Enter Agreement, Regulation FD, Other Events, Exhibits
8-K
2018-05-01
Off-BS Arrangement, Regulation FD, Other Events, Exhibits
8-K
2018-04-25
Officers, Amend Bylaw, Shareholder Vote, Other Events, Exhibits
8-K
2018-04-13
Enter Agreement, Off-BS Arrangement, Exhibits
8-K
2018-03-29
Other Events
8-K
2018-03-15
Other Events
8-K
2018-03-09
Other Events
8-K
2018-03-02
Other Events
8-K
2018-02-23
Officers
8-K
2018-02-12
Other Events
8-K
2018-01-25
Earnings, Exhibits
8-K
2018-01-23
Officers, Exhibits
8-K
2018-01-18
Enter Agreement, Exhibits
Comparables
KEY
Keycorp
CSFL
Centerstate Bank
VBTX
Veritex Holdings
CNOB
Connectone Bancorp
FLIC
First of Long Island
EBTC
Enterprise Bancorp
CVCY
Central Valley Community Bancorp
SLCT
Select Bancorp
STND
Standard Avb Financial
OPHC
Optimumbank Holdings
FMBH 2018-09-30
Content
Part I
Note 1 -- Basis of Accounting and Consolidation
Note 2 -- Earnings per Share
Note 3 -- Investment Securities
Note 4 - Loans and Allowance for Loan Losses
Note 5 -- Goodwill and Intangible Assets
Note 6 -- Repurchase Agreements and Other Borrowings
Note 7 -- Fair Value of Assets and Liabilities
Note 8 -- Business Combinations
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations
Item 3. Quantitative and Qualitative Disclosures About Market Risk
Item 4. Controls and Procedures
Part II
Item 1. Legal Proceedings
Item 1A. Risk Factors
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
Item 3. Defaults Upon Senior Securities
Item 4. Mine Safety Disclosures
Item 5. Other Information
Item 6. Exhibits
Exhibits
EX-31.1
fmbh-ex311x2018930.htm
EX-31.2
fmbh-ex312x2018930.htm
EX-32.1
fmbh-ex321x2018930.htm
EX-32.2
fmbh-ex322x2018930.htm
First Mid Illinois Bancshares Earnings 2018-09-30
FMBH 10Q Quarterly Report
Balance Sheet
Income Statement
Cash Flow
10-Q 1 fmbh-2018930x10q.htm 10-Q Document
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2018
Or
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from _____________ to ______________
Commission file number 0-13368
FIRST MID-ILLINOIS BANCSHARES, INC.
(Exact name of Registrant as specified in its charter)
Delaware
37-1103704
(State or other jurisdiction of incorporation or organization)
(I.R.S. employer identification no.)
1421 Charleston Avenue,
Mattoon, Illinois
61938
(Address of principal executive offices)
(Zip code)
(217) 234-7454
(Registrant's telephone number, including area code)
Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark whether the Registrant has submitted electronically and posted on its corporate website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (Section 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes [X ] No [ ]
Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and "emerging growth company" in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer [ ]
Accelerated filer [X]
Non-accelerated filer [ ]
(Do not check if a smaller reporting company)
Smaller reporting company [ ]
Emerging growth company [ ]
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. [ ]
Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Act). [ ] Yes [X] No
As of November 8, 2018, 15,297,425 common shares, $4.00 par value, were outstanding.
PART I
ITEM 1. FINANCIAL STATEMENTS
First Mid-Illinois Bancshares, Inc.
Condensed Consolidated Balance Sheets
(Unaudited)
(In thousands, except share data)
September 30, 2018
December 31, 2017
Assets
Cash and due from banks:
Non-interest bearing
$
53,388
$
75,398
Interest bearing
10,435
12,990
Federal funds sold
662
491
Cash and cash equivalents
64,485
88,879
Certificates of deposit investments
2,183
1,685
Investment securities:
Available-for-sale, at fair value
599,080
578,579
Held-to-maturity, at amortized cost (estimated fair value of $67,395 and $68,457 at September 30, 2018 and December 31, 2017, respectively)
69,409
69,332
Loans held for sale
940
1,025
Loans
2,399,220
1,938,476
Less allowance for loan losses
(23,839
)
(19,977
)
Net loans
2,375,381
1,918,499
Interest receivable
14,928
10,832
Other real estate owned
2,093
2,754
Premises and equipment, net
47,327
38,266
Goodwill, net
86,641
60,150
Intangible assets, net
15,373
10,679
Bank owned life insurance
51,443
41,883
Other assets
26,194
18,976
Total assets
$
3,355,477
$
2,841,539
Liabilities and Stockholders’ Equity
Deposits:
Non-interest bearing
$
493,935
$
480,283
Interest bearing
2,157,462
1,794,356
Total deposits
2,651,397
2,274,639
Securities sold under agreements to repurchase
98,875
155,388
Interest payable
1,400
602
FHLB borrowings
120,736
60,038
Other borrowings
29,500
10,313
Junior subordinated debentures
28,958
24,000
Other liabilities
7,778
8,595
Total liabilities
2,938,644
2,533,575
Stockholders’ Equity:
Common stock, $4 par value; authorized 30,000,000 shares; issued 15,867,990 and 13,231,225 shares in 2018 and 2017, respectively
65,472
54,925
Additional paid-in capital
250,484
163,603
Retained earnings
126,955
104,683
Deferred compensation
2,553
3,540
Accumulated other comprehensive loss
(12,173
)
(2,304
)
Less treasury stock at cost, 573,065 shares in 2018 and 570,477 shares in 2017
(16,458
)
(16,483
)
Total stockholders’ equity
416,833
307,964
Total liabilities and stockholders’ equity
$
3,355,477
$
2,841,539
See accompanying notes to unaudited condensed consolidated financial statements.
2
First Mid-Illinois Bancshares, Inc.
Condensed Consolidated Statements of Income (unaudited)
(In thousands, except per share data)
Three months ended September 30,
Nine months ended September 30,
2018
2017
2018
2017
Interest income:
Interest and fees on loans
$
28,850
$
20,385
$
75,219
$
61,337
Interest on investment securities
4,511
4,179
13,271
12,585
Interest on certificates of deposit investments
13
9
34
41
Interest on federal funds sold
2
1
5
62
Interest on deposits with other financial institutions
112
40
248
217
Total interest income
33,488
24,614
88,777
74,242
Interest expense:
Interest on deposits
2,217
1,028
5,149
2,840
Interest on securities sold under agreements to repurchase
72
51
196
137
Interest on FHLB borrowings
559
283
1,309
602
Interest on other borrowings
148
143
374
385
Interest on subordinated debentures
405
236
1,013
680
Total interest expense
3,401
1,741
8,041
4,644
Net interest income
30,087
22,873
80,736
69,598
Provision for loan losses
2,551
1,489
5,483
5,051
Net interest income after provision for loan losses
27,536
21,384
75,253
64,547
Other income:
Trust revenues
919
925
2,934
2,696
Brokerage commissions
660
536
1,986
1,550
Insurance commissions
877
670
3,202
3,148
Service charges
2,009
1,758
5,447
5,160
Securities gains, net
—
254
901
589
Mortgage banking revenue, net
368
347
939
875
ATM / debit card revenue
1,979
1,595
5,443
4,828
Bank owned life insurance
342
792
933
1,355
Other
765
784
1,982
2,925
Total other income
7,919
7,661
23,767
23,126
Other expense:
Salaries and employee benefits
11,600
9,648
32,851
29,685
Net occupancy and equipment expense
3,530
3,129
10,308
9,378
Net other real estate owned expense (income)
(61
)
385
22
530
FDIC insurance
174
210
740
679
Amortization of intangible assets
838
545
2,059
1,651
Stationery and supplies
328
168
725
539
Legal and professional
1,071
871
3,925
2,596
Marketing and donations
468
338
1,253
909
Other
6,542
2,618
11,777
9,102
Total other expense
24,490
17,912
63,660
55,069
Income before income taxes
10,965
11,133
35,360
32,604
Income taxes
2,731
3,538
8,699
10,545
Net income
$
8,234
$
7,595
$
26,661
$
22,059
Per share data:
Basic net income per common share available to common stockholders
$
0.54
$
0.61
$
1.91
$
1.76
Diluted net income per common share available to common stockholders
$
0.54
$
0.61
$
1.90
$
1.76
Cash dividends declared per common share
$
—
$
—
$
0.34
$
0.32
See accompanying notes to unaudited condensed consolidated financial statements.
3
First Mid-Illinois Bancshares, Inc.
Condensed Consolidated Statements of Comprehensive Income (unaudited)
(in thousands)
Three months ended September 30,
Nine months ended September 30,
2018
2017
2018
2017
Net income
$
8,234
$
7,595
$
26,661
$
22,059
Other Comprehensive Income (Loss)
Unrealized gains (losses) on available-for-sale securities, net of taxes of $1,191 and $327 for three months ended September 30, 2018 and 2017, respectively and $3,796 and $(5,154) for nine months ended September 30, 2018 and 2017, respectively.
(2,919
)
(512
)
(9,289
)
8,068
Amortized holding losses on held-to-maturity securities transferred from available-for-sale, net of taxes of $(8) and $(11) for three months ended September 30, 2018 and 2017, respectively and $(25) and $(32) for nine months ended September 30, 2018 and 2017, respectively.
20
16
60
51
Less: reclassification adjustment for realized gains included in net income, net of taxes of $0 and $99 for three months ended September 30, 2018 and 2017, respectively and $261 and $230 for nine months ended September 30, 2018 and 2017, respectively.
—
(155
)
(640
)
(359
)
Other comprehensive income (loss), net of taxes
(2,899
)
(651
)
(9,869
)
7,760
Comprehensive income
$
5,335
$
6,944
$
16,792
$
29,819
See accompanying notes to unaudited condensed consolidated financial statements.
4
First Mid-Illinois Bancshares, Inc.
Condensed Consolidated Statements of Cash Flows (unaudited)
Nine months ended September 30,
(In thousands)
2018
2017
Cash flows from operating activities:
Net income
$
26,661
$
22,059
Adjustments to reconcile net income to net cash provided by operating activities:
Provision for loan losses
5,483
5,051
Depreciation, amortization and accretion, net
5,431
6,241
Change in cash surrender value of bank owned life insurance
(933
)
(844
)
Stock-based compensation expense
242
300
Gains on investment securities, net
(901
)
(589
)
(Gain) loss on sales of repossessed assets, net
(62
)
349
Loss on write down of premises and equipment
26
337
Gains on sale of loans held for sale, net
(796
)
(809
)
Decrease in accrued interest receivable
(1,767
)
(323
)
Increase in accrued interest payable
541
38
Origination of loans held for sale
(48,214
)
(45,076
)
Proceeds from sale of loans held for sale
49,095
44,981
Decrease in other assets
575
2,475
Decrease in other liabilities
(8,941
)
(1,421
)
Net cash provided by operating activities
26,440
32,769
Cash flows from investing activities:
Proceeds from maturities of certificates of deposit investments
747
12,958
Proceeds from sales of securities available-for-sale
13,152
96,184
Proceeds from maturities of securities available-for-sale
40,476
52,894
Purchases of securities available-for-sale
(30,082
)
(134,807
)
Net increase in loans
(99,308
)
(49,198
)
Purchases of premises and equipment
(1,765
)
(1,304
)
Proceeds from sales of other real property owned
1,490
5,356
Net cash provided by acquisition
10,323
—
Net cash used in investing activities
(64,967
)
(17,917
)
Cash flows from financing activities:
Net decrease in deposits
(8,866
)
(112,410
)
Increase in federal funds purchased
22,000
20,000
Decrease in repurchase agreements
(56,513
)
(69,403
)
Proceeds from FHLB advances
45,000
52,000
Repayment of FHLB advances
(15,000
)
(5,000
)
Repayment from short-term debt
—
(6,813
)
Repayment of long-term debt
(2,813
)
—
Proceeds from issuance of common stock
36,519
4,195
Direct expenses related to capital transactions
(2,243
)
(213
)
Purchase of treasury stock
(95
)
—
Dividends paid on common stock
(3,856
)
(3,467
)
Net cash provided by (used in) financing activities
14,133
(121,111
)
Decrease in cash and cash equivalents
(24,394
)
(106,259
)
Cash and cash equivalents at beginning of period
88,879
175,902
Cash and cash equivalents at end of period
$
64,485
$
69,643
5
First Mid-Illinois Bancshares, Inc.
Condensed Consolidated Statements of Cash Flows (unaudited)
Nine months ended September 30,
(In thousands)
2018
2017
Supplemental disclosures of cash flow information
Cash paid during the period for:
Interest
$
7,243
$
4,627
Income taxes
7,919
7,969
Supplemental disclosures of noncash investing and financing activities
Loans transferred to other real estate owned
224
5,317
Dividends reinvested in common stock
533
527
Net tax benefit related to option and deferred compensation plans
160
221
Supplemental disclosure of purchase of capital stock of First Bank
Fair value of assets acquired
$
501,285
$
—
Consideration paid:
Cash paid
10,275
—
Common stock issued
61,350
—
Total consideration paid
71,625
—
Fair value of liabilities assumed
$
429,660
$
—
See accompanying notes to unaudited condensed consolidated financial statements.
6
Notes to Condensed Consolidated Financial Statements
(unaudited)
Note 1 -- Basis of Accounting and Consolidation
The unaudited condensed consolidated financial statements include the accounts of First Mid-Illinois Bancshares, Inc. (“Company”) and its wholly-owned subsidiaries: First Mid Bank & Trust, N.A. (“First Mid Bank”), formerly known as First Mid-Illinois Bank & Trust, N.A., First Mid Wealth Management, Mid-Illinois Data Services, Inc. (“MIDS”) and The Checkley Agency, Inc. doing business as First Mid Insurance Group (“First Mid Insurance”). All significant intercompany balances and transactions have been eliminated in consolidation. The financial information reflects all adjustments which, in the opinion of management, are necessary for a fair presentation of the results of the interim periods ended September 30, 2018 and 2017, and all such adjustments are of a normal recurring nature. Certain amounts in the prior year’s consolidated financial statements have been reclassified to conform to the September 30, 2018 presentation and there was no impact on net income or stockholders’ equity. The results of the interim period ended September 30, 2018 are not necessarily indicative of the results expected for the year ending December 31, 2018. The Company operates as a one-segment entity for financial reporting purposes.
The 2017 year-end consolidated balance sheet data was derived from audited financial statements, but does not include all disclosures required by accounting principles generally accepted in the United States of America.
The unaudited condensed consolidated financial statements have been prepared in accordance with the instructions to Form 10-Q and Article 10 of Regulation S-X and do not include all of the information required by U.S. generally accepted accounting principles (“GAAP”) for complete financial statements and related footnote disclosures although the Company believes that the disclosures made are adequate to make the information not misleading. These financial statements should be read in conjunction with the consolidated financial statements and notes thereto included in the Company’s 2017 Annual Report on Form 10-K.
Website
The Company maintains a website at www.firstmid.com. All periodic and current reports of the Company and amendments to these reports filed with the Securities and Exchange Commission (“SEC”) can be accessed, free of charge, through this website as soon as reasonably practicable after these materials are filed with the SEC.
Capital Raise
On June 13, 2018, the Company and First Mid Bank, entered into an underwriting agreement (the “Underwriting Agreement”) with FIG Partners, LLC, as the representative of the several underwriters named therein (the “Underwriters”), pursuant to which the Company agreed to issue and sell to the Underwriters and the Underwriters agreed to purchase, subject to and upon the terms and conditions of the Underwriting Agreement, an aggregate of 823,799 shares of the Company’s common stock, par value $4.00 per share, at a public offering price of $38.00 per share, in an underwritten public offering (the “Offering”). The Company granted the Underwriters an option for a period of 30 days after the date of the Underwriting Agreement to purchase up to an additional 123,569 shares of common stock at the public offering price, less discounts and commissions. The Underwriters exercised their option in full on June 13, 2018, resulting in 947,368 shares of common stock being offered in the Offering. The Offering closed on June 15, 2018. The net proceeds to the Company, after deducting underwriting discounts and commissions and offering expenses, were approximately $34.0 million.
First BancTrust Corporation
On December 11, 2017, the Company and Project Hawks Merger Sub LLC (formerly known as Project Hawks Merger Sub Corp.), a newly formed Delaware limited liability company and wholly-owned subsidiary of the Company (“Hawks Merger Sub”), entered into an Agreement and Plan of Merger (as amended as of January 18, 2018, the “First Bank Merger Agreement") with First BancTrust Corporation, a Delaware corporation (“First Bank”), pursuant to which, among other things, the Company agreed to acquire 100% of the issued and outstanding shares of First Bank pursuant to a business combination whereby First Bank merged with and into Hawks Merger Sub, with Hawks Merger Sub as the surviving entity and a wholly-owned subsidiary of the Company (the “First Bank Merger”).
7
Subject to the terms and conditions of the First Bank Merger Agreement, at the effective time of the First Bank Merger, each share of common stock, par value $0.01 per share, of First Bank issued and outstanding immediately prior to the effective time of the First Bank Merger (other than shares held in treasury by First Bank and shares held by stockholders who have properly made and not withdrawn a demand for appraisal rights under Delaware law) converted into and become the right to receive, (a) $5.00 in cash and (b) 0.800 shares of common stock, par value $4.00 per share, of the Company and cash in lieu of fractional shares, less any applicable taxes required to be withheld and subject to certain adjustments, all as set forth in the First Bank Merger Agreement.
The First Bank Merger closed on May 1, 2018 and the Company issued an aggregate total of 1,643,900 shares of common stock paying approximately $10,275,000, including cash in lieu of fractional shares. The accounting for the First Bank Merger is presented in Note 8 to the consolidated financial statements. First Bank’s wholly-owned bank subsidiary, First Bank & Trust, merged with and into the Company’s wholly owned bank subsidiary, First Mid Bank, on August 10, 2018. At the time of the bank merger, First Bank & Trust’s banking offices became branches of First Mid Bank.
SCB Bancorp, Inc.
On June 12, 2018, The Company and Project Almond Merger Sub LLC, a newly formed Illinois limited liability company and wholly-owned subsidiary of the Company (“Almond Merger Sub”), entered into an Agreement and Plan of Merger (the “SCB Merger Agreement”) with SCB Bancorp, Inc., an Illinois corporation (“SCB”), pursuant to which, among other things, the Company agreed to acquire 100% of the issued and outstanding shares of SCB pursuant to a business combination whereby SCB will merge with and into Almond Merger Sub, whereupon the separate corporate existence of SCB will cease and Merger Sub will continue as the surviving company and a wholly-owned subsidiary of the Company (the “SCB Merger”).
Subject to the terms and conditions of the SCB Merger Agreement, at the effective time of the SCB Merger, each share of common stock, par value $7.50 per share, of SCB issued and outstanding immediately prior to the effective time of the SCB Merger (other than shares held in treasury by SCB and shares held by stockholders who have properly made and not withdrawn a demand for appraisal rights under Illinois law) will be converted into and become the right to receive, at the election of each stockholder, either $307.93 in cash or 8.0228 shares of common stock, par value $4.00 per share, of the Company and cash in lieu of fractional shares, less any applicable taxes required to be withheld and subject to certain potential adjustments. Overall elections are subject to proration such that, depending on the number of shares of SCB common stock electing shares of the Company’s common stock, between 19 and 32.5 percent of the SCB shares will be exchanged for cash, and between 67.5 and 81 percent will be exchanged for the Company’s common stock. Additionally, SCB’s outstanding stock options will be fully vested upon consummation of the SCB Merger, and all outstanding SCB options that are unexercised prior to the effective time of the SCB Merger will be cashed out. In addition, immediately prior to the closing of the proposed merger, SCB will pay a special dividend to its shareholders in the aggregate amount of approximately $25 million. The SCB Merger is subject to customary closing conditions, including the approval of the appropriate regulatory authorities and of the stockholders of SCB. The SCB Merger is anticipated to be completed in November 2018.
It is anticipated that SCB’s wholly-owned bank subsidiary, Soy Capital Bank and Trust Company (“Soy Capital Bank”), will be merged with and into First Mid Bank at a date following completion of the Merger. At the time of the bank merger, Soy Capital Bank’s banking offices will become branches of First Mid Bank.
At-The-Market Program
On August 16, 2017, the Company entered into a Sales Agency Agreement, pursuant to which the Company may sell, from time to time, up to an aggregate of $20 million of its common stock. Shares of common stock are offered pursuant to the Company's shelf registration statement filed within the SEC. During the nine months ended September 30, 2018, the company sold no shares of common stock under the program. As of September 30, 2018, approximately $16.53 million of common stock remained available for issuance under the At The Market program.
8
Bank Owned Life Insurance
First Mid Bank has purchased life insurance policies on certain senior management. Bank owned life insurance is recorded at the amount that can be realized under the insurance contract at the balance sheet date, which is the cash surrender value adjusted for other charges or other amounts that are probable at settlement.
Stock Plans
At the Annual Meeting of Stockholders held April 26, 2017, the stockholders approved the First Mid-Illinois Bancshares, Inc. 2017 Stock Incentive Plan (“SI Plan”). The SI Plan was implemented to succeed the Company’s 2007 Stock Incentive Plan, which had a ten-year term. The SI Plan is intended to provide a means whereby directors, employees, consultants and advisors of the Company and its subsidiaries may sustain a sense of proprietorship and personal involvement in the continued development and financial success of the Company and its subsidiaries, thereby advancing the interests of the Company and its stockholders. Accordingly, directors and selected employees, consultants and advisors may be provided the opportunity to acquire shares of common stock of the Company on the terms and conditions established in the SI Plan.
A maximum of 149,983 shares of common stock may be issued under the SI Plan. There have been no stock options awarded under any Company plan since 2008. The Company has awarded 13,250 shares of restricted stock during 2018 and 15,450 and 18,391 restricted stock units during 2018 and 2017, respectively.
Employee Stock Purchase Plan
At the Annual Meeting of Stockholders held April 25, 2018, the stockholders approved the First Mid-Illinois Bancshares, Inc. Employee Stock Purchase Plan (“ESPP”). The ESPP is intended to promote the interests of the Company by providing eligible employees with the opportunity to purchase shares of common stock of the Company at a 5% discount through payroll deductions. The ESPP is also intended to qualify as an employee stock purchase plan under Section 423 of the Internal Revenue Code. A maximum of 600,000 shares of common stock may be issued under the ESPP.
General Litigation
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.
Revenue Recognition
Accounting Standards Codification 606, Revenue from Contracts with Customers (“ASC 606”), establishes a revenue recognition model for reporting information about the nature, amount, timing and uncertainty of revenue and cash flows arising from the entity's contracts to provide goods or services to customers. Most of the Company’s revenue-generating transactions are not subject to ASC 606, including revenue generated from financial instruments, such as loans and investment securities, and revenue related to mortgage servicing activities, which are subject to other accounting standards. A description of the revenue-generating activities that are within the scope of ASC 606, and included in other income in the Company’s condensed consolidated statements of income are as follows:
Trust revenues. The Company generates fee income from providing fiduciary services through its trust department. Fees are billed in arrears based upon the preceding period account balance. Revenue from the farm management department is recorded when service is complete, for example when crops are sold.
Brokerage commissions. The primary brokerage revenue is recorded at the beginning of each quarter through billing to customers based on the account asset size on the last day of the previous quarter. If a withdrawal of funds takes place, a prorated refund may occur; this is reflected within the same quarter as the original billing occurred. All performance obligations are met within the same quarter that the revenue is recorded.
9
Insurance commissions. The Company’s insurance agency subsidiary, First Mid Insurance Group (“FMIG”), receives commissions on premiums of new and renewed business policies. FMIG records commission revenue on direct bill policies as the cash is received. For agency bill policies, FMIG retains its commission portion of the customer premium payment and remits the balance to the carrier. In both cases, the entire performance obligation is held by the carriers.
Service charges on deposits. The Company generates revenue from fees charged for deposit account maintenance, overdrafts, wire transfers, and check fees. The revenue related to deposit fees is recognized at the time the performance obligation is satisfied.
ATM/debit card revenue. The Company generates revenue through service charges on the use of its ATM machines and interchange income from the use of Company issued credit and debit cards. The revenue is recognized at the time the service is used and the performance obligation is satisfied.
Other income. Treasury management fees and lock box fees are received and recorded after the service performance obligation is completed. Merchant bank card fees are received from various vendors, however the performance obligation is with the vendors. The Company records gains on the sale of loans and the sale of OREO properties after the transactions are complete and transfer of ownership has occurred.
As each of the Company’s facilities is located in markets with similar economies, no disaggregation of revenue is necessary.
Accumulated Other Comprehensive Income (Loss)
The components of accumulated other comprehensive income (loss) included in stockholders’ equity as of September 30, 2018 and December 31, 2017 are as follows (in thousands):
Unrealized Gain (Loss) on
Securities
Securities with Other-Than-Temporary Impairment Losses
Total
September 30, 2018
Net unrealized losses on securities available-for-sale
$
(16,949
)
$
—
$
(16,949
)
Unamortized losses on held-to-maturity securities transferred from available-for-sale
(197
)
—
(197
)
Securities with other-than-temporary impairment losses
—
—
—
Tax benefit
4,973
—
4,973
Balance at September 30, 2018
$
(12,173
)
$
—
$
(12,173
)
December 31, 2017
Net unrealized losses on securities available-for-sale
$
(2,619
)
$
—
$
(2,619
)
Unamortized losses on held-to-maturity securities transferred from available-for-sale
(281
)
—
(281
)
Securities with other-than-temporary impairment losses
—
(345
)
(345
)
Tax benefit
841
100
941
Balance at December 31, 2017
$
(2,059
)
$
(245
)
$
(2,304
)
10
Amounts reclassified from accumulated other comprehensive income and the affected line items in the statements of income during the nine months ended September 30, 2018 and 2017, were as follows (in thousands):
Amounts Reclassified from Other Comprehensive Income
Affected Line Item in the Statements of Income
Three months ended September 30,
Nine months ended September 30,
2018
2017
2018
2017
Realized gains on available-for-sale securities
$
—
$
254
$
901
$
589
Securities gains, net
(Total reclassified amount before tax)
—
(99
)
(261
)
(230
)
Income taxes
Total reclassifications out of accumulated other comprehensive income
$
—
$
155
$
640
$
359
Net reclassified amount
See “Note 3 – Investment Securities” for more detailed information regarding unrealized losses on available-for-sale securities.
Adoption of New Accounting Guidance
Accounting Standards Update 2017-09, Compensation-Stock Compensation (Topic 718): Scope of Modification ("ASU 2017-09"). In May 2017, FASB issued ASU 2017-09. This update provides guidance on determining which changes to the terms and conditions of share-based payment awards require the application of modification accounting under Topic 718. The guidance is effective for public companies for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2017. The amendments should be applied on a prospective basis to an award modified on or after adoption date. ASU 2017-09 did not have a significant impact on the Company's consolidated financial statement.
Accounting Standards Update 2017-08, Receivables-Nonrefundable Fees and Other Costs ("ASU 2017-08"). In March 2017, FASB issued ASU 2017-08. This update amends the amortization period for certain purchased callable debt securities held at a premium. The update shortens the premium's amortization period to the earliest call date to more closely align the amortization period of premiums to expectations incorporated in market pricing on the underlying securities. For public companies, the update is effective for annual periods beginning after December 15, 2018, and is to be applied on a modified retrospective basis with a cumulative-effect adjustment directly to retained earnings as of the beginning of the adoption period. Early adoption is permitted, including adoption in an interim period. The Company adopted ASU 2017-08 early and there was not a significant impact on the Company's consolidated financial statements.
Accounting Standards Update 2017-04, Intangibles--Goodwill and Other (Topic 350: Simplifying the Test for Goodwill Impairment ("ASU 2017-04"). In January 2017, FASB issued ASU 2017-04. The amendments in this update simplify the measurement of goodwill by eliminating Step 2 from the goodwill impairment test. Under this guidance, an entity should perform its annual, or interim, goodwill impairment test by comparing the fair value of a reporting unit with its carrying amount. An entity should recognize an impairment charge for the amount by which the carrying amount exceeds the reporting unit's fair value; however, the loss should not exceed the total amount of goodwill allocated to that reporting unit. ASU 2017-04 is effective for public companies for the reporting periods beginning after December 15, 2019. Early adoption is permitted for interim or annual goodwill impairment tests performed on testing dates after January 1, 2017. Although the Company cannot anticipate future goodwill impairment, based on the most recent assessment, it is unlikely that an impairment amount would need to be calculated and, therefore, does not anticipate a material impact on the Company's consolidated financial statements. The current accounting policies and procedures of the Company are not anticipated to change, except for the elimination of the Step 2 analysis.
11
Accounting Standards Update 2016-08, Revenue from Contracts with Customers (Topic 606) (“ASU 2016-08"). In March 2016, the FASB issued ASU 2016-08 which amended the accounting guidance issued by the FASB in May 2014 that revised the criteria for determining when to recognize revenue from contracts with customers and expanded disclosure requirements. The amendment defers the effective date by one year. This accounting guidance can be implemented using either a retrospective method or a cumulative-effect approach. This new guidance is effective for interim and annual reporting periods beginning after December 15, 2017. The Company completed its overall assessment of revenue streams and review of related contracts potentially affected by the ASU, including trust and asset management fees, deposit related fees, interchange fees, merchant income, and annuity and insurance commissions. Based on this assessment, the Company concluded that ASU 2014-09 did not materially change the method in which the Company currently recognizes revenue for these revenue streams.
Accounting Standards Update 2016-01, Financial Instruments (Topic 825): Recognition and Measurement of Financial Assets and Financial Liabilities ("ASU 2016-01"). In January 2016, FASB issued ASU 2016-01 which amends prior guidance to require an entity to measure its equity investments (except those accounted for under the equity method of accounting) to be measured at fair value with changes in fair value recognized in net income. An entity may choose to measure equity investments that do not have readily determinable fair values at cost minus impairment, if any, plus or minus changes resulting from observable price changes in orderly transactions for the identical or similar investment of same issuer. The new guidance simplifies the impairment assessment of equity investments without readily determinable fair values, requires public entities to use the exit price notion when measuring fair value of financial instruments for disclosure purposes, requires an entity to present separately in other comprehensive income the portion of the total change in fair value of a liability resulting from changes in the instrument-specific credit risk when the entity has selected fair value option for financial instruments and requires separate presentation of financial assets and liabilities by measurement category and form of financial asset. The new guidance is effective for reporting periods after January 1, 2018 and did not have a significant impact on the Company's consolidated financial statements other than adoption of the standard resulted in the use of an exit price rather than an entrance price to determine the fair value of loans not measured at fair value on a non-recurring basis. See Note 7 - Fair Value of Assets and Liabilities for further information regarding the valuation of these loans.
Pending New Accounting Guidance
Accounting Standards Update 2016-02, Leases (Topic 842) ("ASU 2016-02"). On February 25, 2016, FASB issued ASU 2016-02 which creates Topic 842, Leases and supersedes Topic 840, Leases. ASU 2016-02 is intended to improve financial reporting about leasing transactions, by increasing transparency and comparability among organizations. Under the new guidance, a lessee will be required to record all leases with lease terms of more than 12 months on their balance sheet as lease liabilities with a corresponding right-of-use asset. ASU 2016-02 maintains the dual model for lease accounting, requiring leases to be classified as either operating or finance, with lease classification determined in a manner similar to existing lease guidance. The new guidance will be effective for public companies for fiscal years beginning on or after December 15, 2018, and for private companies for fiscal years beginning on or after December 15, 2019. Early adoption is permitted for all entities. Management continues to evaluate the impact ASU 2016-02 will have on the Company's consolidated financial statements. Upon adoption of the guidance, the Company expects to report increased assets and increased liabilities as a result of recognizing right-of-use assets and lease liabilities on its consolidated balance sheet. However, the determination of the final amount is dependent on the terms of leases in effect and the level of interest rates on January 1, 2019. The Company does not expect the new guidance will have a material impact on its consolidated statement of income.
Accounting Standards Update 2016-13, Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses of Financial Instruments (“ASU 2016-13”). In June 2016, FASB issued ASU 2016-13. The provisions of ASU 2016-13 requires an entity to utilize a new impairment model known as the current expected credit loss ("CECL") model to estimate its lifetime "expected credit loss" and record an allowance that, when deducted from the amortized cost basis of the financial asset, presents the net amount expected to be collected on the financial asset. The CECL model is expected to result in more timely recognition of credit losses. ASU 2016-13 also requires new disclosures for financial assets measured at amortized cost, loans and available-for-sale debt securities. ASU 2016-13 is effective for annual periods beginning after December 15, 2019, including interim periods within those fiscal years. Entities will apply the standard's provisions as a cumulative-effect adjustment to retained earnings as of the beginning of the first reporting period in which the guidance is adopted.
12
Management has formed an internal committee to evaluate implementation steps and assess the impact ASU 2016-13 will have on the Company’s consolidated financial statements. The committee has assigned roles and responsibilities, key tasks to complete, and has established a general timeline for implementation. The Company has also engaged an outside consultant to assist with the methodology review and data validation, as well as other key aspects of implementing the standard. The committee meets periodically to discuss the latest developments and ensure progress is being made. The team also keeps current on evolving interpretations and industry practices related to ASU 2016-13. The committee continues to evaluate and validate data resources and different loss methodologies. The committee is still evaluating the impact ASU 2016-13 will have on the Company's consolidated financial statements.
Accounting Standards Update 2018-13, Fair Value Measurements (Topic 820): Disclosure Framework - Changes to the Disclosure Requirements for Fair Value Measurement (“ASU 2018-13”). In August 2018, FASB issued ASU 2018-13. This ASU eliminates, adds and modifies certain disclosure requirements for fair value measurements. Among the changes, an entity will no longer be required to disclose the amount of and reasons for transfers between Level 1 and Level 2 of the fair value hierarchy, but will be required to disclose the range and weighted average used to develop significant unobservable inputs for Level 3 fair value measurements. ASU 2018-13 is effective for interim and annual reporting periods beginning after December 15, 2019; early adoption is permitted. As ASU 2018-13 only revises disclosure requirements, it will not have a material impact on the Company’s consolidated financial statements.
13
Note 2 -- Earnings Per Share
Basic net income per common share available to common stockholders is calculated as net income less preferred stock dividends divided by the weighted average number of common shares outstanding. Diluted net income per common share available to common stockholders is computed using the weighted average number of common shares outstanding, increased by the Company’s stock options, unless anti-dilutive.
The components of basic and diluted net income per common share available to common stockholders for the three and nine-month period ended September 30, 2018 and 2017 were as follows:
Three months ended September 30,
Nine months ended September 30,
2018
2017
2018
2017
Basic Net Income per Common Share
Available to Common Stockholders:
Net income
$
8,234,000
$
7,595,000
$
26,661,000
$
22,059,000
Weighted average common shares outstanding
15,290,539
12,528,674
13,982,339
12,498,913
Basic earnings per common share
$
0.54
$
0.61
$
1.91
$
1.76
Diluted Net Income per Common Share
Available to Common Stockholders:
Net income applicable to diluted earnings per share
8,234,000
7,595,000
$
26,661,000
$
22,059,000
Weighted average common shares outstanding
15,290,539
12,528,674
13,982,339
12,498,913
Dilutive potential common shares:
Assumed conversion of stock options
2,429
6,299
3,570
6,827
Restricted stock awarded
13,250
836
13,250
836
Dilutive potential common shares
15,679
7,135
16,820
7,663
Diluted weighted average common shares outstanding
15,306,218
12,535,809
13,999,159
12,506,576
Diluted earnings per common share
$
0.54
$
0.61
$
1.90
$
1.76
There were no shares not considered in computing diluted earnings per share for the three and nine-month periods ended September 30, 2018 and 2017 because they were anti-dilutive.
14
Note 3 -- Investment Securities
The amortized cost, gross unrealized gains and losses and estimated fair values for available-for-sale and held-to-maturity securities by major security type at September 30, 2018 and December 31, 2017 were as follows (in thousands):
Amortized Cost
Gross Unrealized Gains
Gross Unrealized (Losses)
Fair Value
September 30, 2018
Available-for-sale:
U.S. Treasury securities and obligations of U.S. government corporations & agencies
$
127,365
$
—
$
(4,696
)
$
122,669
Obligations of states and political subdivisions
176,273
570
(3,497
)
173,346
Mortgage-backed securities: GSE residential
310,122
132
(9,585
)
300,669
Other securities
2,269
127
—
2,396
Total available-for-sale
$
616,029
$
829
$
(17,778
)
$
599,080
Held-to-maturity:
U.S. Treasury securities and obligations of U.S. government corporations & agencies
$
69,409
$
—
$
(2,014
)
$
67,395
December 31, 2017
Available-for-sale:
U.S. Treasury securities and obligations of U.S. government corporations & agencies
$
115,796
$
8
$
(2,034
)
$
113,770
Obligations of states and political subdivisions
165,037
2,254
(1,025
)
166,266
Mortgage-backed securities: GSE residential
295,778
493
(2,460
)
293,811
Trust preferred securities
2,893
—
(345
)
2,548
Other securities
2,039
145
—
2,184
Total available-for-sale
$
581,543
$
2,900
$
(5,864
)
$
578,579
Held-to-maturity:
U.S. Treasury securities and obligations of U.S. government corporations & agencies
$
69,332
$
103
$
(978
)
$
68,457
Trust preferred securities represents one trust preferred pooled security issued by First Tennessee Financial (“FTN”). This security was sold during the second quarter of 2018.
Realized gains and losses resulting from sales of securities were as follows during the three and nine months ended September 30, 2018 and 2017 (in thousands):
Three months ended September 30,
Nine months ended September 30,
2018
2017
2018
2017
Gross gains
$
—
$
394
$
941
$
746
Gross losses
—
(140
)
(40
)
(157
)
15
The following table indicates the expected maturities of investment securities classified as available-for-sale presented at fair value, and held-to-maturity presented at amortized cost, at September 30, 2018 and the weighted average yield for each range of maturities (dollars in thousands):
One year or less
After 1 through 5 years
After 5 through 10 years
After ten years
Total
Available-for-sale:
U.S. Treasury securities and obligations of U.S. government corporations and agencies
$
85,272
$
37,397
$
—
$
—
$
122,669
Obligations of state and political subdivisions
16,847
78,561
76,890
1,048
173,346
Mortgage-backed securities: GSE residential
4
120,920
179,745
—
300,669
Other securities
—
2,015
—
381
2,396
Total available-for-sale investments
$
102,123
$
238,893
$
256,635
$
1,429
$
599,080
Weighted average yield
2.34
%
2.76
%
2.95
%
3.12
%
2.77
%
Full tax-equivalent yield
2.51
%
3.12
%
3.31
%
4.16
%
3.10
%
Held to Maturity:
U.S. Treasury securities and obligations of U.S. government corporations and agencies
$
39,994
$
29,415
$
—
$
—
$
69,409
Weighted average yield
1.76
%
2.08
%
—
%
—
%
1.90
%
Full tax-equivalent yield
1.76
%
2.08
%
—
%
—
%
1.90
%
The weighted average yields are calculated on the basis of the amortized cost and effective yields weighted for the scheduled maturity of each security. Tax-equivalent yields have been calculated using a 21% tax rate. With the exception of obligations of the U.S. Treasury and other U.S. government agencies and corporations, there were no investment securities of any single issuer, the book value of which exceeded 10% of stockholders' equity at September 30, 2018.
Investment securities carried at approximately $575 million and $479 million at September 30, 2018 and December 31, 2017, respectively, were pledged to secure public deposits and repurchase agreements and for other purposes as permitted or required by law.
16
The following table presents the aging of gross unrealized losses and fair value by investment category as of September 30, 2018 and December 31, 2017 (in thousands):
Less than 12 months
12 months or more
Total
Fair
Value
Unrealized
Losses
Fair
Value
Unrealized
Losses
Fair
Value
Unrealized
Losses
September 30, 2018
Available-for-sale:
U.S. Treasury securities and obligations of U.S. government corporations and agencies
$
67,162
$
(1,957
)
$
55,507
$
(2,739
)
$
122,669
$
(4,696
)
Obligations of states and political subdivisions
101,192
(2,338
)
18,856
(1,159
)
120,048
(3,497
)
Mortgage-backed securities: GSE residential
234,958
(8,724
)
45,257
(861
)
280,215
(9,585
)
Total
$
403,312
$
(13,019
)
$
119,620
$
(4,759
)
$
522,932
$
(17,778
)
Held-to-maturity:
U.S. Treasury securities and obligations of U.S. government corporations and agencies
$
24,510
$
(340
)
$
42,885
$
(1,674
)
$
67,395
$
(2,014
)
December 31, 2017
Available-for-sale:
U.S. Treasury securities and obligations of U.S. government corporations and agencies
$
58,584
$
(540
)
$
47,972
$
(1,494
)
$
106,556
$
(2,034
)
Obligations of states and political subdivisions
42,618
(769
)
9,267
(256
)
51,885
(1,025
)
Mortgage-backed securities: GSE residential
187,949
(1,942
)
22,609
(518
)
210,558
(2,460
)
Trust preferred securities
—
—
2,548
(345
)
2,548
(345
)
Total
$
289,151
$
(3,251
)
$
82,396
$
(2,613
)
$
371,547
$
(5,864
)
Held-to-maturity:
U.S. Treasury securities and obligations of U.S. government corporations and agencies
$
34,101
$
(525
)
$
14,540
$
(453
)
$
48,641
$
(978
)
U.S. Treasury Securities and Obligations of U.S. Government Corporations and Agencies. At September 30, 2018 there were fourteen available-for sale U.S. Treasury securities and obligations of U.S. government corporations and agencies with a fair value of $55,507,000 and unrealized losses of $2,739,000 in a continuous unrealized loss position for twelve months or more. At December 31, 2017 , there were eleven available-for sale U.S. Treasury securities and obligations of U.S. government corporations and agencies with a fair value of $47,972,000 and unrealized losses of $1,494,000 in a continuous unrealized loss position for twelve months or more. At September 30, 2018 there were eight held-to-maturity U.S. Treasury securities and obligations of U.S. government corporations and agencies with a fair value of $42,885,000 and unrealized losses of $1,674,000 in a continuous unrealized loss position for twelve months or more. At December 31, 2017 there were seven held-to-maturity U.S. Treasury securities and obligations of U.S. government corporations and agencies with a fair value of $14,540,000 and unrealized losses of $453,000 in a continuous unrealized loss position for twelve months or more.
Obligations of states and political subdivisions. At September 30, 2018 there were forty-one obligations of states and political subdivisions with a fair value of $18,856,000 and unrealized losses of $1,159,000 in a continuous loss position for twelve months or more. At December 31, 2017, there were thirty-nine obligations of states and political subdivisions with a fair value of $9,267,000 and unrealized losses of $256,000 in a continuous unrealized loss position for twelve months or more.
Mortgage-backed Securities: GSE Residential. At September 30, 2018 there were thirty-two mortgage-backed securities with a fair value of $45,257,000 and unrealized losses of $861,000 in a continuous unrealized loss position for twelve months or more. At December 31, 2017, there were twenty-six mortgage-backed securities with a fair value of $22,609,000 and unrealized losses of $518,000 in a continuous unrealized loss position for twelve months or more.
17
Trust Preferred Securities. At December 31, 2017, there was one trust preferred security with a fair value of $2,548,000 and unrealized loss of $345,000 in a continuous unrealized loss position for twelve months or more. The unrealized loss was primarily due to the long-term nature of the trust preferred security, a lack of demand or inactive market for the security, the impending change to the regulatory treatment of these securities, and concerns regarding the underlying financial institutions that have issued the trust preferred securities. The company sold this security during the second quarter of 2018.
Other securities. At September 30, 2018 and December 31, 2017, there were no other securities in a continuous unrealized loss position for twelve months or more.
The Company does not believe any other individual unrealized loss as of September 30, 2018 represents OTTI. However, given the continued disruption in the financial markets, the Company may be required to recognize OTTI losses in future periods with respect to its available for sale investment securities portfolio. The amount and timing of any additional OTTI will depend on the decline in the underlying cash flows of the securities. Should the impairment of any of these securities become other-than-temporary, the cost basis of the investment will be reduced and the resulting loss recognized in the period the other-than-temporary impairment is identified.
Other-than-temporary Impairment. Upon acquisition of a security, the Company determines whether it is within the scope of the accounting guidance for investments in debt and equity securities or whether it must be evaluated for impairment under the accounting guidance for beneficial interests in securitized financial assets.
If the Company determines that a given pooled trust preferred security position will be subject to a write-down or loss, the Company records the expected credit loss as a charge to earnings.
Credit Losses Recognized on Investments. The following table provides information about the trust preferred security for which only a credit loss was recognized in income and other losses were recorded in other comprehensive income (loss) for the nine months ended September 30, 2018 and 2017 (in thousands).
Accumulated Credit Losses
September 30, 2018
September 30, 2017
Credit losses on trust preferred securities held
Beginning of period
$
1,111
$
1,111
Additions related to OTTI losses not previously recognized
—
—
Reductions due to sales / (recoveries)
(1,111
)
—
Reductions due to change in intent or likelihood of sale
—
—
Additions related to increases in previously recognized OTTI losses
—
—
Reductions due to increases in expected cash flows
—
—
End of period
$
—
$
1,111
On May 29, 2018 the Company sold its trust preferred security. This sale resulted in recovery of all of the book value of the security. The net proceeds exceeded the aggregate book value of these securities by approximately $846,000 and this amount was recorded as a security gain during the second quarter of 2018.
18
Note 4 – Loans and Allowance for Loan Losses
Loans are stated at the principal amount outstanding net of unearned discounts, unearned income and allowance for loan losses. Unearned income includes deferred loan origination fees reduced by loan origination costs and is amortized to interest income over the life of the related loan using methods that approximated the effective interest rate method. Interest on substantially all loans is credited to income based on the principal amount outstanding. A summary of loans at September 30, 2018 and December 31, 2017 follows (in thousands):
September 30, 2018
December 31, 2017
Construction and land development
$
91,768
$
107,721
Agricultural real estate
191,812
127,232
1-4 Family residential properties
368,759
294,483
Multifamily residential properties
100,881
61,966
Commercial real estate
818,093
684,639
Loans secured by real estate
1,571,313
1,276,041
Agricultural loans
120,812
86,602
Commercial and industrial loans
541,099
445,378
Consumer loans
57,788
30,070
All other loans
117,031
108,023
Total Gross loans
2,408,043
1,946,114
Less: Loans held for sale
940
1,025
2,407,103
1,945,089
Less:
Net deferred loan fees, premiums and discounts
7,883
6,613
Allowance for loan losses
23,839
19,977
Net loans
$
2,375,381
$
1,918,499
Net loans increased $456.9 million as of September 30, 2018 compared to December 31, 2017. Of this increase, approximately $364.9 million is a result of the acquisition of First Bank & Trust. Loans expected to be sold are classified as held for sale in the consolidated financial statements and are recorded at the lower of aggregate cost or market value, taking into consideration future commitments to sell the loans. These loans are primarily for 1-4 family residential properties.
Most of the Company’s business activities are with customers located near the Company's branch locations in Illinois and Missouri. At September 30, 2018, the Company’s loan portfolio included $312.6 million of loans to borrowers whose businesses are directly related to agriculture. Of this amount, $236.8 million was concentrated in other grain farming. Total loans to borrowers whose businesses are directly related to agriculture increased $98.8 million from $213.8 million at December 31, 2017 due to $81.8 million acquired from First Bank & Trust and seasonal paydowns based upon timing of cash flow requirements. Loans concentrated in other grain farming increased $66.0 million from $170.8 million at December 31, 2017. While the Company adheres to sound underwriting practices, including collateralization of loans, any extended period of low commodity prices, drought conditions, significantly reduced yields on crops and/or reduced levels of government assistance to the agricultural industry could result in an increase in the level of problem agriculture loans and potentially result in loan losses within the agricultural portfolio.
In addition, the Company has $129.5 million of loans to motels and hotels. The performance of these loans is dependent on borrower specific issues as well as the general level of business and personal travel within the region. While the Company adheres to sound underwriting standards, a prolonged period of reduced business or personal travel could result in an increase in nonperforming loans to this business segment and potentially in loan losses. The Company also has $235.2 million of loans to lessors of non-residential buildings, $230.2 million of loans to lessors of residential buildings and dwellings, and $96.3 million of loans to other gambling industries.
19
The structure of the Company’s loan approval process is based on progressively larger lending authorities granted to individual loan officers, loan committees, and ultimately the board of directors. Outstanding balances to one borrower or affiliated borrowers are limited by federal regulation and the vast majority of borrowers are below regulatory thresholds. The Company can occasionally have outstanding balances to one borrower up to but not exceeding the regulatory threshold should underwriting guidelines warrant. The vast majority of the Company’s loans are to businesses located in the geographic market areas served by the Company’s branch bank system. Additionally, a significant portion of the collateral securing the loans in the portfolio is located within the Company’s primary geographic footprint. In general, the Company adheres to loan underwriting standards consistent with industry guidelines for all loan segments.
The Company’s lending can be summarized into the following primary areas:
Commercial Real Estate Loans. Commercial real estate loans are generally comprised of loans to small business entities to purchase or expand structures in which the business operations are housed, loans to owners of real estate who lease space to non-related commercial entities, loans for construction and land development, loans to hotel operators, and loans to owners of multi-family residential structures, such as apartment buildings. Commercial real estate loans are underwritten based on historical and projected cash flows of the borrower and secondarily on the underlying real estate pledged as collateral on the debt. For the various types of commercial real estate loans, minimum criteria have been established within the Company’s loan policy regarding debt service coverage while maximum limits on loan-to-value and amortization periods have been defined. Maximum loan-to-value ratios range from 65% to 80% depending upon the type of real estate collateral, while the desired minimum debt coverage ratio is 1.20x. Amortization periods for commercial real estate loans are generally limited to twenty years. The Company’s commercial real estate portfolio is well below the thresholds that would designate a concentration in commercial real estate lending, as established by the federal banking regulators.
Commercial and Industrial Loans. Commercial and industrial loans are primarily comprised of working capital loans used to purchase inventory and fund accounts receivable that are secured by business assets other than real estate. These loans are generally written for one year or less. Also, equipment financing is provided to businesses with these loans generally limited to 80% of the value of the collateral and amortization periods limited to seven years. Commercial loans are often accompanied by a personal guaranty of the principal owners of a business. Like commercial real estate loans, the underlying cash flow of the business is the primary consideration in the underwriting process. The financial condition of commercial borrowers is monitored at least annually with the type of financial information required determined by the size of the relationship. Measures employed by the Company for businesses with higher risk profiles include the use of government-assisted lending programs through the Small Business Administration and U.S. Department of Agriculture.
Agricultural and Agricultural Real Estate Loans. Agricultural loans are generally comprised of seasonal operating lines to cash grain farmers to plant and harvest corn and soybeans and term loans to fund the purchase of equipment. Agricultural real estate loans are primarily comprised of loans for the purchase of farmland. Specific underwriting standards have been established for agricultural-related loans including the establishment of projections for each operating year based on industry developed estimates of farm input costs and expected commodity yields and prices. Operating lines are typically written for one year and secured by the crop. Loan-to-value ratios on loans secured by farmland generally do not exceed 65% and have amortization periods limited to twenty five years. Federal government-assistance lending programs through the Farm Service Agency are used to mitigate the level of credit risk when deemed appropriate.
Residential Real Estate Loans. Residential real estate loans generally include loans for the purchase or refinance of residential real estate properties consisting of one-to-four units and home equity loans and lines of credit. The Company sells the vast majority of its long-term fixed rate residential real estate loans to secondary market investors. The Company also releases the servicing of these loans upon sale. The Company retains all residential real estate loans with balloon payment features. Balloon periods are limited to five years. Residential real estate loans are typically underwritten to conform to industry standards including criteria for maximum debt-to-income and loan-to-value ratios as well as minimum credit scores. Loans secured by first liens on residential real estate held in the portfolio typically do not exceed 80% of the value of the collateral and have amortization periods of twenty five years or less. The Company does not originate subprime mortgage loans.
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Consumer Loans. Consumer loans are primarily comprised of loans to individuals for personal and household purposes such as the purchase of an automobile or other living expenses. Minimum underwriting criteria have been established that consider credit score, debt-to-income ratio, employment history, and collateral coverage. Typically, consumer loans are set up on monthly payments with amortization periods based on the type and age of the collateral.
Other Loans. Other loans consist primarily of loans to municipalities to support community projects such as infrastructure improvements or equipment purchases. Underwriting guidelines for these loans are consistent with those established for commercial loans with the additional repayment source of the taxing authority of the municipality.
Purchase Credit-Impaired Loans. Loans acquired with evidence of credit deterioration since origination and for which it is probable that all contractually required payments will not be collected are considered to be credit impaired. Evidence of credit quality deterioration as of the purchase date may include information such as past-due and nonaccrual status, borrower credit scores and recent loan to value percentages. Purchase credit-impaired ("PCI") loans are accounted for under ASC 310-30, Receivables--Loans and Debt Securities Acquired with Deteriorated Credit Quality ("ASC 310-30"), and are initially measured at fair value, which includes the estimated future credit losses expected to be incurred over the life of the loan. Accordingly, an allowance for credit losses related to these loans is not carried over and recorded at the acquisition date. The cash flows expected to be collected were estimated using current key assumptions, such as default rates, value of underlying collateral, severity and prepayment speeds.
Allowance for Loan Losses
The allowance for loan losses represents the Company’s best estimate of the reserve necessary to adequately account for probable losses existing in the current portfolio. The provision for loan losses is the charge against current earnings that is determined by the Company as the amount needed to maintain an adequate allowance for loan losses. In determining the adequacy of the allowance for loan losses, and therefore the provision to be charged to current earnings, the Company relies predominantly on a disciplined credit review and approval process that extends to the full range of the Company’s credit exposure. The review process is directed by the overall lending policy and is intended to identify, at the earliest possible stage, borrowers who might be facing financial difficulty. Factors considered by the Company in evaluating the overall adequacy of the allowance include historical net loan losses, the level and composition of nonaccrual, past due and troubled debt restructurings, trends in volumes and terms of loans, effects of changes in risk selection and underwriting standards or lending practices, lending staff changes, concentrations of credit, industry conditions and the current economic conditions in the region where the Company operates. The Company estimates the appropriate level of allowance for loan losses by separately evaluating large impaired loans and nonimpaired loans.
The Company has loans acquired from business combinations with uncollected principal balances. These loans are carried net of a fair value adjustment for credit risk and interest rates and are only included in the allowance calculation to the extent that the reserve requirement exceeds the fair value adjustment. However, as the acquired loans renew, it is necessary to establish an allowance which represents an amount that, in management’s opinion, will be adequate to absorb probable credit losses inherent in such loans.
Impaired loans
The Company individually evaluates certain loans for impairment. In general, these loans have been internally identified via the Company’s loan grading system as credits requiring management’s attention due to underlying problems in the borrower’s business or collateral concerns. This evaluation considers expected future cash flows, the value of collateral and also other factors that may impact the borrower’s ability to make payments when due. For loans greater than $250,000, impairment is individually measured each quarter using one of three alternatives: (1) the present value of expected future cash flows discounted at the loan’s effective interest rate; (2) the loan’s observable market price, if available; or (3) the fair value of the collateral less costs to sell for collateral dependent loans and loans for which foreclosure is deemed to be probable. A specific allowance is assigned when expected cash flows or collateral do not justify the carrying amount of the loan. The carrying value of the loan reflects reductions from prior charge-offs.
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Non-Impaired loans
Non-impaired loans comprise the vast majority of the Company’s total loan portfolio and include loans in accrual status and those credits not identified as troubled debt restructurings. A small portion of these loans are considered “criticized” due to the risk rating assigned reflecting elevated credit risk due to characteristics, such as a strained cash flow position, associated with the individual borrowers. Criticized loans are those assigned risk ratings of Special Mention, Substandard, or Doubtful. Determining the appropriate level of the allowance for loan losses for all non-impaired loans is based on a migration analysis of net losses over a rolling twelve quarter period by loan segment. A weighted average of the net losses is determined by assigning more weight to the most recent quarters in order to recognize current risk factors influencing the various segments of the loan portfolio more prominently than past periods. Environmental factors including changes in economic conditions, changes in credit policies or underwriting standards, and changes in the level of credit risk associated with specific industries and markets are evaluated each quarter to determine if adjustments to the weighted average historical net losses is appropriate given these current influences on the risk profile of each loan segment. Because the economic and business climate in any given industry or market, and its impact on any given borrower, can change rapidly, the risk profile of the loan portfolio is periodically assessed and adjusted when appropriate. Consumer loans are evaluated for adverse classification based primarily on the Uniform Retail Credit Classification and Account Management Policy established by the federal banking regulators. Classification standards are generally based on delinquency status, collateral coverage, bankruptcy and the presence of fraud.
Due to weakened economic conditions during prior years, the Company established qualitative factor adjustments for each of the loan segments at levels above the historical net loss averages. Some of the economic factors included the potential for reduced cash flow for commercial operating loans from reduction in sales or increased operating costs, decreased occupancy rates for commercial buildings, reduced levels of home sales for commercial land developments, the uncertainty regarding grain prices and increased operating costs for farmers, and increased levels of unemployment and bankruptcy impacting consumer’s ability to pay. Each of these economic uncertainties was taken into consideration in developing the level of the allowance for loan losses.
The Company has not materially changed any aspect of its overall approach in the determination of the allowance for loan losses. However, on an on-going basis the Company continues to refine the methods used in determining management’s best estimate of the allowance for loan losses.
The following tables present the balance in the allowance for loan losses and the recorded investment in loans based on portfolio segment and impairment method for the three and nine-months ended September 30, 2018 and 2017 and for the year ended December 31, 2017 (in thousands):