Quarterly Report (10-q)

Date : 08/02/2019 @ 8:07PM
Source : Edgar (US Regulatory)
Stock : Southern First Bancshares Inc (SFST)
Quote : 40.59  0.0 (0.00%) @ 1:30PM

Quarterly Report (10-q)

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, 2019
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 000-27719

Southern First Bancshares, Inc.
(Exact name of registrant as specified in its charter)

South Carolina 58-2459561
(State or other jurisdiction of incorporation or organization) (I.R.S. Employer Identification No.)
 
100 Verdae Boulevard, Suite 100
Greenville, S.C. 29606
(Address of principal executive offices) (Zip Code)

864-679-9000
(Registrant’s telephone number, including area code)
Not Applicable
(Former name, former address, and former fiscal year, if changed since last report)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the 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 and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes ☒ No ☐

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

Large accelerated filer            Accelerated filer           
Non-accelerated filer Smaller Reporting Company
Emerging growth company

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

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

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date: 7,557,923 shares of common stock, par value $0.01 per share, were issued and outstanding as of July 25, 2019.


SOUTHERN FIRST BANCSHARES, INC. AND SUBSIDIARY
June 30, 2019 Form 10-Q

INDEX

PART I – CONSOLIDATED FINANCIAL INFORMATION       Page
       
Item 1. Consolidated Financial Statements
 
Consolidated Balance Sheets 3
 
Consolidated Statements of Income 4
 
Consolidated Statements of Comprehensive Income 5
 
Consolidated Statements of Shareholders’ Equity 6
 
Consolidated Statements of Cash Flows 7
 
Notes to Unaudited Consolidated Financial Statements 8
 
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations 26
 
Item 3. Quantitative and Qualitative Disclosures about Market Risk 42
 
Item 4. Controls and Procedures 42
 
PART II – OTHER INFORMATION
 
Item 1. Legal Proceedings 43
 
Item 1A. Risk Factors 43
 
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds 43
 
Item 3. Defaults upon Senior Securities 43
 
Item 4. Mine Safety Disclosures 43
 
Item 5. Other Information 43
 
Item 6. Exhibits 43

2


PART I. CONSOLIDATED FINANCIAL INFORMATION
Item 1. CONSOLIDATED FINANCIAL STATEMENTS

SOUTHERN FIRST BANCSHARES, INC. AND SUBSIDIARY
CONSOLIDATED BALANCE SHEETS

 
      June 30,       December 31,
(dollars in thousands, except share data) 2019 2018
(Unaudited) (Audited)
ASSETS
Cash and cash equivalents:
Cash and due from banks $ 12,220 17,434
Federal funds sold 40,044 35,882
Interest-bearing deposits with banks 64,520 19,557
Total cash and cash equivalents 116,784 72,873
Investment securities:
Investment securities available for sale 75,252 74,905
Other investments 3,311 4,121
Total investment securities 78,563 79,026
Mortgage loans held for sale 24,509 9,241
Loans 1,809,355 1,677,332
Less allowance for loan losses (16,144 ) (15,762 )
Loans, net 1,793,211 1,661,570
Bank owned life insurance 39,448 34,010
Property and equipment, net 48,262 32,430
Deferred income taxes 7,049 4,020
Other assets 8,218 7,444
Total assets $ 2,116,044 1,900,614
LIABILITIES
Deposits $ 1,854,008 1,648,136
Federal Home Loan Bank advances and other borrowings 25,000 50,000
Junior subordinated debentures 13,403 13,403
Other liabilities 33,779 15,159
Total liabilities 1,926,190 1,726,698
SHAREHOLDERS’ EQUITY
Preferred stock, par value $.01 per share, 10,000,000 shares authorized - -
Common stock, par value $.01 per share, 10,000,000 shares authorized, 7,557,923 and 7,466,481 shares issued and outstanding at June 30, 2019 and December 31, 2018, respectively 76 75
Nonvested restricted stock (887 ) (741 )
Additional paid-in capital 104,354 102,625
Accumulated other comprehensive income (loss) 188 (917 )
Retained earnings 86,123 72,874
Total shareholders’ equity 189,854 173,916
Total liabilities and shareholders’ equity $     2,116,044       1,900,614

See notes to consolidated financial statements that are an integral part of these consolidated statements.

3


SOUTHERN FIRST BANCSHARES, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF INCOME

(Unaudited)

 
      For the three months For the six months
ended June 30, ended June 30,
(dollars in thousands, except share data) 2019       2018       2019       2018
Interest income
Loans $     22,098 17,591 42,988 34,154
Investment securities 539 430 1,087 798
Federal funds sold 451 514 625 761
Total interest income 23,088 18,535 44,700 35,713
Interest expense
Deposits 6,175 3,524 11,550 6,263
Borrowings 374 399 793 797
Total interest expense 6,549 3,923 12,343 7,060
Net interest income 16,539 14,612 32,357 28,653
Provision for loan losses 300 400 600 900
Net interest income after provision for loan losses 16,239 14,212 31,757 27,753
Noninterest income
Mortgage banking income 2,830 1,629 4,687 2,957
Service fees on deposit accounts 265 256 530 512
ATM and debit card income 443 371 823 705
Income from bank owned life insurance 222 220 438 441
Other income 330 295 606 577
Total noninterest income 4,090 2,771 7,084 5,192
Noninterest expenses
Compensation and benefits 7,399 6,365 14,182 12,208
Occupancy 1,343 1,276 2,682 2,413
Outside service and data processing costs 1,045 824 2,005 1,560
Insurance 280 297 598 610
Professional fees 414 457 853 933
Marketing 236 229 496 438
Other 651 531 1,200 1,022
Total noninterest expenses 11,368 9,979 22,016 19,184
Income before income tax expense 8,961 7,004 16,825 13,761
Income tax expense 1,721 1,494 3,576 3,037
Net income available to common shareholders $ 7,240 5,510 13,249 10,724
Earnings per common share
Basic $ 0.97 0.75 1.77 1.46
Diluted $ 0.93 0.71 1.71 1.39
Weighted average common shares outstanding
Basic 7,495,508 7,370,709 7,477,525 7,353,867
Diluted 7,755,821 7,751,146 7,748,879 7,739,082

See notes to consolidated financial statements that are an integral part of these consolidated statements.

4


SOUTHERN FIRST BANCSHARES, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(Unaudited)

 
      For the three months       For the six months
ended June 30, ended June 30,
(dollars in thousands) 2019       2018 2019       2018
Net income $ 7,240 5,510 13,249 10,724
Other comprehensive income (loss):
Unrealized gain (loss) on securities available for sale:
Unrealized holding gain (loss) arising during the period, pretax 720 (234 ) 1,404 (1,150 )
Tax (expense) benefit (151 ) 51 (294 ) 240
Reclassification of realized (gain) loss (2 ) - (6 ) 1
Tax expense - - 1 -
Other comprehensive income (loss) 567 (183 ) 1,105 (909 )
Comprehensive income $     7,807 5,327 14,354 9,815

See notes to consolidated financial statements that are an integral part of these consolidated statements.

5


SOUTHERN FIRST BANCSHARES, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY
(Unaudited)

 
For the three months ended June 30,


Common stock
Preferred stock Nonvested
restricted
stock

Additional
paid-in
capital
   Accumulated
other
comprehensive
loss
   Retained
earnings
Total
(dollars in thousands, except share data) Shares Amount Shares Amount     
March 31, 2018    7,381,716    74    -    -    (842 )    100,890 (1,182 )       55,799 154,739
Net income - - - - - - - 5,510 5,510
Proceeds from exercise of stock options 41,956 - - - - 409 - - 409
Issuance of restricted stock 2,000 - - - (92 ) 92 - - -
Compensation expense related to restricted stock, net of tax - - - - 81 - - - 81
Compensation expense related to stock options, net of tax - - - - - 300 - - 300
Other comprehensive loss - - - - - - (183 ) - (183 )
                                                         
June 30, 2018 7,425,672 $      74 - $      - $        (853 ) $      101,691 $              (1,365 ) $ 61,309 $      160,856
March 31, 2019 7,505,636 75 - - (993 ) 103,600 (379 ) 78,883 181,186
Net income - - - - - - - 7,240 7,240
Proceeds from exercise of stock options 52,287 1 - - - 436 - - 437
Issuance of restricted stock - - - - - - - - -
Compensation expense related to restricted stock, net of tax - - - - 106 - - - 106
Compensation expense related to stock options, net of tax - - - - - 318 - - 318
Other comprehensive income - - - - - - 567 - 567
June 30, 2019 7,557,923 $      76 - $ - $ (887)     $ 104,354   $ 188 $ 86,123 $ 189,854

For the six months ended June 30,


Common stock
Preferred stock
Nonvested
restricted
stock
Additional
paid-in
capital
Accumulated
other
comprehensive
loss
Retained
earnings
(dollars in thousands, except share data) Shares Amount Shares Amount Total
December 31, 2017    7,347,851    73    -    -    (502 )       99,986    (456 )    50,585    149,686
Net income - - - - - - - 10,724 10,724
Proceeds from exercise of stock options 66,321 1 - - - 637 - - 638
Issuance of restricted stock 11,500 - - - (501 ) 501 - - -
Compensation expense related to restricted stock, net of tax - - - - 150 - - - 150
Compensation expense related to stock options, net of tax - - - - - 567 - - 567
Other comprehensive loss - - - - - - (909 ) - (909 )
                                                         
June 30, 2018 7,425,672 $     74 - $     - $     (853 ) $     101,691 $          (1,365 ) $     61,309 $     160,856
December 31, 2018 7,466,481 75 - - (741 ) 102,625 (917 ) 72,874 173,916
Net income - - - - - - - 13,249 13,249
Proceeds from exercise of stock options 80,742 1 - - - 758 - - 759
Issuance of restricted stock 10,700 - - - (347 ) 347 - - -
Compensation expense related to restricted stock, net of tax - - - - 201 - - - 201
Compensation expense related to stock options, net of tax - - - - - 624 - - 624
Other comprehensive income - - - - - - 1,105 - 1,105
June 30, 2019 7,557,923 $ 76 - $     - $ (887)   $ 104,354 $ 188 $     86,123 $ 189,854

See notes to consolidated financial statements that are an integral part of these consolidated statements.

6


SOUTHERN FIRST BANCSHARES, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)

 
For the six months ended
June 30,
(dollars in thousands)       2019       2018
Operating activities
Net income $      13,249 10,724
Adjustments to reconcile net income to cash provided by (used for) operating activities:
Provision for loan losses 600 900
Depreciation and other amortization 913 850
Accretion and amortization of securities discounts and premium, net 182 220
(Gain) loss on sale of investment securities available for sale (6 ) 1
Gain on sale of fixed assets - (8 )
Net change in operating leases 492 -
Compensation expense related to stock options and restricted stock grants 825 717
Gain on sale of loans held for sale (4,411 ) (2,620 )
Loans originated and held for sale (154,785 ) (109,193 )
Proceeds from sale of loans held for sale 143,928 115,528
Increase in cash surrender value of bank owned life insurance (438 ) (441 )
Increase in deferred tax asset (3,323 ) (2,045 )
(Increase) decrease in other assets, net (774 ) 257
Increase in other liabilities 3,487 3,730
Net cash provided by (used for) operating activities (61 ) 18,620
Investing activities
Increase (decrease) in cash realized from:
Increase in loans, net (132,241 ) (146,700 )
Purchase of property and equipment (2,104 ) (1,328 )
Purchase of investment securities:
Available for sale (5,115 ) (13,904 )
Other investments - (2,596 )
Payments and maturities, calls and repayments of investment securities:
Available for sale 5,991 4,227
Other investments 810 3,999
Proceeds from sale of investment securities available for sale - 5,841
Proceeds from sale of real estate owned - 132
Purchase of life insurance policies (5,000 ) -
Net cash used for investing activities (137,659 ) (150,329 )
Financing activities
Increase (decrease) in cash realized from:
Increase in deposits, net 205,872 186,859
Decrease in Federal Home Loan Bank advances and other borrowings, net (25,000 ) (38,600 )
Proceeds from the exercise of stock options and warrants 759 638
Net cash provided by financing activities 181,631 148,897
Net increase in cash and cash equivalents 43,911 17,188
Cash and cash equivalents at beginning of the period 72,873 92,165
Cash and cash equivalents at end of the period $ 116,784 109,353
Supplemental information
Cash paid for
Interest $ 12,063 6,764
Income taxes 3,323 1,960
Schedule of non-cash transactions
Unrealized gain (loss) on securities, net of income taxes 1,110 (910 )
Right-of-use assets obtained in exchange for lease obligations:
Operating leases 15,395 -

See notes to consolidated financial statements that are an integral part of these consolidated statements.

7


SOUTHERN FIRST BANCSHARES, INC. AND SUBSIDIARY
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

NOTE 1 – Nature of Business and Basis of Presentation

Business Activity
Southern First Bancshares, Inc. (the “Company”) is a South Carolina corporation that owns all of the capital stock of Southern First Bank (the “Bank”) and all of the stock of Greenville First Statutory Trust I and II (collectively, the “Trusts”). The Trusts are special purpose non-consolidated entities organized for the sole purpose of issuing trust preferred securities. The Bank's primary federal regulator is the Federal Deposit Insurance Corporation (the “FDIC”). The Bank is also regulated and examined by the South Carolina Board of Financial Institutions. The Bank is primarily engaged in the business of accepting demand deposits and savings deposits insured by the FDIC, and providing commercial, consumer and mortgage loans to the general public.

Basis of Presentation
The accompanying consolidated financial statements have been prepared in accordance with generally accepted accounting principles (“GAAP”) for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all the information and footnotes required by accounting principles generally accepted in the United States of America for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. Operating results for the three and six month periods ended June 30, 2019 are not necessarily indicative of the results that may be expected for the year ending December 31, 2019. For further information, refer to the consolidated financial statements and footnotes thereto included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2018 as filed with the Securities and Exchange Commission (“SEC”) on February 28, 2019. The consolidated financial statements include the accounts of the Company and the Bank. In accordance with Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) 810, “Consolidation,” the financial statements related to the Trusts have not been consolidated.

Business Segments
In determining proper segment definition, the Company considers the materiality of a potential segment and components of the business about which financial information is available and regularly evaluated, relative to a resource allocation and performance assessment. The Company accounts for intersegment revenues and expenses as if the revenue/expense transactions were generated to third parties, that is, at current market prices. Please refer to “Note 10 – Reportable Segments” for further information on the reporting for the Company’s three business segments.

Use of Estimates
The preparation of consolidated financial statements in conformity with accounting principles generally accepted in the United States of America, or GAAP, requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities as of the date of the consolidated financial statements and the reported amount of income and expenses during the reporting periods. Actual results could differ from those estimates. Material estimates that are particularly susceptible to significant change in the near term relate to the determination of the allowance for loan losses, real estate acquired in the settlement of loans, fair value of financial instruments, evaluating other-than-temporary-impairment of investment securities and valuation of deferred tax assets.

Reclassifications
Certain amounts, previously reported, have been reclassified to state all periods on a comparable basis and had no effect on shareholders’ equity or net income.

Subsequent Events
Subsequent events are events or transactions that occur after the balance sheet date but before financial statements are issued. Recognized subsequent events are events or transactions that provide additional evidence about conditions that existed at the date of the balance sheet, including the estimates inherent in the process of preparing financial statements. Non-recognized subsequent events are events that provide evidence about conditions that did not exist at the date of the balance sheet but arose after that date. Management performed an evaluation to determine whether there have been any subsequent events since the balance sheet date and determined that no subsequent events occurred requiring accrual or disclosure.

8


Adoption of New Accounting Standards
In February 2016, the FASB issued ASU No. 2016-02, “Leases (Topic 842)” . The guidance in the update supersedes the requirements in ASC Topic 840, Leases. The guidance is intended to increase transparency and comparability among organizations by recognizing right-of-use assets and lease liabilities on the balance sheet. For public companies, this update was effective for interim and annual periods beginning after December 15, 2018. The Company adopted this guidance in the first quarter of 2019. Upon adoption, the Company elected a practical expedient which allows existing leases to retain their classification as operating leases. The Company has also elected to not recognize right-of-use assets and lease liabilities arising from short-term leases. Implementation of the guidance resulted in the recording of a right-of-use asset and lease liability on the balance sheet; however it does not have a material impact on the Company's other consolidated financial statements. See additional disclosures in Note 8.

Newly Issued, But Not Yet Effective Accounting Standards
In June 2016, the FASB issued ASU 2016-13, “Financial Instruments – Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments” . Among other things, ASU 2016-13 requires the measurement of all expected credit losses for financial assets held at the reporting date based on historical experience, current conditions, and reasonable and supportable forecasts. Financial institutions and other organizations will now use forward-looking information to form their credit loss estimates. Many of the loss estimation techniques applied today will still be permitted, although the inputs to those techniques will change to reflect the full amount of expected credit losses. In addition, ASU 2016-13 amends the accounting for credit losses on debt securities and purchased financial assets with credit deterioration. ASU 2016-13 is effective for all annual and interim periods beginning after December 31, 2019, with early adoption permitted for fiscal years beginning after December 15, 2018. Adoption will be applied through a cumulative-effect adjustment to retained earnings as of the beginning of the first reporting period in which the guidance is effective. The Company has established a team of individuals from credit, finance and risk management to evaluate the requirements of the new standard and the impact it will have on our processes. Our implementation plan has progressed through the initial design, build, and testing phase and, in the first quarter of 2019, we began running parallel models. While we continue to evaluate the impact the new guidance will have on our financial position and results of operations, we currently expect the new guidance may result in an increase to our allowance for credit losses given the change to estimated losses over the contractual life of the loan portfolio. The amount of any change to our allowance is still under review and will depend, in part, upon the composition of our loan portfolio at the adoption date as well as economic conditions and loss forecasts at that date.

On July 17, 2019, the FASB voted to issue a proposal for public comment that would potentially result in a postponement of the required implementation date for ASU 2016-13. As a smaller reporting company, the Company would be eligible for the proposed delay. The Company is currently evaluating the impact of the proposed delay on its implementation project plan. Management will continue to monitor any new developments regarding this possible delay.

Other accounting standards that have been issued or proposed by the FASB or other standards-setting bodies that do not require adoption until a future date are not expected to have a material impact on the consolidated financial statements upon adoption .

9


NOTE 2 – Investment Securities

The amortized costs and fair value of investment securities are as follows:

 
June 30, 2019
Amortized Gross Unrealized Fair
(dollars in thousands)       Cost       Gains       Losses       Value
Available for sale
US government agencies $       7,716 33 4 7,745
SBA securities 4,066 60 21 4,105
State and political subdivisions 8,019 191 1 8,209
Asset-backed securities 10,909 1 91 10,819
Mortgage-backed securities
FHLMC 11,370 225 59 11,536
FNMA 28,946 123 179 28,890
GNMA 3,988 6 46 3,948
Total mortgage-backed securities 44,304 354 284 44,374
Total investment securities available for sale $ 75,014 639 401 75,252

De cember 31, 2018
Amortized Gross Unrealized       Fair
      Cost       Gains       Losses Value
Available for sale
US government agencies $      8,975 1 194 8,782
SBA securities 3,628 - 103 3,525
State and political subdivisions 8,371 48 63 8,356
Asset-backed securities 9,595 12 49 9,558
Mortgage-backed securities
FHLMC 12,258 87 242 12,103
FNMA 29,068 25 551 28,542
GNMA 4,170 1 132 4,039
Total mortgage-backed securities 45,496 113 925 44,684
Total $ 76,065 174 1,334 74,905

Contractual maturities and yields on the Company’s investment securities at June 30, 2019 and December 31, 2018 are shown in the following table. Expected maturities may differ from contractual maturities because issuers may have the right to call or prepay obligations with or without call or prepayment penalties.

 
June 30, 2019
Less than one year One to five years Five to ten years Over ten years Total
(dollars in thousands) Amount Yield   Amount Yield   Amount   Yield   Amount Yield   Amount Yield
Available for sale
US government agencies        $      -       -       3,969       2.14 %       3,776       2.68 %       -       -       7,745       2.40 %
SBA securities - - - - 752 2.88 % 3,353 2.77 % 4,105 2.79 %
State and political subdivisions - - 1,127 2.97 % 4,175 2.95 % 2,907 2.88 % 8,209 2.93 %
Asset-backed securities - - - - 1,682 3.19 % 9,137 3.19 % 10,819 3.19 %
Mortgage-backed securities - - 4,658 1.94 % 8,922 2.15 % 30,794 2.63 % 44,374 2.46 %
Total $ - - 9,754 2.14 % 19,307 2.55 % 46,191 2.76 % 75,252 2.63 %

December 31, 2018
Less than one year One to five years Five to ten years Over ten years Total
(dollars in thousands) Amount Yield Amount Yield Amount Yield Amount Yield Amount Yield
Available for sale                                                            
US government agencies $      - - 2,665 2.12 % 6,117 2.77 % - - 8,782 2.57 %
SBA securities - - - - - - 3,525 2.72 % 3,525 2.72 %
State and political subdivisions - - 819 2.60 % 4,637 3.04 % 2,900 2.88 % 8,356 2.94 %
Asset-backed securities - - - - 1,862 3.22 % 7,696 3.29 % 9,558 3.27 %
Mortgage-backed securities - - 5,094 1.89 % 9,763 2.22 %   29,827 2.70 % 44,684 2.50 %
Total $ - - 8,578 2.03 % 22,379 2.62 %   43,948 2.81 % 74,905 2.67 %

10


The tables below summarize gross unrealized losses on investment securities and the fair market value of the related securities at June 30, 2019 and December 31, 2018, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position.

     
    June 30, 2019
Less than 12 months 12 months or longer             Total
Fair     Unrealized     Fair     Unrealized Fair     Unrealized
(dollars in thousands) # value losses # value losses # value losses
Available for sale        
     US government agencies 1 $      500 $      1 2 $      1,997 $      3 3 $      2,497 $      4
     SBA securities - - - 1 649 21 1 649 21
     State and political subdivisions - - - 2 979 1 2 979 1
     Asset-backed securities 5 7,614 89 1 1,682 2 6 9,296 91
     Mortgage-backed securities
           FHLMC - - - 9 6,049 59 9 6,049 59
           FNMA 1 1,550 1 22 19,632 178 23 21,182 179
           GNMA - - - 3 2,975 46 3 2,975 46
           Total 7 $ 9,664 $ 91 40       $ 33,963 $ 310 47 $ 43,627 $ 401
 
December 31, 2018
Less than 12 months 12 months or longer Total
Fair   Unrealized Fair   Unrealized Fair Unrealized
(dollars in thousands) # value losses # value losses # value losses
Available for sale
     US government agencies 1 $ 1,246 $ 3 8   $ 7,035 $ 191 9 $ 8,281 $ 194
     SBA securities - - - 2 3,525 103 2 3,525 103
     State and political subdivisions - - - 7 2,829 63 7 2,829 63
     Asset-backed securities 4 6,707 49 - - - 4 6,707 49
     Mortgage-backed securities
           FHLMC - - - 10 7,402 242 10 7,402 242
           FNMA 2 2,689 6 23 22,814 545 25 25,503 551
           GNMA 1 1,104 6 3 2,919 126 4 4,023 132
           Total 8 $ 11,746 $ 64 53 $ 46,524 $ 1,270 61 $ 58,270 $ 1,334

At June 30, 2019, the Company had seven individual investments with a fair market value of $9.7 million that were in an unrealized loss position for less than 12 months and 40 individual investments with a fair market value of $34.0 million that were in an unrealized loss position for 12 months or longer. The unrealized losses were primarily attributable to changes in interest rates, rather than deterioration in credit quality. The individual securities are each investment grade securities. The Company considers the length of time and extent to which the fair value of available-for-sale debt securities have been less than cost to conclude that such securities are not other-than-temporarily impaired. The Company also considers other factors such as the financial condition of the issuer including credit ratings and specific events affecting the operations of the issuer, volatility of the security, underlying assets that collateralize the debt security, and other industry and macroeconomic conditions.

As the Company has no intent to sell securities with unrealized losses and it is not more-likely-than-not that the Company will be required to sell these securities before recovery of amortized cost, the Company has concluded that these securities are not impaired on an other-than-temporary basis. Other investments are comprised of the following and are recorded at cost which approximates fair value.

 
(dollars in thousands) June 30, 2019       December 31, 2018
Federal Home Loan Bank stock $      2,774 3,587
Other investments 134 131
Investment in Trust Preferred securities 403 403
           Total other investments $ 3,311 4,121

The Company has evaluated the Federal Home Loan Bank (“FHLB”) stock for impairment and determined that the investment in the FHLB stock is not other than temporarily impaired as of June 30, 2019 and that ultimate recoverability of the par value of this investment is probable. All of the FHLB stock is used to collateralize advances with the FHLB.

11


NOTE 3 – Mortgage Loans Held for Sale

Mortgage loans originated and intended for sale in the secondary market are reported as loans held for sale and carried at fair value under the fair value option with changes in fair value recognized in current period earnings. At the date of funding of the mortgage loan held for sale, the funded amount of the loan, the related derivative asset or liability of the associated interest rate lock commitment, less direct loan costs becomes the initial recorded investment in the loan held for sale. Such amount approximates the fair value of the loan. At June 30, 2019, mortgage loans held for sale totaled $24.5 million compared to $9.2 million at December 31, 2018. The $15.3 million increase in mortgage loans held for sale during the first six months of 2019 was driven by an increase in volume of mortgage loans originated and sold in the favorable mortgage rate environment.

Mortgage loans held for sale are considered de-recognized, or sold, when the Company surrenders control over the financial assets. Control is considered to have been surrendered when the transferred assets have been isolated from the Company, beyond the reach of the Company and its creditors; the purchaser obtains the right (free of conditions that constrain it from taking advantage of that right) to pledge or exchange the transferred assets; and the Company does not maintain effective control over the transferred assets through an agreement that both entitles and obligates the Company to repurchase or redeem the transferred assets before their maturity or the ability to unilaterally cause the holder to return specific assets.

Gains and losses from the sale of mortgage loans are recognized based upon the difference between the sales proceeds and carrying value of the related loans upon sale and are recorded in mortgage banking income in the statement of income. Mortgage banking income also includes the unrealized gains and losses associated with the loans held for sale and the realized and unrealized gains and losses from derivatives.

Mortgage loans sold by the Company to investors and which were believed to have met investor and agency underwriting guidelines at the time of sale may be subject to repurchase or indemnification in the event of specific default by the borrower or subsequent discovery that underwriting standards were not met. The Company may, upon mutual agreement, agree to repurchase the loans or indemnify the investor against future losses on such loans. In such cases, the Company bears any subsequent credit loss on the loans.

The Company establishes mortgage repurchase reserves related to various representations and warranties that reflect management’s estimate of losses based on a combination of factors. The Company establishes a reserve at the time loans are sold and updates the reserve estimate on a quarterly basis during the estimated life of the loan.

NOTE 4 – Loans and Allowance for Loan Losses

The following table summarizes the composition of our loan portfolio. Total gross loans are recorded net of deferred loan fees and costs, which totaled $2.9 million as of June 30, 2019 and $2.8 million as of December 31, 2018.

 
      June 30, 2019       December 31, 2018
(dollars in thousands) Amount       % of Total Amount       % of Total
Commercial
     Owner occupied RE $      390,727 21.6 % $      367,018 21.9 %
     Non-owner occupied RE 455,346 25.2 % 404,296 24.1 %
     Construction 85,065 4.7 % 84,411 5.0 %
     Business 292,564 16.2 % 272,980 16.3 %
           Total commercial loans 1,223,702 67.7 % 1,128,705 67.3 %
Consumer
     Real estate 342,100 18.9 % 320,943 19.1 %
     Home equity      170,861 9.4 % 165,937 9.9 %
     Construction 46,247 2.6 % 37,925 2.3 %
     Other 26,445 1.4 % 23,822 1.4 %
           Total consumer loans 585,653 32.3 % 548,627 32.7 %
           Total gross loans, net of deferred fees 1,809,355 100.0 % 1,677,332 100.0 %
Less—allowance for loan losses (16,144 )     (15,762 )
           Total loans, net $ 1,793,211 $ 1,661,570

12


Maturities and Sensitivity of Loans to Changes in Interest Rates

The information in the following tables summarizes the loan maturity distribution by type and related interest rate characteristics based on the contractual maturities of individual loans, including loans which may be subject to renewal at their contractual maturity. Renewal of such loans is subject to review and credit approval, as well as modification of terms upon maturity. Actual repayments of loans may differ from the maturities reflected below, because borrowers have the right to prepay obligations with or without prepayment penalties.

     
      June 30, 2019
      After one            
One year but within After five
(dollars in thousands) or less five years years Total
Commercial
     Owner occupied RE $      21,628 161,881 207,218 390,727
     Non-owner occupied RE 50,516 268,178 136,652 455,346
     Construction 23,222 28,283 33,560 85,065
     Business 84,902 144,493 63,169 292,564
          Total commercial loans 180,268 602,835 440,599 1,223,702
Consumer
     Real estate 24,866 77,323 239,911 342,100
     Home equity 10,700 24,353 135,808 170,861
     Construction 16,216 872 29,159 46,247
     Other 7,617 14,294 4,534 26,445
          Total consumer loans 59,399 116,842 409,412 585,653
               Total gross loans, net of deferred fees $ 239,667 719,677 850,011 1,809,355
Loans maturing after one year with:
Fixed interest rates $      1,198,490
Floating interest rates 371,198
               
December 31, 2018
After one
One year but within After five
(dollars in thousands) or less five years years Total
Commercial
     Owner occupied RE $ 20,839 165,436 180,743 367,018
     Non-owner occupied RE 43,000 227,454 133,842 404,296
     Construction 22,941 33,045 28,425 84,411
     Business 80,672 128,911 63,397 272,980
          Total commercial loans 167,452 554,846 406,407 1,128,705
Consumer
     Real estate 29,301 70,467 221,175 320,943
     Home equity 8,867 24,618 132,452 165,937
     Construction 16,006 1,646 20,273 37,925
     Other 7,681 11,253 4,888 23,822
          Total consumer 61,855 107,984 378,788 548,627
               Total gross loan, net of deferred fees $ 229,307 662,830 785,195 1,677,332
Loans maturing after one year with:
Fixed interest rates $ 1,100,854
Floating interest rates 347,171

Portfolio Segment Methodology

Commercial
Commercial loans are assessed for estimated losses by grading each loan using various risk factors identified through periodic reviews. The Company applies historic grade-specific loss factors to each loan class. In the development of statistically derived loan grade loss factors, the Company observes historical losses over 20 quarters for each loan grade. These loss estimates are adjusted as appropriate based on additional analysis of external loss data or other risks identified from current economic conditions and credit quality trends. The allowance also includes an amount for the estimated impairment on nonaccrual commercial loans and commercial loans modified in a troubled debt restructuring (“TDR”), whether on accrual or nonaccrual status.

13


Consumer
For consumer loans, the Company determines the allowance on a collective basis utilizing historical losses over 20 quarters to represent its best estimate of inherent loss. The Company pools loans, generally by loan class with similar risk characteristics. The allowance also includes an amount for the estimated impairment on nonaccrual consumer loans and consumer loans modified in a TDR, whether on accrual or nonaccrual status.

Credit Quality Indicators

Commercial
We manage a consistent process for assessing commercial loan credit quality by monitoring its loan grading trends and past due statistics. All loans are subject to individual risk assessment. Our risk categories include Pass, Special Mention, Substandard, and Doubtful, each of which is defined by our banking regulatory agencies. Delinquency statistics are also an important indicator of credit quality in the establishment of our allowance for loan losses.

We categorize our loans into risk categories based on relevant information about the ability of the borrower to service their debt such as current financial information, historical payment experience, credit documentation, public information, and current economic trends, among other factors. A description of the general characteristics of the risk grades is as follows:

Pass—These loans range from minimal credit risk to average credit risk; however, still have acceptable credit risk.

   

Special mention—A special mention loan has potential weaknesses that deserve management’s close attention. If left uncorrected, these potential weaknesses may result in deterioration of the repayment prospects for the loan or the institution’s credit position at some future date.

   

Substandard—A substandard loan is inadequately protected by the current sound worth and paying capacity of the obligor or of the collateral pledged, if any. Loans so classified must have a well-defined weakness, or weaknesses, that may jeopardize the liquidation of the debt. A substandard loan is characterized by the distinct possibility that the Bank will sustain some loss if the deficiencies are not corrected.

   

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

The tables below provide a breakdown of outstanding commercial loans by risk category.

 
      June 30, 2019
Owner       Non-owner                  
(dollars in thousands) occupied RE occupied RE Construction Business Total
Pass $      386,489 447,808 84,998 286,387 1,205,682
Special mention 1,850 4,194 67 1,969 8,080
Substandard 2,388 3,344 - 4,208 9,940
Doubtful - - - - -
$ 390,727 455,346 85,065 292,564 1,223,702
 
December 31, 2018
Owner Non-owner
(dollars in thousands) occupied RE occupied RE Construction Business Total
Pass $ 363,621 400,266 84,411 266,898 1,115,196
Special mention 296 118 - 2,971 3,385
Substandard 3,101 3,912 - 3,111 10,124
Doubtful - - - - -
$ 367,018 404,296 84,411 272,980 1,128,705

14


The following tables provide past due information for outstanding commercial loans and include loans on nonaccrual status as well as accruing TDRs.

        
       June 30, 2019
Owner       Non-owner                  
(dollars in thousands) occupied RE occupied RE Construction Business Total
Current $      390,538 454,930 85,065 292,284 1,222,817
30-59 days past due 189 206 - 38 433
60-89 days past due - 210 - 177 387
Greater than 90 Days - - - 65 65
$ 390,727 455,346 85,065 292,564 1,223,702
 
December 31, 2018
Owner Non-owner
occupied RE occupied RE Construction Business Total
Current $ 367,018 404,179 84,411 272,864 1,128,472
30-59 days past due - 117 - 36 153
60-89 days past due - - - - -
Greater than 90 Days - - - 80 80
$ 367,018 404,296 84,411 272,980 1,128,705

Consumer
The Company manages a consistent process for assessing consumer loan credit quality by monitoring its loan grading trends and past due statistics. All loans are subject to individual risk assessment. The Company’s categories include Pass, Special Mention, Substandard, and Doubtful, which are defined above. Delinquency statistics are also an important indicator of credit quality in the establishment of the allowance for loan losses.

The tables below provide a breakdown of outstanding consumer loans by risk category.

         
June 30, 2019
(dollars in thousands) Real estate       Home equity       Construction       Other       Total
Pass $      335,618 167,670 46,247 26,322 575,857
Special mention 2,818 256 - 99 3,173
Substandard 3,664 2,935 - 24 6,623
Doubtful - - - - -
$ 342,100 170,861 46,247 26,445 585,653
 
December 31, 2018
(dollars in thousands) Real estate Home equity Construction Other Total
Pass $ 314,586 162,626 37,925 23,586 538,723
Special mention 1,792 864 - 139 2,795
Substandard 4,565 2,447 - 97 7,109
Doubtful - - - - -
$ 320,943 165,937 37,925 23,822 548,627

15


The following tables provide past due information for outstanding consumer loans and include loans on nonaccrual status as well as accruing TDRs.

                   
June 30, 2019
(dollars in thousands) Real estate       Home equity       Construction       Other Total
Current $      339,686 169,686 46,247 26,417 582,036
30-59 days past due 674 604 - 28 1,306
60-89 days past due 247 371 - - 618
Greater than 90 Days 1,493 200 - - 1,693
$ 342,100 170,861 46,247 26,445 585,653
 
December 31, 2018
(dollars in thousands)       Real estate       Home equity       Construction Other       Total
Current $ 317,267 165,727 37,925 23,603 544,522
30-59 days past due 2,555 30 - 106 2,691
60-89 days past due 923 - - 113 1,036
Greater than 90 Days 198 180 - - 378
$ 320,943 165,937 37,925 23,822 548,627

As of June 30, 2019 and December 31, 2018, loans 30 days or more past due represented 0.25% and 0.26% of the Company’s total loan portfolio, respectively. Commercial loans 30 days or more past due were 0.05% and 0.01% of the Company’s total loan portfolio as of June 30, 2019 and December 31, 2018, respectively, while consumer loans 30 days or more past due were 0.20% and 0.25% of total loans as of June 30, 2019 and December 31, 2018, respectively.

Nonperforming assets

The following table shows the nonperforming assets and the related percentage of nonperforming assets to total assets and gross loans. Generally, a loan is placed on nonaccrual status when it becomes 90 days past due as to principal or interest, or when the Company believes, after considering economic and business conditions and collection efforts, that the borrower’s financial condition is such that collection of the contractual principal or interest on the loan is doubtful. A payment of interest on a loan that is classified as nonaccrual is recognized as a reduction in principal when received.

Following is a summary of our nonperforming assets, including nonaccruing TDRs.

         
(dollars in thousands)       June 30, 2019       December 31, 2018
Commercial
Owner occupied RE $         - -
Non-owner occupied RE 372 210
Construction - -
Business 65 81
Consumer
Real estate 1,710                    1,980
Home equity 442 1,006
Construction - -
Other - 12
Nonaccruing troubled debt restructurings 3,220 2,541
Total nonaccrual loans, including nonaccruing TDRs 5,809 5,830
Other real estate owned - -
Total nonperforming assets $ 5,809 5,830
Nonperforming assets as a percentage of:
Total assets 0.27 % 0.31 %
Gross loans 0.32 % 0.35 %
Total loans over 90 days past due 1,758 458
Loans over 90 days past due and still accruing - -
Accruing troubled debt restructurings $ 6,935 6,742

16


Impaired Loans

The table below summarizes key information for impaired loans. The Company’s impaired loans include loans on nonaccrual status and loans modified in a TDR, whether on accrual or nonaccrual status. These impaired loans may have estimated impairment which is included in the allowance for loan losses. The Company’s commercial and consumer impaired loans are evaluated individually to determine the related allowance for loan losses.

           
June 30, 2019
Recorded investment
Impaired loans
Unpaid with related Related
Principal Impaired allowance for allowance for
(dollars in thousands)       Balance       loans       loan losses       loan losses
Commercial
Owner occupied RE $      3,171 3,107 447 75
Non-owner occupied RE 2,870 2,507 1,706 532
Construction - - - -
Business 3,359 2,713 2,118 884
Total commercial 9,400 8,327 4,271 1,491
Consumer
Real estate 2,619 2,612 1,776 466
Home equity 2,197 1,651 270 71
Construction - - - -
Other 154 154 154 17
Total consumer 4,970 4,417 2,201 554
Total $ 14,370 12,744 6,472 2,045
 
December 31, 2018
Recorded investment
Impaired loans
Unpaid with related Related
Principal Impaired allowance for allowance for
(dollars in thousands) Balance loans loan losses loan losses
Commercial
Owner occupied RE $ 2,827 2,762 451 75
Non-owner occupied RE 3,321 2,807 2,204 558
Construction - - - -
Business 3,745 2,520 2,005 895
Total commercial 9,893 8,089 4,660 1,528
Consumer
Real estate 2,993 2,892 1,398 456
Home equity 1,935 1,421 - -
Construction - - - -
Other 170 170 170 30
Total consumer 5,098 4,483 1,568 486
Total $ 14,991 12,572 6,228 2,014

17


The following table provides the average recorded investment in impaired loans and the amount of interest income recognized on impaired loans after impairment by portfolio segment and class.

                   
Three months ended Three months ended
June 30, 2019 June 30, 2018
            Average       Recognized       Average       Recognized
      recorded interest recorded interest
(dollars in thousands) investment income investment income
Commercial
Owner occupied RE $      3,116 44 2,800 45
Non-owner occupied RE 2,544 41 3,878 77
Construction - - - -
Business 2,728 37 3,361 57
Total commercial 8,388 122 10,039 179
Consumer
Real estate 2,622 20 2,892 40
Home equity 1,659 21 2,135 24
Construction - - - -
Other 155 1 165 1
Total consumer 4,436 42 5,192 65
Total $ 12,824 164 15,231 244
 
Six months ended Six months ended Year ended
June 30, 2019 June 30, 2018 December 31, 2018
Average Recognized Average Recognized Average Recognized
recorded interest recorded interest recorded interest
(dollars in thousands) investment income investment income investment income
Commercial
Owner occupied RE $      3,123 79 2,804 62 2,784 142
Non-owner occupied RE 2,565 85 3,920 126 2,860 174
Construction - - - - - -
Business 2,700 77 3,380 79 2,883 162
Total commercial 8,388 241 10,104 267 8,527 478
Consumer
Real estate 2,633 45 2,911 81 2,930 151
Home equity 1,670 51 2,172 51 1,453 99
Construction - - - - - -
Other 156 2 167 3 174 5
Total consumer 4,459 98 5,250 135 4,557 255
Total $ 12,847 339 15,354 402 13,084 733

Allowance for Loan Losses

The allowance for loan loss is management’s estimate of credit losses inherent in the loan portfolio. The allowance for loan losses is established as losses are estimated to have occurred through a provision for loan losses charged to earnings. Loan losses are charged against the allowance when management believes the uncollectibility of a loan balance is confirmed. Subsequent recoveries, if any, are credited to the allowance. The allowance for loan losses is evaluated on a regular basis by management and is based upon management’s periodic review of the collectability of the loans in light of historical experience, the nature and volume of the loan portfolio, adverse situations that may affect the borrower’s ability to repay, estimated value of any underlying collateral and prevailing economic conditions. This evaluation is inherently subjective as it requires estimates that are susceptible to significant revision as more information becomes available.

The Company has an established process to determine the adequacy of the allowance for loan losses that assesses the losses inherent in the portfolio. While the Company attributes portions of the allowance to specific portfolio segments, the entire allowance is available to absorb credit losses inherent in the total loan portfolio. The Company’s process involves procedures to appropriately consider the unique risk characteristics of the commercial and consumer loan portfolio segments. For each portfolio segment, impairment is measured individually for each impaired loan. The Company’s allowance levels are influenced by loan volume, loan grade or delinquency status, historic loss experience and other economic conditions.

18


The following table summarizes the activity related to the allowance for loan losses by commercial and consumer portfolio segments:

     
Three months ended June 30, 2019
Commercial Consumer    
Owner Non-owner                
occupied occupied Real Home
(dollars in thousands)     RE     RE     Construction     Business Estate equity Construction Other Total
Balance, beginning of period $ 2,783 3,886    572 3,796 3,041 1,410 282 281 16,051
Provision for loan losses 135 143 (3 ) (181 ) 49 98 36 23 300
Loan charge-offs (110 ) (13 ) - - - (100 ) - (14 ) (237 )
Loan recoveries - - - 8 14 1 - 7 30
Net loan charge-offs (110 ) (13 ) - 8 14 (99 ) - (7 ) (207 )
Balance, end of period $ 2,808 4,016 569 3,623 3,104 1,409 318 297 16,144
Net charge-offs to average loans (annualized) 0.05 %
Allowance for loan losses to gross loans 0.89 %
Allowance for loan losses to nonperforming loans 277.92 %
 
Three months ended June 30, 2018
Commercial Consumer
Owner Non-owner
occupied occupied Real Home
(dollars in thousands) RE RE Construction Business Estate equity Construction Other Total
Balance, beginning of period $ 2,680 3,366 415 3,553 3,391 1,911 256 280 15,852
Provision for loan losses 19 342 129 280 54 (438 ) 26 (12 ) 400
Loan charge-offs - (234 ) - - - (77 ) - - (311 )
Loan recoveries - 107 - 16 1 35 - - 159
Net loan charge-offs - (127 ) - 16 1 (42 ) - - (152 )
Balance, end of period $ 2,699 3,581 544 3,849 3,446 1,431 282   268 16,100
Net charge-offs to average loans (annualized) 0.04 %
Allowance for loan losses to gross loans 1.05 %
Allowance for loan losses to nonperforming loans 208.52 %
 
Six months ended June 30, 2019
Commercial Consumer
Owner Non-owner
occupied occupied Real Home
(dollars in thousands) RE RE Construction Business Estate equity Construction Other Total
Balance, beginning of period $      2,726         3,811 615 3,616 3,081 1,348 275 290 15,762
Provision for loan losses 192 217               (46 ) (10 ) (6 ) 160 43 50 600
Loan charge-offs (110 ) (14 ) - - - (100 ) - (53 ) (277 )
Loan recoveries - 2 - 17 29 1 - 10 59
Net loan charge-offs (110 ) (12 ) - 17 29 (99 ) - (43 ) (218 )
Balance, end of period $ 2,808 4,016 569 3,623 3,104 1,409 318 297 16,144
Net charge-offs to average loans (annualized) 0.03 %
 
Six months ended June 30, 2018
Commercial Consumer
Owner Non-owner
occupied occupied Real Home
RE RE Construction Business Estate equity Construction Other Total
Balance, beginning of period $ 2,534 3,230 325      3,848  3,495  1,600 210 281 15,523
Provision for loan losses 165 478 219 (14 ) 25 (64 ) 72 19 900
Loan charge-offs - (234 ) - (119 ) (77 ) (140 ) - (34 ) (604 )
Loan recoveries - 107 - 134 3 35 - 2 281
Net loan charge-offs - (127 ) - 15 (74 ) (105 ) - (32 ) (323 )
Balance, end of period $ 2,699 3,581 544 3,849 3,446 1,431 282 268 16,100
Net charge-offs to average loans (annualized) 0.04 %

The following table disaggregates the allowance for loan losses and recorded investment in loans by impairment methodology.

19



     
June 30, 2019
Allowance for loan losses Recorded investment in loans
(dollars in thousands)       Commercial       Consumer       Total       Commercial       Consumer       Total
Individually evaluated $      1,491 554 2,045 8,327 4,417 12,744
Collectively evaluated 9,525 4,574 14,099 1,215,375 581,236 1,796,611
Total $ 11,016 5,128 16,144 1,223,702 585,653  1,809,355
 
December 31, 2018
Allowance for loan losses Recorded investment in loans
(dollars in thousands) Commercial Consumer Total Commercial Consumer Total
Individually evaluated $      1,528 486 2,014 8,089 4,483 12,572
Collectively evaluated 9,240 4,508 13,748 1,120,616 544,144 1,664,760
Total $ 10,768 4,994 15,762 1,128,705 548,627 1,677,332

NOTE 5 – Troubled Debt Restructurings

At June 30, 2019, the Company had 25 loans totaling $10.2 million compared to 26 loans totaling $9.3 million at December 31, 2018, which were considered as TDRs. The Company considers a loan to be a TDR when the debtor experiences financial difficulties and the Company grants a concession to the debtor that it would not normally consider. Concessions can relate to the contractual interest rate, maturity date, or payment structure of the note. As part of the workout plan for individual loan relationships, the Company may restructure loan terms to assist borrowers facing financial challenges in the current economic environment. To date, the Company has restored three commercial loans previously classified as TDRs to accrual status.

The following table summarizes the concession at the time of modification and the recorded investment in the Company’s TDRs before and after their modification.

     
For the six months ended June 30, 2019
Pre-       Post-
modification modification
      Renewals Reduced Converted Maturity Total outstanding outstanding
deemed a       or deferred       to interest       date       Number       recorded recorded
(dollars in thousands) concession payments only extensions of loans investment investment
Consumer
Home equity 1 - - - 1 $      832 $      832
Total loans 1 - - - 1 $ 832 $ 832
 
For the six months ended June 30, 2018
Pre- Post-
modification modification
Renewals Reduced Converted Maturity Total outstanding outstanding
deemed a or deferred to interest date Number recorded recorded
(dollars in thousands) concession payments only extensions of loans investment investment
Commercial
Owner occupied RE 1 - - - 1 $ 506 $ 592
Business 4 - - - 4 1,207 1,532
Consumer
Real estate 2 - - - 2 549 669
Home equity - 1 - - 1 180 180
Total loans 7 1 - - 8 $ 2,442 $ 2,973

As of June 30, 2019 and 2018, there were no loans modified as a TDR for which there was a payment default (60 days past due) within 12 months of the restructuring date.

20


NOTE 6 – Derivative Financial Instruments

The Company utilizes derivative financial instruments primarily to hedge its exposure to changes in interest rates. All derivative financial instruments are recognized as either assets or liabilities and measured at fair value. The Company accounts for all of its derivatives as free-standing derivatives and does not designate any of these instruments for hedge accounting. Therefore, the gain or loss resulting from the change in the fair value of the derivative is recognized in the Company’s statement of income during the period of change.

The Company enters into commitments to originate residential mortgage loans held for sale, at specified interest rates and within a specified period of time, with clients who have applied for a loan and meet certain credit and underwriting criteria (interest rate lock commitments). These interest rate lock commitments (“IRLCs”) meet the definition of a derivative financial instrument and are reflected in the balance sheet at fair value with changes in fair value recognized in current period earnings. Unrealized gains and losses on the IRLCs are recorded as derivative assets and derivative liabilities, respectively, and are measured based on the value of the underlying mortgage loan, quoted mortgage-backed securities (“MBS”) prices and an estimate of the probability that the mortgage loan will fund within the terms of the interest rate lock commitment, net of estimated commission expenses.

The Company manages the interest rate and price risk associated with its outstanding IRLCs and mortgage loans held for sale by entering into derivative instruments such as forward sales of MBS. Management expects these derivatives will experience changes in fair value opposite to changes in fair value of the IRLCs and mortgage loans held for sale, thereby reducing earnings volatility. The Company takes into account various factors and strategies in determining the portion of the mortgage pipeline (IRLCs and mortgage loans held for sale) it wants to economically hedge.

The following table summarizes the Company’s outstanding financial derivative instruments at June 30, 2019 and December 31, 2018.

 
      June 30, 2019
            Fair Value
(dollars in thousands) Notional Balance Sheet Location Asset/(Liability)
Mortgage loan interest rate lock commitments $ 64,019 Other assets $ 801
MBS forward sales commitments 42,500 Other liabilities (165 )
Total derivative financial instruments $ 106,519 $ 636
 
December 31, 2018
Fair Value
(dollars in thousands) Notional Balance Sheet Location Asset/(Liability)
Mortgage loan interest rate lock commitments $ 20,552 Other assets $ 345
MBS forward sales commitments 11,750 Other liabilities           (121 )
Total derivative financial instruments $     32,302 $     224

NOTE 7 – Fair Value Accounting

FASB ASC 820, “Fair Value Measurement and Disclosures,” defines fair value as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. FASB ASC 820 also establishes a fair value hierarchy which requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. The standard describes three levels of inputs that may be used to measure fair value:

Level 1 – Quoted market price in active markets
Quoted prices in active markets for identical assets or liabilities. Level 1 assets and liabilities include certain debt and equity securities that are traded in an active exchange market.

21


Level 2 – Significant other observable inputs
Observable inputs other than Level 1 prices such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities. Level 2 assets and liabilities include fixed income securities and mortgage-backed securities that are held in the Company’s available-for-sale portfolio and valued by a third-party pricing service, as well as certain impaired loans.

Level 3 – Significant unobservable inputs
Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities. Level 3 assets and liabilities include financial instruments whose value is determined using pricing models, discounted cash flow methodologies, or similar techniques, as well as instruments for which the determination of fair value requires significant management judgment or estimation. These methodologies may result in a significant portion of the fair value being derived from unobservable data.

The methods of determining the fair value of assets and liabilities presented in this note are consistent with our methodologies disclosed in Note 13 of the Company’s 2018 Form 10-K. The Company’s loan portfolio is initially fair valued using a segmented approach, using the eight categories as disclosed in Note 4 – Loans and Allowance for Loan Losses. Loans are considered a Level 3 classification.

Assets and Liabilities Recorded at Fair Value on a Recurring Basis
The tables below present the recorded amount of assets and liabilities measured at fair value on a recurring basis as of June 30, 2019 and December 31, 2018.

                   
      June 30, 2019
(dollars in thousands) Level 1 Level 2 Level 3 Total
Assets
Securities available for sale
US government agencies $ - 7,745 - 7,745
SBA securities - 4,105 - 4,105
State and political subdivisions - 8,209 - 8,209
Asset-backed securities - 10,819 - 10,819
Mortgage-backed securities - 44,374 - 44,374
Mortgage loans held for sale - 24,509 - 24,509
Mortgage loan interest rate lock commitments - 801 - 801
Total assets measured at fair value on a recurring basis $ - 100,562 - 100,562
 
Liabilities
MBS forward sales commitments $ - 165 - 165
Total liabilities measured at fair value on a recurring basis $ - 165 - 165
                   
December 31, 2018
(dollars in thousands) Level 1 Level 2 Level 3 Total
Assets
Securities available for sale:
US government agencies $ - 8,782 - 8,782
SBA securities - 3,525 - 3,525
State and political subdivisions - 8,356 - 8,356
Asset-backed securities - 9,558 - 9,558
Mortgage-backed securities - 44,684 - 44,684
Mortgage loans held for sale - 9,241 - 9,241
Mortgage loan interest rate lock commitments - 345