UNITED STATES

SECURITIES AND EXCHANGE COMMISSION      

Washington, D.C. 20549

FORM 10-Q

[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE

SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2018

OR

[  ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE

SECURITIES EXCHANGE ACT OF 1934

For the transition period from ______________to______________________

Commission file number: 001-38229

FIDELITY D & D BANCORP, INC.

STATE OF INCORPORATION:  IRS EMPLOYER IDENTIFICATION NO:

PENNSYLVANIA                                     23-3017653

Address of principal executive offices:

BLAKELY & DRINKER ST.

DUNMORE, PENNSYLVANIA 18512

TELEPHONE:

570-342-8281

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subjected to such filing requirements for the past 90 days.  [X] YES [  ] NO

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted 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 such files).       [X] YES [  ] NO

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.

Large accelerated filer [  ]	Accelerated filer [ X ]
Non-accelerated filer   [  ]	Smaller reporting company [ X  ]
	Emerging growth company [  ]

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.  [  ]

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). 

[  ] YES [X] NO

The number of outstanding shares of Common Stock of Fidelity D & D Bancorp, Inc. on October 31, 2018, the latest practicable date, was 3,759,426 shares.

FIDELITY D & D BANCORP, INC.

Form 10-Q September 30, 2018

Index

Part I.  Financial Information		Page
Item 1.	Financial Statements (unaudited):
	Consolidated Balance Sheets as of September 30, 2018 and December 31, 2017	3
	Consolidated Statements of Income for the three and nine months ended September 30, 2018 and 2017	4
	Consolidated Statements of Comprehensive Income for the three and nine months ended September 30, 2018 and 2017	5
	Consolidated Statements of Changes in Shareholders’ Equity for the three and nine months ended September 30, 2018 and 2017	6
	Consolidated Statements of Cash Flows for the nine months ended September 30, 2018 and 2017	8
	Notes to Consolidated Financial Statements (Unaudited)	10
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	34
Item 3.	Quantitative and Qualitative Disclosure about Market Risk	53
Item 4.	Controls and Procedures	58
Part II.  Other Information
Item 1.	Legal Proceedings	60
Item 1A.	Risk Factors	60
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	60
Item 3.	Defaults upon Senior Securities	60
Item 4.	Mine Safety Disclosures	60
Item 5.	Other Information	60
Item 6.	Exhibits	60
Signatures		62

2

PART I – Financial Information

Item 1: Financial Statements

Fidelity D & D Bancorp, Inc. and Subsidiary
Consolidated Balance Sheets
(Unaudited)
(dollars in thousands)	September 30, 2018		December 31, 2017
Assets:
Cash and due from banks	$	14,336	$	14,143
Interest-bearing deposits with financial institutions		2,608		1,682
Total cash and cash equivalents		16,944		15,825
Available-for-sale securities		171,451		157,385
Federal Home Loan Bank stock		4,717		2,832
Loans and leases, net (allowance for loan losses of
$9,944 in 2018; $9,193 in 2017)		690,944		628,767
Loans held-for-sale (fair value $4,068 in 2018, $2,221 in 2017)		3,998		2,181
Foreclosed assets held-for-sale		577		973
Bank premises and equipment, net		16,204		16,576
Cash surrender value of bank owned life insurance		20,464		20,017
Accrued interest receivable		3,300		2,786
Goodwill		209		209
Other assets		21,046		16,086
Total assets	$	949,854	$	863,637
Liabilities:
Deposits:
Interest-bearing	$	572,473	$	551,515
Non-interest-bearing		206,588		178,631
Total deposits		779,061		730,146
Accrued interest payable and other liabilities		8,768		6,402
Short-term borrowings		40,269		18,502
FHLB advances		31,704		21,204
Total liabilities		859,802		776,254
Shareholders' equity:
Preferred stock authorized 5,000,000 shares with no par value; none issued		-		-
Capital stock, no par value (10,000,000 shares authorized; shares issued and outstanding; 3,757,491 in 2018; and 3,734,478 in 2017)		29,520		28,361
Retained earnings		63,075		57,218
Accumulated other comprehensive (loss) income		(2,543)		1,804
Total shareholders' equity		90,052		87,383
Total liabilities and shareholders' equity	$	949,854	$	863,637
See notes to unaudited consolidated financial statements

3

Fidelity D & D Bancorp, Inc. and Subsidiary
Consolidated Statements of Income
(Unaudited)	Three months ended				Nine months ended
(dollars in thousands except per share data)	September 30, 2018		September 30, 2017		September 30, 2018		September 30, 2017
Interest income:
Loans and leases:
Taxable	$	7,524	$	6,672	$	21,251	$	19,398
Nontaxable		256		220		689		647
Interest-bearing deposits with financial institutions		10		12		94		22
Restricted regulatory securities		44		40		122		96
Investment securities:
U.S. government agency and corporations		799		610		2,377		1,887
States and political subdivisions (nontaxable)		395		368		1,162		1,081
Other securities		-		6		11		17
Total interest income		9,028		7,928		25,706		23,148
Interest expense:
Deposits		981		742		2,671		1,971
Securities sold under repurchase agreements		3		3		13		15
Other short-term borrowings and other		260		60		324		197
FHLB advances		73		77		205		174
Total interest expense		1,317		882		3,213		2,357
Net interest income		7,711		7,046		22,493		20,791
Provision for loan losses		400		375		1,125		925
Net interest income after provision for loan losses		7,311		6,671		21,368		19,866
Other income:
Service charges on deposit accounts		573		582		1,666		1,674
Interchange fees		506		431		1,480		1,256
Fees from trust fiduciary activities		305		253		1,032		756
Fees from financial services		187		169		559		434
Service charges on loans		136		201		443		597
Fees and other revenue		252		222		731		661
Earnings on bank-owned life insurance		150		158		448		422
Gain on sale or disposal of:
Loans		168		232		522		684
Available-for-sale debt securities		4		-		10		-
Equity securities		-		-		44		-
Premises and equipment		2		-		2		-
Total other income		2,283		2,248		6,937		6,484
Other expenses:
Salaries and employee benefits		3,454		3,235		10,241		9,559
Premises and equipment		918		919		2,815		2,816
Advertising and marketing		250		270		872		850
Professional services		355		404		1,237		1,330
Data processing and communication		377		297		1,099		880
Automated transaction processing		202		185		580		543
Office supplies and postage		85		109		293		339
FDIC assessment		70		68		203		201
PA shares tax		196		183		432		394
Loan collection		31		84		82		191
Other real estate owned		63		37		127		183
Other		171		244		561		597
Total other expenses		6,172		6,035		18,542		17,883
Income before income taxes		3,422		2,884		9,763		8,467
Provision for income taxes		559		658		1,604		2,078
Net income	$	2,863	$	2,226	$	8,159	$	6,389
Per share data :
Net income - basic	$	0.76	$	0.60	$	2.17	$	1.72
Net income - diluted	$	0.75	$	0.60	$	2.15	$	1.72
Dividends	$	0.24	$	0.21	$	0.72	$	0.62
See notes to unaudited consolidated financial statements

4

Fidelity D & D Bancorp, Inc. and Subsidiary
Consolidated Statements of Comprehensive Income	Three months ended				Nine months ended
(Unaudited)	September 30,				September 30,
(dollars in thousands)	2018		2017		2018		2017
Net income	$	2,863	$	2,226	$	8,159	$	6,389
Other comprehensive (loss) income, before tax:
Unrealized holding (loss) gain on available-for-sale debt securities		(1,591)		104		(4,960)		818
Reclassification adjustment for net gains realized in income		(4)		-		(10)		-
Net unrealized (loss) gain		(1,595)		104		(4,970)		818
Tax effect		335		(35)		1,044		(278)
Unrealized (loss) gain, net of tax		(1,260)		69		(3,926)		540
Other comprehensive (loss) income, net of tax		(1,260)		69		(3,926)		540
Total comprehensive income, net of tax	$	1,603	$	2,295	$	4,233	$	6,929
See notes to unaudited consolidated financial statements

5

Fidelity D & D Bancorp, Inc. and Subsidiary
Consolidated Statements of Changes in Shareholders' Equity
For the nine months ended September, 2018 and 2017
(Unaudited)							Accumulated
							other
	Capital stock				Retained		comprehensive
(dollars in thousands)	Shares		Amount		earnings		income (loss)		Total
Balance, December 31, 2016		2,453,805	$	27,155	$	52,095	$	1,381	$	80,631
Net income						6,389				6,389
Other comprehensive income								540		540
Issuance of common stock through Employee Stock Purchase Plan		4,085		126						126
Issuance of common stock through Dividend Reinvestment Plan		7,744		331						331
Issuance of common stock from vested restricted share grants through stock compensation plans		9,657
Issuance of common stock through exercise of stock options		11,500		332						332
Stock-based compensation expense				256						256
Issuance of common stock from stock split		1,243,187
Cash in lieu of fractional shares paid due to the stock split						(11)				(11)
Cash dividends declared						(2,310)				(2,310)
Balance, September 30, 2017		3,729,978	$	28,200	$	56,163	$	1,921	$	86,284
Balance, December 31, 2017		3,734,478	$	28,361	$	57,218	$	1,804	$	87,383
Net income						8,159				8,159
Other comprehensive loss								(3,926)		(3,926)
Effect of adopting ASU 2016-01						421		(421)		-
Issuance of common stock through Employee Stock Purchase Plan		6,783		149						149
Issuance of common stock through Dividend Reinvestment Plan		5,486		311						311
Issuance of common stock from vested restricted share grants through stock compensation plans		9,994
Issuance of common stock through exercise of stock options		750		14						14
Stock-based compensation expense				685						685
Cash dividends declared						(2,723)				(2,723)
Balance, September 30, 2018		3,757,491	$	29,520	$	63,075	$	(2,543)	$	90,052

6

For the three months ended September, 2018 and 2017
(Unaudited)							Accumulated
							other
	Capital stock				Retained		comprehensive
(dollars in thousands)	Shares		Amount		earnings		income (loss)		Total
Balance, June 30, 2017		2,470,544	$	27,565	$	54,719	$	1,852	$	84,136
Net income						2,226				2,226
Other comprehensive income								69		69
Issuance of common stock through Dividend Reinvestment Plan		5,266		241						241
Issuance of common stock through exercise of stock options		10,981		317						317
Stock-based compensation expense				77						77
Issuance of common stock from stock split		1,243,187
Cash in lieu of fractional shares paid due to the stock split						(11)				(11)
Cash dividends declared						(771)				(771)
Balance, September 30, 2017		3,729,978	$	28,200	$	56,163	$	1,921	$	86,284
Balance, June 30, 2018		3,752,005	$	29,016	$	61,119	$	(1,283)	$	88,852
Net income						2,863				2,863
Other comprehensive loss								(1,260)		(1,260)
Issuance of common stock through Dividend Reinvestment Plan		5,486		311						311
Stock-based compensation expense				193						193
Cash dividends declared						(907)				(907)
Balance, September 30, 2018		3,757,491	$	29,520	$	63,075	$	(2,543)	$	90,052
See notes to unaudited consolidated financial statements

7

Fidelity D & D Bancorp, Inc. and Subsidiary
Consolidated Statements of Cash Flows
(Unaudited)	Nine months ended September 30,
(dollars in thousands)	2018		2017
Cash flows from operating activities:
Net income	$	8,159	$	6,389
Adjustments to reconcile net income to net cash provided by
operating activities:
Depreciation, amortization and accretion		2,252		2,324
Provision for loan losses		1,125		925
Deferred income tax expense		779		1,070
Stock-based compensation expense		590		419
Excess tax benefit from exercise of stock options		4		66
Proceeds from sale of loans held-for-sale		25,509		33,498
Originations of loans held-for-sale		(25,622)		(29,342)
Earnings from bank-owned life insurance		(448)		(422)
Net gain from sales of loans		(522)		(684)
Net gain from sales of investment securities		(54)		-
Net loss from sale and write-down of foreclosed assets held-for-sale		52		83
Net gain from disposal of equipment		(2)		-
Change in:
Accrued interest receivable		(514)		(519)
Other assets		(2,244)		(4,262)
Accrued interest payable and other liabilities		1,205		1,928
Net cash provided by operating activities		10,269		11,473
Cash flows from investing activities:
Available-for-sale securities:
Proceeds from sales		13,514		-
Proceeds from maturities, calls and principal pay-downs		15,579		14,795
Purchases		(48,931)		(36,786)
(Increase) decrease in FHLB stock		(1,885)		63
Net increase in loans and leases		(65,624)		(39,271)
Purchase of life insurance policies		-		(8,000)
Purchases of bank premises and equipment		(1,869)		(747)
Net cash acquired in acquisition of bank branch		-		11,817
Proceeds from sale of bank premises and equipment		8		6
Proceeds from sale of foreclosed assets held-for-sale		1,125		511
Net cash used in investing activities		(88,083)		(57,612)
Cash flows from financing activities:
Net increase in deposits		48,915		31,308
Net increase in short-term borrowings		21,767		8,697
Proceeds from issuance of FHLB advances		15,000		25,704
Repayment of FHLB advances		(4,500)		(2,000)
Proceeds from employee stock purchase plan participants		149		126
Exercise of stock options		14		332
Dividends paid, net of dividends reinvested		(2,412)		(1,979)
Cash paid in lieu of fractional shares		-		(11)
Net cash provided by financing  activities		78,933		62,177
Net increase in cash and cash equivalents		1,119		16,038
Cash and cash equivalents, beginning		15,825		25,843
Cash and cash equivalents, ending	$	16,944	$	41,881
See notes to consolidated financial statements

8

Fidelity D & D Bancorp, Inc. and Subsidiary
Consolidated Statements of Cash Flows (continued)
(Unaudited)	Nine months ended September 30,
(dollars in thousands)	2018		2017
Supplemental Disclosures of Cash Flow Information
Cash payments for:
Interest	$	3,150	$	2,219
Income tax		300		1,300
Supplemental Disclosures of Non-cash Investing Activities:
Net change in unrealized gains on available-for-sale securities		(4,970)		818
Transfers from loans to foreclosed assets held-for-sale		781		216
Transfers from loans to loans held-for-sale		1,541		2,752
Acquisition of West Scranton Branch from Wayne Bank
Non-cash assets acquired:
Loans			$	1,574
Bank premises and equipment				264
Goodwill				209
Accrued interest receivable and other assets				4
Total non-cash assets acquired			$	2,051
Liabilities assumed:
Deposits			$	13,809
Accrued interest payable and other liabilities				59
Total liabilities assumed			$	13,868
See notes to unaudited consolidated financial statements

9

FIDELITY D & D BANCORP, INC.

Notes to Consolidated Financial Statements

(Unaudited)

1.   Nature of operations and critical accounting policies

Nature of operations

Fidelity Deposit and Discount Bank (the Bank) is a commercial bank chartered under the law of the Commonwealth of Pennsylvania and a wholly-owned subsidiary of Fidelity D & D Bancorp, Inc. (collectively, the Company).  Having commenced operations in 1903, the Bank is committed to provide superior customer service, while offering a full range of banking products and financial and trust services to both our consumer and commercial customers from our main office located in Dunmore and other branches located throughout Lackawanna and Luzerne Counties.

Principles of consolidation

The accompanying unaudited consolidated financial statements of the Company and the Bank have been prepared in accordance with accounting principles generally accepted in the United States of America (GAAP) for interim financial information and with the instructions to this Form 10-Q and Rule 8-03 of Regulation S-X.  Accordingly, they do not include all of the information and footnote disclosures required by GAAP for complete financial statements.  In the opinion of management, all normal recurring adjustments necessary for a fair presentation of the financial condition and results of operations for the periods have been included.  All significant inter-company balances and transactions have been eliminated in consolidation.

For additional information and disclosures required under GAAP, refer to the Company’s Annual Report on Form 10-K for the year ended December 31, 2017.

Management is responsible for the fairness, integrity and objectivity of the unaudited financial statements included in this report.  Management prepared the unaudited financial statements in accordance with GAAP.  In meeting its responsibility for the financial statements, management depends on the Company's accounting systems and related internal controls.  These systems and controls are designed to provide reasonable but not absolute assurance that the financial records accurately reflect the transactions of the Company, the Company’s assets are safeguarded and that the financial statements present fairly the financial condition and results of operations of the Company.

In the opinion of management, the consolidated balance sheets as of September 30, 2018 and December 31, 2017 and the related consolidated statements of income and consolidated statements of comprehensive income for the three and nine months ended September 30, 2018 and 2017, and consolidated statements of changes in shareholders’ equity and consolidated statements of cash flows for the nine months ended September 30, 2018 and 2017 present fairly the financial condition and results of operations of the Company.  All material adjustments required for a fair presentation have been made.  These adjustments are of a normal recurring nature.  Certain reclassifications have been made to the 2017 financial statements to conform to the 2018 presentation. 

In preparing these consolidated financial statements, the Company evaluated the events and transactions that occurred after September 30, 2018 through the date these consolidated financial statements were issued.

This Quarterly Report on Form 10-Q should be read in conjunction with the Company’s audited financial statements for the year ended December 31, 2017, and the notes included therein, included within the Company’s Annual Report filed on Form 10-K.

Critical accounting policies

The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reported periods.  Actual results could differ from those estimates.

A material estimate that is particularly susceptible to significant change relates to the determination of the allowance for loan losses.  Management believes that the allowance for loan losses at September 30, 2018 is adequate and reasonable to cover incurred losses.  Given the subjective nature of identifying and estimating loan losses, it is likely that well-informed individuals could make different assumptions and could, therefore, calculate a materially different allowance amount.  While management uses available information to recognize losses on loans, changes in economic conditions may necessitate revisions in the future.  In addition, various regulatory agencies, as an integral part of their examination process, periodically review the Company’s allowance for loan losses.  Such agencies may require the Company to recognize adjustments to the allowance based on their judgment of information available to them at the time of their examination.

Another material estimate is the calculation of fair values of the Company’s investment securities.  Fair values of investment securities are determined by pricing provided by a third-party vendor, who is a provider of financial market data, analytics and related services to financial institutions.  Based on experience, management is aware that estimated fair values of investment securities tend to vary among valuation services.  Accordingly, when selling investment securities, price quotes may be obtained from more than one source.  All of the Company’s debt securities are classified as available-for-sale (AFS).  AFS debt securities are carried at fair value on the

10

consolidated balance sheets, with unrealized gains and losses, net of income tax, reported separately within shareholders’ equity as a component of accumulated other comprehensive income (AOCI). 

The fair value of residential mortgage loans, classified as held-for-sale (HFS), is obtained from the Federal National Mortgage Association (FNMA) or the Federal Home Loan Bank (FHLB).  Generally, the market to which the Company sells residential mortgages it originates for sale is restricted and price quotes from other sources are not typically obtained.  On occasion, the Company may transfer loans from the loan portfolio to loans HFS.  Under these circumstances, pricing may be obtained from other entities and the residential mortgage loans are transferred at the lower of cost or market value and simultaneously sold.  For other loans transferred to HFS, pricing may be obtained from other entities or modeled and the other loans are transferred at the lower of cost or market value and then sold.  As of September 30, 2018 and December 31, 2017, loans classified as HFS consisted of residential mortgage loans.

Financing of automobiles, provided to customers under lease arrangements of varying terms, are accounted for as direct finance leases.  Interest income on automobile direct finance leasing is determined using the interest method to arrive at a level effective yield over the life of the lease.

Foreclosed assets held-for-sale includes other real estate acquired through foreclosure (ORE) and may, from time-to-time, include repossessed assets such as automobiles.  ORE is carried at the lower of cost (principal balance at date of foreclosure) or fair value less estimated cost to sell.  Any write-downs at the date of foreclosure are charged to the allowance for loan losses.  Expenses incurred to maintain ORE properties, subsequent write downs to the asset’s fair value, any rental income received and gains or losses on disposal are included as components of other real estate owned expense in the consolidated statements of income.   

Goodwill is recorded on the consolidated balance sheets as the excess of liabilities assumed over identifiable assets acquired on the acquisition date.  Goodwill is recorded at its net carrying value which represents estimated fair value.  The goodwill is deductible for tax purposes over a 15 year period.

The Company holds separate supplemental executive retirement (SERP) agreements for certain officers and an amount is credited to each participant’s SERP account monthly while they are actively employed by the bank until retirement.  A deferred tax asset is provided for the non-deductible SERP expense.  The Company also entered into separate split dollar life insurance arrangements with three executives providing post-retirement benefits and accrues monthly expense for this benefit.  The split dollar life insurance expense is not deductible for tax purposes.  Monthly expenses for the SERP and post-retirement split dollar life benefit are recorded as components of salaries and employee benefit expense on the consolidated statements of income.

For purposes of the consolidated statements of cash flows, cash and cash equivalents includes cash on hand, amounts due from banks and interest-bearing deposits with financial institutions.  Expenditures for construction in process, a component of other assets in the consolidated balance sheets, are included in acquisition of premises and equipment.

Revenue Recognition

As of January 1, 2018, the Company adopted ASU 2014-09, Revenue from Contracts with Customers (Topic 606) and all subsequent ASUs that modified Topic 606.  The Company has elected to use the modified retrospective approach with prior period financial statements unadjusted and presented with historical revenue recognition methods.  The implementation of the new standard had no material impact on the measurement or recognition of revenue; as such, a cumulative effect adjustment to opening retained earnings was not deemed necessary. 

The majority of the Company’s revenues are generated through interest earned on securities and loans, which is explicitly excluded from the scope of the guidance.  In addition, certain non-interest income streams such as fees associated with mortgage servicing rights, loan service charges, life insurance earnings, rental income and gains/losses on the sale of loans and securities are not in the scope of the new guidance.  The main types of contracts with customers that are in the scope of the new guidance are:

· Service charges on deposit accounts – Deposit service charges represent fees charged by the Company for the performance obligation of providing services to a customer’s deposit account.  The transaction price for deposit services includes both fixed and variable amounts based on the Company’s fee schedules.  Revenue is recognized and payment is received either at a point in time for transactional fees or on a monthly basis for non-transactional fees.

· Interchange fees – Interchange fees represent fees charged by the Company for customers using debit cards.  The contract is between the Company and the processor and the performance obligation is the ability of customers to use debit cards to make purchases at a point in time.  The transaction price is a percentage of debit card usage and the processor pays the Company and revenue is recorded throughout the month as the performance obligations are being met.

· Fees from trust fiduciary activities – Trust fees represent fees charged by the Company for the management, custody and/or administration of trusts.  These are mostly monthly fees based on the market value of assets in the trust account at the prior month end.  Payment is generally received a few weeks after month end through a direct charge to customers’ accounts.  Estate fees are recognized and charged as the Company reaches each of six different stages of the estate administration process. 

11

· Fees from financial services – Financial service fees represent fees charged by the Company for the performance obligation of providing various services for an investment account.  Revenue is recognized twice monthly for fees on sales transactions and on a monthly basis for advisory fees and quarterly for trail fees.

· Gain/loss on ORE sales – Gain/loss on the sale of ORE is recognized at the closing date when the sales proceeds are received.  In seller-financed ORE transactions, the contract is made subject to our normal underwriting standards and pricing.  The Company does not have any obligation or right to repurchase any sales of ORE.

Contract balances

A contract asset balance occurs when an entity performs a service for a customer before the customer pays consideration (resulting in a contract receivable) or before the payment is due (resulting in a contract asset).  A contract liability balance is an entity’s obligation to transfer a service to a customer for which the entity already received payment (or payment is due) from the customer.  The Company’s non-interest income streams are largely based on transactional activity, or standard month-end revenue accruals such as asset management fees based on month-end market values.  Consideration is often received immediately or shortly after the Company satisfies its performance obligation and revenue is recognized.  The Company typically does not enter into long-term revenue contracts with customers, and therefore, does not experience significant contract balances.  As of September 30, 2018 and December 31, 2017, the Company did not have any significant contract balances.

Remaining performance obligations

The Company’s performance obligations have an original expected duration of less than one year and follow the relevant guidance for recognizing revenue over time.  There is no variable consideration subject to constraint that is not included in information about transaction price.

Contract acquisition costs

In connection with the adoption of Topic 606, an entity is required to capitalize and subsequently amortize into expense, certain incremental costs of obtaining a contract if these costs are expected to be recovered.  The incremental costs of obtaining a contract are those costs that an entity incurs to obtain a contract with a customer that it would not have incurred if the contract had not been obtained (for example, sales commission).  The Company utilizes the practical expedient which allows entities to immediately expense contract acquisition costs when the asset that would have resulted from capitalizing these costs would have been amortized in one year or less.  Upon adoption of Topic 606, the Company did not capitalize any contract acquisition costs.

2.  New accounting pronouncements

In June 2016, the Financial Accounting Standards Board (FASB) issued Accounting Standard Update (ASU) 2016-13, Financial Instruments – Credit Losses (Topic 326) Measurement of Credit Losses on Financial Instruments.  The amendments in this update require financial assets measured at amortized cost basis to be presented at the net amount expected to be collected, through an allowance for credit losses that is deducted from the amortized cost basis.  Previously, when credit losses were measured under GAAP, an entity only considered past events and current conditions when measuring the incurred loss.  The amendments in this update broaden the information that an entity must consider in developing its expected credit loss estimate for assets measured either collectively or individually.  The measurement of expected credit losses is based on relevant information about past events, including historical experience, current conditions, and reasonable and supportable forecasts that affect the collectability of the reported amount.  An entity must use judgement in determining the relevant information and estimation methods that are appropriate under the circumstances.  The amendments in this update also require that credit losses on available-for-sale debt securities be presented as an allowance for credit losses rather than a writedown.  The amendments in this update are effective for fiscal years, including interim periods within those fiscal years, beginning after December 15, 2019 for public companies.  Early adoption is permitted beginning after December 15, 2018, including interim periods within those fiscal years.  An entity will apply the amendments in this update through a cumulative-effect adjustment to retained earnings as of the beginning of the period of adoption (modified-retrospective approach).  Upon adoption, the change in this accounting guidance could result in an increase in the Company's allowance for loan losses and require the Company to record loan losses more rapidly.  The Company is currently evaluating the impact of ASU 2016-13 on its consolidated financial statements.

In May 2014, the FASB issued ASU 2014-09, Revenue from Contracts with Customers, which supersedes nearly all existing revenue recognition guidance under U.S. GAAP.  The core principle of ASU 2014-09 is to recognize revenues when promised goods or services are transferred to customers in an amount that reflects the consideration to which an entity expects to be entitled for those goods or services.  ASU 2014-09 defines a five step process to achieve this core principle and, in doing so, more judgment and estimates may be required within the revenue recognition process than are required under existing U.S. GAAP:  identify the contract(s) with a customer; identify the performance obligations in the contract; determine the transaction price; allocate the transaction price to the performance obligations in the contract; recognize revenue when (or as) the entity satisfies a performance obligation. 

The Company adopted this guidance on January 1, 2018 using the modified retrospective approach.  The adoption of ASU 2014-09 did not materially change the method in which the Company recognizes revenue.  As a result, the Company changed the process for recognizing revenue for estate fees within fees from trust fiduciary services.  The Company concluded the cumulative adjustment to

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retained earnings for estates in process was immaterial and the income was recognized during the first quarter of 2018.  See “Revenue Recognition” in footnote 1 for more information.

In January 2016, the FASB issued ASU 2016-01 related to Financial Instruments - Overall (Subtopic 825-10) Recognition and Measurement of Financial Assets and Financial Liabilities.  The update applies to all entities that hold financial assets or owe financial liabilities.  The amendments in this update make targeted improvements to U.S. GAAP as follows:

· Require equity investments to be measured at fair value with changes in fair value recognized in net income;

· Simplify the impairment assessment of equity investments without readily determinable fair values by requiring a qualitative assessment to identify impairment;

· Require public business entities to use the exit price notion when measuring 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;

· Clarify that an entity should evaluate the need for a valuation allowance on a deferred tax asset related to available-for-sale securities.

The Company adopted this guidance on January 1, 2018.  The adoption did not have a material impact on the consolidated financial statements.  As a result of this guidance, the Company reclassified $0.4 million in net unrealized gains on equity securities from accumulated other comprehensive income to retained earnings on January 1, 2018 and the Company measured the fair value of its loan portfolio using the exit price notion.  See “Fair Value Measurements” in footnote 8 for more information about the fair value measurement of the loan portfolio.

In February 2016, the FASB issued ASU 2016-02, Leases (Topic 842) to increase transparency and comparability among organizations by recognizing lease assets and lease liabilities on the balance sheet and disclosing key information about leasing arrangements.  ASU 2016-02 requires the recognition of a right-of-use asset and related lease liability by lessees for leases classified as operating leases under GAAP.  The Company is expected to make an election to exclude leases less than 12 months from the provisions of this ASU.  The amendments in this update are effective for the Company for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years.  Early adoption of the amendments in this update is permitted.  A modified retroactive approach must be applied for leases existing at, or entered into after, the beginning of the earliest comparative period.  The Company has several lease agreements, such as branch locations, which are currently considered operating leases, and therefore not recognized on the Company’s consolidated balance sheets.  Therefore, the adoption of ASU 2016-02 is expected to impact the Company’s consolidated balance sheets, along with our regulatory capital ratios.  Upon adoption, this change in accounting guidance could also potentially impact debt covenant agreements with our customers.  The Company estimated approximately $8 million will be added to the consolidated balance sheets as a right-of-use-asset and lease liability.  As we finalize our assessment, this amount may change.  There is not expected to be any significant effect on the consolidated statements of income.

In July 2018, the FASB issued ASU 2018-10, Codification Improvements to Topic 842, Leases and ASU 2018-11, Leases (Topic 842) Targeted Improvements to clarify how to apply certain aspects of ASU 2016-02 and to simplify adoption and reduce costs.  ASU 2018-11 allows companies the option to apply the provisions of the new lease standard prospectively as of the effective date, without adjusting comparative periods, and recognizes a cumulative-effect adjustment to the opening balance of retained earnings in the period of adoption.  The Company anticipates using this additional transition method.  The amendments in this update are effective upon adoption of Topic 842.

In August 2016, the FASB released ASU 2016-15, Statement of Cash Flows (Topic 230) to clarify the presentation of certain cash receipts and payments on the statement of cash flows.  The update addressed eight specific cash flow issues with the objective of reducing the existing diversity in practice.  The amendments in this update are effective for public business entities for fiscal years beginning after December 15, 2017, and interim periods within those fiscal years.  Early adoption is permitted, including adoption in an interim period.  The amendments in this update should be applied using a retrospective transition method to each period presented.  The Company adopted ASU 2016-15 on January 1, 2018 and it did not have a significant impact on the Company’s consolidated financial statements.

In January 2017, the FASB issued ASU 2017-04, Intangibles-Goodwill and Other (Topic 350) to simplify the test for goodwill impairment.  To simplify the subsequent measurement of goodwill, the FASB eliminated Step 2 from the goodwill impairment test.  Under the amendments in this update, an entity should perform its annual goodwill impairment test by comparing the fair value of a reporting unit with its carrying amount.  An entity should recognize an impairment charge for the amount by which the carrying amount exceeds the reporting units fair value; however, the loss recognized should not exceed the total amount of goodwill allocated to that reporting unit.  An entity should apply the amendments in his update on a prospective basis.  The amendments in this update are effective for the Company for its annual goodwill impairment tests in fiscal years beginning after December 15, 2019.  Early adoption is permitted for interim or annual goodwill impairment tests performed on testing dates after January 1, 2017.  The Company adopted this standard in 2017 and it did not have an impact on its consolidated financial statements.  The Company did not have any goodwill prior to adoption of this update.

In March 2017, the FASB issued ASU 2017-08, Receivables-Nonrefundable Fees and Other Costs (Subtopic 310-20) Premium Amortization on Purchased Callable Debt Securities to amend the amortization period for certain purchased callable debt securities held at a premium.  The amendments in this update shorten the amortization period for the premium to the earliest call date.  The

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amendments in this update are effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2018.  Early adoption is permitted, including adoption in an interim period.  An entity should apply the amendments in this update on a modified retrospective basis through a cumulative effect adjustment directly to retained earnings as of the beginning of the period of adoption.  The Company adopted this standard in 2017 and it did not have an effect on its consolidated financial statements.

In February 2018, the FASB released ASU 2018-02, Income Statement – Reporting Comprehensive Income (Topic 220) to allow a reclassification from accumulated other comprehensive income to retained earnings for stranded tax effects resulting from the Tax Act.  The amendments in this update also require certain disclosures about stranded tax effects. The guidance is effective for all entities for fiscal years beginning after December 15, 2018, and interim periods within those fiscal years.  Early adoption is permitted for periods for which financial statements have not yet been issued or available for issuance, including in the period the Act was enacted.  The Company elected to early adopt and reclassify the stranded income tax effects of the Act from accumulated other comprehensive income to retained earnings during the fourth quarter of 2017.  The reclassification increased AOCI and decreased retained earnings by $0.3 million, with zero net effect on total shareholders’ equity.

3.  Accumulated other comprehensive income

The following tables illustrate the changes in accumulated other comprehensive income by component and the details about the components of accumulated other comprehensive income as of and for the periods indicated:

As of and for the nine months ended September 30, 2018
	Unrealized gains
	(losses) on
	available-for-sale
(dollars in thousands)	debt securities
Beginning balance	$	1,804
Other comprehensive loss before reclassifications, net of tax		(3,918)
Amounts reclassified from accumulated other comprehensive income, net of tax		(8)
Effect of adopting ASU 2016-01, net of tax*		(421)
Net current-period other comprehensive loss		(4,347)
Ending balance	$	(2,543)

*The Company adopted ASU 2016-01 on January 1, 2018.  As a result, unrealized gains on equity securities were reclassified from accumulated other comprehensive income to retained earnings.

As of and for the three months ended September 30, 2018
	Unrealized gains
	(losses) on
	available-for-sale
(dollars in thousands)	debt securities
Beginning balance	$	(1,283)
Other comprehensive loss before reclassifications, net of tax