EX-13 2 ex_106628.htm EXHIBIT 13 ex_106628.htm
 

Exhibit 13

 

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

 

 

 

To the Stockholders and the Board of Directors of Middlefield Banc Corp. 

 

Opinion on the Financial Statements

 

We have audited the accompanying consolidated balance sheet of Middlefield Banc Corp. and subsidiaries (the “Company”) as of December 31, 2017 and 2016; the related consolidated statements of income, comprehensive income, changes in stockholders’ equity, and cash flows for each of the three years in the period ended December 31, 2017; and the related notes to the consolidated financial statements (collectively, the financial statements). In our opinion, the financial statements present fairly, in all material respects, the financial position of the Company as of December 31, 2017 and 2016, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2017, conformity with accounting principles generally accepted in the United States of America.

 

We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the Company’s internal control over financial reporting as of December 31, 2017, based on criteria established in Internal Control – Integrated Framework, issued by the Committee of Sponsoring Organizations of the Treadway Commission in 2013, and our report dated March 7, 2018, expressed an unqualified opinion on the effectiveness of the Company’s internal control over financial reporting.

 

Basis for Opinion

 

These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on the Company’s financial statements based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (PCAOB) and are required to be independent with respect to the Company in accordance with U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.

 

We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud. Our audits included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks.

 

 

1


 

 

Basis for Opinion (Continued)

 

Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audits provide a reasonable basis for our opinion.

 

We have served as the Company’s auditor since 1986.

 

 

/s/S.R. Snodgrass, P.C.

 

 

Cranberry Township, Pennsylvania

March 7, 2018

 

 

2

 

 

 

 

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

 

 

 

To the Stockholders and the Board of Middlefield Banc Corp. 

 

Opinion on Internal Control over Financial Reporting

 

We have audited Middlefield Banc Corp. and subsidiaries’ (the “Company”) internal control over financial reporting as of December 31, 2017, based on criteria established in Internal Control — Integrated Framework, issued by the Committee of Sponsoring Organizations of the Treadway Commission in 2013. In our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2017, based on criteria established in Internal Control — Integrated Framework, issued by the Committee of Sponsoring Organizations of the Treadway Commission in 2013. 

 

We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the consolidated balance sheet of the Company as of December 31, 2017 and 2016, and the related consolidated statements of income, comprehensive income, changes in stockholders’ equity, and cash flows for each of the three years in the period ended December 31, 2017, of the Company and our report dated March 7, 2018, expressed an unqualified opinion.

 

Basis for Opinion

 

The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting in the accompanying Management’s Annual Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on the Company’s internal control over financial reporting based on our audit. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.

 

We conducted our audit in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audit also included performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.

 

 

3


 

 

 

Definition and Limitations of Internal Control over Financial Reporting

 

A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the company’s assets that could have a material effect on the financial statements.

 

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

 

 

/s/S.R. Snodgrass, P.C.

 

 

Cranberry Township, Pennsylvania 

March 7, 2018

 

 

4


 

 

 

MIDDLEFIELD BANC CORP.

CONSOLIDATED BALANCE SHEET

(Dollar amounts in thousands, except shares)

 

   

December 31,

 
   

2017

   

2016

 
                 

ASSETS

               

Cash and due from banks

  $ 39,886     $ 31,395  

Federal funds sold

    -       1,100  

Cash and cash equivalents

    39,886       32,495  

Investment securities available for sale, at fair value

    95,283       114,376  

Loans held for sale

    463       634  

Loans

    923,213       609,140  

Less allowance for loan and lease losses

    7,190       6,598  

Net loans

    916,023       602,542  

Premises and equipment, net

    11,853       11,203  

Goodwill

    15,071       4,559  

Core deposit intangibles

    2,749       36  

Bank-owned life insurance

    15,652       13,540  

Other real estate owned

    212       934  

Accrued interest receivable and other assets

    9,144       7,502  
                 

TOTAL ASSETS

  $ 1,106,336     $ 787,821  
                 

LIABILITIES

               

Deposits:

               

Noninterest-bearing demand

  $ 192,438     $ 133,630  

Interest-bearing demand

    83,990       59,560  

Money market

    150,277       74,940  

Savings

    208,502       172,370  

Time

    242,987       189,434  

Total deposits

    878,194       629,934  

Short-term borrowings

    74,707       68,359  

Other borrowings

    29,065       9,437  

Accrued interest payable and other liabilities

    4,507       3,131  

TOTAL LIABILITIES

    986,473       710,861  

STOCKHOLDERS' EQUITY

               

Common stock, no par value; 10,000,000 shares authorized, 3,603,881 and 2,640,418 shares issued; 3,217,716 and 2,254,253 shares outstanding

    84,859       47,943  

Retained earnings

    47,431       41,334  

Accumulated other comprehensive income

    1,091       1,201  

Treasury stock, at cost; 386,165 shares

    (13,518 )     (13,518 )

TOTAL STOCKHOLDERS' EQUITY

    119,863       76,960  
                 

TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY

  $ 1,106,336     $ 787,821  

 

See accompanying notes to the consolidated financial statements.

 

5

 

 

 

MIDDLEFIELD BANC CORP.

CONSOLIDATED STATEMENT OF INCOME

(Dollar amounts in thousands, except per share data)

 

   

Year Ended December 31,

 
                         
   

2017

   

2016

   

2015

 

INTEREST AND DIVIDEND INCOME

                       

Interest and fees on loans

  $ 40,235     $ 25,798     $ 23,824  

Interest-bearing deposits in other institutions

    328       53       33  

Federal funds sold

    15       20       13  

Investment securities:

                       

Taxable interest

    762       1,106       1,467  

Tax-exempt interest

    2,406       2,913       3,160  

Dividends on stock

    249       104       98  

Total interest and dividend income

    43,995       29,994       28,595  
                         

INTEREST EXPENSE

                       

Deposits

    5,350       3,618       3,426  

Short-term borrowings

    753       322       194  

Other borrowings

    544       250       200  

Total interest expense

    6,647       4,190       3,820  
                         

NET INTEREST INCOME

    37,348       25,804       24,775  
                         

Provision for loan losses

    1,045       570       315  
                         

NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES

    36,303       25,234       24,460  
                         

NONINTEREST INCOME

                       

Service charges on deposit accounts

    1,875       1,940       1,874  

Investment securities gains, net

    886       303       323  

Earnings on bank-owned life insurance

    431       403       624  

Gain on sale of loans

    826       419       329  

Other income

    841       894       894  

Total noninterest income

    4,859       3,959       4,044  
                         

NONINTEREST EXPENSE

                       

Salaries and employee benefits

    13,758       10,249       9,751  

Occupancy expense

    1,846       1,252       1,253  

Equipment expense

    1,050       991       944  

Data processing costs

    1,792       1,335       1,071  

Ohio state franchise tax

    744       632       300  

Federal deposit insurance expense

    533       438       472  

Professional fees

    1,752       1,441       1,247  

Net loss (gain) on other real estate owned

    30       (119 )     563  

Advertising expense

    821       734       721  

Core deposit intangible amortization

    374       40       40  

Merger expense

    1,060       -       -  

Other expense

    3,725       3,879       3,715  

Total noninterest expense

    27,485       20,872       20,077  
                         

Income before income taxes

    13,677       8,321       8,427  

Income taxes

    4,222       1,905       1,562  
                         

NET INCOME

  $ 9,455     $ 6,416     $ 6,865  
                         

EARNINGS PER SHARE

                       

Basic

  $ 3.12     $ 3.04     $ 3.41  

Diluted

    3.10       3.03       3.39  
                         

DIVIDENDS DECLARED PER SHARE

  $ 1.08     $ 1.08     $ 1.07  

 

See accompanying notes to the consolidated financial statements.

 

6

 

 

 

MIDDLEFIELD BANC CORP.

CONSOLIDATED STATEMENT OF COMPREHENSIVE INCOME

(Dollar amounts in thousands)

 

   

Year Ended December 31,

 
   

2017

   

2016

   

2015

 
                         

Net income

  $ 9,455     $ 6,416     $ 6,865  
                         

Other comprehensive loss:

                       

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

    719       (1,505 )     91  

Tax effect

    (244 )     511       (31 )
                         

Reclassification adjustment for investment securities gains included in net income

    (886 )     (303 )     (323 )

Tax effect

    301       103       110  
                         

Total other comprehensive loss

    (110 )     (1,194 )     (153 )
                         

Comprehensive income

  $ 9,345     $ 5,222     $ 6,712  

 

See accompanying notes to the consolidated financial statements.

 

7

 

 

 

MIDDLEFIELD BANC CORP.

CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY

(Dollar amounts in thousands, except shares and dividend per share amount)

 

                           

Accumulated

                 
                           

Other

           

Total

 
   

Common Stock

   

Retained

   

Comprehensive

   

Treasury

   

Stockholders'

 
   

Shares

   

Amount

   

Earnings

   

Income (Loss)

   

Stock

   

Equity

 

Balance, December 31, 2014

    2,242,025     $ 35,529     $ 32,524     $ 2,548     $ (6,734 )   $ 63,867  
                                                 

Net income

                    6,865                       6,865  

Other comprehensive loss

                            (153 )             (153 )

Purchase of treasury stock (196,635 shares)

                                    (6,784 )     (6,784 )

Dividend reinvestment and purchase plan

    20,393       651                               651  

Stock options exercised

    400       (7 )                             (7 )

Stock-based compensation expense

    585       18                               18  

Cash dividends ($1.07 per share)

                    (2,153 )                     (2,153 )
                                                 

Balance, December 31, 2015

    2,263,403     $ 36,191     $ 37,236     $ 2,395     $ (13,518 )   $ 62,304  
                                                 

Net income

                    6,416                       6,416  

Other comprehensive loss

                            (1,194 )             (1,194 )

Common stock issuance, net of issuance cost ($697)

    360,815       11,210                               11,210  

Dividend reinvestment and purchase plan

    15,300       519                               519  

Stock options exercised

    -       (6 )                             (6 )

Stock-based compensation expense

    900       29                               29  

Cash dividends ($1.08 per share)

                    (2,318 )                     (2,318 )
                                                 

Balance, December 31, 2016

    2,640,418     $ 47,943     $ 41,334     $ 1,201     $ (13,518 )   $ 76,960  
                                                 

Net income

                    9,455                       9,455  

Other comprehensive loss

                            (110 )             (110 )

Common stock issued in business combination

    544,610       20,995                               20,995  

Other common stock issuance, net of offering cost ($760)

    399,008       15,164                               15,164  

Dividend reinvestment and purchase plan

    11,721       540                               540  

Stock options exercised

    7,301       184                               184  

Stock-based compensation expense

    823       33                               33  

Cash dividends ($1.08 per share)

                    (3,358 )                     (3,358 )
                                                 

Balance, December 31, 2017

    3,603,881     $ 84,859     $ 47,431     $ 1,091     $ (13,518 )   $ 119,863  

 

See accompanying notes to the consolidated financial statements.

 

8

 

 

 

MIDDLEFIELD BANC CORP.

CONSOLIDATED STATEMENT OF CASH FLOWS

(Dollar amounts in thousands)

 

   

Year Ended December 31,

 
   

2017

   

2016

   

2015

 

OPERATING ACTIVITIES

                       

Net income

  $ 9,455     $ 6,416     $ 6,865  

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

                       

Provision for loan losses

    1,045       570       315  

Investment securities gains, net

    (886 )     (303 )     (323 )

Depreciation and amortization of premises and equipment, net

    1,291       1,026       973  

Amortization of premium and discount on investment securities, net

    451       119       669  

Accretion of deferred loan fees, net

    (451 )     (245 )     (603 )

Amortization of core deposit intangibles

    374       40       40  

Stock-based compensation expense

    33       29       18  

Origination of loans held for sale

    (10,020 )     (19,736 )     (17,889 )

Proceeds from sale of loans

    10,482       20,628       17,549  

Gain on sale of loans

    (291 )     (419 )     (329 )

Origination of student loans held for sale

    (365,674 )     -       -  

Proceeds from sale of student loans

    372,162       -       -  

Gain on sale of student loans

    (535 )     -       -  

Earnings on bank-owned life insurance

    (431 )     (403 )     (624 )

Deferred income taxes

    293       (93 )     558  

Net (gain) loss on other real estate owned

    30       (119 )     563  

Increase in accrued interest receivable

    (422 )     (39 )     (292 )

Increase in accrued interest payable

    136       -       80  

Other, net

    (3,122 )     330       (388 )

Net cash provided by operating activities

    13,920       7,801       7,182  
                         

INVESTING ACTIVITIES

                       

Investment securities available for sale:

                       

Proceeds from repayments and maturities

    14,899       23,201       13,497  

Proceeds from sale of securities

    6,474       9,063       15,686  

Purchases

    (3,080 )     (1,744 )     (21,946 )

Increase in loans, net

    (119,866 )     (76,199 )     (63,937 )

Proceeds from the sale of other real estate owned

    2,196       1,607       1,762  

Purchase of bank-owned life insurance

    -       -       (4,000 )

Purchase of premises and equipment

    (1,201 )     (2,166 )     (507 )

Purchase of restricted stock

    (899 )     (317 )     -  

Redemption of restricted stock

    795       -       -  

Proceeds from bank-owned life insurance

    -       575       -  

Acquisition, net of cash paid

    5,431       -       -  

Net cash used in investing activities

    (95,251 )     (45,980 )     (59,445 )
                         

FINANCING ACTIVITIES

                       

Net increase in deposits

    50,216       5,487       38,335  

Increase in short-term borrowings, net

    6,348       32,534       21,017  

Repayment of other borrowings

    (10,372 )     (502 )     (685 )

Proceeds from other borrowings

    30,000       -       -  

Proceeds from common stock issued

    15,164       11,210       -  

Stock options exercised

    184       (6 )     (7 )

Proceeds from dividend reinvestment and purchase plan

    540       519       651  

Purchase of treasury stock

    -       -       (6,784 )

Cash dividends

    (3,358 )     (2,318 )     (2,153 )

Net cash provided by financing activities

    88,722       46,924       50,374  
                         

Increase (decrease) in cash and cash equivalents

    7,391       8,745       (1,889 )
                         

CASH AND CASH EQUIVALENTS AT BEGINNING OF YEAR

    32,495       23,750       25,639  
                         

CASH AND CASH EQUIVALENTS AT END OF YEAR

  $ 39,886     $ 32,495     $ 23,750  

 

See accompanying notes to the consolidated financial statements.

 

9

 

 

SUPPLEMENTAL INFORMATION

                       

Cash paid during the year for:

                       

Interest on deposits and borrowings

  $ 6,511     $ 4,190     $ 3,740  

Income taxes

    5,705       1,335       800  
                         

Noncash investing transactions:

                       

Loans to facilitate the sale of other real estate owned

  $ -     $ 63     $ -  

Transfers from loans to other real estate owned

    1,179       720       638  

Life insurance proceeds not yet received from insurance company

    -       -       575  

Common stock issued in business acquisition

    20,995       -       -  
                         

Acquisition of Liberty

                       

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

    10,512       -       -  

Total noncash assets acquired

    218,383       -       -  
                         

Liabilities assumed

                       

Time deposits

    (30,744 )     -       -  

Deposits other than time deposits

    (167,300 )     -       -  

Accrued interest payable

    (47 )     -       -  

Deferred taxes

    (906 )     -       -  

Other liabilities

    (2,754 )     -       -  

Total liabilities assumed

    (201,751 )     -       -  
                         

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 the consolidated financial statements.

 

10

 

 

MIDDLEFIELD BANC CORP.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

 

1.

SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

 

A summary of the significant accounting and reporting policies applied in the presentation of the accompanying financial statements follows:

 

Nature of Operations and Basis of Presentation

 

Middlefield Banc Corp. (the “Company”) is an Ohio corporation organized to become the holding company of The Middlefield Banking Company (“MBC”). MBC is a state-chartered bank located in Ohio. On October 23, 2009, the Company established an asset resolution subsidiary named EMORECO, Inc. The Company and its subsidiaries derive substantially all of their income from banking and bank-related services, which includes interest earnings on residential real estate, commercial mortgage, commercial and consumer financings as well as interest earnings on investment securities and deposit services to its customers through fourteen full-service locations. The Company is supervised by the Board of Governors of the Federal Reserve System, while MBC is subject to regulation and supervision by the Federal Deposit Insurance Corporation and the Ohio Division of Financial Institutions.

 

The consolidated financial statements of the Company include its wholly owned subsidiaries, MBC and EMORECO, Inc. Significant intercompany items have been eliminated in preparing the consolidated financial statements.

 

On January 12, 2017, the Company completed its acquisition of 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, 2017.

 

The financial statements have been prepared in conformity with U.S. Generally Accepted Accounting Principles. In preparing the financial statements, management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities as of the balance sheet date and revenues and expenses for the period. Actual results could differ from those estimates.

 

Investment Securities

 

Investment securities are classified at the time of purchase, based on management’s intention and ability, as securities held to maturity or securities available for sale. Debt securities acquired with the intent and ability to hold to maturity are stated at cost adjusted for amortization of premium and accretion of discount, which are computed using a level yield method and recognized as adjustments of interest income. Certain other debt securities have been classified as available for sale to serve principally as a source of liquidity. Unrealized holding gains and losses for available-for-sale securities are reported as a separate component of stockholders’ equity, net of tax, until realized. Realized security gains and losses are computed using the specific identification method. Interest and dividends on investment securities are recognized as income when earned.

 

Securities are evaluated on at least a quarterly basis and more frequently when economic or market conditions warrant such an evaluation to determine whether a decline in their value is other than temporary. For debt securities, management considers whether the present value of cash flows expected to be collected are less than the security’s amortized cost basis (the difference defined as the credit loss), the magnitude and duration of the decline, the reasons underlying the decline and the Bank’s intent to sell the security or whether it is more likely than not that the Bank would be required to sell the security before its anticipated recovery in market value, to determine whether the loss in value is other than temporary. Once a decline in value is determined to be other than temporary, if the Bank does not intend to sell the security, and it is more likely than not that it will not be required to sell the security, before recovery of the security’s amortized cost basis, the charge to earnings is limited to the amount of credit loss. Any remaining difference between fair value and amortized cost (the difference defined as the non-credit portion) is recognized in other comprehensive income, net of applicable taxes. Otherwise, the entire difference between fair value and amortized cost is charged to earnings. For equity securities where the fair value has been significantly below cost for one year, the Bank’s policy is to recognize an impairment loss unless sufficient evidence is available that the decline is not other than temporary and a recovery period can be predicted.

 

11

 

 

Restricted Stock

 

Common stock of the Federal Home Loan Bank (“FHLB”) represents ownership in an institution that is wholly owned by other financial institutions. This equity security is accounted for at cost and classified with other assets. The FHLB of Cincinnati has reported profits for 2017 and 2016, remains in compliance with regulatory capital and liquidity requirements, and continues to pay dividends on the stock and make redemptions at the par value. With consideration given to these factors, management concluded that the stock was not impaired at December 31, 2017 or 2016.

 

Mortgage Banking Activities 

 

Mortgage loans originated and intended for sale in the secondary market are carried at fair value. The Bank sells the loans on a servicing retained basis. Servicing rights are initially recorded at fair value with the income statement effect recorded in gains on sales of loans. The Bank measures servicing assets using the amortization method. Fair value is based on market prices for comparable mortgage servicing contracts, when available, or alternatively, is based on a valuation model that calculates the present value of estimated future net servicing income. Loan servicing rights are amortized in proportion to and over the period of estimated net future servicing revenue. The expected period of the estimated net servicing income is based in part on the expected prepayment of the underlying mortgages. The unamortized balance of mortgage servicing rights is included in accrued interest and other assets on the Consolidated Balance Sheet.

 

Mortgage servicing rights are periodically evaluated for impairment. Impairment represents the excess of amortized cost over its estimated fair value. Impairment is determined by stratifying rights into tranches based on predominant risk characteristics, such as interest rate and original time to maturity. Any impairment is reported as a valuation allowance for an individual tranche. If the Company later determines that all or a portion of the impairment no longer exists for a particular grouping, a reduction of the allowance will be recorded as an increase to income.

 

Servicing fee income is recorded for fees earned for servicing loans. The fees are based on a contractual percentage of outstanding principal and are recorded as income when earned. The amortization of mortgage servicing rights is netted against loan servicing fee income. Late fees and ancillary fees related to loan servicing are not material. The Bank is servicing loans for others in the amount of $50.4 million and $39.9 million at December 31, 2017 and 2016, respectively.

 

Loans

 

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.

 

Allowance for Loan and Lease Losses

 

The allowance for loan and lease losses represents the amount which management estimates is adequate to provide for probable loan losses inherent in the loan portfolio. The allowance method is used in providing for loan losses. Accordingly, all loan losses are charged to the allowance, and all recoveries are credited to it. The allowance for loan and lease losses is established through a provision for loan losses which is charged to operations. The provision is based on management’s periodic evaluation of the adequacy of the allowance for loan and lease losses, which encompasses the overall risk characteristics of the various portfolio segments, past experience with losses, the impact of economic conditions on borrowers, and other relevant factors. The estimates used in determining the adequacy of the allowance for loan and lease losses, including the amounts and timing of future cash flows expected on impaired loans, are particularly susceptible to significant change in the near term.

 

A loan is considered impaired when it is probable the borrower will not repay the loan according to the original contractual terms of the loan agreement. Management has determined that first mortgage loans on one-to-four family properties and all consumer loans represent large groups of smaller-balance homogeneous loans that are to be collectively evaluated. Loans that experience insignificant payment delays, which are defined as 90 days or less, generally are not classified as impaired. A loan is not impaired during a period of delay in payment if the Company expects to collect all amounts due, including interest accrued, at the contractual interest rate for the period of delay. All loans identified as impaired are evaluated independently by management. The Company estimates credit losses on impaired loans based on the present value of expected cash flows or the fair value of the underlying collateral if the loan repayment is expected to come from the sale or operation of such collateral. Impaired loans, or portions thereof, are charged off when it is determined a realized loss has occurred. Until such time, an allowance for loan and lease losses is maintained for estimated losses. Cash receipts on impaired loans are applied first to accrued interest receivable unless otherwise required by the loan terms, except when an impaired loan is also a nonaccrual loan, in which case the portion of the payment related to interest is used to reduce principal.

 

12

 

 

Mortgage loans secured by one-to-four family properties and all consumer loans are large groups of smaller-balance homogeneous loans and are measured for impairment collectively. Management determines the significance of payment delays on a case-by-case basis, taking into consideration all circumstances concerning the loan, the creditworthiness and payment history of the borrower, the length of the payment delay, and the amount of shortfall in relation to the principal and interest owed.

 

Loans Acquired

 

Loans acquired including loans that have evidence of deterioration of credit quality since origination and for which it is probable, at acquisition, that the Company will be unable to collect all contractually required payments receivable, are initially recorded at fair value (as determined by the present value of expected future cash flows) with no valuation allowance. Loans are evaluated individually to determine if there is evidence of deterioration of credit quality since origination. The difference between the undiscounted cash flows expected at acquisition and the investment in the loan, or the “accretable yield,” is recognized as interest income on a level-yield method over the life of the loan. Contractually required payments for interest and principal that exceed the undiscounted cash flows expected at acquisition, or the “non-accretable difference,” are not recognized as a yield adjustment or as a loss accrual or a valuation allowance. Increases in expected cash flows subsequent to the initial investment are recognized prospectively through adjustment of the yield on the loan over its remaining estimated life. Decreases in expected cash flows are recognized immediately as impairment. Any valuation allowances on these impaired loans reflect only losses incurred after acquisition.

 

For purchased loans acquired that are not deemed impaired at acquisition, credit discounts representing the principal losses expected over the life of the loan are a component of the initial fair value. Loans are aggregated and accounted for as a pool of loans if the loans being aggregated have common risk characteristics. Subsequent to the purchase date, the methods utilized to estimate the required allowance for credit losses for these loans is similar to originated loans; however, the Company records a provision for loan losses only when the required allowance exceeds any remaining credit discounts. The remaining differences between the purchase price and the unpaid principal balance at the date of acquisition are recorded in interest income over the life of the loans.

 

Premises and Equipment

 

Land is carried at cost. Premises and equipment are stated at cost net of accumulated depreciation. Depreciation is computed on the straight-line method over the estimated useful lives of the assets, which range from 3 to 20 years for furniture, fixtures, and equipment and 3 to 40 years for buildings and leasehold improvements. Expenditures for maintenance and repairs are charged against income as incurred. Costs of major additions and improvements are capitalized.

 

Goodwill

 

The Company accounts for goodwill using a three-step process for testing the impairment of goodwill on at least an annual basis. This approach could cause more volatility in the Company’s reported net income because impairment losses, if any, could occur irregularly and in varying amounts. No impairment of goodwill was recognized in any of the periods presented.

 

Intangible Assets

 

Intangible assets include core deposit intangibles, which are a measure of the value of consumer demand and savings deposits acquired in business combinations accounted for as purchases. The core deposit intangibles are being amortized to their estimated residual values over their expected useful lives, commonly of ten years. The recoverability of the carrying value of intangible assets is evaluated on an ongoing basis, and permanent declines in value, if any, are charged to expense.

 

Bank-Owned Life Insurance (“BOLI”)

 

The Company owns insurance on the lives of a certain group of key employees. The policies were purchased to help offset the increase in the costs of various fringe benefit plans including healthcare. The cash surrender value of these policies is included as an asset on the Consolidated Balance Sheet and any increases in the cash surrender value are recorded as noninterest income on the Consolidated Statement of Income. In the event of the death of an insured individual under these policies, the Company would receive a death benefit, which would be recorded as noninterest income.

 

Other Real Estate Owned

 

Real estate properties acquired through foreclosure are initially recorded at fair value at the date of foreclosure, establishing a new cost basis. After foreclosure, management periodically performs valuations and the real estate is carried at the lower of cost or fair value less estimated cost to sell. Revenue and expenses from operations of the properties, gains or losses on sales and additions to the valuation allowance are included in operating results.

 

13

 

 

Income Taxes

 

The Company and its subsidiaries file a consolidated federal income tax return. Deferred tax assets and liabilities are reflected at currently enacted income tax rates applicable to the period in which the deferred tax assets or liabilities are expected to be realized or settled. As changes in tax laws or rates are enacted, deferred tax assets and liabilities are adjusted through the provision for income taxes.

 

Earnings Per Share

 

The Company provides dual presentation of basic and diluted earnings per share. Basic earnings per share is calculated utilizing net income as reported in the numerator and average shares outstanding in the denominator. The computation of diluted earnings per share differs in that the dilutive effects of any stock options, warrants, and convertible securities are adjusted in the denominator.

 

Stock-Based Compensation

 

The Company accounts for stock compensation based on the grant date fair value of all share-based payment awards that are expected to vest, including employee share options to be recognized as employee compensation expense over the requisite service period.

 

Compensation cost is recognized for restricted stock units issued to employees based on the fair value of these awards at the date of grant. The market price of the Company’s common shares at the date of grant is used to estimate the fair value of restricted stock units and stock awards. Compensation cost is recognized over the required service period, generally defined as the vesting period, and is recorded in "Salaries" expense. (See Note 14-Employee Benefits)

 

Cash Flow Information

 

The Company has defined cash and cash equivalents as those amounts included in the Consolidated Balance Sheet captions as “Cash and due from banks” and “Federal funds sold” with original maturities of less than 90 days.

 

Advertising Costs

 

Advertising costs are expensed as incurred.

 

Reclassification of Comparative Amounts

 

Certain comparative amounts for prior years have been reclassified to conform to current-year presentations. Such reclassifications did not affect net income or retained earnings.

 

Recent Accounting Pronouncements:

 

In May 2014, the FASB issued ASU 2014-09, Revenue from Contracts with Customers (a new revenue recognition standard). The Update’s core principle is that a company will recognize revenue 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 addition, this Update specifies the accounting for certain costs to obtain or fulfill a contract with a customer and expands disclosure requirements for revenue recognition. This Update is effective for annual reporting periods beginning after December 15, 2016, including interim periods within that reporting period. Since the guidance does not apply to revenue associated with financial instruments, including loan receivables and investment securities, we do not expect the adoption of the new standard, or any of the amendments, to result in a material change from our current accounting for revenue because the majority of the Company's revenue is not within the scope of Topic 606.  However, we do expect that the standard will result in new disclosure requirements, which are currently being evaluated.

 

In August 2015, the FASB issued ASU 2015-14, Revenue from Contracts with Customers (Topic 606). The amendments in this Update defer the effective date of ASU 2014-09 for all entities by one year. Public business entities, certain not-for-profit entities, and certain employee benefit plans should apply the guidance in ASU 2014-09 to annual reporting periods beginning after December 15, 2017, including interim reporting periods within that reporting period. All other entities should apply the guidance in ASU 2014-09 to annual reporting periods beginning after December 15, 2018, and interim reporting periods within annual reporting periods beginning after December 15, 2019. The Company is evaluating the effect of adopting this new accounting Update.

 

14

 

 

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.

 

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 recording 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. Management is currently evaluating the impact of the adoption of this guidance on the Company's consolidated financial statements. Management will oversee the implementation of CECL and is currently in the process of implementing a software solution to assist in the adoption of this ASU. Management plans to run the current incurred loss model and the CECL model concurrently for 12 months prior to the adoption of this guidance on January 1, 2020.

 

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.

 

15

 

 

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 the Company’s financial position or results of operations.

 

In February 2018, the FASB issued ASU 2018-02, Income Statement – Reporting Comprehensive Income (Topic 220), which allows for optional reclassification of stranded tax effects related to the Tax Cuts and Jobs Act of 2017 (TCJA). When elected, this Update requires all stranded tax effects related to the TCJA to be reclassified (i.e., including other income tax effects not specifically related to the change in rates). Entities electing to reclassify stranded tax effects related to the TCJA are required to disclose that the election was made, including a description of the other income tax effects, if any, related to the TCJA that were reclassified. Entities not electing to reclassify stranded tax effects related to the TCJA are required to disclose, in the period of adoption, that the election was not made. In addition, all entities are required to disclose their accounting policy for releasing income tax effects from accumulated other comprehensive income (i.e., including those income tax effects not related to the TCJA). This Update requires certain additional transitional disclosures. Application is allowed at the beginning of the period of adoption (annual or interim) or retrospectively and is effective for all entities for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2018. All entities, including public entities, that have not yet issued their financial statements may early adopt the standard. The Company is currently evaluating the impact the adoption of the standard will have on the Company’s financial position or results of operations.

 

 

2.

EARNINGS PER SHARE

 

There are no convertible securities that would affect the numerator in calculating basic and diluted earnings per share; therefore, net income as presented on the Consolidated Statement of Income will be used as the numerator. 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 year ended December 31:

 

   

2017

   

2016

   

2015

 

Weighted-average common shares outstanding

    3,415,115       2,494,022       2,251,365  
                         

Average treasury stock shares

    (386,165 )     (386,165 )     (236,399 )
                         

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

    3,028,950       2,107,857       2,014,966  
                         

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

    23,635       11,357       9,154  
                         

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

    3,052,585       2,119,214       2,024,120  

 

Options to purchase 19,750 shares of common stock at prices ranging from $17.55 to $23.00 were outstanding during the year ended December 31, 2017. Also outstanding were 14,601 shares of restricted stock units. None of the outstanding options or RSU’s were anti-dilutive.

 

16

 

 

Options to purchase 29,324 shares of common stock at prices ranging from $17.55 to $37.48 were outstanding during the year ended December 31, 2016. Of those options, 29,324 were considered dilutive based on the average market price exceeding the strike price for the year ended December 31, 2016, 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 year ended December 31, 2015. Of those options, 27,250 were considered dilutive based on the average market price exceeding the strike price for the year ended December 31, 2015, and 4,699 options were anti-dilutive.

 

 

3.

INVESTMENT SECURITIES AVAILABLE FOR SALE

 

The amortized cost, gross gains and losses and fair values of securities available for sale are as follows:

 

   

December 31, 2017

 
           

Gross

   

Gross

         
   

Amortized

   

Unrealized

   

Unrealized

   

Fair

 

(Dollar amounts in thousands)

 

Cost

   

Gains

   

Losses

   

Value

 
                                 

U.S. government agency securities

  $ 8,664     $ 126     $ (71 )   $ 8,719  

Obligations of states and political subdivisions:

                               

Taxable

    504       8       -       512  

Tax-exempt

    65,408       1,547       (38 )     66,917  

Mortgage-backed securities in government-sponsored entities

    18,640       157       (287 )     18,510  

Total debt securities

    93,216       1,838       (396 )     94,658  

Equity securities in financial institutions

    415       210       -       625  

Total

  $ 93,631     $ 2,048     $ (396 )   $ 95,283  

 

   

December 31, 2016

 
           

Gross

   

Gross

         
   

Amortized

   

Unrealized

   

Unrealized

   

Fair

 

(Dollar amounts in thousands)

 

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  

 

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The amortized cost and fair value of debt securities at December 31, 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

  $ 2,340     $ 2,377  

Due after one year through five years

    9,718       9,878  

Due after five years through ten years

    10,992       11,012  

Due after ten years

    70,166       71,391  
                 

Total

  $ 93,216     $ 94,658  

 

Investment securities with an approximate carrying value of $57.9 million and $60.3 million at December 31, 2017 and 2016, respectively, were pledged to secure deposits and other purposes as required by law.

 

 

 

Proceeds from the sales of securities available for sale and the gross realized gains and losses for the years ended December 31, 2017 through 2015, are as follows (in thousands):

 

   

2017

   

2016

   

2015

 

Proceeds from sales

  $ 6,474     $ 9,063     $ 15,686  

Gross realized gains

    911

 

*   309       440  

Gross realized losses

    (25 )     (6 )     (117 )

 

*Prior to the acquisition of Liberty, 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 year ended December 31, 2017.

 

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.

   

December 31, 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

  $ 557     $ (4 )   $ 4,036     $ (67 )   $ 4,593     $ (71 )

Obligations of states and political subdivisions

                                               

Tax-exempt

    1,009       (6 )     2,784       (32 )     3,793       (38 )

Mortgage-backed securities in government-sponsored entities

    5,698       (71 )     8,734       (216 )     14,432       (287 )

Total

  $ 7,264     $ (81 )   $ 15,554     $ (315 )   $ 22,818     $ (396 )

 

   

December 31, 2016

 
   

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

  $ 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 )

 

18

 

 

There were 29 securities that were considered temporarily impaired at December 31, 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 accounting literature requires the Company to assess whether the unrealized loss is other than temporary. For equity securities where the fair value has been significantly below cost for one year, the Company’s policy is to recognize an impairment loss unless sufficient evidence is available that the decline is not other than temporary and a recovery period can be predicted.

 

The Company has asserted that at December 31, 2017 and 2016, the declines outlined in the above table represent temporary declines and the Company does not intend to sell and does not believe it will be required to sell these securities before recovery of their cost basis, which may be at maturity. The Company has concluded that any impairment of its investment securities portfolio outlined in the above table is not other than temporary and is the result of interest rate changes, sector credit rating changes, or company-specific rating changes that are not expected to result in the non-collection of principal and interest during the period.

 

Debt securities issued by U.S. government agencies, U.S. government-sponsored enterprises, and state and political subdivisions accounted for 99.3% of the total available-for-sale portfolio as of December 31, 2017, and no credit losses are expected, given the explicit and implicit guarantees provided by the U.S. federal government and the lack of significant unrealized loss positions within the obligations of state and political subdivisions security portfolio. The Company evaluates credit losses on a quarterly basis. The Company considered 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.

 

 

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

 

 

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.

 

 

4.

LOANS AND RELATED ALLOWANCE FOR LOAN AND LEASE LOSSES

 

Major classifications of loans at December 31 are summarized as follows (in thousands):

   

2017

   

2016

 
                 

Commercial and industrial

  $ 101,346     $ 60,630  

Real estate - construction

    47,017       23,709  

Real estate - mortgage:

               

Residential

    318,157       270,830  

Commercial

    437,947       249,490  

Consumer installment

    18,746       4,481  
      923,213       609,140  

Less: Allowance for loan and lease losses

    (7,190 )     (6,598 )
                 

Net loans

  $ 916,023     $ 602,542  

 

The amounts above include net deferred loan origination costs of $1.5 million and $1.7 million at December 31, 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 at December 31, 2017 and 2016, loans outstanding to individuals and businesses are dependent upon the local economic conditions in the Company’s immediate trade area.

 

19

 

 

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

 

                   

Real Estate- Mortgage

                 

December 31, 2017

 

Commercial and

industrial

   

Real estate-

construction

   

Residential

   

Commercial

     

Consumer installment 

   

Total

 

Loans:

                                               

Individually evaluated for impairment

  $ 3,627     $ 44     $ 2,824     $ 5,610     $ 4     $ 12,109  

Collectively evaluated for impairment

    97,719       46,973       315,333       432,337       18,742       911,104  

Total loans

  $ 101,346     $ 47,017     $ 318,157     $ 437,947     $ 18,746     $ 923,213  

 

 

                   

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

                 

December 31, 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

  $ 694     $ -     $ 140     $ 733     $ -     $ 1,567  

Collectively evaluated for impairment

    305       313       1,620       3,303       82       5,623  

Total ending allowance balance

  $ 999     $ 313     $ 1,760     $ 4,036     $ 82     $ 7,190  

 

 

                   

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, 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.

 

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.

 

20

 

 

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 three 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):

 

December 31, 2017

 

Impaired Loans

 
           

Unpaid

         
   

Recorded

    Principal    

Related

 
   

Investment

    Balance    

Allowance

 
With no related allowance recorded:                        

Commercial and industrial

  $ 450     $ 1,006     $ -  

Real estate - construction

    44       44       -  

Real estate - mortgage:

                       

Residential

    1,685       1,904       -  

Commercial

    1,870       1,984       -  

Consumer installment

    4       4       -  

Total

  $ 4,053     $ 4,942     $ -  
                         

With an allowance recorded:

                       

Commercial and industrial

  $ 3,177     $ 3,888     $ 694  

Real estate - mortgage:

                       

Residential

    1,139       1,179       140  

Commercial

    3,740       3,913       733  

Total

  $ 8,056     $ 8,980     $ 1,567  
                         

Total:

                       

Commercial and industrial

  $ 3,627     $ 4,894     $ 694  

Real estate - construction

    44       44       -  

Real estate - mortgage:

                       

Residential

    2,824       3,083       140  

Commercial

    5,610       5,897       733  

Consumer installment

    4       4       -  

Total

  $ 12,109     $ 13,922     $ 1,567  

 

21

 

 

December 31, 2016

 

Impaired Loans

 
           

Unpaid

         
   

Recorded

    Principal    

Related

 
   

Investment

    Balance    

Allowance

 
With no related allowance recorded:                        

Commercial and industrial

  $ 319     $ 318     $ -  

Real estate - construction

    913       909       -  

Real estate - mortgage:

                       

Residential

    2,142       2,140       -  

Commercial

    2,031       2,027       -  

Total

  $ 5,405     $ 5,394     $ -  
                         

With an allowance recorded:

                       

Commercial and industrial

  $ 871     $ 868     $ 90  

Real estate - mortgage:

                       

Residential

    993       991       251  

Commercial

    5,156       5,147       186  

Consumer installment

    5