First US Bancshares (FUSB) 10-Q 2018 Q2 Quarterly report

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

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

For the quarterly period ended June 30, 2018

OR

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

For the transition period from                        to                        

Commission File Number: 0-14549

First US Bancshares, Inc.

(Exact Name of Registrant as Specified in Its Charter)

Delaware	63-0843362
(State or Other Jurisdiction of Incorporation or Organization)	(IRS Employer Identification No.)

3291 U.S. Highway 280 Birmingham, AL	35243
(Address of Principal Executive Offices)	(Zip Code)

(205) 582-1200

(Registrant’s Telephone Number, Including Area Code)

N/A

(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    ☒  No    ☐

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulations S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files).     Yes    ☒  No    ☐

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

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

If an emerging growth company, indicate by check mark of 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    ☒

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

Class	Outstanding at August 6, 2018
Common Stock, $0.01 par value	6,092,264 shares

1

FIRST US BANCSHARES, INC. AND SUBSIDIARIES

		PAGE
	PART I. FINANCIAL INFORMATION
ITEM 1.	FINANCIAL STATEMENTS
Interim Condensed Consolidated Balance Sheets at June 30, 2018 (Unaudited) and December 31, 2017		4
Interim Condensed Consolidated Statements of Operations for the Three and Six Months Ended June 30, 2018 and 2017 (Unaudited)		5
Interim Condensed Consolidated Statements of Comprehensive Income for the Three and Six Months Ended June 30, 2018 and 2017 (Unaudited)		6
Interim Condensed Consolidated Statements of Cash Flows for the Six Months Ended June 30, 2018 and 2017 (Unaudited)		7
Notes to Interim Condensed Consolidated Financial Statements (Unaudited)		8
ITEM 2.	MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS	36
ITEM 3.	QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK	47
ITEM 4.	CONTROLS AND PROCEDURES	48
	PART II. OTHER INFORMATION	49
ITEM 1.	LEGAL PROCEEDINGS	49
ITEM 1A.	RISK FACTORS	49
ITEM 2.	UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS	49
ITEM 6.	EXHIBITS	49
Signature Page		50

2

FORWARD-LOOKING STATEMENTS

Statements contained in this Quarterly Report on Form 10-Q that are not historical facts are forward-looking statements (as defined in the Private Securities Litigation Reform Act of 1995). In addition, First US Bancshares, Inc. (“Bancshares” and, together with its subsidiaries, the “Company”), through its senior management, from time to time makes forward-looking statements concerning its expected future operations and performance and other developments. The words “estimate,” “project,” “intend,” “anticipate,” “expect,” “believe,” “continues” and similar expressions are indicative of forward-looking statements. Such forward-looking statements are necessarily estimates reflecting the Company’s best judgment based on current information and involve a number of risks and uncertainties, and various factors could cause results to differ materially from those contemplated by such forward-looking statements. Such factors could include those identified from time to time in the Company’s Securities and Exchange Commission (“SEC”) filings and other public announcements, including the risk factors described in Part I, Item 1A of the Company's Annual Report on Form 10-K as of and for the year ended December 31, 2017. Specifically, with respect to statements relating to loan demand, cash flows, growth and earnings potential, geographic expansion and the adequacy of the allowance for loan losses for the Company, these factors include, but are not limited to, the rate of growth (or lack thereof) in the economy generally and in the Company’s service areas, market conditions and investment returns, changes in interest rates, the availability of quality loans in the Company’s service areas, the relative strength and weakness in the consumer and commercial credit sectors and in the real estate markets, collateral values and cybersecurity threats. With respect to the proposed acquisition of The Peoples Bank, these factors include, but are not limited to, the possibility that regulatory and other approvals and conditions to the proposed transaction are not received or satisfied on a timely basis or at all, or contain unanticipated terms and conditions; the possibility that modifications to the terms of the transaction may be required in order to obtain or satisfy such approvals or conditions; delays in closing the transaction; difficulties, delays and unanticipated costs in integrating the organizations’ businesses or realized expected cost savings and other benefits; business disruptions as a result of the integration of the organizations, including possible loss of customers; diversion of management time to address transaction-related issues; and changes in asset quality and credit risk as a result of the transaction. With respect to statements relating to the lease of the unused remaining leasable space in Pump House Plaza, these factors include, but are not limited to, the adherence of the leasing counterparty to the terms and conditions of the lease agreement and commercial real estate conditions in the Birmingham, Alabama market in general. There can be no assurance that such factors or other factors will not affect the accuracy of such forward-looking statements. Forward-looking statements speak only as of the date they are made, and the Company undertakes no obligation to revise forward-looking statements to reflect circumstances or events that occur after the dates on which the forward-looking statements are made, except as required by law.

3

PART I. FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

FIRST US BANCSHARES, INC. AND SUBSIDIARIES

INTERIM CONDENSED CONSOLIDATED BALANCE SHEETS

(Dollars in Thousands)

	June 30,			December 31,
	2018			2017
	(Unaudited)
ASSETS
Cash and due from banks	$	8,536		$	7,577
Interest-bearing deposits in banks		33,262			19,547
Total cash and cash equivalents		41,798			27,124
Federal funds sold		15,000			15,000
Investment securities available-for-sale, at fair value		141,421			153,871
Investment securities held-to-maturity, at amortized cost		24,319			26,279
Federal Home Loan Bank stock, at cost		1,413			1,609
Loans, net of allowance for loan losses of $4,952 and $4,774, respectively		355,529			346,121
Premises and equipment, net		26,336			26,433
Cash surrender value of bank-owned life insurance		15,079			14,923
Accrued interest receivable		1,959			2,057
Other real estate owned		2,181			3,792
Other assets		9,001			8,372
Total assets	$	634,036		$	625,581
LIABILITIES AND SHAREHOLDERS’ EQUITY
Deposits	$	531,428		$	517,079
Accrued interest payable		444			381
Other liabilities		6,164			6,319
Short-term borrowings		10,366			15,594
Long-term debt		10,000			10,000
Total liabilities		558,402			549,373
Commitments and contingencies
Shareholders’ equity:
Common stock, par value $0.01 per share, 10,000,000 shares authorized; 7,356,466 and 7,345,946 shares issued, respectively; 6,092,264 and 6,081,744 shares outstanding, respectively		73			73
Surplus		10,970			10,755
Accumulated other comprehensive loss, net of tax		(2,187	)		(868	)
Retained earnings		87,203			86,673
Less treasury stock: 1,264,202 shares at cost		(20,414	)		(20,414	)
Noncontrolling interest		(11	)		(11	)
Total shareholders’ equity		75,634			76,208
Total liabilities and shareholders’ equity	$	634,036		$	625,581

The accompanying notes are an integral part of these Interim Condensed Consolidated Statements.

4

FIRST US BANCSHARES, INC. AND SUBSIDIARIES

INTERIM CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(Dollars in Thousands, Except Per Share Data)

	Three Months Ended				Six Months Ended
	June 30,				June 30,
	2018		2017		2018		2017
	(Unaudited)				(Unaudited)
Interest income:
Interest and fees on loans	$	7,331	$	6,630	$	14,420	$	13,126
Interest on investment securities		1,059		1,053		2,089		2,067
Total interest income		8,390		7,683		16,509		15,193
Interest expense:
Interest on deposits		798		568		1,499		1,096
Interest on borrowings		90		58		194		121
Total interest expense		888		626		1,693		1,217
Net interest income		7,502		7,057		14,816		13,976
Provision for loan losses		702		576		1,360		1,091
Net interest income after provision for loan losses		6,800		6,481		13,456		12,885
Non-interest income:
Service and other charges on deposit accounts		444		461		911		925
Credit insurance income		100		43		318		299
Net gain on sales and prepayments of investment securities		102		1		105		50
Mortgage fees from secondary market		144		58		261		58
Other income, net		342		367		677		765
Total non-interest income		1,132		930		2,272		2,097
Non-interest expense:
Salaries and employee benefits		4,533		4,280		9,100		8,678
Net occupancy and equipment		873		693		1,762		1,470
Computer services		317		312		609		699
Fees for professional services		266		230		539		463
Other expense		1,503		1,348		2,783		2,590
Total non-interest expense		7,492		6,863		14,793		13,900
Income before income taxes		440		548		935		1,082
Provision for income taxes		81		132		162		262
Net income	$	359	$	416	$	773	$	820
Basic net income per share	$	0.06	$	0.07	$	0.13	$	0.13
Diluted net income per share	$	0.06	$	0.06	$	0.12	$	0.13
Dividends per share	$	0.02	$	0.02	$	0.04	$	0.04

The accompanying notes are an integral part of these Interim Condensed Consolidated Statements.

5

FIRST US BANCSHARES, INC. AND SUBSIDIARIES

INTERIM CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(Dollars in Thousands)

	Three Months Ended						Six Months Ended
	June 30,						June 30,
	2018			2017			2018			2017
	(Unaudited)						(Unaudited)
Net income	$	359		$	416		$	773		$	820
Other comprehensive income (loss):
Unrealized holding gains (losses) on securities available-for-sale arising during period, net of tax expense (benefit) of $(74), $429, $(547) and $871, respectively		(222	)		736			(1,640	)		1,493
Reclassification adjustment for net gains on securities available-for-sale realized in net income, net of tax of $26, $0, $26 and $18, respectively		(76	)		(1	)		(79	)		(32	)
Unrealized holding gains (losses) arising during the period on effective cash flow hedge derivatives, net of tax expense (benefit) of $22, $(24), $134 and $(20), respectively		66			(41	)		400			(33	)
Other comprehensive income (loss)		(232	)		694			(1,319	)		1,428
Total comprehensive income (loss)	$	127		$	1,110		$	(546	)	$	2,248

The accompanying notes are an integral part of these Interim Condensed Consolidated Statements.

6

FIRST US BANCSHARES, INC. AND SUBSIDIARIES

INTERIM CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(Dollars in Thousands)

	Six Months Ended
	June 30,
	2018			2017
	(Unaudited)
Cash flows from operating activities:
Net income	$	773		$	820
Adjustments to reconcile net income to cash provided by operating activities:
Depreciation and amortization		704			502
Provision for loan losses		1,360			1,091
Deferred income tax provision		154			242
Net gain on sale and prepayment of investment securities		(105	)		(50	)
Stock-based compensation expense		215			169
Net amortization of securities		424			590
Net loss on premises and equipment and other real estate		293			224
Changes in assets and liabilities:
Decrease in accrued interest receivable		98			167
Increase in other assets		(77	)		(67	)
Increase in accrued interest expense		63			12
Decrease in other liabilities		(155	)		(80	)
Net cash provided by operating activities		3,747			3,620
Cash flows from investing activities:
Purchases of investment securities, available-for-sale		(15,224	)		(15,254	)
Purchases of investment securities, held-to-maturity		—			(4,696	)
Proceeds from sales of investment securities, available-for-sale		4,221			—
Proceeds from maturities and prepayments of investment securities, available-for-sale		20,899			26,719
Proceeds from maturities and prepayments of investment securities, held-to-maturity		1,903			1,986
Net decrease in Federal Home Loan Bank stock		196			185
Proceeds from the sale of premises and equipment and other real estate		1,915			707
Net increase in loans		(11,146	)		(9,198	)
Purchases of premises and equipment		(715	)		(7,850	)
Net cash provided by (used in) investing activities		2,049			(7,401	)
Cash flows from financing activities:
Net increase in deposits		14,349			11,689
Net increase (decrease) in short-term borrowings		(5,228	)		573
Payments on long-term Federal Home Loan Bank advances		—			(5,000	)
Net share-based compensation transactions		—			(41	)
Dividends paid		(243	)		(243	)
Net cash provided by financing activities		8,878			6,978
Net increase in cash and cash equivalents		14,674			3,197
Cash and cash equivalents, beginning of period		27,124			23,530
Cash and cash equivalents, end of period	$	41,798		$	26,727
Supplemental disclosures:
Cash paid for:
Interest	$	1,630		$	1,205
Income taxes		137			13
Non-cash transactions:
Assets acquired in settlement of loans		378			353
Reissuance of treasury stock as compensation	$	—		$	278

The accompanying notes are an integral part of these Interim Condensed Consolidated Statements.

7

FIRST US BANCSHARES, INC. AND SUBSIDIARIES

NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

1. GENERAL

The accompanying unaudited interim condensed consolidated financial statements include the accounts of First US Bancshares, Inc. (“Bancshares”) and its subsidiaries (collectively, the “Company”). Bancshares is the parent holding company of First US Bank (the “Bank”). The Bank operates a finance company subsidiary, Acceptance Loan Company, Inc. (“ALC”). Management has determined that the Bank and ALC comprise Bancshares’ two reportable operating segments. All significant intercompany transactions and accounts have been eliminated.

The unaudited interim condensed consolidated financial statements, in the opinion of management, reflect all adjustments necessary for a fair presentation of the Company’s consolidated financial position, results of operations and cash flows for the periods presented. Such adjustments are of a normal, recurring nature. The results of operations for any interim period are not necessarily indicative of results expected for the fiscal year ending December 31, 2018. While certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States (“U.S. GAAP”) have been condensed or omitted pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”), management believes that the disclosures herein are adequate to make the information presented not misleading. These unaudited interim condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and notes thereto contained in the Company’s Annual Report on Form 10-K as of and for the year ended December 31, 2017.

2. BASIS OF PRESENTATION

Summary of Significant Accounting Policies

Certain significant accounting policies followed by the Company are set forth in Note 2, “Summary of Significant Accounting Policies,” of the Notes to Consolidated Financial Statements in the Company’s Annual Report on Form 10-K as of and for the year ended December 31, 2017.

Net Income Per Share

Basic net income per share is computed by dividing net income by the weighted average number of shares of common stock outstanding (basic shares). Included in basic shares are certain shares that have been accrued as of the balance sheet date as deferred compensation for members of Bancshares’ Board of Directors. Diluted net income per share is computed by dividing net income by the weighted average number of shares of common stock outstanding, adjusted for the effect of potentially dilutive stock awards outstanding during the period (dilutive shares). The dilutive shares consist of nonqualified stock option grants issued to employees and members of Bancshares’ Board of Directors pursuant to Bancshares’ 2013 Incentive Plan (the “2013 Incentive Plan”) previously approved by Bancshares’ shareholders. The following table reflects weighted average shares used to calculate basic and diluted net income per share for the periods presented.

	Three Months Ended				Six Months Ended
	June 30,				June 30,
	2018		2017		2018		2017
Basic shares		6,195,801		6,173,544		6,192,117		6,168,446
Dilutive shares		378,701		318,501		378,701		318,501
Diluted shares		6,574,502		6,492,045		6,570,818		6,486,947

	Three Months Ended				Six Months Ended
	June 30,				June 30,
	2018		2017		2018		2017
	(Dollars in Thousands, Except Per Share Data)
Net income	$	359	$	416	$	773	$	820
Basic net income per share	$	0.06	$	0.07	$	0.13	$	0.13
Diluted net income per share	$	0.06	$	0.06	$	0.12	$	0.13

Comprehensive Income

Comprehensive income consists of net income, as well as unrealized holding gains and losses that arise during the period associated with the Company’s available-for-sale securities portfolio and the effective portion of cash flow hedge derivatives. In the calculation of comprehensive income, reclassification adjustments are made for gains or losses realized in the statement of operations associated with the sale of available-for-sale securities or changes in the fair value of cash flow derivatives.

8

Accounting Policies Recently Adopted and Pending Accounting Pronouncements

Accounting Standards Update (“ASU”) 2017-12, “Targeted Improvements to Accounting for Hedging Activities.” This ASU simplifies and expands the eligible hedging strategies for financial and nonfinancial risks by more closely aligning hedge accounting with a company’s risk management activities, and also simplifies the application of Accounting Standards Codification (“ASC”) Topic 815, Derivatives and Hedging, through targeted improvements in key practice areas. This includes expanding the list of items eligible to be hedged and amending the methods used to measure the effectiveness of hedging relationships. In addition, the ASU prescribes how hedging results should be presented and requires incremental disclosures. These changes are intended to allow preparers more flexibility and to enhance the transparency of how hedging results are presented and disclosed. Further, the ASU provides partial relief on the timing of certain aspects of hedge documentation and eliminates the requirement to recognize hedge ineffectiveness separately in earnings in the current period. The ASU is effective for years beginning after December 15, 2018, and interim periods within those years. The Company does not expect the adoption of ASU 2017-12 to have a material impact on the Company's consolidated financial statements.

ASU 2016-13, "Financial Instruments - Credit Losses: Measurement of Credit Losses on Financial Instruments.” Issued in June 2016, ASU 2016-13 removes the thresholds that companies apply to measure credit losses on financial instruments measured at amortized cost, such as loans, receivables and held-to-maturity debt securities. Under current U.S. GAAP, companies generally recognize credit losses when it is probable that the loss has been incurred. The revised guidance will remove all current recognition thresholds and will require companies to recognize an allowance for lifetime expected credit losses. Credit losses will be immediately recognized through net income; the amount recognized will be based on the current estimate of contractual cash flows not expected to be collected over the financial asset’s contractual term. ASU 2016-13 also amends the credit loss measurement guidance for available-for-sale debt securities. For public business entities, ASU 2016-13 is effective for financial statements issued for fiscal years and for interim periods within those fiscal years beginning after December 15, 2019. Institutions will be required 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 guidance is effective. Management is currently evaluating the impact that this ASU will have on the Company’s consolidated financial statements.

ASU 2016-02, “Leases (Topic 842).” Issued in February 2016, ASU 2016-02 was issued by the Financial Accounting Standards Board (“FASB”) to increase transparency and comparability among organizations by recognizing lease assets and lease liabilities on the balance sheet and by disclosing key information about leasing arrangements. ASU 2016-02 will require organizations that lease assets (lessees) to recognize on the balance sheet the assets and liabilities for the rights and obligations created by the lease for all operating leases under current U.S. GAAP with a term of more than 12 months. The recognition, measurement and presentation of expenses and cash flows arising from a lease are not significantly changed under ASU 2016-02, and there will continue to be differentiation between finance leases and operating leases. The accounting applied by the lessor in a lease transaction remains largely unchanged from previous U.S. GAAP. ASU 2016-02 is effective for fiscal years beginning after December 15, 2018. Management is currently evaluating the impact that this ASU will have on the Company’s consolidated financial statements; however, because the Company has several leases, assets and liabilities are expected to increase upon adoption for right-of-use assets and lease liabilities.

ASU 2016-01, “Financial Instruments - Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities (An Amendment of FASB ASC 825).” Issued in January 2016, ASU 2016-01 was intended to enhance the reporting model for financial instruments to provide users of financial statements with improved decision-making information. The amendments of ASU 2016-01 include: (i) requiring equity investments, except those accounted for under the equity method of accounting or those that result in the consolidation of an investee, to be measured at fair value, with changes in fair value recognized in net income; (ii) requiring a qualitative assessment to identify impairment of equity investments without readily determinable fair values; and (iii) clarifying that an entity should evaluate the need for a valuation allowance on a deferred tax asset related to available-for-sale securities in combination with the entity’s other deferred tax assets. ASU 2016-01 became effective for the Company on January 1, 2018. The adoption of ASU 2016-01 did not have a material impact on the Company's consolidated financial statements.

ASU 2014-09, “Revenue from Contracts with Customers (Topic 606).” Issued in May 2014, ASU 2014-09 added FASB ASC Topic 606, Revenue from Contracts with Customers, and superseded revenue recognition requirements in FASB ASC Topic 605, Revenue Recognition and certain cost guidance in FASB ASC Topic 605-35, Revenue Recognition – Construction-Type and Production-Type Contracts. ASU 2014-09 requires an entity to recognize revenue when (or as) an entity transfers control of goods or services to a customer at the amount to which the entity expects to be entitled. Depending on whether certain criteria are met, revenue should be recognized either over time, in a manner that depicts the entity’s performance, or at a point in time, when control of the goods or services is transferred to the customer. ASU 2014-09 became effective for the Company on January 1, 2018. The adoption of ASU 2014-09 did not have a material impact on the Company's consolidated financial statements.

Revenue

On January 1, 2018, the Company implemented Accounting Standards Update 2014-09, Revenue from Contracts with Customers, codified at ASC Topic 606. The Company adopted ASC 606 using the modified retrospective transition method. As of December 31, 2017, the Company had no uncompleted customer contracts and, as a result, no cumulative transition adjustment was made to the Company’s accumulated deficit during the first half of 2018. Results for reporting periods beginning January 1, 2018 are presented under ASC 606, while prior period amounts continue to be reported under legacy U.S. GAAP.

The majority of the Company’s revenue is generated through interest earned on financial instruments, including loans and investment securities, which falls outside the scope of ASC 606. The Company also generates revenue from insurance- and lease-related contracts that also fall outside the scope of ASC 606.

All of the Company’s revenue that is subject to ASC 606 is included in non-interest income; however, not all non-interest income is subject to ASC 606. Revenue earned by the Company subject to ASC 606 primarily consisted of service and other charges on deposit accounts, mortgage fees from secondary market transactions at the Bank, ATM fee income and other non-interest income. Revenue generated from these sources for the six months ended June 30, 2018 and 2017 was $1.6 million and $1.4 million, respectively, and for the three months ended June 30, 2018 and 2017 was $0.8 million and $0.7 million, respectively. All sources of the Company’s revenue subject to ASC 606 are transaction-based, and revenue is recognized at the time the transaction is executed, which is the same time the Company’s performance obligation is satisfied. The Company had no contract liabilities or unsatisfied performance obligations with customers as of June 30, 2018.

9

3. INVESTMENT SECURITIES

Details of investment securities available-for-sale and held-to-maturity as of June 30, 2018 and December 31, 2017 were as follows:

	Available-for-Sale
	June 30, 2018
			Gross		Gross			Estimated
	Amortized		Unrealized		Unrealized			Fair
	Cost		Gains		Losses			Value
	(Dollars in Thousands)
Mortgage-backed securities:
Residential	$	80,551	$	134	$	(1,997	)	$	78,688
Commercial		63,674		13		(2,068	)		61,619
Obligations of states and political subdivisions		1,010		26		(2	)		1,034
U.S. Treasury securities		80		—		—			80
Total	$	145,315	$	173	$	(4,067	)	$	141,421

	Held-to-Maturity
	June 30, 2018
			Gross		Gross			Estimated
	Amortized		Unrealized		Unrealized			Fair
	Cost		Gains		Losses			Value
	(Dollars in Thousands)
Mortgage-backed securities:
Commercial	$	13,410	$	—	$	(399	)	$	13,011
Obligations of U.S. government-sponsored agencies		9,110		—		(283	)		8,827
Obligations of states and political subdivisions		1,799		—		(22	)		1,777
Total	$	24,319	$	—	$	(704	)	$	23,615

	Available-for-Sale
	December 31, 2017
			Gross		Gross			Estimated
	Amortized		Unrealized		Unrealized			Fair
	Cost		Gains		Losses			Value
	(Dollars in Thousands)
Mortgage-backed securities:
Residential	$	83,360	$	286	$	(860	)	$	82,786
Commercial		67,281		27		(1,234	)		66,074
Obligations of states and political subdivisions		4,752		182		(3	)		4,931
U.S. Treasury securities		80		—		—			80
Total	$	155,473	$	495	$	(2,097	)	$	153,871

	Held-to-Maturity
	December 31, 2017
	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses			Estimated Fair Value
	(Dollars in Thousands)
Mortgage-backed securities:
Commercial	$	15,065	$	1	$	(186	)	$	14,880
Obligations of U.S. government-sponsored agencies		9,326		7		(144	)		9,189
Obligations of states and political subdivisions		1,888		5		(13	)		1,880
Total	$	26,279	$	13	$	(343	)	$	25,949

The scheduled maturities of investment securities available-for-sale and held-to-maturity as of June 30, 2018 are presented in the following table:

	Available-for-Sale				Held-to-Maturity
	Amortized Cost		Estimated Fair Value		Amortized Cost		Estimated Fair Value
	(Dollars in Thousands)
Maturing within one year	$	234	$	235	$	—	$	—
Maturing after one to five years		33,949		33,267		1,766		1,750
Maturing after five to ten years		64,634		62,494		6,168		6,024
Maturing after ten years		46,498		45,425		16,385		15,841
Total	$	145,315	$	141,421	$	24,319	$	23,615

10

For purposes of the maturity table, mortgage-backed securities, which are not due at a single maturity date, have been allocated over maturity groupings based on the weighted-average contractual maturities of underlying collateral. The mortgage-backed securities generally mature earlier than their weighted-average contractual maturities because of principal prepayments.

The following table reflects gross unrealized losses and fair value, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position, as of June 30, 2018 and December 31, 2017.

	Available-for-Sale
	June 30, 2018
	Less than 12 Months					12 Months or More
	Fair Value		Unrealized Losses			Fair Value		Unrealized Losses
	(Dollars in Thousands)
Mortgage-backed securities:
Residential	$	33,424	$	(722	)	$	39,041	$	(1,275	)
Commercial		16,215		(418	)		44,911		(1,650	)
Obligations of states and political subdivisions		424		(2	)		—		—
U.S. Treasury securities		80		—			—		—
Total	$	50,143	$	(1,142	)	$	83,952	$	(2,925	)

	Held-to-Maturity
	June 30, 2018
	Less than 12 Months					12 Months or More
	Fair Value		Unrealized Losses			Fair Value		Unrealized Losses
	(Dollars in Thousands)
Mortgage-backed securities:
Commercial	$	4,730	$	(109	)	$	8,280	$	(290	)
Obligations of U.S. government-sponsored agencies		1,633		(25	)		7,194		(258	)
Obligations of states and political subdivisions		841		(16	)		524		(6	)
Total	$	7,204	$	(150	)	$	15,998	$	(554	)

	Available-for-Sale
	December 31, 2017
	Less than 12 Months					12 Months or More
	Fair Value		Unrealized Losses			Fair Value		Unrealized Losses
	(Dollars in Thousands)
Mortgage-backed securities:
Residential	$	47,007	$	(467	)	$	21,122	$	(393	)
Commercial		18,554		(180	)		46,312		(1,054	)
Obligations of states and political subdivisions		428		(3	)		—		—
U.S. Treasury securities		80		—			—		—
Total	$	66,069	$	(650	)	$	67,434	$	(1,447	)

	Held-to-Maturity
	December 31, 2017
	Less than 12 Months					12 Months or More
	Fair Value		Unrealized Losses			Fair Value		Unrealized Losses
	(Dollars in Thousands)
Mortgage-backed securities:
Commercial	$	7,895	$	(63	)	$	6,675	$	(123	)
Obligations of U.S. government-sponsored agencies		865		(2	)		7,388		(142	)
Obligations of states and political subdivisions		571		(3	)		531		(10	)
Total	$	9,331	$	(68	)	$	14,594	$	(275	)

Management evaluates securities for other-than-temporary impairment no less frequently than quarterly, and more frequently when economic or market concerns warrant such evaluation. Consideration is given to: (i) the length of time and the extent to which fair value has been less than cost, (ii) the financial condition and near-term prospects of the issuer, (iii) whether the Company intends to sell securities, and (iv) whether it is more likely than not that the Company will be required to sell the securities before recovery of their amortized cost bases.

11

As of June 30, 2018, 110 debt securities had been in a loss position for more than 12 months, and 58 debt securities had been in a loss position for less than 12 months. As of December 31, 2017, 72 debt securities had been in a loss position for more than 12 months, and 83 debt securities had been in a loss position for less than 12 months. As of both June 30, 2018 and December 31, 2017, the losses for all securities were considered to be a direct result of the effect that the prevailing interest rate environment had on the value of debt securities and were not related to the creditworthiness of the issuers. Further, the Company has the current intent and ability to retain its investments in the issuers for a period of time that management believes to be sufficient to allow for any anticipated recovery in fair value. Therefore, the Company did not recognize any other-than-temporary impairments as of June 30, 2018 or December 31, 2017.

Investment securities with a carrying value of $79.2 million and $86.8 million as of June 30, 2018 and December 31, 2017, respectively, were pledged to secure public deposits and for other purposes.

4. LOANS AND ALLOWANCE FOR LOAN LOSSES

Portfolio Segments

The Company has divided the loan portfolio into eight portfolio segments, each with different risk characteristics described as follows:

Construction, land development and other land loans – Commercial construction, land and land development loans include the development of residential housing projects, loans for the development of commercial and industrial use property and loans for the purchase and improvement of raw land. These loans are secured in whole or in part by the underlying real estate collateral and are generally guaranteed by the principals of the borrowing entity.

Secured by 1-4 family residential properties – These loans include conventional mortgage loans on one-to-four family residential properties. These properties may serve as the borrower’s primary residence, vacation home or investment property. Also included in this portfolio are home equity loans and lines of credit. This type of lending, which is secured by a first or second mortgage on the borrower’s residence, allows customers to borrow against the equity in their home.

Secured by multi-family residential properties – This portfolio segment includes mortgage loans secured by apartment buildings.

Secured by non-farm, non-residential properties – This portfolio segment includes real estate loans secured by commercial and industrial properties, office or mixed-use facilities, strip shopping centers or other commercial property. These loans are generally guaranteed by the principals of the borrowing entity.

Other real estate loans – Other real estate loans are loans primarily for agricultural production, secured by mortgages on farmland.

Commercial and industrial loans – This portfolio segment includes loans to commercial customers for use in the normal course of business. These credits may be loans and lines of credit to financially strong borrowers, secured by inventories, equipment or receivables, and are generally guaranteed by the principals of the borrowing entity.

Consumer loans – This portfolio segment includes a variety of secured and unsecured personal loans, including automobile loans, loans for household and personal purposes and all other direct consumer installment loans.

Indirect sales – This portfolio segment includes loans secured by collateral that is purchased by consumers at retail stores with whom ALC has an established relationship to provide financing for the retail products sold if applicable underwriting standards are met.

12

As of June 30, 2018 and December 31, 2017, the composition of the loan portfolio by reporting segment and portfolio segment was as follows:

	June 30, 2018
	Bank		ALC		Total
	(Dollars in Thousands)
Real estate loans:
Construction, land development and other land loans	$	22,878	$	—	$	22,878
Secured by 1-4 family residential properties		38,968		9,176		48,144
Secured by multi-family residential properties		18,374		—		18,374
Secured by non-farm, non-residential properties		112,461		—		112,461
Other		187		—		187
Commercial and industrial loans		59,320		—		59,320
Consumer loans:
Consumer		5,420		32,902		38,322
Indirect sales		—		67,429		67,429
Total loans		257,608		109,507		367,115
Less: Unearned interest, fees and deferred cost		351		6,283		6,634
Allowance for loan losses		2,520		2,432		4,952
Net loans	$	254,737	$	100,792	$	355,529

	December 31, 2017
	Bank		ALC		Total
	(Dollars in Thousands)
Real estate loans:
Construction, land development and other land loans	$	26,143	$	—	$	26,143
Secured by 1-4 family residential properties		34,272		10,801		45,073
Secured by multi-family residential properties		16,579		—		16,579
Secured by non-farm, non-residential properties		105,133		—		105,133
Other		190		—		190
Commercial and industrial loans		69,969		—		69,969
Consumer loans:
Consumer		5,217		34,083		39,300
Indirect sales		—		55,071		55,071
Total loans		257,503		99,955		357,458
Less: Unearned interest, fees and deferred cost		374		6,189		6,563
Allowance for loan losses		2,447		2,327		4,774
Net loans	$	254,682	$	91,439	$	346,121

The Company makes commercial, real estate and installment loans to its customers. Although the Company has a diversified loan portfolio, 55.0% and 54.0% of the portfolio was concentrated in loans secured by real estate located primarily within a single geographic region of the United States as of June 30, 2018 and December 31, 2017, respectively.

Related Party Loans

In the ordinary course of business, the Bank makes loans to certain officers and directors of the Company, including companies with which they are associated. These loans are made on the same terms as those prevailing for comparable transactions with unrelated parties. Management believes that such loans do not represent more than a normal risk of collectability, nor do they present other unfavorable features. The aggregate balances of such related party loans and commitments as of June 30, 2018 and December 31, 2017 were $0.4 million and $0.5 million, respectively. During the six months ended June 30, 2018, there were no new loans to these parties, and repayments by active related parties were $0.2 million. During the year ended December 31, 2017, there were no new loans to these related parties, and repayments by active related parties were $11 thousand.

13

Allowance for Loan Losses

The following tables present changes in the allowance for loan losses during the six months ended June 30, 2018 and the year ended December 31, 2017 and the related loan balances by loan portfolio segment and loan type as of June 30, 2018 and December 31, 2017:

	Bank
	Six Months Ended June 30, 2018
	Construction, Land			1-4 Family			Real Estate Multi- Family		Non-Farm Non- Residential		Other		Commercial			Consumer			Indirect Sales		Total
	(Dollars in Thousands)
Allowance for loan losses:
Beginning balance	$	203		$	238		$	116	$	777	$	2	$	1,049		$	62		$	—	$	2,447
Charge-offs		—			(9	)		—		—		—		(2	)		—			—		(11	)
Recoveries		—			27			—		3		—		7			8			—		45
Provision		(37	)		15			12		28		—		44			(23	)		—		39
Ending balance	$	166		$	271		$	128	$	808	$	2	$	1,098		$	47		$	—	$	2,520
Ending balance of allowance attributable to loans:
Individually evaluated for impairment	$	—		$	5		$	—	$	17	$	—	$	68		$	—		$	—	$	90
Collectively evaluated for impairment		166			266			128		791		2		1,030			47			—		2,430
Total allowance for loan losses	$	166		$	271		$	128	$	808	$	2	$	1,098		$	47		$	—	$	2,520
Ending balance of loans receivable:
Individually evaluated for impairment	$	—		$	185		$	—	$	524	$	—	$	68		$	—		$	—	$	777
Collectively evaluated for impairment		22,878			38,783			18,374		111,937		187		59,252			5,420			—		256,831
Total loans receivable	$	22,878		$	38,968		$	18,374	$	112,461	$	187	$	59,320		$	5,420		$	—	$	257,608

	ALC
	Six Months Ended June 30, 2018
	Construction, Land		1-4 Family			Real Estate Multi- Family		Non-Farm Non-Residential		Other		Commercial		Consumer			Indirect Sales			Total
	(Dollars in Thousands)
Allowance for loan losses:
Beginning balance	$	—	$	52		$	—	$	—	$	—	$	—	$	1,653		$	622		$	2,327
Charge-offs		—		(32	)		—		—		—		—		(1,213	)		(278	)		(1,523	)
Recoveries		—		8			—		—		—		—		245			54			307
Provision		—		(4	)		—		—		—		—		1,038			287			1,321
Ending balance	$	—	$	24		$	—	$	—	$	—	$	—	$	1,723		$	685		$	2,432
Ending balance of allowance attributable to loans:
Individually evaluated for impairment	$	—	$	—		$	—	$	—	$	—	$	—	$	—		$	—		$	—
Collectively evaluated for impairment		—		24			—		—		—		—		1,723			685			2,432
Total allowance for loan losses	$	—	$	24		$	—	$	—	$	—	$	—	$	1,723		$	685		$	2,432
Ending balance of loans receivable:
Individually evaluated for impairment	$	—	$	—		$	—	$	—	$	—	$	—	$	—		$	—		$	—
Collectively evaluated for impairment		—		9,176			—		—		—		—		32,902			67,429			109,507
Total loans receivable	$	—	$	9,176		$	—	$	—	$	—	$	—	$	32,902		$	67,429		$	109,507

14

	Bank and ALC
	Six Months Ended June 30, 2018
	Construction, Land			1-4 Family			Real Estate Multi- Family		Non-Farm Non-Residential		Other		Commercial			Consumer			Indirect Sales			Total
	(Dollars in Thousands)
Allowance for loan losses:
Beginning balance	$	203		$	290		$	116	$	777	$	2	$	1,049		$	1,715		$	622		$	4,774
Charge-offs		—			(41	)		—		—		—		(2	)		(1,213	)		(278	)		(1,534	)
Recoveries		—			35			—		3		—		7			253			54			352
Provision		(37	)		11			12		28		—		44			1,015			287			1,360
Ending balance	$	166		$	295		$	128	$	808	$	2	$	1,098		$	1,770		$	685		$	4,952
Ending balance of allowance attributable to loans:
Individually evaluated for impairment	$	—		$	5		$	—	$	17	$	—	$	68		$	—		$	—		$	90
Collectively evaluated for impairment		166			290			128		791		2		1,030			1,770			685			4,862
Total allowance for loan losses	$	166		$	295		$	128	$	808	$	2	$	1,098		$	1,770		$	685		$	4,952
Ending balance of loans receivable:
Individually evaluated for impairment	$	—		$	185		$	—	$	524	$	—	$	68		$	—		$	—		$	777
Collectively evaluated for impairment		22,878			47,959			18,374		111,937		187		59,252			38,322			67,429			366,338
Total loans receivable	$	22,878		$	48,144		$	18,374	$	112,461	$	187	$	59,320		$	38,322		$	67,429		$	367,115

	Bank
	Year Ended December 31, 2017
	Construction, Land			1-4 Family			Real Estate Multi- Family		Non-Farm Non-Residential			Other		Commercial			Consumer			Indirect Sales		Total
	(Dollars in Thousands)
Allowance for loan losses:
Beginning balance	$	535		$	304		$	88	$	903		$	2	$	527		$	50		$	—	$	2,409
Charge-offs		—			—			—		—			—		(16	)		(63	)		—		(79	)
Recoveries		—			103			—		69			—		19			56			—		247
Provision		(332	)		(169	)		28		(195	)		—		519			19			—		(130	)
Ending balance	$	203		$	238		$	116	$	777		$	2	$	1,049		$	62		$	—	$	2,447
Ending balance of allowance attributable to loans:
Individually evaluated for impairment	$	—		$	5		$	—	$	21		$	—	$	72		$	—		$	—	$	98
Collectively evaluated for impairment		203			233			116		756			2		977			62			—		2,349
Total allowance for loan losses	$	203		$	238		$	116	$	777		$	2	$	1,049		$	62		$	—	$	2,447
Ending balance of loans receivable:
Individually evaluated for impairment	$	—		$	187		$	—	$	532		$	—	$	72		$	—		$	—	$	791
Collectively evaluated for impairment		26,143			34,085			16,579		104,601			190		69,897			5,217			—		256,712
Total loans receivable	$	26,143		$	34,272		$	16,579	$	105,133		$	190	$	69,969		$	5,217		$	—	$	257,503

15

	ALC
	Year Ended December 31, 2017
	Construction, Land		1-4 Family			Real Estate Multi- Family		Non-Farm Non-Residential		Other		Commercial		Consumer			Indirect Sales			Total
	(Dollars in Thousands)
Allowance for loan losses:
Beginning balance	$	—	$	107		$	—	$	—	$	—	$	—	$	1,717		$	623		$	2,447
Charge-offs		—		(28	)		—		—		—		—		(2,297	)		(587	)		(2,912	)
Recoveries		—		32			—		—		—		—		545			98			675
Provision		—		(59	)		—		—		—		—		1,688			488			2,117
Ending balance	$	—	$	52		$	—	$	—	$	—	$	—	$	1,653		$	622		$	2,327
Ending balance of allowance attributable to loans:
Individually evaluated for impairment	$	—	$	—		$	—	$	—	$	—	$	—	$	—		$	—		$	—
Collectively evaluated for impairment		—		52			—		—		—		—		1,653			622			2,327
Total allowance for loan losses	$	—	$	52		$	—	$	—	$	—	$	—	$	1,653		$	622		$	2,327
Ending balance of loans receivable:
Individually evaluated for impairment	$	—	$	—		$	—	$	—	$	—	$	—	$	—		$	—		$	—
Collectively evaluated for impairment		—		10,801			—		—		—		—		34,083			55,071			99,955
Total loans receivable	$	—	$	10,801		$	—	$	—	$	—	$	—	$	34,083		$	55,071		$	99,955

	Bank and ALC
	Year Ended December 31, 2017
	Construction, Land			1-4 Family			Real Estate Multi- Family		Non-Farm Non-Residential			Other		Commercial			Consumer			Indirect Sales			Total
	(Dollars in Thousands)
Allowance for loan losses:
Beginning balance	$	535		$	411		$	88	$	903		$	2	$	527		$	1,767		$	623		$	4,856
Charge-offs		—			(28	)		—		—			—		(16	)		(2,360	)		(587	)		(2,991	)
Recoveries		—			135			—		69			—		19			601			98			922
Provision		(332	)		(228	)		28		(195	)		—		519			1,707			488			1,987
Ending balance	$	203		$	290		$	116	$	777		$	2	$	1,049		$	1,715		$	622		$	4,774
Ending balance of allowance attributable to loans:
Individually evaluated for impairment	$	—		$	5		$	—	$	21		$	—	$	72		$	—		$	—		$	98
Collectively evaluated for impairment		203			285			116		756			2		977			1,715			622			4,676
Total allowance for loan losses	$	203		$	290		$	116	$	777		$	2	$	1,049		$	1,715		$	622		$	4,774
Ending balance of loans receivable:
Individually evaluated for impairment	$	—		$	187		$	—	$	532		$	—	$	72		$	—		$	—		$	791
Collectively evaluated for impairment		26,143			44,886			16,579		104,601			190		69,897			39,300			55,071			356,667
Total loans receivable	$	26,143		$	45,073		$	16,579	$	105,133		$	190	$	69,969		$	39,300		$	55,071		$	357,458

Credit Quality Indicators

The Bank utilizes a credit grading system that provides a uniform framework for establishing and monitoring credit risk in the loan portfolio. Under this system, each loan is graded based on pre-determined risk metrics and categorized into one of nine risk grades. These risk grades can be summarized into categories described as pass, special mention, substandard, doubtful and loss, as described in further detail below.

● Pass (Risk Grades 1-5): Loans in this category include obligations in which the probability of default is considered low.

● Special Mention (Risk Grade 6): Loans in this category exhibit potential credit weaknesses or downward trends deserving Bank management’s close attention. If left uncorrected, these potential weaknesses may result in the deterioration of the repayment prospects for the asset or in the Bank’s credit position at some future date. Special mention loans are not adversely classified and do not expose the Bank to sufficient risk to warrant adverse classification. Although a special mention asset has a higher probability of default than pass-rated categories, its default is not imminent.

16

● Substandard (Risk Grade 7): Loans in this category have defined weaknesses that jeopardize the orderly liquidation of debt. A substandard loan is inadequately protected by the current worth and paying capacity of the obligor or by the collateral pledged, if any. Normal repayment from the borrower is in jeopardy, although no loss of principal is envisioned. There is a distinct possibility that a partial loss of interest and/or principal will occur if the deficiencies are not corrected. Loss potential, while existing in the aggregate amount of substandard assets, does not have to exist in individual assets classified as substandard.

● Doubtful (Risk Grade 8): Loans classified as doubtful have all of the weaknesses found in substandard loans, with the added characteristic that the weaknesses make collection of debt in full, based on currently existing facts, conditions and values, highly questionable or improbable. Serious problems exist such that partial loss of principal is likely; however, because of certain important, reasonably specific pending factors that may work to strengthen the assets, the loans’ classification as estimated losses is deferred until a more exact status may be determined. Such pending factors may include proposed merger, acquisition or liquidation procedures, capital injection, perfection of liens on additional collateral and refinancing plans. Loans classified as doubtful may include loans to borrowers that have demonstrated a history of failing to live up to agreements.

● Loss (Risk Grade 9): Loans are classified in this category when borrowers are deemed incapable of repayment of unsecured debt. Loans to such borrowers are considered uncollectable and of such little value that continuance as active assets of the Bank is not warranted. This classification does not mean that the loan has absolutely no recovery or salvage value, but rather that it is not prudent to defer writing off these assets, even though partial recovery may be affected in the future.

At ALC, because the loan portfolio is more uniform in nature, each loan is categorized into one of two risk grades, depending on whether the loan is considered to be performing or nonperforming. Performing loans are loans that are paying principal and interest in accordance with a contractual agreement. Nonperforming loans are loans that have demonstrated characteristics that indicate a probability of loss.

The tables below illustrate the carrying amount of loans by credit quality indicator as of June 30, 2018.

	Bank
	Pass 1-5		Special Mention 6		Substandard 7		Doubtful 8		Total
	(Dollars in Thousands)
Loans secured by real estate:
Construction, land development and other land loans	$	22,614	$	83	$	181	$	—	$	22,878
Secured by 1-4 family residential properties		37,831		345		792		—		38,968
Secured by multi-family residential properties		18,374		—		—		—		18,374
Secured by non-farm, non-residential properties		109,454		2,069		938		—		112,461
Other		187		—		—		—		187
Commercial and industrial loans		56,935		2,047		338		—		59,320
Consumer loans		5,334		—		86		—		5,420
Total	$	250,729	$	4,544	$	2,335	$	—	$	257,608

	ALC
	Performing		Nonperforming		Total
	(Dollars in Thousands)
Loans secured by real estate:
Secured by 1-4 family residential properties	$	8,994	$	182	$	9,176
Consumer loans:
Consumer		32,082		820		32,902
Indirect sales		67,078		351		67,429
Total	$	108,154	$	1,353	$	109,507

17

The tables below illustrate the carrying amount of loans by credit quality indicator as of December 31, 2017.

	Bank
	Pass 1-5		Special Mention 6		Substandard 7		Doubtful 8		Total
	(Dollars in Thousands)
Loans secured by real estate:
Construction, land development and other land loans	$	25,872	$	84	$	187	$	—	$	26,143
Secured by 1-4 family residential properties		33,278		339		655		—		34,272
Secured by multi-family residential properties		16,579		—		—		—		16,579
Secured by non-farm, non-residential properties		99,847		4,766		520		—		105,133
Other		190		—		—		—		190
Commercial and industrial loans		67,689		2,066		214		—		69,969
Consumer loans		5,155		—		62		—		5,217
Total	$	248,610	$	7,255	$	1,638	$	—	$	257,503

	ALC
	Performing		Nonperforming		Total
	(Dollars in Thousands)
Loans secured by real estate:
Secured by 1-4 family residential properties	$	10,495	$	306	$	10,801
Consumer loans:
Consumer		32,933		1,150		34,083
Indirect sales		54,611		460		55,071
Total	$	98,039	$	1,916	$	99,955

The following tables provide an aging analysis of past due loans by class as of June 30, 2018.

	Bank
	As of June 30, 2018
	30-59 Days Past Due		60-89 Days Past Due		90 Days Or Greater		Total Past Due		Current		Total Loans		Recorded Investment > 90 Days And Accruing
	(Dollars in Thousands)
Loans secured by real estate:
Construction, land development and other land loans	$	—	$	—	$	—	$	—	$	22,878	$	22,878	$	—
Secured by 1-4 family residential properties		246		36		82		364		38,604		38,968		—
Secured by multi-family residential properties		—		—		—		—		18,374		18,374		—
Secured by non-farm, non-residential properties		483		113		—		596		111,865		112,461		—
Other		—		—		—		—		187		187		—
Commercial and industrial loans		204		19		—		223		59,097		59,320		—
Consumer loans		4		16		—		20		5,400		5,420		—
Total	$	937	$	184	$	82	$	1,203	$	256,405	$	257,608	$	—

18

	ALC
	As of June 30, 2018
	30-59 Days Past Due		60-89 Days Past Due		90 Days Or Greater		Total Past Due		Current		Total Loans		Recorded Investment > 90 Days And Accruing
	(Dollars in Thousands)
Loans secured by real estate:
Construction, land development and other land loans	$	—	$	—	$	—	$	—	$	—	$	—	$	—
Secured by 1-4 family residential properties		69		24		182		275		8,901		9,176		—
Secured by multi-family residential properties		—		—		—		—		—		—		—
Secured by non-farm, non-residential properties		—		—		—		—		—		—		—
Other		—		—		—		—		—		—		—
Commercial and industrial loans		—		—		—		—		—		—		—
Consumer loans:
Consumer		571		362		820		1,753		31,149		32,902		—
Indirect sales		323		137		351		811		66,618		67,429		—
Total	$	963	$	523	$	1,353	$	2,839	$	106,668	$	109,507	$	—

The following tables provide an aging analysis of past due loans by class as of December 31, 2017.

	Bank
	As of December 31, 2017
	30-59 Days Past Due		60-89 Days Past Due		90 Days Or Greater		Total Past Due		Current		Total Loans		Recorded Investment > 90 Days And Accruing
	(Dollars in Thousands)
Loans secured by real estate:
Construction, land development and other land loans	$	—	$	—	$	—	$	—	$	26,143	$	26,143	$	—
Secured by 1-4 family residential properties		227		—		52		279		33,993		34,272		—
Secured by multi-family residential properties		—		—		—		—		16,579		16,579		—
Secured by non-farm, non-residential properties		13		—		—		13		105,120		105,133		—
Other		—		—		—		—		190		190		—
Commercial and industrial loans		70		—		—		70		69,899		69,969		—
Consumer loans		42		—		—		42		5,175		5,217		—
Total	$	352	$	—	$	52	$	404	$	257,099	$	257,503	$	—

19

	ALC
	As of December 31, 2017
	30-59 Days Past Due		60-89 Days Past Due		90 Days Or Greater		Total Past Due		Current		Total Loans		Recorded Investment > 90 Days And Accruing
	(Dollars in Thousands)
Loans secured by real estate:
Construction, land development and other land loans	$	—	$	—	$	—	$	—	$	—	$	—	$	—
Secured by 1-4 family residential properties		61		23		290		374		10,427		10,801		—
Secured by multi-family residential properties		—		—		—		—		—		—		—
Secured by non-farm, non-residential properties		—		—		—		—		—		—		—
Other		—		—		—		—		—		—		—
Commercial and industrial loans		—		—		—		—		—		—		—
Consumer loans:
Consumer		490		323		1,111		1,924		32,159		34,083		—
Indirect sales		281		230		433		944		54,127		55,071		—
Total	$	832	$	576	$	1,834	$	3,242	$	96,713	$	99,955	$	—

The following table provides an analysis of non-accruing loans by class as of June 30, 2018 and December 31, 2017.

	Loans on Non-Accrual Status
	June 30, 2018		December 31, 2017
	(Dollars in Thousands)
Loans secured by real estate:
Construction, land development and other land loans	$	—	$	—
Secured by 1-4 family residential properties		444		501
Secured by multi-family residential properties		—		—
Secured by non-farm, non-residential properties		20		29
Commercial and industrial loans		24		12
Consumer loans:
Consumer		874		1,173
Indirect sales		351		433
Total loans	$	1,713	$	2,148

Impaired Loans

A loan is considered impaired when, based on current information and events, it is probable that the Company will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the related loan agreement. If a loan is impaired, a specific valuation allowance is allocated, if necessary, so that the loan is reported at the present value of estimated future cash flows using the loan’s existing rate or at the fair value of collateral if repayment is expected solely from the liquidation of the collateral at the Bank. All loans of $0.5 million or more that have a credit quality risk grade of seven or above are identified for impairment analysis. At management’s discretion, additional loans may be impaired based on homogeneous factors such as changes in the nature and volume of the portfolio, portfolio quality, adequacy of the underlying collateral value, loan concentrations, historical charge-off trends and economic conditions that may affect the borrower’s ability to pay. At ALC, all real estate loans of $0.1 million or more are identified for impairment analysis. There are currently no loans at ALC that meet that criteria. Impaired loans, or portions thereof, are charged off when deemed uncollectable.

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As of June 30, 2018, the carrying amount of impaired loans at the Bank consisted of the following:

	June 30, 2018
Impaired loans with no related allowance recorded	Carrying Amount		Unpaid Principal Balance		Related Allowances
	(Dollars in Thousands)
Loans secured by real estate
Construction, land development and other land loans	$	—	$	—	$	—
Secured by 1-4 family residential properties		—		—		—
Secured by multi-family residential properties		—		—		—
Secured by non-farm, non-residential properties		—		—		—
Commercial and industrial		—		—		—
Total loans with no related allowance recorded	$	—	$	—	$	—
Impaired loans with an allowance recorded
Loans secured by real estate
Construction, land development and other land loans	$	—	$	—	$	—
Secured by 1-4 family residential properties		185		185		5
Secured by multi-family residential properties		—		—		—
Secured by non-farm, non-residential properties		524		524		17
Commercial and industrial		68		68		68
Total loans with an allowance recorded	$	777	$	777	$	90
Total impaired loans
Loans secured by real estate
Construction, land development and other land loans	$	—	$	—	$	—
Secured by 1-4 family residential properties		185		185		5
Secured by multi-family residential properties		—		—		—
Secured by non-farm, non-residential properties		524		524		17
Commercial and industrial		68		68		68
Total impaired loans	$	777	$	777	$	90

21

As of December 31, 2017, the carrying amount of impaired loans at the Bank consisted of the following:  

	December 31, 2017
Impaired loans with no related allowance recorded	Carrying Amount		Unpaid Principal Balance		Related Allowances
	(Dollars in Thousands)
Loans secured by real estate
Construction, land development and other land loans	$	—	$	—	$	—
Secured by 1-4 family residential properties		—		—		—
Secured by multi-family residential properties		—		—		—
Secured by non-farm, non-residential properties		—		—		—
Commercial and industrial		—		—		—
Total loans with no related allowance recorded	$	—	$	—	$	—
Impaired loans with an allowance recorded
Loans secured by real estate
Construction, land development and other land loans	$	—	$	—	$	—
Secured by 1-4 family residential properties		187		187		5
Secured by multi-family residential properties		—		—		—
Secured by non-farm, non-residential properties		532		532		21
Commercial and industrial		72		72		72
Total loans with an allowance recorded	$	791	$	791	$	98
Total impaired loans
Loans secured by real estate
Construction, land development and other land loans	$	—	$	—	$	—
Secured by 1-4 family residential properties		187		187		5
Secured by multi-family residential properties		—		—		—
Secured by non-farm, non-residential properties		532		532		21
Commercial and industrial		72		72		72
Total impaired loans	$	791	$	791	$	98

The average net investment in impaired loans and interest income recognized and received on impaired loans during the six months ended June 30, 2018 and the year ended December 31, 2017 were as follows:

	June 30, 2018
	Average Recorded Investment		Interest Income Recognized		Interest Income Received
	(Dollars in Thousands)
Loans secured by real estate
Construction, land development and other land loans	$	—	$	—	$	—
Secured by 1-4 family residential properties		186		6		3
Secured by multi-family residential properties		—		—		—
Secured by non-farm, non-residential properties		526		17		9
Commercial and industrial		68		2		2
Total	$	780	$	25	$	14

22

	December 31, 2017
	Average Recorded Investment		Interest Income Recognized		Interest Income Received
	(Dollars in Thousands)
Loans secured by real estate
Construction, land development and other land loans	$	902	$	—	$	—
Secured by 1-4 family residential properties		190		13		14
Secured by multi-family residential properties		—		—		—
Secured by non-farm, non-residential properties		537		35		35
Commercial and industrial		59		7		5
Total	$	1,688	$	55	$	54

Loans on which the accrual of interest has been discontinued amounted to $1.7 million and $2.1 million as of June 30, 2018 and December 31, 2017, respectively. If interest on those loans had been accrued, there would have been $10 thousand and $19 thousand of interest accrued for the periods ended June 30, 2018 and December 31, 2017, respectively. Interest income related to these loans as of June 30, 2018 and December 31, 2017 was $2 thousand and $3 thousand, respectively.

Troubled Debt Restructurings

Troubled debt restructurings include loans with respect to which concessions have been granted to borrowers that generally would not have otherwise been considered had the borrowers not been experiencing financial difficulty. The concessions granted may include payment schedule modifications, interest rate reductions, maturity date extensions, modifications of note structure, principal balance reductions or some combination of these concessions. There were no loans modified with concessions granted during the six-month period ended June 30, 2018. Restructured loans may involve loans remaining on non-accrual, moving to non-accrual or continuing on accrual status, depending on the individual facts and circumstances of the borrower. Non-accrual restructured loans are included with all other non-accrual loans. In addition, all accruing restructured loans are reported as troubled debt restructurings. Generally, restructured loans remain on non-accrual until the customer has attained a sustained period of repayment performance under the modified loan terms (generally a minimum of six months). However, performance prior to the restructuring, or significant events that coincide with the restructuring, are considered in assessing whether the borrower can meet the new terms and whether the loan should be returned to or maintained on non-accrual status. If the borrower’s ability to meet the revised payment schedule is not reasonably assured, then the loan remains on non-accrual. As of both June 30, 2018 and December 31, 2017, the Company had $0.1 million of non-accruing loans that were previously restructured and that remained on non-accrual status. For both the six months ended June 30, 2018 and the year ended December 31, 2017, the Company had no loans that were restored to accrual status based on a sustained period of repayment performance.

The following table provides the number of loans remaining in each loan category, as of June 30, 2018 and December 31, 2017, that the Bank had previously modified in a troubled debt restructuring, as well as the pre- and post-modification principal balance as of each date.

	June 30, 2018						December 31, 2017
	Number of Loans		Pre- Modification Outstanding Principal Balance		Post- Modification Principal Balance		Number of Loans		Pre- Modification Outstanding Principal Balance		Post- Modification Principal Balance
	(Dollars in Thousands)
Loans secured by real estate:
Construction, land development and other land loans		1	$	107	$	78		1	$	107	$	82
Secured by 1-4 family residential properties		3		318		132		3		318		165
Secured by non-farm, non-residential properties		1		53		36		1		53		37
Commercial loans		2		116		78		2		116		81
Total		7	$	594	$	324		7	$	594	$	365

23

As of June 30, 2018 and December 31, 2017, no loans that previously had been modified in a troubled debt restructuring had defaulted subsequent to modification.

Restructured loan modifications primarily included maturity date extensions and payment schedule modifications. There were no modifications to principal balances of the loans that were restructured. Accordingly, there was no impact on the Company’s allowance for loan losses resulting from the modifications.

All loans with a principal balance of $0.5 million or more that have been modified in a troubled debt restructuring are considered impaired and evaluated individually for impairment. The nature and extent of impairment of restructured loans, including those that have experienced a subsequent payment default, are considered in the determination of an appropriate level of allowance for loan losses. This evaluation resulted in an allowance for loan losses attributable to such restructured loans of $2 thousand as of both June 30, 2018 and December 31, 2017.

5. OTHER REAL ESTATE OWNED AND REPOSSESSIONS

Other real estate and certain other assets acquired in foreclosure are reported at the net realizable value of the property, less estimated costs to sell. The following tables summarize foreclosed property activity as of the six months ended June 30, 2018 and 2017:

	June 30, 2018
	Bank			ALC			Total
	(Dollars in Thousands)
Beginning balance	$	3,527		$	265		$	3,792
Additions (1)		106			25			131
Sales proceeds		(1,598	)		(43	)		(1,641	)
Gross gains		121			—			121
Gross losses		(45	)		(54	)		(99	)
Net gains (losses)		76			(54	)		22
Impairment		(109	)		(14	)		(123	)
Ending balance	$	2,002		$	179		$	2,181

	June 30, 2017
	Bank			ALC			Total
	(Dollars in Thousands)
Beginning balance	$	4,353		$	505		$	4,858
Additions (1)		—			68			68
Sales proceeds		(369	)		(125	)		(494	)
Gross gains		14			—			14
Gross losses		(1	)		(48	)		(49	)
Net gains (losses)		13			(48	)		(35	)
Impairment		(46	)		—			(46	)
Ending balance	$	3,951		$	400		$	4,351

⁽¹⁾Additions to other real estate owned (“OREO”) include transfers from loans and capitalized improvements to existing OREO properties.

Valuation adjustments are recorded in other non-interest expense and are primarily post-foreclosure write-downs that are a result of continued declining property values based on updated appraisals or other indications of value, such as offers to purchase. Net realizable value less estimated costs to sell of foreclosed residential real estate held by the Company was $0.5 million and $0.8 million as of June 30, 2018 and 2017, respectively. In addition, the Company held $48 thousand and $62 thousand in consumer mortgage loans collateralized by residential real estate that were in the process of foreclosure as of June 30, 2018 and 2017, respectively.

Repossessions

In addition to the other real estate and other assets acquired in foreclosure, ALC also acquires assets through the repossession of the underlying collateral of loans in default. Total repossessed assets at ALC as of June 30, 2018 and December 31, 2017 were $0.1 million and $0.2 million, respectively.

24

6. INVESTMENT IN LIMITED PARTNERSHIP

The Bank holds an investment in an affordable housing project for which it provides funding as a limited partner and has received tax credits related to its investment in the project based on its partnership share. The net assets of the partnership consist primarily of apartment complexes, and the primary liabilities consist of those associated with the operation of the partnership. The Company has determined that this investment requires consolidation as a variable interest entity under ASC Topic 810, Consolidation. The Company holds a 99.9% interest in the limited partnership. Assets recorded by the Company as a result of the consolidation were less than $0.1 million as of both June 30, 2018 and December 31, 2017.

7. SHORT-TERM BORROWINGS

Short-term borrowings consist of federal funds purchased, securities sold under repurchase agreements, and short-term Federal Home Loan Bank (“FHLB”) advances with original maturities of one year or less. Short-term borrowings totaled $10.4 million and $15.6 million as of June 30, 2018 and December 31, 2017, respectively.

Federal funds purchased, which represent unsecured lines of credit that generally mature within one to four days, are available to the Bank through arrangements with correspondent banks and the Federal Reserve. As of both June 30, 2018 and December 31, 2017, there were no federal funds purchased outstanding, and the Bank had $18.8 million in available unused lines of credit with correspondent banks and the Federal Reserve.

Securities sold under repurchase agreements, which are secured borrowings, generally are reflected at the amount of cash received in connection with the transaction. The Bank may be required to provide additional collateral based on the fair value of the underlying securities. The Bank monitors the fair value of the underlying securities on a daily basis. Securities sold under repurchase agreements as of June 30, 2018 and December 31, 2017 totaled $0.4 million and $0.6 million, respectively.

Short-term FHLB advances are secured borrowings available to the Bank as an alternative funding source. As of June 30, 2018 and December 31, 2017, the Bank had $10.0 million and $15.0 million, respectively, in outstanding FHLB advances with original maturities of less than one year. 

8. LONG-TERM DEBT

The Company uses FHLB advances as an alternative to funding sources with similar maturities, such as certificates of deposit or other deposit programs. These advances generally offer more attractive rates than other mid-term financing options. They are also flexible, allowing the Company to quickly obtain the necessary maturities and rates that best suit its overall asset/liability strategy. FHLB advances with an original maturity of more than one year are classified as long-term. The Company had long-term FHLB advances outstanding of $10.0 million as of both June 30, 2018 and December 31, 2017. 

Assets pledged associated with FHLB advances totaled $21.5 million and $26.0 million as of June 30, 2018 and December 31, 2017, respectively. As of June 30, 2018 and December 31, 2017, the Bank had $168.1 million and $159.3 million, respectively, in remaining credit from the FHLB (subject to available collateral).

9. INCOME TAXES

The Tax Cuts and Jobs Act of 2017 (“Tax Reform”) was enacted in December 2017. This legislation made significant changes in federal tax law, including a reduction in the corporate income tax rates, changes to net operating loss carryforwards and carrybacks and a repeal of the corporate alternative minimum tax. The legislation reduced the U.S. corporate income tax rate to 21% beginning in 2018.

The Company’s provision for income taxes was $0.2 million and $0.3 million for the six-month periods ended June 30, 2018 and 2017, respectively. The Company’s effective tax rate was 17.3% and 24.2%, respectively, for the same periods. The effective tax rate is impacted by recurring permanent differences, such as those associated with bank-owned life insurance and tax-exempt investment and loan income. The reduced effective tax rate for the six months ended June 30, 2018 compared to the same period of 2017 resulted from the reduction in the Company's statutory federal rate under Tax Reform.

The Company had a net deferred tax asset of $5.9 million and $5.6 million as of June 30, 2018 and December 31, 2017, respectively. The increase in the net deferred tax asset resulted primarily from the impact of changes in the fair value of securities available-for-sale.

25

10. DEFERRED COMPENSATION PLANS

The Bank has entered into supplemental retirement compensation benefits agreements with certain directors and executive officers. The measurement of the liability under these agreements includes estimates involving life expectancy, length of time before retirement and the expected returns on the bank-owned life insurance policies used to fund those agreements. Should these estimates prove materially wrong, the cost of these agreements could change accordingly. The related deferred compensation obligation to these directors and executive officers included in other liabilities was $3.4 million and $3.5 million as of June 30, 2018 and December 31, 2017, respectively.

Non-employee directors may elect to defer payment of all or any portion of their Bancshares and Bank director fees under Bancshares’ Non-Employee Directors’ Deferred Compensation Plan (the “Deferral Plan”). The Deferral Plan permits non-employee directors to invest their directors’ fees and to receive the adjusted value of the deferred amounts in cash and/or shares of Bancshares’ common stock. Neither Bancshares nor the Bank makes any contribution to participants’ accounts under the Deferral Plan.  As of June 30, 2018 and December 31, 2017, a total of 109,450 and 103,620 shares of Bancshares common stock, respectively, were deferred in connection with the Deferral Plan. All deferred fees, whether in the form of cash or shares of Bancshares common stock, are reflected as compensation expense in the period earned. The Company classifies all deferred directors’ fees allocated to be paid in shares as equity surplus. The Company uses shares of treasury stock to satisfy these obligations when due.  

11. STOCK AWARDS

In accordance with the Company’s 2013 Incentive Plan, stock awards, including stock options and restricted stock, have been granted to certain employees and non-employee directors. Shares of common stock available for distribution to satisfy the grants may consist, in whole or in part, of authorized and unissued shares, treasury shares or shares reacquired by the Company in any manner. Stock-based compensation expense related to stock awards totaled $0.1 million for both of the six-month periods ended June 30, 2018 and 2017.

Stock Options

Stock option awards have been granted with an exercise price equal to the market price of the Company’s common stock on the date of the grant and have vesting periods ranging from one to three years, with 10-year contractual terms. 

The Company recognizes the cost of services received in exchange for stock option awards based on the grant date fair value of the award, with compensation expense recognized on a straight-line basis over the award’s vesting period. The fair value of outstanding awards was determined using the Black-Scholes option pricing model based on the assumptions noted in the table below. Expected volatilities are based on historical volatilities of the Company’s common stock.

	2018			2017
Risk-free interest rate		2.77	%		2.23	%
Expected term (in years)		7.5			7.5
Expected stock price volatility		28.3	%		25.4	%
Dividend yield		1.50	%		1.50	%

The following table summarizes the Company's stock option activity for the periods presented.

	Six Months Ended
	June 30, 2018				June 30, 2017
	Number of Shares		Average Exercise Price		Number of Shares		Average Exercise Price
Options:
Outstanding, beginning of period		318,000	$	9.43		272,550	$	8.21
Granted		62,150		11.71		68,600		13.91
Exercised		—		—		19,316		8.15
Expired		—		—		—		—
Forfeited		1,450		11.05		3,333		11.79
Options outstanding, end of period		378,700	$	9.80		318,501	$	9.41
Options exercisable, end of period		249,300	$	8.71		208,633	$	8.20

The aggregate intrinsic value of stock options outstanding (calculated as the amount by which the market value of underlying stock exceeds the exercise price of the option) was approximately $0.9 million and $0.8 million as of June 30, 2018 and 2017, respectively.

Restricted Stock

During the first six months of 2018 and 2017, respectively, Bancshares granted 10,520 shares and 7,533 shares of restricted stock under its 2013 Incentive Plan. The Company recognizes the cost of services received in exchange for restricted stock awards based on the grant date closing price of the stock, with compensation expense recognized on a straight-line basis over the award’s vesting period. 

26

12. DERIVATIVE FINANCIAL INSTRUMENTS

The Company is exposed to certain risks arising from both its business operations and economic conditions. The Company principally manages its exposures to a wide variety of business and operational risks through management of its core business activities. The Company manages economic risks, including interest rate, liquidity and credit risk, primarily by managing the amount, sources and duration of certain balance sheet assets and liabilities. In the normal course of business, the Company also uses derivative financial instruments to add stability to interest income or expense and to manage its exposure to movements in interest rates. The Company does not use derivatives for trading or speculative purposes and only enters into transactions that have a qualifying hedging relationship. The Company's hedging strategies involving interest rate derivatives are classified as either Fair Value Hedges or Cash Flow Hedges, depending upon the rate characteristic of the hedged item.

Effective April 5, 2016, the Bank entered into a forward interest rate swap contract on a variable-rate FHLB advance (indexed to three-month LIBOR) with a total notional amount of $10.0 million. The FHLB advance will be renewed at least every 18 months and will remain outstanding until April 5, 2023. The interest rate swap was designated as a derivative instrument in a cash flow hedge with the objective of protecting the quarterly interest rate payments on the FHLB advance from the risk of variability of those payments resulting from changes in the three-month LIBOR interest rate throughout the seven-year period beginning on April 5, 2016 and ending on April 5, 2023. Under the swap arrangement, the Bank will pay a fixed interest rate of 1.46% and receive a variable interest rate based on three-month LIBOR on the notional amount of $10.0 million, with quarterly net settlements.

On October 18, 2017, the Bank entered into a forward interest rate swap contract on a variable-rate FHLB advance (indexed to three-month LIBOR) with a total notional amount of $10.0 million. The FHLB advance will be renewed on at least a semi-annual basis and will remain outstanding until October 18, 2024. The interest rate swap was designated as a derivative instrument in a cash flow hedge with the objective of protecting the quarterly interest rate payments on the FHLB advance from the risk of variability of those payments resulting from changes in the three-month LIBOR interest rate throughout the seven-year period beginning on October 18, 2017 and ending on October 18, 2024. Under the swap arrangement, which became effective on October 18, 2017, the Bank will pay a fixed interest rate of 2.16% and receive a variable interest rate based on three-month LIBOR on the notional amount of $10.0 million, with quarterly net settlements.

No ineffectiveness related to the interest rate swaps designated as cash flow hedges was recognized in the consolidated statements of operations for the three- or six-month periods ended June 30, 2018. The accumulated net after-tax gain related to the effective cash flow hedge included in accumulated other comprehensive income totaled $0.7 million and $0.3 million as of June 30, 2018 and December 31, 2017, respectively.

Subsequent to June 30, 2018, the Bank voluntarily settled both of its forward interest rate swap contracts with the counterparty and concurrently paid down the associated hedged variable-rate FHLB advances. Since the forecasted transactions (the variable interest rate payments associated with the FHLB advances) are no longer expected to occur as previously expected, all amounts associated with the fair value of the derivative assets and net after-tax gains recorded in accumulated other comprehensive income will be recognized as gains during the third quarter of 2018. The amounts to be recognized as gains total approximately $1.0 million on a pre-tax basis and $0.7 million on an after-tax basis.

13. SEGMENT REPORTING

Under ASC Topic 280, Segment Reporting, certain information is disclosed for the two reportable operating segments of Bancshares: the Bank and ALC. The reportable segments were determined using the internal management reporting system. These segments comprise Bancshares’ and the Bank’s significant subsidiaries. The accounting policies for each segment are the same as those described in Note 2, “Summary of Significant Accounting Policies,” of the Notes to Consolidated Financial Statements in the Company’s Annual Report on Form 10-K as of and for the year ended December 31, 2017. The segment results include certain overhead allocations and intercompany transactions that were recorded at current market prices. All intercompany transactions have been eliminated to determine the consolidated balances. The results for the two reportable segments of the Company are included in the tables below.

27

					All
	Bank		ALC		Other			Eliminations			Consolidated
	(Dollars in Thousands)
As of and for the three months ended June 30, 2018:
Net interest income	$	4,244	$	3,254	$	4		$	—		$	7,502
Provision for loan losses		—		702		—			—			702
Total non-interest income		948		272		684			(772	)		1,132
Total non-interest expense		4,888		2,426		365			(187	)		7,492
Income before income taxes		304		398		323			(585	)		440
Provision for income taxes		60		82		(61	)		—			81
Net income	$	244	$	316	$	384		$	(585	)	$	359
Other significant items:
Total assets	$	636,623	$	103,624	$	81,132		$	(187,343	)	$	634,036
Total investment securities		165,660		—		80			—			165,740
Total loans, net		345,673		100,792		—			(90,936	)		355,529
Investment in subsidiaries		5		—		75,241			(75,241	)		5
Fixed asset additions		439		55		—			—			494
Depreciation and amortization expense		321		32		—			—			353
Total interest income from external customers		3,983		4,407		—			—			8,390
Total interest income from affiliates		1,154		—		4			(1,158	)		—
For the six months ended June 30, 2018:
Net interest income	$	8,361	$	6,447	$	8		$	—		$	14,816
Provision for loan losses		39		1,321		—			—			1,360
Total non-interest income		1,815		528		1,537			(1,608	)		2,272
Total non-interest expense		9,419		4,950		812			(388	)		14,793
Income before income taxes		718		704		733			(1,220	)		935
Provision for income taxes		130		152		(120	)		—			162
Net income	$	588	$	552	$	853		$	(1,220	)	$	773
Other significant items:
Fixed asset additions		658		57		—			—			715
Depreciation and amortization expense		639		65		—			—			704
Total interest income from external customers		7,820		8,689		—			—			16,509
Total interest income from affiliates		2,243		—		8			(2,251	)		—

28

					All
	Bank		ALC		Other			Eliminations			Consolidated
	(Dollars in Thousands)
As of and for the three months ended June 30, 2017:
Net interest income	$	4,066	$	2,988	$	3		$	—		$	7,057
Provision (reduction in reserve) for loan losses		—		576		—			—			576
Total non-interest income		806		237		647			(760	)		930
Total non-interest expense		4,422		2,286		310			(155	)		6,863
Income before income taxes		450		363		340			(605	)		548
Provision for income taxes		103		126		(97	)		—			132
Net income	$	347	$	237	$	437		$	(605	)	$	416
Other significant items:
Total assets	$	618,431	$	91,629	$	83,655		$	(177,497	)	$	616,218
Total investment securities		200,751		—		80			—			200,831
Total loans, net		321,797		88,049		—			(79,320	)		330,526
Investment in subsidiaries		5		—		78,036			(78,036	)		5
Fixed asset additions		3,735		28		—			—			3,763
Depreciation and amortization expense		218		42		—			—			260
Total interest income from external customers		3,506		4,177		—			—			7,683
Total interest income from affiliates		1,189		—		3			(1,192	)		—
For the six months ended June 30, 2017:
Net interest income	$	7,977	$	5,993	$	6		$	—		$	13,976
Provision (reduction in reserve) for loan losses		—		1,091		—			—			1,091
Total non-interest income		1,642		480		1,498			(1,523	)		2,097
Total non-interest expense		8,823		4,662		739			(324	)		13,900
Income before income taxes		796		720		765			(1,199	)		1,082
Provision for income taxes		201		256		(195	)		—			262
Net income	$	595	$	464	$	960		$	(1,199	)	$	820
Other significant items:
Fixed asset additions		7,760		90		—			—			7,850
Depreciation and amortization expense		419		83		—			—			502
Total interest income from external customers		6,897		8,296		—			—			15,193
Total interest income from affiliates		2,302		—		6			(2,308	)		—

29

14. GUARANTEES, COMMITMENTS AND CONTINGENCIES

The Bank’s exposure to credit loss in the event of nonperformance by the other party for commitments to make loans and standby letters of credit is represented by the contractual amount of those instruments. The Bank uses the same credit policies in making these commitments as it does for on-balance sheet instruments. For interest rate swap transactions and commitments to purchase or sell securities for forward delivery, the contract or notional amounts do not represent exposure to credit loss. The Bank controls the credit risk of these derivative instruments through credit approvals, limits and monitoring procedures. Certain derivative contracts have credit risk for the carrying value plus the amount to replace such contracts in the event of counterparty default. All of the Bank’s financial instruments are held for risk management and not for trading purposes. During the six-month periods ended June 30, 2018 and 2017, there were no credit losses associated with derivative contracts.

In the normal course of business, there are outstanding commitments and contingent liabilities, such as commitments to extend credit, letters of credit and others, that are not included in the consolidated financial statements. The financial instruments involve, to varying degrees, elements of credit and interest rate risk in excess of amounts recognized in the financial statements. A summary of these commitments and contingent liabilities is presented below:

	June 30, 2018		December 31, 2017
	(Dollars in Thousands)
Standby letters of credit	$	180	$	180
Commitments to extend credit	$	42,875	$	55,801

Standby letters of credit are contingent commitments issued by the Bank generally to guarantee the performance of a customer to a third party. The Bank has recourse against the customer for any amount that it is required to pay to a third party under a standby letter of credit. Revenues are recognized over the lives of the standby letters of credit. As of June 30, 2018 and December 31, 2017, the potential amount of future payments that the Bank could be required to make under its standby letters of credit, which represent the Bank’s total credit risk in this category, is included in the table above.

A commitment to extend credit is an agreement to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. The Bank evaluates each customer’s creditworthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary by the Bank upon the extension of credit, is based on management’s credit evaluation of the counterparty. Collateral held varies but may include accounts receivable, inventory, property, plant and equipment and income-producing commercial properties.

Commitments to purchase securities for delayed delivery require the Bank to purchase a specified security at a specified price for delivery on a specified date. Similarly, commitments to sell securities for delayed delivery require the Bank to sell a specified security at a specified price for delivery on a specified date. Market risk arises from potential movements in security values and interest rates between the commitment and delivery dates. As of both June 30, 2018 and December 31, 2017, there were no outstanding commitments to purchase securities for delayed delivery and no outstanding commitments to sell securities for delayed delivery.

The Company is self-insured for a significant portion of employee health benefits. However, the Company maintains stop-loss coverage with third-party insurers to limit the Company’s individual claim and total exposure related to self-insurance. The Company estimates the accrued liability for the ultimate costs to close known claims, as well as claims incurred but not yet reported, as of the balance sheet date. The Company’s recorded estimated liability for self-insurance is based on the insurance companies’ incurred loss estimates and management’s judgment, including assumptions and factors related to the frequency and severity of claims, the Company’s claims development history and the Company’s claims settlement practices. The assessment of loss contingencies and self-insurance reserves is a highly subjective process that requires judgments about future events. Contingencies are reviewed at least quarterly to determine the adequacy of self-insurance accruals. Self-insurance accruals totaled $0.2 million as of both June 30, 2018 and December 31, 2017. The ultimate settlement of loss contingencies and self-insurance reserves may differ significantly from amounts accrued in the Company’s consolidated financial statements.

Subsequent to June 30, 2018, the Bank entered into an agreement with a third party to lease all unused remaining office space at the Bank’s Birmingham, Alabama location (known as “Pump Hose Plaza”). Under the terms of the lease, the Bank agreed to pay for a one-time build-out of the tenant space, subject to a maximum amount. The total cost to the Bank under the agreement is estimated to be approximately $2.8 million. Depreciation of the costs will commence upon the effective date of the lease, which is scheduled for the fourth quarter of 2018.

Litigation

The Company is party to certain ordinary course litigation from time to time, and the Company intends to vigorously defend itself in all such litigation. In the opinion of the Company, based on review and consultation with legal counsel, the outcome of such ordinary course litigation should not have a material adverse effect on the Company’s consolidated financial statements or results of operations.

30

15. FAIR VALUE OF FINANCIAL INSTRUMENTS

The Company follows the provisions of ASC Topic 820, Fair Value Measurements and Disclosures, which defines fair value, establishes a framework for measuring fair value and expands disclosures about fair value measurements. The assumptions used in the estimation of the fair value of the Company’s financial instruments are detailed below. The following disclosures should not be considered a surrogate of the liquidation value of the Company, but rather represent a good-faith estimate of the increase or decrease in value of financial instruments held by the Company since purchase, origination or issuance.

Fair Value Hierarchy

Fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between willing market participants at the measurement date. In determining fair value, the Company uses various methods, including market, income and cost approaches. Based on these approaches, the Company often utilizes certain assumptions that market participants would use in pricing the asset or liability, including assumptions about risk and/or the risks inherent in the inputs to the valuation technique. These inputs can be readily observable, market-corroborated or generally unobservable inputs. The Company utilizes valuation techniques that maximize the use of observable inputs and minimize the use of unobservable inputs. Based on the observability of the inputs used in the valuation techniques, the Company is required to provide the following information according to the fair value hierarchy. The fair value hierarchy ranks the quality and reliability of the information used to determine fair values. Assets and liabilities carried at fair value will be classified and disclosed in one of the following three categories:

● Level 1 — Valuations for assets and liabilities traded in active exchange markets, such as the New York Stock Exchange or Nasdaq. Valuations are obtained from readily available pricing sources for market transactions involving identical assets or liabilities.

● Level 2 — Valuations for assets and liabilities traded in less active dealer or broker markets. Valuations are obtained from third-party pricing services for identical or similar assets or liabilities.

● Level 3 — Valuations for assets and liabilities that are derived from other valuation methodologies, including option pricing models, discounted cash flow models and similar techniques, and not based on market exchange, dealer or broker-traded transactions. Level 3 valuations incorporate certain assumptions and projections in determining the fair value assigned to such assets or liabilities.

The Company rarely transfers assets and liabilities measured at fair value between Level 1 and Level 2 measurements. Trading account assets and securities available-for-sale may be periodically transferred to or from Level 3 valuation based on management’s conclusion regarding the best method of pricing for an individual security. Such transfers are accounted for as if they occurred at the beginning of a reporting period. There were no such transfers during the six months ended June 30, 2018 or the year ended December 31, 2017.

Fair Value Measurements on a Recurring Basis

Securities Available-for-Sale

Where quoted market prices are available in an active market, securities are classified within Level 1 of the valuation hierarchy. Level 1 securities include exchange-traded equities. Level 2 securities include U.S. Treasury and agency securities, mortgage-backed agency securities, obligations of states and political subdivisions and certain corporate, asset-backed and other securities. Level 2 fair values are obtained from quoted prices of securities with similar characteristics. In certain cases, where Level 1 or Level 2 inputs are not available, securities are classified within Level 3 of the hierarchy.

Interest Rate Derivative Agreements

Interest rate derivative agreements are used by the Company to mitigate risk associated with changes in interest rates. The fair value of these agreements is based on information obtained from third-party financial institutions. This information is periodically evaluated by the Company and, as necessary, corroborated against other third-party valuations. The Company classifies these derivative assets within Level 2 of the valuation hierarchy.

31

The following table presents assets measured at fair value on a recurring basis as of June 30, 2018 and December 31, 2017. There were no liabilities measured at fair value on a recurring basis for either period presented.

	Fair Value Measurements as of June 30, 2018 Using
	Totals At June 30, 2018		Quoted Prices in Active Markets For Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
	(Dollars in Thousands)
Investment securities, available-for-sale
Mortgage-backed securities:
Residential	$	78,688	$	—	$	78,688	$	—
Commercial		61,619		—		61,619		—
Obligations of states and political subdivisions		1,034		—		1,034		—
U.S. Treasury securities		80		—		80		—
Other assets - derivatives		977		—		977		—

	Fair Value Measurements as of December 31, 2017 Using
	Totals At December 31, 2017		Quoted Prices in Active Markets For Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
	(Dollars in Thousands)
Investment securities, available-for-sale
Mortgage-backed securities:
Residential	$	82,786	$	—	$	82,786	$	—
Commercial		66,074		—		66,074		—
Obligations of states and political subdivisions		4,931		—		4,931		—
U.S. Treasury securities		80		—		80		—
Other assets - derivatives		443		—		443		—

Fair Value Measurements on a Non-recurring Basis

Impaired Loans

Loans that are considered impaired are loans for which, based on current information and events, it is probable that the Company will be unable to collect all principal and interest payments due under the contractual terms of the loan agreement. Impaired loans can be measured based on the present value of expected payments using the loan’s original effective rate as the discount rate, the loan’s observable market price, or the fair value of the collateral less estimated selling cost if the loan is collateral-dependent. For the Company, the fair value of impaired loans is primarily measured based on the value of the collateral securing the loans (typically real estate). The Company determines the fair value of the collateral based on independent appraisals performed by qualified licensed appraisers. The appraisals may include a single valuation approach or a combination of approaches, including comparable sales and income approaches. Appraised values are discounted for estimated costs to sell and may be discounted further based on management’s knowledge of the collateral, changes in market conditions since the most recent appraisal and/or management’s knowledge of the borrower and the borrower’s business. Such discounts by management are subjective and are typically significant unobservable inputs for determining fair value. Impaired loans are evaluated by management for additional impairment at least quarterly and are adjusted accordingly.

32

OREO

OREO consists of properties obtained through foreclosure or in satisfaction of loans and is recorded at net realizable value, less estimated cost to sell. Estimates of fair value are generally based on third-party appraisals of the property and are classified within Level 3 of the fair value hierarchy. The appraisals are sometimes discounted based on management’s knowledge of the property and/or changes in market conditions from the date of the most recent appraisal. Such discounts are typically significant unobservable inputs for determining fair value.

Assets Held-for-Sale

Included within other assets are certain assets that were formerly included as premises and equipment but have been removed from service, and as of the balance sheet date, were designated as assets to be disposed of by sale. These include assets associated with branches of the Bank that have been closed. When an asset is designated as held-for-sale, the Company ceases depreciation of the asset, and the asset is recorded at the lower of its carrying amount or fair value less estimated cost to sell. Estimates of fair value are generally based on third-party appraisals of the property and are classified within Level 3 of the fair value hierarchy. The appraisals are sometimes discounted based on management’s knowledge of the property and/or changes in market conditions from the date of the most recent appraisal. Such discounts are typically unobservable inputs for determining fair value.

The following table presents the balances of impaired loans, OREO and assets held-for-sale measured at fair value on a non-recurring basis as of June 30, 2018 and December 31, 2017.

	Fair Value Measurements as of June 30, 2018 Using
	Totals At June 30, 2018		Quoted Prices in Active Markets For Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
	(Dollars in Thousands)
Impaired loans	$	691	$	—	$	—	$	691
OREO		2,181		—		—		2,181
Assets held-for-sale		198		—		—		198

	Fair Value Measurements as of December 31, 2017 Using
	Totals At December 31, 2017		Quoted Prices in Active Markets For Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
	(Dollars in Thousands)
Impaired loans	$	694	$	—	$	—	$	694
OREO		3,792		—		—		3,792
Assets held-for-sale		228		—		—		228

33

Non-recurring Fair Value Measurements Using Significant Unobservable Inputs

The following table presents information regarding assets and liabilities measured at fair value using significant unobservable inputs (Level 3) as of June 30, 2018. The table includes the valuation techniques and the significant unobservable inputs utilized. The range of each unobservable input and the weighted average within the range utilized as of June 30, 2018 are both included. Following the table is a description of the valuation technique and the sensitivity of the technique to changes in the significant unobservable input.

	Level 3 Significant Unobservable Input Assumptions
	Fair Value June 30, 2018		Valuation Technique	Unobservable Input	Quantitative Range of Unobservable Inputs (Weighted Average)
	(Dollars in Thousands)
Non-recurring fair value measurements:
Impaired loans	$	691	Multiple data points, including discount to appraised value of collateral based on recent market activity	Appraisal comparability adjustment (discount)	9%	-	10%	(9.5%)
OREO	$	2,181	Discount to appraised value of property based on recent market activity for sales of similar properties	Appraisal comparability adjustment (discount)	9%	-	10%	(9.5%)
Assets held-for-sale	$	198	Discount to appraised value of property based on recent market activity for sales of similar properties	Appraisal comparability adjustment (discount)	9%	-	10%	(9.5%)

Impaired Loans

Impaired loans are valued based on multiple data points indicating the fair value for each loan. The primary data point is the appraisal value of the underlying collateral, to which a discount is applied. Management establishes this discount or comparability adjustment based on recent sales of similar property types. As liquidity in the market increases or decreases, the comparability adjustment and the resulting asset valuation are impacted.

OREO

OREO under a binding contract for sale is valued based on contract price. If no sale contract is pending for a specific property, management establishes a comparability adjustment to the appraised value based on historical activity, considering proceeds for properties sold versus the corresponding appraised value. Increases or decreases in realization for properties sold impact the comparability adjustment for similar assets remaining on the balance sheet.

Assets Held-for-Sale

Assets designated as held-for-sale that are under a binding contract are valued based on the contract price. If no sale contract is pending for a specific property, management establishes a comparability adjustment to the appraised value based on historical activity, considering proceeds for properties sold versus the corresponding appraised value. Increases or decreases in realization for properties sold impact the comparability adjustment for similar assets remaining on the balance sheet.

Fair Value of Financial Instruments

ASC Topic 825, Financial Instruments, requires disclosure of fair value information about financial instruments, whether or not recognized on the face of the balance sheet, for which it is practicable to estimate that value. The following methods and assumptions were used by the Company in estimating the fair value of its financial instruments:

Cash, due from banks and federal funds sold: The carrying amount of cash, due from banks and federal funds sold approximates fair value.

Federal Home Loan Bank stock: Based on the redemption provision of the FHLB, the stock has no quoted market value and is carried at cost.

Investment securities: Fair values of investment securities are based on quoted market prices where available. If quoted market prices are not available, estimated fair values are based on market prices of comparable instruments.

Derivative instruments: The fair value of derivative instruments is based on information obtained from a third-party financial institution. This information is periodically evaluated by the Company and, as necessary, corroborated against other third-party information.

Accrued interest receivable and payable: The carrying amount of accrued interest approximates fair value.

34

Loans, net: For variable-rate loans, fair values are based on carrying values. Fixed-rate commercial loans, other installment loans and certain real estate mortgage loans are valued using discounted cash flows. The discount rate used to determine the present value of these loans is based on interest rates charged by the Company on comparable loans as to credit risk and term at the determination date.

Demand and savings deposits: The fair values of demand deposits are equal to the carrying value of such deposits. Demand deposits include non-interest-bearing demand deposits, savings accounts, NOW accounts and money market demand accounts.

Time deposits: The fair values of relatively short-term time deposits are equal to their carrying values. Discounted cash flows are used to value long-term time deposits. The discount rate used is based on interest rates currently being offered by the Company on comparable deposits as to amount and term.

Short-term borrowings: These borrowings may consist of federal funds purchased, securities sold under agreements to repurchase and the floating rate borrowings from the FHLB account. Due to the short-term nature of these borrowings, fair values approximate carrying values.

Long-term debt: The fair value of this debt is estimated using discounted cash flows based on the Company’s current incremental borrowing rate for similar types of borrowing arrangements as of the determination date.

Off-balance sheet instruments: The carrying amount of commitments to extend credit and standby letters of credit approximates fair value. The carrying amount of the off-balance sheet financial instruments is based on fees currently charged to enter into such agreements.

The estimated fair value and related carrying or notional amounts, as well as the level within the fair value hierarchy, of the Company’s financial instruments as of June 30, 2018 and December 31, 2017 were as follows:

	June 30, 2018
	Carrying Amount		Estimated Fair Value		Level 1		Level 2		Level 3
	(Dollars in Thousands)
Assets:
Cash and cash equivalents	$	41,798	$	41,798	$	41,798	$	—	$	—
Investment securities available-for-sale		141,421		141,421		—		141,421		—
Investment securities held-to-maturity		24,319		23,615		—		23,615		—
Federal funds sold		15,000		15,000		—		15,000		—
Federal Home Loan Bank stock		1,413		1,413		—		—		1,413
Loans, net of allowance for loan losses		355,529		348,455		—		—		348,455
Other assets – derivatives		977		977		—		977		—
Liabilities:
Deposits		531,428		528,744		—		528,744		—
Short-term borrowings		10,366		10,366		—		10,366		—
Long-term debt		10,000		9,999		—		9,999		—

	December 31, 2017
	Carrying Amount		Estimated Fair Value		Level 1		Level 2		Level 3
	(Dollars in Thousands)
Assets:
Cash and cash equivalents	$	27,124	$	27,124	$	27,124	$	—	$	—
Investment securities available-for-sale		153,871		153,871		—		153,871		—
Investment securities held-to-maturity		26,279		25,949		—		25,949		—
Federal funds sold		15,000		15,000		—		15,000		—
Federal Home Loan Bank stock		1,609		1,609		—		—		1,609
Loans, net of allowance for loan losses		346,121		342,248		—		—		342,248
Other assets – derivatives		443		443		—		443		—
Liabilities:
Deposits		517,079		515,645		—		515,645		—
Short-term borrowings		15,594		15,594		—		15,594		—
Long-term debt		10,000		9,998		—		9,998		—

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

DESCRIPTION OF THE BUSINESS

First US Bancshares, Inc., (“Bancshares”) a Delaware corporation, is a bank holding company with its principal offices in Birmingham, Alabama. Bancshares operates one commercial banking subsidiary, First US Bank (the “Bank”). As of June 30, 2018, the Bank operated and served its customers through 16 banking offices located in Birmingham, Bucksville, Butler, Calera, Centreville, Columbiana, Gilbertown, Grove Hill, Harpersville, Jackson, Thomasville, Tuscaloosa and Woodstock, Alabama. At the end of the first quarter of 2018, the Bank closed its loan production office in Mountain Brook, Alabama and merged all of its Birmingham operations into its main office in Birmingham, Alabama.

The Bank owns all of the stock of Acceptance Loan Company, Inc., an Alabama corporation (“ALC”). ALC is a finance company organized for the purpose of making and purchasing consumer loans. ALC’s principal office is located in Mobile, Alabama. The Bank is the funding source for ALC. As of June 30, 2018, in addition to its principal office, ALC operated twenty-one offices located in Alabama and southeast Mississippi. In addition, ALC conducted indirect lending operations through retailers in 10 states. 

The Bank provides a wide range of commercial banking services to small- and medium-sized businesses, property managers, business executives, professionals and other individuals, while ALC’s business is focused on consumer lending.

FUSB Reinsurance, Inc., an Arizona corporation and a wholly owned subsidiary of the Bank (“FUSB Reinsurance”), reinsures or “underwrites” credit life and credit accident and health insurance policies sold to the Bank’s and ALC’s consumer loan customers. FUSB Reinsurance is responsible for the first level of risk on these policies up to a specified maximum amount, and a third-party insurer retains the remaining risk. The third-party insurer is also responsible for performing most of the administrative functions of FUSB Reinsurance on a contract basis.

Delivery of the best possible financial services to customers remains an overall operational focus of Bancshares and its subsidiaries (collectively, the “Company”). The Company recognizes that attention to detail and responsiveness to customers’ desires are critical to customer satisfaction. The Company continues to upgrade technology, both in its financial services and in the training of its 257 full-time equivalent employees (as of June 30, 2018), to ensure customer satisfaction and convenience.

The preparation of the Company’s consolidated financial statements requires management to make subjective judgments associated with estimates. These estimates are necessary to comply with accounting principles generally accepted in the United States of America (“U.S. GAAP”) and general banking practices. These estimates include accounting for the allowance for loan losses, other real estate owned, valuation of deferred tax assets and fair value measurements. A description of these estimates, which significantly affect the determination of the Company’s consolidated financial position, results of operations and cash flows, is set forth in Note 2, “Summary of Significant Accounting Policies,” of the Notes to Consolidated Financial Statements in Bancshares’ Annual Report on Form 10-K as of and for the year ended December 31, 2017.

The emphasis of this discussion is a comparison of assets, liabilities and shareholders’ equity as of June 30, 2018 to December 31, 2017, while comparing income and expense for the six-month periods ended June 30, 2018 and 2017.

All yields and ratios presented and discussed herein are recorded and presented on the accrual basis and not on the tax-equivalent basis, unless otherwise indicated.

This information should be read in conjunction with the Company’s unaudited consolidated financial statements and related notes appearing elsewhere in this report and Management’s Discussion and Analysis of Financial Condition and Results of Operations appearing in Bancshares’ Annual Report on Form 10-K as of and for the year ended December 31, 2017. As used in the following discussion, the words “we,” “us,” “our” and the “Company” refer to Bancshares and its consolidated subsidiaries, unless the context indicates otherwise.

EXECUTIVE OVERVIEW

The Company earned net income of $0.06 per diluted common share during both of the three-month periods ended June 30, 2018 and 2017. For the six months ended June 30, 2018, net income totaled $0.12 per diluted common share, compared to $0.13 per diluted common share for the corresponding six-month period of 2017.

The composition of earnings changed significantly during both the three- and six-month periods ended June 30, 2018 compared to the corresponding periods of the previous year. As compared to both periods in 2017, the 2018 results were positively impacted by increased net interest income, which resulted primarily from growth in net loans. The growth in net interest income was offset by increased provision for loan losses and non-interest expense compared to the same periods in 2017. In addition, the Company’s effective tax rate decreased to 18.4% and 17.3% for the three and six months ended June 30, 2018, respectively, compared to 24.1% and 24.2% for the corresponding periods of 2017. The reduced effective tax rate resulted from the reduction in the Company’s statutory federal income tax rate under the Tax Cuts and Jobs Act of 2017 (“Tax Reform”).

As of June 30, 2018, the Company’s net loans totaled $355.5 million, an increase of $9.4 million, or 5.5% on an annualized basis, compared to December 31, 2017. Loan growth at the Bank was relatively flat during the six months ended June 30, 2018, while ALC grew its loan portfolio by $9.3 million during the same period. Consistent with prior periods, the focus of the Bank’s loan growth was on commercial lending in the Bank’s larger metropolitan service territories of Birmingham and Tuscaloosa, Alabama. ALC’s loan growth was attributable to continued expansion of indirect lending through point-of-sale retail opportunities.

Loan growth has been the primary driver of the increase in the Company’s net interest income over the past five quarters. Pre-provision net interest income totaled $14.8 million for the first half of 2018, compared to $14.0 million for the first half of 2017. Average loans totaled $355.7 million and $325.4 million for the six months ended June 30, 2018 and 2017, respectively.   

Deposits also increased during the first half of 2018, totaling $531.4 million as of June 30, 2018, compared to $517.1 million as of December 31, 2017. Average deposits totaled $519.5 million for the six months ended June 30, 2018, compared to $503.1 million for the same period of 2017. The growth in deposits compared to the first half of 2017 was largely attributable to deposits generated at the Bank’s new office in the Birmingham, Alabama area (known as Pump House Plaza) that opened during the third quarter of 2017.

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The rising interest rate environment has led to higher net yields on the Company’s earning assets. Net yield on interest-earning assets totaled 5.28% for the six months ended June 30, 2018, compared to 5.07% for the corresponding period of 2017. The increase in net yield has been driven by increases in yields on loans, taxable securities, federal funds sold and interest-bearing deposits at the Bank. These increases were partially offset by reduced yields on ALC’s loan portfolio. The yield on ALC’s portfolio has generally declined in recent quarters due to the shift in loan mix from ALC’s traditional consumer portfolio to indirect lending products that have enhanced the credit quality of the loan portfolio, with a corresponding decrease in yield commensurate with reduced risk. The Bank’s average yield on loans totaled 4.46% for the first half of 2018, compared to 4.10% for the first half of 2017. At ALC, average yield on loans was 18.15% and 19.06% for the six months ended June 30, 2018 and 2017, respectively. Average cost of interest-bearing liabilities was 0.74% for the six months ended June 30, 2018, compared to 0.55% for the corresponding period of 2017.  

The provision for loan losses totaled $1.4 million for the first half of 2018, compared to $1.1 million for the first half of 2017. The increase in provision expense in 2018 compared to 2017 was due to more substantial loan growth in ALC’s retail consumer lending portfolio during the first half of 2018 compared to the first half of 2017. In general, ALC’s consumer loans require a higher level of loss provisioning than commercial lending at the Bank. The Company’s allowance for loan losses as a percentage of loans was 1.37% as of June 30, 2018, compared to 1.36% as of December 31, 2017 and 1.46% as of June 30, 2017. The reduction in the allowance for loan losses as a percentage of net loans since June 30, 2017 resulted from continued favorable charge-off experience at the Bank, coupled with the mix-shift in lending at ALC that has led to reduced losses in ALC’s portfolio. The credit quality of the loan portfolio continued to improve during the first six months of 2018. Nonaccrual loans as a percentage of total loans was 0.48% as of June 30, 2018, compared to 0.64% as of December 31, 2017.

Non-interest income totaled $2.3 million for the six months ended June 30, 2018, compared to $2.1 million for the first six months of the previous year. The increase in non-interest income for the six months ended June 30, 2018 compared to the same period in 2017 resulted primarily from fees earned from secondary market mortgage closings and gains on the sale of investment securities at the Bank. The Bank’s mortgage division became operational during the second quarter of 2017 and is expected to enhance the Company’s non-interest income over time through fees earned on the closing of mortgage loans with third-party secondary market financial institutions. Fees generated from secondary market closings totaled $0.3 million during the six months ended June 30, 2018, compared to $0.1 million for the corresponding period of 2017. In addition, during the second quarter of 2018, the Bank generated $0.1 million in gains on the sale of investment securities that were not generated during the second quarter of 2017.

Non-interest expense totaled $14.8 million for the six months ended June 30, 2018, compared to $13.9 million for the first six months of the previous year. The increase in non-interest expense for the six months ended June 30, 2018 compared to the same period in 2017 resulted primarily from increased expenses associated with the Bank’s Pump House Plaza in Birmingham, Alabama, which became operational during the third quarter of 2017.  Salaries and benefits expense increased due to the addition of retail and commercial lending staff at the new location.  In addition, occupancy and equipment expense increased as a result of depreciation and operating expenses associated with the location, which now serves as the headquarters of both the Bank and the Company. Subsequent to June 30, 2018, the Bank entered into an agreement to lease all unused remaining leasable space in Pump House Plaza. The lease, which is scheduled to commence during the fourth quarter of 2018, is expected to generate in excess of $750 thousand of lease revenue annually and is expected to offset a significant portion of the expense associated with the location. Under the terms of the lease, the Bank agreed to pay for a one-time build-out of the tenant-occupied space, subject to a maximum amount. The total cost to the Bank under the agreement is estimated to be approximately $2.8 million. Depreciation of the costs will commence upon the effective date of the lease, which is scheduled for the fourth quarter of 2018. The initial lease term is scheduled to be in excess of 10 years.

On April 16, 2018, the Company signed a definitive agreement to acquire The Peoples Bank (“TPB”), headquartered in Rose Hill, Virginia. TPB serves communities in the Knoxville, Tennessee and southwest Virginia areas. Under the terms of the agreement, the Company will acquire all of the outstanding capital stock of TPB and then merge TPB with and into the Bank. The transaction, which is expected to result in a combined institution approaching $800 million in assets, remains subject to the satisfaction of customary closing conditions, including receipt of certain regulatory approvals. Management expects to incur increased expenses in the future in connection with the pending acquisition. However, the addition of TPB is expected to enhance the Company’s earnings through the addition of approximately $150 million in loans and approximately $137 million in deposits as reported by TPB in regulatory filings as of June 30, 2018. In accordance with the Stock Purchase and Affiliate Merger Agreement pursuant to which the Company will acquire TPB, 90% of the transaction consideration, subject to certain adjustments, will be in cash, with the remaining 10% to be in shares of Bancshares common stock.

Asset quality metrics continued to improve during the first half of 2018. Non-performing assets, including loans in non-accrual status and OREO, decreased to 0.61% of total assets as of June 30, 2018, compared to 0.96% and 1.01% as of December 31, 2017 and June 30, 2017, respectively.   

The Company continues to maintain excess funding capacity to provide adequate liquidity for loan growth, capital expenditures and ongoing operations. The Company benefits from a strong deposit base, a liquid investment securities portfolio and access to funding from a variety of sources, including federal funds lines, Federal Home Loan Bank (“FHLB”) advances and brokered deposits. Management believes that continued success in loan growth efforts at both the Bank and ALC, combined with continued adherence to established credit underwriting standards, will strengthen both the diversity and credit quality of the Company’s loan portfolio, while improving interest and fee income on loans.

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RESULTS OF OPERATIONS

	Three Months Ended				Six Months Ended
	June 30,		June 30,		June 30,		June 30,
	2018		2017		2018		2017
	(Dollars in Thousands)
Interest income	$	8,390	$	7,683	$	16,509	$	15,193
Interest expense		888		626		1,693		1,217
Net interest income		7,502		7,057		14,816		13,976
Provision for loan losses		702		576		1,360		1,091
Net interest income after provision for loan losses		6,800		6,481		13,456		12,885
Non-interest income		1,132		930		2,272		2,097
Non-interest expense		7,492		6,863		14,793		13,900
Income before income taxes		440		548		935		1,082
Provision for income taxes		81		132		162		262
Net income	$	359	$	416	$	773	$	820

Net Interest Income

Net interest income is calculated as the difference between interest and fee income generated from earning assets and the interest expense paid on deposits and borrowed funds. Fluctuations in interest rates, as well as volume and mix changes in earning assets and interest-bearing liabilities, can materially impact net interest income. The Company’s earning assets consist of loans at both the Bank and ALC, as well as taxable and nontaxable investments and federal funds sold by the Bank. Interest-bearing liabilities consist of interest-bearing demand deposits and savings and time deposits, as well as short-term borrowings and long-term debt.

38

The following tables show the average balances of each principal category of assets, liabilities and shareholders’ equity for the three- and six-month periods ended June 30, 2018 and 2017. Additionally, the tables provide an analysis of interest revenue or expense associated with each category, along with the accompanying yield or rate percentage. Net yield is calculated for each period presented as net interest income divided by average total interest-earning assets.

	Three Months Ended							Three Months Ended
	June 30, 2018							June 30, 2017
	Average Balance		Interest		Annualized Yield/ Rate %			Average Balance		Interest		Annualized Yield/ Rate %
	(Dollars in Thousands)
ASSETS
Interest-earning assets:
Loans – Bank (Note A)	$	258,956	$	2,923		4.53	%	$	237,546	$	2,453		4.14	%
Loans – ALC (Note A)		99,080		4,408		17.84	%		88,112		4,177		19.01	%
Taxable investment securities		171,752		869		2.03	%		200,302		918		1.84	%
Non-taxable investment securities		4,992		44		3.54	%		8,668		80		3.70	%
Federal funds sold		4,121		22		2.14	%		—		—		—	%
Interest-bearing deposits in banks		27,682		124		1.80	%		21,050		55		1.06	%
Total interest-earning assets		566,583		8,390		5.94	%		555,678		7,683		5.55	%
Non-interest-earning assets:
Other assets		58,053							55,526
Total	$	624,636						$	611,204
LIABILITIES AND SHAREHOLDERS’ EQUITY
Interest-bearing liabilities:
Demand deposits	$	157,335	$	169		0.43	%	$	163,825	$	158		0.39	%
Savings deposits		102,627		140		0.55	%		81,459		43		0.21	%
Time deposits		180,505		489		1.09	%		182,982		367		0.80	%
Borrowings		20,341		90		1.77	%		19,151		58		1.21	%
Total interest-bearing liabilities		460,808		888		0.77	%		447,417		626		0.56	%
Non-interest-bearing liabilities:
Demand deposits		82,200							79,040
Other liabilities		6,181							6,717
Shareholders’ equity		75,447							78,030
Total	$	624,636						$	611,204
Net interest income (Note B)			$	7,502						$	7,057
Net yield on interest-earning assets						5.31	%						5.09	%

Note A	—	For the purpose of these computations, non-accruing loans are included in the average loan amounts outstanding. At the Bank, these loans averaged $0.4 million and $0.5 million for the three months ended June 30, 2018 and 2017, respectively. At ALC, these loans averaged $1.7 million and $1.5 million for the respective periods presented.
Note B	—	Loan fees are included in the interest amounts presented. At the Bank, loan fees totaled $0.1 million for both of the three-month periods ended June 30, 2018 and 2017. At ALC, loan fees totaled $0.5 million for both of the respective periods presented.

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	Six Months Ended							Six Months Ended
	June 30, 2018							June 30, 2017
	Average Balance		Interest		Annualized Yield/ Rate %			Average Balance		Interest		Annualized Yield/ Rate %
	(Dollars in Thousands)
ASSETS
Interest-earning assets:
Loans – Bank (Note A)	$	259,099	$	5,731		4.46	%	$	237,625	$	4,830		4.10	%
Loans – ALC (Note A)		96,566		8,689		18.15	%		87,761		8,296		19.06	%
Taxable investment securities		175,313		1,734		1.99	%		200,536		1,802		1.81	%
Non-taxable investment securities		5,549		100		3.63	%		9,378		170		3.66	%
Federal funds sold		7,182		65		1.83	%		—		—		—	%
Interest-bearing deposits in banks		22,454		190		1.71	%		20,396		95		0.94	%
Total interest-earning assets		566,163		16,509		5.88	%		555,697		15,193		5.51	%
Non-interest-earning assets:
Other assets		58,308							54,602
Total	$	624,471						$	610,299
LIABILITIES AND SHAREHOLDERS’ EQUITY
Interest-bearing liabilities:
Demand deposits	$	162,122	$	340		0.42	%	$	161,938	$	303		0.38	%
Savings deposits		93,705		210		0.45	%		79,430		80		0.20	%
Time deposits		180,387		949		1.06	%		183,667		713		0.78	%
Borrowings		22,496		194		1.74	%		22,358		121		1.09	%
Total interest-bearing liabilities		458,710		1,693		0.74	%		447,393		1,217		0.55	%
Non-interest-bearing liabilities:
Demand deposits		83,311							78,105
Other liabilities		6,815							7,193
Shareholders’ equity		75,635							77,608
Total	$	624,471						$	610,299
Net interest income (Note B)			$	14,816						$	13,976
Net yield on interest-earning assets						5.28	%						5.07	%

Note A	—	For the purpose of these computations, non-accruing loans are included in the average loan amounts outstanding. At the Bank, these loans averaged $0.4 million and $0.6 million for the six months ended June 30, 2018 and 2017, respectively. At ALC, these loans averaged $1.7 million and $1.5 million for the respective periods presented.
Note B	—	Loan fees are included in the interest amounts presented. At the Bank, loan fees totaled $0.2 million for both of the six-month periods ended June 30, 2018 and 2017. At ALC, loan fees totaled $0.9 million and $1.1 million for the respective periods presented.

Interest income earned on loans for both the Bank and ALC increased in both the three- and six-month periods ended June 30, 2018 compared to the corresponding periods of the previous year, primarily as a result of growth in average loan volume, as well as increased yield in most earning asset categories. The loan volume increases were partially offset by decreases in the average balances of taxable and non-taxable investments. The shift in the mix of earning assets is consistent with management’s ongoing strategy to utilize cash flows from the maturity and paydown of investment securities to fund loan growth as opportunities permit. The investment portfolio has been structured to provide monthly cash flows through the maturity and paydown of securities in a manner that management believes can continue to fund a substantial portion of loan growth over time. Aggregate yield on earning assets increased in both the three- and six-month periods presented compared to the corresponding periods of 2017. Yield increased in all categories of earning assets, except loans at ALC. The decrease in yield on loans at ALC is consistent with the focus on indirect lending at ALC which generally provides lower yielding loans, but with corresponding higher credit quality and lower losses.

Interest expense increased in both the three- and six-month periods ended June 30, 2018 compared to the corresponding periods of 2017 due to increases in the volume of interest-bearing liabilities, as well as increases in rates commensurate with the interest rate environment experienced during the twelve months between June 30, 2018 and 2017.

We expect that continued growth in net loan volume at both the Bank and ALC with loans of sufficient credit quality will enhance net interest income, particularly as resources are shifted from lower-earning investment securities to higher-earning loan balances. However, the competitive environment is significant relative to the generation of loans of high credit quality, resulting in a lack of loan growth at the Bank for the six months ended June 30, 2018. At both the Bank and ALC, management is continuing to focus efforts on new loan origination within the parameters of established credit policy, while also maintaining vigilance in the deployment of strategies to effectively manage risks associated with interest rate fluctuations. Net interest income could experience downward pressure as a result of increased competition for quality loan and deposit funding opportunities.

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Provision for Loan Losses

The provision for loan losses is an expense used to establish the allowance for loan losses. Actual loan losses, net of recoveries, are charged directly to the allowance for loan losses. The expense recorded for each reporting period is a reflection of actual net losses experienced during the period and management’s judgment as to the adequacy of the allowance to absorb losses inherent in the portfolio as of the balance sheet date. The following table presents the provision for loan losses for the Bank and ALC for the three and six months ended June 30, 2018 and 2017.

	Three Months Ended				Six Months Ended
	June 30,		June 30,		June 30,		June 30,
	2018		2017		2018		2017
Bank	$	—	$	—	$	39	$	—
ALC		702		576		1,321		1,091
Total	$	702	$	576	$	1,360	$	1,091

At the Bank, during both the three- and six-month periods ended June 30, 2018, recoveries of previously charged-off loans exceeded current period charge-offs. The provision for loan losses did not increase during the second quarter of 2018 due to relatively flat net loan growth comparing June 30, 2018 to December 31, 2017. The Bank’s allowance for loan losses as a percentage of loans totaled 0.98% as of June 30, 2018, compared to 0.95% as of December 31, 2017 and 1.03% as of June 30, 2017.

At ALC, the provision for loan losses increased comparing both the three- and six-month periods ended June 30, 2018 to the corresponding periods of 2017 based primarily on growth in ALC’s loan balances. ALC’s allowance for loan losses as a percentage of loans totaled 2.36% as of June 30, 2018, compared to 2.48% as of December 31, 2017 and 2.63% as of June 30, 2017. The decrease in the allowance for loan losses as a percentage of loans was due to the changing mix of ALC’s portfolio to point-of-sale indirect lending, which has enhanced the credit quality of ALC’s loan portfolio.

For the Company, the allowance for loan losses as a percentage of loans totaled 1.37% as of June 30, 2018, compared to 1.36% as of December 31, 2017 and 1.46% as of June 30, 2017.  Based on our evaluation of the loan portfolio, we believe that the allowance for loan losses at both the Bank and ALC is adequate to absorb losses inherent in the loan portfolio as of June 30, 2018. While we believe that the methodologies and calculations that have been used in the determination of the allowance are adequate, our conclusions are based on estimates and judgments and are, therefore, approximate and imprecise. Factors beyond our control, such as changes in economic conditions impacting the national economy or the local service areas in which the Bank and ALC operate, may negatively and materially affect asset quality and the adequacy of the allowance for loan losses, as well as the resulting provision for loan losses. In general, we expect the provision for loan losses to increase commensurate with growth in loan volume at both the Bank and ALC; however, we would also expect such increases to be partially offset should credit quality of the portfolio continue to improve.

Non-Interest Income

Non-interest income represents fees and income derived from sources other than interest-earning assets. The following table presents the major components of non-interest income.

	Three Months Ended June 30,										Six Months Ended June 30,
	2018		2017		$ Change			% Change			2018		2017		$ Change			% Change
	(Dollars in Thousands)										(Dollars in Thousands)
Service charges and other fees on deposit accounts	$	444	$	461	$	(17	)		(3.7	)%	$	911	$	925	$	(14	)		(1.5	)%
Credit insurance commissions and fees		100		43		57			132.6	%		318		299		19			6.4	%
Bank-owned life insurance		106		106		—			—	%		211		211		—			—	%
Net gain on sale and prepayment of investment securities		102		1		101			NM	%		105		50		55			110.0	%
Mortgage fees from secondary market		144		58		86			148.3	%		261		58		203			350.0	%
Other income		236		261		(25	)		(9.6	)%		466		554		(88	)		(15.9	)%
Total non-interest income	$	1,132	$	930	$	202			21.7	%	$	2,272	$	2,097	$	175			8.3	%

NM: Not meaningful

Non-interest income at the Bank consists of service charges and other fees on deposit accounts; bank-owned life insurance; net gains on the sale and prepayment of investment securities; mortgage fees from the secondary market; and other non-interest income, which includes fee income generated by the Bank, such as ATM fees and real estate rental income. Non-interest income at ALC consists of credit insurance commissions and fees and other non-interest income generated for ancillary services, such as ALC’s auto club membership program. The increase in non-interest income for both the three- and six-month periods ended June 30, 2018 compared to the same periods in 2017 resulted primarily from fees earned from secondary market mortgage closings at the Bank. The Bank’s mortgage division, which began operating in the second quarter of 2017, generates non-interest income by closing loans in the secondary market. In addition, during the second quarter of 2018, the Bank generated $0.1 million in gains on the sale of investment securities that were not generated during the corresponding quarter of 2017. Given the nature of the types of revenues categorized as non-interest income, there is uncertainty as to the level of revenue that will be derived from these sources in the future.

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Non-Interest Expense

Non-interest expense represents expenses incurred from sources other than interest-bearing liabilities. The following table presents the major components of non-interest expense for the periods indicated.

	Three Months Ended June 30,										Six Months Ended June 30,
	2018		2017		$ Change			% Change			2018		2017		$ Change			% Change
	(Dollars in Thousands)										(Dollars in Thousands)
Salaries and employee benefits	$	4,533	$	4,280	$	253			5.9	%	$	9,100	$	8,678	$	422			4.9	%
Net occupancy and equipment expense		873		693		180			26.0	%		1,762		1,470		292			19.9	%
Computer services		317		312		5			1.6	%		609		698		(89	)		(12.8	)%
Insurance expense and assessments		191		157		34			21.7	%		377		318		59			18.6	%
Fees for professional services		266		230		36			15.7	%		539		463		76			16.4	%
Postage, stationery and supplies		190		150		40			26.7	%		402		304		98			32.2	%
Telephone/data communications		193		201		(8	)		(4.0	)%		388		422		(34	)		(8.1	)%
Other real estate/foreclosure expense:
Write-downs, net of gain or loss on sale		152		78		74			94.9	%		101		81		20			24.7	%
Carrying costs		35		55		(20	)		(36.4	)%		75		136		(61	)		(44.9	)%
Total other real estate/foreclosure expense		187		133		54			40.6	%		176		217		(41	)		(18.9	)%
Other		742		707		35			5.0	%		1,440		1,330		110			8.3	%
Total non-interest expense	$	7,492	$	6,863	$	629			9.2	%	$	14,793	$	13,900	$	893			6.4	%

Non-interest expense consists of the items noted above. The increase in non-interest expense for the three and six months ended June 30, 2018 compared to the same periods in 2017 resulted primarily from increased expenses associated with the Bank’s Pump House Plaza office complex in Birmingham, Alabama, which became operational during the third quarter of 2017. Salaries and benefits expense increased due to the addition of retail and commercial lending staff at the new location. In addition, occupancy and equipment expense increased as a result of depreciation and operating expenses associated with the location, which now serves as the headquarters of both the Bank and the Company. Subsequent to June 30, 2018, the Bank entered into an agreement with a third party to lease all unused remaining leasable space in Pump House Plaza. The lease, which is scheduled to commence during the fourth quarter of 2018, is expected to generate in excess of $0.75 million of lease revenue annually and is expected to offset a significant portion of expense associated with the location. In general, non-interest expense is expected to increase over time due to inflationary pressures; however, management continues to maintain vigilance in efforts to reduce these costs where opportunities to do so exist. Additionally, management expects to incur increased expenses in the future in connection with the pending acquisition of The Peoples Bank.

Provision for Income Taxes

The provision for income taxes was $0.1 million for both of the three-month periods ended June 30, 2018 and 2017. The Company’s effective tax rate was 18.4% for the second quarter of 2018, compared to 24.1% for the second quarter of 2017. For the six months ended June 30, 2018 and 2017, the provision for income taxes was $0.2 million and $0.3 million, respectively, and the effective tax rate was 17.3% and 24.2% respectively. The reduced effective tax rate resulted from the reduction in the Company’s statutory federal income tax rate under the Tax Cuts and Jobs Act of 2017 (“Tax Reform”). Under Tax Reform, beginning January 1, 2018, the Company’s federal statutory income tax rate was set at 21%, reduced from the 34% statutory income tax rate previously applied. Aside from the impact of Tax Reform, the effective tax rate is also expected to fluctuate based on recurring items, such as changes in tax-exempt interest income earned from bank-qualified municipal bonds and loans and the cash surrender value of bank-owned life insurance. Management makes decisions about whether to invest in tax-exempt instruments on a case-by-case basis after considering a number of factors, including investment return, credit quality and the consistency of such investments with the Company’s overall strategy. The Company’s effective tax rate is expected to fluctuate commensurate with the level of these investments as compared to total pre-tax income.

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BALANCE SHEET ANALYSIS

Investment Securities

The investment securities portfolio is used by management to provide liquidity, to generate interest income and for use as collateral for public deposits and wholesale funding. Risk and return can be adjusted by altering the duration, composition and/or balance of the portfolio. The expected average life of securities in the investment portfolio was 2.8 years as of both June 30, 2018 and December 31, 2017.

Available-for-sale securities are recorded at estimated fair value, with unrealized gains or losses recognized, net of taxes, in accumulated other comprehensive income, a separate component of shareholders’ equity. As of June 30, 2018, available-for-sale securities totaled $141.4 million, or 85.3% of the total investment portfolio, compared to $153.9 million, or 85.4% of the total investment portfolio, as of December 31, 2017. Available-for-sale securities consisted of residential and commercial mortgage-backed securities, U.S. Treasury securities and obligations of state and political subdivisions.

Held-to-maturity securities are recorded at amortized cost and represent securities that the Company both intends and has the ability to hold to maturity. As of June 30, 2018, held-to-maturity securities totaled $24.3 million, or 14.7% of the total investment portfolio, compared to $26.3 million, or 14.6% of the total investment portfolio, as of December 31, 2017. Held-to-maturity securities consisted of commercial mortgage-backed securities, obligations of U.S. government-sponsored agencies and obligations of state and political subdivisions.

Loans and Allowance for Loan Losses

The tables below summarize loan balances by portfolio category for both the Bank and ALC at the end of each of the most recent five quarters as of June 30, 2018.

	Bank
	2018				2017
	June 30,		March 31,		December 31,		September 30,		June 30,
	(Dollars in Thousands)
Real estate loans:
Construction, land development and other land loans	$	22,878	$	25,965	$	26,143	$	20,213	$	12,424
Secured by 1-4 family residential properties		38,968		36,618		34,272		35,125		32,227
Secured by multi-family residential properties		18,374		16,396		16,579		16,498		16,702
Secured by non-farm, non-residential properties		112,461		111,546		105,133		107,679		113,037
Other		187		188		190		223		226
Commercial and industrial loans		59,320		65,996		69,969		66,320		65,087
Consumer loans		5,420		5,416		5,217		5,431		5,671
Total loans	$	257,608	$	262,125	$	257,503	$	251,489	$	245,374
Less unearned interest, fees and deferred cost		351		349		374		367		371
Allowance for loan losses		2,520		2,500		2,447		2,422		2,526
Net loans	$	254,737	$	259,276	$	254,682	$	248,700	$	242,477

	ALC
	2018				2017
	June 30,		March 31,		December 31,		September 30,		June 30,
	(Dollars in Thousands)
Real estate loans:
Construction, land development and other land loans	$	—	$	—	$	—	$	—	$	—
Secured by 1-4 family residential properties		9,176		9,963		10,801		11,490		12,229
Secured by multi-family residential properties		—		—		—		—		—
Secured by non-farm, non-residential properties		—		—		—		—		—
Other		—		—		—		—		—
Commercial and industrial loans		—		—		—		—		—
Consumer loans:
Consumer		32,902		32,758		34,083		35,650		31,920
Indirect sales		67,429		60,157		55,071		50,553		52,134
Total loans	$	109,507	$	102,878	$	99,955	$	97,693	$	96,283
Less unearned interest, fees and deferred cost		6,283		6,020		6,189		5,981		5,855
Allowance for loan losses		2,432		2,329		2,327		2,386		2,379
Net loans	$	100,792	$	94,529	$	91,439	$	89,326	$	88,049

43

The tables below summarize changes in the allowance for loan losses for each of the most recent five quarters as of June 30, 2018 at both the Bank and ALC.

	Bank
	2018						2017
	Second Quarter			First Quarter			Fourth Quarter			Third Quarter			Second Quarter
	(Dollars in Thousands)
Balance at beginning of period	$	2,500		$	2,447		$	2,422		$	2,526		$	2,521
Charge-offs:
Real estate loans:
Construction, land development and other land loans		—			—			—			—			—
Secured by 1-4 family residential properties		(1	)		(8	)		—			—			—
Secured by multi-family residential properties		—			—			—			—			—
Secured by non-farm, non-residential properties		—			—			—			—			—
Other		—			—			—			—			—
Commercial and industrial		(2	)		—			—			—			(16	)
Consumer loans		—			—			—			(1	)		(60	)
Other loans		—			—			—			—			—
Total charge-offs		(3	)		(8	)		—			(1	)		(76	)
Recoveries		23			22			25			27			81
Net recoveries (charge-offs)		20			14			25			26			5
Provision (reduction in reserve) for loan losses		—			39			—			(130	)		—
Ending balance	$	2,520		$	2,500		$	2,447		$	2,422		$	2,526
as a % of loans		0.98	%		0.96	%		0.95	%		0.96	%		1.03	%

	ALC
	2018						2017
	Second Quarter			First Quarter			Fourth Quarter			Third Quarter			Second Quarter
	(Dollars in Thousands)
Balance at beginning of period	$	2,329		$	2,327		$	2,386		$	2,379		$	2,358
Charge-offs:
Real estate loans:
Construction, land development and other land loans		—			—			—			—			—
Secured by 1-4 family residential properties		(18	)		(14	)		(1	)		(10	)		(4	)
Secured by multi-family residential properties		—			—			—			—			—
Secured by non-farm, non-residential properties		—			—			—			—			—
Other		—			—			—			—			—
Commercial and industrial		—			—			—			—			—
Consumer loans:
Consumer		(609	)		(604	)		(576	)		(494	)		(569	)
Indirect sales		(131	)		(147	)		(142	)		(150	)		(160	)
Other loans		—			—			—			—			—
Total charge-offs		(758	)		(765	)		(719	)		(654	)		(733	)
Recoveries		159			148			137			158			178
Net recoveries (charge-offs)		(599	)		(617	)		(582	)		(496	)		(555	)
Provision (reduction in reserve) for loan losses		702			619			523			503			576
Ending balance	$	2,432		$	2,329		$	2,327		$	2,386		$	2,379
as a % of loans		2.36	%		2.40	%		2.48	%		2.60	%		2.63	%

44

Nonperforming Assets

Nonperforming assets at the end of the five most recent quarters as of June 30, 2018 were as follows:

	Consolidated
	2018						2017
	June 30,			March 31,			December 31,			September 30,			June 30,
	(Dollars in Thousands)
Non-accrual loans	$	1,713		$	2,037		$	2,148		$	1,956		$	1,847
Other real estate owned		2,181			3,343			3,792			3,819			4,351
Total	$	3,894		$	5,380		$	5,940		$	5,775		$	6,198
Nonperforming assets as a percentage of loans and other real estate		1.07	%		1.49	%		1.67	%		1.67	%		1.82	%
Nonperforming assets as a percentage of total assets		0.61	%		0.86	%		0.95	%		0.94	%		1.01	%

	Bank
	2018						2017
	June 30,			March 31,			December 31,			September 30,			June 30,
	(Dollars in Thousands)
Non-accrual loans	$	360		$	369		$	315		$	332		$	343
Other real estate owned		2,002			3,100			3,527			3,527			3,951
Total	$	2,362		$	3,469		$	3,842		$	3,859		$	4,294
Nonperforming assets as a percentage of loans and other real estate		0.91	%		1.31	%		1.47	%		1.52	%		1.72	%
Nonperforming assets as a percentage of total assets		0.37	%		0.55	%		0.61	%		0.63	%		0.69	%

	ALC
	2018						2017
	June 30,			March 31,			December 31,			September 30,			June 30,
	(Dollars in Thousands)
Non-accrual loans	$	1,353		$	1,668		$	1,833		$	1,624		$	1,504
Other real estate owned		179			243			265			292			400
Total	$	1,532		$	1,911		$	2,098		$	1,916		$	1,904
Nonperforming assets as a percentage of loans and other real estate		1.48	%		1.97	%		2.23	%		2.08	%		2.10	%
Nonperforming assets as a percentage of total assets		1.48	%		1.96	%		2.22	%		2.06	%		2.08	%

45

Deposits

Total deposits increased by 2.8% to $531.4 million as of June 30, 2018, from $517.1 million as of December 31, 2017. Core deposits, which exclude time deposits of $250 thousand or more, provide a relatively stable funding source that supports earning assets. Core deposits totaled $508.1 million, or 95.6% of total deposits, as of June 30, 2018, compared to $489.0 million, or 94.6% of total deposits, as of December 31, 2017.

Deposits, in particular core deposits, have historically been the Company’s primary source of funding and have enabled the Company to successfully meet both short-term and long-term liquidity needs. Management anticipates that such deposits will continue to be one of the Company’s primary sources of funding in the future, and we will continue to monitor deposit levels closely to help ensure an adequate level of funding for the Company’s activities. However, various economic and competitive factors could affect this funding source in the future, including increased competition from other financial institutions in deposit gathering, national and local economic conditions and interest rate policies adopted by the Federal Reserve and other central banks.

Other Interest-Bearing Liabilities

Other interest-bearing liabilities consist of federal funds purchased, securities sold under agreements to repurchase and FHLB advances. This category continues to be utilized as an alternative source of funds. During the second quarter of 2018, these borrowings represented 4.4% of average interest-bearing liabilities, compared to 4.3% in the second quarter of 2017.

Shareholders’ Equity

The Company has historically placed significant emphasis on maintaining its strong capital base. As of June 30, 2018, shareholders’ equity totaled $75.6 million, or 11.9% of total assets, compared to $76.2 million, or 12.2% of total assets, as of December 31, 2017. Management believes that this level of equity is an indicator of the financial soundness of the Company and the Company’s ability to sustain future growth and profitability. The decrease in shareholders’ equity during the six months ended June 30, 2018 resulted primarily from an increase in accumulated other comprehensive loss associated with unrealized losses in the fair value of available-for-sale securities during the first half of 2018, which was partially offset by growth in retained earnings. The fair value of the available-for-sale portfolio fluctuates based primarily on changes in interest rates. Accordingly, the net unrealized losses during the first half of 2018 are not necessarily indicative of future performance of the portfolio.

Bancshares’ Board of Directors evaluates dividend payments based on the Company’s level of earnings and the desire to maintain a strong capital base, as well as regulatory requirements relating to the payment of dividends. During each of the three-month periods ended June 30, 2018 and 2017, Bancshares declared a dividend of $0.02 per common share, or approximately $0.1 million in aggregate amount.

As of both June 30, 2018 and December 31, 2017, the Company retained approximately $20.4 million in treasury stock. The Company initiated a share repurchase program in January 2006, under which the Company was authorized to repurchase up to 642,785 shares of Bancshares’ common stock before December 31, 2007. In December 2007, and in each year since, the Board of Directors has extended the expiration date of the share repurchase program for an additional year. Currently, the share repurchase program is set to expire on December 31, 2018. There are 242,303 shares available for repurchase under this program, at management’s discretion. No shares were purchased under this program during the first six months of 2018 or in 2017.

As of June 30, 2018 and December 31, 2017, a total of 109,450 and 103,620 shares of stock, respectively, were deferred in connection with Bancshares’ Non-Employee Directors’ Deferred Compensation Plan. The plan permits non-employee directors to invest their directors’ fees and to receive the adjusted value of the deferred amounts in cash or shares of Bancshares common stock. All deferred fees, whether in the form of cash or shares of Bancshares common stock, are reflected as compensation expense in the period earned. The Company classifies all deferred directors’ fees allocated to be paid in shares of stock as equity surplus. The Company uses shares of treasury stock to satisfy these obligations when due.

46

LIQUIDITY AND CAPITAL RESOURCES

The asset portion of the balance sheet provides liquidity primarily from two sources: (1) principal payments and maturities of loans and (2) maturities and principal payments from the investment portfolio. Other short-term investments, such as federal funds sold, may also provide additional sources of liquidity. Loans maturing or repricing in one year or less amounted to $115.0 million as of June 30, 2018 and $117.3 million as of December 31, 2017. Investment securities forecasted to mature or reprice in one year or less were estimated to be $8.4 million of the investment portfolio as of June 30, 2018.

Although some securities in the investment portfolio have legal final maturities exceeding 10 years, a substantial percentage of the portfolio provides monthly principal and interest payments and consists of securities that are readily marketable and easily convertible into cash on short notice. As of June 30, 2018, the investment securities portfolio had an estimated average life of 2.8 years, and approximately 85.6% of the portfolio (including both available-for-sale and held-to-maturity investments) was expected to be repaid within five years. However, management does not rely solely upon the investment portfolio to generate cash flows to fund loans, capital expenditures, dividends, debt repayment and other cash requirements. These activities are also funded by cash flows from loan payments, as well as increases in deposits and short-term borrowings.

The liability portion of the balance sheet provides liquidity through interest-bearing and non-interest-bearing deposit accounts, which represent the Company’s primary sources of funds. In addition, federal funds purchased, FHLB advances, securities sold under agreements to repurchase and short-term and long-term borrowings are additional sources of available liquidity. Liquidity management involves the continual monitoring of the sources and uses of funds to maintain an acceptable cash position. Long-term liquidity management focuses on considerations related to the total balance sheet structure. The Bank manages the pricing of its deposits to maintain a desired deposit balance. In addition, the Bank invests in short-term interest-earning assets, which provide liquidity to meet lending requirements.

The Bank entered into an agreement to lease space in Pump House Plaza and agreed to pay approximately $2.8 million for the build-out of the tenant space. The Bank expects to fund the build-out using available cash.

As of June 30, 2018 and December 31, 2017, the Company had $20.0 million and $25.0 million, respectively, in outstanding borrowings under FHLB advances. The Company had up to $168.1 million and $159.3 million in remaining unused credit from the FHLB (subject to available collateral) as of June 30, 2018 and December 31, 2017, respectively. In addition, the Company had $18.8 million in unused established federal funds lines as of both June 30, 2018 and December 31, 2017.

The Company’s acquisition of The Peoples Bank is expected to close in 2018, subject to the satisfaction of customary closing conditions, including receipt of regulatory approvals. The total purchase price of approximately $23 million, subject to adjustment in accordance with the terms of the Stock Purchase and Affiliate Merger Agreement governing the transaction, will be settled in cash (90%) and Bancshares common stock (10%). The Company expects to fund the cash portion of the purchase price with available cash, including cash expected from a special, one-time dividend from the Bank to Bancshares, as the sole shareholder of the Bank.

Management believes that the Company has adequate sources of liquidity to satisfy its contractual obligations and commitments over the next twelve months. Management is not aware of any condition that currently exists that would have an adverse effect on the liquidity, capital resources or operation of the Company.

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

The primary purpose of managing interest rate risk is to invest capital effectively and preserve the value created by our core banking business. This is accomplished through the development and implementation of lending, funding, pricing and hedging strategies designed to maximize net interest income performance under varying interest rate environments, subject to liquidity and interest rate risk guidelines. Effective interest rate sensitivity management ensures that both assets and liabilities respond to changes in interest rates within an acceptable time frame, thereby minimizing the effect of such interest rate movements on short- and long-term net interest margin and net interest income.

Financial simulation models are the primary tools used by the Asset/Liability Committee of the Bank’s board of directors to measure interest rate exposure. Using a wide range of scenarios, management is provided with extensive information on the potential impact on net interest income caused by changes in interest rates. In these simulations, assumptions are made about the direction and volatility of interest rates, the slope of the yield curve and the changing composition of the Company’s balance sheet resulting from both strategic plans and customer behavior. Simulation models also incorporate management’s assumptions regarding such factors as loan and deposit growth, pricing, prepayment speeds and spreads between interest rates.

47

Measuring Interest Rate Sensitivity

Interest rate sensitivity is a function of the repricing characteristics of all of the Company’s portfolio of assets and liabilities. These repricing characteristics are the timeframes during which the interest-bearing assets and liabilities are subject to fluctuation based on changes in interest rates, either at replacement or maturity, during the life of the instruments. Measuring interest rate sensitivity is a function of the differences in the volume of assets and the volume of liabilities that are subject to repricing in future time periods. These differences are known as interest sensitivity gaps and are usually calculated for segments of time and on a cumulative basis.

The Company measures changes in net interest income and net interest margin on a monthly basis through income simulation over various interest rate shock scenarios, including plus or minus 1%, 2%, 3% and 4% scenarios. Each month, management evaluates how changes in short- and long-term interest rates may impact future profitability, as reflected in the Company’s net interest margin.

Also on a monthly basis, management calculates how changes in interest rates would impact the market value of the Company’s assets and liabilities, as well as its long-term profitability. The process is similar to assessing short-term risk but emphasizes and is measured over a five-year time period, which allows for a more comprehensive assessment of longer-term repricing and cash flow imbalances that may not be captured by short-term net interest margin simulations. The results of these calculations are representative of long-term interest rate risk, both in terms of changes in the present value of the Company’s assets and liabilities and long-term changes in core profitability.

See Part II, Item 7A, “ Quantitative and Qualitative Disclosures About Market Risk,” of Bancshares' Annual Report on Form 10-K as of and for the year ended December 31, 2017 for additional disclosures related to market risk. Management’s evaluation as of June 30, 2018 did not indicate any significant increase in the Company’s exposure to market risk from those disclosed as of December 31, 2017. The analysis evaluated by management as of June 30, 2018 included certain assumptions related to the pending acquisition of The Peoples Bank. Management continues to perform ongoing due diligence related to the acquisition. Accordingly, it is possible that information could come to management's attention through the due diligence process that indicates higher exposure to market risk than currently understood by management.

ITEM 4. CONTROLS AND PROCEDURES

Conclusion Regarding the Effectiveness of Disclosure Controls and Procedures

Bancshares maintains disclosure controls and procedures that are designed to ensure that information required to be disclosed in Bancshares’ reports under the Securities Exchange Act of 1934, as amended (the “Exchange Act”), is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms and that such information is accumulated and communicated to Bancshares’ management, including its Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure. In designing and evaluating the disclosure controls and procedures, management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives.

Bancshares’ management carried out an evaluation, under the supervision and with the participation of its Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of Bancshares’ disclosure controls and procedures (as such term is defined in Rules 13a-15(e) and 15d-15(e) promulgated under the Exchange Act) as of June 30, 2018, pursuant to the evaluation of these controls and procedures required by Rule 13a-15 of the Exchange Act. Based on that evaluation, Bancshares’ management concluded, as of June 30, 2018, that Bancshares’ disclosure controls and procedures are effective to ensure that the information required to be disclosed in Bancshares’ periodic filings with the SEC is recorded, processed, summarized and reported within the time periods specified.

Changes in Internal Control Over Financial Reporting

There were no changes in Bancshares’ internal control over financial reporting (as defined in Rule 13a-15(f) under the Exchange Act) during the quarter ended June 30, 2018 that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

48

PART II. OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

The Company is a party to certain ordinary course litigation, and the Company intends to vigorously defend itself in all such litigation. In the opinion of the Company, based on review and consultation with legal counsel, the outcome of such ordinary course litigation should not have a material adverse effect on the Company’s consolidated financial statements or results of operations.

ITEM 1A. RISK FACTORS

In addition to the other information set forth in this report, you should carefully consider the factors discussed in Part I, Item 1A, “Risk Factors,” in Bancshares’ Annual Report on Form 10-K as of and for the year ended December 31, 2017 that could materially affect the Company’s business, financial condition or future results. The risks described in Bancshares’ Annual Report on Form 10-K are not the only risks facing the Company. Additional risks and uncertainties not currently known to the Company or that the Company currently deems to be immaterial also may materially adversely affect the Company’s business, financial condition and/or operating results.

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

The following table sets forth purchases made by or on behalf of Bancshares or any “affiliated purchaser,” as defined in Rule 10b-18(a)(3) of the Exchange Act, of shares of Bancshares’ common stock during the second quarter of 2018.

Issuer Purchases of Equity Securities

Period	Total Number of Shares Purchased (2)		Average Price Paid per Share		Total Number of Shares Purchased as Part of Publicly Announced Programs (1)		Maximum Number (or Approximate Dollar Value) of Shares that May Yet Be Purchased Under the Programs (1)
April 1 – April 30		—	$	—		—		242,303
May 1 – May 31		4,480	$	11.08		—		242,303
June 1 – June 30		—	$	—		—		242,303
Total		4,480	$	11.08		—		242,303

(1) On December 20, 2017, the Board of Directors extended the share repurchase program previously approved by the Board on January 19, 2006. Under the repurchase program, Bancshares is authorized to repurchase up to 642,785 shares of common stock before December 31, 2018, of which 242,303 shares remain available.

(2) 4,480 shares were purchased in open-market transactions by an independent trustee for Bancshares’ 401(k) Plan during the second quarter of 2018.

ITEM 6. EXHIBITS

The exhibits listed in the Index to Exhibits below are filed herewith and are incorporated herein by reference.

49

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.

FIRST US BANCSHARES, INC.

DATE: August 8, 2018

BY:	/s/ Thomas S. Elley
	Thomas S. Elley
	Its Vice President, Treasurer and Assistant Secretary, Chief Financial Officer and Principal Accounting Officer
	(Duly Authorized Officer and Principal Financial Officer)

50

INDEX TO EXHIBITS

Exhibit No.	Description
3.1	Certificate of Incorporation of United Security Bancshares, Inc. (incorporated by reference to Exhibit 3(i) to the Quarterly Report on Form 10-Q (File No. 000-14549), filed on November 12, 1999)
3.1A	Certificate of Amendment to the Certificate of Incorporation of United Security Bancshares, Inc., effective as of October 11, 2016 (incorporated by reference to Exhibit 3.1 to the Current Report on Form 8-K (File No. 000-14549), filed on October 11, 2016)
3.2	Bylaws of First US Bancshares, Inc., effective as of October 11, 2016 (incorporated by reference to Exhibit 3.2 to the Current Report on Form 8-K (File No. 000-14549), filed on October 11, 2016)
31.1	Certification of Chief Executive Officer pursuant to Rule 13a-14(a) and Rule 15d-14(a) of the Securities Exchange Act, as amended.
31.2	Certification of Chief Financial Officer pursuant to Rule 13a-14(a) and Rule 15d-14(a) of the Securities Exchange Act, as amended.
32	Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
101	Interactive Data Files for the Quarterly Report on Form 10-Q for the quarterly period ended June 30, 2018.