MIDDLEFIELD BANC CORP - Quarter Report: 2020 March (Form 10-Q)

 

 

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 March 31, 2020

 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 ☒     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 ☒    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 ☒
Non-accelerated filer ☐	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.

Outstanding at May 6, 2020:  6,369,467

 

 

 

MIDDLEFIELD BANC CORP.

 

INDEX

 

Part I – Financial Information
Item 1.	Financial Statements (unaudited)
	Consolidated Balance Sheet as of March 31, 2020 and December 31, 2019	3
	Consolidated Statement of Income for the Three Months ended March 31, 2020 and 2019	4
	Consolidated Statement of Comprehensive Income for the Three Months ended March 31, 2020 and 2019	5
	Consolidated Statement of Changes in Stockholders' Equity for the Three Months March 31, 2020 and 2019	6
	Consolidated Statement of Cash Flows for the Three Months ended March 31, 2020 and 2019	7
	Notes to Unaudited Consolidated Financial Statements	9
Item 2.	Management's Discussion and Analysis of Financial Condition and Results of Operations	31
Item 3.	Quantitative and Qualitative Disclosures about Market Risk	40
Item 4.	Controls and Procedures	41
Part II – Other Information
Item 1.	Legal Proceedings	42
Item 1a.	Risk Factors	42
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	43
Item 3.	Defaults by the Company on its Senior Securities	43
Item 4.	Mine Safety Disclosures	43
Item 5.	Other Information	44
Item 6.	Exhibits and Reports on Form 8-K	44
Signatures		49
Exhibit 31.1
Exhibit 31.2
Exhibit 32

 

 

 

		March 31,				December 31,
		2020				2019
ASSETS
Cash and due from banks		$	53,533			$	35,113
Federal funds sold			1,800				-
Cash and cash equivalents			55,333				35,113
Equity securities, at fair value			550				710
Investment securities available for sale, at fair value			102,959				105,733
Loans held for sale			513				1,220
Loans:
Commercial real estate:
Owner occupied			113,272				102,386
Non-owner occupied			292,775				302,180
Multifamily			52,276				62,028
Residential real estate			233,900				234,798
Commercial and industrial			106,797				89,527
Home equity lines of credit			114,933				112,248
Construction and other			71,186				66,680
Consumer installment			12,861				14,411
Total loans			998,000				984,258
Less: allowance for loan and lease losses			9,244				6,768
Net loans			988,756				977,490
Premises and equipment, net			17,653				17,874
Goodwill			15,071				15,071
Core deposit intangibles			1,973				2,056
Bank-owned life insurance			16,618				16,511
Accrued interest receivable and other assets			14,513				10,697
TOTAL ASSETS		$	1,213,939			$	1,182,475
LIABILITIES
Deposits:
Noninterest-bearing demand		$	206,372			$	191,370
Interest-bearing demand			125,184				107,844
Money market			156,556				160,826
Savings			175,468				192,003
Time			340,130				368,800
Total deposits			1,003,710				1,020,843
Short-term borrowings:
Federal funds purchased			-				75
Federal Home Loan Bank advances			60,000				5,000
Total short-term borrowings			60,000				5,075
Other borrowings			12,662				12,750
Accrued interest payable and other liabilities			4,880				6,032
TOTAL LIABILITIES			1,081,252				1,044,700
STOCKHOLDERS' EQUITY
Common stock, no par value; 10,000,000 shares authorized, 7,298,829 and 7,294,792 shares issued; 6,369,467 and 6,423,630 shares outstanding			86,722				86,617
Retained earnings			65,140				65,063
Accumulated other comprehensive (loss) income			(2,237	)			1,842
Treasury stock, at cost; 929,362 and 871,162 shares			(16,938	)			(15,747	)
TOTAL STOCKHOLDERS' EQUITY			132,687				137,775
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY		$	1,213,939			$	1,182,475

 

		Three Months Ended
		March 31,
		2020				2019
INTEREST AND DIVIDEND INCOME
Interest and fees on loans		$	12,078			$	12,488
Interest-earning deposits in other institutions			94				187
Federal funds sold			21				7
Investment securities:
Taxable interest			157				179
Tax-exempt interest			629				565
Dividends on stock			30				58
Total interest and dividend income			13,009				13,484
INTEREST EXPENSE
Deposits			2,865				2,945
Short-term borrowings			35				213
Other borrowings			76				96
Total interest expense			2,976				3,254
NET INTEREST INCOME			10,033				10,230
Provision for loan losses			2,740				240
NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES			7,293				9,990
NONINTEREST INCOME
Service charges on deposit accounts			553				508
(Loss) gain on equity securities			(160	)			58
Earnings on bank-owned life insurance			107				105
Gain on sale of loans			114				59
Other income			460				402
Total noninterest income			1,074				1,132
NONINTEREST EXPENSE
Salaries and employee benefits			3,524				4,124
Occupancy expense			550				553
Equipment expense			273				235
Data processing costs			666				465
Ohio state franchise tax			268				259
Federal deposit insurance expense			123				130
Professional fees			349				431
Advertising expense			209				203
Software amortization expense			141				145
Core deposit intangible amortization			83				85
Other expense			1,066				870
Total noninterest expense			7,252				7,500
Income before income taxes			1,115				3,622
Income taxes			74				611
NET INCOME		$	1,041			$	3,011
EARNINGS PER SHARE
Basic		$	0.16			$	0.46
Diluted		$	0.16			$	0.46

 

		Three Months Ended
		March 31,
		2020				2019
Net income		$	1,041			$	3,011
Other comprehensive (loss) income:
Net unrealized holding (loss) gain on available-for-sale investment securities			(5,163	)			1,006
Tax effect			1,084				(211	)
Total other comprehensive (loss) income			(4,079	)			795
Comprehensive (loss) income		$	(3,038	)		$	3,806

 

														Accumulated
														Other								Total
		Common Stock								Retained				Comprehensive				Treasury				Stockholders'
		Shares				Amount				Earnings				Income (Loss)				Stock				Equity
Balance, December 31, 2019			7,294,792			$	86,617			$	65,063			$	1,842			$	(15,747	)		$	137,775
Net income											1,041												1,041
Other comprehensive loss															(4,079	)							(4,079	)
Stock-based compensation, net			4,037				105																105
Treasury shares acquired (58,200 shares)																			(1,191	)			(1,191	)
Cash dividends ($0.15 per share)											(964	)											(964	)
Balance, March 31, 2020			7,298,829			$	86,722			$	65,140			$	(2,237	)		$	(16,938	)		$	132,687

														Accumulated
														Other								Total
		Common Stock								Retained				Comprehensive				Treasury				Stockholders'
		Shares				Amount				Earnings				Income (Loss)				Stock				Equity
Balance, December 31, 2018			7,260,994			$	85,925			$	56,037			$	(154	)		$	(13,518	)		$	128,290
Net income											3,011												3,011
Other comprehensive income															795								795
Dividend reinvestment and purchase plan			9,044				196																196
Stock-based compensation, net			15,032				316																316
Cash dividends ($0.14 per share)											(909	)											(909	)
Balance, March 31, 2019			7,285,070			$	86,437			$	58,139			$	641			$	(13,518	)		$	131,699

 

		Three Months Ended
		March 31,
		2020				2019
OPERATING ACTIVITIES
Net income		$	1,041			$	3,011
Adjustments to reconcile net income to net cash provided by operating activities:
Provision for loan losses			2,740				240
Loss (gain) on equity securities			160				(58	)
Depreciation and amortization of premises and equipment, net			306				259
Software amortization expense			141				145
Financing lease amortization expense			99				69
Amortization of premium and discount on investment securities, net			84				94
Accretion of deferred loan fees, net			(255	)			(259	)
Amortization of core deposit intangibles			83				85
Stock-based compensation (income) expense, net			(302	)			186
Restricted stock cash portion			-				(44	)
Origination of loans held for sale			(3,232	)			(2,556	)
Proceeds from sale of loans			4,053				1,960
Gain on sale of loans			(114	)			(37	)
Earnings on bank-owned life insurance			(107	)			(105	)
Deferred income tax			(308	)			295
Net gain on other real estate owned			-				(43	)
Increase in accrued interest receivable			(195	)			(200	)
Increase in accrued interest payable			63				192
Other, net			(1,277	)			(2,553	)
Net cash provided by operating activities			2,980				681
INVESTING ACTIVITIES
Investment securities available for sale:
Proceeds from repayments and maturities			2,779				3,799
Purchases			(5,252	)			(2,679	)
Increase in loans, net			(14,052	)			(12,616	)
Proceeds from the sale of other real estate owned			-				225
Purchase of premises and equipment			(184	)			(295	)
Purchase of restricted stock			(1,600	)			-
Net cash used in investing activities			(18,309	)			(11,566	)
FINANCING ACTIVITIES
Net (decrease) increase in deposits			(17,133	)			24,164
Increase in short-term borrowings, net			54,925				602
Net repayment of other borrowings			(88	)			(56	)
Proceeds from dividend reinvestment and purchase plan			-				196
Repurchase of treasury shares			(1,191	)			-
Cash dividends			(964	)			(909	)
Net cash provided by financing activities			35,549				23,997
Increase in cash and cash equivalents			20,220				13,112
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD			35,113				107,933
CASH AND CASH EQUIVALENTS AT END OF PERIOD		$	55,333			$	121,045

		Three Months Ended
		March 31,
		2020				2019
SUPPLEMENTAL INFORMATION
Cash paid during the year for:
Interest on deposits and borrowings		$	2,913			$	3,062
Noncash operating transactions:
Operating lease assets added to other, net		$	-			$	(2,101	)
Operating lease liabilities added to other, net			-				2,101
Noncash investing transactions:
Transfers from loans to other real estate owned		$	301			$	38
Finance lease assets added to premises and equipment			-				(2,771	)
Noncash financing transactions:
Finance lease liabilities added to borrowed funds		$	-			$	2,771

 

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, 2019.  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 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. 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. In November 2019, the FASB issued ASU 2019-10, Financial Instruments ‒ Credit Losses (Topic 326), Derivatives and Hedging (Topic 815), and Leases (Topic 842). This Update defers the effective date of ASU 2016-13 for SEC filers that are eligible to be smaller reporting companies, non-SEC filers, and all other companies, to fiscal years beginning after December 15, 2022, including interim periods within those fiscal years. Management will continue to monitor model output throughout the deferral period.

 

In November 2019, the FASB issued ASU 2019-11, Codification Improvements to Topic 326, Financial Instruments – Credit Losses, to clarify its new credit impairment guidance in ASC 326, based on implementation issues raised by stakeholders. This Update clarified, among other things, that expected recoveries are to be included in the allowance for credit losses for these financial assets; an accounting policy election can be made to adjust the effective interest rate for existing troubled debt restructurings based on the prepayment assumptions instead of the prepayment assumptions applicable immediately prior to the restructuring event; and extends the practical expedient to exclude accrued interest receivable from all additional relevant disclosures involving amortized cost basis. The effective dates in this Update are the same as those applicable for ASU 2019-10. The Company is currently evaluating the impact the adoption of the standard will have on the Company's financial position or results of operations.

 

In January 2020, the FASB issued ASU 2020-2, Financial Instruments – Credit Losses (Topic 326) and Leases (Topic 842): Amendments to SEC Paragraphs Pursuant to SEC Staff Accounting Bulletin No. 119 and Update to SEC Section on Effective Date Related to Accounting Standards Update No. 2016-02, Leases (Topic 842), February 2020, to add and amend SEC paragraphs in the Accounting Standards Codification to reflect the issuance of SEC Staff Accounting Bulletin No. 119, related to the new credit losses standard, and comments by the SEC staff related to the revised effective date of the new leases standard. This ASU is effective upon issuance. The Company is currently evaluating the impact the adoption of the standard will have on the Company's financial position or results of operations.

 

 

In March 2020, the FASB issued ASU 2020-3, Codification Improvements to Financial Instruments. This ASU was issued to improve and clarify various financial instruments topics, including the current expected credit losses (CECL) standard issued in 2016. The ASU includes seven issues that describe the areas of improvement and the related amendments to GAAP; they are intended to make the standards easier to understand and apply and to eliminate inconsistencies, and they are narrow in scope and are not expected to significantly change practice for most entities. Among its provisions, the ASU clarifies that all entities, other than public business entities that elected the fair value option, are required to provide certain fair value disclosures under ASC 825, Financial Instruments, in both interim and annual financial statements. It also clarifies that the contractual term of a net investment in a lease under Topic 842 should be the contractual term used to measure expected credit losses under Topic 326. Amendments related to ASU 2019-04 are effective for fiscal years beginning after December 15, 2019, including interim periods within those fiscal years. Early adoption is not permitted before an entity’s adoption of ASU 2016-01. Amendments related to ASU 2016-13 for entities that have not yet adopted that guidance are effective upon adoption of the amendments in ASU 2016-13. Early adoption is not permitted before an entity’s adoption of ASU 2016-13. Amendments related to ASU 2016-13 for entities that have adopted that guidance are effective for fiscal years beginning after December 15, 2019, including interim periods within those years. Other amendments are effective upon issuance of this ASU. The Company is currently evaluating the impact the adoption of the standard will have on the Company's financial position or results of operations.

 

Reclassification of Comparative Amounts

 

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

 

 

 

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 91.8% of the total revenue of the Company.

 

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

 

Service charges on deposit accounts – The Company has contracts with its deposit customers where fees are charged if the account balance falls below predetermined levels defined as compensating balances. 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 for the three months ended March 31,

 

 

(a) Not within scope of ASC 606

 

 

 

NOTE 3 - STOCK-BASED COMPENSATION

 

The Company had no nonvested stock options outstanding as of March 31, 2020 and 2019.

 

Stock option activity during the three months ended March 31, 2020 is as follows:

 

 

The following table presents the activity during the three months ended March 31, 2020 related to awards of restricted stock:

 

 

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

 

Share-based compensation expense of ($408,000) and $90,000 was recognized for the three-month periods ended March 31, 2020 and 2019, respectively. The expense recorded as of March 31, 2020 is the result of the decrease in the market valuations of the plans. Vesting of shares under the plan is contingent on a combination of service period and a performance condition tied to the total shareholder return on the Company’s stock. Due to the change in market conditions during the quarter ended March 31, 2020, there was a significant decrease in the probability of the achievement of the performance condition which resulted in a decrease in the liability related to the Plan and a reversal of compensation expense. 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 $287,000 and $236,000 at March 31, 2020 and 2019, 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 March 31, 2020 totals $219,000, of which $94,000 is estimated for the rest of 2020, $88,000 for 2021, $34,000 for 2022, and $4,000 for 2023.

 

 

 

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 13,500 shares of common stock at $8.78 per share, were outstanding during the three months ended March 31, 2020. Also outstanding were 84,688 shares of restricted stock. None of the outstanding options or restricted stock were anti-dilutive.

 

Options to purchase 14,900 shares of common stock at $8.78 per share, were outstanding during the three months ended March 31, 2019. Also outstanding were 61,334 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. The reserve for the Company’s treasury shares comprises the cost of the Company’s shares held by the Company. As of March 31, 2020, the Company held 929,362 of the Company’s shares, which is an increase of 58,200 for the three months ended March 31, 2020, from the 871,162 shares held as of December 31, 2019.

 

 

 

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 three months ended March 31, 2020.

 

 

 

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 $2.1 million as of March 31, 2020 and December 31, 2019, 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 months ended March 31, 2020 and 2019, respectively:

 

 

(a)

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

 

There were no other reclassifications of amounts from accumulated other comprehensive income (loss) for the three months ended March 31, 2020 and 2019.

 

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 ($160,000) and $58,000, respectively, for the three months ended March 31, 2020 and 2019. No net gains or losses on sold equity securities were realized during these periods.

 

The amortized cost and fair value of debt securities at March 31, 2020, 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.

 

 

There were no securities sold during the three months ended March 31, 2020 and 2019, respectively.

 

Investment securities with an approximate carrying value of $53.1 million and $55.6 million at March 31, 2020 and December 31, 2019, 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 86 securities considered temporarily impaired at March 31, 2020.

 

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 March 31, 2020 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 three months ended March 31, 2020 and 2019, 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 March 31, 2020 or December 31, 2019 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.

 

NOTE 8 - LOANS AND RELATED ALLOWANCE FOR LOAN AND LEASE LOSSES

 

The Company’s primary business activity is with customers located within its local Northeastern Ohio trade area, eastern Geauga County, and contiguous counties. The Company also serves the central Ohio market with offices in Dublin, Sunbury, Westerville, Powell, and Plain City, Ohio. Commercial, residential, consumer, and agricultural loans are granted. Although the Company has a diversified loan portfolio, loans outstanding to individuals and businesses are dependent upon the local economic conditions in the Company’s immediate trade area.

 

Loans that management has the intent and ability to hold for the foreseeable future or until maturity or payoff generally are reported at their outstanding unpaid principal balances net of the allowance for loan and lease losses. Interest income is recognized on the accrual method. The accrual of interest is discontinued on a loan when management believes, after considering economic and business conditions, the borrower’s financial condition is such that collection of interest is doubtful. Interest payments received on nonaccrual loans are applied against the unpaid principal balance until accrual status is restored.

 

Loan origination fees and certain direct loan origination costs are deferred with the net amount amortized over the contractual life of the loan as an adjustment of the related loan’s yield.

 

 

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

 

 

 

The amounts above include net deferred loan origination costs of $1.3 million at March 31, 2020 and December 31, 2019.

 

 

 

 

The Company’s loan portfolio is segmented to a level that allows management to monitor risk and performance. The portfolio is segmented into Commercial Real Estate (“CRE”) which is further segmented into Owner Occupied (“CRE OO”), Non-owner Occupied (“CRE NOO”), and Multifamily Residential, Residential Real Estate (“RRE”), Commercial and Industrial (“C&I”), Home Equity Lines of Credit (“HELOC”), Construction and Other (“COO”), and Consumer Installment Loans. The commercial real estate loan segments consist of loans made for the purpose of financing the activities of commercial real estate owners and operators. The residential real estate and HELOC loan segments consist of loans made for the purpose of financing the activities of residential homeowners. The C&I loan segment consists of loans made for the purpose of financing the activities of commercial customers. The consumer loan segment consists primarily of installment loans and overdraft lines of credit connected with customer deposit accounts. The increases in the allowance for loan loss for the Commercial Real Estate, Residential Real Estate, C&I, HELOC, and Construction and other portfolios were partially offset by a decrease in the allowance for the Consumer Installment portfolios.

 

Management evaluates individual loans in all of the commercial segments for possible impairment based on guidance established by the Board of Directors. Loans are considered to be impaired when, based on current information and events, it is probable that the Company will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement.  Factors considered by management in evaluating impairment include payment status, collateral value, and the probability of collecting scheduled principal and interest payments when due. Management determines the significance of payment delays and payment shortfalls on a case-by-case basis, taking into consideration all of the circumstances surrounding the loan and the borrower, including the length of the delay, the reasons for the delay, the borrower’s prior payment record, and the amount of the shortfall in relation to the principal and interest owed. The Company does not separately evaluate individual consumer and residential mortgage loans for impairment, unless such loans are part of a larger relationship that is impaired, or the loan was modified in a troubled debt restructuring.

 

Once the determination has been made that a loan is impaired, the determination of whether a specific allocation of the allowance is necessary is measured by comparing the recorded investment in the loan to the fair value of the loan using one of the following methods: (a) the present value of expected future cash flows discounted at the loan’s effective interest rate; (b) the loan’s observable market price; or (c) the fair value of the collateral less selling costs. The method is selected on a loan-by-loan basis. The evaluation of the need and amount of a specific allocation of the allowance and whether a loan can be removed from impairment status is made on a quarterly basis. The Company’s policy for recognizing interest income on impaired loans does not differ from its overall policy for interest recognition.

 

 

The following tables present impaired loans by class, segregated by those for which a specific allowance was required and those for which a specific allowance was not necessary (in thousands):

 

 

 

 

The tables above include troubled debt restructuring totaling $3.6 million as of March 31, 2020 and December 31, 2019. The amounts allocated within the allowance for losses for troubled debt restructurings was $70,000 and $33,000 at March 31, 2020 and December 31, 2019, respectively.

 

 

The following tables present the average balance and interest income by class, recognized on impaired loans (in thousands):

 

 

Management uses a nine-point internal risk-rating system to monitor the credit quality of the overall loan portfolio. The first five categories are considered not criticized and are aggregated as Pass rated. The criticized rating categories utilized by management generally follow bank regulatory definitions. The Special Mention category includes assets that are currently protected but have potential weaknesses, resulting in an undue and unwarranted credit risk, but not to the point of justifying a Substandard classification. Loans in the Substandard category have well-defined weaknesses that jeopardize the liquidation of the debt and have a distinct possibility that some loss will be sustained if the weaknesses are not corrected. All loans greater than 90 days past due are considered Substandard. Any portion of a loan that has been charged off is placed in the Loss category.  

 

To help ensure that risk ratings are accurate and reflect the present and future capacity of borrowers to repay a loan as agreed, the Company has a structured loan-rating process with several layers of internal and external oversight. Generally, consumer and residential mortgage loans are included in the Pass categories unless a specific action, such as payment delinquency, bankruptcy, repossession, or death, occurs to raise awareness of a possible credit event.  The Company’s Commercial Loan Officers are responsible for the timely and accurate risk rating of the loans in their portfolios at origination and on an ongoing basis.  The Credit Department performs an annual review of all commercial relationships with loan balances of $500,000 or greater.  Confirmation of the appropriate risk grade is included in the review on an ongoing basis.  The Company engages an external consultant to conduct loan reviews on a semiannual basis. Generally, the external consultant reviews commercial relationships greater than $250,000 and criticized relationships greater than $150,000.  Detailed reviews, including plans for resolution, are performed on criticized loans on at least a quarterly basis.  Loans in the Special Mention and Substandard categories that are collectively evaluated for impairment are given separate consideration in the determination of the allowance.

 

The primary risk of commercial and industrial loans is related to deterioration in the cash flow of the business that may result in the liquidation of the business assets securing the loan. C&I loans are, by nature, secured by less substantial collateral than real estate-secured loans. The primary risk of real estate construction loans is potential delays and disputes during the completion process. The primary risk of residential real estate loans is current economic uncertainties along with the slow recovery in the housing market. The primary risk of commercial real estate loans is loss of income of the owner or occupier of the property and the inability of the market to sustain rent levels. Consumer installment loans historically have experienced higher delinquency rates. Consumer installments are typically secured by less substantial collateral than other types of credits.

 

 

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

 

 

 

Management further monitors the performance and credit quality of the loan portfolio by analyzing the age of the portfolio as determined by the length of time a recorded payment is past due.

 

Nonperforming assets are nonaccrual loans including nonaccrual troubled debt restructurings (“TDR”), loans 90 days or more past due, other real estate owned, and repossessed assets. A loan is classified as nonaccrual when, in the opinion of management, there are serious doubts about collectability of interest and principal. Accrual of interest is discontinued on a loan when management believes, after considering economic and business conditions, the borrower’s financial condition is such that collection of principal and interest is doubtful.  Payments received on nonaccrual loans are applied against the principal balance.

 

 

The following tables present the aging of the recorded investment in past-due loans by class of loans (in thousands):

 

 

 

The following tables present the recorded investment in nonaccrual loans and loans past due over 89 days and still on accrual by class of loans (in thousands):

 

 

 

 

Interest income that would have been recorded had these loans not been placed on nonaccrual status was $100,000 for the three months ended March 31, 2020 and $342,000 for the year ended December 31, 2019.

 

An allowance for loan and lease losses (“ALLL”) is maintained to absorb losses from the loan portfolio.  The ALLL is based on management’s continuing evaluation of the risk characteristics and credit quality of the loan portfolio, assessment of current economic conditions, diversification and size of the portfolio, adequacy of collateral, past and anticipated loss experience, and the amount of nonperforming loans.

 

The Company’s methodology for determining the ALLL is based on the requirements of ASC Section 310-10-35 for loans individually evaluated for impairment (discussed above) and ASC Subtopic 450-20 for loans collectively evaluated for impairment, as well as the Interagency Policy Statement on the Allowance for Loan and Lease Losses and other bank regulatory guidance. The total of the two components represents the Company’s ALLL. Management also performs impairment analyses on TDRs, which may result in specific reserves.

 

Loans that are collectively evaluated for impairment are analyzed with general allowances being made as appropriate.  For general allowances, historical loss trends are used in the estimation of losses in the current portfolio.  These historical loss amounts are modified by other qualitative factors.

 

The classes described above, which are based on the purpose code assigned to each loan, provide the starting point for the ALLL analysis.  Management tracks the historical net charge-off activity at the call code level. The historical charge-off factor was calculated using the last twelve consecutive historical quarters.

 

Management has identified a number of additional qualitative factors which it uses to supplement the historical charge-off factor because these factors are likely to cause estimated credit losses associated with the existing loan pools to differ from historical loss experience. The additional factors that are evaluated quarterly and updated using information obtained from internal, regulatory, and governmental sources are: national and local economic trends and conditions; levels of and trends in delinquency rates and nonaccrual loans; trends in volumes and terms of loans; effects of changes in lending policies; experience, ability, and depth of lending staff; value of underlying collateral; and concentrations of credit from a loan type, industry and geographic standpoint.

 

Management reviews the loan portfolio on a quarterly basis using a defined, consistently applied process in order to make appropriate and timely adjustments to the ALLL. When information confirms all or part of specific loans to be uncollectible, these amounts are promptly charged off against the ALLL.

 

 

The following tables summarize the primary segments of the loan portfolio and the activity within those segments (in thousands):

 

 

 

The provision fluctuations during the three-month period ended March 31, 2020 allocated to all loan categories are from an increase in qualitative factors, resulting in a $1.8 million increase, due to economic uncertainty. The provision also increased for the non-owner occupied portfolio because of the increase of a specific reserve for one relationship of $510,000 during the period.

 

The provision fluctuations during the three-month period ended March 31, 2019 allocated to:

●

commercial and industrial loans are due to the charge-off of a large relationship of $336,000 from a previous reserve of $358,000.

●

construction and other loans are due to the addition of a large loan requiring a reserve of $661,000.

●

owner occupied commercial real estate loans are due to the payoff of one relationship that had a previous reserve balance of $435,000.

 

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

 

●

reduction in the interest rate to below market rates

●

extension of repayment requirements beyond normal terms

●

reduction of the principal amount owed

●

reduction of accrued interest due

●

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

 

In each case, the concession is made due to deterioration in the borrower’s financial condition, and the new terms are less stringent than those required on a new loan with similar risk.

 

 

On April 7, 2020, federal banking regulators issued a revised interagency statement that included guidance on their approach for the accounting of loan modifications in light of the economic impact of the COVID-19 pandemic. The guidance interprets current accounting standards and indicates that a lender can conclude that a borrower is not experiencing financial difficulty if short-term modifications are made in response to COVID-19, such as payment deferrals, fee waivers, extensions of repayment terms, or other delays in payment that are insignificant related to the loans in which the borrower is less than 30 days past due on its contractual payments at the time a modification program is implemented. The agencies confirmed in working with the staff of the FASB that short-term modifications made on a good faith basis in response to COVID-19 to borrowers who were current prior to any relief are not TDRs.

 

The following tables summarize troubled debt restructurings (in thousands):

 

 

There were no troubled debt restructurings during the three months ended March 31, 2019. 

 

There were no subsequent defaults of troubled debt restructurings for the three months ended March 31, 2020 and March 31, 2019.