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 March 31, 2018

Farmers Capital Bank Corporation

(Exact name of registrant as specified in its charter)

Kentucky

000-14412

61-1017851

(State or other jurisdiction of incorporation or organization)

(Commission

File Number)

(IRS Employer

Identification No.)

P.O. Box 309

202 West Main St.

Frankfort, KY

40601

(Address of principal executive offices)

(Zip Code)

Registrant’s telephone number, including area code – (502) 227-1668

Not Applicable

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

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days.

Yes ☒ 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 (Section 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).

Yes ☒ No ☐

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

Large accelerated filer ☐	Accelerated filer ☒

Non-accelerated filer ☐ (Do not check if a smaller reporting company)	Smaller reporting company ☐

Emerging growth company ☐

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

Indicate by 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.

Common stock, par value $0.125 per share

7,519,814 shares outstanding at May 1, 2018

TABLE OF CONTENTS

PART I – FINANCIAL INFORMATION

Item 1. Condensed Consolidated Financial Statements
Unaudited Condensed Consolidated Balance Sheets	3
Unaudited Condensed Consolidated Statements of Income	4
Unaudited Condensed Consolidated Statements of Comprehensive Income	5
Unaudited Condensed Consolidated Statements of Changes in Shareholders’ Equity	6
Unaudited Condensed Consolidated Statements of Cash Flows	7
Notes to Unaudited Condensed Consolidated Financial Statements	8

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations	32

Item 3. Quantitative and Qualitative Disclosures About Market Risk	46

Item 4. Controls and Procedures	46

PART II - OTHER INFORMATION

Item 1. Legal Proceedings	47

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds	47

Item 6. Exhibits	47

SIGNATURES	50

PART I – FINANCIAL INFORMATION

Item 1. Condensed Consolidated Financial Statements

Unaudited Condensed Consolidated Balance Sheets

	March 31,			December 31,
(In thousands, except share and per share data)	2018			2017
Assets
Cash and cash equivalents:
Cash and due from banks	$	22,143		$	25,581
Interest bearing deposits in other banks		96,099			58,154
Money market mutual funds		34,979			36,673
Total cash and cash equivalents		153,221			120,408
Investment securities:
Available for sale, amortized cost of $411,995 (2018) and $427,831 (2017)		402,288			423,318
Equity investments, amortized cost of $1,560 (2018) and $864 (2017)		1,575			935
Held to maturity, fair value of $3,424 (2018) and $3,478 (2017)		3,350			3,364
Total investment securities		407,213			427,617
Loans, net of unearned income		1,035,469			1,035,263
Allowance for loan losses		(9,748	)		(9,783	)
Loans, net		1,025,721			1,025,480
Premises and equipment, net		30,909			30,928
Company-owned life insurance		30,731			30,817
Other real estate owned		5,087			5,489
Other assets		33,105			33,133
Total assets	$	1,685,987		$	1,673,872
Liabilities
Deposits:
Noninterest bearing	$	375,645		$	361,855
Interest bearing		1,018,446			1,018,048
Total deposits		1,394,091			1,379,903
Securities sold under agreements to repurchase		33,343			34,252
Federal Home Loan Bank advances		3,436			3,479
Subordinated notes payable to unconsolidated trusts		33,506			33,506
Dividends payable, common stock		940			939
Other liabilities		26,643			28,440
Total liabilities		1,491,959			1,480,519
Shareholders’ Equity
Common stock, par value $.125 per share; 14,608,000 shares authorized; 7,519,445 and 7,517,446 shares issued and outstanding at March 31, 2018 and December 31, 2017, respectively		940			940
Capital surplus		52,278			52,201
Retained earnings		148,535			143,778
Accumulated other comprehensive loss		(7,725	)		(3,566	)
Total shareholders’ equity		194,028			193,353
Total liabilities and shareholders’ equity	$	1,685,987		$	1,673,872

See accompanying notes to unaudited condensed consolidated financial statements.

Unaudited Condensed Consolidated Statements of Income

	Three Months Ended
	March 31,
(In thousands, except per share data)	2018			2017
Interest Income
Interest and fees on loans	$	12,469		$	11,722
Interest on investment securities:
Taxable		2,025			1,900
Nontaxable		475			591
Interest on deposits in other banks		269			142
Interest on federal funds sold and money market mutual funds		106			24
Total interest income		15,344			14,379
Interest Expense
Interest on deposits		586			533
Interest on securities sold under agreements to repurchase		19			25
Interest on Federal Home Loan Bank advances		28			160
Interest on subordinated notes payable to unconsolidated trusts		254			198
Total interest expense		887			916
Net interest income		14,457			13,463
Provision for loan losses		(261	)		580
Net interest income after provision for loan losses		14,718			12,883
Noninterest Income
Service charges and fees on deposits		1,912			1,958
Allotment processing fees		720			715
Other service charges, commissions, and fees		1,372			1,372
Trust income		789			704
Net loss on sales of available for sale investment securities		-			(9	)
Gains on sale of mortgage loans, net		95			154
Income from company-owned life insurance		293			235
Other		20			122
Total noninterest income		5,201			5,251
Noninterest Expense
Salaries and employee benefits		7,490			7,860
Occupancy expenses, net		1,254			1,214
Equipment expenses		601			553
Data processing and communication expenses		1,083			1,293
Bank franchise tax		500			557
Deposit insurance expense		126			137
Other real estate expenses, net		117			74
Other		1,947			1,841
Total noninterest expense		13,118			13,529
Income before income taxes		6,801			4,605
Income tax expense		1,160			1,276
Net income	$	5,641		$	3,329
Per Common Share
Net income – basic and diluted	$	.75		$	.44
Cash dividends declared		.125			.10
Weighted Average Common Shares Outstanding
Basic and diluted		7,518			7,510

See accompanying notes to unaudited condensed consolidated financial statements.

Unaudited Condensed Consolidated Statements of Comprehensive Income

	Three Months Ended
	March 31,
(In thousands)	2018			2017
Net Income	$	5,641		$	3,329
Other comprehensive (loss) income:
Unrealized holding (loss) gain on available for sale securities arising during the period, net of tax of $(1,093) and $510, respectively		(4,102	)		948

Reclassification adjustment for net realized loss included in net income, net of tax of $- and $(3), respectively		-			6

Change in unfunded portion of postretirement benefit obligation, net of tax of $- and $32, respectively		(1	)		59
Other comprehensive (loss) income		(4,103	)		1,013
Comprehensive income	$	1,538		$	4,342

See accompanying notes to unaudited condensed consolidated financial statements.

Unaudited Condensed Consolidated Statements of Changes in Shareholders’ Equity

(In thousands, except per share data)										Accumulated
										Other			Total
Three months ended	Common Stock				Capital		Retained			Comprehensive			Shareholders’
March 31, 2018 and 2017	Shares		Amount		Surplus		Earnings			(Loss) Income			Equity
Balance at January 1, 2018		7,517	$	940	$	52,201	$	143,778		$	(3,566	)	$	193,353
Net income		-		-		-		5,641			-			5,641
Other comprehensive loss		-		-		-		-			(4,103	)		(4,103	)
Adoption of Accounting Standards Update 2016-01		-		-		-		56			(56	)		-
Cash dividends declared – common, $.125 per share		-		-		-		(940	)		-			(940	)
Shares issued under director compensation plan		-		-		18		-			-			18
Shares issued pursuant to employee stock purchase plan		2		-		51		-			-			51
Expense related to employee stock purchase plan		-		-		8		-			-			8
Balance at March 31, 2018		7,519	$	940	$	52,278	$	148,535		$	(7,725	)	$	194,028


Balance at January 1, 2017		7,509	$	939	$	51,885	$	134,650		$	(3,408	)	$	184,066
Net income		-		-		-		3,329			-			3,329
Other comprehensive income		-		-		-		-			1,013			1,013
Cash dividends declared – common, $.10 per share		-		-		-		(751	)		-			(751	)
Shares issued under director compensation plan		1		-		28		-			-			28
Shares issued pursuant to employee stock purchase plan		2		-		46		-			-			46
Expense related to employee stock purchase plan		-		-		9		-			-			9
Balance at March 31, 2017		7,512	$	939	$	51,968	$	137,228		$	(2,395	)	$	187,740

See accompanying notes to unaudited condensed consolidated financial statements.

Unaudited Condensed Consolidated Statements of Cash Flows

Three months ended March 31, (In thousands)	2018			2017
Cash Flows from Operating Activities
Net income	$	5,641		$	3,329
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization		800			862
Net premium amortization of investment securities:
Available for sale		616			897
Held to maturity		14			13
Provision for loan losses		(261	)		580
Deferred income tax (benefit) expense		(10	)		18
Noncash employee stock purchase plan expense		8			9
Noncash director fee compensation		18			28
Mortgage loans originated for sale		(2,557	)		(5,324	)
Proceeds from sale of mortgage loans		2,537			6,624
Gain on sale of mortgage loans, net		(95	)		(154	)
Loss on disposal of premises and equipment, net		-			37
Net loss (gain) on sale and write downs of other real estate		76			(5	)
Net loss on sale of available for sale investment securities		-			9
Unrealized loss on equity investment securities		55			-
Curtailment gain on postretirement benefits plan liability		-			(351	)
Increase in cash surrender value of company-owned life insurance		(213	)		(216	)
Death benefits in excess of cash surrender value on company-owned life insurance		(67	)		-
Decrease in accrued interest receivable		363			434
Decrease in other assets		517			1,787
Increase (decrease) in accrued interest payable		4			(32	)
Decrease in other liabilities		(1,802	)		(2,603	)
Net cash provided by operating activities		5,644			5,942
Cash Flows from Investing Activities
Proceeds from maturities and calls of available for sale investment securities		16,715			19,474
Purchase of available for sale investment securities		(1,536	)		(31,058	)
Purchase of equity investment securities		(695	)		(3	)
Proceeds from cancelation of cost method investment securities		239			666
Purchase of cost method investment securities		-			(4,236	)
Loans originated for investment greater than principal collected, net		(493	)		(18,347	)
Purchase of loans held for investment		(709	)		(732	)
Principal collected on purchased loans		1,317			643
Proceeds from death benefits of company-owned life insurance		366			-
Purchase of premises and equipment		(729	)		(1,145	)
Proceeds from sale of other real estate		346			699
Net cash provided by (used in) investing activities		14,821			(34,039	)
Cash Flows from Financing Activities
Net increase in deposits		14,188			18,170
Net decrease in short-term securities sold under agreements to repurchase		(910	)		(2,299	)
Proceeds from long-term securities sold under agreements to repurchase		1			2
Repayments of long-term securities sold under agreements to repurchase		-			(5,041	)
Repayments of Federal Home Loan Bank advances		(43	)		-
Dividends paid, common stock		(939	)		(751	)
Shares issued under employee stock purchase plan		51			46
Net cash provided by financing activities		12,348			10,127
Net increase (decrease) in cash and cash equivalents		32,813			(17,970	)
Cash and cash equivalents at beginning of year		120,408			113,534
Cash and cash equivalents at end of period	$	153,221		$	95,564
Supplemental Disclosures
Cash paid during the period for interest	$	883		$	948
Transfers from loans to other real estate		104			187
Sale and financing of other real estate		84			2,172
Cash dividends payable, common		940			751

See accompanying notes to unaudited condensed consolidated financial statements.

Notes to Unaudited Condensed Consolidated Financial Statements

1. Basis of Presentation and Nature of Operations

The condensed consolidated financial statements include the accounts of Farmers Capital Bank Corporation (the “Company” or “Parent Company”), a financial holding company, and its wholly owned subsidiaries. The Company has one bank subsidiary, United Bank & Capital Trust Company (“United Bank”), and one nonbank subsidiary, FFKT Insurance Services, Inc. (“FFKT Insurance”).

FFKT Insurance is a captive insurance company that provides property and casualty coverage to the Parent Company and its subsidiaries for risk management purposes or where insurance may not be available or economically feasible. The Company has two subsidiaries organized as Delaware statutory trusts that are not consolidated into its financial statements. These trusts were formed for the purpose of issuing trust preferred securities.

United Bank’s significant subsidiaries include EG Properties, Inc. and Farmers Capital Insurance Corporation (“Farmers Insurance”). EG Properties, Inc. is involved in real estate management and liquidation for certain repossessed properties of United Bank. Farmers Insurance is an insurance agency in Frankfort, KY.

The Company provides financial services at its 34 locations in 21 communities throughout Central and Northern Kentucky to individual, business, agricultural, governmental, and educational customers. Its primary deposit products are checking, savings, and term certificate accounts. Its primary lending products are residential mortgage, commercial lending, and consumer installment loans. Substantially all loans are secured by specific items of collateral including business assets, consumer assets, and commercial and residential real estate. Commercial loans are expected to be repaid from cash flow from operations of businesses. Other services include, but are not limited to, cash management services, issuing letters of credit, safe deposit box rental, and providing funds transfer services. Other financial instruments, which could potentially represent concentrations of credit risk, include deposit accounts in other financial institutions and federal funds sold.

The preparation of financial statements in conformity with accounting principles generally accepted in the United States (“U.S. GAAP”) 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. Estimates used in the preparation of the condensed financial statements are based on various factors including the current interest rate environment and the general strength of the local and state economy. Changes in the overall interest rate environment can significantly affect the Company’s net interest income and the value of its recorded assets and liabilities. Actual results could differ from those estimates used in the preparation of the condensed financial statements. The allowance for loan losses, carrying value of other real estate owned, actuarial assumptions used to calculate postretirement benefits, and the fair values of financial instruments are estimates that are particularly subject to change.

The consolidated balance sheet as of December 31, 2017 has been derived from the audited financial statements of the Company as of that date. For further information, refer to the consolidated financial statements and footnotes thereto for the year ended December 31, 2017 included in the Company’s annual report on Form 10-K. The accompanying condensed consolidated financial statements have been prepared in accordance with the instructions to Form 10-Q and Rule 10-01 of Regulation S-X and do not include all of the information and the footnotes required by U.S. GAAP for complete statements. In the opinion of management, all adjustments, consisting of normal recurring adjustments, necessary for a fair presentation of such condensed financial statements, have been included. The results of operations for the interim periods are not necessarily indicative of the results to be expected for the full year. All significant intercompany transactions and balances are eliminated in consolidation.

2. Reclassifications

Certain reclassifications have been made to the condensed consolidated financial statements of prior periods to conform to the current period presentation. These reclassifications do not affect net income or total shareholders’ equity as previously reported.

3. Accumulated Other Comprehensive (Loss) Income

The following table presents changes in accumulated other comprehensive (loss) income (“AOCI”) by component, net of tax, for the periods indicated. The table also includes $56 thousand cumulative-effect adjustment from AOCI to retained earnings related to the adoption of Accounting Standards Update (“ASU”) 2016-01 effective January 1, 2018. ASU 2016-01 requires changes in the fair value of the Company’s equity investments to be recognized through net income. Prior to 2018, changes in the fair value of equity securities were recognized through AOCI. Additional information related to the adoption of ASU 2016-01 can be found in Note 4 and Note 7.

	Three Months Ended March 31, 2018									Three Months Ended March 31, 2017
(In thousands)	Unrealized Gains (Losses) on Available for Sale Investment Securities			Postretirement Benefit Obligation			Total			Unrealized Gains (Losses) on Available for Sale Investment Securities			Postretirement Benefit Obligation			Total
Beginning balance	$	(3,510	)	$	(56	)	$	(3,566	)	$	(3,363	)	$	(45	)	$	(3,408	)
Other comprehensive (loss) income before reclassifications		(4,102	)		-			(4,102	)		948			10			958
Amounts reclassified from accumulated other comprehensive income		-			(1	)		(1	)		6			49			55
Net current-period other comprehensive (loss) income		(4,102	)		(1	)		(4,103	)		954			59			1,013
Adoption of Accounting Standards Update 2016-01		(56	)		-			(56	)		-			-			-
Ending balance	$	(7,668	)	$	(57	)	$	(7,725	)	$	(2,409	)	$	14		$	(2,395	)

The following table presents amounts reclassified out of accumulated other comprehensive income by component for the periods indicated. Line items in the statement of income affected by the reclassification are also presented.

	Amount Reclassified from Accumulated Other Comprehensive Income					Affected Line Item in the Statement Where Net Income is Presented
(In thousands)	Three Months Ended March 31, 2018		Three Months Ended March 31, 2017
Unrealized gains (losses) on available for sale investment securities	$	-	$	(9	)	Net loss on sales of available for sale investment securities
		-		3		Income tax expense
	$	-	$	(6	)	Net of tax

Amortization related to postretirement benefits
Prior service costs	$	-	$	(75	)	Salaries and employee benefits
Actuarial gains (losses)		1		(1	)	Other noninterest expense
		1		(76	)	Total before tax
		-		27		Income tax expense
	$	1	$	(49	)	Net of tax

Total reclassifications for the period	$	1	$	(55	)	Net of tax

4. Accounting Policy

Loans and Interest Income

Loans that management has the intent and ability to hold for the foreseeable future or until maturity or pay-off are reported at their unpaid principal amount outstanding adjusted for any charge-offs, deferred fees or costs on originated loans, and unamortized premiums and discounts on purchased loans. Interest income on loans is recognized using the interest method based on loan principal amounts outstanding during the period. Interest income also includes amortization and accretion of any premiums or discounts over the expected life of acquired loans at the time of purchase or business acquisition. Loan origination fees, net of certain direct origination costs, are deferred and amortized as yield adjustments over the contractual term of the loans.

The Company disaggregates certain disclosure information related to loans, the related allowance for loan losses, and credit quality measures by either portfolio segment or by loan class. The Company segregates its loan portfolio segments based on similar risk characteristics as follows: real estate loans, commercial loans, and consumer loans. Portfolio segments are further disaggregated into classes for certain required disclosures as follows:

Portfolio Segment	Class

Real estate loans	Real estate mortgage – construction and land development Real estate mortgage – residential Real estate mortgage – farmland and other commercial enterprises
Commercial loans	Commercial and industrial Depository institutions Agriculture production and other loans to farmers States and political subdivisions Other
Consumer loans	Secured Unsecured

The Company has a loan policy in place that is amended and approved from time to time as needed to reflect current economic conditions and product offerings in its markets. The policy establishes written procedures concerning areas such as the lending authorities of loan officers, committee review and approval of certain credit requests, underwriting criteria, policy exceptions, appraisal requirements, and loan review. Credit is extended to borrowers based primarily on their ability to repay as demonstrated by income and cash flow analysis.

Loans secured by real estate make up the largest segment of the Company’s loan portfolio. If a borrower fails to repay a loan secured by real estate, the Company may liquidate the collateral in order to satisfy the amount owed. Determining the value of real estate is a key component to the lending process for real estate backed loans. If the fair value of real estate (less estimated cost to sell) securing a collateral dependent loan declines below the outstanding loan amount, the Company will write down the carrying value of the loan and thereby incur a loss. The Company uses independent third party state certified or licensed appraisers in accordance with its loan policy to mitigate risk when underwriting real estate loans. Cash flow analysis of the borrower, loan to value limits as adopted by loan policy, and other customary underwriting standards are also in place which are designed to maximize credit quality and mitigate risks associated with real estate lending.

Commercial loans are made to businesses and are secured mainly by assets such as inventory, accounts receivable, machinery, fixtures and equipment, or other business assets. Commercial lending involves significant risk, as loan repayments are more dependent on the successful operation or management of the business and its cash flows. Consumer lending includes loans to individuals mainly for personal autos, boats, or a variety of other personal uses and may be secured or unsecured. Loan repayment associated with consumer loans is highly dependent upon the borrower’s continuing financial stability, which is heavily influenced by local unemployment rates. The Company mitigates its risk exposure to each of its loan segments by analyzing the borrower’s repayment capacity, imposing restrictions on the amount it will loan compared to estimated collateral values, limiting the payback periods, and following other customary underwriting practices as adopted in its loan policy.

The accrual of interest on loans is discontinued when it is determined that the collection of interest or principal is doubtful, or when a default of interest or principal has existed for 90 days or more, unless such loan is well secured and in the process of collection. Past due status is based on the contractual terms of the loan. Interest accrued but not received for a loan placed on nonaccrual status is reversed against interest income. Cash payments received on nonaccrual loans generally are applied to principal until qualifying for return to accrual status. Loans are returned to accrual status when all the principal and interest amounts contractually due are brought current and future payments are reasonably assured. The Company’s policy for placing a loan on nonaccrual status or subsequently returning a loan to accrual status does not differ based on its portfolio class or segment.

Commercial and real estate loans delinquent in excess of 120 days and consumer loans delinquent in excess of 180 days are charged off, unless the collateral securing the debt is of such value that any loss appears to be unlikely. In all cases, loans are charged off at an earlier date if classified as loss under the Company’s loan grading process or as a result of regulatory examination. The Company’s charge-off policy for impaired loans does not differ from the charge-off policy for loans outside the definition of impaired.

Provision and Allowance for Loan Losses

The provision for loan losses represents charges or credits made to earnings to maintain an allowance for loan losses at a level considered adequate to provide for probable incurred credit losses at the balance sheet date. The allowance for loan losses is a valuation allowance increased by the provision for loan losses and decreased by net charge-offs. Loan losses are charged against the allowance when management believes the uncollectibility of a loan is confirmed. Subsequent recoveries, if any, are credited to the allowance.

The Company estimates the adequacy of the allowance using a risk-rated methodology which is based on the Company’s past loan loss experience, known and inherent risks in the loan portfolio, adverse situations that may affect the borrower’s ability to repay, the estimated value of any underlying collateral securing loans, composition of the loan portfolio, current economic conditions, and other relevant factors. This evaluation is inherently subjective as it requires significant judgment and the use of estimates that may be susceptible to change.

The allowance for loan losses consists of specific and general components. The specific component relates to loans that are individually classified as impaired. The general component covers non-impaired loans and is based on historical loss experience adjusted for current risk factors. Allocations of the allowance may be made for specific loans, but the entire allowance is available for any loan that, in management’s judgment, should be charged off. Actual loan losses could differ significantly from the amounts estimated by management.

The general portion of the Company’s loan portfolio is segregated into portfolio segments having similar risk characteristics identified as follows: real estate loans, commercial loans, and consumer loans. Each of these portfolio segments is assigned a loss percentage based on their respective twelve quarter rolling historical loss rates, adjusted for the qualitative risk factors summarized below.

The qualitative risk factors used in the methodology are consistent with the guidance in the most recent Interagency Policy Statement on the Allowance for Loan Losses issued. Each factor is supported by a detailed analysis and is both measurable and supportable. Some factors include a minimum allocation in instances where loss levels are extremely low and it is determined to be prudent from a safety and soundness perspective. Qualitative risk factors that are used in the methodology include the following for each loan portfolio segment:

●

Delinquency trends

●

Trends in net charge-offs

●

Trends in loan volume

●

Lending philosophy risk

●

Management experience risk

●

Concentration of credit risk

●

Economic conditions risk

A loan is impaired when, based on current information and events, it is probable that the Company will be unable to collect all amounts due according to the contractual terms of the loan agreement. Loans for which the terms have been modified resulting in a concession, and for which the borrower is experiencing financial difficulties, are considered troubled debt restructurings and classified as impaired. Factors considered by management in determining impairment include payment status, collateral value, and the probability of collecting scheduled principal and interest payments when due. Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired. Management determines the significance of payment delays and payment shortfalls on a case-by-case basis, taking into consideration all of the circumstances surrounding the loan and the borrower, including the length of the delay, the reasons for the delay, the borrower’s prior payment record, and the amount of the shortfall in relation to the principal and interest owed.

The Company accounts for impaired loans in accordance with Accounting Standards Codification (“ASC”) Topic 310, “Receivables.” ASC Topic 310 requires that impaired loans be measured at the present value of expected future cash flows, discounted at the loan’s effective interest rate, at the loan’s observable market price, or at the fair value of the collateral if the loan is collateral dependent. Impaired loans may also be classified as nonaccrual. In many circumstances, however, the Company continues to accrue interest on an impaired loan. Cash receipts on accruing impaired loans are applied to the recorded investment in the loan, including any accrued interest receivable. Cash payments received on nonaccrual impaired loans generally are applied to principal until qualifying for return to accrual status. Loans that are part of a large group of smaller-balance homogeneous loans, such as residential mortgage, consumer, and smaller-balance commercial loans, are collectively evaluated for impairment. Troubled debt restructurings are measured at the present value of estimated future cash flows using the loan’s effective interest rate at inception, or at the fair value of collateral. The Company determines the amount of reserve for troubled debt restructurings that subsequently default in accordance with its accounting policy for the allowance for loan losses.

Adoption of New Accounting Standards

In May 2014, the Financial Accounting Standards Board (“FASB”) issued ASU No. 2014-09, Revenue from Contracts with Customers (Topic 606), and subsequently issued several amendments to the standard during 2015, 2016, and 2017. The primary principle of ASU No. 2014-09 is that entities should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. This ASU also requires disclosure of the nature, amount, timing, and uncertainty of revenue and cash flows arising from contracts with customers.

The majority of the Company’s revenues earned are excluded from the scope of the new standard. Revenue streams within the scope of this ASU include services charges and fees on deposits, allotment processing fees, trust income, and certain components of other service charges, commission, and fees. The Company has analyzed each revenue stream under Topic 606 and determined that there were no material changes to existing recognition practices. The Company adopted ASU No. 2014-09 effective January 1, 2018 using a modified retrospective approach and no cumulative-effect adjustment was recorded. Additional disclosures required by the new standard are included in Note 5.

In January 2016, the FASB issued ASU No. 2016-01, Financial Instruments – Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities and, in February 2018, issued an amendment for technical corrections and improvements related to this ASU. The amendments in this ASU require all equity investments to be measured at fair value with changes in the fair value recognized through net income (other than those accounted for under equity method of accounting or those that result in consolidation of the investee). In addition, this ASU eliminates the requirement to disclose the method(s) and significant assumptions used to estimate the fair value that is required to be disclosed for financial instruments measured at amortized cost on the balance sheet for public business entities. Public business entities are required to use the exit price notion when measuring the fair value of financial instruments for disclosure purposes. For public business entities, the amendments in this ASU are effective for fiscal years beginning after December 15, 2017, including interim periods within those fiscal years. The amendments should be applied by means of a cumulative-effect adjustment to the balance sheet as of the beginning of the year of adoption. The amendments related to equity securities without readily determinable fair values (including disclosure requirements) should be applied prospectively to equity investments that exist as of the date of adoption. The Company adopted ASU No. 2016-01 effective January 1, 2018, recorded a cumulative-effect adjustment of $56 thousand, and began using the exit price notion rather than entrance price to determine the fair value for disclosure purposes. For equity securities without a readily determinable fair value, the Company elected the practical expedient and recorded them at cost adjusted for impairment (if any), plus or minus changes resulting from observable price changes in orderly transactions. Additional information related to the cumulative-effect adjustment can be found in Note 3 and Note 7. Fair value disclosures can be found in Note 13.

In March 2017, the FASB issued ASU No. 2017-07, “Compensation—Retirement Benefits (Topic 715): Improving the Presentation of Net Periodic Pension Cost and Net Periodic Postretirement Benefit Cost,” which requires that employers offering benefit plans accounted for under Topic 715 report the service cost component in the same line item or items as other compensation costs arising from services rendered by the pertinent employees during the period. The other components of net benefit cost are required to be presented in the income statement separately from the service cost component. If a separate line item or items are not used, the line item or items used in the income statement to present the other components of net benefit cost must be disclosed. The Company retrospectively adopted ASU 2017-07 effective January 1, 2018, which did not have a material impact on its consolidated financial position, results of operations, or cash flows upon adoption. For prior periods, the interest cost, recognized actuarial loss, and recognized curtailment gain have been reclassified from salaries and employee benefits to other noninterest expense.

In February 2018, the FASB issued ASU No. 2018-02, “Income Statement—Reporting Comprehensive Income (Topic 220): Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income,” which allows entities to reclassify the stranded tax effects caused by the Tax Cuts and Jobs Act (“Tax Act”), which was enacted in December 2017, from accumulated other comprehensive income (“AOCI”) to retained earnings. This ASU is effective for annual and interim periods beginning after December 15, 2018, with early adoption permitted. The Company early adopted this standard, resulting in the reclassification of $633 thousand from AOCI to retained earnings for the year ended December 31, 2017. There was no impact on total equity.

Recently Issued Accounting Standards

In February 2016, the FASB issued ASU No. 2016-02, “Leases (Topic 842),” to improve financial reporting about leasing transactions. This ASU will require organizations that lease assets (“lessees”) to recognize a lease liability and a right-of-use asset on its balance sheet for all leases with terms of more than twelve months. A lease liability is a lessee’s obligation to make lease payments arising from a lease, measured on a discounted basis and a right-of-use asset represents the lessee’s right to use, or control use of, a specified asset for the lease term. The amendments in this ASU simplify the accounting for sale and leaseback transactions primarily because lessees must recognize lease assets and lease liabilities. This ASU leaves the accounting for the organizations that own the assets leased to the lessee (“lessor”) largely unchanged except for targeted improvements to align it with the lessee accounting model and Topic 606, Revenue from Contracts with Customers.

For public companies, ASU No. 2016-02 is effective for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. Lessees (for capital and operating leases) and lessors (for sales-type, direct financing, and operating leases) must apply a modified retrospective transition approach for leases existing at, or entered into after, the beginning of the earliest comparative period presented in the financial statements. The modified retrospective approach would not require any transition accounting for leases that expired before the earliest comparative period presented. Lessees and lessors may not apply a full retrospective transition approach. The Company has identified a project team and is in the process of reviewing its leases and assessing the impact of ASU No. 2016-02 on its consolidated financial position, results of operations, and cash flows.

In June 2016, the FASB issued ASU No. 2016-13, “Financial Instruments—Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments,” to improve financial reporting by requiring timelier recording of credit losses on loans and other financial instruments held by financial institutions and other organizations. The ASU requires an organization to measure all expected credit losses for financial assets held at the reporting date based on historical experience, current conditions, and reasonable and supportable forecasts. The ASU requires enhanced disclosures, including qualitative and quantitative requirements, which provide additional information about the amounts recorded in the financial statements. Additionally, the ASU amends the accounting for credit losses on available-for-sale debt securities and purchased financial assets with credit deterioration.

ASU No. 2016-13 is effective for the Company in annual and interim reporting periods beginning after December 15, 2019. Although early adoption is permitted for fiscal years beginning after December 15, 2018, the Company does not plan to early adopt. The Company has been preserving certain historical loan information from its core processing system in anticipation of adopting the standard. The Company has identified a project team to assess the impact of this ASU on its consolidated financial position, results of operations, and cash flows. The project team has developed a timeline for implementing the standard, has begun working with a third party software solution provider, and has identified an independent third party for validation of the impending changes to our credit loss methodologies and processes. The team continues to assess the impact of the standard; however, the Company expects adopting this ASU will result in an increase in its allowance for loan losses. The amount of the increase in the allowance for loan losses upon adoption will be dependent upon the characteristics of the portfolio at the adoption date, as well as macroeconomic conditions and forecasts at that date. A cumulative effect adjustment will be made to retained earnings for the impact of the standard at the beginning of the period the standard is adopted.

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.

5. Revenue From Contracts With Customers

The Company records revenue from contracts with customers in accordance with ASC Topic 606, “Revenue from Contracts with Customers.” ASC Topic 606 requires an entity to recognize revenue to depict the transfer of goods or services to customers in an amount that reflects the consideration that it expects to be entitled to receive in exchange for those goods or services recognized when, or as, the Company satisfies a performance obligation. Primarily all of the Company’s revenue from contracts with customers in the scope of ASC Topic 606 is recognized within noninterest income. Net gains or losses on the sale of other real estate owned (“OREO”) are included in net other real estate expenses. The following table presents the Company’s sources of noninterest income for the three months ended March 31, 2018 and 2017. Amounts in the table are within the scope of ASC Topic 606 unless otherwise noted.

Three Months Ended March 31, (In thousands)	2018		2017
Service charges and fees on deposits
Overdraft fees	$	956	$	927
Dormant account fees		593		665
Service charges on checking and savings accounts		314		310
Other		49		56
Allotment processing fees		720		715
Other service charges, commissions, and fees
Interchange fees		827		781
Other¹		545		591
Trust income		789		704
Investment securities (losses) gains, net²		-		(9	)
Gain on sale of mortgage loans, net²		95		154
Income from company-owned life insurance²		293		235
Other		20		122
Total noninterest income	$	5,201	$	5,251

¹Includes broker, ATM, and other fees totaling $402 thousand and $457 thousand for the three months ended March 31, 2018 and 2017, respectively, which is within the scope of ASC Topic 606.

²Not within the scope of ASC Topic 606.

Net other real estate expenses include a net loss on the sale of OREO of $43 thousand and a net gain of $115 thousand for the three months ended March 31, 2018 and 2017, respectively.

A description of the Company’s revenue-generating activities accounted for under Topic 606 follows.

Service charges and fees on deposits consist primarily of overdraft fees, dormant account fees, and service charges on checking and savings accounts. Overdraft fees are recognized at the time an account is overdrawn. Dormant account fees are recognized when an account is inactive for 365 days. The majority of service charges on checking and savings accounts are for account maintenance services performed and recognized in the same calendar month. Other fees are primarily for transaction-based services completed at the request of the customer and recognized at the time the transaction is executed. These transaction-based services include foreign ATM usage and stop payments services. All service charges and fees on deposits are withdrawn from the customer’s account balance.

Allotment processing fees relate to the Company’s bill payment and electronic funds transfer (“EFT”) services provided under the name of FirstNet. The Company processes payments by individual customers to unaffiliated third party lenders on bi-weekly and monthly schedules. Other EFT services are available to customers upon request. The Company does not provide credit to individuals under the program. Fees are primarily withdrawn from the customer’s account and recognized at the time the transaction is executed.

Other service charges, commissions, and fees include interchange fees earned primarily from debit card holder transactions conducted through the VISA payment network and other networks. Interchange fees from cardholder transactions represent a percentage of the underlying transaction value and are received and recognized daily, concurrent with the transaction processing services provided to the cardholder.

Trust income is earned from living trusts and investment management agency accounts, estate planning and estate settlement, custody accounts, individual retirement accounts, and other related services. These fees are primarily earned and accrued over the period of time the Company provides the contracted services and are generally assessed based on tiered scale of the market value of the assets of the accounts. Fees for other services, including the preparation of fiduciary income tax returns, are recognized when the services are rendered. Fees are generally paid out of the assets held in the customer’s account.

6. Net Income Per Common Share

Basic net income per common share is determined by dividing net income by the weighted average total number of common shares issued and outstanding. There were no dilutive instruments at March 31, 2018 and 2017.

Net income per common share computations were as follows for the periods indicated:

	Three Months Ended March 31,
(In thousands, except per share data)	2018		2017

Net income, basic and diluted	$	5,641	$	3,329


Average common shares issued and outstanding, basic and diluted		7,518		7,510

Net income per common share, basic and diluted	$	.75	$	.44

7. Investment Securities

Equity Securities

Equity securities consist of money market mutual funds classified as cash and cash equivalents on the balance sheet and mutual funds and equity securities in the investment portfolio of the Company’s captive insurance subsidiary. Money market mutual funds were $35.0 million and $36.7 million at March 31, 2018 and December 31, 2017, respectively. The Company held $1.6 million and $935 thousand in mutual funds and equity securities recorded at fair value at March 31, 2018 and December 31, 2017, respectively.

Effective January 1, 2018, the Company adopted ASU 2016-01, which requires the Company to recognize changes in the fair value of its equity securities through net income. Prior to 2018, changes in the fair value of equity securities were recognized through AOCI. At December 31, 2017, unrealized gains, net of tax, of $56 thousand had been recognized in AOCI. At the beginning of 2018, the Company made a cumulative-effect adjustment to reclassify those gains out of AOCI and into retained earnings. During the three months ended March 31, 2018, the Company recognized an unrealized loss of $55 thousand on the equity securities held at March 31, 2018, which was recorded in other noninterest income. There were no sales of equity securities during the three months ended March 31, 2018.

Debt Securities

The Company’s debt securities are classified as available for sale or held to maturity. The following tables summarize the amortized costs and estimated fair value of the Company’s debt securities at March 31, 2018 and December 31, 2017.

March 31, 2018 (In thousands)

Amortized
Cost

Gross

Unrealized
Gains

Gross

Unrealized
Losses

Estimated
Fair Value

Available For Sale

Obligations of U.S. government-sponsored entities

42,633

691

41,956

Obligations of states and political subdivisions

109,652

281

2,365

107,568

Mortgage-backed securities – residential

186,441

318

5,158

181,601

Mortgage-backed securities – commercial

49,990

2,116

47,874

Asset-backed securities

15,538

15,517

Corporate debt securities

7,741

7,772

Total securities – available for sale

411,995

670

10,377

402,288

Held To Maturity

Obligations of states and political subdivisions

3,350

3,424

December 31, 2017 (In thousands)

Amortized
Cost

Gross

Unrealized
Gains

Gross

Unrealized
Losses

Estimated
Fair Value

Available For Sale

Obligations of U.S. government-sponsored entities

43,601

437

43,208

Obligations of states and political subdivisions

114,960

562

1,273

114,249

Mortgage-backed securities – residential

195,605

523

2,735

193,393

Mortgage-backed securities – commercial

50,518

1,208

49,352

Asset-backed securities

15,569

15,574

Corporate debt securities

7,578

7,542

Total securities – available for sale

427,831

1,181

5,694

423,318

Held To Maturity

Obligations of states and political subdivisions

3,364

114

3,478

Debt securities with a carrying value of $208 million and $214 million at March 31, 2018 and December 31, 2017, respectively, were pledged to secure public and trust deposits, repurchase agreements, and for other purposes.

The amortized cost and estimated fair value of the debt securities portfolio at March 31, 2018, by contractual maturity, are detailed 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. Mortgage-backed securities are stated separately due to the nature of payment and prepayment characteristics of these securities, as principal is not due at a single date.

Available For Sale

Held To Maturity

Amortized

Estimated

Amortized

Estimated

March 31, 2018 (In thousands)

Cost

Fair Value

Cost

Fair Value

Due in one year or less

28,921

28,872

Due after one year through five years

52,222

51,572

Due after five years through ten years

55,496

53,726

1,232

1,289

Due after ten years

38,925

38,643

2,118

2,135

Mortgage-backed securities

236,431

229,475

Total

411,995

402,288

3,350

3,424

Gross realized gains and losses on the sale of available for sale debt securities are presented in the table below for the periods indicated.

	Three Months Ended
	March 31,
(In thousands)	2018		2017

Gross realized gains	$	-	$	-
Gross realized losses		-		9
Net realized loss	$	-	$	(9	)

Debt securities with unrealized losses at March 31, 2018 and December 31, 2017 not recognized in income are presented in the tables below. The tables segregate debt securities that have been in a continuous unrealized loss position for less than twelve months from those that have been in a continuous unrealized loss position for twelve months or more. The tables also include the fair value of the related securities.

Less than 12 Months

12 Months or More

Total

March 31, 2018 (In thousands)

Fair Value

Unrealized

Losses

Fair Value

Unrealized

Losses

Fair Value

Unrealized

Losses

Obligations of U.S. government-sponsored entities

13,336

182

27,010

509

40,346

691

Obligations of states and political subdivisions

52,756

956

33,058

1,409

85,814

2,365

Mortgage-backed securities – residential

74,591

1,642

93,924

3,516

168,515

5,158

Mortgage-backed securities – commercial

14,798

378

33,076

1,738

47,874

2,116

Asset-backed securities

11,721

Corporate debt securities

2,721

498

3,219

Total

169,923

3,202

187,566

7,175

357,489

10,377

Less than 12 Months

12 Months or More

Total

December 31, 2017 (In thousands)

Fair Value

Unrealized

Losses

Fair Value

Unrealized

Losses

Fair Value

Unrealized

Losses

Obligations of U.S. government-sponsored entities

11,544

25,298

394

36,842

437

Obligations of states and political subdivisions

40,402

413

33,965

860

74,367

1,273

Mortgage-backed securities – residential

77,312

481

99,986

2,254

177,298

2,735

Mortgage-backed securities – commercial

7,758

34,139

1,146

41,897

1,208

Asset-backed securities

1,166

Corporate debt securities

7,251

200

7,451

Total

145,433

1,039

193,588

4,655

339,021

5,694

Unrealized losses included in the tables above have not been recognized in income since they have been identified as temporary. The Company evaluates debt securities for other-than-temporary impairment (“OTTI”) at least quarterly, and more frequently when economic or market conditions warrant. Many factors are considered, including: (1) the length of time and the extent to which the fair value has been less than cost, (2) the financial condition and near-term prospects of the issuer, (3) whether the market decline was effected by macroeconomic conditions, and (4) whether the Company has the intent to sell the security or more likely than not will be required to sell the security before its anticipated recovery. The assessment of whether an OTTI charge exists involves a high degree of subjectivity and judgment and is based on the information available to the Company at a point in time.

The Company attributes the unrealized losses in its debt securities portfolio to changes in market interest rates and volatility. Debt securities with unrealized losses at March 31, 2018 and December 31, 2017 are performing according to their contractual terms, and the Company does not expect to incur a loss on these securities unless they are sold prior to maturity. The Company does not have the intent to sell these securities nor does it believe it is likely that it will be required to sell these securities prior to their anticipated recovery. The Company does not consider any of the securities to be impaired due to reasons of credit quality or other factors.

8. Loans and Allowance for Loan Losses

Major classifications of loans outstanding are summarized as follows:

(In thousands)	March 31, 2018		December 31, 2017

Real Estate
Real estate mortgage – construction and land development	$	131,376	$	129,181
Real estate mortgage – residential		351,838		355,304
Real estate mortgage – farmland and other commercial enterprises		440,680		432,321
Commercial
Commercial and industrial		68,472		63,417
States and political subdivisions		18,883		27,209
Other		16,663		19,916
Consumer
Secured		3,980		4,853
Unsecured		3,577		3,062
Total loans		1,035,469		1,035,263
Less unearned income		-		-
Total loans, net of unearned income	$	1,035,469	$	1,035,263

Activity in the allowance for loan losses by portfolio segment was as follows for the periods indicated:

(In thousands)

Real Estate

Commercial

Consumer

Total

Three months ended M arch 31, 2018

Balance, beginning of period

8,509

951

323

9,783

Provision for loan losses

(191

)

(47

)

(23

)

(261

)

Recoveries

341

388

Loans charged off

(58

)

(88

)

(16

)

(162

)

Balance, end of period

8,601

836

311

9,748

(In thousands)	Real Estate			Commercial			Consumer			Total
Three months ended M arch 31, 2017
Balance, beginning of period	$	8,205		$	854		$	285		$	9,344
Provision for loan losses		396			(7	)		191			580
Recoveries		17			49			11			77
Loans charged off		(434	)		(32	)		(28	)		(494	)
Balance, end of period	$	8,184		$	864		$	459		$	9,507

The following tables present individually impaired loans by class of loans for the dates indicated.

March 31, 2018 (In thousands)

Unpaid
Principal

Balance

Recorded
Investment

With No

Allowance

Recorded
Investment

With

Allowance

Total

Recorded

Investment

Allowance

for
Loan Losses
Allocated

Real Estate

Real estate mortgage – construction and land development

3,473

1,501

1,597

3,098

325

Real estate mortgage – residential

10,177

3,056

7,120

10,176

2,115

Real estate mortgage – farmland and other commercial enterprises

8,675

2,169

6,338

8,507

307

Commercial

Commercial and industrial

391

214

Consumer

Unsecured

305

212

Total

23,021

6,726

15,751

22,477

3,173

December 31, 2017 (In thousands)

Unpaid
Principal

Balance

Recorded
Investment

With No

Allowance

Recorded
Investment

With

Allowance

Total

Recorded

Investment

Allowance

for
Loan Losses
Allocated

Real Estate

Real estate mortgage – construction and land development

4,076

1,746

1,955

3,701

402

Real estate mortgage – residential

10,112

3,233

6,877

10,110

1,973

Real estate mortgage – farmland and other commercial enterprises

8,737

2,203

6,367

8,570

319

Commercial

Commercial and industrial

448

270

Consumer

Unsecured

312

218

Total

23,685

7,182

15,959

23,141

3,182

Three Months Ended March 31,	2018						2017
(In thousands)	Average		Interest Income Recognized		Cash Basis Interest Recognized		Average		Interest Income Recognized		Cash Basis Interest Recognized
Real Estate
Real estate mortgage – construction and land development	$	3,616	$	46	$	26	$	6,247	$	76	$	52
Real estate mortgage – residential		10,343		136		133		9,702		118		117
Real estate mortgage – farmland and other commercial enterprises		8,887		100		96		24,089		302		291
Commercial
Commercial and industrial		393		5		4		499		7		6
Consumer
Unsecured		320		4		4		335		5		2
Total	$	23,559	$	291	$	263	$	40,872	$	508	$	468

The following tables present the balance of the allowance for loan losses and the recorded investment in loans by portfolio segment based on impairment method as of March 31, 2018 and December 31, 2017.

March 31, 2018 (In thousands)

Real Estate

Commercial

Consumer

Total

Allowance for Loan Losses

Ending allowance balance attributable to loans:

Individually evaluated for impairment

2,747

214

212

3,173

Collectively evaluated for impairment

5,854

622

6,575

Total ending allowance balance

8,601

836

311

9,748

Loans

Loans individually evaluated for impairment

21,781

391

305

22,477

Loans collectively evaluated for impairment

902,113

103,627

7,252

1,012,992

Total ending loan balance, net of unearned income

923,894

104,018

7,557

1,035,469

December 31, 2017 (In thousands)

Real Estate

Commercial

Consumer

Total

Allowance for Loan Losses

Ending allowance balance attributable to loans:

Individually evaluated for impairment

2,694

270

218

3,182

Collectively evaluated for impairment

5,815

681

105

6,601

Total ending allowance balance

8,509

951

323

9,783

Loans

Loans individually evaluated for impairment

22,381

448

312

23,141

Loans collectively evaluated for impairment

894,425

110,094

7,603

1,012,122

Total ending loan balance, net of unearned income

916,806

110,542

7,915

1,035,263

The following tables present the recorded investment in nonperforming loans by class of loans as of March 31, 2018 and December 31, 2017.

March 31, 2018 (In thousands)

Nonaccrual

Restructured

Loans

Loans Past

Due 90 Days

or More and

Still Accruing

Real Estate

Real estate mortgage – construction and land development

150

1,597

Real estate mortgage – residential

1,636

5,648

Real estate mortgage – farmland and other commercial enterprises

1,738

3,682

Commercial

Commercial and industrial

369

Consumer

Unsecured

165

126

Total

3,719

11,422

December 31, 2017 (In thousands)

Nonaccrual

Restructured

Loans

Loans Past

Due 90 Days

or More and

Still Accruing

Real Estate

Real estate mortgage – construction and land development

151

1,955

Real estate mortgage – residential

1,763

5,326

Real estate mortgage – farmland and other commercial enterprises

1,752

3,703

Commercial

Commercial and industrial

370

Consumer

Unsecured

168

128

Total

3,887

11,482

The Company has allocated $1.7 million and $1.8 million of specific reserves as of March 31, 2018 and December 31, 2017, respectively, to customers whose loan terms have been modified in troubled debt restructurings and that are in compliance with those terms. The Company had no commitments to lend additional amounts to customers with outstanding loans that are classified as troubled debt restructurings at March 31, 2018 and December 31, 2017. The Company had no credits during the first three months of 2018 or 2017 that were modified as troubled debt restructurings.

The tables below present an age analysis of past due loans 30 days or more by class of loans as of the dates indicated. Past due loans that are also classified as nonaccrual are included in their respective past due category.

March 31, 2018 (In thousands)

30-89

Days Past

Due

90 Days

or More

Past Due

Total

Current

Total Loans

Real Estate

Real estate mortgage – construction and land development

131,289

131,376

Real estate mortgage – residential

2,145

250

2,395

349,443

351,838

Real estate mortgage – farmland and other commercial enterprises

712

989

1,701

438,979

440,680

Commercial

Commercial and industrial

68,425

68,472

States and political subdivisions

18,883

Other

16,663

Consumer

Secured

3,980

Unsecured

3,576

3,577

Total

2,905

1,326

4,231

1,031,238

1,035,469

December 31, 2017 (In thousands)

30-89

Days Past

Due

90 Days

or More

Past Due

Total

Current

Total Loans

Real Estate

Real estate mortgage – construction and land development

102

129,079

129,181

Real estate mortgage – residential

1,160

538

1,698

353,606

355,304

Real estate mortgage – farmland and other commercial enterprises

966

948

1,914

430,407

432,321

Commercial

Commercial and industrial

63,355

63,417

States and political subdivisions

27,209

Other

19,895

19,916

Consumer

Secured

4,853

Unsecured

3,053

3,062

Total

2,233

1,573

3,806

1,031,457

1,035,263

The Company categorizes loans into risk categories based on relevant information about the ability of borrowers to service their debt such as: current financial information, historical payment experience, credit documentation, public information, and current economic trends and conditions. The Company analyzes loans individually by classifying the loans as to credit risk. This analysis includes large-balance loans and non-homogeneous loans, such as commercial real estate and certain residential real estate loans. Loan rating grades, as described further below, are assigned based on a continuous process. The amount and adequacy of the allowance for loan loss is determined on a quarterly basis. The Company uses the following definitions for its risk ratings:

Special Mention. Loans classified as special mention have a potential weakness that deserves management's close attention. If left uncorrected, these potential weaknesses may result in deterioration of the borrower’s repayment ability, weaken the collateral or inadequately protect the Company’s credit position at some future date. These credits pose elevated risk, but their weaknesses do not yet justify a substandard classification.

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

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

Loans not meeting the criteria above which are analyzed individually as part of the above described process are considered to be pass rated loans and are considered to have a low risk of loss. Based on the most recent analysis performed, the risk category of loans by class of loans is as follows for the dates indicated.

Real Estate

Commercial

March 31, 2018
(In thousands)

Real Estate

Mortgage – Construction

and Land

Development

Real Estate

Mortgage –

Residential

Real Estate

Mortgage –

Farmland and

Other

Commercial Enterprises

Commercial

and

Industrial

States and

Political Subdivisions

Other

Credit risk profile by internally assigned rating grades

Pass

127,443

326,807

423,824

67,586

18,883

16,647

Special Mention

681

9,355

6,174

461

Substandard

3,252

15,676

10,682

425

Doubtful

Total

131,376

351,838

440,680

68,472

18,883

16,663

Real Estate

Commercial

December 31, 2017
(In thousands)

Real Estate

Mortgage –Construction

and Land

Development

Real Estate Mortgage –Residential

Real Estate

Mortgage –

Farmland and

Other

Commercial

Enterprises

Commercial

and

Industrial

States and

Political

Subdivisions

Other

Credit risk profile by internally assigned rating grades

Pass

124,926

330,401

414,663

62,490

27,209

19,898

Special Mention

396

9,196

7,556

474

Substandard

3,859

15,707

10,102

453

Doubtful

Total

129,181

355,304

432,321

63,417

27,209

19,916

The Company considers the performance of the loan portfolio and its impact on the allowance for loan losses. For consumer loan classes, the Company evaluates credit quality based on the aging status of the loan, which was previously presented, and by payment activity. The following table presents the consumer loans outstanding based on payment activity as of March 31, 2018 and December 31, 2017.

March 31, 2018

December 31, 2017

Consumer

(In thousands)

Secured

Unsecured

Secured

Unsecured

Credit risk profile based on payment activity

Performing

3,980

3,286

4,853

2,766

Nonperforming

291

296

Total

3,980

3,577

4,853

3,062

9. Other Real Estate Owned

Other real estate owned (“OREO”) was as follows for the dates indicated:

(In thousands)	March 31, 2018		December 31, 2017
Construction and land development	$	4,089	$	4,433
Residential real estate		35		157
Farmland and other commercial enterprises		963		899
Total	$	5,087	$	5,489

OREO activity for the three months ended March 31, 2018 and 2017 was as follows:

Three months ended March 31, (In thousands)	2018			2017
Beginning balance	$	5,489		$	10,673
Transfers from loans and other increases		104			193
Proceeds from sales		(430	)		(2,871	)
(Loss) gain on sales, net		(43	)		115
Write downs and other decreases, net		(33	)		(110	)
Ending balance	$	5,087		$	8,000

At March 31, 2018, the Company had a total of $136 thousand of loans secured by residential real estate mortgages that were in the process of foreclosure.

10. Securities Sold under Agreements to Repurchase

Securities sold under agreements to repurchase represent transactions where the Company sells certain of its investment securities and agrees to repurchase them at a specific date in the future. Securities sold under agreements to repurchase are accounted for as secured borrowings and reflect the amount of cash received in connection with the transaction.

Securities sold under agreements to repurchase are collateralized by U.S. government agency securities, primarily mortgage-backed securities. The Company may be required to provide additional collateral securing the borrowings in the event of principal pay downs or a decrease in the market value of the pledged securities. The Company mitigates this risk by monitoring the market value and liquidity of the collateral and ensuring that it holds a sufficient level of eligible securities to cover potential increases in collateral requirements.

The following tables represent the remaining maturity of repurchase agreements disaggregated by the class of securities pledged as of the dates indicated.

Remaining Contractual Maturity of the Agreements

March 31, 2018 (In thousands)

Overnight/
Continuous

Less

Than 30

Days

30-89
Days

90 Days

to One

Year

Over One

Year to

Three Years

Total

Mortgage-backed securities – residential

31,431

254

1,400

258

33,343

Total

31,431

254

1,400

258

33,343

Remaining Contractual Maturity of the Agreements

December 31, 2017 (In thousands)

Overnight/
Continuous

Less

Than 30

Days

30-89
Days

90 Days

to One

Year

Over One

Year to

Three Years

Total

Mortgage-backed securities – residential

32,341

1,200

454

257

34,252

Total

32,341

1,200

454

257

34,252

11. Postretirement Medical Benefits

The Company provides lifetime medical and dental benefits upon retirement for certain employees meeting the eligibility requirements as of December 31, 1989 (“Plan 1”). Additional participants are not eligible to be included in Plan 1 unless they met the requirements on this date. During 2003, the Company implemented an additional postretirement health insurance program (“Plan 2”). Under Plan 2, any employee meeting the service requirement of 20 years of full time service to the Company and is at least age 55 upon retirement is eligible to continue their health insurance coverage. Under both plans, retirees not yet eligible for Medicare have coverage identical to the coverage offered to active employees. Under both plans, Medicare-eligible retirees are provided with a Medicare Advantage plan. The Company pays 100% of the cost of Plan 1. The Company and the retirees each pay 50% of the cost under Plan 2. Both plans are unfunded. Employees hired on or after January 1, 2016 are not eligible for benefits under Plan 2.

The following disclosures of the net periodic benefit cost components of Plan 1 and Plan 2 were measured at January 1, 2018 and 2017.

Three months ended March 31, (In thousands)	2018		2017
Service cost	$	140	$	146
Interest cost		153		167
Curtailment gain recognized		-		(417	)
Recognized prior service cost		-		75
Net periodic benefit cost	$	293	$	(29	)

Service costs and recognized prior service costs are recorded as a component of salaries and employee benefits with the remaining portion of net periodic benefit cost recorded in other noninterest expense on the Company’s unaudited condensed consolidated statements of income. In connection with the merger of certain of its subsidiaries in February 2017, the Company recognized a curtailment gain of $417 thousand and prior service costs of $66 thousand, for a net gain of $351 thousand at the time of curtailment. This gain is a result of revaluing its postretirement medical benefits plan liability due to a reduction in workforce during the first quarter of 2017.

The Company expects benefit payments of $459 thousand for 2018, of which $96 thousand have been made during the first three months of 2018.

12. Regulatory Matters

The Company and its subsidiary bank are subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements will initiate certain mandatory and possibly additional discretionary actions by regulators that, if undertaken, could have a direct material effect on the Company’s financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, banks must meet specific capital guidelines that involve quantitative measures of the bank’s assets, liabilities, and certain off-balance sheet items as calculated under regulatory accounting practices. The Company and its subsidiary bank’s capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors.

The regulatory ratios of the consolidated Company and its subsidiary bank were as follows for the dates indicated:

March 31, 2018

December 31, 2017

Common Equity Tier 1 Risk-based Capital¹

Tier 1
Risk-based
Capital¹

Total
Risk-based
Capital¹

Tier 1
Leverage²

Common Equity Tier 1 Risk-based Capital¹

Tier 1
Risk-based
Capital¹

Total
Risk-based
Capital¹

Tier 1
Leverage²

Consolidated

17.07

19.82

20.65

13.99

16.56

19.30

20.12

13.75

United Bank

14.63

15.47

10.47

14.05

14.88

10.13

Regulatory minimum

4.50

6.00

8.00

4.00

4.50

6.00

8.00

4.00

Well-capitalized status

6.50

8.00

10.00

5.00

6.50

8.00

10.00

5.00

¹Common Equity Tier 1 Risked-based, Tier 1 Risk-based, and Total Risk-based Capital ratios are computed by dividing a bank’s Common Equity Tier 1, Tier 1 or Total Capital, as defined by regulation, by a risk-weighted sum of the bank’s assets, with the risk weighting determined by general standards established by regulation.

²Tier 1 Leverage ratio is computed by dividing a bank’s Tier 1 Capital by its total quarterly average assets, as defined by regulation.

13. Fair Value Measurements

ASC Topic 820, “Fair Value Measurements and Disclosures,” defines fair value, establishes a framework for measuring fair value, and sets forth disclosures about fair value measurements. ASC Topic 825, “Financial Instruments,” allows entities to choose to measure certain financial assets and liabilities at fair value. The Company has not elected the fair value option for any of its financial assets or liabilities.

ASC Topic 820 defines fair value as the price that would be received to sell an asset or paid to transfer a liability (exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants at the measurement date. It 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. This Topic describes three levels of inputs that may be used to measure fair value:

Level 1:

Quoted prices for identical assets or liabilities in active markets that the entity has the ability to access at the measurement date.

Level 2:

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

Level 3:

Significant unobservable inputs that reflect a reporting entity’s own assumptions supported by little or no market activity about the assumptions that market participants would use in pricing the asset or liability.

Following is a description of the valuation method used for financial instruments measured at fair value on a recurring basis. For this disclosure, the Company only has available for sale debt securities, equity securities, and money market mutual funds classified as cash equivalents that meet the requirement. The carrying value of the $35.0 million and $36.7 million in money market mutual funds at March 31, 2018 and December 31, 2017, respectively, is equivalent to its fair value and based on Level 1 inputs.

Available for sale debt securities and equity securities

Valued primarily by independent third party pricing services under the market valuation approach that include, but are not limited to, the following inputs:

●

Mutual funds and equity securities are priced utilizing real-time data feeds from active market exchanges for identical securities and are considered Level 1 inputs.

●

Government-sponsored agency debt securities, obligations of states and political subdivisions, mortgage-backed securities, corporate bonds, and other similar investment securities are priced with available market information through processes using benchmark yields, matrix pricing, prepayment speeds, cash flows, live trading data, and market spreads sourced from new issues, dealer quotes, and trade prices, among others sources and are considered Level 2 inputs.

Fair value disclosure for available for sale debt securities and equity securities classified as investments on the balance sheet as of March 31, 2018 and December 31, 2017 are as follows:

Fair Value Measurements Using

(In thousands)

March 31, 2018

Fair Value

Quoted Prices in

Active Markets

for Identical

Assets
(Level 1)

Significant Other

Observable Inputs
(Level 2)

Significant

Unobservable

Inputs
(Level 3)

Available For Sale Securities

Obligations of U.S. government-sponsored entities

41,956

Obligations of states and political subdivisions

107,568

Mortgage-backed securities – residential

181,601

Mortgage-backed securities – commercial

47,874

Asset-backed securities

15,517

Corporate debt securities

7,772

Total available for sale securities

402,288

Equity Securities

Mutual funds and equity securities

1,575

December 31, 2017

Available For Sale Securities

Obligations of U.S. government-sponsored entities

43,208

Obligations of states and political subdivisions

114,249

Mortgage-backed securities – residential

193,393

Mortgage-backed securities – commercial

49,352

Asset-backed securities

15,574

Corporate debt securities

7,542

Total available for sale securities

423,318

Equity Securities

Mutual funds and equity securities

935

The Company is required to measure and disclose certain other assets and liabilities at fair value on a nonrecurring basis in periods following their initial recognition. The Company’s disclosure about assets and liabilities measured at fair value on a nonrecurring basis consists of collateral-dependent impaired loans and OREO.

Adjustments to the fair value of collateral-dependent loans are recorded by either direct loan charge-offs through the allowance for loan losses or an adjustment to the specific reserve through an increase or decrease to the provision for loan losses. The fair value of collateral-dependent impaired loans with specific allocations of the allowance for loan losses is measured based on recent appraisals of the underlying collateral. These appraisals may utilize a single valuation approach or a combination of approaches including comparable sales and the income approach. Appraisers take absorption rates into consideration and adjustments are routinely made in the appraisal process to identify differences between the comparable sales and income data available. Such adjustments consist mainly of estimated costs to sell that are not included in certain appraisals or to update appraised collateral values as a result of market declines of similar properties for which a newer appraisal is available. These adjustments can be significant and typically result in a Level 3 classification of the inputs for determining fair value.

OREO includes properties acquired by the Company through, or in lieu of, actual loan foreclosures and is carried at fair value less estimated costs to sell. Fair value of OREO at acquisition is generally based on third party appraisals of the property that includes comparable sales data and is considered as Level 3 inputs. The carrying value of each OREO property is updated at least annually and more frequently when market conditions significantly impact the value of the property. If the carrying amount of the OREO exceeds fair value less estimated costs to sell, an impairment loss is recorded through noninterest expense.

The following table represents the carrying amount of assets measured at fair value on a nonrecurring basis and still held by the Company as of the dates indicated. The amounts in the table only represent assets whose carrying amount has been adjusted during the period in a manner as described above; therefore, these amounts will differ from the total amounts outstanding. With the exception of those calculated using the collateral valuation method, collateral-dependent impaired loan amounts in the tables below exclude restructured loans that are measured based on present value techniques, which are outside the scope of the fair value reporting framework.

				Fair Value Measurements Using
(In thousands) Description	Fair Value			Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)

March 31, 2018
Collateral-dependent Impaired Loans
Real estate mortgage – construction and land development	$	1,271		$	-	$	-	$	1,271
Real estate mortgage – residential		4,176			-		-		4,176
Total	$	5,447		$	-	$	-	$	5,447

OREO
Construction and land development	$	125		$	-	$	-	$	125
Residential real estate		35	&

FARMERS CAPITAL BANK CORP 10-Q