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LIMESTONE BANCORP, INC. - Quarter Report: 2018 September (Form 10-Q)

pbib20180930_10q.htm
 

 

Table of Contents


 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549
 


 FORM 10-Q  

 

(Mark One)

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

 

For the Quarterly Period Ended September 30, 2018

 

Or

 

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

 

For the transition period from              to             

 

Commission file number: 001-33033

 

LIMESTONE BANCORP, INC.

(Exact name of registrant as specified in its charter)

 

  

  

  

Kentucky

  

61-1142247

(State or other jurisdiction of

incorporation or organization)

  

(I.R.S. Employer

Identification No.)

  

  

2500 Eastpoint Parkway, Louisville, Kentucky

  

40223

(Address of principal executive offices)

  

(Zip Code)

 

(502) 499-4800

(Registrant’s telephone number, including area code)

 


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

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes ☒ No ☐

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer  ☐    

Accelerated filer  ☐    

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

Smaller reporting company  ☒

 

Emerging growth company  ☐

 

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

 

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

 

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

 

6,236,590 Common Shares and 1,220,000 Non-Voting Common Shares, no par value, were outstanding at October 31, 2018.

 

 

 

INDEX

 

 

  

  

Page

PART I –

FINANCIAL INFORMATION

  

ITEM 1.

FINANCIAL STATEMENTS

3

ITEM 2. 

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

33

ITEM 3.

QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

48

ITEM 4.

CONTROLS AND PROCEDURES

48

  

  

  

PART II –

OTHER INFORMATION

  

ITEM 1.

LEGAL PROCEEDINGS

49

ITEM 1A.

RISK FACTORS

49

ITEM 2.

UNREGISTERED SALES ON EQUITY SECURITIES AND USE OF PROCEEDS

49

ITEM 3.

DEFAULTS UPON SENIOR SECURITIES

49

ITEM 4.

MINE SAFETY DISCLOSURES

49

ITEM 5.

OTHER INFORMATION

49

ITEM 6.

EXHIBITS

49

 

 

PART I – FINANCIAL INFORMATION

 

Item 1. Financial Statements

 

The following consolidated financial statements of Limestone Bancorp, Inc. and subsidiary, Limestone Bank, Inc. are submitted:

 

Unaudited Consolidated Balance Sheets for September 30, 2018 and December 31, 2017

Unaudited Consolidated Statements of Income for the three and nine months ended September 30, 2018 and 2017

Unaudited Consolidated Statements of Comprehensive Income for the three and nine months ended September 30, 2018 and 2017

Unaudited Consolidated Statement of Changes in Stockholders’ Equity for the nine months ended September 30, 2018

Unaudited Consolidated Statements of Cash Flows for the nine months ended September 30, 2018 and 2017

Notes to Unaudited Consolidated Financial Statements

 

 

 

LIMESTONE BANCORP, INC.

Unaudited Consolidated Balance Sheets

(dollars in thousands except share data)

 

 

   

September 30,

2018

   

December 31,

2017

 

Assets

               

Cash and due from banks

  $ 5,770     $ 8,137  

Interest bearing deposits in banks

    31,761       25,966  

Cash and cash equivalents

    37,531       34,103  

Securities available for sale

    184,870       152,720  

Loans held for sale

          70  

Loans, net of allowance of $8,634 and $8,202, respectively

    748,417       703,913  

Premises and equipment, net

    17,027       16,789  

Other real estate owned

    3,750       4,409  

Federal Home Loan Bank stock

    7,233       7,323  

Bank owned life insurance

    15,551       15,229  

Deferred taxes, net

    30,230       31,313  

Accrued interest receivable and other assets

    5,882       4,932  

Total assets

  $ 1,050,491     $ 970,801  
                 

Liabilities and Stockholders’ Equity

               

Deposits

               

Non-interest bearing

  $ 135,561     $ 137,386  

Interest bearing

    738,465       709,638  

Total deposits

    874,026       847,024  

Federal Home Loan Bank advances

    51,591       11,797  

Accrued interest payable and other liabilities

    5,662       6,057  

Subordinated capital note

          2,250  

Junior subordinated debentures

    21,000       21,000  

Senior debt

    10,000       10,000  

Total liabilities

    962,279       898,128  

Commitments and contingent liabilities (Note 13)

           

Stockholders’ equity

               

Preferred stock, no par

               

Series E - none and 6,198 issued and outstanding, respectively; Liquidation preference of $6.2 million

          1,644  

Series F - none and 4,304 issued and outstanding, respectively; Liquidation preference of $4.3 million

          1,127  

Total preferred stockholders’ equity

          2,771  

Common stock, no par, 39,000,000 shares authorized, 6,236,590 and 6,039,864 voting, and 1,220,000 and 220,000 non-voting issued and outstanding, respectively

    140,639       125,729  

Additional paid-in capital

    24,097       24,497  

Retained deficit

    (68,641

)

    (75,108

)

Accumulated other comprehensive loss

    (7,883

)

    (5,216

)

Total common stockholders’ equity

    88,212       69,902  

Total stockholders' equity

    88,212       72,673  

Total liabilities and stockholders’ equity

  $ 1,050,491     $ 970,801  

 

 

See accompanying notes to unaudited consolidated financial statements.

 

 

 

LIMESTONE BANCORP, INC.

Unaudited Consolidated Statements of Income

(dollars in thousands, except per share data)

 

 

   

Three Months Ended

September 30,

   

Nine Months Ended

September 30,

 
   

2018

   

2017

   

2018

   

2017

 
Interest income                                

Loans, including fees

  $ 9,539     $ 8,021     $ 27,423     $ 23,493  

Taxable securities

    1,245       1,088       3,386       3,370  

Tax exempt securities

    95       143       287       432  

Federal funds sold and other

    241       194       624       510  
      11,120       9,446       31,720       27,805  
Interest expense                                

Deposits

    2,130       1,324       5,123       3,877  

Federal Home Loan Bank advances

    233       13       605       64  

Senior debt

    98       97       292       97  

Junior subordinated debentures

    247       193       694       553  

Subordinated capital note

          32       39       98  
      2,708       1,659       6,753       4,689  

Net interest income

    8,412       7,787       24,967       23,116  

Provision (negative) provision for loan losses

    (350

)

          (500

)

     

Net interest income after provision for loan losses

    8,762       7,787       25,467       23,116  
                                 
Non-interest income                                

Service charges on deposit accounts

    608       568       1,767       1,617  

Bank card interchange fees

    411       387       1,258       1,118  

Income from bank owned life insurance

    100       103       337       309  

Net gain (loss) on sales and calls of investment securities

                (6

)

    (5

)

Other

    390       266       751       723  
      1,509       1,324       4,107       3,762  
Non-interest expense                                

Salaries and employee benefits

    3,893       3,683       11,566       11,433  

Occupancy and equipment

    896       836       2,671       2,501  

Professional fees

    186       232       613       776  

Marketing expense

    259       364       867       880  

FDIC Insurance

    118       356       439       1,055  

Data processing expense

    281       321       912       931  

State franchise and deposit tax

    282       225       846       675  

Deposit account related expense

    213       222       653       646  

Other real estate owned expense

    271       111       590       92  

Litigation and loan collection expense

    61       78       162       121  

Other

    770       889       2,485       2,585  
      7,230       7,317       21,804       21,695  

Income before income taxes

    3,041       1,794       7,770       5,183  

Income tax expense

    604             1,416        

Net income

    2,437       1,794       6,354       5,183  

Basic and diluted income per common share

  $ 0.33     $ 0.29     $ 0.90     $ 0.83  

 

 

See accompanying notes to unaudited consolidated financial statements.

 

 

 

 

LIMESTONE BANCORP, INC.

Unaudited Consolidated Statements of Comprehensive Income (Loss)

(in thousands)

                                              

 

   

Three Months Ended

September 30,

   

Nine Months Ended

September 30,

 
   

2018

   

2017

   

2018

   

2017

 

Net income

  $ 2,437     $ 1,794     $ 6,354     $ 5,183  

Other comprehensive income (loss):

                               

Unrealized gain (loss) on securities:

                               

Unrealized gain (loss) arising during the period

    (1,006

)

    (280

)

    (3,234

)

    1,783  

Amortization during the period of net unrealized loss transferred to held to maturity

          32             98  

Net unrealized gain (loss) recognized in comprehensive income

    (1,006

)

    (248

)

    (3,234

)

    1,881  

Tax effect

    211             680        

Other comprehensive income (loss)

    (795

)

    (248

)

    (2,554

)

    1,881  
                                 

Comprehensive income

  $ 1,642     $ 1,546     $ 3,800     $ 7,064  

 

 

See accompanying notes to unaudited consolidated financial statements.

 

 

 

LIMESTONE BANCORP, INC. 

Unaudited Consolidated Statements of Changes in Stockholders’ Equity

For Nine Months Ended September 30, 2018

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

 

    Shares     Amount  
    Preferred     Common     Preferred     Common  
   

Series E

   

Series F

   

Common

   

Non-Voting

Common

   

Total

Common

   

Series E

    Series F    

Common and

Non-Voting

Common

   

Additional

Paid-In Capital

    Retained
Deficit
    Accumulated
Other
Comprehensive Income (Loss)
    Total  
                                                                                                 

Balances, January 1, 2018

    6,198       4,304       6,039,864       220,000       6,259,864     $ 1,644     $ 1,127     $ 125,729     $ 24,497     $ (75,108

)

  $ (5,216

)

  $ 72,673  

Issuance of unvested stock

                46,726             46,726                                            

Issuance of stock

                150,000       1,000,000       1,150,000                   14,910                         14,910  

Redemption and retirement of preferred shares

    (6,198

)

    (4,304

)

                      (1,644

)

    (1,127

)

          (734

)

                (3,505

)

Stock-based compensation expense

                                                    334                   334  

Net income

                                                          6,354             6,354  

Reclassification of disproportionate tax effect

                                                                                               

due to change in federal tax rate

                                                          113       (113

)

     

Net change in accumulated other

                                                                (2,554

)

    (2,554

)

comprehensive income, net of taxes

                                                                                               

Balances, September 30, 2018

                6,236,590       1,220,000       7,456,590     $     $     $ 140,639     $ 24,097     $ (68,641

)

  $ (7,883

)

  $ 88,212  

 

 

See accompanying notes to unaudited consolidated financial statements.

 

 

 

LIMESTONE BANCORP, INC.

Unaudited Consolidated Statements of Cash Flows

For Nine Months Ended September 30, 2018 and 2017

(dollars in thousands)

 

   

2018

   

2017

 

Cash flows from operating activities

               

Net income

  $ 6,354     $ 5,183  

Adjustments to reconcile net income to net cash from operating activities

               

Depreciation and amortization

    739       896  

Provision (negative provision) for loan losses

    (500

)

     

Net amortization on securities

    669       931  

Stock-based compensation expense

    334       271  

Deferred taxes, net

    1,762        

Net gain on sales of loans held for sale

    (1

)

    (39

)

Origination of loans for sale

          (2,179

)

Proceeds from sales of loans held for sale

    71       2,218  

Net gain on sales of other real estate owned

    (72

)

    (75

)

Net write-down of other real estate owned

    585       98  

Net (gain) loss on sale of premises and equipment

    (46

)

     

Net realized loss on sales and calls of investment securities

    6       5  

Earnings on bank owned life insurance, net of premium expense

    (322

)

    (293

)

Net change in accrued interest receivable and other assets

    (950

)

    1,929  

Net change in accrued interest payable and other liabilities

    (395

)

    (10,183

)

Net cash from operating activities

    8,234       (1,238

)

                 

Cash flows from investing activities

               

Purchases of available for sale securities

    (58,965

)

    (15,340

)

Proceeds from sales and calls of available for sale securities

    6,054       2,000  

Proceeds from maturities and prepayments of available for sale securities

    16,852       17,480  

Proceeds from calls of held to maturity securities

          47  

Proceeds from maturities of held to maturity securities

          145  

Proceeds from redemptions of Federal Home Loan Bank stock

    90        

Proceeds from sale of other real estate owned

    876       738  

Net change in loans

    (44,823

)

    (43,590

)

           Proceeds from sale of premises and equipment     141       328  

Purchases of premises and equipment

    (982

)

    (153 )

Net cash from investing activities

    (80,757

)

    (38,345

)

                 

Cash flows from financing activities

               

Net change in deposits

    27,002       16,922  

Payments of Federal Home Loan Bank advances

    (85,206

)

    (30,611

)

Advances from Federal Home Loan Bank

    125,000       25,000  

Payments of subordinated capital note

    (2,250

)

    (675

)

Proceeds from senior debt

          10,000  

Proceeds from issuance of common stock

    14,910        

Redemption of preferred stock

    (3,505

)

     

Net cash from financing activities

    75,951       20,636  

Net change in cash and cash equivalents

    3,428       (18,947

)

Beginning cash and cash equivalents

    34,103       66,316  

Ending cash and cash equivalents

  $ 37,531     $ 47,369  
                 

Supplemental cash flow information:

               

Interest paid

  $ 7,631     $ 4,140  

Supplemental non-cash disclosure:

               

Transfer from loans to other real estate

  $ 730     $ 270  

 

 

See accompanying notes to unaudited consolidated financial statements.

 

 

LIMESTONE BANCORP, INC.

Notes to Unaudited Consolidated Financial Statements

 

 

 

Note 1 – Basis of Presentation and Summary of Significant Accounting Policies

 

Basis of Presentation – The consolidated financial statements include Limestone Bancorp, Inc. (Company) and its subsidiary, Limestone Bank (Bank). The Company owns a 100% interest in the Bank. All significant inter-company transactions and accounts have been eliminated in consolidation.

 

The accompanying unaudited consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles (GAAP) for interim financial information and with the instructions to Form 10-Q and Rule 10-01 of Regulation S-X. Accordingly, the financial statements do not include all of the information and footnotes required by U.S. generally accepted accounting principles for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. Operating results for the three and nine months ended September 30, 2018 are not necessarily indicative of the results that may be expected for the entire year. A description of other significant accounting policies is presented in the notes to the Consolidated Financial Statements for the year ended December 31, 2017 included in the Company’s Annual Report on Form 10-K.

 

Use of Estimates – To prepare financial statements in conformity with U.S. generally accepted accounting principles, management makes estimates and assumptions based on available information. These estimates and assumptions affect the amounts reported in the financial statements and the disclosures provided, and future results could differ.

 

Reclassifications – Some items in the prior year financial statements were reclassified to conform to the current presentation. The reclassifications did not impact net income or stockholders’ equity.

 

New Accounting Standards – In May 2014, FASB issued ASU 2014-09, Revenue from Contracts with Customers (Topic 606) (“ASC 606”). The ASU provides guidance on revenue recognition for entities that enter into contracts with customers to transfer goods or services or enter into contracts for the transfer of non-financial assets. The core principle of the guidance is that an entity should recognize revenue to depict the transfer of promised 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. The majority of the Company’s revenues come from interest income and other sources, including loans and securities that are outside the scope of ASC 606. The Company’s services that fall within the scope of ASC 606 are presented in non-interest income and are recognized as revenue as the Company satisfies its obligation to the customer. Services within the scope of ASC 606 include service charges on deposit accounts, bank card interchange income, and the sale of OREO. Additional disclosures are required to provide quantitative and qualitative information regarding the nature, amount, timing, and uncertainty of revenue and cash flows arising from contracts with customers. The new guidance became effective for the Company on January 1, 2018. The impact of adopting this new guidance did not have a material impact on the consolidated financial statements, but did result in additional disclosures, which have been incorporated into “Note 14 – Revenue from Contracts with Customers.”

 

In January 2016, the FASB issued an update ASU No. 2016-01, Financial Instruments – Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities. The amendments in this update impact public business entities as follows: 1) Require 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. 2) Simplify the impairment assessment of equity investments without readily determinable fair values by requiring a qualitative assessment to identify impairment. When a qualitative assessment indicates that impairment exists, an entity is required to measure the investment at fair value. 3) Eliminate the requirement to disclose the methods 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. 4) Require entities to use the exit price notion when measuring the fair value of financial instruments for disclosure purposes. 5) Require an entity to present separately in other comprehensive income the portion of the total change in fair value of a liability resulting from a change in the instrument-specific credit risk when the entity has elected to measure the liability at fair value in accordance with the fair value option for financial instruments. 6) Require 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. 7) Clarify 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. The amendments in this update became effective for the Company on January 1, 2018. The impact of adopting the new guidance did not have a material impact on the consolidated financial statements, but did require additional disclosures. The additional disclosures have been incorporated into “Note 8 – Fair Value Measurements.”

 

In February 2016, the FASB issued an update ASU No. 2016-02, Leases (Topic 842). Under the new guidance, lessees will be required to recognize the following for all leases, with the exception of short-term leases, at the commencement date: a lease liability, which is a lessee’s obligation to make lease payments arising from a lease, measured on a discounted basis; and a right-of-use asset, which is an asset that represents the lessee’s right to use, or control the use of, a specified asset for the lease term. Under the new guidance, lessor accounting in largely unchanged. The amendments in this update become effective for annual periods and interim periods within those annual periods beginning after December 15, 2018. Based on the Company’s current lease agreements, the impact of adopting the new guidance on the consolidated financial statements will not have a material impact on the consolidated financial statements.

 

 

In June 2016, the FASB issued ASU No. 2016-13, –Financial Instruments – Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments. The final standard will change estimates for credit losses related to financial assets measured at amortized cost such as loans, held-to-maturity debt securities, and certain other contracts. For estimating credit losses, the FASB is replacing the incurred loss model with an expected loss model, which is referred to as the current expected credit loss (CECL) model. Under the CECL model, certain financial assets that are carried at amortized cost, such as loans held for investment and held-to-maturity debt securities, are required to be presented at the net amount expected to be collected. The measurement of expected credit losses is to be based on information about past events, including historical experience, current conditions, and reasonable and supportable forecasts that affect the collectability of the reported amount. This measurement will take place at the time the financial asset is first added to the balance sheet and periodically thereafter. This differs significantly from the “incurred loss” model required under current GAAP, which delays recognition until it is probable a loss has been incurred. The change could materially affect how the allowance for loan losses is determined. The standard is effective for public companies for fiscal years beginning after December 15, 2019. Management has formed a cross functional committee that has overseen the enhancement of existing technology required to source and model data for the purpose of meeting this standard. The committee has selected a vendor to assist in generating loan level cash flows and disclosures. The impact of CECL model implementation is being evaluated, but it is expected that a one-time cumulative-effect adjustment to the allowance for loan losses will be recognized in retained earnings on the consolidated balance sheet as of the beginning of the first reporting period in which the new standard is effective, as is consistent with regulatory expectations set forth in interagency guidance. The magnitude of any adjustment or the overall impact of the new standard on financial condition or results of operation cannot yet be determined.

 

In March 2017, the FASB issued ASU No. 2017-08, Receivables – Nonrefundable Fees and Other Costs (Subtopic 310-20): Premium Amortization of Purchased Callable Debt Securities. The final standard will shorten the amortization period for premiums on callable debt securities by requiring that premiums be amortized to the first (or earliest) call date instead of as an adjustment to the yield over the contractual life. The standard is effective for public companies for fiscal years beginning after December 15, 2018. Adoption of this new guidance will not have a material impact on the consolidated financial statements.

 

In February 2018, the FASB issued ASU No. 2018-02, –Income Statement – Reporting Comprehensive Income (Topic 220): Reclassification of Certain Tax Effects From Other Comprehensive Income. The final standard allows institutions to elect to reclassify the stranded tax effects from AOCI to retained earnings, limited to amounts in AOCI that are affected by the tax reform law. This includes remeasuring deferred tax assets and liabilities related to items presented in AOCI at the newly enacted tax rate and on other income tax effects of items remaining in AOCI. The standard is effective for public companies for fiscal years beginning after December 15, 2018, and interim periods during 2018. Early adoption is permitted. The Company adopted the standard on January 1, 2018 and adoption did not have a material impact on the consolidated financial statements as it resulted in a $113,000 entry between AOCI and retained deficit.

 

 

Note 2 – Securities

 

Securities are classified as available for sale (AFS). AFS securities may be sold if needed for liquidity, asset liability management, or other reasons. AFS securities are reported at fair value, with unrealized gains or losses included as a separate component of equity, net of tax.

 

The amortized cost and fair value of securities and the related gross unrealized gains and losses recognized in accumulated other comprehensive income (loss) were as follows:

 

   

Amortized

Cost

   

Gross

Unrealized

Gains

   

Gross

Unrealized

Losses

   

Fair Value

 
   

(in thousands)

 

September 30, 2018

                               

Available for sale

                               

U.S. Government and federal agency

  $ 23,762     $     $ (1,112

)

  $ 22,650  

Agency mortgage-backed: residential

    88,526       79       (2,793

)

    85,812  

Collateralized loan obligations

    34,908       4       (36

)

    34,876  

State and municipal

    32,835       194       (381

)

    32,648  

Corporate bonds

    8,877       32       (25

)

    8,884  

Total available for sale

  $ 188,908     $ 309     $ (4,347

)

  $ 184,870  

 

 

December 31, 2017

 

Amortized

Cost

   

Gross

Unrealized

Gains

   

Gross

Unrealized

Losses

   

Fair Value

 

Available for sale

                               

U.S. Government and federal agency

  $ 22,105     $ 2     $ (483

)

  $ 21,624  

Agency mortgage-backed: residential

    65,935       117       (1,087

)

    64,965  

Collateralized loan obligations

    25,343       182       (20

)

    25,505  

State and municipal

    33,303       508       (101

)

    33,710  

Corporate bonds

    6,838       78             6,916  

Total available for sale

  $ 153,524     $ 887     $ (1,691

)

  $ 152,720  

 

 

Sales and calls of securities were as follows:

   

Three Months Ended

September 30,

   

Nine Months Ended

September 30,

 
   

2018

   

2017

   

2018

   

2017

 
    (in thousands)     (in thousands)  

Proceeds

  $     $ 2,000     $ 6,054     $ 2,047  

Gross gains

                       

Gross losses

                6       5  

 

The amortized cost and fair value of our debt securities are shown by contractual maturity. Expected maturities may differ from actual maturities when borrowers have the right to call or prepay obligations with or without call or prepayment penalties. Mortgage-backed securities not due at a single maturity date are shown separately. 

 

   

September 30, 2018

 
   

Amortized

Cost

   

Fair

Value

 
   

(in thousands)

 

Maturity

               

Available for sale

               

Within one year

  $ 25,700     $ 25,720  

One to five years

    55,798       54,962  

Five to ten years

    15,877       15,370  

Beyond ten years

    3,007       3,006  

Agency mortgage-backed: residential

    88,526       85,812  

Total

  $ 188,908     $ 184,870  

                                                                          

Securities pledged at September 30, 2018 and December 31, 2017 had carrying values of approximately $55.7 million and $76.8 million, respectively, and were pledged to secure public deposits.

 

At September 30, 2018 and December 31, 2017, the Bank held securities issued by the Commonwealth of Kentucky or Kentucky municipalities having a book value of $15.2 million and $15.4 million, respectively. At September 30, 2018 and December 31, 2017, there were no other holdings of securities of any one issuer, other than the U.S. Government and its agencies, in an amount greater than 10% of stockholders’ equity.

 

The Company evaluates securities for other-than-temporary impairment on a quarterly basis, and more frequently when economic or market concerns warrant such evaluation. Consideration is given to the length of time and the extent to which the fair value has been less than cost, the financial condition and near-term prospects of the issuer, underlying credit quality of the issuer, and the intent and ability of the Company to retain its investment in the issuer for a period of time sufficient to allow for any anticipated recovery in fair value. In analyzing an issuer’s financial condition, the Company may consider whether the securities are issued by the federal government or its agencies, whether downgrades by bond rating agencies have occurred, the sector or industry trends and cycles affecting the issuer, and the results of reviews of the issuer’s financial condition. As of September 30, 2018, management does not believe any securities in the portfolio with unrealized losses should be classified as other than temporarily impaired.

 

 

Securities with unrealized losses at September 30, 2018 and December 31, 2017, aggregated by investment category and length of time the individual securities have been in a continuous unrealized loss position, are as follows:

 

   

Less than 12 Months

   

12 Months or More

   

Total

 

Description of Securities

 

Fair

Value

   

Unrealized

Loss

   

Fair

Value

   

Unrealized

Loss

   

Fair

Value

   

Unrealized

Loss

 
   

(in thousands)

 

September 30, 2018

                                               

Available for sale

                                               

U.S. Government and federal agency

  $ 7,191     $ (206

)

  $ 15,459     $ (906

)

  $ 22,650     $ (1,112

)

Agency mortgage-backed: residential

    50,542       (1,172

)

    27,602       (1,621

)

    78,144       (2,793

)

Collateralized loan obligations

    25,808       (36

)

                25,808       (36

)

State and municipal

    18,591       (381

)

                18,591       (381

)

Corporate bonds

    1,975       (25

)

                1,975       (25

)

Total temporarily impaired

  $ 104,107     $ (1,820

)

  $ 43,061     $ (2,527

)

  $ 147,168     $ (4,347

)

                                                 
                                                 

December 31, 2017

                                               

Available for sale

                                               

U.S. Government and federal agency

  $ 5,788     $ (97

)

  $ 14,121     $ (386

)

  $ 19,909     $ (483

)

Agency mortgage-backed: residential

    21,104       (172

)

    27,158       (915

)

    48,262       (1,087

)

Collateralized loan obligations

    6,038       (20

)

                6,038       (20

)

State and municipal

    7,492       (101

)

                7,492       (101

)

Total temporarily impaired

  $ 40,422     $ (390

)

  $ 41,279     $ (1,301

)

  $ 81,701     $ (1,691

)

 

 

 

Note 3 – Loans

 

Loans net of unearned income, deferred loan origination costs, and net premiums on acquired loans by class were as follows:

 

   

September 30,

   

December 31,

 
   

2018

   

2017

 
   

(in thousands)

 

Commercial

  $ 125,699     $ 113,771  

Commercial Real Estate:

               

Construction

    83,368       57,342  

Farmland

    83,917       88,320  

Nonfarm nonresidential

    163,346       156,724  

Residential Real Estate:

               

Multi-family

    46,144       56,588  

1-4 Family

    173,674       179,222  

Consumer

    40,242       18,439  

Agriculture

    40,144       41,154  

Other

    517       555  

Subtotal

    757,051       712,115  

Less: Allowance for loan losses

    (8,634

)

    (8,202

)

Loans, net

  $ 748,417     $ 703,913  

 

 

The following table presents the activity in the allowance for loan losses by portfolio segment for the three months ended September 30, 2018 and 2017:

 

   

Commercial

   

Commercial

Real Estate

   

Residential

Real Estate

   

Consumer

   

Agriculture

   

Other

   

Total

 
   

(in thousands)

 

September 30, 2018:

                                                       

Beginning balance

  $ 1,133     $ 4,234     $ 2,778     $ 66     $ 367     $ 2     $ 8,580  

Provision (negative provision)

    65       (48

)

    (393

)

    21       5             (350

)

Loans charged off

    (50

)

          (78

)

    (15

)

                (143

)

Recoveries

    10       295       231       9       2             547  

Ending balance

  $ 1,158     $ 4,481     $ 2,538     $ 81     $ 374     $ 2     $ 8,634  
                                                         
                                                         

September 30, 2017:

                                                       

Beginning balance

  $ 956     $ 4,223     $ 3,317     $ 53     $ 335     $ 1     $ 8,885  

Provision (negative provision)

    (41

)

    206       (147

)

    (31

)

    15       (2

)

     

Loans charged off

    (5

)

          (57

)

    (5

)

                (67

)

Recoveries

    3       9       103       25       16       3       159  

Ending balance

  $ 913     $ 4,438     $ 3,216     $ 42     $ 366     $ 2     $ 8,977  

 

 

The following table presents the activity in the allowance for loan losses by portfolio segment for the nine months ended September 30, 2018 and 2017: 

 

   

Commercial

   

Commercial

Real Estate

   

Residential

Real Estate

   

Consumer

   

Agriculture

   

Other

   

Total

 
   

(in thousands)

 

September 30, 2018:

                                                       

Beginning balance

  $ 892     $ 4,032     $ 2,900     $ 64     $ 313     $ 1     $ 8,202  

Provision (negative provision)

    61       (68

)

    (557

)

    7       60       (3

)

    (500

)

Loans charged off

    (50

)

    (198

)

    (166

)

    (49

)

    (12

)

    (8

)

    (483

)

Recoveries

    255       715       361       59       13       12       1,415  

Ending balance

  $ 1,158     $ 4,481     $ 2,538     $ 81     $ 374     $ 2     $ 8,634  
                                                         
                                                         

September 30, 2017:

                                                       

Beginning balance

  $ 475     $ 4,894     $ 3,426     $ 8     $ 162     $ 2     $ 8,967  

Provision (negative provision)

    399       (791

)

    134       (5

)

    274       (11

)

     

Loans charged off

    (5

)

    (58

)

    (512

)

    (30

)

    (95

)

          (700

)

Recoveries

    44       393       168       69       25       11       710  

Ending balance

  $ 913     $ 4,438     $ 3,216     $ 42     $ 366     $ 2     $ 8,977  

 

 

The following table presents the balance in the allowance for loan losses and the recorded investment in loans by portfolio segment and based on the impairment method as of September 30, 2018:

 

 

   

Commercial

   

Commercial

Real Estate

   

Residential

Real Estate

   

Consumer

   

Agriculture

   

Other

   

Total

 
   

(in thousands)

 

Allowance for loan losses:

                                                       

Ending allowance balance attributable to loans:

                                                       

Individually evaluated for impairment

  $     $ 46     $ 190     $     $     $     $ 236  

Collectively evaluated for impairment

    1,158       4,435       2,348       81       374       2       8,398  

Total ending allowance balance

  $ 1,158     $ 4,481     $ 2,538     $ 81     $ 374     $ 2     $ 8,634  
                                                         

Loans:

                                                       

Loans individually evaluated for impairment

  $ 56     $ 1,377     $ 2,371     $     $     $     $ 3,804  

Loans collectively evaluated for impairment

    125,643       329,254       217,447       40,242       40,144       517       753,247  

Total ending loans balance

  $ 125,699     $ 330,631     $ 219,818     $ 40,242     $ 40,144     $ 517     $ 757,051  

 

 

The following table presents the balance in the allowance for loan losses and the recorded investment in loans by portfolio segment and based on the impairment method as of December 31, 2017:

 

 

   

Commercial

   

Commercial

Real Estate

   

Residential

Real Estate

   

Consumer

   

Agriculture

   

Other

   

Total

 
   

(in thousands)

 

Allowance for loan losses:

                                                       

Ending allowance balance attributable to loans:

                                                       

Individually evaluated for impairment

  $ 13     $     $ 206     $     $     $     $ 219  

Collectively evaluated for impairment

    879       4,032       2,694       64       313       1       7,983  

Total ending allowance balance

  $ 892     $ 4,032     $ 2,900     $ 64     $ 313     $ 1     $ 8,202  
                                                         
                                                         

Loans:

                                                       

Loans individually evaluated for impairment

  $ 587     $ 2,635     $ 3,950     $ 1     $     $     $ 7,173  

Loans collectively evaluated for impairment

    113,184       299,751       231,860       18,438       41,154       555       704,942  

Total ending loans balance

  $ 113,771     $ 302,386     $ 235,810     $ 18,439     $ 41,154     $ 555     $ 712,115  

 

 

Impaired Loans

 

Impaired loans include restructured loans and loans on nonaccrual or classified as doubtful, whereby collection of the total amount is improbable, or loss, whereby all or a portion of the loan has been written off or a specific allowance for loss has been provided.

 

The following tables present information related to loans individually evaluated for impairment by class of loans as of September 30, 2018 and December 31, 2017 and for the nine months ended September 30, 2018 and 2017:

 

   

As of September 30, 2018

   

Three Months Ended

September 30, 2018

   

Nine Months Ended

September 30, 2018

 
   

Unpaid

Principal

Balance

   

Recorded

Investment

   

Allowance

For Loan

Losses

Allocated

   

Average

Recorded

Investment

   

Interest

Income

Recognized

   

 

Average

Recorded

Investment

   

 

Interest

Income

Recognized

 
   

(in thousands)

                 

With No Related Allowance Recorded:

                                                       

Commercial

  $ 122     $ 56     $     $ 33     $     $ 143     $ 1  

Commercial real estate:

                                                       

Construction

                                         

Farmland

    2,753       952             974       27       1,423       308  

Nonfarm nonresidential

    714       255             259       11       343       19  

Residential real estate:

                                                       

Multi-family

                                         

1-4 Family

    2,761       1,619             1,591       116       2,048       151  

Consumer

    8                               1        

Agriculture

                                         

Other

                                         

Subtotal

    6,358       2,882             2,857       154       3,958       479  

With An Allowance Recorded:

                                                       

Commercial

                      50             75       4  

Commercial real estate:

                                                       

Construction

                                         

Farmland

    170       170       46       171             86        

Nonfarm nonresidential

                                         

Residential real estate:

                                                       

Multi-family

                                         

1-4 Family

    752       752       190       1,102             1,208       32  

Consumer

                                         

Agriculture

                                         

Other

                                         

Subtotal

    922       922       236       1,323             1,369       36  

Total

  $ 7,280     $ 3,804     $ 236     $ 4,180     $ 154     $ 5,327     $ 515  

 

 

   

As of December 31, 2017

   

Three Months Ended

September 30, 2017

   

Nine Months Ended

September 30, 2017

 
   

Unpaid

Principal

Balance

   

Recorded

Investment

   

Allowance

For Loan

Losses

Allocated

   

Average

Recorded

Investment

   

Interest

Income

Recognized

   

 

Average

Recorded

Investment

   

 

Interest

Income

Recognized

 
   

(in thousands)

                 

With No Related Allowance Recorded:

                                                       

Commercial

  $ 703     $ 487     $     $ 499     $     $ 497     $  

Commercial real estate:

                                                       

Construction

                                         

Farmland

    3,687       2,059             2,336             2,800       209  

Nonfarm nonresidential

    1,047       576             311       1       752       53  

Residential real estate:

                                                       

Multi-family

                                  1,025        

1-4 Family

    4,293       2,787             2,879       22       2,909       50  

Consumer

    9       1                   2       2       2  

Agriculture

                      60       1       30       1  

Other

                                         

Subtotal

    9,739       5,910             6,085       26       8,015       315  

With An Allowance Recorded:

                                                       

Commercial

    100       100       13       100       1       100       5  

Commercial real estate:

                                                       

Construction

                                         

Farmland

                                  294        

Nonfarm nonresidential

                      294       5       298       14  

Residential real estate:

                                                       

Multi-family

                                         

1-4 Family

    1,163       1,163       206       1,412       17       1,465       51  

Consumer

                                         

Agriculture

                                  30        

Other

                                         

Subtotal

    1,263       1,263       219       1,806       23       2,187       70  

Total

  $ 11,002     $ 7,173     $ 219     $ 7,891     $ 49     $ 10,202     $ 385  

 

Cash basis income recognized for the three and nine months ended September 30, 2018 was $93,000 and $410,000, respectively, compared to $24,000 and $309,000 for the three and nine months ended September 30, 2017, respectively.

 

Troubled Debt Restructuring

 

A troubled debt restructuring (TDR) occurs when the Bank has agreed to a loan modification in the form of a concession for a borrower who is experiencing financial difficulty. The Bank’s TDRs typically involve a reduction in interest rate, a deferral of principal for a stated period of time, or an interest only period. All TDRs are considered impaired and the Bank has allocated reserves for these loans to reflect the present value of the concessionary terms granted to the borrower.

 

The following table presents the types of TDR loan modifications by portfolio segment outstanding as of September 30, 2018 and December 31, 2017:

 

   

TDRs

Performing to

Modified Terms

   

TDRs Not

Performing to

Modified Terms

   

Total

TDRs

 
   

(in thousands)

 

September 30, 2018

                       

Commercial Real Estate:

                       

Farmland

                       

Principal deferral

          700       700  

Nonfarm nonresidential

                       

Rate reduction

    186             186  

Residential Real Estate:

                       

1-4 Family

                       

Rate reduction

    724             724  

Total TDRs

  $ 910     $ 700     $ 1,610  

 

 

   

TDRs

Performing to

Modified Terms

   

TDRs Not

Performing to

Modified Terms

   

Total

TDRs

 
   

(in thousands)

 

December 31, 2017

                       

Commercial

                       

Rate reduction

  $     $ 33     $ 33  

Principal deferral

          434       434  

Commercial Real Estate:

                       

Farmland

                       

Principal deferral

          1,362       1,362  

Nonfarm nonresidential

                       

Rate reduction

    483             483  

Residential Real Estate:

                       

1-4 Family

                       

Rate reduction

    734             734  

Total TDRs

  $ 1,217     $ 1,829     $ 3,046  

 

At September 30, 2018 and December 31, 2017, 57% and 40%, respectively, of the Company’s TDRs were performing according to their modified terms. The Company allocated $162,000 and $122,000 in reserves to borrowers whose loan terms have been modified in TDRs as of September 30, 2018, and December 31, 2017, respectively. The Company has committed to lend no additional amounts as of September 30, 2018 and December 31, 2017 to borrowers with outstanding loans classified as TDRs.

 

Management periodically reviews renewals and modifications of previously identified TDRs, for which there was no principal forgiveness, to consider if it is appropriate to remove the TDR classification. If the borrower is no longer experiencing financial difficulty and the renewal/modification did not contain a concessionary interest rate or other concessionary terms, management considers the potential removal of the TDR classification. If deemed appropriate based upon current underwriting, the TDR classification is removed as the borrower has complied with the terms of the loan at the date of renewal/modification and there was a reasonable expectation that the borrower would continue to comply with the terms of the loan subsequent to the date of the renewal/modification. In this instance, the TDR was originally considered a restructuring in a prior year as a result of a modification with an interest rate that was not commensurate with the risk of the underlying loan. Additionally, TDR classification can be removed in circumstances in which the Company performs a non-concessionary re-modification of the loan at terms that were considered to be at market for loans with comparable risk. Management expects the borrower will continue to perform under the re-modified terms based on the borrower’s past history of performance.

 

No TDR loan modifications occurred during the three or nine months ended September 30, 2018 or September 30, 2017. During the first nine months of 2018 and 2017, no TDRs defaulted on their restructured loan within the twelve-month period following the loan modification. A default is considered to have occurred once the TDR is past due 90 days or more or it has been placed on nonaccrual.

 

Non-performing Loans

 

Non-performing loans include impaired loans and smaller balance homogeneous loans, such as residential mortgage and consumer loans, that are collectively evaluated for impairment. The following table presents the recorded investment in nonaccrual and loans past due 90 days and still on accrual by class of loan as of September 30, 2018, and December 31, 2017: 

 

   

Nonaccrual

   

Loans Past Due 90 Days

And Over Still Accruing

 
   

September 30,

2018

   

December 31,

2017

   

September 30,

2018

   

December 31,

2017

 
   

(in thousands)

 
                                 

Commercial

  $ 56     $ 487     $     $  

Commercial Real Estate:

                               

Construction

                       

Farmland

    1,122       2,059              

Nonfarm nonresidential

    69       93              

Residential Real Estate:

                               

Multi-family

                       

1-4 Family

    1,445       2,817              

Consumer

          1              

Agriculture

                      1  

Other

                       

Total

  $ 2,692     $ 5,457     $     $ 1  

 

 

The following table presents the aging of the recorded investment in past due loans as of September 30, 2018 and December 31, 2017:

 

   

30 – 59

Days

Past Due

   

60 – 89

Days

Past Due

   

90 Days

And Over

Past Due

   

 

 

Nonaccrual

   

Total

Past Due

And

Nonaccrual

 
   

(in thousands)

 

September 30, 2018

                                       

Commercial

  $     $     $     $ 56     $ 56  

Commercial Real Estate:

                                       

Construction

                             

Farmland

    369       372             1,122       1,863  

Nonfarm nonresidential

    128                   69       197  

Residential Real Estate:

                                       

Multi-family

                             

1-4 Family

    808       147             1,445       2,400  

Consumer

    43       8                   51  

Agriculture

    144       402                   546  

Other

                             

Total

  $ 1,492     $ 929     $     $ 2,692     $ 5,113  

 

   

30 – 59

Days

Past Due

   

60 – 89

Days

Past Due

   

90 Days

And Over

Past Due

   

 

 

Nonaccrual

   

Total

Past Due

And

Nonaccrual

 
                                         
   

(in thousands)

 

December 31, 2017

                                       

Commercial

  $     $     $     $ 487     $ 487  

Commercial Real Estate:

                                       

Construction

                             

Farmland

    593                   2,059       2,652  

Nonfarm nonresidential

                      93       93  

Residential Real Estate:

                                       

Multi-family

                             

1-4 Family

    850       126             2,817       3,793  

Consumer

    30       45             1       76  

Agriculture

    5             1             6  

Other

                             

Total

  $ 1,478     $ 171     $ 1     $ 5,457     $ 7,107  

 

Credit Quality Indicators

 

Management categorizes all loans into risk categories at origination based upon original underwriting. Thereafter, management categorizes loans into risk categories based on relevant information about the ability of borrowers to service their debt such as current financial information, historical payment experience, credit documentation, public information, and current economic trends. Additionally, loans are analyzed through internal and external loan review processes. Borrower relationships in excess of $500,000 are routinely analyzed through the credit administration processes which classify the loans as to credit risk. The following definitions are used for risk ratings:

 

Watch – Loans classified as watch are those loans which have or may experience a potentially adverse development which necessitates increased monitoring.

 

Special Mention – Loans classified as special mention do not have all of the characteristics of substandard or doubtful loans. They have one or more deficiencies which warrant special attention and which corrective action, such as accelerated collection practices, may remedy.

 

Substandard – Loans classified as substandard are those loans with clear and defined weaknesses such as a highly leveraged position, unfavorable financial ratios, uncertain repayment sources or poor financial condition which may jeopardize the repayment of the debt as contractually agreed. They are characterized by the distinct possibility that the Bank will sustain some losses if the deficiencies are not corrected.

 

 

Doubtful – Loans classified as doubtful are those loans which have characteristics similar to substandard loans but with an increased risk that collection or liquidation in full is highly questionable and improbable.

 

Loans not meeting the criteria above that are analyzed individually as part of the above described process are considered to be “Pass” rated loans. As of September 30, 2018, and December 31, 2017, and based on the most recent analysis performed, the risk category of loans by class of loans is as follows:

 

   

Pass

   

Watch

   

Special

Mention

   

Substandard

   

Doubtful

   

Total

 
   

(in thousands)

 

September 30, 2018

                                               

Commercial

  $ 125,392     $ 180     $     $ 127     $     $ 125,699  

Commercial Real Estate:

                                               

Construction

    83,368                               83,368  

Farmland

    77,827       2,796             3,294             83,917  

Nonfarm nonresidential

    160,671       2,017             658             163,346  

Residential Real Estate:

                                               

Multi-family

    40,992       5,152                         46,144  

1-4 Family

    167,620       1,965       114       3,975             173,674  

Consumer

    39,890       23             329             40,242  

Agriculture

    39,916       181             47             40,144  

Other

    517                               517  

Total

  $ 736,193     $ 12,314     $ 114     $ 8,430     $     $ 757,051  

 

   

Pass

   

Watch

   

Special

Mention

   

Substandard

   

Doubtful

   

Total

 
                                                 
   

(in thousands)

 

December 31, 2017

                                               

Commercial

  $ 112,978     $ 84     $     $ 709     $     $ 113,771  

Commercial Real Estate:

                                               

Construction

    57,342                               57,342  

Farmland

    76,563       7,607             4,150             88,320  

Nonfarm nonresidential

    152,004       2,906             1,814             156,724  

Residential Real Estate:

                                               

Multi-family

    47,121       9,467                         56,588  

1-4 Family

    169,774       3,535       164       5,749             179,222  

Consumer

    18,042       306             91             18,439  

Agriculture

    38,654       1,810             690             41,154  

Other

    555                               555  

Total

  $ 673,033     $ 25,715     $ 164     $ 13,203     $     $ 712,115  

 

 

Note 4 – Other Real Estate Owned

 

Other real estate owned (OREO) is real estate acquired as a result of foreclosure or by deed in lieu of foreclosure. It is classified as real estate owned until such time as it is sold. When property is acquired as a result of foreclosure or by deed in lieu of foreclosure, it is recorded at its fair market value less cost to sell. Any write-down of the property at the time of acquisition is charged to the allowance for loan losses.

 

Fair value of OREO is determined on an individual property basis. When foreclosed properties are acquired, management obtains a new appraisal of the subject property or has staff from the Bank’s special assets group evaluate the latest in-file appraisal in connection with the transfer to OREO. Updated appraisals are typically obtained within five quarters of the anniversary date of ownership unless a sale is imminent. Subsequent reductions in fair value are recorded as non-interest expense when a new appraisal indicates a decline in value or in cases where a marketing price is lowered below the appraised amount. 

 

The following table presents the major categories of OREO at the period-ends indicated:

 

   

September 30,

2018

   

December 31,

2017

 
   

(in thousands)

 

Commercial Real Estate:

               

Construction, land development, and other land

  $ 3,750     $ 4,335  

Farmland

          74  
    $ 3,750     $ 4,409  

 

 

Residential loans secured by 1-4 family residential properties in the process of foreclosure totaled $813,000 and $616,000 at September 30, 2018 and December 31, 2017, respectively.

 

Activity relating to OREO during the nine months ended September 30, 2018 and 2017 is as follows:

 

   

For the Nine

Months Ended

September 30,

 
   

2018

   

2017

 
   

(in thousands)

 

OREO Activity

               

OREO as of January 1

  $ 4,409     $ 6,821  

Real estate acquired

    730       270  

Valuation adjustment write-downs

    (585

)

    (98

)

Net gain on sales

    72       75  

Proceeds from sales of properties

    (876

)

    (738

)

OREO as of September 30

  $ 3,750     $ 6,330  

 

 

Expenses related to other real estate owned include:

 

   

Three Months Ended

September 30,

   

Nine Months Ended

September 30,

 
   

2018

   

2017

   

2018

   

2017

 
    (in thousands)     (in thousands)  

Net gain on sales

  $ (22

)

  $ (10

)

  $ (72

)

  $ (75

)

Valuation adjustment write-downs

    260       98       585       98  

Operating expense

    33       23       77       69  

Total

  $ 271     $ 111     $ 590     $ 92  

 

 

 

Note 5 – Deposits

 

The following table details deposits by category:

 

   

September 30,

2018

   

December 31,

2017

 
   

(in thousands)

 

Non-interest bearing

  $ 135,561     $ 137,386  

Interest checking

    87,407       99,383  

Money market

    159,499       151,388  

Savings

    34,320       34,632  

Certificates of deposit

    457,239       424,235  

Total

  $ 874,026     $ 847,024  

 

 

Time deposits of $250,000 or more were $29.2 million and $31.7 million at September 30, 2018 and December 31, 2017, respectively.

 

Scheduled maturities of total time deposits at September 30, 2018 for each of the next five years are as follows (in thousands):

 

Year 1

  $ 233,009  

Year 2

    200,558  

Year 3

    6,832  

Year 4

    6,714  

Year 5

    10,126  
    $ 457,239  

 

 

 

Note 6 – Advances from the Federal Home Loan Bank

 

Advances from the Federal Home Loan Bank were as follows:

 

   

September 30,

   

December 31,

 
   

2018

   

2017

 
   

(in thousands)

 
                 

Short term advances (fixed rates 2.18% to 2.29%) maturing October 2018

  $ 50,000     $ 10,000  

Long term advances (fixed rates 0.00% to 5.24%) maturing April 2020 to August 2033

    1,591       1,797  

Total advances from the Federal Home Loan Bank

  $ 51,591     $ 11,797  

 

FHLB advances had a weighted-average rate of 2.24% at September 30, 2018 and 1.48% at December 31, 2017. Each advance is payable per terms on agreement, with a prepayment penalty. No prepayment penalties were incurred during 2018 or 2017. The advances were collateralized by approximately $127.4 million and $130.9 million of first mortgage loans, under a blanket lien arrangement at September 30, 2018 and December 31, 2017, respectively. At September 30, 2018, our additional borrowing capacity with the FHLB was $41.1 million.

 

Scheduled principal payments on FHLB advances during the next five years and thereafter (in thousands):

 

   

Advances

 

Year 1

  $ 50,174  

Year 2

    476  

Year 3

    728  

Year 4

    100  

Year 5

    77  

Thereafter

    36  
    $ 51,591  

 

 

Note 7 – Senior Debt

 

The Company has a $10.0 million senior secured loan agreement with a commercial bank. The loan matures on June 30, 2022. Interest is payable quarterly at a rate of three-month LIBOR plus 250 basis points through June 30, 2020, at which time quarterly principal payments of $250,000 plus interest will commence. The loan is secured by a first priority pledge of 100% of the issued and outstanding stock of the Bank. The Company may prepay any amount due under the promissory note at any time without premium or penalty. The lender retained a portion of the proceeds in escrow to service quarterly interest payments. At September 30, 2018, the escrow account had a balance of $514,000.

 

The loan agreement contains customary representations, warranties, covenants and events of default, including the following financial covenants: (i) the Company must maintain minimum cash on hand of not less than $750,000 through June 30, 2018, and not less than $2,500,000 thereafter, (ii) the Company must maintain a total risk based capital ratio at least equal to 9% of risk-weighted assets to June 30, 2018, and 10% thereafter, (iii) the Bank must maintain a total risk based capital ratio at least equal to 10% of risk-weighted assets to June 30, 2018, and 11% thereafter, and (iv) non-performing assets of the Bank may not exceed 2.5% of the Bank’s total assets. Both the Company and Bank were in compliance with the covenants as of September 30, 2018.

 

 

Note 8 – Fair Values Measurement

 

Fair value is the exchange price that would be received for an asset or paid to transfer a liability (exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. Various valuation techniques are used to determine fair value, including market, income and cost approaches. There are three levels of inputs that may be used to measure fair values:

 

Level 1: Quoted prices (unadjusted) for identical assets or liabilities in active markets that an entity has the ability to access as of the measurement date, or observable inputs.

 

Level 2: Significant other observable inputs other than Level 1 prices, such as quoted prices for similar assets or liabilities, quoted prices in markets that are not active, and other inputs that are observable or can be corroborated by observable market data.

 

Level 3: Significant unobservable inputs that reflect an entity’s own assumptions about the assumptions that market participants would use in pricing an asset or liability.

 

 

In certain cases, the inputs used to measure fair value may fall into different levels of the fair value hierarchy. When that occurs, the fair value hierarchy is classified on the lowest level of input that is significant to the fair value measurement. The following methods and significant assumptions are used to estimate fair value.

 

Securities: The fair values of securities available for sale are determined by obtaining quoted prices on nationally recognized securities exchanges, if available. This valuation method is classified as Level 1 in the fair value hierarchy. For securities where quoted prices are not available, fair values are calculated on market prices of similar securities, or matrix pricing, which is a mathematical technique used widely in the industry to value debt securities without relying exclusively on quoted prices for the specific securities but rather by relying on the securities’ relationship to other benchmark quoted securities. Matrix pricing relies on the securities’ relationship to similarly traded securities, benchmark curves, and the benchmarking of like securities. Matrix pricing utilizes observable market inputs such as benchmark yields, reported trades, broker/dealer quotes, issuer spreads, two-sided markets, benchmark securities, bids, offers, reference data, and industry and economic events. In instances where broker quotes are used, these quotes are obtained from market makers or broker-dealers recognized to be market participants. This valuation method is classified as Level 2 in the fair value hierarchy. For securities where quoted prices or market prices of similar securities are not available, fair values are calculated using discounted cash flows or other market indicators. This valuation method is classified as Level 3 in the fair value hierarchy. Discounted cash flows are calculated using spread to swap and LIBOR curves that are updated to incorporate loss severities, volatility, credit spread and optionality. During times when trading is more liquid, broker quotes are used (if available) to validate the model. Rating agency and industry research reports as well as defaults and deferrals on individual securities are reviewed and incorporated into the calculations.

 

Impaired Loans: An impaired loan is evaluated at the time the loan is identified as impaired and is recorded at fair value less costs to sell. Fair value is measured based on the value of the collateral securing the loan and is classified as Level 3 in the fair value hierarchy. Fair value is determined using several methods. Generally, the fair value of real estate is determined based on appraisals by qualified licensed appraisers. These appraisals may utilize a single valuation approach or a combination of approaches including comparable sales and the income approach.

 

Adjustments are routinely made in the appraisal process by the appraisers to adjust for differences between the comparable sales and income data available. These routine adjustments are made to adjust the value of a specific property relative to comparable properties for variations in qualities such as location, size, and income production capacity relative to the subject property of the appraisal. Such adjustments are typically significant and result in a Level 3 classification of the inputs for determining fair value.

 

Management routinely apply an internal discount to the value of appraisals used in the fair value evaluation of our impaired loans. The deductions to the appraisal take into account changing business factors and market conditions, as well as potential value impairment in cases where our appraisal date predates a likely change in market conditions. These deductions range from 10% for routine real estate collateral to 25% for real estate that is determined (1) to have a thin trading market or (2) to be specialized collateral. This is in addition to estimated discounts for cost to sell of six to ten percent.

 

Management also apply discounts to the expected fair value of collateral for impaired loans where the likely resolution involves litigation or foreclosure. Resolution of this nature generally results in receiving lower values for real estate collateral in a more aggressive sales environment. Discounts ranging from 10% to 33% have been utilized in our impairment evaluations when applicable.

 

Impaired loans are evaluated quarterly for additional impairment. Management obtains updated appraisals on properties securing our loans when circumstances are warranted such as at the time of renewal or when market conditions have significantly changed. This determination is made on a property-by-property basis in light of circumstances in the broader economic climate and the assessment of deterioration of real estate values in the market in which the property is located. The first stage of management’s assessment involves management’s inspection of the property in question. Management also engages in conversations with local real estate professionals, investors, and market participants to determine the likely marketing time and value range for the property. The second stage involves an assessment of current trends in the regional market. After thorough consideration of these factors, management will either internally evaluate fair value or order a new appraisal.

 

Other Real Estate Owned (OREO): OREO is evaluated at the time of acquisition and recorded at fair value as determined by independent appraisal or internal evaluation less estimated cost to sell. Quarterly evaluations of OREO for impairment are driven by property type. For smaller dollar single family homes, management consults with staff from the Bank’s special assets group as well as external realtors and appraisers. Based on these consultations, management determines asking prices for OREO properties being marketed for sale. If the internally evaluated fair value or asking price is below the recorded investment in the property, appropriate write-downs are taken.

 

 

 

 

For larger dollar commercial real estate properties, management obtains a new appraisal of the subject property or has staff in the special assets group evaluate the latest in-file appraisal in connection with the transfer to OREO. Management generally obtains updated appraisals within five quarters of the anniversary date of ownership unless a sale is imminent. When an asking price is lowered below the most recent appraised value, appropriate write-downs are taken.

 

Financial assets measured at fair value on a recurring basis at September 30, 2018 and December 31, 2017 are summarized below:

 

 

           

Fair Value Measurements at September 30, 2018 Using

 
           

(in thousands)

 
           

Quoted Prices In

           

Significant

 
           

Active Markets for

   

Significant Other

   

Unobservable

 
   

Carrying

   

Identical Assets

   

Observable Inputs

   

Inputs

 

Description

 

Value

   

(Level 1)

   

(Level 2)

   

(Level 3)

 

Available for sale securities

                               

U.S. Government and federal agency

  $ 22,650     $     $ 22,650     $  

Agency mortgage-backed: residential

    85,812             85,812        

Collateralized loan obligations

    34,876             34,876        

State and municipal

    32,648             32,648        

Corporate bonds

    8,884             8,884        

Total

  $ 184,870     $     $ 184,870     $  

 

 

           

Fair Value Measurements at December 31, 2017 Using

 
           

(in thousands)

 

Description

 

Carrying

Value

   

Quoted Prices In

Active Markets for

Identical Assets

(Level 1)

   

Significant Other

Observable Inputs

(Level 2)

   

Significant

Unobservable

Inputs

(Level 3)

 

Available for sale securities

                               

U.S. Government and federal agency

  $ 21,624     $     $ 21,624     $  

Agency mortgage-backed: residential

    64,965             64,965        

Collateralized loan obligations

    25,505             25,505        

State and municipal

    33,710             33,710        

Corporate bonds

    6,916             6,916        

Total

  $ 152,720     $     $ 152,720     $  

 

 

There were no transfers between Level 1 and Level 2 during 2018 or 2017.

 

 

Financial assets measured at fair value on a non-recurring basis are summarized below: 

 

           

Fair Value Measurements at September 30, 2018 Using

 
           

(in thousands)

 
Description     

Carrying

Value

   

Quoted Prices In

Active Markets for

Identical Assets

(Level 1)

   

 

Significant Other

Observable Inputs

(Level 2)

   

Significant

Unobservable

Inputs

(Level 3)

 

Impaired loans:

                               

Commercial

  $     $     $     $  

Commercial real estate:

                               

Construction

                       

Farmland

    124                   124  

Nonfarm nonresidential

                       

Residential real estate:

                               

Multi-family

                       

1-4 Family

    562                   562  

Consumer

                       

Agriculture

                       

Other

                       

Other real estate owned:

                               

Commercial real estate:

                               

Construction

    3,750                   3,750  

Farmland

                       

Nonfarm nonresidential

                       

Residential real estate:

                               

Multi-family

                       

1-4 Family

                       

 

           

Fair Value Measurements at December 31, 2017 Using

 
           

(in thousands)

 
Description      

Carrying

Value

   

Quoted Prices In

Active Markets for

Identical Assets

(Level 1)

   

 

Significant Other

Observable Inputs

(Level 2)

   

Significant

Unobservable

Inputs

(Level 3)

 

Impaired loans:

                               

Commercial

  $ 87     $     $     $ 87  

Commercial real estate:

                               

Construction

                       

Farmland

                       

Nonfarm nonresidential

                       

Residential real estate:

                               

Multi-family

                       

1-4 Family

    957                   957  

Consumer

                       

Agriculture

                       

Other

                       

Other real estate owned, net:

                               

Commercial real estate:

                               

Construction

    4,335                   4,335  

Farmland

    74                   74  

Nonfarm nonresidential

                       

Residential real estate:

                               

Multi-family

                       

1-4 Family

                       

 

Impaired loans, which are measured for impairment using the fair value of the collateral for collateral dependent loans, had a carrying amount of $922,000 at September 30, 2018 with a valuation allowance of $236,000, resulting in no additional provision for loan losses for the three months ended September 30, 2018 and an additional provision for loan losses of $18,000 for the nine months ended September 30, 2018. Impaired loans had a carrying amount of $1.7 million at September 30, 2017 with a valuation allowance of $399,000, resulting in additional provision for loan losses of $171,000 and $29,000, respectively, for the three and nine months ended September 30, 2017. At December 31, 2017, impaired loans had a carrying amount of $1.3 million, with a valuation allowance of $219,000.

 

 

OREO, which is measured at the lower of carrying or fair value less costs to sell, had a net carrying amount of $3.8 million as of September 30, 2018, compared with $6.3 million at September 30, 2017 and $4.4 million at December 31, 2017. Write-downs of $260,000 and $585,000 were recorded on OREO for the three and nine months ended September 30, 2018, compared to write-downs of $98,000 for the three and nine months ended September 30, 2017, respectively.

 

The following table presents qualitative information about level 3 fair value measurements for financial instruments measured at fair value on a non-recurring basis at September 30, 2018:

 

   

Fair Value

 

Valuation

Technique(s)

 

Unobservable Input(s)

 

Range (Weighted

Average)

 
   

(in thousands)

                   
                           

Impaired loans – Residential real estate

  $ 562  

Sales comparison approach

 

Adjustment for differences between the comparable sales

    0% -  26% (9%)
                           

Other real estate owned – Commercial real estate

  $ 3,750  

Sales comparison approach

 

Adjustment for differences between the comparable sales

    0% - 35% (18%)
                           
          Income approach   Discount or capitalization rate       25%   (25%)

 

The following table presents qualitative information about level 3 fair value measurements for financial instruments measured at fair value on a non-recurring basis at December 31, 2017:

 

   

Fair Value

 

Valuation

Technique(s)

 

Unobservable Input(s)

 

Range (Weighted

Average)

 
   

(in thousands)

                   
                           

Impaired loans – Residential real estate

  $ 957  

Sales comparison approach

 

Adjustment for differences between the comparable sales

    0% - 26% (9%)
                           

Other real estate owned – Commercial real estate

  $ 4,409  

Sales comparison approach

 

Adjustment for differences between the comparable sales

    0% - 35% (18%)
                           
          Income approach   Discount or capitalization rate       25%   (25%)

 

Carrying amount and estimated fair values of financial instruments were as follows for the periods indicated:

 

           

Fair Value Measurements at September 30, 2018 Using

 
   

Carrying

Amount

   

Level 1

   

Level 2

   

Level 3

   

Total

 
   

(in thousands)

 

Financial assets

                                       

Cash and cash equivalents

  $ 37,531     $ 5,770     $ 31,761     $     $ 37,531  

Securities available for sale

    184,870             184,870             184,870  

Federal Home Loan Bank stock

    7,233       N/A       N/A       N/A       N/A  

Loans, net

    748,417                   733,877       733,877  

Accrued interest receivable

    3,707             1,119       2,588       3,707  

Financial liabilities

                                       

Deposits

  $ 874,026     $ 135,561     $ 737,570     $     $ 873,131  

Federal Home Loan Bank advances

    51,591             51,549             51,549  

Junior subordinated debentures

    21,000                   16,344       16,344  

Senior debt

    10,000                   9,908       9,908  

Accrued interest payable

    597             544       53       597  

 

 

           

Fair Value Measurements at December 31, 2017 Using

 
   

Carrying

Amount

   

Level 1

   

Level 2

   

Level 3

   

Total

 
   

(in thousands)

 

Financial assets

                                       

Cash and cash equivalents

  $ 34,103     $ 8,137     $ 25,966     $     $ 34,103  

Securities available for sale

    152,720             152,720             152,720  

Federal Home Loan Bank stock

    7,323       N/A       N/A       N/A       N/A  

Loans held for sale

    70             70             70  

Loans, net

    703,913                   703,263       703,263  

Accrued interest receivable

    3,136             925       2,211       3,136  

Financial liabilities

                                       

Deposits

  $ 847,024     $ 137,386     $ 693,320     $     $ 830,706  

Federal Home Loan Bank advances

    11,797             11,799             11,799  

Subordinated capital notes

    2,250                   2,246       2,246  

Junior subordinated debentures

    21,000                   19,090       19,090  

Senior Debt

    10,000                   10,000       10,000  

Accrued interest payable

    1,475             357       1,118       1,475  

 

The methods and assumptions, not previously presented, used to estimate fair values are described as follows:

 

(a) Cash and Cash Equivalents

The carrying amounts of cash and short-term instruments approximate fair values and are classified as either Level 1 or Level 2. Noninterest bearing deposits are Level 1 whereas interest bearing due from bank accounts and fed funds sold are Level 2.

 

(b) FHLB Stock

It is not practical to determine the fair value of FHLB stock due to restrictions placed on its transferability.  

 

(c) Loans, Net

At September 30, 2018, fair values of loans, excluding loans held for sale, are determined using an estimated exit price. Contractual cash flow estimates are projected using a loan’s balance, interest rate, repricing characteristics, maturity and payment amounts. Loans are grouped into homogenous pools for valuation purposes based on type and credit risk metrics. Contractual cash flows are adjusted for potential prepayment estimates, as well as potential defaults over the expected life of each pool. A discount rate is determined based upon current financial conditions and the nature of the cash flow forecast. The resulting exit price for the portfolio is a Level 3 classification. Impaired loans are valued at the lower of cost or fair value as described previously.

 

At December 31, 2017, fair values of loans, excluding loans held for sale, was estimated as follows: For variable rate loans that reprice frequently and with no significant change in credit risk, fair values were based on carrying values resulting in a Level 3 classification. Fair values for other loans were estimated using discounted cash flow analyses, using interest rates being offered for loans with similar terms to borrowers of similar credit quality resulting in a Level 3 classification. Impaired loans are valued at the lower of cost or fair value as described previously. The methods utilized to estimate the fair value of loans did not necessarily represent an exit price.

 

(d) Loans Held for Sale

The fair value of loans held for sale is estimated based upon binding contracts and quotes from third party investors resulting in a Level 2 classification.

 

(e) Deposits

The fair values for non-interest bearing non-maturity deposits are, by definition, equal to the amount payable on demand at the reporting date resulting in a Level 1 classification. The carrying amounts of interest bearing non-maturity deposits approximate their fair values at the reporting date resulting in a Level 2 classification. Fair values for interest bearing time deposits are estimated using discounted cash flow calculations that utilize the contract rate of the deposits discounted at current market rates for like maturities resulting in a Level 2 classification.

 

 

(f) Other Borrowings 

 

At September 30, 2018, fair values of FHLB advances are determined using an estimated exit price. Contractual cash flow estimates are projected for each advance utilizing contractual interest rates, repricing characteristics, maturities and payment amounts. Contractual cash flows are adjusted for potential prepayment estimates. A discount rate is determined based upon current market conditions and the nature of the cash flow forecast. The resulting exit price for FHLB advances is a Level 2 classification. At December 31, 2017, the fair values of FHLB advances were estimated using discounted cash flow analyses based on the current borrowing rates resulting in a Level 2 classification.

 

At September 30, 2018, fair values of junior subordinated debentures and senior debt are determined using an estimated exit price. Contractual cash flow estimates are projected for each instrument utilizing contractual interest rates, repricing characteristics, maturities and payment amounts. Contractual cash flows are adjusted for potential prepayment estimates and credit risk. A discount rate is determined based upon current market conditions and the nature of the cash flow forecast. The resulting exit price is a Level 3 classification. At December 31, 2017, the fair values of subordinated capital notes, junior subordinated debentures, and senior debt were estimated using discounted cash flow analyses based on the current borrowing rates for similar types of borrowing arrangements resulting in a Level 3 classification.

 

(g) Accrued Interest Receivable/Payable

The carrying amounts of accrued interest approximate fair value resulting in a Level 2 or Level 3 classification based on the level of the asset or liability with which the accrual is associated.

 

 

 

Note 9 – Income Taxes

 

Deferred tax assets and liabilities were due to the following as of:

 

   

September

30,

   

December 31,

 
   

2018

   

2017

 
   

(in thousands)

 

Deferred tax assets:

               

Net operating loss carry-forward

  $ 24,079     $ 25,645  

Allowance for loan losses

    1,813       1,723  

OREO write-down

    2,555       2,432  

Alternative minimum tax credit carry-forward

    346       692  

Net assets from acquisitions

    307       358  

Net unrealized loss on securities

    848       169  

New market tax credit carry-forward

    208       208  

Nonaccrual loan interest

    234       271  

Accrued expenses

    204       172  

Deferred compensation

    269       277  

Other

    241       241  
      31,104       32,188  
                 

Deferred tax liabilities:

               

FHLB stock dividends

    557       557  

Fixed assets

    77       68  

Deferred loan costs

    141       152  

Other

    99       98  
      874       875  

Net deferred tax asset

  $ 30,230     $ 31,313  

 

At September 30, 2018, the Company had net operating loss carryforwards (“NOLs”) of $114.7 million, which will begin to expire in 2031. As of September 30, 2018, a total of $346,000 in alternative minimum tax credit carry-forward was reclassified to other assets as it is currently refundable for the 2018 tax year.

 

The Company does not have any beginning and ending unrecognized tax benefits. The Company does not expect the total amount of unrecognized tax benefits to significantly increase or decrease in the next twelve months. There were no interest and penalties recorded in the income statement or accrued for the three or nine months ended September 30, 2018 or September 30, 2017 related to unrecognized tax benefits.

 

Under Section 382 of the Internal Revenue Code, as amended (“Section 382”), the Company’s net operating loss carryforwards and other deferred tax assets can generally be used to offset future taxable income and therefore reduce federal income tax obligations. However, the Company's ability to use its NOLs would be limited if there was an “ownership change” as defined by Section 382. This would occur if shareholders owning (or deemed to own under the tax rules) 5% or more of the Company's voting and non-voting common shares increase their aggregate ownership of the Company by more than 50 percentage points over a defined period of time.

 

 

In 2015, the Company took two measures to preserve the value of its NOLs. First, the Company adopted a tax benefits preservation plan designed to reduce the likelihood of an “ownership change” occurring as a result of purchases and sales of the Company's common shares. Upon adoption of this plan, the Company declared a dividend of one preferred stock purchase right for each common share outstanding as of the close of business on July 10, 2015. Any shareholder or group that acquires beneficial ownership of 5% or more of the Company (an “acquiring person”) could be subject to significant dilution in its holdings if the Company's Board of Directors does not approve such acquisition. Existing shareholders holding 5% or more of the Company will not be considered acquiring persons unless they acquire additional shares, subject to certain exceptions described in the plan. In addition, the Board of Directors has the discretion to exempt certain transactions and certain persons whose acquisition of securities is determined by the Board not to jeopardize the Company's deferred tax assets. The rights plan was extended in May 2018 to expire upon the earlier of (i) June 30, 2021, (ii) the beginning of a taxable year with respect to which the Board of Directors determines that no tax benefits may be carried forward, (iii) the repeal or amendment of Section 382 or any successor statute, if the Board of Directors determines that the plan is no longer needed to preserve the tax benefits, and (iv) certain other events as described in the plan.

 

On September 23, 2015, the Company’s shareholders approved an amendment to its articles of incorporation to further help protect the long-term value of the Company’s NOLs. The amendment provides a means to block transfers of our common shares that could result in an ownership change under Section 382. The transfer restrictions were extended in May 2018 by shareholder vote and will expire on the earlier of (i) May 23, 2021, (ii) the beginning of a taxable year with respect to which the Board of Directors determines that no tax benefit may be carried forward, (iii) the repeal of Section 382 or any successor statute if our Board determines that the transfer restrictions are no longer needed to preserve the tax benefits of our NOLs, or (iv) such date as the Board otherwise determines that the transfer restrictions are no longer necessary.

 

The Company and its subsidiaries are subject to U.S. federal income tax and the Company is subject to income tax in the Commonwealth of Kentucky. The Company is no longer subject to examination by taxing authorities for years before 2015.

 

 

Note 10 – Stock Plans and Stock Based Compensation

 

Shares available for issuance under the 2018 Omnibus Equity Compensation Plan (“2018 Plan”) total 328,274. Shares issued to employees under the plan vest annually on the anniversary date of the grant over three years.

 

Shares issued annually to non-employee directors have a fair market value of $25,000 and vest on December 31 in the year of grant.

 

The fair value of the 2018 unvested shares issued was $654,000, or $13.99 per weighted-average share. The Company recorded $171,000 and $334,000 of stock-based compensation to salaries and employee benefits for the three and nine months ended September 30, 2018, respectively, and $129,000 and $271,000 for the three and nine months ended September 30, 2017, respectively. Management expects substantially all of the unvested shares outstanding at the end of the period to vest according to the vesting schedule. A deferred tax benefit of $36,000 and $70,000 was recognized related to this expense during the three and nine months ended September 30, 2018, respectively, and no deferred tax benefit during the three and nine months ended September 30, 2017.

 

The following table summarizes unvested share activity as of and for the periods indicated for the Stock Incentive Plan:

 

   

Nine Months Ended

   

Twelve Months Ended

 
   

September 30, 2018

   

December 31, 2017

 
           

Weighted

           

Weighted

 
           

Average

           

Average

 
           

Grant

           

Grant

 
   

Shares

   

Price

   

Shares

   

Price

 

Outstanding, beginning

    142,334     $ 5.67       179,513     $ 4.89  

Granted

    46,726       13.99       37,865       9.64  

Vested

    (66,164

)

    5.39       (73,728

)

    5.75  

Forfeited

                (1,316

)

    9.35  

Outstanding, ending

    122,896     $ 8.98       142,334     $ 5.67  

 

 

Unrecognized stock based compensation expense related to unvested shares for the remainder of 2018 and beyond is estimated as follows (in thousands):

 

October 2018 – December 2018

  $ 190  

2019

    259  

2020

    185  

2021

    67  

 

 

 

Note 11 – Earnings per Share

 

The factors used in the basic and diluted earnings per share computations follow:

 

   

Three Months Ended

   

Nine Months Ended

 
   

September 30,

   

September 30,

 
   

2018

   

2017

   

2018

   

2017

 
   

(in thousands, except share and per share data)

 
                                 

Net income

  $ 2,437     $ 1,794     $ 6,354     $ 5,183  

Less:

                               

Earnings allocated to unvested shares

    40       45       105       133  

Net income available to common shareholders, basic and diluted

  $ 2,397     $ 1,749     $ 6,249     $ 5,050  
                                 

Basic

                               

Weighted average common shares including unvested common shares outstanding

    7,455,316       6,259,864       7,059,472       6,245,418  

Less:

                               

Weighted average unvested common shares

    122,097       157,412       117,060       160,825  

Weighted average common shares outstanding

    7,333,219       6,102,452       6,942,412       6,084,593  

Basic income per common share

  $ 0.33     $ 0.29     $ 0.90     $ 0.83  
                                 

Diluted

                               

Add: Dilutive effects of assumed exercises of common stock warrants

                       

Weighted average common shares and potential common shares

    7,333,219       6,102,452       6,942,412       6,084,593  

Diluted income per common share

  $ 0.33     $ 0.29     $ 0.90     $ 0.83  

 

The Company had no outstanding stock options at September 30, 2018 or 2017. A warrant for the purchase of 66,113 shares of the Company’s common stock at an exercise price of $79.41 was outstanding at September 30, 2018 and 2017, but was not included in the diluted EPS computation as inclusion would have been anti-dilutive. The warrant is exercisable at the holder’s option through November 21, 2018.

 

 

Note 12Regulatory Capital Matters

 

Banks and bank holding companies are subject to regulatory capital requirements administered by federal banking agencies. Capital adequacy guidelines and, additionally for banks, prompt corrective action regulations involve quantitative measures of assets, liabilities, and certain off-balance-sheet items calculated under regulatory accounting practices. Capital amounts and classifications are also subject to qualitative judgments by regulators. Failure to meet capital requirements can result in regulatory action.

 

The final rules implementing Basel Committee on Banking Supervision’s capital guidelines for U.S. Banks (Basel III rules) became effective for the Company and Bank on January 1, 2015 with full compliance with all of the requirements being phased in over a multi-year schedule through January 1, 2019. The final rules allowed banks and their holding companies with less than $250 billion in assets a one-time opportunity to opt-out of a requirement to include unrealized gains and losses in accumulated other comprehensive income in their capital calculation. The Company and the Bank opted out of this requirement. The rules also establish a “capital conservation buffer” of 2.5% above the regulatory minimum risk-based capital ratios. Once the capital conservation buffer is fully phased in, the minimum ratios are a common equity Tier 1 risk-based capital ratio of 7.0%, a Tier 1 risk-based capital ratio of 8.5%, and a total risk-based capital ratio of 10.5%. The capital conservation buffer for 2018 is 1.875% and 1.25% for 2017. An institution is subject to limitations on paying dividends, engaging in share repurchases, and paying discretionary bonuses if capital levels fall below minimum levels plus the buffer amounts. These limitations establish a maximum percentage of eligible retained income that could be utilized for such actions.

 

 

The following tables show the ratios (excluding capital conservation buffer) and amounts of common equity Tier 1, Tier 1 capital, and total capital to risk-adjusted assets and the leverage ratios for the Company and the Bank at the dates indicated (dollars in thousands):

 

   

Actual

   

Minimum Requirement for Capital Adequacy Purposes

   

Minimum Requirement to be Well Capitalized Under Prompt Corrective Action Provisions

 
   

Amount

   

Ratio

   

Amount

   

Ratio

   

Amount

   

Ratio

 

As of September 30, 2018:

                                               

Total risk-based capital (to risk-weighted assets)

                                               

Consolidated

  $ 100,936       12.07

%

  $ 66,910       8.00

%

    N/A       N/A  

Bank

    105,243       12.60       66,836       8.00     $ 83,545       10.00

%

Tier 1 capital (to risk-weighted assets)

                                               

Consolidated

    90,555       10.83       50,183       6.00       N/A       N/A  

Bank

    96,609       11.56       50,127       6.00       66,836       8.00  

Total common equity Tier 1 risk-based capital (to risk-weighted assets)

                                               

Consolidated

    77,013       9.21       37,637       4.50       N/A       N/A  

Bank

    96,609       11.56       37,595       4.50       54,304       6.50  

Tier 1 capital (to average assets)

                                               

Consolidated

    90,555       8.91       40,638       4.00       N/A       N/A  

Bank

    96,609       9.51       40,622       4.00       50,778       5.00  

 

 

   

Actual

   

Minimum Requirement for Capital Adequacy Purposes

   

Minimum Requirement to be Well Capitalized Under Prompt Corrective Action Provisions

 
   

Amount

   

Ratio

   

Amount

   

Ratio

   

Amount

   

Ratio

 

As of December 31, 2017:

                                               

Total risk-based capital (to risk- weighted assets)

                                               

Consolidated

  $ 83,072       10.55

%

  $ 63,014       8.00

%

    N/A       N/A  

Bank

    91,305       11.61       62,938       8.00     $ 78,672       10.00

%

Tier 1 capital (to risk-weighted assets)

                                               

Consolidated

    66,487       8.44       47,260       6.00       N/A       N/A  

Bank

    81,393       10.35       47,203       6.00       62,938       8.00  

Total common equity Tier 1 risk- based capital (to risk-weighted assets)

                                               

Consolidated

    54,535       6.92       35,445       4.50       N/A       N/A  

Bank

    81,393       10.35       35,403       4.50       51,137       6.50  

Tier 1 capital (to average assets)

                                               

Consolidated

    66,487       7.11       37,392       4.00       N/A       N/A  

Bank

    81,393       8.70       37,421       4.00       46,777       5.00  

 

   N/A: Not applicable. Regulatory framework does not define well capitalized for holding companies.

 

Kentucky banking laws limit the amount of dividends that may be paid to a holding company by its subsidiary banks without prior approval. These laws limit the amount of dividends that may be paid in any calendar year to current year’s net income, as defined in the laws, combined with the retained net income of the preceding two years, less any dividends declared during those periods. In addition, a bank must have positive retained earnings.

 

 

 

Note 13Off Balance Sheet Risks, Commitments, and Contingent Liabilities

 

The Company, in the normal course of business, is party to financial instruments with off balance sheet risk. The financial instruments include commitments to extend credit and standby letters of credit. The contract or notional amounts of these instruments reflect the potential future obligations of the Company pursuant to those financial instruments. Creditworthiness for all instruments is evaluated on a case-by-case basis in accordance with the Company’s credit policies. Collateral from the client may be required based on the Company’s credit evaluation of the client and may include business assets of commercial clients, as well as personal property and real estate of individual clients or guarantors.

 

An approved but unfunded loan commitment represents a potential credit risk and a liquidity risk, since the Company’s client(s) may demand immediate cash that would require funding. In addition, unfunded loan commitments represent interest rate risk as market interest rates may rise above the rate committed to the Company’s client. Since a portion of these loan commitments normally expire unused, the total amount of outstanding commitments at any point in time may not require future funding. Commitments to make loans are generally made for periods of one year or less.

 

Standby letters of credit are conditional commitments issued by the Company to guarantee the performance of a client to a third party. The terms and risk of loss involved in issuing standby letters of credit are similar to those involved in issuing loan commitments and extending credit. In addition to credit risk, the Company also has liquidity risk associated with standby letters of credit because funding for these obligations could be required immediately. The Company does not deem this risk to be material. No liability is currently established for standby letters of credit.

 

The following table presents the contractual amounts of financial instruments with off-balance sheet risk for each period ended:

 

   

September 30, 2018

   

December 31, 2017

 
   

Fixed

Rate

   

Variable

Rate

   

Fixed

Rate

   

Variable

Rate

 
   

(in thousands)

 

Commitments to make loans

  $ 6,609     $ 11,436     $ 27,349     $ 31,412  

Unused lines of credit

    5,505       63,887       11,034       57,727  

Standby letters of credit

    542       1,749       2,216       373  

 

 

Commitments to make loans are generally made for periods of one year or less.

 

In connection with the purchase of loan participations, the Bank is party to risk participation agreements, which had notional amounts totaling $26.6 million at September 30, 2018 and $19.8 million at December 31, 2017. The risk participation agreements are not designated against specific assets or liabilities under ASC 815, Derivatives and Hedging, and, therefore, do not qualify for hedge accounting. The derivatives are recorded on the balance sheet at fair value and changes in fair value of both the borrower and the offsetting swap agreements are recorded (and essentially offset) in non-interest income. The fair value of the derivative instruments incorporates a consideration of credit risk in accordance with ASC 820, resulting in some volatility in earnings each period. At September 30, 2018 and December 31, 2017, the fair value of the risk participation agreements were $26.6 million and $19.8 million, respectively.

 

The Company is subject to claims and lawsuits that arise primarily in the ordinary course of business. Litigation is subject to inherent uncertainties and unfavorable rulings could occur. The Company records contingent liabilities resulting from claims against it when a loss is assessed to be probable and the amount of the loss is reasonably estimable. Accruals are not made in cases where liability is not probable or the amount cannot be reasonably estimated. Assessing probability of loss and estimating probable losses requires analysis of multiple factors, including in some cases judgments about the potential actions of third party claimants and courts. Recorded contingent liabilities are based on the best information available and actual losses in any future period are inherently uncertain. Based upon current knowledge and after consultation with counsel, the Company believes pending legal proceedings or claims should not have a material impact on its financial position or results of operations. However, in light of the uncertainties involved in such proceedings, the outcome of a particular matter may be material to the financial position or results of operations for a particular reporting period in the future.

 

 

 

Note 14 – Revenue from Contracts with Customers

 

The Company adopted ASC 606 using the full retrospective method. The adoption of ASC 606 for in-scope revenue streams did not result in a cumulative effect adjustment. Bank card interchange income and expenses were previously reported net in non-interest income. The income statement impact of adopting ASC 606 resulted in a reclassification adjustment of $142,000 and $405,000 related to the three and nine months ended September 30, 2017, respectively, between bank card interchange income and deposit account related expense in order to report debit card interchange income gross and provide a comparable disclosure for 2018 and 2017 results. This reclassification adjustment had no impact on previously reported net income for the three or nine months ended September 30, 2017.

 

All of the Company’s revenue from customers in the scope of ASC 606 is recognized within non-interest income. A description of the Company’s revenue streams accounted for under ASC 606 follows:

 

Service Charges on Deposit Accounts: The Company earns fees from its deposit customers for transaction-based, account maintenance, and overdraft services. Transaction-based fees, which include services such as ATM use fees, stop payment charges, statement rendering, and ACH fees, are recognized at the time the transaction is executed as that is the point in time the Company fulfills the customer’s request. Account maintenance fees, which relate primarily to monthly maintenance, are earned over the course of a month, representing the period over which the Company satisfies the performance obligation. Overdraft fees are recognized at the point in time that the overdraft occurs. Service charges are withdrawn from the customer’s account balance.

 

Bank Card Interchange Income: The Company earns interchange fees from bank cardholder transactions conducted through the Shazam payment network. 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. Prior to adopting ASC 606, the Company reported bank card interchange fees net of expenses. Under ASC 606, bank card interchange fees are reported gross.

 

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. When the Company finances the sale of OREO to the buyer, the Company assess whether the buyer is committed to perform their obligations under the contract and whether collectability of the transaction price is probable. Once these criteria are met, the OREO asset is derecognized and the gain or loss on sale is recorded upon transfer of control of the property to the buyer. In determining the gain or loss on the sale, the Company adjusts the transaction price and related gain (loss) on sale if a significant financing component is present. The Company did not finance any OREO sale during 2018 or 2017. Gains and losses on sales of OREO are netted with OREO expense and reported in non-interest expense.

 

Other Non-interest Income: Other non-interest income includes revenue from several sources that are within the scope of ASC 606, including title insurance commissions, income from secondary market loan sales, and other transaction-based revenue that is individually immaterial. Other non-interest income included approximately $301,000 and $546,000 of revenue for the three and nine months ended September 30, 2018, respectively, within the scope of ASC 606. Other non-interest income included approximately $195,000 and $531,000 of revenue for the three and nine months ended September 30, 2017, respectively, within the scope of ASC 606. The remaining other non-interest income for the three and nine months is excluded from the scope of ASC 606.

 

 

 

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

This item analyzes the Company’s financial condition, change in financial condition and results of operations. It should be read in conjunction with the unaudited consolidated financial statements and accompanying notes presented in Part I, Item 1 of this report.

 

Preliminary Note Concerning Forward-Looking Statements

 

This report contains statements about the future expectations, activities and events that constitute forward-looking statements. Forward-looking statements express our beliefs, assumptions and expectations of our future financial and operating performance and growth plans, taking into account information currently available to us. These statements are not statements of historical fact. The words “believe,” “may,” “should,” “anticipate,” “estimate,” “expect,” “intend,” “objective,” “seek,” “plan,” “strive” or similar words, or the negatives of these words, identify forward-looking statements.

 

Forward-looking statements are not guarantees of performance or results. A forward-looking statement may include the assumptions or bases underlying the forward-looking statement. Management has made assumptions and bases in good faith and believe they are reasonable. However, that estimates based on such assumptions or bases frequently differ from actual results, and the differences can be material. The forward-looking statements included in this report speak only as of the date of the report. Management does not intend to update these statements unless required by applicable laws.

 

Forward-looking statements involve risks and uncertainties that may cause our actual results to differ materially from the expectations of future results we expressed or implied in any forward-looking statements. These risks and uncertainties can be difficult to predict and may be out of management’s control. Factors that could contribute to differences in results include, but are not limited to the following:

 

 

Changes in fiscal, monetary, regulatory and tax policies;

 

Changes in political and economic conditions;

 

The magnitude and frequency of changes to the Federal Funds Target Rate implemented by the Federal Open Market Committee of the Federal Reserve Bank;

 

Long-term and short-term interest rate fluctuations as well as the overall steepness of the yield curve;

 

Competitive product and pricing pressures;

 

Equity and fixed income market fluctuations;

 

Client bankruptcies and loan defaults;

 

Inflation;

 

Recession;

 

Natural disasters impacting Company operations;

 

Future acquisitions;

 

Integrations of acquired businesses;

 

Changes in technology and regulations or the interpretation and enforcement thereof;

 

Changes in accounting standards;

 

Changes to the Company’s overall internal control environment;

 

Success in gaining regulatory approvals when required;

 

 

Information security breaches or cyber security attacks involving either the Company or one of the Company’s third-party service providers; and

 

Other risks and uncertainties reported from time to time in the Company’s filings with the Securities and Exchange Commission (“SEC”), including Part 1 Item 1A “Risk Factors” of the Company’s December 31, 2017 Annual Report on Form 10-K for the year ended December 31, 2017.

 

Forward-looking statements are not guarantees of performance or results. A forward-looking statement may include the assumptions or bases underlying the forward-looking statement. Management has made assumptions and bases in good faith and believe they are reasonable. However, that estimates based on such assumptions or bases frequently differ from actual results, and the differences can be material. The forward-looking statements included in this report speak only as of the date of the report. Management does not intend to update these statements unless required by applicable laws.

 

Overview

 

The Company is a bank holding company headquartered in Louisville, Kentucky. The Company’s common stock is traded on Nasdaq’s Capital Market under the symbol LMST. The Company operates Limestone Bank (the Bank), our wholly owned subsidiary and the eleventh largest bank domiciled in the Commonwealth of Kentucky based on total assets. The Bank operates banking offices in twelve counties in Kentucky. The Bank’s markets include metropolitan Louisville in Jefferson County and the surrounding counties of Henry and Bullitt. The Bank serves south central Kentucky and southern Kentucky from banking offices in Butler, Green, Hart, Edmonson, Barren, Warren, Ohio, and Daviess Counties. The Bank also has an office in Lexington, the second largest city in Kentucky. The Bank is a community bank with a wide range of commercial and personal banking products. As of September 30, 2018, the Company had total assets of $1.05 billion, total loans of $757.1 million, total deposits of $874.0 million and stockholders’ equity of $88.2 million.

 

 

The Company reported net income of $2.4 million and $6.4 million for the three and nine months ended September 30, 2018, compared with net income of $1.8 million and $5.2 million for the same periods of 2017. 

 

Highlights for the nine months ended September 30, 2018 are as follows:

 

 

Loan growth outpaced paydowns during the period. Average loans receivable increased approximately $77.9 million or 11.8% to $735.9 million for the nine months ended September 30, 2018, compared with $658.0 million for the first nine months of 2017. This resulted in an increase in interest revenue volume of approximately $2.9 million for the nine months September 30, 2018 compared with the nine months of 2017.

 

 

Deposits were $874.0 million at September 30, 2018, compared with $847.0 million at December 31, 2017. Certificate of deposit balances increased $33.0 million during the first nine months of 2018 to $457.2 million at September 30, 2018, from $424.2 million at December 31, 2017. Interest checking accounts decreased $12.0 million and money market accounts increased $8.1 million during the first nine months of 2018 compared with December 31, 2017.

 

 

Net interest margin increased eight basis points to 3.55% in the first nine months of 2018 compared with 3.47% in the first nine months of 2017. The cost of interest bearing liabilities increased from 0.81% in the first nine months of 2017 to 1.14% in the first nine months of 2018 as a result of increases in short-term interest rates during 2017 and 2018.

 

 

Improving trends in asset quality continued. The Company recorded negative provision for loan losses expense of $500,000 during the first nine months of 2018, compared to no provision for loan losses expense for the first nine months of 2017. The negative provision was attributable to net loan recoveries, declining historical loss rates, improvements in asset quality, and management’s assessment of risk in the loan portfolio. Net loan recoveries were $932,000 for the first nine months of 2018, compared to net loan recoveries of $10,000 for the first nine months of 2017.

 

 

Nonaccrual loans decreased $2.8 million to $2.7 million at September 30, 2018, compared with $5.5 million at December 31, 2017. The decrease in nonaccrual loans was primarily due to $2.5 million in paydowns and $730,000 in loans moved to OREO, which were partially offset by $777,000 in loans placed on nonaccrual.

 

 

Loans past due 30-59 days remained unchanged at $1.5 million at September 30, 2018 compared to December 31, 2017, and loans past due 60-89 days increased from $171,000 at December 31, 2017 to $929,000 at September 30, 2018. Total loans past due and nonaccrual loans decreased to $5.1 million at September 30, 2018, from $7.1 million at December 31, 2017.

 

 

Foreclosed properties were $3.8 million at September 30, 2018, compared with $4.4 million at December 31, 2017, and $6.3 million at September 30, 2017. During the first nine months of 2018, the Company acquired $730,000 and sold $876,000 of OREO. Operating expenses, fair value write downs, and a net gain on sales totaled $590,000 for the first nine months of 2018 compared to $92,000 for the first nine months of 2017.

 

 

The ratio of non-performing assets to total assets decreased to 0.70% at September 30, 2018, compared with 1.14% at December 31, 2017, and 1.38% at September 30, 2017.

 

 

Application of Critical Accounting Policies

 

Management continually reviews accounting policies and financial information disclosures. The Company’s more significant accounting policies that require the use of estimates and judgments in preparing the financial statements are summarized in “Application of Critical Accounting Policies” in Item 7 - Management’s Discussion and Analysis of Financial Condition and Results of Operation of our Annual Report on Form 10-K for the calendar year ended December 31, 2017. Management has discussed the development, selection, and application of our critical accounting policies with our Audit Committee. During the first nine months of 2018, there were no material changes in the critical accounting policies and assumptions.

 

 

Results of Operations

 

The following table summarizes components of income and expense and the change in those components for the three months ended September 30, 2018, compared with the same period of 2017:

 

   

For the Three Months

   

Change from

 
   

Ended September 30,

   

Prior Period

 
   

2018

   

2017

   

Amount

   

Percent

 
   

(dollars in thousands)

 
                                 

Gross interest income

  $ 11,120     $ 9,446     $ 1,674       17.7

%

Gross interest expense

    2,708       1,659       1,049       63.2  

Net interest income

    8,412       7,787       625       8.0  

Provision (negative provision) for loan losses

    (350

)

          (350

)

    100.0  

Non-interest income

    1,509       1,324       185       14.0  

Non-interest expense

    7,230       7,317       (87

)

    (1.2

)

Net income before taxes

    3,041       1,794       1,247       69.5  

Income tax expense

    604             604       100.0  

Net income

    2,437       1,794       643       35.8  

 

Net income for the three months ended September 30, 2018 totaled $2.4 million, compared with $1.8 million for the comparable period of 2017. Net interest income increased $625,000 from the 2017 third quarter as a result of an increase in earning assets and an improvement in net interest margin. Net interest margin increased one basis point to 3.45% in the third quarter of 2018 compared with 3.44% in the third quarter of 2017. The increase in margin between periods was due in part to an increase in the yield of interest earning assets from 4.16% in the third quarter of 2017 to 4.56% in the third quarter of 2018. Average earning assets increased from $907.7 million for the third quarter of 2017 to $968.9 for the third quarter of 2018. Non-interest income increased by $185,000 to $1.5 million from $1.3 million in the third quarter of 2017 due to increases in service charges on deposit accounts as well as the sale of the Bank’s fully amortized secondary market residential mortgage servicing rights portfolio during the third quarter of 2018, which resulted in a one-time gain of approximately $150,000. The gain on sale is included in other non-interest income. The Bank no longer sells residential mortgages on a servicing retained basis to the secondary market. Non-interest expense decreased from $7.3 million in the third quarter of 2017 to $7.2 million in the third quarter of 2018 primarily due to decreased FDIC insurance expense of $238,000 attributable to the Bank’s improved risk profile, a $105,000 decrease in marketing expenses, and a decrease in other non-interest expense of $119,000, which were partially offset by a $210,000 increase in salaries and employee benefits and an increase in OREO expenses of $160,000 primarily attributable to fair value write-downs arising from lower marketing prices.

 

Income tax expense was $604,000 for the three months ended September 30, 2018 compared to no tax expense for the comparable period of 2017. The Company previously had a full valuation allowance against its net deferred tax asset and therefore, the effective tax rate was 0% for the three months ended September 30, 2017.

 

The following table summarizes components of income and expense and the change in those components for the nine months ended September 30, 2018, compared with the same period of 2017:

 

   

For the Nine Months

   

Change from

 
   

Ended September 30,

   

Prior Period

 
   

2018

   

2017

   

Amount

   

Percent

 
   

(dollars in thousands)

 
                                 

Gross interest income

  $ 31,720     $ 27,805     $ 3,915       14.1

%

Gross interest expense

    6,753       4,689       2,064       44.0  

Net interest income

    24,967       23,116       1,851       8.0  

Provision (negative provision) for loan losses

    (500

)

          (500

)

    100.0  

Non-interest income

    4,107       3,762       345       9.2  

Non-interest expense

    21,804       21,695       109       0.5  

Net income before taxes

    7,770       5,183       2,587       49.9  

Income tax expense

    1,416             1,416       100.0  

Net income

    6,354       5,183       1,171       22.6  

 

Net income for the nine months ended September 30, 2018 totaled $6.4 million, compared with net income of $5.2 million for the comparable period of 2017. Net interest income increased $1.9 million from the first nine months of 2017 as a result of an increase in earning assets and an improvement in net interest margin. Net interest margin increased eight basis points to 3.55% in the first nine months of 2018 compared with 3.47% in the first nine months of 2017. The increase in margin between periods was due to an increase in the yield on earning assets from 4.17% for the first nine months of 2017 to 4.51% for the first nine months of 2018, partially offset by an increase in the cost of interest bearing liabilities from 0.81% for the first nine months of 2017 to 1.14% for the first nine months of 2018. Average earning assets increased from $899.9 million for the first nine months of 2017 to $942.7 million for the first nine months of 2018. Non-interest income increased by $345,000 to $4.1 million from $3.8 million in the first nine months of 2017 primarily due to an increase in service charges on deposit accounts of $150,000, an increase in bank card interchange fees of $140,000, and a $150,000 one-time gain on sale of the fully amortized secondary market residential mortgage servicing portfolio. The one-time gain was partially offset by a reduction in title insurance commissions and secondary market income as compared to 2017. Non-interest expense increased to $21.8 million in the first nine months of 2018 compared with $21.7 million for the first nine months of 2017. FDIC insurance expense decreased $616,000 due to improvements in the Bank’s risk profile. This savings was partially offset by increases in salaries and employee benefits, state franchise taxes, and OREO expenses.

 

 

Income tax expense was $1.4 million for the nine months ended September 30, 2018 compared to no tax expense for the comparable period of 2017. The Company previously had a full valuation allowance against its net deferred tax asset and therefore, the effective tax rate was 0% for the nine months ended September 30, 2017.

 

Net Interest Income – Net interest income was $8.4 million for the three months ended September 30, 2018, an increase of $625,000, or 8.0%, compared with $7.8 million for the same period in 2017. Net interest spread and margin were 3.24% and 3.45%, respectively, for the third quarter of 2018, compared with 3.31% and 3.44%, respectively, for the third quarter of 2017. Net average non-accrual loans were $3.0 million and $6.2 million for the third quarters of 2018 and 2017, respectively.

 

Average loans receivable increased approximately $78.9 million for the third quarter of 2018 compared with the third quarter of 2017. This resulted in an increase in interest revenue of approximately $984,000 attributable to volume and an increase of $534,000 attributable to increasing interest rates for the quarter ended September 30, 2018, compared with the third quarter of 2017. Interest foregone on non-accrual loans totaled $59,000 for the third quarter of 2018, compared with $105,000 for the third quarter of 2017.

 

Net interest margin increased one basis point from our margin of 3.44% in the prior year third quarter to 3.45% for the third quarter of 2018. The yield on earning assets increased 40 basis point and rates paid on interest-bearing liabilities increased 47 basis points from the third quarter of 2017. Both the yield on earning assets and cost of interest-bearing liabilities were impacted by increases in short-term interest rates during 2017 and 2018.

 

Net interest income was $25.0 million for the nine months ended September 30, 2018, an increase of $1.9, or 8.0%, compared with $23.1 million for the same period in 2017. Net interest spread and margin were 3.37% and 3.55%, respectively, for the first nine months of 2018, compared with 3.36% and 3.47%, respectively, for the first nine months of 2017. Net average non-accrual loans were $4.0 million and $7.5 million for the first nine months of 2018 and 2017, respectively.

 

Average loans receivable increased approximately $77.9 million for the nine months ended September 30, 2018 compared with the first nine months of 2017. This resulted in an increase in interest revenue of approximately $2.9 million attributable to volume and an increase of $1.1 million attributable to increasing interest rates for the nine months ended September 30, 2018 compared with the prior year period. Interest foregone on non-accrual loans totaled $220,000 for the nine months ended September 30, 2018, compared with $368,000 for the nine months ended September 30, 2017.

 

Net interest margin increased eight basis points to 3.55% for the first nine months of 2018 from our margin of 3.47% in the first nine months of 2017. The yield on earning assets increased 34 basis points for the first nine months of 2018 from the first nine months of 2017, compared with an increase of 33 basis points in rates paid on interest-bearing liabilities. Both the yield on earning assets and cost of interest-bearing liabilities were impacted by increases in short-term interest rates during 2017 and 2018.

 

 

Average Balance Sheets

 

The following table presents the average balance sheets for the three month periods ended September 30, 2018 and 2017, along with the related calculations of tax-equivalent net interest income, net interest margin and net interest spread for the related periods.

 

   

Three Months Ended September 30,

 
   

2018

   

2017

 
   

Average

Balance

   

Interest

Earned/Paid

   

Average

Yield/Cost

   

Average

Balance

   

Interest

Earned/Paid

   

Average

Yield/Cost

 
   

(dollars in thousands)

 

ASSETS

                                               

Interest-earning assets:

                                               

Loan receivables (1)(2)

  $ 748,444     $ 9,539       5.06

%

  $ 669,592     $ 8,021       4.75

%

Securities

                                               

Taxable

    167,280       1,245       2.95       174,776       1,088       2.47  

Tax-exempt (3)

    14,147       95       3.37       19,547       143       4.47  

FHLB stock

    7,243       110       6.03       7,323       95       5.15  

Federal funds sold and other

    31,762       131       1.64       36,485       99       1.08  

Total interest-earning assets

    968,876       11,120       4.56

%

    907,723       9,446       4.16

%

Less: Allowance for loan losses

    (8,742

)

                    (8,964

)

               

Non-interest earning assets

    77,502                       52,928                  

Total assets

  $ 1,037,636                     $ 951,687                  
                                                 

LIABILITIES AND STOCKHOLDERS’ EQUITY

                                               

Interest-bearing liabilities:

                                               

Certificates of deposit and other time deposits

  $ 450,125     $ 1,671       1.47

%

  $ 451,948     $ 1,059       0.93

%

NOW and money market deposits

    251,020       445       0.70       253,699       250       0.39  

Savings accounts

    34,778       14       0.16       35,904       15       0.17  

FHLB advances

    43,995       233       2.10       2,350       13       2.19  

Junior subordinated debentures

    20,999       247       4.67       23,696       225       3.77  

Senior debt

    10,000       98       3.89       10,000       97       3.85  

Total interest-bearing liabilities

    810,917       2,708       1.32

%

    777,597       1,659       0.85

%

                                                 

Non-interest-bearing liabilities:

                                               

Non-interest-bearing deposits

    133,784                       129,072                  

Other liabilities

    5,449                       5,859                  

Total liabilities

    950,150                       912,528                  

Stockholders’ equity

    87,486                       39,159                  

Total liabilities and stockholders’ equity

  $ 1,037,636                     $ 951,687                  
                                                 

Net interest income

          $ 8,412                     $ 7,787          
                                                 

Net interest spread

                    3.24

%

                    3.31

%

Net interest margin

                    3.45

%

                    3.44

%

 

 


(1)

Includes loan fees in both interest income and the calculation of yield on loans.

(2)

Calculations include non-accruing loans averaging $3.0 million and $6.2 million, respectively, in average loan amounts outstanding.

(3)

Taxable equivalent yields are calculated assuming a federal income tax rate of 21% and 35% for 2018 and 2017, respectively. 

 

 

The following table presents the average balance sheets for the nine month periods ended September 30, 2018 and 2017, along with the related calculations of tax-equivalent net interest income, net interest margin and net interest spread for the related periods.

 

   

Nine Months Ended September 30,

 
   

2018

   

2017

 
   

Average

Balance

   

Interest

Earned/Paid

   

Average

Yield/Cost

   

Average

Balance

   

Interest

Earned/Paid

   

Average

Yield/Cost

 
   

(dollars in thousands)

 

ASSETS

                                               

Interest-earning assets:

                                               

Loan receivables (1)(2)

  $ 735,874     $ 27,423       4.98

%

  $ 657,980     $ 23,493       4.77

%

Securities

                                               

Taxable

    157,537       3,386       2.87       175,838       3,370       2.56  

Tax-exempt (3)

    14,184       287       3.42       19,805       432       4.49  

FHLB stock

    7,296       320       5.86       7,323       264       4.82  

Federal funds sold and other

    27,857       304       1.46       38,913       246       0.85  

Total interest-earning assets

    942,748       31,720       4.51

%

    899,859       27,805       4.17

%

Less: Allowance for loan losses

    (8,655

)

                    (8,950

)

               

Non-interest earning assets

    78,769                       52,904                  

Total assets

  $ 1,012,862                     $ 943,813                  
                                                 

LIABILITIES AND STOCKHOLDERS’ EQUITY

                                               

Interest-bearing liabilities:

                                               

Certificates of deposit and other time deposits

  $ 433,933     $ 4,041       1.25

%

  $ 458,732     $ 3,149       0.92

%

NOW and money market deposits

    246,271       1,040       0.56       244,521       683       0.37  

Savings accounts

    35,221       42       0.16       35,650       45       0.17  

FHLB advances

    43,035       605       1.88       6,594       64       1.30  

Junior subordinated debentures

    22,057       733       4.44       23,920       651       3.64  

Senior debt

    10,000       292       3.90       3,407       97       3.81  

Total interest-bearing liabilities

    790,517       6,753       1.14

%

    772,824       4,689       0.81

%

                                                 

Non-interest-bearing liabilities:

                                               

Non-interest-bearing deposits

    133,756                       125,932                  

Other liabilities

    5,406                       8,401                  

Total liabilities

    929,679                       907,157                  

Stockholders’ equity

    83,183                       36,656                  

Total liabilities and stockholders’ equity

  $ 1,012,862                     $ 943,813                  
                                                 

Net interest income

          $ 24,967                     $ 23,116          
                                                 

Net interest spread

                    3.37

%

                    3.36

%

                                                 

Net interest margin

                    3.55

%

                    3.47

%

 


(1)

Includes loan fees in both interest income and the calculation of yield on loans.

(2)

Calculations include non-accruing loans averaging $4.0 million and $7.5 million, respectively, in average loan amounts outstanding.

(3)

Taxable equivalent yields are calculated assuming a federal income tax rate of 21% and 35% for 2018 and 2017, respectively.

 

 

Rate/Volume Analysis 

 

The table below sets forth certain information regarding changes in interest income and interest expense for the periods indicated. For each category of interest-earning assets and interest-bearing liabilities, information is provided on changes attributable to (1) changes in rate (changes in rate multiplied by old volume); (2) changes in volume (changes in volume multiplied by old rate); and (3) changes in rate-volume (change in rate multiplied by change in volume). Changes in rate-volume are proportionately allocated between rate and volume variance.

 

   

Three Months Ended September 30,

2018 vs. 2017

   

Nine Months Ended September 30,

2018 vs. 2017

 
   

Increase (decrease)

due to change in

   

Increase (decrease)

due to change in

 
   

Rate

   

Volume

   

Net

Change

   

Rate

   

Volume

   

Net

Change

 
   

(in thousands)

 

Interest-earning assets:

                                               

Loan receivables

  $ 534     $ 984     $ 1,518     $ 1,060     $ 2,870     $ 3,930  

Securities

    195       (86

)

    109       362       (491

)

    (129

)

FHLB stock

    16       (1

)

    15       57       (1

)

    56  

Federal funds sold and other

    46       (14

)

    32       142       (84

)

    58  

Total increase (decrease) in interest income

    791       883       1,674       1,621       2,294       3,915  
                                                 

Interest-bearing liabilities:

                                               

Certificates of deposit and other time deposits

    616       (4

)

    612       1,070       (178

)

    892  

NOW and money market accounts

    198       (3

)

    195       352       5       357  

Savings accounts

    (1

)

          (1

)

    (2

)

    (1

)

    (3

)

FHLB advances

    (1

)

    221       220       41       500       541  

Junior subordinated debentures

    50       (28

)

    22       136       (54

)

    82  

Senior debt

    1             1       2       193       195  

Total increase (decrease) in interest expense

    863       186       1,049       1,599       465       2,064  

Increase (decrease) in net interest income

  $ (72

)

  $ 697     $ 625     $ 22     $ 1,829     $ 1,851  

 

 

Non-Interest Income – The following table presents the major categories of non-interest income for the three and nine months ended September 30, 2018 and 2017:

 

   

For the Three Months

   

For the Nine Months

 
   

Ended September 30,

   

Ended September 30,

 
   

2018

   

2017

   

2018

   

2017

 
   

(dollars in thousands)

 
                                 

Service charges on deposit accounts

  $ 608     $ 568     $ 1,767     $ 1,617  

Bank card interchange fees

    411       387       1,258       1,118  

Income from bank owned life insurance

    100       103       337       309  

Net gain (loss) on sales and calls of securities

                (6

)

    (5

)

Other

    390       266       751       723  

Total non-interest income

  $ 1,509     $ 1,324     $ 4,107     $ 3,762  

 

Non-interest income for the third quarter of 2018 increased by $185,000, or 14.0%, compared with the third quarter of 2017. The increase in non-interest income was due to increases in service charges on deposit accounts as well as the sale of the Bank’s fully amortized secondary market residential mortgage servicing rights portfolio, which resulted in a one-time gain of approximately $150,000. The gain on sale is included in other non-interest income. The Bank no longer sells residential mortgage loans on a servicing retained basis to the secondary market. For the nine months, ended September 30, 2018, non-interest income increased by $345,000, or 9.2% to $4.1 million compared with $3.8 million for the same period of 2017. The increase in non-interest income between the nine-month comparative periods was primarily due to a $150,000 increase in service charges on deposit accounts, a $140,000 increase in bank card interchange fees, and the $150,000 one-time gain on sale of the fully amortized servicing rights portfolio. The gain on sale of the servicing rights portfolio was offset by decreases in title insurance commissions and secondary market increases as compared to 2017.

 

 

Non-interest ExpenseThe following table presents the major categories of non-interest expense for the three and nine months ended September 30, 2018 and 2017:

 

 

   

For the Three Months

   

For the Nine Months

 
   

Ended September 30,

   

Ended September 30,

 
   

2018

   

2017

   

2018

   

2017

 
   

(dollars in thousands)

 
                                 

Salary and employee benefits

  $ 3,893     $ 3,683     $ 11,566     $ 11,433  

Occupancy and equipment

    896       836       2,671       2,501  

Professional fees

    186       232       613       776  

Marketing expense

    259       364       867       880  

FDIC insurance

    118       356       439       1,055  

Data processing expense

    281       321       912       931  

State franchise and deposit tax

    282       225       846       675  

Deposit account related expenses

    213       222       653       646  

Other real estate owned expense

    271       111       590       92  

Litigation and loan collection expense

    61       78       162       121  

Other

    770       889       2,485       2,585  

Total non-interest expense

  $ 7,230     $ 7,317     $ 21,804     $ 21,695  

 

Non-interest expense for the third quarter ended September 30, 2018 decreased $87,000, or 1.2%, compared with the third quarter of 2017. This decrease was primarily due to a decrease in FDIC insurance expense of $238,000 and a $119,000 decrease in other non-interest expense, which was partially offset by a $210,000 increase in salaries and employee benefits and an increase in OREO expenses of $160,000 primarily attributable to fair value write-downs arising from lower marketing prices. For the nine months ended September 30, 2018, non-interest expense increased $109,000, or 0.5% to $21.8 million compared with $21.7 million for the first nine months of 2017. The increase in non-interest expense for the nine months ended September 30, 2018 was primarily attributable to increased OREO expenses of $498,000, due to to fair value write-downs arising from lower marketing prices, as well as an increase in state franchise and deposit tax expense of $171,000, which was partially offset by a $616,000 decrease in FDIC insurance expense due to improvements in the Bank’s risk profile.

   

Income Tax Expense Effective tax rates differ from the federal statutory rate of 21% for 2018 and 35% for 2017 applied to income before income taxes due to the following:

 

   

For the Three Months

   

For the Nine Months

 
   

Ended September 30,

   

Ended September 30,

 
   

2018

   

2017

   

2018

   

2017

 
   

(dollars in thousands)

 
                                 

Federal statutory rate times financial statement income

  $ 639     $ 628     $ 1,632     $ 1,814  

Effect of:

                               

Valuation allowance

          (551

)

          (1,488

)

Tax-exempt income

    (20

)

    (50

)

    (60

)

    (147

)

Non-taxable life insurance income

    (13

)

    (36

)

    (63

)

    (108

)

Restricted stock vesting

                (116

)

    (98

)

Other, net

    (2

)

    9       23       27  

Total

  $ 604     $     $ 1,416     $  

 

The Company previously had a full valuation allowance against its net deferred tax asset and therefore, the effective tax rate was 0% for the nine months ended September 30, 2017. During the fourth quarter of 2017, management concluded it was more-likely-than-not the asset would be utilized to reduce future taxes payable related to the future taxable income of the Company, and as such, reversed the valuation allowance and recorded an income tax benefit.

 

 

Analysis of Financial Condition

 

Total assets increased $79.7 million, or 8.2%, to $1.05 billion at September 30, 2018, from $970.8 million at December 31, 2017. This increase was primarily attributable to an increase in net loans of $44.5 million and an increase in securities available for sale of $32.2 million.

 

Loans ReceivableLoans receivable increased $44.9 million, or 6.3%, during the nine months ended September 30, 2018 to $757.1 million as loan growth outpaced paydowns. Our commercial and commercial real estate portfolios increased by an aggregate of $40.2 million, or 9.7% during the first nine months of 2018 and comprised 60.3% of the loan portfolio at September 30, 2018.

 

Loan Portfolio CompositionThe following table presents a summary of the loan portfolio at the dates indicated, net of deferred loan fees, by type. There are no foreign loans in our portfolio and other than the categories noted, there is no concentration of loans in any industry exceeding 10% of total loans.

 

 

   

As of September 30,

   

As of December 31,

 
   

2018

   

2017

 
   

Amount

   

Percent

   

Amount

   

Percent

 
           

(dollars in thousands)

         
                                 

Commercial

  $ 125,699       16.60

%

  $ 113,771       15.98

%

Commercial Real Estate

                               

Construction

    83,368       11.01       57,342       8.05  

Farmland

    83,917       11.08       88,320       12.40  

Nonfarm nonresidential

    163,346       21.58       156,724       22.01  

Residential Real Estate

                               

Multi-family

    46,144       6.10       56,588       7.94  

1-4 Family

    173,674       22.94       179,222       25.17  

Consumer

    40,242       5.32       18,439       2.59  

Agriculture

    40,144       5.30       41,154       5.78  

Other

    517       0.07       555       0.08  

Total loans

  $ 757,051       100.00

%

  $ 712,115       100.00

%

 

Loan Portfolio by Risk Category – The following table presents a summary of the loan portfolio at the dates indicated, by risk category.

 

   

September 30, 2018

   

December 31, 2017

 
   

Loans

   

% to Total

   

 

 

Loans

   

 

% to Total

 
   

(dollars in thousands)

 
                                 

Pass

  $ 736,193       97.2

%

  $ 673,033       94.5

%

Watch

    12,314       1.6       25,715       3.6  

Special Mention

    114       0.1       164       0.0  

Substandard

    8,430       1.1       13,203       1.9  

Doubtful

                       

Total

  $ 757,051       100.0

%

  $ 712,115       100.0

%

 

Loans receivable increased $44.9 million, or 6.3%, during the nine months ended September 30, 2018. Since December 31, 2017, the pass category increased approximately $63.2 million, the watch category decreased approximately $13.4 million, the special mention category decreased approximately $50,000, and the substandard category declined approximately $4.8 million. The $4.8 million decrease in loans classified as substandard was primarily driven by $10.0 million in principal payments received, $730,000 in loans moved to OREO, $394,000 in charge-offs, and $77,000 in loans upgraded from substandard, offset by $6.5 million in loans moved to substandard during the first nine months of 2018.

 

 

Loan Delinquency – The following table presents a summary of loan delinquencies at the dates indicated.

 

   

September 30,

2018

   

December 31,

2017

 

Past Due Loans:

  (in thousands)  

30-59 Days

  $ 1,492     $ 1,478  

60-89 Days

    929       171  

90 Days and Over

          1  

Total Loans Past Due 30-90+ Days

    2,421       1,650  
                 

Nonaccrual Loans

    2,692       5,457  

Total Past Due and Nonaccrual Loans

  $ 5,113     $ 7,107  

 

During the nine months ended September 30, 2018, nonaccrual loans decreased by $2.8 million to $2.7 million. This decrease was due primarily to $2.5 million in pay downs, $730,000 in loans foreclosed and transferred to OREO, and $265,000 in charge-offs, offset by $777,000 in loans placed on nonaccrual status. During the nine months ended September 30, 2018, loans past due 30-59 days remained unchanged at $1.5 million compared to December 31, 2017. Loans past due 60-89 days increased from $171,000 at December 31, 2017 to $929,000 at September 30, 2018. This represents a $772,000 increase from December 31, 2017 to September 30, 2018, in loans past due 30-89 days. This trend in delinquency levels is considered during the evaluation of qualitative trends in the portfolio when establishing the general component of our allowance for loan losses.

 

Troubled Debt Restructuring - A troubled debt restructuring (TDR) occurs when the Bank has agreed to a loan modification in the form of a concession to a borrower who is experiencing financial difficulty. The Bank’s TDRs typically involve a reduction in interest rate, a deferral of principal for a stated period of time, or an interest only period. All TDRs are considered impaired, and the Bank has allocated reserves for these loans to reflect the present value of the concessionary terms granted to the borrower. If the loan is considered collateral dependent, it is reported net of allocated reserves, at the fair value of the collateral less cost to sell.

The Bank does not have a formal loan modification program. If a borrower is unable to make contractual payments, management reviews the particular circumstances of that borrower’s situation and determine whether or not to negotiate a revised payment stream. The goal when restructuring a credit is to afford the borrower a reasonable period of time to remedy the issue causing cash flow constraints so that they may return to performing status over time.

 

Loan modifications have taken the form of a reduction in interest rate and/or curtailment of scheduled principal payments for a short-term period, usually three to six months, but in some cases until maturity of the loan. In some circumstances management may restructure real estate secured loans in a bifurcated fashion whereby there is a fully amortizing “A” loan at a market interest rate and an interest-only “B” loan at a reduced interest rate. The majority of restructured loans are collateral secured loans. If a borrower fails to perform under the modified terms, the loan(s) are placed on nonaccrual status and collection actions are initiated.

 

Management considers any loan that is restructured for a borrower experiencing financial difficulties due to a borrower’s potential inability to pay in accordance with contractual terms of the loan to be a troubled debt restructuring. Specifically, management consider a concession involving a modification of the loan terms, such as (i) a reduction of the stated interest rate, (ii) a reduction or deferral of principal, or (iii) a reduction or deferral of accrued interest at a stated interest rate lower than the current market rate for new debt with similar risk all to be troubled debt restructurings. When a modification of terms is made for a competitive reason, management does not consider it to be a troubled debt restructuring. A primary example of a competitive modification would be an interest rate reduction for a performing customer’s loan to a market rate as the result of a market decline in rates.

 

Management periodically reviews renewals and modifications of previously identified TDRs for which there was no principal forgiveness, to consider if it is appropriate to remove the TDR classification. If the borrower is no longer experiencing financial difficulty and the renewal/modification did not contain a concessionary interest rate or other concessionary terms, management considers the potential removal of the TDR classification. If deemed appropriate based upon current underwriting, the TDR classification is removed as the borrower has complied with the terms of the loan at the date of renewal/modification and there was a reasonable expectation that the borrower would continue to comply with the terms of the loan after the date of the renewal/modification. Additionally, the TDR classification may be removed in circumstances in which the Company performs a non-concessionary re-modification of the loan at terms that were considered to be at market for loans with comparable risk. Management expects the borrower will continue to perform under the re-modified terms based on the borrower’s past history of performance.

 

If the borrower fails to perform, management places the loan on nonaccrual status and seeks to liquidate the underlying collateral. The nonaccrual policy for restructured loans is identical to the nonaccrual policy for all loans. The policy calls for a loan to be reported as nonaccrual if it is maintained on a cash basis because of deterioration in the financial condition of the borrower, payment in full of principal and interest is not expected, or principal or interest is past due 90 days or more unless the assets are both well secured and in the process of collection. Changes in value for impairment, including the amount attributed to the passage of time, are recorded entirely within the provision for loan losses. Upon determination that a loan is collateral dependent, the loan is charged down to the fair value of collateral less estimated costs to sell.

 

 

At September 30, 2018, the Bank had three restructured loans totaling $1.6 million with borrowers who experienced deterioration in financial condition compared with six loans totaling $3.0 million at December 31, 2017. In general, these loans were granted interest rate reductions to provide cash flow relief to borrowers experiencing cash flow difficulties. At September 30, 2018, one loan totaling approximately $700,000 had been granted principal payment deferrals until maturity. That loan is on nonaccrual status. There were no concessions made to forgive principal relative to these loans, although we have recorded partial charge-offs for certain restructured loans. In general, these loans are secured by first liens on 1-4 residential or commercial real estate properties, or farmland. At September 30, 2018, $910,000 of TDRs were performing according to their modified terms.

 

There were no modifications granted during the first nine months of 2018 or during all of 2017 that resulted in loans being identified as TDRs. During the nine months ended September 30, 2018, TDRs were reduced as a result of $774,000 in payments and $500,000 due to a transfer of a loan to OREO. See “Note 3 - Loans,” of the notes to the financial statements for additional disclosure related to troubled debt restructuring.

 

Non-Performing AssetsNon-performing assets consist of certain restructured loans for which interest rate or other terms have been renegotiated, loans past due 90 days or more still on accrual, loans on which interest is no longer accrued, real estate acquired through foreclosure and repossessed assets. The following table sets forth information with respect to non-performing assets as of September 30, 2018 and December 31, 2017.

 

   

September

30,

2018

   

December

31,

2017

 
   

(dollars in thousands)

 
                 

Loans on nonaccrual status

  $ 2,692     $ 5,457  

Troubled debt restructurings on accrual

    910       1,217  

Loans past due 90 days or more still on accrual

          1  

Total non-performing loans

    3,602       6,675  

Real estate acquired through foreclosure

    3,750       4,409  

Other repossessed assets

           

Total non-performing assets

  $ 7,352     $ 11,084  
                 

Non-performing loans to total loans

    0.48

%

    0.94

%

Non-performing assets to total assets

    0.70

%

    1.14

%

Allowance for non-performing loans

  $ 123     $ 108  

Allowance for non-performing loans to non-performing loans

    3.41

%

    1.62

%

 

Nonperforming loans at September 30, 2018, were $3.6 million, or 0.48% of total loans, compared with $6.7 million, or 0.94% of total loans at December 31, 2017, and $7.0 million, or 1.02% of total loans at September 30, 2017.

 

Allowance for Loan LossesThe allowance for loan losses is based on management’s continuing review and evaluation of individual loans, loss experience, current economic conditions, risk characteristics of various categories of loans and such other factors that, in management’s judgment, require current recognition in estimating loan losses.

 

Management has established loan grading procedures that result in specific allowance allocations for any estimated inherent risk of loss. For loans not individually evaluated, a general allowance allocation is computed using factors developed over time based on actual loss experience. The specific and general allocations plus consideration of qualitative factors represent management’s estimate of probable losses contained in the loan portfolio at the evaluation date. Although the allowance for loan losses is comprised of specific and general allocations, the entire allowance is available to absorb any credit losses.

 

 

An analysis of changes in the allowance for loan losses and selected ratios for the three and nine month periods ended September 30, 2018 and 2017, and for the year ended December 31, 2017 follows: 

 

   

Three Months Ended

September 30,

   

Nine Months Ended

September 30,

   

 

Year Ended

December 31,

 
   

2018

   

2017

   

2018

   

2017

    2017  
   

(in thousands)

 

Balance at beginning of period

  $ 8,580     $ 8,885     $ 8,202     $ 8,967     $ 8,967  
                                         

Loans charged-off:

                                       

Real estate

    78       57       364       570       750  

Commercial

    50       5       50       5       5  

Consumer

    15       5       49       30       51  

Agriculture

                12       95       95  

Other

                8              

Total charge-offs

    143       67       483       700       901  
                                         

Recoveries

                                       

Real estate

    526       112       1,076       561       714  

Commercial

    10       3       255       44       59  

Consumer

    9       25       59       69       115  

Agriculture

    2       16       13       25       33  

Other

          3       12       11       15  

Total recoveries

    547       159       1,415       710       936  

Net charge-offs (recoveries)

    (404

)

    (92

)

    (932

)

    (10

)

    (35

)

Provision (negative provision) for loan losses

    (350

)

          (500

)

          (800

)

Balance at end of period

  $ 8,634     $ 8,977     $ 8,634     $ 8,977     $ 8,202  
                                         

Allowance for loan losses to period-end loans

    1.14

%

    1.32

%

    1.14

%

    1.32

%

    1.15

%

Net charge-offs (recoveries) to average loans

    (0.21

%)

    (0.05

%)

    (0.17

%)

    0.00

%

    (0.01

%)

Allowance for loan losses to non-performing loans

    239.70

%

    128.33

%

    239.70

%

    128.33

%

    122.88

%

 

The allowance for loan losses is a reserve established through charges to earnings in the form of a provision for loan losses. The allowance for loan losses is comprised of general reserves and specific reserves. The loan loss reserve, as a percentage of total loans at September 30, 2018, decreased to 1.14% compared to 1.15% at December 31, 2017 and 1.32% at September 30, 2017. The change in loan loss reserve as a percentage of total loans between periods is attributable to growth in the portfolio driven by new loans underwritten with lower loss expectations, improving historical loss experience, improvement in risk grade classification metrics, and improved charge-off levels. The allowance for loan losses to non-performing loans was 239.70% at September 30, 2018, compared with 122.88% at December 31, 2017, and 128.33% at September 30, 2017. Net recoveries in the first nine months of 2018 totaled $932,000 compared to net loan recoveries of $10,000 in the first nine months of 2017.

 

The majority of nonperforming loans are secured by real estate collateral, and the underlying collateral coverage for nonperforming loans supports the likelihood of collection of principal. Management has assessed these loans for collectability and considered, among other things, the borrower’s ability to repay, the value of the underlying collateral, and other market conditions to ensure the allowance for loan losses is adequate to absorb probable incurred losses. The allowance for non-performing loans to non-performing loans was 3.41% at September 30, 2018 compared with 1.98% at December 31, 2017, and 4.99% at September 30, 2017. The increase in this ratio from December 31, 2017 to September 30, 2018 was primarily attributable to the improving non-performing loan trends during the period.

 

 

The following table presents the unpaid principal balance, recorded investment and allocated allowance related to loans individually evaluated for impairment in the commercial real estate and residential real estate portfolios as of September 30, 2018 and December 31, 2017.

 

   

September 30, 2018

   

December 31, 2017

 
   

Commercial

Real Estate

   

Residential

Real Estate

   

Commercial

Real Estate

   

Residential

Real Estate

 
   

(in thousands)

 

Unpaid principal balance

  $ 3,637     $ 3,513     $ 4,734     $ 5,456  

Prior charge-offs

    (2,260

)

    (1,142

)

    (2,099

)

    (1,506

)

                                 

Recorded investment

    1,377       2,371       2,635       3,950  

Allocated allowance

    (46

)

    (190

)

          (206

)

                                 

Recorded investment, less allocated allowance

  $ 1,331     $ 2,181     $ 2,635     $ 3,744  
                                 

Recorded investment, less allocated allowance/ Unpaid principal balance

    36.60

%

    62.08

%

    55.66

%

    68.62

%

 

Based on prior charge-offs, the current recorded investment in loans individually evaluated for impairment in the commercial real estate and residential real estate segments of the portfolio are significantly below the unpaid principal balance for these loans. The recorded investment net of the allocated allowance was 36.60% and 62.08% of the unpaid principal balance in the commercial real estate and residential real estate segments of the portfolio, respectively, at September 30, 2018.

 

Provision for Loan Losses A negative provision for loan losses of $350,000 was recorded for the third quarter and total negative provision for loan losses for the first nine months of 2018 totaled $500,000. No provision was recorded for the same periods in 2017. This was a result of declining historical loss rates, net recoveries for the three and nine-month periods, improvements in asset quality, changes in the composition of the portfolio, and management’s assessment of risk within the portfolio. Asset quality improvement is evidenced by, among other things, improvements in loan risk category migration. The pass category increased approximately $63.2 million, the watch category decreased approximately $13.4 million, the special mention category decreased approximately $50,000, and the substandard category declined approximately $4.8 million. Net recoveries were $932,000 for the nine months ended September 30, 2018, compared with net recoveries of $10,000 for the nine months ended September 30, 2017. Management considers the size and volume of our portfolio as well as the credit quality of the loan portfolio based upon risk category classification when determining the loan loss provision for each period and the allowance for loan losses at period end.

 

Foreclosed Properties – Foreclosed properties at September 30, 2018 were $3.8 million compared with $6.3 million at September 30, 2017 and $4.4 million at December 31, 2017. See Note 4 – “Other Real Estate Owned,” to the financial statements. During the first nine months of 2018, the Bank acquired $730,000 of OREO properties and sold properties totaling approximately $876,000. Management values foreclosed properties at fair value less estimated costs to sell when acquired and expects to liquidate these properties to recover our investment in the due course of business.

 

OREO is recorded at fair market value less estimated cost to sell at time of acquisition. Any write-down of the property at the time of acquisition is charged to the allowance for loan losses. When foreclosed properties are acquired, management obtains a new appraisal or has staff from the Bank’s special assets group evaluate the latest in-file appraisal in connection with the transfer to OREO. Management typically obtains updated appraisals within five quarters of the anniversary date of ownership unless a sale is imminent. Subsequent reductions in fair value are recorded as non-interest expense when a new appraisal indicates a decline in value or in cases where a listing price is lowered below the appraisal amount.

 

Net gain (loss) on sales, write-downs, and operating expenses for OREO totaled $590,000 for the nine months ended September 30, 2018, compared to $92,000 for the nine months ended September 30, 2017. During the nine months ended September 30, 2018, fair value write-downs of $585,000 were recorded to reflect declines in fair value driven by reductions in marketing prices compared with $98,000 in write-downs for the nine months ended September 30, 2017.

 

LiabilitiesTotal liabilities at September 30, 2018 were $962.3 million compared with $898.1 million at December 31, 2017, an increase of $64.2 million, or 7.1%. This increase was primarily attributable to an increase in FHLB advances of $39.8 million and an increase in total interest bearing deposits of $28.8 million, offset by a decrease in junior subordinated debentures of $2.3.

 

 

Deposits are our primary source of funds. The following table sets forth the average daily balances and weighted average rates paid for our deposits for the periods indicated:

 

   

For the Nine Months

   

For the Year

 
   

Ended September 30,

   

Ended December 31,

 
   

2018

   

2017

 
   

Average

   

Average

   

Average

   

Average

 
   

Balance

   

Rate

   

Balance

   

Rate

 
   

(dollars in thousands)

 

Demand

  $ 133,756             $ 129,088          

Interest checking

    90,980       0.13

%

    101,980       0.13

%

Money market

    155,291       0.82       145,281       0.55  

Savings

    35,221       0.16       35,486       0.17  

Certificates of deposit

    433,933       1.25       452,443       0.93  

Total deposits

  $ 849,181       0.81

%

  $ 864,278       0.60

%

 

The following table sets forth the average daily balances and weighted average rates paid for our certificates of deposit for the periods indicated:

 

   

For the Nine Months

   

For the Year

 
   

Ended September 30,

   

Ended December 31,

 
   

2018

   

2017

 
   

Average

   

Average

   

Average

   

Average

 
   

Balance

   

Rate

   

Balance

   

Rate

 
   

(dollars in thousands)

 

Less than $250,000

  $ 405,154       1.23

%

  $ 419,816       0.92

%

$250,000 or more

    28,779       1.39

%

    32,627       1.01

%

Total

  $ 433,933       1.25

%

  $ 452,443       0.93

%

 

The following table shows at September 30, 2018 the amount of our time deposits of $250,000 or more by time remaining until maturity (in thousands):

  

Maturity Period

 
         

Three months or less

  $ 2,391  

Three months through six months

    5,055  

Six months through twelve months

    6,357  

Over twelve months

    15,364  

Total

  $ 29,167  

 

Liquidity

 

Liquidity risk arises from the possibility the Company may not be able to satisfy current or future financial commitments, or may become unduly reliant on alternative funding sources. The objective of liquidity risk management is to ensure that we meet the cash flow requirements of depositors and borrowers, as well as operating cash needs, taking into account all on- and off-balance sheet funding demands. Liquidity risk management also involves ensuring that cash flow needs are met at a reasonable cost. Management maintains an investment and funds management policy, which identifies the primary sources of liquidity, establishes procedures for monitoring and measuring liquidity, and establishes minimum liquidity requirements in compliance with regulatory guidance. The Asset Liability Committee regularly monitors and reviews the liquidity position.

 

Funds are available to the Bank from a number of sources, including the sale of securities in the available for sale investment portfolio, principal pay-downs on loans and investment securities, customer deposit inflows, and other wholesale funding.

 

The Bank also borrows from the FHLB to supplement funding requirements. At September 30, 2018, the Bank had an unused borrowing capacity with the FHLB of $41.1 million. Advances are collateralized by first mortgage residential loans and borrowing capacity is based on the underlying book value of eligible pledged loans.

 

The Bank also has available on an unsecured basis federal funds borrowing lines from a correspondent bank totaling $5.0 million. Management believes the sources of liquidity are adequate to meet expected cash needs for the foreseeable future. Historically, the Bank has also utilized brokered deposits to supplement it’s funding strategy. At September 30, 2018, the Bank had no brokered deposits.

 

 

The Company uses cash on hand to service senior debt, service junior subordinated debentures, and to provide for operating cash flow needs. The Company also may issue common equity, preferred equity and debt to support cash flow needs and liquidity requirements. At September 30, 2018, cash on hand totaled $5.8 million, of which, $514,000 is held in escrow by the Company’s senior debt holder to service interest payments.

 

Capital

 

Stockholders’ equity increased $15.5 million to $88.2 million at September 30, 2018, compared with $72.7 million at December 31, 2017 primarily due to the $14.9 million issuance of common stock completed during the first quarter of 2018, as well as current year net income of $6.4 million, offset by the $3.5 million repurchase of the Company’s series E and F preferred shares and the other comprehensive loss for the first nine months of 2018 of $2.6 million.

 

The Company completed a private placement of common stock on March 30, 2018. In the transaction, the Company issued 150,000 common shares and 1.0 million non-voting common shares to Patriot Financial Partners III, L.P. at $13.00 per share resulting in net proceeds of $14.9 million of which $5.0 million was contributed as capital to the Bank. The balance of the proceeds were for general corporate purposes and to support the growth of the Bank.

 

On June 26, 2018, the Company completed the purchase and retirement of all of its issued and outstanding Series E and Series F Non-Voting Perpetual Preferred Shares for an aggregate price of $3.5 million paid in cash. The Series E and Series F Shares had an aggregate liquidation preference of $10.5 million.

 

The following table shows the ratios of Tier 1 capital, common equity Tier 1 capital, and total capital to risk-adjusted assets and the leverage ratios (excluding the capital conservation buffer) for the Bank at the dates indicated:

 

   

Regulatory

Minimums

   

Well-Capitalized

Minimums

   

September 30, 2018

   

December 31, 2017

 
                                 

Tier 1 Capital

    6.0 %     8.0 %     11.56 %     10.35 %

Common equity Tier 1 capital

    4.5       6.5       11.56       10.35  

Total risk-based capital

    8.0       10.0       12.60       11.61  

Tier 1 leverage ratio

    4.0       5.0       9.51       8.70  

 

 

Failure to meet minimum capital requirements could result in discretionary actions by regulators that, if taken, could have a materially adverse effect on our financial condition.

 

Each of the federal bank regulatory agencies has established risk-based capital requirements for banking organizations. The Basel III regulatory capital reforms became effective for the Company and Bank on January 1, 2015, and include new minimum risk-based capital and leverage ratios. These rules refine the definition of what constitutes “capital” for purposes of calculating those ratios, including the definitions of Tier 1 capital and Tier 2 capital. The final rules allow banks and their holding companies with less than $250 billion in assets a one-time opportunity to opt-out of a requirement to include unrealized gains and losses in accumulated other comprehensive income in their capital calculation. The Company and the Bank opted out of this requirement. The rules also establish a “capital conservation buffer” of 2.5%, to be phased in over three years, above the regulatory minimum risk-based capital ratios. Once the capital conservation buffer is fully phased in, the minimum ratios are a common equity Tier 1 risk-based capital ratio of 7.0%, a Tier 1 risk-based capital ratio of 8.5%, and a total capital to total risk-weighted assets (“total risk-based capital ratio”) of 10.5%. The capital conservation buffer for 2018 is 1.875% and 1.25% for 2017. An institution is subject to limitations on paying dividends, engaging in share repurchases and paying discretionary bonuses if capital levels fall below minimum levels plus the buffer amounts. These limitations establish a maximum percentage of eligible retained income that could be utilized for such actions.

 

 

Item 3. Quantitative and Qualitative Disclosures about Market Risk

 

Given an instantaneous 100 basis point increase in interest rates, the base net interest income would increase by an estimated 1.4% at September 30, 2018 compared with an increase of 0.9% at December 31, 2017. Given a 200 basis point increase in interest rates, base net interest income would increase by an estimated 2.7% at September 30, 2018, compared with an increase of 1.7% at December 31, 2017.

 

The following table indicates the estimated impact on net interest income under various interest rate scenarios for the twelve months following September 30, 2018, as calculated using the static shock model approach:

 

   

Change in Future

Net Interest Income

 
   

Dollar

Change

   

Percentage

Change

 
   

(dollars in thousands)

 

+ 200 basis points

  $ 896       2.65

%

+ 100 basis points

    462       1.37  

- 100 basis points

    (835

)

    (2.47

)

- 200 basis points

    (785

)

    (2.32

)

 

 

Item 4. Controls and Procedures

 

As of the end of the quarterly period covered by this report, an evaluation was carried out under the supervision and with the participation of the Company’s management, including the Company’s Chief Executive Officer and Chief Financial Officer, of the effectiveness of the Company’s disclosure controls and procedures (as defined in Rules 13a-15(e) or 15d-15(e) under the Securities Exchange Act of 1934 (“Exchange Act”)). Based on this evaluation, the Company’s Chief Executive Officer and Chief Financial Officer have concluded that the Company’s disclosure controls and procedures were, to the best of their knowledge, effective to ensure that information required to be disclosed by the Company in reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in Securities and Exchange Commission rules and forms as of such date.

 

There was no change in the Company’s internal control over financial reporting that occurred during the Company’s fiscal quarter covered by this report that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.

 

 

PART II – OTHER INFORMATION

 

Item 1. Legal Proceedings

 

The Company and Bank are subject to claims and lawsuits that arise primarily in the ordinary course of business. Litigation is subject to inherent uncertainties and unfavorable outcomes could occur. See Note 13, “Off Balance Sheet Risks, Commitments, and Contingent Liabilities” to the consolidated financial statements for additional detail regarding involvement in legal proceedings.

 

Item 1A. Risk Factors

 

Refer to the detailed cautionary statements and discussion of risks that affect the Company and its business in “Item 1A – Risk Factors” of the Annual Report on Form 10-K, for the year ended December 31, 2017. There have been no material changes from the risk factors previously discussed in those reports.

 

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

 

Not applicable.

 

Item 3. Default Upon Senior Securities

 

Not applicable.

 

Item 4. Mine Safety Disclosures

 

Not applicable.

 

Item 5. Other Information

 

Not applicable

 

Item 6. Exhibits

 

(a)           Exhibits

The following exhibits are filed or furnished as part of this report:

 

Exhibit Number

Description of Exhibit

  

3.1

Amended and Restated Articles of Incorporation of the Company, incorporated by reference to Exhibit 3.1 of the Quarterly Report on Form 10-Q filed August 2, 2018.
   

3.2

Amended and Restated Bylaws of the Company dated June 18, 2018, incorporated by reference to Exhibit 3.2 of the Current Report on Form 8-K dated June 18, 2018.

   

4.1

Tax Benefits Preservation Plan, dated as of June 25, 2015, between the Company and American Stock Transfer Company, as Rights Agent. Exhibit 3.1 to Form 8-K filed June 29, 2015 is incorporated by reference.

   

4.2

Amendment No. 1 to the Tax Benefits Preservation Plan, dated August 4, 2015. Exhibit 4.2 to the Quarterly Report on Form 10-Q filed August 5, 2015 is incorporated by reference.

   

4.3

Amendment No. 2 to the Tax Benefits Preservation Plan dated May 23, 2018, incorporated by reference to Exhibit 4 of the Current Report on Form 8-K dated May 23, 2018.

   

31.1

Certification of Principal Executive Officer, pursuant to Rule 13a - 14(a).

  

31.2

Certification of Principal Financial Officer, pursuant to Rule 13a - 14(a).

  

32.1

Certification of Principal Executive Officer, pursuant to 18 U.S.C Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

  

32.2

Certification of Principal Financial Officer, pursuant to 18 U.S.C Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

 

 

101

The following financial statements from the Company’s Quarterly Report on Form 10Q for the quarter ended September 30, 2018, formatted in XBRL: (i) Consolidated Balance Sheets, (ii) Consolidated Statements of Income, (iii) Consolidated Statements of Comprehensive Income (Loss), (iv) Consolidated Statement of Changes in Stockholders’ Equity, (v) Consolidated Statements of Cash Flows, (vi) Notes to Consolidated Financial Statements.

 

 

SIGNATURES

 

Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant had duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

 

 

  

LIMESTONE BANCORP, INC.

  

(Registrant)

  

November 2, 2018

By:

/s/ John T. Taylor

  

  

John T. Taylor

  

  

Chief Executive Officer 

  

November 2, 2018

By:

/s/ Phillip W. Barnhouse

 

 

Phillip W. Barnhouse 

  

  

Chief Financial Officer

  

  

 

 

 

50