UNITED STATES 

SECURITIES AND EXCHANGE COMMISSION  

WASHINGTON, D.C. 20549

 

FORM 10-K

 

/X/ Annual Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 for the fiscal year ended December 31, 2016 or

 

/ / Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 for the transition period from              to             

 

Commission file number 0-7818

  

INDEPENDENT BANK CORPORATION
(Exact name of Registrant as specified in its charter)

 

 

MICHIGAN   38-2032782
(State or other jurisdiction of incorporation)   (I.R.S. employer identification no.)

 

4200 East Beltline, Grand Rapids, Michigan   49525
(Address of principal executive offices)    (Zip Code)

 

Registrant’s telephone number, including area code         (616)  527-5820

 

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

 

Common Stock, No Par Value   NASDAQ
 (Title of class)   (Name of Exchange)

 

Securities registered pursuant to Section 12(g) of the Act: None.

 

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes ___ No X

 

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes ___ No X

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No___

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes X No___

 

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. X

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company.

 

Large accelerated filer ____ Accelerated filer X Non-accelerated filer _____ Smaller reporting company _____

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b of the Act). Yes ___ No X

 

The aggregate market value of common stock held by non-affiliates of the registrant as of June 30, 2016, was $300,063,109.

 

The number of shares outstanding of the registrant’s common stock as of March 3, 2017 was 21,328,758.

 

Documents incorporated by reference: Portions of our definitive proxy statement and annual report, to be delivered to shareholders in connection with the April 25, 2017 Annual Meeting of Shareholders, are incorporated by reference into Part I, Part II, Part III, and Part IV of this Form 10-K.

 

The Exhibit Index appears on Pages 34-35

 

 

 

 
 

  

FORWARD-LOOKING STATEMENTS

 

Statements in this Annual Report on Form 10-K that are not statements of historical fact, including statements that include terms such as “will,” “may,” “should,” “believe,” “expect,” “forecast,” “anticipate,” “estimate,” “project,” “intend,” “likely,” “optimistic” and “plan” and statements about future or projected financial and operating results, plans, projections, objectives, expectations, and intentions, are forward-looking statements. Forward-looking statements include, but are not limited to, descriptions of plans and objectives for future operations, products or services; projections of our future revenue, earnings or other measures of economic performance; forecasts of credit losses and other asset quality trends; statements about our business and growth strategies; and expectations about economic and market conditions and trends. These forward-looking statements express our current expectations, forecasts of future events, or long-term goals. They are based on assumptions, estimates, and forecasts that, although believed to be reasonable, may turn out to be incorrect. Actual results could differ materially from those discussed in the forward-looking statements for a variety of reasons, including:

 

· economic, market, operational, liquidity, credit, and interest rate risks associated with our business;

 

· economic conditions generally and in the financial services industry, particularly economic conditions within Michigan and the regional and local real estate markets in which our bank operates;

 

· the failure of assumptions underlying the establishment of, and provisions made to, our allowance for loan losses;

 

· increased competition in the financial services industry, either nationally or regionally;

 

· our ability to achieve loan and deposit growth;

 

· volatility and direction of market interest rates;

 

· the continued services of our management team; and

 

· implementation of new legislation, which may have significant effects on us and the financial services industry.

 

This list provides examples of factors that could affect the results described by forward-looking statements contained in this Annual Report on Form 10-K, but the list is not intended to be all-inclusive. The risk factors disclosed in Part I – Item 1A below include all known risks our management believes could materially affect the results described by forward-looking statements in this report. However, those risks may not be the only risks we face. Our results of operations, cash flows, financial position, and prospects could also be materially and adversely affected by additional factors that are not presently known to us, that we currently consider to be immaterial, or that develop after the date of this report. We cannot assure you that our future results will meet expectations. While we believe the forward-looking statements in this report are reasonable, you should not place undue reliance on any forward-looking statement. In addition, these statements speak only as of the date made. We do not undertake, and expressly disclaim, any obligation to update or alter any statements, whether as a result of new information, future events, or otherwise, except as required by applicable law.

 

1
 

 

PART I

 

ITEM 1.     BUSINESS

 

Independent Bank Corporation was incorporated under the laws of the State of Michigan on September 17, 1973, for the purpose of becoming a bank holding company. We are registered under the Bank Holding Company Act of 1956, as amended, and own all of the outstanding stock of Independent Bank (the “bank”), which is also organized under the laws of the State of Michigan.

 

Aside from the stock of our bank, we have no other substantial assets. We conduct no business except for the collection of dividends or returns of capital from our bank and the payment of dividends to our shareholders and the payment of interest on subordinated debentures. We have established certain employee retirement plans, including an employee stock ownership plan (ESOP) and deferred compensation plans, as well as health and other insurance programs, the cost of which is borne by our subsidiaries. We have no material patents, trademarks, licenses or franchises except the corporate charter of our bank, which permits it to engage in commercial banking pursuant to Michigan law.

 

Our bank transacts business in the single industry of commercial banking. It offers a broad range of banking services to individuals and businesses, including checking and savings accounts, commercial lending, direct and indirect consumer financing, mortgage lending, and safe deposit box services. Our bank does not offer trust services. Our principal markets are the rural and suburban communities across lower Michigan, which are served by the bank’s main office in Grand Rapids, Michigan, and a total of 62 branches, one drive-thru facility, and 12 loan production offices. We also recently opened two loan production offices in Ohio (Columbus and Fairlawn). Most of our bank’s branches provide full-service lobby and drive-thru services, as well as automatic teller machines (ATMs). In addition, we provide internet and mobile banking capabilities to our customers. We continue to see customer transaction volume declining at our bank offices and increasing through our electronic channels.

 

Our bank competes with other commercial banks, savings banks, credit unions, mortgage banking companies, securities brokerage companies, insurance companies, and money market mutual funds. Many of these competitors have substantially greater resources than we do and offer certain services that we do not currently provide. Such competitors may also have greater lending limits than our bank. In addition, non-bank competitors are generally not subject to the extensive regulations applicable to us. Price (the interest charged on loans and paid on deposits) remains a principal means of competition within the financial services industry. Our bank also competes on the basis of service and convenience in providing financial services.

 

As of December 31, 2016, our bank had total loans (excluding loans held for sale) of $1.608 billion and total deposits of $2.226 billion. As of December 31, 2016, we had 737 full-time employees and 148 part-time employees.

 

In addition to general banking services, our bank also offers title insurance services through a separate subsidiary and investment and insurance services through a third party agreement with Cetera Investment Services LLC.

 

On December 30, 2016, we entered into an asset purchase agreement to sell substantially all of the assets of Mepco Finance Corporation (“Mepco”), a subsidiary of our bank that is engaged in the business of acquiring and servicing payment plans used by consumers to purchase vehicle service contracts provided and administered by third parties. Mepco purchases payment plans from companies (which we referred to as Mepco’s “counterparties”) that provide vehicle service contracts to consumers. The payment plans (which are classified as payment plan receivables for periods prior to December 31, 2016 and “payment plan receivables and other assets held for sale” as of December 31, 2016 in our Consolidated Statements of Financial Condition) permit a consumer to purchase a service contract by making installment payments, generally for a term of 12 to 30 months, to the sellers of those contracts (one of the counterparties). Mepco does not have recourse against the consumer for non-payment of a payment plan and therefore does not evaluate the creditworthiness of the individual customer. When consumers stop making payments or exercise their right to voluntarily cancel the contract, the remaining unpaid balance of the payment plan is normally recouped by Mepco from the counterparties that sold the contract and provided the coverage. The refund obligations of these counterparties are not fully secured. We record losses or charges in vehicle service contract counterparty contingencies expense, included in non-interest expense-other in the Consolidated Statements of Operations, for estimated defaults by these counterparties in their obligations to Mepco.

 

2
 

 

ITEM 1.     BUSINESS (continued)

 

On a consolidated basis, our principal sources of revenue are interest and fees on loans, other interest income, and non-interest income. The sources of revenue for the three most recent years are as follows:

 

    2016   2015   2014
      Interest and fees on loans   57.6%   58.6%   60.2%
      Other interest income     9.6     8.2     7.3
      Non-interest income   32.8   33.2   32.5
  100.0 % 100.0 % 100.0 %

 

Supervision and Regulation

 

The following is a summary of certain statutes and regulations affecting us. This summary is qualified in its entirety by reference to the particular statutes and regulations. A change in applicable laws or regulations may have a material effect on us and our bank.

 

General

 

Financial institutions and their holding companies are extensively regulated under federal and state law. Consequently, our growth and earnings performance can be affected not only by management decisions and general and local economic conditions, but also by the statutes administered by, and the regulations and policies of, various governmental regulatory authorities. Those authorities include, but are not limited to, the Federal Reserve, the Federal Deposit Insurance Corporation (“FDIC”), the Michigan Department of Insurance and Financial Services (“Michigan DIFS”), the Internal Revenue Service, and state taxing authorities. The effect of such statutes, regulations and policies and any changes thereto can be significant and cannot necessarily be predicted.

 

Federal and state laws and regulations generally applicable to financial institutions and their holding companies regulate, among other things, the scope of business, investments, reserves against deposits, capital levels, lending activities and practices, the nature and amount of collateral for loans, the establishment of branches, mergers, consolidations and dividends. The system of supervision and regulation applicable to us establishes a comprehensive framework for our operations and is intended primarily for the protection of the FDIC’s deposit insurance fund, our depositors, and the public, rather than our shareholders.

 

Independent Bank Corporation

 

We are a bank holding company and, as such, are registered with, and subject to regulation by, the Federal Reserve under the Bank Holding Company Act, as amended (the “BHCA”). Under the BHCA, we are subject to periodic examination by the Federal Reserve and are required to file periodic reports of operations and such additional information as the Federal Reserve may require.

 

Federal law requires bank holding companies to act as a source of strength to their bank subsidiaries and to commit capital and financial resources to support those subsidiaries. Such support may be required by the Federal Reserve at times when we might otherwise determine not to provide it.

 

In addition, if the Michigan DIFS deems a bank’s capital to be impaired, it may require a bank to restore its capital by special assessment upon the bank holding company, as the bank’s sole shareholder. If the bank holding company failed to pay such assessment, the directors of that bank would be required, under Michigan law, to sell the shares of bank stock owned by the bank holding company to the highest bidder at either public or private auction and use the proceeds of the sale to restore the bank’s capital.

 

Any capital loans by a bank holding company to a subsidiary bank are subordinate in right of payment to deposits and to certain other indebtedness of such subsidiary bank. In the event of a bank holding company’s bankruptcy, any commitment by the bank holding company to a federal bank regulatory agency to maintain the capital of a subsidiary bank will be assumed by the bankruptcy trustee and entitled to a priority of payment.

 

3
 

 

ITEM 1.     BUSINESS (continued)

 

Investments and Activities . Federal law places restrictions on the ability of our holding company to engage in certain transactions, make investments, and participate (directly or indirectly through a subsidiary) in various activities.

 

In general, any direct or indirect acquisition by a bank holding company of any voting shares of any bank which would result in the bank holding company’s direct or indirect ownership or control of more than 5% of any class of voting shares of such bank, and any merger or consolidation of the bank holding company with another bank holding company, will require the prior written approval of the Federal Reserve under the BHCA. In acting on such applications, the Federal Reserve must consider various statutory factors including the effect of the proposed transaction on competition in relevant geographic and product markets and each party’s financial condition, managerial resources, and record of performance under the Community Reinvestment Act.

 

The merger or consolidation of an existing bank subsidiary of a bank holding company with another bank, or the acquisition by such a subsidiary of the assets of another bank, or the assumption of the deposit and other liabilities by such a subsidiary requires the prior written approval of the responsible federal regulatory agency under the Bank Merger Act, based upon a consideration of statutory factors similar to those outlined above with respect to the BHCA. In addition, in certain cases, an application to, and the prior approval of, the Federal Reserve under the BHCA and/or Michigan DIFS under Michigan banking laws, may be required.

 

With certain limited exceptions, the BHCA prohibits any bank holding company from engaging, either directly or indirectly through a subsidiary, in any activity other than managing or controlling banks unless the proposed non-banking activity is one the Federal Reserve has determined to be so closely related to banking as to be a proper incident thereto. Under current Federal Reserve regulations, such permissible non-banking activities include such things as mortgage banking, equipment leasing, securities brokerage, and consumer and commercial finance company operations. Well-capitalized and well-managed bank holding companies may, however, engage de novo in certain types of non-banking activities without prior notice to, or approval of, the Federal Reserve, provided that written notice of the new activity is given to the Federal Reserve within 10 business days after the activity is commenced. If a bank holding company wishes to engage in a non-banking activity by acquiring a going concern, prior notice and/or prior approval will be required, depending upon the activities in which the company to be acquired is engaged, the size of the company to be acquired and the financial and managerial condition of the acquiring bank holding company.

 

Eligible bank holding companies that elect to operate as financial holding companies may engage in, or own shares in companies engaged in, a wider range of non-banking activities, including securities and insurance activities and any other activity the Federal Reserve, in consultation with the Treasury, determines by regulation or order is financial in nature, incidental to any such financial activity or complementary to any such financial activity and does not pose a substantial risk to the safety or soundness of depository institutions or the financial system generally. The BHCA generally does not place territorial restrictions on the domestic activities of non-bank subsidiaries of bank or financial holding companies. We have not applied for approval to operate as a financial holding company and have no current intention of doing so.

 

Capital Requirements . The Federal Reserve uses capital adequacy guidelines in its examination and regulation of bank holding companies. If capital falls below minimum guidelines, a bank holding company may, among other things, be denied approval to acquire or establish additional banks or non-bank businesses.

 

The Federal Reserve’s capital guidelines establish the following minimum regulatory capital requirements for bank holding companies: (i) a leverage capital requirement expressed as a percentage of total assets, and (ii) a risk-based requirement expressed as a percentage of total risk-weighted assets. The leverage capital requirement consists of a minimum ratio of Tier 1 capital (which consists principally of shareholders’ equity) to total assets of 3% for the most highly-rated companies with minimum requirements of 4% to 5% for all others. The risk-based requirement consists of a minimum ratio of total capital to total risk-weighted assets of 8%, of which at least one-half must be Tier 1 capital. The risk-based and leverage standards presently used by the Federal Reserve are minimum requirements, and higher capital levels will be required if warranted by the particular circumstances or risk profiles of individual banking organizations. The federal bank regulatory agencies are required biennially to review risk-based capital standards to ensure that they adequately address interest rate risk, concentration of credit risk and risks from non-traditional activities.

 

4
 

 

ITEM 1.     BUSINESS (continued)

 

Our Tier 1 capital as of December 31, 2016, includes $34.5 million of trust preferred securities (classified on our balance sheet as “Subordinated debentures”). The Federal Reserve has issued rules regarding trust preferred securities as a component of the Tier 1 capital of bank holding companies. The aggregate amount of trust preferred securities and certain other capital elements is limited to 25 percent of Tier 1 capital elements, net of goodwill (net of any associated deferred tax liability). The amount of trust preferred securities and certain other elements in excess of the limit could be included in the Tier 2 capital, subject to restrictions. The provisions of the Dodd-Frank Wall Street Reform and Consumer Protection Act adopted in 2010 (the “Dodd-Frank Act”) imposed additional limitations on the ability to include trust preferred securities as Tier 1 capital; however, these additional limitations do not apply to our outstanding trust preferred securities.

 

On January 1, 2015, we became subject to new regulatory capital rules issued by the Federal Reserve in 2013. In general, these new capital rules increase the minimum requirements for both the quantity and quality of capital we maintain. The rules include a new minimum ratio of common equity Tier 1 capital to risk-weighted assets of 4.5% and a common equity Tier 1 capital conservation buffer of 2.5% of risk-weighted assets. This 2.5% capital conservation buffer is being phased in over a four-year period that began in 2016. The rules also raise the minimum ratio of Tier 1 capital to risk-weighted assets from 4% to 6% and include a minimum leverage ratio of 4%. As to the quality of capital, the new rules emphasize common equity Tier 1 capital, the most loss-absorbing form of capital, and implements strict eligibility criteria for regulatory capital instruments. The rules also change the methodology for calculating risk-weighted assets to enhance risk sensitivity. The application of the new capital rules to our organization is described below. Under these new capital rules, our existing trust preferred securities are grandfathered as qualifying regulatory capital. We believe we currently exceed all of the capital ratio requirements of these new capital rules.

 

Dividends . Historically, most of our revenues have been received in the form of dividends paid by our bank. We can also make requests for returns of capital from our bank; however, such requests require the approval of the Michigan DIFS. Thus, our ability to pay dividends to our shareholders is indirectly limited by restrictions on the ability of our bank to pay dividends or return capital to us, as described below. Further, in a policy statement, the Federal Reserve has expressed its view that a bank holding company experiencing earnings weaknesses should not pay cash dividends exceeding its net income or that can only be funded in ways that weaken the bank holding company’s financial health, such as by borrowing. The Federal Reserve possesses enforcement powers over bank holding companies and their non-bank subsidiaries to prevent or remedy actions that represent unsafe or unsound practices or violations of applicable statutes and regulations. Among these powers is the ability to proscribe the payment of dividends by banks and bank holding companies. The “prompt corrective action” provisions of federal law and regulation authorize the Federal Reserve to restrict the amount of dividends that can be paid by an insured bank that fails to meet specified capital levels.

 

In addition to the restrictions on dividends imposed by the Federal Reserve, the Michigan Business Corporation Act provides that dividends may be legally declared or paid only if, after the distribution, the corporation can pay its debts as they come due in the usual course of business and its total assets equal or exceed the sum of its liabilities plus the amount that would be needed to satisfy the preferential rights upon dissolution of any holders of preferred stock whose preferential rights are superior to those receiving the distribution.

 

Change in Control Limitations . Subject to certain exceptions, the Change in the Bank Control Act (“Control Act”) and regulations promulgated thereunder by the Federal Reserve, require any person acting directly or indirectly, or through or in concert with one or more persons, to give the Federal Reserve 60 days’ written notice before acquiring control of a bank holding company. Pursuant to the Control Act, the Federal Reserve has the authority to prevent any such acquisition. Transactions that are presumed to constitute the acquisition of control include the acquisition of any voting securities of a bank holding company having securities registered under Section 12 of the Securities Exchange Act of 1934, as amended, if, after the transaction, the acquiring person (or persons acting in concert) owns, controls or holds with power to vote 10% or more of any class of voting securities of the institution.

 

Federal Securities Regulation . Our common stock is registered with the SEC under the Securities Act of 1933, as amended, and the Securities Exchange Act of 1934, as amended (the “Exchange Act”). We are therefore subject to the information, proxy solicitation, insider trading and other restrictions and requirements of the SEC under the Exchange Act.

 

5
 

 

ITEM 1.     BUSINESS (continued)

 

Independent Bank

 

Independent Bank is a Michigan banking corporation and a member of the Federal Reserve System, and its deposit accounts are insured by the FDIC’s Deposit Insurance Fund (“DIF”). As a member of the Federal Reserve System and a Michigan-chartered bank, our bank is subject to the examination, supervision, reporting and enforcement requirements of the Federal Reserve as its primary federal regulator and the Michigan DIFS as the chartering authority for Michigan banks. These agencies and the federal and state laws applicable to our bank and its operations extensively regulate various aspects of the banking business including, among other things, permissible types and amounts of loans, investments and other activities, capital adequacy, branching, interest rates on loans and on deposits, the maintenance of non-interest bearing reserves on deposit accounts, and the safety and soundness of banking practices.

 

Deposit Insurance . As an FDIC-insured institution, our bank is required to pay deposit insurance premium assessments to the FDIC. Under the FDIC’s risk-based assessment system for deposit insurance premiums, all insured depository institutions are placed into one of four categories (Risk Categories I, II, III, and IV), based primarily on their level of capital and supervisory evaluations, for purposes of determining the institution’s assessment rate. Deposit insurance premium assessments are generally based on an institution’s total assets minus its tangible equity.

 

FICO Assessments . Our bank, as a member of the DIF, is subject to assessments to cover the payments on outstanding obligations of the Financing Corporation (“FICO”). FICO was created to finance the recapitalization of the Federal Savings and Loan Insurance Corporation, the predecessor to the FDIC’s Savings Association Insurance Fund, which was created to insure the deposits of thrift institutions and was merged with the Bank Insurance Fund into the newly formed DIF in 2006. From now until the maturity of the outstanding FICO obligations in 2019, DIF members will share the cost of the interest on the FICO bonds on a pro rata basis. It is estimated that FICO assessments during this period will be approximately 0.006% of average tangible assets.

 

Michigan DIFS Assessments . Michigan banks are required to pay supervisory fees to the Michigan DIFS to fund their operations. The amount of supervisory fees paid by a bank is based upon the bank’s total assets.

 

Capital Requirements . The Federal Reserve has established the following minimum capital standards for state-chartered, FDIC-insured member banks, such as our bank: a leverage requirement consisting of a minimum ratio of Tier 1 capital to total assets of 3% for the most highly-rated banks with minimum requirements of 4% to 5% for all others, and a risk-based capital requirement consisting of a minimum ratio of total capital to total risk-weighted assets of 8%, at least one-half of which must be Tier 1 capital. Tier 1 capital consists principally of shareholders’ equity. These capital requirements are minimum requirements. Higher capital levels will be required if warranted by the particular circumstances or risk profiles of individual institutions. For example, Federal Reserve regulations provide that higher capital may be required to take adequate account of, among other things, interest rate risk and the risks posed by concentrations of credit, nontraditional activities, or securities trading activities.

 

On January 1, 2015, we became subject to new regulatory capital rules issued by the Federal Reserve in 2013. In general, these new capital rules increase the minimum requirements for both the quantity and quality of capital we maintain. The rules include a new minimum ratio of common equity Tier 1 capital to risk-weighted assets of 4.5% and a common equity Tier 1 capital conservation buffer of 2.5% of risk-weighted assets. This 2.5% capital conservation buffer is being phased in over a four-year period that began in 2016. The rules also raise the minimum ratio of Tier 1 capital to risk-weighted assets from 4% to 6% and include a minimum leverage ratio of 4%. As to the quality of capital, the new rules emphasize common equity Tier 1 capital, the most loss-absorbing form of capital, and implements strict eligibility criteria for regulatory capital instruments. The rules also change the methodology for calculating risk-weighted assets to enhance risk sensitivity. The application of the new capital rules to our organization is described below. We believe we currently exceed all of the capital ratio requirements of these new capital rules.

 

6
 

 

ITEM 1.     BUSINESS (continued)

 

Federal law provides the federal banking regulators with broad power to take prompt corrective action to resolve the problems of undercapitalized institutions. The extent of the regulators’ powers depends on whether the institution in question is “well capitalized,” “adequately capitalized,” “undercapitalized,” “significantly undercapitalized,” or “critically undercapitalized.” Federal regulations define these capital categories as follows:

 

    Total   
Risk-Based   
Capital Ratio 		  Tier 1   
Risk-Based   
Capital Ratio 		  Common   
Equity Tier 1   
Risk-Based   
Capital Ratio 		  Leverage   
Ratio
 Well capitalized   10% or above   8% or above   6.5% or above   5% or above
 Adequately capitalized   8% or above   6% or above   4.5% or above   4% or above
 Undercapitalized   Less than 8%   Less than 6%   Less than 4.5%   Less than 4%
 Significantly undercapitalized   Less than 6%   Less than 4%   Less than 3%   Less than 3%
 Critically undercapitalized   Tangible equity to total assets of 2% or less

 

At December 31, 2016, our bank’s ratios exceeded minimum requirements for the well-capitalized category.

 

Depending upon the capital category to which an institution is assigned, the regulators’ corrective powers include: requiring the submission of a capital restoration plan; placing limits on asset growth and restrictions on activities; requiring the institution to issue additional capital stock (including additional voting stock) or to be acquired; restricting transactions with affiliates; restricting the interest rates the institution may pay on deposits; ordering a new election of directors of the institution; requiring that senior executive officers or directors be dismissed; prohibiting the institution from accepting deposits from correspondent banks; requiring the institution to divest certain subsidiaries; prohibiting the payment of principal or interest on subordinated debt; and ultimately, appointing a receiver for the institution.

 

In general, a depository institution may be reclassified to a lower category than is indicated by its capital levels if the appropriate federal depository institution regulatory agency determines the institution to be otherwise in an unsafe or unsound condition or to be engaged in an unsafe or unsound practice. This could include a failure by the institution to correct the deficiency following receipt of a less-than-satisfactory rating on its most recent examination report.

 

Dividends . Under Michigan law, banks are restricted as to the maximum amount of dividends they may pay on their common stock. Our bank may not pay dividends except out of its net income after deducting its losses and bad debts. In addition, a Michigan bank may not declare or pay a dividend unless the bank will have a surplus amounting to at least 20 percent of its capital after the payment of the dividend.

 

In addition, as a member of the Federal Reserve System, our bank is required to obtain the prior approval of the Federal Reserve for the declaration or payment of a dividend if the total of all dividends declared in any year will exceed the total of (a) the bank’s retained net income (as defined by federal regulation) for that year, plus (b) the bank’s retained net income for the preceding two years.

 

Federal law also generally prohibits a depository institution from making any capital distribution (including payment of a dividend) or paying any management fee to its holding company if the depository institution would thereafter be undercapitalized. In addition, the Federal Reserve may prohibit the payment of dividends by a bank if such payment is determined, by reason of the financial condition of the bank, to be an unsafe and unsound banking practice or if the bank is in default of payment of any assessment due to the FDIC.

 

7
 

 

ITEM 1.     BUSINESS (continued)

 

Insider Transactions . Our bank is subject to certain restrictions imposed by the Federal Reserve Act on “covered transactions” with us or our subsidiaries, which include investments in our stock or other securities issued by us or our subsidiaries, the acceptance of our stock or other securities issued by us or our subsidiaries as collateral for loans, and extensions of credit to us or our subsidiaries. Certain limitations and reporting requirements are also placed on extensions of credit by our bank to the directors and officers of the holding company, the bank, and the subsidiaries of the bank; to the principal shareholders of the holding company; and to “related interests” of such directors, officers, and principal shareholders. In addition, federal law and regulations may affect the terms upon which any person becoming one of our directors or officers or a principal shareholder may obtain credit from banks with which our bank maintains a correspondent relationship.

 

Safety and Soundness Standards . Pursuant to the Federal Deposit Insurance Corporation Improvement Act of 1991 (“FDICIA”), the FDIC adopted guidelines to establish operational and managerial standards to promote the safety and soundness of federally-insured depository institutions. The guidelines establish standards for internal controls, information systems, internal audit systems, loan documentation, credit underwriting, interest rate exposure, asset growth, compensation, fees and benefits, asset quality, and earnings.

 

Investment and Other Activities . Under federal law and regulations, FDIC-insured state banks are prohibited, subject to certain exceptions, from making or retaining equity investments of a type, or in an amount, that are not permissible for a national bank. FDICIA, as implemented by FDIC regulations, also prohibits FDIC-insured state banks and their subsidiaries, subject to certain exceptions, from engaging as a principal in any activity that is not permitted for a national bank or its subsidiary, respectively, unless the bank meets, and continues to meet, its minimum regulatory capital requirements and the bank’s primary federal regulator determines the activity would not pose a significant risk to the DIF. Impermissible investments and activities must be otherwise divested or discontinued within certain time frames set by the bank’s primary federal regulator in accordance with federal law. These restrictions are not currently expected to have a material impact on the operations of our bank.

 

Consumer Banking . Our bank’s business includes making a variety of types of loans to individuals. In making these loans, our bank is subject to state usury and other consumer protection laws and to various federal statutes, including provisions of the Gramm Leach-Bliley Act aimed at protecting the privacy of consumer financial information, the Equal Credit Opportunity Act, the Fair Credit Reporting Act, the Truth in Lending Act (TILA), the Real Estate Settlement Procedures Act (RESPA), the Home Mortgage Disclosure Act, and the regulations promulgated under these statutes, which (among other things) prohibit discrimination, specify disclosures to be made to borrowers regarding credit and settlement costs, and regulate the mortgage loan servicing activities of our bank, including the maintenance and operation of escrow accounts and the transfer of mortgage loan servicing. In receiving deposits, our bank is subject to extensive regulation under state and federal law and regulations, including the Truth in Savings Act, the Expedited Funds Availability Act, the Bank Secrecy Act, the Electronic Funds Transfer Act, and the Federal Deposit Insurance Act. Violation of these laws could result in the imposition of significant damages and fines upon our bank and its directors and officers.

 

A number of new consumer protection laws were implemented following the recent recession, including:

 

· The Homeowner Affordability and Stability Plan (HASP) was implemented in 2009 to support a recovery in the housing market and ensure that borrowers can continue to pay off their mortgages through initiatives such as access to low-cost refinancing for responsible homeowners suffering from falling home prices; a $75 billion homeowner stability plan to prevent foreclosure, and support of low mortgage rates by strengthening confidence in Fannie Mae and Freddie Mac.

 

· The Dodd-Frank Act, adopted in 2010, included the creation of the Consumer Financial Protection Bureau (CFPB), which was given the power to issue and enforce certain consumer protection laws. The CFPB has issued several new consumer protection regulations, including regulations that impact residential mortgage lending and servicing.

 

· The Dodd-Frank Act also implemented new restrictions on how mortgage brokers and loan originators may be compensated.

 

8
 

 

ITEM 1.     BUSINESS (continued)

 

We have experienced, and expect to continue to experience, increased costs and expenses related to compliance with these and other new consumer protection regulations.

 

Branching Authority . Michigan banks, such as our bank, have the authority under Michigan law to establish branches anywhere in the State of Michigan, subject to receipt of all required regulatory approvals. Banks may establish interstate branch networks through acquisitions of other banks. The establishment of de novo interstate branches or the acquisition of individual branches of a bank in another state (rather than the acquisition of an out-of-state bank in its entirety) is allowed only if specifically authorized by state law.

 

Michigan permits both U.S. and non-U.S. banks to establish branch offices in Michigan. The Michigan Banking Code permits, in appropriate circumstances and with the approval of the Michigan DIFS (1) the acquisition of Michigan banks by FDIC-insured banks or savings banks located in other states, (2) the sale by a Michigan bank of branches to an FDIC-insured bank or savings bank located in a state in which a Michigan bank could purchase branches of the purchasing entity, (3) the consolidation of Michigan banks and FDIC-insured banks or savings banks located in other states having laws permitting such consolidation, (4) the establishment of branches in Michigan by FDIC-insured banks located in other states, the District of Columbia or U.S. territories or protectorates having laws permitting a Michigan bank to establish a branch in such jurisdiction, and (5) the establishment by foreign banks of branches located in Michigan.

 

Future Legislation

 

Various other legislative and regulatory initiatives, including proposals to overhaul the bank regulatory system, are from time to time introduced in Congress and state legislatures, as well as regulatory agencies. Such future legislation regarding financial institutions may change banking statutes and our operating environment in substantial and unpredictable ways and could increase or decrease the cost of doing business, limit or expand permissible activities, or affect the competitive balance among organizations within the industry. The nature and extent of future legislative and regulatory changes affecting financial institutions is very unpredictable. We cannot determine the ultimate effect that any such potential legislation, if enacted, would have upon our financial condition or results of operations.

 

Available Information

 

Our annual reports on Forms 10-K, quarterly reports on Forms 10-Q, current reports on Forms 8-K, and all amendments to those reports are available free of charge through our website at www.IndependentBank.com as soon as reasonably practicable after filing with the Securities and Exchange Commission (SEC).

 

9
 

 

ITEM 1.     BUSINESS -- STATISTICAL DISCLOSURE

 

I.   (A) DISTRIBUTION OF ASSETS, LIABILITIES AND STOCKHOLDERS’ EQUITY;

 

     (B) INTEREST RATES AND INTEREST DIFFERENTIAL

 

     (C) INTEREST RATES AND DIFFERENTIAL

 

The information set forth in the tables captioned “Average Balances and Rates” and “Change in Net Interest Income” of our annual report, to be delivered to shareholders in connection with the April 25, 2017 Annual Meeting of Shareholders (filed as exhibit 13 to this report on Form 10-K), is incorporated herein by reference.

 

II.    INVESTMENT PORTFOLIO

 

(A)  The following table sets forth the fair value of securities at December 31:

 

    2016   2015   2014
    (in thousands)
Trading - preferred stock   $ 410     $ 148     $ 203  
                         
Available for sale                        
  Obligations of states and political subdivisions   $ 170,899     $ 144,984     $ 143,415  
  U.S. agency residential mortgage-backed     156,289       196,056       257,558  
  Other asset backed     146,709       116,904       32,353  
  Corporate     56,180       38,614       22,664  
  Private label mortgage-backed     34,727       4,903       6,013  
  U.S. agency     28,988       47,512       35,006  
  U.S. agency commercial mortgage-backed     12,632       34,028       33,728  
  Trust preferred     2,579       2,483       2,441  
  Foreign government     1,613       —         —    
     Total   $ 610,616     $ 585,484     $ 533,178  

 

10
 

 

ITEM 1.     BUSINESS -- STATISTICAL DISCLOSURE (Continued)

 

(B) The following table sets forth contractual maturities of securities at December 31, 2016 and the weighted average yield of such securities:

 

    Maturing 
Within
One Year 		  Maturing
After One
But Within
Five Years 		  Maturing
After Five
But Within
Ten Years 		  Maturing
After
Ten Years
    Amount   Yield   Amount   Yield   Amount   Yield   Amount   Yield
    (dollars in thousands)
 Trading - Preferred stock                                                   $ 410       0.00 %
                                                                 
 Tax equivalent adjustment for calculation of yield                                                   $ —            
                                                                 
Available for sale                                                                
  Obligations of states and political subdivisions   $ 9,823       2.11 %   $ 58,655       2.59 %   $ 43,478       3.53 %   $ 58,943       3.48 %
  U.S. agency residential mortgage-backed     —                 55,159       1.36       56,278       1.44       44,852       2.32  
  Other asset backed     67,810       1.92       68,613       1.98       8,734       1.81       1,552       1.45  
  Corporate     8,388       1.67       33,509       2.07       14,283       3.30       —            
  Private label mortage-backed     13,340       5.58       7,719       2.47       12,442       3.12       1,226       5.67  
  U.S. agency     540       2.33       8,069       1.50       20,379       1.93       —            
  U.S. agency commercial mortgage-backed     2,128       1.01       9,099       2.47       —                 1,405       2.92  
  Trust preferred     —                 —                 —                 2,579       2.10  
  Foreign government     —                  1,613       4.34       —                 —             
     Total   $ 102,029       2.38 %   $ 242,436       2.03 %   $ 155,594       2.41 %   $ 110,557       2.96 %
                                                                 
 Tax equivalent adjustment for calculation of yield   $ 37             $ 371             $ 361             $ 198          

 

 

The rates set forth in the tables above for those obligations of state and political subdivisions that are tax exempt have been restated on a tax equivalent basis assuming a marginal tax rate of 35%. The amount of the adjustment is as follows.

 

Available for sale   Tax-Exempt
Rate 		  Adjustment   Rate on Tax
Equivalent
Basis
  Under 1 year     1.66 %     0.90 %     2.56 %
  1-5 years     1.89       1.02       2.91  
  5-10 years     2.49       1.34       3.83  
  After 10 years     3.40       1.83       5.23  

 

11
 

 

ITEM 1.     BUSINESS -- STATISTICAL DISCLOSURE (Continued)

 

III.    LOAN PORTFOLIO

 

(A) The following table sets forth total loans outstanding at December 31:

 

    2016   2015   2014   2013   2012
    (in thousands)
Loans held for sale(a)   $ 67,380     $ 27,866     $ 23,662     $ 20,390     $ 50,779  
Mortgage     538,615       498,036       471,435       486,115       526,969  
Commercial     804,017       748,398       690,955       635,234       617,258  
Installment     265,616       234,017       207,571       192,583       190,220  
Payment plan receivables     —         34,599       40,001       60,638       84,692  
    Total Loans   $ 1,675,628     $ 1,542,916     $ 1,433,624     $ 1,394,960     $ 1,469,918  

 

(a) 2016 includes $30.6 million of payment plan receivables and $0.8 million commercial loans related to the pending sale of Mepco and $35.9 of 1-4 family residential mortgages.

 

The loan portfolio is periodically and systematically reviewed, and the results of these reviews are reported to the Board of Directors of our bank. The purpose of these reviews is to assist in assuring proper loan documentation, to facilitate compliance with applicable laws and regulations, to provide for the early identification of potential problem loans (which enhances collection prospects) and to evaluate the adequacy of the allowance for loan losses.

 

(B) The following table sets forth scheduled loan repayments (excluding 1-4 family residential mortgages and installment loans) at December 31, 2016:

 

    Due
Within
One Year 		  Due
After One
But Within
Five Years 		  Due
After
Five Years 		  Total
    (in thousands)
  Mortgage     $ 9     $ 110     $ 53,688     $ 53,807  
  Commercial       83,006       239,598       481,413       804,017  
      Total     $ 83,015     $ 239,708     $ 535,101     $ 857,824  

 

The following table sets forth loans due after one year which have predetermined (fixed) interest rates and/or adjustable (variable) interest rates at December 31, 2016:

 

    Fixed Rate   Variable Rate   Total
    (in thousands)
Due after one but within five years   $ 102,990     $ 136,718     $ 239,708  
Due after five years     306,827       228,274       535,101  
    Total   $ 409,817     $ 364,992     $ 774,809  

 

12
 

 

ITEM 1.     BUSINESS -- STATISTICAL DISCLOSURE (Continued)

 

(C) The following table sets forth loans on non-accrual, loans ninety days or more past due and troubled debt restructured loans at December 31:

 

    2016   2015   2014   2013   2012
    (in thousands)
(a)  Loans accounted for on a non-accrual basis (1, 2)   $ 13,364     $ 10,607     $ 15,231     $ 17,905     $ 32,929  
                                         
(b)  Aggregate amount of loans ninety days or more past due (excludes loans in (a) above)     —         116       7       —         7  
                                         
(c)  Loans not included above which are “troubled debt restructurings” as defined by accounting guidance     70,286       81,512       102,971       114,887       126,730  
                                         
            Total   $ 83,650     $ 92,235     $ 118,209     $ 132,792     $ 159,666  

 

(1) The accrual of interest income is discontinued when a loan becomes 90 days past due and the borrower’s capacity to repay the loan and collateral values appear insufficient. Non-accrual loans may be restored to accrual status when interest and principal payments are current and the loan appears otherwise collectible.

 

(2) Interest in the amount of $4.42 million would have been earned in 2016 had loans in categories (a) and (c) remained at their original terms; however, only $3.32 million was included in interest income for the year with respect to these loans.

 

Other loans of concern identified by the loan review department which are not included as non-performing in the table above were zero at December 31, 2016.

 

At December 31, 2016, there was no concentration of loans exceeding 10% of total loans which is not already disclosed as a category of loans in this section “Loan Portfolio” (Item III(A)).

 

There were no other interest-bearing assets at December 31, 2016, that would be required to be disclosed above (Item III(C)), if such assets were loans.

 

There were no foreign loans at December 31, 2016, 2015, 2014, 2013 and 2012.

 

13
 

 

ITEM 1.     BUSINESS -- STATISTICAL DISCLOSURE (Continued)

 

IV. SUMMARY OF LOAN LOSS EXPERIENCE

 

(A) The following table sets forth loan balances and summarizes the changes in the allowance for loan losses for each of the years ended December 31:

 

    2016     2015     2014  
    (dollars in thousands)
Total loans outstanding at the end of the year (net of unearned fees)   $ 1,675,628           $ 1,542,916         $ 1,433,624      
                                                 
Average total loans outstanding for the year (net of unearned fees)   $ 1,599,899             $ 1,461,480             $ 1,388,772          
                                                 
    Loan Losses   Unfunded Commitments   Loan Losses   Unfunded Commitments   Loan Losses   Unfunded
Commitments
Balance at beginning of year   $ 22,570     $ 652     $ 25,990     $ 539     $ 32,325     $ 508  
Loans charged-off                                                
  Mortgage     2,599               2,567               4,119          
  Commercial     1,317               1,694               4,613          
  Installment     1,671               1,467               1,885          
  Payment plan receivables     —                 —                 2          
    Total loans charged-off     5,587               5,728               10,619          
Recoveries of loans previously charged-off                                                
  Mortgage     1,047               1,258               1,397          
  Commercial     2,472               2,656               4,914          
  Installment     1,100               1,108               1,104          
  Payment plan receivables     —                 —                 5          
    Total recoveries     4,619               5,022               7,420          
    Net loans charged-off     968               706               3,199          
Reclassification to loans held for sale     59                                          
Additions (deductions) included in operations     (1,309 )     (2 )     (2,714 )     113       (3,136 )     31  
Balance at end of year   $ 20,234     $ 650     $ 22,570     $ 652     $ 25,990     $ 539  
                                                 
Net loans charged-off as a percent of average loans outstanding (includes loans held for sale) for the year     0.06 %             0.05 %             0.23 %        
                                                 
Allowance for loan losses as a percent of loans outstanding (includes loans held for sale) at the end of the year     1.21               1.46               1.81          

 

14
 

 

ITEM 1.     BUSINESS -- STATISTICAL DISCLOSURE (Continued)

 

    2013     2012  
    (dollars in thousands)  
Total loans outstanding at the end of the year (net of unearned fees)   $ 1,394,960             $ 1,469,918          
                                 
Average total loans outstanding for the year (net of unearned fees)   $ 1,413,796             $ 1,550,456          
                                 
    Loan Losses   Unfunded Commitments   Loan Losses   Unfunded Commitments
Balance at beginning of year   $ 44,275     $ 598     $ 58,884     $ 1,286  
Loans charged-off                                
  Mortgage     6,319               10,741          
  Commercial     7,358               12,588          
  Installment     2,520               4,009          
  Payment plan receivables     35               70          
    Total loans charged-off     16,232               27,408          
Recoveries of loans previously charged-off                                
  Mortgage     1,996               1,581          
  Commercial     5,119               3,610          
  Installment     1,074               1,311          
  Payment plan receivables     81               20          
    Total recoveries     8,270               6,522          
    Net loans charged-off     7,962               20,886          
Reclassification to loans held for sale                     610          
Additions (deductions) included in operations     (3,988 )     (90 )     6,887       (688 )
Balance at end of year   $ 32,325     $ 508     $ 44,275     $ 598  
                                 
Net loans charged-off as a percent of average loans outstanding (includes loans held for sale) for the year     0.56 %             1.35 %        
                                 
Allowance for loan losses as a percent of loans outstanding (includes loans held for sale) at the end of the year     2.32               3.01          

 

The allowance for loan losses reflected above is a valuation allowance in its entirety and the only allowance available to absorb probable incurred loan losses.

 

Further discussion of the provision and allowance for loan losses (a critical accounting policy) as well as non-performing loans, is presented in Management’s Discussion and Analysis of Financial Condition and Results of Operations in our annual report, to be delivered to shareholders in connection with the April 25, 2017 Annual Meeting of Shareholders (filed as exhibit 13 to this report on Form 10-K), and is incorporated herein by reference.

 

15
 

 

ITEM 1.     BUSINESS -- STATISTICAL DISCLOSURE (Continued)

 

IV. SUMMARY OF LOAN LOSS EXPERIENCE (Continued)

 

(B)  We have allocated the allowance for loan losses to provide for probable incurred losses within the categories of loans set forth in the table below. The amount of the allowance that is allocated and the ratio of loans within each category to total loans at December 31 follow:

 

    2016   2015   2014
    Allowance
Amount 		  Percent
of Loans to
Total Loans 		  Allowance
Amount 		  Percent
of Loans to
Total Loans 		  Allowance
Amount 		  Percent
of Loans to
Total Loans
    (dollars in thousands)
Commercial   $ 4,880       48.0 %   $ 5,670       48.5 %   $ 5,445       48.2 %
Mortgage     8,681       34.3       10,391       34.1       13,444       34.5  
Installment     1,011       15.9       1,181       15.2       1,814       14.5  
Payment plan receivables(a)     —         1.8       56       2.2       64       2.8  
Subjective allocation     5,662       —         5,272       —         5,223       —    
    Total   $ 20,234       100.0 %   $ 22,570       100.0 %   $ 25,990       100.0 %

 

    2013   2012
    Allowance
Amount 		  Percent
of Loans to
Total Loans 		  Allowance
Amount 		  Percent
of Loans to
Total Loans
    (dollars in thousands)
Commercial   $ 6,827       45.5 %   $ 11,402       42.2 %
Mortgage     17,195       36.3       21,447       39.1  
Installment     2,246       13.8       3,378       12.9  
Payment plan receivables     97       4.4       144       5.8  
Subjective allocation     5,960       —         7,904       —    
    Total   $ 32,325       100.0 %   $ 44,275       100.0 %

 

(a) Allowance of $0.06 million related to payment plan receivables was reclassified to loans held for sale at December 31, 2016.

 

16
 

 

ITEM 1.     BUSINESS -- STATISTICAL DISCLOSURE (Continued)

 

V. DEPOSITS

 

The following table sets forth average deposit balances and the weighted-average rates paid thereon for the years ended December 31:

 

    2016   2015   2014
    Average Balance   Rate   Average Balance   Rate   Average Balance   Rate
    (dollars in thousands)
Non-interest bearing   $ 688,697             $ 619,206             $ 540,107          
Savings and interest-bearing checking     1,018,685       0.11 %     988,504       0.11 %     951,745       0.11 %
Time     447,243       0.86       386,035       0.76       413,729       0.94  
    Total   $ 2,154,625       0.23 %   $ 1,993,745       0.20 %   $ 1,905,581       0.26 %

 

The following table summarizes time deposits in amounts of $100,000 or more by time remaining until maturity at December 31, 2016:

 

      (in thousands)  
Three months or less   $ 46,294  
Over three through six months     75,516  
Over six months through one year     119,143  
Over one year     50,799  
Total   $ 291,752  

 

VI. RETURN ON EQUITY AND ASSETS

 

The ratio of net income to average shareholders’ equity and to average total assets, and certain other ratios, for the years ended December 31 follow:

 

    2016   2015   2014   2013   2012
Net income as a percent of (1)                    
   Average common equity     9.21 %     7.89 %     7.43 %     64.22 %     68.29 %
   Average total assets     0.92       0.86       0.80       3.87       0.92  
                                         
Dividends declared per share as a percent of diluted net income per share     32.38       30.23       23.38       0.00       0.00  
                                         
Average shareholders’ equity as a percent of average total assets     9.98       10.93       10.83       8.69       4.82  

 

 

(1) These amounts are calculated using net income applicable to common stock.

 

Additional performance ratios are set forth in Selected Consolidated Financial Data in our annual report, to be delivered to shareholders in connection with the April 25, 2017 Annual Meeting of Shareholders (filed as exhibit 13 to this report on Form 10-K), and is incorporated herein by reference. Any significant changes in the current trend of the above ratios are reviewed in Management’s Discussion and Analysis of Financial Condition and Results of Operations in our annual report, to be delivered to shareholders in connection with the April 25, 2017 Annual Meeting of Shareholders (filed as exhibit 13 to this report on Form 10-K), and is incorporated herein by reference.

 

VII. SHORT-TERM BORROWINGS

 

Short-term borrowings are discussed in note 9 to the consolidated financial statements incorporated herein by reference to Part II, Item 8 of this report.

 

17
 

ITEM 1A.     RISK FACTORS

 

Investing in our common stock involves risks, including (among others) the following factors:

 

General political, economic or industry conditions, either domestically or internationally, may be less favorable than expected.

 

Local, domestic, and international economic, political and industry-specific conditions affect the financial services industry, directly and indirectly. Conditions such as or related to inflation, recession, unemployment, volatile interest rates, international conflicts and other factors outside of our control, such as real estate values, energy costs, fuel prices, state and local municipal budget deficits, and government spending and the U.S. national debt, may, directly and indirectly, adversely affect us. As has been the case with the impact of recent economic conditions, economic downturns could result in the delinquency of outstanding loans, which could have a material adverse impact on our earnings.

 

Governmental monetary and fiscal policies may adversely affect the financial services industry and therefore impact our financial condition and results of operations.

 

Monetary and fiscal policies of various governmental and regulatory agencies, particularly the Federal Reserve, affect the financial services industry, directly and indirectly. The Federal Reserve regulates the supply of money and credit in the U.S., and its monetary and fiscal policies determine in a large part our cost of funds for lending and investing and the return that can be earned on such loans and investments. Changes in such policies, including changes in interest rates, will influence the origination of loans, the value of investments, the generation of deposits and the rates received on loans and investment securities and paid on deposits. Changes in monetary and fiscal policies are beyond our control and difficult to predict. Our financial condition and results of operations could be materially adversely impacted by changes in governmental monetary and fiscal policies.

 

Volatility and disruptions in global capital and credit markets may adversely impact our business, financial condition and results of operations.

 

Even though we operate in a distinct geographic region in the U.S., we are impacted by global capital and credit markets, which are sometimes subject to periods of extreme volatility and disruption. Disruptions, uncertainty or volatility in the capital and credit markets may limit our ability to access capital and manage liquidity, which may adversely affect our business, financial condition and results of operations. Further, our customers may be adversely impacted by such conditions, which could have a negative impact on our business, financial condition and results of operations.

 

The soundness of other financial institutions could adversely affect us.

 

Our ability to engage in routine funding transactions could be adversely affected by the actions and commercial soundness of other financial institutions. Financial services institutions are interrelated as a result of trading, clearing, counterparty and other relationships. We have exposure to many different industries and counterparties, and we routinely execute transactions with counterparties in the financial industry. As a result, defaults by, or even rumors or questions about, one or more financial services institutions, or the financial services industry generally, have led, and may further lead, to market-wide liquidity problems and could lead to losses or defaults by us or by other institutions. Many of these transactions could expose us to credit risk in the event of default by a counterparty. In addition, our credit risk may be impacted when the collateral held by us cannot be realized upon or is liquidated at prices not sufficient to recover the full amount of the financial instrument exposure due to us. There is no assurance that any such losses would not adversely affect us and possibly be material in nature.

 

Changes in regulation or oversight may have a material adverse impact on our operations.

 

We are subject to extensive regulation, supervision and examination by the Federal Reserve, the FDIC, the Michigan DIFS, the SEC and other regulatory bodies. Such regulation and supervision governs the activities in which we may engage. Regulatory authorities have extensive discretion in their supervisory and enforcement activities, including the imposition of restrictions on our operations, investigations and limitations related to our securities, the classification of our assets and determination of the level of our allowance for loan losses. Any change in such

 

18
 

ITEM 1A.     RISK FACTORS (continued)

 

regulation and oversight, whether in the form of regulatory policy, regulations, legislation or supervisory action, may have a material adverse impact on our business, financial condition or results of operations.

 

In particular, Congress and other regulators have increased their focus on the regulation of the financial services industry in recent years. While recent changes in the executive branch may mitigate this impact, the effects on us of recent legislation and regulatory actions cannot reliably be fully determined at this time. Moreover, as some of the legislation and regulatory actions previously implemented in response to the recent financial crisis expire, the impact of the conclusion of these programs on the financial sector and on the economic recovery is unknown. Any delay in the economic recovery or a worsening of current financial market conditions could adversely affect us. We can neither predict when or whether future regulatory or legislative reforms will be enacted nor what their contents will be. The impact of any future legislation or regulatory actions on our businesses or operations cannot be determined at this time, and such impact may adversely affect us.

 

We have credit risk inherent in our loan portfolios, and our allowance for loan losses may not be sufficient to cover actual loan losses.

 

Our loan customers may not repay their loans according to their respective terms, and the collateral securing the payment of these loans may be insufficient to cover any losses we may incur. We make various assumptions and judgments about the collectability of our loan portfolio, including the creditworthiness of our borrowers and the value of the real estate and other assets serving as collateral for the repayment of many of our loans. Non-performing loans amounted to $13.4 million and $10.7 million at December 31, 2016 and December 31, 2015, respectively. Our allowance for loan losses coverage ratio of non-performing loans was 151.4% and 210.5% at December 31, 2016 and December 31, 2015, respectively. In determining the size of the allowance for loan losses, we rely on our experience and our evaluation of current economic conditions. If our assumptions or judgments prove to be incorrect, our current allowance for loan losses may not be sufficient to cover certain loan losses inherent in our loan portfolio, and adjustments may be necessary to account for different economic conditions or adverse developments in our loan portfolio. Material additions to our allowance for loan losses would adversely impact our operating results.

 

In addition, federal and state regulators periodically review our allowance for loan losses and may require us to increase our provision for loan losses or recognize additional loan charge-offs, notwithstanding any internal analysis that has been performed. Any increase in our allowance for loan losses or loan charge-offs required by these regulatory agencies could have a material adverse effect on our results of operations and financial condition.

 

We have credit risk in our securities portfolio.

 

We maintain diversified securities portfolios, which include obligations of the Treasury and government-sponsored agencies as well as securities issued by states and political subdivisions, mortgage-backed securities, corporate securities and asset-backed securities. We seek to limit credit losses in our securities portfolios by principally purchasing highly rated securities (generally rated “AA” or higher by a major debt rating agency) and by conducting due diligence on the issuer. However, gross unrealized losses on securities available for sale in our portfolio totaled approximately $7.6 million as of December 31, 2016 (compared to approximately $3.5 million as of December 31, 2015). We believe these unrealized losses are temporary in nature and are expected to be recovered within a reasonable time period as we believe we have the ability to hold the securities to maturity or until such time as the unrealized losses reverse. However, we evaluate securities available for sale for other than temporary impairment (OTTI) at least quarterly and more frequently when economic or market concerns warrant such evaluation. Those evaluations may result in OTTI charges to our earnings. In addition to these impairment charges, we may, in the future, experience additional losses in our securities portfolio which may result in charges that could materially adversely affect our results of operations.

 

19
 

ITEM 1A.     RISK FACTORS (continued)

 

We have agreed to indemnify the purchaser of Mepco’s business against certain losses it may incur as a result of its purchase of the business.

 

In connection with our pending sale of substantially all of the assets of our Mepco subsidiary, we agreed to contractually indemnify the purchaser from certain losses it may incur, including as a result of its failure to collect certain receivables it purchased as part of the business as well as breaches of representations and warranties we made in the sale agreement, subject to various limitations. We have not accrued any liability related to this sale in our financial statements because we believe the likelihood of having to pay any amount as a result of these indemnification obligations is remote. However, if the purchaser is unable to collect the receivables it purchased from Mepco or otherwise encounters difficulties in operating the business, it is possible it could make one or more claims against us pursuant to the sale agreement. In that event, we may incur expenses in defending any such claims and/or amounts paid to such purchaser to resolve such claims.

 

Our mortgage-banking revenues are susceptible to substantial variations, due in part to factors we do not control, such as market interest rates.

 

A portion of our revenues are derived from net gains on mortgage loans. These net gains primarily depend on the volume of loans we sell, which in turn depends on our ability to originate real estate mortgage loans and the demand for fixed-rate obligations and other loans that are outside of our established interest-rate risk parameters. Net gains on mortgage loans are also dependent upon economic and competitive factors as well as our ability to effectively manage exposure to changes in interest rates. Consequently, they can often be a volatile part of our overall revenues. We realized net gains of $10.6 million on mortgage loans during 2016 compared to $7.4 million during 2015 and $5.6 million during 2014.

 

We are subject to liquidity risk in our operations, which could adversely impact our ability to fund various obligations.

 

Liquidity risk is the possibility of being unable to meet obligations as they come due or capitalize on growth opportunities as they arise because of an inability to liquidate assets or obtain adequate funding on a timely basis, at a reasonable cost and within acceptable risk tolerances. Liquidity is required to fund various obligations, including credit obligations to borrowers, loan originations, withdrawals by depositors, repayment of debt, dividends to shareholders, operating expenses and capital expenditures. Liquidity is derived primarily from retail deposit growth and earnings retention, principal and interest payments on loans and investment securities, net cash provided from operations and access to other funding. If we are unable to maintain adequate liquidity, then our business, financial condition and results of operations could be negatively impacted.

 

Our parent company must rely on dividends or returns of capital from our bank for most of its cash flow.

 

Our parent company is a separate and distinct legal entity from our bank. Generally, our parent company receives substantially all of its cash flow from dividends or returns of capital from our subsidiary bank. These dividends or returns of capital are the principal source of funds to pay our parent company’s operating expenses and for cash dividends on our common stock. Various federal and/or state laws and regulations limit the amount of dividends that the bank may pay to the parent company.

 

Any future strategic acquisitions or divestitures may present certain risks to our business and operations.

 

Difficulties in capitalizing on the opportunities presented by a future acquisition may prevent us from fully achieving the expected benefits from the acquisition, or may cause the achievement of such expectations to take longer to realize than expected. Further, the assimilation of the acquired entity’s customers and markets could result in higher than expected deposit attrition, loss of key employees, disruption of our businesses or the businesses of the acquired entity or otherwise adversely affect our ability to maintain relationships with customers and employees or achieve the anticipated benefits of the acquisition. These matters could have an adverse effect on us for an undetermined period. We will be subject to similar risks and difficulties in connection with any future decisions to downsize, sell or close units or otherwise change our business mix.

 

20
 

ITEM 1A.     RISK FACTORS (continued)

 

Compliance with new capital requirements may adversely affect us.

 

The capital requirements applicable to us as a bank holding company as well as to our subsidiary bank have been substantially revised in connection with Basel III and the requirements of the Financial Reform Act. These more stringent capital requirements, and any other new regulations, could adversely affect our ability to pay dividends in the future, or could require us to reduce business levels or to raise capital, including in ways that may adversely affect our results of operations or financial condition and/or existing shareholders. The ultimate impact of the new capital requirements cannot be determined at this time and will depend on a number of factors, including treatment and implementation by the U.S. bank regulators. However, maintaining higher levels of capital may reduce our profitability and otherwise adversely affect our business, financial condition, or results of operations.

 

Declines in the businesses or industries of our customers could cause increased credit losses, which could adversely affect us.

 

Our business customer base consists, in part, of customers in volatile businesses and industries such as the automotive production industry and the real estate business. These industries are sensitive to global economic conditions and supply chain factors. Any decline in one of those customers’ businesses or industries could cause increased credit losses, which in turn could adversely affect us.

 

The introduction, implementation, withdrawal, success and timing of business initiatives and strategies may be less successful or may be different than anticipated, which could adversely affect our business.

 

We make certain projections and develop plans and strategies for our banking and financial products. If we do not accurately determine demand for or changes in our banking and financial product needs, it could result in us incurring significant expenses without the anticipated increases in revenue, which could result in a material adverse effect on our business.

 

We may not be able to utilize technology to efficiently and effectively develop, market, and deliver new products and services to our customers.

 

The financial services industry experiences rapid technological change with regular introductions of new technology-driven products and services. The efficient and effective utilization of technology enables financial institutions to better serve customers and to reduce costs. Our future success depends, in part, upon our ability to address the needs of our customers by using technology to market and deliver products and services that will satisfy customer demands, meet regulatory requirements, and create additional efficiencies in our operations. We may not be able to effectively develop new technology-driven products and services or be successful in marketing or supporting these products and services to our customers, which could have a material adverse impact on our financial condition and results of operations.

 

Operational difficulties, failure of technology infrastructure or information security incidents could adversely affect our business and operations.

 

We are exposed to many types of operational risk, including reputational risk, legal and compliance risk, the risk of fraud or theft by employees or outsiders, failure of our controls and procedures and unauthorized transactions by employees or operational errors, including clerical or recordkeeping errors or those resulting from computer or telecommunications systems malfunctions. Given the high volume of transactions we process, certain errors may be repeated or compounded before they are identified and resolved. In particular, our operations rely on the secure processing, storage and transmission of confidential and other information on our technology systems and networks. Any failure, interruption or breach in security of these systems could result in failures or disruptions in our customer relationship management, general ledger, deposit, loan and other systems.

 

We also face the risk of operational disruption, failure or capacity constraints due to our dependency on third party vendors for components of our business infrastructure, including our core data processing systems which are largely outsourced. While we have selected these third party vendors carefully, we do not control their operations. As such, any failure on the part of these business partners to perform their various responsibilities could also adversely affect our business and operations.

 

21
 

ITEM 1A.     RISK FACTORS (continued)

 

We may also be subject to disruptions of our operating systems arising from events that are wholly or partially beyond our control, which may include, for example, computer viruses, cyber attacks, spikes in transaction volume and/or customer activity, electrical or telecommunications outages, or natural disasters. Although we have programs in place related to business continuity, disaster recovery and information security to maintain the confidentiality, integrity, and availability of our systems, business applications and customer information, such disruptions may give rise to interruptions in service to customers and loss or liability to us.

 

The occurrence of any failure or interruption in our operations or information systems, or any security breach, could cause reputational damage, jeopardize the confidentiality of customer information, result in a loss of customer business, subject us to regulatory intervention or expose us to civil litigation and financial loss or liability, any of which could have a material adverse effect on us.

 

Changes in the financial markets, including fluctuations in interest rates and their impact on deposit pricing, could adversely affect our net interest income and financial condition.

 

The operations of financial institutions such as us are dependent to a large degree on net interest income, which is the difference between interest income from loans and investments and interest expense on deposits and borrowings. Prevailing economic conditions, the trade, fiscal and monetary policies of the federal government and the policies of various regulatory agencies all affect market rates of interest and the availability and cost of credit, which in turn significantly affect financial institutions’ net interest income. Volatility in interest rates can also result in disintermediation, which is the flow of funds away from financial institutions into direct investments, such as federal government and corporate securities and other investment vehicles, which, because of the absence of federal insurance premiums and reserve requirements, generally pay higher rates of return than financial institutions. Our financial results could be materially adversely impacted by changes in financial market conditions.

 

Competitive product and pricing pressures among financial institutions within our markets may change.

 

We operate in a very competitive environment, which is characterized by competition from a number of other financial institutions in each market in which we operate. We compete with large national and regional financial institutions and with smaller financial institutions in terms of products and pricing. If we are unable to compete effectively in products and pricing in our markets, business could decline, which could have a material adverse effect on our business, financial condition or results of operations.

 

Changes in customer behavior may adversely impact our business, financial condition and results of operations.

 

We use a variety of methods to anticipate customer behavior as a part of our strategic planning and to meet certain regulatory requirements. Individual, economic, political, industry-specific conditions and other factors outside of our control, such as fuel prices, energy costs, real estate values or other factors that affect customer income levels, could alter predicted customer borrowing, repayment, investment and deposit practices. Such a change in these practices could materially adversely affect our ability to anticipate business needs and meet regulatory requirements.

 

Further, difficult economic conditions may negatively affect consumer confidence levels. A decrease in consumer confidence levels would likely aggravate the adverse effects of these difficult market conditions on us, our customers and others in the financial institutions industry.

 

Our ability to maintain and expand customer relationships may differ from expectations

 

The financial services industry is very competitive. We not only vie for business opportunities with new customers, but also compete to maintain and expand the relationships we have with our existing customers. While we believe that we can continue to grow many of these relationships, we will continue to experience pressures to maintain these relationships as our competitors attempt to capture our customers. Failure to create new customer relationships and to maintain and expand existing customer relationships to the extent anticipated may adversely impact our earnings.

 

22
 

ITEM 1A.     RISK FACTORS (continued)

 

Our ability to retain key officers and employees may change.

 

Our future operating results depend substantially upon the continued service of our executive officers and key personnel. Our future operating results also depend in significant part upon our ability to attract and retain qualified management, financial, technical, marketing, sales and support personnel. Competition for qualified personnel is intense, and we cannot ensure success in attracting or retaining qualified personnel. There may be only a limited number of persons with the requisite skills to serve in these positions, and it may be increasingly difficult for us to hire personnel over time.

 

Further, our ability to retain key officers and employees may be impacted by legislation and regulation affecting the financial services industry. Our business, financial condition or results of operations could be materially adversely affected by the loss of any key employees, or our inability to attract and retain skilled employees.

 

Legal and regulatory proceedings and related matters with respect to the financial services industry, including those directly involving us, could adversely affect us or the financial services industry in general.

 

We have been, and may in the future be, subject to various legal and regulatory proceedings. It is inherently difficult to assess the outcome of these matters, and there can be no assurance that we will prevail in any proceeding or litigation. Any such matter could result in substantial cost and diversion of our efforts, which by itself could have a material adverse effect on our financial condition and operating results. Further, adverse determinations in such matters could result in actions by our regulators that could materially adversely affect our business, financial condition or results of operations.

 

Methods of reducing risk exposures might not be effective.

 

Instruments, systems and strategies used to hedge or otherwise manage exposure to various types of credit, market and liquidity, operational, compliance, business risks and enterprise-wide risk could be less effective than anticipated. As a result, we may not be able to effectively mitigate our risk exposures in particular market environments or against particular types of risk, which could have a material adverse impact on our business, financial condition or results of operations.

 

Terrorist activities or other hostilities may adversely affect the general economy, financial and capital markets, specific industries, and us.

 

Terrorist attacks or other hostilities may disrupt our operations or those of our customers. In addition, these events have had and may continue to have an adverse impact on the U.S. and world economies in general and consumer confidence and spending in particular, which could harm our operations. Any of these events could increase volatility in the U.S. and world financial markets, which could harm our stock price and may limit the capital resources available to us and our customers. This could have a material adverse impact on our operating results, revenues and costs and may result in increased volatility in the market price of our common stock.

 

Catastrophic events, including, but not limited to, hurricanes, tornadoes, earthquakes, fires and floods, may adversely affect the general economy, financial and capital markets, specific industries, and us.

 

We have significant operations and a significant customer base in Michigan where natural and other disasters may occur, such as tornadoes and floods. These types of natural catastrophic events at times have disrupted the local economy, our business, and our customers and have posed physical risks to our property. In addition, catastrophic events occurring in other regions of the world may have an impact on our customers and in turn, on us. A significant catastrophic event could materially adversely affect our operating results.

 

23
 

ITEM 1A.     RISK FACTORS (continued)

 

Changes in accounting standards could materially impact our financial statements.

 

From time to time, changes are made to the financial accounting and reporting standards that govern the preparation of our financial statements. These changes can be difficult to predict and can materially impact how we record and report our financial condition and results of operations. In some cases, we could be required to apply a new or revised standard retroactively, resulting in changes to previously reported financial results, or a cumulative charge to accumulated deficit.

 

Our failure to appropriately apply certain critical accounting policies could result in our misstatement of our financial results and condition.

 

Accounting policies and processes are fundamental to how we record and report our financial condition and results of operations. We must exercise judgment in selecting and applying many of these accounting policies and processes so they comply with U.S. GAAP. In some cases, we must select the accounting policy or method to apply from two or more alternatives, any of which may be reasonable under the circumstances, yet may result in our reporting materially different results than would have been reported under a different alternative.

 

We have identified certain accounting policies as being critical because they require us to make difficult, subjective or complex judgments about matters that are uncertain. Materially different amounts could be reported under different conditions or using different assumptions or estimates. We have established detailed policies and control procedures that are intended to ensure these critical accounting estimates and judgments are well controlled and applied consistently. In addition, the policies and procedures are intended to ensure that the process for changing methodologies occurs in an appropriate manner. Because of the uncertainty surrounding management’s judgments and the estimates pertaining to these matters, we cannot guarantee that we will not be required to adjust accounting policies or restate prior period financial statements. See note #1, “Accounting Policies” in the Notes to Consolidated Financial Statements in our annual report, to be delivered to shareholders in connection with the April 25, 2017 Annual Meeting of Shareholders (filed as exhibit 13 to this report on Form 10-K).

 

The trading price of our common stock may be subject to significant fluctuations and volatility.

 

The market price of our common stock could be subject to significant fluctuations due to, among other things:

 

· variations in quarterly or annual results of operations;

 

· changes in dividends per share;

 

· deterioration in asset quality, including declining real estate values;

 

· changes in interest rates;

 

· significant acquisitions or business combinations, strategic partnerships, joint ventures, or capital commitments by or involving us or our competitors;

 

· regulatory actions, including changes to regulatory capital levels, the components of regulatory capital and how regulatory capital is calculated;

 

· new regulations that limit or significantly change our ability to continue to offer products or services;

 

· volatility of stock market prices and volumes;

 

· issuance of additional shares of common stock or other debt or equity securities;

 

· changes in market valuations of similar companies;

 

· changes in securities analysts’ estimates of financial performance or recommendations;

 

· perceptions in the marketplace regarding the financial services industry, us and/or our competitors; and/or

 

· the occurrence of any one or more of the risk factors described above.

 

24
 

ITEM 1B.     UNRESOLVED STAFF COMMENTS

 

None.

 

ITEM 2.     PROPERTIES

 

We and our bank operate a total of 86 facilities in Michigan, two leased facilities in Ohio and one leased facility in Chicago, Illinois.

 

With the exception of the potential remodeling of certain facilities to provide for the efficient use of work space or to maintain an appropriate appearance, each property is considered reasonably adequate for current and anticipated needs.

 

ITEM 3.     LEGAL PROCEEDINGS

 

In December 2016, we reached a tentative settlement regarding litigation initiated against us in Wayne County, Michigan Circuit Court. This litigation concerned checking account transaction sequencing during a period from February 2009 to June 2011. Under the terms of the settlement, we have agreed to pay $2.2 million and are also responsible for class notification costs and certain other expenses which are estimated to total approximately $0.1 million. Although, we deny any liability associated with this matter and believe we have meritorious defenses to the allegations in the complaint, given the costs and uncertainty of litigation, it was determined that this settlement was in the best interests of the organization.

 

We are also involved in various other litigation matters in the ordinary course of business. At the present time, we do not believe any of these other matters will have a significant impact on our consolidated financial position or results of operations. The aggregate amount we have accrued for losses we consider probable as a result of these other litigation matters is immaterial. However, because of the inherent uncertainty of outcomes from any litigation matter, we believe it is reasonably possible we may incur losses in addition to the amounts we have accrued. At this time, we estimate the maximum amount of additional losses that are reasonably possible is approximately $0.3 million. However, because of a number of factors, including the fact that certain of these other litigation matters are still in their early stages and involve claims for which, at this point, we believe have little to no merit, this maximum amount may change in the future.

 

The litigation matters described in the preceding paragraph primarily include claims that have been brought against us for damages, but do not include litigation matters where we seek to collect amounts owed to us by third parties (such as litigation initiated to collect delinquent loans). These excluded, collection-related matters may involve claims or counterclaims by the opposing party or parties, but we have excluded such matters from the disclosure contained in the preceding paragraph in all cases where we believe the possibility of us paying damages to any opposing party is remote. Risks associated with the likelihood that we will not collect the full amount owed to us, net of reserves, are disclosed elsewhere in this report.

 

ITEM 4.     MINE SAFETY DISCLOSURES

 

Not applicable.


25
 

ADDITIONAL ITEM - EXECUTIVE OFFICERS

 

Our executive officers are appointed annually by our Board of Directors at the meeting of directors preceding the Annual Meeting of Shareholders. There are no family relationships among these officers and/or our directors nor any arrangement or understanding between any officer and any other person pursuant to which the officer was elected.

 

The following sets forth certain information with respect to our executive officers at February 24, 2017.

 

    First elected
    as an executive
Name (Age) Position officer
William B. Kessel  (52) President, Chief Executive Officer and Director (1) 2004
     
Robert N. Shuster (59) Executive Vice President and Chief Financial Officer 1999
     
Stefanie M. Kimball (57) Executive Vice President and Chief Risk Officer 2007
     
David C. Reglin (57) Executive Vice President, Retail Banking 1998
     
Mark L. Collins (59) Executive Vice President, General Counsel 2009
     
Dennis J. Mack (55) Executive Vice President and Chief Lending Officer (2) 2012
     
James J. Twarozynski (51) Senior Vice President, Controller 2002
       
(1) Mr. Kessel assumed the role of President as of April 1, 2011, and assumed the roles of CEO and director starting January 1, 2013. Prior to being appointed President, Mr. Kessel was Executive Vice President and COO.

 

(2) Prior to being named Executive Vice President and Chief Lending Officer in 2012, Mr. Mack was a Senior Vice President and commercial credit officer since 2009 and a Senior Vice President at Comerica Incorporated since 2001.

 

26
 

PART II.

 

ITEM 5.     MARKET FOR OUR COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES

 

The information set forth under the caption “Quarterly Summary” in our annual report, to be delivered to shareholders in connection with the April 25, 2017 Annual Meeting of Shareholders (filed as exhibit 13 to this report on Form 10-K), is incorporated herein by reference.

 

We maintain a Deferred Compensation and Stock Purchase Plan for Non-Employee Directors (the “Plan”) pursuant to which non-employee directors can elect to receive shares of our common stock in lieu of fees otherwise payable to the director for his or her service as a director.  A director can elect to receive shares on a current basis or to defer receipt of the shares, in which case the shares are issued to a trust to be held for the account of the director and then generally distributed to the director after his or her retirement from the Board.  Pursuant to this Plan, during the fourth quarter of 2016, we issued 562 shares of common stock to non-employee directors on a current basis and 1,143 shares of common stock to the trust for distribution to directors on a deferred basis.  The shares were issued on October 1, 2016, at a price of $16.83 per share, representing aggregate fees of $0.03 million.   The price per share was the consolidated closing bid price per share of our common stock as of the date of issuance, as determined in accordance with NASDAQ Marketplace Rules.  We issued the shares pursuant to an exemption from registration under Section 4(2) of the Securities Act of 1933 due to the fact that the issuance of the shares was made on a private basis pursuant to the Plan.

 

ISSUER PURCHASES OF EQUITY SECURITIES

 

The following table shows certain information relating to purchases of common stock for the three-months ended December 31, 2016:

 

      Total Number of Remaining
      Shares Purchased Number of
      as Part of a Shares Authorized
  Total Number of Average Price Publicly for Purchase
Period Shares Purchased Paid Per Share Announced Plan Under the Plan
October 2016 - - - (1)
November 2016 - - - (1)
December 2016 - - - -
  Total - - - -

 

(1)     Plus an additional $4.4 million.

 

The share repurchase plan we had in place for 2016 expired on December 31, 2016.

 

ITEM 6.     SELECTED FINANCIAL DATA

 

The information set forth under the caption “Selected Consolidated Financial Data” in our annual report, to be delivered to shareholders in connection with the April 25, 2017 Annual Meeting of Shareholders (filed as exhibit 13 to this report on Form 10-K), is incorporated herein by reference.

 

ITEM 7.     MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

The information set forth under the caption “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in our annual report, to be delivered to shareholders in connection with the April 25, 2017 Annual Meeting of Shareholders (filed as exhibit 13 to this report on Form 10-K), is incorporated herein by reference.

 

ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

 

The information set forth in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” under the caption “Asset/liability management” in our annual report, to be delivered to shareholders in connection with the April 25, 2017 Annual Meeting of Shareholders (filed as exhibit 13 to this report on Form 10-K), is incorporated herein by reference.

 

27
 

ITEM 8.     FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

 

The following consolidated financial statements and the independent auditor’s report are set forth in our annual report, to be delivered to shareholders in connection with the April 25, 2017 Annual Meeting of Shareholders (filed as exhibit 13 to this report on Form 10-K), and are incorporated herein by reference.

 

Management’s Annual Report on Internal Control Over Financial Reporting

 

Report of Independent Registered Public Accounting Firm

 

Consolidated Statements of Financial Condition at 

December 31, 2016 and 2015

 

Consolidated Statements of Operations for the years ended 

December 31, 2016, 2015 and 2014

 

Consolidated Statements of Comprehensive Income 

for the years ended December 31, 2016, 2015 and 2014

 

Consolidated Statements of Shareholders’ Equity 

for the years ended December 31, 2016, 2015 and 2014

 

Consolidated Statements of Cash Flows for the years ended 

December 31, 2016, 2015 and 2014

 

Notes to Consolidated Financial Statements

 

ITEM 8.     FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA (continued)

 

The supplementary data required by this item set forth under the caption “Quarterly Financial Data (Unaudited)” in our annual report, to be delivered to shareholders in connection with the April 25, 2017 Annual Meeting of Shareholders (filed as exhibit 13 to this report on Form 10-K), is incorporated herein by reference.

 

The portions of our annual report, to be delivered to shareholders in connection with the April 25, 2017 Annual Meeting of Shareholders (filed as exhibit 13 to this report on Form 10-K), which are not specifically incorporated by reference as part of this Form 10-K are not deemed to be a part of this report.

 

ITEM 9.     CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE

 

None

 

ITEM 9A.     CONTROLS AND PROCEDURES

 

1. Evaluation of Disclosure Controls and Procedures . With the participation of management, our chief executive officer and chief financial officer, after evaluating the effectiveness of our disclosure controls and procedures (as defined in Exchange Act Rules 13a – 15e and 15d – 15e) as of the year ended December 31, 2016 (the “Evaluation Date”), have concluded that, as of such date, our disclosure controls and procedures were effective.

 

2. Internal Control Over Financial Reporting . “Management’s Annual Report on Internal Control Over Financial Reporting” and our independent registered public accounting firm’s audit of internal control over financial reporting as of December 31, 2016 included within the “Report of Independent Registered Public Accounting Firm,” each as set forth in our annual report, to be delivered to shareholders in connection with the April 25, 2017 Annual Meeting of Shareholders (filed as exhibit 13 to this report on Form 10-K) are incorporated herein by reference.

 

28
 

ITEM 9B.     OTHER INFORMATION

 

None.

 

29
 

PART III.

 

ITEM 10.     DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE

 

DIRECTORS - The information with respect to our directors set forth under the caption “Proposal I Submitted for Your Vote -- Election of Directors” in our definitive proxy statement, to be delivered to shareholders in connection with the April 25, 2017 Annual Meeting of Shareholders, is incorporated herein by reference.

 

BENEFICIAL OWNERSHIP REPORTING – The information set forth under the caption “Section 16(a) Beneficial Ownership Reporting Compliance” in our definitive proxy statement, to be delivered to shareholders in connection with the April 25, 2017 Annual Meeting of Shareholders, is incorporated herein by reference.

 

EXECUTIVE OFFICERS - Reference is made to the additional item under Part I of this report on Form 10-K.

 

CODE OF ETHICS - We have adopted a “Code of Ethics for Chief Executive Officer and Senior Financial Officers” that applies to our Chief Executive Officer, Chief Financial Officer, and Controller. A copy of our Code of Ethics is posted on our website at www.IndependentBank.com , under Investor Relations, and a printed copy is available upon request by writing to our Chief Financial Officer, Independent Bank Corporation, 4200 East Beltline, Grand Rapids, Michigan 49525.

 

CORPORATE GOVERNANCE – Information relating to our audit committee, set forth under the caption “Board Committees and Functions” in our definitive proxy statement, to be delivered to shareholders in connection with the April 25, 2017 Annual Meeting of Shareholders, is incorporated herein by reference.

 

ITEM 11.     EXECUTIVE COMPENSATION

 

The information set forth under the captions “Executive Compensation,” “Director Compensation,” “Compensation Committee Interlocks and Insider Participation,” and “Compensation Committee Report” in our definitive proxy statement, to be delivered to shareholders in connection with the April 25, 2017 Annual Meeting of Shareholders, is incorporated herein by reference.

 

ITEM 12.     SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS

 

The information set forth under the captions “Voting Securities and Record Date”, “Proposal I Submitted for Your Vote -- Election of Directors” and “Securities Ownership of Management” in our definitive proxy statement, to be delivered to shareholders in connection with the April 25, 2017 Annual Meeting of Shareholders, is incorporated herein by reference.

 

We maintain certain equity compensation plans under which our common stock is authorized for issuance to employees and directors, including our Deferred Compensation and Stock Purchase Plan for Non-employee Directors and our Long-Term Incentive Plan.

 

The following sets forth certain information regarding our equity compensation plans as of December 31, 2016.

 

      (c)
      Number of securities
  (a)   remaining available for
  Number of securities (b) future issuance under
  to be issued upon Weighted-average equity compensation
  exercise of outstanding exercise price of plans  (excluding
  options, warrants outstanding options, securities reflected
Plan Category and rights warrants and rights in column (a))
       
Equity compensation plans approved by security holders 211,018 $5.05 144,330
Equity compensation plan not approved by security holders None N/A 216,177

 

30
 

ITEM 12.     SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS (continued)

 

The equity compensation plan not approved by security holders referenced above is our Deferred Compensation and Stock Purchase Plan for Non-employee Directors.  This plan allows our non-employee directors to defer payment of all or a part of their director fees and to receive shares of common stock in lieu of cash for these fees. Under the plan, each non-employee director may elect to participate in a Current Stock Purchase Account, a Deferred Cash Investment Account, or a Deferred Stock Account.  A Current Stock Purchase Account is credited with shares of our common stock having a fair market value equal to the fees otherwise payable. A Deferred Cash Investment Account is credited with an amount equal to the fees deferred and on each quarterly credit date with an appreciation factor that may not exceed the prime rate of interest charged by our bank. A Deferred Stock Account is credited with the amount of fees deferred and converted into stock units based on the fair market value of our common stock at the time of the deferral. Amounts in the Deferred Stock Account are credited with cash dividends and other distributions on our common stock. Fees credited to a Deferred Cash Investment Account or a Deferred Stock Account are deferred for income tax purposes. This plan does not provide for distributions of amounts deferred prior to a participant’s termination as a non-employee director. Participants may generally elect either a lump sum or installment distribution.

 

ITEM 13.     CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE

 

The information set forth under the captions “Transactions Involving Management” and “Determination of Independence of Board Members” in our definitive proxy statement, to be delivered to shareholders in connection with the April 25, 2017 Annual Meeting of Shareholders, is incorporated herein by reference.

 

ITEM 14.     PRINCIPAL ACCOUNTANT FEES AND SERVICES

 

The information set forth under the caption “Disclosure of Fees Paid to our Independent Auditors” in our definitive proxy statement, to be delivered to shareholders in connection with the April 25, 2017 Annual Meeting of Shareholders, is incorporated herein by reference.

 

31
 

PART IV.

 

ITEM 15.     EXHIBITS AND FINANCIAL STATEMENT SCHEDULES

 

(a) 1.    Financial Statements
    All of our financial statements are incorporated herein by reference as set forth in the annual report to be delivered to shareholders in connection with the April 25, 2017 Annual Meeting of Shareholders (filed as exhibit 13 to this report on Form 10-K.)
     
  2.    Exhibits (Numbered in accordance with Item 601 of Regulation S-K)
    The Exhibit Index is located on the final three pages of this report on Form 10-K.

 

32
 

SIGNATURES

 

Pursuant to the requirements of Section 13 or 15 (d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized, dated March 7, 2017.

 

INDEPENDENT BANK CORPORATION

 

 /s/Robert N. Shuster  Robert N. Shuster, Executive Vice President and Chief Financial
   Officer (Principal Financial Officer)

 

Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated. Each director whose signature appears below hereby appoints William B. Kessel and Robert N. Shuster and each of them severally, as his or her attorney-in-fact, to sign in his or her name and on his or her behalf, as a director, and to file with the Securities and Exchange Commission any and all amendments to this Annual Report on Form 10-K.

 

William B. Kessel, President, Chief
Executive Officer, and Director
Principal Executive Officer) 		 s/William B. Kessel March 7, 2017
     
Robert N. Shuster, Executive Vice
President and Chief Financial Officer
(Principal Financial Officer) 		 /s/Robert N. Shuster March 7, 2017
     
James J. Twarozynski, Senior Vice
President and Controller
(Principal Accounting Officer) 		 /s/James J. Twarozynski March 7, 2017
     
Michael M. Magee, Jr.
Chairman and Director 		 /s/Michael M. Magee Jr. March 7, 2017
     
William J. Boer, Director  /s/William J. Boer March 7, 2017
     
Joan A. Budden, Director  
     
Stephen L. Gulis, Jr., Director  /s/Stephen L. Gulis, Jr. March 7, 2017
     
Terry L. Haske, Director
     
Christina L. Keller, Director
     
William B. Kessel, Director  /s/William B. Kessel March 7, 2017
     
Matthew J. Missad, Director  /s/Matthew J. Missad March 7, 2017
     
James E. McCarty, Director  
     
Charles C. Van Loan, Director  /s/Charles C. Van Loan March 7, 2017

 

33
 

EXHIBIT INDEX

 

Exhibit number and description 

EXHIBITS FILED HEREWITH 

3.2 Amended and Restated Bylaws, conformed through January 24, 2017.
13 Annual report, relating to the April 25, 2017 Annual Meeting of Shareholders. This annual report will be delivered to our shareholders in compliance with Rule 14(a)-3 of the Securities Exchange Act of 1934, as amended.
21 List of Subsidiaries.
23 Consent of Independent Registered Public Accounting Firm (Crowe Horwath LLP).
24 Power of Attorney (included on page 33).
31.1 Certificate of the Chief Executive Officer of Independent Bank Corporation pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
31.2 Certificate of the Chief Financial Officer of Independent Bank Corporation pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
32.1 Certificate of the Chief Executive Officer of Independent Bank Corporation pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
32.2 Certificate of the Chief Financial Officer of Independent Bank Corporation pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

101.INS 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 Label Linkbase Document

101.PRE XBRL Taxonomy Extension Presentation Linkbase Document

 

EXHIBITS INCORPORATED BY REFERENCE

 

3.1 Restated Articles of Incorporation, conformed through May 12, 2009 (incorporated herein by reference to Exhibit 3.1 to our Form S-4 Registration Statement dated January 27, 2010, filed under registration No. 333-164546).
3.1(a) Amendment to Article III of the Articles of Incorporation (incorporated herein by reference to Exhibit 99.1 to our current report on Form 8-K dated February 1, 2010 and filed February 3, 2010).
3.1(b) Amendment to Article III of the Articles of Incorporation (incorporated herein by reference to Exhibit 3.1 to our current report on Form 8-K dated April 9, 2010 and filed April 9, 2010).
3.1(c) Certificate of Designations for Fixed Rate Cumulative Mandatorily Convertible Preferred Stock, Series B, filed as an amendment to the Articles of Incorporation (incorporated herein by reference to Exhibit 3.1 to our current report on Form 8-K dated April 16, 2010 and filed April 21, 2010).
3.1(d) Amendment to Article III of the Articles of Incorporation (incorporated herein by reference to Exhibit 3.1 to our current report on Form 8-K dated August 31, 2010 and filed August 31, 2010).
3.1(e) Certificate of Designations for Series C Junior Participating Preferred Stock, filed as an amendment to the Articles of Incorporation (incorporated herein by reference to Exhibit 4.2 to our Registration Statement on Form 8-A dated November 15, 2011 and filed November 15, 2011).
10.1* Deferred Benefit Plan for Directors (incorporated herein by reference to Exhibit 10(C) to our report on Form 10-K for the year ended December 31, 1984).
10.2 The form of Indemnity Agreement approved by our shareholders at the April 19, 1988 Annual Meeting, as executed with all of the directors of the registrant (incorporated herein by reference to Exhibit 10(F) to our report on Form 10-K for the year ended December 31, 1988).
10.3 The form of Management Continuity Agreement as executed with executive officers and certain senior managers (incorporated herein by reference to Exhibit 10 to our report on Form 10-K for the year ended December 31, 1998).
10.4* Long-Term Incentive Plan, as amended through April 23, 2013 (incorporated herein by reference to Appendix A to our proxy statement filed on Schedule 14A on March 13, 2013).
10.5* Amended and Restated Deferred Compensation and Stock Purchase Plan for Nonemployee Directors, as amended through March 8, 2011 (incorporated herein by reference to Exhibit 10.2 to our annual report on Form 10-K filed March 10, 2011).

 

34
 
10.6* First Amendment to Amended and Restated Deferred Compensation and Stock Purchase Plan for Nonemployee Directors, effective March 1, 2012 (incorporated herein by reference to Exhibit 10.1 to our annual report on Form 10-K filed March 13, 2012).
10.7* Form of Restricted Stock Unit Grant Agreement as executed with certain executive officers (incorporated herein by reference to Exhibit 10.2 to our quarterly report on Form 10-Q filed May 9, 2011).
10.8* Form of TSR Performance Share Award Agreement as executed with certain executive officers (incorporated herein by reference to Exhibit 10.12 to our annual report on Form 10-K filed March 7, 2014).
10.9* Summary of Independent Bank Corporation Management Incentive Compensation Plan (incorporated herein by reference to Exhibit 10.10 to our annual report on Form 10-K filed March 6, 2015).

 

* Represents a compensation plan.

 

35
 

EXHIBIT 3.2

 

AMENDED AND RESTATED BYLAWS

 

of

 

INDEPENDENT BANK CORPORATION

 

A Michigan Corporation

(Conformed Through January 24, 2017)

 

ARTICLE I . OFFICES

 

Section 1 . Registered Office . The registered office of the Corporation shall be as specified in the Articles of Incorporation. The Corporation shall keep records containing the names and addresses of all shareholders, the number, class and series of shares held by each, and the dates when they respectively became holders of record thereof, at its registered office or at the office of its transfer agent.

 

Section 2 . Other Offices . The business of the Corporation may be transacted in such locations other than the registered office, within or outside the State of Michigan, as the Board of Directors may from time to time determine.

 

ARTICLE II . CAPITAL STOCK

 

Section 1 . Stock Certificates . Certificates representing shares of the Corporation shall be in such form as is approved by the Board of Directors. Certificates shall be signed by the Chairman of the Board of Directors, Vice Chairman of the Board of Directors, President or a Vice President, and by the Treasurer, Assistant Treasurer, Secretary or Assistant Secretary of the Corporation, and shall be sealed with the seal of the Corporation, or a facsimile thereof, if one is adopted. The signatures of the officers may be facsimiles if the certificate is countersigned by a transfer agent or registered by a registrar other than the Corporation itself, or its employees. In the event an officer who has signed, or whose facsimile signature has been placed upon, a certificate ceases to be such officer before the certificate is issued, it may be issued by the Corporation with the same effect as if he were such officer at the date of issue.

 

Section 2 . Replacement of Lost or Destroyed Certificates . In the event of the loss or destruction of a stock certificate, no new certificate shall be issued in place thereof until the Corporation has received from the registered holder such assurances, representations, warranties and/or guarantees as the Board of Directors, in its sole discretion, shall deem advisable, and until the Corporation receives sufficient indemnification protecting it against any claim that may be made on account of such loss or destroyed certificate, or the issuance of any new certificate in place thereof, including an indemnity bond in such amount and with sureties, if any, as the Board of Directors, in its sole discretion, deems advisable. Any new certificate issued in place of any such lost or destroyed certificate shall be plainly marked “duplicate” upon its face.

 

Section 3 . Transfer of Shares . The Board of Directors may appoint a transfer agent or registrar of transfer and, upon such appointment, capital shares of the Corporation shall be transferable only upon the books of the transfer agent or registrar of transfer. The old certificates shall be surrendered by delivery to the transfer agent or registrar, promptly endorsed for transfer, and the old certificates shall be cancelled before a new certificate is issued. The signature of an officer required by Section 1 of this Article II, and the corporate seal, if any, may be facsimiles if the certificate is countersigned by a transfer agent or registrar other than the Corporation itself or its employees. If an officer whose facsimile signature has been placed upon a certificate ceases to be such officer before the certificate is issued, it may be issued by the Corporation with the same effect as if he or she were such officer at the date of issue. The transfer agent or registrar of transfer shall keep records containing the names and addresses of all shareholders, the number, class, and series of shares held by each, and the dates when they became holders of record thereof, respectively. The Corporation shall be entitled to treat the person in whose name any share, right, or option is registered as the owner thereof for all purposes and shall not be bound to recognize any equitable or other claim, regardless of any notice thereof, except as may be specifically required by the laws of the state of Michigan.

 

 
 

 

Section 4 . Rules Governing Stock Certificates . The Board of Directors shall have the power and authority to make all such rules and regulations as they may deem expedient concerning the issue, transfer and registration of certificates of stock, and may appoint a transfer agent and a registrar of transfer, and may require all such certificates to bear the signature of such transfer agent and/or such registrar of transfers.

 

Section 5 . Record Date for Stock Rights . The Board of Directors may fix, in advance, a date not exceeding sixty (60) days preceding the date of payment of any dividend, or the date for the allotment of rights, or the date when any change or conversion or exchange of capital stock shall go into effect, as a record date for the determination of the shareholders entitled to receive payment of any such dividends, or any such allotment of rights, or to exercise the rights with respect to any such change, conversion, or exchange of capital stock; and in such case, only shareholders of record on the date so fixed shall be entitled to receive payment of such dividends, or allotment of rights, or exercise such rights, as the case may be, notwithstanding any transfer of any stock on the books of the Corporation after any such record date is fixed.

 

In the event the Board of Directors shall fail to fix a record date as provided in this Section 5 of Article II, the record date for the purposes specified herein shall be the close of business on the day on which the resolution of the Board of Directors relating thereto is adopted.

 

Section 6 . Dividends . The Board of Directors, in its discretion, may from time to time declare and direct payment of dividends or other distributions upon its outstanding shares out of funds legally available for such purposes, which dividends may be paid in cash, the Corporation’s bonds or the Corporation’s property, including the shares or bonds of other corporations. In addition to the declaration of dividends and other distributions provided in this Section 6 of Article II, the Board of Directors, in its discretion, from time to time may declare and direct the payment of a dividend in shares of this Corporation, upon its outstanding shares, in accordance with and subject to the provisions of the Michigan Business Corporation Act.

 

Section 7 . Acquisition of Shares . Subject to the limitations of the Michigan Business Corporation Act, the Board of Directors may authorize the Corporation to acquire its own shares, and shares so acquired shall constitute authorized but unissued shares.

 

Section 8 . Inapplicability of Control Share Acquisition Provisions of the Michigan Business Corporation Act . Pursuant to Section 794 of the Michigan Business Corporation Act (the “ Act ”), Chapter 7B of the Act and any successor provision thereof does not apply to control share acquisitions of shares of the Corporation on or after December 8, 2008. The term “control share acquisitions” as used herein shall have the meaning ascribed to it in Chapter 7B of the Act or any successor provision thereof.

 

ARTICLE III . SHAREHOLDERS

 

Section 1 . Place of Meetings . Meetings of shareholders shall be held at the registered office of the Corporation or at such other place, within or outside the State of Michigan, as may be determined from time to time by the Board of Directors; provided, however, if a meeting of shareholders is to be held at a place other than the registered office of the Corporation, the notice of the meeting shall designate such place.

 

Section 2 . Annual Meeting . Annual meetings of shareholders for the election of directors and for such other business as may come before the meeting shall be held on a date not later than 180 days after the end of the immediately preceding fiscal year, which date shall be determined by the Board of Directors. If the annual meeting is not held on the designated date, the Board of Directors shall cause a meeting to be held as soon thereafter as convenient.

 

Section 3 . Special Meetings . Special meetings of shareholders may be called by the Chairman of the Board, the President or the Secretary, and shall be called by either of them pursuant to resolution therefor by the Board of Directors, or upon receipt by them of a request in writing, stating the purpose or purposes thereof, and signed by shareholders of record owning at least three-fourths (3/4) of the voting shares of the Corporation’s issued and outstanding capital stock.

 

 
 

 

Section 4 . Record Date for Notice and Vote . For the purpose of determining shareholders entitled to notice of and to vote at a meeting of shareholders or an adjournment of a meeting, the Board of Directors may fix a record date which shall not precede the date on which the resolution fixing the record date is adopted by the Board. The date shall be not more than sixty (60) nor less than ten (10) days before the date of the meeting. If a record date is not fixed, the record date for determination of shareholders entitled to notice of or to vote at a meeting of shareholders shall be the close of business on the day next preceding the day on which notice is given or, if no notice is given, the day next preceding the day on which the meeting is held. When a determination of shareholders of record entitled to notice of or to vote at a meeting of shareholders has been made as provided in this Section 4, the determination applies to any adjournment of the meeting, unless the Board fixes a new record date under this section for the adjourned meeting.

 

Section 5 . Notice of Shareholder Meetings . Written notice of the time, place and purposes of any meeting of shareholders shall be given not less than ten (10) nor more than sixty (60) days before the date of the meeting to each shareholder of record entitled to vote at the meeting. Such notice may be given either by delivery in person to such shareholders or by mailing such notice to shareholders at their addresses as the same appear on the stock books of the Corporation.

 

A shareholder’s attendance at a meeting, in person or by proxy, constitutes a waiver of his objection to lack of notice or defective notice of the meeting unless, at the beginning of the meeting, the shareholder objects to holding the meeting or transacting business at the meeting, and constitutes a waiver of his objection to consideration of a particular matter at the meeting that is not within the purpose or purposes described in the meeting notice, unless the shareholder objects to considering the matter when it is presented.

 

Section 6 . Voting Lists . The Corporation’s officer or agent having charge of its stock transfer books shall prepare and certify a complete list of the shareholders entitled to vote at a shareholders’ meeting or any adjournment thereof, which list shall be arranged alphabetically within each class and series, and shall show the address of, and the number of shares held by each share holder. The list shall be produced at the time and place of the meeting of shareholders and be subject to inspection by any shareholder at any time during the meeting. If for any reason the requirements with respect to the shareholder list specified in this Section 6 of Article III have not been complied with, any shareholder, either in person or by proxy, who in good faith challenges the existence of sufficient votes to carry any action at the meeting, may demand that the meeting be adjourned and the same shall be adjourned until the requirements are complied with; provided, however, that failure to comply with such requirements does not affect the validity of any action taken at the meeting before such demand is made.

 

Section 7 . Voting .

 

(A) General . Except as may otherwise be provided in the Articles of Incorporation, each shareholder entitled to vote at a meeting of shareholders, or to express consent or dissent without a meeting, shall be entitled to one (1) vote, in person or by proxy, for each share of stock entitled to vote held by such shareholder; provided, however, no proxy shall be voted after three (3) years from its date unless such proxy provides for a longer period. A vote may be cast either orally or in writing as announced or directed by the chairperson of the meeting prior to the taking of the vote. When an action other than the election of directors is to be taken by vote of the shareholders, it shall be authorized by a majority of the votes cast by the holders of shares entitled to vote thereon, unless a greater plurality is required by express requirement of the Michigan Business Corporation Act or of the Articles of Incorporation, in which case such express provision shall govern and control the decision of such question.

 

(B) Election of Directors . The vote required for the election of a director shall, except in a contested election, be the affirmative vote of a majority of the votes cast in the election of a nominee. For purposes of this Section 7(B), a “majority of the votes cast” shall mean that the number of votes cast “for” a director’s election exceeds the number of votes cast “against” that director’s election, with “abstentions” and “broker nonvotes” not counted as votes cast either “for” or “against” that director’s election. In a contested election, directors shall be elected by a plurality of the votes cast at a meeting of shareholders. An election shall be considered contested if there are more nominees for election than positions on the Board of Directors to be filled by election at that meeting.

 

 
 

 

In any non-contested election of directors, any incumbent director nominee who receives a greater number of votes cast against his or her election than in favor of his or her election shall immediately tender his or her resignation to the Board. The Nominating and Corporate Governance Committee will make a recommendation to the Board on whether to accept or reject the resignation or whether other action should be taken. The Board will act on the Committee’s recommendation and publicly disclose its decision within 90 days from the date of the certification of the election results for that meeting.

 

Section 8 . Quorum . Shares equaling a majority of all of the voting shares of the capital stock of the Corporation issued and outstanding represented in person or by proxy, shall constitute a quorum at the meeting. Meetings at which less than a quorum is represented may be adjourned by a vote of a majority of the shares present to a further date without further notice other than the announcement at such meeting, and when the quorum shall be present upon such adjourned date, any business may be transacted which might have been transacted at the meeting as originally called. Shareholders present in person or by proxy at any meeting of shareholders may continue to do business until adjournment, notwithstanding the withdrawal of shareholders to leave less than a quorum.

 

Section 9 . Conduct of Meetings . The Chairman of the Board of Directors of the Corporation or his designee shall call meetings of the shareholders to order and shall act as chairman of such meetings unless otherwise determined by the affirmative vote of a majority of all the voting shares of the capital stock of the Corporation issued and outstanding. The Secretary of the Corporation shall act as secretary of all meetings of shareholders, but in the absence of the Secretary at any meeting of shareholders, or his inability or refusal to act as secretary, the presiding officer may appoint any person to act as secretary of the meeting.

 

Section 10 . Inspector of Elections . The Board of Directors may, in advance of a meeting of shareholders, appoint one or more inspectors to act at the meeting or any adjournment thereof. In the event inspectors are not so appointed, or an appointed inspector fails to appear or act, the person presiding at the meeting of shareholders may, and on request of a shareholder entitled to vote shall, appoint one or more persons to fill such vacancy or vacancies, or to act as inspector. The inspector(s) shall determine the number of shares outstanding and the voting power of each, the shares represented at the meeting, the existence of a quorum, the validity and effect of proxies, and shall receive votes, ballots or consents, hear and determine challenges and questions arising in connection with the right to vote, count and tabulate votes, ballots or consents, determine the results, and do such acts as are proper to conduct the election or vote with fairness to all shareholders.

 

Section 11 . Notification of Shareholder Proposals . The Board of Directors of the Corporation shall submit for consideration and vote by the shareholders, at any meeting of the shareholders, only those proposals that are first brought before the meeting by or at the direction of the Board of Directors, or by any shareholder entitled to vote at such meeting; (a) who submits to the Corporation a timely Notice of Proposal in accordance with the requirements of this Section 11 and the proposal is a proper subject for action by shareholders under Michigan law; or (b) whose proposal is included in the Corporation’s proxy materials in compliance with all the requirements set forth in the applicable rules and regulations of the Securities and Exchange Commission.

 

Each shareholder’s Notice of Proposal shall set forth:

 

  (i) The name and address of the shareholder submitting the proposal, as they appear on the Corporation’s books and records;

 

  (ii) A representation that the shareholder (1) is a holder of stock of the Corporation entitled to vote at such meeting, (2) will continue to hold such stock through the date on which the meeting is held, and (3) intends to appear in person or by proxy at the meeting to submit the proposal for shareholder vote;

 

  (iii) A brief description of the proposal desired to be submitted to the meeting for shareholder vote and for the reasons for conducting such business at the meeting; and

 

  (iv) A description of any financial or other interest of such shareholder in the proposal.

 

 
 

 

A Notice of Proposal must be given, either by personal delivery or by United States mail, postage prepaid, and received by the Corporation not less than sixty (60) days nor more than ninety (90) days prior to the date of the first anniversary of the preceding year’s annual meeting of shareholders, or if the date of the annual meeting is changed by more than twenty (20) days from such anniversary date, within ten (10) days after the date the Corporation mails or otherwise gives notice of the date of the meeting.

 

The Secretary of the Corporation shall notify a shareholder in writing whether his or her Notice of Proposal has been made in accordance with all the requirements of this Section 11. The chairman of the meeting may refuse to acknowledge the proposal of any shareholder not made in compliance with all such requirements.

 

ARTICLE IV . DIRECTORS

 

Section 1 . Board of Directors . Except as may otherwise be provided in the Corporation’s Articles or Incorporation or these Bylaws, the business and affairs of the Corporation shall be managed by a Board of Directors. The size of the Board, the classification of the Board, the manner of filling vacancies occurring in the Board, nominations for directors, and removal of directors shall be as provided for in the Corporation’s Articles of Incorporation.

 

Section 2 . Place of Meetings and Records . The directors shall hold their meetings, and maintain the minutes of the proceedings of meetings of shareholders, Board of Directors, and executive and other committees, if any, and keep the books and records of account for the Corporation, in such place or places, within or outside the State of Michigan, as the Board may from time to time determine.

 

Section 3 . Annual Meetings of Directors . The newly elected Directors shall hold their first meeting promptly after the Annual Meeting of Shareholders at which they were elected, for purposes of electing officers of the Corporation and transacting such other business as may properly come before the meeting. No notice of such meeting, other than these Bylaws, shall be necessary in order to legally constitute the meeting, provided a quorum is present.

 

Section 4 . Regular Meetings of the Board . Regular meetings of the Board of Directors may be held at such times and places and pursuant to such notice, if any, as may be established from time to time by resolution of the Board of Directors.

 

Section 5 . Special Meetings of the Board . Special meetings of the Board of Directors may be called by the Chairman of the Board, the President or the Secretary, and shall be called by one of them upon the written request of a majority of the Directors. Notice of the time and place of special meetings of the Board shall be given by facsimile or by telephone to each director at least two (2) hours prior thereto. Attendance of a Director at a special meeting constitutes a waiver of notice of the meeting, except where a director attends the meeting for the express purpose of objecting to the transaction of any business because the meeting is not lawfully called or convened.

 

Section 6 . Meeting Participation By Means Of Communication Equipment . Members of the Board of Directors or any committee designated by the Board of Directors may participate in the meeting of the Board of Directors or of such committee by means of a conference telephone or similar communication equipment by means of which all persons participating in the meeting can hear each other, and participation in a meeting pursuant to this Section 6 shall constitute presence in person at such meeting.

 

Section 7 . Quorum and Vote . At all meetings of the Board or a committee thereof, a majority of the members of the Board of Directors then in office or members of such committee, but not less than two (2) (if there are at least two (2) members of the Board or such committee) shall constitute a quorum for the transaction of business. The act of a majority of the members present at any meeting at which there is a quorum shall be the act of the Board of Directors or the committee. If a quorum shall not be present at any meeting of the Board of Directors or a committee, the members present thereat may adjourn the meeting from time to time into another place without notice other than an announcement at the meeting until a quorum shall be present.

 

 
 

 

Section 8 . Action of the Board Without a Meeting . Any action required or permitted to be taken pursuant to authorization voted at a meeting of the Board of Directors, or any committee thereof, may be taken without a meeting if, before or after the action, all members of the Board of Directors then in office, or of such committee, consent thereto in writing. Such written consent shall be filed with the minutes of the proceedings of the Board of Directors and the consent shall have the same effect as a vote of the Board of Directors for all purposes.

 

Section 9 . Committees . The Board of Directors may, by resolution passed by a majority of the whole Board, designate one or more committees, each committee to consist of one or more of the directors of the Corporation. The Board of Directors may designate one or more directors as alternate members of any committee, who may replace any absent or disqualified member of any committee. In the absence or in the event of the disqualification of a member of a committee, the member or members thereof present at any meeting and not disqualified from voting, whether or not he or they constitute a quorum, may unanimously appoint another member of the Board of Directors to act at the meeting in the place of any such absent or disqualified member. A committee and each member thereof shall serve at the pleasure of the Board.

 

Any committee, to the extent provided in the resolution of the Board or in these Bylaws, shall have and may exercise the powers of the Board of Directors in the management of the business and affairs of the Corporation. No committee, however, shall have the power or authority to amend the Articles of Incorporation or Bylaws of the Corporation, adopt an agreement of merger or consolidation, recommend to the shareholders the sale, lease or exchange of all or substantially all of the Corporation’s property and assets, recommend to the shareholders a dissolution of the Corporation or a revocation of a dissolution, or fill vacancies in the Board of Directors. The committee shall not have the power or authority to declare a distribution, dividend or authorize the issuance of stock unless such power is granted to such committee by specific resolution of the Board of Directors. Such committee or committees shall have such name or names as may be determined from time to time by resolution adopted by the Board of Directors. The committees shall keep regular minutes of their proceedings and report the same to the Board when required.

 

Section 10 . Compensation . By resolution of the Board of Directors, the directors may be paid their expenses, if any, of attendance at each meeting of the Board or of any committees of which they are a member, and may be paid a fixed sum for attendance at each meeting of the Board or such committee, and/or a stated fee for serving as a director or for serving on any such committee.

 

ARTICLE V . OFFICERS

 

Section 1 . Designation of Officers . The officers of the Corporation shall consist of such officers as the Board of Directors shall determine from time to time, and may include a Chairman of the Board, a President, a Secretary, a Treasurer, one or more Vice Presidents, and such other or different offices as may be established by the Board of Directors. The officers of the Corporation need not be directors or shareholders. Any two or more offices may be held by the same person, but an officer shall not execute, acknowledge or verify any instrument in more than one capacity if the instrument is required by law to be executed, acknowledged or verified by two or more officers.

 

Section 2 . Election of Officers . The officers of the Corporation shall be elected at the first meeting of the Board of Directors, or by action taken pursuant to written consent, after the annual meeting of shareholders. Officers shall hold office for the term of their election and until their respective successors are elected and qualified, or until resignation or removal.

 

Section 3 . Resignation and Removal . An officer may resign by written notice to the Corporation, which resignation is effective upon its receipt by the Corporation or at a subsequent time specified in the notice of resignation. The Chairman or President may be removed at any time, with or without cause, but only on the affirmative vote of a majority of the full Board of Directors. All vice presidents, the secretary and the treasurer may be removed at any time, with or without cause, by the President or by majority vote of the directors present at any meeting. Any assistant secretary or assistant treasurer, or subordinate officer or agent appointed pursuant to Section 2 of Article V of these Bylaws may be removed at any time, with or without cause, by a majority vote of directors present in a meeting, by the President or any committee authorized to do so by resolution of the Board.

 

 
 

 

Section 4 . Compensation of Officers . The Board of Directors, by affirmative vote of a majority of Directors in office and irrespective of any personal interest of any of them, may establish reasonable compensation of officers for services to the Corporation.

 

Section 5 . Chairman of the Board . The Chairman of the Board of Directors, if one be elected, shall be elected by the directors from among the directors then serving. The Chairman of the Board shall preside at all meetings of the Board of Directors and meetings of the shareholders, and shall perform such other duties as from time to time may be determined by resolution of the Board of Directors not inconsistent with these Bylaws.

 

Section 6 . President . The President shall be the chief executive officer of the Corporation and shall have such authority and shall have general supervision, direction, and control of the business of the Corporation, as well as the duty and responsibility to implement and accomplish the objectives of the Corporation. In the absence or nonelection of the Chairman of the Board of Directors, the President shall preside at all meetings of the Board of Directors and meetings of the shareholders.

 

Section 7 . Vice Presidents . The Vice Presidents shall have such authority and shall perform such duties as shall be assigned to them by the Board of Directors and may be designated by such special titles as the Board of Directors shall approve.

 

Section 8 . Treasurer . The Treasurer, or other officer performing the duties of a Treasurer, shall have custody of the corporate funds and securities and shall keep full and accurate account of receipts and disbursements in books belonging to the Corporation. The Treasurer shall deposit all money and other valuables in the name and to the credit of the Corporation in such depositories as may be designated by the Board of Directors. The Treasurer shall disburse the funds of the Corporation as may be ordered by the Board of Directors or President taking proper vouchers for such disbursements. The Treasurer shall render to the President and Board of Directors, or any member thereof, at such times as they may request within reason, an account of all his transactions as Treasurer and of the financial condition of the Corporation. In general the Treasurer shall perform all duties incident to the office of Treasurer and such other duties as may be assigned by the Board of Directors. The Treasurer may be required to give bond for the faithful performance of his duties in such sum and with such surety, at the expense of the Corporation, as the Board of Directors may from time to time require.

 

Section 9 . Secretary . The Secretary shall give or cause to be given notice of all meetings of shareholders and Directors and all other notices required by law or by these Bylaws, and in case of his absence or refusal or neglect to do so, any such notice may be given by the shareholders upon whose requisition the meeting is called, as provided in these Bylaws. The Secretary shall record all the proceedings of the meetings of the shareholders and of the Directors in one or more books provided for that purpose. The Secretary shall have custody of the seal of the Corporation, if one be provided, and shall affix the same to all instruments requiring it when authorized by the Directors or the President. The Secretary shall have such authority and perform such other duties as may be assigned by the Board of Directors.

 

Section 10 . Other Offices . Other officers elected by the Board of Directors shall have such authority and shall perform such duties in the management of the Corporation as may be determined by resolution of the Board of Directors not inconsistent with these Bylaws.

 

Section 11 . Bonds . If the Board of Directors shall so require, the treasurer, and the assistant treasurer and/or other officer or agent of the Corporation, shall give bond to the Corporation in such amount and with such surety as the Board of Directors may deem sufficient, conditioned upon the faithful performance of the respective duties and offices.

 

ARTICLE VI . CONTRACTS, LOANS, CHECKS AND DEPOSITS

 

Section 1 . Contracts . The Board of Directors may authorize any officer or officers, agent or agents to enter into any contract or execute and deliver any instrument in the name of and on behalf of the Corporation, and such authority may be general or confined to specific instances.

 

 
 

 

Section 2 . Loans . No loans shall be contracted on behalf of the Corporation, and no evidences of indebtedness shall be issued in its name, unless authorized by resolution of the Board of Directors. Such authorization may be general or confined to specific instances.

 

Section 3 . Checks . All checks, drafts or other orders for the payment of money, notes or other evidences of indebtedness issued in the name of the Corporation shall be signed by such officer or officers, agent or agents of the Corporation and in such manner as shall from time to time be determined by resolution of the Board of Directors.

 

Section 4 . Deposits . All funds of the Corporation, not otherwise employed, shall be deposited from time to time to the credit of the Corporation in such banks, trust companies or other depositories as the Board of Directors may determine.

 

ARTICLE VII . MISCELLANEOUS

 

Section 1 . Fiscal Year . The fiscal year of this Corporation shall end on the 31st day of December of each year.

 

Section 2 . Notices . Whenever any notice is required to be given under the provisions of any law, the Articles of Incorporation for this Corporation, or by these Bylaws, it shall not be construed or interpreted to mean personal notice, unless expressly so stated, and any notice so required shall be deemed to be sufficient if given in writing by mail, by depositing the same in a Post Office box, postage prepaid, addressed to the person entitled thereto at his last known Post Office address, and such notice shall be deemed to have been given on the day of such mailing. Shareholders not entitled to vote shall not be entitled to receive notice of any meetings, except as otherwise provided by law or these Bylaws.

 

Section 3 . Waiver of Notice . Whenever any notice is required to be given under the provisions of any law, or the Articles of Incorporation for this Corporation, or these Bylaws, a waiver thereof in writing, signed by the person or persons entitled to said notice, whether before or after the time stated therein, shall be deemed equivalent thereto.

 

Section 4 . Voting of Securities . Securities of another corporation, foreign or domestic, standing in the name of this Corporation which are entitled to vote shall be voted, in person or by proxy, by the President of this Corporation or by such other or additional persons as may be designated by the Board of Directors.

 

ARTICLE VIII . AMENDMENTS

 

Except as may otherwise be provided in the Articles of Incorporation or these Bylaws, these Bylaws may be amended, repealed or new Bylaws adopted either by a majority vote of the Board of Directors at a regular or special meeting of the Board, or by vote of the holders of a majority of the stock of the Corporation voting at any annual or special meeting, if notice of the proposed amendment, repeal or adoption be contained in the notice of such meeting.

 

 
 

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Exhibit 13

Performance Graph
 
8
 
Selected Consolidated Financial Data
 
9
 
Management’s Discussion and Analysis
 
10
 
Management’s Annual Report on Internal Control Over Financial Reporting
 
33
 
Report of Independent Registered Public Accounting Firm
 
34
 
Consolidated Financial Statements
 
35
 
Notes to Consolidated Financial Statements
 
40
 
Quarterly Data
 
98
 

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PERFORMANCE GRAPH

The graph below compares the total returns (assuming reinvestment of dividends) of Independent Bank Corporation common stock, the NASDAQ Composite Index and the NASDAQ Bank Stock Index. The graph assumes $100 invested in Independent Bank Corporation common stock (returns based on stock prices per the NASDAQ) and each of the indices on December 31, 2011 and the reinvestment of all dividends during the periods presented. The performance shown on the graph is not necessarily indicative of future performance.

 

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SELECTED CONSOLIDATED FINANCIAL DATA (1)

 
Year Ended December 31,
 
2016
2015
2014
2013
2012
 
(Dollars in thousands, except per share amounts)
SUMMARY OF OPERATIONS
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Interest income
$
86,523
 
$
80,842
 
$
80,555
 
$
87,121
 
$
99,398
 
Interest expense
 
6,882
 
 
5,856
 
 
7,299
 
 
9,162
 
 
13,143
 
Net interest income
 
79,641
 
 
74,986
 
 
73,256
 
 
77,959
 
 
86,255
 
Provision for loan losses
 
(1,309
)
 
(2,714
)
 
(3,136
)
 
(3,988
)
 
6,887
 
Net gains on securities
 
563
 
 
20
 
 
320
 
 
369
 
 
887
 
Net gain on branch sale
 
—
 
 
1,193
 
 
—
 
 
—
 
 
5,402
 
Gain on extinguishment of debt
 
—
 
 
—
 
 
500
 
 
—
 
 
—
 
Other non-interest income
 
41,735
 
 
38,917
 
 
37,955
 
 
44,460
 
 
57,276
 
Non-interest expenses
 
90,347
 
 
88,450
 
 
89,951
 
 
104,118
 
 
116,735
 
Income before income tax
 
32,901
 
 
29,380
 
 
25,216
 
 
22,658
 
 
26,198
 
Income tax expense (benefit)
 
10,135
 
 
9,363
 
 
7,195
 
 
(54,851
)
 
—
 
Net income
$
22,766
 
$
20,017
 
$
18,021
 
$
77,509
 
$
26,198
 
Preferred stock dividends
 
—
 
 
—
 
 
—
 
 
(3,001
)
 
(4,347
)
Preferred stock discount
 
—
 
 
—
 
 
—
 
 
7,554
 
 
—
 
Net income applicable to common stock
$
22,766
 
$
20,017
 
$
18,021
 
$
82,062
 
$
21,851
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
PER COMMON SHARE DATA
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Net income per common share
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Basic
$
1.06
 
$
0.88
 
$
0.79
 
$
5.87
 
$
2.51
 
Diluted
 
1.05
 
 
0.86
 
 
0.77
 
 
3.55
 
 
0.80
 
Cash dividends declared and paid
 
0.34
 
 
0.26
 
 
0.18
 
 
0.00
 
 
0.00
 
Book value
 
11.71
 
 
11.28
 
 
10.91
 
 
10.15
 
 
5.58
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
SELECTED BALANCES
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Assets
$
2,548,950
 
$
2,409,066
 
$
2,248,730
 
$
2,209,943
 
$
2,023,867
 
Loans
 
1,608,248
 
 
1,515,050
 
 
1,409,962
 
 
1,374,570
 
 
1,419,139
 
Allowance for loan losses
 
20,234
 
 
22,570
 
 
25,990
 
 
32,325
 
 
44,275
 
Deposits
 
2,225,719
 
 
2,085,963
 
 
1,924,302
 
 
1,884,806
 
 
1,779,537
 
Shareholders’ equity
 
248,980
 
 
251,092
 
 
250,371
 
 
231,581
 
 
134,975
 
Other borrowings
 
9,433
 
 
11,954
 
 
12,470
 
 
17,188
 
 
17,622
 
Subordinated debentures
 
35,569
 
 
35,569
 
 
35,569
 
 
40,723
 
 
50,175
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
SELECTED RATIOS
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Net interest income to average interest earning assets
 
3.52
%
 
3.58
%
 
3.67
%
 
4.11
%
 
4.04
%
Net income to (2)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Average common equity
 
9.21
 
 
7.89
 
 
7.43
 
 
64.22
 
 
68.29
 
Average assets
 
0.92
 
 
0.86
 
 
0.80
 
 
3.87
 
 
0.92
 
Average shareholders’ equity to average assets
 
9.98
 
 
10.93
 
 
10.83
 
 
8.69
 
 
4.82
 
Tier 1 capital to average assets
 
10.50
 
 
10.91
 
 
11.18
 
 
10.61
 
 
8.08
 
Non-performing loans to Portfolio Loans
 
0.83
 
 
0.71
 
 
1.08
 
 
1.30
 
 
2.32
 
(1) The significant variations in the results of operations for the five years presented above is a result of a number of factors, including changes in asset quality metrics, our consolidation, closing or sale of 36 branches in 2012, our exit from the Troubled Asset Relief Program in 2013, and a significant income tax benefit realized in 2013.
(2) These amounts are calculated using net income applicable to common stock.

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MANAGEMENT’S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Disclaimer Regarding Forward-Looking Statements. Statements in this report that are not statements of historical fact, including statements that include terms such as “will,” “may,” “should,” “believe,” “expect,” “forecast,” “anticipate,” “estimate,” “project,” “intend,” “likely,” “optimistic” and “plan” and statements about future or projected financial and operating results, plans, projections, objectives, expectations, and intentions, are forward-looking statements. Forward-looking statements include, but are not limited to, descriptions of plans and objectives for future operations, products or services; projections of our future revenue, earnings or other measures of economic performance; forecasts of credit losses and other asset quality trends; statements about our business and growth strategies; and expectations about economic and market conditions and trends. These forward-looking statements express our current expectations, forecasts of future events, or long-term goals. They are based on assumptions, estimates, and forecasts that, although believed to be reasonable, may turn out to be incorrect. Actual results could differ materially from those discussed in the forward-looking statements for a variety of reasons, including:

• economic, market, operational, liquidity, credit, and interest rate risks associated with our business;
• economic conditions generally and in the financial services industry, particularly economic conditions within Michigan and the regional and local real estate markets in which our bank operates;
• the failure of assumptions underlying the establishment of, and provisions made to, our allowance for loan losses;
• increased competition in the financial services industry, either nationally or regionally;
• our ability to achieve loan and deposit growth;
• volatility and direction of market interest rates;
• the continued services of our management team; and
• implementation of new legislation, which may have significant effects on us and the financial services industry.

This list provides examples of factors that could affect the results described by forward-looking statements contained in this report, but the list is not intended to be all-inclusive. The risk factors disclosed in Part I – Item 1A of our Annual Report on Form 10-K for the year ended December 31, 2016, as updated by any new or modified risk factors disclosed in Part II – Item 1A of any subsequently filed Quarterly Report on Form 10-Q, include all known risks our management believes could materially affect the results described by forward-looking statements in this report. However, those risks may not be the only risks we face. Our results of operations, cash flows, financial position, and prospects could also be materially and adversely affected by additional factors that are not presently known to us that we currently consider to be immaterial, or that develop after the date of this report. We cannot assure you that our future results will meet expectations. While we believe the forward-looking statements in this report are reasonable, you should not place undue reliance on any forward-looking statement. In addition, these statements speak only as of the date made. We do not undertake, and expressly disclaim, any obligation to update or alter any statements, whether as a result of new information, future events, or otherwise, except as required by applicable law.

Introduction. The following section presents additional information to assess the financial condition and results of operations of Independent Bank Corporation, its wholly-owned bank, Independent Bank (the “Bank”), and their subsidiaries. This section should be read in conjunction with the consolidated financial statements and the supplemental financial data contained elsewhere in this annual report. We also encourage you to read our Annual Report on Form 10-K filed with the U.S. Securities and Exchange Commission (“SEC”). That report includes a list of risk factors that you should consider in connection with any decision to buy or sell our securities.

Overview. We provide banking services to customers located primarily in Michigan’s Lower Peninsula. As a result, our success depends to a great extent upon the economic conditions in Michigan’s Lower Peninsula. At times, we have experienced a difficult economy in Michigan. Economic conditions in Michigan began to show signs of improvement during 2010. Generally, these improvements have continued into 2016, albeit at an uneven pace. There has been an overall decline in the unemployment rate as well as generally improving housing prices and other related

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statistics (such as home sales and new building permits). In addition, since early- to mid-2009, we have seen an improvement in our asset quality metrics. In particular, since early 2012, we have generally experienced a decline in non-performing assets, lower levels of new loan defaults, and reduced levels of loan net charge-offs.

Recent Developments. On December 30, 2016, the Bank and its wholly-owned subsidiary, Mepco Finance Corporation (“Mepco”), entered into an Asset Purchase Agreement (“APA”) with Seabury Asset Management LLC (“Seabury”). Pursuant to the terms of the APA, we are selling our payment plan processing business, payment plan receivables, and certain other assets to Seabury, who also is assuming certain liabilities of Mepco. These assets and liabilities are categorized as “held for sale” in the December 31, 2016 Consolidated Statement of Financial Condition. We also recorded a $0.32 million loss related to the sale of these assets in the fourth quarter of 2016. This loss is included in non-interest expenses in the 2016 Consolidated Statement of Operations. This transaction is expected to close during the first half of 2017. The closing is subject to various conditions, including the ability of Mepco to assign certain specified contracts to Seabury. During 2016, Mepco recorded $4.2 million of interest income, $3.6 million of net interest income, $4.3 million of non-interest expense, a loss before income taxes of $0.65 million and a net loss of $0.35 million. We do not believe that the sale of the Mepco assets will have a significant impact on our overall financial condition or results of operations.

In the fourth quarter of 2016, we reached a tentative settlement regarding litigation initiated against the Bank in Wayne County, Michigan Circuit Court. This litigation concerned the Bank’s checking account transaction sequencing during a period from February 2009 to June 2011. Under the terms of the settlement, we have agreed to pay $2.2 million and we are also responsible for class notification costs and certain other expenses which are estimated to total approximately $0.1 million. We recorded a $2.3 million expense in the fourth quarter of 2016 for this settlement. Although we deny any liability associated with this matter and believe we have meritorious defenses to the allegations in the complaint, given the costs and uncertainty of litigation, we determined that this settlement was in the best interests of the organization.

Regulation. On July 2, 2013, the Federal Reserve Board approved a final rule that establishes an integrated regulatory capital framework (the “New Capital Rules”). The rule implements in the United States the Basel III regulatory capital reforms from the Basel Committee on Banking Supervision and certain changes required by the 2010 Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”). In general, under the New Capital Rules, minimum requirements have increased for both the quantity and quality of capital held by banking organizations. Consistent with the international Basel framework, the New Capital Rules include a new minimum ratio of common equity tier 1 capital to risk-weighted assets of 4.5% and a common equity tier 1 capital conservation buffer of 2.5% of risk-weighted assets that applies to all supervised financial institutions. The 2.5% capital conservation buffer is being phased in over a four-year period beginning in 2016 with 0.625% added to the minimum ratio for adequately capitalized institutions for 2016 and each subsequent year until being fully phased in during 2019. To avoid limits on capital distributions and certain discretionary bonus payments we must meet the minimum ratio for adequately capitalized institutions plus the phased in buffer. The rule also raises the minimum ratio of tier 1 capital to risk-weighted assets from 4% to 6% and includes a minimum leverage ratio of 4% for all banking organizations. As to the quality of capital, the New Capital Rules emphasize common equity tier 1 capital, the most loss-absorbing form of capital, and implements strict eligibility criteria for regulatory capital instruments. The New Capital Rules also change the methodology for calculating risk-weighted assets to enhance risk sensitivity. Under the New Capital Rules our existing trust preferred securities are grandfathered as qualifying regulatory capital. We were subject to the New Capital Rules beginning on January 1, 2015, and as of December 31, 2016 and 2015, we exceeded all of the capital ratio requirements of the New Capital Rules.

It is against this backdrop that we discuss our results of operations and financial condition in 2016 as compared to earlier periods.

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RESULTS OF OPERATIONS

Summary. We recorded net income of $22.8 million, or $1.05 per diluted share, in 2016, net income of $20.0 million, or $0.86 per diluted share, in 2015, and net income of $18.0 million, or $0.77 per diluted share, in 2014.

KEY PERFORMANCE RATIOS

 
Year Ended December 31,
 
2016
2015
2014
Net income to
 
 
 
 
 
 
 
 
 
Average common equity
 
9.21
%
 
7.89
%
 
7.43
%
Average assets
 
0.92
 
 
0.86
 
 
0.80
 
Net income per common share
 
 
 
 
 
 
 
 
 
Basic
$
1.06
 
$
0.88
 
$
0.79
 
Diluted
 
1.05
 
 
0.86
 
 
0.77
 

Net interest income. Net interest income is the most important source of our earnings and thus is critical in evaluating our results of operations. Changes in our net interest income are primarily influenced by our level of interest-earning assets and the income or yield that we earn on those assets and the manner and cost of funding our interest-earning assets. Certain macro-economic factors can also influence our net interest income such as the level and direction of interest rates, the difference between short-term and long-term interest rates (the steepness of the yield curve) and the general strength of the economies in which we are doing business. Finally, risk management plays an important role in our level of net interest income. The ineffective management of credit risk and interest-rate risk in particular can adversely impact our net interest income.

Net interest income totaled $79.6 million during 2016, compared to $75.0 million and $73.3 million during 2015 and 2014, respectively. The increase in net interest income in 2016 compared to 2015 primarily reflects a $173.7 million increase in average interest-earning assets that was partially offset by a six basis point decrease in our tax equivalent net interest income as a percent of average interest-earning assets (the “net interest margin”).

The decline in our net interest margin is primarily due to the prolonged low interest rate environment that has pushed our average yield on loans lower.

Interest rates have generally been at extremely low levels since 2008 due primarily to the Federal Reserve Bank’s (“FRB”) monetary policies and its efforts to stimulate the U.S. economy. This very low interest rate environment has generally had an adverse impact on our interest income and net interest income. The FRB did move the target federal funds rate up by 0.25% in each of December of 2016 and 2015. Future changes in the target federal funds rate are uncertain; however, we anticipate that any upward movements in short-term interest rates will be gradual. Given the repricing characteristics of our interest-earning assets and interest-bearing liabilities (and our level of non-interest bearing demand deposits), we would expect that our net interest margin will generally benefit on a long-term basis from rising interest rates.

The increase in net interest income in 2015 compared to 2014 primarily reflects a $96.5 million increase in average interest-earning assets that was partially offset by a nine basis point decrease in our net interest margin.

Our net interest income is also impacted by our level of non-accrual loans. Average non-accrual loans totaled $10.9 million, $13.8 million and $17.9 million in 2016, 2015 and 2014, respectively.

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AVERAGE BALANCES AND RATES

 
2016
2015
2014
 
Average
Balance
Interest
Rate
Average
Balance
Interest
Rate
Average
Balance
Interest
Rate
 
(Dollars in thousands)
ASSETS
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Taxable loans
$
1,596,136
 
$
74,014
 
 
4.64
%
$
1,457,508
 
$
70,770
 
 
4.86
%
$
1,383,883
 
$
71,621
 
 
5.18
%
Tax-exempt loans (1)
 
3,763
 
 
220
 
 
5.85
 
 
3,972
 
 
246
 
 
6.19
 
 
4,889
 
 
310
 
 
6.34
 
Taxable securities
 
534,233
 
 
9,921
 
 
1.86
 
 
529,571
 
 
7,805
 
 
1.47
 
 
475,917
 
 
6,341
 
 
1.33
 
Tax-exempt securities (1)
 
54,390
 
 
1,917
 
 
3.52
 
 
34,039
 
 
1,388
 
 
4.08
 
 
40,200
 
 
1,510
 
 
3.76
 
Interest bearing cash and repurchase agreement
 
78,606
 
 
403
 
 
0.51
 
 
66,595
 
 
275
 
 
0.41
 
 
84,244
 
 
282
 
 
0.33
 
Other investments
 
15,474
 
 
792
 
 
5.12
 
 
17,171
 
 
925
 
 
5.39
 
 
23,252
 
 
1,118
 
 
4.81
 
Interest earning assets
 
2,282,602
 
 
87,267
 
 
3.82
 
 
2,108,856
 
 
81,409
 
 
3.86
 
 
2,012,385
 
 
81,182
 
 
4.03
 
Cash and due from banks
 
36,831
 
 
 
 
 
 
 
 
44,842
 
 
 
 
 
 
 
 
45,213
 
 
 
 
 
 
 
Other assets, net
 
155,778
 
 
 
 
 
 
 
 
166,363
 
 
 
 
 
 
 
 
182,099
 
 
 
 
 
 
 
Total assets
$
2,475,211
 
 
 
 
 
 
 
$
2,320,061
 
 
 
 
 
 
 
$
2,239,697
 
 
 
 
 
 
 
LIABILITIES
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Savings and interest- bearing checking
$
1,018,685
 
 
1,115
 
 
0.11
 
$
988,504
 
 
1,056
 
 
0.11
 
$
951,745
 
 
1,064
 
 
0.11
 
Time deposits
 
447,243
 
 
3,826
 
 
0.86
 
 
386,035
 
 
2,953
 
 
0.76
 
 
413,729
 
 
3,903
 
 
0.94
 
Other borrowings
 
47,058
 
 
1,941
 
 
4.12
 
 
47,842
 
 
1,847
 
 
3.86
 
 
60,225
 
 
2,332
 
 
3.87
 
Interest bearing liabilities
 
1,512,986
 
 
6,882
 
 
0.45
 
 
1,422,381
 
 
5,856
 
 
0.41
 
 
1,425,699
 
 
7,299
 
 
0.51
 
Non-interest bearing deposits
 
688,697
 
 
 
 
 
 
 
 
619,206
 
 
 
 
 
 
 
 
540,107
 
 
 
 
 
 
 
Other liabilities
 
26,439
 
 
 
 
 
 
 
 
24,840
 
 
 
 
 
 
 
 
31,247
 
 
 
 
 
 
 
Shareholders’ equity
 
247,089
 
 
 
 
 
 
 
 
253,634
 
 
 
 
 
 
 
 
242,644
 
 
 
 
 
 
 
Total liabilities and shareholders’ equity
$
2,475,211
 
 
 
 
 
 
 
$
2,320,061
 
 
 
 
 
 
 
$
2,239,697
 
 
 
 
 
 
 
Net interest income
 
 
 
$
80,385
 
 
 
 
 
 
 
$
75,553
 
 
 
 
 
 
 
$
73,883
 
 
 
 
Net interest income as a percent of average interest earning assets
 
 
 
 
 
 
 
3.52
%
 
 
 
 
 
 
 
3.58
%
 
 
 
 
 
 
 
3.67
%
(1) Interest on tax-exempt loans and securities is presented on a fully tax equivalent basis assuming a marginal tax rate of 35%.

RECONCILIATION OF NET INTEREST MARGIN, FULLY TAXABLE EQUIVALENT (“FTE”)

 
Year Ended December 31,
 
2016
2015
2014
 
(Dollars in thousands)
Net interest income
$
79,641
 
$
74,986
 
$
73,256
 
Add: taxable equivalent adjustment
 
744
 
 
567
 
 
627
 
Net interest income - taxable equivalent
$
80,385
 
$
75,553
 
$
73,883
 
Net interest margin (GAAP)
 
3.49
%
 
3.56
%
 
3.64
%
Net interest margin (FTE)
 
3.52
%
 
3.58
%
 
3.67
%

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CHANGE IN NET INTEREST INCOME

 
2016 compared to 2015
2015 compared to 2014
 
Volume
Rate
Net
Volume
Rate
Net
 
(In thousands)
Increase (decrease) in interest income (1)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Taxable loans
$
6,526
 
$
(3,282
)
$
3,244
 
$
3,701
 
$
(4,552
)
$
(851
)
Tax-exempt loans (2)
 
(13
)
 
(13
)
 
(26
)
 
(57
)
 
(7
)
 
(64
)
Taxable securities
 
69
 
 
2,047
 
 
2,116
 
 
754
 
 
710
 
 
1,464
 
Tax-exempt securities (2)
 
738
 
 
(209
)
 
529
 
 
(244
)
 
122
 
 
(122
)
Interest bearing cash and repurchase agreement
 
55
 
 
73
 
 
128
 
 
(66
)
 
59
 
 
(7
)
Other investments
 
(88
)
 
(45
)
 
(133
)
 
(316
)
 
123
 
 
(193
)
Total interest income
 
7,287
 
 
(1,429
)
 
5,858
 
 
3,772
 
 
(3,545
)
 
227
 
Increase (decrease) in interest expense (1)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Savings and interest bearing checking
 
33
 
 
26
 
 
59
 
 
40
 
 
(48
)
 
(8
)
Time deposits
 
500
 
 
373
 
 
873
 
 
(248
)
 
(702
)
 
(950
)
Other borrowings
 
(31
)
 
125
 
 
94
 
 
(478
)
 
(7
)
 
(485
)
Total interest expense
 
502
 
 
524
 
 
1,026
 
 
(686
)
 
(757
)
 
(1,443
)
Net interest income
$
6,785
 
$
(1,953
)
$
4,832
 
$
4,458
 
$
(2,788
)
$
1,670
 
(1) The change in interest due to changes in both balance and rate has been allocated to change due to balance and change due to rate in proportion to the relationship of the absolute dollar amounts of change in each.
(2) Interest on tax-exempt loans and securities is presented on a fully tax equivalent basis assuming a marginal tax rate of 35%.

COMPOSITION OF AVERAGE INTEREST EARNING ASSETS AND INTEREST BEARING LIABILITIES

 
Year Ended December 31,
 
2016
2015
2014
As a percent of average interest earning assets
 
 
 
 
 
 
 
 
 
Loans
 
70.1
%
 
69.3
%
 
69.0
%
Other interest earning assets
 
29.9
 
 
30.7
 
 
31.0
 
Average interest earning assets
 
100.0
%
 
100.0
%
 
100.0
%
Savings and NOW
 
44.6
%
 
46.9
%
 
47.3
%
Time deposits
 
19.6
 
 
18.2
 
 
19.9
 
Brokered CDs
 
—
 
 
0.1
 
 
0.6
 
Other borrowings
 
2.1
 
 
2.2
 
 
3.0
 
Average interest bearing liabilities
 
66.3
%
 
67.4
%
 
70.8
%
Earning asset ratio
 
92.2
%
 
90.9
%
 
89.9
%
Free-funds ratio (1)
 
33.7
 
 
32.6
 
 
29.2
 
(1) Average interest earning assets less average interest bearing liabilities.

Provision for loan losses. The provision for loan losses was a credit of $1.3 million, $2.7 million and $3.1 million during 2016, 2015 and 2014, respectively. The provision reflects our assessment of the allowance for loan losses taking into consideration factors such as loan mix, levels of non-performing and classified loans and loan net charge-offs. While we use relevant information to recognize losses on loans, additional provisions for related losses may be necessary based on changes in economic conditions, customer circumstances and other credit risk factors. See “Portfolio Loans and asset quality” for a discussion of the various components of the allowance for loan losses and their impact on the provision for loan losses.

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Non-interest income. Non-interest income is a significant element in assessing our results of operations. We regard net gains on mortgage loans as a recurring source of revenue but they are quite cyclical and thus can be volatile.

Non-interest income totaled $42.3 million during 2016 compared to $40.1 million and $38.8 million during 2015 and 2014, respectively. The components of non-interest income are as follows:

NON-INTEREST INCOME

 
Year Ended December 31,
 
2016
2015
2014
 
(In thousands)
Service charges on deposit accounts
$
12,406
 
$
12,389
 
$
13,446
 
Interchange income
 
7,938
 
 
8,481
 
 
8,164
 
Net gains (losses) on assets
 
 
 
 
 
 
 
 
 
Mortgage loans
 
10,566
 
 
7,448
 
 
5,628
 
Securities
 
563
 
 
20
 
 
329
 
Other than temporary impairment loss on securities:
 
 
 
 
 
 
 
 
 
Total impairment loss
 
—
 
 
—
 
 
(9
)
Loss recognized in other comprehensive income (loss)
 
—
 
 
—
 
 
—
 
Net impairment loss recognized in earnings
 
—
 
 
—
 
 
(9
)
Mortgage loan servicing, net
 
2,222
 
 
1,751
 
 
791
 
Investment and insurance commissions
 
1,647
 
 
1,827
 
 
1,814
 
Bank owned life insurance
 
1,124
 
 
1,282
 
 
1,371
 
Title insurance fees
 
1,187
 
 
1,156
 
 
995
 
Net gain on branch sale
 
—
 
 
1,193
 
 
—
 
Gain on extinguishment of debt
 
—
 
 
—
 
 
500
 
Other
 
4,645
 
 
4,583
 
 
5,746
 
Total non-interest income
$
42,298
 
$
40,130
 
$
38,775
 

Service charges on deposit accounts totaled $12.4 million during both 2016 and 2015 and was $13.4 million during 2014. Although service charges were relatively unchanged in 2016 as compared to 2015, over the last few years, such service charges had been decreasing, principally due to a decline in non-sufficient funds (“NSF”) occurrences and related NSF fees. We believe the long-term decline in NSF occurrences is due to our customers managing their finances more closely and having real-time access to deposit account information through electronic channels allowing them to reduce NSF activity and avoid the associated fees.

Interchange income totaled $7.9 million in 2016 compared to $8.5 million in 2015 and $8.2 million in 2014. The decrease in interchange income in 2016 as compared to 2015 primarily results from lower incentives under our Debit Brand Agreement with MasterCard. In addition, although transaction volume increased 1.5% year-over-year, interchange revenue per transaction declined by 3.1%, primarily due to a higher mix of debit (PIN-based) versus credit (signature-based) transactions. The increase in interchange income in 2015 compared to 2014 primarily results from the new Debit Brand Agreement with MasterCard that was executed in January 2014. We began converting our debit card base to MasterCard in June 2014 and completed the conversion in September 2014. Certain volume incentives under the new Debit Brand Agreement began to abate in the fourth quarter of 2015.

We realized net gains of $10.6 million on mortgage loans during 2016, compared to $7.4 million and $5.6 million during 2015 and 2014 respectively. The volume of loans sold is dependent upon our ability to originate mortgage loans as well as the demand for fixed-rate obligations and other loans that we choose to not put into our portfolio because of our established interest-rate risk parameters. (See “Portfolio Loans and asset quality.”) Net gains on mortgage loans are also dependent upon economic and competitive factors as well as our ability to effectively manage exposure to changes in interest rates and thus can often be a volatile part of our overall revenues.

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MORTGAGE LOAN ACTIVITY

 
Year Ended December 31,
 
2016
2015
2014
 
(Dollars in thousands)
Mortgage loans originated
$
428,249
 
$
336,618
 
$
265,494
 
Mortgage loans sold
 
313,985
 
 
281,494
 
 
223,580
 
Net gains on mortgage loans
 
10,566
 
 
7,448
 
 
5,628
 
Net gains as a percent of mortgage loans sold (“Loan Sales Margin”)
 
3.37
%
 
2.65
%
 
2.52
%
Fair value adjustments included in the Loan Sales Margin
 
0.12
 
 
0.16
 
 
0.01
 

Net gains on mortgage loans have increased over the past two years due primarily to decreases in mortgage loan interest rates during parts of 2016 and 2015 that resulted in an increase in mortgage loan refinance volumes as well as an improving housing market which has resulted in an increase in purchase money mortgage origination volume.

Net gains as a percentage of mortgage loans sold (our “Loan Sales Margin”) are impacted by several factors including competition and the manner in which the loan is sold. Gains on mortgage loans are also impacted by recording fair value accounting adjustments. Excluding these fair value accounting adjustments, the Loan Sales Margin would have been 3.25% in 2016, 2.49% in 2015 and 2.51% in 2014. The higher Loan Sales Margins in 2016 as compared to 2015 and 2014, was principally due to more favorable competitive conditions including wider primary-to-secondary market pricing spreads during the first ten months of 2016. However, during the last two months of 2016, mortgage loan interest rates rose by approximately 0.75% and Loan Sales Margins contracted considerably due to competitive factors. In general, as overall industry-wide mortgage loan origination levels drop, pricing becomes more competitive. The changes in the fair value accounting adjustments are primarily due to changes in the amount of commitments to originate mortgage loans for sale during each period.

During the last quarter of 2016 and the first two months of 2017, we significantly expanded our mortgage-banking operations by adding over fifty new employees and opening five new loan production offices (Ann Arbor, Brighton, Traverse City and Troy, Michigan and Columbus, Ohio). We are also in the process of opening two additional loan production offices (Dearborn, Michigan and Fairlawn, Ohio). We expect this business expansion to add to net gains on mortgage loans and on a longer-term basis, accelerate the growth of portfolio mortgage loans and mortgage loans serviced for others, leading to increased interest and mortgage loan servicing income. However, this expansion will also increase non-interest expenses, particularly compensation and employee benefits and occupancy. In addition, due to higher interest rates, we expect mortgage loan refinance volume to decline in 2017 on an industry wide basis. It is important to our future results of operations that we effectively and successfully manage this business expansion.

GAINS AND LOSSES ON SECURITIES

 
Year Ended December 31,
 
Proceeds
Gains (1)
Losses (2)
Net
 
(In thousands)
2016
$
64,103
 
$
616
 
$
53
 
$
563
 
2015
 
12,037
 
 
75
 
 
55
 
 
20
 
2014
 
14,633
 
 
624
 
 
304
 
 
320
 
(1) Gains in 2016 include $0.262 million related to an increase in the fair value of trading securities and 2014 includes $0.295 million relating to a U.S. Treasury short position.
(2) Losses in 2015 and 2014 includes $0.055 million and $0.295 million, respectively related to a decrease in the fair value of trading securities and 2014 includes $0.009 million of other than temporary impairment charges.

We generated net gains on securities of $0.6 million in 2016, and $0.02 million and $0.3 million in 2015 and 2014, respectively. The 2016 net gain on securities was due primarily to a $0.3 million increase in the fair value of trading securities and $64.1 million of securities sales that produced net gains of $0.3 million. The 2015 net gain on securities was due primarily to the sales of U.S. agency residential mortgage-backed securities that were partially offset by a $0.06 million decline in the fair value of trading securities. The 2014 net gain on securities was primarily

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due to the sales of U.S. Government agency securities and municipal securities as well as fair value adjustments on a U.S. treasury short sale position that were partially offset by a $0.3 million decline in the fair value of trading securities.

We recorded no net impairment losses in 2016 or 2015 as compared to a net impairment loss of $0.01 million in 2014, related to other than temporary impairment of securities available for sale. The 2014 impairment charge related to private label residential mortgage-backed securities.

Mortgage loan servicing generated net earnings of $2.2 million, $1.8 million and $0.8 million in 2016, 2015 and 2014, respectively. These yearly comparative variances are primarily due to changes in the valuation allowance on capitalized mortgage loan servicing rights and the level of amortization of this asset. The period end valuation allowance is based on the valuation of the mortgage loan servicing portfolio and the amortization is primarily impacted by prepayment activity. The changes in the valuation allowance are principally due to changes in the estimated future prepayment rates being used in the period end valuations.

CAPITALIZED MORTGAGE LOAN SERVICING RIGHTS

 
2016
2015
2014
 
(In thousands)
Balance at January 1,
$
12,436
 
$
12,106
 
$
13,710
 
Originated servicing rights capitalized
 
3,119
 
 
2,697
 
 
1,823
 
Amortization
 
(2,850
)
 
(2,868
)
 
(2,509
)
Change in valuation allowance
 
966
 
 
501
 
 
(918
)
Balance at December 31,
$
13,671
 
$
12,436
 
$
12,106
 
Valuation allowance at December 31,
$
2,306
 
$
3,272
 
$
3,773
 

At December 31, 2016, we were servicing approximately $1.66 billion in mortgage loans for others on which servicing rights have been capitalized. This servicing portfolio had a weighted average coupon rate of 4.20% and a weighted average service fee of approximately 25.6 basis points. Remaining capitalized mortgage loan servicing rights at December 31, 2016 totaled $13.7 million, representing approximately 82 basis points on the related amount of mortgage loans serviced for others. The capitalized mortgage loan servicing rights had an estimated fair market value of $14.2 million at December 31, 2016. As of January 1, 2017, we elected the fair value measurement method for our mortgage loan servicing rights (in lieu of the amortization method).

Investment and insurance commissions declined to $1.6 million in 2016, as compared to $1.8 million in both 2015 and 2014. The decline in 2016 was due primarily to open sales positions during part of the year.

We earned $1.1 million, $1.3 million and $1.4 million in 2016, 2015 and 2014, respectively, on our separate account bank owned life insurance principally as a result of increases in the cash surrender value. Our separate account is primarily invested in agency mortgage-backed securities and managed by PIMCO. The crediting rate (on which the earnings are based) reflects the performance of the separate account. The total cash surrender value of our bank owned life insurance was $54.0 million and $54.4 million at December 31, 2016 and 2015, respectively.

Title insurance fees totaled $1.2 million in both 2016 and 2015 as compared to $1.0 million in 2014. The fluctuation in title insurance fees is primarily a function of the level of mortgage loans (particularly refinances) that we originated.

On April 29, 2015 the Bank entered into a Purchase and Assumption Agreement (“PAA”) with Isabella Bank (based in Mt. Pleasant, Michigan). Pursuant to the PAA, on August 28, 2015, we sold the fixed assets, real property and certain other assets of our bank branch located in Midland, Michigan (the “Midland Branch”) to Isabella Bank. The deposit liabilities of the Midland Branch were assumed by Isabella Bank. Under the terms of the PAA, Isabella Bank paid a premium of $0.6 million (which was equal to 6.0% of the average deposit liabilities of $9.7 million based on the 20-day average ending two business days prior to the closing date of August 28, 2015) and $0.85 million for the real property and fixed assets (including the ATM). The real property and the fixed assets had a net book value of approximately $0.2 million as of August 28, 2015. We recorded a net gain of $1.2 million in the third quarter of 2015 on the sale of the Midland Branch.

On December 1, 2014, we entered into a Securities Purchase Agreement with EJF Capital LLC. Under the terms of this agreement, we purchased 5,000 shares of trust preferred securities (liquidation amount of $1,000 per security)

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that were issued by IBC Capital Finance IV, a special purpose entity whose common stock we own. The trust preferred securities have been retired along with certain related common stock issued by IBC Capital Finance IV and subordinated debentures issued by us. We paid $4.5 million for the trust preferred securities that had a par value of $5.0 million, as well as $0.033 million in accrued and unpaid interest. We recorded a gain on the extinguishment of debt of $0.5 million in the fourth quarter of 2014.

Other non-interest income totaled $4.6 million in both 2016 and 2015 as compared to $5.7 million in 2014. The decrease in 2016 and 2015 as compared to 2014 is primarily due to a decline in rental income on other real estate due to the sales of income-producing properties.

Non-interest expense. Non-interest expense is an important component of our results of operations. We strive to efficiently manage our cost structure.

Non-interest expense totaled $90.3 million in 2016, $88.5 million in 2015, and $90.0 million in 2014. The components of non-interest expense are as follows:

NON-INTEREST EXPENSE

 
Year ended December 31,
 
2016
2015
2014
 
(In thousands)
Compensation
$
33,991
 
$
33,346
 
$
33,833
 
Performance-based compensation
 
6,955
 
 
6,732
 
 
5,154
 
Payroll taxes and employee benefits
 
8,633
 
 
8,108
 
 
8,234
 
Compensation and employee benefits
 
49,579
 
 
48,186
 
 
47,221
 
Occupancy, net
 
8,023
 
 
8,369
 
 
8,912
 
Data processing
 
7,952
 
 
7,944
 
 
7,532
 
Furniture, fixtures and equipment
 
3,912
 
 
3,892
 
 
4,137
 
Communications
 
3,142
 
 
2,957
 
 
2,926
 
Loan and collection
 
2,512
 
 
3,609
 
 
5,392
 
Litigation settlement expense
 
2,300
 
 
—
 
 
—
 
Advertising
 
1,856
 
 
2,121
 
 
2,193
 
Legal and professional
 
1,742
 
 
2,013
 
 
1,969
 
Interchange expense
 
1,111
 
 
1,125
 
 
1,291
 
FDIC deposit insurance
 
1,049
 
 
1,366
 
 
1,567
 
Credit card and bank service fees
 
791
 
 
797
 
 
946
 
Supplies
 
728
 
 
809
 
 
993
 
Amortization of intangible assets
 
347
 
 
347
 
 
536
 
Loss on sale of payment plan business
 
320
 
 
—
 
 
—
 
Net (gains) losses on other real estate and repossessed assets
 
250
 
 
(180
)
 
(500
)
Provision (credit) for loss reimbursement on sold loans
 
30
 
 
(59
)
 
(466
)
Other
 
4,703
 
 
5,154
 
 
5,302
 
Total non-interest expense
$
90,347
 
$
88,450
 
$
89,951
 

Compensation expense, which is primarily salaries, totaled $34.0 million, $33.3 million and $33.8 million in 2016, 2015 and 2014, respectively. The increase in 2016 as compared to 2015 is primarily due to annual merit based salary increases. 2016 average total full-time equivalent employee levels were unchanged compared to 2015. The decrease in 2015 as compared to 2014 is due to a decline in total full-time equivalent employees related to branch consolidations or closings and other staffing reductions. 2015 average total full-time equivalent employee levels fell by 4.1% compared to 2014.

Performance-based compensation expense totaled $7.0 million, $6.7 million and $5.2 million in 2016, 2015 and 2014, respectively. The increases in 2016 as compared to 2015, and in 2015 as compared to 2014, are both primarily related to higher compensation under our incentive compensation plans based on our improved financial performance.

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We maintain performance-based compensation plans. In addition to commissions and cash incentive awards, such plans include an ESOP and a long-term equity based incentive plan. The amount of expense recognized in 2016, 2015 and 2014 for share-based awards under our long-term equity based incentive plan was $1.5 million, $1.4 million and $1.0 million, respectively. In 2016, 2015 and 2014, there were new grants of restricted stock and performance share awards.

Payroll taxes and employee benefits expense totaled $8.6 million, $8.1 million and $8.2 million in 2016, 2015 and 2014, respectively. The increase in 2016 as compared to 2015 is primarily due to a $0.2 million increase in our 401(k) plan match and a $0.2 million increase in employee training costs (primarily sales training). The decrease in 2015 as compared to 2014 is primarily due to a $0.3 million decrease in health insurance costs that was partially offset by a $0.2 million increase in the 401(k) match. In 2014, we increased our 401(k) plan match from 1% to 2% of eligible compensation. In 2015, we added auto-enrollment to our 401(k) plan. In 2016, we increased our 401(k) plan match from 2% to 3% of eligible compensation.

Occupancy expenses, net, totaled $8.0 million, $8.4 million and $8.9 million in 2016, 2015 and 2014, respectively. The decrease in 2016 as compared to 2015 is primarily due to a decline in utilities and real estate property taxes due to branch closings or sales that took place during 2015 and a decline in leasehold improvement depreciation expense at Mepco related to its former Chicago location. The decrease in 2015 as compared to 2014 is primarily due to branch consolidations or closings and lower snow removal costs.

Data processing expenses totaled $8.0 million, $7.9 million, and $7.5 million in 2016, 2015 and 2014, respectively. Although data processing expenses were relatively unchanged in 2016 as compared to 2015 on a consolidated basis, such expenses declined by $0.6 million at Mepco (due primarily to a decrease in software amortization), but this decline was offset by a comparable increase in such expenses at the Bank (various new or expanded electronic banking services and network security costs). The increase in 2015 as compared to 2014 is due primarily to the addition of new products and services (desktop software, sales management software and a new mortgage loan origination platform) as well as increased costs due to growth in mobile banking usage.

Furniture, fixtures and equipment expense was relatively unchanged in 2016 as compared to 2015 and declined by $0.2 million in 2015 from 2014. The decline in 2015 was due primarily to the closing or consolidation of certain branch offices.

Communications expense increased by $0.2 million in 2016 as compared to 2015 and was relatively unchanged in 2015 as compared to 2014. The increase in 2016 as compared to 2015 was due primarily to an increase in postage costs principally as a result of mailing new Chip-enabled debit cards to our entire debit card customer base.

Loan and collection expenses primarily reflect costs related to the management and collection of non-performing loans and other problem credits. These expenses have declined steadily during the past several years primarily due to decreases in non-performing loans, new loan defaults and watch/problem credits.

We incurred a $2.3 million expense in 2016 for the settlement of a litigation matter as described earlier under “Recent Developments.”

Advertising expense totaled $1.9 million, $2.1 million, and $2.2 million in 2016, 2015 and 2014, respectively. The decrease in 2016 as compared to 2015 was primarily due to declines in outdoor (billboard) advertising, television and radio advertising and market research that were partially offset by an increase in checking account acquisition costs (principally direct mail). The slight decrease in 2015 as compared to 2014 is due primarily to a reduction in outdoor advertising.

Legal and professional fees totaled $1.7 million, $2.0 million, and $2.0 million in 2016, 2015 and 2014, respectively. The decrease in 2016 as compared to 2015 was due primarily to a $0.4 million decline in such costs at Mepco resulting from the resolution of certain litigation matters and a related reduction in legal fees.

Interchange expense primarily represents fees paid to our core information systems processor and debit card licensor related to debit card and ATM transactions. This expense was relatively unchanged in 2016 as compared to 2015. The decrease in this expense in 2015 as compared to 2014 is primarily due to the impact of our new seven-year core data processing contract that we executed in March 2014.

FDIC deposit insurance expense totaled $1.0 million, $1.4 million, and $1.6 million in 2016, 2015 and 2014, respectively. The decline in 2016 as compared to 2015 principally results from the FDIC Deposit Insurance Fund

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reserve ratio reaching a 1.15% reserve ratio at June 30, 2016, which triggered a new assessment method and generally lower deposit insurance premiums for banks with less than $10 billion in assets. The decline in 2015 as compared to 2014 reflected a reduction in the Bank’s risk based premium rate due to our improved financial metrics.

Credit card and bank service fees primarily relate to card processing fees incurred by Mepco in its payment plan processing business and variations in this expense are principally due to changes in the number of payment plans being administered by Mepco.

Supplies expense has declined over the past two years consistent with our cost reduction initiatives and the smaller size of the organization resulting from the closing or consolidation of branches.

The amortization of intangible assets primarily relates to branch acquisitions and the amortization of the deposit customer relationship value, including core deposit value, which was acquired in connection with those acquisitions. We had remaining unamortized intangible assets of $1.9 million and $2.3 million at December 31, 2016 and 2015 respectively. See note #7 to the Consolidated Financial Statements for a schedule of future amortization of intangible assets.

We incurred a $0.3 million loss in 2016 on the expected sale of Mepco’s payment plan business as described earlier under “Recent Developments.”

Net (gains) losses on other real estate and repossessed assets represent the gain or loss on the sale or additional write downs on these assets subsequent to the transfer of the asset from our loan portfolio. This transfer occurs at the time we acquire the collateral that secured the loan. At the time of acquisition, the other real estate or repossessed asset is valued at fair value, less estimated costs to sell, which becomes the new basis for the asset. Any write-downs at the time of acquisition are charged to the allowance for loan losses. The net loss of $0.25 million in 2016 is primarily due to $0.46 million of write-downs on a group of commercial income-producing properties. These properties ($2.9 million balance in other real estate at December 31, 2016) are now under contract for sale. We expect this sale to close in the first half of 2017. The net gains of $0.2 million and $0.5 million in 2015 and 2014, respectively, primarily reflect greater stability in real estate prices, with many markets even experiencing price increases.

The provision for loss reimbursement on sold loans was an expense of $0.03 million in 2016 compared to a credit of $0.06 million and $0.5 million in 2015 and 2014, respectively. This provision represents our estimate of incurred losses related to mortgage loans that we have sold to investors (primarily Fannie Mae, Freddie Mac and Ginnie Mae). The credit provisions in 2015 and 2014 are due primarily to the reduction or rescission of certain loss reimbursement requests that had been pending and accrued for in earlier periods. Since we sell mortgage loans without recourse, loss reimbursements only occur in those instances where we have breached a representation or warranty or other contractual requirement related to the loan sale. The reserve for loss reimbursements on sold mortgage loans totaled $0.56 million and $0.53 million at December 31, 2016 and 2015, respectively. This reserve is included in accrued expenses and other liabilities in our Consolidated Statements of Financial Condition. This reserve is based on an analysis of mortgage loans that we have sold which are further categorized by delinquency status, loan to value, and year of origination. The calculation includes factors such as probability of default, probability of loss reimbursement (breach of representation or warranty) and estimated loss severity. The reserve levels at December 31, 2016 and 2015 also reflect the resolution of the mortgage loan origination years of 2000 to 2008 with Fannie Mae and Freddie Mac. We believe that the amounts that we have accrued for incurred losses on sold mortgage loans are appropriate given our analyses. However, future losses could exceed our current estimate.

Other non-interest expenses totaled $4.7 million, $5.2 million, and $5.3 million in 2016, 2015 and 2014, respectively. The $0.5 million decrease in 2016 as compared to 2015 is primarily due to declines in vehicle service contract counterparty contingency expense, costs related to unfunded lending commitments and fraud costs related to deposit account and debit card activities.

Income tax expense. We recorded an income tax expense of $10.1 million, $9.4 million and $7.2 million in 2016, 2015 and 2014, respectively.

Our actual federal income tax expense is different than the amount computed by applying our statutory income tax rate to our income before income tax primarily due to tax-exempt interest income and tax-exempt income from the increase in the cash surrender value on life insurance.

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In addition, 2016 included a $0.3 million income tax benefit resulting from the adoption of Financial Accounting Standards Board Accounting Standards Update 2016-09 “Compensation – Stock Compensation (718) Improvements to Employee Share-Based Payment Accounting.” See note #1 to the Consolidated Financial Statements. Also, 2014 income tax expense was reduced by a credit of approximately $0.7 million due to a true-up of the amount of unrecognized tax benefits relative to certain net operating loss carryforwards and the reversal of a valuation allowance on a capital loss carryforward that was believed to not be more likely than not to be realized prior to a strategy executed during the second quarter of 2014 that generated capital gains.

We assess whether a valuation allowance should be established against our deferred tax assets based on the consideration of all available evidence using a “more likely than not” standard. The ultimate realization of this asset is primarily based on generating future income. We concluded at December 31, 2016, 2015 and 2014, that the realization of substantially all of our deferred tax assets continues to be more likely than not.

We did maintain a valuation allowance against our deferred tax assets of approximately $1.1 million at December 31, 2016 and 2015 and $1.0 million at December 31, 2014. This valuation allowance on our deferred tax assets primarily relates to state income taxes at Mepco. In this instance, we determined that the future realization of these particular deferred tax assets was not more likely than not. This conclusion in 2016 was based on the pending sale of Mepco’s payment plan business and in 2015 and 2014 was primarily based on the uncertainty of Mepco’s future earnings attributable to particular states (given the various apportionment criteria) and the significant reduction in the size of Mepco’s business.

Business segments. Prior to 2016, we reported on two segments: Independent Bank and Mepco. However, given the significant reduction in the size of Mepco’s business and its relative immateriality, we have now eliminated any separate segment reporting on Mepco. Rather, we evaluate the operations of the organization as one single unit.

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FINANCIAL CONDITION

Summary. Our total assets increased to $2.55 billion at December 31, 2016, compared to $2.41 billion at December 31, 2015, primarily due to increases in securities available for sale and loans. Loans, excluding loans held for sale (“Portfolio Loans”), totaled $1.61 billion at December 31, 2016, an increase of 6.2% from $1.52 billion at December 31, 2015. (See “Portfolio Loans and asset quality”). Not included in Portfolio Loans at December 31, 2016 are $30.6 million of payment plan receivables and $0.8 million of commercial loans. These balances are included in “Payment plan receivables and other assets held for sale” in our December 31, 2016 Consolidated Statement of Financial Condition. They are classified as held for sale due to the pending sale of our Mepco payment plan business as described above under “Recent Developments.”

Deposits totaled $2.23 billion at December 31, 2016, compared to $2.09 billion at December 31, 2015. The increase in deposits during 2016 is primarily due to growth in checking, savings and time account balances.

Securities. We maintain diversified securities portfolios, which include obligations of U.S. government-sponsored agencies, securities issued by states and political subdivisions, residential and commercial mortgage-backed securities, asset-backed securities, corporate securities and trust preferred securities. We regularly evaluate asset/liability management needs and attempt to maintain a portfolio structure that provides sufficient liquidity and cash flow. Except as discussed below, we believe that the unrealized losses on securities available for sale are temporary in nature and are expected to be recovered within a reasonable time period. We believe that we have the ability to hold securities with unrealized losses to maturity or until such time as the unrealized losses reverse. (See “Asset/liability management.”)

Securities available for sale increased during 2016 due primarily to the purchase of asset-backed securities, securities issued by states and political subdivisions and corporate securities. The securities were purchased to utilize funds generated from the increase in total deposits. (See “Deposits and borrowings” and “Liquidity and capital resources.”)

Our portfolio of securities available for sale is reviewed quarterly for impairment in value. In performing this review, management considers (1) the length of time and extent that fair value has been less than cost, (2) the financial condition and near term prospects of the issuer, (3) the impact of changes in market interest rates on the market value of the security and (4) an assessment of whether we intend to sell, or it is more likely than not that we will be required to sell, a security in an unrealized loss position before recovery of its amortized cost basis. For securities that do not meet these recovery criteria, the amount of impairment recognized in earnings is limited to the amount related to credit losses, while impairment related to other factors is recognized in other comprehensive income (loss).

We recorded net impairment losses related to other than temporary impairment on securities available for sale of zero, zero, and $0.009 million, in 2016, 2015 and 2014, respectively. The 2014 net other than temporary impairment charge was all related to private label residential mortgage-backed securities. In this instance, we believed that the decline in value was directly due to matters other than changes in interest rates, was not expected to be recovered within a reasonable timeframe based upon available information and was therefore other than temporary in nature. (See “Non-interest income” and “Asset/liability management.”)

SECURITIES

 
 
Unrealized
 
 
Amortized
Cost
Gains
Losses
Fair
Value
 
(In thousands)
Securities available for sale
 
 
 
 
 
 
 
 
 
 
 
 
December 31, 2016
$
615,709
 
$
2,548
 
$
7,641
 
$
610,616
 
December 31, 2015
 
585,851
 
 
3,152
 
 
3,519
 
 
585,484
 

Portfolio Loans and asset quality. In addition to the communities served by our Bank branch network, our principal lending markets also include nearby communities and metropolitan areas. Subject to established underwriting criteria, we also may participate in commercial lending transactions with certain non-affiliated banks and make whole loan purchases from other financial institutions. In August 2016 and December 2015, we purchased

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$14.8 million and $32.6 million, respectively, of single-family residential fixed rate mortgage loans from other Michigan-based financial institutions. These mortgage loans were all on properties located in Michigan. At December 31, 2016, the remaining balance on these purchased mortgage loans was $38.9 million.

The senior management and board of directors of our Bank retain authority and responsibility for credit decisions and we have adopted uniform underwriting standards. Our loan committee structure and the loan review process attempt to provide requisite controls and promote compliance with such established underwriting standards. However, there can be no assurance that our lending procedures and the use of uniform underwriting standards will prevent us from incurring significant credit losses in our lending activities.

We generally retain loans that may be profitably funded within established risk parameters. (See “Asset/liability management.”) As a result, we may hold adjustable-rate conventional and fixed rate jumbo mortgage loans as Portfolio Loans, while 15- and 30-year, fixed-rate non-jumbo mortgage loans are generally sold to mitigate exposure to changes in interest rates. (See “Non-interest income.”)

LOAN PORTFOLIO COMPOSITION

 
December 31,
 
2016
2015
 
(In thousands)
Real estate (1)
 
 
 
 
 
 
Residential first mortgages
$
453,348
 
$
432,215
 
Residential home equity and other junior mortgages
 
105,550
 
 
106,297
 
Construction and land development
 
77,287
 
 
62,629
 
Other (2)
 
525,748
 
 
498,706
 
Consumer
 
234,632
 
 
193,350
 
Commercial
 
206,607
 
 
180,424
 
Agricultural
 
5,076
 
 
6,830
 
Payment plan receivables (3)
 
—
 
 
34,599
 
Total loans
$
1,608,248
 
$
1,515,050
 
(1) Includes both residential and non-residential commercial loans secured by real estate.
(2) Includes loans secured by multi-family residential and non-farm, non-residential property.
(3) Payment plan receivables were reclassified to held for sale at December 31, 2016. See “Recent Developments”.

Future growth of overall Portfolio Loans is dependent upon a number of competitive and economic factors. Further, it is our desire to reduce or restrict certain loan categories for risk management reasons.

NON-PERFORMING ASSETS (1)

 
December 31,
 
2016
2015
2014
 
(Dollars in thousands)
Non-accrual loans
$
13,364
 
$
10,607
 
$
15,231
 
Loans 90 days or more past due and still accruing interest
 
—
 
 
116
 
 
7
 
Total non-performing loans
 
13,364
 
 
10,723
 
 
15,238
 
Other real estate and repossessed assets
 
5,004
 
 
7,150
 
 
6,454
 
Total non-performing assets
$
18,368
 
$
17,873
 
$
21,692
 
 
 
 
 
 
 
 
 
 
 
As a percent of Portfolio Loans
 
 
 
 
 
 
 
 
 
Non-performing loans
 
0.83
%
 
0.71
%
 
1.08
%
Allowance for loan losses
 
1.26
 
 
1.49
 
 
1.84
 
Non-performing assets to total assets
 
0.72
 
 
0.74
 
 
0.96
 
Allowance for loan losses as a percent of non-performing loans
 
151.41
 
 
210.48
 
 
170.56
 
(1) Excludes loans classified as “troubled debt restructured” that are performing and vehicle service contract counterparty receivables, net.

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TROUBLED DEBT RESTRUCTURINGS

 
December 31, 2016
 
Commercial
Retail
Total
 
(In thousands)
Performing TDR’s
$
10,560
 
$
59,726
 
$
70,286
 
Non-performing TDR’s (1)
 
3,565
 
 
4,071
(2)
 
7,636
 
Total
$
14,125
 
$
63,797
 
$
77,922
 
 
December 31, 2015
 
Commercial
Retail
Total
 
(In thousands)
Performing TDR’s
$
13,318
 
$
68,194
 
$
81,512
 
Non-performing TDR’s (1)
 
3,041
 
 
3,777
(2)
 
6,818
 
Total
$
16,359
 
$
71,971
 
$
88,330
 
(1) Included in non-performing loans table above.
(2) Also includes loans on non-accrual at the time of modification until six payments are received on a timely basis.

Non-performing loans totaled $13.4 million, $10.7 million and $15.2 million at December 31, 2016, 2015 and 2014, respectively. The increase in 2016 as compared to 2015 is primarily due to the default of one commercial loan relationship and one mortgage loan relationship in the fourth quarter. The decline in 2015 as compared to 2014 is principally due to declines in non-performing commercial loans, residential mortgage loans and consumer loans. These declines reflected reduced levels of new loan defaults as well as loan charge-offs, pay-offs, negotiated transactions, and the migration of loans into other real estate. In general, improving economic conditions in our market areas, as well as our collection and resolution efforts, have resulted in modest levels of non-performing loans over the past three years. However, we are still experiencing some loan defaults, particularly related to commercial loans secured by income-producing property and mortgage loans secured by resort/vacation property.

Non-performing loans exclude performing loans that are classified as troubled debt restructurings (“TDRs”). Performing TDRs totaled $70.3 million, or 4.4% of total Portfolio Loans, and $81.5 million, or 5.4% of total Portfolio Loans, at December 31, 2016 and 2015, respectively. The decrease in the amount of performing TDRs during 2016 reflects declines in both commercial loan and retail loan TDRs.

Other real estate and repossessed assets totaled $5.0 million at December 31, 2016, compared to $7.2 million at December 31, 2015. The decrease in other real estate during 2016 primarily reflects the sale of properties during the year being in excess of the inward migration of new properties.

We will place a loan that is 90 days or more past due on non-accrual, unless we believe the loan is both well secured and in the process of collection. Accordingly, we have determined that the collection of the accrued and unpaid interest on any loans that are 90 days or more past due and still accruing interest is probable.

ALLOCATION OF THE ALLOWANCE FOR LOAN LOSSES

 
December 31,
 
2016
2015
2014
 
(In thousands)
Specific allocations
$
9,152
 
$
10,983
 
$
13,233
 
Other adversely rated commercial loans
 
491
 
 
1,053
 
 
761
 
Historical loss allocations
 
4,929
 
 
5,262
 
 
6,773
 
Additional allocations based on subjective factors
 
5,662
 
 
5,272
 
 
5,223
 
Total
$
20,234
 
$
22,570
 
$
25,990
 

Some loans will not be repaid in full. Therefore, an allowance for loan losses (“AFLL”) is maintained at a level which represents our best estimate of losses incurred. In determining the AFLL and the related provision for loan

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losses, we consider four principal elements: (i) specific allocations based upon probable losses identified during the review of the loan portfolio, (ii) allocations established for other adversely rated commercial loans, (iii) allocations based principally on historical loan loss experience, and (iv) additional allowances based on subjective factors, including local and general economic business factors and trends, portfolio concentrations and changes in the size and/or the general terms of the loan portfolios.

The first AFLL element (specific allocations) reflects our estimate of probable incurred losses based upon our systematic review of specific loans. These estimates are based upon a number of factors, such as payment history, financial condition of the borrower, discounted collateral exposure and discounted cash flow analysis. Impaired commercial, mortgage and installment loans are allocated allowance amounts using this first element. The second AFLL element (other adversely rated commercial loans) reflects the application of our commercial loan rating system. This rating system is similar to those employed by state and federal banking regulators. Commercial loans that are rated below a certain predetermined classification are assigned a loss allocation factor for each loan classification category that is based upon a historical analysis of both the probability of default and the expected loss rate (“loss given default”). The lower the rating assigned to a loan or category, the greater the allocation percentage that is applied. The third AFLL element (historical loss allocations) is determined by assigning allocations to higher rated (“non-watch credit”) commercial loans using a probability of default and loss given default similar to the second AFLL element and to homogenous mortgage and installment loan groups based upon borrower credit score and portfolio segment. For homogenous mortgage and installment loans, a probability of default for each homogenous pool is calculated by way of credit score migration. Historical loss data for each homogenous pool coupled with the associated probability of default is utilized to calculate an expected loss allocation rate. The fourth AFLL element (additional allocations based on subjective factors) is based on factors that cannot be associated with a specific credit or loan category and reflects our attempt to ensure that the overall AFLL appropriately reflects a margin for the imprecision necessarily inherent in the estimates of expected credit losses. We consider a number of subjective factors when determining this fourth element, including local and general economic business factors and trends, portfolio concentrations and changes in the size, mix and the general terms of the overall loan portfolio.

Increases in the AFLL are recorded by a provision for loan losses charged to expense. Although we periodically allocate portions of the AFLL to specific loans and loan portfolios, the entire AFLL is available for incurred losses. We generally charge-off commercial, homogenous residential mortgage and installment loans and payment plan receivables when they are deemed uncollectible or reach a predetermined number of days past due based on product, industry practice and other factors. Collection efforts may continue and recoveries may occur after a loan is charged against the AFLL.

While we use relevant information to recognize losses on loans, additional provisions for related losses may be necessary based on changes in economic conditions, customer circumstances and other credit risk factors.

The AFLL decreased $2.3 million to $20.2 million at December 31, 2016 from $22.6 million at December 31, 2015 and was equal to 1.26% of total Portfolio Loans at December 31, 2016 compared to 1.49% at December 31, 2015. Three of the four components of the AFLL outlined above declined during 2016. The AFLL related to specific loans decreased $1.8 million in 2016 due primarily to a $9.3 million, or 10.4%, decline in the balance of individually impaired loans as well as charge-offs. The AFLL related to other adversely rated commercial loans decreased $0.6 million in 2016 as the total balance of such loans included in this component decreased to $11.8 million at December 31, 2016, from $27.8 million at December 31, 2015. The AFLL related to historical losses decreased $0.3 million during 2016 due principally to the use of a lower estimated probability of default for homogenous mortgage and installment loans (resulting from lower loan net charge-offs and reduced levels of new defaults on loans over the relevant measurement period). The AFLL related to subjective factors increased $0.4 million due primarily to Portfolio Loan growth.

Two of the four components of the AFLL outlined above declined during 2015. The AFLL related to specific loans decreased $2.3 million in 2015 due primarily to a $24.0 million, or 21.6%, decline in the balance of individually impaired loans as well as charge-offs. The AFLL related to other adversely rated commercial loans increased $0.3 million in 2015. Although the total balance of such loans included in this component decreased to $27.8 million at December 31, 2015, from $30.6 million at December 31, 2014, the allowance related to such loans increased slightly due to the use of higher loss given default rates. The AFLL related to historical losses decreased $1.5 million during 2015 due principally to the use of a lower estimated probability of default for homogenous mortgage and installment loans (resulting from lower loan net charge-offs and reduced levels of new defaults on loans). The AFLL related to subjective factors was relatively unchanged (increased by just $0.05 million during 2015).

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ALLOWANCE FOR LOSSES ON LOANS AND UNFUNDED COMMITMENTS

 
2016
2015
2014
 
Loan
Losses
Unfunded
Commitments
Loan
Losses
Unfunded
Commitments
Loan
Losses
Unfunded
Commitments
 
(Dollars in thousands)
Balance at beginning of year
$
22,570
 
$
652
 
$
25,990
 
$
539
 
$
32,325
 
$
508
 
Additions (deductions)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Provision for loan losses
 
(1,309
)
 
—
 
 
(2,714
)
 
—
 
 
(3,136
)
 
—
 
Recoveries credited to allowance
 
4,619
 
 
—
 
 
5,022
 
 
—
 
 
7,420
 
 
—
 
Loans charged against the allowance
 
(5,587
)
 
—
 
 
(5,728
)
 
—
 
 
(10,619
)
 
—
 
Reclassification to loans held for sale
 
(59
)
 
—
 
 
—
 
 
—
 
 
—
 
 
—
 
Additions (deductions) included in non-interest expense
 
—
 
 
(2
)
 
—
 
 
113
 
 
—
 
 
31
 
Balance at end of year
$
20,234
 
$
650
 
$
22,570
 
$
652
 
$
25,990
 
$
539
 
Net loans charged against the allowance to average Portfolio Loans
 
0.06
%
 
 
 
 
0.05
%
 
 
 
 
0.23
%
 
 
 

The ratio of loan net charge-offs to average loans was 0.06% in 2016 (or $1.0 million) compared to 0.05% in 2015 (or $0.7 million) and 0.23% in 2014 (or $3.2 million). The slight increase in loan net charge-offs in 2016 as compared to 2015 were in mortgage loans and deposit overdrafts. The decrease in loan net charge-offs in 2015 as compared to 2014 occurred across all loan categories. This decrease primarily reflected reduced levels of non-performing loans and improvement in collateral liquidation values.

Vehicle service contract (“VSC”) counterparty receivables, net totaled $2.3 million and $7.2 million as of December 31, 2016 and 2015, respectively. These VSC counterparty receivables represent funds due to Mepco related to the cancellation of payment plan receivables. The $2.3 million balance at December 31, 2016 is not part of the Mepco assets being sold as described above in “Recent Developments.” In the past, we have had to initiate litigation against certain counterparties, including third party insurers, to collect amounts owed to Mepco as a result of those parties’ dispute of their contractual obligations to Mepco. During the first quarter of 2016, we settled our last significant remaining litigation matter with certain of Mepco’s counterparties. This settlement resulted in our receipt of a cash payment of $4.0 million on March 31, 2016. This settlement also resulted in our receipt of an interest-bearing promissory note from one of Mepco’s counterparties for $1.5 million with monthly payments scheduled over a five-year period beginning in May 2016. Due to the lack of any payment history and limited financial information on this counterparty, we established a full reserve on this promissory note. This reserve (representing the remaining balance on the note) totaled $1.3 million at December 31, 2016. Thus far, this counterparty has made all required monthly payments on the note. As a longer-term payment history is developed, we will continue to evaluate the need for all or any part of a reserve.

Deposits and borrowings. Historically, the loyalty of our customer base has allowed us to price deposits competitively, contributing to a net interest margin that compares favorably to our peers. However, we still face a significant amount of competition for deposits within many of the markets served by our branch network, which limits our ability to materially increase deposits without adversely impacting the weighted-average cost of core deposits.

To attract new core deposits, we have implemented various account acquisition strategies as well as branch staff sales training. Account acquisition initiatives have historically generated increases in customer relationships. Over the past several years, we have also expanded our treasury management products and services for commercial businesses and municipalities or other governmental units and have also increased our sales calling efforts in order to attract additional deposit relationships from these sectors. We view long-term core deposit growth as an important objective. Core deposits generally provide a more stable and lower cost source of funds than alternative sources such as short-term borrowings. (See “Liquidity and capital resources.”)

Deposits totaled $2.23 billion and $2.09 billion at December 31, 2016 and 2015, respectively. The $139.8 million increase in deposits in 2016 is due to growth in checking, savings and time deposit account balances. Reciprocal deposits totaled $38.7 million and $50.2 million at December 31, 2016 and 2015, respectively. These deposits represent demand, money market and time deposits from our customers that have been placed through

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Promontory Interfinancial Network’s Insured Cash Sweep ® service and Certificate of Deposit Account Registry Service ® . These services allow our customers to access multi-million dollar FDIC deposit insurance on deposit balances greater than the standard FDIC insurance maximum.

We cannot be sure that we will be able to maintain our current level of core deposits. In particular, those deposits that are uninsured may be susceptible to outflow. At December 31, 2016, we had approximately $572.1 million of uninsured deposits. A reduction in core deposits would likely increase our need to rely on wholesale funding sources.

We have also implemented strategies that incorporate using federal funds purchased, other borrowings and Brokered CDs to fund a portion of our interest-earning assets. The use of such alternate sources of funds supplements our core deposits and is also a part of our asset/liability management efforts.

Other borrowings, comprised almost entirely of advances from the Federal Home Loan Bank (the “FHLB”), totaled $9.4 million and $12.0 million at December 31, 2016 and 2015, respectively.

As described above, we utilize wholesale funding, including FHLB borrowings and Brokered CDs to augment our core deposits and fund a portion of our assets. At December 31, 2016, our use of such wholesale funding sources (including reciprocal deposits) amounted to approximately $48.1 million, or 2.2% of total funding (deposits and total borrowings, excluding subordinated debentures). Because wholesale funding sources are affected by general market conditions, the availability of such funding may be dependent on the confidence these sources have in our financial condition and operations. The continued availability to us of these funding sources is not certain, and Brokered CDs may be difficult for us to retain or replace at attractive rates as they mature. Our liquidity may be constrained if we are unable to renew our wholesale funding sources or if adequate financing is not available in the future at acceptable rates of interest or at all. Our financial performance could also be affected if we are unable to maintain our access to funding sources or if we are required to rely more heavily on more expensive funding sources. In such case, our net interest income and results of operations could be adversely affected.

We historically employed derivative financial instruments to manage our exposure to changes in interest rates. We discontinued the active use of derivative financial instruments during 2008. We began to again utilize interest-rate swaps in 2014, relating to our commercial lending activities. During 2016, 2015 and 2014, we entered into $24.1 million, $24.3 million and $3.3 million (original aggregate notional amounts), respectively, of interest rate swaps with commercial loan customers, which were offset with interest rate swaps that the Bank entered into with a broker-dealer. We recorded $0.380 million, $0.412 million and $0.070 million of fee income related to these transactions during 2016, 2015 and 2014, respectively.

Liquidity and capital resources. Liquidity risk is the risk of being unable to timely meet obligations as they come due at a reasonable funding cost or without incurring unacceptable losses. Our liquidity management involves the measurement and monitoring of a variety of sources and uses of funds. Our Consolidated Statements of Cash Flows categorize these sources and uses into operating, investing and financing activities. We primarily focus our liquidity management on maintaining adequate levels of liquid assets (primarily funds on deposit with the FRB and certain investment securities) as well as developing access to a variety of borrowing sources to supplement our deposit gathering activities and provide funds for purchasing investment securities or originating Portfolio Loans as well as to be able to respond to unforeseen liquidity needs.

Our primary sources of funds include our deposit base, secured advances from the FHLB, a federal funds purchased borrowing facility with another commercial bank, and access to the capital markets (for Brokered CDs).

At December 31, 2016, we had $363.4 million of time deposits that mature in the next 12 months. Historically, a majority of these maturing time deposits are renewed by our customers. Additionally, $1.74 billion of our deposits at December 31, 2016, were in account types from which the customer could withdraw the funds on demand. Changes in the balances of deposits that can be withdrawn upon demand are usually predictable and the total balances of these accounts have generally grown or have been stable over time as a result of our marketing and promotional activities. However, there can be no assurance that historical patterns of renewing time deposits or overall growth or stability in deposits will continue in the future.

We have developed contingency funding plans that stress test our liquidity needs that may arise from certain events such as an adverse change in our financial metrics (for example, credit quality or regulatory capital ratios). Our liquidity management also includes periodic monitoring that measures quick assets (defined generally as short-term assets with maturities less than 30 days and loans held for sale) to total assets, short-term liability

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dependence and basic surplus (defined as quick assets compared to short-term liabilities). Policy limits have been established for our various liquidity measurements and are monitored on a monthly basis. In addition, we also prepare cash flow forecasts that include a variety of different scenarios.

We believe that we currently have adequate liquidity at our Bank because of our cash and cash equivalents, our portfolio of securities available for sale, our access to secured advances from the FHLB, our ability to issue Brokered CDs and our improved financial metrics.

We also believe that the available cash on hand at the parent company (including time deposits) of approximately $14.5 million as of December 31, 2016 provides sufficient liquidity resources at the parent company to meet operating expenses, to make interest payments on the subordinated debentures and to pay a cash dividend on our common stock for the foreseeable future.

In the normal course of business, we enter into certain contractual obligations. Such obligations include requirements to make future payments on debt and lease arrangements, contractual commitments for capital expenditures, and service contracts. The table below summarizes our significant contractual obligations at December 31, 2016.

CONTRACTUAL COMMITMENTS (1)

 
1 Year or Less
1-3 Years
3-5 Years
After
5 Years
Total
 
(In thousands)
Time deposit maturities
$
363,382
 
$
93,857
 
$
27,026
 
$
853
 
$
485,118
 
FHLB advances
 
1,587
 
 
5,185
 
 
2,656
 
 
—
 
 
9,428
 
Subordinated debentures
 
—
 
 
—
 
 
—
 
 
35,569
 
 
35,569
 
Operating lease obligations
 
1,444
 
 
2,307
 
 
1,387
 
 
499
 
 
5,637
 
Purchase obligations (2)
 
1,757
 
 
3,514
 
 
2,196
 
 
—
 
 
7,467
 
Total
$
368,170
 
$
104,863
 
$
33,265
 
$
36,921
 
$
543,219
 
(1) Excludes approximately $0.5 million of accrued tax and interest relative to uncertain tax benefits due to the high degree of uncertainty as to when, or if, those amounts would be paid.
(2) Includes contracts with a minimum annual payment of $1.0 million and are not cancellable within one year.

Effective management of capital resources is critical to our mission to create value for our shareholders. In addition to common stock, our capital structure also currently includes cumulative trust preferred securities.

CAPITALIZATION

 
December 31,
 
2016
2015
 
(In thousands)
Subordinated debentures
$
35,569
 
$
35,569
 
Amount not qualifying as regulatory capital
 
(1,069
)
 
(1,069
)
Amount qualifying as regulatory capital
 
34,500
 
 
34,500
 
Shareholders’ equity
 
 
 
 
 
 
Common stock
 
323,745
 
 
339,462
 
Accumulated deficit
 
(65,657
)
 
(82,334
)
Accumulated other comprehensive loss
 
(9,108
)
 
(6,036
)
Total shareholders’ equity
 
248,980
 
 
251,092
 
Total capitalization
$
283,480
 
$
285,592
 

We currently have three special purpose entities that originally issued $39.5 million of cumulative trust preferred securities. These special purpose entities issued common securities and provided cash to our parent company that in

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turn issued subordinated debentures to these special purpose entities equal to the trust preferred securities and common securities. The subordinated debentures represent the sole asset of the special purpose entities. The common securities and subordinated debentures are included in our Consolidated Statements of Financial Condition.

On December 1, 2014, we purchased 5,000 shares of trust preferred securities (liquidation amount of $1,000 per security, representing a total of $5.0 million) that were issued by IBC Capital Finance IV. The trust preferred securities have been retired along with certain related common stock issued by IBC Capital Finance IV and subordinated debentures issued by us.

At both December 31, 2016 and 2015, we had $34.5 million of cumulative trust preferred securities remaining outstanding.

The Federal Reserve Board has issued rules regarding trust preferred securities as a component of the Tier 1 capital of bank holding companies. The aggregate amount of trust preferred securities (and certain other capital elements) are limited to 25 percent of Tier 1 capital elements, net of goodwill (net of any associated deferred tax liability). The amount of trust preferred securities and certain other elements in excess of the limit can be included in Tier 2 capital, subject to restrictions. At the parent company, all of these securities qualified as Tier 1 capital at December 31, 2016 and 2015. Although the Dodd-Frank Act further limited Tier 1 treatment for trust preferred securities, those new limits did not apply to our outstanding trust preferred securities. Further, the New Capital Rules grandfathered the treatment of our trust preferred securities as qualifying regulatory capital.

Common shareholders’ equity decreased to $249.0 million at December 31, 2016 from $251.1 million at December 31, 2015 due primarily to share repurchases, dividends and an increase in our accumulated other comprehensive loss that was substantially offset by our net income in 2016. Our tangible common equity (“TCE”) totaled $247.0 million and $248.8 million, respectively, at those same dates. Our ratio of TCE to tangible assets was 9.70% and 10.34% at December 31, 2016 and 2015, respectively. TCE and the ratio of TCE to tangible assets are non-GAAP measures. TCE represents total common equity less intangible assets.

In January 2015 and 2016, our Board of Directors authorized share repurchase plans. Under the terms of these share repurchase plans, we were authorized to buy back up to 5% of our outstanding common stock (plus an additional $5.0 million for the 2016 plan). These repurchase plans expired on December 31, 2016 and 2015, respectively. During 2016, we repurchased 1,153,136 shares of our comment stock at an average price of $14.62 per share. During 2015, we repurchased 967,199 shares of our comment stock at an average price of $13.96 per share.

In January 2017, our Board of Directors authorized another share repurchase plan. Under the terms of the 2017 share repurchase plan, we are authorized to buy back up to 5% of our outstanding common stock. This repurchase plan is authorized to last through December 31, 2017.

We resumed a quarterly cash dividend on our common stock of six cents per share in May 2014 and continued to pay regular quarterly dividends at that amount through August 2015. In October 2016 and 2015, our Board of Directors increased the quarterly cash dividend on our common stock to ten cents and eight cents per share, respectively.

Because the Bank had negative “undivided profits” (i.e. a retained deficit) during 2014, 2015 and for the first quarter of 2016, under Michigan banking regulations, the Bank was not permitted to pay a dividend. However, we were able to request regulatory approval for a return of capital from the Bank to the parent company. During the first quarter of 2016, we requested regulatory approval for an $18.0 million return of capital from the Bank to the parent company. This return of capital request was approved by our banking regulators on February 24, 2016, and the Bank returned $18.0 million of capital to the parent company on February 25, 2016. Our banking regulators approved previous return of capital requests of $18.5 million and $15.0 million in 2015 and 2014, respectively. In the second quarter of 2016, the Bank returned to a positive retained earnings position. At December 31, 2016, the Bank had positive retained earnings of $9.9 million. In January 2017 and October 2016, the Bank paid $5.0 million dividends to the parent company. Also see note #20 to the Consolidated Financial Statements included within this report.

As of December 31, 2016 and 2015, our Bank (and holding company) continued to meet the requirements to be considered “well-capitalized” under federal regulatory standards (also see note #20 to the Consolidated Financial Statements included within this report).

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Asset/liability management. Interest-rate risk is created by differences in the cash flow characteristics of our assets and liabilities. Options embedded in certain financial instruments, including caps on adjustable-rate loans as well as borrowers’ rights to prepay fixed-rate loans, also create interest-rate risk.

Our asset/liability management efforts identify and evaluate opportunities to structure our statement of financial condition in a manner that is consistent with our mission to maintain profitable financial leverage within established risk parameters. We evaluate various opportunities and alternate asset/liability management strategies carefully and consider the likely impact on our risk profile as well as the anticipated contribution to earnings. The marginal cost of funds is a principal consideration in the implementation of our asset/liability management strategies, but such evaluations further consider interest-rate and liquidity risk as well as other pertinent factors. We have established parameters for interest-rate risk. We regularly monitor our interest-rate risk and report at least quarterly to our board of directors.

We employ simulation analyses to monitor our interest-rate risk profile and evaluate potential changes in our net interest income and market value of portfolio equity that result from changes in interest rates. The purpose of these simulations is to identify sources of interest-rate risk inherent in our Consolidated Statement of Financial Condition. The simulations do not anticipate any actions that we might initiate in response to changes in interest rates and, accordingly, the simulations do not provide a reliable forecast of anticipated results. The simulations are predicated on immediate, permanent and parallel shifts in interest rates and generally assume that current loan and deposit pricing relationships remain constant. The simulations further incorporate assumptions relating to changes in customer behavior, including changes in prepayment rates on certain assets and liabilities.

CHANGES IN MARKET VALUE OF PORTFOLIO EQUITY AND NET INTEREST INCOME

Change in Interest Rates
Market
Value of
Portfolio
Equity (1)
Percent
Change
Net
Interest Income (2)
Percent
Change
 
(Dollars in thousands)
December 31, 2016
 
 
 
 
 
 
 
 
 
 
 
 
200 basis point rise
$
427,400
 
 
6.90
%
$
84,800
 
 
6.94
%
100 basis point rise
 
417,800
 
 
4.50
 
 
82,500
 
 
4.04
 
Base-rate scenario
 
399,800
 
 
—
 
 
79,300
 
 
—
 
100 basis point decline
 
366,000
 
 
(8.45
)
 
73,500
 
 
(7.31
)
 
 
 
 
 
 
 
 
 
 
 
 
 
December 31, 2015
 
 
 
 
 
 
 
 
 
 
 
 
200 basis point rise
$
419,600
 
 
8.42
%
$
80,700
 
 
6.32
%
100 basis point rise
 
407,300
 
 
5.25
 
 
78,700
 
 
3.69
 
Base-rate scenario
 
387,000
 
 
—
 
 
75,900
 
 
—
 
100 basis point decline
 
356,500
 
 
(7.88
)
 
72,000
 
 
(5.14
)
 
 
 
 
 
 
 
 
 
 
 
 
 
(1) Simulation analyses calculate the change in the net present value of our assets and liabilities, including debt and related financial derivative instruments, under parallel shifts in interest rates by discounting the estimated future cash flows using a market-based discount rate. Cash flow estimates incorporate anticipated changes in prepayment speeds and other embedded options.
(2) Simulation analyses calculate the change in net interest income under immediate parallel shifts in interest rates over the next twelve months, based upon a static Consolidated Statement of Financial Condition, which includes debt and related financial derivative instruments, and do not consider loan fees.

Accounting Standards Update. See note #1 to the Consolidated Financial Statements included elsewhere in this report for details on recently issued accounting pronouncements and their impact on our financial statements.

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FAIR VALUATION OF FINANCIAL INSTRUMENTS

Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) topic 820 - “Fair Value Measurements and Disclosures” (“FASB ASC topic 820”) defines fair value as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date.

We utilize fair value measurements to record fair value adjustments to certain financial instruments and to determine fair value disclosures. FASB ASC topic 820 differentiates between those assets and liabilities required to be carried at fair value at every reporting period (“recurring”) and those assets and liabilities that are only required to be adjusted to fair value under certain circumstances (“nonrecurring”). Trading securities, securities available-for-sale, loans held for sale, and derivatives are financial instruments recorded at fair value on a recurring basis. Additionally, from time to time, we may be required to record at fair value other financial assets on a nonrecurring basis, such as loans held for investment, capitalized mortgage loan servicing rights and certain other assets. These nonrecurring fair value adjustments typically involve application of lower of cost or market accounting or write-downs of individual assets. See note #21 to the Consolidated Financial Statements for a complete discussion on our use of fair valuation of financial instruments and the related measurement techniques.

LITIGATION MATTERS

As described in “Recent Developments” we settled a litigation matter in December 2016 and recorded a $2.3 million expense in the fourth quarter. We are also involved in various other litigation matters in the ordinary course of business. At the present time, we do not believe any of these other matters will have a significant impact on our consolidated financial position or results of operations. The aggregate amount we have accrued for losses we consider probable as a result of these other litigation matters is immaterial. However, because of the inherent uncertainty of outcomes from any litigation matter, we believe it is reasonably possible we may incur losses in addition to the amounts we have accrued. At this time, we estimate the maximum amount of additional losses that are reasonably possible is approximately $0.3 million. However, because of a number of factors, including the fact that certain of these other litigation matters are still in their early stages, this maximum amount may change in the future.

The litigation matters described in the preceding paragraph primarily include claims that have been brought against us for damages, but do not include litigation matters where we seek to collect amounts owed to us by third parties (such as litigation initiated to collect delinquent loans). These excluded, collection-related matters may involve claims or counterclaims by the opposing party or parties, but we have excluded such matters from the disclosure contained in the preceding paragraph in all cases where we believe the possibility of us paying damages to any opposing party is remote. Risks associated with the likelihood that we will not collect the full amount owed to us, net of reserves, are disclosed elsewhere in this report.

CRITICAL ACCOUNTING POLICIES

Our accounting and reporting policies are in accordance with accounting principles generally accepted in the United States of America and conform to general practices within the banking industry. Accounting and reporting policies for the AFLL, originated mortgage loan servicing rights, and income taxes are deemed critical since they involve the use of estimates and require significant management judgments. Application of assumptions different than those that we have used could result in material changes in our financial position or results of operations.

Our methodology for determining the AFLL and related provision for loan losses is described above in “Portfolio Loans and asset quality.” In particular, this area of accounting requires a significant amount of judgment because a multitude of factors can influence the ultimate collection of a loan or other type of credit. It is extremely difficult to precisely measure the amount of probable incurred losses in our loan portfolio. We use a rigorous process to attempt to accurately quantify the necessary AFLL and related provision for loan losses, but there can be no assurance that our modeling process will successfully identify all of the probable incurred losses in our loan portfolio. As a result, we could record future provisions for loan losses that may be significantly different than the levels that we recorded in prior periods.

At December 31, 2016 and 2015, we had approximately $13.7 million and $12.4 million, respectively, of mortgage loan servicing rights capitalized on our Consolidated Statements of Financial Condition. There are several critical assumptions involved in establishing the value of this asset including estimated future prepayment speeds on

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the underlying mortgage loans, the interest rate used to discount the net cash flows from the mortgage loan servicing, the estimated amount of ancillary income that will be received in the future (such as late fees) and the estimated cost to service the mortgage loans. We believe the assumptions that we utilize in our valuation are reasonable based upon accepted industry practices for valuing mortgage loan servicing rights and represent neither the most conservative or aggressive assumptions. We recorded decreases in the valuation allowance on capitalized mortgage loan servicing rights of $1.0 million and $0.5 million in 2016 and 2015, respectively compared to an increase of $0.9 million in 2014. As of January 1, 2017, we elected the fair value measurement method for our mortgage loan servicing rights (in lieu of the amortization method). We expect the cumulative effective of this accounting change to decrease January 1, 2017 retained deficit by $0.4 million, net of tax. We will no longer record amortization of or impairment against capitalized mortgage loan servicing rights, rather we will now record capitalized mortgage loan servicing rights at fair value with subsequent changes in fair value recorded as an increase or decrease to mortgage loan servicing, net, in our Consolidated Statements of Operations.

Our accounting for income taxes involves the valuation of deferred tax assets and liabilities primarily associated with net operating loss carryforwards and differences in the timing of the recognition of revenues and expenses for financial reporting and tax purposes. At December 31, 2016 we had gross deferred tax assets of $39.2 million, gross deferred tax liabilities of $5.3 million and a valuation allowance of $1.1 million. This compares to gross deferred tax assets of $45.5 million, gross deferred tax liabilities of $4.8 million and a valuation allowance of $1.1 million at December 31, 2015. We assess whether a valuation allowance should be established against our deferred tax assets based on the consideration of all available evidence using a “more likely than not” standard. The ultimate realization of this asset is primarily based on generating future income. We concluded at both December 31, 2016 and 2015, that the realization of substantially all of our deferred tax assets continues to be more likely than not.

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MANAGEMENT’S ANNUAL REPORT ON INTERNAL CONTROL OVER
FINANCIAL REPORTING

The management of Independent Bank Corporation is responsible for establishing and maintaining adequate internal control over financial reporting. Our internal control system was designed to provide reasonable assurance to us and the board of directors regarding the preparation and fair presentation of published financial statements.

All internal control systems, no matter how well designed, have inherent limitations. Therefore, even those systems determined to be effective can provide only reasonable assurance with respect to financial statement preparation and presentation.

We assessed the effectiveness of our internal control over financial reporting as of December 31, 2016. In making this assessment, we used the criteria established in the 2013 Internal Control – Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Based on our assessment, management has concluded that as of December 31, 2016, the Company’s internal control over financial reporting was effective 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.

There were no changes in our internal control over financial reporting during the quarter ended December 31, 2016, that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

Our independent registered public accounting firm has issued an audit report on the effectiveness of the Company’s internal control over financial reporting as of December 31, 2016. Their report immediately follows our report.

 
 
William B. Kessel
President and
Chief Executive Officer
Robert N. Shuster
Executive Vice President
and Chief Financial Officer
   
 
Independent Bank Corporation
March 7, 2017
 

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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

Board of Directors and Shareholders
Independent Bank Corporation
Grand Rapids, Michigan

We have audited the accompanying consolidated statements of financial condition of Independent Bank Corporation as of December 31, 2016 and 2015, and the related consolidated statements of operations, comprehensive income, shareholders’ equity and cash flows for each of the years in the three-year period ended December 31, 2016. We also have audited Independent Bank Corporation’s internal control over financial reporting as of December 31, 2016, based on criteria established in the 2013 Internal Control – Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Independent Bank Corporation’s management is responsible for these financial statements, for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management’s Annual Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on these financial statements and an opinion on the company’s internal control over financial reporting based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement and whether effective internal control over financial reporting was maintained in all material respects. Our audits of the financial statements included examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions.

A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Independent Bank Corporation as of December 31, 2016 and 2015, and the results of its operations and its cash flows for each of the years in the three-year period ended December 31, 2016 in conformity with accounting principles generally accepted in the United States of America. Also in our opinion, Independent Bank Corporation maintained, in all material respects, effective internal control over financial reporting as of December 31, 2016, based on criteria established in the 2013 Internal Control – Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission.

 

Grand Rapids, Michigan
March 7, 2017

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CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION

 
December 31,
 
2016
2015
 
(In thousands, except share amounts)
ASSETS
Cash and due from banks
$
35,238
 
$
54,260
 
Interest bearing deposits
 
47,956
 
 
31,523
 
Cash and Cash Equivalents
 
83,194
 
 
85,783
 
Interest bearing deposits - time
 
5,591
 
 
11,866
 
Trading securities
 
410
 
 
148
 
Securities available for sale
 
610,616
 
 
585,484
 
Federal Home Loan Bank and Federal Reserve Bank stock, at cost
 
15,543
 
 
15,471
 
Loans held for sale, carried at fair value
 
35,946
 
 
27,866
 
Payment plan receivables and other assets held for sale
 
33,360
 
 
—
 
Loans
 
 
 
 
 
 
Commercial
 
804,017
 
 
748,398
 
Mortgage
 
538,615
 
 
498,036
 
Installment
 
265,616
 
 
234,017
 
Payment plan receivables
 
—
 
 
34,599
 
Total Loans
 
1,608,248
 
 
1,515,050
 
Allowance for loan losses
 
(20,234
)
 
(22,570
)
Net Loans
 
1,588,014
 
 
1,492,480
 
Other real estate and repossessed assets
 
5,004
 
 
7,150
 
Property and equipment, net
 
40,175
 
 
43,103
 
Bank-owned life insurance
 
54,033
 
 
54,402
 
Deferred tax assets, net
 
32,818
 
 
39,635
 
Capitalized mortgage loan servicing rights
 
13,671
 
 
12,436
 
Vehicle service contract counterparty receivables, net
 
2,271
 
 
7,229
 
Other intangibles
 
1,932
 
 
2,280
 
Accrued income and other assets
 
26,372
 
 
23,733
 
Total Assets
$
2,548,950
 
$
2,409,066
 
 
 
 
 
 
 
 
LIABILITIES AND SHAREHOLDERS' EQUITY
Deposits
 
 
 
 
 
 
Non-interest bearing
$
717,472
 
$
659,793
 
Savings and interest-bearing checking
 
1,015,724
 
 
988,174
 
Reciprocal
 
38,657
 
 
50,207
 
Time
 
453,866
 
 
387,789
 
Total Deposits
 
2,225,719
 
 
2,085,963
 
Other borrowings
 
9,433
 
 
11,954
 
Subordinated debentures
 
35,569
 
 
35,569
 
Other liabilities held for sale
 
718
 
 
—
 
Accrued expenses and other liabilities
 
28,531
 
 
24,488
 
Total Liabilities
 
2,299,970
 
 
2,157,974
 
 
 
 
 
 
 
 
Commitments and contingent liabilities
 
 
 
 
 
 
 
 
 
 
 
 
 
Shareholders’ Equity
 
 
 
 
 
 
Preferred stock, no par value, 200,000 shares authorized; none issued or outstanding
 
—
 
 
—
 
Common stock, no par value, 500,000,000 shares authorized; issued and outstanding: 21,258,092 shares at December 31, 2016 and 22,251,373 shares at December 31, 2015
 
323,745
 
 
339,462
 
Accumulated deficit
 
(65,657
)
 
(82,334
)
Accumulated other comprehensive loss
 
(9,108
)
 
(6,036
)
Total Shareholders’ Equity
 
248,980
 
 
251,092
 
Total Liabilities and Shareholders’ Equity
$
2,548,950
 
$
2,409,066
 

See accompanying notes to consolidated financial statements

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CONSOLIDATED STATEMENTS OF OPERATIONS

 
Year Ended December 31,
 
2016
2015
2014
 
(In thousands, except per share amounts)
INTEREST INCOME
 
 
 
 
 
 
 
 
 
Interest and fees on loans
$
74,157
 
$
70,930
 
$
71,823
 
Interest on securities
 
 
 
 
 
 
 
 
 
Taxable
 
9,921
 
 
7,805
 
 
6,341
 
Tax-exempt
 
1,250
 
 
907
 
 
991
 
Other investments
 
1,195
 
 
1,200
 
 
1,400
 
Total Interest Income
 
86,523
 
 
80,842
 
 
80,555
 
INTEREST EXPENSE
 
 
 
 
 
 
 
 
 
Deposits
 
4,941
 
 
4,009
 
 
4,967
 
Other borrowings
 
1,941
 
 
1,847
 
 
2,332
 
Total Interest Expense
 
6,882
 
 
5,856
 
 
7,299
 
Net Interest Income
 
79,641
 
 
74,986
 
 
73,256
 
Provision for loan losses
 
(1,309
)
 
(2,714
)
 
(3,136
)
Net Interest Income After Provision for Loan Losses
 
80,950
 
 
77,700
 
 
76,392
 
NON-INTEREST INCOME
 
 
 
 
 
 
 
 
 
Service charges on deposit accounts
 
12,406
 
 
12,389
 
 
13,446
 
Interchange income
 
7,938
 
 
8,481
 
 
8,164
 
Net gains (losses) on assets
 
 
 
 
 
 
 
 
 
Mortgage loans
 
10,566
 
 
7,448
 
 
5,628
 
Securities
 
563
 
 
20
 
 
329
 
Other than temporary impairment loss on securities
 
 
 
 
 
 
 
 
 
Total impairment loss
 
—
 
 
—
 
 
(9
)
Loss recognized in other comprehensive income (loss)
 
—
 
 
—
 
 
—
 
Net impairment loss recognized in earnings
 
—
 
 
—
 
 
(9
)
Mortgage loan servicing, net
 
2,222
 
 
1,751
 
 
791
 
Title insurance fees
 
1,187
 
 
1,156
 
 
995
 
Net gain on branch sale
 
—
 
 
1,193
 
 
—
 
Gain on extinguishment of debt
 
—
 
 
—
 
 
500
 
Other
 
7,416
 
 
7,692
 
 
8,931
 
Total Non-interest Income
 
42,298
 
 
40,130
 
 
38,775
 
NON-INTEREST EXPENSE
 
 
 
 
 
 
 
 
 
Compensation and employee benefits
 
49,579
 
 
48,186
 
 
47,221
 
Occupancy, net
 
8,023
 
 
8,369
 
 
8,912
 
Data processing
 
7,952
 
 
7,944
 
 
7,532
 
Furniture, fixtures and equipment
 
3,912
 
 
3,892
 
 
4,137
 
Communications
 
3,142
 
 
2,957
 
 
2,926
 
Loan and collection
 
2,512
 
 
3,609
 
 
5,392
 
Litigation settlement expense
 
2,300
 
 
—
 
 
—
 
Advertising
 
1,856
 
 
2,121
 
 
2,193
 
Legal and professional
 
1,742
 
 
2,013
 
 
1,969
 
Interchange expense
 
1,111
 
 
1,125
 
 
1,291
 
FDIC deposit insurance
 
1,049
 
 
1,366
 
 
1,567
 
Credit card and bank service fees
 
791
 
 
797
 
 
946
 
Loss on sale of payment plan business
 
320
 
 
—
 
 
—
 
Net (gains) losses on other real estate and repossessed assets
 
250
 
 
(180
)
 
(500
)
Provision for loss reimbursement on sold loans
 
30
 
 
(59
)
 
(466
)
Other
 
5,778
 
 
6,310
 
 
6,831
 
Total Non-interest Expense
 
90,347
 
 
88,450
 
 
89,951
 
Income Before Income Tax
 
32,901
 
 
29,380
 
 
25,216
 
Income tax expense
 
10,135
 
 
9,363
 
 
7,195
 
Net Income
$
22,766
 
$
20,017
 
$
18,021
 
Net income per common share
 
 
 
 
 
 
 
 
 
Basic
$
1.06
 
$
0.88
 
$
0.79
 
Diluted
$
1.05
 
$
0.86
 
$
0.77
 
Cash dividends declared and paid per common share
$
0.34
 
$
0.26
 
$
0.18
 

See accompanying notes to consolidated financial statements

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CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

 
Year Ended December 31,
 
2016
2015
2014
 
(In thousands)
Net income
$
22,766
 
$
20,017
 
$
18,021
 
Other comprehensive income (loss)
 
 
 
 
 
 
 
 
 
Securities available for sale
 
 
 
 
 
 
 
 
 
Unrealized gain (loss) arising during period
 
(4,465
)
 
(540
)
 
5,095
 
Change in unrealized gains and losses for which a portion of other than temporary impairment has been recognized in earnings
 
40
 
 
—
 
 
398
 
Reclassification adjustment for other than temporary impairment included in earnings
 
—
 
 
—
 
 
9
 
Reclassification adjustments for gains included in earnings
 
(301
)
 
(75
)
 
(329
)
Unrealized gains (losses) recognized in other comprehensive income (loss) on securities available for sale
 
(4,726
)
 
(615
)
 
5,173
 
Income tax expense (benefit)
 
(1,654
)
 
(215
)
 
1,811
 
Unrealized gains (losses) recognized in other comprehensive income (loss) on securities available for sale, net of tax
 
(3,072
)
 
(400
)
 
3,362
 
Derivative instruments
 
 
 
 
 
 
 
 
 
Reclassification adjustment for accretion on settled derivatives
 
—
 
 
—
 
 
380
 
Unrealized gains recognized in other comprehensive income (loss) on derivative instruments
 
—
 
 
—
 
 
380
 
Income tax expense
 
—
 
 
—
 
 
133
 
Unrealized gains recognized in other comprehensive income (loss) on derivative instruments, net of tax
 
—
 
 
—
 
 
247
 
Other comprehensive income (loss)
 
(3,072
)
 
(400
)
 
3,609
 
Comprehensive income
$
19,694
 
$
19,617
 
$
21,630
 

See accompanying notes to consolidated financial statements

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CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY

 
Common
Stock
Accumulated
Deficit
Accumulated
Other
Comprehensive
Loss
Total
Shareholders’
Equity
Balances at January 1, 2014
$
351,173
 
$
(110,347
)
$
(9,245
)
$
231,581
 
Net income for 2014
 
—
 
 
18,021
 
 
—
 
 
18,021
 
Cash dividends declared, $.18 per share
 
—
 
 
(4,129
)
 
—
 
 
(4,129
)
Issuance of 30,828 shares of common stock
 
97
 
 
—
 
 
—
 
 
97
 
Share based compensation (issuance of 107,359 shares of common stock)
 
1,192
 
 
—
 
 
—
 
 
1,192
 
Other comprehensive income
 
—
 
 
—
 
 
3,609
 
 
3,609
 
Balances at December 31, 2014
 
352,462
 
 
(96,455
)
 
(5,636
)
 
250,371
 
Net income for 2015
 
—
 
 
20,017
 
 
—
 
 
20,017
 
Cash dividends declared, $.26 per share
 
—
 
 
(5,896
)
 
—
 
 
(5,896
)
Repurchase of 967,199 shares of common stock
 
(13,498
)
 
—
 
 
—
 
 
(13,498
)
Issuance of 39,610 shares of common stock
 
112
 
 
—
 
 
—
 
 
112
 
Share based compensation (issuance of 299,263 shares of common stock)
 
1,477
 
 
—
 
 
—
 
 
1,477
 
Share based compensation withholding obligation (withholding of 77,624 shares of common stock)
 
(1,091
)
 
—
 
 
—
 
 
(1,091
)
Other comprehensive loss
 
—
 
 
—
 
 
(400
)
 
(400
)
Balances at December 31, 2015
 
339,462
 
 
(82,334
)
 
(6,036
)
 
251,092
 
Cumulative effect of change in accounting principle
 
62
 
 
1,185
 
 
—
 
 
1,247
 
Balances at December 31, 2015, as adjusted
 
339,524
 
 
(81,149
)
 
(6,036
)
 
252,339
 
Net income for 2016
 
—
 
 
22,766
 
 
—
 
 
22,766
 
Cash dividends declared, $.34 per share
 
—
 
 
(7,274
)
 
—
 
 
(7,274
)
Repurchase of 1,153,136 shares of common stock
 
(16,854
)
 
—
 
 
—
 
 
(16,854
)
Issuance of 21,402 shares of common stock
 
82
 
 
—
 
 
—
 
 
82
 
Share based compensation (issuance of 180,380 shares of common stock)
 
1,620
 
 
—
 
 
—
 
 
1,620
 
Share based compensation withholding obligation (withholding of 41,927 shares of common stock)
 
(627
)
 
—
 
 
—
 
 
(627
)
Other comprehensive loss
 
—
 
 
—
 
 
(3,072
)
 
(3,072
)
Balances at December 31, 2016
$
323,745
 
$
(65,657
)
$
(9,108
)
$
248,980
 

See accompanying notes to consolidated financial statements

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CONSOLIDATED STATEMENTS OF CASH FLOWS

 
Year Ended December 31,
 
2016
2015
2014
 
(In thousands)
Net Income
$
22,766
 
$
20,017
 
$
18,021
 
ADJUSTMENTS TO RECONCILE NET INCOME TO NET CASH FROM OPERATING ACTIVITIES
 
 
 
 
 
 
 
 
 
Proceeds from sales of loans held for sale
 
324,828
 
 
288,852
 
 
228,906
 
Disbursements for loans held for sale
 
(322,342
)
 
(285,608
)
 
(226,550
)
Provision for loan losses
 
(1,309
)
 
(2,714
)
 
(3,136
)
Deferred income tax expense
 
8,064
 
 
8,997
 
 
8,918
 
Deferred loan fees
 
(1,911
)
 
(1,234
)
 
(753
)
Net depreciation, amortization of intangible assets and premiums and accretion of discounts on securities, loans and interest bearning deposits - time
 
5,216
 
 
4,553
 
 
3,014
 
Net gains on mortgage loans
 
(10,566
)
 
(7,448
)
 
(5,628
)
Net gains on securities
 
(563
)
 
(20
)
 
(329
)
Securities impairment recognized in earnings
 
—
 
 
—
 
 
9
 
Net (gains) losses on other real estate and repossessed assets
 
250
 
 
(180
)
 
(500
)
Vehicle service contract counterparty contingencies
 
(50
)
 
119
 
 
199
 
Share based compensation
 
1,620
 
 
1,477
 
 
1,192
 
Litigation settlement expense
 
2,300
 
 
—
 
 
—
 
Loss on sale of payment plan business
 
320
 
 
—
 
 
—
 
Net gain on branch sale
 
—
 
 
(1,193
)
 
—
 
Gain on extinguishment of debt
 
—
 
 
—
 
 
(500
)
Increase in accrued income and other assets
 
(5,478
)
 
(1,387
)
 
(2,579
)
Increase (decrease) in accrued expenses and other liabilities
 
838
 
 
(196
)
 
(7,213
)
Total Adjustments
 
1,217
 
 
4,018
 
 
(4,950
)
Net Cash From Operating Activities
 
23,983
 
 
24,035
 
 
13,071
 
CASH FLOW USED IN INVESTING ACTIVITIES
 
 
 
 
 
 
 
 
 
Proceeds from the sale of securities available for sale
 
64,103
 
 
12,037
 
 
14,633
 
Proceeds from the maturity of securities available for sale
 
40,530
 
 
36,808
 
 
58,220
 
Principal payments received on securities available for sale
 
162,499
 
 
130,232
 
 
84,487
 
Purchases of securities available for sale
 
(297,925
)
 
(234,693
)
 
(224,946
)
Purchases of interest bearing deposits - time
 
—
 
 
(4,595
)
 
(2,401
)
Proceeds from the maturity of interest bearing deposits - time
 
6,253
 
 
6,222
 
 
6,719
 
Redemption of Federal Home Loan Bank and Federal Reserve Bank stock
 
371
 
 
4,906
 
 
3,814
 
Purchase of Federal Reserve Bank stock
 
(443
)
 
(458
)
 
(314
)
Net increase in portfolio loans (loans originated, net of principal payments)
 
(107,472
)
 
(74,343
)
 
(37,195
)
Purchase of portfolio loans
 
(15,000
)
 
(32,872
)
 
—
 
Net cash paid for branch sale
 
—
 
 
(7,229
)
 
—
 
Proceeds from the collection of vehicle service contract counterparty receivables
 
4,786
 
 
1,092
 
 
385
 
Proceeds from the sale of other real estate and repossessed assets
 
4,251
 
 
6,179
 
 
18,471
 
Proceeds from bank-owned life insurance
 
2,235
 
 
—
 
 
—
 
Proceeds from the sale of property and equipment
 
416
 
 
555
 
 
309
 
Capital expenditures
 
(3,459
)
 
(4,354
)
 
(4,298
)
Net Cash Used in Investing Activities
 
(138,855
)
 
(160,513
)
 
(82,116
)
CASH FLOW FROM FINANCING ACTIVITIES
 
 
 
 
 
 
 
 
 
Net increase in total deposits
 
139,756
 
 
170,314
 
 
39,496
 
Net decrease in other borrowings
 
—
 
 
(1
)
 
(1
)
Proceeds from Federal Home Loan Bank advances
 
—
 
 
100
 
 
100
 
Payments of Federal Home Loan Bank advances
 
(2,521
)
 
(615
)
 
(4,817
)
Net decrease in vehicle service contract counterparty payables
 
(279
)
 
(1,180
)
 
(2,112
)
Dividends paid
 
(7,274
)
 
(5,896
)
 
(4,129
)
Proceeds from issuance of common stock
 
82
 
 
112
 
 
97
 
Repurchase of common stock
 
(16,854
)
 
(13,498
)
 
—
 
Share based compensation withholding obligation
 
(627
)
 
(1,091
)
 
—
 
Redemption of subordinated debt
 
—
 
 
—
 
 
(4,654
)
Net Cash From Financing Activities
 
112,283
 
 
148,245
 
 
23,980
 
Net Increase (Decrease) in Cash and Cash Equivalents
 
(2,589
)
 
11,767
 
 
(45,065
)
Cash and Cash Equivalents at Beginning of Year
 
85,783
 
 
74,016
 
 
119,081
 
Cash and Cash Equivalents at End of Year
$
83,194
 
$
85,783
 
$
74,016
 
Cash paid during the year for
 
 
 
 
 
 
 
 
 
Interest
$
6,416
 
$
5,769
 
$
7,365
 
Income taxes
 
563
 
 
295
 
 
216
 
Transfers to other real estate and repossessed assets
 
2,355
 
 
6,694
 
 
6,143
 
Transfer of payment plan receivables to vehicle service contract counterparty receivables
 
200
 
 
1,203
 
 
180
 
Purchase of securities available for sale and interest bearing deposits - time not yet settled
 
1,582
 
 
—
 
 
265
 
Transfers to payment plan receivables and other assets held for sale
 
33,360
 
 
—
 
 
—
 
Transfers to other liabilities held for sale
 
718
 
 
—
 
 
—
 

See accompanying notes to consolidated financial statements

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 1 – ACCOUNTING POLICIES

The accounting and reporting policies and practices of Independent Bank Corporation and subsidiaries conform to accounting principles generally accepted in the United States of America and prevailing practices within the banking industry. Our critical accounting policies include the determination of the AFLL, the valuation of originated mortgage loan servicing rights and the valuation of deferred tax assets. We are required to make material estimates and assumptions that are particularly susceptible to changes in the near term as we prepare the consolidated financial statements and report amounts for each of these items. Actual results may vary from these estimates.

Our subsidiary Independent Bank (“Bank”) transacts business in the single industry of commercial banking. Our Bank’s activities cover traditional phases of commercial banking, including checking and savings accounts, commercial lending, direct and indirect consumer financing and mortgage lending. Our principal markets are the rural and suburban communities across Lower Michigan and Ohio that are served by our Bank’s branches and loan production offices. We also purchase payment plans from companies (which we refer to as “counterparties”) that provide vehicle service contracts and similar products to consumers, through our wholly owned subsidiary, Mepco Finance Corporation (“Mepco”). At December 31, 2016, 72.2% of our Bank’s loan portfolio was secured by real estate.

PRINCIPLES OF CONSOLIDATION — The consolidated financial statements include the accounts of Independent Bank Corporation and its subsidiaries. The income, expenses, assets and liabilities of the subsidiaries are included in the respective accounts of the consolidated financial statements, after elimination of all material intercompany accounts and transactions.

STATEMENTS OF CASH FLOWS — For purposes of reporting cash flows, cash and cash equivalents include cash on hand, amounts due from banks, interest bearing deposits and federal funds sold. Generally, federal funds are sold for one-day periods. We report net cash flows for customer loan and deposit transactions, for short-term borrowings and for vehicle service contract counterparty payables.

INTEREST BEARING DEPOSITS — Interest bearing deposits consist of overnight deposits with the Federal Reserve Bank.

INTEREST BEARING DEPOSITS - TIME — Interest bearing deposits - time consist of deposits with original maturities of 3 months or more.

LOANS HELD FOR SALE — Mortgage loans originated and intended for sale in the secondary market are carried at fair value. Fair value adjustments, as well as realized gains and losses, are recorded in current earnings.

PAYMENT PLAN RECEIVABLES AND OTHER ASSETS HELD FOR SALE — On December 30, 2016 Mepco executed an Asset Purchase Agreement (the “APA”) with Seabury Asset Management LLC (“Seabury”). Pursuant to the terms of the APA, Mepco is selling its payment plan processing business, payment plan receivables ($30.6 million), commercial loans ($0.8 million) and certain other assets ($2.0 million) to Seabury, who also is assuming certain liabilities ($0.7 million) of Mepco. These assets and liabilities are categorized as “held for sale” in our December 31, 2016 Consolidated Statement of Financial Condition. This transaction is expected to close during the first half of 2017. These assets and corresponding liabilities held for sale are carried at the lower of cost or fair value on an aggregate basis. Fair value adjustments, if any, are recorded in current earnings.

OPERATING SEGMENTS — While chief decision-makers monitor the revenue streams of our various products and services, operations are managed and financial performance is evaluated as one single unit. Discrete financial information is not available other than on a consolidated basis for material lines of business. Prior to 2016, we reported on two segments: Independent Bank and Mepco. However, given the significant reduction in the size of Mepco’s business and its relative immateriality, we have now eliminated any separate segment reporting on Mepco.

CAPITALIZED MORTGAGE LOAN SERVICING RIGHTS — We recognize as separate assets the rights to service mortgage loans for others. The fair value of originated mortgage loan servicing rights has been determined based upon fair value indications for similar servicing. The mortgage loan servicing rights are amortized in proportion to and over the period of estimated net loan servicing income. We assess mortgage loan servicing rights for impairment based on the fair value of those rights. For purposes of measuring impairment, the characteristics used include interest rate, term and type. Amortization of and changes in the impairment reserve on originated mortgage loan servicing rights are included in mortgage loan servicing, net in the Consolidated Statements of Operations. The

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  — (Continued)

fair values of mortgage loan servicing rights are subject to significant fluctuations as a result of changes in estimated and actual prepayment speeds and default rates and losses. Mortgage loan servicing income is recorded for fees earned for servicing loans previously sold. The fees are generally based on a contractual percentage of the outstanding principal and are recorded as income when earned. Mortgage loan servicing fees, excluding amortization of and changes in the impairment reserve on originated mortgage loan servicing rights, totaled $4.1 million, $4.1 million and $4.2 million for the years ended December 31, 2016, 2015 and 2014, respectively. Late fees and ancillary fees related to loan servicing are not material. As of January 1, 2017, we elected the fair value measurement method for our mortgage loan servicing rights (in lieu of the amortization method). We expect the cumulative effective of this accounting change to decrease January 1, 2017 retained deficit by $0.4 million, net of tax. We will no longer record amortization of or impairment against capitalized mortgage loan servicing rights, rather we will now record capitalized mortgage loan servicing rights at fair value with subsequent changes in fair value recorded as an increase or decrease to mortgage loan servicing, net, in our Consolidated Statements of Operations.

TRANSFERS OF FINANCIAL ASSETS — Transfers of financial assets are accounted for as sales when control over the assets has been relinquished. Control over transferred assets is deemed to be surrendered when the assets have been isolated from us, the transferee obtains the right (free of conditions that constrain it from taking advantage of that right) to pledge or exchange the transferred assets, and we do not maintain effective control over the transferred assets through an agreement to repurchase them before their maturity.

SECURITIES — We classify our securities as trading, held to maturity or available for sale. Trading securities are bought and held principally for the purpose of selling them in the near term and are reported at fair value with realized and unrealized gains and losses included in earnings. Securities held to maturity represent those securities for which we have the positive intent and ability to hold until maturity and are reported at cost, adjusted for amortization of premiums and accretion of discounts computed on the level-yield method. We did not have any securities held to maturity at December 31, 2016 and 2015. Securities available for sale represent those securities not classified as trading or held to maturity and are reported at fair value with unrealized gains and losses, net of applicable income taxes reported in other comprehensive income (loss).

We evaluate securities for other than temporary impairment (“OTTI”) at least on a quarterly basis and more frequently when economic or market conditions warrant such an evaluation. In performing this evaluation, management considers (1) the length of time and extent that fair value has been less than cost, (2) the financial condition and near term prospects of the issuer, (3) the impact of changes in market interest rates on the market value of the security and (4) an assessment of whether we intend to sell, or it is more likely than not that we will be required to sell a security in an unrealized loss position before recovery of its amortized cost basis. For securities that do not meet the aforementioned recovery criteria, the amount of impairment recognized in earnings is limited to the amount related to credit losses, while impairment related to other factors is recognized in other comprehensive income (loss). The credit loss is defined as the difference between the present value of the cash flows expected to be collected and the amortized cost basis.

Gains and losses realized on the sale of securities available for sale are determined using the specific identification method and are recognized on a trade-date basis.

FEDERAL HOME LOAN BANK (“FHLB”) STOCK — Our Bank subsidiary is a member of the FHLB system. Members are required to own a certain amount of stock based on the level of borrowings and other factors, and may invest in additional amounts. FHLB stock is carried at cost, classified as a restricted security, and periodically evaluated for impairment based on ultimate recovery of par value. Both cash and stock dividends are reported as income in interest income-other investments on the Consolidated Statements of Operations.

FEDERAL RESERVE BANK (“FRB”) STOCK — Our Bank subsidiary is a member of its regional Federal Reserve Bank. FRB stock is carried at cost, classified as a restricted security, and periodically evaluated for impairment based on ultimate recovery of par value. Both cash and stock dividends are reported as income in interest income-other investments on the Consolidated Statements of Operations.

LOAN REVENUE RECOGNITION — Interest on loans is accrued based on the principal amounts outstanding. In general, the accrual of interest income is discontinued when a loan becomes 90 days past due for commercial loans and installment loans and when a loan misses four consecutive payments for mortgage loans and the borrower’s capacity to repay the loan and collateral values appear insufficient for each loan class. However, loans may be placed

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  — (Continued)

on non-accrual status regardless of whether or not such loans are considered past due if, in management’s opinion, the borrower is unable to meet payment obligations as they become due or as required by regulatory provisions. All interest accrued but not received for all loans placed on non-accrual is reversed from interest income. Payments on such loans are generally applied to the principal balance until qualifying to be returned to accrual status. A non-accrual loan may be restored to accrual status when interest and principal payments are current and the loan appears otherwise collectible. Delinquency status for all classes in the commercial and installment loan segments is based on the actual number of days past due as required by the contractual terms of the loan agreement while delinquency status for mortgage loan segment classes is based on the number of payments past due.

Certain loan fees and direct loan origination costs are deferred and recognized as an adjustment of yield generally over the contractual life of the related loan. Fees received in connection with loan commitments are deferred until the loan is advanced and are then recognized generally over the contractual life of the loan as an adjustment of yield. Fees on commitments that expire unused are recognized at expiration. Fees received for letters of credit are recognized as revenue over the life of the commitment.

PAYMENT PLAN RECEIVABLE REVENUE RECOGNITION — Payment plan receivables are acquired by Mepco at a discount and reported net of this discount in the Consolidated Statements of Financial Condition. This discount is accreted into interest and fees on loans in the Consolidated Statements of Operations over the life of the receivable computed on a level-yield method. All classes of payment plan receivables that have been canceled and are 90 days or more past due as required by the contractual terms of the payment plan are classified as non-accrual.

ALLOWANCE FOR LOAN LOSSES — Portfolios are disaggregated into segments for purposes of determining the allowance for loan losses (“AFLL”) which include commercial, mortgage and installment loans and prior to December 31, 2016, payment plan receivables. These segments are further disaggregated into classes for purposes of monitoring and assessing credit quality based on certain risk characteristics. Classes within the commercial loan segment include (i) income producing – real estate, (ii) land, land development and construction – real estate and (iii) commercial and industrial. Classes within the mortgage loan segment include (i) 1-4 family, (ii) resort lending, (iii) home equity – 1st lien, (iv) home equity – 2nd lien and beginning in 2015 (v) purchased loans. Classes within the installment loan segment include (i) home equity – 1st lien, (ii) home equity – 2nd lien, (iii) loans not secured by real estate and (iv) other. Classes within the payment plan receivables segment include (i) full refund, (ii) partial refund and (iii) other. Commercial loans are subject to adverse market conditions which may impact the borrower’s ability to make repayment on the loan or could cause a decline in the value of the collateral that secures the loan. Mortgage and installment loans and payment plan receivables are subject to adverse employment conditions in the local economy which could increase default rates. In addition, mortgage loans and real estate based installment loans are subject to adverse market conditions which could cause a decline in the value of collateral that secures the loan. For an analysis of the AFLL by portfolio segment and credit quality information by class, see note #4.

Some loans will not be repaid in full. Therefore, an AFLL is maintained at a level which represents our best estimate of losses incurred. In determining the AFLL and the related provision for loan losses, we consider four principal elements: (i) specific allocations based upon probable losses identified during the review of the loan portfolio, (ii) allocations established for other adversely rated commercial loans, (iii) allocations based principally on historical loan loss experience, and (iv) additional allocations based on subjective factors, including local and general economic business factors and trends, portfolio concentrations and changes in the size and/or the general terms of the loan portfolios.

The first AFLL element (specific allocations) reflects our estimate of probable incurred losses based upon our systematic review of specific loans. These estimates are based upon a number of objective factors, such as payment history, financial condition of the borrower, discounted collateral exposure and discounted cash flow analysis. Impaired commercial, mortgage and installment loans are allocated allowance amounts using this first element. The second AFLL element (other adversely rated commercial loans) reflects the application of our loan rating system. This rating system is similar to those employed by state and federal banking regulators. Commercial loans that are rated below a certain predetermined classification are assigned a loss allocation factor for each loan classification category that is based upon a historical analysis of both the probability of default and the expected loss rate (“loss given default”). The lower the rating assigned to a loan or category, the greater the allocation percentage that is applied. The third AFLL element (historical loss allocations) is determined by assigning allocations to higher rated (“non-watch credit”) commercial loans using a probability of default and loss given default similar to the second

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  — (Continued)

AFLL element and to homogenous mortgage and installment loan groups based upon borrower credit score and portfolio segment. For homogenous mortgage and installment loans a probability of default for each homogenous pool is calculated by way of credit score migration. Historical loss data for each homogenous pool coupled with the associated probability of default is utilized to calculate an expected loss allocation rate. The fourth AFLL element (additional allocations based on subjective factors) is based on factors that cannot be associated with a specific credit or loan category and reflects our attempt to reasonably ensure that the overall AFLL appropriately reflects a margin for the imprecision necessarily inherent in the estimates of expected credit losses. We consider a number of subjective factors when determining this fourth element, including local and general economic business factors and trends, portfolio concentrations and changes in the size, mix and the general terms of the overall loan portfolio.

Increases in the AFLL are recorded by a provision for loan losses charged to expense. Although we periodically allocate portions of the AFLL to specific loans and loan portfolios, the entire AFLL is available for incurred losses.

We generally charge-off commercial, homogenous residential mortgage and installment loans and payment plan receivables when they are deemed uncollectible or reach a predetermined number of days past due based on loan product, industry practice and other factors. Collection efforts may continue and recoveries may occur after a loan is charged against the AFLL.

While we use relevant information to recognize losses on loans, additional provisions for related losses may be necessary based on changes in economic conditions, customer circumstances and other credit risk factors.

A loan is impaired when full payment under the loan terms is not expected. Generally, those loans included in each commercial loan class that are rated substandard, classified as non-performing or were classified as non-performing in the preceding quarter, are evaluated for impairment. Those loans included in each mortgage loan or installment loan class whose terms have been modified and considered a troubled debt restructuring are also impaired. Loans which have been modified resulting in a concession, and which the borrower is experiencing financial difficulties, are considered troubled debt restructurings (“TDR”) and classified as impaired. We measure our investment in an impaired loan based on one of three methods: the loan’s observable market price, the fair value of the collateral or the present value of expected future cash flows discounted at the loan’s effective interest rate. Large groups of smaller balance homogeneous loans, such as those loans included in each installment and mortgage loan class and each payment plan receivable class, are collectively evaluated for impairment and accordingly, they are not separately identified for impairment disclosures. TDR loans are measured at the present value of estimated future cash flows using the loan’s effective interest rate at inception of the loan. If a TDR is considered to be a collateral dependent loan, the loan is reported net, at the fair value of collateral. A loan can be removed from TDR status if it is subsequently restructured and the borrower is no longer experiencing financial difficulties and the newly restructured agreement does not contain any concessions to the borrower. The new agreement must specify market terms, including a contractual interest rate not less than a market interest rate for new debt with similar credit risk characteristics, and other terms no less favorable to us than those we would offer for similar new debt.

PROPERTY AND EQUIPMENT — Property and equipment is stated at cost less accumulated depreciation and amortization. Depreciation and amortization is computed using both straight-line and accelerated methods over the estimated useful lives of the related assets. Buildings are generally depreciated over a period not exceeding 39 years and equipment is generally depreciated over periods not exceeding 7 years. Leasehold improvements are depreciated over the shorter of their estimated useful life or lease period.

BANK OWNED LIFE INSURANCE — We have purchased a group flexible premium non-participating variable life insurance contract on approximately 267 lives (who were salaried employees at the time we purchased the contract) in order to recover the cost of providing certain employee benefits. Bank owned life insurance is recorded at its cash surrender value or the amount that can be currently realized.

OTHER REAL ESTATE AND REPOSSESSED ASSETS — Other real estate at the time of acquisition is recorded at fair value, less estimated costs to sell, which becomes the property’s new basis. Fair value is typically determined by a third party appraisal of the property. Any write-downs at date of acquisition are charged to the AFLL. Expense incurred in maintaining other real estate and subsequent write-downs to reflect declines in value and gains or losses on the sale of other real estate are recorded in the Consolidated Statements of Operations. Non-real estate repossessed assets are treated in a similar manner.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  — (Continued)

OTHER INTANGIBLES — Other intangible assets consist of core deposits. They are initially measured at fair value and then are amortized on both straight-line and accelerated methods over their estimated useful lives, which range from 10 to 15 years.

VEHICLE SERVICE CONTRACT COUNTERPARTY RECEIVABLES, NET — These amounts represent funds due to Mepco from its counterparties for cancelled service contracts. Upon the cancellation of a service contract and the completion of the billing process to the counterparties for amounts due to Mepco, there is a decrease in the amount of “payment plan receivables” and an increase in the amount of “vehicle service contract counterparty receivables” until such time as the amount due from the counterparty is collected.

INCOME TAXES — We employ the asset and liability method of accounting for income taxes. This method establishes deferred tax assets and liabilities for the temporary differences between the financial reporting basis and the tax basis of our assets and liabilities at tax rates expected to be in effect when such amounts are realized or settled. Under this method, the effect of a change in tax rates is recognized in the period that includes the enactment date. The deferred tax asset is subject to a valuation allowance for that portion of the asset for which it is more likely than not that it will not be realized.

A tax position is recognized as a benefit only if it is “more likely than not” that the tax position would be sustained in a tax examination, with a tax examination being presumed to occur. The amount recognized is the largest amount of tax benefit that is greater than 50% likely of being realized on examination.

We recognize interest and/or penalties related to income tax matters in income tax expense.

We file a consolidated federal income tax return. Intercompany tax liabilities are settled as if each subsidiary filed a separate return.

COMMITMENTS TO EXTEND CREDIT AND RELATED FINANCIAL INSTRUMENTS — Financial instruments may include commitments to extend credit and standby letters of credit. Financial instruments involve varying degrees of credit and interest-rate risk in excess of amounts reflected in the Consolidated Statements of Financial Condition. Exposure to credit risk in the event of non-performance by the counterparties to the financial instruments for loan commitments to extend credit and letters of credit is represented by the contractual amounts of those instruments. In general, we use a similar methodology to estimate our liability for these off-balance sheet credit exposures as we do for our AFLL. For commercial related commitments, we estimate liability using our loan rating system and for mortgage and installment commitments we estimate liability principally upon historical loss experience. Our estimated liability for off balance sheet commitments is included in accrued expenses and other liabilities in our Consolidated Statements of Financial Condition and any charge or recovery is recorded in non-interest expense - other in our Consolidated Statements of Operations.

DERIVATIVE FINANCIAL INSTRUMENTS — We record derivatives on our Consolidated Statements of Financial Condition as assets and liabilities measured at their fair value. The accounting for increases and decreases in the value of derivatives depends upon the use of derivatives and whether the derivatives qualify for hedge accounting.

At the inception of the derivative we designate the derivative as one of three types based on our intention and belief as to likely effectiveness as a hedge. These three types are (1) a hedge of the fair value of a recognized asset or liability or of an unrecognized firm commitment (“Fair Value Hedge”), (2) a hedge of a forecasted transaction or the variability of cash flows to be received or paid related to a recognized asset or liability (“Cash Flow Hedge”), or (3) an instrument with no hedging designation. For a Fair Value Hedge, the gain or loss on the derivative, as well as the offsetting loss or gain on the hedged item, are recognized in current earnings as fair values change. For a Cash Flow Hedge, the gain or loss on the derivative is reported in other comprehensive income (loss) and is reclassified into earnings in the same periods during which the hedged transaction affects earnings. We did not have any Fair Value Hedges or Cash Flow Hedges at December 31, 2016 or 2015. For both types of hedges, changes in the fair value of derivatives that are not highly effective in hedging the changes in fair value or expected cash flows of the hedged item are recognized immediately in current earnings. For instruments with no hedging designation, the gain or loss on the derivative is reported in earnings. These free standing instruments currently consist of (i) mortgage banking related derivatives and include rate-lock loan commitments to fund mortgage loans (interest rate locks) to be sold into the secondary market and mandatory forward commitments for the future delivery of these mortgage loans, (ii) certain pay-fixed and pay-variable interest rate swap agreements related to commercial loan customers and

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(iii) certain purchased and written options related to a time deposit product. Fair values of the mortgage derivatives are estimated based on mortgage backed security pricing for comparable assets. We enter into mandatory forward commitments for the future delivery of mortgage loans generally when interest rate locks are entered into in order to hedge the change in interest rates resulting from our commitments to fund the loans. Changes in the fair values of these derivatives are included in net gains on mortgage loans in the Consolidated Statements of Operations. Fair values of the pay-fixed and pay-variable interest rate swap agreements are based on discounted cash flow analyses and are included in net interest income in the Consolidated Statements of Operations. Fair values of the purchased and written options are based on prices of financial instruments with similar characteristics and are included in net interest income in the Consolidated Statements of Operations.

Net cash settlements on derivatives that qualify for hedge accounting are recorded in interest expense. Net cash settlements on derivatives that do not qualify for hedge accounting are reported in non-interest income (mortgage banking related derivatives) or net interest income (interest rate swap agreements and options). Cash flows on hedges are classified in the cash flow statement the same as the cash flows of the items being hedged.

We formally document the relationship between derivatives and hedged items, as well as the risk- management objective and the strategy for undertaking hedge transactions, at the inception of the hedging relationship. This documentation includes linking Fair Value or Cash Flow Hedges to specific assets and liabilities on the Consolidated Statements of Financial Condition or to specific firm commitments or forecasted transactions. We also assess, both at the hedge’s inception and on an ongoing basis, whether the derivative instruments that are used are highly effective in offsetting changes in fair values or cash flows of the hedged items. We discontinue hedge accounting when it is determined that the derivative is no longer effective in offsetting changes in the fair value or cash flows of the hedged item, the derivative is settled or terminates, a hedged forecasted transaction is no longer probable, a hedged firm commitment is no longer firm, or treatment of the derivative as a hedge is no longer appropriate or intended.

When hedge accounting is discontinued, subsequent changes in fair value of the derivative are recorded in earnings. When a fair value hedge is discontinued, the hedged asset or liability is no longer adjusted for changes in fair value and the existing basis adjustment is amortized or accreted over the remaining life of the asset or liability. When a cash flow hedge is discontinued but the hedged cash flows or forecasted transactions are still expected to occur, gains or losses that were accumulated in other comprehensive loss are amortized into earnings over the same periods which the hedged transactions will affect earnings.

COMPREHENSIVE INCOME — Comprehensive income consists of net income, unrealized gains and losses on securities available for sale and derivative instruments classified as cash flow hedges.

NET INCOME PER COMMON SHARE — Basic net income per common share is computed by dividing net income by the weighted average number of common shares outstanding during the period and participating share awards. All outstanding unvested share-based payment awards that contain rights to nonforfeitable dividends are considered participating securities for this calculation. For diluted net income per common share, net income is divided by the weighted average number of common shares outstanding during the period plus the assumed exercise of stock options, restricted stock units, performance share units and stock units for a deferred compensation plan for non-employee directors.

SHARE BASED COMPENSATION — Cost is recognized for non-vested share awards issued to employees based on the fair value of these awards at the date of grant. A simulation analysis which considers potential outcomes for a large number of independent scenarios is utilized to estimate the fair value of performance share units and the market price of our common stock at the date of grant is used for other non-vested share awards. Cost is recognized over the required service period, generally defined as the vesting period. Cost is also recognized for stock issued to non-employee directors. These shares vest immediately and cost is recognized during the period they are issued.

COMMON STOCK — At December 31, 2016, 0.1 million shares of common stock were reserved for issuance under the dividend reinvestment plan and 0.4 million shares of common stock were reserved for issuance under our long-term incentive plans.

RECLASSIFICATION — Certain amounts in the 2015 and 2014 consolidated financial statements have been reclassified to conform to the 2016 presentation.

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ADOPTION OF NEW ACCOUNTING STANDARDS — In June 2014, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2014-12, “Compensation – Stock Compensation (Topic 718) – Accounting for Share-Based Payments When the Terms of an Award Provide That a Performance Target Could Be Achieved After the Requisite Service Period”. This ASU amends existing guidance related to the accounting for share-based payments when the terms of an award provide that a performance target could be achieved after the requisite service period. These amendments require that a performance target that affects vesting and that could be achieved after the requisite service period be treated as a performance condition. The total amount of compensation cost recognized during and after the requisite service period should reflect the number of awards that are expected to vest and should be adjusted to reflect those awards that ultimately vest. The requisite service period ends when the employee can cease rendering service and still be eligible to vest in the award if the performance target is achieved. This amended guidance became effective for us on January 1, 2016, and did not have a material impact on our consolidated operating results or financial condition.

In March 2016, the FASB issued ASU 2016-09, “Compensation – Stock Compensation (718) Improvements to Employee Share-Based Payment Accounting”. This ASU amends existing guidance in an effort to simplify certain aspects of accounting for share-based payments. The areas for simplification in this ASU include income tax consequences, classification of awards as either equity or liabilities and classification on the statement of cash flows. This amended guidance is effective for us on January 1, 2017, with early adoption permitted. We adopted this amended guidance during the second quarter of 2016 using a modified retrospective approach. The impact of this adoption was to adjust our January 1, 2016 Consolidated Statement of Financial Position to reflect cumulative effect adjustments as follows:

 
January 1,
2016
Originally
Presented
Cumulative
Retrospective
Adjustments
January 1,
2016
Adjusted
 
(Dollars in thousands)
Deferred tax assets
$
39,635
 
$
1,247
 
$
40,882
 
Total assets
$
2,409,066
 
$
1,247
 
$
2,410,313
 
Common stock
$
339,462
 
$
62
 
$
339,524
 
Accumulated deficit
$
(82,334
)
$
1,185
 
$
(81,149
)
Total Shareholders’ Equity
$
251,092
 
$
1,247
 
$
252,339
 
Total Liabilities and Shareholders’ Equity
$
2,409,066
 
$
1,247
 
$
2,410,313
 

The adjustments above reflect the recording of $1.23 million of unrealized excess benefits on share based compensation and $0.06 million (impact to equity of $0.02 million after consideration of deferred taxes) for the impact of making an accounting policy election to account for forfeitures as they occur. After January 1, 2016, excess tax benefits or deficiencies resulting from share-based payments will be recognized as tax benefit or expense when they occur. Tax benefits of $0.3 million were recorded during the year ended December 31, 2016, as a result of share awards vesting and stock option exercises. In addition, we have elected to apply the amendments related to the presentation of excess tax benefits in the statement of cash flows on a prospective basis.

In May 2014, the FASB issued ASU 2014-09, “Revenue from Contracts with Customers (Topic 606) ”. This ASU supersedes and replaces nearly all existing revenue recognition guidance, including industry-specific guidance, establishes a new control-based revenue recognition model, changes the basis for deciding when revenue is recognized over time or at a point in time, provides new and more detailed guidance on specific topics and expands and improves disclosures about revenue. In addition, this ASU specifies the accounting for some costs to obtain or fulfill a contract with a customer. This amended guidance is effective for us on January 1, 2018, and is not expected to have a material impact on our consolidated operating results or financial condition. Financial instruments for the most part and related contractual rights and obligations which are the sources of the majority of our operating revenue are excluded from the scope of this amended guidance. In addition, for those operating revenue streams that are included in the scope of this amended guidance, based upon our review of these sources of income we do not believe they will be materially impacted by this amended guidance.

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In January 2016, the FASB issued ASU 2016-01, “Financial Instruments – Overall (Subtopic 825-10) – Recognition and Measurement of Financial Assets and Financial Liabilities”. This ASU amends existing guidance related to the accounting for certain financial assets and liabilities. These amendments, among other things, requires equity investments (except those accounted for under the equity method of accounting, or those that result in consolidation of the investee) to be measured at fair value with changes in fair value recognized in net income, requires public business entities to use the exit price notion when measuring the fair value of financial instruments for disclosure purposes, requires separate presentation of financial assets and financial liabilities by measurement category and form of financial asset and eliminates the requirement for public business entities to disclose the method(s) and significant assumptions used to estimate the fair value that is required to be disclosed for financial instruments measured at amortized cost. This amended guidance is effective for us on January 1, 2018. We have reviewed the types of financial instruments impacted by this amended guidance, including certain equity investments and liabilities measured under the fair value election, and have determined that we do not currently own any such instruments. The balance of this amended guidance is expected to impact certain disclosure items but is not expected to have any impact on our consolidated operating results or financial condition.

In February 2016, the FASB issued ASU 2016-02, “Leases (Topic 842)”. This ASU amends existing guidance related to the accounting for leases. These amendments, among other things, requires lessees to account for most leases on the balance sheet while recognizing expense on the income statement in a manner similar to existing guidance. For lessors the guidance modifies the classification criteria and the accounting for sales-type and direct finance leases. This amended guidance is effective for us on January 1, 2019 and is not expected to have a material impact on our consolidated operating results or financial condition. Based on a review of our operating leases that we currently have in place (see note #18) we do not expect a material change in the recognition, measurement and presentation of lease expense or impact on cash flow. While the primary impact will be the recognition of certain operating leases on our Consolidated Statements of Financial Condition, this impact is not expected to be material.

In June 2016, the FASB issued ASU 2016-13, “Financial Instruments — Credit Losses (Topic 326), Measurement of Credit Losses on Financial Instruments”. This ASU significantly changes how entities will measure credit losses for most financial assets and certain other instruments that are not measured at fair value through net income. This ASU will replace today’s “incurred loss” approach with an “expected loss” model for instruments measured at amortized cost. For securities available for sale, allowances will be recorded rather than reducing the carrying amount as is done under the current other-than-temporary impairment model. This ASU also simplifies the accounting model for purchased credit-impaired debt securities and loans. This amended guidance is effective for us on January 1, 2020. We began evaluating this ASU in 2016 and have formed a committee that includes personnel from various areas of the Bank that meets regularly to discuss the implementation of this ASU. We are in the process of gathering data and reviewing loss methodologies as well as reviewing certain software applications that would assist us in the implementation of this ASU. While we have not yet determined what the impact will be on our consolidated operating results or financial condition by the nature of the implementation of an expected loss model compared to an incurred loss approach, we would expect our AFLL to increase under this ASU.

NOTE 2 – RESTRICTIONS ON CASH AND DUE FROM BANKS

Our Bank is required to maintain reserve balances in the form of vault cash and non-interest earning balances with the FRB. The average reserve balances to be maintained during 2016 and 2015 were $4.0 million and $3.2 million, respectively. We do not maintain compensating balances with correspondent banks. We are also required to maintain reserve balances related primarily to our merchant payment processing operations and for certain investment security transactions. These balances are held at unrelated financial institutions and totaled $2.4 million and $2.5 million at December 31, 2016 and 2015, respectively.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  — (Continued)

NOTE 3 – SECURITIES

Securities available for sale consist of the following at December 31:

 
Amortized
Cost
Unrealized
Fair Value
 
Gains
Losses
 
(In thousands)
2016
 
 
 
 
 
 
 
 
 
 
 
 
U.S. agency
$
28,909
 
$
159
 
$
80
 
$
28,988
 
U.S. agency residential mortgage-backed
 
156,053
 
 
1,173
 
 
937
 
 
156,289
 
U.S. agency commercial mortgage-backed
 
12,799
 
 
28
 
 
195
 
 
12,632
 
Private label mortgage-backed
 
35,035
 
 
216
 
 
524
 
 
34,727
 
Other asset backed
 
146,829
 
 
271
 
 
391
 
 
146,709
 
Obligations of states and political subdivisions
 
175,180
 
 
478
 
 
4,759
 
 
170,899
 
Corporate
 
56,356
 
 
223
 
 
399
 
 
56,180
 
Trust preferred
 
2,922
 
 
—
 
 
343
 
 
2,579
 
Foreign government
 
1,626
 
 
—
 
 
13
 
 
1,613
 
Total
$
615,709
 
$
2,548
 
$
7,641
 
$
610,616
 
 
 
 
 
 
 
 
 
 
 
 
 
 
2015
 
 
 
 
 
 
 
 
 
 
 
 
U.S. agency
$
47,283
 
$
309
 
$
80
 
$
47,512
 
U.S. agency residential mortgage-backed
 
195,055
 
 
1,584
 
 
583
 
 
196,056
 
U.S. agency commercial mortgage-backed
 
34,017
 
 
94
 
 
83
 
 
34,028
 
Private label mortgage-backed
 
5,061
 
 
161
 
 
319
 
 
4,903
 
Other asset backed
 
117,431
 
 
54
 
 
581
 
 
116,904
 
Obligations of states and political subdivisions
 
145,193
 
 
941
 
 
1,150
 
 
144,984
 
Corporate
 
38,895
 
 
9
 
 
290
 
 
38,614
 
Trust preferred
 
2,916
 
 
—
 
 
433
 
 
2,483
 
Total
$
585,851
 
$
3,152
 
$
3,519
 
$
585,484
 

Total OTTI recognized in accumulated other comprehensive loss for securities available for sale was zero at both December 31, 2016 and 2015, respectively.

Our investments’ gross unrealized losses and fair values aggregated by investment type and length of time that individual securities have been at a continuous unrealized loss position, at December 31 follows:

 
Less Than Twelve Months
Twelve Months or More
Total
 
Fair
Value
Unrealized
Losses
Fair
Value
Unrealized
Losses
Fair
Value
Unrealized
Losses
 
(In thousands)
2016
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
U.S. agency
$
4,179
 
$
41
 
$
8,217
 
$
39
 
$
12,396
 
$
80
 
U.S. agency residential mortgage-backed
 
62,524
 
 
732
 
 
20,857
 
 
205
 
 
83,381
 
 
937
 
U.S. agency commercial mortgage-backed
 
6,079
 
 
194
 
 
143
 
 
1
 
 
6,222
 
 
195
 
Private label mortgage-backed
 
20,545
 
 
281
 
 
1,413
 
 
243
 
 
21,958
 
 
524
 
Other asset backed
 
52,958
 
 
172
 
 
17,763
 
 
219
 
 
70,721
 
 
391
 
Obligations of states and political subdivisions
 
113,078
 
 
4,014
 
 
14,623
 
 
745
 
 
127,701
 
 
4,759
 
Corporate
 
25,546
 
 
292
 
 
2,810
 
 
107
 
 
28,356
 
 
399
 
Trust preferred
 
—
 
 
—
 
 
2,579
 
 
343
 
 
2,579
 
 
343
 
Foreign government
 
1,613
 
 
13
 
 
—
 
 
—
 
 
1,613
 
 
13
 
Total
$
286,522
 
$
5,739
 
$
68,405
 
$
1,902
 
$
354,927
 
$
7,641
 

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  — (Continued)

 
Less Than Twelve Months
Twelve Months or More
Total
 
Fair
Value
Unrealized
Losses
Fair
Value
Unrealized
Losses
Fair
Value
Unrealized
Losses
 
(In thousands)
2015
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
U.S. agency
$
12,164
 
$
47
 
$
6,746
 
$
33
 
$
18,910
 
$
80
 
U.S. agency residential mortgage-backed
 
57,538
 
 
316
 
 
23,340
 
 
267
 
 
80,878
 
 
583
 
U.S. agency commercial mortgage-backed
 
16,747
 
 
60
 
 
2,247
 
 
23
 
 
18,994
 
 
83
 
Private label mortgage-backed
 
—
 
 
—
 
 
3,393
 
 
319
 
 
3,393
 
 
319
 
Other asset backed
 
102,660
 
 
434
 
 
5,189
 
 
147
 
 
107,849
 
 
581
 
Obligations of states and political subdivisions
 
52,493
 
 
597
 
 
12,240
 
 
553
 
 
64,733
 
 
1,150
 
Corporate
 
30,550
 
 
290
 
 
—
 
 
—
 
 
30,550
 
 
290
 
Trust preferred
 
—
 
 
—
 
 
2,483
 
 
433
 
 
2,483
 
 
433
 
Total
$
272,152
 
$
1,744
 
$
55,638
 
$
1,775
 
$
327,790
 
$
3,519
 

Our portfolio of securities available for sale is reviewed quarterly for impairment in value. In performing this review, management considers (1) the length of time and extent that fair value has been less than cost, (2) the financial condition and near term prospects of the issuer, (3) the impact of changes in market interest rates on the market value of the security and (4) an assessment of whether we intend to sell, or it is more likely than not that we will be required to sell a security in an unrealized loss position before recovery of its amortized cost basis. For securities that do not meet the aforementioned recovery criteria, the amount of impairment recognized in earnings is limited to the amount related to credit losses, while impairment related to other factors is recognized in other comprehensive income (loss).

U.S. agency, U.S. agency residential mortgage-backed securities and U.S. agency commercial mortgage backed securities — at December 31, 2016, we had 25 U.S. agency, 118 U.S. agency residential mortgage-backed and nine U.S. agency commercial mortgage-backed securities whose fair market value is less than amortized cost. The unrealized losses are largely attributed to increases in interest rates since acquisition and widening spreads to Treasury bonds. As management does not intend to liquidate these securities and it is more likely than not that we will not be required to sell these securities prior to recovery of these unrealized losses, no declines are deemed to be other than temporary.

Private label residential mortgage backed securities — at December 31, 2016, we had 34 of this type of security whose fair value is less than amortized cost. The unrealized losses are centered in four securities purchased prior to 2016. Two of these four securities have an impairment in excess of 10% and all four of these holdings have been impaired for more than 12 months. The unrealized losses are largely attributable to credit spread widening on these four securities since their acquisition.

These four securities are receiving principal and interest payments. Most of these transactions are pass-through structures, receiving pro rata principal and interest payments from a dedicated collateral pool. The nonreceipt of interest cash flows is not expected and thus not presently considered in our discounted cash flow methodology discussed below.

These four private label mortgage-backed securities are reviewed for OTTI utilizing a cash flow projection. The cash flow analysis forecasts cash flow from the underlying loans in each transaction and then applies these cash flows to the bonds in the securitization. Our cash flow analysis forecasts complete recovery of our cost basis for all four of these securities whose fair value is less than amortized cost.

As management does not intend to liquidate these securities and it is more likely than not that we will not be required to sell these securities prior to recovery of these unrealized losses, no other declines discussed above are deemed to be other than temporary.

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Other asset backed — at December 31, 2016, we had 111 other asset backed securities whose fair value is less than amortized cost. The unrealized losses are primarily due to credit spread widening and increases in interest rates since acquisition. As management does not intend to liquidate these securities and it is more likely than not that we will not be required to sell these securities prior to recovery of these unrealized losses, no declines are deemed to be other than temporary.

Obligations of states and political subdivisions — at December 31, 2016, we had 329 municipal securities whose fair value is less than amortized cost. The unrealized losses are primarily due to increases in interest rates since acquisition. Fifty-one of these securities have an impairment in excess of 10%. The larger relative impairments on obligations of states and political subdivisions is due primarily to the longer maturities of many of the securities in this portfolio and interest rate spread widening relative to treasury securities in late 2016, due in part, to market reaction to the potential for a future reduction in corporate income tax rates, which would reduce the tax benefit of owning tax-exempt securities. As management does not intend to liquidate these securities and it is more likely than not that we will not be required to sell these securities prior to recovery of these unrealized losses, no declines are deemed to be other than temporary.

Corporate — at December 31, 2016, we had 30 corporate securities whose fair value is less than amortized cost. The unrealized losses are primarily due to credit spread widening and increases in interest rates since acquisition. As management does not intend to liquidate these securities and it is more likely than not that we will not be required to sell these securities prior to recovery of these unrealized losses, no declines are deemed to be other than temporary.

Trust preferred securities — at December 31, 2016, we had three trust preferred securities whose fair value is less than amortized cost. All of our trust preferred securities are single issue securities issued by a trust subsidiary of a bank holding company. The pricing of trust preferred securities has suffered from credit spread widening.

One of the three securities is rated by two major rating agencies as investment grade, while one (a Bank of America issuance) is rated below investment grade by two major rating agencies and the other one is non-rated. The non-rated issue is a relatively small bank and was never rated. The issuer of this non-rated trust preferred security, which had a total amortized cost of $1.0 million and total fair value of $0.8 million as of December 31, 2016, continues to have satisfactory credit metrics and make interest payments.

The following table breaks out our trust preferred securities in further detail as of December 31:

 
2016
2015
 
Fair
Value
Net
Unrealized
Loss
Fair
Value
Net
Unrealized
Loss
 
(In thousands)
Trust preferred securities
 
 
 
 
 
 
 
 
 
 
 
 
Rated issues
$
1,800
 
$
(123
)
$
1,690
 
$
(226
)
Unrated issues
 
779
 
 
(220
)
 
793
 
 
(207
)

As management does not intend to liquidate these securities and it is more likely than not that we will not be required to sell these securities prior to recovery of these unrealized losses, no declines are deemed to be other than temporary.

Foreign government — at December 31, 2016, we had one foreign government security whose fair value is less than amortized cost. The unrealized loss is primarily due to increases in interest rates since acquisition. As management does not intend to liquidate this security and it is more likely than not that we will not be required to sell this security prior to recovery of this unrealized loss, this decline is not deemed to be other than temporary.

We recorded zero credit related OTTI charges in the Consolidated Statements of Operations on securities available for sale during 2016 and 2015 and $0.01 million during 2014.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  — (Continued)

At December 31, 2016, three private label residential mortgage-backed securities had credit related OTTI and are summarized as follows:

 
Senior
Security
Super
Senior
Security
Senior
Support
Security
Total
 
(In thousands)
As of December 31, 2016
 
 
 
 
 
 
 
 
 
 
 
 
Fair value
$
1,226
 
$
1,096
 
$
74
 
$
2,396
 
Amortized cost
 
1,184
 
 
1,029
 
 
—
 
 
2,213
 
Non-credit unrealized loss
 
—
 
 
—
 
 
—
 
 
—
 
Unrealized gain
 
42
 
 
67
 
 
74
 
 
183
 
Cumulative credit related OTTI
 
757
 
 
457
 
 
380
 
 
1,594
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Credit related OTTI recognized in our Consolidated Statements of Operations
 
 
 
 
 
 
 
 
 
 
 
 
For the years ended December 31,
 
 
 
 
 
 
 
 
 
 
 
 
2016
$
—
 
$
—
 
$
—
 
$
—
 
2015
 
—
 
 
—
 
 
—
 
 
—
 
2014
 
9
 
 
—
 
 
—
 
 
9
 

Each of these securities is receiving principal and interest payments similar to principal reductions in the underlying collateral. All three of these securities have unrealized gains at December 31, 2016. The original amortized cost for each of these securities has been permanently adjusted downward for previously recorded credit related OTTI. The unrealized loss (based on original amortized cost) for these securities is now less than previously recorded credit related OTTI amounts.

A roll forward of credit losses recognized in earnings on securities available for sale for the years ending December 31 follow:

 
2016
2015
2014
 
(In thousands)
Balance at beginning of year
$
1,844
 
$
1,844
 
$
1,835
 
Additions to credit losses on securities for which no previous OTTI was recognized
 
—
 
 
—
 
 
—
 
Increases to credit losses on securities for which OTTI was previously recognized
 
—
 
 
—
 
 
9
 
Total
$
1,844
 
$
1,844
 
$
1,844
 

The amortized cost and fair value of securities available for sale at December 31, 2016, by contractual maturity, follow:

 
Amortized
Cost
Fair
Value
 
(In thousands)
Maturing within one year
$
18,728
 
$
18,751
 
Maturing after one year but within five years
 
102,330
 
 
101,846
 
Maturing after five years but within ten years
 
79,798
 
 
78,140
 
Maturing after ten years
 
64,137
 
 
61,522
 
 
 
264,993
 
 
260,259
 
U.S. agency residential mortgage-backed
 
156,053
 
 
156,289
 
U.S. agency commercial mortgage-backed
 
12,799
 
 
12,632
 
Private label mortgage-backed
 
35,035
 
 
34,727
 
Other asset backed
 
146,829
 
 
146,709
 
Total
$
615,709
 
$
610,616
 

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The actual maturity may differ from the contractual maturity because issuers may have the right to call or prepay obligations with or without call or prepayment penalties.

A summary of proceeds from the sale of securities available for sale and gains and losses for the years ended December 31 follow:

 
Proceeds
Realized
Gains (1)
Losses (2)
 
(In thousands)
2016
$
64,103
 
$
354
 
$
53
 
2015
 
12,037
 
 
75
 
 
—
 
2014
 
14,633
 
 
329
 
 
—
 
(1) Gains in 2014 exclude $0.3 million of realized gain related to a U.S. Treasury short position.
(2) Losses in 2014 exclude $0.01 million of credit related OTTI recognized in earnings.

During 2016, 2015 and 2014, our trading securities consisted of various preferred stocks. During each of those years, we recognized gains (losses) on trading securities of $0.26 million, $(0.06) million and $(0.30) million, respectively, that are included in net gains on securities in the Consolidated Statements of Operations. All of these amounts relate to gains (losses) recognized on trading securities still held at December 31, 2016 and 2015.

Securities available for sale with a book value of $2.4 million and $1.1 million at December 31, 2016 and 2015, respectively, were pledged to secure borrowings, derivatives, public deposits and for other purposes as required by law. There were no investment obligations of state and political subdivisions that were payable from or secured by the same source of revenue or taxing authority that exceeded 10% of consolidated shareholders’ equity at December 31, 2016 or 2015.

NOTE 4 – LOANS AND PAYMENT PLAN RECEIVABLES

Our loan portfolios at December 31 follow:

 
2016
2015
 
(In thousands)
Real estate (1)
 
 
 
 
 
 
Residential first mortgages
$
453,348
 
$
432,215
 
Residential home equity and other junior mortgages
 
105,550
 
 
106,297
 
Construction and land development
 
77,287
 
 
62,629
 
Other (2)
 
525,748
 
 
498,706
 
Consumer
 
234,632
 
 
193,350
 
Commercial
 
206,607
 
 
180,424
 
Agricultural
 
5,076
 
 
6,830
 
Payment plan receivables (3)
 
—
 
 
34,599
 
Total loans
$
1,608,248
 
$
1,515,050
 
(1) Includes both residential and non-residential commercial loans secured by real estate.
(2) Includes loans secured by multi-family residential and non-farm, non-residential property.
(3) Payment plan receivables were reclassified to held for sale at December 31, 2016. See note #1.

Loans include net deferred loan costs of $4.1 million and $2.2 million at December 31, 2016 and 2015, respectively. Payment plan receivables totaling $36.9 million at December 31, 2015, are presented net of unamortized discount of $2.3 million at December 31, 2015. These payment plan receivables had effective yields of 13% at December 31, 2015.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  — (Continued)

In August 2016 and December 2015, we purchased $15.0 million and $32.6 million, respectively of single-family residential fixed rate jumbo mortgage loans from two separate Michigan-based financial institutions. These mortgage loans were all on properties located in Michigan, had weighted average interest rates (after a 0.25% servicing fee) of 3.65% and 3.94%, respectively and weighted average remaining contractual maturities of 332 months and 344 months, respectively.

An analysis of the allowance for loan losses by portfolio segment for the years ended December 31 follows:

 
Commercial
Mortgage
Installment
Payment
Plan
Receivables
Subjective
Allocation
Total
 
(In thousands)
2016
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Balance at beginning of period
$
5,670
 
$
10,391
 
$
1,181
 
$
56
 
$
5,272
 
$
22,570
 
Additions (deductions)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Provision for loan losses
 
(1,945
)
 
(158
)
 
401
 
 
(4
)
 
397
 
 
(1,309
)
Recoveries credited to allowance
 
2,472
 
 
1,047
 
 
1,100
 
 
—
 
 
—
 
 
4,619
 
Loans charged against the allowance
 
(1,317
)
 
(2,599
)
 
(1,671
)
 
—
 
 
—
 
 
(5,587
)
Reclassification to loans held for sale
 
—
 
 
—
 
 
—
 
 
(52
)
 
(7
)
 
(59
)
Balance at end of period
$
4,880
 
$
8,681
 
$
1,011
 
$
—
 
$
5,662
 
$
20,234
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
2015
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Balance at beginning of period
$
5,445
 
$
13,444
 
$
1,814
 
$
64
 
$
5,223
 
$
25,990
 
Additions (deductions)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Provision for loan losses
 
(737
)
 
(1,744
)
 
(274
)
 
(8
)
 
49
 
 
(2,714
)
Recoveries credited to allowance
 
2,656
 
 
1,258
 
 
1,108
 
 
—
 
 
—
 
 
5,022
 
Loans charged against the allowance
 
(1,694
)
 
(2,567
)
 
(1,467
)
 
—
 
 
—
 
 
(5,728
)
Balance at end of period
$
5,670
 
$
10,391
 
$
1,181
 
$
56
 
$
5,272
 
$
22,570
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
2014
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Balance at beginning of period
$
6,827
 
$
17,195
 
$
2,246
 
$
97
 
$
5,960
 
$
32,325
 
Additions (deductions)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Provision for loan losses
 
(1,683
)
 
(1,029
)
 
349
 
 
(36
)
 
(737
)
 
(3,136
)
Recoveries credited to allowance
 
4,914
 
 
1,397
 
 
1,104
 
 
5
 
 
—
 
 
7,420
 
Loans charged against the allowance
 
(4,613
)
 
(4,119
)
 
(1,885
)
 
(2
)
 
—
 
 
(10,619
)
Balance at end of period
$
5,445
 
$
13,444
 
$
1,814
 
$
64
 
$
5,223
 
$
25,990
 

53

TABLE OF CONTENTS

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  — (Continued)

Allowance for loan losses and recorded investment in loans by portfolio segment follows:

 
Commercial
Mortgage
Installment
Payment
Plan
Receivables
Subjective
Allocation
Total
 
(In thousands)
2016
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Allowance for loan losses:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Individually evaluated for impairment
$
2,244
 
$
6,579
 
$
329
 
$
—
 
$
—
 
$
9,152
 
Collectively evaluated for impairment
 
2,636
 
 
2,102
 
 
682
 
 
—
 
 
5,662
 
 
11,082
 
Total ending allowance balance
$
4,880
 
$
8,681
 
$
1,011
 
$
—
 
$
5,662
 
$
20,234
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Loans
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Individually evaluated for impairment
$
15,767
 
$
59,151
 
$
4,913
 
$
—
 
 
 
 
$
79,831
 
Collectively evaluated for impairment
 
790,228
 
 
481,828
 
 
261,474
 
 
—
 
 
 
 
 
1,533,530
 
Total loans recorded investment
 
805,995
 
 
540,979
 
 
266,387
 
 
—
 
 
 
 
 
1,613,361
 
Accrued interest included in recorded investment
 
1,978
 
 
2,364
 
 
771
 
 
—
 
 
 
 
 
5,113
 
Total loans
$
804,017
 
$
538,615
 
$
265,616
 
$
—
 
 
 
 
$
1,608,248
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
2015
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Allowance for loan losses:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Individually evaluated for impairment
$
2,708
 
$
7,818
 
$
457
 
$
—
 
$
—
 
$
10,983
 
Collectively evaluated for impairment
 
2,962
 
 
2,573
 
 
724
 
 
56
 
 
5,272
 
 
11,587
 
Total ending allowance balance
$
5,670
 
$
10,391
 
$
1,181
 
$
56
 
$
5,272
 
$
22,570
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Loans
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Individually evaluated for impairment
$
16,868
 
$
66,375
 
$
5,888
 
$
—
 
 
 
 
$
89,131
 
Collectively evaluated for impairment
 
733,399
 
 
433,931
 
 
228,827
 
 
34,599
 
 
 
 
 
1,430,756
 
Total loans recorded investment
 
750,267
 
 
500,306
 
 
234,715
 
 
34,599
 
 
 
 
 
1,519,887
 
Accrued interest included in recorded investment
 
1,869
 
 
2,270
 
 
698
 
 
—
 
 
 
 
 
4,837
 
Total loans
$
748,398
 
$
498,036
 
$
234,017
 
$
34,599
 
 
 
 
$
1,515,050
 

Non-performing loans include both smaller balance homogeneous loans that are collectively evaluated for impairment and individually classified impaired loans. If these loans had continued to accrue interest in accordance with their original terms, approximately $0.5 million, $0.6 million and $0.8 million of interest income would have been recognized in 2016, 2015 and 2014, respectively. Interest income recorded on these loans was approximately zero during the years ended 2016, 2015 and 2014.

54

TABLE OF CONTENTS

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  — (Continued)

Loans on non-accrual status and past due more than 90 days (“Non-performing Loans”) at December 31 follow:

 
90+ and
Still
Accruing
Non-
Accrual
Total Non-
Performing
Loans
 
(In thousands)
2016
 
 
 
 
 
 
 
 
 
Commercial
 
 
 
 
 
 
 
 
 
Income producing - real estate
$
—
 
$
628
 
$
628
 
Land, land development and construction - real estate
 
—
 
 
105
 
 
105
 
Commercial and industrial
 
—
 
 
4,430
 
 
4,430
 
Mortgage
 
 
 
 
 
 
 
 
 
1-4 family
 
—
 
 
5,248
 
 
5,248
 
Resort lending
 
—
 
 
1,507
 
 
1,507
 
Home equity - 1st lien
 
—
 
 
222
 
 
222
 
Home equity - 2nd lien
 
—
 
 
317
 
 
317
 
Purchased loans
 
—
 
 
—
 
 
—
 
Installment
 
 
 
 
 
 
 
 
 
Home equity - 1st lien
 
—
 
 
266
 
 
266
 
Home equity - 2nd lien
 
—
 
 
289
 
 
289
 
Loans not secured by real estate
 
—
 
 
351
 
 
351
 
Other
 
—
 
 
1
 
 
1
 
Total recorded investment
$
—
 
$
13,364
 
$
13,364
 
Accrued interest included in recorded investment
$
—
 
$
—
 
$
—
 
2015
 
 
 
 
 
 
 
 
 
Commercial
 
 
 
 
 
 
 
 
 
Income producing - real estate
$
—
 
$
1,027
 
$
1,027
 
Land, land development and construction - real estate
 
49
 
 
401
 
 
450
 
Commercial and industrial
 
69
 
 
2,028
 
 
2,097
 
Mortgage
 
 
 
 
 
 
 
 
 
1-4 family
 
—
 
 
4,744
 
 
4,744
 
Resort lending
 
—
 
 
1,094
 
 
1,094
 
Home equity - 1st lien
 
—
 
 
187
 
 
187
 
Home equity - 2nd lien
 
—
 
 
147
 
 
147
 
Purchased loans
 
—
 
 
2
 
 
2
 
Installment
 
 
 
 
 
 
 
 
 
Home equity - 1st lien
 
—
 
 
106
 
 
106
 
Home equity - 2nd lien
 
—
 
 
443
 
 
443
 
Loans not secured by real estate
 
—
 
 
421
 
 
421
 
Other
 
—
 
 
2
 
 
2
 
Payment plan receivables
 
 
 
 
 
 
 
 
 
Full refund
 
—
 
 
2
 
 
2
 
Partial refund
 
—
 
 
2
 
 
2
 
Other
 
—
 
 
1
 
 
1
 
Total recorded investment
$
118
 
$
10,607
 
$
10,725
 
Accrued interest included in recorded investment
$
2
 
$
—
 
$
2
 

55

TABLE OF CONTENTS

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  — (Continued)

An aging analysis of loans by class at December 31 follows:

 
Loans Past Due
Loans not
Past Due
Total
Loans
 
30-59 days
60-89 days
90+ days
Total
 
(In thousands)
2016
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Commercial
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Income producing - real estate
$
—
 
$
—
 
$
383
 
$
383
 
$
287,255
 
$
287,638
 
Land, land development and construction - real estate
 
74
 
 
—
 
 
31
 
 
105
 
 
51,670
 
 
51,775
 
Commercial and industrial
 
100
 
 
1,385
 
 
66
 
 
1,551
 
 
465,031
 
 
466,582
 
Mortgage
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
1-4 family
 
2,361
 
 
869
 
 
5,248
 
 
8,478
 
 
306,063
 
 
314,541
 
Resort lending
 
—
 
 
—
 
 
1,507
 
 
1,507
 
 
101,541
 
 
103,048
 
Home equity - 1st lien
 
149
 
 
—
 
 
222
 
 
371
 
 
28,645
 
 
29,016
 
Home equity - 2nd lien
 
470
 
 
218
 
 
317
 
 
1,005
 
 
54,232
 
 
55,237
 
Purchased loans
 
13
 
 
2
 
 
—
 
 
15
 
 
39,122
 
 
39,137
 
Installment
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Home equity - 1st lien
 
311
 
 
48
 
 
266
 
 
625
 
 
12,025
 
 
12,650
 
Home equity - 2nd lien
 
238
 
 
41
 
 
289
 
 
568
 
 
13,390
 
 
13,958
 
Loans not secured by real estate
 
533
 
 
95
 
 
351
 
 
979
 
 
236,022
 
 
237,001
 
Other
 
8
 
 
1
 
 
1
 
 
10
 
 
2,768
 
 
2,778
 
Total recorded investment
$
4,257
 
$
2,659
 
$
8,681
 
$
15,597
 
$
1,597,764
 
$
1,613,361
 
Accrued interest included in recorded investment
$
45
 
$
19
 
$
—
 
$
64
 
$
5,049
 
$
5,113
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
2015
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Commercial
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Income producing - real estate
$
203
 
$
209
 
$
647
 
$
1,059
 
$
305,155
 
$
306,214
 
Land, land development and construction - real estate
 
—
 
 
—
 
 
252
 
 
252
 
 
44,231
 
 
44,483
 
Commercial and industrial
 
785
 
 
16
 
 
151
 
 
952
 
 
398,618
 
 
399,570
 
Mortgage
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
1-4 family
 
1,943
 
 
640
 
 
4,744
 
 
7,327
 
 
269,880
 
 
277,207
 
Resort lending
 
307
 
 
—
 
 
1,094
 
 
1,401
 
 
114,619
 
 
116,020
 
Home equity - 1st lien
 
50
 
 
—
 
 
187
 
 
237
 
 
22,327
 
 
22,564
 
Home equity - 2nd lien
 
439
 
 
54
 
 
147
 
 
640
 
 
50,618
 
 
51,258
 
Purchased loans
 
9
 
 
1
 
 
2
 
 
12
 
 
33,245
 
 
33,257
 
Installment
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Home equity - 1st lien
 
315
 
 
107
 
 
106
 
 
528
 
 
16,707
 
 
17,235
 
Home equity - 2nd lien
 
231
 
 
149
 
 
443
 
 
823
 
 
19,727
 
 
20,550
 
Loans not secured by real estate
 
567
 
 
83
 
 
421
 
 
1,071
 
 
193,680
 
 
194,751
 
Other
 
15
 
 
3
 
 
2
 
 
20
 
 
2,159
 
 
2,179
 
Payment plan receivables
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Full refund
 
492
 
 
62
 
 
2
 
 
556
 
 
21,294
 
 
21,850
 
Partial refund
 
415
 
 
228
 
 
2
 
 
645
 
 
5,834
 
 
6,479
 
Other
 
110
 
 
3
 
 
1
 
 
114
 
 
6,156
 
 
6,270
 
Total recorded investment
$
5,881
 
$
1,555
 
$
8,201
 
$
15,637
 
$
1,504,250
 
$
1,519,887
 
Accrued interest included in recorded investment
$
53
 
$
17
 
$
2
 
$
72
 
$
4,765
 
$
4,837
 

56

TABLE OF CONTENTS

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  — (Continued)

Impaired loans are as follows :

 
December 31,
 
2016
2015
 
(In thousands)
Impaired loans with no allocated allowance
 
 
 
 
 
 
TDR
$
1,782
 
$
2,518
 
Non - TDR
 
1,107
 
 
203
 
Impaired loans with an allocated allowance
 
 
 
 
 
 
TDR - allowance based on collateral
 
3,527
 
 
4,810
 
TDR - allowance based on present value cash flow
 
72,613
 
 
81,002
 
Non - TDR - allowance based on collateral
 
491
 
 
260
 
Non - TDR - allowance based on present value cash flow
 
—
 
 
—
 
Total impaired loans
$
79,520
 
$
88,793
 
 
 
 
 
 
 
 
Amount of allowance for loan losses allocated
 
 
 
 
 
 
TDR - allowance based on collateral
$
1,868
 
$
2,436
 
TDR - allowance based on present value cash flow
 
7,146
 
 
8,471
 
Non - TDR - allowance based on collateral
 
138
 
 
76
 
Non - TDR - allowance based on present value cash flow
 
—
 
 
—
 
Total amount of allowance for loan losses allocated
$
9,152
 
$
10,983
 

Impaired loans by class as of December 31 are as follows (1):

 
2016
2015
 
Recorded
Investment
Unpaid
Principal
Balance
Related
Allowance
Recorded
Investment
Unpaid
Principal
Balance
Related
Allowance
 
(In thousands)
With no related allowance recorded:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Commercial
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Income producing - real estate
$
517
 
$
768
 
$
—
 
$
641
 
$
851
 
$
—
 
Land, land development & construction-real estate
 
31
 
 
709
 
 
—
 
 
818
 
 
1,393
 
 
—
 
Commercial and industrial
 
2,341
 
 
3,261
 
 
—
 
 
1,245
 
 
1,241
 
 
—
 
Mortgage
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
1-4 family
 
2
 
 
387
 
 
—
 
 
23
 
 
183
 
 
—
 
Resort lending
 
—
 
 
—
 
 
—
 
 
—
 
 
—
 
 
—
 
Home equity - 1st lien
 
—
 
 
—
 
 
—
 
 
—
 
 
—
 
 
—
 
Home equity - 2nd lien
 
—
 
 
—
 
 
—
 
 
—
 
 
—
 
 
—
 
Installment
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Home equity - 1st lien
 
—
 
 
66
 
 
—
 
 
—
 
 
76
 
 
—
 
Home equity - 2nd lien
 
—
 
 
—
 
 
—
 
 
—
 
 
—
 
 
—
 
Loans not secured by real estate
 
—
 
 
—
 
 
—
 
 
—
 
 
—
 
 
—
 
Other
 
—
 
 
—
 
 
—
 
 
—
 
 
—
 
 
—
 
 
 
2,891
 
 
5,191
 
 
—
 
 
2,727
 
 
3,744
 
 
—
 

57

TABLE OF CONTENTS

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  — (Continued)

 
2016
2015
 
Recorded
Investment
Unpaid
Principal
Balance
Related
Allowance
Recorded
Investment
Unpaid
Principal
Balance
Related
Allowance
 
(In thousands)
With an allowance recorded:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Commercial
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Income producing - real estate
 
7,737
 
 
7,880
 
 
554
 
 
8,377
 
 
9,232
 
 
516
 
Land, land development & construction-real estate
 
239
 
 
244
 
 
36
 
 
1,690
 
 
1,778
 
 
296
 
Commercial and industrial
 
4,902
 
 
5,246
 
 
1,654
 
 
4,097
 
 
4,439
 
 
1,896
 
Mortgage
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
1-4 family
 
41,701
 
 
43,479
 
 
4,100
 
 
47,792
 
 
49,808
 
 
5,132
 
Resort lending
 
16,898
 
 
16,931
 
 
2,453
 
 
18,148
 
 
18,319
 
 
2,662
 
Home equity - 1st lien
 
235
 
 
242
 
 
10
 
 
168
 
 
172
 
 
9
 
Home equity - 2nd lien
 
315
 
 
398
 
 
16
 
 
244
 
 
325
 
 
15
 
Installment
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Home equity - 1st lien
 
1,994
 
 
2,117
 
 
118
 
 
2,364
 
 
2,492
 
 
143
 
Home equity - 2nd lien
 
2,415
 
 
2,443
 
 
182
 
 
2,929
 
 
2,951
 
 
271
 
Loans not secured by real estate
 
504
 
 
540
 
 
29
 
 
587
 
 
658
 
 
42
 
Other
 
—
 
 
—
 
 
—
 
 
8
 
 
8
 
 
1
 
 
 
76,940
 
 
79,520
 
 
9,152
 
 
86,404
 
 
90,182
 
 
10,983
 
Total
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Commercial
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Income producing - real estate
 
8,254
 
 
8,648
 
 
554
 
 
9,018
 
 
10,083
 
 
516
 
Land, land development & construction-real estate
 
270
 
 
953
 
 
36
 
 
2,508
 
 
3,171
 
 
296
 
Commercial and industrial
 
7,243
 
 
8,507
 
 
1,654
 
 
5,342
 
 
5,680
 
 
1,896
 
Mortgage
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
1-4 family
 
41,703
 
 
43,866
 
 
4,100
 
 
47,815
 
 
49,991
 
 
5,132
 
Resort lending
 
16,898
 
 
16,931
 
 
2,453
 
 
18,148
 
 
18,319
 
 
2,662
 
Home equity - 1st lien
 
235
 
 
242
 
 
10
 
 
168
 
 
172
 
 
9
 
Home equity - 2nd lien
 
315
 
 
398
 
 
16
 
 
244
 
 
325
 
 
15
 
Installment
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Home equity - 1st lien
 
1,994
 
 
2,183
 
 
118
 
 
2,364
 
 
2,568
 
 
143
 
Home equity - 2nd lien
 
2,415
 
 
2,443
 
 
182
 
 
2,929
 
 
2,951
 
 
271
 
Loans not secured by real estate
 
504
 
 
540
 
 
29
 
 
587
 
 
658
 
 
42
 
Other
 
—
 
 
—
 
 
—
 
 
8
 
 
8
 
 
1
 
Total
$
79,831
 
$
84,711
 
$
9,152
 
$
89,131
 
$
93,926
 
$
10,983
 
Accrued interest included in recorded investment
$
311
 
 
 
 
 
 
 
$
338
 
 
 
 
 
 
 
(1) There were no impaired payment plan receivables or purchased mortgage loans at December 31, 2016 or 2015.

58

TABLE OF CONTENTS

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  — (Continued)

Average recorded investment in and interest income earned on impaired loans by class for the years ended December 31 follows (1):

 
2016
2015
2014
 
Average
Recorded
Investment
Interest
Income
Recognized
Average
Recorded
Investment
Interest
Income
Recognized
Average
Recorded
Investment
Interest
Income
Recognized
 
(In thousands)
With no related allowance recorded:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Commercial
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Income producing - real estate
$
609
 
$
2
 
$
4,520
 
$
387
 
$
7,660
 
$
250
 
Land, land development & construction-real estate
 
330
 
 
7
 
 
952
 
 
79
 
 
1,145
 
 
64
 
Commercial and industrial
 
961
 
 
54
 
 
2,125
 
 
257
 
 
3,351
 
 
152
 
Mortgage
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
1-4 family
 
10
 
 
16
 
 
19
 
 
11
 
 
29
 
 
—
 
Resort lending
 
—
 
 
—
 
 
12
 
 
—
 
 
40
 
 
1
 
Home equity - 1st lien
 
—
 
 
—
 
 
—
 
 
—
 
 
—
 
 
—
 
Home equity - 2nd lien
 
—
 
 
—
 
 
—
 
 
—
 
 
—
 
 
—
 
Installment
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Home equity - 1st lien
 
—
 
 
5
 
 
—
 
 
5
 
 
—
 
 
2
 
Home equity - 2nd lien
 
3
 
 
—
 
 
—
 
 
—
 
 
—
 
 
—
 
Loans not secured by real estate
 
—
 
 
—
 
 
—
 
 
—
 
 
—
 
 
—
 
Other
 
—
 
 
—
 
 
—
 
 
—
 
 
—
 
 
—
 
 
 
1,913
 
 
84
 
 
7,628
 
 
739
 
 
12,225
 
 
469
 
With an allowance recorded:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Commercial
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Income producing - real estate
 
8,069
 
 
427
 
 
12,677
 
 
439
 
 
12,772
 
 
677
 
Land, land development & construction-real estate
 
1,129
 
 
31
 
 
2,219
 
 
54
 
 
3,939
 
 
149
 
Commercial and industrial
 
5,723
 
 
189
 
 
6,663
 
 
104
 
 
8,500
 
 
294
 
Mortgage
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
1-4 family
 
44,923
 
 
1,918
 
 
50,421
 
 
2,140
 
 
55,877
 
 
2,286
 
Resort lending
 
17,544
 
 
619
 
 
18,448
 
 
670
 
 
19,458
 
 
753
 
Home equity - 1st lien
 
226
 
 
10
 
 
161
 
 
8
 
 
160
 
 
6
 
Home equity - 2nd lien
 
248
 
 
14
 
 
172
 
 
13
 
 
57
 
 
2
 
Installment
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Home equity - 1st lien
 
2,185
 
 
147
 
 
2,539
 
 
176
 
 
2,837
 
 
174
 
Home equity - 2nd lien
 
2,661
 
 
162
 
 
3,055
 
 
193
 
 
3,359
 
 
188
 
Loans not secured by real estate
 
546
 
 
35
 
 
653
 
 
37
 
 
719
 
 
35
 
Other
 
4
 
 
—
 
 
10
 
 
1
 
 
14
 
 
1
 
 
 
83,258
 
 
3,552
 
 
97,018
 
 
3,835
 
 
107,692
 
 
4,565
 

59

TABLE OF CONTENTS

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  — (Continued)

 
2016
2015
2014
 
Average
Recorded
Investment
Interest
Income
Recognized
Average
Recorded
Investment
Interest
Income
Recognized
Average
Recorded
Investment
Interest
Income
Recognized
 
(In thousands)
Total
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Commercial
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Income producing - real estate
 
8,678
 
 
429
 
 
17,197
 
 
826
 
 
20,432
 
 
927
 
Land, land development & construction-real estate
 
1,459
 
 
38
 
 
3,171
 
 
133
 
 
5,084
 
 
213
 
Commercial and industrial
 
6,684
 
 
243
 
 
8,788
 
 
361
 
 
11,851
 
 
446
 
Mortgage
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
1-4 family
 
44,933
 
 
1,934
 
 
50,440
 
 
2,151
 
 
55,906
 
 
2,286
 
Resort lending
 
17,544
 
 
619
 
 
18,460
 
 
670
 
 
19,498
 
 
754
 
Home equity - 1st lien
 
226
 
 
10
 
 
161
 
 
8
 
 
160
 
 
6
 
Home equity - 2nd lien
 
248
 
 
14
 
 
172
 
 
13
 
 
57
 
 
2
 
Installment
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Home equity - 1st lien
 
2,185
 
 
152
 
 
2,539
 
 
181
 
 
2,837
 
 
176
 
Home equity - 2nd lien
 
2,664
 
 
162
 
 
3,055
 
 
193
 
 
3,359
 
 
188
 
Loans not secured by real estate
 
546
 
 
35
 
 
653
 
 
37
 
 
719
 
 
35
 
Other
 
4
 
 
—
 
 
10
 
 
1
 
 
14
 
 
1
 
Total
$
85,171
 
$
3,636
 
$
104,646
 
$
4,574
 
$
119,917
 
$
5,034
 
(1) There were no impaired payment plan receivables or purchased mortgage loans during the years ending December 31, 2016, 2015 and 2014.

Our average investment in impaired loans was approximately $85.2 million, $104.6 million and $119.9 million in 2016, 2015 and 2014, respectively. Cash receipts on impaired loans on non-accrual status are generally applied to the principal balance. Interest income recognized on impaired loans was approximately $3.6 million, $4.6 million and $5.0 million in 2016, 2015 and 2014, respectively, of which the majority of these amounts were received in cash and related primarily to performing TDR’s.

Troubled debt restructurings at December 31 follow:

 
2016
 
Commercial
Retail (1)
Total
 
(In thousands)
Performing TDR's
$
10,560
 
$
59,726
 
$
70,286
 
Non-performing TDR's (2)
 
3,565
 
 
4,071
(3)
 
7,636
 
Total
$
14,125
 
$
63,797
 
$
77,922
 
 
2015
 
Commercial
Retail (1)
Total
 
(In thousands)
Performing TDR's
$
13,318
 
$
68,194
 
$
81,512
 
Non-performing TDR's (2)
 
3,041
 
 
3,777
(3)
 
6,818
 
Total
$
16,359
 
$
71,971
 
$
88,330
 
(1) Retail loans include mortgage and installment loan segments.
(2) Included in non-performing loans table above.
(3) Also includes loans on non-accrual at the time of modification until six payments are received on a timely basis.

60

TABLE OF CONTENTS

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  — (Continued)

We have allocated $9.0 million and $10.9 million of specific reserves to customers whose loan terms have been modified in troubled debt restructurings as of December 31, 2016 and 2015, respectively. We have committed to lend additional amounts totaling up to $0.04 million at both December 31, 2016 and 2015, respectively, to customers with outstanding loans that are classified as troubled debt restructurings.

The terms of certain loans were modified as troubled debt restructurings and generally included one or a combination of the following: a reduction of the stated interest rate of the loan; an extension of the maturity date at a stated rate of interest lower than the current market rate for new debt with similar risk; or a permanent reduction of the recorded investment in the loan.

Modifications involving a reduction of the stated interest rate of the loan have generally been for periods ranging from 9 months to 36 months but have extended to as much as 480 months in certain circumstances. Modifications involving an extension of the maturity date have generally been for periods ranging from 1 month to 60 months but have extended to as much as 230 months in certain circumstances.

Loans that have been classified as troubled debt restructurings during the years ended December 31 follow (1):

 
Number of
Contracts
Pre-modification
Recorded
Balance
Post-modification
Recorded
Balance
 
(Dollars in thousands)
2016
 
 
 
 
 
 
 
 
 
Commercial
 
 
 
 
 
 
 
 
 
Income producing - real estate
 
4
 
$
290
 
$
290
 
Land, land development & construction-real estate
 
—
 
 
—
 
 
—
 
Commercial and industrial
 
9
 
 
2,044
 
 
2,027
 
Mortgage
 
 
 
 
 
 
 
 
 
1-4 family
 
9
 
 
927
 
 
1,004
 
Resort lending
 
1
 
 
116
 
 
117
 
Home equity - 1st lien
 
1
 
 
107
 
 
78
 
Home equity - 2nd lien
 
2
 
 
77
 
 
78
 
Installment
 
 
 
 
 
 
 
 
 
Home equity - 1st lien
 
6
 
 
141
 
 
145
 
Home equity - 2nd lien
 
6
 
 
154
 
 
157
 
Loans not secured by real estate
 
2
 
 
46
 
 
46
 
Other
 
—
 
 
—
 
 
—
 
Total
 
40
 
$
3,902
 
$
3,942
 
 
 
 
 
 
 
 
 
 
 
2015
 
 
 
 
 
 
 
 
 
Commercial
 
 
 
 
 
 
 
 
 
Income producing - real estate
 
2
 
$
229
 
$
227
 
Land, land development & construction-real estate
 
—
 
 
—
 
 
—
 
Commercial and industrial
 
17
 
 
3,188
 
 
2,960
 
Mortgage
 
 
 
 
 
 
 
 
 
1-4 family
 
8
 
 
1,345
 
 
1,128
 
Resort lending
 
1
 
 
313
 
 
307
 
Home equity - 1st lien
 
1
 
 
20
 
 
20
 
Home equity - 2nd lien
 
1
 
 
27
 
 
27
 
Installment
 
 
 
 
 
 
 
 
 
Home equity - 1st lien
 
6
 
 
220
 
 
186
 
Home equity - 2nd lien
 
8
 
 
228
 
 
217
 
Loans not secured by real estate
 
2
 
 
19
 
 
25
 
Other
 
—
 
 
—
 
 
—
 
Total
 
46
 
$
5,589
 
$
5,097
 

61

TABLE OF CONTENTS

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  — (Continued)

 
Number of
Contracts
Pre-modification
Recorded
Balance
Post-modification
Recorded
Balance
 
(Dollars in thousands)
2014
 
 
 
 
 
 
 
 
 
Commercial
 
 
 
 
 
 
 
 
 
Income producing - real estate
 
4
 
$
426
 
$
389
 
Land, land development & construction-real estate
 
2
 
 
55
 
 
44
 
Commercial and industrial
 
13
 
 
2,236
 
 
1,606
 
Mortgage
 
 
 
 
 
 
 
 
 
1-4 family
 
15
 
 
1,576
 
 
1,570
 
Resort lending
 
6
 
 
1,583
 
 
1,572
 
Home equity - 1st lien
 
1
 
 
17
 
 
14
 
Home equity - 2nd lien
 
1
 
 
85
 
 
84
 
Installment
 
 
 
 
 
 
 
 
 
Home equity - 1st lien
 
13
 
 
631
 
 
523
 
Home equity - 2nd lien
 
9
 
 
400
 
 
400
 
Loans not secured by real estate
 
6
 
 
114
 
 
106
 
Other
 
—
 
 
—
 
 
—
 
Total
 
70
 
$
7,123
 
$
6,308
 
(1) There were no payment plan receivables or purchased mortgage loans classified as troubled debt restructurings during the years ending 2016, 2015 and 2014.

The troubled debt restructurings described above increased (decreased) the AFLL by $(0.1) million, $0.4 million and $0.2 million during the years ended December 31, 2016, 2015 and 2014, respectively and resulted in charge offs of $0.53 million, $0.16 million and $0.04 million during the years ended December 31, 2016, 2015 and 2014, respectively.

Loans that have been classified as troubled debt restructured during the past twelve months and that have subsequently defaulted during the years ended December 31 follows:

 
Number of
Contracts
Recorded
Balance
 
(Dollars in thousands)
2016
 
 
 
 
 
 
Commercial
 
 
 
 
 
 
Income producing - real estate
 
—
 
$
—
 
Land, land development & construction-real estate
 
—
 
 
—
 
Commercial and industrial
 
1
 
 
1,767
 
Mortgage
 
 
 
 
 
 
1-4 family
 
—
 
 
—
 
Resort lending
 
—
 
 
—
 
Home equity - 1st lien
 
—
 
 
—
 
Home equity - 2nd lien
 
—
 
 
—
 
Installment
 
 
 
 
 
 
Home equity - 1st lien
 
—
 
 
—
 
Home equity - 2nd lien
 
—
 
 
—
 
Loans not secured by real estate
 
—
 
 
—
 
Other
 
—
 
 
—
 
Total
 
1
 
$
1,767
 

62

TABLE OF CONTENTS

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  — (Continued)

 
Number of
Contracts
Recorded
Balance
 
(Dollars in thousands)
2015
 
 
 
 
 
 
Commercial
 
 
 
 
 
 
Income producing - real estate
 
—
 
$
—
 
Land, land development & construction-real estate
 
—
 
 
—
 
Commercial and industrial
 
2
 
 
157
 
Mortgage
 
 
 
 
 
 
1-4 family
 
2
 
 
73
 
Resort lending
 
—
 
 
—
 
Home equity - 1st lien
 
—
 
 
—
 
Home equity - 2nd lien
 
—
 
 
—
 
Installment
 
 
 
 
 
 
Home equity - 1st lien
 
—
 
 
—
 
Home equity - 2nd lien
 
—
 
 
—
 
Loans not secured by real estate
 
1
 
 
4
 
Other
 
—
 
 
—
 
Total
 
5
 
$
234
 
 
 
 
 
 
 
 
2014
 
 
 
 
 
 
Commercial
 
 
 
 
 
 
Income producing - real estate
 
—
 
$
—
 
Land, land development & construction-real estate
 
—
 
 
—
 
Commercial and industrial
 
2
 
 
319
 
Mortgage
 
 
 
 
 
 
1-4 family
 
1
 
 
125
 
Resort lending
 
—
 
 
—
 
Home equity - 1st lien
 
—
 
 
—
 
Home equity - 2nd lien
 
—
 
 
—
 
Installment
 
 
 
 
 
 
Home equity - 1st lien
 
—
 
 
—
 
Home equity - 2nd lien
 
—
 
 
—
 
Loans not secured by real estate
 
—
 
 
—
 
Other
 
—
 
 
—
 
Total
 
3
 
$
444
 

A loan is generally considered to be in payment default once it is 90 days contractually past due under the modified terms for commercial loans and installment loans and when four consecutive payments are missed for mortgage loans.

The troubled debt restructurings that subsequently defaulted described above increased (decreased) the AFLL by $(0.17) million, $(0.03) million and $0.02 million during the years ended December 31, 2016, 2015 and 2014, respectively and resulted in charge offs of $0.51 million, zero and zero during the years ended December 31, 2016, 2015 and 2014, respectively.

The terms of certain other loans were modified during the years ending December 31, 2016, 2015 and 2014 that did not meet the definition of a troubled debt restructuring. The modification of these loans could have included modification of the terms of a loan to borrowers who were not experiencing financial difficulties or a delay in a payment that was considered to be insignificant.

63

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  — (Continued)

In order to determine whether a borrower is experiencing financial difficulty, we perform an evaluation of the probability that the borrower will be in payment default on any of its debt in the foreseeable future without the modification. This evaluation is performed under our internal underwriting policy.

Credit Quality Indicators – As part of our on on-going monitoring of the credit quality of our loan portfolios, we track certain credit quality indicators including (a) weighted-average risk grade of commercial loans, (b) the level of classified commercial loans, (c) credit scores of mortgage and installment loan borrowers, (d) financial performance of certain counterparties for payment plan receivables and (e) delinquency history and non-performing loans.

For commercial loans, we use a loan rating system that is similar to those employed by state and federal banking regulators. Loans are graded on a scale of 1 to 12. A description of the general characteristics of the ratings follows:

Rating 1 through 6 : These loans are generally referred to as our “non-watch” commercial credits that include very high or exceptional credit fundamentals through acceptable credit fundamentals.

Rating 7 and 8 : These loans are generally referred to as our “watch” commercial credits. This rating includes loans to borrowers that exhibit potential credit weakness or downward trends. If not checked or cured these trends could weaken our asset or credit position. While potentially weak, no loss of principal or interest is envisioned with these ratings.

Rating 9 : These loans are generally referred to as our “substandard accruing” commercial credits. This rating includes loans to borrowers that exhibit a well-defined weakness where payment default is probable and loss is possible if deficiencies are not corrected. Generally, loans with this rating are considered collectible as to both principal and interest primarily due to collateral coverage.

Rating 10 and 11 : These loans are generally referred to as our “substandard - non-accrual” and “doubtful” commercial credits. This rating includes loans to borrowers with weaknesses that make collection of debt in full, on the basis of current facts, conditions and values at best questionable and at worst improbable. All of these loans are placed in non-accrual.

Rating 12 : These loans are generally referred to as our “loss” commercial credits. This rating includes loans to borrowers that are deemed incapable of repayment and are charged-off.

The following table summarizes loan ratings by loan class for our commercial loan segment at December 31:

 
Commercial
 
Non-watch
1-6
Watch
7-8
Substandard
Accrual
9
Non-
Accrual
10-11
Total
 
(In thousands)
2016
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Income producing - real estate
$
282,886
 
$
3,787
 
$
337
 
$
628
 
$
287,638
 
Land, land development and construction - real estate
 
51,603
 
 
67
 
 
—
 
 
105
 
 
51,775
 
Commercial and industrial
 
449,365
 
 
9,788
 
 
2,998
 
 
4,431
 
 
466,582
 
Total
$
783,854
 
$
13,642
 
$
3,335
 
$
5,164
 
$
805,995
 
Accrued interest included in total
$
1,915
 
$
52
 
$
11
 
$
—
 
$
1,978
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
2015
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Income producing - real estate
$
296,898
 
$
6,866
 
$
1,423
 
$
1,027
 
$
306,214
 
Land, land development and construction - real estate
 
40,844
 
 
2,995
 
 
243
 
 
401
 
 
44,483
 
Commercial and industrial
 
371,357
 
 
19,502
 
 
6,683
 
 
2,028
 
 
399,570
 
Total
$
709,099
 
$
29,363
 
$
8,349
 
$
3,456
 
$
750,267
 
Accrued interest included in total
$
1,729
 
$
108
 
$
32
 
$
—
 
$
1,869
 

64

TABLE OF CONTENTS

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  — (Continued)

For each of our mortgage and installment segment classes we generally monitor credit quality based on the credit scores of the borrowers. These credit scores are generally updated semi-annually. The following tables summarize credit scores by loan class for our mortgage and installment loan segments at December 31:

 
Mortgage (1)
 
1-4
Family
Resort
Lending
Home
Equity
1st Lien
Home
Equity
2nd Lien
Purchased
Loans
Total
 
(In thousands)
2016
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
800 and above
$
36,534
 
$
10,484
 
$
6,048
 
$
8,392
 
$
8,462
 
$
69,920
 
750-799
 
102,382
 
 
41,999
 
 
10,006
 
 
20,113
 
 
20,984
 
 
195,484
 
700-749
 
69,337
 
 
24,727
 
 
5,706
 
 
12,360
 
 
9,115
 
 
121,245
 
650-699
 
50,621
 
 
13,798
 
 
4,106
 
 
8,167
 
 
437
 
 
77,129
 
600-649
 
25,270
 
 
5,769
 
 
1,674
 
 
3,067
 
 
—
 
 
35,780
 
550-599
 
13,747
 
 
3,030
 
 
455
 
 
1,699
 
 
—
 
 
18,931
 
500-549
 
9,215
 
 
1,438
 
 
486
 
 
981
 
 
—
 
 
12,120
 
Under 500
 
5,145
 
 
92
 
 
255
 
 
279
 
 
—
 
 
5,771
 
Unknown
 
2,290
 
 
1,711
 
 
280
 
 
179
 
 
139
 
 
4,599
 
Total
$
314,541
 
$
103,048
 
$
29,016
 
$
55,237
 
$
39,137
 
$
540,979
 
Accrued interest included in total
$
1,466
 
$
450
 
$
111
 
$
226
 
$
111
 
$
2,364
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
2015
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
800 and above
$
28,760
 
$
13,943
 
$
4,374
 
$
7,696
 
$
2,310
 
$
57,083
 
750-799
 
78,802
 
 
40,888
 
 
7,137
 
 
17,405
 
 
23,283
 
 
167,515
 
700-749
 
56,519
 
 
31,980
 
 
4,341
 
 
11,022
 
 
6,940
 
 
110,802
 
650-699
 
51,813
 
 
17,433
 
 
3,203
 
 
7,691
 
 
—
 
 
80,140
 
600-649
 
27,966
 
 
4,991
 
 
1,467
 
 
3,684
 
 
—
 
 
38,108
 
550-599
 
16,714
 
 
3,070
 
 
1,027
 
 
1,918
 
 
—
 
 
22,729
 
500-549
 
10,610
 
 
1,051
 
 
572
 
 
1,295
 
 
—
 
 
13,528
 
Under 500
 
4,708
 
 
554
 
 
244
 
 
265
 
 
—
 
 
5,771
 
Unknown
 
1,315
 
 
2,110
 
 
199
 
 
282
 
 
724
 
 
4,630
 
Total
$
277,207
 
$
116,020
 
$
22,564
 
$
51,258
 
$
33,257
 
$
500,306
 
Accrued interest included in total
$
1,396
 
$
477
 
$
87
 
$
196
 
$
114
 
$
2,270
 
(1) Credit scores have been updated within the last twelve months.
 
Installment (1)
 
Home
Equity
1st Lien
Home
Equity
2nd Lien
Loans not
Secured by
Real Estate
Other
Total
 
(In thousands)
2016
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
800 and above
$
1,354
 
$
1,626
 
$
53,281
 
$
86
 
$
56,347
 
750-799
 
2,478
 
 
3,334
 
 
107,460
 
 
793
 
 
114,065
 
700-749
 
1,920
 
 
2,686
 
 
43,456
 
 
821
 
 
48,883
 
650-699
 
2,852
 
 
2,541
 
 
19,053
 
 
624
 
 
25,070
 
600-649
 
1,691
 
 
1,775
 
 
4,638
 
 
298
 
 
8,402
 
550-599
 
1,231
 
 
1,063
 
 
1,942
 
 
53
 
 
4,289
 
500-549
 
981
 
 
692
 
 
1,095
 
 
45
 
 
2,813
 
Under 500
 
114
 
 
220
 
 
276
 
 
24
 
 
634
 
Unknown
 
29
 
 
21
 
 
5,800
 
 
34
 
 
5,884
 
Total
$
12,650
 
$
13,958
 
$
237,001
 
$
2,778
 
$
266,387
 
Accrued interest included in total
$
54
 
$
59
 
$
638
 
$
20
 
$
771
 

65

TABLE OF CONTENTS

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  — (Continued)

 
Installment (1)
 
Home
Equity
1st Lien
Home
Equity
2nd Lien
Loans not
Secured by
Real Estate
Other
Total
 
(In thousands)
2015
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
800 and above
$
1,792
 
$
1,782
 
$
44,254
 
$
58
 
$
47,886
 
750-799
 
4,117
 
 
5,931
 
 
86,800
 
 
531
 
 
97,379
 
700-749
 
2,507
 
 
3,899
 
 
34,789
 
 
694
 
 
41,889
 
650-699
 
3,508
 
 
4,182
 
 
16,456
 
 
499
 
 
24,645
 
600-649
 
2,173
 
 
2,153
 
 
4,979
 
 
200
 
 
9,505
 
550-599
 
1,800
 
 
1,346
 
 
1,997
 
 
109
 
 
5,252
 
500-549
 
1,056
 
 
855
 
 
1,170
 
 
61
 
 
3,142
 
Under 500
 
223
 
 
370
 
 
385
 
 
23
 
 
1,001
 
Unknown
 
59
 
 
32
 
 
3,921
 
 
4
 
 
4,016
 
Total
$
17,235
 
$
20,550
 
$
194,751
 
$
2,179
 
$
234,715
 
Accrued interest included in total
$
78
 
$
83
 
$
520
 
$
17
 
$
698
 
(1) Credit scores have been updated within the last twelve months.

Mepco is a wholly-owned subsidiary of our Bank that operates a vehicle service contract payment plan business throughout the United States. As discussed in note #1 all payment plan receivables have been reclassified to held for sale at December 31, 2016. In addition, see note #11 for more information about Mepco’s business. As of December 31, 2015, approximately 63.2% of Mepco’s outstanding payment plan receivables related to programs in which a third party insurer or risk retention group was obligated to pay Mepco the full refund owing upon cancellation of the related service contract (including with respect to both the portion funded to the service contract seller and the portion funded to the administrator). These receivables are shown as “Full Refund” in the table below. Another approximately 18.7% of Mepco’s outstanding payment plan receivables as of December 31, 2015, related to programs in which a third party insurer or risk retention group is obligated to pay Mepco the refund owing upon cancellation only with respect to the unearned portion previously funded by Mepco to the administrator (but not to the service contract seller). These receivables are shown as “Partial Refund” in the table below. The balance of Mepco’s outstanding payment plan receivables related to programs in which there was no insurer or risk retention group that had any contractual liability to Mepco for any portion of the refund amount. These receivables are shown as “Other” in the table below. For each class of our payment plan receivables we monitored financial information on the counterparties as we evaluated the credit quality of this portfolio.

The following table summarizes credit ratings of insurer or risk retention group counterparties by class of payment plan receivable at December 31:

 
Payment Plan Receivables
 
Full
Refund
Partial
Refund
Other
Total
 
(In thousands)
2015
 
 
 
 
 
 
 
 
 
 
 
 
AM Best rating
 
 
 
 
 
 
 
 
 
 
 
 
A+
$
—
 
$
6
 
$
—
 
$
6
 
A
 
2,712
 
 
5,203
 
 
—
 
 
7,915
 
A-
 
3,418
 
 
1,177
 
 
6,265
 
 
10,860
 
Not rated
 
15,720
 
 
93
 
 
5
 
 
15,818
 
Total
$
21,850
 
$
6,479
 
$
6,270
 
$
34,599
 

Although Mepco has contractual recourse against various counterparties for refunds owing upon cancellation of vehicle service contracts, see note #11 below regarding certain risks and difficulties associated with collecting these refunds.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  — (Continued)

Mortgage loans serviced for others are not reported as assets on the Consolidated Statements of Financial Condition. The principal balances of these loans at December 31 follow:

 
2016
2015
 
(In thousands)
Mortgage loans serviced for:
 
 
 
 
 
 
Fannie Mae
$
944,703
 
$
898,443
 
Freddie Mac
 
622,885
 
 
707,891
 
Ginnie Mae
 
85,290
 
 
37,884
 
Other
 
6,115
 
 
107
 
Total
$
1,658,993
 
$
1,644,325
 

Custodial deposit accounts maintained in connection with mortgage loans serviced for others totaled $18.9 million and $21.8 million, at December 31, 2016 and 2015, respectively.

If we do not remain well capitalized for regulatory purposes (see note #20), meet certain minimum capital levels or certain profitability requirements or if we incur a rapid decline in net worth, we could lose our ability to sell and/or service loans to these investors. This could impact our ability to generate gains on the sale of loans and generate servicing income. A forced liquidation of our servicing portfolio could also impact the value that could be recovered on this asset. Fannie Mae has the most stringent eligibility requirements covering capital levels, profitability and decline in net worth. Fannie Mae requires seller/servicers to be well capitalized for regulatory purposes. For the profitability requirement, we cannot record four or more consecutive quarterly losses and experience a 30% decline in net worth over the same period. Finally, our net worth cannot decline by more than 25% in one quarter or more than 40% over two consecutive quarters. The highest level of capital we are required to maintain is at least $2.5 million plus 0.25% of loans serviced for Freddie Mac.

An analysis of capitalized mortgage loan servicing rights for the years ended December 31 follows:

 
2016
2015
2014
 
(In thousands)
Balance at beginning of year
$
12,436
 
$
12,106
 
$
13,710
 
Originated servicing rights capitalized
 
3,119
 
 
2,697
 
 
1,823
 
Amortization
 
(2,850
)
 
(2,868
)
 
(2,509
)
Change in valuation allowance
 
966
 
 
501
 
 
(918
)
Balance at end of year
$
13,671
 
$
12,436
 
$
12,106
 
Valuation allowance
$
2,306
 
$
3,272
 
$
3,773
 
Loans sold and serviced that have had servicing rights capitalized
$
1,657,996
 
$
1,643,086
 
$
1,661,269
 

The fair value of capitalized mortgage loan servicing rights was $14.2 million and $12.9 million at December 31, 2016 and 2015, respectively. Fair value was determined using an average coupon rate of 4.20%, average servicing fee of 0.256%, average discount rate of 10.07% and an average Public Securities Association (“PSA”) prepayment rate of 175 for December 31, 2016; and an average coupon rate of 4.32%, average servicing fee of 0.254%, average discount rate of 10.04% and an average PSA prepayment rate of 203 for December 31, 2015.

NOTE 5 – OTHER REAL ESTATE

A summary of other real estate activity for the years ended December 31 follows (1):

 
2016
2015
2014
 
(In thousands)
Balance at beginning of year, net of valuation allowance
$
7,070
 
$
6,370
 
$
18,088
 
Loans transferred to other real estate
 
2,355
 
 
6,694
 
 
6,143
 
Sales of other real estate
 
(3,596
)
 
(5,502
)
 
(17,198
)
Additions to valuation allowance charged to expense
 
(873
)
 
(492
)
 
(663
)
Balance at end of year, net of valuation allowance
$
4,956
 
$
7,070
 
$
6,370
 
(1) Table excludes other repossessed assets totaling $0.05 and $0.08 million at December 31, 2016 and 2015, respectively.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  — (Continued)

We periodically review our real estate properties and establish valuation allowances on these properties if values have declined since the date of acquisition. An analysis of our valuation allowance for other real estate follows:

 
2016
2015
2014
 
(In thousands)
Balance at beginning of year
$
1,692
 
$
2,511
 
$
4,047
 
Additions charged to expense
 
873
 
 
492
 
 
663
 
Direct write-downs upon sale
 
(1,772
)
 
(1,311
)
 
(2,199
)
Balance at end of year
$
793
 
$
1,692
 
$
2,511
 

At December 31, 2016 and 2015, the balance of other real estate includes $1.9 million and $2.8 million of foreclosed residential real estate properties. Retail mortgage loans secured by residential real estate properties for which formal foreclosure proceedings are in process according to local requirements totaled $1.0 million and $1.1 million at December 31, 2016 and 2015, respectively.

Other real estate and repossessed assets totaling $5.0 million and $7.2 million at December 31, 2016 and 2015, respectively, are presented net of the valuation allowance on the Consolidated Statements of Financial Condition.

NOTE 6 – PROPERTY AND EQUIPMENT

A summary of property and equipment at December 31 follows:

 
2016
2015
 
(In thousands)
Land
$
15,486
 
$
15,152
 
Buildings
 
54,656
 
 
57,638
 
Equipment
 
72,090
 
 
79,842
 
 
 
142,232
 
 
152,632
 
Accumulated depreciation and amortization
 
(102,057
)
 
(109,529
)
Property and equipment, net
$
40,175
 
$
43,103
 

Depreciation expense was $5.8 million, $6.6 million and $6.7 million in 2016, 2015 and 2014, respectively.

NOTE 7 – INTANGIBLE ASSETS

Intangible assets, net of amortization, at December 31 follows:

 
2016
2015
 
Gross
Carrying
Amount
Accumulated
Amortization
Gross
Carrying
Amount
Accumulated
Amortization
 
(In thousands)
Amortized intangible assets - core deposits
$
6,118
 
$
4,186
 
$
6,118
 
$
3,838
 

Intangible amortization expense was $0.3 million, $0.3 million and $0.5 million in 2016, 2015 and 2014, respectively.

A summary of estimated core deposit intangible amortization at December 31, 2016, follows:

 
(In thousands)
2017
$
346
 
2018
 
346
 
2019
 
346
 
2020
 
346
 
2021
 
346
 
2022 and thereafter
 
202
 
Total
$
1,932
 

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  — (Continued)

NOTE 8 – DEPOSITS

A summary of interest expense on deposits for the years ended December 31 follows:

 
2016
2015
2014
 
(In thousands)
Savings and interest bearing checking
$
1,115
 
$
1,056
 
$
1,064
 
Time deposits under $100,000
 
1,628
 
 
1,586
 
 
2,467
 
Time deposits of $100,000 or more
 
2,198
 
 
1,367
 
 
1,436
 
Total
$
4,941
 
$
4,009
 
$
4,967
 

Aggregate time deposits in denominations of $250,000 or more amounted to $174.6 million and $110.4 million at December 31, 2016 and 2015, respectively.

A summary of the maturity of time deposits at December 31, 2016, follows:

 
(In thousands)
2017
$
363,382
 
2018
 
74,019
 
2019
 
19,838
 
2020
 
11,341
 
2021
 
15,685
 
2022 and thereafter
 
853
 
Total
$
485,118
 

Reciprocal deposits totaled $38.7 million and $50.2 million at December 31, 2016 and 2015, respectively. These deposits represent demand, money market and time deposits from our customers that have been placed through Promontory Interfinancial Network’s Insured Cash Sweep® service and Certificate of Deposit Account Registry Service®. These services allow our customers to access multi-million dollar FDIC deposit insurance on deposit balances greater than the standard FDIC insurance maximum.

A summary of reciprocal deposits at December 31 follows:

 
2016
2015
 
(In thousands)
Demand
$
3,055
 
$
3,436
 
Money market
 
4,350
 
 
8,340
 
Time
 
31,252
 
 
38,431
 
Total
$
38,657
 
$
50,207
 

NOTE 9 – OTHER BORROWINGS

A summary of other borrowings at December 31 follows:

 
2016
2015
 
(In thousands)
Advances from the FHLB
$
9,428
 
$
11,949
 
Other
 
5
 
 
5
 
Total
$
9,433
 
$
11,954
 

Advances from the FHLB are secured by unencumbered qualifying mortgage and home equity loans with a market value equal to at least 135% to 174%, respectively, of outstanding advances. Advances are also secured by FHLB stock that we own, which totaled $7.8 million at December 31, 2016. Unused borrowing capacity with the

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  — (Continued)

FHLB (subject to the FHLB’s credit requirements and policies) was $205.3 million at December 31, 2016. Interest expense on advances amounted to $0.8 million, $0.8 million and $0.9 million for the years ended December 31, 2016, 2015 and 2014, respectively. No FHLB advances were terminated during 2016, 2015 or 2014.

As a member of the FHLB, we must own FHLB stock equal to the greater of 1.0% of the unpaid principal balance of residential mortgage loans or 5.0% of our outstanding advances. At December 31, 2016, we were in compliance with the FHLB stock ownership requirements.

The maturity dates and weighted average interest rates of FHLB advances at December 31 follow:

 
2016
2015
 
Amount
Rate
Amount
Rate
 
(Dollars in thousands)
Fixed-rate advances
 
 
 
 
 
 
 
 
 
 
 
 
2016
 
 
 
 
 
 
$
2,089
 
 
6.55
%
2017
$
1,192
 
 
7.04
%
 
1,258
 
 
7.04
 
2018
 
5,183
 
 
5.99
 
 
5,437
 
 
5.99
 
2019
 
—
 
 
 
 
 
—
 
 
 
 
2020
 
3,053
 
 
7.49
 
 
3,165
 
 
7.49
 
Total advances
$
9,428
 
 
6.61
%
$
11,949
 
 
6.59
%

A summary of contractually required repayments of FHLB advances at December 31, 2016 follow:

 
(In thousands)
2017
$
1,587
 
2018
 
5,042
 
2019
 
143
 
2020
 
2,656
 
Total
$
9,428
 

We had no borrowings outstanding with the FRB during the years ended or at December 31, 2016, 2015 or 2014. We had unused borrowing capacity with the FRB (subject to the FRB’s credit requirements and policies) of $391.2 million at December 31, 2016. Collateral for FRB borrowings are certain commercial loans.

Assets, consisting of FHLB stock and loans, pledged to secure other borrowings and unused borrowing capacity totaled $904.6 million at December 31, 2016.

NOTE 10 – SUBORDINATED DEBENTURES

We have formed various special purpose entities (the “trusts”) for the purpose of issuing trust preferred securities in either public or pooled offerings or in private placements. Independent Bank Corporation owns all of the common stock of each trust and has issued subordinated debentures to each trust in exchange for all of the proceeds from the issuance of the common stock and the trust preferred securities. Trust preferred securities totaling $34.5 million at both December 31, 2016 and 2015, respectively, qualified as Tier 1 regulatory capital.

These trusts are not consolidated with Independent Bank Corporation and accordingly, we report the common securities of the trusts held by us in accrued income and other assets and the subordinated debentures that we have issued to the trusts in the liability section of our Consolidated Statements of Financial Condition.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  — (Continued)

Summary information regarding subordinated debentures as of December 31 follows:

 
 
2016 and 2015
Entity Name
Issue
Date
Subordinated
Debentures
Trust
Preferred
Securities
Issued
Common
Stock
Issued
 
 
(In thousands)
IBC Capital Finance III
May 2007
$
12,372
 
$
12,000
 
$
372
 
IBC Capital Finance IV
September 2007
 
15,465
 
 
15,000
 
 
465
 
Midwest Guaranty Trust I
November 2002
 
7,732
 
 
7,500
 
 
232
 
 
 
$
35,569
 
$
34,500
 
$
1,069
 

Other key terms for the subordinated debentures and trust preferred securities that were outstanding at December 31, 2016 and 2015 follow:

Entity Name
Maturity
Date
Interest Rate
First Permitted
Redemption Date
IBC Capital Finance III
July 30, 2037
3 month LIBOR plus 1.60%
July 30, 2012
IBC Capital Finance IV
September 15, 2037
3 month LIBOR plus 2.85%
September 15, 2012
Midwest Guaranty Trust I
November 7, 2032
3 month LIBOR plus 3.45%
November 7, 2007

The subordinated debentures and trust preferred securities are cumulative and have a feature that permits us to defer distributions (payment of interest) from time to time for a period not to exceed 20 consecutive quarters. Interest is payable quarterly on each of the subordinated debentures and trust preferred securities and no distributions were deferred at December 31, 2016 and 2015.

We have the right to redeem the subordinated debentures and trust preferred securities (at par) in whole or in part from time to time on or after the first permitted redemption date specified above or upon the occurrence of specific events defined within the trust indenture agreements. During 2014, we redeemed trust preferred securities issued by IBC Capital Finance IV with a par value of $5.0 million. These trust preferred securities were redeemed at a discount of $0.5 million and we recognized a gain on extinguishment of debt in our Consolidated Statements of Operations for this same amount.

Issuance costs have been capitalized and are being amortized on a straight- line basis over a period not exceeding 30 years and are included in interest expense in the Consolidated Statements of Operations. Distributions (payment of interest) on the trust preferred securities are also included in interest expense – other borrowings in the Consolidated Statements of Operations.

NOTE 11 – COMMITMENTS AND CONTINGENT LIABILITIES

In the normal course of business, we enter into financial instruments with off-balance sheet risk to meet the financing needs of customers or to reduce exposure to fluctuations in interest rates. These financial instruments may include commitments to extend credit and standby letters of credit. Financial instruments involve varying degrees of credit and interest-rate risk in excess of amounts reflected in the Consolidated Statements of Financial Condition. Exposure to credit risk in the event of non-performance by the counterparties to the financial instruments for loan commitments to extend credit and standby letters of credit is represented by the contractual amounts of those instruments. We do not, however, anticipate material losses as a result of these financial instruments.

A summary of financial instruments with off-balance sheet risk at December 31 follows:

 
2016
2015
 
(In thousands)
Financial instruments whose risk is represented by contract amounts
 
 
 
 
 
 
Commitments to extend credit
$
364,270
 
$
243,458
 
Standby letters of credit
 
3,140
 
 
3,582
 

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Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and generally require payment of a fee. Since commitments may expire without being drawn upon, the commitment amounts do not represent future cash requirements. Commitments are issued subject to similar underwriting standards, including collateral requirements, as are generally involved in the extension of credit facilities.

Standby letters of credit are written conditional commitments issued to guarantee the performance of a customer to a third party. The credit risk involved in such transactions is essentially the same as that involved in extending loan facilities and, accordingly, standby letters of credit are issued subject to similar underwriting standards, including collateral requirements, as are generally involved in the extension of credit facilities. The majority of the standby letters of credit are to corporations, have variable rates that range from 0.60% to 8.25% and mature through 2018.

In December 2016, we reached a tentative settlement regarding litigation initiated against us in Wayne County, Michigan Circuit Court. This litigation concerned checking account transaction sequencing during a period from February 2009 to June 2011. Under the terms of the settlement, we have agreed to pay $2.2 million and are also responsible for class notification costs and certain other expenses which are estimated to total approximately $0.1 million. Although, we deny any liability associated with this matter and believe we have meritorious defenses to the allegations in the complaint, given the costs and uncertainty of litigation, it was determined that this settlement was in the best interests of the organization.

We are also involved in various other litigation matters in the ordinary course of business. At the present time, we do not believe any of these other matters will have a significant impact on our consolidated financial position or results of operations. The aggregate amount we have accrued for losses we consider probable as a result of these other litigation matters is immaterial. However, because of the inherent uncertainty of outcomes from any litigation matter, we believe it is reasonably possible we may incur losses in addition to the amounts we have accrued. At this time, we estimate the maximum amount of additional losses that are reasonably possible is approximately $0.3 million. However, because of a number of factors, including the fact that certain of these other litigation matters are still in their early stages, this maximum amount may change in the future.

The litigation matters described in the preceding paragraph primarily include claims that have been brought against us for damages, but do not include litigation matters where we seek to collect amounts owed to us by third parties (such as litigation initiated to collect delinquent loans). These excluded, collection-related matters may involve claims or counterclaims by the opposing party or parties, but we have excluded such matters from the disclosure contained in the preceding paragraph in all cases where we believe the possibility of us paying damages to any opposing party is remote. Risks associated with the likelihood that we will not collect the full amount owed to us, net of reserves, are disclosed elsewhere in this report.

Mepco conducts its payment plan business activities across the United States. Mepco acquires the payment plans from companies (which we refer to as Mepco’s “counterparties”) at a discount from the face amount of the payment plan. Each payment plan (which are classified as payment plan receivables in our Consolidated Statements of Financial Condition) permits a consumer to purchase a vehicle service contract by making installment payments, generally for a term of 12 to 30 months, to the sellers of those contracts (one of the “counterparties”). Mepco thereafter collects the payments from consumers. In acquiring the payment plan, Mepco generally funds a portion of the cost to the seller of the service contract and a portion of the cost to the administrator of the service contract. The administrator, in turn, pays the necessary contractual liability insurance policy (“CLIP”) premium to the insurer or risk retention group.

Consumers are allowed to voluntarily cancel the service contract at any time and are generally entitled to receive a refund from the administrator of the unearned portion of the service contract at the time of cancellation. As a result, while Mepco does not owe any refund to the consumer, it also does not have any recourse against the consumer for nonpayment of a payment plan and therefore does not evaluate the creditworthiness of the individual consumer. If a consumer stops making payments on a payment plan or exercises the right to voluntarily cancel the service contract, the service contract seller and administrator are each obligated to refund to Mepco the amount necessary to make Mepco whole as a result of its funding of the service contract. In addition, the insurer or risk retention group that issued the CLIP for the service contract often guarantees all or a portion of the refund to Mepco.

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Upon the cancellation of a service contract and the completion of the billing process to the counterparties for amounts due to Mepco, there is a decrease in the amount of “payment plan receivables” and an increase in the amount of “vehicle service contract counterparty receivables” until such time as the amount due from the counterparty is collected. These amounts represent funds actually due to Mepco from its counterparties for cancelled service contracts. Mepco is currently in the process of working to recover these receivables, primarily through negotiated settlements with the counterparties. In some cases, Mepco requires collateral or guaranties by the principals of the counterparties to secure these refund obligations; however, this is generally only the case when no insurance company is involved to guarantee the repayment obligation of the seller and administrator counterparties. In most cases, there is no collateral to secure the counterparties’ refund obligations to Mepco, but Mepco has the contractual right to offset unpaid refund obligations against amounts Mepco would otherwise be obligated to fund to the counterparties. In addition, even when collateral is involved, the refund obligations of these counterparties are not fully secured. Mepco incurs losses when it is unable to fully recover funds owed to it by counterparties upon cancellation of the underlying service contracts. The sudden failure of one of Mepco’s major counterparties (an insurance company, administrator, or seller/dealer) could expose us to significant losses.

When counterparties do not honor their contractual obligations to Mepco to repay funds, we recognize estimated losses. Mepco pursues collection (including commencing legal action if necessary) of funds due to it under its various contracts with counterparties. Mepco has had to initiate litigation against certain counterparties, including third party insurers, to collect amounts owed to Mepco as a result of those parties’ dispute of their contractual obligations to Mepco. During the first quarter of 2016, we settled our last significant remaining litigation matter with certain of Mepco’s counterparties. This settlement resulted in our receipt of a cash payment of $4.0 million on March 31, 2016. This settlement also resulted in our receipt of an interest-bearing promissory note from one of Mepco’s counterparties for $1.5 million with monthly payments scheduled over a five-year period beginning in May 2016. Due to the lack of any payment history and limited financial information on this counterparty, we established a full reserve on this promissory note as of March 31, 2016. A full reserve on the remaining balance ($1.3 million) on this note was maintained at December 31, 2016. Thus far, this counterparty has made all required monthly payments on the note. As a longer-term payment history is developed on this note, we will continue to evaluate the need for all or any part of a reserve. Vehicle service contract counterparty receivables, net totaled $2.3 million as of December 31, 2016 compared to $7.2 million as of December 31, 2015. For 2016, 2015 and 2014, non-interest expenses include $(0.1) million, $0.1 million and $0.2 million, respectively, of (recoveries) charges related to vehicle service contract counterparty contingencies. These (recoveries) charges are being classified in non-interest expense – other in the Consolidated Statements of Operations because they are associated with a default or potential default of a contractual obligation under our counterparty contracts as opposed to loss on the administration of the payment plan itself.

Our estimate of probable incurred losses from vehicle service contract counterparty contingencies requires a significant amount of judgment because a number of factors can influence the amount of loss that we may ultimately incur. These factors include our estimate of future cancellations of vehicle service contracts, our evaluation of collateral that may be available to recover funds due from our counterparties, and our assessment of the amount that may ultimately be collected from counterparties in connection with their contractual obligations. We apply a rigorous process, based upon historical payment plan activity and past experience, to estimate probable incurred losses and quantify the necessary reserves for our vehicle service contract counterparty contingencies, but there can be no assurance that our modeling process will successfully identify all such losses.

We believe our assumptions regarding the collection of vehicle service contract counterparty receivables are reasonable, and we based them on our good faith judgments using data currently available. We also believe the current amount of reserves we have established and the vehicle service contract counterparty contingencies expense that we have recorded are appropriate given our estimate of probable incurred losses at the applicable Consolidated Statement of Financial Condition date. However, because of the uncertainty surrounding the numerous and complex assumptions made, actual losses could exceed the charges we have taken to date.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  — (Continued)

An analysis of our vehicle service contract counterparty receivable, net follows:

 
2016
2015
2014
 
(In thousands)
Balance at beginning of year, net of reserve
$
7,229
 
$
7,237
 
$
7,716
 
Transfers in from payment plan receivables
 
200
 
 
1,203
 
 
180
 
Reserves (established) reversed and charge-offs recorded to expense
 
88
 
 
(119
)
 
(199
)
Recovery of previously charged-off receivable
 
1,500
 
 
—
 
 
—
 
Reserve established on previously charged-off receivable
 
(1,500
)
 
—
 
 
—
 
Transferred from contingency reserves
 
(38
)
 
—
 
 
(75
)
Transfer to held for sale
 
(422
)
 
—
 
 
—
 
Cash received
 
(4,786
)
 
(1,092
)
 
(385
)
Balance at end of year, net of reserve
$
2,271
 
$
7,229
 
$
7,237
 
Reserve at end of year
$
1,437
 
$
56
 
$
1,370
 

An analysis of our vehicle service contract counterparty reserve follows:

 
2016
2015
2014
 
(In thousands)
Balance at beginning of year
$
56
 
$
1,370
 
$
1,375
 
Additions (recoveries) recorded to expense
 
(88
)
 
119
 
 
199
 
Reserve established on previously charged-off receivable
 
1,500
 
 
—
 
 
—
 
Charge-offs, net
 
(31
)
 
(1,433
)
 
(204
)
Balance at end of year
$
1,437
 
$
56
 
$
1,370
 

In connection with our pending sale of Mepco (see note #1), we agreed to contractually indemnify the purchaser from certain losses it may incur, including as a result of its failure to collect certain receivables it purchased as part of the business as well as breaches of representations and warranties we made in the sale agreement, subject to various limitations. We have not accrued any liability related to these indemnification requirements in our December 31, 2016 Consolidated Statement of Financial Condition because we believe the likelihood of having to pay any amount as a result of these indemnification obligations is remote. However, if the purchaser is unable to collect the receivables it purchased from Mepco or otherwise encounters difficulties in operating the business, it is possible it could make one or more claims against us pursuant to the sale agreement. In that event, we may incur expenses in defending any such claims and/or amounts paid to such purchaser to resolve such claims.

The provision for loss reimbursement on sold loans represents our estimate of incurred losses related to mortgage loans that we have sold to investors (primarily Fannie Mae, Freddie Mac and Ginnie Mae). Since we sell mortgage loans without recourse, loss reimbursements only occur in those instances where we have breached a representation or warranty or other contractual requirement related to the loan sale. The provision for loss reimbursement on sold loans was an expense (credit) of $0.03 million, $(0.06) million and $(0.47) million for the years ended December 31, 2016, 2015 and 2014, respectively. The small expense in 2016 is primarily due to establishing specific reserves for pending loss reimbursement claims. The credit provisions in 2015 and 2014 are due primarily to the settlements of certain loss reimbursement claims at lower amounts than what had been specifically reserved for at the end of the respective previous period. The reserve for loss reimbursements on sold mortgage loans totaled $0.6 million and $0.5 million at December 31, 2016 and 2015, respectively. This reserve is included in accrued expenses and other liabilities in our Consolidated Statements of Financial Condition. This reserve is based on an analysis of mortgage loans that we have sold which are further categorized by delinquency status, loan to value, and year of origination. The calculation includes factors such as probability of default, probability of loss reimbursement (breach of representation or warranty) and estimated loss severity. The reserve levels at December 31, 2016 and 2015 also reflect the resolution of the mortgage loan origination years of 2000 to 2008 with Fannie Mae and Freddie Mac. We believe that the amounts that we have accrued for incurred losses on sold mortgage loans are appropriate given our analyses. However, future losses could exceed our current estimate.

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NOTE 12 – SHAREHOLDERS’ EQUITY AND INCOME PER COMMON SHARE

On January 21, 2016 and 2015, our Board of Directors authorized share repurchase plans to buy back up to 5% of our outstanding common stock through the end of each respective year. On April 26, 2016 our Board of Directors authorized a $5.0 million expansion of the 2016 repurchase plan. During 2016 and 2015 repurchases were made through open market transactions and totaled 1,153,136 and 967,199 shares of common stock, respectively for an aggregate purchase price of $16.9 million and $13.5 million, respectively.

On November 15, 2011, we entered into a Tax Benefits Preservation Plan (the “Preservation Plan”) with our stock transfer agent, American Stock Transfer & Trust Company. Our Board of Directors adopted the Preservation Plan in an effort to protect the value to our shareholders of our ability to use deferred tax assets, such as net operating loss carry forwards, to reduce potential future federal income tax obligations. Under federal tax rules, this value could be lost in the event we experienced an “ownership change,” as defined in Section 382 of the federal Internal Revenue Code. The Preservation Plan attempted to protect this value by reducing the likelihood that we would experience such an ownership change by discouraging any person who is not already a 5% shareholder from becoming a 5% shareholder (with certain limited exceptions).

On October 25, 2016, the Board of Directors took affirmative action to not renew the Preservation Plan, which expired on November 15, 2016. None of the Rights had been exercised or had become exercisable because no unpermitted 4.99% or more change in the beneficial ownership of the outstanding common stock had occurred.

A reconciliation of basic and diluted net income per common share for the years ended December 31 follows:

 
2016
2015
2014
 
(In thousands, except per share amounts)
Net income
$
22,766
 
$
20,017
 
$
18,021
 
 
 
 
 
 
 
 
 
 
 
Weighted average shares outstanding (1)
 
21,378
 
 
22,716
 
 
22,927
 
Effect of stock options
 
151
 
 
119
 
 
124
 
Stock units for deferred compensation plan for non-employee directors
 
115
 
 
112
 
 
114
 
Performance share units
 
48
 
 
—
 
 
—
 
Restricted stock units
 
35
 
 
233
 
 
306
 
Weighted average shares outstanding for calculation of diluted earnings per share
 
21,727
 
 
23,180
 
 
23,471
 
 
 
 
 
 
 
 
 
 
 
Net income per common share
 
 
 
 
 
 
 
 
 
Basic (1)
$
1.06
 
$
0.88
 
$
0.79
 
Diluted
$
1.05
 
$
0.86
 
$
0.77
 
(1) Basic net income per common share includes weighted average common shares outstanding during the period and participating share awards.

Weighted average stock options outstanding that were not considered in computing diluted net income per common share because they were anti-dilutive totaled zero, 0.03 million and 0.03 million for 2016, 2015 and 2014, respectively.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  — (Continued)

NOTE 13 – INCOME TAX

The composition of income tax expense for the years ended December 31 follows:

 
2016
2015
2014
 
(In thousands)
Current expense (benefit)
$
362
 
$
200
 
$
(359
)
Deferred expense
 
9,756
 
 
9,128
 
 
7,672
 
Valuation allowance - change in estimate
 
17
 
 
35
 
 
(118
)
Income tax expense
$
10,135
 
$
9,363
 
$
7,195
 

Income tax expense includes income taxes in a variety of other states due primarily to Mepco’s operations. The amounts of such state income taxes were an expense (benefit) of $(0.1) million, $(0.1) million and zero in 2016, 2015 and 2014, respectively.

The deferred income tax expense of $9.8 million, $9.1 million and $7.7 million during 2016, 2015 and 2014 can be primarily attributed to the utilization of our net operating loss (“NOL”) carryfoward and decrease in our AFLL.

A reconciliation of income tax expense to the amount computed by applying the statutory federal income tax rate of 35% in each year presented to the income before income tax for the years ended December 31 follows:

 
2016
2015
2014
 
(In thousands)
Statutory rate applied to income before income tax
$
11,515
 
$
10,283
 
$
8,826
 
Tax-exempt income
 
(534
)
 
(434
)
 
(522
)
Bank owned life insurance
 
(477
)
 
(449
)
 
(480
)
Share-based compensation
 
(348
)
 
—
 
 
—
 
Unrecognized tax benefit
 
(155
)
 
(135
)
 
(595
)
Non-deductible meals, entertainment and memberships
 
46
 
 
43
 
 
53
 
Net change in valuation allowance
 
17
 
 
35
 
 
(118
)
Other, net
 
71
 
 
20
 
 
31
 
Income tax expense
$
10,135
 
$
9,363
 
$
7,195
 

As described in Note #1, we adopted ASU 2016-09, “Compensation – Stock Compensation (718) Improvements to Employee Share-Based Payment Accounting” during the second quarter of 2016 which now requires us to recognize for book purposes either income tax expense or benefit on deficiencies / excess benefits relating to share-based compensation. Included in income tax expense for the year ended December 31, 2016 are tax benefits of $0.3 million due to the vesting of certain share-based compensation grants and the exercise of stock options during the period.

The tax effects of temporary differences that give rise to significant portions of the deferred tax assets and deferred tax liabilities at December 31 follow:

 
2016
2015
 
(In thousands)
Deferred tax assets
 
 
 
 
 
 
Loss carryforwards
$
17,131
 
$
25,516
 
Allowance for loan losses
 
7,104
 
 
7,901
 
Alternative minimum tax credit carry forward
 
4,064
 
 
3,427
 
Property and equipment
 
3,143
 
 
3,369
 
Unrealized loss on securities available for sale
 
1,782
 
 
128
 
Purchase premiums, net
 
1,460
 
 
1,755
 
Share based payments
 
1,011
 
 
786
 
Litigation settlement
 
805
 
 
—
 

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  — (Continued)

 
2016
2015
 
(In thousands)
Vehicle service contract counterparty contingency reserve
 
500
 
 
21
 
Unrealized loss on trading securities
 
486
 
 
578
 
Other than temporary impairment charge on securities available for sale
 
400
 
 
382
 
Deferred compensation
 
375
 
 
404
 
Valuation allowance on other real estate
 
277
 
 
592
 
Non accrual loan interest income
 
246
 
 
232
 
Reserve for unfunded lending commitments
 
228
 
 
228
 
Loss reimbursement on sold loans reserve
 
196
 
 
186
 
Other
 
1
 
 
—
 
Gross deferred tax assets
 
39,209
 
 
45,505
 
Valuation allowance
 
(1,071
)
 
(1,054
)
Gross deferred tax assets, net of valuation allowance
 
38,138
 
 
44,451
 
Deferred tax liabilities
 
 
 
 
 
 
Capitalized mortgage loan servicing rights
 
4,785
 
 
4,353
 
Deferred loan fees
 
490
 
 
256
 
Federal Home Loan Bank stock
 
45
 
 
45
 
Other
 
—
 
 
162
 
Gross deferred tax liabilities
 
5,320
 
 
4,816
 
Deferred tax assets, net
$
32,818
 
$
39,635
 

We assess whether a valuation allowance should be established against our deferred tax assets based on the consideration of all available evidence using a “more likely than not” standard. The ultimate realization of this asset is primarily based on generating future income. We concluded at both December 31, 2016 and 2015, that the realization of substantially all of our deferred tax assets continues to be more likely than not.

The valuation allowance against our deferred tax assets totaled $1.1 million at both December 31, 2016 and 2015. The valuation allowance against our deferred tax assets at December 31, 2016 primarily relates to state income taxes from Mepco. In this instance, we determined that the future realization of these particular deferred tax assets was not more likely than not. This conclusion in 2016 was based on the pending sale of Mepco’s payment plan business and in 2015 was primarily based on the uncertainty of Mepco’s future earnings attributable to particular states (given the various apportionment criteria) and the significant reduction in the size of Mepco’s business.

Because of our NOL and tax credit carryforwards, we are still subject to the rules of Section 382 of the Internal Revenue Code of 1986, as amended. An ownership change, as defined by these rules, would negatively affect our ability to utilize our NOL carryforwards and other deferred tax assets in the future. If such an ownership change were to occur, we may suffer higher-than-anticipated tax expense, and consequently lower net income and cash flow, in those future years.

At December 31, 2016, we had federal NOL carryforwards of approximately $46.0 million which, if not used against taxable income, will expire as follows:

 
(In thousands)
2031
$
8,301
 
2032
 
37,739
 
Total
$
46,040
 

In addition to the amounts in the table above we also had a minor amount of state NOL carryforwards in certain states where Mepco operates. In addition, we had $4.1 million of alternative minimum tax credit carryforwards with indefinite lives at December 31, 2016.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  — (Continued)

Changes in unrecognized tax benefits for the years ended December 31 follow:

 
2016
2015
2014
 
(In thousands)
Balance at beginning of year
$
976
 
$
1,091
 
$
1,672
 
Additions based on tax positions related to the current year
 
19
 
 
20
 
 
18
 
Reductions due to the statute of limitations
 
(155
)
 
(135
)
 
(595
)
Reductions due to settlements
 
—
 
 
—
 
 
(4
)
Balance at end of year
$
840
 
$
976
 
$
1,091
 

If recognized, the entire amount of unrecognized tax benefits, net of $0.3 million of federal tax on state benefits, would affect our effective tax rate. We do not expect the total amount of unrecognized tax benefits to significantly increase or decrease in the next twelve months. No amounts were expensed for interest and penalties for the years ended December 31, 2016, 2015 and 2014. No amounts were accrued for interest and penalties at December 31, 2016, 2015 or 2014. At December 31, 2016, U.S. Federal tax years 2013 through the present remain open to examination.

NOTE 14 – SHARE BASED COMPENSATION AND BENEFIT PLANS

We maintain share based payment plans that include a non-employee director stock purchase plan and a long-term incentive plan that permits the issuance of share based compensation, including stock options and non-vested share awards. The long-term incentive plan, which is shareholder approved, permits the grant of additional share based awards for up to 0.2 million shares of common stock as of December 31, 2016. The non-employee director stock purchase plan permits the grant of additional share based payments for up to 0.2 million shares of common stock as of December 31, 2016. Share based awards and payments are measured at fair value at the date of grant and are expensed over the requisite service period. Common shares issued upon exercise of stock options come from currently authorized but unissued shares.

During 2016, 2015 and 2014 pursuant to our long-term incentive plan, we granted 0.10 million, 0.07 million and 0.07 million shares, respectively of restricted stock and 0.05 million, 0.03 million and 0.03 million performance stock units (“PSUs”), respectively to certain officers. The shares of restricted stock issued during 2016 cliff vest after periods ranging from one to four years, the shares of restricted stock issued during 2015 cliff vest after a period of three years and the shares of restricted stock issued during 2014 vest ratably over three years. The PSUs issued during 2016 cliff vest after periods ranging from three to five years and the PSUs issued during 2015 and 2014 cliff vest after a period of three years. The performance feature of the PSUs is based on a comparison of our total shareholder return over the three year period starting on the grant date to the total shareholder return over that period for a banking index of our peers.

Our directors may elect to receive at least a portion of their quarterly cash retainer fees in the form of common stock (either on a current basis or on a deferred basis) pursuant to the non-employee director stock purchase plan referenced above. Shares equal in value to that portion of each director’s fees that he or she has elected to receive in stock are issued each quarter and vest immediately. We issued 0.01 million shares to directors during each of the years ending 2016, 2015 and 2014 and expensed their value during those same periods.

Total compensation expense recognized for grants pursuant to our long-term incentive plan was $1.5 million, $1.4 million and $1.0 million in 2016, 2015 and 2014, respectively. The corresponding tax benefit relating to this expense was $0.5 million, $0.5 million and $0.4 million in 2016, 2015 and 2014, respectively. Total expense recognized for non-employee director share based payments was $0.1 million, $0.1 million and $0.2 million in 2016, 2015 and 2014, respectively. The corresponding tax benefit relating to this expense was $0.04 million, $0.03 million and $0.1million in 2016, 2015 and 2014, respectively.

At December 31, 2016, the total expected compensation cost related to non-vested restricted stock and PSUs not yet recognized was $2.2 million. The weighted-average period over which this amount will be recognized is 2.4 years.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  — (Continued)

A summary of outstanding stock option grants and related transactions follows:

 
Number of
Shares
Average
Exercise
Price
Weighted-
Average
Remaining
Contractual
Term (Years)
Aggregated
Intrinsic
Value
 
 
(In thousands)
Outstanding at January 1, 2016
 
235,596
 
$
4.94
 
 
 
 
 
 
 
Granted
 
—
 
 
 
 
 
 
 
 
 
 
Exercised
 
(21,614
)
 
3.93
 
 
 
 
 
 
 
Forfeited
 
(664
)
 
6.42
 
 
 
 
 
 
 
Expired
 
(2,300
)
 
3.54
 
 
 
 
 
 
 
Outstanding at December 31, 2016
 
211,018
 
$
5.05
 
 
5.09
 
$
3,514
 
Vested and expected to vest at December 31, 2016
 
211,018
 
$
5.05
 
 
5.09
 
$
3,514
 
Exercisable at December 31, 2016
 
211,018
 
$
5.05
 
 
5.09
 
$
3,514
 

A summary of outstanding non-vested stock and related transactions follows:

 
Number
of Shares
Weighted-
Average
Grant Date
Fair Value
Outstanding at January 1, 2016
 
261,981
 
$
11.29
 
Granted
 
147,160
 
 
15.39
 
Vested
 
(107,795
)
 
7.92
 
Forfeited
 
(4,924
)
 
13.24
 
Outstanding at December 31, 2016
 
296,422
 
$
14.52
 

Certain information regarding options exercised during the periods ending December 31 follows:

 
2016
2015
2014
 
(In thousands)
Intrinsic value
$
254
 
$
444
 
$
321
 
Cash proceeds received
$
85
 
$
137
 
$
96
 
Tax benefit realized
$
89
 
$
155
 
$
112
 

We maintain 401(k) and employee stock ownership plans covering substantially all of our full-time employees. During 2016 and 2015 we matched 50% of employee contributions to the 401(k) plan up to a maximum of 6% and 4% of participating employees’ eligible wages, respectively. During 2014 we matched 100% of employee contributions up to a maximum of 2% of participating employees’ eligible wages. Contributions to the employee stock ownership plan are determined annually and require approval of our Board of Directors. The maximum contribution is 6% of employees’ eligible wages. Contributions to the employee stock ownership plan were 2% for 2016, 2015 and 2014. Amounts expensed for these retirement plans were $1.4 million, $1.2 million, and $1.0 million in 2016, 2015 and 2014, respectively.

Our employees participate in various performance-based compensation plans. Amounts expensed for all incentive plans totaled $6.2 million, $5.7 million and $4.2 million, in 2016, 2015 and 2014, respectively.

We also provide certain health care and life insurance programs to substantially all full-time employees. Amounts expensed for these programs totaled $3.5 million, $3.6 million and $3.9 million in 2016, 2015 and 2014 respectively. These insurance programs are also available to retired employees at their own expense.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  — (Continued)

NOTE 15 – OTHER NON-INTEREST INCOME

Other non-interest income for the years ended December 31 follows:

 
2016
2015
2014
 
(In thousands)
Investment and insurance commissions
$
1,647
 
$
1,827
 
$
1,814
 
ATM fees
 
1,496
 
 
1,551
 
 
1,599
 
Bank owned life insurance
 
1,124
 
 
1,282
 
 
1,371
 
Other real estate rental income
 
58
 
 
128
 
 
1,295
 
Other
 
3,091
 
 
2,904
 
 
2,852
 
Total other non-interest income
$
7,416
 
$
7,692
 
$
8,931
 

NOTE 16 – DERIVATIVE FINANCIAL INSTRUMENTS

We are required to record derivatives on our Consolidated Statements of Financial Condition as assets and liabilities measured at their fair value. The accounting for increases and decreases in the value of derivatives depends upon the use of derivatives and whether the derivatives qualify for hedge accounting.

Our derivative financial instruments according to the type of hedge in which they are designated at December 31 follow:

 
2016
 
Notional
Amount
Average
Maturity
(years)
Fair
Value
 
(Dollars in thousands)
No hedge designation
 
 
 
 
 
 
 
 
 
Rate-lock mortgage loan commitments
$
26,658
 
 
0.1
 
$
646
 
Mandatory commitments to sell mortgage loans
 
61,954
 
 
0.1
 
 
630
 
Pay-fixed interest rate swap agreements
 
46,121
 
 
8.6
 
 
249
 
Pay-variable interest rate swap agreements
 
46,121
 
 
8.6
 
 
(249
)
Purchased options
 
3,119
 
 
4.5
 
 
238
 
Written options
 
3,119
 
 
4.5
 
 
(238
)
Total
$
187,092
 
 
4.4
 
$
1,276
 
 
2015
 
Notional
Amount
Average
Maturity
(years)
Fair
Value
 
(Dollars in thousands)
No hedge designation
 
 
 
 
 
 
 
 
 
Rate-lock mortgage loan commitments
$
20,581
 
 
0.1
 
$
550
 
Mandatory commitments to sell mortgage loans
 
46,320
 
 
0.1
 
 
69
 
Pay-fixed interest rate swap agreements
 
27,587
 
 
8.0
 
 
(497
)
Pay-variable interest rate swap agreements
 
27,587
 
 
8.0
 
 
497
 
Purchased options
 
2,098
 
 
5.7
 
 
122
 
Written options
 
2,098
 
 
5.7
 
 
(122
)
Total
$
126,271
 
 
3.7
 
$
619
 

We have established management objectives and strategies that include interest-rate risk parameters for maximum fluctuations in net interest income and market value of portfolio equity. We monitor our interest rate risk position via simulation modeling reports. The goal of our asset/liability management efforts is to maintain profitable financial leverage within established risk parameters.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  — (Continued)

To meet our asset/liability management objectives, we may periodically enter into derivative financial instruments to mitigate exposure to fluctuations in cash flows resulting from changes in interest rates (“Cash Flow Hedges”). Cash Flow Hedges included certain pay-fixed interest rate swaps which converted the variable-rate cash flows on debt obligations to fixed-rates. In 2013 we terminated our last Cash Flow Hedge pay-fixed interest rate swap and paid a termination fee of $0.6 million. The remaining unrealized loss on the terminated pay-fixed interest rate swap which was equal to this termination fee was included as a component of accumulated other comprehensive loss and was amortized into earnings through December 31, 2014, the original remaining life of the pay-fixed interest rate swap.

Certain derivative financial instruments have not been designated as hedges. The fair value of these derivative financial instruments has been recorded on our Consolidated Statements of Financial Condition and is adjusted on an ongoing basis to reflect their then current fair value. The changes in fair value of derivative financial instruments not designated as hedges are recognized in earnings.

In the ordinary course of business, we enter into rate-lock mortgage loan commitments with customers (“Rate-Lock Commitments”). These commitments expose us to interest rate risk. We also enter into mandatory commitments to sell mortgage loans (“Mandatory Commitments”) to reduce the impact of price fluctuations of mortgage loans held for sale and Rate-Lock Commitments. Mandatory Commitments help protect our loan sale profit margin from fluctuations in interest rates. The changes in the fair value of Rate Lock Commitments and Mandatory Commitments are recognized currently as part of net gains on mortgage loans in the Consolidated Statements of Operations. We obtain market prices on Mandatory Commitments and Rate-Lock Commitments. Net gains on mortgage loans, as well as net income, may be more volatile as a result of these derivative instruments, which are not designated as hedges.

During 2015, we began offering to our deposit customers an equity linked time deposit product (“Altitude CD”). The Altitude CD is a time deposit that provides the customer a guaranteed return of principal at maturity plus a potential equity return (a written option), while we receive a like stream of funds based on the equity return (a purchased option). The written and purchased options will generally move in opposite directions resulting in little or no net impact on our Consolidated Statements of Operations. All of the written and purchased options in the table above relate to this Altitude CD product.

During 2014, we began a program that allows commercial loan customers to lock in a fixed rate for a longer period of time than we would normally offer for interest rate risk reasons. We will enter into a variable rate commercial loan and an interest rate swap agreement with a customer and then enter into an offsetting interest rate swap agreement with an unrelated party. The interest rate swap agreement fair values will generally move in opposite directions resulting in little or no net impact on our Consolidated Statements of Operations. All of the interest rate swap agreements in the table above relate to this program.

During the second quarter of 2014, we completed a securities trade in which we shorted a $13 million UST security. This UST short was terminated during the fourth quarter of 2014 and the change in the fair value of the short position from the inception date to the termination date has been recorded in net gains on securities in our Consolidated Statements of Operations.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  — (Continued)

The following tables illustrate the impact that the derivative financial instruments discussed above have on individual line items in the Consolidated Statements of Financial Condition for the periods presented:

Fair Values of Derivative Instruments

 
Asset Derivatives
Liability Derivatives
 
December 31,
December 31,
 
2016
2015
2016
2015
 
Balance
Sheet
Location
Fair
Value
Balance
Sheet
Location
Fair
Value
Balance
Sheet
Location
Fair
Value
Balance
Sheet
Location
Fair
Value
 
(In thousands)
Derivatives not designated as hedging instruments
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Rate-lock mortgage loan commitments
Other assets
$
646
 
Other assets
$
550
 
Other liabilities
$
—
 
Other liabilities
$
—
 
Mandatory commitments to sell mortgage loans
Other assets
 
630
 
Other assets
 
69
 
Other liabilities
 
—
 
Other liabilities
 
—
 
Pay-fixed interest rate swap agreements
Other assets
 
493
 
Other assets
 
—
 
Other liabilities
 
244
 
Other liabilities
 
497
 
Pay-variable interest rate swap agreements
Other assets
 
244
 
Other assets
 
497
 
Other liabilities
 
493
 
Other liabilities
 
—
 
Purchased options
Other assets
 
238
 
Other assets
 
122
 
Other liabilities
 
—
 
Other liabilities
 
—
 
Written options
Other assets
 
—
 
Other assets
 
—
 
Other liabilities
 
238
 
Other liabilities
 
122
 
Total derivatives
 
$
2,251
 
 
$
1,238
 
 
$
975
 
 
$
619
 

The effect of derivative financial instruments on the Consolidated Statements of Operations follows:

 
Year Ended December 31,
 
Loss Recognized
in Other
Comprehensive
Income (Loss)
(Effective Portion)
Location
of Loss
Reclassified
from
Accumulated Other
Comprehensive
Loss
into Income
(Effective Portion)
Loss Reclassified from
Accumulated Other
Comprehensive
Loss into Income
(Effective Portion)
Location of
Gain (Loss)
Recognized
in Income (1)
Gain (Loss)
Recognized
in Income (1)
 
2016
2015
2014
2016
2015
2014
2016
2015
2014
 
(In thousands)
Cash Flow Hedges
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Pay-fixed interest rate swap agreements
$
—
 
$
—
 
$
—
 
Interest
   expense
$
—
 
$
—
 
$
(380
)
Interest
   expense
$
—
 
$
—
 
$
—
 
Total
$
—
 
$
—
 
$
—
 
 
$
—
 
$
—
 
$
(380
)
 
$
—
 
$
—
 
$
—
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
No hedge designation
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Rate-lock mortgage loan commitments
Net gains on
   mortgage
   loans
$
96
 
$
113
 
$
71
 
Mandatory commitments to sell mortgage loans
Net gains on
   mortgage
   loans
 
561
 
 
253
 
 
(312
)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Pay-fixed interest rate swap agreements
Interest
   income
 
746
 
 
(315
)
 
(182
)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Pay-variable interest rate swap agreements
Interest
   income
 
(746
)
 
315
 
 
182
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Purchased options
Interest
   expense
 
116
 
 
122
 
 
—
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Written options
Interest
   expense
 
(116
)
 
(122
)
 
—
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
UST short position
Net gains on
   securities
 
—
 
 
—
 
 
295
 
Total
 
$
657
 
$
366
 
$
54
 
(1) For cash flow hedges, this location and amount refers to the ineffective portion.

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NOTE 17 – RELATED PARTY TRANSACTIONS

Certain of our directors and executive officers, including companies in which they are officers or have significant ownership, were loan and deposit customers during 2016 and 2015.

A summary of loans to our directors and executive officers whose borrowing relationship (which includes loans to entities in which the individual owns a 10% or more voting interest) exceeds $60,000 for the years ended December 31 follows:

 
2016
2015
 
(In thousands)
Balance at beginning of year
$
190
 
$
216
 
New loans and advances
 
594
 
 
—
 
Repayments
 
(369
)
 
(26
)
Balance at end of year
$
415
 
$
190
 

Deposits held by us for directors and executive officers totaled $1.0 million and $1.3 million at December 31, 2016 and 2015, respectively.

NOTE 18 – LEASES

We have non-cancelable operating leases for certain office facilities, some of which include renewal options and escalation clauses.

A summary of future minimum lease payments under non-cancelable operating leases at December 31, 2016, follows:

 
(In thousands)
2017
$
1,444
 
2018
 
1,313
 
2019
 
994
 
2020
 
927
 
2021
 
460
 
2022 and thereafter
 
499
 
Total
$
5,637
 

Rental expense on operating leases totaled $1.2 million, $1.2 million and $1.3 million in 2016, 2015 and 2014, respectively.

NOTE 19 – CONCENTRATIONS OF CREDIT RISK

Credit risk is the risk to earnings and capital arising from an obligor’s failure to meet the terms of any contract with our organization or otherwise fail to perform as agreed. Credit risk can occur outside of our traditional lending activities and can exist in any activity where success depends on counterparty, issuer or borrower performance. Concentrations of credit risk (whether on- or off-balance sheet) arising from financial instruments can exist in relation to individual borrowers or groups of borrowers, certain types of collateral, certain types of industries or certain geographic regions. Credit risk associated with these concentrations could arise when a significant amount of loans or other financial instruments, related by similar characteristics, are simultaneously impacted by changes in economic or other conditions that cause their probability of repayment or other type of settlement to be adversely affected. Our major concentrations of credit risk arise by collateral type and by industry. The significant concentrations by collateral type at December 31, 2016, include $558.9 million of loans secured by residential real estate and $77.3 million of construction and development loans.

Additionally, within our commercial real estate and commercial loan portfolio, we had significant standard industry classification concentrations in the following categories as of December 31, 2016: Lessors of Nonresidential Real Estate ($247.1 million); Lessors of Residential Real Estate ($98.5 million); Health Care and Social Assistance

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($70.1 million) and Construction General Contractors and Land Development ($62.5 million). A geographic concentration arises because we primarily conduct our lending activities in the State of Michigan.

NOTE 20 – REGULATORY MATTERS

Capital guidelines adopted by federal and state regulatory agencies and restrictions imposed by law limit the amount of cash dividends our Bank can pay to us. Under these guidelines, the amount of dividends that may be paid in any calendar year is limited to the Bank’s current year net profits, combined with the retained net profits of the preceding two years. Further, the Bank cannot pay a dividend at any time that it has negative undivided profits. As of December 31, 2016, the Bank had positive undivided profits of $9.9 million. We can request regulatory approval for a return of capital from the Bank to the parent company. During the first quarters of 2016, 2015 and 2014, we requested regulatory approval for returns of capital from the Bank to the parent company for $18.0 million, $18.5 million and $15.0 million. These return of capital requests were approved by our banking regulators on February 24, 2016, February 13, 2015 and March 28, 2014, respectively and the Bank returned these amounts to the parent company on February 25, 2016, February 17, 2015 and April 9, 2014, respectively. It is not our intent to have dividends paid in amounts that would reduce the capital of our Bank to levels below those which we consider prudent and in accordance with guidelines of regulatory authorities.

We are also subject to various regulatory capital requirements. The prompt corrective action regulations establish quantitative measures to ensure capital adequacy and require minimum amounts and ratios of total, Tier 1, and common equity Tier 1 capital to risk-weighted assets and Tier 1 capital to average assets. Failure to meet minimum capital requirements can result in certain mandatory, and possibly discretionary, actions by regulators that could have a material effect on our consolidated financial statements. Under capital adequacy guidelines, we must meet specific capital requirements that involve quantitative measures as well as qualitative judgments by the regulators. The most recent regulatory filings as of December 31, 2016 and 2015, categorized our Bank as well capitalized. Management is not aware of any conditions or events that would have changed the most recent Federal Deposit Insurance Corporation (“FDIC”) categorization.

On July 2, 2013, the Federal Reserve approved a final rule that establishes an integrated regulatory capital framework (the “New Capital Rules”). The rule implements in the United States the Basel III regulatory capital reforms from the Basel Committee on Banking Supervision and certain changes required by the Dodd-Frank Act. In general, under the New Capital Rules, minimum requirements have increased for both the quantity and quality of capital held by banking organizations. Consistent with the international Basel framework, the New Capital Rules include a new minimum ratio of common equity Tier 1 capital to risk-weighted assets of 4.5% and a common equity Tier 1 capital conservation buffer of 2.5% of risk-weighted assets that applies to all supervised financial institutions. The capital conservation buffer began to phase in on January 1, 2016 with 0.625% added to the minimum ratio for adequately capitalized institutions for 2016 and 0.625% will be added each subsequent year until fully phased in during 2019. This capital conservation buffer is not reflected in the table that follows. To avoid limits on capital distributions and certain discretionary bonus payments we must meet the minimum ratio for adequately capitalized institutions plus the phased in buffer. The rule also raises the minimum ratio of Tier 1 capital to risk-weighted assets from 4% to 6% and includes a minimum leverage ratio of 4% for all banking organizations. As to the quality of capital, the New Capital Rules emphasize common equity Tier 1 capital, the most loss-absorbing form of capital, and implement strict eligibility criteria for regulatory capital instruments. The New Capital Rules also change the methodology for calculating risk-weighted assets to enhance risk sensitivity. The New Capital Rules became effective for us on January 1, 2015

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Our actual capital amounts and ratios at December 31 follow:

 
Actual
Minimum for
Adequately Capitalized
Institutions
Minimum for
Well-Capitalized
Institutions
 
Amount
Ratio
Amount
Ratio
Amount
Ratio
 
(Dollars in thousands)
2016
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Total capital to risk-weighted assets
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Consolidated
$
286,289
 
 
15.86
%
$
144,413
 
 
8.00
%
NA
NA
Independent Bank
 
270,855
 
 
15.02
 
 
144,223
 
 
8.00
 
$
180,279
 
 
10.00
%
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Tier 1 capital to risk-weighted assets
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Consolidated
$
265,405
 
 
14.70
%
$
108,309
 
 
6.00
%
NA
NA
Independent Bank
 
249,971
 
 
13.87
 
 
108,167
 
 
6.00
 
$
144,223
 
 
8.00
%
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Common equity tier 1 capital to risk-weighted assets
Consolidated
$
238,996
 
 
13.24
%
$
81,232
 
 
4.50
%
NA
NA
Independent Bank
 
249,971
 
 
13.87
 
 
81,126
 
 
4.50
 
$
117,181
 
 
6.50
%
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Tier 1 capital to average assets
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Consolidated
$
265,405
 
 
10.50
%
$
101,112
 
 
4.00
%
NA
NA
Independent Bank
 
249,971
 
 
9.90
 
 
101,019
 
 
4.00
 
$
126,274
 
 
5.00
%
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
2015
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Total capital to risk-weighted assets
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Consolidated
$
278,170
 
 
16.65
%
$
133,668
 
 
8.00
%
NA
NA
Independent Bank
 
261,894
 
 
15.69
 
 
133,514
 
 
8.00
 
$
166,893
 
 
10.00
%
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Tier 1 capital to risk-weighted assets
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Consolidated
$
257,050
 
 
15.38
%
$
100,251
 
 
6.00
%
NA
NA
Independent Bank
 
240,867
 
 
14.43
 
 
100,136
 
 
6.00
 
$
133,514
 
 
8.00
%
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Common equity tier 1 capital to risk-weighted assets
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Consolidated
$
239,271
 
 
14.32
%
$
75,188
 
 
4.50
%
NA
NA
Independent Bank
 
240,867
 
 
14.43
 
 
75,102
 
 
4.50
 
$
108,480
 
 
6.50
%
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Tier 1 capital to average assets
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Consolidated
$
257,050
 
 
10.91
%
$
94,217
 
 
4.00
%
NA
NA
Independent Bank
 
240,867
 
 
10.23
 
 
94,145
 
 
4.00
 
$
117,682
 
 
5.00
%

NA - Not applicable

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The components of our regulatory capital are as follows:

 
Consolidated
Independent Bank
 
December 31,
December 31,
 
2016
2015
2016
2015
 
(In thousands)
Total shareholders' equity
$
248,980
 
$
251,092
 
$
258,814
 
$
259,947
 
Add (deduct)
 
 
 
 
 
 
 
 
 
 
 
 
Accumulated other comprehensive loss for regulatory purposes
 
3,310
 
 
238
 
 
3,310
 
 
238
 
Intangible assets
 
(1,159
)
 
(912
)
 
(1,159
)
 
(912
)
Disallowed deferred tax assets
 
(12,135
)
 
(11,147
)
 
(10,994
)
 
(18,406
)
Common equity tier 1 capital
 
238,996
 
 
239,271
 
 
249,971
 
 
240,867
 
Qualifying trust preferred securities
 
34,500
 
 
34,500
 
 
—
 
 
—
 
Disallowed deferred tax assets
 
(8,091
)
 
(16,721
)
 
—
 
 
—
 
Tier 1 capital
 
265,405
 
 
257,050
 
 
249,971
 
 
240,867
 
Allowance for loan losses and allowance for unfunded lending commitments limited to 1.25% of total risk-weighted assets
 
20,884
 
 
21,120
 
 
20,884
 
 
21,027
 
Total risk-based capital
$
286,289
 
$
278,170
 
$
270,855
 
$
261,894
 

NOTE 21 – FAIR VALUE DISCLOSURES

FASB ASC topic 820 defines fair value as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. FASB ASC topic 820 also establishes a fair value hierarchy which requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value.

The standard describes three levels of inputs that may be used to measure fair value:

Level 1: Valuation is based upon quoted prices for identical instruments traded in active markets. Level 1 instruments include securities traded on active exchange markets, such as the New York Stock Exchange, as well as U.S. Treasury securities that are traded by dealers or brokers in active over-the-counter markets.

Level 2: Valuation is based upon quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active, and model-based valuation techniques for which all significant assumptions are observable in the market. Level 2 instruments include securities traded in less active dealer or broker markets.

Level 3: Valuation is generated from model-based techniques that use at least one significant assumption not observable in the market. These unobservable assumptions reflect estimates of assumptions that market participants would use in pricing the asset or liability. Valuation techniques include use of option pricing models, discounted cash flow models and similar techniques.

We used the following methods and significant assumptions to estimate fair value:

Securities : Where quoted market prices are available in an active market, securities (trading or available for sale) are classified as Level 1 of the valuation hierarchy. Level 1 securities include certain preferred stocks included in our trading portfolio for which there are quoted prices in active markets. If quoted market prices are not available for the specific security, then fair values are estimated by (1) using quoted market prices of securities with similar characteristics, (2) matrix pricing, which is a mathematical technique used widely in the industry to value debt securities without relying exclusively on quoted prices for specific securities but rather by relying on the securities’ relationship to other benchmark quoted prices, or (3) a discounted cash flow analysis whose significant fair value

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inputs can generally be verified and do not typically involve judgment by management. These securities are classified as Level 2 of the valuation hierarchy and primarily include agency securities, private label mortgage-backed securities, other asset backed securities, obligations of states and political subdivisions, trust preferred securities, corporate securities and foreign government securities.

Loans held for sale : The fair value of mortgage loans held for sale is based on mortgage backed security pricing for comparable assets (recurring Level 2).

Impaired loans with specific loss allocations based on collateral value : From time to time, certain loans are considered impaired and an AFLL is established. Loans for which it is probable that payment of interest and principal will not be made in accordance with the contractual terms of the loan agreement are considered impaired. We measure our investment in an impaired loan based on one of three methods: the loan’s observable market price, the fair value of the collateral or the present value of expected future cash flows discounted at the loan’s effective interest rate. Those impaired loans not requiring an allowance represent loans for which the fair value of the expected repayments or collateral exceed the recorded investments in such loans. At December 31, 2016 and 2015, all of our total impaired loans were evaluated based on either the fair value of the collateral or the present value of expected future cash flows discounted at the loan’s effective interest rate. When the fair value of the collateral is based on an appraised value or when an appraised value is not available we record the impaired loan as nonrecurring Level 3. These appraisals may utilize a single valuation approach or a combination of approaches including comparable sales and the income approach. Adjustments are routinely made in the appraisal process by the independent appraisers to adjust for differences between the comparable sales and income data available. Such adjustments can be significant and thus will typically result in a Level 3 classification of the inputs for determining fair value.

Other real estate : At the time of acquisition, other real estate is recorded at fair value, less estimated costs to sell, which becomes the property’s new basis. Subsequent write-downs to reflect declines in value since the time of acquisition may occur from time to time and are recorded in net (gains) losses on other real estate and repossessed assets in the Consolidated Statements of Operations. The fair value of the property used at and subsequent to the time of acquisition is typically determined by a third party appraisal of the property. These appraisals may utilize a single valuation approach or a combination of approaches including comparable sales and the income approach. Adjustments are routinely made in the appraisal process by the independent appraisers to adjust for differences between the comparable sales and income data available. Such adjustments can be significant and typically result in a Level 3 classification of the inputs for determining fair value.

Appraisals for both collateral-dependent impaired loans and other real estate are performed by certified general appraisers (for commercial properties) or certified residential appraisers (for residential properties) whose qualifications and licenses have been reviewed and verified by us. Once received, an independent third party (for commercial properties over $0.25 million) or a member of our Collateral Evaluation Department (for commercial properties under $0.25 million) or a member of our Special Assets Group (for retail properties) reviews the assumptions and approaches utilized in the appraisal as well as the overall resulting fair value in comparison with independent data sources such as recent market data or industry-wide statistics. We compare the actual selling price of collateral that has been sold to the most recent appraised value of our properties to determine what additional adjustment, if any, should be made to the appraisal value to arrive at fair value. For commercial and retail properties we typically discount an appraisal to account for various factors that the appraisal excludes in its assumptions. These additional discounts generally do not result in material adjustments to the appraised value.

Capitalized mortgage loan servicing rights : The fair value of capitalized mortgage loan servicing rights is based on a valuation model used by an independent third party that calculates the present value of estimated net servicing income. The valuation model incorporates assumptions that market participants would use in estimating future net servicing income. Certain model assumptions are generally unobservable and are based upon the best information available including data relating to our own servicing portfolio, reviews of mortgage servicing assumption and valuation surveys and input from various mortgage servicers and, therefore, are recorded as nonrecurring Level 3. Management evaluates the third party valuation for reasonableness each quarter as part of our financial reporting control processes.

Derivatives : The fair value of rate-lock mortgage loan commitments and mandatory commitments to sell mortgage loans is based on mortgage backed security pricing for comparable assets (recurring Level 2). The fair value of interest rate swap agreements is based on a discounted cash flow analysis whose significant fair value inputs can

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generally be observed in the market place and do not typically involve judgment by management (recurring Level 2). The fair value of purchased and written options is based on prices of financial instruments with similar characteristics and do not typically involve judgment by management (recurring Level 2).

Assets and liabilities measured at fair value, including financial assets for which we have elected the fair value option, were as follows:

 
 
Fair Value Measurements Using
 
Fair Value
Measure-
ments
Quoted
Prices
in Active
Markets
for
Identical
Assets
(Level 1)
Significant
Other
Observable
Inputs
(Level 2)
Significant
Un-
observable
Inputs (Level 3)
 
(In thousands)
December 31, 2016:
 
 
 
 
 
 
 
 
 
 
 
 
Measured at Fair Value on a Recurring Basis:
 
 
 
 
 
 
 
 
 
 
 
 
Assets
 
 
 
 
 
 
 
 
 
 
 
 
Trading securities
$
410
 
$
410
 
$
—
 
$
—
 
Securities available for sale
 
 
 
 
 
 
 
 
 
 
 
 
U.S. agency
 
28,988
 
 
—
 
 
28,988
 
 
—
 
U.S. agency residential mortgage-backed
 
156,289
 
 
—
 
 
156,289
 
 
—
 
U.S. agency commercial mortgage-backed
 
12,632
 
 
—
 
 
12,632
 
 
—
 
Private label mortgage-backed
 
34,727
 
 
—
 
 
34,727
 
 
—
 
Other asset backed
 
146,709
 
 
—
 
 
146,709
 
 
—
 
Obligations of states and political subdivisions
 
170,899
 
 
—
 
 
170,899
 
 
—
 
Corporate
 
56,180
 
 
—
 
 
56,180
 
 
—
 
Trust preferred
 
2,579
 
 
—
 
 
2,579
 
 
—
 
Foreign government
 
1,613
 
 
—
 
 
1,613
 
 
—
 
Loans held for sale
 
35,946
 
 
—
 
 
35,946
 
 
—
 
Derivatives (1)
 
2,251
 
 
—
 
 
2,251
 
 
—
 
Liabilities
 
 
 
 
 
 
 
 
 
 
 
 
Derivatives (2)
 
975
 
 
—
 
 
975
 
 
—
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Measured at Fair Value on a Non-recurring basis:
 
 
 
 
 
 
 
 
 
 
 
 
Assets
 
 
 
 
 
 
 
 
 
 
 
 
Capitalized mortgage loan servicing rights (3)
 
8,163
 
 
—
 
 
—
 
 
8,163
 
Impaired loans (4)
 
 
 
 
 
 
 
 
 
 
 
 
Commercial
 
 
 
 
 
 
 
 
 
 
 
 
Income producing - real estate
 
255
 
 
—
 
 
—
 
 
255
 
Land, land development & construction-real estate
 
54
 
 
—
 
 
—
 
 
54
 
Commercial and industrial
 
1,342
 
 
—
 
 
—
 
 
1,342
 
Mortgage
 
 
 
 
 
 
 
 
 
 
 
 
1-4 family
 
361
 
 
—
 
 
—
 
 
361
 
Other real estate (5)
 
 
 
 
 
 
 
 
 
 
 
 
Commercial
 
 
 
 
 
 
 
 
 
 
 
 
Income producing - real estate (6)
 
2,863
 
 
—
 
 
2,863
 
 
—
 
Land, land development & construction-real estate
 
176
 
 
—
 
 
—
 
 
176
 
Mortgage
 
 
 
 
 
 
 
 
 
 
 
 
1-4 family
 
98
 
 
—
 
 
—
 
 
98
 
Resort lending
 
133
 
 
—
 
 
—
 
 
133
 
(1) Included in accrued income and other assets.
(2) Included in accrued expenses and other liabilities.
(3) Only includes servicing rights that are carried at fair value due to recognition of a valuation allowance.
(4) Only includes impaired loans with specific loss allocations based on collateral value.
(5) Only includes other real estate with subsequent write downs to fair value.
(6) Level 2 valuation is based on a signed purchase agreement.

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Fair Value Measurements Using
 
Fair Value
Measure-
ments
Quoted Prices
in Active
Markets
for
Identical
Assets
(Level 1)
Significant
Other
Observable
Inputs
(Level 2)
Significant
Un-
observable
Inputs
(Level 3)
 
(In thousands)
December 31, 2015:
 
 
 
 
 
 
 
 
 
 
 
 
Measured at Fair Value on a Recurring Basis:
 
 
 
 
 
 
 
 
 
 
 
 
Assets
 
 
 
 
 
 
 
 
 
 
 
 
Trading securities
$
148
 
$
148
 
$
—
 
$
—
 
Securities available for sale
 
 
 
 
 
 
 
 
 
 
 
 
U.S. agency
 
47,512
 
 
—
 
 
47,512
 
 
—
 
U.S. agency residential mortgage-backed
 
196,056
 
 
—
 
 
196,056
 
 
—
 
U.S. agency commercial mortgage-backed
 
34,028
 
 
—
 
 
34,028
 
 
—
 
Private label mortgage-backed
 
4,903
 
 
—
 
 
4,903
 
 
—
 
Other asset backed
 
116,904
 
 
—
 
 
116,904
 
 
—
 
Obligations of states and political subdivisions
 
144,984
 
 
—
 
 
144,984
 
 
—
 
Corporate
 
38,614
 
 
—
 
 
38,614
 
 
—
 
Trust preferred
 
2,483
 
 
—
 
 
2,483
 
 
—
 
Loans held for sale
 
27,866
 
 
—
 
 
27,866
 
 
—
 
Derivatives (1)
 
1,238
 
 
—
 
 
1,238
 
 
—
 
Liabilities
 
 
 
 
 
 
 
 
 
 
 
 
Derivatives (2)
 
619
 
 
—
 
 
619
 
 
—
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Measured at Fair Value on a Non-recurring basis:
 
 
 
 
 
 
 
 
 
 
 
 
Assets
 
 
 
 
 
 
 
 
 
 
 
 
Capitalized mortgage loan servicing rights (3)
 
8,481
 
 
—
 
 
—
 
 
8,481
 
Impaired loans (4)
 
 
 
 
 
 
 
 
 
 
 
 
Commercial
 
 
 
 
 
 
 
 
 
 
 
 
Income producing - real estate
 
711
 
 
—
 
 
—
 
 
711
 
Land, land development & construction-real estate
 
40
 
 
—
 
 
—
 
 
40
 
Commercial and industrial
 
1,257
 
 
—
 
 
—
 
 
1,257
 
Mortgage
 
 
 
 
 
 
 
 
 
 
 
 
1-4 family
 
421
 
 
—
 
 
—
 
 
421
 
Resort lending
 
129
 
 
—
 
 
—
 
 
129
 
Other real estate (5)
 
 
 
 
 
 
 
 
 
 
 
 
Commercial
 
 
 
 
 
 
 
 
 
 
 
 
Land, land development & construction-real estate
 
639
 
 
—
 
 
—
 
 
639
 
Commercial and industrial
 
165
 
 
—
 
 
—
 
 
165
 
Mortgage
 
 
 
 
 
 
 
 
 
 
 
 
1-4 family
 
26
 
 
—
 
 
—
 
 
26
 
Resort lending
 
107
 
 
—
 
 
—
 
 
107
 
Home equity - 1st lien
 
14
 
 
—
 
 
—
 
 
14
 
Installment
 
 
 
 
 
 
 
 
 
 
 
 
Home equity - 1st lien
 
36
 
 
—
 
 
—
 
 
36
 
(1) Included in accrued income and other assets.
(2) Included in accrued expenses and other liabilities.
(3) Only includes servicing rights that are carried at fair value due to recognition of a valuation allowance.
(4) Only includes impaired loans with specific loss allocations based on collateral value.
(5) Only includes other real estate with subsequent write downs to fair value.

There were no transfers between Level 1 and Level 2 during the years ended December 31, 2016 and 2015.

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Changes in fair values of financial assets for which we have elected the fair value option for the years ended December 31 were as follows:

 
   
   
   
   
   
Net Gains (Losses)
on Assets
Total
Change
in Fair
Values
Included
in Current
Period
Earnings
 
Securities
Loans
 
(In thousands)
2016
 
 
 
 
 
 
 
 
 
Trading securities
$
262
 
$
—
 
$
262
 
Loans held for sale
 
—
 
 
(277
)
 
(277
)
 
 
 
 
 
 
 
 
 
 
2015
 
 
 
 
 
 
 
 
 
Trading securities
$
(55
)
$
—
 
$
(55
)
Loans held for sale
 
—
 
 
90
 
 
90
 
 
 
 
 
 
 
 
 
 
 
2014
 
 
 
 
 
 
 
 
 
Trading securities
$
(295
)
$
—
 
$
(295
)
Loans held for sale
 
—
 
 
258
 
 
258
 

For those items measured at fair value pursuant to our election of the fair value option, interest income is recorded within the Consolidated Statements of Operations based on the contractual amount of interest income earned on these financial assets and dividend income is recorded based on cash dividends received.

The following represent impairment charges recognized during the years ended December 31, 2016, 2015 and 2014 relating to assets measured at fair value on a non-recurring basis:

• Capitalized mortgage loan servicing rights, whose individual strata are measured at fair value, had a carrying amount of $8.2 million, which is net of a valuation allowance of $2.3 million, at December 31, 2016, and had a carrying amount of $8.5 million, which is net of a valuation allowance of $3.3 million, at December 31, 2015. A recovery (charge) of $1.0 million, $0.5 million and $(0.9) million was included in our results of operations for the years ending December 31, 2016, 2015 and 2014, respectively.
• Loans which are measured for impairment using the fair value of collateral for collateral dependent loans had a carrying amount of $4.0 million, with a valuation allowance of $2.0 million at December 31, 2016, and had a carrying amount of $5.1 million, with a valuation allowance of $2.5 million at December 31, 2015. An additional provision for loan losses relating to impaired loans of $0.2 million, $1.1 million and $2.1 million was included in our results of operations for the years ending December 31, 2016, 2015 and 2014, respectively.
• Other real estate, which is measured using the fair value of the property, had a carrying amount of $3.2 million which is net of a valuation allowance of $0.8 million at December 31, 2016, and a carrying amount of $1.0 million, which is net of a valuation allowance of $1.7 million, at December 31, 2015. An additional charge relating to other real estate measured at fair value of $0.6 million, $0.3 million and $0.3 million was included in our results of operations during the years ended December 31, 2016, 2015 and 2014, respectively.

We had no assets or liabilities measured at fair value on a recurring basis that used significant unobservable inputs (Level 3) during the years ended December 31, 2016 and 2015.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  — (Continued)

Quantitative information about Level 3 fair value measurements measured on a non-recurring basis follows:

 
Asset
Fair
Value
Valuation
Technique
Unobservable
Inputs
Weighted
Average
 
(In thousands)
 
2016
 
 
 
 
 
 
 
 
 
 
 
 
Capitalized mortgage
loan servicing rights
$
8,163
 
Present value of net
Discount rate
 
10.07
%
 
 
 
 
servicing revenue
Cost to service
$
83
 
 
 
 
 
 
Ancillary income
 
24
 
 
 
 
 
 
Float rate
 
1.97
%
Impaired loans
 
 
 
 
 
 
 
 
Commercial (1)
 
1,446
 
Sales comparison
Adjustment for differences
 
 
 
 
 
 
 
approach
between comparable sales
 
(1.5
)%
Mortgage
 
361
 
Sales comparison
Adjustment for differences
 
 
 
 
 
 
 
approach
between comparable sales
 
(4.7
)
Other real estate
 
 
 
 
 
 
 
 
Commercial
 
176
 
Sales comparison
Adjustment for differences
 
 
 
 
 
 
 
approach
between comparable sales
 
(22.5
)
Mortgage and installment
 
231
 
Sales comparison
Adjustment for differences
 
 
 
 
 
 
 
approach
between comparable sales
 
(5.1
)
 
 
 
 
 
 
 
 
 
2015
 
 
 
 
 
 
 
 
Capitalized mortgage
loan servicing rights
$
8,481
 
Present value of net
Discount rate
 
10.04
%
 
 
 
 
servicing revenue
Cost to service
$
80
 
 
 
 
 
 
Ancillary income
 
24
 
 
 
 
 
 
Float rate
 
1.73
%
Impaired loans
 
 
 
 
 
 
 
 
Commercial (1)
 
1,605
 
Sales comparison
Adjustment for differences
 
 
 
 
 
 
 
approach
between comparable sales
 
(2.1
)%
 
 
 
 
Income approach
Capitalization rate
 
9.3
 
Mortgage
 
550
 
Sales comparison
Adjustment for differences
 
 
 
 
 
 
 
approach
between comparable sales
 
0.7
 
Other real estate
 
 
 
 
 
 
 
 
Commercial
 
804
 
Sales comparison
Adjustment for differences
 
 
 
 
 
 
 
approach
between comparable sales
 
(3.9
)
Mortgage and installment
 
183
 
Sales comparison
Adjustment for differences
 
 
 
 
 
 
 
approach
between comparable sales
 
75.6
 
(1) In addition to the valuation techniques and unobservable inputs discussed above, at December 31, 2016 and 2015, we had an impaired collateral dependent commercial relationship that totaled $0.2 million and $0.4 million, respectively that was primarily secured by collateral other than real estate. Collateral securing this relationship primarily included machinery and equipment and inventory at December 31, 2016 and 2015. Valuation techniques at December 31, 2016 and 2015, included appraisals and discounting restructuring firm valuations based on estimates of value recovery of each particular asset type. Discount rates used ranged from 0% to 100% of stated values.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  — (Continued)

The following table reflects the difference between the aggregate fair value and the aggregate remaining contractual principal balance outstanding for loans held for sale for which the fair value option has been elected at December 31.

 
Aggregate
Fair Value
Difference
Contractual
Principal
 
(In thousands)
Loans held for sale
 
 
 
 
 
 
 
 
 
2016
$
35,946
 
$
437
 
$
35,509
 
2015
 
27,866
 
 
714
 
 
27,152
 
2014
 
23,662
 
 
624
 
 
23,038
 

NOTE 22 – FAIR VALUES OF FINANCIAL INSTRUMENTS

Most of our assets and liabilities are considered financial instruments. Many of these financial instruments lack an available trading market and it is our general practice and intent to hold the majority of our financial instruments to maturity. Significant estimates and assumptions were used to determine the fair value of financial instruments. These estimates are subjective in nature, involving uncertainties and matters of judgment, and therefore, fair values may not be a precise estimate. Changes in assumptions could significantly affect the estimates.

Estimated fair values have been determined using available data and methodologies that are considered suitable for each category of financial instrument. For instruments with adjustable-interest rates which reprice frequently and without significant credit risk, it is presumed that estimated fair values approximate the recorded book balances. Fair value methodologies discussed below do not necessarily represent an exit price in the determination of the fair value of these financial instruments.

Cash and due from banks and interest bearing deposits : The recorded book balance of cash and due from banks and interest bearing deposits approximate fair value and are classified as Level 1.

Interest bearing deposits - time : Interest bearing deposits - time have been valued based on a model using a benchmark yield curve plus a base spread and are classified as Level 2.

Securities : Financial instrument assets actively traded in a secondary market have been valued using quoted market prices. Trading securities are classified as Level 1 while securities available for sale are classified as Level 2 as described in note #21.

Federal Home Loan Bank and Federal Reserve Bank Stock : It is not practicable to determine the fair value of FHLB and FRB Stock due to restrictions placed on transferability.

Net loans and loans held for sale : The fair value of loans is calculated by discounting estimated future cash flows using estimated market discount rates that reflect credit and interest-rate risk inherent in the loans and do not necessarily represent an exit price. Loans are classified as Level 3. Impaired loans are valued at the lower of cost or fair value as described in Note #21. Loans held for sale are classified as Level 2 as described in Note #21. Payment plan receivables held for sale are also classified as Level 2 based on a signed APA as described in Note #1.

Accrued interest receivable and payable : The recorded book balance of accrued interest receivable and payable approximate fair value and are classified at the same Level as the asset and liability they are associated with.

Derivative financial instruments : The fair value of rate-lock mortgage loan commitments and mandatory commitments to sell mortgage loans is based on mortgage backed security pricing for comparable assets, the fair value of interest rate swap agreements is based on a discounted cash flow analysis whose significant fair value inputs can generally be observed in the market place and do not typically involve judgment by management and the fair value of purchased and written options is based on prices of financial instruments with similar characteristics and do not typically involve judgment by management. Each of these instruments has been classified as Level 2 as described in note #21.

Deposits : Deposits without a stated maturity, including demand deposits, savings, NOW and money market accounts, have a fair value equal to the amount payable on demand. Each of these instruments is classified as Level 1. Deposits with a stated maturity, such as time deposits, have generally been valued based on the discounted value of contractual cash flows using a discount rate approximating current market rates for liabilities with a similar maturity resulting in a Level 2 classification.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  — (Continued)

Other borrowings : Other borrowings have been valued based on the discounted value of contractual cash flows using a discount rate approximating current market rates for liabilities with a similar maturity resulting in a Level 2 classification.

Subordinated debentures : Subordinated debentures have generally been valued based on a quoted market price of similar instruments resulting in a Level 2 classification.

The estimated recorded book balances and fair values at December 31 follow:

 
 
 
Fair Value Using
 
Recorded
Book
Balance
Fair Value
Quoted Prices
in Active
Markets for
Identical
Assets
(Level 1)
Significant
Other
Observable
Inputs
(Level 2)
Significant
Un-
observable
Inputs
(Level 3)
 
(In thousands)
2016
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Assets
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Cash and due from banks
$
35,238
 
$
35,238
 
$
35,238
 
$
—
 
$
—
 
Interest bearing deposits
 
47,956
 
 
47,956
 
 
47,956
 
 
—
 
 
—
 
Interest bearing deposits - time
 
5,591
 
 
5,611
 
 
—
 
 
5,611
 
 
—
 
Trading securities
 
410
 
 
410
 
 
410
 
 
—
 
 
—
 
Securities available for sale
 
610,616
 
 
610,616
 
 
—
 
 
610,616
 
 
—
 
Federal Home Loan Bank and Federal
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Reserve Bank Stock
 
15,543
 
 
NA
 
 
NA
 
 
NA
 
 
NA
 
Net loans and loans held for sale (1)
 
1,655,335
 
 
1,629,587
 
 
—
 
 
67,321
 
 
1,562,266
 
Accrued interest receivable
 
7,316
 
 
7,316
 
 
5
 
 
2,364
 
 
4,947
 
Derivative financial instruments
 
2,251
 
 
2,251
 
 
—
 
 
2,251
 
 
—
 
Liabilities
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Deposits with no stated maturity (2)
$
1,740,601
 
$
1,740,601
 
$
1,740,601
 
$
—
 
$
—
 
Deposits with stated maturity (2)
 
485,118
 
 
483,469
 
 
—
 
 
483,469
 
 
—
 
Other borrowings
 
9,433
 
 
10,371
 
 
—
 
 
10,371
 
 
—
 
Subordinated debentures
 
35,569
 
 
25,017
 
 
—
 
 
25,017
 
 
—
 
Accrued interest payable
 
932
 
 
932
 
 
21
 
 
911
 
 
—
 
Derivative financial instruments
 
975
 
 
975
 
 
—
 
 
975
 
 
—
 
2015
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Assets
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Cash and due from banks
$
54,260
 
$
54,260
 
$
54,260
 
$
—
 
$
—
 
Interest bearing deposits
 
31,523
 
 
31,523
 
 
31,523
 
 
—
 
 
—
 
Interest bearing deposits - time
 
11,866
 
 
11,858
 
 
—
 
 
11,858
 
 
—
 
Trading securities
 
148
 
 
148
 
 
148
 
 
—
 
 
—
 
Securities available for sale
 
585,484
 
 
585,484
 
 
—
 
 
585,484
 
 
—
 
Federal Home Loan Bank and Federal
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Reserve Bank Stock
 
15,471
 
 
NA
 
 
NA
 
 
NA
 
 
NA
 
Net loans and loans held for sale
 
1,520,346
 
 
1,472,613
 
 
—
 
 
27,866
 
 
1,444,747
 
Accrued interest receivable
 
6,565
 
 
6,565
 
 
5
 
 
1,969
 
 
4,591
 
Derivative financial instruments
 
1,238
 
 
1,238
 
 
—
 
 
1,238
 
 
—
 
Liabilities
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Deposits with no stated maturity (2)
$
1,659,743
 
$
1,659,743
 
$
1,659,743
 
$
—
 
$
—
 
Deposits with stated maturity (2)
 
426,220
 
 
423,776
 
 
—
 
 
423,776
 
 
—
 
Other borrowings
 
11,954
 
 
13,448
 
 
—
 
 
13,448
 
 
—
 
Subordinated debentures
 
35,569
 
 
23,069
 
 
—
 
 
23,069
 
 
—
 
Accrued interest payable
 
466
 
 
466
 
 
21
 
 
445
 
 
—
 
Derivative financial instruments
 
619
 
 
619
 
 
—
 
 
619
 
 
—
 
(1) Net loans and loans held for sale at December 31, 2016 include $31.4 million of payment plan receivables and commercial loans held for sale.
(2) Deposits with no stated maturity include reciprocal deposits with a recorded book balance of $7.4 million and $11.8 million at December 31, 2016 and 2015, respectively. Deposits with a stated maturity include reciprocal deposits with a recorded book balance of $31.3 million and $38.4 million at December 31, 2016 and 2015, respectively.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  — (Continued)

The fair values for commitments to extend credit and standby letters of credit are estimated to approximate their aggregate book balance, which is nominal, and therefore are not disclosed.

Fair value estimates are made at a specific point in time, based on relevant market information and information about the financial instrument. These estimates do not reflect any premium or discount that could result from offering for sale the entire holdings of a particular financial instrument.

Fair value estimates are based on existing on- and off-balance sheet financial instruments without attempting to estimate the value of anticipated future business, the value of future earnings attributable to off-balance sheet activities and the value of assets and liabilities that are not considered financial instruments.

Fair value estimates for deposit accounts do not include the value of the core deposit intangible asset resulting from the low-cost funding provided by the deposit liabilities compared to the cost of borrowing funds in the market.

NOTE 23 – ACCUMULATED OTHER COMPREHENSIVE LOSS

A summary of changes in accumulated other comprehensive loss (“AOCL”), net of tax during the years ended December 31 follows:

 
Unrealized
Gains
(Losses) on
Securities
Available
for Sale
Dispropor-
tionate
Tax Effects
from
Securities
Available
for Sale
Unrealized
Losses on
Settled
Derivatives
Total
2016
 
 
 
 
 
 
 
 
 
 
 
 
Balances at beginning of period
$
(238
)
$
(5,798
)
$
—
 
$
(6,036
)
Other comprehensive loss before reclassifications
 
(2,876
)
 
—
 
 
—
 
 
(2,876
)
Amounts reclassified from AOCL
 
(196
)
 
—
 
 
—
 
 
(196
)
Net current period other comprehensive loss
 
(3,072
)
 
—
 
 
—
 
 
(3,072
)
Balances at end of period
$
(3,310
)
$
(5,798
)
$
—
 
$
(9,108
)
2015
 
 
 
 
 
 
 
 
 
 
 
 
Balances at beginning of period
$
162
 
$
(5,798
)
$
—
 
$
(5,636
)
Other comprehensive loss before reclassifications
 
(351
)
 
—
 
 
—
 
 
(351
)
Amounts reclassified from AOCL
 
(49
)
 
—
 
 
—
 
 
(49
)
Net current period other comprehensive loss
 
(400
)
 
—
 
 
—
 
 
(400
)
Balances at end of period
$
(238
)
$
(5,798
)
$
—
 
$
(6,036
)
2014
 
 
 
 
 
 
 
 
 
 
 
 
Balances at beginning of period
$
(3,200
)
$
(5,798
)
$
(247
)
$
(9,245
)
Other comprehensive income before reclassifications
 
3,570
 
 
—
 
 
—
 
 
3,570
 
Amounts reclassified from AOCL
 
(208
)
 
—
 
 
247
 
 
39
 
Net current period other comprehensive income
 
3,362
 
 
—
 
 
247
 
 
3,609
 
Balances at end of period
$
162
 
$
(5,798
)
$
—
 
$
(5,636
)

The disproportionate tax effects from securities available for sale arose due to tax effects of other comprehensive income (“OCI”) in the presence of a valuation allowance against our deferred tax assets and a pretax loss from operations. Generally, the amount of income tax expense or benefit allocated to operations is determined without regard to the tax effects of other categories of income or loss, such as OCI. However, an exception to the general rule is provided when, in the presence of a valuation allowance against deferred tax assets, there is a pretax loss from operations and pretax income from other categories in the current period. In such instances, income from other categories must offset the current loss from operations, the tax benefit of such offset being reflected in operations.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  — (Continued)

A summary of reclassifications out of each component of AOCL for the years ended December 31 follows:

AOCL Component
Reclassified
From
AOCL
Affected Line Item in
Consolidated Statements of Operations
 
(In thousands)
 
2016
 
 
 
 
Unrealized gains (losses) on securities available for sale
 
 
 
 
 
$
301
 
Net gains on securities
 
 
—
 
Net impairment loss recognized in earnings
 
 
301
 
Total reclassifications before tax
 
 
105
 
Income tax expense
 
$
196
 
Reclassifications, net of tax
 
 
 
 
 
2015
 
 
 
 
Unrealized gains (losses) on securities available for sale
 
 
 
 
 
$
75
 
Net gains on securities
 
 
—
 
Net impairment loss recognized in earnings
 
 
75
 
Total reclassifications before tax
 
 
26
 
Income tax expense
 
$
49
 
Reclassifications, net of tax
 
 
 
 
 
2014
 
 
 
 
Unrealized gains (losses) on securities available for sale
 
 
 
 
 
$
329
 
Net gains on securities
 
 
(9
)
Net impairment loss recognized in earnings
 
 
320
 
Total reclassifications before tax
 
 
112
 
Income tax expense
 
$
208
 
Reclassifications, net of tax
 
 
 
 
 
Unrealized losses on settled derivatives
 
 
 
 
 
$
(380
)
Interest expense
 
 
(133
)
Income tax benefit
 
$
(247
)
Reclassification, net of tax
 
$
(39
)
Total reclassifications for the period, net of tax

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  — (Continued)

NOTE 24 – INDEPENDENT BANK CORPORATION (PARENT COMPANY ONLY) FINANCIAL INFORMATION

Presented below are condensed financial statements for our parent company.

CONDENSED STATEMENTS OF FINANCIAL CONDITION

 
December 31,
 
2016
2015
 
(In thousands)
ASSETS
 
 
 
 
 
 
Cash and due from banks
$
9,515
 
$
10,800
 
Interest bearing deposits - time
 
5,000
 
 
5,000
 
Investment in subsidiaries
 
259,883
 
 
261,016
 
Accrued income and other assets
 
10,489
 
 
10,120
 
Total Assets
$
284,887
 
$
286,936
 
 
 
 
 
 
 
 
LIABILITIES AND SHAREHOLDERS’ EQUITY
 
 
 
 
 
 
Subordinated debentures
$
35,569
 
$
35,569
 
Accrued expenses and other liabilities
 
379
 
 
378
 
Shareholders’ equity
 
248,939
 
 
250,989
 
Total Liabilities and Shareholders’ Equity
$
284,887
 
$
286,936
 

CONDENSED STATEMENTS OF OPERATIONS

 
Year Ended December 31,
 
2016
2015
2014
 
(In thousands)
OPERATING INCOME
 
 
 
 
 
 
 
 
 
Dividends from subsidiary
$
5,000
 
$
—
 
$
—
 
Interest income
 
27
 
 
72
 
 
64
 
Gain on extinguishment of debt
 
—
 
 
—
 
 
500
 
Gain on securities
 
—
 
 
—
 
 
295
 
Other income
 
153
 
 
31
 
 
35
 
Total Operating Income
 
5,180
 
 
103
 
 
894
 
 
 
 
 
 
 
 
 
 
 
OPERATING EXPENSES
 
 
 
 
 
 
 
 
 
Interest expense
 
1,167
 
 
1,021
 
 
1,462
 
Administrative and other expenses
 
554
 
 
560
 
 
527
 
Total Operating Expenses
 
1,721
 
 
1,581
 
 
1,989
 
Income (Loss) Before Income Tax and Equity in Undistributed Net Income of Subsidiaries
 
3,459
 
 
(1,478
)
 
(1,095
)
Income tax benefit
 
(615
)
 
(542
)
 
(383
)
Income (Loss) Before Equity in Undistributed Net Income of Subsidiaries
 
4,074
 
 
(936
)
 
(712
)
Equity in undistributed net income of subsidiaries
 
18,692
 
 
20,953
 
 
18,733
 
Net Income
$
22,766
 
$
20,017
 
$
18,021
 

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  — (Continued)

CONDENSED STATEMENTS OF CASH FLOWS

 
Year Ended December 31,
 
2016
2015
2014
 
(In thousands)
Net Income
$
22,766
 
$
20,017
 
$
18,021
 
ADJUSTMENTS TO RECONCILE NET INCOME TO NET CASH FROM (USED) IN OPERATING ACTIVITIES
 
 
 
 
 
 
 
 
 
Deferred income tax benefit
 
(615
)
 
(542
)
 
(383
)
Share based compensation
 
29
 
 
21
 
 
46
 
Gain on extinguishment of debt
 
—
 
 
—
 
 
(500
)
Net gains on securities
 
—
 
 
—
 
 
(295
)
Decrease in accrued income and other assets
 
246
 
 
5
 
 
118
 
Increase (decrease) in accrued expenses and other liabilities
 
1
 
 
(6
)
 
287
 
Equity in undistributed net income of subsidiaries
 
(18,692
)
 
(20,953
)
 
(18,733
)
Total Adjustments
 
(19,031
)
 
(21,475
)
 
(19,460
)
Net Cash From (Used) in Operating Activities
 
3,735
 
 
(1,458
)
 
(1,439
)
 
 
 
 
 
 
 
 
 
 
CASH FLOW FROM INVESTING ACTIVITIES
 
 
 
 
 
 
 
 
 
Purchases of interest bearing deposits - time
 
(7,500
)
 
(5,000
)
 
(17,500
)
Maturity of interest bearing deposits - time
 
7,500
 
 
12,500
 
 
5,000
 
Return of capital from subsidiary
 
18,000
 
 
18,500
 
 
15,000
 
Net Cash From Investing Activities
 
18,000
 
 
26,000
 
 
2,500
 
 
 
 
 
 
 
 
 
 
 
CASH FLOW USED IN FINANCING ACTIVITIES
 
 
 
 
 
 
 
 
 
Repurchase of common stock
 
(16,854
)
 
(13,498
)
 
—
 
Dividends paid
 
(7,274
)
 
(5,896
)
 
(4,129
)
Proceeds from issuance of common stock
 
1,735
 
 
1,569
 
 
1,242
 
Share based compensation withholding obligation
 
(627
)
 
(1,091
)
 
—
 
Redemption of subordinated debt
 
—
 
 
—
 
 
(4,654
)
Net Cash Used in Financing Activities
 
(23,020
)
 
(18,916
)
 
(7,541
)
Net Increase (Decrease) in Cash and Cash Equivalents
 
(1,285
)
 
5,626
 
 
(6,480
)
Cash and Cash Equivalents at Beginning of Year
 
10,800
 
 
5,174
 
 
11,654
 
Cash and Cash Equivalents at End of Year
$
9,515
 
$
10,800
 
$
5,174
 

NOTE 25 – BRANCH SALE

On April 29, 2015 we entered into a Purchase and Assumption Agreement (“PAA”) with Isabella Bank (based in Mt. Pleasant, Michigan). Pursuant to the PAA, on August 28, 2015, we sold the fixed assets, real property and certain other assets of our bank branch located in Midland, Michigan (the “Midland Branch”) to Isabella Bank. The deposit liabilities of the Midland Branch were assumed by Isabella Bank which totaled $8.7 million on the date of sale. Under the terms of the PAA, Isabella Bank paid a premium of $0.6 million (which was equal to 6.0% of the average deposit liabilities of $9.7 million based on the 20-day average ending two business days prior to the closing date of August 28, 2015) and $0.85 million for the real property and fixed assets (including the ATM). The real property and the fixed assets had a net book value of approximately $0.2 million as of August 28, 2015. We recorded a net gain of $1.2 million in the third quarter of 2015 on the sale of the Midland Branch.

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QUARTERLY FINANCIAL DATA (UNAUDITED)

A summary of selected quarterly results of operations for the years ended December 31 follows:

 
Three Months Ended
 
March 31,
June 30,
September 30,
December 31,
 
(In thousands, except per share amounts)
2016
 
 
 
 
 
 
 
 
 
 
 
 
Interest income
$
21,354
 
$
21,267
 
$
21,745
 
$
22,157
 
Net interest income
 
19,763
 
 
19,630
 
 
19,998
 
 
20,250
 
Provision for loan losses
 
(530
)
 
(734
)
 
(175
)
 
130
 
Income before income tax
 
6,057
 
 
9,049
 
 
9,352
 
 
8,443
 
Net income
 
4,100
 
 
6,438
 
 
6,373
 
 
5,855
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Net income per common share
 
 
 
 
 
 
 
 
 
 
 
 
Basic
 
0.19
 
 
0.30
 
 
0.30
 
 
0.28
 
Diluted
 
0.19
 
 
0.30
 
 
0.30
 
 
0.27
 
 
 
 
 
 
 
 
 
 
 
 
 
 
2015
 
 
 
 
 
 
 
 
 
 
 
 
Interest income
$
19,552
 
$
20,131
 
$
20,293
 
$
20,866
 
Net interest income
 
18,091
 
 
18,701
 
 
18,841
 
 
19,353
 
Provision for loan losses
 
(659
)
 
(134
)
 
(244
)
 
(1,677
)
Income before income tax
 
5,561
 
 
8,243
 
 
7,325
 
 
8,251
 
Net income
 
3,781
 
 
5,619
 
 
5,047
 
 
5,570
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Net income per common share
 
 
 
 
 
 
 
 
 
 
 
 
Basic
 
0.16
 
 
0.25
 
 
0.22
 
 
0.25
 
Diluted
 
0.16
 
 
0.24
 
 
0.22
 
 
0.25
 

During the fourth quarter of 2016, we recognized a recovery of impairment on our capitalized mortgage loan servicing rights of $2.4 million (see note #4) and recorded a litigation settlement expense of $2.3 million (see note #11). During the fourth quarter of 2015, we recognized a recovery of impairment on our capitalized mortgage loan servicing rights of $0.8 million (see note #4).

QUARTERLY SUMMARY (UNAUDITED)

 
Reported Sales Prices of Common Shares
Cash Dividends
Declared
 
2016
2015
 
High
Low
Close
High
Low
Close
2016
2015
First quarter
$
16.15
 
$
13.89
 
$
14.55
 
$
13.20
 
$
12.07
 
$
12.83
 
$
0.08
 
$
0.06
 
Second quarter
 
15.32
 
 
13.42
 
 
14.51
 
 
13.93
 
 
12.62
 
 
13.56
 
 
0.08
 
 
0.06
 
Third quarter
 
17.00
 
 
14.32
 
 
16.83
 
 
15.27
 
 
13.20
 
 
14.76
 
 
0.08
 
 
0.06
 
Fourth quarter
 
22.25
 
 
16.33
 
 
21.70
 
 
15.88
 
 
13.71
 
 
15.23
 
 
0.10
 
 
0.08
 

We have approximately 1,400 holders of record of our common stock. Our common stock trades on the Nasdaq Global Select Market System under the symbol “IBCP.” The prices shown above are supplied by Nasdaq and reflect the inter-dealer prices and may not include retail markups, markdowns or commissions. There may have been transactions or quotations at higher or lower prices of which we are not aware.

In addition to limitations imposed by the provisions of the Michigan Business Corporation Act (which, among other things, limits us from paying dividends to the extent we are insolvent), our ability to pay dividends is limited by our ability to obtain funds from our Bank and by regulatory capital guidelines applicable to us (see note #20).

98

EXHIBIT 21

 

INDEPENDENT BANK CORPORATION

 Subsidiaries of the Registrant

 

  State of Incorporation
IBC Capital Finance III  
              Ionia, Michigan   Delaware
IBC Capital Finance IV  
              Ionia, Michigan   Delaware
Midwest Guaranty Trust I  
              Ionia, Michigan Delaware
Independent Bank  
              Grand Rapids, Michigan Michigan
IBC Financial Services, Inc., Grand Rapids, Michigan                      
              (a subsidiary of Independent Bank) Michigan
Independent Title Services, Inc., Grand Rapids, Michigan  
             (a subsidiary of Independent Bank)  Michigan
Mepco Finance Corporation, Chicago, Illinois    
              (a subsidiary of Independent Bank) Michigan
Independent Life Insurance Trust, Grand Rapids, Michigan                 
              (a subsidiary of Independent Bank) Michigan

 

 

 

 

 

 

 

 

 

 

 

Note: Table excludes insignificant subsidiaries, such as single-member limited liability companies formed solely to hold other real estate.

 

 
 

EXHIBIT 23

 

CONSENT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

 

We consent to the incorporation by reference in the Registration Statements (Nos. 333-89072, 333-125484 and 333-189437) on Forms S-8 of Independent Bank Corporation of our report dated March 7, 2017 with respect to the consolidated financial statements and effectiveness of internal control over financial reporting, appearing in this Annual Report on Form 10-K for the year ended December 31, 2016.

 

/s/ Crowe Horwath LLP

 

Grand Rapids, Michigan 

March 7, 2017

 

 
 

EXHIBIT 31.1

 

CERTIFICATION

 

I, William B. Kessel, certify that:

 

1. I have reviewed this annual report on Form 10-K of Independent Bank Corporation;

 

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 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 15.15(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 fiscal 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 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 the 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 controls over financial reporting.

 

Date: March 7, 2017 

/s/ William B. Kessel
  William B. Kessel
President and Chief Executive Officer

  

 
 

 

EXHIBIT 31.2

 

CERTIFICATION

 

I, Robert N. Shuster, certify that:

 

1. I have reviewed this annual report on Form 10-K of Independent Bank Corporation;

 

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 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 15.15(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 fiscal 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 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 the 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 controls over financial reporting.

 

Date:  March 7, 2017 /s/ Robert N. Shuster
 

Robert N. Shuster 

Chief Financial Officer 

 

 
 

 

EXHIBIT 32.1

 

Certificate of the 

Chief Executive Officer of 

INDEPENDENT BANK CORPORATION

 

P ursuant to Section 906 of the Sarbanes-Oxley Act of 2002:

 

I, William B. Kessel, President and Chief Executive Officer of Independent Bank Corporation, certify pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 that:

 

(1) The annual report on Form 10-K for the annual period ended December 31, 2016, which this statement accompanies, fully complies with requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934 and;

 

(2) The information contained in this annual report on Form 10-K for the annual period ended December 31, 2016, fairly presents, in all material respects, the financial condition and results of operations of Independent Bank Corporation.

 

Date:  March 7, 2017 /s/ William B. Kessel
 

William B. Kessel 

President and Chief Executive Officer 

 

The signed original of this written statement required by Section 906, or other document authenticating, acknowledging, or otherwise adopting the signature that appears in typed form within the electronic version of this written statement required by Section 906, has been provided to Independent Bank Corporation and will be retained by Independent Bank Corporation and furnished to the Securities and Exchange Commission or its staff upon request.

 

 
 

 

EXHIBIT 32.2

 

Certificate of the

Chief FINANCIAL Officer of

INDEPENDENT BANK CORPORATION

 

P ursuant to Section 906 of the Sarbanes-Oxley Act of 2002:

 

I, Robert N. Shuster, Chief Financial Officer of Independent Bank Corporation, certify pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 that:

 

(1) The annual report on Form 10-K for the annual period ended December 31, 2016, which this statement accompanies, fully complies with requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934 and;

 

(2) The information contained in this annual report on Form 10-K for the annual period ended December 31, 2016, fairly presents, in all material respects, the financial condition and results of operations of Independent Bank Corporation.

 

Date:  March 7, 2017 /s/ Robert N. Shuster
  Robert N. Shuster
Chief Financial Officer

 

The signed original of this written statement required by Section 906, or other document authenticating, acknowledging, or otherwise adopting the signature that appears in typed form within the electronic version of this written statement required by Section 906, has been provided to Independent Bank Corporation and will be retained by Independent Bank Corporation and furnished to the Securities and Exchange Commission or its staff upon request.