SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C.  20549

FORM 10-Q

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED June 30, 2015

Commission file number   0-7818
 
INDEPENDENT BANK CORPORATION  
 (Exact name of registrant as specified in its charter)

Michigan
 
38-2032782
(State or jurisdiction of Incorporation or Organization)
 
(I.R.S. Employer Identification Number)
 
4200 East Beltline, Grand Rapids, Michigan  49525
(Address of principal executive offices)

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

NONE
Former name, address and fiscal year, if changed since last report.
 
     Indicate by check mark whether the registrant (1) has filed all documents and reports required to be filed by Sections 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.          YES    ☒       NO    ☐
 
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).
YES    ☒      NO   ☐
 
Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, non-accelerated filer or smaller reporting company.
 
Large accelerated filer ☐
Accelerated filer ☒
Non-accelerated filer  ☐
Smaller reporting company ☐
 
Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
YES   ☐      NO   ☒                                                           

 
     Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date.  
 
Common stock, no par value
 
22,630,283
Class
 
Outstanding at August 4, 2015
 


INDEPENDENT BANK CORPORATION AND SUBSIDIARIES

INDEX

   
Number(s)
PART I -
Financial Information
 
Item 1.
3
 
4
 
5
 
6
 
7
 
8-60
Item 2.
61-86
Item 3.
87
Item 4.
87
     
PART II -
Other Information
 
Item 1A
88
Item 2.
88
Item 6.
89
 
1

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;
the failure of assumptions underlying our estimate of probable incurred losses from vehicle service contract payment plan counterparty contingencies, including our assumptions regarding future cancellations of vehicle service contracts, the value to us of collateral that may be available to recover funds due from our counterparties, and our ability to enforce the contractual obligations of our counterparties to pay amounts owing to us;
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, 2014, as updated by any new or modified risk factors disclosed in Part II – Item 1A of any subsequently filed Quarterly Report on Form 10-Q, include all known risks our management believes could materially affect the results described by forward-looking statements in this report. However, those risks may not be the only risks we face. Our results of operations, cash flows, financial position, and prospects could also be materially and adversely affected by additional factors that are not presently known to us that we currently consider to be immaterial, or that develop after the date of this report. We cannot assure you that our future results will meet expectations. While we believe the forward-looking statements in this report are reasonable, you should not place undue reliance on any forward-looking statement. In addition, these statements speak only as of the date made. We do not undertake, and expressly disclaim, any obligation to update or alter any statements, whether as a result of new information, future events, or otherwise, except as required by applicable law.
 
2

Part I - Item 1.

INDEPENDENT BANK CORPORATION AND SUBSIDIARIES
Condensed Consolidated Statements of Financial Condition

   
June 30,
2015
   
December 31,
2014
 
   
(unaudited)
 
   
(In thousands, except share amounts)
 
Assets
 
Cash and due from banks
 
$
44,272
   
$
48,326
 
Interest bearing deposits
   
14,045
     
25,690
 
Cash and Cash Equivalents
   
58,317
     
74,016
 
Interest bearing deposits - time
   
10,853
     
13,561
 
Trading securities
   
180
     
203
 
Securities available for sale
   
557,695
     
533,178
 
Federal Home Loan Bank and Federal Reserve Bank stock, at cost
   
15,146
     
19,919
 
Loans held for sale, carried at fair value
   
30,518
     
23,662
 
Loans
               
Commercial
   
711,007
     
690,955
 
Mortgage
   
469,662
     
472,628
 
Installment
   
228,761
     
206,378
 
Payment plan receivables
   
40,577
     
40,001
 
Total Loans
   
1,450,007
     
1,409,962
 
Allowance for loan losses
   
(24,586
)
   
(25,990
)
Net Loans
   
1,425,421
     
1,383,972
 
Other real estate and repossessed assets
   
4,471
     
6,454
 
Property and equipment, net
   
44,172
     
45,948
 
Bank-owned life insurance
   
54,300
     
53,625
 
Deferred tax assets, net
   
44,157
     
48,632
 
Capitalized mortgage loan servicing rights
   
12,535
     
12,106
 
Vehicle service contract counterparty receivables, net
   
7,273
     
7,237
 
Other intangibles
   
2,453
     
2,627
 
Accrued income and other assets
   
21,463
     
23,590
 
Total Assets
 
$
2,288,954
   
$
2,248,730
 
                 
Liabilities and Shareholders' Equity
 
Deposits
               
Non-interest bearing
 
$
617,126
   
$
576,882
 
Savings and interest-bearing checking
   
965,330
     
943,734
 
Reciprocal
   
49,015
     
53,668
 
Retail time
   
328,646
     
338,720
 
Brokered time
   
1,300
     
11,298
 
Total Deposits
   
1,961,417
     
1,924,302
 
Other borrowings
   
12,325
     
12,470
 
Subordinated debentures
   
35,569
     
35,569
 
Vehicle service contract counterparty payables
   
2,305
     
1,977
 
Accrued expenses and other liabilities
   
22,963
     
24,041
 
Total Liabilities
   
2,034,579
     
1,998,359
 
                 
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: 22,769,416 shares at June 30, 2015 and 22,957,323 shares at December 31, 2014
   
349,580
     
352,462
 
Accumulated deficit
   
(89,815
)
   
(96,455
)
Accumulated other comprehensive loss
   
(5,390
)
   
(5,636
)
Total Shareholders’ Equity
   
254,375
     
250,371
 
Total Liabilities and Shareholders’ Equity
 
$
2,288,954
   
$
2,248,730
 

See notes to interim condensed consolidated financial statements (unaudited)
 
3

INDEPENDENT BANK CORPORATION AND SUBSIDIARIES
Condensed Consolidated Statements of Operations

   
Three months ended June 30,
   
Six months ended June 30,
 
   
2015
   
2014
   
2015
   
2014
 
   
(unaudited)
   
(unaudited)
 
   
(In thousands, except per share amounts)
 
Interest Income
               
Interest and fees on loans
 
$
17,751
   
$
18,146
   
$
34,990
   
$
36,361
 
Interest on securities
                               
Taxable
   
1,869
     
1,596
     
3,627
     
2,979
 
Tax-exempt
   
222
     
287
     
439
     
549
 
Other investments
   
289
     
328
     
627
     
751
 
Total Interest Income
   
20,131
     
20,357
     
39,683
     
40,640
 
Interest Expense
                               
Deposits
   
967
     
1,260
     
1,974
     
2,553
 
Other borrowings
   
463
     
559
     
917
     
1,071
 
Total Interest Expense
   
1,430
     
1,819
     
2,891
     
3,624
 
Net Interest Income
   
18,701
     
18,538
     
36,792
     
37,016
 
Provision for loan losses
   
(134
)
   
(1,845
)
   
(793
)
   
(1,417
)
Net Interest Income After Provision for Loan Losses
   
18,835
     
20,383
     
37,585
     
38,433
 
Non-interest Income
                               
Service charges on deposit accounts
   
3,117
     
3,532
     
5,967
     
6,587
 
Interchange income
   
2,240
     
2,067
     
4,382
     
4,008
 
Net gains (losses) on assets
                               
Mortgage loans
   
1,784
     
1,505
     
3,923
     
2,649
 
Securities
   
(33
)
   
54
     
52
     
166
 
Mortgage loan servicing
   
1,452
     
193
     
1,032
     
457
 
Title insurance fees
   
337
     
217
     
593
     
491
 
Other
   
2,090
     
2,508
     
4,000
     
4,673
 
Total Non-interest Income
   
10,987
     
10,076
     
19,949
     
19,031
 
Non-Interest Expense
                               
Compensation and employee benefits
   
11,791
     
11,818
     
23,576
     
23,056
 
Occupancy, net
   
2,040
     
2,153
     
4,459
     
4,636
 
Data processing
   
2,027
     
1,777
     
3,957
     
3,863
 
Loan and collection
   
967
     
1,427
     
2,122
     
2,892
 
Furniture, fixtures and equipment
   
965
     
1,053
     
1,917
     
2,122
 
Communications
   
694
     
711
     
1,430
     
1,500
 
Advertising
   
448
     
601
     
932
     
1,120
 
Legal and professional
   
453
     
420
     
833
     
821
 
FDIC deposit insurance
   
351
     
422
     
694
     
839
 
Interchange expense
   
289
     
342
     
580
     
744
 
Credit card and bank service fees
   
203
     
245
     
405
     
508
 
Vehicle service contract counterparty contingencies
   
30
     
73
     
59
     
141
 
Costs related to unfunded lending commitments
   
4
     
5
     
20
     
15
 
Provision for loss reimbursement on sold loans
   
45
     
15
     
(24
)
   
(466
)
Net gain on other real estate and repossessed assets
   
(139
)
   
(38
)
   
(178
)
   
(125
)
Other
   
1,411
     
1,536
     
2,948
     
3,294
 
Total Non-interest Expense
   
21,579
     
22,560
     
43,730
     
44,960
 
Income Before Income Tax
   
8,243
     
7,899
     
13,804
     
12,504
 
Income tax expense
   
2,624
     
1,847
     
4,404
     
3,314
 
Net Income
 
$
5,619
   
$
6,052
   
$
9,400
   
$
9,190
 
Net Income Per Common Share
                               
Basic
 
$
0.25
   
$
0.26
   
$
0.41
   
$
0.40
 
Diluted
 
$
0.24
   
$
0.26
   
$
0.40
   
$
0.39
 
Dividends Per Common Share
                               
Declared
 
$
0.06
   
$
0.06
   
$
0.12
   
$
0.06
 
Paid
 
$
0.06
   
$
0.06
   
$
0.12
   
$
0.06
 

See notes to interim condensed consolidated financial statements (unaudited)
 
4

INDEPENDENT BANK CORPORATION AND SUBSIDIARIES
Condensed Consolidated Statements of Comprehensive Income

   
Three months ended
June 30,
   
Six months ended
June 30,
 
   
2015
   
2014
   
2015
   
2014
 
   
(unaudited)
   
(unaudited)
 
   
(In thousands)
 
                 
Net income
 
$
5,619
   
$
6,052
   
$
9,400
   
$
9,190
 
Other comprehensive income, before tax
                               
Available for sale securities
                               
Unrealized gains (losses) arising during period
   
(1,806
)
   
1,759
     
464
     
4,009
 
Change in unrealized gains (losses) for which a portion of other than temporary impairment has been recognized in earnings
   
(21
)
   
219
     
(10
)
   
338
 
Reclassification adjustments for gains included in earnings
   
-
     
(2
)
   
(75
)
   
(2
)
Unrealized gains (losses) recognized in other comprehensive income on available for sale securities
   
(1,827
)
   
1,976
     
379
     
4,345
 
Income tax expense (benefit)
   
(639
)
   
691
     
133
     
1,521
 
Unrealized gains (losses) recognized in other comprehensive income on available for sale securities, net of tax
   
(1,188
)
   
1,285
     
246
     
2,824
 
Derivative instruments
                               
Reclassification adjustment for accretion on settled derivatives
   
-
     
95
     
-
     
190
 
Unrealized gains recognized in other comprehensive  income on derivative instruments
   
-
     
95
     
-
     
190
 
Income tax expense
   
-
     
34
     
-
     
67
 
Unrealized gains recognized in other comprehensive  income on derivative instruments, net of tax
   
-
     
61
     
-
     
123
 
Other comprehensive income (loss)
   
(1,188
)
   
1,346
     
246
     
2,947
 
Comprehensive income
 
$
4,431
   
$
7,398
   
$
9,646
   
$
12,137
 

See notes to interim condensed consolidated financial statements (unaudited)
 
5

INDEPENDENT BANK CORPORATION AND SUBSIDIARIES
Condensed Consolidated Statements of Cash Flows

   
Six months ended June 30,
 
   
2015
   
2014
 
   
(unaudited - In thousands)
 
Net Income
 
$
9,400
   
$
9,190
 
Adjustments to Reconcile Net Income to Net Cash From Operating Activities
               
Proceeds from sales of loans held for sale
   
154,938
     
96,384
 
Disbursements for loans held for sale
   
(157,871
)
   
(96,544
)
Provision for loan losses
   
(793
)
   
(1,417
)
Deferred federal income tax expense
   
4,475
     
4,874
 
Deferred loan fees
   
(930
)
   
(526
)
Depreciation, amortization of intangible assets and premiums and accretion of discounts on securities and loans
   
2,228
     
1,019
 
Net gains on mortgage loans
   
(3,923
)
   
(2,649
)
Net gains on securities
   
(52
)
   
(166
)
Net gains on other real estate and repossessed assets
   
(178
)
   
(125
)
Vehicle service contract counterparty contingencies
   
59
     
141
 
Share based compensation
   
772
     
581
 
Decrease in accrued income and other assets
   
551
     
511
 
Decrease in accrued expenses and other liabilities
   
(894
)
   
(3,115
)
Total Adjustments
   
(1,618
)
   
(1,032
)
Net Cash From Operating Activities
   
7,782
     
8,158
 
Cash Flow Used in Investing Activities
               
Proceeds from the sale of securities available for sale
   
11,786
     
5,126
 
Proceeds from the maturity of securities available for sale
   
16,047
     
39,579
 
Principal payments received on securities available for sale
   
58,587
     
38,891
 
Purchases of securities available for sale
   
(111,908
)
   
(136,127
)
Purchases of interest bearing deposits
   
(245
)
   
-
 
Proceeds from the maturity of interest bearing deposits
   
2,915
     
2,593
 
Purchase of Federal Reserve Bank stock
   
(132
)
   
-
 
Redemption of Federal Reserve Bank stock
   
391
     
5
 
Redemption of Federal Home Loan Bank stock
   
4,514
     
-
 
Net increase in portfolio loans (loans originated, net of principal payments)
   
(39,442
)
   
(3,712
)
Proceeds from the collection of vehicle service contract counterparty receivables
   
15
     
327
 
Proceeds from the sale of other real estate and repossessed assets
   
4,515
     
2,870
 
Proceeds from the sale of property and equipment
   
490
     
-
 
Capital expenditures
   
(1,898
)
   
(1,606
)
Net Cash Used in Investing Activities
   
(54,365
)
   
(52,054
)
Cash Flow From Financing Activities
               
Net increase in total deposits
   
37,115
     
23,265
 
Net increase (decrease) in other borrowings
   
(1
)
   
13,799
 
Payments of Federal Home Loan Bank advances
   
(144
)
   
(4,373
)
Net increase (decrease) in vehicle service contract counterparty payables
   
328
     
(1,001
)
Dividends paid
   
(2,760
)
   
(1,375
)
Proceeds from issuance of common stock
   
80
     
37
 
Repurchase of common stock
   
(3,668
)
   
-
 
Share based compensation withholding obligation
   
(66
)
   
-
 
Net Cash From Financing Activities
   
30,884
     
30,352
 
Net Decrease in Cash and Cash Equivalents
   
(15,699
)
   
(13,544
)
Cash and Cash Equivalents at Beginning of Period
   
74,016
     
119,081
 
Cash and Cash Equivalents at End of Period
 
$
58,317
   
$
105,537
 
Cash paid during the period for
               
Interest
 
$
2,878
   
$
3,659
 
Income taxes
   
91
     
5
 
Transfers to other real estate and repossessed assets
   
2,354
     
2,584
 
Transfer of payment plan receivables to vehicle service contract counterparty receivables
   
110
     
297
 
 
See notes to interim condensed consolidated financial statements (unaudited)
 
6

INDEPENDENT BANK CORPORATION AND SUBSIDIARIES
Condensed Consolidated Statements of Shareholders' Equity

   
Six months ended
June 30,
 
   
2015
   
2014
 
   
(unaudited)
 
   
(In thousands)
 
         
Balance at beginning of period
 
$
250,371
   
$
231,581
 
Net income
   
9,400
     
9,190
 
Cash dividends declared
   
(2,760
)
   
(1,375
)
Issuance of common stock
   
80
     
37
 
Share based compensation
   
772
     
581
 
Share based compensation withholding obligation
   
(66
)
   
-
 
Repurchase of common stock
   
(3,668
)
   
-
 
Net change in accumulated other comprehensive loss, net of related tax effect
   
246
     
2,947
 
Balance at end of period
 
$
254,375
   
$
242,961
 

See notes to interim condensed consolidated financial statements (unaudited)
 
7

NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)

1. Preparation of Financial Statements

The condensed consolidated financial statements have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission. Certain information and note disclosures normally included in annual financial statements prepared in accordance with U.S. generally accepted accounting principles (“GAAP”) have been condensed or omitted pursuant to those rules and regulations, although we believe that the disclosures made are adequate to make the information not misleading.  The unaudited condensed consolidated financial statements should be read in conjunction with the audited consolidated financial statements and notes for the year ended December 31, 2014 included in our Annual Report on Form 10-K.

In our opinion, the accompanying unaudited condensed consolidated financial statements contain all the adjustments necessary to present fairly our consolidated financial condition as of June 30, 2015 and December 31, 2014, and the results of operations for the three and six-month periods ended June 30, 2015 and 2014.  The results of operations for the three and six-month periods ended June 30, 2015, are not necessarily indicative of the results to be expected for the full year.  Certain reclassifications have been made in the prior period financial statements to conform to the current period presentation.  Our critical accounting policies include the assessment for other than temporary impairment (“OTTI”) on investment securities,  the determination of the allowance for loan losses, the determination of vehicle service contract counterparty contingencies, the valuation of originated mortgage loan servicing rights and the valuation of deferred tax assets.  Refer to our 2014 Annual Report on Form 10-K for a disclosure of our accounting policies.

2. New Accounting Standards

In January 2014, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2014-04, “Reclassification of Residential Real Estate Collateralized Consumer Mortgage Loans upon Foreclosure”. The amendments in this ASU clarify that an in substance repossession or foreclosure occurs, and a creditor is considered to have received physical possession of residential real estate property collateralizing a consumer mortgage loan, upon either (1) the creditor obtaining legal title to the residential real estate property upon completion of a foreclosure or (2) the borrower conveying all interest in the residential real estate property to the creditor to satisfy that loan through completion of a deed in lieu of foreclosure or through a similar legal agreement. This amendment is effective for fiscal years, and interim periods within those years, beginning after December 15, 2014, with early adoption and retrospective or prospective application permitted.  This amended guidance became effective for us on January 1, 2015, and did not have a material impact on our consolidated operating results or financial condition.

In May 2014, the FASB issued ASU 2014-09, “Revenue from Contracts with Customers (Topic 606)”. This ASU supersedes and replaces nearly all existing revenue recognition guidance, including industry-specific guidance, establishes a new control-based revenue recognition model, changes the basis for deciding when revenue is recognized over time or at a point in time, provides new and more detailed guidance on specific topics and expands and improves disclosures about revenue. In addition, this ASU specifies the accounting for some costs to obtain or fulfill a contract with a customer.  This amended guidance is effective for fiscal years, and interim periods within those years, beginning after December 15, 2017, with early adoption for fiscal years beginning after December 15, 2016, permitted. This amended guidance is not expected to have a material impact on our consolidated operating results or financial condition.
 
8

NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
(unaudited)

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

3. Securities

Securities available for sale consist of the following:

   
Amortized
   
Unrealized
     
   
Cost
   
Gains
   
Losses
   
Fair Value
 
   
(In thousands)
 
June 30, 2015
               
U.S. agency
 
$
36,068
   
$
231
   
$
28
   
$
36,271
 
U.S. agency residential mortgage-backed
   
216,466
     
1,868
     
354
     
217,980
 
U.S. agency commercial mortgage-backed
   
30,074
     
113
     
27
     
30,160
 
Private label residential mortgage-backed
   
5,644
     
187
     
371
     
5,460
 
Other asset backed
   
108,314
     
115
     
117
     
108,312
 
Obligations of states and political subdivisions
   
135,007
     
640
     
1,284
     
134,363
 
Corporate
   
22,582
     
63
     
10
     
22,635
 
Trust preferred
   
2,913
     
-
     
399
     
2,514
 
Total
 
$
557,068
   
$
3,217
   
$
2,590
   
$
557,695
 
                                 
December 31, 2014
                               
U.S. agency
 
$
34,936
   
$
133
   
$
63
   
$
35,006
 
U.S. agency residential mortgage-backed
   
256,387
     
1,838
     
667
     
257,558
 
U.S. agency commercial mortgage-backed
   
33,779
     
68
     
119
     
33,728
 
Private label residential mortgage-backed
   
6,216
     
187
     
390
     
6,013
 
Other asset backed
   
32,314
     
77
     
38
     
32,353
 
Obligations of states and political subdivisions
   
143,698
     
961
     
1,244
     
143,415
 
Corporate
   
22,690
     
53
     
79
     
22,664
 
Trust preferred
   
2,910
     
-
     
469
     
2,441
 
Total
 
$
532,930
   
$
3,317
   
$
3,069
   
$
533,178
 
 
9

NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
(unaudited)

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 follows:

   
Less Than Twelve Months
   
Twelve Months or More
   
Total
 
   
Fair Value
   
Unrealized
Losses
   
Fair Value
   
Unrealized
Losses
   
Fair Value
   
Unrealized
Losses
 
   
(In thousands)
 
                         
June 30, 2015
                       
U.S. agency
 
$
9,564
   
$
25
   
$
760
   
$
3
   
$
10,324
   
$
28
 
U.S. agency residential mortgage-backed
   
48,277
     
221
     
14,933
     
133
     
63,210
     
354
 
U.S. agency commercial mortgage-backed
   
10,921
     
21
     
1,342
     
6
     
12,263
     
27
 
Private label residential mortgage-backed
   
193
     
1
     
3,603
     
370
     
3,796
     
371
 
Other asset backed
   
35,787
     
69
     
5,691
     
48
     
41,478
     
117
 
Obligations of states and political subdivisions
   
35,965
     
355
     
29,252
     
929
     
65,217
     
1,284
 
Corporate
   
4,233
     
10
     
-
     
-
     
4,233
     
10
 
Trust preferred
   
-
     
-
     
2,514
     
399
     
2,514
     
399
 
Total
 
$
144,940
   
$
702
   
$
58,095
   
$
1,888
   
$
203,035
   
$
2,590
 
                                                 
December 31, 2014
                                               
U.S. agency
 
$
12,851
   
$
58
   
$
606
   
$
5
   
$
13,457
   
$
63
 
U.S. agency residential mortgage-backed
   
89,547
     
531
     
15,793
     
136
     
105,340
     
667
 
U.S. agency commercial mortgage-backed
   
21,325
     
119
     
-
     
-
     
21,325
     
119
 
Private label residential mortgage-backed
   
208
     
1
     
4,013
     
389
     
4,221
     
390
 
Other asset backed
   
2,960
     
15
     
8,729
     
23
     
11,689
     
38
 
Obligations of states and political subdivisions
   
28,114
     
106
     
37,540
     
1,138
     
65,654
     
1,244
 
Corporate
   
8,660
     
79
     
-
     
-
     
8,660
     
79
 
Trust preferred
   
-
     
-
     
2,441
     
469
     
2,441
     
469
 
Total
 
$
163,665
   
$
909
   
$
69,122
   
$
2,160
   
$
232,787
   
$
3,069
 

Our portfolio of available-for-sale securities 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 or loss.
 
10

NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
(unaudited)

U.S. agency, U.S. agency residential mortgage-backed securities and U.S. agency commercial mortgage backed securities — at June 30, 2015, we had 16 U.S. agency, 74 U.S. agency residential mortgage-backed and eight U.S. agency commercial mortgage-backed securities whose fair market value is less than amortized cost. The unrealized losses are largely attributed to rises in term interest rates since acquisition and widening spreads to Treasury bonds. As management does not intend to liquidate these securities and it is more likely than not that we will not be required to sell these securities prior to recovery of these unrealized losses, no declines are deemed to be other than temporary.

Private label residential mortgage backed securities — at June 30, 2015, we had five of this type of security whose fair value is less than amortized cost. Two of the five issues are rated by a major rating agency as investment grade, two are rated below investment grade and one is split rated. Two of these bonds have an impairment in excess of 10% and four of these holdings have been impaired for more than 12 months.  The unrealized losses are largely attributable to credit spread widening on these securities since their acquisition.

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

All private label residential mortgage-backed securities are reviewed for OTTI utilizing a cash flow projection. The cash flow analysis forecasts cash flow from the underlying loans in each transaction and then applies these cash flows to the bonds in the securitization.  Our cash flow analysis forecasts complete recovery of our cost basis for four of the five securities whose fair value is less than amortized cost while the fifth security had credit related OTTI and is discussed in further detail below.

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

Other asset backed — at June 30, 2015, we had 47 other asset backed securities whose fair value is less than amortized cost. The unrealized losses are primarily due to credit spread widening.  As management does not intend to liquidate these securities and it is more likely than not that we will not be required to sell these securities prior to recovery of these unrealized losses, no declines are deemed to be other than temporary.

Obligations of states and political subdivisions — at June 30, 2015, we had 90 municipal securities whose fair value is less than amortized cost.  The unrealized losses are primarily due to increases in interest rates since acquisition.  As management does not intend to liquidate these securities and it is more likely than not that we will not be required to sell these securities prior to recovery of these unrealized losses, no declines are deemed to be other than temporary.

Corporate — at June 30, 2015, we had four corporate securities whose fair value is less than amortized cost. The unrealized losses are primarily due to credit spread widening.  As management does not intend to liquidate these securities and it is more likely than not that we will not be required to sell these securities prior to recovery of these unrealized losses, no declines are deemed to be other than temporary.
 
11

NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
(unaudited)

Trust preferred securities — at June 30, 2015, we had three trust preferred securities whose fair value is less than amortized cost. All of our trust preferred securities are single issue securities issued by a trust subsidiary of a bank holding company. The pricing of trust preferred securities has suffered from credit spread widening.

One of the three securities is rated by two major rating agencies as investment grade, while one (a Bank of America issuance) is rated below investment grade by two major rating agencies and the other one is non-rated. The non-rated issue is a relatively small bank and was never rated. The issuer of this non-rated trust preferred security, which had a total amortized cost of $1.0 million and total fair value of $0.8 million as of June 30, 2015, continues to have satisfactory credit metrics and make interest payments.

The following table breaks out our trust preferred securities in further detail as of June 30, 2015 and December 31, 2014:

   
June 30, 2015
   
December 31, 2014
 
   
Fair
Value
   
Net
Unrealized
Loss
   
Fair
Value
   
Net
Unrealized
Loss
 
   
(In thousands)
 
                 
Trust preferred securities
               
Rated issues
 
$
1,700
   
$
(213
)
 
$
1,643
   
$
(267
)
Unrated issues
   
814
     
(186
)
   
798
     
(202
)

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

We recorded no credit related OTTI charges in earnings on securities available for sale during the three or six month periods ended June 30, 2015 and 2014, respectively.

At June 30, 2015, three private label residential mortgage-backed securities had credit related OTTI and are summarized as follows:

   
Senior
Security
   
Super
Senior
Security
   
Senior
Support
Security
   
Total
 
   
(In thousands)
 
                 
As of June 30, 2015
               
Fair value
 
$
1,835
   
$
1,466
   
$
96
   
$
3,397
 
Amortized cost
   
1,889
     
1,374
     
-
     
3,263
 
Non-credit unrealized loss
   
54
     
-
     
-
     
54
 
Unrealized gain
   
-
     
92
     
96
     
188
 
Cumulative credit related OTTI
   
757
     
457
     
380
     
1,594
 
                                 
Credit related OTTI recognized in our Condensed
                               
Consolidated Statements of Operations
                               
For the three months ended June 30,
                               
2015
 
$
-
   
$
-
   
$
-
   
$
-
 
2014
   
-
     
-
     
-
     
-
 
For the six months ended June 30,
                               
2015
   
-
     
-
     
-
     
-
 
2014
   
-
     
-
     
-
     
-
 
 
12

NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
(unaudited)

Each of these securities is receiving principal and interest payments similar to principal reductions in the underlying collateral.  Two of these securities have unrealized gains and one has an unrealized loss at June 30, 2015.  Prior to the second quarter of 2013, all three of these securities had an unrealized loss.  The original amortized cost for each of these securities has been permanently adjusted downward for previously recorded credit related OTTI.  The unrealized loss (based on original amortized cost) for two of these securities is now less than previously recorded credit related OTTI amounts.  The remaining non-credit related unrealized loss in the senior security is attributed to other factors and is reflected in other comprehensive income during those same periods.

A roll forward of credit losses recognized in earnings on securities available for sale for the three and six month periods ending June 30, follows:

   
Three months ended
June 30,
   
Six months ended
June 30,
 
   
2015
   
2014
   
2015
   
2014
 
   
(In thousands)
 
Balance at beginning of period
 
$
1,844
   
$
1,835
   
$
1,844
   
$
1,835
 
Additions to credit losses on securities for which no previous OTTI was recognized
   
-
     
-
     
-
     
-
 
Increases to credit losses on securities for which OTTI was previously recognized
   
-
     
-
     
-
     
-
 
Balance at end of period
 
$
1,844
   
$
1,835
   
$
1,844
   
$
1,835
 

The amortized cost and fair value of securities available for sale at June 30, 2015, by contractual maturity, follow:
 
   
Amortized
Cost
   
Fair
Value
 
   
(In thousands)
 
Maturing within one year
 
$
24,875
   
$
24,904
 
Maturing after one year but within five years
   
59,355
     
59,631
 
Maturing after five years but within ten years
   
34,747
     
34,991
 
Maturing after ten years
   
77,593
     
76,257
 
     
196,570
     
195,783
 
U.S. agency residential mortgage-backed
   
216,466
     
217,980
 
U.S. agency commercial mortgage-backed
   
30,074
     
30,160
 
Private label residential mortgage-backed
   
5,644
     
5,460
 
Other asset backed
   
108,314
     
108,312
 
Total
 
$
557,068
   
$
557,695
 

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.

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.  A summary of proceeds from the sale of securities available for sale and gains and losses for the six month periods ending June 30, follows:

   
Proceeds
   
Realized
Gains (1)
   
Losses
 
   
(In thousands)
 
2015
 
$
11,786
   
$
75
   
$
-
 
2014
   
5,126
     
2
     
-
 


(1)
Gains in 2014 exclude $0.053 million of unrealized gain related to a U.S. Treasury short position.
 
13

NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
(unaudited)

During 2015 and 2014, our trading securities consisted of various preferred stocks.  During the first six months of 2015 and 2014, we recognized gains (losses) on trading securities of $(0.023) million and $0.111 million, respectively, that are included in net gains on securities in the Condensed Consolidated Statements of Operations.  Both of these amounts relate to gains (losses) recognized on trading securities still held at each respective period end.

4. Loans

Our assessment of the allowance for loan losses is based on an evaluation of the loan portfolio, recent loss experience, current economic conditions and other pertinent factors.
 
An analysis of the allowance for loan losses by portfolio segment for the three months ended June 30, follows:
 
   
Commercial
   
Mortgage
   
Installment
   
Payment
Plan
Receivables
   
Unallocated
   
Total
 
   
(In thousands)
 
2015
                       
Balance at beginning of period
 
$
5,916
   
$
12,081
   
$
1,564
   
$
62
   
$
5,056
   
$
24,679
 
Additions (deductions)
                                               
Provision for loan losses
   
177
     
(101
)
   
(45
)
   
3
     
(168
)
   
(134
)
Recoveries credited to allowance
   
652
     
319
     
284
     
-
     
-
     
1,255
 
Loans charged against the allowance
   
(38
)
   
(834
)
   
(342
)
   
-
     
-
     
(1,214
)
Balance at end of period
 
$
6,707
   
$
11,465
   
$
1,461
   
$
65
   
$
4,888
   
$
24,586
 
                                                 
2014
                                               
Balance at beginning of period
 
$
5,763
   
$
17,000
   
$
2,061
   
$
87
   
$
5,526
   
$
30,437
 
Additions (deductions)
                                               
Provision for loan losses
   
(1,070
)
   
(579
)
   
(76
)
   
(6
)
   
(114
)
   
(1,845
)
Recoveries credited to allowance
   
2,138
     
400
     
352
     
1
     
-
     
2,891
 
Loans charged against the allowance
   
(1,656
)
   
(1,279
)
   
(349
)
   
(2
)
   
-
     
(3,286
)
Balance at end of period
 
$
5,175
   
$
15,542
   
$
1,988
   
$
80
   
$
5,412
   
$
28,197
 
 
14

NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
(unaudited)
 
An analysis of the allowance for loan losses by portfolio segment for the six months ended June 30, follows:
   
Commercial
   
Mortgage
   
Installment
   
Payment
Plan
Receivables
   
Unallocated
   
Total
 
   
(In thousands)
 
2015
                       
Balance at beginning of period
 
$
5,445
   
$
13,444
   
$
1,814
   
$
64
   
$
5,223
   
$
25,990
 
Additions (deductions)
                                               
Provision for loan losses
   
505
     
(834
)
   
(130
)
   
1
     
(335
)
   
(793
)
Recoveries credited to allowance
   
1,085
     
557
     
603
     
-
     
-
     
2,245
 
Loans charged against the allowance
   
(328
)
   
(1,702
)
   
(826
)
   
-
     
-
     
(2,856
)
Balance at end of period
 
$
6,707
   
$
11,465
   
$
1,461
   
$
65
   
$
4,888
   
$
24,586
 
                                                 
2014
                                               
Balance at beginning of period
 
$
6,827
   
$
17,195
   
$
2,246
   
$
97
   
$
5,960
   
$
32,325
 
Additions (deductions)
                                               
Provision for loan losses
   
(563
)
   
(386
)
   
100
     
(20
)
   
(548
)
   
(1,417
)
Recoveries credited to allowance
   
2,493
     
858
     
603
     
5
     
-
     
3,959
 
Loans charged against the allowance
   
(3,582
)
   
(2,125
)
   
(961
)
   
(2
)
   
-
     
(6,670
)
Balance at end of period
 
$
5,175
   
$
15,542
   
$
1,988
   
$
80
   
$
5,412
   
$
28,197
 
 
15

NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
(unaudited)
 
Allowance for loan losses and recorded investment in loans by portfolio segment follows:
   
Commercial
   
Mortgage
   
Installment
   
Payment
Plan
Receivables
   
Unallocated
   
Total
 
   
(In thousands)
 
June 30, 2015
                       
Allowance for loan losses
Individually evaluated for impairment
 
$
3,531
   
$
8,420
   
$
584
   
$
-
   
$
-
   
$
12,535
 
Collectively evaluated for impairment
   
3,176
     
3,045
     
877
     
65
     
4,888
     
12,051
 
Total ending allowance balance
 
$
6,707
   
$
11,465
   
$
1,461
   
$
65
   
$
4,888
   
$
24,586
 
                                                 
Loans
                                               
Individually evaluated for impairment
 
$
31,802
   
$
69,097
   
$
6,248
   
$
-
           
$
107,147
 
Collectively evaluated for impairment
   
680,758
     
402,719
     
223,191
     
40,577
             
1,347,245
 
Total loans recorded investment
   
712,560
     
471,816
     
229,439
     
40,577
             
1,454,392
 
Accrued interest included in recorded investment
   
1,553
     
2,154
     
678
     
-
             
4,385
 
Total loans
 
$
711,007
   
$
469,662
   
$
228,761
   
$
40,577
           
$
1,450,007
 
                                                 
December 31, 2014
                                               
Allowance for loan losses
Individually evaluated for impairment
 
$
3,194
   
$
9,311
   
$
728
   
$
-
   
$
-
   
$
13,233
 
Collectively evaluated for impairment
   
2,251
     
4,133
     
1,086
     
64
     
5,223
     
12,757
 
Total ending allowance balance
 
$
5,445
   
$
13,444
   
$
1,814
   
$
64
   
$
5,223
   
$
25,990
 
                                                 
Loans
                                               
Individually evaluated for impairment
 
$
34,147
   
$
72,340
   
$
6,679
   
$
-
           
$
113,166
 
Collectively evaluated for impairment
   
658,423
     
402,458
     
200,368
     
40,001
             
1,301,250
 
Total loans recorded investment
   
692,570
     
474,798
     
207,047
     
40,001
             
1,414,416
 
Accrued interest included in recorded investment
   
1,615
     
2,170
     
669
     
-
             
4,454
 
Total loans
 
$
690,955
   
$
472,628
   
$
206,378
   
$
40,001
           
$
1,409,962
 
 
16

NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
(unaudited)

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

   
90+ and
Still
Accruing
   
Non-
Accrual
   
Total Non-
Performing
Loans
 
   
(In thousands)
 
June 30, 2015
           
Commercial
           
Income producing - real estate
 
$
-
   
$
1,151
   
$
1,151
 
Land, land development and construction - real estate
   
-
     
552
     
552
 
Commercial and industrial
   
64
     
2,467
     
2,531
 
Mortgage
                       
1-4 family
   
-
     
5,200
     
5,200
 
Resort lending
   
-
     
1,268
     
1,268
 
Home equity - 1st lien
   
-
     
257
     
257
 
Home equity - 2nd lien
   
-
     
187
     
187
 
Installment
                       
Home equity - 1st lien
   
-
     
210
     
210
 
Home equity - 2nd lien
   
-
     
475
     
475
 
Loans not secured by real estate
   
-
     
486
     
486
 
Other
   
-
     
3
     
3
 
Payment plan receivables
                       
Full refund
   
-
     
8
     
8
 
Partial refund
   
-
     
8
     
8
 
Other
   
-
     
2
     
2
 
Total recorded investment
 
$
64
   
$
12,274
   
$
12,338
 
Accrued interest included in recorded investment
 
$
1
   
$
-
   
$
1
 
 
December 31, 2014
                       
Commercial
                       
Income producing - real estate
 
$
-
   
$
1,233
   
$
1,233
 
Land, land development and construction - real estate
   
-
     
594
     
594
 
Commercial and industrial
   
-
     
2,746
     
2,746
 
Mortgage
                       
1-4 family
   
7
     
5,945
     
5,952
 
Resort lending
   
-
     
2,168
     
2,168
 
Home equity - 1st lien
   
-
     
331
     
331
 
Home equity - 2nd lien
   
-
     
605
     
605
 
Installment
                       
Home equity - 1st lien
   
-
     
576
     
576
 
Home equity - 2nd lien
   
-
     
517
     
517
 
Loans not secured by real estate
   
-
     
454
     
454
 
Other
   
-
     
48
     
48
 
Payment plan receivables
                       
Full refund
   
-
     
2
     
2
 
Partial refund
   
-
     
12
     
12
 
Other
   
-
     
-
     
-
 
Total recorded investment
 
$
7
   
$
15,231
   
$
15,238
 
Accrued interest included in recorded investment
 
$
-
   
$
-
   
$
-
 
 
17

NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
(unaudited)
 
An aging analysis of loans by class follows:
   
Loans Past Due
   
Loans not
   
Total
 
   
30-59 days
   
60-89 days
   
90+ days
   
Total
   
Past Due
   
Loans
 
   
(In thousands)
 
June 30, 2015
                       
Commercial
                       
Income producing - real estate
 
$
112
   
$
26
   
$
720
   
$
858
   
$
258,349
   
$
259,207
 
Land, land development and construction - real estate
   
11
     
-
     
210
     
221
     
35,763
     
35,984
 
Commercial and industrial
   
787
     
-
     
114
     
901
     
416,468
     
417,369
 
Mortgage
                                               
1-4 family
   
1,180
     
865
     
5,200
     
7,245
     
274,036
     
281,281
 
Resort lending
   
298
     
-
     
1,268
     
1,566
     
118,719
     
120,285
 
Home equity - 1st lien
   
29
     
35
     
257
     
321
     
22,322
     
22,643
 
Home equity - 2nd lien
   
239
     
180
     
187
     
606
     
47,001
     
47,607
 
Installment
                                               
Home equity - 1st lien
   
416
     
187
     
210
     
813
     
18,887
     
19,700
 
Home equity - 2nd lien
   
228
     
38
     
475
     
741
     
24,244
     
24,985
 
Loans not secured by real estate
   
248
     
73
     
486
     
807
     
181,746
     
182,553
 
Other
   
3
     
2
     
3
     
8
     
2,193
     
2,201
 
Payment plan receivables
                                               
Full refund
   
545
     
157
     
8
     
710
     
23,810
     
24,520
 
Partial refund
   
585
     
89
     
8
     
682
     
9,778
     
10,460
 
Other
   
82
     
21
     
2
     
105
     
5,492
     
5,597
 
Total recorded investment
 
$
4,763
   
$
1,673
   
$
9,148
   
$
15,584
   
$
1,438,808
   
$
1,454,392
 
Accrued interest included in recorded investment
 
$
32
   
$
22
   
$
1
   
$
55
   
$
4,330
   
$
4,385
 
                                                 
December 31, 2014
                                               
Commercial
                                               
Income producing - real estate
 
$
89
   
$
-
   
$
214
   
$
303
   
$
252,763
   
$
253,066
 
Land, land development and construction - real estate
   
131
     
-
     
223
     
354
     
33,984
     
34,338
 
Commercial and industrial
   
2,391
     
279
     
209
     
2,879
     
402,287
     
405,166
 
Mortgage
                                               
1-4 family
   
1,877
     
1,638
     
5,952
     
9,467
     
269,719
     
279,186
 
Resort lending
   
226
     
-
     
2,168
     
2,394
     
126,342
     
128,736
 
Home equity - 1st lien
   
39
     
50
     
331
     
420
     
19,782
     
20,202
 
Home equity - 2nd lien
   
711
     
89
     
605
     
1,405
     
45,269
     
46,674
 
Installment
                                               
Home equity - 1st lien
   
466
     
37
     
576
     
1,079
     
20,995
     
22,074
 
Home equity - 2nd lien
   
369
     
81
     
517
     
967
     
28,125
     
29,092
 
Loans not secured by real estate
   
589
     
231
     
454
     
1,274
     
152,115
     
153,389
 
Other
   
15
     
3
     
48
     
66
     
2,426
     
2,492
 
Payment plan receivables
                                               
Full refund
   
838
     
214
     
2
     
1,054
     
26,799
     
27,853
 
Partial refund
   
409
     
123
     
12
     
544
     
6,550
     
7,094
 
Other
   
96
     
24
     
-
     
120
     
4,934
     
5,054
 
Total recorded investment
 
$
8,246
   
$
2,769
   
$
11,311
   
$
22,326
   
$
1,392,090
   
$
1,414,416
 
Accrued interest included in recorded investment
 
$
55
   
$
29
   
$
-
   
$
84
   
$
4,370
   
$
4,454
 
 
18

NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
(unaudited)
 
Impaired loans are as follows:

   
June 30,
2015
   
December 31,
2014
 
Impaired loans with no allocated allowance
 
(In thousands)
 
TDR
 
$
9,074
   
$
9,325
 
Non - TDR
   
283
     
299
 
Impaired loans with an allocated allowance
               
TDR - allowance based on collateral
   
4,439
     
5,879
 
TDR - allowance based on present value cash flow
   
90,814
     
94,970
 
Non - TDR - allowance based on collateral
   
2,190
     
2,296
 
Non - TDR - allowance based on present value cash flow
   
-
     
-
 
Total impaired loans
 
$
106,800
   
$
112,769
 
                 
Amount of allowance for loan losses allocated
               
TDR - allowance based on collateral
 
$
1,655
   
$
2,025
 
TDR - allowance based on present value cash flow
   
9,430
     
10,188
 
Non - TDR - allowance based on collateral
   
1,450
     
1,020
 
Non - TDR - allowance based on present value cash flow
   
-
     
-
 
Total amount of allowance for loan losses allocated
 
$
12,535
   
$
13,233
 
 
19

NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
(unaudited)
 
Impaired loans by class  are as follows (1):
 
   
June 30, 2015
   
December 31, 2014
 
   
Recorded
Investment
   
Unpaid
Principal
Balance
   
Related
Allowance
   
Recorded
Investment
   
Unpaid
Principal
Balance
   
Related
Allowance
 
With no related allowance recorded:
 
(In thousands)
     
Commercial
                       
Income producing - real estate
 
$
5,488
   
$
5,717
   
$
-
   
$
5,868
   
$
6,077
   
$
-
 
Land, land development & construction-real estate
   
1,012
     
1,579
     
-
     
1,051
     
1,606
     
-
 
Commercial and industrial
   
2,859
     
2,839
     
-
     
2,685
     
2,667
     
-
 
Mortgage
                                               
1-4 family
   
25
     
169
     
-
     
-
     
49
     
-
 
Resort lending
   
-
     
-
     
-
     
48
     
397
     
-
 
Home equity - 1st lien
   
-
     
-
     
-
     
-
     
-
     
-
 
Home equity - 2nd lien
   
-
     
-
     
-
     
-
     
-
     
-
 
Installment
                                               
Home equity - 1st lien
   
-
     
37
     
-
     
-
     
40
     
-
 
Home equity - 2nd lien
   
-
     
-
     
-
     
-
     
-
     
-
 
Loans not secured by real estate
   
-
     
-
     
-
     
-
     
-
     
-
 
Other
   
-
     
-
     
-
     
-
     
-
     
-
 
     
9,384
     
10,341
     
-
     
9,652
     
10,836
     
-
 
With an allowance recorded:
                                               
Commercial
                                               
Income producing - real estate
   
12,895
     
13,881
     
767
     
12,836
     
13,797
     
689
 
Land, land development & construction-real estate
   
1,925
     
2,013
     
374
     
3,456
     
3,528
     
499
 
Commercial and industrial
   
7,623
     
7,870
     
2,390
     
8,251
     
8,486
     
2,006
 
Mortgage
                                               
1-4 family
   
50,166
     
52,274
     
5,562
     
53,206
     
56,063
     
6,195
 
Resort lending
   
18,499
     
18,761
     
2,830
     
18,799
     
18,963
     
3,075
 
Home equity - 1st lien
   
158
     
174
     
11
     
162
     
177
     
14
 
Home equity - 2nd lien
   
249
     
328
     
17
     
125
     
205
     
27
 
Installment
                                               
Home equity - 1st lien
   
2,514
     
2,688
     
156
     
2,744
     
2,930
     
219
 
Home equity - 2nd lien
   
3,066
     
3,079
     
367
     
3,212
     
3,215
     
419
 
Loans not secured by real estate
   
658
     
767
     
60
     
711
     
835
     
89
 
Other
   
10
     
10
     
1
     
12
     
12
     
1
 
     
97,763
     
101,845
     
12,535
     
103,514
     
108,211
     
13,233
 
Total
                                               
Commercial
                                               
Income producing - real estate
   
18,383
     
19,598
     
767
     
18,704
     
19,874
     
689
 
Land, land development & construction-real estate
   
2,937
     
3,592
     
374
     
4,507
     
5,134
     
499
 
Commercial and industrial
   
10,482
     
10,709
     
2,390
     
10,936
     
11,153
     
2,006
 
Mortgage
                                               
1-4 family
   
50,191
     
52,443
     
5,562
     
53,206
     
56,112
     
6,195
 
Resort lending
   
18,499
     
18,761
     
2,830
     
18,847
     
19,360
     
3,075
 
Home equity - 1st lien
   
158
     
174
     
11
     
162
     
177
     
14
 
Home equity - 2nd lien
   
249
     
328
     
17
     
125
     
205
     
27
 
Installment
                                               
Home equity - 1st lien
   
2,514
     
2,725
     
156
     
2,744
     
2,970
     
219
 
Home equity - 2nd lien
   
3,066
     
3,079
     
367
     
3,212
     
3,215
     
419
 
Loans not secured by real estate
   
658
     
767
     
60
     
711
     
835
     
89
 
Other
   
10
     
10
     
1
     
12
     
12
     
1
 
Total
 
$
107,147
   
$
112,186
   
$
12,535
   
$
113,166
   
$
119,047
   
$
13,233
 
                                                 
Accrued interest included in recorded investment
 
$
347
                   
$
397
                 

(1) There were no impaired payment plan receivables at June 30, 2015 or December 31, 2014.
 
20

NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
(unaudited)
 
 Average recorded investment in and interest income earned on impaired loans by class for the three month periods ending June 30, follows (1):
 
   
2015
   
2014
 
   
Average
Recorded
Investment
   
Interest
Income
Recognized
   
Average
Recorded
Investment
   
Interest
Income
Recognized
 
With no related allowance recorded:
 
(In thousands)
 
Commercial
               
Income producing - real estate
 
$
5,658
   
$
50
   
$
8,403
   
$
86
 
Land, land development & construction-real estate
   
1,021
     
15
     
821
     
15
 
Commercial and industrial
   
2,855
     
37
     
3,352
     
26
 
Mortgage
                               
1-4 family
   
25
     
2
     
33
     
-
 
Resort lending
   
7
     
-
     
35
     
-
 
Home equity - 1st lien
   
-
     
-
     
-
     
-
 
Home equity - 2nd lien
   
-
     
-
     
-
     
-
 
Installment
                               
Home equity - 1st lien
   
-
     
1
     
-
     
1
 
Home equity - 2nd lien
   
-
     
-
     
-
     
-
 
Loans not secured by real estate
   
-
     
-
     
-
     
-
 
Other
   
-
     
-
     
-
     
-
 
     
9,566
     
105
     
12,644
     
128
 
With an allowance recorded:
                               
Commercial
                               
Income producing - real estate
   
12,878
     
163
     
12,780
     
141
 
Land, land development & construction-real estate
   
1,943
     
13
     
4,418
     
40
 
Commercial and industrial
   
7,863
     
67
     
8,615
     
80
 
Mortgage
                               
1-4 family
   
50,931
     
539
     
56,778
     
589
 
Resort lending
   
18,482
     
173
     
19,485
     
195
 
Home equity - 1st lien
   
160
     
2
     
160
     
2
 
Home equity - 2nd lien
   
185
     
4
     
40
     
-
 
Installment
                               
Home equity - 1st lien
   
2,576
     
44
     
2,861
     
44
 
Home equity - 2nd lien
   
3,101
     
49
     
3,453
     
48
 
Loans not secured by real estate
   
668
     
9
     
715
     
7
 
Other
   
11
     
1
     
15
     
1
 
     
98,798
     
1,064
     
109,320
     
1,147
 
Total
                               
Commercial
                               
Income producing - real estate
   
18,536
     
213
     
21,183
     
227
 
Land, land development & construction-real estate
   
2,964
     
28
     
5,239
     
55
 
Commercial and industrial
   
10,718
     
104
     
11,967
     
106
 
Mortgage
                               
1-4 family
   
50,956
     
541
     
56,811
     
589
 
Resort lending
   
18,489
     
173
     
19,520
     
195
 
Home equity - 1st lien
   
160
     
2
     
160
     
2
 
Home equity - 2nd lien
   
185
     
4
     
40
     
-
 
Installment
                               
Home equity - 1st lien
   
2,576
     
45
     
2,861
     
45
 
Home equity - 2nd lien
   
3,101
     
49
     
3,453
     
48
 
Loans not secured by real estate
   
668
     
9
     
715
     
7
 
Other
   
11
     
1
     
15
     
1
 
Total
 
$
108,364
   
$
1,169
   
$
121,964
   
$
1,275
 

(1) There were no impaired payment plan receivables during the three month periods ended June 30, 2015 and 2014, respectively.
 
21

NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
(unaudited)
 
 Average recorded investment in and interest income earned on impaired loans by class for the  six month periods ending June 30, follows (1):
 
   
2015
   
2014
 
   
Average
Recorded
Investment
   
Interest
Income
Recognized
   
Average
Recorded
Investment
   
Interest
Income
Recognized
 
With no related allowance recorded:
 
(In thousands)
 
Commercial
               
Income producing - real estate
 
$
5,728
   
$
103
   
$
7,949
   
$
186
 
Land, land development & construction-real estate
   
1,031
     
49
     
1,276
     
28
 
Commercial and industrial
   
2,798
     
74
     
3,605
     
66
 
Mortgage
                               
1-4 family
   
17
     
2
     
24
     
-
 
Resort lending
   
20
     
-
     
35
     
-
 
Home equity line of credit - 1st lien
   
-
     
-
     
-
     
-
 
Home equity line of credit - 2nd lien
   
-
     
-
     
-
     
-
 
Installment
                               
Home equity installment - 1st lien
   
-
     
1
     
-
     
1
 
Home equity installment - 2nd lien
   
-
     
-
     
-
     
-
 
Loans not secured by real estate
   
-
     
-
     
-
     
-
 
Other
   
-
     
-
     
-
     
-
 
     
9,594
     
229
     
12,889
     
281
 
With an allowance recorded:
                               
Commercial
                               
Income producing - real estate
   
12,864
     
320
     
13,366
     
281
 
Land, land development & construction-real estate
   
2,447
     
27
     
4,067
     
82
 
Commercial and industrial
   
7,992
     
133
     
8,871
     
158
 
Mortgage
                               
1-4 family
   
51,689
     
1,090
     
57,056
     
1,219
 
Resort lending
   
18,587
     
344
     
19,713
     
386
 
Home equity line of credit - 1st lien
   
160
     
4
     
158
     
3
 
Home equity line of credit - 2nd lien
   
165
     
6
     
41
     
1
 
Installment
                               
Home equity installment - 1st lien
   
2,632
     
94
     
2,894
     
89
 
Home equity installment - 2nd lien
   
3,138
     
100
     
3,419
     
97
 
Loans not secured by real estate
   
682
     
19
     
724
     
17
 
Other
   
11
     
1
     
15
     
1
 
     
100,367
     
2,138
     
110,324
     
2,334
 
Total
                               
Commercial
                               
Income producing - real estate
   
18,592
     
423
     
21,315
     
467
 
Land, land development & construction-real estate
   
3,478
     
76
     
5,343
     
110
 
Commercial and industrial
   
10,790
     
207
     
12,476
     
224
 
Mortgage
                               
1-4 family
   
51,706
     
1,092
     
57,080
     
1,219
 
Resort lending
   
18,607
     
344
     
19,748
     
386
 
Home equity line of credit - 1st lien
   
160
     
4
     
158
     
3
 
Home equity line of credit - 2nd lien
   
165
     
6
     
41
     
1
 
Installment
                               
Home equity installment - 1st lien
   
2,632
     
95
     
2,894
     
90
 
Home equity installment - 2nd lien
   
3,138
     
100
     
3,419
     
97
 
Loans not secured by real estate
   
682
     
19
     
724
     
17
 
Other
   
11
     
1
     
15
     
1
 
Total
 
$
109,961
   
$
2,367
   
$
123,213
   
$
2,615
 

(1) There were no impaired payment plan receivables during the six month periods ended June 30, 2015 and 2014, respectively.
 
22

NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
(unaudited)

Our average investment in impaired loans was approximately $108.4 million and $122.0 million for the three-month periods ended June 30, 2015 and 2014, respectively and $110.0 million and $123.2 million for the six-month periods ended June 30, 2015 and 2014, respectively.  Cash receipts on impaired loans on non-accrual status are generally applied to the principal balance.  Interest income recognized on impaired loans during the three months ending June 30, 2015 and 2014, was approximately $1.2 million and $1.3 million, respectively, and was approximately $2.4 million and $2.6 million during the six months ending June 30, 2015 and 2014, respectively.

Troubled debt restructurings follow:

   
June 30, 2015
 
   
Commercial
   
Retail
   
Total
 
   
(In thousands)
 
Performing TDRs
 
$
27,540
   
$
70,576
   
$
98,116
 
Non-performing TDRs(1)
   
1,698
     
4,513
(2) 
   
6,211
 
Total
 
$
29,238
   
$
75,089
   
$
104,327
 
                         
   
December 31, 2014
 
   
Commercial
   
Retail
   
Total
 
   
(In thousands)
 
Performing TDRs
 
$
29,475
   
$
73,496
   
$
102,971
 
Non-performing TDRs(1)
   
1,978
     
5,225
(2) 
   
7,203
 
Total
 
$
31,453
   
$
78,721
   
$
110,174
 

(1) Included in non-performing loans table above.
(2) Also includes loans on non-accrual at the time of modification until six payments are received on a timely basis.
 
We allocated $11.1 million and $12.2 million of specific reserves to customers whose loan terms have been modified in troubled debt restructurings as of June 30, 2015 and December 31, 2014, respectively.

During the six months ended June 30, 2015 and 2014, the terms of certain loans were modified as troubled debt restructurings. The modification of the terms of such loans generally included one or a combination of the following: a reduction of the stated interest rate of the loan; an extension of the maturity date at a stated rate of interest lower than the current market rate for new debt with similar risk; or a permanent reduction of the recorded investment in the loan.

Modifications involving a reduction of the stated interest rate of the loan have generally been for periods ranging from 9 months to 36 months but have extended to as much as 480 months in certain circumstances. Modifications involving an extension of the maturity date have generally been for periods ranging from 1 month to 60 months but have extended to as much as 230 months in certain circumstances.
 
23

NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
(unaudited)

Loans that have been classified as troubled debt restructurings during the three-month periods ended June 30 follow:

   
Number of
Contracts
   
Pre-modification
Recorded
Balance
   
Post-modification
Recorded
Balance
 
   
(Dollars in thousands)
 
2015
           
Commercial
           
Income producing - real estate
   
1
   
$
73
   
$
73
 
Land, land development & construction-real estate
   
-
     
-
     
-
 
Commercial and industrial
   
1
     
17
     
17
 
Mortgage
                       
1-4 family
   
1
     
25
     
40
 
Resort lending
   
1
     
313
     
309
 
Home equity - 1st lien
   
-
     
-
     
-
 
Home equity - 2nd lien
   
-
     
-
     
-
 
Installment
                       
Home equity - 1st lien
   
1
     
23
     
24
 
Home equity - 2nd lien
   
3
     
58
     
58
 
Loans not secured by real estate
   
1
     
-
     
6
 
Other
   
-
     
-
     
-
 
Total
   
9
   
$
509
   
$
527
 
                         
2014
                       
Commercial
                       
Income producing - real estate
   
1
   
$
141
   
$
122
 
Land, land development & construction-real estate
   
1
     
15
     
15
 
Commercial and industrial
   
2
     
1,177
     
1,439
 
Mortgage
                       
1-4 family
   
3
     
226
     
229
 
Resort lending
   
1
     
339
     
341
 
Home equity - 1st lien
   
1
     
17
     
14
 
Home equity - 2nd lien
   
-
     
-
     
-
 
Installment
                       
Home equity - 1st lien
   
2
     
314
     
294
 
Home equity - 2nd lien
   
2
     
73
     
72
 
Loans not secured by real estate
   
-
     
-
     
-
 
Other
   
-
     
-
     
-
 
Total
   
13
   
$
2,302
   
$
2,526
 
 
24

NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
(unaudited)

Loans that have been classified as troubled debt restructurings during the six-month periods ended June 30 follow:

   
Number of
Contracts
   
Pre-modification
Recorded
Balance
   
Post-modification
Recorded
Balance
 
   
(Dollars in thousands)
 
2015
           
Commercial
           
Income producing - real estate
   
2
   
$
229
   
$
234
 
Land, land development & construction-real estate
   
-
     
-
     
-
 
Commercial and industrial
   
3
     
253
     
247
 
Mortgage
                       
1-4 family
   
6
     
1,030
     
845
 
Resort lending
   
1
     
313
     
309
 
Home equity - 1st lien
   
-
     
-
     
-
 
Home equity - 2nd lien
   
-
     
-
     
-
 
Installment
                       
Home equity - 1st lien
   
5
     
190
     
164
 
Home equity - 2nd lien
   
3
     
58
     
58
 
Loans not secured by real estate
   
1
     
-
     
6
 
Other
   
-
     
-
     
-
 
Total
   
21
   
$
2,073
   
$
1,863
 
                         
2014
                       
Commercial
                       
Income producing - real estate
   
3
   
$
354
   
$
332
 
Land, land development & construction-real estate
   
1
     
15
     
15
 
Commercial and industrial
   
6
     
1,367
     
1,628
 
Mortgage
                       
1-4 family
   
7
     
950
     
968
 
Resort lending
   
3
     
633
     
634
 
Home equity - 1st lien
   
1
     
17
     
14
 
Home equity - 2nd lien
   
-
     
-
     
-
 
Installment
                       
Home equity - 1st lien
   
5
     
420
     
372
 
Home equity - 2nd lien
   
5
     
294
     
292
 
Loans not secured by real estate
   
2
     
33
     
29
 
Other
   
-
     
-
     
-
 
Total
   
33
   
$
4,083
   
$
4,284
 

The troubled debt restructurings described above for 2015 increased the allowance for loan losses by $0.1 million and resulted in zero charge offs during the three months ended June 30, 2015, and increased the allowance by $0.1 million and resulted in zero charge offs during the six months ended June 30, 2015.

The troubled debt restructurings described above for 2014 decreased the allowance for loan losses by $0.1 million and resulted in $0.02 million of charge offs during the three months ended June 30, 2014 and increased the allowance by $0.1 million and resulted in $0.03 million of charge offs during the six months ended June 30, 2014.
 
25

NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
(unaudited)

Loans that have been classified as troubled debt restructurings during the past twelve months and that have subsequently defaulted during the three-month periods ended June 30 follow:

   
Number of
Contracts
   
Recorded
Balance
 
   
(Dollars in thousands)
 
2015
       
Commercial
       
Income producing - real estate
   
-
   
$
-
 
Land, land development & construction-real estate
   
-
     
-
 
Commercial and industrial
   
1
     
65
 
Mortgage
               
1-4 family
   
-
     
-
 
Resort lending
   
-
     
-
 
Home equity - 1st lien
   
-
     
-
 
Home equity - 2nd lien
   
-
     
-
 
Installment
               
Home equity - 1st lien
   
-
     
-
 
Home equity - 2nd lien
   
-
     
-
 
Loans not secured by real estate
   
1
     
4
 
Other
   
-
     
-
 
     
2
   
$
69
 
                 
2014
               
Commercial
               
Income producing - real estate
   
-
   
$
-
 
Land, land development & construction-real estate
   
-
     
-
 
Commercial and industrial
   
1
     
253
 
Mortgage
               
1-4 family
   
-
     
-
 
Resort lending
   
-
     
-
 
Home equity - 1st lien
   
-
     
-
 
Home equity - 2nd lien
   
-
     
-
 
Installment
               
Home equity - 1st lien
   
-
     
-
 
Home equity - 2nd lien
   
-
     
-
 
Loans not secured by real estate
   
-
     
-
 
Other
   
-
     
-
 
     
1
   
$
253
 
 
26

NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
(unaudited)

Loans that have been classified as troubled debt restructurings during the past twelve months and that have subsequently defaulted during the six-month periods ended June 30 follow:

 
Number of
Contracts
   
Recorded
Balance
 
   
(Dollars in thousands)
 
2015
       
Commercial
       
Income producing - real estate
   
-
   
$
-
 
Land, land development & construction-real estate
   
-
     
-
 
Commercial and industrial
   
2
     
157
 
Mortgage
               
1-4 family
   
-
     
-
 
Resort lending
   
-
     
-
 
Home equity - 1st lien
   
-
     
-
 
Home equity - 2nd lien
   
-
     
-
 
Installment
               
Home equity - 1st lien
   
-
     
-
 
Home equity - 2nd lien
   
-
     
-
 
Loans not secured by real estate
   
1
     
4
 
Other
   
-
     
-
 
     
3
   
$
161
 
                 
2014
               
Commercial
               
Income producing - real estate
   
-
   
$
-
 
Land, land development & construction-real estate
   
-
     
-
 
Commercial and industrial
   
1
     
253
 
Mortgage
               
1-4 family
   
-
     
-
 
Resort lending
   
-
     
-
 
Home equity - 1st lien
   
-
     
-
 
Home equity - 2nd lien
   
-
     
-
 
Installment
               
Home equity - 1st lien
   
-
     
-
 
Home equity - 2nd lien
   
-
     
-
 
Loans not secured by real estate
   
-
     
-
 
Other
   
-
     
-
 
     
1
   
$
253
 

A loan is considered to be in payment default generally once it is 90 days contractually past due under the modified terms.

The troubled debt restructurings that subsequently defaulted described above for 2015 had no impact on the allowance for loan losses and resulted in zero charge offs during the three months ended June 30, 2015 and decreased the allowance for loan losses by $0.01 million and resulted in zero charge offs during the six months ended June 30, 2015.

The troubled debt restructurings that subsequently defaulted described above for 2014 increased the allowance for loan losses by $0.2 million and resulted in zero charge offs during the three months ended June 30, 2014 and increased the allowance for loan losses by $0.2 million and resulted in zero charge offs during the six months ended June 30, 2014.
 
27

NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
(unaudited)

The terms of certain other loans were modified during the six months ended June 30, 2015 and 2014 in a manner 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.

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

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

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

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

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

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

Rating 12: These loans are generally referred to as our “loss” commercial credits. This rating includes loans to borrowers that are deemed incapable of repayment and are charged-off.
 
28

NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
(unaudited)

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

   
Commercial
 
   
Non-watch
1-6
   
Watch
7-8
   
Substandard
Accrual
9
   
Non-
Accrual
10-11
   
Total
 
           
(In thousands)
         
June 30, 2015
                   
Income producing - real estate
 
$
244,392
   
$
7,606
   
$
6,058
   
$
1,151
   
$
259,207
 
Land, land development and construction - real estate
   
31,811
     
3,370
     
251
     
552
     
35,984
 
Commercial and industrial
   
374,628
     
35,160
     
5,114
     
2,467
     
417,369
 
Total
 
$
650,831
   
$
46,136
   
$
11,423
   
$
4,170
   
$
712,560
 
Accrued interest included in total
 
$
1,377
   
$
146
   
$
30
   
$
-
   
$
1,553
 
                                         
December 31, 2014
                                       
Income producing - real estate
 
$
241,266
   
$
8,649
   
$
1,918
   
$
1,233
   
$
253,066
 
Land, land development and construction - real estate
   
30,869
     
2,485
     
390
     
594
     
34,338
 
Commercial and industrial
   
372,947
     
23,475
     
5,998
     
2,746
     
405,166
 
Total
 
$
645,082
   
$
34,609
   
$
8,306
   
$
4,573
   
$
692,570
 
Accrued interest included in total
 
$
1,479
   
$
111
   
$
25
   
$
-
   
$
1,615
 

For each of our mortgage and installment segment classes we generally monitor credit quality based on the credit scores of the borrowers. These credit scores are generally updated semi-annually.
 
29

NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
(unaudited)

The following tables summarize credit scores by loan class for our mortgage and installment loan segments:

   
Mortgage (1)
 
   
1-4 Family
   
Resort
Lending
   
Home
Equity
1st Lien
   
Home
Equity
2nd Lien
   
Total
 
 
 
   
(In thousands)
 
June 30, 2015
                   
800 and above
 
$
28,612
   
$
12,812
   
$
4,853
   
$
6,646
   
$
52,923
 
750-799
   
76,395
     
43,145
     
6,796
     
14,533
     
140,869
 
700-749
   
51,900
     
34,511
     
3,825
     
11,073
     
101,309
 
650-699
   
54,494
     
16,971
     
3,475
     
7,826
     
82,766
 
600-649
   
29,328
     
5,872
     
1,813
     
3,784
     
40,797
 
550-599
   
17,245
     
2,566
     
648
     
1,948
     
22,407
 
500-549
   
14,357
     
1,266
     
787
     
1,133
     
17,543
 
Under 500
   
4,351
     
997
     
210
     
406
     
5,964
 
Unknown
   
4,599
     
2,145
     
236
     
258
     
7,238
 
Total
 
$
281,281
   
$
120,285
   
$
22,643
   
$
47,607
   
$
471,816
 
Accrued interest included in total
 
$
1,349
   
$
510
   
$
95
   
$
200
   
$
2,154
 
                                         
December 31, 2014
                                       
800 and above
 
$
27,918
   
$
14,484
   
$
3,863
   
$
6,225
   
$
52,490
 
750-799
   
72,674
     
45,950
     
6,128
     
14,323
     
139,075
 
700-749
   
52,843
     
32,660
     
3,054
     
9,642
     
98,199
 
650-699
   
51,664
     
20,250
     
3,257
     
8,194
     
83,365
 
600-649
   
27,770
     
6,538
     
1,704
     
3,862
     
39,874
 
550-599
   
21,361
     
3,639
     
994
     
1,721
     
27,715
 
500-549
   
14,575
     
2,156
     
699
     
1,401
     
18,831
 
Under 500
   
6,306
     
875
     
261
     
632
     
8,074
 
Unknown
   
4,075
     
2,184
     
242
     
674
     
7,175
 
Total
 
$
279,186
   
$
128,736
   
$
20,202
   
$
46,674
   
$
474,798
 
Accrued interest included in total
 
$
1,311
   
$
562
   
$
88
   
$
209
   
$
2,170
 
 
(1) Credit scores have been updated within the last twelve months.
 
30

NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
(unaudited)

   
Installment(1)
 
   
Home
Equity
1st Lien
   
Home
Equity
2nd Lien
   
Loans not
Secured by
Real Estate
   
Other
   
Total
 
 
 
   
(In thousands)
 
June 30, 2015
                   
800 and above
 
$
2,189
   
$
2,377
   
$
39,189
   
$
73
   
$
43,828
 
750-799
   
4,762
     
7,711
     
81,899
     
557
     
94,929
 
700-749
   
2,816
     
5,259
     
34,688
     
594
     
43,357
 
650-699
   
3,987
     
4,413
     
15,871
     
498
     
24,769
 
600-649
   
2,299
     
2,452
     
5,014
     
263
     
10,028
 
550-599
   
2,002
     
1,581
     
2,223
     
122
     
5,928
 
500-549
   
800
     
875
     
1,062
     
53
     
2,790
 
Under 500
   
780
     
301
     
502
     
12
     
1,595
 
Unknown
   
65
     
16
     
2,105
     
29
     
2,215
 
Total
 
$
19,700
   
$
24,985
   
$
182,553
   
$
2,201
   
$
229,439
 
Accrued interest included in total
 
$
76
   
$
89
   
$
496
   
$
17
   
$
678
 
                                         
December 31, 2014
                                       
800 and above
 
$
2,272
   
$
2,835
   
$
31,507
   
$
60
   
$
36,674
 
750-799
   
5,677
     
8,557
     
66,558
     
583
     
81,375
 
700-749
   
3,111
     
6,358
     
28,179
     
689
     
38,337
 
650-699
   
3,963
     
5,477
     
16,152
     
615
     
26,207
 
600-649
   
3,434
     
2,408
     
5,128
     
255
     
11,225
 
550-599
   
2,019
     
1,913
     
1,896
     
134
     
5,962
 
500-549
   
1,128
     
1,036
     
1,672
     
84
     
3,920
 
Under 500
   
393
     
427
     
455
     
28
     
1,303
 
Unknown
   
77
     
81
     
1,842
     
44
     
2,044
 
Total
 
$
22,074
   
$
29,092
   
$
153,389
   
$
2,492
   
$
207,047
 
Accrued interest included in total
 
$
93
   
$
112
   
$
445
   
$
19
   
$
669
 
 
(1) Credit scores have been updated within the last twelve months.

Mepco Finance Corporation (“Mepco”) is a wholly-owned subsidiary of our Bank that operates a vehicle service contract payment plan business throughout the United States. See Note #14 for more information about Mepco’s business. As of June 30, 2015, approximately 60.4% of Mepco’s outstanding payment plan receivables relate to programs in which a third party insurer or risk retention group is obligated to pay Mepco the full refund owing upon cancellation of the related service contract (including with respect to both the portion funded to the service contract seller and the portion funded to the administrator). These receivables are shown as “Full Refund” in the table below. Another approximately 25.8% of Mepco’s outstanding payment plan receivables as of June 30, 2015, relate to programs in which a third party insurer or risk retention group is obligated to pay Mepco the refund owing upon cancellation only with respect to the unearned portion previously funded by Mepco to the administrator (but not to the service contract seller). These receivables are shown as “Partial Refund” in the table below. The balance of Mepco’s outstanding payment plan receivables relate to programs in which there is no insurer or risk retention group that has any contractual liability to Mepco for any portion of the refund amount. These receivables are shown as “Other” in the table below. For each class of our payment plan receivables we monitor financial information on the counterparties as we evaluate the credit quality of this portfolio.
 
31

NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
(unaudited)

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

   
Payment Plan Receivables
 
   
Full
Refund
   
Partial
Refund
   
Other
   
Total
 
   
(In thousands)
 
June 30, 2015
               
AM Best rating
               
A+
 
$
-
   
$
17
   
$
-
   
$
17
 
A
   
4,850
     
9,674
     
-
     
14,524
 
A-
   
2,779
     
671
     
5,585
     
9,035
 
Not rated
   
16,891
     
98
     
12
     
17,001
 
Total
 
$
24,520
   
$
10,460
   
$
5,597
   
$
40,577
 
                                 
December 31, 2014
                               
AM Best rating
                               
A+
 
$
-
   
$
43
   
$
-
   
$
43
 
A
   
10,007
     
6,190
     
-
     
16,197
 
A-
   
1,989
     
685
     
5,054
     
7,728
 
Not rated
   
15,857
     
176
     
-
     
16,033
 
Total
 
$
27,853
   
$
7,094
   
$
5,054
   
$
40,001
 

Although Mepco has contractual recourse against various counterparties for refunds owing upon cancellation of vehicle service contracts, see Note #14 below regarding certain risks and difficulties associated with collecting these refunds.

Foreclosed residential real estate properties included in other real estate and repossessed assets on our Condensed Consolidated Statements of Financial Condition totaled $3.4 million and $2.9 million at June 30, 2015 and December 31, 2014, respectively.  Retail mortgage loans secured by residential real estate properties for which formal foreclosure proceedings are in process according to local requirements totaled $2.0 million and $2.5 million at June 30, 2015 and December 31, 2014, respectively.

5. Segments

Our reportable segments are based upon legal entities.  We currently have two reportable segments:  Independent Bank (“IB” or “Bank”) and Mepco.  These business segments are also differentiated based on the products and services provided.  We evaluate performance based principally on net income (loss) of the respective reportable segments.

In the normal course of business, our IB segment provides funding to our Mepco segment through an intercompany line of credit priced at the prime rate of interest as published in the Wall Street Journal. Our IB segment also provides certain administrative services to our Mepco segment which are reimbursed at an agreed upon rate. These intercompany transactions are eliminated upon consolidation. The only other material intersegment balances and transactions are investments in subsidiaries at the parent entities and cash balances on deposit at our IB segment.
 
32

NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
(unaudited)

A summary of selected financial information for our reportable segments follows:

   
IB
   
Mepco
   
Other(1)
   
Elimination(2)
   
Total
 
   
(In thousands)
 
Total assets
                   
June 30, 2015
 
$
2,214,504
   
$
63,314
   
$
289,977
   
$
(278,841
)
 
$
2,288,954
 
December 31, 2014
   
2,174,536
     
63,378
     
286,158
     
(275,342
)
   
2,248,730
 
                                         
For the three months ended June 30,
                                 
2015
                                       
Interest income
 
$
18,701
   
$
1,430
   
$
20
   
$
(20
)
 
$
20,131
 
Net interest income
   
17,717
     
1,218
     
(234
)
   
-
     
18,701
 
Provision for loan losses
   
(138
)
   
4
     
-
     
-
     
(134
)
Income (loss) before income tax
   
8,843
     
(221
)
   
(356
)
   
(23
)
   
8,243
 
Net income (loss)
   
5,935
     
(77
)
   
(225
)
   
(14
)
   
5,619
 
                                         
2014
                                       
Interest income
 
$
18,511
   
$
1,846
   
$
16
   
$
(16
)
 
$
20,357
 
Net interest income
   
17,384
     
1,480
     
(326
)
   
-
     
18,538
 
Provision for loan losses
   
(1,838
)
   
(7
)
   
-
     
-
     
(1,845
)
Income (loss) before income tax
   
8,014
     
305
     
(397
)
   
(23
)
   
7,899
 
Net income (loss)
   
6,115
     
201
     
(136
)
   
(128
)
   
6,052
 
                                         
For the six months ended June 30,
                                       
2015
                                       
Interest income
 
$
36,922
   
$
2,761
   
$
40
   
$
(40
)
 
$
39,683
 
Net interest income
   
34,900
     
2,353
     
(461
)
   
-
     
36,792
 
Provision for loan losses
   
(794
)
   
1
     
-
     
-
     
(793
)
Income (loss) before income tax
   
15,102
     
(512
)
   
(739
)
   
(47
)
   
13,804
 
Net income (loss)
   
10,168
     
(269
)
   
(469
)
   
(30
)
   
9,400
 
                                         
2014
                                       
Interest income
 
$
36,709
   
$
3,931
   
$
16
   
$
(16
)
 
$
40,640
 
Net interest income
   
34,467
     
3,162
     
(613
)
   
-
     
37,016
 
Provision for loan losses
   
(1,395
)
   
(22
)
   
-
     
-
     
(1,417
)
Income (loss) before income tax
   
12,692
     
661
     
(802
)
   
(47
)
   
12,504
 
Net income (loss)
   
9,297
     
444
     
(399
)
   
(152
)
   
9,190
 


(1)
Includes amounts relating to our parent company and certain insignificant operations.
(2)
Includes parent company's investment in subsidiaries and cash balances maintained at subsidiary.

6. Shareholders’ Equity and Earnings Per Common Share

On January 21, 2015, our Board of Directors authorized a share repurchase plan (the “Repurchase Plan”) to buy back up to 5% of our outstanding common stock through December 31, 2015.  We expect to accomplish the repurchases through open market transactions, though we could effect repurchases through other means, such as privately negotiated transactions.  The timing and amount of any share repurchases will depend on a variety of factors, including, among others, securities law restrictions, the trading price of our common stock, regulatory requirements, potential alternative uses for capital, and our financial performance. The Repurchase Plan does not obligate us to acquire any particular amount of common stock, and it may be modified or suspended at any time at our discretion. We expect to fund any repurchases from cash on hand.  During the six months ended June 30, 2015, we repurchased 277,415 shares of common stock for an aggregate purchase price of $3.7 million.
 
33

NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
(unaudited)

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

On November 15, 2011, our Board of Directors declared a dividend of one preferred share purchase right (a "Right") for each outstanding share of our common stock under the terms of the Preservation Plan. The dividend is payable to the holders of common stock outstanding as of the close of business on November 15, 2011, or outstanding at any time thereafter but before the earlier of a "Distribution Date" and the date the Preservation Plan terminates. Each Right entitles the registered holder to purchase from us 1/1000 of a share of our Series C Junior Participating Preferred Stock, no par value per share ("Series C Preferred Stock"). Each 1/1000 of a share of Series C Preferred Stock has economic and voting terms similar to those of one whole share of common stock. The Rights are not exercisable and generally do not become exercisable until a person or group has acquired, subject to certain exceptions and conditions, beneficial ownership of 4.99% or more of the outstanding shares of common stock. At that time, each Right will generally entitle its holder to purchase securities of the Company at a discount of 50% to the current market price of the common stock. However, the Rights owned by the person acquiring beneficial ownership of 4.99% or more of the outstanding shares of common stock would automatically be void. The significant dilution that would result is expected to deter any person from acquiring beneficial ownership of 4.99% or more and thereby triggering the Rights.

To date, none of the Rights have been exercised or have become exercisable because no unpermitted 4.99% or more change in the beneficial ownership of the outstanding common stock has occurred. The Rights will generally expire on the earlier to occur of the close of business on November 15, 2016, and certain other events described in the Preservation Plan, including such date as our Board of Directors determines that the Preservation Plan is no longer necessary for its intended purposes.
 
34

NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
(unaudited)

A reconciliation of basic and diluted net income per common share follows:

   
Three Months Ended
June 30,
   
Six Months Ended
June 30,
 
   
2015
   
2014
   
2015
   
2014
 
   
(In thousands, except per share amounts)
 
         
Net income
 
$
5,619
   
$
6,052
   
$
9,400
   
$
9,190
 
                                 
Weighted average shares outstanding (1)
   
22,889
     
22,928
     
22,943
     
22,908
 
Restricted stock units
   
310
     
305
     
310
     
304
 
Effect of stock options
   
120
     
126
     
120
     
126
 
Stock units for deferred compensation plan for non-employee directors
   
111
     
107
     
111
     
116
 
Weighted average shares outstanding for calculation of diluted earnings per share
   
23,430
     
23,466
     
23,484
     
23,454
 
                                 
Net income per common share
                               
Basic (1)
 
$
0.25
   
$
0.26
   
$
0.41
   
$
0.40
 
Diluted
 
$
0.24
   
$
0.26
   
$
0.40
   
$
0.39
 

(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 share because they were anti-dilutive totaled 0.03 million and 0.03 million for the three-month periods ended June 30, 2015 and 2014, respectively and totaled 0.03 million and 0.03 million for the six-month periods ended June 30, 2015 and 2014, respectively.
 
7. Derivative Financial Instruments
 
We are required to record derivatives on our Condensed 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.
 
35

NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
(unaudited)
 
Our derivative financial instruments according to the type of hedge in which they are designated follows:

   
June 30, 2015
 
   
Notional
Amount
   
Average
Maturity
(years)
   
Fair
Value
 
   
(Dollars in thousands)
 
No hedge designation
           
Rate-lock mortgage loan commitments
 
$
22,118
     
0.1
   
$
542
 
Mandatory commitments to sell mortgage loans
   
53,935
     
0.1
     
336
 
Pay-fixed interest rate swap agreements
   
19,888
     
7.5
     
(222
)
Pay-variable interest rate swap agreements
   
19,888
     
7.5
     
222
 
Total
 
$
115,829
     
2.6
   
$
878
 
                         
   
December 31, 2014
 
   
Notional
Amount
   
Average
Maturity
(years)
   
Fair
Value
 
   
(Dollars in thousands)
 
No hedge designation
                       
Rate-lock mortgage loan commitments
 
$
16,759
     
0.1
   
$
437
 
Mandatory commitments to sell mortgage loans
   
38,600
     
0.1
     
(184
)
Pay-fixed interest rate swap agreements
   
3,300
     
9.4
     
(182
)
Pay-variable interest rate swap agreements
   
3,300
     
9.4
     
182
 
Total
 
$
61,959
     
1.1
   
$
253
 

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.

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

In the ordinary course of business, we enter into rate-lock mortgage loan commitments with customers (“Rate-Lock Commitments”).  These commitments expose us to interest rate risk.  We also enter into mandatory commitments to sell mortgage loans (“Mandatory Commitments”) to reduce the impact of price fluctuations of mortgage loans held for sale and Rate-Lock Commitments.  Mandatory Commitments help protect our loan sale profit margin from fluctuations in interest rates. The changes in the fair value of Rate-Lock Commitments and Mandatory Commitments are recognized currently as part of net gains on mortgage loans.  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.
 
36

NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
(unaudited)

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

Fair Values of Derivative Instruments
 
 
Asset Derivatives
 
Liability Derivatives
 
 
June 30,
2015
 
December 31,
2014
 
June 30,
2015
 
December 31,
2014
 
 Balance
 Sheet
 Location
 
Fair
Value
 
 Balance
 Sheet
 Location
 
Fair
Value
 
 Balance
 Sheet
 Location
 
Fair
Value
 
 Balance
 Sheet
 Location
 
Fair
Value
 
 
(In thousands)
 
Derivatives not designated as hedging instruments
                       
Rate-lock mortgage loan commitments
Other assets
 
$
542
 
Other  assets
 
$
437
 
Other liabilities
 
$
-
 
Other liabilities
 
$
-
 
Mandatory commitments to sell mortgage loans
Other assets
   
336
 
Other assets
   
-
 
Other liabilities
   
-
 
Other liabilities
   
184
 
Pay-fixed interest rate swap agreements
Other assets
   
-
 
Other assets
   
-
 
Other liabilities
   
222
 
Other liabilities
   
182
 
Pay-variable interest rate swap agreements
Other assets
   
222
 
Other assets
   
182
 
Other liabilities
   
-
 
Other liabilities
   
-
 
Total derivatives
   
$
1,100
     
$
619
     
$
222
     
$
366
 
 
37

NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
(unaudited)

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

Three Month Periods Ended June 30,
 
   
Gain (Loss)
Recognized in
Other
Comprehensive
Income (Loss)
(Effective Portion)
 
 Location of
 Gain (Loss)
 Reclassified
 from
 Accumulated
 Other
 Comprehensive
 Income into
 Income
 (Effective
 
Gain (Loss)
Reclassified from
Accumulated Other
Comprehensive
Loss into Income
(Effective Portion)
 
 Location of
 Gain (Loss)
 Recognized
 
Gain (Loss)
Recognized
in Income
 
   
2015
   
2014
 
 Portion)
 
2015
   
2014
 
 in Income (1)
 
2015
   
2014
 
   
(In thousands)
 
Cash Flow Hedges
                           
Pay-fixed interest rate swap agreements (2)
 
$
-
   
$
-
 
 Interest expense
 
$
-
   
$
(95
)
   
$
-
   
$
-
 
Total
 
$
-
   
$
-
     
$
-
   
$
(95
)
   
$
-
   
$
-
 
                                                     
No hedge designation
                                             
Rate-lock mortgage loan commitments
                                 
Net mortgage loan gains
 
$
(283
)
 
$
238
 
Mandatory commitments to sell mortgage loans
                           
Net mortgage loan gains
   
559
     
(271
)
Pay-fixed interest rate swap agreements
                                 
Interest income
   
221
     
(99
)
Pay-variable interest rate swap agreements
                                 
Interest income
   
(221
)
   
99
 
U.S. Treasury short position
                                 
Gain on securities
   
-
     
52
 
Total
                                          
$
276
   
$
19
 

(1) For cash flow hedges, this location and amount refers to the ineffective portion.
(2) Relates to a terminated pay-fixed interest rate swap whose termination fee was included in accumulated other comprehensive income and was being amortized into earnings through December 31, 2014.
 
38

NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
(unaudited)

Six Month Periods Ended June 30,  
 
Gain (Loss)
Recognized in
Other
Comprehensive
Income (Loss)
(Effective Portion)
 
 Location of
 Gain (Loss)
 Reclassified
 from
 Accumulated
 Other
 Comprehensive
 Income into
 Income
 (Effective
 
Gain (Loss)
Reclassified from
Accumulated Other
Comprehensive
Loss into Income
(Effective Portion)
 
 Location of
 Gain (Loss)
 Recognized
 
Gain (Loss)
Recognized
in Income
 
 
2015
   
2014
 
 Portion)
 
2015
   
2014
 
 in Income (1)
 
2015
   
2014
 
 
(In thousands)
 
Cash Flow Hedges
                           
Pay-fixed interest rate swap agreements (2)
 
$
-
   
$
-
 
 Interest expense
 
$
-
   
$
(190
)
   
$
-
   
$
-
 
Total
 
$
-
   
$
-
     
$
-
   
$
(190
)
   
$
-
   
$
-
 
                                                   
No hedge designation
                                                   
Rate-lock mortgage loan commitments
                                 
Net mortgage 
loan gains
 
$
105
   
$
224
 
Mandatory commitments to sell mortgage loans
                                 
Net mortgage
loan gains
   
520
     
(354
)
Pay-fixed interest rate swap agreements
                                 
Interest income
   
(40
)
   
(99
)
Pay-variable interest rate swap agreements
                                 
Interest income
   
40
     
99
 
U.S. Treasury short position
                                 
Gain on securities
   
-
     
52
 
Total
                                         
$
625
   
$
(78
)
 
(1)
For cash flow hedges, this location and amount refers to the ineffective portion.
(2)
Relates to a terminated pay-fixed interest rate swap whose termination fee was included in accumulated other comprehensive income and was being amortized into earnings through December 31, 2014.

8. Intangible Assets

The following table summarizes intangible assets, net of amortization:

   
June 30, 2015
   
December 31, 2014
 
   
Gross
Carrying
Amount
   
Accumulated
Amortization
   
Gross
Carrying
Amount
   
Accumulated
Amortization
 
   
(In thousands)
 
                 
Amortized intangible assets - core deposits
 
$
6,118
   
$
3,665
   
$
6,118
   
$
3,491
 
 
39

NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
(unaudited)

Amortization of other intangibles has been estimated through 2020 and thereafter in the following table.
 
   
(In thousands)
 
     
     
Six months ending December 31, 2015
 
$
173
 
2016
   
347
 
2017
   
346
 
2018
   
346
 
2019
   
346
 
2020 and thereafter
   
895
 
Total
 
$
2,453
 

9. Share Based Compensation
 
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 0.3 million shares of common stock as of June 30, 2015.  The non-employee director stock purchase plan permits the issuance of additional share based payments for up to 0.2 million shares of common stock as of June 30, 2015. 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 each first quarter period of 2015 and 2014, pursuant to our long-term incentive plan, we granted 0.07 million shares of restricted stock and 0.03 million performance stock units (“PSU”) to certain officers.  The shares of restricted stock issued during 2015 cliff vest after a period of three years, the shares of restricted stock issued during 2014 vest ratably over three years and the PSUs issued in both periods cliff vest after a period of three years.  The performance feature of the PSUs is based on a comparison of our total shareholder return over the three year period starting on the grant date to the total shareholder return over that period for an index of our peers in the banking industry.  No long term incentive grants were made during the second quarters of 2015 or 2014.

Our directors may elect to receive a portion of their quarterly cash retainer fees in the form of common stock (either on a current basis or on a deferred basis pursuant to the non-employee director stock purchase plan referenced above). Shares equal in value to that portion of each director’s fees that he or she has elected to receive in stock are issued each quarter and vest immediately.  We issued 0.002 million shares and 0.007 million shares to directors during the first six months of 2015 and 2014, respectively and expensed their value during those same periods.
 
40

NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
(unaudited)

Total compensation expense recognized for grants pursuant to our long-term incentive plan was $0.4 million and $0.7 million during the three and six month periods ended June 30, 2015, respectively, and was $0.3 million and $0.5 million during the same periods in 2014, respectively.  The corresponding tax benefit relating to this expense was $0.1 million and $0.3 million for the three and six month periods ended June 30, 2015, respectively and $0.1 million and $0.2 million for the same periods in 2014. Total expense recognized for non-employee director share based payments was $0.02 million and $0.03 million during the three and six month periods ended June 30, 2015, respectively, and was $0.05 million and $0.09 million during the same periods in 2014, respectively.  The corresponding tax benefit relating to this expense was $0.01 million and $0.01 million for the three and six month periods ended June 30, 2015, respectively and $0.02 million and $0.03 million during the same periods in 2014.

At June 30, 2015, the total expected compensation cost related to non-vested stock options, restricted stock, PSUs and restricted stock unit awards not yet recognized was $2.1 million.  The weighted-average period over which this amount will be recognized is 2.0 years.

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

   
Number of
Shares
   
Average
Exercise
Price
   
Weighted-
Average
Remaining
Contractual
Term (Years)
   
Aggregated
Intrinsic
Value
 
               
(In thousands)
 
Outstanding at January 1, 2015
   
281,820
   
$
4.69
         
Granted
   
-
                 
Exercised
   
(24,774
)
   
3.33
         
Forfeited
   
(1,531
)
   
4.72
         
Expired
   
(757
)
   
13.81
         
Outstanding at June 30, 2015
   
254,758
   
$
4.80
     
6.59
   
$
2,293
 
                                 
Vested and expected to vest at June 30, 2015
   
252,880
   
$
4.79
     
6.58
   
$
2,278
 
Exercisable at June 30, 2015
   
198,882
   
$
4.96
     
6.34
   
$
1,772
 

A summary of outstanding non-vested restricted stock, restricted stock units and PSUs and related transactions follows:

   
Number
of Shares
   
Weighted-
Average
Grant Date
Fair Value
 
Outstanding at January 1, 2015
   
407,130
   
$
6.31
 
Granted
   
107,156
     
13.04
 
Vested
   
(22,119
)
   
12.78
 
Forfeited
   
(3,380
)
   
12.93
 
Outstanding at June 30, 2015
   
488,787
   
$
7.45
 
 
41

NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
(unaudited)

Certain information regarding options exercised during the periods follows:

   
Three Months Ended
June 30,
   
Six Months Ended
June 30,
 
   
2015
   
2014
   
2015
   
2014
 
   
(In thousands)
 
Intrinsic value
 
$
187
   
$
93
   
$
243
   
$
108
 
Cash proceeds received
 
$
67
   
$
26
   
$
82
   
$
36
 
Tax benefit realized
 
$
65
   
$
32
   
$
85
   
$
37
 

10. Income Tax

Income tax expense was $2.6 million and $1.8 million during the three months ended June 30, 2015 and 2014, respectively and $4.4 million and $3.3 million during the six months ended June 30, 2015 and 2014, respectively.

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 June 30, 2015 and 2014, that the realization of substantially all of our deferred tax assets continues to be more likely than not.

We did maintain a valuation allowance against our deferred tax assets of approximately $1.0 million at both June 30, 2015 and December 31, 2014. This valuation allowance on our deferred tax assets primarily relates to state income taxes at our Mepco segment.  In this instance, we determined that the future realization of these particular deferred tax assets was not more likely than not.  This conclusion was primarily based on the uncertainty of Mepco’s future earnings attributable to particular states (given the various apportionment criteria) and the significant reduction in the size of Mepco’s business.

At June 30, 2015 and December 31, 2014, we had approximately $1.0 million and $1.1 million, respectively of gross unrecognized tax benefits.  We do not expect the total amount of unrecognized tax benefits to significantly increase or decrease during the balance of 2015.

11. 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’s 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 June 30, 2015, the Bank had negative undivided profits of $21.2 million.  We can request regulatory approval for a return of capital from the Bank to the parent company. During the first quarter of 2014, we requested regulatory approval for a $15.0 million return of capital from the Bank to the parent company.  This return of capital request was approved by our banking regulators on March 28, 2014 and the Bank returned $15.0 million of capital to the parent company on April 9, 2014.  During January of 2015, we requested regulatory approval for an additional $18.5 million return of capital from the Bank to the parent company.  This return of capital request was approved by our banking regulators on February 13, 2015, and the Bank returned $18.5 million of capital to the parent company on February 17, 2015It 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.
 
42


NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
(unaudited)

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 (as of January 1, 2015) capital to risk-weighted assets and Tier 1 capital to average assets. Failure to meet minimum capital requirements can result in certain mandatory, and possibly discretionary, actions by regulators that could have a material effect on our consolidated financial statements. Under capital adequacy guidelines, we must meet specific capital requirements that involve quantitative measures as well as qualitative judgments by the regulators. The most recent regulatory filings as of June 30, 2015 and December 31, 2014, categorized our Bank as well capitalized. Management is not aware of any conditions or events that would have changed the most recent Federal Deposit Insurance Corporation (“FDIC”) categorization.
 
On July 2, 2013, the Federal Reserve approved a final rule that establishes an integrated regulatory capital framework (the “New Capital Rules”). The rule implements in the United States the Basel III regulatory capital reforms from the Basel Committee on Banking Supervision and certain changes required by the Dodd-Frank Act.  In general, under the New Capital Rules, minimum requirements have increased for both the quantity and quality of capital held by banking organizations. Consistent with the international Basel framework, the New Capital Rules include a new minimum ratio of common equity Tier 1 capital to risk-weighted assets of 4.5% and a common equity Tier 1 capital conservation buffer of 2.5% of risk-weighted assets that applies to all supervised financial institutions. The rule also raises the minimum ratio of Tier 1 capital to risk-weighted assets from 4% to 6% and includes a minimum leverage ratio of 4% for all banking organizations.  As to the quality of capital, the New Capital Rules emphasize common equity Tier 1 capital, the most loss-absorbing form of capital, and implement strict eligibility criteria for regulatory capital instruments. The New Capital Rules also change the methodology for calculating risk-weighted assets to enhance risk sensitivity.  The New Capital Rules became effective for us on January 1, 2015.
 
43

NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
(unaudited)

Our actual capital amounts and ratios follow:

   
Actual
   
Minimum for
Adequately Capitalized
Institutions
   
Minimum for
Well-Capitalized
Institutions
 
   
Amount
   
Ratio
   
Amount
   
Ratio
   
Amount
   
Ratio
 
   
(Dollars in thousands)
 
                         
June 30, 2015
                       
Total capital to risk-weighted assets
                       
Consolidated
 
$
275,836
     
17.33
%
 
$
127,340
     
8.00
%
 
NA
   
NA
 
Independent Bank
   
245,543
     
15.45
     
127,178
     
8.00
   
$
158,972
     
10.00
%
                                                 
Tier 1 capital to risk-weighted assets
                                               
Consolidated
 
$
255,639
     
16.06
%
 
$
95,505
     
6.00
%
 
NA
   
NA
 
Independent Bank
   
225,439
     
14.18
     
95,383
     
6.00
   
$
127,178
     
8.00
%
                                                 
Common equity tier 1 capital to risk-weighted assets
                                               
Consolidated
 
$
240,247
     
15.09
%
 
$
71,629
     
4.50
%
 
NA
   
NA
 
Independent Bank
   
225,439
     
14.18
     
71,538
     
4.50
   
$
103,332
     
6.50
%
                                                 
Tier 1 capital to average assets
                                               
Consolidated
 
$
255,639
     
11.32
%
 
$
90,357
     
4.00
%
 
NA
   
NA
 
Independent Bank
   
225,439
     
9.99
     
90,283
     
4.00
   
$
112,853
     
5.00
%
                                                 
December 31, 2014
                                               
Total capital to risk-weighted assets
                                               
Consolidated
 
$
265,163
     
18.06
%
 
$
117,427
     
8.00
%
 
NA
   
NA
 
Independent Bank
   
247,883
     
16.90
     
117,374
     
8.00
   
$
146,718
     
10.00
%
                                                 
Tier 1 capital to risk-weighted assets
                                               
Consolidated
 
$
246,628
     
16.80
%
 
$
58,714
     
4.00
%
 
NA
   
NA
 
Independent Bank
   
229,361
     
15.63
     
58,687
     
4.00
   
$
88,031
     
6.00
%
                                                 
Tier 1 capital to average assets
                                               
Consolidated
 
$
246,628
     
11.18
%
 
$
88,206
     
4.00
%
 
NA
   
NA
 
Independent Bank
   
229,361
     
10.46
     
87,687
     
4.00
   
$
109,609
     
5.00
%
 

NA - Not applicable
 
44

NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
(unaudited)

The components of our regulatory capital are as follows:

   
Consolidated
   
Independent Bank
 
   
June 30,
2015
   
December 31,
2014
   
June 30,
2015
   
December 31,
2014
 
   
(In thousands)
 
Total shareholders' equity
 
$
254,375
   
$
250,371
   
$
249,477
   
$
257,832
 
Add (deduct)
                               
Accumulated other comprehensive (gain) loss for regulatory purposes
   
(408
)
   
5,636
     
(408
)
      5,636   
Intangible assets
   
(981
)
   
(2,627
)
   
(981
)
   
(2,627
)
Disallowed deferred tax assets
   
(12,739
)
   
(40,500
)
   
(22,649
)
   
(30,728
)
Disallowed capitalized mortgage loan servicing rights
   
-
     
(752
)
   
-
     
(752
)
Common equity tier 1 capital
   
240,247
     
212,128
     
225,439
     
229,361
 
Qualifying trust preferred securities
   
34,500
     
34,500
     
-
     
-
 
Disallowed deferred tax assets
   
(19,108
)
   
-
     
-
     
-
 
Tier 1 capital
   
255,639
     
246,628
     
225,439
     
229,361
 
Allowance for loan losses and allowance for unfunded lending commitments limited to 1.25% of total risk-weighted assets
   
20,197
     
18,535
     
20,104
     
18,522
 
Total risk-based capital
 
$
275,836
   
$
265,163
   
$
245,543
   
$
247,883
 

12. 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.
 
45

NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
(unaudited)

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

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

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

Impaired loans with specific loss allocations based on collateral valueFrom time to time, certain loans are considered impaired and an allowance for loan losses 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 June 30, 2015 and December 31, 2014, all of our total impaired loans were evaluated based on either the fair value of the collateral or the present value of expected future cash flows discounted at the loan’s effective interest rate. When the fair value of the collateral is based on an appraised value or when an appraised value is not available we record the impaired loan as nonrecurring Level 3.  These appraisals may utilize a single valuation approach or a combination of approaches including comparable sales and the income approach. Adjustments are routinely made in the appraisal process by the independent appraisers to adjust for differences between the comparable sales and income data available. Such adjustments can be significant and thus will typically result in a Level 3 classification of the inputs for determining fair value.

Other real estate:  At the time of acquisition, other real estate is recorded at fair value, less estimated costs to sell, which becomes the property’s new basis. Subsequent write-downs to reflect declines in value since the time of acquisition may occur from time to time and are recorded in net gain on other real estate and repossessed assets in the Condensed 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.
 
46

NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
(unaudited)

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

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

Derivatives:  The fair value of rate-lock mortgage loan commitments and mandatory commitments to sell mortgage loans is based on mortgage backed security pricing for comparable assets (recurring Level 2).  The fair value of interest rate swap agreements is based on a discounted cash flow analysis whose significant fair value inputs can generally be observed in the market place and do not typically involve judgment by management (recurring Level 2).
 
47

NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
(unaudited)

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

       
Fair Value Measurements Using
 
   
Fair Value
Measure-
ments
   
Quoted
Prices
in Active
Markets
for
Identical
Assets
(Level 1)
   
Significant
Other
Observable
Inputs
(Level 2)
   
Significant
Un-
observable
Inputs
(Level 3)
 
   
(In thousands)
 
June 30, 2015:
 
 
   
 
   
 
   
 
 
Measured at Fair Value on a Recurring Basis:
               
Assets
               
Trading securities
 
$
180
   
$
180
   
$
-
   
$
-
 
Securities available for sale
                               
U.S. agency
   
36,271
     
-
     
36,271
     
-
 
U.S. agency residential mortgage-backed
   
217,980
     
-
     
217,980
     
-
 
U.S. agency commercial mortgage-backed
   
30,160
     
-
     
30,160
     
-
 
Private label residential mortgage-backed
   
5,460
     
-
     
5,460
     
-
 
Other asset backed
   
108,312
     
-
     
108,312
     
-
 
Obligations of states and political subdivisions
   
134,363
     
-
     
134,363
     
-
 
Corporate
   
22,635
     
-
     
22,635
     
-
 
Trust preferred
   
2,514
     
-
     
2,514
     
-
 
Loans held for sale
   
30,518
     
-
     
30,518
     
-
 
Derivatives (1)
   
1,100
     
-
     
1,100
     
-
 
Liabilities
                               
Derivatives (2)
   
222
     
-
     
222
     
-
 
                                 
Measured at Fair Value on a Non-recurring basis:
                               
Assets
                               
Capitalized mortgage loan servicing rights (3)
   
8,895
     
-
     
-
     
8,895
 
Impaired loans (4)
                               
Commercial
                               
Income producing - real estate
   
852
     
-
     
-
     
852
 
Land, land development & construction-real estate
   
126
     
-
     
-
     
126
 
Commercial and industrial
   
1,774
     
-
     
-
     
1,774
 
Mortgage
                               
1-4 Family
   
631
     
-
     
-
     
631
 
Resort Lending
   
141
     
-
     
-
     
141
 
Other real estate (5)
                               
Commercial
                               
Land, land development & construction-real estate
   
639
     
-
     
-
     
639
 
Commercial and industrial
   
165
     
-
     
-
     
165
 
Mortgage
                               
1-4 Family
   
135
     
-
     
-
     
135
 
Resort Lending
   
251
     
-
     
-
     
251
 
Home equity - 1st lien
   
10
     
-
     
-
     
10
 
Installment
                               
Home equity - 1st lien
   
43
     
-
     
-
     
43
 
 
(1) Included in accrued income and other assets
(2) Included in accrued expenses and other liabilities
(3) Only includes servicing rights that are carried at fair value due to recognition of a valuation allowance.
(4) Only includes impaired loans with specific loss allocations based on collateral value.
(5) Only includes other real estate with subsequent write downs to fair value.
 
48

NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
(unaudited)

       
Fair Value Measurements Using
 
   
Fair Value
Measure-
ments
   
Quoted
Prices
in Active
Markets
for
Identical
Assets
(Level 1)
   
Significant
Other
Observable
Inputs
(Level 2)
   
Significant
Un-
observable
Inputs
(Level 3)
 
   
(In thousands)
 
December 31, 2014:
 
   
 
   
 
   
 
 
Measured at Fair Value on a Recurring Basis:
               
Assets
               
Trading securities
 
$
203
   
$
203
   
$
-
   
$
-
 
Securities available for sale
                               
U.S. agency
   
35,006
     
-
     
35,006
     
-
 
U.S. agency residential mortgage-backed
   
257,558
     
-
     
257,558
     
-
 
U.S. agency commercial mortgage-backed
   
33,728
     
-
     
33,728
     
-
 
Private label residential mortgage-backed
   
6,013
     
-
     
6,013
     
-
 
Other asset backed
   
32,353
     
-
     
32,353
     
-
 
Obligations of states and political subdivisions
   
143,415
     
-
     
143,415
     
-
 
Corporate
   
22,664
     
-
     
22,664
     
-
 
Trust preferred
   
2,441
     
-
     
2,441
     
-
 
Loans held for sale
   
23,662
     
-
     
23,662
     
-
 
Derivatives (1)
   
619
     
-
     
619
     
-
 
Liabilities
                               
Derivatives (2)
   
366
     
-
     
366
     
-
 
                                 
Measured at Fair Value on a Non-recurring basis:
                               
Assets
                               
Capitalized mortgage loan servicing rights (3)
   
9,197
     
-
     
-
     
9,197
 
Impaired loans (4)
                               
Commercial
                               
Income producing - real estate
   
869
     
-
     
-
     
869
 
Land, land development &  construction-real estate
   
354
     
-
     
-
     
354
 
Commercial and industrial
   
2,601
     
-
     
-
     
2,601
 
Mortgage
                               
1-4 Family
   
1,306
     
-
     
-
     
1,306
 
Other real estate (5)
                               
Commercial
                               
Income producing - real estate
   
479
     
-
     
-
     
479
 
Land, land development & construction-real estate
   
737
     
-
     
-
     
737
 
Mortgage
                               
1-4 Family
   
102
     
-
     
-
     
102
 
Resort Lending
   
575
     
-
     
-
     
575
 
Installment
                               
Home equity - 1st lien
   
13
     
-
     
-
     
13
 
 
(1)
Included in accrued income and other assets
(2)
Included in accrued expenses and other liabilities
(3)
Only includes servicing rights that are carried at fair value due to recognition of a valuation allowance.
(4)
Only includes impaired loans with specific loss allocations based on collateral value.
(5)
Only includes other real estate with subsequent write downs to fair value.
 
49

NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
(unaudited)

There were no transfers between Level 1 and Level 2 during the three months ended June 30, 2015 and 2014.

Changes in fair values for financial assets which we have elected the fair value option for the periods presented were as follows:
 
   
Changes in Fair Values for the Six-Month
Periods Ended June 30 for Items Measured at
Fair Value Pursuant to Election of the Fair Value Option
 
   
2015
   
2014
 
     
Net Gains (Losses)
on Assets
     
Total
Change
in Fair
Values
Included
in Current
Period
     
Net Gains (Losses)
on Assets
     
Total
Change
in Fair
Values
Included
in Current
Period
  
   
Securities
   
Loans
   
Earnings
   
Securities
   
Loans
   
Earnings
 
 
(In thousands)
 
Trading securities
 
$
(23
)
 
$
-
   
$
(23
)
 
$
111
   
$
-
   
$
111
 
Loans held for sale
   
-
     
(121
)
   
(121
)
   
-
     
348
     
348
 

For those items measured at fair value pursuant to our election of the fair value option, interest income is recorded within the Condensed 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.

The following represent impairment charges recognized during the three and six month periods ended June 30, 2015 and 2014 relating to assets measured at fair value on a non-recurring basis:
 
· Capitalized mortgage loan servicing rights, whose individual strata are measured at fair value, had a carrying amount of $8.9 million which is net of a valuation allowance of $3.2 million at June 30, 2015, and had a carrying amount of $9.2 million which is net of a valuation allowance of $3.8 million at December 31, 2014.  A recovery (charge) of $1.2 million and $0.5 million was included in our results of operations for the three and six month periods ending June 30, 2015, respectively and $(0.2) million and $(0.5) million during the same periods in 2014.
· Loans which are measured for impairment using the fair value of collateral for collateral dependent loans had a carrying amount of $6.6 million, with a valuation allowance of $3.1 million at June 30, 2015, and had a carrying amount of $8.2 million, with a valuation allowance of $3.1 million at December 31, 2014.  The provision for loan losses included in our results of operations relating to impaired loans was an expense of $0.5 million and $0.2 million for the three month periods ending June 30, 2015 and 2014, respectively, and an expense of $1.0 million and $1.5 million for the six month periods ending June 30, 2015 and 2014, respectively.
· Other real estate, which is measured using the fair value of the property, had a carrying amount of $1.2 million which is net of a valuation allowance of $2.3 million at June 30, 2015, and a carrying amount of $1.9 million which is net of a valuation allowance of $2.5 million at December 31, 2014.  An additional charge relating to other real estate measured at fair value of $0.22 million and $0.37 million was included in our results of operations during the three and six month periods ended June 30, 2015, respectively and $0.03 million and $0.06 million during the same periods in 2014.

We had no assets or liabilities measured at fair value on a recurring basis that used significant unobservable inputs (Level 3) during the three months ended June 30, 2015 and 2014.
 
50

NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
(unaudited)

Quantitative information about Level 3 fair value measurements measured on a non-recurring basis follows:
 
       
Asset
(Liability)
         
       
Fair
Value
 
Valuation
Technique
Unobservable
Inputs
 
Weighted
Average
 
   
(In thousands)
     
June 30, 2015
           
Capitalized mortgage 
loan servicing rights
 
$
8,895
 
Present value of net servicing revenue
Discount rate
   
10.02
%
         
    
Cost to service
 
$
80
 
                
Ancillary income
   
24
 
                
Float rate
   
1.79
%
                     
Impaired loans
                   
Commercial (1)
   
2,220
 
Sales comparison approach
Adjustment for differences between comparable sales
   
(2.3
)%
         
Income approach
Capitalization rate
   
9.3
 
Mortgage
   
772
 
Sales comparison approach
Adjustment for differences between comparable sales
   
5.6
 
 
                   
Other real estate
     
 
 
   
 
 
Commercial
804
Sales comparison approach
Adjustment for differences between comparable sales
(3.9
)
Mortgage and installment
   
439
 
Sales comparison approach
Adjustment for differences between comparable sales
   
20.6
 
                     
December 31, 2014
                   
Capitalized mortgage
loan servicing rights
 
$
9,197
 
Present value of net servicing revenue
Discount rate
   
10.07
%
         
   
Cost to service
 
$
82
 
                
Ancillary income
   
25
 
                
Float rate
   
1.77
%
                     
Impaired loans
   
 
 
 
 
   
 
 
Commercial (1)
2,751
Sales comparison approach
Adjustment for differences between comparable sales
(3.8
)%
         
Income approach
Capitalization rate
   
9.3
 
Mortgage
   
1,306
 
Sales comparison approach
Adjustment for differences between comparable sales
   
8.6
 
                     
Other real estate
   
 
 
 
 
   
Commercial
1,216
Sales comparison approach
Adjustment for differences between comparable sales
(9.0
)
Mortgage and  installment
   
690
 
Sales comparison approach
Adjustment for differences between comparable sales
   
34.3
 


(1)
In addition to the valuation techniques and unobservable inputs discussed above, at June 30, 2015 and December 31, 2014, we had an impaired collateral dependent commercial relationship that totaled $0.5 million and $1.1 million, respectively that was primarily secured by collateral other than real estate.  Collateral securing this relationship primarily included machinery and equipment, accounts receivable, inventory and company stock.  Valuation techniques at June 30, 2015, included discounting restructuring firm valuations based on estimates of value recovery of each particular asset type.  Discount rates used ranged from 0% to 100% of stated values.  Valuation techniques at December 31, 2014, included discounting cost and financial statement value approaches based on estimates of value recovery of each particular asset type.  Discount rates used ranged from 35% to 100% of stated values.
 
51

NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
(unaudited)

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 for the periods presented.

   
Aggregate
Fair Value
   
Difference
   
Contractual
Principal
 
   
(In thousands)
 
Loans held for sale
           
June 30, 2015
 
$
30,518
   
$
503
   
$
30,015
 
December 31, 2014
   
23,662
     
624
     
23,038
 

13. 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 cannot be determined with precision. 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.

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

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

Securities:  Financial instrument assets actively traded in a secondary market have been valued using quoted market prices.  Trading securities are classified as Level 1 while securities available for sale are classified as Level 2 as described in Note #12.

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

Net loans and loans held for sale:  The fair value of loans is calculated by discounting estimated future cash flows using estimated market discount rates that reflect credit and interest-rate risk inherent in the loans resulting in a Level 3 classification.  Impaired loans are valued at the lower of cost or fair value as described in Note #12.  Loans held for sale are classified as Level 2 as described in Note #12.

Accrued interest receivable and payable:  The recorded book balance of accrued interest receivable and payable approximate fair value and are classified at the same Level as the asset and liability they are associated with.
 
52

NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
(unaudited)

Derivative financial instruments:  The fair value of rate-lock mortgage loan commitments and mandatory commitments to sell mortgage loans is based on mortgage backed security pricing for comparable assets, while the fair value of interest rate swap agreements is based on a discounted cash flow analysis whose significant fair value inputs can generally be observed in the market place and do not typically involve judgment by management. Each of these instruments has been classified as Level 2 as described in note #12.

Deposits:  Deposits without a stated maturity, including demand deposits, savings, NOW and money market accounts, have a fair value equal to the amount payable on demand.  Each of these instruments is classified as Level 1.  Deposits with a stated maturity, such as certificates of deposit have generally been valued based on the discounted value of contractual cash flows using a discount rate approximating current market rates for liabilities with a similar maturity resulting in a Level 2 classification.

Other borrowings:  Other borrowings have been valued based on the discounted value of contractual cash flows using a discount rate approximating current market rates for liabilities with a similar maturity resulting in a Level 2 classification.

Subordinated debentures:  Subordinated debentures have generally been valued based on a quoted market price of similar instruments resulting in a Level 2 classification.
 
53

NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
(unaudited)

The estimated recorded book balances and fair values follow:

           
Fair Value Using
 
   
Recorded
Book
Balance
   
Fair Value
   
Quoted
Prices
in Active
Markets
for
Identical
Assets
(Level 1)
   
Significant
Other
Observable
Inputs
(Level 2)
   
Significant
Un-
observable
Inputs
(Level 3)
 
   
(In thousands)
 
June 30, 2015
                   
Assets
                   
Cash and due from banks
 
$
44,272
   
$
44,272
   
$
44,272
   
$
-
   
$
-
 
Interest bearing deposits
   
14,045
     
14,045
     
14,045
     
-
     
-
 
Interest bearing deposits - time
   
10,853
     
10,892
     
-
     
10,892
     
-
 
Trading securities
   
180
     
180
     
180
     
-
     
-
 
Securities available for sale
   
557,695
     
557,695
     
-
     
557,695
     
-
 
Federal Home Loan Bank and Federal
                                       
Reserve Bank Stock
   
15,146
   
NA
   
NA
   
NA
   
NA
 
Net loans and loans held for sale
   
1,455,939
     
1,435,236
     
-
     
30,518
     
1,404,718
 
Accrued interest receivable
   
6,059
     
6,059
     
1
     
1,647
     
4,411
 
Derivative financial instruments
   
1,100
     
1,100
     
-
     
1,100
     
-
 
                                         
Liabilities
                                       
Deposits with no stated maturity (1)
 
$
1,594,948
   
$
1,594,948
   
$
1,594,948
   
$
-
   
$
-
 
Deposits with stated maturity (1)
   
366,469
     
365,081
     
-
     
365,081
     
-
 
Other borrowings
   
12,325
     
14,165
     
-
     
14,165
     
-
 
Subordinated debentures
   
35,569
     
24,117
     
-
     
24,117
     
-
 
Accrued interest payable
   
392
     
392
     
20
     
372
     
-
 
Derivative financial instruments
   
222
     
222
     
-
     
222
     
-
 
                                         
December 31, 2014
                                       
Assets
                                       
Cash and due from banks
 
$
48,326
   
$
48,326
   
$
48,326
   
$
-
   
$
-
 
Interest bearing deposits
   
25,690
     
25,690
     
25,690
     
-
     
-
 
Interest bearing deposits - time
   
13,561
     
13,585
     
-
     
13,585
     
-
 
Trading securities
   
203
     
203
     
203
     
-
     
-
 
Securities available for sale
   
533,178
     
533,178
     
-
     
533,178
     
-
 
Federal Home Loan Bank and Federal
                                       
Reserve Bank Stock
   
19,919
   
NA
   
NA
   
NA
   
NA
 
Net loans and loans held for sale
   
1,407,634
     
1,394,424
     
-
     
23,662
     
1,370,762
 
Accrued interest receivable
   
5,995
     
5,995
     
2
     
1,599
     
4,394
 
Derivative financial instruments
   
619
     
619
     
-
     
619
     
-
 
                                         
Liabilities
                                       
Deposits with no stated maturity (1)
 
$
1,534,175
   
$
1,534,175
   
$
1,534,175
   
$
-
   
$
-
 
Deposits with stated maturity (1)
   
390,127
     
389,139
     
-
     
389,139
     
-
 
Other borrowings
   
12,470
     
14,560
     
-
     
14,560
     
-
 
Subordinated debentures
   
35,569
     
23,328
     
-
     
23,328
     
-
 
Accrued interest payable
   
380
     
380
     
21
     
359
     
-
 
Derivative financial instruments
   
366
     
366
     
-
     
366
     
-
 

(1)
Deposits with no stated maturity include reciprocal deposits with a recorded book balance of $12.5 million and $13.6 million at June 30, 2015 and December 31, 2014, respectively.  Deposits with a stated maturity include reciprocal deposits with a recorded book balance of $36.5 million and $40.1 million at June 30, 2015 and December 31, 2014, respectively.

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.
 
54

NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
(unaudited)

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.

14.
Contingent Liabilities

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 approximately $0.5 million. 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 or vehicle service contract counterparty receivables). These excluded, collection-related matters may involve claims or counterclaims by the opposing party or parties, but we have excluded such matters from the disclosure contained in the preceding paragraph in all cases where we believe the possibility of us paying damages to any opposing party is remote. Risks associated with the likelihood that we will not collect the full amount owed to us, net of reserves, are disclosed elsewhere in this report.

Our Mepco segment conducts its payment plan business activities across the United States. Mepco acquires the payment plans from companies (which we refer to as Mepco’s “counterparties”) at a discount from the face amount of the payment plan. Each payment plan (which are classified as payment plan receivables in our Condensed Consolidated Statements of Financial Condition) permits a consumer to purchase a vehicle service contract by making installment payments, generally for a term of 12 to 24 months, to the sellers of those contracts (one of the “counterparties”). Mepco thereafter collects the payments from consumers. In acquiring the payment plan, Mepco generally funds a portion of the cost to the seller of the service contract and a portion of the cost to the administrator of the service contract. The administrator, in turn, pays the necessary contractual liability insurance policy (“CLIP”) premium to the insurer or risk retention group.
 
55

NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
(unaudited)

Consumers are allowed to voluntarily cancel the service contract at any time and are generally entitled to receive a refund from the administrator of the unearned portion of the service contract at the time of cancellation. As a result, while Mepco does not owe any refund to the consumer, it also does not have any recourse against the consumer for nonpayment of a payment plan and therefore does not evaluate the creditworthiness of the individual consumer. If a consumer stops making payments on a payment plan or exercises the right to voluntarily cancel the service contract, the service contract seller and administrator are each obligated to refund to Mepco the amount necessary to make Mepco whole as a result of its funding of the service contract. In addition, the insurer or risk retention group that issued the CLIP for the service contract often guarantees all or a portion of the refund to Mepco. See note #4 above for a breakdown of Mepco’s payment plan receivables by the level of recourse Mepco has against various counterparties.

Upon the cancellation of a service contract and the completion of the billing process to the counterparties for amounts due to Mepco, there is a decrease in the amount of “payment plan receivables” and an increase in the amount of “vehicle service contract counterparty receivables” until such time as the amount due from the counterparty is collected. These amounts represent funds actually due to Mepco from its counterparties for cancelled service contracts. At June 30, 2015 and December 31, 2014, the aggregate amount of such obligations owing to Mepco by counterparties, net of write-downs and reserves made through the recognition of vehicle service contract counterparty contingencies expense, totaled $7.3 million and $7.2 million, respectively.  Mepco is currently in the process of working to recover these receivables, primarily through litigation against counterparties.

In some cases, Mepco requires collateral or guaranties by the principals of the counterparties to secure these refund obligations; however, this is generally only the case when no rated insurance company is involved to guarantee the repayment obligation of the seller and administrator counterparties. In most cases, there is no collateral to secure the counterparties’ refund obligations to Mepco, but Mepco has the contractual right to offset unpaid refund obligations against amounts Mepco would otherwise be obligated to fund to the counterparties. In addition, even when collateral is involved, the refund obligations of these counterparties are not fully secured. Mepco incurs losses when it is unable to fully recover funds owing to it by counterparties upon cancellation of the underlying service contracts. The sudden failure of one of Mepco’s major counterparties (an insurance company, administrator, or seller/dealer) could expose us to significant losses.

When counterparties do not honor their contractual obligations to Mepco to repay funds, we recognize estimated losses. Mepco pursues collection (including commencing legal action if necessary) of funds due to it under its various contracts with counterparties.  Mepco has had to initiate litigation against certain counterparties, including third party insurers, to collect amounts owed to Mepco as a result of those parties' dispute of their contractual obligations to Mepco.  Charges related to estimated losses for vehicle service contract counterparty contingencies included in non-interest expense totaled $0.03 million and $0.07 million for the three month periods ended June 30, 2015 and 2014, respectively and totaled $0.06 million and $0.14 million for the six month periods ended June 30, 2015 and 2014, respectively.  These charges are being classified in non-interest expense because they are associated with a default or potential default of a contractual obligation under our counterparty contracts as opposed to loss on the administration of the payment plan itself.
 
56

NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
(unaudited)

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

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

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 and Freddie Mac). 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 $0.05 million and $0.02 million for the three months ended June 30, 2015 and 2014, respectively and a credit of $0.02 million and $0.47 million for the six months ended June 30, 2015 and 2014, respectively.  The credit provision in the first six months of 2015 is due primarily to the settlement of certain loss reimbursement claims at slightly lower amounts than what had been specifically reserved for at the end of 2014.  The credit provision in the first six months of 2014 is due primarily to the rescission of certain loss reimbursement requests by Freddie Mac that had been pending and accrued for at the end of 2013.  The reserve for loss reimbursements on sold mortgage loans totaled $0.7 million at both June 30, 2015 and December 31, 2014. This reserve is included in accrued expenses and other liabilities in our Condensed Consolidated Statements of Financial Condition. This reserve is based on an analysis of mortgage loans that we have sold which are further categorized by delinquency status, loan to value, and year of origination. The calculation includes factors such as probability of default, probability of loss reimbursement (breach of representation or warranty) and estimated loss severity. The reserve levels at June 30, 2015 and December 31, 2014 also reflect the resolution of the mortgage loan origination years of 2000 to 2008 with Fannie Mae and Freddie Mac.  We believe that the amounts that we have accrued for incurred losses on sold mortgage loans are appropriate given our analyses.  However, future losses could exceed our current estimate.
 
57

NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
(unaudited)

15. Accumulated Other Comprehensive Loss (“AOCL”)

A summary of changes in AOCL follows:

   
Unrealized
Gains
(Losses) on
Available
for Sale
Securities
   
Dispropor-
tionate
Tax Effects
from
Securities
Available
for Sale
   
Unrealized
Losses on
Settled
Derivatives
   
Total
 
For the three months ended June 30,
               
2015
               
Balances at beginning of period
 
$
1,596
   
$
(5,798
)
 
$
-
   
$
(4,202
)
Other comprehensive loss before reclassifications
   
(1,188
)
   
-
     
-
     
(1,188
)
Amounts reclassified from AOCL
   
-
     
-
     
-
     
-
 
Net current period other comprehensive loss
   
(1,188
)
   
-
     
-
     
(1,188
)
Balances at end of period
 
$
408
   
$
(5,798
)
 
$
-
   
$
(5,390
)
                                 
2014
                               
Balances at beginning of period
 
$
(1,661
)
 
$
(5,798
)
 
$
(185
)
 
$
(7,644
)
Other comprehensive income before reclassifications
   
1,286
     
-
     
-
     
1,286
 
Amounts reclassified from AOCL
   
(1
)
   
-
     
61
     
60
 
Net current period other comprehensive income
   
1,285
     
-
     
61
     
1,346
 
Balances at end of period
 
$
(376
)
 
$
(5,798
)
 
$
(124
)
 
$
(6,298
)
                                 
                                 
For the six months ended June 30,
                               
2015
                               
Balances at beginning of period
 
$
162
   
$
(5,798
)
 
$
-
   
$
(5,636
)
Other comprehensive income before reclassifications
   
295
     
-
     
-
     
295
 
Amounts reclassified from AOCL
   
(49
)
   
-
     
-
     
(49
)
Net current period other comprehensive ncome
   
246
     
-
     
-
     
246
 
Balances at end of period
 
$
408
   
$
(5,798
)
 
$
-
   
$
(5,390
)
                                 
2014
                               
Balances at beginning of period
 
$
(3,200
)
 
$
(5,798
)
 
$
(247
)
 
$
(9,245
)
Other comprehensive income before reclassifications
   
2,825
     
-
     
-
     
2,825
 
Amounts reclassified from AOCL
   
(1
)
   
-
     
123
     
122
 
Net current period other comprehensive income
   
2,824
     
-
     
123
     
2,947
 
Balances at end of period
 
$
(376
)
 
$
(5,798
)
 
$
(124
)
 
$
(6,298
)
 
58

NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
(unaudited)

The disproportionate tax effects from securities available for sale arose due to tax effects of other comprehensive income (“OCI”) in the presence of a valuation allowance against our deferred tax assets and a pretax loss from operations.  Generally, the amount of income tax expense or benefit allocated to operations is determined without regard to the tax effects of other categories of income or loss, such as OCI. However, an exception to the general rule is provided when, in the presence of a valuation allowance against deferred tax assets, there is a pretax loss from operations and pretax income from other categories in the current period.  In such instances, income from other categories must offset the current loss from operations, the tax benefit of such offset being reflected in operations.

A summary of reclassifications out of each component of AOCL for the three months ended June 30 follows:

AOCL Component
 
Amount
Reclassified
From
AOCL
 
 Affected Line Item in Condensed
 Consolidated Statements of Operations
   
(In thousands)
   
2015
      
Unrealized gains on available for sale securities
      
   
$
-
 
 Net gains on securities
     
-
 
 Net impairment loss recognized in earnings
     
-
 
 Total reclassifications before tax
     
-
 
 Tax expense
   
$
-
 
 Reclassifications, net of tax
             
2014
          
Unrealized gains on available for sale securities
          
   
$
2
 
 Net gains on securities
     
-
 
 Net impairment loss recognized in earnings
     
2
 
 Total reclassifications before tax
     
1
 
 Tax expense
   
$
1
 
 Reclassifications, net of tax
             
Unrealized gains on settled derivatives
          
   
$
(95
)
 Interest expense
     
(34
)
 Tax benefit
   
$
(61
)
 Reclassification, net of tax
             
   
$
(60
)
 Total reclassifications for the period, net of tax
 
59

NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
(unaudited)

A summary of reclassifications out of each component of AOCL for the six months ended June 30 follows:

AOCL Component
 
Amount
Reclassified
From
AOCL
 
 Affected Line Item in Condensed
 Consolidated Statements of Operations
   
(In thousands)
   
2015
      
Unrealized gains on available for sale securities
      
   
$
75
 
 Net gains on securities
     
-
 
 Net impairment loss recognized in earnings
     
75
 
 Total reclassifications before tax
     
26
 
 Tax expense
   
$
49
 
 Reclassifications, net of tax
             
2014
          
Unrealized gains on available for sale securities
          
   
$
2
 
 Net gains on securities
     
-
 
 Net impairment loss recognized in earnings
     
2
 
 Total reclassifications before tax
     
1
 
 Tax expense
   
$
1
 
 Reclassifications, net of tax
             
Unrealized gains on settled derivatives
          
   
$
(190
)
 Interest expense
     
(67
)
 Tax benefit
   
$
(123
)
 Reclassification, net of tax
             
   
$
(122
)
 Total reclassifications for the period, net of tax
 
60

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

Introduction. The following section presents additional information to assess the financial condition and results of operations of Independent Bank Corporation, its wholly-owned bank, Independent Bank (the "Bank"), and their subsidiaries. This section should be read in conjunction with the Condensed Consolidated Financial Statements. We also encourage you to read our 2014 Annual Report on Form 10-K filed with the U.S. Securities and Exchange Commission ("SEC"). That report includes a list of risk factors that you should consider in connection with any decision to buy or sell our securities.

Overview. We provide banking services to customers located primarily in Michigan’s Lower Peninsula.  As a result, our success depends to a great extent upon the economic conditions in Michigan’s Lower Peninsula. Beginning in 2001, we have experienced a difficult economy in Michigan which had at times, a significant adverse effect on our performance.  As a result of the recession, we incurred net losses from 2008 through 2011 and found it necessary to take certain steps to preserve capital and maintain our regulatory capital ratios.

Economic conditions in Michigan began to show signs of improvement during 2010.  Generally, these improvements have continued into 2015, albeit at an uneven pace.  There has been an overall decline in the unemployment rate and housing prices and other related statistics (such as home sales and new building permits) have generally been improving.  In addition, since early- to mid-2009, we have seen an improvement in our asset quality metrics. In particular, since early 2012, we have generally experienced a decline in non-performing assets, reduced levels of new loan defaults, and reduced levels of loan net charge-offs.  As a result of the foregoing factors and others, we returned to profitability in 2012 and have now been profitable for 14 consecutive quarters.  In addition, we completed various transactions to improve our capital structure.

Recent Developments. On April 29, 2015 the Bank entered into a Purchase and Assumption Agreement (“PAA”) with Isabella Bank (based in Mt. Pleasant, Michigan).  Pursuant to the PAA, we are selling the fixed assets (including an automated teller machine), real property and certain other assets of our bank branch located at 210 South Saginaw Road, Midland, Michigan (the “Midland Branch”) to Isabella Bank.  The deposit liabilities of the Midland Branch (which totaled approximately $13.8 million at June 30, 2015) will be assumed by Isabella Bank.  Under the terms of the PAA, Isabella Bank will pay a premium equal to 6.0% of the average deposit liabilities (based on the 20-day average ending two business days prior to the closing date) of the Midland Branch and $850,000 for the real property and fixed assets (including the ATM).  The real property and the fixed assets (including the ATM) had a net book value of approximately $0.2 million as of June 30, 2015.  Subject to the satisfaction of customary closing conditions, the closing of the transaction is expected to occur on August 28, 2015.

In January 2015, we adopted a plan to consolidate certain branch offices (the “Branch Consolidation”). This Branch Consolidation reflects our ongoing cost reduction initiatives and undertakings to further improve the overall efficiency of our operations.  The Branch Consolidation resulted in the closing of six of our branch offices on April 30, 2015.  It is expected that the aggregate, annual reduction in non-interest expenses resulting from the Branch Consolidation will amount to approximately $1.6 million.  We also estimate a potential annual loss of revenue of approximately $0.3 million to $0.4 million due to possible customer attrition. We also undertook certain additional staffing reductions related to our retail banking operations. In connection with the Branch Consolidation and these staffing reductions, we recorded $0.2 million of severance expenses in the first quarter of 2015.  We recorded a net gain of approximately $0.2 million in the second quarter of 2015 (included in Other Non-Interest Income) that was comprised of a $0.3 million gain on the sale of the real property of two of the branches that was partially offset by $0.1 million of write downs of the fixed assets (including real property) of the other four branches.  We are in the process of disposing of the real property associated with these other four branches.
 
61

Regulation. On July 2, 2013, the Federal Reserve Board (the "FRB") approved a final rule that establishes an integrated regulatory capital framework (the "New Capital Rules"). The rule implements in the United States the Basel III regulatory capital reforms from the Basel Committee on Banking Supervision and certain changes required by the 2010 Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”).  In general, under the New Capital Rules, minimum requirements have increased for both the quantity and quality of capital held by banking organizations. Consistent with the international Basel framework, the New Capital Rules include a new minimum ratio of common equity tier 1 capital to risk-weighted assets of 4.5% and a common equity tier 1 capital conservation buffer of 2.5% of risk-weighted assets that applies to all supervised financial institutions. The 2.5% capital conservation buffer is being phased in over a four-year period beginning in 2016. The rule also raises the minimum ratio of tier 1 capital to risk-weighted assets from 4% to 6% and includes a minimum leverage ratio of 4% for all banking organizations. As to the quality of capital, the New Capital Rules emphasize common equity tier 1 capital, the most loss-absorbing form of capital, and implements strict eligibility criteria for regulatory capital instruments. The New Capital Rules also change the methodology for calculating risk-weighted assets to enhance risk sensitivity.  Under the New Capital Rules our existing trust preferred securities are grandfathered as qualifying regulatory capital. We were subject to the New Capital Rules beginning on January 1, 2015 and as of June 30, 2015 we exceeded all of the capital ratio requirements of the New Capital Rules.

It is against this backdrop that we discuss our results of operations and financial condition for the second quarter and first six months of 2015 as compared to 2014.

Results of Operations

Summary.  We recorded net income of $5.6 million and $6.1 million, respectively, during the three months ended June 30, 2015 and 2014.  The decline in 2015 results as compared to 2014 primarily reflects an increase in the provision for loan losses (a smaller credit) and an increase in income tax expense that were partially offset by increases in net interest income and non-interest income and by a decrease in non-interest expenses.

We recorded net income of $9.4 million and $9.2 million, respectively, during the six months ended June 30, 2015 and 2014.  The increase in 2015 year-to-date results as compared to 2014 primarily reflects an increase in non-interest income and a decrease in non-interest expenses that were partially offset by a decrease in net interest income, an increase in the provision for loan losses (a smaller credit) and an increase in income tax expense.
 
62

Key performance ratios
 
   
Three months ended
June 30,
   
Six months ended
June 30,
 
   
2015
   
2014
   
2015
   
2014
 
Net income (annualized) to
               
Average assets
   
0.98
%
   
1.08
%
   
0.83
%
   
0.83
%
Average common shareholders’ equity
   
8.86
     
10.13
     
7.46
     
7.81
 
                                 
Net income per common share
                               
Basic
 
$
0.25
   
$
0.26
   
$
0.41
   
$
0.40
 
Diluted
   
0.24
     
0.26
     
0.40
     
0.39
 

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.

Our net interest income totaled $18.7 million during the second quarter of 2015, an increase of $0.2 million, or 0.9% from the year-ago period.  The increase in net interest income in 2015 compared to 2014 primarily reflects a $74.6 million increase in average interest-earning assets that was partially offset by a 12 basis point decrease in our tax equivalent net interest income as a percent of average interest-earning assets (the “net interest margin”)

For the first six months of 2015, net interest income totaled $36.8 million, a decrease of $0.2 million, or 0.6% from 2014.  Our net interest margin for the first six months of 2015 declined to 3.60% compared to 3.76% in 2014.  The impact of the lower net interest margin was partially offset by a $72.7 million increase in average interest-earning assets.

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

Interest rates have generally been at extremely low levels since 2008 due primarily to the FRB’s monetary policies and its efforts to stimulate the U.S. economy.  This very low interest rate environment has had an adverse impact on our interest income and net interest income.   Based on recent announcements by the FRB, short-term interest rates are expected to remain extremely low until at least late-2015.  Given the repricing characteristics of our interest-earning assets and interest-bearing liabilities (and our level of non-interest bearing demand deposits), we would expect that our net interest margin will generally benefit on a long-term basis from rising interest rates.

Our net interest income is also adversely impacted by our level of non-accrual loans.  In the second quarter and first six months of 2015 non-accrual loans averaged $13.2 million and $14.1 million, respectively compared to $19.4 million and $19.0 million, respectively for the same periods in 2014.  In addition, in the second quarter and first six months of 2015 we had net recoveries of $0.130 million and $0.178 million, respectively, of accrued and unpaid interest on loans placed on or taken off non-accrual during each period compared to net recoveries of $0.159 million and $0.152 million, respectively, during the same periods in 2014.
 
63

Average Balances and Tax Equivalent Rates
 
    
Three Months Ended
June 30,
 
 
2015
   
 
   
2014
 
   
Average
Balance
   
Interest
   
Rate (3)
   
Average
Balance
   
Interest
   
Rate (3)
 
 
   
(Dollars in thousands)
 
Assets (1)
                       
Taxable loans
 
$
1,449,218
   
$
17,707
     
4.90
%
 
$
1,373,429
   
$
18,094
     
5.28
%
Tax-exempt loans (2)
   
4,198
     
67
     
6.40
     
5,092
     
80
     
6.30
 
Taxable securities
   
529,345
     
1,869
     
1.41
     
486,043
     
1,596
     
1.32
 
Tax-exempt securities (2)
   
31,397
     
341
     
4.34
     
42,849
     
439
     
4.11
 
Interest bearing cash and
repurchase agreement
       
50,664
          
54
          
0.43
          
77,502
          
67
          
0.35
  
Other investments
   
18,145
     
235
     
5.19
     
23,414
     
261
     
4.47
 
Interest Earning Assets
   
2,082,967
     
20,273
     
3.90
     
2,008,329
     
20,537
     
4.10
 
Cash and due from banks
   
42,980
                     
43,314
                 
Other assets, net
   
167,499
                     
186,342
                 
Total Assets
 
$
2,293,446
                   
$
2,237,985
                 
                                                 
Liabilities
                                               
Savings and interest-
bearing checking
    
$
 
990,019
          
260
          
0.11
       
$
 
963,662
          
266
          
0.11
  
Time deposits
   
371,304
     
707
     
0.76
     
419,190
     
994
     
0.95
 
Other borrowings
   
47,986
     
463
     
3.87
     
56,503
     
559
     
3.97
 
Interest Bearing Liabilities
   
1,409,309
     
1,430
     
0.41
     
1,439,355
     
1,819
     
0.51
 
Non-interest bearing deposits
   
603,706
                     
525,441
                 
Other liabilities
   
25,948
                     
33,568
                 
Shareholders’ equity
   
254,483
                     
239,621
                 
Total liabilities and shareholders’ equity
 
$
2,293,446
                   
$
2,237,985
                 
                                                 
Net Interest Income
         
$
18,843
                   
$
18,718
         
                                                 
Net Interest Income as a Percent of Average Interest Earning Assets
                   
3.62
%
                   
3.74
%


(1) All domestic.
(2) Interest on tax-exempt loans and securities is presented on a fully tax equivalent basis assuming a marginal tax rate of 35%
(3)
Annualized
 
64

Average Balances and Tax Equivalent Rates

 
   
Six Months Ended
June 30,
 
   
2015
   
2014
 
   
Average
Balance
   
Interest
   
Rate (3)
   
Average
Balance
   
Interest
   
Rate (3)
 
   
(Dollars in thousands)
 
Assets (1)
                       
Taxable loans
 
$
1,434,817
   
$
34,902
     
4.89
%
 
$
1,371,274
   
$
36,256
     
5.32
%
Tax-exempt loans (2)
   
4,279
     
135
     
6.36
     
5,142
     
162
     
6.35
 
Taxable securities
   
517,941
     
3,627
     
1.40
     
464,035
     
2,979
     
1.29
 
Tax-exempt securities (2)
   
32,630
     
674
     
4.13
     
41,941
     
838
     
4.03
 
Interest bearing cash and
repurchase agreement
     
62,850
        
124
        
0.40
        
93,093
        
158
        
0.34
  
Other investments
   
19,063
     
503
     
5.32
     
23,416
     
593
     
5.11
 
Interest Earning Assets
   
2,071,580
     
39,965
     
3.88
     
1,998,901
     
40,986
     
4.13
 
Cash and due from banks
   
44,500
                     
44,370
                 
Other assets, net
   
169,678
                     
187,290
                 
Total Assets
 
$
2,285,758
                   
$
2,230,561
                 
                                                 
Liabilities
                                               
Savings and interest-
bearing checking
    
$
 
987,763
          
526
          
0.11
       
$
 
955,026
          
529
          
0.11
  
Time deposits
   
374,115
     
1,448
     
0.78
     
431,343
     
2,024
     
0.95
 
Other borrowings
   
48,012
     
917
     
3.85
     
55,422
     
1,071
     
3.90
 
Interest Bearing Liabilities
   
1,409,890
     
2,891
     
0.41
     
1,441,791
     
3,624
     
0.51
 
Non-interest bearing deposits
   
596,935
                     
518,491
                 
Other liabilities
   
24,951
                     
32,944
                 
Shareholders’ equity
   
253,982
                     
237,335
                 
Total liabilities and shareholders’ equity
 
$
2,285,758
                   
$
2,230,561
                 
                                                 
Net Interest Income
         
$
37,074
                   
$
37,362
         
                                                 
Net Interest Income as a Percent of Average Interest Earning Assets
                   
3.60
%
                   
3.76
%
 

(1) All domestic.
(2) Interest on tax-exempt loans and securities is presented on a fully tax equivalent basis assuming a marginal tax rate of 35%
(3) Annualized
 
65

Provision for loan losses.  The provision for loan losses was a credit of $0.1 million and $1.8 million during the three months ended June 30, 2015 and 2014, respectively. During the six-month periods ended June 30, 2015 and 2014, the provision was a credit of $0.8 million and $1.4 million, 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 in the second quarter and first half of 2015.

Non-interest income.  Non-interest income is a significant element in assessing our results of operations. We regard net gains on mortgage loans as a core recurring source of revenue but they are quite cyclical and thus can be volatile. We regard net gains (losses) on securities as a “non-operating” component of non-interest income.

Non-interest income totaled $11.0 million during the second quarter of 2015 compared to $10.1 million in 2014.  For the first six months of 2015 non-interest income totaled $19.9 million compared to $19.0 million for the first six months of 2014.  The quarterly and year-to-date comparative increases are primarily due to increases in interchange income, net gains on mortgage loans, mortgage loan servicing income and title insurance fees that were partially offset by decreases in service charges on deposit accounts and other non-interest income.

Non-Interest Income
 
   
Three months ended
June 30,
   
Six months ended
June 30,
 
   
2015
   
2014
   
2015
   
2014
 
   
(In thousands)
 
Service charges on deposit accounts
 
$
3,117
   
$
3,532
   
$
5,967
   
$
6,587
 
Interchange income
   
2,240
     
2,067
     
4,382
     
4,008
 
Net gains (losses) on assets:
                               
Mortgage loans
   
1,784
     
1,505
     
3,923
     
2,649
 
Securities
   
(33
)
   
54
     
52
     
166
 
Mortgage loan servicing
   
1,452
     
193
     
1,032
     
457
 
Investment and insurance commissions
   
487
     
499
     
933
     
901
 
Bank owned life insurance
   
325
     
341
     
675
     
660
 
Title insurance fees
   
337
     
217
     
593
     
491
 
Other
   
1,278
     
1,668
     
2,392
     
3,112
 
Total non-interest income
 
$
10,987
   
$
10,076
   
$
19,949
   
$
19,031
 

Service charges on deposit accounts declined on both a comparative quarterly and year-to-date basis in 2015 as compared to 2014.  The decrease in such service charges in 2015 principally results from a decline in non-sufficient funds (“NSF”) occurrences and related NSF fees. We believe the decline in NSF occurrences is principally due to our customers managing their finances more closely in order to reduce NSF activity and avoid the associated fees.

Interchange income increased on both a comparative quarterly and year-to-date basis in 2015 as compared to 2014.  The increase in interchange income in 2015 as compared to 2014 primarily results from a new Debit Brand Agreement with MasterCard (which replaced our former agreement with VISA) that we executed in January 2014.  We began converting our debit card base to MasterCard in June 2014 and completed the conversion in September 2014.
 
66

The Dodd-Frank Act includes a provision under which interchange fees for debit cards are set by the FRB under a restrictive “reasonable and proportional cost” per transaction standard. On June 29, 2011, the FRB issued final rules (that were effective October 1, 2011) on interchange fees for debit cards. Overall, these final rules established price caps for debit card interchange fees that were significantly lower than previous averages. However, debit card issuers with less than $10 billion in assets (like us) are exempt from this rule. On a long-term basis, it is not clear how competitive market factors may impact debit card issuers who are exempt from the rule.  However, we have been experiencing some reduction in per transaction interchange revenue due to certain transaction routing changes, particularly at large merchants.

Net gains on mortgage loans increased on both a quarterly and a year to date basis. Mortgage loan activity is summarized as follows:

Mortgage Loan Activity

   
Three months ended
June 30,
   
Six months ended
June 30
 
   
2015
   
2014
   
2015
   
2014
 
   
(Dollars in thousands)
 
Mortgage loans originated
 
$
101,306
   
$
65,430
   
$
181,096
   
$
109,671
 
Mortgage loans sold
   
82,167
     
46,965
     
150,894
     
94,083
 
Mortgage loans sold with servicing rights released
   
773
     
8,357
     
3,442
     
16,218
 
Net gains on the sale of mortgage loans
   
1,784
     
1,505
     
3,923
     
2,649
 
Net gains as a percent of mortgage loans sold (“Loan Sales Margin”)
   
2.17
%
   
3.20
%
   
2.60
%
   
2.82
%
Fair value adjustments included in the Loan Sales Margin
   
(0.07
)
   
0.61
     
0.33
     
0.23
 

The increases in mortgage loan originations, sales and net gains in 2015 as compared to 2014 is due primarily to a decrease in mortgage loan interest rates during the first four months of 2015 that resulted in an increase in  mortgage loan refinance volumes.  However, mortgage loan interest rates have increased during the last two months of the second quarter of 2015 and, as a result, we anticipate mortgage loan refinance volumes to decline in the second half of 2015.

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 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 (with servicing rights retained or released). Our decision to sell or retain mortgage loan servicing rights is primarily influenced by an evaluation of the price being paid for mortgage loan servicing by outside third parties compared to our calculation of the economic value of retaining such servicing. Net gains on mortgage loans are also impacted by recording fair value accounting adjustments.  Excluding the aforementioned fair value accounting adjustments, the Loan Sales Margin would have been 2.24% and 2.59% in the second quarters of 2015 and 2014, respectively and 2.27% and 2.59% for the comparative 2015 and 2014 year-to-date periods, respectively.  The decrease in the Loan Sales Margin (excluding fair value adjustments) in 2015 was generally due to a narrowing of primary-to-secondary market pricing spreads reflecting increased price competition. The changes in the fair value accounting adjustments are primarily due to changes in the amount of commitments to originate mortgage loans for sale.
 
67

Securities net gains (losses) totaled $(0.03) million and $0.05 million during the three and six months ended June 30, 2015, respectively, and $0.05 million and $0.17 million for the respective comparable periods in 2014.  The second quarter 2015 securities net loss was due to a decline in the fair value of our trading securities.  The 2015 year to date securities net gain was due primarily to the sale of U.S. agency residential mortgage-backed securities.  The 2014 net securities gains were due primarily to fair value adjustments related to the short sale of a U.S. Treasury security and an increase in the fair value of trading securities. (See “Securities.”)

We recorded no net impairment losses in either 2015 or 2014 for other than temporary impairment of securities available for sale.  (See “Securities.”)

Mortgage loan servicing generated income of $1.5 million and $1.0 million in the second quarter and first six months of 2015, respectively, compared to income of $0.2 million and $0.5 million in the corresponding periods of 2014, respectively. These variances are primarily due to changes in the valuation allowance on and the amortization of capitalized mortgage loan servicing rights. The period end valuation allowance is based on the valuation of the mortgage loan servicing portfolio.  Activity related to capitalized mortgage loan servicing rights is as follows:
 
Capitalized Mortgage Loan Servicing Rights
 
   
Three months ended
June 30,
   
Six months ended
June 30,
 
   
2015
   
2014
   
2015
   
2014
 
   
(In thousands)
 
Balance at beginning of period
 
$
11,318
   
$
13,273
   
$
12,106
   
$
13,710
 
Originated servicing rights capitalized
   
787
     
382
     
1,450
     
764
 
Amortization
   
(800
)
   
(665
)
   
(1,559
)
   
(1,199
)
Change in valuation allowance
   
1,230
     
(194
)
   
538
     
(479
)
Balance at end of period
 
$
12,535
   
$
12,796
   
$
12,535
   
$
12,796
 
                                 
Valuation allowance at end of period
 
$
3,235
   
$
3,334
   
$
3,235
   
$
3,334
 

At June 30, 2015 we were servicing approximately $1.65 billion in mortgage loans for others on which servicing rights have been capitalized. This servicing portfolio had a weighted average coupon rate of 4.36% and a weighted average service fee of approximately 25.3 basis points. Remaining capitalized mortgage loan servicing rights at June 30, 2015 totaled $12.5 million, representing approximately 76 basis points on the related amount of mortgage loans serviced for others. The capitalized mortgage loan servicing had an estimated fair market value of $13.2 million at June 30, 2015.
 
68

Investment and insurance commissions represent revenues generated on the sale or management of investments and insurance for our customers.  These revenues were relatively unchanged on both a quarterly and year-to-date basis in 2015 as compared to 2014.

Income from bank owned life insurance was relatively consistent on both a comparative quarterly and year-to-date basis in 2015 compared to 2014 reflecting a stable average crediting rate on our cash surrender value. Our separate account is primarily invested in agency mortgage-backed securities and managed by PIMCO. The crediting rate (on which the earnings are based) reflects the performance of the separate account.  The total cash surrender value of our bank owned life insurance was $54.3 million and $53.6 million at June 30, 2015 and December 31, 2014, respectively.

Title insurance fees were higher on both a comparative quarterly and year-to-date basis in 2015 as compared to 2014.  The amount of title insurance fees is primarily a function of the level of mortgage loans that we originated. During 2015, an increase in title insurance revenues related to mortgage loans was partially offset by a decline in title insurance revenues related to commercial loans and a lower retention bonus as compared to 2014.

Other non-interest income decreased on both a comparative quarterly and year-to-date basis in 2015 compared to 2014.  This decrease is primarily due to a decline in rental income on other real estate (“ORE”) due to the sales of such properties.

Non-interest expense.  Non-interest expense is an important component of our results of operations. We strive to efficiently manage our cost structure and management is focused on a number of initiatives to reduce and contain non-interest expenses.

Non-interest expense decreased by $1.0 million to $21.6 million and by $1.2 million to $43.7 million during the three- and six-month periods ended June 30, 2015, respectively, compared to the same periods in 2014.  These decreases were primarily due to declines in loan and collection costs as well as several other expense categories (occupancy, furniture, fixtures and equipment, advertising, FDIC deposit insurance, interchange expense, supplies and credit card and bank service fees).
 
69

Non-Interest Expense

   
Three months ended
June 30,
   
Six months ended
June 30,
 
   
2015
   
2014
   
2015
   
2014
 
   
(in thousands)
 
Compensation
 
$
8,131
   
$
8,439
   
$
16,461
   
$
16,747
 
Performance-based compensation
   
1,744
     
1,233
     
3,032
     
2,145
 
Payroll taxes and employee benefits
   
1,916
     
2,146
     
4,083
     
4,164
 
Compensation and employee benefits
   
11,791
     
11,818
     
23,576
     
23,056
 
Occupancy, net
   
2,040
     
2,153
     
4,459
     
4,636
 
Data processing
   
2,027
     
1,777
     
3,957
     
3,863
 
Loan and collection
   
967
     
1,427
     
2,122
     
2,892
 
Furniture, fixtures and equipment
   
965
     
1,053
     
1,917
     
2,122
 
Communications
   
694
     
711
     
1,430
     
1,500
 
Advertising
   
448
     
601
     
932
     
1,120
 
Legal and professional fees
   
453
     
420
     
833
     
821
 
FDIC deposit insurance
   
351
     
422
     
694
     
839
 
Interchange expense
   
289
     
342
     
580
     
744
 
Supplies
   
216
     
258
     
429
     
497
 
Credit card and bank service fees
   
203
     
245
     
405
     
508
 
Amortization of intangible assets
   
87
     
134
     
174
     
268
 
Vehicle service contract counterparty contingencies
   
30
     
73
     
59
     
141
 
Costs related to unfunded lending commitments
   
4
     
5
     
20
     
15
 
Provision for loss reimbursement on sold loans
   
45
     
15
     
(24
)
   
(466
)
Net gains on ORE and repossessed assets
   
(139
)
   
(38
)
   
(178
)
   
(125
)
Other
   
1,108
     
1,144
     
2,345
     
2,529
 
Total non-interest expense
 
$
21,579
   
$
22,560
   
$
43,730
   
$
44,960
 

Compensation and employee benefits expenses, in total, decreased slightly on a quarterly comparative basis and increased $0.5 million, or 2.3%, for the first six months of 2015 compared to the same periods in 2014.

Compensation expense decreased by $0.3 million, or 3.6%, and by $0.3 million, or 1.7%, in the second quarter and first six months of 2015, respectively, compared to the same periods in 2014.  Average full-time equivalent employees (“FTEs”) were reduced by approximately 4.7% and  3.8% during the second quarter and first six months of 2015, respectively, compared to the year ago periods.  However, the impact of the FTE reductions was partially offset by merit raises granted in 2015.

Performance-based compensation increased by $0.5 million and by $0.9 million in the second quarter and first six months of 2015, respectively, compared to the same periods in 2014, due primarily to a higher accrual for anticipated incentive compensation based on our estimated 2015 performance as compared to goals.

Payroll taxes and employee benefits decreased by $0.2 million and $0.1 million in the second quarter and first six months of 2015, respectively, compared to the same periods in 2014, due primarily to declines in medical insurance, workers’ compensation insurance, and employee training costs.
 
70

Occupancy, net, decreased by $0.1 million and $0.2 million in the second quarter and first six months of 2015, respectively, compared to the same periods in 2014.  These declines are primarily due to decreases in utility costs, real estate property taxes and property insurance which reflect fewer properties owned due to sales or other dispositions.

Data processing expenses increased by $0.25 million and by $0.1 million in the second quarter and first six months of 2015, respectively, compared to the same periods in 2014, due primarily to costs associated with a new sales and marketing system and the outsourcing of certain network and desktop delivery functions as well as an increase in mobile banking expenses.

Loan and collection expenses primarily reflect costs related to the management and collection of non-performing loans and other problem credits. These expenses have further declined in 2015, which primarily reflects the overall year-over-year decrease in non-performing assets. (See “Portfolio Loans and asset quality.”)

Furniture, fixtures and equipment, communications, and supplies expenses were all lower on both a comparative quarterly and year-to-date basis, which primarily reflects our cost reduction efforts.

Advertising expenses were lower on both a comparative quarterly and year-to-date basis due primarily to a reduction in outdoor (billboard) advertising and 2014 including expenses related to a website redesign.

Legal and professional fees increased slightly on both a comparative quarterly and year-to-date basis due primarily to an increase in legal fees at Mepco related to counterparty litigation associated with collection matters.

FDIC deposit insurance expense decreased by $0.07 million and by $0.15 million in the second quarter and first six months of 2015, respectively, compared to the same periods in 2014. The decline in 2015 principally reflects a reduction in the Bank’s risk based premium rate due to our continued improving financial metrics.

Interchange expense primarily represents our third-party cost to process debit card transactions.  This cost has declined on both a comparative quarterly and year-to-date basis due primarily to the impact of a new seven-year core data processing contract that we executed in March 2015.

Credit card and bank service fees decreased on both a comparative quarterly and year-to-date basis primarily due to a decline in the number of payment plans being serviced by Mepco in 2015 compared to 2014.

The amortization of intangible assets primarily relates to branch acquisitions and the amortization of the deposit customer relationship value, including core deposit value, which was acquired in connection with those acquisitions. We had remaining unamortized intangible assets of $2.5 million and $2.6 million at June 30, 2015 and December 31, 2014, respectively. See Note #8 to the Condensed Consolidated Financial Statements for a schedule of future amortization of intangible assets.
 
71

We record estimated incurred losses associated with Mepco’s vehicle service contract payment plan receivables in our provision for loan losses and establish a related allowance for loan losses. (See “Portfolio Loans and asset quality.”) We record estimated incurred losses associated with defaults by Mepco’s counterparties as “vehicle service contract counterparty contingencies expense,” which is included in non-interest expenses in our Condensed Consolidated Statements of Operations. Such expenses totaled $0.03 million and $0.06 million for vehicle service contract payment plan counterparty contingencies in the second quarter and first six months of 2015, respectively, compared to $0.07 million and $0.14 million, respectively, for the same periods in 2014.

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

In particular, as noted in our Risk Factors included in Part I - Item 1A of our Annual Report on Form 10-K for the year ended December 31, 2014, Mepco has had to initiate litigation against certain counterparties, including third party insurers, to collect amounts owed to Mepco as a result of those parties' dispute of their contractual obligations to Mepco.  In addition, see Note #14 to the Condensed Consolidated Financial Statements included within this report for more information about Mepco's business, certain risks and difficulties we currently face with respect to that business, and reserves we have established (through vehicle service contract counterparty contingencies expense) for losses related to the business.

The changes in cost 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 $0.05 million and a credit of $0.02 million in the second quarter and first six months of 2015, respectively, compared to an expense of $0.02 million and a credit of $0.47 million in the second quarter and first six months of 2014, respectively. This provision represents our estimate of incurred losses related to mortgage loans that we have sold to investors (primarily Fannie Mae and Freddie Mac).  The credit provision in the first half of 2015 is due primarily to the settlement of certain loss reimbursement claims at slightly lower amounts than what had been specifically reserved for at the end of 2014. The credit provision in the first half of 2014 is due primarily to the rescission of certain loss reimbursement requests by Freddie Mac that had been pending and accrued for at the end of 2013.  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 $0.7 million at both June 30, 2015 and December 31, 2014, respectively. This reserve is included in accrued expenses and other liabilities in our Condensed Consolidated Statements of Financial Condition. This reserve is based on an analysis of mortgage loans that we have sold which are further categorized by delinquency status, loan to value, and year of origination. The calculation includes factors such as probability of default, probability of loss reimbursement (breach of representation or warranty) and estimated loss severity. The reserve levels at June 30, 2015 and December 31, 2014 also reflect the resolution of the mortgage loan origination years of 2000 to 2008 with Fannie Mae and Freddie Mac.  We believe that the amounts that we have accrued for incurred losses on sold mortgage loans are appropriate given our analyses.  However, future losses could exceed our current estimate.
 
72

Net gains on ORE and repossessed assets primarily 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 $0.14 million and $0.18 million recorded in the second quarter and first six months of 2015, respectively (as compared to net gains of $0.04 million and $0.13 million, respectively, recorded in the same periods in 2014) primarily reflect greater stability in real estate prices during the last two years, with some markets even experiencing price increases.

Other non-interest expenses were relatively unchanged and decreased by $0.2 million in the second quarter and first six months of 2015, respectively, compared to the same periods in 2014.  The year-to-date comparative decline is due primarily to decreases in insurance costs and fraud related expenses.

Income tax expense.  We recorded an income tax expense of $2.6 million and $4.4 million in the second quarter and the first six months of 2015, respectively. This compares to an income tax expense of $1.8 million and $3.3 million in the second quarter and the first six months of 2014, respectively.

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 and tax-exempt income from the increase in the cash surrender value on life insurance.  In addition, the second quarter and year-to-date 2014 income tax expense was reduced by a credit of approximately $0.7 million due to a true-up of the amount of unrecognized tax benefits relative to certain net operating loss carryforwards and the reversal of a valuation allowance on our capital loss carryforward that we believed was more likely than not to be realized due to a strategy executed during the second quarter of 2014 that generated a capital gain.

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 June 30, 2015 and 2014, that the realization of substantially all of our deferred tax assets continues to be more likely than not.

We did maintain a valuation allowance against our deferred tax assets of approximately $1.0 million at both June 30, 2015 and December 31, 2014. This valuation allowance on our deferred tax assets primarily relates to state income taxes at our Mepco segment.  In this instance, we determined that the future realization of these particular deferred tax assets was not more likely than not.  This conclusion was primarily based on the uncertainty of Mepco’s future earnings attributable to particular states (given the various apportionment criteria) and the significant reduction in the size of Mepco’s business.
 
73

Because of our net operating loss and tax credit carryforwards, we are still subject to the rules of Section 382 of the Internal Revenue Code of 1986, as amended.  An ownership change, as defined by these rules, would negatively affect our ability to utilize our net operating loss carryforwards and other deferred tax assets in the future. If such an ownership change were to occur, we may suffer higher-than-anticipated tax expense, and consequently lower net income and cash flow, in those future years.  Although we cannot control market purchases or sales of our common stock, we have in place a Tax Benefits Preservation Plan to dissuade any movement in our stock that would trigger an ownership change to avoid triggering any Section 382 limitations.

Business Segments.  Our reportable segments are based upon legal entities.  We currently have two reportable segments:  Independent Bank and Mepco.  These business segments are also differentiated based on the products and services provided.  We evaluate performance based principally on net income (loss) of the respective reportable segments.
 
The following table presents net income (loss) by business segment.
 
Business Segments

   
Three months ended
June 30,
   
Six months ended
June 30,
 
   
2015
   
2014
   
2015
   
2014
 
   
(in thousands)
 
Independent Bank
 
$
5,935
   
$
6,115
   
$
10,168
   
$
9,297
 
Mepco
   
(77
)
   
201
     
(269
)
   
444
 
Other(1)
   
(225
)
   
(136
)
   
(469
)
   
(399
)
Elimination
   
(14
)
   
(128
)
   
(30
)
   
(152
)
Net income
 
$
5,619
   
$
6,052
   
$
9,400
   
$
9,190
 

(1)
Includes amounts relating to our parent company and certain insignificant operations.

The decrease in second quarter net income at Independent Bank in 2015 compared to 2014 is primarily due to increases in the provision for loan losses (a smaller credit) and in income tax expense that were partially offset by increases in net interest income and non-interest income and a decrease in non-interest expense.  The increase in year-to-date net income at Independent Bank in 2015 compared to 2014 is primarily due to increases in net interest income and non-interest income and a decrease in non-interest expense that were partially offset by increases in the provision for loan losses (a smaller credit) and in income tax expense.  (See “Net interest income,” “Provision for loan losses,” “Non-interest income,” “Non-interest expense,” “Income tax expense,” and “Portfolio Loans and asset quality.”)

The change in Mepco’s results (net losses in 2015 compared to net income in 2014) is due to a decrease in net interest income as a result of a decline in year-over-year average payment plan receivables and a decrease in non-interest income due to a decline in rental income on ORE that were partially offset by a decrease in non-interest expense.  All of Mepco’s funding is provided by Independent Bank through an intercompany loan (that is eliminated in consolidation).  The rate on this intercompany loan is based on the Prime Rate (currently 3.25%). Mepco might not be able to obtain such favorable funding costs on its own in the open market.
 
74

Financial Condition

Summary.  Our total assets increased by $40.2 million during the first six months of 2015 due primarily to increases in securities available for sale and loans.  Loans, excluding loans held for sale ("Portfolio Loans"), totaled $1.45 billion at June 30, 2015, an increase of $40.0 million, or 2.8%, from December 31, 2014.  (See "Portfolio Loans and asset quality.")

Deposits totaled $1.96 billion at June 30, 2015, compared to $1.92 billion at December 31, 2014.  The $37.1 million increase in total deposits during the period is primarily due to growth in checking and savings account balances.

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

Securities
 
  Unrealized
   
Amortized
Cost
   
Gains
   
Losses
   
Fair
Value
 
   
(In thousands)
 
Securities available for sale
               
June 30, 2015
 
$
557,068
   
$
3,217
   
$
2,590
   
$
557,695
 
December 31, 2014
   
532,930
     
3,317
     
3,069
     
533,178
 

Securities available for sale increased during 2015 due primarily to the purchase of U.S. government-sponsored agency mortgage-backed securities, asset-backed securities, and municipal securities. The securities were purchased to utilize cash and cash equivalents as well as to utilize funds generated from the increase in total deposits. (See “Deposits” and “Liquidity and capital resources.”)

Our portfolio of available-for-sale securities 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 or loss. We recorded no net other than temporary impairment charges in earnings on securities in 2015 or 2014.
 
75

Sales of securities were as follows (See “Non-interest income.”):

   
Six months ended
June 30,
 
   
2015
   
2014
 
   
(In thousands)
 
 
Proceeds
 
$
11,786
   
$
5,126
 
                 
Gross gains
 
$
75
   
$
2
 
Gross losses
   
-
     
-
 
Net impairment charges
   
-
     
-
 
Fair value adjustments
   
(23
)
   
164
 
Net gains
 
$
52
   
$
166
 

Portfolio Loans and asset quality.  In addition to the communities served by our Bank branch network, our principal lending markets also include nearby communities and metropolitan areas. Subject to established underwriting criteria, we also may participate in commercial lending transactions with certain non-affiliated banks.

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 mortgage loans as Portfolio Loans, while 15- and 30-year, fixed-rate obligations are generally sold to mitigate exposure to changes in interest rates. (See “Non-interest income.”)

76

Non-performing assets (1)

   
June 30,
2015
   
December 31,
2014
 
   
(Dollars in thousands)
 
 
Non-accrual loans
 
$
12,274
   
$
15,231
 
Loans 90 days or more past due and still accruing interest
   
63
     
7
 
Total non-performing loans
   
12,337
     
15,238
 
Other real estate and repossessed assets
   
4,471
     
6,454
 
Total non-performing assets
 
$
16,808
   
$
21,692
 
                 
As a percent of Portfolio Loans
               
Non-performing loans
   
0.85
%
   
1.08
 
Allowance for loan losses
   
1.70
     
1.84
 
Non-performing assets to total assets
   
0.73
     
0.96
 
Allowance for loan losses as a percent of non-performing loans
   
199.29
     
170.56
 
 
(1)
Excludes loans classified as "trouble debt restructured" that are not past due and vehicle service contract counterparty receivables, net.
 
Troubled debt restructurings ("TDR")
 
 
June 30, 2015
 
 
Commercial
   
Retail
   
Total
 
 
(In thousands)
 
Performing TDR's
 
$
27,540
   
$
70,576
   
$
98,116
 
Non-performing TDR's(1)
   
1,698
     
4,513
 (2)     
6,211
 
Total
 
$
29,238
   
$
75,089
   
$
104,327
 
 
 
December 31, 2014
 
 
Commercial
   
Retail
   
Total
 
 
(In thousands)
 
Performing TDR's
 
$
29,475
   
$
73,496
   
$
102,971
 
Non-performing TDR's(1)
   
1,978
     
5,225
(2)    
7,203
 
Total
 
$
31,453
   
$
78,721
   
$
110,174
 
 
(1)
Included in non-performing assets table above.
(2)
Also includes loans on non-accrual at the time of modification until six payments are received on a timely basis.

Non-performing loans decreased by $2.9 million, or 19.0%, during the first half of 2015 due principally to decreases in non-performing mortgage and consumer/installment loans. These declines primarily reflect reduced levels of new loan defaults as well as loan charge-offs, pay-offs, negotiated transactions, and the migration of loans into ORE. In general, improving economic conditions in our market areas, as well as our collection and resolution efforts, have resulted in a downward trend in non-performing loans.  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.
 
77

Non-performing loans exclude performing loans that are classified as troubled debt restructurings (“TDRs”). Performing TDRs totaled $98.1 million, or 6.8% of total Portfolio Loans, and $103.0 million, or 7.3% of total Portfolio Loans, at June 30, 2015 and December 31, 2014, respectively. The decrease in the amount of performing TDRs in the first half of 2015 reflects declines in both commercial loan and retail loan TDRs.

ORE and repossessed assets totaled $4.5 million at June 30, 2015, compared to $6.5 million at December 31, 2014. This decrease is primarily the result of sales of ORE being in excess of the migration of non-performing loans secured by real estate into ORE as the foreclosure process is completed.

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.

The ratio of loan net charge-offs to average Portfolio Loans was 0.09% on an annualized basis in the first six months of 2015 compared to 0.40% in the first six months of 2014.  The $2.1 million decline in loan net charge-offs is primarily due to a $1.8 million decrease in commercial loan net charge-offs as well as slight decreases in mortgage and consumer/installment loan net charge-offs.  The overall decrease in loan net charge-offs primarily reflects a year-over-year reduction in non-performing loans and improvement in collateral liquidation values.

Allowance for loan losses

   
Six months ended
June 30,
 
   
2015
   
2014
 
   
Loans
   
Unfunded
Commitments
   
Loans
   
Unfunded
Commitments
 
   
(Dollars in thousands)
 
Balance at beginning of period
 
$
25,990
   
$
539
   
$
32,325
   
$
508
 
Additions (deductions)
                               
Provision for loan losses
   
(793
)
   
-
     
(1,417
)
   
-
 
Recoveries credited to allowance
   
2,245
     
-
     
3,959
     
-
 
Loans charged against the allowance
   
(2,856
)
   
-
     
(6,670
)
   
-
 
Additions (deductions) included in non-interest expense
   
-
     
20
     
-
     
15
 
Balance at end of period
 
$
24,586
   
$
559
   
$
28,197
   
$
523
 
                                 
                               
Net loans charged against the allowance to average Portfolio Loans (annualized)
   
0.09
%
           
0.40
%
       

 
78

Allocation of the Allowance for Loan Losses

   
June 30,
2015
   
December 31,
2014
 
   
(In thousands)
 
Specific allocations
 
$
12,535
   
$
13,233
 
Other adversely rated commercial loans
   
1,525
     
761
 
Historical loss allocations
   
5,638
     
6,773
 
Additional allocations based on subjective factors
   
4,888
     
5,223
 
Total
 
$
24,586
   
$
25,990
 

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

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

Increases in the AFLL are recorded by a provision for loan losses charged to expense. Although we periodically allocate portions of the AFLL to specific loans and loan portfolios, the entire AFLL is available for incurred losses. We generally charge-off commercial, homogenous residential mortgage, and installment loans and payment plan receivables when they are deemed uncollectible or reach a predetermined number of days past due based on product, industry practice and other factors. Collection efforts may continue and recoveries may occur after a loan is charged against the allowance.
 
79

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.

Mepco’s allowance for losses is determined in a similar manner as discussed above, and primarily takes into account historical loss experience and other subjective factors deemed relevant to Mepco’s payment plan business. Estimated incurred losses associated with Mepco’s outstanding vehicle service contract payment plans are included in the provision for loan losses. Mepco recorded an expense of $0.001 million and a credit of $0.02 million in the first six months of 2015 and 2014, respectively, for its provision for loan losses.  Mepco’s allowance for loan losses totaled $0.07 million at both June 30, 2015 and December 31, 2014. Mepco has established procedures for vehicle service contract payment plan servicing, administration and collections, including the timely cancellation of the vehicle service contract, in order to protect our position in the event of payment default or voluntary cancellation by the customer. Mepco has also established procedures to attempt to prevent and detect fraud since the payment plan origination activities and initial customer contacts are done entirely through unrelated third parties (vehicle service contract administrators and sellers or automobile dealerships). However, there can be no assurance that the aforementioned risk management policies and procedures will prevent us from the possibility of incurring significant credit or fraud related losses in this business segment. The estimated incurred losses described in this paragraph should be distinguished from the possible losses we may incur from counterparties failing to pay their obligations to Mepco.  See Note #14 to the Condensed Consolidated Financial Statements included within this report.

The allowance for loan losses decreased $1.4 million to $24.6 million at June 30, 2015 from $26.0 million at December 31, 2014 and was equal to 1.70% of total Portfolio Loans at June 30, 2015 compared to 1.84% at December 31, 2014. Three of the four components of the allowance for loan losses outlined above declined in the first six months of 2015. The allowance for loan losses related to specific loans decreased $0.7 million in 2015 due primarily to a decline in the balance of individually impaired loans as well as charge-offs. The allowance for loan losses related to other adversely rated commercial loans increased $0.8 million in 2015 primarily due to an increase in the balance of such loans included in this component to $42.1 million at June 30, 2015 from $30.6 million at December 31, 2014. The allowance for loan losses related to historical losses decreased $1.1 million during 2015 due principally to the use of a lower estimated probability of default for homogenous mortgage and installment loans (resulting from lower loan net charge-offs and reduced levels of new defaults on loans). The allowance for loan losses related to subjective factors decreased $0.3 million during 2015 primarily due to the improvement of various economic indicators used in computing this portion of the allowance.

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.
 
80

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

Deposits totaled $1.96 billion and $1.92 billion at June 30, 2015 and December 31, 2014, respectively.  The $37.1 million increase in deposits in the first half of 2015 is due to growth in checking and savings deposit account balances.  Reciprocal deposits totaled $49.0 million and $53.7 million at June 30, 2015 and December 31, 2014, 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.

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 June 30, 2015, we had approximately $400.0 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 an integral part of our asset/liability management efforts.

Other borrowings, comprised almost entirely of advances from the Federal Home Loan Bank (the “FHLB”), totaled $12.3 million and $12.5 million at June 30, 2015 and December 31, 2014, respectively.

As described above, we utilize wholesale funding, including FHLB borrowings and Brokered CDs to augment our core deposits and fund a portion of our assets. At June 30, 2015, our use of such wholesale funding sources (including reciprocal deposits) amounted to approximately $62.6 million, or 3.2% of total funding (deposits and total borrowings, excluding subordinated debentures). Because wholesale funding sources are affected by general market conditions, the availability of such funding may be dependent on the confidence these sources have in our financial condition and operations. The continued availability to us of these funding sources is not certain, and Brokered CDs may be difficult for us to retain or replace at attractive rates as they mature. Our liquidity may be constrained if we are unable to renew our wholesale funding sources or if adequate financing is not available in the future at acceptable rates of interest or at all.  Our financial performance could also be affected if we are unable to maintain our access to funding sources or if we are required to rely more heavily on more expensive funding sources. In such case, our net interest income and results of operations could be adversely affected.

We historically employed derivative financial instruments to manage our exposure to changes in interest rates. We discontinued the active use of derivative financial instruments during 2008.  We began to again utilize interest-rate swaps in 2014, relating to our commercial lending activities.  During the first six months of 2015 and 2014, we entered into $16.6 million and $2.4 million (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 $0.3 million and $0.05 million of fee income related to these transactions during the first six months of 2015 and 2014, respectively.
 
81

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 Condensed Consolidated Statements of Cash Flows categorize these sources and uses into operating, investing and financing activities. We primarily focus our liquidity management on maintaining adequate levels of liquid assets (primarily funds on deposit with the FRB and certain investment securities) as well as developing access to a variety of borrowing sources to supplement our deposit gathering activities and provide funds for purchasing investment securities or originating Portfolio Loans as well as to be able to respond to unforeseen liquidity needs.

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

At June 30, 2015, we had $232.1 million of time deposits that mature in the next 12 months. Historically, a majority of these maturing time deposits are renewed by our customers. Additionally, $1.59 billion of our deposits at June 30, 2015, were in account types from which the customer could withdraw the funds on demand. Changes in the balances of deposits that can be withdrawn upon demand are usually predictable and the total balances of these accounts have generally grown or have been stable over time as a result of our marketing and promotional activities. However, there can be no assurance that historical patterns of renewing time deposits or overall growth or stability in deposits will continue in the future.

We have developed contingency funding plans that stress test our liquidity needs that may arise from certain events such as an adverse change in our financial metrics (for example, credit quality or regulatory capital ratios). Our liquidity management also includes periodic monitoring that measures quick assets (defined generally as short-term assets with maturities less than 30 days and loans held for sale) to total assets, short-term liability dependence and basic surplus (defined as quick assets compared to short-term liabilities). Policy limits have been established for our various liquidity measurements and are monitored on a monthly basis. In addition, we also prepare cash flow forecasts that include a variety of different scenarios.

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

We also believe that the available cash on hand at the parent company (including time deposits) of approximately $29.5 million as of June 30, 2015 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.

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.
 
82

Capitalization

   
June 30,
2015
   
December 31,
2014
 
   
(In thousands)
 
Subordinated debentures
 
$
35,569
   
$
35,569
 
Amount not qualifying as regulatory capital
   
(1,069
)
   
(1,069
)
Amount qualifying as regulatory capital
   
34,500
     
34,500
 
Shareholders’ equity
               
Common stock
   
349,580
     
352,462
 
Accumulated deficit
   
(89,815
)
   
(96,455
)
Accumulated other comprehensive loss
   
(5,390
)
   
(5,636
)
Total shareholders’ equity
   
254,375
     
250,371
 
Total capitalization
 
$
288,875
   
$
284,871
 

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

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

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) are limited to 25 percent of Tier 1 capital elements, net of goodwill (net of any associated deferred tax liability). The amount of trust preferred securities and certain other elements in excess of the limit can be included in Tier 2 capital, subject to restrictions. At the parent company, all of these securities qualified as Tier 1 capital at June 30, 2015 and December 31, 2014. 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 $254.4 million at June 30, 2015 from $250.4 million at December 31, 2014, due primarily to our net income in the first six months of 2015 as well as a decline in our accumulated other comprehensive loss that were partially offset by dividends and share repurchases. Our tangible common equity (“TCE”) totaled $251.9 million and $247.7 million, respectively, at those same dates. Our ratio of TCE to tangible assets was 11.02% and 11.03% at June 30, 2015 and December 31, 2014, respectively.
 
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Because the Bank currently has negative “undivided profits” (i.e. a retained deficit) of $21.2 million at June 30, 2015, under Michigan banking regulations, the Bank is not currently permitted to pay a dividend.  We can request regulatory approval for a return of capital from the Bank to the parent company. During the first quarter of 2015, we requested regulatory approval for an $18.5 million return of capital from the Bank to the parent company.  This return of capital request was approved by our banking regulators on February 13, 2015 and the Bank returned $18.5 million of capital to the parent company on February 17, 2015.  Also see note #11 to the Condensed Consolidated Financial Statements included within this report.

On January 21, 2015, our Board of Directors authorized a share repurchase plan.  Under the terms of the share repurchase plan, we are authorized to buy back up to 5% of our outstanding common stock.    The repurchase plan is authorized to last through December 31, 2015.  We intend and expect to accomplish the repurchases through open market transactions, though we could effect repurchases through other means, such as privately negotiated transactions.  The timing and amount of any share repurchases will depend on a variety of factors, including, among others, securities law restrictions, the trading price of our common stock, other regulatory requirements, potential alternative uses for capital, and our financial performance. The repurchase program does not obligate us to acquire any particular amount of common stock, and it may be modified or suspended at any time at our discretion.  During the first six months of 2015 we repurchased 277,415 shares of our comment stock pursuant to this plan at an average price of $13.22 per share.

We resumed a quarterly cash dividend on our common stock of six cents per share in May 2014 and have continued to pay regular quarterly dividends at that amount ever since.

As of June 30, 2015 and December 31, 2014, our Bank (and holding company) continued to meet the requirements to be considered “well-capitalized” under federal regulatory standards (also see note #11 to the Condensed Consolidated Financial Statements included within this report).

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. 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.
 
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Changes in Market Value of Portfolio Equity and Net Interest Income

Change in Interest
Rates
 
Market Value
Of Portfolio
Equity(1)
   
Percent
Change
   
Net Interest
Income(2)
   
Percent
Change
 
   
(Dollars in thousands)
 
June 30, 2015
               
200 basis point rise
 
$
425,300
     
10.96
%
 
$
79,100
     
7.77
%
100 basis point rise
   
408,100
     
6.47
     
76,500
     
4.22
 
Base-rate scenario
   
383,300
     
-
     
73,400
     
-
 
100 basis point decline
   
350,100
     
(8.66
)
   
70,700
     
(3.68
)
                                 
December 31, 2014
                               
200 basis point rise
 
$
421,700
     
9.56
%
 
$
75,600
     
6.03
%
100 basis point rise
   
406,800
     
5.69
     
73,600
     
3.23
 
Base-rate scenario
   
384,900
     
-
     
71,300
     
-
 
100 basis point decline
   
355,000
     
(7.77
)
   
69,200
     
(2.95
)


(1) Simulation analyses calculate the change in the net present value of our assets and liabilities, including debt and related financial derivative instruments, under parallel shifts in interest rates by discounting the estimated future cash flows using a market-based discount rate. Cash flow estimates incorporate anticipated changes in prepayment speeds and other embedded options.
(2) Simulation analyses calculate the change in net interest income under immediate parallel shifts in interest rates over the next twelve months, based upon a static statement of financial condition, which includes debt and related financial derivative instruments, and do not consider loan fees.

Accounting standards update. See Note #2  to  the Condensed Consolidated Financial Statements included elsewhere in this report for details on recently issued accounting pronouncements and their impact on our financial statements.

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.
 
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We utilize fair value measurements to record fair value adjustments to certain financial instruments and to determine fair value disclosures. FASB ASC topic 820 differentiates between those assets and liabilities required to be carried at fair value at every reporting period (“recurring”) and those assets and liabilities that are only required to be adjusted to fair value under certain circumstances (“nonrecurring”). Trading securities, securities available-for-sale, loans held for sale, and derivatives are financial instruments recorded at fair value on a recurring basis. Additionally, from time to time, we may be required to record at fair value other financial assets on a nonrecurring basis, such as loans held for investment, capitalized mortgage loan servicing rights and certain other assets. These nonrecurring fair value adjustments typically involve application of lower of cost or market accounting or write-downs of individual assets. See Note #12 to the Condensed Consolidated Financial Statements included within this report 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 approximately $0.5 million.  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 or vehicle service contract counterparty receivables). These excluded, collection-related matters may involve claims or counterclaims by the opposing party or parties, but we have excluded such matters from the disclosure contained in the preceding paragraph in all cases where we believe the possibility of us paying damages to any opposing party is remote. Risks associated with the likelihood that we will not collect the full amount owed to us, net of reserves, are disclosed elsewhere in this report.

 Critical Accounting Policies

Our accounting and reporting policies are in accordance with accounting principles generally accepted in the United States of America and conform to general practices within the banking industry. Accounting and reporting policies for other than temporary impairment of investment securities, the allowance for loan losses, originated mortgage loan servicing rights, vehicle service contract payment plan counterparty contingencies, and income taxes are deemed critical since they involve the use of estimates and require significant management judgments. Application of assumptions different than those that we have used could result in material changes in our consolidated financial position or results of operations.  There have been no material changes to our critical accounting policies as disclosed in our Annual Report on Form 10-K for the year ended December 31, 2014.
 
86

Item 3.

Quantitative and Qualitative Disclosures about Market Risk

See applicable disclaimers set forth in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in Item 2 under the caption “Asset/liability management.”

Item 4.

Controls and Procedures

(a) Evaluation of Disclosure Controls and Procedures.

With the participation of management, our chief executive officer and chief financial officer, after evaluating the effectiveness of our disclosure controls and procedures (as defined in Exchange Act Rules 13a – 15(e) and 15d – 15(e)) for the period ended June 30, 2015, have concluded that, as of such date, our disclosure controls and procedures were effective.

(b) Changes in Internal Controls.

During the quarter ended June 30, 2015, there were no changes in our internal control over financial reporting that materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
 
87

Part II

Item 1A.
Risk Factors

There have been no material changes to the risk factors disclosed in Item 1A. Risk Factors of our Annual Report on Form 10-K for the year ended December 31, 2014.

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

The Company maintains a Deferred Compensation and Stock Purchase Plan for Non-Employee Directors (the "Plan") pursuant to which non-employee directors can elect to receive shares of the Company's common stock in lieu of fees otherwise payable to the director for his or her service as a director.  A director can elect to receive shares on a current basis or to defer receipt of the shares, in which case the shares are issued to a trust to be held for the account of the director and then generally distributed to the director after his or her retirement from the Board.  Pursuant to this Plan, during the second quarter of 2015, the Company issued 733 shares of common stock to non-employee directors on a current basis and 499 shares of common stock to the trust for distribution to directors on a deferred basis.  The shares were issued on April 1, 2015, at a price of $12.83 per share, representing aggregate fees of $0.02 million.   The price per share was the consolidated closing bid price per share of the Company's common stock as of the date of issuance, as determined in accordance with NASDAQ Marketplace Rules.  The Company issued the shares pursuant to an exemption from registration under Section 4(2) of the Securities Act of 1933 due to the fact that the issuance of the shares was made on a private basis pursuant to the Plan.

The following table shows certain information relating to purchases of common stock for the three-months ended June 30, 2015:

Period
Total Number of
Shares Purchased
   
Average Price
Paid Per Share
   
Total Number of
Shares Purchased
as Part of a
Publicly
Announced Plan
   
Remaining
Number of
Shares Authorized
for Purchase
Under the Plan
 
April 2015
   
-
   
$
-
     
-
     
1,077,287
 
May 2015
   
93,224
     
13.25
     
93,224
     
984,063
 
June 2015
   
113,548
     
13.49
     
113,548
     
870,515
 
Total
   
206,772
   
$
13.38
     
206,772
     
870,515
 
 
88

Item 6.   
Exhibits
 
 
(a)
The following exhibits (listed by number corresponding to the Exhibit Table as Item 601 in Regulation S-K) are filed with this report:
 
Computation of Earnings Per Share.
 
Certificate of the Chief Executive Officer of Independent Bank Corporation pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 (18 U.S.C. 1350).
 
Certificate of the Chief Financial Officer of Independent Bank Corporation pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 (18 U.S.C. 1350).
 
Certificate of the Chief Executive Officer of Independent Bank Corporation pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (18 U.S.C. 1350).
 
Certificate of the Chief Financial Officer of Independent Bank Corporation pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (18 U.S.C. 1350).
 
101.INS Instance Document
 
101.SCH XBRL Taxonomy Extension Schema Document
 
101.CAL XBRL Taxonomy Extension Calculation Linkbase Document
 
101.DEF XBRL Taxonomy Extension Definition Linkbase Document
 
101.LAB XBRL Taxonomy Extension Label Linkbase Document
 
101.PRE XBRL Taxonomy Extension Presentation Linkbase Document
 
89

SIGNATURES

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

Date
August 5, 2015
By
/s/ Robert N. Shuster
     
Robert N. Shuster, Principal Financial Officer
       
Date
August 5, 2015 
By
/s/ James J. Twarozynski
     
James J. Twarozynski, Principal Accounting Officer
 
 
90