Poage Bankshares (PBSK) 10-Q 2017 Q3 Quarterly report

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

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

For the Quarterly Period ended September 30, 2017

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

For transition period from ______________________ to___________________

Commission File Number 001-35295

Poage Bankshares, Inc.

(Exact Name of Registrant as Specified in Charter)

Maryland	45-3204393
(State of Other Jurisdiction	(I.R.S Employer
of Incorporation)	Identification Number)

1500 Carter Avenue, Ashland, KY 41101	41101
(Address of Principal Executive Officer)	(Zip Code)

606-324-7196

Registrant’s telephone number, including area code

Not Applicable

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

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

Indicate by check mark whether the registrant has submitted electronically 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 during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes x     No ¨

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

Large accelerated filer	¨	Accelerated filer	¨
Non-accelerated filer	¨	Smaller reporting company	x
		Emerging growth company	¨

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

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

As of November 14, 2017, the number of shares of the Registrant’s common stock, par value $.01 per share, was 3,522,098.

POAGE BANKSHARES, INC.

Form 10-Q Quarterly Report

Table of Contents

	PART I. FINANCIAL INFORMATION
ITEM 1.	CONSOLIDATED FINANCIAL STATEMENTS – POAGE BANKSHARES, INC.	3
ITEM 2.	MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS	33
ITEM 3.	QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK	44
ITEM 4.	CONTROLS AND PROCEDURES	44
	PART II. OTHER INFORMATION
ITEM 1.	LEGAL PROCEEDINGS	45
ITEM 1A.	RISK FACTORS	45
ITEM 2.	UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS	45
ITEM 3.	DEFAULTS UPON SENIOR SECURITIES	46
ITEM 4.	MINE SAFETY DISCLOSURES	46
ITEM 5.	OTHER INFORMATION	46
ITEM 6.	EXHIBITS	46
SIGNATURES		47

2

PART I

ITEM 1.     CONSOLIDATED FINANCIAL STATEMENTS

POAGE BANKSHARES, INC.

UNAUDITED CONSOLIDATED BALANCE SHEETS

(Dollar amounts in thousands except per share data)

	September 30,			December 31,
	2017			2016
ASSETS
Cash and due from financial institutions	$	25,822		$	24,389
Interest-bearing deposits in other financial institutions		2,490			1,992
Securities available for sale		64,660			58,261
Loans held for sale		-			611
Loans, net of allowance of $3,186 and $2,349		336,237			343,921
Restricted stock, at cost		3,276			3,276
Other real estate owned, net		1,860			718
Premises and equipment, net		10,681			11,115
Company owned life insurance		7,249			7,121
Accrued interest receivable		1,307			1,397
Goodwill		1,277			1,277
Other intangible assets, net		750			1,006
Deferred tax asset, net		1,319			1,454
Other assets		3,273			1,927
Total assets	$	460,201		$	458,465
LIABILITIES AND SHAREHOLDERS' EQUITY
Deposits
Non-interest bearing	$	55,798		$	52,288
Interest bearing		319,115			322,420
Total deposits		374,913			374,708
Federal Home Loan Bank advances		10,805			9,332
Subordinated debenture		2,873			2,825
Other borrowings		1,500			-
Accrued interest payable		80			52
Other liabilities		3,995			2,847
Total liabilities		394,166			389,764
Commitments and contingent liabilities		-			-
Shareholders' equity
Common stock, $.01 par value, 30,000,000 shares authorized, 3,521,903 and 3,704,704 issued and outstanding at September 30, 2017 and December 31, 2016, respectively		35			37
Additional paid-in-capital		32,417			35,742
Retained earnings		35,223			35,065
Unearned Employee Stock Ownership Plan (ESOP) shares		(1,888	)		(1,990	)
Accumulated other comprehensive income (loss)		248			(153	)
Total shareholders' equity		66,035			68,701
Total liabilities and shareholders' equity	$	460,201		$	458,465

See notes to unaudited consolidated financial statements.

3

POAGE BANKSHARES, INC.

UNAUDITED CONSOLIDATED STATEMENTS OF OPERATIONS

(Dollar amounts in thousands except per share data)

	Three months ended					Nine months ended
	September 30,					September 30,
	2017			2016		2017		2016
Interest and dividend income
Loans, including fees	$	4,297		$	4,455	$	12,877	$	13,134
Taxable securities		255			207		729		703
Tax-exempt securities		116			115		345		336
Federal funds sold and other		113			49		302		149
		4,781			4,826		14,253		14,322
Interest expense
Deposits		629			501		1,808		1,459
Federal Home Loan Bank advances and other borrowings		114			101		283		292
		743			602		2,091		1,751
Net interest income		4,038			4,224		12,162		12,571
Provision for loan losses		947			352		1,646		812
Net interest income after provision for loan losses		3,091			3,872		10,516		11,759
Non-interest income
Service charges on deposits		496			525		1,495		1,531
Other service charges		13			13		39		40
Net gain on disposal of land and equipment		-			-		16		92
Loan servicing fees		55			151		219		357
Gains on mortgage loans sold, net		91			64		165		161
Net gains (losses) on securities		-			-		-		(3	)
Income from company owned life insurance		43			45		128		135
Other		6			2		13		14
		704			800		2,075		2,327
Non-interest expense
Salaries and employee benefits		1,599			1,865		5,156		5,586
Occupancy and equipment		458			502		1,403		1,466
Data processing		698			668		1,965		1,991
Federal deposit insurance		32			60		99		176
Loan processing and collection		82			108		272		268
Foreclosed assets, net		67			191		214		306
Advertising		75			121		290		237
Professional fees		303			137		464		395
Other taxes		116			106		352		320
Director fees and expenses		51			44		130		136
Amortization of intangible assets		85			87		256		261
Other		298			297		840		812
		3,864			4,186		11,441		11,954
Income (loss) before income taxes		(69	)		486		1,150		2,132
Income tax expense (benefit)		(51	)		122		338		581
Net income (loss)	$	(18	)	$	364	$	812	$	1,551
Earnings (loss) per common share:
Basic	$	(0.01	)	$	0.10	$	0.23	$	0.43
Dilutive		(0.01	)		0.10	$	0.23	$	0.43
Dividend per share	$	0.06		$	0.08	$	0.18	$	0.20

See notes to unaudited consolidated financial statements.

4

POAGE BANKSHARES, INC.

UNAUDITED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)

(Dollar amounts in thousands except per share data)

	Three months ended						Nine months ended
	September 30,						September 30,
	2017			2016			2017			2016
Net income (loss)	$	(18	)	$	364		$	812		$	1,551
Other comprehensive income (loss):
Unrealized holding gains (loss) on available for sale securities		(103	)		(135	)		608			664
Reclassification adjustments for losses recognized in income		-			-			-			3
Net unrealized holding gains (loss) on available for sale securities		(103	)		(135	)		608			667
Tax effect		35			46			(207	)		(227	)
Other comprehensive income (loss)		(68	)		(89	)		401			440
Comprehensive income (loss)	$	(86	)	$	275		$	1,213		$	1,991

See notes to unaudited consolidated financial statements.

5

POAGE BANKSHARES, INC.

UNAUDITED CONSOLIDATED STATEMENT OF SHAREHOLDERS’ EQUITY

(Dollar amounts in thousands except per share data)

													Accumulated
				Additional						Unearned			Other			Total
	Common			Paid-In			Retained			ESOP			Comprehensive			Shareholders'
	Stock			Capital			Earnings			Shares			Income (Loss)			Equity
Balances,  January 1, 2017	$	37		$	35,742		$	35,065		$	(1,990	)	$	(153	)	$	68,701
Net income		-			-			812			-			-			812
Stock repurchases, 188,428 shares repurchased		(2	)		(3,646	)		-			-			-			(3,648	)
Dividends paid ($0.18/share)		-			-			(654	)		-			-			(654	)
ESOP compensation earned		-			93			-			102			-			195
Stock based compensation expense		-			228			-			-			-			228
Exercise of stock options, 5,627 shares exercised, net		-			-			-			-			-			-
Other comprehensive income		-			-			-			-			401			401
Balances, September 30, 2017	$	35		$	32,417		$	35,223		$	(1,888	)	$	248		$	66,035

See notes to unaudited consolidated financial statements.

6

POAGE BANKSHARES, INC.

UNAUDITED CONSOLIDATED STATEMENTS OF CASH FLOWS

(Dollar amounts in thousands except per share data)

	Nine months ended
	September 30,
	2017			2016
Operating activities:
Net income	$	812		$	1,551
Adjustments to reconcile net income to net cash from operating activities:
Depreciation		569			583
Provision for loan losses		1,646			812
ESOP compensation expense		195			177
Stock based compensation expense		228			301
Loss on securities		-			3
Net gain on sale of premises and equipment		(16	)		(92	)
Loss on sale and write-downs of other real estate owned		126			182
(Gain) Loss on sale of repossessed assets		6			5
Loss on fictitious loans		25			-
Amortization of core deposit intangible		256			261
Accretion of fair value adjustments related to loans		(303	)		(594	)
Accretion of fair value adjustments related to deposits		(49	)		(49	)
Amortization of fair value related to subordinated debenture		48			48
Net amortization on securities		97			209
Deferred income tax expense (benefit)		(72	)		472
Net gain on mortgage banking activities		(165	)		(161	)
Origination of loans held for sale		(5,475	)		(6,067	)
Proceeds from loans held for sale		6,251			5,885
Increase in cash value of life insurance		(128	)		(135	)
Change in asset and liabilities, net assets and liabilities acquired:
Accrued interest receivable		90			(55	)
Other assets		58			311
Accrued interest payable		28			63
Other liabilities		1,148			1,533
Net cash provided by operating activities		5,375			5,243
Investing activities:
Net increase in interest-bearing deposits with other institutions		(498	)		-
Securities available for sale:
Proceeds from calls		65			6,655
Proceeds from maturities		435			-
Purchases		(11,762	)		(5,565	)
Principal payments received		5,374			5,541
Loan originations and principal payments on loans, net		2,738			(26,785	)
Proceeds from the sale of other real estate owned		856			1,184
Proceeds from the sale of repossessed assets		44			-
Proceeds from the sale of premises and equipment		54			-
Purchase of premises and equipment, net		(173	)		(403	)
Net cash used in investing activities		(2,867	)		(19,373	)
Financing activities:
Net change in deposits		254			16,714
Proceeds from other borrowings		1,500			-
Proceeds from Federal Home Loan Bank borrowings		13,000			80,500
Payments on Federal Home Loan Bank borrowings		(11,527	)		(83,510	)
Cash dividend paid		(654	)		(762	)
Stock repurchases		(3,648	)		(3,195	)
Net cash provided by (used in) financing activities		(1,075	)		9,747
Net increase (decrease) in cash and cash equivalents		1,433			(4,383	)
Cash and cash equivalents at beginning of period		24,389			23,876
Cash and cash equivalents at the end of the period	$	25,822		$	19,493
Additional cash flows and supplementary information:
Cash paid during the year for:
Interest on deposits and debt	$	2,064		$	1,689
Income taxes (refund) payment		250			(450	)
Other real estate owned and other repossessed assets acquired in settlement of loans	$	2,124		$	1,196
Loans provided for sales of real estate owned	$	-		$	142

See notes to unaudited consolidated financial statements

7

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 1 – BASIS OF PRESENTATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

The accompanying unaudited consolidated financial statements of Poage Bankshares, Inc. (the “Company” or “Poage”) and its wholly owned subsidiary Town Square Bank (which was formerly operated under the name “Home Federal Savings and Loan Association”) (the “Bank”) have been prepared in accordance with U.S. generally accepted accounting principles (“GAAP”) for interim financial information and with the instructions to Form 10-Q and Rule 8-03 of Regulation S-X. Accordingly, certain information and footnote disclosures normally included in financial statements prepared in accordance with GAAP have been condensed or omitted pursuant to such rules and regulations.

The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities as of the date of the financial statements and the reported amounts of revenues and expenses during the reporting period.  Estimates used in the preparation of the financial statements are based on various factors including the current interest rate environment and the general strength of the local economy.  Changes in the overall interest rate environment can significantly affect the Company’s net interest income and the value of its recorded assets and liabilities.  Actual results could differ from those estimates used in the preparation of the financial statements.

In the opinion of management, the accompanying unaudited financial statements contain all adjustments (consisting only of normal recurring accruals) necessary to present fairly the Company’s financial position as of September 30, 2017 and December 31, 2016 and the results of operations and cash flows for the interim periods ended September 30, 2017 and 2016. All interim amounts have not been audited, and the results of operations for the interim periods herein are not necessarily indicative of the results of operations to be expected for the year. These consolidated financial statements should be read in conjunction with the Company’s audited consolidated financial statements and notes thereto filed as part of the Company’s 2016 Annual Report on Form 10-K filed with the Securities and Exchange Commission.

Recently Adopted Accounting Pronouncements

In March 2016, the FASB issued ASU No. 2016-09,Compensation—Stock Compensation: Improvements to Employee Share-Based Payment Accounting.This ASU will require recognition of the income tax effects of share-based awards in the income statement when the awards vest or are settled (i.e., Additional Paid-in-Capital pools will be eliminated). The amendments are effective for public companies for annual periods beginning after December 15, 2016. The guidance in the ASU No. 2016-09 was adopted by the Company and did not have a material impact on its consolidated financial statements.

Newly Issued Accounting Standards Not Yet Effective

In May 2014, the FASB issuedAccounting Standards Update 2014-09 Revenue from Contracts with Customers (Topic 606)developed as a joint project with the International Accounting Standards Board to remove inconsistencies in revenue requirements and provide a more robust framework for addressing revenue issues. The ASU's requires that revenue from contracts with clients be recognized upon transfer of control of a good or service in the amount of consideration expected to be received and changes the accounting for certain contract costs, including whether they may be offset against revenue in the statements of income, and requires additional disclosures about revenue and contract costs. The ASU may be adopted using either a modified retrospective method or a full retrospective method. Poage intends to adopt the ASU during the first quarter of 2018, as required, using a modified retrospective approach. Poage’s preliminary analysis suggests that the adoption of this accounting guidance is not expected to have a material impact on the Company's consolidated financial statements as the majority of its revenue stream is generated from financial instruments which are not within the scope of this ASU. While the Company believes this ASU will have an immaterial impact, it continues to evaluate this ASU for changing facts and circumstances in the Company's consolidated operations as the effective date approaches.

In January 2016, the FASB issued ASU No. 2016-01,Financial Instruments—Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities. The ASU makes several modifications to Subtopic 825-10 including the elimination of the available-for-sale classification of equity investments, and requires equity investments with readily determinable fair values to be measured at fair value with changes in fair value recognized in net income.  This ASU will become effective for the Company for interim and annual periods beginning after December 15, 2017. The adoption of ASU No. 2016-01 is not expected to have a material effect on the Company’s consolidated operating results or financial condition.

In February 2016, the FASB issued Accounting Standards Update 2016-02 Leases guidance requiring the recognition in the statement of financial position of lease assets and lease liabilities by lessees for those leases classified as operating leases under previous GAAP. The guidance requires that a lessee should recognize lease assets and lease liabilities as compared to previous GAAP that did not require lease assets and lease liabilities to be recognized for most leases. The guidance becomes effective for us on January 1, 2019.  The Company leases two facilities. Upon adoption of this standard, an asset will be recorded to recognize the right of the Company to use the leased facilities and a liability will be recorded representing the obligation to make all future lease payments on those facilities. Management is currently evaluating the impact of the new guidance on the Company’s consolidated financial statements.

8

In June 2016, the FASB issued ASU 2016-13, Financial Instruments - Credit Losses: Measurement of Credit Losses on Financial Instruments (the ASU), which introduces the current expected credit losses methodology. Among other things, the ASU requires the measurement of all expected credit losses for financial assets, including loans and available-for-sale debt securities, held at the reporting date based on historical experience, current conditions, and reasonable and supportable forecasts that affect the collectability of the reported amount. The new model will require institutions to calculate all probable and estimable losses that are expected to be incurred through the loan's entire life. ASU 2016-13 also requires the allowance for credit losses for purchased financial assets with credit deterioration since origination to be determined in a manner similar to that of other financial assets measured at amortized cost; however, the initial allowance will be added to the purchase price rather than recorded as credit loss expense. The disclosure of credit quality indicators related to the amortized cost of financing receivables will be further disaggregated by year of origination (or vintage). Institutions are to apply the changes through a cumulative-effect adjustment to their retained earnings as of the beginning of the first reporting period in which the standard is effective. The amendments are effective for fiscal years beginning after December 15, 2019. Early application will be permitted for fiscal years beginning after December 15, 2018. Management has formed a steering committee that is evaluating the data gathering requirements, available economic forecasting and loss estimation models and potential software that would be employed by the Company to facilitate the adoption of this guidance and its required disclosures on the Company financial statements. Upon adoption, management anticipates an initial one-time increase in the allowance for loan losses along with a corresponding decrease in capital as permitted by the standard.

In January 2017, FASB issued ASU 2017-4,Intangible—Goodwill and Other (Topic 350), to simplify accounting for goodwill impairment. The new guidance will simplify financial reporting because it eliminates the need to determine the fair value of individual assets and liabilities of a reporting unit to measure goodwill impairment. The revised guidance is effective for fiscal years beginning after December 15, 2019. Early adoption is permitted for any impairment tests performed after January 1, 2017. Poage is currently evaluating the impact of the new guidance on its consolidated financial statements.

In March 2017, the FASB issued ASU No. 2017-08,Receivables—Nonrefundable Fee and Other Costs (Subtopic 310-20), Premium Amortization on Purchased Callable Debt Securities.The amendments affect all entities that hold investments in callable debt securities that have an amortized cost basis in excess of the amount that is repayable by the issuer. The amendments requires the premium for certain callable debt securities to be amortized to the earliest call date. The amendments are effective for public companies for annual periods beginning after December 15, 2019. The adoption of ASU No. 2017-08 is not expected to have a material effect on the Company’s consolidated operating results or financial condition.

In May 2017, the FASB issued ASU No. 2017-09,Scope of Modification Accountingwhich amends the scope of modification accounting for share-based payment arrangements. The ASU provided guidance on the types of changes to the terms or conditions of share-based payment awards to which an entity would be required to apply modification accounting under ASC 718,Compensation—Stock Compensation.Specifically, an entity would not apply modification accounting if the fair value, vesting conditions, and classification of the awards are the same immediately before and after the modification. The amendments are effective for public companies for annual periods beginning after December 15, 2017. The adoption of ASU No. 2017-09 is not expected to have a material effect on the Company’s consolidated operating results or financial condition.

In July 2017, the FASB issued Update No. 2017-11—Earnings Per Share (Topic 260); Distinguishing Liabilities from Equity (Topic 480); Derivatives and Hedging (Topic 815): (Part I) Accounting for Certain Financial Instruments with Down Round Features, (Part II) Replacement of the Indefinite Deferral for Mandatorily Redeemable Financial Instruments of Certain Nonpublic Entities and Certain Mandatorily Redeemable Noncontrolling Interests with a Scope Exception For public business entities, the amendments in Part I of this Update are effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2018. The amendments in Part II of this Update do not require any transition guidance because those amendments do not have an accounting effect. Poage is currently assessing the impact of the new guidance on its consolidated financial statements.

9

NOTE 2 – SECURITIES AVAILABLE FOR SALE

The amortized cost and fair value of securities available for sale at September 30, 2017 and December 31, 2016 and the corresponding amounts of gross unrealized gains and losses recognized in accumulated other comprehensive income (loss) were as follows (in thousands):

			Gross		Gross
	Amortized		Unrealized		Unrealized			Fair
	Cost		Gains		Losses			Value
September 30, 2017
States and political subdivisions	$	19,205	$	342	$	(16	)	$	19,531
U.S. Government agencies and sponsored entities		3,500		-		(55	)		3,445
Government sponsored entities residential mortgage-backed:
FHLMC		10,983		112		(10	)		11,085
FNMA		15,728		70		(26	)		15,772
Collateralized mortgage obligations		5,486		3		(54	)		5,435
SBA loan pools		9,383		39		(30	)		9,392
Total securities	$	64,285	$	566	$	(191	)	$	64,660

			Gross		Gross
	Amortized		Unrealized		Unrealized			Fair
	Cost		Gains		Losses			Value
December 31, 2016
States and political subdivisions	$	19,785	$	291	$	(184	)	$	19,892
U.S. Government agencies and sponsored entities		3,500		-		(37	)		3,463
Government sponsored entities residential mortgage-backed:
FHLMC		10,954		29		(88	)		10,895
FNMA		11,349		19		(108	)		11,260
Collateralized mortgage obligations		5,495		-		(89	)		5,406
SBA loan pools		7,411		9		(75	)		7,345
Total securities	$	58,494	$	348	$	(581	)	$	58,261

There were no sales of securities for the three and nine months ended September 30, 2017 and 2016.

The amortized cost and fair value of the securities portfolio at September 30, 2017 are shown in the following table by contractual maturity. Expected maturities may differ from contractual maturities if borrowers have the right to call or prepay obligations with or without call or prepayment penalties. Securities not due at a single maturity date are shown separately (in thousands):

	September 30,
	2017
	Amortized		Fair
	Cost		Value
Within one year	$	1,449	$	1,453
One to five years		8,536		8,520
Five to ten years		9,799		10,038
Beyond ten years		2,921		2,965
Mortgage-backed securities and collateralized mortgage obligations		32,197		32,292
SBA loan pools		9,383		9,392
Total	$	64,285	$	64,660

10

The following table summarizes the securities with unrealized losses at September 30, 2017 and December 31, 2016, aggregated by major security type and length of time in a continuous unrealized loss position (in thousands):

	Less Than 12 Months					12 Months or Longer					Total
	Fair		Unrealized			Fair		Unrealized			Fair		Unrealized
	Value		Losses			Value		Losses			Value		Losses
September 30, 2017
States and political subdivisions	$	1,747	$	(4	)	$	1,065	$	(12	)	$	2,812	$	(16	)
U.S. Government agencies and sponsored entities		3,444		(55	)		-		-			3,444		(55	)
Government sponsored entities residential mortgage backed:
FHLMC		2,684		(10	)		-		-			2,684		(10	)
FNMA		6,210		(26	)		-		-			6,210		(26	)
Collateralized mortgage obligations		1,408		(5	)		3,052		(49	)		4,460		(54	)
SBA loan pools		4,593		(30	)		-		-			4,593		(30	)
Total available-for-sale securities	$	20,086	$	(130	)	$	4,117	$	(61	)	$	24,203	$	(191	)

	Less Than 12 Months					12 Months or Longer					Total
	Fair		Unrealized			Fair		Unrealized			Fair		Unrealized
	Value		Losses			Value		Losses			Value		Losses
December 31, 2016
States and political subdivisions	$	6,952	$	(184	)	$	296	$	-		$	7,248	$	(184	)
U.S. Government agencies and sponsored entities		3,463		(37	)		-		-			3,463		(37	)
Government sponsored entities residential mortgage backed:
FHLMC		6,479		(88	)		-		-			6,479		(88	)
FNMA		6,930		(108	)		-		-			6,930		(108	)
Collateralized mortgage obligations		2,671		(33	)		2,735		(56	)		5,406		(89	)
SBA loan pools		5,865		(75	)		-		-			5,865		(75	)
Total available-for-sale securities	$	32,360	$	(525	)	$	3,031	$	(56	)	$	35,391	$	(581	)

Unrealized losses on bonds have not been recognized into income because the issuers of the bonds are of high credit quality, management does not intend to sell and it is not more likely than not that management would be required to sell the securities prior to their anticipated recovery, and the decline in fair value is largely due to changes in interest rates. The fair value is expected to recover as the bonds approach maturity.

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

11

NOTE 3 – LOANS

Loans at September 30, 2017 and December 31, 2016 were as follows (in thousands):

	September 30,		December 31,
	2017		2016
Real estate:
One to four family	$	171,791	$	177,801
Multi-family		7,310		6,823
Commercial real estate		82,077		83,169
Construction and land		12,685		11,019
		273,863		278,812
Commercial and industrial		36,962		38,747
Consumer
Home equity loans and lines of credit		10,969		10,655
Motor vehicle		10,502		10,624
Other		7,612		7,877
		29,083		29,156
Total		339,908		346,715
Less: Net deferred loan fees		485		445
Allowance for loan losses		3,186		2,349
	$	336,237	$	343,921

On September 12, 2017, the Bank uncovered evidence of suspected fraud involving the origination of fictitious loans by an employee of the Bank. The Bank has informed its fidelity blanket bond insurer of the suspected fraud and engaged an outside firm to perform a forensic audit. To date, the Bank believes it has identified suspected fraudulent loans totaling approximately $1.4 million, but this amount may change based on the results of the ongoing investigation. It is the Company’s conclusion, based on the advice of qualified outside legal counsel, that the bond should provide indemnity for the lost principal of $1.4 million, less a $25,000 deductible, and it is probable that the Bank will recover its loss. The Company recorded a receivable on insurance proceeds in other assets and a net loss of $25,000 in other expenses during the three months ended September 30, 2017.

12

The following tables present the balance in the allowance for loan losses and the recorded investment in loans by portfolio segment based on impairment method as of September 30, 2017 and December 31, 2016. Accrued interest receivable and net deferred loan fees are not considered significant and therefore are not included in the loan balances presented in the table below (in thousands):

September 30, 2017

	Allowance for Loan Losses								Loan Balances
	Individually		Purchased		Collectively				Individually		Purchased		Collectively
	Evaluated for		Credit-Impaired		Evaluated for				Evaluated for		Credit-Impaired		Evaluated for
Loan Segment	Impairment		Loans		Impairment		Total		Impairment		Loans		Impairment		Total
Real estate	$	222	$	-	$	2,388	$	2,610	$	4,862	$	1,664	$	267,337	$	273,863
Commercial and industrial		45		-		320	$	365		68		-		36,894		36,962
Consumer		-		-		211	$	211		32		-		29,051		29,083
Unallocated		-		-		-		-		-		-		-		-
Total	$	267	$	-	$	2,919	$	3,186	$	4,962	$	1,664	$	333,282	$	339,908

December 31, 2016

	Allowance for Loan Losses								Loan Balances
	Individually		Purchased		Collectively				Individually		Purchased		Collectively
	Evaluated for		Credit-Impaired		Evaluated for				Evaluated for		Credit-Impaired		Evaluated for
Loan Segment	Impairment		Loans		Impairment		Total		Impairment		Loans		Impairment		Total
Real estate	$	23	$	-	$	1,923	$	1,946	$	4,844	$	1,871	$	272,097	$	278,812
Commercial and industrial		7		-		211		218		89		-		38,658		38,747
Consumer		-		-		185		185		40		1		29,115		29,156
Unallocated		-		-		-		-		-		-		-		-
Total	$	30	$	-	$	2,319	$	2,349	$	4,973	$	1,872	$	339,870	$	346,715

13

The following table presents information related to impaired loans by class of loans as of September 30, 2017 and December 31, 2016 (in thousands):

	September 30, 2017						December 31, 2016
					Allowance						Allowance
	Unpaid				for Loan		Unpaid				for Loan
	Principal		Recorded		Losses		Principal		Recorded		Losses
	Balance		Investment		Allocated		Balance		Investment		Allocated
With no related allowance recorded:
Real Estate:
One to four family	$	632	$	601	$	-	$	883	$	883	$	-
Multi-family		-		-		-		-		-		-
Commercial real estate		3,504		3,363		-		3,780		3,726		-
Construction and land		184		184		-		193		193		-
Commercial and industrial		23		23		-		270		82		-
Consumer:
Home equity and lines of credit		32		32		-		40		40		-
Motor vehicle		-		-		-		-		-		-
Other		-		-		-		-		-		-
Subtotal	$	4,375	$	4,203	$	-	$	5,166	$	4,924	$	-
With a related allowance recorded:
Real Estate:
One to four family	$	817	$	714	$	222	$	42	$	42	$	23
Multi-family		-		-		-		-		-		-
Commercial real estate		-		-		-		-		-		-
Construction and land		-		-		-		-		-		-
Commercial and industrial		45		45		45		7		7		7
Consumer:
Home equity and lines of credit		-		-		-		-		-		-
Motor vehicle		-		-		-		-		-		-
Other		-		-		-		-		-		-
Subtotal		862		759		267		49		49		30
Total	$	5,237	$	4,962	$	267	$	5,215	$	4,973	$	30

The recorded investment in loans excludes accrued interest receivable and loan origination fees, net, due to immateriality. For purposes of this disclosure, the unpaid balance is not reduced for partial charge-offs.

14

The following tables present the average balance of loans individually evaluated for impairment and interest income recognized on these loans for the three and nine months ended September 30, 2017 and 2016 (in thousands):

	Three months ended September 30, 2017						Three months ended September 30, 2016
	Average		Interest		Cash Basis		Average		Interest		Cash Basis
	Recorded		Income		Interest		Recorded		Income		Interest
	Investment		Recognized		Recognized		Investment		Recognized		Recognized
Real Estate:
One to four family	$	2,345	$	1	$	1	$	698	$	1	$	-
Multi-family		-		-		-		-		-		-
Commercial real estate		3,358		29		29		3,089		32		-
Construction and land		169		2		2		-		-		-
Commercial and industrial		96		1		1		1,001		6		-
Consumer:
Home equity and lines of credit		33		-		-		40		-		-
Motor vehicle		-		-		-		-		-		-
Other		-		-		-		-		-		-
Total	$	6,001	$	33	$	33	$	4,828	$	39	$	-

	Nine months ended September 30, 2017						Nine months ended September 30, 2016
	Average		Interest		Cash Basis		Average		Interest		Cash Basis
	Recorded		Income		Interest		Recorded		Income		Interest
	Investment		Recognized		Recognized		Investment		Recognized		Recognized
Real Estate:
One to four family	$	1,710	$	16	$	16	$	854	$	7	$	-
Multi-family		-		-		-		-		-		-
Commercial real estate		2,991		99		94		1,287		101		-
Construction and land		122		6		5		-		-		-
Commercial and industrial		196		1		1		499		31		-
Consumer:
Home equity and lines of credit		32		-		-		23		1		-
Motor vehicle		-		-		-		-		-		-
Other		-		-		-		-		-		-
Total	$	5,051	$	122	$	116	$	2,663	$	140	$	-

15

The following tables set forth an analysis of our allowance for loan losses for the three and nine months ended September 30, 2017 and 2016 (in thousands):

Three months ended				Commercial
September 30, 2017	Real Estate			and Industrial		Consumer			Unallocated		Total
Allowance for loan losses:
Beginning balance	$	2,244		$	233	$	210		$	-	$	2,687
Provision for loan losses		811			123		13			-		947
Loans charged-off		(449	)		-		(27	)		-		(476	)
Recoveries		4			9		15			-		28
Total ending allowance balance	$	2,610		$	365	$	211		$	-	$	3,186

Nine months ended				Commercial
September 30, 2017	Real Estate			and Industrial			Consumer			Unallocated		Total
Allowance for loan losses:
Beginning balance	$	1,946		$	218		$	185		$	-	$	2,349
Provision for loan losses		1,397			134			115			-		1,646
Loans charged-off		(742	)		(23	)		(137	)		-		(902	)
Recoveries		9			36			48			-		93
Total ending allowance balance	$	2,610		$	365		$	211		$	-	$	3,186

Three months ended				Commercial
September 30, 2016	Real Estate			and Industrial		Consumer			Unallocated		Total
Allowance for loan losses:
Beginning balance	$	1,797		$	126	$	144		$	-	$	2,067
Provision for loan losses		249			58		45			-		352
Loans charged-off		(83	)		-		(51	)		-		(134	)
Recoveries		7			5		20			-		32
Total ending allowance balance	$	1,970		$	189	$	158		$	-	$	2,317

Nine months ended				Commercial
September 30, 2016	Real Estate			and Industrial			Consumer			Unallocated		Total
Allowance for loan losses:
Beginning balance	$	1,676		$	77		$	105		$	-	$	1,858
Provision for loan losses		527			151			134			-		812
Loans charged-off		(250	)		(77	)		(165	)		-		(492	)
Recoveries		17			38			84			-		139
Total ending allowance balance	$	1,970		$	189		$	158		$	-	$	2,317

Nonaccrual loans, and loans past due 90 days still on accrual status, consist of smaller balance homogeneous loans that are collectively evaluated for impairment.

16

The following table presents the recorded investment in nonaccrual and loans past due over 90 days still on accrual status, by class of loans, as of September 30, 2017 and December 31, 2016 (in thousands):

	September 30, 2017				December 31, 2016
			Loans Past Due				Loans Past Due
			Over 90 Days				Over 90 Days
	Nonaccrual		Still Accruing		Nonaccrual		Still Accruing
Real estate:
One to four family	$	2,882	$	-	$	3,428	$	-
Multi-family		-		-		-		-
Commercial real estate		1,337		-		970		-
Construction and land		36		-		41		-
Commercial and industrial		28		-		90		-
Consumer:
Home equity loans and lines of credit		167		-		155		-
Motor vehicle		30		-		-		-
Other		19		-		5		-
Total	$	4,499	$	-	$	4,689	$	-

17

The following tables present the aging of the recorded investment in past due loans as of September 30, 2017 and December 31, 2016 by class of loans. Non-accrual loans of $4.5 million as of September 30, 2017 and $4.7 million at December 31, 2016 are included in the tables below and have been categorized based on their payment status (in thousands):

	30 - 59		60 - 89		Greater than				Purchased
	Days		Days		89 Days		Total		Credit-Impaired		Loans Not
	Past Due		Past Due		Past Due		Past Due		Loans		Past Due		Total
September 30, 2017
Real estate:
One to four family	$	1,286	$	227	$	1,144	$	2,657	$	946	$	168,188	$	171,791
Multi-family		-		-		-		-		-		7,310		7,310
Commercial real estate		535		-		1,019		1,554		718		79,805		82,077
Construction and land		-		-		-		-		-		12,685		12,685
Commercial and industrial		532		20		19		571		-		36,391		36,962
Consumer:
Home equity loans and lines of credit		-		68		99		167		-		10,802		10,969
Motor vehicle		59		-		19		78		-		10,424		10,502
Other		14		3		11		28		-		7,584		7,612
Total	$	2,426	$	318	$	2,311	$	5,055	$	1,664	$	333,189	$	339,908

	30 - 59		60 - 89		Greater than				Purchased
	Days		Days		89 Days		Total		Credit-Impaired		Loans Not
	Past Due		Past Due		Past Due		Past Due		Loans		Past Due		Total
December 31, 2016
Real estate:
One to four family	$	899	$	454	$	1,679	$	3,032	$	1,013	$	173,756	$	177,801
Multi-family		-		-		-		-		-		6,823		6,823
Commercial real estate		101		-		465		566		858		81,745		83,169
Construction and land		41		-		-		41		-		10,978		11,019
Commercial and industrial		1		47		76		124		-		38,623		38,747
Consumer:
Home equity loans and lines of credit		-		1		155		156		-		10,499		10,655
Motor vehicle		40		15		-		55		-		10,569		10,624
Other		2		20		-		22		1		7,854		7,877
Total	$	1,084	$	537	$	2,375	$	3,996	$	1,872	$	340,847	$	346,715

18

Troubled Debt Restructurings:

As of September 30, 2017, the Company had a recorded investment in six TDRs which totaled $3.3 million. There were three TDRs which totaled $3.2 million at December 31, 2016. A less than market rate and extended term was granted as concessions for TDRs. No additional charge-off has been made for the loan relationships. No additional commitments to lend have been made to the borrower. The Company has allocated $20,000 and $0 of specific allowance for the loan relationships at September 30, 2017 and December 31, 2016.

September 30, 2017	TDRs on
(in thousands)	Non-accrual		Other TDRs		Total TDRs
Real Estate:
One to four family	$	143	$	16	$	159
Multi-family		-		-		-
Commercial real estate		942		2,195		3,137
Construction and land		-		-		-
Commercial and industrial		-		-		-
Consumer:
Home equity loans and lines of credit		-		-		-
Motor vehicle		-		-		-
Other		-		-		-
Total	$	1,085	$	2,211	$	3,296

December 31, 2016	TDRs on
(in thousands)	Non-accrual		Other TDRs		Total TDRs
Real Estate:
One to four family	$	-	$	17	$	17
Multi-family		-		-		-
Commercial real estate		166		3,047		3,213
Construction and land		-		-		-
Commercial and industrial		19		-		19
Consumer:
Home equity loans and lines of credit		-		-		-
Motor vehicle		-		-		-
Other		-		-		-
Total	$	185	$	3,064	$	3,249

19

The following table presents TDRs that occurred during the three and nine months ended September 30, 2017 and 2016 (dollars in thousands):

	Three months ended September 30, 2017						Three months ended September 30, 2016
Loan Class	Number of Loans		Pre-Modification Outstanding Recorded Investment		Post-Modification Outstanding Recorded Investment		Number of Loans		Pre-Modification Outstanding Recorded Investment		Post-Modification Outstanding Recorded Investment
Real Estate:
One to four family		-	$	-	$	-		-	$	-	$	-
Multi-family		-		-		-		-		-		-
Commercial real estate		-		-		-		2		3,053		3,053
Construction and land		-		-		-		-		-		-
Commercial and industrial		-		-		-		-		-		-
Consumer:
Home equity loans and lines of credit		-		-		-		-		-		-
Motor vehicle		-		-		-		-		-		-
Other		-		-		-		-		-		-
Total		-	$	-	$	-		2	$	3,053	$	3,053

	Nine months ended September 30, 2017						Nine months ended September 30, 2016
Loan Class	Number of Loans		Pre-Modification Outstanding Recorded Investment		Post-Modification Outstanding Recorded Investment		Number of Loans		Pre-Modification Outstanding Recorded Investment		Post-Modification Outstanding Recorded Investment
Real Estate:
One to four family		2	$	148	$	148		1	$	17	$	17
Multi-family		-		-		-		-		-		-
Commercial real estate		1		117		117		2		3,053		3,053
Construction and land		-		-		-		-		-		-
Commercial and industrial		-		-		-		-		-		-
Consumer:
Home equity loans and lines of credit		-		-		-		-		-		-
Motor vehicle		-		-		-		-		-		-
Other		-		-		-		-		-		-
Total		3	$	265	$	265		3	$	3,070	$	3,070

20

There were 2 TDRs considered to be in default within twelve months of modification as of September 30, 2017. A loan is considered to be in payment default once it is 90 days contractually past due under the modified terms. There were no defaults that occurred during the three months ended September 30, 2017 and 2016. The following table includes defaults that occurred during the nine months ended September 30, 2017 and 2016 which were within twelve months of modification.

	Nine months ended September 30, 2017						Nine months ended September 30, 2016
	TDRs on		Other		Total		TDRs on		Other		Total
(in thousands)	Non-accrual		TDRs		TDRs		Non-accrual		TDRs		TDRs
Real Estate:
One to four family	$	114	$	-	$	114	$	-	$	-	$	-
Multi-family		-		-		-		-		-		-
Commercial real estate		833		-		833		-		-		-
Construction and land		-		-		-		-		-		-
Commercial and industrial		-		-		-		-		-		-
Consumer:
Home equity loans and lines of credit		-		-		-		-		-		-
Motor vehicle		-		-		-		-		-		-
Other		-		-		-		-		-		-
Total	$	947	$	-	$	947	$	-	$	-	$	-

21

CREDIT QUALITY INDICATORS:

The Company categorizes loans into risk categories based on relevant information about the ability of borrowers to service their debt such as: current financial information, historical payment experience, credit documentation, public information, and current economic trends, among other factors. The Company analyzes loans individually by classifying the loans as to credit risk. This analysis includes all non-homogeneous loans, such as commercial and commercial real estate loans. The analysis for residential real estate and consumer loans primarily includes review of past due status. This analysis is performed on a quarterly basis. The Company uses the following definitions for risk ratings:

Special Mention. Loans classified as special mention have a potential weakness that deserves management’s close attention. If left uncorrected, these potential weaknesses may result in deterioration of the repayment prospects for the loan or of the institution’s credit position at some future date.

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

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

Loss. Loans classified as loss are considered uncollectable and of such little value that continuing to carry them as an asset is not feasible.  Loans will be classified as a loss when it is not practical or desirable to defer writing off or reserving all or a portion of a basically worthless asset, even though partial recovery may be possible at some time in the future.

Loans not meeting the criteria above that are analyzed individually as part of the above described process are considered to be pass rated loans.

Based on the most recent analysis performed, the risk category of loans by class of loans is as follows (in thousands):

			Special
September 30, 2017	Pass		Mention		Substandard		Doubtful		Loss		Total
One to four family	$	164,772	$	1,409	$	5,610	$	-	$	-	$	171,791
Multi-family		7,310		-		-		-		-		7,310
Commercial real estate		74,466		2,484		5,127		-		-		82,077
Construction and land		12,501		-		184		-		-		12,685
Commercial and industrial		30,665		420		5,837		40		-		36,962
Home equity loans and lines of credit		10,708		-		261		-		-		10,969
Motor vehicle		10,391		22		89		-		-		10,502
Other		7,603		1		8		-		-		7,612
Total	$	318,416	$	4,336	$	17,116	$	40	$	-	$	339,908

			Special
December 31, 2016	Pass		Mention		Substandard		Doubtful		Loss		Total
One to four family	$	171,109	$	2,167	$	4,525	$	-	$	-	$	177,801
Multi-family		6,823		-		-		-		-		6,823
Commercial real estate		74,267		4,048		4,854		-		-		83,169
Construction and land		10,826		-		193		-		-		11,019
Commercial and industrial		36,172		1,802		773		-		-		38,747
Home equity loans and lines of credit		10,478		6		171		-		-		10,655
Motor vehicle		10,594		2		28		-		-		10,624
Other		7,872		-		5		-		-		7,877
Total	$	328,141	$	8,025	$	10,549	$	-	$	-	$	346,715

There were $1.7 million and $1.9 million purchased credit impaired (“PCI”) loans included in substandard loans at September 30, 2017 and December 31, 2016, respectively.

22

The Company holds purchased loans without evidence of credit quality deterioration. In addition, the Company holds purchased loans for which there was, at their acquisition date, evidence of deterioration of credit quality since their origination and it was probable that all contractually required payments would not be collected. A summary of non-impaired purchased loans and credit-impaired purchased loans with the carrying amount of those loans is as follows at September 30, 2017 and December 31, 2016 (in thousands):

	Non-impaired		Credit-impaired
	Purchased		Purchased
Purchased Loans as of September 30, 2017	Loans		Loans
Real estate:
One to four family	$	26,803	$	946
Multi-family		2,011		-
Commercial real estate		16,035		718
Construction and land		521		-
Commercial and industrial		1,733		-
Consumer loans:
Home equity loans and lines of credit		1,091		-
Motor vehicle		62		-
Other		556		-
Total loans	$	48,812	$	1,664

	Non-impaired		Credit-impaired
	Purchased		Purchased
Purchased Loans as of December 31, 2016	Loans		Loans
Real estate:
One to four family	$	30,449	$	1,013
Multi-family		2,115		-
Commercial real estate		19,278		858
Construction and land		652		-
Commercial and industrial		2,783		-
Consumer loans:
Home equity loans and lines of credit		1,433		-
Motor vehicle		202		-
Other		706		1
Total loans	$	57,618	$	1,872

For the purchased loans disclosed above, the Company did not increase the allowance for loan losses for the three and nine months ended September 30, 2017 and 2016.

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The following table presents the composition of the acquired loans at September 30, 2017:

As of September 30, 2017

	Contractual		Remaining			Carrying
(in thousands)	Amount		Discount			Amount
Real estate:
One to four family	$	28,144	$	(395	)	$	27,749
Multi-family		2,017		(6	)		2,011
Commercial real estate		16,960		(207	)		16,753
Construction and land		523		(2	)		521
Commercial and industrial		1,738		(5	)		1,733
Consumer loans:
Home equity loans and lines of credit		1,096		(5	)		1,091
Motor vehicle		62		-			62
Other		558		(2	)		556
Total loans	$	51,098	$	(622	)	$	50,476

The following tables presents the purchased loans that are included within the scope of ASC Topic 310-30,Loans and Debt Securities Acquired with Deteriorated Credit Quality, as of September 30, 2017 and December 31, 2016.

(in thousands)	September 30, 2017		December 31, 2016
Carrying amount	$	1,664	$	1,872
Non-accretable difference		258		272
Accretable yield		113		146
Contractually-required principal and interest payments	$	2,035	$	2,290

The Company adjusted interest income to recognize $9,000 and $33,000 for the three and nine months ended September 30, 2017 of accretable yield on credit-impaired purchased loans. The Company adjusted interest income to recognize $42,000 and $128,000 for the three and nine months ended September 30, 2016 of accretable yield on credit-impaired purchased loans.

Accretable yield, or income expected to be collected, is as follows for the nine months ended September 30, 2017 and 2016 (in thousands):

	2017			2016
Balance at January 1	$	146		$	292
New Loans Purchased		-			-
Accretion of income		(33	)		(128	)
Reclassifications from nonaccretable difference		-			-
Disposals		-			-
Balance at September 30	$	113		$	164

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NOTE 4 – FEDERAL HOME LOAN BANK ADVANCES AND OTHER BORROWINGS

Advances from the FHLB at September 30, 2017 and December 31, 2016 were as follows (dollars in thousands):

	September 30, 2017		December 31, 2016
Maturities December 2017 through January 2029, fixed rate at rates from 1.22% to 4.27%, weighted average rate of 1.69% at September 30, 2017 and 1.80% at December 31, 2016	$	10,805	$	9,332

Payments contractually required over the next five years are as follows as of September 30, 2017 (in thousands):

September 30,
2018	$	9,685
2019		632
2020		93
2021		79
2022		67
Thereafter		249
Total	$	10,805

Other borrowings at September 30, 2017 were $1.5 million. There were no other borrowings at December 31, 2016. On June 16, 2016, Poage Bankshares, Inc. executed a $2.0 million commercial line of credit secured with Town Square Bank common stock, with an unaffiliated lender. The initial variable rate on the line of credit was 4.0% with an interest rate equal to the Wall Street Prime plus 0.50%. On June 20, 2017, the Company borrowed $1.5 million for general working capital purposes and stock repurchases. At September 30, 2017, the interest rate on the line of credit was 4.75%. The line of credit matures June 16, 2018.

NOTE 5 – FAIR VALUE

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

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

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

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

The Company used the following methods and significant assumptions to estimate fair value:

Securities: The fair values for securities are determined by quoted market prices, if available (Level 1). If quoted market prices are not available, fair values are based on quoted market prices of similar securities (Level 2). This includes the use of “matrix pricing” used to value debt securities absent the exclusive use of quoted prices. For securities where quoted prices or market prices of similar securities are not available, fair values are calculated using discounted cash flows (Level 3).

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Impaired Loans: The fair value of impaired loans with specific allocations of the allowance for loan losses is generally based on recent real estate appraisals. Adjustments are routinely made in the appraisal process by the independent appraisers to adjust for differences between the comparable sales and income data available for similar loans and collateral underlying such loans. Non-real estate collateral may be valued using an appraisal, net book value per the borrower’s financial statements, or aging reports, adjusted or discounted based on management’s historical knowledge, changes in market conditions from the time of the valuation, and management’s expertise and knowledge of the client and client’s business, resulting in a Level 3 fair value classification. Impaired loans are evaluated on a quarterly basis for additional impairment and adjusted in accordance with the allowance policy.

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

Assets and liabilities measured at fair value on a recurring basis, at September 30, 2017 and December 31, 2016, are as follows (in thousands):

	Fair Value Measurements at
	September 30, 2017 Using:
			Quoted Prices in		Significant		Significant
			Active Markets for		Other Observable		Unobservable
	Carrying		Identical Assets		Inputs		Inputs
	Value		(Level 1)		(Level 2)		(Level 3)
Financial Assets
Securities:
States and political subdivisions	$	19,531	$	-	$	19,531	$	-
U.S. Government agencies and sponsored entities		3,445		-		3,445		-
Mortgage backed securities: residential		26,857		-		26,857		-
Collateralized mortgage obligations		5,435		-		5,435		-
SBA loan pools		9,392		-		9,392		-
Total securities	$	64,660	$	-	$	64,660	$	-

	Fair Value Measurements at
	December 31, 2016 Using:
			Quoted Prices in		Significant		Significant
			Active Markets for		Other Observable		Unobservable
	Carrying		Identical Assets		Inputs		Inputs
	Value		(Level 1)		(Level 2)		(Level 3)
Financial Assets
Securities:
States and political subdivisions	$	19,892	$	-	$	19,892	$	-
U.S. Government agencies and sponsored entities		3,463		-		3,463		-
Mortgage backed securities: residential		22,155		-		22,155		-
Collateralized mortgage obligations		5,406		-		5,406		-
SBA loan pools		7,345		-		7,345		-
Total securities	$	58,261	$	-	$	58,261	$	-

There were no transfers between Level 1 and Level 2 during the nine months ended September 30, 2017.

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Assets measured at fair value on a non-recurring basis at September 30, 2017 and December 31, 2016 are summarized below (in thousands):

	Fair Value Measurements at
	September 30, 2017 Using:
			Quoted Prices in		Significant		Significant
			Active Markets for		Other Observable		Unobservable
	Carrying		Identical Assets		Inputs		Inputs
	Value		(Level 1)		(Level 2)		(Level 3)
Impaired loans
Residential real estate, net	$	509	$	-	$	-	$	509
Other real estate owned
Residential real estate, net	$	214	$	-	$	-	$	214
Commercial real estate, net		46		-		-		46

	Fair Value Measurements at
	December 31, 2016 Using:
			Quoted Prices in		Significant		Significant
			Active Markets for		Other Observable		Unobservable
	Carrying		Identical Assets		Inputs		Inputs
	Value		(Level 1)		(Level 2)		(Level 3)
Impaired loans
Residential real estate, net	$	613	$	-	$	-	$	613
Commercial real estate, net		250		-		-		250
Commercial and industrial, net		58		-		-		58
Other real estate owned
Residential real estate, net	$	268	$	-	$	-	$	268
Commercial real estate, net		8		-		-		8

Commercial and residential real estate properties classified as OREO are measured at fair value, less estimated costs to sell. Fair values are based on recent real estate appraisals. These appraisals may use a single valuation approach or a combination of approaches including comparable sales and the income approach. Adjustments are routinely made in the appraisal process by the independent appraisers to adjust for differences between the comparable sales and income data available. Such adjustments are usually significant and typically result in a Level 3 classification of the inputs for determining fair value. Appraisals for real estate properties classified as other real estate owned are performed by certified general appraisers (for commercial properties) or certified residential appraisers (for residential properties) whose qualifications and licenses have been reviewed and verified by the Bank’s management. The appraisal values are discounted to allow for estimated selling expenses and fees, and the discounts range from 5% to 10%.

At September 30, 2017, impaired loans recorded at fair value had a net carrying amount of $509,000 equal to the outstanding balance of $776,000, net of a valuation allowance of $267,000. At December 31, 2016, impaired loans recorded at fair value had a net carrying amount of $921,000 equal to the outstanding balance of $951,000, net of a valuation allowance of $30,000. There were charge-offs of $353,000 and $391,000 for the three and nine months ended September 30, 2017, and $0 and $31,000 for the three and nine months ended September 30, 2016. There Company recorded provisions of $294,000 and $488,000 for the three and nine months ended September 30, 2017, and $10,000 and $80,000 for the three and nine months ended September 30, 2016.

At September 30, 2017, OREO recorded at fair value had a net carrying amount of $260,000 equal to the outstanding balance of $362,000, net of a valuation allowance of $102,000. There were $42,000 in write-downs for the three months ended September 30, 2017 and $100,000 in write-downs for the nine months ended September 30, 2017. There were $34,000 in write-downs for the three months ended September 30, 2016 and $48,000 in write-downs for the nine months ended September 30, 2016. At December 31, 2016, other real estate owned recorded at fair value had a net carrying amount of $276,000, equal to the outstanding balance of $390,000, net of a valuation allowance of $114,000.

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The carrying amounts and estimated fair values of financial instruments at September 30, 2017 and December 31, 2016 are as follows (in thousands):

			Fair Value Measurements
	Carrying
September 30, 2017	Value		Level 1		Level 2		Level 3		Total
Financial assets
Cash and cash equivalents	$	25,822	$	25,822	$	-	$	-	$	25,822
Interest-bearing deposits		2,490		-		2,502		-		2,502
Securities		64,660		-		64,660		-		64,660
Restricted stock		3,276		N/A		N/A		N/A		N/A
Loans, net		336,237		-		-		340,373		340,373
Accrued interest receivable		1,307		-		333		974		1,307
Financial liabilities
Deposits	$	374,913	$	209,701	$	165,031	$	-	$	374,732
Other borrowings		1,500		-		1,500		-		1,500
Federal Home Loan Bank advances		10,805		-		10,810		-		10,810
Subordinated debenture		2,873		-		2,403		-		2,403
Accrued interest payable		80		-		80		-		80

			Fair Value Measurements
	Carrying
December 31, 2016	Value		Level 1		Level 2		Level 3		Total
Financial assets
Cash and cash equivalents	$	24,389	$	24,389	$	-	$	-	$	24,389
Interest bearing deposits		1,992		-		1,992		-		1,992
Securities		58,261		-		58,261		-		58,261
Restricted stock		3,276		N/A		N/A		N/A		N/A
Loans held for sale		611		-		611		-		611
Loans, net		343,921		-		-		341,288		341,288
Accrued interest receivable		1,397		-		300		1,097		1,397
Financial liabilities
Deposits	$	374,708	$	164,914	$	179,266	$	-	$	344,180
Federal Home Loan Bank advances		9,332		5,004		4,454		-		9,458
Subordinated debenture		2,825		-		2,825		-		2,825
Accrued interest payable		52		-		52		-		52

The methods and assumptions, not previously presented, used to estimate fair values are described as follows:

Cash and Cash Equivalents:

The carrying amounts of cash and short-term instruments approximate fair values and are classified as Level 1.

Restricted Stock:

It is not practical to determine the fair value of FHLB and Bankers Bank of Kentucky stock due to restrictions placed on their transferability.

Loans:

Fair values of loans, excluding loans held for sale, are estimated as follows: For variable rate loans that reprice frequently and with no significant change in credit risk, fair values are based on carrying values resulting in a Level 3 classification. Fair values for other loans are estimated using discounted cash flow analyses, using interest rates currently being offered for loans with similar terms to borrowers of similar credit quality resulting in a Level 3 classification. The methods utilized to estimate the fair value of loans do not necessarily represent an exit price.

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The fair value of loans held for sale is estimated based upon binding contracts and quotes from third party investors resulting in a Level 2 classification.

Deposits:

The fair values disclosed for demand deposits (e.g., interest and non-interest checking, passbook savings, and certain types of money market accounts) are by definition equal to the amount payable on demand at the reporting date (i.e., their carrying amount) resulting in a Level 1 classification. The carrying amounts of variable rate, fixed-term money market accounts and certificates of deposit approximate their fair values at the reporting date resulting in a Level 1 classification. Fair values for fixed rate certificates of deposit are estimated using a discounted cash flows calculation that applies interest rates currently being offered on certificates to a schedule of aggregated expected monthly maturities on time deposits resulting in a Level 2 classification.

Other borrowings, Federal Home Loan Bank advances and Subordinate debenture:

The fair values of the Company’s long-term borrowings are estimated using discounted cash flow analyses based on the current borrowing rates for similar types of borrowing arrangements resulting in a Level 2 classification.

Accrued Interest Receivable/Payable:

The carrying amounts of accrued interest approximate fair value and are classified by level consistent with the level of the related assets or liabilities.

NOTE 6 – ESOP

Employees participate in an Employee Stock Ownership Plan (“ESOP”). The ESOP borrowed from the Company to purchase 269,790 shares of the Company’s common stock at $10 per share. The Company makes discretionary contributions to the ESOP, and pays dividends on unallocated shares to the ESOP, and the ESOP uses funds it receives to repay the loan. When loan payments are made, ESOP shares are allocated to participants based on relative compensation and expense is recorded. Dividends on allocated shares increase participant accounts. Participants receive the shares at the end of employment.

There were no contributions to the ESOP for the three and nine months ended September 30, 2017 and 2016.

Shares held by the ESOP at September 30, 2017 and December 31, 2016 were as follows (dollars in thousands):

	September 30,		December 31,
	2017		2016
Allocated to participants		64,148		54,165
Committed to be released		10,152		13,501
Unearned		188,806		198,958
Total ESOP shares		263,106		266,624
Fair value of unearned shares	$	3,417	$	3,740

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NOTE 7 – EARNINGS PER SHARE

The factors used in the earnings per share computation for the three and nine months ended September 30, 2017 and 2016, were as follows (dollar amounts in thousands, except per share data):

	Three months ended					Nine months ended
	September 30,					September 30,
	2017			2016		2017		2016
Basic
Net income (loss)	$	(18	)	$	364	$	812	$	1,551
Less: Earnings (loss) allocated to participating securities		-			3		5		16
Net income (loss) available to common shareholders	$	(18	)	$	361		807		1,535
Weighted average common shares outstanding		3,522,121			3,764,946		3,627,092		3,808,622
Less: Average unallocated ESOP shares		191,037			204,571		194,388		207,922
Average participating shares		15,357			31,098		21,170		39,139
Average shares		3,315,727			3,529,277		3,411,534		3,561,561
Basic earnings (loss) per common share	$	(0.01	)	$	0.10	$	0.23	$	0.43
Diluted
Net income (loss) available to common shareholders	$	(18	)	$	361	$	807	$	1,535
Weighted average common shares outstanding for basic earnings per common share		3,315,727			3,529,277		3,411,534		3,561,561
Add: Dilutive effects of assumed exercises of stock options		-			31,012		29,765		20,744
Average shares and dilutive potential common shares		3,315,727			3,560,289		3,441,299		3,582,305
Diluted earnings (loss) per common share	$	(0.01	)	$	0.10	$	0.23	$	0.43

All stock were considered anti-dilutive for the three months ended September 30, 2017. There were no stock options considered antidilutive for the nine months ended September 30, 2017 and the three and nine months ended September 30, 2016.

NOTE 8 – STOCK BASED COMPENSATION

On January 8, 2013, the shareholders of Poage Bankshares, Inc. approved the Poage Bankshares, Inc. 2013 Equity Incentive Plan (the “Plan”) for employees and directors of the Company. The Plan authorizes the issuance of up to 472,132 shares of the Company’s common stock, with no more than 134,895 of shares as restricted stock awards and 337,237 as stock options, either incentive stock options or non-qualified stock options. The exercise price of options granted under the Plan may not be less than the fair market value on the date the stock option is granted. The compensation committee of the board of directors has sole discretion to determine the amount and to whom equity incentive awards are granted.

On April 16, 2013, the compensation committee of the board of directors approved the issuance of 134,895 shares of restricted stock to its directors and officers. In addition, on May 10, 2013, the compensation committee of the board of directors approved the issuance of 300,000 stock options to its directors and officers. An additional 20,000 stock option shares were issued on March 19, 2014 as a result of the acquisition of Town Square Financial Corporation by Poage Bankshares, Inc. An additional 5,000 stock option shares were issued on May 31, 2015 to employees. All stock options and restricted stock awards vest ratably over five years. Stock options expire ten years after issuance. Apart from the vesting schedule for both stock options and restricted stock, there are no performance-based conditions or any other material conditions applicable to the awards issued.

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The following table summarizes stock option activity for the nine months ended September 30, 2017:

				Weighted Average
	Options			Exercise Price
Outstanding -December 31, 2016		179,900		$	14.92
Granted		-			-
Exercised and settled		(37,050	)		14.99
Forfeited		-			-
Outstanding -September 30, 2017		142,850		$	14.90
Fully vested and exercisable at September 30, 2017		100,600
Fully vested and exercisable at December 31, 2016		101,400
Expected to vest in future periods		42,250

Stock options are assumed to be earned ratably over their respective vesting periods and charged to compensation expense based upon their grant date fair value and the number of options assumed to be earned. At September 30, 2017, 142,850 options were outstanding and 100,600 options were fully vested and exercisable with intrinsic value of $457,000 and $322,000, respectively. At December 31, 2016, 179,900 options were outstanding and 101,400 options were fully vested and exercisable with intrinsic value of $698,000 and $393,000, respectively.

During the nine months ended September 30, 2017, 36,250 options vested. Stock-based compensation expense for stock options included in salaries and benefits for the three and nine months ended September 30, 2017 and 2016 was $18,000, $54,000, $18,000 and $68,000, respectively. Total unrecognized compensation cost related to non-vested stock options was $58,000 at September 30, 2017 and $112,000 at December 31, 2016 and is expected to be recognized over a period of 2.6 years. During the nine months ended September 30, 2017, the aggregate intrinsic value of the options exercised under the plan was $164,000 determined as of the date of the option exercise.

The following table summarizes non-vested restricted stock activity for the nine months ended September 30, 2017:

Balance -December 31, 2016	30,471
Granted	-
Forfeited	-
Vested	(15,114	)
Balance -September 30, 2017	15,357

The fair value of the restricted stock awards is amortized to compensation expense over the vesting period (generally five years) and is based on the market price of the Company’s common stock at the date of the grant multiplied by the number of shares granted that are expected to vest. Stock-based compensation expense for the restricted stock included in salaries and benefits for the three and nine months ended September 30, 2017 and 2016 was $58,000, $173,000, $55,000 and $233,000, respectively. Unrecognized compensation expense for non-vested restricted stock awards was $126,000 at September 30, 2017 and $299,000 at December 31, 2016 and is expected to be recognized over a weighted-average period of 1.1 years.

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NOTE 9 – ACCUMULATED OTHER COMPREHENSIVE INCOME

The following table is changes in Accumulated Other Comprehensive Income by component, net of tax, for the three and nine months ended September 30, 2017 and 2016 (in thousands):

	Unrealized Gains and Losses on Available-for-Sale Securities
	Three months ended						Nine months ended
	September 30,						September 30,
	2017			2016			2017			2016
Beginning balance	$	316		$	913		$	(153	)	$	384
Other comprehensive income (loss), net of tax before reclassification		(68	)		(89	)		401			438
Amounts reclassified from accumulated other comprehensive income for loss on call of securities, net of tax expense of $0, $0, $0 and $1 respectively		-			-			-			2
Net current period other comprehensive income (loss)		(68	)		(89	)		401			440
Ending Balance	$	248		$	824		$	248		$	824

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

Critical Accounting Policies

There are no material changes to the critical accounting policies disclosed in the Annual Report on Form 10-K for Poage Bankshares, Inc. for the year ended December 31, 2016, as filed with the Securities and Exchange Commission.

Forward-Looking Statements

This Quarterly Report contains forward-looking statements, which can be identified by the use of such words as “estimate,” “project,” “believe,” “intend,” “anticipate,” “plan,” “seek,” “expect,” “will,” “may,” and similar expressions. These forward-looking statements include, but are not limited to:

> statements of our goals, intentions and expectations;

> statements regarding our business plans and prospects and growth and operating strategies;

> statements regarding the credit quality of our loan and investment portfolios;

> estimates of our risks and future costs and benefits;

> non-historical statements about our financial condition, results of operations and business.

These forward-looking statements are based on our current beliefs and expectations and are inherently subject to significant business, economic, and competitive uncertainties and contingencies, many of which are beyond our control. In addition, these forward-looking statements are subject to assumptions with respect to future business strategies and decisions that are subject to change. Except as may be required by law, we do not take any obligation to update any forward-looking statements after the date of this Quarterly Report on Form 10-Q. You should not place undue reliance on such forward-looking statements.

The following factors, among others, could cause the actual results to differ materially from the anticipated results or other expectations expressed in the forward-looking statements:

> our ability to manage our operations under the current adverse economic conditions (including real estate values, loan demand, inflation, commodity prices and unemployment levels) nationally and in our market area;

> adverse changes in the financial industry, securities, credit and national local real estate markets (including real estate values);

> significant increases in our loan losses, including as a result of our inability to resolve classified assets, and management’s assumptions in determining the adequacy of the allowance for loan losses;

> credit risks of lending activities, including changes in the level and trend of loan delinquencies and write-offs and in our allowance for loan losses and provision for loan losses;

> our ability to successfully enhance and maintain internal controls;

> competition among depository and other financial institutions;

> our success in increasing our commercial business and commercial real estate loans;

> our ability to improve our asset quality even as we increase our commercial business, commercial real estate and multi-family lending;

> our success in introducing new financial products;

> our ability to attract and maintain deposits;

33

> decreases in our asset quality;

> changes in interest rates generally, including changes in the relative differences between short term and long term interest rates and in deposit interest rates, that may affect our net interest margin and funding sources;

> fluctuations in the demand for loans, which may be affected by the number of unsold homes, land and other properties in our market areas and by declines in the value of real estate in our market area;

> changes in consumer spending, borrowing and savings habits;

> declines in the yield on our assets resulting from the current low interest rate environment;

> risks related to a high concentration of loans secured by real estate located in our market area;

> the results of examinations by our regulators, including the possibility that our regulators may, among other things, require us to increase our reserve for loan losses, write down assets, change our regulatory capital position, limit our ability to borrow funds or maintain or increase deposits, or prohibit us from paying dividends, which could adversely affect our dividends and earnings;

> changes in laws or government regulations or policies affecting financial institutions, including the Dodd-Frank Act, which could result in, among other things, increased deposit insurance premiums and assessments, capital requirements (particularly the new capital regulations), regulatory fees and compliance costs and the resources we have available to address such changes;

> changes in the level of government support of housing finance;

> our ability to enter new markets successfully and capitalize on growth opportunities

> changes in accounting policies and practices, as may be adopted by the bank regulatory agencies, the Financial Accounting Standards Board, the Securities and Exchange Commission and the Public Company Accounting Oversight Board;

> changes in our organization, compensation and benefit plans and our ability to retain key members of our senior management team;

> loan delinquencies and changes in the underlying cash flows of our borrowers;

> the failure or security breaches of computer systems on which we depend;

> the ability of key third-party providers to perform their obligations to us; and

> changes in the financial condition or future prospects of issuers of securities that we own.

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Comparison of Financial Condition at September 30, 2017 and December 31, 2016

Total assets at September 30, 2017 increased $1.7 million, or 0.4%, to $460.2 million from $458.5 million at December 31, 2016. The increase was attributed to an increase of $1.5 million in other borrowings.

Cash and Cash equivalents increased by $1.4 million, or 5.9%, to $25.8 million at September 30, 2017 from $24.4 million at December 31, 2016. The increase in cash was primarily attributable to an increase in other borrowings.

Interest-bearing deposits in other financial institutions increased $498,000, or 25.0%, to $2.5 million at September 30, 2017 from $2.0 million at December 31, 2016 due to the purchase of a certificate of deposit.

Securities available for sale increased by $6.4 million, or 11.0%, to $64.7 million at September 30, 2017 from $58.3 million at December 31, 2016. This increase is primarily due to $11.8 million in purchases and an increase of $608,000 in unrealized gain on securities held for sale, offset by maturities, calls and principal payments of $5.9 million.

Loans held for sale decreased $611,000, or 100.0%, to $0 at September 30, 2017 from $611,000 at December 31, 2016 due to a decrease in secondary market mortgage lending activity.

Loans, net, decreased $7.7 million, or 2.2%, to $336.2 million at September 30, 2017 from $343.9 million at December 31, 2016. The decrease was primarily attributable to a decrease in one to four family, commercial real estate and commercial and industrial loans, offset by an increase in construction and land loans. Non-performing loans decreased $200,000, or 4.1%, to $4.5 million at September 30, 2017 from $4.7 million at December 31, 2016.

Deposits increased $205,000 or 0.1%, to $374.9 million at September 30, 2017 from $374.7 million at December 31, 2016. The increase was attributable to an increase of $3.5 million in savings accounts and money market accounts, offset by a decrease of $3.3 million in certificates of deposits.

Federal Home Loan Bank advances increased $1.5 million, or 15.8%, to $10.8 million at September 30, 2017 from $9.3 million at December 31, 2016.

Other borrowings increased by $1.5 million, or 100%, to $1.5 million at September 30, 2017 from $0 at December 31, 2016 for general working capital purposes. On September 16, 2016, Poage Bankshares, Inc. executed a $2.0 million commercial line of credit secured with Town Square Bank common stock, with an unaffiliated lender. On September 30, 2017, the interest rate on the line of credit was 4.50%.

Subordinated debenture increased by $48,000, or 1.7%, to $2.9 million at September 30, 2017 from $2.7 million at December 31, 2016 due to the amortization of the fair value related to the subordinated debenture assumed in conjunction with acquisition of Town Square Financial Corporation. In December 2006, Town Square Statutory Trust I, a trust formed by Town Square Financial Corporation, closed a pooled private offering of 4,124 trust preferred securities with a liquidation amount of $1,000 per security. The subordinated debt of $2.9 million is shown as a liability because the Company is not considered the primary beneficiary of the Trust. The investment in common stock of the trust is $124,000 and is included in other assets. The subordinated debt has a variable rate of interest equal to the three month London Interbank Offered Rate (LIBOR) plus 1.83%, which was 3.15% at September 30, 2017.

Total shareholders’ equity decreased by $2.7 million, or 3.9%, to $66.0 million at September 30, 2017 from $68.7 million at December 31, 2016. The decrease resulted from the repurchase of common stock totaling $3.6 million and the payment of cash dividends totaling $654,000, offset by net income of $812,000, an increase in accumulated other comprehensive income of $401,000 and an increase in additional paid-in capital of $423,000 related to the stock based compensation plans.

35

Average Balances and Yields

The following table sets forth average balances, average yields and costs, and certain other information at the dates and for the periods indicated. All average balances are daily average balances. Non-accrual loans are included in the computation of average balances, but have been reflected in the tables as loans carrying a zero yield. The yields set forth below include the effect of deferred fees, discounts and premiums that are amortized or accreted to interest income. Interest income and rates exclude the effects of a tax equivalent adjustment to adjust tax exempt investment income on tax exempt investment securities to a fully taxable basis due to immateriality (dollars in thousands).

	For the Three Months Ended September 30,
	2017							2016
	Average		Interest and					Average		Interest and
	Balance		Dividends		Yield/ Cost			Balance		Dividends		Yield/ Cost
Assets:
Interest earning assets:					��
Loans	$	339,956	$	4,297		5.01	%	$	344,546	$	4,455		5.14	%
Investment securities		63,809		371		2.31	%		59,414		322		2.16	%
Restricted Stock		3,276		40		4.84	%		3,276		30		3.64	%
Other interest earning assets		27,280		73		1.06	%		13,164		19		0.57	%
Total interest earning assets		434,321		4,781		4.37	%		420,400		4,826		4.57	%
Non-interest earning assets		25,096							27,437
Total assets		459,417							447,837
Liabilities and equity:
Interest bearing liabilities:
Interest bearing deposits:
NOW, savings, money market, and other		155,047		114		0.29	%		140,453		62		0.18	%
Certificates of deposit		165,065		515		1.24	%		161,467		439		1.08	%
Total interest bearing deposits		320,112		629		0.78	%		301,920		501		0.66	%
FHLB advances		10,932		47		1.71	%		19,559		58		1.18	%
Subordinated debenture		2,865		49		6.79	%		2,800		43		6.11	%
Other borrowings		1,500		18		4.76	%		-		-		-
Total borrowings		15,297		114		2.96	%		22,359		101		1.80	%
Total interest bearing liabilities		335,409		743		0.88	%		324,279		602		0.74	%
Non-interest bearing liabilities:
Non-interest bearing deposits		53,710							48,860
Accrued interest payable		148							163
Other liabilities		3,688							3,572
Total non-interest bearing liabilities		57,546							52,595
Total liabilities		392,955							376,874
Total equity		66,462							70,963
Total liabilities and equity		459,417							447,837
Net interest income				4,038							4,224
Interest rate spread						3.49	%						3.83	%
Net interest margin						3.69	%						4.00	%
Average interest-earning assets to average interest-bearing liabilities						129.49	%						129.64	%

36

	For the Nine Months Ended September 30,
	2017							2016
	Average		Interest and					Average		Interest and
	Balance		Dividends		Yield/ Cost			Balance		Dividends		Yield/ Cost
Assets:
Interest earning assets:
Loans	$	340,625	$	12,877		5.05	%	$	333,755	$	13,134		5.26	%
Investment securities		61,414		1,074		2.34	%		62,622		1,039		2.22	%
Restricted Stock		3,276		110		4.49	%		3,276		91		3.71	%
Other interest earning assets		27,773		192		0.92	%		13,339		58		0.58	%
Total interest earning assets		433,088		14,253		4.40	%		412,992		14,322		4.63	%
Non-interest earning assets		25,480							27,462
Total assets		458,568							440,454
Liabilities and equity:
Interest bearing liabilities:
Interest bearing deposits:
NOW, savings, money market, and other		151,661		308		0.27	%		138,145		184		0.18	%
Certificates of deposit		169,648		1,500		1.18	%		160,470		1,275		1.06	%
Total interest bearing deposits		321,309		1,808		0.75	%		298,615		1,459		0.65	%
FHLB advances		9,430		122		1.73	%		16,493		167		1.35	%
Subordinated debenture		2,849		141		6.62	%		2,785		125		6.00	%
Other borrowings		566		20		4.72	%		-		-		-
Total borrowings		12,845		283		2.95	%		19,278		292		2.02	%
Total interest bearing liabilities		334,154		2,091		0.84	%		317,893		1,751		0.74	%
Non-interest bearing liabilities:
Non-interest bearing deposits		52,784							48,414
Accrued interest payable		137							143
Other liabilities		3,319							2,929
Total non-interest bearing liabilities		56,240							51,486
Total liabilities		390,394							369,379
Total equity		68,174							71,075
Total liabilities and equity		458,568							440,454
Net interest income				12,162							12,571
Interest rate spread						3.56	%						3.89	%
Net interest margin						3.75	%						4.07	%
Average interest-earning assets to average interest-bearing liabilities						129.61	%						129.92	%

37

Liquidity and Capital Resources

Our primary sources of funds are deposits and the proceeds from principal and interest payments on loans and investment securities. We also utilize Federal Home Loan Bank advances. While maturities and scheduled amortization of loans and securities are predicable sources of funds, deposit flows and mortgage prepayments are greatly influenced by general interest rates, economic conditions and competition. We generally manage the pricing of our deposits to be competitive within our market and to increase core deposit relationships.

Liquidity management is both a daily and long-term responsibility of management. We adjust our investments in liquid assets based upon management’s assessment of (i) expected loan demand, (ii) expected deposit flows, (iii) yields available on interest-earning deposits and investment securities, and (iv) the objectives of our asset/liability management program. Excess liquid assets are invested generally in interest-earning overnight deposits, federal funds sold, and short and intermediate-term investment securities. If we require funds beyond our ability to generate them internally we have additional borrowing capacity with the Federal Home Loan Bank of Cincinnati. At September 30, 2017, we had $10.8 million in advances from the Federal Home Loan Bank of Cincinnati and an additional borrowing capacity of $92.3 million.

Poage Bankshares, Inc. is a separate legal entity from Town Square Bank and must provide its own liquidity to pay dividends, repurchase stock and to fund other general corporate activities. Poage Bankshares, Inc.’s primary source of liquidity is dividend payments from Town Square Bank. The ability of Town Square Bank to pay dividends is subject to regulatory requirements. At September 30, 2017, Poage Bankshares, Inc. (on an unconsolidated basis) had liquid assets of $300,000.

On June 16, 2016, Poage Bankshares, Inc. executed a $2.0 million commercial line of credit secured with Town Square Bank common stock, with an unaffiliated lender. The variable interest rate on the line of credit is 4.50% with an interest rate equal to the Wall Street Prime plus 0.50% adjusting monthly. The line of credit matures June 16, 2018. The line of credit will be used for general working capital purposes. At September 30, 2017, we had $500,000 available on the line of credit.

Federal regulations require FDIC-insured depository institutions to meet several minimum capital standards: a common equity Tier 1 capital to risk-based assets ratio of 4.5%, a Tier 1 capital to risk-based assets ratio of 6.0%, a total capital to risk-based assets of 8%, and a 4% Tier 1 capital to total assets leverage ratio. The existing capital requirements were effective January 1, 2015 and are the result of a final rule implementing regulatory amendments based on recommendations of the Basel Committee on Banking Supervision and certain requirements of the Dodd-Frank Act.

For purposes of the regulatory capital requirements, common equity Tier 1 capital is generally defined as common shareholders’ equity and retained earnings. Tier 1 capital is generally defined as common equity Tier 1 and additional Tier 1 capital. Additional Tier 1 capital includes certain noncumulative perpetual preferred stock and related surplus and minority interests in equity accounts of consolidated subsidiaries. Total capital includes Tier 1 capital (common equity Tier 1 capital plus additional Tier 1 capital) and Tier 2 capital. Tier 2 capital is comprised of capital instruments and related surplus, meeting specified requirements, and may include cumulative preferred stock and long-term perpetual preferred stock, mandatory convertible securities, intermediate preferred stock and subordinated debt. Also included in Tier 2 capital is the allowance for loan and lease losses limited to a maximum of 1.25% of risk-weighted assets and, for institutions that made such an election regarding the treatment of Accumulated Other Comprehensive Income (“AOCI”), up to 45% of net unrealized gains on available-for-sale equity securities with readily determinable fair market values. Institutions that have not exercised the AOCI opt-out have AOCI incorporated into common equity Tier 1 capital (including unrealized gains and losses on available-for-sale-securities). We have exercised the AOCI opt-out. Calculation of all types of regulatory capital is subject to deductions and adjustments specified in the regulations.

In determining the amount of risk-weighted assets for purposes of calculating risk-based capital ratios, all assets, including certain off-balance sheet assets (e.g., recourse obligations, direct credit substitutes, residual interests) are multiplied by a risk weight factor assigned by the regulations based on the risks believed inherent in the type of asset. Higher levels of capital are required for asset categories believed to present greater risk. For example, a risk weight of 0% is assigned to cash and U.S. government securities, a risk weight of 50% is generally assigned to prudently underwritten first lien one- to four-family residential mortgages, a risk weight of 100% is assigned to commercial and consumer loans, a risk weight of 150% is assigned to certain past due loans and a risk weight of between 0% to 600% is assigned to permissible equity interests, depending on certain specified factors.

In addition to establishing the minimum regulatory capital requirements, the regulations limit capital distributions and certain discretionary bonus payments to management if the institution does not hold a “capital conservation buffer” consisting of 2.5% of common equity Tier 1 capital to risk-weighted assets above the amount necessary to meet its minimum risk-based capital requirements. The capital conservation buffer requirement is being phased in beginning January 1, 2016 at 0.625% of risk-weighted assets and increasing each year until fully implemented at 2.5% on January 1, 2019. When fully implemented, the capital conservation buffer will be 2.50% of risk weighted assets over and above the regulatory minimum capital ratios for Common Equity Tier 1 Capital (CET1) to risk weighted assets, Tier 1 Capital to risk weighted assets, and Total Capital to risk weighted assets.  The consequences of not meeting the capital conservation buffer thresholds include restrictions on the payment of dividends, restrictions on the payment of discretionary bonuses, and restrictions on the repurchasing of common shares by the Company. At September 30, 2017, the actual capital conservation buffer for Town Square Bank was 13.46% compared to the capital conservation buffer requirement of 1.25%.

In assessing an institution’s capital adequacy, the OCC takes into consideration, not only these numeric factors, but qualitative factors as well, and has the authority to establish higher capital requirements for individual institutions when deemed necessary.

As of September 30, 2017, the capital of the Town Square Bank exceeded all required regulatory guidelines and Town Square Bank was categorized as well-capitalized.

38

The following table reflects the Bank’s current regulatory capital levels in more detail, including comparisons to the regulatory minimums at September 30, 2017 and December 31, 2016 (in thousands).

											To Be Well
											Capitalized Under
						For Capital Adequacy					Prompt Corrective
	Actual					Purposes					Action Regulations
As of September 30, 2017	Amount		Ratio			Amount		Ratio			Amount		Ratio
Total Risk-Based Capital
(to Risk-weighted Assets)	$	67,303		21.70	%	$	24,815		8.00	%	$	31,019		10.00	%
Tier I Capital
(to Risk-weighted Assets)		64,033		20.64			18,612		6.00			24,815		8.00
Common Equity
(to Risk-weighted Assets)		64,033		20.64			13,959		4.50			20,163		6.50
Tier I Capital
(to Adjusted Total Assets)		64,033		13.99			18,311		4.00			22,889		5.00

											To Be Well
											Capitalized Under
						For Capital Adequacy					Prompt Corrective
	Actual					Purposes					Action Regulations
As of December 31, 2016	Amount		Ratio			Amount		Ratio			Amount		Ratio
Total Risk-Based Capital
(to Risk-weighted Assets)	$	64,925		21.01	%	$	24,722		8.00	%	$	30,903		10.00	%
Tier I Capital
(to Risk-weighted Assets)		62,513		20.23			18,542		6.00			24,722		8.00
Common Equity
(to Risk-weighted Assets)		62,513		20.23			13,906		4.50			20,087		6.50
Tier I Capital
(to Adjusted Total Assets)		62,513		13.52			18,501		4.00			23,126		5.00

Off-Balance Sheet Arrangements. In the normal course of operations, we engage in a variety of financial transactions that, in accordance with U.S. generally accepted accounting principles, are not recorded in our financial statements. These transactions involve, to varying degrees, elements of credit, interest rate and liquidity risk. Such transactions are used primarily to manage customers’ requests for funding and take the form of loan commitments and lines of credit. These arrangements are not expected to have a material impact on the Company’s consolidated financial condition or results of operations.

39

Comparison of Operating Results for the Three and Nine Months Ended September 30, 2017 and September 30, 2016

General. Net income for the three months ended September 30, 2017 decreased $382,000, or 104.9%, to a net loss of $18,000 from net income of $364,000 for the three months ended September 30, 2016. The decrease in net income is attributable to a decrease in net interest income of $186,000 to $4.0 million for the three months ended September 30, 2017 from $4.2 million for the three months ended September 30, 2016, a decrease in non-interest income of $96,000 to $704,000 for the three months ended September 30, 2017 from $800,000 for the three months ended September 30, 2016 and an increase in the provision for loan losses of $595,000 to $947,000 for the three months ended September 30, 2017 from $352,000 for the three months ended September 30, 2016. The decreases in income are offset by a decrease in non-interest expense of $322,000 to $3.9 million for the three months ended September 30, 2017 from $4.2 million for the three months ended September 30, 2016, and a decrease of $173,000 in income taxes to a benefit of $51,000 for the three months ended September 30, 2017 compared to a tax expense of $122,000 for the three months ended September 30, 2016.

Net income decreased $739,000, or 47.6%, to $812,000 for the nine months ended September 30, 2017 from net income of $1.5 million for the nine months ended September 30, 2016. The decrease in net income is attributable to a decrease in net interest income of $409,000 to $12.2 million for the nine months ended September 30, 2017 from $12.6 million for the nine months ended September 30, 2016, a decrease in non-interest income of $252,000 to $2.0 million for the nine months ended September 30, 2017 from $2.3 million for the nine months ended September 30, 2016 and in increase in the provision for loan losses of $834,000 to $1.6 million for the nine months ended September 30, 2017 from $812,000 for the nine months ended September 30, 2016. The decreases in income are offset by a decrease in non-interest expense of $513,000 to $11.4 million for the nine months ended September 30, 2017 from $11.9 million for the nine months ended September 30, 2016, and a decrease of $243,000 in income taxes to $338,000 for the nine months ended September 30, 2017 compared to $581,000 for the nine months ended September 30, 2016.

Interest Income. Interest income decreased $45,000, or 0.9%, to remain constant at $4.8 million for the three months ended September 30, 2017 and 2016. The average balance of interest-earning assets increased $13.9 million, or 3.3%, to $434.3 million from $420.4 million.

Interest income on loans decreased $158,000, or 3.5%, to $4.3 million for the three months ended September 30, 2017 from $4.5 million for the three months ended September 30, 2016. The average yields on loans decreased 13 basis points to 5.01% for the three months ended September 30, 2017 compared to 5.14% for the three months ended September 30, 2016. The average balance of loans decreased $4.5 million, or 1.3%, to $340.0 million for the three months ended September 30, 2017 from $344.5 million for the three months ended September 30, 2016. Income recognized from purchase discounts attributable to the Town Square and Commonwealth acquisitions decreased $83,000, or 49.6%, to $84,000 for the three months ended September 30, 2017 from $167,000 for the three months ended September 30, 2016 and contributed to the decrease in the average yields on loans.

Interest income on investment securities increased $49,000, or 15.2%, to $371,000 for the three months ended September 30, 2017 from $322,000 for the three months ended September 30, 2016. The average yield on securities increased 15 basis points to 2.31% for the three months ended September 30, 2017, compared to 2.16% for the three months ended September 30, 2016. The average balance of investment securities increased $4.4 million, or 7.4%, to $63.8 million for the three months ended September 30, 2017 from $59.4 million for the three months ended September 30, 2016.

Interest income on restricted stock increased $10,000, or 33.3%, to $40,000 for the three months ended September 30, 2017 from $30,000 for the three months ended September 30, 2016. The average yield on restricted stock increased 120 basis points to 4.84% for the three months ended September 30, 2017 compared to 3.64% for the three months ended September 30, 2016. The average balance of restricted stock remained constant at $3.3 million for the three months ended September 30, 2017 and 2016. Interest income on other interest-earning assets increased $54,000, or 284.2%, to $73,000 for the three months ended September 30, 2017 from $19,000 for the three months ended September 30, 2016. The average yield on other interest-earning assets increased 49 basis points to 1.06% for the three months ended September 30, 2017 compared to 0.57% for the three months ended September 30, 2016. The average balance of other interest earning assets increased $14.1 million, or 107.2%, to $27.3 million for the three months ended September 30, 2017 from $13.2 million for the three months ended September 30, 2016.

Interest income decreased $69,000, or 0.5%, to remain constant at $14.3 million for the nine months ended September 30, 2017 and 2016. The average balance of interest-earning assets increased $20.1 million, or 4.9%, to $433.1 million from $413.0 million.

Interest income on loans decreased $257,000, or 2.0%, to $12.9 million for the nine months ended September 30, 2017 from $13.1 million for the nine months ended September 30, 2016. The average yields on loans decreased 21 basis points to 5.05% for the nine months ended September 30, 2017 compared to 5.26% for the nine months ended September 30, 2016. The average balance of loans increased $6.8 million, or 2.1%, to $340.6 million for the nine months ended September 30, 2017 from $333.8 million for the nine months ended September 30, 2016. Income recognized from purchase discounts attributable to the Town Square and Commonwealth acquisitions decreased $291,000, or 48.9%, to $303,000 for the nine months ended September 30, 2017 from $594,000 for the nine months ended September 30, 2016 and contributed to the decrease in the average yields on loans.

Interest income on investment securities increased $35,000, or 3.4%, to $1.1 million for the nine months ended September 30, 2017 from $1.0 million for the nine months ended September 30, 2016. The average yield on securities increased 12 basis points to 2.34% for the nine months ended September 30, 2017, compared to 2.22% for the nine months ended September 30, 2016. The average balance of investment securities decreased $1.2 million, or 1.9%, to $61.4 million for the nine months ended September 30, 2017 from $62.6 million for the nine months ended September 30, 2016.

40

Interest income on restricted stock increased $19,000, or 20.9%, to $110,000 for the nine months ended September 30, 2017 from $91,000 for the nine months ended September 30, 2016. The average yield on restricted stock increased 78 basis points to 4.49% for the nine months ended September 30, 2017 compared to 3.71% for the nine months ended September 30, 2016. The average balance of restricted stock remained constant at $3.3 million for the nine months ended September 30, 2017 and 2016. Interest income on other interest-earning assets increased $134,000, or 231.0%, to $192,000 for the nine months ended September 30, 2017 from $58,000 for the nine months ended September 30, 2016. The average yield on other interest-earning assets increased 34 basis points to 0.92% for the nine months ended September 30, 2017 compared to 0.58% for the nine months ended September 30, 2016. The average balance of other interest earning assets increased $14.5 million, or 108.2%, to $27.8 million for the nine months ended September 30, 2017 from $13.3 million for the nine months ended September 30, 2016.

Interest Expense. Interest expense increased $141,000, or 23.4%, to $743,000 for the three months ended September 30, 2017 from $602,000 for the three months ended September 30, 2016. The average balance of interest bearing liabilities increased $11.1 million, or 3.4%, to $335.4 million from $324.3 million.

Interest expense on interest bearing deposits increased $128,000, or 25.5% to $629,000 for the three months ended September 30, 2017 from $501,000 for the three months ended September 30, 2016. The average balance of interest bearing deposits increased $18.2 million, or 6.0%, to $320.1 million for the three months ended September 30, 2017 from $301.9 million for the three months ended September 30, 2016. The average interest rate paid on interest bearing deposits increased 12 basis points to 0.78% for the three months ended September 30, 2017 compared to 0.66% for the three months ended September 30, 2016. The increase in average balance on interest bearing deposits is primarily attributable to an increase in NOW and money market accounts combined with an increase of $7.9 million in short-term non-brokered deposits acquired in the national market.

Interest expense on FHLB advances, subordinated debentures and other borrowings increased $13,000, or 12.9%, to $114,000 for the three months ended September 30, 2017 from $101,000 for the three months ended September 30, 2016. The average balance on FHLB advances decreased $8.6 million, or 44.1%, to $10.9 million for the three months ended September 30, 2017 from $19.6 million for the three months ended September 30, 2016. The average interest rate paid on FHLB advances increased 53 basis points to 1.71% from 1.18%. The average balance on subordinated debentures increased $65,000, or 2.3%, to $2.9 million for the three months ended September 30, 2017 from $2.8 million for the three months ended September 30, 2016. The average interest rate paid on subordinated debentures increased 68 basis points to 6.79% for the three months ended September 30, 2017 from 6.11% for the three months ended September 30, 2016. The average balance on other borrowings increased $1.5 million, or 100.0%, to $1.5 million for the three months ended September 30, 2017 from $0 for the three months ended September 30, 2016. The average interest rate paid on other borrowings increased 476 basis points to 4.76% for the three months ended September 30, 2017 from 0.00% for the three months ended September 30, 2016.

Interest expense increased $340,000, or 19.4%, to $2.1 million for the nine months ended September 30, 2017 from $1.8 million for the nine months ended September 30, 2016. The average balance of interest bearing liabilities increased $16.3 million, or 5.1%, to $334.2 million from $317.9 million.

Interest expense on interest bearing deposits increased $349,000, or 23.9% to $1.8 million for the nine months ended September 30, 2017 from $1.5 million for the nine months ended September 30, 2016. The average balance of interest bearing deposits increased $22.7 million, or 7.6%, to $321.3 million for the nine months ended September 30, 2017 from $298.6 million for the nine months ended September 30, 2016. The average interest rate paid on interest bearing deposits increased 10 basis point to 0.75% for the nine months ended September 30, 2017 from 0.65% for the nine months ended September 30, 2016. The increase in average balance on interest bearing deposits is primarily attributable to an increase in NOW and money market accounts combined with an increase of $7.9 million in short-term non-brokered deposits acquired in the national market.

Interest expense on FHLB advances decreased $45,000, or 26.9%, to $122,000 for the nine months ended September 30, 2017 from $167,000 for the nine months ended September 30, 2016. The average balance on FHLB advances decreased $7.1 million, or 42.8%, to $9.4 million for the nine months ended September 30, 2017 from $16.5 million for the nine months ended September 30, 2016. The average interest rate paid on FHLB advances increased 38 basis points to 1.73% for the nine months ended September 30, 2017 from 1.35% for the nine months ended September 30, 2016. The average balance on subordinated debentures increased $64,000, or 2.3%, to remain at $2.8 million for the nine months ended September 30, 2017 and 2016. The average interest rate paid on subordinated debentures increased 62 basis points to 6.62% for the nine months ended September 30, 2017 from 6.00% for the nine months ended September 30, 2016. The average balance on other borrowings increased $566,000, or 100.0%, to $566,000 for the nine months ended September 30, 2017 from $0 for the nine months ended September 30, 2016. The average interest rate paid on other borrowings increased 472 basis points to 4.72% for the nine months ended September 30, 2017 from 0.00% for the nine months ended September 30, 2016.

Net Interest Income. Net interest income decreased $186,000, or 4.4%, to $4.0 million for the three months ended September 30, 2017 from $4.2 million for the three months ended September 30, 2016. The ratio of average interest earning assets to average interest bearing liabilities decreased to 129.49% for the three months ended September 30, 2017 from 129.64% for the three months ended September 30, 2016. The interest rate spread decreased 34 basis points to 3.49% for the three months ended September 30, 2017 from 3.83% for the three months ended September 30, 2016. Net interest margin decreased 31 basis points to 3.69% for the three months ended September 30, 2017 from 4.00% for the three months ended September 30, 2016.

Net interest income decreased $409,000, or 3.3%, to $12.2 million for the nine months ended September 30, 2017 from $12.6 million for the nine months ended September 30, 2016. The ratio of average interest earning assets to average interest bearing liabilities decreased to 129.61% for the nine months ended September 30, 2017 from 129.92% for the nine months ended September 30, 2016. The interest rate spread decreased 33 basis points to 3.56% for the nine months ended September 30, 2017 from 3.89% for the nine months ended September 30, 2016. Net interest margin decreased 32 basis points to 3.75% for the nine months ended September 30, 2017 from 4.07% for the nine months ended September 30, 2016.

41

Provision for Loan Losses. We recorded $947,000 in provision for loan losses for the three months ended September 30, 2017 compared to $352,000 in provision for loan losses for the three months ended September 30, 2016. The increase in the provision is primarily attributable to charge-offs and the establishment of an allowance of $434,000 on five large commercial relationships classified as substandard.

We recorded $1.6 million in provision for loan losses for the nine months ended September 30, 2017, compared to $812,000 in provision for loan losses for the nine months ended September 30, 2016, primarily due to charge-offs and an increase in loans classified as substandard.

Noninterest Income. Noninterest income decreased $96,000, or 12.0%, to $704,000 for the three months ended September 30, 2017 from $800,000 for the three months ended September 30, 2016. The decrease in noninterest income was primarily attributable to a decrease in loan servicing fees associated with mortgage banking activities of $96,000, or 63.6%, to $55,000 for the three months ended September 30, 2017 from $151,000 for the three months ended September 30, 2016 and a decrease in service charges on deposits of $29,000, or 5.5%, to $496,000 for the three months ended September 30, 2017 from $525,000 for the three months ended September 30, 2016, offset by an increase in gains on mortgage loans sold of $27,000, or 42.2%, to $91,000 for the three months ended September 30, 2017 from $64,000 for the three months ended September 30, 2016.

Noninterest income decreased $252,000, or 10.8%, to $2.1 million for the nine months ended September 30, 2017 from $2.3 million for the nine months ended September 30, 2016. The decrease in noninterest income was attributable to a decrease in loan servicing fees associated with mortgage banking activities of $138,000, or 38.7%, to $219,000 for the nine months ended September 30, 2017 from $357,000 for the nine months ended September 30, 2016, a decrease in net gain on disposal of land and equipment of $76,000 or 82.6%, to $16,000 for the nine months ended September 30, 2017 from $92,000 for the nine months ended September 30, 2016 and a decrease in service charges on deposits of $36,000, or 2.4%, to remain constant at $1.5 million for the nine months ended September 30, 2017 and 2016.

Noninterest Expense. Noninterest expense decreased $322,000, or 7.7%, to $3.9 million for the three months ended September 30, 2017 from $4.2 million for the three months ended 2016. This decrease was primarily attributable to the decrease in salaries and employee benefits of $266,000, or 14.3%, to $1.6 million for the three months ended September 30, 2017 from $1.8 million for the three months ended September 30, 2016, a decrease in foreclosed assets expense of $124,000, or 64.9%, to $67,000 for the three months ended September 30, 2017 from $191,000 for the three months ended September 30, 2016, a decrease in advertising of $46,000, or 38.0% to $75,000 for the three months ended September 30, 2017 from $121,000 for the three months ended September 30, 2016 and a decrease in occupancy expense of $44,000, or 8.8%, to $458,000 for the three months ended September 30, 2017 from $502,000 for the three months ended September 30, 2016.

The decreases above are offset by an increase in professional fees of $166,000, or 121.2%, to $303,000 for the three months ended September 30, 2017 from $137,000 for the three months ended September 30, 2016, an increase in loss on fictitious loans of $25,000, or 100.0%, to $25,000 for the three months ended September 30, 2017 from $0 for the three months ended September 30, 2016. Professional fees increased to accrue for potential legal and audit related expenses associated with the fictitious loans. On September 12, 2017, Town Square Bank, the wholly-owned bank subsidiary of Poage Bankshares, Inc., uncovered evidence of suspected fraud involving the origination of fictitious loans by an employee of the Bank. The Bank has informed its fidelity blanket bond insurer of the suspected fraud and engaged an outside firm to perform a forensic audit. To date, the Bank believes it has identified suspected fraudulent loans totaling approximately $1.4 million, but this amount may change based on the results of the ongoing investigation. It is the Company’s conclusion, based on the advice of qualified outside legal counsel, that the bond should provide indemnity for the lost principal of $1.4 million, less a $25,000 deductible, and it is probable that the Bank will recover its loss. The Company recorded a receivable on insurance proceeds in other assets and a net loss of $25,000 in other expenses during the three months ended September 30, 2017.

Noninterest expense decreased $513,000, or 4.3%, to $11.4 million for the nine months ended September 30, 2017 from $11.9 million for the nine months ended September 30, 2016. This decrease was primarily due to a decrease of $430,000, or 7.7%, to $5.1 million in salaries and employee benefits for the nine months ended September 30, 2017 from $5.6 million for the nine months ended September 30, 2016, a decrease in foreclosed assets expense of $92,000, or 30.1%, to $214,000 for the nine months ended September 30, 2017 from $306,000 for the nine months ended September 30, 2016 and a decrease in federal deposit insurance of $77,000, or 43.8%, to $99,000 for the nine months ended September 30, 2017 from $176,000 for the nine months ended September 30, 2016 due to reduced assessment rates effective July 1, 2016.

The decreases above are offset by an increase in advertising of $53,000, or 22.4%, to $290,000 for the nine months ended September 30, 2017 from $237,000 for the nine months ended September 30, 2016, an increase in professional fees of $69,000, or 17.5%, to $464,000 for the nine months ended September 30, 2017 from $395,000 for the nine months ended September 30, 2016 and an increase in loss on fictitious loans of $25,000, or 100.0%, to $25,000 for the nine months ended September 30, 2017 from $0 for the nine months ended September 30, 2016.

The Company has engaged a third party consultant to assist in data processing services evaluation and contract negotiation. The Company’s current data processing contract will expire in April 2019. The Company intends to convert to a new data processing system, offered by a new service provider, which provides for improved customer service and an enhanced platform to accommodate expected growth in the Company’s operations. Conversion to the new system before the expiration of the current data processing contract will result in deconversion fees and early termination costs. The Company expects to sign a contract with the new data processing provider during the fourth quarter of 2017 at which time it would record deconversion fees estimated between $590,000 and $650,000. The Company expects to convert to the new system in the second half of 2018 at which time it would record early termination costs estimated between $1.5 million and $1.8 million. By converting to the new system, the Company expects to recoup these deconversion fees and early termination costs during the five years following conversion through the recognition of significant cost savings.

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Income Tax Expense. The provision for income tax benefit was $51,000 for the three months ended September 30, 2017 compared to and income tax expense of $122,000 for the three months ended September 30, 2016. Our effective tax rate for the three months ended September 30, 2017 was 73.9% compared to 25.1% for the three months ended September 30, 2016 due to sustaining a net operation loss for the three months ended September 30, 2017.

The provision for income taxes decreased $243,000, or 41.8%, to $338,000 for the nine months ended September 30, 2017 compared to a $581,000 tax expense for the nine months ended September 30, 2016 due to lower pre-tax income for the nine months ended September 30, 2016. Our effective tax rate for the nine months ended September 30, 2016 was 29.4% compared to 27.3% for the nine months ended September 30, 2016 due to tax expense related to nondeductible incentive stock options.

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ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Disclosures of quantitative and qualitative market risk are not required by smaller reporting companies, such as the Company.

ITEM 4. CONTROLS AND PROCEDURES

Management is responsible for establishing and maintaining effective disclosure controls and procedures, as defined under Rules 13a-15(e) and 15d-15(e) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). As of September 30, 2017, an evaluation was performed under the supervision and with the participation of management, including the Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures. Based on that evaluation, the Company’s management, including the Chief Executive Officer and the Chief Financial Officer, concluded that, as of the evaluation date, our disclosure controls and procedures were not effective, because of the material weakness described below, to enable us to provide that information required to be disclosed by us in reports filed or submitted under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the rules and forms of the SEC, and to ensure that the information required to be disclosed in the reports that we file or submit under the Exchange Act is accumulated and communicated to our management, including our chief executive officer and chief financial officer, as appropriate to allow timely decisions regarding required disclosure.

Management determined that a material weakness existed in the Company's internal control over financial reporting at September 30, 2017. The Company uncovered evidence of suspected fraud involving the origination of fictitious loans by an employee of the Bank. Management discovered that an employee had been using falsified brokerage statements, financial statements, tax returns, deeds and mortgages to make fictitious loans. The employee is no longer with the Company. The Company’s internal audit department has conducted an extensive internal review of our internal controls with the assistance of outside independent professional firm, with specific focus on our loan underwriting, approval and administration procedures. As a result of the internal review, management discovered a material weakness in the operating effectiveness of procedures and documentation related to loan underwriting. Additionally, these processes lacked effective supervision and oversight by lending management personnel. Our management, overseen by the Audit Committee, is working to implement new procedures to improve this process and remediate this control weakness. These new procedures will include separation of duties related to validating collateral and borrower identification, the cashing of third party business checks, the handling of returned mail and authorization of loan payments from deposit accounts, as well as increased monitoring of loan renewals.

The identified material weakness will not be considered remediated until the new procedures have been in operation for a sufficient period of time to be tested and determined by management to be operating effectively. Based on our evaluation and the reasons described above, management, including our Chief Executive Officer and our Chief Financial Officer, concluded that our internal control over financial reporting was not effective as of the end of the period covered by this report. There was no other change in our internal control over financial reporting that occurred during the three months ended September 30, 2017 that has materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

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PART II

OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

The Company and its subsidiaries are subject to various legal actions that are considered ordinary routine litigation incidental to the business of the Company, and no claim for money damages exceeds ten percent of the Company’s consolidated assets. In the opinion of management, based on currently available information, the resolution of these legal actions is not expected to have a material adverse effect on the Company’s consolidated financial condition and results of operations.

ITEM 1A. RISK FACTORS

Disclosures of risk factors are not required by smaller reporting companies, such as the Company.

ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

(a) None.

(b) Not applicable.

(c) Issuer repurchases. The following table sets forth information in connection with repurchases of the Company’s common stock for the period July 1, 2017 through September 30, 2017. On June 2, 2016, Poage Bankshares, Inc. commenced a stock repurchase program. The Board of Directors of Poage Bankshares, Inc. authorized program to repurchase up to 150,000 shares, which represented approximately 3.9% of the Company’s then issued and outstanding shares of common stock through open-market purchases, block trades, negotiated private transactions and pursuant to a trading plan that was adopted in accordance with Rule 10b5-1 under the Securities Exchange Act of 1934. The Company repurchased 125,681 shares at a weighted average price of $18.18 per share and there remained 24,319 shares to be repurchased under this plan at September 30, 2017.

On December 20, 2016, the Board of Directors of Poage Bankshares, Inc. authorized a new program to repurchase up to 185,000 shares, which represents approximately 5% of the Company’s then issued and outstanding shares of common stock through open-market purchases, block trades, negotiated private transactions and pursuant to a trading plan that was adopted in accordance with Rule 10b5-1 under the Securities Exchange Act of 1934. On June 26, 2017, the Company completed the stock program for up to 185,000 shares of common stock at a weighted average price of $19.07 per share. 

The Company’s stock repurchases pursuant to the repurchase programs are dependent on certain factors, including but not limited to, market conditions and prices, available funds and alternative uses of capital. The repurchase program may be carried out through open-market purchases, block trades, negotiated private transactions and pursuant to a trading plan adopted in accordance with Rule 10b5-1 under the Securities Exchange Act of 1934. Any repurchased shares will be treated by the Company as authorized but unissued shares.

					Total Number		Number of Shares
					of Shares		That May Yet
	Total				Purchased as		Be Purchased
	Number of		Average		Part of		Under Publicly
	Shares		Price Paid		Publicly		Announced
	Purchased		Per Share		Announced Plan		Plan
July 1 - July 31, 2017		800	$	18.44		800		23,519
August 1 - August 31, 2017		56		18.38		56		23,463
September 1 - September 30, 2017		-		-		-		23,463
Total		856	$	18.44		856

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ITEM 3. DEFAULTS UPON SENIOR SECURITIES

None.

ITEM 4. MINE SAFETY DISCLOSURES

None.

ITEM 5. OTHER INFORMATION

None.

ITEM 6. EXHIBITS

Exhibit
number	Description
3.1	Articles of Incorporation of Poage Bankshares, Inc.(1)
3.2	Bylaws of Poage Bankshares, Inc.(2)
31.1	Certification of President, and Chief Executive Officer, Pursuant to Rule 13a-14(a) and Rule 15-d-14(a).
31.2	Certification of Chief Financial Officer, Pursuant to Rule 13a-14(a) and Rule 15d-14(a).
32.1	Certification of President and Chief Executive Officer, and Chief Financial Officer, Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
101	The following material from the Company’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2017, formatted in XBRL (Extensible Business Reporting Language): (i) Unaudited Consolidated Balance Sheets, (ii) Unaudited Consolidated Statements of Operations, (iii) Unaudited Consolidated Statements of Comprehensive Income (Loss), (iv) Unaudited Consolidated Statement of Shareholders’ Equity, (v) Unaudited Consolidated Statements of Cash Flows, and (vi) Notes to the Consolidated Financial Statements.

(1) Incorporated by reference to the Registration Statement on Form S-1 (File No. 333-172192, originally filed on February 11, 2011, and as subsequently amended)

(2) Incorporated by reference to the Current Report on Form 8-K (File No. 001-35295, filed on September 21, 2016)

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SIGNATURES

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

	Poage Bankshares, Inc.
Date: November 14, 2017
	/s/ Bruce VanHorn
	Bruce VanHorn
	President  & Chief Executive Officer
	/s/ Jane Gilkerson
	Jane Gilkerson
	Chief Financial Officer

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