ITEM 1B.
UNRESOLVED STAFF COMMENTS
None.
The Company's headquarters is located at 1421 Charleston Avenue, Mattoon Illinois . This location is also used by the loan and deposit operations departments of First Mid Bank. In addition, the Company owns a facility located at 1500 Wabash Avenue, Mattoon, Illinois, which it is currently leasing to a non-affiliated third party.
The main office of First Mid Bank is located at 1515 Charleston Avenue, Mattoon, Illinois and is owned by First Mid Bank. First Mid Bank also owns a building located at 1520 Charleston Avenue, which is used by First Mid Insurance, MIDS or its data processing and by First Mid Bank for back room operations. First Mid Bank also conducts business through numerous facilities, owned and leased, located in twenty-three counties throughout Illinois. Of the forty-five other banking offices operated by First Mid Bank, twenty-four are owned and twenty-one are leased from non-affiliated third parties.
The main office of First Clover Leaf Bank is located at 6814 Goshen Road, Edwardsville, Illinois and is owned by First Clover Leaf Bank. Of the six other banking offices operated by First Clover Leaf Bank, four are owned and two are leased. Six of these locations are located in one Illinois county and one is located in a Missouri county.
None of the properties owned by the Corporation are subject to any major encumbrances. The Company believes these facilities are suitable and adequate to operate its banking and related business. The net investment of the Company and subsidiaries in real estate and equipment at December 31, 2016 was $40.3 million.
ITEM 3.
ITEM 3.
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 are 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 is 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. The Lawsuit alleges breaches of fiduciary duty by the individual officers and directors of First Clover Leaf relating to the process leading to the merger of First Clover Leaf and the Company. The Lawsuit alleges that the merger consideration was inadequate and that the joint proxy statement/prospectus did not contain sufficient disclosures and detail. The Lawsuit also alleges that First Clover Leaf and the Company aided and abetted the alleged breaches of fiduciary duty by the individual defendants. The relief sought includes class certification, rescission of the merger and damages and costs, including attorneys’ fees. The Company and the individual defendants believe that the factual allegations in the Lawsuit are without merit and legally unfounded. They have moved to dismiss the complaint and intend to vigorously defend against these allegations.
ITEM 4.
ITEM 4.
MINE SAFETY DISCLOSURES
Not applicable.
PART II
ITEM 5.
ITEM 5.
MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED SHAREHOLDER MATTERS AND ISSUER OF PURCHASES OF EQUITY SECURITIES
The Company’s common stock was held by approximately 861 shareholders of record as of December 31, 2016 and is included for quotation on the NASDAQ Stock Market, LLC.
The following table shows the high and low bid prices per share of the Company’s common stock for the indicated periods. These quotations represent inter-dealer prices without retail mark-ups, mark-downs or commissions and may not necessarily represent actual transactions.
The Board of Directors of the Company declared cash dividends semi-annually during the two years ended December 31, 2016 and 2015. A special dividend was declared in 2016 immediately preceding the acquisition of First Clover Leaf. The following table sets forth the cash dividends per share on the Company’s common stock for the last two years.
The Company’s shareholders are entitled to receive such dividends as are declared by the Board of Directors, which considers payment of dividends semi-annually. The ability of the Company to pay dividends, as well as fund its operations, is dependent upon receipt of dividends from First Mid Bank and First Clover Leaf Bank. Regulatory authorities limit the amount of dividends that can be paid by First Mid Bank and First Clover Leaf Bank without prior approval from such authorities. For further discussion of the Bank’s dividend restrictions, see Item1 - “Business” - “First Mid Bank and First Clover Leaf Bank” - “Dividends” and Note 16 - “Dividend Restrictions” herein.
The following table summarizes share repurchase activity for the fourth quarter of 2016:
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:
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On August 5, 1998, repurchases of up to 3%, or $2 million, of the Company’s common stock.
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In March 2000, repurchases up to an additional 5%, or $4.2 million of the Company’s common stock.
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In September 2001, repurchases of $3 million of additional shares of the Company’s common stock.
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In August 2002, repurchases of $5 million of additional shares of the Company’s common stock.
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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.
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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.
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On February 27, 2007, repurchases of $5 million of additional shares of the Company’s common stock.
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On November 13, 2007, repurchases of $5 million of additional shares of the Company’s common stock.
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On December 16, 2008, repurchases of $2.5 million of additional shares of the Company’s common stock.
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On May 26, 2009, repurchases of $5 million of additional shares of the Company’s common stock.
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On February 22, 2011, repurchases of $5 million of additional shares of the Company’s common stock.
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On November 13, 2012 repurchases of $5 million of additional shares of the Company’s common stock.
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On November 19, 2013, repurchases of $5 million additional shares of the Company's common stock.
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On October 28, 2014, repurchases of $5 million additional shares of the Company's common stock.
ITEM 6.
ITEM 6.
SELECTED FINANCIAL DATA
The following sets forth a five-year comparison of selected financial data (dollars in thousands, except per share data).
ITEM 7.
ITEM 7.
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 years ended December 31, 2016, 2015 and 2014. 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 1955. 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, 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.
Recent Acquisition
On September 8, 2016, the Company completed its acquisition of First Clover Leaf. Financial results for 2016 include the income and expenses of First Clover Leaf Bank for the period September 9 through December 31, 2016. At the date of the acquisition, the fair value of First Clover Leaf’s total assets was $669 million, including $438 million in loans. $537 million in deposits were also included. Net income before taxes was positively impacted by $911,000 due to First Clover Leaf Bank’s purchase accounting net accretion during 2016, net of amortization expense of intangibles. During 2016, the Company incurred $1,340,000 of pre-tax acquisition expenses related to the acquisition of First Clover Leaf, comprised primarily of legal, investment banking, and consulting costs.
For the Years Ended December 31, 2016, 2015 and 2014
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, you should carefully read this entire document. These have an impact on the Company’s financial condition and results of operations.
Net income was $21.8 million, $16.5 million, and $15.5 million and diluted earnings per share were $2.05, $1.81, and $1.85 for the years ended December 31, 2016, 2015 and 2014, respectively. The increase in net income in 2016 was primarily the result of an increase in net interest income due to growth in earning assets from the acquisitions and strong loan growth in our legacy markets. Also, non-interest income increased with increased revenues from insurance, electronic services and deposit service charges. The following table shows the Company’s annualized performance ratios for the years ended December 31, 2016, 2015 and 2014:
Total assets at December 31, 2016, 2015 and 2014 were $2.88 billion, $2.11 billion, and $1.61 billion, respectively. Net loan balances increased to $1.81 billion at December 31, 2016, from $1.27 billion at December 31, 2015, from $1.05 billion at December 31, 2014. Of the increase in 2016, $439 million was due to loans acquired in the First Clover Leaf acquisition. In addition, $65 million or 12% was due to increases in commercial real estate loans and $35.8 million or 6.6% was due to increases in commercial and industrial loans. Of the increase in 2015, $152 million was due to loans acquired in ONB Branch purchase. In addition, $48.7 million or 22% was due to increases in commercial and industrial loans and $20.7 million or 9.0% was due to increases in loans secured by real estate. Of the increase in 2014, $19.8 million or 2.7% was due to increases in loans secured by real estate and $55.4 million or 32.9% was due to increases in commercial and industrial loans.
Total deposit balances increased to $2.33 billion at December 31, 2016 from $1.73 billion at December 31, 2015 and from $1.27 billion at December 31, 2014. The increase in 2016 was primarily the result of the acquisition of First Clover Leaf during the third quarter of 2016 that included $550 million in deposits. The increase in 2015 was primarily the result of the acquisition of the ONB Branches during third quarter of 2015 that included $454 million in deposits .
Net interest margin, defined as net interest income divided by average interest-earning assets, was 3.28% for 2016, 3.27% for 2015 and 3.43% for 2014. In 2016, the ratio was modestly higher due to loan growth and the inclusion of First Clover Leaf for a full quarter. The decrease during 2015 was primarily due to the decline in earning asset yields from the higher amount of interest bearing deposits or short-term liquidity from the ONB Branch acquisition and declines in loan yields.
Net interest income increased to $71.2 million in 2016 from $55.8 million in 2015 and $51.5 million in 2014. In 2016, net interest income increased primarily due to growth in average earnings assets including loans and investments primarily due to the acquisition of First Clover Leaf and the ONB branches. The net interest margin was higher due to loan growth and the acquisition of First Clover leaf. In 2015, net interest income increased primarily due to assets added in the acquisition of twelve ONB Branches and the growth in average earning assets. The net interest margin decreased primarily due to the decline in earning asset yield from the higher amount of interest bearing deposits or short-term liquidity from the acquisition and declines in loan and investment yields.
Non-interest income increased to $26.9 million in 2016 compared to $20.5 million in 2015 and $18.4 million in 2014. ATM revenue increased by $1.3 million or 28.4%, and service charge income increased $1.1 million or 19.5% primarily due to increased transactions following the First Clover Leaf acquisition, Mortgage banking income increased $418,000 or 55.4% as refinance activity and new purchase activity has increased due to lower mortgage rates. Additionally, insurance commissions increased $1.3 million or 63.8% compared to last year due to additional revenues from Illiana Insurance Agency.
Non-interest expenses increased $12.3 million, to $61.5 million in 2016 compared to $49.2 million in 2015, and $44.5 million in 2014. The increase during 2016 was primarily due to expenses incurred of $1.3 million to acquire First Clover Leaf, expenses for the operation of the First Clover Leaf branches from acquisition in September to year-end and expense for the operation of the twelve ONB Branches acquired in August of 2015. In addition, salaries & benefits expense increased $6.0 million or 22.8%, and occupancy & equipment expense increased $2.3 million or 24.9%. The increase during 2015 was primarily due to expenses incurred of $1.4 million to acquire the twelve ONB Branches and expenses for the operation of the branches from acquisition in August through year-end.
Following is a summary of the factors that contributed to the changes in net income (in thousands):
Credit quality is an area of importance to the Company. Year-end total nonperforming loans were $18.2 million at December 31, 2016 compared to $4.0 million at December 31, 2015, and $4.5 million at December 31, 2014. The increase in provision expense in 2016 was primarily due to an increase in loan balances and an increase in non-performing loans. Total non-performing loans for First Clover Leaf were $10.8 million and First Mid Bank non-performing loans were $7.4 million at December 31, 2016. The decrease in 2015 and 2014 was the result of loans that paid off or became current during the year and loans transferred to other real estate owned. Other real estate owned balances totaled $2.0 million at December 31, 2016 compared to $478,000 at December 31, 2015, and $263,000 at December 31, 2014. The increase in 2016 was primarily due to properties acquired in the acquisition of First Clover Leaf Bank net of properties sold during 2016. The increase in 2015 was due to more properties being transferred in than sold during the year. The Company’s provision for loan losses was $2.8 million for 2016, compared to $1.3 million for 2015, and $629,000 for 2014. The increase in provision expense was primarily due to an increase in loan balances and an increase in non-performing loans for First Mid Bank. Loans secured by both commercial and residential real estate comprised 67%, 66%, and 70% of the loan portfolio for 2016, 2015, and 2014, respectively.
The Company also held an investment in one trust preferred security with a fair value of $1.7 million and unrealized losses of $1.4 million compared to a fair value of $1.9 million and unrealized losses of $1.2 million at December 31, 2015. During 2016 and 2015 the Company did not record any additional impairment charges for these securities. See Note 4 - “Investment Securities” for additional details regarding these investments.
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 ratio to risk weighted assets ratio at December 31, 2016, 2015 and 2014 was 11.99%, 13.23%, and 14.42%, respectively. The Company’s total capital to risk weighted assets ratio at December 31, 2016, 2015 and 2014 was 12.79%, 14.25% ,and 15.60%, respectively. In 2016, the primary reason for the decrease in these ratios was the First Clover Leaf acquisition which increased risk-weighted assets by approximately $649 million offset by stock issued of approximately $65.9 million, lower preferred dividends due to the conversion of Series C Preferred Stock, and the movement of cash from the Old National branch acquisition into loans and investments that require higher capital allocation. In 2015, the primary reason for the decrease in these ratios was completion of the acquisition of twelve ONB Branches which increased risk-weighted assets by approximately $227 million offset by completion of private placement capital raise completed during the second quarter of 2015 which resulted in an increase in common stockholder's equity of approximately $29.3 million. The increase in these ratios during 2014 was primarily the result of an increase in retained earnings from current year net income and slightly lower preferred dividends due to the conversion of Series B Preferred Stock.
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 “Liquidity” herein for a full listing of its sources and anticipated significant contractual obligations.
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 December 31, 2016, 2015 and 2014 were $485.1 million, $298.3 million, and $242.8 million, respectively. See Note 17 - “Commitments and Contingent Liabilities” herein for further information.
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. 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 uses 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 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 nonimpaired 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 nonimpaired loan is more subjective. Generally, the allowance assigned to nonimpaired loans is determined by applying historical loss rates to existing loans 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.
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 during 2016 as part of the goodwill impairment test and no impairment was deemed necessary.
As a result of the Company’s acquisition activity, goodwill, an intangible asset with an indefinite life, is reflected on the 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:
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Level 1 - quoted prices (unadjusted) for identical assets or liabilities in active markets.
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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.
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Level 3 - inputs that are unobservable and significant to the fair value measurement.
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 11 - “Disclosures of Fair Values of Financial Instruments.”
Results of Operations
Net Interest Income
The largest source of operating 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.
The Company’s average balances, interest income and expense and rates earned or paid for major balance sheet categories are set forth in the following table (dollars in thousands):
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 past two years (in thousands):
Net interest income increased $15.5 million or 27.7% in 2016 compared to an increase of $4.3 million or 8.3% in 2015. In 2016, net interest income increased primarily due to growth in average earnings assets including loans and investments primarily due to the acquisition of First Clover Leaf and the ONB Branches. The net interest margin was higher due to loan growth and the acquisition of First Clover Leaf. In 2015, net interest income increased primarily due to assets added in the acquisition of twelve ONB Branches and the growth in average earning assets. The net interest margin decreased primarily due to the decline in earning asset yield from the higher amount of interest bearing deposits or short-term liquidity from the acquisition and declines in loan and investment yields.
In 2016, average earning assets increased by $467.9 million, or 27.5%, and average interest-bearing liabilities increased by $370.9 million or 27.6%. In 2015, average earning assets increased by $199.9 million or 13.3% and average interest-bearing liabilities increased $143.1 million or 11.9% compared with 2014. Changes in average balances are shown below:
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Average interest-bearing deposits held by the Company decreased $40.2 million or 51.2% in 2016 compared to 2015. In 2015, average interest-bearing deposits held by the Company increased $46.2 million or 142.8% compared to 2014.
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Average federal funds sold increased $7.9 million or 1,602.2% in 2016 compared to 2015. In 2015, average federal funds sold decreased $2,000 or 0.4% compared to 2014.
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Average certificates of deposit investments increased $23.7 million or 462.3% in 2016 compared to 2015. In 2015, average certificates of deposit investments increased $5.1 million or 100.0% compared to 2014.
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Average loans increased by $328.1 million or 29.1% in 2016 compared to 2015. In 2015, average loans increased by $103.9 million or 10.2% compared to 2014.
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Average securities increased by $148.5 million or 30.4% in 2016 compared to 2015. In 2015, average securities increased by $44.7 million or 10.1% compared to 2014.
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Average deposits increased by $333.0 million or 28.0% in 2016 compared to 2015. In 2015, average deposits increased by $117.8 million or 11.0% compared to 2014.
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Average securities sold under agreements to repurchase increased by $16.0 million or 14.1% in 2016 compared to 2015. In 2015, average securities sold under agreements to repurchase increased by $16.3 million or 16.7% compared to 2014.
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Average borrowings and other debt increased by $21.9 million or 49.3% in 2016 compared to 2015. In 2015, average borrowings and other debt increased by $9.1 million or 25.7% compared to 2014.
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The federal funds rate remained at a range of .25% to .625% at December 31, 2016, 2015 and 2014.
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Net interest margin increased to 3.28% compared to 3.27% in 2015 and 3.43% in 2014. Asset yields decreased by 2 basis points in 2016, and interest-bearing liabilities decreased by 1 basis point.
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 where the interest earned on tax-exempt 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 tax equivalent basis adjustments to net interest income for 2016, 2015 and 2014 were $2,428,000, $1,674,000, and $1,435,000, respectively. The net yield on interest-earning assets on a tax equivalent basis was 3.39% in 2016, 3.37% in 2015 and 3.53% in 2014.
Provision for Loan Losses
The provision for loan losses in 2016 was $2,826,000 compared to $1,318,000 in 2015 and $629,000 in 2014. Nonperforming loans increased to $18,241,000 at December 31, 2016 from $4,013,000 at December 31, 2015 and $4,540,000 at December 31, 2014. The increase in provision expense in 2016 was primarily due to an increase in loan balances and an increase in non-performing loans for First Mid Bank. Total non-performing loans for First Clover Leaf were $10.8 million and First Mid Bank non-performing loans were $7.4 million at December 31, 2016. The increase in provision expense in 2015 was the result of an increase in net charge offs and an increase in loan balances. Net charge-offs were $649,000 during 2016, $424,000 during 2015 and $196,000 during 2014. For information on loan loss experience and nonperforming loans, see “Nonperforming Loans and Repossessed Assets” and “Loan Quality and Allowance for Loan Losses” herein.
Other Income
An important source of the Company’s revenue is derived from other income. The following table sets forth the major components of other income for the last three years (in thousands):
Total non-interest income increased to $26.9 million in 2016 compared to $20.5 million in 2015 and $18.4 million in 2014. The primary reasons for the more significant year-to-year changes in other income components are as follows:
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Trust revenues decreased $229,000 or 6.1% in 2016 to $3,517,000 from $3,746,000 in 2015 and $3,571,000 in 2014. The decreases during 2016 and 2015 were primarily due to a decrease in revenue from defined contribution and other retirement accounts and movement of trust assets to the brokerage platform
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+. Trust assets were $831.6 million at December 31, 2016 compared to $794.0 million at December 31, 2015 and $757.3 million at December 31, 2014.
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Revenue from brokerage increased $593,000 or 45.1% to $1,908,000 in 2016 from $1,315,000 in 2015 and $1,039,000 in 2014 primarily due to an increase in the number of brokerage accounts from the ONB Branch acquisition.
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Insurance commissions increased $1,345,000 or 63.8% to $3,452,000 in 2016 from $2,107,000 in 2015 compared to $1,796,000 in 2014. The increase from 2015 to 2016 was primarily due to revenues from the Illiana Insurance Agency acquisition. The increase from 2014 to 2015 was due to an increase in contingency income received from carriers based on claims experience and an increase in commission and fee income received.
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Fees from service charges increased $1,110,000 or 19.5% to $6,791,000 in 2016 from $5,681,000 in 2015 and $5,264,000 in 2014. The increase from 2015 to 2016 was primarily due to additional income from the ONB Branches acquired in the third quarter of 2015 and First Clover Leaf branches acquired in the third quarter of 2016. The increase from 2014 to 2015 was primarily due to the additional income from the ONB Branches acquired in the third quarter of 2015.
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Net securities gains in 2016 were $1,192,000 up $740,000 or 163.7% from $452,000 in 2015 and $715,000 in 2014. The increase in 2016 was due to the sale of securities that resulted in net securities gains. The decline in 2015 was due to market conditions and balance sheet position.
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Mortgage banking income increased $418,000 or 55.4% to $1,172,000 in 2016 from $754,000 in 2015 and $596,000 in 2014. The increase during 2015 and 2016 was due to a increase in the volume of loans originated and sold by First Mid Bank and First Clover Leaf Bank. Loans sold balances are as follows:
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$80 million (representing 566 loans) in 2016
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$57 million (representing 457 loans) in 2015
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$44 million (representing 368 loans) in 2014
First Mid Bank and First Clover Leaf Bank generally releases the servicing rights on loans sold into the secondary market.
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Revenue from ATMs and debit cards increased $1,328,000 or 28.4% to $6,004,000 in 2016 from $4,676,000 in 2015 compared to $3,915,000 in 2014. The increase from 2015 to 2016 was due to an increase in electronic transactions primarily from the ONB Branches acquired in the third quarter of 2015 and incentives received from VISA. The increase from 2014 to 2015 was due to the ONB Branches acquired during the third quarter of 2015 and an increase in electronic transactions and incentives received from VISA.
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Bank owned life insurance increased $671,000 or 100.0%. 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.
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Other income increased $392,000 or 21.6% in 2016 to $2,205,000 from $1,813,000 in 2015 compared to $1,473,000 in 2014. The increase from 2015 to 2016 was primarily due to income from the ONB Branches acquired during the third quarter of 2015. The increase from 2014 to 2015 was due to income from the ONB Branches acquired during the third quarter of 2015 and an increase in merchant card processing fees.
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 last three years (in thousands):
Total non-interest expense increased to $61.5 million in 2016 from $49.2 million in 2015 and $44.5 million in 2014. The primary reasons for the more significant year-to-year changes in other expense components are as follows:
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Salaries and employee benefits, the largest component of other expense, increased $6.0 million or 22.8% to $32.4 million from $26.3 million in 2015, and $24.8 million in 2014. The increase in 2016 was due to the addition of 93 employees in the First Clover Leaf acquisition and merit increases in 2016 for continuing employees. The increase in 2015 was due to the addition of 86 employees with the acquisition of twelve ONB Branches, the addition of 12 employees in the Illiana Insurance Agency acquisition, and merit increases for continuing employees during the first quarter of 2015. There were 598 full-time equivalent employees at December 31, 2016, compared to 513 at December 31, 2015, and 400 at December 31, 2014.
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Occupancy and equipment expense increased $2,275,000 or 24.9% to $11.4 million in 2016 from $9.1 million in 2015, compared to $8.3 million in 2014. The increase in 2016 was primarily due to increases in rent, property taxes, and depreciation expenses related to the acquisition of the ONB Branches during the third quarter of 2015 and First Clover Leaf Bank during the third quarter of 2016. The increase in 2015 was primarily due to increases in rent and depreciation expenses related to the acquisition of twelve ONB Branches.
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Net other real estate owned expense increased $41,000 or 215.8% to $60,000 from $19,000 in 2015, and $23,000 in 2014. The increase in 2016 was primarily due to losses on properties sold during 2016. The decrease in 2015 was primarily due to less losses on properties sold during 2015 compared to properties sold in 2014.
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FDIC insurance expense increased $62,000 or 6.9% to $966,000 from $904,000 in 2015, and $804,000 in 2014. The increase in 2016 was primarily due to an increase in average assets due to the acquisition of First Clover Leaf offset by a decrease in FDIC insurance rates in the third quarter of 2016. The increase in 2015 was primarily due to an increase in average assets due to the acquisition of twelve ONB Branches.
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Amortization of other intangibles expense increased $1,018,000 or 114.3% to $1,909,000 from $891,000 in 2015, compared to $643,000 in 2014. The increase in 2016 was due to the amortization of deposit premiums and insurance company intangibles of the ONB Branches, Illiana Insurance Agency, and FIrst Clover Leaf Bank. The increase in 2015 was due to the acquisition of twelve ONB Branches.
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Other operating expenses increased $1,401,000 or 18.2% to $9,108,000 from $7,707,000 in 2015, compared to $5,925,000 in 2014. The increase in 2016 was primarily due to the additional expenses of the ONB Branches and costs related to the acquisition of First Clover Leaf. The increase in 2015 was primarily due to expenses incurred to acquire of twelve ONB Branches during the third quarter of 2015.
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On a net basis, all other categories of operating expenses increased $1,448,000 or 34.1% to $5,695,000 from $4,247,000 in 2015, compared to $3,994,000 in 2014. The increase in 2016 was primarily due to the donation of a building located in Monticello, Illinois with a book value of $653,000 and increases in marketing and other legal and professional fees including costs related to the acquisition of First Clover Leaf. The increase in 2015 was primarily due to an increase in legal and professional fees, marketing and promotion, and stationary and supplies due to the acquisition of twelve ONB Branches.
Income Taxes
Income tax expense amounted to $11,940,000 in 2016 compared to $9,218,000 in 2015, and $9,254,000 in 2014. Effective tax rates were 35.3% for 2016, 35.8% for 2015, and 37.4% for 2014. The decline in effective tax rate in 2016 was primarily due to an increase in tax-exempt municipal investments and bank owned life insurance. The decline in effective tax rate for 2015 was primarily due to a reduction in the Company's state tax rate, from 9.5% to 7.75% beginning January 1, 2015.
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 for the last three years (dollars in thousands):
At December 31, 2016, the amortized cost of the Company’s investment portfolio increased by $101.1 million from December 31, 2015 primarily due to $104.6 million of securities added in the acquisition of First Clover Leaf, net of declines due to securities that matured or declined and were not replaced. At December 31, 2015, the Company's investment portfolio increased by $170.4 million from December 31, 2014 primarily due to purchases of obligation of U.S. government corporations and agencies securities and mortgaged-backed securities as the company deploys the excess cash received in the acquisition of the ONB Branches. 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. During the third quarter of 2014, management evaluated its available-for-sale portfolio and transferred obligations of U.S. government corporations & agencies securities with a fair value of $53.6 million from available-for-sale to held-to-maturity to reduce price volatility. Management determined it has both the intent and ability to hold these securities to maturity. Transfers of investment securities into the held-to-maturity category from available-for-sale are made at fair value on the date of transfer. There were no gains or losses recognized as a result of this transfer. The related $1.4 million of unrealized holding loss that was included in the transfer is retained in the carrying value of the held-to-maturity securities and in other comprehensive income net of deferred taxes. These amounts are being amortized into net interest income over the remaining life of the related securities as a yield adjustment, resulting in no impact on future net income.
The table below presents the credit ratings as of December 31, 2016 for certain investment securities (in thousands):
(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.
The trust preferred securities consist of one trust preferred pooled security issued by FTN Financial Securities Corp. (“FTN”). The following table contains information regarding this security as of December 31, 2016:
(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 Obligations (“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 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.
During the year ended December 31, 2016, the Company received all of the contractual interest payments for its trust preferred security. During 2014 and 2013, the Company was receiving “payment in kind” (“PIK”) in lieu of cash interest on its trust preferred security investment as and to the extent described below. The Company’s use of “PIK” does not indicate that additional securities have been issued in satisfaction of any outstanding obligation; rather, it indicates that a coverage test of a class or tranche directly senior to the class in question failed and interest received on the PIK note was being capitalized, which means the principal balance was being increased. Once the coverage test is met, capitalized interest is paid in cash and current cash interest payments resume.
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 or semi-annual 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 these securities, 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 branch or class which are subordinate to the more senior tranches of the issue. The Company is receiving PIK for this security due to failure of the required senior tranche coverage tests described. This security if projected to remain in PIK status for approximately two more quarters.
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 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 its 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 securities. The Company intends to keep its remaining trust preferred security on non-accrual status until the scheduled interest payments resume on a regular basis and the full payment of the securities is ensured. The PIK status of these securities, among other factors, indicates potential other-than-temporary impairment (“OTTI”) and accordingly, the Company 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 the 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 4 - 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 its trust preferred securities investments accurately reflects the position of these securities at December 31, 2016 and 2015.
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.
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:
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how much fair value has declined below amortized cost;
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how long the decline in fair value has existed;
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the financial condition of the issuers;
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contractual or estimated cash flows of the security;
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underlying supporting collateral;
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past events, current conditions and forecasts;
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significant rating agency changes on the issuer; and
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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 4 -- Investment Securities in the notes to the financial statements for a discussion of the Company’s evaluation and, when applicable, 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, for the last five years (in thousands):
Loan balances increased by $544.1 million or 42.5% from December 31, 2015 to December 31, 2016 primarily due to $438.9 million of loans at fair value added in the acquisition of First Clover Leaf and increases in commercial operating and commercial real estate loans. Loan balances increased by $219.5 million or 20.7% from December 31, 2014 to December 31, 2015 primarily due to loans added in the acquisition of twelve ONB Branches and increases in originations of loans secured by real estate and commercial and industrial loans. The balances of loans sold into the secondary market were $79.5 million in 2016 compared to $57.1 million in 2015. The balance of real estate loans held for sale, included in the balances shown above, amounted to $1,175,000 and $968,000 as of December 31, 2016 and 2015, 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 December 31, 2016 and 2015 (dollars in thousands):
Loans are geographically dispersed among these regions located in central and southwestern Illinois. While these regions have experienced some economic stress during 2016 and 2015, the Company does not consider these locations high risk areas since these regions have not experienced the significant volatility 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 December 31, 2016 and 2015, the Company did have industry loan concentrations in excess of 25% of total risk-based capital in the following industries (dollars in thousands):
Balances of automobile dealers were not considered a concentration during 2015, but is shown here for comparative purposes. The Company had no further industry loan concentrations in excess of 25% of total risk-based capital. Changes in principal balances from 2015 to 2016 are primarily due to the addition of FIrst Clover Leaf loans. The Highland region includes First Clover Leaf Bank acquired loans which accounts for the significant increase from 2015.
The following table presents the balance of loans outstanding as of December 31, 2016, by contractual maturities (in thousands):
(1) Based upon remaining contractual maturity.
(2) Includes demand loans, past due loans and overdrafts.
As of December 31, 2016, loans with maturities over one year consisted of approximately $1.2 billion in fixed rate loans and approximately $184 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.
The following table presents information concerning the aggregate amount of nonperforming loans and repossessed assets (in thousands):
The $8,641,000 increase in nonaccrual loans during 2016 resulted from the net of $7.1 million of loans put on nonaccrual status, offset by $344,000 of loans transferred to other real estate owned, $248,000 of loans charged off and $1.8 million of loans becoming current or paid-off. The following table summarizes the composition of nonaccrual loans (in thousands):
Interest income that would have been reported if nonaccrual and restructured loans had been performing totaled $133,000, $48,000 and $71,000 for the years ended December 31, 2016, 2015 and 2014, respectively.
The $1,507,000 increase in repossessed assets during 2016 resulted from the net of $3,192,000 of additional assets repossessed, $931,000 of repossessed assets sold and $754,000 of further write-downs of repossessed assets to current market value.
The following table summarizes the composition of repossessed assets (in thousands):
Repossessed assets sold during 2016 resulted in net losses of $7,100, of which $13,300 of net losses was related to real estate asset sales, $14,700 was related to a deferred gain recognized, and $8,500 of net losses was related to other repossessed assets sales. Repossessed assets sold during 2015 resulted in net losses of $21,000, of which $14,000 were related to real estate asset sales and $7,000 was related to other repossessed asset sales.
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. Once identified, the magnitude of exposure to individual borrowers is quantified in the form of specific allocations of the allowance for loan losses. Management considers collateral values and guarantees in the determination of such specific allocations. Additional factors considered by management in evaluating the overall adequacy of the allowance include historical net loan losses, 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 for more recent economic trends. Management utilizes a five-year loss history as one of several components in assessing the probability of inherent future losses. Given the continued weakened economic conditions, management also increased its allocation to various loan categories for economic factors during 2015 and 2014. 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, drought conditions 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 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 central and southern 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 December 31, 2016, the Company’s loan portfolio included $212.8 million of loans to borrowers whose businesses are directly related to agriculture. Of this amount, $171.3 million was concentrated in other grain farming. Total loans to borrowers whose businesses are directly related to agriculture increased $14.4 million from $198.4 million at December 31, 2015 while loans concentrated in other grain farming increased $9.8 million from $161.5 million at December 31, 2015.
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 $103.8 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 $134.0 million of loans to lessors of non-residential buildings and $139.6 million of loans to lessors of residential buildings and dwellings and $54.3 million of loans to automobile dealers.
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. On a quarterly basis, the Board of Directors and management review the status of problem loans and determine a best estimate of the allowance. 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 for the past five years and of changes in the allowance for these periods is summarized as follows (dollars in thousands):
The ratio of the allowance for loan losses to nonperforming loans is 92.0% as of December 31, 2016 compared to 363.0% as of December 31, 2015. The decrease in this ratio is primarily due to the increase in nonperforming loans during 2016 and the addition of loans from First Clover Leaf that were recorded under fair value accounting which does not allow the carryover of the allowance for loan losses. At December 31, 2016, the balance of nonperforming loans for First Clover Leaf was $10.8 million and First Mid Bank was $7.4 million. Management believes that the overall estimate of the allowance for loan losses appropriately accounts for probable losses attributable to current exposures.
During 2016, the Company had net charge-offs of $649,000 compared to $424,000 in 2015. During 2016, the Company's significant charge-offs included a significant charge off of one residential real estate loan to a single borrower of $83,000, and charge offs of seven commercial real estate loans to a single borrower of $67,000, charge offs of four commercial operating loans to a single borrower of $437,000 and charge offs of two consumer loans to a single borrower of $108,000. During 2015, the Company's significant charge-offs included $49,000 on one commercial real estate loan, $149,000 on one commercial loan, and $251,000 on one consumer loan.
At December 31, 2016, the allowance for loan losses amounted to $16.8 million or 0.92% of total loans. At December 31, 2015, the allowance for loan losses amounted to $14.6 million or 1.14% of total loans. The decline in the ratio from December 31, 2015 to December 31, 2016 is due to the increase in loan balances that were recorded at fair value from the First Clover Leaf acquisition.
The allowance is allocated to the individual loan categories by a specific allocation for all classified loans plus a percentage of loans not classified based on historical losses and other factors. The allowance for loan losses, in management's judgment, is allocated as follows to cover probable loan losses (dollars in thousands):
The unallocated allowance represents an estimate of the probable, inherent, but yet undetected, losses in the loan portfolio. It is based on factors that cannot necessarily be associated with a specific credit or loan category and represents management's estimate to ensure that the overall allowance for loan losses appropriately reflects a margin for the imprecision necessarily inherent in the estimates of expected credit losses. Fluctuations in the unallocated portion of the allowance result from qualitative factors such as economic conditions, expansionary activities and portfolio composition that influence the level of risk in the portfolio but are not specifically quantified.
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 the years ended December 31, 2016, 2015 and 2014 (in thousands):
The following table sets forth the high and low month-end balances for the years ended December 31, 2016, 2015 and 2014 (in thousands):
In 2016, the average balance of deposits increased by $438.2 million from 2015. The increase was primarily the result of deposit balances acquired in the acquisition of First Clover Leaf during the third quarter of 2016. Average non-interest bearing deposits increased $105.2 million, other interest-bearing deposits increased by $212.6 million, savings accounts increased by $42.2 million, and time deposits increased $78.3 million. In 2015, the average balance of deposits increased by $161.4 million from 2014. The increase was primarily attributable the acquisition of ONB Branches during the third quarter of 2015. Average non-interest bearing deposits increased by $43.7 million, savings accounts increased by $17.4 million, average balances of other interest-bearing deposits increased $110 million and time deposits decreased by $9.9 million.
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 (in thousands):
The balance of time deposits of $100,000 or more increased $62.4 million from December 31, 2015 to December 31, 2016. The balance of time deposits of $100,000 or more decreased $9.6 million from December 31, 2014 to December 31, 2015. The increase in 2016 was primarily due to the acquisition of First Clover Leaf in the third quarter of 2016. The decrease in 2015 was a result of time deposits that were not renewed and brokered CDs that were not replaced.
In 2016 the Company maintained account relationships with various public entities throughout its market areas. Public entities had total balances of $146.1 million in various checking accounts and time deposits as of December 31, 2016. These balances are subject to change depending upon the cash flow needs of the public entity.
Repurchase Agreements and Other Borrowings
Securities sold under agreements to repurchase are short-term obligations of First Mid Bank and First Clover Leaf Bank. The Banks collateralizes these obligations with certain government securities that are direct obligations of the United States or one of its agencies. The Banks offer these retail repurchase agreements 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 December 31, 2016, 2015 and 2014 is presented below (in thousands):
Securities sold under agreements to repurchase increased $56.9 million during 2016 primarily due to agreements added with the acquisition of First Clover Leaf Bank. FHLB advances represent borrowings by the Banks to economically fund loan demand.
At December 31, 2016 the advances totaling $40.0 million were as follows:
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$5 million advance with a 1-year maturity, at 0.82%, due June 21, 2017
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$5 million advance with a 3-year maturity, at 1.30% due May 7, 2018
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$5 million advance with a 2-year maturity, at 0.99% due June 21, 2018
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$10 million advance with a 3-year maturity, at 1.42%, due November 5, 2018
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$5 million advance with a 6-year maturity, at 2.30%, due August 24, 2020
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$5 million advance with a 7-year maturity, at 2.55%, due October 1, 2021
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$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 $4 million as of December 31, 2016. This loan was renewed on April 15, 2016 for one year as a revolving credit agreement with a maximum available balance of $15 million and was amended on September 7, 2016 to a maximum available balance of $10 million. The interest rate is floating at 2.25% over the federal funds rate (2.9% at December 31, 2016). The loan is secured by all of the stock of First Mid Bank and First Clover Leaf Bank. The Company and
its subsidiary bank were in compliance with the then existing covenants at December 31, 2016 and 2015.
Also on September 7, 2016, as part of the amendment to the Northern Trust Company revolving credit agreement, the Company entered into a $15 million fixed-rate note with a maturity date of September 7, 2020. The interest rate is floating at 2.25% over the federal funds rate (2.9% at December 31, 2016) and interest and principal payments are due quarterly. As of December 31, 2016, the balance due was $14.1 million. The loan is secured by all of the stock of First Mid Bank and First Clover Leaf Bank. The Company used the proceeds of this note to fund the cash portion of the acquisition price of First Clover Leaf Financial.
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 (3.73% and 3.17% at December 31, 2016 and 2015, respectively), 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) after June 15, 2011 (2.56% and 2.11% at December 31, 2016 and 2015, 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 (2.81% at December 31, 2016) 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. 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 a final rule to permit banking entities to retain interests in certain collateralized debt obligations backed primarily by trust preferred securities. Under the 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, First Mid Bank, or First Clover Leaf 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.
The following table sets forth the Company’s interest rate repricing GAP for selected maturity periods at December 31, 2016 (dollars in thousands):
The static GAP analysis shows that at December 31, 2016, 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 has currently experienced 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.
Capital Resources
At December 31, 2016, the Company’s stockholders' equity had increased $75.7 million, or 36.9%, to $280,673,000 from $205,009,000 as of December 31, 2015. During 2016, net income contributed $21,840,000 to equity before the payment of dividends to stockholders and stock issued in the acquisition of First Clover Leaf added $65.9 million. The change in market value of available-for-sale investment securities decreased stockholders' equity by $6,484,000, net of tax. There were no purchases of treasury stock during 2016.
During 2011 and 2012, the Company sold to certain accredited investors including directors, executive officers, and certain major customers and holders of the Company’s common stock, $27,500,000, in the aggregate, of a newly authorized series of its preferred stock designated as Series C Preferred Stock. During 2016, the Company converted the Series C Preferred Stock to approximately 1,355,319 shares of common stock in accordance with the terms of the offering.
Stock Plans
Deferred Compensation Plan. The Company follows the provisions of the Emerging Issues Task Force Issue No. 97-14, “Accounting for Deferred Compensation Arrangements Where Amounts Earned Are Held in a Rabbi Trust and Invested” (“EITF 97-14”), which was codified into ASC 710-10, for purposes of the First Mid-Illinois Bancshares, Inc. Deferred Compensation Plan (“DCP”). At December 31, 2016, the Company classified the cost basis of its common stock issued and held in trust in connection with the DCP of approximately $3,590,000 as treasury stock. The Company also classified the cost basis of its related deferred compensation obligation of approximately $3,590,000 as an equity instrument (deferred compensation).
The DCP was effective as of June 1984. The purpose of the DCP is to enable directors, advisory directors, and key employees the opportunity to defer a portion of the fees and cash compensation paid by the Company as a means of maximizing the effectiveness and flexibility of compensation arrangements. The Company invests all participants’ deferrals in shares of common stock. Dividends paid on the shares are credited to participants’ DCP accounts and invested in additional shares. The Company issued, pursuant to DCP:
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4,683 common shares during 2016
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6,153 common shares during 2015, and
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13,724 common shares during 2014
First Retirement and Savings Plan. The First Retirement and Savings Plan (“401(k) plan”) was effective beginning in 1985. Employees are eligible to participate in the 401(k) plan after three months of service with the Company. The Company offers common stock as an investment option for participants of the 401(k) plan. The Company issued, pursuant to the 401(k) plan:
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558 common shares during 2016
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11,885 common shares during 2015, and
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8,971 common shares during 2014
Dividend Reinvestment Plan. The Dividend Reinvestment Plan (“DRIP”) was effective as of October 1994. The purpose of the DRIP is to provide participating stockholders with a simple and convenient method of investing cash dividends paid by the Company on its common and preferred shares into newly issued common shares of the Company. All holders of record of the Company’s common or preferred stock are eligible to voluntarily participate in the DRIP. The DRIP is administered by Computershare Investor Services, LLC and offers a way to increase one’s investment in the Company. Of the $6,511,000 in common stock dividends paid during 2016, $1,234,000 or 18.9% was reinvested into shares of common stock of the Company through the DRIP. Of the $1,375,000 in preferred stock dividends paid during 2016, $89,000 or 6.5% was reinvested into shares of common stock through the DRIP. Events that resulted in common shares being reinvested in the DRIP:
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During 2016, 46,894 common shares were issued from common stock dividends and 3,552 common shares were issued from preferred stock dividends.
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During 2015, 50,003 common shares were issued from common stock dividends and 9,714 common shares were issued from preferred stock dividends.
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During 2014, 43,969 common shares were issued from common stock dividends and 17,339 common shares were issued from preferred stock dividends.
Stock Incentive Plan. At the Annual Meeting of Stockholders held May 23, 2007, the stockholders approved the First Mid-Illinois Bancshares, Inc. 2007 Stock Incentive Plan (“SI Plan”). The SI Plan was implemented to succeed the Company’s 1997 Stock Incentive Plan, which had a ten-year term that expired October 21, 2007. 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 herein in the SI Plan.
On September 27, 2011, the Board of Directors passed a resolution authorizing and approving the Executive Long-Term Incentive Plan (“LTIP”). The LTIP was implemented to provide methodology for granting Stock Awards and Stock Unit Awards under the SI Plan to select senior executives of the Company or any subsidiary.
A maximum of 300,000 shares of common stock may be issued under the SI Plan. As of December 31, 2016, the Company had awarded 59,500 shares as stock options under the SI Plan. There were no shares awarded as stock options during 2016 or 2015. During 2016 and 2015, the Company awarded 13,912 and 18,002 shares as stock unit awards, respectively. During 2014 the Company awarded 19,377 shares as 50% Stock Awards and 50% Stock Unit Awards under the SI Plan. This SI Plan is more fully described in Note 13 - 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:
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On August 5, 1998, repurchases of up to 3%, or $2 million, of the Company’s common stock.
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In March 2000, repurchases up to an additional 5%, or $4.2 million of the Company’s common stock.
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In September 2001, repurchases of $3 million of additional shares of the Company’s common stock.
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In August 2002, repurchases of $5 million of additional shares of the Company’s common stock.
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In September 2003, repurchases of $10 million of additional shares of the Company’s common stock.
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On April 27, 2004, repurchases of $5 million of additional shares of the Company’s common stock.
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On August 23, 2005, repurchases of $5 million of additional shares of the Company’s common stock.
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On August 22, 2006, repurchases of $5 million of additional shares of the Company’s common stock.
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On February 27, 2007, repurchases of $5 million of additional shares of the Company’s common stock.
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On November 13, 2007, repurchases of $5 million of additional shares of the Company’s common stock.
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On December 16, 2008, repurchases of $2.5 million of additional shares of the Company’s common stock.
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On May 26, 2009, repurchases of $5 million of additional shares of the Company’s common stock.
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On February 22, 2011, repurchases of $5 million of additional shares of the Company’s common stock.
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On November 13, 2012, repurchases of $5 million of additional shares of the Company’s common stock.
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On November 19, 2013, repurchases of $5 million additional shares of the Company's common stock.
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On October 24, 2014, repurchases of $5 million additional shares of the Company's common stock.
During 2016, the Company repurchased no shares of common stock. During 2015, the Company repurchased 53,246 (0.6% of common shares) at a total price of $1,066,000. As of December 31, 2016, approximately $7.2 million remains available for purchase under the repurchase programs. Treasury stock is further affected by activity in the DCP.
Capital Ratios
Minimum regulatory requirements are 8% for the Total Risk-based capital ratio, 6% for the Tier 1 Risk-based capital ratio, 4.5% for the Common Equity Tier 1 capital ratio, and 4% for the Tier 1 Leverage ratio. The Company, First Mid Bank, and FIrst Clover Leaf Bank have capital ratios above the minimum regulatory capital requirements and, as of December 31, 2016, the Company, First Mid Bank, and First Clover Leaf Bank had capital ratios above the levels required for categorization as well-capitalized under the capital adequacy guidelines established by the bank regulatory agencies. A tabulation of the Company, First Mid Bank, and First Clover Leaf Bank’s capital ratios as of December 31, 2016 follows:
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, 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 these sources include:
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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 December 31, 2016, First Mid Bank met these regulatory requirements.
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First Mid Bank and First Clover Leaf 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 December 31, 2016, the excess collateral at the FHLB would support approximately $103.1 million of additional advances for First Mid Bank and $142.4 million of additional advances for First Clover Leaf Bank.
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First Mid Bank and First Clover Leaf Bank are members of the Federal Reserve System and can borrow funds provided that sufficient collateral is pledged.
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In addition, as of December 31, 2016, the Company had a revolving credit agreement in the amount of $10 million with The Northern Trust Company with an outstanding balance of $4 million and $6 million in available funds. This loan was renewed on April 17, 2016 for one year as a revolving credit agreement and was amended on September 7, 2016 to a maximum available balance of $10 million. 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 and First Clover Leaf Bank, including requirements for operating and capital ratios. The Company and its subsidiary banks were in compliance with the existing covenants at December 31, 2016 and 2015.
Management continues to monitor its expected liquidity requirements carefully, focusing primarily on cash flows from:
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lending activities, including loan commitments, letters of credit and mortgage prepayment assumptions;
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deposit activities, including seasonal demand of private and public funds;
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investing activities, including prepayments of mortgage-backed securities and call provisions on U.S. Treasury and government agency securities; and
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operating activities, including scheduled debt repayments and dividends to stockholders.
The following table summarizes significant contractual obligations and other commitments at December 31, 2016 (in thousands):
For the year ended December 31, 2016, net cash of $27.4 million was provided from operating activities, $78.1 million was used in investing activities, and $110.8 million was provided from financing activities. In total cash and cash equivalents increased by $60.1 million from year-end 2015.
For the year ended December 31, 2015, net cash of $22.0 million was provided from operating activities, $10.4 million was provided from investing activities, and $31.7 million was provided from financing activities. In total cash and cash equivalents increased by $64.1 million from year-end 2014.
For the year ended December 31, 2014, net cash of $17.8 million was provided from operating activities, $10.0 million was used in investing activities, and $21.1 million was used in financing activities. In total cash and cash equivalents increased by $8.4 million from year-end 2013.
For the years ended December 31, 2016 and 2015, the Company also had $10 million of floating rate trust preferred securities outstanding through each of Trust I and Trust II, and in September 2016, the Company acquired $4 million of floating rate trust preferred securities from First Clover Leaf under Clover Leaf Statutory Trust I. See Note 9 - “Borrowings” for a more detailed description.
Effects of Inflation
Unlike industrial companies, virtually all of the assets and liabilities of the Company are monetary in nature. As a result, interest rates have a more significant impact on the Company’s performance than the effects of general levels of inflation. Interest rates do not necessarily move in the same direction or experience the same magnitude of changes as goods and services, since such prices are affected by inflation. In the current economic environment, liquidity and interest rate adjustments are features of the Company’s assets and liabilities that are important to the maintenance of acceptable performance levels. The Company attempts to maintain a balance between monetary assets and monetary liabilities, over time, to offset these potential effects.
Adoption of New Accounting Guidance
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 financial statements. The current accounting policies and procedures 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 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 is is expecting to begin developing policies and procedures during the next two years to ensure it is fully compliant with the provisions of ASU 2016-13 at the adoption date.
Accounting Standards Update 2016-09, Compensation - Stock Compensation (Topic 718): Improvements to Employee Share-Based Payment Accounting (“ASU 2016-09”). In March 2016, FASB issued ASU 2016-09. The objective of the simplification initiative is to identify, evaluate, and improve areas of US GAAP for which cost and complexity can be reduced while maintaining or improving the usefulness of the information provided to users of financial statements. The areas for simplification involve several aspects of the accounting for share-based payment transactions, including the income tax consequences, classification of awards as either equity or liabilities, and classification on the statement of cash flows. Amendments related to the timing of when excess tax benefits are recognized, minimum statutory withholding requirements, forfeitures, and intrinsic value should be applied using a modified retrospective transition method by means of a cumulative-effect adjustment to equity as of the beginning of the period in which the guidance is adopted. The new guidance will be effective for public companies for reporting periods beginning after December 15, 2016. Management is currently implementing the new guidance and does not expect it to have a significant impact on the Company’s 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, 2018. Early adoption is permitted but only for interim and annual reporting periods beginning after December 15, 2016. Several subsequent amendments have been issued that provide clarifying guidance and are effective with the adoption of the original update. Management is in the early stages of evaluating the impact ASU 2016-08 will have on the Company’s financial statements and currently does not know or cannot reasonably quantify the impact of adoption of this update due to the complexity and extensive changes to be implemented.The amendments potentially could impact the accounting procedures and processes over the recognition of the majority of the Company's revenue sources, including, but not limited to interest income, non-interest income, and other revenue sources.
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 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 is currently evaluating this guidance and will subsequently implement new policies and procedures to address these changes. Management is also currently evaluating the impact ASU 2016-02 will have on the Company's 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 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, OtherAssets 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 for the effective dates.
ITEM 7A.
ITEM 7A.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company’s market risk arises primarily from interest rate risk inherent in its lending, investing and deposit taking activities, which are restricted to First Mid Bank and First Clover Leaf Bank (the "Banks"). The Company does not currently use derivatives to manage market or interest rate risks. For a discussion of how management of the Company addresses and evaluates interest rate risk see also “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations - Interest Rate Sensitivity.”
Based on the financial analysis performed as of December 31, 2016, which takes into account how the specific interest rate scenario would be expected to impact each interest-earning asset and each interest-bearing liability, the Company estimates that changes in the prime interest rate would impact the Banks' performance, on a consolidated basis, as follows:
The following table shows the same analysis for First Mid Bank performed as of December 31, 2015:
The Company's Board of Directors has adopted an interest rate risk policy that establishes maximum decreases in the percentage change in net interest income of 5% in a 100 basis point rate shift and 10% in a 200 basis point rate shift. No assurance can be given that the actual net interest income would increase or decrease by such amounts in response to a 100 or 200 basis point increase or decrease in the prime rate because it is also affected by many other factors. The results above are based on one-time “shock” moves and ramped rate increases and do not take into account any management response or mitigating action.
Interest rate sensitivity analysis is also used to measure the Company’s interest risk by computing estimated changes in the Economic Value of Equity (“EVE”) of the Banks under various interest rate shocks. EVE is determined by calculating the net present value of each asset and liability category by rate shock. The net differential between assets and liabilities is the EVE. EVE is an expression of the long-term interest rate risk in the balance sheet as a whole.
The following table presents the Banks' projected change in EVE, on a consolidated basis, for the various rate shock levels at December 31, 2016 and for First Mid Bank at 2015 (in thousands). All market risk sensitive instruments presented in the tables are held-to-maturity or available-for-sale. The Banks have no trading securities.
As indicated above, at December 31, 2016, in the event of a sudden and sustained increase in prevailing market interest rates, the Banks' EVE would be expected to decrease if rates increased 100 or 200 basis points. In the event of a sudden and sustained decrease in prevailing market interest rates, the Banks' EVE would be expected to decrease. At December 31, 2016, the Banks' estimated changes in EVE were within the Company’s policy guidelines that normally allow for a change in capital of +/-10% from the base case scenario under a 100 basis point shock and +/- 20% from the base case scenario under a 200 basis point shock. At December 31, 2016, the change in EVE slightly exceeded policy guidelines for a decrease in interest rates of 200 basis points. The general level of interest rates are at historically low levels and the bank is monitoring its position and the likelihood of further rate decreases.
Computation of prospective effects of hypothetical interest rate changes are based on numerous assumptions, including relative levels of market interest rates, loan prepayments and declines in deposit balances, and should not be relied upon as indicative of actual results. Further, the computations do not contemplate any actions the Company may undertake in response to changes in interest rates.
Certain shortcomings are inherent in the method of analysis presented in the computation of EVE. Actual values may differ from those projections set forth in the table, should market conditions vary from assumptions used in the preparation of the table. Certain assets, such as adjustable-rate loans, have features that restrict changes in interest rates on a short-term basis and over the life of the asset. In addition, the proportion of adjustable-rate loans in the Banks' portfolio change in future periods as market rates change. Further, in the event of a change in interest rates, prepayment and early withdrawal levels would likely deviate significantly from those assumed in the table. Finally, the ability of many borrowers to repay their adjustable-rate debt may decrease in the event of an interest rate increase.
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
See accompanying notes to consolidated financial statements.
See accompanying notes to consolidated financial statements.
See accompanying notes to consolidated financial statements.
See accompanying notes to consolidated financial statements.
See accompanying notes to consolidated financial statements.
See accompanying notes to consolidated financial statements.
See accompanying notes to consolidated financial statements.
First Mid-Illinois Bancshares, Inc.
Notes to Condensed Consolidated Financial Statements
Note 1 -- Summary of Significant Accounting Policies
Basis of Accounting and Consolidation
The accompanying consolidated financial statements include the accounts of First Mid-Illinois Bancshares, Inc. (“Company”) and its wholly-owned subsidiaries: Mid-Illinois Data Services, Inc. (“MIDS”), First Mid-Illinois Bank & Trust, N.A. (“First Mid Bank”), First Clover Leaf Bank, N.A. ("First Clover Leaf Bank"), 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. Certain amounts in the prior year’s consolidated financial statements have been reclassified to conform to the 2016 presentation and there was no impact on net income or stockholders’ equity from these reclassifications. The Company operates as a single segment entity for financial reporting purposes. The accounting and reporting policies of the Company conform to accounting principles generally accepted in the United States of America. Following is a description of the more significant of these policies.
Use of Estimates
The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires the Company to make estimates and assumptions that affect the amounts reported in the consolidated financial statements and accompanying notes. The Company uses estimates and employs the judgments of management in determining the amount of its allowance for loan losses and income tax accruals and deferrals, in its fair value measurements of investment securities, and in the evaluation of impairment of loans, goodwill, investment securities, and fixed assets. As with any estimate, actual results could differ from these estimates. Material estimates that are particularly susceptible to significant change relate to the determination of the allowance for loan losses. In connection with the determination of the allowance for loan losses, management obtains independent appraisals for significant properties.
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.
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 11 - “Disclosures of Fair Values of Financial Instruments.”
Cash and Cash Equivalents
For purposes of reporting cash flows, cash equivalents include non-interest bearing and interest bearing cash and due from banks and federal funds sold. Generally, federal funds are sold for one-day periods.
Certificates of Deposit Investments
Certificates of deposit investments have original maturities of six months to four years and are carried at cost.
Investment 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.
Loans
Loans are stated at the principal amount outstanding net of unearned discounts, unearned income and the 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 approximate the effective interest rate method. Interest on substantially all loans is credited to income based on the principal amount outstanding.
The Company’s policy is to discontinue the accrual of interest income on any loan that becomes ninety days past due as to principal or interest or earlier when, in the opinion of management there is reasonable doubt as to the timely collection of principal or interest. 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 collectability of interest or principal.
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.
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 is 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 uses 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 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 nonimpaired 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 nonimpaired loan is more subjective. Generally, the allowance assigned to nonimpaired loans is determined by applying historical loss rates to existing loans 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.
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.
Premises and Equipment
Premises and equipment are stated at cost less accumulated depreciation and amortization. Depreciation and amortization is charged to expense and determined principally by the straight-line method over the estimated useful lives of the assets. The estimated useful lives for each major depreciable classification of premises and equipment are as follows:
Buildings and improvements 20 years to 40 years
Leasehold improvements 5 years to 15 years
Furniture and equipment 3 years to 7 years
Goodwill and Intangible Assets
The Company has goodwill from business combinations, identifiable intangible assets assigned to core deposit relationships and customer lists acquired, and intangible assets arising from the rights to service mortgage loans for others.
Identifiable intangible assets generally arise from branches acquired that the Company accounted for as purchases. Such assets consist of the excess of the purchase price over the fair value of net assets acquired, with specific amounts assigned to core deposit relationships and customer lists primarily related to insurance agency. Intangible assets are amortized by the straight-line method over various periods up to fifteen years. Management reviews intangible assets for possible impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable.
In accordance with the provisions of SFAS No. 142, “Goodwill and Other Intangible Assets,” codified into ASC 350, the Company performed testing of goodwill for impairment as of September 30, 2016 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.
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.
Bank Owned Life Insurance
First Mid Bank has purchased life insurance policies on certain senior management. The Company acquired additional life insurance policies in the acquisition of First Clover Leaf which are held by First Clover Leaf Bank. 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.
Federal Home Loan Bank Stock
Federal Home Loan Bank stock is a required investment for institutions that are members of the Federal Home Loan Bank system. The required investment in the common stock is based on a predetermined formula.
Income Taxes
The Company and its subsidiaries file consolidated federal and state income tax returns with each organization computing its taxes on a separate company basis. Amounts provided for income tax expense are based on income reported for financial statement purposes rather than amounts currently payable under tax laws.
Deferred tax assets and liabilities are recognized for future tax consequences attributable to the temporary differences existing between the financial statement carrying amounts of assets and liabilities and their respective tax basis, as well as operating loss and tax credit carry forwards. To the extent that current available evidence about the future raises doubt about the realization of a deferred tax asset, a valuation allowance is established. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized as an increase or decrease in income tax expense in the period in which such change is enacted.
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.
Trust Department Assets
Assets held in fiduciary or agency capacities are not included in the consolidated balance sheets since such items are not assets of the Company or its subsidiaries. Fees from trust activities are recorded on a cash basis over the period in which the service is provided. Fees are a function of the market value of assets managed and administered, the volume of transactions, and fees for other services rendered, as set forth in the underlying client agreement with the Trust & Wealth Management Division of First Mid Bank. This revenue recognition involves the use of estimates and assumptions, including components that are calculated based on asset valuations and transaction volumes. Any out of pocket expenses or services not typically covered by the fee schedule for trust activities are charged directly to the trust account on a gross basis as trust revenue is incurred.
At December 31, 2016, the Company managed or administered 1,231 accounts with assets totaling approximately $831.6 million. At December 31, 2015, the Company managed or administered 1,346 accounts with assets totaling approximately $794.0 million.
Preferred Stock
On May 16, 2016 the Company completed the mandatory conversion of the Series C Preferred Stock. The conversion ratio for each share of the Series C Preferred Stock was computed by dividing $5,000 (the issuance price per share of the Series C Preferred Stock) by $20.29 (the conversion price). The conversion ratio, therefore, was 246.427 shares of the Company's common stock for each share of Series C Preferred Stock. This resulted in the issuance of approximately 1,355,319 shares of common stock in the aggregate. As a result of the conversion, dividends ceased to accrue on the Series C Preferred Stock and certificates for shares of Series C Preferred Stock only represent the right to receive the appropriate number of shares of common stock, together with net accrued but unpaid dividends on the Series C Preferred Stock, and cash in lieu of fractional share interests.
Treasury Stock
Treasury stock is stated at cost. Cost is determined by the first-in, first-out method.
Stock Incentive Awards
At the Annual Meeting of Stockholders held May 23, 2007, the stockholders approved the First Mid-Illinois Bancshares, Inc. 2007 Stock Incentive Plan (“SI Plan”). The SI Plan was implemented to succeed the Company’s 1997 Stock Incentive Plan, which had a ten-year term that expired October 21, 2007. 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. On September 27, 2011, the Board of Directors passed a resolution relating to the SI Plan whereby they authorized and approved the Executive Long-Term Incentive Plan (“LTIP”). The LTIP was implemented to provide methodology for granting Stock Awards and Stock Unit Awards to select senior executives of the Company or any Subsidiary.
A maximum of 300,000 shares of common stock may be issued under the SI Plan. Prior to December 31, 2008, the Company had awarded 59,500 shares as stock options under the SI plan. There have been no stock options awarded since 2008. The Company awarded 13,912 and 18,002 shares during 2016 and 2015, respectively as stock unit awards and 19,377 shares during 2014 as 50% Stock Awards and 50% Stock Unit Awards under the SI plan.
Accumulated Other Comprehensive Income (Loss)
The components of accumulated other comprehensive income (loss) included in stockholders’ equity as of December 31, 2016 and 2015 are as follows (in thousands):
Amounts reclassified from accumulated other comprehensive income and the affected line items in the statements of income during the years ended December 31, 2016, 2015 and 2014 , were as follows (in thousands):
See “Note 4 - Investment Securities” for more detailed information regarding unrealized losses on available-for-sale securities.
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 and restricted stock awarded, unless anti-dilutive. The components of basic and diluted net income per common share available to common stockholders for the years ended December 31, 2016, 2015 and 2014 were as follows:
The following shares were not considered in computing diluted earnings per share for the years ended December 31, 2016, 2015 and 2014 because they were anti-dilutive:
Note 3 -- Cash and Due from Banks
Aggregate cash and due from bank balances of $16,643,000, $8,175,000 and $3,903,000 were maintained in satisfaction of statutory reserve requirements of the Federal Reserve Bank at December 31, 2016, 2015 and 2014, respectively. At December 31, 2016, the Company’s cash accounts did not exceed the federally insured limits.
Note 4 -- 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 December 31, 2016 and December 31, 2015 were as follows (in thousands):
During the third quarter of 2014, management evaluated its available-for-sale portfolio and transferred obligations of U.S. government corporations & agencies securities with a fair value of $53.6 million from available-for-sale to held-to-maturity to reduce price volatility. Management determined it had both the intent and ability to hold these securities to maturity. Transfers of investment securities into the held-to-maturity category from available-for-sale are made at fair value on the date of transfer. There were no gains or losses recognized as a result of this transfer. The related $1.4 million of unrealized holding loss that was included in the transfer is retained in the carrying value of the held-to-maturity securities and in other comprehensive income net of deferred taxes. These amounts are being amortized into net interest income over the remaining life of the related securities as a yield adjustment, resulting in no impact on future net income.
Trust preferred securities at December 31, 2016, is one trust preferred pooled security issued by First Tennessee Financial (“FTN”). The unrealized loss of this security, which has a maturity of twenty-one 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” below for further information regarding this security.
Proceeds from sales of investment securities, realized gains and losses and income tax expense and benefit were as follows during the years ended December 31, 2016, 2015 and 2014 (in thousands):
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 December 31, 2016 and the weighted average yield for each range of maturities (in thousands):
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 December 31, 2016.
Investment securities carried at approximately $509 million and $404 million at December 31, 2016 and 2015, respectively, were pledged to secure public deposits and repurchase agreements and for other purposes as permitted or required by law. The increase in pledge securities is due to the acquisition of First Clover Leaf during 2016.
The following table presents the aging of gross unrealized losses and fair value by investment category as of December 31, 2016 and 2015 (in thousands):
U.S. Treasury Securities and Obligations of U.S. Government Corporations and Agencies. 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 December 31, 2015 there were six available-for-sale U.S. Treasury securities and obligations of U.S. government corporations and agencies with a fair value of $12,971,000 and unrealized losses of $126,000 in a continuous unrealized loss position for twelve months or more. At December 31, 2016 and December 31, 2015 there were 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 December 31, 2016 there were no obligations of states and political subdivisions in a continuous unrealized loss position for twelve months or more. At December 31, 2015, there were two obligations of states and political subdivisions with a fair value of $979,000 and unrealized losses of $23,000 in a continuous unrealized loss position for twelve months or more.
Mortgage-backed Securities: GSE Residential. 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. At December 31, 2015, there were seven mortgage-backed security with a fair value of $20,011,000 and unrealized losses of $611,000 in a continuous unrealized loss position for twelve months or more.
Trust Preferred Securities. At December 31, 2016, there was one trust preferred security with a fair value of $1,652,000 and unrealized losses of $1,398,000 in a continuous unrealized loss position for twelve months or more. At December 31, 2015, there was one trust preferred securities with a fair value of $1,906,000 and unrealized losses of $1,224,000 in a continuous unrealized loss position for twelve months or more. These unrealized losses were primarily due to the long-term nature of the trust preferred securities, a lack of demand or inactive market for these securities, 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 2016 or 2015. Because the Company does not intend to sell the remaining security and it is not more-likely-than-not that the Company will be required to sell this securities before recovery of its amortized cost basis, which may be maturity, the Company does not consider the remainder of the investment in this security to be other-than-temporarily impaired at December 31, 2016. However, future downgrades or additional deferrals and defaults in the security could result in additional OTTI and consequently, have a material impact on future earnings.
Following are the details for the impaired trust preferred security remaining as of December 31, 2016 (in thousands):
Other securities. At December 31, 2016 and 2015, 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. At December 31, 2015, there were no corporate bonds in a continuous unrealized loss position for twelve months or more.
The Company does not believe any other individual unrealized loss as of December 31, 2016 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. 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, some of the Company’s investments in trust preferred securities have experienced fair value deterioration due to credit losses but are not otherwise other-than-temporarily impaired. The following table provides information about those trust preferred securities for which only a credit loss was recognized in income and other losses are recorded in other comprehensive income (loss) for the years ended December 31, 2016, 2015 and 2014 (in thousands).
Maturities of investment securities were as follows at December 31, 2016 (in thousands):
Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.
Note 5 -- 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 December 31, 2016 and 2015 follows (in thousands):
Net loans increased $541.7 million as of December 31, 2016 compared to December 31, 2015. Of this increase, approximately $439.1 million is a result of the acquisition of First Clover Leaf Bank. 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. The balance of loans held for sale, excluded from the balances above, were $1,175,000 and $968,000 at December 31, 2016 and 2015, respectively.
Most of the Company’s business activities are with customers located within central Illinois. At December 31, 2016, the Company’s loan portfolio included $213.0 million of loans to borrowers whose businesses are directly related to agriculture. Of this amount, $171.3 million was concentrated in other grain farming. Total loans to borrowers whose businesses are directly related to agriculture increased $14.4 million from $198.6 million at December 31, 2015 while loans concentrated in other grain farming increased $9.8 million from $161.5 million at December 31, 2015. 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 $103.8 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 $134.0 million of loans to lessors of non-residential buildings, $139.6 million of loans to lessors of residential buildings and dwellings, and $54.3 million of loans to automobile dealers .
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’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.
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 Watch, Substandard, or Doubtful. Determining the appropriate level of the allowance for loan losses for all non-impaired loans is based on a migration analysis of net losses over a rolling twelve quarter period by loan segment. A weighted average of the net losses is determined by assigning more weight to the most recent quarters in order to recognize current risk factors influencing the various segments of the loan portfolio more prominently than past periods. Environmental factors including changes in economic conditions, changes in credit policies or underwriting standards, and changes in the level of credit risk associated with specific industries and markets are evaluated each quarter to determine if adjustments to the weighted average historical net losses is appropriate given these current influences on the risk profile of each loan segment. Because the economic and business climate in any given industry or market, and its impact on any given borrower, can change rapidly, the risk profile of the loan portfolio is periodically assessed and adjusted when appropriate. Consumer loans are evaluated for adverse classification based primarily on the Uniform Retail Credit Classification and Account Management Policy established by the federal banking regulators. Classification standards are generally based on delinquency status, collateral coverage, bankruptcy and the presence of fraud.
Due to weakened economic conditions during recent 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 as of December 31, 2016, 2015 and 2014 (in thousands):
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":
Watch. Loans classified as watch 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. The following tables present the credit risk profile of the Company’s loan portfolio based on rating category and payment activity as of December 31, 2016 and 2015 (in thousands):
The following table presents the Company’s loan portfolio aging analysis at December 31, 2016 and 2015 (in thousands):
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.
The following tables present impaired loans as of December 31, 2016 and 2015 (in thousands):
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 average recorded investment and interest income recognized on impaired loans for the years ended December 31, 2016, 2015 and 2014 (in thousands):
The amount of interest income recognized by the Company within the periods stated above was due to loans modified in a troubled debt restructuring that remained on accrual status. The balance of loans modified in a troubled debt restructuring included in the impaired loans stated above that were still accruing was $603,000 of 1-4 Family residential properties, $41,000 of commercial & industrial, $3,419,000 of multifamily residential properties, $2,116,000 of commercial real estate, and $6,000 of consumer loans at December 31, 2016 and $397,000 of 1-4 Family residential properties, $36,000 of commercial real estate loans, $147,000 of commercial and industrial loans and $21,000 of consumer loans at December 31, 2015. For the years ended December 31, 2016, 2015 and 2014, the amount of interest income recognized using a cash-basis method of accounting during the period that the loans were impaired was not material.
Non Accrual Loans
The following table presents the Company’s recorded balance of nonaccrual loans at December 31, 2016 and December 31, 2015 (in thousands). This table excludes purchased credit-impaired loans and performing troubled debt restructurings.
The aggregate principal balances of nonaccrual, past due ninety days or more loans were $12.1 million and $3.4 million at December 31, 2016 and 2015, respectively. Interest income that would have been recorded under the original terms of such nonaccrual loans totaled $133,000, $48,000 and $71,000 in 2016, 2015 and 2014, respectively.
Purchased Credit-Impaired Loans
The Company acquired certain loans considered to be credit-impaired 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 December 31, 2016 are as follows (in thousands):
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 December 31, 2016 approximately $1.2 million was accreted on the PCI loans acquired due to sales and charge offs on these loans. 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. There were no other changes in the estimated expected cash flows for the period from acquisition to December 31, 2016.
The PCI loans acquired during the twelve months ended December 31, 2016 for which it was probable that all contractually required payments would not be collected were as follows (in thousands):
Income would not be recognized on certain PCI loans if cash flows could not be reasonably estimated. The Company had no purchased loans for which it could not reasonably estimate cash flows to be collected.
Troubled Debt Restructuring
The balance of troubled debt restructurings ("TDRs") at December 31, 2016 and 2015 was $10,889,000 and $1,743,000, respectively. Approximately $196,000 and $0 in specific reserves were established with respect to these loans as of December 31, 2016 and 2015, 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 December 31, 2016 and 2015 (in thousands).
The following table presents loans modified as TDRs during the years ended December 31, 2016 and 2015 as a result of various modified loan factors (in thousands):
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
A loan is considered to be in payment default once it is ninety days past due under the modified terms. There was one loan modified as troubled debt restructurings during the prior twelve months that experienced a default during the year ended December 31, 2016. There were no loans in payment default as of December 31, 2015.
At December 31, 2016 and 2015, the balance of real estate owned includes $1,982,000 and $477,000, respectively of foreclosed real estate properties recorded as a result of obtaining physical possession of the property. At December 31, 2016 and 2015, the recorded investment of consumer mortgage loans secured by residential real estate properties for which formal foreclosure proceeds are in process was $661,000 and $55,000.
Note 6 -- Premises and Equipment, Net
Premises and equipment at December 31, 2016 and 2015 consisted of (in thousands):
Depreciation and amortization expense was $2.5 million, $2.2 million and $2.4 million for the years ended December 31, 2016, 2015 and 2014, respectively.
Note 7 -- 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 insurance agencies acquired. The following table presents gross carrying amount and accumulated amortization by major intangible asset class as of December 31, 2016 and 2015 (in thousands):
During the third quarter of 2016, goodwill of $16.8 million was recorded for the acquisition of First Clover Leaf. 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):
During the third quarter of 2015, goodwill of $14.3 million was recorded for the acquisition of twelve Old National Bank Branches. The goodwill consisted largely of the synergies and economies of scale expected from combining the operations of the Company and the ONB Branches. All of the goodwill was assigned to the banking segment of the Company. The Company expects this goodwill to be fully deductible for tax purposes.
The following table provides a reconciliation of the purchase price paid for the ONB Branches and the amount of goodwill recorded (in thousands):
During the fourth quarter of 2015, goodwill of $980,000 was also recorded for the acquisition of certain assets used by Illiana Insurance Agency, Ltd., in connection with its health plan and life insurance and annuity's business. The goodwill consists primarily of the customer list of the agency.
The following table provides a reconciliation of the purchase price paid for Illiana and the amount of goodwill recorded (in thousands):
As part of the acquisition of First Clover Leaf Bank, the Company acquired mortgage servicing righted valued at $1,069,000. The following table summarizes the activity pertaining to the mortgage servicing rights included in intangible assets as of December 31, 2016 (in thousands):
Total amortization expense for the years ended December 31, 2016, 2015 and 2014 was as follows (in thousands):
Estimated amortization expense for each of the five succeeding years is shown in the table below (in thousands):
In accordance with the provisions of SFAS 142,”Goodwill and Other Intangible Assets,” codified in ASC 350, the Company performed testing of goodwill for impairment as of September 30, 2016 and 2015, and determined, as of each of these dates, that goodwill was not impaired. Management also concluded that the remaining amounts and amortization periods were appropriate for all intangible assets.
Note 8 -- Deposits
As of December 31, 2016 and 2015, deposits consisted of the following (in thousands):
Total interest expense on deposits for the years ended December 31, 2016, 2015 and 2014 was as follows (in thousands):
As of December 31, 2016, 2015 and 2014, the aggregate amount of time deposits in denominations of more than $100,000 and the total interest expense on such deposits was as follows (in thousands):
The following table shows the amount of maturities for all time deposits as of December 31, 2016:
In 2016 the Company maintained account relationships with various public entities throughout its market areas. These public entities had total balances of $146.1 million in various checking accounts and time deposits as of December 31, 2016. These balances are subject to change depending upon the cash flow needs of the public entity.
Note 9 -- Repurchase Agreements and Other Borrowings
As of December 31, 2016 and 2015 borrowings consisted of the following (in thousands):
Aggregate annual maturities of FHLB advances and subordinated debentures (excluding unamortized discounts and premiums) at December 31, 2016 are (in thousands):
FHLB advances represent borrowings by First Mid Bank to fund loan demand. At December 31, 2016 the advances totaling $40 million were as follows:
•
$5 million advance with a 1-year maturity, at 0.82%, due June 21, 2017
•
$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 6-year maturity, at 2.30%, due August 24, 2020
•
$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
Securities sold under agreements to repurchase were $185.8 million at December 31, 2016, an increase of $57 million from $128.8 million at December 31, 2015. The increase during 2016 was primarily due to increases in balances of customers due to changes in cash flow needs for their businesses and balances acquired with First Clover Leaf Bank. Securities sold under agreements to repurchase have overnight maturities and a weighted average rate of .05%.
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.
Repurchase agreements by class of collateral pledged are as follows (in thousands):
At December 31, 2016, there was a $4 million outstanding loan balance on the revolving credit agreement with The Northern Trust Company. This loan was renewed on April 15, 2016 for one year as a revolving credit agreement with a maximum available balance of $15 million and was amended on September 7, 2016 to a maximum available balance of $10 million. The interest rate (2.9% at December 31, 2016) is floating at 2.25% over the federal funds rate. The loan is secured by all of the stock of First Mid Bank and First Clover Leaf Bank. Management believes the Company and its subsidiary banks were in compliance with all the existing covenants at December 31, 2016 and 2015.
Also on September 7, 2016, as part of the amendment to the Northern Trust Company revolving credit agreement, the Company entered into a $15 million fixed-rate note with a maturity date of September 7, 2020. The interest rate is floating at 2.25% over the federal funds rate (2.9% at December 31, 2016) and interest and principle payments are due quarterly. As of December 31, 2016, the balance due was $14.1 million. The loan is secured by all of the stock of First Mid Bank and First Clover Leaf Bank. The Company used the proceeds of this note to fund the cash portion of the acquisition price of First Clover Leaf Financial.
On February 27, 2004, the Company completed the issuance and sale of $10 million of floating rate trust preferred securities through 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 the Trust, 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, reset quarterly, and are callable, at the option of the Company, at par on or after April 7, 2009. At December 31, 2016 and 2015 the rate was 3.73% and 3.17%, respectively. 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 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) after June 15, 2011 (2.56% and 2.11% at December 31, 2016 and 2015). The net proceeds to the Company were used for general corporate purposes, including the Company’s acquisition of Mansfield.
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 million 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 (2.81% at December 31, 2016) 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, First Mid Bank, or First Clover Leaf Bank.
Note 10 -- Regulatory Capital
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 and First Clover Leaf 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 each regulatory capital standards to ensure capital adequacy require 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 December 31, 2016 and 2015, the Company,First Mid Bank, and First Clover Leaf Bank met all capital adequacy requirements.
As of December 31, 2016 and 2015, the most recent notification from the primary regulators categorized the Banks as well capitalized under the regulatory framework for prompt corrective action. To be categorized as well capitalized, minimum 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 table below. At December 31, 2016, there were no conditions or events since the most recent notification that management believes have changed this categorization.
The Company's risk-weighted assets, capital and capital ratios for December 31, 2016 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 Basel III rules. As of December 31, 2016, the Company, First Mid Bank, and First Clover Leaf Bank had capital ratios above the required minimums for regulatory capital adequacy, and First Mid Bank and First Clover Leaf Bank had capital ratios that qualified it for treatment as well-capitalized under the regulatory framework for prompt corrective action with respect to banks. The decrease in capital ratios from December 31, 2015 is primarily due to additional assets from the acquisition of the ONB Branches.
Note 11 -- Disclosures of Fair Values of Financial Instruments
Fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. Fair value measurements must maximize the use of observable inputs and minimize the use of unobservable inputs. There is a hierarchy of three levels of inputs that may be used to measure fair value:
Level 1
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 independently sources 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 December 31, 2016 and 2015 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 December 31, 2016 and 2015,
•
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.
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 December 31, 2016 and 2015 (in thousands):
The change in fair value of assets measured on a recurring basis using significant unobservable inputs (Level 3) for the years ended December 31, 2016 and 2015 is summarized as follows (in thousands):
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 loans that have an estimated fair value that is below the carrying value. The total carrying amount of loans for which a specific allowance has been established as of December 31, 2016 was $8,370,000 and a fair value of $6,938,000 resulting in specific loss exposures of $1,432,000. As of December 31, 2015, the total carrying amount of loans for which a specific reserve had been established was $428,000. These loans had a fair value of $294,000 which resulted in specific loss exposures of $134,000.
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 December 31, 2016 was $1,982,000. Other real estate owned included in the total carrying amount and measured at fair value on a nonrecurring basis during the period amounted to $173,000. The total carrying amount of other real estate owned as of December 31, 2015 was $477,000. Other real estate owned included in the total carrying amount and measured at fair value on a nonrecurring basis during the period amounted to $423,000.
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 December 31, 2016 and 2015 (in thousands):
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 December 31, 2016.
(1)
Every five years
The following table presents quantitative information about unobservable inputs used in recurring and nonrecurring Level 3 fair value measurements other than goodwill at December 31, 2015.
(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, 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.
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 December 31, 2016 and 2015 in accordance with FAS 107-1 and APB 28-1, codified with ASC 805 (in thousands):
Note 12 -- Deferred Compensation Plan
The Company follows the provisions of ASC 710, for purposes of the First Mid-Illinois Bancshares, Inc. Deferred Compensation Plan (“DCP”). At December 31, 2016, the Company classified the cost basis of its common stock issued and held in trust in connection with the DCP of approximately $3,590,000 as treasury stock. The Company also classified the cost basis of its related deferred compensation obligation of approximately $3,590,000 as an equity instrument (deferred compensation).
The DCP was effective as of June 1984. The purpose of the DCP is to enable directors, advisory directors, and key employees the opportunity to defer a portion of the fees and cash compensation paid by the Company as a means of maximizing the effectiveness and flexibility of compensation arrangements. The Company invests all participants’ deferrals in shares of common stock. Dividends paid on the shares are credited to participants’ DCP accounts and invested in additional shares. During 2016 and 2015 the Company issued 4,683 common shares and 6,153 common shares, respectively, pursuant to the DCP.
Note 13 -- Stock Incentive Plan
At the Annual Meeting of Stockholders held May 23, 2007, the stockholders approved the First Mid-Illinois Bancshares, Inc. 2007 Stock Incentive Plan (“SI Plan”). The SI Plan was implemented to succeed the Company’s 1997 Stock Incentive Plan, which had a ten-year term that expired October 21, 2007, under which there are still options outstanding. 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.
On September 27, 2011, the Board of Directors passed a resolution authorizing and approving the Executive Long-Term Incentive Plan (“LTIP”). The LTIP was implemented to provide methodology for granting Stock Awards and Stock Unit Awards under the SI Plan to select senior executives of the Company or any subsidiary.
A maximum of 300,000 shares are authorized under the SI Plan. This amount reflects the Company’s stock split which occurred on June 29, 2007. Options to acquire shares are awarded at an exercise price equal to the fair market value of the shares on the date of grant and have a 10-year term. Options granted to employees vested over a four-year period and options granted to directors vested at the time they were issued. Prior to December 31, 2008, the Company had awarded 59,500 shares as stock options under the SI Plan. There have been no options awarded since 2008. During 2016 and 2015, the Company awarded 13,912 and 18,002 shares, respectively. During 2014, 19,377 shares as 50% Stock Awards and 50% Stock Unit Awards under the LTIP of the SI Plan.
The fair value of options granted was estimated on the grant date using the Black-Scholes option-pricing model. Expected volatility was based on historical volatility of the Company’s stock and other factors. The Company used historical data to estimate option exercises and employee termination within the valuation model; separate groups of employees who had similar historical exercise behavior were considered separately for valuation purposes. The expected term of options granted was derived from the output of the option valuation model and represented the period of time that options granted were expected to be outstanding. The risk-free rate for periods within the contractual life of the option was based on the U.S. Treasury yield curve in effect at the time of the grant. There were no options granted during 2016, 2015 or 2014.
The following table summarizes the compensation cost, net of forfeitures, related to stock-based compensation for the years ended December 31, 2016, 2015 and 2014 (in thousands):
A summary of option activity under the SI Plan and the 1997 Stock Incentive Plan as of December 31, 2016, 2015 and 2014, and changes during the years then ended is presented below:
The total intrinsic value of options exercised during 2016 was $14,000. Stock options for 0 shares of common stock were not considered in computing the aggregate intrinsic value of outstanding shares and exercisable shares for 2016 because they were anti-dilutive.
There were no options exercised during 2015. Stock options for 24,500 shares of common stock were not considered in computing the aggregate intrinsic value of outstanding shares and exercisable shares for 2015 because they were anti-dilutive.
There were no options exercised during 2014. Stock options for 52,000 shares of common stock were not considered in computing the aggregate intrinsic value of outstanding shares and exercisable shares for 2014 because they were anti-dilutive.
The following table summarizes information about stock options under the SI Plan outstanding at December 31, 2016:
In September 2011, as part of the LTIP approval, the Board approved a form of Stock Award/Stock Unit Award Agreement and a form of Stock Unit Award Agreement. These forms set forth the terms and conditions of the Stock Awards and Stock Units granted to participants in the Plan as part of their Annual Performance Award and Cumulative Performance Award. Each of the Annual Performance Award and Cumulative Performance Award consists of Stock Awards (50%) and Stock Units (50%), except that Awards to retirement-eligible employees are made 100% in Stock Units. The target number of shares subject to the Stock Awards and/or Stock Units is adjusted by the Board at the end of each applicable performance period based on the actual level of attainment of performance goals previously set by the Board. The Annual Performance Award has a one-year performance period and vest over four years. The Cumulative Performance Award has a three-year performance period and vest at the end of the three-year period. Stock Awards are settled in shares while Stock Units are settled in cash (although Stock Units held by retirement-eligible employees are settled half in shares and half in cash). During 2015, the Board approved a revision to the LTIP, whereby all awards granted to participants were stock unit awards, cumulative with a three-year performance period and to be settled entirely in shares. All other provisions of the plan remain the same. The following table summarizes non-vested stock and stock unit activity for the years ended December 31, 2016, 2015 and 2014:
The fair value of the awards is amortized to compensation expense over the vesting periods of the awards (four years for annual awards and three years for cumulative awards) and is based on the market price of the Company’s common stock at the date of grant multiplied by the number of shares granted that are expected to vest. As of December 31, 2016, 2015 and 2014, there was $344,000, $386,000, and $435,000, respectively, of total unrecognized compensation cost related to unvested stock and stock unit awards under the SI. That cost is expected to be recognized over the remainder of the three-year period.
Note 14 -- Retirement Plans
The Company has a defined contribution retirement plan which covers substantially all employees and which provides for a Company contribution equal to 4% of each participant’s compensation and a Company matching contribution of up to 100% of the first 3% and 50% of the next 2% of pre tax contributions made by each participant. Employee contributions are limited to the 402(g) limit of compensation. The total expense for the plan amounted to $1,383,000, $1,080,000 and $1,074,000 in 2016, 2015 and 2014, respectively. The Company also has two agreements in place to pay $50,000 annually for 20 years from the retirement date to the surviving spouse of a deceased former senior officer of the Company and to a senior officer that retired December 31, 2013. Total expense under these two agreements amounted to $43,000, $29,000 and $15,000 in 2016, 2015 and 2014, respectively. The current liability recorded for these two agreements was $658,000 and $715,000, as of December 31, 2016 and 2015, respectively.
Note 15 -- Income Taxes
The components of federal and state income tax expense for the years ended December 31, 2016, 2015 and 2014 were as follows (in thousands):
Recorded income tax expense differs from the expected tax expense (computed by applying the applicable statutory U.S. federal tax rate of 35% to income before income taxes). During 2016, 2015 and 2014, the Company was in a graduated tax rate position. The principal reasons for the difference are as follows (in thousands):
Tax expense recorded by the Company during 2016, 2015 and 2014 did not include any interest or penalties. Tax returns filed with the Internal Revenue Service and Illinois Department of Revenue are subject to review by law under a three-year statute of limitations. The Company is no longer subject to U.S. federal or state income tax examinations by tax authorities for years before 2013.
The tax effects of the temporary differences that gave rise to significant portions of the deferred tax assets and deferred tax liabilities at December 31, 2016 and 2015 are presented below (in thousands):
Net deferred tax assets are recorded in other assets on the consolidated balance sheets. No valuation allowance related to deferred tax assets was recorded at December 31, 2016 and 2015 as management believes it is more likely than not that the deferred tax assets will be fully realized.
Note 16 -- Dividend Restrictions
The National Bank Act imposes limitations on the amount of dividends that may be paid by a national bank, such as First Mid Bank and First Clover Leaf Bank. Generally, a national bank may pay dividends out of its undivided profits, in such amounts and at such times as the bank’s board of directors deems prudent. Without prior OCC approval, however, a national bank may not pay dividends in any calendar year which, in the aggregate, exceed the bank’s year-to-date net income plus the bank’s adjusted retained net income for the two preceding years. Factors that could adversely affect First Mid Bank’s net income include other-than-temporary impairment on investment securities that result in credit losses and economic conditions in industries where there are concentrations of loans outstanding that result in impairment of these loans and, consequently loan charges and the need for increased allowances for losses. See “Item 1A. Risk Factors,” Note 4 - “Investment Securities” and Note 5 - “Loans” for a more detailed discussion of the factors.
The payment of dividends by any financial institution or its holding company is affected by the requirement to maintain adequate capital pursuant to applicable capital adequacy guidelines and regulations, and a financial institution generally is prohibited from paying any dividends if, following payment thereof, the institution would be undercapitalized. As described above, First Mid Bank and First Clover Leaf Bank exceeded their minimum capital requirements under applicable guidelines as of December 31, 2016. As of December 31, 2016, approximately $16.4 million was available to be paid as dividends to the Company by First Mid Bank and approximately $664,000 was available to be paid as dividends to the Company by First Clover Leaf Bank. Notwithstanding the availability of funds for dividends, however, the OCC may prohibit the payment of any dividends by First Mid Bank or First Clover Leaf Bank if the OCC determines that such payment would constitute an unsafe or unsound practice.
Note 17 -- Commitments and Contingent Liabilities
First Mid Bank and First Clover Leaf 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 December 31, 2016 and 2015 were as follows (in thousands):
The increase in 2016 was primarily due to outstanding commitments acquired in the acquisition of First Clover Leaf during the third quarter of 2016. 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 at December 31, 2016 and 2015. The Company's deferred revenue under standby letters of credit was nominal.
The Company is also subject to claims and lawsuits that arise primarily in the ordinary course of business. It is the opinion of management that the disposition of ultimate resolution of such claims and lawsuits will not have a material adverse effect on the consolidated financial position, results of operations and cash flows of the Company.
Note 18 -- Related Party Transactions
Certain officers, directors and principal stockholders of the Company and its subsidiaries, their immediate families or their affiliated companies (“related parties”) have loans with one or more of the subsidiaries. These loans are made in the ordinary course of business on substantially the same terms, including interest and collateral, as those prevailing for comparable transactions with others. Loans to related parties totaled approximately $54,502,000 and $56,045,000 at December 31, 2016 and 2015, respectively. Activity during 2016 and 2015 was as follows (in thousands):
Deposits from related parties held by First Mid Bank and First Clover Leaf Bank at December 31, 2016 and 2015 totaled $156,709,000 and $107,606,000, respectively.
Note 19 -- 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 in cash, 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 will have an opportunity to increase its deposit base and reduce 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 $16.8 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.
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).
The Company has recognized approximately $1,340,000, pre-tax, of acquisition costs for the First Clover Leaf acquisition. These costs are included in legal and professional and other expense. The operating results of First Clover Leaf Bank since acquisition, including revenue of $7,417,000 and net income of $2,514,000, are also included in the Company’s consolidated financial statements. 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, is being amortized on an accelerated basis over its estimated life of ten years.
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 (in thousands, except share data):
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.
Old National Bank Branches
On August 14, 2015, First Mid-Illinois Bank completed the acquisition of twelve Illinois bank branches from Old National Bank, a national banking association having its principal office in Evansville, Indiana. The acquisition expanded First Mid Bank's service area into Southern Illinois and provided a stable source of core deposits. Pursuant to the terms of the Branch Purchase and Assumption Agreement, dated January 30, 2015, as amended, by and between First Mid Bank and Old National Bank, First Mid Bank, among other matters, assumed certain deposit liabilities and acquired certain loans, as well as cash, real property, furniture, and other fixed operating assets associated with the ONB Branches. The deposit and loan balances assumed were approximately $453 million and $156 million at book value, respectively. First Mid Bank also assumed certain leases, and entered into certain subleases, related to the ONB Branches.
First Mid Bank agreed to pay Old National Bank the sum of: (i) a deposit premium of 3.6% on the amount of deposit accounts of the ONB Branches, other than brokered deposits and municipal deposits, which equated to approximately $15.9 million, (ii) $500,000, representing the fixed deposit premium related to the municipal deposits of the ONB Branches, (iii) the principal amount of the loans being purchased, plus the accrued but unpaid interest, (iv) the aggregate net book value of the other assets purchased including facilities of approximately $4.5 million, and (v) the aggregate amount of cash on hand of $2.7 million as of the closing. The acquisition was settled by Old National Bank paying cash of approximately $276.8 million to First Mid Bank for the difference between these amounts and the total deposits assumed.
The purchase was accounted for under the acquisition method in accordance with Accounting Standards Codification (“ASC”) 805, “Business Combinations,” and accordingly the assets and liabilities were recorded at their fair values on the date of acquisition.
The following table summarizes the estimated fair values of assets acquired and liabilities assumed at the date of acquisition (in thousands).
The Company recognized approximately $1.4 million of costs related to completion of the acquisition during 2015. These acquisition costs are included in legal and professional and other expense. The difference between the fair value and acquired value of the purchased loans of $3,377,000 is being accreted to interest income over the remaining term of the loans. The difference between the fair value and acquired value of the assumed time deposits of $837,000 is being amortized to interest expense over the remaining term of the time deposits. The core deposit intangible asset, with a fair value of $6,216,000, is being amortized on an accelerated basis over its estimated life of ten years.
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 acquisition taken place at the beginning of the period (in thousands):
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 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.
Actual revenue and earnings of the ONB branches included in the consolidated statement of income of the Company for the year ended December 31, 2015, was $3,270,000 and $(228,380), respectively.
Note 20 -- Leases
The Company has several noncancellable operating leases, primarily for property rental of banking buildings. These leases are for terms from one year to fifteen years and generally contain renewal options for periods ranging from one year to five years. Rental expense for these leases was $2,620,000, $1,749,000 and $1,240,000 for the years ended December 31, 2016, 2015 and 2014, respectively. Future minimum lease payments under operating leases are (in thousands):
Note 21 -- Parent Company Only Financial Statements
Presented below are condensed balance sheets, statements of income and cash flows for the Company (in thousands):
Note 22 -- Quarterly Financial Data - Unaudited
The following table presents summarized quarterly data for each of the two years ended December 31, 2016 and 2015 (in thousands):
Report of Independent Registered Public Accounting Firm
Audit Committee, Board of Directors and Stockholders
First Mid-Illinois Bancshares, Inc.
Mattoon, Illinois
We have audited the accompanying consolidated balance sheets of First Mid-Illinois Bancshares, Inc. as of December 31, 2016 and 2015 and the related consolidated statements of income, comprehensive income, changes in stockholders’ equity and cash flows for each of the years in the three-year period ended December 31, 2016. The Company's management is responsible for these financial statements. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. Our audits included examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of First Mid-Illinois Bancshares, Inc. as of December 31, 2016 and 2015, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2016, in conformity with accounting principles generally accepted in the United States of America.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), First Mid-Illinois Bancshares, Inc.’s internal control over financial reporting as of December 31, 2016, based on criteria established in Internal Control-Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) and our report dated March 3, 2017 expressed an unqualified opinion on the effectiveness of the Company’s internal control over financial reporting.
Decatur, Illinois
March 3, 2017
ITEM 9.
ITEM 9.
CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
None.
ITEM 9A.
ITEM 9A.
CONTROLS AND PROCEDURES
Disclosure Controls and Procedures
The Company’s management carried out an evaluation, under the supervision and with the participation of the chief executive officer and the chief financial officer, of the effectiveness of the design and operation of the Company’s disclosure controls and procedures (as such term is defined in Rule 13a-15(e) under the Securities Exchange Act of 1934) as of December 31, 2016. Based upon that evaluation, the chief executive officer along with the chief financial officer concluded that the Company’s disclosure controls and procedures as of December 31, 2016, were effective.
Management’s Annual Report on Internal Control over Financial Reporting
The Company’s management is responsible for establishing and maintaining adequate internal control over financial reporting for the Company. The Company’s internal control over financial reporting is a process designed under the supervision of the Company’s chief executive officer and chief financial officer to provide reasonable assurance regarding the reliability of financial reporting and the preparation of the Company’s financial statements for external reporting purposes in accordance with U.S. generally accepted accounting principles.
Management assessed the effectiveness of the Company’s internal control over financial reporting as of December 31, 2016 based on the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”) in “Internal Control-Integrated Framework (2013).” As permitted, the Company excluded the operations of First Clover Leaf Bank acquired on September 8, 2016, from the scope of the assessment. Based on the assessment, management determined that, as of December 31, 2016, the Company’s internal control over financial reporting is effective, based on those criteria. Management’s assessment of the effectiveness of the Company’s internal control over financial reporting as of December 31, 2016 has been audited by BKD, LLP, an independent registered public accounting firm, as stated in their report following.
March 3, 2017
Joseph R. Dively
President and Chief Executive Officer
Michael L. Taylor
Chief Financial Officer
Changes in Internal Control Over Financial Reporting
There were no changes in the Company’s internal control over financial reporting that occurred during the Company’s fourth fiscal quarter of 2016 that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.
Report of Independent Registered Public Accounting Firm
Audit Committee, Board of Directors and Stockholders
First Mid-Illinois Bancshares, Inc.
Mattoon, Illinois
We have audited First Mid-Illinois Bancshares, Inc.’s internal control over financial reporting as of December 31, 2016, based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management’s report. Our responsibility is to express an opinion on the Company’s internal control over financial reporting based on our audit.
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audit also included performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions or that the degree of compliance with the policies or procedures may deteriorate.
As permitted, the Company excluded the operations of First Clover Leaf Bank acquired on September 8, 2016, from the scope of the management's report on internal control over financial reporting. As such, this entity has also been excluded from the scope of our audit of internal control over financial reporting.
In our opinion, First Mid-Illinois Bancshares, Inc. maintained, in all material respects, effective internal control over financial reporting as of December 31, 2016, based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO).
We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated financial statements of First Mid-Illinois Bancshares, Inc. and our report dated March 3, 2017 expressed an unqualified opinion thereon.
Decatur, Illinois
March 3, 2017
ITEM 9B.
ITEM 9B.
OTHER INFORMATION
On February 28, 2017 the Board of Directors of First Mid-Illinois Bancshares, Inc. (the "Company") approved an Executive Employment Agreement entered into between the Company and Eric S. McRae effective February 1, 2017, for three years, until December 31, 2019, under which Mr. McRae agrees to serve as Executive Vice President of the Company (the "McRae Agreement"). Under the McRae Agreement, Mr. McRae will receive an annual base salary of $252,049 and will participate in the Company's Incentive Compensation Plan and Deferred Compensation Plan. The McRae Agreement also provides Mr. McRae with severance benefits in the event of the termination of his employment under certain circumstances and contains certain confidentiality and non-competition and non-solicitation provisions. The McRae Agreement is filed as Exhibit 10.7 and is incorporated by reference herein.
PART III
ITEM 10.
ITEM 10.
DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE
The information called for by Item 10 with respect to directors and director nominees is incorporated by reference to the Company’s Proxy Statement for the 2017 Annual Meeting of the Company’s shareholders under the captions “Proposal 1 - Election of Directors,” “Corporate Governance Matters” and “Section 16 - Beneficial Ownership Reporting Compliance.”
The information called for by Item 10 with respect to executive officers is incorporated by reference to Part I hereof under the caption “Supplemental Item - Executive Officers of the Company” and to the Company’s Proxy Statement for the 2017 Annual Meeting of the Company’s shareholders under the caption “Section 16 - Beneficial Ownership Reporting Compliance.”
The information called for by Item 10 with respect to audit committee financial expert is incorporated by reference to the Company’s Proxy Statement for the 2017 Annual Meeting of the Company’s shareholders under the captions “Audit Committee” and “Report of the Audit Committee to the Board of Directors.”
The information called for by Item 10 with respect to corporate governance is incorporated by reference to the Company’s Proxy Statement for the 2017 Annual Meeting of the Company’s shareholders under the caption “Corporate Governance Matters.”
The Company has adopted a code of conduct for directors, officers, and employees including senior financial management of the Company. This code of conduct is posted on the Company’s website. In the event that the Company amends or waives any provisions of this code of conduct, the Company intends to disclose the same on its website at www.firstmid.com.
The information called for by Item 11
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS
The information called for by Item 12 with respect to equity compensation plans is provided in the table below.
(1)
Consists of shares issuable with respect to participant deferral contributions invested in common stock.
(2)
Consists of stock options.
(3)
Represents the weighted-average exercise price of outstanding stock options.
(4)
Consists of stock options, restricted stock and/or restricted stock units.
(5)
The Company does not maintain any equity compensation plans not approved by stockholders.
The Company’s equity compensation plans approved by security holders consist of the Deferred Compensation Plan and the Stock Incentive Plan. Additional information regarding each plan is available in “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations - Stock Plans” and Note 13 - Stock Incentive Plan herein.
The information called for by Item 12 with respect to security ownership is incorporated by reference to the Company’s Proxy Statement for the 2017 Annual Meeting of the Company’s shareholders under the caption “Voting Securities and Principal Holders Thereof.”
ITEM 13.
ITEM 13.
CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS AND DIRECTOR INDEPENDENCE
The information called for by Item 13 is incorporated by reference to the Company’s Proxy Statement for the 2017 Annual Meeting of the Company’s shareholders under the captions “Certain Relationships and Related Transactions” and “Corporate Governance Matters - Board of Directors.”
ITEM 14.
ITEM 14.
PRINCIPAL ACCOUNTANT FEES AND SERVICES
The information called for by Item 14 is incorporated by reference to the Company’s Proxy Statement for the 2017 Annual Meeting of the Company’s shareholders under the caption “Fees of Independent Auditors.”
PART IV
ITEM 15.
ITEM 15.
EXHIBIT AND FINANCIAL STATEMENT SCHEDULES
(a)(1) and (2) -- Financial Statements and Financial Statement Schedules
The following consolidated financial statements and financial statement schedules of the Company are filed as part of this document under Item 8.
Financial Statements and Supplementary Data:
•
Consolidated Balance Sheets -- December 31, 2016 and 2015
•
Consolidated Statements of Income -- For the Years Ended December 31, 2016, 2015 and 2014
•
Consolidated Statements of Comprehensive Income -- For the Years Ended December 31, 2016, 2015 and 2014
•
Consolidated Statements of Changes in Stockholders’ Equity -- For the Years Ended December 31, 2016, 2015 and 2014
•
Consolidated Statements of Cash Flows -- For the Years Ended December 31, 2016, 2015 and 2014.
(a)(3) - 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 immediately precedes the exhibits filed.
None.
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: March 3, 2017
Joseph R. Dively
President and Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below on the 3rd day of March 2017, by the following persons on behalf of the Company and in the capacities listed.
Signature and Title
Joseph R. Dively, Chairman of the Board,
President and Chief Executive Officer and Director
(Principal Executive Officer)
Michael L. Taylor, Senior Executive Vice President and Chief Financial Officer
(Principal Financial Officer and Principal Accounting Officer)
Holly A. Bailey, Director
Robert Cook, Director
Steven L. Grissom, Director
Gary W. Melvin, Director
William S. Rowland, Director
Ray A. Sparks, Director
Mary J. Westerhold, Director
James Zimmer, Director