Document
 
 
 
 
 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
 
 
 
 
 
FORM 10-Q
 
 
 
 
 
☒
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 2018
OR
☐
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from              to             
 
Commission file number 001-35968
 
 
 
 
MIDWESTONE FINANCIAL GROUP, INC.
(Exact name of Registrant as specified in its charter)
 
 
 
 
Iowa
42-1206172
(State or other jurisdiction of incorporation or organization)
(I.R.S. Employer Identification No.)
102 South Clinton Street
Iowa City, IA 52240
(Address of principal executive offices, including zip code)
319-356-5800
(Registrant’s telephone number, including area code)
  
 
 
 
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    ☒  Yes    ☐  No
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    ☒  Yes    ☐  No
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer
☐
 
Accelerated filer
☒
Non-accelerated filer
☐  (Do not check if a smaller reporting company)
 
Smaller reporting company
☐
 
 
 
Emerging growth company
☐
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    ☐  Yes    ☒  No

As of May 1, 2018, there were 12,215,342 shares of common stock, $1.00 par value per share, outstanding.
 
 
 
 
 

Table of Contents

MIDWESTONE FINANCIAL GROUP, INC.
Form 10-Q Quarterly Report
Table of Contents
 
 
 
 
Page No.
PART I
 
 
 
 
 
 
 
 
 
Item 1.
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Item 2.
 
 
 
 
 
 
 
Item 3.
 
 
 
 
 
 
 
Item 4.
 
 
 
 
 
 
 
Part II
 
 
 
 
 
 
 
 
 
Item 1.
 
 
 
 
 
 
 
Item 1A.
 
 
 
 
 
 
 
Item 2.
 
 
 
 
 
 
 
Item 3.
 
 
 
 
 
 
 
Item 4.
 
 
 
 
 
 
 
Item 5.
 
 
 
 
 
 
 
Item 6.
 
 
 
 
 
 
 
 
 
 


Table of Contents

PART I – FINANCIAL INFORMATION
Item 1.   Financial Statements.

MIDWESTONE FINANCIAL GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
 
March 31, 2018
 
December 31, 2017
(dollars in thousands)
(unaudited)
 
 
ASSETS
 
 
 
Cash and due from banks
$
39,929

 
$
44,818

Interest-bearing deposits in banks
2,467

 
5,474

Federal funds sold
—

 
680

Cash and cash equivalents
42,396

 
50,972

Investment securities:
 
 
 
Equity securities
2,815

 
2,336

Available for sale debt securities
446,087

 
445,324

Held to maturity debt securities (fair value of $190,593 as of March 31, 2018 and $194,343 as of December 31, 2017)
194,617

 
195,619

Loans held for sale
870

 
856

Loans
2,326,158

 
2,286,695

Allowance for loan losses
(29,671
)
 
(28,059
)
Net loans
2,296,487

 
2,258,636

Premises and equipment, net
77,552

 
75,969

Accrued interest receivable
13,337

 
14,732

Goodwill
64,654

 
64,654

Other intangible assets, net
11,389

 
12,046

Bank-owned life insurance
59,812

 
59,831

Other real estate owned
1,001

 
2,010

Deferred income taxes, net
7,866

 
6,525

Other assets
22,759

 
22,761

Total assets
$
3,241,642

 
$
3,212,271

LIABILITIES AND SHAREHOLDERS' EQUITY
 
 
 
Deposits:
 
 
 
Non-interest-bearing demand
$
450,168

 
$
461,969

Interest-bearing checking
1,240,208

 
1,228,112

Savings
215,940

 
213,430

Certificates of deposit under $100,000
332,727

 
324,681

Certificates of deposit $100,000 and over
392,878

 
377,127

Total deposits
2,631,921

 
2,605,319

Federal funds purchased
25,573

 
1,000

Securities sold under agreements to repurchase
67,738

 
96,229

Federal Home Loan Bank borrowings
123,000

 
115,000

Junior subordinated notes issued to capital trusts
23,817

 
23,793

Long-term debt
11,250

 
12,500

Deferred compensation liability
5,258

 
5,199

Accrued interest payable
1,459

 
1,428

Other liabilities
10,249

 
11,499

Total liabilities
2,900,265

 
2,871,967

Shareholders' equity:
 
 
 
Preferred stock, no par value; authorized 500,000 shares; no shares issued and outstanding at March 31, 2018 and December 31, 2017
$
—

 
$
—

Common stock, $1.00 par value; authorized 30,000,000 shares at March 31, 2018 and December 31, 2017; issued 12,463,481 shares at March 31, 2018 and December 31, 2017; outstanding 12,214,942 shares at March 31, 2018 and 12,219,611 shares at December 31, 2017
12,463

 
12,463

Additional paid-in capital
187,188

 
187,486

Treasury stock at cost, 248,539 shares as of March 31, 2018 and 243,870 shares as of December 31, 2017
(5,612
)
 
(5,121
)
Retained earnings
153,542

 
148,078

Accumulated other comprehensive loss
(6,204
)
 
(2,602
)
Total shareholders' equity
341,377

 
340,304

Total liabilities and shareholders' equity
$
3,241,642

 
$
3,212,271

See accompanying notes to consolidated financial statements.  

1
Table of Contents

MIDWESTONE FINANCIAL GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
 
 
 
Three Months Ended
 
 
March 31,
(unaudited) (dollars in thousands, except per share amounts)
 
2018
 
2017
Interest income:
 
 
 
 
Interest and fees on loans
 
$
26,567

 
$
24,279

Interest on bank deposits
 
8

 
5

Interest on investment securities:
 
 
 
 
Taxable securities
 
2,888

 
2,718

Tax-exempt securities
 
1,529

 
1,565

Total interest income
 
30,992

 
28,567

Interest expense:
 
 
 
 
Interest on deposits:
 
 
 
 
Interest-bearing checking
 
1,085

 
798

Savings
 
63

 
51

Certificates of deposit under $100,000
 
995

 
859

Certificates of deposit $100,000 and over
 
1,393

 
917

Total interest expense on deposits
 
3,536

 
2,625

Interest on federal funds purchased
 
125

 
46

Interest on securities sold under agreements to repurchase
 
134

 
38

Interest on Federal Home Loan Bank borrowings
 
517

 
443

Interest on other borrowings
 
2

 
3

Interest on junior subordinated notes issued to capital trusts
 
258

 
221

Interest on long-term debt
 
107

 
110

Total interest expense
 
4,679

 
3,486

Net interest income
 
26,313

 
25,081

Provision for loan losses
 
1,850

 
1,041

Net interest income after provision for loan losses
 
24,463

 
24,040

Noninterest income:
 
 
 
 
Trust, investment, and insurance fees
 
1,640

 
1,612

Service charges and fees on deposit accounts
 
1,168

 
1,283

Loan origination and servicing fees
 
941

 
802

Other service charges and fees
 
1,380

 
1,458

Bank-owned life insurance income
 
433

 
328

Gain on sale or call of available for sale debt securities
 
9

 
—

Gain on sale or call of held to maturity debt securities
 
—

 
43

Loss on sale of premises and equipment
 
(1
)
 
(2
)
Other gain
 
102

 
13

Total noninterest income
 
5,672

 
5,537

Noninterest expense:
 
 
 
 
Salaries and employee benefits
 
12,371

 
11,884

Net occupancy and equipment expense
 
3,251

 
3,304

Professional fees
 
794

 
1,022

Data processing expense
 
688

 
711

FDIC insurance expense
 
319

 
367

Amortization of intangible assets
 
657

 
849

Other operating expense
 
2,278

 
2,198

Total noninterest expense
 
20,358

 
20,335

Income before income tax expense
 
9,777

 
9,242

Income tax expense
 
1,984

 
2,529

Net income
 
$
7,793

 
$
6,713

Share and per share information:
 
 
 
 
Ending number of shares outstanding
 
12,214,942

 
11,959,521

Average number of shares outstanding
 
12,222,690

 
11,505,687

Diluted average number of shares
 
12,241,714

 
11,555,356

Earnings per common share - basic
 
$
0.64

 
$
0.58

Earnings per common share - diluted
 
0.64

 
0.58

Dividends paid per common share
 
0.195

 
0.165

See accompanying notes to consolidated financial statements.

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Table of Contents

MIDWESTONE FINANCIAL GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
 
 
 
Three Months Ended
 
 
March 31,
(unaudited) (dollars in thousands, except per share amounts)
 
2018
 
2017
Net income
 
$
7,793

 
$
6,713

 
 
 
 
 
Other comprehensive income, available for sale debt securities:
 
 
 
 
Unrealized holding gains (losses) arising during period
 
(4,788
)
 
1,567

Reclassification adjustment for gains included in net income
 
(9
)
 
—

Income tax (expense) benefit
 
1,252

 
(616
)
Other comprehensive income (loss) on available for sale debt securities
 
(3,545
)
 
951

Other comprehensive income (loss), net of tax
 
(3,545
)
 
951

Comprehensive income
 
$
4,248

 
$
7,664

See accompanying notes to consolidated financial statements.


3
Table of Contents

MIDWESTONE FINANCIAL GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY

(unaudited)
(dollars in thousands, except per share amounts)
 
Preferred
Stock
 
Common
Stock
 
Additional
Paid-in
Capital
 
Treasury
Stock
 
Retained
Earnings
 
Accumulated
Other
Comprehensive
Income (Loss)
 
Total
Balance at December 31, 2016
 
$
—


$
11,713


$
163,667


$
(5,766
)

$
136,975


$
(1,133
)

$
305,456

Net income
 
—


—


—


—


6,713


—


6,713

Issuance of common stock (500,000 shares), net of expenses of $983
 
—

 
500

 
15,642

 
—

 
—

 
—

 
16,142

Dividends paid on common stock ($0.165 per share)
 
—

 
—

 
—

 
—

 
(1,891
)
 
—


(1,891
)
Stock options exercised (5,800 shares)
 
—

 
—

 
(74
)
 
121

 
—

 
—

 
47

Release/lapse of restriction on RSUs (20,200 shares)
 
—

 
—

 
(420
)
 
317

 
—

 
—


(103
)
Stock compensation
 
—

 
—

 
199

 
—

 
—

 



199

Other comprehensive income, net of tax
 
—

 
—

 
—

 
—

 
—

 
951

 
951

Balance at March 31, 2017
 
$
—

 
$
12,213

 
$
179,014

 
$
(5,328
)
 
$
141,797

 
$
(182
)

$
327,514

Balance at December 31, 2017
 
$
—

 
$
12,463

 
$
187,486

 
$
(5,121
)
 
$
148,078

 
$
(2,602
)
 
$
340,304

Net income
 
—

 
—

 
—

 
—

 
7,793

 
—

 
7,793

Dividends paid on common stock ($0.195 per share)
 
—

 
—

 
—

 
—

 
(2,386
)
 
—

 
(2,386
)
Stock options exercised (9,700 shares)
 
—

 
—

 
(68
)
 
204

 
—

 
—

 
136

Release/lapse of restriction on RSUs (22,200 shares)
 
—

 
—

 
(467
)
 
387

 
—

 
—

 
(80
)
Repurchase of common stock (33,998 shares)
 
—

 
—

 
—

 
(1,082
)
 
—

 
—

 
(1,082
)
Stock compensation
 
—

 
—

 
237

 
—

 
—

 
—

 
237

ASU 2016-01, reclassification from AOCI to Retained Earnings, unrealized gain on equity securities, net of tax
 
—

 
—

 
—

 
—

 
57

 
(57
)
 
—

Other comprehensive loss, net of tax
 
—

 
—

 
—

 
—

 
—

 
(3,545
)
 
(3,545
)
Balance at March 31, 2018
 
$
—

 
$
12,463

 
$
187,188

 
$
(5,612
)
 
$
153,542

 
$
(6,204
)
 
$
341,377

See accompanying notes to consolidated financial statements.  

4
Table of Contents

MIDWESTONE FINANCIAL GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
 
 
Three Months Ended March 31,
(unaudited) (dollars in thousands)
2018
 
2017
Cash flows from operating activities:
 
 
 
Net income
$
7,793

 
$
6,713

Adjustments to reconcile net income to net cash provided by operating activities:
 
 
 
Provision for loan losses
1,850

 
1,041

Depreciation of premises and equipment
1,034

 
1,040

Amortization of other intangibles
657

 
849

Amortization of premiums and discounts on investment securities, net
244

 
373

Loss on sale of premises and equipment
1

 
2

Deferred income taxes
(89
)
 
(289
)
Excess tax benefit from share-based award activity
—

 
(75
)
Stock-based compensation
237

 
199

Net losses on equity securities
24

 
—

Net gain on sale or call of available for sale debt securities
(9
)
 
—

Net gain on sale or call of held to maturity debt securities
—

 
(43
)
Net gain on sale of other real estate owned
(93
)
 
(19
)
Net gain on sale of loans held for sale
(253
)
 
(323
)
Writedown of other real estate owned
5

 
23

Origination of loans held for sale
(12,916
)
 
(18,770
)
Proceeds from sales of loans held for sale
13,155

 
22,953

Decrease in accrued interest receivable
1,395

 
1,175

Increase in cash surrender value of bank-owned life insurance
(433
)
 
(328
)
Decrease in other assets
2

 
784

Increase in deferred compensation liability
59

 
20

Increase (decrease) in accrued interest payable, accounts payable, accrued expenses, and other liabilities
(1,219
)
 
2,921

Net cash provided by operating activities
11,444

 
18,246

Cash flows from investing activities:
 
 
 
Purchases of equity securities
(503
)
 
(1,002
)
Proceeds from sales of available for sale debt securities
496

 
—

Proceeds from maturities and calls of available for sale debt securities
13,546

 
15,005

Purchases of available for sale debt securities
(19,770
)
 
(6,811
)
Proceeds from sales of held to maturity debt securities
—

 
1,153

Proceeds from maturities and calls of held to maturity debt securities
1,488

 
1,047

Purchase of held to maturity debt securities
(553
)
 
(8,474
)
Net increase in loans
(40,065
)
 
(672
)
Purchases of premises and equipment
(2,594
)
 
(1,004
)
Proceeds from sale of other real estate owned
1,461

 
494

Proceeds of principal and earnings from bank-owned life insurance
452

 
—

Net cash used in investing activities
(46,042
)
 
(264
)
Cash flows from financing activities:
 
 
 
Net increase in deposits
26,602

 
50,445

Increase (decrease) in federal funds purchased
24,573

 
(35,684
)
Decrease in securities sold under agreements to repurchase
(28,491
)
 
(14,596
)
Proceeds from Federal Home Loan Bank borrowings
35,000

 
50,000

Repayment of Federal Home Loan Bank borrowings
(27,000
)
 
(70,000
)
Proceeds from stock options exercised
135

 
123

Excess tax benefit from share-based award activity
—

 
75

Taxes paid relating to net share settlement of equity awards
(79
)
 
(104
)
Payments on long-term debt
(1,250
)
 
(1,250
)
Dividends paid
(2,386
)
 
(1,891
)
Proceeds from issuance of common stock
—

 
17,125

Payment of stock issuance costs
—

 
(983
)
Repurchase of common stock
(1,082
)
 
—

Net cash provided by (used in) financing activities
26,022

 
(6,740
)
Net increase (decrease) in cash and cash equivalents
(8,576
)
 
11,242

Cash and cash equivalents at beginning of period
50,972

 
43,228

Cash and cash equivalents at end of period
$
42,396

 
$
54,470


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Table of Contents

(unaudited) (dollars in thousands)
Three Months Ended March 31,
 
2018
 
2017
Supplemental disclosures of cash flow information:
 
 
 
Cash paid during the period for interest
$
4,648

 
$
3,553

Supplemental schedule of non-cash investing activities:
 
 
 
Transfer of loans to other real estate owned
$
364

 
$
97

Transfer due to adoption of ASU 2016-01, equity securities fair value adjustment, reclassification from AOCI to Retained Earnings, net of tax
$
57

 
$
—

See accompanying notes to consolidated financial statements.

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Table of Contents

MidWestOne Financial Group, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
(Unaudited)

1.    Principles of Consolidation and Presentation
MidWestOne Financial Group, Inc. (the “Company,” which is also referred to herein as “we,” “our” or “us”) is an Iowa corporation incorporated in 1983, a bank holding company under the Bank Holding Company Act of 1956, as amended, and a financial holding company under the Gramm-Leach-Bliley Act of 1999. Our principal executive offices are located at 102 South Clinton Street, Iowa City, Iowa 52240.
The Company owns all of the common stock of MidWestOne Bank, an Iowa state non-member bank chartered in 1934 with its main office in Iowa City, Iowa (the “Bank”), and all of the common stock of MidWestOne Insurance Services, Inc., Oskaloosa, Iowa. We operate primarily through MidWestOne Bank, our bank subsidiary, and MidWestOne Insurance Services, Inc., our wholly-owned subsidiary that operates an insurance agency business through six offices located in central and east-central Iowa.
The accompanying unaudited consolidated financial statements have been prepared in accordance with the instructions to Form 10-Q and, therefore, do not include all the information and notes necessary for complete financial statements in conformity with U.S. generally accepted accounting principles (“GAAP”). The information in this Quarterly Report on Form 10-Q is written with the presumption that the users of the interim financial statements have read or have access to the most recent Annual Report on Form 10-K of the Company, which contains the latest audited financial statements and notes thereto, together with Management’s Discussion and Analysis of Financial Condition and Results of Operations as of December 31, 2017 and for the year then ended. Management believes that the disclosures in this Form 10-Q are adequate to make the information presented not misleading. In the opinion of management, the accompanying consolidated financial statements contain all adjustments (consisting of only normal recurring accruals) necessary to present fairly the Company’s financial position as of March 31, 2018 and December 31, 2017, and the results of operations and cash flows for the three months ended March 31, 2018 and 2017. All significant intercompany accounts and transactions have been eliminated in consolidation.
The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect: (1) the reported amounts of assets and liabilities, (2) the disclosure of contingent assets and liabilities at the date of the financial statements, and (3) the reported amounts of revenues and expenses during the reporting period. These estimates are based on information available to management at the time the estimates are made. Actual results could differ from those estimates. The results for the three months ended March 31, 2018 may not be indicative of results for the year ending December 31, 2018, or for any other period.
All significant accounting policies followed in the preparation of the quarterly financial statements are disclosed in the Annual Report on Form 10-K for the year ended December 31, 2017.
In the consolidated statements of cash flows, cash and cash equivalents include cash and due from banks, interest-bearing deposits in banks, and federal funds sold.
Certain reclassifications have been made to prior periods’ consolidated financial statements to present them on a basis comparable with the current period’s consolidated financial statements.

2.    Effect of New Financial Accounting Standards
Accounting Guidance Adopted in 2018
In May 2014, the Financial Accounting Standards Board (the “FASB”) issued Accounting Standards Update (“ASU”) No. 2014-09, Revenue from Contract with Customers (Topic 606). Subsequent to the issuance of ASU 2014-09, the FASB issued targeted updates to clarify specific implementation issues including ASU No. 2016-08, “Principal versus Agent Considerations (Reporting Revenue Gross versus Net),” ASU No. 2016-10, “Identifying Performance Obligations and Licensing,” ASU No. 2016-12, “Narrow-Scope Improvements and Practical Expedients,” and ASU No. 2016-20 “Technical Corrections and Improvements to Topic 606, Revenue from Contracts with Customers.” For financial reporting purposes, the standard allows for either full retrospective adoption, meaning the standard is applied to all of the periods presented, or modified retrospective adoption, meaning the standard is applied only to the most current period presented in the financial statements with the cumulative effect of initially applying the standard recognized at the date of initial application. Since the guidance does not apply to revenue associated with financial instruments, including loans and securities that are accounted for under other GAAP, the new guidance did not have a material impact on revenue most closely associated with financial instruments, including interest income and expense. The Company completed its overall assessment of revenue streams and review of related contracts potentially affected by the ASU, including trust

7
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and asset management fees, service charges on deposit accounts, sales of other real estate, and debit card interchange fees. Based on this assessment, the Company concluded that ASU 2014-09 did not materially change the method in which the Company currently recognizes revenue for these revenue streams. The Company also completed its evaluation of certain costs related to these revenue streams to determine whether such costs should be presented as expenses or contra-revenue (i.e., gross vs. net). Based on its evaluation, the Company determined that ASU 2014-09 also did not materially change the method in which the Company currently recognizes costs for these revenue streams. The Company adopted this update on January 1, 2018, utilizing the modified retrospective transition method. Since there was no net income impact upon adoption of the new guidance, a cumulative effect adjustment to opening retained earnings was not deemed necessary. See Note 14 “Revenue Recognition” for more information.

In January 2016, the FASB issued Accounting Standards Update No. 2016-01, Financial Instruments-Overall: Recognition and Measurement of Financial Assets and Financial Liabilities. The guidance in this update makes changes to the current GAAP model primarily affect the accounting for equity investments, financial liabilities under the fair value option, and the presentation and disclosure requirements for financial instruments. In addition, the FASB clarified guidance related to the valuation allowance assessment when recognizing deferred tax assets resulting from unrealized losses on available-for-sale debt securities. The accounting for other financial instruments, such as loans, investments in debt securities, and financial liabilities is largely unchanged. The treatment of gains and losses for all equity securities, including those without a readily determinable market value, is expected to result in additional volatility in the income statement, with the loss of mark to market via equity for these investments. Additionally, changes in the allowable method for determining the fair value of financial instruments in the financial statement footnotes (“exit price” only) require changes to current methodologies of determining these vales, and how they are disclosed in the financial statement footnotes. The new standard applies to public business entities in fiscal years beginning after December 15, 2017, including interim periods within those fiscal years. The Company adopted this update on January 1, 2018. With the elimination of the classification of available for sale equity securities, the net unrealized gain or loss on these securities that had been included in accumulated other comprehensive income at December 31, 2017, in the amount of $57,000, has been transferred to retained earnings, as shown in the Consolidated Statement of Shareholders’ Equity. Changes in the fair value of equity securities with readily determinable fair values are now reflected in the noninterest income portion of the Consolidated Statements of Operations, in the other gains (losses) line item. In accordance with the ASU requirements, the Company measured the fair value of its loan portfolio as of March 31, 2018 using an exit price notion. See Note 13. “Estimated Fair Value of Financial Instruments and Fair Value Measurements” to our consolidated financial statements.

Accounting Guidance Pending Adoption at March 31, 2018
In February 2016, the FASB issued Accounting Standards Update No. 2016-02, Leases (Topic 842). The guidance in this update is meant to increase transparency and comparability among organizations by recognizing lease assets and lease liabilities on the balance sheet and disclosing key information about leasing arrangements. The core principle of Topic 842 is that a lessee should recognize the assets and liabilities that arise from leases. All leases create an asset and a liability for the lessee in accordance with FASB Concepts Statement No. 6, Elements of Financial Statements, and, therefore, recognition of those lease assets and lease liabilities represents an improvement over previous GAAP, which did not require lease assets and lease liabilities to be recognized for most leases. Disclosures are required by lessees and lessors to meet the objective of enabling users of financial statements to assess the amount, timing, and uncertainty of cash flows arising from leases. To meet that objective, qualitative disclosures along with specific quantitative disclosures are required. The new standard applies to public business entities in fiscal years beginning after December 15, 2018, including interim periods within those fiscal years, with early adoption permitted. The Company has several lease agreements, such as branch locations, which are currently considered operating leases, and therefore not recognized on the Company’s consolidated balance sheets. The Company expects the new guidance will require these lease agreements to now be recognized on the consolidated balance sheets as right-of-use assets and a corresponding lease liability. However, the Company continues to evaluate the extent of the potential impact the new guidance will have on the Company’s consolidated financial statements and the availability of outside vendor products to assist in the implementation, and does not expect to early adopt the standard.

In June 2016, the FASB issued Accounting Standards Update No. 2016-13, Financial Instruments-Credit Losses (Topic 326) - Measurement of Credit Losses on Financial Instruments. The new guidance introduces an approach based on expected losses to estimate credit losses on certain types of financial instruments. It also modifies the impairment model for available-for-sale debt securities and provides for a simplified accounting model for purchased financial assets with credit deterioration since their origination. The amendment requires the use of a new model covering current expected credit losses (CECL), which will apply to: (1) financial assets subject to credit losses and measured at amortized cost, and (2) certain off-balance sheet credit exposures. Upon initial recognition of the exposure, the CECL model requires an entity to estimate the credit losses expected over the life of an exposure (or pool of exposures). The estimate of expected credit losses (ECL) should consider historical information, current information, and reasonable and supportable forecasts,

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including estimates of prepayments. The new guidance also amends the current available for sale (AFS) security OTTI model for debt securities. The new model will require an estimate of ECL only when the fair value is below the amortized cost of the asset. The length of time the fair value of an AFS debt security has been below the amortized cost will no longer impact the determination of whether a credit loss exists. As such, it is no longer an other-than-temporary model. Finally, the purchased financial assets with credit deterioration (PCD) model applies to purchased financial assets (measured at amortized cost or AFS) that have experienced more than insignificant credit deterioration since origination. This represents a change from the scope of what are considered purchased credit-impaired assets under today’s model. Different than the accounting for originated or purchased assets that do not qualify as PCD, the initial estimate of expected credit losses for a PCD would be recognized through an allowance for loan and lease losses with an offset to the cost basis of the related financial asset at acquisition. The new standard applies to public business entities that are SEC filers in fiscal years beginning after December 15, 2019, including interim periods within those fiscal years, with early adoption permitted for fiscal years beginning after December 31, 2018, including interim periods within those fiscal years, and is expected to increase the allowance for loan losses upon adoption. The Company has formed a working group to evaluate the impact of the standard’s adoption on the Company’s consolidated financial statements, and has completed viewing demonstrations of the capabilities of outside vendor software systems, and is currently evaluating the ability of these systems to meet the processing necessary to support the data collection, retention, and disclosure requirements of the Company in implementation of the new standard.

3.    Investment Securities
The amortized cost and fair value of investment securities available for sale, with gross unrealized gains and losses, are as follows:
 
 
As of March 31, 2018
 
(in thousands)
Amortized
Cost
 
Gross
Unrealized
Gains
 
Gross
Unrealized
Losses
 
Estimated
Fair Value
 
U.S. Government agencies and corporations
$
15,678

 
$
—

 
$
279

 
$
15,399

 
State and political subdivisions
146,386

 
1,663

 
523

 
147,526

 
Mortgage-backed securities
48,065

 
147

 
952

 
47,260

 
Collateralized mortgage obligations
178,068

 
13

 
7,276

 
170,805

 
Corporate debt securities
66,285

 
25

 
1,213

 
65,097

 
Total
$
454,482

 
$
1,848

 
$
10,243

 
$
446,087

 
 
 
As of December 31, 2017
 
(in thousands)
Amortized
Cost
 
Gross
Unrealized
Gains
 
Gross
Unrealized
Losses
 
Estimated
Fair Value
 
U.S. Government agencies and corporations
$
15,716

 
$
—

 
$
90

 
$
15,626

 
State and political subdivisions
139,561

 
2,475

 
197

 
141,839

 
Mortgage-backed securities
48,744

 
181

 
428

 
48,497

 
Collateralized mortgage obligations
173,339

 
29

 
5,172

 
168,196

 
Corporate debt securities
71,562

 
31

 
427

 
71,166

 
Total debt securities
448,922

 
2,716

 
6,314

 
445,324

 
Other equity securities
2,268

 
124

 
56

 
2,336

 
Total
$
451,190

 
$
2,840

 
$
6,370

 
$
447,660

 
The amortized cost and fair value of investment debt securities held to maturity, with gross unrealized gains and losses, are as follows:
 
 
As of March 31, 2018
 
(in thousands)
Amortized
Cost
 
Gross
Unrealized
Gains
 
Gross
Unrealized
Losses
 
Estimated
Fair Value
 
U.S. Government agencies and corporations
$
10,047

 
$
—

 
$
278

 
$
9,769

 
State and political subdivisions
126,356

 
315

 
3,089

 
123,582

 
Mortgage-backed securities
1,882

 
2

 
45

 
1,839

 
Collateralized mortgage obligations
21,204

 
—

 
932

 
20,272

 
Corporate debt securities
35,128

 
504

 
501

 
35,131

 
Total
$
194,617

 
$
821

 
$
4,845

 
$
190,593


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As of December 31, 2017
 
(in thousands)
Amortized
Cost
 
Gross
Unrealized
Gains
 
Gross
Unrealized
Losses
 
Estimated
Fair Value
 
U.S. Government agencies and corporations
$
10,049

 
$
—

 
$
—

 
$
10,049

 
State and political subdivisions
126,413

 
804

 
1,631

 
125,586

 
Mortgage-backed securities
1,906

 
4

 
13

 
1,897

 
Collateralized mortgage obligations
22,115

 
—

 
707

 
21,408

 
Corporate debt securities
35,136

 
548

 
281

 
35,403

 
Total
$
195,619

 
$
1,356

 
$
2,632

 
$
194,343

Investment securities with a carrying value of $238.2 million and $237.4 million at March 31, 2018 and December 31, 2017, respectively, were pledged on public deposits, securities sold under agreements to repurchase and for other purposes, as required or permitted by law.
As of March 31, 2018, the Company owned $0.4 million of equity securities in banks and financial service-related companies, and $2.4 million of mutual funds invested in debt securities and other debt instruments that will cause units of the fund to be deemed to be qualified under the Community Reinvestment Act. Prior to January 1, 2018, we accounted for our marketable equity securities at fair value with unrealized gains and losses recognized in accumulated other comprehensive income on the balance sheet. Realized gains and losses on marketable equity securities sold or impaired were recognized in noninterest income. Effective with the January 1, 2018 adoption of ASU 2016-01, both the realized and unrealized net gains and losses on equity securities are required to be recognized in the statement of operations. A breakdown between net realized and unrealized gains and losses is provided later in this financial statement footnote. These net changes are included in the other gains line item in the noninterest income section of the Consolidated Statements of Operations.
The summary of investment securities shows that some of the securities in the available for sale and held to maturity investment portfolios had unrealized losses, or were temporarily impaired, as of March 31, 2018 and December 31, 2017. This temporary impairment represents the estimated amount of loss that would be realized if the securities were sold on the valuation date. 
The following tables present information pertaining to securities with gross unrealized losses as of March 31, 2018 and December 31, 2017, aggregated by investment category and length of time that individual securities have been in a continuous loss position:  
 
 
 
 
As of March 31, 2018
 
 
Number
of
Securities
 
Less than 12 Months
 
12 Months or More
 
Total
 
Available for Sale
 
Fair
Value
 
Unrealized
Losses 
 
Fair
Value
 
Unrealized
Losses 
 
Fair
Value
 
Unrealized
Losses 
 
(in thousands, except number of securities)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
U.S. Government agencies and corporations
3

 
$
15,399

 
$
279

 
$
—

 
$
—

 
$
15,399

 
$
279

 
State and political subdivisions
72

 
33,470

 
452

 
2,757

 
71

 
36,227

 
523

 
Mortgage-backed securities
21

 
36,330

 
871

 
3,627

 
81

 
39,957

 
952

 
Collateralized mortgage obligations
41

 
47,328

 
1,010

 
117,834

 
6,266

 
165,162

 
7,276

 
Corporate debt securities
12

 
54,639

 
995

 
8,576

 
218

 
63,215

 
1,213

 
Total
149

 
$
187,166

 
$
3,607

 
$
132,794

 
$
6,636

 
$
319,960

 
$
10,243


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As of December 31, 2017
 
 
Number
of
Securities
 
Less than 12 Months
 
12 Months or More
 
Total
 
 
 
Fair
Value
 
Unrealized
Losses 
 
Fair
Value
 
Unrealized
Losses 
 
Fair
Value
 
Unrealized
Losses 
 
(in thousands, except number of securities)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
U.S. Government agencies and corporations
3

 
$
15,626

 
$
90

 
$
—

 
$
—

 
$
15,626

 
$
90

 
State and political subdivisions
34

 
11,705

 
167

 
1,800

 
30

 
13,505

 
197

 
Mortgage-backed securities
20

 
37,964

 
359

 
3,961

 
69

 
41,925

 
428

 
Collateralized mortgage obligations
35

 
37,881

 
489

 
122,757

 
4,683

 
160,638

 
5,172

 
Corporate debt securities
12

 
55,340

 
298

 
8,778

 
129

 
64,118

 
427

 
Other equity securities
1

 
—

 
—

 
1,944

 
56

 
1,944

 
56

 
Total
105

 
$
158,516

 
$
1,403

 
$
139,240

 
$
4,967

 
$
297,756

 
$
6,370

 
 
 
 
As of March 31, 2018
 
 
Number
of
Securities
 
Less than 12 Months
 
12 Months or More
 
Total
 
Held to Maturity
 
Fair
Value
 
Unrealized
Losses 
 
Fair
Value
 
Unrealized
Losses 
 
Fair
Value
 
Unrealized
Losses 
 
(in thousands, except number of securities)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
U.S. Government agencies and corporations
1

 
$
9,769

 
$
278

 
$
—

 
$
—

 
$
9,769

 
$
278

 
State and political subdivisions
227

 
52,946

 
1,212

 
25,191

 
1,877

 
78,137

 
3,089

 
Mortgage-backed securities
5

 
902

 
15

 
857

 
30

 
1,759

 
45

 
Collateralized mortgage obligations
7

 
4,941

 
155

 
15,314

 
777

 
20,255

 
932

 
Corporate debt securities
5

 
11,236

 
222

 
2,616

 
279

 
13,852

 
501

 
Total
245

 
$
79,794

 
$
1,882

 
$
43,978

 
$
2,963

 
$
123,772

 
$
4,845

 
 
 
 
As of December 31, 2017
 
 
Number
of
Securities
 
Less than 12 Months
 
12 Months or More
 
Total
 
 
 
Fair
Value
 
Unrealized
Losses 
 
Fair
Value
 
Unrealized
Losses 
 
Fair
Value
 
Unrealized
Losses 
 
(in thousands, except number of securities)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
State and political subdivisions
167

 
$
33,237

 
$
393

 
$
25,843

 
$
1,238

 
$
59,080

 
$
1,631

 
Mortgage-backed securities
4

 
349

 
2

 
887

 
11

 
1,236

 
13

 
Collateralized mortgage obligations
7

 
5,221

 
90

 
16,168

 
617

 
21,389

 
707

 
Corporate debt securities
3

 
3,093

 
4

 
2,617

 
277

 
5,710

 
281

 
Total
181

 
$
41,900

 
$
489

 
$
45,515

 
$
2,143

 
$
87,415

 
$
2,632

The Company's assessment of other-than-temporary impairment ("OTTI") is based on its reasonable judgment of the specific facts and circumstances impacting each individual debt security at the time such assessments are made. The Company reviews and considers factual information, including expected cash flows, the structure of the debt security, the creditworthiness of the issuer, the type of underlying assets and the current and anticipated market conditions.
At March 31, 2018 and December 31, 2017, the Company’s mortgage-backed securities and collateralized mortgage obligations portfolios consisted of securities predominantly backed by one- to four-family mortgage loans and underwritten to the standards of and guaranteed by the following government-sponsored agencies: the Federal Home Loan Mortgage Corporation, the Federal National Mortgage Association, and the Government National Mortgage Association. The receipt of principal, at par, and interest on mortgage-backed securities is guaranteed by the respective government-sponsored agency guarantor, such that the Company believes that its mortgage-backed securities and collateralized mortgage obligations do not expose the Company to credit-related losses.
At March 31, 2018, approximately 56% of the municipal bonds held by the Company were Iowa-based, and approximately 22% were Minnesota-based. The Company does not intend to sell these municipal obligations, and it is more likely than not that the Company will not be required to sell them until the recovery of their cost. Due to the issuers’ continued satisfaction of their obligations under the securities in accordance with their contractual terms and the expectation that they will continue to do so, management’s intent and ability to hold these securities for a period of time sufficient to allow for any anticipated recovery in fair value, as well as the evaluation of the fundamentals of the issuers’ financial conditions

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and other objective evidence, the Company believed that the municipal obligations identified in the tables above were temporarily impaired as of March 31, 2018 and December 31, 2017.
At March 31, 2018 and December 31, 2017, all but one of the Company’s corporate bonds held an investment grade rating from Moody’s, S&P or Kroll, or carried a guarantee from an agency of the US government. We have evaluated  financial statements of the company issuing the non-investment grade bond and found the company’s earnings and equity position to be satisfactory and in line with industry norms. Therefore, we expect to receive all contractual payments. The internal evaluation of the non-investment grade bond along with the investment grade ratings on the remainder of the corporate portfolio lead us to conclude that all of the corporate bonds in our portfolio will continue to pay according to their contractual terms. Since the Company has the ability and intent to hold securities until price recovery, we believe that there is no other-than-temporary-impairment in the corporate bond portfolio.
It is reasonably possible that the fair values of the Company’s investment securities could decline in the future if interest rates increase or the overall economy or the financial conditions of the issuers deteriorate. As a result, there is a risk that OTTI may be recognized in the future, and any such amounts could be material to the Company’s consolidated statements of operations.
During the first quarter of 2017 as part of the Company’s annual review and analysis of municipal investments, $1.2 million of municipal bonds from a single issuer in the held to maturity portfolio, which did not carry a credit rating from one of the major statistical rating agencies, were identified as having an elevated level of credit risk. While the instruments were currently making payments as agreed, certain financial trends were identified that provided material doubt as to the ability of the entity to continue to service the debt in the future. The investment securities were classified as “watch,” and the Company’s asset and liability management committee was notified of the situation. In early March 2017 the Company learned of a potential buyer for the investments and a bid to purchase was received and accepted. Investment securities designated as held to maturity may generally not be sold without calling into question the Company’s stated intention to hold other debt securities to maturity in the future (“tainting”), unless certain conditions are met that provide for an exception to accounting policy. One of these exceptions, as outlined under Accounting Standards Codification (“ASC”) 320-10-25-6(a), allows for the sale of an investment that is classified as held to maturity due to significant deterioration of the issuer’s creditworthiness. Since the bonds had been internally classified as “watch” due to credit deterioration, the Company believes that the sale was in accordance with the allowable provisions of ASC 320-10-25-6(a), and as such, does not “taint” the remainder of the held to maturity portfolio. A small gain was realized on the sale.
The contractual maturity distribution of investment debt securities at March 31, 2018, is summarized as follows:
 
 
Available For Sale
 
Held to Maturity
 
(in thousands)
Amortized
Cost
 
Fair Value
 
Amortized
Cost
 
Fair Value
 
Due in one year or less
$
28,726

 
$
28,807

 
$
—

 
$
—

 
Due after one year through five years
116,063

 
115,334

 
18,777

 
18,573

 
Due after five years through ten years
70,509

 
71,045

 
91,309

 
90,725

 
Due after ten years
13,051

 
12,836

 
61,445

 
59,184

 
Debt securities without a single maturity date
226,133

 
218,065

 
23,086

 
22,111

 
Total
$
454,482

 
$
446,087

 
$
194,617

 
$
190,593

Mortgage-backed securities and collateralized mortgage obligations are collateralized by mortgage loans and guaranteed by U.S. government agencies. Our experience has indicated that principal payments will be collected sooner than scheduled because of prepayments. Therefore, these securities are not scheduled in the maturity categories indicated above.
Proceeds from the sales of investment debt securities available for sale during the three months ended March 31, 2018 and March 31, 2017 were $0.5 million and zero, respectively.

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Realized gains and losses on sales are determined on the basis of specific identification of investments based on the trade date. Realized gains (losses) on investments, including impairment losses for the three months ended March 31, 2018 and 2017, were as follows:
 
 
Three Months Ended March 31,
 
(in thousands)
2018
 
2017
 
Available for sale debt securities:
 
 
 
 
Gross realized gains
$
9

 
$
—

 
Gross realized losses
—

 
—

 
Other-than-temporary impairment
—

 
—

 
 
9

 
—

 
Held to maturity debt securities:
 
 
 
 
Gross realized gains
—

 
43

The following tables present the net gains and losses on equity investments during the three months ended March 31, 2018, disaggregated into realized and unrealized gains and losses:
 
 
Three Months Ended March 31,
 
(in thousands)
2018
 
Net losses recognized
$
(24
)
 
Less: Net gains and losses recognized due to sales
—

 
Unrealized losses on securities still held at the reporting date
$
(24
)

4.    Loans Receivable and the Allowance for Loan Losses
The composition of allowance for loan losses and loans by portfolio segment and based on impairment method are as follows:
 
 
Allowance for Loan Losses and Recorded Investment in Loan Receivables
 
 
As of March 31, 2018 and December 31, 2017
 
(in thousands)
Agricultural
 
Commercial and Industrial
 
Commercial Real Estate
 
Residential Real Estate
 
Consumer
 
Total
 
March 31, 2018
 
 
 
 
 
 
 
 
 
 
 
 
Allowance for loan losses:
 
 
 
 
 
 
 
 
 
 
 
 
Individually evaluated for impairment
$
580

 
$
1,708

 
$
3,338

 
$
167

 
$
—

 
$
5,793

 
Collectively evaluated for impairment
2,573

 
6,654

 
11,408

 
2,254

 
282

 
23,171

 
Purchased credit impaired loans
—

 
—

 
251

 
456

 
—

 
707

 
Total
$
3,153

 
$
8,362

 
$
14,997

 
$
2,877

 
$
282

 
$
29,671

 
Loans receivable
 
 
 
 
 
 
 
 
 
 
 
 
Individually evaluated for impairment
$
10,945

 
$
10,899

 
$
17,448

 
$
3,855

 
$
—

 
$
43,147

 
Collectively evaluated for impairment
101,030

 
502,824

 
1,166,913

 
457,180

 
36,030

 
2,263,977

 
Purchased credit impaired loans
—

 
55

 
14,085

 
4,894

 
—

 
19,034

 
Total
$
111,975

 
$
513,778

 
$
1,198,446

 
$
465,929

 
$
36,030

 
$
2,326,158

 
(in thousands)
Agricultural
 
Commercial and Industrial
 
Commercial Real Estate
 
Residential Real Estate
 
Consumer
 
Total
 
December 31, 2017
 
 
 
 
 
 
 
 
 
 
 
 
Allowance for loan losses:
 
 
 
 
 
 
 
 
 
 
 
 
Individually evaluated for impairment
$
140

 
$
1,126

 
$
2,157

 
$
226

 
$
—

 
$
3,649

 
Collectively evaluated for impairment
2,650

 
7,392

 
11,144

 
2,182

 
244

 
23,612

 
Purchased credit impaired loans
—

 
—

 
336

 
462

 
—

 
798

 
Total
$
2,790

 
$
8,518

 
$
13,637

 
$
2,870

 
$
244

 
$
28,059

 
Loans receivable
 
 
 
 
 
 
 
 
 
 
 
 
Individually evaluated for impairment
$
2,969

 
$
9,734

 
$
10,386

 
$
3,722

 
$
—

 
$
26,811

 
Collectively evaluated for impairment
102,543

 
493,844

 
1,147,133

 
460,475

 
36,158

 
2,240,153

 
Purchased credit impaired loans
—

 
46

 
14,452

 
5,233

 
—

 
19,731

 
Total
$
105,512

 
$
503,624

 
$
1,171,971

 
$
469,430

 
$
36,158

 
$
2,286,695

As of March 31, 2018, the gross purchased credit impaired loans included above were $20.5 million, with a discount of $1.5 million.

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Loans with unpaid principal in the amount of $487.7 million and $477.6 million at March 31, 2018 and December 31, 2017, respectively, were pledged to the Federal Home Loan Bank (the “FHLB”) as collateral for borrowings.
The changes in the allowance for loan losses by portfolio segment were as follows:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Allowance for Loan Loss Activity
 
 
For the Three Months Ended March 31, 2018 and 2017
 
(in thousands)
Agricultural
 
Commercial and Industrial
 
Commercial Real Estate
 
Residential Real Estate
 
Consumer
 
Total
 
2018
 
 
 
 
 
 
 
 
 
 
 
 
Beginning balance
$
2,790

 
$
8,518

 
$
13,637

 
$
2,870

 
$
244

 
$
28,059

 
Charge-offs
—

 
(87
)
 
(264
)
 
(104
)
 
(21
)
 
(476
)
 
Recoveries
6

 
79

 
76

 
62

 
15

 
238

 
Provision
357

 
(148
)
 
1,548

 
49

 
44

 
1,850

 
Ending balance
$
3,153

 
$
8,362

 
$
14,997

 
$
2,877

 
$
282

 
$
29,671

 
2017
 
 
 
 
 
 
 
 
 
 
 
 
Beginning balance
$
2,003

 
$
6,274

 
$
9,860

 
$
3,458

 
$
255

 
$
21,850

 
Charge-offs
(537
)
 
(65
)
 
(61
)
 
(28
)
 
(25
)
 
(716
)
 
Recoveries
10

 
19

 
10

 
—

 
3

 
42

 
Provision
984

 
(207
)
 
(58
)
 
334

 
(12
)
 
1,041

 
Ending balance
$
2,460

 
$
6,021

 
$
9,751

 
$
3,764

 
$
221

 
$
22,217

Loan Portfolio Segment Risk Characteristics
Agricultural - Agricultural loans, most of which are secured by crops, livestock, and machinery, are provided to finance capital improvements and farm operations as well as acquisitions of livestock and machinery. The ability of the borrower to repay may be affected by many factors outside of the borrower’s control including adverse weather conditions, loss of livestock due to disease or other factors, declines in market prices for agricultural products and the impact of government regulations. The ultimate repayment of agricultural loans is dependent upon the profitable operation or management of the agricultural entity. Collateral for these loans generally includes accounts receivable, inventory, equipment and real estate. However, depending on the overall financial condition of the borrower, some loans are made on an unsecured basis. The collateral securing these loans may depreciate over time, may be difficult to appraise and may fluctuate in value based on the success of the business.
Commercial and Industrial - Commercial and industrial loans are primarily made based on the reported cash flow of the borrower and secondarily on the underlying collateral provided by the borrower. The collateral support provided by the borrower for most of these loans and the probability of repayment are based on the liquidation of the pledged collateral and enforcement of a personal guarantee, if any exists. The primary repayment risks of commercial and industrial loans are that the cash flows of the borrower may be unpredictable, and the collateral securing these loans may fluctuate in value. The size of the loans the Company can offer to commercial customers is less than the size of the loans that competitors with larger lending limits can offer. This may limit the Company’s ability to establish relationships with the largest businesses in the areas in which the Company operates. As a result, the Company may assume greater lending risks than financial institutions that have a lesser concentration of such loans and tend to make loans to larger businesses. Collateral for these loans generally includes accounts receivable, inventory, equipment and real estate. However, depending on the overall financial condition of the borrower, some loans are made on an unsecured basis. The collateral securing these loans may depreciate over time, may be difficult to appraise and may fluctuate in value based on the success of the business. In addition, a decline in the U.S. economy could harm or continue to harm the businesses of the Company’s commercial and industrial customers and reduce the value of the collateral securing these loans.
Commercial Real Estate - The Company offers mortgage loans to commercial and agricultural customers for the acquisition of real estate used in their businesses, such as offices, warehouses and production facilities, and to real estate investors for the acquisition of apartment buildings, retail centers, office buildings and other commercial buildings. The market value of real estate securing commercial real estate loans can fluctuate significantly in a short period of time as a result of market conditions in the geographic area in which the real estate is located. Adverse developments affecting real estate values in one or more of the Company’s markets could increase the credit risk associated with its loan portfolio. Additionally, real estate lending typically involves higher loan principal amounts than other loans, and the repayment of the loans generally is dependent, in large part, on sufficient income from the properties securing the loans to cover operating expenses and debt service. Economic events or governmental regulations outside of the Company’s control or that of the borrower could negatively impact the future cash flow and market values of the affected properties.

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Residential Real Estate - The Company generally retains short-term residential mortgage loans that are originated for its own portfolio but sells most long-term loans to other parties while retaining servicing rights on the majority of those loans. The market value of real estate securing residential real estate loans can fluctuate as a result of market conditions in the geographic area in which the real estate is located. Adverse developments affecting real estate values in one or more of the Company’s markets could increase the credit risk associated with its loan portfolio. Additionally, real estate lending typically involves higher loan principal amounts than other loans, and the repayment of the loans generally is dependent, in large part, on the borrower’s continuing financial stability, and is therefore more likely to be affected by adverse personal circumstances.
Consumer - Consumer loans typically have shorter terms, lower balances, higher yields and higher risks of default than real estate-related loans. Consumer loan collections are dependent on the borrower’s continuing financial stability, and are therefore more likely to be affected by adverse personal circumstances. Collateral for these loans generally includes automobiles, boats, recreational vehicles, mobile homes, and real estate. However, depending on the overall financial condition of the borrower, some loans are made on an unsecured basis. The collateral securing these loans may depreciate over time, may be difficult to recover and may fluctuate in value based on condition. In addition, a decline in the United States economy could result in reduced employment, impacting the ability of customers to repay their obligations.
Purchased Loans Policy
All purchased loans (nonimpaired and impaired) are initially measured at fair value as of the acquisition date in accordance with applicable authoritative accounting guidance. Credit discounts are included in the determination of fair value. An allowance for loan losses is not recorded at the acquisition date for loans purchased.
Individual loans acquired through the completion of a transfer, including loans that have evidence of deterioration of credit quality since origination and for which it is probable, at acquisition, that the Company will be unable to collect all contractually required payments receivable, are referred to herein as “purchased credit impaired loans.” In determining the acquisition date fair value and estimated credit losses of purchased credit impaired loans, and in subsequent accounting, the Company accounts for loans individually. Contractually required payments for interest and principal that exceed the undiscounted cash flows expected at acquisition, or the “nonaccretable difference,” are not recognized as a yield adjustment or as a loss accrual or valuation allowance. Expected cash flows at the purchase date in excess of the fair value of loans, if any, are recorded as interest income over the expected life of the loans if the timing and amount of future cash flows are reasonably estimable. Subsequent to the purchase date, increases in cash flows over those expected at the purchase date are recognized as interest income prospectively. The present value of any decreases in expected cash flows after the purchase date is recognized by recording an allowance for loan losses and a provision for loan losses. If the Company does not have the information necessary to reasonably estimate cash flows to be expected, it may use the cost-recovery method or cash-basis method of income recognition.
Charge-off Policy
The Company requires a loan to be charged-off, in whole or in part, as soon as it becomes apparent that some loss will be incurred, or when its collectability is sufficiently questionable that it no longer is considered a bankable asset. The primary considerations when determining if and how much of a loan should be charged-off are as follows: (1) the potential for future cash flows; (2) the value of any collateral; and (3) the strength of any co-makers or guarantors.
When it is determined that a loan requires a partial or full charge-off, a request for approval of a charge-off is submitted to the Company's President, Executive Vice President and Chief Credit Officer, and the Senior Regional Loan officer. The Bank's board of directors formally approves all loan charge-offs. Once a loan is charged-off, it cannot be restructured and returned to the Company's books.
Allowance for Loan and Lease Losses
The Company requires the maintenance of an adequate allowance for loan and lease losses (“ALLL”) in order to cover estimated probable losses without eroding the Company’s capital base. Calculations are done at each quarter end, or more frequently if warranted, to analyze the collectability of loans and to ensure the adequacy of the allowance. In line with FDIC directives, the ALLL calculation does not include consideration of loans held for sale or off-balance-sheet credit exposures (such as unfunded letters of credit). Determining the appropriate level for the ALLL relies on the informed judgment of management, and as such, is subject to inexactness. Given the inherently imprecise nature of calculating the necessary ALLL, the Company’s policy permits the actual ALLL to be between 20% above and 5% below the “indicated reserve.”
Loans Reviewed Individually for Impairment
The Company identifies loans to be reviewed and evaluated individually for impairment based on current information and events and the probability that the borrower will be unable to repay all amounts due according to the contractual

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terms of the loan agreement. Specific areas of consideration include: size of credit exposure, risk rating, delinquency, nonaccrual status, and loan classification.
The level of individual impairment is measured using one of the following methods: (1) the fair value of the collateral less costs to sell; (2) the present value of expected future cash flows, discounted at the loan's effective interest rate; or (3) the loan's observable market price. Loans that are deemed fully collateralized or have been charged down to a level corresponding with any of the three measurements require no assignment of reserves from the ALLL.
A loan modification is a change in an existing loan contract that has been agreed to by the borrower and the Bank, which may or may not be a troubled debt restructure or “TDR.” All loans deemed TDR are considered impaired. A loan is considered a TDR when, for economic or legal reasons related to a borrower’s financial difficulties, a concession is granted to the borrower that would not otherwise be considered. Both financial distress on the part of the borrower and the Bank’s granting of a concession, which are detailed further below, must be present in order for the loan to be considered a TDR.
All of the following factors are indicators that the debtor is experiencing financial difficulties (one or more items may be present):
•
The debtor is currently in default on any of its debt.
•
The debtor has declared or is in the process of declaring bankruptcy.
•
There is significant doubt as to whether the debtor will continue to be a going concern.
•
Currently, the debtor has securities being held as collateral that have been delisted, are in the process of being delisted, or are under threat of being delisted from an exchange.
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Based on estimates and projections that only encompass the current business capabilities, the debtor forecasts that its entity-specific cash flows will be insufficient to service the debt (both interest and principal) in accordance with the contractual terms of the existing agreement through maturity.
•
Absent the current modification, the debtor cannot obtain funds from sources other than the existing creditors at an effective interest rate equal to the current market interest rate for similar debt for a non-troubled debtor.
The following factors are potential indicators that a concession has been granted (one or multiple items may be present):
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The borrower receives a reduction of the stated interest rate for the remaining original life of the debt.
•
The borrower receives an extension of the maturity date or dates at a stated interest rate lower that the current market interest rate for new debt with similar risk characteristics.
•
The borrower receives a reduction of the face amount or maturity amount of the debt as stated in the instrument or other agreement.
•
The borrower receives a deferral of required payments (principal and/or interest).
•
The borrower receives a reduction of the accrued interest.

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The following table sets forth information on the Company’s TDRs by class of loan occurring during the stated periods:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Three Months Ended March 31,
 
 
2018
 
2017
 
(dollars in thousands)
Number of Contracts
 
Pre-Modification Outstanding Recorded Investment
 
Post-Modification Outstanding Recorded Investment
 
Number of Contracts
 
Pre-Modification Outstanding Recorded Investment
 
Post-Modification Outstanding Recorded Investment
 
Troubled Debt Restructurings(1):
 
 
 
 
 
 
 
 
 
 
 
 
Commercial and industrial
 
 
 
 
 
 
 
 
 
 
 
 
Extended maturity date
—

 
$
—