MIDDLEFIELD BANC CORP - Quarter Report: 2019 September (Form 10-Q)

 

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

 

	(Mark One)
	X	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
		For the quarterly period ended September 30, 2019
or
	☐	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
		For the transition period from ___________ to ___________

 

Commission File Number  001-36613

 

 

Middlefield Banc Corp.

(Exact Name of Registrant as Specified in its Charter)

 

Ohio		34-1585111
State or Other Jurisdiction of		I.R.S. Employer Identification No.
Incorporation or Organization
15985 East High Street, Middlefield, Ohio		44062-0035
Address of Principal Executive Offices		Zip Code

 

	440-632-1666
Registrant’s Telephone Number, Including Area Code

 

Former Name, Former Address and Former Fiscal Year, if Changed Since Last Report

 

Securities Registered Pursuant to Section 12(b) of The Act:

 

Title of Each Class		Trading Symbol(s)	Name of Each Exchange on Which Registered
Common Stock, Without Par Value		MBCN	The NASDAQ Stock Market, LLC      (NASDAQ Capital Market)

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes X     No ☐
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted 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 such files).  Yes X    No ☐
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.
	Large accelerated filer ☐	Accelerated filer X
	Non-accelerated filer ☐	Smaller reporting company X
	Emerging growth company ☐
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.    ☐
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes ☐    No X
Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.
Outstanding at November 5, 2019:  3,211,713

 

 

 

MIDDLEFIELD BANC CORP.

 

INDEX

 

Part I – Financial Information
Item 1.					Financial Statements (unaudited)
					Consolidated Balance Sheet as of September 30, 2019 and December 31, 2018	3
					Consolidated Statement of Income for the Three and Nine Months ended September 30, 2019 and 2018	4
					Consolidated Statement of Comprehensive Income for the Three and Nine Months ended September 30, 2019 and 2018	5
					Consolidated Statement of Changes in Stockholders' Equity for the Three and Nine Months ended September 30, 2019 and 2018	6
					Consolidated Statement of Cash Flows for the Nine Months ended September 30, 2019 and 2018	8
					Notes to Unaudited Consolidated Financial Statements	10
Item 2.					Management's Discussion and Analysis of Financial Condition and Results of Operations	32
Item 3.					Quantitative and Qualitative Disclosures about Market Risk	42
Item 4.					Controls and Procedures	43
Part II – Other Information
Item 1.					Legal Proceedings	44
Item 1a.					Risk Factors	44
Item 2.					Unregistered Sales of Equity Securities and Use of Proceeds	44
Item 3.					Defaults by the Company on its Senior Securities	44
Item 4.					Mine Safety Disclosures	44
Item 5.					Other Information	44
Item 6.					Exhibits and Reports on Form 8-K	45
Signatures						50
Exhibit 31.1
Exhibit 31.2
Exhibit 32

 

 

 

		September 30,				December 31,
		2019				2018
ASSETS
Cash and due from banks		$	118,956			$	107,933
Federal funds sold			1,069				-
Cash and cash equivalents			120,025				107,933
Equity securities, at fair value			628				616
Investment securities available for sale, at fair value			105,041				98,322
Loans held for sale			791				597
Loans			999,282				992,109
Less allowance for loan and lease losses			7,001				7,428
Net loans			992,281				984,681
Premises and equipment, net			17,182				13,003
Goodwill			15,071				15,071
Core deposit intangibles			2,141				2,397
Bank-owned life insurance			16,403				16,080
Accrued interest receivable and other assets			11,015				9,698
TOTAL ASSETS		$	1,280,578			$	1,248,398
LIABILITIES
Deposits:
Noninterest-bearing demand		$	199,235			$	203,410
Interest-bearing demand			107,033				92,104
Money market			155,419				196,685
Savings			182,005				222,954
Time			390,721				300,914
Total deposits			1,034,413				1,016,067
Short-term borrowings:
Federal funds purchased			-				398
Federal Home Loan Bank advances			92,000				90,000
Total short-term borrowings			92,000				90,398
Other borrowings			12,359				8,803
Accrued interest payable and other liabilities			5,893				4,840
TOTAL LIABILITIES			1,144,665				1,120,108
STOCKHOLDERS' EQUITY
Common stock, no par value; 10,000,000 shares authorized, 3,647,146 and 3,630,497 shares issued; 3,211,565 and 3,244,332 shares outstanding			86,617				85,925
Retained earnings			62,886				56,037
Accumulated other comprehensive income (loss)			2,157				(154	)
Treasury stock, at cost; 435,581 and 386,165 shares			(15,747	)			(13,518	)
TOTAL STOCKHOLDERS' EQUITY			135,913				128,290
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY		$	1,280,578			$	1,248,398

---

 

		Three Months Ended								Nine Months Ended
		September 30,								September 30,
		2019				2018				2019				2018
INTEREST AND DIVIDEND INCOME
Interest and fees on loans		$	12,804			$	11,821			$	37,998			$	34,109
Interest-earning deposits in other institutions			193				178				549				412
Federal funds sold			24				8				56				29
Investment securities:
Taxable interest			206				167				599				506
Tax-exempt interest			613				598				1,731				1,673
Dividends on stock			45				57				156				169
Total interest and dividend income			13,885				12,829				41,089				36,898
INTEREST EXPENSE
Deposits			3,173				2,178				9,395				5,803
Short-term borrowings			42				296				334				764
Other borrowings			92				104				283				344
Total interest expense			3,307				2,578				10,012				6,911
NET INTEREST INCOME			10,578				10,251				31,077				29,987
Provision for loan losses			80				210				430				630
NET INTEREST INCOME AFTER
PROVISION FOR LOAN LOSSES			10,498				10,041				30,647				29,357
NONINTEREST INCOME
Service charges on deposit accounts			571				491				1,609				1,416
Investment securities gains on sale, net			4				-				194				-
(Loss) gain on equity securities			(32	)			15				12				46
Earnings on bank-owned life insurance			109				108				323				318
Gain on sale of loans			128				43				285				164
Other income			325				291				1,113				807
Total noninterest income			1,105				948				3,536				2,751
NONINTEREST EXPENSE
Salaries and employee benefits			4,272				3,839				12,474				11,684
Occupancy expense			535				460				1,584				1,468
Equipment expense			244				262				770				696
Data processing costs			580				481				1,594				1,360
Ohio state franchise tax			262				244				782				603
Federal deposit insurance expense			-				150				230				450
Professional fees			401				346				1,235				1,118
Advertising expense			202				236				605				694
Software amortization expense			182				155				479				460
Core deposit intangible amortization			86				87				256				265
Other expense			909				832				2,646				2,702
Total noninterest expense			7,673				7,092				22,655				21,500
Income before income taxes			3,930				3,897				11,528				10,608
Income taxes			661				593				1,958				1,602
NET INCOME		$	3,269			$	3,304			$	9,570			$	9,006
EARNINGS PER SHARE
Basic		$	1.01			$	1.02			$	2.95			$	2.79
Diluted		$	1.01			$	1.02			$	2.94			$	2.78

---

 

		Three Months Ended								Nine Months Ended
		September 30,								September 30,
		2019				2018				2019				2018
Net income		$	3,269			$	3,304			$	9,570			$	9,006
Other comprehensive income (loss):
Net unrealized holding gain (loss) on available-for-sale investment securities			883				(1,297	)			3,011				(3,282	)
Tax effect			(100	)			272				(547	)			689
Reclassification adjustment for investment securities gains included in net income			(4	)			-				(194	)			-
Tax effect			1				-				41				-
Total other comprehensive income (loss)			780				(1,025	)			2,311				(2,593	)
Comprehensive income		$	4,049			$	2,279			$	11,881			$	6,413

---

 

														Accumulated
														Other								Total
		Common Stock								Retained				Comprehensive				Treasury				Stockholders'
		Shares				Amount				Earnings				Income				Stock				Equity
Balance, June 30, 2019			3,646,497			$	86,590			$	60,517			$	1,377			$	(14,224	)		$	134,260
Net income											3,269												3,269
Other comprehensive income															780								780
Dividend reinvestment and purchase plan			649				27																27
Treasury shares acquired (31,669)																			(1,523	)			(1,523	)
Cash dividends ($0.28 per share)											(900	)											(900	)
Balance, September 30, 2019			3,647,146			$	86,617			$	62,886			$	2,157			$	(15,747	)		$	135,913

														Accumulated
														Other								Total
		Common Stock								Retained				Comprehensive				Treasury				Stockholders'
		Shares				Amount				Earnings				Loss				Stock				Equity
Balance, June 30, 2018			3,619,843			$	85,544			$	51,121			$	(431	)		$	(13,518	)		$	122,716
Net income											3,304												3,304
Other comprehensive loss															(1,025	)							(1,025	)
Dividend reinvestment and purchase plan			2,861				140																140
Stock options exercised			150				3																3
Cash dividends ($0.28 per share)											(905	)											(905	)
Balance, September 30, 2018			3,622,854			$	85,687			$	53,520			$	(1,456	)		$	(13,518	)		$	124,233

---

														Accumulated
														Other								Total
		Common Stock								Retained				Comprehensive				Treasury				Stockholders'
		Shares				Amount				Earnings				Income (Loss)				Stock				Equity
Balance, December 31, 2018			3,630,497			$	85,925			$	56,037			$	(154	)		$	(13,518	)		$	128,290
Net income											9,570												9,570
Other comprehensive income															2,311								2,311
Dividend reinvestment and purchase plan			8,933				372																372
Stock options exercised			200				4																4
Stock-based compensation, net			7,516				316																316
Treasury shares acquired (49,416)																			(2,229	)			(2,229	)
Cash dividends ($0.84 per share)											(2,721	)											(2,721	)
Balance, September 30, 2019			3,647,146			$	86,617			$	62,886			$	2,157			$	(15,747	)		$	135,913

														Accumulated
														Other								Total
		Common Stock								Retained				Comprehensive				Treasury				Stockholders'
		Shares				Amount				Earnings				Income (Loss)				Stock				Equity
Balance, December 31, 2017			3,603,881			$	84,859			$	47,431			$	1,091			$	(13,518	)		$	119,863
Change in accounting principle for adoption of ASU 2016-01											141				(141	)							-
Change in accounting principle for adoption of ASU 2018-02											(187	)			187								-
Net income											9,006												9,006
Other comprehensive loss															(2,593	)							(2,593	)
Dividend reinvestment and purchase plan			8,763				441																441
Stock options exercised			4,650				107																107
Stock-based compensation, net			5,560				280																280
Cash dividends ($0.89 per share)											(2,871	)											(2,871	)
Balance, September 30, 2018			3,622,854			$	85,687			$	53,520			$	(1,456	)		$	(13,518	)		$	124,233

---

 

		Nine Months Ended
		September 30,
		2019				2018
OPERATING ACTIVITIES
Net income		$	9,570			$	9,006
Adjustments to reconcile net income to net cash provided by operating activities:
Provision for loan losses			430				630
Investment securities gains on sale, net			(194	)			-
Gain on equity securities			(12	)			(46	)
Depreciation and amortization of premises and equipment, net			778				694
Software amortization expense			479				460
Financing lease amortization expense			264				-
Amortization of premium and discount on investment securities, net			240				317
Accretion of deferred loan fees, net			(557	)			(690	)
Amortization of core deposit intangibles			256				265
Stock-based compensation expense			366				360
Origination of loans held for sale			(12,845	)			(9,588	)
Proceeds from sale of loans			12,936				9,290
Gain on sale of loans			(285	)			(164	)
Earnings on bank-owned life insurance			(323	)			(318	)
Deferred income tax			117				184
Net (gain) loss on other real estate owned			(123	)			5
Increase in accrued interest receivable			(51	)			(445	)
Increase in accrued interest payable			276				126
Other, net			(1,609	)			(1,721	)
Net cash provided by operating activities			9,713				8,365
INVESTING ACTIVITIES
Investment securities available for sale:
Proceeds from repayments and maturities			8,571				4,340
Proceeds from sale of securities			12,325				-
Purchases			(24,844	)			(12,998	)
Increase in loans, net			(7,529	)			(49,467	)
Proceeds from the sale of other real estate owned			360				26
Purchase of premises and equipment			(1,420	)			(1,843	)
Purchase of restricted stock			(169	)			(90	)
Net cash used in investing activities			(12,706	)			(60,032	)
FINANCING ACTIVITIES
Net increase in deposits			18,346				135,567
Increase (decrease) in short-term borrowings, net			1,602				(19,403	)
Repayment of other borrowings			(245	)			(20,109	)
Restricted stock cash portion			(44	)			-
Stock options exercised			4				107
Proceeds from dividend reinvestment and purchase plan			372				441
Repurchase of treasury shares			(2,229	)			-
Cash dividends			(2,721	)			(2,871	)
Net cash provided by financing activities			15,085				93,732
Increase in cash and cash equivalents			12,092				42,065
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD			107,933				39,886
CASH AND CASH EQUIVALENTS AT END OF PERIOD		$	120,025			$	81,951

---

		Nine Months Ended
		September 30,
		2019				2018
SUPPLEMENTAL INFORMATION
Cash paid during the year for:
Interest on deposits and borrowings		$	9,736			$	6,785
Income taxes			2,180				1,675
Noncash operating transactions:
Operating lease assets added to other, net		$	(1,071	)		$	-
Operating lease liabilities added to other, net			1,071				-
Noncash investing transactions:
Transfers from loans to other real estate owned		$	56			$	76
Transfer of equity securities from investment securities available for sale, at fair value			-				(625	)
Finance lease assets added to premises and equipment			(3,801	)			-
Noncash financing transactions:
Finance lease liabilities added to borrowed funds		$	3,801			$	-

---

 

NOTE 1 - BASIS OF PRESENTATION

 

The consolidated financial statements of Middlefield Banc Corp. ("Company") include its bank subsidiary, The Middlefield Banking Company (“MBC” or “Middlefield Bank”), and a nonbank asset resolution subsidiary EMORECO, Inc. The consolidated financial statements also include the accounts of MBC’s subsidiary, Middlefield Investments, Inc. (MI), established March 13, 2019. All significant inter-company items have been eliminated.

 

The unaudited condensed consolidated financial statements have been prepared in conformity with the instructions to Form 10-Q and Article 10 of Regulation S-X.  Accordingly, they do not include all of the information and footnotes required by U.S. generally accepted accounting principles (“GAAP”) for complete financial statements.  The financial statements should be read in conjunction with the consolidated financial statements and notes thereto included in the Company’s Form 10-K for the year ended December 31, 2018.  The interim consolidated financial statements include all adjustments (consisting of only normal recurring items) that, in the opinion of management, are necessary for a fair presentation of the financial position and results of operations for the periods presented.  The results of operations for the interim periods disclosed herein are not necessarily indicative of the results that may be expected for a full year.  

 

Recently Adopted Accounting Pronouncements –

 

In February 2016, the FASB issued ASU 2016-02, Leases (Topic 842). The standard requires lessees to recognize the assets and liabilities that arise from leases on the balance sheet. A lessee should recognize in the statement of financial position a liability to make lease payments (the lease liability) and a right-of-use asset representing its right to use the underlying asset for the lease term. A short-term lease is defined as one in which (a) the lease term is 12 months or less and (b) there is not an option to purchase the underlying asset that the lessee is reasonably certain to exercise. For short-term leases, lessees may elect to recognize lease payments over the lease term on a straight-line basis. For public business entities, the amendments in this Update are effective for fiscal years beginning after December 15, 2018, and interim periods within those years. For all other entities, the amendments in this Update are effective for fiscal years beginning after December 15, 2019, and for interim periods within fiscal years beginning after December 15, 2020. The amendments should be applied at the beginning of the earliest period presented using a modified retrospective approach with earlier application permitted as of the beginning of an interim or annual reporting period. On January 1, 2019, the Company adopted ASU 2016-02 which resulted in the recording of finance lease assets and liabilities of $3.8 million and operating lease assets and liabilities of $1.1 million on the Consolidated Balance Sheet. See Note 9 to the financial statements.

 

Recently Issued Accounting Pronouncements –

 

In June 2016, the FASB issued ASU 2016-13, Financial Instruments – Credit Losses: Measurement of Credit Losses on Financial Instruments (“CECL”), which changes the impairment model for most financial assets. This Update is intended to improve financial reporting by requiring timelier recording of credit losses on loans and other financial instruments held by financial institutions and other organizations. The underlying premise of the Update is that financial assets measured at amortized cost should be presented at the net amount expected to be collected, through an allowance for credit losses that is deducted from the amortized cost basis. The allowance for credit losses should reflect management’s current estimate of credit losses that are expected to occur over the remaining life of a financial asset. The income statement will be effected for the measurement of credit losses for newly recognized financial assets, as well as the expected increases or decreases of expected credit losses that have taken place during the period. ASU 2016-13 is effective for annual and interim periods beginning after December 15, 2019, and early adoption is permitted for annual and interim periods beginning after December 15, 2018. With certain exceptions, transition to the new requirements will be through a cumulative effect adjustment to opening retained earnings as of the beginning of the first reporting period in which the guidance is adopted. On October 16, 2019, the FASB voted to defer the effective date for ASC 326, Financial Instruments – Credit Losses, for smaller reporting companies to fiscal years beginning after December 15, 2022, and interim periods within those fiscal years.  The final ASU is expected to be issued in mid-November. The CECL model has been completed and runs concurrently with the existing incurred loss model each month.  Management continues monitoring model output, with final assumption changes expected to be made in the fourth quarter.

 

 

 

NOTE 2 – REVENUE RECOGNITION

 

In accordance with ASC Topic 606, management determined that the primary sources of revenue, which emanate from interest income on loans and investments, along with noninterest revenue resulting from investment security gains, gains on the sale of loans, and BOLI income, are not within the scope of ASC 606. These revenue sources cumulatively comprise 92.2% of the total revenue of the Company.

 

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

 

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

 

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

 

The following table depicts the disaggregation of revenue derived from contracts with customers to depict the nature, amount, timing, and uncertainty of revenue and cash flows:

 

 

(a)  Not within scope of ASC 606

 

 

 

NOTE 3 - STOCK-BASED COMPENSATION

 

The Company had no nonvested stock options outstanding as of September 30, 2019 and 2018.

 

Stock option activity during the nine months ended September 30, 2019 is as follows:

 

 

The following table presents the activity during the nine months ended September 30, 2019 related to awards of restricted stock:

 

 

The Company recognizes restricted stock forfeitures in the period they occur.

 

Share-based compensation expense of $180,000 and $90,000 was recognized for the three-month periods ended September 30, 2019 and 2018, respectively. Share-based compensation expense of $270,000 and $226,000 was recognized for the nine-month periods ended September 30, 2019 and 2018, respectively. Since the shares of restricted stock are historically paid out at the vesting date in a combination of shares and cash, the Company has recorded a liability related to this plan which totals $416,000 and $351,000 at September 30, 2019 and 2018, respectively. When the shares vest, the amount distributed in shares is transferred to common stock and the remainder is distributed in cash.

 

Total unrecognized stock compensation cost related to nonvested share-based compensation on restricted stock as of September 30, 2019 totals $354,000, of which $63,000 is estimated for the rest of 2019, $139,000 for 2020, $131,000 for 2021, and $21,000 for 2022.

 

 

 

NOTE 4 - EARNINGS PER SHARE

 

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

 

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

 

 

Options to purchase 7,250 shares of common stock at $17.55 per share, were outstanding during the three and nine months ended September 30, 2019. Also outstanding were 30,770 shares of restricted stock. None of the outstanding options or restricted stock were anti-dilutive.

 

Options to purchase 13,600 shares of common stock, at prices ranging from $17.55 to $23.00, were outstanding during the three and nine months ended September 30, 2018. Also outstanding were 20,425 shares of restricted stock. None of the outstanding options or restricted stock were anti-dilutive.

 

When shares recognized as equity are repurchased, the amount of the consideration paid, which includes directly attributable costs, is recognized as a deduction from equity. Repurchased shares are classified as treasury shares and are presented in the treasury share reserve. When treasury shares are sold or reissued subsequently, the amount received is recognized as an increase in equity and the resulting surplus or deficit on the transaction is presented within the share premium. The reserve for the Company’s treasury shares comprises the cost of the Company’s shares held by the Company. As of September 30, 2019, the Company held 435,581 of the Company’s shares, which is an increase of 31,669 for the quarter, and 49,416 for the nine months ended September 30, 2019, from the 386,165 shares held as of December 31, 2018.

 

 

 

NOTE 5 - FAIR VALUE MEASUREMENTS

 

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

 

Level I:

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

 

Level II:

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

 

Level III:

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

 

This hierarchy requires the use of observable market data when available.

 

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

 

 

 

Investment Securities Available for Sale - The Company obtains fair values from an independent pricing service which represent quoted prices for similar assets, fair values determined by pricing models using a market approach that considers observable market data, such as interest rate volatilities, LIBOR yield curve, credit spreads and prices from market makers and live trading systems (Level II).

 

Equity Securities - Equity securities that are traded on a national securities exchange are valued at their last reported sales price as of the measurement date. Equity securities traded in the over-the-counter (“OTC”) markets and listed securities for which no sale was reported on that date are generally valued at their last reported “bid” price if held long, and last reported “ask” price if sold short. To the extent equity securities are actively traded and valuation adjustments are not applied, they are categorized in Level I of the fair value hierarchy.

 

 

The following tables present the assets measured on a nonrecurring basis on the Consolidated Balance Sheet at their fair value by level within the fair value hierarchy. Collateral-dependent impaired loans are carried at fair value if they have been charged down to fair value or if a specific valuation allowance has been established. A new cost basis is established at the time a property is initially recorded in OREO. OREO properties are carried at fair value if a devaluation has been taken to the property’s value at initial foreclosure or subsequent to the initial measurement. No such devaluation occurred in the nine months ended September 30, 2019.

 

 

 

Impaired Loans – The Company has measured impairment on collateral-dependent impaired loans generally based on the fair value of the loan’s collateral. Fair value is generally determined based upon independent third-party appraisals of the properties. In some cases, management may adjust the appraised value due to the age of the appraisal, changes in market conditions, or observable deterioration of the property since the appraisal was completed. Additionally, management makes estimates about expected costs to sell the property which are also included in the net realizable value. If the fair value of the collateral-dependent loan is less than the carrying amount of the loan, a specific reserve for the loan is made in the allowance for loan losses or a charge-off is taken to reduce the loan to the fair value of the collateral (less estimated selling costs) and the loan is included in the above table as a Level III measurement. If the fair value of the collateral exceeds the carrying amount of the loan, then the loan is not included in the above table as it is not currently being carried at its fair value. The fair values in the above table exclude estimated selling costs of $2.0 million and $492,000 as of September 30, 2019 and December 31, 2018, respectively.

 

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

 

 

 

(1)

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

(2)

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

 

 

The estimated fair value of the Company’s financial instruments not recorded at fair value on a recurring basis is as follows:

 

 

 

 

All financial instruments included in the above tables, with the exception of net loans, deposits, and other borrowings, are carried at cost, which approximates the fair value of the instrument.

 

 

 

NOTE 6 – ACCUMULATED OTHER COMPREHENSIVE INCOME (LOSS)

 

The following table presents the changes in accumulated other comprehensive income (loss) (“AOCI”) by component net of tax for the three and nine months ended September 30, 2019 and 2018, respectively:

 

 

 

 

(a)

All amounts are net of tax. Amounts in parentheses indicate debits to AOCI.

(b)

Reclassifications are the result of the adoption of ASUs 2016-01 and 2018-02 effective for the Company beginning January 1, 2018. The reclassifications are presented within the Consolidated Statement of Changes in Stockholders’ Equity for the affected transitional periods.

 

The following tables present significant amounts reclassified from or to each component of AOCI: 

 

 

 

 

(a)

For unrealized gains on available-for-sale securities, amounts in parentheses indicate expenses and other amounts indicate income.

 

NOTE 7 – INVESTMENT AND EQUITY SECURITIES

 

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

 

 

 

The Company recognized net (loss) gains on equity investments of ($32,000) and $12,000, respectively, for the three and nine months ended September 30, 2019. The Company recognized net gains on equity investments of $15,000 and $46,000, respectively, for the three and nine months ended September 30, 2018. No net gains on sold equity securities were realized during these periods.

 

 

The amortized cost and fair value of debt securities at September 30, 2019, by contractual maturity, are shown below. Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.

 

 

Proceeds from the sales of investment securities and the gross realized gains and losses are as follows:

 

 

Investment securities with an approximate carrying value of $62.6 million and $63.5 million at September 30, 2019 and December 31, 2018, respectively, were pledged to secure deposits and for other purposes as required by law.

 

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

 

 

 

There were 14 securities considered temporarily impaired at September 30, 2019.

 

 

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

 

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

 

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

 

Debt securities issued by U.S. government agencies, U.S. government-sponsored enterprises, and state and political subdivisions accounted for 96% of the total available-for-sale portfolio as of September 30, 2019 and no credit losses are expected, given the explicit and implicit guarantees provided by the U.S. federal government and the lack of prolonged unrealized loss positions within the obligations of the state and political subdivisions security portfolio. The Company considers the following factors in determining whether a credit loss exists and the period over which the debt security is expected to recover:

 

	•	The length of time and the extent to which the fair value has been less than the amortized cost basis;
	•	Changes in the near-term prospects of the underlying collateral of a security such as changes in default rates, loss severity given default and significant changes in prepayment assumptions;
	•	The level of cash flows generated from the underlying collateral supporting the principal and interest payments of the debt securities; and
	•	Any adverse change to the credit conditions and liquidity of the issuer, taking into consideration the latest information available about the overall financial condition of the issuer, credit ratings, recent legislation and government actions affecting the issuer’s industry and actions taken by the issuer to deal with the present economic climate.

 

For the nine months ended September 30, 2019 and 2018, there were no available-for-sale debt securities with an unrealized loss that suffered OTTI. Management does not believe any individual unrealized loss as of September 30, 2019 or December 31, 2018 represented an other-than-temporary impairment. The unrealized losses on debt securities are primarily the result of interest rate changes. These conditions will not prohibit the Company from receiving its contractual principal and interest payments on these debt securities. The fair value of these debt securities is expected to recover as payments are received on these securities and they approach maturity. Should the impairment of any of these securities become other than temporary, the cost basis of the investment will be reduced and the resulting loss recognized in net income in the period the other-than-temporary impairment is identified.