MUTUALFIRST FINANCIAL INC (Form: 10-Q, Received: 11/06/2019 14:04:49)

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

☒ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2019

☐ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from to

Commission File Number 000‑27905

MutualFirst Financial, Inc.

(Exact name of registrant as specified in its charter)


Maryland		35‑2085640
(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer Identification No.)

110 E. Charles Street, Muncie, Indiana		47305‑2419
(Address of principal executive offices)		(Zip Code)

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

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

Title of each class

Trading Symbol

Name of each exchange on which registered

Common stock, par value $.01 per share

MFSF

The NASDAQ Stock Market, LLC

(Global Select Market)

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

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

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


Large accelerated filer ☐	Accelerated filer ☒	Non-accelerated filer ☐	Smaller reporting company ☒	Emerging growth company ☐

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

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

Indicate the number of shares outstanding of each of the registrant’s classes of common stock as of the latest practicable date. As of November 6, 2019, there were 8,531,491 shares of the registrant’s common stock outstanding.

MutualFirst Financial, Inc.

Form 10‑Q Quarterly Report for the Period ended September 30, 2019

Table of Contents


			Page
			Number
PART I – FINANCIAL INFORMATION

Item 1.	Financial Statements
	Consolidated Condensed Balance Sheets	3
	Consolidated Condensed Statements of Income	4
	Consolidated Condensed Statements of Comprehensive Income	5
	Consolidated Condensed Statement of Stockholders’ Equity	6
	Consolidated Condensed Statements of Cash Flows	7
	Notes to Unaudited Consolidated Condensed Financial Statements	8

Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	38

Item 3.	Quantitative and Qualitative Disclosures about Market Risk	56

Item 4.	Controls and Procedures	57

PART II – OTHER INFORMATION

Item 1.	Legal Proceedings	58

Item 1A.	Risk Factors	58

Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	59

Item 3.	Defaults Upon Senior Securities	59

Item 4.	Mine Safety Disclosure	59

Item 5.	Other Information	59

Item 6.	Exhibits	60


Index to Exhibits		62
Signature Page		63

Table of Contents

MutualFirst Financial, Inc.

Consolidated Condensed Balance Sheets

(In Thousands, Except Share and Per Share Data)


	September 30,		December 31,
	2019		2018
	(Unaudited)
Assets
Cash and due from banks	$	10,440	$	13,078
Interest-bearing demand deposits		20,875		20,336
Cash and cash equivalents		31,315		33,414
Interest-bearing time deposits		4,023		4,239
Investment securities available for sale (carried at fair value)		382,976		370,875
Loans held for sale		19,643		3,987
Loans, net of allowance for loan losses of $13,411 and $13,281, at September 30, 2019 and December 31, 2018, respectively		1,483,611		1,482,662
Premises and equipment, net		24,518		25,641
Federal Home Loan Bank stock		13,115		13,034
Deferred tax asset, net		4,241		7,744
Cash value of life insurance		61,099		60,160
Goodwill		22,310		22,310
Core deposit intangibles		2,969		3,569
Other real estate owned and repossessed assets		1,952		2,013
Other assets		21,778		19,665
Total assets	$	2,073,550	$	2,049,313

Liabilities and Stockholders' Equity
Liabilities
Deposits
Noninterest-bearing	$	273,140	$	259,909
Interest-bearing		1,299,948		1,259,316
Total deposits		1,573,088		1,519,225
Federal Home Loan Bank advances		239,661		292,497
Other borrowings		17,653		17,988
Other liabilities		21,170		17,240
Total liabilities		1,851,572		1,846,950

Commitments and Contingencies

Stockholders' Equity
Common stock, $0.01 par value
Authorized - 20,000,000 shares
Issued and outstanding - 8,498,491 and 8,603,462 shares
at September 30, 2019 and December 31, 2018, respectively		85		86
Additional paid-in capital		113,879		117,883
Retained earnings		99,002		87,018
Accumulated other comprehensive income (loss)		9,012		(2,624)
Total stockholders' equity		221,978		202,363
Total liabilities and stockholders' equity	$	2,073,550	$	2,049,313

See notes to consolidated condensed financial statements

Table of Contents

MutualFirst Financial, Inc.

Consolidated Condensed Statements of Income

(Unaudited)

(In Thousands, Except Share and Per Share Data)


	Three Months Ended September 30,				Nine Months Ended September 30,
	2019		2018		2019		2018
Interest and Dividend Income
Loans receivable	$	18,754	$	17,902	$	55,566	$	49,965
Investment securities		2,604		2,732		8,100		7,591
Federal Home Loan Bank stock		180		144		536		460
Deposits with financial institutions		79		58		235		188
Total interest and dividend income		21,617		20,836		64,437		58,204

Interest Expense
Deposits		3,960		2,892		11,434		7,538
Federal Home Loan Bank advances		1,175		1,302		3,933		3,438
Other		237		225		739		619
Total interest expense		5,372		4,419		16,106		11,595

Net Interest Income		16,245		16,417		48,331		46,609
Provision for loan losses		425		570		1,375		1,520
Net Interest Income After Provision for Loan Losses		15,820		15,847		46,956		45,089

Non-interest Income
Service fee income		2,081		2,024		5,930		5,547
Net realized gain on sales of available for sale securities		109		406		975		666
Commissions		1,147		1,121		3,625		3,751
Net gains on sales of loans		1,778		853		4,149		2,224
Net servicing fees		158		129		446		433
Increase in cash value of life insurance		312		313		939		924
Gain (loss) on sale of other real estate and repossessed assets		28		23		(30)		(34)
Other income		236		170		604		766
Total non-interest income		5,849		5,039		16,638		14,277

Non-interest Expenses
Salaries and employee benefits		8,826		8,152		25,927		24,069
Net occupancy expenses		1,005		1,087		3,045		2,979
Equipment expenses		574		635		1,805		1,889
Data processing fees		680		669		1,970		1,938
ATM and debit card expenses		590		664		1,750		1,708
Deposit insurance		(3)		209		413		691
Professional fees		484		460		1,364		1,714
Advertising and promotion		296		416		970		1,275
Software subscriptions and maintenance		723		702		2,308		1,987
Intangible amortization		187		316		601		854
Other real estate and repossessed assets		47		51		170		140
Other expenses		1,074		1,213		3,363		4,470
Total non-interest expenses		14,483		14,574		43,686		43,714

Income Before Income Tax		7,186		6,312		19,908		15,652
Income tax expense		1,052		910		2,785		2,079
Net Income	$	6,134	$	5,402	$	17,123	$	13,573

Earnings Per Common Share
Basic	$	0.72	$	0.63	$	2.00	$	1.63
Diluted	$	0.71	$	0.62	$	1.97	$	1.60
Dividends Per Common Share	$	0.20	$	0.18	$	0.60	$	0.54

See notes to consolidated condensed financial statements

Table of Contents

MutualFirst Financial, Inc.

Consolidated Condensed Statements of Comprehensive Income

(Unaudited)

(In Thousands)


	Three Months Ended September 30,				Nine Months Ended September 30,
	2019		2018		2019		2018
Net Income	$	6,134	$	5,402	$	17,123	$	13,573
Other Comprehensive Income (Loss)
Net unrealized holding gain (loss) on securities available for sale		3,340		(3,186)		15,729		(9,429)
Reclassification adjustment for realized gains included in net income		(109)		(406)		(975)		(666)
		3,231		(3,592)		14,754		(10,095)
Income tax (benefit) expense related to other comprehensive income		(683)		758		(3,118)		2,139
Other comprehensive income (loss), net of tax		2,548		(2,834)		11,636		(7,956)
Comprehensive Income	$	8,682	$	2,568	$	28,759	$	5,617

See notes to consolidated condensed financial statements

Table of Contents

MutualFirst Financial, Inc.

Consolidated Condensed Statements of Stockholders’ Equity

(Unaudited)

(In Thousands, Except Share and Per Share Data)


	Three Months Ended
							Accumulated
			Additional				Other
	Common		Paid-in		Retained		Comprehensive
	Stock		Capital		Earnings		Income (Loss)		Total
Balances June 30, 2018	$	86	$	117,751	$	79,592	$	(4,741)	$	192,688
Net income						5,402				5,402
Other comprehensive loss, net of taxes								(2,834)		(2,834)
Cash dividends, common stock ($0.18 per share)						(1,546)				(1,546)
Balances September 30, 2018	$	86	$	117,751	$	83,448	$	(7,575)	$	193,710


Balances June 30, 2019	$	86	$	115,741	$	94,567	$	6,464	$	216,858
Net income						6,134				6,134
Other comprehensive income, net of taxes								2,548		2,548
Stock repurchased		(1)		(1,910)						(1,911)
Stock options, exercised				48						48
Cash dividends, common stock ($0.20 per share)						(1,699)				(1,699)
Balances September 30, 2019	$	85	$	113,879	$	99,002	$	9,012	$	221,978


	Nine Months Ended
							Accumulated
			Additional				Other
	Common		Paid-in		Retained		Comprehensive
	Stock		Capital		Earnings		Income (Loss)		Total
Balances December 31, 2017	$	74	$	75,319	$	74,508	$	381	$	150,282
Net income						13,573				13,573
Other comprehensive loss, net of taxes								(7,956)		(7,956)
Stock options, exercised				121						121
Cash dividends, common stock ($0.54 per share)						(4,633)				(4,633)
Issuance of common stock related to acquisition		12		42,311						42,323
Balances September 30, 2018	$	86	$	117,751	$	83,448	$	(7,575)	$	193,710


Balances December 31, 2018	$	86	$	117,883	$	87,018	$	(2,624)	$	202,363
Net income						17,123				17,123
Other comprehensive income, net of taxes								11,636		11,636
Stock repurchased		(1)		(4,261)						(4,262)
Stock options, exercised				257						257
Cash dividends, common stock ($0.60 per share)						(5,139)				(5,139)
Balances September 30, 2019	$	85	$	113,879	$	99,002	$	9,012	$	221,978

See notes to consolidated condensed financial statements

Table of Contents

MutualFirst Financial, Inc.

Consolidated Condensed Statements of Cash Flows

(Unaudited)

(In Thousands)


	Nine Months Ended September 30,
	2019		2018
Operating Activities
Net income	$	17,123	$	13,573
Items not requiring cash
Provision for loan losses		1,375		1,520
Depreciation and amortization		4,969		4,209
Deferred income tax		385		366
Increase in cash value of life insurance		(939)		(924)
Net accretion of purchase accounting adjustments		(34)		(134)
Loans originated for sale		(147,009)		(86,800)
Proceeds from sales of loans held for sale		135,410		85,846
Net gain on sale of loans		(4,149)		(2,224)
Net gain on sale of securities, available for sale		(975)		(666)
Gain on bank owned life insurance		-		(327)
Loss on sale of other real estate and repossessed assets		30		34
Change in
Interest receivable and other assets		3,249		1,280
Interest payable and other liabilities		(1,391)		528
Other adjustments		150		75
Net cash provided by operating activities		8,194		16,356

Investing Activities
Net change in interest-bearing time deposits		216		6,364
Purchases of securities, available for sale		(56,233)		(87,195)
Proceeds from maturities and paydowns of securities, available for sale		28,704		23,569
Proceeds from sales of securities, available for sale		29,939		57,689
Purchase of Federal Home Loan Bank stock		(81)		-
Net change in loans		(32,496)		(44,357)
Net cash and cash equivalents paid in acquisition		-		(7,673)
Proceeds from sales of portfolio loans		26,624		-
Purchases of premises and equipment		(946)		(907)
Proceeds from sale of real estate owned and repossessed assets		2,332		1,562
Proceeds from bank owned life insurance		-		1,669
Proceeds from sale of premises and equipment		375		67
Net cash used in investing activities		(1,566)		(49,212)

Financing Activities
Net change in
Noninterest-bearing, interest-bearing demand and savings deposits		36,486		(21,888)
Certificates of deposit		17,260		35,730
Proceeds from FHLB advances		298,500		367,000
Repayments of FHLB advances		(351,419)		(348,608)
Proceeds from other borrowings		-		10,000
Repayments of other borrowings		(410)		(335)
Cash dividends		(5,139)		(4,633)
Stock options exercised		257		121
Stock repurchased		(4,262)		-
Net cash provided by (used in) financing activities		(8,727)		37,387
Net Change in Cash and Cash Equivalents		(2,099)		4,531
Cash and Cash Equivalents, Beginning of Period		33,414		27,341
Cash and Cash Equivalents, End of Period	$	31,315	$	31,872

Additional Cash Flows Information
Interest paid	$	16,305	$	11,145
Income tax paid		1,500		350
Transfers from loans to loans held for sale		26,937		-
Transfers from loans to foreclosed assets		2,011		1,359
Mortgage servicing rights capitalized		405		321
Right of use assets obtained in exchange for lease obligations		3,603		-

In conjunction with the acquisition, liabilities were assumed as follows:
Fair value of assets acquired	$	-	$	406,858
Cash paid in acquisition		-		(18,999)
Common stock issued		-		(42,323)
Liabilities assumed	$	-	$	345,536

See notes to consolidated condensed financial statements

Table of Contents

MutualFirst Financial, Inc.

Notes to Consolidated Financial Statements

(Unaudited)

(In Thousands, Except Share and Per Share Data)

Note 1: Basis of Presentation

The consolidated condensed financial statements include the accounts of MutualFirst Financial, Inc. (MutualFirst or the “Company”), its wholly owned subsidiaries, MFBC Statutory Trust, Universal Preferred Trust, MutualFirst Risk Management, Inc., Mutual Risk Advisors, Inc., and MutualBank, an Indiana commercial bank (“Mutual” or the “Bank”), Mutual’s wholly owned subsidiaries, First MFSB Corporation, Mishawaka Financial Services, Summit Service Corp. and the wholly owned subsidiary of Summit Service Corp., Summit Mortgage Inc. (“Summit”), Mutual Federal Investment Company (“MFIC”), and MFIC majority owned subsidiary, Mutual Federal REIT, Inc. All significant inter-company accounts and transactions have been eliminated in consolidation. These companies conform to accounting principles generally accepted in the United States of America and reporting practices followed by the banking industry. The more significant of the policies are described below.

Certain information and note disclosures normally included in the Company’s annual financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted. These consolidated condensed financial statements should be read in conjunction with the consolidated financial statements and notes thereto included in the Company’s Annual Report on Form 10‑K for the year ended December 31, 2018, filed with the Securities and Exchange Commission on March 15, 2019.

The interim consolidated condensed financial statements at and for the three and nine months ended September 30, 2019 and 2018, have not been audited by independent accountants, but in the opinion of management, reflect all adjustments necessary to present fairly the financial position, results of operations and cash flows for such periods. The results of operations for the period are not necessarily indicative of the results to be expected for the full year.

The Consolidated Condensed Balance Sheet of the Company as of December 31, 2018 has been derived from the Audited Consolidated Balance Sheet of the Company as of that date.

Note 2: Acquisitions

On February 28, 2018, the Company completed the 100% acquisition of Universal Bancorp (“Universal”). Universal and BloomBank, a wholly-owned subsidiary of Universal, merged with and into the Company and the Bank, respectively. BloomBank was headquartered in Bloomfield, Indiana and had 13 retail financial center offices serving counties in central and southern Indiana. Under terms of the merger agreement, shareholders of Universal received fixed consideration of 15.6 shares of MutualFirst common stock and $250.00 in cash for each share of Universal common stock. The Company issued approximately 1.2 million shares of common stock, which was valued at approximately $42.3 million. Based upon the February 28, 2018 closing price of $35.70 per share of MutualFirst common stock, the transaction had an implied valuation of approximately $61.3 million. The Company incurred approximately $2.2 million in pre-tax expenses related to the acquisition in the first nine months of 2018. These expenses were classified in the non-interest expense section of the income statement, primarily in professional fees and other expenses. As a result of the acquisition, the Company was able to increase both its deposit and loan base and expects to reduce costs through economies of scale. Goodwill resulted from this transaction due to the expected synergies and economies of scale.

Under the acquisition method of accounting, the total purchase price is allocated to net tangible and intangible assets based on their current estimated fair values on the date of the acquisition. Based on valuations of the fair value of tangible and intangible assets acquired, liabilities assumed and related deferred

Table of Contents

tax impacts, which were based on assumptions that were subject to change as management evaluated, the purchase price for the Universal acquisition is detailed in the following table. If, prior to the end of the one-year measurement period for finalizing the purchase price allocation, information becomes available which would indicate adjustments were required to the purchase price allocation, such adjustments would be recorded in the reporting period in which the adjustment amounts were determined. The first quarter of 2019 was the final period allowing for measurement period adjustments. There were no measurement period adjustments in 2019. Measurement period adjustments recorded in 2018 were calculated as if the accounting had been completed as of the acquisition date.


Assets			Liabilities
Cash and cash equivalents	$	11,326	Deposits
Interest-bearing time deposits		8,747	Non-interest bearing	$	81,061
Investment securities, available for sale		87,817	NOW accounts		66,372
			Savings and money market		85,690
Loans			Certificated of deposits		82,107
Commercial		203,489	Total deposits		315,230
Residential mortgage		36,410
Consumer		12,532	Borrowings		25,463
Total loans		252,431	Interest payable		81
			Subordinated debt		4,000
Premises and equipment, net		4,799	Other liabilities		462
Federal Home Loan Bank stock		1,637	Total liabilities assumed	$	345,236
Deferred tax asset, net		2,848
Cash value of life insurance		7,556
Goodwill		20,511
Core deposit intangible		4,545
Interest receivable		1,259
Other real estate owned and repossessed assets		1,009
Other assets		2,073
Total assets purchased	$	406,558

Common shares issued	$	42,323
Cash paid		18,999
Total purchase price	$	61,322

Of the total purchase price, $4.5 million was allocated to a core deposit intangible that is being amortized over its estimated life of 15 years. Of the remaining purchase price, $20.5 million was allocated to goodwill, which is not deductible for tax purposes. Loans acquired had a fair value of $252.4 million. The contractual principal at the acquisition date was $257.0 million. The $4.6 million will be accreted into income for the performing loans or utilized for charging off non-performing loans.

Pro Forma Financial Information

The results of operations of Universal Bancorp have been included in the Company’s consolidated financial statements since the acquisition date. The following schedule includes pro forma results for the three and

Table of Contents

nine months ended September 30, 2018, as if the Universal acquisition occurred as of the beginning of the reporting periods presented.


	Three Months Ended		Nine Months Ended
	September 30, 2018		September 30, 2018
Summary of Operations
Net interest income	$	16,417	$	48,900
Provision for loan losses		(570)		(1,520)
Net interest income after provision	$	15,847	$	47,380
Non-interest income		5,039		14,556
Non-interest expense		(14,574)		(49,532)
Income before income taxes	$	6,312	$	12,404
Income tax benefit (expense)		(910)		(1,286)
Net income to common shareholders	$	5,402	$	11,118
Basic earnings per share	$	0.63	$	1.30
Diluted earnings per share	$	0.62	$	1.27

The pro-forma information for September 30, 2018 includes operating revenue from Universal of $9.1 million since the date of acquisition. Earnings of Universal since the acquisition date, net of tax and non-recurring expenses related to the acquisition were $4.2 million as of September 30, 2018. The pro forma information is presented for information purposes only and is not indicative of the results of operations that actually would have been achieved had the acquisition been consummated as of that time, nor is it intended to be a projection of future results.

Note 3: Earnings Per Share

Earnings per share were computed as follows:


	Three Months Ended September 30,
	2019					2018
			Weighted-Average	Per-Share				Weighted-Average	Per-Share
	Net Income		Shares	Amount		Net Income		Shares	Amount
Basic Earnings Per Share
Net income	$	6,134	8,516,038	$	0.72	$	5,402	8,587,424	$	0.63
Effect of Dilutive Securities
Stock options			112,992					146,267
Diluted Earnings Per Share
Net income available and assumed conversions	$	6,134	8,629,030	$	0.71	$	5,402	8,733,691	$	0.62


	Nine Months Ended September 30,
	2019					2018
			Weighted-Average	Per-Share				Weighted-Average	Per-Share
	Net Income		Shares	Amount		Net Income		Shares	Amount
Basic Earnings Per Share
Net income	$	17,123	8,579,514	$	2.00	$	13,573	8,327,963	$	1.63
Effect of Dilutive Securities
Stock options			117,851					151,945
Diluted Earnings Per Share
Net income available and assumed conversions	$	17,123	8,697,365	$	1.97	$	13,573	8,479,908	$	1.60

As of September 30, 2019 and 2018, the exercise price for all options was lower than the average market price of the common shares.

Table of Contents

Note 4: Impact of Accounting Pronouncements

In March 2019, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2019-01 “Leases (Topic 842): Codification Improvements.” These amendments align the guidance for fair value of the underlying asset by lessors that are not manufacturers or dealers in Topic 842 with that of existing guidance. Finally, the ASU exempts both lessees and lessors from having to provide certain interim disclosures in the fiscal year in which a company adopts the new leases standard. The guidance is effective for fiscal years beginning after December 15, 2019, and interim periods within those fiscal years. Early application is permitted. An entity should apply the amendments as of the date that it first applied Topic 842, using the same transition methodology in accordance with paragraph 842-10-65-1(c). The Company adopted Topic 842 on January 1, 2019 and applied the amendments in ASU 2019-01 as of the same date and it did not have a material impact on its accounting and disclosures.

In August 2018, the FASB issued ASU 2018‑13, Fair Value Measurement (Topic 820): Disclosure Framework - Changes to the Disclosure Requirements for Fair Value Measurement. These amendments modify the disclosure requirements in Topic 820 as follows:

Removal of the amount of and reasons for transfers between Level 1 and Level 2 of the fair value hierarchy; the policy for timing of transfers between levels; and the valuation processes for Level 3 fair value measurements.

For investments in certain entities that calculate net asset value, an entity is required to disclose the timing of liquidation of an investee’s assets and the date when restrictions from redemption might lapse only if the investee has communicated the timing to the entity or announced the timing publicly; and the amendments clarify that the measurement uncertainty disclosure is to communicate information about the uncertainty in measurement as of the reporting date.

Additional disclosure of the changes in unrealized gains and losses for the period included in other comprehensive income for recurring Level 3 fair value measurements held at the end of the reporting period; and the range and weighted average of significant unobservable inputs used to develop Level 3 fair value measurements.

The guidance is effective for all entities for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2019. Early adoption is permitted. An entity is permitted to early adopt any removed or modified disclosures upon issuance of ASU No. 2018‑13 and delay adoption of the additional disclosures until their effective date. The adoption of ASU 2018‑13 is not anticipated to have a material effect on the Company's consolidated financial statements.

In June 2018, the FASB issued ASU 2018‑07, Compensation – Stock Compensation (Topic 718) – Improvements to Nonemployee Share-Based Payment Accounting. This ASU expands the scope of Topic 718, Compensation – Stock Compensation to include share-based payments issued to nonemployees for goods and services. Topic 718 currently only includes share-based payments to employees where the ASU will substantially align the accounting for share-based payments to nonemployees and employees. The ASU supersedes Subtopic 505‑50, Equity – Equity-Based Payments to Non-Employees. The guidance is effective for public companies for fiscal year, and interim fiscal periods within those fiscal years, beginning after December 15, 2018. Early adoption is permitted, but no earlier than a company’s adoption date of Topic 606, Revenue from Contracts with Customers. The Company has adopted ASU 2018‑07 and it did not have a material impact on the Company’s accounting and disclosures.

In August 2017, the FASB issued ASU 2017-12, Targeted Improvements to Accounting for Hedging Activities. The new guidance will make more financial and nonfinancial hedging strategies eligible for hedge accounting. It also amends the presentation and disclosure requirements and changes how companies assess effectiveness. It is intended to more closely align hedge accounting with companies’ risk management strategies, simplify the application of hedge accounting, and increase transparency as to the scope and results of hedging programs. The guidance is effective for fiscal years beginning after December 15, 2018,

Table of Contents

with early adoption, permitted. The Company adopted ASU 2017-12 on January 1, 2019 and it did not have a material impact on the Company’s accounting and disclosures.

In June 2016, the FASB issued ASU 2016‑13, Financial Instruments-Credit Losses (Topic 326): Measurement of Credit Losses on Financial Statements. Topic 326 amends guidance on reporting credit losses for assets held at amortized cost basis and available for sale debt securities. The ASU is intended to provide financial statement users with useful information about the expected credit losses on financial instruments and other commitments to extend credit.

The ASU requires financial assets measured at amortized cost (primarily loans) be presented at the amount net of a valuation allowance for credit losses, and that the income statement include the measurement of credit losses for newly recognized financial assets as well as changes in expected losses on previously recognized financial assets. The provisions of this ASU do not specify the method for measuring expected credit losses, and an entity is allowed to apply methods that reasonably reflect its expectations of the credit loss estimate. The new model will be based on relevant information including past events, historical experience, current conditions, and reasonable and supportive forecasts that affect the collectability of the asset. The provisions of this ASU differ from current U.S. generally accepted accounting principles (“GAAP”) in that current U.S. GAAP generally delays recognition of the full amount of credit losses until the loss is probable of occurring.

This ASU requires that credit losses on available-for-sale debt securities be presented as an allowance rather than as a write-down.

This ASU was originally effective for the Company for interim and annual periods beginning in the first quarter of 2020, but on October 16, 2019, FASB approved a final ASU delaying the effective date for smaller reporting companies, such as the Company. The final ASU expected to be issued by the end of November, delays the effective date of this ASU for the Company until fiscal years beginning after December 15, 2022. Earlier adoption is permitted beginning in the first quarter of 2019. The Company is in the process of implementing a third-party software solution to assist in the application of the new standard. The Company continues to evaluate all resources and data (both current and historical) needed. The overall impact of the new standard on the financial condition or results of operations cannot yet be determined.

In February 2016, the FASB issued ASU 2016‑02, Leases. The objective of the amendment is to establish the principles that lessees and lessors shall apply to report useful information to users of financial statements about the amount, timing, and uncertainty of cash flows arising from a lease. These changes will increase transparency among companies by recognizing lease assets and liabilities on the balance sheet and disclosing additional information about lease arrangements. The amendments in this update were effective for annual and interim periods beginning in the first quarter of 2019. The Company has operating leases in place for some locations as well as equipment. In July 2018, the FASB issued ASU 2018-10, which provides narrow-scope improvements to the lease standard and ASU 2018-11, which allows entities to choose an additional transition method, under which an entity initially applies the new lease standard at the adoption date and recognizes a cumulative-effect adjustment to the opening balance of retained earnings in the period of adoption. Under this transitional method, the entity shall recognize and measure the leases that exist at the adoption date and the prior comparative periods are not adjusted. The Company adopted this ASU as of January 1, 2019 using the transitional method. The new standard provides a number of optional practical expedients in transition. The Company has elected the practical expedients that allowed the Company to retain the classifications of existing leases, not re-assess if existing leases have initial direct costs and hindsight when determining the lease term and assessment of impairment. The Company adopted ASU 2016-02 on January 1, 2019 and recorded a right-of-use asset and lease liability of $3.6 million, based on the present value of the expected remaining lease payments.

Note 5: Investment Securities

The amortized costs and approximate fair values, together with gross unrealized gains and losses on securities, are in the tables below. All mortgage-backed securities and collateralized mortgage obligations

Table of Contents

held as of September 30, 2019 and December 31, 2018 were guaranteed by government sponsored entities, government corporations or federal agencies.


	September 30, 2019
			Gross		Gross
			Unrealized		Unrealized
	Amortized Cost		Gains		Losses		Fair Value
Available for Sale Securities
Mortgage-backed securities	$	113,701	$	1,970	$	(215)	$	115,456
Collateralized mortgage obligations		99,769		720		(217)		100,272
Municipal obligations		154,948		9,951		-		164,899
Corporate obligations		2,991		-		(642)		2,349
Total investment securities	$	371,409	$	12,641	$	(1,074)	$	382,976


	December 31, 2018
			Gross		Gross
			Unrealized		Unrealized
	Amortized Cost		Gains		Losses		Fair Value
Available for Sale Securities
Mortgage-backed securities	$	106,094	$	296	$	(2,047)	$	104,343
Collateralized mortgage obligations		110,994		157		(1,870)		109,281
Municipal obligations		153,976		2,008		(1,088)		154,896
Corporate obligations		2,998		-		(643)		2,355
Total investment securities	$	374,062	$	2,461	$	(5,648)	$	370,875

The amortized cost and fair value of securities available for sale at September 30, 2019, by contractual maturity, are shown below. Expected maturities will differ from contractual maturities because issuers may have the right to call or prepay obligations with or without call or prepayment penalties.


	Available for Sale
Description of Securities	Amortized Cost		Fair Value
Security obligations due
Within one year	$	-	$	-
One to five years		285		290
Five to ten years		16,518		17,260
After ten years		141,136		149,698
		157,939		167,248
Mortgage-backed securities		113,701		115,456
Collateralized mortgage obligations		99,769		100,272
Totals	$	371,409	$	382,976

The carrying value of securities pledged as collateral, to secure interest rate swaps, was $2.9 million at September 30, 2019. No securities were pledged as collateral at December 31, 2018.

Proceeds from sales of securities available for sale for the three and nine months ended September 30, 2019 were $5.2 million and $29.9 million, respectively. For the three and nine months ended September 30, 2018, proceeds from sales of securities available for sale were $14.4 million and $57.7 million, respectively. Gross gains were recognized on the sales for the three and nine months ended September 30, 2019 of $110,000 and $977,000, respectively. Gross gains of $485,000 and $748,000 were recognized on the sales for the three and nine months ended September 30, 2018, respectively. Gross losses of $1,000 and $2,000 were also recognized on the sales for the three and nine months ended September 30, 2019, respectively. Gross losses of $79,000 and $82,000 were recognized on the sales of securities for the three and nine months ended September 30, 2018, respectively.

Certain investments in debt securities are reported in the financial statements at an amount less than their amortized cost. Total fair value of these investments at September 30, 2019 and December 31, 2018 was

Table of Contents

$72.5 million and $206.9 million, respectively, which were approximately 19.0% and 55.8%, respectively, of the Company’s investment portfolio at those dates.

Based on our evaluation of available evidence, including recent changes in market interest rates, management believes the fair value for the securities at less than amortized cost for the periods presented are temporary.

Should the impairment of any of these securities become other-than-temporary, the cost basis of the investment will be reduced and the resulting loss recognized in net income in the period the other-than-temporary impairment is identified.

During the first nine months of 2019 and 2018, the Bank determined that its security holdings had no other-than-temporary impairment.

The following tables show the gross unrealized losses and fair value of the Company’s investments, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position at September 30, 2019 and December 31, 2018:


	September 30, 2019
	Less than 12 Months				12 Months or More				Total
			Unrealized				Unrealized				Unrealized
	Fair Value		Losses		Fair Value		Losses		Fair Value		Losses
Available for Sale Securities
Mortgage-backed securities	$	10,137	$	(17)	$	20,085	$	(198)	$	30,222	$	(215)
Collateralized mortgage obligations		21,156		(65)		18,737		(152)		39,893		(217)
Corporate obligations		-		-		2,349		(642)		2,349		(642)
Total temporarily impaired securities	$	31,293	$	(82)	$	41,171	$	(992)	$	72,464	$	(1,074)


	December 31, 2018
	Less than 12 Months				12 Months or More				Total
			Unrealized				Unrealized				Unrealized
	Fair Value		Losses		Fair Value		Losses		Fair Value		Losses
Available for Sale Securities
Mortgage-backed securities	$	33,176	$	(348)	$	42,230	$	(1,699)	$	75,406	$	(2,047)
Collateralized mortgage obligations		15,139		(111)		64,495		(1,759)		79,634		(1,870)
Municipal obligations		35,501		(542)		14,018		(546)		49,519		(1,088)
Corporate obligations		-		-		2,355		(643)		2,355		(643)
Total temporarily impaired securities	$	83,816	$	(1,001)	$	123,098	$	(4,647)	$	206,914	$	(5,648)

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

The unrealized losses on the Company’s investments in MBSs and CMOs were caused by interest rate changes and illiquidity. The Company expects to recover the amortized cost basis over the term of the securities. Because (1) the decline in market value is attributable to changes in interest rates and illiquidity and not credit quality, (2) the Company does not intend to sell the investments and (3) it is more likely than not the Company will not be required to sell the investments before recovery of their amortized cost bases, which may be at maturity, the Company does not consider any of these investments to be other-than-temporarily impaired at September 30, 2019.

Municipal Obligations

The unrealized losses on the Company’s investments in securities of state and political subdivisions were caused by changes in interest rates and illiquidity. The contractual terms of those investments do not permit the issuer to settle the securities at a price less than the par value of the investments. The Company does not intend to sell these investments and it is more likely than not that the Company will not be required to sell these investments. The Company does not consider any of these investment securities to be other-than-temporarily impaired at September 30, 2019.

Table of Contents

Corporate Obligations

The Company’s unrealized losses on investments in corporate obligations primarily relates to a pooled trust preferred security. The unrealized losses were primarily due to illiquidity.

Other-Than-Temporary Impairment (OTTI)

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

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

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

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

Detailed credit and structural evaluation of each piece of collateral in the trust preferred securities;

Collateral performance projections for each piece of collateral in the trust preferred security;

Terms of the trust preferred structure, as laid out in the indenture; and

Discounted cash flow modeling.

MutualFirst Financial uses market-based yield indicators as a baseline for determining appropriate discount rates, and then adjusts the resulting discount rates on the basis of its credit and structural analysis of specific trust preferred securities. The primary focus is on the returns a fixed income investor would require in order to allocate capital on a risk adjusted basis. There is currently little demand for pooled trust preferred securities; however, the Company looks principally to market yields for stand-alone trust preferred securities issued by banks, thrifts and insurance companies for which there is an active and liquid market. The next step is to make a series of adjustments to reflect the differences that exist between these products (both credit and structural) and, most importantly, to reflect idiosyncratic credit performance differences (both actual and projected) between these products and the underlying collateral in the specific trust preferred security. Importantly, as part of the analysis described above, MutualFirst Financial considers the fact that structured instruments frequently exhibit leverage not present in stand-alone instruments, and makes adjustments as necessary to reflect this additional risk.

Table of Contents

Pooled Trust Preferred Securities. The Bank has invested in a pooled trust preferred security. At September 30, 2019, the current book value of our pooled trust preferred security was $3.0 million. The original par value of this security was $3.0 million. The pooled trust preferred security owned was performing as agreed in the first nine months of 2019. As of September 2019, current Moody’s rating for this bond was B3. The pooled trust preferred security owned by the Bank is exempt from the Volcker Rule.

The following table provides additional information related to the Bank’s investment in a pooled trust preferred security as of September 30, 2019:

Total

Excess

Number

subordination

Number of

of Banks

Actual

Total

(after taking

Banks /

and

Deferrals/

Projected

into account

Insurance

Defaults

best estimate

Realized

Cos.

Cos. In

(as a % of

of future

Original

Book

Fair

Unrealized

Losses

Lowest

Currently

Issuance

original

performing

deferrals/

Deal Name

Class

Par

Value

Loss

2019

Ratings

Performing

(Unique)

collateral)

collateral) (1)

defaults) (2)

(Dollars in Thousands)

U.S. Capital Funding I

3,000

2,991

2,349

(642)

Caa1

7.95

5.78

6.69

(1) A 10% recovery is applied to all projected defaults by depository institutions. A 15% recovery is applied to all projected defaults by insurance companies.

No recovery is applied to current defaults.

(2) Excess subordination represents the additional defaults in excess of both current and projected defaults that the collateralized debt obligation can absorb

before the bond experiences any credit impairment. Excess subordinated percentage is calculated by (a) determining what percentage of defaults a pool

can experience before the bond has credit impairment, and (b) subtracting from this default breakage percentage both total current and expected future

default percentages.

Table of Contents

Note 6: Loans and Allowance

Classes of loans at September 30, 2019 and December 31, 2018 include:


	September 30,		December 31,
	2019		2018
Real estate
Commercial	$	500,152	$	485,808
Commercial construction and development		57,780		53,310
Consumer closed end first mortgage		415,714		464,539
Consumer open end and junior liens		75,566		77,072
Total real estate loans		1,049,212		1,080,729
Other loans
Consumer loans
Auto		57,861		43,667
Boat/RVs		217,412		216,608
Other consumer loans		7,114		6,893
Commercial and industrial		159,069		149,359
Total other loans		441,456		416,527
Total loans		1,490,668		1,497,256
Undisbursed loans in process		(2,681)		(10,096)
Unamortized deferred loan costs, net		9,035		8,783
Allowance for loan losses		(13,411)		(13,281)
Net loans	$	1,483,611	$	1,482,662

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

Commercial

Real estate

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

Construction and Development

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

Table of Contents

Commercial and Industrial

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

Consumer Real Estate and Other Consumer Loans

With respect to residential loans that are secured by consumer closed end first mortgages and are primarily owner occupied, the Company generally establishes a maximum loan-to-value ratio and requires private mortgage insurance if that ratio is exceeded. Consumer open end and junior lien loans are typically secured by a subordinate interest in 1‑4 family residences, and other consumer loans are secured by consumer assets such as automobiles or recreational vehicles. Some consumer loans are unsecured such as small installment loans and certain lines of credit. Repayment of these loans is primarily dependent on the personal income of the borrowers, which can be impacted by economic conditions in their market areas such as unemployment levels. Repayment can also be impacted by changes in property values on residential properties. Risk is mitigated by the fact that the loans are of smaller individual amounts and spread over a large number of borrowers.

Nonaccrual Loans and Past Due Loans

Loans are considered past due if the required principal and interest payments have not been received as of the date such payments were due. Loans are placed on non-accrual status when the loan is greater than 90 days past due, the borrower, in management’s opinion, may be unable to meet payment obligations as they become due or when required by regulatory provisions.

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

Nonaccrual loans, segregated by class of loans, as of September 30, 2019 and December 31, 2018 are as follows:


	September 30,		December 31,
	2019		2018
Real estate
Commercial	$	881	$	4,782
Commercial construction and development		-		62
Consumer closed end first mortgage		3,574		2,777
Consumer open end and junior liens		184		273
Consumer loans
Auto		185		88
Boat/RVs		531		470
Other consumer loans		16		46
Commercial and industrial		323		91
Total nonaccrual loans	$	5,694	$	8,589

Table of Contents

An age analysis of the Company’s past due loans, segregated by class of loans, as of September 30, 2019 and December 31, 2018 are as follows:


	September 30, 2019
													Total Loans
													90 Days
	30‑59		60‑89		90 Days		Total				Total		Past Due
	Days Past		Days Past		or More		Past				Loans		and
	Due		Due		Past Due		Due		Current		Receivable		Accruing
Real estate
Commercial	$	2,798	$	3,662	$	531	$	6,991	$	493,161	$	500,152	$	-
Commercial construction and development		—		-		-		—		57,780		57,780		-
Consumer closed end first mortgage		6,164		1,465		3,046		10,675		405,039		415,714		148
Consumer open end and junior liens		557		116		92		765		74,801		75,566		-
Consumer loans
Auto		447		102		107		656		57,205		57,861		-
Boat/RVs		2,119		567		421		3,107		214,305		217,412		-
Other consumer loans		88		43		13		144		6,970		7,114		-
Commercial and industrial		1,577		220		311		2,108		156,961		159,069		-
Total	$	13,750	$	6,175	$	4,521	$	24,446	$	1,466,222	$	1,490,668	$	148


	December 31, 2018
													Total Loans
													90 Days
	30‑59		60‑89		90 Days		Total				Total		Past Due
	Days Past		Days Past		or More		Past				Loans		and
	Due		Due		Past Due		Due		Current		Receivable		Accruing
Real estate
Commercial	$	1,145	$	536	$	4,377	$	6,058	$	479,750	$	485,808	$	-
Commercial construction and development		4,633		-		61		4,694		48,616		53,310		-
Consumer closed end first mortgage		7,847		1,662		2,696		12,205		452,334		464,539		517
Consumer open end and junior liens		353		114		220		687		76,385		77,072		-
Consumer loans
Auto		257		16		72		345		43,322		43,667		-
Boat/RVs		2,174		594		350		3,118		213,490		216,608		-
Other consumer loans		65		8		41		114		6,779		6,893		-
Commercial and industrial		617		93		91		801		148,558		149,359		-
Total	$	17,091	$	3,023	$	7,908	$	28,022	$	1,469,234	$	1,497,256	$	517

Impaired Loans

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

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

Table of Contents

The following tables present impaired loans as of and for the three and nine month periods ended September 30, 2019 and 2018 and as of and for the year ended December 31, 2018.


	September 30, 2019
							Average		Average		Interest
			Unpaid				Investment in		Investment		Income		Interest
	Recorded		Principal		Specific		Impaired		in Impaired		Recognized –		Income
	Balance		Balance		Allowance		Loans - QTD		Loans - YTD		QTD		Recognized - YTD
Loans without a specific valuation allowance
Real estate
Commercial	$	5,607	$	5,607	$	-	$	5,609	$	5,962	$	70	$	312
Commercial construction and development		371		371		-		373		459		4		13
Consumer closed end first mortgage		844		844		-		844		918		-		-
Commercial and industrial		48		48		-		49		97		-		2

Loans with a specific valuation allowance
Real estate
Consumer closed end first mortgage		336		336		40		336		252		-		-
Other consumer
Boat and RV		254		254		87		127		64		-		-

Total
Real estate
Commercial	$	5,607	$	5,607	$	-	$	5,609	$	5,962	$	70	$	312
Commercial construction and development	$	371	$	371	$	-	$	373	$	459	$	4	$	13
Consumer closed end first mortgage	$	1,180	$	1,180	$	40	$	1,180	$	1,170	$	-	$	-
Commercial and industrial	$	48	$	48	$	-	$	49	$	97	$	-	$	2
Other consumer
Boat and RV	$	254	$	254	$	87	$	127	$	64	$	-	$	-

Total	$	7,460	$	7,460	$	127	$	7,338	$	7,752	$	74	$	327

Table of Contents


	September 30, 2018
							Average		Average		Interest
			Unpaid				Investment in		Investment		Income		Interest
	Recorded		Principal		Specific		Impaired		in Impaired		Recognized –		Income
	Balance		Balance		Allowance		Loans - QTD		Loans - YTD		QTD		Recognized - YTD
Loans without a specific valuation allowance
Real estate
Commercial	$	703	$	703	$	-	$	704	$	772	$	-	$	-
Commercial construction and development		607		607		-		623		653		7		21
Consumer closed end first mortgage		1,140		1,140		-		1,105		1,291		-		-
Commercial and industrial		138		138		-		141		177		1		4

Loans with a specific valuation allowance
Real estate
Commercial		214		214		100		214		214		-		-

Total
Real estate
Commercial	$	917	$	917	$	100	$	918	$	986	$	-	$	-
Commercial construction and development	$	607	$	607	$	-	$	623	$	653	$	7	$	21
Consumer closed end first mortgage	$	1,140	$	1,140	$	-	$	1,105	$	1,291	$	-	$	-
Commercial and industrial	$	138	$	138	$	-	$	141	$	177	$	1	$	4

Total	$	2,802	$	2,802	$	100	$	2,787	$	3,107	$	8	$	25


	December 31, 2018
							Average
			Unpaid				Investment		Interest
	Recorded		Principal		Specific		in Impaired		Income
	Balance		Balance		Allowance		Loans		Recognized
Loans without a specific valuation allowance
Real estate
Commercial	$	6,324	$	6,377	$	-	$	1,882	$	-
Commercial construction and development		549		549		-		633		27
Consumer closed end first mortgage		1,137		1,137		-		1,260		-
Commercial and industrial		131		131		-		167		5

Loans with a specific valuation allowance
Real estate
Commercial		174		214		100		206		-

Total
Real estate
Commercial	$	6,498	$	6,591	$	100	$	2,088	$	-
Commercial construction and development	$	549	$	549	$	-	$	633	$	27
Consumer closed end first mortgage	$	1,137	$	1,137	$	-	$	1,260	$	-
Commercial and industrial	$	131	$	131	$	-	$	167	$	5

Total	$	8,315	$	8,408	$	100	$	4,148	$	32

The following information presents the credit risk profile of the Company’s loan portfolio based on rating category and payment activity as of September 30, 2019.

Table of Contents

Commercial Loan Grades

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

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

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

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

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

Retail Loan Grades

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

Table of Contents

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


	September 30, 2019
	Commercial								Consumer
			Special
	Pass		Mention		Substandard		Doubtful		Pass		Substandard		Total
Real estate
Commercial	$	473,342	$	17,722	$	9,088	$	-					$	500,152
Commercial construction and development		49,082		8,328		370		-						57,780
Consumer closed end first mortgage									$	411,029	$	4,685		415,714
Consumer open end and junior liens										75,324		242		75,566

Other loans
Consumer loans
Auto										57,658		203		57,861
Boat/RVs										216,616		796		217,412
Other consumer loans										7,097		17		7,114
Commercial and industrial		152,406		2,178		4,485		-						159,069
	$	674,830	$	28,228	$	13,943	$	-	$	767,724	$	5,943	$	1,490,668


	December 31, 2018
	Commercial								Consumer
			Special
	Pass		Mention		Substandard		Doubtful		Pass		Substandard		Total
Real estate
Commercial	$	465,888	$	9,501	$	10,419	$	-					$	485,808
Commercial construction and development		46,649		6,112		549		-						53,310
Consumer closed end first mortgage									$	459,771	$	4,768		464,539
Consumer open end and junior liens										76,752		320		77,072

Other loans
Consumer loans
Auto										43,559		108		43,667
Boat/RVs										215,830		778		216,608
Other consumer loans										6,835		58		6,893
Commercial and industrial		141,705		4,009		3,645		-						149,359
	$	654,242	$	19,622	$	14,613	$	-	$	802,747	$	6,032	$	1,497,256

Allowance for Loan Losses.

We maintain an allowance for loan losses to absorb losses inherent in the loan portfolio. The allowance is based on ongoing, quarterly assessments of the estimated losses inherent in the loan portfolio. Our methodology for assessing the appropriateness of the allowance consists of several key elements, including the general allowance and specific allowances for identified problem loans and portfolio segments. In addition, the allowance incorporates the results of measuring impaired loans as provided in FASB ASC 310, Receivables. These accounting standards prescribe the measurement methods, income recognition and disclosures related to impaired loans. The general allowance is calculated by applying loss factors to outstanding loans based on the internal risk evaluation of such loans or pools of loans. Changes in risk evaluations of both performing and nonperforming loans affect the amount of the general allowance. Loss factors are based on our historical loss experience as well as on significant factors that, in management’s judgment, affect the collectability of the portfolio as of the evaluation date.

Table of Contents

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

The allowance for loan losses is based on estimates of losses inherent in the loan portfolio. Actual losses can vary significantly from the estimated amounts. Our methodology as described permits adjustments to any loss factor used in the computation of the general allowance in the event that, in management’s judgment, significant factors which affect the collectability of the portfolio as of the evaluation date are not reflected in the loss factors. By assessing the probable incurred losses inherent in the loan portfolio on a quarterly basis, we are able to adjust specific and inherent loss estimates based upon any more recent information that has become available.

The following tables detail activity in the allowance for loan losses by portfolio segment for the three and nine month periods ended September 30, 2019 and 2018, respectively. Allocation of a portion of the allowance to one category of loans does not preclude its availability to absorb losses in other segments.


	Three Months Ended September 30, 2019
	Commercial		Mortgage		Consumer		Total
Allowance for loan losses:
Balance, beginning of period	$	8,540	$	1,363	$	3,532	$	13,435
Provision charged (credited) to expense		134		36		255		425
Losses charged off		(69)		(42)		(388)		(499)
Recoveries		4		1		45		50
Balance, end of period	$	8,609	$	1,358	$	3,444	$	13,411


	Three Months Ended September 30, 2018
	Commercial		Mortgage		Consumer		Total
Allowance for loan losses:
Balance, beginning of period	$	8,043	$	1,606	$	3,080	$	12,729
Provision charged (credited) to expense		133		59		378		570
Losses charged off		(25)		(67)		(248)		(340)
Recoveries		-		1		49		50
Balance, end of period	$	8,151	$	1,599	$	3,259	$	13,009


	Nine Months Ended September 30, 2019
	Commercial		Mortgage		Consumer		Total
Allowance for loan losses:
Balance, beginning of year	$	8,426	$	1,548	$	3,307	$	13,281
Provision charged (credited) to expense		332		(78)		1,121		1,375
Losses charged off		(167)		(115)		(1,134)		(1,416)
Recoveries		18		3		150		171
Balance, end of period	$	8,609	$	1,358	$	3,444	$	13,411

Table of Contents


	Nine Months Ended September 30, 2018
	Commercial		Mortgage		Consumer		Total
Allowance for loan losses:
Balance, beginning of year	$	7,704	$	1,761	$	2,922	$	12,387
Provision charged (credited) to expense		600		(28)		948		1,520
Losses charged off		(165)		(144)		(771)		(1,080)
Recoveries		12		10		160		182
Balance, end of period	$	8,151	$	1,599	$	3,259	$	13,009

The following tables provide a breakdown of the allowance for loan losses and loan portfolio balances by segment as of September 30, 2019 and 2018, and December 31, 2018.


	September 30, 2019
	Commercial		Mortgage		Consumer		Total
Allowance balances
Individually evaluated for impairment	$	-	$	40	$	87	$	127
Collectively evaluated for impairment		8,609		1,318		3,357		13,284
Total allowance for loan losses	$	8,609	$	1,358	$	3,444	$	13,411
Loan balances
Individually evaluated for impairment	$	6,026	$	1,180	$	254	$	7,460
Collectively evaluated for impairment		710,975		414,534		357,699		1,483,208
Gross loans	$	717,001	$	415,714	$	357,953	$	1,490,668


	September 30, 2018
	Commercial		Mortgage		Consumer		Total
Allowance balances
Individually evaluated for impairment	$	100	$	-	$	-	$	100
Collectively evaluated for impairment		8,051		1,599		3,259		12,909
Loans acquired with deteriorated credit quality		-		-		-		-
Total allowance for loan losses	$	8,151	$	1,599	$	3,259	$	13,009
Loan balances
Individually evaluated for impairment	$	1,662	$	1,140	$	-	$	2,802
Collectively evaluated for impairment		676,767		469,278		329,275		1,475,320
Loans acquired with deteriorated credit quality		-		-		-		-
Gross loans	$	678,429	$	470,418	$	329,275	$	1,478,122


	December 31, 2018
	Commercial		Mortgage		Consumer		Total
Allowance balances
Individually evaluated for impairment	$	100	$	-	$	-	$	100
Collectively evaluated for impairment		8,326		1,548		3,307		13,181
Loans acquired with deteriorated credit quality		-		-		-		-
Total allowance for loan losses	$	8,426	$	1,548	$	3,307	$	13,281
Loan balances
Individually evaluated for impairment	$	7,178	$	1,137	$	-	$	8,315
Collectively evaluated for impairment		681,299		463,402		344,240		1,488,941
Loans acquired with deteriorated credit quality		-		-		-		-
Gross loans	$	688,477	$	464,539	$	344,240	$	1,497,256

Management’s general practice is to proactively charge down loans individually evaluated for impairment to the fair value of the underlying collateral.

For all loan portfolio segments except consumer real estate and other consumer loans, 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.

Table of Contents

The Company charges-off consumer real estate and other 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.

Troubled Debt Restructurings

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

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

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

At September 30, 2019, the Company had loans that were modified in troubled debt restructurings. The modification of terms of such loans included one or a combination of the following: an extension of maturity or a reduction of the stated interest rate.

Table of Contents

The following tables describe troubled debts restructured during the three and nine month periods ended September 30, 2019 and 2018:


	Three Months Ended
	September 30, 2019					September 30, 2018
	No. of	Pre-Modification		Post-Modification		No. of	Pre-Modification		Post-Modification
	Loans	Recorded Balance		Recorded Balance		Loans	Recorded Balance		Recorded Balance
Real estate
Consumer closed end first mortgage	1	$	80	$	81	3	$	99	$	101
Consumer open end and junior liens	1		26		26	-		-		-

Other loans
Consumer Loans
Boat/RVs	2		271		271	2		39		36
Other	-		-		-	1		4		4
Commercial and industrial	1		49		49	-		-		-


	Nine Months Ended
	September 30, 2019					September 30, 2018
	No. of	Pre-Modification		Post-Modification		No. of	Pre-Modification		Post-Modification
	Loans	Recorded Balance		Recorded Balance		Loans	Recorded Balance		Recorded Balance
Real estate
Consumer closed end first mortgage	5		131		134	7		286		288
Consumer open end and junior liens	2		33		33	4		82		94

Other loans
Consumer loans
Auto	1		17		17	1		10		10
Boat/RVs	4		316		316	3		58		55
Other	-		-		-	1		4		4
Commercial and industrial	1		49		49	1		61		61

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

Newly restructured loans by type for the three and nine months ended September 30, 2019 and 2018 are as follows:


	Three Months Ended September 30, 2019
							Total
	Rate		Term		Combination		Modification
Real estate
Consumer closed end first mortgage	$	-	$	-	$	81	$	81
Consumer open end and junior liens		-		-		26		26

Other loans
Consumer loans
Boat/RVs		-		8		263		271
Commercial and industrial		-		49		-		49


	Three Months Ended September 30, 2018
							Total
	Rate		Term		Combination		Modification
Real estate
Consumer closed end first mortgage	$	-	$	38	$	63	$	101

Other loans
Consumer loans
Boat/RVs		-		15		21		36
Other		-		4		-		4

Table of Contents


	Nine Months Ended September 30, 2019
							Total
	Rate		Term		Combination		Modification
Real estate
Consumer closed end first mortgage	$	-	$	-	$	134	$	134
Consumer open end and junior liens		-		7		26		33

Other loans
Consumer loans
Auto		-		-		17		17
Boat/RVs		-		16		300		316
Commercial and industrial		-		49		-		49


	Nine Months Ended September 30, 2018
							Total
	Rate		Term		Combination		Modification
Real Estate
Consumer closed end first mortgage	$	-	$	38	$	250	$	288
Consumer open end and junior liens		-		35		59		94

Other loans
Consumer loans
Auto		-		10		-		10
Boat/RVs		-		34		21		55
Other		-		4		-		4
Commercial and industrial		-		61		-		61

The following table describes troubled debt restructurings that have subsequently defaulted during the three and nine months ended September 30, 2019 and 2018. There were no defaults on loans modified as troubled debt restructurings made in the three months ended September 30, 2019 and 2018. A default is defined as any loans that become 90 days past due.


	Three Months Ended
	September 30, 2019			September 30, 2018
		Post-Modification Outstanding			Post-Modification Outstanding
	No. of Loans	Recorded Balance		No. of Loans	Recorded Balance
Real Estate
Consumer closed end first mortgage	-	$	-	1	$	48
Consumer open end and junior liens	-		-	1		5

Other loans
Consumer loans
Boat/RV	1		36	-		-


	Nine Months Ended
	September 30, 2019			September 30, 2018
		Post-Modification Outstanding			Post-Modification Outstanding
	No. of Loans	Recorded Balance		No. of Loans	Recorded Balance
Real Estate
Consumer closed end first mortgage	-	$	-	1	$	48
Consumer open end and junior liens	-		-	1		5

Other Loans
Consumer Loans
Boat/RV	2		299	-		-

Table of Contents

At September 30, 2019, the Company had residential real estate owned as a result of foreclosure totaling $832,000 compared to $541,000 at December 31, 2018. Real estate in the process of foreclosure was $1.9 million at September 30, 2019, compared to $833,000 at December 31, 2018.

Note 7: Goodwill

Goodwill is recorded on the acquisition date of an entity. During the measurement period, the Company may record subsequent adjustments to goodwill for provisional amounts recorded at the acquisition date. The Universal acquisition on February 28, 2018 resulted in $20.5 million of goodwill, after a total reduction of $1.6 million. This reduction was recorded in the second and fourth quarters of 2018 as measurement period adjustments. Details regarding the Universal acquisition are discussed in Note 2 Acquisitions of this Form 10‑Q. There have been no changes in goodwill since December 31, 2018.


	September 30,		December 31,
	2019		2018
Balance as of beginning of period	$	22,310	$	1,800
Goodwill acquired during the year		-		22,069
Measurement period adjustments		-		(1,559)
Balance as of end of period	$	22,310	$	22,310

Note 8: Accounting for Certain Loans Acquired in a Transfer

The following table presents the carrying amounts of the loans acquired in the acquisition of Universal included in the balance sheet amounts of loans receivable as of September 30, 2019.


	September 30, 2019		December 31, 2018
Outstanding balance
Real estate
Commercial	$	95,155	$	120,249
Commercial construction and development		6,439		8,664
Consumer closed end first mortgage		26,237		30,694
Consumer open end and junior liens		7,058		8,032
Total real estate loans		134,889		167,639
Other loans
Consumer loans
Auto		646		1,138
Boat/RVs		26		97
Other		357		523
Commercial and industrial		8,803		10,571
Total other loans		9,832		12,329
Total loans	$	144,721	$	179,968

Carrying amount	$	142,830	$	177,169
Allowance		-		-
Carrying amount net of allowance	$	142,830	$	177,169

Note 9: Lease Commitments

The Company and its subsidiaries are obligated under leases for certain office premises, land, and equipment. In determining whether a contract contains a lease, the Company examines the contract to ensure an asset was specifically identified and that the Company has control of use over the asset. To determine whether a lease is classified as operating or financing, the Company performs an economic life test. The Company has recognized sixteen operating leases.

At lease inception, the Company determines the lease term by adding together the minimum lease term and all optional renewal periods that it is reasonably certain to renew. Our leases primarily have initial lease terms of generally 1 to 7 years with various lease renewal options at the Company’s sole discretion. We include

Table of Contents

certain renewal options in the measurement of our right-of-use assets and lease liabilities if they are reasonably certain to be exercised.

We have made a policy election to exclude the recognition requirements of Topic 842 to all classes of leases with original terms of 12 months or less. Instead, lease obligations with an initial term of 12 months or less are expensed.

The Company also elected not to separate lease components from non-lease components.

The discount rate used in determining the lease liability and related right of use asset is based upon what would be obtained by the Company for similar loans at an incremental rate as of the date of origination or renewal.

The following table shows lease right of use assets and lease liabilities as of September 30, 2019.


	Statement of Financial Condition classification	September 30, 2019
Operating lease right of use asset	Other Assets	$	2,799

Operating lease liabilities	Other Liabilities	$	2,816

The following table shows the components of operating leases expense for the three and nine months ended September 30, 2019.


		Three Months Ended		Nine Months Ended
	Statement of Income classification	September 30, 2019		September 30, 2019
Operating lease cost	Net occupancy expenses and equipment expenses	$	154	$	459
Short-term lease cost	Net occupancy expenses and equipment expenses		13		66
Variable lease cost	Net occupancy expenses		50		135
Total operating lease cost		$	217	$	660

Operating lease costs are included in net occupancy expenses and equipment expenses. Gross rental expense for the operating leases in net occupancy expenses for the three and nine months ended September 30, 2019 were $186,000 and $548,000, respectively. Gross rental expense for the operating leases in equipment expenses for the three and nine months ended September 30, 2019 were $34,000 and $119,000, respectively.

The following table shows future minimum rental commitments for all noncancelable operating leases for the next five years and thereafter.


Remaining 2019	$	203
2020		753
2021		619
2022		530
2023		333
Thereafter		1,215
Total lease payments	$	3,653
Less: present value discount		837
Present value of lease liabilities	$	2,816

Table of Contents

The following table shows the weighted average remaining lease term, the weighted average discount rate and supplemental Consolidated Statement of Cash Flows information for operating leases at September 30, 2019.


	September 30, 2019
Weighted average remaining lease term		10.80	years
Weighted average discount rate		3.73	%
Cash paid for amounts included in the measurement of lease liabilities
Operating cash flows from leases	$	594

There are no new significant leases that have not yet commenced as of September 30, 2019.

Note 10: Derivative Financial Instruments

The Company has certain interest rate derivative positions that are not designated as hedging instruments. Derivative assets and liabilities are recorded at fair value on the Consolidated Balance Sheet and do not take into account the effects of master netting agreements. Master netting agreements allow the Company to settle all derivative contracts held with a single counterparty on a net basis, and to offset net derivative positions with related collateral, where applicable. These derivative positions relate to transactions in which the Company enters into an interest rate swap with a client while at the same time entering into an offsetting interest rate swap with another financial institution. In connection with each transaction, the Company agrees to pay interest to the client on a notional amount at a variable interest rate and receive interest from the client on the same notional amount at a fixed interest rate. At the same time, the Company agrees to pay another financial institution the same fixed interest rate on the same notional amount and receive the same variable interest rate on the same notional amount. The transaction allows the client to effectively convert a variable rate loan to a fixed rate. Because the terms of the swaps with the customers and the other financial institution offset each other, with the only difference being counterparty credit risk, changes in the fair value of the underlying derivative contracts are not materially different and do not significantly impact the Company’s Consolidated Statements of Income. The notional amount of customer-facing swaps as of September 30, 2019 and December 31, 2018 was approximately $30.2 million and $21.1 million, respectively. During the nine months ended September 30, 2019 and 2018, the Company did not recognize any net gains or losses related to the changes in fair value of these swaps. Additionally, for the three and nine months ended September 30, 2019, the Company recognized income for the related swap fees of $24,000 and $107,000, respectively. No swap fee income was recognized for the three and nine months ended September 30, 2018.

The following table shows the fair values of derivative financial instruments at September 30, 2019 and December 31, 2018.


	Derivatives
		Fair Value					Fair Value
	Balance Sheet	September 30,		December 31,		Balance Sheet	September 30,		December 31,
	Location	2019		2018		Location	2019		2018
Derivatives not designated as hedging instruments:
Interest rate contracts	Other assets	$	1,718	$	599	Other liabilities	$	1,718	$	599

Table of Contents

Note 11: Other Borrowings

Other borrowings consisted of the following components:


	September 30,		December 31,
	2019		2018
Notes payable	$	9,255	$	9,665
Subordinated debentures, net of discount		8,398		8,323
Total	$	17,653	$	17,988

The Company acquired $5.0 million of subordinated debentures in the 2008 acquisition of MFB Corp, which had a net balance of $4.3 million at September 30, 2019 due to the purchase accounting adjustment in that acquisition. These securities mature 30 years from the date of issuance, or September 15, 2035. The securities bear a rate of interest of the prevailing three-month LIBOR rate plus 170 basis points, which was 3.82% at September 30, 2019 and 4.49% at December 31, 2018. The Company has the right to redeem the trust preferred securities, in whole or in part, without penalty.

The Company acquired $5.0 million of subordinated debentures in the acquisition of Universal, which had a net balance of $4.1 million at September 30, 2019 due to the purchase accounting adjustment in the acquisition. These securities mature 30 years from the date of issuance, or October 7, 2035. The securities bear a rate of interest of the prevailing three-month LIBOR rate plus 169 basis points, which was 3.99% at September 30, 2019 and 4.13% at December 31, 2018. The Company has the right to redeem the trust preferred securities, in whole or in part, without penalty.

The Company borrowed $10.0 million in two $5.0 million term notes from First Tennessee Bank, N.A. to use in the acquisition of Universal. These loans had a combined balance of $9.3 million at September 30, 2019. The fixed rate term note had a balance of $4.3 million as of September 30, 2019 and matures 5 years from the date of issuance, or February 28, 2023. This term note bears a fixed rate of interest of 4.99% per annum and requires quarterly principal payments, which began March 31, 2018. The variable rate term note had a balance of $5.0 million as of September 30, 2019 and matures 5 years from the date of issuance, or February 28, 2023. This term note bears a rate of interest of the prevailing three-month LIBOR rate plus 195 basis points, which was 4.27% at September 30, 2019 and 4.35% at December 31,2018. The Company has the right to redeem either note at any time, in whole or in part, without penalty.

Note 12: Accumulated Other Comprehensive Income (Loss)

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


	September 30,		December 31,
	2019		2018
Net unrealized gain (loss) on securities available for sale	$	11,567	$	(3,187)
Net unrealized gain relating to defined benefit plan liability		(99)		(99)
		11,468		(3,286)
Tax effect		(2,456)		662
Net of tax amount	$	9,012	$	(2,624)

Table of Contents

The following table presents the reclassification adjustments out of accumulated other comprehensive income that were included in net income in the Consolidated Statements of Income for the three and nine months ended September 30, 2019 and 2018.


	Amount Reclassified from
	Accumulated Other
	Comprehensive Income For the
	Three Months Ended September 30,
Details about Accumulated Other Comprehensive Income Components	2019		2018		Affected Line Item in the Statements of Income
Realized gains on available for sale securities
Realized securities gains reclassified into income	$	109	$	406	Total non-interest income - net realized gains on sale of available for sale securities
Related income tax expense		(23)		(85)	Income tax expense

Total reclassifications for the period, net of tax	$	86	$	321


	Amount Reclassified from
	Accumulated Other
	Comprehensive Income For the
	Nine Months Ended September 30,
Details about Accumulated Other Comprehensive Income Components	2019		2018		Affected Line Item in the Statements of Income
Realized gains on available for sale securities
Realized securities gains reclassified into income	$	975	$	666	Total non-interest income - net realized gains on sale of available for sale securities
Related income tax expense		(205)		(140)	Income tax expense

Total reclassifications for the period, net of tax	$	770	$	526

Note 13: Fair Values of Financial Instruments

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


	Level 1	Quoted prices in active markets for identical assets or liabilities


	Level 2	Observable inputs other than Level 1 prices, such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities


	Level 3	Unobservable inputs supported by little or no market activity and are significant to the fair value of the assets or liabilities

Items Measured at Fair Value on a Recurring Basis

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

Table of Contents

Available-for-Sale Securities

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

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

Interest Rate Derivative Agreements

Interest rate swap positions, both assets and liabilities, are valued by a third-party pricing agent using an income approach and utilizing models that use as their basis readily observable market parameters. This valuation process considers various factors including interest rate yield curves, time value and volatility factors.

The following tables present the fair value measurements of assets and liabilities measured on a recurring basis and level within the ASC 820 fair value hierarchy.


	Fair Value Measurements Using
	Fair Value		Level 1		Level 2		Level 3
September 30, 2019
Available for sale securities
Mortgage-backed securities	$	115,456	$	-	$	115,456	$	-
Collateralized mortgage obligations		100,272		-		100,272		-
Municipal obligations		164,899		-		164,899		-
Corporate obligations		2,349		-		-		2,349
Interest rate swap asset		1,718		-		1,718		-
Interest rate swap liability		1,718		-		1,718		-


	Fair Value Measurements Using
	Fair Value		Level 1		Level 2		Level 3
December 31, 2018
Available for sale securities
Mortgage-backed securities	$	104,343	$	-	$	104,343	$	-
Collateralized mortgage obligations		109,281		-		109,281		-
Municipal obligations		154,896		-		154,896		-
Corporate obligations		2,355		-		-		2,355
Interest rate swap asset		599		-		599		-
Interest rate swap liability		599		-		599		-

Table of Contents

The following is a reconciliation of the beginning and ending balances for the three and nine months ended September 30, 2019 and 2018 of recurring fair value measurements recognized in the accompanying balance sheets using significant unobservable (Level 3) inputs:


	Three Months Ended				Nine Months Ended
	September 30,				September 30,
	2019		2018		2019		2018
Beginning balance	$	2,351	$	2,721	$	2,355	$	2,721
Total realized and unrealized gains (losses)
Included in net income		-		(44)		-		(44)
Included in other comprehensive income (loss)		-		326		-		326
Purchases, issuances and settlements		(2)		(883)		(6)		(883)
Ending balance	$	2,349	$	2,120	$	2,349	$	2,120
Total gains for the period included in net income attributable to the change in unrealized gains or losses related to assets still held at the reporting date	$	-	$	-	$	-	$	-

Items Measured at Fair Value on a Non-Recurring Basis

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

The following tables present quantitative information about unobservable inputs used in recurring and nonrecurring Level 3 fair value measurements:


September 30, 2019	Fair Value		Valuation Technique	Unobservable Inputs	Range
Trust Preferred Securities	$	2,349	Discounted cash flow	Discount rate	6.8	%
				Constant prepayment rate	2.0	%
				Cumulative projected prepayments	40.0	%
				Probability of default	1.7	%
				Projected cures given deferral	0 - 15.0	%
				Loss severity	21.4	%
Other real estate owned	$	235	Third party valuations	Discount to reflect realizable value less estimated selling costs	0 - 24.7	%


December 31, 2018	Fair Value		Valuation Technique	Unobservable Inputs	Range
Trust Preferred Securities	$	2,355	Discounted cash flow	Discount rate	6.8	%
				Constant prepayment rate	2.0	%
				Cumulative projected prepayments	40.0	%
				Probability of default	1.7	%
				Projected cures given deferral	0 - 15.0	%
				Loss severity	21.4	%

Table of Contents

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


					Fair Value Measurements Using
	Carrying
September 30, 2019	Amount		Fair Value		Level 1		Level 2		Level 3
Assets
Cash and cash equivalents	$	31,315	$	31,315	$	31,315	$	-	$	-
Interest-bearing time deposits		4,023		4,023		4,023		-		-
Loans held for sale		19,643		20,860		-		20,860		-
Loans, net		1,483,611		1,457,202		-		-		1,457,202
FHLB stock		13,115		13,115		-		13,115		-
Interest receivable		6,895		6,895		-		6,895		-
Liabilities
Deposits		1,573,088		1,574,598		1,067,270		-		507,328
FHLB advances		239,661		240,922		-		240,922		-
Other borrowings		17,653		17,255		-		17,255		-
Interest payable		875		875		-		875		-


					Fair Value Measurements Using
	Carrying
December 31, 2018	Amount		Fair Value		Level 1		Level 2		Level 3
Assets
Cash and cash equivalents	$	33,414	$	33,414	$	33,414	$	-	$	-
Interest-bearing time deposits		4,239		4,239		4,239		-		-
Loans held for sale		3,987		4,011		-		4,011		-
Loans, net		1,482,662		1,456,270		-		-		1,456,270
FHLB stock		13,034		13,034		-		13,034		-
Interest receivable		6,940		6,940		-		6,940		-
Liabilities
Deposits		1,519,225		1,514,852		1,030,785		-		484,067
FHLB advances		292,497		290,092		-		290,092		-
Other borrowings		17,988		17,665		-		17,665		-
Interest payable		1,075		1,075		-		1,075		-

Note 14: Subsequent Event

On a Form 8-K filed on October 29, 2019, MutualFirst announced it had entered into an Agreement and Plan of Merger (the “Merger Agreement”) with Northwest Bancshares, Inc. (“Northwest Bancshares”). Pursuant to the Merger Agreement at the closing of the merger, MutualFirst will merge with and into Northwest Bancshares, with Northwest Bancshares as the surviving entity. Immediately thereafter, Mutual will merge with and into Northwest Bank, the wholly owned subsidiary of Northwest Bancshares, with Northwest Bank as the surviving entity.

Under the terms of the Merger Agreement, each share of common stock of MutualFirst will be converted into the right to receive 2.4 shares of Northwest Bancshares’s common stock, for total consideration valued at approximately $346 million.

The Merger Agreement has been approved by the Boards of Directors of Northwest Bancshares and MutualFirst. Completion of the transaction is subject to customary closing conditions, including the receipt of required regulatory approvals and the approval of stockholders of MutualFirst. The parties anticipate completing the Merger during the second quarter 2020.

MutualFirst has also agreed not to (i) solicit proposals relating to alternative business combination transactions involving MutualFirst or Mutual or (ii) subject to certain exceptions, enter into discussions or an agreement concerning, or to provide confidential information in connection with, any proposals for alternative business combination transactions involving MutualFirst or Mutual.

Table of Contents

At the same time that Northwest Bancshares entered into the Merger Agreement, Northwest Bancshares also entered into voting agreements with MutualFirst directors and certain of its officers in which those persons agreed to vote the MutualFirst common stock they hold in favor of the Merger Agreement.

The Merger Agreement also provides for certain termination rights for both MutualFirst and Northwest Bancshares, and further provides that upon termination of the Merger Agreement under certain circumstances, MutualFirst will be obligated to pay Northwest Bancshares a termination fee.

A complete copy of the Merger Agreement is attached as an exhibit to the Form 8-K filed October 29, 2019.

Table of Contents

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operation

The following should be read in conjunction with the Management’s Discussion and Analysis in Item 7 of the Company’s Annual Report on Form 10‑K for the year ended December 31, 2018, which was filed with the SEC on March 15, 2019.

MutualFirst is a Maryland corporation and a bank holding company headquartered in Muncie, Indiana, with banking operations in Allen, Delaware, Elkhart, Grant, Greene, Hamilton, Jackson, Johnson, Knox, Kosciusko, Lawrence, Monroe, Randolph, St. Joseph and Wabash counties in Indiana. It owns MutualBank, an Indiana commercial bank with 39 full-service branches in Indiana, trust offices in Fishers and Crawfordsville, Indiana and a loan origination office in New Buffalo, Michigan. MutualBank’s wholly owned subsidiary, Summit Service Corp, owns Summit Mortgage, a mortgage banking company located in Ft. Wayne, Indiana. The Company is subject to examination, supervision and regulation by the Federal Reserve Board (FRB), and the Bank is subject to regulation, supervision and examination by the Indiana Department of Financial Institutions (IDFI) and the Federal Deposit Insurance Corporation (FDIC).

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

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

Third Quarter Highlights. At September 30, 2019, we had $2.1 billion in assets, $1.5 billion in net loans, $1.6 billion in deposits and $222.0 million in stockholders’ equity. The Bank’s total risk-based capital ratio at September 30, 2019 was 13.4%, exceeding the 10.0% requirement for a well-capitalized institution. Tangible common equity, as a percentage of tangible assets, increased to 9.6% as of September 30, 2019 compared to 8.7% and 8.4% at December 31, 2018 and September 30, 2018, respectively. For the quarter ended September 30, 2019, net income was $6.1 million, or $0.71 diluted earnings per common share, compared with net income of $5.4 million, or $0.62 diluted earnings per common share for the quarter ended September 30, 2018.

The Management’s Discussion and Analysis in Item 7 of the Company’s Annual Report on Form 10‑K for the year ended December 31, 2018, contains a summary of our management’s strategic plan for 2015‑2019. The financial highlights of our strategic progress during the quarter and year to date include:

Commercial and non-real estate consumer lending was 67.0% of the lending portfolio as of September 30, 2019 compared to 63.8% at December 31, 2018.

Table of Contents

Core deposits were $1.1 billion and $1.0 billion as of September 30, 2019 and December 31, 2018, respectively, or 67.8% of total deposits as of September 30, 2019 and December 31, 2018.

On October 29, 2019, MutualFirst entered into a Merger Agreement with Northwest Bancshares, pursuant to which the Company will merge with and into Northwest Bancshares. See "Note 14 Subsequent Event" of the Notes to Consolidated Financial Statements for additional information.

Critical Accounting Policies

Note 1 to the Consolidated Financial Statements in Item 8 of the Form 10‑K for the year ended December 31, 2018 contains a summary of the Company’s significant accounting policies. Certain of these policies are important to the portrayal of the Company’s financial condition, since they require management to make difficult, complex or subjective judgments, some of which may relate to matters that are inherently uncertain. Management believes that its critical accounting policies include determining the allowance for loan losses, the valuation of foreclosed assets, mortgage servicing rights, valuation of intangible assets and securities, deferred tax asset and income tax accounting.

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

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

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

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

Goodwill is tested for impairment on an annual basis as of November 30, or whenever events or changes in circumstances indicate the carrying amount of goodwill exceeds its implied fair value. No events or changes in circumstances have occurred since the annual impairment test that would suggest it was more likely than not goodwill impairment existed.

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

Table of Contents

are classified as available-for-sale and are carried at fair value, with the unrealized holding gains and losses, net of tax, reported in other comprehensive income and do not affect earnings until realized.

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

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

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

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

Deferred Tax Asset. The Company has evaluated its deferred tax asset to determine if it is more likely than not that the asset will be utilized in the future. The Company’s most recent evaluation has determined that, except for the amounts represented by the valuation allowance in Note 17 to the Consolidated Financial Statements in Item 8 of the Form 10‑K for the year ended December 31, 2018, the Company will more likely than not be able to utilize the remaining deferred tax asset. As of year-end 2018, the Company had generated average annual positive pre-tax pre-provision earnings of $19.1 million, or 1.2% of pre-tax pre-provision ROA over the previous five years. This level of earnings, if maintained in the future, would be sufficient to utilize portions of the operating losses, tax credit carryforwards and temporary tax differences over the allowable periods. The analysis as of September 30, 2019, supports the position that no additional valuation reserve is needed.

Table of Contents

The valuation allowances established are the result of net operating losses for state franchise tax purposes totaling $35.0 million. See Note 17 to the Consolidated Financial Statements in Item 8 of the Form 10‑K for the year ended December 31, 2018.

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

Revenue Recognition. The Company recognizes revenues as they are earned based on contractual terms, as transactions occur, or as services are provided and collectability is reasonably assured. The Company’s principal source of revenue is interest income from loans and leases and investment securities. The Company also earns noninterest income from various banking and financial services offered primarily through the Bank and its subsidiaries.

Interest Income – The largest source of revenue for the Company is interest income which is primarily recognized on an accrual basis according to nondiscretionary formulas in written contracts, such as loan and lease agreements or investment securities contracts.

Noninterest Income – The Company earns noninterest income through a variety of financial and transaction services provided to business and consumer clients such as trust and wealth advisory, deposit account, debit card, and mortgage banking. Revenue is recorded for noninterest income based on the contractual terms for the service or transaction performed. In certain circumstances, noninterest income is reported net of associated expenses.

Forward-Looking Statements

This Form 10‑Q, and our future filings with the SEC, Company press releases, other public pronouncements, stockholder communications and oral statements made by or with the approval of an authorized executive officer, will contain “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995. You can identify these forward-looking statements through our use of words such as “may,” “will,” “anticipate,” “assume,” “should,” “indicate,” “would,” “believe,” “contemplate,” “expect,” “estimate,” “continue,” “plan,” “project,” “could,” “intend,” “target” and other similar words and expressions of the future. These forward-looking statements include, but are not limited to: (i) statements of our goals, intentions and expectations; (ii) statements regarding our business plans, prospects, growth and operating strategies; (iii) statements regarding the asset quality of our loan and investment portfolios; and (iv) estimates of our risks and future costs and benefits. These forward-looking statements are based on current beliefs and expectations of our management and are inherently subject to significant business, economic and competitive uncertainties and contingencies, many of which are beyond our control. In addition, these forward-looking statements are subject to assumptions with respect to future business strategies and decisions that are subject to change. The Company does not undertake and specifically declines any obligation to publicly release the result of any revisions that may be made to any forward-looking statements to reflect events or circumstances after the date of such statements or to reflect the occurrence of unanticipated events.

The following factors, among others, could cause actual results to differ materially from the anticipated results or other expectations expressed in the forward-looking statements: (i) the credit risks of lending activities, including changes in the level and trend of loan delinquencies and write-offs and changes in our allowance for loan losses and provision for loan losses that may be impacted by deterioration in the housing and commercial real estate markets; (ii) changes in general economic conditions, either nationally or in our market areas; (iii) changes in the levels of general interest rates and the relative differences between short- and long-

Table of Contents

term interest rates, deposit interest rates, our net interest margin and funding sources; (iv) fluctuations in the demand for loans, the number of unsold homes, land and other properties and fluctuations in real estate values in our market areas; (v) decreases in the secondary market for the sale of loans that we originate; (vi) results of examinations of us by the IDFI, FDIC, FRB or other regulatory authorities, including the possibility that any such regulatory authority may, among other things, require us to increase our reserve for loan losses, write-down assets, change our regulatory capital position or affect our ability to borrow funds or maintain or increase deposits, which could adversely affect our liquidity and earnings; (vii) legislative or regulatory changes that adversely affect our business including the effect of Dodd-Frank Wall Street Reform and Consumer Protection Act (the Dodd-Frank Act”), changes in regulatory policies and principles, or the interpretation of regulatory capital or other rules, including changes that increase our capital requirements; (viii) our ability to attract and retain deposits; (ix) increases in premiums for deposit insurance; (xi) management’s assumptions in determining the adequacy of the allowance for loan losses; (xi) our ability to control operating costs and expenses; (xii) the use of estimates in determining fair value of certain of our assets, which estimates may prove to be incorrect and result in significant declines in valuation; (xiii) difficulties in reducing risks associated with the loans on our balance sheet; (xiv) staffing fluctuations in response to product demand or the implementation of corporate strategies that affect our workforce and potential associated charges; (xv) a failure or security breach in the computer systems on which we depend; (xvi) our ability to retain key members of our senior management team; (xvii) costs and effects of litigation, including settlements and judgments; (xviii) our ability to successfully integrate into our operations any assets, liabilities, customers, systems, and management personnel acquired and those we may in the future acquire, and our ability to realize related revenue synergies and cost savings within expected time frames or at all and any goodwill charges related thereto; (xix) increased competitive pressures among financial services companies; (xx) changes in consumer spending, borrowing and savings habits; (xxi) the availability of resources to address changes in laws, rules, or regulations or to respond to regulatory actions; (xxii) adverse changes in the securities markets; (xxiii) inability of key third-party providers to perform their obligations to us; (xxiv) changes in accounting policies and practices, as may be adopted by the financial institution regulatory agencies, the Public Company Accounting Oversight Board or the Financial Accounting Standards Board; (xxv) other economic, competitive, governmental, regulatory, and technological factors affecting our operations, pricing, products and services and the other risks described elsewhere in this report; (xxvi) business disruption may occur in connection with the Company’s merger with Northwest Bancshares; (xxvii) the Company’s businesses may experience disruptions due to transaction-related uncertainty or other factors making it more difficult to maintain relationships with employees, customers, other business partners or governmental entities; and (xxviii) the diversion of managements’ attention from ongoing business operations and opportunities as a result of the merger with Northwest Bancshares or otherwise.

The Company wishes to advise readers that these factors could affect the Company’s financial performance and could cause the Company’s actual results for future periods to differ materially from any opinions or statements expressed with respect to future periods in any current statements.

Financial Condition

General. Total assets at September 30, 2019 were $2.1 billion, reflecting a $24.2 million increase since December 31, 2018. Loans held for sale increased $15.7 million primarily due to strong mortgage production as originations have increased in 2019 compared to 2018. The net loan portfolio at September 30, 2019 increased by $1.1 million since December 31, 2018 primarily due to organic loan growth of $15.2 million in non-residential consumer loans and $28.5 million growth in commercial loans. These increases were offset by a reduction in residential loan balances of $42.7 million primarily due to the bulk loan sale of $26.6 million mortgage loans in the third quarter of 2019. Total liabilities as of September 30, 2019 were $1.9 billion, an increase of $4.6 million compared to December 31, 2018, primarily due to a $53.9 million increase in deposits, offset by a decrease in Federal Home Loan Bank of Indianapolis (“FHLBI”) advances of $52.8 million. Total stockholders’ equity increased to $222.0 million, an increase of $19.6 million compared to December 31, 2018 primarily due to $17.1 million in net income and an $11.6 million increase in accumulated other comprehensive income due to market value changes in the investment portfolio partially offset by $5.1

Table of Contents

million of dividends paid and $4.3 million used to repurchase 136,471 shares of stock during the nine months ended September 30, 2019.

Loans. Our gross loan portfolio, excluding loans held for sale, decreased $6.6 million at September 30, 2019 to $1.5 billion. The following table reflects the changes in the gross amount of loans, excluding loans held for sale, by type during the nine month period:


	September 30,		December 31,		Amount		Percent
	2019		2018		Change		Change
	(Dollars in thousands)
Real estate
Commercial	$	500,152	$	485,808	$	14,344	2.95	%
Commercial construction and development		57,780		53,310		4,470	8.38
Consumer closed end first mortgage		415,714		464,539		(48,825)	(10.51)
Consumer open end and junior liens		75,566		77,072		(1,506)	(1.95)
Total real estate loans		1,049,212		1,080,729		(31,517)	(2.92)

Consumer loans
Auto		57,861		43,667		14,194	32.51
Boat/RV		217,412		216,608		804	0.37
Other		7,114		6,893		221	3.21
Total consumer other		282,387		267,168		15,219	5.70
Commercial and industrial		159,069		149,359		9,710	6.50
Total other loans		441,456		416,527		24,929	5.98
Total loans	$	1,490,668	$	1,497,256	$	(6,588)	(0.44)	%

The Company’s strategy to increase commercial and non-real estate consumer loans remains a primary focus as we continued to see growth in these areas during the first nine months of 2019. Commercial and non-real estate consumer loans increased by $43.7 million to $999.4 million. These increases were partially offset by a decline during the first nine months of 2019 in residential mortgage loans primarily as a result of a sale of $26.6 million of portfolio mortgage loans. The mix of loans in our portfolio as of September 30, 2019 compared to December 31, 2018 continued to shift toward our desired strategic objective of increasing commercial and consumer loans. We continue to seek to provide sound commercial borrowers opportunities for new loans to meet their growing demands, refinance loans currently served by other financial institutions and build relationships with commercial clients in our footprint. The Company continues to sell longer term fixed-rate mortgage loans to reduce related interest rate risk.

Delinquencies and Non-performing Assets. As of September 30, 2019, our total loans delinquent 30‑to‑89 days were $19.9 million, or 1.3% of total loans, down slightly from $20.1 million, or 1.3% of total loans at 2018 year-end. Delinquencies in commercial real estate loans increased $4.7 million offset by a decrease in commercial construction and development loans and consumer closed end first mortgage loans of $4.6 million and $1.9 million, respectively, compared to delinquent loans at 2018 year-end.

At September 30, 2019, our non-performing assets totaled $7.8 million or 0.38% of total assets, compared to $11.1 million or 0.54% of total assets at December 31, 2018. This $3.3 million, or 29.9% decrease was primarily due to a $3.0 million loan going on non-accrual in the fourth quarter of 2018 but performing as agreed at the end of the third quarter of 2019.

Table of Contents

The table below sets forth the amounts and categories of non-performing assets at the dates indicated.


	September 30,		December 31,		Amount		Percent
	2019		2018		Change		Change
	(Dollars in thousands)
Non-accruing loans	$	5,694	$	8,589	$	(2,895)	(33.71)	%
Accruing loans delinquent 90 days or more		148		517		(369)	(71.37)
Other real estate owned and repossessed assets		1,952		2,013		(61)	(3.03)
Total	$	7,794	$	11,119	$	(3,325)	(29.90)	%

The Company continues to diligently monitor and write down loans that appear to have irreversible weakness. The Company works to ensure possible problem loans have been identified and steps have been taken to reduce loss by restructuring loans to improve cash flow or by increasing collateral. Total classified assets decreased by 3.6% from $22.6 million at December 31, 2018 to $21.8 million at September 30, 2019.

At September 30, 2019, foreclosed real estate and real estate in judgment totaled $1.3 million compared to $1.2 million at December 31, 2018. At September 30, 2019, all foreclosed real estate owned was in consumer or commercial real estate. As of September 30, 2019, the Company also held $669,000 in other repossessed assets, such as autos, boats, RVs and horse trailers.

Allowance for Loan Losses. Allowance for loan losses increased to $13.4 million as of September 30, 2019 compared to $13.3 million as of December 31, 2018. The allowance for loan losses to non-performing loans as of September 30, 2019 was 229.6% compared to 145.9% as of December 31, 2018. The allowance for loan losses to total loans was 0.90% at September 30, 2019 compared to 0.89% as of December 31, 2018. Non-performing loans to total loans at September 30, 2019 were 0.39% compared to 0.61% at December 31, 2018. Non-performing assets to total assets were 0.38% at September 30, 2019 compared 0.54% at December 31, 2018.

Deposits. Deposits increased by $53.9 million in the first nine months of 2019 primarily due to seasonality of deposit growth. The increase in deposits was a result of a $36.5 million increase in core deposits to $1.1 billion and a $17.4 million increase in certificates of deposit to $505.8 million. Core deposits are 67.8% of the Bank’s total deposits as of September 30, 2019.


	At
	September 30, 2019				December 31, 2018
			Weighted				Weighted
			Average				Average		Amount		Percent
	Amount		Rate		Amount		Rate		Change		Change
	(Dollars in thousands)
Type of Account:
Non-interest Checking	$	273,140	0.00	%	$	259,909	0.00	%	$	13,231	5.09	%
Interest-bearing NOW		405,548	0.69			408,135	0.78			(2,587)	(0.63)
Savings		176,470	0.01			182,346	0.01			(5,876)	(3.22)
Money Market		212,113	0.89			180,395	0.65			31,718	17.58
Certificates of Deposit		505,817	2.02			488,440	1.83			17,377	3.56
Total	$	1,573,088	0.95	%	$	1,519,225	0.87	%	$	53,863	3.55	%

Borrowings. Total borrowings decreased $53.2 million to $257.3 million at September 30, 2019, or 17.1%, since year-end 2018. The decrease was primarily due to decreased FHLB advance borrowing due to deposit growth. Other borrowings decreased $335,000 during the nine months ended September 30, 2019.

The Company acquired $5.0 million of subordinated debentures in the 2008 acquisition of MFB Corp, which had a net balance of $4.3 million at September 30, 2019 due to the purchase accounting adjustment in that acquisition. These securities mature 30 years from the date of issuance, or September 15, 2035. The securities bear a rate of interest of the prevailing three-month LIBOR rate plus 170 basis points. The Company has the right to redeem the trust preferred securities, in whole or in part, without penalty.

Table of Contents

The Company acquired $5.0 million of subordinated debentures in the acquisition of Universal, which had a net balance of $4.1 million at September 30, 2019 due to the purchase accounting adjustment in the acquisition. These securities mature 30 years from the date of issuance, or October 7, 2035. The securities bear a rate of interest of the prevailing three-month LIBOR rate plus 169 basis points. The Company has the right to redeem the trust preferred securities, in whole or in part, without penalty.

The Company borrowed $10.0 million in two $5.0 million term notes from First Tennessee Bank, N.A. to help fund the acquisition of Universal. These loans had a combined balance of $9.3 million at September 30, 2019. The fixed rate term note had a balance of $4.3 million and matures 5 years from the date of issuance, or February 28, 2023. This term note bears a fixed rate of interest of 4.99% per annum. The variable rate term note had a balance of $5.0 million and matures 5 years from the date of issuance, or February 28, 2023. This term note bears a rate of interest of the prevailing three-month LIBOR rate plus 195 basis points. The Company has the right to redeem either note at any time, in whole or in part, without penalty.

Stockholders’ Equity. Stockholders’ equity was $222.0 million at September 30, 2019, an increase of $19.6 million from December 31, 2018. The increase was primarily due to net income of $17.1 million and an increase in accumulated other comprehensive income of $11.6 million due to the market value changes in the investment portfolio. These increases were partially offset by common stock cash dividends paid of $5.1 million and stock repurchases of 136,471 shares for $4.3 million during the first nine months of 2019. The Company’s tangible book value per common share as of September 30, 2019 increased to $23.15 compared to $20.51 as of December 31, 2018 and the tangible common equity ratio increased to 9.60% as of September 30, 2019 compared to 8.72% as of December 31, 2018. The increases in tangible book value per share and the tangible common equity ratio were due to the reasons noted above. The Bank’s risk-based capital ratios were well in excess of “well-capitalized” levels as defined by all regulatory standards as of September 30, 2019.

Comparison of Results of Operations for the Three Months Ended September 30, 2019 and 2018.

General. Net income for the quarter ended September 30, 2019 was $6.1 million, or $0.71 diluted earnings per common share compared to net income of $5.4 million, or $0.62 diluted earnings per common share for the quarter ended September 30, 2018. Annualized return on average assets was 1.18% and annualized return on average tangible common equity was 12.65% for the third quarter of 2019 compared to 1.07% and 12.92% respectively, for the same period of 2018.

Table of Contents

Net Interest Margin and Average Balance Sheet. The following table presents the Company’s average balance sheet, interest income/interest expense, and the average rate as a percent of average earning assets for the periods indicated. All average balances are daily average balances. Non-accruing loans have been included in the table as loans carrying a zero yield.


	Three Months Ended
	September 30, 2019							September 30, 2018
	Average							Average
	Outstanding			Interest		Average		Outstanding			Interest		Average
	Balance			Earned/Paid		Yield/Rate		Balance			Earned/Paid		Yield/Rate

Interest-Earning Assets:
Interest-bearing deposits	$	24,247		$	79	1.30	%	$	21,654		$	58	1.07	%
Mortgage-backed securities available for sale (1)		213,006			1,336	2.51			210,518			1,433	2.72
Investment securities available for sale (1)		156,313			1,268	3.24			158,671			1,299	3.27
Loans (2)		1,517,257			18,754	4.94			1,475,178			17,902	4.85
Stock in FHLB of Indianapolis		13,115			180	5.49			12,820			144	4.49
Total interest-earning assets		1,923,938			21,617	4.49			1,878,841			20,836	4.44
Non-Interest Earning Assets (net of allowance for loan losses and unrealized gain (loss))		154,170							134,096
Total Assets	$	2,078,108						$	2,012,937

Interest-Bearing Liabilities:
Demand and NOW accounts	$	404,589		$	785	0.78		$	402,393		$	664	0.66
Savings deposits		181,116			5	0.01			186,659			5	0.01
Money market accounts		205,301			525	1.02			190,851			253	0.53
Certificate accounts		508,095			2,645	2.08			471,061			1,970	1.67
Total deposits		1,299,101			3,960	1.22			1,250,964			2,892	0.92
Borrowings		249,262			1,412	2.27			270,940			1,527	2.25
Total interest-bearing liabilities		1,548,363			5,372	1.39			1,521,904			4,419	1.16
Non-Interest Bearing Accounts		288,961							279,574
Other Liabilities		21,484							17,788
Total Liabilities		1,858,808							1,819,266
Stockholders’ Equity		219,300							193,671
Total liabilities and stockholders’ equity	$	2,078,108						$	2,012,937
Net Earning Assets	$	375,575						$	356,937
Net Interest Income				$	16,245						$	16,417
Net Interest Rate Spread (3)						3.11	%						3.27	%
Net interest margin (4)						3.38	%						3.50	%
Net interest margin, tax equivalent (5)						3.45	%						3.57	%
Average Interest-Earning Assets to Average Interest- Bearing Liabilities		124.26	%						123.45	%

(1) Average balances of securities is computed based on the average of the historical amortized cost balances without the effects of the fair value adjustments.
(2) Calculated net of deferred loan fees, loan discounts and loans in process.
(3) Interest rate spread is calculated by subtracting weighted average interest rate cost from weighted average interest rate yield for the period indicated.
(4) The net yield on weighted average interest-earning assets is calculated by dividing net interest income by weighted average interest-earning assets for the period indicated.
(5) Tax equivalent margin is calculated by taking non-taxable interest and grossing up by 21% applicable tax rate.

Table of Contents

Interest Income. Total interest income increased $781,000, or 3.7%, to $21.6 million during the three months ended September 30, 2019 from $20.8 million during the same period in 2018. The increase was primarily a result of an increase of $45.1 million in average interest-earning assets due to an increase in the average loan portfolio of $42.1 million, due primarily to organic loan growth and an increase in yield on interest-earning assets of five basis points for the quarter ended September 30, 2019 compared to the same period in 2018.

Interest Expense. Interest expense increased $953,000, or 21.6%, to $5.4 million during the three months ended September 30, 2019 compared to the same period in 2018. The primary reason for this increase was an increase in yield on interest-bearing liabilities of twenty-three basis points for the quarter ended September 30, 2019 compared to the same period in 2018. Average interest-bearing liabilities increased $26.5 million. due to an increase in average interest-bearing deposits of $48.1 million, primarily certificates of deposit. This increase was partially offset by a decrease in average borrowings of $21.7 million as a result of a decrease in average FHLB advances. In addition, the average rate paid on interest-bearing liabilities increased by twenty-three basis points for the quarter ended September 30, 2019 compared to the same period in 2018 due to an increase in market rates of interest and a change in deposit mix.

Net Interest Income and Net Interest Margin. Net interest income before the provision for loan losses decreased $172,000 for the quarter ended September 30, 2019 compared to the same period in 2018. The decrease in net interest income was primarily a result of a decline in net interest margin. Net interest margin and tax equivalent margins both decreased twelve basis points to 3.38% and 3.50%, respectively. The decrease in net interest margin is a result of the yield on average interest-earning assets yield increasing five basis points which was offset by an increase in the cost of interest-bearing liabilities of twenty-three basis points. For more information on our asset/liability management, especially as it relates to interest rate risk, see “Item 7A - Quantitative and Qualitative Disclosures About Market Risk” in the Form 10‑K for the year ended December 31, 2018.

Provision for Loan Losses. Provision for loan losses in the third quarter of 2019 was $425,000 compared to $570,000 during last year’s comparable period. The decrease was due to management’s ongoing evaluation of the adequacy of the allowance for loan losses, which was partially attributable to a change in the loan portfolio. Net charge offs in the third quarter of 2019 were $449,000, or 0.12% of total average loans on an annualized basis, compared to net charge offs of $290,000, or 0.08% of total average loans on an annualized basis, in the third quarter of 2018.

Non-Interest Income. Non-interest income for the third quarter of 2019 was $5.8 million, an increase of $810,000 compared to the third quarter of 2018.


	Three Months Ended
	September 30,				Amount		Percent
	2019		2018		Change		Change
	(Dollars in thousands)
Non-Interest Income:
Service fee income	$	2,081	$	2,024	$	57	2.82	%
Net realized gain (loss) on sale of securities		109		406		(297)	(73.15)
Commissions		1,147		1,121		26	2.32
Net gains on sales of loans		1,778		853		925	108.44
Net servicing fees		158		129		29	22.48
Increase in cash surrender value of life insurance		312		313		(1)	(0.32)
Loss on sale of other real estate and repossessed assets		28		23		5	21.74
Other income		236		170		66	38.82
Total	$	5,849	$	5,039	$	810	16.07	%

Increases in non-interest income included an increase of $925,000 in net gain on sales of loans due to a 75.8% increase in the dollar amount of mortgages sold excluding the $26.6 million bulk loan sale compared to the same period in 2018. This increase was partially offset by a decrease on net gain on sale of investments of $297,000.

Table of Contents

Non-Interest Expense. Non-interest expenses decreased $91,000, to $14.5 million, for the third quarter of 2019.


	Three Months Ended
	September 30,				Amount		Percent
	2019		2018		Change		Change
	(Dollars in thousands)
Non-Interest Expenses:
Salaries and employee benefits	$	8,826	$	8,152	$	674	8.27	%
Net occupancy expenses		1,005		1,087		(82)	(7.54)
Equipment expenses		574		635		(61)	(9.61)
Data processing fees		680		669		11	1.64
ATM and debit card expenses		590		664		(74)	(11.14)
Deposit insurance		(3)		209		(212)	(101.44)
Professional fees		484		460		24	5.22
Advertising and promotion		296		416		(120)	(28.85)
Software subscriptions and maintenance		723		702		21	2.99
Intangible amortization		187		316		(129)	(40.82)
Other real estate and repossessed assets		47		51		(4)	(7.84)
Other expenses		1,074		1,213		(139)	(11.46)
Total	$	14,483	$	14,574	$	(91)	(0.62)	%

Decreases in non-interest expense during the current quarter were primarily due to the higher level of expenses resulting from the acquisition and integration of Universal in 2018, which included severance, integration and termination expenses in 2018. One-time pre-tax merger-related expenses primarily included in other expenses were $238,000 in the third quarter of 2018 with no similar activity in the same period of 2019. The Bank's deposit insurance premium decreased $212,000 due to Small Bank Assessment Credits received as a result of the Deposit Insurance Fund reserve ratio exceeding 1.38% as of June 30, 2019. Core deposit intangible amortization decreased $129,000 in the third quarter of 2019 compared to the same period in 2018. Advertising and promotion expense decreased due to campaign focus and timing in 2019 compared to the same period in 2018. These decreases were partially offset by a $674,000 increase in salaries and employee benefits in the third quarter of 2019 due to increases in health insurance claim activity and an increase in commission compensation primarily due to increased mortgage loan production.

Income Tax Expense. The effective tax rate for the third quarter of 2019 was 14.6% compared to 14.4% in the same quarter of 2018. The increase was due to an increase in pre-tax net income while investments in non-taxable earning assets remained consistent.

Comparison of Results of Operations for the Nine months ended September 30, 2019 and 2018.

General. Net income for the nine months ended September 30, 2019 was $17.1 million, or $1.97 diluted earnings per common share compared to net income of $13.6 million, or $1.60 diluted earnings per common share for the nine months ended September 30, 2018. Annualized return on average assets was 1.10% and annualized return on average tangible common equity was 12.22% for the first nine months of 2019 compared to 0.95% and 11.34% respectively, for the same period of 2018.

Table of Contents


	Nine Months Ended
	September 30, 2019							September 30, 2018
	Average							Average
	Outstanding			Interest		Average		Outstanding			Interest		Average
	Balance			Earned/Paid		Yield/Rate		Balance			Earned/Paid		Yield/Rate
	(Dollars in thousands)
Interest-Earning Assets:
Interest-bearing deposits	$	24,072		$	235	1.30	%	$	22,991		$	188	1.09	%
Mortgage-backed securities available for sale (1)		218,065			4,370	2.67			199,540			4,002	2.67
Investment securities available for sale (1)		152,715			3,730	3.26			147,801			3,589	3.24
Loans (2)		1,513,717			55,566	4.89			1,406,011			49,965	4.74
Stock in FHLB of Indianapolis		13,106			536	5.45			12,468			460	4.92
Total interest-earning assets		1,921,675			64,437	4.47			1,788,811			58,204	4.34
Non-Interest Earning Assets (net of allowance for loan losses and unrealized gain (loss))		147,403							126,199
Total Assets	$	2,069,078						$	1,915,010

Interest-Bearing Liabilities:
Demand and NOW accounts	$	403,891		$	2,451	0.81		$	383,120		$	1,683	0.59
Savings deposits		184,223			14	0.01			178,605			15	0.01
Money market accounts		192,169			1,267	0.88			193,928			724	0.50
Certificate accounts		510,169			7,702	2.01			444,413			5,116	1.53
Total deposits		1,290,452			11,434	1.18			1,200,066			7,538	0.84
Borrowings		267,971			4,672	2.32			254,317			4,057	2.13
Total interest-bearing liabilities		1,558,423			16,106	1.38			1,454,383			11,595	1.06
Non-Interest Bearing Accounts		277,773							262,137
Other Liabilities		20,484							17,021
Total Liabilities		1,856,680							1,733,541
Stockholders’ Equity		212,398							181,469
Total liabilities and stockholders’ equity	$	2,069,078						$	1,915,010
Net Earning Assets	$	363,252						$	334,428
Net Interest Income				$	48,331						$	46,609
Net Interest Rate Spread (3)						3.09	%						3.28	%
Net interest margin (4)						3.35	%						3.47	%
Net interest margin, tax equivalent (5)						3.43	%						3.55	%
Average Interest-Earning Assets to Average Interest- Bearing Liabilities		123.31	%						122.99	%

(1) Average balances of securities is computed based on the average of the historical amortized cost balances without the effects of the fair value adjustments.
(2) Calculated net of deferred loan fees, loan discounts and loans in process.
(3) Interest rate spread is calculated by subtracting weighted average interest rate cost from weighted average interest rate yield for the period indicated.
(4) The net yield on weighted average interest-earning assets is calculated by dividing net interest income by weighted average interest-earning assets for the period indicated.
(5) Tax equivalent margin is calculated by taking non-taxable interest and grossing up by 21% applicable tax rate.

Table of Contents

Interest Income. Total interest income increased $6.2 million, or 10.7%, to $64.4 million during the nine months ended September 30, 2019 from $58.2 million during the same period in 2018. The increase was a result of an increase of $132.9 million in average interest-earning assets due to an increase in the average loan portfolio of $107.7 million, due to organic loan growth and increases in average interest-earning assets as a result of the Universal acquisition occurring at the end of the first quarter of 2018. An increase of thirteen basis points in the average interest rate earned on average interest-earning assets for the nine months ended September 30, 2019 compared to the same period in 2018 also contributed to the increase in interest income.

Interest Expense. Interest expense increased $4.5 million, or 38.9%, to $16.1 million during the nine months ended September 30, 2019 compared to the same period in 2018. The primary reason for this increase was the average rate paid on interest-bearing liabilities increased by thirty-two basis points for the nine months ended September 30, 2019 compared to the same period in 2018 due to an increase in market rates of interest and a change in deposit mix. In addition, average interest-bearing liabilities increased $104.0 million as a result of the Universal acquisition occurring at the end of the first quarter of 2018. This increase was due to a $90.4 million increase in average interest-bearing deposits, primarily certificates of deposit, and a $13.7 million increase in average borrowings, primarily FHLB advances.

Net Interest Income and Net Interest Margin. Net interest income before the provision for loan losses increased $1.7 million for the nine months ended September 30, 2019 compared to the same period in 2018. The increase in net interest income was primarily a result of an increase of $132.9 million in average interest-earning assets, due to an increase of $107.7 million in average loans due primarily to the acquisition of Universal Bancorp in the first quarter of 2018 and organic loan growth. This increase was partially offset by an increase in interest-bearing liabilities of $104.0 million due to a $90.4 increase of average deposits due primarily to the acquisition of Universal Bancorp in the first quarter of 2018. The net interest margin and tax equivalent margin both decreased twelve basis points in the first nine months of 2019 to 3.35% and 3.43%, respectively. The decrease in net interest margin is a result of an increase in the cost of interest-bearing liabilities of thirty-two basis points being partially offset by the yield on interest-earning assets increasing thirteen basis points. For more information on our asset/liability management, especially as it relates to interest rate risk, see “Item 7A - Quantitative and Qualitative Disclosures About Market Risk” in the Form 10‑K for the year ended December 31, 2018.

Provision for Loan Losses. Provision for loan losses in the first nine months of 2019 and 2018 were $1.4 million. Net charge offs in the first nine months of 2019 were $1.2 million, or 0.11% of total average loans on an annualized basis, compared to net charge offs of $898,000, or 0.09% of total average loans on an annualized basis, in the same period of 2018.

Non-Interest Income. Non-interest income for the first nine months of 2019 was $16.6 million, an increase of $2.4 million compared to the same period of 2018.


	Nine Months Ended
	September 30,				Amount		Percent
	2019		2018		Change		Change
	(Dollars in thousands)
Non-Interest Income:
Service fee income	$	5,930	$	5,547	$	383	6.90	%
Net realized gain (loss) on sale of securities		975		666		309	46.40
Commissions		3,625		3,751		(126)	(3.36)
Net gains on sales of loans		4,149		2,224		1,925	86.56
Net servicing fees		446		433		13	3.00
Increase in cash surrender value of life insurance		939		924		15	1.62
Loss on sale of other real estate and repossessed assets		(30)		(34)		4	(11.76)
Other income		604		766		(162)	(21.15)
Total	$	16,638	$	14,277	$	2,361	16.54	%

The increase in non-interest income for the first nine months of 2019 was primarily as a result of $1.9 million in gains on sale of mortgage loans due to a 57.8% increase in the dollar amount of mortgages sold, excluding the $26.6 million bulk loan sale completed in the third quarter of 2019, compared to the same period in 2018.

Table of Contents

An increase of $309,000 in gain on sale of securities was primarily due to an opportunistic restructure of a portion of the investment portfolio and an increase of $383,000 in service fee income due to increases in interchange fee income as a result of increased transaction volume. These increases were partially offset by decreases of other income of $162,000 primarily due to a death benefit received in the first nine months of 2018 which was not repeated in 2019 and a decrease of commission income of $126,000.

Non-Interest Expense. Non-interest expenses decreased $28,000, to $43.7 million, for the first nine months of 2019.


	Nine Months Ended
	September 30,				Amount		Percent
	2019		2018		Change		Change
	(Dollars in thousands)
Non-Interest Expenses:
Salaries and employee benefits	$	25,927	$	24,069	$	1,858	7.72	%
Net occupancy expenses		3,045		2,979		66	2.22
Equipment expenses		1,805		1,889		(84)	(4.45)
Data processing fees		1,970		1,938		32	1.65
ATM and debit card expenses		1,750		1,708		42	2.46
Deposit insurance		413		691		(278)	(40.23)
Professional fees		1,364		1,714		(350)	(20.42)
Advertising and promotion		970		1,275		(305)	(23.92)
Software subscriptions and maintenance		2,308		1,987		321	16.16
Intangible amortization		601		854		(253)	(29.63)
Other real estate and repossessed assets		170		140		30	21.43
Other expenses		3,363		4,470		(1,107)	(24.77)
Total	$	43,686	$	43,714	$	(28)	(0.06)	%

Non-interest expenses decreased as a result the Bank's deposit insurance premium decrease. Increases in general non-interest expenses including salaries and employee benefits have been primarily due to the timing of the acquisition of Universal Bancorp occurring at the end of the first quarter of 2018, whereas these general expenses have been incurred during the entire first nine months of 2019. The increase in expenses were offset by one-time pre-tax merger expenses included in professional fees, advertising and promotion, and other expenses of $2.2 million in the first nine months of 2018 with no similar activity incurred in the same period of 2019.

Income Tax Expense. The effective tax rate for the first nine months of 2019 was 14.0% compared to 13.3% for the same period in 2018. The increase was due to an increase in pre-tax net income while investments in non-taxable earning assets remained consistent.

Table of Contents

Reconciliation of Non-GAAP Financial Measures

This report on Form 10‑Q contains financial information determined by methods other than in accordance with U.S. GAAP. Non-GAAP financial measures are used by management to measure the strength of its capital and its ability to generate earnings on tangible capital invested by its shareholders. Although the Company believes these non-GAAP measures provide a greater understanding of its business, they should not be considered a substitute for financial measures determined in accordance with GAAP, nor are they necessarily comparable to non-GAAP performance measures that may be presented by other companies. Reconciliations of these non-GAAP financial measures to the most directly compared GAAP financial measures are included in the following table.


	At and for the Three Months Ended									At and for the Nine Months Ended
	September 30,			December 31,			September 30,			September 30,			September 30,
	2019			2018			2018			2019			2018
Total Stockholders' Equity (GAAP)	$	221,978		$	202,363		$	193,710		$	221,978		$	193,710
Less: Intangible Assets		25,279			25,879			26,297			25,279			26,297
Tangible common equity (non-GAAP)	$	196,699		$	176,484		$	167,413		$	196,699		$	167,413

Total assets (GAAP)	$	2,073,550		$	2,049,313		$	2,021,171		$	2,073,550		$	2,021,171
Less: Intangible Assets		25,279			25,879			26,297			25,279			26,297
Tangible assets (non-GAAP)	$	2,048,271		$	2,023,434		$	1,994,874		$	2,048,271		$	1,994,874

Tangible common equity to tangible assets (non-GAAP)		9.60	%		8.72	%		8.39	%		9.60	%		8.39	%

Book value per common share (GAAP)	$	26.12		$	23.52		$	22.56		$	26.12		$	22.56
Less: Effect of Intangible Assets		2.97			3.01			3.06			2.97			3.06
Tangible book value per common share (non-GAAP)	$	23.15		$	20.51		$	19.50		$	23.15		$	19.50

Return on average stockholders' equity (GAAP)		11.19	%		10.87	%		11.16	%		10.75	%		9.97	%
Add: Effect of Intangible Assets		1.46			1.69			1.76			1.47			1.37
Return on average tangible common equity (non-GAAP)		12.65	%		12.56	%		12.92	%		12.22	%		11.34	%

Total tax free interest income (GAAP)
Loans receivable	$	98		$	106		$	106		$	302		$	314
Investment securities		1,236			1,226			1,185			3,628			3,268
Total tax free interest income	$	1,334		$	1,332		$	1,291		$	3,930		$	3,582
Total tax free interest income, gross (at 21%)	$	1,689		$	1,686		$	1,634		$	4,975		$	4,534

Net interest margin (GAAP)
Net interest income (GAAP)	$	16,245		$	16,494		$	16,417		$	48,331		$	46,609
Add: Tax effect tax free interest income at 21%		355			354			343			1,045			952
Net interest income (non-GAAP)		16,600			16,848			16,760			49,376			47,561
Divided by: Average interest-earning assets		1,923,938			1,898,949			1,878,841			1,921,675			1,788,811
Net interest margin, tax equivalent		3.45	%		3.55	%		3.57	%		3.43	%		3.55	%

Ratio Summary:
Return on average equity (ROE)		11.19	%		10.87	%		11.16	%		10.75	%		9.97	%
Return on average tangible common equity		12.65	%		12.56	%		12.92	%		12.22	%		11.34	%
Return on average assets (ROA)		1.18	%		1.04	%		1.07	%		1.10	%		0.95	%
Tangible common equity to tangible assets		9.60	%		8.72	%		8.39	%		9.60	%		8.39	%
Net interest margin, tax equivalent		3.45	%		3.55	%		3.57	%		3.43	%		3.55	%

Table of Contents

Liquidity

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

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

Liquidity management is both a daily and long-term function of the management of the Company and the Bank. It is overseen by the Asset and Liability Management Committee. The Board of Directors requires the Bank to maintain a minimum liquidity ratio of 10% of deposits. At September 30, 2019, our ratio was 23.0%. The Company is currently in excess of the minimum liquidity ratio set by the Board due to the size of the investment portfolio. Management continues to seek to utilize liquidity off of the investment portfolio to fund loan growth over the next few years as demand for loans increases. Excess liquidity is generally invested in short-term investments, such as overnight deposits and federal funds. On a longer term basis, we maintain a strategy of investing in various lending products and investment securities, including mortgage-backed securities. The Bank uses its sources of funds primarily to meet its ongoing commitments, pay maturing deposits, fund deposit withdrawals and fund loan commitments.

We hold cash and investments that qualify as liquid assets to maintain adequate liquidity to ensure safe and sound operation and meet demands for funds (particularly withdrawals of deposits). At September 30, 2019, on a consolidated basis, the Company had $414.3 million in cash and investment securities available for sale and $19.6 million in loans held for sale generally available for its cash needs. We can also generate funds from borrowings, primarily FHLB advances, portfolio loans, and, to a lesser degree, third party loans. At September 30, 2019, the Bank had the ability to borrow an additional $86.4 million in FHLB advances based on current pledged collateral. In addition, we have historically sold 15‑ and 30‑year, fixed-rate mortgage loans in the secondary market in order to reduce interest rate risk and to create another source of liquidity. The Company is a separate legal entity from the Bank and must provide for its own liquidity. In addition to its own operating expenses, the Company is responsible for paying amounts owed on its trust preferred securities, any dividends declared to its common stockholders, and interest and principal on outstanding debt. The Company’s primary source of funds is Bank dividends, the payment of which is subject to regulatory limits. At September 30, 2019, the Company, on an unconsolidated basis, had $2.8 million in cash, interest-bearing deposits and liquid investments generally available for its cash needs.

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

Table of Contents

cash through borrowings. We utilize FHLB advances to leverage our capital base and provide funds for our lending and investment activities, and to enhance our interest rate risk management.

We use our sources of funds primarily to meet ongoing commitments, pay maturing deposits and fund withdrawals, and to fund loan commitments. At September 30, 2019, the approved outstanding loan commitments, including unused lines of credit, amounted to $293.3 million. Certificates of deposit scheduled to mature in one year or less as of September 30, 2019, totaled $259.8 million. It is management’s policy to offer deposit rates that are competitive with other local financial institutions. Based on this management strategy, we believe that a majority of maturing deposits will remain with the Bank.

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

Off-Balance Sheet Activities

In the normal course of operations, the Bank engages in a variety of financial transactions that are not recorded in our financial statements. These transactions involve varying degrees of off-balance sheet credit, interest rate and liquidity risks. These transactions are used primarily to manage customers’ requests for funding and take the form of loan commitments and lines of credit. We also have off-balance sheet obligations to repay borrowings and deposits. For the quarter ended September 30, 2019, we engaged in no off-balance sheet transactions likely to have a material effect on our financial condition, results of operations or cash flows. At September 30, 2019, the Bank had $170.2 million in commitments to make loans, $7.0 million in undisbursed portions of closed loans, $111.5 million in unused lines of credit and $3.3 million in standby letters of credit. In addition, on a consolidated basis, at September 30, 2019, the Company had $257.3 million in outstanding non-deposit borrowings, primarily FHLB advances, of which $98.1 million is due in the next twelve months.

Capital Resources

The Bank is subject to minimum capital requirements imposed by the FDIC. See ‘Item 1 - Business- How We Are Regulated - Regulatory Capital Requirements’ of the Company’s Annual Report on Form 10‑K for the year ended December 31, 2018. The FDIC may require the Bank to have additional capital above the specific regulatory levels if it believes the Bank is subject to increased risk due to asset problems, high interest rate risk and other risks.

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

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

Table of Contents

Implementation of the deductions and other adjustments to CET1 began on January 1, 2015 and phased in over a four-year period. Under the new rule, in order to avoid limitations on capital distributions, including dividend payments and certain discretionary bonus payments to executive officers, a banking organization must hold a capital conservation buffer composed of CET1 capital above its minimum risk-based capital requirements. The implementation of the capital conservation buffer began on January 1, 2016, at the 0.625% level and continued to phase in over a four-year period (increasing by that amount on each subsequent January 1 until it reached 2.5%). As of January 1, 2019 the capital conservation buffer was fully phased in. As of September 30, 2019, the Bank exceeded the minimum buffer requirement.

In May 2018, the Economic Growth, Regulatory Relief and Consumer Protection Act (the “Act”), was enacted to modify or remove certain financial reform rules and regulations, including some of those implemented under the Dodd-Frank Act. The Act expands the category of holding companies that may rely on the “Small Bank Holding Company and Savings and Loan Holding Company Policy Statement” (the “HC Policy Statement”) by raising the maximum amount of assets a qualifying holding company may have from $1.0 billion to $3.0 billion. This expansion also excludes such holding companies from the minimum capital requirements of the Dodd-Frank Act.

The Bank’s capital ratios as of September 30, 2019, are presented in the table below.


										Minimum Required To
						Minimum Regulatory				Be Considered Well-
		Actual Capital Levels				Capital Levels				Capitalized
		Amount		Ratio		Amount		Ratio		Amount		Ratio
Leverage Capital Level (1) :
MutualBank		$	195,495	9.6	%	$	81,561	4.0	%	$	101,951	5.0	%
Common Equity Tier 1 Capital Level (2) :
MutualBank		$	195,495	12.5	%	$	70,189	4.5	%	$	101,384	6.5	%
Tier 1 Risk-Based Capital Level (3) :
MutualBank		$	195,495	12.5	%	$	93,585	6.0	%	$	124,781	8.0	%
Total Risk-Based Capital Level (4) :
MutualBank		$	208,906	13.4	%	$	124,781	8.0	%	$	155,976	10.0	%

(1)	Tier 1 Capital to Total Average Assets of $2.0 billion for Leverage Ratio for the Bank at September 30, 2019.
(2)	Common Equity Tier 1 Capital to Risk-Weighted Assets of $1.6 billion for the Bank at September 30, 2019.
(3)	Tier 1 Capital to Risk-Weighted Assets.
(4)	Total Capital to Risk-Weighted Assets.

Impact of Inflation

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

Table of Contents

Item 3 Quantitative and Qualitative Disclosures About Market Risk

Information about the Company’s asset and liability management and market and interest-rate risks is included in Item 7A of the Form 10‑K for the year ended December 31, 2018, filed with the SEC on March 15, 2019.

Asset and Liability Management and Market Risk

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

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

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

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

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

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

originate shorter-duration consumer loans,

manage our deposits to establish stable deposit relationships,

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

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

Depending on the level of general interest rates, the relationship between long and short-term interest rates, market conditions and competitive factors, the Asset and Liability Management Committee may increase our

Table of Contents

interest rate risk position somewhat in order to maintain our net interest margin and improve earnings. We will continue to increase our emphasis on the origination of relatively short-term and/or adjustable rate loans. In addition, in an effort to avoid an increase in the percentage of long-term, fixed-rate loans in our portfolio, during the first nine months of 2019 we sold in the secondary market $157.9 million of primarily fixed rate, one- to four-family mortgage loans with a term to maturity of 15 years or greater.

If past rate movements are an indication of future changes, they usually are neither instantaneous nor do a majority of core deposits reprice at the same level as rates change. The following chart reflects the Bank’s percentage change in net interest income, over a one year time period, and net portfolio value (NPV) assuming an instantaneous parallel rate shock in a range from down 100 basis points to up 400 basis points as of September 30, 2019.


	Percentage Change in
	Net Interest Income		NPV
Rate Shock:
Up 400 basis points	(8.4)	%	(11.6)	%
Up 300 basis points	(6.0)	%	(6.9)	%
Up 200 basis points	(3.7)	%	(2.9)	%
Up 100 basis points	(1.7)	%	(0.3)	%
Down 100 basis points	(0.9)	%	(11.6)	%

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


	Percentage Change in
	Net Interest Income		NPV
Rate Shock:
Up 400 basis points	(1.4)	%	(9.9)	%
Up 300 basis points	(1.0)	%	(5.8)	%
Up 200 basis points	(0.6)	%	(2.1)	%
Up 100 basis points	(0.3)	%	0.0	%
Down 100 basis points	(0.5)	%	(11.2)	%

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

Item 4. Controls and Procedures

Evaluation of Disclosure Controls and Procedures

We maintain a system of disclosure controls (as defined in SEC Rule 13a‑15(e) of the Securities Exchange Act of 1934 (the “Exchange Act”)) that is designed to provide reasonable assurance that information required to be disclosed by us in the reports that we file under the Exchange Act is recorded, processed, summarized and reported accurately and within the time periods specified in the SEC’s rules and forms, and that such information is accumulated and communicated to our management, including our principal executive officer and principal financial officer, as appropriate. An evaluation of the Company’s disclosure controls and procedures as of September 30, 2019, was carried out under the supervision and with the participation of our Chief Executive Officer, Chief Financial Officer and several other members of our senior management preceding the filing date of this annual report. Our Chief Executive Officer and Chief Financial Officer

Table of Contents

concluded that, as of September 30, 2019, the Company’s disclosure controls and procedures were effective in ensuring that the information required to be disclosed by the Company in the reports it files or submits under the Exchange Act is (i) accumulated and communicated to the Company’s management (including our Chief Executive Officer and Chief Financial Officer) in a timely manner, and (ii) recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms.

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

Changes in Internal Controls over Financial Reporting

There were no changes in our internal controls over financial reporting (as defined in SEC Rule 13a‑15(f) under the Exchange Act) that occurred during the quarter ended September 30, 2019, that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

PART II.OTHER INFORMATION

Item 1.Legal Proceedings

There are no pending legal proceedings, other than litigation incidental to the ordinary course of business of the Company or its subsidiaries, of a material nature to which the Company or its subsidiaries is a party or of which any of their properties are subject. We are not party to any pending legal proceedings that we believe would have a material adverse effect on the financial condition, results of operations or cash flows of the Company.

Item 1A.Risk Factors

There are no material changes to the risk factors disclosed in the Company’s Annual Report on Form 10‑K for the year ended December 31, 2018.

Table of Contents

Item 2.Unregistered Sales of Equity Securities and Use of Proceeds

On January 18, 2019, the Company announced that its Board of Directors had authorized the repurchase of up to approximately 430,000 shares of common stock, or 5% of its then-outstanding shares over a one-year period. These stock repurchases may be made from time-to-time in open market or negotiated transactions as deemed appropriate by the Company and will depend on market conditions. As of September 30, 2019, the Company had repurchased 136,471 shares under this plan at a weighted average price per share of $31.23 for a total of $4.3 million. There were 293,529 remaining shares that may be repurchased under the current authorization. The following table provides detail on the stock repurchases during the three months ended September 30, 2019.


	Total Number of	Average		Number of Shares Purchased as	Maximum Number of Shares that May Yet
	Shares	Price Paid		Part of Publicly Announced Plan or	Be Purchased Under the Publicly
	Purchased	Per Share		Programs	Announced Plans or Programs
July	21,909	$	31.97	21,909	331,362
August	37,833		30.56	37,833	293,529
September	-		-	-	293,529
	59,742	$	31.23	59,742

Item 3. Defaults Upon Senior Securities.

None.

Item 4. Mine Safety Disclosures.

Not applicable.

Item 5. Other Information.

None.

Table of Contents

Item 6. Exhibits.


Regulation S-K Exhibit Number		Document
2.1		Agreement and Plan of Merger, dated as of October 4, 2017, by and among the Registrant and Universal Bancorp (included as Appendix A to the accompanying proxy statement-prospectus and incorporated herein by reference)
3.1		Articles of Incorporation (incorporated herein by reference to Exhibit 3.1 to the Registrant’s Registration Statement on Form S‑1 filed with the SEC on September 16, 1999 (No. 333‑87239)).
3.1a		Articles Supplementary to the Articles of Incorporation (incorporated herein by reference to Exhibit 3.1 to the Registrant’s Current Report on Form 8‑K filed with the SEC on July 15, 2008 (File No. 000‑27905))
3.2		Amended and Restated Bylaws of the Registrant (incorporated herein by reference to Exhibit 3(ii) to the Registrant’s Current Report on Form 8‑K filed with the SEC on February 27, 2015 (File No. 000‑27905))
4.1		Certificate of Registrant’s common stock (incorporated herein by reference to Exhibit 4.0 to the Registrant’s Registration Statement on Form S‑1 filed with the SEC on September 16, 1999 (No. 333‑87239))
10.1		Amended and Restated Employment Agreement between the Registrant, MutualBank and David W. Heeter (incorporated herein by reference to Exhibit 10.1 to the Registrant’s Quarterly Report on Form 10‑Q for the quarter ended September 30, 2016 (File No. 000‑27905))
10.2		Amended and Restated Employment Agreement between the Registrant, MutualBank and Patrick D. Botts (incorporated herein by reference to Exhibit 10.2 to the Registrant’s Quarterly Report on Form 10‑Q for the quarter ended September 30, 2016 (File No. 000‑27905))
10.3		Amended and Restated Employment Agreement between the Registrant, MutualBank and Christopher D. Cook (incorporated herein by reference to Exhibit 10.22 to the Registrant’s Quarterly Report on Form 10‑Q for the quarter ended September 30, 2016 (File No. 000‑27905))
10.4		Amended and Restated Employment Agreement between the Registrant, MutualBank and Charles J. Viater (incorporated herein by reference to Exhibit 10.14 to the Registrant’s Quarterly Report on Form 10‑Q for the quarter ended September 30, 2016 (File No. 000‑27905))
10.5		Salary Continuation Agreement between the Registrant and Charles J. Viater (incorporated herein by reference to Exhibit 10.17 to the Registrant’s Annual Report on Form 10‑K for the year ended December 31, 2008 filed with the SEC on March 23, 2009 (File No. 000‑27905))
10.6		Form of Supplemental Retirement Plan Income Agreements for David W. Heeter and Patrick C. Botts (incorporated herein by reference to Exhibit 10.3 to the Registrant’s Annual Report on Form 10‑K for the year ended December 31, 1999 filed with the SEC on March 30, 2000 (File No. 000‑27905))
10.7		Form of Director Shareholder Benefit Program Agreement, as amended, for Jerry D. McVicker (incorporated herein by reference to Exhibit 10.4 to the Registrant’s Annual Report on Form 10‑K for the year ended December 31, 2000 filed with the SEC on April 2, 2001 (File No. 000‑27905))
10.8		Form of Executive Deferred Compensation Plan Agreements for David W. Heeter and Patrick C. Botts (incorporated herein by reference to Exhibit 10.4 to the Registrant’s Annual Report on Form 10‑K for the year ended December 31, 1999 filed with the SEC on March 30, 2000 (File No. 000‑27905))
10.9		Registrant’s 2000 Stock Option and Incentive Plan (incorporated herein by reference to Appendix D to the joint proxy statement-prospectus included in the Registrant’s Registration Statement on Form S‑4 filed with the SEC on October 19, 2000 (No. 333‑46510))

Table of Contents

Regulation S-K Exhibit Number	Document
10.10	Director Deferred Compensation Master Agreement (incorporated herein by reference to Exhibit 10.3 to the Registrant’s Annual Report on Form 10‑K for the year ended December 31, 2006 filed with the SEC on March 16, 2007 (File No. 000‑27905))
10.11	Registrant’s 2008 Stock Option and Incentive Plan (incorporated herein by reference to Exhibit 10.13 to the Registrant’s Annual Report on Form 10‑K for the year ended December 31, 2008 filed with the SEC on March 23, 2009 (File No. 000‑27905))
10.12	Form of Incentive Stock Option Agreement for 2008 Stock Option and Incentive Plan (incorporated herein by reference to Exhibit 10.21 to the Registrant’s Annual Report on Form 10‑K for the year ended December 31, 2009 filed with the SEC on March 18, 2010 (File No. 000‑27905))
10.13	Form of Non-Qualified Stock Option Agreement for 2008 Stock Option and Incentive Plan (incorporated herein by reference to Exhibit 10.22 to the Registrant’s Annual Report on Form 10‑K for the year ended December 31, 2009 filed with the SEC on March 18, 2010 (File No. 000‑27905))
10.14	Change in Control Agreement between the Registrant, MutualBank and Christopher L. Caldwell (incorporated herein by reference to Exhibit 10.14 to the Registrant’s Quarterly Report on Form 10‑Q for the quarter ended September 30, 2017 (File No. 000‑27905))
10.15	Change in Control Agreement between the Registrant, MutualBank and Sharon L. Ferguson (incorporated herein by reference to Exhibit 10.15 to the Registrant’s Quarterly Report on Form 10‑Q for the quarter ended September 30, 2017 (File No. 000‑27905))
11	Statement re computation of earnings per share (See Note 3 of the Notes to Unaudited Consolidated Condensed Statements included in this Form 10‑Q)
31.1	Rule 13(a)‑14(a) Certification (Chief Executive Officer)
31.2	Rule 13(a)‑14(a) Certification (Chief Financial Officer)
32	Section 1350 Certification

101	Financial statements from Quarterly Report on Form 10‑Q of the Registrant for the quarter ended September 30, 2019, formatted in eXtensible Business Reporting Language (XBRL): (i) the Consolidated Condensed Balance Sheets, (ii) the Consolidated Condensed Statements of Income, (iii) the Consolidated Condensed Statements of Comprehensive Income, (iv) the Consolidated Condensed Statement of Stockholders’ Equity, (v) the Consolidated Condensed Statements of Cash Flows and (vi) the Notes to Unaudited Consolidated Condensed Financial Statements.
	101.INS	XBRL Instance Document
	101.SCH	XBRL Taxonomy Extension Schema Document
	101.CAL	XBRL Taxonomy Extension Calculation Linkbase Document
	101.DEF	XBRL Taxonomy Extension Definition Linkbase Document
	101.LAB	XBRL Taxonomy Extension Labels Linkbase Document
	101.PRE	XBRL Taxonomy Extension Presentation Linkbase Document

(b) Exhibits - See list in (a)(3) and the Exhibit Index following the signature page.

Table of Contents

INDEX TO EXHIBITS


Number	Description
31.1	Rule 13(a)‑14(a) Certification (Chief Executive Officer)

31.2	Rule 13(a)‑14(a) Certification (Chief Financial Officer)

32	Section 1350 Certification

101	Financial statements from Quarterly Report on Form 10‑Q of the Registrant for the quarter ended September 30, 2019, formatted in eXtensible Business Reporting Language (XBRL): (i) the Consolidated Condensed Balance Sheets, (ii) the Consolidated Condensed Statements of Income, (iii) the Consolidated Condensed Statements of Comprehensive Income, (iv) the Consolidated Condensed Statements of Stockholders’ Equity, (v) the Consolidated Condensed Statements of Cash Flows and (vi) the Notes to Unaudited Consolidated Condensed Financial Statements.
	101.INS	XBRL Instance Document
	101.SCH	XBRL Taxonomy Extension Schema Document
	101.CAL	XBRL Taxonomy Extension Calculation Linkbase Document
	101.DEF	XBRL Taxonomy Extension Definition Linkbase Document
	101.LAB	XBRL Taxonomy Extension Labels Linkbase Document
	101.PRE	XBRL Taxonomy Extension Presentation Linkbase Document

Table of Contents

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, as amended, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.


Date: November 6, 2019	By:	/s/ David W. Heeter
		David W. Heeter
		President and Chief Executive Officer

Date: November 6, 2019	By:	/s/ Christopher D. Cook
		Christopher D. Cook
		Senior Vice President, Treasurer and Chief Financial Officer

EXHIBIT 31.1

CERTIFICATIONS

I, David W. Heeter, certify that:

1. I have reviewed this quarterly report on Form 10-Q of MutualFirst Financial, Inc.;

2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;

3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;

4. The registrant’s other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:

a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;

b) Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, 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;

c) Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

d) Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and

5. The registrant’s other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of registrant’s board of directors (or persons performing the equivalent functions):

a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and

b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

Ay 9
Date: November 6, 2019	By:	/s/ David W. Heeter
		David W. Heeter
		President and Chief Executive Officer

EXHIBIT 31.2

CERTIFICATIONS

I, Christopher D. Cook, certify that:

1. I have reviewed this quarterly report on Form 10-Q of MutualFirst Financial, Inc.;

b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.


Date: November 6, 2019	By:	/s/ Christopher D. Cook
		Christopher D. Cook
		Senior Vice President, Treasurer and Chief Financial Officer
		(Principal Financial and Accounting Officer)

EXHIBIT 32

SECTION 1350 CERTIFICATION

Each of the undersigned hereby certifies in his capacity as an officer of MutualFirst Financial, Inc. (the “Registrant”) that the Quarterly Report of the Registrant on Form 10-Q for the period ended September 30, 2019 fully complies with the requirements of Section 13(a) of the Securities Exchange Act of 1934 and that the information contained in such report fairly presents, in all material respects, the consolidated financial condition of the Registrant at the end of such period and the results of operations of the Registrant for such period.

ay
Date: November 6, 2019	By:	/s/ David W. Heeter
		David W. Heeter
		President and Chief Executive Officer

Date: November 6, 2019	By:	/s/ Christopher D. Cook
		Christopher D. Cook
		Senior Vice President, Treasurer and Chief Financial Officer