10-Q 1 form10q.htm 10-Q  
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-Q
(Mark One)
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 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: 000-12896

OLD POINT FINANCIAL CORPORATION
(Exact name of registrant as specified in its charter)

VIRGINIA
54-1265373
(State or other jurisdiction of incorporation or organization)
(I.R.S. Employer Identification No.)

1 West Mellen Street, Hampton, Virginia 23663
(Address of principal executive offices) (Zip Code)

(757) 728-1200
(Registrant's telephone number, including area code)

Not Applicable
(Former name, former address and former fiscal year, if changed since last report)

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

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§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, a non-accelerated filer, smaller reporting company, or 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
   
Non-accelerated filer
(Do not check if a smaller reporting company)
Smaller reporting company
   
 
Emerging growth company

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

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes       No

Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date.

5,181,106 shares of common stock ($5.00 par value) outstanding as of July 25, 2018



OLD POINT FINANCIAL CORPORATION

FORM 10-Q

INDEX

PART I - FINANCIAL INFORMATION

   
Page
     
Item 1.
1
     
 
1
     
 
2
     
 
3
     
 
4
     
 
5
     
 
6
     
Item 2.
34
     
Item 3.
45
     
Item 4.
45
     
 
PART II - OTHER INFORMATION
 
     
Item 1.
46
     
Item 1A.
46
     
Item 2.
46
     
Item 3.
46
     
Item 4.
46
     
Item 5.
46
     
Item 6.
47
     
 
47


i


GLOSSARY OF DEFINED TERMS

ALLL
Allowance for Loan and Lease Losses
ASC
Accounting Standards Codification
ASU
Accounting Standards Update
Bank
The Old Point National Bank of Phoebus
CET1
Common Equity Tier 1
Citizens
Citizens National Bank
Company
Old Point Financial Corporation
CRA
Community Reinvestment Act
ESPP
Employee Stock Purchase Plan
EVE
Economic Value of Equity
FASB
Financial Accounting Standards Board
FHLB
Federal Home Loan Bank
FOMC
Federal Open Market Committee
Federal Reserve
Board of Governors of the Federal Reserve System
FRB
Federal Reserve Bank
GAAP
Generally Accepted Accounting Principles
Incentive Stock Plan
Old Point Financial Corporation 2016 Incentive Stock Plan
IRS
Internal Revenue Service
OAEM
Other Assets Especially Mentioned
OCC
Office of the Comptroller of the Currency
OPM
Old Point Mortgage
OREO
Other Real Estate Owned
SEC
Securities and Exchange Commission
TDR
Troubled Debt Restructuring
Trust
Old Point Trust & Financial Services N.A.
VIE
Variable Interest Entities





PART I – FINANCIAL INFORMATION

Item 1.  Financial Statements.

Old Point Financial Corporation and Subsidiaries
Consolidated Balance Sheets

   
June 30, 2018
   
December 31, 2017
 
   
(in thousands except per share data)
 
   
(unaudited)
     
*
 
Assets
             
               
Cash and due from banks
 
$
20,079
   
$
13,420
 
Interest-bearing due from banks
   
15,305
     
908
 
Federal funds sold
   
1,902
     
84
 
Cash and cash equivalents
   
37,286
     
14,412
 
Securities available-for-sale, at fair value
   
142,981
     
157,121
 
Restricted securities, at cost
   
3,869
     
3,846
 
Loans held for sale
   
849
     
779
 
Loans, net
   
766,344
     
729,092
 
Premises and equipment, net
   
37,775
     
37,197
 
Bank-owned life insurance
   
26,363
     
25,981
 
Goodwill
   
1,620
     
621
 
Other real estate owned, net
   
251
     
-
 
Core deposit intangible, net
   
429
     
-
 
Other assets
   
14,363
     
12,777
 
Total assets
 
$
1,032,130
   
$
981,826
 
                 
Liabilities & Stockholders' Equity
               
                 
Deposits:
               
Noninterest-bearing deposits
 
$
245,069
   
$
225,716
 
Savings deposits
   
360,478
     
345,053
 
Time deposits
   
234,788
     
212,825
 
Total deposits
   
840,335
     
783,594
 
Federal funds purchased
   
-
     
10,000
 
Overnight repurchase agreements
   
26,048
     
20,693
 
Federal Home Loan Bank advances
   
60,000
     
67,500
 
Other borrowings
   
2,850
     
-
 
Accrued expenses and other liabilities
   
3,604
     
3,651
 
Total liabilities
   
932,837
     
885,438
 
                 
Commitments and contingencies
               
                 
Stockholders' equity:
               
Common stock, $5 par value, 10,000,000 shares authorized; 5,181,106 and 5,019,703 shares outstanding (includes 12,083 and 2,245 shares of nonvested restricted stock, respectively)
   
25,847
     
25,087
 
Additional paid-in capital
   
20,568
     
17,270
 
Retained earnings
   
55,767
     
54,738
 
Accumulated other comprehensive loss, net
   
(2,889
)
   
(707
)
Total stockholders' equity
   
99,293
     
96,388
 
Total liabilities and stockholders' equity
 
$
1,032,130
   
$
981,826
 

See Notes to Consolidated Financial Statements.
*  Derived from audited Consolidated Financial Statements
1


Old Point Financial Corporation and Subsidiaries
Consolidated Statements of Income

   
Three Months Ended June 30,
   
Six Months Ended June 30,
 
   
2018
   
2017
   
2018
   
2017
 
   
(unaudited, in thousands except per share data)
 
Interest and Dividend Income:
                       
Interest and fees on loans
 
$
8,688
   
$
7,110
   
$
16,583
   
$
13,890
 
Interest on due from banks
   
22
     
3
     
26
     
8
 
Interest on federal funds sold
   
8
     
2
     
10
     
5
 
Interest on securities:
                               
Taxable
   
499
     
491
     
993
     
987
 
Tax-exempt
   
302
     
420
     
646
     
847
 
Dividends and interest on all other securities
   
75
     
35
     
135
     
49
 
Total interest and dividend income
   
9,594
     
8,061
     
18,393
     
15,786
 
                                 
Interest Expense:
                               
Interest on savings deposits
   
141
     
73
     
245
     
137
 
Interest on time deposits
   
698
     
520
     
1,314
     
1,039
 
Interest on federal funds purchased, securities sold under agreements to repurchase and other borrowings
   
42
     
8
     
52
     
13
 
Interest on Federal Home Loan Bank advances
   
287
     
72
     
611
     
72
 
Total interest expense
   
1,168
     
673
     
2,222
     
1,261
 
Net interest income
   
8,426
     
7,388
     
16,171
     
14,525
 
Provision for loan losses
   
575
     
1,000
     
1,100
     
1,650
 
Net interest income, after provision for loan losses
   
7,851
     
6,388
     
15,071
     
12,875
 
                                 
Noninterest Income:
                               
Fiduciary and asset management fees
   
916
     
951
     
1,899
     
1,917
 
Service charges on deposit accounts
   
1,078
     
916
     
1,948
     
1,843
 
Other service charges, commissions and fees
   
1,164
     
1,075
     
2,231
     
2,091
 
Bank-owned life insurance income
   
173
     
199
     
382
     
397
 
Mortgage banking income
   
236
     
284
     
377
     
290
 
Gain on sale of securities, net
   
40
     
87
     
120
     
87
 
Gain on acquisition of Old Point Mortgage
   
-
     
550
     
-
     
550
 
Other operating income
   
40
     
29
     
45
     
79
 
Total noninterest income
   
3,647
     
4,091
     
7,002
     
7,254
 
                                 
Noninterest Expense:
                               
Salaries and employee benefits
   
5,935
     
5,449
     
11,412
     
10,546
 
Occupancy and equipment
   
1,487
     
1,454
     
2,964
     
2,903
 
Data processing
   
596
     
441
     
1,112
     
855
 
FDIC insurance
   
186
     
98
     
377
     
194
 
Customer development
   
135
     
154
     
317
     
298
 
Professional services
   
537
     
520
     
1,025
     
893
 
Employee professional development
   
208
     
219
     
400
     
455
 
Other taxes
   
142
     
138
     
312
     
281
 
ATM and other losses
   
157
     
155
     
254
     
332
 
Loss (gain) on other real estate owned
   
86
     
(18
)
   
86
     
(18
)
Merger expenses
   
391
     
-
     
596
     
-
 
Other operating expenses
   
581
     
660
     
1,215
     
1,237
 
Total noninterest expense
   
10,441
     
9,270
     
20,070
     
17,976
 
Income before income taxes
   
1,057
     
1,209
     
2,003
     
2,153
 
Income tax expense
   
65
     
48
     
69
     
50
 
Net income
 
$
992
   
$
1,161
   
$
1,934
   
$
2,103
 
                                 
Basic earnings per share:
                               
Weighted average shares outstanding
   
5,177,233
     
4,984,151
     
5,099,088
     
4,980,728
 
Net income per share of common stock
 
$
0.19
   
$
0.23
   
$
0.38
   
$
0.42
 
                                 
Diluted earnings per share:
                               
Weighted average shares outstanding
   
5,177,233
     
4,996,880
     
5,099,124
     
4,993,916
 
Net income per share of common stock
 
$
0.19
   
$
0.23
   
$
0.38
   
$
0.42
 

See Notes to Consolidated Financial Statements.

2


Old Point Financial Corporation and Subsidiaries
Consolidated Statements of Comprehensive Income (Loss)

   
Three Months Ended
June 30,
   
Six Months Ended
June 30,
 
   
2018
   
2017
   
2018
   
2017
 
   
(unaudited, in thousands)
 
Net income
 
$
992
   
$
1,161
   
$
1,934
   
$
2,103
 
Other comprehensive income (loss), net of tax
                               
Net unrealized gain (loss) on available-for-sale securities
   
(120
)
   
1,093
     
(1,871
)
   
1,521
 
Reclassification for gain included in net income
   
(32
)
   
(57
)
   
(95
)
   
(57
)
Other comprehensive income (loss), net of tax
   
(152
)
   
1,036
     
(1,966
)
   
1,464
 
Comprehensive income (loss)
 
$
840
   
$
2,197
   
$
(32
)
 
$
3,567
 

See Notes to Consolidated Financial Statements.

3


Old Point Financial Corporation and Subsidiaries
Consolidated Statements of Changes in Stockholders' Equity

   
Shares of
Common
Stock
   
Common
Stock
   
Additional
Paid-in
Capital
   
Retained
Earnings
   
Accumulated
Other
Comprehensive
Loss
   
Total
 
   
(unaudited, in thousands except share and per share data)
 
SIX MONTHS ENDED JUNE 30, 2018
                         
                                     
Balance at beginning of period
   
5,017,458
   
$
25,087
   
$
17,270
   
$
54,738
   
$
(707
)
 
$
96,388
 
Net income
   
-
     
-
     
-
     
1,934
     
-
     
1,934
 
Other comprehensive loss, net of tax
   
-
     
-
     
-
     
-
     
(1,966
)
   
(1,966
)
Issuance of common stock related to acquisition
   
149,625
     
750
     
3,207
     
-
     
-
     
3,957
 
Reclassification of the stranded income tax effects of the Tax Cuts and Jobs Act from AOCI
   
-
     
-
     
-
     
139
     
(139
)
   
-
 
Reclassification of net unrealized gains on equity securities from AOCI per ASU 2016-01
   
-
     
-
     
-
     
77
     
(77
)
   
-
 
Employee Stock Purchase Plan share issuance
   
1,940
     
10
     
38
     
-
     
-
     
48
 
Stock-based compensation expense
   
-
     
-
     
53
     
-
     
-
     
53
 
Cash dividends ($0.22 per share)
   
-
     
-
     
-
     
(1,121
)
   
-
     
(1,121
)
                                                 
Balance at end of period
   
5,169,023
   
$
25,847
   
$
20,568
   
$
55,767
   
$
(2,889
)
 
$
99,293
 
                                   
                                   
SIX MONTHS ENDED JUNE 30, 2017
                                 
                                                 
Balance at beginning of period
   
4,961,258
   
$
24,806
   
$
16,427
   
$
56,965
   
$
(4,208
)
 
$
93,990
 
Net income
   
-
     
-
     
-
     
2,103
     
-
     
2,103
 
Other comprehensive income, net of tax
   
-
     
-
     
-
     
-
     
1,464
     
1,464
 
Exercise of stock options
   
24,806
     
124
     
373
     
-
     
-
     
497
 
Employee Stock Purchase Plan share issuance
   
1,687
     
9
     
38
     
-
     
-
     
47
 
Repurchase and retirement of common stock
   
(3,600
)
   
(18
)
   
(80
)
   
-
     
-
     
(98
)
Cash dividends ($0.22 per share)
   
-
     
-
     
-
     
(1,095
)
   
-
     
(1,095
)
                                                 
Balance at end of period
   
4,984,151
   
$
24,921
   
$
16,758
   
$
57,973
   
$
(2,744
)
 
$
96,908
 

See Notes to Consolidated Financial Statements.
4


Old Point Financial Corporation and Subsidiaries
Consolidated Statements of Cash Flows

   
Six Months Ended June 30,
 
   
2018
   
2017
 
   
(unaudited, dollars in thousands)
 
CASH FLOWS FROM OPERATING ACTIVITIES
           
Net income
 
$
1,934
   
$
2,103
 
Adjustments to reconcile net income to net cash provided by operating activities:
               
Depreciation and amortization
   
1,250
     
1,394
 
Accretion related to acquisition, net
   
(121
)
   
-
 
Provision for loan losses
   
1,100
     
1,650
 
Gain on sale of securities, net
   
(120
)
   
(87
)
Net amortization of securities
   
928
     
1,178
 
Increase in loans held for sale, net
   
(70
)
   
(1,600
)
Net loss on disposal of premises and equipment
   
9
     
4
 
Net (gain) loss on write-down/sale of other real estate owned
   
86
     
(18
)
Income from bank owned life insurance
   
(382
)
   
(397
)
Stock compensation expense
   
53
     
-
 
Deferred tax benefit
   
-
 
   
(352
)
(Increase) decrease in other assets
   
(41
   
335
 
Decrease in accrued expenses and other liabilities
   
(371
)
   
(560
)
Net cash provided by operating activities
   
4,255
     
3,650
 
                 
CASH FLOWS FROM INVESTING ACTIVITIES
               
Purchases of available-for-sale securities
   
(9,815
)
   
(22,899
)
Proceeds from redemption (cash used in purchases) of restricted securities, net
   
254
     
(2,132
)
Proceeds from maturities and calls of available-for-sale securities
   
6,470
     
44,555
 
Proceeds from sales of available-for-sale securities
   
11,039
     
6,480
 
Paydowns on available-for-sale securities
   
5,014
     
4,770
 
Proceeds from sale of loans held for investment
   
8,746
     
-
 
Net increase in loans held for investment
   
(4,417
)
   
(77,092
)
Proceeds from sales of other real estate owned
   
93
     
1,084
 
Purchases of premises and equipment
   
(317
)
   
(444
)
Cash paid in acquisition
   
(3,164
)
   
-
 
Cash acquired in acquisition
   
2,304
     
-
 
Net cash provided by (used in) investing activities
   
16,207
     
(45,678
)
                 
CASH FLOWS FROM FINANCING ACTIVITIES
               
Increase (decrease) in noninterest-bearing deposits
   
13,040
     
(3,856
)
Increase in savings deposits
   
8,050
     
3,771
 
Decrease in time deposits
   
(8,310
)
   
(7,237
)
Increase (decrease) in federal funds purchased, repurchase agreements and other borrowings, net
   
(1,795
)
   
4,517
 
Increase in Federal Home Loan Bank advances
   
78,000
     
80,000
 
Repayment of Federal Home Loan Bank advances
   
(85,500
)
   
(30,000
)
Proceeds from exercise of stock options and ESPP issuance
   
48
     
544
 
Repurchase and retirement of common stock
   
-
     
(98
)
Cash dividends paid on common stock
   
(1,121
)
   
(1,095
)
Net cash provided by financing activities
   
2,412
     
46,546
 
                 
Net increase in cash and cash equivalents
   
22,874
     
4,518
 
Cash and cash equivalents at beginning of period
   
14,412
     
25,854
 
Cash and cash equivalents at end of period
 
$
37,286
   
$
30,372
 
                 
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION
               
Cash payments for:
               
Interest
 
$
2,128
   
$
1,236
 
                 
SUPPLEMENTAL SCHEDULE OF NONCASH TRANSACTIONS
               
Unrealized gain (loss) on securities available-for-sale
 
$
(2,585
)
 
$
2,218
 
Loans transferred to other real estate owned
 
$
203
   
$
-
 
                 
TRANSACTIONS RELATED TO ACQUISITIONS
               
Assets acquired
 
$
50,446
   
$
-
 
Liabilities assumed
 
$
44,324
   
$
-
 
Common stock issued in acquisition
 
$
3,957
   
$
-
 

See Notes to Consolidated Financial Statements.
5



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

Note 1. Accounting Policies

The accompanying unaudited consolidated financial statements of Old Point Financial Corporation (NASDAQ: OPOF) (the Company) and its subsidiaries have been prepared in accordance with U.S. GAAP for interim financial information. All significant intercompany balances and transactions have been eliminated. In the opinion of management, the accompanying unaudited consolidated financial statements contain all adjustments and reclassifications of a normal and recurring nature considered necessary to present fairly the financial position at June 30, 2018 and December 31, 2017, the statements of income and comprehensive income for the three and six months ended June 30, 2018 and 2017, and the statements of changes in stockholders' equity and cash flows for the six months ended June 30, 2018 and 2017. The results of operations for the interim periods are not necessarily indicative of the results that may be expected for the full year.

These consolidated financial statements should be read in conjunction with the consolidated financial statements and notes thereto included in the Company's 2017 annual report on Form 10-K. Certain previously reported amounts have been reclassified to conform to current period presentation, none of which were material in nature.

PRINCIPLES OF CONSOLIDATION

The consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries, The Old Point National Bank of Phoebus (the Bank) and Old Point Trust & Financial Services N.A. (Trust). All significant intercompany balances and transactions have been eliminated in consolidation.

BUSINESS COMBINATIONS

On April 1, 2018, the Company completed its acquisition of Citizens National Bank (Citizens) based in Windsor, Virginia for a purchase price of approximately $7.1 million. Under the terms of the merger agreement, Citizens common stockholders received 0.1041 shares of the Company's common stock and $2.19 in cash for each share of Citizens common stock, resulting in the Company issuing 149,625 shares of the Company's common stock.

In connection with the acquisition, the Company recorded $999 thousand in goodwill and $440 thousand of amortizable assets, which relate to core deposit intangibles. The transaction was accounted for using the acquisition method of accounting and, accordingly, assets acquired, liabilities assumed, and consideration exchanged were recorded at estimated fair values on the acquisition date. Fair values are preliminary and subject to refinement for up to one year after the closing date of the acquisition.

NATURE OF OPERATIONS

Old Point Financial Corporation is a holding company that conducts substantially all of its operations through two subsidiaries, the Bank and Trust. The Bank serves individual and commercial customers, the majority of which are in Hampton Roads, Virginia. As of June 30, 2018, the Bank had 19 branch offices. The Bank offers a full range of deposit and loan products to its retail and commercial customers, including mortgage loan products offered through its Old Point Mortgage (OPM) division. A full array of insurance products is also offered through Old Point Insurance, LLC in partnership with Morgan Marrow Company. Trust offers a full range of services for individuals and businesses. Products and services include retirement planning, estate planning, financial planning, estate and trust administration, retirement plan administration, tax services and investment management services.


RECENT ACCOUNTING PRONOUNCEMENTS

In February 2016, the FASB issued ASU No. 2016-02, "Leases (Topic 842)." Among other things, in the amendments in ASU 2016-02, lessees will be required to recognize the following for all leases (with the exception of short-term leases) at the commencement date: (1) A lease liability, which is a lessee's obligation to make lease payments arising from a lease, measured on a discounted basis; and (2) A right-of-use asset, which is an asset that represents the lessee's right to use, or control the use of, a specified asset for the lease term. Under the new guidance, lessor accounting is largely unchanged. Certain targeted improvements were made to align, where necessary, lessor accounting with the lessee accounting model and Topic 606, Revenue from Contracts with Customers. The amendments in this ASU are effective for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. Early application is permitted upon issuance. Lessees (for capital and operating leases) and lessors (for sales-type, direct financing, and operating leases) must apply a modified retrospective transition approach for leases existing at, or entered into after, the beginning of the earliest comparative period presented in the financial statements. The modified retrospective approach would not require any transition accounting for leases that expired before the earliest comparative period presented. Lessees and lessors may not apply a full retrospective transition approach. The Company is currently assessing the impact that ASU 2016-02 will have on its consolidated financial statements. As the Company owns the majority of its buildings, management does not anticipate that the ASU will have a material impact.

In June 2016, the FASB issued ASU No. 2016-13, "Financial Instruments—Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments." The amendments in this ASU, among other things, require the measurement of all expected credit losses for financial assets held at the reporting date based on historical experience, current conditions, and reasonable and supportable forecasts. Financial institutions and other organizations will now use forward-looking information to better inform their credit loss estimates. Many of the loss estimation techniques applied today will still be permitted, although the inputs to those techniques will change to reflect the full amount of expected credit losses. In addition, the ASU amends the accounting for credit losses on available-for-sale debt securities and purchased financial assets with credit deterioration. The amendments in this ASU are effective for Securities and Exchange Commission (SEC) filers for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2019. The Company is currently assessing the impact that ASU 2016-13 will have on its consolidated financial statements and has formed a committee to oversee the adoption of the new standard. The ALLL model currently in use by the Company already provides it with the ability to archive prior period information and contains loan balance and charge-off information beginning with September 30, 2011. The committee has reviewed the data included in each monthly archive file and has added fields to enhance its data analysis capabilities under the new standard.

6

In January 2017, the FASB issued ASU No. 2017-04, "Intangibles—Goodwill and Other (Topic 350): Simplifying the Test for Goodwill Impairment." The amendments in this ASU simplify how an entity is required to test goodwill for impairment by eliminating Step 2 from the goodwill impairment test. Step 2 measures a goodwill impairment loss by comparing the implied fair value of a reporting unit's goodwill with the carrying amount of that goodwill. Instead, under the amendments in this ASU, an entity should perform its annual, or interim, goodwill impairment test by comparing the fair value of a reporting unit with its carrying amount. An entity still has the option to perform the qualitative assessment for a reporting unit to determine if the quantitative impairment test is necessary. Public business entities that are SEC filers should adopt the amendments in this ASU for annual or interim 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 does not expect the adoption of ASU 2017-04 to have a material impact on its consolidated financial statements.

During March 2017, the FASB issued ASU No. 201708, "Receivables—Nonrefundable Fees and Other Costs (Subtopic 31020), Premium Amortization on Purchased Callable Debt Securities." The amendments in this ASU shorten the amortization period for certain callable debt securities purchased at a premium. Upon adoption of the standard, premiums on these qualifying callable debt securities will be amortized to the earliest call date. Discounts on purchased debt securities will continue to be accreted to maturity. The amendments are effective for fiscal years beginning after December 15, 2018, and interim periods within those fiscal years. Early adoption is permitted, including adoption in an interim period. Upon transition, entities should apply the guidance on a modified retrospective basis, with a cumulative-effect adjustment to retained earnings as of the beginning of the period of adoption and provide the disclosures required for a change in accounting principle. The Company is currently assessing the impact that ASU 201708 will have on its consolidated financial statements.

In August 2017, the FASB issued ASU 2017-12, "Derivatives and Hedging (Topic 815): Targeted Improvements to Accounting for Hedging Activities."  The amendments in this ASU modify the designation and measurement guidance for hedge accounting as well as provide for increased transparency regarding the presentation of economic results on both the financial statements and related footnotes.  Certain aspects of hedge effectiveness assessments will also be simplified upon implementation of this update.   The amendments are effective for annual periods, including interim periods within those annual periods, beginning after December 15, 2018.  Early adoption is permitted, including adoption in any interim period.  The Company does not expect the adoption of ASU 2017-12 to have a material impact on its consolidated financial statements.
 
In February 2018, the FASB issued ASU 2018-03, "Technical Corrections and Improvements to Financial Instruments-Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities."  The amendments provide targeted improvements to address certain aspects of recognition, measurement, presentation, and disclosure of financial instruments. Specifically, the amendments include clarifications related to:  measurement elections, transition requirements, and adjustments associated with equity securities without readily determinable fair values; fair value measurement requirements for forward contracts and purchased options on equity securities; presentation requirements for hybrid financial liabilities for which the fair value option has been elected; and measurement requirements for liabilities denominated in a foreign currency for which the fair value option has been elected. The amendments are effective for fiscal years beginning after December 15, 2017, and interim periods within those fiscal years beginning after June 15, 2018.  Early adoption is permitted. The Company does not expect the adoption of ASU 2018-03 to have a material impact on its consolidated financial statements.

In June 2018, the FASB issued ASU 2018-07, "Compensation- Stock Compensation (Topic 718): Improvements to Nonemployee Share-Based Payment Accounting." The amendments expand the scope of Topic 718 to include share-based payments issued to non-employees for goods or services, which were previously excluded. The amendments will align the accounting for share-based payments to non-employees and employees more similarly. The amendments are effective for fiscal years beginning after December 15, 2018, and interim periods within those fiscal years. Early adoption is permitted. The Company does not expect the adoption of ASU 2018-07 to have a material impact on its consolidated financial statements.

ACCOUNTING STANDARDS ADOPTED IN 2018

In January 2016, the FASB issued ASU No. 2016-01, "Financial Instruments - Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities." This ASU requires an entity to, among other things: (i) measure equity investments at fair value through net income, with certain exceptions; (ii) present in OCI the changes in instrument-specific credit risk for financial liabilities measured using the fair value option; (iii) present financial assets and financial liabilities by measurement category and form of financial asset; (iv) calculate the fair value of financial instruments for disclosure purposes based on an exit price and; (v) assess a valuation allowance on deferred tax assets related to unrealized losses of AFS debt securities in combination with other deferred tax assets. The ASU provides an election to subsequently measure certain nonmarketable equity investments at cost less any impairment and adjusted for certain observable price changes. The ASU also requires a qualitative impairment assessment of such equity investments and amends certain fair value disclosure requirements. This ASU is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2017. The Company adopted ASU No. 2016-01 on January 1, 2018, and during the first quarter of 2018, measured its equity investments at fair value through net income and reclassified $77 thousand of AOCI to retained earnings, with no effect on total stockholders' equity. During the second quarter of 2018, the Company sold the equity investments, recognizing an additional gain on sale of $24 thousand, net of tax. The Company also measured the fair value of its loan portfolio and time deposits at June 30, 2018 using an exit price notion (see Note 9. Fair Value Measurements).

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." The amendments provide financial statement preparers with an option to reclassify stranded tax effects within accumulated other comprehensive income (AOCI) to retained earnings in each period in which the effect of the change in the U.S. federal corporate income tax rate in the Tax Cuts and Jobs Act (or portion thereof) is recorded.  The amendments are effective for all organizations for fiscal years beginning after December 15, 2018, and interim periods within those fiscal years.  Early adoption is permitted. Organizations should apply the proposed amendments either in the period of adoption or retrospectively to each period (or periods) in which the effect of the change in the U.S. federal corporate income tax rate in the Tax Cuts and Jobs Act is recognized. The Company has elected to reclassify the stranded income tax effects from the Tax Cuts and Jobs Act in the consolidated financial statements for the period ending March 31, 2018. The reclassification decreased AOCI and increased retained earnings by $139 thousand, with no effect on total stockholders' equity.

7

On January 1, 2018 the Company adopted ASU 2014-09 "Revenue from Contracts with Customers" and all subsequent amendments to the ASU (collectively, "ASC 606"). The majority of the Company's revenues are associated with financial instruments, including loans and securities, to which ASC 606 does not apply. ASC 606 is applicable to certain noninterest revenues including services charges on deposit accounts, interchange fees, merchant services income, trust and asset management income, and the sale of other real estate owned. However, the recognition of these revenue streams did not change upon adoption of ASC 606. Substantially all of the Company's revenue is generated from contracts with customers. Noninterest revenue streams in-scope of ASC 606 are discussed below.
 
Fiduciary and Asset Management Fees

Fiduciary and asset management income is primarily comprised of fees earned from the management and administration of trusts and other customer assets. The Company's performance obligation is generally satisfied over time and the resulting fees are recognized monthly, based upon the applicable fee schedule or contract terms. Payment is generally received immediately or in the following month. The Company does not earn performance-based incentives. Additional services such as tax return preparation services are transactional-based, and the performance obligation is generally satisfied, and related revenue recognized, as incurred. Payment is received shortly after services are rendered.

Service Charges on Deposit Accounts

Service charges on deposit accounts consist of account analysis fees (i.e., net fees earned on analyzed business and public checking accounts), monthly service fees, and other deposit account related fees. The Company's performance obligation for account analysis fees and monthly service fees is generally satisfied, and the related revenue recognized, over the period in which the service is provided. Other deposit account related fees are largely transactional based, and therefore, the Company's performance obligation is satisfied, and related revenue recognized, at a point in time. Payment for service charges on deposit accounts is primarily received immediately or in the following month through a direct charge to customers' accounts.

Other Service Charges, Commissions and Fees

Other service charges, commissions and fees are primarily comprised of debit card income, ATM fees, merchant services income, investment services income, and other service charges. Debit card income is primarily comprised of interchange fees earned whenever the Company's debit and credit cards are processed through card payment networks. ATM fees are primarily generated when a Company cardholder uses a non-Company ATM or a non-Company cardholder uses a Company ATM. Merchant services income mainly represents fees charged to merchants to process their debit and credit card transactions, in addition to account management fees. Investment services income relates to commissions earned on brokered trades of investment securities. Other service charges include revenue from processing wire transfers, safe deposit box rentals, cashier's checks, and other services. The Company's performance obligation for other service charges, commission and fees are largely satisfied, and related revenue recognized, when the services are rendered or upon completion. Payment is typically received immediately or in the following month.

Other Operating Income

Other operating income mainly consists of check sales to customers and fees charged for the early redemption of time deposits. Other operating income is largely transactional based, and therefore, the Company's performance obligation is satisfied, and related revenue recognized, at a point in time. Payment is generally received immediately.

8

Note 2. Acquisitions

On April 1, 2018, the Company completed its acquisition of Citizens. Under the terms of the merger agreement, Citizens shareholders received 0.1041 shares of the Company's common stock and $2.19 in cash for each share of Citizens common stock, resulting in the Company issuing 149,625 shares of the Company's common stock at a fair value of $4.0 million, for a total purchase price of $7.1 million. Citizens is operating as a division of the Bank.

The transaction was accounted for using the acquisition method of accounting and, accordingly, assets acquired, liabilities assumed, and consideration exchanged were recorded at estimated fair values on the acquisition date. Fair values are preliminary and subject to refinement for up to one year after the closing date of the acquisition, in accordance with ASC 350, Intangibles-Goodwill and Other. The following table provides a preliminary assessment of the consideration transferred, assets acquired, and liabilities assumed as of the date of the acquisition (dollars in thousands):

   
As Recorded by Citizens
   
Fair Value Adjustments
   
As Recorded by the Company
 
Consideration paid:
                 
Cash
             
$
3,164
 
Company common stock
               
3,957
 
Total purchase price
               
7,121
 
                     
Identifiable assets acquired:
                   
Cash and cash equivalents
 
$
2,304
   
$
-
   
$
2,304
 
Securities available for sale
   
1,959
     
-
     
1,959
 
Restricted securities, at cost
   
278
     
-
     
278
 
Loans, net
   
42,824
     
(34
)
   
42,790
 
Premises and equipment
   
1,070
     
450
     
1,520
 
Other real estate owned
   
237
     
(11
)
   
226
 
Core deposit intangibles
   
-
     
440
     
440
 
Other assets
   
1,055
     
(126
)
   
929
 
Total assets
 
$
49,727
   
$
719
   
$
50,446
 
                         
Identifiable liabilities assumed:
                       
Deposits
 
$
43,754
   
$
246
   
$
44,000
 
Other liabilities
   
324
     
-
     
324
 
Total liabilities
 
$
44,078
   
$
246
   
$
44,324
 
                         
Net assets acquired
                 
$
6,122
 
Preliminary goodwill
                 
$
999
 

Goodwill and intangible assets acquired in a purchase business combination and determined to have an indefinite useful life are not amortized, but tested for impairment at least annually or more frequently if events and circumstances exists that indicate that a goodwill impairment test should be performed.  Purchased intangible assets subject to amortization, such as the core deposit intangible asset, are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Recoverability of assets to be held and used is measured by a comparison of the carrying amount of an asset to estimated undiscounted future cash flows expected to be generated by the asset. If the carrying amount of an asset exceeds its estimated future cash flows, an impairment charge is recognized in the amount by which the carrying amount of the asset exceeds the fair value of the asset.

The acquired loans were recorded at fair value at the acquisition date without carryover of Citizens' allowance for loan losses. The fair value of the loans was determined using market participant assumptions in estimating the amount and timing of both principal and interest cash flows expected to be collected on the loans and then applying a market-based discount rate to those cash flows. In this regard, the acquired loans were segregated into pools based on call code with other key inputs identified such as payment structure, rate type, remaining maturity, and credit risk characteristics including risk rating groups (pass rated loans and adversely classified loans), and past due status.

The acquired loans were divided into loans with evidence of credit quality deterioration which are accounted for under ASC 310-30, Receivables - Loans and Debt Securities Acquired with Deteriorated Credit Quality, (acquired impaired) and loans that do not meet these criteria, which are accounted for under ASC 310-20, Receivables - Nonrefundable Fees and Other Costs, (acquired performing). The fair values of the acquired performing loans were $42.1 million and the fair value of the acquired impaired loans were $710 thousand.
9

The following table presents the acquired impaired loans receivable at the acquisition date (dollars in thousands):

Contractually required principal and interest payments
 
$
1,031
 
Nonaccretable difference
   
(211
)
Cash flows expected to be collected
   
820
 
Accretable difference
   
(110
)
Fair value of loans acquired impaired loans
 
$
710
 

The amortization and accretion of premiums and discounts associated with the Company's acquisition accounting adjustments related to the Citizens acquisition had the following impact on the consolidated Statements of Income during the three months ended June 30, 2018 (dollars in thousands). The acquisition occurred on April 1, 2018, therefore the first quarter of 2018 and the comparative 2017 periods had no impact.

   
Three Months Ended
 
   
June 30, 2018
 
Acquired performing loans
 
$
92
 
Acquired impaired loans
   
1
 
Certificate of deposit valuation
   
39
 
Amortization of core deposit intangible
   
(11
)
Net impact to income before taxes
 
$
121
 

Note 3. Securities

Amortized costs and fair values of securities available-for-sale as of the dates indicated are as follows:

   
Amortized
Cost
   
Gross
Unrealized
Gains
   
Gross
Unrealized
Losses
   
Fair
Value
 
   
(in thousands)
 
June 30, 2018
                       
U.S. Treasury securities
 
$
6,844
   
$
-
   
$
(26
)
 
$
6,818
 
Obligations of  U.S. Government agencies
   
11,519
     
-
     
(160
)
   
11,359
 
Obligations of state and political subdivisions
   
51,846
     
111
     
(716
)
   
51,241
 
Mortgage-backed securities
   
71,152
     
-
     
(2,893
)
   
68,259
 
Money market investments
   
1,326
     
-
     
-
     
1,326
 
Corporate bonds and other securities
   
3,950
     
44
     
(16
)
   
3,978
 
Total
 
$
146,637
   
$
155
   
$
(3,811
)
 
$
142,981
 
                                 
December 31, 2017
                               
Obligations of  U.S. Government agencies
 
$
9,530
   
$
27
   
$
(122
)
 
$
9,435
 
Obligations of state and political subdivisions
   
64,413
     
489
     
(137
)
   
64,765
 
Mortgage-backed securities
   
75,906
     
-
     
(1,610
)
   
74,296
 
Money market investments
   
1,194
     
-
     
-
     
1,194
 
Corporate bonds and other securities
   
7,049
     
195
     
(10
)
   
7,234
 
Other marketable equity securities
   
100
     
97
     
-
     
197
 
Total
 
$
158,192
   
$
808
   
$
(1,879
)
 
$
157,121
 

The Company has a process in place to identify debt securities that could potentially have a credit or interest-rate related impairment that is other-than-temporary. This process involves monitoring late payments, pricing levels, downgrades by rating agencies, key financial ratios, financial statements, revenue forecasts, and cash flow projections as indicators of credit issues. On a quarterly basis, management reviews all securities to determine whether an other-than-temporary decline in value exists and whether losses should be recognized. Management considers relevant facts and circumstances in evaluating whether a credit or interest-rate related impairment of a security is other-than-temporary. Relevant facts and circumstances considered include: (a) the extent and length of time the fair value has been below cost; (b) the reasons for the decline in value; (c) the financial position and access to capital of the issuer, including the current and future impact of any specific events; and (d) for fixed maturity securities, the Company's intent to sell a security or whether it is more-likely-than-not the Company will be required to sell the security before the recovery of its amortized cost which, in some cases, may extend to maturity, and for equity securities, the Company's ability and intent to hold the security for a period of time that allows for the recovery in value.

10

The Company has not recorded impairment charges through income on securities for the three or six months ended June 30, 2018 or the year ended December 31, 2017.

The following table summarizes net realized gains and losses on the sale of investment securities during the periods indicated (dollars in thousands):

 
Three Months Ended
 
Six Months Ended
 
 
June 30,
 
June 30,
 
 
2018
 
2017
 
2018
 
2017
 
Securities Available-for-sale
               
Realized gains on sales of securities
 
$
51
   
$
87
   
$
131
   
$
87
 
Realized losses on sales of securities
   
(11
)
   
-
     
(11
)
   
-
 
Net realized gain
 
$
40
   
$
87
   
$
120
   
$
87
 


The following table shows the gross unrealized losses and fair value of the Company's investments with unrealized losses that are not deemed to be other-than-temporarily impaired as of June 30, 2018 and December 31, 2017, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position as of the dates indicated:

June 30, 2018
 
 
Less Than Twelve Months
   
More Than Twelve Months
 
Total
 
 
Gross
Unrealized
Losses
 
Fair
Value
   
Gross
Unrealized
Losses
   
Fair
Value
 
Gross
Unrealized
Losses
 
Fair
Value
 
 
(dollars in thousands)
 
Securities Available-for-Sale
                       
U.S. Treasury securities
 
$
26
   
$
6,818
   
$
-
   
$
-
   
$
26
   
$
6,818
 
Obligations of U.S. Government agencies
   
37
     
7,678
     
123
     
3,481
     
160
     
11,159
 
Obligations of state and political subdivisions
   
332
     
20,739
     
384
     
10,625
     
716
     
31,364
 
Mortgage-backed securities
   
130
     
4,170
     
2,763
     
64,089
     
2,893
     
68,259
 
Corporate bonds
   
4
     
996
     
12
     
188
     
16
     
1,184
 
Total securities available-for-sale
 
$
529
   
$
40,401
   
$
3,282
   
$
78,383
   
$
3,811
   
$
118,784
 

December 31, 2017
 
 
Less Than Twelve Months
 
More Than Twelve Months
 
Total
 
 
Gross
Unrealized
Losses
 
Fair
Value
 
Gross
Unrealized
Losses
 
Fair
Value
 
Gross
Unrealized
Losses
 
Fair
Value
 
 
(dollars in thousands)
 
Securities Available-for-Sale
                       
Obligations of U.S. Government agencies
 
$
11
   
$
3,189
   
$
111
   
$
3,089
   
$
122
   
$
6,278
 
Obligations of state and political subdivisions
   
32
     
11,141
     
105
     
10,999
     
137
     
22,140
 
Mortgage-backed securities
   
67
     
9,742
     
1,543
     
64,554
     
1,610
     
74,296
 
Corporate bonds
   
2
     
1,098
     
8
     
792
     
10
     
1,890
 
Total securities available-for-sale
 
$
112
   
$
25,170
   
$
1,767
   
$
79,434
   
$
1,879
   
$
104,604
 


The number of investments at an unrealized loss position as of June 30, 2018 and December 31, 2017 were 103 and 77, respectively. Certain investments within the Company's portfolio had unrealized losses for more than twelve months at June 30, 2018 and December 31, 2017, as shown in the tables above. The unrealized losses were caused by increases in market interest rates. Because the Company does not intend to sell the investments and management believes it is unlikely that the Company will be required to sell the investments before recovery of their amortized cost basis, which may be maturity, the Company does not consider the investments to be other-than-temporarily impaired at June 30, 2018 or December 31, 2017.

Restricted Securities
The restricted security category is comprised of stock in the Federal Home Loan Bank of Atlanta (FHLB), the Federal Reserve Bank (FRB), and Community Bankers' Bank (CBB). These stocks are classified as restricted securities because their ownership is restricted to certain types of entities and the securities lack a market. Therefore, FHLB, FRB, and CBB stock are carried at cost and evaluated for impairment. When evaluating these stocks for impairment, their value is determined based on the ultimate recoverability of the par value rather than by recognizing temporary declines in value. Restricted stock is viewed as a long-term investment and management believes that the Company has the ability and the intent to hold this stock until its value is recovered.
11


Note 4. Loans and the Allowance for Loan Losses

The following is a summary of the balances in each class of the Company's portfolio of loans held for investment as of the dates indicated:

   
June 30, 2018
   
December 31, 2017
 
   
(in thousands)
 
Mortgage loans on real estate:
           
Residential 1-4 family
 
$
109,961
   
$
101,021
 
Commercial
   
301,241
     
289,682
 
Construction
   
36,929
     
27,489
 
Second mortgages
   
18,007
     
17,918
 
Equity lines of credit
   
55,250
     
56,610
 
Total mortgage loans on real estate
   
521,388
     
492,720
 
Commercial and industrial loans
   
64,701
     
60,398
 
Consumer automobile loans
   
125,866
     
119,251
 
Other consumer loans
   
52,109
     
54,974
 
Other
   
12,153
     
11,197
 
Total loans, net of deferred fees (1)
   
776,217
     
738,540
 
Less: Allowance for loan losses
   
(9,873
)
   
(9,448
)
Loans, net of allowance and deferred fees and costs (1)
 
$
766,344
   
$
729,092
 

(1) Net deferred loan fees totaled $925 thousand and $916 thousand at June 30, 2018 and December 31, 2017, respectively.

Overdrawn deposit accounts are reclassified as loans and included in the Other category in the table above. Overdrawn deposit accounts totaled $613 thousand and $594 thousand at June 30, 2018 and December 31, 2017, respectively.

Acquired Loans

The Company had no acquired loans as of December 31, 2017. The outstanding principal balance and the carrying amount of acquired loans included in the consolidated balance sheet as of June 30, 2018 are as follows:

 
June 30, 2018
 
 
(in thousands)
 
Outstanding principal balance
 
$
37,528
 
Carrying amount
   
36,923
 


The outstanding principal balance and related carrying amount of acquired impaired loans, for which the Company applies FASB ASC 310-30 to account for interest earned, as of June 30, 2018 are as follows:

 
June 30, 2018
 
 
(in thousands)
 
Outstanding principal balance
 
$
686
 
Carrying amount
   
458
 


The following table presents changes in the accretable yield on acquired impaired loans, for which the Company applies FASB ASC 310-30, at June 30, 2018:

   
June 30, 2018
 
   
(in thousands)
 
Balance at January 1, 2018
 
$
-
 
Additions from acquisition of Citizens
   
110
 
Accretion
   
(11
)
Other changes, net
   
-
 
Balance at end of period
 
$
99
 


12

CREDIT QUALITY INFORMATION

The Company uses internally-assigned risk grades to estimate the capability of borrowers to repay the contractual obligations of their loan agreements as scheduled or at all. The Company's internal risk grade system is based on experiences with similarly graded loans. Credit risk grades are updated at least quarterly as additional information becomes available, at which time management analyzes the resulting scores to track loan performance.

The Company's internally assigned risk grades are as follows:

Pass: Loans are of acceptable risk.
Other Assets Especially Mentioned (OAEM): Loans have potential weaknesses that deserve management's close attention.
Substandard: Loans reflect significant deficiencies due to several adverse trends of a financial, economic or managerial nature.
Doubtful: Loans have all the weaknesses inherent in a substandard loan with added characteristics that make collection or liquidation in full based on currently existing facts, conditions and values highly questionable or improbable.
Loss: Loans have been identified for charge-off because they are considered uncollectible and of such little value that their continuance as bankable assets is not warranted.


The following table presents credit quality exposures by internally assigned risk ratings as of the dates indicated:

Credit Quality Information
 
As of June 30, 2018
 
(in thousands)
 
   
Pass
   
OAEM
   
Substandard
   
Doubtful
   
Total
 
Mortgage loans on real estate:
                             
Residential 1-4 family
 
$
107,835
   
$
-
   
$
2,126
   
$
-
   
$
109,961
 
Commercial
   
275,700
     
6,147
     
19,394
     
-
     
301,241
 
Construction
   
36,135
     
73
     
721
     
-
     
36,929
 
Second mortgages
   
17,250
     
413
     
344
     
-
     
18,007
 
Equity lines of credit
   
54,896
     
-
     
354
     
-
     
55,250
 
Total mortgage loans on real estate
   
491,816
     
6,633
     
22,939
     
-
     
521,388
 
Commercial and industrial loans
   
62,297
     
1,932
     
472
     
-
     
64,701
 
Consumer automobile loans
   
125,506
     
-
     
360
     
-
     
125,866
 
Other consumer loans
   
52,063
     
-
     
46
     
-
     
52,109
 
Other
   
12,153
     
-
     
-
     
-
     
12,153
 
Total
 
$
743,835
   
$
8,565
   
$
23,817
   
$
-
   
$
776,217
 

Credit Quality Information
 
As of December 31, 2017
 
(in thousands)
 
   
Pass
   
OAEM
   
Substandard
   
Doubtful
   
Total
 
Mortgage loans on real estate:
                             
Residential 1-4 family
 
$
98,656
   
$
-
   
$
2,365
   
$
-
   
$
101,021
 
Commercial
   
264,275
     
10,526
     
14,881
     
-
     
289,682
 
Construction
   
26,694
     
74
     
721
     
-
     
27,489
 
Second mortgages
   
17,211
     
431
     
276
     
-
     
17,918
 
Equity lines of credit
   
56,318
     
-
     
292
     
-
     
56,610
 
Total mortgage loans on real estate
   
463,154
     
11,031
     
18,535
     
-
     
492,720
 
Commercial and industrial loans
   
58,091
     
1,469
     
838
     
-
     
60,398
 
Consumer automobile loans
   
119,211
     
-
     
40
     
-
     
119,251
 
Other consumer loans
   
54,926
     
-
     
48
     
-
     
54,974
 
Other
   
11,197
     
-
     
-
     
-
     
11,197
 
Total
 
$
706,579
   
$
12,500
   
$
19,461
   
$
-
   
$
738,540
 
13


AGE ANALYSIS OF PAST DUE LOANS BY CLASS

All classes of loans are considered past due if the required principal and interest payments have not been received as of the date such payments were due. Interest and fees continue to accrue on past due loans until the date the loan is placed in nonaccrual status, if applicable. The following table includes an aging analysis of the recorded investment in past due loans as of the dates indicated. Also included in the table below are loans that are 90 days or more past due as to interest and principal and still accruing interest, because they are well-secured and in the process of collection. Loans in nonaccrual status that are also past due are included in the aging categories in the table below.

Age Analysis of Past Due Loans as of June 30, 2018
 
   
30 - 59
Days Past
Due
   
60 - 89
Days Past
Due
   
90 or More
Days Past
Due
   
Acquired Impaired
   
Total
Current
Loans (1)
   
Total
Loans
   
Recorded
Investment
> 90 Days
Past Due
and
Accruing
 
   
(in thousands)
 
Mortgage loans on real estate:
                                         
Residential 1-4 family
 
$
503
   
$
-
   
$
941
   
$
350
   
$
108,167
   
$
109,961
   
$
262
 
Commercial
   
626
     
-
     
3,235
     
108
     
297,272
     
301,241
     
-
 
Construction
   
-
     
-
     
721
     
-
     
36,208
     
36,929
     
-
 
Second mortgages
   
13
     
-
     
95
     
-
     
17,899
     
18,007
     
52
 
Equity lines of credit
   
29
     
20
     
53
     
-
     
55,148
     
55,250
     
-
 
Total mortgage loans on real estate
   
1,171
     
20
     
5,045
     
458
     
514,694
     
521,388
     
314
 
Commercial loans
   
-
     
-
     
-
     
-
     
64,701
     
64,701
     
-
 
Consumer automobile loans
   
925
     
63
     
95
     
-
     
124,783
     
125,866
     
95
 
Other consumer loans
   
850
     
151
     
1,880
     
-
     
49,228
     
52,109
     
1,880
 
Other
   
79
     
11
     
6
     
-
     
12,057
     
12,153
     
6
 
Total
 
$
3,025
   
$
245
   
$
7,026
   
$
458
   
$
765,463
   
$
776,217
   
$
2,295
 

(1) For purposes of this table, Total Current Loans includes loans that are 1 - 29 days past due.

In the table above, the other consumer loans category includes student loans with principal and interest amounts that are 97 - 98% guaranteed by the federal government. The past due principal portion of these guaranteed loans totaled $2.7 million at June 30, 2018.

Age Analysis of Past Due Loans as of December 31, 2017
 
   
30 - 59
Days Past
Due
   
60 - 89
Days Past
Due
   
90 or More
Days Past
Due
   
Total
Current
Loans (1)
   
Total
Loans
   
Recorded
Investment
> 90 Days
Past Due
and
Accruing
 
   
(in thousands)
 
Mortgage loans on real estate:
                                   
Residential 1-4 family
 
$
229
   
$
153
   
$
1,278
   
$
99,361
   
$
101,021
   
$
261
 
Commercial
   
194
     
771
     
1,753
     
286,964
     
289,682
     
-
 
Construction
   
-
     
-
     
721
     
26,768
     
27,489
     
-
 
Second mortgages
   
15
     
-
     
163
     
17,740
     
17,918
     
45
 
Equity lines of credit
   
75
     
19
     
53
     
56,463
     
56,610
     
-
 
Total mortgage loans on real estate
   
513
     
943
     
3,968
     
487,296
     
492,720
     
306
 
Commercial loans
   
709
     
-
     
1,060
     
58,629
     
60,398
     
471
 
Consumer automobile loans
   
517
     
122
     
41
     
118,571
     
119,251
     
41
 
Other consumer loans
   
2,222
     
544
     
2,360
     
49,848
     
54,974
     
2,360
 
Other
   
84
     
9
     
4
     
11,100
     
11,197
     
4
 
Total
 
$
4,045
   
$
1,618
   
$
7,433
   
$
725,444
   
$
738,540
   
$
3,182
 

(1) For purposes of this table, Total Current Loans includes loans that are 1 - 29 days past due.

In the table above, the other consumer loans category includes student loans with principal and interest amounts that are 97 - 98% guaranteed by the federal government. The past due principal portion of these guaranteed loans totaled $4.2 million at December 31, 2017.
14


Although the portion of the student loan portfolio that is 90 days or more past due would normally be considered impaired, the Company does not include these loans in its impairment analysis. Because the federal government has provided guarantees of repayment of these student loans in an amount ranging from 97% to 98% of the total principal and interest of the loans, management does not expect significant increases in past due student loans to have a material effect on the Company.

NONACCRUAL LOANS

The Company generally places commercial loans (including construction loans and commercial loans secured and not secured by real estate) in nonaccrual status when the full and timely collection of interest or principal becomes uncertain, part of the principal balance has been charged off and no restructuring has occurred or the loan reaches 90 days past due, unless the credit is well-secured and in the process of collection.

Under regulatory rules, consumer loans, which are loans to individuals for household, family and other personal expenditures, and consumer loans secured by real estate (including residential 1 - 4 family mortgages, second mortgages, and equity lines of credit) are not required to be placed in nonaccrual status. Although consumer loans and consumer loans secured by real estate are not required to be placed in nonaccrual status, the Company may elect to place these loans in nonaccrual status, if necessary to avoid a material overstatement of interest income. Generally, consumer loans secured by real estate are placed in nonaccrual status only when payments are 120 days past due.

Generally, consumer loans not secured by real estate are placed in nonaccrual status only when part of the principal has been charged off. If a charge-off has not occurred sooner for other reasons, a consumer loan not secured by real estate will generally be placed in nonaccrual status when payments are 120 days past due. These loans are charged off or written down to the net realizable value of the collateral when deemed uncollectible, when classified as a "loss," when repayment is unreasonably protracted, when bankruptcy has been initiated, or when the loan is 120 days or more past due unless the credit is well-secured and in the process of collection.

When management places a loan in nonaccrual status, the accrued unpaid interest receivable is reversed against interest income and the loan is accounted for by the cash basis or cost recovery method, until it qualifies for return to accrual status or is charged off. Generally, loans are returned to accrual status when all the principal and interest amounts contractually due are brought current and future payments are reasonably assured, or when the borrower has resumed paying the full amount of the scheduled contractual interest and principal payments for at least six months.

The following table presents loans in nonaccrual status by class of loan as of the dates indicated:

Nonaccrual Loans by Class
 
   
June 30, 2018
   
December 31, 2017
 
   
(in thousands)
 
Mortgage loans on real estate
           
Residential 1-4 family
 
$
1,540
   
$
1,447
 
Commercial
   
10,802
     
9,468
 
Construction
   
722
     
721
 
Second mortgages
   
154
     
118
 
Equity lines of credit
   
354
     
292
 
Total mortgage loans on real estate
   
13,572
     
12,046
 
Commercial loans
   
319
     
836
 
Total
 
$
13,891
   
$
12,882
 

No acquired impaired loans were on nonaccrual status at June 30, 2018.

The following table presents the interest income that the Company would have earned under the original terms of its nonaccrual loans and the actual interest recorded by the Company on nonaccrual loans for the periods presented:

 
Six Months Ended June 30,
 
 
2018
   
2017
 
 
(in thousands)
 
Interest income that would have been recorded under original loan terms
 
$
235
   
$
241
 
Actual interest income recorded for the period
   
173
     
180
 
Reduction in interest income on nonaccrual loans
 
$
62
   
$
61
 
15


TROUBLED DEBT RESTRUCTURINGS

The Company's loan portfolio includes certain loans that have been modified in a troubled debt restructuring (TDR), where economic concessions have been granted to borrowers who are experiencing financial difficulties. These concessions typically result from the Company's loss mitigation activities and could include reduction in the interest rate below current market rates for borrowers with similar risk profiles, payment extensions, forgiveness of principal, forbearance or other actions intended to maximize collection. The Company defines a TDR as nonperforming if the TDR is in nonaccrual status or is 90 days or more past due and still accruing interest at the report date.

When the Company modifies a loan, management evaluates any possible impairment as stated in the impaired loan section below.

The following tables present TDRs during the periods indicated, by class of loan. There were no troubled debt restructurings in the three or six months ended June 30, 2018.

Troubled Debt Restructurings by Class
 
For the Three Months Ended June 30, 2017
 
   
Number of Modifications
   
Recorded Investment Prior to Modification
   
Recorded Investment After Modification
   
Current Investment on
June 30, 2017
 
   
(dollars in thousands)
 
Mortgage loans on real estate:
                       
Commercial
   
2
   
$
3,663
   
$
3,663
   
$
4
 

Troubled Debt Restructurings by Class
 
For the Six Months Ended June 30, 2017
 
   
Number of Modifications
   
Recorded Investment Prior to Modification
   
Recorded Investment After Modification
   
Current Investment on June 30, 2017
 
   
(dollars in thousands)
 
Mortgage loans on real estate:
                       
Residential 1-4 family
   
1
   
$
142
   
$
142
   
$
142
 
Commercial
   
2
     
3,663
     
3,663
     
3,663
 
Total
   
3
   
$
3,805
   
$
3,805
   
$
3,805
 


The three loans restructured in the first six months ended June 30, 2017 were given below-market rates for debt with similar risk characteristics. At June 30, 2018 and December 31, 2017, the Company had no outstanding commitments to disburse additional funds on any TDR. At June 30, 2018 the Company had no loans secured by residential 1 - 4 family real estate that were in the process of foreclosure. At December 31, 2017, loans totaling $77 thousand were in the process of foreclosure.

In the three and six months ended June 30, 2018 and 2017, there were no defaulting TDRs where the default occurred within twelve months of restructuring. The Company considers a TDR in default when any of the following occurs: the loan, as restructured, becomes 90 days or more past due; the loan is moved to nonaccrual status following the restructure; the loan is restructured again under terms that would qualify it as a TDR if it were not already so classified; or any portion of the loan is charged off.

All TDRs are factored into the determination of the allowance for loan losses and included in the impaired loan analysis, as discussed below.

16

IMPAIRED LOANS

A loan is considered impaired when, based on current information and events, it is probable that the Company will be unable to collect all amounts when due from the borrower in accordance with the contractual terms of the loan. Impaired loans include nonperforming loans and loans modified in a TDR. When management identifies a loan as impaired, the impairment is measured based on the present value of expected future cash flows, discounted at the loan's effective interest rate, except when the sole or remaining source of repayment for the loan is the operation or liquidation of the collateral. In these cases, management uses the current fair value of the collateral, less selling costs, when foreclosure is probable, instead of the discounted cash flows. If management determines that the value of the impaired loan is less than the recorded investment in the loan (net of previous charge-offs, deferred loan fees or costs and unamortized premium or discount), impairment is recognized through a specific allocation in the allowance or a charge-off to the allowance.

When the ultimate collectability of the total principal of an impaired loan is in doubt and the loan is in nonaccrual status, all payments are applied to principal under the cost-recovery method. For financial statement purposes, the recorded investment in the loan is the actual principal balance reduced by payments that would otherwise have been applied to interest. When reporting information on these loans to the applicable customers, the unpaid principal balance is reported as if payments were applied to principal and interest under the original terms of the loan agreements. Therefore, the unpaid principal balance reported to the customer would be higher than the recorded investment in the loan for financial statement purposes. When the ultimate collectability of the total principal of the impaired loan is not in doubt and the loan is in nonaccrual status, contractual interest is credited to interest income when received under the cash-basis method.


The following table includes the recorded investment and unpaid principal balances (a portion of which may have been charged off) for impaired loans, exclusive of acquired impaired loans, with the associated allowance amount, if applicable, as of the dates presented. Also presented are the average recorded investments in the impaired loans and the related amount of interest recognized for the periods presented. The average balances are calculated based on daily average balances.

Impaired Loans by Class
 
 
As of June 30, 2018
 
For the six months ended
June 30, 2018
 
     
Recorded Investment
             
 
Unpaid
Principal
Balance
 
Without
Valuation
Allowance
 
With
Valuation
Allowance
 
Associated
Allowance
 
Average
Recorded
Investment
 
Interest
Income
Recognized
 
 
(in thousands)
 
Mortgage loans on real estate:
                       
Residential 1-4 family
 
$
2,186
   
$
1,777
   
$
390
   
$
151
   
$
2,111
   
$
29
 
Commercial
   
15,619
     
13,254
     
608
     
111
     
14,807
     
131
 
Construction
   
817
     
721
     
94
     
20
     
815
     
5
 
Second mortgages
   
502
     
350
     
132
     
14
     
490
     
6
 
Equity lines of credit
   
355
     
102
     
253
     
24
     
335
     
1
 
Total mortgage loans on real estate
 
$
19,479
   
$
16,204
   
$
1,477
   
$
320
   
$
18,558
   
$
172
 
Commercial loans
   
357
     
319
     
-
     
-
     
583
     
-
 
Other consumer loans
   
32
     
-
     
-
     
-
     
85
     
-
 
Total
 
$
19,868
   
$
16,523
   
$
1,477
   
$
320
   
$
19,226
   
$
172
 

Impaired Loans by Class
 
   
As of December 31, 2017
 
For the Year Ended
December 31, 2017
 
       
Recorded Investment
             
   
Unpaid
Principal
Balance
 
Without
Valuation
Allowance
 
With
Valuation
Allowance
 
Associated
Allowance
 
Average
Recorded
Investment
 
Interest
Income
Recognized
 
   
(in thousands)
 
Mortgage loans on real estate:
                         
Residential 1-4 family
 
$
2,873
   
$
2,499
   
$
316
   
$
52
   
$
2,525
   
$
90
 
Commercial
   
15,262
     
11,622
     
1,644
     
1
     
13,541
     
579
 
Construction
   
814
     
721
     
92
     
18
     
406
     
23
 
Second mortgages
   
473
     
318
     
135
     
14
     
464
     
20
 
Equity lines of credit
   
293
     
53
     
239
     
10
     
261
     
-
 
Total mortgage loans on real estate
 
$
19,715
   
$
15,213
   
$
2,426
   
$
95
   
$
17,197
   
$
712
 
Commercial loans
   
1,115
     
836
     
-
     
-
     
1,388
     
30
 
Other consumer loans
   
-
     
-
     
-
     
-
     
41
     
-
 
Total
 
$
20,830
   
$
16,049
   
$
2,426
   
$
95
   
$
18,626
   
$
742
 

17

MONITORING OF LOANS AND EFFECT OF MONITORING FOR THE ALLOWANCE FOR LOAN LOSSES

Loan officers are responsible for continual portfolio analysis and prompt identification and reporting of problem loans, which includes assigning a risk grade to each applicable loan at its origination and revising such grade as the situation dictates. Loan officers maintain frequent contact with borrowers, which should enable the loan officer to identify potential problems before other personnel. In addition, meetings with loan officers and upper management are held to discuss problem loans and review risk grades. Nonetheless, in order to avoid over-reliance upon loan officers for problem loan identification, the Company's loan review system provides for review of loans and risk grades by individuals who are independent of the loan approval process. Risk grades and historical loss rates (determined by migration analysis) by risk grades are used as a component of the calculation of the allowance for loan losses.

ALLOWANCE FOR LOAN LOSSES

Management has an established methodology to determine the adequacy of the allowance for loan losses that assesses the risks and probable losses inherent in the loan portfolio. The Company segments the loan portfolio into categories as defined by Schedule RC-C of the Federal Financial Institutions Examination Council Consolidated Reports of Condition and Income Form 041 (Call Report).  Loans are segmented into the following pools: commercial, real estate-construction, real estate-mortgage, consumer and other loans. The Company also sub-segments the real estate-mortgage segment into four classes: residential 1-4 family, commercial real estate, second mortgages and equity lines of credit.

The Company uses an internally developed risk evaluation model in the estimation of the credit risk process. The model and assumptions used to determine the allowance are independently validated and reviewed to ensure that the theoretical foundation, assumptions, data integrity, computational processes and reporting practices are appropriate and properly documented.

Each portfolio segment has risk characteristics as follows:

·
Commercial: Commercial loans carry risks associated with the successful operation of a business or project, in addition to other risks associated with the ownership of a business. The repayment of these loans may be dependent upon the profitability and cash flows of the business. In addition, there is risk associated with the value of collateral other than real estate which may depreciate over time and cannot be appraised with as much precision.
·
Real estate-construction: Construction loans carry risks that the project will not be finished according to schedule, the project will not be finished according to budget and the value of the collateral may at any point in time be less than the principal amount of the loan. Construction loans also bear the risk that the general contractor, who may or may not be the loan customer, may be unable to finish the construction project as planned because of financial pressure unrelated to the project.
·
Real estate-mortgage: Residential mortgage loans and equity lines of credit carry risks associated with the continued credit-worthiness of the borrower and changes in the value of the collateral. Commercial real estate loans carry risks associated with the successful operation of a business if owner occupied. If non-owner occupied, the repayment of these loans may be dependent upon the profitability and cash flow from rent receipts.
·
Consumer loans: Consumer loans carry risks associated with the continued credit-worthiness of the borrowers and the value of the collateral. Consumer loans are more likely than real estate loans to be immediately adversely affected by job loss, divorce, illness or personal bankruptcy.
·
Other loans: Other loans are loans to mortgage companies, loans for purchasing or carrying securities, and loans to insurance, investment and finance companies. These loans carry risks associated with the successful operation of a business. In addition, there is risk associated with the value of collateral other than real estate which may depreciate over time, depend on interest rates or fluctuate in active trading markets.

Each segment of the portfolio is pooled by risk grade or by days past due. Consumer loans not secured by real estate and made to individuals for household, family and other personal expenditures are segmented into pools based on days past due, while all other loans, including loans to consumers that are secured by real estate, are segmented by risk grades. A historical loss percentage is then calculated by migration analysis and applied to each pool. The migration analysis applied to all pools is able to track the risk grading and historical performance of individual loans throughout a number of periods set by management, which provides management with information regarding trends (or migrations) in a particular loan segment. At June 30, 2018 and December 31, 2017 management used eight twelve-quarter migration periods.

Management also provides an allocated component of the allowance for loans that are specifically identified that may be impaired, and are individually analyzed for impairment. An allocated allowance is established when the present value of expected future cash flows from the impaired loan (or the collateral value or observable market price of the impaired loan) is lower than the carrying value of that loan.

Based on credit risk assessments and management's analysis of qualitative factors, additional loss factors are applied to loan balances. These additional qualitative factors include: economic conditions, trends in growth, loan concentrations, changes in certain loans, changes in underwriting, changes in management and changes in the legal and regulatory environment.

Acquired loans are recorded at their fair value at acquisition date without carryover of the acquiree's previously established ALL, as credit discounts are included in the determination of fair value. The fair value of the loans is determined using market participant assumptions in estimating the amount and timing of both principal and interest cash flows expected to be collected on the loans and then applying a market-based discount rate to those cash flows. During evaluation upon acquisition, acquired loans are also classified as either acquired impaired or acquired performing.

Acquired impaired loans reflect credit quality deterioration since origination, as it is probable at acquisition that the Company will not be able to collect all contractually required payments. These acquired impaired loans are accounted for under ASC 310-30, Receivables – Loans and Debt Securities Acquired with Deteriorated Credit Quality. The acquired impaired loans are segregated into pools based on loan type and credit risk. Loan type is determined based on collateral type, purpose, and lien position. Credit risk characteristics include risk rating groups, nonaccrual status, and past due status. For valuation purposes, these pools are further disaggregated by maturity, pricing characteristics, and re-payment structure. Acquired impaired loans are written down at acquisition to fair value using an estimate of cash flows deemed to be collectible. Accordingly, such loans are no longer classified as nonaccrual even though they may be contractually past due because the Company expects to fully collect the new carrying values of such loans, which is the new cost basis arising from purchase accounting.

Acquired performing loans are accounted for under ASC 310-20, Receivables – Nonrefundable Fees and Other Costs. The difference between the fair value and unpaid principal balance of the loan at acquisition date (premium or discount) is amortized or accreted into interest income over the life of the loans. If the acquired performing loan has revolving privileges, it is accounted for using the straight-line method; otherwise, the effective interest method is used.


18

ALLOWANCE FOR LOAN LOSSES BY SEGMENT

The total allowance reflects management's estimate of losses inherent in the loan portfolio at the balance sheet date. The Company considers the allowance for loan losses of $9.9 million adequate to cover probable loan losses inherent in the loan portfolio at June 30, 2018.

The following table presents, by portfolio segment, the changes in the allowance for loan losses and the recorded investment in loans for the periods presented. Allocation of a portion of the allowance to one category of loans does not preclude its availability to absorb losses in other categories.

ALLOWANCE FOR LOAN LOSSES AND RECORDED INVESTMENT IN LOANS
 
(in thousands)
 
For the Six Months Ended
June 30, 2018
 
Commercial
   
Real Estate -
Construction
   
Real Estate -
Mortgage (1)
   
Consumer (2)
   
Other
   
Total
 
Allowance for Loan Losses:
                                   
Balance at the beginning of period
 
$
1,889