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.

 

On March 13, 2019, MBC established a wholly owned subsidiary named Middlefield Investments, Inc. (MII), headquartered in Middlefield, Ohio. This operating subsidiary exists to hold and manage a portion of MBC’s investment portfolio. At March 31, 2019, MII’s assets consist of one cash account. MII may only hold and manage investments for MBC, and may not engage in any other activity without prior approval of the Ohio Division of Financial Institutions. All significant inter-company items have been eliminated between MBC and this subsidiary.

 

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

 

Recently Adopted Accounting Pronouncements –

 

In February 2016, the FASB issued ASU 2016-02, Leases (Topic 842) . The standard requires lessees to recognize the assets and liabilities that arise from leases on the balance sheet. A lessee should recognize in the statement of financial position a liability to make lease payments (the lease liability) and a right-of-use asset representing its right to use the underlying asset for the lease term. A short-term lease is defined as one in which (a) the lease term is 12 months or less and (b) there is not an option to purchase the underlying asset that the lessee is reasonably certain to exercise. For short-term leases, lessees may elect to recognize lease payments over the lease term on a straight-line basis. For public business entities, the amendments in this Update are effective for fiscal years beginning after December 15, 2018, and interim periods within those years. For all other entities, the amendments in this Update are effective for fiscal years beginning after December 15, 2019, and for interim periods within fiscal years beginning after December 15, 2020. The amendments should be applied at the beginning of the earliest period presented using a modified retrospective approach with earlier application permitted as of the beginning of an interim or annual reporting period.  On January 1, 2019, the Company adopted ASU 2016-02 which resulted in the recording of finance lease assets and liabilities of $2.8 million and operating lease assets and liabilities of $2.1 million on the Consolidated Balance Sheet.  See Note 9 to the financial statements.

 

Recently Issued Accounting Pronouncements –

 

In June 2016, the FASB issued ASU 2016-13, Financial Instruments - Credit Losses: Measurement of Credit Losses on Financial Instruments (“CECL”) , which changes the impairment model for most financial assets. This Update is intended to improve financial reporting by requiring timelier recording of credit losses on loans and other financial instruments held by financial institutions and other organizations. The underlying premise of the Update is that financial assets measured at amortized cost should be presented at the net amount expected to be collected, through an allowance for credit losses that is deducted from the amortized cost basis. The allowance for credit losses should reflect management’s current estimate of credit losses that are expected to occur over the remaining life of a financial asset. The income statement will be effected for the measurement of credit losses for newly recognized financial assets, as well as the expected increases or decreases of expected credit losses that have taken place during the period. ASU 2016-13 is effective for annual and interim periods beginning after December 15, 2019, and early adoption is permitted for annual and interim periods beginning after December 15, 2018. With certain exceptions, transition to the new requirements will be through a cumulative effect adjustment to opening retained earnings as of the beginning of the first reporting period in which the guidance is adopted. The CECL model has been completed by the Company and runs concurrently with the existing incurred loss model each month.  Management continues monitoring model output, with final assumption changes expected to be made in the third quarter.  Management anticipates the model to be validated by a third-party by December 31, 2019.

 

 

 

NOTE 2 – REVENUE RECOGNITION

 

In accordance with ASC Topic 606, management determined that the primary sources of revenue, which emanate from interest income on loans and investments, along with noninterest revenue resulting from investment security gains, gains on the sale of loans, and BOLI income, are not within the scope of ASC 606. These revenue sources cumulatively comprise 92.0% 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 – 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:   

 

Noninterest Income		2019				2018
(Dollar amounts in thousands)
Service charges on deposit accounts:
Overdraft fees		$	248			$	193
ATM banking fees			194				201
Service charges and other fees			66				59
Gain on equity securities (a)			58				18
Earnings on bank-owned life insurance (a)			105				112
Gain on sale of loans (a)			37				4
Other income			402				199
Total noninterest income		$	1,110			$	786

 

(a) Not within scope of ASC 606

 

 

 

NOTE 3 - STOCK-BASED COMPENSATION

 

The Company had no unvested stock options outstanding as of March 31, 2019 and 2018.

 

Stock option activity during the three months ended March 31, 2019 is as follows:

 

						Weighted-
						average
						Exercise Price
		Shares				Per Share
Outstanding, January 1, 2019			7,450			$	17.55
Outstanding, March 31, 2019			7,450			$	17.55
Exercisable, March 31, 2019			7,450			$	17.55

 

 

The following table presents the activity during the three months ended March 31, 2019 related to awards of restricted stock:

 

						Weighted-
						average
						Grant Date Fair
		Units				Value Per Unit
Nonvested at January 1, 2019			21,072			$	41.96
Granted			14,565				41.90
Vested			(4,970	)			32.40
Nonvested at March 31, 2019			30,667			$	43.48
Expected to vest at March 31, 2019			20,715			$	41.22

 

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

 

Share-based compensation expense of $90,000 and $55,000 was recognized for the three-month periods ended March 31, 2019 and 2018, respectively. Since the shares of restricted stock are historically paid out at the vesting date in a combination of shares and cash, the Company has recorded a liability related to this plan which totals $236,000 and $426,000 at March 31, 2019 and 2018, respectively.

 

The expected remaining compensation expense that will be recognized on restricted stock totals $351,000, of which $113,000 will be recognized in 2019, $110,000 will be recognized in 2020, $110,000 will be recognized in 2021, and $18,000 will be recognized in 2022.

 

 

 

NOTE 4 - EARNINGS PER SHARE

 

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

 

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

 

		For the Three
		Months Ended
		March 31,
		2019				2018
Weighted-average common shares issued			3,635,304				3,606,427
Average treasury stock shares			(386,165	)			(386,165	)
Weighted-average common shares and common stock equivalents used to calculate basic earnings per share			3,249,139				3,220,262
Additional common stock equivalents (stock options and restricted stock) used to calculate diluted earnings per share			6,145				17,807
Weighted-average common shares and common stock equivalents used to calculate diluted earnings per share			3,255,284				3,238,069

 

Options to purchase 7,450 shares of common stock at $17.55 per share, were outstanding during the three months ended March 31, 2019. Also outstanding were 30,667 shares of restricted stock. None of the outstanding options or restricted stock were anti-dilutive.

 

Options to purchase 18,250 shares of common stock, at prices ranging from $17.55 to $23.00, were outstanding during the three months ended March 31, 2018. Also outstanding were 14,601 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.

 

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.

 

						March 31, 2019
(Dollar amounts in thousands)		Level I				Level II				Level III				Total
Assets measured on a recurring basis:
U.S. government agency securities		$	-			$	7,182			$	-			$	7,182
Obligations of states and political subdivisions			-				70,735				-				70,735
Mortgage-backed securities in government-sponsored entities			-				20,197				-				20,197
Total debt securities			-				98,114				-				98,114
Equity securities in financial institutions			674				-				-				674
Total		$	674			$	98,114			$	-			$	98,788

 

						December 31, 2018
(Dollar amounts in thousands)		Level I				Level II				Level III				Total
Assets measured on a recurring basis:
U.S. government agency securities		$	-			$	7,471			$	-			$	7,471
Obligations of states and political subdivisions			-				73,093				-				73,093
Mortgage-backed securities in government-sponsored entities			-				17,758				-				17,758
Total debt securities			-				98,322				-				98,322
Equity securities in financial institutions			616				-				-				616
Total		$	616			$	98,322			$	-			$	98,938

 

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.

 

 

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 three months ended March 31, 2019.

 

						March 31, 2019
(Dollar amounts in thousands)		Level I				Level II				Level III				Total
Assets measured on a non-recurring basis:
Impaired loans		$	-			$	-			$	4,604			$	4,604

 

						December 31, 2018
(Dollar amounts in thousands)		Level I				Level II				Level III				Total
Assets measured on a non-recurring basis:
Impaired loans		$	-			$	-			$	1,075			$	1,075

 

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 $1.8 million and $492,000 as of March 31, 2019 and December 31, 2018, respectively.

 

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

 

 

 

(1)

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

(2)

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

 

 

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

 

		March 31, 2019
		Carrying																Total
		Value				Level I				Level II				Level III				Fair Value
		(Dollar amounts in thousands)
Financial assets:
Cash and cash equivalents		$	121,045			$	121,045			$	-			$	-			$	121,045
Loans held for sale			1,230				-				1,230				-				1,230
Net loans			997,278				-				-				993,098				993,098
Bank-owned life insurance			16,185				16,185				-				-				16,185
Federal Home Loan Bank stock			3,679				3,679				-				-				3,679
Accrued interest receivable			3,833				3,833				-				-				3,833
Financial liabilities:
Deposits		$	1,040,231			$	664,874			$	-			$	375,132			$	1,040,006
Short-term borrowings			91,000				91,000				-				-				91,000
Other borrowings			11,518				-				-				11,550				11,550
Accrued interest payable			936				936				-				-				936

 

 

		December 31, 2018
		Carrying																Total
		Value				Level I				Level II				Level III				Fair Value
		(Dollar amounts in thousands)
Financial assets:
Cash and cash equivalents		$	107,933			$	107,933			$	-			$	-			$	107,933
Loans held for sale			597				-				597				-				597
Net loans			984,681				-				-				973,124				973,124
Bank-owned life insurance			16,080				16,080				-				-				16,080
Federal Home Loan Bank stock			3,679				3,679				-				-				3,679
Accrued interest receivable			3,633				3,633				-				-				3,633
Financial liabilities:
Deposits		$	1,016,067			$	715,153			$	-			$	298,891			$	1,014,044
Short-term borrowings			90,398				90,398				-				-				90,398
Other borrowings			8,803				-				-				8,827				8,827
Accrued interest payable			744				744				-				-				744

 

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

 

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, 2019 and 2018, respectively:

 

(Dollars in thousands)		Unrealized gains on available-for-sale securities (a)
Balance as of December 31, 2018		$	(154	)
Other comprehensive income			795
Balance at March 31, 2019		$	641
Balance as of December 31, 2017		$	1,091
Other comprehensive loss			(1,510	)
Change in accounting principle, ASC 2016-01 (b)			(141	)
Change in accounting principle, ASC 2018-02 (b)			187
Period change			(1,464	)
Balance at March 31, 2018		$	(373	)

 

(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.

 

There were no other reclassifications of amounts from accumulated other comprehensive income for the three months ended March 31, 2019 and 2018.

 

NOTE 7 – INVESTMENT AND EQUITY SECURITIES

 

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

 

		March 31, 2019
						Gross				Gross
		Amortized				Unrealized				Unrealized				Fair
(Dollar amounts in thousands)		Cost				Gains				Losses				Value
U.S. government agency securities		$	7,120			$	111			$	(49	)		$	7,182
Obligations of states and political subdivisions:
Taxable			501				8				-				509
Tax-exempt			69,233				1,057				(64	)			70,226
Mortgage-backed securities in government-sponsored entities			20,448				112				(363	)			20,197
Total		$	97,302			$	1,288			$	(476	)		$	98,114

 

 

		December 31, 2018
						Gross				Gross
		Amortized				Unrealized				Unrealized				Fair
(Dollar amounts in thousands)		Cost				Gains				Losses				Value
U.S. government agency securities		$	7,442			$	90			$	(61	)		$	7,471
Obligations of states and political subdivisions:
Taxable			502				10				-				512
Tax-exempt			72,387				667				(473	)			72,581
Mortgage-backed securities in government-sponsored entities			18,185				88				(515	)			17,758
Total		$	98,516			$	855			$	(1,049	)		$	98,322

 

The Company recognized net gains on equity investments of $58,000 and $18,000 for the three months ended March 31, 2019 and 2018, respectively. No net gains on sold equity securities were realized during this period.

 

The amortized cost and fair value of debt securities at March 31, 2019, by contractual maturity, are shown below. Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.

 

		Amortized				Fair
(Dollar amounts in thousands)		Cost				Value
Due in one year or less		$	6,479			$	6,519
Due after one year through five years			1,665				1,683
Due after five years through ten years			13,024				13,074
Due after ten years			76,134				76,838
Total		$	97,302			$	98,114

 

There were no securities sold during the three months ended March 31, 2019 and 2018, respectively.

 

Investment securities with an approximate carrying value of $59.5 million and $63.5 million at March 31, 2019 and December 31, 2018, respectively, were pledged to secure deposits and for other purposes as required by law.

 

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

 

		March 31, 2019
		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		$	-			$	-			$	2,927			$	(49	)		$	2,927			$	(49	)
Obligations of states and political subdivisions:
Tax-exempt			926				(4	)			7,954				(60	)			8,880				(64	)
Mortgage-backed securities in government-sponsored entities			2,063				(4	)			12,074				(359	)			14,137				(363	)
Total		$	2,989			$	(8	)		$	22,955			$	(468	)		$	25,944			$	(476	)

 

 

		December 31, 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		$	-			$	-			$	4,105			$	(61	)		$	4,105			$	(61	)
Obligations of states and political subdivisions:
Tax-exempt			20,451				(286	)			11,053				(187	)			31,504				(473	)
Mortgage-backed securities in government-sponsored entities			2,068				(9	)			12,257				(506	)			14,325				(515	)
Total		$	22,519			$	(295	)		$	27,415			$	(754	)		$	49,934			$	(1,049	)

 

There were 39 securities considered temporarily impaired at March 31, 2019.

 

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

 

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

 

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

 

Debt securities issued by U.S. government agencies, U.S. government-sponsored enterprises, and state and political subdivisions accounted for 100% of the total available-for-sale portfolio as of March 31, 2019 and no credit losses are expected, given the explicit and implicit guarantees provided by the U.S. federal government and the lack of prolonged unrealized loss positions within the obligations of the state and political subdivisions security portfolio. The Company considers the following factors in determining whether a credit loss exists and the period over which the debt security is expected to recover:

 

•

The length of time and the extent to which the fair value has been less than the amortized cost basis.

•

Changes in the near-term prospects of the underlying collateral of a security such as changes in default rates, loss severity given default and significant changes in prepayment assumptions;

•

The level of cash flows generated from the underlying collateral supporting the principal and interest payments of the debt securities; and,

•

Any adverse change to the credit conditions and liquidity of the issuer, taking into consideration the latest information available about the overall financial condition of the issuer, credit ratings, recent legislation and government actions affecting the issuer’s industry and actions taken by the issuer to deal with the present economic climate.

 

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

 

 

 

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

 

Major classifications of loans are summarized as follows (in thousands):

 

		March 31,				December 31,
		2019				2018
Commercial and industrial		$	85,756			$	83,857
Real estate - construction			58,019				56,731
Real estate - mortgage:
Residential			340,483				336,487
Commercial			504,289				498,247
Consumer installment			15,937				16,787
			1,004,484				992,109
Less: Allowance for loan and lease losses			(7,206	)			(7,428	)
Net loans		$	997,278			$	984,681

 

The amounts above include deferred loan origination costs of $1.4 million and $1.6 million at March 31, 2019 and December 31, 2018.

 

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, and Powell, 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):

 

										Real Estate - Mortgage
March 31, 2019		Commercial and industrial				Real estate- construction				Residential				Commercial				Consumer installment				Total
Loans:
Individually evaluated for impairment		$	1,825			$	3,239			$	1,856			$	9,049			$	2			$	15,971
Collectively evaluated for impairment			83,931				54,780				338,627				495,240				15,935				988,513
Total loans		$	85,756			$	58,019			$	340,483			$	504,289			$	15,937			$	1,004,484

 

										Real Estate - Mortgage
December 31, 2018		Commercial and industrial				Real estate- construction				Residential				Commercial				Consumer installment				Total
Loans:
Individually evaluated for impairment		$	2,570			$	-			$	1,970			$	9,533			$	2			$	14,075
Collectively evaluated for impairment			81,287				56,731				334,517				488,714				16,785				978,034
Total loans		$	83,857			$	56,731			$	336,487			$	498,247			$	16,787			$	992,109

 

										Real Estate - Mortgage
March 31, 2019		Commercial and industrial				Real estate- construction				Residential				Commercial				Consumer installment				Total
Allowance for loan and lease losses:
Ending allowance balance attributable to loans:
Individually evaluated for impairment		$	203			$	661			$	45			$	54			$	-			$	963
Collectively evaluated for impairment			383				87				1,578				4,107				88				6,243
Total ending allowance balance		$	586			$	748			$	1,623			$	4,161			$	88			$	7,206

 

										Real Estate - Mortgage
December 31, 2018		Commercial and industrial				Real estate- construction				Residential				Commercial				Consumer installment				Total
Allowance for loan and lease losses:
Ending allowance balance attributable to loans:
Individually evaluated for impairment		$	667			$	-			$	43			$	643			$	1			$	1,354
Collectively evaluated for impairment			302				100				1,538				4,008				126				6,074
Total ending allowance balance		$	969			$	100			$	1,581			$	4,651			$	127			$	7,428

 

The Company’s loan portfolio is segmented to a level that allows management to monitor risk and performance. The portfolio is segmented into Commercial and Industrial (“C&I”), Real Estate Construction, Real Estate - Mortgage which is further segmented into Residential and Commercial Real Estate (“CRE”), and Consumer Installment Loans. The C&I loan segment consists of loans made for the purpose of financing the activities of commercial customers. The residential mortgage loan segment consists of loans made for the purpose of financing the activities of residential homeowners. The commercial mortgage loan segment consists of loans made for the purpose of financing the activities of commercial real estate owners and operators. 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 C&I, Real Estate Construction, Residential, and CRE portfolios were partially offset by a decrease in the allowance for the Consumer Installment portfolio.

 

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, with management primarily utilizing the present value of expected cash flows. 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):

 

March 31, 2019
Impaired Loans
						Unpaid
		Recorded				Principal				Related
		Investment				Balance				Allowance
With no related allowance recorded:
Commercial and industrial		$	671			$	1,169			$	-
Real estate - mortgage:
Residential			1,496				1,660				-
Commercial			2,621				2,887				-
Consumer installment			2				2				-
Total		$	4,790			$	5,718			$	-
With an allowance recorded:
Commercial and industrial		$	1,154			$	1,365			$	203
Real estate - construction			3,239				3,239				661
Real estate - mortgage:
Residential			360				411				45
Commercial			6,428				6,446				54
Total		$	11,181			$	11,461			$	963
Total:
Commercial and industrial		$	1,825			$	2,534			$	203
Real estate - construction			3,239				3,239				661
Real estate - mortgage:
Residential			1,856				2,071				45
Commercial			9,049				9,333				54
Consumer installment			2				2				-
Total		$	15,971			$	17,179			$	963

 

 

December 31, 2018
Impaired Loans
						Unpaid
		Recorded				Principal				Related
		Investment				Balance				Allowance
With no related allowance recorded:
Commercial and industrial		$	207			$	413			$	-
Real estate - mortgage:
Residential			1,306				1,462				-
Commercial			1,867				2,186				-
Total		$	3,380			$	4,061			$	-
With an allowance recorded:
Commercial and industrial		$	2,363			$	3,013			$	667
Real estate - mortgage:
Residential			664				715				43
Commercial			7,666				7,676				643
Consumer installment			2				2				1
Total		$	10,695			$	11,406			$	1,354
Total:
Commercial and industrial		$	2,570			$	3,426			$	667
Real estate - mortgage:
Residential			1,970				2,177				43
Commercial			9,533				9,862				643
Consumer installment			2				2				1
Total		$	14,075			$	15,467			$	1,354

 

The tables above include troubled debt restructuring totaling $3.8 million as of March 31, 2019 and $4.4 million as of December 31, 2018.

 

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

 

		For the Three Months Ended March 31, 2019								For the Three Months Ended March 31, 2018
		Average Recorded Investment				Interest Income Recognized				Average Recorded Investment				Interest Income Recognized
Commercial and industrial		$	2,198			$	30			$	5,631			$	187
Real estate - construction			1,620				45				283				-
Real estate - mortgage:
Residential			1,913				12				2,892				21
Commercial			9,291				98				6,719				136
Consumer installment			2				-				4				-
Total		$	15,024			$	185			$	15,529			$	344

 

 

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 are potentially weak, 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 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/or criticized relationships greater than $125,000.  Detailed reviews, including plans for resolution, are performed on loans classified as Substandard on 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 value of collateral securing the loan should foreclosure become necessary. 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):

 

						Special												Total
March 31, 2019		Pass				Mention				Substandard				Doubtful				Loans
Commercial and industrial		$	80,203			$	3,204			$	2,349			$	-			$	85,756
Real estate - construction			53,458				1,322				3,239				-				58,019
Real estate - mortgage:
Residential			335,486				547				4,450				-				340,483
Commercial			489,289				6,744				8,256				-				504,289
Consumer installment			15,927				-				10				-				15,937
Total		$	974,363			$	11,817			$	18,304			$	-			$	1,004,484

 

						Special												Total
December 31, 2018		Pass				Mention				Substandard				Doubtful				Loans
Commercial and industrial		$	77,002			$	4,572			$	2,283			$	-			$	83,857
Real estate - construction			55,397				1,334				-				-				56,731
Real estate - mortgage:
Residential			332,475				553				3,459				-				336,487
Commercial			483,516				6,617				8,114				-				498,247
Consumer installment			16,776				-				11				-				16,787
Total		$	965,166			$	13,076			$	13,867			$	-			$	992,109

 

 

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 TDRs, loans 90 days or more past due, EMORECO assets, 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):

 

						30-59 Days				60-89 Days				90 Days+				Total				Total
March 31, 2019		Current				Past Due				Past Due				Past Due				Past Due				Loans
Commercial and industrial		$	85,157			$	279			$	73			$	247			$	599			$	85,756
Real estate - construction			54,515				265				3,239				-				3,504				58,019
Real estate - mortgage:
Residential			335,148				2,816				1,094				1,425				5,335				340,483
Commercial			502,895				499				422				473				1,394				504,289
Consumer installment			15,918				17				2				-				19				15,937
Total		$	993,633			$	3,876			$	4,830			$	2,145			$	10,851			$	1,004,484

 

						30-59 Days				60-89 Days				90 Days+				Total				Total
December 31, 2018		Current				Past Due				Past Due				Past Due				Past Due				Loans
Commercial and industrial		$	82,770			$	288			$	213			$	586			$	1,087			$	83,857
Real estate - construction			56,731				-				-				-				-				56,731
Real estate - mortgage:
Residential			331,379				2,612				1,083				1,413				5,108				336,487
Commercial			496,597				664				-				986				1,650				498,247
Consumer installment			16,768				19				-				-				19				16,787
Total		$	984,245			$	3,583			$	1,296			$	2,985			$	7,864			$	992,109

 

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

 

March 31, 2019		Nonaccrual				90+ Days Past Due and Accruing
Commercial and industrial		$	1,004			$	-
Real estate - construction			3,239				-
Real estate - mortgage:
Residential			3,844				-
Commercial			2,379				-
Consumer installment			6				-
Total		$	10,472			$	-

 

 

December 31, 2018		Nonaccrual				90+ Days Past Due and Accruing
Commercial and industrial		$	996			$	91
Real estate - construction			-				-
Real estate - mortgage:
Residential			2,731				754
Commercial			2,864				100
Consumer installment			4				-
Total		$	6,595			$	945

 

Interest income that would have been recorded had these loans not been placed on nonaccrual status was $91,000 for the three months ended March 31, 2019 and $456,000 for the year ended December 31, 2018.

 

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 purpose 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/or 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):

 

		Commercial and industrial				Real estate- construction				Real estate- residential mortgage				Real estate- commercial mortgage				Consumer installment				Total
ALLL balance at December 31, 2018		$	969			$	100			$	1,581			$	4,651			$	127			$	7,428
Charge-offs			(347	)			-				(91	)			(32	)			(47	)			(517	)
Recoveries			16				23				14				1				1				55
Provision			(52	)			625				119				(459	)			7				240
ALLL balance at March 31, 2019		$	586			$	748			$	1,623			$	4,161			$	88			$	7,206

 

 

		Commercial and industrial				Real estate- construction				Real estate- residential mortgage				Real estate- commercial mortgage				Consumer installment				Total
ALLL balance at December 31, 2017		$	999			$	313			$	1,760			$	4,036			$	82			$	7,190
Charge-offs			(9	)			-				-				-				(4	)			(13	)
Recoveries			109				17				20				-				18				164
Provision			157				(238	)			2				287				2				210
ALLL balance at March 31, 2018		$	1,256			$	92			$	1,782			$	4,323			$	98			$	7,551

 

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.

●

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

●

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

 

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

 

		For the Three Months Ended
		March 31, 2018
		Number of Contracts												Pre-Modification				Post-Modification
Troubled Debt Restructurings		Term Modification				Other				Total				Outstanding Recorded Investment				Outstanding Recorded Investment
Commercial and industrial			2				-				2			$	6,977			$	6,977
Residential real estate			2				-				2				63				63

 

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, 2019 and March 31, 2018.