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Section 1: 10-Q (10-Q 09302016)

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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
 
FORM 10-Q

x
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2016

o
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE  ACT OF 1934 FOR THE TRANSITION PERIOD FROM             TO             .

Commission file number: 000-32897

UNITED SECURITY BANCSHARES
(Exact name of registrant as specified in its charter)
 
CALIFORNIA
 
91-2112732
(State or other jurisdiction of incorporation or organization)
 
(I.R.S. Employer Identification No.)
 
 
 
2126 Inyo Street, Fresno, California
 
93721
(Address of principal executive offices)
 
(Zip Code)

Registrants telephone number, including area code    (559) 248-4943

Indicate by check mark whether the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes o  No  x
 
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing for the past 90 days. Yes x No

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x No o           

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Act).
 Large accelerated filer o
Accelerated filer o
Non-accelerated filer o
Small reporting company x
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes o  No  x

Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date.

Common Stock, no par value
(Title of Class)

Shares outstanding as of October 31, 2016: 16,540,185

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TABLE OF CONTENTS

Facing Page

Table of Contents


PART I. Financial Information
 
 
 
 
 
 
Item 1. Financial Statements
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
PART II. Other Information
 
 
Item 1.
 
Item 1A.
 
Item 2.
 
Item 3.
 
Item 4.
 
Item 5.
 
Item 6.
 
 
 
 

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Table of Contents

PART I. Financial Information


United Security Bancshares and Subsidiaries
Consolidated Balance Sheets – (unaudited)
September 30, 2016 and December 31, 2015
(in thousands except shares)
September 30, 2016
 
December 31, 2015
Assets
 
 
 
Cash and non-interest bearing deposits in other banks
$
29,156

 
$
29,733

Cash and due from Federal Reserve Bank
82,591

 
96,018

Cash and cash equivalents
111,747

 
125,751

Interest-bearing deposits in other banks
1,534

 
1,528

Investment securities available for sale (at fair value)
60,388

 
30,893

Loans
559,599

 
515,318

Unearned fees and unamortized loan origination costs, net
1,052

 
58

Allowance for credit losses
(8,918
)
 
(9,713
)
Net loans
551,733

 
505,663

Accrued interest receivable
3,581

 
2,220

Premises and equipment – net
10,225

 
10,800

Other real estate owned
7,065

 
12,873

Goodwill
4,488

 
4,488

Cash surrender value of life insurance
18,738

 
18,337

Investment in limited partnerships
792

 
917

Deferred tax assets - net
5,146

 
5,228

Other assets
6,155

 
6,946

Total assets
$
781,592

 
$
725,644

 
 
 
 
Liabilities & Shareholders' Equity
 

 
 

Liabilities
 

 
 

Deposits
 

 
 

Noninterest bearing
$
283,462

 
$
262,168

Interest bearing
387,824

 
359,637

Total deposits
671,286

 
621,805

 
 
 
 
Accrued interest payable
39

 
29

Accounts payable and other liabilities
6,420

 
5,875

Junior subordinated debentures (at fair value)
8,262

 
8,300

Total liabilities
686,007

 
636,009

 
 
 
 
Shareholders' Equity
 

 
 

Common stock, no par value 20,000,000 shares authorized, 16,540,185 issued and outstanding at September 30, 2016, and 16,051,406 at December 31, 2015
55,305

 
52,572

Retained earnings
40,390

 
37,265

Accumulated other comprehensive loss
(110
)
 
(202
)
Total shareholders' equity
95,585

 
89,635

Total liabilities and shareholders' equity
$
781,592

 
$
725,644


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United Security Bancshares and Subsidiaries
Consolidated Statements of Income
(Unaudited)
 
 
Quarter Ended September 30,
 
Nine Months Ended September 30,
(In thousands except shares and EPS)
2016
 
2015
 
2016
 
2015
Interest Income:
 
 
 
 
 
 
 
Loans, including fees
$
7,435

 
$
6,728

 
$
20,722

 
$
19,641

Investment securities – AFS – taxable
244

 
175

 
618

 
555

Interest on deposits in FRB
72

 
55

 
348

 
138

Interest on deposits in other banks
2

 
1

 
6

 
5

Total interest income
7,753

 
6,959

 
21,694

 
20,339

Interest Expense:
 

 
 

 
 

 
 

Interest on deposits
289

 
268

 
837

 
780

Interest on other borrowings
60

 
58

 
176

 
175

Total interest expense
349

 
326

 
1,013


955

Net Interest Income
7,404

 
6,633

 
20,681

 
19,384

Provision (Recovery of Provision) for Credit Losses
4

 
(23
)
 
(7
)
 
434

Net Interest Income after (Recovery of Provision) Provision for Credit Losses
7,400

 
6,656

 
20,688

 
18,950

Noninterest Income:
 

 
 

 
 

 
 

Customer service fees
924

 
963

 
2,867

 
2,661

Increase in cash surrender value of bank-owned life insurance
131

 
130

 
394

 
389

(Loss) gain on fair value of financial liability
(423
)
 
148

 
48

 
346

Gain on redemption of JR subordinated debentures

 
78

 

 
78

Loss on sale of investment in limited partnership

 
(23
)
 

 
(23
)
Other
154

 
153

 
464

 
463

Total noninterest income
786

 
1,449

 
3,773

 
3,914

Noninterest Expense:
 

 
 

 
 
 
 
Salaries and employee benefits
2,533

 
2,341

 
7,592

 
7,044

Occupancy expense
1,097

 
1,047

 
3,212

 
3,021

Data processing
23

 
29

 
108

 
90

Professional fees
327

 
277

 
1,116

 
877

Regulatory assessments
131

 
234

 
632

 
705

Director fees
75

 
78

 
218

 
202

Correspondent bank service charges
20

 
19

 
59

 
56

Loss (gain) on California tax credit partnership
49

 
(1
)
 
122

 
60

Net cost on operation of OREO
39

 
401

 
216

 
594

Other
570

 
589

 
1,713

 
1,755

Total noninterest expense
4,864

 
5,014

 
14,988

 
14,404

Income Before Provision for Taxes
3,322

 
3,091

 
9,473

 
8,460

Provision for Taxes on Income
1,282

 
1,205

 
3,643

 
3,283

Net Income
$
2,040

 
$
1,886

 
$
5,830

 
$
5,177


 
 
 
 
 
 
 
Net Income per common share
 

 
 

 
 
 
 
Basic
$
0.12

 
$
0.11

 
$
0.35

 
$
0.31

Diluted
$
0.12

 
$
0.11

 
$
0.35

 
$
0.31

Shares on which net income per common shares were based
 

 
 

 
 
 
 
Basic
16,538,605

 
16,537,697

 
16,538,019

 
16,537,697

Diluted
16,547,506

 
16,539,834

 
16,543,540

 
16,539,745


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United Security Bancshares and Subsidiaries
Consolidated Statements of Comprehensive Income
(Unaudited)

(In thousands)
Three Months Ended  
 September 30, 2016
 
Three Months Ended  
 September 30, 2015
 
Nine Months Ended 
 September 30, 2016
 
Nine Months Ended 
 September 30, 2015
Net Income
$
2,040

 
$
1,886

 
$
5,830

 
$
5,177

 
 
 
 
 
 
 
 
Unrealized holdings (losses) gains on securities
(190
)
 
189

 
118

 
(58
)
Unrealized gains on unrecognized post-retirement costs
13

 
19

 
37

 
55

Other comprehensive (loss) income, before tax
(177
)
 
208

 
155

 
(3
)
Tax benefit (expense) related to securities
76

 
(76
)
 
(47
)
 
23

Tax expense related to unrecognized post-retirement costs
(6
)
 
(8
)
 
(16
)
 
(23
)
Total other comprehensive (loss) income
(107
)
 
124

 
92

 
(3
)
Comprehensive income
$
1,933

 
$
2,010

 
$
5,922

 
$
5,174



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United Security Bancshares and Subsidiaries
Consolidated Statements of Changes in Shareholders' Equity
(unaudited)
 
Common stock
 
 
 
 
 
 
(In thousands except shares)
Number of Shares
 
Amount
 
Retained Earnings
 
Accumulated Other Comprehensive Loss
 
 Total
 
 
 
 
Balance December 31, 2014
15,425,086

 
$
49,271

 
$
33,730

 
$
(175
)
 
$
82,826

 
 
 
 
 
 
 
 
 
 
  Other comprehensive loss
 

 
 

 
 

 
(3
)
 
(3
)
Common stock dividends
467,402

 
2,435

 
(2,435
)
 
 

 

Stock-based compensation expense
 

 
20

 
 

 
 

 
20

Net income
 

 
 

 
5,177

 
 

 
5,177

Balance September 30, 2015
15,892,488

 
$
51,726

 
$
36,472

 
$
(178
)
 
$
88,020

 
 
 
 
 
 
 
 
 
 
Other comprehensive loss
 

 
 

 
 

 
(24
)
 
(24
)
Common stock dividends
158,918

 
840

 
(840
)
 
 

 

   Stock-based compensation expense
 

 
6

 
 

 
 

 
6

Net income
 

 
 

 
1,633

 
 

 
1,633

Balance December 31, 2015
16,051,406

 
$
52,572

 
$
37,265

 
$
(202
)
 
$
89,635

 
 
 
 
 
 
 
 
 
 
  Other comprehensive income
 

 
 

 
 

 
92

 
92

Common stock dividends
486,316

 
2,705

 
(2,705
)
 
 

 

Stock options exercised
2,463

 
6

 
 
 
 
 
6

Stock-based compensation expense
 

 
22

 
 

 
 

 
22

Net income
 

 
 

 
5,830

 
 

 
5,830

Balance September 30, 2016
16,540,185

 
$
55,305

 
$
40,390

 
$
(110
)
 
$
95,585



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United Security Bancshares and Subsidiaries
Consolidated Statements of Cash Flows (unaudited)
 
Nine months ended September 30,
(In thousands)
2016
 
2015
Cash Flows From Operating Activities:
 
 
 
Net Income
$
5,830

 
$
5,177

Adjustments to reconcile net income:to cash provided by operating activities:
 

 
 

(Recovery of provision) provision for credit losses
(7
)
 
434

Depreciation and amortization
1,091

 
1,101

Amortization of investment securities
335

 
205

Accretion of investment securities
(25
)
 
(24
)
Increase in accrued interest receivable
(1,361
)
 
(245
)
Increase (decrease) in accrued interest payable
10

 
(10
)
Decrease in accounts payable and accrued liabilities
(487
)
 
(165
)
Increase in unearned fees and unamortized loan origination costs, net
(994
)
 
(469
)
Decrease in income taxes receivable
2,512

 
1,181

Stock-based compensation expense
22

 
20

Benefit for deferred income taxes
20

 
142

Gain on sale of other real estate owned
(53
)
 
(17
)
Write down on other real estate owned

 
188

Increase in cash surrender value of bank-owned life insurance
(401
)
 
(389
)
Gain on fair value option of financial liabilities
(48
)
 
(346
)
Gain on redemption of Jr subordinated debentures

 
(78
)
Loss on tax credit limited partnership interest
122

 
60

Loss on sale of investment in limited partnership

 
23

Net increase in other assets
(541
)
 
(49
)
Net cash provided by operating activities
6,025

 
6,739

 
 
 
 
Cash Flows From Investing Activities:
 

 
 

Net increase in interest-bearing deposits with banks
(6
)
 
(4
)
Purchase of correspondent bank stock
(101
)
 
(147
)
Purchases of available-for-sale securities
(34,987
)
 

Maturities of available-for-sale securities
2,600

 
9,000

Principal payments of available-for-sale securities
2,700

 
4,639

Net increase in loans
(41,303
)
 
(57,456
)
Cash proceeds from sales of other real estate owned
2,800

 
1,192

Payoff of senior liens on other real estate owned
(705
)
 

Distributions from (investment in) limited partnership
2

 
(119
)
Capital expenditures of premises and equipment
(516
)
 
(495
)
Net cash used in investing activities
(69,516
)
 
(43,390
)
 
 
 
 
Cash Flows From Financing Activities:
 

 
 

Net increase in demand deposits and savings accounts
38,068

 
58,232

Net increase (decrease) in time deposits
11,413

 
(6,970
)
Redemption of Jr subordinated debentures

 
(1,800
)
Proceeds from exercise of stock options
6

 

Net cash provided by financing activities
49,487

 
49,462


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Net (decrease) increase in cash and cash equivalents
(14,004
)
 
12,811

Cash and cash equivalents at beginning of period
125,751

 
103,577

Cash and cash equivalents at end of period
$
111,747

 
$
116,388

 

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United Security Bancshares and Subsidiaries - Notes to Consolidated Financial Statements - (Unaudited)
 
1.
Organization and Summary of Significant Accounting and Reporting Policies
 
The consolidated financial statements include the accounts of United Security Bancshares, and its wholly owned subsidiary United Security Bank (the “Bank”) and two bank subsidiaries, USB Investment Trust (the “REIT”) and United Security Emerging Capital Fund (collectively the “Company” or “USB”). Intercompany accounts and transactions have been eliminated in consolidation.

These unaudited financial statements have been prepared in accordance with generally accepted accounting principles for interim financial information on a basis consistent with the accounting policies reflected in the audited financial statements of the Company included in its 2015 Annual Report on Form 10-K. These interim financial statements do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. In the opinion of management, all adjustments (consisting of a normal, recurring nature) considered necessary for a fair presentation have been included. Operating results for the interim periods presented are not necessarily indicative of the results that may be expected for any other interim period or for the year as a whole.

Recently Issued Accounting Standards:

In June 2016, FASB issued ASU 2016-13, Financial Instruments- Credit Losses (Topic 326). The FASB is issuing this Update 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 Update requires enhanced disclosures and judgments in estimating credit losses and also amends the accounting for credit losses on available-for-sale debt securities and purchased financial assets with credit deterioration. This amendment is effective for fiscal years beginning after December 15, 2019, including interim periods within those fiscal years. We are currently evaluating the impacts of this ASU on the consolidated financial statements.

In March 2016, FASB issued ASU 2016-09, Compensation-Stock Compensation (Topic 718). The Board is issuing this Update as part of its Simplification Initiative. The objective of the Simplification Initiative is to identify, evaluate, and improve areas of generally accepted accounting principles (GAAP) for which cost and complexity can be reduced while maintaining or improving the usefulness of the information provided to users of financial statements. The areas for simplification in this Update were identified through outreach for the Simplification Initiative, pre-agenda research for the Private Company Council, and the August 2014 Post-Implementation Review Report on FASB No. 123(R), Share-Based Payment. This ASU is effective for annual reporting periods beginning after December 15, 2016, including interim periods within those annual reporting periods. We are currently evaluating the impacts of this ASU on the consolidated financial statements.

In February 2016, FASB issued ASU 2016-02, Leases (Topic 842). The FASB is issuing this Update to increase transparency and comparability among organizations by recognizing lease assets and lease liabilities on the balance sheet and disclosing key information about leasing arrangements. To meet that objective, the FASB is amending the FASB Accounting Standards Codification® and creating Topic 842, Leases. This Update, along with IFRS 16, Leases, are the results of the FASB’s and the International Accounting Standards Board’s (IASB’s) efforts to meet that objective and improve financial reporting. This ASU will be effective for public business entities for annual periods beginning after December 15, 2018 (i.e., calendar periods beginning on January 1, 2019), and interim periods therein. We are currently evaluating the impacts of this ASU on the consolidated financial statements.

In January 2016, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) No. 2016-01 Financial Instruments-Overall: Recognition and Measurements of Financial Assets and Financial Liabilities. This ASU requires equity investments to be measured at fair value, with changes in fair value recognized in net income. The amendment also simplifies the impairment assessment of equity investments for which fair value is not readily determinable by requiring an entity to perform a qualitative assessment to identify impairment. The ASU is effective for fiscal years beginning after December 15, 2017, and interim periods therein. We are currently evaluating the impacts of this ASU on the consolidated financial statements. We are currently evaluating the impacts of this ASU on the consolidated financial statements, however, we believe the accounting and reporting for our mutual fund investments will be impacted.

In September 2015, FASB issued ASU 2015-16, Business Combinations (Topic 805) -Simplifying the Accounting for Measurement-Period Adjustments. GAAP requires that during the amendment period, the acquirer retrospectively adjust the provisional amounts recognized at the acquisition date with a corresponding adjustment to goodwill. Those adjustments are required when new information is obtained about facts and circumstances that existed as of the acquisition date that, if known, would have affected the measurement of the amounts initially recognized or would have resulted in the recognition of additional assets or liabilities. To simplify the accounting for adjustments made to provisional amounts recognized in a business

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combination, the amendments in this Update eliminate the requirement to retrospectively account for those adjustments. These amendments in this Update are effective for fiscal years beginning after December 15, 2015. The Company does not expect any impact on the Company's consolidated financial statements resulting from the adoption of the update.


2.
Investment Securities

Following is a comparison of the amortized cost and fair value of securities available-for-sale, as of September 30, 2016 and December 31, 2015:
(in 000's)
 Amortized Cost
 
Gross Unrealized Gains
 
Gross Unrealized Losses
 
Fair Value (Carrying Amount)
September 30, 2016
 
 
 
Securities available for sale:
 
 
 
U.S. Government agencies
$
23,671

 
$
331

 
$
(80
)
 
$
23,922

U.S. Government sponsored entities & agencies collateralized by mortgage obligations
32,318

 
315

 
(39
)
 
32,594

Mutual Funds
4,000

 

 
(128
)
 
3,872

Total securities available for sale
$
59,989

 
$
646

 
$
(247
)
 
$
60,388

(in 000's)
 Amortized Cost
 
Gross Unrealized Gains
 
Gross Unrealized Losses
 
Fair Value (Carrying Amount)
December 31, 2015
 
 
 
Securities available for sale:
 
 
 
U.S. Government agencies
$
9,778

 
$
453

 
$
(108
)
 
$
10,123

U.S. Government sponsored entities & agencies collateralized by mortgage obligations
16,835

 
175

 
(52
)
 
16,958

Mutual Funds
4,000

 

 
(188
)
 
3,812

Total securities available for sale
$
30,613

 
$
628

 
$
(348
)
 
$
30,893

 
The amortized cost and fair value of securities available for sale at September 30, 2016, by contractual maturity, are shown below. Actual maturities may differ from contractual maturities because issuers have the right to call or prepay obligations with or without call or prepayment penalties. Contractual maturities on collateralized mortgage obligations cannot be anticipated due to allowed paydowns. Mutual funds are included in the "due in one year or less" category below.
 
September 30, 2016
 
Amortized Cost
 
Fair Value (Carrying Amount)
(in 000's)
 
Due in one year or less
$
4,002

 
$
3,874

Due after one year through five years

 

Due after five years through ten years
886

 
903

Due after ten years
22,783

 
23,017

Collateralized mortgage obligations
32,318

 
32,594

 
$
59,989

 
$
60,388


There were no realized gains or losses on sales of available-for-sale securities for the three and nine month periods ended September 30, 2016 and September 30, 2015. There were no other-than-temporary impairment losses for the three and nine month periods ended September 30, 2016 and September 30, 2015.

At September 30, 2016, available-for-sale securities with an amortized cost of approximately $20,611,478 (fair value of $21,123,859) were pledged as collateral for FHLB borrowings and public funds balances.

The Company had no held-to-maturity or trading securities at September 30, 2016 or December 31, 2015.


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Management periodically evaluates each available-for-sale investment security in an unrealized loss position to determine if the impairment is temporary or other-than-temporary.

The following summarizes temporarily impaired investment securities:
(in 000's)
Less than 12 Months
 
12 Months or More
 
Total
September 30, 2016
Fair Value (Carrying Amount)
 
 Unrealized Losses
 
Fair Value (Carrying Amount)
 
 Unrealized Losses
 
Fair Value (Carrying Amount)
 
 Unrealized Losses
Securities available for sale:
 
 
 
 
 
U.S. Government agencies
$
12,502

 
$
(80
)
 

 

 
$
12,502

 
$
(80
)
U.S. Government sponsored entities & agencies collateralized by mortgage obligations
9,192

 
(39
)
 

 

 
9,192

 
(39
)
Mutual Funds

 

 
3,872

 
(128
)
 
3,872

 
(128
)
Total impaired securities
$
21,694

 
$
(119
)
 
$
3,872

 
$
(128
)
 
$
25,566

 
$
(247
)
 
 
 
 
 
 
 
 
 
 
 
 
December 31, 2015
 

 
 

 
 

 
 

 
 

 
 

Securities available for sale:
 

 
 

 
 

 
 

 
 

 
 

U.S. Government agencies
$
79

 
$
(108
)
 
$

 
$

 
$
79

 
$
(108
)
U.S. Government sponsored entities & agencies collateralized by mortgage obligations
9,913

 
(52
)
 

 

 
9,913

 
(52
)
Mutual Funds

 

 
3,812

 
(188
)
 
3,812

 
(188
)
Total impaired securities
$
9,992

 
$
(160
)
 
$
3,812

 
$
(188
)
 
$
13,804

 
$
(348
)
 
Temporarily impaired securities at September 30, 2016, were comprised of one mutual fund, four U.S. government agency securities, and three U.S. government sponsored entities and agencies collateralized by mortgage obligations securities.

The Company evaluates investment securities for other-than-temporary impairment (OTTI) at least quarterly, and more frequently when economic or market conditions warrant such an evaluation. The investment securities portfolio is evaluated for OTTI by segregating the portfolio into two general segments and applying the appropriate OTTI model. Investment securities classified as available-for-sale or held-to-maturity are generally evaluated for OTTI under ASC Topic 320, Investments – Debt and Equity Instruments. Certain purchased beneficial interests, including non-agency mortgage-backed securities, asset-backed securities, and collateralized debt obligations, are evaluated under ASC Topic 325-40, Beneficial Interest in Securitized Financial Assets.

In the first segment, the Company considers many factors in determining OTTI, including: (1) the length of time and the extent to which the fair value has been less than cost, (2) the financial condition and near-term prospects of the issuer, (3) whether the market decline was affected by macroeconomic conditions, and (4) whether the Company has the intent to sell the debt security or more likely than not will be required to sell the debt security before its anticipated recovery. The assessment of whether an other-than-temporary decline exists involves a high degree of subjectivity and judgment and is based on the information available to the Company at the time of the evaluation.
 
The second segment of the portfolio uses the OTTI guidance that is specific to purchased beneficial interests including private label mortgage-backed securities. Under this model, the Company compares the present value of the remaining cash flows as estimated at the preceding evaluation date to the current expected remaining cash flows. An OTTI is deemed to have occurred if there has been an adverse change in the remaining expected future cash flows.
 

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Additionally, other-than-temporary-impairment occurs when the Company intends to sell the security or more likely than not will be required to sell the security before recovery of its amortized cost basis less any current-period credit loss. If the Company intends to sell or more likely than not will be required to sell the security before recovery of its amortized cost basis less any current-period credit loss, the other-than-temporary-impairment shall be recognized in earnings equal to the entire difference between the investment’s amortized cost basis and its fair value at the balance sheet date. If the Company does not intend to sell the security and it is not more likely than not that the Company will be required to sell the security before recovery of its amortized cost basis less any current-period loss, the other-than-temporary-impairment shall be separated into the amount representing the credit loss and the amount related to all other factors. The amount of the total other-than-temporary-impairment related to the credit loss is recognized in earnings, and is determined based on the difference between the present value of cash flows expected to be collected and the current amortized cost of the security. The amount of the total other-than-temporary-impairment related to other factors shall be recognized in other comprehensive (loss) income, net of applicable taxes. The previous amortized cost basis less the other-than-temporary-impairment recognized in earnings shall become the new amortized cost basis of the investment.

At September 30, 2016, the decline in market value of the impaired mutual fund, the four U.S. government agency securities, and the three U.S. government sponsored entities and agencies collateralized by mortgage obligations securities is attributable to changes in interest rates, and not credit quality. Because the Company does not have the intent to sell these impaired securities, and it is not more likely than not that it will be required to sell these securities before its anticipated recovery, the Company does not consider these securities to be other-than-temporarily impaired at September 30, 2016.

3.
Loans

Loans are comprised of the following:
(in 000's)
September 30, 2016

 
December 31, 2015

Commercial and Business Loans
$
45,814

 
$
54,503

Government Program Loans
1,899

 
1,323

Total Commercial and Industrial
47,713

 
55,826

Real Estate – Mortgage:
 

 
 

Commercial Real Estate
197,533

 
182,554

Residential Mortgages
91,852

 
68,811

Home Improvement and Home Equity loans
627

 
867

Total Real Estate Mortgage
290,012

 
252,232

Real Estate Construction and Development
131,177

 
130,596

Agricultural
53,269

 
52,137

Installment
37,428

 
24,527

Total Loans
$
559,599

 
$
515,318

 
The Company's loans are predominantly in the San Joaquin Valley and the greater Oakhurst/East Madera County area, as well as the Campbell area of Santa Clara County. Although the Company does participate in loans with other financial institutions, they are primarily in the state of California.

Commercial and industrial loans represent 8.5% of total loans at September 30, 2016 and are generally made to support the ongoing operations of small-to-medium sized commercial businesses. Commercial and industrial loans have a high degree of industry diversification and provide working capital, financing for the purchase of manufacturing plants and equipment, or funding for growth and general expansion of businesses. A substantial portion of commercial and industrial loans are secured by accounts receivable, inventory, leases, or other collateral including real estate. The remainder are unsecured; however, extensions of credit are predicated upon the financial capacity of the borrower. Repayment of commercial loans is generally from the cash flow of the borrower.

Real estate mortgage loans, representing 51.8% of total loans at September 30, 2016, are secured by trust deeds on primarily commercial property, but are also secured by trust deeds on single family residences. Repayment of real estate mortgage loans generally comes from the cash flow of the borrower.

Commercial real estate mortgage loans comprise the largest segment of this loan category and are available on all types of income producing and commercial properties, including: office buildings, shopping centers; apartments

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and motels; owner occupied buildings; manufacturing facilities and more. Commercial real estate mortgage loans can also be used to refinance existing debt. Although real estate associated with the business is the primary collateral for commercial real estate mortgage loans, the underlying real estate is not the source of repayment. Commercial real estate loans are made under the premise that the loan will be repaid from the borrower's business operations, rental income associated with the real property, or personal assets.

Residential mortgage loans are provided to individuals to finance or refinance single-family residences. Residential mortgages are not a primary business line offered by the Company, and a majority are conventional mortgages that were purchased as a pool. Most residential mortgages originated by the Company are of a shorter term than conventional mortgages, with maturities ranging from 3 to 15 years on average.

Home Improvement and Home Equity loans comprise a relatively small portion of total real estate mortgage loans, and are offered to borrowers for the purpose of home improvements, although the proceeds may be used for other purposes. Home equity loans are generally secured by junior trust deeds, but may be secured by 1st trust deeds.

Real estate construction and development loans, representing 23.4% of total loans at September 30, 2016, consist of loans for residential and commercial construction projects, as well as land acquisition and development, or land held for future development. Loans in this category are secured by real estate including improved and unimproved land, as well as single-family residential, multi-family residential, and commercial properties in various stages of completion. All real estate loans have established equity requirements. Repayment on construction loans generally comes from long-term mortgages with other lending institutions obtained at completion of the project.

Agricultural loans represent 9.5% of total loans at September 30, 2016 and are generally secured by land, equipment, inventory and receivables. Repayment is from the cash flow of the borrower.

Installment loans represent 6.7% of total loans at September 30, 2016 and generally consist of student loans, loans to individuals for household, family and other personal expenditures such as credit cards, automobiles or other consumer items.

In the normal course of business, the Company is party to financial instruments with off-balance sheet risk to meet the financing needs of its customers. At September 30, 2016 and December 31, 2015, these financial instruments include commitments to extend credit of $113,058,000 and $107,084,000, respectively, and standby letters of credit of $2,833,000 and $3,295,000, respectively. These instruments involve elements of credit risk in excess of the amount recognized on the consolidated balance sheet. The contract amounts of these instruments reflect the extent of the involvement the Company has in off-balance sheet financial instruments.

The Company’s exposure to credit loss in the event of nonperformance by the counterparty to the financial instrument for commitments to extend credit and standby letters of credit is represented by the contractual amounts of those instruments. The Company uses the same credit policies as it does for on-balance sheet instruments.

Commitments to extend credit are agreements to lend to a customer, as long as there is no violation of any condition established in the contract. A majority of these commitments are at floating interest rates based on the Prime rate. Commitments generally have fixed expiration dates. The Company evaluates each customer's creditworthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary, is based on management's credit evaluation. Collateral held varies but includes accounts receivable, inventory, leases, property, plant and equipment, residential real estate and income-producing properties.

Standby letters of credit are generally unsecured and are issued by the Company to guarantee the performance of a customer to a third party. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loans to customers.


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Table of Contents

Past Due Loans

The Company monitors delinquency and potential problem loans on an ongoing basis through weekly reports to the Loan Committee and monthly reports to the Board of Directors. The following is a summary of delinquent loans at September 30, 2016 (in 000's):
September 30, 2016
Loans
30-60 Days Past Due
 
Loans
61-89 Days Past Due
 
Loans
90 or More
Days Past Due
 
Total Past Due Loans
 
Current Loans
 
Total Loans
 
Accruing
Loans 90 or
More Days Past Due
Commercial and Business Loans
$

 
$

 
$

 
$

 
$
45,814

 
$
45,814

 
$

Government Program Loans

 
288

 

 
288

 
1,611

 
1,899

 

Total Commercial and Industrial

 
288

 

 
288

 
47,425

 
47,713

 

Commercial Real Estate Loans

 

 

 

 
197,533

 
197,533

 

Residential Mortgages

 

 
383

 
383

 
91,469

 
91,852

 

Home Improvement and Home Equity Loans

 

 

 

 
627

 
627



Total Real Estate Mortgage

 

 
383

 
383

 
289,629

 
290,012

 

 
 
 
 
 
 
 
 
 
 
 
 
 
 
Real Estate Construction and Development Loans

 

 

 

 
131,177

 
131,177

 

Agricultural Loans

 

 

 

 
53,269

 
53,269

 

Consumer Loans

 
965

 

 
965

 
36,219

 
37,184

 

Overdraft Protection Lines

 

 

 

 
55

 
55

 

Overdrafts

 

 

 

 
189

 
189

 

Total Installment

 
965

 

 
965

 
36,463

 
37,428

 

Total Loans
$

 
$
1,253

 
$
383

 
$
1,636

 
$
557,963

 
$
559,599

 
$


The following is a summary of delinquent loans at December 31, 2015 (in 000's):
December 31, 2015
Loans
30-60 Days Past Due
 
Loans
61-89 Days Past Due
 
Loans
90 or More
Days Past Due
 
Total Past Due Loans
 
Current Loans
 
Total Loans
 
Accruing
Loans 90 or
More Days Past Due
Commercial and Business Loans
$

 
$

 
$

 
$

 
$
54,503

 
$
54,503

 
$

Government Program Loans
13

 

 

 
13

 
1,310

 
1,323

 

Total Commercial and Industrial
13

 

 

 
13

 
55,813

 
55,826

 

Commercial Real Estate Loans
721

 

 

 
721

 
181,833

 
182,554

 

Residential Mortgages
62

 
392

 

 
454

 
68,357

 
68,811

 

Home Improvement and Home Equity Loans

 
39

 

 
39

 
828

 
867

 

Total Real Estate Mortgage
783

 
431

 

 
1,214

 
251,018

 
252,232

 

Real Estate Construction and Development Loans

 
706

 

 
706

 
129,890

 
130,596

 

Agricultural Loans

 

 

 

 
52,137

 
52,137

 

Consumer Loans

 
650

 

 
650

 
23,657

 
24,307

 

Overdraft Protection Lines

 

 

 

 
61

 
61

 

Overdrafts

 

 

 

 
159

 
159

 

Total Installment

 
650

 

 
650

 
23,877

 
24,527

 

Total Loans
$
796

 
$
1,787

 
$

 
$
2,583

 
$
512,735

 
$
515,318

 
$


Nonaccrual Loans

Commercial, construction and commercial real estate loans are placed on nonaccrual status under the following circumstances:

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- When there is doubt regarding the full repayment of interest and principal.

- When principal and/or interest on the loan has been in default for a period of 90-days or more, unless the asset is both well secured and in the process of collection that will result in repayment in the near future.

- When the loan is identified as having loss elements and/or is risk rated "8" Doubtful.

Other circumstances which jeopardize the ultimate collectability of the loan including certain troubled debt restructurings, identified loan impairment, and certain loans to facilitate the sale of OREO.
 
Loans meeting any of the preceding criteria are placed on nonaccrual status and the accrual of interest for financial statement purposes is discontinued. Previously accrued but unpaid interest is reversed and charged against interest income.

All other loans where principal or interest is due and unpaid for 90 days or more are placed on nonaccrual and the accrual of interest for financial statement purposes is discontinued. Previously accrued but unpaid interest is reversed and charged against interest income.

When a loan is placed on nonaccrual status and subsequent payments of interest (and principal) are received, the interest received may be accounted for in two separate ways.

Cost recovery method: If the loan is in doubt as to full collection, the interest received in subsequent payments is diverted from interest income to a valuation reserve and treated as a reduction of principal for financial reporting purposes.

Cash basis: This method is only used if the recorded investment or total contractual amount is expected to be fully collectible, under which circumstances the subsequent payments of interest are credited to interest income as received.

Loans on non-accrual status are usually not returned to accrual status unless all delinquent principal and/or interest has been brought current, there is no identified element of loss, and current and continued satisfactory performance is expected (loss of the contractual amount not the carrying amount of the loan). Return to accrual is generally demonstrated through the timely receipt of at least six monthly payments on a loan with monthly amortization.

Nonaccrual loans totaled $7,747,000 and $8,193,000 at September 30, 2016 and December 31, 2015, respectively. There were no remaining undisbursed commitments to extend credit on nonaccrual loans at September 30, 2016 or December 31, 2015.

The following is a summary of nonaccrual loan balances at September 30, 2016 and December 31, 2015 (in 000's).
 
September 30, 2016
 
December 31, 2015
Commercial and Business Loans
$
282

 
$

Government Program Loans
287

 
328

Total Commercial and Industrial
569

 
328

 
 
 
 
Commercial Real Estate Loans
1,156

 
1,243

Residential Mortgages
383

 
392

Home Improvement and Home Equity Loans

 

Total Real Estate Mortgage
1,539

 
1,635

 
 
 
 
Real Estate Construction and Development Loans
4,674

 
5,580

 Agricultural Loans

 

 
 
 
 
Consumer Loans
965

 
650

Overdraft Protection Lines

 

Overdrafts

 

Total Installment
965

 
650

Total Loans
$
7,747

 
$
8,193



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Table of Contents

Impaired Loans

A loan is considered impaired when based on current information and events, it is probable that the Company will be unable to collect all amounts due, including principal and interest, according to the contractual terms of the loan agreement.

The Company applies its normal loan review procedures in making judgments regarding probable losses and loan impairment. The Company evaluates for impairment those loans on nonaccrual status, graded doubtful, graded substandard or those that are troubled debt restructures. The primary basis for inclusion in impaired status under generally accepted accounting pronouncements is that it is probable that the Bank will be unable to collect all amounts due according to the contractual terms of the loan agreement.

A loan is not considered impaired if there is merely an insignificant delay or shortfall in the amounts of payments and the Company expects to collect all amounts due, including interest accrued, at the contractual interest rate for the period of the delay.

Review for impairment does not include large groups of smaller balance homogeneous loans that are collectively evaluated to estimate the allowance for loan losses. The Company’s present allowance for loan losses methodology, including migration analysis, captures required reserves for these loans in the formula allowance.

For loans determined to be impaired, the Company evaluates impairment based upon either the fair value of underlying collateral, discounted cash flows of expected payments, or observable market price.

-
For loans secured by collateral including real estate and equipment, the fair value of the collateral less selling costs will determine the carrying value of the loan. The difference between the recorded investment in the loan and the fair value, less selling costs, determines the amount of impairment. The Company uses the measurement method based on fair value of collateral when the loan is collateral dependent and foreclosure is probable. For loans that are not considered collateral dependent, a discounted cash flow methodology is used.

-
The discounted cash flow method of measuring the impairment of a loan is used for impaired loans that are not considered to be collateral dependent. Under this method, the Company assesses both the amount and timing of cash flows expected from impaired loans. The estimated cash flows are discounted using the loan's effective interest rate. The difference between the amount of the loan on the Bank's books and the discounted cash flow amounts determines the amount of impairment to be provided. This method is used for most of the Company’s troubled debt restructurings or other impaired loans where some payment stream is being collected.

-
The observable market price method of measuring the impairment of a loan is only used by the Company when the sale of loans or a loan is in process.
 
The method for recognizing interest income on impaired loans is dependent on whether the loan is on nonaccrual status or is a troubled debt restructure. For income recognition, the existing nonaccrual and troubled debt restructuring policies are applied to impaired loans. Generally, except for certain troubled debt restructurings which are performing under the restructure agreement, the Company does not recognize interest income received on impaired loans, but reduces the carrying amount of the loan for financial reporting purposes.

Loans other than certain homogeneous loan portfolios are reviewed on a quarterly basis for impairment. Impaired loans are written down to estimated realizable values by the establishment of specific reserves for loan utilizing the discounted cash flow method, or charge-offs for collateral-based impaired loans, or those using observable market pricing.
 

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Table of Contents

The following is a summary of impaired loans at September 30, 2016 (in 000's).
September 30, 2016
Unpaid
Contractual
Principal Balance
 
Recorded
Investment
With No Allowance (1)
 
Recorded
Investment
With Allowance (1)
 
Total
Recorded Investment
 
Related Allowance
 
Average
Recorded Investment (2)
 
Interest Recognized (2)
Commercial and Business Loans
$
4,936

 
$
664

 
$
4,291

 
$
4,955

 
$
735

 
$
5,105

 
$
238

Government Program Loans
357

 
357

 

 
357

 

 
364

 
24

Total Commercial and Industrial
5,293

 
1,021

 
4,291

 
5,312

 
735

 
5,469

 
262

 
 
 
 
 
 
 
 
 
 
 
 
 
 
Commercial Real Estate Loans
1,485

 

 
1,487

 
1,487

 
472

 
1,450

 
66

Residential Mortgages
2,869

 
915

 
1,961

 
2,876

 
163

 
3,268

 
100

Home Improvement and Home Equity Loans

 

 

 

 

 

 

Total Real Estate Mortgage
4,354

 
915

 
3,448

 
4,363

 
635

 
4,718

 
166

 
 
 
 
 
 
 
 
 
 
 
 
 
 
Real Estate Construction and Development Loans
5,109

 
5,111

 

 
5,111

 

 
10,355

 
272

Agricultural Loans
1

 
2

 

 
2

 

 
9

 
6

 
 
 
 
 
 
 
 
 
 
 
 
 
 
Consumer Loans
965

 
965

 

 
965

 

 
889

 
35

Overdraft Protection Lines

 

 

 

 

 

 

Overdrafts

 

 

 

 

 

 

Total Installment
965

 
965

 

 
965

 

 
889

 
35

Total Impaired Loans
$
15,722

 
$
8,014

 
$
7,739

 
$
15,753

 
$
1,370

 
$
21,440

 
$
741


(1) The recorded investment in loans includes accrued interest receivable of $31,000.
(2) Information is based on the nine month period ended September 30, 2016.    


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Table of Contents

The following is a summary of impaired loans at December 31, 2015 (in 000's).

December 31, 2015
Unpaid
Contractual
Principal Balance
 
Recorded
Investment
With No Allowance (1)
 
Recorded
Investment
With Allowance (1)
 
Total
Recorded Investment
 
Related Allowance
 
Average
Recorded Investment (2)
 
Interest Recognized (2)
Commercial and Business Loans
$
4,855

 
$
541

 
$
4,333

 
$
4,874

 
$
530

 
$
2,537

 
$
302

Government Program Loans
327

 
327

 

 
327

 

 
358

 
29

Total Commercial and Industrial
5,182

 
868

 
4,333

 
5,201

 
530

 
2,895

 
331

 
 
 
 
 
 
 
 
 
 
 
 
 
 
Commercial Real Estate Loans
1,243

 

 
1,243

 
1,243

 
477

 
1,618

 
74

Residential Mortgages
4,032

 
1,051

 
2,999

 
4,050

 
158

 
4,092

 
185

Home Improvement and Home Equity Loans

 

 

 

 

 
11

 

Total Real Estate Mortgage
5,275

 
1,051

 
4,242

 
5,293

 
635

 
5,721

 
259

 
 
 
 
 
 
 
 
 
 
 
 
 
 
Real Estate Construction and Development Loans
12,489

 
5,340

 
7,179

 
12,519

 
1,282

 
7,781

 
820

Agricultural Loans
16

 
16

 

 
16

 

 
22

 
9

 
 
 
 
 
 
 
 
 
 
 
 
 
 
Consumer Loans
650

 

 
650

 
650

 
650

 
1,043

 
21

Overdraft Protection Lines

 

 

 

 

 

 

Overdrafts

 

 

 

 

 

 

Total Installment
650

 

 
650

 
650

 
650

 
1,043

 
21

Total Impaired Loans
$
23,612

 
$
7,275

 
$
16,404

 
$
23,679

 
$
3,097

 
$
17,462

 
$
1,440


(1) The recorded investment in loans includes accrued interest receivable of $67,000.
(2) Information is based on the twelve month period ended December 31, 2015.

In most cases, the Company uses the cash basis method of income recognition for impaired loans. In the case of certain troubled debt restructurings for which the loan is performing under the current contractual terms for a reasonable period of time, income is recognized under the accrual method.

The average recorded investment in impaired loans for the quarters ended September 30, 2016 and 2015 was $19,397,000 and $14,506,000, respectively. Interest income recognized on impaired loans for the quarters ended September 30, 2016 and 2015 was approximately $34,000 and $199,000, respectively. For impaired nonaccrual loans, interest income recognized under a cash-basis method of accounting was approximately $126,000 and $126,000 for the quarters ended September 30, 2016 and 2015, respectively.

The average recorded investment in impaired loans for the nine months ended September 30, 2016 and 2015 was $21,440,000 and $15,550,000, respectively. Interest income recognized on impaired loans for the nine months ended September 30, 2016 and 2015 was approximately $741,000 and $590,000, respectively. For impaired nonaccrual loans, interest income recognized under a cash-basis method of accounting was approximately $362,000 and $326,000 for the nine months ended September 30, 2016 and 2015, respectively.


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Table of Contents

Troubled Debt Restructurings

In certain circumstances, when the Company grants a concession to a borrower as part of a loan restructuring, the restructuring is accounted for as a troubled debt restructuring (TDR). TDRs are reported as a component of impaired loans.

A TDR is a type of restructuring in which the Company, for economic or legal reasons related to the borrower's financial difficulties, grants a concession (either imposed by court order, law, or agreement between the borrower and the Bank) to the borrower that it would not otherwise consider. Although the restructuring may take different forms, the Company's objective is to maximize recovery of its investment by granting relief to the borrower.

A TDR may include, but is not limited to, one or more of the following:

- A transfer from the borrower to the Company of receivables from third parties, real estate, other assets, or an equity interest in the borrower is granted to fully or partially satisfy the loan.

- A modification of terms of a debt such as one or a combination of:

The reduction (absolute or contingent) of the stated interest rate.
The extension of the maturity date or dates at a stated interest rate lower than the current market rate for new debt with similar risk.
The reduction (absolute or contingent) of the face amount or maturity amount of debt as stated in the instrument or agreement.
The reduction (absolute or contingent) of accrued interest.
For a restructured loan to return to accrual status there needs to be, among other factors, at least 6 months successful payment history. In addition, the Company performs a financial analysis of the credit to determine whether the borrower has the ability to continue to meet payments over the remaining life of the loan. This includes, but is not limited to, a review of financial statements and cash flow analysis of the borrower. Only after determination that the borrower has the ability to perform under the terms of the loans, will the restructured credit be considered for accrual status. Although the Company does not have a policy which specifically addresses when a loan may be removed from TDR classification, as a matter of practice, loans classified as TDRs generally remain classified as such until the loan either reaches maturity or its outstanding balance is paid off.

The following tables illustrates TDR activity for the periods indicated:
 
Three Months Ended September 30, 2016
($ in 000's)
Number of
Contracts
 
Pre-
Modification
Outstanding
Recorded
Investment
 
Post-
Modification
Outstanding
Recorded
Investment
 
Number of Contracts which Defaulted During Period
 
Recorded Investment on Defaulted TDRs
Troubled Debt Restructurings
 
 
 
 
 
 
 
 
 
Commercial and Business Loans

 
$

 
$

 

 
$

Government Program Loans

 

 

 

 

Commercial Real Estate Term Loans

 

 

 

 

Single Family Residential Loans

 

 

 

 

Home Improvement and Home Equity Loans

 

 

 

 

Real Estate Construction and Development Loans

 

 

 

 

Agricultural Loans

 

 

 

 

Consumer Loans

 

 

 

 

Overdraft Protection Lines

 

 

 

 

Total Loans

 
$

 
$

 

 
$



19

Table of Contents





 
Nine Months Ended September 30, 2016
($ in 000's)
Number of
Contracts
 
Pre-
Modification
Outstanding
Recorded
Investment
 
Post-
Modification
Outstanding
Recorded
Investment
 
Number of Contracts which Defaulted During Period
 
Recorded Investment on Defaulted TDRs
Troubled Debt Restructurings
 
 
 
 
 
 
 
 
 
Commercial and Business Loans
4

 
$
1,021

 
$
749

 

 
$

Government Program Loans
1

 
100

 
100

 

 

Commercial Real Estate Term Loans

 

 

 

 

Single Family Residential Loans

 

 

 

 

Home Improvement and Home Equity Loans

 

 

 

 

Real Estate Construction and Development Loans

 

 

 

 

Agricultural Loans

 

 

 

 

Consumer Loans

 

 

 

 

Overdraft Protection Lines

 

 

 

 

Total Loans
5

 
$
1,121

 
$
849

 

 
$


 
Three Months Ended  
 September 30, 2015
($ in 000's)
Number of
Contracts
 
Pre-
Modification
Outstanding
Recorded
Investment
 
Post-
Modification
Outstanding
Recorded
Investment
 
Number of Contracts which Defaulted During Period
 
Recorded Investment on Defaulted TDRs
Troubled Debt Restructurings
 
 
 
 
 
 
 
 
 
Commercial and Business Loans
1

 
$
81

 
$
81

 

 
$

Government Program Loans

 

 

 

 

Commercial Real Estate Term Loans

 

 

 

 

Single Family Residential Loans

 

 

 

 

Home Improvement and Home Equity Loans