Document


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 ended September 30, 2016
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.)
 
 
 
11201 USA Parkway
Fishers, IN
 
46037
(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 þ
Non-accelerated Filer ¨ (Do not check if a smaller reporting company)
Smaller Reporting Company ¨
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ No þ
 
As of November 3, 2016, the registrant had 5,533,050 shares of common stock issued and outstanding.



Cautionary Note Regarding Forward-Looking Statements
  
This Quarterly Report on Form 10-Q contains “forward-looking statements” within the meaning of the federal securities laws. These statements are not historical facts, but rather statements based on the current expectations of First Internet Bancorp and its consolidated subsidiaries (“we,” “our,” “us” or the “Company”) regarding its business strategies, intended results and future performance. Forward-looking statements are generally preceded by terms such as “expects,” “believes,” “anticipates,” “intends,” “plan,” and similar expressions. Such statements are subject to certain risks and uncertainties including: general economic conditions, whether national or regional, and conditions in the lending markets in which we participate that may have an adverse effect on the demand for our loans and other products; our credit quality and related levels of nonperforming assets and loan losses, and the value and salability of the real estate that we own or that is the collateral for our loans; failures of or interruptions in the communication and information systems on which we rely to conduct our business that could reduce our revenues, increase our costs or lead to disruptions in our business; our plans to grow our commercial real estate and commercial and industrial loan portfolios which may carry greater risks of non-payment or other unfavorable consequences; our dependence on capital distributions from First Internet Bank of Indiana (the “Bank”); results of examinations of us by our regulators, including the possibility that our regulators may, among other things, require us to increase our allowance for loan losses or to write-down assets; changing bank regulatory conditions, policies or programs, whether arising as new legislation or regulatory initiatives, that could lead to restrictions on activities of banks generally, or the Bank in particular; more restrictive regulatory capital requirements; increased costs, including deposit insurance premiums; regulation or prohibition of certain income producing activities or changes in the secondary market for loans and other products; changes in market rates and prices that may adversely impact the value of securities, loans, deposits and other financial instruments and the interest rate sensitivity of our balance sheet; our liquidity requirements being adversely affected by changes in our assets and liabilities; the effect of legislative or regulatory developments, including changes in laws concerning taxes, banking, securities, insurance and other aspects of the financial services industry; competitive factors among financial services organizations, including product and pricing pressures and our ability to attract, develop and retain qualified banking professionals; the growth and profitability of noninterest or fee income being less than expected; the loss of any key members of senior management; the effect of changes in accounting policies and practices, as may be adopted by the Financial Accounting Standards Board, the Securities and Exchange Commission (the “SEC”), the Public Company Accounting Oversight Board and other regulatory agencies; and the effect of fiscal and governmental policies of the United States federal government. 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 SEC. We caution 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 our financial performance and could cause our 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, we do not undertake, and specifically disclaim 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.
FINANCIAL STATEMENTS 

First Internet Bancorp
Condensed Consolidated Balance Sheets
(Amounts in thousands except share data)
 
 
September 30, 2016
 
December 31, 2015
 
 
(Unaudited)
 
 
Assets
 
 

 
 

Cash and due from banks
 
$
2,314

 
$
1,063

Interest-bearing demand deposits
 
65,511

 
24,089

Total cash and cash equivalents
 
67,825

 
25,152

Interest-bearing time deposits
 
250

 
1,000

Securities available-for-sale, at fair value (amortized cost of $469,539 and $215,576 in 2016 and 2015, respectively)
 
470,978

 
213,698

Securities held-to-maturity, at amortized cost (fair value of $5,578 and $0 in 2016 and 2015, respectively)
 
5,500

 
—

Loans held-for-sale (includes $31,196 and $24,065 at fair value in 2016 and 2015, respectively)
 
32,471

 
36,518

Loans
 
1,198,932

 
953,859

Allowance for loan losses
 
(10,561
)
 
(8,351
)
Net loans
 
1,188,371

 
945,508

Accrued interest receivable
 
5,848

 
4,105

Federal Home Loan Bank of Indianapolis stock
 
8,595

 
8,595

Cash surrender value of bank-owned life insurance
 
18,044

 
12,727

Premises and equipment, net
 
10,116

 
8,521

Goodwill
 
4,687

 
4,687

Other real estate owned
 
4,533

 
4,488

Accrued income and other assets
 
6,978

 
4,871

Total assets
 
$
1,824,196

 
$
1,269,870

Liabilities and Shareholders’ Equity
 
 

 
 

Liabilities
 
 

 
 

Noninterest-bearing deposits
 
$
32,938

 
$
23,700

Interest-bearing deposits
 
1,460,663

 
932,354

Total deposits
 
1,493,601

 
956,054

Advances from Federal Home Loan Bank
 
147,978

 
190,957

Subordinated debt, net of unamortized discounts and debt issuance costs of $1,459 and $276 in 2016 and 2015, respectively
 
36,541

 
12,724

Accrued interest payable
 
125

 
117

Accrued expenses and other liabilities
 
8,797

 
5,688

Total liabilities
 
1,687,042

 
1,165,540

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; 5,533,050 and 4,481,347 shares issued and outstanding in 2016 and 2015, respectively
 
95,839

 
72,559

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

 
—

Retained earnings
 
40,389

 
32,980

Accumulated other comprehensive income (loss)
 
926

 
(1,209
)
Total shareholders’ equity
 
137,154

 
104,330

Total liabilities and shareholders’ equity
 
$
1,824,196

 
$
1,269,870


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,
 
 
2016
 
2015
 
2016
 
2015
Interest Income
 
 

 
 

 
 

 
 

Loans
 
$
12,544

 
$
9,326

 
$
35,394

 
$
26,759

Securities – taxable
 
2,148

 
994

 
5,064

 
2,661

Securities – non-taxable
 
637

 
116

 
1,170

 
175

Other earning assets
 
142

 
100

 
507

 
258

Total interest income
 
15,471

 
10,536

 
42,135

 
29,853

Interest Expense
 
 

 
 

 
 

 
 

Deposits
 
4,368

 
2,260

 
11,186

 
6,350

Other borrowed funds
 
765

 
437

 
2,164

 
1,318

Total interest expense
 
5,133

 
2,697

 
13,350

 
7,668

Net Interest Income
 
10,338

 
7,839

 
28,785

 
22,185

Provision for Loan Losses
 
2,204

 
454

 
4,074

 
1,200

Net Interest Income After Provision for Loan Losses
 
8,134

 
7,385

 
24,711

 
20,985

Noninterest Income
 
 

 
 

 
 

 
 

Service charges and fees
 
207

 
202

 
622

 
571

Mortgage banking activities
 
4,442

 
2,095

 
9,991

 
7,195

Gain on sale of securities
 
—

 
—

 
177

 
—

Gain (loss) on asset disposals
 
5

 
(27
)
 
(59
)
 
(74
)
Other
 
244

 
104

 
455

 
306

Total noninterest income
 
4,898

 
2,374

 
11,186

 
7,998

Noninterest Expense
 
 

 
 

 
 

 
 

Salaries and employee benefits
 
4,550

 
3,446

 
12,777

 
10,811

Marketing, advertising, and promotion
 
454

 
544

 
1,352

 
1,330

Consulting and professional services
 
901

 
544

 
2,434

 
1,700

Data processing
 
286

 
248

 
835

 
729

Loan expenses
 
240

 
97

 
624

 
459

Premises and equipment
 
983

 
676

 
2,744

 
2,009

Deposit insurance premium
 
420

 
163

 
815

 
473

Other
 
579

 
489

 
1,712

 
1,280

Total noninterest expense
 
8,413

 
6,207

 
23,293

 
18,791

Income Before Income Taxes
 
4,619

 
3,552

 
12,604

 
10,192

Income Tax Provision
 
1,521

 
1,229

 
4,240

 
3,541

Net Income
 
$
3,098

 
$
2,323


$
8,364

 
$
6,651

Income Per Share of Common Stock
 
 

 
 

 
 

 
 

Basic
 
$
0.55

 
$
0.51

 
$
1.66

 
$
1.47

Diluted
 
$
0.55

 
$
0.51

 
$
1.65

 
$
1.46

Weighted-Average Number of Common Shares Outstanding
 
 

 
 

 
 

 
 

Basic
 
5,597,867

 
4,532,360

 
5,039,497

 
4,526,377

Diluted
 
5,622,181

 
4,574,455

 
5,063,299

 
4,549,447

Dividends Declared Per Share
 
$
0.06

 
$
0.06

 
$
0.18

 
$
0.18


See Notes to Condensed Consolidated Financial Statements

2


First Internet Bancorp
Condensed Consolidated Statements of Comprehensive Income – Unaudited
(Amounts in thousands)
 
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
 
2016
 
2015
 
2016
 
2015
Net income
 
$
3,098

 
$
2,323

 
$
8,364

 
$
6,651

Other comprehensive income (loss)
 
 
 
 
 
 
 
 
Net unrealized holding gains (losses) on securities available-for-sale recorded within other comprehensive income (loss) before income tax
 
(2,297
)
 
1,193

 
3,494

 
(528
)
Reclassification adjustment for gains realized
 
—

 
—

 
(177
)
 
—

Other comprehensive income (loss) before income tax
 
(2,297
)
 
1,193

 
3,317

 
(528
)
Income tax provision (benefit)
 
(816
)
 
429

 
1,182

 
(189
)
Other comprehensive income (loss)
 
(1,481
)
 
764

 
2,135

 
(339
)
Comprehensive income
 
$
1,617

 
$
3,087

 
$
10,499

 
$
6,312

 
 See Notes to Condensed Consolidated Financial Statements

3


First Internet Bancorp
Condensed Consolidated Statement of Shareholders’ Equity - Unaudited
Nine Months Ended September 30, 2016
(Amounts in thousands except per share data)
 
 
Voting and
Nonvoting
Common
Stock
 
Accumulated
Other
Comprehensive
Income (Loss)
 
Retained
Earnings
 
Total
Shareholders’
Equity
Balance, January 1, 2016
 
$
72,559

 
$
(1,209
)
 
$
32,980

 
$
104,330

Net income
 
—

 
—

 
8,364

 
8,364

Other comprehensive income
 
—

 
2,135

 
—

 
2,135

Dividends declared ($0.18 per share)
 
—

 
—

 
(955
)
 
(955
)
Net cash proceeds from common stock issuance
 
22,754

 
—

 
—

 
22,754

Recognition of the fair value of share-based compensation
 
547

 
—

 
—

 
547

Deferred stock rights and restricted stock units issued in lieu of cash dividends payable on outstanding deferred stock rights and restricted stock units
 
22

 
—

 
—

 
22

Excess tax benefit on share-based compensation
 
48

 
—

 
—

 
48

Common stock redeemed for the net settlement of share-based awards
 
(91
)
 
—

 
—

 
(91
)
Balance, September 30, 2016
 
$
95,839

 
$
926

 
$
40,389

 
$
137,154

 
See Notes to Condensed Consolidated Financial Statements

4


First Internet Bancorp
Condensed Consolidated Statements of Cash Flows – Unaudited
(Amounts in thousands)
 
 
Nine Months Ended September 30,
 
 
2016
 
2015
Operating Activities
 
 

 
 

Net income
 
$
8,364

 
$
6,651

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

 
 

Depreciation and amortization
 
2,567

 
1,388

Increase in cash surrender value of bank-owned life insurance
 
(317
)
 
(300
)
Provision for loan losses
 
4,074

 
1,200

Share-based compensation expense
 
547

 
631

Gain from sale of available-for-sale securities
 
(177
)
 
—

Loans originated for sale
 
(439,159
)
 
(386,353
)
Proceeds from sale of loans
 
452,242

 
400,003

Gain on loans sold
 
(8,476
)
 
(6,895
)
(Increase) decrease in fair value of loans held-for-sale
 
(560
)
 
143

Gain on derivatives
 
(955
)
 
(443
)
Net change in accrued income and other assets
 
(3,318
)
 
304

Net change in accrued expenses and other liabilities
 
350

 
407

Net cash provided by operating activities
 
15,182

 
16,736

Investing Activities
 
 
 
 
Net loan activity, excluding purchases
 
(210,844
)
 
(143,481
)
Net change in interest-bearing time deposits
 
750

 
750

Maturities of securities available-for-sale
 
29,015

 
16,322

Proceeds from sale of securities available-for-sale
 
49,430

 
—

Purchase of securities available-for-sale
 
(331,501
)
 
(78,481
)
Purchase of securities held-to-maturity
 
(5,500
)
 
—

Purchase of Federal Home Loan Bank of Indianapolis stock
 
—

 
(1,596
)
Purchase of bank-owned life insurance
 
(5,000
)
 
—

Purchase of premises and equipment
 
(2,867
)
 
(2,233
)
Loans purchased
 
(36,138
)
 
—

Net cash used in investing activities
 
(512,655
)
 
(208,719
)
Financing Activities
 
 
 
 
Net increase in deposits
 
537,547

 
141,152

Cash dividends paid
 
(869
)
 
(800
)
Net proceeds from issuance of subordinated debt
 
23,757

 
—

Proceeds from advances from Federal Home Loan Bank
 
65,000

 
220,000

Repayment of advances from Federal Home Loan Bank
 
(108,000
)
 
(176,000
)
Net proceeds from common stock issuance
 
22,754

 
—

Other, net
 
(43
)
 
(13
)
Net cash provided by financing activities
 
540,146

 
184,339

Net Increase (Decrease) in Cash and Cash Equivalents
 
42,673

 
(7,644
)
Cash and Cash Equivalents, Beginning of Period
 
25,152

 
28,289

Cash and Cash Equivalents, End of Period
 
$
67,825

 
$
20,645

Supplemental Disclosures
 
 
 
 
Cash paid during the period for interest
 
$
13,342

 
$
7,653

Cash paid during the period for taxes
 
5,886

 
2,503

Loans transferred to other real estate owned
 
45

 
—

Cash dividends declared, paid in subsequent period
 
331

 
267

Securities purchased during the period, settled in subsequent period
 
2,238

 
3,922

See Notes to Condensed Consolidated Financial Statements

5


First Internet Bancorp
Notes to Condensed Consolidated Financial Statements – Unaudited
(Table amounts in thousands except share and 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 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, 2016 are not necessarily indicative of the results expected for the year ending December 31, 2016 or any other period. The September 30, 2016 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, 2015.
 
The preparation of the condensed consolidated financial statements in conformity with 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 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.
 
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.
 
Certain reclassifications have been made to the 2015 financial statements to conform to the presentation of the 2016 financial statements. These reclassifications had no effect on net income.


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, 2016 and 2015. 
 
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
 
2016
 
2015
 
2016
 
2015
Basic earnings per share
 
 

 
 

 
 
 
 
Net income
 
$
3,098

 
$
2,323

 
$
8,364

 
$
6,651

Weighted-average common shares
 
5,597,867

 
4,532,360

 
5,039,497

 
4,526,377

Basic earnings per common share
 
$
0.55

 
$
0.51

 
$
1.66

 
$
1.47

Diluted earnings per share
 
 

 
 

 
 

 
 

Net income
 
$
3,098

 
$
2,323

 
$
8,364

 
$
6,651

Weighted-average common shares
 
5,597,867

 
4,532,360

 
5,039,497

 
4,526,377

Dilutive effect of warrants
 
8,877

 
17,264

 
9,967

 
8,153

Dilutive effect of equity compensation
 
15,437

 
24,831

 
13,835

 
14,917

     Weighted-average common and incremental shares
 
5,622,181

 
4,574,455

 
5,063,299

 
4,549,447

Diluted earnings per common share
 
$
0.55

 
$
0.51

 
$
1.65

 
$
1.46

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
 
—

 
—

 
—

 
—

  
Note 3:         Securities
 
The following tables summarize securities available-for-sale and securities held-to-maturity as of September 30, 2016 and December 31, 2015. There were no securities held-to-maturity as of December 31, 2015.
 
 
September 30, 2016
 
 
Amortized
 
Gross Unrealized
 
Fair
 
 
Cost
 
Gains
 
Losses
 
Value
Securities available-for-sale
 
 

 
 

 
 

 
 

U.S. Government-sponsored agencies
 
$
85,630

 
$
652

 
$
(292
)
 
$
85,990

Municipal securities
 
96,665

 
1,345

 
(509
)
 
97,501

Mortgage-backed securities
 
244,780

 
1,715

 
(410
)
 
246,085

Asset-backed securities
 
19,464

 
59

 
(27
)
 
19,496

Corporate securities
 
20,000

 
—

 
(1,120
)
 
18,880

Other securities
 
3,000

 
26

 
—

 
3,026

Total available-for-sale
 
$
469,539

 
$
3,797

 
$
(2,358
)
 
$
470,978

 
 
September 30, 2016
 
 
Amortized
 
Gross Unrealized
 
Fair
 
 
Cost
 
Gains
 
Losses
 
Value
Securities held-to-maturity
 
 

 
 

 
 

 
 

Corporate securities
 
$
5,500

 
$
78

 
$
—

 
$
5,578

Total held-to-maturity
 
$
5,500

 
$
78

 
$
—

 
$
5,578



7


 
 
 
December 31, 2015
 
 
Amortized
 
Gross Unrealized
 
Fair
 
 
Cost
 
Gains
 
Losses
 
Value
Securities available-for-sale
 
 

 
 

 
 

 
 

U.S. Government-sponsored agencies
 
$
38,093

 
$
139

 
$
(482
)
 
$
37,750

Municipal securities
 
21,091

 
385

 
(7
)
 
21,469

Mortgage-backed securities
 
113,948

 
110

 
(1,006
)
 
113,052

Asset-backed securities
 
19,444

 
—

 
(83
)
 
19,361

Corporate securities
 
20,000

 
—

 
(913
)
 
19,087

Other securities
 
3,000

 
—

 
(21
)
 
2,979

Total available-for-sale
 
$
215,576

 
$
634

 
$
(2,512
)
 
$
213,698


The carrying value of securities at September 30, 2016 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
 
$
—

 
$
—

One to five years
 
298

 
263

Five to ten years
 
36,851

 
36,536

After ten years
 
165,146

 
165,572

 
 
202,295

 
202,371

Mortgage-backed securities
 
244,780

 
246,085

Asset-backed securities
 
19,464

 
19,496

Other securities
 
3,000

 
3,026

Total
 
$
469,539

 
$
470,978

 
 
Held-to-Maturity
 
 
Amortized
Cost
 
Fair
Value
Five to ten years
 
$
5,500

 
$
5,578

Total
 
$
5,500

 
$
5,578


 
There were no sales of available-for-sale securities during the three months ended September 30, 2016. Gross gains of $0.2 million and gross losses of $0.0 million resulted from sales of available-for-sale securities during the nine months ended September 30, 2016. There were no sales of available-for-sale securities during the three and nine months ended September 30, 2015.
 
Certain investments in debt securities are reported in the condensed consolidated financial statements at an amount less than their historical cost. The total fair value of these investments at September 30, 2016 and December 31, 2015 was $166.9 million and $166.1 million, which was approximately 35% and 78%, respectively, of the Company’s available-for-sale securities portfolio. These declines resulted primarily from fluctuations in market interest rates after purchase.

U. S. Government-Sponsored Agencies, Municipal Securities and Corporate Securities

The unrealized losses on the Company’s investments in securities issued by U.S. Government-sponsored agencies, municipal organizations and corporate entities 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 and it is not likely that 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, 2016.

8


 
Mortgage-Backed and Asset-Backed Securities
 
The unrealized losses on the Company’s investments in mortgage-backed and asset-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 Company does not intend to sell the investments and it is not likely that 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, 2016.

Should any future impairment of these securities become other-than-temporary, the cost basis of the security will be reduced, with 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 available-for-sale securities portfolio’s 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, 2016 and December 31, 2015. 
 
 
September 30, 2016
 
 
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 agencies
 
$
29,919

 
$
(257
)
 
$
263

 
$
(35
)
 
$
30,182

 
$
(292
)
Municipal securities
 
38,854

 
(509
)
 
—

 
—

 
38,854

 
(509
)
Mortgage-backed securities
 
64,526

 
(410
)
 
—

 
—

 
64,526

 
(410
)
Asset-backed securities
 
4,913

 
(9
)
 
9,589

 
(18
)
 
14,502

 
(27
)
Corporate securities
 
4,861

 
(139
)
 
14,019

 
(981
)
 
18,880

 
(1,120
)
Total
 
$
143,073

 
$
(1,324
)
 
$
23,871

 
$
(1,034
)
 
$
166,944

 
$
(2,358
)
 
 
 
December 31, 2015
 
 
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 agencies
 
$
18,289

 
$
(237
)
 
$
8,537

 
$
(245
)
 
$
26,826

 
$
(482
)
Municipal securities
 
1,026

 
(7
)
 
—

 
—

 
1,026

 
(7
)
Mortgage-backed securities
 
74,198

 
(562
)
 
22,655

 
(444
)
 
96,853

 
(1,006
)
Asset-backed securities
 
19,361

 
(83
)
 
—

 
—

 
19,361

 
(83
)
Corporate securities
 
19,087

 
(913
)
 
—

 
—

 
19,087

 
(913
)
Other securities
 
2,979

 
(21
)
 
—

 
—

 
2,979

 
(21
)
Total
 
$
134,940

 
$
(1,823
)
 
$
31,192

 
$
(689
)
 
$
166,132

 
$
(2,512
)

There were no held-to-maturity securities in an unrealized loss position at September 30, 2016, and there were no held-to-maturity securities at December 31, 2015.


9


There were no amounts reclassified from accumulated other comprehensive income (loss) during the three and nine months ended September 30, 2015. Amounts reclassified from accumulated other comprehensive income (loss) and the affected line items in the consolidated statements of income during the three and nine months ended September 30, 2016 were as follows:
Details About Accumulated Other Comprehensive Income (Loss) Components
 
Amounts Reclassified from
Accumulated Other Comprehensive Income (Loss) for the
 
Affected Line Item in the
Statements of Income
 
Three Months Ended September 30, 2016
 
Nine Months Ended September 30, 2016
 
Unrealized gains and losses on securities available-for-sale
 
 

 
 

 
 
Gain realized in earnings
 
$
—

 
$
177

 
Gain on sale of securities
Total reclassified amount before tax
 
—

 
177

 
Income Before Income Taxes
Tax expense
 
—

 
60

 
Income Tax Provision
Total reclassifications out of accumulated other comprehensive income (loss)
 
$
—

 
$
117

 
Net Income

Note 4:        Loans
 
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.
 
Categories of loans include:
 
 
September 30,
2016
 
December 31,
2015
Commercial loans
 
 

 
 

Commercial and industrial
 
$
107,250

 
$
102,000

Owner-occupied commercial real estate
 
45,540

 
44,462

Investor commercial real estate
 
12,752

 
16,184

Construction
 
56,391

 
45,898

Single tenant lease financing
 
571,972

 
374,344

Total commercial loans
 
793,905

 
582,888

Consumer loans
 
 
 
 
Residential mortgage
 
200,889

 
214,559

Home equity
 
37,849

 
43,279

Other consumer
 
163,158

 
108,312

Total consumer loans
 
401,896

 
366,150

Total commercial and consumer loans
 
1,195,801

 
949,038

Deferred loan origination costs and premiums and discounts on purchased loans
 
3,131

 
4,821

Total loans
 
1,198,932

 
953,859

Allowance for loan losses
 
(10,561
)
 
(8,351
)
Net loans
 
$
1,188,371

 
$
945,508

 

10


The risk characteristics of each loan portfolio segment are as follows:

Commercial and Industrial: Commercial and industrial loans’ sources of repayment 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 and industrial loans are secured by the assets being financed and may incorporate a personal guarantee.

Owner-Occupied Commercial Real Estate: The primary source of repayment is the cash flow from the ongoing operations and activities conducted by the borrower, or an affiliate of the borrower, who owns the property. This portfolio segment is generally concentrated in the Central Indiana and greater Phoenix, Arizona markets and its loans often times are secured by manufacturing and service facilities, as well as office buildings.

Investor Commercial Real Estate: These loans are underwritten primarily based on the cash flow expected to be generated from the property and are secondarily supported by the value of the real estate. These loans typically incorporate a personal guarantee. This portfolio segment 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. Investor commercial real estate loans may be more adversely affected by conditions in the real estate markets, changing industry dynamics, or the overall health of the general economy. The properties securing the Company’s investor commercial real estate portfolio tend to be diverse in terms of property type and are typically located in the state of Indiana and markets adjacent to Indiana. Management monitors and evaluates commercial real estate loans based on property financial performance, collateral value, guarantor strength, 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.

Construction: Construction loans are secured by real estate and improvements and are made to assist in the construction of new structures, which may include commercial (retail, industrial, office, multi-family) properties or single family residential properties offered for sale by the builder. These loans generally finance a variety of project costs, including land, site preparation, construction, closing and soft costs and interim financing needs. The cash flows of builders, while initially predictable, may fluctuate with market conditions, and the value of the collateral securing these loans may be subject to fluctuations based on general economic changes.
Single Tenant Lease Financing: These loans are made to property owners of real estate subject to long term lease arrangements with single tenant operators. The real estate is typically operated by regionally, nationally or globally branded businesses.  The loans are underwritten based on the financial strength of the borrower, characteristics of the real estate, cash flows generated from the lease arrangements and the financial strength of the tenant.  Similar to the other loan portfolio segments, management monitors and evaluates these loans based on borrower and tenant financial performance, collateral value, industry trends and other risk grade criteria.

Residential Mortgage: With respect to residential loans that are secured by 1-4 family residences and are generally owner occupied, the Company typically establishes a maximum loan-to-value ratio and requires private mortgage insurance if that ratio is exceeded. Repayment of these loans is primarily dependent on the financial circumstances of the borrowers, which can be impacted by economic conditions in their market areas such as unemployment levels. Repayment can also be impacted by changes in residential property values. 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.
Home Equity: Home equity loans and lines of credit are typically secured by a subordinate interest in 1-4 family residences. The properties securing the Company's home equity portfolio segment are generally geographically diverse as the Company offers these products on a nationwide basis. Repayment of home equity loans and lines of credit may be impacted by changes in property values on residential properties and unemployment levels, among other economic conditions and financial circumstances in the market.
Other Consumer: These loans primarily consist of consumer loans and credit cards. Consumer loans may be secured by consumer assets such as horse trailers or recreational vehicles. Some consumer loans are unsecured, such as small installment loans, home improvement 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.

11


Allowance for Loan Losses Methodology
 
Company policy is designed to maintain an adequate allowance for loan losses (“ALLL”). The portfolio is segmented by loan type, and the required ALLL for types of performing homogeneous loans which do not have a specific reserve is determined by applying a factor based on average historical losses, adjusted for current economic factors and portfolio trends. 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, or classified 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 costs 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. 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 less costs to sell and allows existing methods for recognizing interest income.
 
Provision for Loan Losses
 
A provision for estimated losses on loans is charged to income based upon management’s evaluation of the potential losses. Such an evaluation, which includes a review of all loans for which full repayment 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 attempts 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.
 
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 down 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. A home improvement loan generally is charged off no later than when it is 90 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, 2016 and 2015. 
 
 
Three Months Ended September 30, 2016
 
 
Commercial and industrial
 
Owner-occupied commercial real estate
 
Investor commercial real estate
 
Construction
 
Single tenant lease financing
 
Residential mortgage
 
Home equity
 
Other consumer
 
Total
Allowance for loan losses:
 
 

 
 

 
 

 
 

 
 

 
 
 
 
 
 
 
 
Balance, beginning of period
 
$
1,834

 
$
461

 
$
171

 
$
555

 
$
5,059

 
$
781

 
$
121

 
$
1,034

 
$
10,016

Provision (credit) charged to expense
 
1,174

 
(5
)
 
(7
)
 
37

 
832

 
(67
)
 
(15
)
 
255

 
2,204

Losses charged off
 
(1,582
)
 
—

 
—

 
—

 
—

 
—

 
—

 
(155
)
 
(1,737
)
Recoveries
 
—

 
—

 
—

 
—

 
—

 
2

 
4

 
72

 
78

Balance, end of period
 
$
1,426

 
$
456

 
$
164

 
$
592

 
$
5,891

 
$
716

 
$
110

 
$
1,206

 
$
10,561


12


 
 
Nine Months Ended September 30, 2016
 
 
Commercial and industrial
 
Owner-occupied commercial real estate
 
Investor commercial real estate
 
Construction
 
Single tenant lease financing
 
Residential mortgage
 
Home equity
 
Other consumer
 
Total
Allowance for loan losses:
 
 

 
 

 
 

 
 

 
 

 
 
 
 
 
 
 
 
Balance, beginning of period
 
$
1,367

 
$
476

 
$
212

 
$
500

 
$
3,931

 
$
896

 
$
125

 
$
844

 
$
8,351

Provision (credit) charged to expense
 
1,641

 
(20
)
 
(48
)
 
92

 
1,960

 
(75
)
 
8

 
516

 
4,074

Losses charged off
 
(1,582
)
 
—

 
—

 
—

 
—

 
(134
)
 
(33
)
 
(369
)
 
(2,118
)
Recoveries
 
—

 
—

 
—

 
—

 
—

 
29

 
10

 
215

 
254

Balance, end of period
 
$
1,426

 
$
456

 
$
164

 
$
592

 
$
5,891

 
$
716

 
$
110

 
$
1,206

 
$
10,561

 
 
Three Months Ended September 30, 2015
 
 
Commercial and industrial
 
Owner-occupied commercial real estate
 
Investor commercial real estate
 
Construction
 
Single tenant lease financing
 
Residential mortgage
 
Home equity
 
Other consumer
 
Total
Allowance for loan losses:
 
 

 
 

 
 

 
 

 
 

 
 
 
 
 
 
 
 
Balance, beginning of period
 
$
1,201

 
$
439

 
$
261

 
$
227

 
$
3,093

 
$
933

 
$
157

 
$
762

 
$
7,073

Provision (credit) charged to expense
 
29

 
16

 
(31
)
 
129

 
429

 
(132
)
 
(1
)
 
15

 
454

Losses charged off
 
—

 
—

 
—

 
—

 
—

 
(14
)
 
—

 
(62
)
 
(76
)
Recoveries
 
—

 
—

 
—

 
—

 
—

 
130

 
—

 
90

 
220

Balance, end of period
 
$
1,230

 
$
455

 
$
230

 
$
356

 
$
3,522

 
$
917

 
$
156

 
$
805

 
$
7,671

 
 
Nine Months Ended September 30, 2015
 
 
Commercial and industrial
 
Owner-occupied commercial real estate
 
Investor commercial real estate
 
Construction
 
Single tenant lease financing
 
Residential mortgage
 
Home equity
 
Other consumer
 
Total
Allowance for loan losses:
 
 

 
 

 
 

 
 

 
 

 
 
 
 
 
 
 
 
Balance, beginning of period
 
$
920

 
$
345

 
$
261

 
$
330

 
$
2,061

 
$
985

 
$
207

 
$
691

 
$
5,800

Provision (credit) charged to expense
 
310

 
110

 
(531
)
 
26

 
1,461

 
(284
)
 
(51
)
 
159

 
1,200

Losses charged off
 
—

 
—

 
—

 
—

 
—

 
(185
)
 
—

 
(351
)
 
(536
)
Recoveries
 
—

 
—

 
500

 
—

 
—

 
401

 
—

 
306

 
1,207

Balance, end of period
 
$
1,230

 
$
455

 
$
230

 
$
356

 
$
3,522

 
$
917

 
$
156

 
$
805

 
$
7,671



13


The following tables present the recorded investment in loans based on portfolio segment and impairment method as of September 30, 2016, and December 31, 2015. 
 
 
September 30, 2016
 
 
Commercial and industrial
 
Owner-occupied commercial real estate
 
Investor commercial real estate
 
Construction
 
Single tenant lease financing
 
Residential mortgage
 
Home equity
 
Other consumer
 
Total
Loans:
 
 

 
 

 
 

 
 

 
 

 
 
 
 
 
 
 
 
Ending balance: collectively evaluated for impairment
 
$
107,250

 
$
45,540

 
$
12,752

 
$
56,391

 
$
571,972

 
$
198,871

 
$
37,849

 
$
162,976

 
$
1,193,601

Ending balance:   individually evaluated for impairment
 
—

 
—

 
—

 
—

 
—

 
2,018

 
—

 
182

 
2,200

Ending balance
 
$
107,250

 
$
45,540

 
$
12,752

 
$
56,391

 
$
571,972

 
$
200,889

 
$
37,849

 
$
163,158

 
$
1,195,801

Allowance for loan losses:
 
 

 
 

 
 

 
 

 
 

 
 
 
 
 
 
 
 
Ending balance:   collectively evaluated for impairment
 
$
1,426

 
$
456

 
$
164

 
$
592

 
$
5,891

 
$
716

 
$
110

 
$
1,206

 
$
10,561

Ending balance:   individually evaluated for impairment
 
—

 
—

 
—

 
—

 
—

 
—

 
—

 
—

 
—

Ending balance
 
$
1,426

 
$
456

 
$
164

 
$
592

 
$
5,891

 
$
716

 
$
110

 
$
1,206

 
$
10,561

 
 
 
December 31, 2015
 
 
Commercial and industrial
 
Owner-occupied commercial real estate
 
Investor commercial real estate
 
Construction
 
Single tenant lease financing
 
Residential mortgage
 
Home equity
 
Other consumer
 
Total
Loans:
 
 

 
 

 
 

 
 

 
 

 
 
 
 
 
 
 
 
Ending balance:   collectively evaluated for impairment
 
$
102,000

 
$
44,462

 
$
16,184

 
$
45,898

 
$
374,344

 
$
213,426

 
$
43,279

 
$
108,163

 
$
947,756

Ending balance:   individually evaluated for impairment
 
—

 
—

 
—

 
—

 
—

 
1,133

 
—

 
149

 
1,282

Ending balance
 
$
102,000

 
$
44,462

 
$
16,184

 
$
45,898

 
$
374,344

 
$
214,559

 
$
43,279

 
$
108,312

 
$
949,038

Allowance for loan losses:
 
 

 
 

 
 

 
 

 
 

 
 
 
 
 
 
 
 
Ending balance: collectively evaluated for impairment
 
$
1,367

 
$
476

 
$
212

 
$
500

 
$
3,931

 
$
896

 
$
125

 
$
844

 
$
8,351

Ending balance:   individually evaluated for impairment
 
—

 
—

 
—

 
—

 
—

 
—

 
—

 
—

 
—

Ending balance
 
$
1,367

 
$
476

 
$
212

 
$
500

 
$
3,931

 
$
896

 
$
125

 
$
844

 
$
8,351




14


The Company utilizes a risk grading matrix to assign a risk grade to each of its commercial loans. In the third quarter 2016, the Company updated its risk grading matrix to improve precision within the “Pass” risk grades. Commercial loans are now graded on a scale of 1 to 10, whereas commercial loans were previously graded on a scale of 1 to 9. This update to the risk grading matrix did not have an impact on the ALLL. The following table illustrates the risk ratings utilized as of September 30, 2016 and December 31, 2015.
Rating
 
September 30, 2016
 
December 31, 2015
Pass
 
Grade 1-6
 
Grade 1-5
Special Mention
 
Grade 7
 
Grade 6
Substandard
 
Grade 8
 
Grade 7
Doubtful
 
Grade 9
 
Grade 8
Loss
 
Grade 10
 
Grade 9

A description of the general characteristics of the ten risk grades is as follows:
 
•
“Pass” (Grades 1-6) - Higher quality loans that do not fit any of the other categories described below.

•
“Special Mention” (Grade 7) - Loans that possess some credit deficiency or potential weakness which deserve close attention.

•
“Substandard” (Grade 8) - 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 9) - 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 10) - 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 for which the full collection of principal and interest may be in doubt will be considered for nonaccrual status. At the time a loan is placed on nonaccrual status, all accrued but unpaid interest will be reversed from interest income. Placing the loan on nonaccrual status does not relieve the borrower of the obligation to repay interest. A loan placed on nonaccrual status 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 commercial and consumer loan portfolios based on rating category and payment activity as of September 30, 2016 and December 31, 2015. 
 
 
September 30, 2016
 
 
Commercial and industrial
 
Owner-occupied commercial real estate
 
Investor commercial real estate
 
Construction
 
Single tenant lease financing
 
Total
Rating:
 
 

 
 

 
 

 
 

 
 

 
 
1-6 Pass
 
$
106,482

 
$
45,529

 
$
12,752

 
$
56,391

 
$
571,972

 
$
793,126

7 Special Mention
 
243

 
—

 
—

 
—

 
—

 
243

8 Substandard
 
525

 
11

 
—

 
—

 
—

 
536

9 Doubtful
 
—

 
—

 
—

 
—

 
—

 
—

Total
 
$
107,250

 
$
45,540

 
$
12,752

 
$
56,391

 
$
571,972

 
$
793,905


15


 
 
September 30, 2016
 
 
Residential mortgage
 
Home equity
 
Other consumer
 
Total
Performing
 
$
199,864

 
$