Company Quick10K Filing
Quick10K
First Merchants
Closing Price ($) Shares Out (MM) Market Cap ($MM)
$41.13 49 $2,030
10-Q 2018-09-30 Quarter: 2018-09-30
10-Q 2018-06-30 Quarter: 2018-06-30
10-Q 2018-03-31 Quarter: 2018-03-31
10-K 2017-12-31 Annual: 2017-12-31
10-Q 2017-09-30 Quarter: 2017-09-30
10-Q 2017-06-30 Quarter: 2017-06-30
10-Q 2017-03-31 Quarter: 2017-03-31
10-K 2016-12-31 Annual: 2016-12-31
10-Q 2016-09-30 Quarter: 2016-09-30
10-Q 2016-06-30 Quarter: 2016-06-30
10-Q 2016-03-31 Quarter: 2016-03-31
10-K 2015-12-31 Annual: 2015-12-31
8-K 2019-02-11 Regulation FD, Exhibits
8-K 2019-02-05 Other Events, Exhibits
8-K 2019-01-31 Earnings, Exhibits
8-K 2019-01-31 Earnings, Exhibits
8-K 2018-11-07 Other Events, Exhibits
8-K 2018-11-01 Regulation FD, Exhibits
8-K 2018-10-24 Earnings, Exhibits
8-K 2018-10-24 Earnings, Exhibits
8-K 2018-10-10 Enter Agreement, Regulation FD, Exhibits
8-K 2018-08-15 Other Events, Exhibits
8-K 2018-08-10 Regulation FD, Exhibits
8-K 2018-07-26 Earnings, Exhibits
8-K 2018-07-25 Earnings, Exhibits
8-K 2018-05-11 Shareholder Vote
8-K 2018-05-03 Regulation FD, Exhibits
8-K 2018-04-26 Earnings, Exhibits
8-K 2018-04-25 Earnings, Exhibits
8-K 2018-02-16 Regulation FD, Exhibits
8-K 2018-02-09 Other Events, Exhibits
8-K 2018-01-25 Earnings, Exhibits
8-K 2018-01-16 Other Events, Exhibits
BAC Bank of America
STI Suntrust Banks
FITB Fifth Third Bancorp
CVBF CVB Financial
HOPE Hope Bancorp
ACBI Atlantic Capital Bancshares
EVBN Evans Bancorp
CBFV CB Financial Services
RNDB Randolph Bancorp
FUSB First US Bancshares
FRME 2018-09-30
Part I. Financial Information
Item 1. Consolidated Condensed Financial Statements
Item 1. Notes To Consolidated Condensed Financial Statements
Note 1
Part I. Financial Information
Item 1. Notes To Consolidated Condensed Financial Statements
Note 2
Part I. Financial Information
Item 1. Notes To Consolidated Condensed Financial Statements
Note 3
Part I. Financial Information
Item 1. Notes To Consolidated Condensed Financial Statements
Note 4
Part I. Financial Information
Item 1. Notes To Consolidated Condensed Financial Statements
Note 5
Part I. Financial Information
Item 1. Notes To Consolidated Condensed Financial Statements
Note 6
Note 7
Part I. Financial Information
Item 1. Notes To Consolidated Condensed Financial Statements
Note 8
Part I. Financial Information
Item 1. Notes To Consolidated Condensed Financial Statements
Note 9
Part I. Financial Information
Item 1. Notes To Consolidated Condensed Financial Statements
Note 10
Part I. Financial Information
Item 1. Notes To Consolidated Condensed Financial Statements
Note 11
Part I. Financial Information
Item 1. Notes To Consolidated Condensed Financial Statements
Note 12
Part I. Financial Information
Item 1. Notes To Consolidated Condensed Financial Statements
Note 13
Note 14
Part I. Financial Information
Item 1. Notes To Consolidated Condensed Financial Statements
Note 15
Part I. Financial Information
Item 1. Notes To Consolidated Condensed Financial Statements
Note 16
Note 17
Part I: Financial Information
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations
Item 3. Quantitative and Qualitative
Item 3. Quantitative and Qualitative Disclosures About Market Risk
Part I: Financial Information
Item 4. Controls and Procedures
Part Ii: Other Information
Item 1., Item 1A., Item 2., Item 3., Item 4. and Item 5.
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
Part Ii: Other Information
Item 6. Exhibits
EX-31.1 exhibit31110q2018q3.htm
EX-31.2 exhibit31210q2018q3.htm
EX-32 exhibit3210q2018q3.htm

First Merchants Earnings 2018-09-30

FRME 10Q Quarterly Report

Balance SheetIncome StatementCash Flow

10-Q 1 frmeq32018.htm FIRST MERCHANTS CORPORATION 10-Q Document



FORM 10-Q
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
___________________

[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 0-17071

FIRST MERCHANTS CORPORATION
(Exact name of registrant as specified in its charter)

Indiana                                                                            35-1544218
(State or other jurisdiction of                                   (I.R.S. Employer
incorporation or organization)                               Identification No.)

200 East Jackson Street, Muncie, IN                  47305-2814
(Address of principal executive offices)                   (Zip code)

(Registrant’s telephone number, including area code): (765) 747-1500

Not Applicable
(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 [X]   No [ ]

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes [X]   No [  ]

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a 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.
Large accelerated filer [X]
Accelerated filer [ ]
Non-accelerated filer [  ]
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 Exchange Act). Yes [ ]   No [X]

As of October 31, 2018, there were 49,658,419 outstanding common shares of the registrant.

1

TABLE OF CONTENTS


FIRST MERCHANTS CORPORATION



 
 
Page No.
 
 
 
 
Item 1.
 
 
 
 
 
 
 
Item 2.
Item 3.
Item 4.
 
 
 
 
Item 1.
Item 1A.
Item 2.
Item 3.
Item 4.
Item 5.
Item 6.
 
 
 

2

GLOSSARY OF DEFINED TERMS


FIRST MERCHANTS CORPORATION



Arlington Bank
The Arlington Bank, which was acquired by the Corporation on May 19, 2017.
ASC
Accounting Standards Codification
Bank
First Merchants Bank, a wholly-owned subsidiary of the Corporation
CET1
Common Equity Tier 1
CMT
Constant Maturity Treasury
Corporation
First Merchants Corporation
ESPP
Employee Stock Purchase Plan
FDIC
Federal Deposit Insurance Corporation
FHLB
Federal Home Loan Bank
FTE
Fully taxable equivalent
GAAP
Generally Accepted Accounting Principles
IAB
Independent Alliance Banks, Inc., which was acquired by the Corporation on July 14, 2017.
OREO
Other real estate owned
RSA
Restricted Stock Awards
TEFRA
Tax Equity and Fiscal Responsibility Act



3

PART I. FINANCIAL INFORMATION
ITEM 1. CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
(table dollar amounts in thousands, except share data)



CONSOLIDATED CONDENSED BALANCE SHEETS

September 30,
2018

December 31,
2017

(Unaudited)

ASSETS
 

 
Cash and cash equivalents
$
142,501


$
154,905

Interest-bearing time deposits
66,763


35,027

Investment securities available for sale
1,149,162


999,947

Investment securities held to maturity (fair value of $468,452 and $568,208)
476,089


560,655

Loans held for sale
3,022


7,216

Loans, net of allowance for loan losses of $78,406 and $75,032
7,009,665


6,676,167

Premises and equipment
93,728


95,852

Federal Home Loan Bank stock
24,588


23,825

Interest receivable
38,531


37,130

Goodwill
445,355


445,355

Other intangibles
26,054


31,148

Cash surrender value of life insurance
223,865


223,557

Other real estate owned
8,859


10,373

Tax asset, deferred and receivable
25,933


23,983

Other assets
53,167


42,338

TOTAL ASSETS
$
9,787,282


$
9,367,478

LIABILITIES
 

 
Deposits:
 

 
Noninterest-bearing
$
1,464,190


$
1,761,553

Interest-bearing
6,168,962


5,410,977

Total Deposits
7,633,152


7,172,530

Borrowings:
 

 
Federal funds purchased
90,000


144,038

Securities sold under repurchase agreements
118,824


136,623

Federal Home Loan Bank advances
385,458


414,377

Subordinated debentures and term loans
138,408


139,349

Total Borrowings
732,690


834,387

Interest payable
5,920


4,390

Other liabilities
54,094


52,708

Total Liabilities
8,425,856


8,064,015

COMMITMENTS AND CONTINGENT LIABILITIES





STOCKHOLDERS' EQUITY



Cumulative Preferred Stock, $1,000 par value, $1,000 liquidation value:
 

 
Authorized - 600 shares
 

 
Issued and outstanding - 125 shares
125


125

Common Stock, $.125 stated value:
 

 
Authorized - 100,000,000 shares
 

 
Issued and outstanding - 49,304,542 and 49,158,238 shares
6,163


6,145

Additional paid-in capital
837,996


834,870

Retained earnings
552,551


465,231

Accumulated other comprehensive loss
(35,409
)

(2,908
)
Total Stockholders' Equity
1,361,426


1,303,463

TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY
$
9,787,282


$
9,367,478

 

See NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS.

4

PART I. FINANCIAL INFORMATION
ITEM 1. CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
(table dollar amounts in thousands, except share data)


CONSOLIDATED CONDENSED STATEMENTS OF INCOME
(Unaudited)

 
Three Months Ended
September 30,
 
Nine Months Ended
September 30,
 
2018
 
2017
 
2018
 
2017
INTEREST INCOME
 
 
 
 
 
 
 
Loans receivable:
 
 
 
 
 
 
 
Taxable
$
88,479

 
$
71,491

 
$
251,409

 
$
187,234

Tax exempt
3,761

 
2,851

 
10,989

 
7,676

Investment securities:
 
 
 
 
 
 
 
Taxable
5,514

 
4,524

 
16,044

 
13,012

Tax exempt
6,493

 
5,455

 
18,865

 
15,549

Deposits with financial institutions
270

 
284

 
1,034

 
442

Federal Home Loan Bank stock
283

 
242

 
950

 
635

Total Interest Income
104,800

 
84,847

 
299,291

 
224,548

INTEREST EXPENSE
 
 
 
 
 
 
 
Deposits
13,685

 
6,710

 
34,852

 
15,971

Federal funds purchased
229

 
175

 
670

 
506

Securities sold under repurchase agreements
174

 
133

 
519

 
331

Federal Home Loan Bank advances
2,137

 
1,464

 
6,141

 
3,619

Subordinated debentures and term loans
2,089

 
1,945

 
6,136

 
5,602

Total Interest Expense
18,314

 
10,427

 
48,318

 
26,029

NET INTEREST INCOME
86,486

 
74,420

 
250,973

 
198,519

Provision for loan losses
1,400

 
2,083

 
5,563

 
7,343

NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES
85,086

 
72,337

 
245,410

 
191,176

OTHER INCOME
 
 
 
 
 
 
 
Service charges on deposit accounts
5,619

 
5,044

 
15,434

 
13,656

Fiduciary and wealth management fees
3,673

 
3,783

 
11,064

 
10,556

Other customer fees
5,038

 
4,553

 
14,991

 
13,298

Increase in cash surrender value of life insurance
961

 
1,058

 
2,946

 
2,773

Gains on life insurance benefits

 
517

 
198

 
2,671

Net gains and fees on sales of loans
1,841

 
2,317

 
5,262

 
5,209

Net realized gains on sales of available for sale securities
1,285

 
332

 
4,016

 
1,497

Other income
1,110

 
1,064

 
3,368

 
2,288

Total Other Income
19,527

 
18,668

 
57,279

 
51,948

OTHER EXPENSES
 
 
 
 
 
 
 
Salaries and employee benefits
32,936

 
33,244

 
97,354

 
86,052

Net occupancy
4,586

 
4,371

 
13,604

 
12,552

Equipment
3,483

 
3,478

 
10,707

 
9,192

Marketing
1,216

 
1,021

 
3,574

 
2,378

Outside data processing fees
3,422

 
3,162

 
9,848

 
8,864

Printing and office supplies
334

 
366

 
992

 
905

Intangible asset amortization
1,650

 
1,698

 
5,094

 
3,592

FDIC assessments
856

 
704

 
2,286

 
1,853

Other real estate owned and foreclosure expenses
455

 
330

 
1,219

 
1,592

Professional and other outside services
1,844

 
5,843

 
5,174

 
10,843

Other expenses
4,240

 
4,491

 
12,361

 
11,300

Total Other Expenses
55,022

 
58,708

 
162,213

 
149,123

INCOME BEFORE INCOME TAX
49,591

 
32,297

 
140,476

 
94,001

Income tax expense
8,478

 
7,939

 
23,050

 
22,314

NET INCOME AVAILABLE TO COMMON STOCKHOLDERS
$
41,113

 
$
24,358

 
$
117,426

 
$
71,687

Per Share Data:
 
 
 
 
 
 
 
Basic Net Income Available to Common Stockholders
$
0.83

 
$
0.50

 
$
2.38

 
$
1.64

Diluted Net Income Available to Common Stockholders
$
0.83

 
$
0.50

 
$
2.37

 
$
1.63

Cash Dividends Paid
$
0.22

 
$
0.18

 
$
0.62

 
$
0.51

Average Diluted Shares Outstanding (in thousands)
49,492

 
48,644

 
49,458

 
44,063



See NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS.


5

PART I. FINANCIAL INFORMATION
ITEM 1. CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
(table dollar amounts in thousands, except share data)


CONSOLIDATED CONDENSED STATEMENTS OF COMPREHENSIVE INCOME
(Unaudited)


Three Months Ended
September 30,

Nine Months Ended
September 30,
 
2018
 
2017

2018

2017
Net income
$
41,113


$
24,358


$
117,426


$
71,687

Other comprehensive income (loss), net of tax:
 

 

 

 
Unrealized holding gain (loss) on securities available for sale arising during the period, net of tax of $2,596, $4,101, $7,470 and $4,374
(9,765
)

(7,617
)

(30,032
)

8,124

Unrealized gain (loss) on cash flow hedges arising during the period, net of tax of $44, $3, $212 and $134
166


(7
)

1,039


(246
)
Reclassification adjustment for net gains included in net income, net of tax of $250, $32, $766 and $258
(942
)

(60
)

(2,882
)

(480
)
Defined benefit pension plan amortization of prior service cost, net of tax of $31 and $94


(58
)



(175
)
Total other comprehensive income (loss), net of tax
(10,541
)

(7,742
)

(31,875
)

7,223

Comprehensive income
$
30,572


$
16,616


$
85,551


$
78,910

 

See NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS.


6

PART I. FINANCIAL INFORMATION
ITEM 1. CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
(table dollar amounts in thousands, except share data)


CONSOLIDATED CONDENSED STATEMENT OF STOCKHOLDERS’ EQUITY
(Unaudited)
 

Preferred

Common Stock

Additional



Accumulated
Other



Shares

Amount

Shares

Amount

Paid in
Capital

Retained
Earnings

Comprehensive
Loss

Total
Balances, December 31, 2017
125


$
125


49,158,238


$
6,145


$
834,870


$
465,231


$
(2,908
)

$
1,303,463

Comprehensive income:
 

 

 

 

 

 

 


Net income
 









117,426




117,426

Other comprehensive loss, net of tax
 











(31,875
)

(31,875
)
Cash dividends on common stock ($.62 per share)
 



 

 

 

(30,732
)

 

(30,732
)
Reclassification adjustment under ASU 2018-02
 
 
 
 
 
 
 
 
 
 
626
 
(626
)
 

Share-based compensation
 



106,833


13


2,533


 

 

2,546

Stock issued under employee benefit plans
 



13,448


2


513


 

 

515

Stock issued under dividend reinvestment and
stock purchase plan
 



18,761


2


877


 

 

879

Stock options exercised
 



51,243


6


1,087


 

 

1,093

Stock redeemed
 



(43,981
)

(5
)

(1,884
)

 

 

(1,889
)
Balances, September 30, 2018
125


$
125


49,304,542


$
6,163


$
837,996


$
552,551


$
(35,409
)

$
1,361,426



See NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS.


7

PART I. FINANCIAL INFORMATION
ITEM 1. CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
(table dollar amounts in thousands, except share data)


CONSOLIDATED CONDENSED STATEMENTS OF CASH FLOWS
(Unaudited)
 
Nine Months Ended
 
September 30, 2018

September 30, 2017
Cash Flow From Operating Activities:
 

 
Net income
$
117,426


$
71,687

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

 
Provision for loan losses
5,563


7,343

Depreciation and amortization
6,630


5,696

Change in deferred taxes
3,750


3,542

Share-based compensation
2,546


1,884

Loans originated for sale
(277,312
)

(246,979
)
Proceeds from sales of loans held for sale
285,297


257,695

Gains on sales of loans held for sale
(3,791
)

(4,081
)
Gains on sales of securities available for sale
(4,016
)

(1,497
)
Increase in cash surrender of life insurance
(2,946
)

(2,773
)
Gains on life insurance benefits
(198
)

(2,671
)
Change in interest receivable
(1,401
)

(2,074
)
Change in interest payable
1,530


597

Other adjustments
3,077


(9,006
)
Net cash provided by operating activities
136,155


79,363

Cash Flows from Investing Activities:
 

 
Net change in interest-bearing deposits
(31,736
)

200,013

Purchases of:


 
Securities available for sale
(341,433
)

(307,220
)
Securities held to maturity



(30,220
)
Proceeds from sales of securities available for sale
126,136


54,513

Proceeds from maturities of:


 
Securities available for sale
56,533


52,176

Securities held to maturity
52,258


55,276

Change in Federal Home Loan Bank stock
(763
)

40

Net change in loans
(347,054
)

(401,977
)
Net cash and cash equivalents received in acquisition



54,536

Proceeds from the sale of other real estate owned
2,069


5,046

Proceeds from life insurance benefits
2,836


11,642

Other adjustments
2,708


(1,656
)
Net cash used in investing activities
(478,446
)

(307,831
)
Cash Flows from Financing Activities:
 

 
Net change in :
 

 
Demand and savings deposits
342,471


132,145

Certificates of deposit and other time deposits
118,151


107,322

Borrowings
1,451,467


894,674

Repayment of borrowings
(1,552,068
)

(866,231
)
Cash dividends on common stock
(30,732
)

(22,909
)
Stock issued under employee benefit plans
515


367

Stock issued under dividend reinvestment and stock purchase plans
879


714

Stock options exercised
1,093


2,323

Stock redeemed
(1,889
)

(1,257
)
Net cash provided by financing activities
329,887


247,148

Net Change in Cash and Cash Equivalents
(12,404
)

18,680

Cash and Cash Equivalents, January 1
154,905


127,927

Cash and Cash Equivalents, September 30
$
142,501


$
146,607

Additional cash flow information:
 

 
Interest paid
$
46,788


$
24,183

Income tax paid
13,719


18,000

Loans transferred to other real estate owned
405


8,210

Fixed assets transferred to other real estate owned
374

 


Non-cash investing activities using trade date accounting
828


3,798

Investments transferred from held to maturity to available for sale in accordance with ASU 2017-12
30,794

 
 
 
 
 
 
In conjunction with the acquisitions, liabilities were assumed as follows:
 
 
 
Fair value of assets acquired


 
$
1,531,397

Cash paid in acquisition


 
(12
)
Less: Common stock issued


 
321,431

Liabilities assumed
$

 
$
1,209,954


See NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS.

8

PART I. FINANCIAL INFORMATION
ITEM 1. NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
(table dollar amounts in thousands, except share data)
(Unaudited)




NOTE 1 
 
GENERAL
 
Financial Statement Preparation

The significant accounting policies followed by the Corporation and its wholly-owned subsidiaries for interim financial reporting are consistent with the accounting policies followed for annual financial reporting. All adjustments, which are of a normal recurring nature and are in the opinion of management necessary for a fair statement of the results for the periods reported, have been included in the accompanying Consolidated Condensed Financial Statements.

The Consolidated Condensed Balance Sheet of the Corporation as of December 31, 2017, has been derived from the audited consolidated balance sheet of the Corporation as of that date. Certain information and note disclosures normally included in the Corporation’s annual financial statements, prepared in accordance with accounting principles generally accepted in the United States of America, have been condensed or omitted. These consolidated condensed financial statements should be read in conjunction with the consolidated financial statements and notes thereto included in the Corporation’s Annual Report on Form 10-K for the year ended December 31, 2017 filed with the Securities and Exchange Commission. The results of operations for the three and nine months ended September 30, 2018, are not necessarily indicative of the results to be expected for the year. Reclassifications have been made to prior financial statements to conform to the current financial statement presentation. These reclassifications had no effect on net income.

Recent Accounting Changes

ASU 2018-02 "Income Statement - Reporting Comprehensive Income (Topic 220): Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income" ("ASU 2018-02") allows a reclassification from accumulated other comprehensive income (loss) to retained earnings for the stranded tax effects caused by the revaluation of deferred taxes resulting from the newly enacted corporate tax rate in the Tax Cuts and Jobs Act. The ASU is effective in years beginning after December 15, 2018, but permits early adoption in a period for which financial statements have not yet been issued. The Corporation elected to early adopt the ASU as of January 1, 2018. The adoption of the guidance resulted in an insignificant cumulative-effect adjustment that decreased accumulated other comprehensive income (loss) and increased retained earnings in 2018.

ASU 2017-12 - "Derivatives and Hedging (Topic 815): Targeted Improvements to Accounting for Hedging Activities" ("ASU 2017-12") is intended to improve and simplify accounting rules around hedge accounting. The ASU is effective for public companies in 2019 and private companies in 2020. Early adoption is permitted. The new standard refines and expands hedge accounting for both financial (e.g., interest rate) and commodity risks. Its provisions create more transparency around how economic results are presented, both on the face of the financial statements and in the footnotes, for investors and analysts. The new standard takes effect for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2018, for public companies and for fiscal years beginning after December 15, 2019 (and interim periods for fiscal years beginning after December 15, 2020), for private companies. Early adoption is permitted in any interim period or fiscal years before the effective date of the standard. ASU 2017-12 requires a modified retrospective transition method in which a cumulative effect of the change on the opening balance of each affected component of equity is recognized in the statement of financial position as of the date of adoption. The Corporation adopted this standard in the third quarter of 2018. As permitted by the ASU, the Corporation reclassified $30.8 million of state and municipal securities with unrealized gains of $450,000 from the held to maturity portfolio to the available for sale portfolio. Other than this reclassification of securities, adoption of the standard did not have a significant impact on the Corporation’s consolidated financial statements.

ASU 2017-07 "Compensation - Retirement Benefits (Topic 715): Improving the Presentation of Net Periodic Pension Cost and Net Periodic Postretirement Benefit Cost" ("ASU 2017-07") applies to all employers, including not-for-profit entities, that offer to their employees defined benefit pension plans, other postretirement benefit plans, or other types of benefits accounted for under Topic 715, Compensation - Retirement Benefits. The amendments require that an employer report the service cost component in the same line item or items as other compensation costs arising from services rendered by the pertinent employees during the period. The other components of net benefit cost are required to be presented in the income statement separately from the service cost component and outside a subtotal of income from operations, if one is presented. If a separate line item or items are used to present the other components of net benefit cost, that line item or items must be appropriately described. If a separate line item or items are not used, the line item or items used in the income statement to present the other components of net benefit cost must be disclosed. The amendments also allow only the service cost component to be eligible for capitalization when applicable (e.g., as a cost of internally manufactured inventory or a self-constructed asset). The amendments are effective for public business entities for annual periods beginning after December 15, 2017, including interim periods within those annual periods. For other entities, the amendments are effective for annual periods beginning after December 15, 2018, and interim periods within annual periods beginning after December 15, 2019. Early adoption is permitted as of the beginning of an annual period for which financial statements (interim or annual) have not been issued or made available for issuance. The Corporation adopted this ASU in 2018. Adoption of the standard did not have a significant impact on the Corporation’s consolidated financial statements.

ASU 2016-15 "Statement of Cash Flows (Topic 230)" ("ASU 2016-15") is intended to reduce the diversity in practice around how certain transactions are classified within the statement of cash flows. ASU 2016-15 became effective for the Corporation on January 1, 2018 and did not have a significant impact on the Corporation's financial statements.


9

PART I. FINANCIAL INFORMATION
ITEM 1. NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
(table dollar amounts in thousands, except share data)
(Unaudited)




ASU 2016-01 "Financial Instruments - Overall (Subtopic 825-10): Recognition of Financial Assets and Financial Liabilities" ("ASU 2016-01") makes targeted amendments to the guidance for recognition, measurement, presentation and disclosure of financial instruments. ASU 2016-01 requires equity investments, other than equity method investments, to be measured at fair value with changes in fair value recognized in net income. The ASU requires a cumulative-effect adjustment to retained earnings as of the beginning of the reporting period of adoption to reclassify the cumulative change in fair value of equity securities previously recognized in accumulated other comprehensive income (loss). ASU 2016-01 became effective for the Corporation on January 1, 2018. The adoption of the guidance did not result in any cumulative effect adjustment in 2018. ASU 2016-01 also emphasizes the existing requirement to use exit prices to measure fair value for disclosure purposes and clarifies that entities should not make use of a practicability exception in determining the fair value of loans. Accordingly, the Corporation refined the calculation used to determine the disclosed fair value of loans held for investment as part of adopting this standard. The refined calculation did not have a significant impact on the fair value disclosures included in NOTE 9. DISCLOSURES ABOUT FAIR VALUE OF ASSETS AND LIABILITIES of these Notes to Consolidated Condensed Financial Statements.

ASU 2014-09 "Revenue from Contracts with Customers (Topic 606)" ("ASU 2014-09") implements a common revenue standard that clarifies the principles for recognizing revenue. The core principle of ASU 2014-09 is that an entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. ASU 2014-09 establishes a five-step model which entities must follow to recognize revenue and removes inconsistencies and weaknesses in existing guidance. The guidance does not apply to revenue associated with financial instruments, including loans and investment securities that are accounted for under other GAAP, which comprises a significant portion of our revenue stream. ASU 2014-09 became effective for the Corporation on January 1, 2018. The adoption of ASU 2014-09 did not result in a change to the accounting for any of the in-scope revenue streams; as such, no cumulative effect adjustment was recorded. Additional information related to revenue generated from contracts with customers is detailed below.

Revenue Recognition

ASU 2014-09 establishes principles 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. The core principle requires an entity to recognize revenue to depict the transfer of goods or services to customers in an amount that reflects the consideration that it expects to be entitled to receive in exchange for those goods or services recognized as performance obligations are satisfied.

The majority of the Corporation's revenue-generating transactions are not subject to ASU 2014-09, including revenue generated from financial instruments, such as loans, letters of credit, derivatives and investment securities, as well as revenue related to mortgage servicing activities, as these activities are subject to other GAAP discussed elsewhere within the disclosures. The Corporation has evaluated the nature of its contracts with customers and determined that further disaggregation of revenue from contracts with customers into more granular categories beyond what is presented in the Consolidated Condensed Statements of Income was not necessary. Descriptions of revenue-generating activities that are within the scope of ASU 2014-09, which are presented in our income statements are as follows:

Service charges on deposit accounts: The Corporation earns fees from its deposit customers for transaction-based, account maintenance and overdraft services. Transaction-based fees, which include services such as ATM use fees, stop payment charges, statement rendering and ACH fees, are recognized at the time the transaction is executed, which is the point in time the Corporation fulfills the customer's request. Account maintenance fees, which relate primarily to monthly maintenance, are earned monthly, representing the period which the Corporation satisfies the performance obligation. Overdraft fees are recognized at the point in time that the overdraft occurs. Service charges on deposits are withdrawn from the customer's account balance.

Fiduciary activities: This represents monthly fees due from wealth management customers as consideration for managing the customers' assets. Wealth management and trust services include custody of assets, investment management, fees for trust services and similar fiduciary activities. These fees are primarily earned over time as the Corporation provides the contracted monthly or quarterly services and are generally assessed based on the market value of assets under management at month-end. Fees that are transaction-based are recognized at the point in time that the transaction is executed.

Investment Brokerage Fees: The Corporation earns fees from investment brokerage services provided to its customers by a third-party service provider. The Corporation receives commissions from the third-party provider on a monthly basis based upon customer activity for the month. The fees are paid to us by the third party on a monthly basis and are recognized when received.

Interchange income: The Corporation earns interchange fees from debit and credit cardholder transactions conducted through the Visa and MasterCard payment networks. Interchange fees from cardholder transactions represent a percentage of the underlying transaction value and are recognized concurrent with the transaction processing services provided to the cardholder.

Gains (Losses) on Sales of OREO: The Corporation records a gain or loss from the sale of OREO when control of the property transfers to the buyer, which generally occurs at the time of an executed deed. When the Corporation finances the sale of OREO to the buyer, the Corporation assesses whether the buyer is committed to perform their obligations under the contract and whether collectability of the transaction price is probable. Once these criteria are met, the OREO asset is derecognized and the gain or loss on sale is recorded upon the transfer of control of the property to the buyer. In determining the gain or loss on the sale, the Corporation adjusts the transaction price and related gain (loss) on sale if a significant financing component is present.



10

PART I. FINANCIAL INFORMATION
ITEM 1. NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
(table dollar amounts in thousands, except share data)
(Unaudited)




NOTE 2

ACQUISITIONS

Independent Alliance Banks, Inc.

On November 21, 2016, the Corporation purchased 495,112 shares, or 12.1 percent, of IAB's outstanding common stock from an IAB shareholder for $19.8 million, or $40.00 per share. On July 14, 2017, the Corporation acquired the remaining shares of IAB common stock. IAB, an Indiana Corporation, merged with and into the Corporation, whereupon the separate corporate existence of IAB ceased and the Corporation survived. Immediately following the merger, IAB's wholly-owned subsidiary, iAB Financial Bank, merged with and into the Bank, with the Bank continuing as the surviving bank.

IAB was headquartered in Fort Wayne, Indiana and had 16 banking centers serving the Fort Wayne market. Pursuant to the merger agreement, each IAB shareholder received 1.653 shares of the Corporation's common stock for each outstanding share of IAB common stock held. The Corporation issued approximately 6.0 million shares of common stock. The transaction value for the remaining shares of common stock, not owned by the Corporation, was approximately $238.8 million, resulting in a total purchase price of $258.6 million. The Corporation engaged in this transaction with the expectation that it would be accretive to income and add a new market area with a demographic profile consistent with many of the current Indiana markets served by the Bank. Goodwill resulted from this transaction due to the expected synergies and economies of scale.

In the third quarter of 2017, ASC 805-10 - Business Combinations, required the Corporation to remeasure the 12.1 percent equity interest in IAB's common stock and recognize the resulting gain or loss, if any, in earnings. The remeasurement was based upon the closing price of IAB's common stock immediately prior to the acquisition announcement, and prior to the Corporation obtaining control of IAB. The trading price of IAB's common stock subsequent to the acquisition announcement included a control or acquisition premium and was not indicative of the fair value of the Corporation's pre-existing equity interest immediately prior to the acquisition announcement. The fair value of the equity interest in IAB's common stock after the remeasurement was $19.8 million. The Corporation recorded a $50,000 loss in the third quarter of 2017 as a result of the remeasurement.

Under the acquisition method of accounting, the total purchase price is allocated to net tangible and intangible assets based on their current estimated fair values on the date of the acquisition. Based on valuations of the fair value of tangible and intangible assets acquired and liabilities assumed, which are based on assumptions that are subject to change, the purchase price for the IAB acquisition is detailed in the following table.
 
 
Fair Value
Cash and cash equivalents
 
$
6,016

Interest-bearing time deposits
 
248,212

Investment securities
 
4,078

Loans held for sale
 
594

Loans
 
725,382

Premises and equipment
 
10,107

Federal Home Loan Bank stock
 
4,810

Interest receivable
 
3,445

Cash surrender value of life insurance
 
26,964

Other assets
 
11,780

Deposits
 
(862,271
)
Securities sold under repurchase agreements
 
(17,915
)
Federal Home Loan Bank Advances
 
(47,575
)
Subordinated debentures
 
(10,583
)
Interest payable
 
(1,005
)
Other liabilities
 
(14,472
)
Net tangible assets acquired
 
87,567

Other Intangible assets
 
17,403

Goodwill
 
153,636

Purchase price
 
$
258,606



Of the total purchase price, $17,403,000 has been allocated to other intangible assets. Approximately $13.6 million was allocated to a core deposit intangible, which will be amortized over its estimated life of 10 years. Approximately $3.8 million was allocated to a non-compete intangible, which will be amortized over its estimated life of 2 years. The remaining purchase price was allocated to goodwill, which is not deductible for tax purposes.


11

PART I. FINANCIAL INFORMATION
ITEM 1. NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
(table dollar amounts in thousands, except share data)
(Unaudited)




Acquired loan data for IAB can be found in the table below:

Fair Value of Acquired Loans at Acquisition Date
 
Gross Contractual Amounts Receivable at Acquisition Date
 
Best Estimate at Acquisition Date of Contractual Cash Flows Not Expected to be Collected
Acquired receivables subject to ASC 310-30
$
4,838

 
$
14,131

 
$
8,352

Acquired receivables not subject to ASC 310-30
$
720,544

 
$
864,613

 
$
9,786


Purchased loans with evidence of credit deterioration since origination and for which it is probable at the date of acquisition that the acquirer will not collect all contractually required principal and interest payments are accounted for under ASC 310-30, Loans Acquired with Deteriorated Credit Quality. The difference between contractually required payments and the cash flows expected to be collected at acquisition is referred to as the nonaccretable difference. The accretable portion of the fair value discount or premium is the difference between the expected cash flows and the net present value of expected cash flows, with such difference accreted into earnings over the term of the loans.

The Arlington Bank

On May 19, 2017, the Corporation acquired 100 percent of Arlington Bank. Arlington Bank, an Ohio savings bank, merged with and into the Bank, with the Bank continuing as the surviving bank. Arlington Bank was headquartered in Columbus, Ohio and had 3 banking centers serving the Columbus, Ohio market. Pursuant to the merger agreement, each Arlington Bank shareholder received 2.7245 shares of the Corporation's common stock for each outstanding share of Arlington Bank common stock held. The Corporation issued approximately 2.1 million shares of common stock, which was valued at approximately $82.6 million. The Corporation engaged in this transaction with the expectation that it would be accretive to income and expand the existing footprint in Columbus, Ohio. Goodwill resulted from this transaction due to the expected synergies and economies of scale.

Under the acquisition method of accounting, the total purchase price is allocated to net tangible and intangible assets based on their current estimated fair values on the date of the acquisition. Based on valuations of the fair value of tangible and intangible assets acquired and liabilities assumed, which are based on assumptions that are subject to change, the purchase price for the Arlington Bank acquisition is detailed in the following table.
 
 
Fair Value
Cash and cash equivalents
 
$
48,532

Interest-bearing time deposits
 
292

Loans held for sale
 
7,626

Loans
 
224,680

Premises and equipment
 
1,986

Federal Home Loan Bank stock
 
1,091

Interest receivable
 
653

Other assets
 
1,620

Deposits
 
(252,783
)
Interest payable
 
(244
)
Other liabilities
 
(3,106
)
Net tangible assets acquired
 
30,347

Core deposit intangible
 
4,526

Goodwill
 
47,719

Purchase price
 
$
82,592



Of the total purchase price, $4,526,000 has been allocated to a core deposit intangible that will be amortized over its estimated life of 10 years. The remaining purchase price was allocated to goodwill, which is not deductible for tax purposes.

Acquired loan data for Arlington Bank can be found in the table below:

Fair Value of Acquired Loans at Acquisition Date
 
Gross Contractual Amounts Receivable at Acquisition Date
 
Best Estimate at Acquisition Date of Contractual Cash Flows Not Expected to be Collected
Acquired receivables subject to ASC 310-30
$
2,625

 
$
6,183

 
$
2,891

Acquired receivables not subject to ASC 310-30
$
222,055

 
$
308,857

 
$
2,741




12

PART I. FINANCIAL INFORMATION
ITEM 1. NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
(table dollar amounts in thousands, except share data)
(Unaudited)




Pro Forma Financial Information

The results of operations of Arlington Bank and IAB have been included in the Corporation's consolidated financial statements since the acquisition dates. The following schedule includes pro forma results for the year ended December 31, 2017, as if the Arlington Bank and IAB acquisitions occurred as of the beginning of the period presented.
 
2017
Total revenue (net interest income plus other income)
$
380,324

Net income
$
95,009

Net income available to common shareholders
 
Earnings per share:
 
Basic
$
1.94

Diluted
$
1.93



The pro forma information includes adjustments for interest income on loans, interest expense on deposits and borrowings, premises expense for banking centers acquired and amortization of intangibles arising from the transactions and the related income tax effects. The pro forma information for the year ended December 31, 2017 includes operating revenue of $9.0 million and $21.4 million from the Arlington Bank and IAB acquisitions since the date of acquisition, respectively. Additionally, $15.4 million, net of tax, of expenses directly attributable to the Arlington Bank and IAB acquisitions were included in the year ended December 31, 2017 pro forma information. The pro forma information is presented for information purposes only and is not indicative of the results of operations that actually would have been achieved had the acquisitions been consummated as of that time, nor is it intended to be a projection of future results.


NOTE 3 
 
INVESTMENT SECURITIES
 
The amortized cost, gross unrealized gains, gross unrealized losses and approximate market value of the Corporation's investment securities at the dates indicated were:
 
Amortized
Cost
 
Gross
Unrealized
Gains
 
Gross
Unrealized
Losses
 
Fair
Value
Available for sale at September 30, 2018
 
 
 
 
 
 
 
U.S. Government-sponsored agency securities
$
18,492

 


 
$
134

 
$
18,358

State and municipal
611,528

 
2,920

 
14,280

 
600,168

U.S. Government-sponsored mortgage-backed securities
547,223

 
71

 
16,689

 
530,605

Corporate obligations
31

 

 


 
31

Total available for sale
1,177,274

 
2,991

 
31,103

 
1,149,162

Held to maturity at September 30, 2018
 
 
 
 
 
 
 
U.S. Government-sponsored agency securities
22,618

 


 
833

 
21,785

State and municipal
192,124

 
1,161

 
1,748

 
191,537

U.S. Government-sponsored mortgage-backed securities
260,347

 
300

 
6,514

 
254,133

Foreign Investments
1,000

 
 
 
3

 
997

Total held to maturity
476,089

 
1,461

 
9,098

 
468,452

Total Investment Securities
$
1,653,363

 
$
4,452

 
$
40,201

 
$
1,617,614

 
 
Amortized
Cost
 
Gross
Unrealized
Gains
 
Gross
Unrealized
Losses
 
Fair
Value
Available for sale at December 31, 2017
 
 
 
 
 
 
 
State and municipal
$
510,852

 
$
16,932

 
$
1,091

 
$
526,693

U.S. Government-sponsored mortgage-backed securities
473,325

 
964

 
3,423

 
470,866

Corporate obligations
31

 

 


 
31

Equity securities
2,357

 

 

 
2,357

Total available for sale
986,565

 
17,896

 
4,514

 
999,947

Held to maturity at December 31, 2017
 
 
 
 
 
 
 
U.S. Government-sponsored agency securities
22,618

 
 
 
435

 
22,183

State and municipal
235,594

 
6,295

 
244

 
241,645

U.S. Government-sponsored mortgage-backed securities
301,443

 
3,341

 
1,404

 
303,380

Foreign Investment
1,000

 
 
 
 
 
1,000

Total held to maturity
560,655

 
9,636

 
2,083

 
568,208

Total Investment Securities
$
1,547,220

 
$
27,532

 
$
6,597

 
$
1,568,155


13

PART I. FINANCIAL INFORMATION
ITEM 1. NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
(table dollar amounts in thousands, except share data)
(Unaudited)




The amortized cost and fair value of available for sale and held to maturity securities at September 30, 2018 and December 31, 2017, by contractual maturity, are shown below. Expected maturities will differ from contractual maturities because issuers may have the right to call or prepay obligations with or without call or prepayment penalties.
 
Available for Sale
 
Held to Maturity
 
Amortized Cost
 
Fair Value
 
Amortized Cost
 
Fair Value
Maturity Distribution at September 30, 2018:
 
 
 
 
 
 
 
Due in one year or less
$
24,098

 
$
24,360

 
$
5,161

 
$
5,178

Due after one through five years
17,294

 
17,511

 
48,155

 
47,042

Due after five through ten years
75,416

 
75,498

 
57,950

 
58,212

Due after ten years
513,243

 
501,188

 
104,476

 
103,887

 
630,051

 
618,557

 
215,742

 
214,319

U.S. Government-sponsored mortgage-backed securities
547,223

 
530,605

 
260,347

 
254,133

Total Investment Securities
$
1,177,274

 
$
1,149,162

 
$
476,089

 
$
468,452



 
Available for Sale
 
Held to Maturity
 
Amortized Cost
 
Fair Value
 
Amortized Cost
 
Fair Value
Maturity Distribution at December 31, 2017
 
 
 
 
 
 
 
Due in one year or less
$
425

 
$
425

 
$
12,015

 
$
12,158

Due after one through five years
5,040

 
5,204

 
76,146

 
76,334

Due after five through ten years
74,921

 
78,806

 
54,441

 
55,679

Due after ten years
430,497

 
442,289

 
116,610

 
120,657

 
510,883

 
526,724

 
259,212

 
264,828

U.S. Government-sponsored mortgage-backed securities
473,325

 
470,866

 
301,443

 
303,380

Equity securities
2,357

 
2,357

 

 

Total Investment Securities
$
986,565

 
$
999,947

 
$
560,655

 
$
568,208



The carrying value of securities pledged as collateral, to secure borrowings and for other purposes, was $426,200,000 at September 30, 2018, and $475,999,000 at December 31, 2017.

The book value of securities sold under agreements to repurchase amounted to $122,789,000 at September 30, 2018, and $136,639,000 at December 31, 2017.

Gross gains on the sales and redemptions of available for sale securities for the three and nine months ended September 30, 2018 and 2017 are shown below.
 
Three Months Ended
September 30,
 
Nine Months Ended
September 30,
 
2018
 
2017
 
2018
 
2017
Sales and Redemptions of Available for Sale Securities:
 
 
 
 
 
 
 
Gross gains
$
1,285

 
$
382

 
$
4,016

 
$
1,547

Gross losses


50




50


 

14

PART I. FINANCIAL INFORMATION
ITEM 1. NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
(table dollar amounts in thousands, except share data)
(Unaudited)




The following tables show the Corporation’s gross unrealized losses and fair value, aggregated by investment category and length of time the individual securities have been in a continuous unrealized loss position at September 30, 2018, and December 31, 2017:
 
Less than
12 Months
 
12 Months
or Longer
 
Total
 
Fair
Value
 
Gross
Unrealized
Losses
 
Fair
Value
 
Gross
Unrealized
Losses
 
Fair
Value
 
Gross
Unrealized
Losses
Temporarily Impaired Available for Sale Securities at September 30, 2018
 
 
 
 
 
 
 
 
 
 
 
U.S. Government-sponsored agency securities
$
18,358

 
$
134

 
 
 
 
 
$
18,358

 
$
134

State and municipal
397,852

 
11,780

 
$
30,820

 
$
2,500

 
428,672

 
14,280

U.S. Government-sponsored mortgage-backed securities
386,632

 
9,603

 
134,602

 
7,086

 
521,234

 
16,689

Total Temporarily Impaired Available for Sale Securities
802,842

 
21,517

 
165,422

 
9,586

 
968,264

 
31,103

Temporarily Impaired Held to Maturity Securities at September 30, 2018
 
 
 
 
 
 
 
 
 
 
 
U.S. Government-sponsored agency securities
97

 
3

 
21,688

 
830

 
21,785

 
833

State and municipal
44,857

 
857

 
16,326

 
891

 
61,183

 
1,748

U.S. Government-sponsored mortgage-backed securities
168,488

 
3,473

 
61,139

 
3,041

 
229,627

 
6,514

Corporate Obligations
997

 
3

 
 
 
 
 
997

 
3

Total Temporarily Impaired Held to Maturity Securities
214,439

 
4,336

 
99,153

 
4,762

 
313,592

 
9,098

Total Temporarily Impaired Investment Securities
$
1,017,281

 
$
25,853

 
$
264,575

 
$
14,348

 
$
1,281,856

 
$
40,201


 
Less than
12 Months
 
12 Months
or Longer
 
Total
 
Fair
Value
 
Gross
Unrealized
Losses
 
Fair
Value
 
Gross
Unrealized
Losses
 
Fair
Value
 
Gross
Unrealized
Losses
Temporarily Impaired Available for Sale Securities at December 31, 2017
 
 
 
 
 
 
 
 
 
 
 
State and municipal
$
13,296

 
$
198

 
$
35,324

 
$
893

 
$
48,620

 
$
1,091

U.S. Government-sponsored mortgage-backed securities
182,755

 
1,520

 
68,667

 
1,903

 
251,422

 
3,423

Total Temporarily Impaired Available for Sale Securities
196,051

 
1,718

 
103,991

 
2,796

 
300,042

 
4,514

Temporarily Impaired Held to Maturity Securities at December 31, 2017
 
 
 
 
 
 
 
 
 
 
 
U.S. Government-sponsored agency securities
9,988

 
131

 
12,196

 
304

 
22,184

 
435

State and municipal
2,430

 
36

 
15,805

 
208

 
18,235

 
244

U.S. Government-sponsored mortgage-backed securities
62,508

 
485

 
43,078

 
919

 
105,586

 
1,404

Total Temporarily Impaired Held to Maturity Securities
74,926

 
652

 
71,079

 
1,431

 
146,005

 
2,083

Total Temporarily Impaired Investment Securities
$
270,977

 
$
2,370

 
$
175,070

 
$
4,227

 
$
446,047

 
$
6,597



Certain investments in debt and equity securities are reported in the financial statements at an amount less than their historical cost as indicated in the table below.
 
September 30, 2018
 
December 31, 2017
Investments reported at less than historical cost:
 
 
 
Historical cost
$
1,322,058

 
$
452,644

Fair value
$
1,281,856

 
$
446,047

Percent of the Corporation's investment portfolio
78.9
%
 
28.6
%


Management believes the decline in fair value for these securities was temporary. Should the impairment of any of these securities become other-than-temporary, the cost basis of the investment will be reduced and the resulting loss recognized in net income during the period the other-than-temporary-impairment ("OTTI") is identified.

The Corporation’s management has evaluated all securities with unrealized losses for OTTI as of September 30, 2018. The evaluations are based on the nature of the securities, the extent and duration of the loss and the intent and ability of the Corporation to hold these securities either to maturity or through the expected recovery period.

In determining the fair value of the investment securities portfolio, the Corporation utilizes a third party for portfolio accounting services, including market value input, for those securities classified as Level 1 and Level 2 in the fair value hierarchy.  The Corporation has obtained an understanding of what inputs are being used by the vendor in pricing the portfolio and how the vendor classified these securities based upon these inputs.  From these discussions, the Corporation’s management is comfortable that the classifications are proper.  The Corporation has gained trust in the data for two reasons:  (a) independent spot testing of the data is conducted by the Corporation through obtaining market quotes from various brokers on a periodic basis; and (b) actual gains or loss resulting from the sale of certain securities has proven the data to be accurate over time.   Fair value of securities classified as Level 3 in the valuation hierarchy was determined using a discounted cash flow model that incorporated market estimates of interest rates and volatility in markets that have not been active.


15

PART I. FINANCIAL INFORMATION
ITEM 1. NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
(table dollar amounts in thousands, except share data)
(Unaudited)




State and Municipal and U.S. Government-Sponsored Agency Securities
  
The unrealized losses on the Corporation's investments in securities of state and political subdivisions and U.S. Government-Sponsored Agency securities were caused by interest rate increases. The contractual terms of those investments do not permit the issuer to settle the securities at a price less than the amortized cost basis of the investments. Because the Corporation does not intend to sell the investments and it is not more likely than not that the Corporation will be required to sell the investments before recovery of their amortized cost basis, which may be maturity, the Corporation does not consider those investments to be other-than-temporarily impaired at September 30, 2018. The state and municipal securities portfolio contains unrealized losses of $14,280,000 on three hundred thirty-six securities and $1,748,000 on sixty-eight securities in the available for sale and held to maturity portfolios, respectively. The U.S. Government-Sponsored Agency securities portfolio contains unrealized losses of $134,000 on seven securities and $833,000 on five securities in the available for sale and held to maturity portfolios, respectively.

U.S. Government-Sponsored Mortgage-Backed Securities

The unrealized losses on the Corporation's investment in mortgage-backed securities were a result of interest rate changes. The Corporation expects to recover the amortized cost basis over the term of the securities. Because the decline in market value is attributable to changes in interest rates and not credit quality, and because the Corporation does not intend to sell the investments and it is not more likely than not that the Corporation will be required to sell the investments before recovery of their amortized cost basis, which may be maturity, the Corporation does not consider those investments to be other-than-temporarily impaired at September 30, 2018. The mortgage-backed securities portfolio contains unrealized losses of $16,689,000 on one hundred twenty-five securities and $6,514,000 on one hundred securities in the available for sale and held to maturity portfolios, respectively. All these securities are issued by a U.S. government-sponsored entity.


NOTE 4  
 
LOANS AND ALLOWANCE
 
The Corporation’s primary lending focus is small business and middle market commercial, commercial real estate and residential real estate, which results in portfolio diversification. The following tables show the composition of the loan portfolio, the allowance for loan losses and credit quality characteristics by collateral classification, excluding loans held for sale. Loans held for sale as of September 30, 2018, and December 31, 2017, were $3,022,000 and $7,216,000, respectively.

The following table illustrates the composition of the Corporation’s loan portfolio by loan class for the periods indicated:

September 30, 2018

December 31, 2017
Commercial and industrial loans
$
1,655,569


$
1,493,493

Agricultural production financing and other loans to farmers
88,504


121,757

Real estate loans:
 


Construction
668,608


612,219

Commercial and farmland
2,699,629


2,562,691

Residential
965,893


962,765

Home equity
517,303


514,021

Individuals' loans for household and other personal expenditures
98,709


86,935

Lease financing receivables, net of unearned income
1,830


2,527

Other commercial loans
392,026


394,791

  Loans
$
7,088,071


$
6,751,199

Allowance for loan losses
(78,406
)

(75,032
)
             Net Loans
$
7,009,665


$
6,676,167


 
Allowance, Credit Quality and Loan Portfolio

The Corporation maintains an allowance for loan losses to cover probable credit losses identified during its loan review process. Management believes the allowance for loan losses is adequate to cover probable losses inherent in the loan portfolio at September 30, 2018. The process for determining the adequacy of the allowance for loan losses is critical to the Corporation’s financial results. It requires management to make difficult, subjective and complex judgments to estimate the effect of uncertain matters. The allowance for loan losses considers current factors, including economic conditions and ongoing internal and external examinations, and will increase or decrease as deemed necessary to ensure it remains adequate. In addition, the allowance as a percentage of charge-offs and nonperforming loans will change at different points in time based on credit performance, portfolio mix and collateral values.


16

PART I. FINANCIAL INFORMATION
ITEM 1. NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
(table dollar amounts in thousands, except share data)
(Unaudited)




The allowance for loan losses is maintained through the provision for loan losses, which is a charge against earnings. The allowance is increased by provision expense and decreased by charge-offs less recoveries. All charge-offs are approved by the Bank's senior credit officers and in accordance with established policies. The Bank charges off a loan when a determination is made that all or a portion of the loan is uncollectable. The amount provided for loan losses in a given period may be greater than or less than net loan losses experienced during the period, and is based on management’s judgment as to the appropriate level of the allowance for loan losses. The determination of the provision amount is based on management’s ongoing review and evaluation of the loan portfolio, including an internally administered loan "watch" list and independent loan reviews. The evaluation takes into consideration identified credit problems, the possibility of losses inherent in the loan portfolio that are not specifically identified and management’s judgment as to the impact of the current environment and economic conditions on the portfolio.

The allowance consists of specific impairment reserves as required by ASC 310-10-35, a component for historical losses in accordance with ASC 450 and the consideration of current environmental factors in accordance with ASC 450. A loan is deemed impaired when, based on current information or events, it is probable that all amounts due of principal and interest according to the contractual terms of the loan agreement will not be collected.

The historical loss allocation for loans not deemed impaired according to ASC 450 is the product of the volume of loans within the non-impaired criticized and non-criticized risk grade classifications, each segmented by call code, and the historical loss factor for each respective classification and call code segment. The historical loss factors are based upon actual loss experience within each risk and call code classification. The historical look back period for non-criticized loans looks to the most recent rolling-four-quarter average and aligns with the look back period for non-impaired criticized loans. Each of the rolling four quarter periods used to obtain the average, include all charge-offs for the previous twelve-month period, therefore the historical look back period includes seven quarters. The resulting allocation is reflective of current conditions. Criticized loans are grouped based on the risk grade assigned to the loan. Loans with a special mention grade are assigned a loss factor, and loans with a classified grade but not impaired are assigned a separate loss factor. The loss factor computation for this allocation includes a segmented historical loss migration analysis of risk grades to charge-off.

In addition to the specific reserves and historical loss components of the allowance, consideration is given to various environmental factors to ensure that losses inherent in the portfolio are reflected in the allowance for loan losses. The environmental component adjusts the historical loss allocations for non-impaired loans to reflect relevant current conditions that, in management's opinion, have an impact on loss recognition. Environmental factors that management reviews in the analysis include: national and local economic trends and conditions; trends in growth in the loan portfolio and growth in higher risk areas; levels of, and trends in, delinquencies and non-accruals; experience and depth of lending management and staff; adequacy of, and adherence to, lending policies and procedures including those for underwriting; industry concentrations of credit; and adequacy of risk identification systems and controls through the internal loan review and internal audit processes.

In conformance with ASC 805 and ASC 820, purchased loans are recorded at the acquisition date fair value. Such loans are included in the allowance to the extent a specific impairment is identified that exceeds the fair value adjustment on an impaired loan or the historical loss and environmental factor analysis indicates losses inherent in a purchased portfolio exceeds the fair value adjustment on the portion of the purchased portfolio not deemed impaired.

The following tables summarize changes in the allowance for loan losses by loan segment for the three and nine months ended September 30, 2018 and September 30, 2017:
 
Three Months Ended September 30, 2018
 
Commercial

Commercial
Real Estate

Consumer

Residential

Finance
Leases

Total
Allowance for loan losses:
 

 

 

 

 

 
Balances, June 30, 2018
$
31,465


$
27,731


$
3,921


$
14,424


$
2


$
77,543

Provision for losses
256


410


159


575




1,400

Recoveries on loans
658


306


46


165




1,175

Loans charged off
(313
)

(501
)

(194
)

(704
)



(1,712
)
Balances, September 30, 2018
$
32,066


$
27,946


$
3,932


$
14,460


$
2


$
78,406

 
Nine Months Ended September 30, 2018
 
Commercial

Commercial
Real Estate

Consumer

Residential

Finance
Leases

Total
Allowance for loan losses:
 

 

 

 

 

 
Balances, December 31, 2017
$
30,418


$
27,343


$
3,732


$
13,537


$
2


$
75,032

Provision for losses
1,567


1,448


493


2,055




5,563

Recoveries on loans
2,060


1,858


233


915




5,066

Loans charged off
(1,979
)

(2,703
)

(526
)

(2,047
)



(7,255
)
Balances, September 30, 2018
$
32,066


$
27,946


$
3,932


$
14,460


$
2


$
78,406


17

PART I. FINANCIAL INFORMATION
ITEM 1. NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
(table dollar amounts in thousands, except share data)
(Unaudited)





Three Months Ended September 30, 2017
 
Commercial

Commercial
Real Estate

Consumer

Residential

Finance
Leases

Total
Allowance for loan losses:
 

 

 

 

 

 
Balances, June 30, 2017
$
28,906


$
25,236


$
3,372


$
12,955


$
2


$
70,471

Provision for losses
921


374


342


446





2,083

Recoveries on loans
324


1,327


51


157





1,859

Loans charged off
(468
)

(190
)

(174
)

(227
)



(1,059
)
Balances, September 30, 2017
$
29,683


$
26,747


$
3,591


$
13,331


$
2


$
73,354

 
Nine Months Ended September 30, 2017
 
Commercial

Commercial
Real Estate

Consumer

Residential

Finance
Leases

Total
Allowance for loan losses:
 

 

 

 

 

 
Balances, December 31, 2016
$
27,696


$
23,661


$
2,923


$
11,755


$
2


$
66,037

Provision for losses
2,279


2,023


877


2,164





7,343

Recoveries on loans
987


2,066


253


547





3,853

Loans charged off
(1,279
)

(1,003
)

(462
)

(1,135
)



(3,879
)
Balances, September 30, 2017
$
29,683


$
26,747


$
3,591


$
13,331


$
2


$
73,354



The tables below show the Corporation’s allowance for loan losses and loan portfolio by loan segment as of the periods indicated. There was no related allowance for loan losses for loans acquired with deteriorated credit quality at September 30, 2018 or December 31, 2017.
 
September 30, 2018
 
Commercial

Commercial
Real Estate

Consumer

Residential

Finance
Leases

Total
Allowance Balances:
 

 

 

 

 

 
Individually evaluated for impairment








$
433




$
433

Collectively evaluated for impairment
$
32,066


$
27,946


$
3,932


14,027


$
2


77,973

Total Allowance for Loan Losses
$
32,066


$
27,946


$
3,932


$
14,460


$
2


$
78,406

Loan Balances:










 
Individually evaluated for impairment
$
1,614


$
12,158


$
8


$
2,219




$
15,999

Collectively evaluated for impairment
2,132,193


3,340,898


98,701


1,479,371


$
1,830


7,052,993

Loans acquired with deteriorated credit quality
2,292


15,181





1,606





19,079

Loans
$
2,136,099


$
3,368,237


$
98,709


$
1,483,196


$
1,830


$
7,088,071


 
December 31, 2017
 
Commercial

Commercial
Real Estate

Consumer

Residential

Finance
Leases

Total
Allowance Balances:
 

 

 

 

 

 
Individually evaluated for impairment
$
666


$
567




$
404




$
1,637

Collectively evaluated for impairment
29,752


26,776


$
3,732


13,133


$
2


73,395

Total Allowance for Loan Losses
$
30,418