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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 


FORM 10-K

 


(Mark One)

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

For the Fiscal Year Ended December 31, 2018

 

For the Fiscal Year Ended December 31, 2017OR

 

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: 001-33033

 


PORTERLIMESTONE BANCORP, INC.

(Exact name of registrant as specified in its charter)


 

Kentucky

61-1142247

(State or other jurisdiction of

incorporation or organization)

(I.R.S. Employer Identification No.)

 

2500 Eastpoint Parkway, Louisville, Kentucky

40223

(Address of principal executive offices)

(Zip Code)

Registrant’s

Registrant’s telephone number, including area code: (502) 499-4800

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

 

Title of each class

Name of each exchange on which registered

Common Stock, no par value

Nasdaq Capital Market

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

None

Indicate by check mark if the registrant is a well-known seasoned issuer (as defined in Rule 405 of the Securities Act).    Yes  ☐    No  ☒

 

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.    Yes  ☐    No  ☒

 

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 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  ☒    No  ☐

 

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

 

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.

 

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

 

   Large accelerated filer  ☐    Accelerated filer  ☐    Non-accelerated filer  ☐    Smaller reporting company  ☒    Emerging growth company  ☐

Large accelerated filer  ☐Accelerated filer  ☒Non-accelerated filer  ☐Smaller reporting company  ☒Emerging growth company  ☐

 

If an emerging growth company, indicateindicate 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 pursuant to Section 13(a) of the Exchange Act.    Yes  ☐    No  ☐

 

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

The aggregate market value of the voting and non-voting common equity held by non-affiliates computed by reference to the price at which the common equity was last sold as of the close of business on June 30, 2017,2018, was $22,183,313$79,786,048 based upon the last sales price reported for such date(for purposes of this calculation, the market value of non-voting common shares was based on the Nasdaq Capital Market.market value of the common shares into which they are convertible upon transfer).

 

6,039,8646,261,945 Common Shares and 220,0001,220,000 Non-Voting Common Shares were outstanding as of February 28, 2018.2019.

 

DOCUMENTS INCORPORATED BY REFERENCE

 

Portions of the registrant’sregistrant’s Proxy Statement for the Annual Meeting of Shareholders to be held May 23, 2018June 19, 2019 are incorporated by reference into Part III of this Form 10-K.



 

 

 

 

TABLE OF CONTENTS

 

 

 

Page No.

PART I

 

1

Item 1.

Business

1

Item 1A.

Risk Factors

9

Item 1B.

Unresolved Staff Comments

1817

Item 2.

Properties

1817

Item 3.

Legal Proceedings

1817

Item 4.

Mine Safety Disclosures

1817

   

PART II

 

1918

Item 5.

Market for Registrant’sRegistrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

1918

Item 6.

Selected Financial Data

2121

Item 7.

Management’sManagement’s Discussion and Analysis of Financial Condition and Results of Operation

2222

Item 7A.

Quantitative and Qualitative Disclosures About Market Risk

5246

Item 8.

Financial Statements and Supplementary Data

5448

Item 9.

Changes in and Disagreements With Accountants on Accounting and Financial Disclosure

9790

Item 9A.

Controls and Procedures

9790

Item 9B.

Other Information

9790

   

PART III

 

9891

Item 10.

Directors, Executive Officers and Corporate Governance

9891

Item 11.

Executive Compensation

9891

Item 12.

Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters

9891

Item 13.

Certain Relationships and Related Transactions, and Director Independence

9891

Item 14.

Principal Accounting Fees and Services

9891

   

PART IV

 

9992

Item 15.

Exhibits andExhibits. Financial Statement Schedules

9992

 

Index to Exhibits

93

          Item 16.

100Form 10-K Summary

94

   

 

Signatures 

10295

 

 

 

 

PART I

 

Preliminary Note Concerning Forward-Looking Statements

 

This report contains statements about the future expectations, activities and events that constitute forward-looking statements. Forward-looking statements express our beliefs, assumptions and expectations of our future financial and operating performance and growth plans, taking into account information currently available to us. These statements are not statements of historical fact. The words “believe,” “may,” “should,” “anticipate,” “estimate,” “expect,” “intend,” “objective,” “seek,” “plan,” “strive” or similar words, or the negatives of these words, identify forward-looking statements.

 

Forward-looking statements involve risks and uncertainties that may cause our actual results to differ materially from the expectations of future results wemanagement expressed or implied in any forward-looking statements. These risks and uncertainties can be difficult to predict and may be beyond our control. Factors that could contribute to differences in our results include, but are not limited to deterioration in the financial condition of borrowers resulting in significant increases in loan losses and provisions for those losses; changes in the interest rate environment, which may reduce our margins or impact the value of securities, loans, deposits and other financial instruments; changes in loan underwriting, credit review or loss reserve policies associated with economic conditions, examination conclusions, or regulatory developments; general economic or business conditions, either nationally, regionally or locally in the communities we serve,the Bank serves, may be worse than expected, resulting in, among other things, a deterioration in credit quality or a reduced demand for credit; the results of regulatory examinations; any matter that would cause us to conclude that there was impairment of any asset, including intangible assets; the continued service of key management personnel; our ability to attract, motivate and retain qualified employees; factors that increase the competitive pressure among depository and other financial institutions, including product and pricing pressures; the ability of our competitors with greater financial resources to develop and introduce products and services that enable them to compete more successfully than us; inability to comply with regulatory capital requirements and to secure any required regulatory approvals for capital actions; legislative or regulatory developments, including changes in laws concerning taxes, banking, securities, insurance and other aspects of the financial services industry; and fiscal and governmental policies of the United States federal government.

 

Other risks are detailed in Item 1A. “Risk Factors” of this Form 10-K all of which are difficult to predict and many of which are beyond our control.

 

Forward-looking statements are not guarantees of performance or results. A forward-looking statement may include the assumptions or bases underlying the forward-looking statement. We haveManagement has made our assumptions and bases in good faith and believe they are reasonable. We caution you however,However, that estimates based on such assumptions or bases frequently differ from actual results, and the differences can be material. The forward-looking statements included in this report speak only as of the date of the report. We doManagement does not intend to update these statements unless required by applicable laws require us to do so.laws.

 

Item 1.

Business Overview

 

As used in this report, references to the“the Company,” “we,” “our,” “us,” and similar terms refer to the consolidated entity consisting of PorterLimestone Bancorp, Inc. and its wholly-owned subsidiary. The “Bank” refers to PorterLimestone Bancorp, Inc.’s bank subsidiary, Limestone Bank, Inc.

 

The Company is a bank holding company headquartered in Louisville, Kentucky. The Company’s common stock is traded on Nasdaq’s Capital Market under the symbol PBIB. We operate theLMST. The Company operates Limestone Bank our(the Bank), its wholly owned subsidiary and the fifteenththirteenth largest bank domiciled in the Commonwealth of Kentucky based on total assets (formerly known as PBI Bank). We operateassets. The Bank operates banking offices in twelve counties in Kentucky. OurThe Bank’s markets include metropolitan Louisville in Jefferson County and the surrounding counties of Henry and Bullitt. We serveThe Bank serves south central Kentucky and southern Kentucky from banking offices in Butler, Green, Hart, Edmonson, Barren, Warren, Ohio, and Daviess Counties. WeThe Bank also havehas an office in Lexington, the second largest city in Kentucky. The Bank is a community bank with a wide range of commercial and personal banking products. As of December 31, 2017, we2018, the Company had total assets of $970.8 million,$1.07 billion, total loans of $712.1$765.2 million, total deposits of $847.0$894.2 million and stockholders’ equity of $72.7$92.1 million.

 

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Our Markets

 

We operateThe Bank operates in markets that include the four largest cities in Kentucky – Louisville, Lexington, Bowling Green and Owensboro – and in other communities along the I-65, Western Kentucky Parkway, and Natcher Parkway corridors.

 

 

Louisville/Jefferson, Bullitt and Henry Counties: Our headquarters are in Louisville, the largest city in Kentucky. WeThe Bank also havehas banking offices in Bullitt County, south of Louisville, and Henry County, east of Louisville. Our banking offices in these counties also serve the contiguous counties of Spencer, Shelby and Oldham to the east and northeast of Louisville. The area’s major employers are diversified across many industries and include the air hub for United Parcel Service (“UPS”), two Ford assembly plants, GE Appliances and Lighting, Humana, Norton Healthcare, Brown-Forman, YUM! Brands, Papa John’s Pizza, and Texas Roadhouse.

 

 

Lexington/Fayette County: Lexington, located in Fayette County, is the second largest city in Kentucky. Lexington is the financial, educational, retail, healthcare and cultural hub for Central and Eastern Kentucky. It is known worldwide for its horse farms and Keeneland Race Track, and proudly boasts of itself as “The Horse Capital of the World”. It is also the home of the University of Kentucky and Transylvania University. The area’s major employers include Toyota, Lexmark, IBM Global Services and Valvoline.

 

 

Southern Kentucky: This market includes Bowling Green, the third largest city in Kentucky, located about 120 miles south of Louisville and 60 miles north of Nashville, Tennessee. Bowling Green, located in Warren County, is the home of Western Kentucky University and is the economic hub of the area. This market also includes communities in the contiguous Barren County, including the city of Glasgow. Major employers in Barren and Warren Counties include GM’sGeneral Motor’s Corvette plant, automotive supply chain manufacturers, and R.R. Donnelley’s regional printing facility.

 

 

Owensboro/Daviess County: Owensboro, located on the banks of the Ohio River, is Kentucky’s fourth largest city. The city is called a festival city, with over 20 annual community celebrations that attract visitors from around the world, including its world famous Bar-B-Q Festival which attracts over 80,000 visitors. It is an industrial, medical, retail and cultural hub for Western Kentucky and the area employers include Owensboro Medical System, US Bank Home Mortgage, Titan Contracting, and Specialty Food Group.Group, and Toyotetsu.

 

 

South Central Kentucky: South of the Louisville metropolitan area, we havethe Bank has banking offices in Butler, Edmonson, Green, Hart, and Ohio Counties. This region includes stable community markets comprised primarily of agricultural and service-based businesses. Each of our banking offices in these markets has a stable customer and core deposit base.

 

Our Products and Services

 

We meet our customersThe Bank meets its customers’ banking needs with a broad range of financial products and services. OurIts lending services include real estate, commercial, mortgage, agriculture, and consumer loans to those in ourits communities and to small to medium-sized businesses, the owners and employees of those businesses, as well as other executives and professionals. We complement our lending operations with an array of retail and commercial deposit products. In addition, we offer our customers drive-through banking facilities, automatic teller machines, night depository, personalized checks, credit cards, debit cards, internet banking, mobile banking, treasury management services, remote deposit services, electronic funds transfers through ACH services, domestic and foreign wire transfers, cash management and vault services, along withand loan and deposit sweep accounts.

 

Employees

 

At December 31, 2017,2018, the Company had 217214 full-time equivalent employees. Our employees are not subject to a collective bargaining agreement, and management considers the Company’s relationship with employees to be good.

 

Competition

 

The banking business is highly competitive, and we experiencethe Bank experiences competition from many other financial institutions.institutions and non-bank financial competitors. Competition among financial institutions is based upon interest rates offered on deposit accounts, interest rates charged on loans, other credit and service charges relating to loans, the quality and scope of the services offered, the convenience of banking facilities, the availability of technology channels and, in the case of loans to commercial borrowers, relative lending limits. We competeThe Bank competes with commercial banks, credit unions, savings and loan associations, mortgage banking firms, consumer finance companies, securities brokerage firms, insurance companies, money market funds and other mutual funds, as well as super-regional, national and international financial institutions that operate offices within our market area and beyond.

 

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Supervision and Regulation  

 

Written Agreement. On September 21, 2011, we entered into a written agreement (“Written Agreement”) with the Federal Reserve Bank of St. Louis. The Company made formal commitments in the Written Agreement to use its financial and management resources to serve as a source of strength for the Bank and to assist the Bank in addressing weaknesses identified by the FDIC and the KDFI, to pay no dividends without prior written approval, to pay no interest or principal on subordinated debentures or trust preferred securities without written approval, and to submit an acceptable plan to maintain sufficient capital.

Bank and Holding Company Laws, Rules and Regulations. The following is a summary description of the relevant laws, rules and regulations governing banks and bank holding companies. The descriptions of, and references to, the statutes and regulations below are brief summaries and do not purport to be complete. The descriptions are qualified in their entirety by reference to the specific statutes and regulations discussed.

 

The Dodd-Frank Act. On July 21, 2010, the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (“Dodd-Frank Act”) was signed into law. The Dodd-Frank Act imposed new restrictions and an expanded framework of regulatory oversight for financial institutions, including depository institutions.

 

The Dodd-Frank Act represents a comprehensive overhaul of the financial services industry within the United States. There are a number of reform provisions that significantly impact the ways in which banks and bank holding companies, including the Company and the Bank, do business. For example, regulations issued under the Dodd-Frank Act changed the assessment base for federal deposit insurance premiums by modifying the assessment base calculation to be based on a depository institution’s consolidated assets less tangible capital instead of deposits, and permanently increased the standard maximum amount of deposit insurance per customer to $250,000. The Dodd-Frank Act also imposed more stringent capital requirements on bank holding companies by, among other things, imposing leverage ratios on bank holding companies and prohibiting new trust preferred security issuances from counting as Tier I capital. The Dodd-Frank Act also repealed the federal prohibition on the payment of interest on demand deposits, thereby permitting depository institutions to pay interest on business transaction and other accounts. The Dodd-Frank Act codified and expanded the Federal Reserve’s source of strength doctrine, which requires that all bank holding companies serve as a source of financial strength for its subsidiary banks. Other provisions of the Dodd-Frank Act include, but are not limited to: (i) the creation of a financialthe Consumer Financial Protection Bureau with rulemaking authority with respect to consumer protection agency that is empowered to promulgate new consumer protection regulations and revise existing regulations in many areas of consumer protection;laws; (ii) enhanced regulation of financial markets, including derivatives and securitization markets; (iii) reform related to the regulation of credit rating agencies; (iv) the elimination of certain trading activities by banks; and (v) new disclosure and other requirements relating to executive compensation and corporate governance.

Many provisions The implementation of the Dodd-Frank Act require interpretation and rule-making by federal agencies. The Company monitors all relevant sections of the Dodd-Frank Act to ensure continued compliance with laws and regulations, which resultshas resulted in greater compliance costs and higher fees paid to regulators. Future implementation

Economic Growth, Regulatory Relief, and Consumer Protection Act. The Economic Growth, Regulatory Relief and Consumer Protection Act was signed into law on May 25, 2018. This Act amended certain provisions of the Dodd-Frank Act may result in restrictions on the Company’s operations.and other banking laws. The amendments are designed to provide regulatory relief to banking organizations, primarily small, community banking organizations, by adjusting thresholds at which increased regulatory requirements begin to apply. When fully implemented through regulations, community banking organizations with assets of less than $10 billion will be subject to reduced reporting requirements and an optional simplified capital adequacy measure will be available to those that have a leverage ratio greater than 9%.

 

PorterLimestone Bancorp. The Company is registered as a bank holding company under the Bank Holding Company Act of 1956, as amended, and is subject to supervision and regulation by the Board of Governors of the Federal Reserve System (the “Federal Reserve Board”). As such, wethe Company must file with the Federal Reserve Board annual and quarterly reports and other information regarding our business operations and the business operations of our subsidiaries. We areThe Company is also subject to examination by the Federal Reserve Board and to operational guidelines established by the Federal Reserve Board. We areThe Company is subject to the Bank Holding Company Act and other federal laws on the types of activities in which we may engage, and to other supervisory requirements, including regulatory enforcement actions for violations of laws and regulations.

 

Acquisitions. A bank holding company must obtain Federal Reserve Board approval before acquiring, directly or indirectly, ownership or control of more than 5% of the voting stock or all or substantially all of the assets of a bank, merging or consolidating with any other bank holding company and before engaging, or acquiring a company that is not a bank and is engaged in certain non-banking activities. Federal law also prohibits a person or group of persons from acquiring “control” of a bank holding company without notifying the Federal Reserve Board in advance, and then may only do so if the Federal Reserve Board does not object to the proposed transaction. The Federal Reserve Board has established a rebuttable presumptive standard that the acquisition of 10% or more of the voting stock of a bank holding company would constitute an acquisition of control of the bank holding company. In addition, approval of the Federal Reserve Board is required before acquiring 25% (5% in the case of an acquirer that is a bank holding company) or more of any class of a bank holding company’s voting securities, or otherwise obtaining control or a “controlling influence” over a bank holding company.

 

Permissible Activities. A bank holding company is generally permitted under the Bank Holding Company Act to engage in or acquire direct or indirect control of more than 5% of the voting shares of any bank, bank holding company or company engaged in any activity that the Federal Reserve Board determines to be so closely related to banking as to be a proper incident to the business of banking.

 

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Under current federal law, a bank holding company may elect to become a financial holding company, which enables the holding company to conduct activities that are “financial in nature,,” incidental to financial activity, or complementary to financial activity that do not pose a substantial risk to the safety and soundness of depository institutions or the financial system generally. Activities that are “financial in nature” include securities underwriting, dealing and market making in securities; sponsoring mutual funds and investment companies; insurance underwriting and agency; merchant banking activities; and activities that the Federal Reserve Board has determined to be closely related to banking. No regulatory approval is required for a financial holding company to acquire a company, other than a bank or savings association, engaged in activities that are financial in nature or incidental to activities that are financial in nature, as determined by the Federal Reserve Board. We haveThe Bank has not filed an election to become a financial holding company.

Capital Adequacy Requirements. Both the Company and the Bank are required to comply with capital adequacy guidelines. Guidelines are established by the Federal Reserve Board for the Company and the FDIC for the Bank. Both the Federal Reserve Board and the FDIC have substantially similar risk based and leverage ratio guidelines for banking organizations, which are intended to ensure that banking organizations have adequate capital related to the risk levels of assets and off-balance sheet instruments. The capital adequacy guidelines are minimum supervisory ratios generally applicable to banking organizations that meet certain specified criteria, assuming they have the highest regulatory rating. Banking organizations not meeting these criteria are expected to operate with capital positions well above the minimum ratios. The federal bank regulatory agencies may set capital requirements for a particular banking organization that are higher than the minimum ratios when circumstances warrant. Federal Reserve Board guidelines also provide that banking organizations experiencing internal growth or making acquisitions will be expected to maintain strong capital positions substantially above the minimum supervisory levels, without significant reliance on intangible assets.

In July 2013, the Federal Reserve Board and the FDIC approved final rules that substantially amended the regulatory risk-based capital rules applicable to the Company and Bank. The final rules implement the regulatory capital reforms of the Basel Committee on Banking Supervision reflected in “Basel III: A Global Regulatory Framework for More Resilient Banks and Banking Systems” (“Basel III”) and changes required by the Dodd-Frank Act. The final rules implementing the Basel III regulatory capital reforms became effective for the Company and Bank on January 1, 2015, and include new minimum risk-based capital and leverage ratios. These rules refine the definition of what constitutes “capital” for purposes of calculating the capital ratios.

The Basel III minimum capital level requirements applicable to bank holding companies and banks subject to the rules are a common equity Tier 1 capital ratio of 4.5%, a Tier 1 risk-based capital ratio of 6%, a total risk-based capital ratio of 8%, and a Tier 1 leverage ratio of 4% for all institutions. The rules also establish a “capital conservation buffer” of 2.5%, to be phased in over three years, above the regulatory minimum risk-based capital ratios. Once the capital conservation buffer is fully phased in, the minimum ratios area common equity Tier 1 risk-based capital ratio of 7.0%, a Tier 1 risk-based capital ratio of 8.5%, and a total risk-based capital ratio of 10.5%.

The phase-in of the capital conservation buffer requirement began in January 2016 at 0.625% of risk-weighted assets and increases each year until fully implemented in January 2019. An institution is subject to limitations on paying dividends, engaging in share repurchases and paying discretionary bonuses if capital levels fall below minimum levels plus the buffer amounts. These limitations establish a maximum percentage of eligible retained income that could be utilized for such actions.

Under these new rules, Tier 1 capital generally consists of common stock (plus related surplus) and retained earnings, limited amounts of minority interest in the form of additional Tier 1 capital instruments, and non-cumulative preferred stock and related surplus, subject to certain eligibility standards, less goodwill and other specified intangible assets and other regulatory deductions. Tier 2 capital may consist of subordinated debt, certain hybrid capital instruments, qualifying preferred stock and a limited amount of the allowance for loan losses. Proceeds of trust preferred securities are excluded from Tier 1 capital unless issued before 2010 by an institution with less than $15 billion of assets. Total capital is the sum of Tier 1 and Tier 2 capital.

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Prompt Corrective Action. Pursuant to the Federal Deposit Insurance Act (“FDIA”), the FDIC must take prompt corrective action to resolve the problems of undercapitalized institutions. FDIC regulations define the levels at which an insured institution would be considered “well capitalized,” “adequately capitalized,” “undercapitalized,” “significantly undercapitalized” and “critically undercapitalized”. A bank is “undercapitalized” if it fails to meet any one of the ratios required to be adequately capitalized. A depository institution may be deemed to be in a capitalization category that is lower than is indicated by its actual capital position if it receives an unsatisfactory examination rating. The degree of regulatory scrutiny increases and the permissible activities of a bank decrease, as the bank moves downward through the capital categories. Depending on a bank’s level of capital, the FDIC’s corrective powers include:

requiring a capital restoration plan;

placing limits on asset growth and restriction on activities;

requiring the bank to issue additional voting or other capital stock or to be acquired;

placing restrictions on transactions with affiliates;

restricting the interest rate the bank may pay on deposits;

ordering a new election of the bank’s board of directors;

requiring that certain senior executive officers or directors be dismissed;

prohibiting the bank from accepting deposits from correspondent banks;

requiring the bank to divest certain subsidiaries;

prohibiting the payment of principal or interest on subordinated debt; and

ultimately, appointing a receiver for the bank.

If an institution is required to submit a capital restoration plan, the institution’s holding company must guarantee the subsidiary’s compliance with the capital restoration plan up to a certain specified amount. Any such guarantee from a depository institution’s holding company is entitled to a priority of payment in bankruptcy. The aggregate liability of the holding company of an undercapitalized bank is limited to the lesser of 5% of the institution’s assets at the time it became undercapitalized or the amount necessary to cause the institution to be “adequately capitalized.” The bank regulators have greater power in situations where an institution becomes “significantly” or “critically” undercapitalized or fails to submit a capital restoration plan. For example, a bank holding company controlling such an institution can be required to obtain prior Federal Reserve Board approval of proposed dividends, or might be required to consent to a consolidation or to divest the troubled institution or other affiliates.

Dividends. Under Federal Reserve Board policy, bank holding companies should pay cash dividends on common stock only out of income available over the past year and only if prospective earnings retention is consistent with the organization’s expected future needs and financial condition. The policy provides that bank holding companies should not declare a level of cash dividends that undermines the bank holding company’s ability to serve as a source of strength to its banking subsidiaries.

 

The Company is a legal entity separate and distinct from the Bank. Historically, the majority of the Company’s revenue has been from dividends paid to it by the Bank. The Bank is subject to laws and regulations that limit the amount of dividends it can pay. If, in the opinion of a federal regulatory agency, an institution under its jurisdiction is engaged in or is about to engage in an unsafe or unsound practice, the agency may require, after notice and hearing, that the institution cease such practice. The federal banking agencies have indicated that paying dividends that deplete an institution’s capital base to an inadequate level would be an unsafe and unsound banking practice. Under the Federal Deposit Insurance Corporation Improvement Act (“FDICIA”), an insured institution may not pay any dividend if payment would cause it to become undercapitalized or if it already is undercapitalized. Moreover, the Federal Reserve and the FDIC have issued policy statements providing that bank holding companies and banks should generally pay dividends only out of current operating earnings. A bank holding company may still declare and pay a dividend if it does not have current operating earnings if the bank holding company expects profits for the entire year and the bank holding company obtains the prior consent of the Federal Reserve.

 

Under Kentucky law, dividends by Kentucky banks may be paid only from current or retained net profits. The KDFI must approve the declaration of dividends if the total dividends to be declared by a bank for any calendar year would exceed the bank’s total net profits for such year combined with its retained net profits for the preceding two years, less any required transfers to surplus or a fund for the retirement of preferred stock or debt. Additionally, retained earnings must be positive. We areThe Company is also subject to the Kentucky Business Corporation Act, which generally prohibits dividends to the extent they result in the insolvency of the corporation from a balance sheet perspective or inif the corporation becomingis unable to pay its debts as they come due. The Bank did not pay any dividends in 20172018 or 20162017. The Bank has negative retained earnings and cannot currently pay any dividends without prior regulatory approval.

 

With respect to the payment of dividends, Porter Bancorp’s issued and outstanding Series E and Series F Preferred Shares rank senior to its common shares and non-voting common shares.

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Source of Financial Strength. Under Federal Reserve policy, a bank holding company is expected to act as a source of financial strength to, and to commit resources to support, its bank subsidiaries. This support may be required at times when, absent such a policy, the bank holding company may not be inclined to provide it. In addition, any capital loans by the bank holding company to its bank subsidiaries are subordinate in right of payment to deposits and to certain other indebtedness of the bank subsidiary. In the event of a bank holding company’s bankruptcy, any commitment by the bank holding company to a federal bank regulatory agency to maintain the capital of subsidiary banks will be assumed by the bankruptcy trustee and entitled to a priority of payment. The Federal Reserve’s “Source of Financial Strength” policy was codified in the Dodd-Frank Act.

 

Limestone Bank. The Bank, a Kentucky chartered commercial bank, is subject to regular bank examinations and other supervision and regulation by both the FDIC and the KDFI. Kentucky’s banking statutes contain a “super-parity” provision that permits a well-rated Kentucky banking corporation to engage in any banking activity which could be engaged in by a national bank operating in Kentucky; a state bank, a thrift or savings bank operating in any other state; or a federal chartered thrift or federal savings association meeting the qualified thrift lender test and operating in any state could engage, provided the Kentucky bank first obtains a legal opinion specifying the statutory or regulatory provisions that permit the activity.

 

Capital Adequacy Requirements. Please seeThe Company and the Bank are required to comply with capital adequacy guidelines. Guidelines are established by the Federal Reserve Board for the Company and the FDIC for the Bank. Both the Federal Reserve Board and the FDIC have substantially similar risk based and leverage ratio guidelines for banking organizations, which are intended to ensure that banking organizations have adequate capital related to the risk levels of assets and off-balance sheet instruments. The capital adequacy guidelines are minimum supervisory ratios generally applicable to banking organizations that meet certain specified criteria, assuming they have the highest regulatory rating. Banking organizations not meeting these criteria are expected to operate with capital positions well above the minimum ratios. The federal bank regulatory agencies may set capital requirements discussion above.for a particular banking organization that are higher than the minimum ratios when circumstances warrant. Federal Reserve Board guidelines also provide that banking organizations experiencing internal growth or making acquisitions will be expected to maintain strong capital positions substantially above the minimum supervisory levels, without significant reliance on intangible assets.

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In July 2013, the Federal Reserve Board and the FDIC approved final rules that substantially amended the regulatory risk-based capital rules applicable to the Company and Bank. The final rules implement the regulatory capital reforms of the Basel Committee on Banking Supervision reflected in “Basel III: A Global Regulatory Framework for More Resilient Banks and Banking Systems” (“Basel III”) and changes required by the Dodd-Frank Act, and became effective for the Company and Bank on January 1, 2015.

The Basel III minimum capital level requirements applicable to bank holding companies and banks subject to the rules are  a common equity Tier 1 capital ratio of 4.5%, a Tier 1 risk-based capital ratio of 6%, a total risk-based capital ratio of 8%, and a Tier 1 leverage ratio of 4% for all institutions. The rules also establish a “capital conservation buffer” of 2.5% above the regulatory minimum risk-based capital ratios, which was fully phased in as of January 1, 2019. With the capital conservation buffer fully phased in, the required ratios area common equity Tier 1 risk-based capital ratio of 7.0%, a Tier 1 risk-based capital ratio of 8.5%, and a total risk-based capital ratio of 10.5%.

An institution is subject to limitations on paying dividends, engaging in share repurchases and paying discretionary bonuses if capital levels fall below minimum levels plus the buffer amounts. These limitations establish a maximum percentage of eligible retained income that could be utilized for such actions.

Under the Basel III capital rules, Tier 1 capital generally consists of common stock (plus related surplus) and retained earnings, limited amounts of minority interest in the form of additional Tier 1 capital instruments, and non-cumulative preferred stock and related surplus, subject to certain eligibility standards, less goodwill and other specified intangible assets and other regulatory deductions. Tier 2 capital may consist of subordinated debt, certain hybrid capital instruments, qualifying preferred stock and a limited amount of the allowance for loan losses. Proceeds of trust preferred securities are excluded from Tier 1 capital unless issued before 2010 by an institution with less than $15 billion of assets. Total capital is the sum of Tier 1 and Tier 2 capital.

Prompt Corrective Action. Pursuant to the Federal Deposit Insurance Act (“FDIA”), the FDIC must take prompt corrective action to resolve the problems of undercapitalized institutions. FDIC regulations define the levels at which an insured institution would be considered “well capitalized,” “adequately capitalized,” “undercapitalized,” “significantly undercapitalized” and “critically undercapitalized”. A bank is “undercapitalized” if it fails to meet any one of the ratios required to be adequately capitalized. A depository institution may be deemed to be in a capitalization category that is lower than is indicated by its actual capital position if it receives an unsatisfactory examination rating. The degree of regulatory scrutiny increases and the permissible activities of a bank decrease, as the bank moves downward through the capital categories. Depending on a bank’s level of capital, the FDIC’s corrective powers include:

requiring a capital restoration plan;

placing limits on asset growth and restriction on activities;

requiring the bank to issue additional voting or other capital stock or to be acquired;

placing restrictions on transactions with affiliates;

restricting the interest rate the bank may pay on deposits;

ordering a new election of the bank’s board of directors;

requiring that certain senior executive officers or directors be dismissed;

prohibiting the bank from accepting deposits from correspondent banks;

requiring the bank to divest certain subsidiaries;

prohibiting the payment of principal or interest on subordinated debt; and

ultimately, appointing a receiver for the bank.

If an institution is required to submit a capital restoration plan, the institution’s holding company must guarantee the subsidiary’s compliance with the capital restoration plan up to a certain specified amount. Any such guarantee from a depository institution’s holding company is entitled to a priority of payment in bankruptcy. The aggregate liability of the holding company of an undercapitalized bank is limited to the lesser of 5% of the institution’s assets at the time it became undercapitalized or the amount necessary to cause the institution to be “adequately capitalized.” The bank regulators have greater power in situations where an institution becomes “significantly” or “critically” undercapitalized or fails to submit a capital restoration plan. For example, a bank holding company controlling such an institution can be required to obtain prior Federal Reserve Board approval of proposed dividends, or might be required to consent to a consolidation or to divest the troubled institution or other affiliates.

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Deposit Insurance Assessments. The deposits of the Bank are insured by the Deposit Insurance Fund (“DIF”) of the FDIC up to the limits set forth under applicable law and are subject to the deposit insurance premium assessments of the DIF. The FDIC imposes a risk-based deposit premium assessment system, which was amended pursuant to the Federal Deposit Insurance Reform Act of 2005 (the “Reform Act”). Under this system, as amended, the assessment rates for an insured depository institution vary according to the level of risk incurred in its activities. To arrive at an assessment rate for a banking institution, the FDIC places it in one of four risk categories determined by reference to its capital levels and supervisory ratings. The assessment rate schedule can change from time to time, at the discretion of the FDIC, subject to certain limits.

 

The Dodd-Frank Act imposedimposed additional assessments and costs with respect to deposits. Under the Dodd-Frank Act, the FDIC imposes deposit insurance assessments based on total assets rather than total deposits. Pursuant to the Dodd-Frank Act, the FDIC revised the deposit insurance assessment system and implemented a revised assessment rate process with the goal of differentiating insured depository institutions who pose greater risk to the DIF.

 

Safety and Soundness Standards. The FDIA requires the federal bank regulatory agencies to prescribe standards, by regulations or guidelines, relating to internal controls, information systems and internal audit systems, loan documentation, credit underwriting, interest rate risk exposure, asset growth, asset quality, earnings, stock valuation and compensation, fees and benefits, and such other operational and managerial standards as the agencies deem appropriate. Guidelines adopted by the federal bank regulatory agencies establish general standards relating to these matters. In general, the guidelines require, among other things, appropriate systems and practices to identify and manage the risk and exposures specified in the guidelines. The guidelines prohibit excessive compensation as an unsafe and unsound practice and describe compensation as excessive when the amounts paid are unreasonable or disproportionate to the services performed by an executive officer, employee, director or principal shareholder. In addition, the agencies adopted regulations that authorize, but do not require, an agency to order an institution that has been given notice by an agency that it is not satisfying any of such safety and soundness standards to submit a compliance plan. If, after being so notified, an institution fails to submit an acceptable compliance plan or fails in any material respect to implement an acceptable compliance plan, the agency must issue an order directing action to correct the deficiency and may issue an order directing other actions of the types to which an undercapitalized institution is subject under the “prompt corrective action” provisions of FDIA. See “Prompt Corrective Actions” above. If an institution fails to comply with such an order, the agency may seek to enforce such order in judicial proceedings and to impose civil money penalties.

Incentive Compensation. The Dodd-Frank Act requires the federal bank regulatory agencies and the SEC to establish joint regulations or guidelines prohibiting incentive-based payment arrangements at specified regulated entities having at least $1 billion in total assets, such as Limestone Bancorp and Limestone Bank, that encourage inappropriate risks by providing an executive officer, employee, director or principal shareholder with excessive compensation, fees, or benefits or that could lead to material financial loss to the entity. In addition, these regulators must establish regulations or guidelines requiring enhanced disclosure to regulators of incentive-based compensation arrangements. The agencies proposed such regulations in April 2011, but the regulations have not been finalized. If the regulations are adopted in the form initially proposed, they will impose limitations on the manner in which the Company may structure compensation for its executives.

In June 2010, the Federal Reserve, OCC, and FDIC issued comprehensive final guidance on incentive compensation policies intended to ensure that the incentive compensation policies of banking organizations do not undermine the safety and soundness of such organizations by encouraging excessive risk-taking. The guidance, which covers all employees who have the ability to materially affect the risk profile of an organization, either individually or as part of a group, is based upon the key principles that a banking organization’s incentive compensation arrangements should (i) provide incentives that do not encourage risk-taking beyond the organization’s ability to effectively identify and manage risks, (ii) be compatible with effective internal controls and risk management, and (iii) be supported by strong corporate governance, including active and effective oversight by the organization’s board of directors. These three principles are incorporated into the proposed joint compensation regulations under the Dodd-Frank Act, discussed above.

The Federal Reserve will review, as part of the regular, risk-focused examination process, the incentive compensation arrangements of banking organizations, such as Limestone Bancorp, that are not “large, complex banking organizations.” These reviews will be tailored to each organization based on the scope and complexity of the organization’s activities and the prevalence of incentive compensation arrangements. The findings of the supervisory initiatives will be included in reports of examination. Deficiencies will be incorporated into the organization’s supervisory ratings, which can affect the organization’s ability to make acquisitions and take other actions.

Enforcement actions may be taken against a banking organization if its incentive compensation arrangements, or related risk-management control or governance processes, pose a risk to the organization’s safety and soundness and the organization is not taking prompt and effective measures to correct the deficiencies.

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Branching. Kentucky law permits Kentucky chartered banks to establish a banking office in any county in Kentucky. A Kentucky bank may also establish a banking office outside of Kentucky. Well capitalized Kentucky banks that have been in operation at least three years and satisfy certain criteria relating to, among other things, their composite and management ratings, may establish a banking office in Kentucky without the approval of the KDFI upon notice to the KDFI and any other state bank with its main office located in the county where the new banking office will be located. Otherwise, branching requires the approval of the KDFI, which must ascertain and determine that the public convenience and advantage will be served and promoted and that there is reasonable probability of the successful operation of the banking office. The transaction must also be approved by the FDIC, which considers a number of factors, including financial history, capital adequacy, earnings prospects, character of management, needs of the community and consistency with corporate powers.

 

Section 613 of the Dodd-FrankDodd-Frank Act effectively eliminated the interstate branching restrictions set forth in the Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994. Banks located in any state may now de novo branch in any other state, including Kentucky. Such unlimited branching power may increase competition within the markets in which the Company and the Bank operate.

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Insider Credit Transactions. The restrictions on loans to directors, executive officers, principal shareholders and their related interests (collectively referred to as “insiders”) contained in the Federal Reserve Act and Regulation O apply to all insured depository institutions and their subsidiaries. These restrictions include limits on loans to one borrower and conditions that must be met before such a loan can be made. There is also an aggregate limitation on all loans to insiders and their related interests, which may not exceed the institution’s total unimpaired capital and surplus.

 

Consumer Protection Laws. The Bank is subject to federal consumer protection statues and regulations promulgated under those laws, including, but not limited to, the:

 

 

Truth-In-Lending Act and Regulation Z, governing disclosures of credit terms to consumer borrowers;

 

Home Mortgage Disclosure Act and Regulation C, requiring financial institutions to provide certain information about home mortgage and refinanced loans;

 

Real Estate Settlement Procedures Act (“RESPA”), requiring lenders to provide borrowers with disclosures regarding the nature and cost of real estate settlements and prohibiting certain abusive practices;

 

Secure and Fair Enforcement for Mortgage Licensing Act (“S.A.F.E. Act”), requiring residential loan originators who are employees of financial institutions to meet registration requirements;

 

Fair Credit Reporting Act and Regulation V, governing the provision of consumer information to credit reporting agencies and the use of consumer information;

 

Equal Credit Opportunity Act and Regulation B, prohibiting discrimination on the basis of race, religion or other prohibited factors in the extension of credit;

 

Fair Debt Collection Act, governing the manner in which consumer debts may be collected by collection agencies;

 

Truth in Savings Act, which requires disclosure of deposit terms to consumers;

 

Regulation CC, which relates to the availability of deposit funds to consumers;

 

Right to Financial Privacy Act, which imposes a duty to maintain the confidentiality of consumer financial records and prescribes procedures for complying with administrative subpoenas of financial records;

 

Electronic Funds Transfer Act, governing automatic deposits to and withdrawals from deposit accounts and customerscustomers’ rights and liabilities arising from the use of automated teller machines and other electronic banking services;

 

Automated Overdraft Payment Regulations and Regulation E, requiringrequiring financial institutions to provide customer notices, monitor overdraft payment programs, and prohibiting financial institutions from charging consumer fees for paying overdrafts on automated teller machine and one time debit card transactions unless a consumer consents, or opts in to the service for those types of transactions.

 

The Dodd-Frank Act created the Consumer Financial Protection Bureau, which is granted broad rulemaking, supervisory and enforcement powers under various federal consumer financial protection laws. The CFPB has examination and primary enforcement authority with respect to depository institutions with $10 billion or more in assets. Smaller institutions are subject to rules promulgated by the CFPB, but continue to be examined and supervised by federal banking regulators for consumer compliance purposes. The CFPB has authority to prevent unfair, deceptive or abusive acts or practices in connection with the offering of consumer financial products. The Dodd-Frank Act authorizes the CFPB to establish certain minimum standards for the origination of residential mortgages including a determination of the borrower’s ability to repay. In addition, the Dodd-Frank Act allows borrowers to raise certain defenses to foreclosure if they receive any loan other than a “qualified mortgage” as defined by the CFPB. The Economic Growth, Regulatory Relief and Consumer Protection Act created a qualified mortgage safe harbor for eligible loans that are originated and retained by a bank with total assets of less than $10 billion.

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The Dodd-Frank Act also permits states to adopt consumer protection laws and standards that are more stringent than those adopted at the federal level and, in certain circumstances, permits state attorneys general to enforce compliance with both the state and federal laws andand regulations. Federal preemption of state consumer protection law requirements, traditionally an attribute of the federal savings association charter, has also been modified by the Dodd-Frank Act and now requires a case-by-case determination of preemption by the Office of the Comptroller of the Currency (“OCC”) and eliminates preemption for subsidiaries of a bank. Depending on the implementation of this revised federal preemption standard, the operations of the Bank could become subject to additional compliance burdens in the states in which it operates.

 

Loans to One Borrower. Under current limits, loans and extensions of credit outstanding at one time to a single borrower and not fully secured generally may not exceed 20% of an institution’sinstitution’s unimpaired capital and unimpaired surplus. Loans and extensions of credit fully secured by collateral may represent an additional 10% of unimpaired capital and unimpaired surplus.

 

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Volcker Rule. On December 10, 2013, the final Volcker Rule under the Dodd-Frank Act was approved and implemented by the Federal Reserve Board, the FDIC, the Securities and Exchange Commission (“SEC”), and the Commodity Futures Trading Commission. The Volcker Rule attempts to reduce risk and banking system instability by restricting U.S. banks from investing in or engaging in proprietary trading and speculation and imposing a strict framework to justify exemptions for underwriting, market-making and hedging activities. U.S. banks are restricted from investing in funds with collateral comprised of less than 100% loans that are not registered with the SEC and from engaging in hedging activities that do not hedge a specific identified risk. The Economic Growth, Regulatory Relief and Consumer Protection Act exempted banks, like the Bank, which have less than $10 billion in assets and no material trading assets and liabilities from the Volcker Rule does not have a significant effect on the Bank’s operations.Rule.

 

Privacy. Federal law currently contains extensive customer privacy protection provisions. Under these provisions, a financial institution must provide to its customers, at the inception of the customer relationship and annually thereafter, the institution’s policies and procedures regarding the handling of customers’ nonpublic personal financial information. These provisions also provide that, except for certain limited exceptions, an institution may not provide such personal information to unaffiliated third parties unless the institution discloses to the customer that such information may be so provided and the customer is given the opportunity to opt out of such disclosure. Federal law makes it a criminal offense, except in limited circumstances, to obtain or attempt to obtain customer information of a financial nature by fraudulent or deceptive means.

 

Community Reinvestment Act. The Community Reinvestment Act (“CRA”) requires the FDIC to assess our record in meeting the credit needs of the communities we serve,the Bank serves, including low- and moderate-income neighborhoods and persons. The FDIC’s assessment of our record is made available to the public. The assessment also is part of the Federal Reserve Board’s consideration of applications to acquire, merge or consolidate with another banking institution or its holding company, to establish a new banking office or to relocate an office.

 

Bank Secrecy Act. The Bank Secrecy Act of 1970 (“BSA”) was enacted to deter money laundering, establish regulatory reporting standards for currency transactions and improve detection and investigation of criminal, tax and other regulatory violations. BSA and subsequent laws and regulations require us to take steps to prevent the use of the Bank in the flow of illegal or illicit money, including, without limitation, ensuring effective management oversight, establishing sound policies and procedures, developing effective monitoring and reporting capabilities, ensuring adequate training and establishing a comprehensive internal audit of BSA compliance activities. In recent years, federal regulators have increased the attention paid to compliance with the provisions of BSA and related laws, with particular attention paid to “Know Your Customer” practices. Banks have been encouraged by regulators to enhance their identification procedures prior to accepting new customers in order to deter criminal elements from using the banking system to move and hide illegal and illicit activities.

 

USA Patriot Act. The USA Patriot Act of 2001 (the “Patriot Act”) contains anti-money laundering measures affecting insured depository institutions, broker-dealers and certain other financial institutions. The Patriot Act requires financial institutions to implement policies and procedures to combat money laundering and the financing of terrorism. This includes standards for verifying customer identification at account opening, as well as rules to promote cooperation among financial institutions, regulators and law enforcement entities in identifying parties that may be involved in terrorism or money laundering. It grants the Secretary of the Treasury broad authority to establish regulations and to impose requirements and restrictions on the operations of financial institutions. In addition, the Patriot Act requires the federal bank regulatory agencies to consider the effectiveness of a financial institution’s anti-money laundering activities when reviewing bank mergers and bank holding company acquisitions.

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Effect on Economic Environment. The policies of regulatory authorities, including the monetary policy of the Federal Reserve Board, have a significant effect on the operating results of bank holding companies and bank subsidiaries. Among the means available to the Federal Reserve Board to affect the money supply are open market operations in U.S. government securities, changes in the discount rate on member bank borrowings and changes in reserve requirements against member bank deposits. These means are used in varying combinations to influence overall growth and distribution of bank loans, investments and deposits. Their use may affect interest rates charged on loans or paid for deposits.

 

Federal Reserve Board monetary policies have materially affected the operating results of commercial banks in the past and are expected to continue to do so in the future. The nature of future monetary policies and the effect of such policies on our business and earnings and those of our subsidiaries cannot be predicted.

 

Legislative and Regulatory Initiatives. From time to time various laws, regulations and governmental programs affecting financial institutions and the financial industry are introduced in Congress or otherwise promulgated by regulatory agencies. Such measures may change the environment in which the Company and its subsidiaries operate in substantial and unpredictable ways. The nature and extent of future legislative, regulatory or other changes affecting financial institutions are unpredictable at this time. Future legislation, policies and the effects thereof might have a significant influence on overall growth and distribution of loans, investments and deposits. They also may affect interest rates charged on loans or paid on time and savings deposits. New legislation and policies have had a significant effect on the operating results of commercial banks in the past and are expected to continue to do so in the future.

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Available Information

 

The Company files periodic reports with the SEC including its annual report on Form 10-K, quarterly reports on Form 10-Q, current event reports on Form 8-K and proxy statements. The public may read and copy any materials filed with the SEC at the SEC’s Public Reference Room at 100 F Street, NE, Washington, DC 20549. The public may obtain information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330. The SEC maintains an internet site that contains reports, proxy and information statements and other information regarding issuers that file electronically with the SEC at http://www.sec.gov. Ourwww.sec.gov. The Bank’s Internet address is http://www.limestonebank.com. The Company’s SEC reports are accessible at no cost on ourits web site at http://www.limestonebank.com,www.limestonebank.com, under the Investors Relations section of the About Us tab, once they have been electronically filed with the SEC. A shareholder may also request a copy of ourthe Annual Report on Form 10-K free of charge upon written request to: Chief Financial Officer, PorterLimestone Bancorp, Inc., 2500 Eastpoint Parkway, Louisville, Kentucky 40223. The Internet address of the Company is http://www.snl.com/IRW/CorporateProfile/1022071.

 

Item 1A. Risk Factors

Risk Factors

 

An investment in the Company’s common stock involves a number of risks. Realization of any of the risks described below could have a material adverse effect on the Company’s business, financial condition, results of operations, cash flow and/or future prospects.

 

The Companyis subject to a Written Agreement with the Federal Reserve that restricts the conduct of the Company’s operations and may have a material adverse effect on its business.

In a Written Agreement with the Federal Reserve Bank of St. Louis, the Company made formal commitments in the agreement to use its financial and management resources to serve as a source of strength for the Bank and to assist the Bank in addressing weaknesses identified by the FDIC and the KDFI, to pay no dividends without prior written approval, to pay no interest or principal on subordinated debentures or trust preferred securities without written approval, and to submit an acceptable plan to maintain sufficient capital.

Bank regulatory agencies can exercise discretion when an institution does not meet minimum regulatory capital levels and the other terms of a consent order. The agencies may initiate changes in management, issue mandatory directives, impose monetary penalties or refrain from formal sanctions, depending on individual circumstances. Any action taken by regulatory agencies could damage our reputation and have a material adverse effect on the Company’s business.

As a bank holding company, we depend on dividends and distributions paid to us by our banking subsidiary.

The Company is a legal entity separate and distinct from the Bank and our other subsidiaries. Our principal source of cash flow, from which we would fund any dividends paid to our shareholders, has historically been dividends the Company receives from the Bank. Regulations of the FDIC and the KDFI govern the ability of the Bank to pay dividends and other distributions to the Company, and regulations of the Federal Reserve govern our ability to pay dividends or make other distributions to shareholders. Since the Bank is unlikely to be in a position to pay dividends to the Company without prior regulatory approval until retained earnings are positive, cash inflows for the Company are limited to common stock or debt issuances. See the “Item 1. Business” “Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities – Dividends.”

We are currently precluded from paying any dividends.

Our agreement with the holders of our trust preferred securities provides that we cannot pay dividends until we pay all deferred distributions in full and resume paying quarterly distributions. We have also agreed with the Federal Reserve to obtain its written consent prior to declaring or paying any future dividends. In addition, the dividend preferences of our Series E and Series F Preferred Shares entitle our preferred shareholders to receive an annual, noncumulative 2% dividend before we can pay a dividend on our non-voting common shares and voting common shares.

Interest on junior subordinated debt is in deferral.

At December 31, 2017, we had an aggregate obligation of $22.2 million relating to the principal and accrued unpaid interest on our four issues of junior subordinated debentures, which has resulted in a deferral of distributions on our trust preferred securities. Although we are permitted to defer payments on these securities for up to five years (and we commenced doing so in 2016), the deferred interest payments continue to accrue until paid in full. Our deferral period expires after the second quarter of 2021.

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The Company’s senior debt is secured by the Bank’s common stock and contains financial covenants that must be maintained to avoid default.

The Company’s senior secured loan agreement is with a commercial bank. The loan matures on June 30, 2022. Interest is payable quarterly at a rate of three-month LIBOR plus 250 basis points through June 30, 2020, at which time quarterly principal payments of $250,000 plus interest will commence. The loan is secured by a first priority pledge of 100% of the issued and outstanding stock of the Bank. The Company may prepay any amount due under the promissory note at any time without premium or penalty.

The loan agreement contains customary representations, warranties, covenants and events of default, including the following financial covenants: (i) the Company must maintain minimum cash on hand of not less than $750,000 through June 30, 2018, and not less than $2,500,000 thereafter, (ii) the Company must maintain a total risk based capital ratio at least equal to 9% of risk-weighted assets to June 30, 2018, and 10% thereafter, (iii) the Bank must maintain a total risk based capital ratio at least equal to 10% of risk-weighted assets to June 30, 2018, and 11% thereafter, and (iv) non-performing assets of the Bank may not exceed 2.5% of the Bank’s total assets. Both the Company and Bank were in compliance with the covenants as of December 31, 2017.

We are defendants in various legal proceedings.

The Company and the Bank are involved in judicial proceedings and regulatory investigations concerning matters arising from our business activities. Although we believe we have a meritorious defense in all significant litigation pending against us, we cannot predict the ultimate outcome. Litigation is subject to inherent uncertainties and unfavorable rulings could occur. We record contingent liabilities resulting from claims against us when a loss is assessed to be probable and the amount of the loss is reasonably estimable. Assessing probability of loss and estimating probable losses requires analysis of multiple factors, including in some cases judgments about the potential actions of third party claimants and courts. Recorded contingent liabilities are based on the best information available and actual losses in any future period are inherently uncertain. Accruals are not made in cases where liability is not probable or the amount cannot be reasonably estimated. We provide disclosure of matters where we believe liability is reasonably possible and which may be material to our consolidated financial statements. If we do not prevail, the ultimate outcome of litigation matters could have a material adverse effect on our financial condition, results of operations, or cash flows. For more information about ongoing legal proceedings, see the Notes to Consolidated Financial Statements.

In the past, the Bank served as trustee for employee stock ownership plans (“ESOPs”)which engaged in transactions that are under review by the U. S. Department of Labor (“DOL”), subjecting us to certain legal risks.

From 2007 until the first quarter of 2013, the Bank served as trustee for certain ESOPs that purchased the stock of companies from prior owners in purchase transactions. Stock purchase transactions by ESOPs are subject to regular and routine reviews by the DOL for compliance with ERISA. Failure to fulfill fiduciary duties under ERISA with respect to any such plan would subject the Bank to certain financial risks such as claims for damages as well as fines and penalties assessable under ERISA. The Bank was a defendant in legal proceedings initiated by the DOL with respect to two stock purchase transactions by ESOPs for which the Bank served as trustee. Both matters were settled. A ruling in any future litigation that the Bank failed to fulfill its fiduciary duties under ERISA with respect to an ESOP, including stock purchases by the ESOP, could subject the Bank to claims for damages as well as fines and penalties assessable under ERISA.

Investigations into and heightened scrutiny of our operations could result in additional costs and damage our reputation.

In October 2014, the Department of Justice (“DOJ”) initiated an investigation concerning possible violations of federal laws, including, among other things, possible violations related to false bank entries, bank fraud and securities fraud. The investigation concerns allegations that Bank personnel engaged in practices intended to delay or avoid disclosure of the Bank’s asset quality at the time of and following the United States Treasury’s purchase of preferred shares from the Company in November 2008. The Bank has cooperated with all requests for information from the DOJ. At this time, the DOJ has not indicated whether it intends to pursue any action in the matter. Heightened scrutiny of the operations of the Company and the Bank by federal officials may subject us to governmental or regulatory inquiries, investigations, actions, penalties and fines, which could adversely affect our reputation and result in costs to us in excess of current reserves and management’s estimate of the aggregate range of possible loss for such matters.

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Our business may be adversely affected by conditions in the financial markets and by economic conditions generally.

 

WeaknessWeakness in business and economic conditions generally or specifically in our markets may have one or more of the following adverse effects on our business:

 

 

A decrease in the demand for loans and other products and services we offer;the Bank offers;

 

A decrease in the value of collateral securing ourthe Bank’s loans; and

 

An increase in the number of customers who become delinquent, file for protection under bankruptcy laws or default on their loans.

 

Adverse conditions in the general business environment have had an adverse effect on our business in the past. Although the general business environment has improved, wemanagement cannot predict how long such improvement can be sustained. In addition, the improvement of certain economic indicators, such as real estate asset values, rents, and unemployment, may vary between geographic markets and may continue to lag behind improvement in the overall economy. These economic indicators typically affect the real estate and financial services industries, in which we havethe Bank has a significant number of customers, more significantly than other economic sectors. Furthermore, we havethe Bank has a substantial lending business that depends upon the ability of borrowers to make debt service payments on loans. Should economic conditions worsen, our business, financial condition or results of operations could be adversely affected.

A large percentage of our loans are collateralized by real estate, and prolonged weakness in the real estatemarket may result in losses and adversely affect our profitability.

Approximately 73.7% of our loan portfolio as of December 31, 2017, was comprised of commercial and residential loans collateralized by real estate. Adverse economic conditions could decrease demand for real estate and depress real estate values in our markets. Persistent weakness in the real estate market could significantly impair the value of our collateral and our ability to sell the collateral upon foreclosure. The real estate collateral in each case provides an alternate source of repayment in the event of default by the borrower and may deteriorate in value during the time the credit is extended. If real estate values decline, it will become more likely that we would be required to increase our allowance for loan losses. If during a period of depressed real estate values, we were required to liquidate the collateral securing a loan to satisfy the debt or to increase our allowance for loan losses, it could materially reduce our profitability and adversely affect our financial condition.

We offer real estate construction and development loans, which carry a higher degree of risk than other real estate loans. Weakness in the residential construction and commercial development real estate markets has in the past increased the non-performing assets in our loan portfolio and our provision for loan loss expense. These impacts have had, and could havein the future, a material adverse effect on capital, financial condition and results of operations.

Approximately 8.1% of our loan portfolio as of December 31, 2017 consisted of real estate construction and development loans, up from 5.7% at December 31, 2016 and 5.4% at December 31, 2015. These loans generally carry a higher degree of risk than long-term financing of existing properties because repayment depends on the ultimate completion of the project and permanent financing or sale of the property. If the Bank is forced to foreclose on a project prior to its completion, it may not be able to recover the entire unpaid portion of the loan or it may be required to fund additional money to complete the project, or hold the property for an indeterminate period of time. Any of these outcomes may result in losses and adversely affect profitability and financial condition.

Residential construction and commercial development real estate activity in our markets were affected by the challenging economic conditions that followed the financial crisis of 2008. Weakness in these sectors could lead to valuation adjustments to the loan portfolios and real estate owned. A weak real estate market could reduce demand for residential housing, which, in turn, could adversely affect real estate development and construction activities. Consequently, the longer challenging economic conditions persist, the more likely they are to adversely affect the ability of residential real estate development borrowers to repay loans and the value of property used as collateral for such loans.

Our decisions regarding credit risk may not be accurate, and our allowance for loan losses may not besufficient to cover actual losses, which could adversely affect our business, financial condition and resultsof operations.

The Bank maintains an allowance for loan losses at a level we believe is adequate to absorb probable incurred losses in the loan portfolio based on historical loan loss experience, economic and environmental factors, specific problem loans, value of underlying collateral and other relevant factors. If our assessment of these factors is ultimately inaccurate, the allowance may not be sufficient to cover actual future loan losses, which would adversely affect operating results. Management’s estimates are subjective, and their accuracy depends on the outcome of future events. Changes in economic, operating, and other conditions that are generally beyond our control could cause actual loan losses to increase significantly. In addition, bank regulatory agencies, as an integral part of their supervisory functions, periodically review the adequacy of our allowance for loan losses. Regulatory agencies may require an increase in provision for loan losses or to recognize additional loan charge-offs when their judgment differed from ours. Any of these events could have a material negative impact on our operating results.

 

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Our levels of classified loans and non-performing assets may increase in the foreseeable future if economic conditions cause borrowers to default. Further, the value of the collateral underlying a given loan, and the realizable value of such collateral in a foreclosure sale, may decline, making it less likely to realize a full recovery if a borrower defaults on a loan. Any additional increases in the level of our non-performing assets, loan charge-offs or provision for loan losses, or our inability to realize the estimated net value of underlying collateral in the event of a loan default, could negatively affect our business, financial condition, results of operations and the trading price of our securities.

If we experience greater credit losses than anticipated, our operating resultsThe Bank’swouldbe adversely affected.

As a lender, the Bank is exposed to the risk that borrowers will be unable to repay their loans according to their terms and that any collateral securing the payment of their loans may not be sufficient to assure repayment. Credit losses are inherent in the business of making loans and could have a material adverse effect on our operating results. Our credit risk with respect to our real estate and construction loan portfolio will relate principally to the creditworthiness of borrowers and the value of the real estate serving as security for the repayment of loans. Our credit risk with respect to our commercial and consumer loan portfolio will relate principally to the general creditworthiness of businesses and individuals within our local markets.

We make various assumptions and judgments about the collectability of our loan portfolio and provide an allowance for estimated loss losses based on a number of factors. We believe that our allowance for loan losses is adequate. However, if our assumptions or judgments are wrong, our allowance for loan losses may not be sufficient to cover our actual loan losses. We may have to increase our allowance in the future at the request of one of our primary banking regulators, to adjust for changing conditions and assumptions, or as a result of any deterioration in the quality of our loan portfolio. The actual amount of future provisions for loan losses cannot be determined at this time and may vary from the amounts of past provisions.

We continue to hold and from time to time acquire OREO properties, which could increase operating expenses and result in future losses to the Company.

During recent years, the Bank has acquired and disposed of a significant amount of real estate as a result of foreclosure or by deed in lieu of foreclosure that is listed on our balance sheet as other real estate owned (“OREO”). An increase in our OREO portfolio increases the expenses incurred to manage and dispose of these properties, which sometimes includes funding construction required to facilitate sale.

Properties in our OREO portfolio are recorded at fair value, which represents the estimated sales price of the properties on the date acquired less estimated selling costs. Generally, in determining “fair value” an orderly disposition of the property is assumed, except where a different disposition strategy is expected. Significant judgment is required in estimating the fair value of OREO, and the period of time within which such estimates can be considered current may change during periods of market volatility. Any decreases in market prices of real estate in our market areas may lead to additional OREO write downs, with a corresponding expense in our statement of operations. We evaluate OREO property values periodically and write down the carrying value of the properties if and when the results of our analysis require it.

In response to market conditions and other economic factors, we may utilize alternative sale strategies other than orderly disposition as part of our OREO disposition strategy, such as auctions or bulk sales. In this event, as a result of the significant judgments required in estimating fair value and the variables involved in different methods of disposition, the net proceeds realized from such sales transactions could differ significantly from appraisals, comparable sales, and other estimates used to determine the fair value of our OREO properties. In addition, our disposition of OREO through alternative sales strategies could impact the fair value of comparable OREO properties remaining in our portfolio.

Our profitability depends significantly on local economic conditions.

 

MostMost of ourthe Bank’s business activities are conducted in central Kentucky and most of ourits credit exposure is in that region. We areThe Bank is at risk from adverse economic or business developments affecting this area, including declining regional and local business and employment activity, a downturn in real estate values and agricultural activities and natural disasters. To the extent the central Kentucky economy weakens, delinquency rates, foreclosures, bankruptcies and losses in ourthe Bank’s loan portfolio will likely increase. Moreover, the value of real estate or other collateral that secures ourthe loans could be adversely affected by the economic downturn or a localized natural disaster. Events that adversely affect business activity and real estate values in central Kentucky have had and may continue to have a negative impact on ourthe Bank’s business, financial condition, results of operations and future prospects.

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Our smallSmall to medium-sized business portfolio may have fewer resources to weather a downturn in the economy.

 

Our The loan portfolio includes loans to small and medium-sized businesses and other commercial enterprises. Small and medium-sized businesses frequently have smaller market shares than their competitors, may be more vulnerable to economic downturns, often need additional capital to expand or compete and may experience variations in operating results, any of which may impair a borrower’s ability to repay a loan. In addition, the success of a small or medium-sized business often depends on the management talents and efforts of one or two persons or a small group of persons. The death, disability or resignation of one or more of these persons could have a material adverse impact on the business and its ability to repay ourthe loan. A continued economic downturn may have a more pronounced negative impact on ourthe target market, causing usthe Bank to incur substantial credit losses that could materially harm our operating results.

 

OurThe Bank’s decisions regarding credit risk may not be accurate, and its allowance for loan losses may not besufficient to cover actual losses, which could adversely affect its business, financial condition and resultsof operations.

The Bank maintains an allowance for loan losses at a level management believes is adequate to absorb probable incurred losses in the loan portfolio based on historical loan loss experience, economic and environmental factors, specific problem loans, value of underlying collateral and other relevant factors. If management’s assessment of these factors is ultimately inaccurate, the allowance may not be sufficient to cover actual future loan losses, which would adversely affect operating results. Management’s estimates are subjective, and their accuracy depends on the outcome of future events. Changes in economic, operating, and other conditions that are generally beyond the Bank’s control could cause actual loan losses to increase significantly. In addition, bank regulatory agencies, as an integral part of their supervisory functions, periodically review the adequacy of the allowance for loan losses. Regulatory agencies may require an increase in provision for loan losses or to recognize additional loan charge-offs when their judgment differs. Any of these events could have a material negative impact on operating results.

Levels of classified loans and non-performing assets may increase in the foreseeable future if economic conditions cause borrowers to default. Furthermore, the value of the collateral underlying a given loan, and the realizable value of such collateral in a foreclosure sale, may decline, making it less likely to realize a full recovery if a borrower defaults on a loan. Any additional increases in the level of non-performing assets, loan charge-offs or provision for loan losses, or the inability to realize the estimated net value of underlying collateral in the event of a loan default, could negatively affect the Bank’s business, financial condition, results of operations and the trading price of the Company’s common shares.

If the Bank experiences greater credit losses than anticipated, itsoperating resultswouldbe adversely affected.

As a lender, the Bank is exposed to the risk that borrowers will be unable to repay their loans according to their terms and that any collateral securing the payment of their loans may not be sufficient to assure repayment. Credit losses are inherent in the business of making loans and could have a material adverse effect on operating results. Credit risk with respect to the real estate and construction loan portfolio will relate principally to the creditworthiness of borrowers and the value of the real estate serving as security for the repayment of loans. Credit risk with respect to the commercial and consumer loan portfolio will relate principally to the general creditworthiness of businesses and individuals within the local markets.

Management makes various assumptions and judgments about the collectability of its loan portfolio and provides an allowance for estimated loss losses based on a number of factors. Management believes the Bank’s allowance for loan losses is adequate. However, if assumptions or judgments are wrong, the allowance for loan losses may not be sufficient to cover actual loan losses. Management may have to increase the allowance in the future at the request of one of the Bank’s primary regulators, to adjust for changing conditions and assumptions, or as a result of any deterioration in the quality of the loan portfolio. The actual amount of future provisions for loan losses cannot be determined at this time and may vary from the amounts of past provisions.

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A large percentage of the Bank’s loans are collateralized by real estate, and any prolonged weakness in the real estatemarket may result in losses and adversely affect profitability.

Approximately 75.6% of the Bank’s loan portfolio as of December 31, 2018, was comprised of commercial and residential loans collateralized by real estate. Adverse economic conditions could decrease demand for real estate and depress real estate values in our markets. Persistent weakness in the real estate market could significantly impair the value of loan collateral and the ability to sell the collateral upon foreclosure. The real estate collateral in each case provides an alternate source of repayment in the event of default by the borrower and may deteriorate in value during the time the credit is extended. If real estate values decline, it will become more likely that management would be required to increase the Bank’s allowance for loan losses. If during a period of depressed real estate values, management was required to liquidate the collateral securing a loan to satisfy the debt or to increase the allowance for loan losses, it could materially reduce the Bank’s profitability and adversely affect its financial condition.

The Bank offers real estate construction and development loans, which carry a higher degree of risk than other real estate loans. Weakness in the residential construction and commercial development real estate markets has in the past increased the non-performing assets in the Bank’s loan portfolio and its provision for loan loss expense. These impacts have had, and could havein the future, a material adverse effect on capital, financial condition and results of operations.

Approximately 11.4% of our loan portfolio as of December 31, 2018 consisted of real estate construction and development loans, up from 8.1% at December 31, 2017 and 5.7% at December 31, 2016. These loans generally carry a higher degree of risk than long-term financing of existing properties because repayment depends on the ultimate completion of the project and permanent financing or sale of the property. If the Bank is forced to foreclose on a project prior to its completion, it may not be able to recover the entire unpaid portion of the loan or it may be required to fund additional money to complete the project, or hold the property for an indeterminate period of time. Any of these outcomes may result in losses and adversely affect profitability and financial condition.

Residential construction and commercial development real estate activity in the Bank’s markets were affected by the challenging economic conditions that followed the financial crisis of 2008. Weakness in these sectors could lead to valuation adjustments to the loan portfolios and real estate owned. A weak real estate market could reduce demand for residential housing, which, in turn, could adversely affect real estate development and construction activities. Consequently, the longer challenging economic conditions persist, the more likely they are to adversely affect the ability of residential real estate development borrowers to repay loans and the value of property used as collateral for such loans.

The Bankmay acquire or hold from time to timeOREO properties, which could increase operating expenses and result in future losses to the Company.

During recent years, the Bank has acquired and disposed of a significant amount of real estate as a result of foreclosure or by deed in lieu of foreclosure that is listed on the balance sheet as other real estate owned (“OREO”). An increase in the OREO portfolio increases the expenses incurred to manage and dispose of these properties, which sometimes includes funding construction required to facilitate sale.

Properties in our OREO portfolio are recorded at fair value, which represents the estimated sales price of the properties on the date acquired less estimated selling costs. Generally, in determining “fair value” an orderly disposition of the property is assumed, except where a different disposition strategy is expected. Significant judgment is required in estimating the fair value of OREO, and the period of time within which such estimates can be considered current may change during periods of market volatility. Any decreases in market prices of real estate may lead to additional OREO write downs, with a corresponding expense in the statement of operations. Management evaluates OREO property values periodically and writes down the carrying value of the properties if and when the results of our analysis require it.

In response to market conditions and other economic factors, management may utilize alternative sale strategies other than orderly disposition as part of the Bank’s OREO disposition strategy, such as auctions or bulk sales. In this event, as a result of the significant judgments required in estimating fair value and the variables involved in different methods of disposition, the net proceeds realized from such sales transactions could differ significantly from appraisals, comparable sales, and other estimates used to determine the fair value of OREO properties. In addition, the disposition of OREO through alternative sales strategies could impact the fair value of comparable OREO properties remaining in the portfolio.

Profitability is vulnerable to fluctuations in interest rates.

 

Changes in interest rates could harm our financial condition or results of operations. OurThe results of operations depend substantially on net interest income, the difference between interest earned on interest-earning assets (such as investments and loans) and interest paid on interest-bearing liabilities (such as deposits and borrowings). Interest rates are highly sensitive to many factors, including governmental monetary policies and domestic or international economic or political conditions. Factors beyond our control, such as inflation, recession, unemployment and money supply may also affect interest rates. If, as a result of decreasing interest rates, our interest-earning assets mature or reprice more quickly than our interest-bearing liabilities in a given period, our net interest income may decrease. Likewise, our net interest income may decrease if interest-bearing liabilities mature or reprice more quickly than interest-earning assets in a given period as a result of increasing interest rates.

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Fixed-rate loans increase ourthe exposure to interest rate risk in a rising rate environment because interest-bearinginterest-bearing liabilities may be subject to repricing before assets become subject to repricing. Fixed rate investment securities are subject to fair value declines as interest rates rise. Adjustable-rate loans decrease the risk associated with changes inrising interest rates but involve other risks, such as the inability of borrowers to make higher payments in an increasing interest rate environment. At the same time, for secured loans, the marketability of the underlying collateral may be adversely affected by higher interest rates. In a declining interest rate environment, there may be an increase in prepayments on loans as the borrowers refinance their loans at lower interest rates, which could reduce net interest income and harm our results of operations.

 

If wethe Bank cannot obtain adequate funding, weit may not be able to meet the cash flow requirements of ourits depositors and borrowers, or meet the operating cash needs of the Company.

 

OurThe Company’s liquidity policies and limits are established by the Board of Directors of the Bank, with operating limits managed and monitored by the Asset Liability Committee (“ALCO”), based upon analyses of the ratio of loans to deposits and the percentage of assets funded with non-core or wholesale funding. The ALCO regularly monitors the overall liquidity position of the Bank and the Company to ensure that various alternative strategies exist to meet unanticipated events that could affect liquidity. Liquidity is the ability to meet cash flow needs on a timely basis at a reasonable cost. If our liquidity policies and strategies do not work as well as intended, wethe Bank may be unable to make loans and repay deposit liabilities as they become due or are demanded by customers. The ALCO follows established board approved policies and monitors guidelines to diversify our wholesale funding sources to avoid concentrations in any one-market source. Wholesale funding sources include Federal funds purchased, securities sold under repurchase agreements, and Federal Home Loan Bank (“FHLB”) advances that are collateralized with mortgage-related assets.

 

We maintainThe Bank maintains a portfolio of securities that can be used as a secondary source of liquidity. There are other available sources of liquidity, including additional collateralized borrowings such as FHLB advances, the issuance of debt securities, and the issuance of preferred or common shares in public or private transactions. If we arethe Bank is unable to access any of these funding sources when needed, weit might not be able to meet the needs of our customers, which could adversely impact ourits financial condition, ourits results of operations, cash flows, and ourits level of regulatory-qualifying capital.

 

WeThe Company may not be able to realize the value of ouritsdeferred tax losses and deductions.assets.

 

Due to historic losses, we havethe Company has a net operating loss carry-forward of $25.6$23.4 million, credit carry-forwards of $900,000,$554,000, and other net deferred tax assets of $4.8$5.3 million. In order to realize the benefit of these tax losses, credits and deductions, we will needthe Company needs to generate substantial taxable income in future periods. Our deferredDeferred tax assets are calculated using a federal corporate tax rate of 21%. Changes in tax laws and rates may affect our deferred tax assets in the future. If lower federal corporate tax rates are enacted, our net deferred tax assets would be reduced commensurate with the rate reduction. Additionally, should the Company need to raise additional capital by issuing new common shares or securities convertible into common shares, then depending on the number of common share equivalents issued, it could trigger a “change in control,” as defined by Section 382 of the Internal Revenue Code. Such an event could negatively impact or limit the ability to utilize our net operating loss carry-forwards, credit loss carry-forwards, and other net deferred tax assets.

As a bank holding company, the Company depends on dividends and distributions paid to it by its banking subsidiary.

The Company is a legal entity separate and distinct from the Bank and its other subsidiaries. The principal source of cash flow, from which we would fund any dividends paid to shareholders, has historically been dividends the Company receives from the Bank. Regulations of the FDIC and the KDFI govern the ability of the Bank to pay dividends and other distributions to the Company, and regulations of the Federal Reserve govern the ability to pay dividends or make other distributions to shareholders. Since the Bank is unlikely to be in a position to pay dividends to the Company without prior regulatory approval until retained earnings are positive, cash inflows for the Company are limited to common stock, preferred stock, or debt issuances. See the “Item 1. Business” “Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities – Dividends.”

The Company’s senior debt is secured by the Bank’s common stock and contains financial covenants that must be maintained to avoid default.

The Company’s senior secured loan agreement is with a commercial bank. The loan matures on June 30, 2022. Interest is payable quarterly at a rate of three-month LIBOR plus 250 basis points through June 30, 2020, at which time quarterly principal payments of $250,000 plus interest will commence. The loan is secured by a first priority pledge of 100% of the issued and outstanding stock of the Bank. The Company may prepay any amount due under the promissory note at any time without premium or penalty.

 

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WeThe loan agreement contains customary representations, warranties, covenants and events of default, including the following financial covenants: (i) the Company must maintain minimum cash on hand of not less than $2,500,000, (ii) the Company must maintain a total risk based capital ratio at least equal to 10% of risk-weighted assets, (iii) the Bank must maintain a total risk based capital ratio at least equal to 11% of risk-weighted assets, and (iv) non-performing assets of the Bank may not exceed 2.5% of the Bank’s total assets. Both the Company and Bank were in compliance with the covenants as of December 31, 2018.

Risk related to legal proceedings.

From time to time, the Company is involved in judicial, regulatory, and arbitration proceedings concerning matters arising from our business activities and fiduciary responsibilities. The Company establishes reserves for legal claims when payments associated with the claims become probable and the costs can be reasonably estimated. The Company may still incur legal costs for a matter even if a reserve has not been established. In addition, the actual cost of resolving a legal claim may be substantially higher than any amounts reserved for that matter. The ultimate resolution of a pending or future legal proceeding, depending on the remedy sought and granted, could materially adversely affect results of operations and financial condition.

Acquisitions may not produce revenue enhancements or cost savings at levels or within timeframes originally anticipated and may result in unforeseen integration difficulties.

The Company regularly explores opportunities to acquire banks, financial institutions, or other financial services businesses or assets. The Company cannot predict the number, size or timing of acquisitions. Difficulty in integrating an acquired business or company may cause the Company not to realize expected revenue increases, cost savings, increases in geographic or product presence, and/or other projected benefits from the acquisition. The integration could result in higher than expected deposit attrition (run-off), loss of key employees, disruption of the Company’s business or the business of the acquired company, or otherwise adversely affect the Company’s ability to maintain relationships with customers and employees or achieve the anticipated benefits of the acquisition. Also, the negative effect of any divestitures required by regulatory authorities in acquisitions or business combinations may be greater than expected. The Company may also issue equity securities in connection with acquisitions, which could cause ownership and economic dilution to current shareholders.

The Company may sell capital stock in the future to raise additional capital or for additional liquidity at the holding company. FutureFuture sales or other dilution of our equity may adversely affect the market price of ourthe Company’s common shares.

 

Our The issuance of additional common shares or securities convertible into common shares would dilute the ownership interest of ourthe Company’s existing common shareholders. The market price of ourthe Company’s common shares could decline as a result of such an offering as well as other sales of a large block of shares of our common shares or similar securities in the market after such an offering, or the perception that such sales could occur. OurThe Company’s common shares have traded from time-to-time at a price below our book value per share. A sale of common shares at or below our book value would be dilutive to current shareholders. The sale of shares at a price below market value could negatively impact the market price of ourthe Company’s common shares.

 

Higher FDIC deposit insurance premiums and assessments could significantly increase ourcan impact non-interest expense.

 

OurThe Bank’s deposits are insured by the FDIC up to legal limits and, accordingly, we arethe Bank is subject to FDIC deposit insurance premiums and assessments. FDIC assessments for deposit insurance are based on the average total consolidated assets of the insured institution during the assessment period, less the average tangible equity of the institution during the assessment period. Any increase in assessment rates may adversely affect ourthe Bank’s business, financial condition or results of operations.

 

WeThe Bank faces strong competition from other financial institutions and financial service companies, which could adversely affect ourthe results of operations and financial condition.

 

We competeThe Bank competes with other financial institutions in attracting deposits and making loans. OurThe competition in attracting deposits comes principally from other commercial banks, credit unions, savings and loan associations, securities brokerage firms, insurance companies, money market funds, and other mutual funds. OurThe competition in making loans comes principally from other commercial banks, credit unions, savings and loan associations, mortgage banking firms, and consumer finance companies. In addition, competition for business in the Louisville and Lexington metropolitan areas has grown in recent years as changes in banking law have allowed banks to enter those markets by establishing new branches.

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Competition in the banking industry may also limit ourthe ability to attract and retain banking clients. We maintain smaller staffs of associates and have fewer financial and other resources than larger institutions with which we compete. Financial institutions that have far greater resources and greater efficiencies than we do may have several marketplace advantages resulting from their ability to:

 

 

offer higher interest rates on deposits and lower interest rates on loans than we can;

 

offer a broader range of services than we do;

 

maintain more branch locations than we do; and

 

mount extensive promotional and advertising campaigns.

 

In addition, banks and other financial institutions with larger capitalization and other financial intermediaries may not be subject to the same regulatory restrictions as we are and may have larger lending limits than we do.limits. Some of our current commercial banking clients may seek alternative banking sources as they develop needs for credit facilities larger than we can accommodate. If we are unable to attract and retain customers, we may not be able to maintain growth and ourthe results of operations and financial condition may otherwise be negatively impacted.

 

We dependThe Company depends on our senior management team, and the unexpected loss of one or more of ourthe senior executives could impair our relationships with customers and adversely affect our business and financial results.

 

Our futureFuture success significantly depends on the continued services and performance of our key management personnel. Our futureFuture performance will depend on ourthe ability to motivate and retain these and other key officers. The Dodd-Frank Act, and the policies of bank regulatory agencies have placed restrictions on executive compensation practices. Such restrictions and standards may further impact ourthe ability to compete for talent with other businesses that are not subject to the same limitations as we are.limitations. The loss of the services of members of senior management or other key officers or ourthe inability to attract additional qualified personnel as needed could materially harm our business.

 

Our reportedReported financial results depend on management’smanagement’s selection of accounting methods and certain assumptions and estimates.

 

AccountingAccounting policies and assumptions are fundamental to the reported financial condition and results of operations. Management must exercise judgment in selecting and applying many of these accounting policies and methods so they comply with generally accepted accounting principles and reflect management’s judgment of the most appropriate manner in which to report ourthe financial condition and results. In some cases, management must select the accounting policy or method to apply from two or more alternatives, any of which may be reasonable under the circumstances, yet may result in reporting materially different results than would have been reported under a different alternative.

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Certain accounting policies are critical to presenting our reported financial condition and results. They require management to make difficult, subjective or complex judgments about matters that are uncertain. Materially different amounts could be reported under different conditions or using different assumptions or estimates. These critical accounting policies include the valuation of securities, allowance for loan losses, valuation of OREO valuation of stock based compensation,and valuation of net deferred income tax asset, assessing and estimating contingencies, and revenue recognition.asset. Because of the uncertainty of estimates involved in these matters, we may be required, among other things, to significantly increase the allowance for credit losses, sustain credit losses that are significantly higher than the reserve provided, recognize significant impairment on OREO, or permanently impair deferred tax assets.

 

While management continually monitors and improves ourthe system of internal controls, data processing systems, and corporate wide processes and procedures, wethe Company may suffer losses from operational risk in the future.

 

Management maintains internal operational controls,, and we havehas invested in technology to help us process large volumes of transactions. However, we may not be able to continue processing at the same or higher levels of transactions. If our systems of internal controls should fail to work as expected, if our systems were to be used in an unauthorized manner, or if employees were to subvert the system of internal controls, significant losses could occur.

 

We process large volumes of transactions on a daily basis and are exposed to numerous types of operationaloperational risk, which could cause us to incur substantial losses. Operational risk resulting from inadequate or failed internal processes, people, and systems includes the risk of fraud by employees or persons outside of ourthe company, the execution of unauthorized transactions by employees, errors relating to transaction processing and systems, and breaches of the internal control system and compliance requirements. This risk of loss also includes potential legal actions that could arise as a result of the operational deficiency or as a result of noncompliance with applicable regulatory standards.

 

We establish and maintain systems of internal operational controls that provide management with timely and accurate information about our level of operational risk. While not foolproof, these systems have been designed to manage operational risk at appropriate, cost effective levels. We have also established procedures that are designed to ensure that policies relating to conduct, ethics and business practices are followed. Nevertheless, we experience loss from operational risk from time to time, including the effects of operational errors, and these losses may be substantial.

 

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Our information

Information systems may experience an interruption or security breach.

 

Failure in or breach of our operational or security systems or infrastructure, or those of our third party vendors and other service providers, including as a result of cyber attacks, could disrupt ourthe Bank’s businesses, result in the disclosure or misuse of confidential or proprietary information, damage ourits reputation, increase our costs and cause losses. As a financial institution, we dependthe Bank depends on ourits ability to process, record and monitor a large number of customer transactions on a continuous basis. As customer, public and regulatory expectations regarding operational and information security have increased, our operational systems and infrastructure must continue to be safeguarded and monitored for potential failures, disruptions,, and breakdowns. Our business,Business, financial, accounting, data processing systems or other operating systems and facilities may stop operating properly or become disabled or damaged as a result of a number of factors including events that are wholly or partially beyond our control. For example, there could be sudden increases in customer transaction volume, electrical or telecommunications outages, natural disasters such as earthquakes, tornadoes, and hurricanes; disease pandemics, events arising from local or larger scale political or social matters, including terrorist acts, and, as described below, cyber attacks. Although we have business continuity plans and other safeguards in place, our business operations may be adversely affected by significant and widespread disruption to our physical infrastructure or operating systems that support our businesses and customers.

 

Information security risks for financial institutions have generally increased in recent years in part because of the proliferation of new technologies, the use of the Internet and telecommunications technologies to conduct financial transactions, and the increased sophistication and activities of organized crime, hackers, terrorists, activists, and other external parties. As noted above, our operations rely on the secure processing, transmission and storage of confidential information in our computer systems and networks. In addition, to access our products and services, our customers may use personal smartphones, tablet PC’s, and other mobile devices that are beyond our control systems. Although we believe we have appropriate information security procedures and controls, our technologies, systems, networks, and our customers’ devices may become the target of cyber attacks or information security breaches. These events could result in the unauthorized release, gathering, monitoring, misuse, loss or destruction of our customers’ confidential, proprietary and other information or that of ourits customers, or otherwise disrupt the business operations of ourselves, ourthe Bank, its customers or other third parties.

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Third parties with which we dothe Bank does business or that facilitate our business activities, could also be sources of operational and information security risk to us,the Bank, including from breakdowns or failures of their own systems or capacity constraints. Although to date we have not experienced any material losses relating to cyber attacks or other information security breaches, we can give no assurance that we will not suffer such losses in the future. Our riskRisk and exposure to these matters remains heightened because of, among other things, the evolving nature of these threats and the prevalence of Internet and mobile banking. As cyber threats continue to evolve, we may be required to expend significant additional resources to continue to modify or enhance our protective measures or to investigate and remediate any information security vulnerabilities. Disruptions or failures in the physical infrastructure or operating systems that support our businesses and customers, or cyber attacks or security breaches of the networks, systems or devices that ourthe Bank’s customers use to access our products and services could result in customer attrition, regulatory fines, penalties or intervention, reputational damage, reimbursement or other compensation costs, and/or additional compliance costs, any of which could materially adversely affect our business, results of operations or financial condition.

 

WeThe Company operates in a highly regulated environment and, as a result, areis subject to extensive regulation and supervision that could adversely affect financial performance and ability to implement growth and operating strategies.

 

We areThe Company is subject to examination, supervision and comprehensive regulation by federal and state regulatory agencies, as described under “Item 1 – Business-Supervision and Regulation.” Regulatory oversight of banks is primarily intended to protect depositors, the federal deposit insurance funds, and the banking system as a whole, and not our shareholders. Compliance with these regulations is costly and may make it more difficult to operate profitably.

 

Federal and state banking laws and regulations govern numerous matters including the payment of dividends, the acquisition of other banks, and the establishment of new banking offices. We must also meet specific regulatory capital requirements. Our failureFailure to comply with these laws, regulations, and policies or to maintain required capital could affect ourthe ability to pay dividends on common shares, ourthe ability to grow through the development of new offices, make acquisitions, and remain independent. These limitations may prevent us from successfully implementing our growth and operating strategies.

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In addition, the laws and regulations applicable to banks could change at any time, which could significantly impact our business and profitability. For example, new legislation or regulation could limit the manner in which we may conduct our business, including our ability to attract deposits and make loans. Events that may not have a direct impact on us, such as the bankruptcy or insolvency of a prominent U.S. corporation, can cause legislators and banking regulators and other agencies such as the Consumer Financial Protection Bureau, the SEC, the Public Company Accounting Oversight Board and various taxing authorities to respond by adopting and or proposing substantive revisions to laws, regulations, rules, standards, policies, and interpretations. The nature, extent, and timing of the adoption of significant new laws and regulations, or changes in or repeal of existing laws and regulations may have a material impact on our business and results of operations. Changes in regulation may cause us to devote substantial additional financial resources and management time to compliance, which may negatively affect our operating results.

 

Changes in banking laws could have a material adverse effect on us.effect.

 

We areThe Bank is subject to changes in federal and state laws as well as changes in banking and credit regulations, and governmental economic and monetary policies. WeManagement cannot predict whether any of these changes could adversely and materially affect us. The current regulatory environment for financial institutions entails significant potential increases in compliance requirements and associated costs. Federal and state banking regulators also possess broad powers to take supervisory actions as they deem appropriate. These supervisory actions may result in higher capital requirements, higher insurance premiums and limitations on our activities that could have a material adverse effect on our business and profitability.

Recent legislation regarding the financial services industry may have a significant adverse effect on operations.

Enacted in July 2010, the Dodd-Frank Act has had a significant impact the U.S. financial system, including among other things:

new requirements on banking, derivative and investment activities, including the repeal of the prohibition on the payment of interest on business demand accounts, and debit card interchange fee requirements;

the creation of the Consumer Financial Protection Bureau with supervisory authority, including the power to conduct examinations and take enforcement actions with respect to financial institutions with assets of $10 billion or more and implement regulations that will affect all financial institutions;

provisions affecting corporate governance and executive compensation of all companies subject to the reporting requirements of the Securities and Exchange Act of 1934, as amended; and

a provision requiring bank regulators to set minimum capital levels for bank holding companies that are as strong as those required for their insured depository subsidiaries, subject to a grandfather clause for holding companies with less than $15 billion in assets as of December 31, 2009.

 

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Some provisions in the Dodd-Frank Act remain subject to regulatory rule-making, implementation, and interpretation, the effects of which are not yet known. As a result, it is difficult to gauge the ultimate impact of certain provisions of the Dodd-Frank Act because the implementation of many concepts is left to regulatory agencies. For example, the CFPB is given the power to adopt new regulations to protect consumers and is given control over existing consumer protection regulations adopted by federal banking regulators. The CFPB has already adopted a number of regulations but it is not known at this time when additional rules will be finalized and implemented.

The provisions of the Dodd-Frank Act and any rules adopted to implement those provisions, as well as any additional legislative or regulatory changes may impact the profitability of our business activities and costs of operations, require that we change certain of our business practices, materially affect our business model or affect retention of key personnel, require us to raise additional regulatory capital, including additional Tier 1 capital, and could expose us to additional costs (including increased compliance costs). These and other changes may also require us to invest significant management attention and resources to make any necessary changes and may adversely affect our ability to conduct our business as previously conducted or our results of operations or financial condition.

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Item 1B.

Unresolved Staff Comments

 

Not applicable.

 

Item 2.

Properties

 

The Bank operates 15 banking offices in Kentucky. The following table shows the location, square footage and ownership of each property. We believeManagement believes that each of these locations is adequately insured. Support operations are located in ourat the main office in Louisville and in Glasgow.

 

Markets

Square Footage

 

Owned/Leased

Louisville/Jefferson, Bullitt and Henry Counties

 

Main Office: 2500 Eastpoint Parkway, Louisville

30,000

30,000
 

Owned

Eminence Office: 646 Elm Street, Eminence

1,500

1,500
 

Owned

Hillview Office: 6890 North Preston Highway, Hillview

3,500

3,500
 

Owned

Pleasureville Office: 5440 Castle Highway, Pleasureville

10,000

 

Owned

10,000
Owned

Conestoga Office: 155 Conestoga Parkway, Shepherdsville

3,900

3,900
 

Owned

 

Lexington/Fayette County

 

Lexington Office: 2424 Harrodsburg Road, Suite 100, Lexington

8,500

8,500
 

Leased

 

South Central Kentucky

 

Brownsville Office: 113 East Main Cross Street, Brownsville

8,500

8,500
 

Owned

Greensburg Office: 202 North Main Street, Greensburg

11,000

11,000
 

Owned

Horse Cave Office: 201201 East Main Street, Horse Cave

5,000

5,000
 

Owned

Morgantown Office: 112 West G.L. Smith Street, Morgantown

7,500

7,500
 

Owned

Munfordville Office: 949 South Dixie Highway, Munfordville

9,000

9,000
 

Owned

Beaver Dam Office: 1300 North Main Street, Beaver Dam

3,200

3,200
 

Owned

 

Owensboro/Daviess County

 

Owensboro Office: 1819 Frederica Street, Owensboro

3,000

3,000
 

Owned

 

Southern Kentucky

 

Campbell Lane Office: 751 Campbell Lane, Bowling Green

7,500

7,500
 

Owned

Glasgow Office: 1006 West Main Street, Glasgow

12,000

12,000
 

Owned

Other Properties - Held for Sale

 

Other Properties

 

Office Building: 701 Columbia Avenue, Glasgow

19,000

20,000
 

Owned

 

 

Item 3.

Legal Proceedings

We areIn the normal course of business, the Company and its subsidiaries have been named, from time to time, as defendants in various legal proceedings.actions. Certain of the actual or threatened legal actions may include claims for substantial compensatory and/or punitive damages or claims for indeterminate amount of damages. Litigation is subject to inherent uncertainties and unfavorable outcomes could occur. See Note 16, “Off Balance Sheet Risks, Commitments,

The Company contests liability and/or the amount of damages as appropriate in each pending matter. In view of the inherent difficulty of predicting the outcome of such matters, particularly in cases where claimants seek substantial or indeterminate damages or where investigations and Contingent Liabilities”proceedings are in the Notesearly stages, the Company cannot predict with certainty the loss or range of loss, if any, related to oursuch matters, how or if such matters will be resolved, when they will ultimately be resolved, or what the eventual settlement, or other relief, if any, might be. Subject to the foregoing, the Company believes, based on current knowledge and after consultation with counsel, that the outcome of such pending matters will not have a material adverse effect on the consolidated financial statementscondition of the Company, although the outcome of such matters could be material to the Company’s operating results and cash flows for detail regarding ongoing legal proceedingsa particular future period, depending on, among other things, the level of the Company’s revenues or income for such period. The Company will accrue for a loss contingency if (1) it is probable that a future event will occur and other matters.confirm the loss and (2) the amount of the loss can be reasonably estimated.

The Company is not currently involved in any material litigation.

 

Item 4.

Mine Safety Disclosure

 

Not applicable.applicable.

 

1817

Table of Contents

 

PART II

 

Item 5.

Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

 

Market Information

 

OurThe Company’s common shares are traded on the Nasdaq Capital Market under the ticker symbol “PBIB”“LMST”. The following table presents the high and low market closing prices per share for our common shares reported on the Nasdaq Capital Market for the periods indicated. The per share prices shown in the table have been adjusted for the 1-for-5 reverse stock split of our common shares that took effect on December 16, 2016.

 

  

2017

 
  

Market Value

     

Quarter Ended

 

High

  

Low

  

Dividend

 

Fourth Quarter

 $15.45  $11.42  $0.00 

Third Quarter

  11.81   9.98   0.00 

Second Quarter

  10.49   8.73   0.00 

First Quarter

  12.75   9.14   0.00 

  

2016

 
  

Market Value

     

Quarter Ended

 

High

  

Low

  

Dividend

 

Fourth Quarter

 $12.90  $8.05  $0.00 

Third Quarter

  8.55   7.70   0.00 

Second Quarter

  11.25   5.95   0.00 

First Quarter

  7.10   5.45   0.00 

As of January 31, 2018, we had approximately 1,664 shareholders, including 470 shareholders of record and approximately 1,194 beneficial owners whose shares are held in “street” name by securities broker-dealers or other nominees.

1918

 

As of February 27, 2019, our common shares were held by approximately 1,506 shareholders, including 327 shareholders of record and approximately 1,179 beneficial owners whose shares are held in “street” name by securities broker-dealers or other nominees, and our non-voting common shares were held by two holders.

Dividends

 

As a bank holding company, ourthe Company’s ability to declare and pay dividends depends on various federal regulatory considerations, including the guidelines of the Federal Reserve regarding capital adequacy and dividends.

 

OurThe principal source of revenue with which to pay dividends on our common shares are dividends the Bank may declare and pay out of funds legally available for payment of dividends. Currently, the Bank must obtain the prior written consent of its primary regulators prior to declaring or paying any dividends until retained earnings are positive. A Kentucky chartered bank may declare a dividend of an amount of the bank’s net profits as the board deems appropriate. The approval of the KDFI is required if the total of all dividends declared by a bank in any calendar year exceeds the total of its net profits for that year combined with its retained net profits for the preceding two years, less any required transfers to surplus or a fund for the retirement of preferred stock or debt. Under our Written Agreement, the prior approval of the Federal Reserve Bank of St. Louis is also required for the payment of any Bank dividends.

 

Effective with the third quarter of 2016, the Company resumed deferring interest payments on the junior subordinated notes underlying our trust preferred securities. Deferring interest payments on the junior subordinated notes resulted in the deferral of distributions on our trust preferred securities. If we defer interest payments on our trust preferred securities for 20 consecutive quarters, we must pay all deferred interest or we will be in default. Our deferral period expires after the second quarter of 2021.

We will not be able to pay cash dividends on our common shares until we have paid all deferred distributions on our trust preferred securities. Deferred distributions on trust preferred securities are cumulative, and distributions accrue and compound on each subsequent payment date. If we become subject to any liquidation, dissolution or winding up of affairs, holders of the trust preferred securities and then holders of our preferred shares will be entitled to receive the liquidation amounts to which they are entitled including the amount of any accrued and unpaid distributions and dividends, before any distribution can be made to the holders of common shares or preferred shares. Series E and Series F Preferred Shares have priority over our common shares and non-voting common shares with respect to any payment of dividends.

Purchase of Equity Securities by Issuer

 

During the fourth quarter of 2017,2018, the Company did not repurchase any of its common shares, which is its only registered class of equity securities.

19

Equity Compensation Plan Information

The following table provides information about our equity compensation plans as of December 31, 2018:

Plan category

Number of securities to
be issued upon exercise
of outstanding options,
warrants and rights

Weighted-average
exercise price of
outstanding options,
warrants and rights

Number of securities
remaining available for
future issuance under
equity compensation
plans (excluding
securities reflected in

column 1)

Equity compensation plans approved by shareholders

322,144

Equity compensation plans not approved by shareholders

Total

322,144

At December 31, 2108, 322,144 common shares remain available for issuance under the Company’s 2018 Omnibus Equity Compensation Plan.

 

20

 

Item 6.

Selected Financial Data

 

The following table summarizes ourthe Company’s selected historical consolidated financial data from 20132014 to 2017.2018. You should read this information in conjunction with Item 7. “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and Item 8. “Financial Statements and Supplementary Data.”

 

Selected Consolidated Financial Data

 

 

As of and for the Years Ended December 31,

  

As of and for the Years Ended December 31,

 

(Dollars in thousands except per share data)

 

2017

  

2016

  

2015

  

2014

  

2013

  

2018

  

2017

  

2016

  

2015

  

2014

 

Income Statement Data:

                                        

Interest income

 $37,522  $35,602  $36,574  $39,513  $43,228  $43,461  $37,522  $35,602  $36,574  $39,513 

Interest expense

  6,405   5,981   7,023   9,795   11,143   9,790   6,405   5,981   7,023   9,795 

Net interest income

  31,117   29,621   29,551   29,718   32,085   33,671   31,117   29,621   29,551   29,718 

Provision (negative provision) for loan losses

  (800

)

  (2,450

)

  (4,500

)

  7,100   700   (500

)

  (800

)

  (2,450

)

  (4,500

)

  7,100 

Non-interest income

  4,855   4,764   7,695   4,079   5,919   5,779   5,404   5,218   7,695   4,079 

Non-interest expense

  30,218   39,567   44,959   39,435   38,890   29,126   30,767   40,021   44,959   39,435 

Income (loss) before income taxes

  6,554   (2,732

)

  (3,213

)

  (12,738

)

  (1,586

)

Income (loss) before income taxes

  10,824   6,554   (2,732

)

  (3,213

)

  (12,738

)

Income tax expense (benefit)

  (31,899

)

  21      (1,583

)

     2,030   (31,899

)

  21      (1,583

)

Net income (loss)

  38,453   (2,753

)

  (3,213

)

  (11,155

)

  (1,586

)

  8,794   38,453   (2,753

)

  (3,213

)

  (11,155

)

Less:

                                        

Dividends and accretion on preferred stock

           2,362   2,079               2,362 

Effect of exchange of preferred stock for common stock

           (36,104

)

                 (36,104

)

Earnings (loss) allocated to participating securities

  967   (88

)

  (336

)

  3,159   (267

)

  144   967   (88

)

  (336

)

  3,159 

Net income (loss) attributable to common

 $37,486  $(2,665

)

 $(2,877

)

 $19,428  $(3,398

)

 $8,650  $37,486  $(2,665

)

 $(2,877

)

 $19,428 
                                        

Common Share Data: (1)

                                        

Basic earnings (loss) per common share

 $6.15  $(0.46

)

 $(0.62

)

 $7.94  $(1.44

)

 $1.23  $6.15  $(0.46

)

 $(0.62

)

 $7.94 

Diluted earnings (loss) per common share

  6.15   (0.46

)

  (0.62

)

  7.94   (1.44

)

  1.23   6.15   (0.46

)

  (0.62

)

  7.94 

Cash dividends declared per common share

                              

Book value per common share (2)

  11.17   4.81   5.43   8.37   (0.92

)

Tangible book value per common share (2)

  11.17   4.79   5.33   8.05   (1.46

)

Book value per common share (2)

  12.34   11.17   4.81   5.43   8.37 

Tangible book value per common share (2)

  12.34   11.17   4.79   5.33   8.05 
                                        

Balance Sheet Data (at period end):

                                        

Total assets

 $970,801  $945,177  $948,722  $1,017,989  $1,076,121  $1,069,692  $970,801  $945,177  $948,722  $1,017,989 

Debt obligations:

                                        

FHLB advances

  11,797   22,458   3,081   15,752   4,492   46,549   11,797   22,458   3,081   15,752 

Junior subordinated debentures

  21,000   21,000   21,000   25,000   25,000   21,000   21,000   21,000   21,000   25,000 

Subordinated capital note

  2,250   3,150   4,050   4,950   5,850      2,250   3,150   4,050   4,950 

Senior debt

  10,000               10,000   10,000          
                                        

Average Balance Data:

                                        

Average assets

 $947,961  $929,140  $984,419  $1,049,232  $1,098,400  $1,026,310  $947,961  $929,140  $984,419  $1,049,232 

Average loans

  667,474   621,275   635,948   662,442   788,176   743,352   667,474   621,275   635,948   662,442 

Average deposits

  864,278   852,717   907,785   961,671   1,004,052   860,825   864,278   852,717   907,785   961,671 

Average FHLB advances

  9,184   2,967   3,473   4,473   4,990   43,363   9,184   2,967   3,473   4,473 

Average junior subordinated debentures

  21,000   21,000   23,981   25,000   25,000   21,000   21,000   21,000   23,981   25,000 

Average subordinated capital note

  2,805   3,708   4,608   5,508   6,404   1,791   2,805   3,708   4,608   5,508 

Average senior debt

  5,068               10,000   5,068          

Average stockholders’ equity

  37,851   39,423   33,083   33,881   42,631 

Average stockholders’ equity

  84,860   37,851   39,423   33,083   33,881 

 


(1)

On December 16, 2016, the Company completed a 1-for-5 reverse stock split of its issued and outstanding common and non-voting common shares. As a result of the reverse stock split, all share and per share data has been adjustedadjusted in the accompanying tables. Preferred shares were not impacted by the 1-for-5 reverse stock split.

(2)

After shareholder approval on February 25, 2015, ourthe two series of mandatorily convertible preferred shares converted into a total of 810,720 common shares and 1,291,600 non-voting common shares. 

 

21

 

Item 7.     Management’s Discussion and Analysis of Financial Condition and Results of Operation

Management’s Discussion and Analysis of Financial Condition and Results of Operation

 

Management’sManagement’s discussion and analysis of financial condition and results of operations analyzes the consolidated financial condition and results of operations of PorterLimestone Bancorp, Inc. (the “Company”) and its wholly owned subsidiary, Limestone Bank, Inc. (the “Bank”). The Bank completed a name change from PBI Bank to Limestone Bank on February 20, 2018. The Company is a Louisville, Kentucky-based bank holding company that operates banking offices of the Bank in twelve Kentucky counties. Our markets include metropolitan Louisville in Jefferson County and the surrounding counties of Henry and Bullitt. We serveThe Bank serves south central Kentucky and southern Kentucky from banking offices in Butler, Green, Hart, Edmonson, Barren, Warren, Ohio, and Daviess Counties. WeThe Bank also havehas an office in Lexington, the second largest city in Kentucky. The Bank is a community bank with a wide range of commercial and personal banking products.

 

Historically, we havethe Bank has focused on commercial and commercial real estate lending, both in markets where we have banking offices and other growing markets in our region. Commercial, commercial real estate and real estate construction loans accounted for 58.4%60.9% of our total loan portfolio as of December 31, 2017,2018, and 55.6%58.4% as of December 31, 2016.2017. Commercial lending generally produces higher yields than residential lending, but involves greater risk and requires more rigorous underwriting standards and credit quality monitoring.

 

The following discussion should be read in conjunction with our consolidated financial statements and accompanying notes and other schedules presented elsewhere in the report.

 

Overview

 

Net income before taxes was $10.8 million for the year ended December 31, 2018 compared to $6.6 million for the year ended December 31, 2017. Income tax expense was $2.0 million for 2018 and income tax benefit was $31.9 million for 2017 due to the reversal of the Company’s deferred tax asset valuation allowance and the change in federal corporate tax rates in connection with the enactment of the Tax Cuts and Jobs Act of 2017.

For the year ended December 31, 2017,2018, the Company reported net income of $38.5$8.8 million compared with net income of $38.5 million for the year ended December 31, 2017 and a net loss of $2.8 million for the year ended December 31, 2016 and a net loss of $3.2 million for the year ended December 31, 2015.2016. After allocating earnings to participating securities, net income attributable to common shareholders was $8.7 million for the year ended December 31, 2018, compared with net income attributable to common shareholders of $37.5 million for the year ended December 31, 2017, compared withand a net loss attributable to common shareholders of $2.7 million for the year ended December 31, 2016, and a net loss attributable to common shareholders of $2.9 million for the year ended December 31, 2015.2016. Basic and diluted income per common share were $6.15$1.23 for the year ended December 31, 2017,2018, compared with net income per common share of $6.15 for 2017, and net loss per common share of ($0.46) for 2016, and net loss per common share of ($0.62) for 2015.2016.

 

The following significant items are of note for the year ended December 31, 2017:2018:

 

 

The Company has had a full valuation allowance against its net deferred tax asset since 2011. The abilityAverage loans receivable increased approximately $75.9 million or 11.4% to utilize$743.4 million for the net deferred tax asset depends upon generating sufficient future levels of taxable income. The determination to restore a deferred tax asset and eliminate a valuation allowance depends upon the evaluation of both positive and negative evidence regarding the likelihood of achieving sufficient future taxable income levels. During the fourth quarter of 2017, management concluded it was more-likely-than-not the asset would be utilized to reduce future taxes payable related to the future taxable income of the Company, and as such, reversed the valuation allowance. As a result of the conclusion to reverse the valuation allowance, the Company recorded an income tax benefit of $54.0year ended December 31, 2018, compared with $667.5 million for the year ended December 31, 2017. On December 22, 2017, the Tax Cuts and Jobs Act of 2017 was signed into law. Among other significant changes to the tax code, the new law lowered the federal corporate tax rate from 35% to 21% beginning in 2018. As a result, the Company revalued its net deferred tax asset at the new 21% rate. Due to this revaluation, the Company recorded a $20.3 million charge toLoan interest income tax expense for the year ended December 31, 2017. The combination of the reversal of the valuation allowance and the change in federal corporate tax rates, as well as income tax expense for the year, resulted in an income tax benefit of $31.9 million for the year ended December 31, 2017.

The Bank is no longer subject to a consent orderbenefited with the Federal Deposit Insurance Corporation and Kentucky Department of Financial Institutions. We were notified that the Bank’s prior consent order was terminated, effective October 31, 2017.

Loan growth outpaced paydowns during the period. Average loans receivable increased approximately $46.2 million or 7.4% to $667.5 million for the year ended December 31, 2017, compared with $621.3 million for the year ended December 31, 2016. This resulted in an increase in interest revenue volume of approximately $2.2$3.8 million which was offset byand interest rate decreasesincreases of $895,000$1.7 million for the year ended December 31, 2017,2018, compared with the year ended December 31, 2016.2017.

 

 

Net interest margin increased sixfive basis points to 3.48%3.53% for the year ended 20172018 compared with 3.42%3.48% in the year ended December 31, 2016.2017. The increase in margin between periods was primarily due to an increase in the rate of interest earned on interest earning assets from 4.11% in 2016 to 4.18% in 2017.  2017 to 4.55% in 2018, which was partially offset by an increase in the cost of interest bearing liabilities from 0.83% to 1.23%.  

22

 

 

NegativeImproving trends in asset quality continued. The Company recorded negative provision for loan losses expense was $800,000of $500,000 in 2017,2018, compared to a negative provision for loan losses expense of $2.5 million$800,000 for 2016, because of2017. The negative provision was attributable to net loan recoveries, declining historical loss rates, improvements in loan quality, and management’s assessment of risk in the loan portfolio. Net loan recoveries were $1.2 million for 2018, compared to net loan recoveries of $35,000 for 2017 compared toand net loan charge-offs of $624,000 for 2016 and $2.8 million for 2015. In the following paragraphs, we discuss the improving trends in non-performing loans, past due loans, and loan risk categories during the period, factors that led to the negative provision expense.2016.

 

 

Non-performingNonaccrual loans decreased $3.8$3.5 million to $2.0 million at December 31, 2018, compared with $5.5 million at December 31, 2017, compared with $9.2 million at December 31, 2016.2017. The decrease in non-performingnonaccrual loans was primarily due to $5.0$3.6 million in paydowns, $665,000$293,000 in charge-offs, $199,000$77,000 in loans returned to accrual status, and $270,000$730,000 in transfers to OREO, offset by $2.3$1.2 million in loans placed on non-accrual.

 

 

Loans past due 30-59 daysThe ratio of non-performing assets to total assets decreased from $2.3 millionto 0.60% at December 31, 2016 to $1.5 million2018, compared with 1.14% at December 31, 2017, and loans past due 60-89 days decreased from $315,0001.70% at December 31, 2016 to $171,000 at December 31, 2017. Loans past due 90 days or more totaled $1,000 at December 31, 2017, compared to no loans past due 90 days or more at December 31, 2016. Total loans past due and nonaccrual loans decreased to $7.1 million at December 31, 2017 from $11.8 million at December 31, 2016.

All loan risk categories (other than pass loans) have decreased since December 31, 2016. Pass loans represent 94.5% of the portfolio at December 31, 2017, compared to 91.7% at December 31, 2016 and 83.6% at December 31, 2015. During 2017, the pass category increased approximately $86.6 million, the watch category declined approximately $4.7 million, the special mention category declined approximately $333,000, and the substandard category declined approximately $8.7 million. The $8.7 million decrease in loans classified as substandard was driven by $6.8 million in principal payments received, $270,000 in migration to OREO, $4.6 million in loans upgraded from substandard, and $790,000 in charge-offs, offset by $3.7 million in loans moved to substandard during 2017.

Foreclosed properties were $4.4 million at December 31, 2017, compared with $6.8 million at December 31, 2016. During the year ended December 31, 2017, the Company acquired $270,000 and sold $793,000 of OREO. We incurred OREO losses totaling $2.0 million during the year ended December 31, 2017, reflecting fair value write-downs for updated appraisals, changes in marketing strategies, and reductions in listing prices for certain properties, offset by $74,000 in net gain on sales of OREO.

Non-performing assets decreased to $9.9 million or 1.02% of total assets at December 31, 2017, compared with $16.0 million or 1.70% of total assets at December 31, 2016. In addition, accruing troubled debt restructurings declined to $1.2 million at December 31, 2017 from $5.4 million at December 31, 2016.

Non-interest income increased by $91,000 in 2017 to $4.9 million compared with $4.8 million for the year ended December 31, 2016. This increase was primarily attributable to a $295,000 increase in service charges on deposit accounts, a $123,000 increase in bank card interchange fees, and a $72,000 increase in net gain on sale of securities partially offset by no OREO income during 2017, compared to $456,000 during 2016.

Non-interest expense for the year ended December 31, 2017 of $30.2 million represented a 23.6% decrease from $39.6 million for 2016. The decrease in non-interest expense was attributable primarily to a decrease in litigation and loan collection expense, which decreased $8.6 million. Litigation expense was negatively impacted in 2016 by a ruling from the Kentucky Court of Appeals against the Bank that approximated $8.0 million. Non-interest expense also benefited from a $590,000 decrease in professional fees, a $418,000 decrease in salaries and employee benefits, and a $248,000 decrease in FDIC insurance.

Deposits decreased $2.9 million or 0.3% to $847.0 million at December 31, 2017 compared with $849.9 million at December 31, 2016. Certificate of deposit balances decreased $20.4 million during 2017 to $424.2 million at December 31, 2017, from $444.6 million at December 31, 2016. Non-interest bearing demand deposits increased $13.0 million or 10.4% during 2017 to $137.4 million compared with $124.4 million at December 31, 2016. Money market accounts increased $8.9 million or 6.2% during 2017 to $151.4 million compared with $142.5 million at December 31, 2016.

 

2322

 

 

Deposits were $894.2 million at December 31, 2018, compared with $847.0 million at December 31, 2017. Non-interest bearing demand deposits increased $5.2 million or 3.8% during 2018 to $142.6 million compared with $137.4 million at December 31, 2017. Money market accounts increased $20.5 million or 13.6% during 2018 to $171.9 million compared with $151.4 million at December 31, 2017. Certificate of deposit balances increased $26.7 million during 2018 to $450.9 million at December 31, 2018, from $424.2 million at December 31, 2017.

The Company completed a private placement of common stock on March 30, 2018. In the transaction, the Company issued 150,000 common shares and 1.0 million non-voting common shares to Patriot Financial Partners III, L.P. at $13.00 per share resulting in net proceeds of $14.9 million of which $5.0 million was contributed as capital to the Bank. The balance of proceeds was maintained by the Company for general corporate purposes and to support the growth of the Bank.

On June 30, 2017,26, 2018, the Company entered into a $10.0 million senior secured loan agreement with a commercial bank. The loan matures on June 30, 2022. Interest is payable quarterly at a ratecompleted the purchase and retirement of three-month LIBOR plus 250 basis points through June 30, 2020, at which time quarterly principal paymentsall of $250,000 plus interest will commence. The loan is secured by a first priority pledge of 100% of theits issued and outstanding stockSeries E and Series F Non-Voting Perpetual Preferred Shares for an aggregate price of the Bank.$3.5 million paid in cash.  The Company may prepay any amount due under the promissory note at any time without premium or penalty. The Company contributed $9.0 millionSeries E and Series F Shares had an aggregate liquidation preference of the borrowing proceeds to the Bank as common equity Tier 1 capital. The remaining $1.0 million of the borrowing proceeds was retained by the lender in escrow to service quarterly interest payments. At December 31, 2017, the escrow account had a balance of $806,000.$10.5 million.

 

These items are discussed in further detail throughout this Item 7.

 

Application of Critical Accounting Policies

 

The Company’sCompany’s accounting and reporting policies comply with GAAP and conform to general practices within the banking industry. We believe thatManagement believes the following significant accounting policies may involve a higher degree of management assumptions and judgments that could result in materially different amounts to be reported if conditions or underlying circumstances were to change.

 

Allowance for Loan Losses – The Bank maintains an allowance for loan losses believed to be sufficient to absorb probable incurred credit losses existing in the loan portfolio. The Board of Directors evaluates the adequacy of the allowance for loan losses on a quarterly basis. We evaluateManagement evaluates the adequacy of the allowance using, among other things, historical loan loss experience, known and inherent risks in the portfolio, adverse situations that may affect the borrower’s ability to repay, estimated value of the underlying collateral and current economic conditions and trends. The allowance may be allocated for specific loans or loan categories, but the entire allowance is available for any loan. The allowance consists of specific and general components. The specific component relates to loans that are individually evaluated and measured for impairment. The general component is based on historical loss experience adjusted for qualitative environmental factors. We developManagement develops allowance estimates based on actual loss experience adjusted for current economic conditions and trends. Allowance estimates are a prudent measurement of the risk in the loan portfolio applied to individual loans based on loan type. If the mix and amount of future charge-off percentages differ significantly from the assumptions used by management in making its determination, wemanagement may be required to materially increase ourits allowance for loan losses and provision for loan losses, which could adversely affect our results.

 

Other Real Estate Owned – OREO is real estate acquired as a result of foreclosure or by deed in lieu of foreclosure. It is classified as real estate owned until such time as it is sold. OREO is recorded at its fair market value less estimated cost to sell. Any write-down of the property at the time of acquisition is charged to the allowance for loan losses. Costs incurred in order to perfect the lien prior to foreclosure may be capitalized if the fair value less the cost to sell exceeds the balance of the loan at the time of transfer to OREO. Examples of eligible costs to be capitalized are payments of delinquent property taxes to clear tax liens or payments to contractors and subcontractors to clear mechanics’ liens. Fair value of OREO is determined on an individual property basis. To determine the fair value of OREO for smaller dollar single family homes, we consultmanagement consults with staff from the Bank’s special assets group as well as external realtors and appraisers. If the internally evaluated market price is below ourthe underlying investment in the property, appropriate write-downs are taken. For larger dollar residential and commercial real estate properties, we obtainmanagement obtains a new appraisal of the subject property or havehas staff from our special assets group evaluate the latest in-file appraisal in connection with the transfer to OREO. We typically obtainManagement generally obtains updated appraisals within five quarters of the anniversary date of ownership unless a sale is imminent. Subsequent reductions in fair value are recorded as non-interest expense when a new appraisal indicates a decline in value or in cases where a listingWhen an asking price is lowered below the most recent appraised amount. value, appropriate write-downs are taken. 

 

Stock-based CompensationIncome TaxesCompensation costIncome tax liabilities or assets are established for the amount of taxes payable or refundable for the current year. Deferred tax liabilities (“DTLs”) and assets (“DTAs”) are also established for the future tax consequences of events that have been recognized in the Company’s financial statements or tax returns. A DTL or DTA is recognized for restricted stock awards issuedthe estimated future tax effects attributable to employees,temporary differences and deductions that can be carried forward (used) in future years. The valuation of current and deferred income tax liabilities and assets is considered critical, as it requires management to make estimates based on the fair value of these awards at the date of grant. The market priceprovisions of the Company’s common shares atenacted tax laws. The assessment of tax liabilities and assets involves the dateuse of grant is used for restricted stock awards. Compensation cost is recognized over the required service period, generally defined as the vesting period. For awards with graded vesting, compensation cost is recognized on a straight-line basis over the requisite service period for the entire award.

Valuation of Deferred Tax Asset – We evaluate deferredestimates, assumptions, interpretations and judgments concerning certain accounting pronouncements and federal and state tax assets for impairment on a quarterly basis. We established a 100% deferred tax valuation allowance in December 2011 based upon the analysis of our past performance and our expected future performance. The Company’s ability to utilize the net deferred tax asset depends upon generating suffient future levels of taxable income. The determination to restore a deferred tax asset and eliminate a valuation allowance depends upon the evaluation of both positive and negative evidence regarding the likelihood of achieving future taxable income levels. In 2017, management concluded it was more-likely-than-not the asset would be utilized to reduce future taxes payable related to the future taxable income of the Company, and as such, reversed the valuation allowance.codes.

 

2423

 

Contingencies – We are defendants in various legal proceedings. We record contingent liabilities resultingThere can be no assurance that future events, such as court decisions or positions of federal and state taxing authorities, will not differ from claims against us when a loss is assessedmanagement’s current assessment, the impact of which could be significant to be probablethe consolidated results of operations and the amount of the loss is reasonably estimable. Assessing probability of lossreported earnings. The Company believes its tax assets and estimating probable losses requires analysis of multiple factors, including in some cases judgments about the potential actions of third party claimants and courts. Recorded contingent liabilities are based onadequate and are properly recorded in the best information availableconsolidated financial statements at December 31, 2018 and actual losses in any future period are inherently uncertain.2017.

 

Results of Operations

 

The following table summarizes components of income and expense and the change in those components for 2018 compared with 2017:

  

For the

Years Ended December 31,

  

Change from Prior Period

 
  

2018

  

2017

  

Amount

  

Percent

 
  

(dollars in thousands)

 

Gross interest income

 $43,461  $37,522  $5,939   15.8

%

Gross interest expense

  9,790   6,405   3,385   52.8 

Net interest income

  33,671   31,117   2,554   8.2 

Provision (negative provision) for loan losses

  (500

)

  (800

)

  300   37.5 

Non-interest income

  5,785   5,116   669   13.1 

Gains on sale of securities, net

  (6

)

  288   (294

)

  (102.1

)

Non-interest expense

  29,126   30,767   (1,641

)

  (5.3

)

Net income before taxes

  10,824   6,554   4,270   65.2 

Income tax expense (benefit)

  2,030   (31,899

)

  33,929   NM 

Net income

  8,794   38,453   (29,659

)

  NM 

NM: Not Meaningful

Net income of $8.8 million for the year ended December 31, 2018 decreased by $29.7 million from net income of $38.5 million for 2017. Net income for 2017 was impacted by the reversal of the Company’s deferred tax asset valuation allowance and the change in federal corporate tax rates in connection with the enactment of the Tax Cuts and Jobs Act of 2017. This resulted in an income tax benefit of $31.9 million for 2017. During 2018, improving trends in non-performing loans, past due loans, and loan risk categories continued. A negative provision for loan losses expense of $500,000 was recorded during 2018, compared to $800,000 negative provision for loan losses expense for 2017. Non-interest income increased $669,000 during 2018. There was an increase of $310,000 in bank card interchange fees, $232,000 in other non-interest income, and $102,000 in service charges on deposit accounts. Non-interest expense decreased $1.6 million during 2018 due primarily to decreases in OREO expense of $1.1 million and FDIC insurance of $855,000 offset by an increase in salaries and employee benefits of $399,000.

The following table summarizes components of income and expense and the change in those components for 2017 compared with 2016:

 

 

For the

Years Ended December 31,

  

Change from Prior Period

  

For the

Years Ended December 31,

  

Change from Prior Period

 
 

2017

  

2016

  

Amount

  

Percent

  

2017

  

2016

  

Amount

  

Percent

 
 

(dollars in thousands)

  

(dollars in thousands)

 

Gross interest income

 $37,522  $35,602  $1,920   5.4

%

 $37,522  $35,602  $1,920   5.4

%

Gross interest expense

  6,405   5,981   424   7.1   6,405   5,981   424   7.1 

Net interest income

  31,117   29,621   1,496   5.1   31,117   29,621   1,496   5.1 

Provision (negative provision) for loan losses

  (800

)

  (2,450

)

  1,650   67.3   (800

)

  (2,450

)

  1,650   67.3 

Non-interest income

  4,567   4,548   19   0.4   5,116   5,002   114   2.3 

Gains on sale of securities, net

  288   216   72   33.3   288   216   72   33.3 

Non-interest expense

  30,218   39,567   (9,349

)

  (23.6

)

  30,767   40,021   (9,254

)

  (23.1

)

Net income (loss) before taxes

  6,554   (2,732

)

  9,286   339.9   6,554   (2,732

)

  9,286   339.9 

Income tax expense (benefit)

  (31,899

)

  21   (31,920

)

  NM   (31,899

)

  21   (31,920

)

  NM 

Net income (loss)

  38,453   (2,753

)

  41,206   NM   38,453   (2,753

)

  41,206   NM 

Earnings (losses) attributable to participating securities

  967   (88

)

  1,055   NM 

Net income (loss) attributable to common shareholders

  37,486   (2,665

)

  40,151   NM 

NM: Not Meaningful

24

 

Net income of $38.5 million for the year ended December 31, 2017 increased by $41.2 million from a net loss of $2.8 million for 2016. During the period, improving trends in non-performing loans, past due loans, and loan risk categories continued. In addition, net income for 2017 was impacted by the reversal of the Company’s deferred tax asset valuation allowance and the change in federal corporate tax rates in connection with the enactment of the Tax Cuts and Jobs Act of 2017. The net result of these two items, as well as income tax expense for the year, was an income tax benefit of $31.9 million for 2017. A negative provision for loan losses expense of $800,000 was recorded during 2017, compared to $2.5 million negative provision for loan losses expense for 2016. Non-interest income increased $19,000$114,000 during 2017. There was an increase of $295,000 in service charges on deposit accounts, $123,000$218,000 in bank card interchange fees, and $62,000 in other non-interest income which was offset by no OREO income during 2017, compared to $456,000 during 2016. Non-interest expense decreased $9.3 million during 2017 due primarily to a decrease in litigation and loan collection expense of $8.6 million as 2016 was negatively impacted by a ruling from the Kentucky Court of Appeals against the Bank that approximated $8.0 million. After consideration of earnings attributable to participating securities, net income attributable to common shareholders was $37.5 million for the year ended December 31, 2017, as compared to net loss attributable to common shareholders of $2.7 million for 2016.

 

25

The following table summarizes components ofNet Interest Income – Net interest income and expense and the change in those components for 2016 compared with 2015:

  

For the

Years Ended December 31,

  

Change from Prior Period

 
  

2016

  

2015

  

Amount

  

Percent

 
  

(dollars in thousands)

 

Gross interest income

 $35,602  $36,574  $(972

)

  (2.7

)%

Gross interest expense

  5,981   7,023   (1,042

)

  (14.8

)

Net interest income

  29,621   29,551   70   0.2 

Provision (negative provision) for loan losses

  (2,450

)

  (4,500

)

  (2,050

)

  (45.6

)

Non-interest income

  4,548   5,929   (1,381

)

  (23.3

)

Gains on sale of securities, net

  216   1,766   (1,550

)

  (87.8

)

Non-interest expense

  39,567   44,959   (5,392

)

  (12.0

)

Net loss before taxes

  (2,732

)

  (3,213

)

  481   15.0 

Income tax expense

  21      21   100.0 

Net loss

  (2,753

)

  (3,213

)

  (460

)

  (14.3

)

Earnings (losses) attributable to participating securities

  (88

)

  (336)  248   (73.8

)

Net loss attributable to common shareholders

  (2,665

)

  (2,877

)

  (212

)

  (7.4

)

Net loss of $2.8 million for the year ended December 31, 2016 decreased by $460,000 from a net loss of $3.2 million for 2015. A negative provision for loan losses expense of $2.5 million was recorded for 2016 due to improvements in loan quality and management’s assessment of risk within the portfolio as compared to $4.5 million negative provision for loan losses expense for 2015. Non-interest income decreased $2.9 million during 2016 due primarily to a decrease in OREO rental income of $890,000 driven by the sale of income producing properties and a $1.6 million decrease in gains on the sale of securities compared to 2015. Non-interest expense decreased $5.4 million during 2016. OREO expense decreased by $10.8 million, but was offset by a $7.7 million increase in litigation and loan collection expense primarily resulting from the adverse Kentucky Court of Appeals ruling. After consideration of losses attributable to participating securities, net loss attributable to common shareholders was $2.7$33.7 million for the year ended December 31, 2016,2018, an increase of $2.6 million, or 8.2%, compared with $31.1 million for the same period in 2017. Net interest spread and margin were 3.32% and 3.53%, respectively, for 2018, compared with 3.35% and 3.48%, respectively, for 2017. Average nonaccrual loans were $3.5 million and $7.1 million in 2018 and 2017, respectively.

Average interest-earning assets were $957.5 million for 2018, compared with $904.1 million for 2017, a 5.9% increase, primarily attributable to higher average loans, partially offset by a decrease in average investment securities. Average loans were $743.4 million for 2018, compared with $667.5 million for 2017, an 11.4% increase. Average investment securities were $178.9 million for 2018, compared with $193.1 million for 2017, a 7.3% decrease. Average interest bearing deposits with financial institutions and fed funds sold were $27.9 million in 2018, compared with $36.2 million in 2017, a 22.8% decrease. Total interest income increased 15.8% to $43.5 million for 2018, compared with $37.5 million for 2017.

Average interest-bearing liabilities increased by 3.3% to $799.0 million for 2018, compared with $773.2 million for 2017. Total interest expense increased by 52.8% to $9.8 million for 2018, compared with $6.4 million during 2017, due primarily to increases in rates paid on certificates of deposits and other time deposits as well as increases in average balances of FHLB advances in 2018 compared to net loss attributable2017. Average volume of certificates of deposit decreased 2.8% to common shareholders of $2.9$439.6 million for 2015.2018, compared with $452.4 million for 2017. The average interest rate paid on certificates of deposit increased to 1.35% for 2018, compared with 0.93% for 2017. Average volume of interest checking and money market deposit accounts increased 0.9% to $249.4 million for 2018, compared with $247.3 million for 2017. The average interest rate paid on interest checking and money market deposit accounts increased to 0.62% for 2018, compared with 0.38% for 2017. Both the yield on earning assets and cost of interest-bearing liabilities were impacted by increases in short-term interest rates during 2017 and 2018.

 

Net Interest IncomeNet interest income was $31.1 million for the year ended December 31, 2017, an increase of $1.5 million, or 5.1%, compared with $29.6 million for the same period in 2016. Net interest spread and margin were 3.35% and 3.48%, respectively, for 2017, compared with 3.32% and 3.42%, respectively, for 2016. Average nonaccrual loans were $7.1 million and $11.4 million in 2017 and 2016, respectively.

 

AverageAverage interest-earning assets were $904.1 million for 2017, compared with $875.3 million for 2016, a 3.3% increase, primarily attributable to higher average loans and investment securities, partially offset by a decrease in interest bearing deposits with financial institutions. Average loans were $667.5 million for 2017, compared with $621.3 million for 2016, a 7.4% increase. Average investment securities were $193.1 million for 2017, compared with $183.7 million for 2016, a 5.1% increase. Average interest bearing deposits with financial institutions and fed funds sold were $36.2 million in 2017, compared with $62.9 million in 2016, a 42.4% decrease. Total interest income increased 5.4% to $37.5 million for 2017, compared with $35.6 million for 2016.

 

AverageAverage interest-bearing liabilities increased by 1.7% to $773.2 million for 2017, compared with $760.7 million for 2016. Our totalTotal interest expense increased by 7.1% to $6.4 million for 2017, compared with $6.0 million during 2016, due primarily to the completion of a $10.0 million senior debt transaction during 2017 as well as an increase in FHLB advances outstanding during 2017. Average volume of certificates of deposit decreased 2.9% to $452.4 million for 2017, compared with $466.0 million for 2016. The average interest rate paid on certificates of deposit increased to 0.93% for 2017, compared with 0.88% for 2016. Average volume of interest checking and money market deposit accounts increased 6.2% to $247.3 million for 2017, compared with $232.7 million for 2016. The average interest rate paid on interest checking and money market deposit accounts decreased to 0.38% for 2017, compared with 0.40% for 2016.

Net interest income was $29.6 million for the year ended December 31, 2016, an increase of $70,000, or 0.2%, compared with $29.6 million for the same period in 2015. Net interest spread and margin were 3.32% and 3.42%, respectively, for 2016, compared with 3.18% and 3.27%, respectively, for 2015. Average nonaccrual loans were $11.4 million and $29.0 million in 2016 and 2015, respectively.

Average interest-earning assets were $875.3 million for 2016, compared with $917.5 million for 2015, a 4.6% decrease, primarily attributable to lower average loans, investment securities and interest bearing deposits with financial institutions. Average loans were $621.3 million for 2016, compared with $635.9 million for 2015, a 2.3% decrease. Average investment securities were $183.7 million for 2016, compared with $194.1 million for 2015, a 5.3% decrease. Average interest bearing deposits with financial institutions were $62.3 million in 2016, compared with $78.9 million in 2015, a 21.0% decrease. Our total interest income decreased 2.7% to $35.6 million for 2016, compared with $36.6 million for 2015.

 

2625

 

Average interest-bearing liabilities decreased by 8.0% to $760.7 million for 2016, compared with $826.9 million for 2015. Total interest expense decreased by 14.8% to $6.0 million for 2016, compared with $7.0 million during 2015, due primarily to lower interest rates paid on and lower volume of certificates of deposit. Average volume of certificates of deposit decreased 16.4% to $466.0 million for 2016, compared with $557.4 million for 2015. The average interest rate paid on certificates of deposit decreased to 0.88% for 2016, compared with 0.96% for 2015, as the result of continued re-pricing of certificates of deposit at maturity to lower interest rates. The average volume of interest checking and money market deposit accounts increased 15.7% to $232.7 million for 2016, compared with $201.2 million for 2015. The average interest rate paid on interest checking and money market deposit accounts increased to 0.40% for 2016, compared with 0.38% for 2015.

27

Average Balance Sheets

 

The following table sets forth the average daily balances, the interest earned or paid on such amounts, and the weighted average yield on interest-earning assets and weighted average cost of interest-bearing liabilities for the periods indicated. Dividing income or expense by the average daily balance of assets or liabilities, respectively, derives such yields and costs for the periods presented.

 

 

For the Years Ended December 31,

  

For the Years Ended December 31,

 
 

2017

  

2016

  

2018

  

2017

 
 

Average

Balance

  

Interest

Earned/Paid

  

Average

Yield/Cost

  

Average

Balance

  

Interest

Earned/Paid

  

Average

Yield/Cost

  

Average

Balance

  

Interest

Earned/Paid

  

Average

Yield/Cost

  

Average

Balance

  

Interest

Earned/Paid

  

Average

Yield/Cost

 
 

(dollars in thousands)

  

(dollars in thousands)

 

ASSETS

                                                

Interest-earning assets:

                                                

Loans receivables (1)(2)

                                                

Real estate

 $509,133  $24,544   4.82

%

 $493,068  $24,486   4.97

%

 $548,877  $27,296   4.97

%

 $509,133  $24,544   4.82

%

Commercial

  107,188   4,403   4.11   81,110   3,471   4.28   123,044   5,934   4.82   107,188   4,403   4.11 

Consumer

  10,790   843   7.81   9,818   826   8.41   32,049   1,765   5.51   10,790   843   7.81 

Agriculture

  39,839   2,047   5.14   36,811   1,733   4.71   38,796   2,334   6.02   39,839   2,047   5.14 

Other

  524   29   5.53   468   21   4.49   586   13   2.22   524   29   5.53 

U.S. Treasury and agencies

  31,440   694   2.21   34,049   757   2.22   23,732   549   2.31   31,440   694   2.21 

Mortgage-backed securities

  94,451   2,240   2.37   101,249   2,240   2.21   81,771   2,142   2.62   94,451   2,240   2.37 

Collateralized loan obligations

  20,242   541   2.67   802   28   3.49   32,163   1,177   3.66   20,242   541   2.67 

State and political subdivision securities (non-taxable) (3)

  19,617   571   4.48   21,041   620   4.53   14,189   383   3.42   19,617   571   4.48 

State and political subdivision securities (taxable)

  23,689   757   3.20   23,921   768   3.21   18,890   570   3.02   23,689   757   3.20 

Corporate bonds

  3,651   167   4.57   2,656   93   3.50   8,162   442   5.42   3,651   167   4.57 

FHLB stock

  7,323   366   5.00   7,323   293   4.00   7,280   429   5.89   7,323   366   5.00 

Federal funds sold

  960   10   1.04   639   3   0.47   1,152   22   1.91   960   10   1.04 

Interest-bearing deposits in other financial institutions

  35,222   310   0.88   62,307   263   0.42   26,763   405   1.51   35,222   310   0.88 

Total interest-earning assets

  904,069   37,522   4.18

%

  875,262   35,602   4.11

%

  957,454   43,461   4.55

%

  904,069   37,522   4.18

%

Less: Allowance for loan losses

  (8,961

)

          (10,719

)

          (8,692

)

          (8,961

)

        

Non-interest-earning assets

  52,853           64,597           77,548           52,853         

Total assets

 $947,961          $929,140          $1,026,310          $947,961         
                                                

LIABILITIES AND STOCKHOLDERS’ EQUITY

                        

LIABILITIES AND STOCKHOLDERS’ EQUITY

                        

Interest-bearing liabilities

                                                

Certificates of deposit and other time deposits

 $452,443  $4,191   0.93

%

 $466,007  $4,111   0.88

%

 $439,597  $5,949   1.35

%

 $452,443  $4,191   0.93

%

Interest checking and money market deposits

  247,261   940   0.38   232,717   921   0.40   249,415   1,543   0.62   247,261   940   0.38 

Savings accounts

  35,486   59   0.17   34,257   61   0.18   34,866   57   0.16   35,486   59   0.17 

FHLB advances

  9,184   120   1.31   2,967   70   2.36   43,363   867   2.00   9,184   120   1.31 

Junior subordinated debentures

  23,805   901   3.78   24,708   818   3.31 

Junior subordinated debentures and subordinated capital note

  21,791   985   4.52   23,805   901   3.78 

Senior debt

  5,068   194   3.83            10,000   389   3.89   5,068   194   3.83 

Total interest-bearing liabilities

  773,247   6,405   0.83

%

  760,656   5,981   0.79

%

  799,032   9,790   1.23

%

  773,247   6,405   0.83

%

Non-interest-bearing liabilities

                                                

Non-interest-bearing deposits

  129,088           119,736           136,947           129,088         

Other liabilities

  7,775           9,325           5,471           7,775         

Total liabilities

  910,110           889,717           941,450           910,110         

Stockholders’ equity

  37,851           39,423         

Total liabilities and stockholders equity

 $947,961          $929,140         

Stockholders’ equity

  84,860           37,851         

Total liabilities and stockholders’ equity

 $1,026,310          $947,961         
                                                

Net interest income

     $31,117          $29,621          $33,671          $31,117     
                                                

Net interest spread

          3.35

%

          3.32

%

          3.32

%

          3.35

%

                                                

Net interest margin

          3.48

%

          3.42

%

          3.53

%

          3.48

%

                                                

Ratio of average interest-earning assets to average interest-bearing liabilities

          116.92

%

          115.07

%

          119.83

%

          116.92

%

 


(1)

Includes loan fees in both interest income and the calculation of yield on loans.

(2)

Calculations include non-accruing loans of $3.5 million and $7.1 million in average loan amounts outstanding.

(3)

Taxable equivalent yields are calculated assuming a 21% and 35% federal income tax rate for 2018 and 2017, respectively.

26

  

For the Years Ended December 31,

 
  

2017

  

2016

 
  

Average

Balance

  

Interest

Earned/Paid

  

Average

Yield/Cost

  

Average

Balance

  

Interest

Earned/Paid

  

Average

Yield/Cost

 
  

(dollars in thousands)

 

ASSETS

                        

Interest-earning assets:

                        

Loans receivables (1)(2)

                        

Real estate

 $509,133  $24,544   4.82

%

 $493,068  $24,486   4.97

%

Commercial

  107,188   4,403   4.11   81,110   3,471   4.28 

Consumer

  10,790   843   7.81   9,818   826   8.41 

Agriculture

  39,839   2,047   5.14   36,811   1,733   4.71 

Other

  524   29   5.53   468   21   4.49 

U.S. Treasury and agencies

  31,440   694   2.21   34,049   757   2.22 

Mortgage-backed securities

  94,451   2,240   2.37   101,249   2,240   2.21 

Collateralized loan obligations

  20,242   541   2.67   802   28   3.49 

State and political subdivision securities (non-taxable) (3)

  19,617   571   4.48   21,041   620   4.53 

State and political subdivision securities (taxable)

  23,689   757   3.20   23,921   768   3.21 

Corporate bonds

  3,651   167   4.57   2,656   93   3.50 

FHLB stock

  7,323   366   5.00   7,323   293   4.00 

Federal funds sold

  960   10   1.04   639   3   0.47 

Interest-bearing deposits in other financial institutions

  35,222   310   0.88   62,307   263   0.42 

Total interest-earning assets

  904,069   37,522   4.18

%

  875,262   35,602   4.11

%

Less: Allowance for loan losses

  (8,961

)

          (10,719

)

        

Non-interest-earning assets

  52,853           64,597         

Total assets

 $947,961          $929,140         
                         

LIABILITIES AND STOCKHOLDERS’ EQUITY

                        

Interest-bearing liabilities

                        

Certificates of deposit and other time deposits

 $452,443  $4,191   0.93

%

 $466,007  $4,111   0.88

%

Interest checking and money market deposits

  247,261   940   0.38   232,717   921   0.40 

Savings accounts

  35,486   59   0.17   34,257   61   0.18 

FHLB advances

  9,184   120   1.31   2,967   70   2.36 

Junior subordinated debentures and subordinated capital note

  23,805   901   3.78   24,708   818   3.31 

Senior debt

  5,068   194   3.83          

Total interest-bearing liabilities

  773,247   6,405   0.83

%

  760,656   5,981   0.79

%

Non-interest-bearing liabilities

                        

Non-interest-bearing deposits

  129,088           119,736         

Other liabilities

  7,775           9,325         

Total liabilities

  910,110           889,717         

Stockholders’ equity

  37,851           39,423         

Total liabilities and stockholders’ equity

 $947,961          $929,140         
                         

Net interest income

     $31,117          $29,621     
                         

Net interest spread

          3.35

%

          3.32

%

                         

Net interest margin

          3.48

%

          3.42

%

                         

Ratio of average interest-earning assets to average interest-bearing liabilities

          116.92

%

          115.07

%

 


(1)

Includes loan fees in both interest income and the calculation of yield on loans.

(2)

Calculations include non-accruing loans of $7.1 million and $11.4 million in average loan amounts outstanding.

(3)

Taxable equivalent yields are calculated assuming a 35% federal income tax rate.rate for 2017 and 2016.

 

28

  

For the Years Ended December 31,

 
  

2016

  

2015

 
  

Average

Balance

  

Interest

Earned/Paid

  

Average

Yield/Cost

  

Average

Balance

  

Interest

Earned/Paid

  

Average

Yield/Cost

 
  

(dollars in thousands)

 

ASSETS

                        

Interest-earning assets:

                        

Loans receivables (1)(2)

                        

Real estate

 $493,068  $24,486   4.97

%

 $516,605  $25,423   4.92

%

Commercial

  81,110   3,471   4.28   78,993   3,475   4.40 

Consumer

  9,818   826   8.41   10,432   856   8.21 

Agriculture

  36,811   1,733   4.71   29,395   1,470   5.00 

Other

  468   21   4.49   523   27   5.16 

U.S. Treasury and agencies

  34,049   757   2.22   31,269   684   2.19 

Mortgage-backed securities

  101,249   2,240   2.21   107,277   2,420   2.26 

Collateralized loan obligations

  802   28   3.49          

State and political subdivision securities (non-taxable) (3)

  21,041   620   4.53   25,354   764   4.64 

State and political subdivision securities (taxable)

  23,921   768   3.21   24,059   774   3.22 

Corporate bonds

  2,656   93   3.50   6,116   155   2.53 

FHLB stock

  7,323   293   4.00   7,323   293   4.00 

Other debt securities

           544   43   7.90 

Federal funds sold

  639   3   0.47   752   1   0.13 

Interest-bearing deposits in other financial institutions

  62,307   263   0.42   78,904   189   0.24 

Total interest-earning assets

  875,262   35,602   4.11

%

  917,546   36,574   4.03

%

Less: Allowance for loan losses

  (10,719

)

          (17,154

)

        

Non-interest-earning assets

  64,597           84,027         

Total assets

 $929,140          $984,419         
                         

LIABILITIES AND STOCKHOLDERS’ EQUITY

                        

Interest-bearing liabilities

                        

Certificates of deposit and other time deposits

 $466,007  $4,111   0.88

%

 $557,441  $5,329   0.96

%

Interest checking and money market deposits

  232,717   921   0.40   201,164   756   0.38 

Savings accounts

  34,257   61   0.18   35,604   75   0.21 

Federal funds purchased and repurchase agreements

           587   1   0.17 

FHLB advances

  2,967   70   2.36   3,473   95   2.74 

Junior subordinated debentures

  24,708   818   3.31   28,589   767   2.68 

Total interest-bearing liabilities

  760,656   5,981   0.79

%

  826,858   7,023   0.85

%

Non-interest-bearing liabilities

                        

Non-interest-bearing deposits

  119,736           113,576         

Other liabilities

  9,325           10,902         

Total liabilities

  889,717           951,336         

Stockholders’ equity

  39,423           33,083         

Total liabilities and stockholders equity

 $929,140          $984,419         
                         

Net interest income

     $29,621          $29,551     
                         

Net interest spread

          3.32

%

          3.18

%

                         

Net interest margin

          3.42

%

          3.27

%

                         

Ratio of average interest-earning assets to average interest-bearing liabilities

          115.07

%

          110.97

%


(1)

Includes loan fees in both interest income and the calculation of yield on loans.

(2)

Calculations include non-accruing loans of $11.4 million and $29.0 million in average loan amounts outstanding.

(3)

Taxable equivalent yields are calculated assuming a 35% federal income tax rate.

2927

 

Rate/Volume Analysis

 

The table below sets forth information regarding changes in interest income and interest expense for the periods indicated. For each category of interest-earning assets and interest-bearing liabilities, information is provided on changes attributable to (1) changes in rate (changes in rate multiplied by old volume); (2) changes in volume (changes in volume multiplied by old rate); and (3) changes in rate-volume (change in rate multiplied by change in volume). Changes in rate-volume are proportionately allocated between rate and volume variance.

 

 

Year Ended December 31, 2017 vs. 2016

  

Year Ended December 31, 2016 vs. 2015

  

Year Ended December 31, 2018 vs. 2017

  

Year Ended December 31, 2017 vs. 2016

 
 

Increase (decrease)

due to change in

  

Increase (decrease)

due to change in

  

Increase (decrease)

due to change in

  

Increase (decrease)

due to change in

 
 

Rate

  

Volume

  

Net

Change

  

Rate

  

Volume

  

Net

Change

  

Rate

  

Volume

  

Net

Change

  

Rate

  

Volume

  

Net

Change

 
 

(in thousands)

  

(in thousands)

 

Interest-earning assets:

                                                

Loan receivables

 $(895

)

 $2,224  $1,329  $7  $(721

)

 $(714

)

 $1,723  $3,753  $5,476  $(895

)

 $2,224  $1,329 

U.S. Treasury and agencies

  (5

)

  (58

)

  (63

)

  11   62   73   32   (177

)

  (145

)

  (5

)

  (58

)

  (63

)

Mortgage-backed securities

  155   (155

)

     (46

)

  (134

)

  (180

)

  220   (318

)

  (98

)

  155   (155

)

   

Collateralized loan obligations

  (9

)

  522   513      28   28   245   391   636   (9

)

  522   513 

State and political subdivision securities

  (9

)

  (51

)

  (60

)

  (13

)

  (137

)

  (150

)

  (76

)

  (299

)

  (375

)

  (9

)

  (51

)

  (60

)

Corporate bonds

  33   41   74   126   (188

)

  (62

)

  36   239   275   33   41   74 

FHLB stock

  73      73            65   (2

)

  63   73      73 

Other debt securities

              (43

)

  (43

)

Federal funds sold

  4   3   7   2      2   9   3   12   4   3   7 

Interest-bearing deposits in other financial institutions

  196   (149

)

  47   102   (28

)

  74   182   (87

)

  95   196   (149

)

  47 

Total increase (decrease) in interest income

  (457

)

  2,377   1,920   189   (1,161

)

  (972

)

  2,436   3,503   5,939   (457

)

  2,377   1,920 
                                                

Interest-bearing liabilities:

                                                

Certificates of deposit and other time deposits

  202   (122

)

  80   (390

)

  (828

)

  (1,218

)

  1,880   (122

)

  1,758   202   (122

)

  80 

Interest checking and money market accounts

  (37

)

  56   19   42   123   165   595   8   603   (37

)

  56   19 

Savings accounts

  (4

)

  2   (2

)

  (11

)

  (3

)

  (14

)

  (1

)

  (1

)

  (2

)

  (4

)

  2   (2

)

Federal funds purchased and repurchase agreements

              (1

)

  (1

)

FHLB advances

  (42

)

  92   50   (12

)

  (13

)

  (25

)

  94   653   747   (42

)

  92   50 

Junior subordinated debentures

  114   (31

)

  83   164   (113

)

  51   165   (81

)

  84   114   (31

)

  83 

Senior debt

     194   194            3   192   195      194   194 

Total increase (decrease) in interest expense

  233   191   424   (207

)

  (835

)

  (1,042

)

  2,736   649   3,385   233   191   424 

Increase (decrease) in net interest income

 $(690) $2,186  $1,496  $396  $(326

)

 $70  $(300) $2,854  $2,554  $(690) $2,186  $1,496 

 

Non-interest Income – The following table presents for the periods indicated the major categories of non-interest income:

 

 

For the Years Ended

December 31,

  

For the Years Ended

December 31,

 
 

2017

  

2016

  

2015

  

2018

  

2017

  

2016

 
 

(in thousands)

  

(in thousands)

 

Service charges on deposit accounts

 $2,253  $1,958  $1,851  $2,355  $2,253  $1,958 

Bank card interchange fees

  972   849   839   1,831   1,521   1,303 

Income from bank owned life insurance

  412   417   295   437   412   417 

Net gain on sales and calls of securities

  288   216   1,766 

Net gain (loss) on sales and calls of securities

  (6

)

  288   216 

Other real estate owned rental income

     456   1,346         456 

Gain on extinguishment of junior subordinated debt

        883 

Other

  930   868   715   1,162   930   868 

Total non-interest income

 $4,855  $4,764  $7,695  $5,779  $5,404  $5,218 

 

Non-interest

Non-interest income increased by $91,000$375,000 for 2018 to $5.8 million compared with $5.4 million for the year ended December 31, 2017. This increase was primarily attributable to a $310,000 increase in bank card interchange fees, a $232,000 increase in other non-interest income, and a $102,000 increase in service charges on deposit accounts partially offset by a $6,000 net loss on sale of securities for 2018 compared to a $288,000 net gain during 2017.

28

The $232,000 net increase in other non-interest income for 2018 includes a $150,000 third quarter gain on sale of the Bank’s secondary market residential mortgage servicing rights portfolio, as well as a $632,000 fourth quarter gain on sale of a subdivided lot at the Company’s headquarters, partially offset by a $392,000 fourth quarter impairment charge associated with the transfer of the Bank’s data processing center to Premises Held for Sale.

In December 2018, the Bank completed a core system conversion, which Management believes will provide opportunities for work flow efficiencies and improvements in customer experience. In connection with the completion of the core systems conversion, Management approved the closure of its central data processing facility. Support services personnel will be relocated from the bank-owned data processing facility to other nearby facilities in 2019. In December 2018, the data processing facility was transferred to Premises Held For Sale at fair value, as determined by an independent third party appraisal, less estimated cost to sell. The transfer to held for sale resulted in the $392,000 impairment charge noted above, which is included in other non-interest income. Upon sale of the facility, Management expects to realize annual occupancy expense savings of approximately $200,000.

Non-interest income increased by $186,000 in 2017 to $4.9$5.4 million compared with $4.8$5.2 million for the year ended December 31, 2016. This increase was primarily attributable to a $295,000 increase in service charges on deposit accounts, a $123,000$218,000 increase in bank card interchange fees, and a $72,000 increase in net gain on sale of securities partially offset by no OREO income during 2017, compared to $456,000 during 2016.

30

Non-interest income decreased by $2.9 million in 2016 to $4.8 million compared with $7.7 million for the year ended December 31, 2015 driven primarily by a decline in gains on the sales of securities from $1.8 million in 2015 to $216,000 in 2016, as well as a decrease in OREO rental income of $890,000 between the two periods as a result of income producing properties being sold. Non-interest income for 2015 was also positively impacted by an $883,000 gain on extinguishment of junior subordinated debt.

 

Non-interest Expense The following table presents the major categories of non-interest expense:

 

 

For the Years Ended

December 31,

  

For the Years Ended

December 31,

 
 

2017

  

2016

  

2015

  

2018

  

2017

  

2016

 
 

(in thousands)

  

(in thousands)

 

Salary and employee benefits

 $15,090  $15,508  $15,857  $15,489  $15,090  $15,508 

Occupancy and equipment

  3,420   3,517   3,449   3,586   3,420   3,517 

FDIC insurance

  1,412   1,660   2,212   557   1,412   1,660 

Data processing expense

  1,256   1,185   1,128   1,192   1,256   1,185 

Marketing expense

  1,098   973   560   1,114   1,098   973 

State franchise and deposit tax

  956   965   1,120   1,118   956   965 

Deposit account related expense

  823   896   787 

Professional fees

  978   1,568   2,885   814   978   1,568 

Communications

  722   706   663   701   722   706 

Insurance expense

  540   565   589   478   540   565 

Postage and delivery

  395   359   400   364   395   359 

Litigation and loan collection expense

  179   8,805   1,141   245   179   8,805 

Other real estate owned expense

  1,973   1,541   12,302   868   1,973   1,541 

Other

  2,199   2,215   2,653   1,777   1,852   1,882 

Total non-interest expense

 $30,218  $39,567  $44,959  $29,126  $30,767  $40,021 

 

Non-interest expense for the year ended December 31, 2018 of $29.1 million represented a 3.1% decrease from $30.8 million for 2017. The decrease in non-interest expense was attributable primarily to a decrease in OREO expense of $1.1 million. Non-interest expense also benefited from a $855,000 decrease in FDIC insurance as a result of the Bank’s improved risk profile, partially offset by a $399,000 increase in salaries and employee benefits. As shown below, expenses related to OREO decreased due to lower valuation adjustment write-downs during 2018 compared to 2017.

  

2018

  

2017

 
  

(in thousands)

 

Net gain on sales

 $(72

)

 $(74

)

Valuation adjustment write-downs

  850   1,963 

Operating expense

  90   84 

Total

 $868  $1,973 

During the year ended December 31, 2018, fair value write-downs of $850,000 were recorded compared with $2.0 million for the year ended December 31, 2017. The 2018 write-downs reflect declines in the fair value due to changes in marketing strategies and new appraisals. OREO sales totaled $876,000 and $793,000 during 2018 and 2017, respectively.

Non-interest Expense Comparison – 2017to 2016

Non-interest expense for the year ended December 31, 2017 of $30.2$30.8 million represented a 23.6%23.1% decrease from $39.6$40.0 million for 2016. The decrease in non-interest expense was attributable primarily to a decrease in litigation and loan collection expense, which decreased $8.6 million. Litigation expense was negatively impacted in 2016 by a ruling from the Kentucky Court of Appeals against the Bank that approximated $8.0 million. Non-interest expense also benefited from a $590,000 decrease in professional fees, a $418,000 decrease in salaries and employee benefits, and a $248,000 decrease in FDIC insurance. As shown below, expenses related to OREO trended higher due to higher valuation adjustment writedownswrite-downs during 2017 compared to 2016.

 

 

2017

  

2016

  

2017

  

2016

 
 

(in thousands)

  

(in thousands)

 

Net gain on sales

 $(74

)

 $(222

)

 $(74

)

 $(222

)

Provision to allowance for declining market values

  1,963   1,180 

Valuation adjustment write-downs

  1,963   1,180 

Operating expense

  84   583   84   583 

Total

 $1,973  $1,541  $1,973  $1,541 

 

During the year ended December 31, 2017,2017, fair value write-downs oftotaled $2.0 million were recorded compared with $1.2 million for the year ended December 31, 2016. The 2017 write-downs reflect declines in the fair value due to updated appraisals, changes in marketing strategies, and reductions in listing prices for certain properties. We wereThe Bank was successful in selling OREO totaling $793,000 and $12.7 million during 2017 and 2016, respectively.

31

Non-interest Expense Comparison 2016to 2015

Non-interest expense for the year ended December 31, 2016 of $39.6 million represented a 12.0% decrease from $45.0 million for 2015. The decrease in non-interest expense was attributable primarily to decreases in OREO expenses and professional fees, offset by increases in litigation and loan collection expense as a result of the Kentucky Court of Appeals ruling against the Bank. As shown below, expenses related to OREO trended lower as the size of the portfolio significantly declined.

  

2016

  

2015

 
  

(in thousands)

 

Net (gain) loss on sales

 $(222

)

 $74 

Provision to allowance for declining market values

  1,180   9,855 

Operating expense

  583   2,373 

Total

 $1,541  $12,302 

During the year ended December 31, 2016, fair value write-downs of $1.2 million were recorded compared with $9.9 million for the year ended December 31, 2015. The write-downs reflect declines in the fair value and include reductions in listing prices for certain properties, updated appraisals, and sales of certain properties through auctions. We were successful in selling OREO totaling $12.7 million and $22.6 million during 2016 and 2015, respectively.

 

Income Tax Expense and Benefit – Effective tax rates differ from the federal statutory rate of 35% applied to income (loss) before income taxes due to the following:

 

 

2017

  

2016

  

2015

  

2018

  

2017

  

2016

 
 

(in thousands)

  

(in thousands)

 

Statutory tax rate

  21

%

  35

%

  35

%

Federal statutory rate times financial statement income (loss)

 $2,294  $(956

)

 $(1,125

)

 $2,273  $2,294  $(956

)

Effect of:

                        

Valuation allowance

  (54,049

)

  1,238   717 

Valuation allowance

     (54,049

)

  1,238 

Tax-exempt income

  (196

)

  (211

)

  (264

)

  (80

)

  (196

)

  (211

)

Non-taxable life insurance income

  (144

)

  (146

)

  (103

)

Non-taxable life insurance income

  (92

)

  (144

)

  (146

)

Restricted stock vesting

  (121

)

        (115

)

  (121

)

   

Change in federal statutory rate

  20,274            20,274    

Other, net

  43   96   775   44   43   96 

Total

 $(31,899

)

 $21  $  $2,030  $(31,899

)

 $21 

 

The Company has had a full valuation allowance against its net deferred tax asset since 2011. The Company’s ability to utilize the net deferred tax asset depends upon generating sufficient future levels of taxable income. The determination to restore a deferred tax asset and eliminate a valuation allowance depends upon the evaluation of both positive and negative evidence regarding the likelihood of achieving sufficient future taxable income levels. During the fourth quarter of 2017, management concluded it was more-likely-than-not the asset would be utilized to reduce future taxes payable related to the future taxable income of the Company, and as such, reversed the valuation allowance. As a result of the conclusion to reverse the valuation allowance, the Company recorded an income tax benefit of $54.0 million for the year ended December 31, 2017.

 

On December 22, 2017, the Tax Cuts and Jobs Act of 2017 was signed into law. Among other significant changes to the tax code, the new law lowered the federal corporate tax rate from 35% to 21% beginning in 2018. As a result, the Company revalued its net deferred tax asset at the new 21% rate.rate for 2017. Due to this revaluation, the Company recorded a $20.3 million charge to income tax expense for the year ended December 31, 2017.

 

The combination of the reversal of the valuation allowance and the change in federal corporate tax rates,, as well as income tax expense for the year, resulted in an income tax benefit of $31.9 million for the year ended December 31, 2017.

 

See Note 12,11, “Income Taxes”, for additional discussion of our income taxes.

 

Income tax expense of $21,000 was recorded for 2016, with no income tax expense or benefit recorded for 2015. Our deferred tax valuation allowance increased to $54.0 million at December 31, 2016. Our statutory federal tax rate was 35% in both 2016 and 2015. The effective tax rate for 2016 and 2015 is not meaningful due to the reduction of income tax benefit as the result of the deferred tax valuation allowance.

32

Analysis of Financial Condition

 

Total assets at December 31, 2018 were $1.07 billion compared with $970.8 million at December 31, 2017, an increase of $98.9 million or 10.2%. This increase was primarily attributable to an increase in net loans of $52.5 million as well as an increase in securities available for sale of $48.5 million.

Total assets at December 31, 2017 were $970.8 million compared with $945.2 million at December 31, 2016, an increase of $25.6 million or 2.7%. This increase was primarily attributable to an increase in net loans of $73.6 million as well as the restoration of a net deferred tax asset of $31.3 million. These increases were partially offset by a decrease in investment securities of $41.9 million as well as a $30.9 million decrease in interest bearing deposits in banks.

 

Total assets at December 31, 2016 were $945.2 million compared with $948.7 million at December 31, 2015, a decrease

30

 

Loans Receivable Loans receivable increased $53.1 million, or 7.5%, during the year ended December 31, 2018, to $765.2 million. Our commercial, commercial real estate and real estate construction portfolios increased by an aggregate of $50.2 million, or 12.1%, during 2018 and comprised 60.9% of the total loan portfolio at December 31, 2018.

Loans receivable increased $72.9 million, or 11.4%, during the year ended December 31, 2017, to $712.1 million. Our commercial, commercial real estate and real estate construction portfolios increased by an aggregate of $61.0 million, or 17.2%, during 2017 and comprised 58.4% of the total loan portfolio at December 31, 2017.

Loans receivable increased $20.6 million, or 3.3%, during the year ended December 31, 2016, to $639.2 million. Our commercial, commercial real estate and real estate construction portfolios increased by an aggregate of $18.8 million, or 5.6%, during 2016 and comprised 55.6% of the total loan portfolio at December 31, 2016.

 

Loan Portfolio CompositionThe following table presents a summary of the loan portfolio at the dates indicated, net of deferred loan fees, by type. There are no foreign loans in our portfolio and other than the categories noted, there is no concentration of loans in any industry exceeding 10% of total loans.

 

  

As of December 31,

 
  

2017

  

2016

 
  

Amount

  

Percent

  

Amount

  

Percent

 
  

(dollars in thousands)

 
                 

Commercial

 $113,771   15.98

%

 $97,761   15.29

%

Commercial Real Estate:

                

Construction

  57,342   8.05   36,330   5.68 

Farmland

  88,320   12.40   71,507   11.19 

Nonfarm nonresidential

  156,724   22.01   149,546   23.39 

Residential Real Estate:

                

Multi-family

  56,588   7.94   48,197   7.54 

1-4 Family

  179,222   25.17   188,092   29.42 

Consumer

  18,439   2.59   9,818   1.54 

Agriculture

  41,154   5.78   37,508   5.87 

Other

  555   0.08   477   0.08 

Total loans

 $712,115   100.00

%

 $639,236   100.00

%

33

 

As of December 31,

  

As of December 31,

 
 

2015

  

2014

  

2013

  

2018

  

2017

 
 

Amount

  

Percent

  

Amount

  

Percent

  

Amount

  

Percent

  

Amount

  

Percent

  

Amount

  

Percent

 
 

(dollars in thousands)

  

(dollars in thousands)

 
                                        

Commercial

 $86,176   13.93

%

 $60,936   9.75

%

 $52,878   7.45

%

 $129,368   16.91

%

 $113,771   15.98

%

Commercial Real Estate:

                                        

Construction

  33,154   5.36   33,173   5.31   43,326   6.11   86,867   11.35   57,342   8.05 

Farmland

  76,412   12.35   77,419   12.39   71,189   10.04   77,937   10.18   88,320   12.40 

Nonfarm nonresidential

  140,570   22.72   175,452   28.07   232,026   32.71   172,177   22.50   156,724   22.01 

Residential Real Estate:

                                        

Multi-family

  44,131   7.13   41,891   6.70   46,858   6.61   49,757   6.50   56,588   7.94 

1-4 Family

  201,478   32.57   197,278   31.56   228,505   32.21   175,761   22.97   179,222   25.17 

Consumer

  10,010   1.62   11,347   1.82   14,365   2.03   39,104   5.11   18,439   2.59 

Agriculture

  26,316   4.25   26,966   4.31   19,199   2.71   33,737   4.41   41,154   5.78 

Other

  419   0.07   537   0.09   980   0.13   536   0.07   555   0.08 

Total loans

 $618,666   100.00

%

 $624,999   100.00

%

 $709,326   100.00

%

 $765,244   100.00

%

 $712,115   100.00

%

 

Lending

  

As of December 31,

 
  

2016

  

2015

  

2014

 
  

Amount

  

Percent

  

Amount

  

Percent

  

Amount

  

Percent

 
  

(dollars in thousands)

 
                         

Commercial

 $97,761   15.29

%

 $86,176   13.93

%

 $60,936   9.75

%

Commercial Real Estate:

                        

Construction

  36,330   5.68   33,154   5.36   33,173   5.31 

Farmland

  71,507   11.19   76,412   12.35   77,419   12.39 

Nonfarm nonresidential

  149,546   23.39   140,570   22.72   175,452   28.07 

Residential Real Estate:

                        

Multi-family

  48,197   7.54   44,131   7.13   41,891   6.70 

1-4 Family

  188,092   29.42   201,478   32.57   197,278   31.56 

Consumer

  9,818   1.54   10,010   1.62   11,347   1.82 

Agriculture

  37,508   5.87   26,316   4.25   26,966   4.31 

Other

  477   0.08   419   0.07   537   0.09 

Total loans

 $639,236   100.00

%

 $618,666   100.00

%

 $624,999   100.00

%

Lending activities are subject to a variety of lending limits imposed by state and federal law. The Bank’s secured legal lending limit to a single borrower or guarantor was approximately $31.4$36.2 million at December 31, 2017.2018.

 

At December 31, 2017, weThe Bank had 13 and 12 loan relationships each with aggregate extensions of credit in excess of $10.0 million, all of which were classified as pass by the Bank’s internal loan review process. In 2016, we had four loan relationships each with aggregate extensions of credit in excess of $10.0 million.process at December 31, 2018 and 2017, respectively.

 

As of December 31, 2018, the Bank had $57.5 million of loan participations purchased from, and $20.1 million of loan participations sold to, other banks. As of December 31, 2017, wethe Bank had $46.2 million of loan participations purchased from, and $19.1 million of loan participations sold to, other banks. As of December 31, 2016, we had $33.4 million of loan participations purchased from, and $26.0 million of loan participations sold to, other banks.

 

3431

 

Loan Maturity Schedule – The following table sets forth at December 31, 2017,2018, the dollar amount of loans, net of deferred loan fees, maturing in the loan portfolio based on their contractual terms to maturity:

 

 

As of December 31, 2017

  

As of December 31, 2018

 
 

Maturing

Within

One Year

  

Maturing

1 through

5 Years

  

Maturing

Over 5

Years

  

Total

Loans

  

Maturing

Within

One Year

  

Maturing

1 through

5 Years

  

Maturing

Over 5

Years

  

Total

Loans

 
 

(dollars in thousands)

  

(dollars in thousands)

 

Loans with fixed rates:

                                

Commercial

 $4,509  $25,481  $4,707  $34,697  $2,464  $31,085  $6,759  $40,308 

Commercial Real Estate:

                                

Construction

  5,602   17,765   10,177   33,544   8,594   11,091   23,563   43,248 

Farmland

  5,273   16,985   21,075   43,333   20,268   13,858   3,482   37,608 

Nonfarm nonresidential

  14,801   77,138   22,287   114,226   27,314   67,042   8,861   103,217 

Residential Real Estate:

                                

Multi-family

  5,038   28,337   15,449   48,824   13,022   26,526   3,922   43,470 

1-4 Family

  14,028   27,730   58,034   99,792   69,543   23,345   6,730   99,618 

Consumer

  1,172   5,951   1,275   8,398   29,392   6,406   1,214   37,012 

Agriculture

  3,143   5,582   779   9,504   583   5,262   2,246   8,091 

Other

  90   316   59   465   54   336   64   454 

Total fixed rate loans

 $53,656  $205,285  $133,842  $392,783  $171,234  $184,951  $56,841  $413,026 
                                

Loans with floating rates:

                                

Commercial

 $10,169  $45,673  $23,232  $79,074  $18,547  $59,701  $10,812  $89,060 

Commercial Real Estate:

                                

Construction

  9,790   13,976   32   23,798   13,417   24,917   5,285   43,619 

Farmland

  1,127   5,665   38,195   44,987   32,188   7,021   1,120   40,329 

Nonfarm nonresidential

  1,598   7,170   33,730   42,498   43,791   20,515   4,654   68,960 

Residential Real Estate:

                                

Multi-family

  208   4,956   2,600   7,764   1,208   4,878   201   6,287 

1-4 Family

  1,885   5,096   72,449   79,430   67,496   5,342   3,305   76,143 

Consumer

  10,013      28   10,041   27      2,065   2,092 

Agriculture

  22,087   9,349   214   31,650   546   9,161   15,939   25,646 

Other

        90   90   78   4      82 

Total floating rate loans

 $56,877  $91,885  $170,570  $319,332  $177,298  $131,539  $43,381  $352,218 

 

Loan Portfolio by Risk CategoryThe following table presents a summary of the loan portfolio at the dates indicated, by risk category.

 

  As of December 31,  As of December 31, 
  

2017

  

2016

  

2015

  

2014

  

2013

  

2018

  

2017

  

2016

  

2015

  

2014

 
  

(in thousands)

  

(in thousands)

 
                                         

Pass

Pass

 $673,033  $586,430  $517,484  $461,126  $369,529  $745,604  $673,033  $586,430  $517,484  $461,126 

Watch

Watch

  25,715   30,431   63,363   68,200   144,316   13,164   25,715   30,431   63,363   68,200 

Special Mention

Special Mention

  164   497   1,395   4,189   5,865   113   164   497   1,395   4,189 

Substandard

Substandard

  13,203   21,878   36,424   91,484   189,616   6,363   13,203   21,878   36,424   91,484 

Doubtful

Doubtful

                              
                     

Total

Total

 $712,115  $639,236  $618,666  $624,999  $709,326  $765,244  $712,115  $639,236  $618,666  $624,999 

 

LoansLoans receivable increased $72.9$53.1 million, or 11.4%7.5%, during the year ended December 31, 2017.2018. All loan risk categories have decreased since December 31, 2016,2017, with the exception of pass graded loans. The pass category increased approximately $86.6$72.6 million, the watch category declined approximately $4.7$12.6 million, the special mention category declined approximately $333,000,$51,000, and the substandard category declined approximately $8.7$6.8 million. The $6.8 million decrease in loans classified as substandard was primarily driven by $12.6 million in principal payments received, $730,000 in loans moved to OREO, $480,000 in charge-offs, and $92,000 in loans upgraded from substandard, offset by $7.1 million in loans moved to substandard during 2018.

 

3532

 

Loan DelinquencyThe following table presents a summary of loan delinquencies at the dates indicated.

 

 As of December 31,  As of December 31, 
  

2017

  

2016

  

2015

  

2014

  

2013

  

2018

  

2017

  

2016

  

2015

  

2014

 
  

(in thousands)

  

(in thousands)

 

Past Due Loans:

Past Due Loans:

                                        

30-59 Days

30-59 Days

 $1,478  $2,302  $3,133  $3,960  $10,696  $1,593  $1,478  $2,302  $3,133  $3,960 

60-89 Days

60-89 Days

  171   315   241   980   775   331   171   315   241   980 

90 Days and Over

90 Days and Over

  1         151   232      1         151 

Total Loans Past Due 30-90+ Days

Total Loans Past Due 30-90+ Days

  1,650   2,617   3,374   5,091   11,703   1,924   1,650   2,617   3,374   5,091 
                                         

Nonaccrual Loans

Nonaccrual Loans

  5,457   9,216   14,087   47,175   101,767   1,991   5,457   9,216   14,087   47,175 

Total Past Due and Nonaccrual Loans

Total Past Due and Nonaccrual Loans

 $7,107  $11,833  $17,461  $52,266  $113,470  $3,915  $7,107  $11,833  $17,461  $52,266 

 

LoansLoans past due 30-59 days decreasedincreased from $2.3 million at December 31, 2016 to $1.5 million at December 31, 2017 to $1.6 million at December 31, 2018, and loans past due 60-89 days decreasedincreased from $315,000 at December 31, 2016 to $171,000 at December 31, 2017.2017 to $331,000 at December 31, 2018. This represents a $968,000 decrease$274,000 increase in loans past due 30-89 days. We considered thisThis trend in delinquency levels is considered during the evaluation of qualitative trends in the portfolio when establishing the general component of theour allowance for loan losses.

 

NonaccrualNonaccrual loans decreased $3.8$3.5 million from December 31, 20162017 to December 31, 2017. The $3.8 million2018. This decrease in nonaccrual loans was primarily driven by $5.0$3.6 million in paydowns, $665,000$293,000 in charge-offs, $270,000$730,000 in transfers to OREO, and $199,000$77,000 in loans returned to accrual status, offset by $2.3$1.2 million in loans placed on non-accrual. The $5.5$2.0 million in nonaccrual loans at December 31, 2017,2018, and $9.2$5.5 million at December 31, 2016,2017, were generally secured by farmland other commercial real estate, and other1-4 family residential real estate loans. Management believes it has established adequate loan loss reserves for these credits.

Troubled Debt Restructuring – A troubled debt restructuring (TDR) occurs when the Bank has agreed to a loan modification in the form of a concession to a borrower who is experiencing financial difficulty. The Bank’s TDRs typically involve a reduction in interest rate, a deferral of principal for a stated period of time, or an interest only period. All TDRs are considered impaired, and the Bank has allocated reserves for these loans to reflect the present value of the concessionary terms granted to the borrower. If the loan is considered collateral dependent, it is reported net of allocated reserves, at the fair value of the collateral less cost to sell.

The Bank does not have a formal loan modification program. If a borrower is unable to make contractual payments, management reviews the particular circumstances of that borrower’s situation and determine whether or not to negotiate a revised payment stream. The goal when restructuring a credit is to afford the borrower a reasonable period of time to remedy the issue causing cash flow constraints so that the credit may return to performing status over time. If a borrower fails to perform under the modified terms, the loan(s) are placed on nonaccrual status and collection actions are initiated.

Management periodically reviews renewals and modifications of previously identified TDRs for which there was no principal forgiveness, to consider if it is appropriate to remove the TDR classification. If the borrower is no longer experiencing financial difficulty and the renewal/modification did not contain a concessionary interest rate or other concessionary terms, management considers the potential removal of the TDR classification. If deemed appropriate based upon current underwriting, the TDR classification is removed as the borrower has complied with the terms of the loan at the date of renewal/modification and there was a reasonable expectation that the borrower would continue to comply with the terms of the loan after the date of the renewal/modification. Additionally, the TDR classification may be removed in circumstances in which the Company performs a non-concessionary re-modification of the loan at terms that were considered to be at market for loans with comparable risk. Management expects the borrower will continue to perform under the re-modified terms based on the borrower’s past performance.

If the borrower fails to perform, management places the loan on nonaccrual status and seeks to liquidate the underlying collateral. The nonaccrual policy for restructured loans is identical to the nonaccrual policy for all loans. The policy calls for a loan to be reported as nonaccrual if it is maintained on a cash basis because of deterioration in the financial condition of the borrower, payment in full of principal and interest is not expected, or principal or interest is past due 90 days or more unless the assets are both well secured and in the process of collection. Changes in value for impairment, including the amount attributed to the passage of time, are recorded entirely within the provision for loan losses. Upon determination that a loan is collateral dependent, the loan is charged down to the fair value of collateral less estimated costs to sell.

33

At December 31, 2018, the Bank had two restructured loans totaling $910,000 with borrowers who experienced deterioration in financial condition compared with six restructured loans totaling $3.0 million at December 31, 2017. In general, these loans were granted interest rate reductions to provide cash flow relief to borrowers experiencing cash flow difficulties. At December 31, 2018, the Bank had no restructured loans that had been granted principal payment deferrals until maturity compared with two loans totaling approximately $1.8 million at December 31, 2017. There were no concessions made to forgive principal relative to these loans, although partial charge-offs have been recorded for certain restructured loans. In general, these loans are secured by first liens on 1-4 residential properties, commercial real estate properties, or farmland. At December 31, 2018 both TDRs were performing according to their modified terms, compared to $1.2 million at December 31, 2017.

There were no modifications granted during 2018 or 2017 that resulted in loans being identified as TDRs. During the twelve months ended December 31, 2018, TDRs were reduced as a result of $1.5 million in payments and $500,000 due to the transfer of a loan to OREO. See “Note 3 – Loans,” to the financial statements for additional disclosure related to troubled debt restructuring.

 

Non-Performing Assets – Non-performing assets consist of certain restructured loans for which interest rate or other terms have been renegotiated, loans past due 90 days or more still on accrual, loans on which interest is no longer accrued, real estate acquired through foreclosure and repossessed assets. Loans, including impaired loans, are placed on nonaccrual status when they become past due 90 days or more as to principal or interest, unless they are adequately secured and in the process of collection. Loans are considered impaired if full principal or interest payments are not anticipated in accordance with the contractual loan terms. Impaired loans are carried at the present value of expected future cash flows discounted at the loan’s effective interest rate or at the fair value of the collateral less cost to sell if the loan is collateral dependent. Loans are reviewed on a regular basis and normal collection procedures are implemented when a borrower fails to make a required payment on a loan. If the delinquency on a mortgage loan exceeds 120 days and is not cured through normal collection procedures or an acceptable arrangement is not agreed to with the borrower, we institutemanagement institutes measures to remedy the default, including commencing a foreclosure action. Consumer loans generally are charged off when a loan is deemed uncollectible and often before any available collateral has been disposed. Commercial business and real estate loan delinquencies are handled on an individual basis with the advice of legal counsel.

 

Interest income on loans is recognized on the accrual basis exceptexcept for those loans placed on nonaccrual status. The accrual of interest on impaired loans is discontinued when management believes, after consideration of economic and business conditions and collection efforts, that the borrowers’ financial condition is such that collection of interest is doubtful, which typically occurs after the loan becomes 90 days delinquent. When interest accrual is discontinued, existing accrued interest is reversed and interest income is subsequently recognized only to the extent cash payments are received on well-secured loans.

 

Real estate acquired as a result of foreclosure or by deed in lieu of foreclosure is classified as real estate owned until such time as it is sold. New and used automobilesautomobiles and other motor vehicles acquired as a result of foreclosure are classified as repossessed assets until they are sold. When such property is acquired it is recorded at its fair market value less cost to sell. Any write-down of the property at the time of acquisition is charged to the allowance for loan losses. Subsequent gains and losses are included in non-interest expense.

 

36

TheThe following table sets forth information with respect to non-performing assets as of the dates indicated:

 

  

As of December 31,

 
  

2017

  

2016

  

2015

  

2014

  

2013

 
  

(dollars in thousands)

 

Past due 90 days or more still on accrual

 $1  $  $  $151  $232 

Loans on nonaccrual status

  5,457   9,216   14,087   47,175   101,767 

Total non-performing loans

  5,458   9,216   14,087   47,326   101,999 

Real estate acquired through foreclosure

  4,409   6,821   19,214   46,197   30,892 

Other repossessed assets

               

Total non-performing assets

 $9,867  $16,037  $33,301  $93,523  $132,891 
                     

Non-performing loans to total loans

  0.77

%

  1.44

%

  2.28

%

  7.57

%

  14.38

%

Non-performing assets to total assets

  1.02

%

  1.70

%

  3.51

%

  9.19

%

  12.35

%

Allowance for non-performing loans

 $108  $241  $295  $1,253  $2,285 

Allowance for non-performing loans to non-performing loans

  1.98

%

  2.62

%

  2.09

%

  2.65

%

  2.24

%

Troubled Debt Restructuring – A troubled debt restructuring (TDR) occurs when the Bank has agreed to a loan modification in the form of a concession to a borrower who is experiencing financial difficulty. The Bank’s TDRs typically involve a reduction in interest rate, a deferral of principal for a stated period of time, or an interest only period. All TDRs are considered impaired, and the Bank has allocated reserves for these loans to reflect the present value of the concessionary terms granted to the borrower. If the loan is considered collateral dependent, it is reported net of allocated reserves, at the fair value of the collateral less cost to sell.

The Bank does not have a formal loan modification program. If a borrower is unable to make contractual payments, we review the particular circumstances of that borrower’s situation and determine whether or not to negotiate a revised payment stream. The goal when restructuring a credit is to afford the borrower a reasonable period of time to remedy the issue causing cash flow constraints so that they may return to performing status over time.

Loan modifications have taken the form of a reduction in interest rate and/or curtailment of scheduled principal payments for a short-term period, usually three to six months, but in some cases until maturity of the loan. In some circumstances we may restructure real estate secured loans in a bifurcated fashion whereby there is a fully amortizing “A” loan at a market interest rate and an interest-only “B” loan at a reduced interest rate. The majority of restructured loans are collateral secured loans. If a borrower fails to perform under the modified terms, the loan(s) are placed on nonaccrual status and collection actions are intiated.

We consider any loan that is restructured for a borrower experiencing financial difficulties due to a borrower’s potential inability to pay in accordance with contractual terms of the loan to be a troubled debt restructuring. Specifically, we consider a concession involving a modification of the loan terms, such as (i) a reduction of the stated interest rate, (ii) a reduction or deferral of principal, or (iii) a reduction or deferral of accrued interest at a stated interest rate lower than the current market rate for new debt with similar risk all to be troubled debt restructurings. When a modification of terms is made for a competitive reason, we do not consider it to be a troubled debt restructuring. A primary example of a competitive modification would be an interest rate reduction for a performing customer’s loan to a market rate as the result of a market decline in rates.

Management periodically reviews renewals and modifications of previously identified TDRs for which there was no principal forgiveness, to consider if it is appropriate to remove the TDR classification. If the borrower is no longer experiencing financial difficulty and the renewal/modification did not contain a concessionary interest rate or other concessionary terms, management considers the potential removal of the TDR classification. If deemed appropriate based upon current underwriting, the TDR classification is removed as the borrower has complied with the terms of the loan at the date of renewal/modification and there was a reasonable expectation that the borrower would continue to comply with the terms of the loan after the date of the renewal/modification. Additionally, the TDR classification may be removed in circumstances in which the Company performs a non-concessionary re-modification of the loan at terms that were considered to be at market for loans with comparable risk. Management expects the borrower will continue to perform under the re-modified terms based on the borrower’s past history of performance.

If the borrower fails to perform, we place the loan on nonaccrual status and seek to liquidate the underlying collateral. The nonaccrual policy for restructured loans is identical to the nonaccrual policy for all loans. The policy calls for a loan to be reported as nonaccrual if it is maintained on a cash basis because of deterioration in the financial condition of the borrower, payment in full of principal and interest is not expected, or principal or interest is past due 90 days or more unless the assets are both well secured and in the process of collection. Changes in value for impairment, including the amount attributed to the passage of time, are recorded entirely within the provision for loan losses. Upon determination that a loan is collateral dependent, the loan is charged down to the fair value of collateral less estimated costs to sell.

  

As of December 31,

 
  

2018

  

2017

  

2016

  

2015

  

2014

 
  

(dollars in thousands)

 

Loans on nonaccrual status

 $1,991   5,457   9,216   14,087   47,175 

Troubled debt restructurings on accrual

  910   1,217   5,350   17,440   21,985 

Past due 90 days or more still on accrual

     1         151 

Total non-performing loans and TDRs on accrual

  2,901   6,675   14,566   31,527   69,311 

Real estate acquired through foreclosure

  3,485   4,409   6,821   19,214   46,197 

Other repossessed assets

               

Total non-performing assets and TDRs on accrual

 $6,386  $11,084  $21,387  $50,741  $115,508 
                     

Non-performing loans and TDRs on accrual to total loans

  0.38

%

  0.94

%

  2.28

%

  5.10

%

  11.09

%

Non-performing assets and TDRs on accrual to total assets

  0.60

%

  1.14

%

  2.26

%

  5.35

%

  11.35

%

Allowance for non-performing loans

 $83  $108  $241  $295  $1,253 

Allowance for non-performing loans to non-performing loans and TDRs on accrual

  2.86

%

  1.62

%

  1.65

%

  0.94

%

  1.81

%

 

3734

 

At December 31, 2017, we had six restructured loans totaling $3.0 million with borrowers who experienced deterioration in financial condition compared with nine restructured loans totaling $8.7 million at December 31, 2016. In general, these loans were granted interest rate reductions to provide cash flow relief to borrowers experiencing cash flow difficulties. At December 31, 2017, two loans totaling approximately $1.8 million had been granted principal payment deferrals until maturity. There were no concessions made to forgive principal relative to these loans, although we have recorded partial charge-offs for certain restructured loans. In general, these loans are secured by first liens on 1-4 residential or commercial real estate properties, or farmland. Restructured loans also included $467,000 of commercial loans at December 31, 2017. At December 31, 2017, $1.2 million of TDRs were performing according to their modified terms.

There were no modifications granted during 2017 or 2016 that resulted in loans being identified as TDRs. During the twelve months ended December 31, 2017, TDRs were reduced as a result of $1.6 million in payments. In addition, the TDR classification was removed from two loans that met the requirements discussed above in 2017. These loans totaled $4.1 million at December 31, 2016, and are no longer evaluated individually for impairment.

The following table sets forth information with respect to TDRs, non-performing loans, real estate acquired through foreclosure, and other repossessed assets.

  

As of December 31,

 
  

2017

  

2016

  

 

2015

  

 

2014

  

 

2013

 
  

(dollars in thousands)

 
                     

Total non-performing loans

 $5,458  $9,216  $14,087  $47,326  $101,999 

TDRs on accrual

  1,217   5,350   17,440   21,985   44,346 

Total non-performing loans and TDRs on accrual

 $6,675  $14,566  $31,527  $69,311  $146,345 

Real estate acquired through foreclosure

  4,409   6,821   19,214   46,197   30,892 

Other repossessed assets

               

Total non-performing assets and TDRs on accrual

 $11,084  $21,387  $50,741  $115,508  $177,237 
                     

Total non-performing loans and TDRs on accrual to total loans

  0.94

%

  2.28

%

  5.10

%

  11.09

%

  20.63

%

Total non-performing assets and TDRs on accrual to total assets

  1.14

%

  2.26

%

  5.35

%

  11.35

%

  16.47

%

See Footnote 3, “Loans”, to the financial statements for additional disclosure related to troubled debt restructuring.

Interest income that would have been earned on non-performing loans was $274,000, $465,000, $738,000, and $1.7 million$738,000 for the years ended December 31, 2018, 2017, 2016, and 2015,2016, respectively. Interest income recognized on accruing non-performing loans was $452,000, $135,000, $445,000, and $710,000$445,000 for the years ended December 31, 2018, 2017, and 2016, and 2015, respectively.

 

Allowance for Loan Losses The allowance for loan losses is based on management’s continuing review and evaluation of individual loans, loss experience, current economic conditions, risk characteristics of various categories of loans and such other factors that, in management’s judgment, require current recognition in estimating loan losses.

 

Management has established loan grading procedures that result in specific allowance allocations for any estimatedestimated inherent risk of loss. For loans not individually evaluated, a general allowance allocation is computed using factors developed over time based on actual loss experience. Prior to June 2017, the look-back period for historical losses was 12 quarters, weighted 40% for the most recent eight quarters and 20% for the previous four quarter period. Effective June 30, 2017, the Company extended the look-back period to 16 quarters on a prospective basis, weighted 40% for the most recent four quarters, then declining one tenth for each of the remaining annual periods. Management determined the four-year look-back period was appropriate as the four-year period more appropriately correlates to the period in which the current portfolio was underwritten and originated. The specific and general allocations plus consideration of qualitative factors represent management’s estimate of probable losses contained in the loan portfolio at the evaluation date. Although the allowance for loan losses is comprised of specific and general allocations, the entire allowance is available to absorb any credit losses.

38

 

The following table sets forth an analysis of loan loss experience as of and for the periods indicated:

 

 

As of December 31,

  

As of December 31,

 
 

2017

  

2016

  

2015

  

2014

  

2013

  

2018

  

2017

  

2016

  

2015

  

2014

 
 

(dollars in thousands)

  

(dollars in thousands)

 

Balances at beginning of period

 $8,967  $12,041  $19,364  $28,124  $56,680  $8,202  $8,967  $12,041  $19,364  $28,124 
                                        

Loans charged-off:

                                        

Real estate

  750   2,157   5,050   17,943   28,879   450   750   2,157   5,050   17,943 

Commercial

  5   276   696   1,099   2,828   50   5   276   696   1,099 

Consumer

  51   178   268   354   773   95   51   99   221   335 

Agriculture

  95   18   118   30   128   13   95   18   118   30 

Other

  8      79   47   19 

Total charge-offs

  901   2,629   6,132   19,426   32,608   616   901   2,629   6,132   19,426 
                                        

Recoveries:

                                        

Real estate

  714   1,189   2,338   2,726   1,622   1,437   714   1,189   2,338   2,726 

Commercial

  59   334   723   614   1,212   261   59   334   723   614 

Consumer

  130   368   240   213   266   69   115   299   184   168 

Agriculture

  33   114   8   13   252   15   33   114   8   13 

Other

  12   15   69   56   45 

Total recoveries

  936   2,005   3,309   3,566   3,352   1,794   936   2,005   3,309   3,566 

Net charge-offs (recoveries)

  (35

)

  624   2,823   15,860   29,256   (1,178

)

  (35

)

  624   2,823   15,860 

Provision (negative provision) for loan losses

  (800

)

  (2,450

)

  (4,500

)

  7,100   700   (500

)

  (800

)

  (2,450

)

  (4,500

)

  7,100 

Balance at end of period

 $8,202  $8,967  $12,041  $19,364  $28,124  $8,880  $8,202  $8,967  $12,041  $19,364 
                                        

Allowance for loan losses to period-end loans

  1.15

%

  1.40

%

  1.95

%

  3.10

%

  3.96

%

  1.16

%

  1.15

%

  1.40

%

  1.95

%

  3.10

%

Net charge-offs (recoveries) to average loans

  (0.01

%)

  0.10

%

  0.44

%

  2.39

%

  3.71

%

  (0.16

)%

  (0.01

)%

  0.10

%

  0.44

%

  2.39

%

Allowance for loan losses to non-performing loans

  150.27

%

  97.30

%

  85.48

%

  40.92

%

  27.57

%

                    

Allowance for loan losses for loans individually evaluated for impairment

 $219  $399  $428  $752  $3,471 

Loans individually evaluated for impairment

  7,173   15,131   31,776   71,993   149,883 

Allowance for loan losses to loans individually evaluated for impairment

  3.05%  2.64%  1.35%  1.04%  2.32%
                    

Allowance for loan losses for loans collectively evaluated for impairment

 $7,983  $8,568  $11,613  $18,612  $24,653 

Loans collectively evaluated for impairment

  704,942   624,105   586,890   553,006   559,443 

Allowance for loan losses to loans collectively evaluated for impairment

  1.13%  1.37%  1.98%  3.37%  4.41%

Allowance for loan losses to non-performing loans and TDRs on accrual

  306.10

%

  122.88

%

  61.16

%

  38.19

%

  27.94

%

 

The allowance for loan losses is a reserve established through charges to earnings in the form of a provision for loan losses. The allowance for loan losses is comprised of general reserves and specific reserves. The loan loss reserve, as a percentage of total loans at December 31, 2017, decreased to2018, was stable at 1.16% and 1.15% from 1.40% at December 31, 2016. The change in loan loss reserve as a percentage of total2017. New loans between periods is attributablecontinue to growth in the portfolio driven by new loansbe underwritten with lower loss expectations, improving historicalexpectations. Historical loss experience, improvement in risk grade classification metrics, improved charge-off levels, and improved past due trends.trends remained stable between periods. The allowance for loan losses to non-performing loans was 150.27%306.10% at December 31, 2017,2018, compared with 97.30%122.88% at December 31, 2016.2017. Net recoveries in 2017 totaled $35,000.

39

The following table sets forth the net charge-offs (recoveries)$1.2 million for the periods indicated:2018 compared to $35,000 for 2017.

 

  

Year Ended

December 31,

2017

  

Year Ended

December 31,

2016

  

Year Ended

December 31,

2015

 
  

(in thousands)

 

Commercial

 $(54

)

 $(58

)

 $(27

)

Commercial Real Estate

  (361

)

  (339

)

  1,225 

Residential Real Estate

  397   1,307   1,487 

Consumer

  (64

)

  (200

)

  37 

Agriculture

  62   (96

)

  110 

Other

  (15

)

  10   (9

)

Total net charge-offs (recoveries)

 $(35

)

 $624  $2,823 

A general reserve is maintained for each loan type in the loan portfolio. In determining the amount of the general reserve portion of the allowance for loan losses, management considers factors such as our historical loan loss experience, the growth, composition and diversification of our loan portfolio, current delinquency levels, loan quality grades, the results of recent regulatory examinations and general economic conditions. Based on these factors, we applymanagement applies estimated percentages to the various categories of loans, not including any loan that has a specific allowance allocated to it, based on our historical experience, portfolio trends and economic and industry trends. This information is used by management to set the general reserve portion of the allowance for loan losses at a level it deems prudent.

35

 

Generally, all loans identified as impaired are reviewed on a quarterly basis in order to determine whether a specific allowance is required. A loan is considered impaired when,, based on current information, it is probable that wethe Bank will not receive all amounts due in accordance with the contractual terms of the loan agreement. Once a loan has been identified as impaired, management measures impairment in accordance with ASC 310-10, “Impairment of a Loan. When management’s measured value of the impaired loan is less than the recorded investment in the loan, the amount of the impairment is recorded as a specific reserve or charged-off if the loan is deemed collateral dependent. These specific reserves are determined on an individual loan basis based on management’s current evaluation of our loss exposure for each credit given the payment status, financial condition of the borrower and value of any underlying collateral. Loans for which specific reserves have been provided are excluded from the general reserve calculations described below. Changes in specific reserves from period to period are the result of changes in the circumstances of individual loans such as charge-offs, pay-offs, changes in collateral values or other factors.

 

The allowance for loan losses represents management’smanagement’s estimate of the amount necessary to provide for probable losses in the loan portfolio in the normal course of business. Due to the uncertainty of risks in the loan portfolio, management’s judgment of the amount of the allowance necessary to absorb loan losses is approximate. The allowance for loan losses is also subject to regulatory examinations and may be adjusted in response to a determination by the regulatory agencies as to its adequacy in comparison with peer institutions.

 

We makeManagement makes specific allowances for each impaired loan based on its type and risk classification as discussed above. At year-end 2017,2018, the allowance for loan losses to total non-performing loans and TDRs on accrual increased to 150.27%306.10% from 97.30%122.88% at year-end 2016.2017. It is important to look more closely at this ratio as a significant portion of impaired loans are collateral dependent and have been charged down to the estimated fair value of the underlying collateral less cost to sell. Please see the next table for comparison and disclosure of recorded investment less allocated allowance relative to the unpaid principal balance. Impaired loans have been assessed for collectability which considered, among other things, the borrower’s ability to repay, the value of the underlying collateral, and other market conditions to ensure that the allowance for loan losses is adequate to absorb probable incurred losses.

40

 

The following table presents the unpaid principal balance, recorded investment and allocated allowance related to loans individually evaluated for impairment in the commercial real estate and residential real estate portfolios as of December 31, 20172018 and 2016.2017.

 

 

December 31, 2017

  

December 31, 2016

  

December 31, 2018

  

December 31, 2017

 
 

Commercial

Real Estate

  

Residential

Real Estate

  

Commercial

Real Estate

  

Residential

Real Estate

  

Commercial

Real Estate

  

Residential

Real Estate

  

Commercial

Real Estate

  

Residential

Real Estate

 
 

(in thousands)

  

(in thousands)

 

Unpaid principal balance

 $4,734  $5,456  $10,985  $10,439  $2,421  $3,398  $4,734  $5,456 

Prior charge-offs

  (2,099

)

  (1,506

)

  (5,131

)

  (1,818

)

  (1,911

)

  (1,050

)

  (2,099

)

  (1,506

)

                                

Recorded investment

  2,635   3,950   5,854   8,621   510   2,348   2,635   3,950 

Allocated allowance

     (206

)

  (35

)

  (350

)

  (35

)

  (168

)

     (206

)

                                

Recorded investment, less allocated allowance

 $2,635  $3,744  $5,819  $8,271  $475  $2,180  $2,635  $3,744 
                                

Recorded investment, less allocated allowance/ Unpaid principal balance

  55.66

%

  68.62

%

  52.97

%

  79.23

%

Recorded investment, less allocated allowance/ Unpaid principal balance

  19.62

%

  64.16

%

  55.66

%

  68.62

%

 

Based on prior charge-offs, the current recorded investments in loans individually evaluated for impairment in the commercial real estate and residential real estate segments of the portfolio are significantly below the unpaid principal balances of those loans. The recorded investment net of the allocated allowance was 55.66%19.62% and 68.62%64.16% of the unpaid principal balance in the commercial real estate and residential real estate segments, respectively, at December 31, 2017.

The following table illustrates recent trends in loans collectively evaluated for impairment and the related allowance for loan losses by portfolio segment:

  

December 31, 2017

  

December 31, 2016

 
                         
  

Loans

  

Allowance

  

% to Total

  

Loans

  

Allowance

  

% to Total

 
  

(dollars in thousands)

 

Commercial

 $113,184  $879   0.78

%

 $97,166  $462   0.48

%

Commercial real estate

  299,751   4,032   1.35   251,529   4,859   1.93 

Residential real estate

  231,860   2,694   1.16   227,668   3,076   1.35 

Consumer

  18,438   64   0.35   9,817   8   0.08 

Agriculture

  41,154   313   0.76   37,448   161   0.43 

Other

  555   1   0.18   477   2   0.42 

Total

 $704,942  $7,983   1.13

%

 $624,105  $8,568   1.37

%

The allowance for those loan losses related to loans collectively evaluated for impairment trended downward from 1.37% at December 31, 2016 to 1.13% at December 31, 2017 as a result of declining historical charge-off levels and improving trends in loan category risk ratings. The residential real estate segment constitutes approximately 32.9% of total loans collectively evaluated for impairment. The related allowance for the residential real estate segment trended downward from 1.35% at December 31, 2016 to 1.16% at December 31, 2017 as net charge-offs declined from approximately $1.3 million in 2016 to $397,000 in 2017. The commercial real estate segment constitutes approximately 42.5% of total loans collectively evaluated for impairment. The related allowance for the commercial real estate segment trended downward from 1.93% at December 31, 2016 to 1.35% at December 31, 2017. This is consistent with the decline in historical rates and improvement in loan quality within the commercial real estate segment. The overall decrease in the allowance also reflects improving historical loss experience, qualitative factors, improvement in risk grade classification metrics, improved charge-off levels, improved past due trends, and the negative provision.  2018.

 

A significant portion of the portfolio is comprised of loans secured by real estate. A decline in the value of the real estate serving as collateral for loans may impact our ability to collect those loans. In general, we obtainmanagement obtains updated appraisals on property securing our loans when circumstances are warranted such as at the time of renewal or when market conditions have significantly changed. We useManagement uses qualified licensed appraisers approved by our Board of Directors. These appraisers possess prerequisite certifications and knowledge of the local and regional marketplace.

36

 

Based on its assessment of the loan portfolio, management presents a quarterly review of the allowance for loan losses to the Bank’s Board of Directors, indicating any change in the allowance for loan losses since the last review and any recommendations as to adjustments in the allowance for loan losses.

41

 

This assessment is inherently subjective as it requires estimates that are susceptible to significant revision as more information becomes available or as events change. The allowance for loan losses has decreasedwas stable as a percentage of loans outstanding to 1.15%at 1.16% at December 31, 2017 from 1.40%2018 and 1.15% at December 31, 2016. This decline is the result of growth in the portfolio driven by new2017. New loans continue to be underwritten with lower loss expectations, improving historicalexpectations. Historical loss experience, improvement in risk grade classification metrics, improved charge-off levels, and improved past due trends.trends remained stable between periods. The level of the allowance is based on estimates, and losses may ultimately vary from these estimates.

 

The Bank follows a loan grading program designed to evaluate the credit risk in the loan portfolio. Through this loan grading process, an internally classified watch list is maintained which helps management assess the overall quality of the loan portfolio and the adequacy of the allowance for loan losses. Loans categorized as watch list loans show warning elements where the present status exhibits one or more deficiencies that require attention in the short-term or where pertinent ratios of the loan account have weakened to a point where more frequent monitoring is warranted. These loans do not have all of the characteristics of a classified loan (substandard or doubtful) but show weakened elements as compared with those of a satisfactory credit. These loans are reviewed to assist in assessing the adequacy of the allowance for loan losses.

 

In establishing the appropriate risk rating for specific assets, management considers, among other factors, the borrower’s ability to repay, the borrower’s repayment history, the current delinquency status, the estimated value of the underlying collateral, and the capacity and willingness of a guarantor to satisfy the obligation. As a result of this process, loans are categorized as special mention, substandard or doubtful.

 

Loans classified as “special mention” do not have all of the characteristics of substandard or doubtful loans. They have one or more deficiencies that warrant special attention and which corrective action, such as accelerated collection practices, may remedy.

 

Loans classified as “substandard” are those loans with clear and defined weaknesses such as a highly leveraged position, unfavorable financial ratios, uncertain repayment sources or poor financial condition that may jeopardize the repayment of the debt as contractually agreed. They are characterized by the distinct possibility that wethe Bank will sustain some losses if the deficiencies are not corrected.

 

Loans classified as “doubtful” are those loans which have characteristics similar to substandard loans but with an increased risk that collection or liquidation in full is highly questionable and improbable.

 

Specific reserves may be carried for accruing TDRs in compliancecompliance with restructured terms. Once a loan is deemed impaired or uncollectible as contractually agreed (other than performing TDRs), the loan is charged-off either partially or in-full against the allowance for loan losses, based upon the expected future cash flows discounted at the loan’s effective interest rate, or the fair value of collateral less estimated cost to sell with respect to collateral-based loans if collateral dependent.

 

As of December 31, 2017, $13.22018, $6.4 million of loans were classified as substandard, $164,000$113,000 classified as special mention and no loans classified as doubtful or loss. This compares with $21.9$13.2 million of loans classified as substandard, $497,000$164,000 classified as special mention and no loans classified as doubtful or loss as of December 31, 2016.2017. The $8.7$6.8 million decrease in loans classified as substandard was primarily driven by $6.8$12.6 million in principal payments received, $270,000$730,000 in migration to OREO, $4.6 million$92,000 in loans upgraded from substandard, and $790,000$480,000 in charge-offs, offset by $3.7$7.1 million in loans moved to substandard during 2017.2018. Substandard loans are primarily concentrated in the residential real estate portfolio. As of December 31, 2017, $418,0002018, $266,000 of the allowance for loan losses was allocated to substandard loans. This compares to allocations of $600,000$418,000 in the allowance for loan losses related to substandard loans at December 31, 2016.2017.

 

4237

 

The following table depicts management’s allocation of the allowance for loan losses by loan type. Allowance funding and allocation is based on management’s current evaluation of risk in each category, economic conditions, past loss experience, loan volume, past due history and other factors. Since these factors and management’s assumptions are subject to change, the allocation is not necessarily predictive of future portfolio performance. The allocation is made for analytical purposes and is not necessarily indicative of the categories in which future losses may occur. The total allowance is available to absorb losses from any segment of loans.

 

 

As of December 31,

  

As of December 31,

 
 

2017

  

2016

  

2018

  

2017

 
 

Amount of

Allowance

  

Percent of

Loans to

Total

Loans

  

Amount of

Allowance

  

Percent of

Loans to

Total

Loans

  

Amount of

Allowance

  

Percent of

Loans to Total

Loans

  

Amount of

Allowance

  

Percent of

Loans to Total

Loans

 
 

(dollars in thousands)

  

(dollars in thousands)

 
                                

Commercial

 $892   15.98

%

 $475   15.29

%

 $1,299   16.91

%

 $892   15.98

%

Commercial Real Estate:

                                

Construction

  301   8.05   470   5.68   419   11.35   301   8.05 

Farmland

  449   12.40   288   11.19   543   10.18   449   12.40 

Nonfarm nonresidential

  3,282   22.01   4,136   23.39   3,714   22.50   3,282   22.01 

Residential Real Estate:

                                

Multi-family

  627   7.94   610   7.54   403   6.50   627   7.94 

1-4 Family

  2,273   25.17   2,816   29.42   2,049   22.97   2,273   25.17 

Consumer

  64   2.59   8   1.54   130   5.11   64   2.59 

Agriculture

  313   5.78   162   5.87   321   4.41   313   5.78 

Other

  1   0.08   2   0.08   2   0.07   1   0.08 

Total

 $8,202   100.0

%

 $8,967   100.0

%

 $8,880   100.0

%

 $8,202   100.0

%

  

 

As of December 31,

  

As of December 31,

 
 

2015

  

2014

  

2013

  

2016

  

2015

  

2014

 
 

Amount of

Allowance

  

Percent of

Loans to

Total

Loans

  

Amount of

Allowance

  

Percent of

Loans to

Total

Loans

  

Amount of

Allowance

  

Percent of

Loans to

Total

Loans

  

Amount of

Allowance

  

Percent of

Loans to Total

Loans

  

Amount of

Allowance

  

Percent of

Loans to Total

Loans

  

Amount of

Allowance

  

Percent of

Loans to Total

Loans

 
 

(dollars in thousands)

  

(dollars in thousands)

 
                                                

Commercial

 $818   13.93

%

 $2,046   9.75

%

 $3,221   7.45

%

 $475   15.29

%

 $818   13.93

%

 $2,046   9.75

%

Commercial Real Estate:

                                                

Construction

  424   5.36   739   5.31   2,149   6.11   470   5.68   424   5.36   739   5.31 

Farmland

  364   12.35   1,094   12.39   1,623   10.04   288   11.19   364   12.35   1,094   12.39 

Nonfarm nonresidential

  6,205   22.72   9,098   28.07   12,642   32.71   4,136   23.39   6,205   22.72   9,098   28.07 

Residential Real Estate:

                                                

Multi-family

  422   7.13   886   6.70   1,449   6.61   610   7.54   422   7.13   886   6.70 

1-4 Family

  3,562   32.57   4,901   31.56   6,313   32.21   2,816   29.42   3,562   32.57   4,901   31.56 

Consumer

  122   1.62   274   1.82   416   2.03   8   1.54   122   1.62   274   1.82 

Agriculture

  122   4.25   319   4.31   305   2.71   162   5.87   122   4.25   319   4.31 

Other

  2   0.07   7   0.09   6   0.13   2   0.08   2   0.07   7   0.09 

Total

 $12,041   100.0

%

 $19,364   100.0

%

 $28,124   100.00

%

 $8,967   100.0

%

 $12,041   100.0

%

 $19,364   100.0

%

 

Provision for Loan Losses A negative provision for loan losses of $800,000$500,000 was recorded for the year ended December 31, 2017,2018, compared with a negative provision for loan losses of $800,000 for 2017 and a negative provision for loan losses of $2.5 million for 2016 and a negative provision for loan losses of $4.5 million for 2015.2016. The negative provision in 20172018 was driven by declining historical loss rates, net recoveries for the year, improvements in loanasset quality, changes on the composition of the portfolio, and management’s assessment of risk within the portfolio. Asset quality improvement is evidenced by, among other things, improvements in loan risk category migration. The total allowance for loan losses was $8.2pass category increased approximately $72.6 million, the watch category declined approximately $12.6 million, the special mention category declined approximately $51,000 and the substandard category declined approximately $6.8 million. Additionally, non-accrual loans decreased $3.5 million or 1.15% of total loans, at December 31, 2017,63.5% during 2018. Net recoveries were $1.2 million for 2018 compared with $9.0 million, or 1.40% of total loans, at December 31, 2016, and $12.0 million, or 1.95% of total loans, at December 31, 2015. The decreased allowance is consistent with the overall trends within the portfolio. Substandard loans decreased by $8.7 million or 39.7% during 2017,to net recoveries wereof $35,000 forin 2017 compared toand net charge-offs of $624,000 in 2016 and $2.8 million in 2015, and nonaccrual loans decreased by $3.8 million or 40.8% during 2017. Charge-offs for 2017 were concentrated in the loans secured by the residential real estate category of the portfolio. These net charge-offs consisted of $397,000 of residential real estate loans. We consider2016. Management considers the size and volume of our portfolio as well as the credit quality of our loan portfolio based upon risk category classification when determining the loan loss provision for each period and the allowance for loan losses at period end.

 

4338

 

Foreclosed Properties – Foreclosed properties at December 31, 20172018 were $4.4$3.5 million compared with $6.8$4.4 million at December 31, 2016.2017. See Note“Note 5 “Other- Other Real Estate Owned”,Owned,” to the financial statements. During 2017, we2018, the Bank acquired $270,000$730,000 of OREO properties and sold properties totaling approximately $793,000. We value$876,000. Management values foreclosed properties at fair value less estimated cost to sell when acquired and expectexpects to liquidate these properties to recover our investment in the due course of business.

 

OREO is recorded at fair market value less estimated cost toto sell at time of acquisition. Any write-down of the property at the time of acquisition is charged to the allowance for loan losses. When foreclosed properties are acquired, management obtains a new appraisal or has staff from the Bank’s special assets group evaluate the latest in-file appraisal in connection with the transfer to OREO. WeManagement typically obtainobtains updated appraisals within five quarters of the anniversary date of ownership unless a sale is imminent. Subsequent reductions in fair value are recorded as non-interest expense when a new appraisal indicates a decline in value or in cases where a listing price is lowered below the appraisal amount.

 

The following table presents the major categories of OREO at the year-ends indicated:

  

2017

  

2016

  

2015

 
  

(in thousands)

 

Commercial Real Estate:

            

Construction, land development, and other land

 $4,335  $6,571  $12,344 

Farmland

  74       

Nonfarm nonresidential

        6,746 

Residential Real Estate:

            

1-4 Family

     250   124 
  $4,409  $6,821  $19,214 

  

2018

  

2017

  

2016

 
  

(in thousands)

 

 

Commercial Real Estate:

            

Construction, land development, and other land

 $3,485  $4,335  $6,571 

Farmland

     74    

Residential Real Estate:

            

1-4 Family

        250 
  $3,485  $4,409  $6,821 

 

NetNet activity relating to other real estate owned during the years indicated is as follows:

  

2017

  

2016

  

2015

 
  

(in thousands)

 

OREO Activity

            

OREO as of January 1

 $6,821  $19,214  $46,197 

Real estate acquired

  270   1,273   5,513 

Valuation adjustment write-downs

  (1,963

)

  (1,180

)

  (9,855

)

Net gain (loss) on sale

  74   222   (74

)

Proceeds from sale of properties

  (793

)

  (12,708

)

  (22,567

)

OREO as of December 31

 $4,409  $6,821  $19,214 

  

2018

  

2017

  

2016

 
  

(in thousands)

 

 

OREO Activity

            

OREO as of January 1

 $4,409  $6,821  $19,214 

Real estate acquired

  730   270   1,273 

Valuation adjustment write-downs

  (850

)

  (1,963

)

  (1,180

)

Net gain on sale

  72   74   222 

Proceeds from sale of properties

  (876

)

  (793

)

  (12,708

)

OREO as of December 31

 $3,485  $4,409  $6,821 

 

Net gain on sales, write-downs, and operating expenses for OREO totaled $2.0 million$868,000 for the year ended December 31, 2017,2018, compared with $2.0 million in 2017 and $1.5 million in 2016 and $12.3 million in 2015.2016.

 

During the year ended December 31, 2017,2018, fair value write-downs of $2.0 million$850,000 were recorded compared with $2.0 million for 2017 and $1.2 million for 2016 and $9.9 million for 2015.2016. The write-downs recorded in each year reflect fair value write-downs due to updated appraisals, changes in marketing strategies, and reductions in listing prices for certain properties. OREO sales totaled $876,000, $793,000, and $12.7 million during 2018, 2017, and $22.6 million during 2017, 2016, and 2015, respectively. We expectManagement expects to resolve certain nonaccrual loans through the acquisition and sale of the underlying real estate collateral.

 

Investment Securities – The securities portfolio serves as a source of liquidity and earnings and contributes to the management of interest rate risk. Investments are made in various types of liquid assets, including short-term United StatesU.S. Treasury obligations and securities of various federal agencies, obligations of states and political subdivisions, corporate bonds, collateralized loan obligations, certificates of deposit at insured savings and loans and banks, bankers’ acceptances and federal funds. The investment policy also authorizes investment in mutual funds and stocks whose assets conform to the investments that we are authorized to make directly. The investment portfolio decreasedincreased by $41.9$48.5 million, or 21.5%31.7%, to $201.2 million at December 31, 2018, compared with $152.7 million at December 31, 2017, compared with $194.6 million at December 31, 2016 as the Bank sold selected securities to manage liquidity and interest rate risk.2017.

 

4439

 

The following table sets forth the carrying value of our securities portfolio at the dates indicated.

 

  

December 31, 2017

  

December 31, 2016

 
  

Amortized

Cost

  

Gross

Unrealized

Gains

  

Gross

Unrealized

Losses

  

Fair

Value

  

Amortized

Cost

  

Gross

Unrealized

Gains

  

Gross

Unrealized

Losses

  

Fair

Value

 
  

(dollars in thousands)

 

Securities available for sale

                                

U.S. Government and federal agencies

 $22,105  $2  $(483

)

 $21,624  $34,757  $50  $(708

)

 $34,099 

Agency mortgage-backed: residential

  65,935   117   (1,087

)

  64,965   103,390   455   (1,492

)

  102,353 

Collateralized loan obligations

  25,343   182   (20

)

  25,505   11,203         11,203 

State and municipal

  33,303   508   (101

)

  33,710   2,028   25   (8

)

  2,045 

Corporate bonds

  6,838   78      6,916   3,069   24   (3

)

  3,090 

Total available for sale

 $153,524  $887  $(1,691

)

 $152,720  $154,447  $554  $(2,211

)

 $152,790 

  

Amortized

Cost

  

Gross

Unrecognized

Gains

  

Gross

Unrecognized

Losses

  

Fair

Value

  

Amortized

Cost

  

Gross

Unrecognized

Gains

  

Gross

Unrecognized

Losses

  

Fair

Value

 
                                 

Securities held to maturity

                                

State and municipal

 $  $  $  $  $41,818  $1,272  $(18

)

 $43,072 

Total held to maturity

 $  $  $  $  $41,818  $1,272  $(18

)

 $43,072 

In 2013, the Bank transferred a portion of its tax-free municipal and taxable municipal bond portfolios from available for sale (AFS) to held to maturity (HTM). At that time, the transfer occurred at fair value with the unrealized loss of $1.3 million remaining in other comprehensive income. That unrealized loss has subsequently been amortized on the level yield method out of other comprehensive income with an offsetting entry reducing interest income as a yield adjustment through earnings. No gain or loss was recorded at the time of transfer in 2013. Given the Bank’s current balance sheet composition, interest rate risk profile, the current tax environment, and the Bank’s strategic plan, management reassessed the classification of the held to maturity securities and, effective December 1, 2017, transferred $41.4 million of tax-free municipals and taxable municipals from HTM to AFS. As a result, the $702,000 in remaining unamortized loss from the 2013 transfer was reclassified through a book value adjustment of these securities. At December 31, 2017, these securities were carried at fair value with unrealized holding gains and losses reported in other comprehensive income, net of tax, with the remaining securities classified as AFS.

  

December 31, 2018

  

December 31, 2017

 
  

Amortized

Cost

  

Gross

Unrealized

Gains

  

Gross

Unrealized

Losses

  

Fair

Value

  

Amortized

Cost

  

Gross

Unrealized

Gains

  

Gross

Unrealized

Losses

  

Fair

Value

 
  

(dollars in thousands)

 

Securities available for sale

                                

U.S. Government and federal agencies

 $23,280  $2  $(722

)

 $22,560  $22,105  $2  $(483

)

 $21,624 

Agency mortgage-backed: residential

  87,689   192   (1,891

)

  85,990   65,935   117   (1,087

)

  64,965 

Collateralized loan obligations

  49,942      (103

)

  49,839   25,343   182   (20

)

  25,505 

State and municipal

  32,841   230   (259

)

  32,812   33,303   508   (101

)

  33,710 

Corporate bonds

  9,890   127   (26

)

  9,991   6,838   78      6,916 

Total available for sale

 $203,642  $551  $(3,001

)

 $201,192  $153,524  $887  $(1,691

)

 $152,720 

 

The following table sets forth the contractual maturities, fair values and weighted-average yields for our available for sale securities held at December 31, 2017:2018:

 

 

Due Within

One Year

  

After One Year

But Within

Five Years

  

After Five Years

But Within

Ten Years

  

After Ten Years

  

Total

  

Due Within

One Year

  

After One Year

But Within

Five Years

  

After Five Years

But Within

Ten Years

  

After Ten Years

  

Total

 
 

Amount

  

Yield

  

Amount

  

Yield

  

Amount

  

Yield

  

Amount

  

Yield

  

Amount

  

Yield

  

Amount

  

Yield

  

Amount

  

Yield

  

Amount

  

Yield

  

Amount

  

Yield

  

Amount

  

Yield

 

Available for sale

                                                                                

U.S. Government and federal agencies

 $   

%

 $   

%

 $5,788   2.19

%

 $15,836   2.18

%

 $21,624   2.18

%

 $   

%

 $   

%

 $8,981   2.54

%

 $13,579   2.20

%

 $22,560   2.33

%

Agency mortgage-backed: residential

        2,956   2.64   9,415   2.31   52,594   2.46   64,965   2.45         5,540   2.49   11,020   2.33   69,430   3.02   85,990   2.89 

Collateralized loan obligations

              10,631   0.28   14,874   2.59   25,505   1.63               4,048   4.42   45,791   3.77   49,839   3.82 

State and municipal

  145   2.10   19,612   3.31   11,539   3.27   2,414   5.19   33,710   3.42   5,173   2.89   19,225   3.04   5,968   3.34   2,446   4.36   32,812   3.17 

Corporate bonds

              3,160   4.54   3,756   5.11   6,916   4.86               6,099   5.18   3,892   6.55   9,991   5.71 

Total available for sale

 $145   2.10

%

 $22,568   3.22

%

 $40,533   2.20

%

 $89,474   2.61

%

 $152,720   2.59

%

 $5,173   2.89

%

 $24,765   2.92

%

 $36,116   3.25

%

 $135,138   3.31

%

 $201,192   3.24

%

 


Average yields in the table above were calculated on a tax equivalent basis using a federal income tax rate of 35%21%. Mortgage-backed securities are securities that have been developed by pooling a number of real estate mortgages. These securities are issued by federal agencies such as Ginnie Mae, Fannie Mae and Freddie Mac, as well as non-agency company issuers. These securities are deemed to have high credit ratings, and minimum regular monthly cash flows of principal and interest. Cash flows from agency backed mortgage-backed securities are guaranteed by the issuing agencies.

 

Unlike U.S. Treasury and U.S. government agency securities, which have a lump sum payment at maturity, mortgage-backed securities provide cash flows from regular principal and interest payments and principal prepayments throughout the lives of the securities. Mortgage-backed securities that are purchased at a premium will generally return decreasing net yields as interest rates drop because home owners tend to refinance their mortgages. Thus, the premium paid must be amortized over a shorter period. Therefore, those securities purchased at a discount will obtain higher net yields in a decreasing interest rate environment. As interest rates rise, the opposite will generally be true. During a period of increasing interest rates, fixed rate mortgage-backed securities do not tend to experience heavy prepayments of principal and consequently, average life will not be shortened. If interest rates begin to fall, prepayments will generally increase. Non-agency issuer mortgage-backed securities do not carry a government guarantee. We limit ourManagement limits purchases of these securities to bank qualified issues with high credit ratings. We regularly monitorAt this time, there are no holdings of this type in the performance and credit ratings of these securities and evaluate these securities, as we do all of our securities, for other-than-temporary impairment on a quarterly basis.portfolio. At December 31, 2017, 81.0%2018, 80.7% of the Bank’s agency mortgage-backed securities we held had contractual final maturities of more than ten years with a weighted average life of 23.920.5 years.

The Bank owns Collateralized Loan Obligations (CLOs), which are debt securities secured by professionally managed portfolios of senior-secured loans to corporations. CLO managers are typically large non-bank financial institutions or banks and are typically $300 million to $1 billion in size, contain one hundred or more loans and have five to six credit tranches ranging from AAA, AA, A, BBB, BB, B and equity tranche. Interest and principal are paid first to the AAA tranche then to the next lower rated tranche. Losses are borne first by the equity tranche then by the subsequently higher rated tranche. CLOs may be less liquid than government securities from time to time and volatility in the CLO market may cause the value of these investments to decline.

The market value of CLOs may be affected by, among other things, changes in composition of the underlying loans, changes in the cash flows from the underlying loans, defaults and recoveries on the underlying loans, capital gains and losses on the underlying loans, and prepayments on the underlying loans. Although we attempt to mitigate the credit and liquidity risks associated with CLOs by purchasing CLOs with credit ratings of A or higher, completing pre-purchase due diligence, and through ongoing monitoring, no assurance can be given that these risk mitigation efforts will be successful.

 

4540

 

At December 31, 2018, $33.1 million and $16.7 million of our CLOs were AA and A rated, respectively. There were no CLOs rated below A and none of the CLOs were subject to ratings downgrade in 2018. All of our CLOs are floating rate, with rates set on a quarterly basis at three month LIBOR plus a spread.

DepositsWe attractThe Bank attracts both short-term and long-term deposits from the general public by offering a wide range of deposit accounts and interest rates. In recent years, we havethe Bank has been required by market conditions to rely increasingly on short to mid-term certificate accounts and other deposit alternatives, which are more responsive to market interest rates.

 

WeThe Bank primarily relyrelies on ourits banking office network to attract and retain deposits in ourits local markets and havehas in the past leveraged the online channel to attract out-of-market deposits. Market interest rates and rates on deposit products offered by competing financial institutions can significantly affect our ability to attract and retain deposits. During 2018, total deposits increased $47.2 million compared with 2017. During 2017, total deposits decreased $2.9 million compared with 2016. During 2016, total deposits decreased $28.1 million compared with 2015. The decreaseincrease in deposits for 20172018 and 20162017 was primarily in higher cost certificates of deposit balances.balances as well as money market accounts.

 

To evaluate our funding needs in light of deposit trends resulting from continually changing conditions, we evaluatemanagement evaluates simulated performance reports that forecast changes in margins along with other pertinent economic data. We continueThe Bank continues to offer attractively priced deposit products along ourits product line to allow usit to retain deposit customers and reduce interest rate risk during various rising and falling interest rate cycles.

 

We offerThe Bank offers savings accounts, interest checking accounts, money market accounts and fixed rate certificates with varying maturities. The flow of deposits is influenced significantly by general economic conditions, changes in interest rates and competition. Management adjusts interest rates, maturity terms, service fees and withdrawal penalties on the Bank’s deposit products periodically. The variety of deposit products allows the Bank to compete more effectively in obtaining funds and to respond with more flexibility to the flow of funds away from depository institutions into outside investment alternatives. However, the ability to attract and maintain deposits and the cost of these funds have been, and will continue to be, significantly affected by market conditions.

 

The following table sets forth the average daily balances and weighted average rates paid for our deposits for the periods indicated:

 

 

For the Years Ended December 31,

  

For the Years Ended December 31,

 
 

2017

  

2016

  

2015

  

2018

  

2017

  

2016

 
 

Average

Balance

  

Average

Rate

  

Average

Balance

  

Average

Rate

  

Average

Balance

  

Average

Rate

  

Average

Balance

  

Average

Rate

  

Average

Balance

  

Average

Rate

  

Average

Balance

  

Average

Rate

 
 

(dollars in thousands)

  

(dollars in thousands)

 

Demand

 $129,088      $119,736      $113,576      $136,947      $129,088      $119,736     

Interest Checking

  101,980   0.13

%

  96,294   0.13

%

  88,814   0.13

%

  90,583   0.13

%

  101,980   0.13

%

  96,294   0.13

%

Money Market

  145,281   0.55   136,423   0.58   112,350   0.57   158,832   0.90   145,281   0.55   136,423   0.58 

Savings

  35,486   0.17   34,257   0.18   35,604   0.21   34,866   0.16   35,486   0.17   34,257   0.18 

Certificates of Deposit

  452,443   0.93   466,007   0.88   557,441   0.96   439,597   1.35   452,443   0.93   466,007   0.88 

Total Deposits

 $864,278      $852,717      $907,785      $860,825      $864,278      $852,717     

Weighted Average Rate

      0.60

%

      0.60

%

      0.68

%

      0.88

%

      0.60

%

      0.60

%

 

The following table sets forth the average daily balances and weighted average rates paid for our certificates of deposit for the periods indicated:

 

 

For the Years Ended December 31,

  

For the Years Ended December 31,

 
 

2017

  

2016

  

2015

  

2018

  

2017

  

2016

 
 

Average

Balance

  

Average

Rate

  

Average

Balance

  

Average

Rate

  

Average

Balance

  

Average

Rate

  

Average

Balance

  

Average

Rate

  

Average

Balance

  

Average

Rate

  

Average

Balance

  

Average

Rate

 
 

(dollars in thousands)

  

(dollars in thousands)

 

Certificates of Deposit

                        

Less than $250,000

 $419,816   1.01

%

 $437,955   0.88

%

 $524,279   0.95

%

$250,000 or more

  32,627   0.92   28,052   0.97   33,162   1.12 
                        

Less than $250,000

 $410,942   1.34

%

 $419,816   0.92

%

 $437,955   0.88

%

$250,000 or more

  28,655   1.51   32,627   1.01   28,052   0.97 

Total

 $452,443   0.93

%

 $466,007   0.88

%

 $557,441   0.96

%

 $439,597   1.35

%

 $452,443   0.93

%

 $466,007   0.88

%

 

4641

 

The following table shows at December 31, 20172018 the amount of our time deposits of $250,000 or more by time remaining until maturity:

 

Maturity Period

Maturity Period

Maturity Period

 

(in thousands)

(in thousands)

    

Three months or less

 $5,276  $3,799 

Three months through six months

  1,995   4,002 

Six months through twelve months

  3,497   8,490 

Over twelve months

  20,963   11,820 

Total

 $31,731  $28,111 

 

The Bank maintains competitive pricing on its deposit products, which we believeManagement believes allows it to retain a substantial percentage of our customers when their time deposits mature.

 

Borrowing – Deposits are the primary source of funds for lending and investment activities and for general business purposes. We canThe Bank also useuses advances (borrowings) from the FHLB of Cincinnati to supplement the pool of lendable funds, meet deposit withdrawal requirements and manage the terms of liabilities. Advances from the FHLB are secured by the Bank’s stock in the FHLB, and substantially all of its first mortgage residential loans. At December 31, 2017,2018, the Bank had $11.8$46.5 million in advances outstanding from the FHLB and the capacity to increase borrowings by an additional $79.0$42.7 million. The FHLB of Cincinnati functions as a central reserve bank providing credit for savings banks and other member financial institutions. As a member, the Bank is required to own capital stock in the FHLB and is authorized to apply for advances on the security of such stock and certain of our home mortgages and other assets (principally, securities that are obligations of, or guaranteed by, the United States) provided that it meets certain standards related to creditworthiness.

 

The following table sets forth information about our FHLB advances as of and for the periods indicated:

 

 

December 31,

  

December 31,

 
 

2017

  

2016

  

2015

  

2018

  

2017

  

2016

 
 

(dollars in thousands)

  

(dollars in thousands)

 

Average balance outstanding

 $9,184  $2,967  $3,473  $43,363  $9,184  $2,967 

Maximum amount outstanding at any month-end during the period

  26,830   22,458   8,705   71,630   26,830   22,458 

End of period balance

  11,797   22,458   3,081   46,549   11,797   22,458 

Weighted average interest rate:

                        

At end of period

  1.48

%

  0.85

%

  2.65

%

  2.45

%

  1.48

%

  0.85

%

During the period

  1.31

%

  2.34

%

  2.73

%

  2.00

%

  1.31

%

  2.34

%

 

Subordinated Capital Note – At December 31, 2017, the Bank had a subordinated capital note outstanding in the principal amount of $2.3 million. The note is unsecured, bears interest at three-month LIBOR plus 300 basis points adjusting quarterly, and qualifies as Tier 2 capital until five years before the note matures on July 1, 2020. Beginning on July 1, 2015, one-fifth of the principal amount of the subordinated note was excluded from Tier 2 capital each year until fully excluded during the year before maturity. At December 31, 2017, a total of $1.7 million of the outstanding balance was included in Tier 2 capital. The note requires quarterly principal payments of $225,000 plus interest. At December 31, 2017, the interest rate on this note was 4.34%.

47

Junior Subordinated Debentures – At December 31, 2017,2018, the Company had four issues of junior subordinated debentures outstanding totaling $21.0 million as shown in the table below.

 

Description

 

Liquidation

Amount

Trust

Preferred

Securities

 

Issuance Date

 

Interest Rate (1)

 

Junior

Subordinated

Debt and

Investment

in Trust

 

Maturity Date

(dollars in thousands)

     

Porter Statutory Trust II

 $5,000 

2/13/2004

 

3-month LIBOR + 2.85%

 $5,155 

2/13/2034

Porter Statutory Trust III

  3,000 

4/15/2004

 

3-month LIBOR + 2.79%

  3,093 

4/15/2034

Porter Statutory Trust IV

  10,000 

12/14/2006

 

3-month LIBOR + 1.67%

  10,433 

3/1/2037

Ascencia Statutory Trust I

  3,000 

2/13/2004

 

3-month LIBOR + 2.85%

  3,093 

2/13/2034

  $21,000     $21,774  

Description

 

Liquidation

Amount

Trust

Preferred

Securities

 

Issuance Date

 

Interest Rate (1)

 

Junior

Subordinated

Debt and

Investment

in Trust

 

Maturity Date

(dollars in thousands)

     

Statutory Trust I

 $3,000 

2/13/2004

 

3-month LIBOR + 2.85%

 $3,093 

2/13/2034

Statutory Trust II

  5,000 

2/13/2004

 

3-month LIBOR + 2.85%

  5,155 

2/13/2034

Statutory Trust III

  3,000 

4/15/2004

 

3-month LIBOR + 2.79%

  3,093 

4/15/2034

Statutory Trust IV

  10,000 

12/14/2006

 

3-month LIBOR + 1.67%

  10,435 

3/1/2037

  $21,000     $21,776  

 


 

(1)

As of December 31, 2017,2018, the 3-month LIBOR was 1.69%2.80%.

 

The trust preferred securities are subject to mandatory redemption, in whole or in part, upon repayment of the subordinated debentures at maturity or their earlier redemption at the liquidation preference. The subordinated debentures are redeemable before the maturity date at our option at their principal amount plus accrued interest.

On April 15, 2016, the Company completed the private placement of 580,000 common shares and 220,000 non-voting common shares to accredited investors resulting in total proceeds of $5.0 million. The investors in the private placement directed a portion of the purchase price to pay all deferred interest payments on junior subordinated debentures, bringing interest payments current through the second quarter of 2016.

 

The Company has the option to defer interest payments on the subordinated debentures from time to time for a period not to exceed 20 consecutive quarters. SinceA deferral period may begin at the third quarter ofCompany’s discretion so long as interest payments are current.

On June 29, 2016, we have beenthe Company began deferring interest payments on the junior subordinated debentures held by our trust subsidiaries, requiring the trust subsidiaries to defer distributions on the trust preferred securities held by investors. Deferred distributions on the $21.0 million of trust preferred securities outstanding totaled $1.2 million as ofat December 31, 2017. The deferral period expires afterIn June 2018, the second quarter of 2021, at which time we will be required to pay all accrued interest or be in default. A deferral period may begin at the Company’s discression so long as interest payments are current. We are prohibited from paying cash dividends on our preferred and common shares until such time as we haveCompany paid all deferred distributions on our trust preferred securities. So long as the Written Agreement remains in effect, we will be required to obtain the approval of the Federal Reserve Bank of St. Louis before making any interest payments and brought interest current. At December 31, 2018, the Company is current on the subordinated debentures.all interest payments.

 

42

The

The Federal Reserve Board rules allow trust preferred securities issued prior to May 19, 2010 to be included in Tier 1 capital, subject to quantitative and qualitative limits. Currently, no more than 25% of our Tier 1 capital can consist of trust preferred securities and qualifying perpetual preferred stock. To the extent the amount of our trust preferred securities exceeds the 25% limit, the excess would be includable in Tier 2 capital. As of December 31, 2017,2018, the Company’s trust preferred securities totaled 22%21% of its Tier 1 capital and 40%10% of its Tier 2 capital.

 

Each of the trusts issuing the trust preferred securities holds junior subordinated debentures issued with anan original maturity of 30 years. In the last five years before the junior subordinated debentures mature, the associated trust preferred securities are excluded from Tier 1 capital and included in Tier 2 capital. In addition, the trust preferred securities during this five-year period are amortized out of Tier 2 capital by one-fifth each year and excluded from Tier 2 capital completely during the year before maturity.

 

Senior Debt – On June 30, 2017, the Company entered into a $10.0 million senior secured loan agreement with a commercial bank. The loan matures on June 30, 2022. Interest is payable quarterly at a rate of three-month LIBOR plus 250 basis points through June 30, 2020, at which time quarterly principal payments of $250,000 plus interest will commence. The loan is secured by a first priority pledge of 100% of the issued and outstanding stock of the Bank. The Company may prepay any amount due under the promissory note at any time without premium or penalty.

48

 

The Company contributed $9.0 million of the borrowing proceeds to the Bank as common equity Tier 1 capital. The remaining $1.0 million of the borrowing proceeds were retained by the lender in escrow to service quarterly interest payments. At December 31, 2017,2018, the escrow account had a balance of $806,000.$417,000.

 

The loan agreement contains customary representations, warranties, covenants and events of default, including the following financial covenants: (i) the Company must maintain minimum cash on hand of not less than $750,000 through June 30, 2018, and not less than $2,500,000, thereafter, (ii) the Company must maintain a total risk based capital ratio at least equal to 9% of risk-weighted assets to June 30, 2018, and 10% thereafter, (iii) the Bank must maintain a total risk based capital ratio at least equal to 10% of risk-weighted assets, (iii) the Bank must maintain a total risk based capital ratio at least equal to June 30, 2018, and 11% thereafter,of risk-weighted assets, and (iv) non-performing assets of the Bank may not exceed 2.5% of the Bank’s total assets. Both the Company and Bank were in compliance with the covenants as of December 31, 2017.2018.

 

Liquidity

 

Liquidity risk arises from the possibility the Company may not be able to satisfy current or future financial commitments, or may become unduly reliant on alternative funding sources. The objective of liquidity risk management is to ensure that we meet the cash flow requirements of depositors and borrowers, as well as operating cash needs, taking into account all on- and off-balance sheet funding demands. Liquidity risk management also involves ensuring that we meet our cash flow needs are met at a reasonable cost. We maintainManagement maintains an investment and funds management policy, which identifies the primary sources of liquidity, establishes procedures for monitoring and measuring liquidity, and establishes minimum liquidity requirements in compliance with regulatory guidance. The Asset Liability Committee regularly monitors and reviews our liquidity position.

 

Funds are available to the Bank from a number of sources, including the sale of securities in the available for sale investment portfolio, principal pay-downs on loans and mortgage-backed securities, customer deposit inflows, and other wholesale funding.

 

The Bank also borrows from the FHLB to supplement funding requirements. At December 31, 2017,2018, the unused borrowing capacity with the FHLB was $79.0$42.7 million. Advances are collateralized by first mortgage residential loans and borrowing capacity is based on the underlying book value of eligible pledged loans.

 

The Bank also has available on an unsecured basis federal funds borrowing linesline from a correspondent bank totaling $5.0 million. Management believes the sources of liquidity are adequate to meet expected cash needs for the foreseeable future. However,Historically, the availability of these lines could be affected by our financial position.

Historically, we haveBank has also utilized brokered and wholesale deposits to supplement ourits funding strategy. At December 31, 2017, we2018, the Bank had no brokered deposits.

 

The Company uses cash on hand to service senior debt, service junior subordinated debentures, and to provide for operating cash flow needs. The Company also may issue common equity, preferred equity and debt to support cash flow needs and liquidity requirements. At December 31, 2017,2018, cash on hand totaled $2.0$5.4 million, of which, $806,000$417,000 is held in escrow by the Company’s senior debt holder to service interest payments.

Capital

Stockholders’ equity increased $39.9 million to $72.7 million at December 31, 2017, compared with $32.7 million at December 31, 2016. The increase was due primarily to current year net income $38.5 million.

The Company had a full valuation allowance against its net deferred tax asset since 2011. During the fourth quarter of 2017, management concluded it was more-likely-than-not the asset would be utilized to reduce future taxes payable related to the future taxable income of the Company, and as such, reversed the valuation allowance. On December 22, 2017, the Tax Cuts and Jobs Act of 2017 was signed into law. Among other significant changes to the tax code, the new law lowered the federal corporate tax rate from 35% to 21% beginning in 2018. As a result, the Company revalued its net deferred tax asset at the new 21% rate. The combination of the reversal of the valuation allowance and the change in federal corporate tax rates, as well as income tax expense for the year, resulted in an income tax benefit of $31.9 million for the year ended December 31, 2017.

On June 30, 2017, the Company entered into a $10.0 million senior secured loan agreement with a commercial bank. The loan matures on June 30, 2022. Interest is payable quarterly at a rate of three-month LIBOR plus 250 basis points through June 30, 2020, at which time quarterly principal payments of $250,000 plus interest will commence. The loan is secured by a first priority pledge of 100% of the issued and outstanding stock of the Bank. The Company may prepay any amount due under the promissory note at any time without premium or penalty. A total of $9.0 million of loan proceeds was injected to the Bank as common equity Tier 1 capital.

On December 16, 2016, the Company completed a 1-for-5 reverse stock split of its issued and outstanding common and non-voting common shares. The reverse stock split was intended to increase the trading price per share of the common shares, with the objective to make the common shares a more attractive and cost effective investment and enhance liquidity for shareholders. All share and per share data in this annual report has been adjusted to reflect the reverse stock split. Preferred shares were not affected by the 1-for-5 reverse stock split.

 

4943

 

On April 15, 2016, Capital

Stockholders’ equity increased $19.4 million to $92.1 million at December 31, 2018, compared with $72.7 million at December 31, 2017. The increase was due primarily to the $14.9 million issuance of common stock completed during the first quarter of 2018, as well as current year net income $8.8 million, offset by the $3.5 million repurchase of the Company’s series E and F preferred shares and the other comprehensive loss for the year of $1.3 million.

The Company completed thea private placement of 580,000common stock on March 30, 2018. In the transaction, the Company issued 150,000 common shares and 220,0001.0 million non-voting common shares to accredited investors, raising totalPatriot Financial Partners III, L.P. at $13.00 per share resulting in net proceeds of $14.9 million of which $5.0 million.million was contributed as capital to the Bank. The investors inbalance of proceeds was maintained by the private placement directed a portion of purchase price to pay all deferred interest payments on our junior subordinated debentures, bringing interest payments current through the second quarter of 2016. The remaining proceeds were retainedCompany for general corporate purposes and to support the growth of the Bank.

The following table shows the ratios of Tier 1 capital, common equity Tier 1, and total capital to risk-adjusted assets and the leverage ratios (excluding the capital conservation buffer) for the Bank at December 31, 2018:

  

Regulatory

Minimums

  

Well-Capitalized

Minimums

  

Limestone

Bank

 
             

Tier 1 capital

  6.0

%

  8.0

%

  11.83

%

Common equity Tier 1 capital

  4.5   6.5   11.83 

Total risk-based capital

  8.0   10.0   12.88 

Tier 1 leverage ratio

  4.0   5.0   9.60 

Failure to meet minimum capital requirements could result in additional discretionary actions by regulators that, if taken, could have a materially adverse effect on our financial condition.

 

Each of the federal bank regulatory agencies has established risk-based capital requirements for banking organizations. The Basel III regulatory capital reforms became effective for the Company and Bank on January 1, 2015, and include new minimum risk-based capital and leverage ratios. These rules refine the definition of what constitutes “capital” for purposes of calculating those ratios, including the definitions of Tier 1 capital and Tier 2 capital. The final rules allowed banks and their holding companies with less than $250 billion in assets a one-time opportunity to opt-out of a requirement to include unrealized gains and losses in accumulated other comprehensive income in their capital calculation. The Company and the Bank opted out of this requirement. The rules also establish a “capital conservation buffer” of 2.5% above the regulatory minimum risk-based capital ratios. Once the capital conservation buffer is fully phased in, the minimum ratios are a common equity Tier 1 risk-based capital ratio of 7.0%, a Tier 1 risk-based capital ratio of 8.5%, and a total risk-based capital ratio of 10.5%. The phase-in of the capital conservation buffer requirement began in January 2016 at 0.625% of risk-weighted assets and increases each year until fully implemented at 2.5% of risk-weighted assets in January 2019. An institution is subject to limitations on paying dividends, engaging in share repurchases and paying discretionary bonuses if capital levels fall below minimum levels plus the buffer amounts. These limitations establish a maximum percentage of eligible retained income that could be utilized for such actions.

The following table shows the ratios of Tier 1 capital, common equity Tier 1, and total capital to risk-adjusted assets and the leverage ratios (excluding the capital conservation buffer) for the Bank at December 31, 2017:

  

Regulatory

Minimums

  

Well-Capitalized

Minimums

  

Limestone

Bank

 
             

Tier 1 capital

  6.0

%

  8.0

%

  10.35

%

Common equity Tier 1 capital

  4.5   6.5   10.35 

Total risk-based capital

  8.0   10.0   11.61 

Tier 1 leverage ratio

  4.0   5.0   8.70 

Failure to meet minimum capital requirements could result in additional discretionary actions by regulators that, if taken, could have a materially adverse effect on our financial condition.

 

Off Balance Sheet Arrangements

 

In the normal course of business, we enterthe Bank enters into various transactions, which, in accordance with GAAP, are not included in ourthe Company’s consolidated balance sheets. WeThe Bank enter into these transactions to meet the financing needs of ourits customers. These transactions include commitments to extend credit and standby letters of credit, which involve, to varying degrees, elements of credit risk and interest rate risk in excess of the amounts recognized in the consolidated balance sheets.

 

The commitments associated with outstanding standby letters of credit and commitments to extend credit as of December 31, 20172018 are summarized below. Since commitments associated with letters of credit and commitments to extend credit may expire unused, the amounts shown do not necessarily reflect our actual future cash funding requirements:

 

 

One year

or less

  

More than 1

year but less

than 3 years

  

3 years or

more but less

than 5 years

  

5 years

or more

  

Total

  

One year

or less

  

More than 1

year but less

than 3 years

  

3 years or

more but less

than 5 years

  

5 years

or more

  

Total

 
 

(dollars in thousands)

  

(dollars in thousands)

 

Commitments to extend credit

 $37,862  $36,699  $19,542  $33,419  $127,522  $41,109  $28,102  $7,854  $19,922  $96,987 

Standby letters of credit

  2,588      1      2,589   916   1,376   1      2,293 

Total

 $40,450  $36,699  $19,543  $33,419  $130,111  $42,025  $29,478  $7,855  $19,922  $99,280 

44

 

Standby Letters of Credit Standby letters of credit are written conditional commitments we issuethe Bank issues to guarantee the performance of a borrower to a third party. If the borrower does not perform in accordance with the terms of the agreement with the third party, wethe Bank may be required to fund the commitment. The maximum potential amount of future payments wethe Bank could be required to make is represented by the contractual amount of the commitment. If the commitment is funded, wethe Bank would be entitled to seek recovery from the borrower. OurThe Bank’s policies generally require that standby letter of credit arrangements be underwritten in a manner consistent with a loan of similar characteristics.

 

50

Commitments to Extend CreditWe enterThe Bank enters into contractual commitments to extend credit, normally with fixed expiration dates or termination clauses, at specified rates and for specific purposes. Substantially all of ourthe Bank’s commitments to extend credit are contingent upon borrowers maintaining specific credit standards at the time of loan funding. We minimizeThe Bank minimizes our exposure to loss under these commitments by subjecting them to credit approval and monitoring procedures.

 

Risk Participation Agreements – In connection with the purchase of loan participations, the Bank has entered into risk participation agreements, which had notional amounts totaling $26.6 million at December 31, 2018 and $19.8 million at December 31, 2017 and $14.6 million at December 31, 2016.2017.

 

Contractual Obligations

 

The following table summarizes our contractual obligations and other commitments to make future payments as of December 31, 2017:2018:

  

One year

or less

  

More than 1

year but less

than 3 years

  

3 years or

more but less

than 5 years

  

5 years or

more

  

Total

 
  

(dollars in thousands)

 

Time deposits

 $204,018  $205,986  $14,231  $  $424,235 

FHLB borrowing (1)

  10,200   665   836   96   11,797 

Subordinated capital note

  900   1,350         2,250 

Junior subordinated debentures

           21,000   21,000 

Senior debt

     500   2,000   7,500   10,000 

Total

 $215,118  $208,501  $17,067  $28,596  $469,282 

  

One year

or less

  

More than 1

year but less

than 3 years

  

3 years or

more but less

than 5 years

  

5 years or

more

  

Total

 
  

(dollars in thousands)

 

Time deposits

 $256,745  $176,682  $17,459  $  $450,886 

FHLB borrowing (1)

  45,172   1,190   159   28   46,549 

Junior subordinated debentures

           21,000   21,000 

Senior debt

     500   9,500      10,000 

Total

 $301,917  $178,372  $27,118  $21,028  $528,435 

 


(1)(1)

Fixed rate borrowings with rates ranging from 0% to 5.24%, and maturities ranging from 20182019 through 2033, averaging 1.48%2.45%.

 

Impact of Inflation and Changing Prices

 

The financial statements and related data presented herein have been prepared in accordance with U.S. generally accepted accounting principles, which require the measurement of financial position and operating results in historical dollars without considering changes in the relative purchasing power of money over time due to inflation.

 

We haveThe Bank has an asset and liability structure that is essentially monetary in nature. As a result, interest rates have a more significant impact on performance than the effects of general levels of inflation. Periods of high inflation are often accompanied by relatively higher interest rates, and periods of low inflation are accompanied by relatively lower interest rates. As market interest rates rise or fall in relation to the rates earned on loans and investments, the value of these assets decreases or increases respectively.

 

5145

 

Item 7A.

Quantitative and Qualitative Disclosures About Market Risk

 

To minimize the volatility of net interest income and exposure to economic loss that may result from fluctuating interest rates, we manage ourthe Bank manages its exposure to adverse changes in interest rates through asset and liability management activities within guidelines established by ourthe Asset Liability Committee (“ALCO”). The ALCO, which is comprised of senior officers, has the responsibility for approving and ensuring compliance with asset/liability management policies. Interest rate risk is the exposure to adverse changes in the net interest income as a result of market fluctuations in interest rates. The ALCO, on an ongoing basis, monitors interest rate and liquidity risk in order to implement appropriate funding and balance sheet strategies. Management considers interest rate risk to be our most significant market risk.

 

The Company utilizes an earnings simulation model to analyze net interest income sensitivity. It then evaluates potential changes in market interest rates and their subsequent effects on net interest income. The model projects the effect of instantaneous movements in interest rates of both 100 and 200 basis points that are sustained for one year. Assumptions based on the historical behavior of our deposit rates and balances in relation to changes in interest rates are also incorporated into the model. These assumptions are inherently uncertain and, as a result, the model cannot precisely measure future net interest income or precisely predict the impact of fluctuations in market interest rates on net interest income. Actual results may differ from the model’s simulated results due to timing, magnitude and frequency of interest rate changes as well as changes in market conditions and the application and timing of various management strategies.

 

Given an instantaneousinstantaneous 100 basis point increase in interest rates, the base net interest income would increase by an estimated 2.0% at December 31, 2018 compared with an increase of 0.9% at December 31, 2017 compared with an decrease of 2.5% at December 31, 2016. 2017.

The following table indicates the estimated impact on net interest income under various interest rate scenarios for the year ended December 31, 2017,2018, as calculated using the static shock model approach:

 

 

Change in Future

Net Interest Income

  

Change in Future

Net Interest Income

 
 

Dollar Change 

  

Percentage Change

  

Dollar Change

  

Percentage Change

 
 

(dollars in thousands)

  

(dollars in thousands)

 

+ 200 basis points

 $545   1.7

%

 $1,272   3.9

%

+ 100 basis points

  271   0.9   660   2.0 

- 100 basis points

  (1,061

)

  (3.3

)

  (1,258

)

  (3.8

)

- 200 basis points

  (2,384

)

  (7.5

)

  (1,816

)

  (5.5

)

 

 

ImplementationImplementation of strategies to mitigate the risk of changing interest rates in the future, could lessen our forecasted “base case” net interest income in the event of no interest rate changes. Interest sensitivity at any point in time will be affected by a number of factors. These factors include the mix of interest sensitive assets and liabilities as well as their relative pricing schedules. It is also influenced by market interest rates, deposit growth, loan growth, deposit decay rates and asset prepayment speed assumptions.

46

 

The following table sets forth the amounts of our interest-earning assets and interest-bearing liabilities outstanding at December 31, 2017,2018, which we anticipate,management anticipates, based upon certain assumptions, to reprice or mature in each of the future time periods shown. The projected repricing of assets and liabilities anticipates prepayments and scheduled rate adjustments, as well as contractual maturities under an interest rate unchanged scenario within the selected time intervals. While we believemanagement believes such assumptions are reasonable, wemanagement cannot provide assurance that assumed repricing rates will approximate actual future activity.

 

52

 

Volume Subject to Repricing Within

  

Volume Subject to Repricing Within

 
 

0 – 90

Days

  

91 – 181

Days

  

182 – 365

Days

  

1 – 5

Years

  

Over 5

Years

  

Non-

Interest

Sensitive

  

Total

  

0 – 90

Days

  

91 – 181

Days

  

182 – 365

Days

  

1 – 5

Years

  

Over 5

Years

  

Non-

Interest

Sensitive

  

Total

 
 

(dollars in thousands)

  

(dollars in thousands)

 
                                                        

Assets:

                                                        

Federal funds sold and short-term investments

 $25,966  $  $  $  $  $  $25,966  $28,398  $  $  $  $  $  $28,398 

Investment securities

  46,712   2,726   7,649   58,131   37,056   516   152,790   74,699   4,899   15,837   62,997   44,326   (1,566

)

 ��201,192 

FHLB stock

  7,323                  7,323   7,233                  7,233 

Loans held for sale

  70                  70 

Loans, net of allowance

  272,599   48,677   84,009   260,961   45,869   (8,202

)

  703,913   308,143   45,716   90,951   263,552   56,882   (8,880

)

  756,364 

Fixed and other assets

                 80,739   80,739                  76,505   76,505 

Total assets

 $352,670  $51,403  $91,658  $319,092  $82,925  $73,053  $970,801  $418,373  $50,615  $106,788  $326,549  $101,208  $66,059  $1,069,692 
                                                        
                                                        

Liabilities and Stockholders’ Equity

                            

Liabilities and Stockholders’ Equity

                            

Interest-bearing checking, savings, and money market accounts

 $285,403  $  $  $  $  $  $285,403  $300,727  $  $  $  $  $  $300,727 

Certificates of deposit

  74,560   52,197   76,126   221,184   168      424,235   78,549   61,157   116,509   194,407   264      450,886 

Borrowed funds

  43,274   208   233   1,187   145      45,047   76,032   281   302   892   42      77,549 

Other liabilities

                 143,443   143,443                  148,433   148,433 

Stockholders’ equity

                 72,673   72,673 

Total liabilities and stockholders’ equity

 $403,237  $52,405  $76,359  $222,371  $313  $216,116  $970,801 

Stockholders’ equity

                 92,097   92,097 

Total liabilities and stockholders’ equity

 $455,308  $61,438  $116,811  $195,299  $306  $240,530  $1,069,692 

Period gap

 $(50,567

)

 $(1,002

)

 $15,299  $96,721  $82,612          $(36,835

)

 $(10,823

)

 $(10,023

)

 $131,250  $100,902         

Cumulative gap

 $(50,567

)

 $(51,569

)

 $(36,270

)

 $60,451  $143,063          $(36,835

)

 $(47,658

)

 $(57,681

)

 $73,569  $174,471         
                                                        

Period gap to total assets

  (5.21

)%

  (0.10

)%

  1.58

%

  9.96

%

  8.51

%

          (3.44

)%

  (1.01

)%

  (0.94

)%

  12.27

%

  9.43

%

        

Cumulative gap to total assets

  (5.21

)%

  (5.31

)%

  (3.74

)%

  6.23

%

  14.74

%

          (3.44

)%

  (4.46

)%

  (5.39

)%

  6.88

%

  16.31

%

        

Cumulative interest-earning assets to cumulative interest-bearing liabilities

  87.46

%

  88.68

%

  93.18

%

  108.01

%

  118.96

%

          91.91

%

  90.78

%

  90.90

%

  108.88

%

  121.04

%

        

 

The one-year cumulative gap position as of December 31, 20172018 was negative $36.3$57.7 million or 3.7%5.4% of total assets. This is a one-day position that is continually changing and is not necessarily indicative of the Company’s position at any other time. Any gap analysis has inherent shortcomings because certain assets and liabilities may not move proportionally as interest rates change.

 

5347

 

Item 8.

Financial Statements and Supplementary Data

 

The following consolidated financial statements and reports are included in this section:

 

Report of Independent Registered Public Accounting Firm

       Management’s Report on Internal Control Over Financial Reporting

Report of Independent Registered Public Accounting Firm

Consolidated Balance Sheets as of December 31, 2018 and 2017

Consolidated Statements of Operations for the Years Ended December 31, 2018, 2017, and 2016

Consolidated Statements of Comprehensive Income (Loss) for the Years Ended December 31, 2018, 2017, and 2016

Consolidated Statements of Change in Stockholders’ Equity for the Years Ended December 31, 2018, 2017, and 2016

Consolidated Statements of Cash Flows for the Years Ended December 31, 2018, 2017, and 2016

Consolidated Balance Sheets as of December 31, 2017 and 2016

Consolidated Statements of Operations for the Years Ended December 31, 2017, 2016, and 2015 

Consolidated Statements of Comprehensive Income (Loss) for the Years Ended December 31, 2017, 2016, and 2015

Consolidated Statements of Change in Stockholders’ Equity for the Years Ended December 31, 2017, 2016, and 2015

Consolidated Statements of Cash Flows for the Years Ended December 31, 2017, 2016, and 2015

Notes to Consolidated Financial Statements

 

5448

 

MANAGEMENT’S REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING

The Management of Limestone Bancorp, Inc. (the “Company”) is responsible for the preparation, integrity, and fair presentation of the Company’s annual consolidated financial statements. All information has been prepared in accordance with U.S. generally accepted accounting principles and, as such, includes certain amounts that are based on Management’s best estimates and judgments.

Management is responsible for establishing and maintaining adequate internal control over financial reporting presented in conformity with U.S. generally accepted accounting principles. Internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the Company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with U.S. generally accepted accounting principles, and that receipts and expenditures of the Company are being made only in accordance with authorizations of management and directors of the Company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the Company’s assets that could have a material effect on the financial statements.

Two of the objectives of internal control are to provide reasonable assurance to Management and the Board of Directors that transactions are properly authorized and recorded in the Company’s financial records, and that the preparation of the Company’s financial statements and other financial reporting is done in accordance with U.S. generally accepted accounting principles. There are inherent limitations in the effectiveness of internal control, including the possibility of human error and the circumvention or overriding of controls. Accordingly, even effective internal control can provide only reasonable assurance with respect to reliability of financial statements. Furthermore, internal control can vary with changes in circumstances.

Management has made its own assessment of the effectiveness of the Company’s internal control over financial reporting as of December 31, 2018, in relation to the criteria described in the report, Internal Control — Integrated Framework (2013), issued by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”).

Based on its assessment, Management believes that as of December 31, 2018, the Company’s internal control over financial reporting was effective in achieving the objectives stated above. Crowe LLP has provided its report on the audited 2018 consolidated financial statements and on the effectiveness of the Company’s internal control over financial reporting in their report dated March 8, 2019.

John T. Taylor

Chief Executive Officer

Phillip W. Barnhouse

Chief Financial Officer

March 8, 2019

49

 

 

 

Crowe Horwath LLP

Independent Member Crowe Horwath InternationalGlobal

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

 

Shareholders and the Board of Directors of PorterLimestone Bancorp, Inc.

Louisville, Kentucky

 

OpinionOpinions on the Financial Statements and Internal Control over Financial Reporting

 

We have audited the accompanying consolidated balance sheets of PorterLimestone Bancorp, Inc. (the "Company") as of December 31, 20172018 and 2016,2017, the related consolidated statements of operations, comprehensive income (loss), changes in stockholders’ equity, and cash flows for each of the three years in the three-year period ended December 31, 2017,2018, and the related notes (collectively referred to as the "financial statements"). We also have audited the Company’s internal control over financial reporting as of December 31, 2018, based on criteria established in Internal Control – Integrated Framework: (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO).

In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of the Company as of December 31, 20172018 and 2016,2017, and the results of its operations and its cash flows for each of the three years in the three-year period ended December 31, 2017,2018 in conformity with accounting principles generally accepted in the United States of America.  Also in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2018, based on criteria established in Internal Control – Integrated Framework: (2013) issued by COSO.

 

Basis for OpinionOpinions

 

TheseThe Company’s management is responsible for these financial statements, are the responsibilityfor maintaining effective internal control over financial reporting, and for its assessment of the Company's management.effectiveness of internal control over financial reporting, included in the accompanying Management’s Report on Internal Control Over Financial Reporting.  Our responsibility is to express an opinion on the Company'sCompany’s financial statements and an opinion on the Company’s internal control over financial reporting based on our audits.  We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) ("PCAOB") and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.

 

We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the auditaudits to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud. The Company is not required to have, nor were we engaged to perform, an audit of itsfraud, and whether effective internal control over financial reporting was maintained in accordance with the standards of the PCAOB. As part of our audits we are required to obtain an understanding of internal control over financial reporting but not for the purpose of expressing an opinion on the effectiveness of the Company's internal control over financial reporting. Accordingly, we express no such opinion in accordance with the standards of the PCAOB.all material respects.

 

Our audits of the financial statements included performing procedures to assess the risksrisks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk.  Our audits also included performing such other procedures as we considered necessary in the circumstances.  We believe that our audits provide a reasonable basis for our opinion.opinions.

Definition and Limitations of Internal Control Over Financial Reporting

A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles.  A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements.  Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. 

 

                            /s/ Crowe LLP

/s/ Crowe Horwath, LLP

 

We have served as the Company's auditor since 1998.

 

Louisville, Kentucky

February 28, 2018March 8, 2019

 

5550

 

 

PORTERLIMESTONE BANCORP, INC.

CONSOLIDATED BALANCE SHEETS

December 31,

(Dollar amounts in thousands except share data) 

 

 

2017

  

2016

  

2018

  

2017

 

Assets

                

Cash and due from banks

 $8,137  $9,449  $6,963  $8,137 

Interest bearing deposits in banks

  25,966   56,867   28,398   25,966 

Cash and cash equivalents

  34,103   66,316   35,361   34,103 

Securities available for sale

  152,720   152,790   201,192   152,720 

Securities held to maturity (fair value of $0 and $43,072, respectively)

     41,818 

Loans held for sale

  70         70 

Loans, net of allowance of $8,202 and $8,967, respectively

  703,913   630,269 

Premises and equipment, net

  16,789   17,848 

Loans, net of allowance of $8,880 and $8,202, respectively

  756,364   703,913 

Premises and equipment, net

  14,655   16,789 

Premises held for sale

  1,050    

Other real estate owned

  4,409   6,821   3,485   4,409 

Federal Home Loan Bank stock

  7,323   7,323   7,233   7,323 

Bank owned life insurance

  15,229   14,838   15,646   15,229 

Deferred taxes, net

  31,313      29,282   31,313 

Accrued interest receivable and other assets

  4,932   7,154   5,424   4,932 

Total assets

 $970,801  $945,177  $1,069,692  $970,801 
                

Liabilities and Stockholders’ Equity

        

Liabilities and Stockholders’ Equity

        

Deposits

                

Non-interest bearing

 $137,386  $124,395  $142,618  $137,386 

Interest bearing

  709,638   725,530   751,613   709,638 

Total deposits

  847,024   849,925   894,231   847,024 

Federal Home Loan Bank advances

  11,797   22,458   46,549   11,797 

Accrued interest payable and other liabilities

  6,057   15,911   5,815   6,057 

Subordinated capital note

  2,250   3,150      2,250 

Junior subordinated debentures

  21,000   21,000   21,000   21,000 

Senior debt

  10,000    

Senior debt

  10,000   10,000 

Total liabilities

  898,128   912,444   977,595   898,128 

Commitments and contingent liabilities (Note 16)

      

Stockholders’ equity

        

Commitments and contingent liabilities (Note 15)

      

Stockholders’ equity

        

Preferred stock, no par

                

Series E - 6,198 issued and outstanding; Liquidation preference of $6.2 million

  1,644   1,644 

Series F - 4,304 issued and outstanding; Liquidation preference of $4.3 million

  1,127   1,127 

Total preferred stockholders’ equity

  2,771   2,771 

Common stock, no par, 39,000,000 shares authorized, 6,039,864 and 4,632,933 voting, and 220,000 and 1,591,600 non-voting shares issued and outstanding, respectively

  125,729   125,729 

Series E - none and 6,198, respectively, issued and outstanding; Liquidation preference of $6.2 million

     1,644 

Series F - none and 4,304, respectively, issued and outstanding; Liquidation preference of $4.3 million

     1,127 

Total preferred stockholders’ equity

     2,771 

Common stock, no par, 39,000,000 shares authorized, 6,242,720 and 6,039,864 voting, and 1,220,000 and 220,000 non-voting shares issued and outstanding, respectively

  140,639   125,729 

Additional paid-in capital

  24,497   24,097   24,287   24,497 

Retained deficit

  (75,108

)

  (113,561

)

  (66,201

)

  (75,108

)

Accumulated other comprehensive loss

  (5,216

)

  (6,303

)

Total common stockholders’ equity

  69,902   29,962 

Accumulated other comprehensive loss

  (6,628

)

  (5,216

)

Total common stockholders’ equity

  92,097   69,902 

Total stockholders' equity

  72,673   32,733   92,097   72,673 

Total liabilities and stockholders’ equity

 $970,801  $945,177 

Total liabilities and stockholders’ equity

 $1,069,692  $970,801 

 

See accompanying notes.

 

5651

 

 

PORTERLIMESTONE BANCORP, INC.

CONSOLIDATED STATEMENTS OF OPERATIONS

Years Ended December 31,

(Dollar amounts in thousands except per share data)

 

 

2017

  

2016

  

2015

  

2018

  

2017

  

2016

 

Interest income

                        

Loans, including fees

 $31,866  $30,537  $31,251  $37,342  $31,866  $30,537 

Taxable securities

  4,399   3,886   4,076   4,880   4,399   3,886 

Tax exempt securities

  571   620   764   383   571   620 

Federal funds sold and other

  686   559   483   856   686   559 
  37,522   35,602   36,574   43,461   37,522   35,602 

Interest expense

                        

Deposits

  5,190   5,093   6,160   7,549   5,190   5,093 

Federal Home Loan Bank advances

  120   70   95   867   120   70 

Senior debt

  194       

Senior debt

  389   194    

Junior subordinated debentures

  753   671   606   946   753   671 

Subordinated capital note

  148   147   161   39   148   147 

Federal funds purchased and other

        1 
  6,405   5,981   7,023 
           9,790   6,405   5,981 

Net interest income

  31,117   29,621   29,551   33,671   31,117   29,621 

Negative provision for loan losses

  (800)  (2,450)  (4,500)

Negative provision for loan losses

  (500

)

  (800

)

  (2,450

)

Net interest income after negative provision for loan losses

  31,917   32,071   34,051   34,171   31,917   32,071 
                        

Non-interest income

                        

Service charges on deposit accounts

  2,253   1,958   1,851   2,355   2,253   1,958 

Bank card interchange fees

  972   849   839   1,831   1,521   1,303 

Income from bank owned life insurance

  412   417   295   437   412   417 

Other real estate owned rental income

     456   1,346         456 

Net gain on sales of securities

  288   216   1,766 

Gain on extinguishment of junior subordinated debt

        883 

Net gain (loss) on sales and calls of investment securities

  (6

)

  288   216 

Other

  930   868   715   1,162   930   868 
  4,855   4,764   7,695   5,779   5,404   5,218 

Non-interest expense

                        

Salaries and employee benefits

  15,090   15,508   15,857   15,489   15,090   15,508 

Occupancy and equipment

  3,420   3,517   3,449   3,586   3,420   3,517 

FDIC insurance

  1,412   1,660   2,212   557   1,412   1,660 

Data processing expense

  1,256   1,185   1,128   1,192   1,256   1,185 

Marketing expense

  1,098   973   560   1,114   1,098   973 

State franchise and deposit tax

  956   965   1,120   1,118   956   965 

Deposit account related expense

  823   896   787 

Professional fees

  978   1,568   2,885   814   978   1,568 

Communications

  722   706   663   701   722   706 

Insurance expense

  540   565   589   478   540   565 

Postage and delivery

  395   359   400   364   395   359 

Litigation and loan collection expense

  179   8,805   1,141 

Litigation and loan collection expense

  245   179   8,805 

Other real estate owned expense

  1,973   1,541   12,302   868   1,973   1,541 

Other

  2,199   2,215   2,653   1,777   1,852   1,882 
  30,218   39,567   44,959   29,126   30,767   40,021 

Income (loss) before income taxes

  6,554   (2,732

)

  (3,213

)

Income (loss) before income taxes

  10,824   6,554   (2,732

)

Income tax expense (benefit)

  (31,899

)

  21      2,030   (31,899

)

  21 

Net income (loss)

  38,453   (2,753

)

  (3,213

)

  8,794   38,453   (2,753

)

Less:

            

Earnings (loss) allocated to participating securities

  967   (88

)

  (336

)

Net income (loss) attributable to common shareholders

 $37,486  $(2,665

)

 $(2,877

)

Basic and diluted income (loss) per common share

 $6.15  $(0.46

)

 $(0.62

)

 $1.23  $6.15  $(0.46

)

 

See accompanying notes.

 

57

PORTER BANCORP, INC.

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)

Years Ended December 31,

(in thousands)

  

2017

  

2016

  

2015

 

Net income (loss)

 $38,453  $(2,753

)

 $(3,213

)

Other comprehensive income (loss):

            

   Unrealized gain (loss) on securities:

            

      Unrealized gain (loss) arising during the period

  1,141   (1,917

)

  (490

)

      Transfer of investment securities from held to maturity to available for sale

  702       

      Amortization during the period of net unrealized loss transferred to held to maturity

  119   129   129 

      Reclassification of adjustment for gains included in net income

  (288

)

  (216

)

  (1,766

)

   Net unrealized gain/(loss) recognized in comprehensive income

  1,674   (2,004

)

  (2,127

)

Tax effect

  (587

)

      

Other comprehensive income (loss)

  1,087   (2,004

)

  (2,127

)

             

Comprehensive income (loss) 

 $39,540  $(4,757

)

 $(5,340

)

See accompanying notes.

5852

 

 

PORTERLIMESTONE BANCORP, INC.

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)

Years Ended December 31,

(in thousands)

  

2018

  

2017

  

2016

 

Net income (loss)

 $8,794  $38,453  $(2,753

)

Other comprehensive income (loss):

            

Unrealized gain (loss) on securities:

            

Unrealized gain (loss) arising during the period

  (1,652

)

  1,141   (1,917

)

Transfer of investment securities from held to maturity to available for sale

     702    

Amortization during the period of net unrealized loss transferred to held to maturity

     119   129 

Reclassification of adjustment for (gains) losses included in net income (loss)

  6   (288

)

  (216

)

Net unrealized gain/(loss) recognized in comprehensive income

  (1,646

)

  1,674   (2,004

)

Tax effect

  347   (587

)

   

Other comprehensive income (loss)

  (1,299

)

  1,087   (2,004

)

             

Comprehensive income (loss)

 $7,495  $39,540  $(4,757

)

See accompanying notes.

53

LIMESTONE BANCORP, INC.

CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERSSTOCKHOLDERS’ EQUITY

Years Ended December 31,2018

(Dollar amounts in thousands except share and per share data)

 

 Shares  

Amount

  Shares  Amount 
    Preferred     Preferred  Common     Preferred  Common  Preferred  Common     
 

Voting and

Non-voting

Common

  

Series B

  

Series D

  

Series E

  

Series F

  

Common

  

Series B

  

Series D

  

Series E

  

Series F

  

Additional

Paid-In

Capital

  

Retained

Earnings

(Deficit)

  

Accumulated

Other

Compre-

hensive

Income

(Loss)

  

Total

  Series E  Series F  Common  Non-Voting Common  Total Common  Series E  Series F  Common and Non-Voting Common  Additional Paid-In Capital  

Retained

Deficit

  Accumulated Other Comprehensive Loss  Total 
                                                        

Balances, December 31, 2014

  2,978,103   40,536   64,580   6,198   4,304  $113,238  $2,229  $3,552  $1,644  $1,127  $21,442  $(107,595

)

 $(2,172

)

 $33,465 

Issuance of unvested stock

  183,148                                        

Terminated stock

  (107,696

)

                                       

Balances, December 31, 2015

  6,198   4,304   4,017,907   1,371,600   5,389,507  $1,644  $1,127  $120,699  $23,654  $(110,808

)

 $(4,299

)

 $32,017 

Issuances of unvested stock

        35,465      34,465                      

Forfeited unvested stock

Forfeited unvested stock

  (6,368

)

                                               (1,972

)

     (1,972

)

                     

Reverse stock split rounding shares

        1,533      1,533                      

Stock-based compensation expense

Stock-based compensation expense

           ��                     445         445                           443         443 

Net loss

Net loss

                                   (3,213

)

     (3,213

)

                             (2,753

)

     (2,753

)

Net change in accumulated other comprehensive income, net of taxes

                                      (2,127

)

  (2,127

)

Debt to equity exchange

  240,000               1,680               1,767         3,447 

Conversion of preferred stock to common and non-voting common stock

  2,102,320   (40,536

)

  (64,580

)

        5,781   (2,229

)

  (3,552

)

                  

Balances, December 31, 2015

  5,389,507         6,198   4,304  $120,699  $  $  $1,644  $1,127  $23,654  $(110,808

)

 $(4,299

)

 $32,017 

Issuance of unvested stock

  35,465                                        

Forfeited unvested stock

  (1,972

)

                                       

Reverse stock split rounding shares

  1,533                                        

Stock-based compensation expense

                                443         443 

Net loss

                                   (2,753

)

     (2,753

)

Net change in accumulated other comprehensive income, net of taxes

                                      (2,004

)

  (2,004

)

Net change in accumulated other comprehensive loss, net of taxes

                                (2,004

)

  (2,004

)

Issuance of stock

Issuance of stock

  800,000               5,030                        5,030         580,000   220,000   800,000         5,030            5,030 

Balances, December 31, 2016

Balances, December 31, 2016

  6,224,533         6,198   4,304  $125,729  $  $  $1,644  $1,127  $24,097  $(113,561

)

 $(6,303

)

 $32,733   6,198   4,304   4,632,933   1,591,600   6,224,533  $1,644  $1,127  $125,729  $24,097  $(113,561

)

 $(6,303

)

 $32,733 

Issuance of unvested stock

Issuance of unvested stock

  37,865                                                37,865      37,865                      

Forfeited unvested stock

Forfeited unvested stock

  (1,316

)

                                               (1,316

)

     (1,316

)

                     

Reverse stock split rounding shares

  (1,218

)

                                       

Reverse stock split rounding shares

        (1,218

)

     (1,218

)

                     

Stock-based compensation expense

Stock-based compensation expense

                                400         400                           400         400 

Net income

Net income

                                   38,453      38,453                              38,453      38,453 

Net change in accumulated other comprehensive income, net of taxes

Net change in accumulated other comprehensive income, net of taxes

                                      1,087   1,087

 

                                1,087   1,087 

Non-voting shares converted to voting

        1,371,600   (1,371,600

)

                        

Balances, December 31, 2017

Balances, December 31, 2017

  6,259,864         6,198   4,304  $125,729  $  $  $1,644  $1,127  $24,497  $(75,108

)

 $(5,216

)

 $72,673   6,198   4,304   6,039,864   220,000   6,259,864  $1,644  $1,127  $125,729  $24,497  $(75,108

)

 $(5,216

)

 $72,673 

Issuance of unvested stock

        52,856      52,856                      

Issuance of stock

        150,000   1,000,000   1,150,000         14,910            14,910 

Redemption and retirement of preferred shares

  (6,198

)

  (4,304

)

           (1,644

)

  (1,127

)

     (734

)

        (3,505

)

Stock-based compensation expense

                          524         524 

Net income

                             8,794      8,794 

Reclassification of disproportionate tax effect due to change in federal tax rate

                             113   (113

)

   

Net change in accumulated other comprehensive loss, net of taxes

                                (1,299

)

  (1,299

)

Balances, December 31, 2018

        6,242,720   1,220,000   7,462,720  $  $  $140,639  $24,287  $(66,201

)

 $(6,628

)

 $92,097 

 

See accompanying notes.notes to unaudited consolidated financial statements.

 

5954

Table of Contents

 

 

PORTERLIMESTONE BANCORP, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

Years Ended December 31,

(in thousands)

 

 

2017

  

2016

  

2015

  

2018

  

2017

  

2016

 

Cash flows from operating activities

                        

Net income (loss)

 $38,453  $(2,753

)

 $(3,213

)

 $8,794  $38,453  $(2,753

)

Adjustments to reconcile net income (loss) to net cash from operating activities

                        

Depreciation and amortization

  1,239   1,725   1,711   1,080   1,239   1,725 

Negative provision for loan losses

  (800

)

  (2,450

)

  (4,500

)

  (500

)

  (800

)

  (2,450

)

Net amortization on securities

  1,246   1,297   1,434   865   1,246   1,297 

Stock-based compensation expense

  400   443   445   524   400   443 

Deferred taxes, net

  (31,899

)

        2,376   (31,899

)

   

Gain on extinguishment of junior subordinated debt

        (883

)

Net (gain) loss on sales of loans held for sale

  (46

)

  (86

)

  204 

Loans originated for sale

  (2,859

)

  (5,145

)

  (6,652

)

Net gain on sales of loans held for sale

  (1

)

  (46

)

  (86

)

Origination of loans held for sale

     (2,859

)

  (5,145

)

Proceeds from sales of loans held for sale

  2,835   5,417   6,548   71   2,835   5,417 

Net (gain) loss on sales of other real estate owned

  (74

)

  (222

)

  74 

Net gain on sales of other real estate owned

  (72

)

  (74

)

  (222

)

Net write-down of other real estate owned

  1,963   1,180   9,855   850   1,963   1,180 

Net realized (gain) loss on sales and calls of investment securities

  (288

)

  (216

)

  (1,766

)

  6   (288

)

  (216

)

Net (gain) loss on sale of premises and equipment

  3   (1

)

     (692

)

  3   (1

)

Increase in cash surrender value of owned life insurance, net of premium expense

  (391

)

  (397

)

  (274

)

Impairment on transfer of premises to held for sale

  392       

Increase in cash surrender value of life insurance, net of premium expense

  (417

)

  (391

)

  (397

)

Net change in accrued interest receivable and other assets

  2,079   (814

)

  810   (491

)

  2,079   (814

)

Net change in accrued interest payable and other liabilities

  (9,854

)

  8,133   267   (155

)

  (9,854

)

  8,133 

Net cash from operating activities

  2,007   6,111   4,060   12,630   2,007   6,111 
                        

Cash flows from investing activities

                        

Purchases of available for sale securities

  (21,112

)

  (41,827

)

  (21,828

)

  (77,159

)

  (21,112

)

  (41,827

)

Sales and calls of available for sale securities

  41,686   8,311   45,012 

Maturities and prepayments of available for sale securities

  21,838   22,876   21,084 

Proceeds from calls of held to maturity securities

  47       

Proceeds from sales and calls of available for sale securities

  6,054   41,686   8,311 

Proceeds from maturities and prepayments of available for sale securities

  20,116   21,838   22,876 

Proceeds from calls of held to maturity securities

     47    

Proceeds from maturities of held to maturity securities

  145              145    

Proceeds from sales of loans not originated for sale

        8,640 

Proceeds from sale of other real estate owned

  793   12,438   22,567   876   793   12,438 

Loan originations and payments, net

  (73,202

)

  (22,368

)

  (2,239

)

Proceeds from mandatory redemption of Federal Home Loan Bank stock

  90       

Net changes in loans

  (52,885

)

  (73,202

)

  (22,368

)

Proceeds from sale of premises and equipment

  331   268      1,590   331   268 

Purchases of premises and equipment

  (284

)

  (464

)

  (385

)

  (1,168

)

  (284

)

  (464

)

Purchase of bank owned life insurance

     (5,000

)

           (5,000

)

Net cash from investing activities

  (29,758

)

  (25,766

)

  72,851   (102,486

)

  (29,758

)

  (25,766

)

                        

Cash flows from financing activities

                        

Net change in deposits

  (2,901

)

  (28,072

)

  (48,844

)

  47,207   (2,901

)

  (28,072

)

Net change in repurchase agreements

        (1,341

)

Repayment of Federal Home Loan Bank advances

  (55,661

)

  (623

)

  (17,671

)

Payment of Federal Home Loan Bank advances

  (120,248

)

  (55,661

)

  (623

)

Advances from Federal Home Loan Bank

  45,000   20,000   5,000   155,000   45,000   20,000 

Repayment of subordinated capital note

  (900

)

  (900

)

  (900

)

Payment of subordinated capital note

  (2,250

)

  (900

)

  (900

)

Proceeds from senior debt

  10,000            10,000    

Issuance of common stock

     2,231    

Proceeds from issuance of common stock, net

  14,910      2,231 

Redemption of preferred stock

  (3,505

)

      

Net cash from financing activities

  (4,462

)

  (7,364

)

  (63,756

)

  91,114   (4,462

)

  (7,364

)

Net change in cash and cash equivalents

  (32,213

)

  (27,019

)

  13,155   1,258   (32,213

)

  (27,019

)

Beginning cash and cash equivalents

  66,316   93,335   80,180   34,103   66,316   93,335 

Ending cash and cash equivalents

 $34,103  $66,316  $93,335  $35,361  $34,103  $66,316 
                        

Supplemental cash flow information:

                        

Interest paid

 $5,665  $5,253  $7,076  $10,607  $5,665  $5,253 

Income taxes paid (refunded)

     21            21 

Supplemental non-cash disclosure:

                        

Proceeds from common stock issuance directed by investors to pay junior subordinated debt interest

 $   2,799     $      2,799 

Transfer from loans to other real estate

  270  $1,273  $5,513   730  $270  $1,273 

Transfer from premises and equipment to premises and equipment held for sale

  1,050       

Financed sales of other real estate owned

     270            270 

Effect of junior subordinated debt to equity exchange

        4,330 

Transfer from held to maturity to available for sale securities

  41,380            41,380    

AOCI component of transfer from held to maturity to available for sale, net of tax

  456       

AOCI component of transfer from held to maturity to available for sale, net of tax

     456    

 

See accompanying notes.

 

6055

Table of Contents

 

PORTERLIMESTONE BANCORP, INC. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 20178, 20167 and 20156

 

 

NOTE 1– SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

 

Nature of Operations and Principles of Consolidation – The consolidated financial statements include PorterLimestone Bancorp, Inc. (Company) and its subsidiary, PBILimestone Bank (Bank). The Bank completed a name change to Limestone Bank on February 20, 2018. The Company owns a 100% interest in the Bank.

 

The Company provides financial services through its offices in Central and South Central Kentucky, Lexington and Louisville. Its primary deposit products are checking, savings, and term certificate accounts, and its primary lending products are residential mortgage, commercial, agricultural, and real estate loans. Substantially all loans are collateralized by specific items of collateral including business assets and real estate. Commercial loans are expected to be repaid from cash flow from operations of businesses. There are no significant concentrations of loans to any one industry or customer. However, borrowers’ ability to repay their loans is dependent on the real estate and general economic conditions in the area. Other financial instruments which potentially represent concentrations of credit risk include deposit accounts in other financial institutions, federal funds sold, municipal securities, collateralized loan obligations, corporate securities, and bank owned life insurance.

 

Use of Estimates – To prepare financial statements in conformity with U.S. generally accepted accounting principles, management makes estimates and assumptions based on available information. These estimates and assumptions affect the amounts reported in the financial statements and the disclosures provided, and future results could differ.

 

Cash and Cash Equivalents – For the purpose of presentation in the statements of cash flows, the Company considers all cash and amounts due from depository institutions as well as interest bearing deposits in banks that mature within one year and are carried at cost to be cash equivalents. The Bank isIncluded in cash and due from banks and interest bearing deposits are amounts required to maintain average reserve balances withbe held at the Federal Reserve Bank of St. Louis.Louis or maintained in vault cash in accordance with regulatory reserve requirements. The balance requirements were $7.4 million and $11.0 million at December 31, 2018 and 2017, respectively.

 

Securities – Debt securities are classified as held to maturity and carried at amortized cost when management has the intent and ability to hold them to maturity. Debt securities are classified as available for sale when they might be sold before maturity. Securities available for sale are carried at fair value, with unrealized holding gains and losses reported in other comprehensive income.

 

Interest income includes amortization of purchase premium or discount. Premiums and discounts on securities are amortized on the level-yield method anticipating prepayments on mortgage backed securities. Gains and losses on sales are recorded on the trade date and determined using the specific identification method.

 

Management evaluates securities for other-than-temporary impairment (“OTTI”) on at least a quarterly basis, and more frequently when economic or market conditionsconditions warrant such an evaluation. For securities in an unrealized loss position, management considers the extent and duration of the unrealized loss, and the financial condition and near-term prospects of the issuer. Management also assesses whether it intends to sell, or it is more likely than not that it will be required to sell, a security in an unrealized loss position before recovery of its amortized cost basis. If either of the criteria regarding intent or requirement to sell is met, the entire difference between amortized cost and fair value is recognized as impairment through earnings. For debt securities that do not meet the aforementioned criteria, the amount of impairment is split into 1)1) OTTI related to credit loss, which is recognized in the income statement and 2)2) OTTI related to other factors, which is recognized in other comprehensive income. The credit loss is defined as the difference between the present value of the cash flows expected to be collected and the amortized cost basis.

 

Loans Held for Sale – Loans held for sale include residential mortgage loans originated for sale into the secondary market and are carried at the lower of aggregate cost or fair value, as determined by outstanding commitments from investors. Net unrealized losses, if any, are recorded as a valuation allowance and charged to earnings.

 

Mortgage loans held for sale are generally sold with servicing rights released. If sold with servicing retained, the carrying value of mortgage loans sold is reduced by the amount allocated to the servicing right. Gains and losses on sales of mortgage loans are based on the difference between the selling price and the carrying value of the related loan sold.

 

Mortgage banking derivatives used in the ordinary course of business consist of mandatory forward sales contracts and rate lock loan commitments. Forward contracts represent future commitments to deliver loans at a specified price and date and are used to manage interest rate risk on loan commitments and mortgage loans held for sale. Rate lock commitments represent commitments to fund loans at a specific rate. These derivatives involve underlying items, such as interest rates, and are designed to transfer risk. Substantially all of these instruments expire within 60 days from the date of issuance. Notional amounts are amounts on which calculations and payments are based, but which do not represent credit exposure, as credit exposure is limited to the amounts required to be received or paid. Commitments to deliver loans and rate lock loan commitments were insignificant at year end.

 

6156

 

Loans – Loans that management has the intent and ability to hold for the foreseeable future or until maturity or payoff are reported at the principal balance outstanding, net of deferred loan fees and costs, and an allowance for loan losses. Interest income is accrued on the unpaid principal balance. Loan origination fees, net of certain direct origination costs, are deferred and recognized in interest income using the level-yield method without anticipating prepayments. The recorded investment in loans includes the outstanding principal balance and unamortized deferred origination costs and fees.

 

Interest income recognition on mortgage and commercial loans is discontinued at the time the loan is 90 days delinquent unless the loan is well collateralized and in process of collection. Consumer loans are typically charged off no later than 90 days past due. Past due status is based on the contractual terms of the loan. In all cases, loans are placed on nonaccrual or charged off at an earlier date if collection of principal or interest is not expected.

 

All interest accrued but not received for loans placed on nonaccrual is reversed against interest income. Interest received on such loans is accounted for on the cash-basis or cost-recovery method, until qualifying for return to accrual. Loans are returned to accrual status when all the principal and interest amounts contractually due are brought current and future payments are reasonably assured.

 

Allowance for Loan Losses – The allowance for loan losses is a valuation allowance for probable incurred credit losses. Loan losses are charged against the allowance when management believes the uncollectability of a loan balance is confirmed. Subsequent recoveries, if any, are credited to the allowance. Management estimates the allowance balance required using past loan loss experience, the nature and volume of the portfolio, information about specific borrower situations and estimated collateral values, economic conditions, and other factors. Allocations of the allowance may be made for specific loans, but the entire allowance is available for any loan that, in ourmanagement’s judgment, should be charged off.

 

The allowance consists of specificspecific and general components. The specific component relates to loans that are individually classified as impaired. A loan is deemed impaired when, based on current information and events, it is probable that the CompanyBank will be unable to collect all amounts due according to the contractual terms of the loan agreement. Loans for which the terms have been modified resulting in a concession, and for which the borrower is experiencing financial difficulties, are considered troubled debt restructurings and treated as impaired.

 

Factors considered in determining impairment include payment status, collateral value, and the probability of collecting scheduled principal and interest payments when due. Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired. The significance of payment delays and payment shortfalls is determined on a case-by-case basis, taking into consideration all of the circumstances surrounding the loan and the borrower, including the length of the delay, the reasons for the delay, the borrower’s prior payment record, and the amount of the shortfall in relation to the principal and interest owed.

 

If a loan is impaired, a portion of the allowance is allocated so that the loan is reported, net, at the present value of estimated future cash flows using the loan’sloan’s existing rate or at the fair value of collateral if repayment is expected solely from the collateral. Large groups of smaller balance homogeneous loans, such as consumer and residential real estate loans, are collectively evaluated for impairment and are not separately identified for impairment disclosures. Troubled debt restructurings are separately identified for impairment disclosures and are measured at the present value of estimated future cash flows using the loan’s effective rate at inception. If a troubled debt restructuring is considered to be a collateral dependent loan, the loan is reported at the fair value of the collateral. For troubled debt restructurings that subsequently default, the amount of reserve is determined in accordance with the accounting policy for the allowance for loan losses.

 

The general component covers non-impairednon-impaired loans and is based on historical loss experience adjusted for current factors. The historical loss experience is determined by portfolio segment and is based on actual loss history experienced over the most recent fourfive years with weighting towards the most recent periods.equal weighting. This actual loss experience is supplemented with other economic factors based on the risks present for each portfolio segment. These economic factors include consideration of the following: changes in lending policies, procedures, and practices; effects of any change in risk selection and underwriting standards; national and local economic trends and conditions; industry conditions; trends in volume and terms of loans; experience, ability and depth of lending management and other relevant staff; levels of and trends in delinquencies and impaired loans; levels of and trends in charge-offs and recoveries; and effects of changes in credit concentrations.

 

6257

 

A portfolio segment is defined as the level at which an entity develops and documents a systematic methodology to determine its allowance for loan losses. Management identified the following portfolio segments: commercial, commercial real estate, residential real estate, consumer, agricultural, and other.

 

 

Commercial loans are made to businesses and depend on the strength of the industries, related borrowers, and cash flow from the businesses. Commercial loans are advances for equipment purchases, or to provide working capital, or to meet other financing needs of business enterprises. These loans may be secured by accounts receivable, inventory, equipment or other business assets. Financial information is obtained from the borrowers to evaluate their ability to repay the loans.

 

 

Commercial real estate loans are affected by the local commercial real estate market and the local economy. Commercial real estate loans include loans on commercial properties occupied by borrowers and/or tenants. Construction and development loans are a component of this segment. These loans are generally secured by land under development or homes and commercial buildings under construction. Loans secured by farmland are also a component of this segment. Appraisals are obtained to support the loan amount. Financial information is obtained from the borrowers and/or the individual project to evaluate cash flows sufficiency to service the debt.

 

 

Residential real estate loans are affected by the local residential real estate market, local economy, and, for variable rate mortgages, movement in indices tied to these loans. For owner occupied residential loans,, the borrowers’ repayment ability is evaluated through a review of credit scores and debt to income ratios. For non-owner occupied residential loans, such as rental real estate, financial information is obtained from the borrowers and/or the individual project to evaluate cash flows sufficiency to service the debt. Appraisals are obtained to support the loan amount.

 

 

Consumer loans depend on local economies. Consumer loans are generally unsecured, but may be secured by consumer assets, but may be unsecured.assets. Management evaluates the borrowers’ repayment ability through a review of credit scores and an evaluation of debt to income ratios. Consumer loans may be for consumer goods purchases, cash flow needs, or for student loans or student debt refinances.

 

 

Agriculture loans depend on the industries tied to these loans and are generally secured by livestock, crops, and/or equipment, but may be unsecured. Management evaluates the borrowers’ repayment ability through financial and business performance review.

 

 

Other loans include loans to municipalities, loans secured by stock, and overdrafts. For municipal loans,, management evaluates the borrowers’ revenue streams as well as ability to repay form general funds. For loans secured by stock, management evaluates the market value of the stock securing the loan in relation to the loan amount. Overdrafts are funded based on pre-established criteria related to the deposit account relationship.

 

Management analyzes key relevant risk characteristics for each portfolio segment having determined that loans in each segment possess similar general risk characteristics that are analyzed in connection with loan underwriting processes and procedures. In determining the allocated allowance, the weighted average loss rates over the most recent fourfive years are used with weighting towards the most recent periods.equal weighting. Commercial real estate qualitative adjustment considerations include trends in the markets for underlying collateral values, risks related to tenant rents, and economic factors such as decreased sales demand, elevated inventory levels, and declining collateral values. Residential real estate loan considerations include macro economic factors such as unemployment rates, trends in vacancy rates, and home value trends. The commercial and agricultural portfolio qualitative adjustments are related to economic and portfolio performance trends. The agricultural, consumer and other portfolios are less significant in terms of size and risk is assessed based on the smaller dollar size of these loans and the more geographical areas where the collateral is located.

 

Transfers of Financial Assets – Transfers of financial assets are accounted for as sales, when control over the assets has been relinquished. Control over transferred assets is deemed to be surrendered when the assets have been isolated from the Company, 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 the Company does not maintain effective control over the transferred assets through an agreement to repurchase them before their maturity.

 

Other Real Estate Owned (“OREO”) – Assets acquired through or instead of loan foreclosure are initially recorded at fair value less estimated costs to sell when acquired, establishing a new cost basis. These assets are subsequently accounted for at the lower of cost or fair value, less estimated costs to sell. If fair value declines subsequent to foreclosure, a write-down is recorded through expense. Costs after acquisition are expensed.

58

 

Premises and Equipment – Land is carried at cost. Premises and equipment are stated at cost less accumulated depreciation. Buildings and related components are depreciated using the straight-line method with useful lives generally ranging from 5 to 40 years. Furniture, fixtures and equipment are depreciated using the straight-line or accelerated method with useful lives generally ranging from 2 to 10 years.

 

63

transfer based upon independent third party appraisal. If fair value declines subsequent to transfer, write-downs are recorded through expense.

Premises and equipment are reviewed for impairment when events indicate their carrying amount may not be recoverable from future undiscounted cash flows. If impaired, the assets are recorded at fair value through a charge to earnings.

 

Federal Home Loan Bank (FHLB) Stock – The Bank is a member of the FHLB system. Members are required to own a certain amount of stock based on the level of borrowings and other factors, and may invest in additional amounts. FHLB stock is carried at cost, classified as a restricted security, and periodically evaluated for impairment. Because this stock is viewed as long term investment, impairment is based on ultimate recovery of par value. Both cash and stock dividends are reported as income.

Intangible Assets – Intangible assets with definite useful lives are included with other assets and amortized over their estimated useful lives to their estimated residual values, if any. Other intangible assets consist of core deposit intangible assets arising from whole bank and branch acquisitions. They are initially measured at fair value and then are amortized on an accelerated or straight-line basis over their estimated useful lives, which range from 7 to 10 years.

 

Bank Owned Life Insurance – The Bank has purchased life insurance policies on certain key executives. Company owned life insurance is recorded at the amount that can be realized under the insurance contract at the balance sheet date, which is the cash surrender value adjusted for other charges or other amounts due that are probable at settlement.

Long-Term Assets – Premises and equipment, other intangible assets, and other long-term assets are reviewed for impairment when events indicate their carrying amount may not be recoverable from future undiscounted cash flows. If impaired, the assets are recorded at fair value through a charge to earnings.

 

Benefit Plans – Employee 401(k) and profit sharing401(k) plan expense is the amount of matching contributions. Deferred compensation and supplemental retirement plan expense allocates the benefits over years of service.

 

Stock-Based Compensation – Compensation cost is recognized for unvested stock awards issued to employees, based on the fair value of these awards at the date of grant. The market price of the Corporation’s common stock at the date of grant is used for restricted stock awards. Compensation cost is recognized over the required service period, generally defined as the vesting period. For awards with graded vesting, compensation cost is recognized on a straight-line basis over the requisite service period for the entire award.

 

Income Taxes – Income tax expense is the total of the current year income tax due or refundable and the change in deferred tax assets and liabilities. Deferred tax assets and liabilities are the expected future tax amounts for the temporary differences between carrying amounts and tax bases of assets and liabilities, computed using enacted tax rates. A valuation allowance, if needed, reduces deferred tax assets to the amount expected to be realized.

 

A tax position is recognized as a benefit only if it is "more likely than not" that the tax position would be sustained in a tax examination, with a tax examinationexamination being presumed to occur. The amount recognized is the largest amount of tax benefit that is greater than 50% likely of being realized on examination. For tax positions not meeting the "more likely than not" test, no tax benefit is recorded. The Company recognizes interest and/or penalties related to income tax matters in income tax expense.

 

Loan Commitments and Related Financial Instruments – Financial instruments include off-balance sheet credit instruments, such as commitments to make loans and commercial letters of credit, issued to meet customer-financing needs. The face amount for these items represents the exposure to loss, before considering customer collateral or ability to repay. Such financial instruments are recorded when they are funded.

 

Comprehensive Income (Loss) – Comprehensive loss consists of net income (loss) and other comprehensive income (loss). Other comprehensive income (loss) includes unrealized gains and losses on securities available for sale, which are also recognized as a separate component of equity.

 

Earnings (Loss) Per Common Share – Basic earnings (loss) per common share are net income (loss) attributable to common shareholders divided by the weighted average number of common shares outstanding during the period. Diluted earnings (loss) per common share include the dilutive effect, if any, of additional potential common shares issuable under stock options, warrants, and warrants.any convertible securities. Earnings (loss) and dividends per share are restated for all stock splits and dividends through the date of issue of the financial statements.

 

Earnings (Loss) Allocated to Participating Securities The Company has issued and outstanding unvested common shares to employees and directors through the stock incentive plan. Earnings (loss) are allocated to these participating securities based on their percentage of total issued and outstanding shares.

 

Loss Contingencies – Loss contingencies, including claims and legal actions arising in the ordinarynormal course of business, are recorded as liabilities when the likelihood of loss is probable and an amount or range of loss can be reasonably estimated.

59

 

Dividend Restrictions – Banking regulations require maintaining certain capital levels and may limit the dividends paid by the Bank to the Company or by the Company to shareholders.

64

 

Fair Value of Financial Instruments – Fair values of financial instruments are estimated using relevant market information and other assumptions. Fair value estimates involve uncertainties and matters of significant judgment regarding interest rates, credit risk, prepayments, and other factors, especially in the absence of broad markets for particular items. Changes in assumptions or in market conditions could significantly affect the estimates.

 

Derivative InstrumentsDerivative Instruments are carried at fair value and reflect the estimated amounts that would have been received to terminate these contracts at the reporting date based upon pricing or valuation models applied to current market information.

 

As part of the asset/liability management program, the Company utilizes,utilizes, from time to time, risk participation agreements to reduce its sensitivity to changing interest rates. These are derivative instruments, which are recorded as assets or liabilities in the consolidated balance sheets at fair value. Changes in the fair values of derivatives are reported in the consolidated statements of operations or other comprehensive income (“OCI”) depending on the use of the derivative and whether the instrument qualifies for hedge accounting. The key criterion for the hedge accounting is that the hedged relationship must be highlyfound to be effective in achieving offsetting changes in those cash flows that are attributable to the hedged risk, both at inception of the hedgeas determined by FASB ASC 815 Derivatives and on an ongoing basis.Hedging.

 

Derivatives that qualify for the hedge accounting treatment are designated as either: a hedge of the fair value of the recognized asset or liability or of an unrecognized commitment (a fair value hedge) or a hedge of a forecasted transaction or the variability of cash flows to be received or paid related to a recognized asset or liability (a cash flow hedge). To date, the Company has not entered into a cash flow hedge. For cash flow hedges, changes in the fair values of the derivative instruments are reported in OCI to the extent the hedge is effective. The gains and losses on derivative instruments that are reported in OCI are reflected in the consolidated statements of income in the periods in which the results of operations are impacted by the variability of the cash flows of the hedged item. Generally, net interest income is increased or decreased by amounts receivable or payable with respect to the derivatives, which qualify for hedge accounting. At inception of the hedge, a Company must establish the method it uses for assessing the effectiveness of the hedging derivative and the measurement approach for determining the ineffective aspect of the hedge. The ineffective portion of the hedge, if any, is recognized currently in the consolidated statements of operations and time value expiration of the hedge when measuring ineffectiveness is excluded.

 

The risk participation agreements are not designated against specific assets or liabilities under ASC 815, Derivatives and Hedging, and, therefore, do not qualify for hedge accounting. The derivatives are recorded on the balance sheet at fair value and changes in fair value of both the borrower and the offsetting swap agreements are recorded (and essentially offset) in non-interest income. The fair value of the derivative instruments incorporates a consideration of credit risk in accordance with ASC 820, resulting in some volatility in earnings each period.

 

Adoption of New Accounting Standards In August 2015, May 2014, FASB issued ASU 2015-14,2014-09, Revenue from Contracts with Customers (Topic 606606) (“ASC 606”). This ASU is an update to ASU 2014-09, and delays the effective date of ASU 2014-09. The ASU provides guidance on revenue recognition for entities that enter into contracts with customers to transfer goods or services or enter into contracts for the transfer of nonfinancial assets. The core principle of the guidance is that an entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. The majority of the Company’s revenues come from interest income and other sources, including loans and securities that are outside the scope of ASC 606. The Company’s services that fall within the scope of ASC 606 are presented in non-interest income and are recognized as revenue as the Company satisfies its obligation to the customer. Services within the scope of ASC 606 include service charges on deposit accounts, bank card interchange income, and the sale of OREO. Additional disclosures are required to provide quantitative and qualitative information regarding the nature, amount, timing, and uncertainty of revenue and cash flows arising from contracts with customers. The new guidance isbecame effective for annual reporting periods, and interim reporting periods within those annual periods, beginning after December 15, 2017. the Company on January 1, 2018. The Company’s revenue is comprisedimpact of net interest income on financial assets and liabilities, which is explicitly excluded from the scope of this guidance, and non-interest income. Based on the evaluation of the Company’s non-interest income revenue streams, adoption ofadopting this new guidance will did not have a material impact on the consolidated financial statements. Changes to the relatedstatements, but did result in additional disclosures, are still being finalized.which have been incorporated into “Note 19 – Revenue from Contracts with Customers.”

 

In January 2016, the FASB issued an update ASU No.2016-01, 2016-01, Financial Instruments – Overall (Subtopic 825-10)825-10): Recognition and Measurement of Financial Assets and Financial Liabilities. The amendments in this update impact public business entities as follows: 1)1) Require equity investments (except those accounted for under the equity method of accounting or those that result in consolidation of the investee) to be measured at fair value with changes in fair value recognized in net income. 2)2) Simplify the impairment assessment of equity investments without readily determinable fair values by requiring a qualitative assessment to identify impairment. When a qualitative assessment indicates that impairment exists, an entity is required to measure the investment at fair value. 3)3) Eliminate the requirement to disclose the methods and significant assumptions used to estimate the fair value that is required to be disclosed for financial instruments measured at amortized cost on the balance sheet. 4)4) Require entities to use the exit price notion when measuring the fair value of financial instruments for disclosure purposes. 5)5) Require an entity to present separately in other comprehensive income the portion of the total change in fair value of a liability resulting from a change in the instrument-specific credit risk when the entity has elected to measure the liability at fair value in accordance with the fair value option for financial instruments. 6)6) Require separate presentation of financial assets and financial liabilities by measurement category and form of financial asset (that is, securities or loans and receivables) on the balance sheet or the accompanying notes to the financial statements. 7)7) Clarify that an entity should evaluate the need for a valuation allowance on a deferred tax asset related to available-for-sale securities in combination with the entity’s other deferred tax assets. The amendments in this update becomebecame effective for annual periods and interim periods within those annual periods beginning after December 15,2017.the Company on January 1, 2018. The impact of adopting the new guidance did not have a material impact on the consolidated financial statements, but willdid require additional disclosures. The Company currently does notadditional disclosures have any equity investments.been incorporated into “Note 16 – Fair Values.”

 

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In February 2016, the FASB issued an update ASU No.2016-02, 2016-02, Leases (Topic 842)842). Under the new guidance, lessees will be required to recognize the following for all leases, with the exception of short-term leases, at the commencement date: a lease liability, which is a lessee’slessee’s obligation to make lease payments arising from a lease, measured on a discounted basis; and a right-of-use asset, which is an asset that represents the lessee’s right to use, or control the use of, a specified asset for the lease term. Under the new guidance, lessor accounting in largely unchanged. The amendments in this update become effective for annual periods and interim periods within those annual periods beginning after December 15, 2018. TheBased on the Company’s existing lease agreements, the impact of adopting the new guidance on the consolidated financial statements will not havewas the recording of a material impact.lease liability and a right of use asset of approximately $700,000 on January 1, 2019.

 

In June 2016, the FASB issued ASU No.2016-13, 2016-13, Financial Instruments – Credit Losses (Topic 326)326): Measurement of Credit Losses on Financial Instruments. The final standard will change estimates for credit losses related to financial assets measured at amortized cost such as loans, held-to-maturity debt securities, and certain other contracts. For estimating credit losses, the FASB is replacing the incurred loss model with an expected loss model, which is referred to as the current expected credit loss (CECL) model. Under the CECL model, certain financial assets that are carried at amortized cost, such as loans held for investment and held-to-maturity debt securities, are required to be presented at the net amount expected to be collected. The measurement of expected credit losses is to be based on information about past events, including historical experience, current conditions, and reasonable and supportable forecasts that affect the collectability of the reported amount. This measurement will take place at the time the financial asset is first added to the balance sheet and periodically thereafter. This differs significantly from the “incurred loss” model required under current GAAP, which delays recognition until it is probable a loss has been incurred. The change could materially affect how the allowance for loan losses is determined. The standard is effective for public companies for fiscal years beginning after December 15, 2019. Management is currently gatheringAs previously disclosed, management has formed a cross functional committee that has overseen the enhancement of existing technology required to source and model data for the purpose of meeting this standard. The committee has selected a vendor to assist in generating loan level cash flows and disclosures. The project plan is targeting data and assessing our datamodel validation completion during the first half of 2019, with parallel processing the existing model with the CECL model for two to three quarters prior to implementation, depending on how model completion and system needs.validation occurs. During 2019, management is focused on refining assumptions and continued review and challenges to the model. Additionally, management is researching and resolving interpretive accounting issues in the ASU, contemplating various accounting policies, developing processes and related controls, and considering various reporting disclosures. The impact of CECL model implementation is being evaluated, but it is expected that a one-timeone-time cumulative-effect adjustment to the allowance for loan losses will be recognized in retained earnings on the consolidated balance sheet as of the beginning of the first reporting period in which the new standard is effective, as is consistent with regulatory expectations set forth in interagency guidance. The magnitude of any adjustment or the overall impact of the new standard on financial condition or results of operation cannot yet be determined.determined; however, management expects to identify a range in the Quarterly Report on Form 10-Q for the quarterly period ended September 30, 2019. In December 2018, the OCC, The Board of Governors of the Federal Reserve System, and the FDIC approved a final rule to address changes to the credit loss accounting under GAAP, including banking organizations’ implementation of CECL. The final rule provides banking organizations the option to phase in over a three-year period the day-one adverse effects on regulatory capital that may result from adoption of the new accounting standard.

 

In March 2017, the FASB issued ASU No.2017-08, 2017-08, Receivables – Nonrefundable Fees and Other Costs (Subtopic 310-20)310-20): Premium Amortization of Purchased Callable Debt Securities. The final standard will shorten the amortization period for premiums on callable debt securities by requiring that premiums be amortized to the first (or earliest) call date instead of as an adjustment to the yield over the contractual life. The standard is effective for public companies for fiscal years beginning after December 15, 2018. The Company is currently evaluating the impactAdoption of adopting thethis new guidance will not have a material impact on the consolidated financial statements.

 

In February 2018, the FASB issued ASU No. 2018-02, Income Statement – Reporting Comprehensive Income (Topic 220): Reclassification of Certain Tax Effects From Other Comprehensive Income. The final standard allows institutions to elect to reclassify the stranded tax effects from AOCI to retained earnings, limited to amounts in AOCI that are affected by the tax reform law. This includes remeasuringre-measuring deferred tax assets and liabilities related to items presented in AOCI at the newly enacted tax rate and on other income tax effects of items remaining in AOCI. The standard is effective for public companies for fiscal years beginning after December 15, 2018, and interim periods during 2018. Early adoption iswas permitted. The Company will adoptadopted the standard in the first quarter ofon January 1, 2018 and adoption willdid not have a material impact on the consolidated financial statements.statements as it resulted in a $113,000 entry between AOCI and retained deficit.

 

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NOTE 2 – SECURITIES

 

Securities are classified intoas available for sale (AFS) and held to maturity (HTM) categories.. AFS securities are those that may be sold if needed for liquidity, asset liability management, or other reasons. AFS securities are reported at fair value, with unrealized gains or losses included as a separate component of equity, net of tax. HTM securities are those that the Bank has the intent and ability to hold to maturity and are reported at amortized cost.

 

The amortized cost and fair value of securities and the related gross unrealized gains and losses recognized in accumulated other comprehensive income (loss) were as follows:

 

 

Amortized

Cost

  

Gross

Unrealized

Gains

  

Gross

Unrealized

Losses

  

Fair Value

  

Amortized Cost

  

Gross

Unrealized

Gains

  

Gross

Unrealized

Losses

  

Fair Value

 

December 31, 2017

 

(in thousands)

 

December 31, 2018

 

(in thousands)

 

Available for sale

                                

U.S. Government and federal agency

 $22,105  $2  $(483

)

 $21,624  $23,280  $2  $(722

)

 $22,560 

Agency mortgage-backed: residential

  65,935   117   (1,087

)

  64,965   87,689   192   (1,891

)

  85,990 

Collateralized loan obligations

  25,343   182   (20

)

  25,505   49,942      (103

)

  49,839 

State and municipal

  33,303   508   (101

)

  33,710   32,841   230   (259

)

  32,812 

Corporate bonds

  6,838   78      6,916   9,890   127   (26

)

  9,991 

Total available for sale

 $153,524  $887  $(1,691

)

 $152,720  $203,642  $551  $(3,001

)

 $201,192 

 

  

Amortized

Cost

  

Gross

Unrealized

Gains

  

Gross

Unrealized

Losses

  

Fair Value

December 31, 2016

 

(in thousands)

Available for sale                 

U.S. Government and federal agency

 $34,757  $50  $(708

)

 $34,099  

Agency mortgage-backed: residential

  103,390   455   (1,492

)

  102,353  

Collateralized loan obligations

  11,203         11,203  

State and municipal

  2,028   25   (8

)

  2,045  

Corporate bonds

  3,069   24   (3

)

  3,090  

Total available for sale

 $154,447  $554  $(2,211

)

 $152,790  

  

Amortized

Cost

  

Gross

Unrecognized

Gains

  

Gross

Unrecognized

Losses

  

Fair Value

 

    Held to maturity

                

    State and municipal

 $41,818  $1,272  $(18

)

 $43,072 

Total held to maturity

 $41,818  $1,272  $(18

)

 $43,072 
  

Amortized Cost

  

Gross

Unrealized

Gains

  

Gross

Unrealized

Losses

  

Fair Value

 

December 31, 2017

 

(in thousands)

 

Available for sale

                

U.S. Government and federal agency

 $22,105  $2  $(483

)

 $21,624 

Agency mortgage-backed: residential

  65,935   117   (1,087

)

  64,965 

Collateralized loan obligations

  25,343   182   (20

)

  25,505 

State and municipal

  33,303   508   (101

)

  33,710 

Corporate bonds

  6,838   78      6,916 

Total available for sale

 $153,524  $887  $(1,691

)

 $152,720 

 

In 2013, the Bank transferred a portion of its tax-free municipal and taxable municipal bond portfolios from AFS to HTM.held to maturity (HTM). At that time, the transfer occurred at fair value with the unrealized loss of $1.3$1.3 million remaining in other comprehensive income. That unrealized loss haswas subsequently been amortized on the level yield method out of other comprehensive income with an offsetting entry reducing interest income as a yield adjustment through earnings. No gain or loss was recorded at the time of transfer in 2013. Given the Bank’s current balance sheet composition, interest rate risk profile, the current tax environment, and the Bank’s strategic plan, management reassessed the classification of the held to maturityHTM securities and, effective December 1, 2017, transferred $41.4$41.4 million of tax-free municipals and taxable municipals from HTM to AFS. As a result, the $702,000$702,000 in remaining unamortized loss from the 2013 transfer was reclassified through a book value adjustment of these securities. At December 31, 2017, these securities were carried at fair value with unrealized holding gains and losses reported in other comprehensive income, net of tax, with the remaining securities classified as AFS.

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Sales and calls of securities were as follows:

 

2017

  

2016

  

2015

  

2018

  

2017

  

2016

 
 

(in thousands)

  

(in thousands)

 

Proceeds

 $41,733  $8,311  $45,012  $6,054  $41,733  $8,311 

Gross gains

  449   245   1,902      449   245 

Gross losses

  161   29   136   6   161   29 

 

TheThe tax provision related to net gains and losses realized on sales was $101,000,$76,000,an income tax benefit of $1,000 for 2018 and $618,000,an income tax expense of $101,000, and $76,000 for 2017 and 2016, respectively.

 

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The

The amortized cost and fair value of our debt securities are shown by contractual maturity. Expected maturities may differ from actual maturities when borrowers have the right to call or prepay obligations with or without call or prepayment penalties. Mortgage-backed securities not due at a single maturity date are shown separately. 

 

 

December 31, 2017

  

December 31, 2018

 
 

Amortized

Cost

  

Fair

Value

  

Amortized

Cost

  

Fair

Value

 
 

(in thousands)

  

(in thousands)

 

Maturity

                

Available for sale

                

Within one year

 $14,648  $14,682  $27,583  $27,662 

One to five years

  40,197   40,675   75,548   74,964 

Five to ten years

  32,744   32,398   12,822   12,576 

Agency mortgage-backed: residential

  65,935   64,965   87,689   85,990 

Total

 $153,524  $152,720  $203,642  $201,192 

 

Securities pledged at year-end 20172018 and 20162017 had carrying values of approximately $76.8$64.4 million and $61.2$76.8 million, respectively, and were pledged to secure public deposits.

 

At December 31, 2017 2018 and 2016,2017, the Bank held securities issued by the Commonwealth of Kentucky or Kentucky municipalities having a book value of $15.4$15.3 million and $16.4$15.4 million, respectively. At year-end 2017,2018, there were no other holdings of securities of any one issuer, other than the U.S. Government and its agencies, in an amount greater than 10% of stockholders’ equity.

The Bank owns Collateralized Loan Obligations (CLOs), which are debt securities secured by professionally managed portfolios of senior-secured loans to corporations. CLO managers are typically large non-bank financial institutions or banks and are typically $300 million to $1 billion in size, contain one hundred or more loans and have five to six credit tranches ranging from AAA, AA, A, BBB, BB, B and equity tranche. Interest and principal are paid first to the AAA tranche then to the next lower rated tranche. Losses are borne first by the equity tranche then by the subsequently higher rated tranche. CLOs may be less liquid than government securities from time to time and volatility in the CLO market may cause the value of these investments to decline.

The market value of CLOs may be affected by, among other things, changes in composition of the underlying loans, changes in the cash flows from the underlying loans, defaults and recoveries on the underlying loans, capital gains and losses on the underlying loans, and prepayments on the underlying loans.

At December 31, 2018, $33.1 million and $16.7 million of our CLOs were AA and A rated, respectively. There were no CLOs rated below A and none of the CLOs were subject to ratings downgrade in 2018. All of our CLOs are floating rate, with rates set on a quarterly basis at three month LIBOR plus a spread.

 

The Company evaluates securities for other-than-temporary impairment at least on a quarterly basis, and more frequently when economic or market concerns warrant such evaluation. Consideration is given to the length of time and the extent to which the fair value has been less than cost, the financial condition and near-term prospects of the issuer, underlying credit quality of the issuer, and the intent and ability of the Company to retain its investment in the issuer for a period of time sufficient to allow for any anticipated recovery in fair value. In analyzing an issuer’sissuer’s financial condition, the Company may consider whether the securities are issued by the federal government or its agencies, whether downgrades by bond rating agencies have occurred, the sector or industry trends and cycles affecting the issuer, and the results of reviews of the issuer’s financial condition. As of December 31,2017, 2018, management does not believe any securities in the portfolio with unrealized losses should be classified as other than temporarily impaired.

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Securities with unrealized losses at December 31, 2018 and December 31, 2017, and December 31, 2016, aggregated by investment category and length of time the individual securities have been in a continuous unrealized loss position, are as follows:

 

Less than 12 Months

12 Months or More

Total

Description of Securities

Fair

Value

Unrealized

Loss

Fair

Value

Unrealized

Loss

Fair

Value

Unrealized

Loss

(in thousands)

2017

Available for sale

U.S. Government and federal agency

$5,788$(97

)

$14,121$(386

)

$19,909$(483

)

Agency mortgage-backed: residential

21,104(172

)

27,158(915

)

48,262(1,087

)

State and municipal

7,492(101

)

7,492(101

)

Collateralized loan obligations

6,038(20

)

6,038(20

)

Total temporarily impaired

$40,422$(390

)

$41,279$(1,301

)

$81,701$(1,691

)

  

Less than 12 Months

  

12 Months or More

  

Total

 

Description of Securities

 

Fair

Value

  

Unrealized

Loss

  

Fair

Value

  

Unrealized

Loss

  

Fair

Value

  

Unrealized

Loss

 
  

(in thousands)

 

2018

                        

Available for sale

                        

U.S. Government and federal agency

 $3,431  $(57

)

 $17,212  $(665

)

 $20,643  $(722

)

Agency mortgage-backed: residential

  30,229   (343

)

  40,932   (1,548

)

  71,161   (1,891

)

Collateralized loan obligations

  48,294   (103

)

        48,294   (103

)

State and municipal

  6,133   (29

)

  7,252   (230

)

  13,385   (259

)

Corporate Bonds

  3,569   (26

)

        3,569   (26

)

Total temporarily impaired

 $91,656  $(558

)

 $65,396  $(2,443

)

 $157,052  $(3,001

)

 

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Table of Contents

 

Less than 12 Months

  

12 Months or More

  

Total

  

Less than 12 Months

  

12 Months or More

  

Total

 

Description of Securities

 

Fair

Value

  

Unrealized

Loss

  

Fair

Value

  

Unrealized

Loss

  

Fair

Value

  

Unrealized

Loss

  

Fair

Value

  

Unrealized

Loss

  

Fair

Value

  

Unrealized

Loss

  

Fair

Value

  

Unrealized

Loss

 
 

(in thousands)

  

(in thousands)

 

2016

                        

2017

                        

Available for sale

                                                

U.S. Government and federal agency

 $27,738  $(708

)

 $  $  $27,738  $(708

)

 $5,788  $(97

)

 $14,121  $(386

)

 $19,909  $(483

)

Agency mortgage-backed: residential

  63,460   (1,449

)

  2,745   (43

)

  66,205   (1,492

)

  21,104   (172

)

  27,158   (915

)

  48,262   (1,087

)

Collateralized loan obligations

  6,038   (20

)

        6,038   (20

)

State and municipal

  465   (8

)

        465   (8

)

  7,492   (101

)

        7,492   (101

)

Corporate bonds

        1,566   (3

)

  1,566   (3

)

Total temporarily impaired

 $91,663  $(2,165

)

 $4,311  $(46

)

 $95,974  $(2,211

)

 $40,422  $(390

)

 $41,279  $(1,301

)

 $81,701  $(1,691

)

                        

Held to maturity

                        

State and municipal

  1,540   (18

)

        1,540   (18

)

Total

 $1,540  $(18

)

 $  $  $1,540  $(18

)

 

 

NOTE 3 – LOANS

 

Loans net of unearned income, deferred loan origination costs, and net premiums on acquired loans by class were as follows:

 

 

2017

  

2016

  

2018

  

2017

 
 

(in thousands)

  

(in thousands)

 

Commercial

 $113,771  $97,761  $129,368  $113,771 

Commercial Real Estate:

                

Construction

  57,342   36,330   86,867   57,342 

Farmland

  88,320   71,507   77,937   88,320 

Nonfarm nonresidential

  156,724   149,546   172,177   156,724 

Residential Real Estate:

                

Multi-family

  56,588   48,197   49,757   56,588 

1-4 Family

  179,222   188,092   175,761   179,222 

Consumer

  18,439   9,818   39,104   18,439 

Agriculture

  41,154   37,508   33,737   41,154 

Other

  555   477   536   555 

Subtotal

  712,115   639,236   765,244   712,115 

Less: Allowance for loan losses

  (8,202

)

  (8,967

)

  (8,880

)

  (8,202

)

Loans, net

 $703,913  $630,269  $756,364  $703,913 

 

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The following table presents the activity in the allowance for loan losses by portfolio segment for the year ended December 31, 2018, 2017,2016, and 2015:2016:

 

 

Commercial

  

Commercial

Real Estate

  

Residential

Real Estate

  

Consumer

  

Agriculture

  

Other

  

Total

  

Commercial

  

Commercial

Real Estate

  

Residential

Real Estate

  

Consumer

  

Agriculture

  

Other

  

Total

 

December 31, 2017:

 

(in thousands)

 

December 31, 2018:

 

(in thousands)

 

Beginning balance

 $475  $4,894  $3,426  $8  $162  $2  $8,967  $892  $4,032  $2,900  $64  $313  $1  $8,202 

Provision (negative provision)

  363   (1,223

)

  (129

)

  (8

)

  213   (16

)

  (800

)

Provision (negative provision)

  196   (192

)

  (599

)

  92   6   (3

)

  (500

)

Loans charged off

  (5

)

  (58

)

  (692

)

  (51

)

  (95

)

     (901

)

  (50

)

  (198

)

  (252

)

  (95

)

  (13

)

  (8

)

  (616

)

Recoveries

  59   419   295   115   33   15   936   261   1,034   403   69   15   12   1,794 

Ending balance

 $892  $4,032  $2,900  $64  $313  $1  $8,202  $1,299  $4,676  $2,452  $130  $321  $2  $8,880 

  

Commercial

  

Commercial

Real Estate

  

Residential

Real Estate

  

Consumer

  

Agriculture

  

Other

  

Total

 

December 31, 2017:

 

(in thousands)

 

Beginning balance

 $475  $4,894  $3,426  $8  $162  $2  $8,967 

Provision (negative provision)

  363   (1,223

)

  (129

)

  (8

)

  213   (16

)

  (800

)

Loans charged off

  (5

)

  (58

)

  (692

)

  (51

)

  (95

)

     (901

)

Recoveries

  59   419   295   115   33   15   936 

Ending balance

 $892  $4,032  $2,900  $64  $313  $1  $8,202 
                             

December 31, 2016:

                            

Beginning balance

 $818  $6,993  $3,984  $122  $122  $2  $12,041 

Provision (negative provision)

  (401

)

  (2,438

)

  749   (314

)

  (56

)

  10   (2,450

)

Loans charged off

  (276

)

  (505

)

  (1,652

)

  (99

)

  (18

)

  (79

)

  (2,629

)

Recoveries

  334   844   345   299   114   69   2,005 

Ending balance

 $475  $4,894  $3,426  $8  $162  $2  $8,967 

 

December 31, 2016:

                            

Beginning balance

 $818  $6,993  $3,984  $122  $122  $2  $12,041 

Provision (negative provision)

  (401

)

  (2,438

)

  749   (314

)

  (56

)

  10   (2,450

)

Loans charged off

  (276

)

  (505

)

  (1,652

)

  (99

)

  (18

)

  (79

)

  (2,629

)

Recoveries

  334   844   345   299   114   69   2,005 

Ending balance

 $475  $4,894  $3,426  $8  $162  $2  $8,967 

December 31, 2015:

                            

Beginning balance

 $2,046  $10,931  $5,787  $274  $319  $7  $19,364 

Provision (negative provision)

  (1,255

)

  (2,713

)

  (316

)

  (115

)

  (87

)

  (14

)

  (4,500

)

Loans charged off

  (696

)

  (2,879

)

  (2,171

)

  (221

)

  (118

)

  (47

)

  (6,132

)

Recoveries

  723   1,654   684   184   8   56   3,309 

Ending balance

 $818  $6,993  $3,984  $122  $122  $2  $12,041 

TheThe following table presents the balance in the allowance for loan losses and the recorded investment in loans by portfolio segment and based on the impairment method as of December 31, 2017:2018:

 

 Commercial  

Commercial

Real Estate

  

Residential

Real Estate

  

Consumer

  

Agriculture

  

Other

  

Total

  

Commercial

  

Commercial

Real Estate

  

Residential

Real Estate

  

Consumer

  

Agriculture

  

Other

  

Total

 
 

(in thousands)

  

(in thousands)

 

Allowance for loan losses:

                                                        

Ending allowance balance attributable to loans:

                                                        

Individually evaluated for impairment

 $13  $  $206  $  $  $  $219  $  $35  $168  $  $  $  $203 

Collectively evaluated for impairment

  879   4,032   2,694   64   313   1   7,983   1,299   4,641   2,284   130   321   2   8,677 

Total ending allowance balance

 $892  $4,032  $2,900  $64  $313  $1  $8,202  $1,299  $4,676  $2,452  $130  $321  $2  $8,880 
                                                        

Loans:

                                                        

Loans individually evaluated for impairment

 $587  $2,635  $3,950  $1  $  $  $7,173  $53  $510  $2,348  $  $  $  $2,911 

Loans collectively evaluated for impairment

  113,184   299,751   231,860   18,438   41,154   555   704,942   129,315   336,471   223,170   39,104   33,737   536   762,333 

Total ending loans balance

 $113,771  $302,386  $235,810  $18,439  $41,154  $555  $712,115  $129,368  $336,981  $225,518  $39,104  $33,737  $536  $765,244 

 

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TheThe following table presents the balance in the allowance for loan losses and the recorded investment in loans by portfolio segment and based on the impairment method as of December 31, 2016:2017:

 

 Commercial  

Commercial

Real Estate

  

Residential

Real Estate

  

Consumer

  

Agriculture

  

Other

  

Total

  

Commercial

  

Commercial

Real Estate

  

Residential

Real Estate

  

Consumer

  

Agriculture

  

Other

  

Total

 
 

(in thousands)

  

(in thousands)

 

Allowance for loan losses:

                                                        

Ending allowance balance attributable to loans:

                                                        

Individually evaluated for impairment

 $13  $35  $350  $  $1  $  $399  $13  $  $206  $  $  $  $219 

Collectively evaluated for impairment

  462   4,859   3,076   8   161   2   8,568   879   4,032   2,694   64   313   1   7,983 

Total ending allowance balance

 $475  $4,894  $3,426  $8  $162  $2  $8,967  $892  $4,032  $2,900  $64  $313  $1  $8,202 
                                                        

Loans:

                                                        

Loans individually evaluated for impairment

 $595  $5,854  $8,621  $1  $60  $  $15,131  $587  $2,635  $3,950  $1  $  $  $7,173 

Loans collectively evaluated for impairment

  97,166   251,529   227,668   9,817   37,448   477   624,105   113,184   299,751   231,860   18,438   41,154   555   704,942 

Total ending loans balance

 $97,761  $257,383  $236,289  $9,818  $37,508  $477  $639,236  $113,771  $302,386  $235,810  $18,439  $41,154  $555  $712,115 

 

Impaired Loans

 

ImpairedImpaired loans include restructured loans and loans on nonaccrual or classified as doubtful, whereby collection of the total amount is improbable, or loss, whereby all or a portion of the loan has been written off or a specific allowance for loss had been provided.

 

The following table presents information related to loans individually evaluated for impairment by class of loan as of and for the year ended December 31, 2017:2018:

 

Unpaid

Principal

Balance

  

Recorded

Investment

  

Allowance

For Loan

Losses

Allocated

  

Average

Recorded

Investment

  

Interest

Income

Recognized

  

Cash

Basis

Income

Recognized

  

Unpaid

Principal

Balance

  

Recorded

Investment

  

Allowance

For Loan

Losses

Allocated

  

Average

Recorded

Investment

  

Interest

Income

Recognized

  

Cash

Basis

Income

Recognized

 
 

(in thousands)

      

(in thousands)

     

With No Related Allowance Recorded:

                                                

Commercial

 $703  $487  $  $495  $7  $7  $120  $53  $  $125  $1  $1 

Commercial real estate:

                                                

Construction

                                    

Farmland

  3,687   2,059      2,651   210   210   1,860   89      1,156   525   360 

Nonfarm nonresidential

  1,047   576      716   59   47   402   262      327   19    

Residential real estate:

                                                

Multi-family

           820                         

1-4 Family

  4,293   2,787      2,884   143   143   2,678   1,628      1,964   164   111 

Consumer

  9   1      2   2   2   12         1       

Agriculture

           24   1   1               7   6 

Other

                                    

Subtotal

  9,739   5,910      7,592   422   410   5,072   2,032      3,573   716   478 

With An Allowance Recorded:

                                                

Commercial

  100   100   13   100   7               60   3    

Commercial real estate:

                                                

Construction

                                    

Farmland

           235                         

Nonfarm nonresidential

           238   14      159   159   35   100       

Residential real estate:

                                                

Multi-family

                                    

1-4 Family

  1,163   1,163   206   1,404   68      720   720   168   1,111   44    

Consumer

                                    

Agriculture

           24                         

Other

                                    

Subtotal

  1,263   1,263   219   2,001   89      879   879   203   1,271   47    

Total

 $11,002  $7,173  $219  $9,593  $511  $410  $5,951  $2,911  $203  $4,844  $763  $478 

 

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The following table presents information related to loans individually evaluated for impairment by class of loan as of and for the year ended December 31, 2016:2017:

 

 

Unpaid

Principal

Balance

  

Recorded

Investment

  

Allowance

For Loan

Losses

Allocated

  

Average

Recorded

Investment

  

Interest

Income

Recognized

  

Cash

Basis

Income

Recognized

  

Unpaid

Principal

Balance

  

Recorded

Investment

  

Allowance

For Loan

Losses

Allocated

  

Average

Recorded

Investment

  

Interest

Income

Recognized

  

Cash

Basis

Income

Recognized

 
 

(in thousands)

      

(in thousands)

     

With No Related Allowance Recorded:

                                                

Commercial

 $707  $495  $  $758  $39  $39  $703  $487  $  $495  $7  $7 

Commercial real estate:

                                                

Construction

           156   9                      

Farmland

  5,566   3,742      4,188   94   95   3,687   2,059      2,651   210   210 

Nonfarm nonresidential

  4,502   1,219      4,699   310   189   1,047   576      716   59   47 

Residential real estate:

                                                

Multi-family

  4,100   4,100      2,608   287   1            820       

1-4 Family

  4,663   2,910      5,509   162   94   4,293   2,787      2,884   143   143 

Consumer

  41   1      7   8   8   9   1      2   2   2 

Agriculture

           73   28   28            24   1   1 

Other

                                    

Subtotal

  19,579   12,467      17,998   937   454   9,739   5,910      7,592   422   410 

With An Allowance Recorded:

                                                

Commercial

  100   100   13   20   6      100   100   13   100   7    

Commercial real estate:

                                                

Construction

                                    

Farmland

  614   590   5   358                  235       

Nonfarm nonresidential

  303   303   30   398   23               238   14    

Residential real estate:

                                                

Multi-family

           2,506   101                      

1-4 Family

  1,676   1,611   350   1,659   111      1,163   1,163   206   1,404   68    

Consumer

                                    

Agriculture

  78   60   1   39                  24       

Other

                                    

Subtotal

  2,771   2,664   399   4,980   241      1,263   1,263   219   2,001   89    

Total

 $22,350  $15,131  $399  $22,978  $1,178  $454  $11,002  $7,173  $219  $9,593  $511  $410 

 

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The following table presents information related to loans individually evaluated for impairment by class of loan as of and for the year ended December 31, 2015:2016:

 

  

Unpaid

Principal

Balance

  

Recorded

Investment

  

Allowance

For Loan

Losses

Allocated

  

Average

Recorded

Investment

  

Interest

Income

Recognized

  

Cash

Basis

Income

Recognized

 
  

(in thousands)

     

With No Related Allowance Recorded:

                        

Commercial

 $1,558  $1,112  $  $1,526  $5  $5 

Commercial real estate:

                        

Construction

  278   262      1,993   14   1 

Farmland

  6,004   4,263      4,497   114   114 

Nonfarm nonresidential

  11,256   7,829      16,073   263   9 

Residential real estate:

                        

Multi-family

  32   32      35       

1-4 Family

  14,066   11,756      13,584   456   99 

Consumer

  118   20      23       

Agriculture

  260   152      206       

Other

           49   5   5 

Subtotal

  33,572   25,426      37,986   857   233 

With An Allowance Recorded:

                        

Commercial

           13       

Commercial real estate:

                        

Construction

                  

Farmland

           63       

Nonfarm nonresidential

  574   465   43   4,591   25    

Residential real estate:

                        

Multi-family

  4,195   4,195   57   4,229   204    

1-4 Family

  1,690   1,690   328   1,705   89    

Consumer

           8       

Agriculture

                  

Other

                  

Subtotal

  6,459   6,350   428   10,609   318    

Total

 $40,031  $31,776  $428  $48,595  $1,175  $233 

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Unpaid

Principal

Balance

  

Recorded

Investment

  

Allowance

For Loan

Losses

Allocated

  

Average

Recorded

Investment

  

Interest

Income

Recognized

  

Cash

Basis

Income

Recognized

 
  

(in thousands)

     

With No Related Allowance Recorded:

                        

Commercial

 $707  $495  $  $758  $39  $39 

Commercial real estate:

                        

Construction

           156   9    

Farmland

  5,566   3,742      4,188   94   95 

Nonfarm nonresidential

  4,502   1,219      4,699   310   189 

Residential real estate:

                        

Multi-family

  4,100   4,100      2,608   287   1 

1-4 Family

  4,663   2,910      5,509   162   94 

Consumer

  41   1      7   8   8 

Agriculture

           73   28   28 

Other

                  

Subtotal

  19,579   12,467      17,998   937   454 

With An Allowance Recorded:

                        

Commercial

  100   100   13   20   6    

Commercial real estate:

                        

Construction

                  

Farmland

  614   590   5   358       

Nonfarm nonresidential

  303   303   30   398   23    

Residential real estate:

                        

Multi-family

           2,506   101    

1-4 Family

  1,676   1,611   350   1,659   111    

Consumer

                  

Agriculture

  78   60   1   39       

Other

                  

Subtotal

  2,771   2,664   399   4,980   241    

Total

 $22,350  $15,131  $399  $22,978  $1,178  $454 

 

Troubled Debt Restructuring

 

A troubled debt restructuring (TDR) occurs when the Bank has agreed to a loan modification in the form of a concession for a borrower who is experiencing financial difficulty. The Bank’s TDRs typically involve a reduction in interest rate, a deferral of principal for a stated period of time, or an interest only period. All TDRs are considered impaired and the Bank has allocated reserves for these loans to reflect the present value of the concessionary terms granted to the borrower.

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The following table presents the types of TDR loan modifications by portfolio segment outstanding as of December 31, 2017 2018 and 2016:2017:

 

 

TDRs

Performing to

Modified Terms

  

TDRs Not

Performing to

Modified Terms

  

Total

TDRs

 
 

(in thousands)

 

December 31, 2018

            

Commercial Real Estate:

            
Nonfarm nonresidential 

Rate reduction

 $190  $  $190 

Residential Real Estate:

            

1-4 Family

            

Rate reduction

  720      720 

Total TDRs

 $910  $  $910 
 

TDRs

Performing to

Modified Terms

  

TDRs Not

Performing to

Modified Terms

  

Total

TDRs

             
 

(in thousands)

             

December 31, 2017

                        

Commercial

                        

Rate reduction

 $  $33  $33  $  $33  $33 

Principal deferral

     434   434      434   434 

Commercial Real Estate:

                        

Farmland

                        

Principal deferral

     1,362   1,362      1,362   1,362 

Nonfarm nonresidential

                        

Rate reduction

  483      483   483      483 

Residential Real Estate:

                        

1-4 Family

                        

Rate reduction

  734      734   734      734 

Total TDRs

 $1,217  $1,829  $3,046  $1,217  $1,829  $3,046 
            
            

December 31, 2016

            

Commercial

            

Rate reduction

 $  $33  $33 

Principal deferral

     434   434 

Commercial Real Estate:

            

Farmland

            

Principal deferral

     2,300   2,300 

Nonfarm nonresidential

            

Rate reduction

  507      507 

Principal deferral

     607   607 

Residential Real Estate:

            

Multi-family

            

Rate reduction

  4,100      4,100 

1-4 Family

            

Rate reduction

  743      743 

Total TDRs

 $5,350  $3,374  $8,724 

 

At December 31, 2018 and 2017, 100% and 2016,40% and 61%, respectively, of the Company’s TDRs were performing according to their modified terms. The Company allocated $122,000$168,000 and $197,000$122,000 as of December 31, 2017 2018 and 2016,2017, respectively, in reserves to customers whose loan terms have been modified in TDRs. The Company has committed to lend no additional amounts to customers as of December 31, 2017 2018 or 20162017 with outstanding loans that are classified as TDRs.

 

ManagementManagement periodically reviews renewals and modifications of previously identified TDRs, for which there was no principal forgiveness, to consider if it is appropriate to remove the TDR classification. If the borrower is no longer experiencing financial difficulty and the renewal/modification did not contain a concessionary interest rate or other concessionary terms, management considers the potential removal of the TDR classification. If deemed appropriate based upon current underwriting, the TDR classification is removed as the borrower has complied with the terms of the loan at the date of renewal/modification and there was a reasonable expectation that the borrower would continue to comply with the terms of the loan subsequent to the date of the renewal/modification. In this instance, the TDR was originally considered a restructuring in a prior year as a result of a modification with an interest rate that was not commensurate with the risk of the underlying loan. Additionally, TDR classification can be removed in circumstances in which the Company performs a non-concessionary re-modification of the loan at terms that were considered to be at market for loans with comparable risk. Management expects the borrower will continue to perform under the re-modified terms based on the borrower’s past history of performance. During 2017, the TDR classification was removed from two loans that met the requirements as discussed above. These loans totaled $4.1 million at December 31, 2016. These loans are no longer evaluated individually for impairment.

 

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Table of Contents

No TDR loan modifications occurred during the twelve months ended December 31, 2018, 2017, or 2016. During the year ended December, 31 2018, 2017, and 2016,no TDRs defaulted on their restructured loan within the twelve-monthtwelve-month period following the loan modification. A default is considered to have occurred once the TDR is past due 90 days or more or it has been placed on nonaccrual.

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Table of Contents

 

Non-performing Loans

 

Non-performingNon-performing loans include impaired loans and smaller balance homogeneous loans, such as residential mortgage and consumer loans, that are collectively evaluated for impairment. The following table presents the recorded investment in nonaccrual and loans past due 90 days and still on accrual by class of loan as of December 31, 2017 2018 and 2016:2017:

 

 

Nonaccrual

  

Loans Past

Due 90 Days

And Over Still

Accruing

  

Nonaccrual

  

Loans Past

Due 90 Days

And Over Still

Accruing

 
 

2017

  

2016

  

2017

  

2016

  

2018

  

2017

  

2018

  

2017

 
 

(in thousands)

  

(in thousands)

 
                                

Commercial

 $487  $495  $  $  $53  $487  $  $ 

Commercial Real Estate:

                                

Construction

                        

Farmland

  2,059   4,332         249   2,059       

Nonfarm nonresidential

  93   1,016         61   93       

Residential Real Estate:

                                

Multi-family

                        

1-4 Family

  2,817   3,312         1,628   2,817       

Consumer

  1   1   1         1       

Agriculture

     60                  1 

Other

                        

Total

 $5,457  $9,216  $1  $  $1,991  $5,457  $  $1 

 

TheThe following table presents the aging of the recorded investment in past due loans by class as of December 31, 2017 2018 and 2016:2017:

 

30 – 59

Days

Past Due

  

60 – 89

Days

Past Due

  

90 Days

And Over

Past Due

  

 

 

Nonaccrual

  

Total

Past Due

And

Nonaccrual

  

30 – 59

Days

Past Due

  

60 – 89

Days

Past Due

  

90 Days

And Over

Past Due

  

 

 

Nonaccrual

  

Total

Past Due

And

Nonaccrual

 
                     

(in thousands)

 
 

(in thousands)

    

December 31, 2017

                    

December 31, 2018

                    

Commercial

 $  $  $  $487  $487  $39  $  $  $53  $92 

Commercial Real Estate:

                                        

Construction

                              

Farmland

  593         2,059   2,652   244   107      249   600 

Nonfarm nonresidential

           93   93      52      61   113 

Residential Real Estate:

                                        

Multi-family

                              

1-4 Family

  850   126      2,817   3,793   1,299   137      1,628   3,064 

Consumer

  30   45      1   76   8   35         43 

Agriculture

  5      1      6   3            3 

Other

                              

Total

 $1,478  $171  $1  $5,457  $7,107  $1,593  $331  $  $1,991  $3,915 

 

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30 – 59

Days

Past Due

  

60 – 89

Days

Past Due

  

90 Days

And Over

Past Due

  

 

 

Nonaccrual

  

Total

Past Due

And

Nonaccrual

  

30 – 59

Days

Past Due

  

60 – 89

Days

Past Due

  

90 Days

And Over

Past Due

  

 

 

Nonaccrual

  

Total

Past Due

And

Nonaccrual

 
                     

(in thousands)

 
 

(in thousands)

    

December 31, 2016

                    

December 31, 2017

                    

Commercial

 $  $  $  $495  $495  $  $  $  $487  $487 

Commercial Real Estate:

                                        

Construction

                              

Farmland

  626         4,332   4,958   593         2,059   2,652 

Nonfarm nonresidential

     59      1,016   1,075            93   93 

Residential Real Estate:

                                        

Multi-family

                              

1-4 Family

  1,454   256      3,312   5,022   850   126      2,817   3,793 

Consumer

  19         1   20   30   45      1   76 

Agriculture

  203         60   263   5      1      6 

Other

                              

Total

 $2,302  $315  $  $9,216  $11,833  $1,478  $171  $1  $5,457  $7,107 

 

Credit Quality Indicators

 

Management categorizes all loans into risk categories at origination based upon original underwriting. Thereafter, management categorizes loans into risk categories based on relevant information about the ability of borrowers to service their debt such as current financial information, historical payment experience, credit documentation, public information, and current economic trends. Additionally, loans are analyzed through internal and external loan review processes. Borrower relationships in excess of $500,000$500,000 are routinely analyzed through the credit administration processes which classify the loans as to credit risk. The following definitions are used for risk ratings:ratings:

 

Watch Loans classified as watch are those loans which have or may experience a potentially adverse development which necessitates increased monitoring.

 

Special Mention Loans classified as special mention do not have all of the characteristics of substandard or doubtful loans. They have one or more deficiencies which warrant special attention and which corrective action, such as accelerated collection practices, may remedy.

 

Substandard Loans classified as substandard are those loans with clear and defined weaknesses such as a highly leveraged position, unfavorable financial ratios, uncertain repayment sources or poor financial condition which may jeopardize the repayment of the debt as contractually agreed. They are characterized by the distinct possibility ofthat the Bank will sustain some lossesloss if the deficiencies are not corrected.

 

Doubtful – Loans classified as doubtful are those loans which have characteristics similar to substandard loans but with an increased risk that collection or liquidation in full is highly questionable and improbable.

 

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Loans not meeting the criteria above that are analyzed individually as part of the above described process are considered to be “Pass” rated loans.loans. As of December 31, 2017 2018 and 2016,2017, and based on the most recent analysis performed, the risk category of loans by class of loans is as follows:

 

 

Pass

  

Watch

  

Special

Mention

  

Substandard

  

Doubtful

  

Total

  

Pass

  

Watch

  

Special

Mention

  

Substandard

  

Doubtful

  

Total

 
                                                
 

(in thousands)

  

(in thousands)

 
                                                

December 31, 2017

                        

December 31, 2018

                        

Commercial

 $112,978  $84  $  $709  $  $113,771  $129,106  $141  $  $121  $  $129,368 

Commercial Real Estate:

                                                

Construction

  57,342               57,342   86,867               86,867 

Farmland

  76,563   7,607      4,150      88,320   74,054   2,741      1,142      77,937 

Nonfarm nonresidential

  152,004   2,906      1,814      156,724   169,551   1,983      643      172,177 

Residential Real Estate:

                                                

Multi-family

  47,121   9,467            56,588   44,697   5,060            49,757 

1-4 Family

  169,774   3,535   164   5,749      179,222   169,342   2,209   113   4,097      175,761 

Consumer

  18,042   306      91      18,439   38,768   11      325      39,104 

Agriculture

  38,654   1,810      690      41,154   32,683   1,019      35      33,737 

Other

  555               555   536               536 

Total

 $673,033  $25,715  $164  $13,203  $  $712,115  $745,604  $13,164  $113  $6,363  $  $765,244 

 

 

 

Pass

  

Watch

  

Special

Mention

  

Substandard

  

Doubtful

  

Total

  

Pass

  

Watch

  

Special

Mention

  

Substandard

  

Doubtful

  

Total

 
                                                
 

(in thousands)

  

(in thousands)

 
                                                

December 31, 2016

                        

December 31, 2017

                        

Commercial

 $96,402  $294  $  $1,065  $  $97,761  $112,978  $84  $  $709  $  $113,771 

Commercial Real Estate:

                                                

Construction

  35,823   507            36,330   57,342               57,342 

Farmland

  63,323   1,521      6,663      71,507   76,563   7,607      4,150      88,320 

Nonfarm nonresidential

  142,222   5,217   445   1,662      149,546   152,004   2,906      1,814      156,724 

Residential Real Estate:

                                                

Multi-family

  38,281   6,080      3,836      48,197   47,121   9,467            56,588 

1-4 Family

  173,565   6,909   52   7,566      188,092   169,774   3,535   164   5,749      179,222 

Consumer

  9,397   348      73      9,818   18,042   306      91      18,439 

Agriculture

  26,940   9,555      1,013      37,508   38,654   1,810      690      41,154 

Other

  477               477   555               555 

Total

 $586,430  $30,431  $497  $21,878  $  $639,236  $673,033  $25,715  $164  $13,203  $  $712,115 

 

 

 

NOTE 4 – PREMISES AND EQUIPMENT

 

Year-end premises and equipment were as follows:

 

 

2017

  

2016

  

2018

  

2017

 
 

(in thousands)

  

(in thousands)

 

Land and buildings

 $23,124  $23,515  $19,999  $23,124 

Furniture and equipment

  10,151   10,050   11,283   10,151 
  33,275   33,565   31,282   33,275 

Accumulated depreciation

  (16,486

)

  (15,717

)

  (16,627

)

  (16,486

)

 $16,789  $17,848  $14,655  $16,789 

 

Depreciation expenseDuring 2018, the Company recognized a $692,000 gain on sale of a subdivided lot at the Company’s headquarters. The gain on sale is included in other non-interest income.

In connection with the completion of a core system conversion in December 2018, management approved the closure of the Bank’s central data processing facility. As a result, the data processing facility was $955,000,$1.1transferred to Premises Held for Sale at fair value, as determined by an independent third party appraisal, less estimated cost to sell. The transfer to held for sale resulted in a $392,000 impairment charge, which is included in other non-interest income. The carrying value is $1.1 million and $1.0 million for 2017,2016 and 2015, respectively.at December 31, 2018.

 

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Depreciation expense was $833,000, $955,000 and $1.1 million for 2018, 2017 and 2016, respectively.

 

NOTE 5 – OTHER REAL ESTATE OWNED

 

Other real estate owned (OREO) is real estate acquired as a result of foreclosure or by deed in lieu of foreclosure. It is classified as real estate owned until such time as it is sold. When property is acquired as a result of foreclosure or by deed in lieu of foreclosure, it is recorded at its fair market value less estimated cost to sell. Any write-down of the property at the time of acquisition is charged to the allowance for loan losses.

 

Fair value of OREO is determined on an individual property basis. When foreclosed properties are acquired, management obtains a new appraisal of the subject property or has staff from the Bank’s special assets group evaluate the latest in-file appraisal in connection with the transfer to OREO. Updated appraisals are typically obtained within five quarters of the anniversary date of ownership unless a sale is imminent. Subsequent reductions in fair value are recorded as non-interest expense when a new appraisal indicates a decline in value or in cases where a listingmarketing price is lowered below the appraised amount. 

 

The following table presents the major categories of OREO at the period-ends indicated:

 

 

2017

  

2016

  

2018

  

2017

 
 

(in thousands)

  

(in thousands)

 

Commercial Real Estate:

                

Construction, land development, and other land

 $4,335  $6,571  $3,485  $4,335 

Farmland

  74         74 

Residential Real Estate:

        

1-4 Family

     250 
 $4,409  $6,821  $3,485  $4,409 

 

Residential loans secured by 1-41-4 family residential properties in the process of foreclosure totaled $616,000totaled $771,000 and $932,000$616,000 at December 31, 2018 and December 31, 2017, and December 31, 2016, respectively.

 

ActivityActivity relating to OREO owned during the years indicated is as follows:

  

2017

  

2016

  

2015

 
  

(in thousands)

 

OREO Activity

            

OREO as of January 1

 $6,821  $19,214  $46,197 

Real estate acquired

  270   1,273   5,513 

Valuation adjustment write-downs

  (1,963

)

  (1,180

)

  (9,855

)

Net gain (loss) on sale

  74   222   (74

)

Proceeds from sale of properties

  (793

)

  (12,708

)

  (22,567

)

OREO as of December 31

 $4,409  $6,821  $19,214 

 

There was noOREO rental income for the year ended December 31, 2017, compared to $456,000, and $1.3 million for the years ended December 31, 2016, and 2015, respectively.

  

2018

  

2017

  

2016

 
  

(in thousands)

 

OREO Activity

            

OREO as of January 1

 $4,409  $6,821  $19,214 

Real estate acquired

  730   270   1,273 

Valuation adjustment write-downs

  (850

)

  (1,963

)

  (1,180

)

Net gain on sale

  72   74   222 

Proceeds from sale of properties

  (876

)

  (793

)

  (12,708

)

OREO as of December 31

 $3,485  $4,409  $6,821 

 

Expenses related to OREO owned include:

 

2017

  

2016

  

2015

  

2018

  

2017

  

2016

 
 

(in thousands)

  

(in thousands)

 

Net (gain) loss on sales

 $(74

)

 $(222

)

 $74 

Net gain on sales

 $(72

)

 $(74

)

 $(222

)

Valuation adjustment write-downs

  1,963   1,180   9,855   850   1,963   1,180 

Operating expense

  84   583   2,373   90   84   583 

Total

 $1,973  $1,541  $12,302  $868  $1,973  $1,541 

NOTE 6– DEPOSITS

The following table details deposits by category:

  

December 31,

2018

  

December 31,

2017

 
  

(in thousands)

 

Non-interest bearing

 $142,618  $137,386 

Interest checking

  94,269   99,383 

Money market

  171,924   151,388 

Savings

  34,534   34,632 

Certificates of deposit

  450,886   424,235 

Total

 $894,231  $847,024 

 

7873

 

NOTE 6– DEPOSITS

The following table details deposits by category:

  

December 31,

2017

  

December 31,

2016

 
  

(in thousands)

 

Non-interest bearing

 $137,386  $124,395 

Interest checking

  99,383   103,876 

Money market

  151,388   142,497 

Savings

  34,632   34,518 

Certificates of deposit

  424,235   444,639 

Total

 $847,024  $849,925 

Time deposits of $250,000$250,000 or more were approximately $31.7$28.1 million and $29.1$31.7 million at year-end 20172018 and 2016,2017, respectively.

 

Scheduled maturities of total time deposits for each of the next five years are as follows (in thousands):

 

 

Total

  

Total

 

2018

 $204,018 

2019

  178,479 

2020

  27,507 

2021

  5,316 

2022

  8,915 

2019

 $256,745 

2020

  171,043 

2021

  5,639 

2022

  6,523 

2023

  10,936 
 $424,235  $450,886 

 

 

NOTE 7 ADVANCES FROM FEDERAL HOME LOAN BANK

 

At year-end, advances from the Federal Home Loan Bank were as follows:

 

  

2017

  

2016

 
  

(in thousands)

 

Advances with fixed rates from 0.00% to 5.24% and maturities ranging from 2018 through 2033, averaging 1.48% for 2017 and 0.85% for 2016

 $11,797  $22,458 
  

December 31,

  

December 31,

 
  

2018

  

2017

 
  

(in thousands)

 
         

Short term advances (fixed rates 2.47% to 2.52%) maturing January 2019

 $45,000  $10,000 

Long term advances (fixed rates 0.00% to 5.24%) maturing April 2020 to August 2033

  1,549   1,797 

Total advances from the Federal Home Loan Bank

 $46,549  $11,797 

 

FHLB advances had a weighted-average rate of 2.45% at December 31, 2018 and 1.48% at December 31, 2017. Each advance is payable per terms on agreement, with a prepayment penalty. No prepayment penalties were incurred during 20172018 or 2016.2017. The advances were collateralized by approximately $130.9$130.4 million and $124.2$130.9 million of first mortgage loans, under a blanket lien arrangement at year-end 2017December 31, 2018 and 2016, respectively. At December 31, 2017, respectively. At December 31, 2018, our additional borrowing capacity with the FHLB was $79.0$42.7 million.

 

Scheduled principal payments during the next five years and thereafter (in thousands):

 

Advances

  

Advances

 

2018

 $10,200 

2019

  180  $45,172 

2020

  485   471 

2021

  728   719 

2022

  108 

2022

  100 

2023

  59 

Thereafter

  96   28 
 $11,797  $46,549 

 

At year-end 2017,2018, the Company had a $5.0$5.0 million federal funds line of credit available on an unsecured basis from a correspondent institution.

NOTE 8– SUBORDINATED CAPITAL NOTE

The outstanding principal amount of the Bank’s subordinated capital note totaled $2.3 million at December 31, 2017. The note is unsecured, bears interest at the BBA three-month LIBOR floating rate plus 300 basis points, and qualifies as Tier 2 capital until five years before maturity on July 1, 2020. During the final five-year period to maturity, one-fifth of principal amount of the subordinated note is excluded from Tier 2 capital each year and until fully excluded from Tier 2 capital during the year before maturity. Principal payments of $225,000 plus interest are due quarterly. Scheduled principal payments of $900,000 per year are due each of the next two years with $450,000 due thereafter. The interest rate was 4.34% and 3.85% at December 31, 2017 and 2016, respectively.

79

 

 

NOTE 98 – JUNIOR SUBORDINATED DEBENTURES

 

The junior subordinated debentures are redeemable at par prior to maturity at the option of the Company as defined within the trust indenture. The Company has the option to defer interest payments on the junior subordinated debentures from time to time for a period not to exceed 20 consecutive quarters. A deferral period may begin at the Company’s discressiondiscretion so long as interest payments are current. The Company is prohibited from paying dividends on its preferred and common shares when interest payments are in deferral.

 

On April 15, 2016, the Company completed the private placement of 580,000 common shares and 220,000 non-voting common shares to accredited investors resulting in total proceeds of $5.0 million. The investors in the private placement directed a portion of purchase price to pay all deferred interest payments on junior subordinated debentures, bringing our interest payments current through the second quarter of 2016.

On June 29, 2016, the Company notified the trustees of its election to again defer interest payments effective with the third quarter 2016 payment. The deferral period ends after the second quarter of 2021. After 20 consecutive quarters, the Company must pay all deferred distributions to avoid default. Dividends accrued and unpaid on our junior subordinated debentures totaled $1.2$1.2 million at December 31, 2017. In June 2018, the Company paid all deferred interest payments and brought interest current. At December 31, 2018, the Company is current on all interest payments.

74

 

A summarysummary of the junior subordinated debentures is as follows:

 

Description 

Issuance

Date

 Interest Rate (1) 

Junior

Subordinated

Debt Owed

To Trust

 

Maturity

Date (2)

Porter Statutory Trust II

 

2/13/2004

 

3-month LIBOR + 2.85%

 $5,000,000 

2/13/2034

Porter Statutory Trust III

 

4/15/2004

 

3-month LIBOR + 2.79%

  3,000,000 

4/15/2034

Porter Statutory Trust IV

 

12/14/2006

 

3-month LIBOR + 1.67%

  10,000,000 

3/01/2037

Ascencia Statutory Trust I

 

2/13/2004

 

3-month LIBOR + 2.85%

  3,000,000 

2/13/2034

      $21,000,000  

Description

 

Issuance

Date

 

Interest Rate (1)

 

Junior

Subordinated

Debt Owed

To Trust

 

Maturity

Date (2)

Statutory Trust I

 

2/13/2004

 

3-month LIBOR + 2.85%

 $3,000,000 

2/13/2034

Statutory Trust II

 

2/13/2004

 

3-month LIBOR + 2.85%

  5,000,000 

2/13/2034

Statutory Trust III

 

4/15/2004

 

3-month LIBOR + 2.79%

  3,000,000 

4/15/2034

Statutory Trust IV

 

12/14/2006

 

3-month LIBOR + 1.67%

  10,000,000 

3/01/2037

      $21,000,000  

 


(1)(1)

As of December 31,2017, 2018, the 3-month3-month LIBOR was 1.69%2.80%.

(2)(2)

The debentures are callable at ourthe Company’s option at their principal amount plus accrued interest.

 

On September 30, 2015, the Company completed a common equity for debt exchange with holders of $4.0 million of the capital securities (the “Trust Securities”) of Porter Statutory Trust IV, a trust subsidiary of the Company. Accrued and unpaid interest on the Trust Securities totaled of approximately $330,000. In exchange for the $4.3 million debt and interest liability, the Company issued 160,000 common shares and 80,000 non-voting common shares, for a total of 240,000 shares. In the transaction, a wholly owned subsidiary of the Company received a one-third portion of the Trust Securities directly from an unrelated third party in exchange for the issuance of 80,000 common shares resulting in an $883,000 gain on extinguishment of debt. The $883,000 gain was determined based upon the difference in the $560,000 fair value of the common shares issued and the $1.4 million book value of the debt securities and accrued interest thereon tendered to the Company by the unrelated third party on the date of closing. The fair value of the shares issued to the unrelated third party was computed by multiplying the 80,000 shares issued by $7.00 per share, which was the NASDAQ closing price of the Company’s common stock on September 30, 2015. The subsidiary also received two-thirds of the Trust Securities having a book value of $2.9 million from related parties in exchange for the issuance of 80,000 common shares and 80,000 non-voting common shares. In accordance with ASC 470-50-40-2 and SEC Guidance 405-20-40-1.J, the debt and interest liability exchanged with related parties was treated as a capital transaction.

 

NOTE 109 – SENIOR DEBT

 

On June 30, 2017, the Company entered into a $10.0$10.0 million senior secured loan agreement with a commercial bank. The loan matures on June 30, 2022. Interest is payable quarterly at a rate of three-monththree-month LIBOR plus 250 basis points through June 30, 2020, at which time quarterly principal payments of $250,000$250,000 plus interest will commence. The loan is secured by a first priority pledge of 100% of the issued and outstanding stock of the Bank. The Company may prepay any amount due under the promissory note at any time without premium or penalty.

 

The Company contributed $9.0$9.0 million of the borrowing proceeds to the Bank as common equity Tier 1 capital. The remaining $1.0$1.0 million of the borrowing proceeds were retained by the lender in escrow to service quarterly interest payments. At December 31, 2017, 2018, the escrow account had a balance of $806,000.$417,000.

80

 

The loan agreement contains customary representations, warranties, covenants and events of default, including the following financial covenants: (i) the Company must maintain minimum cash on hand of not less than $750,000 through June 30, 2018, and not less than $2,500,000 thereafter,$2,500,000, (ii) the Company must maintain a total risk based capital ratio at least equal to 9%10% of risk-weighted assets, to June 30, 2018, and 10% thereafter, (iii) the Bank must maintain a total risk based capital ratio at least equal to 10%11% of risk-weighted assets, to June 30, 2018, and 11% thereafter, and (iv) non-performing assets of the Bank may not exceed 2.5% of the Bank’s total assets. Both the Company and Bank were in compliance with the covenants as of December 31, 2017.2018.

 

 

NOTE 110 – OTHER BENEFIT PLANS

 

401(401(k) Plan – The Company 401(k)Company's 401(k) Savings Plan allows employees to contribute up to the annual limits as determined by the Internal Revenue Service, which isService. For 2018, the Company matched equal to 50%100% of the first 1% of compensation contributed and 50% of the next 5% contributed by employees. In 2017 and 2016, the Company matched 50% of the first 4% of compensation contributed. The Company, at its discretion, may make an additional contribution.contributions. Total contributions made by the Company to the plan totaled approximately $200,000,$189,000$347,000, $200,000 and $160,000$189,000 in 2018, 20172016 and 2015,2016, respectively.

 

Supplemental Executive Retirement Plan – The Company has a supplemental executive retirement plan covering certain executive officers. Under the plan, the Company pays each participant, or their beneficiary, a specific defined benefit amount over 10 years, beginning with the individual’s retirement or early termination of service for reasons other than cause. A liability is accrued for the obligation under these plans. The expense incurred for the plan was $121,000,$121,000$77,000, $121,000 and $121,000$121,000 for the years ended December 31, 2018, 20172016 and 2015,2016, respectively. The related liability was $1.3$1.3 million at December 31,2017 2018 and 20162017 and is included in other liabilities on the balance sheets.

In January 2018, the Company approved the termination of the plan effective January 31, 2018. As a result of the termination, the plan was liquidated with all benefits paid in a lump sum to the participants on February 1, 2019. No additional expenses were incurred as a result of the plan termination.

 

The Company purchased life insurance on the participants of the plan. The cash surrender value of all insurance policies was $15.2$15.6 million and $14.8$15.2 million at December 31,2017 2018 and 2016,2017, respectively. Income earned from the cash surrender value of life insurance totaled $412,000,$417,000$437,000, $412,000 and $295,000$417,000 for the years ended December 31, 2018, 2017,2016, and 2015,2016, respectively. The income is recorded as other non-interest income.

75

 

 

NOTE 121 – INCOME TAXES

 

ThePrior to 2017, the Company has had a full valuation allowance against its net deferred tax asset since which was established in 2011. The Company’s ability to utilize the net deferred tax asset depends upon generating sufficient future levels of taxable income. The determination to restore a deferred tax asset and eliminate a valuation allowance depends upon the evaluation of both positive and negative evidence regarding the likelihood of achieving sufficient future taxable income levels. During the fourth quarter of 2017, management concluded it was more-likely-than-notmore-likely-than-not the asset would be utilized to reduce future taxes payable related to the future taxable income of the Company, and as such, reversed the valuation allowance. The positive evidence that outweighed the negative evidence evaluated by management in arriving at the conclusion to remove the valuation allowance included, but was not limited to, the following:

positive cumulative pre-tax earnings over the prior three-year period ended December 31, 2017

growth in net interest income, stable non-interest income trends, and lower non-interest expense trends

improvement in asset quality which increases management’s ability to forecast future taxable income and achieve forecasted results

the Company’s net operating loss (“NOLs”) carryforwards do not begin to expire until 2032, and

the Bank’s Consent Order was terminated in the fourth quarter of 2017

As a result of the conclusion to reverse the valuation allowance, the Company recorded an income tax benefit of $54.0$54.0 million for the year ended December 31, 2017.

 

On December 22, 2017, the Tax Cuts and Jobs Act of 2017 was signed into law. Among other significant changes to the tax code, the new law lowered the federal corporate tax rate from 35% to 21% beginning in 2018. As a result, the Company revalued its net deferred tax asset at the new 21% rate. Due to this revaluation, the Company recorded a $20.3$20.3 million charge to income tax expense for the year ended December 31, 2017.

 

The combination of the reversal of the valuation allowance and the change in federal corporate tax rates,, as well as income tax expense for the year, resulted in an income tax benefit of $31.9$31.9 million for the year ended December 31, 2017.

81

 

Income tax expense (benefit) was as follows:

 

2017

  

2016

  

2015

  

2018

  

2017

  

2016

 
 

(in thousands)

  

(in thousands)

 

Current

 $  $21  $  $(346

)

 $  $21 

Deferred

  2,523   2,771   5,258   121   2,523   2,771 

Net operating loss

  (647

)

  (4,009

)

  (5,975

)

  2,255   (647

)

  (4,009

)

Change in federal statutory rate

  20,274            20,274    

Change in valuation allowance

  (54,049

)

  1,238   717      (54,049

)

  1,238 
 $(31,899

)

 $21  $  $2,030  $(31,899

)

 $21 

 

Effective tax rates differ from federal statutory rate of 35%applied to income (loss) before income taxes due to the following:

 

 

2017

  

2016

  

2015

  

2018

  

2017

  

2016

 
 

(in thousands)

  

(in thousands)

 

Federal statutory rate

  21

%

  35

%

  35

%

Federal statutory rate times financial statement income (loss)

 $2,294  $(956

)

 $(1,125

)

 $2,273  $2,294  $(956

)

Effect of:

                        

Valuation allowance

  (54,049

)

  1,238   717 

Valuation allowance

     (54,049

)

  1,238 

Tax-exempt income

  (196

)

  (211

)

  (264

)

  (80

)

  (196

)

  (211

)

Non-taxable life insurance income

  (144

)

  (146

)

  (103

)

Non-taxable life insurance income

  (92

)

  (144

)

  (146

)

Restricted stock vesting

  (121

)

        (115

)

  (121

)

   

Change in federal statutory rate

  20,274            20,274    

Other, net

  43   96   775   44   43   96 

Total

 $(31,899

)

 $21  $  $2,030  $(31,899

)

 $21 

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Table of Contents

 

Year-end deferred tax assets and liabilitiesliabilities were due to the following:

 

 

2017

  

2016

  

2018

  

2017

 
 

(in thousands)

  

(in thousands)

 

Deferred tax assets:

                

Net operating loss carry-forward

 $25,645  $42,094  $23,390  $25,645 

Allowance for loan losses

  1,723   3,139   1,865   1,723 

OREO write-down

  2,432   3,366 

OREO write-down

  2,611   2,432 

Alternative minimum tax credit carry-forward

  692   692   346   692 

Net assets from acquisitions

  358   674   290   358 

Net unrealized loss on securities

  169   867   515   169 

New market tax credit carry-forward

  208   208   208   208 

Nonaccrual loan interest

  271   481   235   271 

Accrued expenses

  172   3,860   239   172 

Deferred compensation

  277   465   267   277 

Other

  241   360   241   241 
  32,188   56,206   30,207   32,188 
                

Deferred tax liabilities:

                

FHLB stock dividends

  557   928   557   557 

Fixed assets

  68   89   94   68 

Deferred loan costs

  152   274   136   152 

Other

  98   866   138   98 
  875   2,157   925   875 

Net deferred tax assets before valuation allowance

  31,313   54,049 

Valuation allowance

     (54,049

)

Net deferred tax asset

 $31,313  $ 

Net deferred tax assets

 $29,282  $31,313 

 

At December 31, 2017,2018, the Company had net operating loss carryforwards ("NOLs"(“NOLs”) of $122.1$111.4 million, which will begin to expire in 2031. As of December 31, 2018, a total of $346,000 in alternative minimum tax credit carry-forward was reclassified to other assets as it is currently refundable for the 2018 tax year.

 

The Company does not have any beginning and ending unrecognized tax benefits.benefits. The Company does not expect the total amount of unrecognized tax benefits to significantly increase or decrease in the next twelve months. There were no interest and penalties recorded in the income statement or accrued for 2017the years ended December 31, 2018 or 2016December 31, 2017 related to unrecognized tax benefits.

 

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UnderUnder Section 382 of the Internal Revenue Code, as amended (“Section 382”), the Company’s net operating loss carryforwards and other deferred tax assets can generally be used to offset future taxable income and therefore reduce federal income tax obligations. However, the Company's ability to use its NOLs would be limited if there was an “ownership change” as defined by Section 382. This would occur if shareholders owning (or deemed to own under the tax rules) 5% or more of the Company's voting and non-voting common shares increase their aggregate ownership of the Company by more than 50 percentage points over a defined period of time.

 

In 2015, the Company took two measures to preserve the value of its NOLs. First, the Company adopted a tax benefits preservation plan designed to reduce the likelihood of an “ownership change” occurring as a result of purchases and sales of the Company's common shares. Upon adoption of this plan, the Company declared a dividend of one preferred stock purchase right for each common share outstanding as of the close of business on July 10, 2015. Any shareholder or group that acquires beneficial ownership of 5% or more of the Company (an “acquiring person”) could be subject to significant dilution in its holdings if the Company's Board of Directors does not approve such acquisition. Existing shareholders holding 5% or more of the Company will not be considered acquiring persons unless they acquire additional shares, subject to certain exceptions described in the plan. In addition, the Board of Directors has the discretion to exempt certain transactions and certain persons whose acquisition of securities is determined by the Board not to jeopardize the Company's deferred tax assets. The rights willplan was extended in May 2018 to expire upon the earlier of (i) June 29, 2018, (ii)30, 2021, (ii) the beginning of a taxable year with respect to which the Board of Directors determines that no tax benefits may be carried forward, (iii) the repeal or amendment of Section 382 or any successor statute, if the Board of Directors determines that the plan is no longer needed to preserve the tax benefits, and (iv) certain other events as described in the plan.

 

On September 23, 2015, the Company’sCompany’s shareholders approved an amendment to its articles of incorporation to further help protect the long-term value of the Company’s NOLs. The amendment provides a means to block transfers of our common shares that could result in an ownership change under Section 382. The transfer restrictions were extended in May 2018 by shareholder vote and will expire on the earlier of (i) SeptemberMay 23, 2018, (ii)2021, (ii) the beginning of a taxable year with respect to which the Board of Directors determines that no tax benefit may be carried forward, (iii) the repeal of Section 382 or any successor statute if our Board determines that the transfer restrictions are no longer needed to preserve the tax benefits of our NOLs, or (iv) such date as the Board otherwise determines that the transfer restrictions are no longer necessary.

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Table of Contents

 

The Company and its subsidiaries are subject to U.S. federal income tax and the Company is subject to incomeincome tax in the Commonwealth of Kentucky. The Company is no longer subject to examination by taxing authorities for years before 2014.2015.

 

 

NOTE 132 – RELATED PARTY TRANSACTIONS

 

Loans to principal officers, directors, significant shareholders, and their affiliates in 20172018 were as follows (in thousands):

 

Beginning balance

 $  $9,400 

New loans

  9,400   7,104 

Repayments

     (2,313

)

Ending balance

 $9,400  $14,191 

 

DepositsDeposits from principal officers, directors, significant shareholders, and their affiliates at year-end 20172018 and 20162017 were $401,000$178,000 and $321,000,$401,000, respectively.

 

Hogan Development Company assists the Bank in onboarding, managing,managing, and selling the Bank’s OREO. Hogan Development Company is owned by W. Glenn Hogan, a director. The agreement with Hogan Development Company is periodically reviewed and evaluated by the Audit Committee. The Bank paid real estate management fees of $20,000$20,000 in both 2018 and $56,000 and2017. The Bank paid no real estate sales and leasing commissions of $6,000in 2018 and $478,000$6,000 to Hogan Development Company in 2017 and 2016, respectively.2017.

 

On April 15, 2016, March 30, 2018, the Company completed a private placement of common stock. In the transaction, the Company issued 150,000 common shares and 1.0 million non-voting common shares to Patriot Financial Partners III, L.P. at $13.00 per share resulting in net proceeds of $14.9 million of which $5.0 million was contributed as capital to the Bank. The balance of proceeds was maintained by the Company for general corporate purposes and to support the growth of the Bank. W. Kirk Wycoff, a director of the Company and Bank, serves as a general partner of Patriot Financial Partners III, L.P.

On June 26, 2018, the Company completed the private placementpurchase and retirement of 580,000 common sharesall of its issued and 220,000 non-voting common shares to accredited investors resultingoutstanding Series E and Series F Non-Voting Perpetual Preferred Shares for an aggregate price of $3.5 million paid in total proceedscash. The Series E and Series F Shares had an aggregate liquidation preference of $5.0$10.5 million. The investorsParticipating sellers in the private placement directed a portiontransaction, among others, were directors W. Glenn Hogan, Michael T. Levy, Dr. Edmond J. Seifried, and Patriot Financial Partners, L.P. and Patriot Financial Partners Parallel, L.P., each affiliates of purchase price to pay all deferred interest payments on junior subordinated debentures, bringing our interest payments current through the second quarter of 2016. The investors included three directors of the Company, including President and CEO John T. Taylor, who purchased common shares on the same terms and conditionsdirector W. Kirk Wycoff. An independent third party financial advisory firm served as the other investors.

83

Tablefinancial advisor in this transaction to a special committee of Contents

directors comprised of members having no interest in the repurchase transaction.

 

NOTE 143 – PREFERRED STOCK

 

TheAt December 31, 2017, the Company has had issued and outstanding 6,198 Series E preferred shares and 4,304 Series F preferred shares, both of which series are were not convertible into common shares, havehad a liquidation preference of $1,000$1,000 per share, and arewere entitled to a 2% noncumulative annual dividend if and when declared. Series E and Series F preferred shares rankranked senior to, and havehad liquidation and dividend preferences over, the common shares and non-voting common shares.

On June 26, 2018, the Company completed the purchase and retirement of all of its issued and outstanding Series E and Series F preferred shares for an aggregate price of $3.5 million paid in cash. The Series E and F shares had an aggregate liquidation preference of $10.5 million. 

 

 

NOTE 154 REGULATORY CAPITAL REQUIREMENTS AND RESTRICTIONS ON RETAINED EARNINGSMATTERS

 

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 result in regulatory action.

 

The final rules implementing Basel Committee on Banking Supervision’sSupervision’s capital guidelines for U.S. Banks (Basel III rules) became effective for the Company and Bank on January 1, 2015 with full compliance with all of the requirements being phased in over a multi-year schedule through January 1, 2019. The final rules allowed banks and their holding companies with less than $250$250 billion in assets a one-timeone-time opportunity to opt-out of a requirement to include unrealized gains and losses in accumulated other comprehensive income in their capital calculation. The Company and the Bank opted out of this requirement. The rules also establish a “capital conservation buffer” of 2.5% above the regulatory minimum risk-based capital ratios. Once the capital conservation buffer is fully phased in, the minimum ratios are a common equity Tier 1 risk-based capital ratio of 7.0%, a Tier 1 risk-based capital ratio of 8.5%, and a total risk-based capital ratio of 10.5%. The capital conservation buffer for 20172018 is 1.25%1.875% and 0.625%1.25% for 2016.2017. An institution is subject to limitations on paying dividends, engaging in share repurchases, and paying discretionary bonuses if capital levels fall below minimum levels plus the buffer amounts. These limitations establish a maximum percentage of eligible retained income that could be utilized for such actions.

The Bank is no longer subject to a consent order with the Federal Deposit Insurance Corporation and Kentucky Department of Financial Institutions. The Bank’s prior consent order was terminated effective October 31, 2017.

On September 21, 2011, the Company entered into a Written Agreement with the Federal Reserve Bank of St. Louis. Pursuant to the Agreement, management made formal commitments to use the Company’s financial and management resources to serve as a source of strength for the Bank and to assist the Bank in addressing weaknesses identified by the FDIC and the KDFI (which has since been terminated), to pay no dividends without prior written approval, to pay no interest or principal on subordinated debentures or trust preferred securities without prior written approval, and to submit an acceptable plan to maintain sufficient capital.

 

8478

 

Management believes as of December 31, 2018, the Company and Bank meet all capital adequacy requirements to which they are subject. At year end 2018 and 2017, the most recent regulatory notifications categorized the Bank as well capitalized under the regulatory framework for prompt corrective action. There are no conditions or events since the notification that management believes have changed the institution’s category.

 

The following tables show the ratios (excluding capital conservation buffer) and amounts of common equity Tier 1, Tier 1 capital, and total capital to risk-adjusted assets and the leverage ratios for Porter Bancorp, Inc. and the Bank at the dates indicated (dollars in thousands):

  

Actual

  

Minimum Requirement

for Capital Adequacy

Purposes

  

Minimum Requirement

to be Well Capitalized

Under Prompt

Corrective Action

Provisions

 
                   
  

Amount

  

Ratio

  

Amount

  

Ratio

  

Amount

  

Ratio

 

As of December 31, 2017:

                        

Total risk-based capital (to risk-weighted assets)

                        

Consolidated

 $83,072   10.55

%

 $63,014   8.00

%

  N/A   N/A 

Bank

  91,305   11.61   62,938   8.00  $78,672   10.00

%

Total common equity Tier 1 risk- based capital (to risk-weighted assets)

                        

Consolidated

  54,535   6.92   35,445   4.50   N/A   N/A 

Bank

  81,393   10.35   35,403   4.50   51,137   6.50 

Tier 1 capital (to risk-weighted assets)

                        

Consolidated

  66,487   8.44   47,260   6.00   N/A   N/A 

Bank

  81,393   10.35   47,203   6.00   62,938   8.00 

Tier 1 capital (to average assets)

                        

Consolidated

  66,487   7.11   37,392   4.00   N/A   N/A 

Bank

  81,393   8.70   37,421   4.00   46,777   5.00 

 

  

Actual

  

Minimum Requirement

for Capital Adequacy

Purposes

  

Minimum Requirement

to be Well Capitalized

Under Prompt

Corrective Action

Provisions

 
                   
  

Amount

  

Ratio

  

Amount

  

Ratio

  

Amount

  

Ratio

 

As of December 31, 2016:

                        

Total risk-based capital (to risk-weighted assets)

                        

Consolidated

 $71,109   10.21

%

 $55,714   8.00

%

  N/A   N/A 

Bank

  68,773   9.88   55,663   8.00  $69,579   10.00

%

Total common equity Tier 1 risk- based capital (to risk-weighted assets)

                        

Consolidated

  36,199   5.20   31,339   4.50   N/A   N/A 

Bank

  57,642   8.28   31,311   4.50   45,226   6.50 

Tier 1 capital (to risk-weighted assets)

                        

Consolidated

  48,713   6.99   41,786   6.00   N/A   N/A 

Bank

  57,642   8.28   41,747   6.00   55,663   8.00 

Tier 1 capital (to average assets)

                        

Consolidated

  48,713   5.27   36,975   4.00   N/A   N/A 

Bank

  57,642   6.24   36,949   4.00   46,186   5.00 
  

Actual

  

Minimum Requirement

for Capital Adequacy

Purposes

  

Minimum Requirement

to be Well Capitalized

Under Prompt

Corrective Action

Provisions

 
  

Amount

  

Ratio

  

Amount

  

Ratio

  

Amount

  

Ratio

 

As of December 31, 2018:

                        

Total risk-based capital (to risk-weighted assets)

 $109,309   12.88

%

 $67,920   8.00

%

 $84,900   10.00

%

Total common equity Tier 1 risk-based capital (to risk-weighted assets)

  100,429   11.83   38,205   4.50   55,185   6.50 

Tier 1 capital (to risk-weighted assets)

  100,429   11.83   50,940   6.00   67,920   8.00 

Tier 1 capital (to average assets)

  100,429   9.60   41,837   4.00   52,297   5.00 

 

N/A: Not applicable. Regulatory framework does not define well capitalized for holding companies.

  

Actual

  

Minimum Requirement

for Capital Adequacy

Purposes

  

Minimum Requirement

to be Well Capitalized

Under Prompt

Corrective Action

Provisions

 
  

Amount

  

Ratio

  

Amount

  

Ratio

  

Amount

  

Ratio

 

As of December 31, 2017:

                        

Total risk-based capital (to risk-weighted assets)

 $91,305   11.61

%

 $62,938   8.00

%

 $78,672   10.00

%

Total common equity Tier 1 risk-based capital (to risk-weighted assets)

  81,393   10.35   35,403   4.50   51,137   6.50 

Tier 1 capital (to risk-weighted assets)

  81,393   10.35   47,203   6.00   62,938   8.00 

Tier 1 capital (to average assets)

  81,393   8.70   37,421   4.00   46,777   5.00 

 

Kentucky banking laws limit the amount of dividends that may be paid to a holding company by its subsidiary banks without prior approval. These laws limit the amount of dividends that may be paid in any calendar year to current year’syear’s net income, as defined in the laws, combined with the retained net income of the preceding two years, less any dividends declared during those periods. In addition, a bank must have positive retained earnings.

85

 

 

NOTE 165 OFF BALANCE SHEET RISKS, COMMITMENTS, AND CONTINGENT LIABILITIES

 

The Company, in the normal course of business, is party to financial instruments with off balance sheet risk. The financial instruments include commitments to extend credit and standby letters of credit. The contract or notional amounts of these instruments reflect the potential future obligations of the Company pursuant to those financial instruments. Creditworthiness for all instruments is evaluated on a case-by-case basis in accordance with the Company’sCompany’s credit policies. Collateral from the client may be required based on the Company’s credit evaluation of the client and may include business assets of commercial clients, as well as personal property and real estate of individual clients or guarantors.

 

An approved but unfunded loan commitment represents a potential credit risk and a liquidity risk, since the Company’sCompany’s client(s) may demand immediate cash that would require funding. In addition, unfunded loan commitments represent interest rate risk as market interest rates may rise above the rate committed to the Company’s client. Since a portion of these loan commitments normally expire unused, the total amount of outstanding commitments at any point in time may not require future funding. Commitments to make loans are generally made for periods of one year or less.

79

 

Standby letters of credit are conditional commitments issued by the Company to guarantee the performance of a client to a third party. The terms and risk of loss involved in issuing standby letters of credit are similar to those involved in issuing loan commitments and extending credit. In addition to credit risk, the Company also has liquidity risk associated with standby letters of credit because funding for these obligations could be required immediately. The Company does not deem this risk to be material. No liability is currently established for standby letters of credit.

 

The following table presents the contractual amounts of financial instruments with off-balance sheet risk for each year

ended:

 

 

2017

  

2016

  

2018

  

2017

 
 

Fixed

Rate

  

Variable

Rate

  

Fixed

Rate

  

Variable

Rate

  

Fixed

Rate

  

Variable

Rate

  

Fixed

Rate

  

Variable

Rate

 
 

(in thousands)

  

(in thousands)

 

Commitments to make loans

 $27,349  $31,412  $19,445  $18,347  $5,317  $11,236  $27,349  $31,412 

Unused lines of credit

  11,034   57,727   7,935   51,407   7,410   73,024   11,034   57,727 

Standby letters of credit

  2,216   373   582   360   541   1,752   2,216   373 

 

Commitments to make loans are generally made for periods of one year or less.

 

InIn connection with the purchase of loan participations, the Bank entered into risk participation agreements, which had notional amounts totaling $19.8$26.6 million at December 31, 2017 2018 and $14.6$19.8 million at December 31, 2016.2017. The risk participation agreements are not designated against specific assets or liabilities under ASC 815, Derivatives and Hedging, and, therefore, do not qualify for hedge accounting. The Company does not use derivatives for trading or speculative purposes but rather as a result of services provided to certain borrowers. The derivatives are recorded in other liabilities on the balance sheet at fair value and changes in fair value of both the borrower and the offsetting swap agreements are recorded (and essentially offset) in non-interest income.

In the normal course of business, the Company and its subsidiaries have been named, from time to time, as defendants in various legal actions. Certain of the actual or threatened legal actions may include claims for substantial compensatory and/or punitive damages or claims for indeterminate amounts of damages.

 

The Company is subject to claims and lawsuits that arise primarily in the ordinary course of business. Litigation is subject to inherent uncertainties and unfavorable rulings could occur. The Company records contingent liabilities resulting from claims against it when a loss is assessed to be probable andcontests liability and/or the amount of damages as appropriate in each pending matter. In view of the loss is reasonably estimable. Accruals are not madeinherent difficulty of predicting the outcome of such matters, particularly in cases where liability is not probableclaimants seek substantial or indeterminate damages or where investigations and proceedings are in the amountearly stages, the Company cannot be reasonably estimated. Assessing probabilitypredict with certainty the loss or range of loss, and estimating probable losses requires analysis of multiple factors, including in some cases judgments aboutif any, related to such matters, how or if such matters will be resolved, when they will ultimately be resolved, or what the potential actions of third party claimants and courts. Recorded contingent liabilities areeventual settlement, or other relief, if any, might be. Subject to the foregoing, the Company believes, based on the best information available and actual losses in any future period are inherently uncertain. Based upon current knowledge and after consultation with counsel, that the Company believesoutcome of such pending legal proceedings or claims should matters will not have a material impactadverse effect on itsthe consolidated financial position or results of operations. However, in lightcondition of the uncertainties involved in such proceedings,Company, although the outcome of a particular matter may such matters could be material to the financial position orCompany’s operating results of operationsand cash flows for a particular reportingfuture period, in the future.

On October 17, 2014, the United States Department of Justice (the “DOJ”) notified the Bank that it was the subject of an investigation into possible violations of federal laws, including,depending on, among other things, possible violations related to false bank entries, bank fraud and securities fraud. The investigation concerns allegations that Bank personnel engaged in practices intended to delay or avoid disclosurethe level of the Bank’s asset quality atCompany’s revenues or income for such period. The Company will accrue for a loss contingency if (1) it is probable that a future event will occur and confirm the timeloss and (2) the amount of and following the United States Treasury’s purchase of preferred shares from theloss can be reasonably estimated. The Company is not currently involved in November 2008. The Bank has cooperated with all requests for information from DOJ. At this time, the DOJ has not indicated whether it intends to pursue any action in this matter.material litigation.

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NOTE 176 – FAIR VALUES

 

FairFair 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. Various valuation techniques are used to determine fair value, including market, income and cost approaches. 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 an entity has the ability to access as of the measurement date, or observable inputs.

 

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, and other inputs that are observable or can be corroborated by observable market data.

 

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

80

 

In certain cases, the inputs used to measure fair value may fall into different levels of the fair value hierarchy. When that occurs, the fair value hierarchy is classified on the lowest level of input that is significant to the fair value measurement. The following methods and significant assumptions are used to estimate fair value.

 

Securities: The fair values of securities available for sale are determined by obtaining quoted prices on nationally recognized securities exchanges, if available. This valuation method is classified as Level 1 in the fair value hierarchy. For securities where quoted prices are not available, fair values are calculated on market prices of similar securities, or matrix pricing, which is a mathematical technique used widely in the industry to value debt securities without relying exclusively on quoted prices for the specific securities but rather by relying on the securities’ relationship to other benchmark quoted securities. Matrix pricing relies on the securities’ relationship to similarly traded securities, benchmark curves, and the benchmarking of like securities. Matrix pricing utilizes observable market inputs such as benchmark yields, reported trades, broker/dealer quotes, issuer spreads, two-sidedtwo-sided markets, benchmark securities, bids, offers, reference data, and industry and economic events. In instances where broker quotes are used, these quotes are obtained from market makers or broker-dealers recognized to be market participants. This valuation method is classified as Level 2 in the fair value hierarchy. For securities where quoted prices or market prices of similar securities are not available, fair values are calculated using discounted cash flows or other market indicators. This valuation method is classified as Level 3 in the fair value hierarchy. Discounted cash flows are calculated using spread to swap and LIBOR curves that are updated to incorporate loss severities, volatility, credit spread and optionality. During times when trading is more liquid, broker quotes are used (if available) to validate the model. Rating agency and industry research reports as well as defaults and deferrals on individual securities are reviewed and incorporated into the calculations.

 

Impaired Loans: An impaired loan is evaluated at the time the loan is identified as impaired and is recorded at fair value less costs to sell. Fair value is measured based on the value of the collateral securing the loan and is classified as Level 3 in the fair value hierarchy. Fair value is determined using several methods. Generally, the fair value of real estate is determined based on appraisals by qualified licensed appraisers. These appraisals may utilize a single valuation approach or a combination of approaches including comparable sales and the 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. These routine adjustments are made to adjust the value of a specific property relative to comparable properties for variations in qualities such as location, size, and income production capacity relative to the subject property of the appraisal. Such adjustments are typically significant and result in a Level 3 classification of the inputs for determining fair value.

 

Management routinely apply an internal discountdiscounts to the value of appraisals used in the fair value evaluation of our impaired loans. The deductions to the appraisal take into account changing business factors and market conditions, as well as potential value impairment in cases where our appraisal date predates a likely change in market conditions. These deductions range from 10% for routine real estate collateral to 25% for real estate that is determined (1) to have a thin trading market or (2) to be specialized collateral. This is in addition to estimated discounts for cost to sell of six to ten percent.

87

 

Management also apply discounts to the expected fair value of collateral for impaired loans where the likely resolution involves litigation or foreclosure. Resolution of this nature generally results in receiving lower values for real estate collateral in a more aggressive sales environment. Discounts ranging from 10% to 33% have been utilized in our impairment evaluations when applicable.

 

Impaired loans are evaluated quarterlyquarterly for additional impairment. Management obtains updated appraisals on properties securing our loans when circumstances are warranted such as at the time of renewal or when market conditions have significantly changed. This determination is made on a property-by-property basis in light of circumstances in the broader economic climate and the assessment of deterioration of real estate values in the market in which the property is located. The first stage of management’s assessment involves management’s inspection of the property in question. Management also engages in conversations with local real estate professionals, investors, and market participants to determine the likely marketing time and value range for the property. The second stage involves an assessment of current trends in the regional market. After thorough consideration of these factors, management will either internally evaluate fair value or order a new appraisal.

 

Other Real Estate Owned (OREO): OREO is evaluated at the time of acquisition and recorded at fair value as determined by independent appraisal or internal evaluation less estimated cost to sell. Quarterly evaluations of OREO for impairment are driven by property type. For smaller dollar single family homes, management consults with staff from the Bank’s special assets group as well as external realtors and appraisers. Based on these consultations, management determines asking prices for OREO properties being marketed for sale. If the internally evaluated fair value or asking price is below the recorded investment in the property, appropriate write-downs are taken.

 

For larger dollar commercial real estate properties, management obtains a new appraisal of the subject property or has staff in the special assets group evaluate the latest in-file appraisal in connection with the transfer to OREO. Management generally obtains updated appraisals within five quarters of the anniversary date of ownership unless a sale is imminent. When an asking price is lowered below the most recent appraised value, appropriate write-downs are taken.

Management routinely applies an internal discount to the value of appraisals used in the fair value evaluation of OREO. The deductions to the appraisal take into account changing business factors and market conditions, as well as potential value impairment in cases where our appraisal date predates a likely change in market conditions. These deductions range from 10% for routine real estate collateral to 25% for real estate that is determined (1) to have a thin trading market or (2) to be specialized collateral. This is in addition to estimated discounts for cost to sell of six to ten percent.

 

8881

 

Financial assets measured at fair value on a recurring basis are summarized below:

 

     

Fair Value Measurements at December 31, 2017 Using

      

Fair Value Measurements at December 31, 2018 Using

 
     

(in thousands)

      

(in thousands)

 

Description

 

Carrying

Value

  

Quoted Prices In

Active Markets for

Identical Assets

(Level 1)

  

Significant Other

Observable Inputs

(Level 2)

  

Significant

Unobservable

Inputs

(Level 3)

  

Carrying

Value

  

Quoted Prices In

Active Markets for

Identical Assets

(Level 1)

  

Significant Other

Observable Inputs

(Level 2)

  

Significant

Unobservable

Inputs

(Level 3)

 

Available for sale securities

                                

U.S. Government and federal agency

 $21,624  $  $21,624  $  $22,560  $  $22,560  $ 

Agency mortgage-backed: residential

  64,965      64,965    

Agency mortgage-backed: residential

  85,990      85,990    

Collateralized loan obligations

  25,505      25,505      49,839      49,839    

State and municipal

  33,710      33,710      32,812      32,812    

Corporate bonds

  6,916      6,916      9,991      9,991    

Total

 $152,720  $  $152,720  $  $201,192  $  $201,192  $ 

 

     

Fair Value Measurements at December 31, 2016 Using

      

Fair Value Measurements at December 31, 2017 Using

 
     

(in thousands)

      

(in thousands)

 

Description

 

Carrying

Value

  

Quoted Prices In

Active Markets for

Identical Assets

(Level 1)

  

Significant Other

Observable Inputs

(Level 2)

  

Significant

Unobservable

Inputs

(Level 3)

  

Carrying

Value

  

Quoted Prices In

Active Markets for

Identical Assets

(Level 1)

  

Significant Other

Observable Inputs

(Level 2)

  

Significant

Unobservable

Inputs

(Level 3)

 

Available for sale securities

                                

U.S. Government and federal agency

 $34,099  $  $34,099  $  $21,624  $  $21,624  $ 

Agency mortgage-backed: residential

  102,353      102,353    

Agency mortgage-backed: residential

  64,965      64,965    

Collateralized loan obligations

  11,203      11,203      25,505      25,505    

State and municipal

  2,045      2,045      33,710      33,710    

Corporate bonds

  3,090      3,090      6,916      6,916    

Total

 $152,790  $  $152,790  $  $152,720  $  $152,720  $ 

 

There were no transfers between Level 1 and Level 2 during 20172018 or 2016.2017.

 

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Financial assets measured at fair value on a non-recurring basis are summarized below:

 

     

Fair Value Measurements at December 31, 2017 Using

      

Fair Value Measurements at December 31, 2018 Using

 
     

(in thousands)

      

(in thousands)

 

Description

 

Carrying

Value

  

Quoted Prices In

Active Markets for

Identical Assets

(Level 1)

  

 

Significant Other

Observable Inputs

(Level 2)

  

Significant

Unobservable

Inputs

(Level 3)

  

Carrying

Value

  

Quoted Prices In

Active Markets for

Identical Assets

(Level 1)

  

 

Significant Other

Observable Inputs

(Level 2)

  

Significant

Unobservable

Inputs

(Level 3)

 

Impaired loans:

                                

Commercial

 $87  $  $  $87  $  $  $  $ 

Commercial real estate:

                                

Construction

                        

Farmland

                        

Nonfarm nonresidential

              124         124 

Residential real estate:

                                

Multi-family

                        

1-4 Family

  957         957   552         552 

Consumer

                        

Agriculture

                        

Other

                        

Other real estate owned, net:

                                

Commercial real estate:

                                

Construction

  4,335         4,335   3,485         3,485 

Farmland

  74         74             

Nonfarm nonresidential

                        

Residential real estate:

                                

Multi-family

                        

1-4 Family

                        

 

     

Fair Value Measurements at December 31, 2016 Using

      

Fair Value Measurements at December 31, 2017 Using

 
     

(in thousands)

      

(in thousands)

 

Description

 

Carrying

Value

  

Quoted Prices In

Active Markets for

Identical Assets

(Level 1)

  

 

Significant Other

Observable Inputs

(Level 2)

  

Significant

Unobservable

Inputs

(Level 3)

  

Carrying

Value

  

Quoted Prices In

Active Markets for

Identical Assets

(Level 1)

  

 

Significant Other

Observable Inputs

(Level 2)

  

Significant

Unobservable

Inputs

(Level 3)

 

Impaired loans:

                                

Commercial

 $87  $  $  $87  $87  $  $  $87 

Commercial real estate:

                                

Construction

                        

Farmland

  585         585             

Nonfarm nonresidential

                        

Residential real estate:

                                

Multi-family

                        

1-4 Family

  1,261         1,261   957         957 

Consumer

                        

Agriculture

  59         59             

Other

                        

Other real estate owned, net:

                                

Commercial real estate:

                                

Construction

  6,571         6,571   4,335         4,335 

Farmland

              74         74 

Nonfarm nonresidential

                        

Residential real estate:

                                

Multi-family

                        

1-4 Family

  250         250             

 

Impaired loans,, which are measured for impairment using the fair value of the collateral for collateral dependent loans, had a carrying amount of $1.3 million,$879,000, with a valuation allowance of $219,000,$203,000, at December 31, 2017, 2018, resulting in no additional provision for loan losses for the year ended December 31, 2017. 2018. At December 31, 2016, 2017, impaired loans had a carrying amount of $2.4$1.3 million, with a valuation allowance of $370,000,$219,000, at December 31, 2016, 2017, resulting in no additional provision for loan losses for the year ended December 31, 2016.2017.

 

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OREO,OREO, which is measured at the lower of carrying or fair value less costs to sell, had a net carrying amount of $4.4$3.5 million as of December 31, 2017, 2018, compared with $6.8$4.4 million at December 31, 2016. 2017. Write-downs of $2.0 million$850,000 and $1.2$2.0 million were recorded on OREO for the years ended December 31, 2018 and 2017, and 2016,respectively.

 

The following table presents qualitative information about level 3 fair value measurements for financial instrumentsassets measured at fair value on a non-recurring basis at December 31, 2017:2018:

 

 

Fair Value

 

Valuation

Technique(s)

 

Unobservable Input(s)

 

Range (Weighted

Average)

 

Fair Value

 

Valuation

Technique(s)

 

Unobservable Input(s)

 

Range (Weighted

Average)

 
 

(in thousands)

          

(in thousands)

          
                         
                         

Impaired loans – Residential real estate

 $957 

Sales comparison approach

 

Adjustment for differences between the comparable sales

  0%-26%(9%) $552 

Sales comparison approach

 

Adjustment for differences between the comparable sales

 0%-26%(11%) 
                        
           

Other real estate owned – Commercial real estate

 $4,409 

Sales comparison approach

 

Adjustment for differences between the comparable sales

  0%-35%(18%) $3,485 

Sales comparison approach

 

Adjustment for differences between the comparable sales

 0%-35%(18%) 
    

Income approach

 

Discount or capitalization rate

 25%(25%)    Income approach Discount or capitalization rate 25% (25%) 

 

The following table presents qualitative information about level 3 fair value measurements for financial instrumentsassets measured at fair value on a non-recurring basis at December 31, 2016:2017:

 

 

Fair Value

 

Valuation

Technique(s)

 

Unobservable Input(s)

 

Range (Weighted

Average)

 

Fair Value

 

Valuation

Technique(s)

 

Unobservable Input(s)

 

Range (Weighted

Average)

 
 

(in thousands)

          

(in thousands)

          
                         
                         

Impaired loans – Residential real estate

 $1,261 

Sales comparison approach

 

Adjustment for differences between the comparable sales

  0%-22%(9%) $957 

Sales comparison approach

 

Adjustment for differences between the comparable sales

 0%-26%(9%) 
                         
           

Other real estate owned – Commercial real estate

 $6,571 

Sales comparison approach

 

Adjustment for differences between the comparable sales

  0%-20%(9%) $4,409 

Sales comparison approach

 

Adjustment for differences between the comparable sales

 0%-35%(18%) 
    Income approach Discount or capitalization rate  18%-20%(19%)    

Income approach

 

Discount or capitalization rate

 25% (25%) 

 

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CarryingCarrying amount and estimated fair values of financial instruments were as follows at year-end 2017:2018:

 

     

Fair Value Measurements at December 31, 2017 Using

      

Fair Value Measurements at December 31, 2018 Using

 
 

Carrying

Amount

  

Level 1

  

Level 2

  

Level 3

  

Total

  

Carrying

Amount

  

Level 1

  

Level 2

  

Level 3

  

Total

 
 

(in thousands)

  

(in thousands)

 

Financial assets

                                        

Cash and cash equivalents

 $34,103  $29,898  $4,205  $  $34,103  $35,361  $35,361  $  $  $35,361 

Securities available for sale

  152,720      152,720      152,720   201,192      201,192      201,192 

Federal Home Loan Bank stock

  7,323   N/A   N/A   N/A   N/A   7,233   N/A   N/A   N/A   N/A 

Loans held for sale

  70      70      70 

Loans, net

  703,913         703,263   703,263   756,364         744,076   744,076 

Accrued interest receivable

  3,136      925   2,211   3,136   3,665      1,222   2,443   3,665 

Financial liabilities

                                        

Deposits

 $847,024  $137,386  $693,320  $  $830,706  $894,231  $142,618  $750,015  $  $892,633 

Federal Home Loan Bank advances

  11,797      11,799      11,799   46,549      46,519      46,519 

Subordinated capital notes

  2,250         2,246   2,246 

Junior subordinated debentures

  21,000         19,090   19,090   21,000         16,226   16,226 

Senior debt

  10,000         10,000   10,000   10,000         9,585   9,585 

Accrued interest payable

  1,475      357   1,118   1,475   658      598   60   658 

 

CarryingCarrying amount and estimated fair values of financial instruments were as follows at year-end 2016:2017:

 

     

Fair Value Measurements at December 31, 2016 Using

      

Fair Value Measurements at December 31, 2017 Using

 
 

Carrying

Amount

  

Level 1

  

Level 2

  

Level 3

  

Total

  

Carrying

Amount

  

Level 1

  

Level 2

  

Level 3

  

Total

 
 

(in thousands)

  

(in thousands)

 

Financial assets

                                        

Cash and cash equivalents

 $66,316  $31,091  $35,225  $  $66,316  $34,103  $34,103  $  $  $34,103 

Securities available for sale

  152,790      152,790      152,790   152,720      152,720      152,720 

Securities held to maturity

  41,818      43,072      43,072 

Federal Home Loan Bank stock

  7,323   N/A   N/A   N/A   N/A   7,323   N/A   N/A   N/A   N/A 

Loans held for sale

  70      70      70 

Loans, net

  630,269         632,528   632,528   703,913         703,263   703,263 

Accrued interest receivable

  3,137      1,203   1,934   3,137   3,136      925   2,211   3,136 

Financial liabilities

                                        

Deposits

 $849,925  $124,395  $712,458  $  $836,853  $847,024  $137,386  $693,320  $  $830,706 

Federal Home Loan Bank advances

  22,458      22,475      22,475   11,797      11,799      11,799 

Subordinated capital notes

  3,150         3,091   3,091   2,250         2,246   2,246 

Junior subordinated debentures

  21,000         13,263   13,263   21,000         19,090   19,090 

Senior debt

  10,000         10,000   10,000 

Accrued interest payable

  734      369   365   734   1,475      357   1,118   1,475 

 

The methods and assumptions used to estimate fair value are described as follows:

(a) Cash and Cash Equivalents

The carrying amounts of cash and short-term instruments approximate fair values and are classified as either Level 1 or Level 2. Noninterest bearing deposits are Level1 whereas interest bearing due from bank accounts and fed funds sold are Level 2.

(b) FHLB Stock

It is not practical to determine the fair value of FHLB stock due to restrictions placed on its transferability.  

(c) Loans, Net

Fair values of loans, excluding loans held for sale, are estimated as follows: For variable rate loans that reprice frequently and with no significant change in credit risk, fair values are based on carrying values resulting in a Level 3 classification. Fair values for other loans are estimated using discounted cash flow analyses, using interest rates currently being offered for loans with similar terms to borrowers of similar credit quality resulting in a Level 3 classification. Impaired loans are valued at the lower of cost or fair value as described previously. The methods utilized to estimate the fair value of loans do financial instruments at December 31, 2017 did not necessarily represent an exit price.

92

Table In accordance with the Company’s adoption of Contents

(d) Loans Held for Sale

TheASU 2016-01 as of January 1, 2018, the methods utilized to measure the fair value of loans held for sale is estimated based upon binding contracts and quotes from third party investors resulting in a Level 2 classification.

(e) Deposits

The fair values disclosed for non-interest bearing deposits are, by definition, equal to the amount payable on demandfinancial instruments at the reporting date resulting in a Level 1 classification. The carrying amountsDecember 31, 2018 represent an approximation of variable rate interest bearing deposits approximate their fair values at the reporting date resulting in a Level 2 classification. Fair values for fixed rate interest bearing deposits are estimated using a discounted cash flows calculation that applies interest rates currently being offered on certificates to a schedule of aggregated expected monthly maturities on time deposits resulting in a Level 2 classification.

(f) Other Borrowings

The fair values of FHLB advances are estimated using discounted cash flow analyses based on the current borrowing rates resulting in a Level 2 classification.

The fair values of subordinated capital notes, junior subordinated debentures, and senior debt are estimated using discounted cash flow analyses based on the current borrowing rates for similar types of borrowing arrangements resulting in a Level 3 classification.

(g) Accrued Interest Receivable/Payable

The carrying amounts of accrued interest approximate fair value resulting in a Level 2 or Level 3 classification based on the level of the asset or liability with which the accrual is associated.exit price; however, an actual exit price may differ.

 

 

NOTE 187 – STOCK PLANS AND STOCK BASED COMPENSATION

 

SharesShares available for issuance under the 20162018 Omnibus Equity Compensation Plan (“2016(“2018 Plan”) total 25,000.322,144. Shares issued to employees under the plan vest annually on the anniversary date of the grant generally over three to four years.

The Company also maintains the Porter Bancorp, Inc. 2006 Non-Employee Directors Stock Ownership Incentive Plan (“2006 Director Plan”) pursuant to which 2,834 shares remain available for issuance as annual awards of restricted stock to the Company’s non-employee directors. Shares issued annually to each non-employee directors have a fair market value of $25,000$25,000 and vest on December 31 in the year of grant.

 

The fair value of the 2017the 2018 unvested shares issued was $365,000,$737,000, or $9.64$13.94 per weighted-average share. The Company recorded $400,000$524,000, $400,000, and $443,000$443,000 of stock-based compensation during 2018, 2017, and 2016, respectively, to salaries and employee benefits. Management expects substantially all of the unvested shares outstanding at the end of the period to vest according to the vesting schedule. A deferred tax benefit of $140,000$110,000 was recognized in 20172018 related to this expense, whereas nocompared to a deferred tax benefit was recognizedof $140,000 in 2017 and no deferred tax benefit in 2016.

85

 

The following table summarizes unvested share activity as of and for the periods indicated for the Stock Incentive Plan:

 

 

Twelve Months Ended

  

Twelve Months Ended

  

Twelve Months Ended

  

Twelve Months Ended

 
 

December 31, 2017

  

December 31, 2016

  

December 31, 2018

  

December 31, 2017

 
     

Weighted

      

Weighted

      

Weighted

      

Weighted

 
     

Average

      

Average

      

Average

      

Average

 
     

Grant

      

Grant

      

Grant

      

Grant

 
 

Shares

  

Price

  

Shares

  

Price

  

Shares

  

Price

  

Shares

  

Price

 

Outstanding, beginning

  179,513  $4.89   184,482  $4.81   142,334  $5.67   179,513  $4.89 

Granted

  37,865   9.64   35,465   9.10   52,856   13.94   37,865   9.64 

Vested

  (73,728

)

  5.75   (38,462

)

  8.32   (78,281

)

  6.75   (73,728

)

  5.75 

Forfeited

  (1,316

)

  9.35   (1,972

)

  6.16         (1,316

)

  9.35 

Outstanding, ending

  142,334  $5.67   179,513  $4.89   116,909  $8.69   142,334  $5.67 

 

Unrecognized stock based compensation expense related to unvested shares for 20182019 and beyond is estimated as follows (in thousands):

 

2018

 $258 

2019

  99 

2020

  25 

2021 & thereafter

   

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2019

 $287 

2020

  213 

2021

  94 

2022 & thereafter

   

 

 

NOTE 1918 – EARNINGS (LOSS) PER SHARE

 

The factors used in the basic and diluted earnings per share computation follow:

 

 

2017

  

2016

  

2015

  

2018

  

2017

  

2016

 
 

(in thousands, except share and per share data)

  

(in thousands, except share and per share data)

 

Net income (loss)

 $38,453  $(2,753

)

 $(3,213

)

 $8,794  $38,453  $(2,753

)

Less:

                        

Earnings (losses) allocated to unvested shares

  967   (88

)

  (122

)

Earnings (losses) allocated to participating preferred shares

        (214

)

Earnings (losses) allocated to unvested shares

  144   967   (88

)

Net income (loss) attributable to common shareholders, basic and diluted

 $37,486  $(2,665

)

 $(2,877

)

 $8,650  $37,486  $(2,665

)

                        

Basic

                        

Weighted average common shares including unvested common shares and participating preferred shares outstanding

  6,249,059   5,980,945   5,191,944   7,159,723   6,249,059   5,980,945 

Less:

                        

Weighted average unvested common shares

  157,127   192,232   197,355   117,030   157,127   192,232 

Weighted average Series B Preferred Shares

        133,269 

Weighted average Series D Preferred Shares

        212,318 

Weighted average common shares outstanding

  6,091,932   5,788,713   4,649,002   7,042,693   6,091,932   5,788,713 

Basic income (loss) per common share

 $6.15  $(0.46

)

 $(0.62

)

 $1.23  $6.15  $(0.46

)

                        

Diluted

                        

Add: Dilutive effects of assumed exercises of common stock warrants

                  

Weighted average common shares and potential common shares

  6,091,932   5,788,713   4,649,002   7,042,693   6,091,932   5,788,713 

Diluted income (loss) per common share

 $6.15  $(0.46

)

 $(0.62

)

 $1.23  $6.15  $(0.46

)

 

The Company had no outstanding stock options at December 31, 2018, 2017 2016or 2015.2016. A warrant for the purchase of 66,113 shares of the Company’s common stock at an exercise price of $79.41$79.41 was outstanding at December 31, 2017 2016and 2015,2016, but was not included in the diluted EPS computation as inclusion would have been anti-dilutive. The warrant expired on November 21, 2018.

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NOTE 19 – REVENUE FROM CONTRACTS WITH CUSTOMERS

The Company adopted ASC 606 using the full retrospective method. The adoption of ASC 606 for in-scope revenue streams did not result in a cumulative effect adjustment. Bank card interchange income and expenses were previously reported net in non-interest income. The income statement impact of adopting ASC 606 resulted in a reclassification adjustment of $549,000 and $454,000 related to the year ended December 31, 2017 and 2016, respectively, between bank card interchange income and deposit account related expense in order to report debit card interchange income gross and provide a comparable disclosure for all periods. This reclassification adjustment had no impact on previously reported net income for the year ended December 31, 2017 or 2016.

All of the Company’s revenue from customers in the scope of ASC 606 is exercisablerecognized within non-interest income. A description of the Company’s revenue streams accounted for 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 use fees, stop payment charges, statement rendering, and ACH fees, are recognized at the holder’s optiontime 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 over which the Company satisfies the performance obligation. Overdraft fees are recognized at the point in time that the overdraft occurs. Service charges are withdrawn from the customer’s account balance.

Bank Card Interchange Income: The Company earns interchange fees from bank cardholder transactions conducted through November 21, 2018.a third party 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. Prior to adopting ASC 606, the Company reported bank card interchange fees net of expenses. Under ASC 606, bank card interchange fees are reported gross.

Gains/Losses on Sales of OREO: The Company records a gain or loss from the sale of OREO 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 OREO to the buyer, the Company assess 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 OREO asset is derecognized and the gain or loss on sale is recorded upon 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. Gains and losses on sales of OREO are netted with OREO expense and reported in non-interest expense.

Other Non-interest Income: Other non-interest income includes revenue from several sources that are within the scope of ASC 606, including title insurance commissions, income from secondary market loan sales, gains on sales of premises and equipment, and other transaction-based revenue that is individually immaterial. Other non-interest income included approximately $660,000, $666,000, and $678,000 of revenue for the years ended December 31, 2018, 2017, and 2016, respectively, within the scope of ASC 606. The remaining other non-interest income for the year is excluded from the scope of ASC 606.

87

 

 

NOTE 2020 – PARENT COMPANY ONLY CONDENSED FINANCIAL INFORMATION

 

Condensed financial information of PorterLimestone Bancorp Inc. is presented as follows:

 

CONDENSED BALANCE SHEETS

December31,

 December 31, 
 

2017

  

2016

  

2018

  

2017

 
 

(in thousands)

  

(in thousands)

 

ASSETS

                

Cash and cash equivalents (1)

 $2,045  $2,048  $5,369  $2,045 

Investment in banking subsidiary

  99,651   51,528   114,042   99,651 

Investment in and advances to other subsidiaries

  776   776   776   776 

Deferred taxes, net

  2,497    

Deferred taxes, net

  3,142   2,497 

Other assets

  711   645   682   711 

Total assets

 $105,680  $54,997  $124,011  $105,680 
                

LIABILITIES AND SHAREHOLDERS’ EQUITY

        

LIABILITIES AND SHAREHOLDERS’ EQUITY

        

Debt

 $31,775  $21,775  $31,775  $31,775 

Accrued expenses and other liabilities

  1,232   489   139   1,232 

Shareholders’ equity

  72,673   32,733 

Total liabilities and shareholders’ equity

 $105,680  $54,997 

Shareholders’ equity

  92,097   72,673 

Total liabilities and shareholders’ equity

 $124,011  $105,680 

 


(1)(1)

$806,000417,000 is held in escrow by the senior note lender to be used exclusively for interest payments on senior debt.

 

CONDENSED STATEMENTS OF OPERATIONS

  Years ended December 31, 
  

2018

  

2017

  

2016

 
  

(in thousands)

 

Interest income

 $45  $4  $5 

Dividends from subsidiaries

  35   26   23 

Other income

  38      17 

Interest expense

  (1,370

)

  (973

)

  (694

)

Other expense

  (1,290

)

  (1,137

)

  (1,240

)

Loss before income tax and undistributed subsidiary income

  (2,542

)

  (2,080

)

  (1,889

)

Income tax expense (benefit)

  (645

)

  (2,497

)

  21 

Equity in undistributed subsidiary income (loss)

  10,691   38,036   (843

)

Net income (loss)

 $8,794  $38,453  $(2,753

)

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CONDENSED STATEMENTS OF OPERATIONS

Years ended December31,

  

2017

  

2016

  

2015

 
  

(in thousands)

 

Interest income

 $4  $5  $46 

Dividends from subsidiaries

  26   23   20 

Other income

     17   102 

Interest expense

  (973

)

  (694

)

  (647

)

Other expense

  (1,137

)

  (1,240

)

  (1,457

)

Income (loss) before income tax and undistributed subsidiary income

  (2,080

)

  (1,889

)

  (1,936

)

Income tax expense (benefit)

  (2,497

)

  21    

Equity in undistributed subsidiary income (loss)

  38,036   (843

)

  (1,277

)

Net income (loss)

 $38,453  $(2,753

)

 $(3,213

)

CONDENSED STATEMENTS OF CASH FLOWS

Years ended December31,

  

2017

  

2016

  

2015

 
  

(in thousands)

 

Cash flows from operating activities

            

Net income (loss)

 $38,453  $(2,753

)

 $(3,213

)

Adjustments:

            

Equity in undistributed subsidiary (income) loss

  (38,036

)

  843   1,277 

Deferred taxes, net

  (2,497

)

      

Gain on sale of assets

        (70

)

Change in other assets

  743   (95

)

  (40

)

Change in other liabilities

  (128

)

  358   634 

Other

  462   978   481 

Net cash (used in) operating activities

  (1,003

)

  (669

)

  (931

)

             

Cash flows from investing activities

            

Investments in subsidiaries

  (9,000

)

  (500

)

   

Sales of securities

        642 

Net cash (used in) from investing activities

  (9,000

)

  (500

)

  642 
             

Cash flows from financing activities

            

Proceeds from issuance of common stock

     2,231    

Proceeds from senior debt

  10,000       

Net cash (used in) financing activities

  10,000   2,231    
             

Net change in cash and cash equivalents

  (3

)

  1,062   (289

)

Beginning cash and cash equivalents

  2,048   986   1,275 

Ending cash and cash equivalents

 $2,045  $2,048  $986 

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  Years ended December 31, 
  

2018

  

2017

  

2016

 
  

(in thousands)

 

Cash flows from operating activities

            

Net income (loss)

 $8,794  $38,453  $(2,753

)

Adjustments:

            

Equity in undistributed subsidiary (income) loss

  (10,691

)

  (38,036

)

  843 

Deferred taxes, net

  (645

)

  (2,497

)

   

Change in other assets

  29   743   (95

)

Change in other liabilities

  (1,093

)

  (128

)

  358 

Other

  525   462   978 

Net cash (used in) operating activities

  (3,081

)

  (1,003

)

  (669

)

             

Cash flows from investing activities

            

Investments in subsidiaries

  (5,000

)

  (9,000

)

  (500

)

Net cash (used in) from investing activities

  (5,000

)

  (9,000

)

  (500

)

             

Cash flows from financing activities

            

Proceeds from issuance of common stock

  14,910      2,231 

Redemption of preferred stock

  (3,505

)

      

Proceeds from senior debt

     10,000    

Net cash provided by (used in) from financing activities

  11,405   10,000   2,231 
             

Net change in cash and cash equivalents

  3,324   (3

)

  1,062 

Beginning cash and cash equivalents

  2,045   2,048   986 

Ending cash and cash equivalents

 $5,369  $2,045  $2,048 

 

 

NOTE 21 – QUARTERLY FINANCIAL DATA (UNAUDITED)

 

 

                     

Earnings (Loss)

Per Common Share

                      

Earnings (Loss)

Per Common Share

 
 

Interest

Income

  

Net Interest

Income

  

Provision

For

Loan Losses

  

OREO

Expense

  

Net

Income

(Loss)

  

Basic (1)

  

Diluted (1)

  

Interest

Income

  

Net Interest

Income

  

Negative Provision

For

Loan Losses

  

OREO

Expense

  

Net

Income

(Loss)

  

Basic (1)

  

Diluted (1)

 
 

(in thousands, except per share data)

 

2018

                            

First quarter

 $10,015  $8,181  $  $82  $1,934  $0.31  $0.31 

Second quarter

  10,585   8,374   (150

)

  237   1,983   0.27   0.27 

Third quarter

  11,120  $8,412  $(350

)

 $271  $2,437  $0.33  $0.33 

Fourth quarter

  11,741   8,704      278   2,440   0.33   0.33 
 

(in thousands, except per share data)

                             

2017

                                                        

First quarter

 $9,225  $7,741  $  $(16

)

 $1,680  $0.27  $0.27  $9,225  $7,741  $  $(16

)

 $1,680  $0.27  $0.27 

Second quarter

  9,134   7,588      (3

)

  1,709   0.27   0.27   9,134   7,588      (3

)

  1,709   0.27   0.27 

Third quarter

  9,446   7,787      111   1,794   0.29   0.29   9,446   7,787      111   1,794   0.29   0.29 

Fourth quarter

  9,717   8,001   (800

)

  1,881   33,270 (2) 5.31   5.31   9,717   8,001   (800

)

  1,881   33,270(2)  5.31   5.31 
                            

2016

                            

First quarter

 $9,185  $7,651  $(550

)

 $668  $1,480  $0.27  $0.27 

Second quarter

  8,705   7,196   (600

)

  294   1,012   0.17   0.17 

Third quarter

  8,931   7,458   (750

)

  322   1,393   0.22   0.22 

Fourth quarter

  8,781   7,316   (550

)

  257   (6,638

)

(3) (1.07

)

  (1.07

)

 

 

 

(1)(1)

The sum of the quarterly net income (loss) per share (basic and diluted) differs from the annual net income (loss) per share (basic and diluted) because of the differences in the weighted average number of common shares outstanding and the common shares used in the quarterly and annual computations as well as differences in rounding.

 

 

(2)(2)

Net income for the fourth quarter of 2017 was impacted by the reversal of the Company’sCompany’s deferred tax asset valuation allowance and the change in federal corporate tax rates in connection with the enectmentenactment of the Tax Cuts and Jobs Act of 2017. The net result of these two items, as well as tax expense for the year, was an income tax benefit of $31.9$31.9 million.

(3)

The $6.6 million loss for the fourth quarter of 2016 was due to the $8.0 million in litigation expenses accrued as a result of the Kentucky Court of Appeals ruling against the Bank.

 

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Item 9.Changes in and Disagreements With Accountants on Accounting and Financial Disclosure

Changes in and Disagreements With Accountants on Accounting and Financial Disclosure

 

None

 

Item 9A.

Controls and Procedures

 

Disclosure Controls and Procedures

Management is responsible for establishing and maintaining effective disclosure controls and procedures, as defined under Rules 13a-15(e) and 15d-15(e) of the Securities Exchange Act of 1934. Our management, under the supervision and with the participation of our Chief Executive Officer and our Chief Financial Officer, evaluated the effectiveness of the design and operation of our disclosure controls and procedures as of December 31, 2017.2018. Based on that evaluation, management believes that our disclosure controls and procedures were effective to collect, process, and disclose the information required to be disclosed in the reports filed withor submitted under the SECSecurities Exchange Act of 1934 within the required time periods as of the end of the period covered by this report.

 

There was no change in the internal control over financial reporting during the most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.

 

Management’sInternal Control over Financial Reporting

Management’s Report on Internal ControlControls Over Financial Reporting and the Report of Independent Registered Public Accounting Firm included in Item 8 of this report are incorporated herein by reference.

 

The management of Porter Bancorp, Inc. is responsible for establishing and maintaining adequate internal control over financial reporting. Internal control over financial reporting is defined in Rule 13a-15(f) promulgated under the Securities Exchange Act of 1934 as a process designed by, or under the supervision of; the principal executive and principal financial officers and effected by the board of directors, management and other personnel, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with U.S. generally accepted accounting principles and includes those policies and procedures that:

Pertain to the maintenance of records that in reasonable detail accurately and fairly reflect the transactions and dispositions of our assets;

Provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with U.S. generally accepted accounting principles, and that our receipts and expenditures are being made only in accordance with authorizations of our management and directors; and

Provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of our assets that could have a material effect on the financial statements.

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

Management assessed the effectiveness of our internal control over financial reporting as of December 31, 2017. In making this assessment, management used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission ("COSO") in the 2013 Internal Control-Integrated Framework. Based on that assessment, management believes that, as of December 31, 2017, our internal control over financial reporting is effective based on those criteria.

This annual report does not include an attestation report of our registered public accounting firm regarding internal controls over financial reporting. Management’s report was not subject to attestation by our registered public accounting firm pursuant to rules of the Securities and Exchange Commission that permit us to provide only management’s report in this annual report.

/s/ John T. Taylor

John T. Taylor

President and Chief Executive Officer

/s/ Phillip W. Barnhouse

Phillip W. Barnhouse

Chief Financial Officer

Item 9B.     Other Information

Other Information

 

None

 

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PART III

 

Item 10. Directors, Executive Officers and Corporate Governance.

Directors, Executive Officers and Corporate Governance.

 

The Company has adopted a code of ethics applicable to the Chief Executive Officer and the senior financial officers, which is posted on the Bank’s website at http://www.limestonebank.com under the Investors Relations section of the AboutUs tab.tab. If we amendthe Company amends or waivewaives any of the provisions of the Code of Ethics applicable to ourits Chief Executive Officer or senior financial officers, we intendmanagement intends to disclose the amendment or waiver on our website. WeThe Company will provide to any person without charge, upon request, a copy of this Code of Ethics. You can request a copy by contacting PorterLimestone Bancorp, Inc., Chief Financial Officer, 2500 Eastpoint Parkway, Louisville, Kentucky, 40223, (telephone) 502-499-4800.

 

Additional information required by this Item 10 is omitted because we are filing a definitive proxy statement pursuant to Regulation 14A on or before April 30, 2018,2019, which includes the required information. The required information contained in our proxy statement under the headings “Proposal 1: Election of Directors,” “Corporate Governance,” and “Certain Relationships and Related Transactions – Section 16(a) Beneficial Ownership Reporting Compliance” is incorporated herein by reference.

 

Item 11. Executive Compensation.

Executive Compensation.

 

The information required by this Item 11 is omitted because we are filing a definitive proxy statement pursuant to Regulation 14A on or before April 30, 2018,2019, which includes the required information. The required information contained in our proxy statement under the headings “Corporate Governance,” “Compensation Discussion and Analysis,” “Executive Compensation,” and “Compensation Committee Report” is incorporated herein by reference.

 

Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters

Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters

 

TheCertain information required by this Item 12 is omitted because we are filing a definitive proxy statement pursuant to Regulation 14A on or before April 30, 2018,2019, which includes the required information. The required information contained in our proxy statement under the heading “Stock Ownership of Directors, Officers, and Principal Shareholders” is incorporated herein by reference.

 

Certain information required by this Item 13. Certain Relationships12 appears under the heading “Equity Compensation Plan Information” in Item 5 of this report and Related Transactions, and Director Independence. is incorporated herein by reference.

Item 13.

Certain Relationships and Related Transactions, and Director Independence.

 

The information required by this Item 13 is omitted because we are filing a definitive proxy statement pursuant to Regulation 14A on or before April 30, 2018,2019, which includes the required information. The required information contained in our proxy statement under the headings “Corporate Governance” and “Certain Relationships and Related Transactions” is incorporated herein by reference.

 

Item 14. Principal Accounting Fees and Services.

Principal Accounting Fees and Services.

 

The information required by this Item 14 is omitted because we are filing a definitive proxy statement pursuant to Regulation 14A on or before April 30, 2018,2019, which includes the required information. The required information contained in our proxy statement under the heading “Principal Accountant Fees and Services” is incorporated herein by reference.

 

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PART IV

 

Item 15.

Exhibits and Financial Statement Schedules

(a) 1.

The following financial statements are included in this Form 10-K:

  

 

Consolidated Balance Sheets as of December 31, 20172018 and 20162017

 

Consolidated Statements of Operations for the Years Ended December 31, 2018, 2017, 2016, and 20152016

 

Consolidated Statements of Comprehensive Income (Loss) for the Years Ended December 31, 2018, 2017, 2016, and 20152016

 

Consolidated Statements of Change in StockholdersStockholders’ Equity for the Years Ended December 31, 2018, 2017, 2016, and 20152016

 

Consolidated Statements of Cash Flows for the Years Ended December 31, 2018, 2017, 2016, and 20152016

 

Notes to Consolidated Financial Statements

 

Report of Independent Registered Public Accounting Firm

  

(a) 2.

List of Financial Statement Schedules

  

 

Financial statement schedules are omitted because the information is not applicable.

  

(a) 3.

List of Exhibits

  

 

The Exhibit Index of this report is incorporated by reference. The compensatory plans or arrangement required to be filed as exhibits to this Form 10-K pursuant to Item 15(c) are noted with an asterisk in the Exhibit Index.

 

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EXHIBIT INDEX

Exhibit No. (1)

 

Description

 

3.1

 

Amended and Restated Articles of Incorporation dated March 25, 2016.of the Company, restated to reflect amendments. Exhibit 3.1 to Form 8-K10-Q filed May 26, 2016August 2, 2018 is incorporated by reference.

   
  3.2

3.3

 

Amendment to ArticlesAmended and Restated Bylaws of Incorporation,Limestone Bancorp, Inc. dated December 6, 2016, effecting reverse stock split.June 18, 2018. Exhibit 3.13.2 to Form 8-K filed December 21, 2016June 6, 2018 is hereby incorporated by reference.

   
  3.3

4.1

 

AmendedTax Benefits Preservation Plan, dated as of June 25, 2015, between the Company and Restated Bylaws of Porter Bancorp, Inc.American Stock Transfer Company, as Rights Agent. Exhibit 3.1 to Form 8-K filed May 22, 2013June 29, 2015 is hereby incorporated by reference.

   
  4.1

4.2

 

WarrantAmendment No. 1 to purchase upthe Tax Benefits Preservation Plan, dated August 4, 2015. Exhibit 4.2 to 299,829 shares.  Exhibit 4.1 tothe Quarterly Report on Form 8-K10-Q filed November 24, 2008August 5, 2015 is incorporated by reference.

   
10.1

4.3

 

Amendment No. 2 to the Tax Benefits Preservation Plan dated May 23, 2018. Exhibit 4 to the Form 8-K filed May 23, 2018 is incorporated by reference.

10.1

Loan Agreement between PorterLimestone Bancorp, Inc. and First Merchants Bank dated June 30, 2017. Exhibit 1.1 to Form 8-K filed July 5, 2017 is incorporated by reference.

   

10.2

 

Promissory Note between PorterLimestone Bancorp, Inc. and First Merchants Bank dated June 30, 2017. Exhibit 1.2 to Form 8-K filed July 5, 2017 is incorporated by reference.

   

10.3

 

Pledge Agreement between PorterLimestone Bancorp, Inc. and First Merchants Bank dated June 30, 2017. Exhibit 1.3 to Form 8-K filed July 5, 2017 is incorporated by reference.

   

10.4+

 

PorterLimestone Bancorp, Inc. 2016 Omnibus Equity Compensation Plan. Appendix A to Schedule 14A proxy statement (DEF 14A) filed April 25, 2016 is incorporated by reference.

   

10.5+

 

Form of PorterLimestone Bancorp, Inc. Restricted Stock Award Agreement. Exhibit 10.3 to 8-K filed June 22, 2016 is incorporated by reference.

   

10.6+

 

PorterLimestone Bancorp, Inc. 2006 Non-Employee Directors Stock Ownership Incentive Plan, as amended and restated as of March 26, 2014. Exhibit 10.1 to Form S-8 Registration Statement (Reg. No. 333-202746) filed March 13, 2015 is incorporated by reference.

   

10.7+

 

Non-Employee Director Stock Incentive Program.  Exhibit 10.1 to Form 8-K filed June 22, 2016 is incorporated by reference.

10.8+PorterLimestone Bancorp, Inc. 2017 Incentive Compensation Bonus Plan. Exhibit 10.1 to Form 10-Q filed May 4, 2017 is incorporated by reference.

   
10.9+

10.8+

 

Form of Ascencia Bank (now Limestone Bank) Supplemental Executive Retirement Plan. Exhibit 10.5 to Form S-1 Registration Statement (Reg. No. 333-133198) filed April 11, 2006 is incorporated by reference.

   
10.10+

10.9+

 

Form of Amendment to Supplemental Executive Retirement Plan. Exhibit 10.7 to Form 10-K filed March 26, 2009 is incorporated by reference.

   
10.11+

10.10+

 

Limestone Bancorp, Inc. 2018 Omnibus Equity Compensation Plan, Appendix B to Schedule 14A Proxy Statement (DEF 14A) filed April 13, 2018 is incorporated by reference.

10.11+

Form of Restricted Stock Award Agreement

10.12+

Employment Agreement with John T. Taylor. Exhibit 10.1 to Form 8-K filed September 27, 2016 is incorporated by reference.

   
10.12+

10.13+

 

Employment Agreement with John R. Davis. Exhibit 10.2 to Form 8-K filed September 27, 2016 is incorporated by reference.

   
10.13+

10.14+

 

Employment Agreement with Joseph C. Seiler. Exhibit 10.3 to Form 8-K filed September 27, 2016 is incorporated by reference.

   
10.14+

10.15+

 

Employment Agreement with Phillip W. Barnhouse. Exhibit 10.4 to Form 8-K filed September 27, 2016 is incorporated by reference.

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Exhibit No. (1)Description
   
21.1

10.16

 

ListSecurities Purchase Agreement, dated March 30, 2018, between Limestone Bancorp, Inc. and Patriot Financial Partners III, L.P., incorporated by reference to exhibit 10.1 of Subsidiaries of Porter Bancorp, Inc.the Current Report on Form 8-K dated March 30, 2018.

   
23.1

10.17

 

ConsentRegistration Rights Agreement, dated March 30, 2018, between Limestone Bancorp, Inc. and Patriot Financial Partners III, L.P., incorporated by reference to Exhibit 10.2 of Crowe Horwath LLP, Independent Registered Public Accounting Firm.the Current Report on Form 8-K dated March 30, 2018.

   
31.1

10.18

 

Offer to Purchase Issued and Outstanding Series E Preferred Shares and Series F Preferred Shares dated June 25, 2018. Exhibit 10.1 to Form 8-K filed June 27, 2018 is incorporated by reference

21.1

List of Subsidiaries of Limestone Bancorp, Inc.

23.1

Consent of Crowe LLP, Independent Registered Public Accounting Firm.

31.1

Certification of Chief Executive Officer pursuant to Exchange Act Rules 13a-14 or 15d-14.

   

31.2

 

Certification of Chief Financial Officer pursuant to Exchange Act Rules 13a-14 or 15d-14.

   

32.1

 

Certification of Chief Executive Officer pursuant to Exchange Act Rules 13a-14(b) or 15d-14(b) and 18 U.S.C. Section 1350.

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Exhibit No. (1)Description
   

32.2

 

Certification of Chief Financial Officer pursuant to Exchange Act Rules 13a-14(b) or 15d-14(b) and U.S.C. Section 1350.

   

101

 

The following financial statements from the Company’sCompany’s Annual Report on Form 10-K for the year ended December 31, 2017,2018, formatted in XBRL: (i) Consolidated Balance Sheets, (ii) Consolidated Statements of Operations, (iii) Consolidated Statements of Comprehensive Income, (iv) Consolidated Statements of Changes in Stockholders’ Equity, (v) Consolidated Statements of Cash Flows, (vi) Notes to Consolidated Financial Statements.

 


+

Management contract or compensatory plan or arrangement.

(1)

The Company has other long-term debt agreements that meet the exclusion set forth in Section 601(b)(4)(iii)(A) of Regulation S-K. The Company hereby agrees to furnish a copy of such agreements to the Securities and Exchange Commission upon request.

 

Item 16.   Form 10-K Summary

None

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SIGNATURESSIGNATURES

 

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

 

 

PORTERLIMESTONE BANCORP, INC.

   

February 28, 2018March 8, 2019

By:

/s/ John T. Taylor

 

 

John T. Taylor

 

 

Chief Executive Officer

 

Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities indicated.

 

/s/ John T. Taylor

Chief Executive Officer

February 28, 2018 March 8, 2019

John T. Taylor  
   

/s/ Phillip W. Barnhouse

Chief Financial Officer

February 28, 2018March 8, 2019

Phillip W. Barnhouse  
   

/s/ W. Glenn Hogan

Director

February 28, 2018March 8, 2019

W. Glenn Hogan  
   

/s/ Michael T. Levy

Director

February 28, 2018March 8, 2019

Michael T. Levy  
   

/s/ Bradford T. Ray

Director

February 28, 2018March 8, 2019

Bradford T. Ray

  
   

/s/ W. Kirk Wycoff

Director

February 28, 2018March 8, 2019

W. Kirk Wycoff

  

  

/s/ James M. Parsons

Director

February 28, 2018March 8, 2019

James M. Parsons  
   

/s/ Dr. Edmond J. Seifried

Director

February 28, 2018March 8, 2019

Dr. Edmond J. Seifried  

/s/ Celia P. Catlett

Director

March 8, 2019

Celia P. Catlett

 

10295