Independent Bank
Annual Report 2019

Plain-text annual report

2019 Annual Report Our vision for the future is clear, 2020 ACTUALLY. Every bank will tell you they’re different, but at Independent Bank we know that YOU are. We help you discover what financial independence means to you. Then we help you get there. Be Bold. Be You. LETTER FROM THE PRESIDENT & CEO Dear Shareholders: It is my honor and pleasure to provide you with an update on Independent Bank Corporation (IBC). We continue to be focused on building shareholder value and position the Company to be successful in view of the opportunities and challenges within a marketplace with an accelerating rate of change. This starts with creating and maintaining a high performance culture with talented individuals who are highly engaged and work as a team to serve and guide our customers. This focus involves maintaining disciplined lending standards, a diversified earning asset mix, ample liquidity, continuous emphasis on growing our core deposit base, and strong capital levels. As a community bank, at the center of all our strategies is a focus on serving our customers and investing in our markets and in our people. During 2019, we committed over $1.7 billion in financing in our markets, we invested nearly $750,000 in sponsorships and donations, and our associates volunteered nearly 20,000 hours of time. Our customer base is growing, as is our brand. During 2019, we were recognized by Forbes for the second consecutive year as having the highest customer satisfaction for banks in Michigan. FINANCIAL RESULTS FOR 2019 – CONTINUED STRENGTH AND CONSISTENCY In 2019, we generated excellent growth in our earnings and earnings per share. For the year ended December 31, 2019, the Company reported net income of $46.4 million, or $2.00 per diluted share compared to net income of $39.8 million, or $1.68 per diluted share, in 2018. This represents increases of $6.6 million, or 17%, and 32 cents, or 19%, in net income and diluted earnings per share, respectively. For all of 2019, our pre-tax, pre-provision earnings increased by $7.9 million or 16% to $58.6 million, from $50.6 million in 2018. Over this same period, our tangible book value per share increased by 9%, to $14.08 per share from $12.90 per share at the end of 2018. As reflected in our balance sheet, our fundamentals continue to be strong. The growth in our earnings was fueled by strong loan growth and increased operating leverage. Loans, excluding loans held for sale, totaled $2.73 billion at December 31, 2019, an increase of 6% from $2.58 billion at December 31, 2018. For the year, our commercial loan portfolio increased by 2%, our consumer installment loan portfolio by 16% and our mortgage loan portfolio by 5%. We have now put together a string of 23 consecutive quarters of loan growth. I am also pleased to report that our investments in the mortgage banking business over the last few years continue to pay off for us with mortgage gains of almost $20 million and total originations in excess of $1 billion for the second time in our Company’s history. On the funding side, deposits totaled $3.04 billion at December 31, 2019, compared to $2.91 billion at December 31, 2018. The $123.3 million increase in total deposits during 2019 reflects growth in reciprocal deposits. At year-end 2019, our loan to deposit ratio was a healthy 90%, primarily unchanged from 89% at the prior year end, allowing capacity for additional growth. Our balance sheet is slightly asset sensitive, where generally we benefit from rising interest rates. On the credit quality front, our loan portfolio continues to perform well with past due loans continuing near historic lows. Non-performing loans at December 31, 2019, increased slightly to $9.5 million from $8.6 million at the prior year end. Other real estate and repossessed assets totaled just $1.9 million at December 31, 2 compared to $1.3 million at December 31, 2018. Our ratio of our non-performing assets to total assets increased slightly to 32 basis points at year-end 2019 compared to 29 basis points at year-end 2018. We recorded loan net recoveries of $0.4 million (0.02% of average loans) in 2019 as compared to loan net recoveries of $0.8 million (0.03% of average loans) in 2018. This represents the third consecutive year of net recoveries for our Company. Our capital levels continue to be strong, which supports our growth initiatives and provides us with flexibility to address changes in market and business conditions. Common shareholders’ equity increased to $350.2 million at December 31, 2019, from $339.0 million at December 31, 2018, due primarily to our net income that was partially offset by share repurchases and dividends. Our ratio of tangible common equity to tangible assets was 8.96% as of the end of 2019 compared to 9.17% at the end of 2018. In 2019, we increased our total annual cash dividends by 20%, from $0.60 per share to $0.72 cents per share. In January of 2020, your Board of Directors increased the quarterly cash dividend by 11%, from $0.18 per share to $0.20 per share. Also in 2019, we repurchased 1,204,688 shares of our common stock at average cost of $21.82 per share. During 2019, through a combination of dividends and share repurchases we returned 92% of our 2019 earnings to our shareholders. MARKETPLACE – ACCELERATING RATE OF CHANGE We are in a period of rapid change with innovations in new technology; this creates opportunities to improve the customer experience and become more efficient. I would characterize our market as highly- competitive, as it includes traditional players and increasing new entrant Fintech players who can either compete (at various points in the financial service purchasing cycle) or partner with traditional players. Also, the industry continues its consolidation with similar numbers of sellers each year but on an overall shrinking population base of financial institutions. This includes mergers of equals, as well as non-profit credit unions acquiring for profit community banks. This time last year, the US economy, as measured by GDP, was growing at a respectable 2.9% annual rate, inflation was low, the unemployment rate was low, and consumer confidence was high. The overnight target Federal Funds rate was 2.25% to 2.50% and the futures market had little probability of rate hikes in 2019, although the bias was for some tightening. During 2019, the Federal Reserve did not tighten, but rather eased monetary policy with three successive rate reductions during the year, bringing us to the current targeted range of 1.5% to 1.75%. At the present time, we are nearing the eleventh anniversary of this economic expansion. For all of 2019, GDP grew a modest 2.3%, and the unemployment rate continues to be low, both nationally and in Michigan. Presently, the future market indicates at least one quarter point rate reduction in 2020. At the same time, the yield curve is relatively flat and in recent months, portions of the yield curve have inverted. As we speak with our customer base, their optimism about the future continues, albeit somewhat tempered. Many of the economic indicators are positive; however, uncertainty is high over the impact of a shortage of workers, the 2020 national elections, trade tariffs, and most recently, the impact of a spread of the coronavirus on the global economy. On the regulatory front, we continue to invest additional resources, both in people and in technology to meet the ever changing requirements and expectations of the banking industry. As previously shared, the number of new regulations has slowed, and the tone at the top of the regulatory agencies has been positive and sensitive to the concerns of community banks, yet the regulatory operating environment continues to require an extraordinarily high level of attention. While not a new regulation during 2019, we shared publicly an estimated range of the impact of the Current Expected Credit Loss (CECL) accounting standard on our Company’s allowance for loan losses. We anticipate greater volatility in our quarterly provision for loan losses as a result of this new life of loan loss estimate and believe the more material drivers to this estimate to be loan growth levels and the unemployment rate. There continues to be a place for larger community banks, like Independent Bank, with scale, a deep understanding of our local markets and the ability to serve individuals and businesses in the community with relationship banking. Yet, as banks work to avoid net interest margin compression, cover more normalized loan loss provisions and meet the industry’s high regulatory expectations, to compete we also see a need to continue to invest in new technology and expand our product offering. 3 2019_Annual Report_Internal-Pages_V5.indd 3 2019_Annual Report_Internal-Pages_V5.indd 3 2/28/20 11:34 AM 2/28/20 11:34 AM 2020 VISION – BLENDING PEOPLE WITH TECHNOLOGY The opportunity, winning in our markets with relationship banking – At Independent Bank we know that our customers want to be independent, with personalized, convenient, and safe financial solutions from someone they can trust. Many feel that picking a financial partner can feel overwhelming when there are so many choices, yet we understand our customers’ time is valuable. We believe banking just shouldn’t be that hard. At Independent, we simplify the experience. First, we collaborate with each customer defining their needs and expectations for the future. Next, we help customize a plan that meets their goals. And finally, we empower each of them to Be Independent. This is relationship banking defined. As we look to 2020 and beyond, the key to our success is our ability to continue to execute on our operating plan, which is built around relationship banking. During 2019, we achieved our previously shared performance targets of 1.30% or better return on average assets and a 13.0% or better return on average equity. Prospectively, our operating plan continues to have four primary objectives. Grow our Customer Base – The first objective of our operating plan is organic growth. We will work to grow net interest income through balanced loan growth, disciplined risk-adjusted loan pricing, and the active management of our funding costs. Our plans include adding new customers through outbound calling efforts. We also will continue to use innovative and targeted customer acquisition, retention and cross-sales strategies, leveraging data analytics, inside sales staff, and intra-company referrals with strategic business unit partners. Finally, we will target new customers and grow revenue through the continued addition of talented sales professionals. In addition to these organic growth strategies, we intend to supplement our organic growth through selective and opportunistic bank and branch acquisitions with disciplined pricing. One example of this is our acquisition of Traverse City State Bank in 2018. We liked the market, the customer base, and the culture, and we were able to make a compelling case to sell to Independent with financial metrics that made sense. Since then, we have had multiple opportunities to acquire other financial institutions in our markets. However, in all of these instances, we believed it more important to stay disciplined and not simply acquire to acquire. I think the important point here is your Board and management team is very conscious of protecting and creating shareholder value. Enhance Productivity and the Customer Experience – Our second objective is continuing to increase productivity while continuously improving the customer experience. For six consecutive years we have continued to improve upon our efficiency ratio, currently at 64.9 percent. During this timeframe, while not all inclusive, we have invested in new technologies, including a new mortgage origination platform and new consumer origination platform. We have implemented numerous risk management and fraud prevention tools and replaced almost 100% of our ATM network. We also moved our network to a private cloud. Over this same period we have made tremendous strides in improving the customer experience. A few of the more recent enhancements include: person to person payments via Zelle®; an online chat service; personal financial management tools within our mobile app that include expense categorization, budgeting and account aggregation; and electronic signatures within our branch channels. Also in 2019, we initiated a Private Banking offering with intentions to roll out to all our markets in the future. As we move forward, we have several initiatives we are executing on that we believe will materially improve productivity and/or enhance the customer experience. The first initiative is the change-over to a new core banking partner and new digital banking platform. We have signed a new core agreement with a new partner and will be converting at the end of our current agreement in early 2021. This will allow Independent to move to an open banking environment, providing enhanced speed to market, greater flexibility, and lower overall costs. We will have faster integration with new technology such as digital banking solutions; real-time processing; and more efficient data access and management capabilities. This change will also serve as the foundation to create a unified customer experience through all channels, from remote digital access through to the branch and into back office support. The second initiative is our on-going branch optimization efforts that include: assessing existing locations; exploring new locations; reviewing service hours, staffing levels, etc. We are optimistic that our successful execution of these initiatives will enable us to materially improve our productivity and the overall customer experience. Enterprise-wide Risk Management – Our third objective is a strong on-going enterprise-wide risk management framework for credit risk, market risk (economic, capital, interest rate and liquidity), operating risk (including cyber) and legal and regulatory risk. Included within this objective is being a good steward 4 2019_Annual Report_Internal-Pages_V5.indd 4 2019_Annual Report_Internal-Pages_V5.indd 4 2/28/20 11:34 AM 2/28/20 11:34 AM of our capital. We continue to target a tangible common equity to tangible assets ratio of 8.5% to 9.5%. Our capital priorities include: organic growth; a consistent dividend, paying out one-third to one-half of our earnings; share repurchases when it makes financial sense; followed by acquired growth, provided it meets our internal business objectives and financial metrics. Talent Engagement and Development – Our fourth objective is to continue to attract, retain and develop our service team. We recognize the path to our organization’s success is through the success of each and every one of our team members. Over the last few years, we have been very successful in attracting many new talented team members, often as a result of the market disruptions caused by M&A activity. At the same time, we continue to execute on several key initiatives aimed at raising the engagement level of our entire workforce. In 2019, our turnover level was at the lowest level in many years and the engagement rate of our associates was at the highest level (90%) since we began formally measuring it. We encourage and support the professional development of our colleagues through our leadership programs, mentoring and other initiatives. We are passionate about our desire to ensure that our team members are empowered and supported in a way that will best position them to serve our customers. Finally, we believe that if we are committed to the well-being of our team members, and recognize and reward their contributions, they will promote our success. BOARD UPDATE We are very pleased to have Ronia Kruse join the Independent Bank Corporation Board in October of 2019. Ronia is the founder and CEO of OpTech, LLC and Optech Solutions. These firms provide solutions for clients in areas of analytics, cybersecurity, application development and connected vehicles. Prior to founding this business, Ms. Kruse served as a senior tax consultant for a big 4 CPA firm. She is a certified public accountant, and her role as the CEO of a technology consulting firm, her background in public accounting and her leadership skills provide an important resource for the IBC Board and management team. I would like to acknowledge and thank Chuck Van Loan for his service to the Independent Bank Corporation Board from 1992 through April 2019, and Chairman of the Board from 2007 to 2008. Chuck served as President and CEO of IBC from 1993 until 2004 and as Executive Chairman during 2005. He retired from the Company in 2005. Chuck provided strong leadership for the Company over the years as well as in the communities we serve. He will be missed. I would like to acknowledge and thank Terry Haske who served as member of the Independent Bank Corporation Board from March 1996 through December of 2019, and Chairman of the Board from 2002 to 2004. Terry was a CPA and retired Principal with Anderson, Tuckey, Bernhardt & Doran, and PC. Terry’s contributions were many and he too will be missed. CLOSING In closing, I encourage you to attend the 2020 Annual Meeting of Shareholders of Independent Bank Corporation at 3:00 p.m. Eastern Time, on Tuesday, April 21, 2020. This meeting will be held at our corporate headquarters, 4200 East Beltline Avenue, Grand Rapids, Michigan. I would like thank you, our shareholders, for investing in IBC, and I would like to acknowledge the commitment and ongoing effort of your Board of Directors, our Bank officers, and all of our Bank associates. Their dedication and service is exemplary, and each is truly making a positive difference in the lives of our customers, our shareholders, and the communities we serve. Sincerely, William B. (Brad) Kessel President and CEO 5 2019_Annual Report_Internal-Pages_V5.indd 5 2019_Annual Report_Internal-Pages_V5.indd 5 2/28/20 11:34 AM 2/28/20 11:34 AM FINANCIAL HIGHLIGHTS Dollars in thousands, except per share data FOR THE YEAR Interest income Interest expense 2019 2018 CHANGE AMOUNT CHANGE PERCENT $ 148,928 $ 130,773 $ 1 8,1 5 5 1 3.88 % 26,347 1 7,491 Net interest income 122,58 1 1 1 3,282 Provision for loan losses Net gains on securities Other non-interest income 824 307 47,429 1 ,503 1 38 44,677 Non-interest expense 1 1 1 ,733 107,461 8,856 9,299 (679) 1 69 2,752 4,272 8,627 50.63 8.2 1 (45. 1 8 ) 122.46 6. 1 6 3.98 1 7.56 2,031 21 .85 57,760 1 1 ,325 49,1 33 9,294 $ 46,435 $ 39,839 $ 6,596 1 6.56 % $ 2.03 $ 1.70 $ 0.3 3 1 9.41 % 2.00 0. 72 1.6 8 0.60 0.32 0. 1 2 1 9.05 20.00 $ 3,564,694 $ 3,353,281 $ 2 1 1 ,413 6.30 % 2,725,023 2,582,520 1 4 2,503 3,036,727 2,913,428 1 2 3,299 3,343,941 3,162,9 1 1 1 8 1,030 350,1 69 15.58 338,994 14.38 1 1 ,1 75 1.20 5.52 4.23 5.72 3.30 8.34 Income before income tax Income tax expense Net income PER COMMON SHARE DATA Net income per common share Basic Diluted Cash dividends declared and paid AT YEAR END Assets Loans Deposits Interest-earning assets Shareholders' equity Book value per common share RATIOS Net income to Average common equity 13.63 % 12.38 % 1.25 % 1 0. 1 0 % Average assets 1.35 1.27 0.08 6.30 As a percent of average interest-earning assets Interest income Interest expense Net interest income 4.6 1 % 4.48 % 0. 1 3 % 2.90 % 0.81 3.80 0.60 3.88 0. 21 35.00 (0.08) (2.06) 6 2019_Annual Report_Internal-Pages_V5.indd 6 2019_Annual Report_Internal-Pages_V5.indd 6 2/28/20 11:34 AM 2/28/20 11:34 AM Performance Graph . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Selected Consolidated Financial Data . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Management’s Discussion and Analysis of Financial Condition and Results of Operations . . . . . . . . . Management’s Annual Report on Internal Control Over Financial Reporting. . . . . . . . . . . . . . . . . . . . Report of Independent Registered Public Accounting Firm . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Consolidated Financial Statements . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Notes to Consolidated Financial Statements. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Quarterly Data . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8 9 10 32 33 35 40 100 7 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, 2014, and the reinvestment of all dividends during the periods presented. The performance shown on the graph is not necessarily indicative of future performance. Independent Bank Corporation Independent Bank Corporation NASDAQ Composite NASDAQ Bank $250 $200 $150 l e u a V x e d n I $100 12/31/14 12/31/15 12/31/16 12/31/17 12/31/18 12/31/19 Index 12/31/14 12/31/15 12/31/16 12/31/17 12/31/18 12/31/19 118.93 173.20 181.85 175.46 195.41 Independent Bank Corporation. . . . . . . . . . . . . . . . 100.00 NASDAQ Composite . . . . . . . . . . . . . . . . . . . . . . . 100.00 106.96 116.45 153.23 147.35 200.49 NASDAQ Bank. . . . . . . . . . . . . . . . . . . . . . . . . . . . 100.00 102.21 129.34 154.02 130.28 175.61 Period Ending 8 SELECTED CONSOLIDATED FINANCIAL DATA SUMMARY OF OPERATIONS 2019 Year Ended December 31, 2017 (Dollars in thousands, except per share amounts) 2018 2016 Interest income . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 148,928 $ 130,773 $ Interest expense. . . . . . . . . . . . . . . . . . . . . . . . . . . Net interest income . . . . . . . . . . . . . . . . . . . . . . Provision for loan losses. . . . . . . . . . . . . . . . . . . . Net gains on securities . . . . . . . . . . . . . . . . . . . . . Net gain on branch sale . . . . . . . . . . . . . . . . . . . . Other non-interest income . . . . . . . . . . . . . . . . . . Non-interest expenses . . . . . . . . . . . . . . . . . . . . . . Income before income tax . . . . . . . . . . . . . . . . Income tax expense. . . . . . . . . . . . . . . . . . . . . . . . 17,491 113,282 1,503 138 — 44,677 107,461 49,133 9,294 39,839 $ 26,347 122,581 824 307 — 47,429 111,733 57,760 11,325 46,435 $ Net income . . . . . . . . . . . . . . . . . . . . . . . . . . $ PER COMMON SHARE DATA Net income per common share 98,309 $ 9,123 89,186 1,199 260 — 42,273 92,082 38,438 17,963 20,475 $ 86,523 $ 6,882 79,641 (1,309) 563 — 41,735 90,347 32,901 10,135 22,766 $ 2015 80,842 5,856 74,986 (2,714) 20 1,193 38,917 88,450 29,380 9,363 20,017 Basic . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ Diluted . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Cash dividends declared and paid . . . . . . . . . . . . Book value . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2.03 $ 2.00 0.72 15.58 1.70 $ 1.68 0.60 14.38 0.96 $ 0.95 0.42 12.42 1.06 $ 1.05 0.34 11.71 0.88 0.86 0.26 11.28 SELECTED BALANCES Assets. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $3,564,694 $3,353,281 $2,789,355 $2,548,950 $2,409,066 1,515,050 2,725,023 Loans . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Allowance for loan losses. . . . . . . . . . . . . . . . . . . 22,570 26,148 2,085,963 3,036,727 Deposits . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 251,092 350,169 Shareholders’ equity . . . . . . . . . . . . . . . . . . . . . . . 11,954 88,646 Other borrowings . . . . . . . . . . . . . . . . . . . . . . . . . 35,569 39,456 Subordinated debentures . . . . . . . . . . . . . . . . . . . . 2,018,817 22,587 2,400,534 264,933 54,600 35,569 1,608,248 20,234 2,225,719 248,980 9,433 35,569 2,582,520 24,888 2,913,428 338,994 25,700 39,388 SELECTED RATIOS Net interest income to average interest earning assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3.80% 3.88% 3.65% 3.52% 3.58% Net income to Average shareholders’ equity . . . . . . . . . . . . . . Average assets . . . . . . . . . . . . . . . . . . . . . . . . . . Average shareholders’ equity to average assets . . Tier 1 capital to average assets . . . . . . . . . . . . . . Non-performing loans to Portfolio Loans . . . . . . 13.63 1.35 9.90 10.11 0.35 12.38 1.27 10.27 10.47 0.33 7.82 0.77 9.88 10.57 0.39 9.21 0.92 9.98 10.50 0.75 7.89 0.86 10.93 10.91 0.70 9 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, 2019, 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 the 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 (‘‘IBCP’’), 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 and have also opened two loan production offices in Ohio (Columbus and Fairlawn). A third Ohio loan production office is being opened in Toledo in March 2020. As a result, our success depends to a great extent upon the economic conditions in Michigan’s Lower Peninsula. 10 Significant Developments. On December 22, 2017, ‘‘H.R. 1’’, also known as the ‘‘Tax Cuts and Jobs Act’’ was signed into law. H.R.1, among other things, reduced the federal corporate income tax rate to 21%, effective January 1, 2018. As a result, we concluded that our deferred tax assets, net (‘‘DTA’’) had to be remeasured. Our DTA represents expected corporate tax benefits anticipated to be realized in the future. The reduction in the federal corporate income tax rate reduced these anticipated future benefits. The remeasurement of our DTA at December 31, 2017 resulted in a reduction of these net assets and a corresponding increase in income tax expense of $6.0 million that was recorded in the fourth quarter of 2017. On December 4, 2017, we entered into an Agreement and Plan of Merger with TCSB Bancorp, Inc. (‘‘TCSB’’) (the ‘‘Merger Agreement’’) providing for a business combination of IBCP and TCSB. On April 1, 2018, TCSB was merged with and into IBCP, with IBCP as the surviving corporation (the ‘‘Merger’’). In connection with the Merger, on April 1, 2018, IBCP consolidated Traverse City State Bank, TCSB’s wholly-owned subsidiary bank, with and into Independent Bank (with Independent Bank as the surviving institution). See note #26. It is against this backdrop that we discuss our results of operations and financial condition in 2019 as compared to earlier periods. 11 RESULTS OF OPERATIONS Summary. We recorded net income of $46.4 million, or $2.00 per diluted share, in 2019, net income of $39.8 million, or $1.68 per diluted share, in 2018, and net income of $20.5 million, or $0.95 per diluted share, in 2017. The 2019 and 2018 results include the benefit of a reduced federal income tax rate pursuant to H.R. 1 and the impact of the Merger and 2017 results include an additional $6.0 million ($0.28 per diluted share) of income tax expense related to the remeasurement of our DTA, both as described earlier under ‘‘Significant Developments.’’ KEY PERFORMANCE RATIOS Year Ended December 31, 2018 2019 2017 Net income to Average shareholders’ equity . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Average assets. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 13.63% 12.38% 7.82% 1.27 1.35 0.77 Net income per common share Basic . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Diluted. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 2.03 2.00 $ 1.70 1.68 $0.96 0.95 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 $122.6 million during 2019, compared to $113.3 million and $89.2 million during 2018 and 2017, respectively. The increase in net interest income in 2019 compared to 2018 primarily reflects a $302.1 million increase in average interest-earning assets that was partially offset by an eight basis point decrease in our tax equivalent net interest income as a percent of average interest-earning assets (the ‘‘net interest margin’’). The increase in net interest income in 2018 compared to 2017 reflects a $462.0 million increase in average interest-earning assets and a 23 basis point increase in our net interest margin. The increase in average interest-earning assets during 2019 and 2018 primarily reflects the impact of the Merger as well as loan growth utilizing funds from increases in deposits. The decrease in the net interest margin during 2019 as compared to 2018 primarily reflects reductions in short-term interest rates during that year as well as a flattening of the yield curve. The increase in the net interest margin during 2018 as compared to 2017 primarily reflects increases in short-term interest rates during that year as well as the impact of the Merger. 2019 and 2018 interest income on loans includes $1.5 million and $1.7 million, respectively, of accretion of the discount recorded on the TCSB loans acquired in the Merger. Our net interest income is also impacted by our level of non-accrual loans. Average non-accrual loans totaled $8.1 million, $8.4 million and $9.5 million in 2019, 2018 and 2017, respectively. 12 AVERAGE BALANCES AND RATES 2019 2018 2017 Average Balance Interest Rate Average Balance Interest Rate Average Balance Interest Rate (Dollars in thousands) ASSETS Taxable loans . . . . . . . . . . Tax-exempt loans(1) . . . . . . Taxable securities . . . . . . . Tax-exempt securities(1) . . . Interest bearing cash . . . . . Other investments . . . . . . . $2,713,690 7,937 397,598 52,324 48,023 18,359 $133,574 391 11,842 1,683 818 1,043 4.92% $2,418,421 6,118 4.93 394,160 2.98 67,574 3.22 32,593 1.70 16,936 5.68 $116,634 292 10,874 2,192 371 920 4.82% $1,845,661 4.77 3,199 485,343 2.76 86,902 3.24 37,119 1.14 15,543 5.43 $84,169 172 10,928 3,063 264 836 4.56% 5.38 2.25 3.52 0.71 5.38 Interest earning assets . . 3,237,931 149,351 4.61 2,935,802 131,283 4.48 2,473,767 99,432 4.02 Cash and due from banks . . Other assets, net . . . . . . . . 37,575 164,726 Total assets . . . . . . . . . . $3,440,232 33,384 162,750 $3,131,936 31,980 144,442 $2,650,189 LIABILITIES Savings and interest- bearing checking . . . . . . Time deposits . . . . . . . . . . Other borrowings . . . . . . . $1,453,061 655,718 77,254 10,228 13,197 2,922 0.70 2.01 3.78 $1,218,243 632,330 79,519 4,696 9,782 3,013 0.39 1.55 3.79 $1,052,215 502,284 74,876 1,530 5,245 2,348 0.15 1.04 3.14 Interest bearing liabilities . . . . . . . . . 2,186,033 26,347 1.21 1,930,092 17,491 0.91 1,629,375 9,123 0.56 Non-interest bearing deposits . . . . . . . . . . . . Other liabilities . . . . . . . . . Shareholders’ equity. . . . . . 867,314 46,153 340,732 Total liabilities and shareholders’ equity . . $3,440,232 846,718 33,354 321,772 728,208 30,838 261,768 $3,131,936 $2,650,189 Net interest income . . . . $123,004 $113,792 $90,309 Net interest income as a percent of average interest earning assets . . . . . . . . . . . . 3.80% 3.88% 3.65% (1) Interest on tax-exempt loans and securities is presented on a fully tax equivalent basis assuming a marginal tax rate of 21% in 2019 and 2018 and 35% in 2017. RECONCILIATION OF NET INTEREST MARGIN, FULLY TAXABLE EQUIVALENT (‘‘FTE’’) 2019 Year Ended December 31, 2018 (Dollars in thousands) 2017 Net interest income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $122,581 $113,282 $89,186 1,123 Add: taxable equivalent adjustment . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 423 510 Net interest income - taxable equivalent . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $123,004 $113,792 $90,309 Net interest margin (GAAP) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Net interest margin (FTE) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3.79% 3.80% 3.85% 3.61% 3.88% 3.65% 13 CHANGE IN NET INTEREST INCOME 2019 compared to 2018 Rate Volume 2018 compared to 2017 Rate Net Net (In thousands) Volume Increase (decrease) in interest income(1) Taxable loans . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Tax-exempt loans(2) . . . . . . . . . . . . . . . . . . . . . . . . . Taxable securities. . . . . . . . . . . . . . . . . . . . . . . . . . . Tax-exempt securities(2) . . . . . . . . . . . . . . . . . . . . . . Interest bearing cash . . . . . . . . . . . . . . . . . . . . . . . . Other investments . . . . . . . . . . . . . . . . . . . . . . . . . . $14,491 89 96 (491) 218 80 $ 2,449 10 872 (18) 229 43 $16,940 99 968 (509) 447 123 $27,388 141 (2,263) (641) (35) 76 $5,077 (21) 2,209 (230) 142 8 $32,465 120 (54) (871) 107 84 Total interest income . . . . . . . . . . . . . . . . . . . . . . 14,483 3,585 18,068 24,666 7,185 31,851 Increase (decrease) in interest expense(1) Savings and interest bearing checking . . . . . . . . . . Time deposits . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Other borrowings . . . . . . . . . . . . . . . . . . . . . . . . . . . Total interest expense . . . . . . . . . . . . . . . . . . . . . 1,047 374 (86) 1,335 4,485 3,041 (5) 7,521 5,532 3,415 (91) 8,856 276 1,587 153 2,016 2,890 2,950 512 6,352 3,166 4,537 665 8,368 Net interest income . . . . . . . . . . . . . . . . . . . . . $13,148 $(3,936) $ 9,212 $22,650 $ 833 $23,483 (1) (2) 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. Interest on tax-exempt loans and securities is presented on a fully tax equivalent basis assuming a marginal tax rate of 21% in 2019 and 2018 and 35% in 2017. COMPOSITION OF AVERAGE INTEREST EARNING ASSETS AND INTEREST BEARING LIABILITIES Year Ended December 31, 2017 2018 2019 As a percent of average interest earning assets Loans . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Other interest earning assets. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 84.1% 82.6% 74.7% 17.4 15.9 25.3 Average interest earning assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 100.0% 100.0% 100.0% Savings and interest-bearing checking. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Time deposits . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Other borrowings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 44.9% 41.5% 42.5% 21.5 20.3 2.7 2.3 20.3 3.1 Average interest bearing liabilities. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 67.5% 65.7% 65.9% Earning asset ratio . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Free-funds ratio(1) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 94.1% 93.7% 93.3% 34.3 32.5 34.1 (1) Average interest earning assets less average interest bearing liabilities divided by average interest earning assets. Provision for loan losses. The provision for loan losses was an expense of $0.8 million, $1.5 million and $1.2 million in 2019, 2018 and 2017, 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. Non-interest income. Non-interest income is a significant element in assessing our results of operations. Non-interest income totaled $47.7 million during 2019 compared to $44.8 million and $42.5 million during 2018 and 14 2017, respectively. We adopted Financial Accounting Standards Board Accounting Standards Update 2014-09 ‘‘Revenue from Contracts with Customers (Topic 606)’’ (‘‘ASU 2014-09’’) on January 1, 2018, using the modified retrospective method. Although ASU 2014-09 did not have any impact on our January 1, 2018 shareholders’ equity or 2019 or 2018 net income, it did result in a classification change in non-interest income and non-interest expense as compared to 2017. Specifically, in 2019, interchange income and interchange expense each increased by $1.9 million and in 2018, interchange income and interchange expense each increased by $1.5 million, due to classification changes under ASU 2014-09 (also see note #25 to our Consolidated Financial Statements). NON-INTEREST INCOME 2019 Year Ended December 31, 2018 (In thousands) 2017 Service charges on deposit accounts. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Interchange income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Net gains on assets Mortgage loans. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Securities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Mortgage loan servicing, net . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Investment and insurance commissions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Bank owned life insurance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Other. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $11,208 10,297 $12,258 9,905 $12,673 8,023 19,978 307 (3,336) 1,658 1,111 6,513 10,597 138 3,157 1,971 970 5,819 11,762 260 1,647 1,968 1,061 5,139 Total non-interest income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $47,736 $44,815 $42,533 Service charges on deposit accounts totaled $11.2 million in 2019, as compared to $12.3 million in 2018 and $12.7 million during 2017. These yearly variations primarily reflect declines in non-sufficient funds fees. Interchange income totaled $10.3 million in 2019 compared to $9.9 million in 2018 and $8.0 million in 2017. The increases in 2019 and 2018 as compared to 2017, are primarily due to the aforementioned impact of ASU 2014-09 as well as increased transaction volume. We realized net gains of $20.0 million on mortgage loans during 2019, compared to $10.6 million and $11.8 million during 2018 and 2017 respectively. Mortgage loan activity is summarized as follows: MORTGAGE LOAN ACTIVITY 2019 Year Ended December 31, 2018 (Dollars in thousands) 2017 Mortgage loans originated . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $1,011,141 $807,408 $871,222 Mortgage loans sold(1) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 423,327 Net gains on mortgage loans . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11,762 Net gains as a percent of mortgage loans sold (‘‘Loan Sales Margin’’) . . . . . . . Fair value adjustments included in the Loan Sales Margin . . . . . . . . . . . . . . . . . 491,798 10,597 738,910 19,978 2.15% (0.02) 2.70% 0.22 2.78% (0.07) (1) 2019 includes the sale of $50.5 million of portfolio residential fixed and adjustable mortgage loans to other institutions and securitization of $65.1 million of portfolio residential fixed rate loans. 2018 includes the sale of $27.6 million of portfolio residential fixed and adjustable rate portfolio mortgage loans to another financial institution and securitization of $10.9 million of portfolio residential fixed rate loans. The increase in mortgage loan originations, sales and net gains in 2019 as compared to 2018 and 2017 is due primarily to lower interest rates that resulted in increased mortgage loan refinance activity. In addition, a solid housing market has resulted in strong purchase money mortgage origination volume. However, higher interest rates during 2018, reduced mortgage loan refinance volume during that year on an industry-wide basis. 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 portfolio because of our established interest-rate risk parameters. (See ‘‘Portfolio Loans and asset quality.’’) Net gains on mortgage loans are also dependent upon 15 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. 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. Net 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 2.48% in 2019, 2.17% in 2018 and 2.85% in 2017. The higher Loan Sales Margin in 2019 and 2017, as compared to 2018, was principally due to more favorable competitive conditions including wider primary-to-secondary market pricing spreads for much of each of those years. In 2018, our Loan Sales Margin contracted 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. In addition, in 2018, we recorded a loss on mortgage loans of $0.25 million in the fourth quarter on the pending sale of approximately $41.5 million of portfolio mortgage loans. These loans were classified as held for sale at December 31, 2018, and carried at the lower of cost or fair value. This sale closed on January 30, 2019. We generated net gains on securities of $0.31 million, $0.14 million and $0.26 million in 2019, 2018 and 2017, respectively. These net gains were due to the sales of securities and changes in the fair value of equity/trading securities as outlined in the table below. We recorded no net impairment losses in 2019, 2018 or 2017 for other than temporary impairment of securities available for sale. GAINS AND LOSSES ON SECURITIES 2019 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2018 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2017 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $68,716 48,736 17,308 $415 336 263 $108 198 3 Proceeds Year Ended December 31, Losses(2) Gains(1) (In thousands) Net $307 138 260 (1) Gains in 2019 and 2017 include $0.166 million and $0.045 million, respectively related to equity securities at fair value. Gains in 2018 include $0.144 million related to the sale of 1,000 VISA Class B shares. (2) Losses in 2018 include $0.062 million related to equity securities at fair value. Mortgage loan servicing, net, generated a loss of $3.3 million and earnings of $3.2 million and $1.6 million in 2019, 2018 and 2017, respectively. This activity is summarized in the following table: MORTGAGE LOAN SERVICING ACTIVITY Mortgage loan sevicing: Revenue, net. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Fair value change due to price . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Fair value change due to pay-downs . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 6,196 (6,408) (3,124) $ 5,480 191 (2,514) $ 4,391 (718) (2,026) Total . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $(3,336) $ 3,157 $ 1,647 2019 2018 (In thousands) 2017 16 Effective on January 1, 2017, we adopted the fair value accounting method for capitalized mortgage loan servicing rights. Activity related to capitalized mortgage loan servicing rights is as follows: CAPITALIZED MORTGAGE LOAN SERVICING RIGHTS 2019 2018 (In thousands) 2017 Balance at January 1, . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Change in accounting . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $21,400 — $15,699 — $13,671 542 Balance at January 1, as adjusted . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Originated servicing rights capitalized . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Servicing rights acquired . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Change in fair value . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 21,400 7,303 — (9,532) 15,699 4,977 3,047 (2,323) 14,213 4,230 — (2,744) Balance at December 31, . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $19,171 $21,400 $15,699 At December 31, 2019, we were servicing approximately $2.58 billion in mortgage loans for others on which servicing rights have been capitalized. This servicing portfolio had a weighted average coupon rate of 4.22% and a weighted average service fee of approximately 25.8 basis points. Remaining capitalized mortgage loan servicing rights at December 31, 2019 totaled $19.2 million, representing approximately 74.3 basis points on the related amount of mortgage loans serviced for others. Investment and insurance commissions totaled $1.7 million in 2019 as compared to $2.0 million in both 2018 and 2017. The lower level of revenue in 2019 as compared to the prior two years was due primarily to lower sales volumes reflecting, in part, changes in and newer personnel in certain markets. We earned $1.1 million, $1.0 million and $1.1 million in 2019, 2018 and 2017, 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 a fixed income investment manager. 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 $55.7 million and $55.1 million at December 31, 2019 and 2018, respectively. Other non-interest income totaled $6.5 million, $5.8 million and $5.1 million in 2019, 2018 and 2017, respectively. The increase in 2019 as compared to 2018 is due primarily to growth in fees related to interest rate swaps for commercial loan customers. The increase in 2018 as compared to 2017 is primarily due to increases in a variety of categories including: wire transfer fees, credit card interchange income, merchant processing fees, and income from a small business investment company. Non-interest expense. Non-interest expense is an important component of our results of operations. We strive to efficiently manage our cost structure. 17 Non-interest expense totaled $111.7 million in 2019, $107.5 million in 2018, and $92.1 million in 2017. Many of our components of non-interest expense increased in 2019 and 2018 as compared to 2017 due to the Merger. The components of non-interest expense are as follows: NON-INTEREST EXPENSE 2019 Year ended December 31, 2018 (In thousands) 2017 Compensation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Performance-based compensation. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Payroll taxes and employee benefits . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 41,719 12,066 13,716 $ 37,878 11,942 12,258 $35,397 9,874 9,818 Compensation and employee benefits . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Occupancy, net . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Data processing . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Furniture, fixtures and equipment . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Interchange expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Communications . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Loan and collection. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Advertising . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Legal and professional . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Amortization of intangible assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . FDIC deposit insurance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Supplies . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Credit card and bank service fees . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Costs related to unfunded lending commitments. . . . . . . . . . . . . . . . . . . . . . . . . . Provision for loss reimbursement on sold loans . . . . . . . . . . . . . . . . . . . . . . . . . . Net gains on other real estate and repossessed assets . . . . . . . . . . . . . . . . . . . . . . Merger related expenses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Other . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 67,501 9,013 8,905 4,113 3,215 2,947 2,685 2,450 1,814 1,089 685 638 411 246 229 (90) — 5,882 62,078 8,912 8,262 4,080 2,702 2,848 2,682 2,155 1,839 969 1,081 689 414 171 10 (672) 3,465 5,776 55,089 8,102 7,657 3,870 1,156 2,684 2,230 1,905 1,892 346 894 666 529 475 171 (606) 284 4,738 Total non-interest expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $111,733 $107,461 $92,082 Compensation expense, which is primarily salaries, totaled $41.7 million, $37.9 million and $35.4 million in 2019, 2018 and 2017, respectively. The increases in 2019 and 2018 as compared to 2017 were primarily due to annual merit based salary increases, the Merger and additional staffing particularly in commercial lending and information technology (including data analytics). Performance-based compensation expense totaled $12.1 million, $11.9 million and $9.9 million in 2019, 2018 and 2017, respectively. The increase in 2019 as compared to 2018 was primarily due to an increase in the employee stock ownership plan (‘‘ESOP’’) contribution accrual reflecting the aforementioned higher salaries. The increase in 2018 as compared to 2017 primarily related to the level of compensation under our Management Incentive Compensation Plan (‘‘MICP’’) based on our performance relative to plan targets and increased ESOP contributions. 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 2019, 2018 and 2017 for share-based awards under our long-term equity based incentive plan was $1.6 million, $1.5 million and $1.6 million, respectively. In each of those three years, the Board and Compensation Committee of the Board authorized the grant of restricted stock and performance share awards under the plan. Payroll taxes and employee benefits expense totaled $13.7 million, $12.3 million and $9.8 million in 2019, 2018 and 2017, respectively. The increase in 2019 as compared to 2018 was primarily due to a $0.3 million increase in payroll taxes, a $0.5 million increase in health care insurance, a $0.2 million increase in 401(k) plan employer contributions and a $0.4 million increase in employee education and employee relations costs. The increase in 2018 as compared to 2017 was primarily due to a $0.5 million increase in payroll taxes, a $1.1 million increase in health care insurance and a $0.6 million increase in 401(k) plan employer contributions. A portion of the increases in 2019 and 2018 was due to the Merger. However, we maintain a self-insured health care plan (with an individual claim stop 18 loss limit) and we experienced a significant rise in claims in 2019 and 2018 as compared to 2017. In 2018, we also increased the 401(k) employer match to 4% (from 3%) of an employee’s eligible compensation. Occupancy expenses, net, totaled $9.0 million, $8.9 million and $8.1 million in 2019, 2018 and 2017, respectively. The increases in 2019 and 2018 as compared to 2017 were primarily due to additional locations acquired in the Merger and a few additional loan production offices that were opened during 2017. Data processing expenses totaled $8.9 million, $8.3 million, and $7.7 million in 2019, 2018 and 2017, respectively. The increase in 2019 as compared to 2018 was primarily due to higher mobile banking activity and software costs for new applications in several departments. The increase in 2018 as compared to 2017 was primarily due to the Merger as well as higher mobile banking activity and software costs for new applications in several departments. Furniture, fixtures and equipment expense totaled $4.1 million, $4.1 million, and $3.9 million in 2019, 2018 and 2017, respectively. The increases in 2019 and 2018 as compared to 2017 were primarily due to the Merger. Interchange expense, which totaled $3.2 million, $2.7 million, and $1.2 million in 2019, 2018 and 2017, respectively, primarily represents fees paid to our core information systems processor and debit card licensor related to debit card and ATM transactions. The increases in 2019 and 2018 as compared to 2017 were due primarily to the impact of the implementation of ASU 2014-09 on January 1, 2018. Prior to 2018, certain processing costs were being netted against interchange income. As described above, under ASU 2014-09 these costs are no longer being netted against interchange income but instead are being reported as part of interchange expense. Increased debit card transaction volumes in 2019 and 2018 also contributed to the rise in this expense as well as the addition of a fraud detection service in early 2019. Communications expense totaled $2.9 million, $2.8 million and $2.7 million in 2019, 2018 and 2017, respectively. The increases in 2019 and 2018 as compared to 2017 were primarily due to the Merger. Loan and collection expenses reflect costs related to new lending activity as well as the management and collection of non-performing loans and other problem credits. These expenses totaled $2.7 million, $2.7 million and $2.2 million in 2019, 2018 and 2017, respectively. The reduced level of expense in 2017 primarily reflects a higher level of recoveries of previously incurred expenses related to the resolution and collection of non-performing or previously charged-off loans. Advertising expense totaled $2.5 million, $2.2 million, and $1.9 million in 2019, 2018 and 2017, respectively. The increase in 2019 as compared to 2018 was primarily due to increased outdoor advertising (billboards). The increase in 2018 as compared to 2017 was primarily due to increased outdoor advertising (billboards) as well as the Merger. Legal and professional fees totaled $1.8 million, $1.8 million, and $1.9 million in 2019, 2018 and 2017, respectively. The decreases in 2019 and 2018 as compared to 2017 were primarily due to lower consulting costs for certain deposit account programs. The amortization of intangible assets primarily relates to the Merger (for 2019 and 2018) and branch acquisitions and the related amortization of the deposit customer relationship value, including core deposit value, which was acquired in connection with those transactions. We had remaining unamortized intangible assets of $5.3 million and $6.4 million at December 31, 2019 and 2018 respectively. See note #7 to the Consolidated Financial Statements for a schedule of future amortization of intangible assets. FDIC deposit insurance expense totaled $0.7 million, $1.1 million, and $0.9 million in 2019, 2018 and 2017, respectively. The decrease in 2019 as compared to 2018 was primarily due to the use of our FDIC Small Bank Assessment Credit (the ‘‘Assessment Credit’’) of approximately $0.7 million. We do not have any remaining Assessment Credit to apply against our 2020 FDIC deposit insurance expense. The increase in 2018 as compared to 2017 was primarily due to the Merger and growth in total assets. Supplies expenses were relatively unchanged for all periods presented. Credit card and bank service fees totaled $0.4 million, $0.4 million, and $0.5 million in 2019, 2018 and 2017, respectively. The declines in 2019 and 2018 compared to 2017 were primarily due to the sale of our payment plan processing business in May 2017. 19 The changes in costs related to unfunded lending commitments are primarily impacted by changes in the amounts of such commitments to originate Portfolio Loans as well as (for commercial loan commitments) the grade (pursuant to our loan rating system) of such commitments. The provision for loss reimbursement on sold loans was an expense of $0.23 million, $0.01 million and $0.17 million in 2019, 2018 and 2017, respectively. This provision represents our estimate of incurred losses related to mortgage loans that we have sold to investors (primarily Fannie Mae, Freddie Mac, Ginnie Mae and the Federal Home Loan Bank of Indianapolis). 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 $0.88 million and $0.78 million at December 31, 2019 and 2018, respectively. This reserve is included in accrued expenses and other liabilities in our Consolidated Statements of Financial Condition. We believe that the amounts that we have accrued for incurred losses on sold mortgage loans are appropriate based upon our prior experience and other assumptions. However, future losses could exceed our current estimate. Net gains 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 gains of $0.1 million in 2019 and $0.7 million in 2018 were primarily due to improved market conditions leading to better sales prices for both commercial and residential properties. The net gain of $0.6 million in 2017 was primarily due to the sale of a commercial property in the fourth quarter of that year. Merger related expenses totaled $3.5 million and $0.3 million in 2018 and 2017, respectively. These expenses included our investment banking fees, certain accounting and legal costs, various contract termination fees, data processing conversion costs, payments made on officer change-in-control contracts, and employee severance costs. Other non-interest expenses totaled $5.9 million, $5.8 million, and $4.7 million in 2019, 2018 and 2017, respectively. The increases in 2019 and 2018 as compared to 2017 was due to increases in several expense categories, including: directors’ fees (a new director was added in 2018), travel and entertainment expenses (in part due to the Merger), debit card and check fraud losses and certain outsourcing costs related to mortgage lending. Income tax expense. We recorded an income tax expense of $11.3 million, $9.3 million and $18.0 million in 2019, 2018 and 2017, respectively. 2019 and 2018 reflect a lower corporate federal income tax rate and 2017 includes an additional $6.0 million of income tax expense related to the remeasurement of our DTA, both as described earlier under ‘‘Significant Developments.’’ Our actual federal income tax expense is different than the amount computed by applying our statutory federal income tax rate to our pre-tax income primarily due to tax-exempt interest income, share based compensation and tax-exempt income from the increase in the cash surrender value on life insurance (and for 2017, the remeasurement of our DTA as well). We assess whether a valuation allowance should be established against our DTA 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, 2019 and 2018 that the realization of substantially all of our DTA continues to be more likely than not. 20 FINANCIAL CONDITION Summary. Our total assets increased to $3.56 billion at December 31, 2019, compared to $3.35 billion at December 31, 2018, primarily due to growth in securities available for sale and loans. Loans, excluding loans held for sale (‘‘Portfolio Loans’’), totaled $2.73 billion at December 31, 2019, an increase of 5.5% from $2.58 billion at December 31, 2018. (See ‘‘Portfolio Loans and asset quality’’). The increase in Portfolio Loans during the last few years is part of our overall strategy to grow revenues, earnings and improve our operating leverage by increasing our loans to deposits ratio. The expansion of our mortgage banking operations is part of this strategy along with continuing to increase our commercial and consumer installment lending. Deposits totaled $3.04 billion at December 31, 2019, compared to $2.91 billion at December 31, 2018. The $123.3 million increase in total deposits during the period reflects growth in reciprocal deposits. 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, trust preferred securities and foreign government securities (that are denominated in U.S. dollars). 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 by $90.5 million during 2019, reflecting the deployment of a portion of the funds generated from the growth in deposits and borrowings. 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 no net impairment losses related to other than temporary impairment on securities available for sale in 2019, 2018 or 2017. SECURITIES Securities available for sale Amortized Cost Unrealized Gains (In thousands) Losses Fair Value December 31, 2019 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $513,668 $5,782 $1,050 $518,400 427,926 December 31, 2018 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 433,224 1,520 6,818 Portfolio Loans and asset quality. In addition to the communities served by our Bank branch and loan production office 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. 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.’’) Due primarily to the expansion of our mortgage-banking activities and a change in mix in our mortgage loan originations, we are now originating and putting into Portfolio 21 Loans more fixed rate mortgage loans compared to past periods. These fixed rate mortgage loans generally have terms from 15 to 30 years, do not have prepayment penalties and expose us to more interest rate risk. To date, our interest rate risk profile has not changed significantly. However, we are carefully monitoring this change in the composition of our Portfolio Loans and the impact of potential future changes in interest rates on our changes in market value of portfolio equity and changes in net interest income. (See ‘‘Asset/liability management.’’). As a result, we have added and may continue to add some longer-term borrowings, may utilize derivatives (interest rate swaps and interest rate caps) to manage interest rate risk and may continue to sell certain fixed rate and adjustable rate jumbo or other mortgage loans in the future. In 2019, we sold or securitized $75.0 million (excludes the $41.7 million discussed below) of fixed and adjustable rate portfolio mortgage loans. In 2018, we sold $27.6 million of fixed and adjustable rate portfolio mortgage loans. In addition, in the fourth quarter of 2018 we reclassified $41.7 million (fair value of $41.5 million) of adjustable rate portfolio mortgage loans to held for sale. These loans (which totaled $40.6 million at the time of sale) were sold to another financial institution on a servicing released basis on January 30, 2019. All of these loan sales/securitizations were non-recourse (other than standard representations and warranties) and were executed primarily for asset/liability management purposes. LOAN PORTFOLIO COMPOSITION December 31, 2019 2018 (In thousands) Real estate(1) Residential first mortgages . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Residential home equity and other junior mortgages . . . . . . . . . . . . . . . . . . . . . . . . . Construction and land development. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Other(2) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Consumer . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Commercial . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Agricultural . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Total loans. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 843,746 166,735 249,747 693,580 448,297 318,504 4,414 $2,725,023 $ 811,719 177,574 180,286 707,347 379,607 319,058 6,929 $2,582,520 (1) (2) Includes both residential and non-residential commercial loans secured by real estate. Includes loans secured by multi-family residential and non-farm, non-residential property. NON-PERFORMING ASSETS(1) 2019 Non-accrual loans. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Loans 90 days or more past due and still accruing interest. . . . . . . . . . . . . . . Sub total . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Less: Government guaranteed loans . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Total non-performing loans . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Other real estate and repossessed assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Total non-performing assets. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . December 31, 2018 (Dollars in thousands) $ 9,029 5 9,034 460 8,574 1,299 $ 9,873 2017 $ 8,184 — 8,184 255 7,929 1,643 $ 9,572 $10,178 — 10,178 646 9,532 1,865 $11,397 As a percent of Portfolio Loans Non-performing loans . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Allowance for loan losses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Non-performing assets to total assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Allowance for loan losses as a percent of non-performing loans . . . . . . . . . . 0.35% 0.96 0.32 274.32 0.33% 0.96 0.29 290.27 0.39% 1.12 0.34 284.87 (1) Excludes loans classified as ‘‘troubled debt restructured’’ that are performing and vehicle service contract counterparty receivables, net. 22 TROUBLED DEBT RESTRUCTURINGS Performing TDR’s. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Non-performing TDR’s(2) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Total . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $7,974 540 $8,514 $39,601 2,607(3) $47,575 3,147 $42,208 $50,722 December 31, 2019 Commercial Retail(1) Total (In thousands) December 31, 2018 Commercial Retail(1) Total (In thousands) Performing TDR’s. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Non-performing TDR’s(2) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Total . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $6,460 74 $6,534 $46,627 2,884(3) $53,087 2,958 $49,511 $56,045 (1) (2) Retail loans include mortgage and installment loan portfolio segments. 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. Non-performing loans totaled $9.5 million, $8.6 million and $7.9 million at December 31, 2019, 2018 and 2017, respectively. The increase in 2019 as compared to 2018 was primarily in the residential mortgage loan portfolio segment that was partially offset by the pay-off or liquidation of non-performing commercial loans. The increase in 2018 as compared to 2017 is primarily due to an increase in non-performing commercial loans. In general, stable economic conditions in our market areas, as well as our collection and resolution efforts, have resulted in relatively low levels of non-performing loans the last few 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 $47.6 million, or 1.7% of total Portfolio Loans, and $53.1 million, or 2.1% of total Portfolio Loans, at December 31, 2019 and 2018, respectively. The decrease in the amount of performing TDRs during 2019 reflects a decline in mortgage loan TDRs due primarily to payoffs and amortization. ORE and repossessed assets totaled $1.9 million at December 31, 2019, compared to $1.3 million at December 31, 2018. The increase in ORE during 2019 primarily reflects the addition of a $0.6 million commercial office building located in Grand Rapids, Michigan in the second quarter. 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 Specific allocations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Other adversely rated commercial loans . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Historical loss allocations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Additional allocations based on subjective factors . . . . . . . . . . . . . . . . . . . . . . . . 2019 $ 6,155 2,502 8,764 8,727 December 31, 2018 (In thousands) $ 6,310 1,861 7,792 8,925 2017 $ 6,839 1,228 7,125 7,395 Total . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $26,148 $24,888 $22,587 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 losses, we consider four principal elements: (i) specific allocations based upon probable losses identified during the 23 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 AFLL 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. No allowance for loan losses was brought forward on any of the TCSB loans acquired in the Merger as any credit deterioration evident in the loans was included in the determination of the fair value of the loans at the acquisition date. An allowance for loan losses is being established for any subsequent credit deterioration or adverse changes in expected cash flows. 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 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 increased $1.26 million to $26.15 million at December 31, 2019 from $24.89 million at December 31, 2018 and was equal to 0.96% of total Portfolio Loans at both December 31, 2019 and 2018. During the first quarter of 2019, we deployed a third-party software solution (we previously used spreadsheet software) to assist in the determination of our AFLL. This new third-party software has also assisted us in moving to the expected loss framework that we implemented on January 1, 2020. Although the use of this new third-party software did not have any material impact on our overall AFLL, it did result in some classification shifts from the AFLL related to subjective factors into the AFLL related to historical losses as the new software model allowed us to capture longer historical look-back periods (previously this was being captured in the subjective portion of the AFLL). Two of the four components of the AFLL outlined above increased during 2019. The AFLL related to specific loans decreased $0.2 million during 2019 due primarily to a $2.6 million decline in the amount of such loans. The AFLL related to other adversely rated commercial loans increased $0.6 million during 2019, primarily due to an increase in the balance of such loans included in this component to $54.4 million at December 31, 2019 from $44.7 million at December 31, 2018. The increase in other adversely rated commercial loans was primarily in early watch credit categories and these loans are largely performing. We do not believe that we will experience any 24 significant loan losses as a result of this rise in other adversely rated commercial loans. The AFLL related to historical losses increased $1.0 million during 2019, and the AFLL related to subjective factors decreased $0.2 million during 2019, due in part to the classification shifts discussed above, as well as loan growth, for the AFLL related to historical losses. By comparison, three of the four components of the allowance for loan losses outlined above increased during 2018. The allowance for loan losses related to specific loans decreased $0.5 million in 2018 due primarily to a decline in the balance of individually impaired loans and charge-offs. The allowance for loan losses related to other adversely rated commercial loans increased $0.6 million in 2018 primarily due to an increase in the balance of such loans included in this component to $44.7 million at December 31, 2018 from $27.2 million at December 31, 2017. The allowance for loan losses related to historical losses increased $0.7 million during 2018 due principally to loan growth. The allowance for loan losses related to subjective factors increased $1.5 million during 2018 primarily due to loan growth. ALLOWANCE FOR LOSSES ON LOANS AND UNFUNDED COMMITMENTS 2019 2018 2017 Loan Losses Unfunded Commitments Loan Losses (Dollars in thousands) Unfunded Commitments Loan Losses Unfunded Commitments Balance at beginning of year . . . . . . . . . . . $24,888 Additions (deductions) Provision for loan losses . . . . . . . . . . . . Recoveries credited to allowance. . . . . . Loans charged against the allowance. . . 824 3,961 (3,525) Additions included in non-interest $1,296 $22,587 $1,125 $20,234 $ 650 — — — 1,503 4,622 (3,824) — — — 1,199 4,205 (3,051) — — — expense . . . . . . . . . . . . . . . . . . . . . . . . . . — 246 — 171 — 475 Balance at end of year . . . . . . . . . . . . . . . . $26,148 $1,542 $24,888 $1,296 $22,587 $1,125 Net loans charged against the allowance to average Portfolio Loans . . . . . . . . . . . (0.02)% (0.03)% (0.06)% In 2019, 2018 and 2017, we recorded loan net recoveries of $0.4 million, $0.8 million and $1.2 million, respectively. These net recoveries primarily reflect reduced levels of non-performing loans, improvement in collateral liquidation values and on-going collection efforts on previously charged-off loans. 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 respectively. totaled $3.04 billion and $2.91 billion at December 31, 2019 and 2018, The $123.3 million increase in deposits during 2019 is due to growth in reciprocal deposits. Reciprocal deposits totaled $431.0 million and $182.1 million at December 31, 2019 and 2018, 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. The significant increase in reciprocal deposits is due in part to an automated sweep capability we introduced in mid-2018 as well as the marketing and sales efforts of our treasury management team. 25 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, 2019, we had an estimated $532.9 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 primarily of federal funds purchased and advances from the Federal Home Loan Bank (the ‘‘FHLB’’), totaled $88.6 million and $25.7 million at December 31, 2019 and 2018, respectively. As described above, we utilize wholesale funding, including federal funds purchased, FHLB borrowings and Brokered CDs to augment our core deposits and fund a portion of our assets. At December 31, 2019, our use of such wholesale funding sources (including reciprocal deposits) amounted to approximately $709.7 million, or 22.7% 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 have historically employed derivative financial instruments to manage our exposure to changes in interest rates. During 2019, 2018 and 2017, we entered into $74.5 million, $23.9 million and $39.1 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 $0.94 million, $0.46 million and $0.41 million of fee income related to these transactions during 2019, 2018 and 2017, respectively. Also in 2018 and 2017, we entered into (notional amounts): $10.0 million and $15.0 million, respectively, of pay fixed interest rate swaps and $105.0 million and $45.0 million, respectively, of interest rate caps. These swaps and caps are hedging short-term wholesale funding. 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, federal funds purchased borrowing facilities with other commercial banks, and access to the capital markets (for Brokered CDs). At December 31, 2019, we had $501.6 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, $2.43 billion of our deposits at December 31, 2019, 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 highly liquid or short-term assets) to total assets, short-term liability dependence and basic surplus (defined as quick assets less volatile liabilities to total assets). Policy limits have been established for our various liquidity measurements and are monitored on a quarterly basis. In addition, we also prepare cash flow forecasts that include a variety of different scenarios. 26 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, and our ability to issue Brokered CDs. We also believe that the parent company (including time deposits) of approximately $20.5 million as of December 31, 2019, 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. the available cash on hand at 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, 2019. CONTRACTUAL COMMITMENTS(1) Time deposit maturities . . . . . . . . . . . . . . . . . . . . . . . . . . FHLB advances . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Subordinated debentures. . . . . . . . . . . . . . . . . . . . . . . . . . Operating lease obligations . . . . . . . . . . . . . . . . . . . . . . . Purchase obligations(2) . . . . . . . . . . . . . . . . . . . . . . . . . . . Total. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1 Year or Less 1-3 Years 3-5 Years After 5 Years Total (In thousands) $501,609 28,645 — 1,681 3,088 $ 87,327 $20,156 4,995 — 2,740 8,872 445 $ — 30,000 — 39,456 2,792 21,060 1,988 9,720 $609,537 63,640 39,456 9,201 42,740 $535,023 $103,934 $31,864 $93,753 $764,574 (1) Excludes approximately $0.4 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, 2019 2018 (In thousands) Subordinated debentures. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Amount not qualifying as regulatory capital . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 39,456 (1,224) $ 39,388 (1,224) Amount qualifying as regulatory capital . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 38,232 38,164 Shareholders’ equity Common stock . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Retained earnings (accumulated deficit) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Accumulated other comprehensive loss. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Total shareholders’ equity. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 352,344 1,611 (3,786) 350,169 377,372 (28,270) (10,108) 338,994 Total capitalization . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $388,401 $377,158 We currently have four special purpose entities with $39.5 million of outstanding cumulative trust preferred securities. These special purpose entities issued common securities and provided cash to our parent company that in 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. The FRB 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 27 trust preferred securities and certain other elements in excess of the limit can be included in Tier 2 capital, subject to restrictions. 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 increased to $350.2 million at December 31, 2019 from $339.0 million at December 31, 2018, due primarily to our net income and a decline in our accumulated other comprehensive loss that were partially offset by share repurchases and by dividends that we paid. Our tangible common equity (‘‘TCE’’) totaled $316.5 million and $304.3 million, respectively, at those same dates. Our ratio of TCE to tangible assets was 8.96% and 9.17% at December 31, 2019 and 2018, respectively. TCE and the ratio of TCE to tangible assets are non-GAAP measures. TCE represents total common equity less intangible assets. In December and January 2018, our Board of Directors authorized the 2019 and 2018 share repurchase plans, respectively. Under the original terms of these share repurchase plans, we were authorized to buy back up to 5% of our outstanding common stock. In June 2019, our Board of Directors supplemented the 2019 share repurchase plan and authorized the repurchase of up to 300,000 additional common shares. These share repurchase plans expired on December 31, 2019 and 2018, respectively. We repurchased 1,204,688 shares during 2019 at an average cost of $21.82 per share. We repurchased 587,969 shares during 2018 (all in the fourth quarter) at an average cost of $21.57 per share. In December 2019, our Board of Directors authorized the 2020 share repurchase plan. Under the terms of the 2020 share repurchase plan, we are authorized to buy back up to 1,120,000 shares, or approximately 5%, of our outstanding common stock. This repurchase plan commenced on January 1, 2020, and is expected to last through December 31, 2020. We pay a quarterly cash dividend on our common stock. The annual total dividends paid were $0.72, $0.60 and $0.42 per share for 2019, 2018 and 2017, respectively. We generally favor a dividend payout ratio between 30% and 50% of net income. As of December 31, 2019 and 2018, 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). 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 Statements 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. 28 CHANGES IN MARKET VALUE OF PORTFOLIO EQUITY AND NET INTEREST INCOME Change in Interest Rates Market Value of Portfolio Equity(1) Net Interest Income(2) Percent Change (Dollars in thousands) Percent Change December 31, 2019 200 basis point rise . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 100 basis point rise . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Base-rate scenario . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 100 basis point decline . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $472,500 478,800 467,200 412,100 1.13% $123,900 123,300 2.48 122,400 — 118,100 (11.79) December 31, 2018 200 basis point rise . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 100 basis point rise . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Base-rate scenario . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 100 basis point decline . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $481,100 495,400 497,900 482,800 (3.37)% $126,200 124,800 (0.50) 122,200 — 119,600 (3.03) 1.23% 0.74 — (3.51) 3.27% 2.13 — (2.13) (1) (2) 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. 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. 29 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’’). Equity securities, securities available for sale, loans held for sale, derivatives and capitalized mortgage loan servicing rights 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 and certain other assets. These nonrecurring fair value adjustments typically involve application of lower of cost or fair value 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 We are involved in various litigation matters in the ordinary course of business. At the present time, we do not believe any of these 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 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 insignificant. However, because of a number of factors, including the fact that certain of these 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, however 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. 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 allowance for loan losses and capitalized mortgage loan servicing rights 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 allowance 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 allowance 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. In June 2016, the FASB issued ASU No. 2016-13 ‘‘Financial Instruments – Credit Losses (Topic 326), Measurement of Credit Losses on Financial Instruments’’ (‘‘ASU 2016-13’’). See note #1 to the Consolidated Financial Statements for a description of our implementation of ASU 2016-13. In particular, since ASU 2016-13 requires a current expected (rather than incurred) credit loss model, our provision for loan losses may be more volatile in future periods. 30 At December 31, 2019 and 2018, we had approximately $19.2 million and $21.4 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 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. 31 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, 2019. 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, 2019, 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, 2019, 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, 2019. Their report immediately follows our report. William B. Kessel President and Chief Executive Officer Independent Bank Corporation March 6, 2020 Stephen A. Erickson Executive Vice President and Chief Financial Officer 32 REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM Shareholders and the Board of Directors of Independent Bank Corporation Grand Rapids, Michigan Opinions on the Financial Statements and Internal Control over Financial Reporting We have audited the accompanying consolidated statements of financial condition of Independent Bank Corporation (the ‘‘Corporation’’) as of December 31, 2019 and 2018, 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, 2019, and the related notes (collectively referred to as the ‘‘financial statements’’). We also have audited the Corporation’s internal control over financial reporting as of December 31, 2019, based on criteria established in Internal Control – Integrated Framework: (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of the Corporation as of December 31, 2019 and 2018, and the results of its operations and its cash flows for each of the years in the three-year period ended December 31, 2019 in conformity with accounting principles generally accepted in the United States of America. Also in our opinion, the Corporation maintained, in all material respects, effective internal control over financial reporting as of December 31, 2019, based on criteria established in Internal Control – Integrated Framework: (2013) issued by COSO. Basis for Opinions The 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 the Corporation’s financial statements and an opinion on the Corporation’s internal control over financial reporting based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (‘‘PCAOB’’) and are required to be independent with respect to the Corporation in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud, and whether effective internal control over financial reporting was maintained in all material respects. Our audits of the financial statements included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. 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. Definition and Limitations of Internal Control Over Financial Reporting 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. 33 Because of its inherent 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. limitations, We have served as the Corporation’s auditor since 2005. Grand Rapids, Michigan March 6, 2020 34 CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION December 31, 2019 2018 (In thousands, except share amounts) ASSETS Cash and due from banks . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Interest bearing deposits . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Cash and Cash Equivalents . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Interest bearing deposits - time . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Equity securities at fair value. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Securities available for sale . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Federal Home Loan Bank and Federal Reserve Bank stock, at cost . . . . . . . . . . Loans held for sale, carried at fair value . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Loans held for sale, carried at lower of cost or fair value . . . . . . . . . . . . . . . . . . Loans Commercial . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Mortgage . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Installment . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Total Loans . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Allowance for loan losses. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Net Loans . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Other real estate and repossessed assets, net . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Property and equipment, net. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Bank-owned life insurance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Deferred tax assets, net. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Capitalized mortgage loan servicing rights . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Other intangibles . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Goodwill . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Accrued income and other assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Total Assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 53,295 12,009 65,304 350 — 518,400 18,359 69,800 — 1,166,695 1,098,911 459,417 2,725,023 (26,148) 2,698,875 1,865 38,411 55,710 2,072 19,171 5,326 28,300 42,751 $3,564,694 LIABILITIES AND SHAREHOLDERS’ EQUITY Deposits Non-interest bearing . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Savings and interest-bearing checking . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Reciprocal . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Time. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Brokered time . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Total Deposits . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Other borrowings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Subordinated debentures . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Accrued expenses and other liabilities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Total Liabilities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 852,076 1,186,745 431,027 376,877 190,002 3,036,727 88,646 39,456 49,696 3,214,525 $ 23,350 46,894 70,244 595 393 427,926 18,359 44,753 41,471 1,144,481 1,042,890 395,149 2,582,520 (24,888) 2,557,632 1,299 38,777 55,068 5,779 21,400 6,415 28,300 34,870 $3,353,281 $ 879,549 1,194,865 182,072 385,981 270,961 2,913,428 25,700 39,388 35,771 3,014,287 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: 22,481,643 shares at December 31, 2019 and 23,579,725 shares at December 31, 2018 . . . . . . . . . . . . . . . . . . . . . . . . . . . Retained earnings (accumulated deficit) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Accumulated other comprehensive loss . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Total Shareholders’ Equity . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Total Liabilities and Shareholders’ Equity . . . . . . . . . . . . . . . . . . . . . . . . . . . 352,344 1,611 (3,786) 350,169 $3,564,694 377,372 (28,270) (10,108) 338,994 $3,353,281 See accompanying notes to consolidated financial statements 35 CONSOLIDATED STATEMENTS OF OPERATIONS Year Ended December 31, 2018 (In thousands, except per share amounts) 2017 2019 INTEREST INCOME Interest and fees on loans . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Interest on securities Taxable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Tax-exempt . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Other investments. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Total Interest Income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . INTEREST EXPENSE Deposits . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Other borrowings and subordinated debentures . . . . . . . . . . . . . . . . . . . . . . Total Interest Expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Net Interest Income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Provision for loan losses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Net Interest Income After Provision for Loan Losses . . . . . . . . . . . . . . . NON-INTEREST INCOME Service charges on deposit accounts . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Interchange income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Net gains on assets Mortgage loans . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Securities. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Mortgage loan servicing, net . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Other . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Total Non-interest Income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . NON-INTEREST EXPENSE Compensation and employee benefits . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Occupancy, net . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Data processing . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Furniture, fixtures and equipment . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Interchange expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Communications . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Loan and collection . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Advertising . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Legal and professional . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . FDIC deposit insurance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Net gains on other real estate and repossessed assets . . . . . . . . . . . . . . . . . Merger related expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Other . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Total Non-interest Expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Income Before Income Tax . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Income tax expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Net Income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Net income per common share $133,883 $116,865 $84,281 11,842 1,342 1,861 148,928 23,425 2,922 26,347 122,581 824 121,757 11,208 10,297 19,978 307 (3,336) 9,282 47,736 67,501 9,013 8,905 4,113 3,215 2,947 2,685 2,450 1,814 685 (90) — 8,495 111,733 57,760 11,325 $ 46,435 10,874 1,743 1,291 130,773 14,478 3,013 17,491 113,282 1,503 111,779 12,258 9,905 10,597 138 3,157 8,760 44,815 10,928 2,000 1,100 98,309 6,775 2,348 9,123 89,186 1,199 87,987 12,673 8,023 11,762 260 1,647 8,168 42,533 62,078 8,912 8,262 4,080 2,702 2,848 2,682 2,155 1,839 1,081 (672) 3,465 8,029 107,461 49,133 9,294 $ 39,839 55,089 8,102 7,657 3,870 1,156 2,684 2,230 1,905 1,892 894 (606) 284 6,925 92,082 38,438 17,963 $20,475 Basic . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Diluted . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ $ 2.03 2.00 $ $ 1.70 1.68 $ $ 0.96 0.95 See accompanying notes to consolidated financial statements 36 CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME 2019 Year Ended December 31, 2018 (In thousands) 2017 Net income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Other comprehensive income (loss) $46,435 $39,839 $20,475 Securities available for sale Unrealized gain (loss) arising during period . . . . . . . . . . . . . . . . . . . . . . . . . . . Change in unrealized gains and losses for which a portion of other than 10,235 (4,594) 4,065 temporary impairment has been recognized in earnings . . . . . . . . . . . . . . . . Reclassification adjustments for gains included in earnings . . . . . . . . . . . . . . . (65) (140) (53) (56) 186 (215) Unrealized gains (losses) recognized in other comprehensive income (loss) on securities available for sale . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Income tax expense (benefit) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10,030 2,106 (4,703) (988) 4,036 1,413 Unrealized gains (losses) recognized in other comprehensive income (loss) on securities available for sale, net of tax . . . . . . . . . . . . . . . . . . . . 7,924 (3,715) 2,623 Derivative instruments Unrealized gains (losses) arising during period . . . . . . . . . . . . . . . . . . . . . . . . . Reclassification adjustment for (income) expense recognized in earnings . . . . (1,603) (425) Unrealized gains (losses) recognized in other comprehensive income (loss) on derivative instruments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Income tax expense (benefit) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (2,028) (426) (262) (237) (499) (105) 324 18 342 120 Unrealized gains (losses) recognized in other comprehensive income (loss) on derivative instruments, net of tax . . . . . . . . . . . . . . . . . . . . . . . . (1,602) (394) 222 Other comprehensive income (loss) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6,322 (4,109) 2,845 Comprehensive income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $52,757 $35,730 $23,320 See accompanying notes to consolidated financial statements 37 CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY Balances at January 1, 2017 . . . . . . . . . . . . . . . . . . . . . . . . . Net income for 2017 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Cash dividends declared, $.42 per share . . . . . . . . . . . . . . . Issuance of 27,046 shares of common stock . . . . . . . . . . . . Share based compensation (issuance of 71,256 shares of Retained Earnings (Accumulated Deficit) Accumulated Other Comprehensive Loss Total Shareholders’ Equity Common Stock (Dollars in thousands, except per share amounts) $323,745 — — 72 $(65,605) 20,475 (8,960) — $ (8,808) — — — $249,332 20,475 (8,960) 72 common stock) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,748 Share based compensation withholding obligation (withholding of 22,525 shares of common stock) . . . . . . Reclassification of certain deferred tax effects . . . . . . . . . . Other comprehensive income . . . . . . . . . . . . . . . . . . . . . . . . Balances at December 31, 2017 . . . . . . . . . . . . . . . . . . . . . . Net income for 2018 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Cash dividends declared, $.60 per share . . . . . . . . . . . . . . . Repurchase of 587,969 shares of common stock. . . . . . . . . Acquistion of TCSB Bancorp, Inc. . . . . . . . . . . . . . . . . . . . Issuance of 152,549 shares of common stock . . . . . . . . . . . Share based compensation (issuance of 80,028 shares of (579) — — 324,986 — — (12,681) 64,536 267 common stock) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,731 Share based compensation withholding obligation (withholding of 108,185 shares of common stock) . . . . . Other comprehensive loss . . . . . . . . . . . . . . . . . . . . . . . . . . . Balances at December 31, 2018 . . . . . . . . . . . . . . . . . . . . . . Net income for 2019 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Cash dividends declared, $.72 per share . . . . . . . . . . . . . . . Repurchase of 1,204,688 shares of common stock . . . . . . . Issuance of 71,799 shares of common stock . . . . . . . . . . . . Share based compensation (issuance of 92,275 shares of (1,467) — 377,372 — — (26,284) 284 common stock) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,854 Share based compensation withholding obligation (withholding of 57,468 shares of common stock) . . . . . . Other comprehensive income . . . . . . . . . . . . . . . . . . . . . . . . (882) — — — 36 — (54,054) 39,839 (14,055) — — — — — — (28,270) 46,435 (16,554) — — — — — — 1,748 — (36) 2,845 (5,999) — — — — — (579) — 2,845 264,933 39,839 (14,055) (12,681) 64,536 267 — 1,731 — (4,109) (10,108) — — — — (1,467) (4,109) 338,994 46,435 (16,554) (26,284) 284 — 1,854 — 6,322 (882) 6,322 Balances at December 31, 2019 . . . . . . . . . . . . . . . . . . . . . . $352,344 $ 1,611 $ (3,786) $350,169 See accompanying notes to consolidated financial statements 38 CONSOLIDATED STATEMENTS OF CASH FLOWS Net Income. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . ADJUSTMENTS TO RECONCILE NET INCOME TO NET CASH FROM OPERATING ACTIVITIES Proceeds from the sale of equity securities at fair value . . . . . . . . . . . . . . . . . . . . . . . Proceeds from sales of loans held for sale . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Disbursements for loans held for sale . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Provision for loan losses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Deferred income tax expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Deferred loan fees and costs. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Net depreciation, amortization of intangible assets and premiums and accretion of discounts on securities, loans and interest bearing deposits - time . . . . . . . . . . . . . . Net gains on mortgage loans . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Net gains on securities. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Net gains on other real estate and repossessed assets . . . . . . . . . . . . . . . . . . . . . . . . . Share based compensation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Increase in accrued income and other assets. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Increase in accrued expenses and other liabilities . . . . . . . . . . . . . . . . . . . . . . . . . . . . Total Adjustments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Net Cash From Operating Activities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . CASH FLOW USED IN INVESTING ACTIVITIES Proceeds from the sale of securities available for sale . . . . . . . . . . . . . . . . . . . . . . . . . Proceeds from maturities, prepayments and calls of securities available for sale . . . . . . Purchases of securities available for sale . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Proceeds from the sale of interest bearing deposits - time . . . . . . . . . . . . . . . . . . . . . . Proceeds from the maturity of interest bearing deposits - time . . . . . . . . . . . . . . . . . . . Purchase of Federal Reserve Bank stock . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Net increase in portfolio loans (loans originated, net of principal payments) . . . . . . . . . Proceeds from the sale of portfolio loans . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Cash received in the acquisition of TCSB Bancorp Inc. Cash received from the sale of Mepco Finance Corporation assets, net . . . . . . . . . . . . . Proceeds from the collection of vehicle service contract counterparty receivables . . . . . Proceeds from the sale of other real estate and repossessed assets . . . . . . . . . . . . . . . . Proceeds from bank-owned life insurance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Proceeds from the sale of property and equipment . . . . . . . . . . . . . . . . . . . . . . . . . . . Capital expenditures . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Net Cash Used in Investing Activities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . CASH FLOW FROM FINANCING ACTIVITIES Net increase in total deposits . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Net increase (decrease) in other borrowings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Proceeds from Federal Home Loan Bank advances. . . . . . . . . . . . . . . . . . . . . . . . . . . Payments of Federal Home Loan Bank advances . . . . . . . . . . . . . . . . . . . . . . . . . . . . Dividends paid . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Proceeds from issuance of common stock . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Repurchase of common stock . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Share based compensation withholding obligation. . . . . . . . . . . . . . . . . . . . . . . . . . . . Net Cash From Financing Activities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Net Increase (Decrease) in Cash and Cash Equivalents . . . . . . . . . . . . . . . . . . . . . . Cash and Cash Equivalents at Beginning of Year . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Cash and Cash Equivalents at End of Year . . . . . . . . . . . . . . . . . . . . . . . . . . . . Cash paid during the year for Interest. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Income taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Operating leases . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Transfers to other real estate and repossessed assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . Transfer of mortgage loans to held for sale . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Securitization of portfolio loans . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Right of use assets obtained in exchange for lease obligations . . . . . . . . . . . . . . . . . . . . . Purchase of securities available for sale and interest bearing deposits - time not yet settled. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Common stock and stock options issued in TCSB Bancorp, Inc. acquisition . . . . . . . . . . . 2019 Year Ended December 31, 2018 (In thousands) 39,839 $ 2017 $ 20,475 $ 46,435 560 642,537 (647,606) 824 1,088 (2,936) 6,059 (19,978) (307) (90) 1,854 (6,573) 12,113 (12,455) 33,980 68,716 153,938 (237,672) — 250 — (215,276) 50,516 — — 512 1,766 470 74 (4,936) (181,642) 123,299 25,002 111,000 (73,143) (16,554) 284 (26,284) (882) 142,722 (4,940) 70,244 $ 65,304 $ 26,697 9,534 2,201 2,242 36,622 65,070 9,906 — — — 463,699 (457,077) 1,503 9,294 (4,044) — 434,682 (426,410) 1,199 16,009 (5,159) 6,033 (10,597) (138) (672) 1,731 (4,890) 240 5,082 44,921 48,736 160,627 (103,493) 2,474 3,728 (2,038) (344,330) 27,658 23,516 — 511 2,526 474 106 (3,862) (183,367) 6,957 (11,762) (260) (606) 1,748 (3,708) 5,442 18,132 38,607 17,308 173,723 (100,584) — 2,850 — (406,859) — — 33,446 528 5,703 523 26 (4,242) (277,578) 225,185 (6,600) 1,272,000 (1,308,697) (14,055) 267 (12,681) (1,467) 153,952 15,506 54,738 70,244 174,815 6,754 622,000 (583,587) (8,960) 72 — (579) 210,515 (28,456) 83,194 $ 54,738 $ 16,737 120 — 1,510 41,471 10,869 — — 64,536 9,163 1,970 — 1,735 — — — 1,000 — $ $ See accompanying notes to consolidated financial statements 39 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 1 – ACCOUNTING POLICIES The accounting and reporting policies and practices of Independent Bank Corporation and subsidiaries (‘‘IBCP’’) 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 allowance for loan losses (‘‘AFLL’’) and the valuation of capitalized mortgage loan servicing rights. 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. Through April, 2017 we also purchased payment plans from companies (which we referred to as ‘‘counterparties’’) that provided vehicle service contracts and similar products to consumers, through our wholly owned subsidiary, Mepco Finance Corporation (‘‘Mepco’’) which was sold effective May 1, 2017. See note #27. At December 31, 2019, 71.7% 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 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 and for short-term borrowings. 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. All of these deposits are FDIC insured. 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. Certain portfolio loans were reclassified to held for sale as of December 31, 2018, were carried at the lower of cost or fair value on an aggregate loan basis and were sold during the first quarter of 2019. 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. CAPITALIZED MORTGAGE LOAN SERVICING RIGHTS — During the first quarter of 2017, we adopted the fair value method of accounting for our capitalized mortgage loan servicing rights pursuant to Financial Accounting Standards Board (‘‘FASB’’) Accounting Standards Codification topic 860 – ‘‘Transfers and Servicing’’. Prior to January 1, 2017, we were accounting for our capitalized mortgage loan servicing rights under the amortization method. We adopted the fair value method using a modified retrospective adjustment to beginning accumulated deficit. We recognize as separate assets the rights to service mortgage loans for others. The fair value of capitalized mortgage loan servicing rights has been determined based upon fair value indications for similar servicing. Under the fair value method we measure capitalized mortgage loan servicing rights at fair value at each reporting date and report changes in fair value of capitalized mortgage loan servicing rights in earnings in the period in which the changes occur and are included in mortgage loan servicing, net in the Consolidated Statements of Operations. The fair values of capitalized 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. 40 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS − (Continued) 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 fair value changes of capitalized mortgage loan servicing rights, totaled $6.2 million, $5.5 million and $4.4 million for the years ended December 31, 2019, 2018 and 2017, respectively. Late fees and ancillary fees related to loan servicing are not material. 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 equity, trading, held to maturity or available for sale. Equity securities are investments in certain preferred stocks and are reported at fair value with realized and unrealized gains and losses included in earnings. 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. We did not have any trading securities at December 31, 2019 and 2018. 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, 2019 and 2018. Securities available for sale represent those securities not classified as equity, 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 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 41 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS − (Continued) 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 were acquired by Mepco at a discount which was accreted into interest income – interest and fees on loans in the Consolidated Statements of Operations over the life of the receivable computed on a level-yield method. loan segment 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. These segments are further disaggregated into classes for purposes of monitoring and assessing credit quality based on certain risk characteristics. Classes within the commercial include (i) commercial and industrial and (ii) commercial real estate. Classes within the mortgage loan segment include (i) 1-4 family owner occupied - jumbo, (ii) 1-4 family owner occupied - non-jumbo, (iii) 1-4 family non-owner occupied (iv) 1-4 family - 2nd lien and (v) resort lending. Classes within the installment loan segment include (i) boat lending, (ii) recreational vehicle lending, 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 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 AFLL 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 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. 42 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS − (Continued) During the first quarter of 2019, we deployed a third-party software solution (we previously used spreadsheet software) to assist in the determination of our AFLL. This new third-party software also has assisted us in moving to the expected loss framework that was required to be implemented on January 1, 2020. Although the use of this new third-party software did not have any material impact on our overall AFLL, it did result in some classification shifts from the AFLL related to subjective factors into the AFLL related to historical losses as the new software model allowed us to capture longer historical look-back periods (previously this was being captured in the subjective portion of the AFLL). 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 prior to the sale of Mepco) 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 prior to the sale of Mepco), 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 a new loan with similar credit risk characteristics, and other terms no less favorable to us than those we would offer for a similar new loan. PROPERTY AND EQUIPMENT — Property and equipment is stated at cost less accumulated depreciation and amortization. Depreciation and amortization is computed using the straight-line method 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 265 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 non-interest expense in the Consolidated Statements of Operations. Non-real estate repossessed assets are treated in a similar manner. 43 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. GOODWILL — Goodwill arises from business combinations and is generally determined as the excess of the fair value of the consideration transferred over the fair value of the net assets acquired and liabilities assumed as of the acquisition date. Goodwill acquired in a purchase business combination and determined to have an indefinite useful life is not amortized, but tested for impairment at least annually or more frequently if events and circumstances exists that indicate that a goodwill impairment test should be performed. We have selected December 31 as the date to perform the annual impairment test. Goodwill is the only intangible asset with an indefinite life on our Consolidated Statements of Financial Condition. 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 in the Consolidated Statements of Operations. 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 non-interest income – other in our Consolidated Statements of Operations. 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. 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 44 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS − (Continued) pay-variable interest rate swap agreements related to commercial loan customers and (iii) certain purchased and written options related to a time deposit product. The fair value of rate-lock mortgage loan commitments is based on agency cash window loan pricing for comparable assets and the fair value of mandatory commitments to sell mortgage loans is 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 derived from proprietary models which utilize current market data 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 in the Consolidated Statements of Operations. 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) in the Consolidated Statements of Operations. 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 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 income (loss) are amortized into earnings over the same periods which the hedged transactions will affect earnings. COMPREHENSIVE INCOME — Comprehensive income consists of net income and unrealized gains and losses, net of tax, 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. Forfeitures are recognized as they occur. 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, 2019, 0.1 million shares of common stock were reserved for issuance under the dividend reinvestment plan and 0.7 million shares of common stock were reserved for issuance under our long-term incentive plans. 45 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS − (Continued) RECLASSIFICATION — Certain amounts in the 2018 and 2017 consolidated financial statements have been reclassified to conform to the 2019 presentation. ADOPTION OF NEW ACCOUNTING STANDARDS — In February 2016, the Financial Accounting Standards Board (‘‘FASB’’) issued Accounting Standards Update (‘‘ASU’’) 2016-02, ‘‘Leases (Topic 842)’’. This ASU amends existing guidance related to the accounting for leases. These amendments, among other things, require 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 was effective for us on January 1, 2019 and did not have a material impact on our consolidated operating results or financial condition. Based on our operating leases that we had in place at the date of adoption we did not have a material change in the recognition, measurement and presentation of lease expense or impact on cash flow. The primary impact was the recognition of certain operating leases on our Consolidated Statements of Financial Condition which resulted in the recording of right of use (‘‘ROU’’) assets and offsetting lease liabilities each totaling approximately $7.7 million at January 1, 2019. See note #18. In August 2017, the FASB issued ASU 2017-12, ‘‘Derivatives and Hedging (Topic 815), Targeted Improvements to Accounting for Hedging Activities’’. This new ASU amends the hedge accounting model in Topic 815 to enable entities to better portray the economics of their risk management activities in the financial statements and enhance the transparency and understandability of hedge results. The amendments expand an entity’s ability to hedge nonfinancial and financial risk components and reduce complexity in fair value hedges of interest rate risk. The guidance eliminates the requirement to separately measure and report hedge ineffectiveness and generally requires the entire change in the fair value of a hedging instrument to be presented in the same income statement line as the hedged item. The guidance also eases certain documentation and assessment requirements and modifies the accounting for components excluded from the assessment of hedge effectiveness. This amended guidance was effective for us on January 1, 2019, and did not have a material impact on our consolidated operating results or financial condition. 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: • • • • • Replaces the existing incurred loss impairment guidance and establishes a single allowance framework for financial assets carried at amortized cost, which will reflect our estimate of credit losses over the full remaining expected life of the financial assets and will consider expected future changes in macroeconomic conditions. Eliminates existing guidance for purchase credit impaired (‘‘PCI’’) loans, and requires recognition of the nonaccretable difference as an increase to the allowance for expected credit losses on financial assets purchased with more than insignificant credit deterioration since origination, which will be offset by an increase in the recorded investment of the related loans. Requires inclusion of expected recoveries, limited to the cumulative amount of prior write-offs, when estimating the allowance for credit losses for in scope financial assets (including collateral dependent assets). Amends existing impairment guidance for securities available for sale to incorporate an allowance, which will allow for reversals of credit impairments in the event that the credit of an issuer improves. Credit losses on securities available for sale are limited to the amount of the decline in fair value regardless of what the credit loss model would show for impairment. Generally requires a cumulative-effect adjustment to retained earnings as of the beginning of the reporting period of adoption. We began evaluating this ASU in 2016 and established a company-wide, cross-discipline governance structure, which provides implementation oversight. We continued to test and refine our current expected credit loss models that satisfied the requirements of this ASU. Oversight and testing, as well as efforts to meet expanded disclosure requirements, extended through the end of 2019. We currently estimate losses over approximately a two year forecast 46 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS − (Continued) period using the Federal Open Market Committee median economic projections as well as considering other economic forecast sources, and then revert to longer term historical loss experience to estimate losses over more extended periods. This amended guidance was effective for us on January 1, 2020. We have not completed finalizing the results of our current expected credit loss (‘‘CECL’’) estimate as of year-end. The required financial reporting disclosures are being further refined and internally validated. We are in the process of finalizing the review of our model and assumptions including qualitative adjustments and economic forecasts. During the first quarter of 2020, we expect to finalize our model and all assumptions as well as obtain formal approval from all internal committees and governance processes related to CECL. We expect to recognize a one-time cumulative effect adjustment increasing the allowance for loan losses. Because we do not have final approval from our oversight and governance committees, we are estimating an increase to the allowance for loan losses to be in the range of $8.0 million to $10.0 million primarily driven by the longer contractual maturities of our mortgage and consumer installment loan segments. In addition, we currently expect this ASU to increase the allowance for losses related to unfunded loan commitments between $1.0 million and $2.0 million. The ultimate impact of adopting this ASU, and at each subsequent reporting period, is highly dependent on credit quality, economic forecasts and conditions, composition of our loan portfolios and securities available for sale, along with other management judgements. The transition adjustment to record the allowance for credit losses may fall outside of our estimated increase based on the finalization of assumptions including qualitative adjustments and the economic forecast used in calculating the allowance for credit losses upon the adoption of CECL. We do not expect a material allowance for credit losses to be recorded on securities available for sale upon adoption of this ASU. In August 2018, the FASB issued ASU 2018-13, ‘‘Fair Value Measurement (Topic 820), Disclosure Framework – Changes to the Disclosure Requirements for Fair Value Measurement’’. This new ASU amends disclosure requirements in Topic 820 to eliminate, add and modify certain disclosure requirements for fair value measurements as part of its disclosure framework project. The amended guidance eliminates the requirements to disclose the amount of and reasons for transfers between Level 1 and Level 2 of the fair value hierarchy, the entity’s policy for the timing of transfers between levels of the fair value hierarchy and the entity’s valuation processes for Level 3 fair value measurements. The amended guidance adds the requirements to disclose the changes in unrealized gains and losses for the period included in other comprehensive income (loss) for recurring Level 3 fair value measurements of instruments held at the end of the reporting period and for recurring and nonrecurring Level 3 fair value measurements, the range and weighted average used to develop significant unobservable inputs and how the weighted average was calculated, with certain exceptions. This amended guidance was effective for us on January 1, 2020, and did not have a material impact on our consolidated operating results or financial condition. NOTE 2 – RESTRICTIONS ON CASH AND DUE FROM BANKS Our Bank is required to maintain reserve balances in the form of vault cash and balances with the FRB. The average reserve balances to be maintained during 2019 and 2018 were $26.6 million and $9.6 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 $0.01 million and $0.13 million at December 31, 2019 and 2018, respectively. 47 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS − (Continued) NOTE 3 – SECURITIES Securities available for sale consist of the following at December 31: 2019 Amortized Cost Unrealized Gains (In thousands) Losses Fair Value U.S. agency . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 14,591 $ U.S. agency residential mortgage-backed. . . . . . . . . . . . . . . . . . . . . . . . . U.S. agency commercial mortgage-backed . . . . . . . . . . . . . . . . . . . . . . . Private label mortgage-backed . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Other asset backed. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Obligations of states and political subdivisions . . . . . . . . . . . . . . . . . . . . Corporate . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Trust preferred . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Foreign government. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 226,130 10,671 39,248 94,158 94,499 31,904 1,968 499 1,910 113 544 103 1,724 1,296 — 3 89 $ 19 $ 14,661 227,762 278 10,756 28 39,693 99 93,886 375 96,102 121 33,195 5 1,843 125 502 — Total . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $513,668 $5,782 $1,050 $518,400 2018 U.S. agency . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 20,198 $ U.S. agency residential mortgage-backed. . . . . . . . . . . . . . . . . . . . . . . . . U.S. agency commercial mortgage-backed . . . . . . . . . . . . . . . . . . . . . . . Private label mortgage-backed . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Other asset backed. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Obligations of states and political subdivisions . . . . . . . . . . . . . . . . . . . . Corporate . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Trust preferred . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Foreign government. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 124,777 5,909 29,735 83,481 130,244 34,866 1,964 2,050 9 $ 193 $ 20,014 123,751 5,726 29,419 83,319 127,555 34,309 1,819 2,014 1,843 184 637 248 2,946 586 145 36 817 1 321 86 257 29 — — Total . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $433,224 $1,520 $6,818 $427,926 Total OTTI recognized in accumulated other comprehensive loss for securities available for sale was zero at both December 31, 2019 and 2018, 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 Unrealized Losses Unrealized Losses Fair Value Fair Value Total Fair Value Unrealized Losses (In thousands) 2019 U.S. agency. . . . . . . . . . . . . . . . . . . . . . . . . . . $ U.S. agency residential mortgage-backed . . . U.S. agency commercial mortgage-backed . . Private label mortgage-backed. . . . . . . . . . . . Other asset backed . . . . . . . . . . . . . . . . . . . . . Obligations of states and political subdivisions . . . . . . . . . . . . . . . . . . . . . . . . Corporate . . . . . . . . . . . . . . . . . . . . . . . . . . . . Trust preferred . . . . . . . . . . . . . . . . . . . . . . . . 2,782 56,377 3,284 16,387 34,027 15,666 2,125 — 8 $ 126 24 55 233 84 5 — $ 2,712 13,551 659 343 13,839 5,396 — 1,843 $ 11 152 4 44 142 37 — 125 $ 5,494 69,928 3,943 16,730 47,866 21,062 2,125 1,843 $ 19 278 28 99 375 121 5 125 Total . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $130,648 $535 $38,343 $515 $168,991 $1,050 48 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS − (Continued) Less Than Twelve Months Twelve Months or More Unrealized Losses Unrealized Losses Fair Value Fair Value Total Fair Value Unrealized Losses (In thousands) 2018 U.S. agency. . . . . . . . . . . . . . . . . . . . . . . . . . . $ U.S. agency residential mortgage-backed . . . U.S. agency commercial mortgage-backed . . Private label mortgage-backed. . . . . . . . . . . . Other asset backed . . . . . . . . . . . . . . . . . . . . . Obligations of states and political subdivisions . . . . . . . . . . . . . . . . . . . . . . . . Corporate . . . . . . . . . . . . . . . . . . . . . . . . . . . . Trust preferred . . . . . . . . . . . . . . . . . . . . . . . . Foreign government . . . . . . . . . . . . . . . . . . . . 7,150 18,374 566 8,273 53,043 25,423 17,758 939 — $ 46 180 3 57 160 262 343 61 — $ 11,945 48,184 5,094 16,145 10,235 80,701 9,222 880 2,014 $ 147 1,663 181 580 88 2,684 243 84 36 $ 19,095 66,558 5,660 24,418 63,278 106,124 26,980 1,819 2,014 $ 193 1,843 184 637 248 2,946 586 145 36 Total . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $131,526 $1,112 $184,420 $5,706 $315,946 $6,818 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, 2019, we had 29 U.S. agency, 111 U.S. agency residential mortgage-backed and 9 U.S. agency commercial mortgage-backed securities whose fair 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. Private label mortgage backed, other asset backed and corporate securities — at December 31, 2019, we had 22 private label mortgage backed, 58 other asset backed and two corporate securities whose fair value is less than amortized cost. Unrealized losses are primarily due to credit spread widening and increases in interest rates since their acquisition. Two private label mortgage-backed securities (discussed further below) were reviewed for other than temporary impairment (‘‘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. Obligations of states and political subdivisions — at December 31, 2019, we had 42 municipal securities whose fair value is less than amortized cost. The unrealized losses are primarily due to wider benchmark pricing spreads and increases in interest rates since acquisition. Trust preferred securities — at December 31, 2019, we had two trust preferred securities whose fair value is less than amortized cost. Both 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 securities is rated by a major rating agency as investment grade while 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 $0.91 million as of December 31, 2019, continues to have satisfactory credit metrics and make interest payments. As management does not intend to liquidate any of the securities discussed above 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 discussed above (other than certain declines related to the two private label mortgage-backed securities currently being reviewed for OTTI) are deemed to be other than temporary. 49 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS − (Continued) We recorded zero credit related OTTI charges in the Consolidated Statements of Operations on securities available for sale during 2019, 2018, and 2017. At December 31, 2019, two private label mortgage-backed securities had credit related OTTI and are summarized as follows: Senior Security Super Senior Security (In thousands) As of December 31, 2019 Fair value . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Amortized cost . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Non-credit unrealized loss . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Unrealized gain . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Cumulative credit related OTTI . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $601 511 — 90 757 $603 442 — 161 457 Total $1,204 953 — 251 1,214 Both of these securities are receiving principal and interest payments similar to principal reductions in the underlying collateral and have unrealized gains at December 31, 2019. The original amortized cost (current amortized cost excluding cumulative credit related OTTI) 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: Balance at beginning of year. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $1,594 $1,594 $1,594 2019 2018 (In thousands) 2017 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 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Reduction(1) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Total . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . — (380) — — — — — — $1,214 $1,594 $1,594 (1) During 2019 one security with previously recorded OTTI was settled and balance is now zero. The amortized cost and fair value of securities available for sale at December 31, 2019, by contractual maturity, follow: Maturing within one year. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Maturing after one year but within five years . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Maturing after five years but within ten years . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Maturing after ten years. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . U.S. agency residential mortgage-backed . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . U.S. agency commercial mortgage-backed . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Private label mortgage-backed. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Other asset backed . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Amortized Cost Fair Value (In thousands) $ 10,737 50,035 47,634 35,055 143,461 226,130 10,671 39,248 94,158 $ 10,761 50,839 49,070 35,633 146,303 227,762 10,756 39,693 93,886 Total . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $513,668 $518,400 50 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS − (Continued) 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: Realized Proceeds Gains(1) Losses (In thousands) 2019 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2018 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2017 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $68,716 48,736 17,308 $248 192 218 $108 136 3 (1) 2018 excludes a $0.144 million gain on the sale of 1,000 VISA Class B shares. Certain preferred stocks which were all sold during the first quarter of 2019 had been classified as equity securities at fair value in our Consolidated Statement of Financial Condition. During 2019, 2018 and 2017, we recognized gains (losses) on these preferred stocks of $0.17 million, $(0.06) million and $0.05 million, respectively, that are included in net gains on securities in the Consolidated Statements of Operations. Zero, $(0.06) million and $0.05 million of these amounts relate to gains (losses) recognized on preferred stock still held at each respective year end. Securities available for sale with a book value of $8.7 million and zero at December 31, 2019 and 2018, 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 total shareholders’ equity at December 31, 2019 or 2018. NOTE 4 – LOANS AND PAYMENT PLAN RECEIVABLES Our loan portfolios at December 31 follow: 2019 2018 (In thousands) Real estate(1) Residential first mortgages . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 843,746 $ 811,719 177,574 Residential home equity and other junior mortgages . . . . . . . . . . . . . . . . . . . . . . . . . . . 180,286 Construction and land development . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Other(2). . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 707,347 379,607 Consumer . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 319,058 Commercial . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6,929 Agricultural . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Total loans . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $2,725,023 $2,582,520 166,735 249,747 693,580 448,297 318,504 4,414 (1) (2) Includes both residential and non-residential commercial loans secured by real estate. Includes loans secured by multi-family residential and non-farm, non-residential property. Loans include net deferred loan costs of $16.3 million and $13.3 million at December 31, 2019 and 2018, respectively. During the first quarter of 2019, we sold $40.6 million, of residential adjustable rate mortgage loans servicing released (classified on the Consolidated Statements of Financial Condition as held for sale, carried at the lower of cost or fair value at December 31, 2018) to another financial institution and recognized a gain on sale of $0.01 million. During the first quarter of 2019 we also securitized $29.8 million, of portfolio residential fixed rate mortgage loans servicing retained with Freddie Mac and recognized a gain on sale of $0.53 million. During the third quarter of 2019, we sold $9.9 million of residential fixed and adjustable rate portfolio mortgage loans servicing retained to another financial institution and recognized a gain on sale of $0.07 million. During the third quarter of 2019 we also transferred $36.6 million, of portfolio residential fixed rate mortgage loans to loans held for sale, carried 51 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS − (Continued) at the lower of cost or fair value of which $35.3 million were subsequently securitized in the fourth quarter of 2019 servicing retained with Freddie Mac recognizing a gain on sale of approximately $1.2 million. These transactions were done primarily for asset/liability management purposes. During the first and third quarters of 2018, we sold $16.5 million and $11.1 million, respectively, of residential fixed and adjustable rate portfolio mortgage loans servicing retained to another financial institution and recognized a gain (loss) on sale of $0.05 million and ($0.01) million, respectively. During the fourth quarter of 2018 we securitized $10.9 million of portfolio residential fixed rate mortgage loans servicing retained with Freddie Mac recognizing a loss on sale of approximately $0.1 million. These transactions were done primarily for asset/liability management purposes. An analysis of the allowance for loan losses by portfolio segment for the years ended December 31 follows: 2019 Balance at beginning of period . . . . . . . . . . . . . . . . . . Additions (deductions) Commercial Mortgage Installment (In thousands) Subjective Allocation Total $7,090 $ 7,978 $ 895 $8,925 $24,888 Provision for loan losses . . . . . . . . . . . . . . . . . . . . . Recoveries credited to allowance . . . . . . . . . . . . . . Loans charged against the allowance . . . . . . . . . . . (651) 2,165 (682) 526 933 (1,221) 1,147 863 (1,622) (198) — — 824 3,961 (3,525) Balance at end of period . . . . . . . . . . . . . . . . . . . . . . . $7,922 $ 8,216 $ 1,283 $8,727 $26,148 2018 Balance at beginning of period . . . . . . . . . . . . . . . . . . Additions (deductions) $5,595 $ 8,733 $ 864 $7,395 $22,587 Provision for loan losses . . . . . . . . . . . . . . . . . . . . . Recoveries credited to allowance . . . . . . . . . . . . . . Loans charged against the allowance . . . . . . . . . . . (946) 2,889 (448) 457 734 (1,946) 462 999 (1,430) 1,530 — — 1,503 4,622 (3,824) Balance at end of period . . . . . . . . . . . . . . . . . . . . . . . $7,090 $ 7,978 $ 895 $8,925 $24,888 2017 Balance at beginning of period . . . . . . . . . . . . . . . . . . Additions (deductions) $4,880 $ 8,681 $ 1,011 $5,662 $20,234 Provision for loan losses . . . . . . . . . . . . . . . . . . . . . Recoveries credited to allowance . . . . . . . . . . . . . . Loans charged against the allowance . . . . . . . . . . . (327) 1,497 (455) (567) 1,741 (1,122) 360 967 (1,474) 1,733 — — 1,199 4,205 (3,051) Balance at end of period . . . . . . . . . . . . . . . . . . . . . . . $5,595 $ 8,733 $ 864 $7,395 $22,587 52 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS − (Continued) Allowance for loan losses and recorded investment in loans by portfolio segment at December 31 follows: Commercial Mortgage Installment (In thousands) Subjective Allocation Total 2019 Allowance for loan losses: Individually evaluated for impairment. . . . . . . . . . . $ Collectively evaluated for impairment. . . . . . . . . . . Loans acquired with deteriorated credit quality . . . 1,031 $ 6,891 — 4,863 $ 3,353 — 261 1,022 — $ — $ 8,727 — 6,155 19,993 — Total ending allowance for loan losses balance . . . . . $ 7,922 $ 8,216 $ 1,283 $8,727 $ 26,148 Loans Individually evaluated for impairment. . . . . . . . . . . $ Collectively evaluated for impairment. . . . . . . . . . . Loans acquired with deteriorated credit quality . . . 1,158,906 1,394 Total loans recorded investment. . . . . . . . . . . . . . . . . . Accrued interest included in recorded investment . . . 1,169,693 2,998 9,393 $ 43,574 $ 1,058,917 575 1,103,066 4,155 2,925 457,370 316 460,611 1,194 Total loans. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $1,166,695 $1,098,911 $459,417 55,892 $ 2,675,193 2,285 2,733,370 8,347 $2,725,023 2018 Allowance for loan losses: Individually evaluated for impairment. . . . . . . . . . . $ Collectively evaluated for impairment. . . . . . . . . . . Loans acquired with deteriorated credit quality . . . 1,305 $ 5,785 — 4,799 $ 3,179 — Total ending allowance for loan losses balance . . . . . $ 7,090 $ 7,978 $ 206 689 — 895 $ — $ 8,925 — 6,310 18,578 — $8,925 $ 24,888 Loans Individually evaluated for impairment. . . . . . . . . . . $ Collectively evaluated for impairment. . . . . . . . . . . Loans acquired with deteriorated credit quality . . . 1,137,586 1,609 Total loans recorded investment. . . . . . . . . . . . . . . . . . Accrued interest included in recorded investment . . . 1,147,892 3,411 8,697 $ 46,394 $ 1,000,038 555 1,046,987 4,097 3,370 392,460 349 396,179 1,030 Total loans. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $1,144,481 $1,042,890 $395,149 $ 58,461 2,530,084 2,513 2,591,058 8,538 $2,582,520 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 $0.4 million of interest income would have been recognized in each of the years ended 2019, 2018 and 2017. Interest income recorded on these loans was approximately zero during each of the years ended 2019, 2018 and 2017. 53 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(1): 2019 Commercial 90+ and Still Accruing Non- Accrual Total Non- Performing Loans (In thousands) Commercial and industrial(2) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Commercial real estate . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $— $ 565 735 — $ 565 735 Mortgage 1-4 family owner occupied - jumbo . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1-4 family owner occupied - non-jumbo(3). . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1-4 family non-owner occupied . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1-4 family - 2nd lien . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Resort lending . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Installment Boat lending . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Recreational vehicle lending . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Other. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . — — — — — — — — 1,179 3,540 1,039 979 690 332 3 470 1,179 3,540 1,039 979 690 332 3 470 Total recorded investment . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $— $9,532 $9,532 Accrued interest included in recorded investment . . . . . . . . . . . . . . . . . . . . . . . . . $— $ — $ — 2018 Commercial Commercial and industrial(2) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Commercial real estate . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $— $1,345 778 — $1,345 778 Mortgage 1-4 family owner occupied - jumbo . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1-4 family owner occupied - non-jumbo(3). . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1-4 family non-owner occupied . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1-4 family - 2nd lien . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Resort lending . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Installment Boat lending . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Recreational vehicle lending . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Other. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . — 5 — — — — — — 184 2,974 1,259 493 755 166 7 608 184 2,979 1,259 493 755 166 7 608 Total recorded investment . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 5 $8,569 $8,574 Accrued interest included in recorded investment . . . . . . . . . . . . . . . . . . . . . . . . . $— $ — $ — (1) Non-performing loans exclude purchase credit impaired loans. (2) Non-performing commercial and industrial loans exclude $0.077 million and $0.097 million of government guaranteed loans at December 31, 2019 and 2018, respectively. (3) Non-performing 1-4 family owner occupied – non jumbo loans exclude $0.569 million and $0.363 million of government guaranteed loans at December 31, 2019 and 2018, respectively. 54 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS − (Continued) An aging analysis of loans by class at December 31 follows: Loans Past Due 30-59 days 60-89 days 90+ days Total Loans not Past Due Total Loans (In thousands) 2019 Commercial Commercial and industrial . . . . . . . . . . . . . Commercial real estate. . . . . . . . . . . . . . . . $ — $ 289 — 177 $ 102 $ 735 391 $ 564,480 $ 564,871 604,822 912 603,910 Mortgage 1-4 family owner occupied - jumbo . . . . . 1-4 family owner occupied - non-jumbo. . 1-4 family non-owner occupied. . . . . . . . . 1-4 family - 2nd lien . . . . . . . . . . . . . . . . . Resort lending. . . . . . . . . . . . . . . . . . . . . . . Installment Boat lending . . . . . . . . . . . . . . . . . . . . . . . . Recreational vehicle lending . . . . . . . . . . . Other . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,757 2,672 695 909 364 337 161 377 1,037 852 136 90 53 107 97 275 — 2,794 4,911 1,454 1,385 982 1,387 623 386 565 88 3 202 532 261 854 398,759 342,349 168,083 115,157 67,192 202,750 153,184 103,030 401,553 347,260 169,537 116,542 68,174 203,282 153,445 103,884 Total recorded investment . . . . . . . . . . . $7,449 $2,936 $4,091 $14,476 $2,718,894 $2,733,370 Accrued interest included in recorded investment. . . . . . . . . . . . . . . . . . . . . . . . . . $ 74 $ 34 $ — $ 108 $ 8,239 $ 8,347 2018 Commercial Commercial and industrial . . . . . . . . . . . . . Commercial real estate. . . . . . . . . . . . . . . . $1,582 — Mortgage 1-4 family owner occupied - jumbo . . . . . 1-4 family owner occupied - non-jumbo. . 1-4 family non-owner occupied. . . . . . . . . 1-4 family - 2nd lien . . . . . . . . . . . . . . . . . Resort lending. . . . . . . . . . . . . . . . . . . . . . . Installment Boat lending . . . . . . . . . . . . . . . . . . . . . . . . Recreational vehicle lending . . . . . . . . . . . Other . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . — 1,519 265 446 252 316 28 552 $ — $ — $ 1,582 $ 580,935 $ 582,517 565,375 — 565,375 — — — 145 49 100 — 295 21 210 184 3,524 1,259 493 755 166 7 627 184 5,188 1,573 1,039 1,007 777 56 1,389 313,154 362,767 162,673 118,628 80,774 169,117 125,780 99,060 313,338 367,955 164,246 119,667 81,781 169,894 125,836 100,449 Total recorded investment . . . . . . . . . . . $4,960 $ 820 $7,015 $12,795 $2,578,263 $2,591,058 Accrued interest included in recorded investment. . . . . . . . . . . . . . . . . . . . . . . . . . $ 44 $ 11 $ — $ 55 $ 8,483 $ 8,538 55 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS − (Continued) Impaired loans are as follows: December 31, 2019 2018 (In thousands) Impaired loans with no allocated allowance for loan losses TDR . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ Non - TDR . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 337 $ — — 1,550 Impaired loans with an allocated allowance for loan losses TDR - allowance based on collateral . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . TDR - allowance based on present value cash flow . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Non - TDR - allowance based on collateral . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,587 48,798 3,365 2,787 53,258 2,145 Total impaired loans . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $55,637 $58,190 Amount of allowance for loan losses allocated TDR - allowance based on collateral . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ TDR - allowance based on present value cash flow . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Non - TDR - allowance based on collateral . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 542 $ 4,641 972 769 4,849 692 Total amount of allowance for loan losses allocated. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 6,155 $ 6,310 Impaired loans by class as of December 31 are as follows: 2019 Unpaid Principal Balance Recorded Investment Related Allowance for Loan Losses Recorded Investment (In thousands) 2018 Unpaid Principal Balance Related Allowance for Loan Losses With no related allowance for loan losses recorded: Commercial Commercial and industrial . . . . . . . . . . . . . Commercial real estate. . . . . . . . . . . . . . . . $ 257 796 $ 257 796 $— — $— — $ — — $— — Mortgage 1-4 family owner occupied - jumbo . . . . . 1-4 family owner occupied - non-jumbo. . 1-4 family non-owner occupied. . . . . . . . . 1-4 family - 2nd lien . . . . . . . . . . . . . . . . . Resort lending. . . . . . . . . . . . . . . . . . . . . . . Installment Boat lending . . . . . . . . . . . . . . . . . . . . . . . . Recreational vehicle lending . . . . . . . . . . . Other . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . — 212 214 407 — — — 1 — 217 366 438 — — — 41 1,887 2,115 — — — — — — — — — — 3 — — — — — 1 4 — 474 — — — 5 — 137 616 — — — — — — — — — 56 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS − (Continued) 2019 Unpaid Principal Balance Recorded Investment Related Allowance for Loan Losses Recorded Investment (In thousands) 2018 Unpaid Principal Balance Related Allowance for Loan Losses With an allowance for loan losses recorded: Commercial Commercial and industrial . . . . . . . . . . . . . Commercial real estate. . . . . . . . . . . . . . . . 1,655 6,685 1,706 6,661 Mortgage 1-4 family owner occupied - jumbo . . . . . 1-4 family owner occupied - non-jumbo. . 1-4 family non-owner occupied. . . . . . . . . 1-4 family - 2nd lien . . . . . . . . . . . . . . . . . Resort lending. . . . . . . . . . . . . . . . . . . . . . . Installment Boat lending . . . . . . . . . . . . . . . . . . . . . . . . Recreational vehicle lending . . . . . . . . . . . Other . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,447 10,163 4,962 14,059 12,110 — — 2,924 1,445 10,695 5,542 15,243 12,263 — — 3,153 453 578 91 1,031 572 1,695 1,474 — — 261 3,637 5,060 3,735 5,047 1,348 25,877 5,565 273 13,328 — 79 3,290 1,649 26,737 5,988 272 13,354 — 79 3,421 967 338 151 2,203 507 11 1,927 — 4 202 54,005 56,708 6,155 58,457 60,282 6,310 Total Commercial Commercial and industrial . . . . . . . . . . . . . Commercial real estate. . . . . . . . . . . . . . . . 1,912 7,481 1,963 7,457 Mortgage 1-4 family owner occupied - jumbo . . . . . 1-4 family owner occupied - non-jumbo. . 1-4 family non-owner occupied. . . . . . . . . 1-4 family - 2nd lien . . . . . . . . . . . . . . . . . Resort lending. . . . . . . . . . . . . . . . . . . . . . . Installment Boat lending . . . . . . . . . . . . . . . . . . . . . . . . Recreational vehicle lending . . . . . . . . . . . Other . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,447 10,375 5,176 14,466 12,110 — — 2,925 1,445 10,912 5,908 15,681 12,263 — — 3,194 453 578 91 1,031 572 1,695 1,474 — — 261 3,637 5,060 3,735 5,047 1,348 25,880 5,565 273 13,328 — 79 3,291 1,649 27,211 5,988 272 13,354 5 79 3,558 967 338 151 2,203 507 11 1,927 — 4 202 Total . . . . . . . . . . . . . . . . . . . . . . . . . . . . $55,892 $58,823 $6,155 $58,461 $60,898 $6,310 Accrued interest included in recorded investment. . . . . . . . . . . . . . . . . . . . . . . . . . $ 255 $ 271 57 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS − (Continued) Average recorded investment in and interest income earned (of which the majority of these amounts were received in cash and related primarily to performing TDR’s) on impaired loans by class for the years ended December 31 follows: 2019 2018 2017 Average Recorded Investment Interest Income Recognized Average Recorded Investment Interest Income Recognized Average Recorded Investment Interest Income Recognized (In thousands) With no related allowance for loan losses recorded: Commercial Commercial and industrial . . . . . . . . . . . . . Commercial real estate. . . . . . . . . . . . . . . . $ Mortgage 1-4 family owner occupied - jumbo . . . . . 1-4 family owner occupied - non-jumbo. . 1-4 family non-owner occupied. . . . . . . . . 1-4 family - 2nd lien . . . . . . . . . . . . . . . . . Resort lending. . . . . . . . . . . . . . . . . . . . . . . Installment Boat lending . . . . . . . . . . . . . . . . . . . . . . . . Recreational vehicle lending . . . . . . . . . . . Other . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 51 278 — 201 123 136 — — — — 789 With an allowance for loan losses recorded: Commercial Commercial and industrial . . . . . . . . . . . . . Commercial real estate. . . . . . . . . . . . . . . . 2,256 5,778 Mortgage 1-4 family owner occupied - jumbo . . . . . 1-4 family owner occupied - non-jumbo. . 1-4 family non-owner occupied. . . . . . . . . 1-4 family - 2nd lien . . . . . . . . . . . . . . . . . Resort lending. . . . . . . . . . . . . . . . . . . . . . . Installment Boat lending . . . . . . . . . . . . . . . . . . . . . . . . Recreational vehicle lending . . . . . . . . . . . Other . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 995 15,183 2,874 13,383 11,697 54 22 3,186 $ — $ 5 378 961 $ $ 751 183 $ 20 — — 27 — — — — — 11 58 127 288 69 1,408 314 12 606 — 4 224 — 52 — — — — — 1 987 3,298 7,242 2,425 31,468 5,362 306 16,383 1 100 4,335 22 — — 21 — — — — — 6 49 132 377 67 1,439 269 11 616 1 5 265 — — — 7 — — — 1 13 72 315 39 594 291 809 669 — — 189 41 15 — — — — — 1 1,396 2,641 5,199 1,335 28,183 5,475 284 14,687 1 84 3,640 55,428 2,978 61,529 3,052 70,920 3,182 58 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS − (Continued) 2019 2018 2017 Average Recorded Investment Interest Income Recognized Average Recorded Investment Interest Income Recognized Average Recorded Investment Interest Income Recognized (In thousands) Total Commercial Commercial and industrial . . . . . . . . . . . . . Commercial real estate. . . . . . . . . . . . . . . . 2,307 6,056 Mortgage 1-4 family owner occupied - jumbo . . . . . 1-4 family owner occupied - non-jumbo. . 1-4 family non-owner occupied. . . . . . . . . 1-4 family - 2nd lien . . . . . . . . . . . . . . . . . Resort lending. . . . . . . . . . . . . . . . . . . . . . . Installment Boat lending . . . . . . . . . . . . . . . . . . . . . . . . Recreational vehicle lending . . . . . . . . . . . Other . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 995 15,384 2,997 13,519 11,697 54 22 3,186 72 320 39 594 291 816 669 — — 190 3,019 6,160 1,376 28,198 5,475 284 14,687 1 84 3,641 147 288 69 1,435 314 12 606 — 4 235 4,049 7,425 2,425 31,520 5,362 306 16,383 1 100 4,336 154 377 67 1,460 269 11 616 1 5 271 Total . . . . . . . . . . . . . . . . . . . . . . . . . . . . $56,217 $2,991 $62,925 $3,110 $71,907 $3,231 Troubled debt restructurings at December 31 follow: Performing TDR’s. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Non-performing TDR’s(2) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Total . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $7,974 540 $8,514 $39,601 2,607(3) $47,575 3,147 $42,208 $50,722 Commercial 2019 Retail(1) Total (In thousands) Commercial 2018 Retail(1) Total (In thousands) Performing TDR’s. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Non-performing TDR’s(2) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Total . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $6,460 74 $6,534 $46,627 2,884(3) $53,087 2,958 $49,511 $56,045 (1) (2) Retail loans include mortgage and installment loan portfolio segments. 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. We have allocated $5.2 million and $5.6 million of specific reserves to customers whose loan terms have been modified in troubled debt restructurings as of December 31, 2019 and 2018, respectively. We have committed to lend additional amounts totaling up to $0.05 million and $0.04 million at December 31, 2019 and 2018, 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 a new loan 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 59 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS − (Continued) 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: Number of Contracts Pre-modification Recorded Balance Post-modification Recorded Balance (Dollars in thousands) 2019 Commercial Commercial and industrial . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Commercial real estate . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Mortgage 1-4 family owner occupied - jumbo . . . . . . . . . . . . . . . . . . . . . . . . 1-4 family owner occupied - non-jumbo . . . . . . . . . . . . . . . . . . . . . 1-4 family non-owner occupied . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1-4 family - 2nd lien . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Resort lending . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Installment Boat lending . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Recreational vehicle lending . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Other . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Total. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2018 Commercial Commercial and industrial . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Commercial real estate . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Mortgage 1-4 family owner occupied - jumbo . . . . . . . . . . . . . . . . . . . . . . . . 1-4 family owner occupied - non-jumbo . . . . . . . . . . . . . . . . . . . . . 1-4 family non-owner occupied . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1-4 family - 2nd lien . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Resort lending . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Installment Boat lending . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Recreational vehicle lending . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Other . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Total. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8 3 — 2 1 3 — — — 7 24 7 2 1 9 — — 1 — — 14 34 $1,609 1,479 $1,609 1,479 — 478 507 75 — — — 188 — 483 505 75 — — — 191 $4,336 $4,342 $ 652 204 $ 652 204 419 991 — — 115 — — 708 419 994 — — 114 — — 709 $3,089 $3,092 60 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS − (Continued) Number of Contracts Pre-modification Recorded Balance Post-modification Recorded Balance (Dollars in thousands) 2017 Commercial Commercial and industrial . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Commercial real estate . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Mortgage 1-4 family owner occupied - jumbo . . . . . . . . . . . . . . . . . . . . . . . . 1-4 family owner occupied - non-jumbo . . . . . . . . . . . . . . . . . . . . . 1-4 family non-owner occupied . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1-4 family - 2nd lien . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Resort lending . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Installment Boat lending . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Recreational vehicle lending . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Other . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Total. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 15 — — 5 1 — 1 — — 15 37 $ 925 — $ 925 — — 423 33 — 189 — — 551 — 429 33 — 189 — — 559 $2,121 $2,135 The troubled debt restructurings described above increased (decreased) the AFLL by $0.5 million, $(0.2) million and $0.1 million during the years ended December 31, 2019, 2018 and 2017, respectively and resulted in charge offs of zero during each of the years ended December 31, 2019, 2018 and 2017, 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: Recorded Number of Contracts Balance (Dollars in thousands) 2019 Commercial Commercial and industrial . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Commercial real estate. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Mortgage 1-4 family owner occupied - jumbo . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1-4 family owner occupied - non-jumbo. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1-4 family non-owner occupied. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1-4 family - 2nd lien . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Resort lending. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Installment Boat lending . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Recreational vehicle lending . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Other . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Total . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1 — — 1 — — — — — — 2 $19 — — 12 — — — — — — $31 61 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS − (Continued) Recorded Number of Balance Contracts (Dollars in thousands) 2018 Commercial Commercial and industrial . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Commercial real estate. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Mortgage 1-4 family owner occupied - jumbo . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1-4 family owner occupied - non-jumbo. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1-4 family non-owner occupied. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1-4 family - 2nd lien . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Resort lending. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Installment Boat lending . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Recreational vehicle lending . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Other . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Total . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2017 Commercial Commercial and industrial . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Commercial real estate. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Mortgage 1-4 family owner occupied - jumbo . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1-4 family owner occupied - non-jumbo. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1-4 family non-owner occupied. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1-4 family - 2nd lien . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Resort lending. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Installment Boat lending . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Recreational vehicle lending . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Other . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Total . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . — — — — — — — — — 1 1 6 — — — — — — — — 1 7 $ — — — — — — — — — 13 $ 13 $164 — — — — — — — — 13 $177 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 zero, zero and $0.04 million during the years ended December 31, 2019, 2018 and 2017, respectively and resulted in charge offs of zero, zero and $0.05 million during the years ended December 31, 2019, 2018 and 2017, respectively. The terms of certain other loans were modified during the years ending December 31, 2019, 2018 and 2017 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. 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. 62 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS − (Continued) Credit Quality Indicators – As part of our 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, and (d) 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. These ratings include 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. Our doubtful rating includes a sub classification for a loss rate other than 50% (which is the standard doubtful loss rate). These ratings include 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 portfolio segment at December 31: 2019 Non-watch 1-6 Watch 7-8 Commercial Substandard Accrual 9 (In thousands) Non- Accrual 10-11 Total Commercial and industrial. . . . . . . . . . . . . . . . . . . . Commercial real estate . . . . . . . . . . . . . . . . . . . . . . $ 515,955 580,516 $44,384 23,036 Total . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $1,096,471 $67,420 $3,967 535 $4,502 $ 565 735 $ 564,871 604,822 $1,300 $1,169,693 Accrued interest included in total . . . . . . . . . . . . . . $ 2,763 $ 205 $ 30 $ — $ 2,998 2018 Commercial and industrial. . . . . . . . . . . . . . . . . . . . Commercial real estate . . . . . . . . . . . . . . . . . . . . . . $ 551,441 531,069 $23,910 33,274 Total . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $1,082,510 $57,184 $5,577 200 $5,777 $1,589 832 $ 582,517 565,375 $2,421 $1,147,892 Accrued interest included in total . . . . . . . . . . . . . . $ 3,107 $ 174 $ 130 $ — $ 3,411 63 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS − (Continued) For each of our mortgage and installment portfolio 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 portfolio segments at December 31: Mortgage(1) 1-4 Family Owner Occupied - Jumbo 1-4 Family Owner Occupied - Non-jumbo 1-4 Family Non-owner Occupied 1-4 Family 2nd Lien Resort Lending Total (In thousands) 2019 800 and above. . . . . . . . . . . . . . . . . . . . 750-799 . . . . . . . . . . . . . . . . . . . . . . . . . 700-749 . . . . . . . . . . . . . . . . . . . . . . . . . 650-699 . . . . . . . . . . . . . . . . . . . . . . . . . 600-649 . . . . . . . . . . . . . . . . . . . . . . . . . 550-599 . . . . . . . . . . . . . . . . . . . . . . . . . 500-549 . . . . . . . . . . . . . . . . . . . . . . . . . Under 500 . . . . . . . . . . . . . . . . . . . . . . . Unknown . . . . . . . . . . . . . . . . . . . . . . . . Total. . . . . . . . . . . . . . . . . . . . . . . . . . $ 48,486 198,491 106,609 31,553 13,230 514 1,519 641 510 $401,553 $ 43,848 111,521 95,064 51,174 21,938 12,308 7,940 2,208 1,259 $347,260 $ 24,315 84,656 34,839 13,995 5,897 1,863 1,870 533 1,569 $169,537 $ 13,905 50,012 30,697 14,267 4,097 1,703 1,281 511 69 $116,542 $11,076 29,364 14,626 8,063 2,074 673 889 79 1,330 $68,174 $ 141,630 474,044 281,835 119,052 47,236 17,061 13,499 3,972 4,737 $1,103,066 Accrued interest included in total . . . . . . $ 1,139 $ 1,662 $ 586 $ 502 $ 266 $ 4,155 2018 800 and above. . . . . . . . . . . . . . . . . . . . 750-799 . . . . . . . . . . . . . . . . . . . . . . . . . 700-749 . . . . . . . . . . . . . . . . . . . . . . . . . 650-699 . . . . . . . . . . . . . . . . . . . . . . . . . 600-649 . . . . . . . . . . . . . . . . . . . . . . . . . 550-599 . . . . . . . . . . . . . . . . . . . . . . . . . 500-549 . . . . . . . . . . . . . . . . . . . . . . . . . Under 500 . . . . . . . . . . . . . . . . . . . . . . . Unknown . . . . . . . . . . . . . . . . . . . . . . . . Total. . . . . . . . . . . . . . . . . . . . . . . . . . $ 33,337 167,992 69,018 28,637 9,911 2,034 — 647 1,762 $313,338 $ 46,509 136,105 96,378 48,663 19,139 9,619 7,463 1,181 2,898 $367,955 $ 19,191 79,837 36,103 15,854 5,533 2,396 1,338 802 3,192 $164,246 $ 11,077 56,008 33,345 11,361 4,077 1,385 882 382 1,150 $119,667 $10,898 36,542 17,282 9,945 3,088 1,867 106 143 1,910 $81,781 $ 121,012 476,484 252,126 114,460 41,748 17,301 9,789 3,155 10,912 $1,046,987 Accrued interest included in total . . . . . . $ 851 $ 1,789 $ 550 $ 544 $ 363 $ 4,097 (1) Credit scores have been updated within the last twelve months. Installment(1) Boat Lending Recreational Vehicle Lending Other Total (In thousands) 2019 800 and above . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 750-799 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 700-749 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 650-699 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 600-649 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 550-599 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 500-549 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Under 500 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Unknown . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Total . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 28,041 118,380 41,490 11,485 2,254 946 377 309 — $203,282 $ 24,470 88,164 31,055 7,267 1,411 592 464 22 — $153,445 $ 7,611 $ 60,122 244,127 99,749 41,269 8,135 3,422 1,968 615 1,204 $103,884 $460,611 37,583 27,204 22,517 4,470 1,884 1,127 284 1,204 Accrued interest included in total . . . . . . . . . . . . . . . . . . . . . . . . . $ 490 $ 378 $ 326 $ 1,194 64 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS − (Continued) Installment(1) Boat Lending Recreational Vehicle Lending Other Total (In thousands) 2018 800 and above . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 750-799 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 700-749 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 650-699 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 600-649 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 550-599 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 500-549 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Under 500 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Unknown . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Total . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 20,767 100,191 35,455 10,581 1,657 652 286 266 39 $169,894 $ 20,197 74,154 24,890 4,918 992 453 225 7 — $125,836 $ 7,062 $ 48,026 208,972 87,978 28,162 7,668 3,360 1,775 548 9,690 $100,449 $396,179 34,627 27,633 12,663 5,019 2,255 1,264 275 9,651 Accrued interest included in total . . . . . . . . . . . . . . . . . . . . . . . . . $ 403 $ 311 $ 316 $ 1,030 (1) Credit scores have been updated within the last twelve months. 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: 2019 2018 (In thousands) Mortgage loans serviced for : Fannie Mae . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Freddie Mac . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Ginnie Mae . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . FHLB . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Other . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $1,449,935 852,123 180,941 69,149 29,018 $1,350,703 712,740 165,467 78,687 26,148 Total. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $2,581,166 $2,333,745 Custodial deposit accounts maintained in connection with mortgage loans serviced for others totaled $29.9 million and $22.0 million, at December 31, 2019 and 2018, 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 net gains on mortgage 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. 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 all loans serviced for others. 65 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS − (Continued) An analysis of capitalized mortgage loan servicing rights for the years ended December 31 follows: 2019 2018 (In thousands) 2017 Balance at beginning of period . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Change in accounting (see note #1). . . . . . . . . . . . . . . . . . . . . . . . . . . Balance at beginning of period, as adjusted . . . . . . . . . . . . . . . . . . . . . . Originated servicing rights capitalized. . . . . . . . . . . . . . . . . . . . . . . . . Servicing rights acquired . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Change in fair value due to price . . . . . . . . . . . . . . . . . . . . . . . . . . . . Change in fair value due to pay downs. . . . . . . . . . . . . . . . . . . . . . . . $ $ $ $ $ $ 21,400 — 21,400 7,303 — (6,408) (3,124) 15,699 — 15,699 4,977 3,047 191 (2,514) 13,671 542 14,213 4,230 — (718) (2,026) Balance at end of year . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 19,171 $ 21,400 $ 15,699 Loans sold and serviced that have had servicing rights capitalized. . . . $2,580,705 $2,333,081 $1,815,668 Fair value of capitalized mortgage loan servicing rights was determined using an average coupon rate of 4.22%, average servicing fee of 0.258%, average discount rate of 10.14% and an average Public Securities Association (‘‘PSA’’) prepayment rate of 250 for December 31, 2019; and average coupon rate of 4.23%, average servicing fee of 0.258%, average discount rate of 10.15% and an average PSA prepayment rate of 182 for December 31, 2018. Purchase Credit Impaired (‘‘PCI’’) Loans Loans acquired in a business combination are recorded at estimated fair value on their purchase date with no carryover of the related allowance for loan losses. In determining the estimated fair value of purchased loans, management considers a number of factors including, among others, the remaining life of the acquired loans, estimated prepayments, estimated loss ratios, estimated value of the underlying collateral, and net present value of cash flows expected to be received. Purchased loans are accounted for in accordance with guidance for certain loans acquired in a transfer (ASC 310-30), when the loans have evidence of credit deterioration since origination and it is probable at the date of acquisition that the acquirer will not collect all contractually required principal and interest payments. The difference between contractually required payments and the cash flows expected to be collected at acquisition is referred to as the non-accretable difference. Subsequent decreases to the expected cash flows will generally result in a provision for loan losses. Subsequent increases in expected cash flows will result in a reversal of the provision for loan losses to the extent of prior charges and then an adjustment to accretable yield, which would have a positive impact on interest income. As a result of our acquisition of TCSB Bancorp, Inc. (‘‘TCSB’’) (see note #26) we purchased loans for which there was, at acquisition, evidence of deterioration of credit quality since origination and it was probable, at acquisition, that all contractually required payments would not be collected. For these loans that meet the criteria of ASC 310-30 treatment, the carrying amount was as follows: Commercial . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Mortgage . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Installment . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Total carrying amount . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Allowance for loan losses. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . December 31, 2019 2018 (In thousands) $1,394 575 316 2,285 — $1,609 555 349 2,513 — Carrying amount, net of allowance for loan losses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $2,285 $2,513 66 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS − (Continued) The accretable difference on PCI loans is the difference between the expected cash flows and the net present value of expected cash flows with such difference accreted into earnings using the effective yield method over the term of the loans. Accretion recorded as loan interest income is included in the table below. Accretable yield of PCI loans, or income expected to be collected follows: Year ended December 31, 2019 2018 (In thousands) Balance at beginning of period. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . New loans purchased. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Accretion of income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Reclassification from (to) nonaccretable difference. . . . . . . . . . . . . . . . . . . . . . . . . . . . . Displosals/other adjustments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Balance at end of period . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 462 — (187) 365 — $ 640 $ — 568 (106) — — $ 462 NOTE 5 – OTHER REAL ESTATE A summary of other real estate activity for the years ended December 31 follows(1): Balance at beginning of year, net of valuation allowance . . . . . . . . . . . . . . . . . . . . . Loans transferred to other real estate . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Sales of other real estate . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Additions to valuation allowance charged to expense . . . . . . . . . . . . . . . . . . . . . . $ 1,178 2,242 (1,438) (267) $ 1,628 1,510 (1,822) (138) $ 4,956 1,735 (4,737) (326) Balance at end of year, net of valuation allowance . . . . . . . . . . . . . . . . . . . . . . . . . . $ 1,715 $ 1,178 $ 1,628 2019 2018 (In thousands) 2017 (1) Table excludes other repossessed assets totaling $0.15 million and $0.12 million at December 31, 2019 and 2018, respectively. 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: Balance at beginning of year. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Additions charged to expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Direct write-downs upon sale . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Balance at end of year. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2019 2018 (In thousands) 2017 $ 144 267 (319) $ 92 $ 123 138 (117) $ 144 $ 793 326 (996) $ 123 At both December 31, 2019 and 2018, the balance of other real estate includes $1.2 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 $0.7 million and $0.3 million at December 31, 2019 and 2018, respectively. Other real estate and repossessed assets totaling $1.9 million and $1.3 million at December 31, 2019 and 2018, respectively, are presented net of the valuation allowance on the Consolidated Statements of Financial Condition. 67 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS − (Continued) NOTE 6 – PROPERTY AND EQUIPMENT A summary of property and equipment at December 31 follows: Land and land improvements . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Buildings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Equipment . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Accumulated depreciation and amortization . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Property and equipment, net . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2019 2018 (In thousands) $ 17,478 57,363 71,194 146,035 (107,624) $ 38,411 $ 16,843 56,385 70,039 143,267 (104,490) $ 38,777 Depreciation expense was $5.2 million, $5.1 million and $5.3 million in 2019, 2018 and 2017, respectively. NOTE 7 – GOODWILL AND OTHER INTANGIBLES Intangible assets, net of amortization, at December 31 follows: 2019 2018 Gross Carrying Amount Accumulated Amortization Gross Carrying Amount Accumulated Amortization (In thousands) Amortized intangible assets - core deposits. . . . . . . . . . . . . . . . . . $11,916 $6,590 $11,916 $5,501 Unamortized intangible assets - goodwill . . . . . . . . . . . . . . . . . . . $28,300 $28,300 At December 31, 2019, the Bank (our reporting unit) had positive equity and we elected to perform a qualitative assessment to determine if it was more likely than not that the fair value of the Bank exceeds its carrying value, including goodwill. The qualitative assessment indicated that it was more likely than not that the fair value of the Bank exceeded its carrying value, resulting in no impairment. Intangible amortization expense was $1.1 million, $1.0 million and $0.3 million during the years ended 2019, 2018 and 2017, respectively. A summary of estimated core deposit intangible amortization at December 31, 2019, follows: (In thousands) 2020. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2021. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2022. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2023. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2024. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2025 and thereafter . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Total. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $1,020 970 785 547 516 1,488 $5,326 NOTE 8 – DEPOSITS A summary of interest expense on deposits for the years ended December 31 follows: Savings and interest-bearing checking . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Reciprocal. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Time . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Brokered time. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Total . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 5,371 6,024 7,148 4,882 $23,425 $ 4,146 1,292 5,343 3,697 $14,478 $1,530 342 4,288 615 $6,775 2019 2018 (In thousands) 2017 68 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS − (Continued) Aggregate time deposits in denominations of $0.25 million or more amounted to $71.5 million and $74.0 million at December 31, 2019 and 2018, respectively. A summary of the maturity of time deposits at December 31, 2019, follows: 2020. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2021. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2022. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2023. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2024. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2025 and thereafter . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $501,609 73,398 13,929 15,136 5,020 445 Total. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $609,537 (In thousands) Reciprocal 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: Demand . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Money market . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Time . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $383,953 4,416 42,658 $114,503 8,577 58,992 Total . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $431,027 $182,072 2019 2018 (In thousands) NOTE 9 – OTHER BORROWINGS A summary of other borrowings at December 31 follows: Advances from the FHLB. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Federal funds purchased . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Other . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Total . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2019 2018 (In thousands) $63,640 25,000 6 $88,646 $25,696 — 4 $25,700 Advances from the FHLB are secured by unencumbered qualifying mortgage and home equity loans with a market value equal to at least 132% to 165%, respectively, of outstanding advances. Advances are also secured by FHLB stock that we own, which totaled $8.6 million at December 31, 2019. Unused borrowing capacity with the FHLB (subject to the FHLB’s credit requirements and policies) was $836.5 million at December 31, 2019. Interest expense on advances amounted to $0.7 million, $1.0 million and $0.9 million for the years ended December 31, 2019, 2018 and 2017, respectively. No FHLB advances were terminated during 2019, 2018 or 2017. As a member of the FHLB, we must own FHLB stock equal to the greater of 0.75% of the unpaid principal balance of residential mortgage assets or 4.5% of our outstanding advances. At December 31, 2019, we were in compliance with the FHLB stock ownership requirements. 69 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS − (Continued) The maturity dates, weighted average interest rates and contractually required repayments of FHLB advances at December 31 follow: Fixed-rate advances 2019 2018 Amount Rate Amount (Dollars in thousands) Rate 2019. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2020. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2022. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2025 and thereafter . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Total advances. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $28,645 4,995 30,000 $63,640 $10,000 10,762 4,934 1.60% 3.18 1.69 2.19% 1.69 0.74 1.47% $25,696 2.28% Borrowings with the FRB at December 31, 2019 and 2018 were zero. Average borrowings with the FRB during the years ended December 31, 2019, 2018 and 2017 totaled $0.305 million, $0.003 million and $0.047 million. We had unused borrowing capacity with the FRB (subject to the FRB’s credit requirements and policies) of $348.6 million at December 31, 2019. Collateral for FRB borrowings are certain commercial and installment loans. Interest expense on federal funds purchased totaled $0.1 million for each of the years ended December 31, 2019, 2018 and 2017. Assets, consisting of FHLB stock and loans, pledged to secure other borrowings and unused borrowing capacity totaled $1.9 billion at December 31, 2019. 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 $38.2 million at both December 31, 2019 and 2018, 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. As a result of our acquisition of TCSB (see note #26) we acquired TCSB Statutory Trust I as summarized in the tables below at a discount. The discount at acquisition totaled $1.4 million and is being amortized through its maturity date and is included in interest expense – other borrowings and subordinated debentures in the Consolidated Statements of Operations. Summary information regarding subordinated debentures as of December 31 follows: Entity Name 2019 Issue Date Subordinated Debentures Trust Preferred Securities Issued Common Stock Issued IBC Capital Finance III. . . . . . . . . . . . . . . . . . . . . . . . . . . . . May 2007 IBC Capital Finance IV . . . . . . . . . . . . . . . . . . . . . . . . . . . . September 2007 Midwest Guaranty Trust I . . . . . . . . . . . . . . . . . . . . . . . . . . . November 2002 TCSB Statutory Trust I . . . . . . . . . . . . . . . . . . . . . . . . . . . . . March 2005 Discount on TCSB Statutory Trust I . . . . . . . . . . . . . . . . . . (In thousands) $12,372 15,465 7,732 5,155 (1,268) $12,000 15,000 7,500 5,000 (1,268) $39,456 $38,232 $ 372 465 232 155 — $1,224 70 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS − (Continued) Entity Name 2018 Issue Date Subordinated Debentures (In thousands) Trust Preferred Securities Issued Common Stock Issued IBC Capital Finance III. . . . . . . . . . . . . . . . . . . . . . . . . . . . . May 2007 IBC Capital Finance IV . . . . . . . . . . . . . . . . . . . . . . . . . . . . September 2007 Midwest Guaranty Trust I . . . . . . . . . . . . . . . . . . . . . . . . . . . November 2002 TCSB Statutory Trust I . . . . . . . . . . . . . . . . . . . . . . . . . . . . . March 2005 Discount on TCSB Statutory Trust I . . . . . . . . . . . . . . . . . . $12,372 15,465 7,732 5,155 (1,336) $12,000 15,000 7,500 5,000 (1,336) $39,388 $38,164 $ 372 465 232 155 — $1,224 Other key terms for the subordinated debentures and trust preferred securities that were outstanding at December 31, 2019 and 2018 follow: Entity Name Maturity Date Interest Rate First Permitted Redemption Date IBC Capital Finance III. . . . . IBC Capital Finance IV . . . . Midwest Guaranty Trust I . . . November 7, 2032 TCSB Statutory Trust I . . . . . March 17, 2035 July 30, 2037 September 15, 2037 3 month LIBOR plus 1.60% July 30, 2012 3 month LIBOR plus 2.85% September 15, 2012 3 month LIBOR plus 3.45% November 7, 2007 3 month LIBOR plus 2.20% March 17, 2010 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, 2019 and 2018. 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. Distributions (payment of interest) on the trust preferred securities are included in interest expense – other borrowings and subordinated debentures 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: Financial instruments whose risk is represented by contract amounts Commitments to extend credit. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Standby letters of credit . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $582,457 7,207 $505,421 4,998 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 2019 2018 (In thousands) 71 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS − (Continued) 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 on-demand with no stated maturity date and have variable rates that range from 3.75% to 10.75%. We are also involved in various litigation matters in the ordinary course of business. At the present time, we do not believe any of these 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 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 insignificant. However, because of a number of factors, including the fact that certain of these 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, however, 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. 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, Ginnie Mae and the FHLB). 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 of $0.23 million, $0.01 million and $0.17 million for the years ended December 31, 2019, 2018 and 2017, respectively. The reserve for loss reimbursements on sold mortgage loans totaled $0.9 million and $0.8 million at December 31, 2019 and 2018, 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. 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. We own 12,566 shares of VISA Class B common stock. At the present time, these shares can only be sold to other Class B shareholders. As a result, there has generally been limited transfer activity in private transactions between buyers and sellers. Given the limited activity that we have become aware of and the continuing uncertainty regarding the likelihood, ultimate timing and eventual exchange rate for Class B shares into Class A shares, we continue to carry these shares at zero, representing cost basis less impairment. However, given the current conversion ratio of 1.6228 to Class A shares and the closing price of VISA Class A shares on February 27, 2020 of $180.01 per share, our 12,566 Class B shares would have a current ‘‘value’’ of approximately $3.7 million. We continue to monitor Class B trading activity and the status of the resolution of certain litigation matters at VISA that would trigger the conversion of Class B common shares into Class A common shares that would have no trading restrictions. NOTE 12 – SHAREHOLDERS’ EQUITY AND INCOME PER COMMON SHARE In January, 2019, 2018 and 2017, 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. In addition, in June, 2019 our Board of Directors authorized a 300,000 share expansion of the 2019 repurchase plan. During 2019, 2018 and 2017 repurchases were made through open market and negotiated transactions and totaled 1,204,688, 587,969 and zero shares of common stock, respectively for an aggregate purchase price of $26.3 million, $12.7 million and zero, respectively. 72 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS − (Continued) A reconciliation of basic and diluted net income per common share for the years ended December 31 follows: 2019 2018 (In thousands, except per share amounts) 2017 Net income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $46,435 $39,839 $20,475 Weighted average shares outstanding(1) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Stock units for deferred compensation plan for non-employee directors . . Effect of stock options . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Performance share units . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 22,894 132 115 42 23,412 128 176 53 21,327 121 142 60 Weighted average shares outstanding for calculation of diluted earnings per share. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 23,183 23,769 21,650 Net income per common share . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Basic(1) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Diluted . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ $ 2.03 2.00 $ $ 1.70 1.68 $ 0.96 $ 0.95 (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 were zero for each year ended 2019, 2018 and 2017, respectively. NOTE 13 – INCOME TAX The composition of income tax expense for the years ended December 31 follows: Current expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Deferred expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Change in statutory rate . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Income tax expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2019 2018 (In thousands) 2017 $10,237 1,088 — $11,325 $ — 9,294 — $9,294 $ 1,927 10,071 5,965 $17,963 The deferred income tax expense of $1.1 million in 2019 can be primarily attributed to the utilization of our alternative minimum tax credit carryforward while the deferred income tax expense of $9.3 million during 2018 can be primarily attributed to the utilization of our net operating loss (‘‘NOL’’) carryfoward and alternative minimum tax credit carryforward while the deferred income tax expense of $10.1 million during 2017 can be primarily attributed to the utilization of our NOL carryfoward. On December 22, 2017, ‘‘H.R. 1’’, also known as the ‘‘Tax Cuts and Jobs Act’’, was signed into law. H.R.1, among other things, reduced the federal corporate income tax rate to 21% effective January 1, 2018. As a result, we concluded that our deferred tax assets, net had to be remeasured. Our deferred tax assets, net represents expected corporate tax benefits anticipated to be realized in the future. The reduction in the federal corporate income tax rate reduces these anticipated future benefits. The remeasurement of our deferred tax assets, net at December 31, 2017 resulted in a reduction of these net assets and a corresponding increase in income tax expense of $6.0 million that was recorded in the fourth quarter of 2017. 73 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS − (Continued) A reconciliation of income tax expense to the amount computed by applying the statutory federal income tax rate of 21% for 2019 and 2018 and 35% for 2017 to the income before income tax for the years ended December 31 follows: Statutory rate applied to income before income tax. . . . . . . . . . . . . . . . . . . . . Tax-exempt income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Bank owned life insurance. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Share-based compensation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Unrecognized tax benefit . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Non-deductible meals, entertainment and memberships. . . . . . . . . . . . . . . . . . Change in statutory rate . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Other, net . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2019 2018 (In thousands) 2017 $12,130 (375) (233) (204) (134) 86 — 55 $10,318 (383) (229) (367) (162) 85 — 32 $13,453 (777) (372) (287) (123) 64 5,965 40 Income tax expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $11,325 $ 9,294 $17,963 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: 2019 2018 (In thousands) Deferred tax assets Allowance for loan losses. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 5,355 $ 5,052 — Lease liabilities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,744 1,569 Property and equipment . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,528 900 Share-based compensation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 808 33 Unrealized loss on derivative financial instruments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 459 272 Reserve for unfunded lending commitments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 324 253 Deferred compensation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 285 165 Loss reimbursement on sold loans reserve . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 185 179 Non accrual loan interest income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 173 187 Other than temporary impairment charge on securities available for sale . . . . . . . . . . . . . . . . 147 38 Vehicle service contract counterparty contingency reserve . . . . . . . . . . . . . . . . . . . . . . . . . . . . 70 — 1,686 Alternative minimum tax credit carry forward . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,113 — Unrealized loss on securities available for sale . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 295 — Unrealized loss on equity securities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 71 — Purchase premiums, net . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 161 — Other . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Gross deferred tax assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11,046 12,006 Deferred tax liabilities Capitalized mortgage loan servicing rights . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Deferred loan fees. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Lease right of use asset . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Unrealized gain on securities available for sale . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Purchase premiums, net . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Federal Home Loan Bank stock. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Other . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Gross deferred tax liabilities. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4,026 1,852 1,739 994 293 27 43 8,974 4,494 1,706 — — — 27 — 6,227 Deferred tax assets, net. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 2,072 $ 5,779 74 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS − (Continued) 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, 2019 and 2018, that the realization of substantially all of our deferred tax assets continues to be more likely than not. Changes in unrecognized tax benefits for the years ended December 31 follow: Balance at beginning of year. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Additions based on tax positions related to the current year. . . . . . . . . . . . . . . . . Reductions due to the statute of limitations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Reductions due to settlements . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Balance at end of year. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2019 2018 (In thousands) 2017 $ 588 20 (170) — $ 438 $ 724 26 (162) — $ 588 $ 840 7 (123) — $ 724 If recognized, the entire amount of unrecognized tax benefits, net of $0.1 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, 2019, 2018 and 2017. No amounts were accrued for interest and penalties at December 31, 2019, 2018 and 2017. At December 31, 2019, U.S. Federal tax years 2016 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 0.5 million shares of common stock as of December 31, 2019. 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, 2019. 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 2019, 2018 and 2017 pursuant to our long-term incentive plan, we granted 0.06 million, 0.05 million and 0.05 million shares, respectively of restricted stock and 0.02 million, 0.02 million and 0.02 million performance stock units (‘‘PSUs’’), respectively to certain officers. Except for 0.010 million shares and 0.002 million shares of restricted stock issued in 2019 and 2018, respectively that vest ratably over three years, all shares of restricted stock and PSUs 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 vesting period starting on the grant date to the total shareholder return over that period for a banking index of our peers. We have not issued stock options since 2013, other than in connection with the Merger (see note #26). 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 on a current basis are issued each quarter and vest immediately. Shares issued on a deferred basis are credited at the rate of 90% of the current value and vest immediately. We issued 0.01 million shares to directors during each of the years ending 2019, 2018 and 2017 and expensed their value during those same periods. Total compensation expense recognized for grants pursuant to our long-term incentive plan was $1.6 million, $1.5 million and $1.6 million in 2019, 2018 and 2017, respectively. The corresponding tax benefit relating to this expense was $0.3 million, $0.3 million and $0.6 million in 2019, 2018 and 2017, respectively. Total expense recognized for non-employee director share based payments was $0.3 million, $0.2 million and $0.2 million in 2019, 2018 and 2017, respectively. The corresponding tax benefit relating to this expense was $0.05 million, $0.04 million and $0.06 million in 2019, 2018 and 2017, respectively. 75 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS − (Continued) At December 31, 2019, the total expected compensation cost related to non-vested restricted stock and PSUs not yet recognized was $2.1 million. The weighted-average period over which this amount will be recognized is 1.8 years. A summary of outstanding stock option grants and related transactions follows: Number of Shares Outstanding at January 1, 2019 . . . . . . . . . . . . . . . . . . . . . . . . . . . Granted . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Exercised . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Forfeited . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Expired . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 211,421 — (71,799) — (1,116) Weighted- Average Remaining Contractual Term (Years) Aggregated Intrinsic Value (In thousands) Average Exercise Price $ 6.48 9.84 22.35 Outstanding at December 31, 2019 . . . . . . . . . . . . . . . . . . . . . . . . 138,506 $ 4.62 3.01 $2,498 Vested and expected to vest at December 31, 2019 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 138,506 $ 4.62 Exercisable at December 31, 2019. . . . . . . . . . . . . . . . . . . . . . . . . 138,506 $ 4.62 3.01 3.01 $2,498 $2,498 A summary of outstanding non-vested stock and related transactions follows: Outstanding at January 1, 2019 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Granted. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Vested. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Forfeited. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Number of Shares 258,419 86,283 (85,978) (12,998) Outstanding at December 31, 2019 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 245,726 Certain information regarding options exercised during the periods ending December 31 follows: Weighted- Average Grant Date Fair Value $19.00 22.87 14.57 22.85 $21.72 Intrinsic value. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Cash proceeds received . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Tax benefit realized . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2019 $897 $706 $188 2018 (In thousands) $2,333 $1,420 $ 490 2017 $623 $142 $218 We maintain 401(k) and employee stock ownership plans covering substantially all of our full-time employees. During 2019, 2018 and 2017, we matched 50% of employee contributions to the 401(k) plan up to a maximum of 8%, 8% and 6% of participating employees’ eligible wages, respectively. 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 2019, 2018 and 2017. Amounts expensed for these retirement plans were $2.6 million, $2.3 million and $1.6 million in 2019, 2018 and 2017, respectively. Our employees participate in various performance-based compensation plans. Amounts expensed for all incentive plans totaled $9.5 million, $9.8 million and $8.0 million in 2019, 2018 and 2017, respectively. 76 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS − (Continued) We also provide certain health care and life insurance programs to substantially all full-time employees. Amounts expensed for these programs totaled $5.7 million, $5.2 million and $4.0 million in 2019, 2018 and 2017 respectively. These insurance programs are also available to retired employees at their own expense. NOTE 15 – OTHER NON-INTEREST INCOME Other non-interest income for the years ended December 31 follows: Investment and insurance commissions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . ATM fees . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Bank owned life insurance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Other. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Total other non-interest income. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2019 2018 (In thousands) 2017 $1,658 1,403 1,111 5,110 $9,282 $1,971 1,457 970 4,362 $8,760 $1,968 1,446 1,061 3,693 $8,168 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: 2019 Average Maturity (years) (Dollars in thousands) Notional Amount Fair Value Fair value hedge designation - Pay-fixed interest rate swap agreements . . . . . . . . . $ 7,117 9.4 $ (242) Cash flow hedge designation Pay-fixed interest rate swap agreements. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Interest rate cap agreements . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 25,000 150,000 Total . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $175,000 No hedge designation Rate-lock mortgage loan commitments. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Mandatory commitments to sell mortgage loans . . . . . . . . . . . . . . . . . . . . . . . . . . Pay-fixed interest rate swap agreements - commercial . . . . . . . . . . . . . . . . . . . . . Pay-variable interest rate swap agreements - commercial . . . . . . . . . . . . . . . . . . . Purchased options . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Written options. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 49,268 95,363 153,946 153,946 2,908 2,848 Total . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $458,279 1.6 2.6 2.5 0.1 0.1 5.5 5.5 1.5 1.5 3.7 $ (174) 214 $ 40 $ 1,412 (150) (3,641) 3,641 141 (139) $ 1,264 77 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS − (Continued) 2018 Average Maturity (years) Fair Value Notional Amount (Dollars in thousands) Cash flow hedge designation Pay-fixed interest rate swap agreements. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Interest rate cap agreements . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 25,000 150,000 Total . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $175,000 No hedge designation Rate-lock mortgage loan commitments. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Mandatory commitments to sell mortgage loans . . . . . . . . . . . . . . . . . . . . . . . . . . Pay-fixed interest rate swap agreements - commercial . . . . . . . . . . . . . . . . . . . . . Pay-variable interest rate swap agreements - commercial . . . . . . . . . . . . . . . . . . . Purchased options . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Written options. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 32,473 57,583 94,451 94,451 3,095 3,095 Total . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $285,148 2.6 3.6 3.5 0.1 0.1 5.5 5.5 2.5 2.5 3.7 $ 280 2,245 $2,525 $ 687 (383) 405 (405) 116 (116) $ 304 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. 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 and interest rate cap agreements. Pay-fixed interest rate swaps convert the variable-rate cash flows on debt obligations to fixed-rates. Under interest-rate cap agreements, we will receive cash if interest rates rise above a predetermined level. As a result, we effectively have variable-rate debt with an established maximum rate. We pay an upfront premium on interest rate caps which is recognized in earnings in the same period in which the hedged item affects earnings. Unrecognized premiums from interest rate caps aggregated to $2.2 million and $2.7 million at December 31, 2019 and 2018, respectively. It is anticipated that $0.05 million, net of tax, of unrealized losses on Cash Flow Hedges at December 31, 2019, will be reclassified into earnings over the next twelve months. The maximum term of any Cash Flow Hedge at December 31, 2019 is 3.8 years. Beginning in the second quarter of 2019 we entered into a pay-fixed interest rate swap to protect a portion of the fair value of a certain fixed rate commercial loan commitment (‘‘Fair Value Hedge’’). As a result, changes in the fair value of the pay-fixed interest rate swap is expected to offset changes in the fair value of the fixed rate commercial loan commitment due to fluctuations in interest rates. We record the fair value of Fair Value Hedges in accrued income and other assets and accrued expenses and other liabilities on our Consolidated Statements of Financial Condition. The hedged item (fixed rate commercial loan commitment) is also recorded at fair value which offsets the adjustment to the Fair Value Hedge. On an ongoing basis, we adjust our Consolidated Statements of Financial Condition to reflect the then current fair value of both the Fair Value Hedge and the hedged item. The related gains or losses are reported in non-interest income – other in our Consolidated Statements of Operations. 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 78 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS − (Continued) 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. In prior periods we offered to our deposit customers an equity linked time deposit product (‘‘Altitude CD’’). The Altitude CD was a time deposit that provided 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. We have 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 with no hedge designation in the table above relate to this program. 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 December 31, Liability Derivatives December 31, 2019 2018 Balance Sheet Location Fair Value Balance Sheet Location Fair Value 2019 Balance Sheet Location Fair Value 2018 Balance Sheet Location Fair Value (In thousands) Derivatives designated as hedging instruments Pay-fixed interest rate swap agreements . . . . . . Other assets $ — Other assets $ 280 Other liabilities $ 416 Other liabilities $ — Interest rate cap agreements . . . . . . . . . . Other assets 214 Other assets 2,245 Other liabilities — Other liabilities 214 2,525 416 — — Derivatives not designated as hedging instruments Rate-lock mortgage loan commitments . . . . . . . . . Other assets 1,412 Other assets 687 Other liabilities — Other liabilities — Mandatory commitments to sell mortgage loans. . . . . Other assets — Other assets — Other liabilities 150 Other liabilities 383 Pay-fixed interest rate swap agreements - commercial . . . . . . . . . . Other assets Pay-variable interest rate swap agreements - commercial . . . . . . . . . . Other assets Purchased options. . . . . . . . Other assets Written options . . . . . . . . . Other assets 28 Other assets 1,116 Other liabilities 3,669 Other liabilities 711 3,669 Other assets 141 Other assets — Other assets 711 Other liabilities 116 Other liabilities — Other liabilities 28 Other liabilities — Other liabilities 139 Other liabilities 1,116 — 116 2,326 $2,326 Total derivatives. . . . . . . 5,250 $5,464 2,630 $5,155 3,986 $4,402 79 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS − (Continued) The effect of derivative financial instruments on the Consolidated Statements of Operations follows: Year Ended December 31, Gain (loss) Recognized in Other Comprehensive Income (Loss) (Effective Portion) 2019 2018 2017 Location Gain (Loss) Reclassified from Accumulated Other Comprehensive Loss into Income (Effective Portion) Gain (Loss) Reclassified from Accumulated Other Comprehensive Loss into Income (Effective Portion) 2019 2018 2017 (In thousands) Location of Gain (Loss) Recognized in Income(1) Gain (Loss) Recognized in Income(1) 2019 2018 2017 Non-interest income- other $ (242) $ — $ — Fair Value Hedges Pay-fixed interest rate swap agreements . . . . Cash Flow Hedges Interest rate cap agreements . . . . . . . . $(1,211) $(340) $108 Pay-fixed interest rate swap agreements . . . . (392) 78 216 Interest expense Interest expense $363 $206 $ — 62 31 (18) Interest expense Interest expense $ — $ — $ — — (12) (12) Total . . . . . . . . . . . . . . $(1,603) $(262) $324 $425 $237 $(18) $ — $ (12) $ (12) No hedge designation Rate-lock mortgage loan commitments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Mandatory commitments to sell mortgage loans . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Pay-fixed interest rate swap agreements - commercial . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Pay-variable interest rate swap agreements -commercial. . . . . . . . . . . . . . . . . . . . . . . . . . . . . Purchased options . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Written options . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Net gains on mortgage loans Net gains on mortgage loans Interest income Interest income Interest expense Interest expense $ 725 $ 157 $(116) 233 (420) (593) (4,046) 113 43 4,046 (113) (43) 25 (206) 84 (23) 206 (84) Total . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 960 $(263) $(709) (1) For cash flow hedges, this location and amount refers to the ineffective portion. 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 2019 and 2018. A summary of loans to our directors and executive officers (which includes loans to entities in which the individual owns a 10% or more voting interest) for the years ended December 31 follows: Balance at beginning of year . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . New loans and advances . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Repayments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $14,205 713 (1,841) $ 2,621 13,572 (1,988) Balance at end of year . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $13,077 $14,205 Deposits held by us for directors and executive officers totaled $2.0 million and $1.5 million at December 31, 2019 and 2018, respectively. 2019 2018 (In thousands) 80 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS − (Continued) NOTE 18 – LEASES We have entered into leases in the normal course of business primarily for office facilities, some of which include renewal options and escalation clauses. Certain leases also include both lease components (fixed payments including rent, taxes and insurance costs) and non-lease components (common area or other maintenance costs) which are accounted for as a single lease component as we have elected the practical expedient to group lease and non-lease components together for all leases. We have also elected not to recognize leases with original lease terms of 12 months or less (short-term leases) on our Consolidated Statements of Financial Condition. Most of our leases include one or more options to renew. The exercise of lease renewal options is typically at our sole discretion and are included in our ROU assets and lease liabilities if they are reasonably certain of exercise. Leases are classified as operating or finance leases at the lease commencement date (we did not have any finance leases as of December 31, 2019). Lease expense for operating leases and short-term leases is recognized on a straight-line basis over the lease term. The ROU assets represent our right to use an underlying asset for the lease term and lease liabilities represent our obligation to make lease payments arising from the lease. ROU assets and lease liabilities are recognized at the lease commencement date based on the estimated present value of the lease payment over the lease term. As most of our leases do not provide an implicit rate, we use our incremental borrowing rate based on the information available at the lease commencement date in determining the present value of the lease payments. The cost components of our operating leases follows: Operating lease cost . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Variable lease cost . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Short-term lease cost . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Total. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2019 (In thousands) $2,217 142 19 $2,378 Variable lease costs consist primarily of taxes, insurance, and common area or other maintenance costs for our leased facilities. Supplemental balance sheet information related to our operating leases follows: Lease right of use asset(1). . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Lease liabilities(2) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $8,282 $8,304 Weighted average remaining lease term (years) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7.47 Weighted average discount rate . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2.8% 2019 (In thousands) (1) (2) Included in Accrued income and other assets in our Consolidated Statements of Financial Condition. Included in Accrued expenses and other liabilities in our Consolidated Statements of Financial Condition. 81 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS − (Continued) Maturity analysis of our lease liabilities at December 31, 2019 based on required contractual payments follows: 2020. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2021. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2022. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2023. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2024. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2025 and thereafter . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Total lease payments. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Less imputed interest . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $1,681 1,418 1,322 1,186 802 2,792 9,201 (897) Total. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $8,304 (In thousands) 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, 2019, include $1.010 billion of loans secured by residential real estate and $249.7 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, 2019: Lessors of Nonresidential Real Estate ($379.9 million); Lessors of Residential Real Estate ($142.0 million); Construction ($97.3 million); Accommodation and Food Services ($76.6 million); Manufacturing ($74.6 million) and Health Care and Social Assistance ($58.9 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, 2019, the Bank had positive undivided profits of $44.7 million. 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. In addition, capital adequacy rules include a common equity Tier 1 capital conservation buffer of 2.5% of risk-weighted assets that applies to all supervised financial institutions. To avoid limits on capital distributions and certain discretionary bonus payments we must meet the minimum ratio for adequately capitalized institutions plus the buffer. 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, 2019 and 2018, 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. 82 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS − (Continued) Our actual capital amounts and ratios at December 31 follow(1): Actual Amount Ratio Minimum for Adequately Capitalized Institutions Amount (Dollars in thousands) Ratio Minimum for Well-Capitalized Institutions Amount Ratio $380,454 358,914 13.74% 12.96 $221,562 221,482 8.00% 8.00 NA $276,852 NA 10.00% $352,764 331,224 12.74% 11.96 $166,171 166,111 6.00% 6.00 NA $221,482 NA 8.00% $314,532 331,224 11.36% 11.96 $124,628 124,583 4.50% 4.50 NA $179,954 NA 6.50% 2019 Total capital to risk-weighted assets Consolidated . . . . . . . . . . . . . . Independent Bank . . . . . . . . . . Tier 1 capital to risk-weighted assets Consolidated . . . . . . . . . . . . . . Independent Bank . . . . . . . . . . Common equity tier 1 capital to risk-weighted assets Consolidated . . . . . . . . . . . . . . Independent Bank . . . . . . . . . . Tier 1 capital to average assets Consolidated . . . . . . . . . . . . . . Independent Bank . . . . . . . . . . $352,764 331,224 10.11% 9.49 $139,632 139,615 4.00% 4.00 NA $174,519 NA 5.00% 2018 Total capital to risk-weighted assets Consolidated . . . . . . . . . . . . . . Independent Bank . . . . . . . . . . Tier 1 capital to risk-weighted assets Consolidated . . . . . . . . . . . . . . Independent Bank . . . . . . . . . . Common equity tier 1 capital to risk-weighted assets . . . . . . . . Consolidated . . . . . . . . . . . . . . Independent Bank . . . . . . . . . . Tier 1 capital to average assets $371,603 337,227 14.25% 12.94 $208,572 208,456 8.00% 8.00 NA $260,569 NA 10.00% $345,419 311,043 13.25% 11.94 $156,429 156,342 6.00% 6.00 NA $208,456 NA 8.00% $307,255 311,043 11.79% 11.94 $117,322 117,256 4.50% 4.50 NA $169,370 NA 6.50% Consolidated . . . . . . . . . . . . . . Independent Bank . . . . . . . . . . $345,419 311,043 10.47% 9.44 $131,930 131,778 4.00% 4.00 NA $164,723 NA 5.00% (1) These ratios do not reflect a capital conservation buffer of 2.50% and 1.875% at December 31, 2019 and 2018, respectively. NA - Not applicable 83 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS − (Continued) The components of our regulatory capital are as follows: Consolidated December 31, Independent Bank December 31, 2019 2018 2019 2018 (In thousands) Total shareholders’ equity. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $350,169 $338,994 $366,861 $341,496 Add (deduct) Accumulated other comprehensive loss for regulatory purposes. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Goodwill and other intangibles . . . . . . . . . . . . . . . . . . . . . . . Disallowed deferred tax assets . . . . . . . . . . . . . . . . . . . . . . . . Common equity tier 1 capital. . . . . . . . . . . . . . . . . . . . . . . Qualifying trust preferred securities . . . . . . . . . . . . . . . . . . . . Disallowed deferred tax assets . . . . . . . . . . . . . . . . . . . . . . . . Tier 1 capital . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Allowance for loan losses and allowance for unfunded lending commitments limited to 1.25% of total risk- weighted assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (2,011) (33,626) — 314,532 38,232 — 352,764 4,311 (34,715) (1,335) 307,255 38,164 — 345,419 (2,011) (33,626) — 331,224 — — 331,224 4,311 (34,715) (49) 311,043 — — 311,043 27,690 26,184 27,690 26,184 Total risk-based capital . . . . . . . . . . . . . . . . . . . . . . . . . . . . $380,454 $371,603 $358,914 $337,227 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 (equity securities at fair value or available for sale) are classified as Level 1 of the valuation hierarchy. Level 1 securities include certain preferred stocks included in our equity securities at fair value for which there are quoted prices in active markets (at December 31, 2018). 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 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 84 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS − (Continued) 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, carried at fair value is based on agency cash window loan pricing for comparable assets (recurring Level 2) and the fair value of mortgage loans held for sale, carried at the lower of cost or fair value is based on a quoted sales price (non-recurring Level 1). 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, 2019 and 2018, 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 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 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, or a member of our Collateral Evaluation Department (for commercial properties), or a member of our Special Assets/ORE Group (for residential 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 residential 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 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 is based on agency cash window loan pricing for comparable assets and the fair value of 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 and interest rate cap agreements are derived from proprietary models which utilize current market data. The significant 85 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS − (Continued) fair value inputs can 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 Quoted Prices in Active Markets for Identical Assets (Level 1) Significant Other Observable Inputs (Level 2) Significant Un- observable Inputs (Level 3) (In thousands) Fair Value Measure- ments December 31, 2019: Measured at Fair Value on a Recurring Basis Assets Securities available for sale U.S. agency . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . U.S. agency residential mortgage-backed . . . . . . . . . . . . . . . . . U.S. agency commercial mortgage-backed . . . . . . . . . . . . . . . . Private label mortgage-backed. . . . . . . . . . . . . . . . . . . . . . . . . Other asset backed . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Obligations of states and political subdivisions . . . . . . . . . . . . Corporate. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Trust preferred . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Foreign government . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Loans held for sale, carried at fair value . . . . . . . . . . . . . . . . . . . Capitalized mortgage loan servicing rights. . . . . . . . . . . . . . . . . . Derivatives(1) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Liabilities. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Derivatives(2) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 14,661 227,762 10,756 39,693 93,886 96,102 33,195 1,843 502 69,800 19,171 5,464 4,402 Measured at Fair Value on a Non-recurring Basis: Assets Impaired loans(3) Commercial Commercial and industrial . . . . . . . . . . . . . . . . . . . . . . . . . Commercial real estate . . . . . . . . . . . . . . . . . . . . . . . . . . . . Mortgage 1-4 family owner occupied - jumbo. . . . . . . . . . . . . . . . . . . 1-4 family owner occupied - non-jumbo . . . . . . . . . . . . . . . 1-4 family non-owner occupied. . . . . . . . . . . . . . . . . . . . . . 1-4 family - 2nd lien . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Resort lending . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Installment Boat lending . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Recreational vehicle lending . . . . . . . . . . . . . . . . . . . . . . . . Other . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Other real estate(4) Mortgage - 1-4 family owner occupied - non-jumbo . . . . . . Installment - other . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 655 316 987 470 281 294 245 67 2 121 31 28 $— — — — — — — — — — — — — — — — — — — — — — — — — $ 14,661 227,762 10,756 39,693 93,886 96,102 33,195 1,843 502 69,800 — 5,464 $ — — — — — — — — — — 19,171 — 4,402 — — — — — — — — — — — — — 655 316 987 470 281 294 245 67 2 121 31 28 (1) (2) Included in accrued income and other assets in the Consolidated Statements of Financial Condition. Included in accrued expenses and other liabilities in the Consolidated Statements of Financial Condition. (3) Only includes impaired loans with specific loss allocations based on collateral value. (4) Only includes other real estate with subsequent write downs to fair value. 86 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS − (Continued) December 31, 2018: Measured at Fair Value on a Recurring Basis Assets Equity securities at fair value . . . . . . . . . . . . . . . . . . . . . . . . . . Securities available for sale U.S. agency . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . U.S. agency residential mortgage-backed . . . . . . . . . . . . . . . U.S. agency commercial mortgage-backed . . . . . . . . . . . . . . Private label mortgage-backed . . . . . . . . . . . . . . . . . . . . . . . Other asset backed . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Obligations of states and political subdivisions. . . . . . . . . . . Corporate . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Trust preferred . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Foreign government . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Loans held for sale, carried at fair value . . . . . . . . . . . . . . . . . Capitalized mortgage loan servicing rights . . . . . . . . . . . . . . . . Derivatives(1) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 20,014 123,751 5,726 29,419 83,319 127,555 34,309 1,819 2,014 44,753 21,400 5,155 Liabilities Derivatives(2) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2,326 Fair Value Measurements Using Quoted Prices in Active Markets for Identical Assets (Level 1) Significant Other Observable Inputs (Level 2) Significant Un- observable Inputs (Level 3) (In thousands) Fair Value Measure- ments $ 393 $ 393 $ — $ — — — — — — — — — — — — — — 20,014 123,751 5,726 29,419 83,319 127,555 34,309 1,819 2,014 44,753 — 5,155 — — — — — — — — — — 21,400 — 2,326 — Measured at Fair Value on a Non-recurring Basis: Assets Loans held for sale, carried at the lower of cost or fair value . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 41,471 41,471 Impaired loans(3) Commercial Commercial and industrial . . . . . . . . . . . . . . . . . . . . . . . . Commercial real estate . . . . . . . . . . . . . . . . . . . . . . . . . . . 2,243 323 Mortgage 1-4 family owner occupied - non-jumbo. . . . . . . . . . . . . . 1-4 family non-owner occupied . . . . . . . . . . . . . . . . . . . . Resort lending. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Other real estate(4) Mortgage 1-4 family owner occupied - non-jumbo. . . . . . . . . . . . . . 1-4 family - 2nd lien . . . . . . . . . . . . . . . . . . . . . . . . . . . . 316 17 572 95 59 — — — — — — — — — — — — — — — — 2,243 323 316 17 572 95 59 (1) (2) Included in accrued income and other assets in the Consolidated Statements of Financial Condition. Included in accrued expenses and other liabilities in the Consolidated Statements of Financial Condition. (3) Only includes impaired loans with specific loss allocations based on collateral value. (4) 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, 2019 and 2018. 87 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS − (Continued) 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 Securities Mortgage Loans Mortgage Loan Servicing, net (In thousands) Total Change in Fair Values Included in Current Period Earnings 2019 Equity securities at fair value. . . . . . . . . . . . . . . . . . . . . . . . . . . Loans held for sale . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Capitalized mortgage loan servicing rights . . . . . . . . . . . . . . . . $167 — — 2018 Trading securities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Loans held for sale . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Capitalized mortgage loan servicing rights . . . . . . . . . . . . . . . . $ (62) — — 2017 Trading securities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Loans held for sale . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Capitalized mortgage loan servicing rights . . . . . . . . . . . . . . . . $ 45 — — $ — 637 — $ — 413 — $ — 407 — $ — — (9,532) $ 167 637 (9,532) $ — — (2,323) $ (62) 413 (2,323) $ — — (2,744) $ 45 407 (2,744) 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, 2019, 2018 and 2017 relating to assets measured at fair value on a non-recurring basis: • • Loans which are measured for impairment using the fair value of collateral for collateral dependent loans had a carrying amount of $3.4 million, which is net of a valuation allowance of $1.5 million at December 31, 2019, and had a carrying amount of $3.5 million, which is net of a valuation allowance of $1.5 million at December 31, 2018. An additional provision for loan losses relating to these impaired loans of $1.3 million, $1.3 million and $0.5 million was included in our results of operations for the years ending December 31, 2019, 2018 and 2017, respectively. Other real estate, which is measured using the fair value of the property, had a carrying amount of $0.06 million which is net of a valuation allowance of $0.09 million at December 31, 2019, and a carrying amount of $0.15 million which is net of a valuation allowance of $0.14 million, at December 31, 2018. An additional charge relating to other real estate measured at fair value of $0.03 million, $0.09 million and $0.08 million was included in our results of operations during the years ended December 31, 2019, 2018 and 2017, respectively. 88 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS − (Continued) A reconciliation for all assets and (liabilities) measured at fair value on a recurring basis using significant unobservable inputs (Level 3) for the years ended December 31 follows: Capitalized Mortgage Loan Servicing Rights 2018 (In thousands) 2017 2019 Beginning balance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Change in accounting . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $21,400 — $15,699 $ — — 14,213 Beginning balance, as adjusted . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 21,400 15,699 14,213 Total losses realized and unrealized: Included in results of operations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Included in other comprehensive income (loss) . . . . . . . . . . . . . . . . . . . . . . . . . Purchases, issuances, settlements, maturities and calls . . . . . . . . . . . . . . . . . . . . . Transfers in and/or out of Level 3 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (9,532) — 7,303 — (2,323) — 8,024 — (2,744) — 4,230 — Ending balance. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $19,171 $21,400 $15,699 Amount of total losses for the period included in earnings attributable to the change in unrealized losses relating to assets and liabilities still held at December 31 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ (9,532) $ (2,323) $ (2,744) The fair value of our capitalized mortgage loan servicing rights has been determined based on a valuation model used by an independent third party as discussed above. The significant unobservable inputs used in the fair value measurement of the capitalized mortgage loan servicing rights are discount rate, cost to service, ancillary income, float rate and prepayment rate. Significant changes in all five of these assumptions in isolation would result in significant changes to the value of our capitalized mortgage loan servicing rights. Quantitative information about our Level 3 fair value measurements measured on a recurring basis follows: Asset Fair Value (In thousands) Valuation Technique Unobservable Inputs Range Weighted Average 2019 Capitalized mortgage loan servicing rights . . . . . . . $19,171 2018 Capitalized mortgage loan servicing rights . . . . . . . $21,400 Present value of net servicing revenue Discount rate Cost to service Ancillary income Float rate Prepayment rate 10.00% to 13.00% $66 to $316 20 to 37 1.73% 7.01% to 69.34% Present value of net servicing revenue Discount rate Cost to service Ancillary income Float rate Prepayment rate 10.00% to 13.00% $68 to $216 20 to 36 2.57% 6.68% to 78.78% 10.14% $81 22 1.73% 14.96 10.15% $81 23 2.57% 10.54 89 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS − (Continued) Quantitative information about Level 3 fair value measurements measured on a non-recurring basis follows: Asset Fair Value (In thousands) Valuation Technique Unobservable Inputs Range Weighted Average 2019 Impaired loans Commercial . . . . . . . . . . . . . . $ 971 Mortgage and Installment(1) . . . 2,467 Other real estate Mortgage and Installment. . . . . 59 2018 Impaired loans Commercial(2). . . . . . . . . . . . . $2,566 Mortgage . . . . . . . . . . . . . . . . 905 Other real estate Mortgage . . . . . . . . . . . . . . . . 154 Sales comparison approach Sales comparison approach Sales comparison approach Sales comparison approach Sales comparison approach Sales comparison approach Adjustment for differences between comparable sales Adjustment for differences between comparable sales Adjustment for differences between comparable sales Adjustment for differences between comparable sales Adjustment for differences between comparable sales Adjustment for differences between comparable sales (48.0)% to 19.2% (5.6)% (25.2) to 49.2 11.5 (11.6) to 5.0 (5.1) (32.5)% to 60.0% (1.9)% (40.1) to 25.6 0.7 0.0 to 34.1 11.2 (1) (2) In addition to the valuation techniques and unobservable inputs discussed above, at December 31, 2019 certain impaired collateral dependent installment loans totaling approximately $0.14 million are secured by collateral other than real estate. For the majority of these loans, we apply internal discount rates to industry valuation guides. In addition to the valuation techniques and unobservable inputs discussed above, at December 31, 2018, we had an impaired collateral dependent commercial relationship that totaled $0.7 million that was secured by collateral other than real estate. Collateral securing this relationship primarily included accounts receivable, inventory and cash at December 31, 2018. Valuation techniques at December 31, 2018, included discounting financial statement values for each particular asset type. Discount rates used ranged from 20% to 80% of stated values at December 31, 2018. 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 Contractual Principal Difference (In thousands) Loans held for sale 2019 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2018 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2017 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $69,800 44,753 39,436 $1,894 1,257 844 $67,906 43,496 38,592 90 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS − (Continued) 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. The estimated recorded book balances and fair values at December 31 follow: Recorded Book Balance Fair Value Fair Value Using Quoted Prices in Active Markets for Identical Assets (Level 1) (In thousands) Significant Other Observable Inputs (Level 2) Significant Un- observable Inputs (Level 3) 2019 Assets Cash and due from banks . . . . . . . . . . . . . . . . . . . . $ Interest bearing deposits . . . . . . . . . . . . . . . . . . . . . Interest bearing deposits - time . . . . . . . . . . . . . . . . Securities available for sale . . . . . . . . . . . . . . . . . . . Federal Home Loan Bank and Federal Reserve Bank Stock . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Net loans and loans held for sale . . . . . . . . . . . . . . . Accrued interest receivable . . . . . . . . . . . . . . . . . . . Derivative financial instruments . . . . . . . . . . . . . . . . 53,295 $ 12,009 350 518,400 53,295 12,009 350 518,400 $ 53,295 12,009 — — $ — $ — 350 518,400 — — — — 18,359 2,768,675 10,108 5,464 NA 2,768,817 10,108 5,464 NA — 8 — NA 69,800 1,752 5,464 NA 2,699,017 8,348 — Liabilities Deposits with no stated maturity(1). . . . . . . . . . . . . . $2,427,190 $2,427,190 Deposits with stated maturity(1) . . . . . . . . . . . . . . . . 610,235 88,680 Other borrowings . . . . . . . . . . . . . . . . . . . . . . . . . . 33,149 Subordinated debentures . . . . . . . . . . . . . . . . . . . . . 1,296 Accrued interest payable . . . . . . . . . . . . . . . . . . . . . 4,402 Derivative financial instruments . . . . . . . . . . . . . . . . 609,537 88,646 39,456 1,296 4,402 $2,427,190 — — — 97 — — $ $ 610,235 88,680 33,149 1,199 4,402 2018 Assets Cash and due from banks . . . . . . . . . . . . . . . . . . . . $ Interest bearing deposits . . . . . . . . . . . . . . . . . . . . . Interest bearing deposits - time . . . . . . . . . . . . . . . . Equity securities at fair value. . . . . . . . . . . . . . . . . . Securities available for sale . . . . . . . . . . . . . . . . . . . Federal Home Loan Bank and Federal Reserve Bank Stock . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Net loans and loans held for sale . . . . . . . . . . . . . . . Accrued interest receivable . . . . . . . . . . . . . . . . . . . Derivative financial instruments . . . . . . . . . . . . . . . . $ 23,350 $ 46,894 595 393 427,926 23,350 46,894 594 393 427,926 18,359 2,643,856 10,164 5,155 NA 2,606,256 10,164 5,155 23,350 46,894 — 393 — NA 41,471 22 — Liabilities $ — $ — 594 — 427,926 NA 44,753 1,789 5,155 NA 2,520,032 8,353 — Deposits with no stated maturity(1). . . . . . . . . . . . . . $2,197,494 $2,197,494 Deposits with stated maturity(1) . . . . . . . . . . . . . . . . 711,312 25,706 Other borrowings . . . . . . . . . . . . . . . . . . . . . . . . . . 35,021 Subordinated debentures . . . . . . . . . . . . . . . . . . . . . 1,646 Accrued interest payable . . . . . . . . . . . . . . . . . . . . . 2,326 Derivative financial instruments . . . . . . . . . . . . . . . . 715,934 25,700 39,388 1,646 2,326 $2,197,494 — — — 114 — $ — $ 711,312 25,706 35,021 1,532 2,326 — — — — — — NA – Not applicable (1) Deposits with no stated maturity include reciprocal deposits with a recorded book balance of $388.369 million and $123.080 million at December 31, 2019 and 2018, respectively. Deposits with a stated maturity include reciprocal deposits with a recorded book balance of $42.658 million and $58.992 million at December 31, 2019 and 2018, respectively. 91 — — — — — — — — — — — 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 Gains (Losses) on Cash Flow Hedges Dispropor- tionate Tax Effects from Cash Flow Hedges Total 2019 Balances at beginning of period . . . . . . . . . . . . . . . . . . . . . $(4,185) $(5,798) $ (125) $ — $(10,108) Other comprehensive income (loss) before reclassifications . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Amounts reclassified from AOCL . . . . . . . . . . . . . . . . . . 8,035 (111) — — (1,266) (336) — — 6,769 (447) Net current period other comprehensive income (loss) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Balances at end of period . . . . . . . . . . . . . . . . . . . . . . . . . . 7,924 $ 3,739 — $(5,798) (1,602) $(1,727) — 6,322 $ — $ (3,786) 2018 Balances at beginning of period . . . . . . . . . . . . . . . . . . . . . Other comprehensive loss before reclassifications. . . . . . Amounts reclassified from AOCL . . . . . . . . . . . . . . . . . . Net current period other comprehensive loss. . . . . . . . Balances at end of period . . . . . . . . . . . . . . . . . . . . . . . . . . 2017 Balances at beginning of period . . . . . . . . . . . . . . . . . . . . . Cumulative effect of change in accounting . . . . . . . . . . . Balances at beginning of period, as adjusted. . . . . . . . . . . . Other comprehensive income before reclassifications . . . Amounts reclassified from AOCL . . . . . . . . . . . . . . . . . . Net current period other comprehensive income . . . . . Disproportionate tax effects due to change in tax rate . . Reclassification of certain deferred tax effects(1). . . . . . . Balances at end of period . . . . . . . . . . . . . . . . . . . . . . . . . . $ (470) (3,671) (44) (3,715) $(4,185) $(3,310) 300 (3,010) 2,763 (140) 2,623 (83) — $ (470) $(5,798) — — — $(5,798) $(5,798) — (5,798) — — — 83 (83) $(5,798) $ 269 (207) (187) (394) $ (125) $ — — — 210 12 222 47 — 269 $ $ — $ (5,999) (3,878) (231) (4,109) $ — $(10,108) — — — — — — — — (47) 47 $ — $ (9,108) 300 (8,808) 2,973 (128) 2,845 — (36) $ — $ (5,999) (1) Amounts reclassified to accumulated deficit due to adoption of ASU 2018-02, ‘‘Income Statement – Reporting Comprehensive Income (Topic 220), Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income’’ during the fourth quarter of 2017. The disproportionate tax effects from securities available for sale arose primarily 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 92 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS − (Continued) other categories must offset the current loss from operations, the tax benefit of such offset being reflected in operations. Release of material disproportionate tax effects from other comprehensive income to earnings is done by the portfolio method whereby the effects will remain in AOCL as long as we carry a more than inconsequential portfolio of securities available for sale. A summary of reclassifications out of each component of AOCL for the years ended December 31 follows: AOCL Component 2019 Unrealized gains (losses) on securities available for sale Unrealized gains (losses) on cash flow hedges 2018 Unrealized gains (losses) on securities available for sale Unrealized gains (losses) on cash flow hedges 2017 Unrealized gains (losses) on securities available for sale Unrealized gains (losses) on cash flow hedges Reclassified From AOCL (In thousands) Affected Line Item in Consolidated Statements of Operations Net gains on securities Net impairment loss recognized in earnings Total reclassifications before tax Income tax expense Reclassifications, net of tax Interest expense Income tax expense Reclassification, net of tax Total reclassifications for the period, net of tax Net gains on securities Net impairment loss recognized in earnings Total reclassifications before tax Income tax expense Reclassifications, net of tax Interest expense Income tax expense Reclassification, net of tax Total reclassifications for the period, net of tax Net gains on securities Net impairment loss recognized in earnings Total reclassifications before tax Income tax expense Reclassifications, net of tax Interest expense Income tax expense Reclassification, net of tax Total reclassifications for the period, net of tax $ 140 — 140 29 $ 111 $(425) (89) $(336) $ 447 $ 56 — 56 12 $ 44 $(237) (50) $(187) $ 231 $ 215 — 215 75 $ 140 $ 18 6 $ 12 $ 128 93 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, 2019 2018 (In thousands) ASSETS Cash and due from banks . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Interest bearing deposits - time. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Investment in subsidiaries . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Accrued income and other assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 10,505 10,000 369,861 463 $ 7,624 25,000 343,872 2,857 Total Assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $390,829 $379,353 LIABILITIES AND SHAREHOLDERS’ EQUITY Subordinated debentures . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Accrued expenses and other liabilities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Shareholders’ equity . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 39,456 575 350,798 $ 39,388 530 339,435 Total Liabilities and Shareholders’ Equity . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $390,829 $379,353 CONDENSED STATEMENTS OF OPERATIONS 2019 Year Ended December 31, 2018 (In thousands) 2017 OPERATING INCOME Dividends from subsidiary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Interest income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Other income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Total Operating Income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $29,000 230 61 29,291 $33,500 160 56 33,716 $16,000 29 41 16,070 OPERATING EXPENSES Interest expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Administrative and other expenses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Total Operating Expenses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Income Before Income Tax and Equity in Undistributed Net Income of Subsidiaries. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Income tax expense (benefit). . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Income Before Equity in Undistributed Net Income of Subsidiaries . . . Equity in undistributed net income of subsidiaries. . . . . . . . . . . . . . . . . . . . 2,104 655 2,759 26,532 (423) 26,955 19,480 1,924 748 2,672 31,044 (515) 31,559 8,280 1,347 714 2,061 14,009 1,587 12,422 8,053 Net Income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $46,435 $39,839 $20,475 94 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS − (Continued) CONDENSED STATEMENTS OF CASH FLOWS 2019 Year Ended December 31, 2018 (In thousands) 2017 Net Income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 46,435 $ 39,839 $ 20,475 ADJUSTMENTS TO RECONCILE NET INCOME TO NET CASH FROM OPERATING ACTIVITIES Deferred income tax expense. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Share based compensation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Accretion of discount on subordinated debentures . . . . . . . . . . . . . . . . . . . . (Increase) decrease in accrued income and other assets. . . . . . . . . . . . . . . . Increase in accrued expenses and other liabilities . . . . . . . . . . . . . . . . . . . . Equity in undistributed net income of subsidiaries. . . . . . . . . . . . . . . . . . . . Total Adjustments. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,503 65 68 891 45 (19,480) (16,908) 6,620 53 51 (1,307) 21 (8,280) (2,842) 2,146 45 — (32) 121 (8,053) (5,773) Net Cash From Operating Activities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 29,527 36,997 14,702 CASH FLOW FROM (USED IN) INVESTING ACTIVITIES Purchases of interest bearing deposits - time . . . . . . . . . . . . . . . . . . . . . . . . Maturity of interest bearing deposits - time . . . . . . . . . . . . . . . . . . . . . . . . . Acquisition of business, less cash received . . . . . . . . . . . . . . . . . . . . . . . . . (20,000) 35,000 — Net Cash From (Used In) Investing Activities . . . . . . . . . . . . . . . . . . . . . 15,000 (30,000) 10,000 431 (19,569) (10,000) 10,000 — — CASH FLOW USED IN FINANCING ACTIVITIES Dividends paid . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Proceeds from issuance of common stock . . . . . . . . . . . . . . . . . . . . . . . . . . Share based compensation withholding obligation . . . . . . . . . . . . . . . . . . . . Repurchase of common stock . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (16,554) 2,074 (882) (26,284) (14,055) 1,945 (1,467) (12,681) Net Cash Used in Financing Activities . . . . . . . . . . . . . . . . . . . . . . . . . . . (41,646) (26,258) Net Increase (Decrease) in Cash and Cash Equivalents. . . . . . . . . . . . . . Cash and Cash Equivalents at Beginning of Year . . . . . . . . . . . . . . . . . . . . . . 2,881 7,624 (8,830) 16,454 (8,960) 1,776 (579) — (7,763) 6,939 9,515 Cash and Cash Equivalents at End of Year . . . . . . . . . . . . . . . . . . . . . . . $ 10,505 $ 7,624 $ 16,454 NOTE 25 – REVENUE FROM CONTRACTS WITH CUSTOMERS We account for revenue in accordance with ASC Topic 606, Revenue from Contracts with Customers. We derive the majority of our revenue from financial instruments and their related contractual rights and obligations which for the most part are excluded from the scope of this topic. These sources of revenue that are excluded from the scope of this topic include interest income, net gains on mortgage loans, net gains on securities, mortgage loan servicing, net and bank owned life insurance and were approximately 84.9% and 82.9% of total revenues at December 31, 2019 and 2018, respectively. Material sources of revenue that are included in the scope of ASC Topic 606 include service charges on deposits, other deposit related income, interchange income and investment and insurance commissions and are discussed in the following paragraphs. Generally these sources of revenue are earned at the time the service is delivered or over the course of a monthly period and do not result in any contract asset or liability balance at any given period end. As a result, there were no contract assets or liabilities recorded as of December 31, 2019. Service charges on deposit accounts and other deposit related income: Revenues are earned on depository accounts for commercial and retail customers and include fees for transaction-based, account maintenance and overdraft services. Transaction-based fees, which includes services such as ATM use fees, stop payment charges and ACH fees are recognized at the time the transaction is executed as that is the time we fulfill our customer’s request. 95 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS − (Continued) Account maintenance fees, which includes monthly maintenance services are earned over the course of a month representing the period over which the performance obligation is satisfied. Our obligation for overdraft services is satisfied at the time of the overdraft. Interchange income: Interchange income primarily includes debit card interchange and network revenues. Debit card interchange and network revenues are earned on debit card transactions conducted through payment networks such as MasterCard and NYCE. Interchange income is recognized concurrently with the delivery of services on a daily basis. Interchange and network revenues are presented gross of interchange expenses, which are presented separately as a component of non-interest expense. Investment and insurance commissions: Investment and insurance commissions include fees and commissions from asset management, custody, recordkeeping, investment advisory and other services provided to our customers. Revenue is recognized on an accrual basis at the time the services are performed and are generally based on either the market value of the assets managed or the services provided. We have an agent relationship with a third party provider of these services and net certain direct costs charged by the third party provider associated with providing these services to our customers. Net gains on other real estate and repossessed assets: We record a gain or loss from the sale of other real estate when control of the property transfers to the buyer, which generally occurs at the time of an executed deed. If we were to finance the sale of other real estate to the buyer, we would assess whether the buyer is committed to perform their obligations under the contract and whether collectability of the transaction is probable. Once these criteria are met, the other real estate asset would be derecognized and the gain or loss on sale would be recorded upon the transfer of control of the property to the buyer. There were no other real estate properties sold during 2019 that were financed by us. 96 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS − (Continued) Disaggregation of our revenue sources by attribute for the years ended December 31 follow: 2019 Retail Service Charges on Deposit Accounts Overdraft fees . . . . . . . . . . . . . . . . . . . . . . . . . Account service charges. . . . . . . . . . . . . . . . . . ATM fees . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Other . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 7,590 2,103 — — Business Overdraft fees . . . . . . . . . . . . . . . . . . . . . . . . . ATM fees . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Other . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Interchange income . . . . . . . . . . . . . . . . . . . . . . . Asset management revenue . . . . . . . . . . . . . . . . . Transaction based revenue . . . . . . . . . . . . . . . . . . 1,515 — — — — — Other Deposit Related Income $ — — 1,368 965 — 35 422 — — — Investment and Insurance Commissions Interchange Income (In thousands) $ — — — — — — — 10,297 — — $ — — — — — — — — 1,123 535 Total $ 7,590 2,103 1,368 965 1,515 35 422 10,297 1,123 535 Total. . . . . . . . . . . . . . . . . . . . . . . . . . . . . $11,208 $2,790 $10,297 $1,658 $25,953 Reconciliation to Consolidated Statement of Operations: Non-interest income - other: Other deposit related income. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Investment and insurance commissions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Bank owned life insurance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Other . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Total . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $2,790 1,658 1,111 3,723 $9,282 2018 Retail Overdraft fees . . . . . . . . . . . . . . . . . . . . . . . . . Account service charges. . . . . . . . . . . . . . . . . . ATM fees . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Other . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Business Overdraft fees . . . . . . . . . . . . . . . . . . . . . . . . . ATM fees . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Other . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Interchange income . . . . . . . . . . . . . . . . . . . . . . . Asset management revenue . . . . . . . . . . . . . . . . . Transaction based revenue . . . . . . . . . . . . . . . . . . Service Charges on Deposit Accounts $ 8,285 2,406 — — 1,567 — — — — — Other Deposit Related Income $ — — 1,423 941 — 34 594 — — — Investment and Insurance Commissions Interchange Income (In thousands) $ — — — — — — — 9,905 — — $ — — — — — — — — 1,100 871 Total $ 8,285 2,406 1,423 941 1,567 34 594 9,905 1,100 871 Total. . . . . . . . . . . . . . . . . . . . . . . . . . . . . $12,258 $2,992 $9,905 $1,971 $27,126 Reconciliation to Consolidated Statement of Operations: Non-interest income - other: Other deposit related income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Investment and insurance commissions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Bank owned life insurance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Other . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Total . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $2,992 1,971 970 2,827 $8,760 97 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS − (Continued) NOTE 26 – RECENT ACQUISITION Effective April 1, 2018, we completed the acquisition of all of the issued and outstanding shares of common stock of TCSB through a merger of TCSB into Independent Bank Corporation (‘‘IBCP’’), with IBCP as the surviving corporation (the ‘‘Merger’’). On that same date we also consolidated Traverse City State Bank, TCSB’s wholly-owned subsidiary bank, into Independent Bank (with Independent Bank as the surviving institution). Under the terms of the merger agreement each holder of TCSB common stock received 1.1166 shares of IBCP common stock plus cash in lieu of fractional shares totaling $0.005 million. TCSB option holders had their options converted into IBCP stock options. As a result we issued 2.71 million shares of common stock and 0.19 million stock options with a fair value of approximately $64.5 million to the shareholders and option holders of TCSB. The fair value of common stock and stock options issued as the consideration paid for TCSB was determined using the closing price of our common stock on the acquisition date. This acquisition was accounted for under the acquisition method of accounting. Accordingly, we recognized amounts for identifiable assets acquired and liabilities assumed at their estimated acquisition date fair values. TCSB results of operations are included in our results beginning April 1, 2018. Non-interest expense includes zero, $3.5 million and $0.3 million of costs incurred during the years ended December 31, 2019, 2018 and 2017, respectively related to the Merger. The following table reflects our preliminary valuation of the assets acquired and liabilities assumed: Cash and cash equivalents . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Interest bearing deposits - time . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Securities available for sale . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Federal Home Loan Bank stock . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Loans, net . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Property and equipement, net. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Capitalized mortgage loan servicing rights . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Accrued income and other assets. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Other intangibles(1) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Total assets acquired. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Deposits. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Other borrowings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Subordinated debentures. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Accrued expenses and other liabilities. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Total liabilities assumed . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Net assets acquired . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Goodwill . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (In thousands) $ 23,521 4,054 6,066 778 295,799 1,067 3,047 3,362 5,798 343,492 287,710 14,345 3,768 1,429 307,252 36,240 28,300 Purchase price (fair value of consideration) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 64,540 (1) Relates to core deposit intangibles (see note #7). Management views the disclosed fair values presented above to be final as the one-year measurement period for finalizing acquisition-date fair values has expired. During this measurement period we had one adjustment to our acquisition date fair values. During the third quarter of 2018, goodwill was reduced by $0.7 million (to $28.3 million) related to the collection of a TCSB acquired loan that had been charged off in full prior to the Merger. Because of the status of the collection activities related to this loan at the time of the Merger, we determined that this transaction was a measurement period adjustment and reduced goodwill accordingly. Goodwill related to this acquisition will not be deductible for tax purposes and consists largely of synergies and cost savings resulting from the combining of the operations of TCSB into ours as well as expansion into a new market. 98 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS − (Continued) The estimated fair value of the core deposit intangible was $5.8 million and is being amortized over an estimated useful life of 10 years. The fair value of net assets acquired includes fair value adjustments to certain receivables that were not considered impaired as of the acquisition date. The fair value adjustments were determined using discounted contractual cash flows. However, we believe that all contractual cash flows related to these financial instruments will be collected. As such, these receivables were not considered impaired at the acquisition date and were not subject to the guidance relating to purchased credit impaired loans which have shown evidence of credit deterioration since origination. Receivables acquired that are not subject to these requirements included non-impaired customer receivables with a fair value and gross contractual amounts receivable of $292.9 million and $298.6 million on the date of acquisition. NOTE 27 – MEPCO 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, we sold our payment plan processing business, payment plan receivables, and certain other assets to Seabury, who also assumed certain liabilities of Mepco. This transaction closed on May 18, 2017, with an effective date of May 1, 2017. As a result of the closing, Mepco sold $33.1 million of net payment plan receivables, $0.5 million of commercial loans, $0.2 million of furniture and equipment and $1.6 million of other assets to Seabury, who also assumed $2.0 million of specified liabilities. We received cash totaling $33.4 million and recorded no gain or loss in 2017 as the assets were sold and the liabilities were assumed at book value. 99 A summary of selected quarterly results of operations for the years ended December 31 follows: QUARTERLY FINANCIAL DATA (UNAUDITED) Three Months Ended March 31, June 30, September 30, December 31, (In thousands, except per share amounts) 2019 Interest income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Net interest income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Provision for loan losses . . . . . . . . . . . . . . . . . . . . . . . . . . . . Income before income tax . . . . . . . . . . . . . . . . . . . . . . . . . . . Net income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $36,636 30,243 664 11,548 9,381 $37,573 30,756 652 13,417 10,730 $37,811 30,872 (271) 15,570 12,445 $36,908 30,710 (221) 17,225 13,879 Net income per common share Basic . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Diluted . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 0.40 0.39 0.47 0.46 0.55 0.55 0.62 0.61 2018 Interest income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Net interest income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Provision for loan losses . . . . . . . . . . . . . . . . . . . . . . . . . . . . Income before income tax . . . . . . . . . . . . . . . . . . . . . . . . . . . Net income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $26,797 23,936 315 11,199 9,161 $33,103 28,980 650 10,884 8,817 $34,452 29,697 (53) 14,846 11,925 $36,421 30,669 591 12,204 9,936 Net income per common share Basic . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Diluted . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 0.43 0.42 0.37 0.36 0.49 0.49 0.41 0.41 During the fourth quarter of 2019, we recognized a positive fair value adjustment due to price on our capitalized mortgage loan servicing rights of $0.6 million (see note #4). During the fourth quarter of 2018, we recognized a negative fair value adjustment due to price on our capitalized mortgage loan servicing rights of $2.4 million (see note #4). QUARTERLY SUMMARY (UNAUDITED) First quarter . . . . . . . . . . . . . . . . . . . Second quarter. . . . . . . . . . . . . . . . . Third quarter . . . . . . . . . . . . . . . . . . Fourth quarter . . . . . . . . . . . . . . . . . High $23.64 22.42 22.25 23.93 Reported Sales Prices of Common Shares 2018 2019 Low Low Close High Cash Dividends Declared Close 2019 2018 $20.40 20.60 18.94 20.40 $21.50 21.79 21.32 22.65 $24.50 27.10 26.65 25.13 $22.06 22.20 21.51 20.18 $22.90 25.50 23.65 21.02 $0.18 0.18 0.18 0.18 $0.15 0.15 0.15 0.15 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). 100 [THIS PAGE INTENTIONALLY LEFT BLANK] [THIS PAGE INTENTIONALLY LEFT BLANK] LETTER FROM THE PRESIDENT & CEO Dear Shareholders: It is my honor and pleasure to provide you with an update on Independent Bank Corporation (IBC). We continue to be focused on building shareholder value and position the Company to be successful in view of the opportunities and challenges within a marketplace with an accelerating rate of change. This starts with creating and maintaining a high performance culture with talented individuals who are highly engaged and work as a team to serve and guide our customers. This focus involves maintaining disciplined lending standards, a diversified earning asset mix, ample liquidity, continuous emphasis on growing our core deposit base, and strong capital levels. As a community bank, at the center of all our strategies is a focus on serving our customers and investing in our markets and in our people. During 2019, we committed over $1.7 billion in financing in our markets, we invested nearly $750,000 in sponsorships and donations, and our associates volunteered nearly 20,000 hours of time. Our customer base is growing, as is our brand. During 2019, we were recognized by Forbes for the second consecutive year as having the highest customer satisfaction for banks in Michigan. FINANCIAL RESULTS FOR 2019 – CONTINUED STRENGTH AND CONSISTENCY In 2019, we generated excellent growth in our earnings and earnings per share. For the year ended December 31, 2019, the Company reported net income of $46.4 million, or $2.00 per diluted share compared to net income of $39.8 million, or $1.68 per diluted share, in 2018. This represents increases of $6.6 million, or 17%, and 32 cents, or 19%, in net income and diluted earnings per share, respectively. For all of 2019, our pre-tax, pre-provision earnings increased by $7.9 million or 16% to $58.6 million, from $50.6 million in 2018. Over this same period, our tangible book value per share increased by 9%, to $14.08 per share from $12.90 per share at the end of 2018. As reflected in our balance sheet, our fundamentals continue to be strong. The growth in our earnings was fueled by strong loan growth and increased operating leverage. Loans, excluding loans held for sale, totaled $2.73 billion at December 31, 2019, an increase of 6% from $2.58 billion at December 31, 2018. For the year, our commercial loan portfolio increased by 2%, our consumer installment loan portfolio by 16% and our mortgage loan portfolio by 5%. We have now put together a string of 23 consecutive quarters of loan growth. I am also pleased to report that our investments in the mortgage banking business over the last few years continue to pay off for us with mortgage gains of almost $20 million and total originations in excess of $1 billion for the second time in our Company’s history. On the funding side, deposits totaled $3.04 billion at December 31, 2019, compared to $2.91 billion at December 31, 2018. The $123.3 million increase in total deposits during 2019 reflects growth in reciprocal deposits. At year-end 2019, our loan to deposit ratio was a healthy 90%, primarily unchanged from 89% at the prior year end, allowing capacity for additional growth. Our balance sheet is slightly asset sensitive, where generally we benefit from rising interest rates. On the credit quality front, our loan portfolio continues to perform well with past due loans continuing near historic lows. Non-performing loans at December 31, 2019, increased slightly to $9.5 million from $8.6 million at the prior year end. Other real estate and repossessed assets totaled just $1.9 million at December 31, 2 INDEPENDENT BANK CORPORATION SENIOR OFFICERS William B. Kessel Stephen A. Erickson James J. Twarozynski BOARD OF DIRECTORS1 Michael M. Magee, Jr., Chairman Michael J. Cok Ronia F. Kruse Terance L. Beia Stephen L. Gulis, Jr. Matthew J. Missad William J. Boer, Lead Director Christina L. Keller Joan A. Budden William B. Kessel INDEPENDENT BANK SENIOR OFFICERS William B. Kessel Cheryl A. Bartholic Martha A. Blandford Tami E. Coates Larry R. Daniel Stephen A. Erickson Patrick J. Ervin Susan M. Johnson Stefanie M. Kimball Keith J. Lightbody Dennis J. Mack Jamie L. Macumber Cheryl L. McKellar Edward W. Ryan Tricia L. Schabel Raymond P. Stecko Michael J. Stodolak Christopher S. Michaels James J. Twarozynski Dean M. Morse Kevin D. Pierce Joel F. Rahn Thomas J. Ranville Joane E. VanLuven Denise E. Wheaton 1Individuals listed also serve on the Board of Directors for Independent Bank. STOCK Independent Bank Corporation’s common stock trades on the NASDAQ Global Select Market System under the symbol IBCP. TRANSFER AGENT AND REGISTRAR Broadridge Corporate Issuer Solutions, Inc., P.O. Box 1342, Brentwood, New York 11717, shareholder.broadridge.com, (telephone 866.741.7930), serves as transfer agent and registrar of our common stock. Inquiries related to shareholder records and change of name, address or ownership of stock should be directed to our transfer agent and registrar. INVESTOR RELATIONS ON THE INTERNET Go to our website at IndependentBank.com to find the latest investor relations information about Independent Bank Corporation, including stock quotes, news releases and financial data. DIVIDEND REINVESTMENT AND DIRECT STOCK PURCHASES OR SALES Our Dividend Reinvestment & Direct Stock Purchase and Sale Plan is sponsored and administered by Broadridge Corporate Issuer Solutions, Inc., the transfer agent for Independent Bank Corporation. The plan materials are available at Stockplans.broadridge.com. FORM 10-K Shareholders may obtain, without charge, a copy of Form 10-K, the 2019 Annual Report to the Securities and Exchange Commission, through our website at IndependentBank. com or by writing to the Chief Financial Officer, Independent Bank Corporation, 4200 East Beltline, Grand Rapids, Michigan 49525 or by email at info@ibcp.com. 2019 Annual Report Our vision for the future is clear, 2020 ACTUALLY. Every bank will tell you they’re different, but at Independent Bank we know that YOU are. We help you discover what financial independence means to you. Then we help you get there. Be Bold. Be You. 

Continue reading text version or see original annual report in PDF format above