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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-K

 

x ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
  For the fiscal year ended December 31, 2015
  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 000-27905

 

MutualFirst Financial, Inc.
(Exact name of registrant as specified in its charter)

 

Maryland   35-2085640
(State or other jurisdiction of incorporation or organization)   (I.R.S. Employer Identification No.)
     
110 E. Charles Street, Muncie, Indiana   47305-2400
(Address of principal executive offices)   (Zip Code)

 

Registrant’s telephone number, including area code: (765) 747-2800

 

Securities registered pursuant to Section 12(b) of the Act:

 

Title of each class Name of each exchange on which registered
Common Stock, par value $.01 per share Nasdaq Global 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 ¨ No x

 

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 and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x No ¨

 

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§ 229.405 of this chapter) 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. ¨

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See definition of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Act.

 

Large accelerated filer  ¨ Accelerated filer  x Non-accelerated filer  ¨ Smaller reporting company  ¨
    (Do not check if smaller
    reporting company)
 

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ No x

 

The aggregate market value of the voting and non-voting common equity held by non-affiliates, computed by reference to the last sale price of such stock on the Nasdaq Global Market as of June 30, 2015, the last business day of the registrant’s most recently completed second fiscal quarter, was approximately $120.1 million. (The exclusion from such amount of the market value of the shares owned by any person shall not be deemed an admission by the registrant that such person is an affiliate of the registrant.)

 

Indicate the number of shares outstanding of each of the registrant’s classes of common stock as of the latest practicable date. As of March 13, 2016, there were 7,448,543 shares of the registrant’s common stock outstanding.

 

DOCUMENTS INCORPORATED BY REFERENCE

 

PART III of Form 10-K-Portions of registrant’s Proxy Statement for its 2015 Annual Meeting of Stockholders. 

 

 

 

 

MutualFirst Financial, Inc.

 

Form 10-K Annual Report for the Year Ended December 31, 2015

 

Table of Contents

 

    Page
     
Part I    
Item 1 Business 3
     
Item 1A Risk Factors 38
     
Item 1B Unresolved Staff Comments 53
     
Item 2 Properties 53
     
Item 3 Legal Proceedings 53
     
Item 4 Mine Safety Disclosure 53
     
Part II    
Item 5 Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities 54
     
Item 6 Selected Financial Data 56
     
Item 7 Management’s Discussion and Analysis of Financial Condition and Results of Operations 59
     
Item 7A Quantitative and Qualitative Disclosures About Market Risk 86
     
Item 8 Financial Statements and Supplementary Data 89
     
Item 9 Changes in and Disagreements With Accountants in Accounting and Financial Disclosure 152
     
Item 9A Controls and Procedures 152
     
Item 9B Other Information 155
     
Part III    
Item 10 Directors, Executive Officers and Corporate Governance 155
     
Item 11 Executive Compensation 157
     
Item 12 Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters 157
     
Item 13 Certain Relationships and Related Transactions, and Director Independence 158
     
Item 14 Principal Accountant Fees and Services 158
     
Part IV    
Item 15 Exhibits and Financial Statement Schedules 159
     
SIGNATURES   162
     
EXHIBIT INDEX   164

 

 2 

 

 

Item 1.  Business

 

General

 

MutualFirst Financial, Inc., a Maryland corporation (“MutualFirst” or the “Company”), is the sole owner of MutualBank (“MutualBank” or the “Bank”). The Bank is an Indiana commercial bank regulated by the Indiana Department of Financial Institutions (“IDFI”) and the Federal Deposit Insurance Corporation (“FDIC”). MutualFirst is a bank holding company subject to regulation by the Board of Governors of the Federal Reserve System (“FRB”). The words “we,” “our” and “us” in this Form 10-K refer to MutualFirst and MutualBank on a consolidated basis, unless indicated otherwise herein.

 

At December 31, 2015, we had total assets of $1.5 billion, loans of $1.1 billion, deposits of $1.1 billion and stockholders’ equity of $137.0 million. Our executive offices are located at 110 E. Charles Street, Muncie, Indiana 47305-2400. Our common stock is traded on the Nasdaq Global Market under the symbol “MFSF.” For more general information about our business, and other 2015 material transactions and results, see “Item 7 - Management’s Discussion and Analysis of Financial Condition and Results of Operation - Overview and Significant Events in 2015.”

 

Forward-Looking Statements

 

This Form 10-K contains, and our future filings with the SEC, Company press releases, other public pronouncements, stockholder communications and oral statements made by or with the approval of an authorized executive officer will contain, “forward-looking statements” through our use of words such as “may,” “will,” “anticipate,” “assume,” “should,” “indicate,” “would,” “believe,” “contemplate,” “expect,” “estimate,” “continue,” “plan,” “project,” “could,” “intend,” “target” and other similar words and expressions of the future. These forward-looking statements include, but are not limited to:

 

·statements of our goals, intentions and expectations;

 

·statements regarding our business plans, prospects, growth and operating strategies;

 

·statements regarding the asset quality of our loan and investment portfolios; and

 

·estimates of our risks and future costs and benefits.

 

These forward-looking statements are based on current beliefs and expectations of our management and are inherently subject to significant business, economic and competitive uncertainties and contingencies, many of which are beyond our control. In addition, these forward-looking statements are subject to assumptions with respect to future business strategies and decisions that are subject to change.

 

The following factors, among others, could cause actual results to differ materially from the anticipated results or other expectations expressed in the forward-looking statements:

 

·the credit risks of lending activities, including changes in the level and trend of loan delinquencies and write-offs and changes in our allowance for loan losses and provision for loan losses that may be impacted by deterioration in the housing and commercial real estate markets;

 

 3 

 

 

·changes in general economic conditions, either nationally or in our market areas;

 

·changes in the monetary and fiscal policies of the U.S. Government, including policies of the Treasury and the FRB;

 

·changes in the levels of general interest rates and the relative differences between short- and long-term interest rates, deposit interest rates, our net interest margin and funding sources;

 

·fluctuations in the demand for loans, the number of unsold homes, land and other properties and fluctuations in real estate values in our market areas;

 

·decreases in the secondary market for the sale of loans that we originate;

 

·results of examinations of us by the IDFI, FDIC, FRB or other regulatory authorities, including the possibility that any such regulatory authority may, among other things, require us to increase our reserve for loan losses, write-down assets, change our regulatory capital position or affect our ability to borrow funds or maintain or increase deposits, which could adversely affect our liquidity and earnings;

 

·legislative or regulatory changes that adversely affect our business, including the effect of Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”), changes in regulatory policies and principles, changes in regulatory capital requirements or the interpretation of regulatory capital or other rules;

 

·our ability to attract and retain deposits;

 

·increases in premiums for deposit insurance;

 

·management’s assumptions in determining the adequacy of the allowance for loan losses;

 

·our ability to control operating costs and expenses;

 

·the use of estimates in determining fair value of certain of our assets, which estimates may prove to be incorrect and result in significant losses due to declines in valuation;

 

·difficulties in reducing risks associated with the loans on our balance sheet;

 

·staffing fluctuations in response to product demand or the implementation of corporate strategies that affect our workforce and potential associated charges;

 

·a failure or security breach in the computer systems (or the third party vendors who provide such services) on which we depend;

 

·our ability to retain members of our senior management team;

 

·costs and effects of litigation, including settlements and judgments;

 

·our ability to successfully integrate any assets, liabilities, customers, systems, and management personnel we may in the future acquire into our operations and our ability to realize related revenue synergies and cost savings within expected time frames and any goodwill charges related thereto;

 

 4 

 

 

·increased competitive pressures among financial services companies;

 

·changes in consumer spending, borrowing and savings habits;

 

·the availability of resources to address changes in laws, rules, or regulations or to respond to regulatory actions;

 

·adverse changes in the securities markets;

 

·changes in our ability and the cost to access the capital markets;

 

·inability of key third-party providers to perform their obligations to us;

 

·changes in accounting policies and practices, as may be adopted by the financial institution regulatory agencies, the Public Company Accounting Oversight Board or the Financial Accounting Standards Board; and

 

·other economic, competitive, governmental, regulatory, and technological factors affecting our operations, pricing, products and services and the other risks described elsewhere in this Form 10-K.

 

Some of these and other factors are discussed in “Item 1A-Risk Factors” and elsewhere in this Form 10-K. Certain of these developments could have an adverse impact on our financial position and results of operations.

 

Any of these forward-looking statements are based upon management’s beliefs and assumptions at the time they are made. We undertake no obligation to publicly update or revise any forward-looking statements included in this Form 10-K or to update the reasons why actual results could differ from those contained in such statements, whether as a result of new information, future events or otherwise. In light of these risks, uncertainties and assumptions, the forward-looking statements discussed in this Form 10-K might not occur, and you should not put undue reliance on any forward-looking statements.

 

The Company does not undertake and specifically declines any obligation to publicly release the result of any revisions that may be made to any forward-looking statements to reflect events or circumstances after the date of such statements or to reflect the occurrence of unanticipated events.

 

Market Area

 

We are a community-oriented bank offering a variety of financial services to meet the needs of the communities we serve. We are headquartered in Muncie, Indiana and offer our financial services through 31 full service retail financial center offices in Allen, Delaware, Elkhart, Grant, Kosciusko, Randolph, St. Joseph and Wabash counties in Indiana. MutualBank also has trust offices in Carmel and Crawfordsville, Indiana and a loan origination office in New Buffalo, Michigan. The Bank has a subsidiary, Summit Mortgage, Inc., that operates a mortgage banking firm in Ft. Wayne, Indiana. In addition, we originate residential mortgage and commercial loans in the counties contiguous to those counties. We also originate indirect consumer loans throughout Indiana and contiguous states as described in “Lending Activities - Other Consumer Lending.”

 

 5 

 

 

The market areas where MutualBank operates in Indiana have historically experienced an unemployment rate that has exceeded the federal and state unemployment rates, though in recent years that difference was reduced to below the state rates and in 2015 fell below the federal rate as well. At the end of 2015, the unemployment rate (not seasonally adjusted) was 4.8% at the federal level and 4.6% at the state level, compared to 5.4% and 5.8% at the end of 2014 at the federal and state level, respectively. Our footprint had an unemployment rate of 4.5% and 5.7% at year-end 2015 and 2014, respectively. Our markets have experienced new jobs in the aerospace industry, and jobs in the auto and recreational vehicles industry have improved since the beginning of the recession. During 2015, improvements in local home values, unemployment and the local economy resulted in increasing levels of home sales and residential mortgage activity.

 

Competition

 

We face strong competition from other banks, credit unions, mortgage bankers and finance companies in originating commercial, real estate and other loans and in attracting deposits. Our wealth management division faces strong competition from other banks, brokerage firms, financial advisers and trust companies. We attract deposits primarily through our branch network. Competition for deposits comes principally from local banks and credit unions, but also comes from the availability of other investment opportunities, including mutual funds. We compete for deposits by offering superior service and a variety of deposit accounts at competitive rates. We also offer alternative investment products through a broker/dealer.

 

Internet Website and Information

 

The Company maintains a website at www.bankwithmutual.com - “About Us – Investor Relations.” The information contained on that website is not included as part of or incorporated by reference into this Form 10-K. The Company’s filings with the SEC are available on that website and also are available on the SEC website at sec.gov - “Search for Company Filings.”

 

Lending Activities

 

General. Our loans carry either a fixed- or an adjustable-rate of interest. At December 31, 2015, our net loan portfolio totaled $1.1 billion, which constituted 72.7% of our total assets. Our loan portfolio increased by 6.4% in 2015, primarily due to increased commercial real estate, commercial and industrial and non- real estate consumer loans; however, that increase was partially reduced by a decrease in commercial construction and development and consumer mortgage loans.

 

Loans up to $1.0 million may be approved by certain individual loan officers. Loans in excess of $1.0 million, but not in excess of $2.0 million, may be approved by the combined authority of two officers that have loan authority up to $1.0 million individually. Loans between $2.0 million, but no more than $5.0 million, may be approved by a majority vote of the Loan Committee. All loans in excess of $5.0 million must be approved by the Board of Directors. Commercial Banking Officers may advance additional credit exposure for a commercial loan relationship requiring Board approval up to the lesser of: 10% of the existing previously approved credit exposure to the client, or $100,000. Any additional exposure approved under the 10% Rule must be approved by the Senior Vice President of Commercial Banking or his designee, and reported to the appropriate Loan Committee during the next meeting.

 

 6 

 

 

Major Loan Customers. At December 31, 2015, the maximum amount that we could lend to any one borrower and the borrower’s related entities was approximately $22.1 million. At December 31, 2015, our five largest lending relationships were with commercial borrowers and public entities and constituted an aggregate of $62.6 million in loans and commitments issued, or 5.7% of our $1.1 billion gross loan portfolio, with $34.0 million in loans outstanding. As of December 31, 2015, our largest lending relationship to a single borrower or group of related borrowers consisted of one loan with a total commitment of $15.9 million, with a $2.7 million outstanding balance at year-end. This loan is secured primarily by commercial real estate.

 

Our next four largest relationships consist of $13.2 million in loans and commitments secured primarily by commercial real estate with $2.5 million outstanding; $12.2 million in loans and commitments issued and outstanding which is secured by commercial real estate; $11.6 million in loans and commitments which is secured primarily by commercial business assets with $8.5 million outstanding; and $9.6 million in loans and commitments issued secured primarily by municipal bonds with $8.0 million outstanding. As of December 31, 2015, all loans within these relationships were performing as agreed.

 

 7 

 

 

The following table presents information concerning the composition of our loan portfolio in dollar amounts and in percentages as of the dates indicated.

 

   December 31, 
   2015   2014   2013   2012   2011 
   Amount   Percent   Amount   Percent   Amount   Percent   Amount   Percent   Amount   Percent 
   (Dollars in thousands) 
Real estate                                                  
Commercial  $236,895    21.75%  $198,019    19.25%  $200,817    20.24%  $203,613    20.45%  $197,390    21.42%
Commercial construction and development   15,744    1.45    33,102    3.22    13,321    1.34    17,462    1.75    20,831    2.26 
Consumer closed end first mortgage   497,442(1)   45.66    523,203(2)   50.87    533,160(3)   53.74    533,527(4)   53.58    451,117(5)   48.95 
Consumer open end and junior liens   70,990    6.52    71,073    6.91    69,354    6.99    74,714    7.50    82,164    8.91 
Total real estate loans   821,071    75.38    825,397    80.25    816,652    82.31    829,316    83.28    751,502    81.54 
                                                   
Other loans                                                  
Consumer loans                                                  
Auto   15,480    1.42    14,712    1.43    14,856    1.50    15,572    1.57    15,203    1.65 
Boat/RV   123,621    11.35    94,761    9.21    79,419    8.01    76,416    7.68    83,557    9.07 
Other   6,171    0.56    5,184    0.51    5,766    0.58    6,598    0.66    6,760    0.73 
Total consumer other   145,272    13.33    114,657    11.15    100,041    10.09    98,586    9.91    105,520    11.45 
Commercial and industrial   123,043    11.29    88,474    8.60    75,402    7.60    67,773    6.81    64,628    7.01 
Total other loans   268,315    24.62    203,131    19.75    175,443    17.69    166,359    16.72    170,148    18.46 
                                                   
Total loans receivable, gross   1,089,386    100.00%   1,028,528    100.00%   992,095    100.00%   995,675    100.00%   921,650    100.00%
                                                   
Undisbursed loans in process   (7,432)        (9,285)        (13,346)        (7,418)        (5,352)     
Unamortized deferred loan costs, net   4,882         3,583         2,517         2,432         2,418      
Allowance for loan losses   (12,641)        (13,168)        (13,412)        (16,038)        (16,815)     
Total loans receivable, net  $1,074,195        $1,009,658        $967,854        $974,651        $901,901      

 

 

(1) Includes loans held for sale of $6.0 million.

(2) Includes loans held for sale of $6.1 million.

(3) Includes loans held for sale of $1.9 million.

(4) Includes loans held for sale of $5.1 million.

(5) Includes loans held for sale of $1.4 million.

 

 8 

 

 

The following table shows the composition of our loan portfolio by fixed- and adjustable-rate at the dates indicated.

 

   December 31, 
   2015   2014   2013   2012   2011 
   Amount   Percent   Amount   Percent   Amount   Percent   Amount   Percent   Amount   Percent 
   (Dollars in thousands) 
Fixed-Rate Loans                                                  
Real estate                                                  
Commercial  $72,263    6.63%  $85,230    8.29%  $88,031    8.87%  $118,828    11.93%  $114,615    12.44%
Commercial construction and development   4,732    0.43    3,941    0.38    2,833    0.29    3,673    0.37    2,518    0.27 
Consumer closed end first mortgage   381,372(1)   35.01    392,441(2)   38.16    398,541(3)   40.17    387,353(4)   38.90    272,988(5)   29.62 
Consumer open end and junior liens   17,106    1.57    19,479    1.89    22,990    2.32    27,832    2.80    36,661    3.97 
Total real estate loans   475,473    43.64    501,091    48.72    512,395    51.65    537,686    54.00    426,782    46.30 
                                                   
Consumer   143,171    13.14    112,295    10.92    97,422    9.82    95,448    9.59    103,356    11.22 
Commercial and industrial   61,702    5.66    43,378    4.22    32,369    3.26    30,321    3.04    24,195    2.63 
Total fixed-rate loans   680,346    62.44    656,764    63.86    642,186    64.73    663,455    66.63    554,333    60.15 
                                                   
Adjustable-Rate Loans                                                  
Real estate                                                  
Commercial   164,632    15.12    112,789    10.97    112,786    11.37    84,785    8.52    82,775    8.98 
Commercial construction and development   11,012    1.02    29,161    2.83    10,488    1.06    13,789    1.38    18,313    1.99 
Consumer closed end first mortgage   116,070    10.65    130,762    12.71    134,619    13.57    146,174    14.68    178,129    19.33 
Consumer open end and junior liens   53,884    4.95    51,594    5.02    46,364    4.67    46,882    4.71    45,503    4.94 
Total real estate loans   345,598    31.74    324,306    31.53    304,257    30.67    291,630    29.29    324,720    35.24 
                                                   
Consumer   2,101    0.19    2,362    0.23    2,619    0.26    3,138    0.32    2,164    0.23 
Commercial and industrial   61,341    5.63    45,096    4.38    43,033    4.34    37,452    3.76    40,433    4.38 
Total adjustable-rate loans   409,040    37.56    371,764    36.14    349,909    35.27    332,220    33.37    367,317    39.85 
                                                   
Total loans receivable, gross   1,089,386    100.00%   1,028,528    100.00%   992,095    100.00%   995,675    100.00%   921,650    100.00%
                                                   
Undisbursed loans in process   (7,432)        (9,285)        (13,346)        (7,418)        (5,352)     
Unamortized deferred loan costs, net   4,882         3,583         2,517         2,432         2,418      
Allowance for loan losses   (12,641)        (13,168)        (13,412)        (16,038)        (16,815)     
Total loans receivable, net  $1,074,195        $1,009,658        $967,854        $974,651        $901,901      

 

 

(1) Includes loans held for sale of $6.0 million.

(2) Includes loans held for sale of $6.1 million.

(3) Includes loans held for sale of $1.9 million.

(4) Includes loans held for sale of $5.1 million.

(5) Includes loans held for sale of $1.4 million.

 

 9 

 

 

The following schedule illustrates the contractual maturity of our loan portfolio at December 31, 2015. Mortgages that have adjustable or renegotiable interest rates are shown as maturing in the period during which the contract is due. The total amount of loans due after December 31, 2016 that have predetermined interest rates is $645.2 million, and the total amount of loans due after such date which have floating or adjustable interest rates is $342.8 million. The schedule does not reflect the effects of possible prepayments or enforcement of due-on-sale clauses.

 

   Real Estate                         
   Consumer Closed
End First
Mortgage(1)
   Consumer Open
End
and Junior Liens
   Commercial   Construction and
Development
   Consumer   Commercial
Business
   Total 
   Amount   Weighted
Average
Rate
   Amount   Weighted
Average
Rate
   Amount   Weighted
Average
Rate
   Amount   Weighted
Average
Rate
   Amount   Weighted
Average
Rate
   Amount   Weighted
Average
Rate
   Amount   Weighted
Average
Rate
 
   (Dollars in thousands) 
Due During Years Ending December 31,                                                                      
2016(2)  $4,991    4.00%  $713    5.90%  $29,434    4.77%  $7,718    4.08%  $2,774    7.24%  $49,783    3.92%  $95,413    4.31%
2017   1,092    4.54    610    6.56    15,677    4.79    2,658    3.56    2,550    6.61    3,847    4.75    26,434    4.87 
2018   2,467    4.37    453    6.40    18,005    4.65    766    4.47    4,823    5.74    14,592    3.41    41,106    4.34 
2019 and 2020   11,161    4.07    2,386    6.09    20,734    4.70    1,711    3.52    18,305    5.42    29,765    3.89    84,062    4.50 
2021 and 2022   19,862    3.43    3,666    5.76    8,047    4.79    357    5.75    11,206    6.76    11,532    4.47    54,670    4.70 
2023 to 2037   304,863    3.65    63,162    4.13    126,042    4.45    2,534    4.79    105,614    6.14    13,011    4.67    615,226    4.32 
2038 and following   147,015    4.13    -    -    18,956    3.71    -    -    -    -    513    5.84    166,484    4.09 
Total  $491,451    3.80%  $70,990    4.33%  $236,895    4.50%  $15,744    4.10%  $145,272    6.11%  $123,043    3.99%  $1,083,395    4.33%

 

 

(1) Does not include mortgage loans held for sale.

(2) Includes demand loans, loans having no stated maturity and overdraft loans.

 

 10 

 

 

Consumer Closed End First Mortgages. We originate loans secured by first mortgages on owner-occupied, one- to four-family residences in our market areas for purchase, refinance, home equity and construction purposes. At December 31, 2015, these loans totaled $497.4 million, or 45.7% of our gross loan portfolio.

 

We generally underwrite and document our one- to four-family loans based on the loan applicant’s employment and credit history and the appraised value of the subject property, consistent with secondary market standards or other prudent underwriting guidelines. For loans with a loan-to-value ratio in excess of 80%, we generally require private mortgage insurance to reduce our exposure to below 80%. Properties securing our one- to four-family loans are appraised or evaluated consistent with regulatory requirements and prudent lending principles. Origination and servicing practices include perfection of our lien position and appropriate monitoring of insurance and tax payments.

 

We generally underwrite and document our one- to four-family first lien position home equity loans based on the loan applicant's employment, credit history and the appraised value of the subject property, consistent with prudent underwriting guidelines.  Nearly all first lien home equity loans have a loan-to-value maximum of 80% of value at origination.  Exceptions would be limited to work-out loan circumstances.  Properties securing our one- to four-family loans are appraised or evalutated consistent with regulatory requirements and prudent lending principles.

 

We originate consumer first mortgage one- to four-family loans on either a fixed- or adjustable-rate basis, and generally maintain a tax or insurance escrow account for these loans. Our pricing strategy for mortgage loans includes setting interest rates that are competitive with the secondary market and other local financial institutions and are consistent with our internal needs. Adjustable-rate mortgage or ARM loans are offered with initial fixed rate terms between one and 10 years. After the initial period, the interest rate for each ARM loan adjusts annually for the remainder of the term of the loan using a margin over the standard one-year treasury index. During fiscal 2015, we originated $11.4 million of one- to four-family ARM loans and $204.4 million of one- to four-family fixed-rate mortgage loans. By way of comparison, during fiscal 2014, we originated $18.2 million of one- to four-family ARM loans and $114.2 million of one- to four-family fixed-rate mortgage loans.

 

Fixed-rate loans secured by one- to four-family residences have contractual maturities of up to 30 years and are generally fully amortizing, with payments due monthly. A majority of loans with fixed-rate maturities in excess of 15 years are sold on the secondary market. Some loans are retained if their terms meet current portfolio needs consistent with balance sheet objectives. These retained loans normally remain outstanding, however, for a substantially shorter period of time because of home sales, refinancing and other prepayments. A significant change in interest rates could alter considerably the average life of a residential loan in our portfolio. Our one- to four-family loans are generally not assumable, do not contain prepayment penalties and do not permit negative amortization of principal. Most are written using underwriting guidelines that make them readily saleable in the secondary market. At December 31, 2015, our fixed-rate one- to four-family mortgage loan portfolio totaled $381.4 million, or 35.0% of our gross loan portfolio.

 

 11 

 

 

Our one- to four-family residential ARM loans are fully amortizing loans with contractual maturities of up to 30 years, with payments due monthly. Our ARM loans generally provide for specific minimum and maximum interest rates, with a lifetime cap and floor, and a periodic adjustment on the interest rate over the rate in effect on the date of origination. As a consequence of using caps, the interest rates on these loans may not be as rate sensitive as our cost of funds. In order to remain competitive in our market areas, we sometimes originate ARM loans at initial rates below the fully indexed rate. ARM loans generally pose different credit risks than fixed-rate loans, primarily because as interest rates rise, the borrower’s required payments increase, which may increase the potential for default. Our payment history for ARM loans has not been substantially different from fixed rate loans. See “Asset Quality - Non-performing Assets” and “Classified Assets.” At December 31, 2015, our one- to four-family ARM loan portfolio totaled $116.1 million, or 10.7% of our gross loan portfolio.

 

Construction-permanent loans on one- to four-family residential properties are obtained through referral business with builders, from walk-in customers and through referrals from realtors and architects. The applicant must submit complete plans, specifications and costs of the project to be constructed, which, along with an independent appraisal, are used to determine the value of the subject property. Loans are based on the lesser of the current appraised value and/or the cost of construction, including the land and the building. We generally conduct regular inspections of the construction project being financed. Residential construction loans are done with one closing for both the construction period and the long-term financing. Loans are generally granted with a construction period between six and 12 months. During the construction phase, the borrower generally pays interest only on a monthly basis, and the loan is automatically converted to amortizing payments upon completion of the construction. Single family construction loans with loan-to-value ratios over 80% usually require private mortgage insurance.

 

Consumer Open End and Junior Liens. At December 31, 2015, our consumer loans on residential properties, including home equity lines of credit and subordinate home improvement loans, totaled $71.0 million, or 6.5% of our gross loan portfolio. These loans may be originated in amounts, together with the amount of the existing first mortgage, of up to 100% of the value of the property securing the loan. The term to maturity on our home equity and home improvement loans may be up to 15 years. Most home equity lines of credit have a maximum term to maturity of 20 years and require a minimum monthly payment based on the outstanding loan balance per month, which amount may be re-borrowed at any time. A limited number of home equity lines of credit are approved with monthly payments of accrued interest only. Other consumer loan terms vary according to the type of collateral, length of contract and creditworthiness of the borrower.

 

 12 

 

 

Commercial Real Estate Lending. We offer a variety of commercial real estate (CRE) loans for acquisition and renovation. These loans are secured by the real estate and improvements financed, and the collateral ranges from industrial and commercial buildings to churches, office buildings and multi-family housing complexes. We also have a limited amount of farm loans. At December 31, 2015, commercial real estate loans, including multi-family, totaled $236.9 million, or 21.8% of our gross loan portfolio.

 

Our loans secured by commercial real estate are originated with either a fixed or adjustable interest rate. The interest rate on adjustable-rate loans is based on a variety of indices, generally determined through negotiation with the borrower. Loan-to-value ratios on our commercial real estate loans typically do not exceed 80% of the appraised value, as of origination, of the property securing the loan. These loans typically require monthly payments, may not be fully amortizing and generally have maximum amortizations of 20 years. Loans with amortizations over 20 years require and loan-to-value ratio of 75% or less.

 

Loans secured by commercial real estate are underwritten based on the income-producing potential of the property and the financial strength of the borrower. For income-producing properties, net operating income must be sufficient to cover the payments related to the outstanding debt. Owner-occupied CRE loans are underwritten based on the borrower’s ability to generate cash flow sufficient to repay the loan. We may require personal guarantees of the borrowers in addition to the real estate as collateral for such loans. We also generally require an assignment of rents or leases in order to be assured that the cash flow from the real estate can be used to repay the debt. Appraisals on properties securing commercial real estate loans are performed by qualified independent appraisers approved by MutualBank’s Board of Directors, consistent with regulatory requirements. See “Loan Originations, Purchases, Sales and Repayments” in this Item 1. In order to monitor the adequacy of cash flows on CRE loans, the borrower is required to provide periodic financial information for loans in excess of $250,000.

 

Loans secured by commercial real estate are generally larger and involve a greater degree of credit risk than one- to four-family residential mortgage loans. Commercial real estate loans typically involve large balances to single borrowers or groups of related borrowers. Because payments on loans secured by commercial real estate are often dependent on the successful operation or management of the properties, repayment of such loans may be subject to adverse conditions in the real estate market or the economy. If the cash flow from the project is reduced, or if leases are not obtained or renewed, the borrower’s ability to repay the loan may be impaired. See “Asset Quality - Non-performing Assets” in this Item 1.

 

Construction and Development Lending. MutualBank makes a variety of commercial loans for the purpose of construction or development of commercial real estate.

 

Existing residential development loans are typically provided on property located within our market areas and are granted to developers and builders with previous borrowing experience with MutualBank. Financing of a development may include funding of land acquisition and development costs for lots as well as individual construction loans for speculative or pre-sold homes. New activity in residential development and construction lending has been limited by economic conditions for the past several years. We also provide construction-permanent financing for owner-occupied commercial properties for our business customers in our market areas as well as some income-producing property to established borrowers. We have a limited number of commercial real estate development loans. At December 31, 2015, we had $15.7 million in construction and development loans outstanding, representing 1.5% of our gross loan portfolio.

 

 13 

 

 

Loans financing land development may include funding the acquisition of the land, the infrastructure and lot sales. Development loans are secured by real estate and repaid through proceeds from the sale of lots. The maximum loan amount should not exceed 75% of the appraised value and projected lot sales should show full payout within 24-36 months of each phase being financed. Where the development loan is to be repaid through lot sales to third parties, the loan should be paid in full when no more than 80% of the lots in the phase or development are sold. Release payments should not be less than 85% of the net sales proceeds, or 125% of the original committed amount per lot, whichever is greater.

 

Construction financing must be supported by prints and specs, and an appraisal by an approved appraiser. Construction draws must be supported by a detailed list of work completed, and where appropriate, lien waivers from all contractors. All construction loans should have a maturity date with a written end financing commitment. We also provide end financing to qualified borrowers. Our maximum advance on residential pre-sold and owner occupied commercial loans is 80% of appraised value.

 

Because of the uncertainties inherent in estimating construction and development costs and the market for the project upon completion, there is risk inherent in the accuracy of estimated total loan funds required to complete a project, the related loan-to-value ratios and the likelihood of ultimate success of the project. These loans also involve many of the same risks discussed above regarding commercial real estate loans and tend to be more sensitive to general economic conditions than many other types of loans. Economic conditions in our market areas over the past few years could cause borrowers to be unable to repay development loans due to reduced ability to market the properties consistent with original pro-forma estimates. However, we have seen stabilization in our markets which is reflected in the continued decrease in non-performing assets.

 

Other Consumer Lending. Consumer loans, other than those secured by real estate, generally have shorter terms to maturity and carry higher rates of interest than residential mortgage loans. This reduces our exposure to interest rate risk on these loans. In addition, consumer loan products help to expand and create stronger ties to our customer base by increasing the number of customer relationships and providing cross-marketing opportunities. We offer a variety of secured consumer loans, including auto, boat and recreational vehicle loans, and loans secured by savings deposits. We also offer credit cards and unsecured consumer loans. We originate consumer loans both in our market area through our financial centers and throughout Indiana as well as making consumer loans to customers residing in contiguous states through our indirect lending program. We employ credit scoring models for these types of consumer loan applications. These models evaluate credit and application attributes, with a review of the borrower’s employment and credit history and an assessment of the borrower’s ability to repay the loan. Consumer loans may entail greater risk than one- to four-family residential mortgage loans, especially consumer loans secured by rapidly depreciable assets, such as automobiles, boats and recreational vehicles. In these cases, any repossessed collateral for a defaulted loan may not provide an adequate source of repayment of the outstanding loan balance. As a result, consumer loan collections are dependent on the borrower’s continuing financial stability and, thus, are more likely to be adversely affected by economic downturn, job loss, divorce, illness or personal bankruptcy. At December 31, 2015, our consumer loan portfolio totaled $145.3 million, or 13.3% of our gross loan portfolio.

 

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At December 31, 2015, auto loans totaled $15.5 million, or 1.4% of our gross loan portfolio. Auto loans may be written for up to six years and usually have a fixed rate of interest. Loan-to-value ratios are up to 100% of the MSRP or 120% of invoice for new autos and 110% of value on used cars, based on valuation from official used car guides. Loans for boats and recreational vehicles totaled $123.6 million at December 31, 2015, or 11.4% of our gross loan portfolio. Approximately $118.8 million of other consumer loans at December 31, 2015 had been originated indirectly through dealers and retailers. We generally buy indirect auto, boat and recreational vehicle loans on a rate basis, paying the dealer a cash payment for loans with an interest rate in excess of the rate we require. This premium is amortized over the remaining life of the loan. As specified in written agreements with these dealers, prepayments or delinquencies are charged to future amounts owed to that dealer, with no dealer reserve or other guarantee of payment if the dealer stops doing business with us.

 

Commercial Business Lending. At December 31, 2015, commercial business loans totaled $123 million, or 11.3% of our gross loan portfolio. Most of our commercial business loans have been extended to finance businesses in our market area. Credit accommodations extended include lines of credit for working capital needs, term loans to purchase capital goods and real estate, development lending to foster residential, business and community growth and agricultural lending for inventory and equipment financing.

 

Our commercial business lending policy includes credit file documentation and analysis of the borrower’s background, capacity to repay the loan, the adequacy of the borrower’s capital and collateral as well as an evaluation of other conditions affecting the borrower. Analysis of the borrower’s past, present and future cash flows also is an important aspect of our credit analysis. We may obtain personal guarantees on our commercial business loans. Nonetheless, these loans are believed to carry higher credit risk than residential loans. Unlike residential mortgage loans, commercial business loans are typically made on the basis of the borrower’s ability to make repayment from the cash flow of the borrower’s business. As a result, the availability of funds for the repayment of commercial business loans may substantially depend on the success of the business itself (which, in turn, often depends in part upon general economic conditions). Our commercial business loans are usually secured by business assets. However, the collateral securing the loans may depreciate over time, may be difficult to appraise and may fluctuate in value based on the success of the business.

 

The terms of loans extended on the security of machinery and equipment are based on the projected useful life of the machinery and equipment, generally not to exceed seven years. Lines of credit generally are available to borrowers for up to 12 months, and may be renewed by us after an annual review of current financial information.

 

 15 

 

 

We issue a few financial-based standby letters of credit which are offered at competitive rates and terms and are generally on a secured basis. We continue to expand our volume of commercial business loans.

 

Loan Originations, Purchases, Sales and Repayments. We originate loans through referrals from real estate brokers and builders, our marketing efforts, our existing and walk-in customers, and through our subsidiary, Summit Mortgage, Inc. Historically, we have originated many of our non-real estate consumer loans through relationships with dealerships. While we originate adjustable-rate and fixed-rate loans, our ability to originate loans depends upon customer demand for loans in our market areas. Demand is affected by local competition and the interest rate environment. During the last several years, due to low market rates of interest, our dollar volume of fixed-rate, one- to four-family loans has exceeded the dollar volume of the same type of adjustable-rate loans. As part of our interest rate risk management efforts, we typically sell our fixed rate, one- to four-family residential loans, with terms exceeding 15 years, on the secondary market. We have occasionally purchased adjustable rate one- to four-family residential and commercial real estate loans.

 

In periods of economic uncertainty, the ability of financial institutions, including us, to originate or purchase large dollar volumes of loans may be substantially reduced or restricted, with a resultant decrease in interest income.

 

The Company originates consumer loans in Indiana and contiguous states through our indirect lending program. The indirect lending consumer portfolio consists of loans for autos, boats and recreational vehicles.

 

During the year ended December 31, 2015, we sold $145.4 million of one- to four-family mortgage loans on the secondary market to FHLMC, Federal Home Loan Bank of Indianapolis (“FHLBI”) and other investors. As part of our interest rate risk management, the Company chose to sell these loans and recognized a gain on sale of $4.2 million.

 

 16 

 

 

The following table shows our loan origination, purchase, sale and repayment activities for the years indicated.

 

   Year Ended December 31, 
   2015   2014   2013 
   (Dollars in thousands) 
Originations by type               
Adjustable rate               
Real estate               
Commercial  $28,565   $19,047   $13,980 
Commercial construction and development   1,505    798    - 
Consumer closed end first mortgage   11,372    18,222    15,876 
Consumer open end and junior liens   15,512    14,556    11,861 
Non-real-estate               
Consumer   1,047    40    271 
Commercial and industrial   5,767    2,719    3,602 
Total adjustable-rate   63,768    55,382    45,590 
Fixed Rate               
Real estate               
Commercial   3,201    9,998    8,454 
Commercial construction and development   1,000    697    931 
Consumer closed end first mortgage   204,393    114,212    140,863 
Consumer open end and junior liens   3,891    2,884    4,023 
Non-real-estate               
Consumer   67,117    49,062    36,091 
Commercial and industrial   26,870    15,985    6,677 
Total fixed-rate   306,472    192,838    197,039 
Total loans originated   370,240    248,220    242,629 
                
Purchases               
Real estate               
Consumer closed end first mortgage   144    1,653    - 
Total loans purchased   144    1,653    - 
                
Total additions   370,384    249,873    242,629 
                
Sales and Repayments               
Sales               
Real estate               
Consumer closed end first mortgage   145,437    62,765    70,541 
Total loans sold   145,437    62,765    70,541 
                
Principal repayments   162,342    146,368    177,426 
                
Total reductions   307,779    209,133    247,967 
                
Increase (decrease) in other items, net   2,081    (3,188)   1,758 
                
Net increase (decrease)  $64,686   $37,552   $(3,580)

 

 17 

 

 

Asset Quality

 

Collection Procedures. When a borrower fails to make a payment on a mortgage loan on or before the default date, a late charge and delinquency notice is mailed. All delinquent accounts are reviewed by a loss mitigation counselor, who attempts to cure the delinquency by contacting the borrower once the loan is 30 days past due. If the loan becomes 30 days delinquent, the loss mitigation counselor will generally contact the borrower by phone or send a letter to the borrower in order to identify the reason for the delinquency. Once the loan becomes 60 days delinquent, the borrower is asked to pay the delinquent amount in full, or establish an acceptable repayment plan to bring the loan current. Prior to foreclosure, a drive-by inspection is made to determine the condition of the property. If the account becomes 120 days delinquent, and an acceptable repayment plan has not been agreed upon, a collection officer will generally refer the account to legal counsel, with instructions to prepare a notice of intent to foreclose. The notice of intent to foreclose allows the borrower up to 30 days to bring the account current. During this 30-day period, the loss mitigation counselor may accept a repayment plan from the borrower that would bring the account current prior to foreclosure.

 

For consumer loans, a similar collection process is followed, with the initial written contact being made once the loan is 20 days past due.

 

Commercial loan relationships exceeding $250,000 are reviewed on a regular basis by the commercial credit department.  Larger relationships are monitored through a system of internal and external loan review.  All relationships that are deemed to warrant special attention are monitored at least quarterly.  Individual commercial officers maintain communication with borrowers and recommend action plans to a Loan Quality Review committee which meets monthly to discuss credits graded Special Mention or worse.  The Asset Classification committee meets quarterly and establishes specific allocations, based on appraisals or discounted cash flow analysis, for relationships that are deemed to be under-collateralized and at risk of non-payment.  Collection and loss mitigation efforts are a cooperative effort between the Commercial Loan Department and the Risk Management Division.

 

 18 

 

 

Delinquent Loans. The following table sets forth, as of December 31, 2015, the amounts and categories of delinquent loans that were still accruing interest.

 

   Accruing Loans Delinquent For 
   30 to 59 Days   60 to 89 Days 
   (Dollars in thousands) 
Real estate          
Commercial  $922   $20 
Commercial construction and development   -    - 
Consumer closed end first mortgage   6,921    1,143 
Consumer open end and junior liens   296    171 
Consumer loans   1,303    116 
Commercial and industrial   192    383 
Total  $9,634   $1,833 
Total as a percent of total loans   0.9%   0.2%

 

Non-performing Assets. The table below sets forth the amounts and categories of non-performing assets in our loan portfolio at the dates indicated. Generally, loans are placed on non-accrual status when the loan becomes more than 90 days delinquent or sooner when collection of interest becomes doubtful. At December 31, 2015, we had troubled debt restructurings totaling $6.2 million, $2.1 million of which were included in non-accruing loans. Troubled debt restructurings involve forgiving a portion of interest or principal or making other adjustments to assist a borrower who is unable to meet the original terms of the loan. These restructurings are included in non-accruing loans until they perform according to the modified terms for six months. Then, if continued payments under the modified terms are deemed probable, and it is anticipated all principal will be recovered, they are removed from non-accrual status. Foreclosed assets include assets acquired in settlement of loans.

 

 19 

 

 

   December 31, 
   2015   2014   2013   2012   2011 
   (Dollars in thousands) 
Non-accruing loans(1):                         
Real estate:                         
Commercial real estate  $2,356   $2,023   $1,349   $2,450   $7,592 
Commercial construction and development   -    209    1,103    5,989    9,314 
Consumer closed end first mortgage   3,592    3,499    4,057    11,030    10,433 
Consumer open end and junior liens   783    658    421    1,396    1,087 
Total real estate loans   6,731    6,389    6,930    20,865    28,426 
                          
Other loans:                         
Consumer   148    218    361    1,230    1,125 
Commercial and industrial   25    605    1,109    1,315    1,160 
Total other loans   173    823    1,470    2,545    2,285 
Total non-accruing loans   6,904    7,212    8,400    23,410    30,711 
                          
Accruing loans delinquent 90 days or more:                         
Real estate:                         
Consumer closed end first mortgage   267    226    175    177    1,127 
Consumer open end and junior liens   -    -    13    96    - 
Total   267    226    188    273    1,127 
                          
Total nonperforming loans   7,171    7,438    8,588    23,683    31,838 
                          
Foreclosed assets:                         
Real estate:                         
Commercial real estate   62    1,366    2,477    1,138    2,003 
Construction and development   974    34    1,699    50    97 
Consumer closed end first mortgage   906    1,429    3,974    5,757    4,426 
Other loans:                         
Consumer   513    476    283    755    849 
Commercial business   -    -    -    -    17 
Total foreclosed assets   2,455    3,305    8,433    7,700    7,392 
                          
Total non-performing assets  $9,626   $10,743   $17,021   $31,383   $39,230 
Total as a percentage of total assets   0.65%   0.75%   1.22%   2.21%   2.75%

 

 

(1) Includes non-performing troubled debt restructurings.

 

For the year ended December 31, 2015, gross interest income that would have been recorded had these non-accruing loans been current in accordance with their original terms amounted to $363,000. The amount included in interest income on these loans for the year ended December 31, 2015, was $183,000.

 

See Item 7 –“ Management’s Discussion and Analysis of Financial Condition and Results of Operation - Financial Condition at December 31, 2015 Compared to December 31, 2014 - Delinquencies and Non-performing Assets” for more information on our nonperforming assets.

 

Other Loans of Concern. In addition to the non-performing assets set forth in the table above, as of December 31, 2015, there was an aggregate of $4.9 million of loans with respect to which known information about the possible credit problems of the borrowers has caused management to have doubts as to the ability of the borrowers to comply with present loan repayment terms, which may result in the future inclusion of such loans in the non-performing asset categories. These loans have been considered in management’s determination of the adequacy of our allowance for loan losses. Management reviews each of these relationships at least quarterly to determine if further downgrades and specific loan loss allocations are prudent. This amount includes nine commercial real estate loans totaling $4.3 million, two construction and development loans totaling $594,000, and one commercial business loan totaling $13,000.

 

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Classified Assets. Our regulators require that we classify loans and other assets, such as debt and equity securities considered to be of lesser quality, as “substandard,” “doubtful” or “loss.” An asset is considered “substandard” if it is inadequately protected by the current net worth and paying capacity of the obligor or of the collateral pledged, if any. “Substandard” assets include those characterized by the “distinct possibility” that the insured institution will sustain “some loss” if the deficiencies are not corrected. Assets classified as “doubtful” have all of the weaknesses inherent in those classified “substandard,” with the added characteristic that the weaknesses present make “collection or liquidation in full,” on the basis of currently existing facts, conditions, and values, “highly questionable and improbable.” Assets classified as “loss” are those considered “uncollectible” and of such little value that their continuance as assets without the establishment of a specific loss reserve is not warranted.

 

When an insured institution classifies problem assets as either substandard or doubtful, it may establish general allowances for loan losses in an amount deemed prudent by management and approved by the board of directors. General allowances represent loss allowances that have been established to recognize the inherent risk associated with lending activities, but which, unlike specific allowances, have not been allocated to particular problem assets. When an insured institution classifies problem assets as “loss,” it is required either to establish a specific allowance for losses equal to 100% of that portion of the asset so classified or to charge off such amount. Our determination as to the classification of our assets and the amount of our valuation allowances is subject to review by our regulators, which may order the establishment of additional general or specific loss allowances.

 

In connection with the filing of the Bank’s periodic reports with the FDIC and in accordance with our classification of assets policy, we regularly review the problem assets in our portfolio to determine whether any assets require classification in accordance with applicable regulations. On the basis of management’s review, at December 31, 2015, we had classified $17.4 million of the Bank’s assets as substandard or doubtful; $2.5 million in other real estate owned and repossessed assets, $14.9 million in substandard loans. The total amount classified represented 12.6% of our stockholders’ equity and 1.2% of our assets at December 31, 2015, compared to 20.6% and 1.8%, respectively, at December 31, 2014.

 

Provision for Loan Losses. We recorded a provision for loan losses during the year ended December 31, 2015 of $125,000, compared to $850,000 for the year ended December 31, 2014 and $1.3 million for the year ended December 31, 2013. The provision for loan losses continued to decrease in 2015 due to decreases in our non-performing and troubled loans, which warranted a decrease in our allowance for loan losses. Net charge-offs decreased to $652,000 in 2015 compared to $1.1 million in 2014. The provision for loan losses is charged to income to bring our allowance for loan losses to a level deemed appropriate by management based on the factors discussed below under “Allowance for Loan Losses.”

 

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Allowance for Loan Losses. We maintain an allowance for loan losses to absorb losses inherent in the loan portfolio. The allowance is based on ongoing, quarterly assessments of the estimated losses inherent in the loan portfolio. Our methodology for assessing the appropriateness of the allowance consists of several key elements, including the general allowance and specific allowances for identified problem loans and portfolio segments. In addition, the allowance incorporates the results of measuring impaired loans as provided in FASB ASC 310, Receivables. These accounting standards prescribe the measurement methods, income recognition and disclosures related to impaired loans. See Note 5 of the Notes to Consolidated Financial Statements contained in Item 8.

 

The general allowance is calculated by applying loss factors to outstanding loans based on the internal risk evaluation of such loans or pools of loans. Changes in risk evaluations of both performing and nonperforming loans affect the amount of the general allowance. Loss factors are based on our historical loss experience as well as on significant factors that, in management’s judgment, affect the collectibility of the portfolio as of the evaluation date.

 

The appropriateness of the allowance is reviewed by management based upon its evaluation of then-existing economic and business conditions affecting our key lending areas and other conditions, such as credit quality trends (including trends in non-performing loans expected to result from existing conditions), collateral values, loan volumes and concentrations, specific industry conditions within portfolio segments and recent loss experience in particular segments of the portfolio that existed as of the balance sheet date and the impact that such conditions were believed to have had on the collectibility of the loan. Senior management reviews these conditions quarterly in discussions with our senior credit officers. To the extent that any of these conditions is evidenced by a specifically identifiable problem credit or portfolio segment as of the evaluation date, management’s estimate of the effect of such condition may be reflected as a specific allowance applicable to such credit or portfolio segment. Where any of these conditions is not evidenced by a specifically identifiable problem credit or portfolio segment as of the evaluation date, management’s evaluation of the loss related to this condition is reflected in the general allowance for loan losses. The evaluation of the inherent loss with respect to these conditions is subject to a higher degree of uncertainty because they are not identified with specific problem credits or portfolio segments.

 

The allowance for loan losses is based on estimates of losses inherent in the loan portfolio. Actual losses can vary significantly from the estimated amounts. Our methodology, as described, permits adjustments to any loss factor used in the computation of the general allowance in the event that, in management’s judgment, significant factors which affect the collectibility of the portfolio as of the evaluation date are not reflected in the loss factors. By assessing the probable incurred losses inherent in the loan portfolio on a quarterly basis, we are able to adjust specific and inherent loss estimates based upon any more recent information that has become available. Although the economy is stabilizing in the communities we serve and unemployment rates have improved compared to recent years, management has concluded that our allowance for loan losses should be greater than historical loss experience and specifically identified losses might otherwise indicate. This is while we continue to wait for the market to fully recover and partially due to the increase in higher risk loans like consumer and commercial, as a percentage of total loans.

  

At December 31, 2015, our allowance for loan losses was $12.6 million, or 1.2% of the total loan portfolio, and approximately 176.3% of total non-performing loans. Our allowance for loan losses balance decreased 4.0% from December 31, 2014. Assessing the adequacy of the allowance for loan losses is inherently subjective as it requires making material estimates, including the amount and timing of future cash flows expected to be received on impaired loans that are susceptible to significant change. In the opinion of management, the allowance, when taken as a whole, is adequate to absorb reasonable estimated loan losses inherent in our loan portfolio.

 

 22 

 

 

The following table sets forth an analysis of our allowance for loan losses.

 

   December 31, 
   2015   2014   2013   2012   2011 
   (Dollars in thousands) 
Balance at beginning of period  $13,168   $13,412   $16,038   $16,815   $16,372 
                          
Charge-offs:                         
Commercial   104    289    2,713    4,493    8,260 
Mortgage   643    572    886    1,901    3,432 
Consumer   640    1,021    940    1,608    2,126 
Total charge-offs   1,387    1,882    4,539    8,002    13,818 
                          
Recoveries:                         
Commercial   498    499    69    586    146 
Mortgage   34    31    273    239    274 
Consumer   203    258    271    375    741 
Total recoveries   735    788    613    1,200    1,161 
                          
Net charge-offs   652    1,094    3,926    6,802    12,657 
Provisions charged to operations   125    850    1,300    6,025    13,100 
Balance at end of period  $12,641   $13,168   $13,412   $16,038   $16,815 
                          
Ratio of net charge-offs during the period to average loans outstanding during the period   0.06%   0.11%   0.40%   0.71%   1.31%
                          
Allowance as a percentage of non-performing loans   176.28%   177.04%   156.15%   67.72%   52.81%
                          
Allowance as a percentage of total loans (end of period)   1.17%   1.30%   1.37%   1.63%   1.83%

 

Investment Activities

 

MutualBank may invest in various types of liquid assets, including United States Treasury obligations, securities of various federal agencies, including callable agency securities, certain certificates of deposit of insured banks and savings institutions, certain bankers’ acceptances, repurchase agreements and federal funds. It also may invest in investment grade commercial paper and corporate debt securities and certain mutual funds.

 

The Chief Financial Officer is responsible for the management of our investment portfolio, subject to the direction and guidance of the Asset and Liability Management Committee and the Board of Directors. The Chief Financial Officer considers various factors when making decisions, including the marketability, maturity and tax consequences of the proposed investment. The maturity structure of investments will be affected by various market conditions, including the current and anticipated slope of the yield curve, the level of interest rates, the trend of new deposit inflows, and the anticipated demand for funds via deposit withdrawals and loan originations and purchases.

 

 23 

 

 

The objectives of our investment portfolio are to provide liquidity when loan demand is high, to assist in maintaining earnings when loan demand is low and to maximize earnings while satisfactorily managing risk, including credit risk, reinvestment risk, liquidity risk and interest rate risk. See “Item 7A - Quantitative and Qualitative Disclosures About Market Risk”.

 

Our investment securities currently consist of U.S. Agency securities, mortgage-backed securities, collateralized mortgage obligations, municipal securities and corporate obligations. Our mortgage-backed securities portfolio currently consists of securities issued under government-sponsored agency programs. See Note 4 of the Notes to Consolidated Financial Statements contained in Item 8.

 

While mortgage-backed securities carry a reduced credit risk as compared to whole loans, these securities remain subject to the risk that a fluctuating interest rate environment, along with other factors like the geographic distribution of the underlying mortgage loans, may alter the prepayment rate of the mortgage loans and affect both the prepayment speed and value of the securities.

 

Although the Bank has not had a trading portfolio in recent history, we are permitted by the Board of Directors to have a trading portfolio of up to $5.0 million and to trade up to $2.0 million in these securities at any one time. At December 31, 2015, however, we did not have a trading portfolio. See Note 4 of the Notes to Consolidated Financial Statements contained in Item 8.

 

A majority of MutualBank’s investment portfolio is under the management of its wholly owned subsidiary, Mutual Federal Investment Company. Mutual Federal Investment Company, a Nevada corporation, holds, services, manages and invests that portion of the Bank’s investment portfolio as may be transferred from time to time by the Bank to Mutual Federal Investment Company. Mutual Federal Investment Company’s investment policy, for the most part, mirrors that of the Bank. Mutual Federal Investment Company has hired a third party investment advisor to manage its securities portfolio, subject to the oversight of their Board of Directors. At December 31, 2015, MutualBank had $261.1 million in consolidated investment securities. The portfolio is comprised of available for sale securities. At that date, Mutual Federal Investment Company managed $242.5 million of the total available for sale portfolio.

 

The following table sets forth the composition of our investment and mortgage-related securities portfolio and our other investments at the dates indicated. As of December 31, 2015, our investment securities portfolio did not contain securities of any issuer with an aggregate book value in excess of 10% of our equity capital, excluding those issued by the United States Government, its agencies or government sponsored entities.

 

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   December 31, 
   2015   2014   2013 
   Amortized
Cost
   Fair
Value
   Amortized
Cost
   Fair
Value
   Amortized
Cost
   Fair
Value
 
   (Dollars in thousands) 
Investment securities available for sale:                              
Mortgage-backed securities  $106,524   $107,838   $110,452   $113,290   $104,006   $103,517 
Collateralized mortgage obligations   84,976    84,652    97,325    97,759    108,305    107,578 
Federal agencies   -    -    -    -    5,005    4,774 
Municipal obligations   54,427    57,188    27,250    29,256    27,357    27,338 
Corporate obligations   12,805    11,460    21,763    20,501    24,648    21,141 
Total securities available for sale   258,732    261,138    256,790    260,806    269,321    264,348 
                               
Investment in limited partnerships   427    N/A    1,582    N/A    2,092    N/A 
Federal Home Loan Bank stock   10,482    N/A    11,964    N/A    14,391    N/A 
Total investments  $269,641   $261,138   $270,336   $260,806   $285,804   $264,348 

 

The following table indicates, as of December 31, 2015, the composition and contractual maturities of our investment securities, excluding Federal Home Loan Bank (“FHLB”) stock.

 

   Due In         
   Less Than
1 year
   1 to 5
Years
   5 to 10
Years
   Over
10 Years
   Total
Investment Securities
 
   Amortized   Amortized   Amortized   Amortized   Amortized   Fair 
   Cost   Cost   Cost   Cost   Cost   Value 
   (Dollars in thousands) 
Available for sale:                              
Mortgage-backed securities  $-   $77   $11,600   $94,847   $106,524   $107,838 
Collateralized mortgage obligations   -    -    -    84,976    84,976    84,652 
Municipal obligations   -    1,003    1,489    51,935    54,427    57,188 
Corporate obligations   -    9,000    -    3,805    12,805    11,460 
   $-   $10,080   $13,089   $235,563   $258,732   $261,138 
                               
Weighted average yield   -%   1.83%   3.53%   2.71%   2.72%     

 

MutualBank routinely conducts reviews to identify and evaluate each investment security to determine if any other-than-temporary impairment (“OTTI”) has occurred. During the years ended December 31, 2015, 2014 and 2013 we did not recognize any OTTI on our investments. No securities in the portfolio were non-performing as of December 31, 2015. The remaining two trust preferred securities were priced using a discounted cash flow analysis as of December 31, 2015.

 

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Pooled Trust Preferred Securities. The Company has invested in pooled trust preferred securities. At December 31, 2015, the current par balance of our pooled trust preferred securities was $3.8 million. The original par value of these securities was $4.0 million prior to the OTTI write-downs in 2011 and earlier, based on valuations by a third party. OTTI taken on trust preferred securities prior to 2015 was the result of deterioration in the performance of the underlying collateral. The deterioration was the result of increased defaults and deferrals of dividend payments in the current year, creating credit impairment along with weakening financial performance of performing collateral, increasing the risk of future deferrals of dividends and defaults. No additional OTTI was determined in 2015. All pooled trust preferred securities owned by the Bank are exempt from the Volcker Rule.

 

The following table provides additional information related to the Bank’s investment in trust preferred securities as of December 31, 2015.

 

Deal Name  Class  Original
Par
   Book Value   Fair Value   Unrealized
Loss
   Realized
Losses
2015
   Lowest
Ratings
  Number of
Banks /
Insurance
Cos.
Currently
Performing
   Total
Number
of Banks
and
Insurance
Cos. In
Issuance
(Unique)
   Actual
Deferrals/
Defaults
(as a % of
original
collateral)
   Total
Projected
Defaults
 (as a % of
performing
collateral)
(1)
   Excess
subordination
(after taking
into account
best estimate
of future
deferrals/
 defaults) (2)
 
   (Dollars in Thousands)
Alesco Preferred Funding IX  A2A  $1,000   $914   $548   $(366)  $-   CCC-   43     50     6.75%   10.68%   54.87%
U.S. Capital Funding I  B1   3,000    2,891    1,986    (905)   -   Caa1   29     33     7.95%   6.45%   11.81%
      $4,000   $3,805   $2,534   $(1,271)  $-                             

 

 

(1)A 10% recovery is applied to all projected defaults by depository institutions. A 15% recovery is applied to all projected defaults by insurance companies. No recovery is applied to current defaults.
(2)Excess subordination represents the additional defaults in excess of both current and projected defaults that the CDO can absorb before the bond experiences any credit impairment. Excess subordinated percentage is calculated by (a) determining what percentage of defaults a deal can experience before the bond has credit impairment, and (b) subtracting from this default breakage percentage both total current and expected future default percentages.

 

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The Bank’s trust preferred securities valuation was prepared by an independent third party. Their approach for determining fair value involved several steps including: (1) a detailed credit and structural evaluation of each piece of collateral in the trust preferred securities; (2) collateral performance projections for each piece of collateral in the trust preferred security; (3) terms of the trust preferred structure, as laid out in the indenture; and (4) discounted cash flow modeling.

 

The Company uses market-based yield indicators as a baseline for determining appropriate discount rates, and then adjusts the resulting discount rates on the basis of its credit and structural analysis of specific trust preferred securities. The primary focus is on the returns a fixed income investor would require in order to allocate capital on a risk adjusted basis. There is currently no active market for pooled trust preferred securities; however, the Company looks principally to market yields for stand-alone trust preferred securities issued by banks, thrifts and insurance companies for which there is an active and liquid market. The next step is to make a series of adjustments to reflect the differences that exist between these products (both credit and structural) and, most importantly, to reflect idiosyncratic credit performance differences (both actual and projected) between these products and the underlying collateral in the specific trust preferred security. Importantly, as part of the analysis described above, MutualFirst considers the fact that structured instruments frequently exhibit leverage not present in stand-alone instruments, and makes adjustments as necessary to reflect this additional risk.

 

The default and recovery probabilities for each piece of collateral were formed based on the evaluation of the collateral credit and a review of historical industry default data and current/near-term operating conditions. For collateral that has already defaulted, the Company assumed no recovery. For collateral that was in deferral, the Company assumed a recovery of 10% of par for banks, thrifts or other depository institutions, and 15% of par for insurance companies. Although the Company conservatively assumed that the majority of the deferring collateral continues to defer and eventually defaults, we also recognize there is a possibility that some deferring collateral may become current at some point in the future.

 

Sources of Funds

 

General. Our sources of funds are deposits, borrowings, payment of principal and interest on loans, interest earned on or maturation of other investment securities and funds provided from operations.

 

Deposits. We offer deposit accounts to consumers and businesses having a wide range of interest rates and terms. Our deposits consist of savings deposit accounts, NOW and demand accounts and certificates of deposit. We solicit deposits in our market areas as well as online through our internet banking product. We primarily rely on competitive pricing policies, marketing and customer service to attract and retain these deposits. Occasionally we will accept brokered deposits from a broker but only if no fee is paid. At December 31, 2015, our brokered deposits totaled $31.5 million, or 2.9% of total deposits, with an average interest rate of 1.58% and a 2.0 year weighted-average maturity.

 

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The flow of deposits is influenced significantly by general economic conditions, changes in money market and prevailing interest rates, and competition. The variety of our deposit accounts has allowed us to be competitive in obtaining funds and to respond to changes in consumer demand. We have become more susceptible to short-term fluctuations in deposit flows, as customers have continued to deposit in short-term products while rates remain low. We try to manage the pricing of our deposits in keeping with our asset/liability management, liquidity and profitability objectives, subject to competitive factors. Based on our experience, we believe that our deposits are relatively stable sources of funds. Our ability to attract and maintain these deposits and the rates paid on those deposits has been and will continue to be affected significantly by economic and market conditions.

 

The FRB requires all depository institutions to maintain non-interest bearing reserves at specified levels against their transaction accounts, primarily checking, NOW and Super NOW checking accounts. At December 31, 2015, we were in compliance with these reserve requirements.

 

The following table sets forth the dollar amount of deposits in the various types of deposit programs we offered at the dates indicated.

 

   December 31, 
   2015   2014   2013 
   Amount   Percent
of Total
   Amount   Percent
of Total
   Amount   Percent
of Total
 
   (Dollars in thousands) 
Transactions and savings deposits:                              
Noninterest bearing accounts  $179,542    16.45%  $154,178    14.28%  $144,195    12.95%
Savings accounts   131,578    12.06    124,051    11.49    119,380    10.73 
Interest-bearing NOW and demand accounts   267,089    24.47    253,042    23.44    262,114    23.55 
Money market accounts   162,551    14.89    146,847    13.61    115,600    10.39 
Total non-certificates   740,760    67.87    678,118    62.82    641,289    51.19 
                               
Certificates:                              
0.00 -1.99%   305,517    27.99    331,742    30.74    346,430    31.12 
2.00 -3.99%   45,052    4.13    69,406    6.43    119,678    10.75 
4.00 -5.99%   53    0.01    54    0.01    5,687    0.51 
Total certificates   350,622    32.13    401,202    37.18    471,795    48.81 
Total deposits  $1,091,382    100.00%  $1,079,320    100.00%  $1,113,084    100.00%

 

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The following table shows rate and maturity information for our certificates of deposit as of December 31, 2015.

 

   0.00 -
1.99%
   2.00 -
3.99%
   4.00 -
5.99%
   Total   Percent
of Total
 
   (Dollars in thousands) 
Certificate accounts maturing in quarter ending:                         
March 31, 2016  $33,518   $3,145   $-   $36,663    10.45%
June 30, 2016   46,538    3,306    -    49,844    14.22 
September 30, 2016   19,749    3,633    50    23,432    6.68 
December 31, 2016   33,273    264    -    33,537    9.57 
March 31, 2017   16,276    286    -    16,562    4.72 
June 30, 2017   16,397    2,954    3    19,354    5.52 
September 30, 2017   18,955    3,635    -    22,590    6.44 
December 31, 2017   15,643    1,886    -    17,529    5.00 
March 31, 2018   3,721    599    -    4,320    1.23 
June 30, 2018   11,162    196    -    11,358    3.24 
September 30, 2018   15,724    163    -    15,887    4.53 
December 31, 2018   6,458    -    -    6,458    1.84 
Thereafter   68,103    24,985    -    93,088    26.56 
Total  $305,517   $45,052   $53   $350,622    100.00%
                          
Percent of total  $87.14%   12.85%   0.01%   100.00%     

 

The following table indicates, as of December 31, 2015, the amount of our certificates of deposit and other deposits by time remaining until maturity.

 

   Maturity 
   3 Months
or Less
   Over 3 to
6 Months
   Over 6 to
12 Months
   Over
12 Months
   Total 
   (Dollars in thousands) 
Certificates of deposit less than $100,000  $23,605   $29,083   $35,374   $114,862   $202,924 
Certificates of deposit of $100,000 or more   10,445    20,048    20,031    85,322    135,846 
Public Funds (1)   2,613    713    1,564    6,962    11,852 
Total Certificates of deposit  $36,663   $49,844   $56,969   $207,146   $350,622 

 

 

(1) Deposits from governmental and other public entities.

 

Borrowings. We also utilize borrowings as a source of funds, especially when they are less costly than deposits and can be invested at a positive interest rate spread, when we desire additional capacity to fund loan demand or when they meet our asset/liability management goals. Our borrowings historically have consisted of advances from the FHLB of Indianapolis. See Note 12 of the Notes to Consolidated Financial Statements contained in Item 8 of this Form 10-K.

 

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We may obtain advances from the FHLB of Indianapolis upon the pledging of certain collateral. These advances may be made pursuant to several different credit programs, each of which has its own interest rate, range of maturities and call features. At December 31, 2015 we had $225.6 million in FHLB advances outstanding. Based on current collateral levels, we could borrow an additional $66.4 million from the FHLB at prevailing interest rates. In order to have access to FHLB advances, we are required to own stock in the FHLB of Indianapolis. At December 31, 2015, we had $10.5 million in that stock.

 

In 2013, the Company borrowed $7.6 million from First Tennessee Bank, N.A. to refinance existing long-term debt. The loan was originated at a variable rate of LIBOR plus 2.80%; however the Company entered into an interest rate swap that fixed the rate of the note at 3.92%. The balance of the loan at December 31, 2015 was $5.3 million and matures in December 2017.

 

We also are authorized to borrow from the Federal Reserve Bank of Chicago’s “discount window.” We have never borrowed from the Federal Reserve Bank and currently do not have any assets pledged to them for borrowing.

 

The Bank also has two fed fund lines totaling $15 million. There was no outstanding balance on either of these lines as of December 31, 2015.

 

The Company acquired $5.0 million of issuer trust preferred securities in the 2008 acquisition of another financial institution. The net balance of these securities as of December 31, 2015 was $4.1 million due to the purchase accounting adjustment made at the time of the acquisition. The securities bore a fixed rate of interest of 6.22% for the first five years, resetting quarterly thereafter at the prevailing three-month LIBOR rate plus 170 basis points. The Company has had the right to redeem the trust preferred securities, in whole or in part, without penalty, since September 15, 2010. These securities mature on September 15, 2035.

 

The following table sets forth, for the years indicated, the maximum month-end balance and average balance of FHLB advances and other borrowings.

 

   Year Ended December 31, 
   2015   2014   2013 
   (Dollars in thousands) 
Maximum Balance:               
FHLB advances  $225,617   $192,442   $142,928 
Other borrowings   10,181    11,830    12,589 
                
Average Balance:               
FHLB advances  $198,854   $164,398   $95,654 
Other borrowings   9,875    11,509    12,268 

 

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The following table sets forth certain information as to our borrowings at the dates indicated.

 

   December 31, 
   2015   2014   2013 
   (Dollars in thousands) 
FHLB advances  $225,617   $192,442   $142,928 
Other borrowings   9,458    10,174    10,890 
Total borrowings  $235,075   $202,616   $153,818 
                
Weighted average interest rate of FHLB advances   1.52%   1.36%   1.25%
Weighted average interest rate of other borrowings(1)   3.17%   4.41%   4.38%

 

 

(1) Our other borrowings include a term loan and a subordinated debt as of December 31, 2015.

 

Trust and Financial Services

 

MutualWealth and MutualFinancial Advisors are the wealth management and brokerage divisions of the Bank that provide a variety of fee-based financial services, including trust, investment, insurance, broker advisory, retirement plan and private banking services, in our market areas. Trust services are provided to both individual and corporate customers, including personal trust and agency accounts, employee benefit plans and corporate bond trustee accounts. These activities provide a significant source of fee income to the Company and in 2015 constituted 26.9% of the Company’s non-interest income.

 

Subsidiary and Other Activities

 

As an Indiana commercial bank, MutualBank is allowed to invest in subsidiaries as authorized by Indiana law and the IDFI. Under FDIC regulations, those subsidiaries generally may only engage in activities as principal that are permissible for national bank subsidiaries, unless the Bank receives FDIC approval to engage in other activities permitted by Indiana law and the IDFI. Activities engaged in as agent, including insurance agency activities, are not subject to this FDIC limitation.

 

The Bank's insurance agency subsidiary, Mishawaka Financial Services, Inc., is engaged in the sale, as agent, of life insurance and credit-life and health insurance to the Bank's customers and the general public.

 

At December 31, 2015, MutualBank had an active investment subsidiary, Mutual Federal Investment Company, which is a Nevada corporation that holds and manages a portion of MutualBank’s investment portfolio. As of December 31, 2015, the market value of securities managed was $242.5 million. Mutual Federal Investment Company has one active subsidiary, Mutual Federal REIT, Inc., which is a Maryland corporation holding approximately $50.2 million in consumer closed end first mortgage loans.

 

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The Bank had one other active subsidiary as of December 31, 2015. Summit Service Corporation which controls the 100% wholly owned active subsidiary, Summit Mortgage, Inc., which is an Indiana corporation that originates and sells consumer closed end first mortgage loans. As of December 31, 2015, Summit Mortgage had $3.4 million in loans held for sale.

 

Employees

 

At December 31, 2015, we had a total of 391 full-time and 54 part-time employees. Our employees are not represented by any collective bargaining group. Management considers its employee relations to be good.

 

How We Are Regulated

 

MutualBank is an Indiana commercial bank subject to regulation by the IDFI and the FDIC, and the Company is a bank holding company subject to FRB regulation. The Dodd-Frank Act created the Consumer Financial Protection Bureau (“CFPB”), which has authority to promulgate regulations intended to protect consumers with respect to financial products and services, including those provided by the Bank, and to restrict unfair, deceptive or abusive conduct by providers of consumer financial products and services. The FDIC regulates the Bank under these regulations. As a public company, the Company is subject to the regulation and reporting requirements of the SEC.

 

Set forth below is a brief description of certain laws and regulations that apply to us. This description, as well as other descriptions of laws and regulations contained in this Form 10-K, is not complete and is qualified in its entirety by reference to the applicable laws and regulations.

 

Legislation is introduced from time to time in the United States Congress and the Indiana General Assembly that may affect our operations. In addition, the regulations governing the Company and the Bank may be amended from time to time by the IDFI, the FDIC, CFPB, FRB or the SEC, as appropriate. Any legislative or regulatory changes in the future, including those resulting from the Dodd-Frank Act, could adversely affect our operations and financial condition.

 

MutualFirst Financial. MutualFirst Financial is a bank holding company that has elected to be a treated as a bank holding company and is subject to regulatory oversight by the FRB. MutualFirst is required to register and file reports with the FRB and is subject to regulation and examination by the FRB, including regulations requiring that the Company serve as a source of financial and managerial strength for the Bank, particularly if the Bank is in financial distress. In addition, the FRB has enforcement authority over the Company and any of its non-bank subsidiaries. The Company’s direct activities and those of non-bank subsidiaries are subject to FRB regulation and must be closely related to banking, as determined by the FRB or be activities permissible for a bank holding company; generally securities and insurance. The Company must obtain FRB approval to acquire substantially all the assets of another bank or bank holding company or to merge with another bank holding company. In addition, the Company must obtain FRB authorization to control more than 5% of the shares of any other bank or bank holding company and may not own more than 5% of any other entity engaged in activities not permitted for the Company. The IDFI also has oversight authority over the Company including acquisitions of other Indiana banks or bank holding companies and transactions with the Bank. The FRB imposes consolidated capital requirements on the Company. See “- Regulatory Capital Requirements.”

 

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MutualBank. As an Indiana commercial bank, MutualBank is subject to regulation, examination and supervision by the IDFI. Indiana law and the IDFI extensively regulates many aspects of the Bank’s operations including branching, dividends, interest and fees collected, anti-money laundering activities, confidentiality of customer information, credit card operations, corporate governance, mergers and purchase and assumption transactions, insurance activities, securities investments, real estate investments, trust operations, lending activities, subsidiary operations and required capital levels. Under Indiana law, Indiana banks may have parity authority with national banks.

 

To fund its operations, the IDFI has established a schedule for the assessment of “supervisory fees” for all Indiana financial institutions. These supervisory fees are computed based on the Bank’s total assets and trust assets and increase if the Bank experiences financial distress. The IDFI also charges fees for certain applications and other filings.

 

The Bank’s primary federal regulator is the FDIC. See “- FDIC Regulation and Insurance of Accounts.”

 

FDIC Regulation and Insurance of Accounts. As a state-chartered, non-member bank, MutualBank is subject to regulation, examination and supervision by the FDIC. The FDIC does not assess fees for its examination and supervision of the Bank. The FDIC oversees the Bank’s operations under federal law, regulations and policies, including consumer compliance laws, and ensures that the Bank operates in a safe and sound manner. It regulates the Bank’s branching, transactions with affiliates (including the Company) and loans to insiders. Under FDIC regulations, the Bank generally is prohibited from acquiring or owning any equity investments impermissible for national banks and from engaging as principal in activities that are not permitted for national banks without FDIC approval. During examinations, the FDIC may require the Bank to establish additional reserves for loan losses, which would decrease the Company’s net income. The FDIC has adopted guidelines establishing safety and soundness standards on such matters as loan underwriting and documentation, asset quality, earnings standards, internal controls and audit systems, interest rate risk exposure and compensation and other employee benefits. Any institution that fails to comply with these standards must submit a compliance plan.

 

The Bank’s deposits are insured up to the applicable limits by the FDIC, and such insurance is backed by the full faith and credit of the United States Government. The basic deposit insurance level is $250,000 per each separately insured depositor, as defined in FDIC regulations. As insurer, the FDIC imposes deposit insurance premiums and is authorized to conduct examinations of and to require reporting by FDIC-insured institutions. Our deposit insurance premiums for the year ended December 31, 2015 were $897,000. Those premiums may increase due to strains on the FDIC deposit insurance fund resulting from the cost of bank failures. Also, if the Bank’s regulatory capital or supervisory ratings deteriorate, these deposit premiums may increase.

 

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In accordance with the Dodd-Frank Act, the FDIC has issued regulations setting insurance premium assessments based on an institution's total assets minus its Tier 1 capital instead of its deposits. The Bank’s FDIC premiums are based on its assignment under one of four risk categories based on the Bank’s capital, supervisory ratings and other factors. Federal law requires that the reserve ratio of the FDIC deposit insurance fund be at least 1.35% by September 2020, and the FDIC has established a plan to meet that requirement.

 

It also may prohibit the Bank from engaging in any activity that it determines by regulation or order to pose a serious risk to the deposit insurance fund and may terminate our deposit insurance if it determines that we have engaged in unsafe or unsound practices or are in an unsafe or unsound condition.

 

Regulatory Capital Requirements. Both MutualFirst and MutualBank are required to maintain a minimum level of regulatory capital. The FDIC has established capital standards for the Bank, including a leverage ratio and a risk-based capital requirement, as well as capital standards for purposes of establishing the threshold for taking prompt corrective action against capital deficient institutions. The FDIC also may impose capital requirements in excess of these standards on individual institutions on a case-by-case basis. The FRB has established similar leverage and risk-based capital requirements for the Company. See “Item 7 - Management’s Discussion and Analysis of Financial Condition and Results of Operation - Capital Resources” for information on the Company’s and the Bank’s compliance with these capital requirements.

 

New capital requirements set forth by the FRB and FDIC became effective at the beginning of 2015 (with some changes transitioned into full effectiveness over two to four years). The new capital regulations created a new required ratio for common equity Tier 1 (“CET1”) capital, increased the minimum leverage and Tier 1 capital ratios, changed the risk-weightings of certain assets for purposes of the risk-based capital ratios, created an additional capital conservation buffer over the required capital ratios, and changed what qualifies as capital for purposes of meeting the capital requirements.

 

The minimum capital ratios are: (1) a CET1 capital ratio of 4.5% of risk-weighted assets; (2) a Tier 1 capital ratio of 6.0% of risk-weighted assets; (3) a total capital ratio of 8.0% of risk-weighted assets; and (4) a leverage ratio (the ratio of Tier 1 capital to average total adjusted assets) of 4.0%. CET1 generally consists of common stock; retained earnings; accumulated other comprehensive income (“AOCI”) except in the case of banking organizations that have elected to exclude AOCI from regulatory capital, as discussed below; and certain minority interests; all subject to applicable regulatory adjustments and deductions.

 

There are a number of changes in what constitutes regulatory capital, subject to transition periods. These changes include the phasing-out of certain instruments as qualifying capital. Mortgage servicing and deferred tax assets over designated percentages of CET1 are deducted from capital. In addition, Tier 1 capital includes AOCI, which includes all unrealized gains and losses on available for sale debt and equity securities. Because of our asset size, we had the one-time option of deciding in the first quarter of 2015 whether to permanently opt-out of the inclusion of unrealized gains and losses on available for sale debt and equity securities in our capital calculations. We made the decision to opt out.

 

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The new requirements also include changes in the risk-weighting of assets to better reflect credit risk and other risk exposure. These changes include a 150% risk weight (up from 100%) for certain high volatility commercial real estate acquisition, development and construction loans and for non-residential mortgage loans that are 90 days past due or otherwise in nonaccrual status; a 20% (up from 0%) credit conversion factor for the unused portion of a commitment with an original maturity of one year or less that is not unconditionally cancellable (set at 0%); and a 250% risk weight (up from 100%) for mortgage servicing and deferred tax assets that are not deducted from capital.

 

In addition to the minimum CET1, Tier 1 and total capital ratios, the Company and the Bank must maintain a capital conservation buffer consisting of additional CET1 capital greater than 2.5% of risk-weighted assets above the required minimum levels in order to avoid limitations on paying dividends, engaging in share repurchases, and paying discretionary bonuses. The new capital conservation buffer requirement is phased in beginning on January 1, 2016 when a buffer greater than 0.625% of risk-weighted assets will be required, which amount will increase each year until the buffer requirement is fully implemented on January 1, 2019.

 

The FDIC’s prompt corrective action standards changed when these new capital regulations became effective. Under the new standards, in order to be considered well-capitalized, the Bank must have a ratio of CET1 capital to risk-weighted assets of 6.5% (new), a ratio of Tier 1 capital to risk-weighted assets of 8% (increased from 6%), a ratio of total capital to risk-weighted assets of 10% (unchanged), and a leverage ratio of 5% (unchanged); and in order to be considered adequately capitalized, it must have the minimum capital ratios described above.

 

The FRB has established similar capital ratio requirements that apply to bank holding companies, including the Company, on a consolidated basis. To be considered well-capitalized a bank holding company must have, on a consolidated basis, at least a Tier 1 risk-based capital ratio of 8% and a total risk-based capital ratio of 10% and not be subject to a higher enforceable individualized capital requirement.

 

Limitations on Dividends and Other Capital Distributions. The Company’s major source of funds consists of dividends from the Bank. The ability of the Bank to pay dividends depends on its earnings and capital levels and may be limited by FDIC or IDFI regulations, directives or orders. In addition, under Indiana law, the Bank may pay dividends from undivided profits; however, in some circumstances it may be required to obtain IDFI approval of a dividend if the total dividends declared during the current year, including the proposed dividend, exceeds net income for the current year and retained net income for the prior two years, which excludes dividends paid during those years. The approval from IDFI is not required if the Bank meets exemption guidelines that mandate minimums for examination ratings and the Tier 1 leverage capital ratio, and the Bank is not subject to corrective action or supervisory order agreements. Since the Bank became regulated by the IDFI, it has been exempt from the pre-approval requirements but is still required to notify the IDFI of any proposed dividend. It is the Bank’s policy to maintain a strong capital position, so, in times of financial or economic distress, the Bank will be less likely to pay dividends to the Company.

 

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The ability of the Company to pay dividends to its stockholders is dependent on the receipt of dividends from the Bank. Under Maryland law, the Company cannot pay cash dividends if it would render the Company unable to pay its debts or would be insolvent (unless they are paid from recent earnings).

 

The FRB has issued a policy statement on the payment of cash dividends by bank holding companies, which expresses the FRB’s view that a bank holding company should pay cash dividends only to the extent that its net income for the past year is sufficient to cover both the cash dividends and a rate of earnings retention that is consistent with the holding company’s capital needs, asset quality and overall financial condition. The FRB also indicated that it would be inappropriate for a company experiencing serious financial problems to borrow funds to pay dividends. Furthermore, a bank holding company may be prohibited from paying any dividends if the holding company’s bank subsidiary is not adequately capitalized. The payment of dividends by a bank holding company can also be restricted under the capital conversation buffer requirements in the capital regulations.

 

A bank holding company is required to give the FRB prior written notice of any purchase or redemption of its outstanding equity securities if the gross consideration for the purchase or redemption, when combined with the net consideration paid for all such purchases or redemptions during the preceding 12 months, is equal to 10% or more of the company’s consolidated net worth. The FRB may disapprove such a purchase or redemption if it determines that the proposal would constitute an unsafe or unsound practice or would violate any law, regulation, FRB order, or any condition imposed by, or written agreement with, the FRB. This notification requirement does not apply to any company that meets the well-capitalized standard for bank holding companies, is well-managed, and is not subject to any unresolved supervisory issues.

 

Federal Securities Laws. The common stock of the Company is registered with the SEC under the Securities Exchange Act of 1934, as amended (the “Exchange Act”). Therefore, the Company is subject to the reporting, information disclosure, proxy solicitation, insider trading limits and other requirements imposed on public companies by the SEC under the Exchange Act. This includes limits on sales of stock by certain insiders and the filing of insider ownership reports with the SEC. The SEC and Nasdaq have adopted regulations under the Sarbanes-Oxley Act of 2002 that apply to the Company as a Nasdaq-traded, public company, which seek to improve corporate governance, provide enhanced penalties for financial reporting improprieties and improve the reliability of disclosures in SEC filings.

 

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Federal Taxation

 

General. We are subject to federal income taxation in the same general manner as other corporations, with some exceptions discussed below. The following discussion of federal taxation is intended only to summarize certain pertinent federal income tax matters and is not a comprehensive description of the tax rules applicable to us. MutualFirst’s federal income tax returns have been closed without audit by the IRS through its year ended December 31, 2011. MutualFirst and MutualBank will file a consolidated federal income tax return for fiscal year 2015.

 

Taxable Distributions and Recapture. Prior to 1998, bad debt reserves created prior to the year ended December 31, 1997 were subject to recapture into taxable income if MutualBank failed to meet certain thrift asset and definitional tests. Federal legislation eliminated these thrift recapture rules. However, under current law, pre-1988 reserves remain subject to recapture should MutualBank make certain non-dividend distributions or cease to maintain a bank charter.

 

Minimum Tax. The Internal Revenue Code imposes an alternative minimum tax at a rate of 20% on a base of regular taxable income plus certain tax preferences, called alternative minimum taxable income. The alternative minimum tax is payable to the extent such alternative minimum taxable income is in excess of an exemption amount. Net operating losses can offset no more than 90% of alternative minimum taxable income. Certain payments of alternative minimum tax may be used as credits against regular tax liabilities in future years. MutualBank is subject to the alternative minimum tax, and has $1.4 million available as credits for carryover.

 

Corporate Dividends-Received Deduction. MutualFirst may eliminate from its income dividends received from MutualBank as a wholly owned subsidiary of MutualFirst if it elects to file a consolidated return with MutualBank. The corporate dividends-received deduction is 100% or 80%, in the case of dividends received from corporations with which a corporate recipient does not file a consolidated tax return, depending on the level of stock ownership of the payer of the dividend. Corporations which own less than 20% of the stock of a corporation distributing a dividend may deduct 70% of dividends received or accrued on their behalf.

 

State Taxation

 

MutualBank is subject to Indiana’s financial institutions tax, which is imposed at a flat rate as of December 31, 2015, of 7.5% on “adjusted gross income” apportioned to Indiana. “Adjusted gross income,” for purposes of the financial institutions tax, begins with taxable income as defined by Section 63 of the Internal Revenue Code and incorporates federal tax law to the extent that it affects the computation of taxable income. Federal taxable income is then adjusted by several Indiana modifications including only considering members of the combined group which have Indiana nexus. Indiana legislature has reduced the financial institutions tax from 8.5% to 6.5% in 0.5% increments over the next four years. The full change will be effective at the end of 2017.

 

Other applicable state taxes include generally applicable sales and use taxes plus real and personal property taxes. The Company is subject to a Michigan business tax on apportioned capital employed in the state of Michigan. The Company also files the Pennsylvania Bank & Trust Company shares and loans tax report.  Ultimately, this tax is based on apportioned adjusted capital in the state of Pennsylvania.

 

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Internet Website

 

We maintain a website with the address of www.bankwithmutual.com. The information contained on our website is not included as a part of, or incorporated by reference into, this Annual Report on Form 10-K. This Annual Report on Form 10-K and our other reports, proxy statements and other information, including earnings press releases, filed with the SEC are available on that website through a link to the SEC’s website at “About Us - Investor Relations - SEC Filings.” For more information regarding access to these filings on our website, please contact our Corporate Secretary, MutualFirst Financial, Inc., 110 E. Charles Street, Muncie, Indiana, 47305-2400; telephone number (765) 747-2800.

 

Item 1A. Risk Factors

 

The following are certain risk factors that could impact our business, financial results and results of operations. Investing in our common stock involves risks, including those described below. These risk factors should be considered by prospective and current investors in our common stock when evaluating the disclosures in this Annual Report on Form 10-K (particularly the forward-looking statements). These risk factors could cause actual results and conditions to differ materially from those projected in forward-looking statements. If any of the events in the following risks actually occur, or if additional risks and uncertainties not presently known to us or that we believe are immaterial do materialize, then our business, financial condition or results of operations could be materially adversely impacted. In addition, the trading price of our common stock could decline due to any of the events described in these risks.

 

The recent economic recession was severe in our primary market area of northern and east central Indiana, which is not a high growth market. If those local economic conditions do not continue to improve, our results of operations and financial condition could be impacted adversely as borrowers’ ability to repay loans declines and the value of the collateral securing loans decreases. A return of recessionary conditions could result in increases in our level of non-performing loans and/or reduce demand for our products and services, which could have an adverse effect on our results of operations.

 

Our business activities and earnings are affected by general business conditions in the United States and in our local market area. These conditions are impacted by changes to short-term and long-term interest rates, inflation, unemployment levels, monetary supply, consumer confidence and spending, fluctuations in both debt and equity capital markets, and the strength of the economy in the United States generally and in our primary market area in particular. The economy continues to recover from the recent severe recession, which caused high unemployment levels, declining real estate values and eroded consumer confidence. The recession also reduced demand for commercial business and real estate loans in our local market. Declines in real estate values and other effects of the recession impacted household and corporate incomes, impairing the ability of our borrowers to repay their loans in accordance with their terms and increasing our non-performing loans, loan charge-offs, provisions for loan losses and foreclosures.

 

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Substantially all of our loans are located in northern and east central Indiana, which was impacted by the recession more severely than the national average. Our primary market area, which consists of Allen, Delaware, Elkhart, Grant, Kosciusko, Randolph, St. Joseph and Wabash counties in Indiana and Berrien county in Michigan, has experienced limited population growth of 0.64% from 2000 through 2010. This data from the census bureau reflects population increases in our northern region market of 2.02% compared to the reduction in population of our central region of (3.04%). Unemployment levels in our market areas in Indiana have remained below the state level over the last two years and dropped below the federal level at the end of 2015. According to data published by the Bureau of Labor Statistics of the United States Department of Labor, the national unemployment rate for the United States at December 31, 2015 was 5.0% (seasonally adjusted) compared to an average rate of 4.5% (not seasonally adjusted) for our market areas in Indiana. See “Item 1 - Business - Market Area.”

 

A return of recessionary conditions and/or continued negative developments in the domestic and international credit markets may significantly affect the markets in which we do business, the value of our loans and investments, and our ongoing operations, costs and profitability. Further declines in real estate values and sales volumes and continued high unemployment levels may result in higher than expected loan delinquencies and a decline in demand for our products and services. These negative events may cause us to incur losses and may adversely affect our capital, liquidity, and financial condition. Stock prices for financial institution holding companies, including MutualFirst, would be expected to decline substantially, and it would be significantly more difficult to raise capital or borrow in the debt markets.

 

A substantial portion of our assets consist of various types of loans that carry varying levels of credit and interest rate risk and that are sensitive to changes in the local and national economies.

 

Loans Secured by Residential Property. At December 31, 2015, $568.4 million, or 52.2% of our total loan portfolio, was secured by one- to four-family residential property, including loans held for sale and home equity loans and home equity lines of credit. This type of lending is generally sensitive to regional and local economic conditions that impact the ability of borrowers to meet their loan payment obligations. The decline in residential real estate values as a result of the downturn in the Indiana housing markets has reduced the value of the real estate collateral securing these types of loans and increased the risk that we would incur losses if borrowers default on their loans. In addition, borrowers seeking to sell their homes may find that they cannot sell their properties for an amount equal to or greater than the unpaid principal loan balance. Though the housing market in Indiana continued to experience some improvement in 2015, a return to declines in real estate sales and home values may result in higher than expected residential loan delinquencies or problem assets, a decline in demand for our products and services, or lack of growth or a decrease in deposits. These potential negative events may cause us to incur losses, adversely affect our capital and liquidity and damage our financial condition and business operations.

 

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Commercial Real Estate, Construction and Development and Commercial Business Loans. At December 31, 2015, $375.7 million of our total loan portfolio consisted of commercial real estate, construction and development and commercial business loans to small and mid-sized businesses, predominantly in our primary market area, which are the types of businesses that have a heightened vulnerability to local economic conditions. At December 31, 2015, our loan portfolio included $15.7 million of commercial construction and development loans, $236.9 million of commercial real estate loans and $123.0 million of commercial business loans compared to $33.1 million, $198.0 million and $88.5 million for construction and development, commercial real estate and business loans, respectively, at December 31, 2014. Although we have seen a stabilization in the portfolio in 2015 and a reduction in non-performing loans, a decline in property values and other market impacts could lead to an increase in non-performing loans. See “Item 1 - Business of MutualBank - Asset Quality - Non-Performing Assets.”

 

The credit risk related to these types of loans is considered to be greater than the risk related to one- to four-family residential loans because the repayment of commercial real estate loans and commercial business loans typically is dependent on the successful operation and income stream of the borrowers’ business and the real estate securing the loans as collateral, which can be significantly affected by economic conditions. Any delinquent payments or the failure to repay these loans would hurt our earnings. Additionally, commercial loans typically involve larger loan balances to single borrowers or groups of related borrowers compared to residential real estate loans. Several of our commercial borrowers have more than one commercial real estate or business loan outstanding with us. Consequently, an adverse development with respect to one loan or one credit relationship can expose us to significantly greater risk of loss compared to an adverse development with respect to any one- to four-family residential mortgage loan. Finally, if we foreclose on a commercial real estate loan, our holding period for the collateral, if any, is typically longer than a one- to four-family residential property because there are fewer potential purchasers of the collateral. If loans that are collateralized by real estate become troubled and the value of the real estate has been significantly impaired, then we may not be able to recover the full contractual amount of principal and interest that we anticipated at the time we originated the loan, which could require us to increase our provision for loan losses and adversely affect our operating results and financial condition.

 

Other Consumer Loans. At December 31, 2015, $145.3 million, or 13.3% of our total loan portfolio consisted of consumer loans, of which $15.5 million consisted of automobile loans, $123.6 million consisted of boat/RV loans and $6.2 million consisted of other consumers loans, including unsecured lines of credit. Generally, we consider these types of loans to involve a higher degree of risk compared to mortgage loans on one- to four-family, owner-occupied residential properties, particularly in the case of loans that are secured by rapidly depreciable assets, such as automobiles. In these cases, any repossessed collateral for a defaulted loan may not provide an adequate source of repayment of the outstanding loan balance. Although our indirect loans, which totaled $118.8 million at December 31, 2015, were underwritten by a third party using our guidelines, they were primarily originated to customers outside of our normal lending area which presents greater risks than other types of lending activities. As a result of this portfolio of consumer loans, it may become necessary to increase the level of our provision for loan losses, which could hurt our profits.

 

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Adjustable Rate Loans. At December 31, 2015, $409.0 million, or 37.6% of our total loan portfolio consisted of adjustable rate loans. Borrowers with adjustable rate loans are exposed to increased monthly payments when the related interest rate adjusts upward under the terms of the loan to the rate computed in accordance with the applicable index and margin. Any rise in prevailing market interest rates may result in increased payments for borrowers who have adjustable-rate loans, increasing the possibility of default. Borrowers seeking to avoid these increased monthly payments by refinancing their loans may no longer be able to find available replacement loans at comparably lower interest rates. In addition, declining real estate prices may prevent refinancing or a sale of the property, because borrowers have insufficient equity in the real estate. These events, alone or in combination, may contribute to higher delinquency rates and negatively impact our earnings.

 

If our allowance for loan losses is not sufficient to cover actual loan losses or our non-performing assets increase, our earnings will suffer. Increases in our provision for loan losses adversely impact our earnings and operations.

 

We make various assumptions and judgments about the collectability of our loan portfolio, including the creditworthiness of our borrowers and the value of the real estate and other assets serving as collateral. In determining the amount of the allowance for loan losses, we review our loans and our loss and delinquency experience and evaluate current economic conditions. Management recognizes that significant new growth in loan portfolios, new loan products and the refinancing of existing loans can result in portfolios comprised of unseasoned loans that may not perform in a historical or projected manner. If our assumptions are incorrect, our allowance for loan losses may not be sufficient to cover actual losses, resulting in additions to our allowance. Additions to our allowance decrease our net income. Our regulators periodically review our allowance for loan losses and may require us to recognize additions to the allowance based on their judgments about information available to them at the time of their review. These increases in our allowance for loan losses or loan charge-offs may have a material adverse effect on our financial condition and results of operations. Our allowance for loan losses was 1.17% of gross loans and 176.28% of non-performing loans at December 31, 2015, compared to 1.30% of gross loans and 177.04% of non-performing loans at December 31, 2014 and 1.37% of gross loans and 156.15% of non-performing loans at December 31, 2013.

 

At December 31, 2015, our non-performing assets (which consist of non-accrual loans, loans 90 days or more delinquent, non-accrual troubled debt restructurings and foreclosed real estate assets) totaled $9.6 million, which was a decrease of $1.1 million, or a 10.4% reduction in non-performing assets from December 31, 2014. This decrease reflects improved economic conditions within our market areas. Our non-performing assets adversely affect our net income in various ways. We do not record interest income on non-accrual loans or real estate owned. We must reserve for estimated credit losses, which are established through a current period charge to the provision for loan losses, and from time to time, if appropriate, we must write down the value of properties in our real estate owned (“REO”) portfolio to reflect changing market values. Additionally, there are legal fees associated with the resolution of problem assets as well as carrying costs including taxes, insurance and maintenance related to our REO. Further, the resolution of non-performing assets requires the active involvement of management, potentially distracting them from the overall supervision of our operations and other income-producing activities.

 

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During 2015, we recorded a provision for loan losses of $125,000 compared to $850,000 in 2014 and $1.3 million for 2013. We also recorded net loan charge-offs of $652,000 in 2015, compared to $1.1 million in 2014 and $3.9 million in 2013. During 2015, we experienced less loan delinquencies and credit losses than in 2014 and 2013, due to improved economic conditions. If declining trends in the housing, real estate and local business markets return, we would expect increased levels of delinquencies and credit losses to return, which would adversely impact our financial condition and results of operations.

 

Changes in interest rates could adversely affect our results of operations and financial condition.

 

Our results of operations and financial condition are affected significantly by changes in interest rates. Our results of operations depend substantially on our net interest income, which is the difference between the interest income we earn on our interest-earning assets, such as loans and securities, and the interest expense we pay on our interest-bearing liabilities, such as deposits and borrowings. Because interest-bearing liabilities generally reprice or mature more quickly than interest-earning assets, an increase in interest rates generally would tend to result in a decrease in net interest income.

 

Changes in interest rates also may affect the average life of loans and mortgage-related securities. Decreases in interest rates or continuing low interest rates can result in increased prepayments of loans and mortgage-related securities, as borrowers refinance to reduce their borrowing costs. Under these circumstances, we have been and continue to be subject to reinvestment risk to the extent that we are unable to reinvest the cash received from such prepayments at rates that are comparable to the rates on existing loans and securities. Additionally, increases in interest rates may decrease loan demand and make it more difficult for borrowers to repay adjustable-rate loans. Also, increases in interest rates may extend the life of fixed-rate assets, which could limit the funds we have available to reinvest in higher-yielding alternatives, and may result in customers withdrawing certificates of deposit early so long as the early withdrawal penalty is less than the interest they could receive as a result of the higher market interest rates.

 

Changes in interest rates also affect the current fair value of our interest-earning securities portfolio. Generally, the value of securities moves inversely with changes in interest rates. At December 31, 2015, the fair value of our portfolio of available for sale securities totaled $261.1 million. Gross unrealized gains on these securities totaled $4.9 million, while gross unrealized losses on these securities totaled $2.5 million, resulting in a net unrealized gain of $2.4 million at December 31, 2015.

 

At December 31, 2015, our interest rate risk analysis indicated that our net portfolio value would decrease by 7.9% if there was an instantaneous parallel 200 basis point increase in market interest rates. See the “Management’s Discussion and Analysis of Financial Condition and Results of Operation - Asset/Liability Management.”

 

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Our strategies to modify our interest rate risk profile may be difficult to implement.

 

Our asset/liability management strategies are designed to minimize our interest rate risk sensitivity. One such strategy is to increase the amount of adjustable rate and/or short-term assets. The Bank offers adjustable rate loan products as a means to achieve this strategy. The recent availability of lower rates on fixed-rate loans has generally created a decrease in borrower demand for adjustable rate assets. Additionally, these adjustable-rate assets may prepay. Despite this, at December 31, 2015, 37.6% of our loan portfolio consisted of adjustable-rate loans, compared to 36.1% at December 31, 2014.

 

We also are managing our liabilities to moderate our interest rate risk sensitivity. Customer demand is primarily for short-term certificates of deposit and transaction accounts. Using short-term liabilities to fund long-term, fixed-rate assets will increase the interest rate sensitivity of any financial institution. When needed, we are utilizing FHLB advances and repurchase agreements to mitigate the impact of customer demand by lengthening the maturities of these advances or entering into longer term repurchase agreements, depending on liquidity or investment opportunities.

 

FHLB advances and repurchase agreements are entered into as liquidity is needed or to fund assets that provide for a spread considered sufficient by management. If we are unable to originate adjustable rate assets at favorable rates or fund loan originations or securities purchases with long-term advances or structured borrowings, we may have difficulty executing this asset/liability management strategy and/or it may result in a reduction in profitability.

 

OTTI charges in our investment securities portfolio could result in losses and adversely affect our continuing operations. Our securities portfolio may be negatively impacted by fluctuations in market value and interest rates, which may have an adverse effect on our financial condition.

 

Our securities portfolio may be impacted by fluctuations in market value, potentially reducing accumulated other comprehensive income and/or earnings, which may materially adversely affect our stockholders’ equity, regulatory capital and continuing operations. Fluctuations in market value may be caused by decreases in interest rates, lower market prices for securities and limited investor demand, as well as the default rates of specific financial institutions whose securities provide the underlying collateral for these securities and changes in credit risk based on the condition of the issuer. The valuation of our investment securities also is influenced by the implementation of Securities and Exchange Commission and Financial Accounting Standards Board guidance on fair value accounting, which requires us to report our available for sale securities at their estimated fair value. We increase or decrease our stockholders’ equity by the amount of change in the estimated fair value of the available for sale securities, net of taxes. At December 31, 2015, the change in unrealized gains on securities available for sale from the level at December 31, 2014 was a decrease of $1.6 million. The current market environment significantly limits our ability to mitigate our exposure to valuation changes in these securities by selling them.

 

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Our securities portfolio is evaluated for OTTI on at least a quarterly basis. If this evaluation shows impairment to the actual or projected cash flows associated with one or more securities, a potential loss to earnings may occur. We have not recorded any OTTI since 2011. As of December 31, 2015, we have no securities that are deemed impaired.

 

If our investments in real estate are not properly valued or sufficiently reserved to cover actual losses, or if we are required to increase our valuation reserves, our earnings could be reduced.

 

We obtain updated valuations in the form of appraisals and broker price opinions when a loan has been foreclosed and the property taken in as REO, and at certain other times during the assets holding period. Our net book value (“NBV”) in the loan at the time of foreclosure and thereafter is compared to the updated market value of the foreclosed property less estimated selling costs (fair value). A charge-off is recorded for any excess in the asset’s NBV over its fair value. If our valuation process is incorrect, the fair value of our investments in real estate may not be sufficient to recover our NBV in such assets, resulting in the need for additional charge-offs. Additional material charge-offs to our investments in real estate could have a material adverse effect on our financial condition and results of operations. Our regulators periodically review our REO and may require us to recognize further charge-offs. Any increase in our charge-offs, as required by our regulator, may have a material adverse effect on our financial condition and results of operations.

 

We face risks related to covenants in our loan sales to investors and secondary mortgage market conditions.

 

Our agreements with investors to sell our loans generally contain covenants that require us to repurchase loans under certain circumstances, including some delinquencies, or to return premiums paid by those investors if the loans are paid off early. If we are required to repurchase sold loans under these covenants, they may be deemed troubled loans, with the potential for charge-offs and/or loss provision changes, which could impact our earnings and asset quality ratios adversely. The Bank was not required to repurchase any loans from investors during 2015 or 2014.

 

Our ability to sell loans on the secondary mortgage market is impacted by interest rate changes and investor demand or expected return. If this market becomes less liquid, we may not be able to rely as much on loan sales to reduce our interest rate and credit risk.

 

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We use estimates in determining the fair value of certain assets, such as mortgage servicing rights (“MSRs”). If our estimates prove to be incorrect, we may be required to write down the value of these assets which could adversely affect our earnings.

 

We sell a portion of our one- to four-family loans in the secondary market. We generally retain the right to service these loans through the Bank. At December 31, 2015, the value of our MSRs was $1.3 million. We use a financial model that uses, wherever possible, quoted market prices to value our MSRs. This model is complex and also uses assumptions related to interest and discount rates, prepayment speeds, delinquency and foreclosure rates and ancillary fee income. Valuations are highly dependent upon the reasonableness of our assumptions and the predictability of the relationships that drive the results of the model. The primary risk associated with MSRs is that they will lose a substantial portion of their value as a result of higher than anticipated prepayments occasioned by declining interest rates. Conversely, these assets generally increase in value in a rising interest rate environment to the extent that prepayments are slower than anticipated. If prepayment speeds increase more than estimated or delinquency and default levels are higher than anticipated we may be required to write down the value of our MSRs which could have a material adverse effect on our net income and capital levels. The Company obtains independent valuations at least semi-annually to determine if impairment in the asset exists.

 

Declining economic conditions may adversely impact the fees generated by our asset management and trust business.

 

To the extent our asset management and trust clients and their assets become adversely impacted by weak economic and stock market conditions, they may choose to withdraw the assets managed by us and/or the value of their assets may decline. Our asset management revenues are based on the value of the assets we manage. If our clients withdraw assets or the value of their assets decline, our revenues from these activities may be adversely affected. These fees totaled $3.5 million and $3.5 million in 2015 and 2014, respectively.

 

We face significant operational and reputational risks. As a community bank, maintaining our reputation in our market area is critical to the success of our business, and the failure to do so may materially adversely affect our performance. Our business may be adversely affected by an increasing prevalence of fraud and other financial crimes impacting the banking industry.

 

We are a community bank, and our reputation is one of the most valuable components of our business.  A key component of our business strategy is to rely on our reputation for customer service and knowledge of local markets to expand our presence by capturing new business opportunities from existing and prospective customers in our current market and contiguous areas.  As such, we strive to conduct our business in a manner that enhances our reputation. This is done, in part, by recruiting, hiring and retaining employees who share our core values of being an integral part of the communities we serve, delivering superior service to our customers and caring about our customers and associates.  We operate in many different financial service businesses and rely on the ability of our employees and systems to process a significant number of transactions. Operational risk is the risk of loss from operations, including fraud by employees or outside persons, employees’ execution of incorrect or unauthorized transactions, data processing and technology errors or hacking and breaches of internal control systems. If our reputation is negatively affected, by the actions of our employees, by our inability to conduct our operations in a manner that is appealing to current or prospective customers, or otherwise, our business and, therefore, our operating results may be materially adversely affected. Our loans to businesses and individuals and our deposit relationships and related transactions are subject to exposure to the risk of loss due to fraud and other financial crimes. Nationally, reported incidents of fraud and other financial crimes have increased. We have experienced an increase in losses due to apparent fraud and other financial crimes. Our policies and procedures designed to prevent such losses may not prevent all such losses.

 

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Strong competition within our market area may limit our growth and profitability.

 

Competition in the banking and financial services industry is intense. In our market area, we compete with commercial banks, savings institutions, mortgage brokerage firms, credit unions, finance companies, mutual funds, insurance companies and brokerage and investment banking firms operating locally and elsewhere. Many of these competitors have national name recognition, greater resources and lending limits than we do and may offer certain services or prices for services that we do not or cannot provide. Our profitability depends upon our continued ability to successfully compete in our market.

 

The financial services industry could become even more competitive as a result of new legislative, regulatory and technological changes and continued consolidation. Banks, securities firms and insurance companies can merge under the umbrella of a bank holding company, which can offer virtually any type of financial service, including banking, securities underwriting, insurance (both agency and underwriting) and merchant banking. Also, technology has lowered barriers to entry and made it possible for non-banks to offer products and services traditionally provided by banks, such as automatic transfer and automatic payment systems. Many of our competitors have fewer regulatory constraints and may have lower cost structures. Additionally, due to their size, many competitors may be able to achieve economies of scale and, as a result, may offer a broader range of products and services as well as better pricing for those products and services than we can.

 

A tightening of credit markets and liquidity risk could impair our ability to fund operations and jeopardize our financial condition.

 

Liquidity is essential to our business. A tightening of the credit markets and the inability to obtain adequate funding to replace deposits and fund continued loan growth may affect asset growth, our earnings capability and capital levels negatively. We rely on a number of different sources in order to meet our potential liquidity demands. Our primary sources of liquidity are increases in deposit accounts, including brokered deposits, as well as cash flows from loan payments and our securities portfolio. Borrowings, especially from the FHLB and repurchase agreements, also provide us with a source of funds to meet liquidity demands. An inability to raise funds through deposits, borrowings, the sale of loans and other sources could have a substantial negative effect on our liquidity. Our access to funding sources in amounts adequate to finance our activities or on terms that are acceptable to us could be impaired by factors that affect us specifically, or the financial services industry or economy in general. Factors that could detrimentally impact our access to liquidity sources include adverse regulatory action against us or a decrease in the level of our business activity as a result of a downturn in the markets in which our loans are concentrated. Our ability to borrow also could be impaired by factors that are not specific to us, such as a disruption in the financial markets, negative views and expectations about the prospects for the financial services industry in light of the recent turmoil faced by banking organizations or continued deterioration in credit markets.

 

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Our core deposit premium could be deemed partially or fully impaired in the future, which would reduce our earnings and the values of that intangible asset.

 

At December 31, 2015, we had a core deposit premium of $444,000, due mainly to our 2008 acquisition of another financial institution. Under GAAP, we are required to periodically assess the value of this intangible asset based on a number of factors to determine if there is partial or full impairment. The factors taken into consideration include the market price of our stock, the net present value of our assets and liabilities and valuation information for similar financial institutions. This evaluation involves a substantial amount of judgment. If actual conditions underlying the factors differ from our assessment, the core deposit intangible could be subjected to faster amortization or partial or complete impairment, which would reduce the value of this asset and reduce our earnings, perhaps materially.

 

We currently hold a significant amount of bank-owned life insurance.

 

At December 31, 2015, we held $91.9 million of bank-owned life insurance or BOLI on key employees and executives, with a cash surrender value of $51.2 million. These policies are maintained to fund amounts owed under various benefit plans. The eventual repayment of the cash surrender value is subject to the ability of the various insurance companies to pay death benefits or to return the cash surrender value to us if needed for liquidity purposes. We continually monitor the financial strength of the various companies with whom we carry these policies. However, any one of these companies could experience a decline in financial strength, which could impair its ability to pay benefits or return our cash surrender value. If we need to liquidate these policies for liquidity purposes, we would be subject to taxation on the increase in cash surrender value and penalties for early termination, both of which would adversely impact earnings.

 

We may not be able to fully realize our deferred tax asset.

 

At December 31, 2015, we had a $12.1 million deferred income tax asset based on differences between the financial statement amounts and tax bases of assets and liabilities and reflecting mainly an allowance for loan loss timing difference and business tax and AMT carryover. The value of our deferred income tax benefit is reviewed regularly under various forecasts and assumptions, including anticipated levels of taxable net income, to determine the likelihood of realizing the benefit. If actual results or subsequent forecasts differ from our current judgments, to the extent that it becomes more likely than not that this benefit will not be fully realized, we would have to write down this asset, which would negatively impact results of operations and reduce our asset size.

 

If our investment in the FHLB of Indianapolis becomes impaired, our earnings and stockholders’ equity could decrease.

 

At December 31, 2015, we owned $10.5 million in FHLB of Indianapolis stock. We are required to own this stock to be a member of and to obtain advances from our FHLB. This stock is not marketable and can only be redeemed by our FHLB. The most recent stock buyback initiated by FHLB was in 2015. Our FHLB’s financial condition is linked, in part, to the eleven other members of the FHLB System and to accounting rules and asset quality risks that could materially lower their capital, which would cause our FHLB stock to be deemed impaired, resulting in a decrease in our earnings and assets.

 

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Changes in laws and regulations and the cost of regulatory compliance with new laws and regulations may adversely affect our operations and our income.

 

The Bank and the Company are subject to extensive regulation, supervision and examination by federal and state regulators, which have extensive discretion in connection with their supervisory and enforcement activities, including the ability to impose restrictions on a bank’s operations, reclassify assets, determine the adequacy of a bank’s allowance for loan losses and determine the level of deposit insurance premiums assessed. Because our business is highly regulated, the applicable laws and regulations are subject to frequent change. Any change in these laws, regulations and oversight, whether in the form of regulatory policy, new regulations or legislation or additional deposit insurance premiums, could have a material impact on our operations. See “Item 1 - How We Are Regulated.”

 

In response to the recent financial crisis, Congress took actions that are intended to strengthen confidence and encourage liquidity in financial institutions, and the FDIC has taken actions to increase insurance coverage on deposit accounts. The Dodd-Frank Act created the CFPB.

 

The CFPB has examination and primary enforcement authority with respect to depository institutions with $10 billion or more in assets, their service providers and certain non-depository entities such as debt collectors and consumer reporting agencies. In the case of banks, such as the Bank, with total assets of less than $10 billion, this examination and enforcement authority is held by the institution’s primary federal banking regulator (the FDIC, in the case of the Bank).

 

The CFPB has finalized a number of significant rules that could have a significant impact on our business and the financial services industry more generally. In particular, the CFPB has adopted ruled impacting nearly every aspect of our lifecycle of a residential mortgage loan. The CFPB has also issued guidance which could significantly affect the automotive financing industry by subjecting indirect auto lenders, such as the Bank, to regulation as creditors under the Equal Credit Opportunity Act, which would make indirect auto lenders monitor and control certain credit policies and procedures undertaken by auto dealers.

 

In the recent economic downturn, federal and state banking regulators have been active in responding to concerns and trends identified in examinations and have issued many formal enforcement orders requiring capital ratios in excess of regulatory requirements. The FDIC and IDFI govern the activities in which the Bank may engage, primarily for the protection of depositors and not for the protection or benefit of stockholders. In addition, new laws and regulations may increase our costs of regulatory compliance and of doing business and otherwise affect our operations. New laws and regulations may significantly affect the markets in which we do business, the markets for and value of our loans and investments, the fees we can charge and our ongoing operations, costs and profitability. Recent regulatory changes regarding card interchange fee income does not currently apply to us but could change in the future. Prior year changes in overdraft protection programs decreased the amount of fees we receive for those services. During 2015, overdraft protection and nonsufficient fund fees totaled $1.9 million. Further, legislative proposals limiting our rights as a creditor could result in credit losses or increased expense in pursuing our remedies as a creditor.

 

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Increases in deposit insurance premiums and special FDIC assessments will negatively impact our earnings.

 

The Dodd-Frank Act established 1.35% of total insured deposits as the minimum reserve ratio for the FDIC Deposit Insurance Fund effective September 30, 2020. The FDIC has adopted a plan under which it will meet this ratio by the statutory deadline and anticipates reaching a 1.15% ratio by 2016. Once the 1.15% ratio is reached, which was the minimum ratio prior to the Dodd-Frank Act, the FDIC is required to offset the effect of the increase in the minimum reserve ratio to 1.35% on institutions with assets less than $10 billion. The FDIC has not announced how it will implement this offset. In addition to the statutory minimum ratio, the FDIC must set a designated reserve ratio or DRR, which may exceed the statutory minimum. The FDIC has set 2.0% as the DRR.

 

As required by the Dodd-Frank Act, the FDIC has adopted final regulations under which insurance premiums are based on an institution's total assets minus its tangible equity instead of its deposits. Since the implementation of these changes, we have seen a decline in our deposit insurance premiums. The insurance costs were $897,000, $1.0 million and $1.1 million for the years ended December 31, 2015, 2014 and 2013, respectively. Our future deposit insurance premiums may increase if the FDIC determines that it will not meet the required or anticipated minimum reserve ratios discussed, which could have a negative impact on our earnings.

 

Our accounting policies and methods impact how we report our financial condition and results of operations. Application of these policies and methods may require management to make estimates about matters that are uncertain.

 

Our accounting policies and methods are fundamental to how we record and report our financial condition and results of operations.  Our management must exercise judgment in selecting and applying many of these accounting policies and methods so they comply with generally accepted accounting principles and reflect management’s judgment of the most appropriate manner to report our financial condition and results of operations.  In some cases, management must select the accounting policy or method to apply from two or more alternatives, any of which might be reasonable under the circumstances yet might result in our reporting materially different amounts than would have been reported under a different alternative.  These accounting policies are critical to presenting our financial condition and results of operations. They may require management to make difficult, subjective or complex judgments about matters that are uncertain.  Materially different amounts could be reported under different conditions or using different assumptions.

 

Our controls and procedures may be ineffective.

 

We regularly review and update our internal controls, disclosure controls and procedures and corporate governance policies and procedures. As a result, we may incur increased costs to maintain and improve our controls and procedures. Any system of controls, however well designed and operated, is based in part on certain assumptions and can provide only reasonable, not absolute, assurances that the objectives of the system are met. Any failure or circumvention of our controls or procedures or failure to comply with regulations related to controls and procedures could have a material adverse effect on our business, results of operations or financial condition.

 

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System failure or breaches of our network security could subject us to increased operating costs as well as litigation and other liabilities.

 

The computer systems and network infrastructure we use could be vulnerable to unforeseen problems. Our operations are dependent upon our ability to protect our computer equipment against damage from physical theft, fire, power loss, telecommunications failure or a similar catastrophic event, as well as from security breaches, denial of service attacks, viruses, worms and other disruptive problems caused by hackers. Any damage or failure that causes an interruption in our operations could have a material adverse effect on our financial condition and results of operations. Computer break-ins, phishing and other disruptions could jeopardize the security of information stored in and transmitted through our computer systems and network infrastructure, which may result in significant liability to us and cause existing and potential customers to refrain from doing business with us. Although we, with the help of third-party service providers, intend to continue to implement security technology and establish operational procedures to prevent such damage, there can be no assurance that these security measures will be successful. Though the third party vendors providing key components of our business infrastructure have been carefully chosen by us, we cannot control their actions, and their failures may impact the Bank’s ability to provide services to its customers and cause us to incur significant expense. In addition, advances in computer capabilities, new discoveries in the field of cryptography or other developments could result in a compromise or breach of the algorithms we and our third-party service providers use to encrypt and protect customer transaction data. A failure of such security measures could have a material adverse effect on our reputation, financial condition and results of operations.

 

We may elect or be compelled to seek additional capital in the future, but that capital may not be available when it is needed or on terms acceptable to us.

 

We are required by federal regulatory authorities to maintain adequate levels of capital to support our operations. In addition, we may elect to raise more capital to support our business or to finance acquisitions, if any, or we may otherwise elect or be required to raise additional capital. Should we be required by regulatory authorities to raise additional capital, we may seek to do so through the issuance of, among other things, our common stock or preferred stock. The issuance of additional shares of common stock or convertible securities to new stockholders would be dilutive to our current stockholders.

 

Our ability to raise additional capital, if needed, will depend on conditions in the capital markets, economic conditions and a number of other factors, many of which are outside our control, and on our financial performance. Accordingly, we cannot assure you of our ability to raise additional capital if needed or on terms acceptable to us. If we cannot raise additional capital when needed, or if the terms of such a capital raise are not advantageous, it may have a material adverse effect on our financial condition, results of operations and prospects.

 

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There may be future sales of additional common stock or preferred stock or other dilution of our equity, which may adversely affect the market price of our common stock.

 

We are not restricted from issuing additional common stock or preferred stock, including any securities that are convertible into or exchangeable for, or that represent the right to receive, common stock or preferred stock or any substantially similar securities. The market value of our common stock could decline as a result of sales by us of a large number of shares of common stock or preferred stock or similar securities in the market or the perception that such sales could occur.

 

Our board of directors is authorized to allow us to issue additional common stock, as well as classes or series of preferred stock, generally without any action on the part of the stockholders. In addition, the board has the power, generally without stockholder approval, to set the terms of any such classes or series of preferred stock that may be issued, including voting rights, dividend rights and preferences over the common stock with respect to dividends or upon the liquidation, dissolution or winding-up of our business and other terms. If we issue additional preferred stock in the future that has a preference over the common stock with respect to the payment of dividends or upon liquidation, dissolution or winding-up, or if we issue additional preferred stock with voting rights that dilute the voting power of the common stock, the rights of holders of the common stock or the market value of the common stock could be adversely affected.

 

Anti-takeover provisions could negatively impact our stockholders.

 

Provisions in our charter and bylaws, the corporate law of the State of Maryland and federal regulations could delay, defer or prevent a third party from acquiring us, despite the possible benefit to our stockholders, or otherwise adversely affect the market price of any class of our equity securities, including our common stock. These provisions include: a prohibition on voting shares of common stock beneficially owned in excess of 10% of total shares outstanding, supermajority voting requirements for certain business combinations with any person who beneficially owns more than 10% of our outstanding common stock; the election of directors to staggered terms of three years; advance notice requirements for nominations for election to our board of directors and for proposing matters that stockholders may act on at stockholder meetings, a requirement that only directors may fill a vacancy in our board of directors, supermajority voting requirements to remove any of our directors and the other provisions of our charter. Our charter also authorizes our board of directors to issue preferred stock, and preferred stock could be issued as a defensive measure in response to a takeover proposal. In addition, pursuant to federal and state laws and regulations, as a general matter, no person or company, acting individually or in concert with others, may acquire more than 10% of our common stock without prior approval from our regulators.

 

These provisions may discourage potential takeover attempts, discourage bids for our common stock at a premium over market price or adversely affect the market price of, and the voting and other rights of the holders of, our common stock. These provisions could also discourage proxy contests and make it more difficult for holders of our common stock to elect directors other than the candidates nominated by our board of directors.

 

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The voting limitation provision in our charter could limit your voting rights as a holder of our common stock.

 

Our charter provides that any person or group who acquires beneficial ownership of our common stock in excess of 10% of the outstanding shares may not vote the excess shares. Accordingly, if you acquire beneficial ownership of more than 10% of the outstanding shares of our common stock, your voting rights with respect to the common stock will not be commensurate with your economic interest in the Company.

 

We rely on dividends from MutualBank for substantially all of the Company’s revenue.

 

MutualFirst’s primary source of revenue is dividends from the Bank. The IDFI must be notified of dividends made from the Bank to the Company and may choose to limit Bank dividends. If the Bank is unable to pay dividends, MutualFirst may not be able to service its debt, pay its other obligations or pay dividends on the Company’s common stock, which could have a material adverse impact on our financial condition or the value of your investment in our common stock.

 

Our common stock trading volume may not provide adequate liquidity for investors.

 

Our common stock is listed on the Nasdaq Global Market. However, the average daily trading volume in our common stock is less than that of many larger financial services companies. A public trading market having the desired depth, liquidity and orderliness depends on the presence of a sufficient number of willing buyers and sellers for our common stock at any given time. This presence is impacted by general economic and market conditions and investors’ views of our Company. Because our trading volume is limited, any significant sales of our shares could cause a decline in the price of our common stock.

 

Our directors and executive officers have the ability to influence stockholder actions in a manner that may be adverse to the personal investment objectives of our stockholders.

 

As of December 31, 2015, our directors and executive officers as a group beneficially owned 1,716,968 shares, or 23.1%, of our common stock (including immediately exercisable options for 315,161 shares). In addition, our employee stock ownership plan controlled 5.6% of our common stock on that date. In addition, as of December 31, 2015, 58,003 shares were reserved under our current stock benefit plan for future awards for our directors, officers and employees. Due to this significant collective ownership of or control over our common stock, our directors and executive officers may be able to influence the outcome of director elections or block significant transactions, such as a merger or acquisition, or any other matter that might otherwise be favored by other stockholders and could prevent any stockholder action requiring a supermajority vote under our articles of incorporation.

 

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Item 1B. Unresolved Staff Comments

 

Not applicable.

 

Item 2. Properties

 

At December 31, 2015 we had 31 full service offices. Our offices are located within east central and northern Indiana. At December 31, 2015, we owned our home office in Muncie, Indiana and all but one of our financial center offices. We lease offices in central and northern Indiana for our trust and brokerage services, a branch office in Ft. Wayne, Indiana and loan origination offices in northwestern Indiana and southwest Michigan. The net book value of our investment in premises and leaseholds was approximately $28.2 million at December 31, 2015. We believe that our current facilities are adequate to meet our present and immediately foreseeable needs. See Note 7 of the Notes to Consolidated Financial Statements contained in Item 8.

 

Item 3. Legal Proceedings

 

From time to time, we are involved as plaintiff or defendant in various legal actions arising in the normal course of business. We do not anticipate incurring any material liability as a result of such litigation. We are not a party to any pending legal proceedings that we believe would have a material adverse effect on our financial condition, results of operations or cash flows.

 

Item 4. Mine Safety Disclosure

 

Not applicable.

 

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PART II

 

Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

 

The common stock of MutualFirst Financial, Inc. is traded under the symbol “MFSF” on the Nasdaq Global Market. The table below shows the high and low closing prices for our common stock for the periods indicated. This information was provided by the Nasdaq.

 

   Stock Price   Dividends 
   High   Low   per Share 
2015 Quarters:               
First Quarter (ended 03/31/15)  $24.00   $21.73   $0.12 
Second Quarter (ended 06/30/15)  $23.30   $20.06   $0.12 
Third Quarter (ended 09/30/15)  $24.96   $22.46   $0.12 
Fourth Quarter (ended 12/31/15)  $24.92   $23.03   $0.12 
                
2014 Quarters:               
First Quarter (ended 03/31/14)  $19.52   $17.34   $0.06 
Second Quarter (ended 06/30/14)  $19.09   $18.68   $0.08 
Third Quarter (ended 09/30/14)  $22.50   $18.87   $0.08 
Fourth Quarter (ended 12/31/14)  $22.47   $20.80   $0.10 

 

At December 31, 2015, there were 7,422,061 shares of common stock outstanding and approximately 1,100 common stockholders of record.

 

Our common stock cash dividend payout policy is continually reviewed by management and the Board of Directors. During 2015, the Company paid total common stock dividends of $0.48 per share up from $0.32 per share in 2014. The Company intends to continue its policy of paying quarterly dividends and hopes to continue to pay dividends at least at the same level as in 2015. However, future common stock dividend payments will depend upon a number of factors, including capital requirements, regulatory limitations, the Company’s financial condition, results of operations and the Bank’s ability to pay dividends to the Company. The Company relies significantly upon dividends from the Bank to accumulate earnings for payment of cash dividends to Treasury and our common stockholders.

 

The Company did not adopt any common stock repurchase plan in 2015, but recently put a 5% common stock repurchase plan in place for 2016. No shares of the Company’s stock were repurchased during 2015.

 

Information regarding our equity compensation plans is included in Part III, Item 12 of this Form 10-K.

 

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Shareholder Performance Graph Presentation

 

The following graph and related discussion are being furnished solely to accompany this Annual Report on Form 10-K pursuant to Item 201(e) of Regulation S-K and shall not be deemed to be “soliciting materials” or to be “filed” with the SEC (other than as provided in Item 201) nor shall this information be incorporated by reference into any future filing under the Securities Act or the Exchange Act, whether made before or after the date hereof and irrespective of any general incorporation language contained therein, except to the extent that the Company specifically incorporates it by reference into a filing.

 

The following graph shows a comparison of stockholder return on MutualFirst Financial Inc.’s common stock with the cumulative total returns for: 1) the Nasdaq Composite® (U.S.) Index; and 2) the SNL U.S. Bank and Thrift Index, which was compiled by SNL Financial LC of Charlottesville, Virginia. The graph assumes an initial investment of $100 and reinvestment of dividends. The graph is historical only and may not be indicative of possible future performance.

 

 

 

   Period Ending 
Index  12/31/10   12/31/11   12/31/12   12/31/13   12/31/14   12/31/15 
MutualFirst Financial, Inc.   100.00    78.37    129.65    197.44    256.27    296.68 
NASDAQ Composite   100.00    99.21    116.82    163.75    188.03    201.40 
SNL U.S. Bank and Thrift   100.00    77.76    104.42    142.97    159.60    162.83 

 

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Item 6. Selected Financial and Other Data

 

 SELECTED CONSOLIDATED FINANCIAL AND OTHER DATA

 

The following information is only a summary and you should read it in conjunction with our consolidated financial statements and accompanying notes contained in Item 8 of this Form 10-K Balances have been updated to reflect the adoption of ASU 2014-01 in January 2015. See Note 25 of the Notes to Consolidated Financial Statements contained in Item 8.

 

   At or For the Year Ended December 31, 
   2015   2014   2013   2012   2011 
   (Dollars in thousands) 
Selected Financial Condition Data:                         
Total assets  $1,478,265   $1,423,423   $1,391,405   $1,422,458   $1,427,193 
Cash and cash equivalents   20,915    29,575    25,285    32,778    55,223 
Loans, net   1,068,204    1,003,518    965,966    969,545    900,460 
Investment securities                         
Available for sale, at fair value   261,138    260,806    264,348    281,197    330,878 
Total deposits   1,091,382    1,079,320    1,113,084    1,184,009    1,168,357 
Total borrowings   235,075    202,616    153,818    86,281    113,861 
Total stockholders' equity   137,025    126,752    110,629    139,493    132,627 
                          
Selected Operations Data:                         
Total interest income  $51,776   $51,178   $51,667   $55,348   $61,353 
Total interest expense   8,803    8,923    11,224    14,704    20,034 
Net interest income   42,973    42,255    40,443    40,644    41,319 
Provision for loan losses   125    850    1,300    6,025    13,100 
Net interest income after provision for loan losses   42,848    41,405    39,143    34,619    28,219 
                          
Service fee income   5,947    5,995    5,989    6,492    6,987 
Gain on sale of loans and investment securities   4,612    2,162    1,687    4,701    4,771 
Other-than-temporary impairment, securities   -    -    -    -    (193)
Other non-interest income   6,580    6,728    6,387    4,331    4,445 
Total non-interest income   17,139    14,885    14,063    15,524    16,010 
                          
Salaries and employee benefits   25,526    23,560    22,492    21,335    21,690 
Other expenses   17,621    17,818    17,195    18,930    18,726 
Total non-interest expense   43,147    41,378    39,687    40,265    40,416 
Income before income taxes   16,840    14,912    13,519    9,878    3,813 
Income tax expense   4,578    3,866    4,136    2,632    329 
Net income   12,262    11,046    9,383    7,246    3,484 
Preferred stock dividends and accretion   -    -    1,257    1,446    2,115 
Net income available to common stockholders  $12,262   $11,046   $8,126   $5,800   $1,369 

 

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Quarter Ended  Interest Income   Interest Expense   Net Interest
Income
   Provision for Loan
Losses
   Net Income   Net Income
Available to
Common
Shareholders
   Basic Earnings Per
Common Share
   Diluted Earnings Per
Common Share
 
                                 
2015                                        
March 31  $12,683   $2,165   $10,518   $-   $2,481   $2,481   $0.34   $0.33 
June 30   12,731    2,191    10,540    -    3,218    3,218    0.44    0.43 
September 30   13,049    2,233    10,816    -    3,225    3,225    0.44    0.43 
December 31   13,313    2,214    11,099    125    3,338    3,338    0.45    0.44 
                                         
Total  $51,776   $8,803   $42,973   $125   $12,262   $12,262   $1.66   $1.62 
                                         
2014                                        
March 31  $12,738   $2,319   $10,419   $350   $2,020   $2,020   $0.28   $0.27 
June 30   12,744    2,186    10,558    500    2,614    2,614    0.37    0.36 
September 30   12,803    2,163    10,640    -    2,751    2,751    0.38    0.37 
December 31   12,893    2,255    10,638    -    3,661    3,661    0.51    0.49 
                                         
Total  $51,178   $8,923   $42,255   $850   $11,046   $11,046   $1.54   $1.49 
                                         
2013                                        
March 31  $12,901   $2,922   $9,979   $950   $2,022   $1,661   $0.24   $0.23 
June 30   12,877    2,857    10,020    550    2,157    1,879    0.27    0.26 
September 30   13,041    2,801    10,240    750    2,518    2,247    0.32    0.31 
December 31   12,848    2,644    10,204    (950)   2,686    2,339    0.33    0.32 
                                         
Total  $51,667   $11,224   $40,443   $1,300   $9,383   $8,126   $1.15   $1.12 

 

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   At or For the Year Ended December 31, 
   2015   2014   2013   2012   2011 
Selected Financial Ratios and Other Financial Data:                         
                          
Performance Ratios:                         
Return on average assets (ratio of net income to average total assets)   0.85%   0.79%   0.67%   0.50%   0.24%
Return on average tangible equity (ratio of net income to average tangible equity)   9.49%   9.42%   7.42%   5.47%   1.39%
Interest rate spread information:                         
Average during the period   3.10%   3.15%   2.99%   2.89%   2.97%
Net interest margin(1)   3.22%   3.26%   3.13%   3.05%   3.16%
Ratio of operating expense to average total assets   2.98%   2.94%   2.83%   2.78%   2.83%
Ratio of average interest-earning assets to average interest-bearing liabilities   118.01%   115.76%   115.79%   114.33%   112.66%
Efficiency ratio(2)   71.78%   72.42%   72.81%   71.69%   70.50%
                          
Asset Quality Ratios:(3)                         
Non-performing assets to total assets   0.65%   0.75%   1.22%   2.21%   2.75%
Non-performing loans to total loans   0.66%   0.73%   0.88%   2.40%   3.47%
Allowance for loan losses to non-performing loans   176.28%   177.03%   156.15%   67.72%   52.81%
Allowance for loan losses to loans receivable, net   1.17%   1.30%   1.37%   1.63%   1.83%
                          
Capital Ratios:                         
Equity to total assets(3)   9.26%   8.90%   7.96%   9.81%   9.29%
Average equity to average assets   9.13%   8.47%   9.24%   9.64%   9.34%
Tangible book value per common share  $18.10   $17.12   $15.46   $15.33   $14.38 
                          
Share and Per Share Data:                         
Average common shares outstanding:                         
Basic   7,374,589    7,160,700    7,076,877    6,951,727    6,907,015 
Diluted   7,547,885    7,391,831    7,257,818    7,055,684    6,976,634 
Per share:                         
Basic earnings available to common stockholders  $1.66   $1.54   $1.15   $0.83   $0.20 
Diluted earnings available to common stockholders  $1.62   $1.49   $1.12   $0.82   $0.20 
Dividends-common stock  $0.48   $0.32   $0.24   $0.24   $0.24 
Dividend payout ratio(4)   29.63%   21.48%   21.43%   29.27%   120.00%
                          
Other Data:                         
Number of full-service offices   31    30    30    31    32 

 

 

(1) Net interest income dividend by average interest earning assets.

(2) Total non-interest expense divided by net interest income plus total non-interest income.

(3) At the end of the period.

(4) Dividends per share divided by diluted earnings per share.

 

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Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operation

 

Overview and Significant Events in 2015

 

MutualFirst is a Maryland corporation and a bank holding company headquartered in Muncie, Indiana, with operations in Allen, Delaware, Elkhart, Grant, Kosciusko, Randolph, St. Joseph and Wabash counties in Indiana. It owns MutualBank, an Indiana commercial bank with 31 bank branches in Indiana, trust offices in Carmel and Crawfordsville, Indiana and a loan origination office in New Buffalo, Michigan. MutualFirst also owns MutualFirst Risk Management, a captive insurance company based in Nevada. The Company is subject to examination, supervision and regulation by the FRB, and the Bank is subject to regulation, supervision and examination by the IDFI and the FDIC.

 

MutualBank is an Indiana commercial bank regulated by the IDFI and the FDIC. MutualFirst is a bank holding company regulated by the FRB, which is subjected to regulatory capital requirements similar to those imposed on the Bank. For more details on these regulations see “Item 1. Business – How We Are Regulated.”

 

At December 31, 2015, we had $1.5 billion in assets, $1.1 billion in loans, $1.1 billion in deposits and $137.0 million in stockholders’ equity. The Company’s total risk-based capital ratio at December 31, 2015 was 13.8%, exceeding the 10.0% requirement for a well-capitalized institution. The ratio of average tangible common equity increased to 9.11% as of year-end 2015 compared to 8.72% at year-end 2014. For the year ended December 31, 2015, net income available to common shareholders was $12.3 million, or $1.66 per basic and $1.62 per diluted share, compared with net income available to common shareholders of $11.0 million, or $1.54 per basic and $1.49 per diluted share for 2014. The details of our 2015 performance are set forth below and in our Consolidated Audited Financial Statements contained in Item 8 of this Form 10-K.

 

Key aspects of our 2015 operations include:

 

·Commercial loans increased $56.1 million, or 17.5% in 2015. Non-real estate consumer loans increased $30.6 million, or 26.7% in 2015.
·Asset quality improved during 2015 as non-performing loans to total loans were 0.66% as of December 31, 2015 compared to 0.73% as of December 31, 2014 and non-performing assets to total assets were 0.65% as of December 31, 2015 compared to 0.75% as of December 31, 2014.
·Deposits increased $12.1 million in 2015 as core deposits increased to 68% of total deposits as of December 31, 2015 compared to 63% of total deposits as of December 31, 2014.
·Tangible common equity to total tangible assets is 9.11% and tangible book value per common share is $18.11 as of December 31, 2015 compared to tangible common equity to total tangible assets of 8.72% and tangible book value per common share of $17.12 as of December 31, 2014.

 

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·Net interest income increased by $718,000 in 2015 compared to 2014.
·Provision for loan losses was $725,000 less in 2015 compared to 2014.
·Non-interest income increased $2.3 million, or 15% in 2015 compared to 2014, primarily due to the acquisition of Summit Mortgage in 2014.
·Non-interest expense increased $1.8 million, or 4% in 2015 compared to 2014, primarily due to the acquisition of Summit Mortgage in 2014.
·In October 2015, MutualBank opened a branch location in Fort Wayne, Indiana, the second largest city in the State of Indiana.

 

Our principal business consists of attracting retail deposits from the general public, including some brokered deposits, and investing those funds primarily in loans secured by first mortgages on owner-occupied, one- to four-family residences, a variety of consumer loans, loans secured by commercial real estate and commercial business loans. Funds not invested in loans generally are invested in investment securities, including mortgage-backed and mortgage-related securities and agency and municipal bonds. We also obtain funds from FHLB advances and other borrowings.

 

MutualWealth is the wealth management division of the Bank providing a variety of fee-based financial services, including trust, investment, insurance, broker advisory, retirement plan and private banking services, in the Bank’s market area. MutualWealth produces non-interest income for the Bank that is tied primarily to the market value of the portfolios being managed. As of December 31, 2015, MutualWealth had $577.9 million of fiduciary assets and generated $3.5 million in commission income during 2015. Decreases in market value could have a negative impact on the non-interest income generated by this division of the Bank.

 

MutualFinancial Services is the brokerage division of the Bank providing a variety of fee-based financial services related to securities and investment transactions. MutualFinancial Services produces non-interest income for the Bank that is tied primarily to the volume of the transactions being processed. During 2015, MutualFinancial Services generated $982,000 in commission income.

 

Our results of operations depend primarily on the level of our net interest income, which is the difference between interest income on interest-earning assets, such as loans, mortgage-backed securities and investment securities, and interest expense on interest-bearing liabilities, primarily deposits and borrowings. The structure of our interest-earning assets versus the structure of interest-bearing liabilities, along with the shape of the yield curve, has a direct impact on our net interest income. Historically, our interest-earning assets have been longer term in nature (i.e., fixed-rate mortgage loans) and interest-bearing liabilities have been shorter term (i.e., certificates of deposit, regular savings accounts, etc.). This structure would impact net interest income favorably in a decreasing rate environment, assuming a normally shaped yield curve, as the rates on interest-bearing liabilities would decrease more rapidly than rates on the interest-earning assets. Conversely, in an increasing rate environment, assuming a normally shaped yield curve, net interest income would be impacted unfavorably as rates on interest-earning assets would increase at a slower rate than rates on interest-bearing liabilities.

 

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The Company continues to reduce the impact of interest rate changes on its net interest income by shortening the term of its interest-earning assets to better match the terms of our interest-bearing liabilities and by selling long-term fixed rate loans and increasing the term of certain liabilities. See “Item 7A - Quantitative and Qualitative Disclosures About Market Risk - Asset and Liability Management and Market Risk” in this Form 10-K. It has been the Company’s strategic objective to change the repricing structure of its interest-earning assets from longer term to shorter term to better match the structure of our interest-bearing liabilities and therefore reduce the impact interest rate changes have on our net interest income. Strategies employed to accomplish this objective have been to increase the originations of variable rate commercial loans and shorter term consumer loans and to sell longer term mortgage loans. The percentage of non-residential consumer and commercial loans to total loans has increased from 42.2% at the end of 2014 to 47.8% as of December 31, 2015. We saw improvement in the economic conditions in some areas within our footprint and were able to take important steps towards reaching our strategic target loan mix. On the liability side of the balance sheet, the Company is employing strategies intended to increase the balance of core deposit accounts, such as low cost checking and money market accounts. The percentage of core deposits to total deposits was 67.9% at December 31, 2015 compared to 62.8% at the end of 2014. The remaining total deposits are mostly retail certificates of deposit, which continue to provide stable funding for the Company. These are ongoing strategies that are dependent on current market conditions and competition. The Company lengthens the term to maturity of FHLB advances when advantageous to lengthen repricing of the liability side of the balance sheet in order to reduce interest rate risk exposure.

 

During 2015, in keeping with our strategic objective to reduce interest rate risk exposure, the Company also sold $145.4 million of long-term fixed rate loans that had been held for sale, which reduced potential earning assets and therefore had a negative impact on net interest income. This was offset, in the short term, by recognizing a gain on the sale of these loans of $4.2 million.

 

Results of operations also are dependent upon the level of the Company’s non-interest income, including fee income and service charges, and the level of its non-interest expense, including general and administrative expenses. The Company continues to look for options to increase the level of non-interest income. In keeping with the strategic focus on commission income, in 2015, we purchased a $65.7 million trust portfolio from an Indiana institution. This acquisition provides additional opportunities for us to increase our non-interest income.

 

As we continue to work to increase our non-interest income and control non-interest expense, regulatory changes continue to have an impact. In 2015, the Company continued to see a decrease in overdraft fee income due to regulatory changes implemented in 2010; we also had an increase in non-interest expense related to administrative costs associated with the impact of the additional regulatory burden. New regulatory requirements regarding interchange income could have an impact on the Company in the future; however, at this time these requirements are limited to larger institutions.

 

Another factor that may lead to changes in net interest income is the level of non-performing assets. An increase in non-performing assets (i.e., loans, repossessed assets, or securities) would decrease interest income and may decrease overall net interest income without additional decreases in interest-bearing liabilities. The recent recession, had a negative impact on our financial condition, operations, net income and stock price. The economy is recovering; however, current troubled loans may continue to incur losses during this recovery.

 

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Recent Accounting Standards

 

For discussion of recent accounting standards, please see Item 8 - “Note 2: Impact of Accounting Pronouncements to our Consolidated Financial Statements” in Item 8 of this Form 10-K.

 

Critical Accounting Policies

 

The Notes to the Consolidated Financial Statements in Item 8 of this Form 10-K contain a summary of the Company’s significant accounting policies. Certain of these policies are important to the portrayal of the Company’s financial condition, since they require management to make difficult, complex or subjective judgments, some of which may relate to matters that are inherently uncertain. Management believes that its critical accounting policies include determining the allowance for loan losses, the valuation of foreclosed assets, mortgage servicing rights, valuation of intangible assets and securities, deferred tax asset and income tax accounting.

 

The determination of the adequacy of the allowance for loan losses is based on estimates that are particularly susceptible to significant changes in the economic environment and market conditions. A worsening or protracted economic decline would increase the likelihood of additional losses due to credit and market risk and could create the need for additional loss reserves.

 

Allowance for Loan Losses. The allowance for loan losses is a significant estimate that can and does change based on management’s assumptions about specific borrowers and current general economic and business conditions, among other factors. Management reviews the adequacy of the allowance for loan losses on at least a quarterly basis. The evaluation by management includes consideration of past loss experience, changes in the composition of the loan portfolio, the current condition and amount of loans outstanding, identified problem loans and the probability of collecting all amounts due.

 

Foreclosed Assets. Foreclosed assets are carried at the lower of cost or fair value less estimated selling costs. Management estimates the fair value of the properties based on current appraisal information. Fair value estimates are particularly susceptible to significant changes in the economic environment, market conditions, and real estate market. A worsening or protracted economic decline would increase the likelihood of a decline in property values and could create the need to write down the properties through current operations.

 

Mortgage Servicing Rights. MSRs associated with loans originated and sold, where servicing is retained, are capitalized and included in other assets in the consolidated balance sheet. The value of the capitalized servicing rights represents the fair value of the right to service loans in the portfolio. Critical accounting policies for MSRs relate to the initial valuation and subsequent impairment tests. The methodology used to determine the valuation of MSRs requires the development and use of a number of estimates, including anticipated principal amortization and prepayments of that principal balance. Events that may significantly affect the estimates used are changes in interest rates, mortgage loan prepayment speeds and the payment performance of the underlying loans. The carrying value of the MSRs is periodically reviewed for impairment based on a determination of fair value. For purposes of measuring impairment, the servicing rights are compared to a valuation prepared based on a discounted cash flow methodology, utilizing current prepayment speeds and discount rates. Impairment, if any, is recognized through a valuation allowance and is recorded as a reduction in loan servicing fee income.

 

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Goodwill and Intangible Assets. MutualFirst periodically assesses the impairment of its goodwill and the recoverability of its core deposit intangible. Impairment is the condition that exists when the carrying amount exceeds its implied fair value. If actual external conditions and future operating results differ from MutualFirst’s judgments, impairment and/or increased amortization charges may be necessary to reduce the carrying value of these assets to the appropriate value.

 

Goodwill is tested for impairment on an annual basis as of October 1, or whenever events or changes in circumstances indicate the carrying amount of goodwill exceeds its implied fair value. No events or changes in circumstances have occurred since the annual impairment test that would suggest is was more likely than not goodwill impairment existed.

 

Securities. Under FASB Codification Topic 320 (ASC 320), Investments-Debt and Equity Securities, investment securities must be classified as held to maturity, available for sale or trading. Management determines the appropriate classification at the time of purchase. The classification of securities is significant since it directly impacts the accounting for unrealized gains and losses on securities. Debt securities are classified as held-to-maturity and carried at amortized cost when management has the positive intent and the Company has the ability to hold the securities to maturity. Securities not classified as held-to-maturity are classified as available for sale and are carried at fair value, with the unrealized holding gains and losses, net of tax, reported in other comprehensive income and do not affect earnings until realized.

 

The fair values of the Company’s securities are generally determined by reference to quoted prices from reliable independent sources utilizing observable inputs. Certain of the Company’s fair values of securities are determined using models whose significant value drivers or assumptions are unobservable and are significant to the fair value of the securities. These models are utilized when quoted prices are not available for certain securities or in markets where trading activity has slowed or ceased. When quoted prices are not available and are not provided by third party pricing services, management judgment is necessary to determine fair value. As such, fair value is determined using discounted cash flow analysis models, incorporating default rates, estimation of prepayment characteristics and implied volatilities.

 

The Company evaluates all securities on a quarterly basis, and more frequently when economic conditions warrant additional evaluations, for determining if OTTI exists pursuant to guidelines established in ASC 320. In evaluating the possible impairment of securities, consideration is given to the length of time and the extent to which the fair value has been less than cost, the financial condition and near-term prospects of the issuer, and the ability and intent of the Company to retain its investment in the issuer for a period of time sufficient to allow for any anticipated recovery in fair value. In analyzing an issuer’s financial condition, the Company may consider whether the securities are issued by the federal government or its agencies or government sponsored agencies, whether downgrades by bond rating agencies have occurred, and the results of reviews of the issuer’s financial condition.

 

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If management determines that an investment experienced an OTTI, management must then determine the amount of the OTTI to be recognized in earnings. If management does not intend to sell the security and it is more likely than not that the Company will not be required to sell the security before recovery of its amortized cost basis less any current period loss, the OTTI will be separated into the amount representing the credit loss and the amount related to all other factors. The amount of 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 OTTI related to other factors will be recognized in other comprehensive income, net of applicable taxes. The previous amortized cost basis less the OTTI recognized in earnings will become the new amortized cost basis of the investment. If management intends to sell the security or more likely than not will be required to sell the security before recovery of its amortized cost basis less any current period credit loss, the OTTI will be recognized in earnings equal to the entire difference between the investment’s amortized cost basis and its fair value at the balance sheet date. Any recoveries related to the value of these securities are recorded as an unrealized gain (as accumulated other comprehensive income (loss) in stockholders’ equity) and not recognized in income until the security is ultimately sold.

 

The Company from time to time may dispose of an impaired security in response to asset/liability management decisions, future market movements, business plan changes, or if the net proceeds can be reinvested at a rate of return that is expected to recover the loss within a reasonable period of time.

 

Deferred Tax Asset. The Company has evaluated its deferred tax asset to determine if it is more likely than not that the asset will be utilized in the future. The Company’s most recent evaluation has determined that, except for the amounts represented by the valuation allowance as discussed below, the Company will more likely than not be able to utilize the remaining deferred tax asset. The Company has generated average positive pre-tax pre-provision earnings of $16.1 million, or 1.1% of pre-tax pre-provision ROA over the previous five years. These earnings would be sufficient to utilize portions of the operating losses, tax credit carryforwards and temporary tax differences over the allowable periods. The analysis supports no additional valuation reserve is needed.

 

The valuation allowances established are the result of net operating losses for state franchise tax purposes and unused business income tax credits totaling $29,783,000 and capital losses realized on the sale of investment securities as well as the recognition of other than temporary impairment on investment securities where the loss, while recognized for financial statement purposes, has not yet been realized.

 

At the end of 2015, the Company had $139,000 in capital losses, a decrease of $5,000 in capital losses in 2014 as capital gains from the sale of available for sale securities were generated. The Company has avoided and will continue to avoid taking any book tax benefit on future capital losses without capital gains to offset the current capital losses. See Note 14 of the Notes to Consolidated Financial Statements contained in Item 8 of this Form 10-K.

 

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Income Tax Accounting. We file a consolidated federal income tax return. The provision for income taxes is based upon income in our consolidated financial statements, rather than amounts reported on our income tax return. Deferred tax assets and liabilities are recognized for future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect of a change in tax rates on our deferred tax assets and liabilities is recognized as income or expense in the period that includes the enactment date.

 

Management Strategy

 

Our strategy is to operate as an independent, business- and retail- oriented financial institution dedicated to serving customers in our market area. Our commitment is to provide a broad range of products and services to meet the needs of our customers. As part of this commitment, we are looking to increase our emphasis on commercial business products and services. We also operate a fully interactive transactional website that also allows consumers to open accounts. In addition, we are continually looking at cost-effective ways to expand our market area. Financial highlights of our strategy have included:

 

Broadening Loan Portfolio Diversification. We continue to work toward diversifying our loan portfolio to reduce our reliance on any one type of loan. Approximately 42.2% of our loan portfolio consisted of loans other than consumer real estate loans at the end of 2014. At the end of 2015, that percentage had increased to 47.8%, reflecting an increase of $86.7 million in our commercial and non-residential consumer loan portfolios.

 

Continuing as a Leading One- to Four-Family Lender in Indiana. We are one of the largest originators of one- to four-family residential loans in our market area. During 2015, we originated $204.4 million of one- to four-family residential first mortgage loans. While the recent economic environment has decreased real estate values, refinancing activity has still been steady as rates have remained low.

 

Increasing Market Share and Changing Mix of Deposits. We continue to be successful in the growth of core deposits. Over the last year, we have increased core deposits as a percentage of total deposits, changing the deposit mix from 62.8% of total deposits at the end of 2014 to 67.9% of total deposits at the end of 2015. This includes an increase in non-interest bearing deposits of 16.5% during the same time period.

 

Expanding Wealth Management Presence. We continue to focus on leveraging our operations in the markets in which we serve. At the same time, the Company has also made strategic decisions to acquire assets within new markets when the appropriate opportunity arises. Total fiduciary accounts increased from $536.1 million at December 31, 2014 to $577.9 million at December 31, 2015. Commission income (non-interest income) generated by these relationships during 2015 totaled $3.5 million.

 

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Financial Condition at December 31, 2015 Compared to December 31, 2014

 

General. Total assets at year-end 2015 were $1.5 billion, reflecting a $54.8 million increase during the year, primarily due to the $64.2 million, or 6.3% increase in the gross loan portfolio, excluding loans held for sale. Average interest-earning assets increased $39.8 million, or 30.7%, to $1.34 billion at December 31, 2015 from $1.30 billion at December 31, 2014. Average interest-bearing liabilities increased by $12.4 million, or 1.1% to $1.13 billion at year-end 2015 from $1.12 billion at year-end 2014 reflecting an increase in FHLB advances. Average stockholders’ equity increased by $12.9 million or 10.8% during 2015.

 

Cash and Securities. Cash and securities (including our bank deposits) decreased from $290.4 million at year-end 2014 to $282.1 million at year-end 2015. The details of our cash and securities are as follows:

 

   At December 31,   Amount   Percent 
   2015   2014   Change   Change 
   (Dollars in thousands) 
Cash  $8,610   $7,475   $1,135    15.18%
Interest-bearing demand deposits   12,305    22,100    (9,795)   (44.32)
Securities available for sale (fair value)   261,138    260,806    332    0.13 
Total  $282,053   $290,381   $(8,328)   (2.87)%

 

At December 31, 2015, our securities portfolio consisted of $192.5 million in government-sponsored agency and government sponsored entity mortgage-backed securities and collateralized mortgage obligations, $57.2 million in municipal securities and $11.5 million in corporate obligations. At December 31, 2015, these securities had gross unrealized gains of $4.9 million and gross unrealized losses of $2.5 million, of which $1.3 million was primarily due to unrealized losses on trust preferred securities. We have the ability to hold the trust preferred securities until maturity and believe that we will be able to collect the adjusted amortized cost basis of the securities. See Note 4 of the Notes to Consolidated Financial Statements in Item 8 for additional information about our investment securities.

 

We expect to maintain a similar level of liquid assets in 2016. We believe it is prudent to maintain higher liquidity as we expect increasing loan demand and a possible rise in interest rates.

 

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Loans. Our gross loan portfolio, excluding loans held for sale, increased to $1.1 billion at year-end 2015 from $1.0 billion at year-end 2014. The following table reflects the changes in the gross amount of loans, excluding loans held for sale, by type during 2015:

 

   At December 31,   Amount   Percent 
   2015   2014   Change   Change 
   (Dollars in thousands) 
Real estate                    
Commercial  $236,895   $198,019   $38,876    19.63%
Commercial construction and development   15,744    33,102    (17,358)   (52.44)
Consumer closed end first mortgage   491,451    517,063    (25,612)   (4.95)
Consumer open end and junior liens   70,990    71,073    (83)   (0.12)
Total real estate loans   815,080    819,257    (4,177)   (0.51)
                     
Consumer loans                    
Auto   15,480    14,712    768    5.22 
Boat/RV   123,621    94,761    28,860    30.46 
Other   6,171    5,184    987    19.04 
Total consumer other   145,272    114,657    30,615    26.70 
Commercial and industrial   123,043    88,474    34,569    39.07 
Total other loans   268,315    203,131    65,184    32.09 
                     
Total Loans  $1,083,395   $1,022,388   $61,007    5.97%

 

The Bank made significant progress in the strategy to increase commercial and consumer loans as we increased the commercial portfolio by $56.1 million and the non-residential consumer portfolio by $30.6 million during 2015. We continue to seek opportunities to provide financing for new and growing commercial borrowers as well as refinancing to sound commercial borrowers currently served by other financial institutions. The increase in the commercial and consumer portfolios was partially offset by the decrease in one- to four-family loans during the period. Lower rates have increased our purchase loan activity while also allowing consumers to refinance their mortgage loans; however we are starting to see those activities slow down. The Bank continues to sell longer term fixed-rate mortgage loans to reduce related interest rate risk.

 

Delinquencies and Non-performing Assets. As of December 31, 2015, our total loans delinquent 30-to-89 days was $12.0 million or 1.1% of total loans, compared to $14.9 million or 1.5% of total loans at the end of 2014.

 

At December 31, 2015, our non-performing assets totaled $9.6 million or 0.65% of total assets, compared to $10.7 million or 0.75% of total assets at December 31, 2014. This $1.1 million, or 10.4% decrease was due to a decrease in non-performing loans primarily in the commercial and industrial loan portfolio. The table below sets forth the amounts and categories of non-performing assets in our loan portfolio at the dates indicated.

 

   At December 31,   Amount   Percent 
   2015   2014   Change   Change 
   (Dollars in thousands) 
Non-accruing loans  $6,904   $7,212   $(308)   (4.27)%
Accruing loans delinquent 90 days or more   267    226    41    18.14 
Foreclosed assets   2,455    3,305    (850)   (25.72)
Total  $9,626   $10,743   $(1,117)   (10.40)%

 

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Our non-performing assets decreased in 2015 as local economic conditions improved. The Bank continues to diligently monitor and write down loans that appear to have irreversible weakness. The Bank works to ensure possible problem loans have been identified and steps have been taken to reduce loss by restructuring loans to improve cash flow or by increasing collateral. In addition to the decrease in non-performing assets, the Company has seen significant improvement during the year in total classified assets. Total classified assets decreased by 33.2% from $26.2 million at December 31, 2014 to $17.5 million at December 31, 2015.

 

At December 31, 2015, foreclosed commercial real estate totaled $1.0 million and consisted of two commercial properties in our existing lending footprint. The Bank has seen improvement in this portfolio as market values have stabilized, which has decreased the number of new foreclosures and assisted in our sale of existing properties. At December 31, 2015, the Bank had 18 foreclosed residential properties with a book value of $906,000. All foreclosed real estate is currently for sale. At the end of 2015, the Bank also held $513,000 in other repossessed assets, such as autos, boats, RVs and horse trailers.

 

In addition to the non-performing assets set forth in the table above, as of December 31, 2015, there was an aggregate of $4.9 million in loans with respect to which known information about the possible credit problems of the borrowers have caused management to have doubts as to the ability of the borrowers to comply with present loan repayment terms and which may result in the future inclusion of such items in the non-performing asset categories. These loans have been considered in management’s determination of the adequacy of our allowance for loan losses. Management reviews each of these relationships at least quarterly to determine if further downgrades and specific loan allocations are prudent.

 

Allowance for Loan Loss. Allowance for loan losses decreased $527,000 from $13.2 million at December 31, 2014 to $12.6 million December 31, 2015 as reflected below:

 

   Year Ended December 31, 
   2015   2014 
   (Dollars in thousands) 
Balance at beginning of period  $13,168   $13,412 
Charge-offs   1,387    1,882 
Recoveries   735    788 
Net charge-offs   652    1,094 
Provisions charged to operations   125    850 
Balance at end of period  $12,641   $13,168 
           
Ratio of net charge-offs during the period to average loans outstanding during the period   0.06%   0.11%
           
Allowance as a percentage of non-performing loans   176.28%   177.04%
Allowance as a percentage of total loans (end of period)   1.17%   1.30%

 

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Specific loan loss allocation related to loans that have been individually evaluated for impairment increased $100,000, and general loan loss reserves have decreased $627,000 as the non-performing loans and classified assets have improved. Net charge offs for the year 2015 were $652,000, or 0.06% of average loans on an annualized basis, compared to $1.1 million, or 0.11% of average loans for 2014. As of December 31, 2015, the allowance for loan losses as a percentage of loans receivable and non-performing loans was 1.17% and 176.3%, respectively, compared to 1.30% and 177.0%, respectively, at December 31, 2014. Allowance for loan losses as a percentage of loans receivable decreased primarily due to an increase in the total loan portfolio. Allowance for loan losses as a percentage of non-performing loans decreased due to the decrease in allowance, based on management’s evaluation, in conjunction with the decrease in non-performing loans as of December 31, 2015. The decrease in the allowance was primarily due to management’s ongoing evaluation of the loan portfolio conditions in our market areas.

 

Our non-accrual loans include four loan relationships totaling $2.6 million, or 38.0% of the non-accrual loan total. This total includes two commercial real estate relationship with two outstanding loans totaling $1.8 million and two consumer mortgage relationships totaling $809,000 in outstanding loans.

 

Other Assets. Other material changes in our assets during 2015 include a decrease in Federal Home Loan Bank stock of $1.5 million.

 

Deposits. Total deposits increased $12.1 million to $1.09 billion at year-end 2015 compared to $1.08 billion at year-end 2014, primarily due to increased non-interest bearing checking accounts, as reflected in the table below, with corresponding weighted average rates as of the same date, partially offset by an increase in core transaction accounts. These changes are consistent with the Bank’s strategy to grow and strengthen core deposit relationships.

 

   At December 31,         
   2015   2014         
   Amount   Weighted
Average
Rate
   Amount   Weighted
Average
Rate
   Amount
Change
   Percent
Change
 
   (Dollars in thousands)         
Type of Account:                              
Non-interest Checking  $179,542    0.00%  $154,178    0.00%  $25,364    16.45%
Interest-bearing NOW   267,089    0.23    253,042    0.23    14,047    5.55 
Savings   131,578    0.01    124,051    0.01    7,527    6.07 
Money Market   162,551    0.20    146,847    0.23    15,704    10.69 
Certificates of Deposit   350,622    1.14    401,202    1.17    (50,580)   (12.61)
Total  $1,091,382    0.45%  $1,079,320    0.67%  $12,062    1.12%

 

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Borrowings. Total borrowings increased $32.5 million, or 16.0%, to $235.1 million at year-end 2015 primarily due to a $33.2 million increase in FHLB advances to fund increases in the loan portfolio. Other borrowings, consisting of a bank loan and trust preferred securities, decreased $716,000 to $9.5 million at year-end 2015 due to regular loan payments.

 

In 2013, the Company borrowed $7.6 million from First Tennessee Bank, N.A. to refinance existing long-term debt. The loan was originated at a variable rate of LIBOR plus 2.80%; however the Company entered into a forward interest rate swap that fixed the rate of the note at 3.92%. The balance of the loan at December 31, 2015 was $5.3 million and matures in December 2017.

 

The Company acquired $5.0 million of issuer trust preferred securities in a 2008 acquisition of another financial institution, which had a net balance of $4.1 million at December 31, 2015 due to the purchase accounting adjustment in the acquisition. These securities mature 30 years from the date of issuance or September 15, 2035. The securities bore a fixed rate of interest of 6.22% through July 2010 and thereafter have to reset quarterly at the prevailing three-month LIBOR rate plus 170 basis points. The Company has had the right to redeem the trust preferred securities, in whole or in part, without penalty, since September 2010.

 

Stockholders’ Equity. Stockholders’ equity was $137.0 million as of December 31, 2015, an increase of $10.3 million from December 31, 2014. The increase was primarily due to net income available to common shareholders of $12.3 million and an increase of $2.0 million due to exercises of stock options. These increases were partially offset by cash dividends of $3.6 million. The Company’s tangible book value per common share as of December 31, 2015 increased to $18.11 compared to $17.12 as of December 31, 2014 and the tangible common equity ratio increased to 9.11% as of December 31, 2015 compared to 8.72% as of December 31, 2014. MFSF and the Bank’s risk-based capital ratios were well in excess of “well-capitalized” levels as defined by all regulatory standards as of December 31, 2015.

 

Financial Condition at December 31, 2014 Compared to December 31, 2013

 

General. Total assets at year-end 2014 were $1.4 billion, reflecting a $32.8 million increase during the year, primarily due to the $37.3 million, or 4.3% increase in the gross loan portfolio. Average interest-earning assets increased $4.8 million, or 0.4%, to $1.30 billion at December 31, 2014 from $1.29 billion at December 31, 2013. Average interest-bearing liabilities increased by $4.4 million, or 0.4% to $1.12 billion at year-end 2014 from $1.11 billion at year-end 2013 reflecting a decrease in term deposits. Average stockholders’ equity increased by $12.9 million or 9.8% during 2014.

 

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Cash and Securities. Cash and securities (including our bank deposits) increased from $289.6 million at year-end 2013 to $290.4 million at year-end 2014. The details of our cash and securities are as follows:

 

   At December 31,   Amount   Percent 
   2014   2013   Change   Change 
   (Dollars in thousands) 
Cash  $7,475   $8,013   $(538)   (6.71)%
Interest-bearing demand deposits   22,100    17,272    4,828    27.95 
Securities available for sale (fair value)   260,806    264,348    (3,542)   (1.34)
Total  $290,381   $289,633   $748    0.26%

 

The decrease in investment securities reflects the use of investments cash flow to fund loan growth.

 

At December 31, 2014, our securities portfolio consisted of $211.0 million in government-sponsored agency mortgage-backed securities and collateralized mortgage obligations, $4,000 in federal agency securities, $29.3 million in municipal securities and $20.5 million in corporate obligations. At December 31, 2014, these securities had gross unrealized gains of $6.3 million and gross unrealized losses of $2.2 million, of which $1.3 million was primarily due to unrealized losses on trust preferred securities. We have the ability to hold the trust preferred securities until maturity and believe that we will be able to collect the adjusted amortized cost basis of the securities. See Note 4 of the Notes to Consolidated Financial Statements in Item 8 for additional information about our investment securities.

 

We expect to maintain a similar level of liquid assets in 2015. We believe it is prudent to maintain higher liquidity as we expect increasing loan demand and a possible rise in interest rates.

 

Loans. Our gross loan portfolio, excluding loans held for sale, increased to $1.0 billion at year-end 2014 from $990.2 million at year-end 2013. The following table reflects the changes in the gross amount of loans, excluding loans held for sale, by type during 2014:

 

   At December 31,   Amount   Percent 
   2014   2013   Change   Change 
   (Dollars in thousands) 
Real estate                    
Commercial  $198,019   $200,817   $(2,798)   (1.39)%
Commercial construction and development   33,102    13,321    19,781    148.49 
Consumer closed end first mortgage   517,063    531,272    (14,209)   (2.67)
Consumer open end and junior liens   71,073    69,354    1,719    2.48 
Total real estate loans   819,257    814,764    4,493    0.55 
                     
Consumer loans                    
Auto   14,712    14,856    (144)   (0.97)
Boat/RV   94,761    79,419    15,342    19.32 
Other   5,184    5,766    (582)   (10.09)
Total consumer other   114,657    100,041    14,616    14.61 
Commercial and industrial   88,474    75,402    13,072    17.34 
Total other loans   203,131    175,443    27,688    15.78 
                     
Total Loans  $1,022,388   $990,207   $32,181    3.25%

 

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The Bank made significant progress in the strategy to increase commercial and consumer loans as we increased the commercial portfolio by $30.1 million and the non-residential consumer portfolio $14.6 million during 2014. We continue to seek opportunities to provide refinancing opportunities to sound commercial borrowers currently served by other financial institutions. The increase in the commercial and consumer portfolios was offset by the decrease in the one- to four-family loans during the period. Lower rates have allowed consumers to refinance their mortgage loans; however we are starting to see those activities slow down. The Bank continues to sell longer term fixed-rate mortgage loans to reduce related interest rate risk.

 

Delinquencies and Non-performing Assets. As of December 31, 2014, our total loans delinquent 30-to-89 days was $14.9 million or 1.5% of total loans, compared to $18.1 million or 1.8% of total loans at the end of 2013.

 

At December 31, 2014, our non-performing assets totaled $10.7 million or 0.75% of total assets, compared to $17.0 million or 1.22% of total assets at December 31, 2012. This $6.3 million, or 36.9% decrease was due to a decrease in non-performing loans in all portfolios as the Company’s footprint has seen economic and market stabilization throughout the year. The table below sets forth the amounts and categories of non-performing assets in our loan portfolio at the dates indicated.

 

   At December 31,   Amount   Percent 
   2014   2013   Change   Change 
   (Dollars in thousands) 
Non-accruing loans  $7,212   $8,400   $(1,188)   (14.14)%
Accruing loans delinquent 90 days or more   226    188    38    20.21 
Foreclosed assets   3,305    8,433    (5,128)   (60.81)
Total  $10,743   $17,021   $(6,278)   (36.88)%

 

Our non-performing assets decreased in 2014 as local economic conditions improved. The Bank continues to diligently monitor and write down loans that appear to have irreversible weakness. The Bank works to ensure possible problem loans have been identified and steps have been taken to reduce loss by restructuring loans to improve cash flow or by increasing collateral. In addition to the decrease in non-performing assets, the Company has seen significant improvement during the year in total classified assets. Total classified assets decreased by 25.4% from $35.1 million at December 31, 2013 to $26.2 million at December 31, 2014.

 

At December 31, 2014, foreclosed commercial real estate totaled $1.4 million and consisted of six commercial properties in our existing lending footprint. The Bank has seen improvement in this portfolio as market values have stabilized, which has decreased the number of new foreclosures and assisted in our sale of existing properties. At December 31, 2014, the Bank had 27 residential properties with a book value of $1.5 million. All foreclosed real estate is currently for sale. At the end of 2014, the Bank also held $476,000 in other repossessed assets, such as autos, boats, RVs and horse trailers.

 

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Non-accruing commercial real estate loans, including construction and development loans, decreased from $2.5 million at December 31, 2013, to $2.2 million at December 31, 2014. Non-accruing commercial business loans as well as consumer mortgage loans also decreased from $1.1 million and $4.5 million, respectively, at the end of 2013 to $605,000 and $4.2 million, respectively, at the end of 2014. Management continues to monitor these non-accruing loans aggressively and it is management’s opinion that the non-accruing loans are sufficiently reserved as of December 31, 2014.

 

In addition to the non-performing assets set forth in the table above, as of December 31, 2014, there was an aggregate of $5.7 million in loans with respect to which known information about the possible credit problems of the borrowers have caused management to have doubts as to the ability of the borrowers to comply with present loan repayment terms and which may result in the future inclusion of such items in the non-performing asset categories. These loans have been considered in management’s determination of the adequacy of our allowance for loan losses. Management reviews each of these relationships at least quarterly to determine if further downgrades and specific loan allocations are prudent.

 

Allowance for Loan Loss. Allowance for loan losses decreased $244,000 from $13.4 million at December 31, 2013 to $13.2 million December 31, 2014 as reflected below:

 

   Year Ended December 31, 
   2014   2013 
   (Dollars in thousands) 
Balance at beginning of period  $13,412   $16,038 
Charge-offs   1,882    4,539 
Recoveries   788    613 
Net charge-offs   1,094    3,926 
Provisions charged to operations   850    1,300 
Balance at end of period  $13,168   $13,412 
           
Ratio of net charge-offs during the period to average loans outstanding during the period   0.11%   0.40%
           
Allowance as a percentage of non-performing loans   177.04%   156.15%
Allowance as a percentage of total loans (end of period)   1.30%   1.37%

 

Specific loan loss allocation related to loans that have been individually evaluated for impairment decreased $335,000, and general loan loss reserves have increased $91,000 as the non-performing loans and classified assets have improved. Net charge offs for the year 2014 were $1.1 million, or 0.11% of average loans on an annualized basis, compared to $3.9 million, or 0.40% of average loans for 2013. As of December 31, 2014, the allowance for loan losses as a percentage of loans receivable and non-performing loans was 1.30% and 177.0%, respectively, compared to 1.37% and 156.15%, respectively, at December 31, 2013. Allowance for loan losses as a percentage of loans receivable decreased primarily due to an increase in the total loan portfolio. Allowance for loan losses as a percentage of non-performing loans increased due to the decrease in non-performing loans in the 2014. The decrease was primarily due to management’s ongoing evaluation of the loan portfolio conditions in our market areas.

 

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Our non-accrual loans include three loan relationships totaling $2.6 million, or 34.9% of the non-accrual loan total. This total includes one commercial real estate relationship with two outstanding loans totaling $1.3 million and two consumer mortgage relationships totaling $1.3 million in outstanding loans.

 

Goodwill. The Company acquired Summit Mortgage, Inc. in 2014. The acquisition of Summit generated goodwill of $1.8 million.

 

Other Assets. Other material changes in our assets during 2014 include: a $1.2 million increase in cash surrender value of BOLI; and a $524,000 reduction in our core deposit and other intangible assets reflecting current amortization.

 

Deposits. Total deposits decreased $33.8 million to $1.08 billion at year-end 2014 compared to $1.11 billion at year-end 2013, primarily due to decreased term deposits, as reflected in the table below, with corresponding weighted average rates as of the same date, partially offset by an increase in core transaction accounts. These changes are consistent with the Bank’s strategy to grow and strengthen core deposit relationships.

 

   At December 31, 
   2014   2013 
   Amount   Weighted
Average
Rate
   Amount   Weighted
Average
Rate
 
   (Dollars in thousands) 
Type of Account:                    
Non-interest Checking  $154,178    0.00%  $144,195    0.00%
Interest-bearing NOW   253,042    0.23    262,114    0.23 
Savings   124,051    0.01    119,380    0.01 
Money Market   146,847    0.23    115,600    0.24 
Certificates of Deposit   401,202    1.17    471,795    1.39 
Total  $1,079,320    0.52%  $1,113,084    0.67%

 

Borrowings. Total borrowings increased $48.8 million, or 31.7%, to $202.6 million at year-end 2014 primarily due to a $49.5 million increase in FHLB advances. Other borrowings, consisting of a bank loan and trust preferred securities, decreased $716,000 to $10.2 million at year-end 2014 due to regular loan payments.

 

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In 2013, the Company borrowed $7.6 million from First Tennessee Bank, N.A. to refinance existing long-term debt. The loan was originated at a variable rate of LIBOR plus 2.80%; however the Company entered into a forward interest rate swap that fixed the rate of the note at 3.92%. The balance of the loan at December 31, 2014 was $6.1 million and matures in December 2017.

 

The Company acquired $5.0 million of issuer trust preferred securities in a 2008 acquisition of another financial institution, which had a net balance of $4.1 million at December 31, 2014 due to the purchase accounting adjustment in the acquisition. These securities mature 30 years from the date of issuance or September 15, 2035. The securities bore a fixed rate of interest of 6.22% through July 2010 and thereafter were to reset quarterly at the prevailing three-month LIBOR rate plus 170 basis points. In December 2009, the Company entered into a cash flow hedge with FTN Financial to fix the floating portion of the issued trust preferred security at 5.15% for the next five years starting on September 15, 2010. The Company has had the right to redeem the trust preferred securities, in whole or in part, without penalty, since establishing the cash flow hedge.

 

Stockholders’ Equity. Stockholders’ equity was $127.5 million at December 31, 2014, an increase of $15.9 million from December 31, 2013. This increase was due primarily to net income of $10.8 million, increases in other comprehensive income of $6.0 million and the exercise of stock options of $1.3 million. These increases were partially offset by common stock dividend payments of $2.3 million. The Company’s tangible book value per share as of December 31, 2014 increased to $17.22 per share compared to $15.46 per share as of December 31, 2013 and the tangible common equity ratio was 8.77% as of December 31, 2014 compared to 7.91% as of December 31, 2013. The Company’s and the Bank’s risk-based capital ratios were in excess of “well-capitalized” levels as defined by all applicable regulatory standards as of December 31, 2014.

 

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Average Balances, Net Interest Income, Yields Earned and Rates Paid

 

The following table presents for the periods indicated the total dollar amount of interest income from average interest-earning assets and the resultant yields, as well as the interest expense on average interest-bearing liabilities, expressed both in dollars and rates. No tax equivalent adjustments were made. All average balances are daily average balances. Non-accruing loans have been included in the table as loans carrying a zero yield.

 

   Year ended December 31, 
   2015   2014   2013 
   Average
Outstanding
Balance
   Interest
Earned/Paid
   Average
Yield/Rate
   Average
Outstanding
Balance
   Interest
Earned/Paid
   Average
Yield/Rate
   Average
Outstanding
Balance
   Interest
Earned/Paid
   Average
Yield/Rate
 
   (Dollars in thousands) 
Interest-Earning Assets:                                             
Interest -bearing deposits  $19,789   $14    0.07%  $21,121   $17    0.08%  $21,718   $29    0.13%
Mortgage-backed securities available for sale (1)   195,781    5,294    2.70    212,494    5,679    2.67    226,675    6,106    2.69 
Investment securities available for sale (1)   63,041    1,796    2.85    51,845    1,357    2.62    50,774    1,001    1.97 
Loans (2)   1,047,313    44,190    4.22    997,064    43,522    4.37    978,495    44,028    4.50 
Stock in FHLB of Indianapolis   10,698    482    4.51    14,285    603    4.22    14,391    503    3.50 
 Total interest-earning assets   1,336,622    51,776    3.87    1,296,809    51,178    3.95    1,292,053    51,667    4.00 
Non-Interest Earning Assets (net of allowance for loan losses and unrealized gain (loss)   108,765              109,221              110,705           
Total Assets  $1,445,387             $1,406,030             $1,402,758           
                                              
Interest-Bearing Liabilities:                                             
Demand and NOW accounts  $262,424   $591    0.23   $257,554   $578    0.22   $264,033   $648    0.25 
Savings deposits   129,980    13    0.01    124,795    13    0.01    117,609    12    0.01 
Money market accounts   160,095    396    0.25    136,732    348    0.25    110,013    267    0.24 
Certificate accounts   375,102    4,259    1.14    429,738    5,189    1.21    514,427    8,410    1.63 
Total deposits   927,601    5,259    0.57    948,819    6,128    0.65    1,006,082    9,337    0.93 
Borrowings   205,066    3,544    1.73    171,471    2,795    1.63    109,791    1,887    1.72 
Total interest-bearing accounts   1,132,667    8,803    0.77    1,120,290    8,923    0.80    1,115,873    11,224    1.01 
Non-Interest Bearing Accounts   165,470              152,057              140,926           
Other Liabilities   15,271              14,586              13,989           
Total Liabilities   1,313,408              1,286,933              1,270,788           
Stockholders' Equity   131,979              119,097              131,970           
Total liabilities and stockholders' equity  $1,445,387             $1,406,030             $1,402,758           
Net Earning Assets  $203,955             $176,519             $176,180           
Net Interest Income       $42,973             $42,255             $40,443      
Net Interest Rate Spread (3)             3.10%             3.15%             2.99%
Net Yield on Average Interest-Earning Assets (4)             3.22%             3.26%             3.13%
Average Interest-Earning Assets to Average Interest- Bearing Liabilities   118.01%             115.76%             115.79%          

 

 

(1) Average balances were calculated using amortized cost, which excludes FASB 115 valuation allowances.

(2) Calculated net of deferred loan fees, loan discounts and loans in process.

(3) Interest rate spread is calculated by subtracting weighted average interest rate cost form weighted average interest rate yield for the period indicated.

(4) The net yield on weighted average interest-earning assets is calculated by dividing net interest income by weighted average interest-earning assets for the period indicated.

 

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Rate/Volume Analysis

 

The following table presents the dollar amount of changes in interest income and interest expense for major components of interest-earning assets and interest-bearing liabilities. For each category of interest-earning assets and interest-bearing liabilities, information is provided on changes attributable to changes in volume, which are changes in volume multiplied by the old rate, and changes in rate, which is a change in rate multiplied by the old volume. Changes attributable to both rate and volume, which cannot be segregated, are allocated proportionately to the change due to volume and the change due to rate.

 

   Year Ended December 31, 
   2015 vs. 2014   2014 vs. 2013 
   Increase (Decrease) Due to       Increase (Decrease) Due to     
   Volume   Rate   Total Increase
(Decrease)
   Volume   Rate   Total Increase
(Decrease)
 
   (Dollars in thousands) 
Interest-Earning Assets:                              
Interest -bearing deposits  $-   $(3)  $(3)  $-   $(12)  $(12)
Investment securities available for sale   (154)   208    54    (361)   290    (71)
Loans receivable   2,193    (1,525)   668    836    (1,342)   (506)
Stock in FHLB of Indianapolis   (151)   30    (121)   (4)   104    100 
                               
 Total interest-earning assets  $1,888   $(1,290)  $598   $471   $(960)  $(489)
                               
Interest-Bearing Liabilities:                              
 Savings deposits  $1   $(1)  $-   $1   $-   $1 
 Money market accounts   59    (11)   48    65    16    81 
 Demand and NOW accounts   11    2    13    (16)   (54)   (70)
 Certificate accounts   (660)   (270)   (930)   (1,385)   (1,836)   (3,221)
 Borrowings   548    201    749    1,060    (152)   908 
                               
Total interest-bearing liabilities  $(41)  $(79)  $(120)  $(275)  $(2,026)  $(2,301)
                               
Change in net interest income            $718             $1,812 

 

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Comparison of Results of Operations for the Years Ended December 31, 2015 and 2014.

 

General. Net income available to common stockholders for the year ended December 31, 2015 was $12.3 million or $1.66 basic and $1.62 diluted earnings per common share compared to net income available to common stockholders of $11.0 million, or $1.54 basic and $1.49 diluted earnings per common share for the year ended December 31, 2014.

 

Interest Income. Total interest income increased $598,000, or 1.2%, to $51.8 million during the year ended December 31, 2015 from $51.2 million during the year ended December 31, 2014. The $39.8 million increase in average interest-earning assets to $1.3 billion at year end 2015 was partially offset by an eight basis point decrease in average yield on interest-earning assets to 3.87% in 2015 compared to 3.95% in 2014 as interest earning assets continue to reprice lower. Interest income on loans in 2015 was $44.2 million compared to $43.5 million in 2014, reflecting a $50.2 million increase in average loan balances, partially offset by a 15 basis point decrease in the weighted average yield on loans in 2014 to 4.22%. Interest income on investments, incuding FHLB stock, decreased slightly in 2015 by $67,000 to $7.6 million reflecting seven basis point increase in the weighted average yield on investments in 2015 to 2.81%, offset by the $9.1 million decrease in average investments to $269.5 in 2015.

 

Interest Expense. Interest expense decreased $120,000, or 1.3%, to $8.8 million during the year ended December 31, 2015 compared to $8.9 million during the year ended December 31, 2014. The primary reason for this decrease was a decline of three basis points on interest-bearing liabilities from 0.80% during 2014 to 0.77% during 2015, which was primarily due to continued re-pricing of deposit accounts. Interest expense on deposits decreased $869,000, due to an eight basis point decline in average rates combined with a $21.2 million decrease in average interest-bearing deposits. Interest expense on borrowings increased $749,000 as a result of a ten basis point increase in average rates and a $33.6 million increase in average borrowings during 2015.

 

Net Interest Income. Net interest income before the provision for loan losses increased $718,000 in 2015 compared to 2014. The increase was a result of an increase of $39.8 million in average interest-earning assets due to an increase in the average loan portfolio of $50.2 million. This increase was partially offset by the net interest margin decreasing to 3.22% in 2015 compared to 3.26% in 2014. Tax equivalent net interest margin was 3.29% in 2015 compared to 3.31% in 2014. For more information on our asset/liability management especially as it relates to interest rate risk, see “Item 7A - Quantitative and Qualitative Disclosures About Market Risk” in this Form 10-K.

 

Provision for Loan Losses. The provision for loan losses for the year 2015 was $125,000 compared to $850,000 in 2014. The decrease was primarily due to a decline in net charge-offs and improving asset quality. Net charge-offs for the year 2015 totaled $652,000, or 0.06% of loans, compared to $1.1 million, or 0.11%, in 2014.

 

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Non-Interest Income. Non-interest income increased in 2015 by $2.3 million, from $14.9 million in 2014.

 

   Year Ended   Amount   Percent 
   12/31/2015   12/31/2014   Change   Change 
   (Dollars in thousands) 
Non-Interest Income:                    
Service fee income  $5,947   $5,995   $(48)   (0.80)%
Net realized gain (loss) on sale of securities   436    313    123    39.30 
Commissions   4,603    4,868    (265)   (5.44)
Net gains on sales of loans   4,176    1,849    2,327    125.85 
Net servicing fees   274    114    160    140.35 
Increase in cash surrender value of life insurance   1,184    1,158    26    2.25 
Loss on sale of other real estate and repossessed assets   (111)   (53)   (58)   109.43 
Other income   630    641    (11)   (1.72)
Total  $17,139   $14,885   $2,254    15.14%

 

The increase in non-interest income was driven by a $2.3 million increase in net gain on sale of loans due to increased activity at the Bank and its subsidiary, Summit Mortgage, Inc., which was acquired in the third quarter of 2014.

 

Non-Interest Expense. Non-interest expense increased by $1.8 million to $43.1 million in 2015.

 

   Year Ended   Amount   Percent 
   12/31/2015   12/31/2014   Change   Change 
   (Dollars in thousands) 
Non-Interest Expense:                    
Salaries and employee benefits  $25,526   $23,560   $1,966    8.34%
Net occupancy expenses   2,260    2,258    2    0.09 
Equipment expenses   1,831    1,872    (41)   (2.19)
Data processing fees   1,746    1,558    188    12.07 
Advertising and promotion   1,193    1,497    (304)   (20.31)
ATM expense   1,436    1,320    116    8.79 
Deposit insurance   897    1,019    (122)   (11.97)
Professional fees   1,695    1,628    67    4.12 
Software subscriptions and publications   1,749    1,652    97    5.87 
Other real estate and repossessed assets   374    631    (257)   (40.73)
Other expenses   4,440    4,383    57    1.30 
Total  $43,147   $41,378   $1,769    4.28%

 

The increase was primarily a result of expenses associated with Summit Mortgage which was acquired in the third quarter of 2014, which increased expenses by $1.6 million in 2015 mainly in salaries and employee benefits.

 

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Income Tax Expense. Income tax expense in 2015 increased $712,000 compared to 2014. The effective tax rate for 2015 was 27.2% compared to 25.9% for 2014 due to increased pre-tax income and decreased low income housing credits.

 

Comparison of Results of Operations for the Years Ended December 31, 2014 and 2013.

 

General. Net income available to common stockholders for the year ended December 31, 2014 was $10.8 million or $1.51 basic and $1.46 diluted earnings per common share compared to net income available to common stockholders of $7.9 million, or $1.12 basic and $1.09 diluted earnings per common share for the year ended December 31, 2013. The primary reason for this increase is an improvement in net interest margin of 13 basis points and an $822,000 increase in non-interest income. Our return on assets and on average tangible equity was 0.77% and 9.37%, respectively in 2014 compared to 0.66% and 7.42% in 2013.

 

Interest Income. Total interest income decreased $489,000, or 1.0%, to $51.2 million during the year ended December 31, 2014 from $51.7 million during the year ended December 31, 2013. The $4.8 million increase in average interest-earning assets to $1.3 billion at year end 2014 was offset by a five basis point decrease in average yield on interest-earning assets to 3.95% in 2014 compared to 4.00% in 2013 as interest earning assets continue to reprice lower. Interest income on loans in 2014 was $43.5 million compared to $44.0 million in 2013, reflecting a 13 basis point decrease in the weighted average yield on loans in 2014 to 4.37%, partially offset by an increase in average loans of $18.6 million. Interest income on investment securities increased slightly in 2014 by $29,000 to $7.6 million in combination with a 14 basis point increase in the weighted average yield on investment securities in 2014 to 2.74%, offset by the $13.2 million decrease in average securities to $278.6 in 2014.

 

Interest Expense. Interest expense decreased $2.3 million, or 20.5%, to $8.9 million during the year ended December 31, 2014 compared to $11.2 million during the year ended December 31, 2013. The primary reason for this decrease was a decline of 21 basis points on interest-bearing liabilities from 1.01% during 2013 to 0.80% during 2014, which was primarily due to continued re-pricing of deposit accounts. Interest expense on deposits decreased $3.2 million, due to a 28 basis point decline in average rates combined with a $57.3 million decrease in average interest-bearing deposits. Interest expense on borrowings increased $908,000 as a result of a one basis point increase in average rates and a $61.2 million increase in average borrowings during 2014.

 

Net Interest Income. Net interest income before the provision for loan losses increased $1.8 million for 2014 compared to 2013. The increase was a result of net interest margin improving by 13 basis points and an increase in average earning assets of $4.8 million, due to average loan growth of $18.6 million offset by a decline in average investments of $13.2 million. For more information on our asset/liability management especially as it relates to interest rate risk, see “Item 7A - Quantitative and Qualitative Disclosures About Market Risk” in this Form 10-K.

 

Provision for Loan Losses. The provision for loan losses for 2014 decreased to $850,000 compared to $1.3 million during 2013. The decrease was primarily due to a reduction in net charge offs to $1.1 million in 2014 compared to net charge offs of $3.9 million in 2013. Non-performing loans decreased $1.2 million, or 13% as of December 31, 2014 compared to December 31, 2013.

 

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Other Income. Other (non-interest) income increased in 2014 by $822,000 from $14.1 million in 2013.

 

   Year Ended   Amount   Percent 
   12/31/2014   12/31/2013   Change   Change 
   (Dollars in thousands) 
Non-Interest Income:                    
Service fee income  $5,995   $5,989   $6    0.10%
Net realized gain (loss) on sale of securities   313    835    (522)   (62.51)
Commissions   4,868    4,354    514    11.81 
Net gains on sales of loans   1,849    852    997    117.02 
Net servicing fees   114    556    (442)   (79.50)
Increase in cash surrender value of life insurance   1,158    1,396    (238)   (17.05)
Loss on sale of other real estate and repossessed assets   (53)   (320)   267    (83.44)
Other income   641    401    240    59.85 
Total  $14,885   $14,063   $822    5.85%

 

The increases were in part due to the acquisitions of Summit Mortgage and a trust portfolio in 2014 which helped increase gain on sale of loans by $997,000 and increased commission income by $514,000. These gains were partially offset by a decline in gain on sale of investments of $522,000 and a decline in servicing fees of $442,000 primarily due to valuation recoveries in 2013 that were not duplicated in 2014.

 

Other Expense. Other (non-interest) expense increased by $1.7 million to $41.4 million in 2014.

 

   Year Ended   Amount   Percent 
   12/31/2014   12/31/2013   Change   Change 
   (Dollars in thousands) 
Non-Interest Expense:                    
Salaries and employee benefits  $23,560   $22,492   $1,068    4.75%
Net occupancy expenses   2,258    2,087    171    8.19 
Equipment expenses   1,872    1,837    35    1.91 
Data processing fees   1,558    1,431    127    8.87 
Advertising and promotion   1,497    1,464    33    2.25 
ATM expense   1,320    1,132    188    16.61 
Deposit insurance   1,019    1,145    (126)   (11.00)
Professional fees   1,628    1,394    234    16.79 
Software subscriptions and publications   1,652    1,452    200    13.77 
Other real estate and repossessed assets   631    773    (142)   (18.37)
Other expenses   4,383    4,480    (97)   (2.17)
Total  $41,378   $39,687   $1,691    4.26%

 

These increases were related to salaries and benefits increasing by $1.1 million primarily due to the acquisition of Summit Mortgage and normal salary increases. Increases in occupancy and equipment of $206,000 were primarily due to the harsh winter at the beginning of 2014. Increases in professional fees of $234,000 were related to increased legal fees associated with certain REOs and investment management services.

 

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Income Tax Expense. Income tax expense in 2014 decreased $225,000 compared to 2013. The Company’s effective tax rate decreased to 24.9% in 2014 from 29.3% in 2013 primarily due to the release of a $600,000 deferred tax asset valuation allowance.

 

Liquidity

 

We are required to have enough cash and investments that qualify as liquid assets in order to maintain sufficient liquidity to ensure safe and sound operation. Liquidity may increase or decrease depending upon the availability of funds and comparative yields on investments in relation to the return on loans. Historically, we have maintained liquid assets above levels believed to be adequate to meet the requirements of normal operations, including potential deposit outflows. Cash flow projections are regularly reviewed and updated to assure that adequate liquidity is maintained.

 

Liquidity management involves the matching of cash flow requirements of customers, who may be either depositors desiring to withdraw funds or borrowers needing assurance that sufficient funds will be available to meet their credit needs and the ability of the Company to manage those requirements. The Company strives to maintain an adequate liquidity position by managing the balances and maturities of interest-earning assets and interest-bearing liabilities so that the balance it has in short-term investments at any given time will cover adequately any reasonably anticipated, immediate need for funds. Additionally, the Bank maintains relationships with correspondent banks, which could provide funds on short-term notice if needed. Our liquidity, represented by cash and cash-equivalents and investment securities, is a product of our operating, investing and financing activities.

 

Liquidity management is both a daily and long-term function of the management of the Company and the Bank. It is overseen by the Asset and Liability Management Committee. The Board of Directors required the Bank to maintain a minimum liquidity ratio of 10% of deposits. At December 31, 2015, our ratio was 26.3%. The Company is currently in excess of the minimum liquidity ratio set by the Board due to a larger than historical investment portfolio. Management continues to seek to utilize liquidity off of the investment portfolio to fund loan growth over the next few years as demand for loans increase. Excess liquidity is generally invested in short-term investments, such as overnight deposits and federal funds. On a longer term basis, we maintain a strategy of investing in various lending products and investment securities, including mortgage-backed and municipal securities. The Bank uses its sources of funds primarily to meet its ongoing commitments, pay maturing deposits, fund deposit withdrawals and fund loan commitments.

 

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We maintain cash and investments that qualify as liquid assets to maintain adequate liquidity to ensure safe and sound operation and meet demands for funds (particularly withdrawals of deposits). At December 31, 2015, on a consolidated basis, the Company had $282.1 million in cash and investment securities available for sale and $6.0 million in loans held for sale generally available for its cash needs. We can also generate funds from borrowings, primarily FHLB advances, and, to a lesser degree, third party loans. At December 31, 2015, the Bank had the ability to borrow an additional $66.4 million in FHLB advances. In addition, we have historically sold 15- and 30-year long-term, fixed-rate mortgage loans in the secondary market in order to reduce interest rate risk and to create another source of liquidity. The Company is a separate legal entity from the Bank and must provide for its own liquidity. In addition to its own operating expenses (many of which are paid to the Bank), the Company is responsible for paying amounts owed on its trust preferred securities, any dividends declared to its common stockholders, and interest and principal on outstanding debt. The Company’s primary source of funds is Bank dividends, the payment of which is subject to regulatory limits. At December 31, 2015, the Company, on an unconsolidated basis, had $2.8 million in cash, interest-bearing deposits and liquid investments generally available for its cash needs.

 

Our liquidity, represented by cash and cash equivalents and investment securities, is a product of our operating, investing and financing activities. Our primary sources of funds are deposits, amortization, prepayments and maturities of outstanding loans and mortgage-backed securities, maturities of investment securities and other short-term investments and funds provided from operations. While scheduled payments from the amortization of loans and mortgage-backed securities and maturing investment securities and short-term investments are relatively predictable sources of funds, deposit flows and loan prepayments are greatly influenced by general interest rates, economic conditions and competition. In addition, we invest excess funds in short-term interest-earning assets, which provide liquidity to meet lending requirements. We also generate cash through borrowings. We utilize FHLB advances to leverage our capital base and provide funds for our lending and investment activities, and to enhance our interest rate risk management.

 

We use our sources of funds primarily to meet ongoing commitments, pay maturing deposits and fund withdrawals, and to fund loan commitments. At December 31, 2015, the approved outstanding loan commitments, including unused lines of credit, amounted to $228.5 million. Certificates of deposit scheduled to mature in one year or less at December 31, 2015, totaled $143.4 million. It is management’s policy to offer deposit rates that are competitive with other local financial institutions. Based on this management strategy, we believe that a majority of maturing deposits will remain with the Bank.

 

Except as set forth above, management is not aware of any trends, events, or uncertainties that will have, or that are reasonably likely to have a material impact on liquidity, capital resources or operations. Further, management is not aware of any current recommendations by regulatory agencies, which, if they were to be implemented, would have this effect.

 

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Off-Balance Sheet Activities

 

In the normal course of operations, the Bank engages in a variety of financial transactions that are not recorded in our financial statements. These transactions involve varying degrees of off-balance sheet credit, interest rate and liquidity risks. These transactions are used primarily to manage customers’ requests for funding and take the form of loan commitments and lines of credit. We also have off-balance sheet obligations to repay borrowings and deposits. For the year ended December 31, 2015, we engaged in no off-balance sheet transactions likely to have a material effect on our financial condition, results of operations or cash flows. At December 31, 2015, the Bank had $128.2 million in commitments to make loans, $7.4 million in undisbursed portions of closed loans, $93.0 million in unused lines of credit and $2.5 million in standby letters of credit. In addition, on a consolidated basis, at December 31, 2015, the Company had $235.1 million in outstanding non-deposit borrowings, of which $24.3 million is due during 2015.

 

Capital Resources

 

The Bank is subject to minimum capital requirements imposed by the FDIC. See “Item 1 - Business- How We Are Regulated - Regulatory Capital Requirements.” The FDIC may require the Bank to have additional capital above the specific regulatory levels if it believes the Bank is subject to increased risk due to asset problems, high interest rate risk and other risks. The Company is subject to minimum capital requirements imposed by the FRB, which are substantially similar to those imposed on the Bank, including guidelines for bank holding companies to be considered well-capitalized.

 

The Company did not repurchase any common stock in 2015.

 

At December 31, 2015, the Bank’s regulatory capital exceeded the FDIC regulatory requirements, and the Bank was well-capitalized under regulatory prompt corrective action standards. In addition, at December 31, 2015, the Company’s capital levels exceeded the FRB’s requirements, and the Company was considered well-capitalized under FRB guidelines. Consistent with our goals to operate a sound and profitable organization, our policy is for the Bank to maintain well-capitalized status.

 

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Our capital ratios at December 31, 2015 are reflected below:

 

   Actual Capital Levels   Minimum Regulatory
Capital Levels
   Minimum Required To be
Considered Well-Capitalized
 
   Amount   Ratio   Amount   Ratio   Amount   Ratio 
                         
Leverage Capital Level (1) :                              
MutualFirst Consolidated  $132,727    9.1%  $58,608    4.0%   N/A    N/A 
MutualBank   134,754    9.2    58,509    4.0   $73,136    5.0%
Common Equity Tier 1 Capital Level (2) :                              
MutualFirst Consolidated  $131,520    12.5%  $47,331    4.5%   N/A    N/A 
MutualBank   134,754    12.8    47,309    4.5   $68,336    6.5%
Tier 1 Risk-Based Capital Level (2) :                              
MutualFirst Consolidated  $132,727    12.6%  $63,108    6.0%   N/A    N/A 
MutualBank   134,757    12.8    63,079    6.0   $84,106    8.0%
Total Risk-Based Capital Level (3) :                              
MutualFirst Consolidated  $145,368    13.8%  $84,144    8.0%   N/A    N/A 
MutualBank   147,395    14.0    84,106    8.0   $105,132    10.0%

 

 

(1) Tier 1 Capital to Average Total Assets of $1.5 billion for the Bank and $1.5 billion for the Company at December 31, 2015.

(2) Common Equity Tier 1 Capital to Risk-Weighted Assets of $1.1 billion for the Bank and $1.1 billion for the Company at December 31, 2015.

(3) Tier 1 Capital to Risk-Weighted Assets.

(4) Total Capital to Risk-Weighted Assets.

 

Impact of Inflation

 

The effects of price changes and inflation can vary substantially for most financial institutions. While management believes that inflation affects the economic value of total assets, it believes that it is difficult to assess the overall impact. Management believes this to be the case due to the fact that generally neither the timing nor the magnitude of the inflationary changes in the consumer price index (“CPI”) coincides with changes in interest rates. For example, the price of one or more of the components of the CPI may fluctuate considerably and thereby influence the overall CPI without having a corresponding effect on interest rates or upon the cost of those goods and services normally purchased by us. In years of high inflation and high interest rates, intermediate and long-term interest rates tend to increase, thereby adversely impacting the market values of investment securities, mortgage loans and other long-term fixed rate loans. In addition, higher short-term interest rates caused by inflation tend to increase the cost of funds. In other years, the opposite may occur.

 

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Item 7A. Quantitative and Qualitative Disclosures About Market Risk

 

Asset and Liability Management and Market Risk

 

Our Risk When Interest Rates Change. The rates of interest we earn on assets and pay on liabilities generally is established contractually for a period of time. Market interest rates change over time. Accordingly, our results of operations, like those of other financial institutions, are impacted by changes in interest rates and the interest rate sensitivity of our assets and liabilities. The risk associated with changes in interest rates and our ability to adapt to these changes is known as interest rate risk and is one of our most significant market risks.

 

Management continues to evaluate options to mitigate interest rate risk in an increasing interest rate environment during this cycle of extremely low interest rates. This includes shortening assets and lengthening liabilities when possible.

 

How We Measure Our Risk of Interest Rate Changes. As part of our attempt to manage our exposure to changes in interest rates, we monitor our interest rate risk. In monitoring interest rate risk, we continually analyze and manage assets and liabilities based on their payment streams and interest rates, the timing of their maturities and their sensitivity to actual or potential changes in market interest rates. In order to minimize the potential for adverse effects of material and prolonged changes in interest rates on our results of operations, the Bank’s board of directors establishes asset and liability management policies to better match the maturities and repricing terms of our interest-earning assets and interest-bearing liabilities.

 

These asset and liability policies are implemented by the Asset and Liability Management Committee, which is chaired by the Chief Financial Officer and is comprised of members of our senior management team. The purpose of the Asset and Liability Management Committee is to communicate, coordinate and control asset/liability management issues consistent with our business plan and board-approved policies. The committee establishes and monitors the volume and mix of assets and funding sources taking into account relative costs and spreads, interest rate sensitivity and liquidity needs. The objective of these actions is to manage assets and funding sources consistent with liquidity, capital adequacy, growth, risk and profitability goals. The Asset and Liability Management Committee generally meets monthly to review, among other things, economic conditions and interest rate outlook, current and projected liquidity needs and capital position, anticipated changes in the volume and mix of assets and liabilities and interest rate risk exposure limits versus current projections pursuant to a net present value of portfolio equity analysis and income simulations. At each meeting, the Asset and Liability Management Committee recommends appropriate strategy changes based on this review. The Chief Financial Officer is responsible for reviewing and reporting on the effects of the policy implementations and strategies to the Board of Directors, at least quarterly.

 

In order to manage our assets and liabilities and achieve the desired liquidity, credit quality, interest rate risk, profitability and capital targets, we have sought to:

 

·originate and purchase adjustable rate mortgage loans and commercial business loans;

 

·originate shorter-duration consumer loans,

 

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·manage our deposits to establish stable deposit relationships,

 

·acquire longer-term borrowings at fixed rates, when appropriate, to offset the negative impact of longer-term fixed rate loans in our loan portfolio, and

 

·limit the percentage of long-term fixed-rate loans in our portfolio.

 

Depending on the level of general interest rates, the relationship between long and short-term interest rates, market conditions and competitive factors, the Asset and Liability Management Committee may increase our interest rate risk position somewhat in order to maintain our net interest margin and improve earnings. We will continue to increase our emphasis on the origination of relatively short-term and/or adjustable rate loans. In addition, in an effort to avoid an increase in the percentage of long-term, fixed-rate loans in our portfolio, during 2015 we sold in the secondary market $145.4 million of fixed rate, one- to four-family mortgage loans with a term to maturity of 15 years or greater, which was 71% of all such loans originated by the Bank during the year.

 

If past rate movements are an indication of future changes, they usually are neither instantaneous nor do a majority of core deposits reprice at the same level as rates change. The following chart reflects the Bank’s percentage change in net interest income, over a one year time period, and net portfolio value (NPV) assuming an instantaneous parallel rate shock in a range from down 100 basis points to up 400 basis points as of December 31, 2015.

 

   Percentage Change in 
   Net Interest Income   NPV 
Rate Shock:          
Up 400 basis points   (7.0)%   (14.2)%
Up 300 basis points   (4.5)%   (11.9)%
Up 200 basis points   (2.2)%   (7.9)%
Up 100 basis points   (0.5)%   (4.6)%
Down 100 basis points   (7.8)%   (11.4)%

 

The following chart indicates the Company’s percentage change in net interest income and NPV assuming rate movements that are not instantaneous, but change gradually over one year.

 

   Percentage Change in 
   Net Interest Income   NPV 
Rate Shock:          
Up 400 basis points   (2.9)%   (11.0)%
Up 300 basis points   (2.7)%   (10.2)%
Up 200 basis points   (2.0)%   (7.2)%
Up 100 basis points   (0.9)%   (4.4)%
Down 100 basis points   (6.6)%   (11.4)%

 

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The analyses indicate that net interest income and NPV would decline in an instantaneous upward or downward rate shock. While our balance sheet is slightly liability sensitive, the model does not take into consideration any rates below zero. Since deposit rates are close to the floor, there would be limited opportunity to reprice deposits in a downward rate environment.

 

As with any method of measuring interest rate risk, certain shortcomings are inherent in the method of analysis presented in the chart. For example, although certain assets and liabilities may have similar maturities or periods to repricing, they may react in different degrees to changes in market interest rates. Also, the interest rates on certain types of assets and liabilities may fluctuate in advance of changes in market interest rates, while interest rates on other types may lag behind changes in market rates. Additionally, certain assets, such as adjustable rate mortgage loans, have features which restrict changes in interest rates on a short-term basis and over the life of the asset. Further, if interest rates change, expected rates of prepayments on loans and early withdrawals from certificates could deviate significantly from those assumed in calculating the tables. Therefore, the Company also considers potential interest rate shocks that are not immediate parallel shocks in various rate scenarios. Management currently believes that interest rate risk is managed appropriately in more practical rate shock scenarios than those in the chart on the previous page.

 

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Item 8. Financial Statements and Supplementary Data

 

MutualFirst Financial, Inc.

 

Report of Independent Registered Public Accounting Firm and
Consolidated Financial Statements

 

December 31, 2015, 2014 and 2013

 

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Report of Independent Registered Public Accounting Firm

 

Audit Committee, Board of Directors and Stockholders

MutualFirst Financial, Inc.

Muncie, Indiana

 

We have audited the accompanying consolidated balance sheets of MutualFirst Finanacial, Inc. as of December 31, 2015, and 2014, and the related consolidated statements of income, comprehensive income, stockholders' equity and cash flows for each of the years in the three-year period ended December 31, 2015. The Company's management is responsible for these financial statements. Our responsibility is to express an opinion on these financial statements based on our audits.

 

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement. Our audits included examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

 

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of MutualFirst Financial, Inc. as of December 31, 2015, and 2014, and the results of its operations and its cash flows for each of the years in the three-year period ended December 31, 2015, in conformity with accounting principles generally accepted in the United States of America.

 

As discussed in Note 25 to the consolidated financial statements, the Company has changed its method of accounting for investments in qualified affordable housing projects in all periods presented due to the adoption of ASU 2014-01.

 

We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), MutualFirst Financial Inc.'s internal control over financial reporting as of December 31, 2015, based on criteria established in Internal Control-Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) and our report dated March 15, 2016, expressed an unqualified opinion on the effectiveness of the Company's internal control over financial reporting.

 

/s/ BKD, LLP

 

Indianapolis, Indiana

March 15, 2016

 

 

 

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MutualFirst Financial, Inc.

Consolidated Balance Sheets
(In Thousands, Except Share and Per Share Data)

 

   2015   2014 
Assets          
Cash and due from banks  $8,610   $7,475 
Interest-bearing demand deposits   12,305    22,100 
Cash and cash equivalents   20,915    29,575 
Investment securities available for sale (carried at fair value)   261,138    260,806 
Loans held for sale   5,991    6,140 
Loans, net of allowance for loan losses of $12,641 and $13,168, at December 31, 2015 and 2014, respectively   1,068,204    1,003,518 
Premises and equipment, net   31,048    30,939 
Federal Home Loan Bank stock   10,482    11,964 
Deferred tax asset, net   12,084    13,575 
Cash value of life insurance   51,209    51,002 
Goodwill   1,800    1,800 
Core deposit and other intangibles   811    1,105 
Other real estate owned and repossessed assets   2,456    3,305 
Other assets   12,127    9,694 
Total assets  $1,478,265   $1,423,423 
           
Liabilities and Stockholders' Equity          
Liabilities          
Deposits          
Noninterest-bearing  $179,542   $154,178 
Interest-bearing   911,840    925,142 
Total deposits   1,091,382    1,079,320 
Federal Home Loan Bank advances   225,617    192,442 
Other borrowings   9,458    10,174 
Other liabilities   14,783    14,735 
Total liabilities   1,341,240    1,296,671 
           
Commitments and Contingencies          
           
Stockholders' Equity          
Common stock, $.01 par value          
Authorized - 20,000,000 shares          
Issued and outstanding - 7,422,061 and 7,236,002 shares at December 31, 2015 and December 31, 2014, respectively   74    72 
Additional paid-in capital   77,363    74,916 
Retained earnings   58,098    49,386 
Accumulated other comprehensive income   1,490    2,378 
Total stockholders' equity   137,025    126,752 
Total liabilities and stockholders' equity  $1,478,265   $1,423,423 

 

See Notes to Consolidated Financial Statements

 

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MutualFirst Financial, Inc.

Consolidated Statements of Income
(In Thousands, Except Share and Per Share Data)

 

   2015   2014   2013 
Interest and Dividend Income               
Loans receivable  $44,190   $43,522   $44,028 
Investment securities   7,090    7,036    7,107 
Federal Home Loan Bank stock   482    603    503 
Deposits with financial institutions   14    17    29 
Total interest and dividend income   51,776    51,178    51,667 
                
Interest Expense               
Deposits   5,259    6,128    9,337 
Federal Home Loan Bank advances   3,063    2,225    1,284 
Other   481    570    603 
Total interest expense   8,803    8,923    11,224 
                
Net Interest Income   42,973    42,255    40,443 
Provision for loan losses   125    850    1,300 
Net Interest Income After Provision for Loan Losses   42,848    41,405    39,143 
                
Non-interest Income               
Service fee income   5,947    5,995    5,989 
Net realized gain on sales of available for sale securities   436    313    835 
Commissions   4,603    4,868    4,354 
Net gains on sales of loans   4,176    1,849    852 
Net servicing fees   274    114    556 
Increase in cash value of life insurance   1,184    1,158    1,396 
Loss on sale of other real estate and repossessed assets   (111)   (53)   (320)
Other income   630    641    401 
Total non-interest income   17,139    14,885    14,063 
                
Non-interest Expenses               
Salaries and employee benefits   25,526    23,560    22,492 
Net occupancy expenses   2,260    2,258    2,087 
Equipment expenses   1,831    1,872    1,837 
Data processing fees   1,746    1,558    1,431 
Advertising and promotion   1,193    1,497    1,464 
ATM and debit card expenses   1,436    1,320    1,132 
Deposit insurance   897    1,019    1,145 
Professional fees   1,695    1,628    1,394 
Software subscriptions and maintenance   1,749    1,652    1,452 
Other real estate and repossessed assets   374    631    773 
Other expenses   4,440    4,383    4,480 
Total non-interest expenses   43,147    41,378    39,687 
                
Income Before Income Tax   16,840    14,912    13,519 
Income tax expense   4,578    3,866    4,136 
                
Net Income   12,262    11,046    9,383 
Preferred stock dividends and accretion   -    -    1,257 
                
Net Income Available to Common Shareholders  $12,262   $11,046   $8,126 
                
Earnings Per Share               
Basic  $1.66   $1.54   $1.15 
Diluted  $1.62   $1.49   $1.12 
Dividends Per Share  $0.48   $0.32   $0.24 

 

See Notes to Consolidated Financial Statements

 

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MutualFirst Financial, Inc.

Consolidated Statements of Comprehensive Income
(In Thousands)

 

   2015   2014   2013 
Net Income  $12,262   $11,046   $9,383 
Other Comprehensive Income (Loss)               
Net unrealized holding gain (loss) on securities available for sale   (1,186)   8,921    (9,810)
Net unrealized gain on securities available for sale for which a portion of an other-than-temporary impairment has been recognized in income   12    381    800 
Reclassification adjustment for realized gains included in net income   (436)   (313)   (835)
Net unrealized gain on derivative used for cash flow hedges   108    150    157 
Net unrealized gain (loss) relating to defined benefit plan   77    (209)   149 
    (1,425)   8,930    (9,539)
Income tax (expense) benefit related to other comprehensive income   537    (3,137)   3,321 
Other comprehensive income (loss), net of tax   (888)   5,793    (6,218)
                
Comprehensive Income  $11,374   $16,839   $3,165 

 

See Notes to Consolidated Financial Statements

 

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MutualFirst Financial, Inc.

Consolidated Statements of Stockholders’ Equity
(In Thousands, Except Share and Per Share Data)

 

   Preferred
Stock
   Paid-in
Capital
Preferred
   Common
Stock
   Paid-in
Capital
Common
   Retained
Earnings
   Accumulated
Other
Comprehensive
Income (Loss)
   Unearned
Benefit Plan
Shares
   Total 
Balances, January 1, 2013  $1   $28,923   $71   $72,610   $35,403   $2,803   $(318)  $139,493 
Cumulative effect of change in accounting principle for low income housing tax credits                       (1,196)             (1,196)
Balances, January 1, 2013, as adjusted   1    28,923    71    72,610    34,207    2,803    (318)   138,297 
Net income                       9,383              9,383 
Other comprehensive loss, net of taxes                            (6,218)        (6,218)
Stock options, exercised                  538                   538 
Stock options, vested                  32                   32 
Stock repurchased and retired   (1)   (28,923)                            (28,924)
Cash dividends, common stock ($.24 per share)                       (1,696)             (1,696)
Cash dividends, preferred stock (5%)                       (1,257)             (1,257)
ESOP shares earned                  156              318    474 
Balances December 31, 2013   -    -    71    73,336    40,637    (3,415)   -    110,629 
Net income                       11,046              11,046 
Other comprehensive income, net of taxes                            5,793         5,793 
Stock options, exercised             1    1,346                   1,347 
Tax benefit on stock options                  234                   234 
Cash dividends, common stock ($.32 per share)                       (2,297)             (2,297)
Balances December 31, 2014   -    -    72    74,916    49,386    2,378    -    126,752 
Net income                       12,262              12,262 
Other comprehensive loss, net of taxes                            (888)        (888)
Stock options, exercised             2    2,009                   2,011 
Tax benefit on stock options                  438                   438 
Cash dividends, common stock ($.48 per share)                       (3,550)             (3,550)
Balances December 31, 2015  $-   $-   $74   $77,363   $58,098   $1,490   $-   $137,025 

 

See Notes to Consolidated Financial Statements

 

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MutualFirst Financial, Inc.

Consolidated Statements of Cash Flows
(In Thousands, Except Share and Per Share Data)

 

   2015   2014   2013 
Operating Activities               
Net income  $12,262   $11,046   $9,383 
Items not requiring cash               
Provision for loan losses   125    850    1,300 
Depreciation and amortization   4,546    4,113    5,756 
Deferred income tax   1,926    1,087    2,387 
Loans originated for sale   (145,749)   (67,295)   (67,787)
Proceeds from sales of loans held for sale   149,613    64,614    70,926 
Gain on sale of loans held for sale   (4,176)   (1,849)   (852)
Net gain on sale of securities, available for sale   (436)   (313)   (835)
Loss on sale of other real estate and repossessed assets   111    53    320 
Prepaid FDIC premium   -    -    1,647 
Change in               
Interest receivable and other assets   (1,321)   (386)   (586)
Interest payable and other liabilities   277    774    507 
Cash value of life insurance   (1,184)   (1,158)   (1,396)
Other equity adjustment   -    -    474 
Other adjustments   143    474    375 
Net cash provided by operating activities   16,137    12,010    21,619 
                
Investing Activities               
Purchases of securities, available for sale   (67,414)   (48,001)   (99,766)
Proceeds from maturities and paydowns of securities, available for sale   41,824    31,709    53,348 
Proceeds from sales of securities, available for sale   23,109    28,317    53,179 
Redemption of Federal Home Loan Bank stock   2,154    2,427    - 
Purchase of Federal Home Loan Bank stock   (672)   -    - 
Net change in loans   (67,561)   (41,611)   (3,863)
Purchases of premises and equipment   (2,413)   (1,306)   (1,025)
Cash paid in acquisition, net   -    (900)   - 
Proceeds from real estate owned sales   2,260    7,605    3,753 
Proceeds from bank owned life insurance benefit payment   977    -    - 
Net cash provided by (used in) investing activities   (67,736)   (21,760)   5,626 
                
Financing Activities               
Net change in               
Noninterest-bearing, interest-bearing demand and savings deposits   62,642    36,828    35,215 
Certificates of deposit   (50,580)   (70,593)   (106,140)
Proceeds from FHLB advances   355,700    493,700    355,375 
Repayments of FHLB advances   (322,525)   (444,186)   (287,122)
Repayments of other borrowings   (759)   (759)   (759)
Redemption of preferred stock   -    -    (28,924)
Cash dividends   (3,550)   (2,297)   (2,953)
Stock options exercised   2,011    1,347    570 
Net cash provided by (used in) financing activities   42,939    14,040    (34,738)
Net Change in Cash and Cash Equivalents   (8,660)   4,290    (7,493)
Cash and Cash Equivalents, Beginning of Period   29,575    25,285    32,778 
Cash and Cash Equivalents, End of Period  $20,915   $29,575   $25,285 
                
Additional Cash Flows Information               
Interest paid  $8,827   $8,857   $11,145 
Income tax paid   2,850    2,500    1,800 
Transfers from loans to foreclosed real estate   1,301    2,129    5,038 
Mortgage servicing rights capitalized   460    278    464 
Transfers from fixed assets to other assets   702    -    - 

 

See Notes to Consolidated Financial Statements

 

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MutualFirst Financial, Inc.

Notes to Consolidated Financial Statements
(Table Dollar Amounts in Thousands, Except Share and Per Share Data)

 

Note 1: Nature of Operations and Summary of Significant Accounting Policies

 

The accounting and reporting policies of MutualFirst Financial, Inc. (Company) and its wholly owned subsidiaries, MFBC Statutory Trust, MutualFirst Risk Management, Inc., and MutualBank (Bank) and the Bank’s wholly owned subsidiaries, Mishawaka Financial Services, Mutual Federal Investment Company and the wholly owned subsidiary of Mutual Federal Investment Company, Mutual Federal REIT, Inc. and Summit Service Corp. and their wholly owned subsidiary, Summit Mortgage, Inc., conform to accounting principles generally accepted in the United States of America and reporting practices followed by the banking industry. The more significant of the policies are described below.

 

The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.

 

Material estimates that are particularly susceptible to significant change relate to the determination of the allowance for loan losses, goodwill, valuation of real estate acquired in connection with foreclosures or in satisfaction of loans, loan servicing rights, valuation of deferred tax assets, other-than-temporary impairments (OTTI) and fair value of financial instruments.

 

The Bank generates mortgage, consumer and commercial loans and receives deposits from customers located primarily in North and Central Indiana. The Bank’s loans are generally secured by specific items of collateral including real property, consumer assets and business assets. Mutual Federal Investment Company invests in various investment securities and loans through Mutual Federal REIT, Inc.

 

Consolidation - The consolidated financial statements include the accounts of the Company, the Bank, and the Bank’s subsidiaries, after elimination of all material intercompany transactions.

 

Cash Equivalents - The Company considers all liquid investments with original maturities of three months or less to be cash equivalents. At December 31, 2015 and 2014, cash equivalents consisted primarily of money market accounts with brokers and checking accounts with government sponsored entities.

 

At December 31, 2015, the Company’s cash accounts exceeded federally insured limits by approximately $4.2 million. Included in this amount are uninsured accounts of approximately $2.2 million at the Federal Reserve Bank of Chicago and Federal Home Loan Bank of Indianapolis.

 

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MutualFirst Financial, Inc.

Notes to Consolidated Financial Statements
(Table Dollar Amounts in Thousands, Except Share and Per Share Data)

 

Investment Securities - Certain debt securities that management has the positive intent and ability to hold to maturity are classified as “held to maturity” and recorded at amortized cost. At December 31, 2015 and 2014, no securities were classified as held to maturity. Securities not classified as held to maturity, including equity securities with readily determinable fair values, are classified as “available for sale” and recorded at fair value, with unrealized gains and losses excluded from earnings and reported in other comprehensive income. Purchase premiums and discounts are recognized in interest income using the interest method over the terms of the securities. Gains and losses on the sale of securities are recorded on the trade date and are determined using the specific identification method. When the Company does not intend to sell a debt security, and it is more likely than not that, the Company will not have to sell the security before recovery of its cost basis, it recognizes the credit component of an other-than-temporary impairment of a debt security in earnings and the remaining portion in other comprehensive income. For held-to-maturity debt securities, the amount of an other-than-temporary impairment recorded in other comprehensive income for the noncredit portion of a previous other-than-temporary impairment is amortized prospectively over the remaining life of the security on the basis of the timing of future estimated cash flows of the security.

 

The Company’s consolidated statement of income reflects the full impairment (that is, the differences between the security’s amortized cost basis and fair value) on debt securities that the Company intends to sell or would more likely than not be required to sell before the expected recovery of the amortized cost basis. For available for sale and held-to-maturity debt securities that management has no intent to sell and believes that it more likely than not will not be required to sell prior to recovery, only the credit loss component of the impairment is recognized in earnings, while the noncredit loss is recognized in accumulated other comprehensive income. The credit loss component recognized in earnings is identified as the amount of principal cash flows not expected to be received over the remaining term of the security as projected based on cash flow projections.

 

For equity securities, when the Company has decided to sell an impaired available for sale security and does not expect the fair value of the security to fully recover before the expected time of sale, the security is deemed other-than-temporarily impaired in the period in which the decision to sell is made. The Company recognizes an impairment loss when the impairment is deemed other than temporary even if a decision to sell has not been made.

 

Declines in the fair value of securities below their cost that are other-than-temporary are reflected as realized losses. In estimating other-than-temporary losses, management considers the length of time and extent that fair value has been less than cost, the financial condition and near-term prospects of the issuer, and the Company’s ability and intent to hold the security for a period sufficient to allow for any anticipated recovery in fair value.

 

Loans held for sale are carried at the lower of aggregate cost or market. Market is determined using the aggregate method. Net unrealized losses, if any, are recognized through a valuation allowance by charges to income based on the difference between estimated sales proceeds and aggregate cost.

 

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MutualFirst Financial, Inc.

Notes to Consolidated Financial Statements
(Table Dollar Amounts in Thousands, Except Share and Per Share Data)

 

Loans that management has the intent and ability to hold for the foreseeable future or until maturity or payoffs are reported at their outstanding principal balances adjusted for unearned income, charge-offs, the allowance for loan losses, any unamortized deferred fees or costs on originated loans and unamortized premiums or discounts on purchased loans.

 

For loans amortized at cost, interest income is accrued based on the unpaid principal balance. Loan origination fees, net of certain direct origination costs, as well as premiums and discounts, are deferred and amortized as a level yield adjustment over the respective term of the loan.

 

The accrual of interest on mortgage, consumer and commercial loans is discontinued at the time the loan is 90 days past due unless the credit is well-secured and in process of collection. Past due status is based on contractual terms of the loan. In all cases, loans are placed on nonaccrual or charged off at an earlier date if collection of principal or interest is considered doubtful.

 

All interest accrued but not collected for loans that are placed on nonaccrual or charged off is reversed against interest income. The interest on these loans is accounted for on the cash-basis or cost-recovery method, until qualifying for return to accrual. Loans are returned to accrual status when all the principal and interest amounts contractually due are brought current and future payments are reasonably assured.

 

Discounts and premiums on purchased residential real estate and commercial loans is amortized to income using the interest method over the remaining period to contractual maturity, adjusted for anticipated prepayments. Discounts and premiums on purchased consumer loans are recognized over the expected lives of the loans using methods that approximate the interest method.

 

Allowance for loan losses - The allowance for loan losses is established as losses are estimated to have occurred through a provision for loan losses charged to income. Loan losses are charged against the allowance when management believes the inability to collect a loan balance is confirmed. Subsequent recoveries, if any, are credited to the allowance.

 

We maintain an allowance for loan losses to absorb losses inherent in the loan portfolio. The allowance is based on ongoing, quarterly assessments of the estimated losses inherent in the loan portfolio. Our methodology for assessing the appropriateness of the allowance consists of several key elements, including the general allowance and specific allowances for identified problem loans and portfolio segments. In addition, the allowance incorporates the results of measuring impaired loans as provided in ASC 310, Receivables. These accounting standards prescribe the measurement methods, income recognition and disclosures related to impaired loans.

 

The general allowance is calculated by applying loss factors to outstanding loans based on the internal risk evaluation of such loans or pools of loans. Changes in risk evaluations of both performing and nonperforming loans affect the amount of the general allowance. Loss factors are based on our historical loss experience as well as on significant factors that, in management’s judgment, affect the collectability of the portfolio as of the evaluation date. The historical loss experience is determined by portfolio segment and is based on the actual loss history experienced by the Company over the prior three years. Management believes the three year historical loss experience methodology is appropriate in the current economic environment, as it captures loss rates that are comparable to the current period being analyzed.

 

 98 

 

 

MutualFirst Financial, Inc.

Notes to Consolidated Financial Statements
(Table Dollar Amounts in Thousands, Except Share and Per Share Data)

 

The appropriateness of the allowance is reviewed by management based upon its evaluation of then-existing economic and business conditions affecting our key lending areas and other conditions, such as credit quality trends (including trends in non-performing loans expected to result from existing conditions), collateral values, loan volumes and concentrations, specific industry conditions within portfolio segments and recent loss experience in particular segments of the portfolio that existed as of the balance sheet date and the impact that such conditions were believed to have had on the collectability of the loan. Senior management reviews these conditions quarterly in discussions with our senior credit officers. To the extent that any of these conditions is evidenced by a specifically identifiable problem credit or portfolio segment as of the evaluation date, management’s estimate of the effect of such condition may be reflected as a specific allowance applicable to such credit or portfolio segment. Where any of these conditions is not evidenced by a specifically identifiable problem credit or portfolio segment as of the evaluation date, management’s evaluation of the loss related to this condition is reflected in the general allowance for loan losses. The evaluation of the inherent loss with respect to these conditions is subject to a higher degree of uncertainty because they are not identified with specific problem credits or portfolio segments.

 

The allowance for loan losses is based on estimates of losses inherent in the loan portfolio. Actual losses can vary significantly from the estimated amounts. Our methodology as described permits adjustments to any loss factor used in the computation of the general allowance in the event that, in management’s judgment, significant factors which affect the collectability of the portfolio as of the evaluation date are not reflected in the loss factors. By assessing the probable incurred losses inherent in the loan portfolio on a quarterly basis, we are able to adjust specific and inherent loss estimates based upon any more recent information that has become available. Although employment began to stabilize in the prior year, the impact of job losses over the recent years combined with the decline in real estate values and the increase in higher risk loans, like consumer and commercial loans, as a percentage of total loans, management has concluded that our allowance for loan losses should be greater than historical loss experience and specifically identified losses would otherwise indicate.

 

The allowance for loan losses is evaluated on a regular basis by management and is based upon management’s periodic review of the ability to collect the loans in light of historical experience, the nature and volume of the loan portfolio, adverse situations that may affect the borrower’s ability to repay, estimated value of any underlying collateral and prevailing economic conditions. This evaluation is inherently subjective as it requires estimates that are susceptible to significant revision as more information becomes available.

 

The allowance consists of allocated and general components. The allocated component relates to loans that are classified as impaired. For those loans that are classified as impaired, an allowance is established when the discounted cash flows (or collateral value or observable market price) of the impaired loan is lower than the carrying value of that loan. The general component covers nonclassified loans and is based on historical charge-off experience and expected loss given default derived from the Company’s internal risk rating process. Other adjustments may be made to the allowance for pools of loans after an assessment of internal or external influences on credit quality that are not fully reflected in the historical loss or risk rating data.

 

 99 

 

 

MutualFirst Financial, Inc.

Notes to Consolidated Financial Statements
(Table Dollar Amounts in Thousands, Except Share and Per Share Data)

 

A loan is considered impaired when, based on current information and events, it is probable that the Company will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement. Factors considered by management in determining impairment include payment status, collateral value and the probability of collecting scheduled principal and interest payments when due. Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired. Management determines the significance of payment delays and payment shortfalls on a case-by-case basis, taking into consideration all of the circumstances surrounding the loan and the borrower, including the length of the delay, the reasons for the delay, the borrower’s prior payment record and the amount of the shortfall in relation to the principal and interest owed. Impairment is measured on a loan-by-loan basis for commercial and construction loans by either the present value of expected future cash flows discounted at the loan’s effective interest rate, the loan’s obtainable market price or the fair value of the collateral if the loan is collateral dependent.

 

Groups of loans with similar risk characteristics are collectively evaluated for impairment based on the group’s historical loss experience adjusted for changes in trends, conditions and other relevant factors that affect repayment of the loans. Accordingly, the Company does not separately identify individual consumer and residential loans for impairment measurements, unless such loans are the subject of a restructuring agreement due to financial difficulties of the borrower.

 

Premises and equipment are carried at cost net of accumulated depreciation. Depreciation is computed using the straight-line method based principally on the estimated useful lives of the assets which range from 3 to 50 years. Maintenance and repairs are expensed as incurred while major additions and improvements are capitalized. Gains and losses on dispositions are included in current operations.

 

Federal Home Loan Bank stock is a required investment for institutions that are members of the Federal Home Loan Bank (FHLB) system. The required investment in the common stock is based on a predetermined formula, carried at cost and is evaluated for impairment.

 

Mortgage-servicing assets are recognized separately when rights are acquired through purchase or through sale of financial assets. Under the servicing assets and liabilities accounting guidance, servicing rights resulting from the sale or securitization of loans originated by the Company are initially measured at fair value at the date of transfer. The Company subsequently measures each class of servicing asset using the amortization method. Under the amortization method, servicing rights are amortized in proportion to and over the period of estimated net servicing income. The amortized assets are assessed for impairment based on fair value at each reporting date.

 

 100 

 

 

MutualFirst Financial, Inc.

Notes to Consolidated Financial Statements
(Table Dollar Amounts in Thousands, Except Share and Per Share Data)

 

Fair value is based on market prices for comparable mortgage servicing contracts, when available, or alternatively, is based on a valuation model that calculates the present value of estimated future net servicing income. The valuation model incorporates assumptions that market participants would use in estimating future net servicing income, such as the cost to service, the discount rate, the custodial earnings rate, an inflation rate, ancillary income, prepayment speeds and default rates and losses. These variables change from quarter to quarter as market conditions and projected interest rates change, and may have an adverse impact on the value of the mortgage servicing right and may result in a reduction to noninterest income.

 

Each class of separately recognized servicing assets subsequently measured using the amortization method are evaluated and measured for impairment. Impairment is determined by stratifying rights into tranches based on predominant characteristics, such as interest rate, loan type and investor type. Impairment is recognized through a valuation allowance for an individual tranche, to the extent that fair value is less than the carrying amount of the servicing assets for that tranche. The valuation allowance is adjusted to reflect changes in the measurement of impairment after the initial measurement of impairment. Changes in valuation allowances are reported with net servicing fees on the income statement. Fair value in excess of the carrying amount of servicing assets for that stratum is not recognized.

 

Servicing fee income is recorded for fees earned for servicing loans. The fees are based on a contractual percentage of the outstanding principal or a fixed amount per loan and are recorded as income when earned. The amortization of mortgage servicing rights is netted against loan servicing fee income.

 

Investment in limited partnerships is recorded primarily on the proportional amortization method of accounting. Under the proportional amortization method, the Company amortizes the initial cost of the investment in proportion to the tax credits and other tax benefits received and

recognizes the net investment performance in the income statement as a component of income tax expense (benefit).

 

Intangible assets are being amortized on an accelerated basis over periods ranging from three to 11 years. Such assets are periodically evaluated as to the recoverability of their carrying value.

 

Income taxes are accounted for in accordance with income tax accounting guidance. The income tax accounting guidance results in two components of income tax expense: current and deferred. Current income tax expense reflects taxes to be paid or refunded for the current period by applying the provisions of the enacted tax law to the taxable income or excess of deductions over revenues. The Company determines deferred income taxes using the balance sheet method. Under this method, the net deferred tax asset or liability is based on the tax effects of the differences between the book and tax bases of assets and liabilities, and enacted changes in tax rates and laws are recognized in the period in which they occur.

 

 101 

 

 

MutualFirst Financial, Inc.

Notes to Consolidated Financial Statements
(Table Dollar Amounts in Thousands, Except Share and Per Share Data)

 

Deferred tax assets are evaluated on a quarterly basis for recoverability based on all available evidence. This process involves significant management judgment about assumptions that are subject to change from period to period based on changes in tax laws or variances between our future projected operating performance and our actual results. We are required to establish a valuation allowance for deferred tax assets if we determine, based on available evidence at the time the determination is made, that it is more likely than not that some portion or all of the deferred tax assets will not be realized. In determining the more-likely-than-not criterion, we evaluate all positive and negative available evidence as of the end of each reporting period. Future adjustments to the deferred tax asset valuation allowance, if any, will be determined based upon changes in the expected realization of the net deferred tax assets. The realization of the deferred tax assets ultimately depends on the existence of sufficient taxable income in either the carry back or carry forward periods under applicable tax laws. Due to significant estimates utilized in establishing the valuation allowance and the potential for changes in facts and circumstances, it is reasonably possible that we will be required to record adjustments to the valuation allowance in the near term if estimates of future taxable income during the carry forward period are reduced. Such a charge could have a material adverse effect on our results of operations, financial condition, and capital position.

 

Uncertain tax positions are recognized if it is more likely than not, based on the technical merits, that the tax position will be realized or sustained upon examination. The term more likely than not means a likelihood of more than 50 percent; the terms examined and upon examination also include resolution of the related appeals or litigation processes, if any. A tax position that meets the more-likely-than-not recognition threshold is initially and subsequently measured as the largest amount of tax benefit that has a greater than 50 percent likelihood of being realized upon settlement with a taxing authority that has full knowledge of all relevant information. The determination of whether or not a tax position has met the more-likely-than-not recognition threshold considers the facts, circumstances and information available at the reporting date and is subject to management’s judgment.

 

The Company recognizes interest and penalties on income taxes as a component of income tax expense.

 

The Company files consolidated income tax returns with its subsidiaries.

 

Earnings per share is computed based upon the weighted-average common and common equivalent shares outstanding during each year.

 

Comprehensive income consists of net income and other comprehensive income, net of applicable income taxes. Other comprehensive income includes unrealized gains (losses) on available for sale securities, unrealized gains (losses) on available for sale securities for which a portion of an other-than-temporary impairment has been recognized in income, unrealized and realized gains and losses in derivative financial instruments and changes in the funded status of defined benefit pension plans.

 

Stock options - The Company has stock-based employee compensation plans, which are described more fully in Note 20.

 

 102 

 

 

MutualFirst Financial, Inc.

Notes to Consolidated Financial Statements
(Table Dollar Amounts in Thousands, Except Share and Per Share Data)

 

Note 2: Impact of Accounting Pronouncements

 

In February 2016, the Financial Accounting Standards Board (FASB), issued Accounting Standards Update (ASU) 2016-02, Leases. The objective of the amendment is to establish the principles that lessees and lessors shall apply to report useful information to users of financial statements about the amount, timing, and uncertainty of cash flows arising from a lease.

 

The most significant changes under the new guidance, lessees will be required to recognize the following for all leases (with the exception of short-term leases) at the commencement date:

 

·A lease liability, which is a lessee’s obligation to make lease payments arising from a lease, measured on a discounted basis; and
·A right-of-use asset, which is an asset that represents the lessee’s right to use, or control the use of, a specified asset for the lease term.

 

The amendments in this updated are effective for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. The Company is currently evaluating what impact this pronouncement will have on its financial position.

 

In January 2016, the Financial Accounting Standards Board (FASB), issued Accounting Standards Update (ASU) 2016-01, Financial Instruments-Overall: Recognition and Measurement of Financial Assets and Financial Liabilities. The amendments in this Update require all equity investments to be measured at fair value with changes in the fair value recognized through net income (other than those accounted for under equity method of accounting or those that result in consolidation of the investee).

The amendments also require an entity to present separately in other comprehensive income the portion of the total change in the fair value of a liability resulting from a change in the instrument-specific credit risk when the entity has elected to measure the liability at fair value in accordance with the fair value option for financial instruments. In addition the amendments in this Update eliminate the requirement to disclose the fair value of financial instruments measured at amortized cost for entities that are not public business entities and the requirement for to disclose the method(s) and significant assumptions used to estimate the fair value that is required to be disclosed for financial instruments measured at amortized cost on the balance sheet for public business entities.

 

The new guidance is effective for fiscal years beginning of December 15, 2017, including interim periods within those fiscal years. The Company does not anticipate that this ASU will have a material effect on its financial position or results of operations.

 

In December 2015, the Financial Accounting Standards Board (FASB), issued Accounting Standards Update (ASU) 2015-16, Business Combinations, Simplifying the Accounting for Measurement-Period Adjustments. The objective of this Update was to simplify the accounting for adjustments made to provisional amounts recognized in a business combination. The amendments eliminate the requirement to retrospectively account for those adjustments.

 

 103 

 

 

MutualFirst Financial, Inc.

Notes to Consolidated Financial Statements
(Table Dollar Amounts in Thousands, Except Share and Per Share Data)

 

The amendments in this Update are effective for fiscal years beginning after December 15, 2015, including interim period within those fiscal years. The Company does not anticipate that this ASU will have a material effect on its financial position or results of operations.

 

Note 3: Restriction on Cash

 

The Bank is required to maintain reserve funds in cash and/or on deposit with the Federal Reserve Bank of Chicago. The reserve requirement at December 31, 2015 was $2,145,000.

 

Note 4: Investment Securities

 

The amortized costs and approximate fair values, together with gross unrealized gains and losses on securities, are as follows:

 

   2015 
   Amortized
Cost
   Gross
Unrealized
Gains
   Gross
Unrealized
Losses
   Fair Value 
Available for Sale Securities                    
Mortgage-backed securities  $106,524   $1,562   $(248)  $107,838 
Collateralized mortgage obligations   84,976    537    (861)   84,652 
Municipal obligations   54,427    2,781    (20)   57,188 
Corporate obligations   12,805    1    (1,346)   11,460 
Total investment securities  $258,732   $4,881   $(2,475)  $261,138 

 

   2014 
   Amortized
Cost
   Gross
Unrealized
Gains
   Gross
Unrealized
Losses
   Fair Value 
Available for Sale Securities                    
Mortgage-backed securities  $110,452   $2,927   $(89)  $113,290 
Collateralized mortgage obligations   97,325    1,270    (836)   97,759 
Federal agencies   4    -    -    4 
Municipal obligations   27,246    2,013    (7)   29,252 
Corporate obligations   21,763    44    (1,306)   20,501 
Total investment securities  $256,790   $6,254   $(2,238)  $260,806 

 

 104 

 

 

MutualFirst Financial, Inc.

Notes to Consolidated Financial Statements
(Table Dollar Amounts in Thousands, Except Share and Per Share Data)

 

All mortgage-backed securities and collateralized-mortgage obligations held by the Company as of December 31, 2015 were in government-sponsored and federal agency securities.

 

Certain investments in debt securities are reported in the financial statements at an amount less than their historical cost. Total fair value of these investments at December 31, 2015 and 2014 was $97.6 million and $67.5 million, which is approximately 37.4 percent and 25.9 percent of the Company’s investment portfolio at those dates.

 

Based on our evaluation of available evidence, including recent changes in market interest rates, management believes the declines in fair value for these securities are 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 in the period the other-than-temporary impairment is identified.

 

The following tables show the gross unrealized losses and fair value of the Company’s investments, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position at December 31, 2015 and 2014:

 

   2015 
   Less than 12 Months   12 Months or More   Total 
   Fair Value   Unrealized
Losses
   Fair Value   Unrealized
Losses
   Fair Value   Unrealized
Losses
 
Available for Sale                              
Mortgage-backed securities  $38,649   $(248)  $-   $-   $38,649   $(248)
Collateralized mortgage obligations   27,457    (281)   21,271    (580)   48,728    (861)
Municipal obligations   2,739    (17)   491    (3)   3,230    (20)
Corporate obligations   4,425    (75)   2,534    (1,271)   6,959    (1,346)
Total temporarily impaired securities  $73,270   $(621)  $24,296   $(1,854)  $97,566   $(2,475)

 

   2014 
   Less than 12 Months   12 Months or More   Total 
   Fair Value   Unrealized
Losses
   Fair Value   Unrealized
Losses
   Fair Value   Unrealized
Losses
 
Available for Sale                              
Mortgage-backed securities  $1,069   $(9)  $19,580   $(80)  $20,649   $(89)
Collateralized mortgage obligations   5,075    (40)   34,159    (796)   39,234    (836)
Municipal obligations   -    -    631    (7)   631    (7)
Corporate obligations   -    -    6,995    (1,306)   6,995    (1,306)
Total temporarily impaired securities  $6,144   $(49)  $61,365   $(2,189)  $67,509   $(2,238)

 

 105 

 

 

MutualFirst Financial, Inc.

Notes to Consolidated Financial Statements
(Table Dollar Amounts in Thousands, Except Share and Per Share Data)

 

Collateralized Mortgage Obligations (CMO) and Mortgage-Backed Securities (MBS)

 

The unrealized losses on the Company’s investment in CMOs and MBSs were caused by interest rate changes. The Company expects to recover the amortized cost basis over the term of the securities. Because (1) the decline in market value is attributable to changes in interest rates and not credit quality, (2) the Company does not intend to sell the investments and (3) it is more likely than not the Company will not be required to sell the investments before recovery of their amortized cost bases, which may be at maturity, the Company does not consider these investments to be other-than-temporarily impaired at December 31, 2015.

 

Municipals

 

The unrealized losses on the Company’s investments in securities of state and political subdivisions were caused by changes in interest rates. 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. The Company does not intend to sell the investment and it is not more likely than not that the Company will be required to sell the investment before recovery of its new, lower amortized cost basis, which may be maturity. The Corporation does not consider the investment securities to be other-than-temporarily impaired at December 31, 2015.

 

Corporate Obligations

 

The Company’s unrealized loss on investments in corporate obligations primarily relates to investments in pooled trust preferred securities. The unrealized losses were primarily caused by (1) a decrease in performance and regulatory capital resulting from exposure to subprime mortgages and (2) a sector downgrade by several industry analysts. The Company currently expects some of the securities to settle at a price less than the amortized cost basis of the investment (that is, the Company expects to recover less than the entire amortized cost basis of the security). The Company has recognized a loss equal to the credit loss for these securities, establishing a new, lower amortized cost basis. The credit loss was calculated by comparing expected discounted cash flows based on performance indicators of the underlying assets in the security to the carrying value of the investment. Because the Company does not intend to sell these investments and it is likely that the Company will not be required to sell the investments before recovery of its new, lower amortized cost basis, which may be at maturity, it does not consider the remainder of the investments to be other-than-temporarily impaired at December 31, 2015.

 

Other-Than-Temporary Impairment

 

Upon acquisition of a security, the Company decides whether it is within the scope of the accounting guidance for beneficial interests in securitized financial assets or whether it will be evaluated for impairment under the accounting guidance for investments in debt and equity securities.

 

The accounting guidance for beneficial interests in securitized financial assets provides incremental impairment guidance for a subset of the debt securities within the scope of the guidance for investments in debt and equity securities. For securities that are a beneficial interest in securitized financial assets, the Company uses the beneficial interests in securitized financial asset impairment model. For securities where the security is not a beneficial interest in securitized financial assets, the Company uses debt and equity securities impairment model.

 

 106 

 

 

MutualFirst Financial, Inc.

Notes to Consolidated Financial Statements
(Table Dollar Amounts in Thousands, Except Share and Per Share Data)

 

The Company conducts periodic reviews to identify and evaluate each investment security to determine whether an other-than-temporary impairment has occurred. Economic models are used to determine whether an other-than-temporary impairment has occurred on these securities. While all securities are considered, the securities primarily impacted by other-than-temporary impairment testing are private-label mortgage-backed securities and trust preferred securities.

 

The Bank’s trust preferred securities valuation was prepared by an independent third party. Their approach to determining fair value involved several steps including:

 

·Detailed credit and structural evaluation of each piece of collateral in the trust preferred securities;
·Collateral performance projections for each piece of collateral in the trust preferred security;
·Terms of the trust preferred structure, as laid out in the indenture; and
·Discounted cash flow modeling.

 

MutualFirst Financial uses market-based yield indicators as a baseline for determining appropriate discount rates, and then adjusts the resulting discount rates on the basis of its credit and structural analysis of specific trust preferred securities. The primary focus is on the returns a fixed income investor would require in order to allocate capital on a risk adjusted basis. There is currently no active market for pooled trust preferred securities; however, the Company looks principally to market yields for stand-alone trust preferred securities issued by banks, thrifts and insurance companies for which there is an active and liquid market. The next step is to make a series of adjustments to reflect the differences that exist between these products (both credit and structural) and, most importantly, to reflect idiosyncratic credit performance differences (both actual and projected) between these products and the underlying collateral in the specific trust preferred security. Importantly, as part of the analysis described above, MutualFirst considers the fact that structured instruments frequently exhibit leverage not present in stand-alone instruments, and make adjustments as necessary to reflect this additional risk.

 

The default and recovery probabilities for each piece of collateral were formed based on the evaluation of the collateral credit and a review of historical industry default data and current/near-term operating conditions. For collateral that has already defaulted, the Company assumed no recovery. For collateral that was in deferral, the Company assumed a recovery of 10% of par for banks, thrifts or other depository institutions and 15% of par for insurance companies. Although the Company conservatively assumed that the majority of the deferring collateral continues to defer and eventually defaults, we also recognize there is a possibility that some deferring collateral may become current at some point in the future.

 

Credit Losses Recognized on Investments

 

Certain debt securities have experienced fair value deterioration due to credit losses, as well as due to other market factors, but are not otherwise other-than-temporarily impaired.

 

 107 

 

 

MutualFirst Financial, Inc.

Notes to Consolidated Financial Statements
(Table Dollar Amounts in Thousands, Except Share and Per Share Data)

 

The following table provides information about debt securities for which only a credit loss was recognized in income and other losses are recorded in other comprehensive income.

 

   Accumulated Credit Losses 
   2015   2014   2013 
Credit losses on debt securities held               
Beginning of period  $109   $1,205   $1,205 
Reductions related to actual losses incurred   -    -    - 
Reductions for previous credit losses realized on securities sold during the year   -    (1,096)   - 
As of December 31,  $109   $109   $1,205 

 

The amortized cost and fair value of securities available for sale at December 31, 2015, 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 
Description Securities  Amortized Cost   Fair Value 
Security obligations due          
One to five years  $10,003   $9,964 
Five to ten years   1,489    1,591 
After ten years   55,740    57,093 
    67,232    68,648 
Mortgage-backed securities   106,524    107,838 
Collateralized mortgage obligations   84,976    84,652 
Totals  $258,732   $261,138 

 

The Company did not have securities pledged as collateral, to secure public deposits or for other purposes as of December 31, 2015 or 2014.

 

Proceeds from sales of securities available for sale during 2015, 2014 and 2013 were $23,109,000, $28,317,000 and $53,179,000, respectively. Gross gains of $436,000, $1,176,000 and $898,000 in 2015, 2014 and 2013 were recognized on those sales. Gross losses of $0, $863,000 and $63,000 in 2015, 2014 and 2013 were recognized on those sales.

 

 108 

 

 

MutualFirst Financial, Inc.

Notes to Consolidated Financial Statements
(Table Dollar Amounts in Thousands, Except Share and Per Share Data)

 

Note 5: Loans and Allowance

 

Classes of loans at December 31, 2015 and 2014 include:

 

   December 31,   December 31, 
   2015   2014 
Real estate          
Commercial  $236,895   $198,019 
Commercial construction and development   15,744    33,102 
Consumer closed end first mortgage   491,451    517,063 
Consumer open end and junior liens   70,990    71,073 
    815,080    819,257 
Other loans          
Consumer loans          
Auto   15,480    14,712 
Boat/RVs   123,621    94,761 
Other   6,171    5,184 
Commercial and industrial   123,043    88,474 
    268,315    203,131 
Total loans   1,083,395    1,022,388 
Undisbursed loans in process   (7,432)   (9,285)
Unamortized deferred loan costs, net   4,882    3,583 
Allowance for loan losses   (12,641)   (13,168)
Net loans  $1,068,204   $1,003,518 

 

Year-end non-accrual loans, segregated by class of loans, were as follows:

 

   December 31,   December 31, 
   2015   2014 
Real estate          
Commercial  $2,356   $2,023 
Commercial construction and development   -    209 
Consumer closed end first mortgage   3,592    3,499 
Consumer open end and junior liens   783    658 
Consumer loans          
Auto   -    - 
Boat/RVs   81    191 
Other   67    27 
Commercial and industrial   25    605 
   $6,904   $7,212 

 

 109 

 

 

MutualFirst Financial, Inc.

Notes to Consolidated Financial Statements
(Table Dollar Amounts in Thousands, Except Share and Per Share Data)

 

Nonaccrual Loans and Past Due Loans

 

Loans are considered past due if the required principal and interest payments have not been received as of the date such payments were due. Loans are placed on non-accrual status when, in managements’ opinion, the borrower may be unable to meet payment obligations as they become due, as well as when required by regulatory provisions, but never later than 90 days past due. When interest accrual is discontinued, all unpaid accrued interest is reversed. Interest income is subsequently recognized only to the extent cash payments are received in excess of principal due. Loans are returned to accrual status when all the principal and interest amounts contractually due are brought current and future payments are reasonably assured.

 

All interest accrued but not collected for loans that are placed on nonaccrual or charged off is reversed against interest income. The interest on these loans is accounted for on the cash-basis or cost-recovery method, until qualifying for return to accrual. Loans are returned to accrual status when all the principal and interest amounts contractually due are brought current and future payments are reasonably assured and generally only after six months of satisfactory performance.

 

An age analysis of the Company’s past due loans, segregated by class of loans, as of December 31, 2015 and 2014 are as follows:

 

   December 31, 2015 
   30-59
Days Past
Due
   60-89
Days Past
Due
   90 Days
or More
Past Due
   Total Past
Due
   Current   Total
Loans
Receivable
   Total
Loans 90
Days and
Accruing
 
Real estate                                   
Commercial  $922   $20   $2,212   $3,154   $233,741   $236,895   $- 
Commercial construction and development   -    -    -    -    15,744    15,744    - 
Consumer closed end first mortgage   7,272    1,328    3,091    11,691    479,760    491,451    267 
Consumer open end and junior liens   296    187    765    1,248    69,742    70,990    - 
Consumer loans                                   
Auto   89    -    -    89    15,391    15,480    - 
Boat/RVs   1,135    102    71    1,308    122,313    123,621    - 
Other   89    14    62    165    6,006    6,171    - 
Commercial and industrial   192    383    5    580    122,463    123,043    - 
   $9,995   $2,034   $6,206   $18,235   $1,065,160   $1,083,395   $267 

 

 110 

 

 

MutualFirst Financial, Inc.

Notes to Consolidated Financial Statements
(Table Dollar Amounts in Thousands, Except Share and Per Share Data)

 

   December 31, 2014 
   30-59
Days Past
Due
   60-89
Days Past
Due
   90 Days
or More
Past Due
   Total Past
Due
   Current   Total
Loans
Receivable
   Total
Loans 90
Days and
Accruing
 
Real estate                                   
Commercial  $1,308   $848   $325   $2,481   $195,538   $198,019   $- 
Commercial construction and development   -    -    209    209    32,893    33,102    - 
Consumer closed end first mortgage   8,144    1,220    2,160    11,524    505,539    517,063    226 
Consumer open end and junior liens   969    130    27    1,126    69,947    71,073    - 
Consumer loans                                   
Auto   65    -    -    65    14,647    14,712    - 
Boat/RVs   775    158    115    1,048    93,713    94,761    - 
Other   92    27    14    133    5,051    5,184    - 
Commercial and industrial   1,066    176    441    1,683    86,791    88,474    - 
   $12,419   $2,559   $3,291   $18,269   $1,004,119   $1,022,388   $226 

 

Impaired Loans

 

Loans are considered impaired in accordance with the impairment accounting guidance (ASC 310-10-35-16), when based on current information and events, it is probable the Company will be unable to collect all amounts due from the borrower in accordance with the contractual terms of the loan. Impaired loans include nonperforming commercial loans but also include loans modified in troubled debt restructurings where concessions have been granted to borrowers experiencing financial difficulties. These concessions could include a reduction in the interest rate on the loan, payment extensions, forgiveness of principal, forbearance or other actions intended to maximize collection.

 

Interest on impaired loans is recorded based on the performance of the loan. All interest received on impaired loans that are on nonaccrual is accounted for on the cash-basis method until qualifying for return to accrual. Interest is accrued per the contract for impaired loans that are performing.

  

 111 

 

 

MutualFirst Financial, Inc.

Notes to Consolidated Financial Statements
(Table Dollar Amounts in Thousands, Except Share and Per Share Data)

 

The following tables present impaired loans for the years ended December 31, 2015, 2014 and 2013:

 

   December 31, 2015 
   Recorded
Balance
   Unpaid
Principal
Balance
   Specific
Allowance
   Average
Investment
in
Impaired
Loans
   Interest
Income
Recognized
 
Loans without a specific valuation allowance                         
Real estate                         
Commercial  $3,608   $3,608   $-   $4,115   $172 
Commercial construction and development   595    595    -    735    31 
Consumer closed end first mortgage   1,126    1,126    -    1,131    - 
Consumer open end and junior liens   481    481    -    381    - 
Commercial and industrial   214    214    -    423    2 
                          
Loans with a specific valuation allowance                         
Real estate                         
Commercial   676    676    100    793    20 
                          
Total                         
Real estate                         
Commercial  $4,284   $4,284   $100   $4,908   $192 
Commercial construction and development  $595   $595   $-   $735   $31 
Consumer closed end first mortgage  $1,126   $1,126   $-   $1,131   $- 
Consumer open end and junior liens  $481   $481   $-   $381   $- 
Commercial and industrial  $214   $214   $-   $423   $2 
                          
Total  $6,700   $6,700   $100   $7,578   $225 

 

   December 31, 2014 
   Recorded
Balance
   Unpaid
Principal
Balance
   Specific
Allowance
   Average
Investment
in
Impaired
Loans
   Interest
Income
Recognized
 
Loans without a specific valuation allowance                         
Real estate                         
Commercial  $4,933   $4,933   $   -   $3,776   $161 
Commercial construction and development   931    1,860    -    1,323    30 
Consumer closed end first mortgage   1,138    1,138    -    1,142    8 
Consumer open end and junior liens   -    -         100    3 
Commercial and industrial   758    789    -    923    12 
                          
Total  $7,760   $8,720   $-   $7,264   $214 

 

As of December 31, 2014, there were no impaired loans with a valuation allowance.

 

 112 

 

 

MutualFirst Financial, Inc.

Notes to Consolidated Financial Statements
(Table Dollar Amounts in Thousands, Except Share and Per Share Data)

 

   December 31, 2013 
   Recorded
Balance
   Unpaid
Principal
Balance
   Specific
Allowance
   Average
Investment
in
Impaired
Loans
   Interest
Income
Recognized
 
Loans without a specific valuation allowance                         
Real estate                         
Commercial  $3,148   $3,660   $-   $3,894   $160 
Commercial construction and development   1,294    3,218    -    5,386    46 
Consumer closed end first mortgage   1,483    2,071    -    2,582    33 
Commercial and industrial   764    764    -    897    2 
                          
Loans with a specific valuation allowance                         
Real estate                         
Commercial construction and development   344    371    100    344    - 
Commercial and industrial   424    624    235    566    20 
                          
Total                         
Real estate                         
Commercial  $3,148   $3,660   $-   $3,894   $160 
Commercial construction and development  $1,638   $3,589   $100   $5,730   $46 
Consumer closed end first mortgage  $1,483   $2,071   $-   $2,582   $33 
Commercial and industrial  $1,188   $1,388   $235   $1,463   $22 
                          
Total  $7,457   $10,708   $335   $13,669   $261 

 

The following information presents the credit risk profile of the Company’s loan portfolio based on rating category and payment activity as of December 31, 2015 and 2014.

 

Commercial Loan Grades

 

Definition of Loan Grades. Loan grades are numbered 1 through 8. Grades 1-4 are "pass" credits, grade 5 [Special Mention] loans are "criticized" assets, and grades 6 [Substandard], 7 [Doubtful] and 8 [Loss] are "classified" assets. The use and application of these grades by the Bank conform to the Bank's policy and regulatory definitions.

 

Pass. Pass credits are loans in grades prime through fair. These are at least considered to be credits with acceptable risks and would be granted in the normal course of lending operations.

 

Special Mention. Special mention credits have potential weaknesses that deserve management’s close attention. If left uncorrected, these potential weaknesses may result in deterioration of the repayment prospects for the credits or in the Bank’s credit position at some future date. If weaknesses cannot be identified, classifying as special mention is not appropriate. Special mention credits are not adversely classified and do not expose the Bank to sufficient risk to warrant an adverse classification. No apparent loss of principal or interest is expected.

 

 113 

 

  

MutualFirst Financial, Inc.

Notes to Consolidated Financial Statements
(Table Dollar Amounts in Thousands, Except Share and Per Share Data)

 

Substandard. Substandard credits are inadequately protected by the current sound worth and paying capacity of the obligor or by the collateral pledged. Financial statements normally reveal some or all of the following:  poor trends, lack of earnings and cash flow, excessive debt, lack of liquidity, and the absence of creditor protection. Credits so classified must have a well-defined weakness, or weaknesses that jeopardize the liquidation of the debt. They are characterized by the distinct possibility that the Bank will sustain some loss of the deficiencies are not corrected.

 

Doubtful. A doubtful extension of credit has all the weaknesses inherent in a substandard asset with the added characteristic that the weaknesses make collection or liquidation in full, on the basis of currently existing facts, conditions, and values, highly questionable and improbable. The possibility of loss is extremely high, but because of certain important and reasonably specific pending factors that may work to the advantage and strengthening of the asset, its classification as an estimated loss is deferred until its more exact status may be determined. Pending factors include proposed merger, acquisition, or liquidation procedures, capital injection, perfecting liens on additional collateral, and refinancing plans. Doubtful classification for an entire credit should be avoided when collection of a specific portion appears highly probable with the adequately secured portion graded Substandard.

 

Retail Loan Grades

 

Pass. Pass credits are loans that are currently performing as agreed and are not troubled debt restructurings.

 

Special Mention. Special mention credits have potential weaknesses that deserve management’s close attention. If left uncorrected, these potential weaknesses may result in deterioration of the repayment prospects for the credits or in the Bank’s credit position at some future date. If weaknesses cannot be identified, classifying as special mention is not appropriate. Special mention credits are not adversely classified and do not expose the Bank to sufficient risk to warrant an adverse classification. No apparent loss of principal or interest is expected.

 

Substandard. Substandard credits are loans that have reason to be considered to have a weakness and placed on non-accrual. This would include all retail loans over 90 days and troubled debt restructurings.

 

 114 

 

 

MutualFirst Financial, Inc.

Notes to Consolidated Financial Statements
(Table Dollar Amounts in Thousands, Except Share and Per Share Data)

 

December 31, 2015
Commercial Credit Exposure Credit Risk Profile
Internal Rating  Real Estate   Construction
and
Development
   Commercial
and Industrial
 
Pass  $226,439   $13,986   $119,540 
Special Mention   4,137    1,309    3,300 
Substandard   6,319    449    203 
Doubtful   -    -    - 
Total  $236,895   $15,744   $123,043 

 

Consumer Credit Exposure Credit Risk Profile
Internal Rating  Closed End
First
Mortgage
   Real Estate Open
End and Junior
Liens
   Auto   Boat/RV   Other 
Pass  $484,658   $70,086   $15,480   $123,490   $6,097 
Special Mention   -    -    -    -    - 
Substandard   6,793    904    -    131    74 
Total  $491,451   $70,990   $15,480   $123,621   $6,171 

 

December 31, 2014
Commercial Credit Exposure Credit Risk Profile
Internal Rating  Real Estate   Construction
and
Development
   Commercial
and Industrial
 
Pass  $187,436   $30,422   $84,746 
Special Mention   3,316    1,721    439 
Substandard   7,267    959    2,848 
Doubtful   -    -    441 
Total  $198,019   $33,102   $88,474 

 

Consumer Credit Exposure Credit Risk Profile
Internal Rating 

Closed End
First

Mortgage

   Real Estate Open
End and Junior
Liens
   Auto   Boat/RV   Other 
Pass  $509,765   $70,299   $14,704   $94,377   $5,125 
Special Mention   -    -    -    -    - 
Substandard   7,298    774    8    384    59 
Total  $517,063   $71,073   $14,712   $94,761   $5,184 

 

 115 

 

 

MutualFirst Financial, Inc.

Notes to Consolidated Financial Statements
(Table Dollar Amounts in Thousands, Except Share and Per Share Data)

 

Allowance for Loan Losses

 

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

 

Commercial Loans

 

Commercial real estate loans are viewed primarily as cash flow loans and secondarily as loans secured by real estate. Commercial real estate lending typically involves higher loan principal amounts and the repayment of these loans is generally dependent on the successful operation of the property securing the loan or the business conducted on the property securing the loan. Commercial real estate loans may be more adversely affected by conditions in the real estate markets or in the general economy. The properties securing the Company’s commercial real estate portfolio are diverse in terms of type and geographic location. Management monitors and evaluates commercial real estate loans based on collateral, geography and risk grade criteria. As a general rule, the Company avoids financing single purpose projects unless other underwriting factors are present to help mitigate risk. In addition, management tracks the level of owner-occupied commercial real estate loans versus non-owner occupied loans.

 

Commercial construction loans are underwritten utilizing feasibility studies, independent appraisal reviews, sensitivity analyses of absorption and lease rates and financial analyses of the developers and property owners. Construction loans are generally based on estimates of costs and value associated with the complete project. These estimates may be inaccurate. Construction loans often involve the disbursement of substantial funds with repayment substantially dependent on the success of the ultimate project. Sources of repayment for these types of loans may be pre-committed permanent loans from approved long-term lenders, sales of developed property or an interim loan commitment from the Company until permanent financing is obtained. These loans are closely monitored by on-site inspections and are considered to have higher risks than other real estate loans due to their ultimate repayment being sensitive to interest rate changes, governmental regulation of real property, general economic conditions and the availability of long-term financing.

 

Commercial business loans are primarily based on the identified cash flows of the borrower and secondarily on the underlying collateral provided by the borrower. The cash flows of borrowers, however, may not be as expected and the collateral securing these loans may fluctuate in value. Most commercial loans are secured by the assets being financed or other business assets such as accounts receivable or inventory and may incorporate a personal guarantee; however, some short-term loans may be made on an unsecured basis. In the case of loans secured by accounts receivable, the availability of funds for the repayment of these loans may be substantially dependent on the ability of the borrower to collect amounts due from its customers.

 

 116 

 

 

MutualFirst Financial, Inc.

Notes to Consolidated Financial Statements
(Table Dollar Amounts in Thousands, Except Share and Per Share Data)

 

Residential and Consumer

 

With respect to residential loans that are secured by one-to-four family residences and are primarily owner occupied, the Company generally establishes a maximum loan-to-value ratio and requires private mortgage insurance (PMI) if that ratio is exceeded. Home equity loans are typically secured by a subordinate interest in one-to-four family residences, and consumer loans are secured by consumer assets such as automobiles or recreational vehicles. Some consumer loans are unsecured such as small installment loans and certain lines of credit. Repayment of these loans is primarily dependent on the personal income of the borrowers, which can be impacted by economic conditions in their market areas such as unemployment levels. Repayment can also be impacted by changes in property values on residential properties. Risk is mitigated by the fact that the loans are of smaller individual amounts and spread over a large number of borrowers.

 

The following tables detail activity in the allowance for loan losses by portfolio segment for the years ended December 31, 2015, 2014 and 2013. Allocation of a portion of the allowance to one category of loans does not preclude its availability to absorb losses on other segments.

 

   December 31, 2015 
   Commercial   Mortgage   Consumer   Total 
Allowance for loan losses:                    
Balance, beginning of year  $7,085   $3,471   $2,612   $13,168 
Provision charged to expense   (389)   (179)   693    125 
Losses charged off   (104)   (643)   (640)   (1,387)
Recoveries   498    34    203    735 
Balance, end of period  $7,090   $2,683   $2,868   $12,641 
                     
Ending balance:                    
Individually evaluated for impairment  $100   $-   $-   $100 
Collectively evaluated for impairment   6,990    2,683    2,868    12,541 
Total allowance for loan losses  $7,090   $2,683   $2,868   $12,641 
                     
Loans:                    
Ending balance                    
Individually evaluated for impairment  $5,093   $1,126   $481   $6,700 
Collectively evaluated for impairment   370,589    490,325    215,781    1,076,695 
Total Loans  $375,682   $491,451   $216,262   $1,083,395 

 

 117 

 

 

MutualFirst Financial, Inc.

Notes to Consolidated Financial Statements
(Table Dollar Amounts in Thousands, Except Share and Per Share Data)

 

   December 31, 2014 
   Commercial   Mortgage   Consumer   Total 
Allowance for loan losses:                    
Balance, beginning of year  $8,148   $3,124   $2,140   $13,412 
Provision charged to expense   (1,273)   888    1,235    850 
Losses charged off   (289)   (572)   (1,021)   (1,882)
Recoveries   499    31    258    788 
Balance, end of period  $7,085   $3,471   $2,612   $13,168 
                     
Ending balance:                    
Individually evaluated for impairment  $-   $-   $-   $- 
Collectively evaluated for impairment   7,085    3,471    2,612    13,168 
Total allowance for loan losses  $7,085   $3,471   $2,612   $13,168 
                     
Loans:                    
Ending balance                    
Individually evaluated for impairment  $6,622   $1,138   $-   $7,760 
Collectively evaluated for impairment   312,973    515,925    185,730    1,014,628 
Total Loans  $319,595   $517,063   $185,730   $1,022,388 

 

   December 31, 2013 
   Commercial   Mortgage   Consumer   Total 
Allowance for loan losses:                    
Balance, beginning of year  $9,908   $3,394   $2,736   $16,038 
Provision charged to expense   884    343    73    1,300 
Losses charged off   (2,713)   (886)   (940)   (4,539)
Recoveries   69    273    271    613 
Balance, end of period  $8,148   $3,124   $2,140   $13,412 
                     
Ending balance:                    
Individually evaluated for impairment  $335   $-   $-   $335 
Collectively evaluated for impairment   7,813    3,124    2,140    13,077 
Total allowance for loan losses  $8,148   $3,124   $2,140   $13,412 
                     
Loans:                    
Ending balance                    
Individually evaluated for impairment  $5,974   $1,483   $-   $7,457 
Collectively evaluated for impairment   283,566    529,789    169,395    982,750 
Total Loans  $289,540   $531,272   $169,395   $990,207 

 

 118 

 

 

MutualFirst Financial, Inc.

Notes to Consolidated Financial Statements
(Table Dollar Amounts in Thousands, Except Share and Per Share Data)

 

Troubled Debt Restructurings

 

Certain categories of impaired loans include loans that have been modified in a troubled debt restructuring, that involves granting economic concessions to borrowers who have experienced financial difficulties. These concessions typically result from our loss mitigation activities and could include reductions in the interest rate, payment extensions, forgiveness of principal, forbearance or other actions. Modifications of terms for our loans and their inclusion as troubled debt restructurings are based on individual facts and circumstances.

 

When we modify loans in a troubled debt restructuring, we evaluate any possible impairment similar to other impaired loans based on the present value of expected future cash flows, discounted at the contractual interest rate of the original loan agreement, or we use the current fair value of the collateral, less selling costs for collateral dependent loans. If we determine that the value of the modified loan is less than the recorded investment in the loan (net of previous charge-offs, deferred loan fees or costs and unamortized premium or discount), impairment is recognized through a specific reserve or a charge-off to the allowance.

 

Loans retain their accrual status at the time of their modification. As a result, if a loan is on nonaccrual at the time it is modified, it stays as nonaccrual until a period of satisfactory performance, generally six months, is obtained. If a loan is on accrual at the time of the modification, the loan is evaluated to determine the collection of principal and interest is reasonably assured and generally stays on accrual.

 

At December 31, 2015 and 2014, the Company had a number of loans that were modified in troubled debt restructurings and impaired. The modification of terms of such loans included one or a combination of the following: an extension of maturity, a reduction of the stated interest rate or a permanent reduction of the recorded investment in the loan.

 

 119 

 

 

MutualFirst Financial, Inc.

Notes to Consolidated Financial Statements
(Table Dollar Amounts in Thousands, Except Share and Per Share Data)

 

The following tables describe troubled debts restructured during the years ended December 31, 2015, 2014 and 2013.

 

   December 31, 2015 
   No. of Loans   Pre-Modification
Outstanding
Recorded
Balance
   Post-Modification
Outstanding
Recorded Balance
 
Real estate               
Commercial   4   $2,399   $2,406 
Commercial construction and development   1    155    155 
Consumer closed end first mortgage   8    287    287 
Consumer open end and junior liens   3    51    51 
Consumer loans               
Auto   2    25    25 
Commercial and industrial   1    88    83 

 

   December 31, 2014 
   No. of Loans   Pre-Modification
Outstanding
Recorded
Balance
   Post-Modification
Outstanding
Recorded Balance
 
Real estate               
Commercial   6   $1,229   $1,248 
Consumer closed end first mortgage   12    1,493    1,139 
Consumer open end and junior liens   5    58    59 
Commercial and industrial   2    193    223 

 

 120 

 

 

MutualFirst Financial, Inc.

Notes to Consolidated Financial Statements
(Table Dollar Amounts in Thousands, Except Share and Per Share Data)

 

   December 31, 2013 
   No. of Loans   Pre-Modification
Outstanding
Recorded
Balance
   Post-Modification
Outstanding
Recorded Balance
 
Real estate               
Commercial   3   $1,532   $1,601 
Commercial construction and development               
Consumer closed end first mortgage   24    1,706    1,884 
Consumer open end and junior liens   30    1,236    1,249 
Consumer loans               
Auto   2    22    22 
Boat/RVs   6    172    171 
Other   1    11    11 
Commercial and industrial   3    1,122    843 

 

The impact on the allowance for loan losses was insignificant as a result of these modifications.

 

Newly restructured loans by type for the years ended December 31, 2015, 2014 and 2013 are as follows:

 

   December 31, 2015 
   Interest
Only
   Term   Combination   Total
Modification
 
Real Estate                    
Commercial  $-   $2,406   $-   $2,406 
Commercial construction and development   -    -    155    155 
Consumer closed end first mortgage   -    11    276    287 
Consumer open end junior lien   -    51    -    51 
Consumer                    
Auto   -    25    -    25 
Commercial and industrial   -    83    -    83 

 

 121 

 

 

MutualFirst Financial, Inc.

Notes to Consolidated Financial Statements
(Table Dollar Amounts in Thousands, Except Share and Per Share Data)

 

   December 31, 2014 
   Interest
Only
   Term   Combination   Total
Modification
 
Real Estate                    
Commercial  $-   $701   $547   $1,248 
Consumer closed end first mortgage   101    -    1,038    1,139 
Consumer open end junior lien   -    28    31    59 
Commercial and industrial   -    223    -    223 

 

   December 31, 2013 
   Interest
Only
   Term   Combination   Total
Modification
 
Real Estate                    
Commercial  $-   $-   $1,601   $1,601 
Commercial construction and development                    
Consumer closed end first mortgage   -    36    1,848    1,884 
Consumer open end junior lien   250    402    597    1,249 
Consumer Loans                    
Auto   -    4    18    22 
Boat/RVs   -    135    36    171 
Other   -    -    11    11 
Commercial and industrial   -    209    634    843 

 

 122 

 

 

MutualFirst Financial, Inc.

Notes to Consolidated Financial Statements
(Table Dollar Amounts in Thousands, Except Share and Per Share Data)

 

Defaults of any loans modified as troubled debt restructurings made in the years ended December 31, 2015, 2014 and 2013, respectively, are listed in the table below. Defaults are defined as any loans that become 90 days past due. We have included an other commercial loan in the default category as of December 31, 2013 in the table below, due to a large subsequent charge-off after modification.

 

   December 31, 2015 
   No. of Loans   Post-Modification
Outstanding Recorded
Balance
 
Real Estate          
Commercial   1   $820 

 

   December 31, 2014 
   No. of Loans   Post-Modification
Outstanding Recorded
Balance
 
Real Estate          
Consumer closed end first mortgage   4   $663 
Consumer open end and junior liens   1    23 

 

   December 31, 2013 
   No. of Loans   Post-Modification
Outstanding Recorded
Balance
 
Real Estate          
Consumer closed end first mortgage   3   $210 
Commercial and industrial   1    634 

 

At December 31, 2015, the Company held residential real estate held for sale as a result of foreclosure totaling $682,000 and real estate in the process of foreclosure of $1.5 million.

 

Note 6: Related Party Transactions

 

The Bank has entered into transactions with certain directors, executive officers and significant shareholders of the Company and Bank and their affiliates or associates (related parties). Such transactions were made in the ordinary course of business on substantially the same terms and conditions, including interest rates and collateral, as those prevailing at the time for comparable transactions with other customers, and did not, in the opinion of management, involve more than normal credit risk or present other unfavorable features.

 

 123 

 

 

MutualFirst Financial, Inc.

Notes to Consolidated Financial Statements
(Table Dollar Amounts in Thousands, Except Share and Per Share Data)

 

The aggregate amount of loans, as defined, to such related parties was as follows:

 

   2015 
Balances, January 1,  $7,967 
Change in composition   139 
New loans, including renewals   5,457 
Payments, etc., including renewals   (5,501)
Balances, December 31,  $8,062 

 

Note 7: Premises and Equipment

 

Major classifications of premises and equipment, stated at cost, are as follows:

 

   2015   2014 
Cost          
Land  $12,393   $13,100 
Buildings and land improvements   26,651    25,334 
Equipment   12,877    12,555 
Total cost   51,921    50,989 
Accumulated depreciation and amortization   (20,873)   (20,050)
Net  $31,048   $30,939 

 

Note 8: Core Deposit and Other Intangibles

 

The carrying basis of recognized intangible assets at December 31, 2015 and 2014, were:

 

   2015   2014 
Core deposits  $444   $840 
Other intangibles   367    265 
   $811   $1,105 

 

 124 

 

 

MutualFirst Financial, Inc.

Notes to Consolidated Financial Statements
(Table Dollar Amounts in Thousands, Except Share and Per Share Data)

 

Amortization expense for the years ended December 31, 2015, 2014 and 2013, was $517,000, $647,000 and $782,000, respectively. Estimated amortization expense for each of the next five years is:

 

2016  $420 
2017   264 
2018   114 
2019   13 
2020   - 
   $811 

 

Note 9: Goodwill

 

The changes in the carrying amount of goodwill for the years ended December 31, 2015 and 2014 were:

 

   2015   2014 
Balance as of January 1  $1,800,000   $- 
Goodwill acquired during the year   -    1,800,000 
Balance as of December 31  $1,800,000   $1,800,000 

 

On August 1, 2014, the Company acquired Summit Mortgage, Inc., a mortgage broker in Ft. Wayne, Indiana. The acquisition of Summit resulted in the acquisition of insignificant assets, generated goodwill of $1.8 million and no additional material intangible assets. This acquisition allows the Bank to enter a new market and look at more efficient methods of increasing non-interest income and is not expected to have a material impact on the operations of the Company.

 

Goodwill is tested for impairment on an annual basis as of October 1, or whenever events or changes in circumstances indicate the carrying amount of goodwill exceeds its implied fair value. No events or changes in circumstances have occurred since the annual impairment test that would suggest is was more likely than not goodwill impairment existed.

 

 125 

 

 

MutualFirst Financial, Inc.

Notes to Consolidated Financial Statements
(Table Dollar Amounts in Thousands, Except Share and Per Share Data)

 

Note 10: Deposits

 

Deposits were comprised of the following at December 31, 2015 and 2014:

 

   December 31,   December 31, 
   2015   2014 
Noninterest-bearing demand  $179,542   $154,178 
Interest-bearing demand   267,089    253,042 
Savings   131,578    124,051 
Money market savings   162,551    146,847 
Certificates and other time deposits of $100,000 or more   147,268    164,543 
Other certificates   203,354    236,659 
Total deposits  $1,091,382   $1,079,320 

 

Certificates, including other time deposits of $100,000 or more, maturing in years ending December 31 are as follows:

 

2016  $143,476 
2017   76,035 
2018   38,023 
2019   31,960 
2020   57,302 
Thereafter   3,826 
   $350,622 

 

Note 11: Federal Home Loan Bank Advances

 

FHLB advances maturing in years ending December 31 are as follows:

 

2016  $23,526 
2017   47,528 
2018   39,030 
2019   40,533 
2020   36,500 
Thereafter   38,500 
   $225,617 

 

 126 

 

 

MutualFirst Financial, Inc.

Notes to Consolidated Financial Statements
(Table Dollar Amounts in Thousands, Except Share and Per Share Data)

 

At December 31, 2015, the Company had pledged $401,600,000 in qualifying first mortgage loans as collateral for advances and outstanding letters of credit. Advances, at interest rates from 0.58% to 6.73% at December 31, 2015, were subject to restrictions or penalties in the event of prepayment.

 

At December 31, 2015, the Company had a total of $10 million in putable and $35 million in symmetrical advances with Federal Home Loan Bank.

 

Note 12: Other Borrowings

 

Other borrowings consisted of the following components as of December 31:

 

   2015   2014 
Note payable  $5,312   $6,071 
Subordinated debenture, net of discount   4,146    4,103 
Total  $9,458   $10,174 

 

The Company borrowed $7,589,000 from First Tennessee Bank, N.A. at a variable rate of LIBOR plus 2.80%, with principal and interest payments made quarterly. Company also has an interest rate swap that fixed the variable rate portion of this loan for the term of the note at 3.92%. The loan is collateralized by the Bank’s stock and matures in December 2017.

 

The maturity of the First Tennessee note is as follows:

 

Principal Payments Due in Years Ending December 31:    
2016  $759 
2017   4,553 
   $5,312 

 

The Company assumed $5,000,000 in debentures as the result of an acquisition of MFB Corp. in 2008. In 2005, MFB Corp. had formed MFBC Statutory Trust (MFBC), as a wholly owned business trust, to sell trust preferred securities. The proceeds from the sale of these trust preferred securities were used by the trust to purchase an equivalent amount of subordinated debentures from the acquired company. The junior subordinated debentures are the sole assets of MFBC and are fully and unconditionally guaranteed by the Company. The junior subordinated debentures and the trust preferred securities pay interest and dividends, respectively, on a quarterly basis. The rate resets quarterly at the prevailing three-month LIBOR rate plus 170 basis points. The Company may redeem the trust preferred securities, in whole or in part, without penalty, on or after September 15, 2010. These securities mature on September 15, 2035. The net balance of the note as of December 31, 2015 was $4,146,000 due to the fair value adjustment of the note made at the time of the acquisition.

 

 127 

 

 

MutualFirst Financial, Inc.

Notes to Consolidated Financial Statements
(Table Dollar Amounts in Thousands, Except Share and Per Share Data)

 

Note 13: Loan Servicing

 

Loans serviced for others are not included in the accompanying consolidated balance sheets. The unpaid principal balances of these loans consist of the following:

 

   2015   2014 
Loans serviced for          
Freddie Mac  $295,613   $295,589 
Fannie Mae   11,535    16,024 
FHLB   12,677    12,963 
Other investors   1,763    1,670 
   $321,588   $326,246 

 

The aggregate fair value of capitalized mortgage servicing rights is based on comparable market values and expected cash flows, with impairment assessed based on portfolio characteristics including product type and interest rates. The amount of servicing fees collected during 2015, 2014 and 2013 totaled approximately $814,000, $832,000, and $896,000, respectively.

 

   2015   2014   2013 
Mortgage-servicing rights               
Balances, January 1  $1,417   $1,858   $2,396 
Servicing rights capitalized   458    278    464 
Amortization of servicing rights   (540)   (719)   (1,002)
    1,335    1,417    1,858 
Valuation allowance   -    -    - 
   $1,335   $1,417   $1,858 

 

The fair value of servicing rights subsequently measured using the amortization method was as follows:

 

   2015   2014   2013 
Mortgage-servicing rights               
Fair value, beginning of period  $2,048   $2,106   $1,731 
Fair value, end of period   2,179    2,048    2,106 

 

 128 

 

 

MutualFirst Financial, Inc.

Notes to Consolidated Financial Statements
(Table Dollar Amounts in Thousands, Except Share and Per Share Data)

 

Activity in the valuation allowance for mortgage servicing rights was as follows:

 

   2015   2014   2013 
Balance, beginning of year  $-   $-   $665 
Additions   -    -    - 
Reductions   -    -    (665)
Balance, end of year  $-   $-   $- 

 

Note 14: Income Tax

 

The provision for income taxes includes these components:

 

   2015   2014   2013 
Income tax expense               
Currently payable               
Federal  $2,909   $3,040   $2,426 
State   (257)   (261)   (677)
Deferred               
Federal   1,449    606    1,546 
State   477    481    841 
Total income tax expense  $4,578   $3,866   $4,136 

 

A reconciliation of income tax expense at the federal statutory rate to actual tax expense is shown below:

 

   2015   2014   2013 
Federal statutory income tax at 34%  $5,721   $4,897   $4,423 
Other than temporary impairment   -    (615)   - 
State taxes   145    145    109 
Low income housing credits   (96)   (107)   (159)
Tax-exempt income   (1,111)   (818)   (725)
Other   (81)   364    488 
Actual tax expense  $4,578   $3,866   $4,136 
Effective tax rate   27.21%   25.93%   30.59%

 

 129 

 

 

MutualFirst Financial, Inc.

Notes to Consolidated Financial Statements
(Table Dollar Amounts in Thousands, Except Share and Per Share Data)

 

The components of the deferred asset included on the consolidated balance sheets were as follows:

 

   2015   2014 
Assets          
Allowance for loan losses  $5,091   $5,344 
Deferred compensation   3,193    3,191 
Business tax and AMT credit carryovers   4,776    5,463 
Capital loss carryover   139    144 
Net operating loss carryover   1,845    2,148 
Goodwill impairment   2,188    2,611 
Purchase accounting adjustments   1,060    1,120 
Other   1,275    1,306 
Total assets   19,567    21,327 
           
Liabilities          
Unrealized gain on securities available for sale  $(720)  $(1,375)
Depreciation and amortization   (465)   (532)
FHLB stock   (358)   (447)
State income tax   (585)   (757)
Loan fees   (298)   (245)
Investments in limited partnerships   (2,255)   (2,314)
Mortgage servicing rights   (572)   (501)
Other   (1,010)   (361)
Total liabilities   (6,263)   (6,532)
           
Valuation Allowance          
Beginning balance   (1,220)   (1,835)
Decrease during period   -    615 
Ending balance   (1,220)   (1,220)
Net deferred tax asset  $12,084   $13,575 

 

The Company has unused business income tax credits of $3,425,000 that will begin to expire in 2027 and a state net operating loss of $26,358,000 that will begin to expire in 2022. In addition, the Company has an AMT credit carryover of $1,351,000 with an unlimited carryover period. Management believes that the Company will be able to utilize the benefits recorded for the state loss carryforwards and federal credits within the allotted time periods, except for the amount represented by the valuation allowance. The valuation allowance has been recorded for the possible inability to use a portion of the state net operating loss carryover as well as the inability to utilize the capital losses generated from realized losses and losses recognized related to other than temporary impairment.

 

 130 

 

 

MutualFirst Financial, Inc.

Notes to Consolidated Financial Statements
(Table Dollar Amounts in Thousands, Except Share and Per Share Data)

 

Retained earnings include approximately $14,743,000 for which no deferred income tax liability has been recognized. This amount represents an allocation of income to bad debt deductions as of December 31, 1987 for tax purposes only. Reduction of amounts so allocated for purposes other than tax bad debt losses or adjustments arising from carryback of net operating losses would create income for tax purposes only, which income would be subject to the then-current corporate income tax rate. The unrecorded deferred income tax liability on the above amounts was approximately $5,013,000.

  

Note 15: Accumulated Other Comprehensive Income

 

The components of accumulated other comprehensive income, included in stockholders’ equity, are as follows:

 

   2015   2014 
Net unrealized gain on securities available for sale  $3,311   $4,933 
Net unrealized loss on securities available for sale for which a portion of an other-than-temporary impairment has been recognized in income   (905)   (917)
Net unrealized loss on derivative used for cash flow hedges   (1)   (109)
Net unrealized loss relating to defined benefit plan liability   (32)   (109)
    2,373    3,798 
Tax expense   883    1,420 
Net of tax amount  $1,490   $2,378 

 

The following table presents the reclassification adjustments out of accumulated other comprehensive income (loss) that were included in net income in the Consolidated Statement of Income for the years ended December 31, 2015, 2014 and 2013.

 

   Amount Reclassified from Accumulated
Other Comprehensive Income For the
Year Ended December 31,
    
Details about Accumulated Other
Comprehensive Income Components
  2015   2014   2013   Affected Line Item in the Statements of
Income
Unrealized gains on available for sale securities                  
Realized securities gains reclassified into income  $436   $313   $835   Net realized gains on sale of available for sale securities
Related income tax expense   (148)   (106)   (284)  Income tax expense
                   
Total reclassifications for the period, net of tax  $288   $207   $551    

 

 131 

 

 

MutualFirst Financial, Inc.

Notes to Consolidated Financial Statements
(Table Dollar Amounts in Thousands, Except Share and Per Share Data)

 

Note 16: Commitments and Contingent Liabilities

 

In the normal course of business, there are outstanding commitments and contingent liabilities, such as commitments to extend credit and standby letters of credit, which are not included in the accompanying financial statements. The Company’s exposure to credit loss in the event of nonperformance by the other party to the financial instruments for commitments to extend credit and standby letters of credit is represented by the contractual or notional amount of those instruments. The Company uses the same credit policies in making such commitments as it does for instruments that are included in the consolidated statements of financial condition.

 

Financial instruments whose contract amount represents credit risk as of December 31:

 

   2015   2014 
Loan commitments  $228,548   $200,189 
Standby letters of credit   2,464    2,288 

 

Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. The Company evaluates each customer's credit worthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary by the Company upon extension of credit, is based on management's credit evaluation. Collateral held varies, but may include residential real estate, income-producing commercial properties, or other assets of the borrower.

 

Standby letters of credit are conditional commitments issued by the Company to guarantee the performance of a customer to a third party.

 

The Company and Bank are also subject to claims and lawsuits that arise primarily in the ordinary course of business. It is the opinion of management that the disposition or ultimate resolution of such claims and lawsuits will not have a material adverse effect on the consolidated financial position of the Company.

 

The Company has entered into employment agreements with certain officers that provide for the continuation of salary and certain benefits for a specified period of time under certain conditions. Under the terms of the agreement, these payments could occur in the event of a change in control of the Company.

 

Mortgage loans in the process of origination represent amounts that the Company plans to fund within a normal period of 60 to 90 days, and which are primarily intended for sale to investors in the secondary market. Total mortgage loans in the process of origination amounted to $1,730,000 and $817,000, and mortgage loans held for sale amounted to $5,991,000 and $6,140,000, at December 31, 2015 and 2014, respectively.

 

 132 

 

 

MutualFirst Financial, Inc.

Notes to Consolidated Financial Statements
(Table Dollar Amounts in Thousands, Except Share and Per Share Data)

 

Note 17: Stockholders’ Equity

 

Without prior approval, current regulations allow the Bank to pay dividends to the Company not exceeding retained net income for the previous two calendar years and the current year. In the event the Bank becomes unable to pay dividends to the Company, the Company may not be able to service its debt, pay its other obligations or pay dividends on its common stock. At December 31, 2015, the Bank was not able to pay dividends without prior regulatory notification.

 

Note 18: Regulatory Capital

 

The Bank is subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory and possibly additional discretionary actions by regulators that, if undertaken, could have a direct material effect on the Bank’s financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Bank must meet specific capital guidelines that involve quantitative measures of the Bank’s assets, liabilities and certain off-balance-sheet items as calculated under regulatory accounting practices. The Bank’s capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings and other factors. Furthermore, the Bank’s regulators could require adjustments to regulatory capital not reflected in these financial statements.

 

Quantitative measures established by regulation to ensure capital adequacy require the Company and Bank to maintain minimum amounts and ratios (set forth in the table below) of total, Tier I and Common Equity Tier I capital (as defined in the regulations) to risk-weighted assets (as defined) and of Tier I capital to average assets (as defined). As of December 31, 2015 and 2014, the Company and Bank meet all capital adequacy requirements to which it is subject.

 

In July 2013, the three federal bank regulatory agencies jointly published final rules (the Basel III Capital Rules) establishing a new comprehensive capital framework for U.S. banking organizations. The rules implement the Basel Committee’s December 2010 framework known as “Basel III” for strengthening international capital standards as well as certain provisions of the Dodd-Frank Act. These rules substantially revise the risk-based capital requirements applicable to bank holding companies and depository institutions, compared to the current U.S. risk-based capital rules. The Basel III Capital Rules define the components of capital and address other issues affecting the numerator in banking institutions’ regulatory capital ratios. These rules also address risk weights and other issues affecting the denominator in banking institutions’ regulatory capital ratios and replace the existing risk-weighting approach with a more risk-sensitive approach. The Basel III Capital Rules were effective for the Company and Bank on January 1, 2015 (subject to a four-year phase-in period).

 

 133 

 

 

MutualFirst Financial, Inc.

Notes to Consolidated Financial Statements
(Table Dollar Amounts in Thousands, Except Share and Per Share Data)

 

The Basel III Capital Rules, among other things, (i) introduce a new capital measure called “Common Equity Tier 1” (CET1), (ii) specify that Tier 1 capital consist of CET1 and “Additional Tier 1 Capital” instruments meeting specified requirements, (iii) define CET1 narrowly by requiring that most deductions/adjustments to regulatory capital measures be made to CET1 and not to the other components of capital and (iv) expand the scope of the deductions/adjustments as compared to existing regulations.

 

Under the Basel III Capital Rules, the initial minimum capital ratios as of January 1, 2015, are as follows:

 

4.5% CET1 to risk-weighted assets

 

6.0% Tier 1 capital to risk-weighted assets

 

8.0% Total capital to risk-weighted assets

 

4.0% Minimum leverage ratio

 

Implementation of the deductions and other adjustments to CET1 began on January 1, 2015, and will phase in over a four-year period (beginning at 40% on January 1, 2015, and an additional 20% per year thereafter). Under the new rule, in order to avoid limitations on capital distributions, including dividend payments and certain discretionary bonus payments to executive officers, a banking organization must hold a capital conservation buffer composed of CET1 capital above its minimum risk-based capital requirements. The implementation of the capital conservation buffer begins on January 1, 2016, at the 0.625% level and will phase in over a four-year period (increasing by that amount on each subsequent January 1 until it reaches 2.5% on January 1, 2019).

 

The Company’s and Bank’s actual capital amounts and ratios are presented in the table below.

 

   December 31, 2015 
   Actual Capital
Levels
   Minimum Regulatory
Capital Levels
   Minimum Required To
be Considered Well-
Capitalized
 
   Amount   Ratio   Amount   Ratio   Amount   Ratio 
Leverage Capital Level (1) :                              
MutualFirst Consolidated  $132,727    9.1%  $58,608    4.0%   N/A    N/A 
MutualBank   134,754    9.2    58,509    4.0   $73,136    5.0%
Common Equity Tier 1 Capital Level (2) :                              
MutualFirst Consolidated  $131,520    12.5%  $47,331    4.5%   N/A    N/A 
MutualBank   134,754    12.8    47,309    4.5   $68,336    6.5%
Tier 1 Risk-Based Capital Level (3) :                              
MutualFirst Consolidated  $132,727    12.6%  $63,108    6.0%   N/A    N/A 
MutualBank   134,754    12.8    63,079    6.0   $84,106    8.0%
Total Risk-Based Capital Level (4) :                              
MutualFirst Consolidated  $145,368    13.8%  $84,144    8.0%   N/A    N/A 
MutualBank   147,395    14.0    84,106    8.0   $105,132    10.0%

 

(1) Tier 1 Capital to Average Total Assets of $1.5 billion for the Bank and Company at December 31, 2015.

(2) Common Equity Tier 1 Capital to Risk-Weighted Assets of $1.1 billion for the Bank and Company at December 31, 2015.

(3) Tier 1 Capital to Risk-Weighted Assets.

(4) Total Capital to Risk-Weighted Assets.

 134 

 

 

MutualFirst Financial, Inc.

Notes to Consolidated Financial Statements
(Table Dollar Amounts in Thousands, Except Share and Per Share Data)

 

   December 31, 2014 
   Actual Capital
Levels
   Minimum Regulatory
Capital Levels
   Minimum Required To
be Considered Well-
Capitalized
 
   Amount   Ratio   Amount   Ratio   Amount   Ratio 
Leverage Capital Level (1) :                              
MutualFirst Consolidated  $120,568    8.5%  $56,687    4.0%   N/A    N/A 
MutualBank   124,083    8.8    56,610    4.0   $70,763    5.0%
Tier 1 Risk-Based Capital Level (2) :                              
MutualFirst Consolidated  $120,568    12.3%  $39,269    4.0%   N/A    N/A 
MutualBank   124,083    12.6    39,257    4.0   $58,886    6.0%
Total Risk-Based Capital Level (3) :                              
MutualFirst Consolidated  $132,847    13.5%  $78,537    8.0%   N/A    N/A 
MutualBank   136,362    13.9    78,515    8.0   $98,143    10.0%

 

(1) Tier 1 Capital to Average Total Assets of $1.4 billion for the Bank and Company at December 31, 2014.

(2) Tier 1 Capital to Risk-Weighted Assets of $981.4 million for the Bank and $981.7 million for the Company at December 31, 2014.

(3) Total Capital to Risk-Weighted Assets.

 

Note 19: Employee Benefits

 

The Company has a retirement savings 401(k) plan in which substantially all employees may participate. The contributions are discretionary and determined annually. The Company matches employees' contributions at the following rates: 100 percent of participant contributions up to 4% and 50 percent of participant contributions from 5-6%, not to exceed a maximum of 5% of their compensation. The match amounts were increased in 2014 from the prior rates: 100 percent of participant contributions up to 3% and 50 percent of participant contributions from 4-5%, not to exceed a maximum of 4% of their compensation. The Company’s expense for the plan was $810,000, $739,000 and $552,000 for 2015, 2014 and 2013, respectively.

 

The Company has a supplemental retirement plan and deferred compensation arrangements for the benefit of certain officers. The Company also has deferred compensation arrangements with certain directors whereby, in lieu of previously receiving fees, the directors or their beneficiaries will be paid benefits for an established period following the director’s retirement or death. These arrangements are informally funded by life insurance contracts which have been purchased by the Company. The Company records a liability for these vested benefits based on the present value of future payments. The Company’s expense for the plan was $669,000, $730,000 and $748,000 for 2015, 2014 and 2013, respectively.

 

 135 

 

 

MutualFirst Financial, Inc.

Notes to Consolidated Financial Statements
(Table Dollar Amounts in Thousands, Except Share and Per Share Data)

 

The Company has an ESOP covering substantially all of its employees. During 2013 the ESOP reached maturity and the last of the shares were allocated in early 2014. At December 31, 2015 and 2014 the Company had no unearned ESOP shares. Shares were released to participants proportionately as ESOP debt was repaid. Dividends on allocated shares were recorded as dividends and charged to retained earnings. Dividends on unallocated shares were used to repay the loan. Compensation expense was recorded equal to the fair market value of the stock committed-to-be-released when contributions, which were determined annually by the Board of Directors of the Company and Bank, were made to the ESOP. There were no expenses under the ESOP for 2015 and 2014, and $474,000 in 2013. The following table provides information on ESOP shares at December 31:

 

   2015   2014   2013 
Allocated shares   417,848    426,877    414,896 
Suspense shares   -    -    - 
Committed-to-be released shares   -    -    31,785 

 

Note 20: Stock Option Plans

 

Under the Company’s stock option plans, which are accounted for in accordance with FASB ASC 718, Stock Compensation, the Company grants selected executives and other key employees and directors incentive and non-qualified stock option awards that vest and become fully exercisable at the discretion of the Compensation Committee as the options are granted. As of the end of the 2015, the Company is authorized to grant options under our stock option plan approved in 2008. Under certain provisions of the plan, the number of shares available for grant may be increased without shareholder approval by the amount of shares surrendered as payment of the exercise price of the stock option and by the number of shares of common stock of the Company that could be repurchased by the Company using proceeds from the exercise of stock options.

 

The Company had a stock option plan that was approved in 2000 that expired in 2015. Under the plan provisions, all option grants that have not been exercised or expired are still exercisable until the maturity or the participant forfeits the grant. No additional grants of options can be made from this plan.

 

The fair value of each option award is estimated on the date of grant using a Black-Scholes option valuation model that uses the assumptions noted in the following table. Expected volatility is based on historical volatility of the Company’s stock and other factors. The Company uses historical data to estimate timing of option exercises and employee terminations within the valuation model; separate groups of employees that have similar historical exercise behavior are considered separately for valuation purposes. The expected term of options granted represents the period of time that options are expected to be outstanding; the range given below results from certain groups of employees exhibiting different behavior. The risk-free rate for periods within the contractual life of the option is based on the U.S. Treasury yield curve in effect at the time of grant. The discount rate for post-vesting restrictions is estimated based on the Company’s credit-adjusted risk-free rate of return.

 

 136 

 

 

MutualFirst Financial, Inc.

Notes to Consolidated Financial Statements
(Table Dollar Amounts in Thousands, Except Share and Per Share Data)

 

The following is a summary of the status of the Company’s stock option plans and changes in these plans during 2015.

 

   2015 
Options  Shares   Weighted-
Average
Exercise
Price
   Weighted-
Average
Remaining
Contractual
Life
   Aggregate
Intrinsic
Value
 
Outstanding, beginning of year   568,220   $10.57           
Exercised   (186,059)   10.81           
Outstanding and exercisable, end of year   382,161   $10.45    7.2 years   $5,517 

 

There were 186,059, 118,823 and 61,677 options exercised during the years ended December 31, 2015, 2014 and 2013. There were no options granted during those periods. The Company will fulfill options with authorized but unissued shares of stock from the 352,741 shares the Company has authorized under the current shareholder-approved equity compensation plan. There were 58,000 shares remaining to be granted under the current plan. The Company will also fulfill options with authorized but unissued shares of stock from the 194,662 shares the Company has authorized under the 2000 stock option plan. Options will continue to be exercised from that plan; however no further grants can be made.

 

Cash received from options exercised under all share-based payment arrangements for years ended December 31, 2015, 2014 and 2013 was $2.0 million, $1.3 million and $538,000, respectively. The intrinsic value on options exercised during the years ended December 31, 2015, 2014 and 2013 was $2.2 million, $1.0 million and $377,000, respectively.

 

 137 

 

 

MutualFirst Financial, Inc.

Notes to Consolidated Financial Statements
(Table Dollar Amounts in Thousands, Except Share and Per Share Data)

 

Note 21: Earnings Per Share

 

Earnings per share were computed as follows:

 

   2015 
   Income   Weighted-
Average Shares
   Per-Share
Amount
 
Basic Earnings Per Share               
Net income available to common stockholders  $12,262    7,374,589   $1.66 
Effect of Dilutive Securities               
Stock options   -    173,296      
Diluted Earnings Per Share               
Net income available to common stockholders and assumed conversions  $12,262    7,547,885   $1.62 

 

   2014 
   Income   Weighted-
Average Shares
   Per-Share
Amount
 
Basic Earnings Per Share               
Net income available to common stockholders  $11,046    7,160,700   $1.54 
Effect of Dilutive Securities               
Stock options   -    231,131      
Diluted Earnings Per Share               
Net income available to common stockholders and assumed conversions  $11,046    7,391,831   $1.49 

 

 138 

 

 

MutualFirst Financial, Inc.

Notes to Consolidated Financial Statements
(Table Dollar Amounts in Thousands, Except Share and Per Share Data)

 

   2013 
   Income   Weighted-
Average Shares
   Per-Share
Amount
 
Basic Earnings Per Share               
Net income  $9,383    7,076,877      
Dividends and accretion on preferred stock   (1,257)          
Net income available to common stockholders   8,126    7,076,877   $1.15 
Effect of Dilutive Securities               
Stock options   -    180,941      
Diluted Earnings Per Share               
Net income available to common stockholders and assumed conversions  $8,126    7,257,818   $1.12 

 

Options to purchase 37,161, 44,161 and 75,831 shares of common stock were outstanding at December 31, 2015, 2014 and 2013, respectively, but were not included in the computation of diluted EPS because the options’ exercise price was greater than the average market price of the common shares.

 

Note 22: Fair Values of Financial Instruments

 

Fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. Fair value measurements must maximize the use of observable inputs and minimize the use of unobservable inputs. There is a hierarchy of three levels of inputs that may be used to measure fair value:

 

Level 1 Quoted prices in active markets for identical assets or liabilities
   
Level 2 Observable inputs other than Level 1 prices, such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities
   
Level 3 Unobservable inputs supported by little or no market activity and are significant to the fair value of the assets or liabilities

 

Items Measured at Fair Value on a Recurring Basis

 

Following is a description of the valuation methodologies and inputs used for instruments measured at fair value on a recurring basis and recognized in the accompanying comparative balance sheet, as well as the general classification of such instruments pursuant to the valuation hierarchy.

 

 139 

 

 

MutualFirst Financial, Inc.

Notes to Consolidated Financial Statements
(Table Dollar Amounts in Thousands, Except Share and Per Share Data)

 

Available for Sale Securities

 

Where quoted market prices are available in an active market, securities are classified within Level 1 of the valuation hierarchy. The Company uses a third-party provider to provide market prices on its securities. Prices are evaluated by a third party. Level 1 securities include marketable equity securities. If quoted market prices are not available, then fair values are estimated by using pricing models, quoted prices of securities with similar characteristics or discounted cash flows. Level 2 securities include mortgage-backed, collateralized mortgage obligations, municipal, federal agency and certain corporate obligation securities. In certain cases where Level 1 or Level 2 inputs are not available, securities are classified within Level 3 of the hierarchy and include certain corporate obligation securities.

 

Third party vendors compile prices from various sources and may apply such techniques as matrix pricing to determine the value of identical or similar investment securities (Level 2). Matrix pricing is a mathematical technique widely used in the banking industry to value investment securities without relying exclusively on quoted prices for specific investment securities but rather relying on investment securities relationship to other benchmark quoted investment securities. Any investment security not valued based upon the methods above are considered Level 3.

 

The following table presents the fair value measurements of assets measured at fair value on a recurring basis and level within the ASC 820 fair value hierarchy in which the fair value measurements fall:

 

       Fair Value Measurements Using 
   Fair Value   Level 1   Level 2   Level 3 
December 31, 2015                    
Mortgage-backed securities  $107,838   $-   $107,838   $- 
Collateralized mortgage obligations   84,652    -    84,652    - 
Municipal obligations   57,188    -    57,188    - 
Corporate obligations   11,460    -    8,926    2,534 
Available for sale securities  $261,138   $-   $258,604   $2,534 

 

 140 

 

 

MutualFirst Financial, Inc.

Notes to Consolidated Financial Statements
(Table Dollar Amounts in Thousands, Except Share and Per Share Data)

 

       Fair Value Measurements Using 
   Fair Value   Level 1   Level 2   Level 3 
December 31, 2014                    
Mortgage-backed securities  $113,290   $-   $113,290   $- 
Collateralized mortgage obligations   97,759    -    97,759    - 
Federal agencies   4    -    4    - 
Municipal obligations   29,252    -    29,252    - 
Corporate obligations   20,501    -    17,979    2,522 
Available for sale securities  $260,806   $-   $258,284   $2,522 

 

The following is a reconciliation of the beginning and ending balances for the years ended December 31, 2015, 2014 and 2013 of recurring fair value measurements recognized in the accompanying balance sheets using significant unobservable (Level 3) inputs:

 

   2015   2014   2013 
Beginning balance  $2,522   $3,336   $2,475 
Total realized and unrealized gains (losses)               
Included in net income   -    (68)   - 
Included in other comprehensive income (loss)   12    2,098    897 
Sales   -    (2,826)   - 
Settlements   -    (18)   (36)
Ending balance  $2,534   $2,522   $3,336 
Total gains or losses for the period included in net income attributable to the change in unrealized gains or losses related to assets still held at the reporting date  $0   $0   $0 

 

 141 

 

 

MutualFirst Financial, Inc.

Notes to Consolidated Financial Statements
(Table Dollar Amounts in Thousands, Except Share and Per Share Data)

 

Items Measured at Fair Value on a Non-Recurring Basis

 

From time to time, certain assets may be recorded at fair value on a non-recurring basis. These non-recurring fair value adjustments typically are a result of the application of lower of cost or fair value accounting or a write-down occurring during the period. The following is a description of the valuation methodologies used for certain assets that are recorded at fair value.

 

Impaired Loans (Collateral Dependent)

 

Loans for which it is probable that the Bank will not collect all principal and interest due according to contractual terms are measured for impairment. Allowable methods for determining the amount of impairment include estimating fair value using the fair value of the collateral for collateral dependent loans.

 

If the impaired loan is identified as collateral dependent, then the fair value method of measuring the amount of impairment is utilized. This method requires obtaining a current independent appraisal of the collateral and applying a discount factor to the value.

 

Impaired loans that are collateral dependent are classified within Level 3 of the fair value hierarchy when impairment is determined using the fair value method.

 

Other Real Estate Owned

 

The fair value of real estate is generally determined based on appraisals by qualified licensed appraisers. The appraisers typically determine the value of the real estate by utilizing an income or market valuation approach. If an appraisal is not available, the fair value may be determined by using a cash flow analysis.

 

Other real estate owned is classified within Level 3 of the fair value hierarchy.

 

 142 

 

 

MutualFirst Financial, Inc.

Notes to Consolidated Financial Statements
(Table Dollar Amounts in Thousands, Except Share and Per Share Data)

 

The following table presents the fair value measurement of assets measured at fair value on a nonrecurring basis and the level within the ASC 820 fair value hierarchy in which the fair value measurements fall:

 

       Fair Value Measurements Using 
   Fair Value   Level 1   Level 2   Level 3 
December 31, 2015                    
Impaired loans  $676   $-   $-   $676 

 

       Fair Value Measurements Using 
   Fair Value   Level 1   Level 2   Level 3 
December 31, 2014                    
Other real estate owned  $1,280   $-   $-   $1,280 

 

The following table presents quantitative information about unobservable inputs used in recurring and nonrecurring Level 3 fair value measurements.

 

December 31, 2015  Fair Value   Valuation Technique  Unobservable Inputs  Range 
Trust Preferred Securities  $2,534   Discounted cash flow  Discount rate   7.0 - 8.0%
           Constant prepayment rate   2.0%
           Cumulative projected prepayments   40.0%
           Probability of default   1.7 - 1.8%
           Projected cures given deferral   0 - 15.0%
           Loss severity   33.8 - 40.2%
Impaired loans (collateral dependent)  $676   Third party valuations  Discount to reflect realizable value   20.0 - 50.0%

 

 143 

 

 

MutualFirst Financial, Inc.

Notes to Consolidated Financial Statements
(Table Dollar Amounts in Thousands, Except Share and Per Share Data)

 

December 31, 2014  Fair Value   Valuation Technique  Unobservable Inputs  Range 
Trust Preferred Securities  $2,522   Discounted cash flow  Discount rate   8.0%
           Constant prepayment rate   2.0%
           Cumulative projected prepayments   40.0%
           Probability of default   1.7 - 1.8%
           Projected cures given deferral   0 - 15.0%
           Loss severity   34.2 - 39.8%
Other real estate owned  $1,280   Third party valuations  Discount to reflect realizable value less estimated selling costs   24.4 - 36.7%

 

The following methods and assumptions were used to estimate the fair value of all other financial instruments recognized in the accompanying balance sheets at amounts other than fair value:

 

Cash and Cash Equivalents - The fair value of cash and cash-equivalents approximates carrying value.

 

Loans Held For Sale - Fair values are based on quoted market prices.

 

Loans - The fair value for loans is estimated using discounted cash flow analyses using interest rates currently being offered for loans with similar terms to borrowers of similar credit quality.

 

FHLB Stock - Fair value of FHLB stock is based on the price at which it may be resold to the FHLB.

 

Interest Receivable/Payable - The fair values of interest receivable/payable approximate carrying values.

 

Deposits - The fair values of noninterest-bearing, interest-bearing demand and savings accounts are equal to the amount payable on demand at the balance sheet date. Fair values for fixed-rate certificates of deposit are estimated using a discounted cash flow calculation that applies interest rates currently being offered on certificates to a schedule of aggregated expected monthly maturities on such time deposits.

 

FHLB Advances - The fair value of these borrowings is estimated using a discounted cash flow calculation, based on current rates for similar debt for periods comparable to the remaining terms to maturity of these advances.

 

Other Borrowings - The fair value of these borrowings is estimated using discounted cash flow analyses using interest rates for similar financial instruments.

 

 144 

 

 

MutualFirst Financial, Inc.

Notes to Consolidated Financial Statements
(Table Dollar Amounts in Thousands, Except Share and Per Share Data)

 

Off-Balance Sheet Commitments - Commitments include commitments to purchase and originate mortgage loans, commitments to sell mortgage loans, and standby letters of credit and are generally of a short-term nature. The fair values of such commitments are based on fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements and the counterparties’ credit standing. The fair value of these instruments is insignificant.

 

The estimated fair values of the Company’s financial instruments not carried at fair value in the consolidated balance sheets as of the dates noted below are as follows:

 

           Fair Value Measurements Using 
December 31, 2015  Carrying
Amount
   Fair Value   Level 1   Level 2   Level 3 
Assets                         
Cash and cash equivalents  $20,915   $20,915   $20,915   $-   $- 
Loans held for sale   5,991    6,058    -    6,058    - 
Loans, net   1,068,204    1,056,357    -    -    1,056,357 
FHLB stock   10,482    10,482    -    10,482    - 
Interest receivable   4,201    4,201    -    4,201    - 
Liabilities                         
Deposits   1,091,382    1,090,975    740,759    -    350,216 
FHLB advances   225,617    224,621    -    224,621    - 
Other borrowings   9,458    9,459    -    9,459    - 
Interest payable   199    199    -    199    - 

 

 145 

 

 

MutualFirst Financial, Inc.

Notes to Consolidated Financial Statements
(Table Dollar Amounts in Thousands, Except Share and Per Share Data)

 

           Fair Value Measurements Using 
December 31, 2014  Carrying
Amount
   Fair Value   Level 1   Level 2   Level 3 
Assets                         
Cash and cash equivalents  $29,575   $29,575   $29,575   $-   $- 
Loans held for sale   6,140    6,220    -    6,220    - 
Loans, net   1,003,518    1,006,233    -    -    1,006,233 
FHLB stock   11,964    11,964    -    11,964    - 
Interest receivable   3,730    3,730    -    3,730    - 
Liabilities                         
Deposits   1,079,320    1,050,295    648,314    -    401,981 
FHLB advances   192,442    191,995    -    191,995    - 
Other borrowings   10,174    10,283    -    10,283    - 
Interest payable   223    223    -    223    - 

 

Note 23: Condensed Financial Information (Parent Company Only)

 

Presented below is condensed financial information as to financial position, results of operations and cash flows of the Company:

 

Condensed Balance Sheets

 

   2015   2014 
Assets          
Cash on deposit with Bank  $2,732   $1,726 
Cash on deposit with others   24    657 
Total cash   2,756    2,383 
Investment in common stock of subsidiaries   143,459    135,264 
Deferred tax   214    149 
Other assets   262    - 
Total assets  $146,691   $137,796 
           
Liabilities          
Other borrowings  $9,458   $10,174 
Other liabilities   208    85 
Total liabilities   9,666    10,259 
           
Stockholders' Equity   137,025    127,537 
Total liabilities and stockholders' equity  $146,691   $137,796 

 

 146 

 

 

MutualFirst Financial, Inc.

Notes to Consolidated Financial Statements
(Table Dollar Amounts in Thousands, Except Share and Per Share Data)

 

Condensed Statements of Income

 

   2015   2014   2013 
Income               
Interest income from bank  $1   $1   $4 
Dividends from subsidiaries   3,600    3,500    30,692 
Total income   3,601    3,501    30,696 
Expenses   1,182    994    1,036 
Income before income tax and equity in undistributed income of subsidiaries   2,419    2,735    29,843 
Income tax benefit   (591)   (337)   (342)
Income before equity in undistributed income (distributions in excess of income) of subsidiaries   3,010    3,072    30,185 
Equity in undistributed income (distributions in excess of income) of subsidiaries   9,252    7,974    (20,802)
Net Income   12,262    11,046    9,383 
Preferred stock dividends and accretion   -    -    1,257 
Net Income Available to Common Shareholders  $12,262   $11,046   $8,126 

 

Condensed Statements of Comprehensive Income

 

   2015   2014   2013 
Net income  $12,262   $11,046   $9,383 
Other comprehensive income:               
Net unrealized holding gain (loss) on securities available for sale   (1,186)   8,921    (9,810)
Net unrealized gain on securities available for sale for which a portion of an other-than-temporary impairment has been recognized in income   12    381    800 
Less: Reclassification adjustment for realized gains included in net income   (436)   (313)   (835)
Net unrealized gain on derivative used for cash flow hedges   108    150    157 
Net unrealized gain (loss) relating to defined benefit plan   77    (209)   149 
    (1,425)   8,930    (9,539)
Income tax (expense) benefit related to other comprehensive income   537    (3,137)   3,321 
Other comprehensive income (loss)   (888)   5,793    (6,218)
Comprehensive income  $11,374   $16,839   $3,165 

 

 147 

 

 

MutualFirst Financial, Inc.

Notes to Consolidated Financial Statements
(Table Dollar Amounts in Thousands, Except Share and Per Share Data)

 

Condensed Statements of Cash Flows

 

   2015   2014   2013 
Operating Activities               
Net income  $12,262   $11,046   $9,383 
Item not requiring cash               
ESOP shares earned   -    -    474 
Deferred income tax benefit   (102)   159    71 
(Equity in undistributed income) distributions in excess of income of subsidiaries   (9,252)   (8,202)   20,619 
Other   13    19    (365)
Net cash provided by operating activities   2,921    3,022    30,182 
                
Investing Activity               
Investment in subsidiary   (250)   -    - 
Net cash used in investing activity   (250)   -    - 
                
Financing Activities               
Repayment of other borrowings   (759)   (759)   (759)
Stock repurchased   -    -    (28,924)
Cash dividends   (3,550)   (2,297)   (2,953)
Proceeds from stock options exercised   2,011    1,347    570 
Net cash used in financing activities   (2,298)   (1,709)   (32,066)
Net Change in Cash   373    1,313    (1,884)
Cash, Beginning of Year   2,383    1,070    2,954 
Cash, End of Year  $2,756   $2,383   $1,070 

 

 148 

 

 

MutualFirst Financial, Inc.

Notes to Consolidated Financial Statements
(Table Dollar Amounts in Thousands, Except Share and Per Share Data)

 

Note 24: Quarterly Results of Operations (Unaudited)

 

Quarter Ended  Interest
Income
   Interest
Expense
   Net Interest
Income
   Provision for
Loan Losses
   Net Income   Net Income
Available to
Common
Shareholders
   Basic Earnings
Per Common
Share
   Diluted
Earnings Per
Common Share
 
                                         
2015                                        
March 31  $12,683   $2,165   $10,518   $-   $2,481   $2,481   $0.34   $0.33 
June 30   12,731    2,191    10,540    -    3,218    3,218    0.44    0.43 
September 30   13,049    2,233    10,816    -    3,225    3,225    0.44    0.43 
December 31   13,313    2,214    11,099    125    3,338    3,338    0.45    0.44 
                                         
Total  $51,776   $8,803   $42,973   $125   $12,262   $12,262   $1.66   $1.62 
                                         
2014                                        
March 31  $12,738   $2,319   $10,419   $350   $2,020   $2,020   $0.28   $0.27 
June 30   12,744    2,186    10,558    500    2,614    2,614    0.37    0.36 
September 30   12,803    2,163    10,640    -    2,751    2,751    0.38    0.37 
December 31   12,893    2,255    10,638    -    3,661    3,661    0.51    0.49 
                                         
Total  $51,178   $8,923   $42,255   $850   $11,046   $11,046   $1.54   $1.49 
                                         
2013                                        
March 31  $12,901   $2,922   $9,979   $950   $2,022   $1,661   $0.24   $0.23 
June 30   12,877    2,857    10,020    550    2,157    1,879    0.27    0.26 
September 30   13,041    2,801    10,240    750    2,518    2,247    0.32    0.31 
December 31   12,848    2,644    10,204    (950)   2,686    2,339    0.33    0.32 
                                         
Total  $51,667   $11,224   $40,443   $1,300   $9,383   $8,126   $1.15   $1.12 

 

Note 25: Change in Accounting Principle

 

The Company makes certain equity investments in various limited partnerships that sponsor affordable housing projects utilizing the Low Income Housing Tax Credit (LIHTC) pursuant to Section 42 of the Internal Revenue Code. The Bank has investments in eight Indiana limited partnerships within Indiana and contiguous states. The purpose of these investments is to achieve a satisfactory return on capital, to facilitate the sale of additional affordable housing product offerings, and to assist in achieving goals associated with the Community Reinvestment Act. The primary activities of the limited partnerships include the identification, development, and operation of multi-family housing that is leased to qualifying residential tenants. Generally, these types of investments are funded through a combination of debt and equity.

 

 149 

 

 

MutualFirst Financial, Inc.

Notes to Consolidated Financial Statements
(Table Dollar Amounts in Thousands, Except Share and Per Share Data)

 

The Bank is a limited partner in each LIHTC Partnership. A separate unrelated third party is the general partner. Each limited partnership is managed by the general partner, who exercises full and exclusive control over the affairs of the limited partnership. Duties entrusted to the general partner of each limited partnership include, but are not limited to: investment in operating companies, company expenditures, investment of excess funds, borrowing funds, employment of agents, disposition of fund property, prepayment and refinancing of liabilities, votes and consents, contract authority, disbursement of funds, accounting methods, tax elections, bank accounts, insurance, litigation, cash reserve, and use of working capital reserve funds. Except for limited rights granted to consent to certain transactions, the limited partner(s) may not participate in the operation, management, or control of the limited partnership’s business, transact any business in the limited partnership’s name or have any power to sign documents for or otherwise bind the limited partnership. In addition, the general partner may only be removed by the limited partner(s) in the event the general partner fails to comply with the terms of the agreement and/or is negligent in performing its duties.

 

The Company believes the general partner of each limited partnership has the power to direct the activities which most significantly affect the performance of each partnership; therefore, the Bank has determined that it is not the primary beneficiary of any LIHTC partnership. The Company uses the proportional amortization method to account for a majority of its investments in these entities. These investments are included in accrued income and other assets.

 

During the 2015 first quarter, the Bank adopted ASU 2014-01. The amendments are required to be applied retrospectively to all periods presented. As a result of these changes, the Bank recorded a cumulative-effective adjustment to beginning retained earnings. The Company believes the application of the proportional amortization method aligns the accounting more closely with the economics of the transaction and therefore provides more transparency to the financial reporting.

 

The following table summarizes the balance sheet and income statement amounts impacted by the change at the dates or for the periods indicated as of December 31, 2014 and 2013:

 

   December 31,   December 31, 
   2014   2013 
Investment in limited partnerships          
As previously reported  $1,582      
As reported under the new guidance   527      
Deferred tax asset          
As previously reported   13,305      
As reported under the new guidance   13,575      
Retained earnings          
As previously reported   50,171   $41,650 
As reported under the new guidance   49,386    40,637 

 

 150 

 

 

MutualFirst Financial, Inc.

Notes to Consolidated Financial Statements
(Table Dollar Amounts in Thousands, Except Share and Per Share Data)

 

   Year Ended   Year Ended 
   December 31,   December 31, 
   2014   2013 
Non-interest income          
As previously reported  $14,374   $13,552 
As reported under the new guidance   14,885    14,063 
Income tax expense          
As previously reported   3,583    3,808 
As reported under the new guidance   3,866    4,136 
Net income          
As previously reported   10,818    7,943 
As reported under the new guidance   11,046    8,126 
Basic Earnings Per Share          
As previously reported   1.51    1.12 
As reported under the new guidance   1.54    1.15 
Diluted Earnings Per Share          
As previously reported   1.46    1.09 
As reported under the new guidance   1.49    1.12 

 

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Item 9. Changes In and Disagreements With Accountants on Accounting and Financial Disclosure

 

None.

 

Item 9A. Controls and Procedures

 

Evaluation of Disclosure Controls and Procedures

 

We maintain a system of disclosure controls and procedures (as defined in sec Rule 13a-15(e) of the Securities Exchange Act of 1934 (the “Exchange Act”)) that is designed to provide reasonable assurance that information required to be disclosed by us in the reports that we file under the Exchange Act is recorded, processed, summarized and reported accurately and within the time periods specified in the SEC's rules and forms, and that such information is accumulated and communicated to our management, including our principal executive officer and principal financial officer, as appropriate. An evaluation of the Company’s disclosure controls and procedures as of December 31, 2015, was carried out under the supervision and with the participation of our Chief Executive Officer, Chief Financial Officer and several other members of our senior management preceding the filing date of this annual report. Our Chief Executive Officer and Chief Financial Officer concluded that, as of December 31, 2015, the Company’s disclosure controls and procedures were effective in ensuring that the information required to be disclosed by the Company in the reports it files or submits under the Exchange Act is (i) accumulated and communicated to the Company’s management (including our Chief Executive Officer and Chief Financial Officer) in a timely manner, and (ii) recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms.

 

The Company does not expect that its disclosure controls and procedures will prevent all error and all fraud. A control procedure, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control procedure are met. Because of the inherent limitations in all control procedures, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within MutualFirst have been detected. These inherent limitations include the realities that judgment in decision-making can be faulty, and that breakdowns can occur because of simple error or mistake. Additionally, controls can be circumvented by the individual acts of some persons, by collusion of two or more people, or by management override of the control. The design of any control procedure also is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions; over time, controls may become inadequate because of changes in conditions, or the degree of compliance with the policies or procedures may deteriorate. Because of the inherent limitations in a cost-effective control procedure, misstatements due to error or fraud may occur and not be detected.

 

Management’s Report on Internal Control over Financial Reporting

 

The management of MutualFirst Financial, Inc. is responsible for establishing and maintaining adequate internal control over financial reporting. The Company’s internal control over financial reporting is a process designed to provide reasonable assurance to the Company’s management and board of directors regarding the reliability of financial reporting and the preparation of the financial statements for external purposes in accordance with accounting principles generally accepted in the United States of America.

 

 152 

 

 

The Company’s internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the Company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with accounting principles generally accepted in the United States of America, and that receipts and expenditures of the Company are being made only in accordance with authorizations of management and directors of the Company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the Company’s assets that could have a material effect on the financial statements.

 

Because of its inherent limitations, internal controls over financial reporting may not prevent or detect misstatements. All internal control systems, no matter how well designed, have inherent limitations, including the possibility of human error and the circumvention of overriding controls. Accordingly, even effective internal control over financial reporting can provide only reasonable assurance with respect to financial statement preparation. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

 

Our management assessed the effectiveness of the Company’s internal control over financial reporting as of December 31, 2015. In making this assessment, it used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) in Internal Control-Integrated Framework (2013). Based on our assessment, we believe that, as of December 31, 2015, the Company’s internal control over financial reporting was effective based on those criteria.

 

Date: March 15, 2016 By: /s/David W. Heeter
    David W. Heeter
    President and Chief Executive Officer
     
  By: /s/Christopher D. Cook
    Christopher D. Cook
    Senior Vice President, Treasurer and Chief Financial Officer

 

 153 

 

  

Report of Independent Registered Public Accounting Firm

  

Audit Committee, Board of Directors and Stockholders

MutualFirst Financial, Inc.

Muncie, Indiana

 

We have audited MutualFirst Financial, Inc.'s internal control over financial reporting as of December 31, 2015, based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). The Company's management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management’s Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on the Company's internal control over financial reporting based on our audit.

 

We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audit also included performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.

 

A company's internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company's internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the company's assets that could have a material effect on the financial statements.

 

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions or that the degree of compliance with the policies or procedures may deteriorate.

 

In our opinion, MutualFirst Financial, Inc. maintained, in all material respects, effective internal control over financial reporting as of December 31, 2015, based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO).

 

We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated financial statements of MutualFirst Financial, Inc. and our report dated March 15, 2016, expressed an unqualified opinion thereon.

 

/s/ BKD, LLP

 

Indianapolis, Indiana

March 15, 2016

 

 

 

 154 

 

 

Changes in Internal Controls over Financial Reporting

 

There were no changes in our internal controls over financial reporting (as defined in SEC Rule 13a-15(f) under the Exchange Act) that occurred during the quarter ended December 31, 2015, that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

 

Item 9B. Other Information

 

None.

 

PART III

 

Item 10. Directors, Executive Officers and Corporate Governance

 

Directors

 

Information concerning the Company’s directors is incorporated herein by reference from the Company’s definitive proxy statement for its Annual Meeting of Stockholders to be held in May 2015, a copy of which will be filed with the SEC not later than 120 days after the close of the fiscal year.

 

Executive Officers

 

Information concerning the executive officers of the Company who are directors is incorporated herein by reference from the Company’s definitive proxy statement for its Annual Meeting of Stockholders to be held in May 2016, a copy of which will be filed with the SEC not later than 120 days after the close of the fiscal year.

 

The business experience of each of our other current executive officers for at least the past five years is set forth below.

 

Christopher D. Cook. Age 42 years. Mr. Cook, a certified public accountant, has served as Senior Vice President, Treasurer and Chief Financial Officer of MutualFirst and MutualBank since May 2010.  Mr. Cook began his career with MutualBank in 1996. Since that time he has served as Profitability Analyst, Assistant Treasurer, Controller and Director of Finance.

 

Sharon L. Ferguson.  Age 60 years.  Ms. Ferguson has served as Senior Vice President of Risk Management of the Bank since February 2009.  From April 2008 until February 2009, she served as Senior Vice President of Consumer Banking.  From September 2007 to April 2008 she served as Vice President of Retail Products. From October 2005 until September 2007 she served as Assistant Vice President, Retail Products Manager. Prior to October 2005 she served as Assistant Vice President, Consumer Lending and Deposits Manager. She has been with the Bank since March 1998.

 

 155 

 

 

Christopher L. Caldwell. Age 50 years. Mr. Caldwell has served as Senior Vice President of Business Banking of MutualBank since December 2012.  Beginning in 2008, he served as Vice President/Senior Business Banker for the Central Region of MutualBank.  From 2006 to 2008, he served as Regional Head of Commercial Lending for Delaware and Randolph counties.  He became a Vice President of Commercial Lending in 2005.  Mr. Caldwell is a graduate of the ABA Stonier Graduate School of Banking and serves as Secretary of the MutualBank Charitable Foundation.  

 

Audit Committee Matters and Audit Committee Financial Expert

 

The Board of Directors of the Company has a standing Audit/Compliance Committee, which has been established in accordance with Section 3(a)(58)(A) of the Exchange Act. The members of that committee are Directors Linn A. Crull (Chairman), Wilbur R. Davis, Jerry D. McVicker, Edward J. Levy, Jonathan C. Kintner and Richard J. Lashley, all of whom are considered independent under applicable Nasdaq listing standards. The Board of Directors has determined that Mr. Crull, Mr. Levy and Mr. Lashley are each considered to be an “audit committee financial expert” as defined in applicable SEC rules. Additional information concerning the audit committee of the Company’s Board of Directors is incorporated herein by reference from the Company’s definitive proxy statement for its Annual Meeting of Stockholders to be held in May 2016, a copy of which will be filed with the SEC not later than 120 days after the close of the fiscal year.

 

Section 16(a) Beneficial Ownership Reporting Compliance

 

Section 16(a) of the Exchange Act requires the Company’s directors and executive officers, and persons who own more than 10% of a registered class of the Company’s equity securities, to file with the SEC reports of ownership and reports of changes in ownership of common stock and other equity securities of the Company. Officers, directors and greater than 10% stockholders are required by SEC regulation to furnish the Company with copies of all Section 16(a) forms they file.

 

To the Company’s knowledge, based solely on its review of the Section 16 reports filed by its directors and executive officers and written representations from those directors and executive officers, all Section 16(a) filing requirements applicable to the Company’s executive officers and directors during the fiscal year ended December 31, 2015, were met, except for one Form 4 filed by director Rosema covering 5,000 shares which was not timely filed due to a communications error.

 

Code of Ethics

 

The Company adopted a written Code of Ethics based upon the standards set forth under Item 406 of Regulation S-K of the Securities Exchange Act. The Code of Ethics applies to all of the Company’s directors, officers and employees. A copy of the Company’s Code of Ethics was filed with the SEC as Exhibit 14 to the Annual Report on Form 10-K for the year ended December 31, 2003. You may obtain a copy of the Code of Ethics on our website at www.bankwithmutual.com at “About Us – Investor Relations – Governance Documents - Code of Ethics,” or free of charge from the Company by writing to our Corporate Secretary at MutualFirst Financial, Inc., 110 E. Charles Street, Muncie, Indiana 47305-2400 or by calling (765) 747-2800.

 

 156 

 

 

Nomination Procedures

 

There have been no material changes to the procedures by which stockholders may recommend nominees to the Company’s Board of Directors.

 

Item 11. Executive Compensation

 

Information concerning executive compensation is incorporated herein by reference from the Company’s definitive proxy statement for its Annual Meeting of Stockholders to be held in May 2016, a copy of which will be filed with the SEC not later than 120 days after the close of the fiscal year.

 

Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters

 

Information concerning security ownership of certain beneficial owners and management is incorporated herein by reference from the Company’s definitive proxy statement for its Annual Meeting of Stockholders to be held in May 2016, a copy of which will be filed with the SEC not later than 120 days after the close of the fiscal year.

 

Equity Compensation Plan Information. The following table summarizes our equity compensation plans as of December 31, 2015.

 

Plan Category  Number of securities
to be
issued upon
exercise of
outstanding options,
warrants and rights
   Weighted-average
exercise price of
outstanding options
warrants and rights
   Number of securities
remaining available
for future issuance
under equity
compensation plan
 
Equity compensation plans approved by security holders   382,161   $10.45    58,003(1)
                
Equity compensation plans not approved by security holders   -    -    - 

 

 

(1) These shares are available for future grants under the Company’s 2008 stock option plan.

 

 157 

 

 

Item 13. Certain Relationships and Related Transactions

 

Information required by this item concerning certain relationships and related transactions, our independent directors and our audit and nominating committee charters is incorporated herein by reference from the Company’s definitive proxy statement for its Annual Meeting of Stockholders to be held in May 2016, which will be filed no later than 120 days after the close of the fiscal year.

 

Item 14. Principal Accountant Fees and Services

 

Information required by this item concerning principal accountant fees and services is incorporated herein by reference from the Company’s definitive proxy statement for its Annual Meeting of Stockholders to be held in May 2016, a copy of which will be filed with the SEC not later than 120 days after the close of the fiscal year.

 

 158 

 

 

PART IV

 

Item 15. Exhibits and Financial Statement Schedules

 

(a)(1) List of Financial Statements

 

The following are contained in Item 8 of this Form 10-K:

 

Annual Report Section
Report of Independent Registered Public Accounting Firm
Consolidated Balance Sheets at December 31, 2015 and 2014
Consolidated Statements of Income for the Years Ended December 31, 2015, 2014 and 2013
Consolidated Statements of Comprehensive Income for the Years Ended December 31, 2015, 2014 and 2013
Consolidated Statements of Stockholders’ Equity for the Years Ended December 31, 2015, 2014 and 2013
Consolidated Statements of Cash Flows for the Years Ended December 31, 2015, 2014 and 2013
Notes to Consolidated Financial Statements, December 31, 2015, 2014 and 2013

 

(a)(2) Financial Statement Schedules:

 

All financial statement schedules have been omitted as the information is not required under the related instructions or is not applicable.

 

(a)(3) Exhibits:

 

Regulation

S-K

Exhibit

Number

  Document  

Reference

to Prior

Filing or

Exhibit

Number

Attached

Hereto

3.1   Articles of Incorporation   b
3.1a   Articles Supplementary to Charter   p
3.2   Articles Supplementary for the Series A Preferred Stock   c
3.3   Articles Supplementary for the SBLF Preferred Stock   a
3.4   Amended Bylaws   k
3.4a   Amended and Restated Bylaws   q
3.5   Articles Supplementary to the Company’s Charter re: term of appointed directors   l
4.1   Form of Common Stock Certificate   b
4.2   Form of Certificate for the Series A Preferred Stock   c
4.3   Form of Certificate for the SBLF Preferred Stock   a
9   Voting Trust Agreement   None

 

 159 

 

 

10.1   Employment Agreement with David W. Heeter   e
10.2   Employment Agreement with Patrick C. Botts   e
10.3   Form of Supplemental Retirement Plan Income Agreements for Patrick C. Botts and David W. Heeter   f
10.4   Named Executive Officer Salaries and Bonus Arrangements for 2013   n
10.5   Form of Director Shareholder Benefit Program Agreement, as amended, for Jerry D. McVicker   g
10.6   Form of Agreements for Executive Deferred Compensation Plan for Patrick C. Botts and David W. Heeter   f
10.7   Registrant’s 2001 Stock Option and Incentive Plan   h
10.8   Registrant’s 2001 Recognition and Retention Plan   h
10.9   Director Fee Arrangements for 2015   10.9
10.10   Director Deferred Compensation Plan   i
10.11   MutualFirst Financial, Inc. 2008 Stock Option and Incentive Plan   d
10.12   MFB Corp. 2002 Stock Option Plan   d
10.13   MFB Corp. 1997 Stock Option Plan   d
10.14   Employment Agreement with Charles J. Viater   e
10.15   Salary Continuation Agreement with Charles J. Viater   d
10.16   Loan Agreement with First Tennessee Bank National Association dated December 21, 2009.   m
10.17   Form of Incentive Stock Option Agreement for 2008 Stock Option and Incentive Plan   j
10.18   Form of Non-Qualified Stock Option Agreement for 2008 Stock Option and Incentive Plan   j
10.19   Small Business Lending Fund - Securities Purchase Agreement, dated August 25, 2011, between MutualFirst Financial, Inc. and the Secretary of the Treasury, with respect to the issuance and sale of the SBLF Preferred Stock   a
10.20   Repurchase Agreement dated August 25, 2012, between MutualFirst Financial, Inc. and the United States Department of the Treasury, with respect to the repurchase and redemption of the TARP Preferred Stock   a
10.21   Employment Agreement with Christopher D. Cook.   e
10.22   Agreement with Richard J. Lashley and PL Capital Group   q
11   Statement re computation of per share earnings   None
12   Statements re computation of ratios   None
14   Code of Ethics   o
16   Letter re change in certifying accountant   None
18   Letter re change in accounting principles   None
21   Subsidiaries of the registrant   21
22   Published report regarding matters submitted to vote of security holders   None
23   Consents of experts and counsel   23
24   Power of Attorney   None
31.1   Rule 13(a)-14(a) Certification (Chief Executive Officer)   31.1
31.2   Rule 13(a)-14(a) Certification (Chief Financial Officer)   31.2
32   Section 1350 Certification   32

 

 160 

 

 

101   Financial Statements from the Company’s Form 10-K for the year ended December 31, 2015, formatted in Extensive Business Reporting Language (XBRL); (i) Consolidated Condensed Balance Sheets as of December 31, 2015 and 2014; (ii) Consolidated Condensed Statements of Income for the Years Ended December 31, 2015, 2014 and 2013; (iii) Consolidated Condensed Statements of Comprehensive Income for the Years Ended December 31, 2015, 2014 and 2013; (iv) Consolidated Condensed Statement of Stockholders’ Equity for the Years Ended December 31, 2015, 2014 and 2013 (v) Consolidated Condensed Statements of Cash Flows for the Years Ended December 31, 2015, 2014 and 2013; and (vi) Notes to Consolidated Financial Statements, December 31, 2015, 2014 and 2013, as follows:    
    101.INS XBRL Instance Document   101.INS
    101.SCH XBRL Taxonomy Extension Schema Document   101.SCH
    101.CAL XBRL Taxonomy Extension Calculation Linkbase Document   101.CAL
    101.DEF XBRL Taxonomy Extension Definition Linkbase Document   101.DEF
    101.LAB XBRL Taxonomy Extension Labels Linkbase Document   101.LAB
    101.PRE XBRL Taxonomy Extension Presentation Linkbase Document   101.PRE

  

a Filed as an exhibit to the Company’s Form 8-K filed on August 26, 2011 and incorporated herein by reference.
b Filed as an exhibit to the Company’s Form S-1 registration statement filed on September 16, 1999 and incorporated herein by reference.
c Filed as an exhibit to the Company’s Form 8-K filed on December 23, 2008 and incorporated herein by reference.
d Filed as an Exhibit to the Company’s Annual Report on Form 10-K filed on March 23, 2009 and incorporated herein by reference.
e Filed as an exhibit to the Company’s Form 10-Q filed on November 14, 2012 and incorporated herein by reference.
f Filed as an exhibit to the Company’s Annual Report on Form 10-K filed on March 30, 2001 and incorporated herein by reference.
g Filed as an exhibit to the Company’s Annual Report on Form 10-K filed on April 2, 2002 and incorporated herein by reference.
h Filed as an Appendix to the Company’s Form S-4/A Registration Statement filed on October 19, 2001 and incorporated herein by reference.
i Filed as an exhibit to the Company’s Annual Report on Form 10-K filed on March 16, 2007 and incorporated herein by reference.
j Filed as an exhibit to the Company’s Form 10-K filed on March 23, 2010 and incorporated herein by reference.
k Filed as an exhibit to the Company’s Form 8-K filed on October 15, 2007 and incorporated herein by reference.
l Filed as an exhibit to the Company’s Form 8-K filed on July 15, 2008 and incorporated herein by reference.
m Filed as an exhibit to the Company’s Form 8-K filed on December 24, 2009 and incorporated herein by reference.
n Filed as an exhibit to the Company’s Form 8-K filed on February 15, 2012 and incorporated herein by reference.
o Filed as an exhibit to the Company’s Annual Report on Form 10-K filed on March 15, 2004 and incorporated herein by reference.
p Filed as an exhibit to the Company’s Form 8-K filed on July 15, 2008 and incorporated herein by reference.
q Filed as an exhibit to the Company’s Form 8-K filed on February 27, 2015 and incorporated herein by reference.

 

(b) Exhibits - See list in (a)(3) and the Exhibit Index following the signature page.

 

(c) Financial Statements Schedules – None

 

 161 

 

 

SIGNATURES

 

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

 

    MutualFirst Financial, Inc.
     
Date: March 15, 2016 By: /s/David W. Heeter
    David W. Heeter, President and Chief Executive Officer
    (Duly Authorized Representative)  

 

POWER OF ATTORNEY

 

We, the undersigned officers and directors of MutualFirst Financial, Inc., hereby severally and individually constitute and appoint David W. Heeter the true and lawful attorneys and agents of each of us to execute in the name, place and stead of each of us (individually and in any capacity stated below) any and all amendments to this Annual Report on Form 10-K and all instruments necessary or advisable in connection therewith and to file the same with the Securities and Exchange Commission, each of said attorneys and agents to have the power to act with or without the others and to have full power and authority to do and perform in the name and on behalf of each of the undersigned every act whatsoever necessary or advisable to be done in the premises as fully and to all intents and purposes as any of the undersigned might or could do in person, and we hereby ratify and confirm our signatures as they may be signed by our said attorneys and agents or each of them to any and all such amendments and instruments. Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.

 

/s/David W. Heeter   /s/Wilbur R. Davis
David W. Heeter, President and Director   Wilbur R. Davis, Chairman of the Board
(Principal Executive Officer)   Date: March 15, 2016
Date: March 15, 2016    
     
/s/Patrick C. Botts   /s/Linn A. Crull
Patrick C. Botts, Director   Linn A. Crull, Director
Date: March 15, 2016   Date: March 15, 2016
     
/s/James D. Rosema   /s/William V. Hughes
James D. Rosema, Director   William V. Hughes, Director
Date: March 15, 2016   Date: March 15, 2016
     
/s/Jerry D. McVicker   /s/James R. Schrecongost
Jerry D. McVicker, Director   James R. Schrecongost
Date: March 15, 2016   Date: March 15, 2016
     
/s/Jonathan E. Kintner, O.D.   /s/Edward C. Levy
Jonathan E. Kintner, O.D., Director   Edward C. Levy, Director
Date: March 15, 2016   Date: March 15, 2016

 

 162 

 

 

/s/Michael J. Marien   /s/Charles J. Viater
Michael J. Marien, Director   Charles J. Viater, Director
Date: March 15, 2016   Date: March 15, 2016
     
/s/ Christopher D. Cook    /s/Richard J. Lashley
Christopher D. Cook, Senior Vice President    Richard J. Lashley, Director
Treasurer and Chief Financial Officer    Date: March 15, 2016
(Principal Financial and Accounting Officer)    
Date: March 15, 2016    

 

 163 

 

 

INDEX TO EXHIBITS

 

Number Description
   
10.9 Director Fee Arrangements for 2015
   
21 Subsidiaries of the Registrant
   
23 Consent of Accountants
   
31.1 Rule 13(a)-14(a) Certification (Chief Executive Officer)
   
31.2 Rule 13(a)-14(a) Certification (Chief Financial Officer)
   
32 Section 1350 Certification
   

 

 164