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Section 1: 10-Q

 

 

 

UNITED STATES

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 March 31, 2019

 

OR

 
[  ] 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 0-33203

 

LANDMARK BANCORP, INC.

(Exact name of registrant as specified in its charter)

 

Delaware   43-1930755

(State or other jurisdiction of incorporation or organization)

 

(I.R.S. Employer Identification Number)

  

701 Poyntz Avenue, Manhattan, Kansas 66502

(Address of principal executive offices) (Zip code)

 

(785) 565-2000

(Registrant’s telephone number, including area code)

 

Securities registered pursuant to Section 12(b) of the Act:

 

Title of each class:   Trading Symbol(s)   Name of exchange on which registered:

Common Stock, par value $0.01 per share

  LARK   Nasdaq Global Market

 

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 requirements for the past 90 days. Yes [X] No [  ]

 

Indicate by check mark whether the registrant has submitted electronically, every Interactive Data File required to be submitted 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 such files). Yes [X] No [  ]

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer [  ] Accelerated filer [X] Non-accelerated filer [  ] Smaller reporting company [X] Emerging growth company [  ]

 

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. [  ]

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes [  ] No [X]

 

Indicate the number of shares outstanding of each of the issuer’s classes of common stock as of the latest practicable date: as of May 8, 2019, the issuer had outstanding 4,372,116 shares of its common stock, $0.01 par value per share.

 

 

 

 
 

 

LANDMARK BANCORP, INC.

Form 10-Q Quarterly Report

 

Table of Contents

 

   

Page Number

  PART I  
     
Item 1. Financial Statements 2 – 25
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations 26 – 32
Item 3. Quantitative and Qualitative Disclosures about Market Risk 32 – 33
Item 4. Controls and Procedures 34
     
  PART II  
     
Item 1. Legal Proceedings 35
Item 1A. Risk Factors 35
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds 35
Item 3. Defaults Upon Senior Securities 35
Item 4. Mine Safety Disclosures 35
Item 5. Other Information 35
Item 6. Exhibits 35
     
  Signature Page 36

 

1
 

 

PART I – FINANCIAL INFORMATION

 

ITEM 1. FINANCIAL STATEMENTS

 

LANDMARK BANCORP, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

 

(Dollars in thousands, except per share amounts)  March 31, 2019   December 31, 2018 
   (Unaudited)     
Assets          
Cash and cash equivalents  $14,333   $19,114 
Investment securities available-for-sale, at fair value   387,392    388,345 
Bank stocks, at cost   2,994    4,776 
Loans, net of allowance for loans losses of $5,938 at March 31, 2019 and $5,765 at December 31, 2018   490,673    489,373 
Loans held for sale, at fair value   6,607    4,743 
Premises and equipment, net   21,111    21,127 
Bank owned life insurance   24,501    24,342 
Goodwill   17,532    17,532 
Other intangible assets, net   2,925    3,091 
Real estate owned, net   54    35 
Accrued interest and other assets   12,881    13,306 
Total assets  $981,003   $985,784 
           
Liabilities and Stockholders’ Equity          
Liabilities:          
Deposits:          
Non-interest-bearing demand  $184,170   $168,273 
Money market and checking   377,307    393,460 
Savings   98,585    94,895 
Time   161,739    167,020 
Total deposits   821,801    823,648 
           
Federal Home Loan Bank borrowings   10,300    20,000 
Subordinated debentures   21,651    21,651 
Other borrowings   16,813    15,246 
Accrued interest, taxes, and other liabilities   13,591    13,338 
Total liabilities   884,156    893,883 
           
Commitments and contingencies          
           
Stockholders’ equity:          
Preferred stock, $0.01 par value per share, 200,000 shares authorized; none issued   -    - 
Common stock, $0.01 par value per share, 7,500,000 shares authorized; 4,372,116 shares issued at March 31, 2019 and December 31, 2018,   44    44 
Additional paid-in capital   63,844    63,775 
Retained earnings   33,381    32,073 
Accumulated other comprehensive loss   (422)   (3,991)
Total stockholders’ equity   96,847    91,901 
Total liabilities and stockholders’ equity  $981,003   $985,784 

 

See accompanying notes to consolidated financial statements.

 

2
 

 

LANDMARK BANCORP, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF EARNINGS

(Unaudited)

 

   Three months ended 
(Dollars in thousands, except per share amounts)  March 31, 
   2019   2018 
Interest income:          
Loans:          
Taxable  $6,435   $5,350 
Tax-exempt   26    29 
Investment securities:          
Taxable   1,493    1,197 
Tax-exempt   930    1,025 
Total interest income   8,884    7,601 
Interest expense:          
Deposits   1,331    541 
Borrowings   357    466 
Total interest expense   1,688    1,007 
Net interest income   7,196    6,594 
Provision for loan losses   200    200 
Net interest income after provision for loan losses   6,996    6,394 
Non-interest income:          
Fees and service charges   1,689    1,756 
Gains on sales of loans, net   1,120    1,161 
Bank owned life insurance   159    159 
Gains on sales of investment securities, net   -    35 
Other   288    290 
Total non-interest income   3,256    3,401 
Non-interest expense:          
Compensation and benefits   4,143    3,789 
Occupancy and equipment   1,062    1,078 
Data processing   414    365 
Amortization of intangibles   264    277 
Professional fees   396    388 
Advertising   166    167 
Federal deposit insurance premiums   68    72 
Foreclosure and real estate owned expense   41    13 
Other   1,174    1,291 
Total non-interest expense   7,728    7,440 
Earnings before income taxes   2,524    2,355 
Income tax expense   341    256 
Net earnings  $2,183   $2,099 
Earnings per share:          
Basic (1)  $0.50   $0.49 
Diluted (1)  $0.50   $0.48 
Dividends per share (1)  $0.20   $0.19 

 

(1) Per share amounts for the period ended March 31, 2018 have been adjusted to give effect to the 5% stock dividend paid during December 2018.

 

See accompanying notes to consolidated financial statements.

 

3
 

 

LANDMARK BANCORP, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)

(Unaudited)

 

   Three months ended 
(Dollars in thousands)  March 31, 
   2019   2018 
         
Net earnings  $2,183   $2,099 
           
Net unrealized holding gains (losses) on available-for-sale securities   4,727    (6,376)
Less reclassification adjustment for net gains included in earnings   -    (35)
Net unrealized gains (losses)   4,727    (6,411)
Income tax effect on net gains included in earnings   -    9 
Income tax effect on net unrealized holding (losses) gains   (1,158)   1,562 
Other comprehensive income (loss)   3,569    (4,840)
           
Total comprehensive income (loss)  $5,752   $(2,741)

 

See accompanying notes to consolidated financial statements.

 

4
 

 

LANDMARK BANCORP, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY

(Unaudited)

 

(Dollars in thousands, except per share amounts)  Common stock   Additional paid-in capital   Retained earnings   Accumulated other comprehensive income (loss)   Total 
                     
Balance at January 1, 2018  $41   $57,772   $30,214   $(405)  $87,622 
Net earnings   -    -    2,099    -    2,099 
Other comprehensive loss   -    -    -    (4,840)   (4,840)
Dividends paid ($0.19 per share)   -    -    (821)   -    (821)
Stock-based compensation   -    54    -    -    54 
Adjustment of common stock   -    -    7    (7)   - 
Exercise of stock options, 36,424 shares   -    334    -    -    334 
Balance at March 31, 2018  $41   $58,160   $31,499   $(5,252)  $84,448 
                          
Balance at January 1, 2019  $44   $63,775   $32,073   $(3,991)  $91,901 
Net earnings   -    -    2,183    -    2,183 
Other comprehensive income   -    -    -    3,569    3,569 
Dividends paid ($0.20 per share)   -    -    (875)   -    (875)
Stock-based compensation   -    69    -    -    69 
Balance at March 31, 2019  $44   $63,844   $33,381   $(422)  $96,847 

 

See accompanying notes to consolidated financial statements.

 

5
 

 

LANDMARK BANCORP, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

 

   Three months ended 
(Dollars in thousands)  March 31, 
   2019   2018 
Cash flows from operating activities:          
Net earnings  $2,183   $2,099 
Adjustments to reconcile net earnings to net cash provided by (used by) operating activities:          
Provision for loan losses   200    200 
Amortization of investment security premiums, net   440    485 
Amortization of purchase accounting adjustment on loans   (34)   (58)
Amortization of purchase accounting adjustment on subordinated debentures   -    50 
Amortization of intangibles   264    277 
Depreciation   246    250 
Increase in cash surrender value of bank owned life insurance   (159)   (159)
Stock-based compensation   69    54 
Deferred income taxes   (339)   105 
Net gains on sales of investment securities   -    (35)
Net losses on sales of foreclosed assets   -    1 
Net gains on sales of loans   (1,120)   (1,161)
Proceeds from sales of loans   25,395    31,886 
Origination of loans held for sale   (26,139)   (30,477)
Changes in assets and liabilities:          
Accrued interest and other assets   (430)   838 
Accrued expenses, taxes, and other liabilities   (1,605)   (1,232)
Net cash (used in) provided by operating activities   (1,029)   3,123 
Cash flows from investing activities:          
Net increase in loans   (1,548)   (2,596)
Maturities and prepayments of investment securities   14,833    12,682 
Purchases of investment securities   (7,735)   (29,692)
Proceeds from sales of investment securities   -    2,535 
Redemption of bank stocks   4,254    3,666 
Purchase of bank stocks   (2,472)   (3,700)
Proceeds from sales of premises and equipment and foreclosed assets   14    20 
Purchases of premises and equipment, net   (243)   (477)
Net cash provided by (used in) investing activities   7,103    (17,562)
Cash flows from financing activities:          
Net (decrease) increase in deposits   (1,847)   4,003 
Federal Home Loan Bank advance borrowings   101,786    233,570 
Federal Home Loan Bank advance repayments   (111,486)   (225,423)
Proceeds from other borrowings   1,567    - 
Repayments on other borrowings   -    (766)
Proceeds from exercise of stock options   -    334 
Payment of dividends   (875)   (821)
Net cash (used in) provided by financing activities   (10,855)   10,897 
Net decrease in cash and cash equivalents   (4,781)   (3,542)
Cash and cash equivalents at beginning of period   19,114    16,584 
Cash and cash equivalents at end of period  $14,333   $13,042 

 

(Continued)

 

6
 

 

LANDMARK BANCORP, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS, CONTINUED

(Unaudited)

 

   Three months ended 
(Dollars in thousands)  March 31, 
   2019   2018 
Supplemental disclosure of cash flow information:          
Cash paid for interest  $1,685   $973 
Cash paid for operating leases   40    35 
           
Supplemental schedule of noncash investing and financing activities:          
Transfer of loans to real estate owned   20    - 
Investment securities purchases not yet settled   (1,858)   (2,512)
Operating lease asset and related lease liability recorded   353    - 

 

See accompanying notes to consolidated financial statements.

 

7
 

 

LANDMARK BANCORP, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

1. Interim Financial Statements

 

The unaudited consolidated financial statements of Landmark Bancorp, Inc. (the “Company”) and its wholly owned subsidiaries, Landmark National Bank (the “Bank”) and Landmark Risk Management Inc., have been prepared in accordance with the instructions to Form 10-Q. Accordingly, they do not include all the information and footnotes required by U.S. generally accepted accounting principles (“GAAP”) for complete financial statements and should be read in conjunction with the Company’s most recent Annual Report on Form 10-K, containing the latest audited consolidated financial statements and notes thereto. The consolidated financial statements in this report have not been audited by an independent registered public accounting firm, but in the opinion of management, all adjustments, consisting of normal recurring accruals, considered necessary for a fair presentation of financial statements have been reflected herein. The results of the three month interim period ended March 31, 2019 are not necessarily indicative of the results expected for the year ending December 31, 2019 or any other future time period. The Company has evaluated subsequent events for recognition and disclosure up to the date the financial statements were issued.

 

On January 1, 2019, the Company adopted ASU 2016-02, Leases (Topic 842). The guidance is intended to increase transparency and comparability among organizations by recognizing lease assets and lease liabilities on the balance sheet and requiring more disclosures related to leasing transactions. The amendments in Topic 842 are effective for fiscal years, and interim periods within those years, beginning after December 15, 2018. The Company elected the optional transition method permitted with Topic 842. Under this method, the Company measures leases that exist at the adoption date and prior comparative periods are not adjusted. As a result of the adoption of Topic 842, the Company recorded a right of use asset and a lease liability of $132,000 as of January 1, 2019 related to three operating leases with an average life of 5.75 years. During the first quarter of 2019, the Company entered into a new operating lease for office space. As a result, the Company recorded a right of use asset and a lease liability of $221,000 related to this five year lease, which will begin during the second quarter of 2019. The change in lease accounting did not impact net earnings during the first three months of 2019 and was not material to the consolidated financial statements.

 

In March 2017, the FASB issued ASU 2017-08, Receivables - Nonrefundable Fees and Other Costs (Subtopic 310-20): Premium Amortization on Purchased Callable Debt Securities. The amendments in this update shorten the amortization period for certain callable debt securities held at a premium. Specifically, the amendments require the premium to be amortized to the earliest call date. The amendments do not require an accounting change for securities held at a discount; the discount continues to be amortized to maturity. The provisions of this update become effective for interim and annual periods beginning after December 15, 2018. The Company adopted ASU 2017-08 effective January 1, 2019. Management has concluded that based on the Company’s current portfolio of investment securities that the adoption of these amendments will result in a shorter amortization period for investment security premiums; however, the impact was not material to interest income on investment securities.

 

8
 

 

2. Investments

 

A summary of investment securities available-for-sale is as follows:

 

   As of March 31, 2019 
       Gross   Gross     
   Amortized   unrealized   unrealized   Estimated 
(Dollars in thousands)  cost   gains   losses   fair value 
                 
U. S. treasury securities  $2,296   $-   $(15)  $2,281 
U. S. federal agency obligations   6,852    52    (19)   6,885 
Municipal obligations, tax exempt   160,439    1,185    (957)   160,667 
Municipal obligations, taxable   54,184    451    (121)   54,514 
Agency mortgage-backed securities   156,757    747    (1,882)   155,622 
Certificates of deposit   7,423    -    -    7,423 
Total available-for-sale  $387,951   $2,435   $(2,994)  $387,392 

 

   As of December 31, 2018 
       Gross   Gross     
   Amortized   unrealized   unrealized   Estimated 
(Dollars in thousands)  cost   gains   losses   fair value 
                 
U. S. treasury securities  $1,999   $-   $(28)  $1,971 
U. S. federal agency obligations   10,370    32    (41)   10,361 
Municipal obligations, tax exempt   161,529    353    (2,770)   159,112 
Municipal obligations, taxable   53,178    180    (323)   53,035 
Agency mortgage-backed securities   158,765    264    (2,953)   156,076 
Certificates of deposit   7,790    -    -    7,790 
Total available-for-sale  $393,631   $829   $(6,115)  $388,345 

 

The tables above show that some of the securities in the available-for-sale investment portfolio had unrealized losses, or were temporarily impaired, as of March 31, 2019 and December 31, 2018. This temporary impairment represents the estimated amount of loss that would be realized if the securities were sold on the valuation date. Securities which were temporarily impaired are shown below, along with the length of time in a continuous unrealized loss position.

 

       As of March 31, 2019 
(Dollars in thousands)      Less than 12 months   12 months or longer   Total 
   No. of   Fair   Unrealized   Fair   Unrealized   Fair   Unrealized 
   securities   value   losses   value   losses   value   losses 
U. S. treasury securities   1   $-   $-   $1,984   $(15)  $1,984   $(15)
U.S. federal agency obligations   4    -    -    4,624    (19)   4,624    (19)
Municipal obligations, tax exempt   164    2,662    (12)   59,794    (945)   62,456    (957)
Municipal obligations, taxable   51    -    -    22,025    (121)   22,025    (121)
Agency mortgage-backed securities   89    -    -    92,597    (1,882)   92,597    (1,882)
Total   309   $2,662   $(12)  $181,024   $(2,982)  $183,686   $(2,994)

 

       As of December 31, 2018 
(Dollars in thousands)      Less than 12 months   12 months or longer   Total 
   No. of   Fair   Unrealized   Fair   Unrealized   Fair   Unrealized 
   securities   value   losses   value   losses   value   losses 
U. S. treasury securities   1   $-   $-   $1,971   $(28)  $1,971   $(28)
U. S. federal agency obligations   6    145    (1)   7,970    (40)   8,115    (41)
Municipal obligations, tax exempt   296    35,898    (367)   85,921    (2,403)   121,819    (2,770)
Municipal obligations, taxable   86    8,293    (22)   28,984    (301)   37,277    (323)
Agency mortgage-backed securities   101    30,030    (146)   96,155    (2,807)   126,185    (2,953)
Total   490   $74,366   $(536)  $221,001   $(5,579)  $295,367   $(6,115)

 

9
 

 

The Company’s U.S. treasury portfolio consists of securities issued by the United States Department of the Treasury. The receipt of principal and interest on U.S. treasury securities is guaranteed by the full faith and credit of the U.S. government. Based on these factors, along with the Company’s intent to not sell the security and its belief that it was more likely than not that the Company will not be required to sell the security before recovery of its cost basis, the Company believed that the U.S. treasury security identified in the table above was temporarily impaired as of March 31, 2019 and December 31, 2018.

 

The Company’s U.S. federal agency portfolio consists of securities issued by the government-sponsored agencies of Federal Home Loan Mortgage Corporation (“FHLMC”), Federal National Mortgage Association (“FNMA”) and Federal Home Loan Bank (“FHLB”). The receipt of principal and interest on U.S. federal agency obligations is guaranteed by the respective government-sponsored agency guarantor, such that the Company believes that its U.S. federal agency obligations do not expose the Company to credit-related losses. Based on these factors, along with the Company’s intent to not sell the securities and its belief that it was more likely than not that the Company will not be required to sell the securities before recovery of their cost basis, the Company believed that the U.S. federal agency obligations identified in the tables above were temporarily impaired as of March 31, 2019 and December 31, 2018.

 

The Company’s portfolio of municipal obligations consists of both tax-exempt and taxable general obligations securities issued by various municipalities. As of March 31, 2019, the Company did not intend to sell and it is more likely than not that the Company will not be required to sell its municipal obligations in an unrealized loss position until the recovery of its cost. Due to the issuers’ continued satisfaction of the securities’ obligations in accordance with their contractual terms and the expectation that they will continue to do so, the evaluation of the fundamentals of the issuers’ financial condition and other objective evidence, the Company believed that the municipal obligations identified in the tables above were temporarily impaired as of March 31, 2019 and December 31, 2018.

 

The Company’s agency mortgage-backed securities portfolio consists of securities underwritten to the standards of and guaranteed by the government-sponsored agencies of FHLMC, FNMA and the Government National Mortgage Association. The receipt of principal, at par, and interest on agency mortgage-backed securities is guaranteed by the respective government-sponsored agency guarantor, such that the Company believed that its agency mortgage-backed securities did not expose the Company to credit-related losses. Based on these factors, along with the Company’s intent to not sell the securities and the Company’s belief that it was more likely than not that the Company will not be required to sell the securities before recovery of their cost basis, the Company believed that the agency mortgage-backed securities identified in the tables above were temporarily impaired as of March 31, 2019 and December 31, 2018.

 

The table below sets forth amortized cost and fair value of investment securities at March 31, 2019. The table includes scheduled principal payments and estimated prepayments, based on observable market inputs, for agency mortgage-backed securities. Actual maturities will differ from contractual maturities because borrowers have the right to prepay obligations with or without prepayment penalties.

 

(Dollars in thousands)  Amortized   Estimated 
   cost   fair value 
Due in less than one year  $30,617   $30,568 
Due after one year but within five years   155,910    154,386 
Due after five years but within ten years   123,545    124,051 
Due after ten years   77,879    78,387 
Total  $387,951   $387,392 

 

10
 

 

Sales proceeds and gross realized gains and losses on sales of available-for-sale securities were as follows for the periods indicated:

 

(Dollars in thousands)  Three months ended March 31, 
   2019   2018 
Sales proceeds  $-   $2,535 
Realized gains  $-   $35 
Realized losses   -    - 
Net realized gains  $-   $35 

 

Securities with carrying values of $242.2 million and $249.7 million were pledged to secure public funds on deposit, repurchase agreements and as collateral for borrowings at March 31, 2019 and December 31, 2018, respectively. Except for U.S. federal agency obligations, no investment in a single issuer exceeded 10% of consolidated stockholders’ equity.

 

3. Loans and Allowance for Loan Losses

 

Loans consisted of the following as of the dates indicated below:

 

   March 31,   December 31, 
(Dollars in thousands)  2019   2018 
One-to-four family residential real estate  $135,871   $136,895 
Construction and land   18,386    20,083 
Commercial real estate   141,148    138,967 
Commercial   79,103    74,289 
Agriculture   94,905    96,632 
Municipal   2,922    2,953 
Consumer   24,160    25,428 
Total gross loans   496,495    495,247 
Net deferred loan costs and loans in process   116    (109)
Allowance for loan losses   (5,938)   (5,765)
Loans, net  $490,673   $489,373 

 

11
 

 

The following tables provide information on the Company’s allowance for loan losses by loan class and allowance methodology:

 

   Three months ended March 31, 2019 
(Dollars in thousands)  One-to-four family residential real estate   Construction and land   Commercial real estate   Commercial   Agriculture   Municipal   Consumer   Total 
Allowance for loan losses:                                        
Balance at January 1, 2019  $449   $168   $1,686   $1,051   $2,238   $7   $166   $5,765 
Charge-offs   -    -    -    -    -    -    (49)   (49)
Recoveries   1    -    -    1    -    6    14    22 
Provision for loan losses   24    (12)   185    113    (110)   (6)   6    200 
Balance at March 31, 2019  $474   $156   $1,871   $1,165   $2,128   $7   $137   $5,938 

 

   Three months ended March 31, 2018 
(Dollars in thousands)  One-to-four family residential real estate   Construction and land   Commercial real estate   Commercial   Agriculture   Municipal   Consumer   Total 
Allowance for loan losses:                                        
Balance at January 1, 2018  $542   $181   $1,540   $1,226   $1,812   $8   $150   $5,459 
Charge-offs   -    -    -    -    -    -    (33)   (33)
Recoveries   1    -    1    1    -    2    13    18 
Provision for loan losses   (66)   (60)   21    257    55    (3)   (4)   200 
Balance at March 31, 2018  $477   $121   $1,562   $1,484   $1,867   $7   $126   $5,644 

 

  As of March 31, 2019 
(Dollars in thousands)  One-to-four family residential real estate   Construction and land   Commercial real estate   Commercial   Agriculture   Municipal   Consumer   Total 
Allowance for loan losses:                                        
Individually evaluated for loss  $115   $97   $223   $20   $-   $-   $-   $455 
Collectively evaluated for loss   359    59    1,648    1,145    2,128    7    137    5,483 
Total  $474   $156   $1,871   $1,165   $2,128   $7   $137   $5,938 
Loan balances:                                        
Individually evaluated for loss  $958   $1,766   $3,986   $1,567   $1,609   $58   $41   $9,985 
Collectively evaluated for loss   134,913    16,620    137,162    77,536    93,296    2,864    24,119    486,510 
Total  $135,871   $18,386   $141,148   $79,103   $94,905   $2,922   $24,160   $496,495 

 

   As of December 31, 2018 
(Dollars in thousands)  One-to-four family residential real estate   Construction and land   Commercial real estate   Commercial   Agriculture   Municipal   Consumer   Total 
Allowance for loan losses:                                        
Individually evaluated for loss  $100   $103   $67   $27   $13   $-   $-   $310 
Collectively evaluated for loss   349    65    1,619    1,024    2,225    7    166    5,455 
Total  $449   $168   $1,686   $1,051   $2,238   $7   $166   $5,765 
                                         
Loan balances:                                        
Individually evaluated for loss  $623   $1,808   $3,912   $1,528   $717   $58   $45   $8,691 
Collectively evaluated for loss   136,272    18,275    135,055    72,761    95,915    2,895    25,383    486,556 
Total  $136,895   $20,083   $138,967   $74,289   $96,632   $2,953   $25,428   $495,247 

 

12
 

 

The Company recorded net loan charge-offs of $27,000 during the first quarter of 2019 compared to net loan charge-offs of $15,000 during the first quarter of 2018.

 

The Company’s impaired loans increased from $8.7 million at December 31, 2018 to $10.0 million at March 31, 2019. The difference between the unpaid contractual principal and the impaired loan balance is a result of charge-offs recorded against impaired loans. The difference in the Company’s non-accrual loan balances and impaired loan balances at March 31, 2019 and December 31, 2018, was related to troubled debt restructurings (“TDR”) that are current and accruing interest, but still classified as impaired. Interest income recognized on a cash basis was immaterial during the three months ended March 31, 2019 and 2018. The following tables present information on impaired loans:

 

(Dollars in thousands)  As of March 31, 2019 
   Unpaid contractual principal   Impaired loan balance   Impaired loans without an allowance   Impaired loans with an allowance   Related allowance recorded   Year-to-date average loan balance   Year-to-date interest income recognized 
One-to-four family residential real estate  $958   $958   $681   $277   $115   $961   $3 
Construction and land   3,501    1,766    1,341    425    97    1,782    10 
Commercial real estate   3,986    3,986    2,023    1,963    223    3,992    118 
Commercial   1,567    1,567    1,441    126    20    1,570    - 
Agriculture   1,824    1,609    1,609    -    -    1,641    12 
Municipal   58    58    58    -    -    58    - 
Consumer   41    41    41    -    -    43    - 
Total impaired loans  $11,935   $9,985   $7,194   $2,791   $455   $10,047   $143 

 

(Dollars in thousands)  As of December 31, 2018 
   Unpaid contractual principal   Impaired loan balance   Impaired loans without an allowance   Impaired loans with an allowance   Related allowance recorded   Year-to-date average loan balance   Year-to-date interest income recognized 
One-to-four family residential real estate  $623   $623   $413   $210   $100   $640   $10 
Construction and land   3,543    1,808    1,383    425    103    2,689    53 
Commercial real estate   3,912    3,912    2,120    1,792    67    3,928    487 
Commercial   1,528    1,528    1,446    82    27    1,537    - 
Agriculture   932    717    529    188    13    844    52 
Municipal   58    58    58    -    -    58    1 
Consumer   45    45    45    -    -    49    - 
Total impaired loans  $10,641   $8,691   $5,994   $2,697   $310   $9,745   $603 

 

The Company’s key credit quality indicator is a loan’s performance status, defined as accruing or non-accruing. Performing loans are considered to have a lower risk of loss. Non-accrual loans are those which the Company believes have a higher risk of loss. The accrual of interest on non-performing loans is discontinued at the time the loan is 90 days delinquent, unless the credit is well secured and in process of collection. Loans are placed on non-accrual or are charged off at an earlier date if collection of principal or interest is considered doubtful. There were no loans 90 days or more delinquent and accruing interest at March 31, 2019 or December 31, 2018.

 

13
 

 

The following tables present information on the Company’s past due and non-accrual loans by loan class:

 

(Dollars in thousands)  As of March 31, 2019 
   30-59 days delinquent and accruing   60-89 days delinquent and accruing   90 days or more delinquent and accruing   Total past due loans accruing   Non-accrual loans   Total past due and non-accrual loans   Total loans not past due 
One-to-four family residential real estate  $728   $30   $-   $758   $779   $1,537   $134,334 
Construction and land   223    -    -    223    946    1,169    17,217 
Commercial real estate   264    632    -    896    1,962    2,858    138,290 
Commercial   188    73    -    261    1,567    1,828    77,275 
Agriculture   23    -    -    23    1,393    1,416    93,489 
Municipal   -    -    -    -    -    -    2,922 
Consumer   61    2    -    63    41    104    24,056 
Total  $1,487   $737   $-   $2,224   $6,688   $8,912   $487,583 
                                    
Percent of gross loans   0.30%   0.15%   0.00%   0.45%   1.35%   1.79%   98.21%

 

(Dollars in thousands)  As of December 31, 2018 
   30-59 days delinquent and accruing   60-89 days delinquent and accruing   90 days or more delinquent and accruing   Total past due loans accruing   Non-accrual loans   Total past due and non-accrual loans   Total loans not past due 
One-to-four family residential real estate  $131   $206   $-   $337   $442   $779   $136,116 
Construction and land   -    134    -    134    948    1,082    19,001 
Commercial real estate   465    -    -    465    1,791    2,256    136,711 
Commercial   398    20    -    418    1,528    1,946    72,343 
Agriculture   100    88    -    188    482    670    95,962 
Municipal   -    -    -    -    -    -    2,953 
Consumer   106    23    -    129    45    174    25,254 
Total  $1,200   $471   $-   $1,671   $5,236   $6,907   $488,340 
                                    
Percent of gross loans   0.24%   0.10%   0.00%   0.34%   1.06%   1.40%   98.60%

 

Under the original terms of the Company’s non-accrual loans, interest earned on such loans for the three months ended March 31, 2019 and 2018 would have increased interest income by $124,000 and $76,000, respectively. No interest income related to non-accrual loans was included in interest income for the three months ended March 31, 2019 and 2018.

 

The Company also categorizes loans into risk categories based on relevant information about the ability of the borrowers to service their debt, such as current financial information, historical payment experience, credit documentation, public information and current economic trends, among other factors. The Company analyzes loans individually by classifying the loans as to credit risk. This analysis is performed on a quarterly basis. Nonclassified loans generally include those loans that are expected to be repaid in accordance with contractual loan terms. Classified loans are those that are assigned a special mention, substandard or doubtful risk rating using the following definitions:

 

Special Mention: Loans are currently protected by the current net worth and paying capacity of the obligor or of the collateral pledged but such protection is potentially weak. These loans constitute an undue and unwarranted credit risk, but not to the point of justifying a classification of substandard. The credit risk may be relatively minor, yet constitutes an unwarranted risk in light of the circumstances surrounding a specific asset.

 

Substandard: Loans are inadequately protected by the current net worth and paying capacity of the obligor or of the collateral pledged. Loans have a well-defined weakness or weaknesses that jeopardize the liquidation of the debt. Loans are characterized by the distinct possibility that the Company will sustain some loss if the deficiencies are not corrected.

 

Doubtful: Loans classified doubtful have all the weaknesses inherent in those classified as substandard, with the added characteristic that weaknesses make collection or liquidation in full, on the basis of currently existing facts, conditions and values, highly questionable and improbable.

 

14
 

 

The following table provides information on the Company’s risk categories by loan class:

 

(Dollars in thousands)  As of March 31, 2019   As of December 31, 2018 
  Nonclassified   Classified   Nonclassified   Classified 
                 
One-to-four family residential real estate  $134,626   $1,245   $135,947   $948 
Construction and land   17,440    946    19,135    948 
Commercial real estate   129,045    12,103    126,619    12,348 
Commercial   71,275    7,828    66,490    7,799 
Agriculture   86,279    8,626    86,917    9,715 
Municipal   2,922    -    2,953    - 
Consumer   24,119    41    25,383    45 
Total  $465,706   $30,789   $463,444   $31,803 

 

At March 31, 2019, the Company had nine loan relationships consisting of thirteen outstanding loans that were classified as TDRs. There were no loans classified as TDRs during the first three months of 2018 or 2019.

 

The Company evaluates each TDR individually and returns the loan to accrual status when a payment history is established after the restructuring and future payments are reasonably assured. There were no loans modified as TDRs for which there was a payment default within 12 months of modification as of March 31, 2019 and 2018. The Company did not record any charge-offs against loans classified as TDRs in the first quarter of 2019 or 2018. No provision was recorded in the three months ended March 31, 2019 compared to a credit provision of $33,000 related to TDRs recorded in the three months ended March 31, 2018. The Company had $10,000 allowance for loan losses recorded against loans classified as TDRs at March 31, 2019 and December 31, 2018.

 

The following table presents information on loans that are classified as TDRs:

 

(Dollars in thousands)  As of March 31, 2019   As of December 31, 2018 
   Number of
loans
   Non-accrual balance   Accruing balance   Number of
loans
   Non-accrual balance   Accruing balance 
                         
One-to-four family residential real estate   2   $-   $179    2   $-   $181 
Construction and land   4    521    820    4    523    860 
Commercial real estate   1    -    2,024    2    -    2,121 
Commercial   1    32    -    1    36    - 
Agriculture   4    6    216    4    23    235 
Municipal   1    -    58    1    -    58 
Total troubled debt restructurings   13   $559   $3,297    14   $582   $3,455 

 

4. Goodwill and Other Intangible Assets

 

The Company tests goodwill for impairment annually or more frequently if circumstances warrant. The Company’s annual step one impairment test as of December 31, 2018 concluded that its goodwill was not impaired. The Company concluded there were no triggering events during the first three months of 2019 that required an interim goodwill impairment test.

 

15
 

 

Lease intangible assets are amortized over the life of the lease. Core deposit intangible assets are amortized over the estimated useful life of ten years on an accelerated basis. Mortgage servicing rights are amortized over the estimated life of the mortgage loan serviced for others. A summary of the other intangible assets that continue to be subject to amortization is as follows:

 

(Dollars in thousands)  As of March 31, 2019 
   Gross carrying amount   Accumulated amortization   Net carrying amount 
Core deposit intangible assets  $2,067   $(1,632)  $435 
Lease intangible asset   350    (244)   106 
Mortgage servicing rights   6,573    (4,189)   2,384 
Total other intangible assets  $8,990   $(6,065)  $2,925 

 

(Dollars in thousands)   As of December 31, 2018 
    Gross carrying amount    Accumulated amortization    Net carrying amount 
Core deposit intangible assets  $2,067   $(1,588)  $479 
Lease intangible asset   350    (233)   117 
Mortgage servicing rights   6,545    (4,050)   2,495 
Total other intangible assets  $8,962   $(5,871)  $3,091 

 

The following sets forth estimated amortization expense for core deposit and lease intangible assets for the remainder of 2019 and in successive years ending December 31:

 

(Dollars in thousands) 

Amortization

expense

 
Remainder of 2019  $159 
2020   177 
2021   121 
2022   58 
2023   26 
Total  $541 

 

Mortgage loans serviced for others are not reported as assets. The following table provides information on the principal balances of mortgage loans serviced for others:

 

(Dollars in thousands)  March 31,   December 31, 
   2019   2018 
FHLMC  $517,197   $521,489 
FHLB   12,079    10,603 
Total  $529,276   $532,092 

 

Custodial escrow balances maintained in connection with serviced loans were $7.8 million and $4.5 million at March 31, 2019 and December 31, 2018, respectively. Gross service fee income related to such loans was $335,000 and $336,000 for the three months ended March 31, 2019 and 2018, respectively, and is included in fees and service charges in the consolidated statements of earnings.

 

16
 

 

Activity for mortgage servicing rights is as follows:

 

   Three months ended 
(Dollars in thousands)  March 31, 
   2019   2018 
Mortgage servicing rights:          
Balance at beginning of period  $2,495   $2,811 
Additions   97    122 
Amortization   (208)   (211)
Balance at end of period  $2,384   $2,722 

 

The fair value of mortgage servicing rights was $5.7 million and $6.2 million at March 31, 2019 and December 31, 2018, respectively. Fair value at March 31, 2019 was determined using discount rates ranging from 8.76% to 11.00%; prepayment speeds ranging from 6.00% to 25.05%, depending on the stratification of the specific mortgage servicing right; and a weighted average default rate of 1.39%. Fair value at December 31, 2018 was determined using discount rates ranging from 9.00% to 11.00%, prepayment speeds ranging from 6.00% to 22.40%, depending on the stratification of the specific mortgage servicing right, and a weighted average default rate of 1.37%.

 

The Company had a mortgage repurchase reserve of $235,000 at both March 31, 2019 and December 31, 2018, which represents the Company’s best estimate of probable losses that the Company will incur related to the repurchase of one-to-four family residential real estate loans previously sold or to reimburse investors for credit losses incurred on loans previously sold where a breach of the contractual representations and warranties occurred. The Company did not incur any losses charged against the reserve or make any provisions to the reserve during the first three months of 2019 and 2018.

 

5. Earnings per Share

 

Basic earnings per share have been computed based upon the weighted average number of common shares outstanding during each period. Diluted earnings per share include the effect of all potential common shares outstanding during each period. The diluted earnings per share computations for the three months ended March 31, 2019 and 2018 excluded 30,859 unexercised stock options because their inclusion would have been anti-dilutive during such periods. The shares used in the calculation of basic and diluted earnings per share are shown below:

 

   Three months ended 
(Dollars in thousands, except per share amounts)  March 31, 
   2019   2018 
Net earnings  $2,183   $2,099 
           
Weighted average common shares outstanding - basic (1)   4,372,116    4,313,203 
Assumed exercise of stock options (1)   14,177    45,328 
Weighted average common shares outstanding - diluted (1)   4,386,293    4,358,531 
Net earnings per share (1):          
Basic  $0.50   $0.49 
Diluted  $0.50   $0.48 

 

  (1) Share and per share values for the period ended March 31, 2018 have been adjusted to give effect to the 5% stock dividend paid during December 2018.

 

17
 

 

6. Repurchase Agreements

 

The Company has overnight repurchase agreements with certain deposit customers whereby the Company uses investment securities as collateral for non-insured funds. These balances are accounted for as collateralized financing and included in other borrowings on the balance sheet. The following is a summary of the balances and collateral of the Company’s repurchase agreements:

 

(dollars in thousands)  As of March 31, 2019 
   Overnight and
Continuous
   Up to 30 days   30-90 days   Greater than
90 days
   Total 
Repurchase agreements:                                                
U.S. federal treasury obligations  $319   $-   $-   $-   $319 
U.S. federal agency obligations   4,423    -    -    -    4,423 
Agency mortgage-backed securities   12,071    -    -    -    12,071 
Total  $16,813   $-   $-   $-   $16,813 

 

   As of December 31, 2018 
   Overnight and
Continuous
   Up to 30 days   30-90 days   Greater than
90 days
   Total 
Repurchase agreements:                                                
U.S. federal treasury obligations  $416   $-   $-   $-   $416 
U.S. federal agency obligations   5,626    -    -    -    5,626 
Agency mortgage-backed securities   9,204    -    -    -    9,204 
Total  $15,246   $-   $-   $-   $15,246 

 

Repurchase agreements are comprised of non-insured customer funds, totaling $16.8 million at March 31, 2019 and $15.2 million at December 31, 2018, which were secured by $21.2 million and $18.6 million of the Company’s investment portfolio at the same dates, respectively.

 

The investment securities are held by a third party financial institution in the customer’s custodial account. The Company is required to maintain adequate collateral for each repurchase agreement. Changes in the fair value of the investment securities impact the amount of collateral required. If the Company were to default, the investment securities would be used to settle the repurchase agreement with the deposit customer.

 

7. Revenue from Contracts with Customers

 

All of the Company’s revenue from contracts with customers in the scope of ASC 606 is recognized within non-interest income. Items outside the scope of ASC 606 are noted as such.

 

   Three months ended 
(Dollars in thousands)  March 31, 
   2019   2018 
Non-interest income:          
Service charges on deposits          
Overdraft fees  $777   $797 
Other   126    138 
Interchange income   435    442 
Loan servicing fees (1)   335    336 
Office lease income (1)   161    152 
Gains on sales of loans (1)   1,120    1,161 
Bank owned life insurance income (1)   159    159 
Gains on sales of investment securities (1)   -    35 
Gains (losses) on sales of real estate owned   -    1 
Other   143    180 
Total non-interest income  $3,256   $3,401 

 

  (1) Not within the scope of ASC 606.

 

18
 

 

A description of the Company’s revenue streams under ASC 606 follows:

 

Service Charges on Deposit Accounts

 

The Company earns fees from its deposit customers for transaction-based, account maintenance, and overdraft services. Transaction-based fees, which include services such as ATM usage fees, stop payment charges, statement rendering, and ACH fees, are recognized at the time the transaction is executed as that is the point in time the Company fulfills the customer’s request. Account maintenance fees, which relate primarily to monthly maintenance, are earned over the course of a month, representing the period during which the Company satisfies the performance obligation. Overdraft fees are recognized at the point in time that the overdraft occurs. Service charges on deposits are withdrawn from the customer’s account balance.

 

Interchange Income

 

The Company earns interchange fees from debit cardholder transactions conducted through the interchange payment network. Interchange fees from cardholder transactions represent a percentage of the underlying transaction value and are recognized daily, concurrently with the transaction processing services provided to the cardholder.

 

Gains (Losses) on Sales of Real Estate Owned

 

The Company records a gain or loss from the sale of real estate owned when control of the property transfers to the buyer, which generally occurs at the time of an executed deed. When the Company finances the sale of real estate owned to the buyer, the Company assesses whether the buyer is committed to perform their obligations under the contract and whether collectability of the transaction price is probable. Once these criteria are met, the real estate owned asset is derecognized and the gain or loss on sale is recorded upon the transfer of control of the property to the buyer. In determining the gain or loss on the sale, the Company adjusts the transaction price and related gain (loss) on sale if a significant financing component is present. There were no sales of real estate owned that were financed by the Company during the first three months of 2019 or 2018.

 

8. Fair Value of Financial Instruments and Fair Value Measurements

 

Fair value is the exchange price that would be received for an asset or paid to transfer a liability (exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. There are three levels of inputs that may be used to measure fair values:

 

Level 1 – Quoted prices (unadjusted) for identical assets or liabilities in active markets that the entity has the ability to access as of the measurement date.

 

Level 2 – Significant other observable inputs other than Level 1 prices such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data.

 

Level 3 – Significant unobservable inputs that reflect a company’s own assumptions about the assumptions that market participants would use in pricing an asset or liability.

 

19
 

 

Fair value estimates of the Company’s financial instruments as of March 31, 2019 and December 31, 2018, including methods and assumptions utilized, are set forth below:

 

(Dollars in thousands)  As of March 31, 2019 
   Carrying amount   Level 1   Level 2   Level 3   Total 
Financial assets:                         
Cash and cash equivalents  $14,333   $14,333   $-   $-   $14,333 
Investment securities available-for-sale   387,392    2,281    385,111    -    387,392 
Bank stocks, at cost   2,994    n/a    n/a    n/a    n/a 
Loans, net   490,673    -    -    493,913    493,913 
Loans held for sale   6,607    -    6,607    -    6,607 
Derivative financial instruments   687    -    687    -    687 
Accrued interest receivable   4,792    11    2,089    2,692    4,792 
                          
Financial liabilities:                         
Non-maturity deposits  $(660,062)  $(660,062)  $-   $-    (660,062)
Time deposits   (161,739)   -    (160,152)   -    - 
FHLB borrowings   (10,300)   -    (10,300)   -    (10,300)
Subordinated debentures   (21,651)   -    (19,652)   -    - 
Other borrowings   (16,813)   -    (16,813)   -    (16,813)
Derivative financial instruments   (122)   -    (122)   -    (122)
Accrued interest payable   (445)   -    (445)   -    (445)

 

   As of December 31, 2018 
   Carrying amount   Level 1   Level 2   Level 3   Total 
Financial assets:                         
Cash and cash equivalents  $19,114   $19,114   $-   $-   $19,114 
Investment securities available-for-sale   388,345    1,971    386,374    -    388,345 
Bank stocks, at cost   4,776    n/a    n/a    n/a    n/a 
Loans, net   489,373    -    -    494,473    494,473 
Loans held for sale   4,743    -    4,743    -    4,743 
Derivative financial instruments   522    -    522    -    522 
Accrued interest receivable   4,631    -    2,194    2,437    4,631 
                          
Financial liabilities:                         
Non-maturity deposits  $(656,628)  $(656,628)  $-   $-    (656,628)
Time deposits   (167,020)   -    (164,994)   -    (164,994)
FHLB borrowings   (20,000)   -    (20,000)   -    (20,000)
Subordinated debentures   (21,651)   -    (19,678)   -    (19,678)
Other borrowings   (15,246)   -    (15,246)   -    (15,246)
Accrued interest payable   (442)   -    (442)   -    (442)
Derivative financial instruments   (25)   -    (25)   -    (25)

 

Transfers

 

The Company did not transfer any assets or liabilities among levels during the three months ended March 31, 2019 or during the year ended December 31, 2018.

 

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Valuation Methods for Instruments Measured at Fair Value on a Recurring Basis

 

The following tables represent the Company’s financial instruments that are measured at fair value on a recurring basis at March 31, 2019 and December 31, 2018, allocated to the appropriate fair value hierarchy:

 

(Dollars in thousands)      As of March 31, 2019 
       Fair value hierarchy 
   Total   Level 1   Level 2   Level 3 
Assets:                
Available-for-sale investment securities:                    
U. S. treasury securities  $2,281   $2,281   $-   $- 
U. S. federal agency obligations   6,885    -    6,885    - 
Municipal obligations, tax exempt   160,667    -    160,667    - 
Municipal obligations, taxable   54,514    -    54,514    - 
Mortgage-backed securities   155,622    -    155,622    - 
Certificates of deposit   7,423    -    7,423    - 
Loans held for sale   6,607    -    6,607    - 
Derivative financial instruments   687    -    687    - 
Liability:                    
Derivative financial instruments   (122)   -    (122)   - 

 

       As of December 31, 2018 
       Fair value hierarchy 
   Total   Level 1   Level 2   Level 3 
Assets:                
Available-for-sale investment securities:                    
U. S. treasury securities  $1,971   $1,971   $-   $- 
U. S. federal agency obligations   10,361    -    10,361    - 
Municipal obligations, tax exempt   159,112    -    159,112    - 
Municipal obligations, taxable   53,035    -    53,035    - 
Agency mortgage-backed securities   156,076    -    156,076    - 
Certificates of deposit   7,790    -    7,790    - 
Loans held for sale   4,743    -    4,743    - 
Derivative financial instruments   522    -    522    - 
Liabilities:                    
Derivative financial instruments   (25)   -    (25)   - 

 

The Company’s investment securities classified as available-for-sale include U.S. treasury securities, U.S. federal agency obligations, municipal obligations, agency mortgage-backed securities and certificates of deposits. Quoted exchange prices are available for the Company’s U.S treasury securities, which are classified as Level 1. U.S. federal agency securities and agency mortgage-backed securities are priced utilizing industry-standard models that consider various assumptions, including time value, yield curves, volatility factors, prepayment speeds, default rates, loss severity, current market and contractual prices for the underlying financial instruments, as well as other relevant economic measures. Substantially all of these assumptions are observable in the marketplace, can be derived from observable data, or are supported by observable levels at which transactions are executed in the marketplace. These measurements are classified as Level 2. Municipal obligations are valued using a type of matrix, or grid, pricing in which securities are benchmarked against U.S. treasury rates based on credit rating. These model and matrix measurements are classified as Level 2 in the fair value hierarchy.

 

Changes in the fair value of available-for-sale securities are included in other comprehensive income to the extent the changes are not considered other-than-temporary impairments. Other-than-temporary impairment tests are performed on a quarterly basis and any decline in the fair value of an individual security below its cost that is deemed to be other-than-temporary results in a write-down of that security’s cost basis.

 

21
 

 

Mortgage loans originated and intended for sale in the secondary market are carried at fair value. The mortgage loan valuations are based on quoted secondary market prices for similar loans and are classified as Level 2. Changes in the fair value of mortgage loans originated and intended for sale in the secondary market and derivative financial instruments are included in gains on sales of loans.

 

The aggregate fair value, contractual balance (including accrued interest), and gain on loans held for sale were as follows:

 

  

As of

March 31,

  

As of

December 31,

 
(Dollars in thousands)  2019   2018 
Aggregate fair value  $6,607   $4,743 
Contractual balance   6,403    4,687 
Gain  $204   $56 

 

The Company’s derivative financial instruments consist of interest rate lock commitments and corresponding forward sales contracts on mortgage loans held for sale. The fair values of these derivatives are based on quoted prices for similar loans in the secondary market. The market prices are adjusted by a factor, based on the Company’s historical data and its judgment about future economic trends, which considers the likelihood that a commitment will ultimately result in a closed loan. These instruments are classified as Level 2. The amounts are included in other assets or other liabilities on the consolidated balance sheets and gains on sales of loans, net in the consolidated statements of earnings. The total amount of gains from changes in fair value of loans held for sale included in earnings were as follows:

 

   Three months ended 
   March 31, 
(Dollars in thousands)  2019   2018 
Interest income  $51   $48 
Change in fair value   148    (99)
Total change in fair value  $199   $(51)

 

Valuation Methods for Instruments Measured at Fair Value on a Nonrecurring Basis

 

The Company does not value its loan portfolio at fair value. Collateral-dependent impaired loans are generally carried at the lower of cost or fair value of the collateral, less estimated selling costs. Collateral values are determined based on appraisals performed by qualified licensed appraisers hired by the Company and then further adjusted if warranted based on relevant facts and circumstances. The appraisals may utilize a single valuation approach or a combination of approaches including the comparable sales and income approach. Adjustments are routinely made in the appraisal process by the appraisers to adjust for differences between the comparable sales and income data available. Such adjustments are typically significant and result in a Level 3 classification of the inputs for determining fair value. Impaired loans are reviewed and evaluated at least quarterly for additional impairment and adjusted accordingly, based on the same factors identified above. The carrying value of the Company’s impaired loans was $10.0 million and $8.7 million, with an allocated allowance of $455,000 and $310,000, at March 31, 2019 and December 31, 2018, respectively.

 

Real estate owned includes assets acquired through, or in lieu of, foreclosure and land previously acquired for expansion. Real estate owned is initially recorded at the fair value of the collateral less estimated selling costs. Subsequent valuations are updated periodically and are based upon independent appraisals, third party price opinions or internal pricing models. The appraisals may utilize a single valuation approach or a combination of approaches including the comparable sales and income approach. Adjustments are routinely made in the appraisal process by the appraisers to adjust for differences between the comparable sales and income data available. Such adjustments are typically significant and result in a Level 3 classification of the inputs for determining fair value. Real estate owned is reviewed and evaluated at least annually for additional impairment and adjusted accordingly, based on the same factors identified above.

 

22
 

 

The following tables represent the Company’s financial instruments that are measured at fair value on a non-recurring basis as of March 31, 2019 and December 31, 2018 allocated to the appropriate fair value hierarchy:

 

(Dollars in thousands)                    
       As of March 31, 2019   Total 
       Fair value hierarchy   (losses)/ 
   Total   Level 1   Level 2   Level 3   gains 
Assets:                    
Impaired loans:                         
One-to-four family residential real estate  $162   $-   $-   $162   $(15)
Construction and land   328    -    -    328    7 
Commercial real estate   1,740    -    -    1,740    (173)
Commercial   106    -    -    106    6 

 

       As of December 31, 2018   Total 
       Fair value hierarchy   (losses)/ 
   Total   Level 1   Level 2   Level 3   gains 
Assets:                    
Impaired loans:                         
One-to-four family residential real estate  $110   $-   $-   $110   $(29)
Construction and land   322    -    -    322    (103)
Commercial real estate   1,725    -    -    1,725    377 
Commercial   55    -    -    55    (51)
Agriculture   175    -    -    175    11 

 

The following table presents quantitative information about Level 3 fair value measurements measured at fair value on a nonrecurring basis as of March 31, 2019 and December 31, 2018.

 

(Dollars in thousands)              
   Fair value   Valuation technique  Unobservable inputs  Range 
As of March 31, 2019                
Impaired loans:                
One-to-four family residential real estate  $162   Sales comparison  Adjustment to appraised value   0%-47%
Construction and land   328   Sales comparison  Adjustment to appraised value   20%-25%
Commercial real estate   1,740   Sales comparison  Adjustment to appraised value   0%-20%
Commercial   106   Sales comparison  Adjustment to comparable sales   15%-28%
                
As of December 31, 2018                
Impaired loans:                
One-to-four family residential real estate  $110   Sales comparison  Adjustment to appraised value   0%-20%
Construction and land   322   Sales comparison  Adjustment to appraised value   0%-25%
Commercial real estate   1,725   Sales comparison  Adjustment to appraised value   0%
Commercial   55   Sales comparison  Adjustment to comparable sales   0%-15%
Agriculture   175   Sales comparison  Adjustment to appraised value   0%

 

23
 

 

9. Regulatory Capital Requirements

 

Banks and bank holding companies are subject to regulatory capital requirements administered by federal banking agencies. Capital adequacy guidelines and, additionally for banks, prompt corrective action regulations involve quantitative measures of assets, liabilities, and certain off-balance-sheet items calculated under regulatory accounting practices. Capital amounts and classifications are also subject to qualitative judgments by regulators. Failure to meet capital requirements can initiate regulatory action. Management believed that as of March 31, 2019, the Company and the Bank met all capital adequacy requirements to which they were subject at that time.

 

Prompt corrective action regulations provide five classifications: well capitalized, adequately capitalized, undercapitalized, significantly undercapitalized, and critically undercapitalized, although these terms are not used to represent overall financial condition. If adequately capitalized, regulatory approval is required to accept brokered deposits. If undercapitalized, capital distributions are limited, as is asset growth and expansion, and capital restoration plans are required. The Company and the Bank are subject to the Basel III Rule, which is applicable to all U.S. banks that are subject to minimum capital requirements, as well as to bank and savings and loan holding companies other than “small bank holding companies” (generally, non-public bank holding companies with consolidated assets of less than $3.0 billion).

 

The Basel III Rule includes a common equity Tier 1 capital to risk-weighted assets minimum ratio of 4.5%, a minimum ratio of Tier 1 capital to risk-weighted assets of 6.0%, a minimum ratio of Total Capital to risk-weighted assets of 8.0%, and a minimum Tier 1 leverage ratio of 4.0%. A capital conservation buffer, comprised of common equity Tier 1 capital, is also established above the regulatory minimum capital requirements. This capital conservation buffer was 0.625% for 2016, 1.25% for 2017, 1.875% for 2018, and increased to its final level of 2.5% on January 1, 2019. The capital conservation buffer increases the common equity Tier 1 capital ratio, and Tier 1 capital and total risk based capital ratios.

 

As of March 31, 2019 and December 31, 2018, the most recent regulatory notifications categorized the Bank as well capitalized under the regulatory framework for prompt corrective action then in effect. There are no conditions or events since that notification that management believes have changed the institution’s category.

 

The following is a comparison of the Company’s regulatory capital to minimum capital requirements at March 31, 2019 and December 31, 2018:

 

(Dollars in thousands)      For capital 
   Actual   adequacy purposes 
   Amount   Ratio   Amount   Ratio (1) 
As of March 31, 2019                
Leverage  $100,607    10.46%  $38,457    4.0%
Common Equity Tier 1 Capital   79,607    13.19%   42,262    7.0%
Tier 1 Capital   100,607    16.66%   51,318    8.5%
Total Risk Based Capital   106,685    17.67%   63,392    10.5%
                     
As of December 31, 2018                    
Leverage  $99,150    10.34%  $38,373    4.0%
Common Equity Tier 1 Capital   78,150    13.12%   37,982    6.4%
Tier 1 Capital   99,150    16.64%   46,919    7.9%
Total Risk Based Capital   105,055    17.63%   58,835    9.9%

 

  (1) The required ratios for capital adequacy purposes include a capital conservation buffer of 2.5% for March 31, 2019 and 1.875% for December 31, 2018

 

24
 

 

The following is a comparison of the Bank’s regulatory capital to minimum capital requirements at March 31, 2019 and December 31, 2018:

 

           To be well-capitalized 
           under prompt 
(Dollars in thousands)      For capital   corrective 
   Actual   adequacy purposes   action provisions 
   Amount   Ratio   Amount   Ratio(1)   Amount   Ratio 
As of March 31, 2019                              
Leverage  $98,316    10.26%  $38,343    4.0%  $47,929    5.0%
Common Equity Tier 1 Capital   98,316    16.31%   42,195    7.0%   39,181    6.5%
Tier 1 Capital   98,316    16.31%   51,237    8.5%   48,223    8.0%
Total Risk Based Capital   104,394    17.32%   63,293    10.5%   60,279    10.0%
                               
As of December 31, 2018                              
Leverage  $97,112    10.15%  $38,254    4.0%  $47,818    5.0%