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EX-32.1 - EXHIBIT 32.1 CEO - FIRST MID BANCSHARES, INC.fmbh-ex321x2017930.htm
EX-32.2 - EXHIBIT 32.2 CFO - FIRST MID BANCSHARES, INC.fmbh-ex322x2017930.htm
EX-31.2 - EXHIBIT 31.2 CFO - FIRST MID BANCSHARES, INC.fmbh-ex312x2017930.htm
EX-31.1 - EXHIBIT 31.1 CEO - FIRST MID BANCSHARES, INC.fmbh-ex311x2017930.htm


UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C.  20549
 
FORM 10-Q
 
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2017
Or
[  ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from _____________ to ______________
 
Commission file number 0-13368
 
FIRST MID-ILLINOIS BANCSHARES, INC.
(Exact name of Registrant as specified in its charter)
 
Delaware
37-1103704
(State or other jurisdiction of incorporation or organization)
(I.R.S. employer identification no.)
 
1421 Charleston Avenue,
 
Mattoon, Illinois
61938
(Address of principal executive offices)
(Zip code)
 
(217) 234-7454
(Registrant's telephone number, including area code)

Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes [X]  No [  ]

Indicate by check mark whether the Registrant has submitted electronically and posted on its corporate website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (Section 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes [X ]  No [  ]

Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and "emerging growth company" in Rule 12b-2 of the Exchange Act.  (Check one):

Large accelerated filer [  ]
Accelerated filer [X]
Non-accelerated filer [  ]
(Do not check if a smaller reporting company)
Smaller reporting company [  ]
 
 
Emerging growth company [  ]

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. [ ]

Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Act).  [  ] Yes  [X] No

As of November 6, 2017, 12,618,026 common shares, $4.00 par value, were outstanding.

1








PART I

ITEM 1.  FINANCIAL STATEMENTS
 
 
 
First Mid-Illinois Bancshares, Inc.
 
 
 
Condensed Consolidated Balance Sheets
(Unaudited)
 
 
(In thousands, except share data)
September 30, 2017
 
December 31, 2016
Assets
 
 
 
Cash and due from banks:
 
 
 
Non-interest bearing
$
62,591

 
$
57,988

Interest bearing
6,562

 
79,014

Federal funds sold
490

 
38,900

Cash and cash equivalents
69,643

 
175,902

Certificates of deposit investments
1,685

 
14,643

Investment securities:
 

 
 

Available-for-sale, at fair value
621,204

 
619,848

Held-to-maturity, at amortized cost (estimated fair value of $69,137 and $73,096 at September 30, 2017 and December 31, 2016, respectively)
69,306

 
74,231

Loans held for sale
2,079

 
1,175

Loans
1,865,483

 
1,824,817

Less allowance for loan losses
(18,589
)
 
(16,753
)
Net loans
1,846,894

 
1,808,064

Interest receivable
10,876

 
10,553

Other real estate owned
2,229

 
1,982

Premises and equipment, net
38,638

 
40,292

Goodwill, net
60,150

 
57,791

Intangible assets, net
11,181

 
12,832

Bank owned life insurance
41,601

 
41,318

Other assets
18,970

 
25,904

Total assets
$
2,794,456

 
$
2,884,535

Liabilities and Stockholders’ Equity
 

 
 

Deposits:
 

 
 

Non-interest bearing
$
430,036

 
$
471,206

Interest bearing
1,787,441

 
1,858,681

Total deposits
2,217,477

 
2,329,887

Securities sold under agreements to repurchase
116,360

 
185,763

Interest payable
552

 
535

FHLB borrowings
87,052

 
40,094

Other borrowings
31,250

 
18,063

Junior subordinated debentures
23,980

 
23,917

Other liabilities
6,354

 
5,603

Total liabilities
2,483,025

 
2,603,862

Stockholders’ Equity:
 

 
 

Common stock, $4 par value; authorized 18,000,000 shares; issued 13,167,769 and 13,020,742 shares in 2017 and 2016, respectively
54,671

 
54,083

Additional paid-in capital
163,067

 
158,671

Retained earnings
104,281

 
86,216

Deferred compensation
2,987

 
3,201

Accumulated other comprehensive income (loss)
1,999

 
(5,761
)
Less treasury stock at cost, 549,743 shares in 2017 and 2016
(15,574
)
 
(15,737
)
Total stockholders’ equity
311,431

 
280,673

Total liabilities and stockholders’ equity
$
2,794,456

 
$
2,884,535


See accompanying notes to unaudited condensed consolidated financial statements.


2






First Mid-Illinois Bancshares, Inc.
 
 
 
Condensed Consolidated Statements of Income (unaudited)
 
(In thousands, except per share data)
Three months ended September 30,
 
Nine months ended September 30,
 
2017
 
2016
 
2017
 
2016
Interest income:
 
 
 
 
 
 
 
Interest and fees on loans
$
20,385

 
$
15,294

 
$
61,337

 
$
42,496

Interest on investment securities
4,179

 
3,229

 
12,585

 
9,622

Interest on certificates of deposit investments
9

 
78

 
41

 
234

Interest on federal funds sold
1

 
7

 
62

 
8

Interest on deposits with other financial institutions
40

 
15

 
217

 
125

Total interest income
24,614

 
18,623

 
74,242

 
52,485

Interest expense:
 

 
 

 
 

 
 

Interest on deposits
1,028

 
623

 
2,840

 
1,777

Interest on securities sold under agreements to repurchase
51

 
23

 
137

 
62

Interest on FHLB borrowings
283

 
150

 
602

 
465

Interest on other borrowings
143

 
42

 
385

 
45

Interest on subordinated debentures
236

 
162

 
680

 
456

Total interest expense
1,741

 
1,000

 
4,644

 
2,805

Net interest income
22,873

 
17,623

 
69,598

 
49,680

Provision for loan losses
1,489

 
1,081

 
5,051

 
1,927

Net interest income after provision for loan losses
21,384

 
16,542

 
64,547

 
47,753

Other income:
 

 
 

 
 

 
 

Trust revenues
925

 
774

 
2,696

 
2,549

Brokerage commissions
536

 
526

 
1,550

 
1,440

Insurance commissions
670

 
738

 
3,148

 
2,806

Service charges
1,758

 
1,824

 
5,160

 
4,977

Securities gains, net
254

 
466

 
589

 
1,130

Mortgage banking revenue, net
347

 
382

 
875

 
715

ATM / debit card revenue
1,595

 
1,457

 
4,828

 
4,418

Bank owned life insurance
792

 
201

 
1,355

 
384

Other
784

 
530

 
2,925

 
1,582

Total other income
7,661

 
6,898

 
23,126

 
20,001

Other expense:
 

 
 

 
 

 
 

Salaries and employee benefits
9,648

 
7,844

 
29,685

 
23,293

Net occupancy and equipment expense
3,129

 
2,864

 
9,378

 
8,389

Net other real estate owned expense
385

 
32

 
530

 
23

FDIC insurance
210

 
294

 
679

 
841

Amortization of intangible assets
545

 
455

 
1,651

 
1,312

Stationery and supplies
168

 
221

 
539

 
612

Legal and professional
871

 
713

 
2,596

 
2,414

Marketing and donations
338

 
285

 
909

 
1,486

Other
2,618

 
2,612

 
9,102

 
6,264

Total other expense
17,912

 
15,320

 
55,069

 
44,634

Income before income taxes
11,133

 
8,120

 
32,604

 
23,120

Income taxes
3,538

 
2,812

 
10,545

 
8,077

Net income
7,595

 
5,308

 
22,059

 
15,043

Dividends on preferred shares

 

 

 
825

Net income available to common stockholders
$
7,595

 
$
5,308

 
$
22,059

 
$
14,218

Per share data:
 

 
 

 
 

 
 

Basic net income per common share available to common stockholders
$
0.61

 
$
0.51

 
$
1.76

 
$
1.52

Diluted net income per common share available to common stockholders
$
0.61

 
$
0.51

 
$
1.76

 
$
1.50

Cash dividends declared per common share
$

 
$
0.16

 
$
0.32

 
$
0.46


See accompanying notes to unaudited condensed consolidated financial statements.

3






First Mid-Illinois Bancshares, Inc.
 
 
 
 
 
 
 
Condensed Consolidated Statements of Comprehensive Income (unaudited)
 
 
 
(in thousands)
Three months ended September 30,
 
Nine months ended September 30,
 
2017
 
2016
 
2017
 
2016
Net income
$
7,595

 
$
5,308

 
$
22,059

 
$
15,043

Other Comprehensive Income
 

 
 

 
 

 
 

Unrealized gains (losses) on available-for-sale securities, net of taxes of $327 and $(690) for three months ended September 30, 2017 and 2016, respectively and $(5,154) and $(3,698) for nine months ended September 30, 2017 and 2016, respectively.
(512
)
 
1,082

 
8,068

 
5,792

Amortized holding losses on held-to-maturity securities transferred from available-for-sale, net of taxes of $(11) for three months ended September 30, 2017 and 2016, and $(32) and $(161) for nine months ended September 30, 2017 and 2016, respectively.
16

 
16

 
51

 
251

Less: reclassification adjustment for realized gains included in net income, net of taxes of $99 and $182 for three months ended September 30, 2017 and 2016, respectively and $230 and $440 for nine months ended September 30, 2017 and 2016, respectively.
(155
)
 
(284
)
 
(359
)
 
(690
)
Other comprehensive income (loss), net of taxes
(651
)
 
814

 
7,760

 
5,353

Comprehensive income
$
6,944

 
$
6,122

 
$
29,819

 
$
20,396


See accompanying notes to unaudited condensed consolidated financial statements.



4






First Mid-Illinois Bancshares, Inc.
 
Condensed Consolidated Statements of Cash Flows (unaudited)
Nine months ended September 30,
(In thousands)
2017
 
2016
Cash flows from operating activities:
 
 
 
Net income
$
22,059

 
$
15,043

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

 
 

Provision for loan losses
5,051

 
1,927

Depreciation, amortization and accretion, net
6,241

 
5,592

Change in cash surrender value of bank owned life insurance
(844
)
 
(384
)
Stock-based compensation expense
300

 
268

Gains on investment securities, net
(589
)
 
(1,130
)
Loss (gain) on sales of other real property owned, net
349

 
(5
)
Donation of building

 
653

Loss on write down of fixed assets
337

 
26

Gains on sale of loans held for sale, net
(809
)
 
(805
)
Decrease in accrued interest receivable
(323
)
 
(347
)
Increase (decrease) in accrued interest payable
38

 
(36
)
Origination of loans held for sale
(45,076
)
 
(57,199
)
Proceeds from sale of loans held for sale
44,981

 
55,388

Decrease (increase) in other assets
2,475

 
(2,713
)
Decrease in other liabilities
(1,421
)
 
(1,036
)
Net cash provided by operating activities
32,769

 
15,242

Cash flows from investing activities:
 

 
 

Proceeds from maturities of certificates of deposit investments
12,958

 
13,618

Purchases of certificates of deposit investments

 
(12,958
)
Proceeds from sales of securities available-for-sale
96,184

 
68,726

Proceeds from maturities of securities available-for-sale
52,894

 
55,500

Proceeds from maturities of securities held-to-maturity

 
91,899

Purchases of securities available-for-sale
(134,807
)
 
(84,102
)
Purchases of securities held-to-maturity

 
(71,557
)
Net increase in loans
(49,198
)
 
(84,432
)
Sale of premises and equipment

 
147

Purchases of premises and equipment
(1,304
)
 
(449
)
Proceeds from sales of other real property owned
5,356

 
488

Investment in bank owned life insurance

 
(25,000
)
Cash received related to acquisition, net of cash and cash equivalents acquired

 
36,774

Net cash used in investing activities
(17,917
)
 
(11,346
)
Cash flows from financing activities:
 
 
 

Net decrease in deposits
(112,410
)
 
(3,996
)
Increase in federal funds purchased
20,000

 

Decrease in repurchase agreements
(69,403
)
 
(24,673
)
Proceeds from FHLB advances
52,000

 
20,000

Repayment of FHLB advances
(5,000
)
 
(5,000
)
Proceeds from short-term debt

 
7,000

Proceeds from long-term debt

 
15,000

Repayment of other debt
(6,813
)
 

Proceeds from issuance of common stock
4,195

 
97

Direct expenses related to capital transactions
(213
)
 
(230
)
Dividends paid on preferred stock

 
(1,286
)
Dividends paid on common stock
(3,467
)
 
(3,555
)
Net cash (used in) provided by financing activities
(121,111
)
 
3,357

(Decrease) increase in cash and cash equivalents
(106,259
)
 
7,253

Cash and cash equivalents at beginning of period
175,902

 
115,784

Cash and cash equivalents at end of period
$
69,643

 
$
123,037


5






First Mid-Illinois Bancshares, Inc.
 
Condensed Consolidated Statements of Cash Flows (unaudited)
Nine months ended September 30,
(In thousands)
2017
 
2016
 
 
 
 
Supplemental disclosures of cash flow information
 
 
 
Cash paid during the period for:
 
 
 
Interest
$
4,627

 
$
2,568

Income taxes
7,969

 
9,335

Supplemental disclosures of noncash investing and financing activities
 

 
 

Loans transferred to other real estate owned
5,317

 
115

Dividends reinvested in common stock
527

 
1,052

Net tax benefit related to option and deferred compensation plans
221

 
140

Supplemental disclosure of purchase of capital stock of First Clover Leaf
 
 
 
Fair value of assets acquired
 
 
$
668,905

Consideration paid:
 
 
 
     Cash paid
 
 
22,545

     Common stock issued
 
 
65,926

Total consideration paid
 
 
88,471

Fair value of liabilities assumed
 
 
$
580,434


See accompanying notes to unaudited condensed consolidated financial statements.

6






Notes to Condensed Consolidated Financial Statements
(unaudited)

Note 1 --  Basis of Accounting and Consolidation

The unaudited condensed consolidated financial statements include the accounts of First Mid-Illinois Bancshares, Inc. (“Company”) and its wholly-owned subsidiaries:  First Mid-Illinois Bank & Trust, N.A. (“First Mid Bank”), Mid-Illinois Data Services, Inc. (“MIDS”) and The Checkley Agency, Inc. doing business as First Mid Insurance Group (“First Mid Insurance”).  All significant intercompany balances and transactions have been eliminated in consolidation.   The financial information reflects all adjustments which, in the opinion of management, are necessary for a fair presentation of the results of the interim periods ended September 30, 2017 and 2016, and all such adjustments are of a normal recurring nature.  Certain amounts in the prior year’s consolidated financial statements have been reclassified to conform to the September 30, 2017 presentation and there was no impact on net income or stockholders’ equity.  The results of the interim period ended September 30, 2017 are not necessarily indicative of the results expected for the year ending December 31, 2017. The Company operates as a one-segment entity for financial reporting purposes.

The 2016 year-end consolidated balance sheet data was derived from audited financial statements, but does not include all disclosures required by accounting principles generally accepted in the United States of America.

The unaudited condensed consolidated financial statements have been prepared in accordance with the instructions to Form 10-Q and Article 10 of Regulation S-X and do not include all of the information required by U.S. generally accepted accounting principles (“GAAP”) for complete financial statements and related footnote disclosures although the Company believes that the disclosures made are adequate to make the information not misleading.  These financial statements should be read in conjunction with the consolidated financial statements and notes thereto included in the Company’s 2016 Annual Report on Form 10-K.

Website

The Company maintains a website at www.firstmid.com. All periodic and current reports of the Company and amendments to these reports filed with the Securities and Exchange Commission (“SEC”) can be accessed, free of charge, through this website as soon as reasonably practicable after these materials are filed with the SEC.

At-The-Market Program

On August 16, 2017, the Company entered into a Sales Agency Agreement, pursuant to which the Company may sell, from time to time, up to an aggregate of $20 million of it's common stock. Shares of common stock are offered pursuant to the Company's shelf registration statement filed within the SEC. During the three and nine months ended September 30, 2017, the company sold 95,310 shares of common stock at the weighted average price of approximately $35.06, representing gross proceeds of $3.34 million and net proceeds of $3.28 million. As of September 30, 2017, approximately $16.66 million of common stock remained available for issuance under the At The Market program.

Agreement and Plan of Merger

On April 26, 2016, the Company entered into an Agreement and Plan of Merger (the "Merger Agreement") with First Clover Leaf Financial Corp., a Maryland corporation ("First Clover Leaf"), pursuant to which, amongst other things, the Company agreed to acquire 100% of the issued and outstanding shares of First Clover Leaf pursuant to a business combination whereby First Clover Leaf would merge with and into the Company, with the Company as the surviving entity (the "Merger").

On September 8, 2016, the effective time of the Merger, 25% of the shares of First Clover Leaf common stock issued and outstanding immediately prior to the effective time of the Merger converted into the right to receive $12.87 per share, for an approximate aggregate total of $22,545,000, and 75% of the shares of First Clover Leaf common stock issued and outstanding immediately prior to the effective time of the Merger converted into the right to receive 0.495 shares of the Company’s common stock, par value $4.00 per share, for an approximate aggregate total of 2,600,616 shares of the Company’s common stock. Cash in lieu of fractional shares of Company common stock were issued in connection with the Merger.



7






Bank Owned Life Insurance

First Mid Bank has purchased life insurance policies on certain senior management. Bank owned life insurance is recorded at the amount that can be realized under the insurance contract at the balance sheet date, which is the cash surrender value adjusted for other charges or other amounts that are probable at settlement.

Stock Plans

At the Annual Meeting of Stockholders held April 26, 2017, the stockholders approved the First Mid-Illinois Bancshares, Inc. 2017 Stock Incentive Plan (“SI Plan”).  The SI Plan was implemented to succeed the Company’s 2007 Stock Incentive Plan, which had a ten-year term. The SI Plan is intended to provide a means whereby directors, employees, consultants and advisors of the Company and its subsidiaries may sustain a sense of proprietorship and personal involvement in the continued development and financial success of the Company and its subsidiaries, thereby advancing the interests of the Company and its stockholders.  Accordingly, directors and selected employees, consultants and advisors may be provided the opportunity to acquire shares of common stock of the Company on the terms and conditions established in the SI Plan.

A maximum of 149,983 shares of common stock may be issued under the SI Plan. There have been no stock options awarded under any Company plan since 2008. The Company awarded 11,473 and 13,912 stock units during 2017 and 2016, respectively, under the 2007 Stock Incentive Plan.

Accumulated Other Comprehensive Income (Loss)

The components of accumulated other comprehensive income (loss) included in stockholders’ equity as of September 30, 2017 and December 31, 2016 are as follows (in thousands):

 
Unrealized Gain (Loss) on
Securities
 
Securities with Other-Than-Temporary Impairment Losses
 
Total
September 30, 2017
 
 
 
 
 
Net unrealized gains on securities available-for-sale
$
3,817

 
$

 
$
3,817

Unamortized losses on held-to-maturity securities transferred from available-for-sale
(310
)
 

 
(310
)
Securities with other-than-temporary impairment losses

 
(232
)
 
(232
)
Tax benefit (expense)
(1,366
)
 
90

 
(1,276
)
Balance at September 30, 2017
$
2,141

 
$
(142
)
 
$
1,999

December 31, 2016
 
 
 
 
 
Net unrealized losses on securities available-for-sale
$
(7,649
)
 
$

 
$
(7,649
)
Unamortized losses on held-to-maturity securities transferred from available-for-sale
(394
)
 

 
(394
)
Securities with other-than-temporary impairment losses

 
(1,398
)
 
(1,398
)
Tax benefit
3,135

 
545

 
3,680

Balance at December 31, 2016
$
(4,908
)
 
$
(853
)
 
$
(5,761
)










8






Amounts reclassified from accumulated other comprehensive income and the affected line items in the statements of income during the nine months ended September 30, 2017 and 2016, were as follows (in thousands):
 
Amounts Reclassified from Other Comprehensive Income
Affected Line Item in the Statements of Income
 
 
Three months ended September 30,
 
Nine months ended September 30,
 
2017
 
2016
 
2017
 
2016
Realized gains on available-for-sale securities
$
254

 
$
466

 
$
589

 
$
1,130

Securities gains, net
 
 
 
 
 
 
 
 
(Total reclassified amount before tax)
 
(99
)
 
(182
)
 
(230
)
 
(440
)
Income taxes
Total reclassifications out of accumulated other comprehensive income
$
155

 
$
284

 
$
359

 
$
690

Net reclassified amount

See “Note 3 – Investment Securities” for more detailed information regarding unrealized losses on available-for-sale securities.

Adoption of New Accounting Guidance

Accounting Standards Update 2017-09, Compensation-Stock Compensation (Topic 718): Scope of Modification ("ASU 2017-09"). In May 2017, FASB issued ASU 2017-09. This update provides guidance on determining which changes to the terms and conditions of share-based payment awards require the application of modification accounting under Topic 718. The guidance is effective for public companies for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2017. Early adoption is permitted, including adoption in an interim period. The amendments should be applied on a prospective basis to an award modified on or after adoption date. ASU 2017-09 is not expected to have a significant impact on the Company's consolidated financial statement.

Accounting Standards Update 2017-08, Receivables-Nonrefundable Fees and Other Costs ("ASU 2017-08"). In March 2017, FASB issued ASU 2017-08. This update amends the amortization period for certain purchased callable debt securities held at a premium. The update shortens the premium's amortization period to the earliest call date to more closely align the amortization period of premiums to expectations incorporated in market pricing on the underlying securities. For public companies, the update is effective for annual periods beginning after December 15, 2018, and is to be applied on a modified retrospective basis with a cumulative-effect adjustment directly to retained earnings as of the beginning of the adoption period. Early adoption is permitted, including adoption in an interim period. The Company has adopted ASU 2017-08 early and there was not a significant impact on the Company's consolidated financial statements.

Accounting Standards Update 2017-04, Intangibles--Goodwill and Other (Topic 350: Simplifying the Test for Goodwill Impairment ("ASU 2017-04"). In January 2017, FASB issued ASU 2017-04. The amendments in this update simplify the measurement of goodwill by eliminating Step 2 from the goodwill impairment test. Under this guidance, an entity should perform its annual, or interim, goodwill impairment test by comparing the fair value of a reporting unit with its carrying amount. An entity should recognize an impairment charge for the amount by which the carrying amount exceeds the reporting unit's fair value; however, the loss should not exceed the total amount of goodwill allocated to that reporting unit. ASU 2017-04 is effective for public companies for the reporting periods beginning after December 15, 2019. Early adoption is permitted for interim or annual goodwill impairment tests performed on testing dates after January 1, 2017. Although the Company cannot anticipate future goodwill impairment, based on the most recent assessment, it is unlikely that an impairment amount would need to be calculated and, therefore, does not anticipate a material impact on the Company's consolidated financial statements. The current accounting policies and procedures of the Company are not anticipated to change, except for the elimination of the Step 2 analysis.

Accounting Standards Update 2016-13, Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses of Financial Instruments (“ASU 2016-13”). In June 2016, FASB issued ASU 2016-13. The provisions of ASU 2016-13 requires an entity to utilize a new impairment model known as the current expected credit loss ("CECL") model to estimate its lifetime "expected credit loss" and record an allowance that, when deducted from the amortized cost basis of the financial asset, presents the net amount expected to be collected on the financial asset. The CECL model is expected to result in

9






more timely recognition of credit losses. ASU 2016-13 also requires new disclosures for financial assets measured at amortized cost, loans and available-for-sale debt securities. ASU 2016-13 is effective for annual periods beginning after December 15, 2019, including interim periods within those fiscal years. Entities will apply the standard's provisions as a cumulative-effect adjustment to retained earnings as of the beginning of the first reporting period in which the guidance is adopted. Management has formed an internal committee to evaluate implementation steps and assess the impact ASU 2016-13 will have on the Company’s consolidated financial statements.

Accounting Standards Update 2016-08, Revenue from Contracts with Customers (Topic 606) (“ASU 2016-08"). In March 2016, the FASB issued ASU 2016-08 which amended the accounting guidance issued by the FASB in May 2014 that revised the criteria for determining when to recognize revenue from contracts with customers and expanded disclosure requirements. The amendment defers the effective date by one year. This accounting guidance can be implemented using either a retrospective method or a cumulative-effect approach. This new guidance will be effective for interim and annual reporting periods beginning after December 15, 2017. Early adoption is permitted but only for interim and annual reporting periods beginning after December 15, 2016. There are many aspects of the new accounting guidance that are still being interpreted, and the FASB has recently issued and proposed updates to certain aspects of the guidance. Management continues to evaluate the impact ASU 2016-08 will have on the Company’s consolidated financial statements.

Accounting Standards Update 2016-02, Leases (Topic 842) ("ASU 2016-02"). On February 25, 2016, FASB issued ASU 2016-02 which creates Topic 842, Leases and supersedes Topic 840, Leases. ASU 2016-02 is intended to improve financial reporting about leasing transactions, by increasing transparency and comparability among organizations. Under the new guidance, a lessee will be required to record all leases with lease terms of more than 12 months on their balance sheet as lease liabilities with a corresponding right-of-use asset. ASU 2016-02 maintains the dual model for lease accounting, requiring leases to be classified as either operating or finance, with lease classification determined in a manner similar to existing lease guidance. The new guidance will be effective for public companies for fiscal years beginning on or after December 15, 2018, and for private companies for fiscal years beginning on or after December 15, 2019. Early adoption is permitted for all entities. Management continues to evaluate the impact ASU 2016-02 will have on the Company's consolidated financial statements.

Accounting Standards Update 2016-01, Financial Instruments (Topic 825): Recognition and Measurement of Financial Assets and Financial Liabilities ("ASU 2016-01"). In January 2016, FASB issued ASU 2016-01 which amends prior guidance to require an entity to measure its equity investments (except those accounted for under the equity method of accounting) to be measured at fair value with changes in fair value recognized in net income. An entity may choose to measure equity investments that do not have readily determinable fair values at cost minus impairment, if any, plus or minus changes resulting from observable price changes in orderly transactions for the identical or similar investment of same issuer. The new guidance simplifies the impairment assessment of equity investments without readily determinable fair values, requires public entities to use the exit price notion when measuring fair value of financial instruments for disclosure purposes, requires an entity to present separately in other comprehensive income the portion of the total change in fair value of a liability resulting from changes in the instrument-specific credit risk when the entity has selected fair value option for financial instruments and requires separate presentation of financial assets and liabilities by measurement category and form of financial asset. The new guidance will be effective for reporting periods after January 1, 2018 and is not expected to have a significant impact on the Company's consolidated financial statements.

Accounting Standards Update 2014-09, Revenue from Contracts with Customers (Topic 606): ("ASU 2014-09"). In May 2014, FASB issued ASU 2014-09 which created a new topic in the FASB Accounting Standards Codification(R) ("ASC"), Topic 606. In addition to superseding and replacing nearly all existing U.S. GAAP revenue recognition guidance, including industry-specific guidance, ASU 2014-09 establishes a new control-based revenue recognition model, changes the basis for deciding when revenue is recognized over time or at a point in time, provides new and more detailed guidance on specific topics and expands and improves disclosures about revenue. In addition, ASU 2014-09 adds a new Subtopic to the ASC, Other Assets and Deferred Costs: Contracts with Customers ("ASC 340-40"), to provide guidance on costs related to obtaining a contract with a customer and costs incurred in fulfilling a contract with a customer that are not in the scope of another ASC Topic. The new guidance does not apply to certain contracts within the scope of other ASC Topics, such as lease contracts, insurance contracts, financing arrangements, financial instruments, guarantee other than product or service warranties, and non-monetary exchanges between entities in the same line of business to facilitate sales to customers. See ASU 2016-08, above, for the effective dates.



10






Note 2 -- Earnings Per Share

Basic net income per common share available to common stockholders is calculated as net income less preferred stock dividends divided by the weighted average number of common shares outstanding.  Diluted net income per common share available to common stockholders is computed using the weighted average number of common shares outstanding, increased by the assumed conversion of the Company’s convertible preferred stock and the Company’s stock options, unless anti-dilutive.

The components of basic and diluted net income per common share available to common stockholders for the three and nine-month period ended September 30, 2017 and 2016 were as follows:

 
Three months ended September 30,
 
Nine months ended September 30,
 
2017
 
2016
 
2017
 
2016
Basic Net Income per Common Share
 
 
 
 
 
 
 
Available to Common Stockholders:
 
 
 
 
 
 
 
Net income
$
7,595,000

 
$
5,308,000

 
$
22,059,000

 
$
15,043,000

Preferred stock dividends

 

 

 
(825,000
)
Net income available to common stockholders
7,595,000

 
5,308,000

 
22,059,000

 
14,218,000

Weighted average common shares outstanding
12,528,674
 
10,497,072
 
12,498,913
 
9,372,547
Basic earnings per common share
$
0.61

 
$
0.51

 
$
1.76

 
$
1.52

Diluted Net Income per Common Share
 
 
 
 
 
 
 
Available to Common Stockholders:
 
 
 
 
 
 
 
Net income available to common stockholders
$
7,595,000

 
$
5,308,000

 
$
22,059,000

 
$
14,218,000

Effect of assumed preferred stock conversion

 

 

 
825,000

Net income applicable to diluted earnings per share
7,595,000

 
5,308,000

 
22,059,000

 
15,043,000

Weighted average common shares outstanding
12,528,674

 
10,497,072

 
12,498,913

 
9,372,547

Dilutive potential common shares:
 
 
 
 
 
 
 
Assumed conversion of stock options
6,299

 
1,742

 
6,827

 
1,945

Restricted stock awarded
836

 
5,232

 
836

 
5,232

Assumed conversion of preferred stock

 

 

 
677,674

Dilutive potential common shares
7,135

 
6,974

 
7,663

 
684,851

Diluted weighted average common shares outstanding
12,535,809

 
10,504,046

 
12,506,576

 
10,057,398

Diluted earnings per common share
$
0.61

 
$
0.51

 
$
1.76

 
$
1.50



The following shares were not considered in computing diluted earnings per share for the three and nine-month periods ended September 30, 2017 and 2016 because they were anti-dilutive:
 
Three months ended September 30,
 
Nine months ended September 30,
 
2017
 
2016
 
2017
 
2016
Stock options to purchase shares of common stock

 
24,500

 

 
24,500



11






Note 3 -- Investment Securities

The amortized cost, gross unrealized gains and losses and estimated fair values for available-for-sale and held-to-maturity securities by major security type at September 30, 2017 and December 31, 2016 were as follows (in thousands):
 
Amortized Cost
 
Gross Unrealized Gains
 
Gross Unrealized (Losses)
 
Fair Value
September 30, 2017
 
 
 
 
 
 
 
Available-for-sale:
 
 
 
 
 
 
 
U.S. Treasury securities and obligations of U.S. government corporations & agencies
$
126,931

 
$
484

 
$
(1,014
)
 
$
126,401

Obligations of states and political subdivisions
169,526

 
3,486

 
(486
)
 
172,526

Mortgage-backed securities: GSE residential
314,195

 
2,223

 
(1,061
)
 
315,357

Trust preferred securities
2,933

 

 
(232
)
 
2,701

Other securities
4,034

 
185

 

 
4,219

Total available-for-sale
$
617,619

 
$
6,378

 
$
(2,793
)
 
$
621,204

Held-to-maturity:
 
 
 
 
 
 
 
U.S. Treasury securities and obligations of U.S. government corporations & agencies
$
69,306

 
$
328

 
$
(497
)
 
$
69,137

 
 
 
 
 
 
 
 
December 31, 2016
 
 
 
 
 
 
 
Available-for-sale:
 
 
 
 
 
 
 
U.S. Treasury securities and obligations of U.S. government corporations & agencies
$
138,819

 
$
13

 
$
(2,508
)
 
$
136,324

Obligations of states and political subdivisions
164,163

 
1,346

 
(2,804
)
 
162,705

Mortgage-backed securities: GSE residential
318,829

 
531

 
(4,369
)
 
314,991

Trust preferred securities
3,050

 

 
(1,398
)
 
1,652

Other securities
4,034

 
147

 
(5
)
 
4,176

Total available-for-sale
$
628,895

 
$
2,037

 
$
(11,084
)
 
$
619,848

Held-to-maturity:
 
 
 
 
 
 
 
U.S. Treasury securities and obligations of U.S. government corporations & agencies
$
74,231

 
$
203

 
$
(1,338
)
 
$
73,096


Trust preferred securities represents one trust preferred pooled security issued by First Tennessee Financial (“FTN”). The unrealized loss of this security, which has a remaining maturity of twenty years, is primarily due to its long-term nature, a lack of demand or inactive market for the security, and concerns regarding the underlying financial institutions that have issued the trust preferred security. See the heading “Trust Preferred Securities” for further information regarding this security.

Realized gains and losses resulting from sales of securities were as follows during the nine months ended September 30, 2017 and 2016 (in thousands):
 
Three months ended September 30,
 
Nine months ended September 30,
 
2017
 
2016
 
2017
 
2016
Gross gains
$
394

 
$
446

 
$
746

 
$
1,130

Gross losses
(140
)
 

 
(157
)
 






12







The following table indicates the expected maturities of investment securities classified as available-for-sale presented at fair value, and held-to-maturity presented at amortized cost, at September 30, 2017 and the weighted average yield for each range of maturities (dollars in thousands):
 
One year or less
 
After 1 through 5 years
 
After 5 through 10 years
 
After ten years
 
Total
Available-for-sale:
 
 
 
 
 
 
 
 
 
U.S. Treasury securities and obligations of U.S. government corporations and agencies
$
75,846

 
$
39,439

 
$
11,116

 
$

 
$
126,401

Obligations of state and political subdivisions
19,153

 
81,336

 
70,371

 
1,666

 
172,526

Mortgage-backed securities: GSE residential
423

 
213,894

 
101,040

 

 
315,357

Trust preferred securities

 

 

 
2,701

 
2,701

Other securities

 
2,006

 
2,038

 
175

 
4,219

Total available-for-sale investments
$
95,422

 
$
336,675

 
$
184,565

 
$
4,542

 
$
621,204

Weighted average yield
2.23
%
 
2.56
%
 
2.68
%
 
2.57
%
 
2.55
%
Full tax-equivalent yield
2.65
%
 
3.02
%
 
3.47
%
 
3.41
%
 
3.10
%
Held to Maturity:
 
 
 
 
 
 
 
 
 
U.S. Treasury securities and obligations of U.S. government corporations and agencies
$
39,993

 
$
29,313

 
$

 
$

 
$
69,306

Weighted average yield
1.76
%
 
2.08
%
 
%
 
%
 
1.90
%
Full tax-equivalent yield
1.76
%
 
2.08
%
 
%
 
%
 
1.90
%

The weighted average yields are calculated on the basis of the amortized cost and effective yields weighted for the scheduled maturity of each security. Tax-equivalent yields have been calculated using a 35% tax rate.  With the exception of obligations of the U.S. Treasury and other U.S. government agencies and corporations, there were no investment securities of any single issuer, the book value of which exceeded 10% of stockholders' equity at September 30, 2017.

Investment securities carried at approximately $463 million and $509 million at September 30, 2017 and December 31, 2016, respectively, were pledged to secure public deposits and repurchase agreements and for other purposes as permitted or required by law.


13






The following table presents the aging of gross unrealized losses and fair value by investment category as of September 30, 2017 and December 31, 2016 (in thousands):
 
Less than 12 months
 
12 months or more
 
Total
 
Fair
Value
 
Unrealized
Losses
 
Fair
Value
 
Unrealized
Losses
 
Fair
Value
 
Unrealized
Losses
September 30, 2017
 
 
 
 
 
 
 
 
 
 
 
Available-for-sale:
 
 
 
 
 
 
 
 
 
 
 
U.S. Treasury securities and obligations of U.S. government corporations and agencies
$
73,135

 
$
(1,009
)
 
$
1,003

 
$
(5
)
 
$
74,138

 
$
(1,014
)
Obligations of states and political subdivisions
25,250

 
(274
)
 
9,339

 
(212
)
 
34,589

 
(486
)
Mortgage-backed securities: GSE residential
86,744

 
(810
)
 
9,084

 
(251
)
 
95,828

 
(1,061
)
Trust preferred securities

 

 
2,701

 
(232
)
 
2,701

 
(232
)
Other securities

 

 

 

 

 

Total
$
185,129

 
$
(2,093
)
 
$
22,127

 
$
(700
)
 
$
207,256

 
$
(2,793
)
Held-to-maturity:
 
 
 
 
 
 
 
 
 
 
 
U.S. Treasury securities and obligations of U.S. government corporations and agencies
$
29,336

 
$
(229
)
 
$
14,725

 
$
(268
)
 
$
44,061

 
$
(497
)
December 31, 2016
 

 
 

 
 

 
 

 
 

 
 

Available-for-sale:
 
 
 
 
 
 
 
 
 
 
 
U.S. Treasury securities and obligations of U.S. government corporations and agencies
$
125,257

 
$
(2,508
)
 
$

 
$

 
$
125,257

 
$
(2,508
)
Obligations of states and political subdivisions
93,405

 
(2,804
)
 

 

 
93,405

 
(2,804
)
Mortgage-backed securities: GSE residential
266,319

 
(4,099
)
 
5,878

 
(270
)
 
272,197

 
(4,369
)
Trust preferred securities

 

 
1,652

 
(1,398
)
 
1,652

 
(1,398
)
Other securities

 

 
1,995

 
(5
)
 
1,995

 
(5
)
Total
$
484,981

 
$
(9,411
)
 
$
9,525

 
$
(1,673
)
 
$
494,506

 
$
(11,084
)
Held-to-maturity:
 
 
 
 
 
 
 
 
 
 
 
U.S. Treasury securities and obligations of U.S. government corporations and agencies
$
53,295

 
$
(1,338
)
 
$

 
$

 
$
53,295

 
$
(1,338
)

U.S. Treasury Securities and Obligations of U.S. Government Corporations and Agencies. At September 30, 2017 there was one available-for sale U.S. Treasury securities and obligations of U.S. government corporations and agencies with a fair value of $1,003,000 and unrealized losses of $5,000 in a continuous unrealized loss position for twelve months or more. At December 31, 2016 , there were no available-for sale U.S. Treasury securities and obligations of U.S. government corporations and agencies in a continuous unrealized loss position for twelve months or more. At September 30, 2017 there were three held-to-maturity U.S. Treasury securities and obligations of U.S. government corporations and agencies with a fair value of $14,725,000 and unrealized losses of $268,000 in a continuous unrealized loss position for twelve months or more. At December 31, 2016 there were also no held-to-maturity U.S. Treasury securities and obligations of U.S. government corporations and agencies in a continuous unrealized loss position for twelve months or more.

Obligations of states and political subdivisions.  At September 30, 2017 there were twenty-two obligations of states and political subdivisions with a fair value of $9,339,000 and unrealized losses of $212,000 in a continuous loss position for twelve months or more. At December 31, 2016, there were no obligations of states and political subdivisions in a continuous unrealized loss position for twelve months or more.

Mortgage-backed Securities: GSE Residential. At September 30, 2017 there were five mortgage-backed securities with a fair value of $9,084,000 and unrealized losses of $251,000 in a continuous unrealized loss position for twelve months or more. At December 31, 2016, there were two mortgage-backed securities with a fair value of $5,878,000 and unrealized losses of $270,000 in a continuous unrealized loss position for twelve months or more.

14






Trust Preferred Securities. At September 30, 2017, there was one trust preferred security with a fair value of $2,701,000 and unrealized loss of $232,000 in a continuous unrealized loss position for twelve months or more. At December 31, 2016, there was one trust preferred security with a fair value of $1,652,000 and unrealized loss of $1,398,000 in a continuous unrealized loss position for twelve months or more. The unrealized loss was primarily due to the long-term nature of the trust preferred security, a lack of demand or inactive market for the security, the impending change to the regulatory treatment of these securities, and concerns regarding the underlying financial institutions that have issued the trust preferred securities.

The Company recorded no other-than-temporary impairment (OTTI) for these securities during 2017 or 2016.   Because it is not more-likely-than-not that the Company will be required to sell the remaining security before recovery of its new, lower amortized cost basis, which may be maturity, the Company does not consider the remainder of the investment to be other-than-temporarily impaired at September 30, 2017. However, future downgrades or additional deferrals and defaults in this security, could result in additional OTTI and consequently, have a material impact on future earnings.

Following are the details for the currently impaired trust preferred security (in thousands):
 
Book
Value
 
Fair Value
 
Unrealized Gains (Losses)
 
Other-than-
temporary
Impairment
Recorded To-date
PreTSL XXVIII
$
2,933

 
$
2,701

 
$
(232
)
 
$
(1,111
)


Other securities. At September 30, 2017 there were no other securities in a continuous unrealized loss position for twelve months or more. At December 31, 2016, there was one other security with a fair value of $1,995,000 and unrealized losses of $5,000 in a continuous unrealized loss position for twelve months or more.

The Company does not believe any other individual unrealized loss as of September 30, 2017 represents OTTI. However, given the continued disruption in the financial markets, the Company may be required to recognize OTTI losses in future periods with respect to its available for sale investment securities portfolio. The amount and timing of any additional OTTI will depend on the decline in the underlying cash flows of the securities. Should the impairment of any of these securities become other-than-temporary, the cost basis of the investment will be reduced and the resulting loss recognized in the period the other-than-temporary impairment is identified.

Other-than-temporary Impairment. Upon acquisition of a security, the Company determines whether it is within the scope of the accounting guidance for investments in debt and equity securities or whether it must be evaluated for impairment under the accounting guidance for beneficial interests in securitized financial assets.

The Company conducts periodic reviews to evaluate its investment securities to determine whether OTTI has occurred. While all securities are considered, the securities primarily impacted by OTTI evaluation are pooled trust preferred securities. For the pooled trust preferred security currently in the investment portfolio, an extensive review is conducted to determine if any additional OTTI has occurred. The Company utilizes an independent third-party to perform the OTTI evaluation. The Company's management reviews the assumption inputs and methodology with the third-party to obtain an understanding of them and determine if they are appropriate for the evaluation. Economic models are used to project future cash flows for the security based on current assumptions for discount rate, prepayments, default and deferral rates and recoveries. These assumptions are determined based on the structure of the issuance, the specific collateral underlying the security, historical performance of trust preferred securities and general state of the economy. The OTTI test compares the present value of the cash flows from quarter to quarter to determine if there has been an adverse change which could indicate additional OTTI.

The discount rate assumption used in the cash flow model is equal to the current yield used to accrete the beneficial interest. The Company’s current trust preferred security investment has a floating rate coupon of 3-month LIBOR plus 90 basis points. Since the estimate of 3-month LIBOR is based on the forward curve on the measurement date, and is therefore variable, the discount assumption for this security is a range of projected coupons over the expected life of the security.

The Company considers the likelihood that issuers will prepay their securities which changes the amount of expected cash flows. Factors such as the coupon rates of collateral, economic conditions and regulatory changes, such as the Dodd-Frank Act and Basel III, are considered.

15






The trust preferred security includes collateral issued by financial institutions and insurance companies. To identify bank issuers with a high risk of near term default or deferral, a credit model developed by the third-party is utilized that scores each bank issuer based on 29 different ratios covering capital adequacy, asset quality, earnings, liquidity, the Texas Ratio, and sensitivity to interest rates. To account for longer term bank default risk not captured by the credit model, it is assumed that banks will default at a rate of 2% annually for the first two years of the cash flow projection, and 36 basis points in each year thereafter. To project defaults for insurance issuers, each issuer’s credit rating is mapped to its idealized default rate, which is AM Best’s estimate of the historical default rate for insurance companies with that rating.

Lastly, it is assumed that trust preferred securities issued by banks that have already failed will have no recoveries, and that banks projected to default will have recoveries of 10%. Additionally, the 10% recovery assumption, incorporates the potential for cures by banks that are currently in deferral.

If the Company determines that a given pooled trust preferred security position will be subject to a write-down or loss, the Company records the expected credit loss as a charge to earnings.

Credit Losses Recognized on Investments. As described above, the Company’s investment in trust preferred security has experienced fair value deterioration due to credit losses but is not otherwise other-than-temporarily impaired. The following table provides information about the trust preferred security for which only a credit loss was recognized in income and other losses are recorded in other comprehensive income (loss) for the nine months ended September 30, 2017 and 2016 (in thousands).

 
Accumulated Credit Losses
 
September 30, 2017
 
September 30, 2016
Credit losses on trust preferred securities held
 
 
 
Beginning of period
$
1,111

 
$
1,111

Additions related to OTTI losses not previously recognized

 

Reductions due to sales / (recoveries)

 

Reductions due to change in intent or likelihood of sale

 

Additions related to increases in previously recognized OTTI losses

 

Reductions due to increases in expected cash flows

 

End of period
$
1,111

 
$
1,111





16






Note 4 – Loans and Allowance for Loan Losses

Loans are stated at the principal amount outstanding net of unearned discounts, unearned income and allowance for loan losses.  Unearned income includes deferred loan origination fees reduced by loan origination costs and is amortized to interest income over the life of the related loan using methods that approximated the effective interest rate method.  Interest on substantially all loans is credited to income based on the principal amount outstanding. A summary of loans at September 30, 2017 and December 31, 2016 follows (in thousands):
 
September 30,
2017
 
December 31,
2016
Construction and land development
$
77,325

 
$
49,366

Agricultural real estate
126,164

 
126,216

1-4 Family residential properties
302,889

 
328,119

Multifamily residential properties
72,491

 
83,478

Commercial real estate
650,059

 
633,694

Loans secured by real estate
1,228,928

 
1,220,873

Agricultural loans
81,367

 
86,735

Commercial and industrial loans
444,836

 
412,637

Consumer loans
30,394

 
38,404

All other loans
89,117

 
77,602

Total Gross loans
1,874,642

 
1,836,251

Less: Loans held for sale
2,079

 
1,175

 
1,872,563

 
1,835,076

Less:
 

 
 

Net deferred loan fees, premiums and discounts
7,080

 
10,259

Allowance for loan losses
18,589

 
16,753

Net loans
$
1,846,894

 
$
1,808,064


Net loans increased $38.8 million as of September 30, 2017 compared to December 31, 2016. The increase was primarily due to increases in construction and land development and commercial and industrial loans offset by decreases in 1-4 family and multifamily residential properties. Loans expected to be sold are classified as held for sale in the consolidated financial statements and are recorded at the lower of aggregate cost or market value, taking into consideration future commitments to sell the loans. These loans are primarily for 1-4 family residential properties. 

Most of the Company’s business activities are with customers located near the Company's branch locations in Illinois and Missouri.  At September 30, 2017, the Company’s loan portfolio included $207.5 million of loans to borrowers whose businesses are directly related to agriculture. Of this amount, $166.4 million was concentrated in other grain farming. Total loans to borrowers whose businesses are directly related to agriculture decreased $5.5 million from $213.0 million at December 31, 2016 due to seasonal paydowns based upon timing of cash flow requirements. Loans concentrated in other grain farming decreased $4.9 million from $171.3 million at December 31, 2016.  While the Company adheres to sound underwriting practices, including collateralization of loans, any extended period of low commodity prices, drought conditions, significantly reduced yields on crops and/or reduced levels of government assistance to the agricultural industry could result in an increase in the level of problem agriculture loans and potentially result in loan losses within the agricultural portfolio.

In addition, the Company has $120.3 million of loans to motels and hotels.  The performance of these loans is dependent on borrower specific issues as well as the general level of business and personal travel within the region.  While the Company adheres to sound underwriting standards, a prolonged period of reduced business or personal travel could result in an increase in nonperforming loans to this business segment and potentially in loan losses. The Company also has $168.3 million of loans to lessors of non-residential buildings, $129.4 million of loans to lessors of residential buildings and dwellings, and $81.4 million of loans to other gambling industries.


17






The structure of the Company’s loan approval process is based on progressively larger lending authorities granted to individual loan officers, loan committees, and ultimately the board of directors.  Outstanding balances to one borrower or affiliated borrowers are limited by federal regulation and the vast majority of borrowers are below regulatory thresholds. The Company can occasionally have outstanding balances to one borrower up to but not exceeding the regulatory threshold should
underwriting guidelines warrant. The vast majority of the Company’s loans are to businesses located in the geographic market areas served by the Company’s branch bank system.  Additionally, a significant portion of the collateral securing the loans in the portfolio is located within the Company’s primary geographic footprint.  In general, the Company adheres to loan underwriting standards consistent with industry guidelines for all loan segments.

The Company’s lending can be summarized into the following primary areas:

Commercial Real Estate Loans.  Commercial real estate loans are generally comprised of loans to small business entities to purchase or expand structures in which the business operations are housed, loans to owners of real estate who lease space to non-related commercial entities, loans for construction and land development, loans to hotel operators, and loans to owners of multi-family residential structures, such as apartment buildings.  Commercial real estate loans are underwritten based on historical and projected cash flows of the borrower and secondarily on the underlying real estate pledged as collateral on the debt.  For the various types of commercial real estate loans, minimum criteria have been established within the Company’s loan policy regarding debt service coverage while maximum limits on loan-to-value and amortization periods have been defined.  Maximum loan-to-value ratios range from 65% to 80% depending upon the type of real estate collateral, while the desired minimum debt coverage ratio is 1.20x. Amortization periods for commercial real estate loans are generally limited to twenty years. The Company’s commercial real estate portfolio is well below the thresholds that would designate a concentration in commercial real estate lending, as established by the federal banking regulators.

Commercial and Industrial Loans. Commercial and industrial loans are primarily comprised of working capital loans used to purchase inventory and fund accounts receivable that are secured by business assets other than real estate.  These loans are generally written for one year or less. Also, equipment financing is provided to businesses with these loans generally limited to 80% of the value of the collateral and amortization periods limited to seven years. Commercial loans are often accompanied by a personal guaranty of the principal owners of a business.  Like commercial real estate loans, the underlying cash flow of the business is the primary consideration in the underwriting process.  The financial condition of commercial borrowers is monitored at least annually with the type of financial information required determined by the size of the relationship.  Measures employed by the Company for businesses with higher risk profiles include the use of government-assisted lending programs through the Small Business Administration and U.S. Department of Agriculture.

Agricultural and Agricultural Real Estate Loans. Agricultural loans are generally comprised of seasonal operating lines to cash grain farmers to plant and harvest corn and soybeans and term loans to fund the purchase of equipment.  Agricultural real estate loans are primarily comprised of loans for the purchase of farmland.  Specific underwriting standards have been established for agricultural-related loans including the establishment of projections for each operating year based on industry developed estimates of farm input costs and expected commodity yields and prices.  Operating lines are typically written for one year and secured by the crop. Loan-to-value ratios on loans secured by farmland generally do not exceed 65% and have amortization periods limited to twenty five years.  Federal government-assistance lending programs through the Farm Service Agency are used to mitigate the level of credit risk when deemed appropriate.

Residential Real Estate Loans. Residential real estate loans generally include loans for the purchase or refinance of residential real estate properties consisting of one-to-four units and home equity loans and lines of credit.  The Company sells the vast majority of its long-term fixed rate residential real estate loans to secondary market investors.  The Company also releases the servicing of these loans upon sale.  The Company retains all residential real estate loans with balloon payment features.  Balloon periods are limited to five years. Residential real estate loans are typically underwritten to conform to industry standards including criteria for maximum debt-to-income and loan-to-value ratios as well as minimum credit scores.  Loans secured by first liens on residential real estate held in the portfolio typically do not exceed 80% of the value of the collateral and have amortization periods of twenty five years or less. The Company does not originate subprime mortgage loans.

Consumer Loans. Consumer loans are primarily comprised of loans to individuals for personal and household purposes such as the purchase of an automobile or other living expenses.  Minimum underwriting criteria have been established that consider credit score, debt-to-income ratio, employment history, and collateral coverage.  Typically, consumer loans are set up on monthly payments with amortization periods based on the type and age of the collateral.

18







Other Loans. Other loans consist primarily of loans to municipalities to support community projects such as infrastructure improvements or equipment purchases.  Underwriting guidelines for these loans are consistent with those established for commercial loans with the additional repayment source of the taxing authority of the municipality.

Purchase Credit-Impaired Loans. Loans acquired with evidence of credit deterioration since origination and for which it is probable that all contractually required payments will not be collected are considered to be credit impaired. Evidence of credit quality deterioration as of the purchase date may include information such as past-due and nonaccrual status, borrower credit scores and recent loan to value percentages. Purchase credit-impaired ("PCI") loans are accounted for under ASC 310-30, Receivables--Loans and Debt Securities Acquired with Deteriorated Credit Quality ("ASC 310-30"), and are initially measured at fair value, which includes the estimated future credit losses expected to be incurred over the life of the loan. Accordingly, an allowance for credit losses related to these loans is not carried over and recorded at the acquisition date. The cash flows expected to be collected were estimated using current key assumptions, such as default rates, value of underlying collateral, severity and prepayment speeds.

Allowance for Loan Losses

The allowance for loan losses represents the Company’s best estimate of the reserve necessary to adequately account for probable losses existing in the current portfolio. The provision for loan losses is the charge against current earnings that is determined by the Company as the amount needed to maintain an adequate allowance for loan losses. In determining the adequacy of the allowance for loan losses, and therefore the provision to be charged to current earnings, the Company relies predominantly on a disciplined credit review and approval process that extends to the full range of the Company’s credit exposure.  The review process is directed by the overall lending policy and is intended to identify, at the earliest possible stage, borrowers who might be facing financial difficulty. Factors considered by the Company in evaluating the overall adequacy of the allowance include historical net loan losses, the level and composition of nonaccrual, past due and troubled debt restructurings, trends in volumes and terms of loans, effects of changes in risk selection and underwriting standards or lending practices, lending staff changes, concentrations of credit, industry conditions and the current economic conditions in the region where the Company operates. The Company estimates the appropriate level of allowance for loan losses by separately evaluating large impaired loans and nonimpaired loans.

The Company has loans acquired from business combinations with uncollected principal balances.  These loans are carried net of a fair value adjustment for credit risk and interest rates and are only included in the allowance calculation to the extent that the reserve requirement exceeds the fair value adjustment.  However, as the acquired loans renew, it is necessary to establish an allowance which represents an amount that, in management’s opinion, will be adequate to absorb probable credit losses inherent in such loans.

Impaired loans
The Company individually evaluates certain loans for impairment.  In general, these loans have been internally identified via the Company’s loan grading system as credits requiring management’s attention due to underlying problems in the borrower’s business or collateral concerns.  This evaluation considers expected future cash flows, the value of collateral and also other factors that may impact the borrower’s ability to make payments when due.  For loans greater than $250,000, impairment is individually measured each quarter using one of three alternatives: (1) the present value of expected future cash flows discounted at the loan’s effective interest rate; (2) the loan’s observable market price, if available; or (3) the fair value of the collateral less costs to sell for collateral dependent loans and loans for which foreclosure is deemed to be probable. A specific allowance is assigned when expected cash flows or collateral do not justify the carrying amount of the loan. The carrying value of the loan reflects reductions from prior charge-offs.

Non-Impaired loans
Non-impaired loans comprise the vast majority of the Company’s total loan portfolio and include loans in accrual status and those credits not identified as troubled debt restructurings. A small portion of these loans are considered “criticized” due to the risk rating assigned reflecting elevated credit risk due to characteristics, such as a strained cash flow position, associated with the individual borrowers. Criticized loans are those assigned risk ratings of Special Mention, Substandard, or Doubtful. Determining the appropriate level of the allowance for loan losses for all non-impaired loans is based on a migration analysis of net losses over a rolling twelve quarter period by loan segment. A weighted average of the net losses is determined by assigning more weight to the most recent quarters in order to recognize current risk factors influencing the various segments of the loan portfolio more prominently than past periods. Environmental factors including changes in economic conditions, changes in

19






credit policies or underwriting standards, and changes in the level of credit risk associated with specific industries and markets are evaluated each quarter to determine if adjustments to the weighted average historical net losses is appropriate given these current influences on the risk profile of each loan segment. Because the economic and business climate in any given industry or market, and its impact on any given borrower, can change rapidly, the risk profile of the loan portfolio is periodically assessed and adjusted when appropriate. Consumer loans are evaluated for adverse classification based primarily on the Uniform Retail Credit Classification and Account Management Policy established by the federal banking regulators. Classification standards are generally based on delinquency status, collateral coverage, bankruptcy and the presence of fraud.

Due to weakened economic conditions during prior years, the Company established qualitative factor adjustments for each of the loan segments at levels above the historical net loss averages. Some of the economic factors included the potential for reduced cash flow for commercial operating loans from reduction in sales or increased operating costs, decreased occupancy rates for commercial buildings, reduced levels of home sales for commercial land developments, the uncertainty regarding grain prices and increased operating costs for farmers, and increased levels of unemployment and bankruptcy impacting consumer’s ability to pay. Each of these economic uncertainties was taken into consideration in developing the level of the allowance for loan losses.

The Company has not materially changed any aspect of its overall approach in the determination of the allowance for loan losses.  However, on an on-going basis the Company continues to refine the methods used in determining management’s best estimate of the allowance for loan losses.

The following tables present the balance in the allowance for loan losses and the recorded investment in loans based on portfolio segment and impairment method for the three and nine-months ended September 30, 2017 and 2016 and for the year ended December 31, 2016 (in thousands):
 
Commercial/ Commercial Real Estate
 
Agricultural/ Agricultural Real Estate
 
Residential Real Estate
 
Consumer
 
Unallocated
 
Total
Three months ended September 30, 2017
 
 
 
 
 
 
 
 
 
 
Allowance for loan losses:
 

 
 

 
 

 
 

 
 

 
 

Balance, beginning of period
$
14,747

 
$
1,743

 
$
969

 
$
716

 
$
34

 
$
18,209

Provision charged to expense
1,440

 
(57
)
 
(2
)
 
72

 
36

 
1,489

Losses charged off
(1,242
)
 

 
(7
)
 
(160
)
 

 
(1,409
)
Recoveries
158

 
1

 
78

 
63

 

 
300

Balance, end of period
$
15,103

 
$
1,687

 
$
1,038

 
$
691

 
$
70

 
$
18,589

Ending balance:
 

 
 

 
 

 
 

 
 

 
 

Individually evaluated for impairment
$
168

 
$

 
$
125

 
$
2

 
$

 
$
295

Collectively evaluated for impairment
$
14,935

 
$
1,687

 
$
913

 
$
689

 
$
70

 
$
18,294

Acquired with deteriorated credit quality
$

 
$

 
$

 
$

 
$

 
$


20






 
Commercial/ Commercial Real Estate
 
Agricultural/ Agricultural Real Estate
 
Residential Real Estate
 
Consumer
 
Unallocated
 
Total
Three months ended September 30, 2016
 
 

 
 

 
 

 
 

 
 

Allowance for loan losses:
 

 
 

 
 

 
 

 
 

 
 

Balance, beginning of period
$
12,025

 
$
1,419

 
$
924

 
$
733

 
$
63

 
$
15,164

Provision charged to expense
445

 
476

 
(36
)
 
248

 
(52
)
 
1,081

Losses charged off

 

 

 
(271
)
 

 
(271
)
Recoveries
128

 
2

 
1

 
56

 

 
187

Balance, end of period
$
12,598

 
$
1,897

 
$
889

 
$
766

 
$
11

 
$
16,161

Ending balance:
 

 
 

 
 

 
 

 
 

 
 

Individually evaluated for impairment
$
272

 
$
329

 
$

 
$

 
$

 
$
601

Collectively evaluated for impairment
$
12,326

 
$
1,568

 
$
889

 
$
766

 
$
11

 
$
15,560

Acquired with deteriorated credit quality
$

 
$

 
$

 
$

 
$

 
$

Nine months ended September 30, 2017
 
 
 
 
 
 
 
 
 
 
Allowance for loan losses:
 
 
 
 
 
 
 
 
 
 
 
Balance, beginning of year
$
12,901

 
$
2,249

 
$
874

 
$
693

 
$
36

 
$
16,753

Provision charged to expense
4,573

 
98

 
167

 
179

 
34

 
5,051

Losses charged off
(2,725
)
 
(662
)
 
(106
)
 
(397
)
 

 
(3,890
)
Recoveries
354

 
2

 
103

 
216

 

 
675

Balance, end of period
$
15,103

 
$
1,687

 
$
1,038

 
$
691

 
$
70

 
$
18,589

Ending balance:
 

 
 

 
 

 
 

 
 

 
 

Individually evaluated for impairment
$
168

 
$

 
$
125

 
$
2

 
$

 
$
295

Collectively evaluated for impairment
$
14,935

 
$
1,687

 
$
913

 
$
689

 
$
70

 
$
18,294

Acquired with deteriorated credit quality
$

 
$

 
$

 
$

 
$

 
$

Loans:
 

 
 

 
 

 
 

 
 

 
 

Individually evaluated for impairment
$
7,635

 
$
513

 
$
1,418

 
$
210

 
$

 
$
9,776

Collectively evaluated for impairment
1,287,821

 
206,669

 
324,920

 
32,892

 
$

 
1,852,302

Acquired with deteriorated credit quality
5,484

 

 

 

 
$

 
5,484

Ending balance
$
1,300,940

 
$
207,182

 
$
326,338

 
$
33,102

 
$

 
$
1,867,562


21






 
 
Commercial/ Commercial Real Estate
 
Agricultural/ Agricultural Real Estate
 
Residential Real Estate
 
Consumer
 
Unallocated
 
Total
Nine months ended September 30, 2016
 
 
 
 
 
 
 
 
 
 
Allowance for loan losses:
 
 
 
 
 
 
 
 
 
 
 
Balance, beginning of year
$
11,379

 
$
1,337

 
$
994

 
$
642

 
$
224

 
$
14,576

Provision charged to expense
1,058

 
587

 
36

 
459

 
(213
)
 
1,927

Losses charged off
(582
)
 
(30
)
 
(142
)
 
(493
)
 

 
(1,247
)
Recoveries
743

 
3

 
1

 
158

 

 
905

Balance, end of period
$
12,598

 
$
1,897

 
$
889

 
$
766

 
$
11

 
$
16,161

Ending balance:
 

 
 

 
 

 
 

 
 

 
 

Individually evaluated for impairment
$
272

 
$
329

 
$

 
$

 
$

 
$
601

Collectively evaluated for impairment
$
12,326

 
$
1,568

 
$
889

 
$
766

 
$
11

 
$
15,560

Acquired with deteriorated credit quality
$

 
$

 
$

 
$

 
$

 
$

Loans:
 

 
 

 
 

 
 

 
 

 
 

Individually evaluated for impairment
$
1,753

 
$
1,170

 
$
471

 
$
20

 
$

 
$
3,414

Collectively evaluated for impairment
1,162,386

 
208,775

 
378,742

 
44,740

 

 
1,794,643

Acquired with deteriorated credit quality
3,942

 

 
4,746

 

 

 
8,688

Ending balance
$
1,168,081

 
$
209,945

 
$
383,959

 
$
44,760

 
$

 
$
1,806,745

Year ended December 31, 2016
 

 
 

 
 

 
 

 
 

 
 

Allowance for loan losses:
 

 
 

 
 

 
 

 
 

 
 

Balance, beginning of year
$
11,379

 
$
1,337

 
$
994

 
$
642

 
$
224

 
$
14,576

Provision charged to expense
1,467

 
933

 
113

 
501

 
(188
)
 
2,826

Losses charged off
(747
)
 
(30
)
 
(234
)
 
(664
)
 

 
(1,675
)
Recoveries
802

 
9

 
1

 
214

 

 
1,026

Balance, end of year
$
12,901

 
$
2,249

 
$
874

 
$
693

 
$
36

 
$
16,753

Ending balance:
 

 
 

 
 

 
 

 
 

 
 

Individually evaluated for impairment
$
192

 
$
660

 
$
6

 
$

 
$

 
$
858

Collectively evaluated for impairment
$
12,695

 
$
1,589

 
$
868

 
$
693

 
$
36

 
$
15,881

Acquired with deteriorated credit quality
$
14

 
$

 
$

 
$

 
$

 
$
14

Loans:
 

 
 

 
 

 
 

 
 

 
 

Individually evaluated for impairment
$
1,956

 
$
1,345

 
$
1,752

 
$
213

 
$

 
$
5,266

Collectively evaluated for impairment
1,199,003

 
211,168

 
360,825

 
41,644

 

 
1,812,640

Acquired with deteriorated credit quality
3,840

 

 
4,246

 

 

 
8,086

Ending balance
$
1,204,799

 
$
212,513

 
$
366,823

 
$
41,857

 
$

 
$
1,825,992




22






Consistent with regulatory guidance, charge-offs on all loan segments are taken when specific loans, or portions thereof, are considered uncollectible. The Company’s policy is to promptly charge these loans off in the period the uncollectible loss is reasonably determined.

For all loan portfolio segments except 1-4 family residential properties and consumer, the Company promptly charges-off loans, or portions thereof, when available information confirms that specific loans are uncollectible based on information that includes, but is not limited to, (1) the deteriorating financial condition of the borrower, (2) declining collateral values, and/or (3) legal action, including bankruptcy, that impairs the borrower’s ability to adequately meet its obligations. For impaired loans that are considered to be solely collateral dependent, a partial charge-off is recorded when a loss has been confirmed by an updated appraisal or other appropriate valuation of the collateral.

The Company charges-off 1-4 family residential and consumer loans, or portions thereof, when the Company reasonably determines the amount of the loss. The Company adheres to timeframes established by applicable regulatory guidance which provides for the charge-down of 1-4 family first and junior lien mortgages to the net realizable value less costs to sell when the loan is 180 days past due, charge-off of unsecured open-end loans when the loan is 180 days past due, and charge down to the net realizable value when other secured loans are 120 days past due. Loans at these respective delinquency thresholds for which the Company can clearly document that the loan is both well-secured and in the process of collection, such that collection will occur regardless of delinquency status, need not be charged off.

Credit Quality

The Company categorizes loans into risk categories based on relevant information about the ability of borrowers to service their debt such as:  current financial information, historical payment experience, collateral support, credit documentation, public information, and current economic trends, among other factors. The Company analyzes loans individually by classifying the loans as to credit risk. This analysis is performed on a continuous basis. The Company uses the following definitions for risk ratings which are commensurate with a loan considered “criticized”:

Special Mention. Loans classified as special mention have a potential weakness that deserves management’s close attention.  If left uncorrected, these potential weaknesses may result in deterioration of the repayment prospects for the loan or of the institution’s credit position at some future date.

Substandard. Loans classified as substandard are inadequately protected by the current sound-worthiness and paying capacity of the obligor or of the collateral pledged, if any.  Loans so classified have a well-defined weakness or weaknesses that jeopardize the liquidation of the debt. They are characterized by the distinct possibility that the institution will sustain some loss if the deficiencies are not corrected.

Doubtful. Loans classified as doubtful have all the weaknesses inherent in those classified as substandard, with the added characteristic that the weaknesses make collection or liquidation in full, on the basis of currently existing factors, conditions and values, highly questionable and improbable.

Loans not meeting the criteria above that are analyzed individually as part of the above described process are considered pass rated loans.


23






The following tables present the credit risk profile of the Company’s loan portfolio based on rating category and payment activity as of September 30, 2017 and December 31, 2016 (in thousands):

 
Construction &
Land Development
 
Agricultural Real Estate
 
1-4 Family Residential
Properties
 
Multifamily Residential
Properties
 
2017
 
2016
 
2017
 
2016
 
2017
 
2016
 
2017
 
2016
Pass
$
76,913

 
$
48,877

 
$
119,958

 
$
118,934

 
$
290,989

 
$
318,921

 
$
64,938

 
$
81,018

Special Mention

 

 
4,862

 
5,190

 
2,359

 
918

 
89

 
1,651

Substandard
266

 
227

 
1,276

 
1,984

 
8,549

 
6,576

 
7,296

 
531

Doubtful

 

 

 

 

 

 

 

Total
$
77,179

 
$
49,104

 
$
126,096

 
$
126,108

 
$
301,897

 
$
326,415

 
$
72,323

 
$
83,200


 
Commercial Real Estate (Nonfarm/Nonresidential)
 
Agricultural Loans
 
Commercial & Industrial Loans
 
Consumer Loans
 
2017
 
2016
 
2017
 
2016
 
2017
 
2016
 
2017
 
2016
Pass
$
609,203

 
$
610,025

 
$
78,356

 
$
81,922

 
$
424,306

 
$
397,762

 
$
29,669

 
$
37,624

Special Mention
20,082

 
5,229

 
2,128

 
3,271

 
17,560

 
8,485

 
13

 
17

Substandard
17,899

 
14,881

 
899

 
1,492

 
1,607

 
2,786

 
392

 
387

Doubtful

 

 

 

 

 

 

 

Total
$
647,184

 
$
630,135

 
$
81,383

 
$
86,685

 
$
443,473

 
$
409,033

 
$
30,074

 
$
38,028


 
All Other Loans
 
Total Loans
 
2017
 
2016
 
2017
 
2016
Pass
$
85,239

 
$
74,377

 
$
1,779,571

 
$
1,769,460

Special Mention
2,714

 
2,892

 
49,807

 
27,653

Substandard

 
15

 
38,184

 
28,879

Doubtful

 

 

 

Total
$
87,953

 
$
77,284

 
$
1,867,562

 
$
1,825,992


24






The following table presents the Company’s loan portfolio aging analysis at September 30, 2017 and December 31, 2016 (in thousands):

 
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 & Accruing
September 30, 2017
 
 
 
 
 
 
 
 
 
 
 
 
 
Construction and land development
$

 
$

 
$
267

 
$
267

 
$
76,912

 
$
77,179

 
$

Agricultural real estate

 

 
396

 
396

 
125,700

 
126,096

 

1-4 Family residential properties
1,542

 
282

 
2,146

 
3,970

 
297,927

 
301,897

 

Multifamily residential properties

 
4,494

 
56

 
4,550

 
67,773

 
72,323

 

Commercial real estate
968

 
1,129

 
1,130

 
3,227

 
643,957

 
647,184

 

Loans secured by real estate
2,510

 
5,905

 
3,995

 
12,410

 
1,212,269

 
1,224,679

 

Agricultural loans
14

 
41

 
178

 
233

 
81,150

 
81,383

 

Commercial and industrial loans
613

 
407

 
592

 
1,612

 
441,861

 
443,473

 

Consumer loans
188

 
6

 
3

 
197

 
29,877

 
30,074

 

All other loans

 

 

 

 
87,953

 
87,953

 

Total loans
$
3,325

 
$
6,359

 
$
4,768

 
$
14,452

 
$
1,853,110

 
$
1,867,562

 
$

December 31, 2016
 

 
 

 
 

 
 

 
 

 
 

 
 

Construction and land development
$

 
$

 
$

 
$

 
$
49,104

 
$
49,104

 
$

Agricultural real estate

 
131

 
293

 
424

 
125,684

 
126,108

 

1-4 Family residential properties
1,854

 
713

 
1,008

 
3,575

 
322,840

 
326,415

 
105

Multifamily residential properties

 

 
240

 
240

 
82,960

 
83,200

 

Commercial real estate
1,662

 
716

 
43

 
2,421

 
627,714

 
630,135

 

Loans secured by real estate
3,516

 
1,560

 
1,584

 
6,660

 
1,208,302

 
1,214,962

 
105

Agricultural loans
365

 
84

 
37

 
486

 
86,199

 
86,685

 

Commercial and industrial loans
395

 
155

 
249

 
799

 
408,234

 
409,033

 

Consumer loans
192

 
37

 
11

 
240

 
37,788

 
38,028

 

All other loans

 

 

 

 
77,284

 
77,284

 

Total loans
$
4,468

 
$
1,836

 
$
1,881

 
$
8,185

 
$
1,817,807

 
$
1,825,992

 
$
105



Impaired Loans

Within all loan portfolio segments, loans are considered impaired 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. The entire balance of a loan is considered delinquent if the minimum payment contractually required to be made is not received by the specified due date. Impaired loans, excluding certain troubled debt restructured loans, are placed on nonaccrual status. Impaired loans include nonaccrual loans and 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. It is the Company’s policy to have any restructured loans which are on nonaccrual status prior to being modified remain on nonaccrual status until, in the opinion of management, the financial position of the borrower indicates there is no longer any reasonable doubt as to the timely collection of interest or principal. If the restructured loan is on accrual status prior to being modified, the loan is reviewed to determine if the modified loan should remain on accrual status

25






The Company’s policy is to discontinue the accrual of interest income on all loans for which principal or interest is ninety days past due.  The accrual of interest is discontinued earlier when, in the opinion of management, there is reasonable doubt as to the timely collection of interest or principal.  Once interest accruals are discontinued, accrued but uncollected interest is charged against current year income. Subsequent receipts on non-accrual loans are recorded as a reduction of principal, and interest income is recorded only after principal recovery is reasonably assured. Interest on loans determined to be troubled debt restructurings is recognized on an accrual basis in accordance with the restructured terms if the loan is in compliance with the modified terms.  Nonaccrual loans are returned to accrual status when, in the opinion of management, the financial position of the borrower indicates there is no longer any reasonable doubt as to the timely collection of interest or principal. The Company requires a period of satisfactory performance of not less than six months before returning a nonaccrual loan to accrual status.

The following tables present impaired loans as of September 30, 2017 and December 31, 2016 (in thousands):

 
September 30, 2017
 
December 31, 2016
 
Recorded
Balance
 
Unpaid Principal Balance
 
Specific Allowance
 
Recorded
Balance
 
Unpaid Principal Balance
 
Specific Allowance
Loans with a specific allowance:
 
 
 
 
 
 
 
 
 
 
 
Construction and land development
$
266

 
$
607

 
$

 
$
227

 
$
227

 
$

Agricultural real estate
276

 
276

 

 

 

 

1-4 Family residential properties
1,417

 
1,738

 
125

 
997

 
997

 
6

Multifamily residential properties
7,425

 
7,425

 
11

 
528

 
528

 

Commercial real estate
4,391

 
4,547

 
29

 
863

 
884

 

Loans secured by real estate
13,775

 
14,593

 
165

 
2,615

 
2,636

 
6

Agricultural loans
237

 
1,080

 

 
1,345

 
1,345

 
660

Commercial and industrial loans
1,038

 
1,456

 
128

 
1,093

 
1,191

 
192

Consumer loans
210

 
210

 
2

 
213

 
213

 

All other loans

 

 

 

 

 

Total loans
$
15,260

 
$
17,339

 
$
295

 
$
5,266

 
$
5,385

 
$
858

Loans without a specific allowance:
 

 
 

 
 

 
 

 
 

 
 

Construction and land development
$

 
$

 
$

 
$

 
$

 
$

Agricultural real estate
15

 
15

 

 
205

 
207

 

1-4 Family residential properties
1,623

 
2,106

 

 
2,497

 
3,207

 

Multifamily residential properties

 

 

 
3,419

 
3,547

 

Commercial real estate
1,297

 
1,474

 

 
6,224

 
6,802

 

Loans secured by real estate
2,935

 
3,595

 

 
12,345

 
13,763

 

Agricultural loans
597

 
7

 

 
43

 
66

 

Commercial and industrial loans
911

 
1,218

 

 
378

 
572

 

Consumer loans
85

 
95

 

 
206

 
211

 

All other loans

 

 

 

 

 

Total loans
$
4,528

 
$
4,915

 
$

 
$
12,972

 
$
14,612

 
$

Total loans:
 

 
 

 
 

 
 

 
 

 
 

Construction and land development
$
266

 
$
607

 
$

 
$
227

 
$
227

 
$

Agricultural real estate
291

 
291

 

 
205

 
207

 

1-4 Family residential properties
3,040

 
3,844

 
125

 
3,494

 
4,204

 
6

Multifamily residential properties
7,425

 
7,425

 
11

 
3,947

 
4,075

 

Commercial real estate
5,688

 
6,021

 
29

 
7,087

 
7,686

 

Loans secured by real estate
16,710

 
18,188

 
165

 
14,960

 
16,399

 
6

Agricultural loans
834

 
1,087

 

 
1,388

 
1,411

 
660

Commercial and industrial loans
1,949

 
2,674

 
128

 
1,471

 
1,763

 
192

Consumer loans
295

 
305

 
2

 
419

 
424

 

All other loans

 

 

 

 

 

Total loans
$
19,788

 
$
22,254

 
$
295

 
$
18,238

 
$
19,997

 
$
858


26






The following tables present average recorded investment and interest income recognized on impaired loans for the three and nine-month periods ended September 30, 2017 and 2016 (in thousands):
 
 
 
 
 
 
 
 
 
For the three months ended
 
September 30, 2017
 
September 30, 2016
 
Average Investment
in Impaired Loans
 
Interest Income Recognized
 
Average Investment
in Impaired Loans
 
Interest Income Recognized
Construction and land development
$
267

 
$

 
$
231

 
$

Agricultural real estate
291

 

 
474

 

1-4 Family residential properties
3,047

 
5

 
1,572

 
3

Multifamily residential properties
8,017

 
80

 
535

 

Commercial real estate
5,762

 
6

 
1,097

 
1

Loans secured by real estate
17,384

 
91

 
3,909

 
4

Agricultural loans
834

 

 
755

 

Commercial and industrial loans
2,075

 
2

 
744

 
1

Consumer loans
296

 

 
306

 

All other loans

 

 
10

 

Total loans
$
20,589

 
$
93

 
$
5,724

 
$
5

 
For the nine months ended
 
September 30, 2017
 
September 30, 2016
 
Average Investment
in Impaired Loans
 
Interest Income Recognized
 
Average Investment
in Impaired Loans
 
Interest Income Recognized
Construction and land development
$
98

 
$

 
$
231

 
$

Agricultural real estate
293

 

 
476

 

1-4 Family residential properties
3,003

 
16

 
1,344

 
10

Multifamily residential properties
10,839

 
229

 
539

 

Commercial real estate
4,638

 
14

 
1,064

 
2

Loans secured by real estate
18,871

 
259

 
3,654

 
12

Agricultural loans
900

 

 
696

 

Commercial and industrial loans
2,216

 
6

 
777

 
1

Consumer loans
307

 

 
388

 

Total loans
$
22,294

 
$
265

 
$
5,515

 
$
13


The amount of interest income recognized by the Company within the periods stated above was due to loans modified in troubled debt restructurings that remained on accrual status.  The balance of loans modified in troubled debt restructurings included in the impaired loans at September 30, 2017 stated above that were still accruing was $410,000 of 1-4 Family residential properties, $5,217,000 of multifamily residential properties, $347,000 of commercial real estate, $29,000 of commercial & industrial loans and $1,000 of consumer loans. The balance of loans modified in a troubled debt restructurings at September 30, 2016 included in the impaired loans stated above that were still accruing was $514,000 of 1-4 family residential properties, $3,430,000 of multifamily residential properties, $2,152,000 commercial real estate, $46,000 commercial and industrial loans, and $9,000 of consumer loans. For the nine months ended September 30, 2017 and 2016, the amount of interest income recognized using a cash-basis method of accounting during the period that the loans were impaired was not material.





27







Non Accrual Loans

The following table presents the Company’s recorded balance of nonaccrual loans as September 30, 2017 and December 31, 2016 (in thousands). This table excludes purchased impaired loans and performing troubled debt restructurings.
 
September 30,
2017
 
December 31,
2016
Construction and land development
$
266

 
$
227

Agricultural real estate
291

 
205

1-4 Family residential properties
2,630

 
2,890

Multifamily residential properties
2,208

 
528

Commercial real estate
5,341

 
4,971

Loans secured by real estate
10,736

 
8,821

Agricultural loans
834

 
1,388

Commercial and industrial loans
1,920

 
1,430

Consumer loans
294

 
414

Total loans
$
13,784

 
$
12,053


Interest income that would have been recorded under the original terms of such nonaccrual loans totaled $366,000 and $99,000 for the nine months ended September 30, 2017 and 2016, respectively.


Purchased Credit-Impaired Loans

The Company acquired certain loans considered to be credit-impaired ("PCI") in its business combination with First Clover Leaf during the third quarter of 2016. At acquisition, these loans evidenced deterioration of credit quality since origination and it was probable, at acquisition, that all contractually required payments would not be collected. The carrying amount of these loans is included in the consolidated balance sheet amounts for Loans. The Company had no PCI loans prior to the First Clover Leaf acquisition. The amount of these loans at September 30, 2017 and December 31, 2016 are as follows (in thousands):

 
September 30,
2017
 
December 31,
2016
1-4 Family residential properties
$

 
$
827

Multifamily residential properties
3,387

 
3,419

Commercial real estate
2,085

 
3,816

Loans secured by real estate
5,472

 
8,062

Commercial and industrial loans
12

 
24

 Carrying amount
5,484

 
8,086

Allowance for loan losses

 
14

Carrying amount, net of allowance
$
5,484

 
$
8,072


As of September 8, 2016, the acquisition date, the principal outstanding of PCI loans totaled $10,650,000 and the fair value of PCI loans totaled $8,688,000. For PCI loans, the difference between contractually required payments at acquisition and the cash flow expected to collected is referred to as the non-accretable difference. Any excess of expected cash flows over the fair value is referred to as the accretable yield. As of September 30, 2017 there is no accretable yield on the PCI loans acquired. Subsequent decreases to the expected cash flows will result in a provision for loan and lease losses. Subsequent increases in expected cash flows will result in a reversal of the provision for loan and lease losses to the extent of prior charges and then an adjustment to accretable yield, which would have a positive impact on interest income. As of December 31, 2016, there was one loan with a change in expected cash flows and as a result, approximately $14,000 of provision was recorded. Subsequently, expected cash flows improved due to paydown of the loan balance and the provision was reversed. There was no provision recorded for the remaining PCI loans at September 30, 2017.

28






Troubled Debt Restructuring

The balance of troubled debt restructurings ("TDRs") at September 30, 2017 and December 31, 2016 was $8.6 million and $10.9 million, respectively.  There was $99,000 and $196,000 in specific reserves established with respect to these loans as of September 30, 2017 and December 31, 2016, respectively. As troubled debt restructurings, these loans are included in nonperforming loans and are classified as impaired which requires that they be individually measured for impairment. The modification of the terms of these loans included one or a combination of the following: a reduction of stated interest rate of the loan; an extension of the maturity date and change in payment terms; or a permanent reduction of the recorded investment in the loan. The following table presents the Company’s recorded balance of troubled debt restructurings at September 30, 2017 and December 31, 2016 (in thousands).
Troubled debt restructurings:
September 30,
2017
 
December 31,
2016
Construction and land development
$

 
$
227

1-4 Family residential properties
843

 
1,753

Multifamily residential properties
5,217

 
3,419

Commercial real estate
671

 
4,125

Loans secured by real estate
6,731

 
9,524

Agricultural loans
828

 

Commercial and industrial loans
849

 
1,040

Consumer loans
210

 
325

Total
$
8,618

 
$
10,889

Performing troubled debt restructurings:
 

 
 

1-4 Family residential properties
410

 
$
603

Multifamily residential properties
5,217

 
3,419

Commercial real estate
347

 
2,116

Loans secured by real estate
5,974

 
6,138

Commercial and industrial loans
29

 
41

Consumer loans
1

 
6

Total
$
6,004

 
$
6,185


The decrease in TDRs during the period was was primarily due to loans that paid off. The following table presents loans modified as TDRs during the nine months ended September 30, 2017 and 2016, as a result of various modified loan factors (in thousands):
 
September 30, 2017
 
September 30, 2016
 
Number of Modifications
 
Recorded Investment
 
Type of Modifications
 
Number of Modifications
 
Recorded Investment
 
Type of Modifications
Construction and land development

 
$

 

 
1


$
231

 
(b)(c)
1-4 Family residential properties
1

 
17

 
(c)
 
1

 
47

 
(c)
Commercial real estate

 

 

 
1

 
43

 
(b)(c)
Loans secured by real estate
1

 
17

 
 
 
3

 
321

 
 
Agricultural loans
4

 
828

 
(b)(c)(d)
 

 

 

Commercial and industrial loans
1

 
27

 
(c)
 
6

 
405

 
(b)(c)
Consumer Loans

 

 

 
1

 
20

 
(c)
Total
6

 
$
872

 
 
 
10

 
$
746

 
 
Type of modifications:
(a) Reduction of stated interest rate of loan
(b) Change in payment terms
(c) Extension of maturity date
(d) Permanent reduction of the recorded investment

29






A loan is considered to be in payment default once it is 90 days past due under the modified terms.  There were no loans modified as troubled debt restructurings during the prior twelve months that experienced defaults for nine months ended September 30, 2017. There was one loan modified as troubled debt restructuring during the prior twelve months that experienced defaults as of December 31, 2016.

The balance of real estate owned includes $2,229,000 and $1,982,000 of foreclosed real estate properties recorded as a result of obtaining physical possession of the property at September 30, 2017 and December 31, 2016, respectively. The Company also held $35,000 of repossessed collateral, consisting of machinery and equipment, acquired with foreclosed real estate. The recorded investment of consumer mortgage loans secured by residential real estate properties for which formal foreclosure proceeds are in process was $429,000 and $661,000 at September 30, 2017 and December 31, 2016, respectively.

Note 5 -- Goodwill and Intangible Assets

The Company has goodwill from business combinations, intangible assets from branch acquisitions, identifiable intangible assets assigned to core deposit relationships and customer lists of First Mid Insurance. The following table presents gross carrying value and accumulated amortization by major intangible asset class as of September 30, 2017 and December 31, 2016 (in thousands):
 
September 30, 2017
December 31, 2016
 
Gross Carrying Value
Accumulated Amortization
Gross Carrying Value
Accumulated Amortization
Goodwill not subject to amortization (effective 1/1/02)
$
63,910

$
3,760

$
61,551

$
3,760

Intangibles from branch acquisition
3,015

3,015

3,015

3,015

Core deposit intangibles
19,862

11,053

19,862

9,644

Other intangibles
3,731

2,239

3,731

2,102

 
$
90,518

$
20,067

$
88,159

$
18,521



During the third quarter of 2016, goodwill of $16.8 million was provisionally recorded for the acquisition of First Clover Leaf. Goodwill was adjusted to $19.1 million within the twelve month measurement period to reflect information collected through that period to record goodwill. The measurement period adjustment also increased other liabilities by $2 million and decreased other assets by $.3 million. The goodwill consists largely of the synergies and economies of scale expected from combining the operations of First Clover Leaf Bank with First Mid Bank. All of the goodwill was assigned to the banking segment of the Company. The Company expects this goodwill will not be deductible for tax purposes. The following table provides a reconciliation of the purchase price paid for First Clover Leaf and the amount of goodwill recorded (in thousands):

Purchase price (in excess of net book value)
 
$
8,741

Purchase accounting adjustments:
 
 
     Fair value of securities
737

 
     Fair value of loans, net
3,475

 
     Fair value of OREO
754

 
     Fair value of premises and equipment
(1,963
)
 
     Fair value of time deposits
1,994

 
     Fair value of FHLB advances
113

 
     Fair value of subordinated debentures
(731
)
 
     Core deposit intangible
(4,660
)
 
     Other assets
10,683

 
 
 
10,402

Resulting goodwill from acquisition
 
$
19,143



30






As part of the acquisition of First Clover Leaf Bank, the Company acquired mortgage servicing rights valued at $1,069,000. The following table summarizes the activity pertaining to mortgage servicing rights included in intangible assets as of September 30, 2017 and December 31, 2016 (in thousands):
 
September 30, 2017

 
December 31, 2016

Beginning Balance
$
985

 
$

Mortgage servicing rights acquired during period

 
1,069

Mortgage servicing rights capitalized

 
14

Mortgage servicing rights amortized
(105
)
 
(98
)
Ending Balance
$
880

 
$
985


Total amortization expense for the nine months ended September 30, 2017 and 2016 was as follows (in thousands):

 
Three months ended September 30,
 
Nine months ended September 30,
 
2017
 
2016
 
2017
 
2016
Core deposit intangibles
466

 
395

 
$
1,409

 
$
1,161

Other intangibles
46

 
46

 
137

 
137

Mortgage servicing rights
33

 
14

 
105

 
14

 
$
545

 
$
455

 
$
1,651

 
$
1,312



Aggregate amortization expense for the current year and estimated amortization expense for each of the five succeeding years is shown in the table below (in thousands):

Aggregate amortization expense:
 
     For period 01/01/17-09/30/17
$
1,651

Estimated amortization expense:
 
     For period 10/01/17-12/31/17
501

     For year ended 12/31/18
1,954

     For year ended 12/31/19
1,778

     For year ended 12/31/20
1,576

     For year ended 12/31/21
1,304

     For year ended 12/31/22
1,195



In accordance with the provisions of SFAS No. 142,Goodwill and Other Intangible Assets,” codified within ASC 350, the Company performed testing of goodwill for impairment as of September 30, 2017 and determined that, as of that date, goodwill was not impaired. Management also concluded that the remaining amounts and amortization periods were appropriate for all intangible assets.


Note 6 -- Repurchase Agreements and Other Borrowings

Securities sold under agreements to repurchase were $116.4 million at September 30, 2017, a decrease of $69.4 million from $185.8 million at December 31, 2016. The decrease during the first nine months of 2017 was primarily due to decreases in balances of customers due to changes in cash flow needs for their businesses. All of the transactions have overnight maturities with a weighted average rate of 0.09%.


31






The right of setoff for a repurchase agreement resembles a secured borrowing, whereby the collateral pledged by the Company would be used to settle the fair value of the repurchase agreement should the Company be in default (e.g., declare bankruptcy), the Company could cancel the repurchase agreement (i.e., cease payment of principal and interest), and attempt collection on the amount of collateral value in excess of the repurchase agreement fair value.

The collateral is held by a third party financial institution in the counterparty's custodial account. The counterparty has the right to sell or repledge the investment securities. For government entity repurchase agreements, the collateral is held by the Company in a segregated custodial account under a tri-party agreement. The Company is required by the counterparty to maintain adequate collateral levels. In the event the collateral fair value falls below stipulated levels, the Company will pledge additional securities. The Company closely monitors collateral levels to ensure adequate levels are maintained, while mitigating the potential of over-collateralization in the event of counterparty default.

Collateral pledged by class for repurchase agreements are as follows (in thousands):
 
September 30, 2017
December 31, 2016
US Treasury securities and obligations of U.S. government corporations & agencies
$
88,435

$
100,526

Obligations of states and political subdivisions

1,173

Mortgage-backed securities: GSE: residential
27,925

84,064

Total
$
116,360

$
185,763



FHLB borrowings increased to $87 million at September 30, 2017 compared to $40 million December 31, 2016. At September 30, 2017 the advances were as follows:

$20 million overnight advance at 1.20%
$5 million advance with a 3-year maturity, at 1.30%, due May 7, 2018
$5 million advance with a 2-year maturity, at 0.99%, due June 21, 2018
$10 million advance with a 3-year maturity, at 1.42%, due November 5, 2018
$5 million advance with a 1.5-year maturity, at 1.49%, due December 28, 2018
$5 million advance with a 2-year maturity, at 1.56%, due June, 28, 2019
$5 million advance with a 2.5-year maturity, at 1.67%, due January 31, 2020
$5 million advance with a 3-year maturity, at 1.75%, due July 31, 2020
$5 million advance with a 6-year maturity, at 2.30%, due August 24, 2020
$5 million advance with a 3.5-year maturity, at 1.83%, due February 1, 2021
$5 million advance with a 7-year maturity, at 2.55%, due October 1, 2021
$5 million advance with a 8-year maturity, at 2.40%, due January 9, 2023




32






Note 7 -- Fair Value of Assets and Liabilities

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
Valuations for assets and liabilities traded in active exchange markets, such as the New York Stock Exchange.  Valuations are obtained from readily available pricing sources for market transactions involving identical assets or liabilities.
Level 2
Valuations for assets and liabilities traded in less active dealer or broker markets.  Valuations are obtained from third party pricing services for identical or comparable assets or liabilities which use observable inputs other than Level 1 prices, such as quoted prices for similar assets or liabilities; quoted prices in active 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 that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities.

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

Available-for-Sale Securities. The fair value of available-for-sale securities is determined by various valuation
methodologies.  Where quoted market prices are available in an active market, securities are classified within Level 1. If
quoted market prices are not available, then fair values are estimated by using quoted prices of securities with similar characteristics or independent asset pricing services and pricing models, the inputs of which are market-based or independent sources of market parameters, including but not limited to, yield curves, interest rates, volatilities, prepayments, defaults, cumulative loss projections and cash flows.  Such securities are classified in Level 2 of the valuation hierarchy. In certain cases where Level 1 or Level 2 inputs are not available, securities are classified within Level 3 of the hierarchy and include subordinated tranches of collateralized mortgage obligations and investments in trust preferred securities.

Fair value determinations for Level 3 measurements of securities are the responsibility of the Treasury function of the Company.  The Company contracts with a pricing specialist to generate fair value estimates on a monthly basis.  The Treasury function of the Company challenges the reasonableness of the assumptions used and reviews the methodology to ensure the estimated fair value complies with accounting standards generally accepted in the United States, analyzes the changes in fair value and compares these changes to internally developed expectations and monitors these changes for appropriateness.

The trust preferred securities are collateralized debt obligation securities that are backed by trust preferred securities issued by banks, thrifts, and insurance companies. The market for these securities at September 30, 2017 is not active and markets for similar securities are also not active. The inactivity was evidenced first by a significant widening of the bid-ask spread in the brokered markets in which trust preferred securities trade and then by a significant decrease in the volume of trades relative to historical levels. The new issue market is also inactive and will continue to be, as a result of the Dodd-Frank Act’s elimination of trust preferred securities from Tier 1 capital for certain holding companies. There are currently very few market participants who are willing and or able to transact for these securities. The market values for these securities are very depressed relative to historical levels. Given conditions in the debt markets today and the absence of observable transactions in the secondary and new issue markets, we determined:

The few observable transactions and market quotations that are available are not reliable for purposes of determining fair value at September 30, 2017,
An income valuation approach technique (present value technique) that maximizes the use of relevant observable inputs and minimizes the use of unobservable inputs will be equally or more representative of fair value than the market approach valuation technique used at prior measurement dates, and
The trust preferred securities held by the Company will be classified within Level 3 of the fair value hierarchy because we determined that significant adjustments are required to determine fair value at the measurement date.

33






The following table presents the Company’s assets that are measured at fair value on a recurring basis and the level within the fair value hierarchy in which the fair value measurements fall as of September 30, 2017 and December 31, 2016 (in thousands):
 
 
 
Fair Value Measurements Using
 
 
 
Fair Value
 
Quoted Prices in Active Markets for Identical Assets (Level 1)
 
Significant Other Observable Inputs (Level 2)
 
Significant
Unobservable Inputs
(Level 3)
September 30, 2017
 
 
 
 
 
 
 
Available-for-sale securities:
 
 
 
 
 
 
 
U.S. Treasury securities and obligations of U.S. government corporations and agencies
$
126,401

 
$

 
$
126,401

 
$

Obligations of states and political subdivisions
172,526

 

 
172,526

 

Mortgage-backed securities
315,357

 

 
315,357

 

Trust preferred securities
2,701

 

 

 
2,701

Other securities
4,219

 
175

 
4,044

 

Total available-for-sale securities
$
621,204

 
$
175

 
$
618,328

 
$
2,701

December 31, 2016
 
 
 
 
 
 
 
Available-for-sale securities:
 
 
 
 
 
 
 
U.S. Treasury securities and obligations of U.S. government corporations and agencies
$
136,324

 
$

 
$
136,324

 
$

Obligations of states and political subdivisions
162,705

 

 
162,705

 

Mortgage-backed securities
314,991

 

 
314,991

 

Trust preferred securities
1,652

 

 

 
1,652

Other securities
4,176

 
144

 
4,032

 

Total available-for-sale securities
$
619,848

 
$
144

 
$
618,052

 
$
1,652


The change in fair value of assets measured on a recurring basis using significant unobservable inputs (Level 3) for the three and nine months ended September 30, 2017 and 2016 is summarized as follows (in thousands):
 
 
Trust Preferred Securities
 
 
Three months ended
 
Nine months ended
 
 
September 30, 2017
 
September 30, 2016
 
September 30, 2017
 
September 30, 2016
Beginning balance
 
$
2,424

 
$
1,746

 
$
1,652

 
$
1,906

Transfers into Level 3
 

 

 

 

Transfers out of Level 3
 

 

 

 

Total gains or losses:
 
 
 
 
 
 
 
 
Included in net income
 

 

 

 

Included in other comprehensive income (loss)
 
318

 
(66
)
 
1,166

 
(190
)
Purchases, issuances, sales and settlements:
 
 

 
 
 

 
 
Purchases
 

 

 

 

Issuances
 

 

 

 

Sales
 

 

 

 

Settlements
 
(41
)
 
(19
)
 
(117
)
 
(55
)
Ending balance
 
$
2,701

 
$
1,661

 
$
2,701

 
$
1,661

Total gains or losses for the period included in net income attributable to the change in unrealized gains or losses related to assets and liabilities still held at the reporting date
 
$

 
$

 
$

 
$


34






Following is a description of the valuation methodologies used for assets measured at fair value on a nonrecurring basis and recognized in the accompanying balance sheets, as well as the general classification of such assets pursuant to the valuation hierarchy.

Impaired Loans (Collateral Dependent). Loans for which it is probable that the Company will not collect all principal and interest due according to contractual terms are measured for impairment.  Allowable methods for determining the amount of impairment and estimating fair value include 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.

Management establishes a specific allowance for impaired loans that have an estimated fair value that is below the carrying value. The total carrying amount of loans for which a change in specific allowance has occurred as of September 30, 2017 was $7,092,000 and a fair value of $6,793,000 resulting in specific loss exposures of $299,000.

When there is little prospect of collecting principal or interest, loans, or portions of loans, may be charged-off to the allowance for loan losses.  Losses are recognized in the period an obligation becomes uncollectible.  The recognition of a loss does not mean that the loan has absolutely no recovery or salvage value, but rather that it is not practical or desirable to defer writing off the loan even though partial recovery may be affected in the future.

Foreclosed Assets Held For Sale. Other real estate owned acquired through loan foreclosure are initially recorded at fair value less costs to sell when acquired, establishing a new cost basis. The adjustment at the time of foreclosure is recorded through the allowance for loan losses. Due to the subjective nature of establishing the fair value when the asset is acquired, the actual fair value of the other real estate owned or foreclosed asset could differ from the original estimate. If it is determined that fair value declines subsequent to foreclosure, a valuation allowance is recorded through noninterest expense. Operating costs associated with the assets after acquisition are also recorded as noninterest expense. Gains and losses on the disposition of other real estate owned and foreclosed assets are netted and posted to other noninterest expense. The total carrying amount of other real estate owned as of September 30, 2017 was $2,229,000. Other real estate owned included in the total carrying amount and measured at fair value on a nonrecurring basis during the period amounted to $307,000.

The following table presents the fair value measurement of assets measured at fair value on a nonrecurring basis and the level within the fair value hierarchy in which the fair value measurements fall at September 30, 2017 and December 31, 2016 (in thousands):
 
Fair Value Measurements Using
 
 
 
Fair Value
 
Quoted Prices in Active Markets for Identical Assets (Level 1)
 
Significant Other Observable Inputs (Level 2)
 
Significant
Unobservable Inputs
(Level 3)
September 30, 2017
 
 
 
 
 
 
 
Impaired loans (collateral dependent)
$
6,793

 
$

 
$

 
$
6,793

Foreclosed assets held for sale
307

 

 

 
307

December 31, 2016
 

 
 

 
 

 
 

Impaired loans (collateral dependent)
$
6,938

 
$

 
$

 
$
6,938

Foreclosed assets held for sale
173

 

 

 
173



35






Sensitivity of Significant Unobservable Inputs

The following is a discussion of the sensitivity of significant unobservable inputs, the interrelationships between those inputs and other unobservable inputs used in recurring fair value measurement and of how those inputs might magnify or mitigate the effect of changes in the unobservable inputs on the fair value measurement.

Trust Preferred Securities. The significant unobservable inputs used in the fair value measurement of the Company’s trust preferred securities are offered quotes and comparability adjustments.  Significant increases (decreases) in any of those inputs in isolation would result in a significantly lower (higher) fair value measurement.  Generally, changes in either of those inputs will not affect the other input.

The following table presents quantitative information about unobservable inputs used in recurring and nonrecurring Level 3 fair value measurements other than goodwill at June 30, 2017 and December 31, 2016 (in thousands).
September 30, 2017
Fair Value
 
Valuation Technique
 
Unobservable Inputs
 
Range (Weighted Average)
Trust Preferred Securities
$
2,701

 
Discounted cash flow
 
Discount rate
 
13.3%

 
 
Constant prepayment rate (1)
 
1.3%
 
 
 
Cumulative projected prepayments
 
21.9%

 
 
Probability of default
 
0.6%

 
 
Projected cures given deferral
 
0.0%

 
 
Loss severity
 
97.7%

 
 
Impaired loans (collateral dependent)
$
6,793

 
Third party valuations
 
Discount to reflect realizable value
 
0
%
-
40%
(
20%
)
Foreclosed assets held for sale
 
$
307

 
Third party valuations
 
Discount to reflect realizable value less estimated selling costs
 
0
%
-
40%
(
35%
)
December 31, 2016
Fair Value
 
Valuation Technique
 
Unobservable Inputs
 
Range (Weighted Average)
Trust Preferred Securities
$
1,652

 
Discounted cash flow
 
Discount rate
 
13.6%
 
 
 
Constant prepayment rate (1)
 
1.3%
 
 
 
Cumulative projected prepayments
 
22.4%
 
 
 
Probability of default
 
0.5%
 
 
 
Projected cures given deferral
 
0.0%
 
 
 
Loss severity
 
97.6%
 
 
 
Impaired loans (collateral dependent)
$
6,938

 
Third party valuations
 
Discount to reflect realizable value
 
0
%
-
40%
(
20%
)
Foreclosed assets held for sale
 
$
173

 
Third party valuations
 
Discount to reflect realizable value less estimated selling costs
 
0
%
-
40%
(
35%
)
(1) Every five years


Other. The following methods 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, Federal Funds Sold, Interest Receivable and Federal Reserve and Federal Home Loan Bank Stock. The carrying amount approximates fair value.

Certificates of Deposit Investments. The fair value of certificates of deposit investments is estimated using a discounted cash flow calculation that applies the rates currently offered for deposits of similar remaining maturities.

Held-to-Maturity Securities. Fair Value is based on quoted market prices, if available. If a quoted market price is not available, fair value is estimated using quoted market prices for similar securities.

Loans Held for Sale. Loans expected to be sold are classified as held for sale and are recorded at the lower of aggregate cost or market value.


36






Loans. For loans with floating interest rates, it is assumed that the estimated fair values generally approximate the carrying amount balances.  Fixed rate loans have been valued using a discounted present value of projected cash flow. The discount rate used in these calculations is the current rate at which similar loans would be made to borrowers with similar credit ratings and for the same remaining maturities.  The carrying amount of accrued interest approximates its fair value.

Deposits. Deposits include demand deposits, savings accounts, NOW accounts and certain money market deposits. The carrying amount of these deposits approximates fair value. The fair value of fixed-maturity time deposits is estimated using a discounted cash flow calculation that applies the rates currently offered for deposits of similar remaining maturities.

Securities Sold Under Agreements to Repurchase. The fair value of securities sold under agreements to repurchased is estimated using a discounted cash flow calculation that applies the rates currently offered for deposits of similar remaining maturities.

Interest Payable. The carrying amount approximates fair value.

Junior Subordinated Debentures, Federal Home Loan Bank Borrowings and Other Borrowings. Rates currently available to the Company for debt with similar terms and remaining maturities are used to estimate the fair value of existing debt.

The following tables present estimated fair values of the Company’s financial instruments at September 30, 2017 and December 31, 2016 in accordance with FAS 107-1 and APB 28-1, codified with ASC 805 (in thousands):

 
Carrying
Amount
 
Fair
Value
 
Level 1
 
Level 2
 
Level 3
September 30, 2017
 
 
 
 
 
 
 
 
 
Financial Assets
 
 
 
 
 
 
 
 
 
Cash and due from banks
$
69,153

 
$
69,153

 
$
69,153

 
$

 
$

Federal funds sold
490

 
490

 
490

 

 

Certificates of deposit investments
1,685

 
1,708

 

 
1,708

 

Available-for-sale securities
621,204

 
621,204

 
175

 
618,328

 
2,701

Held-to-maturity securities
69,306

 
69,137

 

 
69,137

 

Loans held for sale
2,079

 
2,079

 

 
2,079

 

Loans net of allowance for loan losses
1,846,894

 
1,842,343

 

 

 
1,842,343

Interest receivable
10,876

 
10,876

 

 
10,876

 

Federal Reserve Bank stock
5,160

 
5,160

 

 
5,160

 

Federal Home Loan Bank stock
3,302

 
3,302

 

 
3,302

 

Financial Liabilities
 

 
 

 
 

 
 

 
 

Deposits
$
2,217,477

 
$
2,217,528

 
$

 
$
1,897,161

 
$
320,367

Securities sold under agreements to repurchase
116,360

 
116,348

 

 
116,348

 

Interest payable
552

 
552

 

 
552

 

Federal Home Loan Bank borrowings
87,052

 
87,396

 

 
87,396

 

Other borrowings
31,250

 
31,250

 
20,000

 
11,250

 

Junior subordinated debentures
23,980

 
17,640

 

 
17,640

 


37






 
Carrying
Amount
 
Fair
Value
 
Level 1
 
Level 2
 
Level 3
December 31, 2016
 
 
 
 
 
 
 
 
 
Financial Assets
 
 
 
 
 
 
 
 
 
Cash and due from banks
$
137,002

 
$
137,002

 
$
137,002

 
$

 
$

Federal funds sold
38,900

 
38,900

 
38,900

 

 

Certificates of deposit investments
14,643

 
14,651

 

 
14,651

 

Available-for-sale securities
619,848

 
619,848

 
144

 
618,052

 
1,652

Held-to-maturity securities
74,231

 
73,096

 

 
73,096

 

Loans held for sale
1,175

 
1,175

 

 
1,175

 

Loans net of allowance for loan losses
1,808,064

 
1,795,764

 

 

 
1,795,764

Interest receivable
10,553

 
10,553

 

 
10,553

 

Federal Reserve Bank stock
3,949

 
3,949

 

 
3,949

 

Federal Home Loan Bank stock
4,389

 
4,389

 

 
4,389

 

Financial Liabilities
 

 
 

 
 
 
 
 
 
Deposits
$
2,329,887

 
$
2,331,725

 
$

 
$
1,976,806

 
$
354,919

Securities sold under agreements to repurchase
185,763

 
185,766

 

 
185,766

 

Interest payable
535

 
535

 

 
535

 

Federal Home Loan Bank borrowings
40,094

 
40,318

 

 
40,318

 

Other borrowings
18,063

 
18,063

 

 
18,063

 

Junior subordinated debentures
23,917

 
17,068

 

 
17,068

 



Note 8 -- Business Combinations

First Clover Leaf Financial Corp

On April 26, 2016, the Company entered into an Agreement and Plan of Merger (the "Merger Agreement") with First Clover Leaf Financial Corp., a Maryland corporation ("First Clover Leaf"), pursuant to which, amongst other things, the Company agreed to acquire 100% of the issued and outstanding shares of First Clover Leaf pursuant to a business combination whereby First Clover Leaf would merge with and into the Company, with the Company as the surviving entity (the "Merger").

At the effective time of the Merger, 25% of the shares of First Clover Leaf common stock issued and outstanding immediately prior to the effective time of the Merger converted into the right to receive $12.87 per share, for an approximate aggregate total of $22,545,000, and 75% of the shares of First Clover Leaf common stock issued and outstanding immediately prior to the effective time of the Merger converted into the right to receive 0.495 shares of the Company’s common stock, par value $4.00 per share, for an approximate aggregate total of 2,600,616 shares of the Company’s common stock. Cash in lieu of fractional shares of Company common stock were issued in connection with the Merger.

First Clover Leaf had $659 million in assets at book value including $449 million in loans and $535 million in deposits. As a result of the acquisition, the Company increased its deposit base and reduced transaction costs. The Company also expects to reduce costs through economies of scale.

The acquisition was accounted for under the acquisition method of accounting in accordance with ASC 805, “Business Combinations ("ASC 805"),” and accordingly the assets and liabilities were recorded at their estimated fair values on the date of acquisition. Fair values are subject to refinement for up to one year after the closing date of September 8, 2016 as additional information regarding the closing date fair values become available.  The total consideration paid was used to determine the amount of goodwill resulting from the transaction.  As the total consideration paid exceeded the net assets acquired, goodwill of $19.1 million was recorded for the acquisition. Goodwill recorded in the transaction, which reflects the synergies and economies of scale expected from combining operations and the enhanced revenue opportunities from the Company’s service capabilities in the St. Louis market, is not tax deductible, and was all assigned to the banking segment of the Company.



38






The following table summarizes the estimated fair values of assets acquired and liabilities assumed at the date of the First Clover Leaf acquisition (in thousands).

Acquired
Book Value
Fair Value Adjustments
As Recorded by
First Clover Leaf Bank
Assets



     Cash
$
59,320

$

$
59,320

     Investment Securities
109,911

(737
)
109,174

     Loans
448,668

(10,403
)
438,265

     Allowance for loan losses
(6,928
)
6,928


     Other real estate owned
2,741

(754
)
1,987

     Premises and equipment
9,618

1,963

11,581

     Goodwill
11,385

7,758

19,143

     Core deposit intangible
99

4,561

4,660

     Other assets
23,974

2,875

26,849

              Total assets acquired
$
658,788

$
12,191

$
670,979

Liabilities and Stockholders' Equity



     Deposits
$
534,692

$
1,994

$
536,686

     Securities sold under agreements to repurchase
23,263


23,263

     FHLB advances
15,000

113

15,113

     Subordinated debentures
4,000

(731
)
3,269

     Other liabilities
2,103

2,074

4,177

              Total liabilities assumed
579,058

3,450

582,508

              Net assets acquired
$
79,730

$
8,741

$
88,471

 
 
 
 
Consideration Paid
 
 
 
     Cash
 
 
$
22,545

     Common stock
 
 
65,926

              Total consideration paid
 
 
$
88,471



The Company has recognized approximately $3,302,000, pre-tax, of acquisition costs for the First Clover Leaf acquisition of which $1,962,000 was recorded for 2017. These costs are included in legal and professional and other expense. Of the $10.4 million difference between the fair value and acquired value of the purchased loans, approximately $8.4 million is being accreted to interest income over the remaining term of the loans. The differences between fair value and acquired value of the assumed time deposits of $1.99 million, of the assumed FHLB advances of $113,000 and of the assumed subordinated debentures of $(731,000), are being amortized to interest expense over the remaining life of the liabilities. The core deposit intangible asset, with a fair value of $4.7 million, will be amortized on an accelerated basis over its estimated life of 10 years.














39






The following unaudited pro forma condensed combined financial information presents the results of operations of the Company, including the effects of the purchase accounting adjustments and acquisition expenses, had the First Clover Leaf acquisition taken place at the beginning of the period (dollars in thousands):

Three months ended
Nine months ended

September 30,
September 30,

2016
2016
Net interest income
$
21,255

$
63,727

Provision for loan losses
1,363

2,209

Non-interest income
7,322

21,640

Non-interest expense
20,039

57,145

  Income before income taxes
7,175

26,013

Income tax expense
2,481

9,079

   Net income
$
4,694

$
16,934

 
 
 
Earnings per share


   Basic
$
0.45

$
1.72

   Diluted
$
0.45

$
1.68

 
 
 
Basic weighted average shares outstanding
10,497,072

9,372,547

Diluted weighted average shares outstanding
10,504,046

10,057,398


The unaudited pro forma condensed combined financial statements do not reflect any anticipated cost savings and revenue enhancements. Accordingly, the pro forma results of operations of the Company as of and after the First Clover Leaf business combination may not be indicative of the results that actually would have occurred if the combination had been in effect during the periods presented or of the results that may be attained in the future.






 


40






ITEM 2.   MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following discussion and analysis is intended to provide a better understanding of the consolidated financial condition and results of operations of the Company and its subsidiaries as of, and for the three and nine-month periods ended September 30, 2017 and 2016.  This discussion and analysis should be read in conjunction with the consolidated financial statements, related notes and selected financial data appearing elsewhere in this report.

Forward-Looking Statements

This report may contain certain forward-looking statements, such as discussions of the Company’s pricing and fee trends, credit quality and outlook, liquidity, new business results, expansion plans, anticipated expenses and planned schedules. The Company intends such forward-looking statements to be covered by the safe harbor provisions for forward-looking statements contained in the Private Securities Litigation Reform Act of 1995. Forward-looking statements, which are based on certain assumptions and describe future plans, strategies and expectations of the Company, are identified by use of the words “believe,” ”expect,” ”intend,” ”anticipate,” ”estimate,” ”project,” or similar expressions. Actual results could differ materially from the results indicated by these statements because the realization of those results is subject to many risks and uncertainties, including those described in Item 1A-“Risk Factors” and other sections of the Company’s Annual Report on Form 10-K and the Company’s other filings with the SEC, and changes in interest rates, general economic conditions and those in the Company’s market area, legislative/regulatory changes, monetary and fiscal policies of the U.S. Government, including policies of the U.S. Treasury and the Federal Reserve Board, the quality or composition of the loan or investment portfolios and the valuation of the investment portfolio, the Company’s success in raising capital and effecting and integrating acquisitions, demand for loan products, deposit flows, competition, demand for financial services in the Company’s market area and accounting principles, policies and guidelines. Furthermore, forward-looking statements speak only as of the date they are made. Except as required under the federal securities laws or the rules and regulations of the SEC, we do not undertake any obligation to update or review any forward-looking information, whether as a result of new information, future events or otherwise. Further information concerning the Company and its business, including  a discussion of these and additional factors that could materially affect the Company’s financial results, is included in the Company’s 2016 Annual Report on Form 10-K under the headings “Item 1. Business" and “Item 1A. Risk Factors."

Overview

This overview of management’s discussion and analysis highlights selected information in this document and may not contain all of the information that is important to you. For a more complete understanding of trends, events, commitments, uncertainties, liquidity, capital resources, and critical accounting estimates which have an impact on the Company’s financial condition and results of operations you should carefully read this entire document.

Net income was $22,059,000 and $15,043,000 for the nine months ended September 30, 2017 and 2016, respectively. Diluted net income per common share available to common stockholders was $1.76 and $1.50 for the nine months ended September 30, 2017 and 2016.

The following table shows the Company’s annualized performance ratios for the nine months ended September 30, 2017 and 2016, compared to the performance ratios for the year ended December 31, 2016:
 
Nine months ended
 
Year ended
 
September 30,
2017
 
September 30,
2016
 
December 31,
2016
Return on average assets
1.04
%
 
0.92
%
 
0.94
%
Return on average common equity
9.96
%
 
9.34
%
 
9.30
%
Average equity to average assets
10.42
%
 
10.10
%
 
10.12
%

Total assets were $2.79 billion at September 30, 2017, compared to $2.88 billion as of December 31, 2016. From December 31, 2016 to September 30, 2017, cash and interest bearing deposits decreased $106.2 million, net loan balances increased $38.8 million and investment securities decreased $3.6 million. Net loan balances were $1.85 billion at September 30, 2017 compared to $1.81 billion at December 31, 2016.

41






Net interest margin, defined as net interest income divided by average interest-earning assets, was 3.55% for the nine months ended September 30, 2017, up from 3.27% for the same period in 2016. This increase was primarily due to an increase in earning assets and net accretion income from the acquisition of First Clover Leaf. Net interest income before the provision for loan losses was $69.6 million compared to net interest income of $49.7 million for the same period in 2016. The increase in net interest income was primarily due to growth in average earning assets including loans and investments primarily due to the acquisition of First Clover Leaf. Income from Bank Owned Life Insurance increased $971,000 compared to the same period in 2016 due to a death benefit of $511,000 and nine months of cash surrender value increases for 2017 versus six months for 2016.

Total non-interest income of $23.1 million increased $3.1 million or 15.6% from $20.0 million for the same period last year. Insurance commissions were $342,000 higher than last year primarily due to growth in senior care policies underwritten through the Illiana Insurance Agency branch of First Mid Insurance. Electronic Services revenues were $410,000 greater than last year and deposit service charges increased by $183,000 primarily due to the addition of First Clover Leaf.

Total non-interest expense of $55.1 million increased $10.4 million or 23.4% from $44.6 million for the same period last year. The increase is primarily attributable to the First Clover Leaf acquisition. Salaries and benefits expense increased to $29.7 million compared to $23.3 million for the same period last year. Occupancy expenses have also increased to $9.4 million from $8.4 million for the first nine months of last year primarily due to the additional locations from First Clover Leaf.

Following is a summary of the factors that contributed to the changes in net income (in thousands):
 
Change in Net Income
2017 versus 2016
 
Three months ended September 30,
 
Nine months ended September 30,
Net interest income
$
5,250

 
$
19,918

Provision for loan losses
(408
)
 
(3,124
)
Other income, including securities transactions
763

 
3,125

Other expenses
(2,592
)
 
(10,435
)
Income taxes
(726
)
 
(2,468
)
Increase in net income
$
2,287

 
$
7,016


Credit quality is an area of importance to the Company. Total nonperforming loans were $19.8 million at September 30, 2017, compared to $15.8 million at September 30, 2016 and $18.2 million at December 31, 2016. See the discussion under the heading “Loan Quality and Allowance for Loan Losses” for a detailed explanation of these balances. Repossessed asset balances totaled $2.3 million at September 30, 2017 compared to $2.1 million at September 30, 2016 and $2 million at December 31, 2016. The Company’s provision for loan losses for the nine months ended September 30, 2017 and 2016 was $5,051,000 and $1,927,000, respectively.  Total loans past due 30 days or more were 0.77% of loans at September 30, 2017 compared to 0.38% at September 30, 2016, and 0.45% of loans at December 31, 2016.  At September 30, 2017, the composition of the loan portfolio remained similar to the same period last year. Loans secured by both commercial and residential real estate comprised approximately 65.6% of the loan portfolio as of September 30, 2017 and 66.6% as of December 31, 2016.

The Company’s capital position remains strong and the Company has consistently maintained regulatory capital ratios above the “well-capitalized” standards. The Company’s Tier 1 capital to risk weighted assets ratio calculated under the regulatory risk-based capital requirements at September 30, 2017 and 2016 and December 31, 2016 was 12.41%, 12.03% and 11.99%, respectively. The Company’s total capital to risk weighted assets ratio calculated under the regulatory risk-based capital requirements at September 30, 2017 and 2016 and December 31, 2016 was 13.26%, 12.79% and 12.79%, respectively. The increase in these ratios from December 31, 2016 was primarily due to net income added to retained earnings.

The Company’s liquidity position remains sufficient to fund operations and meet the requirements of borrowers, depositors, and creditors. The Company maintains various sources of liquidity to fund its cash needs. See the discussion under the heading “Liquidity” for a full listing of sources and anticipated significant contractual obligations.


42






The Company enters into financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments include lines of credit, letters of credit and other commitments to extend credit.  The total outstanding commitments at September 30, 2017 and 2016 were $440 million and $455 million, respectively.  


Federal Deposit Insurance Corporation Insurance Coverage. As an FDIC-insured institution, First Mid Bank is required to pay deposit insurance premium assessments to the FDIC.  A number of requirements with respect to the FDIC insurance system have affect results, including insurance assessment rates. The Company expensed $582,000 and $758,000 for this assessment during the first nine months of 2017 and 2016, respectively.

In addition to its insurance assessment, each insured bank is subject to quarterly debt service assessments in connection with bonds issued by a government corporation that financed the federal savings and loan bailout.  The Company expensed $97,000 and $83,000 during the first nine months of 2017 and 2016 for this assessment, respectively.


Basel III. In September 2010, the Basel Committee on Banking Supervision proposed higher global minimum capital standards, including a minimum Tier 1 common capital ratio and additional capital and liquidity requirements. On July 2, 2013, the Federal Reserve Board approved a final rule to implement these reforms and changes required by the Dodd-Frank Act. This final rule was subsequently adopted by the OCC and the FDIC.

As included in the proposed rule of June 2012, the final rule includes new risk-based capital and leverage ratios, which will be phased in from 2015 to 2019, and refines the definition of what constitutes “capital” for purposes of calculating those ratios. The new minimum capital level requirements applicable to the Company and First Mid Bank beginning in 2015 are: (i) a new common equity Tier 1 capital ratio of 4.5%; (ii) a Tier 1 capital ratio of 6%; (iii) a total capital ratio of 8%; and (iv) a Tier 1 leverage ratio of 4%. The rule also establishes a “capital conservation buffer” of 2.5% above the new regulatory minimum capital requirements, which must consist entirely of common equity Tier 1 capital and would result in the following minimum ratios: (i) a common equity Tier 1 capital ratio of 7.0%, (ii) a Tier 1 capital ratio of 8.5%, and (iii) a total capital ratio of 10.5%. The new capital conservation buffer requirement is being phased in beginning in January 2016 at 0.625% of risk weighted assets and will increase by that amount each year until fully implemented in January 2019. An institution will be subject to limitations on paying dividends, engaging in share repurchases and paying discretionary bonuses if its capital level falls below the buffer amount.

The final rule also makes three changes to the proposed rule of June 2012 that impact the Company. First, the proposed rule would have required banking organizations to include accumulated other comprehensive income (“AOCI”) in common equity tier 1 capital. AOCI includes accumulated unrealized gains and losses on certain assets and liabilities that have not been included in net income. Under existing general risk-based capital rules, most components of AOCI are not included in a banking organization's regulatory capital calculations. The final rule allows community banking organizations to make a one-time election not to include these additional components of AOCI in regulatory capital and instead use the existing treatment under the general risk-based capital rules that excludes most AOCI components from regulatory capital.

Second, the proposed rule would have modified the risk-weight framework applicable to residential mortgage exposures to require banking organizations to divide residential mortgage exposure into two categories in order to determine the applicable risk weight. The final rule, however, retains the existing treatment for residential mortgage exposures under the general risk-based capital rules.

Third, the proposed rule would have required banking organizations with total consolidated assets of less than $15 billion as of December 31, 2009, such as the Company, to phase out over ten years any trust preferred securities and cumulative perpetual preferred securities from its Tier 1 capital regulatory capital. The final rule, however, permanently grandfathers into Tier 1 capital of depository institution holding companies with total consolidated assets of less than $15 billion as of December 31, 2009 any trust preferred securities or cumulative perpetual preferred stock issued before May 19, 2010.

See discussion under the heading "Capital Resources" for a description of the Company's and First Mid Bank's risk-based capital.



43






Critical Accounting Policies and Use of Significant Estimates

The Company has established various accounting policies that govern the application of U.S. generally accepted accounting principles in the preparation of the Company’s financial statements. The significant accounting policies of the Company are described in the footnotes to the consolidated financial statements included in the Company’s 2016 Annual Report on Form 10-K. Certain accounting policies involve significant judgments and assumptions by management that have a material impact on the carrying value of certain assets and liabilities; management considers such accounting policies to be critical accounting policies. The judgments and assumptions used by management are based on historical experience and other factors, which are believed to be reasonable under the circumstances. Because of the nature of the judgments and assumptions made by management, actual results could differ from these judgments and assumptions, which could have a material impact on the carrying values of assets and liabilities and the results of operations of the Company.

Allowance for Loan Losses. The Company believes the allowance for loan losses is the critical accounting policy that requires the most significant judgments and assumptions used in the preparation of its consolidated financial statements. An estimate of potential losses inherent in the loan portfolio are determined and an allowance for those losses is established by considering factors including historical loss rates, expected cash flows and estimated collateral values. In assessing these factors, the Company use organizational history and experience with credit decisions and related outcomes. The allowance for loan losses represents the best estimate of losses inherent in the existing loan portfolio. The allowance for loan losses is increased by the provision for loan losses charged to expense and reduced by loans charged off, net of recoveries. The Company formally evaluates the allowance for loan losses quarterly. If the underlying assumptions later prove to be inaccurate based on subsequent loss evaluations, the allowance for loan losses is adjusted.

The Company estimates the appropriate level of allowance for loan losses by separately evaluating impaired and non-impaired loans. A specific allowance is assigned to an impaired loan when expected cash flows or collateral do not justify the carrying amount of the loan. The methodology used to assign an allowance to a non-impaired loan is more subjective. Generally, the allowance assigned to non-impaired loans is determined based on migration analysis of historical net losses on each loan segment with similar risk characteristics, adjusted for qualitative factors including the volume and severity of identified classified loans, changes in economic conditions, changes in credit policies or underwriting standards, and changes in the level of credit risk associated with specific industries and markets. Because the economic and business climate in any given industry or market, and its impact on any given borrower, can change rapidly, the risk profile of the loan portfolio is continually assessed and adjusted when appropriate. Notwithstanding these procedures, there still exists the possibility that the assessment could prove to be significantly incorrect and that an immediate adjustment to the allowance for loan losses would be required.

Other Real Estate Owned. Other real estate owned acquired through loan foreclosure is initially recorded at fair value less costs to sell when acquired, establishing a new cost basis. The adjustment at the time of foreclosure is recorded through the allowance for loan losses. Due to the subjective nature of establishing the fair value when the asset is acquired, the actual fair value of the other real estate owned or foreclosed asset could differ from the original estimate. If it is determined that fair value temporarily declines subsequent to foreclosure, a valuation allowance is recorded through noninterest expense. Operating costs associated with the assets after acquisition are also recorded as noninterest expense. Gains and losses on the disposition of other real estate owned and foreclosed assets are netted and posted to other noninterest expense.

Investment in Debt and Equity Securities. The Company classifies its investments in debt and equity securities as either held-to-maturity or available-for-sale in accordance with Statement of Financial Accounting  Standards (SFAS) No. 115, “Accounting for Certain Investments in Debt and Equity Securities,” which was codified into ASC 320. Securities classified as held-to-maturity are recorded at cost or amortized cost. Available-for-sale securities are carried at fair value. Fair value calculations are based on quoted market prices when such prices are available. If quoted market prices are not available, estimates of fair value are computed using a variety of techniques, including extrapolation from the quoted prices of similar instruments or recent trades for thinly traded securities, fundamental analysis, or through obtaining purchase quotes. Due to the subjective nature of the valuation process, it is possible that the actual fair values of these investments could differ from the estimated amounts, thereby affecting the financial position, results of operations and cash flows of the Company. If the estimated value of investments is less than the cost or amortized cost, the Company evaluates whether an event or change in circumstances has occurred that may have a significant adverse effect on the fair value of the investment. If such an event or change has occurred and the Company determines that the impairment is other-than-temporary, a further determination is made as to the portion of impairment that is related to credit loss. The impairment of the investment that is related to the credit loss is expensed in the period in which the event or change occurred. The remainder of the impairment is recorded in other comprehensive income.

44







Deferred Income Tax Assets/Liabilities. The Company’s net deferred income tax asset arises from differences in the dates that items of income and expense enter into our reported income and taxable income. Deferred tax assets and liabilities are established for these items as they arise. From an accounting standpoint, deferred tax assets are reviewed to determine if they are realizable based on the historical level of taxable income, estimates of future taxable income and the reversals of deferred tax liabilities. In most cases, the realization of the deferred tax asset is based on future profitability. If the Company were to experience net operating losses for tax purposes in a future period, the realization of deferred tax assets would be evaluated for a potential valuation reserve.

Additionally, the Company reviews its uncertain tax positions annually under FASB Interpretation No. 48 (FIN No. 48), “Accounting for Uncertainty in Income Taxes,” codified within ASC 740. An uncertain tax position is recognized as a benefit only if it is "more likely than not" that the tax position would be sustained in a tax examination, with a tax examination being presumed to occur. The amount actually recognized is the largest amount of tax benefit that is greater than 50% likely to be recognized on examination. For tax positions not meeting the "more likely than not" test, no tax benefit is recorded. A significant amount of judgment is applied to determine both whether the tax position meets the "more likely than not" test as well as to determine the largest amount of tax benefit that is greater than 50% likely to be recognized. Differences between the position taken by management and that of taxing authorities could result in a reduction of a tax benefit or increase to tax liability, which could adversely affect future income tax expense.

Impairment of Goodwill and Intangible Assets. Core deposit and customer relationships, which are intangible assets with a finite life, are recorded on the Company’s balance sheets. These intangible assets were capitalized as a result of past acquisitions and are being amortized over their estimated useful lives of up to 15 years. Core deposit intangible assets, with finite lives will be tested for impairment when changes in events or circumstances indicate that its carrying amount may not be recoverable. Core deposit intangible assets were tested for impairment as of September 30, 2017 as part of the goodwill impairment test and no impairment was identified.

As a result of the Company’s acquisition activity, goodwill, an intangible asset with an indefinite life, is reflected on the consolidated balance sheets. Goodwill is evaluated for impairment annually, unless there are factors present that indicate a potential impairment, in which case, the goodwill impairment test is performed more frequently than annually.

Fair Value Measurements. The fair value of a financial instrument is defined as the amount at which the instrument could be exchanged in a current transaction between willing parties, other than in a forced or liquidation sale. The Company estimates the fair value of a financial instrument using a variety of valuation methods. Where financial instruments are actively traded and have quoted market prices, quoted market prices are used for fair value. When the financial instruments are not actively traded, other observable market inputs, such as quoted prices of securities with similar characteristics, may be used, if available, to determine fair value. When observable market prices do not exist, the Company estimates fair value. The Company’s valuation methods consider factors such as liquidity and concentration concerns. Other factors such as model assumptions, market dislocations, and unexpected correlations can affect estimates of fair value. Imprecision in estimating these factors can impact the amount of revenue or loss recorded.

SFAS No. 157, “Fair Value Measurements”, which was codified into ASC 820, establishes a framework for measuring the fair value of financial instruments that considers the attributes specific to particular assets or liabilities and establishes a three-level hierarchy for determining fair value based on the transparency of inputs to each valuation as of the fair value measurement date.

The three levels are defined as follows:

Level 1 — quoted prices (unadjusted) for identical assets or liabilities in active markets.

Level 2 — inputs include quoted prices for similar assets and liabilities in active markets, quoted prices of identical or similar assets or liabilities in markets that are not active, and inputs that are observable for the asset or liability, either directly or indirectly, for substantially the full term of the financial instrument.

Level 3 — inputs that are unobservable and significant to the fair value measurement.


45






At the end of each quarter, the Company assesses the valuation hierarchy for each asset or liability measured. From time to time, assets or liabilities may be transferred within hierarchy levels due to changes in availability of observable market inputs to measure fair value at the measurement date. Transfers into or out of hierarchy levels are based upon the fair value at the beginning of the reporting period. A more detailed description of the fair values measured at each level of the fair value hierarchy can be found in Note 7 – Fair Value of Assets and Liabilities.



Results of Operations

Net Interest Income

The largest source of revenue for the Company is net interest income. Net interest income represents the difference between total interest income earned on earning assets and total interest expense paid on interest-bearing liabilities.  The amount of interest income is dependent upon many factors, including the volume and mix of earning assets, the general level of interest rates and the dynamics of changes in interest rates.  The cost of funds necessary to support earning assets varies with the volume and mix of interest-bearing liabilities and the rates paid to attract and retain such funds.  




46






The Company’s average balances, interest income and expense and rates earned or paid for major balance sheet categories are set forth for the three and nine months ended September 30, 2017 and 2016 in the following table (dollars in thousands):
 
 
 
 
 
 
 
 
 
 
 
 
 
Three months ended September 30, 2017
 
Three months ended September 30, 2016
 
Average
Balance
 
Interest
 
Average
Rate
 
Average
Balance
 
Interest
 
Average
Rate
ASSETS
 
 
 
 
 
 
 
 
 
 
 
Interest-bearing deposits with other financial institutions
$
11,265

 
$
40

 
1.44
%
 
$
9,662

 
$
15

 
0.62
%
Federal funds sold
490

 
1

 
0.83
%
 
6,718

 
7

 
0.41
%
Certificates of deposit investments
1,685

 
9

 
2.17
%
 
29,490

 
78

 
1.05
%
Investment securities
 

 
 

 
 

 
 

 
 

 
 

Taxable
579,025

 
2,984

 
2.06
%
 
522,841

 
2,304

 
1.76
%
Tax-exempt (1)
172,617

 
1,195

 
2.77
%
 
119,986

 
925

 
3.08
%
Loans (2)
1,840,570

 
20,385

 
4.49
%
 
1,445,774

 
15,294

 
4.21
%
Total earning assets
2,605,652

 
24,614

 
3.83
%
 
2,134,471

 
18,623

 
3.47
%
Cash and due from banks
52,458

 
 

 
 

 
47,417

 
 

 
 

Premises and equipment
38,877

 
 

 
 

 
32,249

 
 

 
 

Other assets
140,768

 
 

 
 

 
100,546

 
 

 
 

Allowance for loan losses
(18,595
)
 
 

 
 

 
(15,520
)
 
 

 
 

Total assets
$
2,819,160

 
 

 
 

 
$
2,299,163

 
 

 
 

LIABILITIES AND STOCKHOLDERS’ EQUITY
 
 
 
 
 
 
 
 
 
 
 
Interest-bearing deposits
 

 
 

 
 

 
 

 
 

 
 

Demand deposits
$
1,131,699

 
$
500

 
0.18
%
 
$
851,425

 
$
217

 
0.10
%
Savings deposits
366,541

 
119

 
0.13
%
 
338,583

 
112

 
0.13
%
Time deposits
325,070

 
409

 
0.51
%
 
294,598

 
294

 
0.40
%
Securities sold under agreements to repurchase
135,327

 
51

 
0.15
%
 
130,999

 
23

 
0.07
%
FHLB advances
73,051

 
283

 
1.57
%
 
51,453

 
150

 
1.16
%
Fed Funds Purchased
9,467

 
37

 
1.59
%
 
5,914

 
12

 
0.81
%
Junior subordinated debt
23,966

 
236

 
3.99
%
 
21,437

 
162

 
3.01
%
Other debt
12,177

 
106

 
3.53
%
 
4,728

 
30

 
2.50
%
Total interest-bearing liabilities
2,077,298

 
1,741

 
0.34
%
 
1,699,137

 
1,000

 
0.23
%
Non interest-bearing demand deposits
425,077

 
 

 
 

 
357,160

 
 

 
 

Other liabilities
11,472

 
 

 
 

 
7,502

 
 

 
 

Stockholders' equity
305,313

 
 

 
 

 
235,364

 
 

 
 

Total liabilities & equity
$
2,819,160

 
 

 
 

 
$
2,299,163

 
 

 
 

Net interest income
 

 
$
22,873

 
 

 
 

 
$
17,623

 
 

Net interest spread
 

 
 

 
3.49
%
 
 

 
 

 
3.24
%
Impact of non-interest bearing funds
 

 
 

 
0.06
%
 
 

 
 

 
0.05
%
Net yield on interest- earning assets
 

 
 

 
3.55
%
 
 

 
 

 
3.29
%
 
 
 
 
 
 
 
 
 
 
 
 
(1) The tax-exempt income is not recorded on a tax equivalent basis.
(2) Nonaccrual loans and loans held for sale are included in the average balances. Balances are net of unaccreted discount related to loans acquired.

47






 
Nine months ended September 30, 2017
 
Nine months ended September 30, 2016
 
Average
Balance
 
Interest
 
Average
Rate
 
Average
Balance
 
Interest
 
Average
Rate
Assets
 
 
 
 
 
 
 
 
 
 
 
Interest-bearing deposits with other financial institutions
$
30,200

 
$
217

 
0.96
%
 
$
30,618

 
$
125

 
0.54
%
Federal funds sold
11,901

 
62

 
0.69
%
 
2,582

 
8

 
0.42
%
Certificates of deposit investments
3,867

 
41

 
1.42
%
 
31,166

 
234

 
1.00
%
Investment securities:
 

 
 

 
 

 
 

 
 

 
 

Taxable
579,444

 
8,999

 
2.07
%
 
513,562

 
6,981

 
1.81
%
Tax-exempt (1)
172,447

 
3,586

 
2.77
%
 
111,322

 
2,641

 
3.16
%
Loans (2)
1,820,264

 
61,337

 
4.51
%
 
1,335,898

 
42,496

 
4.25
%
Total earning assets
2,618,123

 
74,242

 
3.79
%
 
2,025,148

 
52,485

 
3.45
%
Cash and due from banks
54,011

 
 

 
 

 
46,092

 
 

 
 

Premises and equipment
39,448

 
 

 
 

 
31,008

 
 

 
 

Other assets
141,180

 
 

 
 

 
85,451

 
 

 
 

Allowance for loan losses
(17,993
)
 
 

 
 

 
(15,078
)
 
 

 
 

Total assets
$
2,834,769

 
 

 
 

 
$
2,172,621

 
 

 
 

Liabilities and Stockholders' Equity
 
 
 
 
 
 
 
 
Interest-bearing deposits
 

 
 

 
 

 
 

 
 

 
 

Demand deposits
$
1,129,427

 
$
1,289

 
0.15
%
 
$
818,397

 
$
613

 
0.10
%
Savings deposits
368,291

 
353

 
0.13
%
 
335,518

 
328

 
0.13
%
Time deposits
353,191

 
1,198

 
0.45
%
 
257,733

 
836

 
0.43
%
Securities sold under agreements to repurchase
149,970

 
137

 
0.12
%
 
127,534

 
62

 
0.07
%
FHLB advances
53,076

 
602

 
1.52
%
 
32,459

 
465

 
1.91
%
Fed Funds Purchased
4,334

 
49

 
1.50
%
 
2,401

 
14

 
0.77
%
Junior subordinated debt
23,945

 
680

 
3.80
%
 
20,894

 
456

 
2.91
%
Other debt
13,987

 
336

 
3.22
%
 
1,624

 
31

 
2.54
%
Total interest-bearing liabilities
2,096,221

 
4,644

 
0.30
%
 
1,596,560

 
2,805

 
0.23
%
Non interest-bearing demand deposits
434,201

 
 

 
 

 
348,476

 
 

 
 

Other liabilities
8,912

 
 

 
 

 
8,043

 
 

 
 

Stockholders' equity
295,435

 
 

 
 

 
219,542

 
 

 
 

Total liabilities & equity
$
2,834,769

 
 

 
 

 
$
2,172,621

 
 

 
 

Net interest income
 

 
$
69,598

 
 

 
 

 
$
49,680

 
 

Net interest spread
 

 
 

 
3.49
%
 
 

 
 

 
3.22
%
Impact of non-interest bearing funds
 

 
 

 
0.06
%
 
 

 
 

 
0.05
%
Net yield on interest- earning assets
 

 
 

 
3.55
%
 
 

 
 

 
3.27
%

(1) The tax-exempt income is not recorded on a tax equivalent basis.
(2) Nonaccrual loans and loans held for sale are included in the average balances. Balances are net of unaccreted discount related to loans acquired.

48






Changes in net interest income may also be analyzed by segregating the volume and rate components of interest income and
interest expense.  The following table summarizes the approximate relative contribution of changes in average volume and interest rates to changes in net interest income for the three and nine-months ended September 30, 2017, compared to the same periods in 2016 (in thousands):
 
Three months ended September 30, 2017 compared to 2016 Increase / (Decrease)
 
Nine months ended September 30,
2017 compared to 2016
Increase / (Decrease)
 
Total
Change
 
Volume (1)
 
Rate (1)
 
Total
Change
 
Volume (1)
 
Rate (1)
Earning Assets:
 
 
 
 
 
 
 
 
 
 
 
Interest-bearing deposits
$
25

 
$
3

 
$
22

 
$
92

 
$
(3
)
 
$
95

Federal funds sold
(6
)
 
(30
)
 
24

 
54

 
46

 
8

Certificates of deposit investments
(69
)
 
(342
)
 
273

 
(193
)
 
(307
)
 
114

Investment securities:
 

 
 

 
 

 
 

 
 

 
 

Taxable
680

 
263

 
417

 
2,018

 
952

 
1,066

Tax-exempt (2)
270

 
372

 
(102
)
 
945

 
1,304

 
(359
)
Loans (3)
5,091

 
4,094

 
997

 
18,841

 
16,121

 
2,720

Total interest income
5,991

 
4,360

 
1,631

 
21,757

 
18,113

 
3,644

Interest-Bearing Liabilities:
 

 
 

 
 

 
 

 
 

 
 

Interest-bearing deposits
 

 
 

 
 

 
 

 
 

 
 

Demand deposits
283

 
82

 
201

 
676

 
292

 
384

Savings deposits
7

 
7

 

 
25

 
25

 

Time deposits
115

 
31

 
84

 
362

 
321

 
41

Securities sold under agreements to repurchase
28

 
1

 
27

 
75

 
15

 
60

FHLB advances
133

 
72

 
61

 
137

 
296

 
(159
)
Federal Funds Purchased
25

 
10

 
15

 
35

 
16

 
19

Junior subordinated debt
74

 
20

 
54

 
224

 
72

 
152

Other debt
76

 
61

 
15

 
305

 
295

 
10

Total interest expense
741

 
284

 
457

 
1,839

 
1,332

 
507

Net interest income
$
5,250

 
$
4,076

 
$
1,174

 
$
19,918

 
$
16,781

 
$
3,137


(1) Changes attributable to the combined impact of volume and rate have been allocated proportionately to the change due to volume and the change due to rate.
(2) The tax-exempt income is not recorded on a tax-equivalent basis.
(3) Nonaccrual loans have been included in the average balances.

Net interest income increased $19.9 million, or 40.1%, to $69.6 million for the nine months ended September 30, 2017, from $49.7 million for the same period in 2016. Net interest income increased due to the growth in average earning assets including loans and investments acquired from First Clover Leaf. The net interest margin increased primarily due to the growth in earning assets, an increase in investment yields and accretion income related to the acquisition of First Clover Leaf.

For the nine months ended September 30, 2017, average earning assets increased by $593.0 million, or 29.3%, and average interest-bearing liabilities increased $499.7 million or 31.3%, compared with average balances for the same period in 2016.

The changes in average balances for these periods are shown below:

Average interest-bearing deposits held by the Company decreased $0.4 million or 1.4%.
Average federal funds sold increased $9.3 million or 360.9%.
Average certificates of deposits investments decreased $27.3 million or 87.6%
Average loans increased by $484.4 million or 36.3%.
Average securities increased by $127.0 million or 20.3%.
Average deposits increased by $439.3 million or 31.1%.
Average securities sold under agreements to repurchase increased by $22.4 million or 17.6%.
Average borrowings and other debt increased by $38.0 million or 66.2%.
Net interest margin increased to 3.55% for the first nine months of 2017 from 3.27% for the first nine months of 2016.

49







To compare the tax-exempt yields on interest-earning assets to taxable yields, the Company also computes non-GAAP net interest income on a tax equivalent basis (TE) where the interest earned on tax-exempt loans and securities is adjusted to an amount comparable to interest subject to normal income taxes assuming a federal tax rate of 35% (referred to as the tax equivalent adjustment). The year-to-date net yield on interest-earning assets (TE) was 3.68% and 3.38% for the first nine months of 2017 and 2016, respectively. The TE adjustments to net interest income for the nine months ended September 30, 2017 and 2016 were $2,547,000 and $1,628,000, respectively.

Provision for Loan Losses

The provision for loan losses for the nine months ended September 30, 2017 and 2016 was $5,051,000 and $1,927,000, respectively.  The increase in provision expense was primarily due to an increase in non-performing loans and net charge-offs. Net charge-offs were $3,215,000 for the nine months ended September 30, 2017, compared to net charge offs of $343,000 for September 30, 2016.  Nonperforming loans were $19.8 million and $15.8 million as of September 30, 2017 and 2016, respectively.   For information on loan loss experience and nonperforming loans, see discussion under the “Nonperforming Loans” and “Loan Quality and Allowance for Loan Losses” sections below.

Other Income

An important source of the Company’s revenue is other income.  The following table sets forth the major components of other income for the three and nine-months ended September 30, 2017 and 2016 (in thousands):
 
Three months ended September 30,
 
Nine months ended September 30,
 
2017
 
2016
 
$ Change
 
2017
 
2016
 
$ Change
Trust revenues
$
925

 
$
774

 
$
151

 
$
2,696

 
$
2,549

 
$
147

Brokerage commissions
536

 
526

 
10

 
1,550

 
1,440

 
110

Insurance commissions
670

 
738

 
(68
)
 
3,148

 
2,806

 
342

Service charges
1,758

 
1,824

 
(66
)
 
5,160

 
4,977

 
183

Security gains, net
254

 
466

 
(212
)
 
589

 
1,130

 
(541
)
Mortgage banking revenue, net
347

 
382

 
(35
)
 
875

 
715

 
160

ATM / debit card revenue
1,595

 
1,457

 
138

 
4,828

 
4,418

 
410

Bank Owned Life Insurance
792

 
201

 
591

 
1,355

 
384

 
971

Other
784

 
530

 
254

 
2,925

 
1,582

 
1,343

Total other income
$
7,661

 
$
6,898

 
$
763

 
$
23,126

 
$
20,001

 
$
3,125


Following are explanations of the changes in these other income categories for the three months ended September 30, 2017 compared to the same period in 2016:

Trust revenues increased $151,000 or 19.5% to $925,000 from $774,000 due to an increase in revenue from defined contribution and other retirement accounts. Trust assets, at market value, were $895.6 million at September 30, 2017 compared to $829.6 million at September 30, 2016.

Revenues from brokerage increased $10,000 or 1.9% to $536,000 from $526,000 primarily due to an increase in the number of brokerage accounts from new business development efforts.

Insurance commissions decreased $68,000 or 9.2% to $670,000 from $738,000 primarily due to the timing of policy commissions receipts.

Fees from service charges decreased $66,000 or 3.6% to $1,758,000 from $1,824,000 primarily due to a decrease in commercial transaction account fees.

The sale of securities during the three months ended September 30, 2017 resulted in net securities gains of $254,000 compared to $466,000 during the three months ended September 30, 2016.



50






Mortgage banking income decreased $35,000 or 9.2% to $347,000 from $382,000. Loans sold balances were as follows:

$12.7 million (representing 124 loans) for the three months ended September 30, 2017
$25.9 million (representing 215 loans) for the three months ended of September 30, 2016

First Mid Bank generally release the servicing rights on loans sold into the secondary market.

Revenue from ATMs and debit cards increased $138,000 or 9.5% to $1,595,000 from $1,457,000 due to an increase in electronic transactions primarily from First Clover Leaf acquired in the third quarter of 2016.

Bank owned life insurance income increased $591,000 or 294.0%. The increase is primarily due to a death benefit of $511,000 received on a single policy. The Company invested $25 million in bank owned life insurance during the first quarter of 2016 and acquired $15.6 million in bank owned life insurance in the First Clover Leaf acquisition during the third quarter of 2016.

Other income increased $254,000 or 47.9% to $784,000 from $530,000 primarily due to income from tax refunds resulting from overpayment of taxes in 2016 by First Clover Leaf.

Following are explanations of the changes in these other income categories for the nine months ended September 30, 2017 compared to the same period in 2016:

Trust revenues increased $147,000 or 5.8% to $2,696,000 from $2,549,000 due to an increase in revenue from defined contribution and other retirement accounts. Trust assets, at market value, were $895.6 million at September 30, 2017 compared to $829.6 million at September 30, 2016.

Revenues from brokerage increased $110,000 or 7.6% to $1,550,000 from $1,440,000 primarily due to an increase in the number of brokerage accounts from new business development efforts.

Insurance commissions increased $342,000 or 12.2% to $3,148,000 from $2,806,000 primarily due to growth in senior care policies underwritten through the Illiana Insurance Agency branch of First Mid Insurance.

Fees from service charges increased $183,000 or 3.7% to $5,160,000 from $4,977,000 primarily due to the acquisition of First Clover Leaf.

The sale of securities during the nine months ended September 30, 2017 resulted in net securities gains of $589,000 compared to $1,130,000 during the nine months ended September 30, 2016.

Mortgage banking income increased $160,000 or 22.4% to $875,000 from $715,000. Loans sold balances were as follows:

$44.2 million (representing 365 loans) for the nine months ended September 30, 2017
$54.6 million (representing 452 loans) for the nine months ended September 30, 2016

First Mid Bank generally release the servicing rights on loans sold into the secondary market.

Revenue from ATMs and debit cards increased $410,000 or 9.3% to $4,828,000 from $4,418,000 due to an increase in electronic transactions primarily from First Clover Leaf acquired in the third quarter of 2016 and incentives received from VISA.

Bank owned life insurance income increased $971,000 or 252.9%. The increase is primarily due to a death benefit of $511,000 and nine months of cash surrender value increases for 2017 versus six months for 2016. The Company invested $25 million in bank owned life insurance during the first quarter of 2016 and acquired $15.6 million in bank owned life insurance in the First Clover Leaf acquisition during the third quarter of 2016.

Other income increased $1,343,000 or 84.9% to $2,925,000 from $1,582,000 primarily due to income from First Clover Leaf acquired during the third quarter of 2016 and income tax refunds resulting from overpayment of taxes in 2016 by First Clover Leaf.


51






Other Expense

The major categories of other expense include salaries and employee benefits, occupancy and equipment expenses and other operating expenses associated with day-to-day operations.  The following table sets forth the major components of other expense for the three and nine-months ended September 30, 2017 and 2016 (in thousands):
 
Three months ended September 30,
 
Nine months ended September 30,
 
2017
 
2016
 
$ Change
 
2017
 
2016
 
$ Change
Salaries and employee benefits
$
9,648

 
$
7,844

 
$
1,804

 
$
29,685

 
$
23,293

 
$
6,392

Net occupancy and equipment expense
3,129

 
2,864

 
265

 
9,378

 
8,389

 
989

Net other real estate owned expense (income)
385

 
32

 
353

 
530

 
23

 
507

FDIC insurance
210

 
294

 
(84
)
 
679

 
841

 
(162
)
Amortization of intangible assets
545

 
455

 
90

 
1,651

 
1,312

 
339

Stationery and supplies
168

 
221

 
(53
)
 
539

 
612

 
(73
)
Legal and professional
871

 
713

 
158

 
2,596

 
2,414

 
182

Marketing and donations
338

 
285

 
53

 
909

 
1,486

 
(577
)
Other operating expenses
2,618

 
2,612

 
6

 
9,102

 
6,264

 
2,838

Total other expense
$
17,912

 
$
15,320

 
$
2,592

 
$
55,069

 
$
44,634

 
$
10,435


Following are explanations for the changes in these other expense categories for the three months ended September 30, 2017 compared to the same period in 2016:

Salaries and employee benefits, the largest component of other expense, increased $1,804,000 or 23.0% to $9,648,000 from $7,844,000.  The increase is primarily due to merit increases in 2017 for continuing employees. There were 584 and 596 full-time equivalent employees at September 30, 2017 and 2016, respectively.

Occupancy and equipment expense increased $265,000 or 9.3% to $3,129,000 from $2,864,000. The increase was primarily due to increases in rent and depreciation expenses related to the acquisition of six First Clover Leaf locations during the third quarter of 2016.

Net other real estate owned expense increased $353,000 or 1,103.1% to $385,000 from $32,000. The increase in 2017 was primarily due to a write down of one property to the now appraised value and real estate taxes and maintenance expenses on properties owned in 2017.

Expense for amortization of intangible assets increased $90,000 or 19.8% to $545,000 from $455,000 for the nine months ended September 30, 2017 and 2016, respectively. The increase in 2017 was due to the core deposit intangible amortization from First Clover Leaf.

Other operating expenses increased $6,000 or 0.2% to $2,618,000 in 2017 from $2,612,000 in 2016 primarily due to the additional expenses from the First Clover Leaf locations and costs associated with the merger of First Clover Leaf Bank into First Mid Bank during the first quarter of 2017.

On a net basis, all other categories of operating expenses increased $74,000 or 4.9% to $1,587,000 in 2017 from $1,513,000 in 2016.  The increase from 2016 to 2017 was primarily due to an increase in legal, marketing and donation expenses, primarily due to First Clover Leaf and a decline in FDIC Insurance rates.

Following are explanations for the changes in these other expense categories for the nine months ended September 30, 2017 compared to the same period in 2016:

Salaries and employee benefits, the largest component of other expense, increased $6,392,000 or 27.4% to $29,685,000 from $23,293,000.  The increase is primarily due to the addition of 88 employees in the acquisition of the First Clover Leaf and merit increases in 2017 for continuing employees. There were 584 and 596 full-time equivalent employees at September 30, 2017 and 2016, respectively.


52






Occupancy and equipment expense increased $989,000 or 11.8% to $9,378,000 from $8,389,000. The increase was primarily due to increases in rent and depreciation expenses related to the acquisition of six First Clover Leaf locations during the third quarter of 2016.

Net other real estate owned expense increased $507,000 or 2,204.3% to $530,000 from $23,000. The increase in 2017 was primarily due to a write down of one property to the now appraised value, real estate taxes and maintenance expenses on properties owned and losses on properties sold during 2017.

Expense for amortization of intangible assets increased $339,000 or 25.8% to $1,651,000 from $1,312,000 for the nine months ended September 30, 2017 and 2016, respectively. The increase in 2017 was due to the core deposit intangible amortization from First Clover Leaf, net of intangibles that were fully amortized during 2016.

Other operating expenses increased $2,838,000 or 45.3% to $9,102,000 in 2017 from $6,264,000 in 2016 primarily due to the additional expenses from the First Clover Leaf locations and costs associated with the merger of First Clover Leaf Bank into First Mid Bank during the first quarter of 2017.

On a net basis, all other categories of operating expenses decreased $630,000 or 11.8% to $4,723,000 in 2017 from $5,353,000 in 2016.  The decrease from 2016 to 2017 was primarily due to the donation of a building located in Monticello, Illinois with a book value of $653,000 and a decline in FDIC Insurance rates, during 2016, net of increases in other expenses from the addition of First Clover Leaf.

Income Taxes

Total income tax expense amounted to $10.5 million (32.3% effective tax rate) for the nine months ended September 30, 2017, compared to $8.1 million (34.9% effective tax rate) for the same period in 2016. The decline in effective tax rate for the nine months ended September 30, 2017 compared to the same period in 2016 is primarily due to an increase in tax-exempt municipal investments and income from bank owned life insurance, net of an increase in State of Illinois tax rate from 7.75% to 9.50% beginning July 1, 2017.

The Company files U.S. federal and state of Illinois income tax returns.  The Company is no longer subject to U.S. federal or state income tax examinations by tax authorities for years before 2014.

53






Analysis of Balance Sheets

Securities

The Company’s overall investment objectives are to insulate the investment portfolio from undue credit risk, maintain adequate liquidity, insulate capital against changes in market value and control excessive changes in earnings while optimizing investment performance.  The types and maturities of securities purchased are primarily based on the Company’s current and projected liquidity and interest rate sensitivity positions.

The following table sets forth the amortized cost of the available-for-sale and held-to-maturity securities as of September 30, 2017 and December 31, 2016 (dollars in thousands):
 
September 30, 2017
 
December 31, 2016
 
Amortized
Cost
 
Weighted
Average
Yield
 
Amortized
Cost
 
Weighted
Average
Yield
U.S. Treasury securities and obligations of U.S. government corporations and agencies
$
196,237

 
1.98
%
 
$
213,050

 
1.83
%
Obligations of states and political subdivisions
169,526

 
2.86
%
 
164,163

 
2.80
%
Mortgage-backed securities: GSE residential
314,195

 
2.59
%
 
318,829

 
2.57
%
Trust preferred securities
2,933

 
2.15
%
 
3,050

 
1.86
%
Other securities
4,034

 
2.50
%
 
4,034

 
2.14
%
Total securities
$
686,925

 
2.55
%
 
$
703,126

 
2.39
%


At September 30, 2017, the Company’s investment portfolio decreased by $16.2 million from December 31, 2016 primarily due to securities that were sold to provide cash flow to fund loans.  When purchasing investment securities, the Company considers its overall liquidity and interest rate risk profile, as well as the adequacy of expected returns relative to the risks assumed. The table below presents the credit ratings as of September 30, 2017 for certain investment securities (in thousands):

 
Amortized Cost
 
Estimated Fair Value
 
Average Credit Rating of Fair Value at September 30, 2017 (1)
 
 
 
AAA
 
AA +/-
 
A +/-
 
BBB +/-
 
< BBB -
 
Not rated
Available-for-sale:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
U.S. Treasury securities and obligations of U.S. government corporations and agencies
$
126,931

 
$
126,401

 
$

 
$
126,401

 
$

 
$

 
$

 
$

Obligations of state and political subdivisions
169,526

 
172,526

 
13,173

 
103,705

 
54,771

 

 

 
877

Mortgage-backed securities (2)
314,195

 
315,357

 

 

 

 

 

 
315,357

Trust preferred securities
2,933

 
2,701

 

 

 

 

 
2,701

 

Other securities
4,034

 
4,219

 

 

 
2,038

 
2,006

 

 
175

Total available-for-sale
$
617,619

 
$
621,204

 
$
13,173

 
$
230,106

 
$
56,809

 
$
2,006

 
$
2,701

 
$
316,409

Held-to-maturity:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
U.S. Treasury securities and obligations of U.S. government corporations and agencies
$
69,306

 
$
69,137

 
$

 
$
69,137

 
$

 
$

 
$

 
$


(1) Credit ratings reflect the lowest current rating assigned by a nationally recognized credit rating agency.

(2) Mortgage-backed securities include mortgage-backed securities (MBS) and collateralized mortgage obligation (CMO) issues from the following government sponsored enterprises: FHLMC, FNMA, GNMA and FHLB. While MBS and CMOs are no longer explicitly rated by credit rating agencies, the industry recognizes that they are backed by agencies which have an implied government guarantee.

54






The trust preferred securities is one trust preferred pooled security issued by FTN Financial Securities Corp. (“FTN”). The following table contains information regarding the trust preferred security as of September 30, 2017:
Deal name
 
PreTSL XXVIII

Class
 
Mezzanine C-1

Book value
 
$
2,933,000

Fair value
 
$
2,701,000

Unrealized gains/(losses)
 
$
(232,000
)
Other-than-temporary impairment recorded in earnings
 
$
1,111,000

Lowest credit rating assigned
 
CCC

Number of performing banks
 
35

Number of issuers in default
 
8

Number of issuers in deferral
 
1

Original collateral
 
$
360,850,000

Actual defaults & deferrals as a % of original collateral
 
13.7
%
Remaining collateral
 
$
334,542,000

Actual defaults & deferrals as a % of remaining collateral
 
14.8
%
Expected defaults & deferrals as a % of remaining collateral
 
40.7
%
Estimated incremental defaults required to break yield
 
$
61,062,000

Performing collateral
 
$
286,342,000

Current balance of class
 
$
34,357,000

Subordination
 
$
257,584,000

Excess subordination
 
$
21,123,000

Excess subordination as a % of remaining performing collateral
 
7.4
%
Discount rate (1)
 
2.51%-3.99%

Expected defaults & deferrals as a % of remaining collateral (2)
 
2% / .36

Recovery assumption (3)
 
10
%
Prepayment assumption (4)
 
1
%

(1) The discount rate for floating rate bonds is a compound interest formula based on the LIBOR forward curve for each payment date
(2) 2% annually for 2 years and 36 basis points annually thereafter
(3) With 2 year lag
(4) Additional assumptions regarding prepayments:
Banks with more than $15 billion in total assets as of 12/31/2009:
(a) For fixed rate TruPS, all securities will be called in one year
(b) For floating rate TruPS, (1) all securities with spreads greater than 250 bps will be called in one year (2) all securities with spreads between 150 bps and 250 bps will be called at a rate of 5% annually (3) all securities with spreads less than 150 bps will be called at a rate of 1% annually
Banks with less than $15 billion in total assets as of 12/31/2009:
(a) For fixed rate TruPS, (1) all securities with coupons greater than 8% that were issued by healthy banks with the capacity to prepay will be called in one year (2) All remaining fixed rate securities will be called at a rate of 1% annually
(b) For floating rate TruPs, all securities will be called at a rate of 1% annually

The trust preferred pooled security is a Collateralized Debt Obligation (“CDOs”) backed by a pool of debt securities issued by financial institutions. The collateral consists of trust-preferred securities and subordinated debt securities issued by banks, bank holding companies and insurance companies. Performing collateral is the amount of remaining collateral less the balances of collateral in deferral or default. Subordination is the amount of performing collateral in excess of the current balance of a specified class and all classes senior to the specified class.  Excess subordination is the amount that the performing collateral balance exceeds the current outstanding balance of the specific class, plus all senior classes. It is a static measure of credit enhancement, but does not incorporate all of the structural elements of the security deal. This amount can also be impacted by future defaults and deferrals, deferring balances that cure or redemptions of securities by issuers. A negative excess subordination indicates that the current performing collateral of the security would be insufficient to pay the current principal balance of the class notes after all of the senior classes’ notes were paid. However, the performing collateral balance excludes

55






the collateral of issuers currently deferring their interest payments. Because these issuers are expected to resume payment in the future (within five years of the first deferred interest period), a negative excess subordination does not necessarily mean a class note holder will not receive a greater than projected or even full payment of cash flow at maturity.

The Company’s trust preferred security investment allows, under the terms of the issue, for issuers to defer interest for up to five consecutive years. After five years, if not cured, the security is considered to be in default and the trustee may demand payment in full of principal and accrued interest. Issuers are also considered to be in default in the event of the failure of the issuer or a subsidiary. The structuring of the trust preferred security provides for a waterfall approach to absorbing losses whereby lower classes or tranches are initially impacted and more senior tranches are only impacted after lower tranches can no longer absorb losses. Likewise, the waterfall approach also applies to principal and interest payments received, as senior tranches have priority over lower tranches in the receipt of payments. Both deferred and defaulted issuers are considered non-performing, and the trustee calculates, on a quarterly basis, certain coverage tests prior to the payment of cash interest to owners of the various tranches of the securities. The coverage tests are compared to an over-collateralization target that states the balance of performing collateral as a percentage of the tranche balance plus the balance of all senior tranches. The tests must show that performing collateral is sufficient to meet requirements for the senior tranches, both in terms of cash flow and collateral value, before cash interest can be paid to subordinate tranches. As a result of the cash flow waterfall provisions within the structure of the security, when a senior tranche fails its coverage test, all of the cash flows that would have been paid to lower tranches are paid to the senior tranche and recorded as a reduction of the senior tranches’ principal. This principal reduction in the senior tranche continues until the coverage test of the senior tranche is passed or the principal of the tranche is paid in full. For so long as the cash flows are being diverted to the senior tranches, the amount of interest due and payable to the subordinate tranches is capitalized and recorded as an increase in the principal value of the tranche. The Company’s trust preferred security investment is in the mezzanine tranche or class which is subordinate to more senior tranches of the issue.

The impact of payment of PIK to subordinate tranches is to strengthen the position of the senior tranches by reducing the senior tranches’ principal balances relative to available collateral and cash flow.  The impact to the subordinate tranches is to increase principal balances, decrease cash flow, and increase credit risk to the tranches receiving the PIK. The risk to holders of a security of a tranche in PIK status is that the remaining total cash flow will not be sufficient to repay all principal and capitalized interest related to the investment.

During the fourth quarter of 2010, after analysis of the expected future cash flows and the timing of resumed interest payments, the Company determined that placing the trust preferred security on non-accrual status was the most prudent course of action. The Company stopped all accrual of interest and ceased to capitalize any PIK to the principal balance of the security.  The Company intends to keep the security on non-accrual status until the scheduled interest payments resume on a regular basis and any previously recorded PIK has been paid. The PIK status of the securities, among other factors, indicates potential other-than-temporary impairment (“OTTI”) and accordingly, the Company has performed further detailed analysis of the investments cash flows and the credit conditions of the underlying issuers. This analysis incorporates, among other things, the waterfall provisions and any resulting PIK status of these securities to determine if cash flow will be sufficient to pay all principal and interest due to the investment tranche held by the Company.  

See discussion below and Note 3 – Investment Securities in the notes to the financial statements for more detail regarding this analysis. Based on this analysis, the Company believes the amortized costs recorded for the trust preferred security investment accurately reflects the position of the security at September 30, 2017 and December 31, 2016.

Other-than-temporary Impairment of Securities

Declines in the fair value, or unrealized losses, of all available for sale investment securities, are reviewed to determine whether the losses are either a temporary impairment or OTTI. Temporary adjustments are recorded when the fair value of a security fluctuates from its historical cost. Temporary adjustments are recorded in accumulated other comprehensive income, and impact the Company’s equity position. Temporary adjustments do not impact net income. A recovery of available for sale security prices also is recorded as an adjustment to other comprehensive income for securities that are temporarily impaired, and results in a positive impact to the Company’s equity position.


56






OTTI is recorded when the fair value of an available for sale security is less than historical cost, and it is probable that all contractual cash flows will not be collected. Investment securities are evaluated for OTTI on at least a quarterly basis. In conducting this assessment, the Company evaluates a number of factors including, but not limited to:

how much fair value has declined below amortized cost;
how long the decline in fair value has existed;
the financial condition of the issuers;
contractual or estimated cash flows of the security;
underlying supporting collateral;
past events, current conditions and forecasts;
significant rating agency changes on the issuer; and
the Company’s intent and ability to hold the security for a period of time sufficient to allow for any anticipated recovery in fair value.

If the Company intends to sell the security or if it is more likely than not the Company will be required to sell the security before recovery of its amortized cost basis, the entire amount of OTTI is recorded to noninterest income, and therefore, results in a negative impact to net income. Because the available for sale securities portfolio is recorded at fair value, the conclusion as to whether an investment decline is other-than-temporarily impaired, does not significantly impact the Company’s equity position, as the amount of the temporary adjustment has already been reflected in accumulated other comprehensive income/loss.

If the Company does not intend to sell the security and it is not more-likely-than-not it will be required to sell the security before recovery of its amortized cost basis, only the amount related to credit loss is recognized in earnings.  In determining the portion of OTTI that is related to credit loss, the Company compares the present value of cash flows expected to be collected from the security with the amortized cost basis of the security. The remaining portion of OTTI, related to other factors, is recognized in other comprehensive earnings, net of applicable taxes.

The term “other-than-temporary” is not intended to indicate that the decline is permanent, but indicates that the prospects for a near-term recovery of value are not necessarily favorable, or that there is a general lack of evidence to support a realizable value equal to or greater than the carrying value of the investment. See Note 3 -- Investment Securities in the Notes to Condensed Consolidated Financial Statements (unaudited) for a discussion of the Company’s evaluation and subsequent charges for OTTI.


Loans

The loan portfolio (net of unearned interest) is the largest category of the Company’s earning assets.  The following table summarizes the composition of the loan portfolio, including loans held for sale, as of September 30, 2017 and December 31, 2016 (in thousands):
 
September 30, 2017
 
% Outstanding
Loans
 
December 31, 2016
 
% Outstanding
Loans
Construction and land development
$
77,179

 
4.1
%
 
$
49,104

 
2.7
%
Agricultural real estate
126,096

 
6.8
%
 
126,108

 
6.9
%
1-4 Family residential properties
301,897

 
16.2
%
 
326,415

 
17.9
%
Multifamily residential properties
72,323

 
3.9
%
 
83,200

 
4.6
%
Commercial real estate
647,184

 
34.6
%
 
630,135

 
34.5
%
Loans secured by real estate
1,224,679

 
65.6
%
 
1,214,962

 
66.6
%
Agricultural loans
81,383

 
4.4
%
 
86,685

 
4.7
%
Commercial and industrial loans
443,473

 
23.7
%
 
409,033

 
22.4
%
Consumer loans
30,074

 
1.6
%
 
38,028

 
2.1
%
All other loans
87,953

 
4.7
%
 
77,284

 
4.2
%
Total loans
$
1,867,562

 
100.0
%
 
$
1,825,992

 
100.0
%



57






Overall loan balances increased $41,570,000, or 2.28%.  The balance of real estate loans held for sale, included in the balances shown above, amounted to $2,079,000 and $1,175,000 as of September 30, 2017 and December 31, 2016, respectively.

Commercial and commercial real estate loans generally involve higher credit risks than residential real estate and consumer loans. Because payments on loans secured by commercial real estate or equipment are often dependent upon the successful operation and management of the underlying assets, repayment of such loans may be influenced to a great extent by conditions in the market or the economy. The Company does not have any sub-prime mortgages or credit card loans outstanding which are also generally considered to be higher credit risk.

The following table summarizes the loan portfolio geographically by branch region as of September 30, 2017 and December 31, 2016 (dollars in thousands):
 
September 30, 2017
 
December 31, 2016
 
Principal
balance
 
% Outstanding
Loans
 
Principal
balance
 
% Outstanding
loans
Central region
486,267

 
26.0
%
 
465,458

 
25.5
%
Sullivan region
163,329

 
8.7
%
 
170,463

 
9.3
%
Decatur region
355,564

 
19.0
%
 
313,459

 
17.2
%
Peoria region
186,356

 
10.0
%
 
204,514

 
11.2
%
Highland region
542,189

 
29.1
%
 
538,325

 
29.5
%
Southern region
133,857

 
7.2
%
 
133,773

 
7.3
%
Total all regions
$
1,867,562

 
100.0
%
 
$
1,825,992

 
100.0
%

Loans are geographically dispersed among these regions located in central and southwestern Illinois. While these regions have experienced some economic stress during 2017 and 2016, the Company does not consider these locations high risk areas since these regions have not experienced the significant declines in real estate values seen in some other areas in the United States.

The Company does not have a concentration, as defined by the regulatory agencies, in construction and land development loans or commercial real estate loans as a percentage of total risk-based capital for the periods shown above. At September 30, 2017 and December 31, 2016, the Company did have industry loan concentrations in excess of 25% of total risk-based capital in the following industries (dollars in thousands):
 
September 30, 2017
 
December 31, 2016
 
Principal
balance
 
% Outstanding
Loans
 
Principal
balance
 
% Outstanding
Loans
Other grain farming
$
166,432

 
8.91
%
 
$
171,336

 
9.38
%
Lessors of non-residential buildings
168,254

 
9.01
%
 
134,019

 
7.34
%
Lessors of residential buildings & dwellings
129,378

 
6.93
%
 
139,584

 
7.64
%
Hotels and motels
120,330

 
6.44
%
 
103,843

 
5.69
%
Other Gambling Industries
81,434

 
4.36
%
 
48,973

 
2.68
%
Automobile Dealers
49,874

 
2.67
%
 
54,261

 
2.97
%

Balances of other gambling industries were not a concentration December 31, 2016, but is shown here for comparative purposes. Balances of automobile dealers were not a concentration September 30, 2017, but is shown here for comparative purposes. The Company had no further industry loan concentrations in excess of 25% of total risk-based capital.


58






The following table presents the balance of loans outstanding as of September 30, 2017, by contractual maturities (in thousands):
 
Maturity (1)
 
One year
or less(2)
 
Over 1 through
5 years
 
Over
5 years
 
Total
Construction and land development
$
54,002

 
$
15,391

 
$
7,786

 
$
77,179

Agricultural real estate
14,370

 
44,405

 
67,321

 
126,096

1-4 Family residential properties
29,474

 
78,604

 
193,819

 
301,897

Multifamily residential properties
9,873

 
53,001

 
9,449

 
72,323

Commercial real estate
73,847

 
293,995

 
279,342

 
647,184

Loans secured by real estate
181,566

 
485,396

 
557,717

 
1,224,679

Agricultural loans
64,404

 
15,120

 
1,859

 
81,383

Commercial and industrial loans
176,715

 
225,657

 
41,101

 
443,473

Consumer loans
3,482

 
25,125

 
1,467

 
30,074

All other loans
19,136

 
23,058

 
45,759

 
87,953

Total loans
$
445,303

 
$
774,356

 
$
647,903

 
$
1,867,562


(1) Based upon remaining contractual maturity.
(2) Includes demand loans, past due loans and overdrafts.

As of September 30, 2017, loans with maturities over one year consisted of approximately $1.2 billion in fixed rate loans and approximately $259 million in variable rate loans.  The loan maturities noted above are based on the contractual provisions of the individual loans.  The Company has no general policy regarding renewals and borrower requests, which are handled on a case-by-case basis.

Nonperforming Loans and Nonperforming Other Assets

Nonperforming loans include: (a) loans accounted for on a nonaccrual basis; (b) accruing loans contractually past due ninety days or more as to interest or principal payments; and (c) loans not included in (a) and (b) above which are defined as “troubled debt restructurings”. Repossessed assets include primarily repossessed real estate and automobiles.

The Company’s policy is to discontinue the accrual of interest income on any loan for which principal or interest is ninety days past due.  The accrual of interest is discontinued earlier when, in the opinion of management, there is reasonable doubt as to the timely collection of interest or principal.  Once interest accruals are discontinued, accrued but uncollected interest is charged against current year income. Subsequent receipts on non-accrual loans are recorded as a reduction of principal, and interest income is recorded only after principal recovery is reasonably assured. Nonaccrual loans are returned to accrual status when, in the opinion of management, the financial position of the borrower indicates there is no longer any reasonable doubt as to the timely collection of interest or principal.

Restructured loans are loans on which, due to deterioration in the borrower’s financial condition, the original terms have been modified in favor of the borrower or either principal or interest has been forgiven. Repossessed assets represent property acquired as the result of borrower defaults on loans. These assets are recorded at estimated fair value, less estimated selling costs, at the time of foreclosure or repossession.  Write-downs occurring at foreclosure are charged against the allowance for loan losses. On an ongoing basis, properties are appraised as required by market indications and applicable regulations. Write-downs for subsequent declines in value are recorded in non-interest expense in other real estate owned along with other expenses related to maintaining the properties.


59






The following table presents information concerning the aggregate amount of nonperforming loans and repossessed assets at September 30, 2017 and December 31, 2016 (in thousands):
 
September 30,
2017
 
December 31,
2016
Nonaccrual loans
$
13,784

 
$
12,053

Restructured loans which are performing in accordance with revised terms
6,004

 
6,185

Total nonperforming loans
19,788

 
18,238

Repossessed assets
2,264

 
1,985

Total nonperforming loans and repossessed assets
$
22,052

 
$
20,223

Nonperforming loans to loans, before allowance for loan losses
1.06
%
 
1.00
%
Nonperforming loans and repossessed assets to loans, before allowance for loan losses
1.18
%
 
1.11
%

The $1,731,000 increase in nonaccrual loans during 2017 resulted from the net of $8,720,000 of loans put on nonaccrual status offset by $5,491,000 of loans becoming current or paid-off, $517,000 of loans transferred to other real estate and $981,000 of loans charged off.

The following table summarizes the composition of nonaccrual loans (in thousands):
 
September 30, 2017
 
December 31, 2016
 
Balance
 
% of Total
 
Balance
 
% of Total
Construction and land development
$
266

 
1.9
%
 
$
227

 
1.9
%
Agricultural real estate
291

 
2.1
%
 
205

 
1.7
%
1-4 Family residential properties
2,630

 
19.1
%
 
2,890

 
24.0
%
Multifamily Residential properties
2,208

 
16.0
%
 
528

 
4.4
%
Commercial real estate
5,341

 
38.8
%
 
4,971

 
41.2
%
Loans secured by real estate
10,736

 
77.9
%
 
8,821

 
73.2
%
Agricultural loans
834

 
6.1
%
 
1,388

 
11.5
%
Commercial and industrial loans
1,920

 
13.9
%
 
1,430

 
11.9
%
Consumer loans
294

 
2.1
%
 
414

 
3.4
%
Total loans
$
13,784

 
100.0
%
 
$
12,053

 
100.0
%

Interest income that would have been reported if nonaccrual and restructured loans had been performing totaled $366,000 and $99,000 for the nine months ended September 30, 2017 and 2016, respectively.

The $279,000 increase in repossessed assets during the first nine months of 2017 resulted from the net of $7,760,000 of additional assets repossessed, $327,000 of assets written down to appraised value and $7,154,000 of repossessed assets sold. The following table summarizes the composition of repossessed assets (in thousands):
 
September 30, 2017
 
December 31, 2016
 
Balance
 
% of Total
 
Balance
 
% of Total
Construction and land development
$
1,799

 
79.5
%
 
$
1,711

 
86.2
%
Farm Loans

 
%
 
40

 
2.0
%
1-4 family residential properties
430

 
19.0
%
 
231

 
11.6
%
Total real estate
2,229

 
98.5
%
 
1,982

 
99.8
%
Consumer loans
35

 
1.5
%
 
3

 
0.2
%
Total repossessed collateral
$
2,264

 
100.0
%
 
$
1,985

 
100.0
%

Repossessed assets sold during the first nine months of 2017 resulted in net losses of $354,000, of which $21,000 of net losses was related to real estate asset sales and $333,000 of net losses was related to other repossessed assets. Repossessed assets sold during the same period in 2016 resulted in net losses of $5,000, all of which was related to other repossessed assets.
Loan Quality and Allowance for Loan Losses

The allowance for loan losses represents management’s estimate of the reserve necessary to adequately account for probable losses existing in the current portfolio. The provision for loan losses is the charge against current earnings that is determined by management as the amount needed to maintain an adequate allowance for loan losses.  In determining the adequacy of the allowance for loan losses, and therefore the provision to be charged to current earnings, management relies predominantly on a disciplined credit review and approval process that extends to the full range of the Company’s credit exposure.  The review process is directed by overall lending policy and is intended to identify, at the earliest possible stage, borrowers who might be facing financial difficulty. Factors considered by management in evaluating the overall adequacy of the allowance include a migration analysis of the historical net loan losses by loan segment, the level and composition of nonaccrual, past due and renegotiated loans, trends in volumes and terms of loans, effects of changes in risk selection and underwriting standards or lending practices, lending staff changes, concentrations of credit, industry conditions and the current economic conditions in the region where the Company operates.

Given the current state of the economy, management did assess the impact of the recession on each category of loans and adjusted historical loss factors to reflect the prolonged weakened economic conditions. Some of the economic factors include the potential for reduced cash flow for commercial operating loans from reduction in sales or increased operating costs, decreased occupancy rates for commercial buildings, reduced levels of home sales for commercial land developments, the uncertainty regarding grain prices, increased operating costs for farmers, and increased levels of unemployment and bankruptcy impacting consumer’s ability to pay. Each of these economic uncertainties was taken into consideration in developing the level of the reserve. Management considers the allowance for loan losses a critical accounting policy.

Management recognizes there are risk factors that are inherent in the Company’s loan portfolio.  All financial institutions face risk factors in their loan portfolios because risk exposure is a function of the business.  The Company’s operations (and therefore its loans) are concentrated in east central Illinois, an area where agriculture is the dominant industry.  Accordingly, lending and other business relationships with agriculture-based businesses are critical to the Company’s success. At September 30, 2017, the Company’s loan portfolio included $207.5 million of loans to borrowers whose businesses are directly related to agriculture. Of this amount, $166.4 million was concentrated in other grain farming. Total loans to borrowers whose businesses are directly related to agriculture decreased $5.47 million from $213.0 million at December 31, 2016 while loans concentrated in other grain farming decreased $4.9 million from $171.3 million at December 31, 2016.  

While the Company adheres to sound underwriting practices, including collateralization of loans, any extended period of low commodity prices, drought conditions, significantly reduced yields on crops and/or reduced levels of government assistance to the agricultural industry could result in an increase in the level of problem agriculture loans and potentially result in loan losses within the agricultural portfolio.

In addition, the Company has $120.3 million of loans to motels and hotels.  The performance of these loans is dependent on borrower specific issues as well as the general level of business and personal travel within the region.  While the Company adheres to sound underwriting standards, a prolonged period of reduced business or personal travel could result in an increase in nonperforming loans to this business segment and potentially in loan losses. The Company also has $168.3 million of loans to lessors of non-residential buildings, $129.4 million of loans to lessors of residential buildings and dwellings, and $81.4 million of loans to other gambling industries.

The structure of the Company’s loan approval process is based on progressively larger lending authorities granted to individual loan officers, loan committees, and ultimately the Board of Directors.  Outstanding balances to one borrower or affiliated borrowers are limited by federal regulation; however, limits well below the regulatory thresholds are generally observed.  The vast majority of the Company’s loans are to businesses located in the geographic market areas served by the Company’s branch bank system.  Additionally, a significant portion of the collateral securing the loans in the portfolio is located within the Company’s primary geographic footprint.  In general, the Company adheres to loan underwriting standards consistent with industry guidelines for all loan segments.

The Company minimizes credit risk by adhering to sound underwriting and credit review policies.  Management and the board of directors of the Company review these policies at least annually.  Senior management is actively involved in business development efforts and the maintenance and monitoring of credit underwriting and approval.  The loan review system and controls are designed to identify, monitor and address asset quality problems in an accurate and timely manner.  The board of directors and management review the status of problem loans each month and formally determine a best estimate of the allowance for loan losses on a quarterly basis.  In addition to internal policies and controls, regulatory authorities periodically review asset quality and the overall adequacy of the allowance for loan losses.

Analysis of the allowance for loan losses as of September 30, 2017 and 2016, and of changes in the allowance for the three and nine month periods ended September 30, 2017 and 2016, is as follows (dollars in thousands):

 
Three months ended September 30,
 
Nine months ended September 30,
 
2017
 
2016
 
2017
 
2016
Average loans outstanding, net of unearned income
$
1,840,570

 
$
1,445,774

 
$
1,820,264

 
$
1,335,898

Allowance-beginning of period
18,209

 
15,164

 
16,753

 
14,576

Charge-offs:
 
 
 
 
 
 
 
Real estate-mortgage
563

 

 
914

 
221

Commercial, financial & agricultural
686

 

 
2,579

 
533

Installment
18

 
148

 
90

 
226

Other
142

 
123

 
307

 
267

Total charge-offs
1,409

 
271

 
3,890

 
1,247

Recoveries:
 

 
 

 
 

 
 

Real estate-mortgage
85

 
108

 
256

 
523

Commercial, financial & agricultural
152

 
23

 
203

 
224

Installment
11

 
7

 
21

 
19

Other
52

 
49

 
195

 
139

Total recoveries
300

 
187

 
675

 
905

Net charge-offs (recoveries)
1,109

 
84

 
3,215

 
342

Provision for loan losses
1,489

 
1,081

 
5,051

 
1,927

Allowance-end of period
$
18,589

 
$
16,161

 
$
18,589

 
$
16,161

Ratio of annualized net charge-offs to average loans
0.24
%
 
0.02
%
 
0.24
%
 
0.03
%
Ratio of allowance for loan losses to loans outstanding (less unearned interest at end of period)
1.00
%
 
0.89
%
 
1.00
%
 
0.89
%
Ratio of allowance for loan losses to nonperforming loans
94
%
 
102
%
 
94
%
 
102
%

The ratio of allowance for loan losses to loans outstanding was 1.00% as of September 30, 2017 compared to 0.89% as of September 30, 2016. The ratio of the allowance for loan losses to nonperforming loans is 94% as of September 30, 2017 compared to 102% as of September 30, 2016.  The decrease in this ratio is primarily due to the increase in nonperforming loans to $19.8 million at September 30, 2017 from $15.8 million at September 30, 2016. The ratios also decreased as acquired First Clover Leaf loans were recorded at fair value and First Clover Leaf's allowance for loan loss was not carried over in accordance with ASC 805.

During the first nine months of 2017, the Company had net charge-offs of $3,215,000 compared to net charge-offs of $342,000 in 2016. During the first nine months of 2017 there were charge offs of commercial real estate loans to three borrowers of $619,000, charge offs of two agricultural loans to one borrower of $662,000, and charge offs of nine commercial operating loans to four borrowers of $1,674,000. During the first nine months of 2016, there was one significant charge off of a residential real estate loan to a single borrower of $83,000, charge offs of four commercial operating loans to a single borrower of $437,000, and a significant charge off of two consumer loans to a single borrower of $108,000.

Deposits

Funding of the Company’s earning assets is substantially provided by a combination of consumer, commercial and public fund deposits.  The Company continues to focus its strategies and emphasis on retail core deposits, the major component of funding sources.  The following table sets forth the average deposits and weighted average rates for the nine months ended September 30, 2017 and 2016 and for the year ended December 31, 2016 (dollars in thousands):
 
Nine months ended September 30, 2017
 
Nine months ended September 30, 2016
 
Year ended December 31, 2016
 
Average
Balance
 
Weighted
Average
Rate
 
Average
Balance
 
Weighted
Average
Rate
 
Average
Balance
 
Weighted
Average
Rate
Demand deposits:
 
 
 
 
 
 
 
 
 
 
 
Non-interest-bearing
$
434,201

 
%
 
$
348,476

 
%
 
$
372,339

 
%
Interest-bearing
1,129,427

 
0.15
%
 
818,397

 
0.10
%
 
881,994

 
0.11
%
Savings
368,291

 
0.13
%
 
335,518

 
0.13
%
 
340,746

 
0.13
%
Time deposits
353,191

 
0.45
%
 
257,733

 
0.43
%
 
298,124

 
0.43
%
Total average deposits
$
2,285,110

 
0.17
%
 
$
1,760,124

 
0.13
%
 
$
1,893,203

 
0.14
%


The following table sets forth the high and low month-end balances for the nine months ended September 30, 2017 and 2016 and for the year ended December 31, 2016 (in thousands):
 
Nine months ended
September 30, 2017
 
Nine months ended
September 30, 2016
 
Year ended
December 31, 2016
High month-end balances of total deposits
$
2,331,084

 
$
2,265,259

 
$
2,329,887

Low month-end balances of total deposits
2,217,477

 
1,699,770

 
1,699,770


During the first nine months of 2017, the average balance of deposits increased by $391.9 million from the average balance for the year ended December 31, 2016. Average non-interest bearing deposits increased by $61.9 million, average interest bearing balances increased by $247.4 million, savings account balances increased $27.5 million and balances of time deposits increased $55.1 million. These increases were primarily the result of average deposit balances acquired in the acquisition of First Clover Leaf during the third quarter of 2016 included in balances for the full nine months of 2017.

Balances of time deposits of $100,000 or more include time deposits maintained for public fund entities and consumer time deposits. The following table sets forth the maturity of time deposits of $100,000 or more at September 30, 2017 and December 31, 2016 (in thousands):
 
September 30, 2017
 
December 31, 2016
3 months or less
$
28,203

 
$
23,796

Over 3 through 6 months
26,949

 
20,352

Over 6 through 12 months
37,215

 
37,094

Over 12 months
45,878

 
70,020

Total
$
138,245

 
$
151,262



Repurchase Agreements and Other Borrowings

Securities sold under agreements to repurchase are short-term obligations of First Mid Bank.  These obligations are collateralized with certain government securities that are direct obligations of the United States or one of its agencies.  These retail repurchase agreements are offered as a cash management service to its corporate customers.  Other borrowings consist of Federal Home Loan Bank (“FHLB”) advances, federal funds purchased, loans (short-term or long-term debt) that the Company has outstanding and junior subordinated debentures.

Information relating to securities sold under agreements to repurchase and other borrowings as of September 30, 2017 and December 31, 2016 is presented below (dollars in thousands):
 
September 30, 2017
 
December 31, 2016
Securities sold under agreements to repurchase
$
116,360

 
$
185,763

Fed funds
20,000

 

Federal Home Loan Bank advances:
 

 
 

FHLB-Overnight
27,000

 

Fixed term – due in one year or less

 
5,000

Fixed term – due after one year
60,052

 
35,094

Debt:
 

 
 

Debt due in one year or less

 
4,000

     Debt due after one year
11,250

 
14,063

Junior subordinated debentures
23,980

 
23,917

Total
$
258,642

 
$
267,837

Average interest rate at end of period
0.90
%
 
0.52
%
Maximum outstanding at any month-end:
 
 
 
Securities sold under agreements to repurchase
$
163,626

 
$
185,763

Federal funds purchased
20,000

 
12,500

Federal Home Loan Bank advances:
 

 
 

FHLB-Overnight
30,000

 
10,000

Fixed term – due in one year or less
5,000

 
20,000

Fixed term – due after one year
60,061

 
35,109

Debt:
 

 
 

Debt due in one year or less
4,000

 
7,000

     Debt due after one year
14,063

 
15,000

Junior subordinated debentures
23,980

 
23,917

Averages for the period (YTD):
 

 
 

Securities sold under agreements to repurchase
$
149,970

 
$
129,734

Federal funds purchased
4,334

 
1,795

Federal Home Loan Bank advances:
 

 
 
FHLB-overnight
8,055

 
3,992

Fixed term – due in one year or less
3,150

 
10,260

Fixed term – due after one year
41,871

 
22,396

Debt:
 

 
 

Loans due in one year or less
879

 
1,454

     Loans due after one year
13,108

 
4,749

Junior subordinated debentures
23,945

 
21,650

Total
$
245,312

 
$
196,030

Average interest rate during the period
0.98
%
 
0.81
%


Securities sold under agreements to repurchase decreased $69.4 million during the first nine months of 2017 primarily due to the seasonal declines in balances and cash flow needs of various customers. FHLB advances represent borrowings by First Mid Bank to economically fund loan demand.  

At September 30, 2017 the fixed term advances consisted of $60 million as follows:

$5 million advance with a 3-year maturity, at 1.30%, due May 7, 2018
$5 million advance with a 2-year maturity, at 0.99%, due June 21, 2018
$10 million advance with a 3-year maturity, at 1.42%, due November 5, 2018
$5 million advance with a 1.5-year maturity, at 1.49%, due December 28, 2018
$5 million advance with a 2-year maturity, at 1.56%, due June 28, 2019
$5 million advance with a 2.5-year maturity, at 1.67%, due January 31, 2020
$5 million advance with a 3-year maturity, at 1.75%, due July 31, 2020
$5 million advance with a 6-year maturity, at 2.30%, due August 24, 2020
$5 million advance with a 3.5-year maturity, at 1.83%, due February 1, 2021
$5 million advance with a 7-year maturity, at 2.55%, due October 1, 2021
$5 million advance with a 8-year maturity, at 2.40%, due January 9, 2023

The Company is party to a revolving credit agreement with The Northern Trust Company in the amount of $10 million. The balance on this line of credit was $0 as of September 30, 2017. This loan was renewed on April 14, 2017 for one year as a revolving credit agreement with a maximum available balance of $10 million. The interest rate is floating at 2.25% over the federal funds rate (3.41% at September 30, 2017). The loan is secured by all of the stock of First Mid Bank. The Company and its subsidiary bank were in compliance with the then existing covenants at September 30, 2017 and 2016 and December 31, 2016.

On September 7, 2016, the Company entered into a credit agreement with The Northern Trust Company in the amount of $15 million as a fixed-rate note with a maturity date of September 7, 2020. The interest rate is floating at 2.25% over the federal funds rate (3.41% at September 30, 2017) and interest and principle payments are due quarterly. As of September 30, 2017, the balance due was $11.3 million. The loan is secured by all of the stock of First Mid Bank. The Company used the proceeds of this note to fund the cash portion of the acquisition price of First Clover Leaf. The Company and its subsidiary bank were in compliance with the then existing covenants at September 30, 2017 and December 31, 2016.

On February 27, 2004, the Company completed the issuance and sale of $10 million of floating rate trust preferred securities through First Mid-Illinois Statutory Trust I (“Trust I”), a statutory business trust and wholly-owned unconsolidated subsidiary of the Company, as part of a pooled offering.  The Company established Trust I for the purpose of issuing the trust preferred securities. The $10 million in proceeds from the trust preferred issuance and an additional $310,000 for the Company’s investment in common equity of Trust I, a total of $10,310,000, was invested in junior subordinated debentures of the Company.  The underlying junior subordinated debentures issued by the Company to Trust I mature in 2034, bear interest at three-month London Interbank Offered Rate (“LIBOR”) plus 280 basis points (4.15% and 3.17% at September 30, 2017 and December 31, 2016), reset quarterly, and are callable at par, at the option of the Company, quarterly. The Company used the proceeds of the offering for general corporate purposes.

On April 26, 2006, the Company completed the issuance and sale of $10 million of fixed/floating rate trust preferred securities through First Mid-Illinois Statutory Trust II (“Trust II”), a statutory business trust and wholly-owned unconsolidated subsidiary of the Company, as part of a pooled offering.  The Company established Trust II for the purpose of issuing the trust preferred securities. The $10 million in proceeds from the trust preferred issuance and an additional $310,000 for the Company’s investment in common equity of Trust II, a total of $10,310 000, was invested in junior subordinated debentures of the Company.  The underlying junior subordinated debentures issued by the Company to Trust II mature in 2036, bore interest at a fixed rate of 6.98% paid quarterly until June 15, 2011 and then converted to floating rate (LIBOR plus 160 basis points, 2.92% and 2.56% at September 30, 2017 and December 31, 2016, respectively). The net proceeds to the Company were used for general corporate purposes, including the Company’s acquisition of Mansfield Bancorp, Inc. in 2006.

On September 8, 2016, the Company assumed the trust preferred securities of Clover Leaf Statutory Trust I (“CLST I”), a statutory business trust that was a wholly owned unconsolidated subsidiary of First Clover Financial. The $4,000,000 of trust preferred securities and an additional $124,000 additional investment in common equity of CLST I, is invested in junior subordinated debentures issued to CLST I. The subordinated debentures mature in 2025, bear interest at three-month LIBOR plus 185 basis points (3.17% and 2.81% at September 30, 2017 and December 31, 2016, respectively) and resets quarterly.

The trust preferred securities issued by Trust I, Trust II, and CLST I are included as Tier 1 capital of the Company for regulatory capital purposes.  On March 1, 2005, the Federal Reserve Board adopted a final rule that allows the continued limited inclusion of trust preferred securities in the calculation of Tier 1 capital for regulatory purposes.  The final rule provided a five-year transition period, ending September 30, 2010, for application of the revised quantitative limits. On March 17, 2009, the Federal Reserve Board adopted an additional final rule that delayed the effective date of the new limits on inclusion of trust preferred securities in the calculation of Tier 1 capital until March 31, 2012. The application of the revised quantitative limits did not and is not expected to have a significant impact on its calculation of Tier 1 capital for regulatory purposes or its classification as well-capitalized. The Dodd-Frank Act, signed into law July 21, 2010, removes trust preferred securities as a permitted component of a holding company’s Tier 1 capital after a three-year phase-in period beginning January 1, 2013 for larger holding companies. For holding companies with less than $15 billion in consolidated assets, existing issues of trust preferred securities are grandfathered and not subject to this new restriction. Similarly, the final rule implementing the Basel III reforms allows holding companies with less than $15 billion in consolidated assets as of December 31, 2009 to continue to count toward Tier 1 capital any trust preferred securities issued before May 19, 2010. New issuances of trust preferred securities, however would not count as Tier 1 regulatory capital.

In addition to requirements of the Dodd-Frank Act discussed above, the act also required the federal banking agencies to adopt rules that prohibit banks and their affiliates from engaging in proprietary trading and investing in and sponsoring certain unregistered investment companies (defined as hedge funds and private equity funds). This rule is generally referred to as the “Volcker Rule.” On December 10, 2013, the federal banking agencies issued final rules to implement the prohibitions required by the Volcker Rule. Following the publication of the final rule, and in reaction to concerns in the banking industry regarding the adverse impact the final rule’s treatment of certain collateralized debt instruments has on community banks, the federal banking agencies approved an interim final rule to permit banking entities to retain interests in certain collateralized debt obligations backed primarily by trust preferred securities. Under the interim final rule, the agencies permit the retention of an interest in or sponsorship of covered funds by banking entities under $15 billion in assets if (1) the collateralized debt obligation was established and issued prior to May 19, 2010, (2) the banking entity reasonably believes that the offering proceeds received by the collateralized debt obligation were invested primarily in qualifying trust preferred collateral, and (3) the banking entity’s interests in the collateralized debt obligation was acquired on or prior to December 10, 2013.  Although the Volcker Rule impacts many large banking entities, the Company does not currently anticipate that the Volcker Rule will have a material effect on the operations of the Company or First Mid Bank.


Interest Rate Sensitivity

The Company seeks to maximize its net interest margin while maintaining an acceptable level of interest rate risk.  Interest rate risk can be defined as the amount of forecasted net interest income that may be gained or lost due to changes in the interest rate environment, a variable over which management has no control. Interest rate risk, or sensitivity, arises when the maturity or repricing characteristics of interest-bearing assets differ significantly from the maturity or repricing characteristics of interest-bearing liabilities. The Company monitors its interest rate sensitivity position to maintain a balance between rate sensitive assets and rate sensitive liabilities.  This balance serves to limit the adverse effects of changes in interest rates.  The Company’s asset liability management committee (ALCO) oversees the interest rate sensitivity position and directs the overall allocation of funds.

In the banking industry, a traditional way to measure potential net interest income exposure to changes in interest rates is through a technique known as “static GAP” analysis which measures the cumulative differences between the amounts of assets and liabilities maturing or repricing at various intervals. By comparing the volumes of interest-bearing assets and liabilities that have contractual maturities and repricing points at various times in the future, management can gain insight into the amount of interest rate risk embedded in the balance sheet.



60






The following table sets forth the Company’s interest rate repricing GAP for selected maturity periods at September 30, 2017 (dollars in thousands):
 
Rate Sensitive Within
 
Fair Value
 
1 year
 
1-2 years
 
2-3 years
 
3-4 years
 
4-5 years
 
Thereafter
 
Total
 
Interest-earning assets:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Federal funds sold and other interest-bearing deposits
$
7,052

 
$

 
$

 
$

 
$

 
$

 
$
7,052

 
$
7,052

Certificates of deposit investments
$

 
$
735

 
$
950

 
$

 
$

 
$

 
$
1,685

 
$
1,708

Taxable investment securities
175

 
5,027

 
3,002

 
22,327

 
38,320

 
449,133

 
517,984

 
517,815

Nontaxable investment securities

 
664

 
1,369

 
2,345

 
7,272

 
160,876

 
172,526

 
172,526

Loans
807,352

 
268,193

 
201,007

 
277,925

 
201,122

 
111,963

 
1,867,562

 
1,863,011

Total
$
814,579


$
274,619


$
206,328


$
302,597


$
246,714


$
721,972


$
2,566,809


$
2,562,112

Interest-bearing liabilities:
 
 
 

 
 

 
 

 
 

 
 

 
 

 
 

Savings and NOW accounts
$
260,620

 
$
89,962

 
$
89,962

 
$
89,962

 
$
89,962

 
$
422,111

 
$
1,042,579

 
$
1,042,579

Money market accounts
309,888

 
17,939

 
17,939

 
17,939

 
17,939

 
41,842

 
423,486

 
423,486

Other time deposits
205,597

 
49,415

 
34,226

 
18,518

 
12,447

 
1,173

 
321,376

 
321,427

Short-term borrowings/debt
163,360

 

 

 

 

 

 
163,360

 
163,348

Long-term borrowings/debt
45,282

 
20,000

 
15,000

 
5,000

 
5,000

 
5,000

 
95,282

 
89,286

Total
$
984,747

 
$
177,316

 
$
157,127

 
$
131,419

 
$
125,348

 
$
470,126

 
$
2,046,083

 
$
2,040,126

Rate sensitive assets – rate sensitive liabilities
$
(170,168
)
 
$
97,303

 
$
49,201

 
$
171,178

 
$
121,366

 
$
251,846

 
$
520,726

 
 

Cumulative GAP
$
(170,168
)
 
$
(72,865
)
 
$
(23,664
)
 
$
147,514

 
$
268,880

 
$
520,726

 
 

 
 

Cumulative amounts as % of total Rate sensitive assets
(6.6
)%
 
3.8
 %
 
1.9
 %
 
6.7
%
 
4.7
%
 
9.8
%
 
 
 
 
Cumulative Ratio
(6.6
)%
 
(2.8
)%
 
(0.9
)%
 
5.7
%
 
10.5
%
 
20.3
%
 
 
 
 

The static GAP analysis shows that at September 30, 2017, the Company was liability sensitive, on a cumulative basis, through the twelve-month time horizon. This indicates that future increases in interest rates could have an adverse effect on net interest income. There are several ways the Company measures and manages the exposure to interest rate sensitivity, including static GAP analysis.  The Company’s ALCO also uses other financial models to project interest income under various rate scenarios and prepayment/extension assumptions consistent with First Mid Bank’s historical experience and with known industry trends.  ALCO meets at least monthly to review the Company’s exposure to interest rate changes as indicated by the various techniques and to make necessary changes in the composition terms and/or rates of the assets and liabilities.  The Company is currently experiencing downward pressure on asset yields resulting from the extended period of historically low interest rates and heightened competition for loans. A continuation of this environment could result in a decline in interest income and the net interest margin.




61






Capital Resources

At September 30, 2017, the Company’s stockholders' equity increased $31 million, or 11%, to $311 million from $281 million as of December 31, 2016. During the first nine months of 2017, net income contributed $22.1 million to equity before the payment of dividends to stockholders. The change in market value of available-for-sale investment securities increased stockholders' equity by $7.8 million, net of tax.

The Company is subject to various regulatory capital requirements administered by the federal banking agencies.  Bank holding companies follow minimum regulatory requirements established by the Board of Governors of the Federal Reserve System (“Federal Reserve System”), and First Mid Bank follows similar minimum regulatory requirements established for national banks by the Office of the Comptroller of the Currency (“OCC”).  Failure to meet minimum capital requirements can initiate certain mandatory and possibly additional discretionary action by regulators that, if undertaken, could have a direct material effect on the Company’s financial statements. Quantitative measures established by regulatory capital standards to ensure capital adequacy require the the Company and its subsidiary bank to maintain a minimum capital amounts and ratios (set forth in the table below). Management believes that, as of September 30, 2017 and December 31, 2016, the Company and First Mid Bank met all capital adequacy requirements.


62






To be categorized as well-capitalized, total risk-based capital, Tier 1 risk-based capital, common equity Tier 1 risk-based capital and Tier 1 leverage ratios must be maintained as set forth in the following table (dollars in thousands):
 
Actual
 
Required Minimum For Capital Adequacy Purposes
 
To Be Well-Capitalized Under Prompt Corrective Action Provisions
 
Amount
 
Ratio
 
Amount
 
Ratio
 
Amount
 
Ratio
September 30, 2017
 
 
 
 
 
 
 
 
 
 
 
Total Capital (to risk-weighted assets)
 
 
 
 
 
 
 
 
 
 
 
Company
$
289,666

 
13.26
%
 
$
174,785

 
> 8.00%
 
N/A

 
N/A
First Mid Bank
281,678

 
12.94

 
174,210

 
> 8.00
 
$
217,763

 
> 10.00%
Tier 1 Capital (to risk-weighted assets)
 

 
 

 
 

 
 
 
 

 
 
Company
271,077

 
12.41

 
131,089

 
> 6.00
 
N/A

 
N/A
First Mid Bank
263,089

 
12.08

 
130,658

 
> 6.00
 
174,210

 
> 8.00
Common Equity Tier 1 Capital (to risk-weighted assets)
 
 

 
 
 
 

 
 
Company
247,104

 
11.31

 
98,317

 
> 4.50
 
N/A

 
N/A
First Mid Bank
263,089

 
12.08

 
97,993

 
> 4.50
 
141,546

 
> 6.50
Tier 1 Capital (to average assets)
 

 
 

 
 

 
 
 
 

 
 
Company
271,077

 
9.84

 
110,225

 
> 4.00
 
N/A

 
N/A
First Mid Bank
263,089

 
9.57

 
109,968

 
> 4.00
 
137,460

 
> 5.00
December 31, 2016
 

 
 

 
 
 
 
 
 

 
 
Total Capital (to risk-weighted assets)
 

 
 

 
 

 
 
 
 

 
 
Company
$
270,062

 
12.79
%
 
$
168,902

 
> 8.00%
 
N/A

 
N/A
First Mid Bank
197,552

 
12.44

 
127,054

 
> 8.00
 
$
158,817

 
> 10.00%
First Clover Leaf Bank
78,145

 
15.08

 
41,459

 
> 8.00
 
51,824

 
> 10.00%
Tier 1 Capital (to risk-weighted assets)
 

 
 
 
 

 
 
 
 

 
 
Company
253,258

 
11.99

 
126,677

 
> 6.00
 
N/A

 
N/A
First Mid Bank
180,826

 
11.39

 
95,290

 
> 6.00
 
127,054

 
> 8.00
First Clover Leaf Bank
78,145

 
15.08

 
31,094

 
> 6.00
 
41,459

 
> 8.00
Common Equity Tier 1 Capital (to risk-weighted assets)
 
 
 
 
 
 
 
 
Company
229,341

 
10.86

 
95,008

 
> 4.50
 
N/A

 
N/A
First Mid Bank
180,826

 
11.39

 
71,468

 
> 4.50
 
103,231

 
> 6.50
First Clover Leaf Bank
78,145

 
15.08

 
23,321

 
> 4.50
 
33,685

 
> 6.50
Tier 1 Capital (to average assets)
 

 
 

 
 

 
 
 
 

 
 
Company
253,258

 
9.19

 
110,242

 
> 4.00
 
N/A

 
N/A
First Mid Bank
180,826

 
8.62

 
83,938

 
> 4.00
 
104,922

 
> 5.00
First Clover Leaf Bank
78,145

 
12.04

 
25,963

 
> 4.00
 
32,453

 
> 5.00

The Company's risk-weighted assets, capital and capital ratios for September 30, 2017 are computed in accordance with Basel III capital rules which were effective January 1, 2015. Prior periods are computed following previous rules. See heading "Basel III" in the Overview section of this report for a more detailed description of the Basel III rules. As of September 30, 2017, both the Company and First Mid Bank had capital ratios above the required minimums for regulatory capital adequacy, and First Mid Bank had capital ratios that qualified it for treatment as well-capitalized under the regulatory framework for prompt corrective action with respect to banks.  First Clover Leaf Bank merged into First Mid Bank during the first quarter of 2017.



63






Stock Plans

Participants may purchase Company stock under the following four plans of the Company: the Deferred Compensation Plan, the First Retirement and Savings Plan, the Dividend Reinvestment Plan, and the Stock Incentive Plan.  For more detailed information on these plans, refer to the Company’s Annual Report on Form 10-K for the year ended December 31, 2016.

At the Annual Meeting of Stockholders held April 26, 2017, the stockholders approved the 2017 Stock Incentive Plan ("SI Plan").  The SI Plan was implemented to succeed the Company’s 2007 Stock Incentive Plan, which had a ten-year term. The SI Plan is intended to provide a means whereby directors, employees, consultants and advisors of the Company and its Subsidiaries may sustain a sense of proprietorship and personal involvement in the continued development and financial success of the Company and its Subsidiaries, thereby advancing the interests of the Company and its stockholders.  Accordingly, directors and selected employees, consultants and advisors may be provided the opportunity to acquire shares of Common Stock of the Company on the terms and conditions established in the SI Plan.

A maximum of 149,983 shares of common stock may be issued under the SI Plan.  There were no stock options granted in 2017 or 2016.  The Company awarded 11,473 and 13,912 stock unit awards during 2017 and 2016, respectively, under the 2007 Stock Incentive Plan.
 

Stock Repurchase Program

Since August 5, 1998, the Board of Directors has approved repurchase programs pursuant to which the Company may repurchase a total of approximately $76.7 million of the Company’s common stock.  The repurchase programs approved by the Board of Directors are as follows:

On August 5, 1998, repurchases of up to 3%, or $2 million, of the Company’s common stock.
In March 2000, repurchases up to an additional 5%, or $4.2 million of the Company’s common stock.
In September 2001, repurchases of $3 million of additional shares of the Company’s common stock.
In August 2002, repurchases of $5 million of additional shares of the Company’s common stock.
In September 2003, repurchases of $10 million of additional shares of the Company’s common stock.
On April 27, 2004, repurchases of $5 million of additional shares of the Company’s common stock.
On August 23, 2005, repurchases of $5 million of additional shares of the Company’s common stock.
On August 22, 2006, repurchases of $5 million of additional shares of the Company’s common stock.
On February 27, 2007, repurchases of $5 million of additional shares of the Company’s common stock.
On November 13, 2007, repurchases of $5 million of additional shares of the Company’s common stock.
On December 16, 2008, repurchases of $2.5 million of additional shares of the Company’s common stock.
On May 26, 2009, repurchases of $5 million of additional shares of the Company’s common stock.
On February 22, 2011, repurchases of $5 million of additional shares of the Company’s common stock.
On November 13, 2012, repurchases of $5 million of additional shares of the Company's common stock.
On November 19, 2013, repurchases of $5 million additional shares of the Company's common stock.
On October 28, 2014, repurchases of $5 million additional shares of the Company's common stock.

During the nine months ended September 30, 2017, the Company did not repurchase any shares. Since 1998, the Company has repurchased a total of 2,042,993 shares at a total price of approximately $69.5 million.  As of September 30, 2017, the Company is authorized per all repurchase programs to purchase $7.2 million in additional shares.








64






Liquidity

Liquidity represents the ability of the Company and its subsidiaries to meet all present and future financial obligations arising in the daily operations of the business.  Financial obligations consist of the need for funds to meet extensions of credit, deposit withdrawals and debt servicing.  The Company’s liquidity management focuses on the ability to obtain funds economically through assets that may be converted into cash at minimal costs or through other sources. The Company’s other sources of cash include overnight federal fund lines, Federal Home Loan Bank advances, deposits of the State of Illinois, the ability to borrow at the Federal Reserve Bank of Chicago, and the Company’s operating line of credit with The Northern Trust Company.  Details for the sources include:

First Mid Bank has $35 million available in overnight federal fund lines, including $10 million from U.S. Bank, N.A., $10 million from Wells Fargo Bank, N.A. and $15 million from The Northern Trust Company.  Availability of the funds is subject to First Mid Bank meeting minimum regulatory capital requirements for total capital to risk-weighted assets and Tier 1 capital to total average assets.  As of September 30, 2017, First Mid Bank met these regulatory requirements.

First Mid Bank can borrow from the Federal Home Loan Bank as a source of liquidity.  Availability of the funds is subject to the pledging of collateral to the Federal Home Loan Bank.  Collateral that can be pledged includes one-to-four family residential real estate loans and securities.  At September 30, 2017, the excess collateral at the FHLB would support approximately $109.0 million of additional advances for First Mid Bank.

First Mid Bank is a member of the Federal Reserve System and can borrow funds provided that sufficient collateral is pledged.

In addition, as of September 30, 2017, the Company had a revolving credit agreement in the amount of $10 million with The Northern Trust Company with an outstanding balance of $0 and $10 million in available funds.  This loan was renewed on April 14, 2017 for one year as a revolving credit agreement. The interest rate is floating at 2.25% over the federal funds rate. The loan is secured by all of the stock of First Mid Bank, including requirements for operating and capital ratios. The Company and its subsidiary bank were in compliance with the then existing covenants at September 30, 2017 and 2016 and December 31, 2016.

Management continues to monitor its expected liquidity requirements carefully, focusing primarily on cash flows from:

lending activities, including loan commitments, letters of credit and mortgage prepayment assumptions;
deposit activities, including seasonal demand of private and public funds;
investing activities, including prepayments of mortgage-backed securities and call provisions on U.S. Treasury and government agency securities; and
operating activities, including scheduled debt repayments and dividends to stockholders.

The following table summarizes significant contractual obligations and other commitments at September 30, 2017 (in thousands):
 
Total
 
Less than
1 year
 
1-3 years
 
3-5 years
 
More than
5 years
Time deposits
$
321,376

 
$
205,597

 
$
83,641

 
$
30,965

 
$
1,173

Debt
35,870

 
3,750

 
7,500

 

 
24,620

Other borrowings
203,360

 
153,360

 
35,000

 
10,000

 
5,000

Operating leases
43,921

 
2,517

 
4,383

 
3,520

 
33,501

Supplemental retirement
597

 
100

 
142

 
100

 
255

 
$
605,124

 
$
365,324

 
$
130,666

 
$
44,585

 
$
64,549


For the nine months ended September 30, 2017, net cash of $32.8 million was provided from operating activities and $17.9 million and $121.1 million was used in investing activities and financing activities, respectively. In total, cash and cash equivalents decreased by $106.2 million since year-end 2016.


65






Off-Balance Sheet Arrangements

First Mid Bank enters into financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of its customers.  These financial instruments include lines of credit, letters of credit and other commitments to extend credit.  Each of these instruments involves, to varying degrees, elements of credit, interest rate and liquidity risk in excess of the amounts recognized in the consolidated balance sheets.  The Company uses the same credit policies and requires similar collateral in approving lines of credit and commitments and issuing letters of credit as it does in making loans. The exposure to credit losses on financial instruments is represented by the contractual amount of these instruments. However, the Company does not anticipate any losses from these instruments.

The off-balance sheet financial instruments whose contract amounts represent credit risk at September 30, 2017 and December 31, 2016 were as follows (in thousands):
 
September 30, 2017
 
December 31, 2016
Unused commitments and lines of credit:
 
 
 
Commercial real estate
$
71,719

 
$
128,576

Commercial operating
259,104

 
236,182

Home equity
38,811

 
40,896

Other
58,927

 
70,092

Total
$
428,561

 
$
475,746

Standby letters of credit
$
11,431

 
$
9,339


Commitments to originate credit represent approved commercial, residential real estate and home equity loans that generally are expected to be funded within ninety days.  Lines of credit are agreements by which the Company agrees to provide a borrowing accommodation up to a stated amount as long as there is no violation of any condition established in the loan agreement.  Both commitments to originate credit and lines of credit generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since many of the lines and some commitments are expected to expire without being drawn upon, the total amounts do not necessarily represent future cash requirements.

Standby letters of credit are conditional commitments issued by the Company to guarantee the financial performance of customers to third parties.  Standby letters of credit are primarily issued to facilitate trade or support borrowing arrangements and generally expire in one year or less.  The credit risk involved in issuing letters of credit is essentially the same as that involved in extending credit facilities to customers.  The maximum amount of credit that would be extended under letters of credit is equal to the total off-balance sheet contract amount of such instrument.

66






ITEM 3.  QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

There has been no material change in the market risk faced by the Company since December 31, 2016.  For information regarding the Company’s market risk, refer to the Company’s Annual Report on Form 10-K for the year ended December 31, 2016.


ITEM 4.  CONTROLS AND PROCEDURES

The Company’s management, with the participation of the Company’s Chief Executive Officer and Chief Financial Officer, evaluated the effectiveness of the Company’s “disclosure controls and procedures” (as such term is defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act), as of the end of the period covered by this report.  Based on such evaluation, such officers have concluded that, as of the end of the period covered by this report, the Company’s disclosure controls and procedures are effective.  Further, there have been no changes in the Company’s internal control over financial reporting during the last fiscal quarter that have materially affected or that are reasonably likely to affect materially the Company’s internal control over financial reporting.




67






PART II

ITEM 1.
LEGAL PROCEEDINGS

The Company as successor to First Clover Leaf, certain former executive officers of First Clover Leaf, and certain former members of First Clover Leaf’s board of directors, and the Company were named as defendants in one purported class action lawsuit brought by an alleged individual First Clover Leaf stockholder challenging the merger of First Clover Leaf into the Company (the “Lawsuit”). The Lawsuit was captioned Raul v. Highlander, et al , Case No. 16- L-703, and was filed on May 20, 2016, in the Circuit Court of Madison County, Illinois, Third Judicial District. On July 12, 2017, the defendants' motion to dismiss was granted and all claims were dismissed with prejudice. The plaintiff did not appeal this decision prior to August 11, 2017 deadline for such an appeal to be filed.

From time to time the Company and its subsidiaries may be involved in litigation that the Company believes is of a type common to our industry. None of any such existing claims are believed to be individually material at this time to the Company, although the outcome of any such existing claims cannot be predicted with certainty.

ITEM 1A.  RISK FACTORS

Various risks and uncertainties, some of which are difficult to predict and beyond the Company’s control, could negatively impact the Company.  As a financial institution, the Company is exposed to interest rate risk, liquidity risk, credit risk, operational risk, risks from economic or market conditions, and general business risks among others.  Adverse experience with these or other risks could have a material impact on the Company’s financial condition and results of operations, as well as the value of its common stock.  See the risk factors and “Supervision and Regulation” described in the Company’s Annual Report on Form 10-K for the year ended December 31, 2016.

ITEM 2.
UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

None.
 
 
 
 
 
 
 
 

ITEM 3.
DEFAULTS UPON SENIOR SECURITIES

None.

ITEM 4.
MINE SAFETY DISCLOSURES

Not applicable.

ITEM 5.
OTHER INFORMATION

None.


ITEM 6.
EXHIBITS

The exhibits required by Item 601 of Regulation S-K and filed herewith are listed in the Exhibit Index that follows the Signature Page and that immediately precedes the exhibits filed.

68






SIGNATURES



Pursuant to the requirements 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.




FIRST MID-ILLINOIS BANCSHARES, INC.
(Registrant)

Date:  November 6, 2017

dively.jpg
Joseph R. Dively
President and Chief Executive Officer


smith.jpg
Matthew K. Smith
Chief Financial Officer






69






Exhibit Index to Quarterly Report on Form 10-Q
Exhibit Number
Description and Filing or Incorporation Reference
4.1
The Registrant agrees to furnish to the Commission, upon request, a copy of each instrument with respect to issues of long-term debt involving a total amount which does not exceed 10% of the total assets of the Registrant and its subsidiaries on a consolidated basis
 
 
 
 
 
 
 
 
 
 
 
 
 
 
101
The following materials from the Company’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2017, formatted in XBRL (Extensible Business Reporting Language): (i) the Consolidated Balance Sheets at September 30, 2017 and December 31, 2016, (ii) the Consolidated Statements of Income for the three and nine months ended September 30, 2017 and 2016, (iii) the Consolidated Statements of Cash Flows for the nine months ended September, 2017 and 2016, and (iv) the Notes to Consolidated Financial Statements.

70