10-Q 1 mbcn20170930_10q.htm FORM 10-Q mbcn20170930_10q.htm

UNITED STATES 

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C.   20549

 

FORM 10-Q

 

(Mark One)

X

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the quarterly period ended September 30, 2017

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       001-36613

 

Middlefield Banc Corp.

(Exact Name of Registrant as Specified in its Charter)

 

Ohio

 

34-1585111

State or Other Jurisdiction of 

 

I.R.S. Employer Identification No.

Incorporation or Organization

 

 

 

 

 

15985 East High Street, Middlefield, Ohio 

 

44062-0035

Address of Principal Executive Offices

 

Zip Code

 

 

440-632-1666

 

Registrant’s Telephone Number, Including Area Code

 

 

 

 

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 X     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 X    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 ☐

Non-accelerated filer ☐  (Do not check if a smaller reporting company)

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 Act).  Yes ☐    No X 

 

APPLICABLE ONLY TO ISSUERS INVOLVED IN BANKRUPTCY PROCEEDINGS DURING THE PRECEDING FIVE YEARS:

 

Indicate by check mark whether the registrant has filed all documents and reports required to be filed by Section 12, 13 or 15(d) of the Securities Exchange Act of 1934 subsequent to the distribution of securities under a plan confirmed by a court.      Yes ☐    No ☐ 

 

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

      Class:  Common Stock, without par value

      Outstanding at November 14, 2017:  3,214,784

 

 

 

 

MIDDLEFIELD BANC CORP.

 

INDEX

 

Part I – Financial Information

 
     
Item 1.

Financial Statements (unaudited)

 

     
 

Consolidated Balance Sheet as of September 30, 2017 and December 31, 2016

3

     
 

Consolidated Statement of Income for the Three and Nine Months ended September 30, 2017 and 2016

4

     
 

Consolidated Statement of Comprehensive Income for the Three and Nine Months ended September 30, 2017 and 2016

5

     
 

Consolidated Statement of Changes in Stockholders' Equity for the Nine Months ended September 30, 2017

6

     
 

Consolidated Statement of Cash Flows for the Nine Months ended September 30, 2017 and 2016

7

     
 

Notes to Unaudited Consolidated Financial Statements

9

     

Item 2.

Management's Discussion and Analysis of Financial Condition and Results of Operations

33

     

Item 3.

Quantitative and Qualitative Disclosures about Market Risk

43

     

Item 4.

Controls and Procedures

44

     

Part II – Other Information

 
   

Item 1.

Legal Proceedings

44

     

Item 1A.

Risk Factors

44

     

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds

44

     

Item 3.

Defaults by the Company on its Senior Securities

44

     

Item 4.

Mine Safety Disclosures

44

     

Item 5.

Other Information

45

     

Item 6.

Exhibits and Reports on Form 8-K

45

     

Signatures

48
   

Exhibit 31.1

 
   

Exhibit 31.2

 
   

Exhibit 32

 

 

2

 

 

MIDDLEFIELD BANC CORP.

CONSOLIDATED BALANCE SHEET

(Dollar amounts in thousands, except share data)

(Unaudited)

 

   

September 30,

   

December 31,

 
   

2017

   

2016

 
                 

ASSETS

               

Cash and due from banks

  $ 47,731     $ 31,395  

Federal funds sold

    1,200       1,100  

Cash and cash equivalents

    48,931       32,495  

Investment securities available for sale, at fair value

    98,334       114,376  

Loans held for sale

    5,930       634  

Loans

    878,541       609,140  

Less allowance for loan and lease losses

    6,852       6,598  

Net loans

    871,689       602,542  

Premises and equipment, net

    11,768       11,203  

Goodwill

    15,299       4,559  

Core deposit intangibles

    2,848       36  

Bank-owned life insurance

    15,542       13,540  

Other real estate owned

    557       934  

Accrued interest and other assets

    9,928       7,502  
                 

TOTAL ASSETS

  $ 1,080,826     $ 787,821  
                 

LIABILITIES

               

Deposits:

               

Noninterest-bearing demand

  $ 181,550     $ 133,630  

Interest-bearing demand

    91,184       59,560  

Money market

    161,101       74,940  

Savings

    212,371       172,370  

Time

    251,449       189,434  

Total deposits

    897,655       629,934  

Short-term borrowings

    20,274       68,359  

Other borrowings

    39,273       9,437  

Accrued interest and other liabilities

    5,130       3,131  

TOTAL LIABILITIES

    962,332       710,861  
                 

STOCKHOLDERS' EQUITY

               

Common stock, no par value; 10,000,000 shares authorized, 3,600,902 and 2,640,418 shares issued; 3,214,737 and 2,254,253 shares outstanding

    84,722       47,943  

Retained earnings

    45,913       41,334  

Accumulated other comprehensive income

    1,377       1,201  

Treasury stock, at cost; 386,165 shares

    (13,518 )     (13,518 )

TOTAL STOCKHOLDERS' EQUITY

    118,494       76,960  
                 

TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY

  $ 1,080,826     $ 787,821  

 

See accompanying notes to unaudited consolidated financial statements.

 

3

 

 

MIDDLEFIELD BANC CORP.

CONSOLIDATED STATEMENT OF INCOME  

(Dollar amounts in thousands, except per share data)

(Unaudited)

 

   

Three Months Ended

   

Nine Months Ended

 
   

September 30,

   

September 30,

 
   

2017

   

2016

   

2017

   

2016

 

INTEREST AND DIVIDEND INCOME

                               

Interest and fees on loans

  $ 10,443     $ 6,459     $ 29,539     $ 18,949  

Interest-bearing deposits in other institutions

    107       15       248       42  

Federal funds sold

    5       7       9       16  

Investment securities:

                               

Taxable interest

    159       235       600       865  

Tax-exempt interest

    579       687       1,846       2,227  

Dividends on stock

    37       17       189       74  

Total interest and dividend income

    11,330       7,420       32,431       22,173  
                                 

INTEREST EXPENSE

                               

Deposits

    1,468       921       3,820       2,665  

Short-term borrowings

    202       49       652       288  

Other borrowings

    148       56       413       164  

Total interest expense

    1,818       1,026       4,885       3,117  
                                 

NET INTEREST INCOME

    9,512       6,394       27,546       19,056  
                                 

Provision for loan losses

    280       105       615       315  
                                 

NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES

    9,232       6,289       26,931       18,741  
                                 

NONINTEREST INCOME

                               

Service charges on deposit accounts

    479       505       1,397       1,443  

Investment securities gains, net

    398       -       886       303  

Earnings on bank-owned life insurance

    109       101       316       297  

Gain on sale of loans

    255       129       720       322  

Other income

    200       242       622       694  

Total noninterest income

    1,441       977       3,941       3,059  
                                 

NONINTEREST EXPENSE

                               

Salaries and employee benefits

    3,725       2,677       10,624       7,740  

Occupancy expense

    476       306       1,397       933  

Equipment expense

    242       221       789       700  

Data processing costs

    468       334       1,376       928  

Ohio state franchise tax

    186       186       558       448  

Federal deposit insurance expense

    165       132       368       396  

Professional fees

    434       547       1,230       1,057  

Net loss on other real estate owned

    18       48       88       247  

Advertising expense

    248       206       660       604  

Core deposit intangible amortization

    101       10       276       30  

Merger expense

    338       -       1,032       -  

Other expense

    896       995       2,870       2,832  

Total noninterest expense

    7,297       5,662       21,268       15,915  
                                 

Income before income taxes

    3,376       1,604       9,604       5,885  

Income taxes

    914       261       2,535       1,129  
                                 

NET INCOME

  $ 2,462     $ 1,343     $ 7,069     $ 4,756  
                                 

EARNINGS PER SHARE

                               

Basic

  $ 0.77     $ 0.60     $ 2.38     $ 2.31  

Diluted

    0.76       0.60       2.37       2.30  
                                 

DIVIDENDS DECLARED PER SHARE

  $ 0.27     $ 0.27     $ 0.81     $ 0.81  

 

See accompanying notes to unaudited consolidated financial statements.

 

4

 

 

MIDDLEFIELD BANC CORP.

CONSOLIDATED STATEMENT OF COMPREHENSIVE INCOME

(Dollar amounts in thousands)

(Unaudited)

 

   

Three Months Ended

   

Nine Months Ended

 
   

September 30,

   

September 30,

 
   

2017

   

2016

   

2017

   

2016

 
                                 

Net income

  $ 2,462     $ 1,343     $ 7,069     $ 4,756  
                                 

Other comprehensive income:

                               

Net unrealized holding gain (loss) on available-for-sale securities

    (264 )     (400 )     1,153       2,153  

Tax effect

    89       137       (392 )     (732 )
                                 

Reclassification adjustment for investment securities gain included in net income

    (398 )     -       (886 )     (303 )

Tax effect

    135       -       301       103  
                                 

Total other comprehensive income (loss)

    (438 )     (263 )     176       1,221  
                                 

Comprehensive income

  $ 2,024     $ 1,080     $ 7,245     $ 5,977  

 

See accompanying notes to unaudited consolidated financial statements.

 

5

 

 

MIDDLEFIELD BANC CORP.

CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS EQUITY

(Dollar amounts in thousands, except share and per share data)

(Unaudited)

 

                   

Accumulated

                 
                   

Other

           

Total

 
   

Common

   

Retained

   

Comprehensive

   

Treasury

   

Stockholders'

 
   

Stock

   

Earnings

   

Income

   

Stock

   

Equity

 
                                         

Balance, December 31, 2016

  $ 47,943     $ 41,334     $ 1,201     $ (13,518 )   $ 76,960  
                                         

Net income

            7,069                       7,069  

Other comprehensive income

                    176               176  

Common stock issued in business combination (544,610 shares)

    20,995                               20,995  

Other common stock issuances, net of offering cost (399,008 shares)

    15,164                               15,164  

Dividend reinvestment and purchase plan (8,917 shares)

    407                               407  

Stock options exercised (7,126 shares)

    180                               180  

Stock issued in connection with equity awards, net (823 shares)

    33                               33  

Cash dividends declared ($0.81 per share)

            (2,490 )                     (2,490 )
                                         

Balance, September 30, 2017

  $ 84,722     $ 45,913     $ 1,377     $ (13,518 )   $ 118,494  

 

See accompanying notes to unaudited consolidated financial statements.

 

6

 

 

MIDDLEFIELD BANC CORP.

CONSOLIDATED STATEMENT OF CASH FLOWS

(Dollar amounts in thousands)

(Unaudited)

 

   

Nine Months Ended

 
   

September 30,

 
   

2017

   

2016

 

OPERATING ACTIVITIES

               

Net income

  $ 7,069     $ 4,756  

Adjustments to reconcile net income to net cash provided by operating activities:

               

Provision for loan losses

    615       315  

Investment securities gain, net

    (886 )     (303 )

Depreciation and amortization of premises and equipment, net

    797       744  

Amortization of premium and discount on investment securities, net

    343       352  

Accretion of deferred loan fees, net

    (246 )     (150 )

Amortization of core deposit intangibles

    275       30  

Equity-based compensation

    33       -  

Origination of loans held for sale

    (13,345 )     (15,497 )

Proceeds from sale of loans

    7,811       16,046  

Gain on sale of loans

    (239 )     (322 )

Origination of student loans held for sale

    (321,942 )     -  

Proceeds from sale of student loans

    328,853       -  

Gain on sale of student loans

    (481 )     -  

Earnings on bank-owned life insurance

    (316 )     (297 )

Deferred income tax

    (532 )     224  

Net (gain) loss on other real estate owned

    (211 )     247  

(Increase) in accrued interest receivable

    (311 )     (139 )

Increase (decrease) in accrued interest payable

    124       (4 )

Other, net

    (2,193 )     253  

Net cash provided by operating activities

    5,218       6,255  
                 

INVESTING ACTIVITIES

               

Investment securities available for sale:

               

Proceeds from repayments and maturities

    9,560       17,896  

Proceeds from sale of securities

    6,474       9,115  

Purchases

    (250 )     (1,744 )

Increase in loans, net

    (75,307 )     (53,430 )

Proceeds from the sale of other real estate owned

    1,767       555  

Purchase of bank-owned life insurance

    (5 )     -  

Purchase of premises and equipment

    (1,037 )     (679 )

Purchase of restricted stock

    (899 )     -  

Redemption of restricted stock

    795       -  

Acquisition, net of cash paid

    5,431       -  

Net cash used in investing activities

    (53,471 )     (28,287 )
                 

FINANCING ACTIVITIES

               

Net increase in deposits

    69,677       14,895  

(Decrease) in short-term borrowings, net

    (48,085 )     (3,022 )

Repayment of other borrowings

    (164 )     (226 )

Proceeds from other borrowings

    30,000       -  

Proceeds from common stock issued

    15,164       11,239  

Net cash from common stock transactions

    180       -  

Proceeds from dividend reinvestment and purchase plan

    407       382  

Cash dividends

    (2,490 )     (1,710 )

Net cash provided by financing activities

    64,689       21,558  
                 

Increase (decrease) in cash and cash equivalents

    16,436       (474 )
                 

CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD

    32,495       23,750  
                 

CASH AND CASH EQUIVALENTS AT END OF PERIOD

  $ 48,931     $ 23,276  

 

See accompanying notes to unaudited consolidated financial statements.

 

7

 

 

SUPPLEMENTAL INFORMATION

               

Cash paid during the year for:

               

Interest on deposits and borrowings

  $ 4,761     $ 3,121  

Income taxes

    4,455       475  
                 

Noncash investing transactions:

               

Transfers from loans to other real estate owned

  $ 1,179     $ 595  

Common stock issued in business acquisition

    20,995       -  
                 
Acquisition of Liberty Bank                

Noncash assets acquired

               

Loans

          $ 195,388  

Loans held for sale

            5,953  

Premises and equipment, net

            325  

Accrued interest receivable

            440  

Bank-owned life insurance

            1,681  

Core deposit intangible

            3,087  

Other assets

            997  

Goodwill

            10,740  
              218,611  

Liabilities assumed

               

Time deposits

            (30,744 )

Deposits other than time deposits

            (167,300 )

Accrued interest payable

            (47 )

Deferred taxes

            (1,134 )

Other liabilities

            (2,754 )
              (201,979 )
                 

Liberty stock acquired in business combination

            (1,068 )
                 

Net noncash assets acquired

          $ 15,564  
                 

Cash and cash equivalents acquired, net

          $ 5,431  

 

See accompanying notes to unaudited consolidated financial statements.

 

8

 

 

MIDDLEFIELD BANC CORP.

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

 

NOTE 1 - BASIS OF PRESENTATION

 

The consolidated financial statements of Middlefield Banc Corp. ("Company") include its bank subsidiary, The Middlefield Banking Company (“MBC” or “Middlefield Bank”), and a nonbank asset resolution subsidiary EMORECO, Inc. All significant inter-company items have been eliminated.

 

On January 12, 2017, the Company completed its acquisition of Liberty Bank, N.A. (“Liberty”), pursuant to a previously announced definitive merger agreement. Under the terms of the merger agreement, Liberty shareholders received $37.96 in cash or 1.1934 shares of the Company’s common stock in exchange for each share of Liberty common stock they owned immediately prior to the merger. The Company issued 544,610 shares of its common stock in the merger and the aggregate merger consideration was approximately $42.2 million. Upon closing, Liberty was merged into MBC, and its three full-service bank offices, in Twinsburg in northern Summit County and in Beachwood and Solon in eastern Cuyahoga County, became offices of MBC. The systems integration of Liberty into MBC was completed in February.

 

The accompanying unaudited financial statements have been prepared in accordance with U.S. generally accepted accounting principles and the instructions for Form 10-Q and Article 10 of Regulation S-X. In management’s opinion, the financial statements include all adjustments, consisting of normal recurring adjustments, that the Company considers necessary to fairly state the Company’s financial position and the results of operations and cash flows. The consolidated balance sheet at December 31, 2016, has been derived from the audited financial statements at that date but does not include all of the necessary informational disclosures and footnotes as required by U.S. generally accepted accounting principles. The accompanying financial statements should be read in conjunction with the financial statements and notes thereto included with the Company’s Form 10-K for the year ended December 31, 2016. The results of the Company’s operations for any interim period are not necessarily indicative for the results of the Company’s operations for any other interim period or for a full fiscal year.

 

Recent Accounting Pronouncements

 

In May 2014, the FASB issued ASU No. 2014-09, Revenue from Contracts with Customers (Topic 606), which will supersede the revenue recognition requirements in Topic 605, Revenue Recognition, and most industry-specific revenue recognition guidance throughout the Accounting Standards Codification. Under ASU No. 2014-09, revenue should be recognized to depict the transfer of goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. In applying the guidance, an entity should 1) identify the contract(s) with a customer, 2) identify the performance obligation in the contract, 3) determine the transaction price, 4) allocate the transaction price to the performance obligations in the contract, and 5) recognize revenue when the entity satisfies a performance obligation. For public entities, the amendments in this update are effective for annual reporting periods beginning after December 15, 2016, including interim periods within that reporting period. In August 2015, the FASB issued ASU No. 2015-14 delaying the effective date of ASU No. 2014-09. Public business entities, certain not-for profit entities, and certain employee benefit plans should apply the guidance in ASU No. 2014-09 to annual reporting periods beginning after December 15, 2017, including interim reporting periods within that reporting period. Because this guidance does not apply to revenue associated with financial instruments, including loans or securities, the new guidance is not expected to have a material impact on the components of income most closely associated with financial instruments, including securities gains/losses and interest income. The Company is currently evaluating this guidance to determine the impact on components of noninterest income. Although management has not completed its evaluation of the impact of adoption of the ASU on noninterest income, management does not expect the amount or timing of the recognition of such revenue to be materially impacted and does not expect adoption to have a material impact on the Company’s consolidated financial position, results of operations or cash flows.

 

In February 2016, the FASB issued ASU 2016-02, Leases (Topic 842). The standard requires lessees to recognize the assets and liabilities that arise from leases on the balance sheet. A lessee should recognize in the statement of financial position a liability to make lease payments (the lease liability) and a right-of-use asset representing its right to use the underlying asset for the lease term. A short-term lease is defined as one in which (a) the lease term is 12 months or less and (b) there is not an option to purchase the underlying asset that the lessee is reasonably certain to exercise. For short-term leases, lessees may elect to recognize lease payments over the lease term on a straight-line basis. For public business entities, the amendments in this Update are effective for fiscal years beginning after December 15, 2018, and interim periods within those years. For all other entities, the amendments in this Update are effective for fiscal years beginning after December 15, 2019, and for interim periods within fiscal years beginning after December 15, 2020. The amendments should be applied at the beginning of the earliest period presented using a modified retrospective approach with earlier application permitted as of the beginning of an interim or annual reporting period. The Company is currently assessing the practical expedients it may elect at adoption, but does not anticipate the amendments will have a significant impact on the financial statements. Based on the Company’s preliminary analysis of its current portfolio, the impact to the Company’s balance sheet is estimated to result in less than a 1 percent increase in assets and liabilities. The Company also anticipates additional disclosures to be provided at adoption.

 

9

 

 

In June 2016, the FASB issued ASU 2016-13, Financial Instruments – Credit Losses: Measurement of Credit Losses on Financial Instruments, which changes the impairment model for most financial assets. This Update is intended to improve financial reporting by requiring timelier recoding of credit losses on loans and other financial instruments held by financial institutions and other organizations. The underlying premise of the Update is that financial assets measured at amortized cost should be presented at the net amount expected to be collected, through an allowance for credit losses that is deducted from the amortized cost basis. The allowance for credit losses should reflect management’s current estimate of credit losses that are expected to occur over the remaining life of a financial asset. The income statement will be effected for the measurement of credit losses for newly recognized financial assets, as well as the expected increases or decreases of expected credit losses that have taken place during the period. ASU 2016-13 is effective for annual and interim periods beginning after December 15, 2019, and early adoption is permitted for annual and interim periods beginning after December 15, 2018. With certain exceptions, transition to the new requirements will be through a cumulative effect adjustment to opening retained earnings as of the beginning of the first reporting period in which the guidance is adopted. We expect to recognize a one-time cumulative effect adjustment to the allowance for loan losses as of the beginning of the first reporting period in which the new standard is effective, but cannot yet determine the magnitude of any such one-time adjustment or the overall impact of the new guidance on the consolidated financial statements.

 

In January 2017, the FASB issued ASU 2017-01, Business Combinations (Topic 805), Clarifying the Definition of a Business, which provides a more robust framework to use in determining when a set of assets and activities (collectively referred to as a “set”) is a business. The screen requires that when substantially all of the fair value of the gross assets acquired (or disposed of) is concentrated in a single identifiable asset or a group of similar identifiable assets, the set is not a business. This screen reduces the number of transactions that need to be further evaluated. Public business entities should apply the amendments in this Update to annual periods beginning after December 15, 2017, including interim periods within those periods. All other entities should apply the amendments to annual periods beginning after December 15, 2018, and interim periods within annual periods beginning after December 15, 2019. The amendments in this Update should be applied prospectively on or after the effective date. This Update is not expected to have a significant impact on the Company’s financial statements.

 

In January 2017, the FASB issued ASU 2017-04, Simplifying the Test for Goodwill Impairment. To simplify the subsequent measurement of goodwill, the FASB eliminated Step 2 from the goodwill impairment test. In computing the implied fair value of goodwill under Step 2, an entity had to perform procedures to determine the fair value at the impairment testing date of its assets and liabilities (including unrecognized assets and liabilities) following the procedure that would be required in determining the fair value of assets acquired and liabilities assumed in a business combination. Instead, under the amendments in this Update, 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 should recognize an impairment charge for the amount by which the carrying amount exceeds the reporting unit’s fair value; however, the loss recognized should not exceed the total amount of goodwill allocated to that reporting unit. A public business entity that is a U.S. Securities and Exchange Commission (“SEC”) filer should adopt the amendments in this Update for its annual or any interim goodwill impairment tests in fiscal years beginning after December 15, 2019. A public business entity that is not an SEC filer should adopt the amendments in this Update for its annual or any interim goodwill impairment tests in fiscal years beginning after December 15, 2020. All other entities, including not-for-profit entities that are adopting the amendments in this Update should do so for their annual or any interim goodwill impairment tests in fiscal years beginning after December 15, 2021. This Update is not expected to have a significant impact on the Company’s financial statements.

 

In March 2017, the FASB issued ASU 2017-08, Receivables – Nonrefundable Fees and Other Costs (Subtopic 310-20). The amendments in this Update shorten the amortization period for certain callable debt securities held at a premium. Specifically, the amendments require the premium to be amortized to the earliest call date. The amendments do not require an accounting change for securities held at a discount; the discount continues to be amortized to maturity. For public business entities, the amendments in this Update are effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2018. For all other entities, the amendments are effective for fiscal years beginning after December 15, 2019, and interim periods within fiscal years beginning after December 15, 2020. Early adoption is permitted, including adoption in an interim period. If an entity early adopts the amendments in an interim period, any adjustments should be reflected as of the beginning of the fiscal year that includes that 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. Additionally, in the period of adoption, an entity should provide disclosures about a change in accounting principle. This Update is not expected to have a significant impact on the Company’s financial statements.

 

In May 2017, the FASB issued ASU 2017-09, Compensation – Stock Compensation (Topic 718), which affects any entity that changes the terms or conditions of a share-based payment award. This Update amends the definition of modification by qualifying that modification accounting does not apply to changes to outstanding share-based payment awards that do not affect the total fair value, vesting requirements, or equity/liability classification of the awards. The amendments in this Update are effective for all entities for annual periods, and interim periods within those annual periods, beginning after December 15, 2017. Early adoption is permitted, including adoption in any interim period, for (1) public business entities for reporting periods for which financial statements have not yet been issued and (2) all other entities for reporting periods for which financial statements have not yet been made available for issuance. The amendments in this Update should be applied prospectively to an award modified on or after the adoption date. The Company is currently evaluating the impact the adoption of the standard will have on its financial position or results of operations.

 

10

 

 

NOTE 2 - STOCK-BASED COMPENSATION

 

The Company had no unvested stock options outstanding or unrecognized stock-based compensation costs outstanding as of September 30, 2017 and 2016.

 

Stock option activity during the nine months ended September 30 is as follows:

 

           

Weighted-

           

Weighted-

 
           

average

           

average

 
           

Exercise

           

Exercise

 
   

2017

   

Price

   

2016

   

Price

 
                                 

Outstanding, January 1

    29,324     $ 23.67       31,949     $ 25.03  

Exercised

    (7,949 )     29.87       -       -  
                                 

Outstanding, September 30

    21,375     $ 21.37       31,949     $ 25.03  
                                 

Exercisable, September 30

    21,375     $ 21.37       31,949     $ 25.03  

 

NOTE 3 - EARNINGS PER SHARE

 

The Company provides dual presentation of basic and diluted earnings per share. Basic earnings per share is calculated by dividing net income by the average shares outstanding. Diluted earnings per share adds the dilutive effects of stock options to average shares outstanding.

 

The following table sets forth the composition of the weighted-average common shares (denominator) used in the basic and diluted earnings per share computation.

 

   

For the Three

   

For the Nine

 
   

Months Ended

   

Months Ended

 
   

September 30,

   

September 30,

 
                         
   

2017

   

2016

   

2017

   

2016

 

Weighted-average common shares outstanding

    3,598,500       2,633,752       3,352,316       2,445,821  
                                 

Average treasury stock shares

    (386,165 )     (386,165 )     (386,165 )     (386,165 )
                                 

Weighted-average common shares and common stock equivalents used to calculate basic earnings per share

    3,212,335       2,247,587       2,966,151       2,059,656  
                                 

Additional common stock equivalents (stock options) used to calculate diluted earnings per share

    11,418       8,643       12,592       8,876  
                                 

Weighted-average common shares and common stock equivalents used to calculate diluted earnings per share

    3,223,753       2,256,230       2,978,743       2,068,532  

 

11

 

 

Options to purchase 21,375 shares of common stock, at prices ranging from $17.55 to $37.00, were outstanding during the three and nine months ended September 30, 2017. Of those options, 21,375 were considered dilutive for the three and nine month periods based on the market price exceeding the strike price and no options were anti-dilutive.

 

Options to purchase 31,949 shares of common stock, at prices ranging from $17.55 to $40.24, were outstanding during the three and nine months ended September 30, 2016. Of those options, 24,700 were considered dilutive for the three and nine month periods based on the market price exceeding the strike price and 7,249 options were anti-dilutive.

 

NOTE 4 - FAIR VALUE MEASUREMENTS

 

Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in the principal or most advantageous market for an asset or liability in an orderly transaction between market participants at the measurement date. GAAP established a fair value hierarchy that prioritizes the use of inputs used in valuation methodologies into the following levels:

 

Level I:

Quoted prices are available in active markets for identical assets or liabilities as of the reported date.

 

Level II:

Pricing inputs are other than the quoted prices in active markets, which are either directly or indirectly observable as of the reported date. The nature of these assets and liabilities includes items for which quoted prices are available but traded less frequently and items that are fair valued using other financial instruments, the parameters of which can be directly observed.

 

Level III:

Assets and liabilities that have little to no pricing observability as of the reported date. These items do not have two-way markets and are measured using management’s best estimate of fair value, where the inputs into the determination of fair value require significant management judgment or estimation.

 

The following tables present the assets measured on a recurring basis on the Consolidated Balance Sheet at their fair value by level within the fair value hierarchy. Financial assets and liabilities are classified in their entirety based on the lowest level of input that is significant to the fair value measurement.

 

           

September 30, 2017

         

(Dollar amounts in thousands)

 

Level I

   

Level II

   

Level III

   

Total

 

Assets measured on a recurring basis:

                               

U.S. government agency securities

  $ -     $ 9,094     $ -     $ 9,094  

Obligations of states and political subdivisions

    -       72,094       -       72,094  

Mortgage-backed securities in government-sponsored entities

    -       16,579       -       16,579  

Total debt securities

    -       97,767       -       97,767  

Equity securities in financial institutions

    -       567       -       567  

Total

  $ -     $ 98,334     $ -     $ 98,334  

 

           

December 31, 2016

         

(Dollar amounts in thousands)

 

Level I

   

Level II

   

Level III

   

Total

 

Assets measured on a recurring basis:

                               

U.S. government agency securities

  $ -     $ 10,236     $ -     $ 10,236  

Obligations of states and political subdivisions

    -       81,223       -       81,223  

Mortgage-backed securities in government-sponsored entities

    -       20,069       -       20,069  

Private-label mortgage-backed securities

    -       1,709       -       1,709  

Total debt securities

    -       113,237       -       113,237  

Equity securities in financial institutions

    -       1,139       -       1,139  

Total

  $ -     $ 114,376     $ -     $ 114,376  

 

The Company obtains fair values from an independent pricing service which represent either quoted market prices for the identical securities (Level I inputs) or fair values determined by pricing models using a market approach that considers observable market data, such as interest rate volatilities, LIBOR yield curve, credit spreads and prices from market makers and live trading systems (Level II).

 

The Company uses prices compiled by third party vendors.

 

12

 

 

Impaired Loans – The Company has measured impairment on collateral-dependent impaired loans generally based on the fair value of the loan’s collateral. Fair value is generally determined based upon independent third-party appraisals of the properties. In some cases, management may adjust the appraised value due to the age of the appraisal, changes in market conditions, or observable deterioration of the property since the appraisal was completed. Additionally, management makes estimates about expected costs to sell the property which are also included in the net realizable value. If the fair value of the collateral dependent loan is less than the carrying amount of the loan, a specific reserve for the loan is made in the allowance for loan losses or a charge-off is taken to reduce the loan to the fair value of the collateral (less estimated selling costs) and the loan is included in the following table as a Level III measurement. If the fair value of the collateral exceeds the carrying amount of the loan, then the loan is not included in the following table as it is not currently being carried at its fair value. The fair values in the following table exclude estimated selling costs of $437,000 at September 30, 2017.

 

Other Real Estate Owned (OREO) – OREO is carried at the lower of cost or fair value, which is measured at the date of foreclosure. If the fair value of the collateral exceeds the carrying amount of the loan, no charge-off or adjustment is necessary, the loan is not considered to be carried at fair value, and is therefore not included in the following table. If the fair value of the collateral is less than the carrying amount of the loan, management will charge the loan down to its estimated realizable value. The fair value of OREO is based on the appraised value of the property, which is generally unadjusted by management and is based on comparable sales for similar properties in the same geographic region as the subject property, and is included in the following table as a Level II measurement. In some cases, management may adjust the appraised value due to the age of the appraisal, changes in market conditions, or observable deterioration of the property since the appraisal was completed. In these cases, the loans are categorized in the following table as Level III measurement since these adjustments are considered to be unobservable inputs. Income and expenses from operations and further declines in the fair value of the collateral subsequent to foreclosure are included in net expenses from OREO.

 

The following tables present the assets measured on a nonrecurring basis on the Consolidated Balance Sheet at their fair value by level within the fair value hierarchy. Collateral-dependent impaired loans are carried at fair value if they have been charged down to fair value or if a specific valuation allowance has been established. A new cost basis is established at the time a property is initially recorded in OREO. OREO properties are carried at fair value if a devaluation has been taken to the property’s value subsequent to the initial measurement.

 

           

September 30, 2017

         

(Dollar amounts in thousands)

 

Level I

   

Level II

   

Level III

   

Total

 

Assets measured on a nonrecurring basis:

                               

Impaired loans

  $ -     $ -     $ 1,620     $ 1,620  

Other real estate owned

    -       -       81       81  

 

           

December 31, 2016

         

(Dollar amounts in thousands)

 

Level I

   

Level II

   

Level III

   

Total

 

Assets measured on a nonrecurring basis:

                               

Impaired loans

  $ -     $ -     $ 6,498     $ 6,498  

Other real estate owned

    -       -       511       511  

 

13

 

 

The following tables present additional quantitative information about assets measured at fair value on a nonrecurring basis and for which the Company uses Level III inputs to determine fair value:

 

   

Quantitative Information about Level III Fair Value Measurements

(Dollar amounts in thousands)

                       
   

Fair Value Estimate

  Valuation Techniques   Unobservable Input  

Range (Weighted Average)

 

September 30, 2017

                       

Impaired loans

  $ 1,620  

Appraisal of collateral (1)

 

Appraisal adjustments (2)

  3.3% to 8.3% (5.3%)  

Other real estate owned

  $ 81  

Appraisal of collateral (1)

 

Appraisal adjustments (2)

  0.0% to 10.0%  

 

 

   

Quantitative Information about Level III Fair Value Measurements

 

(Dollar amounts in thousands)

     

 

 

 

 

 

 
   

Fair Value Estimate

   Valuation Techniques    Unobservable Input  

Range (Weighted Average)

 

December 31, 2016

                       

Impaired loans

  $ 1,570  

Appraisal of collateral (1)

 

Appraisal adjustments (2)

  0.0% to 59.7% (28.2%)  

Other real estate owned

  $ 511  

Appraisal of collateral (1)

 

Appraisal adjustments (2)

  0% to 10.0%  

 

 

(1)

Fair value is generally determined through independent appraisals of the underlying collateral, which generally include various level III inputs which are not identifiable, less any associated allowance.

 

(2)

Appraisals may be adjusted by management for qualitative factors such as economic conditions and estimated liquidation expenses. The range and weighted average of liquidation expenses and other appraisal adjustments are presented as a percent of the appraisal.

 

The estimated fair value of the Company’s financial instruments is as follows:

 

   

September 30, 2017

 
   

Carrying

                           

Total

 
   

Value

   

Level I

   

Level II

   

Level III

   

Fair Value

 
   

(Dollar amounts in thousands)

 
       

Financial assets:

                                       

Cash and cash equivalents

  $ 48,931     $ 48,931     $ -     $ -     $ 48,931  

Investment securities

                                       

Available for sale

    98,334       -       98,334       -       98,334  

Loans held for sale

    5,930       4,995       935       -       5,930  

Net loans

    871,689       -       -       879,206       879,206  

Bank-owned life insurance

    15,542       15,542       -       -       15,542  

Federal Home Loan Bank stock

    3,589       3,589       -       -       3,589  

Accrued interest receivable

    3,177       3,177       -       -       3,177  
                                         

Financial liabilities:

                                       

Deposits

  $ 897,655     $ 646,206     $ -     $ 252,112     $ 898,318  

Short-term borrowings

    20,274       20,274       -       -       20,274  

Other borrowings

    39,273       -       -       39,306       39,306  

Accrued interest payable

    566       566       -       -       566  

 

14

 

 

   

December 31, 2016

 
   

Carrying

                           

Total

 
   

Value

   

Level I

   

Level II

   

Level III

   

Fair Value

 
   

(Dollar amounts in thousands)

 

Financial assets:

                                       

Cash and cash equivalents

  $ 32,495     $ 32,495     $ -     $ -     $ 32,495  

Investment securities

                                       

Available for sale

    114,376       -       114,376       -       114,376  

Loans held for sale

    634       -       634       -       634  

Net loans

    602,542       -       -       604,447       604,447  

Bank-owned life insurance

    13,540       13,540       -       -       13,540  

Restricted stock

    2,204       2,204       -       -       2,204  

Accrued interest receivable

    2,426       2,426       -       -       2,426  
                                         

Financial liabilities:

                                       

Deposits

  $ 629,934     $ 440,500     $ -     $ 189,871     $ 630,371  

Short-term borrowings

    68,359       68,359       -       -       68,359  

Other borrowings

    9,437       -       -       9,512       9,512  

Accrued interest payable

    395       395       -       -       395  

 

Financial instruments are defined as cash, evidence of ownership interest in an entity, or a contract which creates an obligation or right to receive or deliver cash or another financial instrument from/to a second entity on potentially favorable or unfavorable terms.

 

Fair value is defined as the amount at which a financial instrument could be exchanged in a current transaction between willing parties other than in a forced liquidation sale. If a quoted market price is available for a financial instrument, the estimated fair value would be calculated based upon the market price per trading unit of the instrument.

 

If no readily available market exists, the fair value estimates for financial instruments should be based upon management’s judgment regarding current economic conditions, interest rate risk, expected cash flows, future estimated losses, and other factors as determined through various option pricing formulas or simulation modeling. Since many of these assumptions result from judgments made by management based upon estimates which are inherently uncertain, the resulting estimated fair values may not be indicative of the amount realizable in the sale of a particular financial instrument. In addition, changes in assumptions on which the estimated fair values are based may have a significant impact on the resulting estimated fair values.

 

As certain assets such as deferred tax assets and premises and equipment are not considered financial instruments, the estimated fair value of financial instruments would not represent the full value of the Company.

 

The Company employed simulation modeling in determining the estimated fair value of financial instruments for which quoted market prices were not available based upon the following assumptions:

 

Cash and Cash Equivalents, Federal Home Loan Bank Stock, Accrued Interest Receivable, Accrued Interest Payable, and Short-Term Borrowings

The fair value is equal to the current carrying value.

 

Bank-Owned Life Insurance

The fair value is equal to the cash surrender value of the life insurance policies.

 

Investment Securities Available for Sale

The fair value of investment securities is equal to the available quoted market price.  If no quoted market price is available, fair value is estimated using the quoted market price for similar securities. 

 

Loans Held for Sale

Loans held for sale are carried at lower of cost or fair value. The fair value of loans held for sale is based on secondary market pricing on portfolios with similar characteristics. The changes in fair value of the assets are largely driven by changes in interest rates subsequent to loan funding and changes in the fair value of servicing associated with the mortgage loan held for sale. Within this total are student loans held for sale for which the fair value is based on readily determinable market prices, which is a level I Price.

 

15

 

 

Net Loans

The fair value is estimated by discounting future cash flows using current market inputs at which loans with similar terms and qualities would be made to borrowers of similar credit quality. Where quoted market prices were available, primarily for certain residential mortgage loans, such market rates were used as estimates for fair value.

 

Deposits and Other Borrowings

The fair values of certificates of deposit and other borrowings are based on the discounted value of contractual cash flows. The discount rates are estimated using rates currently offered for similar instruments with similar remaining maturities. Demand, savings, and money market deposits are valued at the amount payable on demand as of period end.

 

Commitments to Extend Credit

These financial instruments are generally not subject to sale, and estimated fair values are not readily available. The carrying value, represented by the net deferred fee arising from the unrecognized commitment or letter of credit, and the fair value, determined by discounting the remaining contractual fee over the term of the commitment using fees currently charged to enter into similar agreements with similar credit risk, are not considered material for disclosure.

 

NOTE 5 – ACCUMULATED OTHER COMPREHENSIVE INCOME

 

The following tables present the changes in accumulated other comprehensive income by component net of tax for the three and nine months ended September 30, 2017 and 2016, respectively:

 

   

Unrealized gains on

 
   

available-for-sale

 

(Dollars in thousands)

 

securities

 

Balance as of June 30, 2017

  $ 1,815  

Other comprehensive income before reclassification

    (175 )

Amount reclassified from accumulated other comprehensive income

    (263 )

Period change

    (438 )

Balance at September 30, 2017

  $ 1,377  
         

Balance as of December 31, 2016

  $ 1,201  

Other comprehensive income before reclassification

    761  

Amount reclassified from accumulated other comprehensive income

    (585 )

Period change

    176  

Balance at September 30, 2017

  $ 1,377  

 

   

Unrealized gains on

 
   

available-for-sale

 

(Dollars in thousands)

 

securities

 

Balance as of June 30, 2016

  $ 3,879  

Other comprehensive loss before reclassification

    (263 )

Amount reclassified from accumulated other comprehensive income

    -  

Period change

    (263 )

Balance at September 30, 2016

  $ 3,616  
         

Balance as of December 31, 2015

  $ 2,395  

Other comprehensive income before reclassification

    1,421  

Amount reclassified from accumulated other comprehensive income

    (200 )

Period change

    1,221  

Balance at September 30, 2016

  $ 3,616  

 

 

(a)

All amounts are net of tax. Amounts in parentheses indicate debits to accumulated other comprehensive income.

 

16

 

 

The following tables present significant amounts reclassified out of each component of accumulated other comprehensive income:

 

    Amount Reclassified from Accumulated Other Comprehensive  

Affected Line Item in

     Income (a)       

the Statement Where

(Dollars in thousands)

   For the Three Months Ended       

Net Income is

Details about other comprehensive income

 

September 30, 2017

   

September 30, 2016

 

Presented

Unrealized gains on available-for-sale securities

                 
    $ 398     $ -  

Investment securities gains, net

      (135 )     -  

Income taxes

    $ 263     $ -    

 

   

Amount Reclassified from Accumulated Other Comprehensive

 

Affected Line Item in

    Income (a)  

the Statement Where

(Dollars in thousands)

  For the Nine Months Ended  

Net Income is

Details about other comprehensive income

 

September 30, 2017

   

September 30, 2016

 

Presented

Unrealized gains on available-for-sale securities

                 
    $ 886     $ 303  

Investment securities gains, net

      (301 )     (103 )

Income taxes

    $ 585     $ 200    

 

(a) Amounts in parentheses indicate expenses and other amounts indicate income.

 

NOTE 6 - INVESTMENT SECURITIES AVAILABLE FOR SALE

 

The amortized cost and fair values of securities available for sale are as follows:

 

   

September 30, 2017

 
           

Gross

   

Gross

         
   

Amortized

   

Unrealized

   

Unrealized

   

Fair

 

(Dollar amounts in thousands)

 

Cost

   

Gains

   

Losses

   

Value

 
                                 

U.S. government agency securities

  $ 9,004     $ 146     $ (56 )   $ 9,094  

Obligations of states and political subdivisions:

                               

Taxable

    505       12       -       517  

Tax-exempt

    69,750       1,886       (59 )     71,577  

Mortgage-backed securities in government-sponsored entities

    16,574       175       (170 )     16,579  

Total debt securities

    95,833       2,219       (285 )     97,767  

Equity securities in financial institutions

    415       152       -       567  

Total

  $ 96,248     $ 2,371     $ (285 )   $ 98,334  

 

17

 

 

   

December 31, 2016

 
           

Gross

   

Gross

         
   

Amortized

   

Unrealized

   

Unrealized

   

Fair

 
   

Cost

   

Gains

   

Losses

   

Value

 
                                 

U.S. government agency securities

  $ 10,158     $ 174     $ (96 )   $ 10,236  

Obligations of states and political subdivisions:

                               

Taxable

    1,615       129       (4 )     1,740  

Tax-exempt

    78,327       1,678       (522 )     79,483  

Mortgage-backed securities in government-sponsored entities

    20,128       202       (261 )     20,069  

Private-label mortgage-backed securities

    1,579       130       -       1,709  

Total debt securities

    111,807       2,313       (883 )     113,237  

Equity securities in financial institutions

    750       389       -       1,139  

Total

  $ 112,557     $ 2,702     $ (883 )   $ 114,376  

 

The amortized cost and fair value of debt securities at September 30, 2017, by contractual maturity, are shown below. Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.

 

   

Amortized

   

Fair

 

(Dollar amounts in thousands)

 

Cost

   

Value

 
                 

Due in one year or less

  $ 4,689     $ 4,742  

Due after one year through five years

    9,884       10,193  

Due after five years through ten years

    9,643       9,783  

Due after ten years

    71,617       73,049  

Total

  $ 95,833     $ 97,767  

 

 

Proceeds from the sales of securities available for sale and the gross realized gains and losses are as follows:

 

(Dollar amounts in thousands)

 

For the Three Months

Ended September 30,

   

For the Nine Months

Ended September 30,

 
   

2017

   

2016

   

2017

   

2016

 

Proceeds from sales

  $ 3,787     $ -     $ 6,474     $ 9,115  

Gross realized gains

    430       -       918

*

    306  

Gross realized losses

    (32 )     -       (32 )     (3 )

 

*Prior to the acquisition of Liberty Bank, N.A., the Company had a previously held equity interest in Liberty which was re-measured at fair value on the acquisition date and resulted in a gain of $488,000, which was recorded in Investment Securities Gains on the consolidated Income Statement for the nine months ended September 30, 2017.

 

Investment securities with an approximate carrying value of $64.9 million and $60.3 million at September 30, 2017 and December 31, 2016, respectively, were pledged to secure deposits and other purposes as required by law. Cash of $4.5 million at September 30, 2017 was also pledged to secure deposits and other purposes as required by law.

 

18

 

 

The following tables show the Company’s gross unrealized losses and fair value, aggregated by investment category and length of time that the individual securities have been in a continuous unrealized loss position.

 

   

September 30, 2017

 
   

Less than Twelve Months

   

Twelve Months or Greater

   

Total

 
           

Gross

           

Gross

           

Gross

 
   

Fair

   

Unrealized

   

Fair

   

Unrealized

   

Fair

   

Unrealized

 

(Dollar amounts in thousands)

 

Value

   

Losses

   

Value

   

Losses

   

Value

   

Losses

 
                                                 

U.S. government agency securities

  $ 952     $ (9 )   $ 3,211     $ (47 )   $ 4,163     $ (56 )

Obligations of states and political subdivisions

                                               

Tax-exempt

    3,008       (18 )     2,112       (41 )     5,120       (59 )

Mortgage-backed securities in government-sponsored entities

    7,997       (57 )     3,798       (113 )     11,795       (170 )

Total

  $ 11,957     $ (84 )   $ 9,121     $ (201 )   $ 21,078     $ (285 )

 

   

December 31, 2016

 
   

Less than Twelve Months

   

Twelve Months or Greater

   

Total

 
           

Gross

           

Gross

           

Gross

 
   

Fair

   

Unrealized

   

Fair

   

Unrealized

   

Fair

   

Unrealized

 
   

Value

   

Losses

   

Value

   

Losses

   

Value

   

Losses

 
                                                 

U.S. government agency securities

  $ 3,803     $ (47 )   $ 1,316     $ (49 )   $ 5,119     $ (96 )

Obligations of states and political subdivisions

                                               

Taxable

    502       (4 )     -       -       502       (4 )

Tax-exempt

    23,554       (522 )     -       -       23,554       (522 )

Mortgage-backed securities in government-sponsored entities

    9,066       (126 )     4,438       (135 )     13,504       (261 )

Total

  $ 36,925     $ (699 )   $ 5,754     $ (184 )   $ 42,679     $ (883 )

 

 

There were 28 securities considered temporarily impaired at September 30, 2017.

 

On a quarterly basis, the Company performs an assessment to determine whether there have been any events or economic circumstances indicating that a security with an unrealized loss has suffered other-than-temporary impairment (“OTTI”). A debt security is considered impaired if the fair value is less than its amortized cost basis at the reporting date. The Company assesses whether the unrealized loss is other than temporary.

 

OTTI losses are recognized in earnings when the Company has the intent to sell the debt security or it is more likely than not that it will be required to sell the debt security before recovery of its amortized cost basis. However, even if the Company does not expect to sell a debt security, it must evaluate expected cash flows to be received and determine if a credit loss has occurred.

 

An unrealized loss is generally deemed to be other than temporary and a credit loss is deemed to exist if the present value of the expected future cash flows is less than the amortized cost basis of the debt security. As a result the credit loss component of an OTTI is recorded as a component of investment securities gains (losses) in the accompanying Consolidated Statement of Income, while the remaining portion of the impairment loss is recognized in other comprehensive income, provided the Company does not intend to sell the underlying debt security and it is “more likely than not” that the Company will not have to sell the debt security prior to recovery.

 

Debt securities issued by U.S. government agencies, U.S. government-sponsored enterprises, and state and political subdivisions accounted for 99% of the total available-for-sale portfolio as of September 30, 2017 and no credit losses are expected, given the explicit and implicit guarantees provided by the U.S. federal government and the lack of prolonged unrealized loss positions within the obligations of state and political subdivisions security portfolio. The Company considers the following factors in determining whether a credit loss exists and the period over which the debt security is expected to recover:

 

 

The length of time and the extent to which the fair value has been less than the amortized cost basis.

     
 

Changes in the near-term prospects of the underlying collateral of a security such as changes in default rates, loss severity given default and significant changes in prepayment assumptions;

 

19

 

 

 

The level of cash flows generated from the underlying collateral supporting the principal and interest payments of the debt securities; and

     
 

Any adverse change to the credit conditions and liquidity of the issuer, taking into consideration the latest information available about the overall financial condition of the issuer, credit ratings, recent legislation and government actions affecting the issuer’s industry and actions taken by the issuer to deal with the present economic climate.

 

For the nine months ended September 30, 2017 and 2016, there were no available-for-sale debt securities with an unrealized loss that suffered OTTI. Management does not believe any individual unrealized loss as of September 30, 2017 or December 31, 2016 represented an other-than-temporary impairment. The unrealized losses on debt securities are primarily the result of interest rate changes. These conditions will not prohibit the Company from receiving its contractual principal and interest payments on these debt securities. The fair value of these debt securities is expected to recover as payments are received on these securities and they approach maturity. Should the impairment of any of these securities become other than temporary, the cost basis of the investment will be reduced and the resulting loss recognized in net income in the period the other-than-temporary impairment is identified.

 

NOTE 7 - LOANS AND RELATED ALLOWANCE FOR LOAN AND LEASE LOSSES

 

Major classifications of loans are summarized as follows (in thousands):

 

   

September 30,

   

December 31,

 
   

2017

   

2016

 
                 

Commercial and industrial

  $ 99,314     $ 60,630  

Real estate - construction

    40,760       23,709  

Real estate - mortgage:

               

Residential

    316,191       270,830  

Commercial

    403,135       249,490  

Consumer installment

    19,141       4,481  
      878,541       609,140  

Less: Allowance for loan and lease losses

    6,852       6,598  
                 

Net loans

  $ 871,689     $ 602,542  

 

The amounts above include deferred loan origination costs of $2.0 million and $1.7 million at September 30, 2017 and December 31, 2016, respectively.

 

The Company’s primary business activity is with customers located within its local Northeastern Ohio trade area, eastern Geauga County, and contiguous counties to the north, east, and south. The Company also serves the central Ohio market with offices in Dublin, Sunbury and Westerville, Ohio. The Northeastern Ohio trade area includes the newly acquired Liberty locations in Beachwood, Twinsburg, and Solon, Ohio. Commercial, residential, consumer, and agricultural loans are granted. Although the Company has a diversified loan portfolio, loans outstanding to individuals and businesses are dependent upon the local economic conditions in the Company’s immediate trade area.

 

Loans that management has the intent and ability to hold for the foreseeable future or until maturity or payoff generally are reported at their outstanding unpaid principal balances net of the allowance for loan and lease losses. Interest income is recognized as income when earned on the accrual method. The accrual of interest is discontinued on a loan when management believes, after considering economic and business conditions, the borrower’s financial condition is such that collection of interest is doubtful. Interest received on nonaccrual loans is recorded as income or applied against principal according to management’s judgment as to the collectability of such principal.

 

Loan origination fees and certain direct loan origination costs are being deferred and the net amount amortized as an adjustment of the related loan’s yield.  Management is amortizing these amounts over the contractual life of the related loans.

 

20

 

 

The following tables summarize the primary segments of the loan portfolio and allowance for loan and lease losses (in thousands):

 

                   

Real Estate- Mortgage

                 

September 30, 2017

 

Commercial and industrial

   

Real estate- construction

   

Residential

   

Commercial

   

Consumer installment

   

Total

 

Loans:

                                               

Individually evaluated for impairment

  $ 3,038     $ 185     $ 2,844     $ 5,788     $ 4     $ 11,859  

Collectively evaluated for impairment

    96,276       40,575       313,347       397,347       19,137       866,682  

Total loans

  $ 99,314     $ 40,760     $ 316,191     $ 403,135     $ 19,141     $ 878,541  

 

 

                   

Real estate- Mortgage

                 

December 31, 2016

 

Commercial and industrial

   

Real estate- construction

   

Residential

   

Commercial

   

Consumer installment

   

Total

 

Loans:

                                               

Individually evaluated for impairment

  $ 1,190     $ 913     $ 3,135     $ 7,187     $ 5     $ 12,430  

Collectively evaluated for impairment

    59,440       22,796       267,695       242,303       4,476       596,710  

Total loans

  $ 60,630     $ 23,709     $ 270,830     $ 249,490     $ 4,481     $ 609,140  

 

 

                   

Real Estate- Mortgage

                 

September 30, 2017

 

Commercial and industrial

   

Real estate- construction

   

Residential

   

Commercial

   

Consumer installment

   

Total

 

Allowance for loan and lease losses:

                                               

Ending allowance balance attributable to loans:

                                               

Individually evaluated for impairment

  $ 436     $ -     $ 132     $ 692     $ -     $ 1,260  

Collectively evaluated for impairment

    291       259       1,704       2,991       347       5,592  

Total ending allowance balance

  $ 727     $ 259     $ 1,836     $ 3,683     $ 347     $ 6,852  

 

                   

Real Estate- Mortgage

                 

December 31, 2016

 

Commercial and industrial

   

Real estate- construction

   

Residential

   

Commercial

   

Consumer installment

   

Total

 

Allowance for loan and lease losses:

                                               

Ending allowance balance attributable to loans:

                                               

Individually evaluated for impairment

  $ 90     $ -     $ 251     $ 186     $ -     $ 527  

Collectively evaluated for impairment

    358       172       2,567       2,949       25       6,071  

Total ending allowance balance

  $ 448     $ 172     $ 2,818     $ 3,135     $ 25     $ 6,598  

 

 

The Company’s loan portfolio is segmented to a level that allows management to monitor risk and performance. The portfolio is segmented into Commercial and Industrial (“C&I”), Real Estate Construction, Real Estate - Mortgage which is further segmented into Residential and Commercial real estate (“CRE”), and Consumer Installment Loans. The C&I loan segment consists of loans made for the purpose of financing the activities of commercial customers. The residential mortgage loan segment consists of loans made for the purpose of financing the activities of residential homeowners. The commercial mortgage loan segment consists of loans made for the purpose of financing the activities of commercial real estate owners and operators. The consumer loan segment consists primarily of installment loans and overdraft lines of credit connected with customer deposit accounts. The increase in the allowance for loan loss for C&I, Real Estate Construction, CRE, and Consumer Installment loan portfolios were partially offset by a decrease in the allowance for the Residential loan portfolio.

 

Management evaluates individual loans in all of the commercial segments for possible impairment based on guidance established by the Board of Directors. Loans are considered to be impaired when, based on current information and events, it is probable that the Company will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement.  Factors considered by management in evaluating impairment include payment status, collateral value, and the probability of collecting scheduled principal and interest payments when due. Management determines the significance of payment delays and payment shortfalls on a case-by-case basis, taking into consideration all of the circumstances surrounding the loan and the borrower, including the length of the delay, the reasons for the delay, the borrower’s prior payment record, and the amount of the shortfall in relation to the principal and interest owed. The Company does not separately evaluate individual consumer and residential mortgage loans for impairment, unless such loans are part of a larger relationship that is impaired, or the loan was modified in a troubled debt restructuring.

 

21

 

 

Once the determination has been made that a loan is impaired, the determination of whether a specific allocation of the allowance is necessary is measured by comparing the recorded investment in the loan to the fair value of the loan using one of the following methods: (a) the present value of expected future cash flows discounted at the loan’s effective interest rate; (b) the loan’s observable market price; or (c) the fair value of the collateral less selling costs. The method is selected on a loan-by-loan basis, with management primarily utilizing the fair value of collateral method. The evaluation of the need and amount of a specific allocation of the allowance and whether a loan can be removed from impairment status is made on a quarterly basis. The Company’s policy for recognizing interest income on impaired loans does not differ from its overall policy for interest recognition.

 

The following tables present impaired loans by class, segregated by those for which a specific allowance was required and those for which a specific allowance was not necessary (in thousands):

 

September 30, 2017

 

Impaired Loans

 
           

Unpaid

         
   

Recorded

    Principal    

Related

 
   

Investment

    Balance    

Allowance

 

With no related allowance recorded:

                       

Commercial and industrial

  $ 1,368     $ 1,550     $ -  

Real estate - construction

    185       185       -  

Real estate - mortgage:

                       

Residential

    1,875       2,092       -  

Commercial

    2,969       3,108       -  

Total

  $ 6,397     $ 6,935     $ -  
                         

With an allowance recorded:

                       

Commercial and industrial

  $ 1,670     $ 2,115     $ 436  

Real estate - mortgage:

                       

Residential

    969       1,005       132  

Commercial

    2,819       2,984       692  

Consumer installment

    4       4       -  

Total

  $ 5,462     $ 6,108     $ 1,260  
                         

Total:

                       

Commercial and industrial

  $ 3,038     $ 3,665     $ 436