Item 5. Market for The Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities.
Part Ii: Item 5. and Item 6.
Item 6. Selected Financial Data.
Part Ii: Item 7. and Item 7A. Management's Discussion and Analysis of Financial Condition and Results of Operations
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk.
Part Ii: Item 8. Financial Statements and Supplementary Data Report of Independent Registered Public Accounting Firm
Item 8. Financial Statements and Supplementary Data.
Part Ii: Item 8. Financial Statements and Supplementary Data
Note 1
Note 2
Part Ii: Item 8. Financial Statements and Supplementary Data
Note 3
Note 4
Part Ii: Item 8. Financial Statements and Supplementary Data
Note 5
Note 6
Part Ii: Item 8. Financial Statements and Supplementary Data
Note 7
Note 8
Part Ii: Item 8. Financial Statements and Supplementary Data
Note 9
Note 10
Part Ii: Item 8. Financial Statements and Supplementary Data
Note 11
Note 12
Part Ii: Item 8. Financial Statements and Supplementary Data
Note 13
Note 14
Part Ii: Item 8. Financial Statements and Supplementary Data
Note 15
Note 16
Part Ii: Item 8. Financial Statements and Supplementary Data
Note 17
Note 18
Note 19
Part Ii: Item 8. Financial Statements and Supplementary Data
Note 20
Note 21
Part Ii: Item 8. Financial Statements and Supplementary Data
Note 22
Note 23
Note 24
Part Ii: Item 8. Financial Statements and Supplementary Data
Note 25
Note 26
Note 27
Part Ii: Item 9., Item 9A. and Item 9B.
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.
Item 9A. Controls and Procedures
Part Ii: Item 9., Item 9A. and Item 9B.
Item 9B. Other Information
Part Iii: Item 10., Item 11., Item 12., Item 13. and Item 14.
Part III
Item 10. Directors, Executive Officers and Corporate Governance
Item 11. Executive Compensation
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
Item 13. Certain Relationships and Related Transactions, and Director Independence
Item 14. Principal Accountant Fees and Services
Part Iv: Item 15. and Item 16.
Part IV
Item 15. Exhibits and Financial Statement Schedules
Part Iv: Item 15. and Item 16.
Item 16. Form 10-K Summary
Exhibits
EX-10.1
exhibit101-201810k.htm
EX-21
exhibit21-201810k.htm
EX-23
exhibit23-201810k.htm
EX-24
exhibit24-201810k.htm
EX-31.1
exhibit311-201810k.htm
EX-31.2
exhibit312-201810k.htm
EX-32
exhibit32-201810k.htm
EX-99.1
exhibit991-201810k.htm
First Merchants Earnings 2018-12-31
FRME 10K Annual Report
Balance Sheet
Income Statement
Cash Flow
10-K 1 frme-12312018x10k.htm FIRST MERCHANTS CORPORATION 10-K Document
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
_______________________________
FORM 10-K
[Mark One]
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 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
incorporation or organization)
(I.R.S. Employer Identification No.)
200 East Jackson
Muncie, Indiana
47305-2814
(Address of principal executive offices)
(Zip Code)
Registrant’s telephone number, including area code: (765)747-1500
Securities registered pursuant to Section 12(b) of the Act:
Title of Each Class
Name of each exchange on which registered
Common Stock, $0.125 stated value per share
The NASDAQ Stock Market
Securities registered pursuant to Section 12(g) of the Act:
None
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes [X] No [ ]
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes [ ] No [X]
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 if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [X]
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, 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 Act). Yes [ ] No[X]
The aggregate market value (not necessarily a reliable indication of the price at which more than a limited number of shares would trade) of the voting stock held by non-affiliates of the registrant was $2,286,601,000 as of the last business day of the registrant's most recently completed second fiscal quarter (June 30, 2018).
As of February 20, 2019 there were 49,697,568 outstanding common shares, without par value, of the registrant.
Ameriana Bancorp, Inc., which was acquired by the Corporation on December 31, 2015.
Arlington Bank
The Arlington Bank, which was acquired by the Corporation on May 19, 2017
ASC
Accounting Standards Codification
AOCI
Accumulated Other Comprehensive Income
Bank
First Merchants Bank, a wholly-owned subsidiary of the Corporation
BHC Act
Bank Holding Company Act of 1956
CET1
Common Equity Tier 1
C Financial
C Financial Corporation, which was acquired by the Corporation on April 17, 2015.
CFPB
Consumer Financial Protection Bureau
CMT
Constant Maturity Treasury
Community
Community Bancshares, Inc., which was acquired by the Corporation on November 7, 2014.
Corporation
First Merchants Corporation
Dodd-Frank Act
Dodd-Frank Wall Street Reform and Consumer Protection Act
ERISA
Employee Retirement Income Security Act of 1974
ESPP
Employee Stock Purchase Plan
FDIC
Federal Deposit Insurance Corporation
FDICIA
Federal Deposit Insurance Corporation Improvement Act of 1991
Federal Reserve
Federal Reserve Banking System
FHLB
Federal Home Loan Bank
FMIG
First Merchants Insurance Services, Inc., an Indiana corporation
FTE
Fully taxable equivalent
GAAP
Accounting Principles Generally Accepted in the United States of America
IAB
Independent Alliance Banks, Inc., which was acquired by the Corporation on July 14, 2017
Indiana DFI
Indiana Department of Financial Institutions
OCC
Office of the Comptroller of the Currency
OREO
Other real estate owned
OTTI
Other-than-temporary impairment
RSA
Restricted Stock Awards
Sarbanes-Oxley Act
Sarbanes-Oxley Act of 2002
Savings Plan
The First Merchants Corporation Retirement and Income Savings Plan
SEC
Securities and Exchange Commission
TCJA
Tax Cuts and Jobs Act, which was enacted by the U.S. Government on December 22, 2017
TEFRA
Tax Equity and Fiscal Responsibility Act. The TEFRA disallowance reduces the amount of interest expense an entity may deduct for the purpose of carrying tax-free investment securities.
The Corporation from time to time includes forward-looking statements in its oral and written communication. The Corporation may include forward-looking statements in filings with the SEC, such as its Annual Reports on Form 10-K and its Quarterly Reports on Form 10-Q, in other written materials and oral statements made by senior management to analysts, investors, representatives of the media and others. The Corporation intends these forward-looking statements to be covered by the safe harbor provisions for forward-looking statements contained in the Private Securities Litigation Reform Act of 1995, and the Corporation is including this statement for purposes of these safe harbor provisions. Forward-looking statements can often be identified by the use of words like “believe”, “continue”, “pattern”, “estimate”, “project”, “intend”, “anticipate”, “expect” and similar expressions or future or conditional verbs such as “will”, “would”, “should”, “could”, “might”, “can”, “may” or similar expressions. These forward-looking statements include:
•
statements of the Corporation’s goals, intentions and expectations;
•
statements regarding the Corporation’s business plan and growth strategies;
•
statements regarding the asset quality of the Corporation’s loan and investment portfolios; and
•
estimates of the Corporation’s risks and future costs and benefits.
These forward-looking statements are subject to significant risks, assumptions and uncertainties, including, among other things, those discussed in Item 1A, “RISK FACTORS”.
Because of these and other uncertainties, the Corporation’s actual future results may be materially different from the results indicated by these forward-looking statements. In addition, the Corporation’s past results of operations do not necessarily indicate its future results.
The Corporation is a financial holding company headquartered in Muncie, Indiana and was organized in September 1982. The Corporation’s Common Stock is traded on NASDAQ’s Global Select Market System under the symbol FRME. The Corporation has one full-service bank charter, First Merchants Bank, which opened for business in Muncie, Indiana, in March 1893. The Bank also operates First Merchants Private Wealth Advisors (a division of First Merchants Bank). The Bank includes 116 banking locations in thirty-one Indiana, two Illinois and two Ohio counties. In addition to its branch network, the Corporation offers comprehensive electronic and mobile delivery channels to its customers. The Corporation’s business activities are currently limited to one significant business segment, which is community banking.
Through the Bank, the Corporation offers a broad range of financial services, including accepting time, savings and demand deposits; making consumer, commercial, agri-business and real estate mortgage loans; providing personal and corporate trust services; offering full-service brokerage and private wealth management; and providing letters of credit, repurchase agreements and other corporate services.
All inter-company transactions are eliminated during the preparation of consolidated financial statements.
As of December 31, 2018, the Corporation had consolidated assets of $9.9 billion, consolidated deposits of $7.8 billion and stockholders’ equity of $1.4 billion. As of December 31, 2018, the Corporation and its subsidiaries had 1,702 full-time equivalent employees.
AVAILABLE INFORMATION
The Corporation makes its Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended, available on its website at https://www.firstmerchants.com without charge, as soon as reasonably practicable, after such reports are electronically filed with, or furnished to, the Securities and Exchange Commission. The SEC maintains an internet site that contains reports, proxy and information statements, and other information regarding issuers that file electronically with the SEC, including the Corporation. Those filings are accessible on the SEC’s website at http://www.sec.gov.
ACQUISITION AND DIVESTITURE POLICY
The Corporation anticipates that it will continue its policy of geographic expansion of its banking business through the acquisition of banks whose operations are consistent with its banking philosophy. Management routinely explores opportunities to acquire financial institutions and other financial services-related businesses and to enter into strategic alliances to expand the scope of its services and its customer base.
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 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.
On May 19, 2017, the Corporation acquired 100 percent of Arlington 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.
On December 31, 2015, the Corporation acquired 100 percent of Ameriana. Ameriana was headquartered in New Castle, Indiana and had 13 full service banking centers in east central and central Indiana. Pursuant to the merger agreement, shareholders of Ameriana received .9037 shares of the Corporation's common stock for each share of Ameriana common stock held. The Corporation issued approximately 2.8 million shares of common stock, which was valued at approximately $70.4 million.
On June 12, 2015, the Corporation sold all of its stock in FMIG to USI, a Delaware limited liability company. The sale price was $18.0 million, of which $16.0 million was paid at closing with the remaining $2.0 million paid through a two-year promissory note. The sale of FMIG generated a pre-tax gain on sale of $8.3 million.
On April 17, 2015, the Corporation acquired 100 percent of C Financial. C Financial was headquartered in Columbus, Ohio and had 6 full service banking centers serving the Columbus, Ohio market. Pursuant to the merger agreement, shareholders of C Financial received $6.738 in cash for each share of C Financial stock held, resulting in a total purchase price of $14.5 million.
On November 7, 2014, the Corporation acquired 100 percent of Community. Community was headquartered in Noblesville, Indiana and had 10 full-service banking centers serving central Indiana. Pursuant to the merger agreement, each outstanding share of common stock of Community was converted into the right to receive either (a) 4.0926 shares of the Corporation's common stock, plus cash in lieu of fractional shares; or (b) $85.94 in cash, based upon shareholder elections. The Corporation paid $14.2 million in cash and issued approximately 1.6 million shares of common stock, valued at approximately $35.0 million, for a total purchase price of approximately $49.2 million.
Details of the 2017 acquisitions can be found in NOTE 2. ACQUISITIONS of the Notes to Consolidated Financial Statements included in Item 8 of this Annual Report on Form 10-K.
COMPETITION
The Bank is located in Indiana, Ohio and Illinois counties where other financial services companies provide similar banking services. In addition to the competition provided by the lending and deposit gathering subsidiaries of national manufacturers, retailers, insurance companies and investment brokers, the Bank competes vigorously with other banks, thrift institutions, credit unions and finance companies located within its service areas.
REGULATION AND SUPERVISION OF FIRST MERCHANTS CORPORATION AND SUBSIDIARIES
Bank Holding Company Regulation
The Corporation is registered as a bank holding company and has elected to be a financial holding company. It is subject to the supervision of, and regulation by the Board of Governors of the Federal Reserve under the BHC Act, as amended. Bank holding companies are required to file periodic reports with and are subject to periodic examination by the Federal Reserve. The Federal Reserve has issued regulations under the BHC Act requiring a bank holding company to serve as a source of financial and managerial strength to the Bank. Thus, it is the policy of the Federal Reserve that a bank holding company should stand ready to use its resources to provide adequate capital funds to the Bank during periods of financial stress or adversity. Additionally, under the FDICIA, a bank holding company is required to guarantee the compliance of any subsidiary bank that may become “undercapitalized” (as defined in the FDICIA section of this Form 10-K) with the terms of any capital restoration plan filed by such subsidiary with its appropriate federal banking agency. Under the BHC Act, the Federal Reserve has the authority to require a bank holding company to terminate any activity or relinquish control of a non-bank subsidiary (other than a non-bank subsidiary of a bank) upon the determination that such activity constitutes a serious risk to the financial stability of any bank subsidiary.
The BHC Act requires the Corporation to obtain the prior approval of the Federal Reserve before:
•
acquiring direct or indirect control or ownership of any voting shares of any bank or bank holding company if, after such acquisition, the bank holding company will directly or indirectly own or control more than 5 percent of the voting shares of the bank or bank holding company;
•
merging or consolidating with another bank holding company; or
•
acquiring substantially all of the assets of any bank.
The BHC Act generally prohibits bank holding companies that have not become financial holding companies from (i) engaging in activities other than banking or managing or controlling banks or other permissible subsidiaries, and (ii) acquiring or retaining direct or indirect control of any company engaged in the activities other than those activities determined by the Federal Reserve to be closely related to banking or managing or controlling banks.
Capital Adequacy Guidelines for Bank Holding Companies
In July 2013, the United States banking regulators adopted new capital rules which modified the risk-based capital and leverage capital requirements applicable to bank holding companies and depository institutions. These rules are commonly known as "Basel III". Basel III was effective for the Corporation on January 1, 2015. Basel III addresses the components of capital and other issues affecting the numerator in banking institutions' regulatory capital ratios. Basel III also implements the requirements of Section 939A of the Dodd-Frank Act to remove references to credit ratings from the federal banking agencies' rules. Certain of the Basel III rules came into effect for the Corporation and the Bank on January 1, 2015, and the balance of the rules were subject to a phase-in period which continued through January 1, 2019.
Basel III introduced a new capital measure CET1. Basel III specifies that Tier 1 capital consists of CET1 and "Additional Tier 1 Capital" instruments meeting specified requirements. CET1 capital consists of common stock instruments that meet the eligibility criteria, retained earnings, accumulated other comprehensive income and CET1 minority interest. Basel III also defines CET1 narrowly by requiring that most adjustments to regulatory capital measures be made to CET1, and not to the other components of capital.
Basel III requires the Corporation to maintain a minimum ratio of CET1 to risk weighted assets, as defined in the regulation. Under Basel III, in order to avoid limitations on capital distributions, including dividends, the Corporation must hold a capital conservation buffer above the adequately capitalized CET1 to risk-weighted assets ratio. The capital conservation buffer was phased in from zero percent in 2015 to the fully- implemented 2.50 percent in 2019.
Basel III requires banking organizations to maintain:
•
a minimum ratio of CET1 to risk-weighted assets of a least 4.5 percent, plus, when fully phased-in on January 1, 2019, a 2.5 percent "capital conservation buffer" (which is added to the 4.5 percent CET1 as that buffer was phased in, effectively resulting in a minimum ratio of CET1 to risk-weighted assets of at least 7.0 percent upon full implementation);
•
a minimum ratio of Tier 1 capital to risk-weighted assets of at least 6.0 percent, plus, when fully phased-in on January 1, 2019, the 2.5 percent capital conservation buffer (which is added to the 6.0 percent Tier 1 capital ratio as that buffer was phased-in, effectively resulting in a minimum Tier 1 capital ratio of 8.5 percent upon full implementation);
•
a minimum ratio of total capital (Tier 1 plus Tier 2 capital) to risk-weighted assets of at least 8.0 percent, plus, when fully phased-in on January 1, 2019, the 2.5 percent capital conservation buffer (which is added to the 8.0 percent total capital ratio as that buffer was phased-in, effectively resulting in a minimum total capital ratio of 10.5 percent upon full implementation); and
•
a minimum leverage ratio of 4.0 percent, calculated as the ratio of Tier 1 capital to adjusted average consolidated assets.
Basel III also provides for a “countercyclical capital buffer” that is applicable to only certain covered institutions and is not expected to have any current applicability to the Corporation or the Bank.
The aforementioned capital conservation buffer is designed to absorb losses during periods of economic stress. Banking institutions with a ratio of CET1 to risk-weighted assets above the minimum but below the conservation buffer will face limitations on the payment of dividends, common stock repurchases and discretionary cash payments to executive officers based on the amount of the shortfall.
Basel III provides for a number of deductions from and adjustments to CET1. These include, for example, the requirement that mortgage servicing rights, deferred tax assets dependent upon future taxable income and significant investments in non-consolidated financial entities be deducted from CET1 to the extent that any one such category exceeds 10 percent of CET1 or all such categories in the aggregate exceed 15 percent of CET1. Under Basel III, the Corporation and the Bank were given a one-time election (the “Opt-out Election”) to filter out certain AOCI components. The AOCI Opt-out Election was made on the March 31, 2015 Call Report and FR Y-9C for the Bank and the Corporation, respectively.
Implementation of the deductions and other adjustments to CET1 began on January 1, 2015 and were phased-in over a five-year period (20 percent per year). The implementation of the capital conservation buffer began on January 1, 2016 at the 0.625 percent level and was phased-in over a four-year period (increasing by that amount on each subsequent January 1, until it reached 2.5 percent on January 1, 2019).
Basel III permits banks with less than $15 billion in assets to continue to treat trust preferred securities as Tier 1 capital. This treatment is permanently grandfathered as Tier 1 capital even if the Corporation should ever exceed $15 billion in assets due to organic growth. Should the Corporation exceed $15 billion in assets as the result of a merger or acquisition, then the Tier 1 treatment of its outstanding trust preferred securities will be phased out, but those securities will still be treated as Tier 2 capital. Basel III permits banks with less than $250 billion in assets to choose to continue excluding unrealized gains and losses on certain securities holdings for purposes of calculating regulatory capital. The rules limit a banking organization’s capital distributions and certain discretionary bonus payments if the banking organization does not hold a “capital conservation buffer” consisting of a specified amount of CET1 capital in addition to the amount necessary to meet its minimum risk-based capital requirements.
Historically, the regulation and monitoring of a bank and bank holding company's liquidity has been addressed as a supervisory matter, without minimum required formulaic measures. The Basel III liquidity framework requires banks and bank holding companies to measure their liquidity against specific liquidity tests that, although similar in some respects to liquidity measures historically applied by banks and regulators for management and supervisory purposes, is now required by regulation. One test, referred to as the liquidity coverage ratio, is designed to ensure that the banking entity maintains an adequate level of unencumbered high-quality liquid assets equal to the entity’s expected net cash outflow for a 30-day time horizon (or, if greater, 25% of its expected total cash outflow) under an acute liquidity stress scenario. The other test, referred to as the net stable funding ratio ("NSFR"), is designed to promote more medium- and long-term funding of the assets and activities of banking entities over a one-year time horizon. These requirements are expected to incent banking entities to increase their holdings of U.S. Treasury securities and other sovereign debt as a component of assets and increase the use of long-term debt as a funding source. However, the federal banking agencies have not proposed rules implementing the Basel III liquidity framework and have not determined to what extent they will apply to U.S. banks that are not large, internationally active banks.
The following are the Corporation’s regulatory capital ratios as of December 31, 2018:
Corporation
Regulatory Minimum Requirement*
Total risk-based capital to risk-weighted assets
14.61
%
8.00
%
Tier 1 capital to risk-weighted assets
12.80
%
6.00
%
Common equity tier 1 capital to risk-weighted assets
On April 1, 2016, the Board of Directors of the Bank adopted final resolutions approving the conversion of the Bank’s banking charter from a national association to an Indiana state-chartered bank. The initial application to convert was filed with the Indiana DFI on February 9, 2016. Between the date of initial application and adoption of the final resolutions by the Bank’s Board, the Indiana DFI and the FDIC conducted a joint exam of the Bank and its banking activities. Final regulatory approval of the application was obtained at the meeting of the Members of the Indiana DFI on April 14, 2016. The Bank filed official conversion documents effective April 15, 2016. As a result of the conversion, the Indiana DFI became the Bank’s primary regulator and the FDIC became the Bank’s primary federal regulator. Upon conversion, the Bank’s official name changed from “First Merchants Bank, National Association” to “First Merchants Bank.” The conversion did not affect the Bank’s operations or customers, and Bank customers continue to receive identical protection on deposits through the FDIC’s deposit insurance program.
The Indiana DFI and FDIC have the authority to issue cease-and-desist orders if they determine that activities of the Bank regularly represent an unsafe and unsound banking practice or a violation of law. Federal law extensively regulates various aspects of the banking business such as reserve requirements, truth-in-lending and truth-in-savings disclosures, equal credit opportunity, fair credit reporting, trading in securities and other aspects of banking operations. Current federal law also requires banks, among other things, to make deposited funds available within specified time periods.
Requirements for Bank Holding Companies with $10 Billion or More in Assets
Various federal banking laws and regulations, including rules adopted by the Federal Reserve pursuant to the requirements of the Dodd-Frank Act, impose heightened requirements on certain large banks and bank holding companies. Most of these rules apply primarily to bank holding companies with at least $50 billion in total consolidated assets, but certain rules also apply to banks and bank holding companies with at least $10 billion in total consolidated assets.
Following the fourth consecutive quarter (and any applicable phase-in period) where the Corporation’s or the Bank’s total consolidated assets, as applicable, equal or exceed $10 billion, the Corporation or the Bank, as applicable, will, among other requirements:
•
calculate our FDIC deposit assessment base using the performance score and a loss-severity score system described below in “ - Deposit Insurance;” and
•
be examined for compliance with federal consumer protection laws primarily by the Consumer Financial Protection Bureau as described below in “ - Consumer Financial Protection.”
While neither the Corporation nor the Bank currently has $10 billion or more in total consolidated assets, we have analyzed these rules to ensure we are prepared to comply with the rules when and if they become applicable. Based upon our strategy for expansion through acquisition and our historic organic growth, we expect that the Corporation’s and the Bank’s total assets will exceed $10 billion in 2019.
Bank Capital Requirements
Capital adequacy is an important indicator of financial stability and performance. The Corporation and the Bank are subject to various regulatory capital requirements administered by the federal banking agencies and are assigned to a capital category. The assigned capital category is largely determined by four ratios that are calculated according to the regulations: total risk-based capital, tier 1 risk-based capital, common equity tier 1 capital, and tier 1 leverage ratios. The ratios are intended to measure capital relative to assets and credit risk associated with those assets and off-balance sheet exposures of the entity. The capital category assigned to an entity can also be affected by qualitative judgments made by regulatory agencies about the risk inherent in the entity's activities that are not part of the calculated ratios.
There are five capital categories defined in the regulations, ranging from well capitalized to critically undercapitalized. Classification of a bank in any of the undercapitalized categories can result in actions by regulators that could have a material effect on a bank's operations. Quantitative measures established by regulation to ensure capital adequacy require the Bank to maintain minimum amounts and ratios of total and tier 1 capital to risk-weighted assets, and of tier 1 capital to average assets, or leverage ratio, all of which are calculated as defined in the regulations. Banks with lower capital levels are deemed to be undercapitalized, significantly undercapitalized or critically undercapitalized, depending on their actual levels. The appropriate federal regulatory agency may also downgrade a bank to the next lower capital category upon a determination that the bank is in an unsafe or unsound practice. Banks are required to monitor closely their capital levels and to notify their appropriate regulatory agency of any basis for a change in capital category.
Basel III was effective for the Bank on January 1, 2015. Basel III requires the Bank to maintain minimum amounts and ratio of common equity tier 1 capital to risk weighted assets, as defined in the regulation. Under Basel III, the Bank elected to opt-out of including accumulated other comprehensive income in regulatory capital. As of December 31, 2018, the Bank met all capital adequacy requirements to be considered well capitalized.
The FDICIA requires, among other things, federal bank regulatory authorities to take “prompt corrective action” with respect to banks, which do not meet minimum capital requirements. For these purposes, FDICIA establishes five capital tiers: well capitalized, adequately capitalized, undercapitalized, significantly undercapitalized and critically undercapitalized. The FDIC has adopted regulations to implement the prompt corrective action provisions of FDICIA.
Basel III revised the "prompt corrective action" regulations by:
•
introducing CET1 ratio requirement at each level (other than critically undercapitalized), with the required CET1 ratio being 6.5 percent for well-capitalized status;
•
increasing the minimum Tier 1 capital ratio requirement for each category, with the minimum Tier 1 risk-based capital ratio for well-capitalized status being 8.0 percent; and
•
eliminating a provision that provides that a bank with a composite supervisory rating of 1 may have a 3.0 percent leverage ratio and still be well-capitalized.
The FDICIA generally prohibits a depository institution from making any capital distributions (including payment of a dividend) or paying any management fee to its parent holding company if the depository institution would thereafter be “undercapitalized.” “Undercapitalized” banks are subject to growth limitations and are required to submit a capital restoration plan. A bank’s compliance with such plan is required to be guaranteed by the bank’s parent holding company. If an “undercapitalized” bank fails to submit an acceptable plan, it is treated as if it is significantly undercapitalized. “Significantly undercapitalized” banks are subject to various requirements and restrictions, including an order by the FDIC to sell sufficient voting stock to become "adequately capitalized", requirements to reduce total assets and cease receipt of deposits from correspondent banks, and restrictions on compensation of executive officers. “Critically undercapitalized” institutions may not, beginning 60 days after becoming “critically undercapitalized,” make any payment of principal or interest on certain subordinated debt, extend credit for a highly leveraged transaction, or enter into any transaction outside the ordinary course of business. In addition, “critically undercapitalized” institutions are subject to appointment of a receiver or conservator.
As of December 31, 2018, the Bank was “well capitalized” based on the “prompt corrective action” ratios described above. It should be noted that a bank’s capital category is determined solely for the purpose of applying the FDIC’s “prompt corrective action” regulations and that the capital category may not constitute an accurate representation of the bank’s overall financial condition or prospects.
Dodd-Frank Wall Street Reform and Consumer Protection Act
On July 21, 2010, President Obama signed the Dodd-Frank Act into law. The Dodd-Frank Act has had a broad impact on the financial services industry, including significant regulatory and compliance changes. Although most of the required regulations of the Dodd-Frank Act have been promulgated and implemented (or are being implemented over time), there are additional regulations yet to be finalized by the authorized federal agencies. The changes resulting from the Dodd-Frank Act have impacted the profitability of the Corporation’s business activities, required changes to certain business practices, and imposed more stringent capital, liquidity and leverage requirements, and, when fully implemented, may further adversely affect our business. Among other things, the Dodd-Frank Act has resulted, and in the future will likely result, in:
•
increases to the cost of the Corporation’s operations due to greater regulatory oversight, supervision and examination of banks and bank holding companies, including higher deposit insurance premiums;
•
limitations on the Corporation’s ability to raise additional capital through the use of trust preferred securities, as new issuances of these securities may no longer be included as Tier 1 capital;
•
reduced flexibility for the Corporation to generate or originate certain revenue-producing assets based on increased regulatory capital standards; and
•
limitations on the Corporation’s ability to expand consumer product and service offerings due to stricter consumer protection laws and regulations.
•
once the Corporation's assets exceed $10 billion, compliance with the Durbin Amendment will result in a material reduction of interchange fee income paid by merchants when debit cards are used as payment.
The Corporation’s management continues to take the steps necessary to minimize the adverse impact of the Dodd-Frank Act on its business, financial condition and results of operation.
Volcker Rule
In December 2013, United States banking regulators adopted final rules implementing the Volcker Rule under the Dodd-Frank Act. The Volcker Rule places certain limitations on the trading activity of insured depository institutions and their affiliates subject to certain exceptions. The restricted trading activity includes purchasing or selling certain types of securities or instruments in order to benefit from short-term price movements or to realize short-term profits. Exceptions to the Volcker Rule include trading in certain U.S. Government or other municipal securities and trading conducted (i) in certain capacities as a broker or other agent, or as a fiduciary on behalf of customers, (ii) to satisfy a debt previously contracted, (iii) pursuant to repurchase and securities lending agreements, and (iv) in risk-mitigating hedging activities. The Volcker Rule also prohibits banking institutions from having an ownership interest in a hedge fund or private equity fund.
A banking entity that engages in proprietary trading (which excludes the exceptions discussed above) or covered fund-related activities or investments, and has total consolidated assets of more than $10 billion, as reported on December 31 of the previous two calendar years, must implement and maintain a compliance program that meets certain minimum requirements and must also maintain certain documentation with respect to covered fund activities, in each case, as described in the Volcker Rule. The implementation of the Volcker Rule has not had, and is not expected to have, a material impact on the Corporation or the Bank.
The Bank’s deposit accounts are currently insured by the Deposit Insurance Fund of the FDIC. The insurance benefit generally covers up to a maximum of $250,000 per separately insured depositor. As an FDIC-insured bank, our bank subsidiary is subject to deposit insurance premiums and assessments to maintain the Deposit Insurance Fund. The Bank’s deposit insurance premium assessment rate depends on the asset and supervisory categories to which it is assigned. The FDIC has authority to raise or lower assessment rates on insured banks in order to achieve statutorily required reserve ratios in the Deposit Insurance Fund and to impose special additional assessments.
Under the current system, deposit insurance assessments are based on average total assets minus average tangible equity. The FDIC assigns a banking institution to one of two categories based on asset size. As an institution with under $10 billion in assets, the Bank falls into the “Established Small Institution” category. This category has three sub-categories based on supervisory ratings designed to measure risk (the FDIC’s “CAMELS Composite” ratings). The assessment rate, which ranges from 1.5 to 30.0 basis points (such basis points representing a per annum rate) for Established Small Institutions, is determined based upon each applicable institution’s most recent supervisory and capital evaluations.
In addition, each FDIC insured institution is required to pay to the FDIC an assessment on the institution’s total assets less tangible capital in order to fund interest payments on bonds issued by the Financing Corporation, an agency of the federal government established to recapitalize the predecessor to the Savings Association Insurance Fund. The Federal Housing Finance Agency, the agency authorized to prescribe regulations relating to the Financing Corporation, is projecting that the last payment will be collected on the March 29, 2019 FDIC assessment.
Following the fourth consecutive quarter (and any applicable phase-in period) where the Bank's total assets equal or exceed $10 billion (thereby being deemed a “Large Institution”), the FDIC will use a performance score and a loss-severity score to calculate an initial assessment rate. In calculating these scores, the FDIC uses a bank’s capital level and regulatory supervisory ratings and certain financial measures to assess an institution’s ability to withstand asset-related stress and funding-related stress. The assessment rates for Large Institutions range from 1.5 to 40.0 basis points (such basis points representing a per annum rate). Based upon our strategy for expansion through acquisition and our historic organic growth, we expect that the Bank’s total assets will exceed $10 billion in 2019.
Dividend Limitations
The Corporation's principal source of funds for dividend payments to shareholders is dividends received from the Bank. Banking regulations limit the maximum amount of dividends that a bank may pay without requesting prior approval of regulatory agencies. Under these regulations, the amount of dividends that may be paid in any calendar year is limited to the bank’s retained net income (as defined) for the current year plus those for the previous two years, subject to the capital requirements described above. As of December 31, 2018, the amount available without prior regulatory approval for 2019 dividends from the Corporation’s subsidiaries (both banking and non-banking) was $192,712,000.
Brokered Deposits
Under FDIC regulations, no FDIC-insured depository institution can accept brokered deposits unless it (i) is well capitalized, or (ii) is adequately capitalized and received a waiver from the FDIC. In addition, these regulations prohibit any depository institution that is not well capitalized from (a) paying an interest rate on deposits in excess of 75 basis points over certain prevailing market rates or (b) offering “pass through” deposit insurance on certain employee benefit plan accounts unless it provides certain notice to affected depositors.
Consumer Financial Protection
The Bank is subject to a number of federal and state consumer protection laws that govern its relationship with customers. These laws include, but are not limited to:
•
the Equal Credit Opportunity Act (prohibiting discrimination on the basis of race, religion or other prohibited factors in the extension of credit);
•
the Fair Credit Reporting Act (governing the provision of consumer information to credit reporting agencies and the use of consumer information);
•
the Truth-In-Lending Act (governing disclosures of credit terms to consumer borrowers);
•
the Truth-in-Savings Act (which requires disclosure of deposit terms to consumers);
•
the Electronic Funds Transfer Act (governing automatic deposits to and withdrawals from deposit accounts and customers’ rights and liabilities arising from the use of automated teller machines and other electronic banking services);
•
the Fair Debt Collection Act (governing the manner in which consumer debts may be collected by collection agencies);
•
the Right to Financial Privacy Act (which imposes a duty to maintain the confidentiality of consumer financial records and prescribes procedures for complying with administrative subpoenas of financial records); and
•
the respective state-law counterparts to the above laws, as applicable, as well as state usury laws and laws regarding unfair and deceptive acts and practices.
Violations of applicable consumer protection laws can result in significant potential liability from litigation brought by customers, including actual damages, restitution and attorneys’ fees. Federal bank regulators, state attorneys general and state and local consumer protection agencies may also seek to enforce consumer protection requirements and obtain these and other remedies, including regulatory sanctions, customer rescission rights, action by the state and local attorneys general in each jurisdiction in which we operate and civil money penalties. Failure to comply with consumer protection requirements may also result in the Corporation’s failure to obtain any required bank regulatory approval for merger or acquisition transactions that it may wish to pursue or prohibition from engaging in such transactions even if approval is not required.
The Dodd-Frank Act also created the Consumer Financial Protection Bureau (“CFPB”), an independent federal agency, which was granted broad rulemaking, supervisory and enforcement powers under various federal consumer financial protection laws. Although all institutions are subject to rules adopted by the CFPB and examination by the CFPB in conjunction with examinations by the institution’s primary federal regulator, the CFPB has primary examination and enforcement authority over institutions with assets of $10 billion or more. The FDIC has primary responsibility for examination of the Bank and enforcement with respect to federal consumer protection laws so long as the Bank has total consolidated assets of less than $10 billion.
The consumer protection provisions of the Dodd-Frank Act and the examination, supervision and enforcement of those laws and implementing regulations by the CFPB have created a more complex environment for consumer finance regulation. The CFPB has significant authority to implement and enforce federal consumer finance laws, including the Truth in Lending Act, the Equal Credit Opportunity Act and new requirements for financial services products provided for in the Dodd-Frank Act, as well as the authority to identify and prohibit unfair, deceptive or abusive acts and practices. The review of products and practices to prevent such acts and practices is a continuing focus of the CFPB, and of banking regulators more broadly. The ultimate impact of this heightened scrutiny is uncertain but could result in changes to pricing, practices, products and procedures. It could also result in increased costs related to regulatory oversight, supervision and examination, additional remediation efforts and possible penalties. In addition, the Dodd-Frank Act provides the CFPB with broad supervisory, examination and enforcement authority over various consumer financial products and services, including the ability to require reimbursements and other payments to customers for alleged legal violations and to impose significant penalties, as well as injunctive relief that prohibits lenders from engaging in allegedly unlawful practices. The CFPB also has the authority to obtain cease and desist orders providing for affirmative relief or monetary penalties. The Dodd-Frank Act does not prevent states from adopting stricter consumer protection standards. State regulation of financial products and potential enforcement actions could also adversely affect our business, financial condition or results of operations.
Community Reinvestment Act
The Community Reinvestment Act of 1977 (the “CRA”) requires depository institutions to assist in meeting the credit needs of their market areas consistent with safe and sound banking practice. Under the CRA, each depository institution is required to help meet the credit needs of its market areas by, among other things, providing credit to low- and moderate-income individuals and communities. These factors are also considered in evaluating mergers, acquisitions and applications to open a branch or facility. The applicable federal regulators regularly conduct CRA examinations to assess the performance of financial institutions and assign one of four ratings to the institution’s records of meeting the credit needs of its community. During its last examination, a rating of “satisfactory” was received by the Bank.
Financial Privacy
The federal banking regulators adopted rules that limit the ability of banks and other financial institutions to disclose non-public information about consumers to nonaffiliated third parties. These limitations require disclosure of privacy policies to consumers and, in some circumstances, allow consumers to prevent disclosure of certain personal information to a nonaffiliated third party. These regulations affect how consumer information is transmitted through diversified financial companies and conveyed to outside vendors.
The Bank is also subject to regulatory guidelines establishing standards for safeguarding customer information. These guidelines describe the federal banking agencies’ expectations for the creation, implementation and maintenance of an information security program, which would include administrative, technical and physical safeguards appropriate to the size and complexity of the institution and the nature and scope of its activities. The standards set forth in the guidelines are intended to ensure the security and confidentiality of customer records and information, protect against any anticipated threats or hazards to the security or integrity of such records and protect against unauthorized access to or use of such records or information that could result in substantial harm or inconvenience to any customer.
Anti-Money Laundering and the USA Patriot Act
A major focus of governmental policy on financial institutions in recent years has been aimed at combating money laundering and terrorist financing. The USA Patriot Act of 2001 (the “USA Patriot Act”) substantially broadened the scope of United States anti-money laundering laws and regulations by imposing significant new compliance and due diligence obligations on financial institutions, creating new crimes and penalties and expanding the extra-territorial jurisdiction of the United States.
The Bank Secrecy Act (the “BSA”) requires financial institutions to develop policies, procedures, and practices to prevent and deter money laundering, and mandates that every bank have a written, board-approved program that is reasonably designed to assure and monitor compliance with the BSA. In addition, banks are required to adopt a customer identification program as part of its BSA compliance program, and are required to file Suspicious Activity Reports when they detect certain known or suspected violations of federal law or suspicious transactions related to a money laundering activity or a violation of the BSA. In May 2016, the regulations implementing the BSA were amended to require covered institutions such as the Bank to (1) identify and verify, subject to certain exceptions, the identity of the beneficial owners of all legal entity customers at the time a new account is opened, and (2) include, in its anti-money laundering program, risk-based procedures for conducting ongoing customer due diligence, which are to include procedures that: (a) assist in understanding the nature and purpose of customer relationships for the purpose of developing a customer risk profile, and (b) require the covered institutions to conduct ongoing monitoring to identify and report suspicious transactions and, on a risk basis, to maintain and update customer information. The Bank was required to comply with these amendments and new requirements as of May 11, 2018.
Failure of a financial institution to maintain and implement adequate programs to combat money laundering and terrorist financing, or to comply with all of the relevant laws or regulations, could have serious legal and reputational consequences for the institution, including causing applicable bank regulatory authorities not to approve merger or acquisition transactions when regulatory approval is required or to prohibit such transactions even if approval is not required.
Office of Foreign Assets Control Regulation
The United States has imposed economic sanctions that affect transactions with designated foreign countries, nationals and others which are administered by the U.S. Treasury Department Office of Foreign Assets Control. Failure to comply with these sanctions could have serious legal and reputational consequences, including causing applicable bank regulatory authorities not to approve merger or acquisition transactions when regulatory approval is required or to prohibit such transactions even if approval is not required.
The Sarbanes-Oxley Act
The Sarbanes-Oxley Act, which became law on July 30, 2002, added new legal requirements for public companies affecting corporate governance, accounting and corporate reporting. The Sarbanes-Oxley Act provides for, among other things:
•
a prohibition on personal loans made or arranged by the issuer to its directors and executive officers (except for loans made by a bank subject to Regulation O);
•
independence requirements for audit committee members;
•
independence requirements for company auditors;
•
certification of financial statements on Forms 10-K and 10-Q reports by the chief executive officer and the chief financial officer;
•
the forfeiture by the chief executive officer and chief financial officer of bonuses or other incentive-based compensation and profits from the sale of an issuer’s securities by such officers in the twelve-month period following initial publication of any financial statements that later require restatement due to corporate misconduct;
•
disclosure of off-balance sheet transactions;
•
two-business day filing requirements for insiders filing Form 4s;
•
disclosure of a code of ethics for financial officers and filing a Form 8-K for a change in or waiver of such code;
•
the reporting of securities violations “up the ladder” by both in-house and outside attorneys;
•
restrictions on the use of non-GAAP financial measures in press releases and SEC filings;
•
the formation of a public accounting oversight board; and
•
various increased criminal penalties for violations of securities laws.
The SEC was delegated the task of enacting rules to implement various provisions. In addition, each of the national stock exchanges developed new corporate governance rules, including rules strengthening director independence requirements for boards, the adoption of corporate governance codes and charters for the nominating, corporate governance and audit committees.
Additional Matters
The Corporation and the Bank are subject to the Federal Reserve Act, which restricts financial transactions between banks and affiliated companies. The statute limits credit transactions between banks, affiliated companies and its executive officers and its affiliates. The statute prescribes terms and conditions for bank affiliate transactions deemed to be consistent with safe and sound banking practices. It also restricts the types of collateral security permitted in connection with the bank’s extension of credit to an affiliate. Additionally, all transactions with an affiliate must be on terms substantially the same or at least as favorable to the institution as those prevailing at the time for comparable transactions with non-affiliated parties.
The earnings of financial institutions are also affected by general economic conditions and prevailing interest rates, both domestic and foreign, and by the monetary and fiscal policies of the United States Government and its various agencies, particularly the Federal Reserve. The Federal Reserve regulates the supply of credit in order to influence general economic conditions, primarily through open market operations in United States Government obligations, varying the discount rate on financial institution borrowings, varying reserve requirements against financial institution deposits, and restricting certain borrowings by financial institutions and their subsidiaries. The monetary policies of the Federal Reserve have had a significant effect on the operating results of the Bank in the past and are expected to continue to do so in the future.
Additional legislation and administrative actions affecting the banking industry may be considered by the United States Congress, state legislatures and various regulatory agencies, including those referred to above. It cannot be predicted with certainty whether such legislation or administrative action will be enacted or the extent to which the banking industry, the Corporation or the Bank would be affected.
The following tables set forth statistical data on the Corporation and its subsidiaries.
DISTRIBUTION OF ASSETS, LIABILITIES AND STOCKHOLDERS’ EQUITY; INTEREST RATES AND INTEREST DIFFERENTIAL
The daily average balance sheet amounts, the related interest income or interest expense, and average rates earned or paid are presented in the following table:
Average Balance
Interest Income / Expense
Average Rate
Average Balance
Interest Income / Expense
Average Rate
Average Balance
Interest Income / Expense
Average Rate
(Dollars in Thousands)
2018
2017
2016
Assets:
Interest-bearing deposits
$
110,232
$
2,241
2.03
%
$
75,417
$
736
0.98
%
$
69,753
$
350
0.50
%
Federal Reserve and Federal Home Loan Bank stock
24,538
1,234
5.03
20,921
894
4.27
24,268
1,098
4.52
Investment Securities: (1)
Taxable
841,203
21,597
2.57
726,004
17,489
2.41
721,689
16,415
2.27
Tax-exempt (2)
762,623
32,290
4.23
632,076
32,891
5.20
550,335
28,649
5.21
Total investment securities
1,603,826
53,887
3.36
1,358,080
50,380
3.71
1,272,024
45,064
3.54
Loans held for sale
11,425
540
4.73
7,707
462
5.99
4,050
372
9.19
Loans: (3)
Commercial
5,143,576
274,302
5.33
4,267,651
204,771
4.80
3,541,098
162,848
4.60
Real estate mortgage
733,709
33,549
4.57
679,284
30,267
4.46
566,050
25,156
4.44
Installment
640,310
34,110
5.33
573,100
28,204
4.92
485,111
21,926
4.52
Tax-exempt (2)
468,751
18,813
4.01
353,542
16,452
4.65
217,696
10,039
4.61
Total loans
6,997,771
361,314
5.16
5,881,284
280,156
4.76
4,814,005
220,341
4.58
Total earning assets
8,736,367
418,676
4.79
%
7,335,702
332,166
4.53
%
6,180,050
266,853
4.32
%
Net unrealized gain (loss) on securities available for sale
(14,790
)
4,360
9,969
Allowance for loan losses
(77,444
)
(70,380
)
(62,976
)
Cash and cash equivalents
131,925
142,503
105,443
Premises and equipment
94,567
97,446
96,023
Other assets
818,432
686,598
570,756
Total Assets
$
9,689,057
$
8,196,229
$
6,899,265
Liabilities:
Interest-bearing deposits:
Interest-bearing deposit accounts
$
2,319,081
$
17,577
0.76
%
$
1,730,272
$
5,817
0.34
%
$
1,427,535
$
2,579
0.18
%
Money market deposit accounts
1,097,762
6,721
0.61
938,959
2,788
0.30
825,681
1,705
0.21
Savings deposits
1,065,031
5,230
0.49
844,825
734
0.09
731,902
618
0.08
Certificates and other time deposits
1,514,271
22,014
1.45
1,339,866
14,467
1.08
1,151,700
11,012
0.96
Total interest-bearing deposits
5,996,145
51,542
0.86
4,853,922
23,806
0.49
4,136,818
15,914
0.38
Borrowings
718,061
17,545
2.44
664,045
13,806
2.08
512,356
10,925
2.13
Total interest-bearing liabilities
6,714,206
69,087
1.03
5,517,967
37,612
0.68
4,649,174
26,839
0.58
Noninterest-bearing deposits
1,573,337
1,514,829
1,301,399
Other liabilities
57,653
52,909
64,028
Total Liabilities
8,345,196
7,085,705
6,014,601
Stockholders' Equity
1,343,861
1,110,524
884,664
Total Liabilities and Stockholders' Equity
$
9,689,057
69,087
$
8,196,229
37,612
$
6,899,265
26,839
Net Interest Income (FTE)
$
349,589
$
294,554
$
240,014
Net Interest Spread (FTE) (4)
3.76
%
3.85
%
3.74
%
Net Interest Margin (FTE):
Interest Income (FTE) / Average Earning Assets
4.79
%
4.53
%
4.32
%
Interest Expense / Average Earning Assets
0.79
%
0.51
%
0.43
%
Net Interest Margin (FTE) (5)
4.00
%
4.02
%
3.89
%
______________________________
(1) Average balance of securities is computed based on the average of the historical amortized cost balances without the effects of the fair value adjustment.
(2) Tax-exempt securities and loans are presented on a fully taxable equivalent basis, using a marginal tax rate of 21 percent for 2018 and 35 percent for both 2017 and 2016. These totals equal $10,732, $17,270 and $13,541, respectively.
(3) Non-accruing loans have been included in the average balances.
(4) Net Interest Spread (FTE) is interest income expressed as a percentage of average earning assets minus interest expense expressed as a percentage of average interest-bearing liabilities.
(5) Net Interest Margin (FTE) is interest income expressed as a percentage of average earning assets minus interest expense expressed as a percentage of average earning assets.
The following table presents net interest income components on a tax-equivalent basis and reflects changes between periods attributable to movement in either the average balance or average interest rate for both earning assets and interest-bearing liabilities. The volume differences were computed as the difference in volume between the current and prior year multiplied by the interest rate from the prior year. The interest rate changes were computed as the difference in rate between the current and prior year multiplied by the volume from the prior year. Volume/rate variances have been allocated on the basis of the absolute relationship between volume variances and rate variances.
2018 Compared to 2017 Increase (Decrease) Due To
2017 Compared to 2016 Increase (Decrease) Due To
2016 Compared to 2015 Increase (Decrease) Due To
(Dollars in Thousands, Fully Taxable Equivalent Basis)
Volume
Rate
Total
Volume
Rate
Total
Volume
Rate
Total
Interest Income:
Interest-bearing deposits
$
450
$
1,055
$
1,505
$
31
$
355
$
386
$
24
$
166
$
190
Federal Reserve and Federal Home Loan Bank stock
168
172
340
(145
)
(59
)
(204
)
(625
)
(244
)
(869
)
Investment securities
8,551
(5,044
)
3,507
3,133
2,183
5,316
3,095
(1,950
)
1,145
Loans held for sale
190
(112
)
78
252
(162
)
90
39
(142
)
(103
)
Loans
56,084
24,996
81,080
50,333
9,392
59,725
28,858
5,459
34,317
Totals
65,443
21,067
86,510
53,604
11,709
65,313
31,391
3,289
34,680
Interest Expense:
Interest-bearing deposit accounts
2,509
9,251
11,760
640
2,598
3,238
463
742
1,205
Money market deposit accounts
540
3,393
3,933
258
825
1,083
(30
)
(33
)
(63
)
Savings deposits
239
4,257
4,496
98
18
116
115
(169
)
(54
)
Certificates and other time deposits
2,061
5,486
7,547
1,929
1,526
3,455
292
(321
)
(29
)
Borrowings
1,185
2,554
3,739
3,160
(279
)
2,881
666
320
986
Totals
6,534
24,941
31,475
6,085
4,688
10,773
1,506
539
2,045
Change in net interest income (fully taxable equivalent basis)
$
58,909
$
(3,874
)
55,035
$
47,519
$
7,021
54,540
$
29,885
$
2,750
32,635
Tax equivalent adjustment using marginal rate of 21% for 2018 and 35% for both 2017, and 2016
6,538
(3,729
)
(2,566
)
Change in net interest income
$
61,573
$
50,811
$
30,069
INVESTMENT SECURITIES
Management evaluates securities for other-than-temporary-impairment ("OTTI") at least on a quarterly basis, and more frequently when economic or market conditions warrant such an evaluation.
In determining OTTI, management considers many factors, including: (1) the length of time and the extent to which the fair value has been less than cost, (2) the financial condition and near term prospects of the issuer, (3) whether the market decline was affected by macroeconomic conditions, and (4) whether the Corporation has the intent to sell the debt security or more likely than not, will be required to sell the debt security before its anticipated recovery. The assessment of whether an other-than-temporary decline exists involves a high degree of subjectivity and judgment and is based on the information available to management at a point in time.
When OTTI occurs, the amount of OTTI recognized in the income statement depends on whether the Corporation intends to sell the security or it is more likely than not that the Corporation will be required to sell the security before recovery of its amortized cost basis, less any recognized credit loss. If the intent is to sell, or it is more likely than not that the Corporation will be required to sell the security before recovery of its amortized cost basis, less any recognized credit loss, the OTTI shall be recognized in earnings equal to the entire difference between the investment’s amortized cost basis, less any recognized credit loss, and its fair value at the balance sheet date. If the intent is not to sell the security and it is not more likely than not that the Corporation will be required to sell the security before the recovery of its amortized cost basis less any recognized credit loss, the OTTI has been separated into the amount representing the credit loss and the amount related to all other factors. The amount of the total OTTI related to the credit loss is determined based on the present value of cash flows expected to be collected and is recognized in earnings. The amount of the total OTTI related to other factors is recognized in other comprehensive income, net of applicable income taxes. The previous amortized cost basis less the OTTI recognized in earnings becomes the new amortized cost basis of the investment.
The Corporation’s management has evaluated all securities with unrealized losses for OTTI as of December 31, 2018 and concluded no OTTI existed in 2018.
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 I and Level II 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 were determined using a discounted cash flow model that incorporated market estimates of interest rates and volatility in markets that have not been active.
The amortized cost, gross unrealized gains, gross unrealized losses and approximate market value of the investment securities at the dates indicated were:
Amortized Cost
Gross Unrealized Gains
Gross Unrealized Losses
Fair Value
Available for sale at December 31, 2018
U.S. Government-sponsored agency securities
$
13,493
$
92
$
3
$
13,582
State and municipal
605,994
5,995
5,854
606,135
U.S. Government-sponsored mortgage-backed securities
530,209
634
8,396
522,447
Corporate obligations
31
31
Total available for sale
1,149,727
6,721
14,253
1,142,195
Held to maturity at December 31, 2018
U.S. Government-sponsored agency securities
22,618
545
22,073
State and municipal
197,909
2,858
872
199,895
U.S. Government-sponsored mortgage-backed securities
268,860
713
3,323
266,250
Foreign investment
1,000
1
999
Total held to maturity
490,387
3,571
4,741
489,217
Total Investment Securities
$
1,640,114
$
10,292
$
18,994
$
1,631,412
Amortized Cost
Gross Unrealized Gains
Gross Unrealized Losses
Fair Value
Available for sale at December 31, 2017
U.S. Government-sponsored agency securities
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
Amortized Cost
Gross Unrealized Gains
Gross Unrealized Losses
Fair Value
Available for sale at December 31, 2016
U.S. Government-sponsored agency securities
$
100
$
100
State and municipal
360,779
$
8,443
$
5,564
363,658
U.S. Government-sponsored mortgage-backed securities
313,459
1,904
3,071
312,292
Corporate obligations
31
31
Equity securities
21,820
1,039
20,781
Total available for sale
696,189
10,347
9,674
696,862
Held to maturity at December 31, 2016
U.S. Government-sponsored agency securities
22,619
479
22,140
State and municipal
224,811
3,136
1,796
226,151
U.S. Government-sponsored mortgage-backed securities
The cost and yield for Federal Home Loan Bank stock is included in the table below.
2018
2017
2016
(Dollars in Thousands)
Cost
Yield
Cost
Yield
Cost
Yield
Federal Home Loan Bank stock
$
24,588
5.0
%
$
23,825
3.8
%
17,964
4.3
%
Total
$
24,588
5.0
%
$
23,825
3.8
%
$
17,964
4.3
%
Federal Home Loan Bank stock has been reviewed for impairment and the analysis reflected no impairment. The Corporation’s Federal Home Loan Bank stock is primarily in the Federal Home Loan Bank of Indianapolis and it continued to produce sufficient financial results to pay dividends.
There were no issuers included in the investment security portfolio at December 31, 2018, 2017 or 2016 where the aggregate carrying value of any one issuer exceeded 10 percent of the Corporation's stockholders' equity at those dates. The term "issuer" excludes the U.S. Government and its sponsored agencies and corporations.
The maturity distribution and average yields for the securities portfolio at December 31, 2018 were:
Within 1 Year
1-5 Years
5-10 Years
(Dollars in Thousands)
Amount
Yield (1)
Amount
Yield (1)
Amount
Yield (1)
Securities available for sale December 31, 2018
U.S. Government-sponsored agency securities
$
1,490
2.5
%
$
12,092
3.3
%
State and municipal
$
13,144
5.6
%
3,888
5.3
%
62,319
4.0
%
$
13,144
5.6
%
$
5,378
4.6
%
$
74,411
3.9
%
Due After Ten Years
U.S. Government- Sponsored Mortgage - Backed Securities
Total
Amount
Yield (1)
Amount
Yield (1)
Amount
Yield (1)
U.S. Government-sponsored agency securities
$
13,582
3.2
%
State and municipal
$
526,784
4.2
%
606,135
4.1
%
U.S. Government-sponsored mortgage-backed securities
$
522,447
2.9
%
522,447
2.9
%
Corporate obligations
31
—
%
31
—
%
$
526,815
4.2
%
$
522,447
2.9
%
$
1,142,195
3.6
%
Within 1 Year
1-5 Years
5-10 Years
(Dollars in Thousands)
Amount
Yield (1)
Amount
Yield (1)
Amount
Yield (1)
Securities held to maturity at December 31, 2018
U.S. Government-sponsored agency securities
$
22,618
1.8
%
State and municipal
$
3,732
4.5
%
26,436
5.0
%
$
62,873
4.2
%
U.S. Government-sponsored mortgage-backed securities
Foreign investment
1,000
2.2
%
$
4,732
4.0
%
$
49,054
3.5
%
$
62,873
4.2
%
Due After Ten Years
U.S. Government- Sponsored Mortgage - Backed Securities
Total
Amount
Yield (1)
Amount
Yield (1)
Amount
Yield (1)
U.S. Government-sponsored agency securities
$
22,618
1.8
%
State and municipal
$
104,868
4.2
%
197,909
4.3
%
U.S. Government-sponsored mortgage-backed securities
$
268,860
2.9
%
268,860
2.9
%
Foreign investment
1,000
2.2
%
$
104,868
4.2
%
$
268,860
2.9
%
$
490,387
3.4
%
_______________________________
(1) Interest yields are presented on a fully taxable equivalent basis using a 21 percent tax rate.
The following tables show the Corporation’s gross unrealized losses and fair value, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position, at December 31, 2018 and 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 December 31, 2018
U.S. Government-sponsored agency securities
$
1,490
$
3
$
1,490
$
3
State and municipal
234,431
3,958
$
38,028
$
1,896
272,459
5,854
U.S. Government-sponsored mortgage-backed securities
196,601
2,400
217,121
5,996
413,722
8,396
Total Temporarily Impaired Available for Sale Securities
432,522
6,361
255,149
7,892
687,671
14,253
Temporarily Impaired Held to Maturity Securities at December 31, 2018
U.S. Government-sponsored agency securities
22,073
545
22,073
545
State and municipal
14,952
369
16,786
503
31,738
872
U.S. Government-sponsored mortgage-backed securities
102,828
876
87,268
2,447
190,096
3,323
Foreign investment
999
1
999
1
Total Temporarily Impaired Held to Maturity Securities
117,780
1,245
127,126
3,496
244,906
4,741
Total Temporarily Impaired Investment Securities
$
550,302
$
7,606
$
382,275
$
11,388
$
932,577
$
18,994
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
LOAN PORTFOLIO
Loans are generated from customers primarily in central, northwest and northeast Indiana, northeast Illinois and central Ohio and are typically secured by specific items of collateral, including real property, consumer assets, and business assets. The following table shows the composition of the Corporation’s loan portfolio by collateral classification, including purchased credit impaired loans, for the years indicated:
2018
2017
2016
2015
2014
(Dollars in Thousands)
Amount
%
Amount
%
Amount
%
Amount
%
Amount
%
Loans at December 31:
Commercial and industrial loans
$
1,726,664
23.9
%
$
1,493,493
22.1
%
$
1,194,646
23.2
%
$
1,057,075
22.5
%
$
896,688
22.8
%
Agricultural production financing and other loans to farmers
92,404
1.3
121,757
1.8
79,689
1.6
97,711
2.1
104,927
2.7
Real estate loans:
Construction
545,729
7.5
612,219
9.1
418,703
8.1
366,704
7.8
207,221
5.3
Commercial and farmland
2,832,102
39.2
2,562,691
38.0
1,953,062
38.1
1,802,921
38.5
1,672,661
42.6
Residential
966,421
13.4
962,765
14.3
739,169
14.4
786,105
16.7
647,315
16.5
Home equity
528,157
7.3
514,021
7.6
418,525
8.1
348,613
7.4
286,529
7.3
Individuals' loans for household and other personal expenditures
99,788
1.4
86,935
1.3
77,479
1.5
74,717
1.6
73,400
1.9
Lease financing receivables, net of unearned income
1,600
2,527
311
588
1,106
Other commercial loans
431,602
6.0
394,791
5.8
258,061
5.0
159,388
3.4
35,018
0.9
Loans
7,224,467
100.0
%
6,751,199
100.0
%
5,139,645
100.0
%
4,693,822
100.0
%
3,924,865
100.0
%
Allowance for loan losses
(80,552
)
(75,032
)
(66,037
)
(62,453
)
(63,964
)
Net Loans
$
7,143,915
$
6,676,167
$
5,073,608
$
4,631,369
$
3,860,901
Other commercial loans is primarily comprised of loans secured by states and political subdivisions in the United States.
At July 14, 2017, loans of $749.7 million with a fair value discount of $23.7 million were acquired in the IAB acquisition. The May 19, 2017 acquisition of Arlington Bank included loans of $238.9 million with a fair value discount of $6.6 million. At December 31, 2015, loans of $331.0 million with a fair value discount of $14.0 million were acquired in the Ameriana transaction. The April 17, 2015 acquisition of C Financial included loans of $113.2 million with a fair value discount of $2.6 million. The assets acquired in the November 7, 2014 Community transaction included $153.9 million in loans which were acquired at a fair value discount of $8.8 million. At December 31, 2018 and 2017, the remaining fair value discount on acquired loans was $30,054,000 and $46,304,000, respectively.
LOAN MATURITIES
Presented in the table below are the maturities of loans (excluding residential real estate, home equity, individuals’ loans for household and other personal expenditures and lease financing) outstanding as of December 31, 2018, by collateral classification. Also presented are the amounts due after one year, classified according to the sensitivity to changes in interest rates. The tables classify variable rate loans pursuant to the contractual repricing dates of the underlying loans, while fixed rate loans are classified by contractual maturity date.
(Dollars in Thousands)
Maturing Within 1 Year
Maturing 1-5 Years
Maturing Over 5 Years
Total
Commercial and industrial loans
$
1,363,716
$
223,078
$
139,870
$
1,726,664
Agriculture production financing and other loans to farmers