NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

United Community Financial Corp. (United Community or the Company) was incorporated under Ohio law in February 1998 by The Home Savings and Loan Company of Youngstown, Ohio (Home Savings) in connection with the conversion of Home Savings from an Ohio mutual savings and loan association to an Ohio capital stock savings association (the Conversion). Upon consummation of the Conversion on July 8, 1998, United Community became the unitary thrift holding company for Home Savings. Home Savings, a state-chartered savings bank, conducts business from its main office located in Youngstown, Ohio, 31 retail banking offices and loan production centers located throughout Ohio, western Pennsylvania and West Virginia.  On January 29, 2016, United Community acquired Forge Financial Services Inc. d/b/a James & Sons Insurance Company of Youngstown Ohio.  James & Sons Insurance, a subsidiary of United Community, is engaged in the business of selling insurance including auto, commercial, homeowners and life-health insurance.

The accompanying consolidated financial statements of United Community have been prepared in accordance with instructions relating to Form 10-Q. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles (U.S. GAAP) for complete financial statements. However, such information reflects all adjustments (consisting solely of normal recurring adjustments) that are, in the opinion of management, necessary for a fair statement of results for the interim periods.

The results of operations for the three and nine months ended September 30, 2016, are not necessarily indicative of the results to be expected for the year ending December 31, 2016. The consolidated financial statements and notes thereto should be read in conjunction with the audited financial statements and notes contained in United Community’s Form 10-K for the year ended December 31, 2015.

The consolidated financial statements include the accounts of United Community and its subsidiaries.  All material inter-company transactions have been eliminated.  Some items in the prior year financial statements were reclassified to conform to the current presentation. These reclassifications had no effect on prior year consolidated statements of operations or shareholders’ equity.

In May 2014, FASB issued ASU 2014-09, Revenue from Contracts with Customers (Topic 606) . The ASU creates a new topic, Topic 606, to provide guidance on revenue recognition for entities that enter into contracts with customers to transfer goods or services or enter into contracts for the transfer of nonfinancial assets. The core principle of the guidance is that an entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. Additional disclosures are required to provide quantitative and qualitative information regarding the nature, amount, timing, and uncertainty of revenue and cash flows arising from contracts with customers. The new guidance is effective for annual reporting periods, and interim reporting periods within those annual periods, beginning after December 15, 2017. Early adoption is not permitted. Management is currently evaluating the impact of the adoption of this guidance on the Company’s consolidated financial statements.

In February 2015, the FASB issued ASU 2015-02, Consolidation (Topic 810): Amendments to the Consolidation Analysis. The ASU amends the current consolidation guidance and affects both the variable interest entity and voting interest entity consolidation models. The new guidance is effective for annual reporting periods and interim reporting periods within those annual periods, beginning after December 15, 2015. Early adoption is permitted. The adoption of this guidance as of January 1, 2016 did not have an impact on the Company’s consolidated financial statements.

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In January 2016, the FASB issued ASU 2016-1 , Financial Instruments – Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities. ASU 2016-1, among other things, (i) requires equity investments, with certain exceptions, to be measured at fair value with changes in fair value recognized in net income, (ii) simplifies the impairment assessment of equity investments without readily determinable fair valu es by requiring a qualitative assessment to identify impairment, (iii) eliminates the requirement for public business entities to disclose the methods and significant assumptions used to estimate the fair value that is required to be disclosed for financia l instruments measured at amortized cost on the balance sheet, (iv) requires public business entities to use the exit price notion when measuring the fair value of financial instruments for disclosure purposes, (v) requires an entity to present separately in other comprehensive income the portion of the total change in the fair value of a liability resulting from a change in the instrument-specific credit risk when the entity has elected to measure the liability at fair value in accordance with the fair val ue option for financial instruments, (vi) requires separate presentation of financial assets and financial liabilities by measurement category and form of financial asset on the balance sheet or the accompanying notes to the financial statements and (viii) clarifies that an entity should evaluate the need for a valuation allowance on a deferred tax asset related to available-for-sale. The new guidance is effective for annual reporting periods and interim reporting periods within those annual periods, beginn ing after December 15, 2017.  Management is currently evaluating the impact of the adoption of this guidance on the Company’s consolidated financial statements.

In February 2016, the FASB issued ASU 2016-02 - Leases (Topic 842) . The ASU will require all organizations that lease assets to recognize on the balance sheet the assets and liabilities for the rights and obligations created by those leases. Additional qualitative and quantitative disclosures will be required so that users can understand more about the nature of an entity’s leasing activities. The new guidance is effective for annual reporting periods and interim reporting periods within those annual periods, beginning after December 15, 2018. Early adoption is permitted. Management is currently evaluating the impact of the adoption of this guidance on the Company’s consolidated financial statements.

In March 2016, the FASB issued ASU 2016-09, Improvements to Employee Share-Based Payment Accounting, which amends ASC Topic 718, Compensation - Stock Compensation. The ASU includes provisions intended to simplify various aspects related to how share-based payments are accounted for and presented in the financial statements.  Key provisions include the elimination of “windfall pools” and removes the requirement to delay recognition of a windfall tax benefit until it reduces current taxes payable.  Additionally, the simplification permits entities to withhold an amount up to the employees’ maximum individual tax rate in the relevant jurisdiction without resulting in a liability classification of the award.  Entities are now permitted to make accounting policy elections for the impact of forfeitures on the recognition of expense for share-based payment awards.  Lastly, there are two provisions that are only available to companies that are nonpublic business entities, as defined in ASC 718: (i) a practical expedient for determining the expected term of certain share-based awards, which would be adopted prospectively, and (ii) a one-time opportunity to change its measurement basis for all liability-classified awards to intrinsic value upon adoption of the ASU.  The new guidance is effective for public business entities for annual reporting periods beginning after December 15, 2016, and interim periods within that reporting period.  For all other entities, it is effective for annual periods beginning after December 17, 2017, and interim periods within annual periods after December 15, 2018.  Early adoption is permitted in any interim or annual period, with adjustments reflected as of the beginning of the fiscal year of adoption.  Management has elected not to early-adopt this ASU and is evaluating the impact of the adoption of this guidance on the Company’s consolidated financial statements.     

In June 2016, FASB Issued ASU 2016-13, Financial Instruments—Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments.   This ASU adds a new Topic 326 to the Codification and removes the thresholds that companies apply to measure credit losses on financial instruments measured at amortized cost, such as loans, receivables, and held-to-maturity debt securities. Under current U.S. GAAP, companies generally recognize credit losses when it is probable that the loss has been incurred. The revised guidance will remove all recognition thresholds and will require companies to recognize an allowance for credit losses for the difference between the amortized cost basis of a financial instrument and the amount of amortized cost that the company expects to collect over the instrument’s contractual life. ASU 2016-13 also amends the credit loss measurement guidance for available-for-sale debt securities and beneficial interests in securitized financial assets. The guidance in ASU 2016-13 is effective for “public business entities,” as defined, that are SEC filers for fiscal years and for interim periods with those fiscal years beginning after December 15, 2019. For all other public business entities, the guidance is effective for fiscal years and for interim periods with those fiscal years beginning after December 15, 2020. All other entities, including not-for-profit entities and employee benefit plans within the scope of ASC 960 through 965 on plan accounting, will be required to adopt the guidance in ASU 2016-13 for fiscal years beginning after December 15, 2020 and for interim periods within fiscal years beginning after December 15, 2021. Early adoption of the guidance is permitted for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. Management is currently evaluating the impact of the adoption of this guidance on the Company’s consolidated financial statements.

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In August 2016, FASB issued ASU 2016-15, Statement of Cash Flows (Topic 230), Classi fication of C e rtain Cash Receipts and Cash Payments , which amends the guidance in ASC 230 on the classification of certain cash receipts and payments in the statement of cash flows. The primary purpose of the ASU is to reduce the diversity in practice that has resulted from the lack of consistent principles on this topic. The ASU’s amendments add or clarify guidance on eight cash flow issues:

For public business entities, the guidance in the ASU is effective for fiscal years beginning after December 15, 2017, including interim periods within those fiscal years. For all other entities, it is effective for fiscal years beginning after December 15, 2018, and interim periods within fiscal years beginning after December 15, 2019. Early adoption is permitted for all entities. Entities must apply the guidance retrospectively to all periods presented but may apply it prospectively from the earliest date practicable if retrospective application would be impracticable.   Management is currently evaluating the impact of the adoption of this guidance on the Company’s consolidated financial statements.

Stock Options:

On April 30, 2015, shareholders approved the United Community Financial Corp. 2015 Long Term Incentive Compensation Plan (the 2015 Plan). The purpose of the 2015 Plan is to provide a means through which United Community may attract and retain employees and non-employee directors, to provide incentives that align their interest with those of United Community’s shareholders and promote the success of United Community’s business.  All employees and non-employee directors are eligible to participate in the 2015 Plan.  The 2015 Plan provides for the issuance of up to 1,200,000 shares that are to be used for awards of stock options, stock awards, stock units, stock appreciation rights, annual bonus awards and long-term incentive awards.

On April 26, 2007, shareholders approved the United Community Financial Corp. 2007 Long-Term Incentive Plan (as amended, the 2007 Plan). The purpose of the 2007 Plan was to promote and advance the interests of United Community and its shareholders by enabling United Community to attract, retain and reward directors, directors emeritus, managerial and other key employees of United Community, including Home Savings, by facilitating their purchase of an ownership interest in United Community. The 2007 Plan was terminated on April 30, 2015 upon the adoption of the 2015 Plan, although the 2007 Plan survives so long as awards issued under the 2007 Plan remain outstanding and exercisable.  The 2007 Plan provided for the issuance of up to 2,000,000 shares that were to be used for awards of restricted stock, stock options, performance awards, stock appreciation rights (SARs), or other forms of stock-based incentive awards.

On July 12, 1999, shareholders approved the United Community Financial Corp. 1999 Long-Term Incentive Plan (as amended, the 1999 Plan). The purpose of the 1999 Plan was the same as the 2007 Plan. The 1999 Plan terminated on May 20, 2009, although the 1999 Plan survives so long as options issued under the 1999 Plan remain outstanding and exercisable. The 1999 Plan provided for the grant of either incentive or nonqualified stock options. Options were awarded at exercise prices that were not less than the fair market value of the share at the grant date. The maximum number of common shares that could be issued under the 1999 Plan was 3,569,766. Because the 1999 Plan terminated, no additional options may be issued under it.

There were no stock options granted in the three and nine months ended September 30, 2016 and there were 2,259 and 6,618 stock options granted in the three and nine months ended September 30, 2015, respectively. The options must be exercised within 10 years from the date of grant.  Expenses related to stock option grants are included with salaries and employee benefits. The Company recognized $2,000 and $8,000 in stock option expense for the three and nine months ended September 30, 2016, respectively.  The Company recognized $6,000 and $19,000 in stock option expense for the three and nine months ended September 30, 2015, respectively. The Company expects to recognize additional expense of $1,000 for the remainder of 2016, and $1,000 in 2017.

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A summary of activity in the plans is as follows:

Information related to the stock option plans for the nine months ended September 30, 2016 and 2015 follows:

As of September 30, 2016, the cost of nonvested stock options is expected to be recognized over a weighted-average period of 6 months.

The Company did not grant options during the three and nine months ended September 30, 2016.  The fair value of options granted during the three and nine months ended September 30, 2015 was determined using the following weighted-average assumptions as of the grant date:

Outstanding stock options at September 30, 2016 have a weighted average remaining life of 3.60 years and may be exercised in the range of $1.20 to $5.89.

Restricted Stock Awards:

The 2007 Plan permitted and the 2015 Plan permits the issuance of restricted stock awards to employees and nonemployee directors. Nonvested shares at September 30, 2016 aggregated 343,178, of which 9,976 will vest during the remainder of 2016, 142,003 will vest in 2017, 97,928 will vest in 2018 and 93,271 will vest in 2019. Expenses related to restricted stock awards are charged to salaries and employee benefits and are recognized over the vesting period of the awards based on the fair value of the shares at the grant date. The Company recognized approximately $254,000 and $716,000 in restricted stock award expenses for the three and nine months ended September 30, 2016, respectively. The Company recognized approximately $183,000 and $549,000 in restricted stock award expense for the three and nine months ended September 30, 2015, respectively.  The Company expects to recognize additional expenses of approximately $240,000 in 2016, $614,000 in 2017, $409,000 in 2018 and $136,000 in 2019.  The total average per share fair value of shares vested during the nine months ended September 30, 2016 was $5.87.

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A summary of changes in the Company’s nonvested restricted shares for the nine months ended September 30, 2016 is as follows:

Executive Incentive Plan

The Executive Incentive Plan (EIP) provides incentive compensation awards to certain officers of the Company. Executive incentive awards are generally based upon the actual performance of the Company and individual participant performance for the twelve months ending December 31, compared to the actual performance of a peer group during the same twelve month period. The target incentive awards for each year are measured as a percentage of the base salary of participating officers.  Once the awards under the EIP are calculated, they are paid 80% in cash and 20% in restricted stock. The restricted stock vests equally over three years, beginning on the first anniversary of the date the restricted stock is issued.  The Company incurred $96,000 and $265,000 in expense for the restricted stock portion of the EIP for the three and nine months ended September 30, 2016, respectively and $306,000 and $924,000 for the cash portion of the EIP for the three and nine months ended September 30, 2016, respectively.  The Company incurred $63,000 and $193,000 in expense for the restricted stock portion of the EIP for the three and nine months ended September 30, 2015 and $244,000 and $731,000 for the cash portion of the EIP for the three and nine months ended September 30, 2015, respectively.  Restricted stock expenses for the EIP are included in the total restricted stock expenses discussed above.  

Long-term Incentive Plan

The Long-term Incentive Plan (LTIP) provides a long-term incentive compensation opportunity to certain executive officers, whose participation and target award opportunities will be approved by the Compensation Committee of the Board of Directors. Each participant in the LTIP will be granted a target number of Performance Share Units (PSUs).  Target PSUs will be determined as a percentage of base salary and translated into share units based on the Company’s average stock price at the appropriate measurement date.  The performance period for the annual grant for a given year will be from January 1, year 1 through December 31, year 3.   The Company incurred $96,000 and $289,000 for the LTIP for the three and nine months ended September 30, 2016, respectively. The Company incurred $1,000 and $72,000 in expense for the LTIP for the three and nine months ended September 30, 2015, respectively.

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Components of held to maturity securities portfolio are as follows:

Debt securities available for sale by contractual maturity, repricing or expected call date are shown below:

Debt securities held to maturity by contractual maturity, repricing or expected call date are shown below: