EX-13 2 ex_135978.htm EXHIBIT 13 ex_135978.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 sheets of Middlefield Banc Corp. and subsidiaries (the “Company”) as of December 31, 2018 and 2017; the related consolidated statements of income, comprehensive income, changes in stockholders’ equity, and cash flows for the years then ended; 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, 2018 and 2017, and the results of its operations and its cash flows for the years then ended, 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, 2018, 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 6, 2019, 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.

 

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 6, 2019

 

 

S.R. Snodgrass, P.C. ● 2009 Mackenzle Way, Suite 340 ● Cranberry Township, Pennsylvania 16066 ● Phone: 724-934-0344 ● Fax: 724-934-0345

 

1

 

 

 

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, 2018, 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, 2018, 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 sheets of the Company as of December 31, 2018 and 2017, and the related consolidated statements of income, comprehensive income, changes in stockholders’ equity, and cash flows for the years then ended, of the Company, and our report dated March 6, 2019, 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.

 

 

S.R. Snodgrass, P.C. ● 2009 Mackenzle Way, Suite 340 ● Cranberry Township, Pennsylvania 16066 ● Phone: 724-934-0344 ● Fax: 724-934-0345

 

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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 6, 2019

 

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MIDDLEFIELD BANC CORP.

CONSOLIDATED BALANCE SHEET

(Dollar amounts in thousands, except shares)

 

   

December 31,

 
   

2018

   

2017

 
                 

ASSETS

               

Cash and cash equivalents

  $ 107,933     $ 39,886  

Equity securities, at fair value

    616       -  

Investment securities available for sale, at fair value

    98,322       95,283  

Loans held for sale

    597       463  

Loans

    992,109       923,213  

Less allowance for loan and lease losses

    7,428       7,190  

Net loans

    984,681       916,023  

Premises and equipment, net

    13,003       11,853  

Goodwill

    15,071       15,071  

Core deposit intangibles

    2,397       2,749  

Bank-owned life insurance

    16,080       15,652  

Accrued interest receivable and other assets

    9,698       9,356  
                 

TOTAL ASSETS

  $ 1,248,398     $ 1,106,336  
                 

LIABILITIES

               

Deposits:

               

Noninterest-bearing demand

  $ 178,386     $ 164,424  

Interest-bearing demand

    117,128       112,004  

Money market

    196,685       150,277  

Savings

    222,954       208,502  

Time

    300,914       242,987  

Total deposits

    1,016,067       878,194  

Short-term borrowings:

               

Federal funds purchased and repurchase agreements

    398       4,707  

Federal Home Loan Bank advances

    90,000       70,000  

Total short-term borrowings

    90,398       74,707  

Other borrowings

    8,803       29,065  

Accrued interest payable and other liabilities

    4,840       4,507  

TOTAL LIABILITIES

    1,120,108       986,473  

STOCKHOLDERS' EQUITY

               

Common stock, no par value; 10,000,000 shares authorized, 3,630,497 and 3,603,881 shares issued; 3,244,332 and 3,217,716 shares outstanding

    85,925       84,859  

Retained earnings

    56,037       47,431  

Accumulated other comprehensive (loss) income

    (154 )     1,091  

Treasury stock, at cost; 386,165 shares

    (13,518 )     (13,518 )

TOTAL STOCKHOLDERS' EQUITY

    128,290       119,863  
                 

TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY

  $ 1,248,398     $ 1,106,336  

 

See accompanying notes to the consolidated financial statements.

 

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MIDDLEFIELD BANC CORP.

CONSOLIDATED STATEMENT OF INCOME

(Dollar amounts in thousands, except per share data)

 

   

Year Ended December 31,

 
                 
   

2018

   

2017

 

INTEREST AND DIVIDEND INCOME

               

Interest and fees on loans

  $ 46,576     $ 40,235  

Interest-earning deposits in other institutions

    558       328  

Federal funds sold

    46       15  

Investment securities:

               

Taxable interest

    688       762  

Tax-exempt interest

    2,262       2,406  

Dividends on stock

    227       249  

Total interest and dividend income

    50,357       43,995  
                 

INTEREST EXPENSE

               

Deposits

    8,631       5,350  

Short-term borrowings

    842       753  

Other borrowings

    436       544  

Total interest expense

    9,909       6,647  
                 

NET INTEREST INCOME

    40,448       37,348  
                 

Provision for loan losses

    840       1,045  
                 

NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES

    39,608       36,303  
                 

NONINTEREST INCOME

               

Service charges on deposit accounts

    1,914       1,875  

Investment securities gains on sale, net

    -       886  

Loss on equity securities

    (9 )     -  

Earnings on bank-owned life insurance

    428       431  

Gain on sale of loans

    231       826  

Other income

    1,164       841  

Total noninterest income

    3,728       4,859  
                 

NONINTEREST EXPENSE

               

Salaries and employee benefits

    15,749       13,758  

Occupancy expense

    1,933       1,846  

Equipment expense

    969       1,050  

Data processing costs

    1,806       1,792  

Ohio state franchise tax

    823       744  

Federal deposit insurance expense

    550       533  

Professional fees

    1,482       1,752  

Advertising expense

    921       821  

Software amortization expense

    605       414  

Core deposit intangible amortization

    352       374  

Merger expense

    -       1,060  

Other expense

    3,553       3,341  

Total noninterest expense

    28,743       27,485  
                 

Income before income taxes

    14,593       13,677  

Income taxes

    2,162       4,222  
                 

NET INCOME

  $ 12,431     $ 9,455  
                 

EARNINGS PER SHARE

               

Basic

  $ 3.85     $ 3.12  

Diluted

    3.83       3.10  
                 

DIVIDENDS DECLARED PER SHARE

  $ 1.17     $ 1.08  

 

See accompanying notes to the consolidated financial statements.

 

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MIDDLEFIELD BANC CORP.

CONSOLIDATED STATEMENT OF COMPREHENSIVE INCOME

(Dollar amounts in thousands)

 

   

Year Ended December 31,

 
   

2018

   

2017

 
                 

Net income

  $ 12,431     $ 9,455  
                 

Other comprehensive loss:

               

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

    (1,636 )     719  

Tax effect

    345       (244 )
                 

Reclassification adjustment for investment securities gains included in net income

    -       (886 )

Tax effect

    -       301  
                 

Total other comprehensive loss

    (1,291 )     (110 )
                 

Comprehensive income

  $ 11,140     $ 9,345  

 

See accompanying notes to the consolidated financial statements.

 

6

 

 

 

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, 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  

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

    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  
                                                 

Change in accounting principle for adoption of ASU 2016-01

                    141       (141 )             -  

Change in accounting principle for adoption of ASU 2018-02

                    (187 )     187               -  

Net income

                    12,431                       12,431  

Other comprehensive loss

                            (1,291 )             (1,291 )

Dividend reinvestment and purchase plan

    12,256       618                               618  

Stock options exercised

    8,800       168                               168  

Stock-based compensation

    5,560       280                               280  

Cash dividends ($1.17 per share)

                    (3,779 )                     (3,779 )
                                                 

Balance, December 31, 2018

    3,630,497     $ 85,925     $ 56,037     $ (154 )   $ (13,518 )   $ 128,290  

 

See accompanying notes to the consolidated financial statements.

 

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MIDDLEFIELD BANC CORP.

CONSOLIDATED STATEMENT OF CASH FLOWS

(Dollar amounts in thousands)

 

   

Year Ended December 31,

 
   

2018

   

2017

 

OPERATING ACTIVITIES

               

Net income

  $ 12,431     $ 9,455  

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

               

Provision for loan losses

    840       1,045  

Investment securities gains on sale, net

    -       (886 )

Loss on equity securities

    9       -  

Depreciation and amortization of premises and equipment, net

    951       1,291  

Software amortization expense

    605       414  

Amortization of premium and discount on investment securities, net

    419       451  

Accretion of deferred loan fees, net

    (868 )     (451 )

Amortization of core deposit intangibles

    352       374  

Stock-based compensation expense

    467       33  

Origination of loans held for sale

    (13,196 )     (10,020 )

Proceeds from sale of loans

    13,293       10,482  

Gain on sale of loans

    (231 )     (291 )

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

    (428 )     (431 )

Deferred income taxes

    (241 )     293  

Net (gain) loss on other real estate owned

    (55 )     30  

Increase in accrued interest receivable

    (345 )     (422 )

Increase in accrued interest payable

    166       136  

Other, net

    112       (3,536 )

Net cash provided by operating activities

    14,281       13,920  
                 

INVESTING ACTIVITIES

               

Investment securities available for sale:

               

Proceeds from repayments and maturities

    7,280       14,899  

Proceeds from sale of securities

    -       6,474  

Purchases

    (12,999 )     (3,080 )

Increase in loans, net

    (68,796 )     (119,866 )

Proceeds from the sale of other real estate owned

    163       2,196  

Purchase of premises and equipment

    (2,101 )     (1,201 )

Purchase of restricted stock

    (90 )     (899 )

Redemption of restricted stock

    -       795  

Acquisition, net of cash paid

    -       5,431  

Net cash used in investing activities

    (76,543 )     (95,251 )
                 

FINANCING ACTIVITIES

               

Net increase in deposits

    137,873       50,216  

Increase in short-term borrowings, net

    15,691       6,348  

Repayment of other borrowings

    (20,262 )     (10,372 )

Proceeds from other borrowings

    -       30,000  

Proceeds from common stock issued

    -       15,164  

Stock options exercised

    168       184  

Proceeds from dividend reinvestment and purchase plan

    618       540  

Cash dividends

    (3,779 )     (3,358 )

Net cash provided by financing activities

    130,309       88,722  
                 

Increase in cash and cash equivalents

    68,047       7,391  
                 

CASH AND CASH EQUIVALENTS AT BEGINNING OF YEAR

    39,886       32,495  
                 

CASH AND CASH EQUIVALENTS AT END OF YEAR

  $ 107,933     $ 39,886  

 

See accompanying notes to the consolidated financial statements.

 

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Year Ended December 31,

 
   

2018

   

2017

 

SUPPLEMENTAL INFORMATION

               

Cash paid during the year for:

               

Interest on deposits and borrowings

  $ 9,743     $ 6,511  

Income taxes

    2,125       5,705  
                 

Noncash investing transactions:

               

Transfers from loans to other real estate owned

  $ 166     $ 1,179  

Common stock issued in business acquisition

    -       20,995  

Transfer of equity securities from investment securities available for sale, at fair value

    (625 )     -  

 

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

    10,740  

Total noncash assets acquired

    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 )

Total liabilities assumed

    (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 the consolidated financial statements.

 

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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 fifteen 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 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, 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 and Equity Securities

 

Investment and equity 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. On January 1, 2018, the Company adopted ASU 2016-01 which resulted in a reclassification of $625,000 from investment securities available for sale to equity securities on the Consolidated Balance Sheet, and a reclassification of $141,000 between accumulated other comprehensive income (loss) and retained earnings on the Consolidated Balance Sheet and Consolidated Statement of Changes in Stockholders' Equity. Additionally, for the year ended December 31, 2018, the unrealized gains and losses on equity securities were recorded as a separate component of noninterest income.

 

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.

 

10

 

 

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 2018 and 2017, 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, 2018 or 2017.

 

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 $59.4 million and $50.4 million at December 31, 2018 and 2017, 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. Loans that experience insignificant payment delays, which are defined as 89 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.

 

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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.

 

Loans acquired from Liberty in 2017 were recorded without their ALLL determination. As such, recoveries received on these loans, and any other loans acquired subsequent to being charged-off, are recorded as noninterest income.

 

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.

 

12

 

 

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.

 

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 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 and stock awards. Compensation cost is recognized over the required service period, generally defined as the vesting period, and is recorded in "Salaries and employee benefits" 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.

 

Recently Adopted 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 scopes out revenue associated with financial instruments, including loan receivables and investment securities, the adoption of the standard and its related amendments did not 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. Upon adoption on January 1, 2018, we have included the related new disclosure requirements in Note 2.

 

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In January 2016, the FASB issued ASU 2016-01, Financial Instruments – Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities. This Update applies to all entities that hold financial assets or owe financial liabilities and is intended to provide more useful information on the recognition, measurement, presentation, and disclosure of financial instruments. Among other things, this Update (a) requires equity investments (except those accounted for under the equity method of accounting or those that result in consolidation of the investee) to be measured at fair value with changes in fair value recognized in net income; (b) simplifies the impairment assessment of equity investments without readily determinable fair values by requiring a qualitative assessment to identify impairment; (c) eliminates the requirement to disclose the fair value of financial instruments measured at amortized cost for entities that are not public business entities; (d) eliminates the requirement for public business entities to disclose the method(s) and significant assumptions used to estimate the fair value that is required to be disclosed for financial instruments measured at amortized cost on the balance sheet; (e) requires public business entities to use the exit price notion when measuring the fair value of financial instruments for disclosure purposes; (f) requires separate presentation of financial assets and financial liabilities by measurement category and form of financial asset (that is, securities or loans and receivables) on the balance sheet or the accompanying notes to the financial statements; and (g) clarifies that an entity should evaluate the need for a valuation allowance on a deferred tax asset related to available-for-sale securities in combination with the entity’s other deferred tax assets. On January 1, 2018, the Company adopted ASU 2016-01 which resulted in a reclassification of $141,000 between accumulated other comprehensive income and retained earnings on the Consolidated Balance Sheet and Consolidated Statement of Changes in Stockholders’ Equity. Additionally, the methods used to calculate the fair value of financial instruments in Note 18 were based on exit pricing assumptions as of December 31, 2018.

 

In October 2016, the FASB issued ASU 2016-16, Income Taxes (Topic 740), which requires recognition of current and deferred income taxes resulting from an intra-entity transfer of any asset (excluding inventory) when the transfer occurs. Consequently, the amendments in this Update eliminate the exception for an intra-entity transfer of an asset other than inventory. The adoption of the standard and its related amendments did not result in a material impact 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), to allow a reclassification from accumulated other comprehensive income to retained earnings for stranded tax effects resulting from the Tax Cuts and Jobs Act. Consequently, the amendments eliminate the stranded tax effects resulting from the Tax Cuts and Jobs Act and will improve the usefulness of information reported to financial statement users. On January 1, 2018, the Company adopted this standard which resulted in a reclassification of $187,000 between accumulated other comprehensive income and retained earnings on the Consolidated Balance Sheet and Consolidated Statement of Changes in Stockholders’ Equity.

 

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.

 

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 Company has determined the adoption of this standard did not have a significant impact on the Company’s financial position or results of operations.

 

Recent Accounting Pronouncements:

 

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 approximates a $6.7 million increase in assets and liabilities.

 

In June 2016, the FASB issued ASU 2016-13, Financial Instruments - Credit Losses: Measurement of Credit Losses on Financial Instruments (“CECL”), 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 affected by 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 is running the current incurred loss model and the CECL model concurrently prior to the adoption of this guidance on January 1, 2020.

 

14

 

 

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 June 2018, the FASB issued ASU 2018-07, Compensation – Stock Compensation (Topic 718), which simplified the accounting for nonemployee share-based payment transactions. The amendments in this update expand the scope of Topic 718 to include share-based payment transactions for acquiring goods and services from nonemployees. The amendments in this Update improve the following areas of nonemployee share-based payment accounting: (a) the overall measurement objective, (b) the measurement date, (c) awards with performance conditions, (d) classification reassessment of certain equity-classified awards, (e) calculated value (nonpublic entities only), and (f) intrinsic value (nonpublic entities only). The amendments in this Update are effective for public business entities for fiscal years beginning after December 15, 2018, including interim periods within that fiscal year. 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. 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 July 2018, the FASB issued ASU 2018-11, Leases (Topic 842): Targeted Improvements. This Update provides another transition method which allows entities to initially apply ASC 842 at the adoption date and recognize a cumulative-effect adjustment to the opening balance of retained earnings in the period of adoption. Entities that elect this approach should report comparative periods in accordance with ASC 840, Leases. In addition, this Update provides a practical expedient under which lessors may elect, by class of underlying assets, to not separate nonlease components from the associated lease component, similar to the expedient provided for lessees. However, the lessor practical expedient is limited to circumstances in which the nonlease component or components otherwise would be accounted for under the new revenue guidance and both (a) the timing and pattern of transfer are the same for the nonlease component(s) and associated lease component and (b) the lease component, if accounted for separately, would be classified as an operating lease. If the nonlease component or components associated with the lease component are the predominant component of the combined component, an entity should account for the combined component in accordance with ASC 606, Revenue from Contracts with Customers. Otherwise, the entity should account for the combined component as an operating lease in accordance with ASC 842. If a lessor elects the practical expedient, certain disclosures are required. This Update is effective for public business entities for fiscal years beginning after December 15, 2018, and interim periods within those fiscal years, with early adoption permitted. 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. The Company is currently evaluating the impact the adoption of the standard will have on the Company’s financial position or results of operations.

 

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In August 2018, the FASB issued ASU 2018-13, Fair Value Measurement (Topic 820): Disclosure Framework – Changes the Disclosure Requirements for Fair Value Measurements. The Update removes the requirement to disclose the amount of and reasons for transfers between Level I and Level II of the fair value hierarchy; the policy for timing of transfers between levels; and the valuation processes for Level III fair value measurements. The Update requires disclosure of changes in unrealized gains and losses for the period included in other comprehensive income (loss) for recurring Level III fair value measurements held at the end of the reporting period and the range and weighted average of significant unobservable inputs used to develop Level III fair value measurements. This Update is effective for all entities for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2019. 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 December 2018, the FASB issued ASU 2018-20, Leases (Topic 842), which addressed implementation questions arising from stakeholders in regard to ASU 2016-02, Leases. Specifically addressed in this Update were issues related to 1) sales taxes and other similar taxes collected from lessees, 2) certain lessor costs, and 3) recognition of variable payments for contracts with lease and nonlease components. The amendments in this Update affect the amendments in Update 2016-02, which are not yet effective but can be early adopted. The effective date and transition requirements for the amendments in this Update are the same as the effective date and transition requirements in Update 2016-02 (for example, January 1, 2019, for calendar-year-end public business entities). Based on the Company’s preliminary analysis of its current portfolio, the impact of the adoption of Update 2016-02 to the Company’s balance sheet approximates a $6.7 million increase in assets and liabilities.

 

 

2.

REVENUE RECOGNITION

 

Effective January 1, 2017, the Company adopted ASU 2014-09 Revenue from Contracts with Customers – (Topic 606) and all subsequent ASUs that modified ASC 606. The implementation of the new standard had no material impact on the measurement or recognition of revenue for prior periods and did not require any cumulative effect adjustment for adoption.

 

Management determined that the primary sources of revenue, which emanate from interest income on loans and investments, along with noninterest revenue resulting from investment security gains, gains on the sale of loans, and BOLI income, are not within the scope of ASC 606. As a result, no changes were made during the period related to these sources or revenue, which cumulatively comprise 92.8% of the total revenue of the Company.

 

The main types of noninterest income within the scope of the standard are as follows:

 

Service charges on deposit accounts – The Company has contracts with its deposit customers where fees are charged if the account balance falls below predetermined levels defined as compensating balances. The agreements can be cancelled at any time by either the Company or the deposit customer. Revenue from these transactions is recognized on a monthly basis as the Company has an unconditional right to the fee consideration. The Company also has transaction fees related to specific customer requests or activities that include overdraft fees, online banking fees, and other transaction fees. All of these fees are attributable to specific performance obligations of the Company where the revenue is recognized at a defined point in time, which is completion of the requested service/transaction.

 

Gains (losses) on sale of other real estate owned - Gains and losses are recognized at the completion of the property sale when the buyer obtains control of the real estate and all of the performance obligations of the Company have been satisfied. Evidence of the buyer obtaining control of the asset include transfer of the property title, physical possession of the asset, and the buyer obtaining control of the risks and rewards related to the asset. In situations where the Company agrees to provide financing to facilitate the sale, additional analysis is performed to ensure that the contract for sale identifies the buyer and seller, the asset to be transferred and the payment terms, that the contract has a true commercial substance and that amounts due from the buyer are reasonable. In situations where financing terms are not reflective of current market terms, the transaction price is discounted impacting the gain/loss and the carrying value of the asset.

 

16

 

 

The following table depicts the disaggregation of revenue derived from contracts with customers to depict the nature, amount, timing, and uncertainty of revenue and cash flows for the years ended December 31,

 

Noninterest Income

 

2018

   

2017

 

(Dollar amounts in thousands)

               
                 

Service charges on deposit accounts:

               

Overdraft fees

  $ 798     $ 790  

ATM banking fees

    867       739  

Service charges and other fees

    249       346  

Investment securities gains on sale, net (a)

    -       886  

Loss on equity securities (a)

    (9 )     -  

Earnings on bank-owned life insurance (a)

    428       431  

Gain on sale of loans (a)

    231       826  

Other income

    1,164       841  

Total noninterest income

  $ 3,728     $ 4,859  
                 

 

(a) Not within scope of ASC 606

               

 

 

3.

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:

 

   

2018

   

2017

 
                 

Weighted-average common shares issued

    3,616,119       3,415,115  
                 

Average treasury stock shares

    (386,165 )     (386,165 )
                 

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

    3,229,954       3,028,950  
                 

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

    13,953       23,635  
                 

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

    3,243,907       3,052,585  

 

Options to purchase 7,450 shares of common stock at $17.55 a share were outstanding during the year ended December 31, 2018. Also outstanding were 21,824 shares of restricted stock. None of the outstanding options or restricted stock were anti-dilutive.

 

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. None of the outstanding options or restricted stock were anti-dilutive.

  

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4.

INVESTMENT AND EQUITY SECURITIES

 

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

 

   

December 31, 2018

 
           

Gross

   

Gross

         
   

Amortized

   

Unrealized

   

Unrealized

   

Fair

 

(Dollar amounts in thousands)

 

Cost

   

Gains

   

Losses

   

Value

 
                                 

U.S. government agency securities

  $ 7,442     $ 90     $ (61 )   $ 7,471  

Obligations of states and political subdivisions:

                               

Taxable

    502       10       -       512  

Tax-exempt

    72,387       667       (473 )     72,581  

Mortgage-backed securities in government-sponsored entities

    18,185       88       (515 )     17,758  

Total

  $ 98,516     $ 855     $ (1,049 )   $ 98,322  

 

   

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  

 

On January 1, 2018, the Company reclassified $625,000 from investment securities available for sale to equity securities in accordance with the adoption of ASU 2016-01. Equity securities totaled $616,000 as of December 31, 2018, which incorporates a recognized net loss on equity investments of $9,000 for the year ended December 31, 2018. There were no net gains on sold equity securities were realized during this period.

 

The amortized cost and fair value of debt securities at December 31, 2018, 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

  $ 8,547     $ 8,590  

Due after one year through five years

    2,108       2,132  

Due after five years through ten years

    13,173       13,133  

Due after ten years

    74,688       74,467  
                 

Total

  $ 98,516     $ 98,322  

 

Investment securities with an approximate carrying value of $63.5 million and $57.9 million at December 31, 2018 and 2017, respectively, were pledged to secure deposits and other purposes as required by law.

 

18

 

 

There were no securities sold during the year ended December 31, 2018. Proceeds from the sales of investment securities and the gross realized gains and losses for the year ended December 31, 2017, are as follows (in thousands):

 

   

2017

 

Proceeds from sales

  $ 6,474  

Gross realized gains

    911  *

Gross realized losses

    (25 )

 

*Prior to the acquisition of Liberty, the Company held an equity interest in Liberty which was remeasured at fair value on the acquisition date and resulted in a gain of $488,000. This gain was recorded in Investment Securities Gains on Sale, Net 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, 2018

 
   

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

  $ -     $ -     $ 4,105     $ (61 )   $ 4,105     $ (61 )

Obligations of states and political subdivisions

                                               

Tax-exempt

    20,451       (286 )     11,053       (187 )     31,504       (473 )

Mortgage-backed securities in government-sponsored entities

    2,068       (9 )     12,257       (506 )     14,325       (515 )

Total

  $ 22,519     $ (295 )   $ 27,415     $ (754 )   $ 49,934     $ (1,049 )

 

   

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 )

 

There were 85 securities that were considered temporarily impaired at December 31, 2018.

 

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, 2018 and 2017, 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.

 

19

 

 

Debt securities issued by U.S. government agencies, U.S. government-sponsored enterprises, and state and political subdivisions accounted for 100% of the total available-for-sale portfolio as of December 31, 2018, 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.

 

 

 

5.

LOANS AND RELATED ALLOWANCE FOR LOAN AND LEASE LOSSES

 

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

 

   

2018

   

2017

 
                 

Commercial and industrial

  $ 83,857     $ 101,346  

Real estate - construction

    56,731       47,017  

Real estate - mortgage:

               

Residential

    336,487       318,157  

Commercial

    498,247       437,947  

Consumer installment

    16,787       18,746  
      992,109       923,213  

Less: Allowance for loan and lease losses

    (7,428 )     (7,190 )
                 

Net loans

  $ 984,681     $ 916,023  

 

The amounts above include net deferred loan origination costs of $1.6 million and $1.5 million at December 31, 2018 and December 31, 2017, 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, Powell and Westerville, Ohio. The Northeastern Ohio trade area includes the recently 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, 2018 and 2017, loans outstanding to individuals and businesses are dependent upon the local economic conditions in the Company’s immediate trade area.

 

20

 

 

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, 2018

 

Commercial and

industrial

   

Real estate-

construction

   

Residential

   

Commercial

   

Consumer

installment

   

Total

 

Loans:

                                               

Individually evaluated for impairment

  $ 2,570     $ -     $ 1,970     $ 9,533     $ 2     $ 14,075  

Collectively evaluated for impairment

    81,287       56,731       334,517       488,714       16,785       978,034  

Total loans

  $ 83,857     $ 56,731     $ 336,487     $ 498,247     $ 16,787     $ 992,109  

 

 

                   

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, 2018

 

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

  $ 667     $ -     $ 43     $ 643     $ 1     $ 1,354  

Collectively evaluated for impairment

    302       100       1,538       4,008       126       6,074  

Total ending allowance balance

  $ 969     $ 100     $ 1,581     $ 4,651     $ 127     $ 7,428  

 

 

                   

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  

 

 

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.

 

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 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. 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, 2018

 

Impaired Loans

 
           

Unpaid

         
   

Recorded

    Principal    

Related

 
   

Investment

    Balance    

Allowance

 

With no related allowance recorded:

                       

Commercial and industrial

  $ 207     $ 413     $ -  

Real estate - mortgage:

                       

Residential

    1,306       1,462       -  

Commercial

    1,867       2,186       -  

Total

  $ 3,380     $ 4,061     $ -  
                         

With an allowance recorded:

                       

Commercial and industrial

  $ 2,363     $ 3,013     $ 667  

Real estate - mortgage:

                       

Residential

    664       715       43  

Commercial

    7,666       7,676       643  

Consumer installment

    2       2       1  

Total

  $ 10,695     $ 11,406     $ 1,354  
                         

Total:

                       

Commercial and industrial

  $ 2,570     $ 3,426     $ 667  

Real estate - mortgage:

                       

Residential

    1,970       2,177       43  

Commercial

    9,533       9,862       643  

Consumer installment

    2       2       1  

Total

  $ 14,075     $ 15,467     $ 1,354  

 

22

 

 

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  

 

The tables above include troubled debt restructuring totaling $4.4 million and $5.4 million as of December 31, 2018 and 2017, respectively.

 

The following table presents interest income by class, recognized on impaired loans (in thousands):

 

   

As of December 31, 2018

   

As of December 31, 2017

 
   

Average

Recorded

Investment

   

 

Interest

Income

Recognized

   

Average Recorded Investment

   

Interest

Income

Recognized

 
                                 

Commercial and industrial

  $ 4,210     $ 172     $ 2,378     $ 123  

Real estate - construction

    9       -       565       20  

Real estate - mortgage:

                               

Residential

    2,531       57       3,068       75  

Commercial

    6,805       377       6,820       159  

Consumer installment

    3       -       5       -  

Total

  $ 13,558     $ 606     $ 12,836     $ 377  

 

Troubled Debt Restructuring (TDR) describes loans on which the bank has granted concessions for reasons related to the customer’s financial difficulties. Such concessions may include one or more of the following:

 

reduction in the interest rate to below market rates

 

extension of repayment requirements beyond normal terms

 

reduction of the principal amount owed

 

reduction of accrued interest due

 

acceptance of other assets in full or partial payment of a debt

 

23

 

 

In each case the concession is made due to deterioration in the borrower’s financial condition, and the new terms are less stringent than those required on a new loan with similar risk. The total impact on the ALLL for 2018 and 2017 related to TDRs was $459,000 and $509,000, respectively.

 

The following tables present the number of loan modifications by class, the corresponding recorded investment, and the subsequently defaulted modifications (in thousands) for the years ended:

 

   

December 31, 2018

 
   

Number of Contracts

   

Pre-Modification

   

Post-Modification

 
   

Term

                    Outstanding Recorded     Outstanding Recorded  
Troubled Debt Restructurings   Modification    

Other

   

Total

    Investment     Investment  

Commercial and industrial

    1       -       1     $ 44     $ 44  

Residential real estate

    3       2       5       286       286  

Commercial real estate

    1       -       1       94       94  
                            $ 424     $ 424  

 

   

December 31, 2017

 
   

Number of Contracts

   

Pre-Modification

   

Post-Modification

 
   

Term

                    Outstanding Recorded     Outstanding Recorded  
Troubled Debt Restructurings   Modification    

Other

   

Total

    Investment     Investment  

Commercial and industrial

    4       -       4     $ 127     $ 127  

Residential real estate

    5       -       5       256       256  
                            $ 383     $ 383  

 

 

   

December 31, 2018

 

 

 

Number of

   

Recorded

 

Troubled Debt Restructurings subsequently defaulted

  Contracts     Investment  

Residential real estate

    1     $ 19  

 

 

There were no subsequent defaults of troubled debt restructurings for the year ended December 31, 2017.

 

Management uses a nine-point internal risk-rating system to monitor the credit quality of the overall loan portfolio. The first five categories are considered not criticized and are aggregated as Pass rated. The criticized rating categories utilized by management generally follow bank regulatory definitions. The Special Mention category includes assets that are currently protected but are potentially weak, resulting in an undue and unwarranted credit risk, but not to the point of justifying a Substandard classification.  Loans in the Substandard category have well-defined weaknesses that jeopardize the liquidation of the debt and have a distinct possibility that some loss will be sustained if the weaknesses are not corrected.  All loans greater than 90 days past due are considered Substandard or Doubtful. Loans classified as doubtful have all the weaknesses inherent in those classified as substandard, with the added characteristic that the weaknesses make collection or liquidation in full, on the basis of currently existing facts, conditions, and values, highly questionable and improbable. Any portion of a loan that has been charged off is placed in the Loss category.

 

To help ensure that risk ratings are accurate and reflect the present and future capacity of borrowers to repay a loan as agreed, the Company has a structured loan-rating process with several layers of internal and external oversight.  Generally, consumer and residential mortgage loans are included in the Pass categories unless a specific action, such as bankruptcy, repossession, or death, occurs to raise awareness of a possible credit event.  The Company’s Commercial Loan Officers are responsible for the timely and accurate risk rating of the loans in their portfolios at origination and on an ongoing basis. The Credit Department performs an annual review of all commercial relationships with loan balances of $500,000 or greater.  Confirmation of the appropriate risk grade is included in the review on an ongoing basis.   The Company engages an external consultant to conduct loan reviews on a semiannual basis. Generally, the external consultant reviews commercial relationships greater than $250,000 and/or criticized relationships greater than $125,000. Detailed reviews, including plans for resolution, are performed on loans classified as Substandard on a quarterly basis.  Loans in the Special Mention and Substandard categories that are collectively evaluated for impairment are given separate consideration in the determination of the allowance.

 

24

 

 

The following tables present the classes of the loan portfolio summarized by the aggregate Pass rating and the criticized categories of Special Mention, Substandard, and Doubtful within the internal risk rating system (in thousands):

 

           

Special

                   

Total

 

December 31, 2018

 

Pass

   

Mention

   

Substandard

   

Doubtful

   

Loans

 
                                         

Commercial and industrial

  $ 77,002     $ 4,572     $ 2,283     $ -     $ 83,857  

Real estate - construction

    55,397       1,334       -       -       56,731  

Real estate - mortgage:

                                       

Residential

    332,475       553       3,459       -       336,487  

Commercial

    483,516       6,617       8,114       -       498,247  

Consumer installment

    16,776       -       11       -       16,787  

Total

  $ 965,166     $ 13,076     $ 13,867     $ -     $ 992,109  

 

           

Special

                   

Total

 

December 31, 2017

 

Pass

   

Mention

   

Substandard

   

Doubtful

   

Loans

 
                                         

Commercial and industrial

  $ 95,621     $ 1,942     $ 3,783     $ -     $ 101,346  

Real estate - construction

    46,995       -       22       -       47,017  

Real estate - mortgage:

                                       

Residential

    312,176       723       5,258       -       318,157  

Commercial

    424,225       9,164       4,558       -       437,947  

Consumer installment

    18,742       -       4       -       18,746  

Total

  $ 897,759     $ 11,829     $ 13,625     $ -     $ 923,213  

 

Management further monitors the performance and credit quality of the loan portfolio by analyzing the age of the portfolio as determined by the length of time a recorded payment is past due. The following tables present the classes of the loan portfolio summarized by the aging categories of loans and nonaccrual loans (in thousands):

 

           

30-59 Days

   

60-89 Days

   

90 Days+

   

Total

   

Total

 

December 31, 2018

 

Current

   

Past Due

   

Past Due

   

Past Due

   

Past Due

   

Loans

 
                                                 

Commercial and industrial

  $ 82,770     $ 288     $ 213     $ 586     $ 1,087     $ 83,857  

Real estate - construction

    56,731       -       -       -       -       56,731  

Real estate - mortgage:

                                               

Residential

    331,379       2,612       1,083       1,413       5,108       336,487  

Commercial

    496,597       664       -       986       1,650       498,247  

Consumer installment

    16,768       19       -       -       19       16,787  

Total

  $ 984,245     $ 3,583     $ 1,296     $ 2,985     $ 7,864     $ 992,109  

 

           

30-59 Days

   

60-89 Days

   

90 Days+

   

Total

   

Total

 

December 31, 2017

 

Current

   

Past Due

   

Past Due

   

Past Due

   

Past Due

   

Loans

 
                                                 

Commercial and industrial

  $ 99,633     $ 1,607     $ 29     $ 77     $ 1,713       101,346  

Real estate - construction

    47,017       -       -       -       -       47,017  

Real estate - mortgage:

                                               

Residential

    314,866       1,977       227       1,087       3,291       318,157  

Commercial

    434,879       1,907       1       1,160       3,068