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Section 1: 8-K/A (8-K/A SMARTFINANCIAL INC. TENNESSEE BANCSHARES INC. ACQUISITION)

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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549

FORM 8-K/A
(Amendment No. 1)

CURRENT REPORT PURSUANT TO
SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934

Date of earliest event reported: May 8, 2018

SMARTFINANCIAL, INC.
(Exact Name of Registrant as Specified in its Charter)
 
 
 
 
 
Tennessee
 
333-203449
 
62-1173944
(State or Other Jurisdiction of Incorporation)
 
(Commission File Number)
 
(IRS Employer Identification No.)
 
 
 
5401 Kingston Pike, Suite 600
Knoxville, Tennessee
 
37919
(Address of Principal Executive Offices)
 
(Zip Code)

(865) 437-5700
(Registrant’s telephone number, including area code)

Not Applicable
(Former Name or Former Address, if Changed Since Last Report)



Check the appropriate box below if the Form 8-K filing is intended to simultaneously satisfy the filing obligation of the registrant under any of the following provisions (see General Instruction A.2. below):

o Written communications pursuant to Rule 425 under the Securities Act (17 CFR 230.425)

o Soliciting material pursuant to Rule 14a-12 under the Exchange Act (17 CFR 240.14a-12)

o Pre-commencement communications pursuant to Rule 14d-2(b) under the Exchange Act (17 CFR 240.14d-2(b))

o Pre-commencement communications pursuant to Rule 13e-4(c) under the Exchange Act (17 CFR 240.13e-4(c))
 






EXPLANATORY NOTE

This Amendment No. 1 on Form 8-K/A (this “Amendment”) amends Item 9.01 of the Current Report on Form 8-K filed by SmartFinancial, Inc., a Tennessee corporation (the “Company”) on May 8, 2018 (the “Original Report”), in which the Company reported, among other events, the completion of its merger (the “Merger”) with Tennessee Bancshares, and Southern Community Bank, a Tennessee-chartered commercial bank and wholly owned subsidiary of Tennessee Bancshares (“Bancshares”). This Amendment provides (i) the historical financial statements required by Item 9.01(a) and (ii) the unaudited pro forma financial information required by Item 9.01(b) that were omitted from the Original Report in reliance on Item 9.01(a)(4) and Item 9.01(b)(2), respectively. This Amendment does not amend any other item of the Original Report or purport to provide an update or a discussion of any developments at the Company subsequent to the filing date of the Original Report. All information contained in the Original Report is subject to updating and supplementing as provided in the Company’s reports filed with the Securities and Exchange Commission subsequent to the date on which the Original Report was filed.

Item 9.01.
Financial Statements and Exhibits

(a)
Financial Statements of Business Acquired.

The audited financial statements of Tennessee Bancshares, Inc as of and for the years ended December 31, 2017 and 2016, including the reports of its independent accounting firm, Mauldin & Jenkins, LLC, and the unaudited financial statements of Bancshares as of March 31, 2018 and for the three months ended March 31, 2018 and 2017 are filed herewith as Exhibit 99.1 and Exhibit 99.2 and incorporated herein by reference.

(b) Pro Forma Financial Information.
 
The pro forma effect of the Merger on the Company is described in the unaudited pro forma combined condensed balance sheet of the Company at March 31, 2018, the unaudited pro forma combined condensed statements of income of the Company for the three months ended March 31, 2018 and for the year ended December 31, 2017, and the notes thereto that are filed herewith as Exhibit 99.3 and incorporated herein by reference.

(d)
Exhibits.

The exhibits filed with this report are listed in the Exhibit Index that immediately follows the signature hereto, which Exhibit Index is incorporated herein by reference.
    








SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned hereunto duly authorized.

SMARTFINANCIAL, INC.

Date: July 17, 2018
/s/ William Y. Carroll, Jr.            
William Y. Carroll, Jr.
President & Chief Executive Officer







EXHIBIT INDEX

Exhibit No.
 
Description
 
Consent of Mauldin & Jenkins, LLC

 
Audited financial statements of Tennessee Bancshares, Inc. for the years ended December 31, 2017 and 2016

 
Unaudited financial statements of Tennessee Bancshares, Inc. for the three months ended March 31, 2018
 
Unaudited pro forma combined condensed balance sheet of SmartFinancial, Inc. as of March 31, 2018, and the unaudited pro forma combined condensed statements of income of SmartFinancial, Inc. for the three months ended March 31, 2018 and twelve months ended December 31, 2017




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Section 2: EX-23.1 (EXHIBIT 23.1)

Exhibit
Exhibit 23.1

CONSENT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

We consent to the incorporation by reference in the registration statements on Form S-3 (No. 333-214802 and 333-208700), Form S-4 (No. 333-219159 and 333-203449 and 333-223316), and Form S-8 (No. 333-208819) of SmartFinancial, Inc. of our report dated March 29, 2018, relating to the consolidated financial statements as of and for the years ended December 31, 2017 and 2016 and March 31, 2018, included therein, which report appears in the Form 8-K/A of SmartFinancial, Inc. dated July 17, 2018.


/s/ Mauldin & Jenkins, LLC

MAULDIN & JENKINS, LLC

Birmingham, Alabama
July 17, 2018





1
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Section 3: EX-99.1 (EXHIBIT 99.1)

Exhibit

Exhibit 99.1














TENNESSEE BANCSHARES, INC.
AND SUBSIDIARY
 
CONSOLIDATED FINANCIAL REPORT

DECEMBER 31, 2017






TENNESSEE BANCSHARES, INC.
AND SUBSIDIARY

CONSOLIDATED FINANCIAL REPORT
DECEMBER 31, 2017

TABLE OF CONTENTS

 
Page
INDEPENDENT AUDITOR’S REPORT
1

 
 
FINANCIAL STATEMENTS
 
Consolidated balance sheets
2

Consolidated statements of income
3

Consolidated statements of comprehensive income
4

Consolidated statements of stockholders’ equity
5

Consolidated statements of cash flows
6

Notes to consolidated financial statements
                                                                  7-47
 
 





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INDEPENDENT AUDITOR’S REPORT


To the Board of Directors
Tennessee Bancshares, Inc.
Tullahoma, Tennessee

We have audited the accompanying consolidated financial statements of Tennessee Bancshares, Inc. and Subsidiary, which comprise the consolidated balance sheets as of December 31, 2017 and 2016, and the related consolidated statements of income, comprehensive income, stockholders’ equity, and cash flows for the years then ended, and the related notes to the consolidated financial statements.

Management’s Responsibility for the Financial Statements

Management is responsible for the preparation and fair presentation of these consolidated financial statements in accordance with accounting principles generally accepted in the United States of America; this includes the design, implementation, and maintenance of internal control relevant to the preparation and fair presentation of financial statements that are free from material misstatement, whether due to fraud or error.

Auditor’s Responsibility

Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement.

An audit involves performing procedures to obtain audit evidence about the amounts and disclosures in the consolidated financial statements. The procedures selected depend on the auditor’s judgment, including the assessment of the risks of material misstatement of the consolidated financial statements, whether due to fraud or error. In making those risk assessments, the auditor considers internal control relevant to the entity’s preparation and fair presentation of the consolidated financial statements in order to design audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the entity’s internal control. Accordingly, we express no such opinion. An audit also includes evaluating the appropriateness of accounting policies used and the reasonableness of significant accounting estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements.

We believe that the audit evidence we have obtained is sufficient and appropriate to provide a basis for our audit opinion.

Opinion

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Tennessee Bancshares, Inc. and Subsidiary as of December 31, 2017 and 2016, and the results of their operations and their cash flows for the years then ended, in accordance with accounting principles generally accepted in the United States of America.

Birmingham, Alabama
March 29, 2018


1


TENNESSEE BANCSHARES, INC.
AND SUBSIDIARY
 
 
 
 
 
 
CONSOLIDATED BALANCE SHEETS
DECEMBER 31, 2017 AND 2016
 
 
 
 
 
 
Assets
2017
 
2016
 
 
 
 
 
 
Cash and due from banks
$
6,005,456
 
$
5,009,248
Interest-bearing deposits in banks
 
3,409,041
 
 
13,199,292
          Cash and cash equivalents
 
9,414,497
 
 
18,208,540
 
 
 
 
 
 
Securities available for sale, at fair value
 
27,340,599
 
 
24,531,986
Securities held to maturity, at cost (fair value $3,940,766 and $3,836,851, respectively)
 
3,899,005
 
 
3,920,717
Restricted equity securities
 
464,300
 
 
400,000
Mortgage loans held for sale
 
363,361
 
 
144,949
 
 
 
 
 
 
Loans
 
196,848,759
 
 
186,531,967
Less allowance for loan losses
 
2,074,600
 
 
2,079,692
          Loans, net
 
194,774,159
 
 
184,452,275
 
 
 
 
 
 
Premises and equipment
 
8,841,669
 
 
9,092,835
Accrued interest receivable
 
986,266
 
 
820,117
Goodwill
 
1,571,053
 
 
1,571,053
Other assets
 
1,467,403
 
 
1,894,825
 
 
 
 
 
 
          Total assets
$
249,122,312
 
$
245,037,297
 
 
 
 
 
 
Liabilities and Stockholders' Equity
 
 
 
 
 
 
 
 
 
 
 
Liabilities:
 
 
 
 
 
  Deposits
 
 
 
 
 
    Noninterest-bearing
$
21,510,446
 
$
19,978,546
    Interest-bearing
 
194,185,432
 
 
194,419,629
           Total deposits
 
215,695,878
 
 
214,398,175
Other borrowings
 
9,264,075
 
 
9,000,000
Accrued interest payable
 
89,734
 
 
79,143
Other liabilities
 
661,304
 
 
654,667
          Total liabilities
 
225,710,991
 
 
224,131,985
 
 
 
 
 
 
Commitments and contingencies
 
 
 
 
 
 
 
 
 
 
 
Stockholders' equity
 
 
 
 
 
    Common stock, $1 par value, 10,000,000 shares authorized;
 
 
 
 
 
        1,809,282 and 1,806,783 shares issued and outstanding, respectively
 
1,809,282
 
 
1,806,783
    Capital surplus
 
16,493,056
 
 
16,465,246
    Retained earnings
 
5,164,471
 
 
2,718,865
    Accumulated other comprehensive loss
 
(55,488)
 
 
(85,582)
 
 
 
 
 
 
          Total stockholders' equity
 
23,411,321
 
 
20,905,312
 
 
 
 
 
 
          Total liabilities and stockholders' equity
$
249,122,312
 
$
245,037,297
See Notes to Consolidated Financial Statements.
 
 
 
 
 

2


TENNESSEE BANCSHARES, INC.
AND SUBSIDIARY
 
 
 
 
 
 
CONSOLIDATED STATEMENTS OF INCOME
YEARS ENDED DECEMBER 31, 2017 AND 2016
 
 
 
 
 
 
 
2017
 
2016
Interest income:
 
 
 
 
 
    Loans, including fees
$
9,981,546
 
$
8,844,146
    Taxable securities
 
517,704
 
 
465,187
    Non-taxable securities
 
222,305
 
 
191,006
    Other interest income
 
39,807
 
 
23,551
          Total interest income
 
10,761,362
 
 
9,523,890
 
 
 
 
 
 
Interest expense:
 
 
 
 
 
    Deposits
 
1,615,723
 
 
1,447,122
    Other borrowings
 
255,599
 
 
132,180
          Total interest expense
 
1,871,322
 
 
1,579,302
 
 
 
 
 
 
          Net interest income
 
8,890,040
 
 
7,944,588
Provision for loan losses
 
158,187
 
 
645,682
          Net interest income after provision for loan losses
 
8,731,853
 
 
7,298,906
 
 
 
 
 
 
Other income:
 
 
 
 
 
    Service charges on deposit accounts
 
430,016
 
 
413,636
    Net loss on sales of securities available for sale
 
(10,549)
 
 
(2,558)
    Mortgage fee income
 
265,417
 
 
317,545
    Investment services
 
544,829
 
 
547,897
    Other operating income
 
183,386
 
 
153,991
          Total other income
 
1,413,099
 
 
1,430,511
 
 
 
 
 
 
Other expenses:
 
 
 
 
 
    Salaries and employee benefits
 
2,848,508
 
 
2,822,425
    Equipment and occupancy expenses
 
801,998
 
 
822,434
    Other operating expenses
 
2,567,085
 
 
2,383,085
          Total other expenses
 
6,217,591
 
 
6,027,944
 
 
 
 
 
 
          Income before income tax expense
 
3,927,361
 
 
2,701,473
 
 
 
 
 
 
Income tax expense
 
1,490,886
 
 
972,390
 
 
 
 
 
 
          Net income
$
2,436,475
 
$
1,729,083
 
 
 
 
 
 
 
 
 
 
 
 
See Notes to Consolidated Financial Statements.
 
 
 
 
 

3


TENNESSEE BANCSHARES, INC.
AND SUBSIDIARY
 
 
 
 
 
 
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
YEARS ENDED DECEMBER 31, 2017 AND 2016
 
 
 
 
 
 
 
 
 
 
 
 
 
2017
 
2016
 
 
 
 
 
 
Net income
$
2,436,475
 
$
1,729,083
 
 
 
 
 
 
Other comprehensive income (loss):
 
 
 
 
 
        Unrealized holding gains (losses) on securities available for sale arising during
 
 
 
 
 
          period, net of tax (benefit) of $20,301 and ($197,942), respectively
 
32,715
 
 
(319,014)
 
 
 
 
 
 
       Reclassification adjustment for losses realized in net income
 
 
 
 
 
          net of tax benefit of $4,039 and $979, respectively
 
6,510
 
 
1,579
 
 
 
 
 
 
            Total other comprehensive income (loss)
 
39,225
 
 
(317,435)
 
 
 
 
 
 
Comprehensive income
$
2,475,700
 
$
1,411,648
 
 
 
 
 
 
 
 
 
 
 
 
See Notes to Consolidated Financial Statements.
 
 
 
 
 

























4


TENNESSEE BANCSHARES, INC.
AND SUBSIDIARY
 
 
 
 
 
 
 
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
YEARS ENDED DECEMBER 31, 2017 AND 2016
 
 
 
 
 
 
 
 
 
 
 
 
Accumulated
 
 
 
 
 
 
Other
Total
 
Common Stock
Capital
Retained
Comprehensive
Stockholders'
 
Shares
Par Value
Surplus
Earnings
Income (loss)
Equity
Balance, December 31, 2015
1,771,175

$1,771,175
$16,107,138
$1,436,528
$231,853
$19,546,694
Net income



1,729,083


1,729,083

Shares issued in accordance with
 
 
 
 
 
dividend reinvestment plan
19,641

19,641

212,712



232,353

Shares issued in accordance with
 
 
 
 
 
director stock plan
967

967

10,396



11,363

Stock options exercised
15,000

15,000

135,000



150,000

Dividends, $.25 per share



(446,746)


(446,746)

Other comprehensive loss




(317,435)

(317,435)

Balance, December 31, 2016
1,806,783

1,806,783

16,465,246

2,718,865

(85,582)

20,905,312

Net income



2,436,475


2,436,475

Shares issued in accordance with
 
 
 
 
 
director stock plan
2,499

2,499

27,810



30,309

Impact of Tax Cuts and Jobs Act



9,131

(9,131)


Other comprehensive income



0

39,225

39,225

Balance, December 31, 2017
1,809,282

$1,809,282
$16,493,056
$5,164,471
-$55,488
$23,411,321
 
 
 
 
 
 
 
 
 
 
 
 
 
 
See Notes to Consolidated Financial Statements.
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
















5


TENNESSEE BANCSHARES, INC.
AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31, 2017 AND 2016
 
 
 
 
 
 
 
2017
 
2016
OPERATING ACTIVITIES
 
 
 
 
 
    Net income
$
2,436,475
 
$
1,729,083
    Adjustments to reconcile net income to net cash
 
 
 
 
 
        provided by operating activities:
 
 
 
 
 
        Depreciation and software amortization
 
369,206
 
 
396,569
        Net amortization of securities
 
267,051
 
 
250,964
        Provision for loan losses
 
158,187
 
 
645,682
        Loss on sale of securities
 
10,549
 
 
2,558
        (Gain) loss on sale of foreclosed assets
 
(9,244)
 
 
20,718
        Writedowns of foreclosed assets
 
4,830
 
 
32,832
        Deferred income taxes
 
88,839
 
 
(113,771)
        Increase in interest receivable
 
(166,149)
 
 
(174,607)
        Increase in interest payable
 
10,591
 
 
15,147
        Net (increase) decrease in mortgage loans held for sale
 
(218,412)
 
 
65,029
        Decrease in advance compensation agreement
 
59,787
 
 
58,727
        Net other operating activities
 
(30,039)
 
 
74,336
 
 
 
 
 
 
            Net cash provided by operating activities
 
2,981,671
 
 
3,003,267
 
 
 
 
 
 
INVESTING ACTIVITIES
 
 
 
 
 
    Purchases of securities available for sale
 
(12,372,866)
 
 
(22,514,191)
    Proceeds from sale of securities available for sale
 
4,871,601
 
 
3,087,867
    Proceeds from maturities, calls, and paydowns of securities available for sale
 
4,500,328
 
 
6,208,095
    Purchases of restricted equity securities
 
(64,300)
 
 
(61,100)
    Net increase in loans
 
(10,559,723)
 
 
(28,372,753)
    Proceeds from sale of foreclosed assets
 
372,924
 
 
543,623
    Purchase of premises and equipment
 
(115,765)
 
 
(62,029)
 
 
 
 
 
 
            Net cash used in investing activities
 
(13,367,801)
 
 
(41,170,488)
 
 
 
 
 
 
FINANCING ACTIVITIES
 
 
 
 
 
    Net increase in deposits
 
1,297,703
 
 
48,532,551
    Net advances of other borrowings
 
264,075
 
 
3,500,000
    Proceeds from issuance of common stock
 
30,309
 
 
243,716
    Proceeds from exercise of stock options
 
0
 
 
150,000
    Dividends paid
 
0
 
 
(446,746)
 
 
 
 
 
 
            Net cash provided by financing activities
 
1,592,087
 
 
51,979,521
 
 
 
 
 
 
Net increase (decrease) in cash and cash equivalents
 
(8,794,043)
 
 
13,812,300
 
 
 
 
 
 
Cash and cash equivalents at beginning of year
 
18,208,540
 
 
4,396,240
 
 
 
 
 
 
Cash and cash equivalents at end of year
$
9,414,497
 
$
18,208,540
 
 
 
 
 
 
SUPPLEMENTAL DISCLOSURES
 
 
 
 
 
    Cash paid during the year for:
 
 
 
 
 
        Interest
$
1,860,731
 
$
1,564,155
        Income taxes
$
1,462,747
 
$
1,167,357
 
 
 
 
 
 
NONCASH TRANSACTIONS
 
 
 
 
 
    Foreclosed assets acquired in settlement of loans
$
79,652
 
$
784,082
See Notes to Consolidated Financial Statements.
 
 
 
 
 


6


TENNESSEE BANCSHARES, INC.
AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


NOTE 1.
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Nature of Business

Tennessee Bancshares, Inc. (the “Company”) is a bank holding company whose principal activity is the ownership and management of its wholly-owned subsidiary, Southern Community Bank (the “Bank”). Southern Community Bank is a commercial bank headquartered in Tullahoma, Tennessee with four branch offices located in portions of the Tennessee Valley. In addition, The Financial Group, LLC, a subsidiary of the Bank, offers financial management services, including a full service brokerage operation.

Basis of Presentation and Accounting Estimates

The consolidated financial statements include the accounts of the Company and its wholly-owned subsidiary. Significant intercompany transactions and balances have been eliminated in consolidation.

In preparing the consolidated financial statements in conformity with accounting principles generally accepted in the United States of America, management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities as of the date of the balance sheet, and reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.

Material estimates that are particularly susceptible to significant change in the near term relate to the determination of the allowance for loan losses, the valuation of foreclosed assets and deferred taxes, other-than-temporary impairments of securities, and the fair value of financial instruments.

The Company has evaluated all transactions, events, and circumstances for consideration or disclosure through March 29, 2018, the date these financial statements were available to be issued, and has reflected or disclosed those items within the consolidated financial statements and related footnotes as deemed appropriate.

Cash, Cash Equivalents and Cash Flows

For purposes of reporting consolidated cash flows, cash and cash equivalents include cash on hand, cash items in process of collection, amounts due from banks and interest-bearing deposits in banks. Cash flows from mortgage loans held for sale, restricted equity securities, loans, deposits and other borrowings are reported net.

The Bank maintains amounts due from banks which, at times, may exceed federally insured limits. The Bank has not experienced any losses in such accounts.

The Bank is required to maintain reserve balances in cash or on deposit with a correspondent bank for the Federal Reserve Bank based on a percentage of deposits. The total of those reserve balances was approximately $677,000 and $529,000 at December 31, 2017 and 2016, respectively.


7




NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


NOTE 1.
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

Securities

Certain debt securities that management has the positive intent and ability to hold to maturity are classified as “held to maturity” and recorded at amortized cost. Securities not classified as held to maturity are classified as “available for sale” and recorded at fair value, with unrealized gains and losses excluded from earnings and reported in other comprehensive income. Purchase premiums and discounts are recognized in interest income using the interest method over the terms of the securities. Gains and losses on the sale of securities are recorded on the trade date and are determined using the specific identification method.

The Company evaluates investment securities for other-than-temporary impairment (OTTI) using relevant accounting guidance on a regular basis. Consideration is given to (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 including an evaluation of credit ratings, (3) the impact of changes in market interest rates, (4) the intent of the Company to sell a security, and (5) whether it is more likely than not the Company will have to sell the security before recovery of its cost basis. If the Company intends to sell an impaired security, or if it is more likely than not the Company will have to sell the security before recovery of its cost basis, the Company records an other-than-temporary loss in an amount equal to the entire difference between fair value and amortized cost in earnings. Otherwise, only the credit portion of the estimated loss is recognized in earnings, with the remaining portion of the loss recognized in other comprehensive income (loss).

Restricted Equity Securities

The Company, as a member of the Federal Home Loan Bank (FHLB) system, is required to maintain an investment in capital stock of the FHLB based upon its assets or outstanding advances. The stock is carried at cost as no readily available market exists. Management reviews for impairment based on the ultimate recoverability of the cost basis in this stock.

Mortgage Loans Held For Sale

Loans originated and intended for sale in the secondary market are carried at the lower of cost or fair value. Gains and losses on loan sales (sales proceeds minus carrying value) are recorded in noninterest income, and direct loan origination costs and fees are deferred at origination of the loan and are recognized in noninterest income upon sale of the loan. The estimated fair value of mortgage loans held for sale is based on independent third party quoted prices.

The Company uses derivatives to hedge interest rate exposures associated with mortgage loans held for sale. The Company regularly enters into derivative financial instruments in the form of interest rate lock commitments and forward sales contracts as part of its normal asset/liability management strategies. The Company’s obligations under forward sales contracts consist of “best effort” commitments to deliver mortgage loans originated in the secondary market at a future date. Interest rate lock commitments related to loans that are originated for later sale are also classified as derivatives. In the normal course of business, the Company regularly extends these interest rate lock commitments to customers during the loan origination process. These interest rate lock and forward sales commitments qualify as derivatives; however, the fair values and changes in fair values of these derivatives during the years ended December 31, 2017 and 2016 did not have a material impact on the Company’s financial position or results of operations and have not been recorded.


8




NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


NOTE 1.
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

Loans

Loans that management has the intent and ability to hold for the foreseeable future or until maturity or pay-off are reported at their outstanding principal balances less deferred fees and costs on originated loans and the allowance for loan losses. Interest income is accrued on the outstanding principal balance. Loan origination fees, net of certain direct origination costs of consumer and installment loans are recognized at the time the loan is placed on the books. Net loan origination fees and costs for all other loans are deferred and recognized over the life of the loan.

The accrual of interest on loans is discontinued when, in management’s opinion, the borrower may be unable to meet payments as they become due, or at the time the loan is 90 days past due, unless the loan is well-secured and in the process of collection. Past due status is based on contractual terms of the loan. In all cases, loans are placed on nonaccrual or charged-off at an earlier date if collection of principal and interest is considered doubtful. All interest accrued but not collected for loans that are placed on nonaccrual or charged-off is reversed against interest income or charged to the allowance, unless management believes that the accrual of interest is recoverable through the liquidation of collateral. Interest income on nonaccrual loans is recognized on the cash basis, until the loans are returned to accrual status. Loans are returned to accrual status when all the principal and interest amounts contractually due are brought current and the loan has been performing according to the contractual terms generally for a period of not less than six months.

A loan is considered impaired when it is probable, based on current information and events, the Company will be unable to collect all principal and interest payments due in accordance with the contractual terms of the loan agreement. Factors considered by management in determining impairment include payment status, collateral value, and the probability of collecting scheduled principal and interest when due. Loans that experience insignificant payment delays and payment shortfalls are generally not classified as impaired.

Impaired loans are measured by either the present value of expected future cash flows discounted at the loan’s effective interest rate, the loan’s obtainable market price, or the fair value of the collateral if the loan is collateral dependent. Interest on accruing impaired loans is recognized as long as such loans do not meet the criteria for non-accrual status. Large groups of smaller balance homogeneous loans are collectively evaluated for impairment.

Troubled Debt Restructurings

A loan is considered a troubled debt restructuring (TDR) based on individual facts and circumstances. The Company designates loan modifications as TDRs when for economic or legal reasons related to the borrower’s financial difficulties, it grants a concession to the borrower that it would not otherwise consider.

In determining whether a borrower is experiencing financial difficulties, the Company considers if the borrower is in payment default or would be in payment default in the foreseeable future without the modification, the borrower declared or is in the process of declaring bankruptcy, the borrower’s projected cash flows will not be sufficient to service any of its debt, or the borrower cannot obtain funds from sources other than the Company at a market rate for debt with similar risk characteristics.

In determining whether the Company has granted a concession, the Company assesses, if it does not expect to collect all amounts due, whether the current value of the collateral will satisfy the amounts owed, whether additional collateral or guarantees from the borrower will serve as adequate compensation for other terms of the restructuring, and whether the borrower otherwise has access to

9


funds at a market rate for debt with similar risk characteristics. These concessions may include rate reductions, principal forgiveness, extension of maturity date and other actions intended to minimize potential losses.

10




NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


NOTE 1.
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

Allowance for Loan Losses

The allowance for loan losses is established as losses are estimated to have occurred through a provision for loan losses charged to expense. Loan losses are charged against the allowance when management believes the uncollectibility of a loan balance is confirmed. Confirmed losses are charged off immediately. Subsequent recoveries, if any, are credited to the allowance.

The allowance is an amount that management believes will be adequate to absorb estimated losses relating to specifically identified loans, as well as probable credit losses inherent in the balance of the loan portfolio. The allowance for loan losses is evaluated on a regular basis by management and is based upon management’s periodic review of the uncollectibility of loans in light of historical experience, the nature and volume of the loan portfolio, overall portfolio quality, review of specific problem loans, current economic conditions that may affect the borrower’s ability to pay, estimated value of any underlying collateral and prevailing economic conditions. This evaluation is inherently subjective as it requires estimates that are susceptible to significant revision as more information becomes available. This evaluation does not include the effects of expected losses on specific loans or groups of loans that are related to future events or expected changes in economic conditions. While management uses the best information available to make its evaluation, future adjustments to the allowance may be necessary if there are significant changes in economic conditions. In addition, regulatory agencies, as an integral part of their examination process, periodically review the Company’s allowance for loan losses, and may require the Company to make additions to the allowance based on their judgment about information available to them at the time of their examinations.

The allowance consists of specific and general components. The specific component relates to loans that are classified as impaired. For those loans that are classified as impaired, an allowance is established when the discounted cash flows, collateral value, or observable market price of the impaired loan is lower than the carrying value of that loan. The general component covers non-impaired loans and is based on historical loss experience adjusted for other qualitative factors.

The Company’s loan pools include real estate construction and land development loans, residential real estate loans, commercial real estate loans, other real estate loans, commercial loans, and consumer loans. The general allocations to these loan pools are based on the historical loss rates for specific loan types and the internal risk grade, if applicable, adjusted for both internal and external qualitative risk factors. The qualitative factors considered by management include, among other factors, (1) changes in local and national economic conditions; (2) changes in asset quality; (3) changes in loan portfolio volume; (4) the composition and concentrations of credit; (5) the impact of competition on loan structuring and pricing; (6) the experience and ability of lending personnel and management; (7) effectiveness of the Company’s loan policies, procedures and internal controls; (8) the loan review system and oversight of the Board of Directors. The total allowance established for each loan pool represents the product of the historical loss ratio as adjusted with qualitative factors and the total dollar amount of the loans in the pool.


11




NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


NOTE 1.    SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

Foreclosed Assets

Foreclosed assets acquired through, or in lieu of, loan foreclosure are held for sale and are initially recorded at fair value less estimated selling costs. Any write-down to fair value at the time of transfer to foreclosed assets is charged to the allowance for loan losses. Subsequent to foreclosure, valuations are periodically performed by management, and the assets are carried at the lower of carrying amount or fair value less estimated costs to sell. Costs of improvements are capitalized, whereas costs relating to holding foreclosed assets and subsequent write-downs to the value are expensed. The carrying amount of foreclosed assets at December 31, 2017 and 2016 was $814,078 and $1,102,936, respectively, and is included in other assets in the consolidated balance sheets. The carrying amount of foreclosed assets categorized as residential real estate at December 31, 2017 and 2016 was $70,500 and $210,000, respectively.

Premises and Equipment

Land is carried at cost. Premises and equipment are carried at cost less accumulated depreciation computed on the straight-line method over the estimated useful lives of the assets as indicated in the table below. Leasehold improvements are amortized over the shorter of the estimated useful life of the asset or the lease term. Expenditures for repairs and maintenance are charged to expense as incurred.

 
Years
 
 
Buildings and land improvements
20-40
Furniture and equipment
5-20

Transfers of Financial Assets

Transfers of financial assets are accounted for as sales, when control over the assets has been surrendered. Control over transferred assets is deemed to be surrendered when (1) the assets have been isolated from the Company - put presumptively beyond the reach of the transferor and its creditors, even in bankruptcy or other receivership, (2) the transferee obtains the right (free of conditions that constrain it from taking advantage of that right) to pledge or exchange the transferred assets, and (3) the Company does not maintain effective control over the transferred assets through an agreement to repurchase them before their maturity or the ability to unilaterally cause the holder to return specific assets.

Goodwill

Goodwill represents the excess of the amount paid over the fair value of the net assets at the date of acquisition. Goodwill is subject to an annual evaluation of impairment. If desired, the Company can assess qualitative factors to determine if comparing the carrying value of the reporting unit to its fair value is necessary. Should the fair value be less than the carrying value, an impairment write-down would be taken. Based on its assessment of qualitative factors, the Company determined that no impairment exists at December 31, 2017 and 2016. Therefore, no calculation of the fair value of the reporting unit was performed.


12




NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


NOTE 1.    SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

Income Taxes

The accounting for income taxes results in two components of income tax expense: current and deferred. Current income tax expense reflects taxes to be paid or refunded for the current period by applying the provisions of the enacted tax law to the taxable income or excess of deductions over revenues. The Company determines deferred income taxes using the liability (or balance sheet) method. Under this method, the net deferred tax asset or liability is based on the tax effects of the differences between the book and tax bases of assets and liabilities, and enacted changes in tax rates and laws are recognized in the period in which they occur.

Deferred income tax expense results from changes in deferred tax assets and liabilities between periods. Deferred tax assets are recognized if it is more likely than not, based on the technical merits, that the tax position will be realized or sustained upon examination. The term more likely than not means a likelihood of more than 50 percent; the terms examined and upon examination also include resolution of the related appeals or litigation processes, if any. A tax position that meets the more-likely-than-not recognition threshold is initially and subsequently measured as the largest amount of tax benefit that has a greater than 50 percent likelihood of being realized upon settlement with a taxing authority that has full knowledge of all relevant information. The determination of whether or not a tax position has met the more-likely-than-not recognition threshold considers the facts, circumstances, and information available at the reporting date and is subject to management’s judgment. Deferred tax assets are reduced by deferred tax liabilities and a valuation allowance if, based on the weight of evidence available, it is more likely than not that some portion or all of a deferred tax asset will not be realized.
The Tax Cuts and Jobs Act of 2017 was signed into law on December 22, 2017. The law includes significant changes to the U.S. corporate income tax system, including a federal corporate rate reduction from 34% to 21%. In accordance with the income tax accounting guidance described above, the Bank has recorded an additional income tax expense of $62,355 as a result of the re-measurement of deferred tax assets and liabilities.

Stock Compensation Plans

Stock compensation accounting guidance requires that the compensation cost relating to share-based payment transactions be recognized in financial statements. That cost will be measured based on the grant date fair value of the equity or liability instruments issued. The stock compensation accounting guidance covers a wide range of share-based compensation arrangements which includes stock options.

The stock compensation accounting guidance requires that compensation cost for all stock awards be calculated and recognized over the employees’ service period, generally defined as the vesting period. A Black-Scholes-Merton model is used to estimate the fair value of stock options.

Comprehensive Income

Accounting principles generally require that recognized revenue, expenses, gains and losses be included in net income. Although certain changes in assets and liabilities, such as unrealized gains and losses on available for sale securities, are reported as a separate component of the equity section of the balance sheet, such items, along with net income, are components of comprehensive income.




13


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS



Fair Value of Financial Instruments

Fair values of financial instruments are estimates using relevant market information and other assumptions, as more fully disclosed in Note 13. Fair value estimates involve uncertainties and matters of significant judgment. Changes in assumptions or in market conditions could significantly affect the estimates.

NOTE 2.    SECURITIES

The amortized cost and fair value of securities with gross unrealized gains and losses are summarized as follows:

 
 

Amortized
Cost
 
Gross
Unrealized
Gains
 
Gross
Unrealized
Losses
 

Fair
Value
 
Securities Available for Sale
 
 
 
 
 
 
 
 
 
 
 
 
December 31, 2017:
 
 
 
 
 
 
 
 
 
 
 
 
U.S. Government sponsored
 
 
 
 
 
 
 
 
 
 
 
 
agency securities
$
3,982,757
 
$
-
 
$
(65,267)
 
$
3,917,490
 
Municipal securities
 
8,461,118
 
 
20,310
 
 
(160,939)
 
 
8,320,489
 
Corporate securities
 
2,559,105
 
 
7,461
 
 
(22,989)
 
 
2,543,577
 
U.S. Government sponsored
 
 
 
 
 
 
 
 
 
 
 
 
mortgage-backed securities
 
12,412,739
 
 
200,435
 
 
(54,131)
 
 
12,559,043
 
 
$
27,415,719
 
$
228,206
 
$
(303,326)
 
$
27,340,599

 
Securities Held to Maturity
 
 
 
 
 
 
 
 
 
 
 
 
December 31, 2017:
 
 
 
 
 
 
 
 
 
 
 
 
Municipal securities
$
1,942,904
 
$
14,541
 
$
-
 
$
1,957,445
 
Corporate securities
 
1,956,101
 
 
27,319
 
 
(99)
 
 
1,983,321
 
 
$
3,899,005
 
$
41,860
 
$
(99)
 
$
3,940,766

 
Securities Available for Sale
 
 
 
 
 
 
 
 
 
 
 
 
December 31, 2016:
 
 
 
 
 
 
 
 
 
 
 
 
U.S. Government sponsored
 
 
 
 
 
 
 
 
 
 
 
 
agency securities
$
7,514,797
 
$
1,890
 
$
(145,124)
 
$
7,371,563
 
Municipal securities
 
6,770,561
 
 
19,003
 
 
(199,769)
 
 
6,589,795
 
Corporate securities
 
1,496,077
 
 
12,525
 
 
(16,077)
 
 
1,492,525
 
U.S. Government sponsored
 
 
 
 
 
 
 
 
 
 
 
 
mortgage-backed securities
 
8,889,236
 
 
261,711
 
 
(72,844)
 
 
9,078,103
 
 
$
24,670,671
 
$
295,129
 
$
(433,814)
 
$
24,531,986

 
Securities Held to Maturity
 
 
 
 
 
 
 
 
 
 
 
 
December 31, 2016:
 
 
 
 
 
 
 
 
 
 
 
 
Municipal securities
$
1,948,927
 
$
4,445
 
$
(32,377)
 
$
1,920,995
 
Corporate securities
 
1,971,790
 
 
-
 
 
(55,934)
 
 
1,915,856
 
 
$
3,920,717
 
$
4,445
 
$
(88,311)
 
$
3,836,851

The amortized cost and fair value of securities as of December 31, 2017, by contractual maturity are shown below. Actual maturities may differ from contractual maturities in mortgage-backed securities

14


because the mortgages underlying the securities may be called or repaid with or without penalty. Therefore, these securities are not included in the maturity categories in the following summary:

 
 
Securities Available for Sale
 
Securities Held to Maturity
 
 
Amortized
Cost
 
Fair
Value
 
Amortized
Cost
 
Fair
Value
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Due from one to five years
$
2,699,192
 
$
2,686,620
 
$
-
 
$
-
 
Due from five to ten years
 
6,000,011
 
 
5,901,401
 
 
1,956,101
 
 
1,983,321
 
Due after ten years
 
6,303,777
 
 
6,193,535
 
 
1,942,904
 
 
1,957,445
 
Mortgage-backed securities
 
12,412,739
 
 
12,559,043
 
 
-
 
 
-
 
 
$
27,415,719
 
$
27,340,599
 
$
3,899,005
 
$
3,940,766

15




NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


NOTE 2.    SECURITIES (Continued)

Securities with a carrying value of $18,793,792 and $21,250,893 at December 31, 2017 and 2016, respectively, were pledged to secure public deposits and for other purposes required or permitted by law.
Gains and losses on sales of securities available for sale consist of the following:

 
 
Years Ended December 31,
 
 
2017
 
2016
 
 
 
 
 
 
 
 
Gross gains on sales of securities available for sale
$
-
 
$
5,182
 
Gross losses on sales of securities available for sale
 
(10,549)
 
 
(7,740)
 
Net losses on sales of securities
$
(10,549)
 
$
(2,558)

Restricted equity securities consist of the following:

 
 
December 31,
 
 
2017
 
2016
 
 
 
 
 
 
 
 
Federal Home Loan Bank of Cincinnati stock
$
464,300
 
$
400,000

Temporarily Impaired Securities

The following tables show the gross unrealized losses and fair value of the Company’s securities with unrealized losses that are not deemed to be other-than-temporarily impaired, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position at December 31, 2017 and 2016.

Securities that have been in a continuous unrealized loss position are as follows:

 
Less Than Twelve Months
 
Over Twelve Months
 
 
 
Fair
Value
 
Gross
Unrealized
Losses
 
Fair
Value
 
Gross
Unrealized
Losses
 
Total Unrealized
Losses
Securities Available for Sale
 
 
 
 
 
 
 
 
 
 
 
 
 
 
December 31, 2017:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
U.S. Government sponsored
 
 
 
 
 
 
 
 
 
 
 
 
 
 
agency securities
$
-
 
$
-
 
$
3,917,490
 
$
(65,267)
 
$
(65,267)
Municipal securities
 
3,762,773
 
 
(73,229)
 
 
3,109,861
 
 
(87,710)
 
 
(160,939)
Corporate securities
 
1,056,116
 
 
(6,385)
 
 
480,000
 
 
(16,604)
 
 
(22,989)
U.S. Government sponsored
 
 
 
 
 
 
 
 
 
 
 
 
 
 
mortgage-backed securities
 
4,865,102
 
 
(39,287)
 
 
1,072,134
 
 
(14,844)
 
 
(54,131)
 
$
9,683,991
 
$
(118,901)
 
$
8,579,485
 
$
(184,425)
 
$
(303,326)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Securities Held to Maturity
 
 
 
 
 
 
 
 
 
 
 
 
 
 
December 31, 2017:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Corporate securities
$
211,883
 
$
(99)
 
$
-
 
$
-
 
$
-
 
$
211,883
 
$
(99)
 
$
-
 
$
-
 
$
-

16




NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


NOTE 2.    SECURITIES (Continued)

Temporarily Impaired Securities (Continued)

 
Less Than Twelve Months
 
Over Twelve Months
 
 
 
Fair
Value
 
Gross
Unrealized
Losses
 
Fair
Value
 
Gross
Unrealized
Losses
 
Total Unrealized
Losses
Securities Available for Sale
 
 
 
 
 
 
 
 
 
 
 
 
 
 
December 31, 2016:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
U.S. Government sponsored
 
 
 
 
 
 
 
 
 
 
 
 
 
 
agency securities
$
6,353,062
 
$
(145,124)
 
$
-
 
$
-
 
$
(145,124)
Municipal securities
 
5,875,273
 
 
(199,769)
 
 
-
 
 
-
 
 
(199,769)
Corporate securities
 
-
 
 
-
 
 
480,000
 
 
(16,077)
 
 
(16,077)
U.S. Government sponsored
 
 
 
 
 
 
 
 
 
 
 
 
 
 
mortgage-backed securities
 
3,680,579
 
 
(72,844)
 
 
-
 
 
-
 
 
(72,844)
 
$
15,908,914
 
$
(417,737)
 
$
480,000
 
$
(16,077)
 
$
(433,814)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Securities Held to Maturity
 
 
 
 
 
 
 
 
 
 
 
 
 
 
December 31, 2016:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Municipal securities
$
1,563,826
 
$
(32,377)
 
$
-
 
$
-
 
$
(32,377)
Corporate securities
 
1,493,080
 
 
(34,611)
 
 
422,777
 
 
(21,323)
 
 
(55,934)
 
$
3,056,906
 
$
(66,988)
 
$
422,777
 
$
(21,323)
 
$
(88,311)

The unrealized losses on forty-three securities were caused by interest rate changes. Because the Company does not intend to sell the securities and it is not more likely than not that the Company will be required to sell the securities before recovery of the amortized cost bases, which may be maturity, the Company does not consider these securities to be other-than-temporarily impaired at December 31, 2017.

Other-Than-Temporary Impairment

Upon acquisition of a security, the Company evaluates for impairment under the accounting guidance for investments in debt and equity securities. The Company routinely conducts periodic reviews to identify and evaluate each investment security to determine whether an other-than-temporary impairment has occurred. Factors included in the evaluation process may include geographic concentrations, credit ratings, and other performance indicators of the underlying asset. As of December 31, 2017 and 2016, no securities within the Company’s investment securities portfolio were considered other-than-temporarily impaired, and no impairment losses were recognized in 2017 or 2016.


17




NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


NOTE 3.
LOANS

Portfolio Segments and Classes

The composition of loans, excluding mortgage loans held for sale, is summarized as follows.

 
 
December 31,
 
 
2017
 
2016
 
Real estate loans:
 
 
 
 
 
 
Construction and development
$
34,820,819
 
$
40,668,222
 
1-4 family first mortgages
 
47,256,479
 
 
46,897,071
 
Commercial
 
68,432,705
 
 
64,098,965
 
Other
 
15,094,645
 
 
8,641,954
 
Commercial loans
 
27,406,390
 
 
22,337,585
 
Consumer loans
 
3,435,487
 
 
3,494,154
 
 
 
196,446,525
 
 
186,137,951
 
Net deferred loan costs
 
402,234
 
 
394,016
 
Allowance for loan losses
 
(2,074,600)
 
 
(2,079,692)
 
 
$
194,774,159
 
$
184,452,275

For purposes of the disclosures required pursuant to ASC 310, the loan portfolio was disaggregated into segments and then further disaggregated into classes for certain disclosures. A portfolio segment is defined as the level at which an entity develops and documents a systematic method for determining its allowance for loan losses. There are three loan portfolio segments that include real estate, commercial, and consumer. A class is generally determined based on the initial measurement attribute, risk characteristic of the loan, and the Company’s method for monitoring and assessing credit risk. Classes within the real estate portfolio segment include construction and development loans, 1-4 family first mortgage loans, commercial real estate loans, and other real estate loans. The portfolio segments of non-real estate commercial loans and consumer loans have not been further segregated by class.

The following describe risk characteristics relevant to each of the portfolio segments and classes:

Real Estate - As discussed below, the Company offers various types of real estate loan products. All loans within this portfolio segment are particularly sensitive to the valuation of real estate:
Construction and development loans are repaid through cash flow related to the operations, sale or refinance of the underlying property. This portfolio class includes extensions of credit to real estate developers or investors where repayment is dependent on the sale of the real estate or income generated from the real estate collateral. The majority of construction and development loans are originated under interest only terms with principal due at maturity.
1-4 family first mortgage loans are repaid by various means such as a borrower’s income, sale of the property, or rental income derived from the property.
Commercial real estate loans include both owner-occupied commercial real estate loans and loans secured by income producing properties. Owner-occupied commercial real estate loans to operating businesses are long-term financing of land and buildings and are repaid by cash flow generated from the business operations. Real estate loans for income-producing properties such as apartment buildings, office and industrial buildings, and retail shopping centers are repaid from rent income derived from the properties.

18


Other real estate mortgage loans include 1-4 family junior liens, home equity lines of credit, loans secured by farmland and multi-family residential loans. These are repaid by various means such as a borrower’s income, sale of the property, or rental income derived from the property.

19




NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


NOTE 3.
LOANS (Continued)

Portfolio Segments and Classes (Continued)

Commercial - The non-real estate commercial loan portfolio segment includes commercial and industrial loans. These loans include those loans to commercial customers for use in normal business operations to finance working capital needs, equipment purchases, or expansion projects. Loans are repaid by business cash flows. Collection risk in this portfolio is driven by the creditworthiness of the underlying borrower, particularly cash flows from the customers’ business operations.

Consumer - The consumer loan portfolio segment includes direct consumer installment loans, overdrafts and other revolving credit loans. Loans in this portfolio are sensitive to unemployment and other key consumer economic measures.

Credit Risk Management

Credit Administration directs the credit risk management process and assesses the accuracy of risk ratings, the quality of the portfolio and the estimation of inherent loan losses in the loan portfolio. This comprehensive process also assists in the prompt identification of problem loans. The Company has taken a number of measures to manage and reduce risk within the loan portfolio.

The Company employs a credit risk management process with defined policies, accountability and routine reporting to manage credit risk in the loan portfolio segments. Credit policies provide for a consistent and prudent approach to underwriting and approvals of credits. Within the Board approved Loan Policy, procedures exist that elevate the approval requirements as credits become larger and more complex. All loans are individually underwritten, risk-rated, approved, and monitored.

Responsibility and accountability for adherence to underwriting policies and accurate risk ratings lies in each portfolio segment. For the consumer portfolio segment, the risk management process focuses on managing customers who become delinquent in their payments. For the commercial and real estate portfolio segments, the risk management process focuses on underwriting new business and, on an ongoing basis, monitoring the credit quality of the portfolios. To insure problem credits are identified on a timely basis, portfolio reviews are conducted to assess the larger adversely rated credits for proper risk rating and accrual status.

Credit quality and trends in the loan portfolio segments are measured and monitored regularly. Detailed reports, by product, collateral, accrual status, etc., are reviewed by the Chief Executive Officer, Chief Lending Officer, Officers Loan Committee, and Directors Loan Committee.

The following risk grade categories are utilized by management to analyze and manage the credit quality and risk of the loan portfolio:
Pass - includes obligations where the probability of default is considered low.
Special Mention - includes obligations that exhibit potential credit weaknesses or downward trends deserving management’s close attention. If left uncorrected, these potential weaknesses may result in the deterioration of the repayment prospects or credit position at a future date. These loans are not adversely classified and do not expose the Company to sufficient risk to warrant adverse classification.

20




NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


NOTE 3.
LOANS (Continued)

Credit Risk Management (Continued)
Substandard - includes obligations considered to be inadequately protected by the current sound worth and debt service capacity of the borrower or of any pledged collateral. These obligations, even if apparently protected by collateral value, have well-defined weaknesses related to adverse financial, managerial, economic, market, or political conditions, which have clearly jeopardized repayment of principal and interest as originally intended. Furthermore, there is the possibility that the Company will sustain some future loss if such weaknesses are not corrected. Clear loss potential, however, does not have to exist in any individual assets classified as substandard.
Doubtful - includes obligations with all the weaknesses inherent in those graded “Substandard,” with the added characteristic that the severity of the weakness makes collection or liquidation in full highly questionable and improbable based on currently existing facts, conditions, and values. The probability of some loss is extremely high, but because of certain important and reasonably specific factors, the amount of loss cannot be determined. Such pending factors could include merger or liquidation, additional capital injection, refinancing plans, or perfection of liens on additional collateral. There are no loans with a doubtful rating in the Company’s portfolio as of December 31, 2017 and 2016.
Loss - includes obligations that are considered uncollectible and cannot be justified as a viable asset of the Company. This classification does not mean the loan has absolutely no recovery value, but that it is neither practical nor desirable to defer writing off the loan even though partial recovery may be obtained in the future. There are no loans with a loss rating in the Company’s portfolio as of December 31, 2017 and 2016.

The following tables summarize the risk categories, as defined above, of the Company’s loan portfolio based upon the most recent analysis performed as of December 31, 2017 and 2016.

 
 
Pass
 
Special Mention
 
Substandard
 
Doubtful
 
Total
December 31, 2017
(Dollars in Thousands)
 
Real estate loans:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Construction and development
$
34,103
 
$
718
 
$
-
 
$
-
 
$
34,821
 
1-4 family first mortgages
 
46,600
 
 
656
 
 
-
 
 
-
 
 
47,256
 
Commercial
 
67,972
 
 
124
 
 
337
 
 
-
 
 
68,433
 
Other
 
14,979
 
 
116
 
 
-
 
 
-
 
 
15,095
 
Commercial loans
 
27,149
 
 
57
 
 
200
 
 
-
 
 
27,406
 
Consumer loans
 
2,887
 
 
546
 
 
3
 
 
-
 
 
3,436
 
Total:
$
193,690
 
$
2,217
 
$
540
 
$
-
 
$
196,447


21


December 31, 2016
 
 
Real estate loans:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Construction and development
$
40,668
 
$
-
 
$
-
 
$
-
 
$
40,668
 
1-4 family first mortgages
 
45,056
 
 
1,841
 
 
-
 
 
-
 
 
46,897
 
Commercial
 
61,937
 
 
1,820
 
 
342
 
 
-
 
 
64,099
 
Other
 
8,642
 
 
-
 
 
-
 
 
-
 
 
8,642
 
Commercial loans
 
20,825
 
 
1,275
 
 
238
 
 
-
 
 
22,338
 
Consumer loans
 
2,957
 
 
537
 
 
-
 
 
-
 
 
3,494
 
Total:
$
180,085
 
$
5,473
 
$
580
 
$
-
 
$
186,138

22




NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


NOTE 3.
LOANS (Continued)

Past Due Loans

A loan is considered past due if any required principal and interest payments have not been received as of the date such payments were required to be made under the terms of the loan agreement.  Generally, the Company places loans on non-accrual when there is a clear indication that the borrower’s cash flow may not be sufficient to meet payments as they become due, which is generally when a loan is 90 days past due. The following tables present the aging of the recorded investment in loans as of December 31, 2017 and 2016.

 
 
 
 
Past Due Status (Accruing Loans)
 
 
 
 
Current
 
30-59 Days
60-89 Days
90+ Days
Total Past Due
Non-accrual
Total
December 31, 2017
(Dollars in Thousands)
 
Real estate loans:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Construction and development
$
34,665
 
$
156
$
-
$
-
$
156
$
-
$
34,821
 
1-4 family first mortgages
 
47,020
 
 
236
 
-
 
-
 
236
 
-
 
47,256
 
Commercial
 
68,433
 
 
-
 
-
 
-
 
-
 
-
 
68,433
 
Other
 
15,095
 
 
-
 
-
 
-
 
-
 
-
 
15,095
 
Commercial loans
 
27,369
 
 
37
 
-
 
-
 
37
 
-
 
27,406
 
Consumer loans
 
3,436
 
 
-
 
-
 
-
 
-
 
-
 
3,436
 
Total:
$
196,018
 
$
429
$
-
$
-
$
429
$
-
$
196,447

December 31, 2016
 
 
Real estate loans:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Construction and development
$
40,668
$
-
$
-
$
-
$
-
$
-
$
40,668
 
1-4 family first mortgages
 
46,739
 
158
 
-
 
-
 
158
 
-
 
46,897
 
Commercial
 
64,020
 
79
 
-
 
-
 
79
 
-
 
64,099
 
Other
 
8,642
 
-
 
-
 
-
 
-
 
-
 
8,642
 
Commercial loans
 
22,338
 
-
 
-
 
-
 
-
 
-
 
22,338
 
Consumer loans
 
3,448
 
46
 
-
 
-
 
46
 
-
 
3,494
 
Total:
$
185,855
$
283
$
-
$
-
$
283
$
-
$
186,138

Allowance for Loan Losses

An analysis of the allowance for loan losses is detailed below.


23


 
 
Years Ended December 31,
 
 
2017
 
2016
 
 
 
 
 
 
 
 
Balance, beginning of year
$
2,079,692
 
$
1,704,417
 
Provision for loan losses
 
158,187
 
 
645,682
 
Loans charged off
 
(163,279)
 
 
(273,238)
 
Recoveries of loans previously charged off
 
-
 
 
2,831
 
Balance, end of year
$
2,074,600
 
$
2,079,692

24




NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


NOTE 3.
LOANS (Continued)

Allowance for Loan Losses (Continued)

The following tables further detail activity in the allowance for loan losses by portfolio segment for the years ended December 31, 2017 and 2016. Allocation of a portion of the allowance to one category of loans does not preclude its availability to absorb losses in other categories.

 
 
Real Estate
 
Commercial
 
Consumer
 
Total
December 31, 2017
(Dollars in Thousands)
 
Allowance for loan losses:
 
 
 
 
 
 
 
 
 
 
 
 
Balance, beginning of year
$
1,779
 
$
270
 
$
31
 
$
2,080
 
Provision (credit) for loan losses
 
(127)
 
 
209
 
 
76
 
 
158
 
Loans charged off
 
-
 
 
(101)
 
 
(62)
 
 
(163)
 
Recoveries of loans previously charged off
 
-
 
 
-
 
 
-
 
 
-
 
Balance, end of year
$
1,652
 
$
378
 
$
45
 
$
2,075
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Ending balance: individually evaluated for impairment
$
-
 
$
41
 
$
10
 
$
51
 
Ending balance: collectively evaluated for impairment
 
1,652
 
 
337
 
 
35
 
 
2,024
 
Total ending balance
$
1,652
 
$
378
 
$
45
 
$
2,075
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Loans:
 
 
 
 
 
 
 
 
 
 
 
 
Ending balance: individually evaluated for impairment
$
2,873
 
$
328
 
$
546
 
$
3,747
 
Ending balance: collectively evaluated for impairment
 
162,732
 
 
27,078
 
 
2,890
 
 
192,700
 
Total ending balance
$
165,605
 
$
27,406
 
$
3,436
 
$
196,447

December 31, 2016
 
 
Allowance for loan losses:
 
 
 
 
 
 
 
 
 
 
 
 
Balance, beginning of year
$
1,163
 
$
510
 
$
31
 
$
1,704
 
Provision (credit) for loan losses
 
769
 
 
(136)
 
 
13
 
 
646
 
Loans charged off
 
(153)
 
 
(107)
 
 
(13)
 
 
(273)
 
Recoveries of loans previously charged off
 
-
 
 
3
 
 
-
 
 
3
 
Balance, end of year
$
1,779
 
$
270
 
$
31
 
$
2,080
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Ending balance: individually evaluated for impairment
$
-
 
$
57
 
$
-
 
$
57
 
Ending balance: collectively evaluated for impairment
 
1,779
 
 
213
 
 
31
 
 
2,023
 
Total ending balance
$
1,779
 
$
270
 
$
31
 
$
2,080
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Loans:
 
 
 
 
 
 
 
 
 
 
 
 
Ending balance: individually evaluated for impairment
$
3,835
 
$
1,332
 
$
536
 
$
5,703
 
Ending balance: collectively evaluated for impairment
 
156,471
 
 
21,006
 
 
2,958
 
 
180,435
 
Total ending balance
$
160,306
 
$
22,338
 
$
3,494
 
$
186,138

Impaired Loans


25


A loan held for investment is considered impaired when, based on current information and events, it is probable that the Company will be unable to collect all amounts due (both principal and interest) according to the terms of the loan agreement. The following tables detail impaired loans, by portfolio class as of December 31, 2017 and 2016.

26




NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 3.
LOANS (Continued)
Impaired Loans (Continued)
 
 
 
 
 
 
Unpaid
 
Related
 
Average
 
Interest
 
 
 
 
Recorded
 
Principal
 
Allowance for
 
Recorded
 
Income
 
 
 
 
Investment
 
Balance
 
Loan Losses
 
Investment
 
Recognized
 
December 31, 2017
 
(Dollars in Thousands)
 
 
With no related allowance recorded:
 
 
 
 
Real estate loans:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Construction and development
 
$
718
 
$
718
 
$
-
 
$
709
 
$
25
 
1-4 family first mortgages
 
 
656
 
 
656
 
 
-
 
 
659
 
 
23
 
Commercial
 
 
1,383
 
 
1,383
 
 
-
 
 
1,389
 
 
46
 
Other
 
 
116
 
 
116
 
 
-
 
 
110
 
 
5
 
Commercial loans
 
 
287
 
 
287
 
 
-
 
 
293
 
 
11
 
Consumer loans
 
 
536
 
 
536
 
 
-
 
 
536
 
 
33
 
Total with no related
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
allowance recorded
 
 
3,696
 
 
3,696
 
 
-
 
 
3,696
 
 
143
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
With an allowance recorded:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Real estate loans:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Construction and development
 
 
-
 
 
-
 
 
-