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. All significant inter-company items have been eliminated.

 

The accompanying unaudited financial statements have been prepared in accordance with U.S. generally accepted accounting principles and the instructions for Form 10 -Q and Article 10 of Regulation S- X. In management’s opinion, the financial statements include all adjustments, consisting of normal recurring adjustments, that the Company considers necessary to fairly state the Company’s financial position and the results of operations and cash flows. The consolidated balance sheet at December 31, 2017, has been derived from the audited financial statements at that date but does not include all of the necessary informational disclosures and footnotes as required by U.S. generally accepted accounting principles. The accompanying financial statements should be read in conjunction with the financial statements and notes thereto included with the Company’s Form 10 -K for the year ended December 31, 2017. The results of the Company’s operations for any interim period are not necessarily indicative for the results of the Company’s operations for any other interim period or for a full fiscal year.

 

Recent Accounting Pronouncements –

 

In January 2016, the FASB issued ASU 2016 - 01, Financial Instruments – Overall (Subtopic 825 - 10 ): Recognition and Measurement of Financial Assets and Financial Liabilities . This Update applies to all entities that hold financial assets or owe financial liabilities and is intended to provide more useful information on the recognition, measurement, presentation, and disclosure of financial instruments. Among other things, this Update (a) requires equity investments (except those accounted for under the equity method of accounting or those that result in consolidation of the investee) to be measured at fair value with changes in fair value recognized in net income; (b) simplifies the impairment assessment of equity investments without readily determinable fair values by requiring a qualitative assessment to identify impairment; (c) eliminates the requirement to disclose the fair value of financial instruments measured at amortized cost for entities that are not public business entities; (d) eliminates the requirement for public business entities to disclose the method(s) and significant assumptions used to estimate the fair value that is required to be disclosed for financial instruments measured at amortized cost on the balance sheet; (e) requires public business entities to use the exit price notion when measuring the fair value of financial instruments for disclosure purposes; (f) requires separate presentation of financial assets and financial liabilities by measurement category and form of financial asset (that is, securities or loans and receivables) on the balance sheet or the accompanying notes to the financial statements; and (g) clarifies that an entity should evaluate the need for a valuation allowance on a deferred tax asset related to available-for-sale securities in combination with the entity’s other deferred tax assets. For public business entities, the amendments in this Update are effective for fiscal years beginning after December 15, 2017, including interim periods within those fiscal years. For all other entities, including not -for-profit entities and employee benefit plans within the scope of Topics 960 through 965 on plan accounting, the amendments in this Update are effective for fiscal years beginning after December 15, 2018, and interim periods within fiscal years beginning after December 15, 2019. All entities that are not public business entities may adopt the amendments in this Update earlier as of the fiscal years beginning after December 15, 2017, including interim periods within those fiscal years. In February 2018, the FASB issued ASU No. 2018 - 03 which includes technical corrections and improvements to clarify the guidance in ASU No. 2016 - 01. On January 1, 2018, the Company adopted ASU 2016 - 01 which resulted in a reclassification of $141,000 between accumulated other comprehensive income and retained earnings on the Consolidated Balance Sheet and Consolidated Statement of Changes in Stockholders’ Equity.

 

In February 2016, the FASB issued ASU 2016 - 02, Leases (Topic 842 ) . The standard requires lessees to recognize the assets and liabilities that arise from leases on the balance sheet. A lessee should recognize in the statement of financial position a liability to make lease payments (the lease liability) and a right-of-use asset representing its right to use the underlying asset for the lease term. A short-term lease is defined as one in which (a) the lease term is 12 months or less and (b) there is not an option to purchase the underlying asset that the lessee is reasonably certain to exercise. For short-term leases, lessees may elect to recognize lease payments over the lease term on a straight-line basis. For public business entities, the amendments in this Update are effective for fiscal years beginning after December 15, 2018, and interim periods within those years. For all other entities, the amendments in this Update are effective for fiscal years beginning after December 15, 2019, and for interim periods within fiscal years beginning after December 15, 2020. The amendments should be applied at the beginning of the earliest period presented using a modified retrospective approach with earlier application permitted as of the beginning of an interim or annual reporting period. The Company is currently assessing the practical expedients it may elect at adoption, but does not anticipate the amendments will have a significant impact on the financial statements. Based on the Company’s preliminary analysis of its current portfolio, the impact to the Company’s balance sheet is estimated to result in less than a 1 percent increase in assets and liabilities. The Company also anticipates additional disclosures to be provided at adoption.

 

 

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. Management is currently evaluating the impact of the adoption of this guidance on the Company’s consolidated financial statements. Management will oversee the implementation of CECL and is currently in the process of implementing a software solution to assist in the adoption of this ASU. Management plans to run the current incurred loss model and the CECL model concurrently for 12 months prior to the adoption of this guidance on January 1, 2020.

 

In February 2018, the FASB issued ASU 2018 - 02, Income Statement – Reporting Comprehensive Income (Topic 220 ) , to allow a reclassification from accumulated other comprehensive income to retained earnings for stranded tax effects resulting from the Tax Cuts and Jobs Act. Consequently, the amendments eliminate the stranded tax effects resulting from the Tax Cuts and Jobs Act and will improve the usefulness of information reported to financial statement users. The amendments in this Update are effective for all entities for fiscal years beginning after December 15, 2018, and interim periods within those fiscal years. Early adoption of the amendments in this Update is permitted, including adoption in any interim period, ( 1 ) for public business entities for reporting periods for which financial statements have not yet been issued and ( 2 ) for all other entities for reporting periods for which financial statements have not yet been made available for issuance. The amendments in this Update should be applied either in the period of adoption or retrospectively to each period (or periods) in which the effect of the change in the U.S. federal corporate income tax rate in the Tax Cuts and Jobs Act is recognized. On January 1, 2018, the Company adopted this standard which resulted in a reclassification of $187,000 between accumulated other comprehensive income and retained earnings on the Consolidated Balance Sheet and Consolidated Statement of Changes in Stockholders’ Equity.

 

In February 2018, the FASB issued ASU 2018 - 03, Technical Corrections and Improvements to Financial Instruments—Overall (Subtopic 825 - 10 ) Recognition and Measurement of Financial Assets and Financial Liabilities , to clarify certain aspects of the guidance issued in ASU 2016 - 01. ( 1 ) An entity measuring an equity security using the measurement alternative may change its measurement approach to a fair value method in accordance with Topic 820, Fair Value Measurement, through an irrevocable election that would apply to that security and all identical or similar investments of the same issuer. Once an entity makes this election, the entity should measure all future purchases of identical or similar investments of the same issuer using a fair value method in accordance with Topic 820. ( 2 ) Adjustments made under the measurement alternative are intended to reflect the fair value of the security as of the date that the observable transaction for a similar security took place. ( 3 ) Remeasuring the entire value of forward contracts and purchased options is required when observable transactions occur on the underlying equity securities. ( 4 ) When the fair value option is elected for a financial liability, the guidance in paragraph 825 - 10 - 45 - 5 should be applied, regardless of whether the fair value option was elected under either Subtopic 815 - 15, Derivatives and Hedging—Embedded Derivatives, or 825 - 10, Financial Instruments—Overall. ( 5 ) Financial liabilities for which the fair value option is elected, the amount of change in fair value that relates to the instrument specific credit risk should first be measured in the currency of denomination when presented separately from the total change in fair value of the financial liability. Then, both components of the change in the fair value of the liability should be remeasured into the functional currency of the reporting entity using end-of-period spot rates. ( 6 ) The prospective transition approach for equity securities without a readily determinable fair value in the amendments in Update 2016 - 01 is meant only for instances in which the measurement alternative is applied. An insurance entity subject to the guidance in Topic 944, Financial Services— Insurance, should apply a prospective transition method when applying the amendments related to equity securities without readily determinable fair values. An insurance entity should apply the selected prospective transition method consistently to the entity’s entire population of equity securities for which the measurement alternative is elected. For public business entities, the amendments in this Update are effective for fiscal years beginning after December 15, 2017, and interim periods within those fiscal years beginning after June 15, 2018. Public business entities with fiscal years beginning between December 15, 2017, and June 15, 2018, are not required to adopt these amendments until the interim period beginning after June 15, 2018, and public business entities with fiscal years beginning between June 15, 2018, and December 15, 2018, are not required to adopt these amendments before adopting the amendments in Update 2016 - 01. For all other entities, the effective date is the same as the effective date in Update 2016 - 01. All entities may early adopt these amendments for fiscal years beginning after December 15, 2017, including interim periods within those fiscal years, as long as they have adopted Update 2016 - 01. The Company is currently evaluating the impact the adoption of the standard will have on the Company’s financial position or results of operations.

 

 

ASU 2018 - 04, Investments – Debt Securities (Topic 320 ) and Regulated Operations (Topic 980 ) - Amendments to SEC Paragraphs Pursuant to SEC Staff Accounting Bulletin No. 117 and SEC Release No. 33 - 9273, ASU 2018 - 04 supersedes various SEC paragraphs and adds an SEC paragraph pursuant to the issuance of Staff Accounting Bulletin No. 117. This Update is not expected to have a significant impact on the Company’s financial statements.

 

In June 2018, the FASB issued ASU 2018 - 07, Compensation – Stock Compensation (Topic 718 ) , which simplified the accounting for nonemployee share-based payment transactions. The amendments in this update expand the scope of Topic 718 to include share-based payment transactions for acquiring goods and services from nonemployees. The amendments in this Update improve the following areas of nonemployee share-based payment accounting; (a) the overall measurement objective, (b) the measurement date, (c) awards with performance conditions, (d) classification reassessment of certain equity-classified awards, (e) calculated value (nonpublic entities only), and (f) intrinsic value (nonpublic entities only). The amendments in this Update are effective for public business entities for fiscal years beginning after December 15, 2018, including interim periods within that fiscal year. For all other entities, the amendments are effective for fiscal years beginning after December 15, 2019, and interim periods within fiscal years beginning after December 15, 2020. The Company is currently evaluating the impact the adoption of the standard will have on the Company’s financial position or results of operations.

 

ASU 2018 - 10, Codification Improvements to Topic 842, Leases , represents changes to clarify, correct errors in, or make minor improvements to the Codification. The amendments in this ASU affect the amendments in ASU 2016 - 02, which are not yet effective, but for which early adoption upon issuance is permitted. For entities that early adopted Topic 842, the amendments are effective upon issuance of this ASU, and the transition requirements are the same as those in Topic 842. For entities that have not adopted Topic 842, the effective date and transition requirements will be the same as the effective date and transition requirements in Topic 842. The Company is currently evaluating the impact the adoption of the standard will have on the Company’s financial position or results of operations.

 

NOTE 2 – REVENUE RECOGNITION

 

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

 

Management determined that the primary sources of revenue, which emanate from interest income on loans and investments, along with noninterest revenue resulting from investment security gains, gains on the sale of loans, and BOLI income, are not within the scope of ASC 606. As a result, no changes were made during the period related to these sources of revenue, which cumulatively comprise 93.1% 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 transactions or activities resulting from a customer request or activity that include overdraft fees, online banking fees, and other transaction fees. All of these fees are attributable to specific performance obligations of the Company where the revenue is recognized at a defined point in time, which is completion of the requested service/transaction.

 

Gains (losses) on sale of other real estate owned – Gains and losses are recognized at the completion of the property sale when the buyer obtains control of the real estate and all of the performance obligations of the Company have been satisfied. Evidence of the buyer obtaining control of the asset include transfer of the property title, physical possession of the asset, and the buyer obtaining control of the risks and rewards related to the asset. In situations where the Company agrees to provide financing to facilitate the sale, additional analysis is performed to ensure that the contract for sale identifies the buyer and seller, the asset to be transferred, payment terms, and that the contract has a true commercial substance and that collection of amounts due from the buyer is 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 June 30,								For the Six Months Ended June 30,
Noninterest Income		2018				2017				2018				2017
(Dollar amounts in thousands)
Service charges on deposit accounts:
Overdraft fees		$	197			$	182			$	390			$	374
ATM banking fees			214				205				415				319
Service charges and other fees			61				62				120				225
Investment securities gains on sale, net (a)			-				-				-				488
Equity securities, unrealized gains (a)			13				-				31				-
Earnings on bank-owned life insurance (a)			98				98				210				207
Gain on sale of loans (a)			117				231				121				465
Other income			305				211				504				422
Total noninterest income		$	1,005			$	989			$	1,791			$	2,500

 

(a) Not within scope of ASC 606

 

 

NOTE 3 - STOCK-BASED COMPENSATION

 

The Company had no unvested stock options outstanding as of June 30, 2018 and 2017.

 

Stock option activity during the six months ended June 30 is as follows:

 

						Weighted-
						average
		Shares				Exercise Price
		2018				Per Share
Outstanding, January 1			19,750			$	20.94
Exercised			(6,000	)			23.00
Outstanding, June 30			13,750			$	20.05
Exercisable, June 30			13,750			$	20.05

 

 

The following table presents the activity during the six months ended June 30, 2018 related to awards of restricted stock:

 

						Weighted-
						average
						Grant Date Fair
		Shares				Value Per Share
Nonvested at January 1, 2018			14,601			$	35.14
Granted			9,952				48.20
Forfeited			(223	)			35.31
Vested			(3,905	)			33.61
Nonvested at June 30, 2018			20,425			$	41.80
Expected to vest at June 30, 2018			10,473			$	35.71

 

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

 

Share-based compensation expense of $91,000 and $45,000 was recognized for the three -month periods ended June 30, 2018 and 2017, respectively. Share-based compensation expense of $136,000 and $90,000 was recognized for the six -month periods ended June 30, 2018 and 2017, respectively.

 

The expected remaining compensation expense that will be recognized on restricted stock totals $141,000, of which $70,000 will be recognized in 2018 and $71,000 will be recognized in 2019.

---

 

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.

 

		For the Three								For the Six
		Months Ended								Months Ended
		June 30,								June 30,
		2018				2017				2018				2017
Weighted-average common shares outstanding			3,611,891				3,386,616				3,609,174				3,227,184
Average treasury stock shares			(386,165	)			(386,165	)			(386,165	)			(386,165	)
Weighted-average common shares and common stock equivalents used to calculate basic earnings per share			3,225,726				3,000,451				3,223,009				2,841,019
Additional common stock equivalents (stock options and restricted stock) used to calculate diluted earnings per share			14,603				13,689				15,227				13,139
Weighted-average common shares and common stock equivalents used to calculate diluted earnings per share			3,240,329				3,014,140				3,238,236				2,854,158

 

Options to purchase 13,750 shares of common stock, at prices ranging from $17.55 to $23.00, were outstanding during the three and six months ended June 30, 2018. Also outstanding were 20,425 shares of restricted stock. None of the outstanding options or restricted stock were anti-dilutive.

 

Options to purchase 21,375 shares of common stock, at prices ranging from $17.55 to $37.48, were outstanding during the three and six months ended June 30, 2017. Also outstanding were 9,975 shares of restricted stock. None of the outstanding options or restricted stock were anti-dilutive.

 

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.

 

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.

 

						June 30, 2018
(Dollar amounts in thousands)		Level I				Level II				Level III				Total
Assets measured on a recurring basis:
U.S. government agency securities		$	-			$	7,988			$	-			$	7,988
Obligations of states and political subdivisions			-				75,397				-				75,397
Mortgage-backed securities in government-sponsored entities			-				16,643				-				16,643
Total debt securities			-				100,028				-				100,028
Equity securities in financial institutions			406				250				-				656
Total		$	406			$	100,278			$	-			$	100,684

 

						December 31, 2017
(Dollar amounts in thousands)		Level I				Level II				Level III				Total
Assets measured on a recurring basis:
U.S. government agency securities		$	-			$	8,719			$	-			$	8,719
Obligations of states and political subdivisions			-				67,429				-				67,429
Mortgage-backed securities in government-sponsored entities			-				18,510				-				18,510
Total debt securities			-				94,658				-				94,658
Equity securities in financial institutions			375				250				-				625
Total		$	375			$	94,908			$	-			$	95,283

 

Investment Securities Available for S ale - 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. Equity securities traded on inactive markets or valued by reference to similar instruments are generally categorized in Level II of the fair value hierarchy. Equity securities are carried at fair value through net income at June 30, 2018.

 

 

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 subsequent to the initial measurement. No such devaluation occurred in the six months ended June 30, 2018.

 

						June 30, 2018
(Dollar amounts in thousands)		Level I				Level II				Level III				Total
Assets measured on a non-recurring basis:
Impaired loans		$	-			$	-			$	1,134			$	1,134

 

						December 31, 2017
(Dollar amounts in thousands)		Level I				Level II				Level III				Total
Assets measured on a non-recurring basis:
Impaired loans		$	-			$	-			$	3,072			$	3,072
Other real estate owned			-				-				32				32

 

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 $419,000 at June 30, 2018.

 

Other Real Estate Owned (OREO) – OREO is carried at the lower of cost or fair value, which is measured at the date of foreclosure. If the fair value of the collateral exceeds the carrying amount of the loan, no charge-off or adjustment is necessary, the loan is not considered to be carried at fair value, and is therefore not included in the above table. If the fair value of the collateral is less than the carrying amount of the loan, management will charge the loan down to its estimated realizable value. The fair value of OREO is based on the appraised value of the property, which is generally unadjusted by management and is based on comparable sales for similar properties in the same geographic region as the subject property, and is included in the above table as a Level II measurement. 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. In these cases, the loans are categorized in the above table as a Level III measurement since these adjustments are considered to be unobservable inputs. Income and expenses from operations and further declines in the fair value of the collateral subsequent to foreclosure are included in net expenses from OREO.

 

 

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:

 

 

Quantitative Information about Level III Fair Value Measurements

(Dollar amounts in thousands)

Fair Value Estimate

Valuation Techniques

Unobservable Input

Range (Weighted Average)

December 31, 2017

Impaired loans

$

3,072

Appraisal of collateral (1)

Appraisal adjustments (2)

0%

to

86.1%

(13.8%)

Other real estate owned

$

32

Appraisal of collateral (1)

Appraisal adjustments (2)

0%

to

10.0%

 

( 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:

 

		June 30, 2018
		Carrying																Total
		Value				Level I				Level II				Level III				Fair Value
		(Dollar amounts in thousands)
Financial assets:
Cash and cash equivalents (1)		$	71,246			$	71,246			$	-			$	-			$	71,246
Loans held for sale			1,132				-				1,132				-				1,132
Net loans			936,172				-				-				925,076				925,076
Bank-owned life insurance (1)			15,862				15,862				-				-				15,862
Federal Home Loan Bank stock (1)			3,679				3,679				-				-				3,679
Accrued interest receivable (1)			3,295				3,295				-				-				3,295
Financial liabilities:
Deposits		$	932,246			$	641,887			$	-			$	287,358			$	929,245
Short-term borrowings (1)			87,833				87,833				-				-				87,833
Other borrowings			18,996				-				-				18,990				18,990
Accrued interest payable (1)			661				661				-				-				661

 

( 1 ) This financial instrument is carried at cost at June 30, 2018, which approximates the fair value of the instrument.

 

 

		December 31, 2017
		Carrying																Total
		Value				Level I				Level II				Level III				Fair Value
		(Dollar amounts in thousands)
Financial assets:
Cash and cash equivalents		$	39,886			$	39,886			$	-			$	-			$	39,886
Loans held for sale			463				-				463				-				463
Net loans			916,023				-				-				913,323				913,323
Bank-owned life insurance			15,652				15,652				-				-				15,652
Federal Home Loan Bank stock			3,589				3,589				-				-				3,589
Accrued interest receivable			3,288				3,288				-				-				3,288
Financial liabilities:
Deposits		$	878,194			$	635,207			$	-			$	242,020			$	877,227
Short-term borrowings			74,707				74,707				-				-				74,707
Other borrowings			29,065				-				-				29,069				29,069
Accrued interest payable			578				578				-				-				578

 

 

NOTE 6 – ACCUMULATED OTHER COMPREHENSIVE INCOME

 

The following tables present the changes in accumulated other comprehensive income (“AOCI”) by component net of tax for the three and six months ended June 30, 2018 and 2017, respectively:

 

(Dollars in thousands)		Unrealized gains on available-for-sale securities (a)
Balance as of March 31, 2018		$	(373	)
Other comprehensive loss before reclassification			(58	)
Balance at June 30, 2018		$	(431	)
Balance as of December 31, 2017		$	1,091
Other comprehensive loss before reclassification			(1,568	)
Change in accounting principle, ASC 2016-01 (b)			(141	)
Change in accounting principle, ASC 2018-02 (b)			187
Period change			(1,522	)
Balance at June 30, 2018		$	(431	)

 

 

(Dollars in thousands)		Unrealized gains on available-for-sale securities (a)
Balance as of March 31, 2017		$	1,032
Other comprehensive income before reclassification			783
Amount reclassified from accumulated other comprehensive income			-
Period change			783
Balance at June 30, 2017		$	1,815
Balance as of December 31, 2016		$	1,201
Other comprehensive income before reclassification			936
Amount reclassified from accumulated other comprehensive income			(322	)
Period change			614
Balance at June 30, 2017		$	1,815

 

(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:

 

		Amount Reclassified from Accumulated Other Comprehensive Income								Affected Line Item in the Statement Where
(Dollars in thousands)		For the Six Months Ended								Net Income is
Details about other comprehensive income		June 30, 2018				June 30, 2017				Presented
Unrealized gains on available-for-sale securities (a)		$	-			$	488			Investment securities gains on sale, net Income taxes
			-				(166	)
		$	-			$	322

 

(a)

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

 

There were no amounts reclassified to or from AOCI for the three months ended June 30, 2018 and June 30, 2017.

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NOTE 7 – INVESTMENT AND EQUITY SECURITIES

 

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

 

		June 30, 2018
						Gross				Gross
		Amortized				Unrealized				Unrealized				Fair
(Dollar amounts in thousands)		Cost				Gains				Losses				Value
U.S. government agency securities		$	8,052			$	43			$	(107	)		$	7,988
Obligations of states and political subdivisions:
Taxable			503				11				-				514
Tax-exempt			74,767				786				(670	)			74,883
Mortgage-backed securities in government-sponsored entities			17,249				44				(650	)			16,643
Total		$	100,571			$	884			$	(1,427	)		$	100,028

 

		December 31, 2017
						Gross				Gross
		Amortized				Unrealized				Unrealized				Fair
(Dollar amounts in thousands)		Cost				Gains				Losses				Value
U.S. government agency securities		$	8,664			$	126			$	(71	)		$	8,719
Obligations of states and political subdivisions:
Taxable			504				8				-				512
Tax-exempt			65,408				1,547				(38	)			66,917
Mortgage-backed securities in government-sponsored entities			18,640				157				(287	)			18,510
Total debt securities			93,216				1,838				(396	)			94,658
Equity securities in financial institutions			415				210				-				625
Total		$	93,631			$	2,048			$	(396	)		$	95,283

 

The Company held one equity investment without a readily determinable fair value at June 30, 2018. For both year-to-date and life-to-date, the equity had an amortized cost of $250,000, with no impairment or observable price changes.

 

The Company recognized net gains on equity investments of $13,000 and $31,000, respectively, for the three and six months ended June 30, 2018. No net gains on sold equity securities were realized during those periods.

 

 

The amortized cost and fair value of debt securities at June 30, 2018, by contractual maturity, are shown below. Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.

 

		Amortized				Fair
(Dollar amounts in thousands)		Cost				Value
Due in one year or less		$	5,676			$	5,729
Due after one year through five years			6,202				6,267
Due after five years through ten years			12,267				12,156
Due after ten years			76,426				75,876
Total		$	100,571			$	100,028

 

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

 

(Dollar amounts in thousands)		For the Three Months Ended June 30,								For the Six Months Ended June 30,
		2018				2017				2018				2017
Proceeds from sales		$	-			$	2,678			$	-			$	2,678
Gross realized gains			-				-				-				488	(1)
Gross realized losses			-				-				-				-

 

^{( 1 )} Prior to the acquisition of Liberty Bank, N.A., the Company held an equity interest in Liberty which was re-measured at fair value on the acquisition date and resulted in a gain of $488,000. This gain was recorded in Equity Securities, Unrealized Gains on the consolidated Income Statement for the six months ended June 30, 2017.

 

Investment securities with an approximate carrying value of $67.9 million and $57.9 million at June 30, 2018 and December 31, 2017, 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.

 

		June 30, 2018
		Less than Twelve Months								Twelve Months or Greater								Total
						Gross								Gross								Gross
		Fair				Unrealized				Fair				Unrealized				Fair				Unrealized
(Dollar amounts in thousands)		Value				Losses				Value				Losses				Value				Losses
U.S. government agency securities		$	495			$	(13	)		$	3,816			$	(94	)		$	4,311			$	(107	)
Obligations of states and political subdivisions:
Tax-exempt			27,247				(571	)			2,713				(99	)			29,960				(670	)
Mortgage-backed securities in government-sponsored entities			4,905				(209	)			8,520				(441	)			13,425				(650	)
Total		$	32,647			$	(793	)		$	15,049			$	(634	)		$	47,696			$	(1,427	)

 

 

		December 31, 2017
		Less than Twelve Months								Twelve Months or Greater								Total
						Gross								Gross								Gross
		Fair				Unrealized				Fair				Unrealized				Fair				Unrealized
(Dollar amounts in thousands)		Value				Losses				Value				Losses				Value				Losses
U.S. government agency securities		$	557			$	(4	)		$	4,036			$	(67	)		$	4,593			$	(71	)
Obligations of states and political subdivisions:
Tax-exempt			1,009				(6	)			2,784				(32	)			3,793				(38	)
Mortgage-backed securities in government-sponsored entities			5,698				(71	)			8,734				(216	)			14,432				(287	)
Total		$	7,264			$	(81	)		$	15,554			$	(315	)		$	22,818			$	(396	)

 

There were 87 securities considered temporarily impaired at June 30, 2018.

 

On a quarterly basis, the Company performs an assessment to determine whether there have been any events or economic circumstances indicating that a security with an unrealized loss has suffered other-than-temporary impairment (“OTTI”). A debt security is considered impaired if the fair value is less than its amortized cost basis at the reporting date. The 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 100% of the total available-for-sale portfolio as of June 30, 2018 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 six months ended June 30, 2018 and 2017, 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 June 30, 2018 or December 31, 2017 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.