CB Financial Services, Inc. - Quarter Report: 2018 June (Form 10-Q)

 

 

Note 1. Summary of Significant Accounting Policies

 

Principles of Consolidation and Basis of Presentation

 

The accompanying consolidated financial statements include the accounts of CB Financial Services, Inc. (“CB Financial”) and its wholly owned subsidiary, Community Bank (the “Bank”), and the Bank’s wholly-owned subsidiary, Exchange Underwriters, Inc. (“Exchange Underwriters” or “EU”). CB Financial and the Bank are collectively referred to as the “Company”. All intercompany transactions and balances have been eliminated in consolidation.

 

The accompanying unaudited interim financial statements have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”) and in conformity with accounting principles generally accepted in the United States of America (“GAAP”). Certain information and note disclosures normally included in annual financial statements prepared in accordance with GAAP have been condensed or omitted pursuant to those rules and regulations, although the Company believes that the disclosures made are adequate to make the information not misleading in any material respect. In preparing financial statements in conformity with GAAP, management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements and income and expenses during the reporting period. Actual results could differ significantly from those estimates. Material estimates that are particularly susceptible to significant change in the near term relate to determination of the allowance for losses on loans, the valuation of real estate acquired in connection with foreclosures or in satisfaction of loans, evaluation of securities for other-than-temporary impairment including related cash flow projections, goodwill and intangible assets impairment, and the valuation of deferred tax assets.

 

In the opinion of management, the accompanying unaudited interim financial statements include all adjustments considered necessary for a fair presentation of the Company’s financial position and results of operations at the dates and for the periods presented. All of these adjustments are of a normal, recurring nature, and they are the only adjustments included in the accompanying unaudited interim financial statements. These interim consolidated financial statements should be read in conjunction with the audited consolidated financial statements and notes thereto in the Company’s Annual Report on Form 10-K for the year ended December 31, 2017. Interim results are not necessarily indicative of results for a full year.

 

On August 1, 2018, the Bank’s insurance subsidiary, Exchange Underwriters merged with Beynon Insurance, headquartered in Pittsburgh, Pennsylvania. Exchange Underwriters is the surviving insurance company and the acquisition price was approximately $1.8 million, which is expected to be allocated to the Beynon Insurance customer list. The acquired customer list will be recorded on the Company’s balance sheet as an intangible asset and amortized over the average life of the customer list in accordance with U.S. GAAP. Our preliminary estimated average life for this customer list is approximately 9 years and will be finalized in a subsequent period. Except as disclosed herein, the Company evaluated subsequent events through the date the consolidated financial statements were filed with the SEC and incorporated into the consolidated financial statements the effect of all material known events determined by ASC Topic 855, Subsequent Events, to be recognizable events.

 

Nature of Operations

 

The Company derives substantially all its income from banking and bank-related services which include interest earnings on commercial, commercial mortgage, residential real estate and consumer loan financing, as well as interest earnings on investment securities and fees generated from deposit services to its customers. The Company provides banking services through its subsidiary, Community Bank; a Pennsylvania-chartered commercial bank headquartered in Carmichaels, Pennsylvania. The Bank operates from sixteen offices in Greene, Allegheny, Washington, Fayette and Westmoreland Counties in southwestern Pennsylvania, seven offices in Brooke, Marshall, Ohio, Upshur and Wetzel Counties in West Virginia, and one office in Belmont County in Ohio. The Bank is a community-oriented institution offering residential and commercial real estate loans, commercial and industrial loans, and consumer loans as well as a variety of deposit products for individuals and businesses in its market area. Property and casualty, commercial liability, surety and other insurance products are offered through Exchange Underwriters, Inc., the Bank’s wholly-owned subsidiary that is a full-service, independent insurance agency.

 

Acquired Loans

 

Loans that were acquired in previous mergers, were recorded at fair value with no carryover of the related allowance for credit losses. The fair value of the acquired loans was estimated by management with the assistance of a third party valuation specialist.

 

For performing loans acquired in a merger, the excess of cash flows expected at acquisition over the estimated fair value is referred to as the accretable discount and is recognized into interest income over the remaining life of the loan. For purchased credit impaired (“PCI”) loans acquired in the merger, the difference between contractually required payments at acquisition and the cash flows expected to be collected at acquisition is referred to as the nonaccretable discount. The nonaccretable discount represents estimated future credit losses expected to be incurred over the life of the loan. Subsequent decreases to the expected cash flows require an evaluation to determine the need for an allowance for loan losses. Subsequent improvements in expected cash flows result in the reversal of a corresponding amount of the nonaccretable discount which is then reclassified as accretable discount that is recognized into interest income over the remaining life of the loan using the interest method. The evaluation of the amount of future cash flows that is expected to be collected is performed in a similar manner as that used to determine our allowance for credit losses. Charge-offs of the principal amount on acquired loans would be first applied to the nonaccretable discount portion of the fair value adjustment.

 

Income Taxes

 

The income tax decrease was due to the enactment of the Tax Cuts and Jobs Act reducing the corporate tax rate from 34% to 21% effective January 1, 2018, and tax-exempt bank-owned life insurance proceeds which was a discrete item and reduced the expected 2018 effective tax rate of 18.1% to 15.0% at June 30, 2018, compared to 30.0% at June 30, 2017.

 

Recognition of a Prior Period Error

 

In April 2018, the Company discovered an error with the collateral position on a commercial and industrial classified loan relationship that had occurred in April 2017. This error resulted in the loss of the Company’s first lien position, leaving the loan with insufficient collateral. The Company corrected the error by recording a specific reserve and recognizing an additional $300,000 (pre-tax) of provision for loan losses for the quarter-ended March 31, 2018. There was no financial statement impact for the three months ended June 30, 2018. The impact of the correction of an error resulted in a decrease of $300,000 in income before income taxes, a decrease of $63,000 in income taxes, and a decrease of $237,000 (after-tax) in net income ($0.05 earnings per share) for the six months ended June 30, 2018.

 

As a result of this error, the Company’s 2017 results were overstated by $237,000 and the Company’s March 31, 2018 quarterly and six months ended June 30, 2018 results were understated by the same amount. Management of the Company concluded the effect of the error was immaterial to the Company’s 2017 results as well as estimated annual results for 2018.

 

Reclassifications

 

Certain comparative amounts for the prior year have been reclassified to conform to the current year presentation. Such reclassifications did not affect net income or stockholders’ equity.

 

Recent Accounting Standards

 

In January 2018, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2018-01, Leases (Topic 842), Land Easement Practical Expedient for Transition to Topic 842. ASU 2018-01 is intended to be effective with ASU 2016-02, as amended. The amendments in ASU 2018-01 are as follows: provide an optional transition practical expedient for the adoption of ASU 2016-02 that, if elected, would not require an organization to reconsider their accounting for existing land easements that are not currently accounted for under the old lease standards; and clarify that new or modified land easements should be evaluated under ASU 2016-02, once an entity has adopted the new standard. ASU 2016-02 will require lessees to recognize a right-of-use (ROU) asset for its right to use the underlying asset and a lease liability for the corresponding lease obligation for leases with terms of more than twelve months. Both the ROU asset and lease liability will initially be measured at the present value of the future minimum lease payments over the lease term. Subsequent measurement, including the presentation of expenses and cash flows, will depend on the classification of the lease as either a finance or an operating lease. Accounting by lessors will remain largely unchanged from current U.S. GAAP. ASU 2016-02 is effective for fiscal years beginning after December 15, 2018, and interim periods within those years, with early adoption permitted, and is to be applied as of the beginning of the earliest period presented using a modified retrospective approach. The Company is currently evaluating the provisions of ASU 2016-02, but expects to report increased assets and liabilities as a result of reporting additional leases on the Company's consolidated financial condition or results of operations.

 

In September 2017, the FASB issued ASU 2017-13, Revenue Recognition (Topic 605), Revenue from Contracts with Customers (Topic 606), Leases (Topic 840), and Leases (Topic 842): Amendments to SEC Paragraphs Pursuant to the Staff Announcement at the July 20, 2017 EITF Meeting and Rescission of Prior SEC Staff Announcements and Observer Comments. ASU 2017-13 amends the early adoption date option for certain companies related to the adoption of ASU No. 2014-09, Revenue from Contracts with Customers (Topic 606) and ASU No. 2016-02, Leases (Topic 842). The SEC staff stated the SEC would not object to a public business entity that otherwise would not meet the definition of a public business entity except for a requirement to include or the inclusion of its financial statements or financial information in another entity’s filing with the SEC adopting ASC Topic 606 for annual reporting periods beginning after December 15, 2018, and interim reporting periods within annual reporting periods beginning after December 15, 2019. The SEC staff stated the SEC would not object to a public business entity that otherwise would not meet the definition of a public business entity except for a requirement to include or the inclusion of its financial statements or financial information in another entity’s filing with the SEC adopting ASC Topic 842 for fiscal years beginning after December 15, 2019, and interim periods within fiscal years beginning after December 15, 2020. The Company is evaluating the provisions of ASU 2017-13 but believes that its adoption will not have a material impact on the Company's consolidated financial condition or results of operations.

 

In July 2017, the FASB issued ASU 2017-11, Earnings Per Share (Topic 260); Distinguishing Liabilities from Equity (Topic 480); Derivatives and Hedging (Topic 815): (Part I) Accounting for Certain Financial Instruments with Down Round Features, (Part II) Replacement of the Indefinite Deferral for Mandatorily Redeemable Financial Instruments of Certain Nonpublic Entities and Certain Mandatorily Redeemable Noncontrolling Interests with a Scope Exception. ASU 2017-11 amendments simplify the accounting for certain financial instruments with down round features. The amendments require companies to disregard the down round feature when assessing whether the instrument is indexed to its own stock, for purposes of determining liability or equity classification. Companies that provide earnings per share (EPS) data will adjust their basic EPS calculation for the effect of the feature when triggered and will also recognize the effect of the trigger within equity. ASU 2017-11 is effective for public business entities that are SEC filers for annual periods beginning after December 15, 2018, and interim periods within those annual periods, for public entities that are not SEC filers for annual periods beginning after December 15, 2019 and for all other entities for annual periods beginning after December 15, 2020 with early adoption permitted. The Company is evaluating the provisions of ASU 2017-11 but believes that its adoption will not have a material impact on the Company's consolidated financial condition or results of operations.

 

In May 2017, the FASB issued ASU 2017-10, Service Concession Arrangements (Topic 853): Determining the Customer of the Operation Services. ASU 2017-10 amendments clarify that the grantor in a service concession arrangement is the customer of the operation services in all cases for those arrangements. ASU 2017-10 is effective for public business entities that are SEC filers for annual periods beginning after December 15, 2017, and interim periods within those annual periods, for public entities that are not SEC filers for annual periods beginning after December 15, 2018 and for all other entities for annual periods beginning after December 15, 2019 with early adoption permitted, including within an interim period, subject to specific transition requirements depending on whether an entity adopted Topic 606 before or after the issuance of ASU 2017-10. The Company adopted the provisions of ASU 2017-10 as of January 1, 2018, and its adoption did not have a material impact on the Company's consolidated financial condition or results of operations.

 

In May 2017, the FASB issued ASU 2017-09, Compensation—Stock Compensation (Topic 718): Scope of Modification Accounting. ASU 2017-09 amendments provide guidance on determining which changes to the terms and conditions of share-based payment awards require an entity to apply modification accounting under ASU Topic 718. ASU 2017-09 is effective for all entities for annual periods, including interim periods within those annual periods beginning after December 15, 2017 with early adoption permitted. The Company adopted the provisions of ASU 2017-09 as of January 1, 2018, and its adoption did not have a material impact on the Company's consolidated financial condition or results of operations.

 

In March 2017, the FASB issued ASU 2017-08, Receivables- Nonrefundable Fees and Other Costs (Subtopic 310-20): Premium Amortization on Purchases of Callable Debt Securities. ASU 2017-08 amends guidance on the amortization period of premiums on certain purchases of callable debt securities. The amendments shorten the amortization period of premiums on certain purchases of callable debt securities to the earliest call date. ASU 2017-08 is effective for public business entities that are SEC filers for annual periods beginning after December 15, 2018, and interim periods within those annual periods, for public entities that are not SEC filers for annual periods beginning after December 15, 2019 and for all other entities for annual periods beginning after December 15, 2020 with early adoption permitted. The Company is evaluating the provisions of ASU 2017-08 but believes that its adoption will not have a material impact on the Company's consolidated financial condition or results of operations.

 

In January 2017, the FASB issued ASU 2017-04, Intangibles - Goodwill and Other (Topic 350): Simplifying the Test for Goodwill Impairment. ASU 2017-04 simplifies the accounting for goodwill impairments by eliminating the second step of the goodwill impairment test. Instead, an entity will apply a one-step quantitative test and record the amount of goodwill impairment as the excess of a reporting unit's carrying amount over its fair value, not to exceed the total amount of goodwill allocated to the reporting unit. The new guidance does not amend the optional qualitative assessment of goodwill impairment. ASU 2017-04 is effective for public business entities that are SEC filers for annual periods beginning after December 15, 2019, and interim periods within those annual periods, with early adoption permitted, and is to be applied on a prospective basis. The Company is currently evaluating the provisions of ASU 2017-04, but does not believe that its adoption will have a material impact on the Company's consolidated financial condition or results of operations.

 

In August 2016, the FASB issued ASU 2016-15, Statement of Cash Flow (Topic 230): Classification of Certain Cash Receipts and Cash Payments. ASU 2016-15 addresses the following eight specific cash flow issues: debt prepayment or debt extinguishment costs; settlement of zero-coupon debt instruments or other debt instruments with coupon interest rates that are insignificant in relation to the effective interest rate of the borrowing; contingent consideration payments made after a business combination; proceeds from the settlement of insurance claims; proceeds from the settlement of corporate-owned life insurance policies, including bank-owned life insurance policies; distributions received from equity method investees; beneficial interests in securitization transactions; and separately identifiable cash flows and application of the predominance principle. ASU 2016-15 is effective for fiscal years beginning after December 15, 2017, and interim periods within those fiscal years. Early adoption is permitted and the amendments should be applied using a retrospective transition method to each period presented.  The Company adopted the provisions of ASU 2016-15 as of January 1, 2018, and the adoption did not have a material impact on the Company's consolidated financial condition or results of operations.

 

In June 2016, the FASB issued ASU 2016-13, Financial Instruments – Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments. ASU 2016-13 amends guidance on reporting credit losses for assets held at amortized cost basis and available for sale debt securities. For assets held at amortized cost basis, ASU 2016-13 eliminates the probable initial recognition threshold in current GAAP; and instead requires an entity to reflect its current estimate of all expected credit losses. The allowance for credit losses is a valuation account that is deducted from the amortized cost basis of the financial assets to present the net amount expected to be collected. For available for sale debt securities, credit losses should be measured in a manner similar to current GAAP, however this ASU will require that credit losses be presented as an allowance rather than as a write-down. ASU 2016-13 affects companies holding financial assets and net investment in leases that are not accounted for at fair value through net income. The ASU 2016-13 amendments affect loans, debt securities, trade receivables, net investments in leases, off balance-sheet credit exposures, reinsurance receivables, and any other financial assets not excluded from the scope that have the contractual right to receive cash. ASU 2016-13 is effective for fiscal years beginning after December 15, 2019, and interim periods within those fiscal years, with early adoption permitted. The Company is currently evaluating the provisions of ASU 2016-13, but does not believe that its adoption will have a material impact on the Company's consolidated financial condition or results of operations.

 

In February 2016, the FASB issued ASU 2016-02, Leases (Topic 842), which increases the transparency and comparability among organizations by recognizing lease assets and lease liabilities on the balance sheet, and disclosing key information about leasing arrangements. ASU 2016-02 will require lessees to recognize a right-of-use (ROU) asset for its right to use the underlying asset and a lease liability for the corresponding lease obligation for leases with terms of more than twelve months. Both the ROU asset and lease liability will initially be measured at the present value of the future minimum lease payments over the lease term. Subsequent measurement, including the presentation of expenses and cash flows, will depend on the classification of the lease as either a finance or an operating lease. Accounting by lessors will remain largely unchanged from current U.S. GAAP. ASU 2016-02 is effective for fiscal years beginning after December 15, 2018, and interim periods within those years, with early adoption permitted, and is to be applied as of the beginning of the earliest period presented using a modified retrospective approach. The Company is currently evaluating the provisions of ASU 2016-02, but expects to report increased assets and liabilities as a result of reporting additional leases on the Company's consolidated statement of financial condition or results of operations.

 

In January 2016, the FASB issued ASU 2016-01, Financial Instruments – Overall (Subtopic 825-10), which enhances the reporting model for financial instruments regarding certain aspects of recognition, measurement, presentation, and disclosure. ASU 2016-01 (i) requires equity investments (except those accounted for under the equity method or that are consolidated) to be measured at fair value with changes in fair value recognized in net income; (ii) simplifies the impairment assessment of equity investments without readily determinable fair values by requiring a qualitative assessment to identify impairment; (iii) eliminates the requirement for an entity to disclose the methods and significant assumptions used to estimate the fair value of financial instruments measured at amortized cost; (iv) requires an entity to use the exit price notion when measuring the fair value of financial instruments for disclosure purposes; and (v) requires separate presentation of financial assets and financial liabilities by measurement category and form of financial asset on the balance sheet or in the accompanying notes to the financial statements. ASU 2016-01 is effective for fiscal years, and interim periods within those years, beginning after December 15, 2017, and is to be applied using a cumulative-effect adjustment to the balance sheet as of the beginning of the fiscal year of adoption. The Company adopted the provisions of ASU 2016-01 effective in the first quarter of 2018. Its adoption did not have a material impact on the Company's consolidated financial condition or results of operations. As of January 1, 2018, there was a one-time $40,000 cumulative fair value adjustment that was reclassified within the June 30, 2018, Statement of Stockholders’ Equity. The fair value adjustments recognized for equity securities were gains of $44,000 and $19,000 for the three and six months ended June 30, 2018, respectively. This fair value adjustment will fluctuate between reporting periods and is based on market conditions.

 

In May 2014, the FASB issued ASU 2014-09, Revenue from Contracts with Customers, which establishes a comprehensive revenue recognition standard for virtually all industries under GAAP, including those that previously followed industry-specific guidance, such as the real estate, construction and software industries. ASU 2014-09 specifies that an entity shall recognize revenue when, or as, the entity satisfies a performance obligation by transferring a promised good or service (i.e., an asset) to a customer. An asset is transferred when, or as, the customer obtains control of the asset. Entities are required to disclose qualitative and quantitative information on the nature, amount, timing and uncertainty of revenue and cash flows arising from contracts with customers. The guidance is effective for the Company’s financial statements beginning January 1, 2018.

 

On January 1, 2018, the Company adopted ASU 2014-09, Revenue from Contracts with Customers and all subsequent amendments to the ASU (collectively, “ASC 606”), which (i) creates a single framework for recognizing a gain (loss) from the transfer of nonfinancial assets, such as OREO. The Company adopted the ASC 2014-09 using the modified retrospective approach. The majority of the Company’s revenues are derived from interest income and other sources, including loans, leases, securities and derivatives that are outside the scope of ASC 606. The Company’s services that fall within the scope of ASC 606 are presented within non-interest income and non-interest expense, and are recognized as revenue as the Company satisfies its obligation to the customer. Services within the scope of ASC 606 include services fees on deposits accounts, interchange income, insurance commissions, other commissions, and the sale of OREO. Refer to Note 4 – Revenue Recognition from Contracts with Customers for further discussion on the Company’s accounting policies for revenue sources within the scope of ASC 606.

 

Note 2. Merger

 

On November 16, 2017, the Company entered into a definitive merger agreement with First West Virginia Bancorp (“FWVB”), the holding company for Progressive Bank, N.A. (“PB”), a national association. The FWVB merger was completed effective April 30, 2018, following the receipt of shareholder and regulatory approvals and the satisfaction of other customary closing conditions. In addition, effective April 30, 2018, PB merged into the Bank. The FWVB merger enhanced the Bank’s exposure into the core of the Tri-State region. Through the FWVB merger, the Company anticipates future revenue and earnings growth from an expanded menu of financial services expanding the Company’s business footprint into the Ohio Valley. The FWVB merger resulted in the addition of eight branches and expanded the Company’s reach into West Virginia with seven branches and one branch in Eastern Ohio. The FWVB merger value was approximately $51.3 million. In connection with the FWVB merger, the Company issued 1,317,647 shares of common stock based on the Company’s closing stock price on April 30, 2018, of $31.9068, and paid cash consideration of $9.8 million in exchange for all the outstanding shares of FWVB common stock.

 

Merger-related expenses are recorded in the Consolidated Statement of Income and include costs relating to the Company’s acquisition of FWVB, as described above.  These charges represent one-time costs associated with acquisition activities and do not represent ongoing costs of the fully integrated combined organization.  Accounting guidance requires that acquisition-related transactional and restructuring costs incurred by the Company be charged to expense as incurred. There were approximately $1.2 million of cumulative merger-related expenses, of which $769,000 and $793,000, were recorded in the Consolidated Statement of Income for the three and six months ended June 30, 2018, respectively.

 

As of the date of merger, FWVB had approximately $334.0 million of assets, $96.8 million of loans, and $282.9 million of deposits held across a network of 8 branches located in West Virginia and eastern Ohio.  The Company stockholders and FWVB stockholders now own approximately 76% and 24% of the combined company, respectively.

 

The FWVB merger is accounted for as an acquisition in accordance with the acquisition method of accounting as detailed in Accounting Standards Codification ("ASC") 805, Business Combinations. The acquisition method of accounting requires an acquirer to recognize the assets acquired and the liabilities assumed based on their fair values as of the date of acquisition. This process is heavily reliant on measuring and estimating the fair values of all the assets and liabilities of the acquired entity. To the extent we did not have the requisite expertise to determine the fair values of the assets acquired and liabilities assumed, we engaged third-party valuation specialists to assist us in determining such values. The preliminary results of the fair value evaluation generated goodwill and intangible assets. Goodwill represents the excess of the cost of an acquisition over the fair value of the net assets acquired. Other intangible assets represent purchased assets that lack physical substance but can be distinguished from goodwill because of contractual obligations or other legal rights.

 

The assets acquired and liabilities assumed of FWVB were recorded on the Company’s Consolidated Statement of Financial Condition at their estimated fair values as of April 30, 2018. Due to the timing of the acquisition relative to the end of the reporting period, the fair values for certain assets and liabilities acquired from FWVB on April 30, 2018, represent preliminary estimates. Based on a preliminary purchase price allocation, the Company recorded $10.5 million in goodwill and $12.8 million in core deposit intangibles, representing the principal change in goodwill and intangibles from December 31, 2017. None of the goodwill is deductible for income tax purposes, as the acquisition is accounted for as a tax-free exchange for tax purposes.

 

The fair value of the assets acquired and liabilities assumed in the FWVB merger were as follows (dollars in thousands):

 

 

As part of the FWVB merger, the Company identified employees from FWVB who would be retained and estimated a severance cost of $100,000 if those employees were terminated without cause within the first year of the merger.

 

The operating results of FWVB have been included in the Company’s Consolidated Statement of Income since the April 30, 2018, acquisition date. Total income of the acquired operations of First West Virginia Bancorp consisted of net interest income of approximately $1.8 million, noninterest income of approximately $155,000, noninterest expense of approximately $1.5 million and net income of approximately $385,000 from May 1, 2018 through June 30, 2018.

 

The following unaudited combined pro forma information presents the operating results for the six months ended June 30, 2018, and year ended December 31, 2017, as if the FWVB acquisition had occurred on January 1, 2017. The pro forma results have been prepared for comparative purposes only and require significant estimates and judgments. As a result, they are not necessarily indicative of the results that would have been obtained had the FWVB merger actually occurred on January 1, 2017 nor are they intended to be indicative of future results of operations (dollars in thousands, except per share data).

 

 

Note 3. Earnings Per Share

 

There are no convertible securities which would affect the numerator in calculating basic and diluted earnings per share; therefore, net income as presented on the Consolidated Statement of Income is 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.

 

 

Note 4. Revenue Recognition from Contracts with Customers

 

The Company adopted ASC 606 using the modified retrospective method applied to all contracts not completed as of January 1, 2018. Results for reporting periods beginning after January 1, 2018 are presented under ASC 606 while prior periods amounts continue to be reported in accordance with legacy GAAP. The adoption of ASC 606 resulted in a change in recognition of revenue for insurance commissions. There were no changes in the accounting for all other in-scope revenue streams.

 

The Company generally fully satisfies its performance obligations on its contracts with customers as services are rendered and the transaction prices are typically fixed; charged either on a periodic basis or based on activity. Because performance obligations are satisfied as services are rendered and the transaction prices are fixed, there is little judgment involved in applying Topic 606 that significantly affects the determination of the amount and timing of revenue from contracts with customers.

 

The following table below presents ASC 606 in-scope revenue streams and the impact of the accounting standard at the date indicted:

 

 

All of the Company’s revenue from contracts with customers in the scope of ASC 606 is recognized within Non-Interest Income with the exception of Other Real Estate Owned (Income) Expense, which is accounted for in Non-Interest Expense. The following table presents the Company’s sources of Non-Interest Income and Expense as of the date indicated:

 

 

(a)

Interchange fees and ATM fees are included within this line item.

 

(b)

Not within the scope of ASC 606.

 

(c)

The Other Commissions category includes wealth management referral fees, check sales and safety deposit box rentals totaling $111,000 and $209,000 for the three and six months ended June 30, 2018, which is in the scope of ASC 606; the remaining balance of $152,000 and $487,000 for three and six months ended June 30, 2018, respectively, mainly represents income derived from an assumable rate conversion (“ARC”) loan referral fee for the three and six months ended June 30, 2018, and a bank-owned life insurance policy claim, for the six months ended June 30, 2018, which are outside the scope of ASC 606.

 

The following narrative describes the Company’s revenue streams accounted for under the guidance of ASC 606 as follows:

 

Service Fees on Deposit Accounts: The Company earns fees from its deposit customers for transaction-based, account maintenance, and overdraft services. Transaction-based fees include services fees for ATM uses, stop payment charges, statement production, ACH and wire fees, which are recognized into income at the occurrence of an executed transaction and the point in time the Company fulfills the customer’s request. Account maintenance fees, which are primarily based on monthly maintenance activities, are earned over the course of the month, and satisfy the Company’s performance obligation. Overdraft fees are recognized as the overdrafts on customer’s accounts are incurred. The services fees on deposit accounts are automatically withdrawn from the customer’s accounts balance per their account agreement with the Company.

 

Interchange Fees: The Company earns interchange fees from debit/credit cardholder transactions conducted through the MasterCard network for our debit cards and through the Visa network for our credit cards. Interchange fees from cardholder transactions represent a percentage of the underlying transaction value and are recognized daily, concurrently with the transaction processing services provided to the cardholder. The Company currently does not offer a cardholder rewards program.

 

Insurance Commissions: The Company’s insurance subsidiary, Exchange Underwriters, derives commission and fee income from direct and agency bill insurance policies. Direct bill policies are invoiced directly from the insurance company provider to the customer, once the customer remits payment for the policy, the insurance company provider then remits the commission or fee income to EU on a monthly basis. Agency bill policies are invoiced from EU, the insurance underwriting agency, to the customer. EU records the insurance company policy payable and the commission or fee income earned on the policy. As all insurance policies are contracts with customers, each policy has different terms and conditions.

 

EU utilizes a report from their core insurance data processing program, The Agency Manager, otherwise known as (“TAM”). The report from TAM captures all in force policies that are active in the system and annualizes the commission over the life of each individual contract. The report then provides an overall commission and fee income total for the monthly reporting financial statement period. This income is then compared to the amount of direct and agency bill income recorded in TAM for the reporting month and an adjustment to income is made according to the report and this is the income recognized for the portion of the insurance contract that has been earned by EU and subsequently the Company.

 

Other Commissions: The Company earns other commissions, such as, wealth management referral fees, check sales and safety deposit box rentals to customers. The wealth management referral fees are earned as a referral of a bank customer initiates a customer relationship with an associated wealth management firm. These fees fulfill the contract/agreement between the Company and the wealth management firm. Check sales are recognized as customers contact the Company for check supplies or the customer initiates the check order through the Company website to our third party check company. These commissions are recognized as the third party check company satisfies the contract of providing check stock to our customers. Safety deposit box rental income is recognized on a monthly basis, per each contract agreement with our customers. The safety deposit box income is automatically withdrawn from the customer’s deposit account on a monthly basis as this revenue is earned by the contract.

 

Gains/Losses on Sales of OREO: The Company records a gain or loss from the sale of OREO when control of the property transfers to the buyer, which generally occurs at the time of an executed deed. It is not common policy that the Company will finance an OREO property with the buyer. It is the Company’s belief that once loan collateral has been recognized as an OREO property, it needs to be sold and free the Company of any additional possible loss exposure.

 

Note 5. Investment Securities

 

The following table presents the amortized cost and fair value of investment securities available-for-sale at the dates indicated:

 

 

 

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 at the dates indicated:

 

 

 

For debt securities, the Company does not believe that any individual unrealized loss as of June 30, 2018 or December 31, 2017 represents an other-than-temporary impairment. The Company performs a review of the entire securities portfolio on a quarterly basis to identify securities that may indicate an other-than-temporary impairment. The Company’s management considers the length of time and the extent to which the fair value has been less than cost, and the financial condition of the issuer. The securities that are temporarily impaired at June 30, 2018 and December 31, 2017 relate principally to changes in interest rates subsequent to the acquisition of the specific securities. The Company does not intend to sell or it is not more likely than not that it will be required to sell any of the securities in an unrealized loss position before recovery of its amortized cost or maturity of the security.

 

The following table presents the scheduled maturities of investment securities as of the date indicated:

 

 

Equity Securities – Mutual Funds and Equity Securities – Other do not have a scheduled maturity date, but have been included in the Due After Ten Years category.

 

Note 6. Loans and Related Allowance for Loan Loss

 

The Company’s loan portfolio is made up of four classifications: real estate loans, commercial and industrial loans, consumer loans and other loans. These segments are further segregated between loans accounted for under the amortized cost method (“Originated Loans”) and acquired loans that were originally recorded at fair value with no carryover of the related pre-merger allowance for loan losses (“Loans Acquired at Fair Value”). The following table presents the classifications of loans as of the dates indicated.

 

 

Total unamortized net deferred loan fees were $1.0 million and $808,000 at June 30, 2018 and December 31, 2017, respectively.

 

Real estate loans serviced for others, which are not included in the Consolidated Statement of Financial Condition, totaled $97.7 million and $95.4 million at June 30, 2018 and December 31, 2017, respectively.

 

The following table presents loans summarized by the aggregate Pass and the criticized categories of Special Mention, Substandard and Doubtful within the internal risk rating system as of the dates indicated. At June 30, 2018 and December 31, 2017, there were no loans in the criticized category of Loss within the internal risk rating system.

 

 

 

 

 

 

 

 

 

 

The following table presents the classes of the loan portfolio summarized by the aging categories of performing loans and nonaccrual loans as of the dates indicated.

 

 

 

 

 

 

 

 

 

 

The following table sets forth the amounts and categories of our nonperforming assets at the dates indicated. Included in nonperforming loans and assets are troubled debt restructurings (“TDRs”), which are loans whose contractual terms have been restructured in a manner which grants a concession to a borrower experiencing financial difficulties. Nonaccrual TDRs are included in their specific loan category in the nonaccrual loans section.

 

 

The recorded investment of residential real estate loans for which formal foreclosure proceedings were in process according to applicable requirements of the local jurisdiction was $1.1 million and $1.5 million at June 30, 2018 and December 31, 2017, respectively.

 

TDRs typically are the result of our loss mitigation activities whereby concessions are granted to minimize loss and avoid foreclosure or repossession of collateral. The concessions granted for the TDRs in the portfolio primarily consist of, but are not limited to, modification of payment or other terms, temporary rate modification and extension of maturity date. Loans classified as TDRs consisted of 14 loans totaling $4.0 million and 16 loans totaling $4.5 million at June 30, 2018 and December 31, 2017, respectively. Originated loans classified as TDRs consisted of seven loans totaling $2.4 million and eight loans totaling $2.6 million at June 30, 2018 and December 31, 2017, respectively. Loans acquired at fair value classified as TDRs consisted of seven loans totaling $1.6 million and eight loans totaling $1.9 million at June 30, 2018 and December 31, 2017, respectively.

 

During the three months ended June 30, 2018, one originated commercial and industrial line of credit loan entered into a TDR and was termed-out due to declining updated financial information and one acquired loan at fair value TDR for residential real estate was due to the FWVB merger. In addition, there was one acquired loan at fair value TDR from the FFCO merger for commercial real estate that paid off during the three months ended June 30, 2018. There were no loans modified into a TDR transaction during the quarter- ended March 31, 2018.

 

 

During the six months ended June 30, 2018, one originated commercial and industrial TDR loan was fully charged-off due to declining updated financial information, one originated consumer loan previously identified as a TDR paid off and one commercial and industrial loan previously identified as an acquired loan at fair value TDR paid off.

 

No TDRs subsequently defaulted during the three and six months ended June 30, 2018 and 2017, respectively.

 

There were no loans modified into a TDR transaction during the three and six months ended June 30, 2017.

 

The following table presents a summary of the loans considered to be impaired as of the dates indicated.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

The following table presents the activity in the allowance for loan losses summarized by major classifications and segregated into the amount required for loans individually evaluated for impairment and the amount required for loans collectively evaluated for potential impairment for the periods indicated.

 

 

 

 

 

 

 

 

 

 

The following table presents changes in the accretable discount on the loans acquired at fair value for the dates indicated.

 

 

The following table presents the major classifications of loans summarized by individually evaluated for impairment and collectively evaluated for potential impairment as of the dates indicated.