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,~~September 30, 2018

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)~~

(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, smaller reporting company or an emerging growth company.

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

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to section 13(a) of the Exchange Act. Yes ☐ No ☐

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		~~24,106,711~~24,105,586
Class		Outstanding at ~~May 2,~~November 1, 2018

INDEPENDENT BANK CORPORATION AND SUBSIDIARIES

INDEX

		Number(s)
PART I -	Financial Information
Item 1.	Condensed Consolidated Statements of Financial Condition ~~March 31,~~September 30, 2018 and December 31, 2017	3
	Condensed Consolidated Statements of Operations ~~Three-month~~Three- and Nine-month periods ended ~~March 31,~~September 30, 2018 and 2017	4
	Condensed Consolidated Statements of Comprehensive Income ~~Three-month~~Three- and Nine-month periods ended ~~March 31,~~September 30, 2018 and 2017	5
	Condensed Consolidated Statements of Cash Flows ~~Three-month~~Nine-month periods ended ~~March 31,~~September 30, 2018 and 2017	6
	Condensed Consolidated Statements of Shareholders' Equity ~~Three-month~~Nine-month periods ended ~~March 31,~~September 30, 2018 and 2017	7
	Notes to Interim Condensed Consolidated Financial Statements	~~8-54~~8-65
Item 2.	Management's Discussion and Analysis of Financial Condition and Results of Operations	~~55-77~~66-90
Item 3.	Quantitative and Qualitative Disclosures about Market Risk	7891
Item 4.	Controls and Procedures	7891

PART II -	Other Information
Item 1A	Risk Factors	7992
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	7992
Item 6.	Exhibits	8093

Index

FORWARD-LOOKING STATEMENTS

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

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

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

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

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

our ability to achieve loan and deposit growth;

volatility and direction of market interest rates;

the continued services of our management team; and

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

This list provides examples of factors that could affect the results described by forward-looking statements contained in this report, but the list is not intended to be all-inclusive.

In addition, factors that may cause actual results to differ from expectations regarding the April 1, 2018 acquisition of TCSB Bancorp, Inc. include, but are not limited to, the reaction to the transaction of the companies’ customers, employees and counterparties; customer disintermediation; inflation; expected synergies, cost savings and other financial benefits of the transaction might not be realized within the expected timeframes or might be less than projected; credit and interest rate risks associated with the parties' respective businesses, customers, borrowings, repayment, investment, and deposit practices; general economic conditions, either nationally or in the market areas in which the parties operate or anticipate doing business, are less favorable than expected; new regulatory or legal requirements or obligations; and other risks.

The risk factors disclosed in Part I – Item 1A of our Annual Report on Form 10-K for the year ended December 31, 2017, 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.

Index

Part I - Item 1.

INDEPENDENT BANK CORPORATION AND SUBSIDIARIES

Condensed Consolidated Statements of Financial Condition

	March 31, 2018			December 31, 2017				September 30, 2018			December 31, 2017
	(unaudited)							(unaudited)
	(In thousands, except share amounts)							(In thousands, except share amounts)
Assets							Assets
Cash and due from banks	$	29,126		$	36,994			$	35,180		$	36,994
Interest bearing deposits		13,250			17,744				17,990			17,744
Cash and Cash Equivalents		42,376			54,738				53,170			54,738
Interest bearing deposits - time		1,738			2,739				593			2,739
Equity securities at fair value		301			-				285			-
Trading securities		-			455				-			455
Securities available for sale		489,119			522,925				436,957			522,925
Federal Home Loan Bank and Federal Reserve Bank stock, at cost		15,543			15,543				18,355			15,543
Loans held for sale, carried at fair value		34,148			39,436				41,325			39,436
Loans
Commercial		857,417			853,260				1,112,101			853,260
Mortgage		888,910			849,530				1,056,482			849,530
Installment		325,108			316,027				393,995			316,027
Total Loans		2,071,435			2,018,817				2,562,578			2,018,817
Allowance for loan losses		(23,071	)		(22,587	)			(24,401	)		(22,587	)
Net Loans		2,048,364			1,996,230				2,538,177			1,996,230
Other real estate and repossessed assets		1,647			1,643				1,445			1,643
Property and equipment, net		38,809			39,149				39,012			39,149
Bank-owned life insurance		54,353			54,572				54,811			54,572
Deferred tax assets, net		13,715			15,089				8,449			15,089
Capitalized mortgage loan servicing rights		17,783			15,699				23,151			15,699
Other intangibles		1,500			1,586				6,709			1,586
Goodwill									28,300			-
Accrued income and other assets		33,723			29,551				46,385			29,551
Total Assets	$	2,793,119		$	2,789,355			$	3,297,124		$	2,789,355

Liabilities and Shareholders' Equity							Liabilities and Shareholders' Equity
Deposits
Non-interest bearing	$	774,046		$	768,333			$	880,932		$	768,333
Savings and interest-bearing checking		1,100,505			1,064,391				1,217,939			1,064,391
Reciprocal		63,012			50,979				92,635			50,979
Time		377,663			374,872				399,110			374,872
Brokered time		115,175			141,959				208,027			141,959
Total Deposits		2,430,401			2,400,534				2,798,643			2,400,534
Other borrowings		27,847			54,600				79,688			54,600
Subordinated debentures		35,569			35,569				39,371			35,569
Accrued expenses and other liabilities		31,385			33,719				34,218			33,719
Total Liabilities		2,525,202			2,524,422				2,951,920			2,524,422

Shareholders’ Equity
Preferred stock, no par value, 200,000 shares authorized; none issued or outstanding		-			-				-			-
Common stock, no par value, 500,000,000 shares authorized; issued and outstanding: 21,374,816 shares at March 31, 2018 and 21,333,869 shares at December 31, 2017		324,517			324,986
Common stock, no par value, 500,000,000 shares authorized; issued and outstanding: 24,150,341 shares at September 30, 2018 and 21,333,869 shares at December 31, 2017									389,689			324,986
Accumulated deficit		(48,098	)		(54,054	)			(34,596	)		(54,054	)
Accumulated other comprehensive loss		(8,502	)		(5,999	)			(9,889	)		(5,999	)
Total Shareholders’ Equity		267,917			264,933				345,204			264,933
Total Liabilities and Shareholders’ Equity	$	2,793,119		$	2,789,355			$	3,297,124		$	2,789,355

See notes to interim condensed consolidated financial statements (unaudited)

Index

INDEPENDENT BANK CORPORATION AND SUBSIDIARIES

Condensed Consolidated Statements of Operations

							Three months ended September 30,					Nine months ended September 30,
	Three months ended March 31,						2018			2017		2018			2017
	2018			2017			(unaudited)					(unaudited)
	(unaudited)						(In thousands, except per share amounts)
	(In thousands, except per share amounts)
Interest Income
Interest and fees on loans	$	23,353		$	19,858		$	31,000		$	21,831	$	84,027		$	61,638
Interest on securities
Taxable		2,635			2,754			2,737			2,765		8,092			8,300
Tax-exempt		479			455			412			512		1,335			1,478
Other investments		330			312			303			263		898			867
Total Interest Income		26,797			23,379			34,452			25,371		94,352			72,283
Interest Expense
Deposits		2,287			1,443			3,976			1,833		9,472			4,754
Other borrowings and subordinated debentures		574			470			779			626		2,267			1,659
Total Interest Expense		2,861			1,913			4,755			2,459		11,739			6,413
Net Interest Income		23,936			21,466			29,697			22,912		82,613			65,870
Provision for loan losses		315			(359	)		(53	)		582		912			806
Net Interest Income After Provision for Loan Losses		23,621			21,825			29,750			22,330		81,701			65,064
Non-interest Income
Service charges on deposit accounts		2,905			3,009			3,166			3,281		9,166			9,465
Interchange income		2,246			1,922			2,486			1,942		7,236			5,869
Net gains (losses) on assets
Mortgage loans		2,571			2,571			2,745			2,971		8,571			8,886
Securities		(173	)		27			93			69		(71	)		62
Mortgage loan servicing, net		2,221			825			1,212			1		4,668			668
Other		1,943			1,985			2,134			2,040		6,294			6,139
Total Non-interest Income		11,713			10,339			11,836			10,304		35,864			31,089
Non-interest Expense
Compensation and employee benefits		14,468			14,147			16,169			13,577		46,506			41,104
Occupancy, net		2,264			2,142			2,233			1,970		6,667			6,032
Data processing		1,878			1,937			2,051			1,796		6,180			5,670
Merger related expenses								98			10		3,354			10
Furniture, fixtures and equipment		967			977			1,043			961		3,029			2,943
Communications		680			683			727			685		2,111			2,046
Interchange expense								715			294		1,974			869
Loan and collection		677			413			531			481		1,900			1,564
Interchange expense		598			283
Advertising		441			506			594			526		1,578			1,551
Legal and professional		378			437			477			540		1,311			1,366
FDIC deposit insurance		230			198			270			208		750			608
Merger related expenses		174			-
Credit card and bank service fees		96			191
Other		1,284			1,655			1,832			1,568		5,276			5,183
Total Non-interest Expense		24,135			23,569			26,740			22,616		80,636			68,946
Income Before Income Tax		11,199			8,595			14,846			10,018		36,929			27,207
Income tax expense		2,038			2,621			2,921			3,159		7,026			8,443
Net Income	$	9,161		$	5,974		$	11,925		$	6,859	$	29,903		$	18,764
Net Income Per Common Share
Basic	$	0.43		$	0.28		$	0.49		$	0.32	$	1.29		$	0.88
Diluted	$	0.42		$	0.28		$	0.49		$	0.32	$	1.27		$	0.87
Dividends Per Common Share
Declared	$	0.15		$	0.10		$	0.15		$	0.10	$	0.45		$	0.30
Paid	$	0.15		$	0.10		$	0.15		$	0.10	$	0.45		$	0.30

See notes to interim condensed consolidated financial statements (unaudited)

Index

INDEPENDENT BANK CORPORATION AND SUBSIDIARIES

Condensed Consolidated Statements of Comprehensive Income

	Three months ended March 31,						Three months ended September 30,						Nine months ended September 30,
	2018			2017			2018			2017			2018			2017
	(unaudited)						(unaudited)
	(In thousands)						(In thousands)

Net income	$	9,161		$	5,974		$	11,925		$	6,859		$	29,903		$	18,764
Other comprehensive income (loss), before tax
Other comprehensive income (loss)
Securities available for sale
Unrealized gains (losses) arising during period		(3,865	)		3,623			(1,157	)		20			(6,220	)		7,738
Change in unrealized gains for which a portion of other than temporary impairment has been recognized in earnings		(1	)		(22	)
Change in unrealized gains (losses) for which a portion of other than temporary impairment has been recognized in earnings								(14	)		126			(17	)		211
Reclassification adjustments for (gains) losses included in earnings		19			(106	)		-			(8	)		45			(125	)
Unrealized gains (losses) recognized in other comprehensive income (loss) on securities available for sale		(3,847	)		3,495			(1,171	)		138			(6,192	)		7,824
Income tax expense (benefit)		(808	)		1,223			(246	)		48			(1,300	)		2,738
Unrealized gains (losses)recognized in other comprehensive income (loss) on securities available for sale, net of tax		(3,039	)		2,272
Unrealized gains (losses) recognized in other comprehensive income (loss) on securities available for sale, net of tax								(925	)		90			(4,892	)		5,086
Derivative instruments
Unrealized gain arising during period		684			-			389			95			1,400			95
Reclassification adjustment for income recognized in earnings		(6	)		-
Reclassification adjustment for income (expense) recognized in earnings								(73	)		5			(132	)		5
Unrealized gains recognized in other comprehensive income (loss) on derivative instruments		678			-			316			100			1,268			100
Income tax expense		142			-			66			35			266			35
Unrealized gains recognized in other comprehensive income (loss) on derivative instruments, net of tax		536			-			250			65			1,002			65
Other comprehensive income (loss)		(2,503	)		2,272			(675	)		155			(3,890	)		5,151
Comprehensive income	$	6,658		$	8,246		$	11,250		$	7,014		$	26,013		$	23,915

See notes to interim condensed consolidated financial statements (unaudited)

Index

INDEPENDENT BANK CORPORATION AND SUBSIDIARIES

Condensed Consolidated Statements of Cash Flows

	Three months ended March 31,						Nine months ended September 30,
	2018			2017			2018			2017
	(unaudited - In thousands)						(unaudited - In thousands)
Net Income	$	9,161		$	5,974		$	29,903		$	18,764
Adjustments to Reconcile Net Income to Net Cash From Operating Activities
Proceeds from sales of loans held for sale		92,607			81,681			351,486			313,559
Disbursements for loans held for sale		(84,748	)		(80,777	)		(343,462	)		(316,338	)
Net increase in other liabilities held for sale		-			717
Provision for loan losses		315			(359	)		912			806
Deferred income tax expense		2,039			2,451			6,972			7,422
Deferred loan fees and costs		(638	)		(931	)		(3,681	)		(4,588	)
Net depreciation, amortization of intangible assets and premiums and accretion of discounts on securities, loans and interest bearing deposits - time		1,819			1,279			4,560			5,079
Net gains on mortgage loans		(2,571	)		(2,571	)		(8,571	)		(8,886	)
Net gains (losses) on securities		173			(27	)
Net (gains) losses on other real estate and repossessed assets		(290	)		11
Net losses on securities								71			(62	)
Share based compensation		407			432			1,293			1,342
Increase in accrued income and other assets		(5,675	)		(1,272	)		(16,925	)		(12,748	)
Decrease in accrued expenses and other liabilities		(5,711	)		(3,229	)
Increase (decrease) in accrued expenses and other liabilities								(1,930	)		2,274
Total Adjustments		(2,273	)		(2,595	)		(9,275	)		(12,140	)
Net Cash From Operating Activities		6,888			3,379			20,628			6,624
Cash Flow Used in Investing Activities
Proceeds from the sale of securities available for sale		22,277			6,152			31,445			8,834
Proceeds from maturities, prepayments and calls of securities available for sale		34,067			50,075			125,275			143,953
Purchases of securities available for sale		(23,637	)		(45,673	)		(71,067	)		(84,080	)
Proceeds from the sale of interest bearing deposits - time								2,474			-
Proceeds from the maturity of interest bearing deposits - time		1,000			251			3,728			2,100
Purchase of Federal Reserve Bank stock								(2,034	)		-
Net increase in portfolio loans (loans originated, net of principal payments)		(68,611	)		(61,003	)		(272,084	)		(326,089	)
Proceeds from the sale of portfolio loans		16,460			-			27,577			-
Net increase in payment plan receivables and other assets held for sale		-			(1,438	)
Acquisition of TCSB Bancorp Inc., less cash received								23,516			-
Cash received from the sale of Mepco Finance Corporation assets, net								-			33,446
Proceeds from bank-owned life insurance		474			523			474			523
Proceeds from the sale of other real estate and repossessed assets		608			238			1,777			4,111
Capital expenditures		(921	)		(680	)		(2,812	)		(2,592	)
Net Cash Used in Investing Activities		(18,283	)		(51,555	)		(131,731	)		(219,794	)
Cash Flow From (Used in) Financing Activities
Cash Flow From Financing Activities
Net increase in total deposits		29,867			37,340			110,400			118,042
Net decrease in other borrowings		(6,753	)		-
Net increase in other borrowings								18,903			3,003
Proceeds from Federal Home Loan Bank Advances		40,000			-			1,202,000			461,000
Payments of Federal Home Loan Bank Advances		(60,000	)		-			(1,210,197	)		(397,587	)
Dividends paid		(3,206	)		(2,133	)		(10,446	)		(6,400	)
Proceeds from issuance of common stock		13			25			202			57
Share based compensation withholding obligation		(888	)		(427	)		(1,327	)		(536	)
Net Cash From (Used in) Financing Activities		(967	)		34,805
Net Cash From Financing Activities								109,535			177,579
Net Decrease in Cash and Cash Equivalents		(12,362	)		(13,371	)		(1,568	)		(35,591	)
Cash and Cash Equivalents at Beginning of Period		54,738			83,194			54,738			83,194
Cash and Cash Equivalents at End of Period	$	42,376		$	69,823		$	53,170		$	47,603
Cash paid during the period for
Interest	$	2,656		$	1,622		$	11,168		$	6,240
Income taxes		-			140			120			988
Transfers to other real estate and repossessed assets		322			502			960			1,389
Transfer of loans to held for sale								27,577			-
Purchase of securities available for sale not yet settled		3,220			6,046			1,000			1,765
Sale of securities available for sale not yet settled								-			760

See notes to interim condensed consolidated financial statements (unaudited)

Index

INDEPENDENT BANK CORPORATION AND SUBSIDIARIES

Condensed Consolidated Statements of Shareholders' Equity

	Three months ended March 31,						Nine months ended September 30,
	2018			2017			2018			2017
	(unaudited)						(unaudited)
	(In thousands)						(In thousands)

Balance at beginning of period	$	264,933		$	248,980		$	264,933		$	248,980
Cumulative effect of change in accounting		-			352			-			352
Balance at beginning of period, as adjusted		264,933			249,332			264,933			249,332
Net income		9,161			5,974			29,903			18,764
Cash dividends declared		(3,206	)		(2,133	)		(10,446	)		(6,400	)
Acquisition of TCSB Bancorp, Inc.								64,536			-
Issuance of common stock		13			25			202			57
Share based compensation		407			432			1,293			1,342
Share based compensation withholding obligation		(888	)		(427	)		(1,327	)		(536	)
Net change in accumulated other comprehensive loss, net of related tax effect		(2,503	)		2,272			(3,890	)		5,151
Balance at end of period	$	267,917		$	255,475		$	345,204		$	267,710

See notes to interim condensed consolidated financial statements (unaudited)

Index

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, 2017 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 ~~March 31,~~September 30, 2018 and December 31, 2017, and the results of operations for the ~~three-month~~three and nine-month periods ended ~~March 31,~~September 30, 2018 and 2017. The results of operations for the ~~three-month period~~three and nine-month periods ended ~~March 31,~~September 30, 2018, 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 determination of the allowance for loan losses, the valuation of capitalized mortgage loan servicing rights and the valuation of deferred tax assets. Refer to our 2017 Annual Report on Form 10-K for a disclosure of our accounting policies.

2.	New Accounting Standards

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

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

Index

NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

(unaudited)

In August 2017, the FASB issued ASU 2017-12, “Derivatives and Hedging (Topic 815), Targeted Improvements to Accounting for Hedging Activities”. This new ASU amends the hedge accounting model in Topic 815 to enable entities to better portray the economics of their risk management activities in the financial statements and enhance the transparency and understandability of hedge results. The amendments expand an entity’s ability to hedge nonfinancial and financial risk components and reduce complexity in fair value hedges of interest rate risk. The guidance eliminates the requirement to separately measure and report hedge ineffectiveness and generally requires the entire change in the fair value of a hedging instrument to be presented in the same income statement line as the hedged item. The guidance also eases certain documentation and assessment requirements and modifies the accounting for components excluded from the assessment of hedge effectiveness. This amended guidance is effective for us on January 1, 2019, and given our current level of derivatives designated as hedges is not expected to 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)”, (“ASU 2014-09”). 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. We adopted this ASU using the modified retrospective approach with no ~~material~~ impact to our accumulated deficit at January 1, 2018. Financial instruments for the most part and related contractual rights and obligations which are the sources of the majority of our operating revenue are excluded from the scope of this amended guidance. Those operating revenue streams that are included in the scope of this amended guidance were not materially impacted. Results for reporting periods beginning after January 1, 2018 are presented under this ASU while prior period amounts continue to be reported in accordance with legacy GAAP. The impact of the adoption of this ASU on our Condensed Consolidated Statements of Operations for the three and nine month ~~period~~periods ending ~~March 31,~~September 30, 2018 is summarized in the table below. In addition, see note #17 for further discussion on our accounting policies for operating revenue streams that are included in the scope of this amended guidance.

The impact of the adoption of ASU 2014-09 on our Condensed Consolidated Statement of Operations ~~for the three months ending March 31, 2018~~ follows:

	As Reported		Under Legacy GAAP		Impact of ASU 2014-09			As Reported		Under Legacy GAAP		Impact of ASU 2014-09
	(In thousands)							(In thousands)

Three months ended September 30, 2018
Non-interest income - Interchange income	$	2,246	$	1,938	$	308	(1)	$	2,486	$	2,088	$	398	(1	)


Non-interest expense - interchange expense	$	598	$	290		308	(1)	$	715	$	317		398	(1	)
Impact on net income					$	-						$	-


Nine months ended September 30, 2018
Non-interest income - Interchange income								$	7,236	$	6,170	$	1,066	(1	)


Non-interest expense - interchange expense								$	1,974	$	908		1,066	(1	)
Impact on net income												$	-

(1)	Represents certain costs charged by payment networks that were previously netted against interchange income.

Index

NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

(unaudited)

In January 2016, the FASB issued ASU 2016-01, “Financial Instruments – Overall (Subtopic 825-10) – Recognition and Measurement of Financial Assets and Financial Liabilities”. This ASU amends existing guidance related to the accounting for certain financial assets and liabilities. These amendments, among other things, require equity investments (except those accounted for under the equity method of accounting, or those that result in consolidation of the investee) to be measured at fair value with changes in fair value recognized in net income, require public business entities to use the exit price notion when measuring the fair value of financial instruments for disclosure purposes, require separate presentation of financial assets and financial liabilities by measurement category and form of financial asset and eliminate the requirement for public business entities to disclose the method(s) and significant assumptions used to estimate the fair value that is required to be disclosed for financial instruments measured at amortized cost. This amended guidance was effective for us on January 1, 2018. The adoption of this ~~of this~~ ASU did not have a material impact on our consolidated operating results or financial condition. As a result of the adoption of this ASU our equity securities previously classified as trading securities are now classified as equity securities at fair value on our ~~March 31,~~September 30, 2018 Condensed Consolidated Statement of Financial Condition. In addition, this amended guidance impacted certain fair value disclosure items (see note #12).

In January 2017, the FASB issued ASU 2017-01, “Business Combinations (Topic 805), Clarifying the Definition of a Business”. This new ASU clarifies the definition of a business with the objective of adding guidance to assist entities with evaluating whether transactions should be accounted for as acquisitions (or disposals) of assets or businesses which distinction determines whether goodwill is recorded or not. This amended guidance was effective for us on January 1, 2018, and did not have a material impact on our consolidated operating results or financial condition.

In January 2017, the FASB issued ASU 2017-4, “Intangibles – Goodwill and Other (Topic 350), Simplifying the Test for Goodwill Impairment”. This new ASU amends the requirement that entities compare the implied fair value of goodwill with its carrying amount as part of step 2 of the goodwill impairment test. As a result, entities should perform their annual or interim goodwill impairment test by comparing the fair value of a reporting unit with its carrying amount and recognize an impairment if the carrying amount exceeds the reporting unit’s fair value. This amended guidance is effective for us on January 1, 2020 with early application permitted. Due to our ~~pending~~recent acquisition (see note #16) and expectations this ASU will be relevant to us in 2018 we elected to adopt this amended guidance as of January 1, 2018. The adoption of this ASU did not have a material impact on our consolidated operating results or financial condition.

In February 2018, the FASB issued ASU 2018-02, ‘‘Income Statement – Reporting Comprehensive Income (Topic 220), Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income’’. This new ASU allows a reclassification from accumulated other comprehensive income to retained earnings for stranded tax effects resulting from the Tax Cuts and Jobs Act. As a result, this amended guidance eliminates the stranded tax effects resulting from the Tax Cuts and Jobs Act and will improve the usefulness of information reported to financial statement users. This amended guidance is effective for us on January 1, 2019, with early application permitted in any period for which financial statements have not yet been issued. We elected to adopt this amended guidance during the fourth quarter of 2017 and it resulted in a $0.04 million reclassification between accumulated other comprehensive loss and accumulated deficit.

Index

NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

(unaudited)

3.	Securities

Securities available for sale consist of the following:

	Amortized		Unrealized						Amortized		Unrealized
	Cost		Gains		Losses		Fair Value		Cost		Gains		Losses		Fair Value
	(In thousands)								(In thousands)
March 31, 2018
U.S. Treasury	$	600	$	-	$	1	$	599
September 30, 2018
U.S. agency		24,067		15		146		23,936	$	20,769	$	-	$	346	$	20,423
U.S. agency residential mortgage-backed		138,270		925		1,951		137,244		126,851		802		2,592		125,061
U.S. agency commercial mortgage-backed		10,218		1		274		9,945		6,039		-		224		5,815
Private label mortgage-backed		28,690		397		636		28,451		29,340		369		736		28,973
Other asset backed		90,559		165		197		90,527		78,567		147		188		78,526
Obligations of states and political subdivisions		154,194		336		2,707		151,823		143,138		219		3,703		139,654
Corporate		41,954		139		344		41,749		35,017		65		512		34,570
Trust preferred		2,931		-		121		2,810		1,963		-		38		1,925
Foreign government		2,078		-		43		2,035		2,060		-		50		2,010
Total	$	493,561	$	1,978	$	6,420	$	489,119	$	443,744	$	1,602	$	8,389	$	436,957

December 31, 2017
U.S. Treasury	$	898	$	-	$	-	$	898	$	898	$	-	$	-	$	898
U.S. agency		25,667		82		67		25,682		25,667		82		67		25,682
U.S. agency residential mortgage-backed		137,785		1,116		983		137,918		137,785		1,116		983		137,918
U.S. agency commercial mortgage-backed		9,894		36		170		9,760		9,894		36		170		9,760
Private label mortgage-backed		29,011		428		330		29,109		29,011		428		330		29,109
Other asset backed		93,811		202		115		93,898		93,811		202		115		93,898
Obligations of states and political subdivisions		174,073		755		1,883		172,945		174,073		755		1,883		172,945
Corporate		47,365		578		90		47,853		47,365		578		90		47,853
Trust preferred		2,929		-		127		2,802		2,929		-		127		2,802
Foreign government		2,087		-		27		2,060		2,087		-		27		2,060
Total	$	523,520	$	3,197	$	3,792	$	522,925	$	523,520	$	3,197	$	3,792	$	522,925

Index

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				Less Than Twelve Months				Twelve Months or More				Total
	Fair Value		Unrealized Losses		Fair Value		Unrealized Losses		Fair Value		Unrealized Losses		Fair Value		Unrealized Losses		Fair Value		Unrealized Losses		Fair Value		Unrealized Losses
	(In thousands)												(In thousands)

March 31, 2018
U.S. Treasury	$	599	$	1	$	-	$	-	$	599	$	1
September 30, 2018
U.S. agency		13,958		101		5,556		45		19,514		146	$	11,938	$	239	$	8,485	$	107	$	20,423	$	346
U.S. agency residential mortgage-backed		44,450		877		31,930		1,074		76,380		1,951		28,672		765		40,857		1,827		69,529		2,592
U.S. agency commercial mortgage-backed		5,775		82		4,025		192		9,800		274		1,358		12		4,391		212		5,749		224
Private label mortgage- backed		15,248		349		4,263		287		19,511		636		10,209		295		8,473		441		18,682		736
Other asset backed		37,043		97		13,897		100		50,940		197		30,663		92		11,226		96		41,889		188
Obligations of states and political subdivisions		85,527		1,323		33,654		1,384		119,181		2,707		59,590		1,157		57,509		2,546		117,099		3,703
Corporate		21,244		237		3,893		107		25,137		344		20,853		361		5,726		151		26,579		512
Trust preferred		-		-		2,810		121		2,810		121		-		-		925		38		925		38
Foreign government		481		18		1,554		25		2,035		43		-		-		2,010		50		2,010		50
Total	$	224,325	$	3,085	$	101,582	$	3,335	$	325,907	$	6,420	$	163,283	$	2,921	$	139,602	$	5,468	$	302,885	$	8,389

December 31, 2017
U.S. agency	$	5,466	$	26	$	5,735	$	41	$	11,201	$	67	$	5,466	$	26	$	5,735	$	41	$	11,201	$	67
U.S. agency residential mortgage-backed		22,198		229		40,698		754		62,896		983		22,198		229		40,698		754		62,896		983
U.S. agency commercial mortgage-backed		2,181		34		3,994		136		6,175		170		2,181		34		3,994		136		6,175		170
Private label mortgage-backed		11,390		92		4,396		238		15,786		330		11,390		92		4,396		238		15,786		330
Other asset backed		20,352		40		16,648		75		37,000		115		20,352		40		16,648		75		37,000		115
Obligations of states and political subdivisions		76,574		936		28,246		947		104,820		1,883		76,574		936		28,246		947		104,820		1,883
Corporate		14,440		33		3,943		57		18,383		90		14,440		33		3,943		57		18,383		90
Trust preferred		-		-		2,802		127		2,802		127		-		-		2,802		127		2,802		127
Foreign government		489		10		1,571		17		2,060		27		489		10		1,571		17		2,060		27
Total	$	153,090	$	1,400	$	108,033	$	2,392	$	261,123	$	3,792	$	153,090	$	1,400	$	108,033	$	2,392	$	261,123	$	3,792

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

Index

NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

(unaudited)

~~U.S. Treasury,~~ U.S. agency, U.S. agency residential mortgage-backed securities and U.S. agency commercial mortgage backed securities — at ~~March 31,~~September 30, 2018, we had ~~one U.S. Treasury, 43~~51 U.S. agency, ~~134~~133 U.S. agency residential mortgage-backed and 1815 U.S. agency commercial mortgage-backed securities whose fair market value is less than amortized cost. The unrealized losses are largely attributed to increases in interest rates since acquisition and widening spreads to Treasury bonds. As management does not intend to liquidate these securities and it is more likely than not that we will not be required to sell these securities prior to recovery of these unrealized losses, no declines are deemed to be other than temporary.

Private label mortgage backed securities — at ~~March 31,~~September 30, 2018, we had 27 of this type of security whose fair value is less than amortized cost. Unrealized losses are primarily due to credit spread widening and increases in interest rates since their acquisition.

Two private label mortgage-backed securities (included in the securities discussed further below) were reviewed for other than temporary impairment (“OTTI”) utilizing a cash flow projection. The cash flow analysis forecasts cash flow from the underlying loans in each transaction and then applies these cash flows to the bonds in the securitization. ~~Our cash flow analysis forecasts complete recovery of our cost basis for these two securities whose fair value is less than amortized cost.~~ See further discussion 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 ~~March 31,~~September 30, 2018, we had ~~103~~72 other asset backed securities whose fair value is less than amortized cost. The unrealized losses are primarily due to credit spread widening and increases in interest rates since acquisition. As management does not intend to liquidate these securities and it is more likely than not that we will not be required to sell these securities prior to recovery of these unrealized losses, no declines are deemed to be other than temporary.

Obligations of states and political subdivisions — at ~~March 31,~~September 30, 2018, we had ~~382~~393 municipal securities whose fair value is less than amortized cost. The unrealized losses are primarily due to wider benchmark pricing spreads and increases in interest rates since acquisition. Tax exempt securities have been negatively impacted by lower federal tax rates signed into law in December, 2017. 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 ~~March 31,~~September 30, 2018, we had 2632 corporate securities whose fair value is less than amortized cost. The unrealized losses are primarily due to credit spread widening and increases in interest rates since acquisition. As management does not intend to liquidate these securities and it is more likely than not that we will not be required to sell these securities prior to recovery of these unrealized losses, no declines are deemed to be other than temporary.

Trust preferred securities — at ~~March 31,~~September 30, 2018, we had ~~three~~one trust preferred ~~securities~~security whose fair value is less than amortized cost. ~~All of our~~This trust preferred ~~securities are~~security is a single issue ~~securities~~security issued by a trust subsidiary of a bank holding company. The pricing of this trust preferred ~~securities~~security has suffered from credit spread widening.

~~Index~~

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

~~(unaudited)~~

~~Two of the three securities are~~ This security is rated by ~~two~~a major rating ~~agencies~~agency as investment grade while the other one is non-rated. The non-rated issue is a relatively small bank and was never rated. The issuer of this non-rated trust preferred security, which had a total amortized cost of $1.0 million and total fair value of $0.9 million as of March 31, 2018, continues to have satisfactory credit metrics and make interest payments.

~~The following table breaks out our trust preferred securities in further detail as of March 31, 2018 and December 31, 2017:~~

March 31, 2018 December 31, 2017

Fair
Value

Net
Unrealized
Loss

Fair
Value

Net
Unrealized
Loss

(In thousands)

Trust preferred securities
Rated issues $ 1,875 $ (56 ) $ 1,860 $ (69 )
Unrated issues 935 (65 ) 942 (58 )

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

Index

NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

(unaudited)

Foreign government — at ~~March 31,~~September 30, 2018, we had two foreign government 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.

We recorded no credit related OTTI charges in our Condensed Consolidated Statements of Operations related to securities available for sale during the three and nine month periods ended ~~March 31,~~September 30, 2018 and 2017, respectively.

At ~~March 31,~~September 30, 2018, three private label mortgage-backed securities had credit related OTTI and are summarized as follows:

	Senior Security		Super Senior Security		Senior Support Security		Total		Senior Security		Super Senior Security		Senior Support Security		Total
	(In thousands)								(In thousands)

Fair value	$	996	$	921	$	58	$	1,975	$	842	$	808	$	32	$	1,682
Amortized cost		853		756		-		1,609		698		633		-		1,331
Non-credit unrealized loss		-		-		-		-		-		-		-		-
Unrealized gain		143		165		58		366		144		175		32		351
Cumulative credit related OTTI		757		457		380		1,594		757		457		380		1,594

Each of these securities is receiving principal and interest payments similar to principal reductions in the underlying collateral. All three of these securities have unrealized gains at ~~March 31,~~September 30, 2018. The original amortized cost (current amortized cost excluding cumulative credit related OTTI) for each of these securities has been permanently adjusted downward for previously recorded credit related OTTI. The unrealized loss (based on original amortized cost) for these securities is now less than previously recorded credit related OTTI amounts.

~~Index~~

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

~~(unaudited)~~

A roll forward of credit losses recognized in earnings on securities available for sale follows:

	Three months ended March 31,				Three months ended September 30,				Nine months ended September 30,
	2018		2017		2018		2017		2018		2017
	(In thousands)				(In thousands)				(In thousands)
Balance at beginning of period	$	1,594	$	1,594	$	1,594	$	1,594	$	1,594	$	1,594
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	$	1,594	$	1,594	$	1,594	$	1,594	$	1,594	$	1,594

Index

NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

(unaudited)

The amortized cost and fair value of securities available for sale at ~~March 31,~~September 30, 2018, by contractual maturity, follow:

	Amortized Cost		Fair Value		Amortized Cost		Fair Value
	(In thousands)				(In thousands)
Maturing within one year	$	27,598	$	27,580	$	14,513	$	14,494
Maturing after one year but within five years		76,940		76,334		79,683		78,634
Maturing after five years but within ten years		68,816		67,803		62,609		60,979
Maturing after ten years		52,470		51,235		46,142		44,475
		225,824		222,952		202,947		198,582
U.S. agency residential mortgage-backed		138,270		137,244		126,851		125,061
U.S. agency commercial mortgage-backed		10,218		9,945		6,039		5,815
Private label mortgage-backed		28,690		28,451		29,340		28,973
Other asset backed		90,559		90,527		78,567		78,526
Total	$	493,561	$	489,119	$	443,744	$	436,957

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 ~~three~~nine month periods ending ~~March 31,~~September 30, follows:

			Realized						Realized
	Proceeds		Gains		Losses		Proceeds (1)		Gains (2)		Losses
	(In thousands)						(In thousands)
2018	$	22,277	$	76	$	95	$	31,445	$	81	$	126
2017		6,152		106		-		9,594		125		-

(1)	2017 includes $0.760 million for trades that did not settle until after September 30, 2017.

(2)	2018 excludes a $0.144 million gain on the sale of 1,000 VISA Class B shares.

Certain preferred stocks have been classified as equity securities at fair value in our Condensed Consolidated Statement of Financial Condition beginning on January 1, 2018. Previously these preferred stocks were classified as trading securities. See note #2. During the ~~three~~nine months ended ~~March 31,~~September 30, 2018 and 2017 we recognized losses on these preferred stocks of ~~$0.154~~$0.170 million and ~~$0.079~~$0.063 million, respectively, that are included in net gains (losses) on securities in the Condensed Consolidated Statements of Operations. These amounts relate to preferred stock still held at each respective period end.

Index

NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

(unaudited)

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 ~~March 31,~~September 30, follows:

	Commercial			Mortgage			Installment			Subjective Allocation		Total
	(In thousands)
2018
Balance at beginning of period	$	6,073		$	8,296		$	848		$	8,287	$	23,504
Additions (deductions)
Provision for loan losses		(907	)		415			(25	)		464		(53	)
Recoveries credited to the allowance		1,418			192			298			-		1,908
Loans charged against the allowance		(225	)		(448	)		(285	)		-		(958	)
Balance at end of period	$	6,359		$	8,455		$	836		$	8,751	$	24,401

2017
Balance at beginning of period	$	5,100		$	8,145		$	900		$	6,441	$	20,586
Additions (deductions)
Provision for loan losses		(97	)		68			(33	)		644		582
Recoveries credited to the allowance		340			587			285			-		1,212
Loans charged against the allowance		(92	)		(471	)		(339	)		-		(902	)
Balance at end of period	$	5,251		$	8,329		$	813		$	7,085	$	21,478

An analysis of the allowance for loan losses by portfolio segment for the nine months ended September 30, follows:

	Commercial			Mortgage			Installment			Subjective Allocation		Total			Commercial			Mortgage			Installment			Subjective Allocation		Total
	(In thousands)														(In thousands)
2018
Balance at beginning of period	$	5,595		$	8,733		$	864		$	7,395	$	22,587		$	5,595		$	8,733		$	864		$	7,395	$	22,587
Additions (deductions)
Provision for loan losses		(135	)		147			69			234		315			(1,404	)		778			182			1,356		912
Recoveries credited to the allowance		606			180			228			-		1,014			2,458			549			761			-		3,768
Loans charged against the allowance		(40	)		(439	)		(366	)		-		(845	)		(290	)		(1,605	)		(971	)		-		(2,866	)
Balance at end of period	$	6,026		$	8,621		$	795		$	7,629	$	23,071		$	6,359		$	8,455		$	836		$	8,751	$	24,401

2017
Balance at beginning of period	$	4,880		$	8,681		$	1,011		$	5,662	$	20,234		$	4,880		$	8,681		$	1,011		$	5,662	$	20,234
Additions (deductions)
Provision for loan losses		(61	)		(699	)		133			268		(359	)		(197	)		(593	)		173			1,423		806
Recoveries credited to the allowance		404			486			239			-		1,129			946			1,264			788			-		2,998
Loans charged against the allowance		(135	)		(359	)		(472	)		-		(966	)		(378	)		(1,023	)		(1,159	)		-		(2,560	)
Balance at end of period	$	5,088		$	8,109		$	911		$	5,930	$	20,038		$	5,251		$	8,329		$	813		$	7,085	$	21,478

Index

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		Subjective Allocation		Total		Commercial		Mortgage		Installment		Subjective Allocation		Total
	(In thousands)										(In thousands)
March 31, 2018
September 30, 2018
Allowance for loan losses
Individually evaluated for impairment	$	739	$	5,345	$	248	$	-	$	6,332	$	727	$	5,155	$	220	$	-	$	6,102
Collectively evaluated for impairment		5,287		3,276		547		7,629		16,739		5,632		3,300		616		8,751		18,299
Loans acquired with deteriorated credit quality												-		-		-		-		-
Total ending allowance balance	$	6,026	$	8,621	$	795	$	7,629	$	23,071	$	6,359	$	8,455	$	836	$	8,751	$	24,401

Loans
Individually evaluated for impairment	$	8,348	$	51,830	$	3,891			$	64,069	$	9,714	$	48,815	$	3,630			$	62,159
Collectively evaluated for impairment		851,338		840,396		322,094				2,013,828		1,103,860		1,011,276		391,093				2,506,229
Loans acquired with deteriorated credit quality												1,653		557		355				2,565
Total loans recorded investment		859,686		892,226		325,985				2,077,897		1,115,227		1,060,648		395,078				2,570,953
Accrued interest included in recorded investment		2,269		3,316		877				6,462		3,126		4,166		1,083				8,375
Total loans	$	857,417	$	888,910	$	325,108			$	2,071,435	$	1,112,101	$	1,056,482	$	393,995			$	2,562,578

December 31, 2017
Allowance for loan losses
Individually evaluated for impairment	$	837	$	5,725	$	277	$	-	$	6,839	$	837	$	5,725	$	277	$	-	$	6,839
Collectively evaluated for impairment		4,758		3,008		587		7,395		15,748		4,758		3,008		587		7,395		15,748
Total ending allowance balance	$	5,595	$	8,733	$	864	$	7,395	$	22,587	$	5,595	$	8,733	$	864	$	7,395	$	22,587

Loans
Individually evaluated for impairment	$	8,420	$	53,179	$	3,945			$	65,544	$	8,420	$	53,179	$	3,945			$	65,544
Collectively evaluated for impairment		847,140		799,629		313,005				1,959,774		847,140		799,629		313,005				1,959,774
Total loans recorded investment		855,560		852,808		316,950				2,025,318		855,560		852,808		316,950				2,025,318
Accrued interest included in recorded investment		2,300		3,278		923				6,501		2,300		3,278		923				6,501
Total loans	$	853,260	$	849,530	$	316,027			$	2,018,817	$	853,260	$	849,530	$	316,027			$	2,018,817

Index

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		90+ and Still Accruing		Non- Accrual		Total Non- Performing Loans
	(In thousands)						(In thousands)
March 31, 2018
September 30, 2018
Commercial
Income producing - real estate	$	-	$	-	$	-	$	-	$	-	$	-
Land, land development and construction - real estate		-		-		-		-		2,402		2,402
Commercial and industrial		-		439		439		-		380		380
Mortgage
1-4 family		-		4,213		4,213		-		4,159		4,159
Resort lending		-		762		762		-		969		969
Home equity - 1st lien		-		309		309		-		324		324
Home equity - 2nd lien		-		301		301		-		353		353
Purchased loans		-		-		-
Installment
Home equity - 1st lien		-		150		150		-		225		225
Home equity - 2nd lien		-		241		241		-		246		246
Boat lending		-		66		66		-		64		64
Recreational vehicle lending		-		14		14		-		8		8
Other		-		134		134		-		213		213
Total recorded investment	$	-	$	6,629	$	6,629	$	-	$	9,343	$	9,343
Accrued interest included in recorded investment	$	-	$	-	$	-	$	-	$	-	$	-
December 31, 2017
Commercial
Income producing - real estate	$	-	$	30	$	30	$	-	$	30	$	30
Land, land development and construction - real estate		-		9		9		-		9		9
Commercial and industrial		-		607		607		-		607		607
Mortgage
1-4 family		-		5,130		5,130		-		5,130		5,130
Resort lending		-		1,223		1,223		-		1,223		1,223
Home equity - 1st lien		-		326		326		-		326		326
Home equity - 2nd lien		-		316		316		-		316		316
Purchased loans		-		-		-
Installment
Home equity - 1st lien		-		141		141		-		141		141
Home equity - 2nd lien		-		159		159		-		159		159
Boat lending		-		100		100		-		100		100
Recreational vehicle lending		-		25		25		-		25		25
Other		-		118		118		-		118		118
Total recorded investment	$	-	$	8,184	$	8,184	$	-	$	8,184	$	8,184
Accrued interest included in recorded investment	$	-	$	-	$	-	$	-	$	-	$	-

Index

NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

(unaudited)

An aging analysis of loans by class follows:

	Loans Past Due								Loans not		Total		Loans Past Due								Loans not Past Due		Total Loans
	30-59 days		60-89 days		90+ days		Total		Past Due		Loans		30-59 days		60-89 days		90+ days		Total		Loans not Past Due		Total Loans
	(In thousands)												(In thousands)
March 31, 2018
September 30, 2018
Commercial
Income producing - real estate	$	-	$	-	$	-	$	-	$	304,709	$	304,709	$	-	$	32	$	-	$	32	$	378,201	$	378,233
Land, land development and construction - real estate		-		-		-		-		51,382		51,382		-		-		2,402		2,402		61,760		64,162
Commercial and industrial		41		8		-		49		503,546		503,595		881		25		51		957		671,875		672,832
Mortgage
1-4 family		2,598		443		4,213		7,254		665,487		672,741		2,146		687		4,344		7,177		844,584		851,761
Resort lending		85		-		762		847		86,582		87,429		418		-		969		1,387		83,420		84,807
Home equity - 1st lien		61		264		309		634		37,191		37,825		81		15		324		420		40,312		40,732
Home equity - 2nd lien		334		254		301		889		59,598		60,487		364		209		353		926		82,422		83,348
Purchased loans		9		1		-		10		33,734		33,744
Installment
Home equity - 1st lien		174		-		150		324		8,497		8,821		285		44		225		554		7,738		8,292
Home equity - 2nd lien		157		59		241		457		8,411		8,868		190		45		246		481		7,099		7,580
Boat lending		156		8		66		230		134,383		134,613		153		16		64		233		169,925		170,158
Recreational vehicle lending		30		24		14		68		98,489		98,557		46		30		8		84		123,199		123,283
Other		124		61		134		319		74,807		75,126		145		140		213		498		85,267		85,765
Total recorded investment	$	3,769	$	1,122	$	6,190	$	11,081	$	2,066,816	$	2,077,897	$	4,709	$	1,243	$	9,199	$	15,151	$	2,555,802	$	2,570,953
Accrued interest included in recorded investment	$	46	$	17	$	-	$	63	$	6,399	$	6,462	$	53	$	21	$	-	$	74	$	8,301	$	8,375

December 31, 2017
Commercial
Income producing - real estate	$	-	$	-	$	30	$	30	$	290,466	$	290,496	$	-	$	-	$	30	$	30	$	290,466	$	290,496
Land, land development and construction - real estate		9		-		-		9		70,182		70,191		9		-		-		9		70,182		70,191
Commercial and industrial		60		-		44		104		494,769		494,873		60		-		44		104		494,769		494,873
Mortgage
1-4 family		1,552		802		5,130		7,484		625,638		633,122		1,559		802		5,130		7,491		659,742		667,233
Resort lending		713		-		1,223		1,936		88,620		90,556		713		-		1,223		1,936		88,620		90,556
Home equity - 1st lien		308		38		326		672		34,689		35,361		308		38		326		672		34,689		35,361
Home equity - 2nd lien		353		155		316		824		58,834		59,658		353		155		316		824		58,834		59,658
Purchased loans		7		-		-		7		34,104		34,111
Installment
Home equity - 1st lien		90		11		141		242		9,213		9,455		90		11		141		242		9,213		9,455
Home equity - 2nd lien		217		94		159		470		9,001		9,471		217		94		159		470		9,001		9,471
Boat lending		59		36		100		195		129,777		129,972		59		36		100		195		129,777		129,972
Recreational vehicle lending		28		20		25		73		92,737		92,810		28		20		25		73		92,737		92,810
Other		275		115		118		508		74,734		75,242		275		115		118		508		74,734		75,242
Total recorded investment	$	3,671	$	1,271	$	7,612	$	12,554	$	2,012,764	$	2,025,318	$	3,671	$	1,271	$	7,612	$	12,554	$	2,012,764	$	2,025,318
Accrued interest included in recorded investment	$	43	$	22	$	-	$	65	$	6,436	$	6,501	$	43	$	22	$	-	$	65	$	6,436	$	6,501

Index

NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

(unaudited)

Impaired loans are as follows:

	March 31, 2018		December 31, 2017		September 30, 2018		December 31, 2017
Impaired loans with no allocated allowance	(In thousands)
Impaired loans with no allocated allowance for loan losses					(In thousands)
TDR	$	382	$	349	$	347	$	349
Non - TDR		164		175		2,402		175
Impaired loans with an allocated allowance
Impaired loans with an allocated allowance for loan losses
TDR - allowance based on collateral		1,988		2,482		2,366		2,482
TDR - allowance based on present value cash flow		61,261		62,113		56,599		62,113
Non - TDR - allowance based on collateral		-		148		168		148
Total impaired loans	$	63,795	$	65,267	$	61,882	$	65,267

Amount of allowance for loan losses allocated
TDR - allowance based on collateral	$	533	$	684	$	692	$	684
TDR - allowance based on present value cash flow		5,799		6,089		5,335		6,089
Non - TDR - allowance based on collateral		-		66		75		66
Total amount of allowance for loan losses allocated	$	6,332	$	6,839	$	6,102	$	6,839

Index

NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

(unaudited)

Impaired loans by class are as ~~follows (1):~~follows:

	March 31, 2018						December 31, 2017						September 30, 2018						December 31, 2017
	Recorded Investment		Unpaid Principal Balance		Related Allowance		Recorded Investment		Unpaid Principal Balance		Related Allowance		Recorded Investment		Unpaid Principal Balance		Related Allowance		Recorded Investment		Unpaid Principal Balance		Related Allowance
With no related allowance recorded:	(In thousands)
With no related allowance for loan losses recorded:													(In thousands)
Commercial
Income producing - real estate	$	-	$	-	$	-	$	-	$	-	$	-	$	-	$	-	$	-	$	-	$	-	$	-
Land, land development & construction-real estate		-		-		-		-		-		-		2,402		2,402		-		-		-		-
Commercial and industrial		515		541		-		524		549		-		347		347		-		524		549		-
Mortgage
1-4 family		35		476		-		2		469		-		2		447		-		2		469		-
Resort lending		-		-		-		-		-		-		-		-		-		-		-		-
Home equity - 1st lien		-		-		-		-		-		-		-		-		-		-		-		-
Home equity - 2nd lien		-		-		-		-		-		-		-		34		-		-		-		-
Installment
Home equity - 1st lien		1		94		-		1		69		-		1		90		-		1		69		-
Home equity - 2nd lien		-		-		-		-		-		-		-		-		-		-		-		-
Boat lending		-		-		-		-		-		-		-		5		-		-		-		-
Recreational vehicle lending		-		-		-		-		-		-		-		-		-		-		-		-
Other		-		17		-		-		-		-		-		16		-		-		-		-
		551		1,128		-		527		1,087		-		2,752		3,341		-		527		1,087		-
With an allowance recorded:
With an allowance for loan losses recorded:
Commercial
Income producing - real estate		5,178		5,158		344		5,195		5,347		347		4,829		4,808		307		5,195		5,347		347
Land, land development & construction-real estate		156		155		5		166		194		9		152		152		4		166		194		9
Commercial and industrial		2,499		2,556		390		2,535		2,651		481		1,984		2,133		416		2,535		2,651		481
Mortgage
1-4 family		35,885		37,464		3,248		36,848		38,480		3,454		34,656		36,169		3,126		36,848		38,480		3,454
Resort lending		15,579		15,607		2,044		15,978		16,046		2,210		13,934		13,972		2,017		15,978		16,046		2,210
Home equity - 1st lien		154		160		36		173		236		43		66		65		3		173		236		43
Home equity - 2nd lien		177		212		17		178		213		18		157		156		9		178		213		18
Installment
Home equity - 1st lien		1,622		1,738		106		1,667		1,804		108		1,520		1,640		97		1,667		1,804		108
Home equity - 2nd lien		1,761		1,778		114		1,793		1,805		140		1,626		1,644		93		1,793		1,805		140
Boat lending		1		5		1		1		5		1		-		-		-		1		5		1
Recreational vehicle lending		87		87		5		90		90		5		81		81		4		90		90		5
Other		419		443		22		393		418		23		402		428		26		393		418		23
		63,518		65,363		6,332		65,017		67,289		6,839		59,407		61,248		6,102		65,017		67,289		6,839
Total
Commercial
Income producing - real estate		5,178		5,158		344		5,195		5,347		347		4,829		4,808		307		5,195		5,347		347
Land, land development & construction-real estate		156		155		5		166		194		9		2,554		2,554		4		166		194		9
Commercial and industrial		3,014		3,097		390		3,059		3,200		481		2,331		2,480		416		3,059		3,200		481
Mortgage
1-4 family		35,920		37,940		3,248		36,850		38,949		3,454		34,658		36,616		3,126		36,850		38,949		3,454
Resort lending		15,579		15,607		2,044		15,978		16,046		2,210		13,934		13,972		2,017		15,978		16,046		2,210
Home equity - 1st lien		154		160		36		173		236		43		66		65		3		173		236		43
Home equity - 2nd lien		177		212		17		178		213		18		157		190		9		178		213		18
Installment
Home equity - 1st lien		1,623		1,832		106		1,668		1,873		108		1,521		1,730		97		1,668		1,873		108
Home equity - 2nd lien		1,761		1,778		114		1,793		1,805		140		1,626		1,644		93		1,793		1,805		140
Boat lending		1		5		1		1		5		1		-		5		-		1		5		1
Recreational vehicle lending		87		87		5		90		90		5		81		81		4		90		90		5
Other		419		460		22		393		418		23		402		444		26		393		418		23
Total	$	64,069	$	66,491	$	6,332	$	65,544	$	68,376	$	6,839	$	62,159	$	64,589	$	6,102	$	65,544	$	68,376	$	6,839

Accrued interest included in recorded investment	$	274					$	277					$	277					$	277

~~(1)~~

~~There were no impaired purchased mortgage loans at March 31, 2018 or December 31, 2017.~~

Index

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 ~~March 31, follows (1):~~September 30, follows:

	2018				2017				2018				2017
	Average Recorded Investment		Interest Income Recognized		Average Recorded Investment		Interest Income Recognized		Average Recorded Investment		Interest Income Recognized		Average Recorded Investment		Interest Income Recognized
With no related allowance recorded	(In thousands)
With no related allowance for loan losses recorded:									(In thousands)
Commercial
Income producing - real estate	$	-	$	-	$	444	$	-	$	-	$	-	$	-	$	-
Land, land development & construction-real estate		-		-		16		-		2,402		-		-		-
Commercial and industrial		520		4		1,171		-		425		7		445		8
Mortgage
1-4 family		19		6		2		4		121		9		127		7
Resort lending		-		-		-		-		-		-		-		-
Home equity - 1st lien		-		-		-		-		-		-		-		-
Home equity - 2nd lien		-		-		-		-		-		-		-		-
Installment
Home equity - 1st lien		1		2		-		1		1		1		1		1
Home equity - 2nd lien		-		-		-		-		-		-		-		-
Boat lending		-		-		-		-		-		-		-		-
Recreational vehicle lending		-		-		-		-		-		-		-		-
Other		-		-		-		-		-		-		-		1
		540		12		1,633		5		2,949		17		573		17
With an allowance recorded
With an allowance for loan losses recorded:
Commercial
Income producing - real estate		5,187		68		7,739		105		4,968		64		7,311		91
Land, land development & construction-real estate		161		2		203		2		153		3		171		2
Commercial and industrial		2,517		32		4,099		35		2,264		24		2,878		26
Mortgage
1-4 family		36,367		458		40,900		464		34,731		458		38,533		462
Resort lending		15,779		164		16,795		161		14,276		161		16,175		153
Home equity - 1st lien		164		2		235		2		67		1		201		1
Home equity - 2nd lien		178		2		254		2		157		2		180		2
Installment
Home equity - 1st lien		1,645		29		1,939		34		1,545		27		1,808		40
Home equity - 2nd lien		1,777		27		2,362		35		1,679		24		2,058		26
Boat lending		1		-		1		-		1		-		1		-
Recreational vehicle lending		89		1		108		1		83		1		98		1
Other		406		6		385		7		406		5		361		6
		64,271		791		75,020		848		60,330		770		69,775		810
Total
Commercial
Income producing - real estate		5,187		68		8,183		105		4,968		64		7,311		91
Land, land development & construction-real estate		161		2		219		2		2,555		3		171		2
Commercial and industrial		3,037		36		5,270		35		2,689		31		3,323		34
Mortgage
1-4 family		36,386		464		40,902		468		34,852		467		38,660		469
Resort lending		15,779		164		16,795		161		14,276		161		16,175		153
Home equity - 1st lien		164		2		235		2		67		1		201		1
Home equity - 2nd lien		178		2		254		2		157		2		180		2
Installment
Home equity - 1st lien		1,646		31		1,939		35		1,546		28		1,809		41
Home equity - 2nd lien		1,777		27		2,362		35		1,679		24		2,058		26
Boat lending		1		-		1		-		1		-		1		-
Recreational vehicle lending		89		1		108		1		83		1		98		1
Other		406		6		385		7		406		5		361		7
Total	$	64,811	$	803	$	76,653	$	853	$	63,279	$	787	$	70,348	$	827

~~(1)~~

~~There were no impaired purchased mortgage loans during the three month periods ended March 31, 2018 and 2017, respectively.~~

Index

NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

(unaudited)

Average recorded investment in and interest income earned on impaired loans by class for the nine month periods ending September 30, follows:

	2018				2017
	Average Recorded Investment		Interest Income Recognized		Average Recorded Investment		Interest Income Recognized
With no related allowance for loan losses recorded:	(In thousands)
Commercial
Income producing - real estate	$	-	$	-	$	222	$	-
Land, land development & construction-real estate		1,201		-		8		-
Commercial and industrial		472		20		808		16
Mortgage
1-4 family		70		18		64		16
Resort lending		-		-		-		-
Home equity - 1st lien		-		-		-		-
Home equity - 2nd lien		-		-		-		-
Installment
Home equity - 1st lien		1		5		1		4
Home equity - 2nd lien		-		-		-		-
Boat lending		-		-		-		-
Recreational vehicle lending		-		-		-		-
Other		-		1		-		1
		1,744		44		1,103		37
With an allowance for loan losses recorded:
Commercial
Income producing - real estate		5,077		202		7,525		300
Land, land development & construction-real estate		157		7		187		6
Commercial and industrial		2,391		90		3,488		98
Mortgage
1-4 family		35,549		1,347		39,716		1,420
Resort lending		15,027		475		16,485		464
Home equity - 1st lien		115		4		218		5
Home equity - 2nd lien		167		5		217		5
Installment
Home equity - 1st lien		1,595		81		1,874		107
Home equity - 2nd lien		1,728		76		2,210		96
Boat lending		1		-		1		-
Recreational vehicle lending		86		3		103		4
Other		406		18		373		19
		62,299		2,308		72,397		2,524
Total
Commercial
Income producing - real estate		5,077		202		7,747		300
Land, land development & construction-real estate		1,358		7		195		6
Commercial and industrial		2,863		110		4,296		114
Mortgage
1-4 family		35,619		1,365		39,780		1,436
Resort lending		15,027		475		16,485		464
Home equity - 1st lien		115		4		218		5
Home equity - 2nd lien		167		5		217		5
Installment
Home equity - 1st lien		1,596		86		1,875		111
Home equity - 2nd lien		1,728		76		2,210		96
Boat lending		1		-		1		-
Recreational vehicle lending		86		3		103		4
Other		406		19		373		20
Total	$	64,043	$	2,352	$	73,500	$	2,561

Index

NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

(unaudited)

Cash receipts on impaired loans on non-accrual status are generally applied to the principal balance.

Troubled debt restructurings follow:

	March 31, 2018							September 30, 2018
	Commercial		Retail (1)			Total		Commercial		Retail (1)			Total
	(In thousands)							(In thousands)
Performing TDRs	$	7,880	$	52,022		$	59,902	$	6,904	$	49,397		$	56,301
Non-performing TDRs(2)		275		3,454	⁽³⁾		3,729		212		2,799	⁽³⁾		3,011
Total	$	8,155	$	55,476		$	63,631	$	7,116	$	52,196		$	59,312

	December 31, 2017
	Commercial		Retail (1)			Total
	(In thousands)
Performing TDRs	$	7,748	$	52,367		$	60,115
Non-performing TDRs(2)		323		4,506	⁽³⁾		4,829
Total	$	8,071	$	56,873		$	64,944

(1)	Retail loans include mortgage and installment portfolio segments.

(2)	Included in non-performing loans table above.

(3)	Also includes loans on non-accrual at the time of modification until six payments are received on a timely basis.

We allocated ~~$6.3~~$6.0 million and $6.8 million of specific reserves to customers whose loan terms have been modified in troubled debt restructurings as of ~~March 31,~~September 30, 2018 and December 31, 2017, respectively.

During the ~~three~~nine months ended ~~March 31,~~September 30, 2018 and 2017, 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.

2324

Index

NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

(unaudited)

Loans that have been classified as troubled debt restructurings during the three-month periods ended ~~March 31 follow(1):~~September 30 follow:

	Number of Contracts		Pre-modification Recorded Balance		Post-modification Recorded Balance		Number of Contracts		Pre-modification Recorded Balance		Post-modification Recorded Balance
	(Dollars in thousands)						(Dollars in thousands)
2018
Commercial
Income producing - real estate		1	$	67	$	67		-	$	-	$	-
Land, land development & construction-real estate		-		-		-		-		-		-
Commercial and industrial		3		434		434		1		24		24
Mortgage
1-4 family		3		228		211		3		609		609
Resort lending		-		-		-		1		115		114
Home equity - 1st lien		-		-		-		-		-		-
Home equity - 2nd lien		-		-		-		-		-		-
Installment
Home equity - 1st lien		3		98		99		1		15		15
Home equity - 2nd lien		1		61		61		1		20		21
Boat lending		-		-		-		-		-		-
Recreational vehicle lending		-		-		-		-		-		-
Other		1		35		32		-		-		-
Total		12	$	923	$	904		7	$	783	$	783

2017
Commercial
Income producing - real estate		-	$	-	$	-		-	$	-	$	-
Land, land development & construction-real estate		-		-		-		-		-		-
Commercial and industrial		3		133		133		-		-		-
Mortgage
1-4 family		1		17		17		1		93		95
Resort lending		1		189		189		-		-		-
Home equity - 1st lien		-		-		-		-		-		-
Home equity - 2nd lien		-		-		-		-		-		-
Installment
Home equity - 1st lien		2		34		37		-		-		-
Home equity - 2nd lien		2		45		46		2		51		50
Boat lending		-		-		-		-		-		-
Recreational vehicle lending		-		-		-		-		-		-
Other		-		-		-		1		10		10
Total		9	$	418	$	422		4	$	154	$	155

~~(1)~~

~~There were no purchased mortgage loans classified as troubled debt restructurings during the three month periods ended March 31, 2018 and 2017, respectively.~~

Index

NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

(unaudited)

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

	Number of Contracts		Pre-modification Recorded Balance		Post-modification Recorded Balance
	(Dollars in thousands)
2018
Commercial
Income producing - real estate		1	$	67	$	67
Land, land development & construction-real estate		-		-		-
Commercial and industrial		6		611		611
Mortgage
1-4 family		7		903		889
Resort lending		1		115		114
Home equity - 1st lien		-		-		-
Home equity - 2nd lien		-		-		-
Installment
Home equity - 1st lien		6		203		205
Home equity - 2nd lien		3		113		114
Boat lending		-		-		-
Recreational vehicle lending		-		-		-
Other		2		76		73
Total		26	$	2,088	$	2,073

2017
Commercial
Income producing - real estate		-	$	-	$	-
Land, land development & construction-real estate		-		-		-
Commercial and industrial		12		786		786
Mortgage
1-4 family		3		142		144
Resort lending		1		189		189
Home equity - 1st lien		-		-		-
Home equity - 2nd lien		-		-		-
Installment
Home equity - 1st lien		2		34		37
Home equity - 2nd lien		7		300		301
Boat lending		-		-		-
Recreational vehicle lending		-		-		-
Other		1		10		10
Total		26	$	1,461	$	1,467

The troubled debt restructurings described above for 2018 decreased the allowance for loan losses by ~~$0.03~~$0.01 million and resulted in zero charge offs ~~while~~during the three months ended September 30, 2018, and decreased the allowance by $0.004 million and resulted in zero charge offs during the nine months ended September 30, 2018.

Index

NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

(unaudited)

The troubled debt restructurings described above for 2017 increased the allowance for loan losses by ~~$0.05~~$0.02 million and resulted in zero charge ~~offs.~~

~~Index~~

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

~~(unaudited)~~offs during the three months ended September 30, 2017, and increased the allowance by $0.08 million and resulted in zero charge offs during the nine months ended September 30, 2017.

There were no troubled debt restructurings that subsequently defaulted within twelve months following the modification during the three and nine months periods ended September 30, 2018.

Six commercial and industrial loans with a recorded balance of $0.16 million that have been classified as troubled debt restructurings during the past twelve months (from September 30, 2017) subsequently defaulted during the three and nine month periods ended September 30, 2017. These subsequent defaults resulted in an increase in the allowance of $0.02 million and $0.04 million during the three and nine month periods ended September 30, 2017, respectively and resulted in charge-offs of $0.05 million during both the three and nine month periods ended September 30, 2017. There were no troubled debt restructurings that subsequently defaulted within twelve months following the modification during the three and nine months ended ~~March 31, 2018 and 2017.~~September 30, 2017 for any other loan class.

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

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-going monitoring of the credit quality of our loan portfolios, we track certain credit quality indicators including (a) weighted-average risk grade of commercial loans, (b) the level of classified commercial loans, (c) credit scores of mortgage and installment loan borrowers, and (d) delinquency history and non-performing loans.

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

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

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

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

Index

NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

(unaudited)

Rating 10 and 11: These loans are generally referred to as our ‘‘substandard - non-accrual’’ and ‘‘doubtful’’ commercial credits. Our doubtful rating includes a sub classification for a loss rate other than 50% (which is the standard doubtful loss rate). These ratings include loans to borrowers with weaknesses that make collection of debt in full, on the basis of current facts, conditions and values at best questionable and at worst improbable. All of these loans are placed in non-accrual.

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

~~Index~~

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

~~(unaudited)~~

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

	Commercial										Commercial
	Non-watch 1-6		Watch 7-8		Substandard Accrual 9		Non- Accrual 10-11		Total		Non-watch 1-6		Watch 7-8		Substandard Accrual 9		Non- Accrual 10-11		Total
	(In thousands)										(In thousands)
March 31, 2018
September 30, 2018
Income producing - real estate	$	303,189	$	1,225	$	295	$	-	$	304,709	$	374,965	$	3,060	$	208	$	-	$	378,233
Land, land development and construction - real estate		48,916		2,466		-		-		51,382		55,126		6,623		11		2,402		64,162
Commercial and industrial		466,289		27,389		9,478		439		503,595		634,763		27,174		10,515		380		672,832
Total	$	818,394	$	31,080	$	9,773	$	439	$	859,686	$	1,064,854	$	36,857	$	10,734	$	2,782	$	1,115,227
Accrued interest included in total	$	2,122	$	103	$	44	$	-	$	2,269	$	2,869	$	146	$	111	$	-	$	3,126

December 31, 2017
Income producing - real estate	$	288,869	$	1,293	$	304	$	30	$	290,496	$	288,869	$	1,293	$	304	$	30	$	290,496
Land, land development and construction - real estate		70,122		60		-		9		70,191		70,122		60		-		9		70,191
Commercial and industrial		463,570		28,351		2,345		607		494,873		463,570		28,351		2,345		607		494,873
Total	$	822,561	$	29,704	$	2,649	$	646	$	855,560	$	822,561	$	29,704	$	2,649	$	646	$	855,560
Accrued interest included in total	$	2,198	$	94	$	8	$	-	$	2,300	$	2,198	$	94	$	8	$	-	$	2,300

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.

2628

Index

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)												Mortgage (1)
	1-4 Family		Resort Lending		Home Equity 1st Lien		Home Equity 2nd Lien		Purchased Loans		Total		1-4 Family		Resort Lending		Home Equity 1st Lien		Home Equity 2nd Lien		Total
	(In thousands)												(In thousands)
March 31, 2018
September 30, 2018
800 and above	$	68,918	$	9,759	$	6,990	$	7,107	$	7,862	$	100,636	$	110,400	$	12,423	$	7,872	$	12,318	$	143,013
750-799		279,211		35,228		17,235		23,504		17,462		372,640		358,072		32,498		15,037		30,573		436,180
700-749		154,631		21,334		8,177		16,633		7,891		208,666		211,575		21,239		9,562		21,561		263,937
650-699		91,118		11,740		2,970		7,336		423		113,587		104,395		9,271		3,222		9,539		126,427
600-649		25,015		2,963		1,226		2,609		-		31,813		30,578		4,142		569		2,884		38,173
550-599		15,341		2,486		418		1,470		-		19,715		13,491		1,220		503		1,261		16,475
500-549		8,755		749		480		1,102		-		11,086		7,641		822		228		1,205		9,896
Under 500		2,905		266		180		377		-		3,728		1,702		84		86		190		2,062
Unknown		26,847		2,904		149		349		106		30,355		13,907		3,108		3,653		3,817		24,485
Total	$	672,741	$	87,429	$	37,825	$	60,487	$	33,744	$	892,226	$	851,761	$	84,807	$	40,732	$	83,348	$	1,060,648
Accrued interest included in total	$	2,400	$	370	$	165	$	283	$	98	$	3,316	$	3,161	$	360	$	206	$	439	$	4,166

December 31, 2017
800 and above	$	70,540	$	11,625	$	6,169	$	7,842	$	7,983	$	104,159	$	78,523	$	11,625	$	6,169	$	7,842	$	104,159
750-799		265,907		36,015		16,561		24,126		17,651		360,260		283,558		36,015		16,561		24,126		360,260
700-749		146,302		22,099		7,317		15,012		7,937		198,667		154,239		22,099		7,317		15,012		198,667
650-699		83,695		12,145		2,793		7,420		426		106,479		84,121		12,145		2,793		7,420		106,479
600-649		25,087		3,025		1,189		2,512		-		31,813		25,087		3,025		1,189		2,512		31,813
550-599		15,136		2,710		518		1,118		-		19,482		15,136		2,710		518		1,118		19,482
500-549		9,548		1,009		397		1,156		-		12,110		9,548		1,009		397		1,156		12,110
Under 500		2,549		269		260		385		-		3,463		2,549		269		260		385		3,463
Unknown		14,358		1,659		157		87		114		16,375		14,472		1,659		157		87		16,375
Total	$	633,122	$	90,556	$	35,361	$	59,658	$	34,111	$	852,808	$	667,233	$	90,556	$	35,361	$	59,658	$	852,808
Accrued interest included in total	$	2,361	$	371	$	157	$	294	$	95	$	3,278	$	2,456	$	371	$	157	$	294	$	3,278

~~(1)~~

~~Credit~~(1) Other than for the TCSB Bancorp, Inc. ("TCSB") acquired loans, credit scores have been updated within the last twelve months.

2729

Index

NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

(unaudited)

	Installment(1)												Installment(1)
	Home Equity 1st Lien		Home Equity 2nd Lien		Boat Lending		Recreational Vehicle Lending		Other		Total		Home Equity 1st Lien		Home Equity 2nd Lien		Boat Lending		Recreational Vehicle Lending		Other		Total
	(In thousands)												(In thousands)
March 31, 2018
September 30, 2018
800 and above	$	829	$	636	$	17,303	$	17,684	$	5,808	$	42,260	$	651	$	264	$	25,231	$	22,621	$	6,223	$	54,990
750-799		1,739		1,731		75,796		56,527		28,221		164,014		1,899		1,519		95,664		72,298		32,094		203,474
700-749		1,713		1,900		30,043		18,801		21,211		73,668		1,471		1,806		36,743		22,996		23,917		86,933
650-699		1,679		1,963		8,556		4,178		9,247		25,623		1,608		1,627		8,760		4,093		10,002		26,090
600-649		1,500		1,231		2,006		907		2,376		8,020		1,174		1,065		2,064		778		2,504		7,585
550-599		862		1,137		577		308		806		3,690		1,065		850		410		334		961		3,620
500-549		444		164		243		107		440		1,398		305		132		340		76		433		1,286
Under 500		40		76		32		5		142		295		87		172		43		21		152		475
Unknown		15		30		57		40		6,875		7,017		32		145		903		66		9,479		10,625
Total	$	8,821	$	8,868	$	134,613	$	98,557	$	75,126	$	325,985	$	8,292	$	7,580	$	170,158	$	123,283	$	85,765	$	395,078
Accrued interest included in total	$	32	$	38	$	331	$	248	$	228	$	877	$	33	$	27	$	431	$	319	$	273	$	1,083

December 31, 2017
800 and above	$	815	$	825	$	15,531	$	16,754	$	7,060	$	40,985	$	815	$	825	$	15,531	$	16,754	$	7,060	$	40,985
750-799		1,912		1,952		73,251		52,610		28,422		158,147		1,912		1,952		73,251		52,610		28,422		158,147
700-749		1,825		2,142		28,922		17,993		20,059		70,941		1,825		2,142		28,922		17,993		20,059		70,941
650-699		1,840		2,036		9,179		4,270		9,258		26,583		1,840		2,036		9,179		4,270		9,258		26,583
600-649		1,567		1,065		2,052		754		2,402		7,840		1,567		1,065		2,052		754		2,402		7,840
550-599		950		1,028		640		305		871		3,794		950		1,028		640		305		871		3,794
500-549		499		303		281		83		475		1,641		499		303		281		83		475		1,641
Under 500		32		88		57		6		194		377		32		88		57		6		194		377
Unknown		15		32		59		35		6,501		6,642		15		32		59		35		6,501		6,642
Total	$	9,455	$	9,471	$	129,972	$	92,810	$	75,242	$	316,950	$	9,455	$	9,471	$	129,972	$	92,810	$	75,242	$	316,950
Accrued interest included in total	$	39	$	43	$	346	$	254	$	241	$	923	$	39	$	43	$	346	$	254	$	241	$	923

~~(1)~~

~~Credit~~(1) Other than for the TCSB acquired loans, credit scores have been updated within the last twelve months.

Foreclosed residential real estate properties included in other real estate and repossessed assets on our Condensed Consolidated Statements of Financial Condition totaled ~~$1.5~~$1.3 million and $1.6 million at ~~March 31,~~September 30, 2018 and December 31, 2017, respectively. Retail mortgage loans secured by residential real estate properties for which formal foreclosure proceedings are in process according to local requirements totaled $0.4 million and $0.8 million at ~~March 31,~~September 30, 2018 and December 31, 2017, respectively.

In March and July 2018, we sold $16.5 million and $11.1 million, respectively, of single-family residential fixed and adjustable rate mortgage loans servicing retained to another financial institution and recognized a gain (loss) on sale of $0.05 ~~million.~~million and ($0.01) million, respectively. These mortgage loans were all on properties located in Ohio, had a weighted average interest ~~rate~~rates of 3.59% and 4.07%, respectively, and were sold primarily for asset/liability management purposes.

2830

Index

NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

(unaudited)

5. ~~Shareholders’ Equity and Earnings Per Common Share~~Purchase Credit Impaired (“PCI”) Loans

Loans acquired in a business combination are recorded at estimated fair value on their purchase date with no carryover of the related allowance for loan losses. In determining the estimated fair value of purchased loans, management considers a number of factors including, among others, the remaining life of the acquired loans, estimated prepayments, estimated loss ratios, estimated value of the underlying collateral, and net present value of cash flows expected to be received. Purchased loans are accounted for in accordance with guidance for certain loans acquired in a transfer (ASC 310-30), when the loans have evidence of credit deterioration since origination and it is probable at the date of acquisition that the acquirer will not collect all contractually required principal and interest payments. The difference between contractually required payments and the cash flows expected to be collected at acquisition is referred to as the non-accretable difference. Subsequent decreases to the expected cash flows will generally result in a provision for loan losses. Subsequent increases in expected cash flows will result in a reversal of the provision for loan losses to the extent of prior charges and then an adjustment to accretable yield, which would have a positive impact on interest income.

As a result of our acquisition of TCSB (see note #16) we purchased loans for which there was, at acquisition, evidence of deterioration of credit quality since origination and it was probable, at acquisition, that all contractually required payments would not be collected. For these loans that meet the criteria of ASC 310-30 treatment, the carrying amount was as follows:

	September 30, 2018		December 31, 2017
	(In thousands)
Commercial	$	1,653	$	-
Mortgage		557		-
Installment		355		-
Total carrying amount		2,565		-
Allowance for loan losses		-		-
Carrying amount, net of allowance for loan losses	$	2,565	$	-

The accretable difference on PCI loans is the difference between the expected cash flows and the net present value of expected cash flows with such difference accreted into earnings using the effective yield method over the term of the loans. Accretion recorded as loan interest income totaled $0.03 million and $0.07 million during the three and nine months ended September 30, 2018, respectively. Accretable yield of PCI loans, or income expected to be collected follows:

	Three months ended September 30,					Nine months ended September 30,
	2018			2017		2018			2017
	(unaudited)					(unaudited)
	(In thousands)					(In thousands)

Balance at beginning of period	$	533		$	-	$	-		$	-
New loans purchased		-			-		568			-
Accretion of income		(32	)		-		(67	)		-
Reclassification from (to) nonaccretable difference		-			-		-			-
Displosals/other adjustments		-			-		-			-
Balance at end of period	$	501		$	-	$	501		$	-

Index

NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

(unaudited)

PCI loans purchased during 2018 (all relating to the TCSB acquisition) for which it was probable at acquisition that all contractually required payments would not be collected follows:

	(In thousands)

Contractually required payments	$	4,213
Non accretable difference		(742	)
Cash flows expected to be collected at acquisition		3,471
Accretable yield		(568	)
Fair value of acquired loans at acquisition	$	2,903

Income would not be recognized on certain purchased loans if we could not reasonably estimate cash flows to be collected. We did not have any purchased loans for which we could not reasonably estimate cash flows to be collected.

5.	Shareholders’ Equity and Earnings Per Common Share

On January 22, 2018, 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, 2018. We expect to accomplish the repurchases through open market transactions, though we could affect 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. We did not repurchase any shares of common stock during the ~~three~~nine months ended ~~March 31,~~September 30, 2018.

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

	Three Months Ended March 31,				Three Months Ended September 30,				Nine Months Ended September 30,
	2018		2017		2018		2017		2018		2017
	(In thousands, except per share data)				(In thousands, except per share data)
Net income	$	9,161	$	5,974	$	11,925	$	6,859	$	29,903	$	18,764

Weighted average shares outstanding (1)		21,365		21,308		24,149		21,334		23,218		21,325
Effect of stock options		135		152		182		138		180		144
Stock units for deferred compensation plan for non-employee directors		125		119		129		121		126		120
Performance share units		49		60		55		59		52		57
Weighted average shares outstanding for calculation of diluted earnings per share		21,674		21,639		24,515		21,652		23,576		21,646

Net income per common share
Basic (1)	$	0.43	$	0.28	$	0.49	$	0.32	$	1.29	$	0.88
Diluted	$	0.42	$	0.28	$	0.49	$	0.32	$	1.27	$	0.87

⁽¹⁾Basic net income per common share includes weighted average common shares outstanding during the period and participating share awards.

Index

NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

(unaudited)

Weighted average stock options outstanding that were not considered in computing diluted net income per common share because they were anti-dilutive were zero for the three and nine month periods ended ~~March 31,~~September 30, 2018 and 2017, respectively.

6.~~Derivative Financial Instruments~~

6.	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.

2933

Index

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:

	March 31, 2018							September 30, 2018
	Notional Amount		Average Maturity (years)		Fair Value			Notional Amount		Average Maturity (years)		Fair Value
	(Dollars in thousands)							(Dollars in thousands)
Cash flow hedge designation
Pay-fixed interest rate swap agreements	$	15,000		3.4	$	426		$	25,000		2.8	$	581
Interest rate cap agreements		45,000		3.3		1,474			130,000		3.6		3,391
	$	60,000		3.3	$	1,900		$	155,000		3.5	$	3,972


No hedge designation
Rate-lock mortgage loan commitments	$	42,159		0.1	$	958		$	44,609		0.1	$	884
Mandatory commitments to sell mortgage loans		61,743		0.1		(123	)		65,633		0.1		182
Pay-fixed interest rate swap agreements - commercial		80,449		6.2		1,348			88,657		5.7		2,242
Pay-variable interest rate swap agreements - commercial		80,449		6.2		(1,348	)		88,657		5.7		(2,242	)
Pay-variable interest rate swap agreements		10,000		0.4		-
Purchased options		3,119		3.2		229			3,119		2.8		178
Written options		3,119		3.2		(229	)		3,119		2.8		(178	)
Total	$	281,038		3.8	$	835		$	293,794		3.5	$	1,066

	December 31, 2017
	Notional Amount		Average Maturity (years)		Fair Value


	(Dollars in thousands)
Cash flow hedge designation
Pay-fixed interest rate swap agreements	$	15,000		3.7	$	245
Interest rate cap agreements		45,000		3.5		976
	$	60,000		3.6	$	1,221

No hedge designation
Rate-lock mortgage loan commitments	$	25,032		0.1	$	530
Mandatory commitments to sell mortgage loans		56,127		0.1		37
Pay-fixed interest rate swap agreements - commercial		75,990		6.2		292
Pay-variable interest rate swap agreements - commercial		75,990		6.2		(292	)
Purchased options		3,119		3.5		322
Written options		3,119		3.5		(322	)
Total	$	239,377		4.1	$	567

3034

Index

NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

(unaudited)

We use variable-rate and short-term fixed-rate (less than 12 months) debt obligations to fund a portion of our ~~balance sheet,~~Condensed Consolidated Statements of Financial Condition, which exposes us to variability in interest rates. To meet our asset/liability management objectives, we may periodically enter into derivative financial instruments to mitigate exposure to fluctuations in cash flows resulting from changes in interest rates (“Cash Flow Hedges”). Cash Flow Hedges included certain pay-fixed interest rate swaps and interest rate cap agreements. Pay-fixed interest rate swaps convert the variable-rate cash flows on debt obligations to fixed-rates. Under interest-rate cap agreements, we will receive cash if interest rates rise above a predetermined level. As a result, we effectively have variable-rate debt with an established maximum rate. We pay an upfront premium on interest rate caps which is recognized in earnings in the same period in which the hedged item affects earnings. Unrecognized premiums from interest rate caps aggregated to $2.3 million at September 30, 2018 and $0.9 million at ~~both March 31, 2018 and~~ December 31, ~~2017, respectively.~~2017.

We record the fair value of Cash Flow Hedges in accrued income and other assets and accrued expenses and other liabilities on our Condensed Consolidated Statements of Financial Condition. On an ongoing basis, we adjust our Condensed Consolidated Statements of Financial Condition to reflect the then current fair value of Cash Flow Hedges. The related gains or losses are reported in other comprehensive income or loss and are subsequently reclassified into earnings, as a yield adjustment in the same period in which the related interest on the hedged items (variable-rate debt obligations) affect earnings. It is anticipated that approximately ~~$0.29~~$0.66 million, of unrealized gains on Cash Flow Hedges at ~~March 31,~~September 30, 2018 will be reclassified to earnings over the next twelve months. To the extent that the Cash Flow Hedges are not effective, the ineffective portion of the Cash Flow Hedges is immediately recognized in interest expense. The maximum term of the Cash Flow Hedge at ~~March 31,~~September 30, 2018 is ~~3.7~~5.0 years.

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 our Condensed Consolidated Statements of Operations.

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

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

Index

NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

(unaudited)

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

We have also entered into a pay-variable interest rate swap agreement unrelated to the commercial loan program noted above. While we have not designated this swap agreement as an accounting hedge the use of this hedge has the expectation to turn certain short-term fixed rate debt into short-term variable rate debt. The change in the swap agreement fair value will be recorded in earnings in our Condensed Consolidated Statement of Operations.

~~Index~~

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

~~(unaudited)~~

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:

Asset Derivatives Liability Derivatives

March 31,
2018

December 31,
2017

March 31,
2018

December 31,
2017

Balance
Sheet
Location

Fair
Value

Balance
Sheet
Location

Fair
Value

Balance
Sheet
Location

Fair
Value

Balance
Sheet
Location

Fair
Value

(In thousands)

Derivatives designated as hedging instruments
Pay-fixed interest rate swap agreements Other assets $ 426 Other assets $ 245 Other liabilities $ - Other liabilities $ -
Interest rate cap agreements Other assets 1,474 Other assets 976 Other liabilities - Other liabilities -
1,900 1,221 - -
Derivatives not designated as hedging instruments
Rate-lock mortgage loan commitments Other assets 958 Other assets 530 Other liabilities - Other liabilities -
Mandatory commitments to sell mortgage loans Other assets - Other assets 37 Other liabilities 123 Other liabilities -
Pay-fixed interest rate swap agreements - commercial Other assets 1,526 Other assets 631 Other liabilities 178 Other liabilities 339
Pay-variable interest rate swap agreements - commercial Other assets 178 Other assets 339 Other liabilities 1,526 Other liabilities 631
Pay-variable interest rate swap agreements Other assets - Other assets - Other liabilities - Other liabilities -
Purchased options Other assets 229 Other assets 322 Other liabilities - Other liabilities -
Written options Other assets - Other assets - Other liabilities 229 Other liabilities 322
2,891 1,859 2,056 1,292
Total derivatives $ 4,791 $ 3,080 $ 2,056 $ 1,292

Fair Values of Derivative Instruments

	Asset Derivatives						Liability Derivatives
	September 30, 2018			December 31, 2017			September 30, 2018			December 31, 2017
	Balance Sheet Location	Fair Value		Balance Sheet Location	Fair Value		Balance Sheet Location	Fair Value		Balance Sheet Location	Fair Value
	(In thousands)

Derivatives designated as hedging instruments

Pay-fixed interest rate swap agreements	Other assets	$	581	Other assets	$	245	Other liabilities	$	-	Other liabilities	$	-
Interest rate cap agreements	Other assets		3,391	Other assets		976	Other liabilities		-	Other liabilities		-
			3,972			1,221			-			-
Derivatives not designated as hedging instruments
Rate-lock mortgage loan commitments	Other assets		884	Other assets		530	Other liabilities		-	Other liabilities		-

Mandatory commitments to sell mortgage loans	Other assets		182	Other assets		37	Other liabilities		-	Other liabilities		-

Pay-fixed interest rate swap agreements - commercial	Other assets		2,380	Other assets		631	Other liabilities		138	Other liabilities		339

Pay-variable interest rate swap agreements - commercial	Other assets		138	Other assets		339	Other liabilities		2,380	Other liabilities		631

Purchased options	Other assets		178	Other assets		322	Other liabilities		-	Other liabilities		-

Written options	Other assets		-	Other assets		-	Other liabilities		178	Otherliabilities		322
			3,762			1,859			2,696			1,292
Total derivatives		$	7,734		$	3,080		$	2,696		$	1,292

3236

Index

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 March 31,

Gain
Recognized in
Other
Comprehensive
Income (Loss)
(Effective Portion)

Location of
Gain (Loss)
Reclassified
from
Accumulated
Other
Comprehensive
Loss 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 (1)

2018 2017 Portion) 2018 2017 in Income (1) 2018 2017
(In thousands)
Cash Flow Hedges
Interest rate cap agreements $ 513 $ - Interest expense $ 7 $ - Interest expense $ - $ -
Pay-fixed interest rate swap agreements 171 - Interest expense (1 ) - Interest expense 12 -
Total $ 684 $ - $ 6 $ - $ 12 $ -

No hedge designation
Rate-lock mortgage loan commitments Net gains on on mortage loans $ 428 $ 371
Mandatory commitments to sell mortgage loans Net gains on on mortage loans (160 ) (796 )
Pay-fixed interest rate swap agreements - commercial Interest income 1,056 110
Pay-variable interest rate swap agreements - commercial Interest income (1,056 ) (110 )
Pay-variable interest rate swap agreements Interest expense - -
Purchased options Interest expense (93 ) 69
Written options Interest expense 93 (69 )
Total $ 268 $ (425 )

Three Month Periods Ended September 30,

	Gain Recognized in Other Comprehensive Income (Loss) (Effective Portion)				Location of Gain (Loss) Reclassified from Accumulated Other Comprehensive Loss into Income (Effective Portion)	Gain (Loss) Reclassified from Accumulated Other Comprehensive Loss into Income (Effective Portion)					Location of Gain Recognized in Income (1)	Gain Recognized in Income (1)
	2018		2017			2018		2017			Location of Gain Recognized in Income (1)	2018			2017
	(In thousands)

Cash Flow Hedges
Interest rate cap agreements	$	297	$	-	Interest expense	$	67	$	-		Interest expense	$	-		$	-
Pay-fixed interest rate swap agreements		92		95	Interest expense		6		(5	)	Interest expense		16			5
Total	$	389	$	95		$	73	$	(5	)		$	16		$	5

No hedge designation
Rate-lock mortgage loan commitments											Net gains on mortgage loans	$	(318	)	$	(313	)
Mandatory commitments to sell mortgage loans											Net gains on mortgage loans		415			2
Pay-fixed interest rate swap agreements - commercial											Interest income		407			52
Pay-variable interest rate swap agreements - commercial											Interest income		(407	)		(52	)
Purchased options											Interest expense		(45	)		5
Written options											Interest expense		45			(5	)
Total												$	97		$	(311	)

(1)	For cash flow hedges, this location and amount refers to the ineffective portion.

Index

NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

(unaudited)

Nine Month Periods Ended September 30,

	Gain Recognized in Other Comprehensive Income (Loss) (Effective Portion)				Location of Gain (Loss) Reclassified from Accumulated Other Comprehensive Loss into Income (Effective Portion)	Gain (Loss) Reclassified from Accumulated Other Comprehensive Loss into Income (Effective Portion)					Location of Gain Recognized in Income (1)	Gain Recognized in Income (1)
	2018		2017			2018		2017			Location of Gain Recognized in Income (1)	2018			2017
	(In thousands)
Cash Flow Hedges
Interest rate cap agreements	$	1,054	$	-	Interest expense	$	119	$	-		Interest expense	$	-		$	-
Pay-fixed interest rate swap agreements		346		95	Interest expense		13		(5	)	Interest expense		4			5
Total	$	1,400	$	95		$	132	$	(5	)		$	4		$	5
No hedge designation
Rate-lock mortgage loan commitments											Net gains on mortgage loans	$	354		$	123
Mandatory commitments to sell mortgage loans											Net gains on mortgage loans		145			(604	)
Pay-fixed interest rate swap agreements - commercial											Interest income		1,950			(197	)
Pay-variable interest rate swap agreements - commercial											Interest income		(1,950	)		197
Purchased options											Interest expense		(144	)		39
Written options											Interest expense		144			(39	)
Total												$	499		$	(481	)

(1)	For cash flow hedges, this location and amount refers to the ineffective portion.

3338

Index

NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

(unaudited)

7. Intangible Assets

The following table summarizes intangible assets, net of amortization:

March 31, 2018 December 31, 2017

Gross
Carrying
Amount

Accumulated
Amortization

Gross
Carrying
Amount

Accumulated
Amortization

(In thousands)

Amortized intangible assets - core deposits $ 6,118 $ 4,618 $ 6,118 $ 4,532

	September 30, 2018				December 31, 2017
	Gross Carrying Amount		Accumulated Amortization		Gross Carrying Amount		Accumulated Amortization
	(In thousands)

Amortized intangible assets - core deposits	$	11,916	$	5,207	$	6,118	$	4,532
Unamortized intangible assets - goodwill	$	28,300			$	-

The $5.8 million and $28.3 million increases in the gross carrying amount of core deposit intangibles and goodwill, respectively are the result of our acquisition of TCSB (see note #16). There is no expected residual value relating to the core deposit intangible asset which is expected to be amortized over a period of 10 years (weighted average of 5.2 years). In the third quarter of 2018, goodwill was reduced by $0.7 million (to $28.3 million) related to the collection of a TCSB acquired loan that had been charged off in full prior to the Merger. Because of the status of the collection activities related to this loan at the time of the Merger, we determined that this transaction was a measurement period adjustment and reduced goodwill accordingly.

Amortization of other intangibles has been estimated through 2022 in the following table.

	(In thousands)		(In thousands)

Nine months ending December 31, 2018	$	260
Three months ending December 31, 2018			$	293
2019		346		1,089
2020		346		1,020
2021		346		970
2022		202		785
2023 and thereafter				2,552
Total	$	1,500	$	6,709

Changes in the carrying amount of goodwill for the nine month period ending September 30, 2018 follows:

	(In thousands)

Balance at beginning of year	$	-
Acquired during the year		28,300
Balance at end of the period	$	28,300

Index

NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

(unaudited)

8. 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 0.5 million shares of common stock as of ~~March 31,~~September 30, 2018. 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 ~~March 31,~~September 30, 2018. 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 the ~~three~~nine month periods ended ~~March 31,~~September 30, 2018 and 2017, pursuant to our long-term incentive plan, we granted ~~0.04 million and~~ 0.05 million shares of restricted stock ~~respectively and 0.02 million~~during each period, and 0.02 million performance stock units (“PSU”), ~~respectively~~during each period to certain officers. No long term incentive grants were made during the three months ended September 30, 2018 and 2017. Except for 0.002 million shares of restricted stock issued in 2018 that vest ratably over three years, the shares of restricted stock and PSUs cliff vest after a period of three years. The performance feature of the PSUs is based on a comparison of our total shareholder return over the three year period starting on the grant date to the total shareholder return over that period for a banking index of our peers.

Our directors may elect to receive 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~~0.007 million shares and 0.006 million shares during ~~each three month period~~the nine months ended ~~March 31, of~~September 30, 2018 and 2017, respectively, and expensed their value during those same periods.

~~Index~~

~~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 $1.1 million during ~~each~~the three and nine month ~~period~~periods ended ~~March 31,~~September 30, 2018, respectively, and ~~2017.~~was $0.4 million and $1.2 million during the same periods in 2017, respectively. The corresponding tax benefit relating to this expense was $0.1 million and $0.2 million for ~~each period.~~the three and nine month periods ended September 30, 2018, respectively and $0.1 million and $0.4 million for the same periods in 2017. Total expense recognized for non-employee director share based payments was $0.05 million and ~~$0.04~~$0.16 million during the three ~~months~~and nine month periods ended ~~March 31,~~September 30, 2018, respectively, and was $0.05 million and $0.12 million during the same periods in 2017, respectively. The corresponding tax benefit relating to this expense was $0.01 million and $0.03 million for ~~each period.~~the three and nine month periods ended September 30, 2018, respectively and $0.02 million and $0.04 million during the same periods in 2017.

At ~~March 31,~~September 30, 2018, the total expected compensation cost related to non-vested restricted stock and PSUs not yet recognized was ~~$3.0~~$2.4 million. The weighted-average period over which this amount will be recognized is ~~2.3~~2.0 years.

Index

NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

(unaudited)

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		Number of Shares			Average Exercise Price		Weighted- Average Remaining Contractual Term (Years)		Aggregated Intrinsic Value
								(In thousands)									(In thousands)
Outstanding at January 1, 2018		176,055		$	5.24						176,055		$	5.24
Granted		-
Issued for acquisition (see note #16)											187,915			9.94
Exercised		(3,800	)		3.39						(113,548	)		9.18
Forfeited		-									-
Expired		-									-
Outstanding at March 31, 2018		172,255		$	5.28		3.8	$	3,035
Outstanding at September 30, 2018											250,422		$	6.98		4.7	$	4,174

Vested and expected to vest at March 31, 2018		172,255		$	5.28		3.8	$	3,035
Exercisable at March 31, 2018		172,255		$	5.28		3.8	$	3,035
Vested and expected to vest at September 30, 2018											250,422		$	6.98		4.7	$	4,174
Exercisable at September 30, 2018											250,422		$	6.98		4.7	$	4,174

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

	Number of Shares			Weighted- Average Grant Date Fair Value		Number of Shares			Weighted- Average Grant Date Fair Value
Outstanding at January 1, 2018		290,527		$	15.88		290,527		$	15.88
Granted		64,406			23.58		73,406			23.62
Vested		(95,036	)		13.14		(96,255	)		13.17
Forfeited		(6,028	)		17.70		(8,259	)		18.53
Outstanding at March 31, 2018		253,869		$	18.82
Outstanding at September 30, 2018							259,419		$	19.00

A summary of weighted-average assumptions used in the Black-Scholes option pricing model for the issue of stock options relating to the acquisition of TCSB (see note #16) during the second quarter of 2018 follows:

Expected dividend yield		2.62	%
Risk-free interest rate		2.40
Expected life (in years)		3.14
Expected volatility		45.99	%
Per share weighted-average fair value	$	13.25

The risk-free interest rate for the expected term of the option is based on the U.S. Treasury yield curve in effect at the time of the grant. The expected life was obtained using a simplified method that, in general, averaged the vesting term and original contractual term of the stock option. This method was used as relevant historical data of actual exercise activity was very limited. The expected volatility was based on historical volatility of our common stock.

Index

NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

(unaudited)

Certain information regarding options exercised during the periods follows:

Three Months Ended
March 31,

2018 2017
(In thousands)
Intrinsic value $ 78 $ 279
Cash proceeds received $ 13 $ 66
Tax benefit realized $ 16 $ 98

~~Index~~

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

~~(unaudited)~~

	Three Months Ended September 30,				Nine Months Ended September 30,
	2018		2017		2018		2017
	(In thousands)
Intrinsic value	$	153	$	39	$	1,827	$	513
Cash proceeds received	$	58	$	18	$	1,042	$	117
Tax benefit realized	$	32	$	14	$	384	$	180

9. Income Tax

Income tax expense was ~~$2.0~~$2.9 million and ~~$2.6~~$3.2 million during the three month periods ended September 30, 2018 and 2017, respectively and $7.0 million and $8.4 million during the nine months ended ~~March 31,~~September 30, 2018 and 2017, respectively. On December 22, 2017, "H.R. 1" (also known as the "Tax Cuts and Jobs Act") was signed into law. H.R. 1, among other things, reduced the federal corporate income tax rate to 21% effective January 1, 2018 from 35% during 2017.

Our actual federal income tax expense is different than the amount computed by applying our statutory income tax rate to our income before income tax primarily due to tax-exempt interest income and tax-exempt income from the increase in the cash surrender value on life insurance. In addition, the ~~first quarters of~~three and nine month periods ending September 30, 2018 ~~and 2017,~~ include reductions of ~~$0.2~~$0.01 million and ~~$0.1~~$0.33 million, respectively, of income tax expense related to impact of the excess value of stock awards that vested and stock options that were exercised as compared to the initial fair values that were expensed. These amounts during the same periods in 2017 were $0.02 million and $0.23 million, 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 ~~March 31,~~September 30, 2018 and 2017, that the realization of substantially all of our deferred tax assets continues to be more likely than not.

At both ~~March 31,~~September 30, 2018 and December 31, 2017, we had approximately $0.7 million, 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 2018.

10. Regulatory Matters

Capital guidelines adopted by federal and state regulatory agencies and restrictions imposed by law limit the amount of cash dividends our Bank can pay to us. Under these guidelines, the amount of dividends that may be paid in any calendar year is limited to the Bank’s current year net profits, combined with the retained net profits of the preceding two years. Further, the Bank cannot pay a dividend at any time that it has negative undivided profits. As of ~~March 31,~~September 30, 2018, the Bank had positive undivided profits of ~~$27.1~~$27.2 million. It is not our intent to have dividends paid in amounts that would reduce the capital of our Bank to levels below those which we consider prudent and in accordance with guidelines of regulatory authorities.

Index

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 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 interim condensed 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 ~~March 31,~~September 30, 2018 and December 31, 2017, categorized our Bank as well capitalized. Management is not aware of any conditions or events that would have changed the most recent Federal Deposit Insurance Corporation (“FDIC”) categorization.

On July 2, 2013, the Federal Reserve approved a final rule that establishes an integrated regulatory capital framework (the “New Capital Rules”). The rule implements in the United States the Basel III regulatory capital reforms from the Basel Committee on Banking Supervision and certain changes required by the Dodd-Frank Act. In general, under the New Capital Rules, minimum requirements have increased for both the quantity and quality of capital held by banking organizations. Consistent with the international Basel framework, the New Capital Rules include a new minimum ratio of common equity Tier 1 capital to risk-weighted assets of 4.5% and a common equity Tier 1 capital conservation buffer of 2.5% of risk-weighted assets that applies to all supervised financial institutions. The capital conservation buffer began to phase in on January 1, 2016 with 1.875% and 1.25% added to the minimum ratio for adequately capitalized institutions for 2018 and 2017, respectively and 0.625% will be added each subsequent year until fully phased in during 2019. This capital conservation buffer is not reflected in the table that follows. To avoid limits on capital distributions and certain discretionary bonus payments we must meet the minimum ratio for adequately capitalized institutions plus the phased in buffer. The rule also raises the minimum ratio of Tier 1 capital to risk-weighted assets from 4% to 6% and includes a minimum leverage ratio of 4% for all banking organizations. As to the quality of capital, the New Capital Rules emphasize common equity Tier 1 capital, the most loss-absorbing form of capital, and implement strict eligibility criteria for regulatory capital instruments. The New Capital Rules also change the methodology for calculating risk-weighted assets to enhance risk sensitivity.

3643

Index

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					Actual					Minimum for Adequately Capitalized Institutions					Minimum for Well-Capitalized Institutions
	Amount		Ratio			Amount		Ratio			Amount		Ratio			Amount		Ratio			Amount		Ratio			Amount		Ratio
	(Dollars in thousands)															(Dollars in thousands)
March 31, 2018

September 30, 2018
Total capital to risk-weighted assets
Consolidated	$	318,837		15.24	%	$	167,402		8.00	%	NA		NA			$	373,748		14.57	%	$	205,173		8.00	%	NA		NA
Independent Bank		301,081		14.40			167,291		8.00		$	209,114		10.00	%		337,905		13.18			205,044		8.00		$	256,305		10.00	%

Tier 1 capital to risk-weighted assets
Consolidated	$	294,755		14.09	%	$	125,551		6.00	%	NA		NA			$	348,228		13.58	%	$	153,880		6.00	%	NA		NA
Independent Bank		276,999		13.25			125,468		6.00		$	167,291		8.00	%		312,385		12.19			153,783		6.00		$	205,044		8.00	%

Common equity tier 1 capital to risk-weighted assets
Consolidated	$	260,255		12.44	%	$	94,164		4.50	%	NA		NA			$	310,081		12.09	%	$	115,410		4.50	%	NA		NA
Independent Bank		276,999		13.25			94,101		4.50		$	135,924		6.50	%		312,385		12.19			115,337		4.50		$	166,598		6.50	%

Tier 1 capital to average assets
Consolidated	$	294,755		10.64	%	$	110,783		4.00	%	NA		NA			$	348,228		10.84	%	$	128,543		4.00	%	NA		NA
Independent Bank		276,999		10.01			110,726		4.00		$	138,408		5.00	%		312,385		9.73			128,376		4.00		$	160,469		5.00	%

December 31, 2017
Total capital to risk-weighted assets
Consolidated	$	312,163		15.16	%	$	164,782		8.00	%	NA		NA			$	312,163		15.16	%	$	164,782		8.00	%	NA		NA
Independent Bank		290,188		14.10			164,675		8.00		$	205,843		10.00	%		290,188		14.10			164,675		8.00		$	205,843		10.00	%

Tier 1 capital to risk-weighted assets
Consolidated	$	288,451		14.00	%	$	123,586		6.00	%	NA		NA			$	288,451		14.00	%	$	123,586		6.00	%	NA		NA
Independent Bank		266,476		12.95			123,506		6.00		$	164,675		8.00	%		266,476		12.95			123,506		6.00		$	164,675		8.00	%

Common equity tier 1 capital to risk-weighted assets
Consolidated	$	255,934		12.43	%	$	92,690		4.50	%	NA		NA			$	255,934		12.43	%	$	92,690		4.50	%	NA		NA
Independent Bank		266,476		12.95			92,630		4.50		$	133,798		6.50	%		266,476		12.95			92,630		4.50		$	133,798		6.50	%

Tier 1 capital to average assets
Consolidated	$	288,451		10.57	%	$	109,209		4.00	%	NA		NA			$	288,451		10.57	%	$	109,209		4.00	%	NA		NA
Independent Bank		266,476		9.78			109,041		4.00		$	136,301		5.00	%		266,476		9.78			109,041		4.00		$	136,301		5.00	%

NA - Not applicable

~~NA - Not applicable~~

3744

Index

NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

(unaudited)

The components of our regulatory capital are as follows:

	Consolidated						Independent Bank						Consolidated						Independent Bank
	March 31, 2018			December 31, 2017			March 31, 2018			December 31, 2017			September 30, 2018			December 31, 2017			September 30, 2018			December 31, 2017
	(In thousands)												(In thousands)
Total shareholders' equity	$	267,917		$	264,933		$	276,646		$	269,481		$	345,204		$	264,933		$	343,351		$	269,481

Add (deduct)
Accumulated other comprehensive (gain) loss for regulatory purposes		2,705			201			2,705			201
Intangible assets		(1,500	)		(1,269	)		(1,500	)		(1,269	)
Accumulated other comprehensive loss for regulatory purposes														4,092			201			4,092			201
Goodwill and other intangibles														(35,009	)		(1,269	)		(35,009	)		(1,269	)
Disallowed deferred tax assets		(8,867	)		(7,931	)		(852	)		(1,937	)		(4,206	)		(7,931	)		(49	)		(1,937	)
Common equity tier 1 capital		260,255			255,934			276,999			266,476			310,081			255,934			312,385			266,476
Qualifying trust preferred securities		34,500			34,500			-			-			38,147			34,500			-			-
Disallowed deferred tax assets		-			(1,983	)		-			-			-			(1,983	)		-			-
Tier 1 capital		294,755			288,451			276,999			266,476			348,228			288,451			312,385			266,476
Allowance for loan losses and allowance for unfunded lending commitments limited to 1.25% of total risk-weighted assets		24,082			23,712			24,082			23,712			25,520			23,712			25,520			23,712
Total risk-based capital	$	318,837		$	312,163		$	301,081		$	290,188		$	373,748		$	312,163		$	337,905		$	290,188

~~11.~~

11.	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.

3845

Index

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 (equity securities at fair value, 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~~equity securities at fair value (trading securities as of December 31, 2017) for which there are quoted prices in active markets and US Treasuries (at December 31, 2017) in our securities available for sale portfolio. 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 primarily include agency securities, private label mortgage-backed securities, other asset backed securities, obligations of states and political subdivisions, trust preferred securities, corporate securities and foreign government securities.

Loans held for sale: The fair value of mortgage loans held for sale is based on agency cash window loan pricing for comparable assets (recurring Level 2).

Impaired loans with specific loss allocations based on collateral value: From time to time, certain loans are considered impaired and an 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 for loan losses represent loans for which the fair value of the expected repayments or collateral exceed the recorded investments in such loans. At ~~March 31,~~September 30, 2018 and December 31, 2017, all of our impaired loans were evaluated based on either the fair value of the collateral or the present value of expected future cash flows discounted at the loan’s effective interest rate. When the fair value of the collateral is based on an appraised value or when an appraised value is not available we record the impaired loan as nonrecurring Level 3. These appraisals may utilize a single valuation approach or a combination of approaches including comparable sales and the income approach. Adjustments are routinely made in the appraisal process by the independent appraisers to adjust for differences between the comparable sales and income data available. Such adjustments can be significant and thus will typically result in a Level 3 classification of the inputs for determining fair value.

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

3946

Index

NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

(unaudited)

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

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

Derivatives: The fair value of rate-lock mortgage loan commitments is based on agency cash window loan pricing for comparable assets and the fair value of mandatory commitments to sell mortgage loans is based on mortgage backed security pricing for comparable assets (recurring Level 2). The fair value of interest rate swap and interest rate cap agreements are derived from proprietary models which utilize current market data. The significant fair value inputs can generally be observed in the market place and do not typically involve judgment by management (recurring Level 2). The fair value of purchased and written options is based on prices of financial instruments with similar characteristics and do not typically involve judgment by management (recurring Level 2).

4047

Index

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)
March 31, 2018:
Measured at Fair Value on a Recurring Basis
Assets
Equity securities at fair value $ 301 $ 301 $ - $ -
Securities available for sale
U.S. Treasury 599 599 - -
U.S. agency 23,936 - 23,936 -
U.S. agency residential mortgage-backed 137,244 - 137,244 -
U.S. agency commercial mortgage-backed 9,945 - 9,945 -
Private label mortgage-backed 28,451 - 28,451 -
Other asset backed 90,527 - 90,527 -
Obligations of states and political subdivisions 151,823 - 151,823 -
Corporate 41,749 - 41,749 -
Trust preferred 2,810 - 2,810 -
Foreign government 2,035 - 2,035 -
Loans held for sale 34,148 - 34,148 -
Capitalized mortgage loan servicing rights 17,783 - - 17,783
Derivatives (1) 4,791 - 4,791 -
Liabilities
Derivatives (2) 2,056 - 2,056 -

Measured at Fair Value on a Non-recurring basis:
Assets
Impaired loans (3)
Commercial
Income producing - real estate 302 - - 302
Land, land development & construction-real estate 3 - - 3
Commercial and industrial 874 - - 874
Mortgage
1-4 family 276 - - 276
Other real estate (4)
Mortgage
1-4 family 35 - - 35
Resort lending 136 - - 136

~~(1)~~

~~Included in accrued income and other assets~~

~~(2)~~

~~Included in accrued expenses and other liabilities~~

~~(3)~~

~~Only includes impaired loans with specific loss allocations based on collateral value.~~

~~(4)~~

~~Only includes other real estate with subsequent write downs to fair value.~~

~~Index~~

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

~~(unaudited)~~

			Fair Value Measurements Using						Fair Value Measure- ments		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)		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)								(In thousands)
December 31, 2017:
Measured at Fair Value on a Recurring Basis:
September 30, 2018:
Measured at Fair Value on a Recurring Basis
Assets
Trading securities	$	455	$	455	$	-	$	-
Equity securities at fair value									$	285	$	285	$	-	$	-
Securities available for sale
U.S. Treasury		898		898		-		-
U.S. agency		25,682		-		25,682		-		20,423		-		20,423		-
U.S. agency residential mortgage-backed		137,918		-		137,918		-		125,061		-		125,061		-
U.S. agency commercial mortgage-backed		9,760		-		9,760		-		5,815		-		5,815		-
Private label mortgage-backed		29,109		-		29,109		-		28,973		-		28,973		-
Other asset backed		93,898		-		93,898		-		78,526		-		78,526		-
Obligations of states and political subdivisions		172,945		-		172,945		-		139,654		-		139,654		-
Corporate		47,853		-		47,853		-		34,570		-		34,570		-
Trust preferred		2,802		-		2,802		-		1,925		-		1,925		-
Foreign government		2,060		-		2,060		-		2,010		-		2,010		-
Loans held for sale		39,436		-		39,436		-		41,325		-		41,325		-
Capitalized mortgage loan servicing rights		15,699		-		-		15,699		23,151		-		-		23,151
Derivatives (1)		3,080		-		3,080		-		7,734		-		7,734		-
Liabilities
Derivatives (2)		1,292		-		1,292		-		2,696		-		2,696		-

Measured at Fair Value on a Non-recurring basis:
Assets
Impaired loans (3)
Commercial
Income producing - real estate		274		-		-		274		225		-		-		225
Land, land development & construction-real estate		9		-		-		9
Commercial and industrial		1,051		-		-		1,051		944		-		-		944
Mortgage
1-4 family		339		-		-		339		334		-		-		334
Resort lending		207		-		-		207		264		-		-		264
Other real estate (4)
Mortgage
1-4 family		186		-		-		186		94		-		-		94
Resort lending		65		-		-		65		1		-		-		1

(1)	Included in accrued income and other assets

(2)	Included in accrued expenses and other liabilities

(3)	Only includes impaired loans with specific loss allocations based on collateral value.

(4)	Only includes other real estate with subsequent write downs to fair value.

Index

NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

(unaudited)

	Fair Value Measure- ments		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, 2017:
Measured at Fair Value on a Recurring Basis:
Assets
Trading securities	$	455	$	455	$	-	$	-
Securities available for sale
U.S. Treasury		898		898		-		-
U.S. agency		25,682		-		25,682		-
U.S. agency residential mortgage-backed		137,918		-		137,918		-
U.S. agency commercial mortgage-backed		9,760		-		9,760		-
Private label mortgage-backed		29,109		-		29,109		-
Other asset backed		93,898		-		93,898		-
Obligations of states and political subdivisions		172,945		-		172,945		-
Corporate		47,853		-		47,853		-
Trust preferred		2,802		-		2,802		-
Foreign government		2,060		-		2,060		-
Loans held for sale		39,436		-		39,436		-
Capitalized mortgage loan servicing rights		15,699		-		-		15,699
Derivatives (1)		3,080		-		3,080		-
Liabilities
Derivatives (2)		1,292		-		1,292		-

Measured at Fair Value on a Non-recurring basis:
Assets
Impaired loans (3)
Commercial
Income producing - real estate		274		-		-		274
Land, land development & construction-real estate		9		-		-		9
Commercial and industrial		1,051		-		-		1,051
Mortgage
1-4 family		339		-		-		339
Resort lending		207		-		-		207
Other real estate (4)
Mortgage
1-4 family		186		-		-		186
Resort lending		65		-		-		65

(1) Included in accrued income and other assets

(2) Included in accrued expenses and other liabilities

(3) Only includes impaired loans with specific loss allocations based on collateral value.

(4) Only includes other real estate with subsequent write downs to fair value.

There were no transfers between Level 1 and Level 2 during the ~~three~~nine months ended ~~March 31,~~September 30, 2018 and 2017.

4249

Index

NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

(unaudited)

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 three-Month Periods Ended March 31 for Items Measured at Fair Value Pursuant to Election of the Fair Value Option												Changes in Fair Values for the nine-Month Periods Ended September 30 for Items Measured at Fair Value Pursuant to Election of the Fair Value Option
	Net Gains (Losses) on Assets						Mortgage			Total Change in Fair Values Included in Current			Net Gains (Losses) on Assets						Mortgage Loan Servicing, net			Total Change in Fair Values Included in Current Period Earnings
	Securities			Mortgage Loans			Loan Servicing, net			Period Earnings			Securities			Mortgage Loans			Mortgage Loan Servicing, net
	(In thousands)												(In thousands)
2018
Equity securities at fair value	$	(154	)	$	-		$	-		$	(154	)	$	(170	)	$	-		$	-		$	(170	)
Loans held for sale		-			(153	)		-			(153	)		-			(120	)		-			(120	)
Capitalized mortgage loan servicing rights		-			-			1,029			1,029			-			-			694			694
																��
2017
Trading securities	$	(79	)	$	-		$	-		$	(79	)	$	(63	)	$	-		$	-		$	(63	)
Loans held for sale		-			581			-			581			-			713			-			713
Capitalized mortgage loan servicing rights		-			-			(264	)		(264	)		-			-			(2,585	)		(2,585	)

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 received.

The following represent impairment charges recognized during the three and nine month periods ended ~~March 31,~~September 30, 2018 and 2017 relating to assets measured at fair value on a non-recurring basis:

Loans which are measured for impairment using the fair value of collateral for collateral dependent loans had a carrying amount of ~~$2.0~~$1.8 million, ~~with~~which is net of a valuation allowance of ~~$0.5~~$0.8 million at ~~March 31,~~September 30, 2018, and had a carrying amount of ~~$2.6~~$1.9 million, ~~with~~which is net of a valuation allowance of $0.7 million at December 31, 2017. The provision for loan losses included in our results of operations relating to impaired loans was ana net expense of $0.1 million and $0.3 million ~~during~~for the three month periods ~~ended March 31,~~ending September 30, 2018 and 2017, respectively, and a net expense of $0.5 million for both nine month periods ending September 30, 2018 and 2017, respectively.

Other real estate, which is measured using the fair value of the property, had a carrying amount of ~~$0.2~~$0.1 million which is net of a valuation allowance of $0.1 million at ~~March 31,~~September 30, 2018, and a carrying amount of $0.3 million, which is net of a valuation allowance of $0.1 million, at December 31, 2017. ~~An additional charge~~Additional charges relating to other real estate measured at fair value of ~~$0.02~~$0.04 million and ~~$0.02~~$0.04 million ~~was~~were included in our results of operations during the three and nine month periods ended ~~March 31,~~September 30, 2018, respectively and ~~2017, respectively.~~$0.03 million and $0.04 million during the same periods in 2017.

4350

Index

NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

(unaudited)

A reconciliation for all assets and (liabilities) measured at fair value on a recurring basis using significant unobservable inputs (Level 3) follows:

	Capitalized Mortgage Loan Servicing Rights					Capitalized Mortgage Loan Servicing Rights
	Three Months Ended March 31,					Three Months Ended September 30,						Nine Months Ended September 30,
	2018		2017			2018			2017			2018		2017
	(In thousands)					(In thousands)						(In thousands)
Beginning balance	$	15,699	$	-		$	21,848		$	14,515		$	15,699	$	-
Change in accounting		-		14,213			-			-			-		14,213
Beginning balance, as adjusted		15,699		14,213			21,848			14,515			15,699		14,213
Total gains (losses) realized and unrealized:
Included in results of operations		1,029		(264	)		(198	)		(1,090	)		694		(2,585	)
Included in other comprehensive income (loss)		-		-			-			-			-		-
Purchases, issuances, settlements, maturities and calls		1,055		778			1,501			1,250			6,758		3,047
Transfers in and/or out of Level 3		-		-			-			-			-		-
Ending balance	$	17,783	$	14,727		$	23,151		$	14,675		$	23,151	$	14,675

Amount of total gains (losses) for the period included in earnings attributable to the change in unrealized gains (losses) relating to assets and liabilities still held at March 31	$	1,029	$	(264	)
Amount of total gains (losses) for the period included in earnings attributable to the change in unrealized gains (losses) relating to assets and liabilities still held at September 30						$	(198	)	$	(1,090	)	$	694	$	(2,585	)

The fair value of our capitalized mortgage loan servicing rights has been determined based on a valuation model used by an independent third party as discussed above. The significant unobservable inputs used in the fair value measurement of the capitalized mortgage loan servicing rights are discount rate, cost to service, ancillary income and float rate. Significant changes in all four of these assumptions in isolation would result in significant changes to the value of our capitalized mortgage loan servicing rights. Quantitative information about our Level 3 fair value measurements measured on a recurring basis follows:

	Asset Fair Value		Valuation Technique	Unobservable Inputs	Range			Weighted Average
	(In thousands)
September 30, 2018
Capitalized mortgage loan servicing rights	$	23,151	Present value of net	Discount rate	10.00% to 13.00		%		10.15	%
			servicing revenue	Cost to service	$	68 to $317		$	81
				Ancillary income	20 to 36				22
				Float rate		3.07	%		3.07	%

December 31, 2017
Capitalized mortgage loan servicing rights	$	15,699	Present value of net	Discount rate	9.88% to 11.00		%		10.11	%
			servicing revenue	Cost to service	$	66 to $216		$	81
				Ancillary income	20 to 36				23
				Float rate		2.24	%		2.24	%

Asset
Fair
Value

Valuation
Technique

Unobservable
Inputs
Range
Weighted
Average

(In thousands)
March 31, 2018
Capitalized mortgage loan servicing rights $ 17,783 Present value of net Discount rate 10.00% to 13.00 % 10.14 %
servicing revenue Cost to service $ 66 to $216 $ 81
    Ancillary income 20 to 36 23
    Float rate 2.70% to 2.70 % 2.70 %

December 31, 2017
Capitalized mortgage loan servicing rights $ 15,699 Present value of net Discount rate 9.88% to 11.00 % 10.11 %
servicing revenue Cost to service $ 66 to $216 $ 81
    Ancillary income 20 to 36 23
    Float rate 2.24% to 2.24 % 2.24 %

4451

Index

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

Fair

Value

Valuation

Technique

Unobservable

Inputs

Range

Weighted

Average

Asset

Fair

Value

Valuation

Technique

Unobservable

Inputs

Range

Weighted

Average

(In thousands)

March 31, 2018

September 30, 2018

Impaired loans

Commercial

1,179

Sales comparison approach

Adjustment for differences between comparable sales

(32.5)% to 25.0%

(3.9

1,169

Sales comparison approach

Adjustment for differences between comparable sales

(32.5)% to 25.0%

(4.5

Mortgage

276

Sales comparison approach

Adjustment for differences between comparable sales

(30.9) to 77.9

7.0

598

Sales comparison approach

Adjustment for differences between comparable sales

(40.1) to 30.4

(1.9

)

Other real estate

Mortgage

171

Sales comparison approach

Adjustment for differences between comparable sales

(33.0) to 44.5

(2.0

)

Sales comparison approach

Adjustment for differences between comparable sales

2.2 to 34.1

17.9

December 31, 2017

Impaired loans

Commercial

1,334

Sales comparison approach

Adjustment for differences between comparable sales

(32.5)% to 25.0%

(4.5

1,334

Sales comparison approach

Adjustment for differences between comparable sales

(32.5)% to 25.0%

(4.5

Mortgage

546

Sales comparison approach

Adjustment for differences between comparable sales

(21.1) to 34.1

(2.7

)

546

Sales comparison approach

Adjustment for differences between comparable sales

(21.1) to 34.1

(2.7

)

Other real estate

Mortgage

251

Sales comparison approach

Adjustment for differences between comparable sales

(33.0) to 44.5

(1.0

)

251

Sales comparison approach

Adjustment for differences between comparable sales

(33.0) to 44.5

(1.0

)

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		Aggregate Fair Value		Difference		Contractual Principal
	(In thousands)						(In thousands)
Loans held for sale
March 31, 2018	$	34,148	$	691	$	33,457
September 30, 2018							$	41,325	$	724	$	40,601
December 31, 2017		39,436		844		38,592		39,436		844		38,592

12.	Fair Values of Financial Instruments

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

4552

Index

NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

(unaudited)

As discussed in note #2, we adopted ASU 2016-02 as of January 1, 2018. This new ASU requires entities to use the exit price notion when measuring the fair value of financial instruments for disclosure purposes. All of estimated fair values of our financial instruments in the table below at ~~March 31,~~September 30, 2018 have used this exit price notion. In addition, except as discussed below in the net loans and loans held for sale section, all of our financial assets and liabilities have historically been valued using an exit price notion. This new ASU also removes the requirement to disclose the methods and significant assumptions used to estimate the fair value of financial instruments measured at amortized cost. The methods and significant assumptions for those financial instruments measured at amortized cost disclosed below are presented for fair values at December 31, 2017.

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. Equity securities at fair value, trading securities and U.S. Treasury securities available for sale are classified as Level 1 while all other securities available for sale are classified as Level 2 as described in note #11.

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 at December 31, 2017 is calculated by discounting estimated future cash flows using estimated market discount rates that reflect credit and interest-rate risk inherent in the loans and do not necessarily represent an exit price. Loans are classified as Level 3. Impaired loans are valued at the lower of cost or fair value as described in note #11. Loans held for sale are classified as Level 2 as described in note #11.

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

Derivative financial instruments: The fair value of rate-lock mortgage loan commitments is based on agency cash window loan pricing for comparable assets, the fair value of mandatory commitments to sell mortgage loans is based on mortgage backed security pricing for comparable assets, the fair value of interest rate swap and interest rate cap agreements is derived from proprietary models which utilize current market data whose significant fair value inputs can generally be observed in the market place and do not typically involve judgment by management and the fair value of purchased and written options is based on prices of financial instruments with similar characteristics and do not typically involve judgment by management. Each of these instruments has been classified as Level 2 as described in note #11.

4653

Index

NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

(unaudited)

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

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.

4754

Index

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		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)		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)										(In thousands)
March 31, 2018
September 30, 2018
Assets
Cash and due from banks	$	29,126	$	29,126	$	29,126	$	-	$	-	$	35,180	$	35,180	$	35,180	$	-	$	-
Interest bearing deposits		13,250		13,250		13,250		-		-		17,990		17,990		17,990		-		-
Interest bearing deposits - time		1,738		1,738		-		1,738		-		593		593		-		593		-
Equity securities at fair value		301		301		301		-		-		285		285		285		-		-
Securities available for sale		489,119		489,119		599		488,520		-		436,957		436,957		-		436,957		-
Federal Home Loan Bank and Federal Reserve Bank Stock		15,543	NA		NA		NA		NA			18,355	NA		NA		NA		NA
Net loans and loans held for sale		2,082,512		2,060,458		-		34,148		2,026,310		2,579,502		2,533,221		-		41,325		2,491,896
Accrued interest receivable		8,909		8,909		-		2,535		6,374		10,791		10,791		1		2,383		8,407
Derivative financial instruments		4,791		4,791		-		4,791		-		7,734		7,734		-		7,734		-

Liabilities
Deposits with no stated maturity (1)	$	1,891,343	$	1,891,343	$	1,891,343	$	-	$	-	$	2,143,552	$	2,143,552	$	2,143,552	$	-	$	-
Deposits with stated maturity (1)		539,058		534,832		-		534,832		-		655,091		649,709		-		649,709		-
Other borrowings		27,847		27,981		-		27,981		-		79,688		79,275		-		79,275		-
Subordinated debentures		35,569		31,248		-		31,248		-		39,371		36,888		-		36,888		-
Accrued interest payable		1,097		1,097		48		1,049		-		1,463		1,463		110		1,353		-
Derivative financial instruments		2,056		2,056		-		2,056		-		2,696		2,696		-		2,696		-

December 31, 2017
Assets
Cash and due from banks	$	36,994	$	36,994	$	36,994	$	-	$	-	$	36,994	$	36,994	$	36,994	$	-	$	-
Interest bearing deposits		17,744		17,744		17,744		-		-		17,744		17,744		17,744		-		-
Interest bearing deposits - time		2,739		2,740		-		2,740		-		2,739		2,740		-		2,740		-
Trading securities		455		455		455		-		-		455		455		455		-		-
Securities available for sale		522,925		522,925		898		522,027		-		522,925		522,925		898		522,027		-
Federal Home Loan Bank and Federal Reserve Bank Stock		15,543	NA		NA		NA		NA			15,543	NA		NA		NA		NA
Net loans and loans held for sale		2,035,666		1,962,937		-		39,436		1,923,501		2,035,666		1,962,937		-		39,436		1,923,501
Accrued interest receivable		8,609		8,609		1		2,192		6,416		8,609		8,609		1		2,192		6,416
Derivative financial instruments		3,080		3,080		-		3,080		-		3,080		3,080		-		3,080		-

Liabilities
Deposits with no stated maturity (1)	$	1,845,716	$	1,845,716	$	1,845,716	$	-	$	-	$	1,845,716	$	1,845,716	$	1,845,716	$	-	$	-
Deposits with stated maturity (1)		554,818		551,489		-		551,489		-		554,818		551,489		-		551,489		-
Other borrowings		54,600		54,918		-		54,918		-		54,600		54,918		-		54,918		-
Subordinated debentures		35,569		29,946		-		29,946		-		35,569		29,946		-		29,946		-
Accrued interest payable		892		892		48		844		-		892		892		48		844		-
Derivative financial instruments		1,292		1,292		-		1,292		-		1,292		1,292		-		1,292		-

(1)

Deposits with no stated maturity include reciprocal deposits with a recorded book balance of ~~$16.8~~$44.681 million and ~~$13.0~~$12.992 million at ~~March 31,~~September 30, 2018 and December 31, 2017, respectively. Deposits with a stated maturity include reciprocal deposits with a recorded book balance of $~~46.2~~47.954 million and ~~$38.0~~$37.987 million ~~March 31,~~September 30, 2018 and December 31, 2017, respectively.

4855

Index

NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

(unaudited)

The fair values for commitments to extend credit and standby letters of credit are estimated to approximate their aggregate book balance, which is nominal and therefore are not disclosed.

Fair value estimates are made at a specific point in time, based on relevant market information and information about the financial instrument. These estimates do not reflect any premium or discount that could result from offering for sale the entire holdings of a particular financial instrument.

Fair value estimates are based on existing on- and off-balance sheet financial instruments without attempting to estimate the value of anticipated future business, the value of future earnings attributable to off-balance sheet activities and the value of assets and liabilities that are not considered financial instruments.

Fair value estimates for deposit accounts do not include the value of the core deposit intangible asset resulting from the low-cost funding provided by the deposit liabilities compared to the cost of borrowing funds in the market.

~~13.~~

~~Contingent Liabilities~~

In the fourth quarter of 2016, we reached a tentative settlement regarding litigation initiated against the Bank in Wayne County, Michigan Circuit Court. The Court issued a preliminary approval of this settlement in the first quarter of 2017 and a final approval of this settlement in January 2018. This litigation concerned the Bank’s checking account transaction sequencing during a period from February 2009 to June 2011. Under the terms of the settlement, we agreed to pay $2.2 million and we are also responsible for class notification costs and certain other expenses which are estimated to total approximately $0.1 million. The $2.2 million was paid in January 2018. We recorded a $2.3 million expense in the fourth quarter of 2016 for this settlement. Although, we deny any liability associated with this matter and believe we have meritorious defenses to the allegations in the complaint, given the costs and uncertainty of litigation, we determined that this settlement was in the best interests of the organization.13. Contingent Liabilities

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

The litigation matters described in the preceding paragraph primarily include claims that have been brought against us for damages, but do not include litigation matters where we seek to collect amounts owed to us by third parties (such as litigation initiated to collect delinquent loans). These excluded, collection-related matters may involve claims or counterclaims by the opposing party or parties, 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.

~~Index~~

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

~~(unaudited)~~

In connection with the sale of Mepco Finance Corporation (“~~Mepco~~”(“Mepco”) (see note #15), we agreed to contractually indemnify the purchaser from certain losses it may incur, including as a result of its failure to collect certain receivables it purchased as part of the business as well as breaches of representations and warranties we made in the sale agreement, subject to various limitations. We have not accrued any liability related to these indemnification requirements in our ~~March 31,~~September 30, 2018 Condensed Consolidated Statement of Financial Condition because we believe the likelihood of having to pay any amount as a result of these indemnification obligations is remote. However, if the purchaser is unable to collect the receivables it purchased from Mepco or otherwise encounters difficulties in operating the business, it is possible it could make one or more claims against us pursuant to the sale agreement. In that event, we may incur expenses in defending any such claims and/or amounts paid to such purchaser to resolve such claims. As of ~~March 31,~~September 30, 2018 these receivables balances had declined to ~~$8.2~~$2.1 million and to date the purchaser has made no claims for indemnification.

Index

NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

(unaudited)

The provision for loss reimbursement on sold loans represents our estimate of incurred losses related to mortgage loans that we have sold to investors (primarily Fannie Mae, Freddie Mac, Ginnie Mae and the FHLB). Since we sell mortgage loans without recourse, loss reimbursements only occur in those instances where we have breached a representation or warranty or other contractual requirement related to the loan sale. The provision for loss reimbursement on sold loans was an expense of ~~$0.01~~$0.05 million and ~~$0.03~~$0.02 million for the three month periods ended ~~March 31,~~September 30, 2018 and 2017 and an expense of $0.08 million and $0.07 million for the nine month periods ended September 30, 2018 and 2017, respectively. The reserve for loss reimbursements on sold mortgage loans totaled ~~$0.7~~$0.85 million and $0.67 million at ~~both March 31,~~September 30, 2018 and December 31, 2017, 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. 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.

5057

Index

NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

(unaudited)

~~14.~~

~~Accumulated Other Comprehensive Loss (“AOCL”)~~

14. Accumulated Other Comprehensive Loss (“AOCL”)

A summary of changes in AOCL follows:

	Unrealized Gains (Losses) on Securities Available for Sale			Dispropor- tionate Tax Effects from Securities Available for Sale			Unrealized Gains on Cash Flow Hedges			Total
	(In thousands)
For the three months ended September 30,
2018
Balances at beginning of period	$	(4,437	)	$	(5,798	)	$	1,021		$	(9,214	)
Other comprehensive income (loss) before reclassifications		(925	)		-			307			(618	)
Amounts reclassified from AOCL		-			-			(57	)		(57	)
Net current period other comprehensive income (loss)		(925	)		-			250			(675	)
Balances at end of period	$	(5,362	)	$	(5,798	)	$	1,271		$	(9,889	)

2017
Balances at beginning of period	$	1,986		$	(5,798	)	$	-		$	(3,812	)
Other comprehensive income before reclassifications		95			-			62			157
Amounts reclassified from AOCL		(5	)		-			3			(2	)
Net current period other comprehensive income		90			-			65			155
Balances at end of period	$	2,076		$	(5,798	)	$	65		$	(3,657	)

For the nine months ended September 30,
2018
Balances at beginning of period	$	(470	)	$	(5,798	)	$	269		$	(5,999	)
Other comprehensive income (loss) before reclassifications		(4,928	)		-			1,106			(3,822	)
Amounts reclassified from AOCL		36			-			(104	)		(68	)
Net current period other comprehensive income (loss)		(4,892	)		-			1,002			(3,890	)
Balances at end of period	$	(5,362	)	$	(5,798	)	$	1,271		$	(9,889	)

2017
Balances at beginning of period	$	(3,310	)	$	(5,798	)	$	-		$	(9,108	)
Cumulative effect of change in accounting		300			-			-			300
Balances at beginning of period, as adjusted		(3,010	)		(5,798	)		-			(8,808	)
Other comprehensive income before reclassifications		5,167			-			62			5,229
Amounts reclassified from AOCL		(81	)		-			3			(78	)
Net current period other comprehensive income		5,086			-			65			5,151
Balances at end of period	$	2,076		$	(5,798	)	$	65		$	(3,657	)

Unrealized
Gains
(Losses) on
Securities
Available
for Sale

Dispropor-
tionate
Tax Effects
from
Securities
Available
for Sale

Unrealized
Gains on
Cash Flow
Hedges
Total
(In thousands)
For the three months ended March 31,
2018
Balances at beginning of period $ (470 ) $ (5,798 ) $ 269 $ (5,999 )
Other comprehensive income (loss) before reclassifications (3,054 ) - 541 (2,513 )
Amounts reclassified from AOCL 15 - (5 ) 10
Net current period other comprehensive income (loss) (3,039 ) - 536 (2,503 )
Balances at end of period $ (3,509 ) $ (5,798 ) $ 805 $ (8,502 )

2017
Balances at beginning of period $ (3,310 ) $ (5,798 ) $ - $ (9,108 )
Cumulative effect of change in accounting 300 - - 300
Balances at beginning of period, as adjusted (3,010 ) (5,798 ) - (8,808 )
Other comprehensive income before reclassifications 2,341 - - 2,341
Amounts reclassified from AOCL (69 ) - - (69 )
Net current period other comprehensive income 2,272 - - 2,272
Balances at end of period $ (738 ) $ (5,798 ) $ - $ (6,536 )

Index

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. Release of material disproportionate tax effects from other comprehensive income to earnings is done by the portfolio method whereby the effects will remain in AOCL as long as we carry a more than insubstantial portfolio of securities available for sale.

~~Index~~

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

~~(unaudited)~~

A summary of reclassifications out of each component of AOCL for the three months ended ~~March 31~~September 30 follows:

AOCL Component	Amount Reclassified From AOCL			Affected Line Item in Condensed Consolidated Statements of Operations	Amount Reclassified From AOCL			Affected Line Item in Condensed Consolidated Statements of Operations
	(In thousands)				(In thousands)
2018
Unrealized losses on securities available for sale
	$	(19	)	Net gains (losses) on securities	$	-		Net gains (losses) on securities
		-		Net impairment loss recognized in earnings		-		Net impairment loss recognized in earnings
		(19	)	Total reclassifications before tax		-		Total reclassifications before tax
		(4	)	Income tax expense		-		Income tax expense
	$	(15	)	Reclassifications, net of tax	$	-		Reclassifications, net of tax
Unrealized gains on cash flow hedges

Unrealized gains on cash flow hedges
	$	(6	)	Interest expense	$	(73	)	Interest expense
		(1	)	Income tax expense		(16	)	Income tax expense
	$	(5	)	Reclassification, net of tax	$	(57	)	Reclassification, net of tax

	$	(10	)	Total reclassifications for the period, net of tax	$	57		Total reclassifications for the period, net of tax

2017
Unrealized gains on securities available for sale
	$	106		Net gains on securities	$	8		Net gains (losses) on securities
		-		Net impairment loss recognized in earnings		-		Net impairment loss recognized in earnings
		106		Total reclassifications before tax		8		Total reclassifications before tax
		37		Income tax expense		3		Income tax expense
	$	69		Reclassifications, net of tax	$	5		Reclassifications, net of tax

Unrealized gains on cash flow hedges
					$	(5	)	Interest expense
						(2	)	Income tax expense
					$	(3	)	Reclassification, net of tax

					$	2		Total reclassifications for the period, net of tax

Index

NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

(unaudited)

~~15.~~

~~Mepco Sale~~

A summary of reclassifications out of each component of AOCL for the nine months ended September 30 follows:

AOCL Component	Amount Reclassified From AOCL			Affected Line Item in Condensed Consolidated Statements of Operations
	(In thousands)
2018
Unrealized losses on securities available for sale
	$	(45	)	Net gains (losses) on securities
		-		Net impairment loss recognized in earnings
		(45	)	Total reclassifications before tax
		(9	)	Income tax expense
	$	(36	)	Reclassifications, net of tax

Unrealized gains on cash flow hedges
	$	(132	)	Interest expense
		(28	)	Income tax expense
	$	(104	)	Reclassification, net of tax

	$	68		Total reclassifications for the period, net of tax

2017
Unrealized gains on securities available for sale
	$	125		Net gains (losses) on securities
		-		Net impairment loss recognized in earnings
		125		Total reclassifications before tax
		44		Income tax expense
	$	81		Reclassifications, net of tax

Unrealized gains on cash flow hedges
	$	(5	)	Interest expense
		(2	)	Income tax expense
	$	(3	)	Reclassification, net of tax

	$	78		Total reclassifications for the period, net of tax

15. Mepco Sale

On December 30, 2016, Mepco executed an Asset Purchase Agreement (the “APA”) with Seabury Asset Management LLC (“Seabury”). Pursuant to the terms of the APA, we sold our payment plan processing business, payment plan receivables, and certain other assets to Seabury, who also assumed certain liabilities of Mepco.

Index

NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

(unaudited)

This transaction closed on May 18, 2017, with an effective date of May 1, 2017. As a result of the closing, Mepco sold $33.1 million of net payment plan receivables, $0.5 million of commercial loans, $0.2 million of furniture and equipment and $1.6 million of other assets to Seabury, who also assumed $2.0 million of specified liabilities. We received cash totaling $33.4 million and recorded no gain or loss in 2017 as the assets were sold and the liabilities were assumed at book value.

~~Index~~

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

~~(unaudited)~~

~~16.~~

~~Recent Acquisition~~

16. Recent Acquisition

Effective April 1, 2018, we completed the acquisition of all of the issued and outstanding shares of common stock of TCSB ~~Bancorp, Inc. (‘‘TCSB’’) and merged~~through a merger of TCSB into Independent Bank Corporation (“IBCP”), with IBCP as the surviving corporation (the ‘‘Merger’’). On that same date we also consolidated Traverse City State Bank, TCSB’s wholly-owned subsidiary bank, into ~~the~~ Independent Bank (with ~~the~~ Independent Bank as the surviving institution). Under the terms of the merger agreement each holder of TCSB common stock received 1.1166 shares of IBCP common stock plus cash in lieu of fractional shares totaling $0.005 million. TCSB option holders had their options converted into IBCP stock options. As a result we issued 2.71 million shares of common stock and 0.19 million stock options with a fair value of approximately $64.5 million to the shareholders and option holders of TCSB. AsThe fair value of common stock and stock options issued as the ~~transaction did not occur until~~consideration paid for TCSB was determined using the closing price of our common stock on the acquisition date. This acquisition was accounted for under the acquisition method of accounting. Accordingly, we recognized amounts for identifiable assets acquired and liabilities assumed at their estimated acquisition date fair values. TCSB results of operations are included in our results beginning April 1, ~~2018, it was not practical to complete the purchase accounting adjustments for inclusion in these Notes to Interim Condensed Consolidated Financial Statements. We will record this acquisition~~2018. Non-interest expense includes $0.1 million and ~~related purchase accounting adjustments in the second quarter of 2018.~~

~~Our 2018 non-interest expenses include $0.2~~$3.4 million of costs incurred during the three ~~months~~and nine month periods ended ~~March, 31,~~September 30, 2018, respectively related to the Merger. AsAny remaining merger related costs will be expensed as incurred in future periods.

Index

NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

(unaudited)

The following table reflects our preliminary valuation of ~~March 31,~~the assets acquired and liabilities assumed:

	(In thousands)
Cash and cash equivalents	$	23,521
Interest bearing deposits - time		4,054
Securities available for sale		6,066
Federal Home Loan Bank stock		778
Loans, net		295,799
Property and equipement, net		1,067
Capitalized mortgage loan servicing rights		3,047
Accrued income and other assets		3,362
Other intangibles (1)		5,798
Total assets acquired		343,492

Deposits		287,710
Other borrowings		14,345
Subordinated debentures		3,768
Accrued expenses and other liabilities		1,429
Total liabilities assumed		307,252
Net assets acquired		36,240
Goodwill		28,300
Purchase price (fair value of consideration)	$	64,540

(1)	Relates to core deposit intangibles (see note #7).

Management views the disclosed fair values presented above to be provisional. Prior to the end of the one-year measurement period for finalizing acquisition-date fair values, if information becomes available which would indicate adjustments are required to the allocation, such adjustments will be included in the allocation in the reporting period in which the adjustment amounts are determined. In the third quarter of 2018, goodwill was reduced by $0.7 million (to $28.3 million) related to the collection of a TCSB acquired loan that had been charged off in full prior to ~~any~~the Merger. Because of the status of the collection activities related to this loan at the time of the Merger, we determined that this transaction was a measurement period adjustment and reduced goodwill accordingly.

Goodwill related to this acquisition will not be deductible for tax purposes and consists largely of synergies and cost savings resulting from the combining of the operations of TCSB into ours as well as expansion into a new market.

The estimated fair value ~~related adjustments, TCSB Bancorp, Inc. had total assets~~ of ~~$343.8 million, total loans of $301.8 million, total deposits of $288.1~~the core deposit intangible was $5.8 million and ~~total shareholders’ equity~~is being amortized over an estimated useful life of ~~$34.7 million.~~10 years.

~~17.~~

~~Revenue from Contracts with Customers~~

Index

NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

(unaudited)

The fair value of net assets acquired includes fair value adjustments to certain receivables that were not considered impaired as of the acquisition date. The fair value adjustments were determined using discounted contractual cash flows. However, we believe that all contractual cash flows related to these financial instruments will be collected. As such, these receivables were not considered impaired at the acquisition date and were not subject to the guidance relating to purchased credit impaired loans which have shown evidence of credit deterioration since origination. Receivables acquired that are not subject to these requirements included non-impaired customer receivables with a fair value and gross contractual amounts receivable of $292.9 million and $298.6 million on the date of acquisition.

17. Revenue from Contracts with Customers

We account for revenue in accordance with ASC Topic 606, Revenue from Contracts with Customers, which we adopted on January 1, 2018, using the modified retrospective method (see note #2). We derive the majority of our revenue from financial instruments and their related contractual rights and obligations which for the most part are excluded from the scope of ASU 2014-09. These sources of revenue that are excluded from the scope of this amended guidance include interest income, net gains on mortgage loans, net gains (losses) on securities, mortgage loan servicing, net and bank owned life insurance and were approximately ~~82.2%~~83.1% and ~~79.5%~~80.0% of total revenues at ~~March 31,~~September 30, 2018 and 2017, respectively.

Material sources of revenue that are included in the scope of ASC Topic 606 include service charges on deposits, other deposit related income, interchange income and investment and insurance commissions and are discussed in the following paragraphs. Generally these sources of revenue are earned at the time the service is delivered or over the course of a monthly period and do not result in any contract asset or liability balance at any given period end. As a result, there were no contract assets or liabilities recorded as of ~~March 31,~~September 30, 2018.

Service charges on deposit accounts and other deposit related income: Revenues are earned on depository accounts for commercial and retail customers and include fees for transaction-based, account maintenance and overdraft services. Transaction-based fees, which includes services such as ATM use fees, stop payment charges and ACH fees are recognized at the time the transaction is executed as that is the time we fulfill our customer’s request. Account maintenance fees, which includes monthly maintenance services are earned over the course of a month representing the period over which the performance obligation is satisfied. Our obligation for overdraft services is satisfied at the time of the overdraft.

Interchange income: Interchange income primarily includes debit card interchange and network revenues. Debit card interchange and network revenues are earned on debit card transactions conducted through payment networks such as MasterCard and NYCE. Interchange income is recognized concurrently with the delivery of services on a daily basis. Interchange and network revenues are presented gross of interchange expenses, which are presented separately as a component of non-interest expense.

~~Index~~

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

~~(unaudited)~~

Investment and insurance commissions: Investment and insurance commissions include fees and commissions from asset management, custody, recordkeeping, investment advisory and other services provided to our customers. Revenue is recognized on an accrual basis at the time the services are performed and are generally based on either the market value of the assets managed or the services provided. We have an agent relationship with a third party provider of these services and net certain direct costs charged by the third party provider associated with providing these services to our customers.

Index

NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

(unaudited)

Net (gains) losses on other real estate and repossessed assets: We record a gain or loss from the sale of other real estate when control of the property transfers to the buyer, which generally occurs at the time of an executed deed. If we were to finance the sale of other real estate to the buyer, we would assess whether the buyer is committed to perform their obligations under the contract and whether collectability of the transaction is probable. Once these criteria are met, the other real estate asset would be derecognized and the gain or loss on sale would be recorded upon the transfer of control of the property to the buyer. There were no other real estate properties sold during the ~~three~~nine months ending ~~March 31,~~September 30, 2018 that were financed by us.

Disaggregation of our revenue sources by attribute for the three months ending ~~March 31,~~September 30, 2018 follows:

	Service Charges on Deposits		Other Deposit Related Income		Interchange Income		Investment and Insurance Commissions		Total
	(In thousands)
Retail
Overdraft fees	$	2,161							$	2,161
Account service charges		519								519
ATM fees			$	374						374
Other				219						219
Business
Overdraft fees		408								408
Account service charges		78								78
ATM fees				10						10
Other				124						124
Interchange income					$	2,486				2,486
Asset management revenue							$	274		274
Transaction based revenue								239		239

Total	$	3,166	$	727	$	2,486	$	513	$	6,892

Reconciliation to Condensed Consolidated Statement of Operations:
Non-interest income - other:
Other deposit related income									$	727
Investment and insurance commissions										513
Bank owned life insurance										237
Other										657
Total									$	2,134

Service
Charges
on Deposits

Other
Deposit
Related
Income

Interchange
Income

Investment
and
Insurance
Commissions
Total
(In thousands)
Retail
Overdraft fees $ 1,972 $ 1,972
Account service charges 500 500
ATM fees $ 345 345
Other 207 207
Business
Overdraft fees 365 365
Account service charges 68 68
ATM fees 8 8
Other 129 129
Interchange income $ 2,246 2,246
Asset management revenue $ 271 271
Transaction based revenue 167 167

Total $ 2,905 $ 689 $ 2,246 $ 438 $ 6,278

Reconciliation to Condensed Consolidated Statement of Operations:
Non-interest income - other:
Other deposit related income $ 689
Investment and insurance commissions 438
Bank owned life insurance 256
Other 560
Total $ 1,943

5464

Index

NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

(unaudited)

Disaggregation of our revenue sources by attribute for the nine months ending September 30, 2018 follows:

	Service Charges on Deposits		Other Deposit Related Income		Interchange Income		Investment and Insurance Commissions		Total
	(In thousands)
Retail
Overdraft fees	$	6,177							$	6,177
Account service charges		1,607								1,607
ATM fees			$	1,077						1,077
Other				656						656
Business
Overdraft fees		1,153								1,153
Account service charges		229								229
ATM fees				26						26
Other				399						399
Interchange income					$	7,236				7,236
Asset management revenue							$	826		826
Transaction based revenue								608		608

Total	$	9,166	$	2,158	$	7,236	$	1,434	$	19,994

Reconciliation to Condensed Consolidated Statement of Operations:
Non-interest income - other:
Other deposit related income									$	2,158
Investment and insurance commissions										1,434
Bank owned life insurance										713
Other										1,989
Total									$	6,294

Index

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 (“IBCP”), 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 2017 Annual Report on Form 10-K filed with the U.S. Securities and Exchange Commission ("SEC"). That report includes a list of risk factors that you should consider in connection with any decision to buy or sell our securities.

Overview. We provide banking services to customers located primarily in Michigan’s Lower Peninsula. As a result, our success depends to a great extent upon the economic conditions in Michigan’s Lower Peninsula. At times, we have experienced a difficult economy in Michigan. Economic conditions in Michigan began to show signs of improvement during 2010. Generally, these improvements have continued into 2018, albeit at an uneven pace. In addition, since early- to mid-2009, we have seen an improvement in our asset quality metrics. In particular, since early 2012, we have generally experienced a decline in non-performing assets, lower levels of new loan defaults, and reduced levels of loan net charge-offs.

Recent Developments. On December 22, 2017, "H.R. 1" (also known as the "Tax Cuts and Jobs Act") was signed into law. H.R. 1, among other things, reduced the federal corporate income tax rate to 21% effective January 1, 2018. As a result, we concluded that our deferred tax assets, net (“DTA”) had to be remeasured. Our DTA represents expected corporate tax benefits anticipated to be realized in the future. The reduction in the federal corporate income tax rate reduces these anticipated future benefits. The remeasurement of our DTA at December 31, 2017 resulted in a reduction of these net assets and a corresponding increase in income tax expense of $6.0 million that was recorded in the fourth quarter of 2017.

On December 4, 2017, we entered into an Agreement and Plan of Merger with TCSB Bancorp, Inc. ("TCSB") (the "Merger Agreement") providing for a business combination of IBCP and TCSB. On April 1, 2018, TCSB was merged with and into IBCP, with IBCP as the surviving corporation (the "Merger"). In connection with the Merger, on April 1, 2018, IBCP consolidated Traverse City State Bank, TCSB's wholly-owned subsidiary bank, with and into Independent Bank (with Independent Bank as the surviving institution).

We paid aggregate Merger consideration of approximately $64.5 million in IBCP common stock or stock options for all of the shares of TCSB common stock and TCSB stock options issued and outstanding immediately before the effective time of the Merger. Based on a preliminary valuation of the assets acquired and liabilities assumed in the Merger, we initially recorded: $29.0 million of goodwill, a core deposit intangible (“CDI”) of $5.8 million, discounts of $6.5 million, $0.4 million and $1.5 million on loans, time deposits and borrowings, respectively, and a $0.5 million write-down of property and equipment. In the third quarter of 2018, goodwill was reduced by $0.7 million (to $28.3 million) related to the collection of a TCSB acquired loan that had been charged off in full prior to the Merger. Because of the status of the collection activities related to this loan at the time of the Merger, we determined that this transaction was a measurement period adjustment and reduced goodwill accordingly. The goodwill will be periodically tested for impairment and the CDI will be amortized over a ten year period ($0.2 million and $0.4 million of amortization for this CDI was recorded in the third quarter and first nine months of 2018, respectively). The discounts will be accreted based on the lives of the related assets or liabilities. On or before March 31, 2019, we will finalize the valuation of the assets acquired and liabilities assumed in the Merger and record and disclose any additional adjustments to the preliminary valuation.

At March 31, 2018, TCSB had $343.8 million of total assets, $301.8 million of loans, $288.1 million of deposits and $34.7 million of shareholders’ equity ($31.9 million of tangible common equity). TCSB reported a net income of $0.03 million in the first quarter of 2018. The TCSB first quarter 2018 results were adversely impacted due to $1.0 million of merger expenses. We expect the Merger to have a significant impact on our second quarter 2018 results because of the inclusion of their operations for the first time that quarter and merger related expenses.

5566

Index

Regulation. On July 2, 2013, the Federal Reserve Board approved a final rule that establishes an integrated regulatory capital framework (the "New Capital Rules"). The rule implements in the United States the Basel III regulatory capital reforms from the Basel Committee on Banking Supervision and certain changes required by the 2010 Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”). In general, under the New Capital Rules, minimum requirements have increased for both the quantity and quality of capital held by banking organizations. Consistent with the international Basel framework, the New Capital Rules include a new minimum ratio of common equity tier 1 capital to risk-weighted assets of 4.5% and a common equity tier 1 capital conservation buffer of 2.5% of risk-weighted assets that applies to all supervised financial institutions. The 2.5% capital conservation buffer is being phased in ratably over a four-year period that began in 2016. In 2018, 1.875% is being added to the minimum ratio for adequately capitalized institutions. To avoid limits on capital distributions and certain discretionary bonus payments we must meet the minimum ratio for adequately capitalized institutions plus the phased in buffer (now 6.375% in 2018). 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. As of ~~March 31,~~September 30, 2018 and December 31, 2017 we exceeded all of the capital ratio requirements of the New Capital Rules.

It is against this backdrop that we discuss our results of operations and financial condition in the third quarter and first ~~quarter~~nine months of 2018 as compared to 2017.

Results of Operations

Summary. We recorded net income of ~~$9.2~~$11.9 million and $6.9 million, respectively, during the three months ended ~~March 31,~~September 30, 2018 ~~compared to net income of $6.0 million during the three months ended March 31,~~and 2017. The increase in 2018 third quarter results as compared to 2017 reflects increases in net interest income and non-interest income as well as decreases in the provision for loan losses and income tax expense that were partially offset by an increase in non-interest expense.

We recorded net income of $29.9 million and $18.8 million, respectively, during the nine months ended September 30, 2018 and 2017. The increase in 2018 year-to-date results as compared to 2017 is ~~primarily~~ due to increases in net interest income and non-interest income ~~and~~as well as a decrease in income tax expense that were partially offset by increases in the provision for loan losses and in non-interest expense.

Key performance ratios

Three months
ended March 31,

2018 2017
Net income (annualized) to
Average assets 1.34 % 0.95 %
Average common shareholders’ equity 14.04 9.63

Net income per common share
Basic $ 0.43 $ 0.28
Diluted 0.42 0.28

5667

Index

Key performance ratios

	Three months ended September 30,						Nine months ended September 30,
	2018			2017			2018			2017
Net income (annualized) to
Average assets		1.46	%		1.01	%		1.30	%		0.96	%
Average common shareholders’ equity		13.83			10.27			12.73			9.69

Net income per common share
Basic	$	0.49		$	0.32		$	1.29		$	0.88
Diluted		0.49			0.32			1.27			0.87

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~~or interest-rate risk, in particular, can adversely impact our net interest income.

~~Net~~Our net interest income totaled ~~$23.9~~$29.7 million during the ~~first~~third quarter of 2018, ~~which represents a $2.5~~an increase of $6.8 million, or ~~11.5% increase,~~29.6% from the ~~comparable quarter one year earlier.~~year-ago period. ~~The~~This increase ~~in net interest income in 2018 compared to 2017~~ primarily reflects a ~~two~~$516.2 million increase in average interest-earning assets as well as a 25 basis point increase in our tax equivalent net interest income as a percent of average interest-earning assets (the “net interest margin”) ~~as well as~~.

For the first nine months of 2018, net interest income totaled $82.6 million, an increase of $16.7 million, or 25.4% from 2017. This increase primarily reflects a $433.5 million increase in average interest-earning ~~assets.~~assets as well as a 21 basis point increase in our net interest margin.

~~Total average interest-earning assets were $2.61 billion~~Interest and fees on loans for the third quarter and first nine months of 2018 include $0.6 million and $1.2 million, respectively, of accretion of the discount recorded on loans acquired in the first quarter of 2018 compared to $2.37 billion in the year ago quarter. Partially offsetting the growth in net interest income was a decline in net recoveries of interest on loans on non-accrual or previously charged-off to $0.18 million in the first quarter of 2018 compared to $0.50 million in the year ago quarter.Merger.

The increase in average interest-earning assets primarily reflects loan growth utilizing funds from increases in deposits and borrowed ~~funds.~~funds as well as the impact of the Merger. The increase in the net interest margin reflects a change in the mix of average-interest earning assets (higher percentage of loans) ~~as well as~~, increases in short-term market interest ~~rates.~~rates and the impact of the Merger.

Our net interest income is also adversely impacted by our level of non-accrual loans. In the third quarter and first ~~quarter~~nine months of 2018 non-accrual loans averaged ~~$7.5~~$9.2 million and $8.1 million, respectively, compared to ~~$11.6~~$8.6 million and $9.7 million, respectively for the same periods in 2017. In addition, in the third quarter and first ~~quarter~~nine months of 2018 we had net (charge-offs)/recoveries of $(0.01) million and $0.35 million, respectively, of unpaid interest on loans placed on or taken off non-accrual during each period or on loans previously charged-off compared to net recoveries of $0.28 million and $0.90 million, respectively, during the same periods in 2017.

5768

Index

Average Balances and Tax Equivalent Rates

	Three Months Ended September 30,
	2018							2017
	Average Balance		Interest		Rate ⁽²⁾			Average Balance		Interest		Rate ⁽²⁾
	(Dollars in thousands)
Assets
Taxable loans	$	2,543,712	$	30,936		4.84	%	$	1,908,497	$	21,801		4.55	%
Tax-exempt loans ⁽¹⁾		6,590		81		4.88			3,138		47		5.94
Taxable securities		379,985		2,737		2.88			474,901		2,765		2.33
Tax-exempt securities⁽¹⁾		62,964		518		3.29			90,645		783		3.46
Interest bearing cash		27,477		66		0.95			29,336		63		0.85
Other investments		17,493		237		5.38			15,543		200		5.11
Interest Earning Assets		3,038,221		34,575		4.53			2,522,060		25,659		4.05
Cash and due from banks		35,874							33,019
Other assets, net		173,508							142,283
Total Assets	$	3,247,603						$	2,697,362

Liabilities
Savings and interest-bearing checking	$	1,241,868		1,223		0.39		$	1,048,289		408		0.15
Time deposits		664,098		2,753		1.64			531,226		1,425		1.06
Other borrowings		80,939		779		3.82			85,219		626		2.91
Interest Bearing Liabilities		1,986,905		4,755		0.95			1,664,734		2,459		0.59
Non-interest bearing deposits		884,003							736,291
Other liabilities		34,697							31,263
Shareholders’ equity		341,998							265,074
Total liabilities and shareholders’ equity	$	3,247,603						$	2,697,362

Net Interest Income			$	29,820						$	23,200

Net Interest Income as a Percent of Average Interest Earning Assets						3.91	%						3.66	%

Three Months Ended
March 31,

2018 2017

Average
Balance
Interest
Rate ⁽²⁾

Average
Balance
Interest
Rate ⁽²⁾

(Dollars in thousands)
Assets
Taxable loans $ 2,060,720 $ 23,339 4.57 % $ 1,685,936 $ 19,824 4.75 %
Tax-exempt loans ⁽¹⁾
2,127 18 3.43 4,067 52 5.19
Taxable securities 422,254 2,635 2.50 521,407 2,754 2.11
Tax-exempt securities⁽¹⁾
78,345 603 3.08 78,044 698 3.58
Interest bearing cash 32,901 82 1.01 66,708 113 0.69
Other investments 15,543 248 6.47 15,543 199 5.19
Interest Earning Assets 2,611,890 26,925 4.15 2,371,705 23,640 4.02
Cash and due from banks 32,135 33,790
Other assets, net 132,961 153,992
Total Assets $ 2,776,986 $ 2,559,487

Liabilities
Savings and interest- bearing checking $ 1,094,981 551 0.20 $ 1,047,114 283 0.11
Time deposits 564,282 1,736 1.25 482,188 1,160 0.98
Other borrowings 64,890 574 3.59 45,004 470 4.24
Interest Bearing Liabilities 1,724,153 2,861 0.67 1,574,306 1,913 0.49
Non-interest bearing deposits 758,643 704,551
Other liabilities 29,606 29,064
Shareholders’ equity 264,584 251,566
Total liabilities and shareholders’ equity $ 2,776,986 $ 2,559,487

Net Interest Income $ 24,064 $ 21,727

Net Interest Income as a Percent of Average Interest Earning Assets 3.71 % 3.69 %

(1)	Interest on tax-exempt loans and securities is presented on a fully tax equivalent basis assuming a marginal tax rate of 21% in 2018 and 35% in 2017.

(2)	Annualized

5869

Index

Average Balances and Tax Equivalent Rates

	Nine Months Ended September 30,
	2018							2017
	Average Balance		Interest		Rate ⁽²⁾			Average Balance		Interest		Rate ⁽²⁾
	(Dollars in thousands)
Assets
Taxable loans	$	2,350,883	$	83,881		4.77	%	$	1,792,381	$	61,544		4.59	%
Tax-exempt loans ⁽¹⁾		5,221		185		4.74			3,410		145		5.69
Taxable securities		400,957		8,092		2.69			499,886		8,300		2.21
Tax-exempt securities⁽¹⁾		70,155		1,680		3.19			85,853		2,264		3.52
Interest bearing cash		29,502		214		0.97			42,610		229		0.72
Other investments		16,457		684		5.56			15,543		638		5.49
Interest Earning Assets		2,873,175		94,736		4.40			2,439,683		73,120		4.00
Cash and due from banks		33,204							32,492
Other assets, net		159,844							146,753
Total Assets	$	3,066,223						$	2,618,928

Liabilities
Savings and interest- bearing checking	$	1,193,388		2,785		0.31		$	1,051,395		1,007		0.13
Time deposits		611,103		6,687		1.46			494,219		3,747		1.01
Other borrowings		82,253		2,267		3.68			66,392		1,659		3.34
Interest Bearing Liabilities		1,886,744		11,739		0.83			1,612,006		6,413		0.53
Non-interest bearing deposits		833,283							717,589
Other liabilities		32,177							30,372
Shareholders’ equity		314,019							258,961
Total liabilities and shareholders’ equity	$	3,066,223						$	2,618,928

Net Interest Income			$	82,997						$	66,707

Net Interest Income as a Percent of Average Interest Earning Assets						3.86	%						3.65	%

(1)	Interest on tax-exempt loans and securities is presented on a fully tax equivalent basis assuming a marginal tax rate of 21% in 2018 and 35% in 2017.

(2)	Annualized

Index

Reconciliation of ~~Net Interest Margin, Fully Taxable Equivalent ("FTE")~~Non-GAAP Financial Measures

	Three Months Ended September 30,						Nine Months Ended September 30,
	2018			2017			2018			2017
	(Dollars in thousands)
Net Interest Margin, Fully Taxable Equivalent ("FTE")

Net interest income	$	29,697		$	22,912		$	82,613		$	65,870
Add: taxable equivalent adjustment		123			288			384			837
Net interest income - taxable equivalent	$	29,820		$	23,200		$	82,997		$	66,707
Net interest margin (GAAP) ⁽¹⁾		3.88	%		3.60	%		3.84	%		3.61	%
Net interest margin (FTE) ⁽¹⁾		3.91	%		3.66	%		3.86	%		3.65	%

Three Months Ended
March 31,

2018 2017
(Dollars in thousands)
Net interest income $ 23,936 $ 21,466
Add: taxable equivalent adjustment 128 261
Net interest income - taxable equivalent $ 24,064 $ 21,727
Net interest margin (GAAP) ⁽¹⁾
3.69 % 3.67 %
Net interest margin (FTE) ⁽¹⁾
3.71 % 3.69 %

(1)	Annualized

Provision for loan losses. The provision for loan losses was a credit of $0.1 million and an expense $0.6 million during the three months ended September 30, 2018 and 2017, respectively. During the nine-month periods ended September 30, 2018 and 2017, the provision was an expense of ~~$0.3~~$0.9 million and ~~a credit of $0.4~~$0.8 million, ~~in the first quarters of 2018 and 2017,~~ respectively. The provision reflects our assessment of the allowance for loan losses taking into consideration factors such as loan growth, 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 third quarter and first ~~quarter~~nine months of 2018.

Non-interest income. Non-interest income is a significant element in assessing our results of operations. Non-interest income totaled ~~$11.5 million and $10.3~~$11.8 million during the third quarter of 2018 compared to $10.3 million in 2017. For the first ~~three~~nine months of 2018 ~~and 2017, respectively.~~non-interest income totaled $35.9 million compared to $31.1 million for the first nine months of 2017. We adopted Financial Accounting Standards Board Accounting Standards Update 2014-09 “Revenue from Contracts with Customers (Topic 606)” (“ASU 2014-09”) on January 1, 2018, using the modified retrospective method. Although ASU 2014-09 did not have any impact on our January 1, 2018 shareholders’ equity or ~~first~~third quarter and year-to-date 2018 net income, it did result in a classification change in non-interest income and non-interest expense as compared to the prior year period. Specifically, in the third quarter and first ~~quarter~~nine months of 2018, interchange income and interchange expense each increased by ~~$0.3~~$0.4 million and $1.1 million, respectively, due to classification changes under ASU 2014-09 (also see notes #2 and #17 to the Condensed Consolidated Financial Statements included within this report).

5971

Index

The components of non-interest income are as follows:

Non-Interest Income

	Three months ended March 31,					Three months ended September 30,				Nine months ended September 30,
	2018			2017		2018		2017		2018			2017
	(In thousands)					(In thousands)
Service charges on deposit accounts	$	2,905		$	3,009	$	3,166	$	3,281	$	9,166		$	9,465
Interchange income		2,246			1,922		2,486		1,942		7,236			5,869
Net gains (losses) on assets
Net gains (losses) on assets:
Mortgage loans		2,571			2,571		2,745		2,971		8,571			8,886
Securities		(173	)		27		93		69		(71	)		62
Mortgage loan servicing, net		2,221			825		1,212		1		4,668			668
Investment and insurance commissions		438			468		513		606		1,434			1,541
Bank owned life insurance		256			253		237		283		713			776
Other		1,249			1,264		1,384		1,151		4,147			3,822
Total non-interest income	$	11,713		$	10,339	$	11,836	$	10,304	$	35,864		$	31,089

Service charges on deposit accounts ~~totaled $2.9 million~~decreased on both a comparative quarterly and year-to-date basis in ~~the first quarter of~~ 2018 ~~a decrease of $0.1 million from the comparable period in~~as compared to 2017. ~~This decrease was~~These decreases were principally due to lower service charges on commercial accounts (due primarily to higher earnings credits) and a ~~decline~~decrease in ~~treasury management fees due in part to an increase in crediting rates to customers (as a result of increased interest rates).~~non-sufficient funds occurrences.

Interchange income ~~totaled $2.2 million~~increased on both a comparative quarterly and year-to-date basis in ~~the first quarter of~~ 2018 as compared to ~~$1.9 million in~~2017 due primarily to the ~~year ago period. As discussed above, most~~aforementioned impact of ~~the first quarter 2018 increase in interchange income was due to a reclassification pursuant to~~ ASU 2014-09. ~~Transaction volume increased 3.4% year-over-year and interchange revenue per transaction was relatively unchanged.~~

Net gains on mortgage loans ~~were $2.6 million in~~decreased on both ~~the first quarters of 2018~~a quarterly and ~~2017.~~a year to date basis. Mortgage loan ~~sales totaled $106.3 million~~activity is summarized as follows:

Mortgage Loan Activity

	Three months ended September 30,						Nine months ended September 30,
	2018			2017			2018			2017
	(Dollars in thousands)
Mortgage loans originated	$	231,849		$	264,177		$	617,080		$	657,345
Mortgage loans sold		148,730			120,981			370,372			305,386
Net gains on mortgage loans		2,745			2,971			8,571			8,886
Net gains as a percent of mortgage loans sold (“Loan Sales Margin”)		1.85	%		2.46	%		2.31	%		2.91	%
Fair value adjustments included in the Loan Sales Margin		(0.26	)		(0.22	)		0.10			0.08

The decrease in ~~the first quarter of 2018 compared to $79.7 million in the first quarter of 2017. Mortgage~~mortgage loans originated ~~totaled $159.0 million in the first quarter of 2018 compared to $158.1 million in the comparable quarter of 2017.~~

During the last quarter of 2016 and the first half of 2017, we significantly expanded our mortgage-banking operations by adding new employees and opening new loan production offices (Ann Arbor, Brighton, Dearborn, Grosse Pointe, Traverse City and Troy, Michigan and Columbus and Fairlawn, Ohio). This business expansion has accelerated the growth of portfolio mortgage loans and mortgage loans serviced for others, leading to increased mortgage loan interest income and mortgage loan servicing revenue. However, this expansion has also increased non-interest expenses, particularly compensation and employee benefits and occupancy. In addition,is due primarily to higher interest rates suppressing refinance volumes. Mortgage loans sold increased due to a higher mix of salable loans in our origination volumes. Net gains on mortgage ~~loan refinance volume has declined on an industry-wide basis. It is important~~loans decreased in 2018 as compared to ~~our future results of operations that we effectively and successfully manage this business expansion.~~2017 due to a lower Loan Sales Margin as discussed below.

6072

Index

Mortgage Loan Activity

Three months ended
March 31,

2018 2017
(Dollars in thousands)
Mortgage loans originated $ 158,967 $ 158,081
Mortgage loans sold 106,343 79,691
Net gains on mortgage loans 2,571 2,571
Net gains as a percentage of mortgage loans sold (“Loan Sales Margin”) 2.42 % 3.23 %
Fair value adjustments included in the Loan Sales Margin 0.11 % 0.20 %

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~~Our Loan Sales ~~Margin”) are~~Margin is impacted by several factors including competition and the manner in which the loan is sold. Net gains on mortgage loans are also impacted by recording fair value accounting adjustments. Excluding ~~these~~the aforementioned fair value accounting adjustments, the Loan Sales Margin would have been ~~2.31%~~2.11% and ~~3.03%~~2.68% in the ~~first~~third quarters of 2018 and 2017, respectively and 2.21% and 2.83% for the comparative 2018 and 2017 year-to-date periods, respectively. ~~In 2018, our~~The decrease in the Loan Sales Margin ~~contracted~~(excluding fair value adjustments) in 2018 was generally due ~~primarily~~to a narrowing of primary-to-secondary market pricing spreads due to competitive ~~factors. In general, as overall industry-wide~~factors throughout the mortgage banking industry (generally higher mortgage loan ~~origination levels drop, pricing becomes more competitive.~~interest rates and a decline in refinance volume). The changes in the fair value accounting adjustments are primarily due to changes in the amount of commitments to originate mortgage loans for ~~sale during each period.~~sale.

~~We recorded net~~Net gains (losses) on securities were relatively nominal for all of ~~approximately $(0.17) million and $0.03 million in~~ the first quarters of 2018 and 2017, respectively. The first quarter 2018 net losses on securities are due primarily to a decline in the fair value of equity securities of $0.15 million. First quarter 2018 securities sales of $22.3 million resulted in a small net loss of $0.02 million. The first quarter 2017 net gains on securities were due primarily to sales of $6.2 million that resulted in net gains of $0.11 million that were partially offset by a $0.08 million decline in the fair value of trading securities.

periods presented. We recorded no net impairment losses in either ~~the first quarter of~~ 2018 or 2017 for other than temporary impairment of securities available for sale. (See “Securities.”)

~~Index~~

Mortgage loan servicing, net, generated income of ~~$2.2~~$1.2 million and ~~$0.8~~$0.001 million in the ~~first~~third quarters of 2018 and 2017, respectively. For the first nine months of 2018, mortgage loan servicing, net, generated income of $4.7 million as compared to income of $0.7 million in 2017. This activity is summarized in the following table:

	Three Months Ended						Three Months Ended						Nine Months Ended
	March 31, 2018			March 31, 2017			9/30/2018			9/30/2017			9/30/2018			9/30/2017
Mortgage loan servicing:	(Dollars in thousands)
Mortgage loan servicing, net:							(In thousands)
Revenue, net	$	1,192		$	1,089		$	1,410		$	1,091		$	3,974		$	3,253
Fair value change due to price		1,458			145			610			(572	)		2,586			(1,075	)
Fair value change due to pay-downs		(429	)		(409	)		(808	)		(518	)		(1,892	)		(1,510	)
Total	$	2,221		$	825		$	1,212		$	1		$	4,668		$	668

The significant variance in the fair value change due to price relates primarily to the rise in mortgage loan interest rates in the first quarter of 2018. That increase reduced projected prepayment rates for mortgage loans serviced for others, leading to an increase in fair value.

Index

Activity related to capitalized mortgage loan servicing rights is as follows:

Capitalized Mortgage Loan Servicing Rights

Capitalized Mortgage Loan Servicing Rights

Three months ended
March 31,

2018 2017
(In thousands)
Balance at beginning of period $ 15,699 $ 13,671
Change in accounting - 542
Balance at beginning of period, as adjusted $ 15,699 $ 14,213
Originated servicing rights capitalized 1,055 778
Change in fair value 1,029 (264 )
Balance at end of period $ 17,783 $ 14,727

	Three months ended September 30,						Nine months ended September 30,
	2018			2017			2018		2017
	(In thousands)
Balance at beginning of period	$	21,848		$	14,515		$	15,699	$	13,671
Change in accounting		-			-			-		542
Balance at beginning of period, as adjusted		21,848			14,515			15,699		14,213
Servicing rights acquired		-			-			3,047		-
Originated servicing rights capitalized		1,501			1,250			3,711		3,047
Change in fair value		(198	)		(1,090	)		694		(2,585	)
Balance at end of period	$	23,151		$	14,675		$	23,151	$	14,675

At ~~March 31,~~September 30, 2018 we were servicing approximately ~~$1.86~~$2.28 billion in mortgage loans for others on which servicing rights have been capitalized. This servicing portfolio had a weighted average coupon rate of ~~4.16%~~4.20% and a weighted average service fee of approximately ~~25.9~~25.8 basis points. Capitalized mortgage loan servicing rights ~~(recorded~~ at ~~fair value) at March 31,~~September 30, 2018 totaled ~~$17.8~~$23.2 million, representing approximately ~~95.6~~101.4 basis points on the related amount of mortgage loans serviced for others.

Investment and insurance commissions ~~were relatively unchanged~~represent revenues generated on the sale or management of investments and insurance for our customers. These revenues declined on both a quarterly and year-to-date basis in ~~the first quarter of~~ 2018 as compared to ~~the year ago period.~~2017 due primarily to reduced product sales.

~~We earned $0.26 million and $0.25 million in the first quarters of 2018 and 2017, respectively, principally as a result of increases in the cash surrender value of our separate account~~Income from bank owned life ~~insurance.~~insurance declined on both a comparative quarterly and year-to-date basis in 2018 compared to 2017 reflecting a lower crediting rate on our cash surrender value. Our separate account is primarily invested in agency mortgage-backed securities and managed by ~~a third-party.~~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 ~~$54.4~~$54.8 million and $54.6 million at ~~March 31,~~September 30, 2018 and December 31, 2017, respectively. The reduction in the cash surrender value of our bank owned life insurance during the first quarter of 2018 was due to the receipt of cash on a death claim that was partially offset by net earnings credits.

~~Index~~

Other non-interest income ~~was relatively unchanged~~increased on both a comparative quarterly and ~~totaled $1.25 million~~year-to-date basis in 2018 compared to 2017, due primarily to increases in a variety of categories including: merchant processing, credit card related fees and ~~$1.26 million during the first quarters of 2018~~earnings from limited partnerships (small business investment company and ~~2017, respectively.~~community/housing related investment funds).

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

Non-interest expense ~~totaled $23.9~~increased by $4.1 million into $26.7 million and by $11.7 million to $80.6 million during the ~~first quarter of~~three- and nine-month periods ended September 30, 2018, respectively, compared to ~~$23.6 million~~the same periods in 2017. Many of our components of non-interest expense increased in 2018 due to the ~~year ago period.~~ TCSB Merger.

Index

The components of non-interest expense are as follows:

Non-Interest Expense

Three months ended
March 31,

2018 2017
(In thousands)
Compensation $ 9,118 $ 9,672
Performance-based compensation 2,595 1,993
Payroll taxes and employee benefits 2,755 2,482
Compensation and employee benefits 14,468 14,147
Occupancy, net 2,264 2,142
Data processing 1,878 1,937
Furniture, fixtures and equipment 967 977
Communications 680 683
Loan and collection 677 413
Interchange expense 598 283
Advertising 441 506
Legal and professional 378 437
FDIC deposit insurance 230 198
Merger related expenses 174 --
Supplies 165 172
Credit card and bank service fees 96 191
Amortization of intangible assets 86 87
Provision for loss reimbursement on sold loans 11 31
Costs (recoveries) related to unfunded lending commitments (114 ) 110
Net (gains) losses on other real estate and repossessed assets (290 ) 11
Other 1,426 1,244
Total non-interest expense $ 24,135 $ 23,569
Non-Interest Expense

	Three months ended September 30,					Nine months ended September 30,
	2018			2017		2018			2017
	(In thousands)
Compensation	$	9,582		$	8,494	$	28,086		$	26,872
Performance-based compensation		3,305			2,688		9,238			6,819
Payroll taxes and employee benefits		3,282			2,395		9,182			7,413
Compensation and employee benefits		16,169			13,577		46,506			41,104
Occupancy, net		2,233			1,970		6,667			6,032
Data processing		2,051			1,796		6,180			5,670
Merger related expenses		98			10		3,354			10
Furniture, fixtures and equipment		1,043			961		3,029			2,943
Communications		727			685		2,111			2,046
Interchange expense		715			294		1,974			869
Loan and collection		531			481		1,900			1,564
Advertising		594			526		1,578			1,551
Legal and professional		477			540		1,311			1,366
FDIC deposit insurance		270			208		750			608
Amortization of intangible assets		295			87		676			260
Supplies		173			176		516			507
Credit card and bank service fees		108			105		310			432
Provision for loss reimbursement on sold loans		47			15		78			66
Costs (recoveries) related to unfunded lending commitments		71			92		(6	)		332
Net (gains) losses on other real estate and repossessed assets		(325	)		30		(619	)		132
Other		1,463			1,063		4,321			3,454
Total non-interest expense	$	26,740		$	22,616	$	80,636		$	68,946

Compensation and employee benefits expenses, in total, increased $2.6 million on a quarterly comparative basis and increased $5.4 million for the first nine months of 2018 compared to the same periods in 2017.

Compensation expense increased by ~~$0.3~~$1.1 million ~~or 2.3%,~~and $1.2 million in the third quarter and first nine months of 2018, respectively, compared to the same periods in 2017. The third quarter and year-over-year increases were primarily due to the TCSB Merger as well as annual compensation increases instituted at the start of the year. The increase on a year to date comparative basis was reduced because the first quarter of ~~2018, as compared to the year ago period.~~

Compensation expense decreased by $0.6 million, or 5.7%. This year-over-year decrease was primarily due to the following factors: a $0.2 million increase in the amount of compensation that was deferred as direct loan origination costs in the first quarter of 2018 and $0.3 million of additional2017 included some one-time compensation costs ~~associated with~~related to the ~~initial~~ expansion of our mortgage banking operations ~~that were incurred~~as well as a reduction in personnel associated with the ~~first quarter~~sale of 2017. Average full-time equivalent employees (“FTEs”) increased by 3.2, or 0.4%, during the first quarter of 2018 compared to the year ago quarter, as additional personnel added due to the expansion of our mortgage-banking operations were largely offset by a decline in employees in our payment plan processing business ~~that was sold~~(Mepco Finance Corporation) in May 2017.

~~Index~~

Performance-based compensation increased by $0.6 million and $2.4 million in the third quarter and first nine months of 2018, respectively, versus the same periods in 2017, due primarily to ~~a higher~~relative comparative changes in the accrual ~~(increased by $0.3 million)~~ for anticipated incentive compensation ~~for salaried employees~~ based on our ~~forecasted 2018~~estimated full-year performance as compared to ~~goals, as well as~~goals. In addition, we introduced a ~~$0.3 million bonus that was paid to~~new incentive compensation plan for hourly employees in ~~the first quarter of 2018.~~2018 that increased performance-based compensation.

Index

Payroll taxes and employee benefits increased ~~$0.3~~by $0.9 million and $1.8 million in the third quarter and first nine months of 2018, respectively, compared to the same periods in 2017, due primarily to ~~higher~~increases in payroll taxes ~~workers’ compensation insurance~~(due to the aforementioned increases in compensation), higher health care costs (due to increased claims in 2018 some of which may be reimbursed prior to year end from a stop-loss reinsurance policy) and higher 401(k) plan costs ~~(the employee~~(due to an increase in the employer match ~~was increased to 4% of eligible compensation in 2018 compared to 3% in 2017)~~percentage).

Occupancy, net, increased ~~$0.1~~by $0.3 million ~~or 5.7%,~~and $0.6 million in the third quarter and first ~~quarter~~nine months of 2018, respectively, compared to the same periods in 2017, ~~primarily because of~~principally due to additional locations acquired in the TCSB Merger and additional loan production offices opened ~~as described above and higher snow removal costs.~~during 2017.

Data processing ~~expense~~ ~~decreased $0.1~~expenses increased by $0.3 million ~~or 3.0%, in~~and $0.5 million for the third quarter and first ~~quarter~~nine months of 2018, respectively, compared to the ~~year earlier period~~same periods in 2017. The third quarter and year-to-date 2018 increases are primarily due ~~primarily~~ to ~~2017 including expenses related to~~the TCSB Merger. We completed the conversion of TCSB loan and deposit accounts onto our ~~payment processing business that was sold~~core systems in ~~May 2017.~~June 2018.

Merger related expenses totaled $0.1 million and $3.4 million for the third quarter and first nine months of 2018, respectively. These expenses include our investment banking fees, certain accounting and legal costs, various contract termination fees, data processing conversion costs, payments made on officer change-in-control contracts, and employee severance costs. We do not expect to have any remaining TCSB Merger related expenses after the third quarter of 2018.

Furniture, fixtures and equipment, communications, advertising, legal and professional and supplies expenses were ~~all~~ relatively ~~unchanged~~ comparable on both a quarterly and year-to-date basis in ~~the first quarter of~~ 2018 as compared to ~~the year earlier period.~~2017.

Loan and collection expenses primarily reflect costs related to lending activities, including the management and collection of non-performing loans and other problem credits. These expenses increased by $0.3 million in the first quarter of 2018 compared to the year ago quarter, as the first quarter of 2017 included a $0.2 million recovery of previously incurred costs related to a commercial loan relationship.

Interchange expense primarily represents our third-party cost to process debit card transactions. This cost increased ~~by $0.3 million~~ in ~~the first quarter of~~ 2018 ~~compared to the year ago quarter~~ on both a comparative quarterly and year-to-date basis due primarily to the impact of the implementation of ASU 2014-09 on January 1, 2018. Prior to the first quarter of 2018, certain processing costs were being netted against interchange income. As described above, under ASU 2014-09 these costs are no longer being netted against interchange income but instead are being reported as part of interchange expense.

~~Legal~~Loan and ~~professional fees decreased by $0.06 million in~~collection expenses reflect costs related to new lending activity as well as the management and collection of non-performing loans and other problem credits. The year-to-date comparative increase is primarily because the first quarter of ~~2018 compared~~2017 included a $0.2 million reimbursement of previously incurred expenses related to the ~~year ago quarter due primarily to~~resolution and payoff of a ~~decline in co-sourced internal audit costs and the sale of our payment processing business in May 2017.~~non-accrual loan.

FDIC deposit insurance expense increased ~~by $0.03 million~~ in ~~the first quarter of~~ 2018 ~~compared to the year ago quarter~~on both a comparative quarterly and year-to-date basis due primarily to ~~the growth~~our increase in ~~our~~ total assets.

~~Merger related expenses totaled $0.2 million in the first quarter of 2018 and primarily represent professional fees incurred related to the TCSB Merger. (See “Recent Developments.” above.)~~

Credit card and bank service fees decreased by $0.1 million in the first quarter of 2018 as compared to the year earlier period primarily due to the sale of our payment plan processing business in May 2017.

~~Index~~

The amortization of intangible assets ~~primarily~~ relates to the TCSB Merger and prior branch acquisitions and the amortization of the deposit customer relationship value, including core deposit value, which was acquired in connection with those acquisitions. We had remaining unamortized intangible assets of ~~$1.5~~$6.7 million and $1.6 million at ~~March 31,~~September 30, 2018 and December 31, 2017, respectively. See note #7 to the Condensed Consolidated Financial Statements for a schedule of future amortization of intangible assets. ~~However, this category of non-interest expense will increase~~

Index

Credit card and bank service fees decreased in ~~the second quarter of~~ 2018 on a comparative year-to-date basis primarily due to the ~~TCSB Merger.~~sale of our payment plan processing business in May 2017.

The provision for loss reimbursement on sold loans was an expense of ~~$0.01~~$0.05 million and ~~$0.03~~$0.08 million in the third quarter and first ~~quarters~~nine months of 2018, respectively, compared to an expense of $0.02 million and $0.07 million in the third quarter and first nine months of 2017, ~~respectively, and~~respectively. This provision represents our estimate of incurred losses related to mortgage loans that we have sold to investors (primarily Fannie Mae, Freddie Mac, Ginnie Mae and the Federal Home Loan Bank of ~~Indianapolis [“FHLB”])~~Indianapolis). The small expense provisions in 2018 and 2017 are primarily due to growth in the balance of loans serviced for investors. 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 ~~$0.68~~$0.85 million and $0.67 million at ~~March 31,~~September 30, 2018 and December 31, 2017, respectively. This reserve is included in accrued expenses and other liabilities in our Condensed Consolidated Statements of Financial Condition. ~~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.~~

The changes in cost (recoveries) 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.

Net (gains) losses on other real estate 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 $0.3 million net gain in the first quarter of 2018 primarily relates to the sale of single-family homes and reflects generally increasing housing prices in our markets.~~

Other non-interest expenses increased ~~by $0.2 million~~ in ~~the first quarter of~~ 2018 ~~compared to the year ago quarter~~on both a comparative quarterly and year-to-date basis due primarily to ~~higher~~ increases in several categories of expenses (directors’ fees, travel and ~~meeting costs~~entertainment, certain state franchise taxes, and ~~increased directors fees (due to the addition of one director)~~deposit account/debit card fraud).

Income tax expense. We recorded an income tax expense of ~~$2.0~~$2.9 million and ~~$2.6~~$7.0 million in the third quarter and the first ~~quarters~~nine months of 2018, respectively. This compares to an income tax expense of $3.2 million and $8.4 million in the third quarter and the first nine months of 2017, respectively. As described earlier under “Recent Developments” our statutory federal corporate income tax rate was reduced to 21% (from 35%) effective on January 1, 2018.

Our actual ~~federal~~ income tax expense is different than the amount computed by applying our statutory income tax rate to our income before income tax primarily due to tax-exempt interest income, ~~and~~ tax-exempt income from the increase in the cash surrender value on life ~~insurance. In addition,~~insurance, and differences in the ~~first quarters of 2018 and 2017, include reductions of $0.2 million and $0.1 million, respectively, of income tax expense related to impact of the excess~~ value of stock awards that ~~vested~~vest and stock options that ~~were~~are exercised as compared to the initial fair values that were expensed.

~~Index~~

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 March 31,~~September 30, 2018 and 2017 and at December 31, 2017, that the realization of substantially all of our deferred tax assets continues to be more likely than not.

Index

Financial Condition

Summary. Our total assets increased by ~~$3.8~~$507.8 million during the first ~~three~~nine months of ~~2018.~~ 2018 reflecting the TCSB Merger and organic loan growth. The total assets, loans and deposits acquired in the TCSB Merger were approximately $343.5 million, $295.8 million (including $1.3 million of loans held for sale) and $287.7 million, respectively.

Loans, excluding loans held for sale ("Portfolio Loans"), totaled ~~$2.07~~$2.56 billion at ~~March 31,~~September 30, 2018, an increase of ~~$52.6~~$543.8 million, or ~~2.6%~~26.9%, from December 31, 2017. (See "Portfolio Loans and asset quality.")

Deposits totaled ~~$2.43~~$2.80 billion at ~~March 31,~~September 30, 2018, compared to $2.40 billion at December 31, 2017. The ~~$29.9~~$398.1 million increase in total deposits during the period is primarily due to the TCSB Merger and growth in ~~savings~~reciprocal deposits and ~~interest-bearing checking deposit account balances.~~brokered time deposits.

Securities. We maintain diversified securities portfolios, which include obligations of U.S. government-sponsored agencies, securities issued by states and political subdivisions, residential and commercial mortgage-backed securities, asset-backed securities, corporate securities, trust preferred securities and foreign government securities (that are denominated in U.S. dollars). We regularly evaluate asset/liability management needs and attempt to maintain a portfolio structure that provides sufficient liquidity and cash flow. Except as discussed below, we believe that the unrealized losses on securities available for sale are temporary in nature and are expected to be ~~recovered within a reasonable time period.~~recovered. 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
September 30, 2018	$	443,744		$	1,602		$	8,389		$	436,957
December 31, 2017		523,520			3,197			3,792			522,925

Securities
Unrealized

Amortized
Cost
Gains Losses
Fair
Value

(In thousands)
Securities available for sale
March 31, 2018 $ 493,561 $ 1,978 $ 6,420 $ 489,119
December 31, 2017 523,520 3,197 3,792 522,925

Securities available for sale declined ~~$33.8~~$86.0 million during the first ~~quarter~~nine months of ~~2018.~~2018 primarily to fund growth in Portfolio Loans. Our portfolio of securities available for sale is reviewed quarterly for impairment in value. In performing this review, management considers (1) the length of time and extent that fair value has been less than cost, (2) the financial condition and near term prospects of the issuer, (3) the impact of changes in market interest rates on the market value of the security and (4) an assessment of whether we intend to sell, or it is more likely than not that we will be required to sell, a security in an unrealized loss position before recovery of its amortized cost basis. For securities that do not meet these recovery criteria, the amount of impairment recognized in earnings is limited to the amount related to credit losses, while impairment related to other factors is recognized in other comprehensive income (loss). We recorded no impairment losses related to other than temporary impairment on securities available for sale in either of the first ~~quarter~~nine months of 2018 or 2017.

6678

Index

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

	Nine months ended September 30,
	2018			2017
	(In thousands)

Proceeds (1)	$	31,445		$	9,594

Gross gains (2)	$	225		$	125
Gross losses		(126	)		-
Net impairment charges		-			-
Fair value adjustments		(170	)		(63	)
Net gains (losses)	$	(71	)	$	62

Three months ended
March 31,

2018 2017
(In thousands)

Proceeds $ 22,277 $ 6,152

Gross gains $ 76 $ 106
Gross losses (95 ) -
Net impairment charges - -
Fair value adjustments (154 ) (79 )
Net gains (losses) $ (173 ) $ 27

(1)

2017 includes $0.760 million for trades that did not settle until after September 30, 2017.

(2)

2018 gains include $0.144 million from the sale of 1,000 VISA Class B shares.

Portfolio Loans and asset quality. In addition to the communities served by our Bank branch and loan production office network, our principal lending markets also include nearby communities and metropolitan areas. Subject to established underwriting criteria, we also may participate in commercial lending transactions with certain non-affiliated banks and make whole loan purchases from other financial institutions. In March 2018 and July 2018, we sold $16.5 million and $11.1 million, respectively of single-family residential fixed and adjustable rate mortgage loans servicing retained to another financial ~~institution and recognized a gain on sale of $0.05 million.~~institution. These mortgage loans were all on properties located in Ohio ~~had a weighted average interest rate of 3.59%~~ and were sold primarily for asset/liability management purposes.

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

We generally retain loans that may be profitably funded within established risk parameters. (See “Asset/liability management.”) As a result, we may hold adjustable-rate conventional and fixed rate jumbo mortgage loans as Portfolio Loans, while 15- and 30-year fixed-rate non-jumbo mortgage loans are generally sold to mitigate exposure to changes in interest rates. (See “Non-interest income.”) Due primarily to the expansion of our mortgage-banking activities and a change in mix in our mortgage loan originations, we are now originating and putting into Portfolio Loans, more fixed rate mortgage loans ~~than~~ as compared to past periods. These fixed rate mortgage loans generally have terms from 15 to 30 years, do not have prepayment penalties and expose us to more interest rate risk. To date, our interest rate risk profile has not changed significantly. However, we are carefully monitoring this change in the composition of our Portfolio Loans and the impact of potential future changes in interest rates on our changes in market value of portfolio equity and changes in net interest income. (See “Asset/liability management.”). As a result, we have added and may continue to add some longer-term borrowings, may utilize derivatives (interest rate swaps and interest rate caps) to manage interest rate risk and may begin to attempt to sell fixed rate jumbo mortgage loans in the future.

6779

Index

A summary of our Portfolio Loans follows:

	September 30, 2018		December 31, 2017
	(In thousands)
Real estate(1)
Residential first mortgages	$	815,202	$	672,592
Residential home equity and other junior mortgages		175,426		136,560
Construction and land development		171,546		143,188
Other(2)		701,711		538,880
Consumer		377,451		291,091
Commercial		314,848		231,786
Agricultural		6,394		4,720
Total loans	$	2,562,578	$	2,018,817

March 31,
2018

December 31,
2017

(In thousands)
Real estate(1)
Residential first mortgages $ 690,288 $ 672,592
Residential home equity and other junior mortgages 143,037 136,560
Construction and land development 133,852 143,188
Other(2) 547,314 538,880
Consumer 306,757 291,091
Commercial 245,845 231,786
Agricultural 4,342 4,720
Total loans $ 2,071,435 $ 2,018,817

(1)	Includes both residential and non-residential commercial loans secured by real estate.

(2)	Includes loans secured by multi-family residential and non-farm, non-residential property.

Non-performing assets⁽¹⁾
	September 30, 2018			December 31, 2017
	(Dollars in thousands)
Non-accrual loans	$	9,343		$	8,184
Loans 90 days or more past due and still accruing interest		--			--
Total non-performing loans		9,343			8,184
Other real estate and repossessed assets		1,445			1,643
Total non-performing assets	$	10,788		$	9,827
As a percent of Portfolio Loans
Non-performing loans		0.36	%		0.41	%
Allowance for loan losses		0.95			1.12
Non-performing assets to total assets		0.33			0.35
Allowance for loan losses as a percent of non-performing loans		261.17			275.99

Non-performing assets⁽¹⁾

March 31,
2018

December 31,
2017

(Dollars in thousands)
Non-accrual loans $ 6,629 $ 8,184
Loans 90 days or more past due and still accruing interest -- --
Total non-performing loans 6,629 8,184
Other real estate and repossessed assets 1,647 1,643
Total non-performing assets $ 8,276 $ 9,827
As a percent of Portfolio Loans
Non-performing loans 0.32 % 0.41 %
Allowance for loan losses 1.11 1.12
Non-performing assets to total assets 0.30 0.35
Allowance for loan losses as a percent of non-performing loans 348.03 275.99

⁽¹⁾

Excludes loans classified as “troubled debt restructured” that are not past due.

6880

Index

Troubled debt restructurings ("TDR")

March 31, 2018
Commercial Retail (1) Total
(In thousands)
Performing TDR's $ 7,880 $ 52,022 $ 59,902
Non-performing TDR's(2) 275 3,454
⁽³⁾
3,729
Total $ 8,155 $ 55,476 $ 63,631

December 31, 2017
Commercial Retail Total
(In thousands)
Performing TDR's $ 7,748 $ 52,367 $ 60,115
Non-performing TDR's(2) 323 4,506 ⁽³⁾ 4,829
Total $ 8,071 $ 56,873 $ 64,944
Troubled debt restructurings ("TDR")

	September 30, 2018
	Commercial		Retail (1)			Total
	(In thousands)
Performing TDR's	$	6,904	$	49,397		$	56,301
Non-performing TDR's(2)		212		2,799	⁽³⁾		3,011
Total	$	7,116	$	52,196		$	59,312

	December 31, 2017
	Commercial		Retail (1)			Total
	(In thousands)
Performing TDR's	$	7,748	$	52,367		$	60,115
Non-performing TDR's(2)		323		4,506	⁽³⁾		4,829
Total	$	8,071	$	56,873		$	64,944

(1)	Retail loans include mortgage and installment portfolio segments.

(2)	Included in non-performing loans table above.

(3)	Also includes loans on non-accrual at the time of modification until six payments are received on a timely basis.

Non-performing loans ~~decreased~~increased by ~~$1.6~~$1.2 million ~~or 19.0%,~~ during the first ~~quarter~~nine months of 2018 due principally to ~~decreases~~an increase in non-performing commercial loans. The increase in non-performing commercial loans ~~and mortgage loans. These declines~~ primarily ~~reflect reduced levels~~reflects one relationship moving into non-accrual in the second quarter of ~~new~~2018. Because of our collateral position, we do not expect any loss from the resolution of this loan defaults as well as loan charge-offs, pay-offs, negotiated transactions, and the migration of loans into other real estate. In general, stable 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.relationship.

Non-performing loans exclude performing loans that are classified as troubled debt restructurings (“TDRs”). Performing TDRs totaled ~~$59.9~~$56.3 million, or ~~2.9%~~2.2% of total Portfolio Loans, and $60.1 million, or 3.0% of total Portfolio Loans, at ~~March 31,~~September 30, 2018 and December 31, 2017, respectively. The decrease in the amount of performing TDRs in the first ~~quarter~~nine months of 2018 primarily reflects pay downs and payoffs.

Other real estate and repossessed assets ~~were essentially unchanged~~totaled $1.4 million and ~~totaled~~ $1.6 million at ~~both March 31,~~September 30, 2018 and December 31, ~~2017.~~2017, respectively.

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 a negative 0.03% (as a result of net recoveries) on an annualized basis in the first quarter of 2018 compared to a negative 0.04% in the first quarter of 2017. The dollar amount of loan net recoveries was essentially unchanged in the first quarter of 2018 as compared to the year-ago period.

6981

Index

Allowance for loan losses

Three months ended
March 31,

2018 2017
Loans
Unfunded
Commitments
Loans
Unfunded
Commitments

(Dollars in thousands)
Balance at beginning of period $ 22,587 $ 1,125 $ 20,234 $ 650
Additions (deductions)
Provision for loan losses 315 - (359 ) -
Recoveries credited to allowance 1,014 - 1,129 -
Loans charged against the allowance (845 ) - (966 ) -
Additions included in non-interest expense - (114 ) - 110
Balance at end of period $ 23,071 $ 1,011 $ 20,038 $ 760

Net loans charged against the allowance to average Portfolio Loans (0.03 )% (0.04 )%

The following tables reflect activity in and the allocation of the allowance for loan losses (“AFLL”).

Allowance for loan losses

	Nine months ended September 30,
	2018						2017
	Loans			Unfunded Commitments			Loans			Unfunded Commitments
	(Dollars in thousands)
Balance at beginning of period	$	22,587		$	1,125		$	20,234		$	650
Additions (deductions)
Provision for loan losses		912			-			806			-
Recoveries credited to allowance		3,768			-			2,998			-
Loans charged against the allowance		(2,866	)		-			(2,560	)		-
Additions included in non-interest expense		-			(6	)		-			332
Balance at end of period	$	24,401		$	1,119		$	21,478		$	982

Net loans charged against the allowance to average Portfolio Loans		(0.04	)%					(0.03	)%

Allocation of the Allowance for Loan Losses

March 31,
2018

December 31,
2017

(In thousands)
Specific allocations $ 6,332 $ 6,839
Other adversely rated commercial loans 1,865 1,228
Historical loss allocations 7,245 7,125
Additional allocations based on subjective factors 7,629 7,395
Total $ 23,071 $ 22,587
Allocation of the Allowance for Loan Losses

	September 30, 2018		December 31, 2017
	(In thousands)
Specific allocations	$	6,102	$	6,839
Other adversely rated commercial loans		1,883		1,228
Historical loss allocations		7,665		7,125
Additional allocations based on subjective factors		8,751		7,395
Total	$	24,401	$	22,587

Some loans will not be repaid in full. Therefore, an ~~allowance for loan losses (“AFLL”)~~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.

7082

Index

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

No allowance for loan losses was brought forward on any of the TCSB acquired loans as any credit deterioration evident in the loans was included in the determination of the fair value of the loans at the acquisition date. An allowance for loan losses will be established for any subsequent credit deterioration or adverse changes in expected cash flows.

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

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

The allowance for loan losses increased ~~$0.5~~$1.8 million to ~~$23.1~~$24.4 million at ~~March 31,~~September 30, 2018 from $22.6 million at December 31, 2017 and was equal to ~~1.11%~~0.95% (1.06% when excluding TCSB acquired loans) of total Portfolio Loans at ~~March 31,~~September 30, 2018 compared to 1.12% at December 31, 2017.

Three of the four components of the allowance for loan losses outlined above increased in the first ~~quarter~~nine months of 2018. The allowance for loan losses related to specific loans decreased ~~$0.5~~$0.7 million in 2018 due primarily to a decline in the balance of individually impaired loans and ~~lower loss given default rates as well as~~ charge-offs. The allowance for loan losses related to other adversely rated commercial loans increased ~~$0.6~~$0.7 million in 2018 primarily due to an increase in the balance of such loans included in this component to ~~$35.3~~$37.5 million at ~~March 31,~~September 30, 2018 from $27.2 million at December 31, 2017 and ~~$11.6~~$23.2 million at ~~March 31,~~September 30, 2017. Approximately two-thirds of the year-over-year increase of $23.7 million was in the earliest watch stage (7-rated commercial loans), all of the loans representing the increase are current and at the present time, no significant loss is expected on any of these credits. The allowance for loan losses related to historical losses increased ~~$0.1~~$0.5 million during 2018 due principally to loan growth. The allowance for loan losses related to subjective factors increased ~~$0.2~~$1.4 million during 2018 primarily due to loan growth.

7183

Index

~~By comparison, three~~Three of the four components of the allowance for loan losses outlined above also increased in the first ~~quarter~~nine months of 2017. The allowance for loan losses related to specific loans decreased ~~$1.5~~$2.1 million in 2017 due primarily to a decline in the balance of individually impaired loans as well as charge-offs. In particular, we received a full payoff in March 2017 on a commercial loan that had a specific reserve of $1.2 million at December 31, 2016. The allowance for loan losses related to other adversely rated commercial loans increased ~~$0.1~~$0.3 million in 2017 primarily due to ~~slight upward adjustments in our probability of default and expected loss rates that were partially offset by a decrease~~an increase in the balance of such loans included in this component to ~~$11.6~~$23.2 million at ~~March 31,~~September 30, 2017 from $11.8 million at December 31, 2016. The allowance for loan losses related to historical losses increased ~~$0.9~~$1.6 million during 2017 due principally to slight upward adjustments in our probability of default and expected loss rates for commercial loans, an additional component of approximately ~~$0.5~~$0.6 million added for loans secured by commercial real estate due primarily to emerging risks in this sector (such as retail store closings and potential overdevelopment in certain markets) and loan growth. We also extended our historical lookback period to be more representative of the probability of default and account for infrequent migration events and extremely low levels of watch credits. The allowance for loan losses related to subjective factors increased ~~$0.3~~$1.4 million during 2017 primarily due to loan growth.

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

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

Deposits totaled ~~$2.43~~$2.80 billion and $2.40 billion at ~~March 31,~~September 30, 2018 and December 31, 2017, respectively. The ~~$29.9~~$398.1 million increase in deposits in the first ~~quarter~~nine months of 2018 is primarily due to the TCSB Merger and growth in ~~savings~~reciprocal deposits and ~~interest-bearing checking deposit account balances.~~brokered time deposits. Reciprocal deposits totaled ~~$63.0~~$92.6 million and $51.0 million at ~~March 31,~~September 30, 2018 and December 31, 2017, 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 ~~March 31,~~September 30, 2018, we had approximately ~~$536.0~~$650.0 million of uninsured deposits. A reduction in core deposits would likely increase our need to rely on wholesale funding sources.

7284

Index

We have also implemented strategies that incorporate using federal funds purchased, other borrowings and ~~Brokered CDs~~brokered time deposits 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 primarily of federal funds purchased and advances from the FHLB, totaled ~~$27.8~~$79.7 million and $54.6 million at ~~March 31,~~September 30, 2018 and December 31, 2017, respectively.

As described above, we utilize wholesale funding, including FHLB borrowings and ~~Brokered CDs~~brokered time deposits to augment our core deposits and fund a portion of our assets. At ~~March 31,~~September 30, 2018, our use of such wholesale funding sources (including reciprocal deposits) amounted to approximately ~~$206.0~~$380.4 million, or ~~8.4%~~13.2% 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. During the first ~~quarters~~nine months of 2018 and 2017, we entered into ~~$11.3~~$16.6 million and ~~$9.8~~$14.6 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 ~~$0.10~~$0.4 million and ~~$0.05~~$0.2 million of fee income related to these transactions during the first ~~quarters~~nine months of 2018 and 2017, respectively. See note #6 to the Condensed Consolidated Financial Statements included within this report for more information on our derivative financial instruments.

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 securities available for sale) as well as developing access to a variety of borrowing sources to supplement our deposit gathering activities and provide funds for purchasing securities available for sale or originating Portfolio Loans as well as to be able to respond to unforeseen liquidity needs.

Our primary sources of funds include our deposit base, secured advances from the FHLB, federal funds purchased borrowing facilities with other banks, and access to the capital markets (for Brokered CDs).

7385

Index

At ~~March 31,~~September 30, 2018, we had ~~$426.3~~$506.9 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, ~~$1.89~~$2.14 billion of our deposits at ~~March 31,~~September 30, 2018, were in account types from which the customer could withdraw the funds on demand. Changes in the balances of deposits that can be withdrawn upon demand are usually predictable and the total balances of these accounts have generally grown or have been stable over time as a result of our marketing and promotional activities. However, there can be no assurance that historical patterns of renewing time deposits or overall growth or stability in deposits will continue in the future.

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

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

We also believe that the available cash on hand at the parent company (including time deposits) of approximately ~~$17.0~~$33.0 million as of ~~March 31,~~September 30, 2018 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.

Capitalization

March 31,
2018

December 31,
2017

(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 324,517 324,986
Accumulated deficit (48,098 ) (54,054 )
Accumulated other comprehensive loss (8,502 ) (5,999 )
Total shareholders’ equity 267,917 264,933
Total capitalization $ 302,417 $ 299,433
Capitalization

	September 30, 2018			December 31, 2017
	(In thousands)
Subordinated debentures	$	39,371		$	35,569
Amount not qualifying as regulatory capital		(1,224	)		(1,069	)
Amount qualifying as regulatory capital		38,147			34,500
Shareholders’ equity
Common stock		389,689			324,986
Accumulated deficit		(34,596	)		(54,054	)
Accumulated other comprehensive loss		(9,889	)		(5,999	)
Total shareholders’ equity		345,204			264,933
Total capitalization	$	383,351		$	299,433

Index

We currently have ~~three~~four special purpose entities with ~~$34.5~~$38.1 million of outstanding cumulative trust preferred securities. These special purpose entities issued common securities and provided cash to our parent company that in turn issued subordinated debentures to these special purpose entities equal to the trust preferred securities and common securities. The subordinated debentures represent the sole asset of the special purpose entities. The common securities and subordinated debentures are included in our Condensed Consolidated Statements of Financial Condition.

74As part of the TCSB Merger we acquired TCSB Statutory Trust I (a statutory business trust formed solely to issue capital securities) and assumed approximately $5.2 million of subordinated debentures that had a fair value of approximately $3.8 million on April 1, 2018. The trust preferred securities issued by TCSB Statutory Trust I mature in March 2035. The discount recorded on these subordinated debentures is being accreted over their remaining life.

~~Index~~

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 ~~March 31,~~September 30, 2018 and December 31, 2017. 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 ~~$267.9~~$345.2 million at ~~March 31,~~September 30, 2018 from $264.9 million at December 31, 2017 due primarily to shares issued in the TCSB Merger and our net income that was partially offset by an increase in our accumulated other comprehensive loss and by ~~a dividend~~dividends that we paid. Our tangible common equity (“TCE”) totaled ~~$266.4~~$310.2 million and $263.3 million, respectively, at those same dates. Our ratio of TCE to tangible assets was ~~9.54%~~9.51% and 9.45% at ~~March 31,~~September 30, 2018 and December 31, 2017, respectively. TCE and the ratio of TCE to tangible assets are non-GAAP measures. TCE represents total common equity less intangible assets.

In January 2018, our Board of Directors authorized a share repurchase plan. Under the terms of the 2018 share repurchase plan, we are authorized to buy back up to 5% of our outstanding common stock. This repurchase plan is authorized to last through December 31, 2018. We did not repurchase any shares during the first ~~quarter~~nine months of 2018.

We pay a quarterly cash dividend on our common stock. These dividends totaled $0.15 per share and $0.10 per share in the ~~first~~third quarters of 2018 and 2017, respectively. We generally favor a dividend payout ratio between 30% and 50% of net income.

As of ~~March 31,~~September 30, 2018 and December 31, 2017, our Bank (and holding company) continued to meet the requirements to be considered “well-capitalized” under federal regulatory standards (also see note #10 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.

Index

Our asset/liability management efforts identify and evaluate opportunities to structure our assets and liabilities 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.

~~Index~~

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.

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)
March 31, 2018
200 basis point rise $ 410,900 (3.86 )% $ 102,300 1.29 %
100 basis point rise 424,200 (0.75 ) 102,400 1.39
Base-rate scenario 427,400 - 101,000 -
100 basis point decline 409,000 (4.31 ) 96,500 (4.46 )

December 31, 2017
200 basis point rise $ 409,200 (1.23 )% $ 99,100 2.27 %
100 basis point rise 417,100 0.68 98,600 1.75
Base-rate scenario 414,300 - 96,900 -
100 basis point decline 386,400 (6.73 ) 91,600 (5.47 )

Index

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)
September 30, 2018
200 basis point rise	$	474,800		(4.33	)%	$	123,700		2.66	%
100 basis point rise		489,900		(1.29	)		122,700		1.83
Base-rate scenario		496,300		-			120,500		-
100 basis point decline		486,100		(2.06	)		117,700		(2.32	)

December 31, 2017
200 basis point rise	$	409,200		(1.23	)%	$	99,100		2.27	%
100 basis point rise		417,100		0.68			98,600		1.75
Base-rate scenario		414,300		-			96,900		-
100 basis point decline		386,400		(6.73	)		91,600		(5.47	)

(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.

~~Index~~

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”). Certain equity securities, securities available for sale, loans held for sale, derivatives and capitalized mortgage loan servicing rights are financial instruments recorded at fair value on a recurring basis. Additionally, from time to time, we may be required to record at fair value other financial assets on a nonrecurring basis, such as loans held for investment and certain other assets. These nonrecurring fair value adjustments typically involve application of lower of cost or market accounting or write-downs of individual assets. See note #11 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.

Index

Litigation Matters

The aggregate amount we have accrued for losses we consider probable as a result of litigation matters is immaterial. However, because of the inherent uncertainty of outcomes from any litigation matter, we believe it is reasonably possible we may incur losses in addition to the amounts we have accrued. At this time, we estimate the maximum amount of additional losses that are reasonably possible is insignificant. However, because of a number of factors, including the fact that certain of these litigation matters are still in their early stages, this maximum amount may change in the future.

Critical Accounting Policies

Our accounting and reporting policies are in accordance with accounting principles generally accepted in the United States of America and conform to general practices within the banking industry. Accounting and reporting policies for the AFLL, capitalized mortgage loan servicing rights, and income taxes are deemed critical since they involve the use of estimates and require significant management judgments. Application of assumptions different than those that we have used could result in material changes in our 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, 2017.

7790

Index

Item 3.

Quantitative and Qualitative Disclosures about Market Risk

See applicable disclosures 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 ~~March 31,~~September 30, 2018, have concluded that, as of such date, our disclosure controls and procedures were effective.

(b)	Changes in Internal Controls.

During the quarter ended ~~March 31,~~September 30, 2018, 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.

7891

Index

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, 2017.

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 ~~first~~third quarter of 2018, the Company issued ~~703~~587 shares of common stock to non-employee directors on a current basis and ~~1,682~~1,455 shares of common stock to the trust for distribution to directors on a deferred basis. The shares were issued ~~in January~~on July 2, 2018, at ~~prices~~a price of ~~$22.35 per share and $22.70~~$25.50 per share, representing aggregate fees of $0.05 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 repurchases of common stock for the three-months ended ~~March 31,~~September 30, 2018:

Period
Total Number of
Shares Purchased (1)

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

January 2018 36,722 $ 23.80 -- 1,066,693
February 2018 29,245 $ 23.15 -- 1,066,693
March 2018 -- -- -- 1,066,693
Total 65,967 $ 23.51 -- 1,066,693

Period	Total Number of Shares Purchased (1)		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
July 2018		-	$	-		-		1,066,693
August 2018		101		25.05		-		1,066,693
September 2018		-		-		-		1,066,693
Total		101	$	25.05		-		1,066,693

(1)

Represents ~~(i) 28,639 shares of our common stock purchased in the open market by the Independent Bank Corporation Employee Stock Ownership Trust as part of our employee stock ownership plan, and (ii) 37,328~~ shares withheld from the shares that would otherwise have been issued to certain officers in order to satisfy tax withholding obligations resulting from vesting of restricted stock.

7992

Index

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:
	31.1	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).
	31.2	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).
	32.1	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).
	32.2	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

8093

Index

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	~~May 4,~~November 2, 2018	By	/s/ Robert N. Shuster
			Robert N. Shuster, Principal Financial Officer

Date	~~May 4,~~November 2, 2018	By	/s/ James J. Twarozynski
			James J. Twarozynski, Principal Accounting Officer

8194

Three Month Periods Ended March 31,
	Gain Recognized in Other Comprehensive Income (Loss) (Effective Portion)				Location of Gain (Loss) Reclassified from Accumulated Other Comprehensive Loss 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 (1)
	2018		2017		Portion)	2018			2017		in Income (1)	2018			2017
	(In thousands)
Cash Flow Hedges
Interest rate cap agreements	$	513	$	-	Interest expense	$	7		$	-	Interest expense	$	-		$	-
Pay-fixed interest rate swap agreements		171		-	Interest expense		(1	)		-	Interest expense		12			-
Total	$	684	$	-		$	6		$	-		$	12		$	-

No hedge designation
Rate-lock mortgage loan commitments											Net gains on on mortage loans	$	428		$	371
Mandatory commitments to sell mortgage loans											Net gains on on mortage loans		(160	)		(796	)
Pay-fixed interest rate swap agreements - commercial											Interest income		1,056			110
Pay-variable interest rate swap agreements - commercial											Interest income		(1,056	)		(110	)
Pay-variable interest rate swap agreements											Interest expense		-			-
Purchased options											Interest expense		(93	)		69
Written options											Interest expense		93			(69	)
Total												$	268		$	(425	)

Key performance ratios
	Three months ended March 31,
	2018			2017
Net income (annualized) to
Average assets		1.34	%		0.95	%
Average common shareholders’ equity		14.04			9.63

Net income per common share
Basic	$	0.43		$	0.28
Diluted		0.42			0.28

Troubled debt restructurings ("TDR")

	March 31, 2018
	Commercial		Retail (1)			Total
	(In thousands)
Performing TDR's	$	7,880	$	52,022		$	59,902
Non-performing TDR's(2)		275		3,454	⁽³⁾		3,729
Total	$	8,155	$	55,476		$	63,631

Capitalization
	March 31, 2018			December 31, 2017
	(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		324,517			324,986
Accumulated deficit		(48,098	)		(54,054	)
Accumulated other comprehensive loss		(8,502	)		(5,999	)
Total shareholders’ equity		267,917			264,933
Total capitalization	$	302,417		$	299,433