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EX-32.2 - EXHIBIT 32.2 - HIGHLANDS BANKSHARES INC /VA/a2018q1ex322.htm
EX-32.1 - EXHIBIT 32.1 - HIGHLANDS BANKSHARES INC /VA/a2018q1ex321.htm
EX-31.2 - EXHIBIT 31.2 - HIGHLANDS BANKSHARES INC /VA/a2018q1ex312.htm
EX-31.1 - EXHIBIT 31.1 - HIGHLANDS BANKSHARES INC /VA/a2018q1ex311.htm


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

[X] Quarterly Report Pursuant to Section 13 or 15(d)
of the Securities Exchange Act of 1934

For the quarterly period ended March 31, 2018

[   ] 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:  0-27622

HIGHLANDS BANKSHARES, INC.
(Exact name of registrant as specified in its charter)

Virginia
(State or other jurisdiction of
incorporation or organization)
54-1796693
(I.R.S. Employer
Identification No.)
P.O. Box 1128
Abingdon, Virginia
(Address of principal executive offices)
 24212-1128
(Zip Code)

276-628-9181
(Registrant's telephone number, including area code)

 Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes [X]  No [ ]
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).   Yes [ X ]        No [    ]
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company.  See the definitions of "large accelerated filer," "accelerated filer," "smaller reporting company," and "emerging growth company" in Rule 12b-2 of the Exchange Act.
Large accelerated filer  ☐
Accelerated filer  ☐
Non-accelerated filer  ☐ (Do not check if a smaller reporting company)
Smaller reporting company  þ
Emerging growth company  ☐

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

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

Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date: 8,199,228 shares of common stock, par value $0.625 per share, outstanding as of May 14, 2018.





Highlands Bankshares, Inc.
Form 10-Q
For the Quarter Ended March 31, 2018

INDEX
PAGE
 
 

2



PART I.
FINANCIAL INFORMATION
ITEM 1.  Financial Statements
Consolidated Balance Sheets
(Amounts in thousands) 
 
 
(Unaudited)
March 31, 2018
 
December 31, 2017
ASSETS
 
 
 
 
Cash and due from banks
 
$
22,626

 
$
15,179

Federal funds sold
 
18,276

 
15,618

Total cash and cash equivalents
 
40,902

 
30,797

Investment securities available for sale (amortized cost $76,898 at March 31, 2018, $79,990 at December 31, 2017)
 
74,140

 
78,527

Other investments, at cost
 
2,793

 
3,116

Loans held for sale
 
1,795

 
4,808

Loans
 
431,266

 
431,574

Allowance for loan losses
 
(4,000
)
 
(3,954
)
Net loans
 
427,266

 
427,620

Premises and equipment, net
 
18,138

 
18,332

Real estate held for sale
 
1,370

 
1,430

Deferred tax assets
 
7,263

 
7,161

Interest receivable
 
1,777

 
1,987

Bank-owned life insurance
 
14,768

 
14,679

Other real estate owned
 
2,169

 
2,350

Other assets
 
3,148

 
3,290

Total assets
 
$
595,529

 
$
594,097

LIABILITIES AND STOCKHOLDERS' EQUITY
 
 
 
 
LIABILITIES
 
 
 
 
Deposits:
 
 
 
 
Non-interest bearing
 
$
157,907

 
$
148,633

Interest bearing
 
352,091

 
350,150

Total deposits
 
509,998

 
498,783

Interest, taxes and other liabilities
 
1,954

 
1,364

Short-term borrowings
 

 
10,000

Long-term debt
 
30,133

 
30,146

Total liabilities
 
542,085

 
540,293

STOCKHOLDERS' EQUITY
 
 
 
 
Common stock (8,199 shares issued and outstanding for each period presented)
 
5,124

 
5,124

Preferred stock (2,092 shares issued and outstanding for each period presented)
 
4,184

 
4,184

Additional paid-in capital
 
19,169

 
19,113

Retained earnings
 
27,149

 
26,539

Accumulated other comprehensive income
 
(2,182
)
 
(1,156
)
Total stockholders' equity
 
53,444

 
53,804

Total liabilities and stockholders' equity
 
$
595,529

 
$
594,097

 
See accompanying Notes to Consolidated Financial Statements

3



Consolidated Statements of Income
(Amounts in thousands, except per share data)
(Unaudited)
 
 
Three months ended March 31
 
 
 
2018
 
2017
 
INTEREST INCOME
 
 
 
 
 
Loans receivable and fees on loans
 
$
5,315

 
$
5,049

 
Investment securities
 
478

 
582

 
Federal funds sold
 
70

 
50

 
Total interest income
 
5,863

 
5,681

 
INTEREST EXPENSE
 
 
 
 
 
Deposits
 
463

 
446

 
Other borrowed funds
 
364

 
585

 
Total interest expense
 
827

 
1,031

 
Net interest income
 
5,036

 
4,650

 
Provision for loan losses
 
172

 
17

 
Net interest income after provision for loan losses
 
4,864

 
4,633

 
NON-INTEREST INCOME
 
 
 
 
 
Mortgage banking income
 
100

 
226

 
Service charges on deposit accounts
 
337

 
397

 
Other service charges, commissions and fees
 
419

 
498

 
Other operating income
 
226

 
166

 
Total non-interest income
 
1,082

 
1,287

 
NON-INTEREST EXPENSE
 
 
 
 
 
Salaries and employee benefits
 
2,403

 
2,493

 
Occupancy and equipment expense
 
731

 
669

 
Foreclosed assets – write-down and operating expenses
 
131

 
20

 
Other operating expense
 
1,901

 
1,267

 
Total non-interest expense
 
5,166

 
4,449

 
Income before income taxes
 
780

 
1,471

 
Income tax expense (benefit) (Note 5)
 
170

 
439

 
Net income
 
$
610

 
$
1,032

 
Net income per common share (Note 7)
 
 
 
 
 
Basic
 
0.07

 
0.13

 
Fully diluted
 
0.06

 
0.10

 

See accompanying Notes to Consolidated Financial Statements

4



Consolidated Statements of Comprehensive Income
(Amounts in thousands)
(Unaudited) 
 
 
Three months ended March 31
 
 
 
2018
 
2017
 
Net income
 
$
610

 
$
1,032

 
Other comprehensive (loss) income
 
 
 
 
 
Unrealized (losses) gains on securities during the period
 
(1,297
)
 
94

 
Less: reclassification adjustment
 

 

 
Other comprehensive (loss) income before tax
 
(1,297
)
 
94

 
Income tax (benefit) expense related to other comprehensive income
 
(271
)
 
32

 
Other comprehensive (loss) income
 
(1,026
)
 
62

 
Comprehensive (loss) income
 
$
(416
)
 
$
1,094

 

See accompanying Notes to Consolidated Financial Statements

5



Consolidated Statements of Cash Flows
(Amounts in thousands)
(Unaudited) 
 
 
Three Months Ended
March 31,
 
 
2018
 
2017
CASH FLOWS FROM OPERATING  ACTIVITIES:
 
 
 
 
Net income
 
$
610

 
$
1,032

Adjustments to reconcile net income to net cash provided by operating activities:
 
 

 
 

Provision for loan losses
 
172

 
17

Depreciation and amortization
 
401

 
404

Provision for deferred tax assets
 
170

 

Restricted stock expense
 
56

 
55

Originations of loans held for sale
 
(7,651
)
 
(7,386
)
Proceeds from loans held for sale
 
10,664

 
5,578

Decrease in interest receivable
 
210

 
202

Valuation adjustment of real estate held for sale
 
60

 

Valuation adjustment of other real estate owned
 
90

 

Decrease in other assets
 
52

 
1,266

Increase in interest, taxes and other liabilities
 
590

 
124

Net cash provided by operating activities
 
5,424

 
1,292

CASH FLOWS FROM INVESTING ACTIVITIES:
 
 

 
 

Securities available for sale:
 
 

 
 

Proceeds from maturities of securities
 
2,965

 
3,910

Purchase of debt and equity securities
 

 
(5,293
)
Redemptions of other investments
 
323

 
252

Net decrease in loans
 
117

 
212

Proceeds from sales of other real estate owned
 
156

 
255

Premises and equipment expenditures
 
(82
)
 
(410
)
Net cash (used in) provided by investing activities
 
3,479

 
(1,074
)
CASH FLOWS FROM FINANCING ACTIVITIES:
 
 

 
 

Net decrease in time deposits
 
(13,922
)
 
(1,966
)
Net increase in demand, savings and other deposits
 
25,137

 
7,564

Decrease in short-term borrowings
 
(10,000
)
 

Decrease in long-term debt
 
(13
)
 
(13
)
Net cash provided by financing activities
 
1,202

 
5,585

Net change in cash and cash equivalents
 
10,105

 
5,803

Cash and cash equivalents at beginning of period
 
30,797

 
50,385

Cash and cash equivalents at end of period
 
$
40,902

 
$
56,188

SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION
 
 

 
 

Cash payments during the period for interest
 
$
860

 
$
1,047

Cash payments during the period for income taxes
 

 

SUPPLEMENTAL DISCLOSURE OF NONCASH TRANSACTIONS
 
 

 
 

Transfer of loans to other real estate owned
 
65

 
228

Loans originated from sales of other real estate owned
 

 

See accompanying Notes to Consolidated Financial Statements

6



Consolidated Statements of Changes in Stockholders' Equity
(Amounts in thousands)
(Unaudited)
 
 
Common stock shares
 
Common stock par value
 
Preferred stock shares
 
Preferred stock par value
 
Additional paid-in-capital
 
Retained earnings
 
Accumulated
other
comprehensive
income (loss)
 
Stockholders'
equity
Balance December 31, 2016
 
8,199

 
$
5,124

 
2,092

 
$
4,184

 
$
18,891

 
$
26,785

 
$
(1,226
)
 
$
53,758

Net income
 
 

 
 

 
 

 
 

 
 

 
1,032

 
 

 
1,032

Other comprehensive income
 
 

 
 

 
 

 
 

 
 

 
 

 
62

 
62

Stock-based compensation
 

 

 
 
 
 
 
55

 
 
 
 
 
55

Balance March 31, 2017
 
8,199

 
$
5,124

 
2,092

 
$
4,184

 
$
18,946

 
$
27,817

 
$
(1,164
)
 
$
54,907

Balance December 31, 2017
 
8,199

 
$
5,124

 
2,092

 
$
4,184

 
$
19,113

 
$
26,539

 
$
(1,156
)
 
$
53,804

Net income
 
 

 
 

 
 

 
 

 
 

 
610

 
 

 
610

Other comprehensive loss
 
 

 
 

 
 

 
 

 
 

 
 

 
(1,026
)
 
(1,026
)
Stock-based compensation
 
 

 
 

 
 

 
 

 
56

 
 

 
 

 
56

Balance March 31, 2018
 
8,199

 
$
5,124

 
2,092

 
$
4,184

 
$
19,169

 
$
27,149

 
$
(2,182
)
 
$
53,444

 
See accompanying Notes to Consolidated Financial Statements

7



Notes to Consolidated Financial Statements
(Unaudited)
(in thousands, except share, per share and percentage data)

Note 1  -  General

The consolidated financial statements of Highlands Bankshares, Inc. (the "Company") conform to United States generally accepted accounting principles and to banking industry practices. The accompanying consolidated interim financial statements are unaudited. In the opinion of management, all adjustments necessary for a fair presentation of the consolidated financial statements have been included. All such adjustments are of a normal and recurring nature. The consolidated balance sheet as of December 31, 2017 has been extracted from the audited financial statements included in the Company's Annual Report on Form 10-K for the year ended December 31, 2017 (the "2017 Form 10-K"). The notes included herein should be read in conjunction with the notes to consolidated financial statements included in the 2017 Form 10-K. The results of operations for the three-month period ended March 31, 2018, are not necessarily indicative of the results to be expected for the full year.

The preparation of financial statements requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.

Note 2 – Summary of Significant Accounting Policy Update For Certain Required Disclosures

In May 2014, the FASB issued ASU No. 2014-09, Revenue from Contracts with Customers. ASU 2014-09 is a comprehensive revenue recognition model that requires a company to recognize revenue to depict the transfer of goods or services to a customer at an amount that reflects the consideration it expects to receive in exchange for those goods or services. ASU 2014-09, as subsequently amended by ASU No. 2015-14 issued in August 2015, required adoption in annual reporting periods beginning after December 15, 2017, including interim reporting periods within that reporting period. Earlier application was permitted only as of annual reporting periods beginning after December 15, 2016, including interim reporting periods within that reporting period. The Company adopted ASU 2014-09 effective January 1, 2018.

Application of ASU 2014-09 requires identification of customer contracts, identification of the performance obligations within those contracts, identification of the transaction price, allocation of the transaction price to the performance obligations, and recognition of revenue once the performance obligation is satisfied. ASU 2014-09 requires disclosure regarding the nature, amount, timing and uncertainty of revenue and cash flows arising from customer contracts, including significant judgments and changes in judgments and assets recognized from costs incurred to obtain or fulfill a contract.
 
The Company’s primary source of revenue is interest income, which is excluded from the scope of this guidance; however, the Company evaluated the impact on noninterest income, which includes fees for services, commissions on sales, and various deposit service charges. The Company concluded that no cumulative-effect adjustment to retained earnings was necessary. The adoption of the standard did not have a material effect on the Company’s financial position or results of operations.

In January 2016, ASU No. 2016-01 Financial Instruments--Overall (ASU 2016-01) was issued by the FASB.  ASU 2016-01 addresses certain aspects of recognition, measurement, presentation, and disclosure of financial instruments. The Company adopted ASU 2016-01 on January 1, 2018. The adoption of ASU 2016-01 did not have a material effect on the Company's consolidated financial statements.

In June 2016, ASU No. 2016-13, Measurement of Credit Losses on Financial Instruments was issued by the FASB. This ASU significantly changes how entities will measure credit losses for most financial assets and certain other instruments that aren't measured at fair value through net income. The ASU is intended to improve financial reporting by requiring timelier recording of credit losses on loans and other financial instruments. ASU No. 2016-13 is effective for interim and annual reporting periods beginning after December 15, 2019; early adoption is permitted for interim and annual reporting periods beginning after December 15, 2018. Entities will apply the standard's provisions as a cumulative-effect adjustment to retained earnings as of the beginning of the first reporting period in which the guidance is effective (i.e., modified retrospective approach). The Company continues to evaluate the effect that implementation of the new standard will have on its financial position, results of operations, and cash flows.

Other accounting standards that have been issued or proposed by the FASB or other standards-setting bodies are not expected to have a material impact on the Company's financial position, results of operations or cash flows.

8



Note 3 - Investment Securities Available For Sale

The amortized cost and market value of securities available for sale are as follows:
 
 
March 31, 2018
 
 
Amortized Cost
 
Gross Unrealized Gains
 
Gross Unrealized Losses
 
Fair Value
State and political subdivisions
 
$
12,459

 
$
8

 
$
615

 
$
11,852

Mortgage backed securities
 
57,925

 
8

 
1,967

 
55,966

SBA Pools
 
6,514

 

 
192

 
6,322

 
 
$
76,898

 
$
16

 
$
2,774

 
$
74,140


 
 
December 31, 2017
 
 
Amortized Cost
 
Gross Unrealized Gains
 
Gross Unrealized Losses
 
Fair Value
State and political subdivisions
 
$
12,766

 
$
44

 
$
299

 
$
12,511

Mortgage backed securities
 
60,383

 
12

 
1,088

 
59,307

SBA Pools
 
6,841

 
1

 
133

 
6,709

 
 
$
79,990

 
$
57

 
$
1,520

 
$
78,527


Investment securities available for sale with a fair value of $28,989 and $26,856 at March 31, 2018 and December 31, 2017, respectively, were pledged as collateral on public deposits, FHLB advances and for other purposes as required or permitted by law.
The following table presents the age of gross unrealized losses and fair value by investment category:
 
 
March 31, 2018
 
 
Less Than 12 months
 
12 Months or More
 
Total
 
 
Fair Value
 
Unrealized Losses
 
Fair Value
 
Unrealized Losses
 
Fair Value
 
Unrealized Losses
State and political subdivisions
 
$
4,071

 
$
102

 
$
6,921

 
$
513

 
$
10,992

 
$
615

Mortgage-backed securities
 
14,150

 
368

 
40,278

 
1,599

 
54,428

 
1,967

SBA Pools
 
160

 
1

 
5,948

 
191

 
6,108

 
192

Total
 
$
18,381

 
$
471

 
$
53,147

 
$
2,303

 
$
71,528

 
$
2,774


 
 
December 31, 2017
 
 
Less Than 12 months
 
12 Months or More
 
Total
 
 
Fair Value
 
Unrealized Losses
 
Fair Value
 
Unrealized Losses
 
Fair Value
 
Unrealized Losses
State and political subdivisions
 
$
1,744

 
$
18

 
$
7,158

 
$
281

 
$
8,902

 
$
299

Mortgage-backed securities
 
14,540

 
177

 
42,415

 
911

 
56,955

 
1,088

SBA Pools
 
176

 
1

 
6,206

 
132

 
6,382

 
133

Total
 
$
16,460

 
$
196

 
$
55,779

 
$
1,324

 
$
72,239

 
$
1,520


The Company assesses its securities for OTTI quarterly by reviewing credit ratings, financial and regulatory reports as well as other pertinent published financial data. As of March 31, 2018 and December 31, 2017, the Company's assessment revealed no impairment other than that deemed temporary on those securities.

The amortized cost and estimated fair value of securities available for sale at March 31, 2018 by contractual maturity are shown below. Expected maturities may differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.

9




 
 
 
Amortized Cost
 
Fair Value
 
 
Investment securities with scheduled maturities:
 
 
 
 
 
Due in one year or less
 
$
125

 
$
125

 
Due after one year through five years
 
599

 
602

 
Due after five years through ten years
 
866

 
827

 
Due after ten years
 
17,382

 
16,619

 
Total investment securities with scheduled maturities
 
18,972

 
18,173

 
Mortgage-backed securities
 
57,926

 
55,967

 
Total investment securities available for sale
 
$
76,898

 
$
74,140


The following table summarizes the securities gains (losses) recognized for the period presented:
 
 
Three months ended March 31
 
 
 
2018
 
2017
 
Gross gains
 
$

 
$

 
Gross losses
 

 

 
Securities gains, net
 
$

 
$

 



Note 4  -  Loans and Allowance for Loan Losses
 The composition of net loans is as follows:
 
 
March 31, 2018
 
December 31, 2017
Real estate secured:
 
 
 
 
Residential 1-4 family
 
$
171,731

 
$
174,889

Multifamily
 
18,157

 
19,469

Construction and land loans
 
16,933

 
15,907

Commercial, owner occupied
 
82,151

 
82,121

Commercial, non-owner occupied
 
34,437

 
33,748

Second mortgages
 
4,670

 
4,684

Equity lines of credit
 
35,568

 
34,378

Farmland
 
12,977

 
13,188

Total real estate secured
 
376,624

 
378,384

Non-real estate secured
 
 
 
 
Personal
 
13,617

 
14,192

Commercial
 
38,734

 
36,785

Agricultural
 
3,002

 
2,950

Total non-real estate secured
 
55,353

 
53,927

Gross loans
 
431,977

 
432,311

Less:
 
 
 
 
Allowance for loan losses
 
4,000

 
3,954

Net deferred fees
 
711

 
737

Loans, net
 
$
427,266

 
$
427,620



10



The following table is an analysis of past due loans as of March 31, 2018:
 
 
Past Due
 
 
 
 
 
 
 
 
30-89 days
 
90 days and over
 
Total
 
Current
 
Total
 
> 90 Days and Accruing
Real estate secured
 
 
 
 
 
 
 
 
 
 
 
 
Residential 1-4 family
 
$
1,647

 
$
689

 
$
2,336

 
$
169,395

 
$
171,731

 
$
243

Equity lines of credit
 

 

 

 
35,568

 
35,568

 

Multifamily
 

 

 

 
18,157

 
18,157

 

Farmland
 
678

 
194

 
872

 
12,105

 
12,977

 

Construction, land development, other land loans
 
74

 

 
74

 
16,859

 
16,933

 

Commercial real estate:
 
 
 
 
 
 
 
 
 
 
 
 
Owner-occupied
 
601

 
317

 
918

 
81,233

 
82,151

 

Non-owner-occupied
 
1,707

 

 
1,707

 
32,730

 
34,437

 

Second mortgages
 

 

 

 
4,670

 
4,670

 

Non-real estate secured
 
 
 
 
 
 
 
 
 
 
 
 
Personal
 
95

 
17

 
112

 
13,505

 
13,617

 

Commercial
 
104

 
209

 
313

 
38,421

 
38,734

 

Agricultural
 

 

 

 
3,002

 
3,002

 

Total
 
$
4,906

 
$
1,426

 
$
6,332

 
$
425,645

 
$
431,977

 
$
243


The following table is an analysis of past due loans as of December 31, 2017:
 
 
Past Due
 
 
 
 
 
 
 
 
30-89 days
 
90 days and over
 
Total
 
Current
 
Total
 
> 90 Days and Accruing
Real estate secured
 
 
 
 
 
 
 
 
 
 
 
 
Residential 1-4 family
 
$
1,092

 
$
566

 
$
1,658

 
$
173,231

 
$
174,889

 
$

Equity lines of credit
 

 

 

 
34,378

 
34,378

 

Multifamily
 

 

 

 
19,469

 
19,469

 

Farmland
 
234

 
50

 
284

 
12,904

 
13,188

 

Construction, land development, other land loans
 

 

 

 
15,907

 
15,907

 

Commercial real estate:
 
 
 
 
 
 
 
 
 
 
 
 
Owner-occupied
 
11

 
708

 
719

 
81,402

 
82,121

 

Non-owner-occupied
 

 

 

 
33,748

 
33,748

 

Second mortgages
 

 

 

 
4,684

 
4,684

 

Non-real estate secured
 
 
 
 
 
 
 
 
 
 
 
 
Personal
 
211

 
23

 
234

 
13,958

 
14,192

 

Commercial
 
502

 
279

 
781

 
36,004

 
36,785

 
26

Agricultural
 
49

 

 
49

 
2,901

 
2,950

 

Total
 
$
2,099

 
$
1,626

 
$
3,725

 
$
428,586

 
$
432,311

 
$
26


Loans are considered delinquent when payments have not been made according to the terms of the contract. The accrual of interest on loans is discontinued at the time the loan is 90 days delinquent unless the credit is well-secured and in process of collection.  Additionally, in certain instances, loans that have been restructured or modified may also be classified as non-accrual per regulatory guidance until a satisfactory payment history has been established. Credit card loans and other personal loans are typically charged off no later than 180 days past due. In all cases, loans are placed on non-accrual or charged-off at an earlier date if collection of principal or interest is considered doubtful.


11



The following is a summary of non-accrual loans at March 31, 2018 and December 31, 2017
 
 
March 31, 2018
 
December 31, 2017
Real estate secured
 
 
 
 
Residential 1-4 family
 
$
553

 
$
887

Commercial real estate:
 
 
 
 
Owner-occupied
 
575

 
708

Non-owner-occupied
 

 

Second mortgages
 

 

Equity lines of credit
 

 

Farmland
 
194

 
193

Non-real estate secured
 
 
 
 
Personal
 
14

 
23

Commercial and agricultural
 
209

 
254

Total
 
$
1,545

 
$
2,065


The following is a summary of residential real estate currently in the process of foreclosure as well as foreclosed residential real estate as of March 31, 2018.
 
 
Number
 
Balance
Residential real estate in the process of foreclosure
 
5

 
$
392

Foreclosed residential real estate
 
3

 
228


The following tables represent a summary of credit quality indicators of the Company's loan portfolio at March 31, 2018 and December 31, 2017. The grades are assigned and/or modified by the Company's credit review and credit analysis departments based on the creditworthiness of the borrower and the overall strength of the loan.

The following tables provide the credit risk profile by internally assigned grade as of March 31, 2018 and December 31, 2017
March 31, 2018
 
Residential 1-4 Family
 
Multifamily
 
Farmland
 
Construction, Land Loans
 
Commercial Real Estate- Owner Occupied
 
Commercial Real Estate Non-Owner Occupied
Quality
 
$
36,436

 
$

 
$
11

 
$
3,158

 
$
3,174

 
$
230

Satisfactory
 
89,329

 
10,055

 
3,965

 
5,921

 
45,999

 
13,932

Acceptable
 
39,696

 
8,102

 
3,616

 
6,177

 
28,795

 
16,351

Special Mention
 
909

 

 
3,185

 
1,677

 
978

 
1,569

Substandard
 
5,361

 

 
2,200

 

 
3,205

 
2,355

Doubtful
 

 

 

 

 

 

Total
 
$
171,731

 
$
18,157

 
$
12,977

 
$
16,933

 
$
82,151

 
$
34,437

December 31, 2017
 
Residential 1-4 Family
 
Multifamily
 
Farmland
 
Construction, Land Loans
 
Commercial Real Estate- Owner Occupied
 
Commercial Real Estate Non-Owner Occupied
Quality
 
$
33,107

 
$

 
$
13

 
$
2,870

 
$
3,535

 
$
295

Satisfactory
 
95,659

 
10,653

 
4,419

 
5,445

 
45,906

 
13,602

Acceptable
 
40,487

 
8,816

 
3,333

 
5,906

 
28,344

 
15,609

Special Mention
 
388

 

 
3,206

 
1,565

 
2,542

 
2,226

Substandard
 
5,248

 

 
2,217

 
121

 
1,661

 
2,016

Doubtful
 

 

 

 

 
133

 

Total
 
$
174,889

 
$
19,469

 
$
13,188

 
$
15,907

 
$
82,121

 
$
33,748


12




Explanation of credit grades:
Quality--This grade is reserved for the Bank's top quality loans. These loans have excellent sources of repayment, with no significant identifiable risk of collection.  Generally, loans assigned this rating will demonstrate the following characteristics:
Conformity in all respects with Bank policy, guidelines, underwriting standards, and Federal and State regulations (no exceptions of any kind).
Documented historical cash flow that meets or exceeds required minimum Bank guidelines, or that can be supplemented with verifiable cash flow from other sources.
Adequate secondary sources to liquidate the debt, including combinations of liquidity, liquidation of collateral, or liquidation value to the net worth of the borrower or guarantor.
For existing loans, all of the requirements above apply plus all payments have been made as agreed, current financial information on all borrowers and guarantors has been obtained and analyzed, and overall business operating trends are either stable or improving.
Satisfactory-This grade is given to performing loans. These loans have adequate sources of repayment, with little identifiable risk of collection. Loans assigned this rating will demonstrate the following characteristics:
General conformity to the Bank's policy requirements, product guidelines and underwriting standards.  Any exceptions that are identified during the underwriting and approval process have been adequately mitigated by other factors.
Documented historical cash flow that meets or exceeds required minimum Bank guidelines, or that can be supplemented with verifiable cash flow from other sources.  
Adequate secondary sources to liquidate the debt, including combinations of liquidity, liquidation of collateral, or liquidation value to the net worth of the borrower or guarantor.
For existing loans, all of the requirements outlined above will apply, plus all payments have been made as agreed, current financial information on all borrowers and guarantors has been obtained and analyzed, and overall business operating trends are stable with any declines considered minor and temporary.
Acceptable-This grade is given to loans that show signs of weakness in either adequate sources of repayment or collateral, but have demonstrated mitigating factors that minimize the risk of delinquency or loss.  Loans assigned this rating may demonstrate some or all of the following characteristics:
Additional exceptions to the Bank's policy requirements, product guidelines or underwriting standards that present a higher degree of risk to the Bank.  Although the combination and/or severity of identified exceptions is greater, all exceptions have been properly mitigated by other factors.
Unproved, insufficient or marginal primary sources of repayment that appear sufficient to service the debt at this time.  Repayment weaknesses may be due to minor operational issues, financial trends, or reliance on projected (not historic) performance.
Marginal or unproven secondary sources to liquidate the debt, including combinations of liquidation of collateral and liquidation value to the net worth of the borrower or guarantor.
For existing loans, payments have generally been made as agreed with only minor and isolated delinquencies.
Special Mention -This grade is given to Watch List loans that include the following characteristics:
Loans with underwriting guideline tolerances and/or exceptions with no identifiable mitigating factors.
Extending loans that are currently performing satisfactorily but with potential weaknesses that may, if not corrected, weaken the asset or inadequately protect the Bank's position at some future date. Potential weaknesses are the result of deviations from prudent lending practices.
Loans where adverse economic conditions that develop subsequent to the loan origination do not jeopardize liquidation of the debt, but do substantially increase the level of risk may also warrant this rating.
Substandard-Loans in this category are characterized by deterioration in quality exhibited by any number of well-defined weaknesses requiring corrective action. A substandard loan is inadequately protected by the current sound net worth and paying capacity of the obligor or of the collateral pledged, if any. Loans classified as substandard must have a well-defined weakness or weaknesses that jeopardize the liquidation of the debt; they are characterized by the distinct possibility that the institution will sustain some loss if the deficiencies are not corrected.
The weaknesses may include, but are not limited to:
High debt to worth ratios and or declining or negative earnings trends
Declining or inadequate liquidity

13



Improper loan structure  or questionable repayment sources
Lack of well-defined secondary repayment source, and
Unfavorable competitive comparisons.
Such loans are no longer considered to be adequately protected due to the borrower's declining net worth, lack of earnings capacity, declining collateral margins and/or unperfected collateral positions. A possibility of loss of a portion of the loan balance cannot be ruled out. The repayment ability of the borrower is marginal or weak and the loan may have exhibited excessive overdue status or extensions and/or renewals.
Doubtful -Loans classified Doubtful have all the weaknesses inherent in loans classified Substandard, plus the added characteristic that the weaknesses make collection or liquidation in full on the basis of currently existing facts, conditions, and values highly questionable and improbable. The ability of the borrower to service the debt is extremely weak, overdue status is constant, the debt has been placed on non-accrual status, and no definite repayment schedule exists.
However, these loans are not yet rated as loss because certain events may occur which would salvage the debt. Among these events are:
Injection of capital
Alternative financing
Liquidation of assets or the pledging of additional collateral.

Credit Risk Profile based on payment activity as of March 31, 2018:

 
 
Consumer - Non Real Estate
 
Equity Line of Credit /Second Mortgages
 
Commercial - Non Real Estate
 
Agricultural - Non Real Estate
Performing
 
$
13,600

 
$
40,238

 
$
38,525

 
$
3,002

Nonperforming (>90 days past due)
 
17

 

 
209

 

Total
 
$
13,617

 
$
40,238

 
$
38,734

 
$
3,002


Credit Risk Profile based on payment activity as of December 31, 2017:

 
 
Consumer - Non Real Estate
 
Equity Line of Credit /Second Mortgages
 
Commercial - Non Real Estate
 
Agricultural - Non Real Estate
Performing
 
$
14,169

 
$
39,062

 
$
36,506

 
$
2,950

Nonperforming (>90 days past due)
 
23

 

 
279

 

Total
 
$
14,192

 
$
39,062

 
$
36,785

 
$
2,950


14




The following tables reflect the Bank's impaired loans at March 31, 2018:
March 31, 2018
 
Recorded Investment
 
Unpaid Principal Balance
 
Related Allowance
 
Average Recorded Investment
 
Interest Income Recognized
With no related allowance
 
 
 
 
 
 
 
 
Real estate secured
 
 
 
 
 
 
 
 
 
 
Residential 1-4 family
 
$
4,769

 
$
4,769

 

 
$
6,084

 
$
74

Equity lines of credit
 
35

 
35

 

 
42

 

Multifamily
 

 

 

 

 

Farmland
 
656

 
656

 

 
571

 
12

Construction, land development, other land loans
 
1,677

 
1,677

 

 
1,721

 

Commercial real estate- owner occupied
 
932

 
932

 

 
1,242

 

Commercial real estate- non owner occupied
 

 

 

 
32

 

Second mortgages
 
122

 
122

 

 
166

 

Non-real estate secured
 
 

 
 
 
 
 
 
 
 
Personal
 

 

 

 
48

 
11

Commercial and agricultural
 
1,177

 
1,177

 

 
841

 
12

Total
 
$
9,368

 
$
9,368

 

 
$
10,747

 
$
109


March 31, 2018
 
Recorded Investment
 
Unpaid Principal Balance
 
Related Allowance
 
Average Recorded Investment
 
Interest Income Recognized
With an allowance recorded
 
 
 
 
 
 
 
 
Real estate secured
 
 
 
 
 
 
 
 
 
 
Residential 1-4 family
 
$
525

 
$
525

 
$
19

 
$
300

 
$
2

Equity lines of credit
 

 

 

 

 

Multifamily
 

 

 

 

 

Farmland
 
1,621

 
1,621

 
192

 
1,676

 

Construction, land development, other land loans
 

 

 

 

 

Commercial real estate- owner occupied
 
2,376

 
2,376

 
516

 
2,125

 

Commercial real estate- non owner occupied
 
4,027

 
4,027

 
782

 
3,960

 

Second mortgages
 

 

 

 

 

Non-real estate secured
 
 
 
 
 
 
 
 
 
 
Personal
 
21

 
21

 
23

 
12

 

Commercial and agricultural
 
349

 
349

 
234

 
426

 

Total
 
$
8,919

 
$
8,919

 
$
1,766

 
$
8,499

 
$
2



15




The following tables reflect the Bank's impaired loans at December 31, 2017:
December 31, 2017
 
Recorded Investment
 
Unpaid Principal Balance
 
Related Allowance
 
Average Recorded Investment
 
Interest Income Recognized
With no related allowance
 
 
 
 
 
 
Real estate secured
 
 
 
 
 
 
 
 
 
 
Residential 1-4 family
 
$
7,398

 
$
7,398

 

 
$
6,123

 
$
279

Equity lines of credit
 
49

 
49

 

 
37

 

Multifamily
 

 

 

 
495

 
56

Farmland
 
486

 
486

 

 
586

 
42

Construction, land development, other land loans
 
1,765

 
1,765

 

 
1,753

 
67

Commercial real estate- owner occupied
 
1,552

 
1,552

 

 
3,677

 
22

Commercial real estate- non owner occupied
 
63

 
63

 

 
973

 
19

Second mortgages
 
209

 
209

 

 
198

 
3

Non real estate secured
 
 
 
 
 
 
 
 
 
 
Personal
 
95

 
95

 

 
55

 

Commercial and agricultural
 
504

 
504

 

 
274

 

Total
 
$
12,121

 
$
12,121

 

 
$
14,171

 
$
488


December 31, 2017
 
Recorded Investment
 
Unpaid Principal Balance
 
Related Allowance
 
Average Recorded Investment
 
Interest Income Recognized
With an allowance recorded
 
 
 
 
 
 
 
 
Real estate secured
 
 
 
 
 
 
 
 
 
 
Residential 1-4 family
 
$
74

 
$
74

 
$
11

 
$
267

 
$
24

Equity lines of credit
 

 

 

 

 

Multifamily
 

 

 

 

 

Farmland
 
1,731

 
1,731

 
257

 
962

 
13

Construction, land development, other land loans
 

 

 

 
183

 
24

Commercial real estate- owner occupied
 
1,873

 
1,873

 
465

 
1,506

 
196

Commercial real estate- non owner occupied
 
3,892

 
3,892

 
955

 
2,951

 
141

Second mortgages
 

 

 

 
9

 

Non real estate secured
 
 
 
 
 
 
 
 
 
 
Personal
 
2

 
2

 
2

 
27

 

Commercial and agricultural
 
502

 
502

 
418

 
568

 
4

Total
 
$
8,074

 
$
8,074

 
$
2,108

 
$
6,473

 
$
402




16



The following tables present the balance in the allowance for loan losses and the recorded investment in loans by loan category and is segregated by impairment evaluation method as of and for the three month periods ended March 31, 2018 and March 31, 2017.

Three months ended March 31, 2018
 
Residential
1-4 Family
 
Multifamily
 
Construction and Land Loans
 
Commercial Owner Occupied
 
Commercial Non-Owner Occupied
 
Second Mortgages
 
Equity Line of Credit
 
Farmland
 
Personal and  Overdrafts
 
Commercial and Agricultural
 
Unallocated
 
Total
Allowance for Loan Losses:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Balance at December 31,  2017
 
$
133

 

 
$
1

 
$
1,636

 
$
955

 
$
12

 
$

 
$
54

 
$
265

 
$
383

 
$
515

 
$
3,954

Provision expense (credit) for credit losses
 
3

 
3

 
2

 
(219
)
 
(167
)
 
(3
)
 
6

 
139

 
21

 
(136
)
 
523

 
172

Charge-offs
 

 

 

 
95

 

 
5

 

 

 
88

 
149

 

 
337

Recoveries
 
(8
)
 

 
(1
)
 
(17
)
 

 

 

 
(1
)
 
(30
)
 
(154
)
 

 
(211
)
Net charge-offs (recoveries)
 
(8
)
 

 
(1
)
 
78

 

 
5

 

 
(1
)
 
58

 
(5
)
 

 
126

Balance at March 31, 2018
 
$
144

 
$
3

 
$
4

 
$
1,339

 
$
788

 
$
4

 
$
6

 
$
194

 
$
228

 
$
252

 
$
1,038

 
$
4,000

Allowance allocated by impairment method:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Individually evaluated
 
$
19

 
$

 
$

 
$
516

 
$
782

 
$

 
$

 
$
192

 
$
24

 
$
233

 
$

 
$
1,766

Collectively evaluated
 
125

 
3

 
4

 
823

 
6

 
4

 
6

 
2

 
204

 
19

 
1,038

 
2,234

Loan balances by impairment method used:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Individually evaluated
 
$
5,269

 
$

 
$
1,677

 
$
3,194

 
$
3,835

 
$
122

 
$
35

 
$
2,200

 
$
21

 
$
1,509

 
$

 
$
17,862

Collectively evaluated
 
166,462

 
18,157

 
15,256

 
78,957

 
30,602

 
4,548

 
35,533

 
10,777

 
13,596

 
40,227

 

 
414,115

Balance at March 31, 2018
 
$
171,731

 
$
18,157

 
$
16,933

 
$
82,151

 
$
34,437

 
$
4,670

 
$
35,568

 
$
12,977

 
$
13,617

 
$
41,736

 

 
$
431,977


17



Three months ended March 31, 2017
 
Residential
1-4 Family
 
Multifamily
 
Construction and Land Loans
 
Commercial Owner Occupied
 
Commercial Non-Owner Occupied
 
Second Mortgages
 
Equity Line of Credit
 
Farmland
 
Personal and  Overdrafts
 
Commercial and Agricultural
 
Unallocated
 
Total
Allowance for Loan Losses:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Balance at December 31, 2016
 
$
371

 

 
$
21

 
$
1,339

 
$
445

 
$
15

 
$
27

 
$
16

 
$
802

 
$
535

 
$
1,258

 
$
4,829

Provision for credit losses
 
(16
)
 

 
(1
)
 
350

 
403

 
(11
)
 
4

 
37

 
204

 
(99
)
 
(854
)
 
17

Charge-offs
 
14

 

 

 

 

 

 

 

 
79

 
59

 

 
152

Recoveries
 
(3
)
 

 
(1
)
 

 
(1
)
 

 

 
(1
)
 
(25
)
 
(3
)
 

 
(34
)
Net charge-offs
 
11

 

 
(1
)
 

 
(1
)
 

 

 
(1
)
 
54

 
56

 

 
118

Balance at March 31, 2017
 
$
344

 
$

 
$
21

 
$
1,689

 
$
849

 
$
4

 
$
31

 
$
54

 
$
952

 
$
380

 
$
404

 
$
4,728

Allowance allocated by impairment method:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Individually evaluated
 
$
47

 
$

 
$
20

 
$
960

 
$
768

 
$

 
$

 
$
20

 
$

 
$
280

 
$

 
$
2,095

Collectively evaluated
 
297

 

 
1

 
729

 
81

 
4

 
31

 
34

 
952

 
100

 
404

 
2,633

Loan balances by impairment method used:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Individually evaluated
 
$
6,396

 
$
980

 
$
1,902

 
$
4,263

 
$
4,225

 
$
64

 
$

 
$
773

 
$
260

 
$
466

 
$

 
$
19,329

Collectively evaluated
 
176,684

 
21,743

 
14,619

 
65,035

 
25,179

 
6,131

 
19,882

 
11,510

 
16,777

 
32,941

 

 
390,501

Balance at March 31, 2017
 
$
183,080

 
$
22,723

 
$
16,521

 
$
69,298

 
$
29,404

 
$
6,195

 
$
19,882

 
$
12,283

 
$
17,037

 
$
33,407

 

 
$
409,830



 

18



The Company's credit administration personnel and senior financial officers are responsible for tracking, coding, and monitoring loans that become Troubled Debt Restructurings ("TDRs"). Concessions are made to existing borrowers in the form of modified interest rates and / or payment terms. The loans are segregated for regulatory and external reporting. Each specific TDR is reviewed to determine if the accrual of interest should be discontinued and also reviewed for impairment. The Company's senior credit officer performs this analysis on a quarterly basis in addition to determining any other loans that are impaired within the loan portfolio. The Company had a total of $9,955 and $8,005 of loans categorized as troubled debt restructurings as of March 31, 2018 and December 31, 2017, respectively. Interest is accrued on TDRs if the loan is otherwise not impaired and the full collection of principal and interest under the modified terms is still deemed probable.

In the determination of the allowance for loan losses, management considers troubled debt restructurings and subsequent defaults in these restructurings by adjusting the loan grades of such loans. Defaults resulting in charge-offs affect the historical loss experience ratios which are a component of the allowance calculation. Additionally, specific reserves may be established on restructured loans evaluated individually.

The following table identifies restructurings completed during the three-month period ended March 31, 2018 that represent new TDRs.
March 31, 2018
Interest only
Number
Pre-Modification Recorded Investment
Post-Modification Recorded Investment
Below Market Rate
 
 
 
Residential 1-4 family
1

$
162

$
162

Commercial real estate-non-owner occupied
1

1,479

1,479

Total below market rate
2

1,641

1,641

Total restructurings
2

$
1,641

$
1,641

 
There were no new TDRs in the three-month period ended March 31, 2017. There were no defaults in the three month periods ending March 31, 2018 and March 31, 2017 of TDRs modified in the previous 12 months.
 
 
 
 
The Bank has engaged an external third party to perform its loan review function in order to identify weaknesses within the loan portfolio. The review, which seeks to cover 50 percent of loan balances each year, considers collateral, repayment history, guarantor strength, debt service coverage, and other relevant information on an individual and global level. These reviews consider borrower cash flow capacity, using financial statements, income tax returns and internally prepared interim statements for borrowers and guarantors. Debt service coverage (DSC) is calculated on each individual customer, or guarantor, as well as the aggregate or global DSC. The DSC is discounted to determine a stressed DSC. Collateral evaluation includes an inspection of the collateral file to determine if the Bank is properly secured.  Collateral is discounted, when appropriate, to determine a stressed loan to value (LTV) ratio. 
The Company also seeks to identify potential problem relationships through a monthly watch list review, which includes a review of past due loans, as well as any other information that might be presented by loan officers, regarding a particular loan relationship that is exhibiting stress. Watch list relationships display distinct characteristics including, but not limited to, late payments greater than 60 days, a low DSC calculation, bankruptcy filings, casualty losses, or other issues that would cause a perceived increase in the risk of loss to the Bank.
The segments of the Company's loan portfolio are disaggregated to a level that allows management to monitor risk and performance. In reviewing risk, management has determined there to be several different risk categories within the loan portfolio. The allowance for loan losses consists of amounts applicable to: (i) the commercial loan portfolio; (ii) the commercial real estate loan portfolio; (iii) the construction loan portfolio; (iv) the consumer loan portfolio; and, (v) the residential loan portfolio. The commercial real estate ("CRE") loan segment is further disaggregated into two classes. Non-owner occupied CRE loans, which include loans secured by non-owner occupied nonfarm nonresidential properties, generally have a greater risk profile than all other CRE loans, which include multifamily structures and owner-occupied commercial structures. The construction loan segment is further disaggregated into two classes. One-to-four family residential construction loans are generally made to individuals for the acquisition of and/or construction on a lot or lots on which a residential dwelling is to be built. Commercial construction loans are generally made to developers or investors for the purpose of acquiring, developing and constructing residential or commercial structures. Construction lending is generally considered to involve a higher degree of credit risk than long-term permanent financing.

The following describes the Company's basic methodology for computing its ALLL.

19




On a quarterly basis, the ALLL methodology begins with the identification of loans subject to ASC 310.  All loans that are rated "7" (Doubtful) are assessed as impaired based on the expectation that the full collection of principal and interest is in doubt. All loans that are rated "6" (Substandard) or are expected to be downgraded to "6", require additional analysis to determine whether they may be impaired under ASC 310. All loans that are rated "5" (Special Mention) are presumed not to be impaired. However, "5" rated loans, together with any Troubled Debt Restructured (TDR) loan, may warrant further analysis before completing an assessment of impairment.

A loan is considered impaired and an allowance for loan losses is established on loans for which it is probable that the full collection of principal and interest is in doubt. Once a loan is identified as individually impaired, management measures impairment using one of several methods, including collateral value based on recent appraisal and /or tax assessment value, liquidation value and/or discounted cash flows. Those impaired loans not requiring an allowance represent loans for which the fair value of the expected repayments or collateral exceed the recorded investments in such loans. At March 31, 2018 and December 31, 2017, all of the total impaired loans were evaluated based on either the fair value of the collateral or the discounted cash flows.

For ASC 310 loans that are individually evaluated and found to be impaired (primarily those designated as Substandard and Doubtful), the associated ALLL will be based upon one of the three impairment measurement methods specified within ASC 310:

(1)
Present value of expected future cash flows discounted at the loan's effective interest rate;
(2)
Loan's observable market price; or
(3)
Fair value of the collateral.

To determine the amount of loan loss exposure for the impaired ASC 310 loans, the value of collateral for secured loans is evaluated to determine the current value and potential exposure.  The collateral value is adjusted for its age and condition, and, for real estate, adjusted for condition, location, and age of the most current appraisal.  If the adjusted value of the collateral is less than the current principal balance, the difference is designated as direct exposure for loan loss calculations.  The total balance of unsecured loans is considered as direct exposure.

ASC 450 Loan Loss:

For all other loans, including individual loans determined not to be impaired under ASC 310, the associated ALLL is calculated in accordance with ASC 450 that provides for estimated credit losses likely to be realized on groups of loans with similar risk characteristics. The Company uses standard call report categories to segregate loans into groups with similar risk characteristics. Estimated credit losses reflect significant factors that affect the collectability of the portfolio as of the evaluation date. Key factors that influence risk within the Company's loan portfolio are divided into three major categories:

Historical loss factors - To calculate the anticipated loan loss in each call report category for ASC 450 loans, the Company begins with the net loss in each category for each of the last twelve quarters. The Company uses a rolling twelve quarter weighted historical loss average where the most recent quarters are weighted heavier than the earlier quarters so that the calculation reflects current risk trends within the portfolio.  The weighting used by the Company is similar to the Rule of 78's with the net losses of the most recent quarter weighted at 12/78ths and those in the first quarter in the twelve quarter period weighted at 1/78th.   Therefore, the net losses of the most recent year represent approximately 54% of the calculation compared with 33% if a simple average of losses over the three-year period was used.  The total of weighted factors for each call report category is applied to the current outstanding loan balance in each category to calculate expected loss based on historical data for a group of loans with similar risk characteristics.  The same weighting is applied to all loan types .

External economic factors - Economic conditions have a significant impact on Company's loan portfolio because deteriorating conditions can adversely impact both collateral values and the customer's ability to service debt.  Management has selected the following external factors as indicators of economic conditions:

National GDP growth rate
Local unemployment rates
Prime interest rate

The values for external factors are updated on a quarterly basis based on current economic data.

Internal process factors - Internal factors that influence loss rates as a result of risk management and control practices include the following:


20



Past-due loans
Non-accrual loans
Commercial real estate concentrations
Loan volume
Level and trend of classified loans

The values for internal factors are updated on a quarterly basis based on current portfolio metrics.

Once the quarterly ALLL is computed, the calculations are reviewed by the Company's management. The ALLL is then reviewed and approved by the Board of Directors.

Loans Held for Sale

The Company's mortgage division originates certain single family, residential first mortgage loans for sale on a presold basis. Loan sale activity is summarized below. Loans are typically sold to investors within 20 days of closing. Management feels the carrying amounts approximate the fair values of loans held for sale.

 
 
Three months ended March 31
 
 
2018
 
2017
Loans held for sale at end of period
 
$
1,795

 
$
3,063

Proceeds from sales of mortgage loans originated for sale
 
10,664

 
5,578

Gain on sales of mortgage loans originated for sale
 
100

 
226




21



Note 5  -  Income Taxes

Income tax expense for the three month periods ended March 31, is different than the amount computed by applying the appropriate statutory corporate federal income tax rate to income before taxes. The reasons for these differences are as follows:

 
 
Three months ended March 31,
 
 
 
2018
 
2017
 
Tax expense (benefit) at statutory rate
 
$
164

 
$
500

 
Increase (decrease) in tax expense resulting from:
 
 
 
 
 
Tax-exempt interest
 
(27
)
 
(29
)
 
Other, net
 
33

 
(32
)
 
Income tax expense
 
$
170

 
$
439

 
Statutory corporate federal income tax rate
 
21
%
 
34
%
 



Note 6  - Capital Requirements

Regulators of the Company and its subsidiary, Highlands Union Bank (the "Bank"), have implemented risk-based capital guidelines which require compliance with certain minimum capital ratios as a percent of assets and other certain off-balance sheet items that are adjusted for predefined credit risk factors.  On July 7, 2013 the Federal Reserve Board approved Basel III Final Rules to begin implementation January 1, 2015. The desired overall objective of Basel III is to improve the banking sector's ability to absorb shocks arising from financial and economic stress. The Final Rule includes a new Common Equity Tier 1 minimum ratio and raises the tier 1 risk weighted assets ratio to 6 percent from 4 percent. In addition, beginning in 2016, the new rules required banks to maintain a capital conservation buffer of between 2 and 2 ½ %. Additionally, the new rules increased the risk weighting of various assets. The new rules will be phased in between 2015 and 2019. Generally, the Basel III Final Rule requires banks to maintain higher levels of common equity and regulatory capital. On December 18, 2014, the President of the United States signed into law Public Law 113-250 (the "Act"), which directs the Board of Governors of the Federal Reserve System (Board) to propose revisions to the Small Bank Holding Company Policy Statement (Policy Statement) to raise the total consolidated asset limit in the Policy Statement from $500 million to $1 billion.

On February 5, 2015 the Company received notification from the Federal Reserve Bank that it would no longer be required to report holding company consolidated capital ratios.

The following table presents the capital ratios for the Bank only.
 
 
March 31, 2018
 
December 31, 2017
 
Tier 1 leverage
 
8.51
%
 
8.36
%
 
Tier 1 risk-based
 
12.13
%
 
12.15
%
 
Total risk-based
 
13.10
%
 
13.11
%
 
Common equity tier 1
 
12.13
%
 
12.15
%
 




22



Note 7 – Stock and Earnings Per Share

Earnings per common share is computed using the weighted average outstanding shares for the three month periods ended March 31, 2018 and 2017. The following is a reconciliation of the numerators and the denominators of the basic and diluted earnings per common share computation:
 
 
Three months ended March 31,
 
(thousands, except per share information)
 
2018
 
2017
 
Net income available to common stockholders
 
$
610

 
$
1,032

 
Weighted average common shares outstanding
 
8,199

 
8,113

 
Total shares outstanding including assumed conversion
 
10,292

 
10,292

 
Basic earnings per common share
 
$
0.07

 
$
0.13

 
Fully diluted earnings per share (including convertible preferred shares outstanding and restricted stock)
 
0.06

 
0.10

 


Note 8 – Commitments and Contingencies

The Bank is a party to various financial instruments with off-balance sheet risk arising in the normal course of business to meet the financing needs of its customers. Those financial instruments include commitments to extend credit and standby letters of credit.
At March 31, 2018, unused commitments totaled $62,721, compared to $55,038 at December 31, 2017. Standby letters of credit totaled $971 at March 31, 2018, compared to $991 at December 31, 2017.


Note 9 – Fair Value

The Company utilizes fair value measurements to record fair value adjustments to certain assets and to determine fair value disclosures. Securities available-for-sale are recorded at fair value on a recurring basis. Additionally, from time to time, the Company may be required to record financial instruments at fair value on a nonrecurring basis. These nonrecurring fair value adjustments typically involve application of lower of cost or market accounting or write-downs of individual assets.

Fair Value Hierarchy
        
Under ASC Topic 820 on Fair Value Measurements and Disclosures, the Company groups assets and liabilities at fair value in three levels, based on the markets in which the assets and liabilities are traded and the reliability of the assumptions used to determine fair value. These levels are:

 
Level 1 
 
Valuation is based upon quoted prices for identical instruments traded in active markets.
 
 
 
 
 
Level 2 
 
Valuation is based upon quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active, and model-based valuation techniques for which all significant assumptions are observable in the market.
 
 
 
 
 
Level 3 
 
Valuation is generated from model-based techniques that use at least one significant assumption not observable in the market. These unobservable assumptions reflect estimates of assumptions that market participants would use in pricing the asset or liability. Valuation techniques include use of option pricing models, discounted cash flow models and similar techniques.
        
In general, fair value is based upon quoted market prices, where available. If such quoted market prices are not available, fair value is based upon third party models that primarily use, as inputs, observable market-based parameters. Valuation adjustments may be made to determine fair value. These adjustments may include amounts to reflect counterparty credit quality, the borrower's creditworthiness, among other things, as well as unobservable parameters. Any such valuation adjustments are applied consistently over time. The Company's valuation methodologies may produce a fair value calculation that may not be indicative of net realizable value or reflective of future fair values. While management believes the Company's valuation methodologies are appropriate and consistent with other market participants, the use of different methodologies or assumptions to determine the fair value of certain financial instruments could result in a different estimate of fair value at the reporting date.

23




Recurring - Investment Securities Available for Sale

Securities classified as available for sale are reported at fair value utilizing level 2. For level 2 securities, the Company obtains fair value measurements from multiple independent third party sources. The fair value measurements consider observable data that may include dealer quotes, market spreads, cash flows, the U.S. Treasury yield curve, live trading levels, trade execution data, market consensus prepayment speeds, credit information, and the bond's terms and conditions, among other things.

The following tables summarize the Company's available for sale securities portfolio measured at fair value on a recurring basis as of March 31, 2018 and December 31, 2017, segregated by the level of the valuation inputs within the fair value hierarchy.

March 31, 2018
 
 
Level 1
 
Level 2
 
Level 3
 
Total Fair Value
 
 
 
 
 
 
 
 
 
State and political subdivisions
 
$

 
$
11,852

 
$

 
$
11,852

Mortgage backed securities
 

 
55,966

 

 
55,966

SBA pools
 

 
6,322

 

 
6,322

Total available for sale securities
 
$

 
$
74,140

 
$

 
$
74,140


December 31, 2017
 
 
Level 1
 
Level 2
 
Level 3
 
Total Fair Value
 
 
 
 
 
 
 
 
 
State and political subdivisions
 
$

 
$
12,511

 
$

 
$
12,511

Mortgage backed securities
 

 
59,307

 

 
59,307

SBA pools
 

 
6,709

 

 
6,709

Total available for sale securities
 

 
$
78,527

 

 
$
78,527


Recurring - Derivatives

Beginning in 2017, the Company entered into interest rate swaps related to customer loan transactions to manage its interest rate risk. These interest rate swaps, which had a notional value of $7,902 as of March 31, 2018 and December 31, 2017, are considered to be derivative financial instruments and are recorded at fair value, based on third party pricing models that are sensitive to market observable data and are therefore classified as level 2 values. The fair value of derivative financial instruments as of March 31, 2018 totaled $144, compared to $45 at December 31, 2017.

Non Recurring - Loans

The Company does not record loans at fair value on a recurring basis. However, from time to time, a loan is considered impaired and an allowance for loan loss is established. Loans for which it is probable that payment of interest and principal will not be made in accordance with the contractual terms of the loan agreement are considered impaired. Once a loan is identified as individually impaired, management measures impairment using one of several methods, including recently appraised collateral value and /or tax assessed value, liquidation value and discounted cash flows. Those impaired loans not requiring an allowance represent loans for which the fair value of the expected repayments or collateral exceed the recorded investments in such loans. At March 31, 2018 and December 31, 2017, all of the total impaired loans were evaluated based on the fair value of the collateral or the present value of the future cash flows. The Company frequently obtains appraisals prepared by external professional appraisers and applies discounts ranging from 8% to 40% depending on type of property, condition, location, etc. The Company also, in certain instances, prepares internally generated valuations from on-site inspections, third-party valuation models or other information.

Non Recurring – Loans Held for Sale

Loans held for sale are carried at the lower of cost or market value. The fair value of loans held for sale is based on inputs derived from secondary markets for loans with similar characteristics. The Company considers loans held for sale as non-recurring level 2.


24



Non Recurring –Other Real Estate Owned  / Repossessions / Real Estate Held for Sale

Other real estate owned and repossessions are adjusted to fair value upon transfer of the loans to other real estate owned and repossessions. Subsequently, foreclosed assets and repossessions are carried at the lower of carrying value or fair value. Fair value is based upon independent market prices or recent appraised values of the collateral which the Company considers as nonrecurring level 2.  When the current appraised value is not available or is further discounted below the most recent appraised value less selling costs due to absorption rates and market conditions, the Company records the foreclosed assets within level 3 of the fair value hierarchy.
Real estate held for sale is adjusted to fair value upon transfer from fixed assets or when no longer being used for banking purposes.

The following table summarizes the Company's assets at fair value on a non-recurring basis as of March 31, 2018 and December 31, 2017, segregated by the level of the valuation inputs within the fair value hierarchy. The tables disclose the recorded investment of impaired loans requiring a specific allowance.

March 31, 2018
 
Level 1
 
Level 2
 
Level 3
 
Total Fair Value
Impaired loans
 
$

 
$

 
$
6,879

 
$
6,879

OREO
 

 

 
2,169

 
2,169

Real estate held for sale
 

 

 
1,370

 
1,370

December 31, 2017
 
Level 1
 
Level 2
 
Level 3
 
Total Fair Value
Impaired loans
 
$

 
$

 
$
5,967

 
$
5,967

OREO
 

 

 
2,350

 
2,350

Real estate held for sale
 

 

 
1,430

 
1,430


The following table presents additional quantitative information about assets measured at fair value on a nonrecurring basis for which the Company uses level 3 inputs to determine fair value (dollars in thousands):
 
 
 
 
 
Quantitative Information about Level 3 Fair Value Measurements
 
 
12/31/17
 
3/31/2018
 
Valuation
Techniques
 
Unobservable
Input (2)
 
Range
(Weighted Average)
OREO, net
 
$
2,350

 
$
2,169

 
Appraisal of collateral (1)
 
Appraisal adjustments
 
0% to 45% (13%)
 
 

 
 

 
 
 
Liquidation expenses
 
0% to 10% (9%)
Real Estate held for sale
 
$
1,430

 
$
1,370

 
Appraisal of collateral (1)
 
Appraisal adjustments
 
0% to 50% (40%)
 
 
 
 
 
 
 
Liquidation expenses
 
0% to 10% (8%)
Impaired loans
 
$
5,967

 
$
7,153

 
Fair value of collateral –real estate  (1), (3)
 
Appraisal adjustments
 
0% to 10% (9%)
 
 

 
 

 
Fair value of collateral –equipment, inventory, other  (1), (3)
 
Appraisal adjustments
 
25% to 50% (33%)
 
 
 
 
 
 
 
Liquidation expenses
 
0% to 10% (9%)

Valuation adjustments and liquidation cost adjustments represent unobservable inputs for OREO and impaired loans.  The ranges of discounts applied are based on age of independent appraisals, type and condition of collateral, current market conditions, and experience with the local market.

25



(1)  Fair value is generally determined through independent appraisals of the underlying collateral, which generally include various level 3 inputs which are not identifiable.
(2)  Appraisals may be adjusted by management for qualitative factors such as economic conditions and estimated liquidation expenses.  The range and weighted average of liquidation expenses and other appraisal adjustments are presented as a percent of the appraisal.
(3)  Includes qualitative adjustments by management.


Fair Value of Financial Instruments

Fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. Fair value is best determined based upon quoted market prices.  However, in many instances, there are no quoted market prices for the Company's various financial instruments.  In cases where quoted market prices are not available, fair values are based on estimates using present value or other valuation techniques.  Those techniques are significantly affected by the assumptions used, including the discount rate and estimates of future cash flows. Accordingly, the fair value estimates may not be realized in an immediate settlement.  Accordingly, the aggregate fair value amounts presented may not necessarily represent the underlying fair value of the Company.

Cash and Cash Equivalents

The carrying amount reported in the balance sheets for cash, short-term investments and federal funds sold approximates fair value.

Securities Available for Sale

Fair values are determined in the manner as described above.

Other Investments

Other investments include Federal Home Loan Bank stock, Federal Reserve Bank stock, Community Bankers Bank stock, and Pacific Coast Bankers Bank.  The carrying value of those securities approximates fair value based on the redemption provisions of those Banks. Also included in other investments are certificates of deposit purchased from other FDIC insured banks in which the carrying amount approximates fair value.

Loans

The fair value of loans represent the amount at which the loans of the Bank could be exchanged on the open market, based upon the current lending rate for similar types of lending arrangements discounted over the remaining life of the loans .  For fixed rate loans and for variable rate loans with infrequent re-pricing or re-pricing limits, fair value is based on discounted cash flows using current market rates applied to the cash flow analysis.

Deposits

The fair value of time deposits is based on discounted cash flows using current market rates applied to the cash flow analysis for each time deposit. Other non-maturity deposits are reported at their carrying values.
Other Short-Term Borrowings

Fair values of other short-term borrowings are estimated using discounted cash flow analyses based on the Company's current incremental borrowing rates for similar types of borrowing arrangements. Estimated maturity dates are also included in the calculation of fair value for these borrowings.

Long-term Debt and Capital Securities

Rates currently available to the Company for debt with similar terms and remaining maturities or established call prices are used to estimate fair value of existing debt.

Off-Balance Sheet Instruments

26




The carrying value of off-balance sheet commitments to extend credit, standby letters of credit, and financial guarantees, is considered equal to fair value.  Because of the uncertainty involved in attempting to assess the likelihood and timing of commitments being drawn upon, coupled with the lack of an established market and the wide diversity of fee structures, the Company does not believe it is meaningful to provide an estimate of fair value that differs from the given value of the commitment.

The carrying amounts and fair values of the Company's financial instruments at March 31, 2018 and December 31, 2017 were as follows:
 
 
March 31, 2018
 
December 31, 2017
 
 
Carrying Amount
 
Fair Value
 
Carrying Amount
 
Fair Value
Cash and cash equivalents
 
$
40,902

 
$
40,902

 
$
30,797

 
$
30,797

Securities available for sale
 
74,140

 
74,140

 
78,527

 
78,527

Other investments
 
2,793

 
2,793

 
3,116

 
3,116

Loans, net
 
427,266

 
427,660

 
427,620

 
429,467

Interest rate swaps
 
144

 
144

 
45

 
45

Deposits
 
509,998

 
423,236

 
498,783

 
424,664

Other short-term borrowings
 

 

 
10,000

 
10,000

Long-term debt
 
30,133

 
30,430

 
30,243

 
30,780


Note 10–Formal Written Agreement

On October 13, 2010, the Company and Bank entered into a written agreement ("Written Agreement") with the Federal Reserve Bank of Richmond (the "Reserve Bank").  Under the terms of the Written Agreement, the Bank has agreed to develop and submit to the Reserve Bank for approval within the time periods specified therein written plans or programs to:

strengthen board oversight of the management and operations of the Bank;
strengthen credit risk management and administration;
provide for the effective grading of the Bank's loan portfolio;
summarize the findings of its review of the adequacy of the staffing of its loan review function;
improve the Bank's position with respect to loans, relationships, or other assets in excess of $500 that currently are, or in the future become past due more than 90 days, on the Bank's problem loan list, or adversely classified in any report of examination of the Bank;
review and revise the Bank's methodology for determining the allowance for loan and lease losses ("ALLL") and maintain an adequate ALLL;
maintain sufficient capital at the Company and the Bank;
establish a revised written contingency funding plan;
establish a revised written strategic and capital plan;
establish a revised investment policy;
improve the Bank's earnings and overall condition;
revise the Bank's information technology program;
establish a disaster recovery and business continuity program; and,
establish a committee to monitor compliance with all aspects of the written agreement.

Further, both the Company and the Bank have agreed to refrain from declaring or paying dividends without prior regulatory approval.  The Company has agreed that it will not take any other form of payment representing a reduction in Bank's capital or make any distributions of interest, principal or other sums on subordinated debentures or trust preferred securities without prior regulatory approval.  The Company also has agreed not to incur, increase or guarantee any debt or not to purchase or redeem any shares of its stock without prior regulatory approval.


27




ITEM 2. Management's Discussion and Analysis of Financial Condition and Results of Operations

The following discussion and analysis is provided to address information about the Company's financial condition and results of operations that is not otherwise apparent from the Consolidated Financial Statements and the notes thereto or included in this report. Reference should be made to those statements and the notes thereto for an understanding of the following discussion and analysis.

The Company generates a significant amount of its income from the net interest income earned by the Bank. Net interest income is the difference between interest income and interest expense. Interest income depends on the amount of interest-earning assets outstanding during the period and the interest rates earned thereon. The Company's cost of money is a function of the average amount of deposits and borrowed money outstanding during the period and the interest rates paid thereon. Asset quality affects the amount of interest income lost on non-accrual loans and the amount of the allowance for loan losses. Highlands Union Insurance Services and Highlands Union Financial Services, which are subsidiaries of Highlands Union Bank, generate fee income by providing insurance and financial service products to its clients. Russell Road Properties, LLC is also an entity in which the Bank has a significant interest and was created to hold and manage certain properties acquired by the Bank through foreclosure or deed in lieu of foreclosure.

Critical Accounting Policies

The financial condition and results of operations presented in the Consolidated Financial Statements, accompanying Notes to Consolidated Financial Statements and management's discussion and analysis are, to a large degree, dependent upon the accounting policies of the Company. The selection and application of these accounting policies involve judgments, estimates, and uncertainties that are susceptible to change. For a discussion of the Company's critical accounting policies related to its allowance for loan losses and other than temporary impairment, see the Company's Annual Report on Form 10-K for the year ended December 31, 2017.


Results of Operations

Consolidated net income totaled $610,000 for the three-month period ended March 31, 2018, compared to $1.0 million for the three-month period ended March 31, 2017.

The following table provides summarized income statements for the three-month periods ended March 31, 2018 and March 31, 2017.
 
 
Three months ended March 31,
 
 
 
2018
 
2017
 
Net interest income
 
$
5,036

 
$
4,650

 
Provision expense
 
172

 
17

 
Noninterest income
 
1,082

 
1,287

 
Noninterest expense
 
5,166

 
4,449

 
Income before income taxes
 
780

 
1,471

 
Income tax expense
 
170

 
439

 
Net income
 
$
610

 
$
1,032

 

Net interest income for the three-month period ended March 31, 2018 increased $386,000 or 8.3 percent compared to the three months ended March 31, 2017 primarily due to reduction in FHLB advances compared to the prior period. Average loan balances for the three months ended March 31, 2018 increased slightly compared to the three month period ended March 31, 2017. Average securities balances declined $15.2 million during the same period. The tax-equivalent yield on average interest-earning assets was 4.31 percent for the three-month period ended March 31, 2018 compared to 4.28 percent in the same period of 2017

Average interest-bearing liabilities decreased $18.1 million for the three months ended March 31, 2018,when compared to the same period of 2017 due to improved yields on interest-earning assets and repayments of FHLB advances. The total yield on interest-earning assets improved from 4.24 percent during the three months ended March 31, 2017 to 4.41 percent for the three-month period ended March 31, 2018. The average rate on interest-bearing liabilities declined from 0.99 percent in the three month

28



period ended March 31, 2017, to 0.86 percent for the three months ended March 31, 2018 due to FHLB advance repayment and change in deposit mix.

The provision for loan losses for the three-month period ended March 31, 2018 totaled $172,000, compared to $17,000 during the corresponding period of 2017.

The Company continually monitors the loan portfolio for signs of credit weaknesses or developing collection problems. Loan loss provisions for each period are determined after evaluating the loan portfolio and determining the level necessary to absorb current charge-offs and maintain the reserve at adequate levels.  The Company's allowance for loan losses at March 31, 2018 was 0.93 percent of total loans compared to 0.92 percent at December 31, 2017. Net charge-offs for the three-month period ended March 31, 2018 totaled $126,000 compared to $118,000 recorded during the same period of 2017.

During the third quarter of 2017, the Company reduced its unallocated allowance for loan losses and established a $97,000 reserve for unfunded commitments, representing the estimated potential exposure for unfunded loan commitments. The reserve for unfunded commitments is reported within other liabilities in the consolidated balance sheet.

During the first quarter of 2018, noninterest income decreased $205,000 compared to the corresponding period for 2017, primarily due to lower mortgage banking income. The Company's mortgage division originates loans to be sold on a servicing-released basis through its branch footprint and in North and South Carolina. The Company is currently transitioning its mortgage banking operation from a correspondent basis to a broker, which will result in narrower margins on originated loans, but will result in lower noninterest expenses associated with the mortgage banking operation. Income from the gain on sale of loans totaled $100,000 during the first quarter of 2018, compared to $226,000 during the same period of 2017.

Other service charges, commissions and fees decreased $79,000 as compared to the same period of 2017, primarily due to lower financial services income. Service charge income decreased $60,000 during the first quarter of 2018, compared to the same period of 2017, due to a reduction in NSF income.

Total noninterest expense for the three-month period ended March 31, 2018 increased $717,000 from the comparable period in 2017, due to increases in OREO-related expenses, occupancy costs, and various other operating expenses. OREO-related expenses increased $111,000 due to writedowns triggered by updated property appraisals. Occupancy expenses were higher due to increased lease expense related to the mortgage operation and depreciation expense related to a new facility in Johnson City, TN.

Other operating expense increased $634,000 from the three months ended March 31, 2017 to the three months ended March 31, 2018, the increase resulting from higher software maintenance costs and nonrecurring increases in legal expense, advisory services related to business continuity and writedowns related to real estate held for sale.

Salaries and employee benefits decreased $90,000 for the three months ended March 31, 2018 as compared to the prior year period, resulting from the impact of earlier workforce reductions, partially offset by the lower deferred salary costs from current year loan originations.

The annualized return on average equity was 7.25 percent for the three-month period ended March 31, 2018, compared to 7.48 percent for the corresponding period of 2017. Annualized return on average assets for the three months ended March 31, 2018 was 0.68 percent compared to 0.68 percent for the three months ended March 31, 2017. While both operating ratios remain below peer averages, the improvements reflect ongoing efforts to achieve stable profitability. The Company continues to identify and implement strategies to improve core operating results.



Financial Position

Investment securities available for sale totaled $74.1 million at March 31, 2018, compared to $78.5 million at December 31, 2017. Investment securities available for sale at March 31, 2018 were comprised of mortgage backed securities/CMOs (75.5 percent of the total securities portfolio), municipal issues (16.0 percent), and SBAs pools (8.5 percent).  There were no investment securities held to maturity at March 31, 2018 or December 31, 2017.

Other investments include holdings of Federal Reserve, Federal Home Loan Bank, Pacific Coast Bankers Bank, and Community Bankers Bank stock. These investments had a carrying value of $2.8 million at March 31, 2018, and are considered to be non-marketable as the Company is required to hold these investments and the only market for these investments is the issuing agency.


29



Loans, net of deferred fees, totaled $431.3 million at March 31, 2018, compared to $431.6 million at December 31, 2017. The loan to deposit ratio was 84.6 percent at March 31, 2018 compared to 86.5 percent at December 31, 2017. Deposits at March 31, 2018 totaled $510.0 million, and have increased $11.2 million since December 31, 2017. Deposit growth during 2018 has been primarily among noninterest bearing deposits, which increased $9.3 million since December 31, 2017.

As of March 31, 2018, the Company has $30.1 million in FHLB advances. No new advances were originated during the last 12 months and, during the three months ended March 31, 2018, the Company elected to utilized existing liquidity to repay $10.0 million of FHLB advances prior to their scheduled maturity dates later in 2018. The Company secures all of its existing and future advances from the FHLB with 1-4 family residential mortgage, commercial real estate and multi-family loans.

Non-performing assets include non-accrual loans, loans contractually past due 90 days or more and still accruing interest, other real estate owned and repossessions. Non-performing assets were $3.7 million or 0.86 percent of loans held for investment and OREO at March 31, 2018, compared to $4.4 million or 1.02 percent of loans held for investment and OREO at December 31, 2017.  The Company continues its efforts to reduce non-performing assets, primarily by reducing non-accrual loans and selling OREO.

The allowance for loan losses is calculated based on management's judgment and analysis of current and historical loss experience, risk characteristics of the loan portfolio, concentrations of credit and asset quality, as well as other internal and external factors, including general economic conditions. The calculation of the allowance for loan losses is reviewed by the senior credit officers, the chief risk officer, senior financial officers and the board of directors.

At March 31, 2018 and December 31, 2017, management determined that the Company's allowance for loan losses is sufficient and is appropriate based on the requirements of accounting principles generally accepted in the United States of America.

At March 31, 2018, other real estate owned totaled $2.2 million and consisted of 14 relationships. At December 31, 2017 OREO balances were $2.4 million and consisted of 15 relationships. The following chart details each category type, number of relationships, and balance.
 
 
March 31, 2018
 
December 31, 2017
 
Balance in thousands
 
Number
 
Balance
 
Number
 
Balance
 
Land development/vacant land
 
8

 
$
452

 
10

 
$
663

 
1-4 family residential mortgage
 
3

 
207

 
2

 
142

 
Commercial real estate
 
3

 
1,510

 
3

 
1,545

 
Total
 
14

 
$
2,169

 
15

 
$
2,350

 
 
 
 

 
 

 
 
 
 
 

The Company's major markets include: Southwestern Virginia; the Tri-City region of Eastern Tennessee; Sevierville and Knoxville, Tennessee; and Boone/Banner Elk, North Carolina. The following table provides information about properties owned in each geographic area, the number of individual properties and book value.
 
 
March 31, 2018
 
December 31, 2017
 
Balance in thousands
 
Number
 
Balance
 
Number
 
Balance
 
Sevierville and Knoxville TN Area
 
1

 
$
71

 
1

 
$
71

 
Southwest VA and Tri-city TN Area
 
11

 
2,028

 
12

 
2,209

 
Boone and Banner Elk NC Area
 
2

 
70

 
2

 
70

 
Total
 
14

 
$
2,169

 
15

 
$
2,350

 

The Company focuses on selling OREO properties and reducing other non-performing assets. The ability to sell OREO continues to be somewhat negatively affected by limited demand.




30



Liquidity and Capital Resources

Total stockholders' equity of the Company was $53.4 million at March 31, 2018, compared to $53.8 million at December 31, 2017. The change in stockholders' equity during 2018 reflects an increase in accumulated other comprehensive loss related to the market value of the Company's available for sale securities portfolio, net of retained earnings.

Quantitative measures established by regulation to ensure capital adequacy require the Company and the Bank to maintain minimum amounts and ratios of total risk-based capital and tier 1 capital to risk-weighted assets (as defined in the regulations), and tier 1 capital to adjusted total assets (as defined).  See Note 6 for a more detailed discussion of the Bank's regulatory capital ratios.

Liquidity is the ability to provide sufficient cash levels to meet financial commitments and to fund loan demand and deposit withdrawals. The Company and subsidiary Bank maintain a significant level of liquidity in the form of cash and cash equivalents ($40.9 million as of March 31, 2018) and unrestricted investment securities available for sale ($45.2 million). Cash and cash equivalents are immediately available for satisfaction of deposit withdrawals, customer credit needs, and operations of the Bank.  The Bank also maintains a significant amount of available credit with both the Federal Home Loan Bank and a correspondent financial institution. Unencumbered investment securities available for sale represent a secondary level of liquidity available for conversion to liquid funds in the event of extraordinary needs. The Company believes that it maintains sufficient liquidity to meet its current and projected requirements and needs.

Caution About Forward-Looking Statements

This quarterly report contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934, including certain plans, expectations, goals and projections, which are inherently subject to numerous assumptions, risks and uncertainties. The Company's actual results could differ materially from those set forth or implied in the forward-looking statements.

Such forward-looking statements involve known and unknown risks including, but not limited to, the following factors:

adverse economic conditions in the market area and the impact on credit quality and risks inherent in the loan portfolio such as repayment risk and fluctuating collateral values;
our inability to manage, dispose of and properly value non-performing assets and other real estate owned;
further deterioration in the housing market and collateral values;
our inability to assess the creditworthiness of our loan portfolio and maintain a sufficient allowance for loan losses;
our inability to maintain adequate sources of funding and liquidity, including secondary sources such as Federal Home Loan Bank advances;
our ability to attract and maintain capital levels adequate to support our asset levels and risk profile;
our inability to comply with the written agreement, dated October 13, 2010, with the Federal Reserve Bank of Richmond;
our successful management of interest rate risk and changes in interest rates and interest rate policies;
reliance on our management team, including our ability to attract and retain key personnel;
our ability to successfully manage our strategic plan;
difficult market conditions in our industry;
problems with technology utilized by us;
our ability to successfully manage third-party vendors upon whom we are dependent;
competition with other banks and financial institutions, and companies outside of the banking industry, including those companies that have substantially greater access to capital and other resources;
potential impact on us of recently enacted legislation and future regulation;
changes in accounting policies or standards;
demand, development and acceptance of new products and services; and,
changing trends in customer profiles and behavior.



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ITEM 3. Quantitative and Qualitative Disclosures About Market Risk  Not Applicable


ITEM 4. Controls and Procedures

We have carried out an evaluation, under the supervision and the participation of our management, including our Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Rule 13a-15(e) under the Exchange Act) as of the end of the period covered by this report. Based upon that evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures are effective in providing reasonable assurance that (a) the information required to be disclosed by us in the reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC's rules and forms, and (b) such information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure.

There have not been any changes in the Company's internal controls over financial reporting during the first quarter of 2018 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.


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PART II. OTHER INFORMATION

Item 1.  Legal Proceedings

On December 23, 2015, James M. Brock and Jean W. Brock (together, "Brock") filed a complaint in the Circuit Court of Grayson County, Virginia, alleging that the Bank acted negligently when it foreclosed on property adjacent to the Brock's property and allegedly failed to remediate the foreclosed property, allegedly causing damage to Brock's property. Brock seeks damages of $200,000 plus prejudgment interest, attorneys' fees, and costs. The Bank denies any wrongdoing in this matter and intends to vigorously defend itself. No trial date has yet been set. The Company is unable to estimate the likelihood of an unfavorable outcome or the amount or range of potential loss.

Item 1A. Risk Factors

Not applicable

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

None

Item 3.  Defaults Upon Senior Securities

None

Item 4.  Mine Safety Disclosures

Not Applicable

Item 5.  Other Information

None
 
Item 6.  Exhibits
 
Exhibit Index
 
31.1
Rule 13a-14(a) Certification of President and Chief Executive Officer
312
Rule 13a-14(a) Certification of Chief Financial Officer
32.1
Certification Statement of President and Chief Executive Officer pursuant to 18 U.S.C. Section 1350.
32.2
Certification Statement of Chief Financial Officer pursuant to 18 U.S.C. Section 1350.
101
The following materials from the Registrant's Quarterly Report on Form 10-Q for the quarter ended March 31, 2018, formatted in Extensible Business Reporting Language (XBRL), include: (i) the Consolidated Balance Sheets, (ii) the Consolidated Statements of Income, (iii) the Consolidated Statements of Comprehensive Income, (iv) Consolidated Statements of Cash Flows; (v) Consolidated Statements of Changes in Stockholders' Equity and (vi) related notes (furnished herewith).
 
 
 
 

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SIGNATURES

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


 
HIGHLANDS BANKSHARES, INC
 
(Registrant)
 
 
 
 
 
Date: 5/14/2018
By:
/s/ Timothy K. Schools
 
 
 
Timothy K. Schools
 
 
 
President and Chief Executive Officer
 
 
 
 
 
 
 
 
Date: 5/14/2018
 
/s/ John H. Gray
 
 
 
John H. Gray
 
 
 
Chief Financial Officer
 


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Exhibit Index
 
31.1
31.2
32.1
32.2
101
The following materials from the Registrant's Quarterly Report on Form 10-Q for the quarter ended March 31, 2018, formatted in Extensible Business Reporting Language (XBRL), include: (i) the Consolidated Balance Sheets, (ii) the Consolidated Statements of Income, (iii) the Consolidated Statements of Comprehensive Income, (iv) Consolidated Statements of Cash Flows; (v) Consolidated Statements of Changes in Stockholders' Equity and (vi) related notes (furnished herewith).
 
 
 
 


35