectively.
 
The Bank does not own or operate any ATMs. Through network participation, the Bank’s customers are able to use nearly any ATM worldwide to withdraw cash. The Bank currently rebates up to $6.00 per customer per month for surcharges our customers incur when using an ATM owned by another institution. Management believes this program is more cost effective for the Bank, and more convenient for customers, than it would be to build and maintain a proprietary nationwide ATM network for our customers.
 
By providing a robust online toolset, quality customer service and a tremendous value for services offered, we have been able to develop relationships with our retail customers and build brand loyalty. The average retail checking or savings account has been open with us for more than eight years. As a result, we are not dependent upon costly account acquisition campaigns to attract new customers on a continual basis.
 
Deposits
 
(dollars in thousands)
 
Fiscal Year ended December 31,
 
 
 
2013
 
2012
 
2011
 
Regular savings accounts
 
$
14,330
 
2.13
%
$
11,583
 
2.18
%
$
7,773
 
1.60
%
Non-interest bearing
 
 
19,386
 
2.88
%
 
13,187
 
2.49
%
 
15,870
 
3.26
%
Interest-bearing
 
 
73,748
 
10.96
%
 
73,660
 
13.88
%
 
64,006
 
13.15
%
Money market accounts
 
 
255,169
 
37.91
%
 
202,388
 
38.14
%
 
165,561
 
34.02
%
Certificates of deposit
 
 
292,685
 
43.48
%
 
211,542
 
39.86
%
 
209,762
 
43.10
%
Brokered deposits
 
 
17,890
 
2.66
%
 
18,490
 
3.48
%
 
23,898
 
4.91
%
Premiums on brokered deposits
 
 
(113)
 
(0.02)
%
 
(159)
 
(0.03)
%
 
(205)
 
(0.04)
%
Total
 
$
673,095
 
100.00
%
$
530,691
 
100.00
%
$
486,665
 
100.00
%
 
Time Deposits
 
 
 
December 31,
 
(dollars in thousands)
 
2013
 
Interest Rate:
 
 
 
 
<1.00%
 
$
146,532
 
1.00% – 1.99%
 
 
50,700
 
2.00% – 2.99%
 
 
75,492
 
3.00% – 3.99%
 
 
34,577
 
4.00% – 4.99%
 
 
736
 
5.00% – 5.99%
 
 
2,538
 
Total
 
$
310,575
 
 
 
11

 
Time Deposit Maturities at December 31, 2013
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Percentage of
 
(dollars in thousands)
 
Period to Maturity
 
 
 
 
Total
 
 
 
Less than 1
 
> 1 year
 
> 2 years
 
More than
 
 
 
Certificate
 
 
 
year
 
to 2 years
 
to 3 years
 
3 years
 
Total
 
Accounts
 
Interest Rate:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
<1.00%
 
$
111,483
 
$
31,692
 
$
2,957
 
$
400
 
$
146,532
 
47.18
%
1.00% – 1.99%
 
 
7,258
 
 
11,939
 
 
10,006
 
 
21,497
 
 
50,700
 
16.32
%
2.00% – 2.99%
 
 
4,132
 
 
26,309
 
 
44,962
 
 
89
 
 
75,492
 
24.31
%
3.00% – 3.99%
 
 
18,936
 
 
5,296
 
 
7,261
 
 
3,084
 
 
34,577
 
11.13
%
4.00% – 4.99%
 
 
1
 
 
735
 
 
—
 
 
—
 
 
736
 
0.24
%
5.00% – 5.99%
 
 
—
 
 
—
 
 
—
 
 
2,538
 
 
2,538
 
0.82
%
Total
 
$
141,810
 
$
75,971
 
$
65,186
 
$
27,608
 
$
310,575
 
100.00
%
  
Time Deposit Maturities of $100,000 or Greater 
 
 
 
December 31,
 
(dollars in thousands)
 
2013
 
Maturity Period:
 
 
 
 
3 months or less
 
$
15,374
 
Over 3 through 6 months
 
 
14,730
 
Over 6 through 12 months
 
 
79,975
 
Over 12 months
 
 
127,194
 
Total
 
$
237,273
 
 
Federal Home Loan Bank Advances
 
Although deposits are the primary source of funds for our lending and investment activities and for general business purposes, we may obtain advances from the Federal Home Loan Bank of Indianapolis (FHLBI) as an alternative to retail deposit funds. The following table is a summary of FHLBI borrowings for the periods indicated. 
 
 
 
Fiscal Year Ended
 
(dollars in thousands)
 
December 31,
 
 
 
2013
 
 
2012
 
 
2011
 
Balance outstanding at end of period
 
$
31,793
 
 
$
40,686
 
 
$
40,573
 
Average amount outstanding during period
 
 
30,054
 
 
 
40,625
 
 
 
38,539
 
Maximum outstanding at any month end during period
 
 
31,793
 
 
 
40,686
 
 
 
40,573
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Weighted average interest rate at end of period
 
 
2.63
%
 
 
3.22
%
 
 
3.22
%
Weighted average interest rate during period
 
 
3.53
%
 
 
3.35
%
 
 
3.52
%
 
Market Areas
 
The market area for our retail banking activities, primarily residential mortgage and consumer lending and deposit gathering, is nationwide. The physical location of our offices is of no consequence to our retail customers.
 
We also deliver our CRE Credit Tenant Lease financing and asset based lending services nationally.  We serve our traditional CRE borrowers in Indiana and bordering states.  Traditional C&I banking focuses on Indiana and Arizona.  Our traditional CRE business and C&I activities are highly dependent on strong lender/borrower relationships.
 
 
12

 
Competition
 
The markets in which we compete to make loans and attract deposits are highly competitive.
 
For retail banking activities, we compete with other banks that use the Internet as a primary service channel, including Ally Bank, EverBank and Bank of Internet. However, we also compete with other banks, savings banks, credit unions, investment banks, insurance companies, securities brokerages and other financial institutions, as nearly all have some form of Internet delivery for their services. For residential mortgage lending, competitors that use the Internet as a primary service channel include Quicken Loans and Discover. However, we also compete with the major banks in residential mortgage lending, including Bank of America, Chase and Wells Fargo.
 
For our commercial lending activities, we compete with larger financial institutions operating in the Midwest and Central Indiana regions, including Key Bank, PNC Bank, Chase, BMO Harris, First Merchants Bank and First Financial Bank.  In the Southwest, we compete with Wells Fargo, Chase, Bank of America, U.S. Bank, Bank of Arizona, and CoBiz Bank.  All of these competitors have significantly greater financial resources and higher lending limits and may also offer specialized products and services we do not. For our commercial clients, we offer a highly personalized relationship and fast, local decision making.
 
In the United States, banking has experienced widespread consolidation over the last decade leading to the emergence of several large nationwide banking institutions. These competitors have significantly greater financial resources and offer many branch locations as well as a variety of services we do not. We have attempted to offset some of the advantages of the larger competitors by leveraging technology to deliver product solutions and better compete in targeted segments. We have positioned ourselves as an alternative to banking conglomerates for consumers who do not wish to subsidize the cost of large branch networks through high fees and unfavorable rates.
 
We anticipate that consolidation will continue in the financial services industry and perhaps accelerate as a result of ongoing financial stress, intensified competition for the same customer segments and significantly increased regulatory burdens and rules that are expected to increase expenses and put pressure on revenues.
 
Regulation and Supervision
 
General
 
We and the Bank are extensively regulated under federal and state law. We are a registered bank holding company under the Bank Holding Company Act of 1956 (the “BHCA”) and, as such, are subject to regulation, supervision and examination by the Board of Governors of the Federal Reserve System (the “Federal Reserve”). We are required to file reports with the Federal Reserve on a quarterly basis.
 
The Bank is an Indiana-chartered bank formed pursuant to the Indiana Financial Institutions Act (the “IFIA”). As such, the Bank is regularly examined by and subject to regulations promulgated by the Indiana Department of Financial Institutions (the “DFI”) and the Federal Deposit Insurance Corporation (the “FDIC”) as its primary federal bank regulator. The Bank is not a member of the Federal Reserve System.
 
The regulatory environment affecting us has been and continues to be altered by the enactment of new statutes and the adoption of new regulations as well as by revisions to, and evolving interpretations of, existing regulations. State and federal banking agencies have significant discretion in the conduct of their supervisory and enforcement activities and their examination policies. Any change in such practices and policies could have a material impact on our operations and shareholders.
 
The following discussion is intended to be a summary of the material statutes, regulations and regulatory directives that are currently applicable to us. It does not purport to be comprehensive or complete and it is expressly subject to and modified by reference to the text of the applicable statutes, regulations and directives.
 
The Dodd-Frank Act
 
The Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”) comprehensively reformed the regulation of financial institutions, products and services. Certain provisions of the Dodd-Frank Act noted in this section are also discussed in other sections. Furthermore, many of the provisions of the Dodd-Frank Act require further study or rulemaking by federal agencies, a process which will take months and years to implement fully.
 
 
13

 
Among other things, the Dodd-Frank Act provides for new capital standards that eliminate the treatment of trust preferred securities as Tier 1 capital. The Company has never issued any trust preferred securities. The Dodd-Frank Act permanently raised deposit insurance levels to $250,000, retroactive to January 1, 2008, and provided unlimited deposit insurance coverage for non-interest bearing transaction accounts through December 31, 2012. Pursuant to modifications under the Dodd-Frank Act, deposit insurance assessments are now being calculated based on an insured depository institution’s assets rather than its insured deposits and the minimum reserve ratio of the FDIC’s Deposit Insurance Fund (the “DIF”) has been raised to 1.35%. The payment of interest on business demand deposit accounts is permitted by the Dodd-Frank Act. The Dodd-Frank Act authorized the Federal Reserve to regulate interchange fees for debit card transactions and established new minimum mortgage underwriting standards for residential mortgages. Further, the Dodd-Frank Act barred certain banking organizations from engaging in proprietary trading and from sponsoring and investing in hedge funds and private equity funds, except as permitted under certain limited circumstances. The Dodd-Frank Act empowered the newly established Financial Stability Oversight Council to designate certain activities as posing a risk to the U.S. financial system and to recommend new or heightened standards and safeguards for financial organizations engaging in such activities.
 
The Dodd-Frank Act also established the Consumer Financial Protection Bureau (the “CFPB”) as an independent agency within the Board of Governors of the Federal Reserve System. The CFPB has the exclusive authority to administer, enforce, and otherwise implement federal consumer financial laws, which includes the power to make rules, issue orders, and issue guidance governing the provision of consumer financial products and services.  The CFPB has exclusive federal consumer law supervisory authority and primary enforcement authority over insured depository institutions with assets totaling over $10 billion.  Authority for institutions with $10 billion or less rests with the prudential regulator, and in the case of the Bank will be enforced by the FDIC.  The CFPB is also required to establish four offices: 1) Office of Fair Lending and Equal Opportunity, 2) Office of Financial Education, 3) Office of Service Member Affairs, and 4) Office of Financial Protection for Older Americans.  Additionally, the Bureau is required to establish a Consumer Advisory Board to advise and consult with the Bureau in the exercise of its functions.  Further, the Dodd-Frank Act established the Office of Financial Research, which has the power to require reports from other financial services companies.
 
On December 10, 2013, five federal agencies published the final “Volcker Rule” pursuant to the Dodd-Frank Act.  Among other things, the Volcker Rule imposes significant limitations on certain activities by covered banks and bank holding companies, including restrictions on holding certain types of securities, proprietary trading, and private equity investing.  Most of the limitations imposed by the Volcker Rule are not likely to impact smaller banks which do not engage in proprietary trading or private equity activities.  However, the restrictions on investing in hedge funds and similar entities could impact the ability to invest in collateralized debt obligations and other investments that many smaller banks hold.  On January 14, 2014, through publication of an Interim Final Rule, the federal banking agencies clarified that investments by banks in certain trust preferred collateralized debt obligations are not prohibited by the Volcker Rule.  However, the ultimate effect of the Volcker Rule on the Bank remains uncertain.
  
Holding Company Regulation
 
We are subject to supervision and examination as a bank holding company by the Federal Reserve under the BHCA. In addition, the Federal Reserve has the authority to issue orders to bank holding companies to cease and desist from unsafe or unsound banking practices and from violations of conditions imposed by, or violations of agreements with, the Federal Reserve. The Federal Reserve is also empowered, among other things, to assess civil money penalties against companies or individuals who violate Federal Reserve orders or regulations, to order termination of nonbanking activities of bank holding companies, and to order termination of ownership and control of a nonbanking subsidiary by a bank holding company. Federal Reserve approval is also required in connection with bank holding companies’ acquisitions of more than 5% of the voting shares of any class of a depository institution or its holding company and, among other things, in connection with the bank holding company’s engaging in new activities.
 
Under the BHCA, our activities are limited to businesses so closely related to banking, managing or controlling banks as to be a proper incident thereto. The BHCA also requires a bank holding company to obtain approval from the Federal Reserve before (1) acquiring or holding more than a 5% voting interest in any bank or bank holding company, (2) acquiring all or substantially all of the assets of another bank or bank holding company or (3) merging or consolidating with another bank holding company.
 
We have not filed an election with the Federal Reserve to be treated as a “financial holding company,” a type of holding company that can engage in certain insurance and securities-related activities that are not permitted for a bank holding company.
 
 
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Source of Strength. Under the Dodd-Frank Act, we are required to serve as a source of financial and managerial strength for the Bank in the event of the financial distress of the Bank. This provision codifies the longstanding policy of the Federal Reserve. Although the Dodd-Frank Act requires the federal banking agencies to issue regulations to implement the source of strength provisions, no regulations have been promulgated at this time. In addition, any capital loans by a bank holding company to any of its depository subsidiaries are subordinate to the payment of deposits and to certain other indebtedness. In the event of a bank holding company’s bankruptcy, any commitment by the bank holding company to a federal bank regulatory agency to maintain the capital of a depository subsidiary will be assumed by the bankruptcy trustee and entitled to a priority of payment.
 
Regulation of Banks, Generally
 
Business Activities. The Bank derives its lending and investment powers from the IFIA, the Federal Deposit Insurance Act (the “FDIA”) and related regulations.
 
Loans-to-One Borrower Limitations. Generally, the Bank’s total loans or extensions of credit to a single borrower, including the borrower's related entities, outstanding at one time, and not fully secured, cannot exceed 15% of the Bank’s unimpaired capital and surplus. If the loans or extensions of credit are fully secured by readily marketable collateral, the Bank may lend up to an additional 10% of its unimpaired capital and surplus.
 
Capital Requirements—Generally. Currently, FDIC regulations require insured non-member banks generally to meet three minimum capital standards:
 
• a ratio of tangible capital to adjusted total assets (tangible capital ratio) of not less than 1.5%;
 
“Tangible capital” for this purpose is defined to include common stockholders’ equity (including retained earnings), noncumulative perpetual preferred stock and related earnings and minority interests in consolidated subsidiaries, less intangibles and investments in certain “non-includable” subsidiaries.
 
• a ratio of “core capital” to adjusted total assets (“Tier 1 Capital Ratio” or “leverage ratio”) of not less than 4%; and
 
“Core capital” (also called “Tier 1 Capital”) is defined similarly to tangible capital, but also includes certain qualifying supervisory goodwill and certain purchased credit card relationships.
 
• a ratio of total capital (core and supplementary) to total risk-weighted assets (“Total Risk-Based Capital Ratio”) of not less than 8%, provided that the amount of supplementary capital used to satisfy this requirement may not exceed the amount of core capital.
 
“Supplementary capital” (also called “Tier 2 Capital”) for this purpose is defined to include cumulative and certain other preferred stock, mandatory convertible debt securities, subordinated debt and the allowance for loan and lease losses (up to a maximum of 1.25% of risk-weighted assets). In addition, up to 45% of unrealized gains on available-for-sale equity securities with a readily determinable fair value may be included in Tier 2 Capital.
 
In determining the amount of risk-weighted assets for purposes of the risk-based capital requirements, the Bank’s balance sheet assets and the credit conversion values of certain off-balance sheet items are multiplied by specified risk-weights, generally ranging from 0% for cash and obligations issued by the U.S. Government or its agencies to 100% for consumer and commercial loans, as specified by the FDIC regulations based on the degree of risk deemed to be inherent in the particular type of asset.
 
The FDIC has adopted regulations to implement its capital adequacy requirements through the system of prompt corrective action established by Section 38 of the FDIA. Under the prompt corrective action regulations, a bank is “well capitalized” if it has: (1) a Total Risk-Based Capital Ratio of 10.0% or greater; (2) a Tier 1 (Core) risk-based capital ratio of 6.0% or greater; (3) a leverage ratio of 5.0% or greater; and (4) is not subject to any written agreement, order, capital directive or prompt corrective action directive to meet and maintain a specific capital level for any capital measure. A bank is “adequately capitalized” if it has: (1) a Total Risk-Based Capital Ratio of 8.0% or greater; (2) a Tier 1 (Core) risk-based capital ratio of 4.0% or greater; and (3) a leverage ratio of 4.0% or greater (3.0% under certain circumstances) and does not meet the definition of a “well capitalized” savings association.
 
Regulators also must take into consideration: (1) concentrations of credit risk, (2) interest rate risk and (3) risks from non-traditional activities, as well as an institution’s ability to manage those risks, when determining the adequacy of an institution’s capital. This evaluation will be made as a part of the institution’s regular safety and soundness examination.
 
 
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Generally, a bank, upon receiving notice that it is not adequately capitalized (i.e., that it is “undercapitalized”), becomes subject to the prompt corrective action provisions of Section 38 of the FDIA that, for example, (1) restrict payment of capital distributions and management fees, (2) require that the FDIC monitor the condition of the bank and its efforts to restore its capital, (3) require submission of a capital restoration plan, (4) restrict the growth of the bank’s assets and (5) require prior regulatory approval of certain expansion proposals. A bank that is required to submit a capital restoration plan must concurrently submit a performance guarantee by each company that controls the bank. A bank that is “critically undercapitalized” (i.e., has a ratio of tangible equity to total assets that is equal to or less than 2.0%) will be subject to further restrictions, and generally will be placed in conservatorship or receivership within 90 days.
 
We are also subject to capital adequacy regulations of the Federal Reserve. These capital requirements are substantially similar to those applicable to the Bank. For bank holding companies, the minimum Tier 1 risk-based capital ratio is 4% and the minimum Total Risk-Based Capital Ratio is 8%. In addition to the risk-based capital requirements, the Federal Reserve requires top rated bank holding companies to maintain a minimum leverage capital ratio of Tier 1 capital (defined by reference to the risk-based capital guidelines) to its average total consolidated assets of at least 3.0%. For most other bank holding companies, the minimum leverage ratio is 4.0%. Bank holding companies with supervisory, financial, operational or managerial weaknesses, as well as bank holding companies that are anticipating or experiencing significant growth, are expected to maintain capital ratios well above the minimum levels. The following summarizes our applicable capital ratios as of December 31, 2013:
 
 
 
 
 
 
 
 
 
 
 
 
 
Minimum to be
 
 
 
 
 
 
 
 
Minimum
 
Well Capitalized
 
 
 
 
 
 
 
 
Capital
 
Under Prompt
 
(dollars in thousands)
 
Actual
 
 
 
Requirement
 
Corrective Actions
 
 
 
Amount
 
Ratio
 
Amount
 
Ratio
 
Amount
 
Ratio
 
As of December 31, 2013:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Total capital (to risk-weighted assets)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Consolidated
 
$
96,981
 
17.1
%
$
45,386
 
8.0
%
N/A
 
N/A
 
Bank
 
 
77,862
 
13.8
%
 
45,287
 
8.0
%
56,609
 
10.0
%
Tier 1 capital (to risk-weighted assets)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Consolidated
 
 
88,555
 
15.6
%
 
22,693
 
4.0
%
N/A
 
N/A
 
Bank
 
 
72,436
 
12.8
%
 
22,644
 
4.0
%
33,965
 
6.0
%
Tier 1 capital (to average assets)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Consolidated
 
 
88,555
 
11.7
%
 
30,385
 
4.0
%
N/A
 
N/A
 
Bank
 
 
72,436
 
9.6
%
 
30,329
 
4.0
%
37,911
 
5.0
%
 
In July 2013, the Federal Reserve published final rules (the “Basel III Capital Rules”) establishing a new comprehensive capital framework for U.S. bank holding companies.  The FDIC adopted substantially identical standards for institutions, like the Bank, subject to its jurisdiction in an interim final rule.  The Basel III Capital Rules implement requirements consistent with agreements reached by the Basel Committee on Banking Supervision as well as certain provisions of the Dodd-Frank Act.  These rules substantially revise the risk-based capital requirements applicable to depository institutions and their holding companies, including the Company and the Bank.  The Basel III Capital Rules are effective for all banks on January 1, 2015 (subject to certain phase-in periods for some requirements).
 
Among other things, the Basel III Capital Rules (i) introduce a new capital measure called “Common Equity Tier 1” (“CET1”), (ii) specify that Tier 1 capital consists of CET1 and “Additional Tier 1 capital” instruments meeting specified requirements, (iii) apply most deductions/adjustments to regulatory capital measures to CET1 and not to the other components of capital, thus potentially requiring higher levels of CET1 in order to meet minimum ratios, and (iv) expand the scope of the deductions/adjustments from capital in comparison to current regulations.
 
As of January 1, 2015, the minimum capital ratios will be: 4.5% CET1 to risk-weighted assets, 6.0% Tier 1 capital to risk-weighted assets, 8.0% Total capital (Tier 1 plus Tier 2) to risk-weighted assets and 4.0% leverage ratio.
 
In addition, a capital conservation buffer of 2.5% above each of these levels will be required for banking institutions like the Company and the Bank to avoid restrictions on their ability to make capital distributions, including the payment of dividends.  The capital conservation buffer will be phased in over a three year period, beginning at 0.625% in 2016 and increasing by that amount each subsequent year on January 1.
 
The Basel III Capital Rules provide for multiple new deductions from and adjustments to CET1.  These include, for example, the requirement that deferred tax assets dependent upon future taxable income and significant investments in non-consolidated financial entities be deducted from CET1 to the extent that any one category exceeds 10% of total CET1 or all such categories in the aggregate exceed 15% of CET1.  Implementation of these adjustments will begin on January 1, 2015, and will be phased in over the following three years.
 
 
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The Basel III Capital Rules will also revise the prompt corrective action framework by (i) introducing a CET1 ratio requirement at each capital level, with a required CET1 ratio to remain well-capitalized at 6.5%, (ii) increasing the minimum Tier 1 capital ratio requirement for each category, with the minimum Tier 1 capital ratio for well-capitalized status being increased to 8% and (iii) transitioning to a leverage ratio of 4% in order to qualify as adequately capitalized and a leverage ratio of 5% to be well-capitalized.
 
The Company believes that, as of December 31, 2013, the Company and the Bank would meet all capital adequacy requirements under the Basel III Capital Rules on a fully phased-in basis if such requirements were currently effective.
 
Community Reinvestment Act. Under the Community Reinvestment Act (the “CRA”), as implemented by FDIC regulations, the Bank has a continuing and affirmative obligation, consistent with safe and sound banking practices, to help meet the credit needs of its entire community, including low and moderate income neighborhoods. The CRA does not establish specific lending requirements or programs for financial institutions nor does it limit an institution’s discretion to develop the types of products and services that it believes are best suited to its particular community, consistent with the CRA. The CRA requires the FDIC, in connection with its examinations of the Bank, to assess the Bank’s record of meeting the credit needs of its entire community and to take that record into account in evaluating certain applications for regulatory approvals that we may file with the FDIC.
 
The CRA regulations establish an assessment system that bases an association’s rating on its actual performance in meeting community needs. In particular, the assessment system focuses on three tests:
 
• a lending test, to evaluate our record of making loans in our local communities, defined as our CRA assessment areas;
 
• an investment test, to evaluate our record of investing in community development projects, affordable housing and programs benefiting low or moderate income individuals and businesses in our CRA assessment areas or a broader area that includes our assessment areas; and
 
• a service test, to evaluate our delivery of services through our retail banking channels and the extent and innovation of our community development services.
 
Due to its Internet focus, the Bank has opted to operate under a CRA Strategic Plan, which was submitted and approved by the FDIC and sets forth certain guidelines the Bank must meet in order to achieve a “Satisfactory” rating. The current Strategic Plan expires December 31, 2014 and the Bank will submit a new plan for approval prior to that date. The Bank received a “Satisfactory” CRA rating in its most recent CRA examination. Failure of an institution to receive at least a “Satisfactory” rating could inhibit such institution or its holding company from undertaking certain activities, including engaging in certain activities and acquisitions of other financial institutions.
 
Transactions with Affiliates. The authority of the Bank, like other FDIC-insured banks, to engage in transactions with its “affiliates” is limited by Sections 23A and 23B of the Federal Reserve Act and the Federal Reserve’s Regulation W. An “affiliate” for this purpose is defined generally as any company that owns or controls the Bank or is under common ownership or control with the Bank, but excludes a company controlled by a bank. In general, transactions between the Bank and its affiliates must be on terms that are consistent with safe and sound banking practices and at least as favorable to the Bank as comparable transactions between the Bank and non-affiliates. In addition, covered transactions with affiliates are restricted individually to 10% and in the aggregate to 20% of the Bank’s capital. Collateral ranging from 100% to 130% of the loan amount depending on the quality of the collateral must be provided for an affiliate to secure a loan or other extension of credit from the Bank. The Company is an “affiliate” of the Bank for purposes of Regulation W and Sections 23A and 23B of the Federal Reserve Act. The Bank is in compliance with these provisions.
 
Loans to Insiders. The Bank’s authority to extend credit to its directors, executive officers and principal stockholders, as well as to entities controlled by such persons (“Related Interests”), is governed by Sections 22(g) and 22(h) of the Federal Reserve Act and Regulation O of the Federal Reserve. Among other things, these provisions require that extensions of credit to insiders: (1) be made on terms that are substantially the same as, and follow credit underwriting procedures that are not less stringent than, those prevailing for comparable transactions with unaffiliated persons and that do not involve more than the normal risk of repayment or present other unfavorable features; and (2) not exceed certain limitations on the amount of credit extended to such persons, individually and in the aggregate, which limits are based, in part, on the amount of the Bank’s capital. In addition, extensions of credit in excess of certain limits must be approved in advance by the Bank’s board of directors. Further, provisions of the Dodd-Frank Act require that after July 21, 2011, any sale or purchase of an asset by the Bank with an insider must be on market terms and if the transaction represents more than 10% of the Bank’s capital stock and surplus it must be approved in advance by a majority of the disinterested directors of the Bank. The Bank is in compliance with these provisions.
 
 
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Enforcement. The DFI and the FDIC share primary regulatory enforcement responsibility over the Bank and its institution-affiliated parties (“IAPs”), including directors, officers and employees. This enforcement authority includes, among other things, the ability to appoint a conservator or receiver for the Bank, to assess civil money penalties, to issue cease and desist orders, to seek judicial enforcement of administrative orders and to remove directors and officers from office and bar them from further participation in banking. In general, these enforcement actions may be initiated in response to violations of laws, regulations and administrative orders, as well as in response to unsafe or unsound banking practices or conditions.
 
Standards for Safety and Soundness. Pursuant to the FDIA, the federal banking agencies have adopted a set of guidelines prescribing safety and soundness standards. These guidelines establish general standards relating to internal controls and information systems, internal audit systems, loan documentation, credit underwriting, interest rate risk exposure, asset growth, asset quality, earnings standards, compensation, fees and benefits. In general, the guidelines require appropriate systems and practices to identify and manage the risks and exposures specified in the guidelines. We believe we are in compliance with the safety and soundness guidelines.
 
Dividends. The ability of the Bank to pay dividends is limited by state and federal laws and regulations that require the Bank to obtain the prior approval of the DFI before paying a dividend that, together with other dividends it has paid during a calendar year, would exceed the sum of its net income for the year to date combined with its retained net income for the previous two years. The amount of dividends the Bank may pay may also be limited by the principles of prudent bank management.
 
Capital Distributions. The FDIC may disapprove of a notice or application to make a capital distribution if:
 
• the Bank would be undercapitalized following the distribution;
 
• the proposed capital distribution raises safety and soundness concerns; or
 
• the capital distribution would violate a prohibition contained in any statute, regulation or agreement applicable to the Bank.
 
Insurance of Deposit Accounts. The Bank is a member of the DIF, which is administered by the FDIC. All deposit accounts at the Bank are insured by the FDIC up to a maximum of $250,000 per depositor.
 
The FDIA, as amended by the Federal Deposit Insurance Reform Act and the Dodd-Frank Act, requires the FDIC to set a ratio of deposit insurance reserves to estimated insured deposits—the designated reserve ratio (the “DRR”)—of at least 1.35%. The FDIC utilizes a risk-based assessment system that imposes insurance premiums based upon a risk matrix that takes into account a bank’s capital level and supervisory rating. On February 27, 2009, the FDIC introduced three possible adjustments to an institution’s initial base assessment rate: (1) a decrease of up to five basis points for long-term unsecured debt, including senior unsecured debt (other than debt guaranteed under the Temporary Liquidity Guarantee Program) and subordinated debt and, for small institutions, a portion of Tier 1 capital; (2) an increase not to exceed 50 percent of an institution’s assessment rate before the increase for secured liabilities in excess of 25 percent of domestic deposits; and (3) for non-Risk Category I institutions, an increase not to exceed 10 basis points for brokered deposits in excess of 10 percent of domestic deposits.
 
On November 9, 2010, the FDIC proposed to change its assessment base from total domestic deposits to average total assets minus average tangible equity, which is defined as Tier 1 capital, as required in the Dodd-Frank Act. The new assessment formula became effective on April 1, 2011, and was used to calculate the June 30, 2011 assessment. The FDIC plans to raise the same expected revenue under the new base as under the current assessment base. Since the new base is larger than the current base, the proposal would lower the assessment rate schedule to maintain revenue neutrality. Assessment rates would be reduced to a range of 2.5 to 9 basis points on the broader assessment base for banks in the lowest risk category (well capitalized and CAMELS I or II) and up to 30 to 45 basis points for banks in the highest risk category.
 
FDIC insurance expense, including assessments relating to Financing Corporation (FICO) bonds, totaled $451,000, $455,000 and $727,000 for 2013, 2012 and 2011, respectively.
 
Under the FDIA, the FDIC may terminate deposit insurance upon a finding that the institution has engaged in unsafe and unsound practices, is in an unsafe or unsound condition to continue operations or has violated any applicable law, regulation, rule, order or condition imposed by the FDIC.
 
 
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Liquidity. The Bank is required to maintain a sufficient amount of liquid assets to ensure its safe and sound operation. To fund its operations, the Bank historically has relied upon core deposits, fed funds lines with correspondent banks, Federal Home Loan Bank of Indianapolis (“FHLBI”) borrowings and brokered deposits. The Bank does not currently solicit brokered deposits. The Bank believes it has sufficient liquidity to meet its funding obligations.
 
Federal Home Loan Bank System. The Bank is a member of the FHLBI, which is one of the regional Federal Home Loan Banks comprising the Federal Home Loan Bank System. Each Federal Home Loan Bank serves as a central credit facility primarily for its member institutions. The Bank, as a member of the FHLBI, is required to acquire and hold shares of FHLBI capital stock. While the required percentage of stock ownership is subject to change by the FHLBI, the Bank is in compliance with this requirement with an investment in FHLBI stock at December 31, 2013 of $2.9 million. Any advances from the FHLBI must be secured by specified types of collateral, and long-term advances may be used for the purpose of providing funds to make residential mortgage or commercial loans and to purchase investments. Long term advances may also be used to help alleviate interest rate risk for asset and liability management purposes. The Bank receives dividends on its FHLBI stock.
 
Federal Reserve System. Although the Bank is not a member of the Federal Reserve System, it is subject to provisions of the Federal Reserve Act and the Federal Reserve’s regulations under which depository institutions may be required to maintain reserves against their deposit accounts and certain other liabilities. In 2008, the Federal Reserve Banks began paying interest on reserve balances. Currently, reserves must be maintained against transaction accounts (primarily NOW and regular checking accounts). As of December 31, 2013, the Federal Reserve’s regulations required reserves equal to 3% on transaction account balances over $12.4 million and up to $79.5 million, plus 10% on the excess over $79.5 million. These requirements are subject to adjustment annually by the Federal Reserve. The Bank is in compliance with the foregoing reserve requirements. The balances maintained to meet the reserve requirements imposed by the Federal Reserve may be used to satisfy liquidity requirements imposed by the FDIC.
 
Anti-Money Laundering and the Bank Secrecy Act. Under the Bank Secrecy Act (the “BSA”), a financial institution is required to have systems in place to detect and report transactions of a certain size and nature. Financial institutions are generally required to report to the U.S. Treasury any cash transactions involving more than $10,000. In addition, financial institutions are required to file suspicious activity reports for transactions that involve more than $5,000 and which the financial institution knows, suspects or has reason to suspect involves illegal funds, is designed to evade the requirements of the BSA or has no lawful purpose. The Uniting and Strengthening America by Providing Appropriate Tools Required to Intercept and Obstruct Terrorism Act of 2001 (the “USA PATRIOT Act”), which amended the BSA, is designed to deny terrorists and others the ability to obtain anonymous access to the U.S. financial system. The USA PATRIOT Act has significant implications for financial institutions and businesses of other types involved in the transfer of money. The USA PATRIOT Act, together with the implementing regulations of various federal regulatory agencies, has caused financial institutions, such as the Bank, to adopt and implement additional policies or amend existing policies and procedures with respect to, among other things, anti-money laundering compliance, suspicious activity, currency transaction reporting, customer identity verification and customer risk analysis.
 
The United States has imposed economic sanctions that affect transactions with designated foreign countries, nationals and others. These sanctions, which are administered by the Treasury Office of Foreign Assets Control (“OFAC”), take many different forms. Generally, however, they contain one or more of the following elements: (1) restrictions on trade with or investment in a sanctioned country, including prohibitions against direct or indirect imports from and exports to a sanctioned country and prohibitions on “U.S. persons” engaging in financial transactions relating to making investments in, or providing investment-related advice or assistance to, a sanctioned country; and (2) blocking of assets in which the government or specially designated nationals of the sanctioned country have an interest, by prohibiting transfers of property subject to U.S. jurisdiction (including property in the possession or control of U.S. persons). Blocked assets (for example, property and bank deposits) cannot be paid out, withdrawn, set off or transferred in any manner without a license from OFAC.
 
Consumer Protection Laws. The Bank is subject to a number of federal and state laws designed to protect consumers and prohibit unfair or deceptive business practices. These laws include the Equal Credit Opportunity Act, Fair Housing Act, Home Ownership Protection Act, Fair Credit Reporting Act, as amended by the Fair and Accurate Credit Transactions Act of 2003 (the “FACT Act”), the Gramm-Leach-Bliley Act (the “GLBA”), the Truth in Lending Act, the CRA, the Home Mortgage Disclosure Act, the Real Estate Settlement Procedures Act, the National Flood Insurance Act and various state law counterparts. These laws and regulations mandate certain disclosure requirements and regulate the manner in which financial institutions must interact with customers when taking deposits, making loans, collecting loans and providing other services. Further, the Dodd-Frank Act established the CFPB, which has the responsibility for making and amending rules and regulations under the federal consumer protection laws relating to financial products and services. The CFPB also has a broad mandate to prohibit unfair or deceptive acts and practices and is specifically empowered to require certain disclosures to consumers and draft model disclosure forms. Failure to comply with consumer protection laws and regulations can subject financial institutions to enforcement actions, fines and other penalties. The FDIC will enforce CFPB rules with respect to the Bank.
 
 
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Mortgage Reform. The Dodd-Frank Act prescribes certain standards that mortgage lenders must consider before making a residential mortgage loan, including verifying a borrower’s ability to repay such mortgage loan. The Dodd-Frank Act also allows borrowers to assert violations of certain provisions of the Truth-in-Lending Act as a defense to foreclosure proceedings. Under the Dodd-Frank Act, prepayment penalties are prohibited for certain mortgage transactions and creditors are prohibited from financing insurance policies in connection with a residential mortgage loan or home equity line of credit. The Dodd-Frank Act requires mortgage lenders to make additional disclosures prior to the extension of credit, in each billing statement and for negative amortization loans and hybrid adjustable rate mortgages. Additionally, the Dodd-Frank Act prohibits mortgage originators from receiving compensation based on the terms of residential mortgage loans and generally limits the ability of a mortgage originator to be compensated by others if compensation is received from a consumer.
 
Customer Information Security. The federal banking agencies have adopted final guidelines for establishing standards for safeguarding nonpublic personal information about customers. These guidelines implement provisions of the GLBA. Specifically, the Information Security Guidelines established by the GLBA require each financial institution, under the supervision and ongoing oversight of its board of directors or an appropriate committee thereof, to develop, implement and maintain a comprehensive written information security program designed to ensure the security and confidentiality of customer information (as defined under the GLBA), to protect against anticipated threats or hazards to the security or integrity of such information and to protect against unauthorized access to or use of such information that could result in substantial harm or inconvenience to any customer. The federal banking regulators have issued guidance for banks on response programs for unauthorized access to customer information. This guidance, among other things, requires notice to be sent to customers whose “sensitive information” has been compromised if unauthorized use of this information is “reasonably possible.”
 
Identity Theft Red Flags. The federal banking agencies jointly issued final rules and guidelines in 2007 implementing Section 114 of the FACT Act and final rules implementing Section 315 of the FACT Act. The rules implementing Section 114 require each financial institution or creditor to develop and implement a written Identity Theft Prevention Program to detect, prevent and mitigate identity theft in connection with the opening of certain accounts or certain existing accounts. In addition, the federal banking agencies issued guidelines to assist financial institutions and creditors in the formulation and maintenance of an Identity Theft Prevention Program that satisfies the requirements of the rules. The rules implementing Section 114 also require credit and debit card issuers to assess the validity of notifications of changes of address under certain circumstances. Additionally, the federal banking agencies issued joint rules, that became effective in 2008, under Section 315 that provide guidance regarding reasonable policies and procedures that a user of consumer reports must employ when a consumer reporting agency sends the user a notice of address discrepancy.
 
Privacy. The GLBA requires financial institutions to implement policies and procedures regarding the disclosure of nonpublic personal information about consumers to nonaffiliated third parties. In general, the statute requires financial institutions to explain to consumers their policies and procedures regarding the disclosure of such nonpublic personal information and, except as otherwise required or permitted by law, financial institutions are prohibited from disclosing such information except as provided in their policies and procedures. The Bank is required to provide notice to its customers on an annual basis disclosing their policies and procedures on the sharing of nonpublic personal information. In December 2009, the federal banking agencies promulgated regulations that incorporate a two-page model form that financial institutions may use to satisfy their privacy disclosure obligations under the GLBA. These regulations became effective in January 2011.
 
Employees
 
At December 31, 2013, we had 130 full-time equivalent employees.  None of our employees are currently represented by a union or covered by a collective bargaining agreement. Management believes that its employee relations are satisfactory.
 
Corporate Information
 
We were incorporated under the laws of the State of Indiana on September 15, 2005. On March 21, 2006, we consummated a plan of exchange by which we acquired all of the outstanding shares of the Bank. Our principal executive offices are located at 8888 Keystone Crossing, Suite 1700, Indianapolis, Indiana 46240, and our telephone number is (317) 532-7900.
 
 
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Available Information
 
Our Internet address is www.firstinternetbancorp.com. We post important information for investors on our website in the “Investor Relations” section and use this website as a means of disclosing material, nonpublic information and for complying with our disclosure obligations under Regulation FD. Accordingly, investors should monitor the Investor Relations section of our website, in addition to following our press releases, SEC filings, public conference calls, presentations and webcasts. Investors can easily find or navigate to pertinent information about us, free of charge, on our website, including:
 
• our Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), as soon as reasonably practicable after we electronically file such material with or furnish it to the SEC;
 
• announcements of investor conferences and events at which our executives talk about our products and competitive strategies. Archives of some of these events are also available;
 
• press releases on quarterly earnings, product announcements, legal developments and other material news that we may post from time to time;
 
• corporate governance information, including our Corporate Governance Principles, Code of Business Conduct and Ethics, information concerning our Board of Directors and its committees, including the charters of the Audit Committee, Compensation Committee, and Nominating and Corporate Governance Committee, and other governance-related policies;
 
• shareholder services information, including ways to contact our transfer agent; and
 
• opportunities to sign up for email alerts and RSS feeds to have information provided in real time.