Table of Contents

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

xQUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED SEPTEMBERJUNE 30, 20172018
o
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE  ACT OF 1934 FOR THE TRANSITION PERIOD FROM             TO             .

Commission file number: 000-32897

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

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

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

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

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a small reporting company, or an emerging growth company. See the definitions of "large accelerated filer," "accelerated filer," "smaller reporting company," and "emerging growth company" in Rule 12b-2 of the Exchange Act.
 Large accelerated filer o
Accelerated filer ox
Non-accelerated filer o
Small reporting company xo

Emerging growth company o

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

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

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

Common Stock, no par value
(Title of Class)

Shares outstanding as of OctoberJuly 31, 20172018: 16,885,61516,901,618

TABLE OF CONTENTS

Facing Page

Table of Contents


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

PART I. Financial Information


United Security Bancshares and Subsidiaries
Consolidated Balance Sheets – (unaudited)
SeptemberJune 30, 20172018 and December 31, 20162017
(in thousands except shares)September 30, 2017 December 31, 2016June 30, 2018 December 31, 2017
Assets      
Cash and non-interest bearing deposits in other banks$22,688
 $25,781
$29,939
 $35,237
Cash and due from Federal Reserve Bank137,204
 87,251
Due from Federal Reserve Bank ("FRB")161,189
 72,697
Cash and cash equivalents159,892
 113,032
191,128
 107,934
Interest-bearing deposits in other banks654
 650
Investment securities available for sale (at fair value)48,356
 57,491
Investment securities (at fair value)   
Available for sale ("AFS") securities56,724
 41,985
Marketable equity securities3,659
 3,737
Total investment securities60,383
 45,722
Loans582,384
 569,759
573,996
 601,351
Unearned fees and unamortized loan origination costs, net1,217
 1,075
355
 1,039
Allowance for credit losses(9,158) (8,902)(8,425) (9,267)
Net loans574,443
 561,932
565,926
 593,123
Accrued interest receivable5,846
 3,895
8,392
 6,526
Premises and equipment – net10,469
 10,445
10,041
 10,165
Other real estate owned5,745
 6,471
5,745
 5,745
Goodwill4,488
 4,488
4,488
 4,488
Cash surrender value of life insurance19,447
 19,047
19,803
 19,752
Investment in limited partnerships1,715
 757
1,592
 1,601
Deferred tax assets - net3,423
 3,298
2,616
 2,389
Other assets9,029
 6,466
9,354
 8,391
Total assets$843,507
 $787,972
$879,468
 $805,836
      
Liabilities & Shareholders' Equity 
  
 
  
Liabilities 
  
 
  
Deposits 
  
 
  
Noninterest bearing$315,877
 $262,697
$281,686
 $307,299
Interest bearing409,421
 413,932
475,277
 380,394
Total deposits725,298
 676,629
756,963
 687,693
      
Accrued interest payable41
 76
43
 44
Accounts payable and other liabilities7,526
 5,781
7,121
 7,017
Junior subordinated debentures (at fair value)9,534
 8,832
10,125
 9,730
Total liabilities742,399
 691,318
774,252
 704,484
      
Shareholders' Equity 
  
 
  
Common stock, no par value 20,000,000 shares authorized, 16,885,615 issued and outstanding at September 30, 2017, and 16,705,594 at December 31, 201657,861
 56,557
Common stock, no par value 20,000,000 shares authorized, 16,901,618 issued and outstanding at June 30, 2018, and 16,885,615 at December 31, 201758,309
 57,880
Retained earnings43,615
 40,701
46,025
 44,182
Accumulated other comprehensive loss(368) (604)
Accumulated other comprehensive income (loss)882
 (710)
Total shareholders' equity101,108
 96,654
105,216
 101,352
Total liabilities and shareholders' equity$843,507
 $787,972
$879,468
 $805,836

United Security Bancshares and Subsidiaries
Consolidated Statements of Income
(Unaudited)
 
Quarter Ended September 30, Nine Months Ended September 30,Quarter Ended June 30, Six Months Ended June 30,
(In thousands except shares and EPS)2017 2016 2017 20162018 2017 2018 2017
Interest Income:              
Loans, including fees$7,978
 $7,435
 $22,782
 $20,722
$7,491
 $7,579
 $15,717
 $14,804
Investment securities – AFS – taxable238
 244
 691
 618
265
 229
 457
 453
Interest on deposits in FRB375
 72
 858
 348
681
 301
 1,065
 484
Interest on deposits in other banks1
 2
 4
 6

 1
 
 2
Total interest income8,592
 7,753
 24,335
 21,694
8,437
 8,110
 17,239
 15,743
       
Interest Expense:     
  
     
  
Interest on deposits355
 289
 1,055
 837
550
 364
 937
 700
Interest on other borrowings80
 60
 223
 176
109
 74
 199
 143
Total interest expense435
 349
 1,278

1,013
659
 438
 1,136

843
       
Net Interest Income8,157
 7,404
 23,057
 20,681
7,778
 7,672
 16,103
 14,900
Provision (Recovery of Provision) for Credit Losses7
 4
 (24) (7)
Net Interest Income after Provision (Recovery of Provision) for Credit Losses8,150
 7,400
 23,081
 20,688
Recovery of Provision for Credit Losses(1,136) (52) (1,325) (31)
Net Interest Income after Recovery of Provision for Credit Losses8,914
 7,724
 17,428
 14,931
       
Noninterest Income:     
  
     
  
Customer service fees959
 924
 2,897
 2,867
1,020
 997
 1,971
 1,938
Increase in cash surrender value of bank-owned life insurance134
 131
 400
 394
132
 134
 257
 266
(Loss) gain on fair value of financial liability(88) (423) (688) 48
Gain on sale of investment in limited partnership3
 
 3
 
Loss on marketable equity securities(18) 
 (78) 
Gain on proceeds from bank-owned life insurance
 
 171
 
Loss on fair value of financial liability(192) (264) (661) (601)
Gain on sale of assets29
 
 29
 
Other168
 154
 539
 464
198
 199
 403
 372
Total noninterest income1,176
 786
 3,151
 3,773
1,169
 1,066
 2,092
 1,975
       
Noninterest Expense:              
Salaries and employee benefits2,578
 2,533
 8,149
 7,592
3,010
 2,586
 5,971
 5,571
Occupancy expense1,087
 1,097
 3,144
 3,212
1,117
 1,043
 2,135
 2,058
Data processing29
 23
 81
 108
38
 25
 90
 52
Professional fees312
 327
 912
 1,116
392
 345
 727
 600
Regulatory assessments43
 131
 313
 632
78
 133
 161
 269
Director fees72
 75
 215
 218
81
 75
 162
 143
(Gain) loss on California tax credit partnership(1) 49
 118
 122
Correspondent bank service charges17
 19
 34
 37
Loss on California tax credit partnership5
 10
 9
 119
Net cost (gain) on operation and sale of OREO21
 39
 (257) 216
49
 (309) 100
 (277)
Other605
 590
 1,868
 1,772
531
 680
 929
 1,226
Total noninterest expense4,746
 4,864
 14,543
 14,988
5,318
 4,607
 10,318
 9,798
       
Income Before Provision for Taxes4,580
 3,322
 11,689
 9,473
4,765
 4,183
 9,202
 7,108
Provision for Taxes on Income1,840
 1,282
 4,685
 3,643
1,373
 1,691
 2,653
 2,845
Net Income$2,740
 $2,040
 $7,004
 $5,830
$3,392
 $2,492
 $6,549
 $4,263

              
Net Income per common share              
Basic$0.16
 $0.12
 $0.41
 $0.35
$0.20
 $0.15
 $0.39
 $0.25
Diluted$0.16
 $0.12
 $0.41
 $0.35
$0.20
 $0.15
 $0.39
 $0.25
Shares on which net income per common shares were based              
Basic16,885,615
 16,881,422
 16,885,578
 16,880,835
16,899,968
 16,875,336
 16,895,135
 16,792,083
Diluted16,907,267
 16,891,066
 16,904,063
 16,887,078
16,957,282
 16,894,373
 16,935,911
 16,808,733

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

(In thousands)Three Months Ended  
 September 30, 2017
 Three Months Ended  
 September 30, 2016
 Nine Months Ended 
 September 30, 2017
 Nine Months Ended 
 September 30, 2016
Three Months Ended  
 June 30, 2018
 Three Months Ended  
 June 30, 2017
 Six Months Ended 
 June 30, 2018
 Six Months Ended 
 June 30, 2017
Net Income$2,740
 $2,040
 $7,004
 $5,830
$3,392
 $2,492
 $6,549
 $4,263
              
Unrealized holdings (loss) gain on securities
 (190) 355
 118
(171) 267
 (428) 355
Unrealized gains on unrecognized post-retirement costs13
 13
 39
 37
18
 13
 27
 26
Unrealized (loss) gain on TRUPs(272) 
 295
 
Other comprehensive income (loss), before tax13
 (177) 394
 155
(425) 280
 (106) 381
Tax benefit (expense) related to securities
 76
 (142) (47)46
 (107) 128
 (142)
Tax expense related to unrecognized post-retirement costs(5) (6) (16) (16)(5) (6) (8) (11)
Tax benefit (expense) related to TRUPs80
 
 (88) 
Total other comprehensive income (loss)8
 (107) 236
 92
(304) 167
 (74) 228
Comprehensive Income$2,748
 $1,933
 $7,240
 $5,922
$3,088
 $2,659
 $6,475
 $4,491


United Security Bancshares and Subsidiaries
Consolidated Statements of Changes in Shareholders' Equity
(unaudited)
Common stock      Common stock      
(In thousands except shares)Number of Shares Amount Retained Earnings Accumulated Other Comprehensive Loss  TotalNumber of Shares Amount Retained Earnings Accumulated Other Comprehensive (Loss) Gain  Total
   
Balance December 31, 2015*16,051,406
 $52,572
 $37,265
 $(202) $89,635
*Excludes 15,019 unvested restricted shares         
Balance December 31, 2016 (1)16,705,594
 $56,557
 $40,701
 $(604) $96,654
(1) Excludes 12,015 unvested restricted shares         
                  
Other comprehensive income 
  
  
 92
 92
 
  
  
 228
 228
Common stock dividends486,316
 2,705
 (2,705)  
 
167,082
 1,221
 (1,221)  
 
Dividends on common stock ($0.05 per share)    (845)   (845)
Dividends payable ($0.05 per share)    (845)   (845)
Stock options exercised2,463
 6
     6
2,514
 6
     6
Stock-based compensation expense 
 22
  
  
 22
 
 60
  
  
 60
Net income 
  
 5,830
  
 5,830
 
  
 4,263
  
 4,263
Balance September 30, 2016*16,540,185
 $55,305
 $40,390
 $(110) $95,585
*Excludes 12,015 unvested restricted shares         
Balance June 30, 2017 (2)16,875,190
 $57,844
 $42,053
 $(376) $99,521
(2) Excludes 9,011 unvested restricted shares         
                  
Other comprehensive loss 
  
  
 (494) (494) 
  
  
 (221) (221)
Common stock dividends165,409
 1,244
 (1,244)  
 
Stock-based compensation expense 
 8
  
  
 8
Net income 
  
 1,555
  
 1,555
Balance December 31, 2016*16,705,594
 $56,557
 $40,701
 $(604) $96,654
*Excludes 12,015 unvested restricted shares         
         
Other comprehensive income 
  
  
 236
 236
Cash dividends on common stock ($0.17 per share)    (2,870)   (2,870)
Common stock dividends167,082
 1,220
 (1,220)  
 
Stock options exercised2,514
 6
     6
Reclassification of income tax effects from accumulated other comprehensive income    113
 (113) 
Dividends on common stock ($0.07 per share)    (1,180)   (1,180)
Dividends payable ($0.07 per share)    (1,182)   (1,182)
Restricted stock units released10,425
       
10,425
    
   
Stock-based compensation expense 
 78
  
  
 78
 
 36
  
   36
Net income 
  
 7,004
  
 7,004
 
  
 4,378
  
 4,378
Balance September 30, 2017*16,885,615
 $57,861
 $43,615
 $(368) $101,108
*Excludes 9,011 unvested restricted shares         
Balance December 31, 2017 (3)16,885,615
 $57,880
 $44,182
 $(710) $101,352
(3) Excludes 46,511 unvested restricted shares         
         
Other comprehensive loss 
  
  
 (74) (74)
Adoption of ASU 2016-01: reclassification of TRUPS to accumulated other comprehensive income    (1,482) 1,482
 
Adoption of ASU 2016-01: recognition of previously unrealized losses within marketable equity securities    (184) 184
 
Dividends on common stock ($0.09 per share)    (1,520)   (1,520)
Dividends payable ($0.09 per share)    (1,520)   (1,520)
Restricted stock units released16,003
       
Stock-based compensation expense 
 429
  
  
 429
Net income 
  
 6,549
  
 6,549
Balance June 30, 2018 (4)16,901,618
 $58,309
 $46,025
 $882
 $105,216
(4) Excludes 78,508 unvested restricted shares         


United Security Bancshares and Subsidiaries
Consolidated Statements of Cash Flows (unaudited)
 Six months ended June 30,
(In thousands)2018 2017
Cash Flows From Operating Activities:   
Net Income$6,549
 $4,263
Adjustments to reconcile net income: to cash provided by operating activities: 
  
Recovery of provision for credit losses(1,325) (31)
Depreciation and amortization666
 654
Amortization of investment securities261
 278
Accretion of investment securities(3) (4)
Increase in accrued interest receivable(1,866) (1,191)
Decrease in accrued interest payable(1) (43)
Decrease in accounts payable and accrued liabilities(1,401) (398)
Decrease in unearned fees and unamortized loan origination costs, net684
 152
Increase in income taxes receivable(1,204) (1,319)
Unrealized loss on marketable equity securities78
 
Stock-based compensation expense429
 60
Provision for deferred income taxes(108) (247)
Gain on sale of other real estate owned
 (336)
Gain on bank owned life insurance(171) 
Increase in cash surrender value of bank-owned life insurance(257) (266)
Loss on fair value option of financial liabilities661
 601
Loss on tax credit limited partnership interest9
 119
Gain on sale of premises and equipment(29) 
Net increase in other assets(28) (42)
Net cash provided by operating activities2,944
 2,250
    
Cash Flows From Investing Activities: 
  
Net increase in interest-bearing deposits with banks
 (2)
Purchase of correspondent bank stock(10) (495)
Purchases of available-for-sale securities(19,860) 
Principal payments of available-for-sale securities4,698
 4,112
Net decrease in loans27,839
 2,654
Cash proceeds from sales of other real estate owned
 1,062
Investment in limited partnership
 (1,028)
Proceeds from bank owned life insurance376
 
Capital expenditures of premises and equipment(542) (919)
Net cash provided by investing activities12,501
 5,384
    
Cash Flows From Financing Activities: 
  
Net increase in demand deposits and savings accounts67,299
 24,885
Net increase (decrease) in time deposits1,970
 (35,203)
Proceeds from exercise of stock options
 6
Dividends on common stock(1,520) (846)
Net cash provided by (used in) financing activities67,749
 (11,158)
    

 Nine months ended September 30,
(In thousands)2017 2016
Cash Flows From Operating Activities:   
Net Income$7,004
 $5,830
Adjustments to reconcile net income:to cash provided by operating activities: 
  
Recovery of provision for credit losses(24) (7)
Depreciation and amortization996
 1,091
Amortization of investment securities406
 335
Accretion of investment securities(6) (25)
Increase in accrued interest receivable(1,951) (1,361)
(Decrease) increase in accrued interest payable(35) 10
Increase (decrease) in accounts payable and accrued liabilities282
 (487)
Increase in unearned fees and unamortized loan origination costs, net(142) (994)
(Increase) decrease in income taxes receivable(734) 2,512
Stock-based compensation expense78
 22
(Benefit) provision for deferred income taxes(283) 20
Gain on sale of other real estate owned(336) (53)
Increase in cash surrender value of bank-owned life insurance(400) (394)
Loss (gain) on fair value option of financial liabilities688
 (48)
Loss on tax credit limited partnership interest118
 122
Net increase in other assets(1,001) (548)
Net cash provided by operating activities4,660
 6,025
    
Cash Flows From Investing Activities: 
  
Net increase in interest-bearing deposits with banks(4) (6)
Purchase of correspondent bank stock(495) (101)
Purchases of available-for-sale securities
 (34,987)
Maturities of available-for-sale securities3,000
 2,600
Principal payments of available-for-sale securities6,091
 2,700
Net increase in loans(12,346) (41,303)
Cash proceeds from sales of other real estate owned1,062
 2,800
Payoff of senior liens on other real estate owned
 (705)
(Investment in) distribution from limited partnership(1,075) 2
Capital expenditures of premises and equipment(1,020) (516)
Net cash used in investing activities(4,787) (69,516)
    
Cash Flows From Financing Activities: 
  
Net increase in demand deposits and savings accounts85,653
 38,068
Net (decrease) increase in time deposits(36,984) 11,413
Proceeds from exercise of stock options6
 6
Dividends on common stock(1,688) 
Net cash provided by financing activities46,987
 49,487
    
Net increase (decrease) in cash and cash equivalents46,860
 (14,004)
Cash and cash equivalents at beginning of period113,032
 125,751
Cash and cash equivalents at end of period$159,892
 $111,747
Net increase (decrease) in cash and cash equivalents83,194
 (3,524)
Cash and cash equivalents at beginning of period107,934
 113,032
Cash and cash equivalents at end of period$191,128
 $109,508

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

These unaudited financial statements have been prepared in accordance with accounting principles generally accepted accounting principlesin the United States (GAAP) for interim financial information on a basis consistent with the accounting policies reflected in the audited financial statements of the Company included in its 20162017 Annual Report on Form 10-K. These interim financial statements do not include all of the information and footnotes required by generally accepted accounting principlesGAAP for complete financial statements. In the opinion of management, all adjustments (consisting of a normal, recurring nature) considered necessary for a fair presentation have been included. Operating results for the interim periods presented are not necessarily indicative of the results that may be expected for any other interim period or for the year as a whole.

Revenue from Contracts with Customers:

The Company records revenue from contracts with customers in accordance with Accounting Standards Codification Topic 606, “Revenue from Contracts with Customers” (“Topic 606”). Under Topic 606, the Company must identify the contract with a customer, identify the performance obligations in the contract, determine the transaction price, allocate the transaction price to the performance obligations in the contract, and recognize revenue when (or as) the Company satisfies a performance obligation.

The Company’s primary sources of revenue are derived from interest and dividends earned on loans, investment securities, and other financial instruments that are not within the scope of Topic 606. The Company has evaluated the nature of its contracts with customers and determined that further disaggregation of revenue from contracts with customers into more granular categories beyond what is presented in the Consolidated Statements of Income was not necessary. The Company generally fully satisfies its performance obligations on its contracts with customers as services are rendered and the transaction prices are typically fixed; charged either on a periodic basis or based on activity. Because performance obligations are satisfied as services are rendered and the transaction prices are fixed, there is little judgment involved in applying Topic 606 that significantly affects the determination of the amount and timing of revenue from contracts with customers. The Company adopted Topic 606 using the modified retrospective method on all contracts not completed as of January 1, 2018. The adoption of Topic 606 did not result in a material change to the accounting for any of the in-scope revenue streams. As such, no cumulative effect adjustment was recorded.
Recently Issued Accounting Standards:

In May 2014,January 2016, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update ("ASU") No. 2014-09, Revenue from Contracts with Customers (Topic 606), which creates Topic 606 and supersedes Topic 605, Revenue Recognition. In August 2015, FASB issued ASU No. 2015-14, Revenue from Contracts with Customers (Topic 606), which postponed the effective date of 2014-09. Multiple ASUs and interpretative guidance have been issued in connection with ASU 2014-09. The core principle of Topic 606 is that an entity recognizes 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. In general, the new guidance requires companies to use more judgment and make more estimates than under current guidance, including identifying performance obligations in the contract, estimating the amount of variable consideration to include in the transaction price and allocating the transaction price to each separate performance obligation. The standard is effective for public entities for interim and annual periods beginning after December 15, 2017; early adoption is not permitted. For financial reporting purposes, the standard allows for either full retrospective adoption, meaning the standard is applied to all of the periods presented, or modified retrospective adoption, meaning the standard is applied only to the most current period presented in the financial statements with the cumulative effect of initially applying the standard recognized at the date of initial application. The Company has begun their process to implement this new standard by reviewing all revenue sources to determine the sources that are in scope for this guidance. As a bank, key revenue sources, such as interest income have been identified as out of scope of this new guidance. The Company does not expect the application of this ASU to have a material impact on the consolidated financial statements.

In January 2016, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) No. 2016-01, Financial Instruments-Overall:“Financial Instruments – Overall: Recognition and MeasurementsMeasurement of Financial Assets and Financial Liabilities. This Liabilities” (“ASU requires2016-01”). The guidance affects the accounting for equity investments, financial liabilities under the fair value option and the presentation and disclosure requirements of financial instruments. ASU 2016-01 was effective for the Company on January 1, 2018 and resulted in separate classification of equity securities previously included in available for sale securities on the consolidated balance sheets with changes in the fair value of the equity securities captured in the consolidated statements of income. See Note 2 – Investment Securities for disclosures related to beequity securities. Adoption of the standard also resulted in the use of an exit price rather than an entrance price to determine the fair value of loans not measured at fair value on a non-recurring basis in the consolidated balance sheets. See Note 11 – Fair Value Disclosures for further information regarding the valuation of these loans. Additionally, adoption of the standard resulted in separately recognizing the instrument-specific credit risk associated with changes in fair value recognized in net income. The amendment also simplifies the impairment assessment of equity investmentsCompany's Junior Subordinated Debt. See Note 10 - Junior Subordinated Debt / Trust Preferred Securities for which fair value is not readily determinable by requiring an entity to perform a qualitative assessment to identify impairment. The ASU is effective for fiscal years beginning after December 15, 2017, and interim periods therein. The Company expects this ASU to impact its consolidated income and other comprehensive income disclosures for the fair value of its mutual fund investment and junior subordinated debenture.additional information.

In February 2016, FASB issued ASU 2016-02, Leases (Topic 842). The FASB is issuing this Update to increase transparency and comparability among organizations by recognizing lease assets and lease liabilities on the balance sheet and disclosing key information about leasing arrangements. To meet that objective, the FASB is amending the FASB Accounting Standards Codification® and creating Topic 842, Leases. This Update, along with IFRS 16, Leases, are the results of the FASB’s and the International Accounting Standards Board’s (IASB’s) efforts to meet that objective and improve financial reporting. This ASU will be effective for public business entities for annual periods beginning after December 15, 2018 (i.e., calendar periods beginning on January 1, 2019), and interim periods therein. Although an estimate of the impact of the new leasing standard has not yet been determined, the Company expects a significant new lease asset and related lease liability on the consolidated balance sheet due to the number of leased branches and standalone ATM sites the BankCompany currently has that are accounted for

under current operating lease guidance. The Company has implemented a lease review team and is in the process of determining the best vendor to assist in the calculation and implementation of this standard.

In June 2016, FASB issued ASU 2016-13, Financial Instruments- Credit Losses (Topic 326). The FASB is issuing this Update to improve financial reporting by requiring timelier recording of credit losses on loans and other financial instruments held by financial institutions and other organizations. The Update requires enhanced disclosures and judgments in estimating credit

losses and also amends the accounting for credit losses on available-for-sale debt securities and purchased financial assets with credit deterioration. This amendment is effective for fiscal years beginning after December 15, 2019, including interim periods within those fiscal years. The Company has established a project team for the implementation of this new standard. The team has started by working with a vendor to put a new Allowance for Loan Loss software in place and is collecting additional historical data to estimate the impact of this standard. An estimate of the impact of this standard has not yet been determined, however, the impact on the Company's consolidated financial statements is expected to be significant.

As of January 1, 2017, the Company adopted the Financial Accounting Standards Board's (FASB) Accounting Standard Update ("ASU") No. 2016-09, Compensation - Stock Compensation (Topic 718): Improvements to Employee Share-Based Payment Accounting. ASU 2016-09, seeks to simplify several aspects of the accounting for employee share-based payment transactions, including income tax consequences, classification of awards as either equity or liabilities, and classification on the statement of cash flows. As required by ASU 2016-09, all adjustments are reflected as of the beginning of the fiscal year, January 1, 2016. By applying this ASU, the Company no longer adjusts common stock for the tax impact of shares released, instead the tax impact is recognized as tax expense in the period the shares are released. This simplifies the tracking of the excess tax benefits and deficiencies, but could cause volatility in tax expense for the periods presented. The statement of cash flows has been adjusted to reflect the provisions of this ASU. The application of this ASU did not have a material impact on the consolidated financial statements.

In January 2017, FASB issued ASU 2017-04, Intangibles - Goodwill and Other (Topic 350). The FASB is issuing this Update to eliminate the requirement to calculate the implied fair value of goodwill to measure a goodwill impairment charge. Instead, entities will record an impairment charge based on the excess of a reporting unit's carrying amount over its fair value. This ASU will be effective for public business entities for annual periods beginning after December 15, 2019 (i.e. calendar periods beginning on January 1, 2020, and interim periods therein. The Company does not expect any impact on the Company's consolidated financial statements resulting from the adoption of this update.Update.

In March 2017, FASB issued ASU 2017-08 - Receivables - Nonrefundable Fees and Other Costs (Subtopic 310-20): Premium Amortization on Purchased Callable Debt Securities. The provisions of the update require premiums recognized upon the purchase of callable debt securities to be amortized to the earliest call date in order to avoid losses recognized upon call. For public business entities that are SEC filers the amendments of the update will become effective in fiscal years beginning after December 15, 2018. The Company does not expect the requirements of this updateUpdate to have a material impact on the Company’s financial position, results of operations or cash flows.

2.Investment Securities

Following is a comparison of the amortized cost and fair value of securities available-for-sale, as of SeptemberJune 30, 20172018 and December 31, 2016:2017:
(in 000's) Amortized Cost Gross Unrealized Gains Gross Unrealized Losses Fair Value (Carrying Amount) Amortized Cost Gross Unrealized Gains Gross Unrealized Losses Fair Value (Carrying Amount)
September 30, 2017 
June 30, 2018 
Securities available for sale: Amortized Cost Gross Unrealized Gains Gross Unrealized Losses Fair Value (Carrying Amount) Amortized Cost Gross Unrealized Gains Gross Unrealized Losses Fair Value (Carrying Amount)
U.S. Government agencies  
U.S. Government sponsored entities & agencies collateralized by mortgage obligations  
Mutual Funds4,000
 
 (217) 3,783
Total securities available for sale$48,369
 $408
 $(421) $48,356
$57,241
 $219
 $(736) $56,724
(in 000's) Amortized Cost Gross Unrealized Gains Gross Unrealized Losses Fair Value (Carrying Amount) Amortized Cost Gross Unrealized Gains Gross Unrealized Losses Fair Value (Carrying Amount)
December 31, 2016 
December 31, 2017 
Securities available for sale: Amortized Cost Gross Unrealized Gains Gross Unrealized Losses Fair Value (Carrying Amount) Amortized Cost Gross Unrealized Gains Gross Unrealized Losses Fair Value (Carrying Amount)
U.S. Government agencies  
U.S. Government sponsored entities & agencies collateralized by mortgage obligations  
Mutual Funds4,000
 
 (284) 3,716
Total securities available for sale$57,859
 $387
 $(755) $57,491
$42,074
 $368
 $(457) $41,985
 

The amortized cost and fair value of securities available for sale at SeptemberJune 30, 20172018, by contractual maturity, are shown below. Actual maturities may differ from contractual maturities because issuers have the right to call or prepay obligations with or without call or prepayment penalties. Contractual maturities on collateralized mortgage obligations cannot be anticipated due to allowed paydowns. Mutual funds are included in the "due in one year or less" category below.

September 30, 2017June 30, 2018
Amortized Cost Fair Value (Carrying Amount)Amortized Cost Fair Value (Carrying Amount)
(in 000's)  
Due in one year or less$4,000
 $3,783
$
 $
Due after one year through five years
 

 
Due after five years through ten years716
 728
6,045
 6,031
Due after ten years19,960
 20,242
24,282
 24,320
Collateralized mortgage obligations23,693
 23,603
26,914
 26,373
$48,369
 $48,356
$57,241
 $56,724

There were no realized gains or losses on sales of available-for-sale securities for the three and ninesix month periods ended SeptemberJune 30, 20172018 and SeptemberJune 30, 20162017. There were no other-than-temporary impairment losses for the three and ninesix month periods ended SeptemberJune 30, 20172018 and SeptemberJune 30, 20162017.

At SeptemberJune 30, 20172018, available-for-sale securities with an amortized cost of approximately $36,896,96050,806,841 (fair value of $36,955,12150,240,058) were pledged as collateral for FHLB borrowings, securitized deposits, and public funds balances.

The Company had no held-to-maturity or trading securities at September 30, 2017 or December 31, 2016.

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


The following summarizes temporarily impaired investment securities:
(in 000's)Less than 12 Months 12 Months or More TotalLess than 12 Months 12 Months or More Total
September 30, 2017Fair Value (Carrying Amount)  Unrealized Losses Fair Value (Carrying Amount)  Unrealized Losses Fair Value (Carrying Amount)  Unrealized Losses
June 30, 2018Fair Value (Carrying Amount)  Unrealized Losses Fair Value (Carrying Amount)  Unrealized Losses Fair Value (Carrying Amount)  Unrealized Losses
Securities available for sale:Fair Value (Carrying Amount)  Unrealized Losses Fair Value (Carrying Amount)  Unrealized Losses Fair Value (Carrying Amount)  Unrealized Losses 
U.S. Government agencies $12,673
 $(55) 7,464
 (103) $20,137
 $(158)
U.S. Government sponsored entities & agencies collateralized by mortgage obligations9,363
 (25) 12,245
 (135) 21,608
 (160)7,188
 (204) 12,134
 (374) 19,322
 (578)
Mutual Funds
 
 3,783
 (217) 3,783
 (217)
Total impaired securities$11,131
 $(29) $23,160
 $(392) $34,291
 $(421)$19,861
 $(259) $19,598
 $(477) $39,459
 $(736)
                      
December 31, 2016 
  
  
  
  
  
December 31, 2017 
  
  
  
  
  
Securities available for sale: 
  
  
  
  
  
 
  
  
  
  
  
U.S. Government agencies$12,281
 $(69) $
 $
 $12,281
 $(69)$1,728
 $(3) $6,625
 $(38) $8,353
 $(41)
U.S. Government sponsored entities & agencies collateralized by mortgage obligations25,904
 (402) 
 
 25,904
 (402)7,483
 (154) 13,583
 (262) 21,066
 (416)
Mutual Funds
 
 3,716
 (284) 3,716
 (284)
Total impaired securities$38,185
 $(471) $3,716
 $(284) $41,901
 $(755)$9,211
 $(157) $20,208
 $(300) $29,419
 $(457)
 
Temporarily impaired securities at SeptemberJune 30, 2017,2018, were comprised of one mutual fund, threeseven U.S. government agency securities, and tentwelve U.S. government sponsored entities and agencies collateralized by mortgage obligations securities.

The Company evaluates investment securities for other-than-temporary impairment (OTTI) at least quarterly, and more frequently when economic or market conditions warrant such an evaluation. The investment securities portfolio is evaluated for OTTI by segregating the portfolio into two general segments and applying the appropriate OTTI model. Investment securities

classified as available-for-sale or held-to-maturity are generally evaluated for OTTI under ASC Topic 320, Investments – Debt and Equity Instruments. Certain purchased beneficial interests, including non-agency mortgage-backed securities, asset-backed securities, and collateralized debt obligations, are evaluated under ASC Topic 325-40, Beneficial Interest in Securitized Financial Assets.

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

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

At SeptemberJune 30, 20172018, the decline in fair value of the impaired mutual fund, the threeseven U.S. government agency securities, and the tentwelve U.S. government sponsored entities and agencies collateralized by mortgage obligations securities is attributable to changes in interest rates, and not credit quality. Because the Company does not have the intent to sell these impaired securities, and it is not more likely than not that it will be required to sell these securities before its anticipated recovery, the Company does not consider these securities to be other-than-temporarily impaired at SeptemberJune 30, 20172018.

As of December 31, 2017, marketable equity securities with a fair value of $3,737,000 were recorded within investment securities available for sale with unrealized losses recorded through comprehensive income and accumulated other comprehensive income. As of January 1, 2018, the Company adopted Accounting Standard Update (“ASU”) 2016-01 and reclassified its marketable equity securities from investments available for sale into a separate component of investment securities. The ASU requires marketable equity securities to be reported at fair value with changes recorded through earnings. As of January 1, 2018, unrealized losses of $184,000 were reclassified from accumulated other comprehensive income to retained earnings.

During the six months ended June 30, 2018, the Company recognized $78,000 of unrealized losses related to equity securities held at June 30, 2018 in the consolidated statements of income. For the quarter ended June 30, 2018, the Company recognized $18,000 of unrealized losses related to equity securities held at June 30, 2018 in the consolidated statements of income. The resulting impact on basic and diluted earnings per share for the quarter and six months ended June 30, 2018 is immaterial.

The Company had no held-to-maturity or trading securities at June 30, 2018 or December 31, 2017.



3.Loans

Loans are comprised of the following:
(in 000's)September 30, 2017
 December 31, 2016
June 30, 2018
 December 31, 2017
Commercial and Business Loans$45,937
 $47,464
$57,047
 $46,065
Government Program Loans1,014
 1,541
908
 961
Total Commercial and Industrial46,951
 49,005
57,955
 47,026
Real Estate – Mortgage: 
  
 
  
Commercial Real Estate199,668
 200,213
212,513
 221,032
Residential Mortgages90,284
 87,388
70,512
 84,804
Home Improvement and Home Equity loans510
 599
386
 457
Total Real Estate Mortgage290,462
 288,200
283,411
 306,293
Real Estate Construction and Development128,883
 130,687
108,571
 122,970
Agricultural58,505
 56,918
56,662
 59,481
Installment and Student Loans57,583
 44,949
67,397
 65,581
Total Loans$582,384
 $569,759
$573,996
 $601,351
 
The Company's loans are predominantly in the San Joaquin Valley and the greater Oakhurst/East Madera County area, as well as the Campbell area of Santa Clara County. Although the Company does participate in loans with other financial institutions, they are primarily in the state of California.

Commercial and industrial loans represent 8.1%10.1% of total loans at SeptemberJune 30, 20172018 and are generally made to support the ongoing operations of small-to-medium sized commercial businesses. Commercial and industrial loans have a high degree of industry diversification and provide working capital, financing for the purchase of manufacturing plants and equipment, or funding for growth and general expansion of businesses. A substantial portion of commercial and industrial loans are secured by accounts receivable, inventory, leases, or other collateral including real estate. The remainder are unsecured; however, extensions of credit are predicated upon the financial capacity of the borrower. Repayment of commercial loans is generally from the cash flow of the borrower.

Real estate mortgage loans, representing 49.9%49.4% of total loans at SeptemberJune 30, 20172018, are secured by trust deeds on primarily commercial property, but are also secured by trust deeds on single family residences. Repayment of real estate mortgage loans generally comes from the cash flow of the borrower.borrower and or guarantor(s).

Commercial real estate mortgage loans comprise the largest segment of this loan category and are available on all types of income producing and non-income producing commercial properties, including: office buildings, shopping centers; apartments and motels; owner occupied buildings; manufacturing facilities and more. Commercial real estate mortgage loans can also be used to refinance existing debt. Although real estate associated with the business is the primary collateral for commercial real estate mortgage loans, the underlying real estate is not the source of repayment.

Commercial real estate loans are made under the premise that the loan will be repaid from the borrower's business operations, rental income associated with the real property, or personal assets.

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

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

Real estate construction and development loans, representing 22.1%18.9% of total loans at SeptemberJune 30, 20172018, consist of loans for residential and commercial construction projects, as well as land acquisition and development, or land held for future development. Loans in this category are secured by real estate including improved and unimproved land, as well as single-family residential, multi-family residential, and commercial properties in various stages of completion. All real estate loans have established equity requirements. Repayment on construction loans generally comes from long-term mortgages with other lending institutions obtained at completion of the project.project or from the sale of the constructed homes to individuals.


Agricultural loans represent 10.0%9.9% of total loans at SeptemberJune 30, 20172018 and are generally secured by land, equipment, inventory and receivables. Repayment is from the cash flow of the borrower.

Installment andloans, including student loans, represent 9.9%11.7% of total loans at SeptemberJune 30, 20172018 and generally consist of student loans, loans to individuals for household, family and other personal expenditures, such as credit cards, automobiles or other consumer items. Included in installment loans are $51,185,000$61,761,000 in unsecured student loans made to medical and pharmacy school students. RepaymentUpon graduation the loan is automatically placed on deferment for 6 months. This may be extended up to 48 months for graduates enrolling in Internship, Medical Residency or Fellowship. As approved the student loans is deferred until 6may receive additional deferment for hardship or administrative reasons in the form of forbearance for a maximum of 24 months after graduation.throughout the life of the loan. Accrued interest on loans that have not entered repayment status totaled $3,769,000$6,186,000 at SeptemberJune 30, 2017.2018. At June 30, 2018 there were 316 loans within repayment, deferment, and forbearance which represented $6,129,000, $1,270,000, and $3,006,000 in outstanding balances respectively. Prior to June 2018, student loans were insured through a Surety Bond issued by ReliaMax Surety Company and provided the Company reasonable expectation of collection. In June 2018, ReliaMax Surety Company was declared insolvent by the South Dakota Division of Insurance and is now in liquidation. As a result of the insolvency, the Company's student loan portfolio is no longer insured.

In the normal course of business, the Company is party to financial instruments with off-balance sheet risk to meet the financing needs of its customers. At SeptemberJune 30, 20172018 and December 31, 20162017, these financial instruments include commitments to extend credit of $107,580,000123,711,000 and $120,485,00099,958,000, respectively, and standby letters of credit of $2,058,000605,000 and $1,201,0002,058,000, respectively. These instruments involve elements of credit risk in excess of the amount recognized on the consolidated balance sheet. The contract amounts of these instruments reflect the extent of the involvement the Company has in off-balance sheet financial instruments.

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

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

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

During the second quarter of 2018, the Bank entered into a Small Business Administration (SBA) 504 Loan Forward Purchase Commitment to buy a one hundred percent (100%) interest in up to $30 million, first mortgage, California SBA 504 loans on a flow basis with servicing released by the Seller.


Past Due Loans

The Company monitors delinquency and potential problem loans on an ongoing basis through weekly reports to the Loan Committee and monthly reports to the Board of Directors.

The following is a summary of delinquent loans at SeptemberJune 30, 20172018 (in 000's):
September 30, 2017
Loans
30-60 Days Past Due
 
Loans
61-89 Days Past Due
 
Loans
90 or More
Days Past Due
 Total Past Due Loans Current Loans Total Loans 
Accruing
Loans 90 or
More Days Past Due
June 30, 2018
Loans
30-60 Days Past Due
 
Loans
61-89 Days Past Due
 
Loans
90 or More
Days Past Due
 Total Past Due Loans Current Loans Total Loans 
Accruing
Loans 90 or
More Days Past Due
Commercial and Business Loans$249
 $
 $22
 $271
 $45,666
 $45,937
 $
$
 $
 $
 $
 $57,047
 $57,047
 $
Government Program Loans
 
 
 
 1,014
 1,014
 

 
 
 
 908
 908
 
Total Commercial and Industrial249
 
 22
 271
 46,680
 46,951
 

 
 
 
 57,955
 57,955
 
Commercial Real Estate Loans
 
 
 
 199,668
 199,668
 

 
 
 
 212,513
 212,513
 
Residential Mortgages
 
 
 
 90,284
 90,284
 

 
 
 
 70,512
 70,512
 
Home Improvement and Home Equity Loans
 14
 
 14
 496
 510
 

 
 
 
 386
 386
 
Total Real Estate Mortgage
 14
 
 14
 290,448
 290,462
 

 
 
 
 283,411
 283,411
 
                          
Real Estate Construction and Development Loans
 360
 
 360
 128,523
 128,883
 

 
 8,825
 8,825
 99,746
 108,571
 
Agricultural Loans
 
 
 
 58,505
 58,505
 

 
 
 
 56,662
 56,662
 
             
Consumer Loans
 
 
 
 57,313
 57,313
 
231
 83
 
 314
 66,929
 67,243
 67
Overdraft Protection Lines
 
 
 
 40
 40
 

 
 
 
 38
 38
 
Overdrafts
 
 
 
 230
 230
 

 
 
 
 116
 116
 
Total Installment
 
 
 
 57,583
 57,583
 
231
 83
 
 314
 67,083
 67,397
 67
Total Loans$249
 $374
 $22
 $645
 $581,739
 $582,384
 $
$231
 $83
 $8,825
 $9,139
 $564,857
 $573,996
 $67

The following is a summary of delinquent loans at December 31, 20162017 (in 000's):
December 31, 2016
Loans
30-60 Days Past Due
 
Loans
61-89 Days Past Due
 
Loans
90 or More
Days Past Due
 Total Past Due Loans Current Loans Total Loans 
Accruing
Loans 90 or
More Days Past Due
December 31, 2017
Loans
30-60 Days Past Due
 
Loans
61-89 Days Past Due
 
Loans
90 or More
Days Past Due
 Total Past Due Loans Current Loans Total Loans 
Accruing
Loans 90 or
More Days Past Due
Commercial and Business Loans$
 $432
 $
 $432
 $48,009
 $48,441
 $
$
 $
 $212
 $212
 $45,853
 $46,065
 $
Government Program Loans
 
 290
 290
 1,251
 1,541
 

 
 
 
 961
 961
 
Total Commercial and Industrial
 432
 290
 722
 49,260
 49,982
 

 
 212
 212
 46,814
 47,026
 
Commercial Real Estate Loans
 
 
 
 199,810
 199,810
 
779
 
 
 779
 220,253
 221,032
 
Residential Mortgages
 
 
 
 87,388
 87,388
 

 
 94
 94
 84,710
 84,804
 
Home Improvement and Home Equity Loans
 
 
 
 599
 599
 

 
 
 
 457
 457
 
Total Real Estate Mortgage
 
 
 
 287,797
 287,797
 
779
 
 94
 873
 305,420
 306,293
 
Real Estate Construction and Development Loans166
 
 1,250
 1,416
 128,697
 130,113
 1,250

 
 360
 360
 122,610
 122,970
 360
Agricultural Loans
 
 
 
 56,918
 56,918
 

 
 
 
 59,481
 59,481
 
             
Consumer Loans
 
 965
 965
 43,785
 44,750
 

 
 
 
 65,446
 65,446
 125
Overdraft Protection Lines
 
 
 
 48
 48
 

 
 
 
 38
 38
 
Overdrafts
 
 
 
 151
 151
 

 
 
 
 97
 97
 
Total Installment
 
 965
 965
 43,984
 44,949
 

 
 
 
 65,581
 65,581
 125
Total Loans$166
 $432
 $2,505
 $3,103
 $566,656
 $569,759
 $1,250
$779
 $
 $666
 $1,445
 $599,906
 $601,351
 $485


Nonaccrual Loans

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

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

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

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

Other circumstances which jeopardize the ultimate collectability of the loan including certain troubled debt restructurings, identified loan impairment, and certain loans to facilitate the sale of OREO.

Loans meeting any of the preceding criteria are placed on nonaccrual status and the accrual of interest for financial statement purposes is discontinued. Previously accrued but unpaid interest is reversed and charged against interest income.

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

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

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

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

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

Nonaccrual loans totaled $5,145,00012,202,000 and $7,264,0005,296,000 at SeptemberJune 30, 20172018 and December 31, 20162017, respectively. Two loans were added to nonaccrual during the quarter ended June 30, 2018. Those loans, totaling $8,825,000, were made to the same borrower and are well-secured by real estate collateral. There were no remaining undisbursed commitments to extend credit on nonaccrual loans at SeptemberJune 30, 20172018 or December 31, 20162017.

The following is a summary of nonaccrual loan balances at SeptemberJune 30, 20172018 and December 31, 20162017 (in 000's).

September 30, 2017 December 31, 2016June 30, 2018 December 31, 2017
Commercial and Business Loans$271
 $275
$
 $212
Government Program Loans
 290

 
Total Commercial and Industrial271
 565

 212
      
Commercial Real Estate Loans466
 1,126
438
 454
Residential Mortgages
 

 288
Home Improvement and Home Equity Loans
 

 
Total Real Estate Mortgage466
 1,126
438
 742
      
Real Estate Construction and Development Loans4,408
 4,608
11,764
 4,342
Agricultural Loans
 

 
      
Consumer Loans
 965

 
Overdraft Protection Lines
 

 
Overdrafts
 

 
Total Installment
 965

 
Total Loans$5,145
 $7,264
$12,202
 $5,296

Impaired Loans

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

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

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

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

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

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

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


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

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

The following is a summary of impaired loans at SeptemberJune 30, 20172018 (in 000's).
September 30, 2017
Unpaid
Contractual
Principal Balance
 
Recorded
Investment
With No Allowance (1)
 
Recorded
Investment
With Allowance (1)
 
Total
Recorded Investment
 Related Allowance 
Average
Recorded Investment (2)
 Interest Recognized (2)
June 30, 2018
Unpaid
Contractual
Principal Balance
 
Recorded
Investment
With No Allowance (1)
 
Recorded
Investment
With Allowance (1)
 
Total
Recorded Investment
 Related Allowance 
Average
Recorded Investment (2)
 Interest Recognized (2)
Commercial and Business Loans$3,590
 $543
 $3,061
 $3,604
 $567
 $3,965
 $63
$2,937
 $535
 $2,414
 $2,949
 $444
 $3,171
 $97
Government Program Loans83
 54
 29
 83
 4
 275
 36
308
 309
 
 309
 
 226
 10
Total Commercial and Industrial3,673
 597
 3,090
 3,687
 571
 4,240
 99
3,245
 844
 2,414
 3,258
 444
 3,397
 107
                          
Commercial Real Estate Loans1,147
 
 1,151
 1,151
 221
 1,102
 10
1,362
 
 1,367
 1,367
 510
 1,409
 34
Residential Mortgages2,783
 512
 2,281
 2,793
 206
 2,643
 150
2,219
 400
 1,828
 2,228
 80
 2,604
 60
Home Improvement and Home Equity Loans
 
 
 
 
 
 

 
 
 
 
 
 
Total Real Estate Mortgage3,930
 512
 3,432
 3,944
 427
 3,745
 160
3,581
 400
 3,195
 3,595
 590
 4,013
 94
                          
Real Estate Construction and Development Loans6,797
 6,816
 
 6,816
 
 6,889
 415
11,764
 11,764
 
 11,764
 
 7,447
 205
Agricultural Loans887
 1
 890
 891
 743
 1,170
 64
1,010
 1
 1,016
 1,017
 706
 1,112
 43
                          
Consumer Loans
 
 
 
 
 322
 
62
 62
 
 62
 
 49
 3
Overdraft Protection Lines
 
 
 
 
 
 

 
 
 
 
 
 
Overdrafts
 
 
 
 
 
 

 
 
 
 
 
 
Total Installment
 
 
 
 
 322
 
62
 62
 
 62
 
 49
 3
Total Impaired Loans$15,287
 $7,926
 $7,412
 $15,338
 $1,741
 $16,366
 $738
$19,662
 $13,071
 $6,625
 $19,696
 $1,740
 $16,018
 $452

(1) The recorded investment in loans includes accrued interest receivable of $51,000.$34.
(2) Information is based on the ninesix month period ended SeptemberJune 30, 2017.2018.    


The following is a summary of impaired loans at December 31, 20162017 (in 000's).

December 31, 2016
Unpaid
Contractual
Principal Balance
 
Recorded
Investment
With No Allowance (1)
 
Recorded
Investment
With Allowance (1)
 
Total
Recorded Investment
 Related Allowance 
Average
Recorded Investment (2)
 Interest Recognized (2)
December 31, 2017
Unpaid
Contractual
Principal Balance
 
Recorded
Investment
With No Allowance (1)
 
Recorded
Investment
With Allowance (1)
 
Total
Recorded Investment
 Related Allowance 
Average
Recorded Investment (2)
 Interest Recognized (2)
Commercial and Business Loans$4,635
 $495
 $4,158
 $4,653
 $757
 $5,050
 $302
$3,255
 $381
 $2,887
 $3,268
 $534
 $3,791
 $229
Government Program Loans356
 356
 
 356
 
 372
 20
49
 50
 
 50
 
 219
 5
Total Commercial and Industrial4,991
 851
 4,158
 5,009
 757
 5,422
 322
3,304
 431
 2,887
 3,318
 534
 4,010
 234
                          
Commercial Real Estate Loans1,454
 
 1,456
 1,456
 450
 1,503
 89
1,233
 
 1,245
 1,245
 385
 1,138
 79
Residential Mortgages2,467
 526
 1,949
 2,475
 153
 2,874
 138
3,040
 1,199
 1,852
 3,051
 103
 2,745
 142
Home Improvement and Home Equity Loans
 
 
 
 
 
 

 
 
 
 
 
 
Total Real Estate Mortgage3,921
 526
 3,405
 3,931
 603
 4,377
 227
4,273
 1,199
 3,097
 4,296
 488
 3,883
 221
                          
Real Estate Construction and Development Loans6,267
 6,274
 
 6,274
 
 8,794
 361
5,951
 5,972
 
 5,972
 
 6,660
 418
Agricultural Loans
 
 
 
 
 5
 8
1,200
 1
 1,203
 1,204
 866
 1,179
 48
                          
Consumer Loans965
 965
 
 965
 
 968
 35

 
 
 
 
 241
 
Overdraft Protection Lines
 
 
 
 
 
 

 
 
 
 
 
 
Overdrafts
 
 
 
 
 
 

 
 
 
 
 
 
Total Installment965
 965
 
 965
 
 968
 35

 
 
 
 
 241
 
Total Impaired Loans$16,144
 $8,616
 $7,563
 $16,179
 $1,360
 $19,566
 $953
$14,728
 $7,603
 $7,187
 $14,790
 $1,888
 $15,973
 $921

(1) The recorded investment in loans includes accrued interest receivable of $35,000.$62.
(2) Information is based on the twelve month period ended December 31, 20162017.

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

The average recorded investment in impaired loans for the quarters ended SeptemberJune 30, 2018 and 2017 was $16,633,000 and 2016 was $15,681,000 and $19,397,000,$16,881,000, respectively. Interest income recognized on impaired loans for the quarters ended SeptemberJune 30, 20172018 and 20162017 was approximately $192,000$282,000 and $34,000,$323,000, respectively. For impaired nonaccrual loans, interest income recognized under a cash-basis method of accounting was approximately $70,000$150,000 and $126,000$111,000 for the quarters ended SeptemberJune 30, 20172018 and 2016,2017, respectively.

The average recorded investment in impaired loans for the ninesix months ended SeptemberJune 30, 2018 and 2017 was $16,018,000 and 2016 was $16,366,000 and $21,440,000,$16,468,000, respectively. Interest income recognized on impaired loans for the ninesix months ended SeptemberJune 30, 20172018 and 20162017 was approximately $738,000$452,000 and $741,000,$546,000, respectively. For impaired nonaccrual loans, interest income recognized under a cash-basis method of accounting was approximately $260,000$213,000 and $362,000$190,000 for the ninesix months ended SeptemberJune 30, 20172018 and 2016,2017, respectively.


Troubled Debt Restructurings

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

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

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

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

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

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


The following tables illustrates TDR activityadditions for the periods indicated:
 Three Months Ended September 30, 2017
($ in 000's)Number of
Contracts
 Pre-
Modification
Outstanding
Recorded
Investment
 Post-
Modification
Outstanding
Recorded
Investment
 Number of Contracts which Defaulted During Period Recorded Investment on Defaulted TDRs
Troubled Debt Restructurings         
Commercial and Business Loans
 $
 $
 
 $
Government Program Loans
 
 
 
 
Commercial Real Estate Term Loans
 
 
 
 
Single Family Residential Loans1
 167
 167
 
 
Home Improvement and Home Equity Loans
 
 
 
 
Real Estate Construction and Development Loans
 
 
 
 
Agricultural Loans1
 587
 587
 
 
Consumer Loans
 
 
 
 
Overdraft Protection Lines
 
 
 
 
Total Loans2
 $754
 $754
 
 $


 Nine Months Ended September 30, 2017
($ in 000's)Number of
Contracts
 Pre-
Modification
Outstanding
Recorded
Investment
 Post-
Modification
Outstanding
Recorded
Investment
 Number of Contracts which Defaulted During Period Recorded Investment on Defaulted TDRs
Troubled Debt Restructurings         
Commercial and Business Loans1
 $69
 $69
 
 $
Government Program Loans1
 178
 178
 
 
Commercial Real Estate Term Loans
 
 
 
 
Single Family Residential Loans2
 404
 404
 
 
Home Improvement and Home Equity Loans
 
 
 
 
Real Estate Construction and Development Loans1
 790
 790
 
 
Agricultural Loans2
 1,437
 1,437
 
 
Consumer Loans
 
 
 
 
Overdraft Protection Lines
 
 
 
 
Total Loans7
 $2,878
 $2,878
 
 $




 Three Months Ended SeptemberJune 30, 20162018
($ in 000's)Number of
Contracts
 Pre-
Modification
Outstanding
Recorded
Investment
 Post-
Modification
Outstanding
Recorded
Investment
 Number of Contracts which Defaulted During Period Recorded Investment on Defaulted TDRs
Troubled Debt Restructurings         
Commercial and Business Loans
 $
 $
 
 $
Government Program Loans
 
 
 
 
Commercial Real Estate Term Loans
 
 
 
 
Single Family Residential Loans
 
 
 
 
Home Improvement and Home Equity Loans
 
 
 
 
Real Estate Construction and Development Loans
 
 
 
 
Agricultural Loans
 
 
 
 
Consumer Loans
 
 
 
 
Overdraft Protection Lines
 
 
 
 
Total Loans
 $
 $
 
 $

Nine Months Ended September 30, 2016Three Months Ended June 30, 2017
($ in 000's)Number of
Contracts
 Pre-
Modification
Outstanding
Recorded
Investment
 Post-
Modification
Outstanding
Recorded
Investment
 Number of Contracts which Defaulted During Period Recorded Investment on Defaulted TDRsNumber of
Contracts
 Pre-
Modification
Outstanding
Recorded
Investment
 Post-
Modification
Outstanding
Recorded
Investment
 Number of Contracts which Defaulted During Period Recorded Investment on Defaulted TDRs
Troubled Debt Restructurings                  
Commercial and Business Loans4
 $1,021
 $749
 
 $

 $
 $
 
 $
Government Program Loans1
 100
 100
 
 
1
 178
 178
 
 
Commercial Real Estate Term Loans
 
 
 
 

 
 
 
 
Single Family Residential Loans
 
 
 
 
1
 238
 238
 
 
Home Improvement and Home Equity Loans
 
 
 
 

 
 
 
 
Real Estate Construction and Development Loans
 
 
 
 

 
 
 
 
Agricultural Loans
 
 
 
 

 
 
 
 
Consumer Loans
 
 
 
 

 
 
 
 
Overdraft Protection Lines
 
 
 
 

 
 
 
 
Total Loans5
 $1,121
 $849
 
 $
2
 $416
 $416
 
 $

 Six Months Ended June 30, 2018
($ in 000's)Number of
Contracts
 Pre-
Modification
Outstanding
Recorded
Investment
 Post-
Modification
Outstanding
Recorded
Investment
 Number of Contracts which Defaulted During Period Recorded Investment on Defaulted TDRs
Troubled Debt Restructurings         
Commercial and Business Loans
 $
 $
 
 $
Government Program Loans
 
 
 
 
Commercial Real Estate Term Loans
 
 
 
 
Single Family Residential Loans
 
 
 
 
Home Improvement and Home Equity Loans
 
 
 
 
Real Estate Construction and Development Loans
 
 
 1
 310
Agricultural Loans
 
 
 
 
Consumer Loans
 
 
 
 
Overdraft Protection Lines
 
 
 
 
Total Loans
 $
 $
 1
 $310

 Six Months Ended June 30, 2017
($ in 000's)Number of
Contracts
 Pre-
Modification
Outstanding
Recorded
Investment
 Post-
Modification
Outstanding
Recorded
Investment
 Number of Contracts which Defaulted During Period Recorded Investment on Defaulted TDRs
Troubled Debt Restructurings         
Commercial and Business Loans1
 $69
 $69
 
 $
Government Program Loans1
 178
 178
 
 
Commercial Real Estate Term Loans
 
 
 
 
Single Family Residential Loans1
 238
 238
 
 
Home Improvement and Home Equity Loans
 
 
 
 
Real Estate Construction and Development Loans1
 790
 790
 
 
Agricultural Loans1
 850
 850
 
 
Consumer Loans
 
 
 
 
Overdraft Protection Lines
 
 
 
 
Total Loans5
 $2,125
 $2,125
 
 $

The Company makes various types of concessions when structuring TDRs including rate reductions,discounts, payment extensions, and forbearance. At SeptemberJune 30, 20172018, the Company had 2917 restructured loans totaling $12,150,0007,641,000 as compared to 2825 restructured loans totaling $12,410,00011,362,000 at December 31, 20162017.

The following tables summarize TDR activity by loan category for the quarters ended SeptemberJune 30, 2018 and June 30, 2017 and September 30, 2016.(in 000's).
Three Months Ended June 30, 2018Commercial and Industrial Commercial Real Estate Residential Mortgages Home Improvement and Home Equity Real Estate Construction Development Agricultural Installment
& Other
 Total
Beginning balance$147
 $1,314
 $2,525
 $
 $4,606
 $1,110
 $
 $9,702
                
Defaults
 
 
 
 
 
 
 
Additions
 
 
 
 
 
 
 
                
Principal (reductions) additions(37) 48
 (305) 
 (1,667) (100) 
 (2,061)
Charge-offs
 
 
 
 
 
 
 
                
Ending balance$110
 $1,362
 $2,220
 $
 $2,939
 $1,010
 $
 $7,641
                
Allowance for loan loss$
 $511
 $80
 $
 $
 $706
 $
 $1,297

Three Months Ended September 30, 2017Commercial and Industrial Commercial Real Estate Residential Mortgages Home Improvement and Home Equity Real Estate Construction Development Agricultural Installment
& Other
 Total
Beginning balance$1,055
 $1,062
 $2,573
 $
 $6,868
 $400
 $
 $11,958
 

 

 

 

 

 

 

  
Defaults
 
 
 
 
 
 
 
Additions
 
 167
 
 
 587
 
 754
 

 

 

 

 
 

 

  
Principal (reductions) additions(425) 85
 (52) 
 (70) (100) 
 (562)
                
Ending balance$630
 $1,147
 $2,688
 $
 $6,798
 $887
 $
 $12,150
                
Allowance for loan loss$15
 $221
 $206
 $
 $
 $743
 $
 $1,185
Three Months Ended September 30, 2016Commercial and Industrial Commercial Real Estate Residential Mortgages Home Improvement and Home Equity Real Estate Construction Development Agricultural Installment
& Other
 Total
Three Months Ended June 30, 2017Commercial and Industrial Commercial Real Estate Residential Mortgages Home Improvement and Home Equity Real Estate Construction Development Agricultural Installment
& Other
 Total
Beginning balance$1,236
 $1,510
 $2,400
 $
 $12,100
 $6
 $965
 $18,217
$1,212
 $1,091
 $2,351
 $
 $6,960
 $850
 $965
 $13,429


 

 

 

 

   

                 
Defaults
 
 
 
 
 
 
 

 
 
 
 
 
 
 
Additions
 
 
 
 
 
 
 
178
 
 238
 
 
 
 
 416


 

 

 

 
   

                 
Principal reductions10
 (25) (15) 
 (6,991) (5) 
 (7,026)(332) (29) (16) 
 (92) (450) (965) (1,884)
Charge-offs(3) 
 
 
 
 
 
  
                              
Ending balance$1,246
 $1,485
 $2,385
 $
 $5,109
 $1
 $965
 $11,191
$1,055
 $1,062
 $2,573
 $
 $6,868
 $400
 $
 $11,958
                              
Allowance for loan loss$38
 $472
 $163
 $
 $
 $
 $
 $673
$36
 $216
 $207
 $
 $
 $203
 $
 $662


The following tables summarize TDR activity by loan category for the ninesix months endedSeptember June 30, 20172018 and SeptemberJune 30, 20162017 (in 000's).
Nine Months Ended September 30, 2017Commercial and Industrial Commercial Real Estate Residential Mortgages Home Improvement and Home Equity Real Estate Construction Development Agricultural 
Installment
& Other
 Total
Six Months Ended June 30, 2018Commercial and Industrial Commercial Real Estate Residential Mortgages Home Improvement and Home Equity Real Estate Construction Development Agricultural 
Installment
& Other
 Total
Beginning balance$1,356
 $1,454
 $2,368
 $
 $6,267
 $
 $965
 $12,410
$436
 $1,233
 $2,542
 $
 $5,951
 $1,200
 $
 $11,362
                              
Defaults
 
 
 
 
 
 
 

 
 
 
 (310) 
 
 (310)
Additions247
 
 404
 
 790
 1,437
 
 2,878

 
 
 
 
 
 
 
                              
Principal reductions(973) (307) (84) 
 (259) (550) (965) (3,138)(263) 129
 (322) 
 (2,702) (190) 
 (3,348)
Charge-offs(63) 
 
 
 
 
 
 (63)
                              
Ending balance$630
 $1,147
 $2,688
 $
 $6,798
 $887
 $
 $12,150
$110
 $1,362
 $2,220
 $
 $2,939
 $1,010
 $
 $7,641
                              
Allowance for loan loss$15
 $221
 $206
 $
 $
 $743
 $
 $1,185
$
 $511
 $80
 $
 $
 $706
 $
 $1,297
Nine Months Ended September 30, 2016Commercial and Industrial Commercial Real Estate Residential Mortgages Home Improvement and Home Equity Real Estate Construction Development Agricultural 
Installment
& Other
 Total
Six Months Ended June 30, 2017Commercial and Industrial Commercial Real Estate Residential Mortgages Home Improvement and Home Equity Real Estate Construction Development Agricultural 
Installment
& Other
 Total
Beginning balance$898
 $1,243
 $3,533
 $
 $12,168
 $16
 $650
 $18,508
$1,356
 $1,454
 $2,368
 $
 $6,267
 $
 $965
 $12,410
                              
Defaults
 
 
 
 
 
 
 

 
 
 
 
 
 
 
Additions849
 
 
 
 
 
 
 849
247
 
 238
 
 790
 850
 
 2,125
                              
Principal additions (reductions)(501) 242
 (1,148) 
 (7,059) (15) 315
 (8,166)(538) (392) (33) 
 (189) (450) (965) (2,567)
Charge-offs(10) 
 
 
 
 
 
 (10)
                              
Ending balance$1,246
 $1,485
 $2,385
 $
 $5,109
 $1
 $965
 $11,191
$1,055
 $1,062
 $2,573
 $
 $6,868
 $400
 $
 $11,958
                              
Allowance for loan loss$38
 $472
 $163
 $
 $
 $
 $
 $673
$36
 $216
 $207
 $
 $
 $203
 $
 $662

Credit Quality Indicators

As part of its credit monitoring program, the Company utilizes a risk rating system which quantifies the risk the Company estimates it has assumed during the life of a loan. The system rates the strength of the borrower and the facility or transaction, and is designed to provide a program for risk management and early detection of problems.

For each new credit approval, credit extension, renewal, or modification of existing credit facilities, the Company assigns risk ratings utilizing the rating scale identified in this policy. In addition, on an on-going basis, loans and credit facilities are reviewed for internal and external influences impacting the credit facility that would warrant a change in the risk rating. Each loan credit facility is to be given a risk rating that takes into account factors that materially affect credit quality.

When assigning risk ratings, the Company evaluates two risk rating approaches, a facility rating and a borrower rating as follows:

Facility Rating:

The facility rating is determined by the analysis of positive and negative factors that may indicate that the quality of a particular loan or credit arrangement requires that it be rated differently from the risk rating assigned to the borrower. The Company assesses the risk impact of these factors:

Collateral - The rating may be affected by the type and quality of the collateral, the degree of coverage, the economic life of the collateral, liquidation value and the Company's ability to dispose of the collateral.

Guarantees - The value of third party support arrangements varies widely. Unconditional guaranties from persons with demonstrable ability to perform are more substantial than that of closely related persons to the borrower who offer only modest support.

Unusual Terms - Credit may be extended on terms that subject the Company to a higher level of risk than indicated in the rating of the borrower.

Borrower Rating:

The borrower rating is a measure of loss possibility based on the historical, current and anticipated financial characteristics of the borrower in the current risk environment. To determine the rating, the Company considers at least the following factors:

-    Quality of management
-    Liquidity
-    Leverage/capitalization
-    Profit margins/earnings trend
-    Adequacy of financial records
-    Alternative funding sources
-    Geographic risk

-    Industry risk
-    Cash flow risk
-    Accounting practices
-    Asset protection
-    Extraordinary risks

The Company assigns risk ratings to loans other than consumer loans and other homogeneous loan pools based on the following scale. The risk ratings are used when determining borrower ratings as well as facility ratings. When the borrower rating and the facility ratings differ, the lowest rating applied is:

-
Grades 1 and 2 – These grades include loans which are given to high quality borrowers with high credit quality and sound financial strength. Key financial ratios are generally above industry averages and the borrower’s strong earnings history or net worth. These may be secured by deposit accounts or high-grade investment securities.

-
Grade 3 – This grade includes loans to borrowers with solid credit quality with minimal risk. The borrower’s balance sheet and financial ratios are generally in line with industry averages, and the borrower has historically demonstrated the ability to manage economic adversity. Real estate and asset-based loans assigned this risk rating must have characteristics, which place them well above the minimum underwriting requirements for those departments. Asset-based borrowers assigned this rating must exhibit extremely favorable leverage and cash flow characteristics, and consistently demonstrate a high level of unused borrowing capacity.Asset-

based borrowers assigned this rating must exhibit extremely favorable leverage and cash flow characteristics, and consistently demonstrate a high level of unused borrowing capacity.

-
Grades 4 and 5 – These include “pass” grade loans to borrowers of acceptable credit quality and risk. The borrower’s balance sheet and financial ratios may be below industry averages, but above the lowest industry quartile. Leverage is above and liquidity is below industry averages. Inadequacies evident in financial performance and/or management sufficiency are offset by readily available features of support, such as adequate collateral, or good guarantors having the liquid assets and/or cash flow capacity to repay the debt. The borrower may have recognized a loss over three or four years, however recent earnings trends, while perhaps somewhat cyclical, are improving and cash flows are adequate to cover debt service and fixed obligations. Real estate and asset-borrowers fully comply with all underwriting standards and are performing according to projections would be assigned this rating. These also include grade 5 loans which are “leveraged” or on management’s “watch list.” While still considered pass loans (loans given a grade 5), the borrower’s financial condition, cash flow or operations evidence more than average risk and short term weaknesses, these loans warrant a higher than average level of monitoring, supervision and attention from the Company, but do not reflect credit weakness trends that weaken or inadequately protect the Company’s credit position. Loans with a grade rating of 5 are not normally acceptable as new credits unless they are adequately secured or carry substantial endorser/guarantors.

-
Grade 6 – This grade includes “special mention” loans which are loans that are currently protected but are potentially weak. This generally is an interim grade classification and should usually be upgraded to an Acceptable rating or downgraded to Substandard within a reasonable time period. Weaknesses in special mention loans may, if not checked or corrected, weaken the asset or inadequately protect the Company’s credit position at some future date. Special mention loans are often loans with weaknesses inherent from the loan origination, loan servicing, and perhaps some technical deficiencies. The main theme in special mention credits is the distinct probability that the classification will deteriorate to a more adverse class if the noted deficiencies are not addressed by the loan officer or loan management.

-
Grade 7 – This grade includes “substandard” loans which are inadequately supported by the current sound net worth and paying capacity of the borrower or of the collateral pledged, if any. Substandard loans have a well-defined weakness or weaknesses that may impair the regular liquidation of the debt. Substandard loans exhibit a distinct possibility that the Company will sustain some loss if the deficiencies are not corrected. Substandard loans also include impaired loans.

-
Grade 8 – This grade includes “doubtful” loans which exhibit the same characteristics as the Substandard loans with the added characteristic that the weaknesses make collection or liquidation in full, on the basis of currently existing facts, conditions and values, highly questionable and improbable. The possibility of loss is extremely high, but because of certain important and reasonably specific pending factors, which may work to the advantage and strengthening of the loan, its classification as an estimated loss is deferred until its more exact status may be determined. Pending factors include a proposed merger, acquisition, or liquidation procedures, capital injection, perfecting liens on additional collateral and refinancing plans.


-
Grade 9 – This grade includes loans classified “loss” which are considered uncollectible and of such little value that their continuance as bankable assets is not warranted. This classification does not mean that the asset has absolutely no recovery or salvage value, but rather it is not practical or desirable to defer writing off the asset even though partial recovery may be achieved in the future.
 
The Company did not carry any loans graded as loss at SeptemberJune 30, 20172018 or December 31, 20162017.


The following tables summarize the credit risk ratings for commercial, construction, and other non-consumer related loans for SeptemberJune 30, 20172018 and December 31, 2016:2017:
Commercial and Industrial Commercial Real Estate Real Estate Construction and Development Agricultural TotalCommercial and Industrial Commercial Real Estate Real Estate Construction and Development Agricultural Total
September 30, 2017 
June 30, 2018 
(in 000's)Commercial and Industrial Commercial Real Estate Real Estate Construction and Development Agricultural TotalCommercial and Industrial Commercial Real Estate Real Estate Construction and Development Agricultural Total
Grades 1 and 2  
Grade 3  
Grades 4 and 5 – pass40,155
 182,089
 108,506
 55,488
 386,238
54,230
 199,707
 85,057
 55,652
 394,646
Grade 6 – special mention2,635
 8,541
 2,609
 985
 14,770
10
 8,376
 
 
 8,386
Grade 7 – substandard3,512
 466
 17,768
 1,962
 23,708
3,173
 439
 23,514
 1,010
 28,136
Grade 8 – doubtful
 
 
 
 

 
 
 
 
Total$46,951
 $199,668
 $128,883
 $58,505
 $434,007
$57,955
 $212,513
 $108,571
 $56,662
 $435,701
Commercial and Industrial Commercial Real Estate Real Estate Construction and Development Agricultural TotalCommercial and Industrial Commercial Real Estate Real Estate Construction and Development Agricultural Total
December 31, 2016 
December 31, 2017 
(in 000's)Commercial and Industrial Commercial Real Estate Real Estate Construction and Development Agricultural TotalCommercial and Industrial Commercial Real Estate Real Estate Construction and Development Agricultural Total
Grades 1 and 2  
Grade 3  
Grades 4 and 5 – pass34,921
 192,699
 110,992
 56,843
 395,455
43,264
 207,568
 104,549
 56,817
 412,198
Grade 6 – special mention4,416
 621
 928
 
 5,965

 8,487
 720
 994
 10,201
Grade 7 – substandard4,505
 1,126
 18,767
 
 24,398
3,169
 454
 17,701
 1,600
 22,924
Grade 8 – doubtful
 
 
 
 

 
 
 
 
Total$49,005
 $200,213
 $130,687
 $56,918
 $436,823
$47,026
 $221,032
 $122,970
 $59,481
 $450,509
 
The Company follows consistent underwriting standards outlined in its loan policy for consumer and other homogeneous loans but, does not specifically assign a risk rating when these loans are originated. Consumer loans are monitored for credit risk and are considered “pass” loans until some issue or event requires that the credit be downgraded to special mention or worse.

The following tables summarize the credit risk ratings for consumer related loans and other homogeneous loans for SeptemberJune 30, 20172018 and December 31, 2016:2017:
September 30, 2017 December 31, 2016June 30, 2018 December 31, 2017
Residential Mortgages 
Home
Improvement and Home Equity
 Installment and Other Total Residential Mortgages 
Home
Improvement and Home Equity
 Installment and Other TotalResidential Mortgages 
Home
Improvement and Home Equity
 Installment and Other Total Residential Mortgages 
Home
Improvement and Home Equity
 Installment and Other Total
(in 000's)  
Not graded$74,355
 $486
 $54,750
 $129,591
 $69,955
 $573
 $41,855
 $112,383
$60,242
 $364
 $65,178
 $125,784
 $69,249
 $433
 $63,565
 $133,247
Pass14,659
 24
 2,827
 17,510
 15,669
 26
 2,120
 17,815
9,415
 22
 2,156
 11,593
 13,899
 24
 2,011
 15,934
Special Mention647
 
 
 647
 
 
 
 
636
 
 
 636
 643
 
 
 643
Substandard623
 
 6
 629
 1,764
 
 9
 1,773
219
 
 63
 282
 1,013
 
 5
 1,018
Doubtful
 
 
 
 
 
 965
 965

 
 
 
 
 
 
 
Total$90,284
 $510
 $57,583
 $148,377
 $87,388
 $599
 $44,949
 $132,936
$70,512
 $386
 $67,397
 $138,295
 $84,804
 $457
 $65,581
 $150,842


The following tables summarize the credit quality indicators for outstanding student loans as of June 30, 2018 and December 31, 2017 (in 000's, except for number of borrowers):
 June 30, 2018 December 31, 2017
 Number of Loans Amount (in 000's) Number of Loans Amount (in 000's)
School992
 $37,565
 1,216
 $48,825
Grace294
 13,724
 55
 1,446
Repayment184
 6,129
 201
 6,473
Deferment40
 1,270
 32
 1,128
Forbearance92
 3,006
 50
 1,981
Claim1
 67
 
 
Total1,603
 $61,761
 1,554
 $59,853

School - The time in which the borrower is still actively in school at least half time. No payments are expected during this stage, though the borrower may begin immediate payments.

Grace - A six month period of time granted to the borrower immediately upon graduation, or if deemed no longer an active student. Interest continues to accrue. Upon completion of the six month grace period the loan is transferred to repayment status. Additionally, if applicable, this status may represent a borrower activated to military duty while in their in-school period, they will be allowed to return to that status once their active duty has expired. The borrower must return to an at least half time status within six months of the active duty end date in order to return to an in-school status.

Repayment - The time in which the borrower is no longer actively in school at least half time, and has not received an approved grace, deferment, or forbearance. Regular payment is expected from these borrowers under an allotted payment plan.

Deferment - May be granted up to 48 months for borrowers who have begun the repayment period on their loans but are (1) actively enrolled in an eligible school at least half time, or (2) are actively enrolled in an approved and verifiable medical residency, internship, or fellowship program.

Forbearance - The period of time during which the borrower may postpone making principal and interest payments, which may be granted for either hardship or administrative reasons. Interest will continue to accrue on loans during periods of authorized forbearance. If the borrower is delinquent at the time the forbearance is granted, the delinquency will be covered by the forbearance and all accrued and unpaid interest from the date of delinquency or if none, from the date of beginning of the forbearance period, will be capitalized at the end of each forbearance period. The term of the loan will not change and payments may be increased to allow the loan to pay off in the required time frame.

Claim - Occurs after a loan has been delinquent for a period of time in which the servicer believes payment may not be received. A claim can be filed at any point in the delinquency, but typically not until 180 - 210 days. ReliaMax Surety Company was declared insolvent by the South Dakota Division of Insurance and is now in liquidation. No future claims will be filed with ReliaMax.

Allowance for Loan Losses

The Company analyzes risk characteristics inherent in each loan portfolio segment as part of the quarterly review of the adequacy of the allowance for loan losses. The following summarizes some of the key risk characteristics for the ten segments of the loan portfolio (Consumer loans include three segments):

Commercial and industrial loans – Commercial loans are subject to the effects of economic cycles and tend to exhibit increased risk as economic conditions deteriorate, or if the economic downturn is prolonged. The Company considers this segment to be one of higher risk given the size of individual loans and the balances in the overall portfolio.
 
Government program loans – This is a relatively a small part of the Company’s loan portfolio, but has historically had a high percentage of loans that have migrated from pass to substandard given their vulnerability to economic cycles.
 
Commercial real estate loans – This segment is considered to have more risk in part because of the vulnerability of commercial businesses to economic cycles as well as the exposure to fluctuations in real estate prices because most of these loans are

secured by real estate. Losses in this segment have however been historically low because most of the loans are real estate secured, and the bank maintains appropriate loan-to-value ratios.
 
Residential mortgages – This segment is considered to have low risk factors both from the Company and peer statistics. These loans are secured by first deeds of trust. The losses experienced over the past sixteen quarters are isolated to approximately nineseven loans and are generally the result of short sales.
 
Home improvement and home equity loans – Because of their junior lien position, these loans have an inherently higher risk level. Because residential real estate has been severely distressed in the recent past, the anticipated risk for this loan segment has increased.
 
Real estate construction and development loans –This segment of loans is considered to have a higher risk profile due to construction and market value issues in conjunction with normal credit risks.
 
Agricultural loans – This segment is considered to have risks associated with weather, insects, and marketing issues. In addition, concentrations in certain crops or certain agricultural areas can increase risk.

Installment and other loans (Includes consumer loans, student loans, overdrafts, and overdraft protection lines) – This segment is higher risk because many of the loans are unsecured. Additionally, in the case of student loans, there are increased risks associated with liquidity as there is a significant time lag between funding of a student loan and eventual repayment. The Company is still evaluating the impact of ReliaMax's insolvency and the elimination of the Surety Bond on the Company's allowance for loan loss related to student loans.

The following summarizes the activity in the allowance for credit losses by loan category for the quarters ended SeptemberJune 30, 20172018 and 20162017 (in 000's).
Three Months EndedCommercial and Industrial Real Estate Mortgage Real Estate Construction Development  Agricultural Installment & Other  Unallocated Total
June 30, 2018      
Beginning balance$1,985
 $1,204
 $2,862
 $1,342
 $821
 $902
 $9,116
Provision (recovery of provision) for credit losses(793) (7) (175) (41) (55) (65) (1,136)
              
Charge-offs
 
 
 
 (7) 
 (7)
Recoveries355
 16
 
 
 81
 
 452
Net charge-offs355
 16
 
 
 74
 
 445
              
Ending balance$1,547
 $1,213
 $2,687
 $1,301
 $840
 $837
 $8,425
Period-end amount allocated to: 
  
  
  
  
  
  
Loans individually evaluated for impairment444
 590
 
 706
 
 
 1,740
Loans collectively evaluated for impairment1,103
 623
 2,687
 595
 840
 837
 6,685
Ending balance$1,547
 $1,213
 $2,687
 $1,301
 $840
 $837
 $8,425

Three Months EndedCommercial and Industrial Real Estate Mortgage Real Estate Construction Development  Agricultural Installment & Other  Unallocated TotalCommercial and Industrial Real Estate Mortgage Real Estate Construction Development  Agricultural Installment & Other  Unallocated Total
September 30, 2017 
June 30, 2017Commercial and Industrial Real Estate Mortgage Real Estate Construction Development  Agricultural Installment & Other  Unallocated Total
Beginning balance$1,764
 $1,174
 $2,887
 $1,589
 $814
 $777
 $9,005
 
Provision (recovery of provision) for credit losses(271) (91) 112
 81
 (69) 245
 7
(72) (118) (209) 492
 (92) (53) (52)


 

 

 

 

 

               
Charge-offs(1) 
 
 
 
 
 (1)(98) 
 
 
 (5) 
 (103)
Recoveries11
 59
 
 
 77
 
 147
154
 7
 
 
 53
 
 214
Net charge-offs10
 59
 
 
 77
 
 146
56
 7
 
 
 48
 
 111
                          
Ending balance$1,503
 $1,142
 $2,999
 $1,670
 $822
 $1,022
 $9,158
$1,765
 $1,174
 $2,887
 $1,589
 $804
 $788
 $9,007
Period-end amount allocated to: 
  
  
  
  
  
  
 
  
  
  
  
  
  
Loans individually evaluated for impairment571
 427
 
 743
 
 
 1,741
711
 441
 
 793
 
 
 1,945
Loans collectively evaluated for impairment932
 715
 2,999
 927
 822
 1,022
 7,417
1,054
 733
 2,887
 796
 804
 788
 7,062
Ending balance$1,503
 $1,142
 $2,999
 $1,670
 $822
 $1,022
 $9,158
$1,765
 $1,174
 $2,887
 $1,589
 $804
 $788
 $9,007

Three Months EndedCommercial and Industrial Real Estate Mortgage Real Estate Construction Development  Agricultural Installment & Other  Unallocated Total
September 30, 2016      
Beginning balance$1,685
 $1,665
 $3,455
 $554
 $1,219
 $331
 $8,909
Provision (recovery of provision) for credit losses(15) (131) 271
 74
 (438) 243
 4
 

 

 

 

 

 

  
Charge-offs(4) (7) 
 
 
 (4) (15)
Recoveries13
 6
 
 
 1
 
 20
Net charge-offs9
 (1) 0
 0
 1
 (4) 5
              
Ending balance$1,679
 $1,533
 $3,726
 $628
 $782
 $570
 $8,918
Period-end amount allocated to: 
  
  
  
  
  
  
Loans individually evaluated for impairment735
 635
 
 
 
 
 1,370
Loans collectively evaluated for impairment944
 898
 3,726
 628
 782
 570
 7,548
Ending balance$1,679
 $1,533
 $3,726
 $628
 $782
 $570
 $8,918

The following summarizes the activity in the allowance for credit losses by loan category for the ninesix months endedSeptember June 30, 20172018 and 20162017 (in 000's).
Nine Months EndedCommercial and Industrial Real Estate Mortgage Real Estate Construction Development  Agricultural Installment & Other  Unallocated Total
September 30, 2017 
Six Months EndedCommercial and Industrial Real Estate Mortgage Real Estate Construction Development  Agricultural Installment & Other  Unallocated Total
June 30, 2018 
Beginning balance$1,843
 $1,430
 $3,378
 $666
 $888
 $697
 $8,902
$1,408
 $1,182
 $2,903
 $1,631
 $887
 $1,256
 $9,267
Provision (recovery of provision) for credit losses(408) (359) (379) 983
 (198) 337
 (24)(181) 11
 (216) (330) (190) (419) (1,325)
                          
Charge-offs(106) (2) 
 
 
 (12) (120)(88) 
 
 
 (11) 
 (99)
Recoveries174
 73
 
 21
 132
 
 400
408
 20
 
 
 154
 
 582
Net recoveries68
 71
 
 21
 132
 (12) 280
320
 20
 
 
 143
 
 483
                          
Ending balance$1,503
 $1,142
 $2,999
 $1,670
 $822
 $1,022
 $9,158
$1,547
 $1,213
 $2,687
 $1,301
 $840
 $837
 $8,425
Period-end amount allocated to: 
  
  
  
  
  
  
 
  
  
  
  
  
  
Loans individually evaluated for impairment571
 427
 
 743
 
 
 1,741
444
 590
 
 706
 
 
 1,740
Loans collectively evaluated for impairment932
 715
 2,999
 927
 822
 1,022
 7,417
1,103
 623
 2,687
 595
 840
 837
 6,685
Ending balance$1,503
 $1,142
 $2,999
 $1,670
 $822
 $1,022
 $9,158
$1,547
 $1,213
 $2,687
 $1,301
 $840
 $837
 $8,425
Nine Months EndedCommercial and Industrial Real Estate Mortgage Real Estate Construction Development  Agricultural Installment & Other  Unallocated Total
September 30, 2016 
Six Months EndedCommercial and Industrial Real Estate Mortgage Real Estate Construction Development  Agricultural Installment & Other  Unallocated Total
June 30, 2017 
Beginning balance$1,652
 $1,449
 $4,629
 $655
 $1,258
 $70
 $9,713
$1,843
 $1,430
 $3,378
 $666
 $888
 $697
 $8,902
Provision (recovery of provision) for credit losses822
 93
 (933) (27) (482) 520
 (7)(137) (268) (491) 902
 (128) 91
 (31)
                          
Charge-offs(846) (29) 
 
 
 (20) (895)(105) (2) 
 
 (10) 
 (117)
Recoveries51
 20
 30
 
 6
 
 107
164
 14
 
 21
 54
 
 253
Net charge-offs(795) (9) 30
 
 6
 (20) (788)59
 12
 
 21
 44
 
 136
                          
Ending balance$1,679
 $1,533
 $3,726
 $628
 $782
 $570
 $8,918
$1,765
 $1,174
 $2,887
 $1,589
 $804
 $788
 $9,007
Period-end amount allocated to: 
  
  
  
  
  
  
 
  
  
  
  
  
  
Loans individually evaluated for impairment735
 635
 
 

 
 
 1,370
711
 441
 
 793
 
 
 1,945
Loans collectively evaluated for impairment944
 898
 3,726
 628
 782
 570
 7,548
1,054
 733
 2,887
 796
 804
 788
 7,062
Ending balance$1,679
 $1,533
 $3,726
 $628
 $782
 $570
 $8,918
$1,765
 $1,174
 $2,887
 $1,589
 $804
 $788
 $9,007


The following summarizes information with respect to the loan balances at SeptemberJune 30, 20172018 and 2016.2017.
September 30, 2017 September 30, 2016June 30, 2018 June 30, 2017
Loans
Individually
Evaluated for Impairment
 
Loans
Collectively
Evaluated for Impairment
 Total Loans 
Loans
Individually
Evaluated for Impairment
 
Loans
Collectively
Evaluated for Impairment
 Total Loans
Loans
Individually
Evaluated for Impairment
 
Loans
Collectively
Evaluated for Impairment
 Total Loans 
Loans
Individually
Evaluated for Impairment
 
Loans
Collectively
Evaluated for Impairment
 Total Loans
(in 000's)  
Commercial and Business Loans$3,604
 $42,333
 $45,937
 $5,101
 $52,404
 $57,505
$2,949
 $54,098
 $57,047
 $3,950
 $47,128
 $51,078
Government Program Loans83
 931
 1,014
 365
 1,612
 1,977
309
 599
 908
 396
 997
 1,393
Total Commercial and Industrial3,687
 43,264
 46,951
 5,466
 54,016
 59,482
3,258
 54,697
 57,955
 4,346
 48,125
 52,471
                      
Commercial Real Estate Loans1,151
 198,517
 199,668
 1,511
 179,983
 181,494
1,367
 211,146
 212,513
 1,066
 201,298
 202,364
Residential Mortgage Loans2,793
 87,491
 90,284
 2,961
 98,339
 101,300
2,228
 68,284
 70,512
 2,678
 76,641
 79,319
Home Improvement and Home Equity Loans
 510
 510
 
 760
 760

 386
 386
 
 572
 572
Total Real Estate Mortgage3,944
 286,518
 290,462
 4,472
 279,082
 283,554
3,595
 279,816
 283,411
 3,744
 278,511
 282,255
                      
Real Estate Construction and Development Loans6,816
 122,067
 128,883
 12,131
 126,043
 138,174
11,764
 96,807
 108,571
 6,878
 117,871
 124,749
                      
Agricultural Loans891
 57,614
 58,505
 6
 46,757
 46,763
1,017
 55,645
 56,662
 1,056
 57,376
 58,432
                      
Installment and Other Loans
 57,583
 57,583
 965
 28,271
 29,236
62
 67,335
 67,397
 
 49,333
 49,333
                      
Total Loans$15,338
 $567,046
 $582,384
 $23,040
 $534,169
 $557,209
$19,696
 $554,300
 $573,996
 $16,024
 $551,216
 $567,240


4.Deposits

Deposits include the following:
(in 000's)September 30, 2017 December 31, 2016June 30, 2018 December 31, 2017
Noninterest-bearing deposits$315,877
 $262,697
$281,686
 $307,299
Interest-bearing deposits: 
  
 
  
NOW and money market accounts262,037
 235,873
322,995
 234,154
Savings accounts81,378
 75,068
85,480
 81,408
Time deposits: 
  
 
  
Under $250,00053,702
 87,419
51,925
 51,687
$250,000 and over12,304
 15,572
14,877
 13,145
Total interest-bearing deposits409,421
 413,932
475,277
 380,394
Total deposits$725,298
 $676,629
$756,963
 $687,693
      
Total brokered deposits included in time deposits above$9,755
 $28,132
Total brokered deposits included in time deposits above *$
 $
* CDARs reciprocal deposits are no longer considered brokered deposits for the Company.
 
5.Short-term Borrowings/Other Borrowings

At  SeptemberJune 30, 20172018, the Company had collateralized lines of credit with the Federal Reserve Bank of San Francisco totaling $283,948,000279,450,000, as well as Federal Home Loan Bank (FHLB) lines of credit totaling $14,400,0004,687,000. At SeptemberJune 30, 2017,2018, the Company had an uncollateralized line of credit with Pacific Coast Bankers Bank ("PCBB") totaling $10,000,000, a Fed Funds line of $10,000,000 with Union Bank, and a Fed Funds line of $20,000,000 with Zions First National Bank. All lines of credit are on an “as available” basis and can be revoked by the grantor at any time. These lines of credit have interest rates that are generally tied to the Federal Funds rate or are indexed to short-term U.S. Treasury rates or LIBOR. FHLB advances are collateralized by the Company’s stock in the FHLB, investment securities, and certain qualifying mortgage loans. As of SeptemberJune 30, 20172018, $15,327,0007,130,000 in investment securities at FHLB were pledged as collateral for FHLB advances. Additionally, $410,463,000415,304,000 in

secured and unsecured loans were pledged at SeptemberJune 30, 20172018, as collateral for borrowing lines with the Federal Reserve Bank totaling $283,948,000.Bank. At SeptemberJune 30, 20172018, the Company had no outstanding borrowings.
 
At December 31, 20162017, the Company had collateralized lines of credit with the Federal Reserve Bank of San Francisco totaling $323,162,000305,236,000, as well as Federal Home Loan Bank (“FHLB”) lines of credit totaling $2,037,00013,363,000. At December 31, 20162017, the Company had an uncollateralized line of credit with Pacific Coast Bankers Bank ("PCBB") totaling $10,000,000 and a Fed Funds line of $20,000,000 with Zions First National Bank. All lines of credit are on an “as available” basis and can be revoked by the grantor at any time. These lines of credit generally have interest rates tied to the Federal Funds rate or are indexed to short-term U.S. Treasury rates or LIBOR. FHLB advances are collateralized by the Company’s stock in the FHLB, investment securities, and certain qualifying mortgage loans. As of December 31, 20162017, $2,152,00017,049,000 in investment securities at FHLB were pledged as collateral for FHLB advances. Additionally, $471,737,000473,364,000 in secured and unsecured loans were pledged at December 31, 20162017, as collateral for used and unused borrowing lines with the Federal Reserve Bank totaling $323,162,000.Bank. At December 31, 20162017, the Company had no outstanding borrowings.

All lines of credit are on an “as available” basis and can be revoked by the grantor at any time.


6.Supplemental Cash Flow Disclosures
 
Nine months ended September 30,Six months ended June 30,
(in 000's)2017 20162018 2017
Cash paid during the period for:      
Interest$1,313
 $1,003
$1,137
 $886
Income taxes$5,700
 $1,110
$4,800
 $4,410
Noncash investing activities: 
  
 
  
OREO financed$
 $3,766
Unrealized gain on securities$355
 $118
Unrealized gains on unrecognized post retirement costs$27
 $26
Unrealized loss on available for sale securities$(428) $355
Unrealized gains on TRUPs$295
 $
Stock dividends issued$1,220
 $1,673
$
 $1,220
Cash dividend declared$1,182
 $
$1,520
 $845
Adoption of ASU 2016-01: reclassification of TRUPS to accumulated other comprehensive income$1,482
 $
Adoption of ASU 2016-01: recognition of previously unrealized losses within CRA Fund$184
 $

7.Dividends on Common Stock

On March 28, 2017, the Company’s Board of Directors declared a one-percent (1%) stock dividend on the Company’s outstanding common stock. Based upon the number of outstanding common shares on the record date of April 7, 2017, 167,082 additional shares were issued to shareholders on April 17, 2017. Because the stock dividend was considered a “small stock dividend,” approximately $1,219,759 was transferred from retained earnings to common stock based upon the $7.38 closing price of the Company’s common stock on the declaration date of March 28, 2017. There were no fractional shares paid. Except for earnings-per-share calculations, shares issued for the stock dividend have been treated prospectively for financial reporting purposes. For purposes of earnings per share calculations, the Company’s weighted average shares outstanding and potentially dilutive shares used in the computation of earnings per share have been restated after giving retroactive effect to a 1% stock dividend to shareholders for all periods presented.

On April 25, 2017,27, 2018, the Company’s Board of Directors declared a cash dividend of $0.05$0.09 per share on the Company's common stock. The dividend was payable on May 17, 2017,April 19, 2018, to shareholders of record as of May 8, 2017.April 9, 2018. Approximately $846,000$1,520,000 was transfered from retained earnings to cashdividends payable to allow for distribution of the dividend to shareholders. The

On June 26, 2018, the Company's Board of Directors alsodeclared a regular quarterly cash dividend $0.09 per share on the Company's common stock. The dividend was payable on July 19, 2018, to shareholders of record as of July 9, 2018. Approximately $1,520,000 was transfered from retained earnings to dividends payable to allow for distribution of the dividend to shareholders.

During 2017, the Board of Directors authorized the repurchase of up to $3 million of the outstanding common stock of the Company. The timing of the purchases will depend on certain factors, including but not limited to, market conditions and prices, available funds, and alternative uses of capital. The stock repurchase program may be carried out through open-market purchases, block trades, or negotiated private transactions.

On June 27, 2017, the Company’s Board of Directors declared a cash dividend of $0.05 per share on the Company's common stock. The dividend was payable on July 21, 2017, to shareholders of record as of July 7, 2017. Approximately $844,000 were transfered from retained earnings to cash to allow for distribution of the dividend to shareholders.

On September 26, 2017, the Company’s Board of Directors declared a cash dividend of $0.07 per share on the Company's common stock. The dividend is payable on October 19, 2017, to shareholders of record as of October 10, 2017. Approximately $1,182,000 were transfered from retained earnings to other liabilities to allow for distribution of the dividend to shareholders.

At this time, no shares have been repurchased.

8.Net Income per Common Share

The following table provides a reconciliation of the numerator and the denominator of the basic EPS computation with the numerator and the denominator of the diluted EPS computation:

Three months ended September 30, Nine months ended September 30,Three months ended June 30, Six months ended June 30,
2017 2016 2017 20162018 2017 2018 2017
Net income (000's, except per share amounts)$2,740
 $2,040
 $7,004
 $5,830
$3,392
 $2,492
 $6,549
 $4,263
              
Weighted average shares issued16,885,615
 16,881,422
 16,885,578
 16,880,835
16,899,968
 16,875,336
 16,895,135
 16,792,083
Add: dilutive effect of stock options21,652
 9,644
 18,485
 6,243
57,314
 19,037
 40,776
 16,650
Weighted average shares outstanding adjusted for potential dilution16,907,267
 16,891,066
 16,904,063
 16,887,078
16,957,282
 16,894,373
 16,935,911
 16,808,733
              
Basic earnings per share$0.16
 $0.12
 $0.41
 $0.35
$0.20
 $0.15
 $0.39
 $0.25
Diluted earnings per share$0.16
 $0.12
 $0.41
 $0.35
$0.20
 $0.15
 $0.39
 $0.25
Anti-dilutive stock options excluded from earnings per share calculation30,000
 21,000
 30,000
 21,000
60,000
 30,000
 103,000
 30,000
Prior year anti-dilutive stock options excluded from earnings per share calculation have been restated to reflect the impact of stock dividends.
9.Taxes on Income
 
The Company periodically reviews its tax positions under the accounting standards related to uncertainty in income taxes, which defines the criteria that an individual tax position would have to meet for some or all of the income tax benefit to be recognized in a taxable entity’s financial statements. Under the guidelines, an entity should recognize the financial statement benefit of a tax position if it determines that it is more likely than not that the position will be sustained on examination. The term “more likely than not” means a likelihood of more than 50 percent. In assessing whether the more-likely-than-not criterion is met, the entity should assume that the tax position will be reviewed by the applicable taxing authority and all available information is known to the taxing authority.

The Company periodically evaluates its deferred tax assets to determine whether a valuation allowance is required based upon a determination that some or all of the deferred assets may not be ultimately realized. At SeptemberJune 30, 20172018 and December 31, 20162017, the Company had no recorded valuation allowance.

The Company and its subsidiary file income tax returns in the U.S federal jurisdiction, and several states within the U.S. There are no filings in foreign jurisdictions. During 2014, the Company began the process to amend its California state tax returns for the years 2009 through 2012 to file a combined report on a unitary basis with the Company and USB Investment Trust. The amended return for 2009 was filed during 2014, the 2010 return was filed during 2015, and the amended returns for 2009, 2010,2011 and 20112012 were filed in 2014, 2015, and 2016 respectively.2016. The amended returnCompany is no longer subject to examination for 2012 was filed during 2016. During the third quarter of 2016, the IRS notified the Company it would be conducting an examination of the Company's 2014 federal return.years before 2013. As of SeptemberJune 30, 2017,2018, the Company is unaware of any change in tax positions as a result of the IRS examination.

The Company's policy is to recognize any interest or penalties related to uncertain tax positions in income tax expense. Interest and penalties recognized during the periods ended SeptemberJune 30, 20172018 and 20162017 were insignificant.

The Company reported a provision for income taxes of $2,653,000 for the six months ended June 30, 2018 as compared to the $2,845,000 provision reported in the comparable period of 2017. The effective tax rate was 28.83% for the six months ended June 30, 2018 as compared to 40.03% for the comparable period of 2017. The disparity between the effective tax rates for 2018 as compared to 2017 is primarily due to a decrease in the federal corporate tax rate from 34% in 2017 to 21% in 2018 related to the Tax Cuts and Jobs Act of 2017.

10.Junior Subordinated Debt/Trust Preferred Securities
 
Effective September 30, 2009 and beginning with the quarterly interest payment due October 1, 2009, the Company elected to defer interest payments on the Company's $15.0 million of junior subordinated debentures relating to its trust preferred securities. The terms of the debentures and trust indentures allow for the Company to defer interest payments for up to 20 consecutive quarters without default or penalty. During the period that the interest deferrals were elected, the Company continued to record interest expense associated with the debentures. As of June 30, 2014, the Company ended the extension period, paid all accrued and unpaid interest, and is currently making quarterly interest payments. The Company may redeem the junior subordinated debentures at any time at par.

During August 2015, the Bank purchased $3.0 million of the Company's junior subordinated debentures related to the Company's trust preferred securities at a fair value discount of 40%. Subsequently, in September 2015, the Company purchased those shares from the Bank and canceled $3.0 million in par value of the junior subordinated debentures, realizing a $78,000 gain on redemption. The contractual principal balance of the Company's debentures relating to its trust preferred securities is $12.0 million as of SeptemberJune 30, 2017.2018.
 

The fair value guidance generally permits the measurement of selected eligible financial instruments at fair value at specified election dates. Effective January 1, 2008, the Company elected the fair value option for its junior subordinated debt issued under USB Capital Trust II. The Company believes the election of fair value accounting for the junior subordinated debentures better reflects the true economic value of the debt instrument on the balance sheet. The rate paid on the junior subordinated debt issued under USB Capital Trust II is 3-month LIBOR plus 129 basis points, and is adjusted quarterly.
 
At SeptemberJune 30, 20172018 the Company performed a fair value measurement analysis on its junior subordinated debt using a cash flow model approach to determine the present value of those cash flows. The cash flow model utilizes the forward 3-month LIBOR curve to estimate future quarterly interest payments due over the thirty-year life of the debt instrument. These cash flows were discounted at a rate which incorporates a current market rate for similar-term debt instruments, adjusted for additional credit and liquidity risks associated with the junior subordinated debt. We believe the 5.89%6.05% discount rate used represents what a

market participant would consider under the circumstances based on current market assumptions. At SeptemberJune 30, 2017,2018, the total cumulative gain recorded on the debt is $3,008,000.$2,447,000.
 
Effective January 1, 2018, the Company elected ASU 2016-01 which modified the recognition and measurement of Financial Assets and Liabilities. Upon adoption of the standard, the fair value determined for the period would separately present in other comprehensive income the portion of the total change in the fair value resulting from a change in the instrument-specific credit risk. As of January 1, 2018 a cumulative effect adjustment of $1,482,000 was made to accumulated other comprehensive income.

The net fair value calculation performed at Septemberas of June 30, 20172018 resulted in a pretax loss adjustment of $688,000 ($405,000,$367,000 for the six months ended June 30, 2018, compared to a pretax loss adjustment of $601,000 ($354,000, net of tax) for the ninesix months endedSeptember June 30, 2017, compared to a pretax gain adjustment2017. As part of $48,000 ($28,000, netthe adoption of tax)ASU 2016-01, for the ninesix months endedSeptember June 30, 2016. Fair2018, net fair value gains and losses are reflectedseparately identified as the portion attributed to non-instrument specific credit risk, recognized as a component of noninterest income on the consolidated statements of income, and instrument specific credit risk, recognized in other comprehensive income.

For the six months ended June 30, 2018, the net $367,000 fair value loss adjustment was separately presented as a $661,000 loss ($464,000, net of tax) recognized on the consolidated statements of income, and a $295,000 gain ($207,000, net of tax) associated with the instrument specific credit risk recognized in other comprehensive income. The adoption of ASU 2016-01's resulting impact on basic and diluted earnings per share was $0.01.

The net fair value calculation performed at SeptemberJune 30, 20172018 resulted in a pretax loss adjustment of $88,000$464,000 for the three months ended June 30, 2018, compared to a pretax loss adjustment of $264,000 ($52,000,126,000, net of tax) for the three months ended SeptemberJune 30, 2017, compared to a pretax gain adjustment2017. As part of $423,000 ($249,000, netthe adoption of tax)ASU 2016-01, for the three months ended SeptemberJune 30, 2016. Fair2018, net fair value gains and losses are reflectedseparately identified as the portion attributed to non-instrument specific credit risk, recognized as a component of noninterest income on the consolidated statements of income, and instrument specific credit risk, recognized in other comprehensive income.

For the three months ended June 30, 2018, the net $464,000 fair value loss adjustment was separately presented as a $192,000 loss ($135,000, net of tax) recognized on the consolidated statements of income, and a $272,000 loss ($192,000, net of tax) associated with the instrument specific credit risk recognized in other comprehensive income. The adoption of ASU 2016-01's resulting impact on basic and diluted earnings per share was $0.01.

11.Fair Value Measurements and Disclosure
 
The following summary disclosures are made in accordance with the guidance provided by ASC Topic 825, Fair Value Measurements and Disclosures (formerly Statement of Financial Accounting Standards No. 107, Disclosures about Fair Value of Financial Instruments), which requires the disclosure of fair value information about both on- and off-balance sheet financial instruments where it is practicable to estimate that value.
 
Generally accepted accounting guidance clarifies the definition of fair value, describes methods used to appropriately measure fair value in accordance with generally accepted accounting principles and expands fair value disclosure requirements. This guidance applies whenever other accounting pronouncements require or permit fair value measurements.

The fair value hierarchy prioritizes the inputs to valuation techniques used to measure fair value into three broad levels (Level 1, Level 2, and Level 3). Level 1 inputs are unadjusted quoted prices in active markets (as defined) for identical assets or liabilities that the reporting entity has the ability to access at the measurement date. Level 2 inputs are inputs other than quoted prices included within Level 1 that are observable for the asset or liability, either directly or indirectly. Level 3 inputs are unobservable inputs for the asset or liability, and reflect the reporting entity’s own assumptions about the assumptions that market participants would use in pricing the asset or liability (including assumptions about risk).

In accordance with the prospective adoption of ASU No. 2016-01, the fair value of loans as of June 30, 2018 was measured using an exit price notion. The fair value of loans as of December 31, 2017 was measured using an entry price notion.
 
The table below is a summary of fair value estimates for financial instruments and the level of the fair value hierarchy within which the fair value measurements are categorized at the periods indicated:

September 30, 2017
June 30, 2018June 30, 2018
(in 000's)Carrying Amount Estimated Fair Value Quoted Prices In Active Markets for Identical Assets Level 1 Significant Other Observable Inputs Level 2 Significant Unobservable Inputs Level 3Carrying Amount Estimated Fair Value Quoted Prices In Active Markets for Identical Assets Level 1 Significant Other Observable Inputs Level 2 Significant Unobservable Inputs Level 3
Financial Assets:                  
Cash and cash equivalents$159,892
 $159,892
 $159,892
 $
 $
$191,128
 $191,128
 $191,128
 $
 $
Interest-bearing deposits654
 654
 
 654
 
Investment securities48,356
 48,356
 3,783
 44,573
 
AFS Investment securities56,724
 56,724
 
 56,724
 
Marketable equity securities3,659
 3,659
 3,659
 
 
Loans574,443
 569,970
 
 
 569,970
565,926
 555,193
 
 
 555,193
Accrued interest receivable5,846
 5,846
 
 5,846
 
8,392
 8,392
 
 8,392
 
Financial Liabilities: 
  
  
  
  
 
  
  
  
  
Deposits: 
  
  
  
  
 
  
  
  
  
Noninterest-bearing315,877
 315,877
 315,877
 
 
281,686
 281,686
 281,686
 
 
NOW and money market262,037
 262,037
 262,037
 
 
322,995
 322,995
 322,995
 
 
Savings81,378
 81,378
 81,378
 
 
85,480
 85,480
 85,480
 
 
Time deposits66,006
 65,658
 
 
 65,658
66,802
 66,159
 
 
 66,159
Total deposits725,298
 724,950
 659,292
  
 65,658
756,963
 756,320
 690,161
  
 66,159
Junior subordinated debt9,534
 9,534
 
 
 9,534
10,125
 10,125
 
 
 10,125
Accrued interest payable41
 41
 
 41
 
43
 43
 
 43
 
December 31, 2016
December 31, 2017December 31, 2017
(in 000's)Carrying Amount Estimated Fair Value Quoted Prices In Active Markets for Identical Assets Level 1 Significant Other Observable Inputs Level 2 Significant Unobservable Inputs Level 3Carrying Amount Estimated Fair Value Quoted Prices In Active Markets for Identical Assets Level 1 Significant Other Observable Inputs Level 2 Significant Unobservable Inputs Level 3
Financial Assets:                  
Cash and cash equivalents$113,032
 $113,032
 $113,032
 $
 $
$107,934
 $107,934
 $107,934
 $
 $
Interest-bearing deposits650
 650
 
 650
 
Investment securities57,491
 57,491
 3,716
 53,775
 
41,985
 45,722
 3,737
 41,985
 
Loans561,932
 557,914
 
 
 557,914
593,123
 588,938
 
 
 588,938
Accrued interest receivable3,895
 3,895
 
 3,895
 
6,526
 6,526
 
 6,526
 
Financial Liabilities: 
  
  
  
  
 
  
  
  
  
Deposits: 
  
  
  
  
 
  
  
  
  
Noninterest-bearing262,697
 262,697
 262,697
 
 
307,299
 307,299
 307,299
 
 
NOW and money market235,873
 235,873
 235,873
 
 
234,154
 234,154
 234,154
 
 
Savings75,068
 75,068
 75,068
 
 
81,408
 81,408
 81,408
 
 
Time deposits102,991
 102,743
 
 
 102,743
64,832
 64,387
 
 
 64,387
Total deposits676,629
 676,381
 573,638
 
 102,743
687,693
 687,248
 622,861
 
 64,387
Junior subordinated debt8,832
 8,832
 
 
 8,832
9,730
 9,730
 
 
 9,730
Accrued interest payable76
 76
 
 76
 
44
 44
 
 44
 
 
The Company performs fair value measurements on certain assets and liabilities as the result of the application of current accounting guidelines. Some fair value measurements, such as available-for-saleinvestment securities (AFS) and junior subordinated debt are performed on a recurring basis, while others, such as impairment of loans, other real estate owned, goodwill and other intangibles, are performed on a nonrecurring basis.

The Company’s Level 1 financial assets consist of money market funds and highly liquid mutual funds for which fair values are based on quoted market prices. The Company’s Level 2 financial assets include highly liquid debt instruments of U.S. government agencies, collateralized mortgage obligations, and debt obligations of states and political subdivisions, whose fair

values are obtained from readily-available pricing sources for the identical or similar underlying security that may, or may not,

be actively traded. The Company’s Level 3 financial assets include certain instruments where the assumptions may be made by us or third parties about assumptions that market participants would use in pricing the asset or liability. From time to time, the Company recognizes transfers between Level 1, 2, and 3 when a change in circumstances warrants a transfer. There were no transfers in or out of Level 1 and Level 2 fair value measurements during the three or nine month periodsperiod ended SeptemberJune 30, 20172018.

The following methods and assumptions were used in estimating the fair values of financial instruments:
Cash and Cash Equivalents - The carrying amounts reported in the consolidated balance sheets for cash and cash equivalents approximate their estimated fair values.
Interest-bearing Deposits – Interest bearing deposits in other banks consist of fixed-rate certificates of deposits. Accordingly,instruments measured at fair value has been estimated based upon interest rates currently being offered on deposits with similar characteristicsa recurring and maturities.non-recurring basis:

Investment Securities – Available for sale and marketable equity securities are valued based upon open-market price quotes obtained from reputable third-party brokers that actively make a market in those securities. Market pricing is based upon specific CUSIP identification for each individual security. To the extent there are observable prices in the market, the mid-point of the bid/ask price is used to determine fair value of individual securities. If that data is not available for the last 30 days, a Level 2-type matrix pricing approach based on comparable securities in the market is utilized. Level 2 pricing may include using a forward spread from the last observable trade or may use a proxy bond like a TBA mortgage to come up with a price for the security being valued. Changes in fair market value are recorded through other comprehensive loss as the securities are available for sale.

Loans - Fair values of variable rate loans, which reprice frequently and with no significant change in credit risk, are based on carrying values adjusted for credit risk.  Fair values for all other loans, except impaired loans, are estimated using discounted cash flows over their remaining maturities, using interest rates at which similar loans would currently be offered to borrowers with similar credit ratings and for the same remaining maturities. The allowance for loan loss is considered to be a reasonable estimate of loan discount for credit quality concerns.
 
Impaired Loans - Fair value measurements for collateral dependent impaired loans are performed pursuant to authoritative accounting guidance and are based upon either collateral values supported by appraisals and observed market prices. Collateral dependent loans are measured for impairment using the fair value of the collateral. Changes are recorded directly as an adjustment to current earnings.

Other Real Estate Owned - Nonrecurring adjustments to certain commercial and residential real estate properties classified as other real estate owned (OREO) are measured at the lower of carrying amount or fair value, less costs to sell.  Fair values are generally based on third party appraisals of the property, resulting in a Level 3 classification.  In cases where the carrying amount exceeds the fair value, less costs to sell, an impairment loss is recognized.

Deposits – Fair values for transaction and savings accounts are equal to the respective amounts payable on demand (i.e., carrying amounts). Fair values of fixed-maturity certificates of deposit were estimated using the rates currently offered for deposits with similar remaining maturities.

Junior Subordinated Debt – The fair value of the junior subordinated debt was determined based upon a discounted cash flows model utilizing observable market rates and credit characteristics for similar debt instruments. In its analysis, the Company used characteristics that market participants generally use, and considered factors specific to (a) the liability, (b) the principal (or most advantageous) market for the liability, and (c) market participants with whom the reporting entity would transact in that market. Cash flows are discounted at a rate which incorporates a current market rate for similar-term debt instruments, adjusted for credit and liquidity risks associated with similar junior subordinated debt and circumstances unique to the Company. The Company believes that the subjective nature of theses inputs, due primarily to the current economic environment, require the junior subordinated debt to be classified as a Level 3 fair value.
 
Accrued Interest Receivable and Payable- The carrying value of these instruments is a reasonable estimate of fair value.
Off-Balance Sheet Instruments - Off-balance sheet instruments consist of commitments to extend credit, standby letters of credit and derivative contracts. Fair values of commitments to extend credit are estimated using the interest rate currently charged to enter into similar agreements, taking into account the remaining terms of the agreements and the present

counterparties’ credit standing. There was no material difference between the contractual amount and the estimated fair value of commitments to extend credit at September 30, 2017 and December 31, 2016.
Fair values of standby letters of credit are based on fees currently charged for similar agreements. The fair value of commitments generally approximates the fees received from the customer for issuing such commitments. These fees are not material to the Company’s consolidated balance sheets and results of operations.
The following table provides a description of the valuation technique, unobservable input, and qualitative information about the unobservable inputs for the Company’s assets and liabilities classified as Level 3 and measured at fair value on a recurring basis at SeptemberJune 30, 20172018 and December 31, 2016:2017:
September 30, 2017 December 31, 2016
June 30, 2018June 30, 2018 December 31, 2017
Financial InstrumentValuation TechniqueUnobservable InputWeighted Average Financial InstrumentValuation TechniqueUnobservable InputWeighted AverageValuation TechniqueUnobservable InputWeighted Average Financial InstrumentValuation TechniqueUnobservable InputWeighted Average
Junior Subordinated DebtDiscounted cash flowDiscount Rate5.89% Junior Subordinated DebtDiscounted cash flowDiscount Rate6.46%Discounted cash flowDiscount Rate6.05% Junior Subordinated DebtDiscounted cash flowDiscount Rate5.81%

Management believes that the credit risk adjusted spread utilized in the fair value measurement of the junior subordinated debentures carried at fair value is indicative of the nonperformance risk premium a willing market participant would require under current market conditions, that is, the inactive market. Management attributes the change in fair value of the junior subordinated debentures during the period to market changes in the nonperformance expectations and pricing of this type of debt, and not as a result of changes to our entity-specific credit risk. The narrowing of the credit risk adjusted spread above the Company’s contractual spreads has primarily contributed to the negative fair value adjustments. Generally, an increase in the credit risk adjusted spread and/or a decrease in the three month LIBOR swap curve will result in positive fair value adjustments (and decrease the fair value measurement).  Conversely, a decrease in the credit risk adjusted spread and/or an increase in the three month LIBOR swap curve will result in negative fair value adjustments (and increase the fair value measurement). The decreaseincrease in discount rate between the periods ended SeptemberJune 30, 20172018 and December 31, 20162017 is primarily due to decreasesincreases in rates for similar debt instruments.

The following tables summarize the Company’s assets and liabilities that were measured at fair value on a recurring and non-recurring basis as of SeptemberJune 30, 20172018 (in 000’s):
Description of AssetsSeptember 30, 2017 
Quoted Prices in
Active Markets
for Identical
Assets
(Level 1)
 
Significant Other
Observable Inputs
(Level 2)
 
Significant
Unobservable
Inputs
(Level 3)
AFS Securities (2):       
U.S. Government agencies$20,970
 $
 $20,970
 $
U.S. Government collateralized mortgage obligations23,603
 
 23,603
 
Mutual Funds3,783
 3,783
 
 
Total AFS securities$48,356
 $3,783
 $44,573
 $
        
Total$48,356
 $3,783
 $44,573
 $






Description of AssetsJune 30, 2018 
Quoted Prices in
Active Markets
for Identical
Assets
(Level 1)
 
Significant Other
Observable Inputs
(Level 2)
 
Significant
Unobservable
Inputs
(Level 3)
AFS Securities (2):       
U.S. Government agencies$30,351
 $
 $30,351
 $
U.S. Government collateralized mortgage obligations26,373
 
 26,373
 
Marketable equity securities (2)3,659
 3,659
 
 
Total investment securities$60,383
 $3,659
 $56,724
 $
        
Total$60,383
 $3,659
 $56,724
 $
Description of LiabilitiesSeptember 30, 2017 
Quoted Prices
in Active
Markets for
Identical
Assets
(Level 1)
 
Significant
Other
Observable
Inputs
(Level 2)
 
Significant
Unobservable
Inputs
(Level 3)
June 30, 2018 
Quoted Prices
in Active
Markets for
Identical
Assets
(Level 1)
 
Significant
Other
Observable
Inputs
(Level 2)
 
Significant
Unobservable
Inputs
(Level 3)
Junior subordinated debt (2)$9,534
 
 
 $9,534
$10,125
 
 
 $10,125
Total$9,534
 
 
 $9,534
$10,125
 
 
 $10,125
 
(1)Nonrecurring
(2)Recurring

The following tables summarize the Company’s assets and liabilities that were measured at fair value on a recurring and non-recurring basis as of December 31, 20162017 (in 000’s):

Description of AssetsDecember 31, 2016 
Quoted Prices
in Active
Markets for
Identical
Assets
(Level 1)
 
Significant
Other
Observable
Inputs
(Level 2)
 
Significant
Unobservable
Inputs
(Level 3)
December 31, 2017 
Quoted Prices
in Active
Markets for
Identical
Assets
(Level 1)
 
Significant
Other
Observable
Inputs
(Level 2)
 
Significant
Unobservable
Inputs
(Level 3)
AFS Securities (2):              
U.S. Government agencies$23,203
 $
 $23,203
 $
$19,954
 $
 $19,954
 $
U.S. Government collateralized mortgage obligations30,572
 
 30,572
 
22,031
 
 22,031
 
Mutual Funds3,716
 3,716
 
 
Total AFS securities57,491
 3,716
 53,775
 $
Impaired Loans (1): 
  
  
  
Commercial and industrial301
 
 
 301
Total impaired loans$301
 $
 $
 $301
Marketable equity securities (2)3,737
 3,737
 
 
Total investment securities45,722
 3,737
 41,985
 $
              
Total$57,792
 $3,716
 $53,775
 $301
$45,722
 $3,737
 $41,985
 $
Description of LiabilitiesDecember 31, 2016 
Quoted Prices
in Active
Markets for
Identical
Assets
(Level 1)
 
Significant
Other
Observable
Inputs
(Level 2)
 
Significant
Unobservable
Inputs
(Level 3)
December 31, 2017 
Quoted Prices
in Active
Markets for
Identical
Assets
(Level 1)
 
Significant
Other
Observable
Inputs
(Level 2)
 
Significant
Unobservable
Inputs
(Level 3)
Junior subordinated debt (2)$8,832
 $
 $
 $8,832
$9,730
 $
 $
 $9,730
Total$8,832
 $
 $
 $8,832
$9,730
 $
 $
 $9,730
 
(1)Nonrecurring
(2)Recurring

The Company did not record a write-down on other real estate owned during the ninesix months ended SeptemberJune 30, 20172018 or the year ended December 31, 2016.2017.

The following table presents quantitative information about Level 3 fair value measurements for the Company's assets measured at fair value on a non-recurring basis at December 31, 2016 (in 000's). There were no assets measured at fair value on a non-recurring basis as of Septemberthe six months ended June 30, 2017.2018 or the year ended December 31, 2017.

December 31, 2016
Financial InstrumentFair ValueValuation TechniqueUnobservable InputRange, Weighted Average
Impaired Loans:    
Commercial and industrial$301
Sales Comparison ApproachAdjustment for difference between comparable sales7% - 29%, 19.1%

The following tables provide a reconciliation of assets and liabilities at fair value using significant unobservable inputs (Level 3) on a recurring basis during the three and ninesix months endedSeptember June 30, 20172018 and 20162017 (in 000’s):
Three Months Ended September 30, 2017 Three Months Ended September 30, 2016 Nine Months Ended September 30, 2017 Nine Months Ended September 30, 2016Three Months Ended June 30, 2018 Three Months Ended June 30, 2017 Six Months Ended June 30, 2018 Six Months Ended June 30, 2017
Reconciliation of Liabilities:
Junior
Subordinated
Debt
 Junior
Subordinated
Debt
 
Junior
Subordinated
Debt
 
Junior
Subordinated
Debt
Junior
Subordinated
Debt
 Junior
Subordinated
Debt
 
Junior
Subordinated
Debt
 
Junior
Subordinated
Debt
Beginning balance$9,441
 $7,837
 $8,832
 $8,300
$9,641
 $9,171
 $9,730
 $8,832
Total loss (gain) included in earnings88
 423
 688
 (48)
Other accrued interest5
 2
 14
 10
Gross loss included in earnings192
 264
 661
 601
Gross loss (gain) related to changes in instrument specific credit risk272
 
 (295) 
Change in accrued interest20
 6
 29
 8
Ending balance$9,534
 $8,262
 $9,534
 $8,262
$10,125
 $9,441
 $10,125
 $9,441
The amount of total loss (gains) for the period included in earnings attributable to the change in unrealized gains or losses relating to liabilities still held at the reporting date$88
 $423
 $688
 $(48)
The amount of total (gain) loss for the period included in earnings attributable to the change in unrealized gains or losses relating to liabilities still held at the reporting date$192
 $264
 $661
 $601

12.Goodwill and Intangible Assets

At SeptemberJune 30, 20172018, the Company had goodwill in the amount of $4,488,000 in connection with various business combinations and purchases. This amount was unchanged from the balance of $4,488,000 at December 31, 20162017. While goodwill is not amortized, the Company does conduct periodic impairment analysis on goodwill at least annually or more often as conditions require. The Company performed its analysis of goodwill impairment and concluded goodwill was not impaired at SeptemberJune 30, 2017.2018.

13.Accumulated Other Comprehensive Income

The components of accumulated other comprehensive income, included in shareholders’ equity, are as follows:
(in 000's)June 30, 2018 December 31, 2017
 
Net unrealized loss on available for sale securities

 
Unfunded status of the supplemental retirement plans

 
Net unrealized gain on junior subordinated debentures

 
Net unrealized loss on available for sale securities

 
Unfunded status of the supplemental retirement plans

 
Net unrealized gain on junior subordinated debentures

Beginning balance$(248) $(462) $
 $(221) $(383) $
Reclassifications upon adoption of ASU 2016-01184
 
 1,482
 
 
 
Current period comprehensive (loss) income(300) 19
 207
 (27) (79) 
Ending balance$(364) $(443) $1,689
 $(248) $(462) $
Accumulated other comprehensive income (loss)    $882
     $(710)


14.Subsequent Events

 
Subsequent events are events or transactions that occur after the balance sheet date but before financial statements are issued. Recognized subsequent events are events or transactions that provide additional evidence about conditions that existed at the date of the balance sheet, including the estimates inherent in the process of preparing financial statements.  Nonrecognized subsequent events are events that provide evidence about conditions that did not exist at the date of the balance sheet but arose after that date.  Management has reviewed events occurring through the date the consolidated financial statements were issued and have identified no subsequent events requiring disclosure.



Item 2  - Management's Discussion and Analysis of Financial Condition and Results of Operations

Overview

Certain matters discussed or incorporated by reference in this Quarterly Report of Form 10-Q are forward-looking statements that are subject to risks and uncertainties that could cause actual results to differ materially from those projected in the forward-looking statements. Such risks and uncertainties include, but are not limited to, those described in Management’s Discussion and Analysis of Financial Condition and Results of Operations. Such risks and uncertainties include, but are not limited to, the following factors: i) competitive pressures in the banking industry and changes in the regulatory environment; ii) exposure to changes in the interest rate environment and the resulting impact on the Company’s interest rate sensitive assets and liabilities; iii) decline in the health of the economy nationally or regionally which could reduce the demand for loans or reduce the value of real estate collateral securing most of the Company’s loans; iv) credit quality deterioration that could cause an increase in the provision for loan losses; v) Asset/Liability matching risks and liquidity risks; vi) volatility and devaluation in the securities markets, vi) expected cost savings from recent acquisitions are not realized, vii) potential impairment of goodwill and other intangible assets, and viii) technology implementation problems and information security breaches. Therefore, the information set forth therein should be carefully considered when evaluating the business prospects of the Company. For additional information concerning risks and uncertainties related to the Company and its operations, please refer to the Company’s Annual Report on Form 10-K for the year ended December 31, 20162017.

United Security Bancshares (the “Company” or “Holding Company") is a California corporation incorporated during March of 2001 and is registered with the Board of Governors of the Federal Reserve System as a bank holding company under the Bank Holding Company Act of 1956, as amended. United Security Bank (the “Bank”) is a wholly-owned bank subsidiary of the Company and was formed in 1987. References to the Company are references to United Security Bancshares (including the Bank). References to the Bank are to United Security Bank, while references to the Holding Company are to the parent only, United Security Bancshares. The Company currently has eleven banking branches, which provide financial services in Fresno, Madera, Kern, and Santa Clara counties in the state of California.

Trends Affecting Results of Operations and Financial Position

The Company’s overall operations are impacted by a number of factors, including not only interest rates and margin spreads, which impact the results of operations, but also the composition of the Company’s balance sheet. One of the primary strategic goals of the Company is to maintain a mix of assets that will generate a reasonable rate of return without undue risk, and to finance those assets with a low-cost and stable source of funds. Liquidity and capital resources must also be considered in the planning process to mitigate risk and allow for growth.

Since the Bank primarily conducts banking operations in California’s Central Valley, its operations and cash flows are subject to changes in the economic condition of the Central Valley. Our business results are dependent in large part upon the business activity, population, income levels, deposits and real estate activity in the Central Valley, and declines in economic conditions can have adverse material effects upon the Bank. In addition, the Central Valley remains largely dependent on agriculture. A downturn in agriculture and agricultural related business could indirectly and adversely affect the Company as many borrowers and customers are involved in, or are impacted to some extent, by the agricultural industry. While a great number of our borrowers are not directly involved in agriculture, they would likely be impacted by difficulties in the agricultural industry since many jobs in our market areas are ancillary to the regular production, processing, marketing and sale of agricultural commodities. While the prolonged drought has been alleviated during the past year due to significant amounts of precipitation, the state of California recently experienced the worst drought in recorded history. It is not possible to quantify the drought's impact on businesses and consumers located in the Company's market areas or to predict adverse economic impacts related to future droughts.

The residential real estate markets in the five county region from Merced to Kern has strengthened since 2013 and that trend has continued through 2017.2018. The severe declines in residential construction and home prices that began in 2008 have ended and home prices are now risingcontinue to rise on a year-over-year basis. The sustained period of double-digit price declines from 2008–2011 adversely impacted the Company’s operations and increased the levels of nonperforming assets, increased expenses related to foreclosed properties, and decreased profit margins. As the Company continues its business development and expansion efforts throughout its market areas, it will also maintainmaintains its commitment to the reduction of nonperforming assets and provision of options for borrowers experiencing difficulties. Those options include combinations of rate and term concessions, as well as forbearance agreements with borrowers.

The Company continues to emphasize relationship banking and core deposit growth, and has focused greater attention on its market area of Fresno, Madera, and Kern Counties, as well as Campbell, in Santa Clara County. The San Joaquin Valley and

other California markets are exhibiting stronger demand for construction lending and commercial lending from small and medium size businesses, as commercial and residential real estate markets have shown improvements.

The Company continually evaluates its strategic business plan as economic and market factors change in its market area. Balance sheet management, enhancing revenue sources, and maintaining market share will continue to be of primary importance during 20172018 and beyond. The previous pressure on net margins as interest rates hit historical lows may now be ending as interest rates are anticipated to rise slowly.rise. As a result, market rates of interest and asset quality will continue to be important factors in the Company’s ongoing strategic planning process.

Results of Operations

On a year-to-date basis, the Company reported net income of $7,004,0006,549,000 or $0.410.39 per share ($0.410.39 diluted), for the ninesix months ended SeptemberJune 30, 20172018, as compared to $5,830,0004,263,000, or $0.35$0.25 per share ($0.350.25 diluted), for the same period in 20162017. The Company’s return on average assets was 1.17%1.57% for the ninesix months ended SeptemberJune 30, 20172018, as compared to 1.04%1.09% for the ninesix months ended SeptemberJune 30, 20162017. The Company’s return on average equity was 9.42%12.69% for the ninesix months ended SeptemberJune 30, 20172018, as compared to 8.38%8.72% for the ninesix months ended SeptemberJune 30, 20162017.

Net Interest Income

The following tables present condensed average balance sheet information, together with interest income and yields earned on average interest earning assets, and interest expense and rates paid on average interest-bearing liabilities for the three and ninesix month periods ended SeptemberJune 30, 20172018 and 2016.2017.

Table 1. Distribution of Average Assets, Liabilities and Shareholders’ Equity:
Interest rates and Interest Differentials
Three Months Ended SeptemberJune 30, 20172018 and 20162017

  2017     2016    2018     2017  
(dollars in thousands)Average Balance Interest Yield/Rate (2) Average Balance Interest Yield/Rate (2)Average Balance Interest Yield/Rate (2) Average Balance Interest Yield/Rate (2)
  
Assets:                      
Interest-earning assets:                      
Loans and leases (1)$574,484
 $7,978
 5.51% $574,885
 $7,435
 5.15%$576,670
 $7,491
 5.21% $554,553
 $7,579
 5.48%
Investment Securities – taxable (3)51,811
 238
 1.82% 56,887
 244
 1.71%49,752
 265
 2.14% 54,505
 229
 1.69%
Interest-bearing deposits in other banks654
 1
 0.61% 1,533
 2
 0.52%
 
 % 651
 1
 0.62%
Interest-bearing deposits in FRB117,803
 375
 1.26% 56,264
 72
 0.51%148,441
 681
 1.84% 113,981
 301
 1.06%
Total interest-earning assets744,752
 $8,592
 4.58% 689,569
 $7,753
 4.47%774,863
 $8,437
 4.37% 723,690
 $8,110
 4.49%
Allowance for credit losses(9,104)  
  
 (8,913)  
  
(9,291)  
  
 (9,021)  
  
Noninterest-earning assets:   
  
  
  
  
   
  
  
  
  
Cash and due from banks22,375
  
  
 21,857
  
  
27,067
  
  
 20,872
  
  
Premises and equipment, net10,623
  
  
 10,321
  
  
10,048
  
  
 10,846
  
  
Accrued interest receivable4,878
  
  
 2,791
  
  
7,221
  
  
 4,269
  
  
Other real estate owned5,745
  
  
 7,407
  
  
5,683
  
  
 6,041
  
  
Other assets37,355
  
  
 36,734
  
  
36,675
  
  
 36,810
  
  
Total average assets$816,624
  
  
 $759,766
  
  
$852,266
  
  
 $793,507
  
  
Liabilities and Shareholders' Equity: 
  
  
  
  
  
 
  
  
  
  
  
Interest-bearing liabilities: 
  
  
  
  
  
 
  
  
  
  
  
NOW accounts$87,435
 $30
 0.14% $86,074
 $30
 0.14%$103,767
 $37
 0.14% $88,015
 $29
 0.13%
Money market accounts156,050
 187
 0.48% 148,411
 142
 0.38%190,724
 328
 0.69% 152,552
 181
 0.48%
Savings accounts81,027
 47
 0.23% 67,652
 34
 0.20%82,623
 47
 0.23% 78,448
 46
 0.24%
Time deposits66,841
 91
 0.54% 70,772
 83
 0.47%65,683
 138
 0.84% 81,230
 108
 0.53%
Junior subordinated debentures9,399
 80
 3.38% 7,805
 60
 3.06%9,493
 109
 4.61% 9,139
 74
 3.25%
Total interest-bearing liabilities400,752
 $435
 0.43% 380,714
 $349
 0.36%452,290
 $659
 0.58% 409,384
 $438
 0.43%
Noninterest-bearing liabilities: 
  
  
  
  
  
 
  
  
  
  
  
Noninterest-bearing checking308,480
  
  
 275,878
  
  
290,490
  
  
 278,457
  
  
Accrued interest payable92
  
  
 73
  
  
119
  
  
 102
  
  
Other liabilities6,298
  
  
 8,194
  
  
5,366
  
  
 6,215
  
  
Total Liabilities715,622
  
  
 664,859
  
  
748,265
  
  
 694,158
  
  
                      
Total shareholders' equity101,002
  
  
 94,907
  
  
104,001
  
  
 99,349
  
  
Total average liabilities and shareholders' equity$816,624
  
  
 $759,766
  
  
$852,266
  
  
 $793,507
  
  
Interest income as a percentage of average earning assets 
  
 4.58%  
  
 4.47% 
  
 4.37%  
  
 4.49%
Interest expense as a percentage of average earning assets 
  
 0.23%  
  
 0.20% 
  
 0.34%  
  
 0.24%
Net interest margin 
  
 4.35%  
  
 4.27% 
  
 4.03%  
  
 4.25%

(1)Loan amounts include nonaccrual loans, but the related interest income has been included only if collected for the period prior to the loan being placed on a nonaccrual basis. Loan interest income includes loan costs of approximately $68,000$719 for the quarter ended SeptemberJune 30, 20172018 and loan costs of $133,000$44 for the quarter ended SeptemberJune 30, 2016.2017.
(2)Interest income/expense is divided by actual number of days in the period times 365 days in the yield calculation
(3)Yields on investments securities are calculated based on average amortized cost balances rather than fair value, as changes in fair value are reflected as a component of shareholders' equity.


For the quarterthree months ended SeptemberJune 30, 2017,2018, total interest income increased $839,000$327,000, or 10.82%4.03%, as compared to the quarter ended SeptemberJune 30, 2016.2017. Comparing those two periods, average interest earning assets increased $55,183,000,$51,173,000, with a $61,539,000$22,117,000 increase onin loans and leases and a $34,460,000 increase in balances held at the Federal Reserve Bank, partially offset by a $5,076,000$4,753,000 decrease in investment securities, and a $401,000 decrease in loans and leases.securities. The average yield on total interest-earning assets increased 11decreased 12 basis points while loan yields decreased 27 basis points. Loan yields increased 36 basis pointsThese decreases were primarily as athe result of loan growth$550,000 in writedowns of unamortized insurance premiums on the higher-yielding student loan portfolio, $175,000 in reversal of accrued interest on nonaccrual loan activity, and increases on rates throughout the loan portfolio reflecting the increase in the prime rate. discontinued accretion of previous nonaccrual interest.

Yields on interest bearing deposits at the Federal Reserve Bank and other banks increased for the quarterthree months ended SeptemberJune 30, 2018 as a result of three 0.25% interest rate increases during 2017 and two during 2018. For the three months ended June 30, 2018, total interest expense increased $221,000, or 50.46%, as compared to the three months ended June 30, 2017, as a result of the two 0.25% interest rate increases during 2017. For the quarter ended September 30, 2017, total interest expense increased $86,000 or 24.64% as compared to the quarter ended September 30, 2016, as a result of a $20,038,000$42,906,000 increase in interest-bearing liabilities. The average rate paid on interest-bearing liabilities was 0.58% for the three months ended June 30, 2018 and 0.43% for the quarterthree months ended SeptemberJune 30, 2017 and 0.36% for the quarter ended September 30, 2016.

2017.

Interest rates and Interest Differentials
NineSix months ended SeptemberJune 30, 20172018 and 20162017



  2017     2016    2018     2017  
(dollars in 000's)Average Balance Interest Yield/Rate (2) Average Balance Interest Yield/Rate (2)Average Balance Interest Yield/Rate (2) Average Balance Interest Yield/Rate (2)
  
Assets:                      
Interest-earning assets:                      
Loans and leases (1)$565,068
 $22,782
 5.39% $532,133
 $20,722
 5.20%$590,905
 $15,717
 5.36% $560,282
 $14,804
 5.33%
Investment Securities – taxable (3)54,284
 691
 1.70% 46,384
 618
 1.78%47,381
 457
 1.95% 55,541
 453
 1.64%
Interest-bearing deposits in other banks652
 4
 0.82% 1,531
 6
 0.52%
 
 % 651
 2
 0.62%
Interest-bearing deposits in FRB107,921
 858
 1.06% 93,305
 348
 0.50%124,215
 1,065
 1.73% 102,898
 484
 0.95%
Total interest-earning assets727,925
 $24,335
 4.47% 673,353

$21,694
 4.30%762,501
 $17,239
 4.56% 719,372
 $15,743
 4.41%
Allowance for credit losses(9,017)  
  
 (9,439)  
  
(9,364)  
  
 (8,973)  
  
Noninterest-earning assets: 
  
  
  
  
  
 
  
  
    
  
Cash and due from banks21,393
  
  
 22,126
  
  
26,906
  
  
 20,894
  
  
Premises and equipment, net10,708
  
  
 10,550
  
  
10,157
  
  
 10,751
  
  
Accrued interest receivable4,248
  
  
 2,350
  
  
6,768
  
  
 3,928
  
  
Other real estate owned6,083
  
  
 9,797
  
  
5,745
  
  
 6,255
  
  
Other assets36,731
  
  
 36,552
  
  
36,930
  
  
 36,414
  
  
Total average assets$798,071
  
  
 $745,289
  
  
$839,643
  
  
 $788,641
  
  
Liabilities and Shareholders' Equity: 
  
  
  
  
  
 
  
  
  
  
  
Interest-bearing liabilities: 
  
  
  
  
  
 
  
  
  
  
  
NOW accounts$87,598
 $87
 0.13% $84,610
 $81
 0.13%$97,124
 $66
 0.14% $87,681
 $57
 0.13%
Money market accounts152,257
 506
 0.44% 146,801
 419
 0.38%174,985
 525
 0.61% 150,329
 319
 0.43%
Savings accounts78,247
 136
 0.23% 66,117
 103
 0.21%83,352
 94
 0.23% 76,834
 89
 0.23%
Time deposits80,861
 326
 0.54% 70,936
 234
 0.44%66,547
 252
 0.76% 87,987
 235
 0.54%
Junior subordinated debentures9,114
 223
 3.27% 7,995
 176
 2.94%9,641
 199
 4.16% 8,969
 143
 3.22%
Total interest-bearing liabilities408,077

$1,278
 0.42% 376,459

$1,013
 0.36%431,649
 $1,136
 0.53% 411,800
 $843
 0.41%
Noninterest-bearing liabilities: 
  
  
  
  
  
 
  
  
  
  
  
Noninterest-bearing checking283,783
  
  
 268,820
  
  
297,712
  
  
 271,230
  
  
Accrued interest payable104
  
  
 73
  
  
110
  
  
 110
  
  
Other liabilities6,714
  
  
 7,218
  
  
6,089
  
  
 6,925
  
  
Total Liabilities698,678
  
  
 652,570
  
  
735,560
  
  
 690,065
  
  
                      
Total shareholders' equity99,393
  
  
 92,719
  
  
104,083
  
  
 98,576
  
  
Total average liabilities and shareholders' equity$798,071
  
  
 $745,289
  
  
$839,643
  
  
 $788,641
  
  
Interest income as a percentage of average earning assets 
  
 4.47%  
  
 4.30% 
  
 4.56%  
  
 4.41%
Interest expense as a percentage of average earning assets 
  
 0.23%  
  
 0.20% 
  
 0.30%  
  
 0.24%
Net interest margin 
  
 4.24%  
  
 4.10% 
  
 4.26%  
  
 4.17%

(1)Loan amounts include nonaccrual loans, but the related interest income has been included only if collected for the period prior to the loan being placed on a nonaccrual basis. Loan interest income includes loan costs of approximately $336,000$835 and $169,000$268 for the ninesix months ended SeptemberJune 30, 20172018 and 2016,2017, respectively.
(2)Interest income/expense is divided by actual number of days in the period times 365 days in the yield calculation
(3)Yields on investments securities are calculated based on average amortized cost balances rather than fair value, as changes in fair value are reflected as a component of shareholders' equity.


The prime rate was raised to 4.00% in Marchthree times during 2017 and raisedtwice during 2018 to 4.25% in June 2017.reach its present rate of 5.00%. These increases affect rates for loans and customer deposits, both of which have increased and are likely to increase further as the prime rate continues to rise.

Both the Company's net interest income and net interest margin are affected by changes in the amount and mix of interest-earning assets and interest-bearing liabilities, referred to as "volume change." Both are also affected by changes in yields on interest-earning assets and rates paid on interest-bearing liabilities, referred to as "rate change." The following table sets forth the changes in interest income and interest expense for each major category of interest-earning asset and interest-bearing liability, and the amount of change attributable to volume and rate changes for the periods indicated.

Table 2.  Rate and Volume Analysis

Increase (decrease) in the nine months ended September 30, 2017 compared to September 30, 2016Increase (decrease) in the six months ended June 30, 2018 compared to June 30, 2017
(in 000's)Total Rate VolumeTotal Rate Volume
Increase (decrease) in interest income:          
Loans and leases$2,060
 $832
 $1,228
$913
 $134
 $779
Investment securities available for sale73
 (25) 98
4
 77
 (73)
Interest-bearing deposits in other banks(2) 4
 (6)(2) (3) 1
Interest-bearing deposits in FRB510
 386
 124
581
 382
 199
Total interest income2,641
 1,197
 1,444
1,496
 590
 906
Increase (decrease) in interest expense: 
  
  
 
  
  
Interest-bearing demand accounts93
 75
 18
215
 156
 59
Savings and money market accounts33
 13
 20
5
 (2) 7
Time deposits92
 57
 35
17
 83
 (66)
Subordinated debentures47
 22
 25
56
 45
 11
Total interest expense265
 167
 98
293
 282
 11
Increase in net interest income$2,376
 $1,030
 $1,346
$1,203
 $308
 $895
 
For the ninesix months ended SeptemberJune 30, 2017,2018, total interest income increased approximately $2,641,000,$1,496,000, or 12.17%9.50%, as compared to the ninesix months ended SeptemberJune 30, 2016. Earning2017. Average earning asset volumes for loans and leases increased $32,935,000 on average.$30,623,000. Overnight investments with the FRB increased $14,616,000 and$21,317,000, while available for sale investment securities increased $7,900,000decreased $8,160,000 between the two periods. The average yield on loans increased 193 basis points between the two periods, and the average yield on investment securities decreasedincreased approximately 831 basis points during the ninesix months ended SeptemberJune 30, 20172018 as compared to the same period of 2016.in 2017.  

The overall average yield on the loan portfolio increased to 5.39%5.36% for the ninesix months ended SeptemberJune 30, 2017,2018, as compared to 5.20%5.33% for the ninesix months ended SeptemberJune 30, 2016.2017. The yield on loans for the six months ended June 30, 2018 includes $550,000 in writedowns of unamortized insurance premiums on the student loan portfolio and $175,000 in reversal of accrued interest on nonaccrual loan activity. The Company has successfully sought to mitigate the low-interest rate environment with loan floors included in new and renewed loans when practical. At SeptemberJune 30, 2017, 53.0%2018, 57.7% of the Company's loan portfolio consisted of floating rate instruments, as compared to 52.1%52.0% of the portfolio at December 31, 2016,2017, with the majority of those tied to the prime rate. Approximately 25.3%19.6%, or $78,201,000,$64,748,000, of the floating rate loans had rate floors at SeptemberJune 30, 2017,2018, making them effectively fixed-rate loans for certain increases in interest rates, and fixed-rate loans for all decreases in interest rates. None of the loans with floors have floor spreads of 100 basis points or more.

Although market rates of interest are at historically low levels, the Company’s disciplined deposit pricing efforts have helped keep the Company's cost of funds low. The Company’s net interest margin increased to 4.24%4.26% for the ninesix months ended SeptemberJune 30, 2017,2018, when compared to 4.10%4.17% for the ninesix months ended SeptemberJune 30, 2016.2017. The net interest margin increased due to increases in the loan portfolio yield, increases in the yield on investment securities, and increases in the yield on overnight investments held at correspondent banks. As interest rates paid on deposits have also increased, the Company’s average cost of funds rose to 0.42%0.53% for the ninesix months ended SeptemberJune 30, 2017,2018, as compared to 0.36%0.41% for the ninesix months ended September 30, 2016. The Company utilizes brokered deposits as an additional source of funding. Currently, the Company holds CDARs reciprocal deposits, which are preferred by some depositors. These comprise $9,755,000 of the balance of certificates of deposits at SeptemberJune 30, 2017. For the ninesix months ended SeptemberJune 30, 2017,2018, total interest expense increased approximately $265,000,$293,000, or 26.16%34.76%, as compared to the ninesix months ended SeptemberJune 30, 2016.2017. Between those two periods, average interest-bearing liabilities increased by $31,618,000$19,849,000 due to increases across all categoriesin NOW, money

market, and savings accounts, partially offset by decreases in time deposits. The Company may utilize brokered deposits as an additional source of customer deposits.funding, however, the Company held no brokered deposits at June 30, 2018.

Net interest income has increased between the ninesix months ended SeptemberJune 30, 2018 and 2017, and 2016, totaling $23,057,000$16,103,000 for the ninesix months ended SeptemberJune 30, 20172018 as compared to $20,681,000$14,900,000 for the ninesix months ended SeptemberJune 30, 2016.2017. The increase in net interest income between 20162017 and 20172018 was primarily the result of reinvestment of lowlower yielding overnight investments into the loan and investment portfolios and growth in total interest-earning assets.

The increase in net interest margin between 2017 and 2018 can be primarily attributed to the relative increase in average loans, the highest yielding asset, as a percentage of total average assets, and the decrease in average time deposits, the most costly interest bearing liability, as a percentage of total interest bearing liabilities.

Table 3. Interest-Earning Assets and Liabilities

The following table summarizes the year-to-date averages of the components of interest-earning assets as a percentage of total interest-earning assets and the components of interest-bearing liabilities as a percentage of total interest-bearing liabilities:
YTD Average
9/30/2017
 
YTD Average
12/31/16
 
YTD Average
9/30/2016
YTD Average
6/30/2018
 
YTD Average
12/31/17
 
YTD Average
6/30/2017
Loans77.63% 79.26% 79.02%77.50% 77.91% 77.89%
Investment securities available for sale7.46% 7.27% 6.89%6.21% 7.18% 7.72%
Interest-bearing deposits in other banks0.09% 0.22% 0.23%—% 0.09% 0.09%
Interest-bearing deposits in FRB14.82% 13.25% 13.86%16.29% 14.82% 14.30%
Total interest-earning assets100.00% 100.00% 100.00%100.00% 100.00% 100.00%
  
NOW accounts21.47% 22.25% 22.48%22.50% 21.55% 21.29%
Money market accounts37.31% 38.82% 39.00%40.54% 37.92% 36.50%
Savings accounts19.17% 17.62% 17.56%19.31% 19.42% 18.66%
Time deposits19.82% 19.21% 18.84%15.42% 18.85% 21.37%
Subordinated debentures2.23% 2.10% 2.12%2.23% 2.26% 2.18%
Total interest-bearing liabilities100.00% 100.00% 100.00%100.00% 100.00% 100.00%

Noninterest Income

Table 3.4. Changes in Noninterest Income

The following tables sets forth the amount and percentage changes in the categories presented for the three and ninesix month periods ended SeptemberJune 30, 20172018 and 2016:2017:

(in 000's)
Three Months Ended September 30, 2017 Three Months Ended September 30, 2016 Amount of
Change
 Percent
 Change
Three Months Ended June 30, 2018 Three Months Ended June 30, 2017 Amount of
Change
 Percent
 Change
Customer service fees$959
 $924
 $35
 3.79 %$1,020
 $997
 $23
 2.31 %
Increase in cash surrender value of BOLI/COLI134
 131
 3
 2.29 %132
 134
 (2) (1.49)%
(Loss) gain on fair value of financial liability(88) (423) 335
 (79.20)%
Gain on sale of other investment3
 
 3
 100.00 %
Loss on marketable equity securities(18) 
 (18) (100.00)%
Loss on fair value of financial liability(192) (264) 72
 (27.27)%
Gain on sale of assets29
 
 29
 100.00 %
Other168
 154
 14
 9.09 %198
 199
 (1) (0.50)%
Total noninterest income$1,176
 $786
 $390
 49.62 %$1,169
 $1,066
 $103
 9.66 %

Noninterest income for the quarter ended SeptemberJune 30, 20172018 increased $390,000$103,000 to $1,176,000,$1,169,000, compared to the quarter ended SeptemberJune 30, 2016.2017. The increase is mostly attributed to athe decrease in the recorded loss on the fair value of financial liability of $335,000$72,000 for the quarter ended SeptemberJune 30, 2017.2018. The fluctuation in fair value of financial liability was caused by changes in the LIBOR yield curve.

(in 000's)
Nine Months Ended September 30, 2017 Nine Months Ended September 30, 2016 
Amount of
Change
 
Percent
 Change
Six Months Ended June 30, 2018 Six Months Ended June 30, 2017 
Amount of
Change
 
Percent
 Change
Customer service fees$2,897
 $2,867
 $30
 1.05 %$1,971
 $1,938
 $33
 1.70 %
Increase in cash surrender value of BOLI/COLI400
 394
 6
 1.52 %257
 266
 (9) (3.38)%
(Loss) gain on fair value of financial liability(688) 48
 (736) (1,533.33)%
Gain on sale of other investment3
 
 3
 100.00 %
Loss on marketable equity securities(78) 
 (78) (100.00)%
Gain on proceeds from bank-owned life insurance171
 
 171
 (100.00)%
Loss on fair value of financial liability(661) (601) (60) 9.98 %
Gain on sale fixed assets29
 
 29
 100.00 %
Other539
 464
 75
 16.16 %403
 372
 31
 8.33 %
Total noninterest income$3,151
 $3,773
 $(622) (16.49)%$2,092
 $1,975
 $117
 5.92 %


Noninterest income for the ninesix months endedSeptember June 30, 2017decreased $622,000, or 16.49%, when2018 increased $117,000 to $2,092,000, compared to the same period of 2016. Customer service fees, the primary component of noninterest income, increased $30,000, or 1.05%, between the two periods presented. The decrease in noninterest income of $622,000 between the two periods is primarily the result of a $688,000 loss recorded on the fair value of a financial liability for the ninesix months ended SeptemberJune 30, 2017 as compared2017. The increase is mostly attributed to a $48,000the gain on death benefit proceeds from bank owned life insurance of $171,000, partially offset by the fair value of a financial liabilityincrease in the recorded for the same period in 2016. The change inloss on the fair value of financial liability of $60,000 for the six months ended June 30, 2018. The fluctuation in fair value of financial liability was primarily caused by fluctuationschanges in the LIBOR yield curve.

The cost of the Company’s subordinated debentures issued by USB Capital Trust II has remained low as market rates have remained low during the first nine months of 2017. With pricing at 3-month-LIBOR plus 129 basis points, the effective cost of the subordinated debt was 2.85% at September 30, 2017, as compared to 2.15% at September 30, 2016. Pursuant to fair value accounting guidance, the Company has recorded $688,000 in pretax fair value loss on its junior subordinated debt during the nine months ended September 30, 2017, bringing the total cumulative gain recorded on the debt to $3,008,000 at September 30, 2017.Noninterest Expense

Table 5. Changes in Noninterest Expense

The following table sets forth the amount and percentage changes in the categories presented for the three and ninesix month periods ended SeptemberJune 30, 20172018 and 2016:

Table 4. Changes in Noninterest Expense

2017:
(in 000's)
Three Months Ended September 30, 2017 Three Months Ended September 30, 2016 
Amount of
Change
 
Percent
 Change
Three Months Ended June 30, 2018 Three Months Ended June 30, 2017 
Amount of
Change
 
Percent
 Change
Salaries and employee benefits$2,578
 $2,533
 $45
 1.78 %$3,010
 $2,586
 $424
 16.40 %
Occupancy expense1,087
 1,097
 (10) (0.91)%1,117
 1,043
 74
 7.09 %
Data processing29
 23
 6
 26.09 %38
 25
 13
 52.00 %
Professional fees312
 327
 (15) (4.59)%392
 345
 47
 13.62 %
FDIC/DFI insurance assessments43
 131
 (88) (67.18)%78
 133
 (55) (41.35)%
Director fees72
 75
 (3) (4.00)%81
 75
 6
 8.00 %
Loss on California tax credit partnership(1) 49
 (50) (102.04)%5
 10
 (5) (50.00)%
Correspondent bank service charges17
 19
 (2) (10.53)%
Net cost on operation of OREO21
 39
 (18) (46.15)%49
 (309) 358
 (115.86)%
Other605
 590
 15
 2.54 %531
 680
 (149) (21.91)%
Total expense$4,746
 $4,864
 $(118) (2.43)%$5,318
 $4,607
 $711
 15.43 %

Noninterest expense for the quarter ended SeptemberJune 30, 2017 decreased $118,0002018 increased $711,000 to $4,746,000,$5,318,000, compared to the quarter ended SeptemberJune 30, 2016.2017. The decreaseincrease was attributed to lowerincreases in OREO expenses and salaries and employee benefits. OREO expense for quarter ended June 30, 2017 includes $336,000 in gains on sale of OREO. The increase in salary and employee benefits was primarily due to the increased employee salary expense and compensation expense related to equity awards.

 
     (in 000's)
Six Months Ended June 30, 2018 Six Months Ended June 30, 2017 
Amount of
Change
 
Percent
 Change
Salaries and employee benefits$5,971
 $5,571
 $400
 7.18 %
Occupancy expense2,135
 2,058
 77
 3.74 %
Data processing90
 52
 38
 73.08 %
Professional fees727
 600
 127
 21.17 %
FDIC/DFI insurance assessments161
 269
 (108) (40.15)%
Director fees162
 143
 19
 13.29 %
Correspondent bank service charges34
 37
 (3) (8.11)%
Loss on California tax credit partnership9
 119
 (110) (92.44)%
Net cost on operation of OREO100
 (277) 377
 (136.10)%
Other929
 1,226
 (297) (24.23)%
Total expense$10,318
 $9,798
 $520
 5.31 %

Noninterest expense increased approximately $520,000 or 5.31% between the six months ended June 30, 2017 and June 30, 2018. The increase experienced during the six months ended June 30, 2018, was primarily the result of $377,000 in increased costs on OREO and $400,000 in additional salaries and employee benefits. OREO expense for six months ended June 30, 2017 includes $336,000 in gains on sale of OREO. The increase in salaries and employee benefits expense for the six months ended June 30, 2018 is primarily attributed to higher stock compensation expense as a result from the issuance of equity awards. The increases in the period were offset by a decrease of $110,000 in the loss ofon a tax credit partnership and a reductiondecrease of $108,000 in regulatory assessment expense. The FDIC assessment rate for the Company was reduced effective third quarter 2017. OREO expenses decreased $18,000 during the quarter ended September 30, 2017 as a result of partial sales on OREO properties in 2016 and 2017.

 
     (in 000's)
Nine Months Ended September 30, 2017 Nine Months Ended September 30, 2016 
Amount of
Change
 
Percent
 Change
Salaries and employee benefits$8,149
 $7,592
 $557
 7.34 %
Occupancy expense3,144
 3,212
 (68) (2.12)%
Data processing81
 108
 (27) (25.00)%
Professional fees912
 1,116
 (204) (18.28)%
FDIC/DFI insurance assessments313
 632
 (319) (50.47)%
Director fees215
 218
 (3) (1.38)%
Loss on California tax credit partnership118
 122
 (4) (3.28)%
Net (gain) cost on operation of OREO(257) 216
 (473) (218.98)%
Other1,868
 1,772
 96
 5.42 %
Total expense$14,543
 $14,988
 $(445) (2.97)%


Noninterest expense decreased approximately $445,000 or 2.97% between the nine months ended September 30, 2016 and September 30, 2017. The decrease experienced during the nine months ended September 30, 2017, was primarily the result of decreases of $473,000 in net cost of OREO, $319,000 in regulatory assessments, $204,000 in professional fees, and $68,000 in occupancy expense, partially offset by an increase of $557,000 in employee salary and benefit expenses. The increase in employee salary and benefit expenses is driven by increases in group insurance and higher employee incentives, compared to the nine months ended September 30, 2016.assessments.

Income Taxes

The Company’s income tax expense is impacted to some degree by permanent taxable differences between income reported for book purposes and income reported for tax purposes, as well as certain tax credits which are not reflected in the Company’s pretax income or loss shown in the statements of operations and comprehensive income. As pretax income or loss amounts become smaller, the impact of these differences become more significant and are reflected as variances in the Company’s effective tax rate for the periods presented. In general, the permanent differences and tax credits affecting tax expense have a positive impact and tend to reduce the effective tax rates shown in the Company’s statements of income and comprehensive income.

The Company reviews its current tax positions at least quarterly based on the accounting standards related to uncertainty in income taxes which includes the criteria that an individual tax position would have to meet for some or all of the income tax benefit to be recognized in a taxable entity’s financial statements. Under the income tax guidelines, an entity should recognize the financial statement benefit of a tax position if it determines that it is more likely than not that the position will be sustained on examination. The term “more likely than not” means a likelihood of more than 50 percent. In assessing whether the more-likely-than-not criterion is met, the entity should assume that the tax position will be reviewed by the applicable taxing authority.
 
The Company has reviewed all of its tax positions as of SeptemberJune 30, 2017,2018, and has determined that, there are no material amounts to be recorded under the current income tax accounting guidelines.

The Company's effective tax rate for the six months ended June 30, 2018 was 28.83% compared to 40.03% for the six months ended June 30, 2017. With the enactment of the Tax Cuts and Jobs Act, which was signed into law on December 22, 2017, the Company's federal income tax rate changed from 34% to 21%.

Financial Condition

Total assets increased $55,535,00073,632,000, or 7.05%9.14%, to a balance of $843,507,000879,468,000 at SeptemberJune 30, 20172018, from the balance of $787,972,000805,836,000 at December 31, 20162017, and increased $61,915,00097,902,000, or 7.92%12.53%, from the balance of $781,592,000$781,566,000 at SeptemberJune 30, 20162017. Total deposits of $725,298,000756,963,000 at SeptemberJune 30, 20172018, increased $48,669,00069,270,000, or 7.19%10.07%, from the balance reported at December 31, 20162017, and increased $54,012,00090,652,000, or 8.05%13.61%, from the balance of $671,286,000$666,311,000 reported at SeptemberJune 30, 20162017. Cash and cash equivalents increased $46,860,00083,194,000, or 41.46%77.08%, between December 31, 20162017 and SeptemberJune 30, 20172018; net loans increasedecreased $12,511,00027,197,000, or 2.23%4.59%, to a balance of $574,443,000565,926,000; and investment securities decreaseincreased $9,135,00014,661,000, or 15.89%32.07%, during the first ninesix months of 20172018.


Earning assets averaged approximately $727,925,000762,501,000 during the ninesix months ended SeptemberJune 30, 20172018, as compared to $673,353,000719,372,000 for the same period in 20162017. Average interest-bearing liabilities increased to $408,077,000431,649,000 for the ninesix months ended SeptemberJune 30, 20172018, from $376,459,000411,800,000 reported for the comparative period of 20162017.

Loans and Leases

The Company's primary business is that of acquiring deposits and making loans, with the loan portfolio representing the largest and most important component of earning assets. Loans totaled $582,384,000573,996,000 at SeptemberJune 30, 20172018, ana increasedecrease of $12,625,00027,355,000, or 2.22%4.55%, when compared to the balance of $569,759,000601,351,000 at December 31, 20162017, and an increase of $22,785,0006,756,000, or 4.07%1.19%, when compared to the balance of $559,599,000567,240,000 reported at SeptemberJune 30, 20162017. Loans on average increased $32,935,00030,623,000, or 6.19%5.47%, between the ninesix months ended SeptemberJune 30, 20162017 and SeptemberJune 30, 20172018, with loans averaging $565,068,000590,905,000 for the ninesix months ended SeptemberJune 30, 20172018, as compared to $532,133,000560,282,000 for the same period of 20162017.

Total loans increased $12,625,000decreased $27,355,000 between December 31, 20162017 and SeptemberJune 30, 2018, and increased $6,756,000 between June 30, 2017 and increased $22,785,000 between SeptemberJune 30, 2016 and September 30, 2017.2018. During the ninesix months ended SeptemberJune 30, 2017,2018, the Company experienced increases in commercial and industrial loans, commercial real estate, agriculture, and consumer loans compared to the same period ended SeptemberJune 30, 2016.2017. Commercial and industrial loans decreased $2,054,000increased $10,929,000 between December 31, 20162017 and SeptemberJune 30, 2018 and increased $5,484,000 between June 30, 2017 and June 30, 2018. Agricultural loans decreased $762,000$2,819,000, or 4.74%, between SeptemberDecember 31, 2017 and June 30, 20162018 and Septemberdecreased $1,770,000 between June 30, 2017. 2017 and June 30, 2018. 

Installment and other loans increased $12,634,000$18,064,000 during the six months ended June 30, 2018 as compared to the same period ended June 30, 2017, due to growth in the student loan portfolio. Included in installment loans are $51,185,000$61,761,000 in student loans made to medical and pharmacy school students. Repayment on student loans is deferred until 6 months after graduation. Accrued interest on loans that have not entered repayment status totaled $3,769,000 at September 30, 2017. The outstanding balance of student loans that have not entered repayment status totaled $47,759,000$55,632,000 at SeptemberJune 30, 2017. Real estate mortgage2018. Upon graduation the loan is automatically placed on deferment for 6 months. This may be extended up to 48 months for graduates enrolling in Internship, Medical Residency or Fellowship. As approved the student may receive additional deferment for hardship or administrative reasons in the form of forbearance for a maximum of 24 months throughout the life of the loan. Accrued interest on loans increased $2,262,000, or 0.78%, between December 31, 2016that have not entered repayment status totaled $6,186,000 at June 30, 2018. At June 30, 2018 there were 316 loans within repayment, deferment, and Septemberforbearance which represented $6,129,000, $1,270,000, and $3,006,000 in outstanding balances respectively. Prior to June 2018, student loans were insured through a Surety Bond issued by ReliaMax Surety Company and provided the Company reasonable expectation of collection. In June 2018, ReliaMax Surety Company was declared insolvent by the South Dakota Division of Insurance and is now in liquidation. As a result of the insolvency, the Company's student loan portfolio is no longer insured. Repayment of the unsecured student loans is premised on the medical and pharmacy students graduating and becoming high wage earners. Underwriting is premised on qualifying credit scores. The weighted average credit score for the portfolio is in the mid-700s.
In addition, there are non-student co-borrowers for roughly one-third of the portfolio that provide additional repayment capacity. Graduation and employment placement rates are high for both medical and pharmacy students. The average student loan borrower balance as of June 30, 2017, and increased $450,000 between September 30, 2016 and September 30, 2017. Agricultural loans increased $1,587,000, or 2.79%, between December 31, 20162018 is approximately $90,000.

and September 30, 2017 and increased $5,236,000 between September 30, 2016 and September 30, 2017. Commercial real estate loans (a component of real estate mortgage loans) continue to represent a significant portion of the total loan portfolio. Commercial real estate loans amounted to 34.28%37.02%, 35.14%36.76%, and 35.30%35.68%, of the total loan portfolio at SeptemberJune 30, 2018, December 31, 2017, and June 30, 2017, respectively. Real estate mortgage loans decreased $22,882,000, or 7.47%, between December 31, 2016,2017 and SeptemberJune 30, 2016, respectively.2018, and increased $1,156,000 between June 30, 2017 and June 30, 2018. Residential mortgage loans are not generally originated by the Company, but some residential mortgage loans have been made over the past several years to facilitate take-out loans for construction borrowers when they were not able to obtain permanent financing elsewhere. These loans are generally 30-year amortizing loans with maturities of between three and five years. Residential mortgages totaled $90,284,000,$70,512,000, or 15.50%12.28%, of the portfolio at SeptemberJune 30, 2017, $87,388,000,2018, $84,804,000, or 15.34%14.10% of the portfolio at December 31, 2016,2017, and $91,852,000$79,319,000 or 16.41%13.98% of the portfolio at SeptemberJune 30, 2016.2017. The Company held no loan participation purchases at SeptemberJune 30, 2016,2017, December 31, 20162017 or SeptemberJune 30, 2017.2018. Loan participations sold decreasedincreased from $7,632,000,$9,712,000, or 1.36%1.71%, of the portfolio at SeptemberJune 30, 2016,2017, to $7,548,000,$15,067,000, or 1.3%2.5%, of the portfolio, at December 31, 2016,2017, and increaseddecreased to $9,069,000,$14,559,000, or 1.6%2.5%, of the portfolio, at SeptemberJune 30, 2017.2018.

Table 6. Loans

The following table sets forth the amounts of loans outstanding by category at SeptemberJune 30, 20172018 and December 31, 2016,2017, the category percentages as of those dates, and the net change between the two periods presented.

Table 5. Loans
 
September 30, 2017 December 31, 2016    June 30, 2018 December 31, 2017    
(in 000's)Dollar Amount % of Loans Dollar Amount % of Loans Net Change % ChangeDollar Amount % of Loans Dollar Amount % of Loans Net Change % Change
Commercial and industrial$46,951
 8.1% $49,005
 8.6% $(2,054) (4.19)%$57,955
 10.1% $47,026
 7.9% $10,929
 23.24 %
Real estate – mortgage290,462
 49.9% 288,200
 50.6% 2,262
 0.78 %283,411
 49.4% 306,293
 50.9% (22,882) (7.47)%
RE construction & development128,883
 22.1% 130,687
 22.9% (1,804) -1.38 %108,571
 18.9% 122,970
 20.4% (14,399) (11.71)%
Agricultural58,505
 10.0% 56,918
 10.0% 1,587
 2.79 %56,662
 9.9% 59,481
 9.9% (2,819) (4.74)%
Installment/other57,583
 9.9% 44,949
 7.9% 12,634
 28.11 %67,397
 11.7% 65,581
 10.9% 1,816
 2.77 %
Total Gross Loans$582,384
 100.0% $569,759
 100.0% $12,625
 2.22 %$573,996
 100.0% $601,351
 100.0% $(27,355) (4.55)%

Deposits

Total deposits totaled $725,298,000756,963,000 at SeptemberJune 30, 20172018, representing an increase of $48,669,00069,270,000, or 7.19%10.07%, from the balance of $676,629,000687,693,000 reported at December 31, 20162017, and an increase of $54,012,00090,652,000, or 8.05%13.61%, from the balance of $671,286,000666,311,000 reported at SeptemberJune 30, 20162017.

Table 7. Deposits

The following table sets forth the amounts of deposits outstanding by category at SeptemberJune 30, 20172018 and December 31, 2016,2017, and the net change between the two periods presented.

Table 6. Deposits
 
(in 000's)September 30, 2017 December 31, 2016 
Net
Change
 
Percentage
Change
June 30, 2018 December 31, 2017 
Net
Change
 
Percentage
Change
Noninterest bearing deposits$315,877
 $262,697
 $53,180
 20.24 %$281,686
 $307,299
 $(25,613) -8.33 %
Interest bearing deposits: 
  
  
  
 
  
  
  
NOW and money market accounts262,037
 235,873
 26,164
 11.09 %322,995
 234,154
 88,841
 37.94 %
Savings accounts81,378
 75,068
 6,310
 8.41 %85,480
 81,408
 4,072
 5.00 %
Time deposits: 
  
  
  
 
  
  
  
Under $250,00053,702
 87,419
 (33,717) -38.57 %51,925
 51,687
 238
 0.46 %
$250,000 and over12,304
 15,572
 (3,268) -20.99 %14,877
 13,145
 1,732
 13.18 %
Total interest bearing deposits409,421
 413,932
 (4,511) -1.09 %475,277
 380,394
 94,883
 24.94 %
Total deposits$725,298
 $676,629
 $48,669
 7.19 %$756,963
 $687,693
 $69,270
 10.07 %

The Company's deposit base consists of two major components represented by noninterest bearing (demand) deposits and interest bearing deposits, totaling $315,877,000281,686,000 and $409,421,000475,277,000 at SeptemberJune 30, 20172018, respectively. Interest bearing

deposits consist of time certificates, NOW and money market accounts, and savings deposits. Total interest bearing deposits decreaseincreased $4,511,00094,883,000, or 1.09%24.94%, between December 31, 20162017 and SeptemberJune 30, 20172018, and noninterest bearing deposits increasedecreased $53,180,00025,613,000, or 20.24%8.33%, between the same two periods presented. Noninterest bearing deposits decreased as the deposits migrated to other interest bearing categories. Included in the decreaseincrease of $4,511,00094,883,000 in interest bearing deposits during the ninesix months ended SeptemberJune 30, 20172018, are decreasesincreases of $36,985,000 in time deposits and $26,164,000$88,841,000 in NOW and money market accounts, offset by increases of $6,310,000$1,970,000 in time deposits, and increases of $4,072,000 in savings accounts and $26,164,000 in NOW and money market accounts. The decreaseincrease in time deposits is attributed to an increase in activity driven by the maturities of $17,285,000increase in brokered deposits and $18,413,000 in out-of-market time deposits.the prime rate, which is the index for the Company's variable CD rate.

Core deposits, as defined by the Company as consisting of all deposits other than time deposits of more than $250,000 and brokered deposits, continue to provide the foundation for the Company's principal sources of funding and liquidity. These core deposits amounted to 96.96%98.03% and 90.82%98.09% of the total deposit portfolio at SeptemberJune 30, 20172018 and December 31, 20162017, respectively. Brokered deposits totaled $9,755,000 at September 30, 2017, as compared to $28,132,000 at December 31, 2016, and $12,146,000 at September 30, 2016. Brokered deposits were 1.34% and 4.16% of totalThe Company held no brokered deposits at SeptemberJune 30, 20172018 and December 31, 2016, respectively.2017

On a year-to-date average, the Company experienced an increase of $45,462,00045,659,000, or 7.13%6.77%, in total deposits between the ninesix months ended SeptemberJune 30, 20172018 and SeptemberJune 30, 20162017. Between these two periods, average interest bearing deposits increased $30,499,00019,177,000, or 8.28%4.76%, and total noninterest-bearing deposits increased $14,963,00026,482,000, or 5.57%9.76%, on a year-to-date average basis.

Short-Term Borrowings

At SeptemberJune 30, 20172018, the Company had collateralized lines of credit with the Federal Reserve Bank of San Francisco totaling $283,948,000279,450,000, as well as Federal Home Loan Bank (FHLB) lines of credit totaling $14,400,0004,687,000. At SeptemberJune 30, 2017,2018, the Company had uncollateralized lines of credit with both Pacific Coast Bankers Bank ("PCBB"), Union Bank, and Zion's Bank, totaling $10,000,000, $10,000,000, and $20,000,000, respectively. These lines of credit generally have interest rates tied to either the Federal Funds rate, short-term U.S. Treasury rates, or LIBOR. All lines of credit are on an “as available” basis and can be revoked by the grantor at any time. At SeptemberJune 30, 20172018 and SeptemberJune 30, 20162017, the Company had no outstanding borrowings. The Company had collateralized FRB lines of credit of $323,162,000305,236,000, collateralized FHLB lines of credit totaling $2,037,00013,363,000, and uncollateralized lines of credit of $10,000,000 with PCBB, $10,000,000 with Union Bank, and $20,000,000 with Zions Bank at December 31, 20162017.

Asset Quality and Allowance for Credit Losses

Lending money is the Company's principal business activity, and ensuring appropriate evaluation, diversification, and control of credit risks is a primary management responsibility. Losses are implicit in lending activities and the amount of such losses will vary, depending on the risk characteristics of the loan portfolio as affected by local economic conditions and the financial experience of borrowers.

The allowance for credit losses is maintained at a level deemed appropriate by management to provide for known and inherent risks in existing loans and commitments to extend credit. The adequacy of the allowance for credit losses is based upon management's continuing assessment of various factors affecting the collectability of loans and commitments to extend credit; including current economic conditions, past credit experience, collateral, and concentrations of credit. There is no precise method of predicting specific losses or amounts which may ultimately be charged off on particular segments of the loan portfolio. The conclusion that a loan may become uncollectible, either in part or in whole is subjective and contingent upon economic, environmental, and other conditions which cannot be predicted with certainty. When determining the adequacy of the allowance for credit losses, the Company follows, in accordance with GAAP, the guidelines set forth in the Revised Interagency Policy Statement on the Allowance for Loan and Lease Losses (“Statement”) issued by banking regulators in December 2006. The Statement is a revision of the previous guidance released in July 2001, and outlines characteristics that should be used in segmentation of the loan portfolio for purposes of the analysis including risk classification, past due status, type of loan, industry or collateral. It also outlines factors to consider when adjusting the loss factors for various segments of the loan portfolio, and updates previous guidance that describes the responsibilities of the board of directors, management, and bank examiners regarding the allowance for credit losses. Securities and Exchange Commission Staff Accounting Bulletin No. 102 was released during July 2001, and represents the SEC staff’s view relating to methodologies and supporting documentation for the Allowance for Loan and Lease Losses that should be observed by all public companies in complying with the federal securities laws and the Commission’s interpretations.  It is also generally consistent with the guidance published by the banking regulators.


The allowance for loan losses includes an asset-specific component, as well as a general or formula-based component. The Company segments the loan and lease portfolio into eleven (11) segments, primarily by loan class and type, that have homogeneity and commonality of purpose and terms for analysis under the formula-based component of the allowance. Those loans which are determined to be impaired under current accounting guidelines are not subject to the formula-based reserve analysis, and evaluated individually for specific impairment under the asset-specific component of the allowance.

The Company’s methodology for assessing the adequacy of the allowance for credit losses consists of several key elements, which include:

- theThe formula allowance
- specificSpecific allowances for problem graded loans identified as impairedimpaired; and
- and theThe unallocated allowance

The formula allowance is calculated by applying loss factors to outstanding loans and certain unfunded loan commitments. Loss factors are based on the Company’s historical loss experience and on the internal risk grade of those loans, and may be adjusted for significant factors that, in management's judgment, affect the collectability of the portfolio as of the evaluation date. Factors that may affect collectability of the loan portfolio include:
 
Levels of, and trends in delinquencies and nonaccrual loans;
Trends in volumes and term of loans;

Effects of any changes in lending policies and procedures including those for underwriting, collection, charge-off, and recovery;
Experience, ability, and depth of lending management and staff;
National and local economic trends and conditions and;
Concentrations of credit that might affect loss experience across one or more components of the portfolio, including high-balance loan concentrations and participations.

Management determines the loss factors for problem graded loans (substandard, doubtful, and loss), special mention loans, and pass graded loans, based on a loss migration model. The migration analysis incorporates loan losses over the previous quarters as determined by management (time horizons adjusted as business cycles or environment changes) and loss factors are adjusted to recognize and quantify the loss exposure from changes in market conditions and trends in the Company’s loan portfolio. For purposes of this analysis, loans are grouped by internal risk classifications and categorized as pass, special mention, substandard, doubtful, or loss. Certain loans are homogeneous in nature and are therefore pooled by risk grade. These homogeneous loans include consumer installment and home equity loans. Special mention loans are currently performing but are potentially weak, as the borrower has begun to exhibit deteriorating trends which, if not corrected, could jeopardize repayment of the loan and result in further downgrades. Substandard loans have well-defined weaknesses which, if not corrected, could jeopardize the full satisfaction of the debt. A loan classified as doubtful has critical weaknesses that make full collection of the obligation improbable. Classified loans, as defined by the Company, include impaired loans and loans categorized as substandard, doubtful, and loss which are not considered impaired. At SeptemberJune 30, 20172018, impaired and classified loans totaled $28,214,000,$31,485,000, or 5.2%5.8%, of gross loans as compared to $29,838,00027,311,000, or 5.2%, of gross loans at December 31, 20162017.

Loan participations are reviewed for allowance adequacy under the same guidelines as other loans in the Company’s portfolio, with an additional participation factor added, if required, for specific risks associated with participations. In general, participations are subject to certain thresholds set by the Company, and are reviewed for geographic location as well as the well-being of the underlying agent bank.

Specific allowances are established based on management’s periodic evaluation of loss exposure inherent in impaired loans. For impaired loans, specific allowances are determined based on the net realizable value of the underlying collateral, the net present value of the anticipated cash flows, or the market value of the underlying assets. Formula allowances for classified loans, excluding impaired loans, are determined on the basis of additional risks involved with individual loans that may be in excess of risk factors associated with the loan portfolio as a whole. The specific allowance is different from the formula allowance in that the specific allowance is determined on a loan-by-loan basis based on risk factors directly related to a particular loan, as opposed to the formula allowance which is determined for a pool of loans with similar risk characteristics, based on past historical trends and other risk factors which may be relevant on an ongoing basis.

The unallocated portion of the allowance is based upon management’s evaluation of various conditions that are not directly measured in the determination of the formula and specific allowances. The conditions may include, but are not limited to,

general economic and business conditions affecting the key lending areas of the Company, credit quality trends, collateral values, loan volumes and concentrations, and other business conditions.


Table 8. Allowance for Loan Losses

The following table summarizes the specific allowance, formula allowance, and unallocated allowance at SeptemberJune 30, 20172018 and December 31, 2016,2017, as well as classified loans at those period-ends.
(in 000's)September 30, 2017 December 31, 2016June 30, 2018 December 31, 2017
Specific allowance – impaired loans$1,741
 $1,360
$1,740
 $1,888
Formula allowance – classified loans not impaired1,286
 1,226
1,104
 1,136
Formula allowance – special mention loans385
 248
57
 181
Total allowance for special mention and classified loans3,412
 2,834
2,901
 3,205
      
Formula allowance for pass loans4,724
 5,371
4,687
 4,806
Unallocated allowance1,022
 697
837
 1,256
Total allowance for loan losses$9,158
 $8,902
$8,425
 $9,267
      
Impaired loans15,338
 16,179
19,696
 14,790
Classified loans not considered impaired12,876
 13,659
11,789
 12,521
Total classified loans / impaired loans$28,214
 $29,838
$31,485
 $27,311
Special mention loans not considered impaired$13,990
 $5,515
$8,386
 $10,201

While impaired loans decreasedincreased $841,0004,906,000 between December 31, 20162017 and SeptemberJune 30, 20172018, the specific allowance related to impaired loans increasedecreased $381,000148,000 between December 31, 20162017 and SeptemberJune 30, 20172018 due to the addition of atwo new highly reservedcollateral dependent impaired Ag loanloans in the period. The decreaseincrease in impaired loans is primarily due to a decreaseincrease in troubled debt restructures.non-performing loans. The formula allowance related to classified and special mention unimpaired loans increasedecreased by $197,000156,000 between December 31, 20162017 and SeptemberJune 30, 20172018. as a result of improvements in loss factors. The unallocated allowance increaseddecreased from $697,000$1,256,000 at December 31, 20162017 to $1,022,000$837,000 at SeptemberJune 30, 2017.2018. The increasedecrease in the unallocated allowance is primarily the result of declining historical loss factors.a reversal in provision. Although there has been a reduction in required loss reserves as economic conditions have improved, the Company has a concentration in loans to finance CRE, construction and land development activities not secured by real estate. These loans have inherently higher risk characteristics and management believes maintaining additional, unallocated reserves to address the inherent losses in these loans is reasonable and appropriate. The level of “pass” loans increaseddecreased approximately $5,972,000$30,009,000 between December 31, 20162017 and SeptemberJune 30, 2017.2018. The related formula allowance decreased $647,000119,000 during the same period. The formula allowance for “pass loans” is derived from the loan loss factors under migration analysis.

The Company’s methodology includes features that are intended to reduce the difference between estimated and actual losses. The specific allowance portion of the analysis is designed to be self-correcting by taking into account the current loan loss experience based on that portion of the portfolio. By analyzing the estimated losses inherent in the loan portfolio on a quarterly basis, management is able to adjust specific and inherent loss estimates using the most recent information available. In performing the periodic migration analysis, management believes that historical loss factors used in the computation of the formula allowance need to be adjusted to reflect current changes in market conditions and trends in the Company’s loan portfolio. There are a number of other factors which are reviewed when determining adjustments in the historical loss factors. Those factors includeinclude: 1) trends in delinquent and nonaccrual loans, 2) trends in loan volume and terms, 3) effects of changes in lending policies, 4) concentrations of credit, 5) competition, 6) national and local economic trends and conditions, 7) experience of lending staff, 8) loan review and Board of Directors oversight, 9) high balance loan concentrations, and 10) other business conditions.

The general reserve requirements (ASC 450-70) decreased with the continued strengthening of local, state, and national economies and their impact on our local lending base, which has resulted in a lower qualitative component for the general reserve calculation. These positive factors were partially offset by the Company including OREOother real estate owned (OREO) financial results in loss history and extending the look back period used to capture the loss history for the quantitative portion of the ALLL.allowance for loan and lease losses (ALLL). In the third quarter of 2013, the look back period was changed from 4 years to stake-in-the-ground (December 31, 2005), in an effort to include higher losses experienced during the credit crisis. Changes in the mix of historical losses in the look back period resulted in a reallocation of the general reserve component of the allowance amount within the various loan segments as compared to SeptemberJune 30, 2017,2018, as loss experience by segment has

fluctuated over time. The stake-in-the-ground

methodology requires the Company to use December 31, 2005, as the starting point of the look back period to capture loss history. Time horizons are subject to Management'smanagement's assessment of the current period, taking into consideration changes in business cycles and environment changes.

Management and the Company’s lending officers evaluate the loss exposure of classified and impaired loans on a weekly/monthly basis. The Company’s Loan Committee meets weekly and serves as a forum to discuss specific problem assets that pose significant concerns to the Company, and to keep the Board of Directors informed through committee minutes. All special mention and classified loans are reported quarterly on Problem Asset Reports and Impaired Loan Reports and are reviewed by senior management. Migration analysis and impaired loan analysis are performed on a quarterly basis and adjustments are made to the allowance as deemed necessary. The Board of Directors is kept abreast of any changes or trends in problem assets on a monthly basis, or more often if required.

The specific allowance for impaired loans is measured based on the present value of the expected future cash flows discounted at the loan's effective interest rate or the fair value of the collateral if the loan is collateral dependent. The amount of impaired loans is not directly comparable to the amount of nonperforming loans disclosed later in this section. The primary differences between impaired loans and nonperforming loans are: i) all loan categories are considered in determining nonperforming loans while impaired loan recognition is limited to commercial and industrial loans, commercial and residential real estate loans, construction loans, and agricultural loans, and ii) impaired loan recognition considers not only loans 90 days or more past due, restructured loans and nonaccrual loans but may also include problem loans other than delinquent loans.

The Company considers a loan to be impaired when, based upon current information and events, it believes it is probable the Company will be unable to collect all amounts due according to the contractual terms of the loan agreement.  Impaired loans include nonaccrual loans, troubled debt restructures, and performing loans in which full payment of principal or interest is not expected. Management bases the measurement of these impaired loans either on the fair value of the loan's collateral or the expected cash flows on the loansloan discounted at the loan's stated interest rates. Cash receipts on impaired loans not performing to contractual terms and that are on nonaccrual status are used to reduce principal balances. Impairment losses are included in the allowance for credit losses through a charge to the provision, if applicable.

In most cases, the Company uses the cash basis method of income recognition for impaired loans. In the case of certain troubled debt restructuring, for which the loan has been performing for a prescribed period of time under the current contractual terms, income is recognized under the accrual method. At SeptemberJune 30, 20172018, included in impaired loans, were troubled debt restructures totaling $12,150,0007,641,000. Nonaccrual loans, totaling $5,124,000,$3,378,000, were included in that balance. The remainingtotal, with $4,263,000 in troubled debt restructures totaling $7,026,000, wereconsidered current with regards to payments, and were performing according to their modified contractual terms.

Commercial and industrial loans and real estate mortgage loans, respectively, comprised approximately 24.04%16.54% and 25.71%18.25% of total impaired loan balances at SeptemberJune 30, 2017.2018. Of the $3,687,000$3,258,000 in commercial and industrial impaired loans reported at SeptemberJune 30, 2017,2018, two loans, with a total recorded investment of $286,000,$734,000, were secured by real estate. Specific collateral related to impaired loans is reviewed for current appraisal information, economic trends within geographic markets, loan-to-value ratios, and other factors that may impact the value of the loan collateral. Adjustments are made to collateral values as needed for these factors. Of total impaired loans at SeptemberJune 30, 2017,2018, approximately $11,046,000,$16,155,000, or 72.0%82.0%, are secured by real estate. The majority of impaired real estate construction and development loans are for the purpose of residential construction, residential and commercial acquisition and development, and land development. Residential construction loans are made for the purpose of building residential 1-4 single family homes. Residential and commercial acquisition and development loans are made for the purpose of purchasing land, developing that land if required, and developing real estate or commercial construction projects on those properties. Land development loans are made for the purpose of converting raw land into construction-ready building sites.

Table 9. Impaired Loans and Specific Reserves

The following table summarizes the components of impaired loans and their related specific reserves at SeptemberJune 30, 20172018 and December 31, 2016.
2017. 

Impaired Loan Balance Reserve Impaired Loan Balance ReserveImpaired Loan Balance Reserve Impaired Loan Balance Reserve
(in 000’s)September 30, 2017 September 30, 2017 December 31, 2016 December 31, 2016June 30, 2018 June 30, 2018 December 31, 2017 December 31, 2017
Commercial and industrial$3,687
 $571
 $5,009
 $757
$3,258
 $444
 $3,318
 $534
Real estate – mortgage3,944
 427
 3,931
 603
3,595
 590
 4,296
 488
RE construction & development6,816
 
 6,274
 
11,764
 
 5,972
 
Agricultural891
 743
 
 
1,017
 706
 1,204
 866
Installment/other
 
 965
 
62
 
 
 
Total Impaired Loans$15,338
 $1,741
 $16,179
 $1,360
$19,696
 $1,740
 $14,790
 $1,888

Included in impaired loans are loans modified in troubled debt restructurings (TDRs), where concessions have been granted to borrowers experiencing financial difficulties in an attempt to maximize collection. The Company makes various types of concessions when structuring TDRs including rate reductions, payment extensions, and forbearance. At SeptemberJune 30, 20172018, approximately $3,835,0003,582,000 of the total $12,150,0007,641,000 in TDRs was comprised of real estate mortgages. An additional $6,798,0002,939,000 was related to real estate construction and development loans. There were no reserve amounts for real estate construction and development impaired loans and impaired installment loans at December 31, 20162017 and SeptemberJune 30, 2017,2018, due to the Companyvalue of the collateral securing collateral on those loans.
 
Total troubled debt restructurings decreased 2.10%32.75% between SeptemberJune 30, 20172018 and December 31, 20162017. Nonaccrual TDRs decreased by 29.46%36.00% while accruing TDRs increasedecreased by 36.53%29.93% over the same period. Total residential mortgages and real estate construction TDRs increasedecreased slightly to 5.39%32.95%. Many of these credits are related to real estate projects that slowed significantly or stalled during the recession, leading the Company to pursue restructuring of the qualified credits allowing the real estate market time to recover and developers opportunity to finish projects at a slower pace. Concessions granted in these circumstances include lengthened maturities and/or rate reductions that enabled the borrower to finish the projects and may be entirely successful. In large part, current successes are related to a recovering real estate market.

Table 10. TDRs

The following table summarizestables summarize TDRs by type, classified separately as nonaccrual or accrual, which are included in impaired loans at SeptemberJune 30, 20172018 and December 31, 2016.2017.
Total TDRs Nonaccrual TDRs Accruing TDRsTotal TDRs Nonaccrual TDRs Accruing TDRs
(in 000's)September 30, 2017 September 30, 2017 September 30, 2017June 30, 2018 June 30, 2018 June 30, 2018
Commercial and industrial$630
 $250
 $381
$110
 $
 $110
Real estate - mortgage: 
  
  
 
  
  
Commercial real estate1,147
 466
 681
1,363
 439
 924
Residential mortgages2,688
 
 2,688
2,219
 
 2,219
Total real estate mortgage3,835
 466
 3,369
3,582
 439
 3,143
RE construction & development6,798
 4,408
 2,389
2,939
 2,939
 
Agricultural887
 
 887
1,010
 
 1,010
Total Troubled Debt Restructurings$12,150
 $5,124
 $7,026
$7,641
 $3,378
 $4,263
 

Total TDRs Nonaccrual TDRs Accruing TDRsTotal TDRs Nonaccrual TDRs Accruing TDRs
(in 000's)December 31, 2016 December 31, 2016 December 31, 2016December 31, 2017 December 31, 2017 December 31, 2017
Commercial and industrial$1,356
 $565
 $791
$436
 $194
 $242
Real estate - mortgage: 
  
  
 
  
  
Commercial real estate1,454
 1,126
 328
1,233
 454
 779
Residential mortgages2,368
 
 2,368
2,542
 288
 2,254
Total real estate mortgage3,822
 1,126
 2,696
3,775
 742
 3,033
RE construction & development6,267
 4,608
 1,659
5,951
 4,342
 1,609
Installment/other965
 965
 

 
 
Total Troubled Debt Restructurings$12,410
 $7,264
 $5,146
$11,362
 $5,278
 $6,084

Of the $12,150,000$7,641,000 in total TDRs at SeptemberJune 30, 2017, $5,124,0002018, $3,378,000 were on nonaccrual status at period-end. Of the $12,410,000$11,362,000 in total TDRs at December 31, 2016, $7,264,0002017, $5,278,000 were on nonaccrual status at period-end. As of SeptemberJune 30, 2017,2018, the Company has no commercial real estate (CRE) workouts whereby an existing loan was restructured into multiple new loans (i.e., A Note/B Note structure).
 
For a restructured loan to return to accrual status there needs to be at least 6 months successful payment history. In addition,history and continued satisfactory performance is expected. to this end, the Company’s Credit AdministrationCompany typically performs a financial analysis of the credit to determine whether the borrower has the ability to continue to perform successfullymeet payments over the remaining life of the loan.loans. This includes, but is not limited to, a review of financial statements and a cash flow analysis of the borrower. Only after determiningdetermination that the borrower has the ability to perform under the terms of the loans, will the restructured credit be considered for accrual status.

Table 7.11. Credit Quality Indicators for Outstanding Student Loans

The following table summarizes the credit quality indicators for outstanding student loans as of June 30, 2018 and December 31, 2017 (in 000's, except for number of borrowers):
 June 30, 2018 December 31, 2017
 Number of Loans Amount Number of Loans Amount
School992
 $37,565
 1,216
 $48,825
Grace294
 13,724
 55
 1,446
Repayment184
 6,129
 201
 6,473
Deferment40
 1,270
 32
 1,128
Forbearance92
 3,006
 50
 1,981
Claim1
 67
 
 
Total1,603
 $61,761
 1,554
 $59,853

School - The time in which the borrower is still actively in school at least half time. No payments are expected during this stage, though the borrower may begin immediate payments.

Grace - A six month period of time granted to the borrower immediately upon graduation, or if deemed no longer an active student. Interest continues to accrue. Upon completion of the six month grace period the loan is transferred to repayment status. Additionally, if applicable, this status may represent a borrower activated to military duty while in their in-school period, they will be allowed to return to that status once their active duty has expired. The borrower must return to an at least half time status within six months of the active duty end date in order to return to an in-school status.

Repayment - The time in which the borrower is no longer actively in school at least half time, and has not received an approved grace, deferment, or forbearance. Regular payment is expected from these borrowers under an allotted payment plan.

Deferment - May be granted up to 48 months for borrowers who have begun the repayment period on their loans but are (1) actively enrolled in an eligible school at least half time, or (2) are actively enrolled in an approved and verifiable medical residency, internship, or fellowship program.


Forbearance - The period of time during which the borrower may postpone making principal and interest payments, which may be granted for either hardship or administrative reasons. Interest will continue to accrue on loans during periods of authorized forbearance. If the borrower is delinquent at the time the forbearance is granted, the delinquency will be covered by the forbearance and all accrued and unpaid interest from the date of delinquency or if none, from the date of beginning of the forbearance period, will be capitalized at the end of each forbearance period. The term of the loan will not change and payments may be increased to allow the loan to pay off in the required time frame.

Claim - Occurs after a loan has been delinquent for a period of time in which the servicer believes payment may not be received. A claim can be filed at any point in the delinquency, but typically not until 180 - 210 days. ReliaMax Surety Company was declared insolvent by the the South Dakota Division of Insurance and is now in liquidation. No future claims will be filed with ReliaMax.

Table 12. Nonperforming Assets
 
The following table summarizes the components of nonperforming assets as of June 30, 2018 and December 31, 2017 (in 000's), and the percentage of nonperforming assets to total gross loans, total assets, and the allowance for loan losses:
(in 000's)September 30, 2017 December 31, 2016June 30, 2018 December 31, 2017
Nonaccrual Loans (1)$5,145
 $7,264
$12,202
 $5,296
Restructured Loans7,026
 5,146
4,263
 6,084
Loans past due 90 days or more, still accruing
 
67
 485
Total nonperforming loans12,171
 12,410
16,532
 11,865
Other real estate owned5,745
 6,471
5,745
 5,745
Total nonperforming assets$17,916
 $18,881
$22,277
 $17,610
      
Nonperforming loans to total gross loans2.09% 2.18%2.88% 1.97%
Nonperforming assets to total assets2.12% 2.40%2.53% 2.19%
Allowance for loan losses to nonperforming loans75.24% 71.73%50.96% 78.10%
 
(1)Included in nonaccrual loans at SeptemberJune 30, 20172018 and December 31, 20162017 are restructured loans totaling $5,124,000$3,378,000 and $7,264,000,$5,278,000, respectively.

Non-performing loans decreased $239,000increased $4,667,000 between December 31, 20162017 and SeptemberJune 30, 2017.2018. Nonaccrual loans decreased $2,119,000increased $6,906,000 between December 31, 20162017 and SeptemberJune 30, 2017,2018, with real estate mortgage and real estate construction loans comprising approximately 94.73%100.00% of total nonaccrual loans at SeptemberJune 30, 2017.2018. The reductionincrease in nonaccrualnon-performing loans is primarily attributed to a payoffthe addition of a $965,000two nonaccrual loans, made to the same borrower, totaling $8,825,000. The ratio of the allowance for loan and the migration of a $589,000 loanlosses to accrual. nonperforming loans decreased from 78.10% at December 31, 2017 to 50.96% at June 30, 2018.

The following table summarizes the nonaccrual totals by loan category for the periods shown. The ratio of the allowance for loan losses to nonperforming loans increased from 71.73% at December 31, 2016 to 75.24% at September 30, 2017.shown:
(in 000's)
Balance Balance Change fromBalance Balance Change from
Nonaccrual Loans:September 30, 2017 December 31, 2016 December 31, 2016June 30, 2018 December 31, 2017 December 31, 2017
Commercial and industrial$271
 $565
 $(294)$
 $212
 $(212)
Real estate - mortgage466
 1,126
 (660)438
 742
 (304)
RE construction & development4,408
 4,608
 (200)11,764
 4,342
 7,422
Installment/other
 965
 (965)
 
 
Total Nonaccrual Loans$5,145
 $7,264
 $(2,119)$12,202
 $5,296
 $6,906

Loans past due more than 30 days receive increased management attention and are monitored for increased risk. The Company continues to move past due loans to nonaccrual status in an ongoing effort to recognize and address loan problems as early and most effectively as possible. As impaired loans, nonaccrual and restructured loans are reviewed for specific reserve allocations, the allowance for credit losses is adjusted accordingly.


Except for the nonaccrual loans included in the above table, or those included in the impaired loan totals, there were no loans at SeptemberJune 30, 20172018 where the known credit problems of a borrower caused the Company to have serious doubts as to the ability of such borrower to comply with the present loan repayment terms and which would result in such loan being included as a nonaccrual, past due, or restructured loan at some future date.

Nonperforming assets, which are primarily related to the real estate loan and other real estate owned portfolio, decreased$965,000increased$4,667,000 from a balance of $18,881,000$17,610,000 at December 31, 20162017 to a balance of $17,916,000$22,277,000 at SeptemberJune 30, 2017, but2018, and remained relatively high compared to peers during the ninesix months ended SeptemberJune 30, 2017.2018. Nonaccrual loans, totaling $5,145,000$12,202,000 at SeptemberJune 30, 2017, decreased $2,119,0002018, increased $6,906,000 from the balance of $7,264,000$5,296,000 reported at December 31, 2016.2017. In determining the adequacy of the underlying collateral related to these loans, management monitors trends within specific geographical areas, loan-to-value ratios, appraisals, and other credit issues related to the specific loans. Impaired loans decreased $841,000increased $4,906,000 during the ninesix months ended SeptemberJune 30, 20172018 to a balance of $15,338,000$19,696,000 at SeptemberJune 30, 2017.2018. Other real estate owned through foreclosure decreased toremained the same at $5,745,000 for the period ended SeptemberJune 30, 2017 from2018 as compared to the $6,471,000 balance recorded at December 31, 2016.2017. Nonperforming assets as a percentage of total assets decreasedincreased from 2.40%2.19% at December 31, 20162017 to 2.12%2.53% at SeptemberJune 30, 2017.2018.

The following table summarizes various nonperforming components of the loan portfolio, the related allowance for credit losses and provision for credit losses for the periods shown.
(in 000's)September 30, 2017 December 31, 2016 September 30, 2016June 30, 2018 December 31, 2017 June 30, 2017
Recovery of provision for credit losses year-to-date$(24) $(21) $(7)$(1,325) $(189) $(31)
Allowance as % of nonperforming loans75.24% 71.73% 77.06%50.96% 78.10% 66.63%
          
Nonperforming loans as % total loans2.09% 2.18% 2.07%2.88% 1.97% 2.46%
Restructured loans as % total loans2.09% 2.18% 2.00%1.33% 1.89% 2.46%

Management continues to monitor economic conditions in the real estate market for signs of further deterioration or improvement which may impact the level of the allowance for loan losses required to cover identified losses in the loan portfolio. Greater focusFocus has been placed on monitoring and reducing the level of problem assets, while working with borrowers to find more options, including loan restructures, to work through these difficult economic times.restructures. Restructured loan balances are comprised of 2917 loans totaling $12,150,000$7,641,000 at SeptemberJune 30, 2017,2018, compared to 2825 loans totaling $12,410,000$11,362,000 at December 31, 2016.

2017.
 
The following table summarizes special mention loans by type at SeptemberJune 30, 20172018 and December 31, 2016.2017.
(in thousands)September 30, 2017 December 31, 2016June 30, 2018 December 31, 2017
Commercial and industrial$2,635
 $4,416
$10
 $
Real estate - mortgage: 
  
 
  
Commercial real estate8,541
 621
8,376
 8,487
Residential mortgages647
 
636
 643
Total real estate mortgage9,188
 621
9,012
 9,130
RE construction & development2,609
 928

 720
Agricultural985
 

 994
Total Special Mention Loans$15,417
 $5,965
$9,022
 $10,844
 
The Company focuses on competition and other economic conditions within its market area and other geographical areas in which it does business, which may ultimately affect the risk assessment of the portfolio. The Company continues to experience increased competition from major banks, local independents and non-bank institutions which creates pressure on loan pricing. Low interest rates and a weak economy continue to dominate, even as real estate prices show signs of stabilization and interest rates have begun to rise. The Company continues to place increased emphasis on reducing both the level of nonperforming assets and the level of losses on the disposition of these assets. It is in the best interest of both the Company and the borrowers to seek alternative options to foreclosure in an effort to reduce the impacts on the real estate market. As part of this strategy, the Company has increased its level of troubled debt restructurings, when it makes economic sense.improves collection prospects. While business and consumer spending show improvement, in recent quarters, current GDP remains anemic. Itit is difficult to forecast what impact Federal Reserve actions to hold rates lowrate increases will have on the economy. Local unemployment rates in the San Joaquin Valley have improved, but remain elevated compared with other regions and historically are higher as a result of the area's agricultural dynamics. The Company believes that the Central San Joaquin Valley

will continue to grow and diversify as property and housing costs remain low relative to other areas of the state. Management recognizes increased risk of loss due to the

Company's exposure to local and worldwide economic conditions, as well as potentially volatile real estate markets, and takes these factors into consideration when analyzing the adequacy of the allowance for credit losses.

The following table provides a summary of the Company's allowance for possible credit losses, provisions made to that allowance, and charge-off and recovery activity affecting the allowance for the ninesix months ended SeptemberJune 30, 20172018 and SeptemberJune 30, 2016.2017.

Table 8.13. Allowance for Credit Losses - Summary of Activity
 
(in 000's)September 30, 2017 September 30, 2016June 30, 2018 June 30, 2017
Total loans outstanding at end of period before deducting allowances for credit losses$583,601
 $560,651
$574,351
 $568,163
Average loans outstanding during period565,068
 532,133
590,905
 560,282
      
Balance of allowance at beginning of period8,902
 9,713
9,267
 8,902
Loans charged off: 
  
 
  
Real estate(2) (29)
 (2)
Commercial and industrial(106) (846)(88) (105)
Installment and other(12) (20)(11) (10)
Total loans charged off(120) (895)(99) (117)
Recoveries of loans previously charged off: 
  
 
  
Real estate73
 50
20
 14
Commercial and industrial195
 51
408
 185
Installment and other132
 6
154
 54
Total loan recoveries400
 107
582
 253
Net loans recovered (charged off)280
 (788)
Net loans recovered483
 136
      
Recovery of provision charged to operating expense(24) (7)(1,325) (31)
Balance of allowance for credit losses at end of period$9,158
 $8,918
$8,425
 $9,007
      
Net loan (recoveries) charge offs to total average loans (annualized)(0.07)% 0.20%
Net loan (recoveries) charge offs to loans at end of period (annualized)(0.10)% 0.19%
Net loan recoveries to total average loans (annualized)(0.16)% (0.05)%
Net loan recoveries to loans at end of period (annualized)(0.17)% (0.03)%
Allowance for credit losses to total loans at end of period1.57 % 1.59%1.47 % 1.59 %
Net loan (recoveries) charge offs to allowance for credit losses (annualized)(6.11)% 35.34%
Provision for credit losses to net (charge offs) recoveries (annualized)(11.43)% 1.18%
Net loan recoveries to allowance for credit losses (annualized)(11.47)% (3.02)%
Recovery of provision for credit losses to net recoveries (annualized)(548.65)% (45.59)%

Provisions for credit losses are determined on the basis of management's periodic credit review of the loan portfolio, consideration of past loan loss experience, current and future economic conditions, and other pertinent factors. Management believes its estimate of the allowance for credit losses adequately covers estimated losses inherent in the loan portfolio and, based on the condition of the loan portfolio, management believes the allowance is sufficient to cover risk elements in the loan portfolio. For the ninesix months ended SeptemberJune 30, 2017,2018, the recovery of provision for the allowance for credit losses was $24,000$1,325,000 as compared to a recovery of provision of $7,000$31,000 for the ninesix months ended SeptemberJune 30, 2016.2017.

Net recoveries during the ninesix months ended SeptemberJune 30, 20172018 totaled $280,000$483,000 as compared to net charge-offsrecoveries of $788,000$136,000 for the ninesix months ended SeptemberJune 30, 2016.2017. The Company charged-off, or had partial charge-offs on 36 loans during the ninesix months ended SeptemberJune 30, 2017,2018, as compared to 11 loansone loan during the same period ended SeptemberJune 30, 2016,2017, and 136 loans during the year ended December 31, 2016.2017. The annualized percentage net recoveries to average loans were 0.07%0.16% for the ninesix months ended SeptemberJune 30, 20172018 and 0.15%0.06% for the year ended December 31, 2016, as compared to net charge-offs of 0.20%2017, and 0.05% for the ninesix months ended SeptemberJune 30, 2016.2017. The Company's loans net loansof unearned fees increased from $560,651,000$568,163,000 at SeptemberJune 30, 20162017 to $583,601,000$574,351,000 at SeptemberJune 30, 2017.2018.


The allowance at SeptemberJune 30, 20172018 was 1.57%1.47% of outstanding loan balances at SeptemberJune 30, 2017,2018, as compared to 1.56%1.54% at December 31, 2016,2017, and 1.59% at SeptemberJune 30, 2016. The increase in the allowance as a percentage of outstanding loan balances between December 31, 2016 and September 30, 2017 is primarily attributed to increases in specific reserves due to newly impaired loans.2017.

At SeptemberJune 30, 2018 and June 30, 2017, $346,000 and September 30, 2016, $370,000 and $316,000,$376,000, respectively, of the formula allowance is allocated to unfunded loan commitments and is, therefore, reported separately in other liabilities on the consolidated balance sheet. Management believes that the 1.57%1.47% credit loss allowance at SeptemberJune 30, 20172018 is adequate to absorb known and inherent risks in the loan portfolio. No assurance can be given, however, regarding economic conditions or other circumstances which may adversely affect the Company's service areas and result in future losses to the loan portfolio.


Asset/Liability Management – Liquidity and Cash Flow

The primary functionfunctions of asset/liability management isare to provide adequate liquidity and maintain an appropriate balance between interest-sensitive assets and interest-sensitive liabilities. In a changing rate environment an inbalance in interest-sensitive assets and interest-sensitive liabilities will impact earnings. For example, in an increasing rate environment if interest-sensitive liabilities reprice sooner than interest sensitive assets, net interest income will be negatively impacted.

Liquidity

Liquidity management may be described as the ability to maintain sufficient cash flows to fulfill financial obligations, including loan funding commitments and customer deposit withdrawals, without straining the Company’s equity structure. To maintain an adequate liquidity position, the CompanyBank relies on, in addition to cash and cash equivalents, cash inflows from deposits and short-term borrowings, repayments of principal on loans and investments, and interest income received. The Company'sBank's principal cash outflows are for loan origination, purchases of investment securities, depositor withdrawals and payment of operating expenses.

The CompanyBank continues to emphasize liability management as part of its overall asset/liability strategy. Through the discretionary acquisition of short term borrowings, the CompanyBank has, when needed, been able to provide liquidity to fund asset growth while, at the same time, better utilizing its capital resources, and better controlling interest rate risk.  This does not preclude the CompanyBank from selling assets such as investment securities to fund liquidity needs but, with favorable borrowing rates, the CompanyBank has maintained a positive yield spread between borrowed liabilities and the assets which those liabilities fund. If, at some time, rate spreads become unfavorable, the CompanyBank has the ability to utilize an asset management approach and, either control asset growth or fund further growth with maturities or sales of investment securities. At SeptemberJune 30, 20172018, the CompanyBank had no borrowings, as its deposit base currently provides funding sufficient to support its asset values.

The Company'sBanks liquid asset base which generally consists of cash and due from banks, federal funds sold, securities purchased under agreements to resell (“reverse repos”) and investment securities, is maintained at a level deemed sufficient to provide the cash outlay necessary to fund loan growth as well as any customer deposit runoff that may occur. Additional liquidity requirements may be funded with overnight or term borrowing arrangements with various correspondent banks, FHLB and the Federal Reserve Bank. Within this framework is the objective of maximizing the yield on earning assets. This is generally achieved by maintaining a high percentage of earning assets in loans, which historically have represented the Company's highest yielding asset. At SeptemberJune 30, 20172018, the loan portfolio totaled 69.19%65.31% of total assets and the loan to deposit ratio was 79.20%74.76%, compared to 72.44%74.75% and 83.05%86.25%, respectively, at December 31, 20162017. Liquid assets at SeptemberJune 30, 20172018, included cash and cash equivalents totaling $159,892,000191,128,000 as compared to $113,032,000107,934,000 at December 31, 20162017. Other sources of liquidity include collateralized lines of credit from the Federal Home Loan Bank, and from the Federal Reserve Bank totaling $298,348,000$284,137,000 and uncollateralized lines of credit from Pacific Coast Banker's Bank (PCBB) of $10,000,000, Union Bank of $10,000,000, and Zion's Bank of $20,000,000 at SeptemberJune 30, 20172018.

The liquidity of the parent company,Holding Company, United Security Bancshares, is primarily dependent on the payment of cash dividends by its subsidiary, United Securitythe Bank, subject to limitations imposed by the Financial Code of the State of California. During the ninesix months ended SeptemberJune 30, 2017,2018, the Holding Company has received $3,109,000$3,282,000 in cash dividends from the Bank.

Cash Flow

The period-end balances of cash and cash equivalents for the periods shown are as follows (from Consolidated Statements of Cash Flows – in 000’s):


  (in 000's)Balance
December 31, 2015$125,751
September 30, 2016$111,747
December 31, 2016$113,032
September 30, 2017$159,892
  (in 000's)Balance
December 31, 2016$113,032
June 30, 2017$109,508
December 31, 2017$107,934
June 30, 2018$191,128

Cash and cash equivalents increased $46,860,000$83,194,000 during the ninesix months ended SeptemberJune 30, 2017,2018, compared to aan decrease of $14,004,000$3,524,000 during the ninesix months ended SeptemberJune 30, 2016.2017.

The Company had a net cash inflow from operating activities of $4,660,000$2,944,000 for the ninesix months ended SeptemberJune 30, 20172018 and a cash inflow from operations totaling $6,025,000$2,250,000 for the period ended SeptemberJune 30, 2016.2017. The Company experienced net cash outflowsinflows from investing activities of $4,787,000$12,501,000 related to a $12,346,000 increase$27,839,000 decrease in loan balances partially offset byand principal payments on available-for-sale securities of $6,091,000 and proceeds from the sale$4,698,000, partially offset by $19,860,000 in purchases of OREO of $1,062,000available-for-sale securities during the ninesix months ended SeptemberJune 30, 2017.2018. For the ninesix months ended SeptemberJune 30, 2016,2017, the Company experienced net cash outflowsinflows from investing activities of $69,516,000$5,384,000 due an increasea decrease of $41,303,000$2,654,000 in loan balances and purchases of $34,987,000 in available-for-sale securities.balances.

During the ninesix months ended SeptemberJune 30, 2017,2018, the Company experienced net cash inflows from financing activities totaling $46,987,000,$67,749,000, primarily as the result of increases of $85,653,000$67,299,000 in demand deposits and savings accounts, offset by decreases of $36,984,000$1,970,000 in time deposits and purchased brokered deposits. For the ninesix months endedSeptember June 30, 2016,2017, the Company experienced net cash inflowsoutflows of $49,487,000$11,158,000 from financing activities due to increasesdecreases in demand deposit accounts, time deposits, and savings accounts.

The Company has the ability to increase or decrease loan growth, increase or decrease deposits and borrowings, or a combination of both to manage balance sheet liquidity.

Regulatory Matters

Termination of Regulatory Agreements

Effective April 12, 2017, the Federal Reserve Bank of San Francisco (the “Reserve Bank”) terminated the informal supervisory agreement with the Company (the “Agreement”) that required, among other things, that the Company obtain prior regulatory approval to accept dividends from the Bank, to pay dividends to its shareholders, or to pay interest on the Company’s junior subordinated debt. The Agreement had replaced a previous formal supervisory agreement with the Reserve Bank effective November 19, 2014.
Effective October 19, 2016, the California Department of Business Oversight (the “DBO”) terminated the informal memorandum of understanding (“MOU”) the Bank had entered into on September 24, 2013, replacing a previous formal order. The MOU required the Bank to maintain a ratio of tangible shareholder’s equity to total tangible assets equal to or greater than 9.0% and also required the DBO’s approval for the Bank to pay a dividend to the Company.

Capital Adequacy

The Company (on a consolidated basis) and the Bank are subject to various regulatory capital requirements adopted by the Board of Governors of the Federal Reserve System (the “Board of Governors”).  Failure to meet minimum capital requirements can initiate certain mandates and possible additional discretionary actions by regulators that, if undertaken, could have a direct material effect on the Company’s consolidated financial statements.  Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the consolidated Company and the Bank must meet specific capital guidelines that involve quantitative measures of their assets, liabilities, and certain off-balance sheet items as calculated under regulatory accounting practices. The capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors. Prompt corrective action provisions are not applicable to bank holding companies.

Quantitative measures established by the capital adequacy guidelines require insured institutions to maintain a minimum leverage ratio of Tier 1 capital (the sum of common stockholders' equity, noncumulative perpetual preferred stock and minority interests in consolidated subsidiaries, minus intangible assets, identified losses and investments in certain subsidiaries, plus unrealized losses or minus unrealized gains on available for sale securities) to total assets. Institutions which have received the

highest composite regulatory rating and which are not experiencing or anticipating significant growth are required to maintain a minimum leverage capital ratio of 3% of Tier 1 capital to total assets. All other institutions are required to maintain a minimum leverage capital ratio of at least 100 to 200 basis points above the 3% minimum requirement.

The Company has adopted a capital plan that includes guidelines and trigger points to ensure sufficient capital is maintained at the Bank and the Company, and that capital ratios are maintained at a level deemed appropriate under regulatory guidelines given the level of classified assets, concentrations of credit, ALLL, current and projected growth, and projected retained earnings. The capital plan also contains contingency strategies to obtain additional capital as required to fulfill future capital requirements for both the Bank, as a separate legal entity, and the Company on a consolidated basis. The capital plan requires the Bank to maintain a ratio of tangible shareholder’s equity to total tangible assets equal to or greater than 9.0%. The Bank’s ratio of tangible shareholders’ equity to total tangible assets was 12.5% and 12.7%13.5% at SeptemberJune 30, 2018 and 2017, and 2016, respectively.


The following table sets forth the Company’s and the Bank's actual capital positions at SeptemberJune 30, 20172018, as well as the minimum capital requirements and requirements to be well capitalized under prompt corrective action provisions (Bank required only) under the regulatory guidelines discussed above:

Table 9.14. Capital Ratios
 
Ratio at September 30, 2017 Ratio at December 31, 2016 Minimum for Capital Adequacy Minimum requirement for "Well Capitalized" InstitutionRatio at June 30, 2018 Ratio at December 31, 2017 Minimum for Capital Adequacy (1) Minimum requirement for "Well Capitalized" Institution
Total capital to risk weighted assets              
Company17.97% 17.26% 8.00% N/A18.42% 17.54% 9.88% N/A
Bank17.85% 17.19% 8.00% 10.00%18.32% 17.31% 9.88% 10.00%
Tier 1 capital to risk-weighted assets  
Company16.72% 16.01% 6.00% N/A17.18% 16.29% 7.88% N/A
Bank16.60% 15.94% 6.00% 8.00%17.07% 16.06% 7.88% 8.00%
Common equity tier 1 capital to risk-weighted assets  
Company15.29% 14.68% 4.50% N/A15.68% 14.81% 6.38% N/A
Bank16.60% 15.94% 4.50% 6.50%17.07% 16.06% 6.38% 6.50%
Tier 1 capital to adjusted average assets (leverage)  
Company12.96% 12.97% 4.00% N/A13.04% 13.01% 5.88% N/A
Bank12.95% 12.99% 4.00% 5.00%12.99% 12.90% 5.88% 5.00%
(1) Includes 1.875% Capital Conservation Buffer

The Federal Reserve and the Federal Deposit Insurance Corporation approved final capital rules in July 2013, that substantially amendamended the then existing capital rules for banks. These new rules reflect, in part, certain standards initially adopted by the Basel Committee on Banking Supervision in December 2010 (commonly referred to as “Basel III”) as well as requirements encompassed by the Dodd-Frank Act.
The final rules set a new common equity tier 1 requirement and higher minimum tier 1 requirements for all banking organizations. The final rules also require a Common Equity Tier 1 capital conservation buffer of 2.5% of risk-weighted assets which is in addition to the other minimum risk-based capital standards in the rule. The capital buffer requirement willis being be phased in over three years beginning in 2016, and will effectively raise the minimum required Common Equity Tier 1 RBC Ratio to 7.0%, the Tier 1 RBC Ratio to 8.5%, and the Total RBC Ratio to 10.5% on a fully phased-in basis. Institutions that do not maintain the required capital buffer will become subject to progressively more stringent limitations on the percentage of earnings that can be paid out in dividends or used for stock repurchases, and on the payment of discretionary bonuses to executive management. The rules revise the prompt corrective action framework to incorporate the new regulatory capital minimums. They also enhance risk sensitivity and address weaknesses identified over recent years with the measure of risk-weighted assets.
As of SeptemberJune 30, 2017,2018, the Company and the Bank meet all capital adequacy requirements to which they are subject. Management believes that, under the current regulations, both will continue to meet their minimum capital requirements in the foreseeable future.

Dividends

Dividends paid to shareholders by the Holding Company are subject to restrictions set forth in the California General Corporation Law. As applicable to the Holding Company, the California General Corporation Law provides that the Holding Company may make a distribution to its shareholders if retained earnings immediately prior to the dividend payout are at least equal to the amount of the proposed distribution or if immediately after the distribution, the value of the Holding Company’s assets would equal or exceed the sum of its total liabilities. The primary source of funds with which dividends will be paid to shareholders will come from cash dividends received by the Company from the Bank.

On April 25, 2017, the Board of Directors announced the authorization of the repurchase of up to $3,000,000 of the outstanding stock of the Holding Company. This amount represents 3% of total shareholders' equity of $101,108,000$105,216,000 at SeptemberJune 30, 2017.2018. The

timing of the purchases will depend on certain factors including, but not limited to, market conditions and prices, available funds, and alternative uses of capital. The stock repurchase program may be carried out through open-market purchases, block trades, or negotiated private transactions. During the threesix months ended SeptemberJune 30, 2017,2018, the Company did not repurchase any of the shares available.

During the nine month periodsix months ended ended SeptemberJune 30, 20172018, the Bank paid $3,109,000$3,282,000 in cash dividends to the Holding Company which funded the Holding Company’s operating costs and payments of interest on its junior subordinated debt, alldebt.

On March 27, 2018, the Company’s Board of which were approved byDirectors declared a cash dividend of $0.09 per share on the Reserve Bank andCompany's common stock. The dividend was payable on April 19, 2018, to shareholders of record as of April 9, 2018. Approximately $1,520,000 was transfered from retained earnings to cash to allow for distribution of the DBO,dividend to shareholders.

On June 26, 2018, the Company's Board of Directors declared a regular quarterly cash dividend $0.09 per share on the Company's common stock. The dividend was payable on July 19, 2018, to shareholders of record as applicable.of July 9, 2018. Approximately $1,520,000 was transfered from retained earnings to dividends payable to allow for distribution of the dividend to shareholders.

The Bank, as a state-chartered bank, is subject to dividend restrictions set forth in the California Financial Code, as administered by the Commissioner of the DBO (“Commissioner”). As applicable to the Bank, the Financial Code provides that the Bank may not pay cash dividends in an amount which exceeds the lesser of the retained earnings of the Bank or the Bank’s net income for the last three fiscal years (less the amount of distributions to the Holding Company during that period of time). If the above test is not met, cash dividends may only be paid with the prior approval of the Commissioner, in an amount not exceeding the Bank’s net income for its last fiscal year or the amount of its net income for the current fiscal year. Such restrictions do not apply to stock dividends, which generally require neither the satisfaction of any tests nor the approval of the Commissioner. Notwithstanding the foregoing, if the Commissioner finds that the shareholder's equity of the Bank is not adequate or that the declaration of a dividend would be unsafe or unsound, the Commissioner may order the Bank not to pay any dividend. The Reserve Bank may also limit dividends paid by the Bank.

Reserve Balances

The Bank is required to maintain average reserve balances with the Federal Reserve Bank. During 2005, the Company implemented a deposit reclassification program which allows the Company to reclassify a portion of transaction accounts to non-transaction accounts for reserve purposes. The deposit reclassification program is provided by a third-party vendor and has been approved by the Federal Reserve Bank.  At SeptemberJune 30, 20172018, the Bank was not subject to a reserve requirement.


Item 3  - Quantitative and Qualitative Disclosures about Market Risk

The Company’s assessment of market risk as of June 30, 2018 indicates there are no material changes in the quantitative and qualitative disclosures from those in our Annual Report on Form 10-K, as amended, for the year ended December 31, 2017.

Item 4. Controls and Procedures

Conclusion Regarding the Effectiveness of Disclosure Controls and Procedures

The Company maintains disclosure controls and procedures that are designed to ensure that information required to be disclosed in Exchange Act reports is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, and that such information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer as appropriate, to allow for timely decisions regarding required disclosure. In designing and evaluating our disclosure controls and procedures, our management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives, and our management is required to apply its judgment in evaluating the cost-benefit relationship of possible controls and procedures.
 
As of SeptemberJune 30, 20172018, the end of the period covered by this report, an evaluation, under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures was carried out. Based on the foregoing, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were effective at the reasonable assurance level.


Changes in Internal Control over Financial Reporting

There have not been any changes in the Company's internal control over financial reporting that occurred during the quarter ended SeptemberJune 30, 2017,2018, that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.
 
The Company does not expect that its disclosure controls and procedures and internal control over financial reporting will prevent all error and fraud.  A control procedure, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control procedure are met.  Because of the inherent limitations in all control procedures, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within the Company have been detected.  These inherent limitations include the realities that judgments in decision-making can be faulty, and that breakdowns in controls or procedures can occur because of simple error or mistake.  Additionally, controls can be circumvented by the individual acts of some persons, by collusion of two or more people, or by management override of the control.  The design of any control procedure is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions; over time, controls become inadequate because of changes in conditions, or the degree of compliance with the policies or procedures may deteriorate.  Because of the inherent limitations in a cost-effective control procedure, misstatements due to error or fraud may occur and not be detected.


PART II. Other Information

Item 1. Legal Proceedings

Not applicable
 
Item 1A. Risk Factors

There have been no material changes to the risk factors disclosed in our Annual Report on Form 10-K, as amended, for the fiscal year ended December 31, 2016.2017.
 
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
 
None during the quarter ended SeptemberJune 30, 20172018.
 
Item 3. Defaults Upon Senior Securities

Not applicable
 
Item 4. Mine Safety Disclosures

Not applicable
 
Item 5. Other Information

Not applicable
 
Item 6. Exhibits:

(a)Exhibits:
11Computation of Earnings per Share*
31.1
31.2
32.1
32.2
 
* Data required by Accounting Standards Codification (ASC) 260, Earnings per Share, is provided in Note 8 to the consolidated financial statements in this report.

Signatures

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

  United Security Bancshares
   
Date:November 2, 2017August 3, 2018/S/ Dennis R. Woods
  Dennis R. Woods
  President and
Chief Executive Officer
   
  /S/ Bhavneet Gill
  Bhavneet Gill
  Senior Vice President and Chief Financial Officer

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