INBK-2014.09.30-10Q


UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
FORM 10-Q
 
(Mark One)
þ
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the Quarterly Period September 30, 2014
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
 
20-3489991
(State or Other Jurisdiction of
Incorporation or Organization)
 
(I.R.S. Employer
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)
 
 
 
 
 
(Former Name, Former Address and Former Fiscal Year,
if Changed Since Last Report)
 
  
Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes 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 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
 
As of November 7, 2014, the registrant had 4,439,575 shares of common stock issued and outstanding.



Cautionary Note Regarding Forward-Looking Statements
  
This Quarterly Report on Form 10-Q may contain forward-looking statements with respect to the financial condition, results of operations, plans, objectives, future performance, or business of First Internet Bancorp (“we,” “our,” “us” or the “Company”). Forward-looking statements are generally identifiable by the use of words such as “believe,” “expect,” “anticipate,” “plan,” “intend,” “estimate,” “may,” “will,” “would,” “could,” “should,” or other similar expressions. Forward-looking statements are not a guarantee of future performance or results, are based on information available at the time the statements are made, and involve known and unknown risks, uncertainties and other factors that could cause actual results to differ materially from the information in the forward-looking statements. Factors that may cause such differences include: failures of or interruptions in the communications and information systems on which we rely to conduct our business; our plans to grow our commercial real estate and commercial and industrial loan portfolios; competition with national, regional, and community financial institutions; the loss of any key members of senior management; fluctuations in interest rates; general economic conditions and risks relating to the regulation of financial institutions. Additional factors that may affect our results include those discussed in our most recent Annual Report on Form 10-K under the heading “Risk Factors” and in other reports filed with the Securities and Exchange Commission (“SEC”). All statements in this Quarterly Report on Form 10-Q, including forward-looking statements, speak only as of the date they are made, and the Company undertakes no obligation to update any statement in light of new information or future events.

(i)


PART I

ITEM 1.
FINANCIAL STATEMENTS 

First Internet Bancorp
Condensed Consolidated Balance Sheets
(Amounts in thousands except share data)
 
 
September 30,
2014
 
December 31,
2013
 
 
(Unaudited)
 
 
Assets
 
 

 
 

Cash and due from banks
 
$
1,137

 
$
2,578

Interest-bearing demand deposits
 
38,470

 
51,112

Total cash and cash equivalents
 
39,607

 
53,690

Interest-bearing time deposits
 
2,000

 
2,500

Securities available-for-sale, at fair value (amortized cost of $129,573 and $185,091, respectively)
 
128,203

 
181,409

Loans held-for-sale (includes $25,701 and $24,254 at fair value, respectively)
 
27,547

 
28,610

Loans receivable
 
695,929

 
501,153

Allowance for loan losses
 
(5,464
)
 
(5,426
)
Net loans receivable
 
690,465

 
495,727

Accrued interest receivable
 
2,803

 
2,904

Federal Home Loan Bank of Indianapolis stock
 
2,943

 
2,943

Cash surrender value of bank-owned life insurance
 
12,226

 
11,935

Premises and equipment, net
 
7,075

 
7,134

Goodwill
 
4,687

 
4,687

Other real estate owned
 
4,545

 
4,381

Accrued income and other assets
 
4,782

 
6,422

Total assets
 
$
926,883

 
$
802,342

Liabilities and Shareholders’ Equity
 
 

 
 

Liabilities
 
 

 
 

Non-interest bearing deposits
 
$
20,359

 
$
19,386

Interest-bearing deposits
 
717,611

 
653,709

Total deposits
 
737,970

 
673,095

Advances from Federal Home Loan Bank
 
86,871

 
31,793

Subordinated debt
 
2,852

 
2,789

Accrued interest payable
 
82

 
102

Accrued expenses and other liabilities
 
4,334

 
3,655

Total liabilities
 
832,109

 
711,434

Commitments and Contingencies
 


 


Shareholders’ Equity
 
 

 
 

Preferred stock, no par value; 4,913,779 shares authorized; issued and outstanding - none
 
—

 
—

Voting common stock, no par value; 45,000,000 shares authorized; 4,439,575 and 4,448,326 shares issued and outstanding, respectively
 
71,705

 
71,378

Nonvoting common stock, no par value; 86,221 shares authorized; issued and outstanding - none
 
—

 
—

Retained earnings
 
23,951

 
21,902

Accumulated other comprehensive loss
 
(882
)
 
(2,372
)
Total shareholders’ equity
 
94,774

 
90,908

Total liabilities and shareholders’ equity
 
$
926,883

 
$
802,342

See Notes to Condensed Consolidated Financial Statements

1


First Internet Bancorp
Condensed Consolidated Statements of Income – Unaudited
(Amounts in thousands except share and per share data)
 
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
 
2014
 
2013
 
2014
 
2013
Interest Income
 
 

 
 

 
 

 
 

Loans
 
$
7,218

 
$
5,170

 
$
19,918

 
$
15,073

Securities – taxable
 
684

 
771

 
2,421

 
2,063

Securities – non-taxable
 
—

 
447

 
58

 
1,146

Other earning assets
 
45

 
54

 
195

 
148

Total interest income
 
7,947

 
6,442

 
22,592

 
18,430

Interest Expense
 
 

 
 

 
 

 
 

Deposits
 
1,958

 
1,758

 
5,740

 
5,042

Other borrowed funds
 
316

 
329

 
940

 
904

Total interest expense
 
2,274

 
2,087

 
6,680

 
5,946

Net Interest Income
 
5,673

 
4,355

 
15,912

 
12,484

Provision (Credit) for Loan Losses
 
(112
)
 
(57
)
 
(38
)
 
101

Net Interest Income After Provision (Credit) for Loan Losses
 
5,785

 
4,412

 
15,950

 
12,383

Noninterest Income
 
 

 
 

 
 

 
 

Service charges and fees
 
179

 
177

 
533

 
515

Mortgage banking activities
 
1,638

 
1,299

 
3,767

 
7,767

Other-than-temporary impairment
 
 

 
 

 
 

 
 

Total loss related to other-than-temporarily impaired securities
 
—

 
—

 
—

 
(129
)
Portion of loss recognized in other comprehensive income
 
—

 
—

 
—

 
80

Other-than-temporary impairment loss recognized in net income
 
—

 
—

 
—

 
(49
)
Gain (loss) on sale of securities
 
54

 
97

 
538

 
(69
)
Loss on asset disposals
 
(28
)
 
(34
)
 
(59
)
 
(121
)
Other
 
100

 
102

 
297

 
304

Total noninterest income
 
1,943

 
1,641

 
5,076

 
8,347

Noninterest Expense
 
 

 
 

 
 

 
 

Salaries and employee benefits
 
3,346

 
2,512

 
9,422

 
7,737

Marketing, advertising, and promotion
 
403

 
562

 
1,179

 
1,389

Consulting and professional services
 
431

 
577

 
1,383

 
1,791

Data processing
 
246

 
247

 
722

 
693

Loan expenses
 
208

 
209

 
458

 
574

Premises and equipment
 
548

 
534

 
1,816

 
1,468

Deposit insurance premium
 
155

 
85

 
437

 
313

Other
 
448

 
414

 
1,366

 
1,263

Total noninterest expense
 
5,785

 
5,140

 
16,783

 
15,228

Income Before Income Taxes
 
1,943

 
913

 
4,243

 
5,502

Income Tax Provision
 
661

 
186

 
1,384

 
1,575

Net Income
 
$
1,282


$
727


$
2,859

 
$
3,927

Income Per Share of Common Stock
 
 

 
 

 
 

 
 

Basic
 
$
0.29

 
$
0.25

 
$
0.64

 
$
1.36

Diluted
 
$
0.28

 
$
0.25

 
$
0.63

 
$
1.36

Weighted-Average Number of Common Shares Outstanding
 
 

 
 

 
 

 
 

Basic
 
4,497,762

 
2,890,369

 
4,496,228

 
2,888,274

Diluted
 
4,511,291

 
2,903,816

 
4,505,801

 
2,889,039

Dividends Declared Per Share
 
$
0.06

 
$
0.06

 
$
0.18

 
$
0.16


See Notes to Condensed Consolidated Financial Statements

2


First Internet Bancorp
Condensed Consolidated Statements of Comprehensive Income – Unaudited
(Dollar amounts in thousands)
 
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
 
2014
 
2013
 
2014
 
2013
Net income
 
$
1,282

 
$
727

 
$
2,859

 
$
3,927

Other comprehensive income
 
 
 
 
 
 
 
 
Net unrealized holding gains (losses) on securities available-for-sale
 
(1,451
)
 
(21
)
 
2,099

 
(5,344
)
Reclassification adjustment for (gains) losses realized
 
(54
)
 
(97
)
 
(538
)
 
69

Net unrealized holding gains (losses) on securities available-for-sale for which an other-than-temporary impairment has been recognized in income
 
—

 
—

 
751

 
(129
)
Reclassification adjustment for other-than-temporary impairment loss recognized in income
 
—

 
—

 
—

 
49

Other comprehensive income (loss) before income tax
 
(1,505
)
 
(118
)
 
2,312

 
(5,355
)
Income tax provision (benefit)
 
(536
)
 
(41
)
 
822

 
(1,874
)
Other comprehensive income (loss)
 
(969
)
 
(77
)
 
1,490

 
(3,481
)
Comprehensive income
 
$
313

 
$
650

 
$
4,349

 
$
446

 
 See Notes to Condensed Consolidated Financial Statements

3


First Internet Bancorp
Condensed Consolidated Statements of Shareholders’ Equity - Unaudited
Nine Months Ended September 30, 2014
(Dollar amounts in thousands except per share data)
 
 
Voting and
Nonvoting
Common
Stock
 
Accumulated
Other
Comprehensive
Loss
 
Retained
Earnings
 
Total
Shareholders’
Equity
Balance, January 1, 2014
 
$
71,378

 
$
(2,372
)
 
$
21,902

 
$
90,908

Net income
 
—

 
—

 
2,859

 
2,859

Other comprehensive income
 
—

 
1,490

 
—

 
1,490

Dividends declared ($0.18 per share)
 
—

 
—

 
(810
)
 
(810
)
Recognition of the fair value of share-based compensation
 
443

 
—

 
—

 
443

Common stock redeemed for the net settlement of share-based awards
 
(71
)
 
—

 
—

 
(71
)
Other
 
(45
)
 
—

 
—

 
(45
)
Balance, September 30, 2014
 
$
71,705

 
$
(882
)
 
$
23,951

 
$
94,774

 
See Notes to Condensed Consolidated Financial Statements

4


First Internet Bancorp
Condensed Consolidated Statements of Cash Flows – Unaudited
(Dollar amounts in thousands)
 
 
Nine Months Ended
September 30,
 
 
2014
 
2013
Operating Activities
 
 

 
 

Net income
 
$
2,859

 
$
3,927

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

 
 

Depreciation and amortization
 
1,432

 
1,774

Increase in cash surrender value of bank-owned life insurance
 
(291
)
 
(296
)
Provision (credit) for loan losses
 
(38
)
 
101

Share-based compensation expense
 
443

 
274

Loss on other-than-temporary impairment of securities
 
—

 
49

Loss (gain) from sale of available-for-sale securities
 
(538
)
 
69

Loans originated for sale
 
(285,686
)
 
(606,768
)
Proceeds from sale of loans
 
290,454

 
659,441

Gain on loans sold
 
(3,278
)
 
(7,208
)
Unrealized gain on loans held-for-sale
 
(427
)
 
(540
)
Gain on derivatives
 
(62
)
 
(19
)
Net change in:
 
 
 
 
Accrued interest receivable
 
101

 
(614
)
Accrued income and other assets
 
530

 
1,161

Accrued expenses and other liabilities
 
638

 
923

Net cash provided by operating activities
 
6,137

 
52,274

Investing Activities
 
 
 
 
Net change in loans
 
(88,148
)
 
(29,105
)
Proceeds from sale of other real estate owned
 
235

 
—

Net change in interest bearing deposits
 
500

 
(2,500
)
Maturities of securities available-for-sale
 
14,394

 
27,319

Proceeds from sale of securities available-for-sale
 
137,816

 
41,680

Purchase of securities available-for-sale
 
(96,803
)
 
(135,627
)
Purchase of premises and equipment
 
(683
)
 
(6,563
)
Loans purchased
 
(106,480
)
 
(53,342
)
Net cash used in investing activities
 
(139,169
)
 
(158,138
)
Financing Activities
 
 
 
 
Net increase in deposits
 
64,875

 
105,962

Cash dividends paid
 
(794
)
 
(282
)
Proceeds from issuance of subordinated debt and related warrants
 
—

 
3,000

Proceeds from advances from Federal Home Loan Bank
 
95,000

 
13,000

Repayment of advances from Federal Home Loan Bank
 
(40,000
)
 
(22,000
)
Other, net
 
(132
)
 
—

Net cash provided by financing activities
 
118,949

 
99,680

Net Decrease in Cash and Cash Equivalents
 
(14,083
)
 
(6,184
)
Cash and Cash Equivalents, Beginning of Period
 
53,690

 
32,513

Cash and Cash Equivalents, End of Period
 
$
39,607

 
$
26,329

Supplemental Disclosures of Cash Flows Information
 
 
 
 
Cash paid during the period for interest
 
$
6,700

 
$
5,985

Cash paid during the period for taxes
 
1,225

 
723

Loans transferred to real estate owned
 
—

 
507

Cash dividends declared, not paid
 
265

 
169

See Notes to Condensed Consolidated Financial Statements

5


First Internet Bancorp
Notes to Condensed Consolidated Financial Statements – Unaudited
(Dollar amounts in thousands except per share data)
  
Note 1:        Basis of Presentation
 
The accompanying unaudited condensed consolidated financial statements have been prepared in conformity with U.S. generally accepted accounting principles (“GAAP”) for interim financial information and pursuant to the rules and regulations of the SEC. Accordingly, they do not include all of the information or footnotes necessary for a complete presentation of financial condition, results of operations, or cash flows in accordance with U.S. GAAP. In our opinion, all adjustments (consisting only of normal recurring adjustments) necessary for a fair presentation have been included. The results of operations for the three and nine months ended September 30, 2014 are not necessarily indicative of the results expected for the year ending December 31, 2014 or any other period. The September 30, 2014 condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and notes included in the First Internet Bancorp Annual Report on Form 10-K for the year ended December 31, 2013.
 
The preparation of the condensed consolidated financial statements in conformity with U.S. GAAP requires management to make estimates, judgments, or assumptions that could have a material effect on the carrying value of certain assets and liabilities. These estimates, judgments, and assumptions affect the amounts reported in the condensed consolidated financial statements and the disclosures provided. The determination of the allowance for loan losses, valuations and impairments of investment securities, and the accounting for income tax expense are highly dependent upon management’s estimates, judgments, and assumptions where changes in any of these could have a significant impact on the financial statements.
 
The Company is subject to claims and lawsuits that arise primarily in the ordinary course of business. It is the opinion of management that the disposition or ultimate resolution of such claims and lawsuits will not have a material adverse effect on the consolidated financial position, results of operations, and cash flows of the Company.

The condensed consolidated financial statements include the accounts of First Internet Bancorp (the "Company”), its wholly-owned subsidiary, First Internet Bank of Indiana (the "Bank”), and the Bank’s wholly-owned subsidiary, JKH Realty Services, LLC. All significant intercompany accounts and transactions have been eliminated in consolidation.
 
Certain reclassifications have been made to the 2013 financial statements to conform to the 2014 financial statement presentation. These reclassifications had no effect on net income.
 
On June 21, 2013, the Company completed a three-for-two (3:2) split of its common stock by the payment of a stock dividend of one-half of one share on each outstanding share of common stock. Except as otherwise indicated, all of the share and per-share information referenced throughout this report has been adjusted to reflect this stock split.

6


Note 2:        Earnings Per Share
 
Earnings per share of common stock are based on the weighted-average number of basic shares and dilutive shares outstanding during the period.
 
The following is a reconciliation of the weighted-average common shares for the basic and diluted earnings per share computations for the three and nine months ended September 30, 2014 and 2013:
 
 
 
Three Months Ended
September 30,
 
 
2014
 
2013
Basic earnings per share
 
 

 
 

Net income available to common shareholders
 
$
1,282

 
$
727

Weighted-average common shares
 
4,497,762

 
2,890,369

Basic earnings per common share
 
$
0.29

 
$
0.25

Diluted earnings per share
 
 

 
 

Net income applicable to diluted earnings per share
 
$
1,282

 
$
727

Weighted-average common shares
 
4,497,762

 
2,890,369

Dilutive effect of warrants
 
—

 
13,447

Dilutive effect of equity compensation
 
13,529

 
—

     Weighted-average common and incremental shares
 
4,511,291

 
2,903,816

Diluted earnings per common share
 
$
0.28

 
$
0.25

Number of warrants excluded from the calculation of diluted earnings per share as the exercise prices were greater than the average market price of the Company’s common stock during the period
 
48,750

 
—

  
 
 
Nine Months Ended 
 September 30,
 
 
2014
 
2013
Basic earnings per share
 
 

 
 

Net income available to common shareholders
 
$
2,859

 
$
3,927

Weighted-average common shares
 
4,496,228

 
2,888,274

Basic earnings per common share
 
$
0.64

 
$
1.36

Diluted earnings per share
 
 

 
 
Net income applicable to diluted earnings per share
 
$
2,859

 
$
3,927

Weighted-average common shares
 
4,496,228

 
2,888,274

Dilutive effect of warrants
 
3,871

 
765

Dilutive effect of equity compensation
 
5,702

 
—

     Weighted-average common and incremental shares
 
4,505,801

 
2,889,039

Diluted earnings per common share
 
$
0.63

 
$
1.36

Number of warrants excluded from the calculation of diluted earnings per share as the exercise prices were greater than the average market price of the Company’s common stock during the period
 
—

 
—



7


Note 3:         Securities
 
Securities at September 30, 2014 and December 31, 2013 are as follows: 
 
 
September 30, 2014
 
 
Amortized
 
Gross Unrealized
 
Fair
 
 
Cost
 
Gains
 
Losses
 
Value
Securities available-for-sale
 
 

 
 

 
 

 
 

U.S. Government-sponsored enterprises
 
$
16,049

 
$
122

 
$
(446
)
 
$
15,725

Mortgage-backed and asset-backed securities – government-sponsored enterprises
 
111,524

 
50

 
(1,085
)
 
110,489

Other securities
 
2,000

 
—

 
(11
)
 
1,989

Total available-for-sale
 
$
129,573

 
$
172

 
$
(1,542
)
 
$
128,203

 
 
 
December 31, 2013
 
 
Amortized
 
Gross Unrealized
 
Fair
 
 
Cost
 
Gains
 
Losses
 
Value
Securities available-for-sale
 
 

 
 

 
 

 
 

U.S. Government-sponsored enterprises
 
$
57,569

 
$
470

 
$
(1,762
)
 
$
56,277

Municipal securities
 
46,126

 
1,080

 
(883
)
 
46,323

Mortgage-backed and asset-backed securities – government-sponsored enterprises
 
75,058

 
696

 
(1,813
)
 
73,941

Mortgage-backed and asset-backed securities – private labeled
 
1,313

 
9

 
(90
)
 
1,232

Other securities
 
5,025

 
—

 
(1,389
)
 
3,636

Total available-for-sale
 
$
185,091

 
$
2,255

 
$
(5,937
)
 
$
181,409

 
The carrying value of securities at September 30, 2014 is shown below by their contractual maturity date. Actual maturities will differ because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.
 
 
Available-for-Sale
 
 
Amortized
Cost
 
Fair
Value
Within one year
 
$
2,000

 
$
1,989

One to five years
 
—

 
—

Five to ten years
 
814

 
803

After ten years
 
15,235

 
14,922

 
 
18,049

 
17,714

Mortgage-backed and asset-backed securities – government-sponsored enterprises
 
111,524

 
110,489

Totals
 
$
129,573

 
$
128,203

 
Gross gains of $450 and $104, and gross losses of $396 and $7 resulting from sales of available-for-sale securities were realized for the three months ended September 30, 2014 and 2013, respectively. In the nine months ended September 30, 2014 and 2013, gross gains of $2,749 and $278 and gross losses of $2,211 and $347 were recognized, respectively.
 
Certain investments in debt securities are reported in the condensed consolidated financial statements at an amount less than their historical cost. Total fair value of these investments at September 30, 2014 and December 31, 2013 was $107,243 and $109,946, which is approximately 84% and 61%, respectively, of the Company’s available-for-sale investment portfolio. These declines primarily resulted from fluctuations in market interest rates after purchase.
 
Except as discussed below, management believes the declines in fair value for these securities are temporary.
 

8


Should the impairment of any of these securities become other-than-temporary, the cost basis of the investment will be reduced and the resulting loss recognized in net income in the period in which the other-than-temporary impairment (“OTTI”) is identified.
 
The following tables show the Company’s investments’ gross unrealized losses and fair value, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position at September 30, 2014 and December 31, 2013: 
 
 
September 30, 2014
 
 
Less Than 12 Months
 
12 Months or Longer
 
Total
 
 
Fair
Value
 
Unrealized
Losses
 
Fair
Value
 
Unrealized
Losses
 
Fair
Value
 
Unrealized
Losses
Securities available for sale:
 
 

 
 

 
 

 
 

 
 

 
 

U.S. Government-sponsored enterprises
 
$
803

 
$
(11
)
 
$
8,729

 
$
(435
)
 
$
9,532

 
$
(446
)
Mortgage-backed and asset-backed securities - government-sponsored enterprises
 
74,317

 
(365
)
 
21,405

 
(720
)
 
95,722

 
(1,085
)
Other securities
 
1,989

 
(11
)
 
—

 
—

 
1,989

 
(11
)
 
 
$
77,109

 
$
(387
)
 
$
30,134

 
$
(1,155
)
 
$
107,243

 
$
(1,542
)
  
 
 
December 31, 2013
 
 
Less Than 12 Months
 
12 Months or Longer
 
Total
 
 
Fair
Value
 
Unrealized
Losses
 
Fair
Value
 
Unrealized
Losses
 
Fair
Value
 
Unrealized
Losses
Securities available for sale:
 
 

 
 

 
 

 
 

 
 

 
 

U.S. Government-sponsored enterprises
 
$
43,085

 
$
(1,761
)
 
$
14

 
$
(1
)
 
$
43,099

 
$
(1,762
)
Municipal securities
 
14,105

 
(882
)
 
351

 
(1
)
 
14,456

 
(883
)
Mortgage-backed and asset-backed securities - government-sponsored enterprises
 
47,875

 
(1,813
)
 
—

 
—

 
47,875

 
(1,813
)
Mortgage-backed and asset-backed securities – private labeled
 
43

 
(1
)
 
838

 
(89
)
 
881

 
(90
)
Other securities
 
1,962

 
(38
)
 
1,673

 
(1,351
)
 
3,635

 
(1,389
)
 
 
$
107,070

 
$
(4,495
)
 
$
2,876

 
$
(1,442
)
 
$
109,946

 
$
(5,937
)
 
U.S. Government Sponsored Enterprise and Municipal Securities
 
The unrealized losses on the Company’s investments in securities issued by U.S. Government-sponsored enterprises and municipal securities were caused by interest rate changes. The contractual terms of those investments do not permit the issuer to settle the securities at a price less than the amortized cost bases of the investments. Because the Company does not intend to sell the investments at a loss and it is not more likely than not the Company will be required to sell the investments before recovery of their amortized cost bases, which may be maturity, the Company does not consider those investments to be other-than-temporarily impaired at September 30, 2014.
 
Mortgage-Backed Securities
 
The unrealized losses on the Company’s investments in mortgage-backed securities were caused by interest rate changes. The Company expects to recover the amortized cost bases over the term of the securities. Because the decline in market value is attributable to changes in interest rates and not credit quality, and because the Company does not intend to sell the investments at a loss and it is not more likely than not the Company will be required to sell the investments before

9


recovery of their amortized cost bases, which may be maturity, the Company does not consider those investments to be other-than-temporarily impaired at September 30, 2014.

For identified mortgage-backed securities in the investment portfolio, an extensive, quarterly review is conducted to determine if an other-than-temporary impairment has occurred. Various inputs to the economic models are used to determine if an unrealized loss is other-than-temporary. The most significant inputs are voluntary prepayment rates, default rates, liquidation rates, and loss severity.
 
To determine if the unrealized loss for mortgage-backed securities is other-than-temporary, the Company projects total estimated defaults of the underlying assets (mortgages) and multiplies that calculated amount by an estimate of realizable value upon sale in the marketplace (severity) in order to determine the projected collateral loss. The Company also evaluates the current credit enhancement underlying the security to determine the impact on cash flows. If the Company determines that a given mortgage-backed security position will be subject to a write-down or loss, the Company records the expected credit loss as a charge to earnings.
 
Other Securities
 
The Company’s unrealized loss on investments in other securities at December 31, 2013 primarily consists of two investments, both of which were sold in the second quarter of 2014.

The first investment was a $2,000 par investment in I-PreTSL I B-2 pooled trust security. The unrealized loss was primarily caused by a sector downgrade by several industry analysts. The determination of no credit loss was calculated by comparing expected discounted cash flows based on performance indicators of the underlying assets in the security to the carrying value of the investment.
 
The second investment was a $2,000 par investment in ALESCO IV Series B2 pooled trust security for which the Company recognized an other-than-temporary impairment loss. The unrealized loss was primarily caused by: (a) a decrease in performance; and (b) a sector downgrade by several industry analysts. The credit loss was calculated by comparing expected discounted cash flows based on performance indicators of the underlying assets in the security to the carrying value of the investment.

The Company did not recognize any credit losses in earnings during the three months ended September 30, 2014 and 2013. The credit losses recognized in earnings during the nine months ended September 30, 2014 and 2013 were as follows: 
 
 
 
 
 
 
 
Nine Months Ended September 30,
 
 
2014
 
2013
Mortgage-backed and asset-backed securities – private labeled
 
—

 
49

    Total credit losses recognized in earnings
 
$
—

 
$
49

 


10


Credit Losses Recognized on Investments
 
Certain debt securities have experienced fair value deterioration due to credit losses, as well as due to other market factors, but are not considered other-than-temporarily impaired.
 
The following tables provide information about debt securities for which only a credit loss was recognized in income and other losses are recorded in accumulated other comprehensive loss. The Company did not own any OTTI securities during the three months ended September 30, 2014.  
 
 
 
 
Accumulated
Credit Losses
Credit losses on debt securities held
 

July 1, 2013
$
1,342

Realized losses related to OTTI
(98
)
Recoveries related to OTTI
—

Additions related to OTTI losses not previously recognized
—

Additions related to increases in previously recognized OTTI losses
—

September 30, 2013
$
1,244


 
Accumulated
Credit Losses
Credit losses on debt securities held
 

January 1, 2014
$
1,183

Realized losses related to OTTI
(1,139
)
Recoveries related to OTTI
(44
)
Additions related to OTTI losses not previously recognized
—

Additions related to increases in previously recognized OTTI losses
—

September 30, 2014
$
—


 
Accumulated
Credit Losses
Credit losses on debt securities held
 

January 1, 2013
$
1,737

Realized losses related to OTTI
(542
)
Recoveries related to OTTI
—

Additions related to OTTI losses not previously recognized
31

Additions related to increases in previously recognized OTTI losses
18

September 30, 2013
$
1,244



11


Amounts reclassified from accumulated other comprehensive loss and the affected line items in the condensed consolidated statements of income during the three and nine months ended September 30, 2014 and 2013, were as follows:
 
 
Amounts Reclassified from
Accumulated Other Comprehensive Loss
for the Three Months Ended
September 30,
 
Affected Line Item in the
Statements of Income
 
 
2014
 
2013
 
Securities available for sale
 
 

 
 

 
 
Gain realized in earnings
 
$
54

 
$
97

 
Gain (loss) on sale of securities
OTTI losses recognized in earnings
 
—

 
—

 
Other-than-temporary impairment loss recognized in net income
Total reclassified amount before tax
 
54

 
97

 
Income Before Income Taxes
Tax expense
 
18

 
34

 
Income Tax Provision
Total reclassifications out of accumulated other comprehensive loss
 
$
36

 
$
63

 
Net Income
 
 
Amounts Reclassified from
Accumulated Other
Comprehensive Loss
for the Nine Months Ended
September 30,
 
Affected Line Item in the
Statements of Income
 
 
2014
 
2013
 
Securities available for sale
 
 

 
 

 
 
Gain (loss) realized in earnings
 
$
538

 
$
(69
)
 
Gain (loss) on sale of securities
OTTI losses recognized in earnings
 
—

 
(49
)
 
Other-than-temporary impairment loss recognized in net income
Total reclassified amount before tax
 
538

 
(118
)
 
Income Before Income Taxes
Tax expense (benefit)
 
183

 
(41
)
 
Income Tax Provision
Total reclassifications out of accumulated other comprehensive loss
 
$
355

 
$
(77
)
 
Net Income
 
Note 4:        Loans Receivable
 
Loans that management intends to hold until maturity are reported at their outstanding principal balance adjusted for unearned income, charge-offs, the allowance for loan losses, any unamortized deferred fees or costs on originated loans, and unamortized premiums or discounts on purchased loans.
 
For loans recorded at cost, interest income is accrued based on the unpaid principal balance. Loan origination fees, net of certain direct origination costs, as well as premiums and discounts, are deferred and amortized as a level yield adjustment over the respective term of the loan.
 

12


Categories of loans include:
 
 
September 30,
2014
 
December 31,
2013
Real estate loans
 
 

 
 

   Residential
 
$
282,298

 
$
191,007

   Commercial
 
235,878

 
142,429

Total real estate loans
 
518,176

 
333,436

Commercial loans
 
72,099

 
55,168

Consumer loans
 
100,074

 
107,562

Total loans
 
690,349

 
496,166

Deferred loan origination costs and premiums and discounts on purchased loans
 
5,580

 
4,987

Allowance for loan losses
 
(5,464
)
 
(5,426
)
Net loans receivable
 
$
690,465

 
$
495,727

 
The risk characteristics of each loan portfolio segment are as follows:
 
Commercial Real Estate: These loans are viewed primarily as cash flow loans and secondarily as loans secured by real estate. These loans may also incorporate a personal guarantee. Commercial real estate lending typically involves higher loan principal amounts, and the repayment of these loans is generally dependent on the successful operation of the property securing the loan or the business conducted on the property securing the loan. Commercial real estate loans may be more adversely affected by conditions in the real estate markets or in the general economy. The properties securing the Company’s commercial real estate portfolio are diverse in terms of property type and geographic location. Management monitors and evaluates commercial real estate loans based on property financial performance, collateral value, and other risk grade criteria. As a general rule, the Company avoids financing special use projects or properties outside of its designated market areas unless other underwriting factors are present to help mitigate risk. In addition, management tracks the level of owner-occupied commercial real estate loans versus non-owner-occupied loans.
 
Commercial: Commercial loans are primarily based on the identified cash flows of the borrower and secondarily on the underlying collateral provided by the borrower. The cash flows of borrowers, however, may not be as expected, and the collateral securing these loans may fluctuate in value. Loans are made for working capital, equipment purchases, or other purposes. Most commercial loans are secured by the assets being financed and may incorporate a personal guarantee; however, some short-term loans may be made on an unsecured basis.
 
Residential and Consumer: With respect to residential loans that are secured by 1-4 family residences and are generally owner occupied, the Company generally establishes a maximum loan-to-value ratio and requires private mortgage insurance if that ratio is exceeded. Home equity loans are typically secured by a subordinate interest in 1-4 family residences. The properties securing the Company's residential loan portfolio are generally geographically diverse as the Company offers these loans on a nationwide basis. Repayment on residential loans can be impacted by changes in property values on residential properties. Consumer loans are secured by consumer assets such as horse trailers, recreational vehicles, or automobiles. Some consumer loans are unsecured, such as small installment loans and certain lines of credit. Repayment of consumer loans is primarily dependent upon the personal income of the borrowers, which can be impacted by economic conditions in their market areas such as unemployment levels. Risk is mitigated by the fact that the loans are of smaller individual amounts and spread over a large number of borrowers in geographically diverse locations throughout the country.

 

13


Allowance for Loan Losses Methodology
 
Company policy is designed to ensure that an adequate allowance for loan losses (“ALLL”) is maintained. The portfolio is segmented by loan type.  The required ALLL for types of performing homogeneous loans which do not have a specific reserve is determined by applying a factor based on historical losses averaged over the past twelve months.  Management believes the historical loss experience methodology is appropriate in the current economic environment, as it captures loss rates that are comparable to the current period being analyzed.  Management adds qualitative factors for observable trends, changes in internal practices, changes in delinquencies and impairments, and external factors.  Observable factors include changes in the composition and size of portfolios, as well as loan terms or concentration levels.  The Company evaluates the impact of internal changes such as management and staff experience levels or modification to loan underwriting processes.  Delinquency trends are scrutinized for both volume and severity of past due, nonaccrual, classified, or graded loans as well as any changes in the value of underlying collateral.  Finally, the Company considers the effect of other external factors such as national, regional, and local economic and business conditions, as well as competitive, legal, and regulatory requirements. Loans that are considered to be impaired are evaluated to determine the need for a specific allowance by applying at least one of three methodologies: present value of future cash flows; fair value of collateral less cost to sell; or the loan’s observable market price.  All troubled debt restructurings (“TDR”) are considered impaired loans.  Loans evaluated for impairment are removed from other pools to prevent double-counting.
 
Provision (Credit) for Loan Losses
 
A provision for estimated losses on loans is charged to operations based upon management’s evaluation of the potential losses. Such an evaluation, which includes a review of all loans for which full collectability may not be reasonably assured considers, among other matters, the estimated net realizable value of the underlying collateral, as applicable, economic conditions, loan loss experience, and other factors that are particularly susceptible to changes that could result in a material adjustment in the near term. While management endeavors to use the best information available in making its evaluations, future allowance adjustments may be necessary if economic conditions change substantially from the assumptions used in making the evaluations.
 
Accounting Standards Codification (“ASC”) Topic 310, Receivables, requires that impaired loans be measured based on the present value of expected future cash flows discounted at the loans’ effective interest rates or the fair value of the underlying collateral and allows existing methods for recognizing interest income.
 
Policy for Charging Off Loans
 
The Company’s policy is to charge off a loan at any point in time when it no longer can be considered a bankable asset, meaning collectible within the parameters of policy. A secured loan is generally charged off to the estimated fair value of the collateral, less costs to sell, no later than when it is 120 days past due as to principal or interest. An unsecured loan generally is charged off no later than when it is 180 days past due as to principal or interest.
 
The following tables present changes in the balance of the ALLL during the three and nine month periods ended September 30, 2014 and 2013: 
 
 
Three Months Ended September 30, 2014
 
 
Residential
Real Estate
 
Commercial
Real Estate
 
Commercial
 
Consumer
 
Total
Allowance for loan losses:
 
 

 
 

 
 

 
 

 
 

Balance, beginning of period
 
$
1,203

 
$
2,395

 
$
735

 
$
807

 
$
5,140

Provision (credit) charged to expense
 
53

 
(248
)
 
188

 
(105
)
 
(112
)
Losses charged off
 
(5
)
 
—

 
(14
)
 
(92
)
 
(111
)
Recoveries
 
7

 
459

 
—

 
81

 
547

Balance, end of period
 
$
1,258


$
2,606


$
909


$
691

 
$
5,464


14


 
 
Nine Months Ended September 30, 2014
 
 
Residential
Real Estate
 
Commercial
Real Estate
 
Commercial
 
Consumer
 
Total
Allowance for loan losses:
 
 

 
 

 
 

 
 

 
 

Balance, beginning of period
 
$
1,219

 
$
2,517

 
$
819

 
$
871

 
$
5,426

Provision (credit) charged to expense
 
224

 
(370
)
 
104

 
4

 
(38
)
Losses charged off
 
(216
)
 
—

 
(14
)
 
(427
)
 
(657
)
Recoveries
 
31

 
459

 
—

 
243

 
733

Balance, end of period
 
$
1,258

 
$
2,606

 
$
909

 
$
691

 
$
5,464

 
 
 
Three Months Ended September 30, 2013
 
 
Residential
Real Estate
 
Commercial
Real Estate
 
Commercial
 
Consumer
 
Total
Allowance for loan losses:
 
 

 
 

 
 

 
 

 
 

Balance, beginning of period
 
$
984

 
$
2,918

 
$
547

 
$
1,078

 
$
5,527

Provision (credit) charged to expense
 
33

 
(36
)
 
168

 
(222
)
 
(57
)
Losses charged off
 
(18
)
 
—

 
—

 
(175
)
 
(193
)
Recoveries
 
73

 
—

 
—

 
109

 
182

Balance, end of period
 
$
1,072

 
$
2,882

 
$
715

 
$
790

 
$
5,459

 

 
 
Nine Months Ended September 30, 2013
 
 
Residential
Real Estate
 
Commercial
Real Estate
 
Commercial
 
Consumer
 
Total
Allowance for loan losses:
 
 

 
 

 
 

 
 

 
 

Balance, beginning of period
 
$
1,149

 
$
3,107

 
$
371

 
$
1,206

 
$
5,833

Provision (credit) charged to expense
 
(97
)
 
13

 
274

 
(89
)
 
101

Losses charged off
 
(72
)
 
(238
)
 
—

 
(573
)
 
(883
)
Recoveries
 
92

 
—

 
70

 
246

 
408

Balance, end of period
 
$
1,072

 
$
2,882

 
$
715

 
$
790

 
$
5,459

 

The following tables present the recorded investment in loans based on portfolio segment and impairment method as of September 30, 2014, and December 31, 2013: 
 
 
September 30, 2014
 
 
Residential
Real Estate
 
Commercial
Real Estate
 
Commercial
 
Consumer
 
Total
Loans:
 
 

 
 

 
 

 
 

 
 

Ending balance
 
$
282,298

 
$
235,878

 
$
72,099

 
$
100,074

 
$
690,349

Ending balance:  individually evaluated for impairment
 
1,080

 
89

 
—

 
283

 
1,452

Ending balance:  collectively evaluated for impairment
 
$
281,218

 
$
235,789

 
$
72,099

 
$
99,791

 
$
688,897

Allowance for loan losses:
 
 

 
 

 
 

 
 

 
 

Ending balance
 
$
1,258

 
$
2,606

 
$
909

 
$
691

 
$
5,464

Ending balance:  individually evaluated for impairment
 
7

 
—

 
—

 
22

 
29

Ending balance:  collectively evaluated for impairment
 
$
1,251

 
$
2,606

 
$
909

 
$
669

 
$
5,435

 

15


 
 
December 31, 2013
 
 
Residential
Real Estate
 
Commercial
Real Estate
 
Commercial
 
Consumer
 
Total
Loans:
 
 

 
 

 
 

 
 

 
 

Ending balance
 
$
191,007

 
$
142,429

 
$
55,168

 
$
107,562

 
$
496,166

Ending balance:  individually evaluated for impairment
 
1,684

 
1,054

 
—

 
339

 
3,077

Ending balance:  collectively evaluated for impairment
 
$
189,323

 
$
141,375

 
$
55,168

 
$
107,223

 
$
493,089

Allowance for loan losses:
 
 

 
 

 
 

 
 

 
 

Ending balance
 
$
1,219

 
$
2,517

 
$
819

 
$
871

 
$
5,426

Ending balance:  individually evaluated for impairment
 
116

 
98

 
—

 
28

 
242

Ending balance:  collectively evaluated for impairment
 
$
1,103

 
$
2,419

 
$
819

 
$
843

 
$
5,184

 
The Company utilizes a risk grading matrix to assign a risk grade to each of its commercial loans. Loans are graded on a scale of 1 to 9. A description of the general characteristics of the nine risk grades is as follows:
 
•
“Pass” (Grades 1-5) - Higher quality loans that do not fit any of the other categories described below.

•
“Special Mention” (Grade 6) - Loans that possess some credit deficiency or potential weakness which deserve close attention.

•
“Substandard” (Grade 7) - Loans that possess a defined weakness or weaknesses that jeopardize the liquidation of the debt. Loans characterized by the distinct possibility that the institution will sustain some loss if the deficiencies are not corrected. Loans that are inadequately protected by the current net worth and paying capacity of the obligor or of the collateral pledged, if any.

•
“Doubtful” (Grade 8) - Such loans have been placed on nonaccrual status and may be heavily dependent upon collateral possessing a value that is difficult to determine or based upon some near-term event which lacks clear certainty. These loans have all of the weaknesses of those classified as Substandard; however, based on existing conditions, these weaknesses make full collection of the principal balance highly improbable.

•
“Loss” (Grade 9) - Loans that are considered uncollectible and of such little value that continuing to carry them as assets is not warranted.

Nonaccrual Loans
 
Any loan which becomes 90 days delinquent or has the full collection of principal and interest in doubt will be considered for nonaccrual status. At the time a loan is placed on nonaccrual, all accrued but unpaid interest will be reversed from interest income. Placing the loan on nonaccrual does not relieve the borrower of the obligation to repay interest. A loan placed on nonaccrual may be restored to accrual status when all delinquent principal and interest has been brought current, and the Company expects full payment of the remaining contractual principal and interest.
 
The following tables present the credit risk profile of the Company’s loan portfolio based on rating category and payment activity as of September 30, 2014 and December 31, 2013: 

16


 
 
September 30, 2014
 
 
Commercial
Real Estate
 
Commercial
Rating:
 
 

 
 

1-5 Pass
 
$
233,437

 
$
69,649

6 Special Mention
 
815

 
—

7 Substandard
 
1,626

 
2,450

8 Doubtful
 
—

 
—

Total
 
$
235,878

 
$
72,099

 
 
 
September 30, 2014
 
 
Residential
Real Estate
 
Consumer
Performing
 
$
282,241

 
$
99,921

Nonaccrual
 
57

 
153

Total
 
$
282,298

 
$
100,074

 
 
 
December 31, 2013
 
 
Commercial
Real Estate
 
Commercial
Rating:
 
 

 
 

1-5 Pass
 
$
139,052

 
$
54,035

6 Special Mention
 
2,323

 
1,133

7 Substandard
 
1,054

 
—

8 Doubtful
 
—

 
—

Total
 
$
142,429

 
$
55,168

 
 
 
December 31, 2013
 
 
Residential
Real Estate
 
Consumer
Performing
 
$
190,377

 
$
107,412

Nonaccrual
 
630

 
150

Total
 
$
191,007

 
$
107,562

 
The following tables present the Company’s loan portfolio delinquency analysis as of September 30, 2014 and December 31, 2013: 
 
 
September 30, 2014
 
 
30-59
Days
Past Due
 
60-89
Days
Past Due
 
90 Days 
or More
Past Due
 
Total 
Past Due
 
Current
 
Total
Loans
Receivable
 
Non-
accrual
Loans
 
Total Loans
90 Days or
More Past
Due and
Accruing
Residential real estate
 
$
48

 
$
160

 
$
96

 
$
304

 
$
281,994

 
$
282,298

 
$
57

 
$
96

Commercial real estate
 
—

 
—

 
—

 
—

 
235,878

 
235,878

 
89

 
—

Commercial
 
—

 
—

 
—

 
—

 
72,099

 
72,099

 
—

 
—

Consumer
 
296

 
93

 
55

 
444

 
99,630

 
100,074

 
153

 
5

Total
 
$
344

 
$
253

 
$
151

 
$
748

 
$
689,601

 
$
690,349

 
$
299

 
$
101

 

17


 
 
December 31, 2013
 
 
30-59
Days
Past Due
 
60-89
Days
Past Due
 
90 Days 
or More
Past Due
 
Total 
Past Due
 
Current
 
Total
Loans
Receivable
 
Non-
accrual
Loans
 
Total Loans
90 Days or
More Past
Due and
Accruing
Residential real estate
 
$
122

 
$
—

 
$
603

 
$
725

 
$
190,282

 
$
191,007

 
$
630

 
$
—

Commercial real estate
 
—

 
—

 
955

 
955

 
141,474

 
142,429

 
1,054

 
—

Commercial
 
—

 
—

 
—

 
—

 
55,168

 
55,168

 
—

 
—

Consumer
 
484

 
45

 
84

 
613

 
106,949

 
107,562

 
150

 
18

Total
 
$
606

 
$
45

 
$
1,642

 
$
2,293

 
$
493,873

 
$
496,166

 
$
1,834

 
$
18

 
Impaired Loans
 
A loan is designated as impaired, in accordance with the impairment accounting guidance (ASC 310-10-35-16) when, based on current information or events, it is probable that the Company will be unable to collect all amounts due (principal and interest) according to the contractual terms of the loan agreement. Payments with delays generally not exceeding 90 days outstanding are not considered impaired. Certain nonaccrual and substantially all delinquent loans more than 90 days past due may be considered to be impaired. Generally, loans are placed on nonaccrual status at 90 days past due and accrued interest is reversed against earnings, unless the loan is well-secured and in the process of collection. The accrual of interest on impaired and nonaccrual loans is discontinued when, in management’s opinion, the borrower may be unable to meet payments as they become due.
 
Impaired loans include nonperforming commercial loans but also include loans modified in TDRs where concessions have been granted to borrowers experiencing financial difficulties. These concessions could include a reduction in the interest rate on the loan, payment extensions, forgiveness of principal, forbearance, or other actions intended to maximize collection.
 
The following table presents the Company’s impaired loans as of September 30, 2014 and December 31, 2013: 
 
 
September 30, 2014
 
December 31, 2013
 
 
Recorded
Balance
 
Unpaid
Principal
Balance
 
Specific
Allowance
 
Recorded
Balance
 
Unpaid
Principal
Balance
 
Specific
Allowance
Loans without a specific valuation allowance
 
 

 
 

 
 

 
 

 
 

 
 

Residential real estate loans
 
$
1,048

 
$
1,057

 
$
—

 
$
1,551

 
$
1,842

 
$
—

Commercial real estate loans
 
89

 
89

 
—

 
956

 
2,310

 
—

Commercial loans
 
—

 
—

 
—

 
—

 
—

 
—

Consumer loans
 
222

 
368

 
—

 
271

 
326

 
—

Total
 
1,359

 
1,514

 
—

 
2,778

 
4,478

 
—

Loans with a specific valuation allowance
 
 

 
 

 
 

 
 

 
 

 
 

Residential real estate loans
 
32

 
32

 
7

 
133

 
141

 
116

Commercial real estate loans
 
—

 
—

 
—