HomeTown Bankshares (HMTA) 10-Q 2018 Q2 Quarterly report

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

  (Mark One)

  ☒ Quarterly Report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

for the quarterly period ended June 30, 2018. 

Or 

  ☐ Transition Report pursuant to Section 13 or 15 (d) of the Securities Exchange Act of 1934

for the transition period from              to             .

Commission File Number: 333-158525

HOMETOWN BANKSHARES CORPORATION

(Exact name of the registrant as specified in its charter) 

Virginia	26-4549960
(State or other jurisdiction of Incorporation or organization)	(I.R.S. Employer Identification No.)
202 South Jefferson Street, Roanoke, Virginia	24011
(Address of principal executive offices)	(Zip Code)

Registrant’s telephone number: (540) 345-6000

(Former name, former address, and former fiscal year, if changed since last report)

Indicate by check mark whether the registrant (1) filed all reports required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934 during the past 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  ☒    No  ☐

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

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

Large accelerated filer	☐	Accelerated filer	☐
Non-accelerated filer	☐	(Do not check if a smaller reporting company)
		Smaller reporting company	☒
		Emerging growth company	☐

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

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

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

As of August 10, 2018, 5,811,483 shares of common stock, par value $5.00 per share, of the issuer were outstanding.

 HOMETOWN BANKSHARES CORPORATION

Form 10-Q

INDEX

PART I. FINANCIAL INFORMATION
Item 1.	FINANCIAL STATEMENTS
Consolidated Balance Sheets as of June 30, 2018 (unaudited) and December 31, 2017		3
Consolidated Statements of Income for the Three and Six Months Ended June 30, 2018 and 2017 (unaudited)		4
Consolidated Statements of Comprehensive Income for the Three and Six Months Ended June 30, 2018 and 2017 (unaudited)		5
Consolidated Statements of Cash Flows for the Six Months Ended June 30, 2018 and 2017 (unaudited)		6
Notes to Consolidated Financial Statements (unaudited)		7
Item 2.	MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS	21
Item 3.	QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK	31
Item 4.	CONTROLS AND PROCEDURES	31
PART II. OTHER INFORMATION
Item 1.	Legal Proceedings	32
Item 1A.	Risk Factors	32
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	32
Item 3.	Defaults Upon Senior Securities	32
Item 4.	Mine Safety Disclosure	32
Item 5.	Other Information	32
Item 6.	Exhibits	33
SIGNATURES		34

All schedules have been omitted because they are inapplicable or the required information is provided in the financial statements, including the notes thereto.

2

HomeTown Bankshares Corporation

Consolidated Balance Sheets

June 30, 2018 and December 31, 2017

Dollars In Thousands, Except Share and Per Share Data	June 30, 2018				December 31, 2017
	(Unaudited)					*
Assets
Cash and due from banks	$	20,689			$	21,714
Federal funds sold		319		��		180
Securities available for sale, at fair value		47,915				55,344
Restricted equity securities, at cost		2,546				2,371
Loans held for sale		280				1,587
Loans, net of allowance for loan losses of $3,917 in 2018 and $3,758 in 2017		457,535				440,437
Property and equipment, net		13,144				12,937
Other real estate owned, net of valuation allowance of $955 in 2018 and $797 in 2017		3,414				3,249
Bank owned life insurance		8,097				8,669
Accrued income		2,592				2,681
Other assets		1,577				1,084
Total assets	$	558,108			$	550,253
Liabilities and Stockholders’ Equity
Deposits:
Noninterest-bearing	$	112,112			$	106,956
Interest-bearing		368,973				370,364
Total deposits		481,085				477,320
Federal Home Loan Bank borrowings		15,116				11,028
Subordinated notes		7,269				7,254
Other borrowings		275				1,558
Accrued interest payable		361				368
Other liabilities		1,925				1,833
Total liabilities		506,031				499,361
Commitments and contingencies
Stockholders’ equity:
Common stock, $5 par value; authorized 10,000,000 shares, issued and outstanding 5,811,483 (includes 42,495 restricted shares) at June 30, 2018 and 5,775,597 (includes 32,087 restricted shares) at December 31, 2017		28,845				28,777
Surplus		18,117				17,980
Retained earnings		5,698				3,767
Accumulated other comprehensive loss		(916	)			(141	)
Total HomeTown Bankshares Corporation stockholders’ equity		51,744				50,383
Noncontrolling interest in consolidated subsidiary		333				509
Total stockholders’ equity		52,077				50,892
Total liabilities and stockholders' equity	$	558,108			$	550,253

*Derived from consolidated audited financial statements.

See Notes to Consolidated Financial Statements

3

HomeTown Bankshares Corporation

Consolidated Statements of Income

For the three and six months ended June 30, 2018 and 2017

	For the Three Months Ended June 30,				For the Six Months Ended June 30,
Dollars in Thousands, Except Share and Per Share Data	2018		2017		2018		2017
	(Unaudited)		(Unaudited)		(Unaudited)		(Unaudited)
Interest and dividend income:
Loans and fees on loans	$	5,126	$	4,703	$	10,030	$	9,327
Taxable investment securities		271		260		562		500
Nontaxable investment securities		57		76		116		164
Dividends on restricted stock		38		33		73		65
Other interest income		40		50		90		92
Total interest and dividend income		5,532		5,122		10,871		10,148
Interest expense:
Deposits		660		552		1,237		1,106
Subordinated notes		134		134		268		268
Other borrowed funds		86		60		158		114
Total interest expense		880		746		1,663		1,488
Net interest income		4,652		4,376		9,208		8,660
Provision for loan losses		110		465		347		535
Net interest income after provision for loan losses		4,542		3,911		8,861		8,125
Noninterest income:
Service charges on deposit accounts		147		146		280		296
ATM and interchange income		262		228		489		406
Mortgage banking		197		255		392		462
Gains on sales of investment securities, net		-		29		60		42
Income from life insurance death benefit		12		-		642		-
Other income		171		375		313		525
Total noninterest income		789		1,033		2,176		1,731
Noninterest expense:
Salaries and employee benefits		2,133		2,064		4,352		4,053
Occupancy and equipment expense		407		439		837		854
Data processing expense		374		318		797		645
ATM processing expense		24		61		41		123
Advertising and marketing expense		174		142		355		272
Professional fees		165		132		274		365
Bank franchise taxes		106		99		207		199
FDIC insurance expense		74		71		156		103
Losses on sales and write-downs of other real estate owned, net		-		380		158		380
Other real estate owned expense		64		24		205		37
Directors’ fees		98		108		203		209
Other expense		491		474		882		865
Total noninterest expense		4,110		4,312		8,467		8,105
Net income before income taxes		1,221		632		2,570		1,751
Income tax expense		232		176		379		518
Net income		989		456		2,191		1,233
Less net income attributable to non-controlling interest		16		22		28		34
Net income attributable to HomeTown Bankshares Corporation	$	973	$	434	$	2,163	$	1,199
Basic earnings per common share	$	0.17	$	0.08	$	0.37	$	0.21
Diluted earnings per common share	$	0.17	$	0.08	$	0.37	$	0.21
Weighted average common shares outstanding		5,806,960		5,768,670		5,801,016		5,766,041
Diluted weighted average common shares outstanding		5,852,758		5,789,905		5,846,814		5,787,276

See Notes to Consolidated Financial Statements

4

HomeTown Bankshares Corporation

Consolidated Statements of Comprehensive Income

For the three and six months ended June 30, 2018 and 2017

	For the Three Months Ended June 30,						For the Six Months Ended June 30,
	2018			2017			2018			2017
Dollars In Thousands	(Unaudited)			(Unaudited)			(Unaudited)			(Unaudited)
Net income	$	989		$	456		$	2,191		$	1,233
Other comprehensive income (loss):
Net unrealized holding gains (losses) on securities available for sale during the period		(171	)		431			(921	)		509
Deferred income tax benefit (expense) on unrealized holding gains on securities available for sale		36			(146	)		193			(173	)
Reclassification adjustment for gains on sales of investment securities included in net income		-			(29	)		(60	)		(42	)
Tax expense related to realized gains on securities sold		-			10			13			14
Total other comprehensive income (loss)		(135	)		266			(775	)		308
Comprehensive income		854			722			1,416			1,541
Less: Comprehensive income attributable to the non-controlling interest		16			22			28			34
Comprehensive income attributable to HomeTown Bankshares Corporation	$	838		$	700		$	1,388		$	1,507

See Notes to Consolidated Financial Statements

5

HomeTown Bankshares Corporation

Consolidated Statements of Cash Flows

For the six months ended June 30, 2018 and 2017

Dollars in Thousands	2018			2017
	(Unaudited)			(Unaudited)
Cash flows from operating activities:
Net income	$	2,191		$	1,233
Adjustments to reconcile net income to net cash provided by operations:
Depreciation and amortization		344			367
Provision for loan losses		347			535
Amortization of premium on securities, net		215			238
Amortization of discount on subordinated notes		15			15
Gains on sales of loans held for sale		(279	)		(327	)
Losses on sales and writedowns of other real estate, net		158			380
Gains on sales of investment securities		(60	)		(42	)
Increase in value of life insurance contracts		(102	)		(97	)
Income from life insurance benefit		(642	)		–
Stock compensation expense		114			73
Originations of loans held for sale		(13,435	)		(15,383	)
Proceeds from sales of loans held for sale		15,021			15,280
Changes in assets and liabilities:
Accrued income		89			(162	)
Other assets		(84	)		(440	)
Deferred taxes, net		(203	)		(175	)
Accrued interest payable		(7	)		27
Other liabilities		92			(177	)
Net cash flows provided by operating activities		3,774			1,345
Cash flows from investing activities:
Net increase in federal funds sold		(139	)		(51	)
Purchases of available for sale securities		(900	)		(6,696	)
Sales, maturities, and calls of available for sale securities		7,193			11,276
Purchase of restricted equity securities, net		(175	)		(158	)
Net increase in loans		(18,142	)		(15,981	)
Proceeds from sales of other real estate		374			646
Death benefit from bank owned life insurance		1,316			–
Purchases of property and equipment		(551	)		(173	)
Net cash flows used in investing activities		(11,024	)		(11,137	)
Cash flows from financing activities:
Net increase in noninterest-bearing deposits		5,156			25,184
Net increase (decrease) in interest-bearing deposits		(1,391	)		324
Net increase in FHLB borrowings		4,088			3,694
Net decrease in other borrowings		(1,283	)		(17	)
Distribution of equity of noncontrolling interest		(204	)		–
Common stock cash dividends paid		(232	)		–
Exercise of stock options		91			13
Net settlement of vested restricted stock		–			(17	)
Net cash flows provided by financing activities		6,225			29,181
Net increase (decrease) in cash and cash equivalents		(1,025	)		19,389
Cash and cash equivalents, beginning		21,714			18,229
Cash and cash equivalents, ending	$	20,689		$	37,618
Supplemental disclosure of cash flow information:
Cash payments for interest	$	1,670		$	1,446
Cash payments for income taxes	$	510		$	786
Supplemental disclosure of noncash investing and financing activities:
Transfer from loans to other real estate owned	$	697		$	–
Change in unrealized gains and losses on available for sale securities	$	(981	)	$	467

See Notes to Consolidated Financial Statements

6

Notes to Consolidated Financial Statements

Note 1. Organization and Summary of Significant Accounting Policies

Organization

On September 4, 2009, Hometown Bankshares Corporation (the “Company”) acquired all outstanding stock of HomeTown Bank (the “Bank”) in an exchange for shares of the Company on a one-for-one basis to become a single-bank holding company with the Bank becoming a wholly-owned subsidiary. The Bank was organized and incorporated under the laws of the State of Virginia on November 9, 2004 and commenced operations on November 14, 2005. The Bank currently serves Roanoke City, Virginia, the County of Roanoke, Virginia, the City of Salem, Virginia, Christiansburg, Virginia, and surrounding areas. As a state chartered bank which is a member of the Federal Reserve System, the Bank is subject to regulation by the Virginia Bureau of Financial Institutions, the Federal Deposit Insurance Corporation and the Federal Reserve Board.

Basis of Presentation

The consolidated financial statements as of June 30, 2018 and for the periods ended June 30, 2018 and 2017 included herein, have been prepared by HomeTown Bankshares Corporation, without audit, pursuant to the rules and regulations of the Securities and Exchange Commission.

Management believes that all interim adjustments for the periods ended June 30, 2018 are of a normal recurring nature. In the opinion of management, the information furnished in the interim consolidated financial statements reflects all adjustments necessary to present fairly the Company’s financial position, results of operations and cash flows for such interim periods. These consolidated financial statements should be read in conjunction with the Company’s audited financial statements and the notes thereto as of December 31, 2017, included in the Company’s Form 10-K for the year ended December 31, 2017. Interim financial performance is not necessarily indicative of performance for the full year.

The accounting and reporting policies of the Company follow generally accepted accounting principles and general practices within the financial services industry.

The consolidated financial statements of HomeTown Bankshares Corporation include the accounts of its wholly-owned subsidiary HomeTown Bank and the accounts of its subsidiary, HomeTown Residential Mortgage LLC. HomeTown Bank owns a 49% interest in HomeTown Residential Mortgage LLC which originates and sells mortgages secured by personal residences. Due to the marketing support and direction provided by HomeTown Bank to HomeTown Residential Mortgage LLC, along with guarantees of warehouse lines of credit used in its operation, the Company is deemed to exercise control of this entity. The ownership interest in HomeTown Residential Mortgage LLC not owned by the Company is reported as Non-Controlling Interest in a Consolidated Subsidiary. All significant intercompany balances and transactions have been eliminated in consolidation.

Except as noted below, the Company’s accounting policies and basic principles have not changed since the summary disclosure of these in our Annual Report on Form 10-K. Please refer to Form 10-K for these policies.

Adoption of New Accounting Standards

During the first quarter of 2018, the Company adopted ASU 2016-01, "Financial Instruments - Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities." The amendments in ASU 2016-01, among other things: (1) requires equity investments (except those accounted for under the equity method of accounting, or those that result in consolidation of the investee) to be measured at fair value with changes in fair value recognized in net income; (2) requires public business entities to use the exit price notion when measuring the fair value of financial instruments for disclosure purposes; (3) Requires separate presentation of financial assets and financial liabilities by measurement category and form of financial asset (i.e., securities or loans and receivables); and (4) eliminates the requirement for public business entities to disclose the method(s) and significant assumptions used to estimate the fair value that is required to be disclosed for financial instruments measured at amortized cost. The adoption of ASU No. 2016-01 on January 1, 2018 did not have a material impact on the Company’s Consolidated Financial Statements. In accordance with (2) above, the Company measured the fair value of its loan and deposit portfolios as of June 30, 2018 using an exit price notion (see Note 7 Fair Value Measurement).

During the first quarter of 2018, the Company adopted ASU 2016-10, "Revenue from Contracts with Customers (Topic 606): Identifying Performance Obligations and Licensing." This standard is on the recognition of revenue from contracts with customers with the core principle being for companies to recognize revenue to depict the transfer of goods or services to customers in amounts that reflect the consideration to which the company expects to be entitled in exchange for those goods or services. The new standard also results in enhanced disclosures about revenue, provides guidance for transactions that were not previously addressed comprehensively and improves guidance for multiple-element arrangements. Our revenue is comprised of net interest income on financial assets and liabilities, which is explicitly excluded from the scope of the new guidance, and noninterest income. The contracts that are in scope of the guidance are primarily related to service charges on deposit accounts, cardholder and merchant income, other service charges and fees, sales of other real estate and miscellaneous fees. We have performed an analysis of contracts for customer service charges, ATM fees and miscellaneous income. The adoption of ASU 2016-10 did not have a material impact on our consolidated financial statements.

7

Revenue Recognition

On January 1, 2018, the Company adopted ASU No. 2016-10 “Revenue from Contracts with Customers” (Topic 606) and all subsequent ASUs that modified Topic 606. As stated previously, the implementation of the new standard did not have a material impact on the measurement or recognition of revenue; as such, a cumulative effect adjustment to opening retained earnings was not deemed necessary. Results for reporting periods beginning after January 1, 2018 are presented under Topic 606, while prior period amounts were not adjusted and continue to be reported in accordance with our historic accounting under Topic 605.

Topic 606 does not apply to revenue associated with financial instruments, including revenue from loans and securities. In addition, certain noninterest income streams such as fees associated with mortgage servicing rights, financial guarantees, derivatives, and certain credit card fees are also not in scope of the new guidance. Topic 606 is applicable to noninterest revenue streams such as trust and asset management income, deposit related fees, interchange fees, merchant income, and annuity and insurance commissions. However, the recognition of these revenue streams did not change significantly upon adoption of Topic 606. Substantially all of the Company’s revenue is generated from contracts with customers. Noninterest revenue streams in-scope of Topic 606 are discussed below.

Service Charges on Deposit Accounts

Service charges on deposit accounts consist of account analysis fees (i.e., net fees earned on analyzed business and public checking accounts), monthly service fees, check orders, and other deposit account related fees. The Company’s performance obligation for account analysis fees and monthly service fees is generally satisfied, and the related revenue recognized, over the period in which the service is provided. Check orders and other deposit account related fees are largely transactional based, and therefore, the Company’s performance obligation is satisfied, and related revenue recognized, at a point in time. Payment for service charges on deposit accounts is primarily received immediately or in the following month through a direct charge to customers’ accounts.

Fees, Exchange, and Other Service Charges

Fees, exchange, and other service charges are primarily comprised of debit and credit card income, ATM fees, merchant services income, and other service charges. Debit and credit card income is primarily comprised of interchange fees earned whenever the Company’s debit and credit cards are processed through card payment networks such as Visa. ATM fees are primarily generated when a Company cardholder uses a non-Company ATM or a non-Company cardholder uses a Company ATM. Merchant services income mainly represents fees charged to merchants to process their debit and credit card transactions, in addition to account management fees. Other service charges include revenue from processing wire transfers, bill pay service, cashier’s checks, and other services. The Company’s performance obligation for fees, exchange, and other service charges are largely satisfied, and related revenue recognized, when the services are rendered or upon completion. Payment is typically received immediately or in the following month.

Annuity and Insurance

Annuity and insurance income primarily consists of commissions received on annuity product sales. The Company acts as an intermediary between the Company’s customer and the insurance carrier. The Company’s performance obligation is generally satisfied upon the issuance of the annuity policy. Shortly after the policy is issued, the carrier remits the commission payment to the Company, and the Company recognizes the revenue. The Company does not earn a significant amount of trailer fees on annuity sales. The majority of the trailer fees relates to variable annuity products and are calculated based on a percentage of market value at period end. Revenue is not recognized until the annuity’s market value can be determined.

Other

Other noninterest income consists of other recurring revenue streams such as commissions from sales of mutual funds and other investments, investment advisor fees from wealth management products, safety deposit box rental fees, and other miscellaneous revenue streams. Commissions from the sale of mutual funds and other investments are recognized on trade date, which is when the Company has satisfied its performance obligation. The Company also receives periodic service fees (i.e., trailers) from mutual fund companies typically based on a percentage of net asset value. Trailer revenue is recorded over time, usually monthly or quarterly, as net asset value is determined. Investment advisor fees from wealth management products are earned over time and based on an annual percentage rate of the net asset value. The investment advisor fees are charged to the customer’s account in advance on the first month of the quarter, and the revenue is recognized over the following three-month period. Safe deposit box rental fees are charged to the customer on an annual basis and recognized upon receipt of payment. The Company determined that since rentals and renewals occur fairly consistently over time, revenue is recognized on a basis consistent with the duration of the performance obligation.

8

Note 2. Investment Securities

The amortized cost and fair value of available-for-sale securities as of June 30, 2018 and December 31, 2017, are as follows:

(Dollars In Thousands)	June 30, 2018
	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses			Fair Value
U. S. Government agency securities	$	12,016	$	18	$	(264	)	$	11,770
Mortgage-backed securities and CMO’s		21,277		-		(843	)		20,434
Corporate securities		6,641		31		(62	)		6,610
Municipal securities		9,141		100		(140	)		9,101
	$	49,075	$	149	$	(1,309	)	$	47,915

(Dollars In Thousands)	December 31, 2017
	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses			Fair Value
U. S. Government agency securities	$	13,475	$	61	$	(101	)	$	13,435
Mortgage-backed securities and CMO’s		24,344		12		(375	)		23,981
Corporate securities		6,991		118		(42	)		7,067
Municipal securities		10,713		213		(65	)		10,861
	$	55,523	$	404	$	(583	)	$	55,344

 U. S. Government agency securities: The unrealized losses on thirty of the Company’s investments in obligations of the U. S. government were caused by increases in market interest rates over the yields available at the time the securities were purchased.  The contractual terms of those investments do not permit the issuer to settle the securities at a price less than the amortized cost basis of the investments. Because the Company does not intend to sell the investments before recovery of their amortized cost basis which may be maturity, the Company does not consider those investments to be other-than-temporarily impaired at June 30, 2018.

Mortgage-backed securities and CMO’s: The unrealized losses on thirty-four of the Company’s investments in government-sponsored entity mortgage-backed securities and collateralized mortgage obligations (“CMOs”) were caused by increases in market interest rates over the yields available at the time the securities were purchased. Because the decline in market value is attributable to changes in interest rates and not credit quality, and because the Company does not intend to sell the investments before recovery of their amortized cost basis, which may be maturity, the Company does not consider those investments to be other-than-temporarily impaired at June 30, 2018.

Corporate securities: The unrealized losses on five of the Company’s investments in corporate securities were caused by increases in market interest rates over the yields available at the time the securities were purchased.  Because the decline in market value is attributable to changes in interest rates and not credit quality, the Company does not consider those investments to be other-than-temporarily impaired at June 30, 2018.

Municipal securities: The unrealized losses on eight of the Company’s investments in municipal securities were caused by increases in market interest rates over the yields available at the time the securities were purchased. All municipal securities are investment grade. Because the decline in market value is attributable to changes in interest rates, credit spreads, and not credit quality, and because the Company does not intend to sell the investments before recovery of their amortized cost basis, which may be maturity, the Company does not consider those investments to be other-than-temporarily impaired at June 30, 2018.

9

The following tables demonstrate the unrealized loss position of available-for-sale securities at June 30, 2018 and December 31, 2017. This information summarizes the amount of time individual securities have been in a continuous, unrealized loss position.

	June 30, 2018
	Less than 12 months					12 months or more					Total
(Dollars In Thousands)	Fair Value		Unrealized Loss			Fair Value		Unrealized Loss			Fair Value		Unrealized Loss
U. S. Government agency securities	$	7,521	$	(186	)	$	2,881	$	(78	)	$	10,402	$	(264	)
Mortgage-backed securities and CMO’s		11,599		(467	)		8,724		(376	)		20,323		(843	)
Corporate securities		3,118		(62	)		-		-			3,118		(62	)
Municipal securities		1,465		(11	)		2,456		(129	)		3,921		(140	)
	$	23,703	$	(726	)	$	14,061	$	(583	)	$	37,764	$	(1,309	)

	December 31, 2017
	Less than 12 months					12 months or more					Total
(Dollars In Thousands)	Fair Value		Unrealized Loss			Fair Value		Unrealized Loss			Fair Value		Unrealized Loss
U.S. Government agency securities	$	6,859	$	(44	)	$	2,995	$	(57	)	$	9,854	$	(101	)
Mortgage-backed securities and CMO’s		15,624		(192	)		7,386		(183	)		23,010		(375	)
Corporate securities		1,438		(42	)		-		-			1,438		(42	)
Municipal securities		453		(3	)		2,332		(62	)		2,785		(65	)
	$	24,374	$	(281	)	$	12,713	$	(302	)	$	37,087	$	(583	)

There are 77 debt securities with fair values totaling $37.8 million considered temporarily impaired at June 30, 2018.  As of June 30, 2018, the Company does not consider any bond in an unrealized loss position to be other-than-temporarily impaired.

The Company realized gains of $69 thousand and $9 thousand of losses on sales of securities in the first six months of 2018. The Company realized gains of $102 thousand and $60 thousand of losses during the same period last year.

The amortized cost and fair values of investment securities available for sale at June 30, 2018, by contractual maturity are as follows:

(Dollars In Thousands)	Amortized Cost		Fair Value
One year or less	$	-	$	-
Over one through five years		3,095		3,035
Over five through ten years		14,196		14,048
Greater than 10 years		31,784		30,832
	$	49,075	$	47,915

 Note 3. Loans Receivable

The major classifications of loans in the consolidated balance sheets at June 30, 2018 and December 31, 2017 were as follows:

(Dollars In Thousands)	June 30, 2018			December 31, 2017
Construction loans:
Residential	$	20,143		$	15,221
Land acquisition, development & commercial		21,343			35,601
Real estate:
Residential		134,721			121,649
Commercial		188,677			173,999
Commercial, industrial & agricultural		59,472			61,129
Equity lines		29,294			28,835
Consumer		7,683			7,693
Overdrafts		119			68
Total		461,452			444,195
Less allowance for loan losses		(3,917	)		(3,758	)
Loans, net	$	457,535		$	440,437

10

The past due and nonaccrual status of loans as of June 30, 2018 was as follows:

(Dollars In Thousands)	30-59 Days Past Due		60-89 Days Past Due		90 Days or More Past Due		Total Past Due		Current		Total Loans		Nonaccrual Loans
Construction loans:
Residential	$	839	$	−	$	−	$	839	$	19,304	$	20,143	$	−
Land acquisition, development & commercial		−		−		−		−		21,343		21,343		308
Real estate:
Residential		99		−		−		99		134,622		134,721		460
Commercial		460		−		−		460		188,217		188,677		471
Commercial, industrial & agricultural		13		−		−		13		59,578		59,591		278
Equity lines		93		100		−		193		29,101		29,294		122
Consumer		12		−		−		12		7,671		7,683		−
Total	$	1,516	$	100	$	−	$	1,616	$	459,836	$	461,452	$	1,639

The past-due and nonaccrual status of loans as of December 31, 2017 was as follows:

(Dollars In Thousands)	30-59 Days Past-Due		60-89 Days Past-Due		90 Days or More Past-Due		��	Total Past- Due		Current		Total Loans		Nonaccrual Loans
Construction:
Residential	$	–	$	–	$	–		$	–	$	15,221	$	15,221	$	–
Land acquisition, development & commercial		43		–		274			317		35,284		35,601		274
Real Estate:
Residential		589		870		546			2,005		119,644		121,649		173
Commercial		278		19		209			506		173,493		173,999		209
Commercial, industrial & agricultural		130		143		392			665		60,532		61,197		403
Equity lines		544		49		–			593		28,242		28,835		49
Consumer		17		2		36			55		7,638		7,693		36
Total	$	1,601	$	1,083	$	1,457		$	4,141	$	440,054	$	444,195	$	1,144

There were no loans which were past due ninety days or more and still accruing interest as of June 30, 2018. There was one loan, totaling $373 thousand, which was past due ninety days or more and still accruing interest at December 31, 2017.

Impaired loans, which include TDR’s of $4.0 million, and the related allowance at June 30, 2018, were as follows:

June 30, 2018 With no related allowance: (Dollars In Thousands)	Recorded Investment in Loans		Unpaid Principal Balance		Related Allowance		Average Balance Total Loans		Interest Income Recognized
Construction loans:
Residential	$	−	$	−	$	−	$	−	$	−
Land acquisition, development & commercial		223		373		−		523		−
Real estate:
Residential		623		623		−		635		8
Commercial		4,301		4,301		−		4,385		78
Commercial, industrial & agricultural		182		182		−		191		−
Equity lines		421		421		−		423		8
Consumer		−		−		−		−		−
Total loans with no allowance	$	5,750	$	5,900	$	−	$	6,157	$	94

11

June 30, 2018 With an allowance recorded: (Dollars In Thousands)	Recorded Investment in Loans		Unpaid Principal Balance		Related Allowance		Average Balance Total Loans		Interest Income Recognized
Construction loans:
Residential	$	−	$	−	$	−	$	−	$	−
Land acquisition, development & commercial		−		−		−		−		−
Real estate:
Residential		−		−		−		−		−
Commercial		−		−		−		−		−
Commercial, industrial & agricultural		−		−		−		−		−
Equity lines		−		−		−		−		−
Consumer		−		−		−		−		−
Total loans with an allowance	$	−	$	−	$	−	$	−	$	−

Impaired loans, which include TDRs of $4.1 million, and the related allowance at December 31, 2017, were as follows:

December 31, 2017 With no related allowance: (Dollars In Thousands)	Recorded Investment in Loans		Unpaid Principal Balance		Related Allowance		Average Balance Total Loans		Interest Income Recognized
Construction:
Residential	$	−	$	−	$	–	$	−	$	−
Land acquisition, development & commercial		181		331		–		331		10
Real Estate:
Residential		360		640		–		638		30
Commercial		4,098		4,273		–		4,166		161
Commercial, industrial & agricultural		379		379		–		379		15
Equity lines		299		299		–		300		14
Consumer		−		−		–		−		−
Total loans with no allowance	$	5,317	$	5,922	$	–	$	5,814	$	230

December 31, 2017 With an allowance recorded: (Dollars In Thousands)	Recorded Investment in Loans		Unpaid Principal Balance		Related Allowance		Average Balance Total Loans		Interest Income Recognized
Construction:
Residential	$	−	$	−	$	−	$	−	$	−
Land acquisition, development & commercial		−		−		−		−		−
Real Estate:
Residential		−		−		−		−		−
Commercial		−		−		−		54		−
Commercial, industrial & agricultural		−		−		−		−		−
Equity lines		−		−		−		−		−
Consumer		−		−		−		−		−
Total loans with an allowance	$	−	$	−	$	−	$	54	$	−

Troubled Debt Restructurings

At June 30, 2018, four loans totaling $4.0 million were classified as troubled debt restructurings (“TDRs”). This compares to four loans totaling $4.1 million at December 31, 2017. Two of the four loans totaling $3.8 million were performing in accordance with their restructured terms and were not on nonaccrual status at June 30, 2018. The other two loans to one borrower totaled $203 thousand and were on nonaccrual status at June 30, 2018.

No loans were modified in a TDR during the first six months of 2018 or 2017.

Management considers troubled debt restructurings and subsequent defaults in restructured loans in the determination of the adequacy of the Company’s allowance for loan losses. When identified as a TDR, a loan is evaluated for potential loss based on the present value of expected future cash flows discounted at the loan’s effective interest rate, the loan’s observable market price, or the estimated fair value of the collateral, less any selling costs if the loan is collateral dependent. Loans identified as TDRs frequently are on non-accrual status at the time of the restructuring and, in some cases, partial charge-offs may have already been taken against the loan and a specific allowance may have already been established for the loan. As a result of any modification as a TDR, if a specific reserve is associated with the loan it may be increased. Additionally, loans modified in a TDR are closely monitored for delinquency as an early indicator of possible future defaults. If loans modified in a TDR subsequently default, the Company evaluates the loan for possible further impairment. As a result, any specific allowance may be increased, adjustments may be made in the allocation of the total allowance balance, or partial charge-offs may be taken to further write-down the carrying value of the loan. Management exercises significant judgment in developing estimates for potential losses associated with TDRs.

12

Note 4. Allowance for Loan Losses

The following table presents, as of June 30, 2018, the total allowance for loan losses, the allowance by impairment methodology (individually evaluated for impairment or collectively evaluated for impairment), the total loans and loans by impairment methodology (individually evaluated for impairment or collectively evaluated for impairment).

June 30, 2018	Allowance for loan losses																Loans
Class of Loan (Dollars in Thousands)	Beginning balance		Charge- offs			Recoveries		Provisions			Ending balance		Ending balance: individually evaluated for impairment		Ending balance: collectively evaluated for impairment		Ending balance		Ending balance: individually evaluated for impairment		Ending balance: collectively evaluated for impairment
Construction loans:
Residential	$	94	$	−		$	−	$	47		$	141	$	−	$	141	$	20,143	$	−	$	20,143
Land acquisition, development & commercial		311		−			−		(116	)		195		−		195		21,343		223		21,120
Real estate:				−
Residential		955		(103	)		30		126			1,008		−		1,008		134,721		623		134,098
Commercial		1,603		−			−		134			1,737		−		1,737		188,677		4,301		184,376
Commercial, industrial & agricultural		441		(35	)		1		50			457		−		457		59,591		182		59,409
Equity lines		237		−			−		2			239		−		239		29,294		421		28,873
Consumer		108		(86	)		5		108			135		−		135		7,683		−		7,683
Unallocated		9		−			−		(4	)		5		−		5		−		−		−
Total	$	3,758	$	(224	)	$	36	$	347		$	3,917	$	−	$	3,917	$	461,452	$	5,750	$	455,702

The following table presents, as of December 31, 2017, the total allowance for loan losses, the allowance by impairment methodology (individually evaluated for impairment or collectively evaluated for impairment), the total loans and loans by impairment methodology (individually evaluated for impairment or collectively evaluated for impairment).

December 31, 2017	Allowance for loan losses																Loans
Class of Loan (Dollars in Thousands)	Beginning balance		Charge- offs			Recoveries		Provisions			Ending balance		Ending balance: individually evaluated for impairment		Ending balance: collectively evaluated for impairment		Ending balance		Ending balance: individually evaluated for impairment		Ending balance: collectively evaluated for impairment
Construction loans:
Residential	$	63	$	−		$	−	$	31		$	94	$	−	$	94	$	15,221	$	−	$	15,221
Land acquisition, development & commercial		173		(150	)		−		288			311		−		311		35,601		181		35,420
Real estate:
Residential		866		(293	)		−		382			955		−		955		121,649		360		121,289
Commercial		1,516		(454	)		43		498			1,603		−		1,603		173,999		4,098		169,901
Commercial, industrial & agricultural		461		(80	)		−		60			441		−		441		61,197		379		60,818
Equity lines		338		−			−		(101	)		237		−		237		28,835		299		28,536
Consumer		97		(101	)		15		97			108		−		108		7,693		−		7,693
Unallocated		122		−			−		(113	)		9		−		9		−		−		−
Total	$	3,636	$	(1,078	)	$	58	$	1,142		$	3,758	$	−	$	3,758	$	444,195	$	5,317	$	438,878

 Loans by credit quality indicators as of June 30, 2018 were as follows:

(Dollars in Thousands)	Pass Accruing		Special Mention Accruing		Special Mention Nonaccrual		Substandard Accruing		Substandard Nonaccrual		Doubtful Nonaccrual		Total
Construction loans:
Residential	$	20,143	$	−	$	−	$	−	$	−	$	−	$	20,143
Land acquisition, development & commercial		21,035		−		266		−		42		−		21,343
Real estate loans:
Residential		133,447		488		221		326		239		−		134,721
Commercial		185,974		1,646		−		586		471		−		188,677
Commercial, industrial, agricultural		59,145		155		118		13		146		14		59,591
Equity lines		28,873		−		122		299		−		−		29,294
Consumer		7,683		−		−		−		−		−		7,683
Total Loans	$	456,300	$	2,289	$	727	$	1,224	$	898	$	14	$	461,452

13

   Loans by credit quality indicators as of December 31, 2017 were as follows:

(Dollars in Thousands)	Pass		Special Mention		Substandard Accruing		Substandard Nonaccrual		Doubtful Nonaccrual		Total
Construction loans:
Residential	$	15,221	$	−	$	−	$	−	$	−	$	15,221
Land acquisition, development & commercial		31,433		3,987		−		181		−		35,601
Real estate loans:
Residential		120,575		342		559		−		173		121,649
Commercial		165,760		7,386		644		209		−		173,999
Commercial, industrial, agricultural		59,042		1,249		503		379		24		61,197
Equity lines		28,536		−		299		−		−		28,835
Consumer		7,658		−		−		35		−		7,693
Total Loans	$	428,225	$	12,964	$	2,005	$	804	$	197	$	444,195

At June 30, 2018 and December 31, 2017, the Company does not have any loans classified as Loss.

Note 5. Other Real Estate Owned

Changes in other real estate owned for the six months ended June 30, 2018 were as follows:

(Dollars in Thousands)	Other Real Estate Owned			Valuation Allowance			Net
Balance at the beginning of the year	$	4,046		$	(797	)	$	3,249
Additions		697			—			697
Write downs		—			(158	)		(158	)
Sales		(374	)		—			(374	)
Balance at the end of the year	$	4,369		$	(955	)	$	3,414

Changes in foreclosed properties for the six months ended June 30, 2017 were as follows:

(Dollars in Thousands)	Other Real Estate Owned			Valuation Allowance			Net
Balance at the beginning of the year	$	4,619		$	(825	)	$	3,794
Additions		—			—			—
Write downs		—			(380	)		(380	)
Sales		(1,262	)		616			(646	)
Balance at the end of the year	$	3,357		$	(589	)	$	2,768

The major classifications of other real estate owned in the consolidated balance sheets at June 30, 2018 and December 31, 2017 were as follows:

(Dollars in Thousands)	June 30, 2018		December 31, 2017
Residential lots	$	1,398	$	1,745
Residential development		366		—
Residential real estate		1,197		1,024
Commercial lots		63		90
Commercial buildings		390		390
Total Other Real Estate Owned	$	3,414	$	3,249

There were no residential real estate loans in the process of foreclosure at June 30, 2018 or December 31, 2017.

14

Other real estate owned related expenses in the consolidated statements of income for the three and six months ended June 30, 2018 and June 30, 2017 include:

(Dollars In Thousands)	Three months Ended June 30, 2018		Three months Ended June 30, 2017		Six months Ended June 30, 2018		Six months Ended June 30, 2017
Provision for unrealized losses	$	–	$	380	$	158	$	380
Operating expenses		64		24		205		37
Total Other Real Estate Owned	$	64	$	404	$	363	$	417

Note 6. Stock Based Compensation

The Company recorded stock-based compensation expense of $114 thousand and $73 thousand for the years to date June 30, 2018 and 2017, respectively.

The 2005 Stock Option Plan (the Plan) pursuant to which the Board of Directors granted stock options to directors, officers and employees expired in 2016, thus there are no options available for future issuance. Under the fair value recognition provisions of relevant accounting guidance, stock-based compensation cost was measured at the grant date based on the fair value of the award and was and continues to be recognized as expense on a straight-line basis over the requisite service period, which is the vesting period. 

The Company used the Black-Scholes option pricing model to determine the fair value of stock options. The fair value of the stock based payment awards was affected by the price of the Company's stock and a number of financial assumptions and variables. These variables included the risk-free interest rate, expected dividend rate, expected stock price volatility and the expected life of the options.  No stock options were granted during 2018 or 2017. Compensation expense is charged to income ratably over the vesting period and was $36 thousand and $36 thousand for the year to date June 30, 2018 and June 30, 2017, respectively. As of June 30, 2018, there was $101 thousand of total unrecognized compensation cost related to nonvested stock options granted under the Plan. The cost will be recognized over the next 1.5 years.

A summary of option activity under the 2005 stock option plan year to date June 30, 2018 is as follows:

	Options Outstanding			Weighted Average Exercise Price		Aggregate Intrinsic Value (1)		Weighted Average Contractual Term (years)
Balance at December 31, 2017		187,000		$	7.78
Granted		–			–
Exercised		(18,300	)		7.83
Expired		(31,500	)		10.79
Forfeited		–			–
Balance at June 30, 2018		137,200		$	7.08	$	958,186		6.24
Exercisable at June 30, 2018		80,000		$	7.21	$	548,474		6.07

(1) The aggregate intrinsic value of a stock option in the table above represents the total pre-tax intrinsic value (the amount by which the current market value of the underlying stock exceeds the exercise price of the option) that would have been received by the option holders had all option holders exercised their options on June 30, 2018.

In 2009, the Board of Directors authorized 132,000 shares of common stock for issuance under the Restricted Stock Plan. On July 11, 2016, a 4% stock dividend was distributed and added 5,280 to the total number of shares authorized for issuance and currently raising the total available to 137,280. The plan provides for restricted stock awards to key employees. Restricted shares awarded to employees generally vest over a five-year period and compensation expense is charged to income ratably over the vesting period and was $78 thousand and $37 thousand for the years to date June 30, 2018 and 2017, respectively. Compensation is accounted for using the fair market value of the Company’s common stock on the date the restricted shares are awarded. The Company granted 22,649 and 8,258 shares of restricted stock under the plan during the years to date June 30, 2018 and June 30, 2017, respectively. The weighted-average grant date fair value of restricted stock granted in 2018 was $11.32 compared to $9.87 in 2017.  

15

As of June 30, 2018, there was $395 thousand of total unrecognized compensation cost related to restricted stock granted under the Plan. The cost is expected to be recognized through 2023. A summary of the activity for restricted stock awards for the periods indicated is presented below:

	For the Six Months Ended June 30, 2018					For the Six Months Ended June 30, 2017
	Shares			Weighted- Average Grant Date Fair Value		Shares			Weighted- Average Grant Date Fair Value
Nonvested at beginning of year		32,087		$	8.63		31,546		$	7.03
Granted		22,649			11.32		8,258			9.87
Vested		(12,241	)		7.71		(11,125	)		6.03
Forfeited		-			-		-			-
Nonvested at the end of the period		42,495		$	10.33		28,679		$	8.23

The Restricted Stock Plan provides for the adjustment of the total number of shares reserved for issuance under the plan and the number of shares covered by each outstanding Award for stock dividends and stock splits.

 Note 7. Fair Value Measurement

The Company uses a hierarchy of valuation techniques based on whether the inputs to those valuation techniques are observable or unobservable. Observable inputs reflect market data obtained from independent sources, while unobservable inputs reflect the Company’s market assumptions. The three levels of the fair value hierarchy based on these two types of inputs are as follows:

Level 1 - Valuation is based on quoted prices in active markets for identical assets and liabilities.

Level 2 - Valuation is based on observable inputs including quoted prices in active markets for similar assets and liabilities, quoted prices for identical or similar assets and liabilities in less active markets, and model-based valuation techniques for which significant assumptions can be derived primarily from or corroborated by observable data in the market.

Level 3 - Valuation is based on model-based techniques that use one or more significant inputs or assumptions that are unobservable in the market.

The following describes the valuation techniques used by the Company to measure certain financial assets and liabilities recorded at fair value on a recurring basis in the consolidated financial statements:

Securities available for sale: Securities available for sale are recorded at fair value on a recurring basis. Fair value measurement is based upon quoted market prices, when available (Level 1). If quoted market prices are not available, fair values are measured utilizing independent valuation techniques of identical or similar securities for which significant assumptions are derived primarily from or corroborated by observable market data. Third party vendors compile prices from various sources and may determine the fair value of identical or similar securities by using pricing models that consider observable market data (Level 2).

The following tables present the balances of financial assets and liabilities measured at fair value on a recurring basis as of June 30, 2018 and December 31, 2017:

(Dollars in Thousands)			Carrying value at June 30, 2018
Description	Balance as of June 30, 2018		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Assets:
U.S. Government agency securities	$	11,770	$	–	$	11,770	$	–
Mortgage-backed securities and CMO’s		20,434		–		20,434		–
Corporate securities		6,610		–		6,610		–
Municipal securities		9,101		–		9,101		–

16

(Dollars in Thousands)			Carrying value at December 31, 2017
Description	Balance as of December 31, 2017		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Assets:
U.S. Government agency securities	$	13,435	$	–	$	13,435	$	–
Mortgage-backed securities and CMO’s		23,981		–		23,981		–
Corporate securities		7,067		–		7,067		–
Municipal securities		10,861		–		10,861		–

Certain assets are measured at fair value on a nonrecurring basis in accordance with generally accepted accounting principles (GAAP). Adjustments to the fair value of these assets usually result from the application of lower-of-cost-or-market accounting or write-downs of individual assets.

The following describes the valuation techniques used by the Company to measure certain assets recorded at fair value on a nonrecurring basis in the consolidated financial statements:

Impaired Loans: The Company does not record loans at fair value on a recurring basis. However, from time to time a loan is considered impaired and a specific reserve is established. Loans for which it is probable that payment of interest and principal will not be made in accordance with the contractual terms of the loan agreement are considered impaired. Once a loan is identified as individually impaired, management measures the extent of any loss. The fair value of impaired loans is estimated using one of several methods, including collateral value, market value, and discounted cash flow. Those impaired loans not requiring an allowance represent loans for which the fair value of the expected repayments or collateral exceed the recorded investment in such loans. Impaired loans where an allowance is established based on the fair value of collateral require classification in the fair value hierarchy. If carried at market price based on appraised value less selling costs using observable market data, it is recorded as nonrecurring Level 2. When an appraised value is not available or management determines the fair value of the collateral is further impaired below the appraisal value and there is no observable market price, the Company records the impaired loan as nonrecurring Level 3.

Loans held for sale: The carrying value of these loans approximates the fair value. These loans close in the name of the Bank’s consolidated joint venture subsidiary HomeTown Residential Mortgage, LLC, but are generally sold within a two-week period.

Other Real Estate Owned (OREO): The carrying amount of real estate owned by the Company resulting from foreclosures is estimated at the lesser of cost or the fair value of the real estate based on an observable market price or a current appraised value less selling costs. If carried at market price based on appraised value using observable market data, it is recorded as nonrecurring Level 2. When an appraised value is not available or is not current, or management determines the fair value of the real estate is further impaired below the appraised value or there is no observable market price, the Company records the real estate as nonrecurring Level 3.

The following tables summarize the Company’s assets that were measured at fair value on a nonrecurring basis as of June 30, 2018 and December 31, 2017.

(Dollars in Thousands)			Carrying value at June 30, 2018
Description	Balance as of June 30, 2018		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Assets:
Loans held for sale	$	280	$	–	$	280	$	–
Other real estate owned		3,414		–		697		2,717

17

(Dollars in Thousands)			Carrying value at December 31, 2017
Description	Balance as of December 31, 2017		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Assets:
Loans held for sale	$	1,587	$	–	$	1,587	$	–
Other real estate owned		3,249		–		697		2,717

At June 30, 2018 and December 31, 2017, the Company did not have any liabilities measured at fair value on a nonrecurring basis.

The following table displays quantitative information about Level 3 Fair Value Measurements for June 30, 2018:

(Dollars in Thousands)	Quantitative information about Level 3 Fair Value Measurements for March 31, 2018
Assets	Fair Value		Valuation Technique(s)	Unobservable input	Range (Weighted Average)
Other real estate owned	$	2,001	Discounted appraised value	Selling cost		6	%	-	10	%	(8%)
				Discount for lack of marketability and age of appraisal		0	%	-	43	%	(0%)
	$	716	Internal evaluations	Internal evaluations		25	%	-	25	%	(25%)

The following table displays quantitative information about Level 3 Fair Value Measurements for December 31, 2017:

(Dollars in Thousands)	Quantitative information about Level 3 Fair Value Measurements for December 31, 2017
Assets	Fair Value		Valuation Technique(s)	Unobservable input	Range (Weighted Average)
Other real estate owned	$	2,254	Discounted appraised value	Selling cost		6	%	-	10	%	(8%)
				Discount for lack of marketability and age of appraisal		0	%	-	43	%	(7%)
	$	995	Internal evaluations	Internal evaluations		19	%	-	19	%	(19%)

The following tables summarize the estimated fair values of the Company’s financial instruments at June 30, 2018 and at December 31, 2017. The Company discloses fair value information about financial instruments, whether or not recognized in the statements of financial condition, for which it is practicable to estimate that value. The following estimated fair value amounts have been determined using available market information and appropriate valuation methodologies. However, management judgment is required to interpret data and develop fair value estimates. Accordingly, the estimates below are not necessarily indicative of the amounts the Company could realize in a current market exchange. The use of different market assumptions and/or estimation methodologies may have a material effect on the estimated fair value amounts.

During the six months ended June 30, 2018, the Company adopted ASU 2016-01 Financial Instruments – Overall (Subtopic 825-10): “Recognition and Measurement of Financial Assets and Financial Liabilities”, which among other things, requires a public business entity to base their fair value disclosures for financial instruments that are not measured at fair value in the financial statements on the exit price notion. In accordance with this guidance, the Company has adopted the exit price disclosure requirements for the below table on a prospective basis for the period ended June 30, 2018. The disclosure included for the period ended December 31, 2017 continues to be presented utilizing the entry price assumption previously utilized.

18

Carrying amount and estimated fair values of financial instruments were as follows for the periods indicated:

(Dollars in Thousands)			Fair value at June 30, 2018
Description	Carrying value as of June 30, 2018		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)		Approximate Fair Values
Financial assets
Cash and due from banks	$	20,689	$	20,689	$	–	$	–	$	20,689
Federal funds sold		319		319		–		–		319
Securities available for sale		47,915		–		47,915		–		47,915
Restricted equity securities		2,546		–		2,546		–		2,546
Loans held for sale		280		–		280		–		280
Loans, net		457,535		–		–		448,501		448,501
Bank owned life insurance		8,097		–		8,097		–		8,097
Accrued income		2,592		–		2,592		–		2,592
Financial liabilities
Total deposits		481,085		–		480,632		–		480,632
FHLB borrowings		15,116		–		15,102		–		15,102
Subordinated notes		7,269		–		7,704		–		7,704
Other borrowings		275		–		275		–		275
Accrued interest payable		361		–		361		–		361

The carrying amounts and approximate fair values of the Company's financial instruments are as follows at December 31, 2017:

(Dollars in Thousands)			Fair value at December 31, 2017
Description	Carrying value as of December 31, 2017		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)		Approximate Fair Values
Financial assets
Cash and due from banks	$	21,714	$	21,714	$	–	$	–	$	21,714
Federal funds sold		180		180		–		–		180
Securities available for sale		55,344		–		55,344		–		55,344
Restricted equity securities		2,371		–		2,371		–		2,371
Loans held for sale		1,587		–		1,587		–		1,587
Loans, net		440,437		–		–		438,449		438,449
Bank owned life insurance		8,669		–		8,669		–		8,669
Accrued income		2,681		–		2,681		–		2,681
Financial liabilities
Total deposits		477,320		–		477,599		–		477,599
FHLB borrowings		11,028		–		11,150		–		11,150
Subordinated notes		7,254		–		7,890		–		7,890
Other borrowings		1,558		–		1,558		–		1,558
Accrued interest payable		368		–		368		–		368

19

Note 8. Reclassifications Out of Other Comprehensive Income

Items reclassified in their entirety to net income for the three and six months ended June 30, 2018 and 2017 are as follows:

Details about Other Comprehensive Components	Amounts Reclassified from Other Comprehensive Income for the Three Months Ended June 30,				Affected Line Item in the Statement Where Net Income is Presented
(Dollars In Thousands)	2018		2017
Available for sale securities
Realized gains on sales of securities held for sale during the period consider available for sale	$	-	$	29	Gains on sales of investment securities
Tax expense related to realized gains on securities sold		-		10	Income tax expense
	$	-	$	19	Net income

Details about Other Comprehensive Components	Amounts Reclassified from Other Comprehensive Income for the Six Months Ended June 30,				Affected Line Item in the Statement Where Net Income is Presented
(Dollars In Thousands)	2017		2017
Available for sale securities
Realized gains on sales of securities held for sale during the period consider available for sale	$	60	$	42	Gains on sales of investment securities
Tax expense related to realized gains on securities sold		13		14	Income tax expense
	$	47	$	28	Net income

Note 9. Earnings per Common Share

The following tables show the weighted average number of shares used in computing earnings per common share and the effect on weighted average number of shares of diluted potential common stock. 

	For the Three Months Ended June 30,
	2018						2017
Dollars in Thousands, except share and per share data	Weighted Average Common Shares Outstanding		Net Income Available to Common Shareholders		Per Share Amount		Weighted Average Common Shares Outstanding		Net Income Available to Common Shareholders		Per Share Amount
Earnings per common share, basic		5,806,960	$	973	$	0.17		5,768,670	$	434	$	0.08
Effect of dilutive securities:
Dilutive stock options		45,798		−		-		21,235		−		−
Earnings per common share, diluted		5,852,758	$	973	$	0.17		5,789,905	$	434	$	0.08

	For the Six Months Ended June 30,
	2018						2017
Dollars in Thousands, except share and per share data	Weighted Average Common Shares Outstanding		Net Income Available to Common Shareholders		Per Share Amount		Weighted Average Common Shares Outstanding		Net Income Available to Common Shareholders		Per Share Amount
Earnings per common share, basic		5,801,016	$	2,163	$	0.37		5,766,041	$	1,199	$	0.21
Effect of dilutive securities:
Dilutive stock options		45,798		−		−		21,235		−		−
Earnings per common share, diluted		5,846,814	$	2,163	$	0.37		5,787,276	$	1,119	$	0.21

At June 30, 2018, as a result of the increase in the Corporation’s stock price, there were no stock options considered antidilutive. At June 30, 2017, the number of stock options considered antidilutive and excluded from the calculation of diluted weighted average shares was 33,000. Nonvested restricted shares were included in weighted average common shares outstanding for computing basic earnings per share, as the holder has voting rights and would share in a stock or cash dividend during the vesting period.

Note 10. Subsequent Events

There were no reportable subsequent events.

20

ITEM 2.          MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.

Forward-looking Statements

HomeTown Bankshares makes forward-looking statements in this report. These forward-looking statements may include: statements of goals, intentions, earnings expectations, and other expectations; estimates of risks and of future costs and benefits; assessments of probable loan and lease losses; assessments of market risk; and statements of the ability to achieve financial and other goals. Forward-looking statements are typically identified by words such as “believe,” “expect,” “anticipate,” “intend,” “outlook,” “estimate,” “forecast,” “project” and other similar words and expressions. Forward-looking statements are subject to numerous assumptions, risks and uncertainties, which change over time. Forward-looking statements speak only as of the date they are made. The Company does not assume any duty and does not undertake to update its forward-looking statements. Because forward-looking statements are subject to assumptions and uncertainties, actual results or future events could differ, possibly materially, from those that the Company anticipated in its forward-looking statements; and future results could differ materially from historical performance.

The Company’s forward-looking statements are subject to the following principal risks and uncertainties: general economic conditions and trends, either nationally or locally; conditions in the securities markets; changes in interest rates; changes in deposit flows, and in the demand for deposit, loan, and investment products and other financial services; changes in real estate values; changes in the quality or composition of the Company’s loan or investment portfolios; changes in competitive pressures among financial institutions or from non-financial institutions; the Company’s ability to retain key members of management; changes in legislation, regulation, and policies; and a variety of other matters which, by their nature, are subject to significant uncertainties. The Company provides greater detail regarding some of these factors in its Form 10-K for the year ended December 31, 2017. The Company’s forward-looking statements may also be subject to other risks and uncertainties, including those that it may discuss elsewhere in this report or in its other filings with the SEC.

Our Business

HomeTown Bankshares provides a full complement of consumer and commercial banking services to its primary service area which includes the Roanoke Valley, the New River Valley and Smith Mountain Lake. The Company serves these markets through a network of six branches, seven ATM’s, HomeTown Mortgage and HomeTown Investments. A high level of responsive and personal service coupled with local decision-making are the hallmarks of the Company’s customer oriented strategy. The Company offers a broad range of commercial and retail banking products and services including checking, savings and time deposits, individual retirement accounts, residential and commercial mortgages, home equity loans, consumer installment loans, commercial loans, and lines and letters of credit. In addition to its main office, the Company has offices in Franklin County, Virginia at Westlake; in the town of Christiansburg, Virginia at 2950 Market Street; in Roanoke County, Virginia at the intersection of Colonial Avenue and Virginia Route 419; in the City of Roanoke, Virginia at 3521 Franklin Road; and in the City of Salem, Virginia at 852 West Main Street. HomeTown Bank, with a 49% interest in the joint venture HomeTown Residential Mortgage, LLC, operates a dedicated mortgage office on Colonial Ave., next to the existing branch. The Company has a secure Operations Center at 4633 Brambleton Avenue in Roanoke.

HomeTown Investments provides diverse investment products and financial advisory services to existing and prospective customers. These products and services provide another source of revenue for the Company. Investment and insurance products and services are offered through an unaffiliated entity LPL Financial, Member FINRA/SIPC. HomeTown Investments is a subsidiary of the Bank. Products and services made available through LPL Financial are not insured by the FDIC or any other agency of the United States and are not deposits or obligations of nor guaranteed or insured by any bank or bank affiliate. These products are subject to investment risk, including the possible loss of value.

The Private Banking Group offers personalized banking solutions to work with customers to clarify financial goals and bring together professionals to satisfy their investment, credit, and other financial needs.

The following is a discussion of factors that significantly affected the financial condition and results of operations of HomeTown Bankshares Corporation. This discussion should be read in connection with the financial statements presented herein.

Critical Accounting Policies

The Company’s significant accounting policies are set forth in Note 1 of the Notes to Financial Statements in the Annual Report for the year ended December 31, 2017. The Company’s financial position and results of operations are affected by management’s application of accounting policies, including estimates, assumptions and judgments made to arrive at the carrying value of assets and liabilities and amounts reported for revenues and expenses.

21

The allowance for loan losses is an estimate of the losses that may be sustained in our loan portfolio. The allowance is based on two basic principles of accounting: (i) that losses be accrued when they are probable of occurring and are capable of estimation and (ii) that losses on impaired loans be accrued based on the differences between the value of collateral less cost to sell, present value of future cash flows or values that are observable in the secondary market and the loan balance. The allowance for loan losses is maintained at a level, which, in management’s judgment, is adequate to absorb credit losses inherent in the loan portfolio.

The amount of the allowance is based on management’s evaluation of the collectability of the loan portfolio, including the nature of the portfolio, credit concentrations, trends in historical loss experience, specific impaired loans, economic conditions, and other risks inherent in the portfolio. Management reviews the past due reports and risk-rated loans and discusses individually the loans on these reports with the responsible loan officers. Management uses these tools and provides a detailed quarterly analysis of the allowance based on the Company’s historical loan loss experience, risk-rated loans, past dues, concentrations of credit, unsecured loans, loan exceptions, and economic trends. These are generally grouped by homogeneous loan pools. Allowances for impaired loans are generally determined based on collateral values less cost to sell, or the present value of estimated cash flows. This allowance, then, is designated as a specific reserve. Although management uses available information to recognize losses on loans, because of uncertainties associated with local economic conditions, collateral values, and future cash flows on impaired loans, it is reasonably possible that a material change could occur in the allowance for loan losses in the near term. However, the amount of the change that is reasonably possible cannot be estimated. The allowance is increased by a provision for loan losses, which is charged to expense, and reduced by charge-offs, net of recoveries. Changes in the allowance relating to impaired loans are charged or credited to the provision for loan losses. Past due status is determined based on contractual terms.

Discussion of Operations

Executive Summary

Net income available to common shareholders for the second quarter of 2018 totaled $973 thousand, an improvement of $539 over the prior year due to the prior year’s higher provision and the prior year's write down of foreclosed property.   The fully diluted earnings per common share was $0.17 and $0.08 for the three months ended June 30, 2018 and 2017, respectively.  HomeTown Bankshares paid its first cash dividend of $0.04 per common share in the second quarter of 2018.  

Net income available to common shareholders amounted to $2.2 million for the first half of 2018 compared to $1.2 million for the same period last year. Excluding a nonrecurring gain on bank owned life insurance of $642 thousand, net income available to shareholders was $322 thousand or 27% more than the prior year. Fully diluted earnings per common share amounted to $0.37 per share for the first half of 2018 compared to $0.21 per share for the first half of 2017.

Three Months Ended June 30, 2018

Net income attributable to HomeTown Bankshares was $973 thousand for the second quarter of 2018, more than double the $434 thousand earned in the second quarter of 2017.  Higher net interest income, lower provision for loan losses, and lower noninterest expense were all contributing factors to higher earnings in 2018.  Net charge-offs were $53 thousand for the three months ended June 30, 2018 compared to $491 thousand for the three months ended June 30, 2017.  Thus, less provision for loan losses was required to replenish the allowance for loan losses for the second quarter of 2018 than the same quarter last year; $110 thousand and $465 thousand, respectively.  

Net interest income for the three months ended June 30, 2018 totaled $4.7 million, and was $276 thousand or 6.3% greater than the second quarter of 2017. The expansion of average earning assets by $19.6 million provided $309 thousand in additional interest income. Loan growth fueled the increase in earning assets.  Average loans for the quarter were $460 million, $28.0 million or 6.5% more than the second quarter of 2017, and was funded primarily by deposit growth, and the utilization of available liquid funds. Average total deposits for the three months ended June 30, 2018 totaled $479 million and were $15.8 million more than average deposits for the same quarter last year. 

The net interest margin was 3.54% for the quarter ended June 30, 2018, an increase of 6 basis points over the 3.48% for the same quarter last year.  Excess funds were shifted from lower yielding interest bearing deposits at other banks to fund loan growth. As the Federal Reserve continues to steadily increase interest rates, loan yields increased 11 basis points, keeping pace and slightly surpassing the 10 basis point rise in interest bearing deposits for the second quarter of 2018 over the second quarter of 2017.  Spread compression may occur in future quarters as competition for loans exerts a downward pressure on loan rates; the promotions of higher interest rate CD and money market deposit products may attract funding unfavorably impacting the mix of deposits and may push up the cost of funds.  

22

	For the Three Months Ended June 30, 2018								For the Three Months Ended June 30, 2017
(Dollars in thousands)	Average Balance			Interest Income/ Expense		Yield/ Rate			Average Balance			Interest Income/ Expense		Yield/ Rate
Assets:
Federal funds sold	$	207		$	—		1.46	%	$	50		$	—		0.83	%
Deposits in banks		9,656			40		1.65			18,801			50		1.06
Securities, taxable		42,007			271		2.59			37,751			260		2.76
Securities, nontaxable (1)		7,923			57		3.61			11,656			76		3.97
Restricted equity securities		2,741			38		5.41			2,417			33		5.51
Loans held for sale		530			6		4.72			745			8		4.13
Loans (1)		459,551			5,120		4.42			431,578			4,695		4.31
Total earnings assets		522,615			5,532		4.21			502,998			5,122		4.07
Less: Allowance for loan losses		(3,897	)							(3,779	)
Total non-earning assets		39,057								37,371
Total Assets	$	557,775							$	536,590
Liabilities and shareholders’ equity
Interest bearing deposits:
Checking	$	106,425		$	66		0.25	%	$	91,805		$	40		0.17	%
Money market savings		74,893			71		0.38			72,060			44		0.25
Regular savings		53,946			61		0.45			49,895			43		0.35
Time Deposits		130,222			462		1.42			139,438			425		1.22
FHLB borrowings		15,724			80		1.99			12,850			52		1.61
Subordinated notes		7,265			134		7.38			7,234			134		7.41
Other borrowings		506			6		4.65			1,267			8		2.54
Total interest bearing liabilities		388,981			880		0.91			374,549			746		0.80
Non-interest bearing liabilities:
Demand deposits		113,905								110,364
Other liabilities		2,621								3,233
Total liabilities		505,507								488,146
Total HomeTown Bankshares Corporation stockholders’ equity		51,747								47,999
Non-controlling interest in consolidated subsidiary		521			—					445			—
Total Liabilities and Stockholders’ Equity	$	557,775			880				$	536,590			746
Net interest income				$	4,652							$	4,376
Interest rate spread							3.30								3.27
Interest expense to average earning assets							0.67								0.59
Net interest margin							3.54	%							3.48	%

(1) Yields are reported on a tax equivalent basis assuming a federal income tax rate of 21 percent for 2018 and 34 percent for 2017.

23

	Three Months Ended June 30, 2018 Compared to Three Months Ended June 30, 2017
	Increase			Change Due To:
(Dollars in thousands)	(Decrease)			Rate			Volume
Interest income:
Federal funds sold	$	—		$	—		$	—
Deposits in banks		(10	)		27			(37	)
Securities, taxable		11			(24	)		35
Securities, nontaxable		(19	)		7			(26	)
Restricted equity securities		5			—			5
Loans held for sale		(2	)		1			(3	)
Loans		425			90			335
Total interest income		410			101			309
Interest expense:
Interest bearing liabilities:
Checking		26			17			9
Money market savings		27			25			2
Regular savings		18			13			5
Time Deposits		37			65			(28	)
FHLB borrowings		28			13			15
Subordinated notes		—			(1	)		1
Other borrowings		(2	)		2			(4	)
Total interest expense		134			134			—
Net interest income	$	276		$	(33	)	$	309

Noninterest income for the second quarter of 2018 was $789 thousand, $244 thousand less than the $1.0 million earned during the same period in 2017.  Other income in the prior year included a one-time bankruptcy settlement of $172 thousand.  Lower mortgage banking income and brokerage commissions also contributed to the decrease.  The unfavorable variance was partially mitigated by higher ATM and interchange income from from deposit growth.   

For the three months ended June 30, 2018, noninterest expense totaled  $4.1 million $202 thousand less than the $4.3 million recorded in the same quarter last year.   The second quarter of 2017 included a  $380 thousand write-down of a foreclosed property in anticipation of its sale in the the third quarter of 2017; no further loss was recognized in the third quarter when the sale was completed.   

Six Months Ended June 30, 2018

Net income attributable to HomeTown Bankshares was $2.2 million for the first half of 2018. Without the nonrecurring gain of $642 thousand, net income attributable to HomeTown Bankshares would have been $1.5 million, an increase of  $322 thousand  over the $1.2 million for the first half of 2017. Favorable variances in net interest income, the provision for loan losses and income tax expense were offset by higher noninterest expense.

Net interest income for the six months ended June 30, 2018 totaled $9.2 million, and was $548 thousand or 6.3% greater than the first half of 2017. The expansion of average earning assets by $19.9 million provided $571 thousand in additional interest income. Average loans for the first half of the year were $454 million, $27.0 million or 6.3% more than the first half of 2017. Average total deposits for the six months ended June, 30, 2018 totaled $477 million and were $16.1 million more than average deposits for the same period last year. While deposit growth was the primary source of funds supporting the growth of loans since last year, the utilization of available interest bearing deposits at other banks provided $7.8 million of additional funding.  

24

The net interest margin was 3.54% for the six months ended June 30, 2018, compared to 3.49% for the six months ended June 30, 2017.   The interest rate spread was 4 basis points higher than the prior year.  The yield on earning assets rose 10 basis points as the result of increasing interest rates and a favorable change in the mix of earning assets, as higher yielding loans comprised a greater percentage of all earning assets.  The yield on loans increased 5 basis points compared to an increase of 6 basis points for interest bearing deposits for the first six months of 2018 compared to the previous year.  This may lead to margin compression in future periods, as rising deposit costs may not be offset by increasing earning asset yields. 

	For the Six Months Ended June 30, 2018								For the Six Months Ended June 30, 2017
(Dollars in thousands)	Average Balance			Interest Income/ Expense		Yield/ Rate			Average Balance			Interest Income/ Expense		Yield/ Rate
Assets:
Federal funds sold	$	197		$	1		1.41	%	$	48		$	—		0.73	%
Deposits in banks		10,895			89		1.64			18,580			92		1.00
Securities, taxable		43,018			562		2.62			38,319			500		2.61
Securities, nontaxable (1)		8,131			116		3.61			12,526			164		3.96
Restricted equity securities		2,624			73		5.53			2,373			65		5.50
Loans held for sale		558			12		4.43			611			12		4.08
Loans (1)		453,943			10,018		4.40			426,975			9,315		4.35
Total earnings assets		519,366			10,871		4.19			499,432			10,148		4.09
Less: Allowance for loan losses		(3,833	)							(3,731	)
Total non-earning assets		38,497								37,108
Total Assets	$	554,030							$	532,809
Liabilities and shareholders’ equity
Interest bearing deposits:
Checking	$	107,235		$	134		0.25	%	$	92,844		$	79		0.17	%
Money market savings		73,237			116		0.32			71,673			87		0.24
Regular savings		54,454			116		0.43			48,466			84		0.35
Time Deposits		130,205			871		1.35			143,016			856		1.21
FHLB borrowings		15,243			146		1.90			12,200			97		1.59
Subordinated notes		7,261			268		7.39			7,230			268		7.41
Other borrowings		560			12		4.40			1,462			17		2.16
Total interest bearing liabilities		388,195			1,663		0.86			376,891			1,488		0.80
Non-interest bearing liabilities:
Demand deposits		111,546								104,590
Other liabilities		2,455								1,953
Total liabilities		502,196								483,434
Total HomeTown Bankshares Corporation stockholders’ equity		51,317								48,932
Non-controlling interest in consolidated subsidiary		517			—					443			—
Total Liabilities and Stockholders’ Equity	$	554,030			1,663				$	532,809			1,488
Net interest income				$	9,208							$	8,660
Interest rate spread							3.33								3.29
Interest expense to average earning assets							0.65								0.60
Net interest margin							3.54	%							3.49	%

(1) Yields are reported on a tax equivalent basis assuming a federal income tax rate of 21 percent for 2018 and 34 percent for 2017.

25

	Six Months Ended June 30, 2018 Compared to Six Months Ended June 30, 2017
	Increase			Change Due To:
(Dollars in thousands)	(Decrease)			Rate			Volume
Interest income:
Federal funds sold	$	1		$	—		$	1
Deposits in banks		(3	)		60			(63	)
Securities, taxable		62			(13	)		75
Securities, nontaxable		(48	)		15			(63	)
Restricted equity securities		8			1			7
Loans held for sale		—			1			(1	)
Loans		703			88			615
Total interest income		723			152			571
Interest expense:
Interest bearing liabilities:
Checking		55			37			18
Money market savings		29			27			2
Regular savings		32			19			13
Time Deposits		15			92			(77	)
FHLB borrowings		49			20			29
Subordinated notes		—			(1	)		1
Other borrowings		(5	)		2			(7	)
Total interest expense		175			196			(21	)
Net interest income	$	548		$	(44	)	$	592

Noninterest income for the first six months of 2018 was $2.2 million, compared to $1.7 million for the same period in 2017; noninterest income, net of non-recurring income amounted to $1.5 million during the first six months of 2018 vs. $1.6 million in the first six months of 2017. The non-recurring income during 2018 was the recognition of a nontaxable net death benefit proceeds of $642 thousand from bank owned life insurance; while other income in the prior year included a one-time bankruptcy settlement of $172 thousand.  The decrease in non-interest income, net of the non-recurring items, was primarily the result of declines in mortgage banking income, partially offset by an increase in ATM and interchange income related to new account growth.

For the six months ended June 30, 2018, noninterest expense was $8.5 million, $362 thousand or 4.5% more than the $8.1 million recorded in the same period last year. Salaries and employee benefits for the six months ended June 30, 2018 were $299 thousand more than the same six months of 2017, and were partially offset by the $91 thousand decrease in professional fees.  The current period includes the wages for the position of Chief Risk Officer that was open in the same period last year.  In 2017 much of the Company's internal audit work was outsourced and the cost included in professional fees.  Other factors contributing to higher personnel expense was annual merit raises, and the acceleration of the vesting of all remaining restricted stock related to the death of a former executive.   Data processing expense was up $152 thousand over the prior year.  

Financial Condition

The Company’s management, under the direction of the Asset/Liability Committee (ALCO) of the Board of Directors, reviews the mix of monetary assets and liabilities to ensure the Company maintains an adequate level of liquidity while maximizing interest rate spreads.

Assets totaled $558 million at June 30, 2018, an increase of $7.9 million or 1.4% since year end 2017. The continuing expansion of the net loan portfolio by $17.1 million during the six months since December 31, 2017 was partially offset by a decrease in the investment portfolio.

The Company’s liabilities at June 30, 2018 totaled $506.0 million compared to $499.4 million at December 31, 2017, an increase of $6.7 million or 1.3%.  Total deposits increased $3.8 million during the same period to $481.1 million at June 30, 2018, while FHLB borrowings grew $4.1 million from year end 2017.

At June 30, 2018 and December 31, 2017, the stockholders’ equity of HomeTown Bankshares was $52.1 million and $50.9 million, respectively, an increase of $1.2 million or 2.4%. The change in stockholders’ equity in the first six months of 2018 was mainly the result of net income, partially offset by increases in unrealized losses in the investment portfolio caused by market volatility.  

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 Non-performing Assets

 Non-performing assets consist of nonaccrual loans, restructured loans, and repossessed and foreclosed assets.

	June 30, 2018		December 31, 2017
(Dollars in thousands)
Real Estate:
Construction and land development	$	308	$	274
Residential 1-4 families		460		173
Commercial real estate		471		209
Commercial loans		278		403
Equity lines		122		49
Loans to individuals		-		36
Total nonperforming loans		1,639		1,144
Other real estate owned		3,414		3,249
Total nonperforming assets, excluding performing restructured loans		5,053		4,393
Performing restructured loans		3,830		3,889
Total nonperforming assets, including restructured loans	$	8,883	$	8,282

At June 30, 2018, four loans totaling $4.0 million were classified as troubled debt restructurings (“TDRs”). Two of the four loans totaling $3.8 million were performing in accordance with their restructured terms and were accruing interest at June 30, 2018. The other two loans from one borrower totaled $203 thousand and were on nonaccrual status at June 30, 2018. See Note 3 for more information.

The major classifications of other real estate owned in the consolidated balance sheets at June 30, 2018 and December 31, 2017 are included in Note 5, and the activity in other real estate owned for the first six months of 2018 and 2017 is also included in Note 5.

Allowance for Loan Losses

The allowance for loan losses is increased by charges to income and decreased by charge-offs, net of recoveries. The allowance consists of three components: specific, general, and unallocated. Their adequacy is evaluated separately. Management’s periodic evaluation of the adequacy of the allowance is based on the Company’s past loan loss experience, known and inherent risks in the portfolio, adverse situations that may affect the borrower’s ability to repay, the estimated value of any underlying collateral, and current economic conditions. Based on the Company’s allowance for loan losses calculation and analysis at the end of the first three months of 2018, a provision of $347 thousand was recorded. Charged off loans exceeded recoveries of previous charge offs by $188 thousand and $471 thousand for the first six months of 2018 and 2017, respectively.

Specific reserves are determined on a loan by loan basis and relate to loans classified as impaired. Management classifies loans as impaired when, based on current information and events, it is probable that the Company will be unable to collect all amounts due according to the contractual terms of the loan agreement.   Included in potentially impaired loan category are current “watch list” credits plus any additional credits which have been past due three or more times within the past 12-month period. Management individually reviews these potentially impaired loans based on generally accepted accounting principles (GAAP) related to receivables and makes a determination if the loan in fact is impaired. Management does not consider a loan impaired during a period of delay in payment if management expects the ultimate collection of all amounts due. If a loan is found to be impaired, an allowance is established when the collateral value less estimated cost to dispose, discounted cash flows, or observable market price of the impaired loan is lower than the carrying value of that loan. There were no specific reserves for loans individually evaluated for impairment at June 30, 2018 and December 31, 2017.  Impaired loans totaled $5.8 million at June 30, 2018, $433 thousand higher than the balance at year end 2017.

The percentage of the allowance for loan losses to total loans was 0.85% at June 30, 2018, and December 31, 2017.  Unallocated reserves were $5 thousand at June 30, 2018 and $9 thousand at December 31, 2017. Some surplus or unallocated reserve is desirable given the inherent weakness in this type of predictive analysis. The allowance for loan losses to nonaccrual loans was 239% at June 30, 2018 and 328% at December 31, 2017. Past due and non-accruing loans to total loans was 0.71% at June 30, 2018 compared to 1.19% at December 31, 2017.

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Liquidity

Liquidity is identified as the ability to generate or acquire sufficient amounts of cash when needed and at a reasonable cost to accommodate withdrawals, payments of debt, and increased loan demand. Liquid assets include cash, federal funds sold, securities classified as available for sale as well as loans and securities maturing within one year. As a result of the Company’s management of liquid assets and the ability to generate liquidity through liability funding, management believes the Company maintains overall liquidity sufficient to satisfy its depositors’ requirements and meet its customers’ credit needs.

The Company’s management, under the direction of the Asset/Liability Committee of the Board of Directors, reviews the mix of monetary assets and liabilities to ensure the Company maintains an adequate level of liquidity at all times. This ensures that the Company’s sources of funds, primarily net fluctuations in customer deposits, investment securities and correspondent banking relationships, must be balanced with the Company’s obligations, commitments, and operational requirements, to maintain overall liquidity in conjunction with the maximization of interest rate spreads.

The Company’s asset based liquidity position, cash and due from bank balances, federal funds sold, loans held for sale, securities available for sale, net of securities pledged and cash balance requirements totaled $57.6 million at June 30, 2018, compared to $65.2 million at December 31, 2017.  Commercial interest bearing deposits remain volatile and withdrawals may result in less liquidity in the future. Surges and declines in commercial deposits will continue to impact liquidity in an unpredictable manner.

The Company’s primary source of funding is its retail deposit base. The Company aggressively markets in its trade area and seeks demand deposits through service-related tactics and savings and time deposits through competitive pricing tactics. If deposits are not an attractive source for funding, either for reasons of maturity or pricing, alternative sources include FHLB advances, brokered deposits, fed funds purchased and lines of credit. The Company is approved to borrow 25% of our total assets from the FHLB subject to providing qualifying collateral.  At June 30, 2018, the Company had borrowed $15.1 million of the $22.4 million of lendable collateral value, leaving $7.3 million of unused credit immediately available. The Company also had $41.0 million of fed funds lines of credit available at June 30, 2018. In addition, the Company had borrowed $7.5 million of the available $10.0 million credit line through Promontory’s Insured Cash Sweep (ICS) one way buy program at a rate of the one month LIBOR plus 11 basis points but not less than 20 basis points. At June 30, 2018 there were no advances on the fed funds or credit lines.   

Capital

To enable future growth of the Company, there must be an adequate level of capital. Management reviews the Company’s capital to ensure that the amount, composition and quality of the Company’s assets and liabilities satisfy regulatory requirements, meet or exceed industry standards, and support projected Company growth. The Company’s stock is traded on the NASDAQ Capital Market under the symbol “HMTA.”

The ability to pay cash dividends to common stockholders is limited by regulatory restrictions and the need to maintain sufficient capital in the Company and in our subsidiaries. The Company must consider different factors to ensure that any future cash dividends to common stockholders would be prudent relative to the organization’s financial position and not based on overly optimistic earnings scenarios. The Company had $5.7 million of retained earnings at June 30, 2018.  On May 15, 2018 at the annual shareholders meeting the Board of Directors declared the Company’s first cash dividend.  The cash dividend of $0.04 per common share was paid on June 15, 2018 to shareholders of record on May 31, 2018.

The Basel III capital framework represents the most comprehensive overhaul of the U.S. banking capital framework in over two decades. This new capital framework and related changes to the standardized calculations of risk-weighted assets are complex and create additional compliance burdens. Basel III rules became effective for the Company on January 1, 2015 with full compliance with all of the requirements being phased in over a multi-year schedule. The Basel III Capital Rules require significantly more capital and adopted more demanding regulatory capital risk weightings and calculations. As a result of the Basel III Capital Rules, many community banks could be forced to limit banking operations and activities, and growth of loan portfolios, in order to focus on retention of earnings to improve capital levels. The Company believes that it maintains sufficient levels of Tier 1 and Common Equity Tier 1 capital to comply with the Basel III Final Rules. However, increased capital requirements imposed by the Basel III Capital Rules may require the Company to limit its banking operations, retain net income to improve regulatory capital levels, which could negatively affect our business, financial condition and results of operations.

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The table presents the Bank’s capital amounts and ratios calculated using the Basel III rules in effect at June 30, 2018 and December 31, 2017.

Risk Based Capital Analysis

Capital Analysis

HomeTown Bank	June 30, 2018		December 31, 2017
(Dollars in thousands)
Common Equity Tier 1 Capital:
Common Stock	$	14,697	$	14,697
Surplus		32,340		32,226
Retained Earnings		12,664		10,551
Common Equity Tier 1 Capital		59,701		57,474
Tier 1 Capital:
Tier 1 Minority Interest		6		25
Tier 1 Capital		59,707		57,499
Total Capital:
Allowance for Loan Losses (allowable portion)		3,917		3,758
Total Capital	$	63,624	$	61,257

The Bank’s total capital increased $2.4 million from December 31, 2017 to June 30, 2018, primarily as the result of retaining the $2.2 million of year to date June 30, 2018 net income attributable to the bank and noncontrolling interest.

The Company meets eligibility criteria of a small bank holding company in accordance with the Federal Reserve Board’s Small Bank Holding Company Policy Statement issued in February 2015, and is no longer obligated to report consolidated regulatory capital. In July 2013, the Federal Reserve Bank issued revised final rules that made technical changes to its market risk capital rules to align it with the Basel III regulatory capital framework and meet certain requirements of the Dodd-Frank Act. The final new capital rules required the Bank to comply with the following new minimum capital ratios, effective January 1, 2015: (1) a new common equity Tier 1 capital ratio of 4.5% of risk-weighted assets; (2) a Tier 1 capital ratio of 6% of risk-weighted assets (increased from the previous requirement of 4%); (3) a total capital ratio of 8% of risk-weighted assets (unchanged from current requirement); and, (4) a leverage ratio of 4% of total assets.  Beginning January 1, 2016, a capital conservation buffer of .625% became effective. The capital conservation buffer will be gradually increased through January 1, 2019 to 2.5%. Banks will be required to maintain capital levels that meet the required minimum plus the capital conservation buffer in order to make distributions or discretionary bonus payments.

The Bank’s actual capital amounts and ratios are also presented in the following tables:

HomeTown Bank June 30, 2018	Actual					Minimum Capital Requirement				Minimum To Be Well Capitalized Under Prompt Corrective Action Provisions
(in thousands except for percentages)	Amount		Ratio			Amount		Ratio		Amount		Ratio
Total Capital (to Risk-Weighted Assets)	$	63,624		12.40	%	$	50,664		9.875	$	51,305		10.00	%
Tier I Common Equity (to Risk-Weighted Assets)		59,701		11.64			32,708		6.375		33,349		6.50
Tier I Capital (to Risk-Weighted Assets)		59,707		11.64			40,403		7.875		41,044		8.00
Tier I Capital (to Average Assets)		59,707		10.70			22,310		4.00		27,888		5.00

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HomeTown Bank December 31, 2017	Actual					Minimum Capital Requirement				Minimum To Be Well Capitalized Under Prompt Corrective Action Provisions
(in thousands except for percentages)	Amount		Ratio			Amount		Ratio		Amount		Ratio
Total Capital (to Risk-Weighted Assets)	$	61,257		12.48	%	$	45,403		9.25	$	49,084		10.00	%
Tier I Common Equity (to Risk-Weighted Assets)		57,474		11.71			28,222		5.75		31,903		6.50
Tier I Capital (to Risk-Weighted Assets)		57,499		11.72			35,569		7.25		39,248		8.00
Tier I Capital (to Average Assets)		57,499		10.39			22,136		4.00		27,670		5.00

Financial Instruments with Off-Balance-Sheet Risk

In the normal course of business to meet the financing needs of its customers, the Company is a party to financial instruments with off-balance-sheet risk. These financial instruments involve commitments to extend credit. These instruments involve, to varying degrees, elements of credit risk in excess of the amount recognized in the consolidated balance sheets.

The Company’s exposure to credit loss in the event of nonperformance by the other party to the financial instruments for commitments to extend credit is represented by the contractual amount of those instruments. The same credit policy is used in making commitments as is used for on-balance-sheet risk.

At June 30, 2018, outstanding commitments to extend credit including letters of credit were $123.3 million. There are no commitments to extend credit on impaired loans.

Commitments to extend credit are agreements to lend to a customer as long as there is no breach of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. The commitments may expire without ever being drawn upon; therefore, the total commitment amounts do not necessarily represent future cash outlays for the Company.

Recent Accounting Pronouncements

In February 2016, the FASB issued ASU No. 2016-02, “Leases (Topic 842).” Among other things, in the amendments in ASU 2016-02, lessees will be required to recognize the following for all leases (with the exception of short-term leases) at the commencement date: (1) A lease liability, which is a lessee‘s obligation to make lease payments arising from a lease, measured on a discounted basis; and (2) A right-of-use asset, which is an asset that represents the lessee’s right to use, or control the use of, a specified asset for the lease term. Under the new guidance, lessor accounting is largely unchanged. Certain targeted improvements were made to align, where necessary, lessor accounting with the lessee accounting model and Topic 606, Revenue from Contracts with Customers. The amendments in this ASU are effective for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. Early application is permitted upon issuance. Lessees (for capital and operating leases) and lessors (for sales-type, direct financing, and operating leases) must apply a modified retrospective transition approach for leases existing at, or entered into after, the beginning of the earliest comparative period presented in the financial statements. The modified retrospective approach would not require any transition accounting for leases that expired before the earliest comparative period presented. Lessees and lessors may not apply a full retrospective transition approach. The Company is currently assessing the impact that ASU 2016-02 will have on its consolidated financial statements.

During June 2016, the FASB issued ASU No. 2016-13, “Financial Instruments – Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments.” The amendments in this ASU, among other things, require the measurement of all expected credit losses for financial assets held at the reporting date based on historical experience, current conditions, and reasonable and supportable forecasts. Financial institutions and other organizations will now use forward-looking information to better inform their credit loss estimates. Many of the loss estimation techniques applied today will still be permitted, although the inputs to those techniques will change to reflect the full amount of expected credit losses. In addition, the ASU amends the accounting for credit losses on available-for-sale debt securities and purchased financial assets with credit deterioration. The amendments in this ASU are effective for SEC filers for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2019. The Bank has formed a committee to address the compliance requirements, data gathering, archiving and analysis efforts.  The Bank began tracking data during the 2nd quarter of 2018 and will reassess its position during the 4th quarter of 2018.  Additionally, the Bank has begun to analyze various software solutions that will assist in complying with this Standard.

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During March 2017, the FASB issued ASU 2017‐08, “Receivables—Nonrefundable Fees and Other Costs (Subtopic 310‐20), Premium Amortization on Purchased Callable Debt Securities.” The amendments in this ASU shorten the amortization period for certain callable debt securities purchased at a premium. Upon adoption of the standard, premiums on these qualifying callable debt securities will be amortized to the earliest call date. Discounts on purchased debt securities will continue to be accreted to maturity. The amendments are effective for fiscal years beginning after December 15, 2018, and interim periods within those fiscal years. Early adoption is permitted, including adoption in an interim period. Upon transition, entities should apply the guidance on a modified retrospective basis, with a cumulative-effect adjustment to retained earnings as of the beginning of the period of adoption and provide the disclosures required for a change in accounting principle. The Company is currently assessing the impact that ASU 2017‐08 will have on its consolidated financial statements.

In August 2017, the FASB issued ASU 2017-12, “Derivatives and Hedging (Topic 815): Targeted Improvements to Accounting for Hedging Activities.” The amendments in this ASU modify the designation and measurement guidance for hedge accounting as well as provide for increased transparency regarding the presentation of economic results on both the financial statements and related footnotes. Certain aspects of hedge effectiveness assessments will also be simplified upon implementation of this update. The amendments are effective for annual periods, including interim periods within those annual periods, beginning after December 15, 2018. Early adoption is permitted, including adoption in any interim period. The Company does not expect the adoption of ASU 2017-12 to have a material impact on its consolidated financial statements.

In February 2018, the FASB issued ASU 2018-03, “Technical Corrections and Improvements to Financial Instruments-Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities.” The amendments provide targeted improvements to address certain aspects of recognition, measurement, presentation, and disclosure of financial instruments. Specifically, the amendments include clarifications related to: measurement elections, transition requirements, and adjustments associated with equity securities without readily determinable fair values; fair value measurement requirements for forward contracts and purchased options on equity securities; presentation requirements for hybrid financial liabilities for which the fair value option has been elected; and measurement requirements for liabilities denominated in a foreign currency for which the fair value option has been elected. The amendments are effective for fiscal years beginning after December 15, 2017, and interim periods within those fiscal years beginning after June 15, 2018. Early adoption is permitted. The Company does not expect the adoption of ASU 2018-03 to have a material impact on its consolidated financial statements.

In June 2018, the FASB issued ASU 2018-07, “Compensation- Stock Compensation (Topic 718): Improvements to Nonemployee Share-Based Payment Accounting.” The amendments expand the scope of Topic 718 to include share-based payments issued to non-employees for goods or services, which were previously excluded. The amendments will align the accounting for share-based payments to nonemployees and employees more similarly. The amendments are effective for fiscal years beginning after December 15, 2018, and interim periods within those fiscal years. Early adoption is permitted. The Company does not expect the adoption of ASU 2018-07 to have a material impact on its consolidated financial statements.

ITEM 3.         QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Not applicable to smaller reporting companies.

ITEM 4.         CONTROLS AND PROCEDURES

As of the end of the period covered by this report, the Company carried out an evaluation, under the supervision and with the participation of the Company’s management, including the Company’s Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of the Company’s disclosure controls and procedures (as defined in Rule 13a-15(e) under the Securities Exchange Act of 1934, as amended.)  Based upon that evaluation, the Company’s Chief Executive Officer and Chief Financial Officer concluded that the Company’s disclosure controls and procedures were effective.

The Company’s management is also responsible for establishing and maintaining adequate internal control over financial reporting. There were no changes in the Company’s internal control over financial reporting identified in connection with the evaluation of it that occurred during the Company’s last fiscal quarter that materially affected, or are reasonably likely to materially affect, internal control over financial reporting.

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PART II OTHER INFORMATION

Item 1. Legal Proceedings.

In the normal course of business, the Company becomes involved in litigation arising from the banking, financial and other activities it conducts. Management, after consultation with legal counsel, does not anticipate that the ultimate liability, if any, arising from these matters will have a material effect on the Company’s financial condition, operating results or liquidity.

Item 1A. Risk Factors.

Not applicable to smaller reporting companies.

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

None

Item 3. Defaults Upon Senior Securities

None

Item 4. Mine Safety Disclosure

Not applicable.

Item 5. Other Information

None

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Item 6. Exhibits

(a) Exhibits

Exhibit No.
31.1	Certification of Chief Executive of Officer (302 Certification).
31.2	Certification of Chief Financial Officer (302 Certification).
32	Certification pursuant to 18 U.S.C. Section 1350 (906 Certification).
101*	Pursuant to Rule 405 of Regulation S-T, the following financial information from the Company’s Quarterly Report on Form 10-Q for the period ended June 30, 2018, is formatted in XBRL interactive data files: (i) Consolidated Balance Sheets at June 30, 2018, and December 31, 2017; (ii) Consolidated Statements of Income for the three and six months ended June 30, 2018, and 2017; (iii) Consolidated Statements of Comprehensive Income for the three and six months ended June 30, 2018, and 2017;  (iv) Consolidated Statements of Cash Flows for the six months ended June 30, 2018 and 2017; and (v) Notes to Consolidated Financial Statements.

 * As provided in Rule 406T of Regulation S-T, this information is furnished and not filed for purposes of Sections 11 and 12 of the Securities Act of 1933 and Section 18 of the Securities Exchange Act of 1934.

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SIGNATURES

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

HOMETOWN BANK
Date: August 13, 2018	By:	/S/ SUSAN K. STILL
		Susan K. Still
		President
		Chief Executive Officer
Date: August 13, 2018	By:	/S/ VANCE W. ADKINS
		Vance W. Adkins
		Executive Vice President
		Chief Financial Officer

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