UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, DC 20549

 

FORM 10-Q

(Mark One)

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

 

For the quarterly period ended June 30, 2019

OR

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

For the transition period from _______ to _______

 

Commission file number 0-23325

---

Guaranty Federal Bancshares, Inc.

(Exact name of registrant as specified in its charter)

 

Delaware	43-1792717
(State or other jurisdiction of incorporation or organization)	(IRS Employer Identification No.)
2144 E Republic Rd, Suite F200
Springfield, Missouri	65804
(Address of principal executive offices)	(Zip Code)

 

Registrant’s telephone number: 1-833-875-2492

 

Securities registered pursuant to Section 12(b) of the Act:

Title of each class	Trading Symbol(s)	Name of each exchange on which registered
Common Stock, Par Value $0.10 per share	GFED	NASDAQ Global Market

 

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 every Interactive Data File required to be submitted 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 such files). Yes [X] No [  ]

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company or an emerging growth company. See 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 [X] Non-accelerated filer [ ] Smaller reporting company [X] Emerging growth company [  ]

 

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period of 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.

Class	Outstanding as of July 31, 2019
Common Stock, Par Value $0.10 per share	4,440,351 Shares

 

 

 

GUARANTY FEDERAL BANCSHARES, INC.
TABLE OF CONTENTS
			Page
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Condensed Consolidated Financial Statements (Unaudited):
	Condensed Consolidated Balance Sheets			3
	Condensed Consolidated Statements of Income			4
	Condensed Consolidated Statements of Comprehensive Income			5
	Condensed Consolidated Statements of Stockholders’ Equity			6
	Condensed Consolidated Statements of Cash Flows			8
	Notes to Condensed Consolidated Financial Statements			9
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations				35
Item 3. Quantitative and Qualitative Disclosures about Market Risk				43
Item 4. Controls and Procedures				44
PART II. OTHER INFORMATION
Item 1. Legal Proceedings			45
Item 1A. Risk factors			45
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds			45
Item 3. Defaults Upon Senior Securities			45
Item 4. Mine Safety Disclosures			45
Item 5. Other Information			45
Item 6. Exhibits			45
Signatures

 

 

 

		6/30/2019				12/31/2018
ASSETS
Cash and due from banks		$	4,169,211			$	5,818,955
Interest-bearing deposits in other financial institutions			48,856,560				28,302,687
Cash and cash equivalents			53,025,771				34,121,642
Interest-bearing time deposits at other financial institutions			250,000				250,000
Available-for-sale securities			95,031,221				86,266,197
Stock in Federal Home Loan Bank, at cost			3,157,500				5,387,200
Mortgage loans held for sale			1,914,419				1,516,849
Loans receivable, net of allowance for loan losses of June 30, 2019 - $7,670,666 - December 31, 2018 - $7,995,569			751,190,822				778,298,606
Accrued interest receivable			3,528,976				3,390,944
Prepaid expenses and other assets			10,749,882				6,261,159
Goodwill			1,434,982				1,434,982
Core deposit intangible			2,742,410				2,980,910
Foreclosed assets held for sale			1,399,221				1,126,963
Premises and equipment, net			19,735,644				20,095,161
Operating lease right-of-use asset			9,334,911				-
Bank owned life insurance			20,422,623				20,198,074
Deferred and income taxes receivable			3,525,426				3,809,183
		$	977,443,808			$	965,137,870
LIABILITIES AND STOCKHOLDERS' EQUITY
LIABILITIES
Deposits		$	802,477,539			$	749,618,822
Federal Home Loan Bank advances			50,000,000				105,300,000
Subordinated debentures			21,716,897				21,760,829
Note payable to bank			5,000,000				5,000,000
Advances from borrowers for taxes and insurance			525,667				289,808
Accrued expenses and other liabilities			3,652,629				1,868,008
Operating lease liability			9,364,989				-
Accrued interest payable			967,815				821,811
			893,705,536				884,659,278
COMMITMENTS AND CONTINGENCIES			-				-
STOCKHOLDERS' EQUITY
Capital Stock:
Common stock, $0.10 par value; authorized 10,000,000 shares; issued June 30, 2019 and December 31, 2018 - 6,912,003 and 6,902,003 shares; respectively			691,200				690,200
Additional paid-in capital			51,575,395				51,382,585
Retained earnings, substantially restricted			69,214,712				65,829,687
Accumulated other comprehensive loss			(676,225	)			(452,756	)
			120,805,082				117,449,716
Treasury stock, at cost; June 30, 2019 and December 31, 2018 - 2,442,774 and 2,443,522 shares, respectively			(37,066,810	)			(36,971,124	)
			83,738,272				80,478,592
		$	977,443,808			$	965,137,870

 

---

		Three months ended								Six months ended
		6/30/2019				6/30/2018				6/30/2019				6/30/2018
Interest Income
Loans		$	10,394,929			$	9,818,707			$	20,698,114			$	17,197,282
Investment securities			680,970				492,931				1,278,504				942,300
Other			223,608				67,487				419,325				195,859
			11,299,507				10,379,125				22,395,943				18,335,441
Interest Expense
Deposits			2,799,220				1,719,614				5,405,440				3,142,184
FHLB advances			288,710				405,817				645,286				739,344
Subordinated debentures			296,771				277,594				588,123				446,561
Other			64,451				3,833				132,021				3,833
			3,449,152				2,406,858				6,770,870				4,331,922
Net Interest Income			7,850,355				7,972,267				15,625,073				14,003,519
Provision for Loan Losses			100,000				500,000				100,000
Net Interest Income After Provision for Loan Losses			7,750,355				7,472,267				15,525,073				13,278,519
Noninterest Income
Service charges			418,938				552,011				820,770				869,177
Net gain (loss) on sale of investment securities			78,911				(10,388	)			48,263				(7,205	)
Gain on sale of mortgage loans held for sale			561,932				616,928				987,930				996,485
Gain on sale of Small Business Administration loans			247,457				225,379				497,576				396,241
Net gain on foreclosed assets			39,923				76,481				20,866				120,812
Other income			586,177				493,401				1,122,268				897,341
			1,933,338				1,953,812				3,497,673				3,272,851
Noninterest Expense
Salaries and employee benefits			3,952,870				4,101,741				7,912,190				7,275,165
Occupancy			1,106,812				1,037,665				2,240,175				1,808,072
FDIC deposit insurance premiums			118,093				116,837				217,628				195,135
Data processing			420,197				464,360				809,141				766,892
Advertising			150,000				134,650				300,000				265,900
Merger costs			22,055				3,192,050				38,651				3,420,050
Amortization of core deposit intangible			119,250				220,000				238,500				220,000
Other expense			937,206				955,334				1,913,757				1,747,278
			6,826,483				10,222,637				13,670,042				15,698,492
Income (Loss) Before Income Taxes			2,857,210				(796,558	)			5,352,704				852,878
Provision (Credit) for Income Taxes			428,711				(453,574	)			803,841				(159,883	)
Net Income (Loss) Available to Common Shareholders		$	2,428,499			$	(342,984	)		$	4,548,863			$	1,012,761
Basic Income (Loss) Per Common Share		$	0.55			$	(0.08	)		$	1.02			$	0.23
Diluted Income (Loss) Per Common Share		$	0.54			$	(0.08	)		$	1.01			$	0.23

 

---

		Three months ended								Six months ended
		6/30/2019				6/30/2018				6/30/2019				6/30/2018
NET INCOME (LOSS)		$	2,428,499			$	(342,984	)		$	4,548,863			$	1,012,761
OTHER ITEMS OF COMPREHENSIVE INCOME:
Change in unrealized gain (loss) on investment securities available-for-sale, before income taxes			1,147,130				(391,138	)			2,720,097				(1,689,930	)
Change in unrealized gain (loss) on interest rate swaps, before income taxes			(1,750,356	)			502,917				(2,842,843	)			1,768,729
Less: Reclassification adjustment for realized (gains) losses on investment securities included in net income, before income taxes			(78,911	)			10,388				(48,263	)			7,205
Total other items of comprehensive income			(682,137	)			122,167				(171,009	)			86,004
Income tax expense (benefit) related to other items of comprehensive income			(77,877	)			31,151				52,460				21,930
Other comprehensive income (loss)			(604,260	)			91,016				(223,469	)			64,074
TOTAL COMPREHENSIVE INCOME (LOSS)		$	1,824,239			$	(251,968	)		$	4,325,394			$	1,076,835

 

---

		Common Stock				Additional Paid- In Capital				Treasury Stock				Retained Earnings				Accumulated Other Comprehensive Loss				Total
Balance, January 1, 2019		$	690,200			$	51,382,585			$	(36,971,124	)		$	65,829,687			$	(452,756	)		$	80,478,592
Net income			-				-				-				2,120,364				-				2,120,364
Other comprehensive income			-				-				-				-				380,791				380,791
Dividends on common stock ($0.13 per share)			-				-				-				(582,817	)			-				(582,817	)
Stock award plans			-				(53,689	)			222,789				-				-				169,100
Stock options exercised			1,000				50,900				-				-				-				51,900
Balance, March 31, 2019			691,200				51,379,796				(36,748,335	)			67,367,234				(71,965	)			82,617,930
Net income			-				-				-				2,428,499				-				2,428,499
Other comprehensive loss			-				-				-				-				(604,260	)			(604,260	)
Dividends on common stock ($0.13 per share)			-				-				-				(581,021	)			-				(581,021	)
Treasury stock purchased			-				-				(312,892	)			-				-				(312,892	)
Stock award plans			-				195,599				(5,583	)			-				-				190,016
Balance, June 30, 2019		$	691,200			$	51,575,395			$	(37,066,810	)		$	69,214,712			$	(676,225	)		$	83,738,272

---

		Common Stock				Additional Paid- In Capital				Treasury Stock				Retained Earnings				Accumulated Other Comprehensive Loss				Total
Balance, January 1, 2018		$	687,850			$	50,856,069			$	(37,125,541	)		$	60,679,308			$	(206,193	)		$	74,891,493
Net income			-				-				-				1,355,745				-				1,355,745
Other comprehensive loss			-				-				-				-				(26,942	)			(26,942	)
Dividends on common stock ($0.12 per share)			-				-				-				(532,771	)			-				(532,771	)
Stock award plans			-				(35,357	)			158,592				-				-				123,235
Stock options exercised			450				23,330				-				-				-				23,780
Balance, March 31, 2018			688,300				50,844,042				(36,966,949	)			61,502,282				(233,135	)			75,834,540
Net income			-				-				-				(342,984	)			-				(342,984	)
Other comprehensive income			-				-				-				-				91,016				91,016
Dividends on common stock ($0.12 per share)			-				-				-				(534,272	)			-				(534,272	)
Stock award plans			-				161,235				-				-				-				161,235
Stock options exercised			750				37,900				-				-				-				38,650
Balance, June 30, 2018			689,050				51,043,177				(36,966,949	)			60,625,026				(142,119	)			75,248,185
Net income			-				-				-				3,934,242				-				3,934,242
Other comprehensive loss			-				-				-				-				(249,491	)			(249,491	)
Dividends on common stock ($0.12 per share)			-				-				-				(534,207	)			-				(534,207	)
Stock award plans			-				154,137				(8,079	)			-				-				146,058
Stock options exercised			500				69,400				-				-				-				69,900
Balance, September 30, 2018			689,550				51,266,714				(36,975,028	)			64,025,061				(391,610	)			78,614,687
Net income			-				-				-				2,384,876				-				2,384,876
Other comprehensive loss			-				-				-				-				(61,146	)			(61,146	)
Dividends on common stock ($0.13 per share)			-				-				-				(580,250	)			-				(580,250	)
Stock award plans			-				82,621				3,904				-				-				86,525
Stock options exercised			650				33,250				-				-				-				33,900
Balance, December 31, 2018		$	690,200			$	51,382,585			$	(36,971,124	)		$	65,829,687			$	(452,756	)		$	80,478,592

 

---

		6/30/2019				6/30/2018
CASH FLOWS FROM OPERATING ACTIVITIES
Net income		$	4,548,863			$	1,012,761
Items not requiring (providing) cash:
Deferred income taxes			135,813				(145,762	)
Depreciation			949,754				660,972
Lease amortization			30,078				-
Provision for loan losses			100,000				725,000
Gain on sale of Small Business Administration loans			(497,576	)			(396,241	)
Gain on sale of mortgage loans held for sale and investment securities			(1,036,193	)			(989,280	)
Gain on sale of foreclosed assets			(58,696	)			(141,477	)
Gain on sale of premises and equipment			(6,069	)			-
Amortization of deferred income, premiums and discounts			165,996				337,877
Stock award plan expense			359,116				284,470
Accretion of purchase accounting adjustments			(661,564	)			(234,792	)
Origination of loans held for sale			(36,450,979	)			(34,084,892	)
Proceeds from sale of loans held for sale			37,041,339				35,155,111
Increase in cash surrender value of bank owned life insurance			(224,549	)			(226,011	)
Changes in:
Accrued interest receivable			(138,032	)			(546,328	)
Prepaid expenses and other assets			(3,175,861	)			5,300,310
Accounts payable and accrued expenses			942,608				(1,530,909	)
Income taxes receivable/payable			95,484				(323,051	)
Net cash provided by operating activities			2,119,532				4,857,758
CASH FLOWS FROM INVESTING ACTIVITIES
Proceeds from sale of loans			5,187,953				5,273,649
Net change in loans			22,453,757				(4,240,878	)
Principal payments on available-for-sale securities			2,893,736				1,139,659
Principal payments on held-to-maturity securities			11,661				2,347
Purchase of premises and equipment			(584,168	)			(2,294,704	)
Net cash received for acquisition			-				2,455,964
Purchase of available-for-sale securities			(38,383,889	)			(9,788,468	)
Proceeds from sale of available-for-sale securities			29,255,408				6,497,699
Redemption (purchase) of FHLB stock			2,229,700				(193,700	)
Purchase of tax credit investments			(3,168,435	)			(452,171	)
Proceeds from sale of foreclosed assets held for sale			487,244				142,193
Net cash provided by (used in) investing activities			20,382,967				(1,458,410	)
CASH FLOWS FROM FINANCING ACTIVITIES
Cash dividends paid			(1,163,091	)			(1,063,744	)
Net increase in demand deposits, NOW accounts and savings accounts			52,638,121				1,507,491
Net increase (decrease) in certificates of deposit			251,733				(5,276,741	)
Net decrease of securities sold under agreements to repurchase			-				(2,159,000	)
Proceeds from FHLB advances			74,565,000				336,550,000
Repayments of FHLB advances			(129,865,000	)			(342,450,000	)
Proceeds from issuance of notes payable			-				5,000,000
Repayments of notes payable			-				(3,000,000	)
Advances from borrowers for taxes and insurance			235,859				380,533
Stock options exercised			51,900				62,430
Treasury stock purchased			(312,892	)			-
Net cash used in financing activities			(3,598,370	)			(10,449,031	)
INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS			18,904,129				(7,049,683	)
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD			34,121,642				37,406,930
CASH AND CASH EQUIVALENTS, END OF PERIOD		$	53,025,771			$	30,357,247

---

 

Note 1: Basis of Presentation

 

The accompanying unaudited interim condensed consolidated financial statements have been prepared in accordance with generally accepted accounting principles (GAAP) for interim financial information and with the instructions to Form 10-Q and Rule 8-03 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by GAAP for complete financial statements. In the opinion of management, all adjustments (consisting only of normal recurring accruals) considered necessary for a fair presentation have been included.

 

These condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and notes thereto included in Guaranty Federal Bancshares, Inc.’s (the “Company”) Annual Report on Form 10-K for the year ended December 31, 2018 (“2018 Annual Report”) filed with the Securities and Exchange Commission (the “SEC”). The results of operations for the periods are not necessarily indicative of the results to be expected for the full year. The condensed consolidated balance sheet of the Company as of December 31, 2018, has been derived from the audited consolidated balance sheet of the Company as of that date. Certain information and note disclosures normally included in the Company’s annual financial statements prepared in accordance with GAAP have been condensed or omitted.

 

 

Note 2: Principles of Consolidation

 

The accompanying condensed consolidated financial statements include the accounts of the Company and its wholly owned subsidiary, Guaranty Bank (the “Bank”). All significant intercompany transactions and balances have been eliminated in consolidation.

 

 

Note 3: Acquisition

 

On April 2, 2018, the Company completed the acquisition of Carthage, Missouri-based Hometown Bancshares, Inc. (“Hometown”), including its wholly owned bank subsidiary, Hometown Bank, National Association. Under the terms of the Agreement and Plan of Merger, each share of Hometown common stock was exchanged for $20.00 in cash and the transaction was valued at approximately $4.6 million. Hometown’s subsidiary bank, Hometown Bank, National Association, was merged into Guaranty Bank on June 8, 2018.

 

Including the effects of the acquisition method accounting adjustments, the Company acquired approximately $178.8 million in assets, including approximately $143.9 million in loans (inclusive of loan discounts) and approximately $161.2 million in deposits. Goodwill of $1.4 million was recorded as a result of the transaction. The merger strengthened the Company’s position in Southwest Missouri and the Company believes it will be able to achieve cost savings by integrating the two companies and combining accounting, data processing, and other administrative functions all of which gave rise to the goodwill recorded. The goodwill will not be deductible for tax purposes.

 

 

A summary, at fair value, of the assets acquired and liabilities assumed in the Hometown transaction, as of acquisition date, is as follows:

 

Guaranty Federal Bancshares, Inc.

Net Assets Acquired from Hometown

April 2, 2018

(In Thousands)

 

 

 

The following is a description of the methods used to determine the fair values of significant assets and liabilities presented in the acquisitions above. The purchase price allocation and certain fair value measurements have been finalized.

 

Cash and due from banks – The carrying amount of these assets is a reasonable estimate of fair value based on the short-term nature of these assets.

 

Investment securities – Investment securities were acquired with an adjustment to fair value based upon quoted market prices if material. Otherwise, the carrying amount of these assets was deemed to be a reasonable estimate of fair value.

 

Loans acquired – Fair values for loans were based on a discounted cash flow methodology that considered factors including the type of loan and related collateral, classification status, fixed or variable interest rate, term of loan and whether or not the loan was amortizing, and current discount rates. The discount rates used for loans are based on current market rates for new originations of comparable loans and include adjustments for liquidity concerns. The discount rate does not include a factor for credit losses as that has been included in the estimated cash flows. Loans were grouped together according to similar characteristics and were treated in the aggregate when applying various valuation techniques.

 

Fixed assets – Fixed assets were acquired with an adjustment to fair value, which represents the difference between the Company’s current analysis of property and equipment values completed in connection with the acquisition and book value acquired.

 

Foreclosed assets held for sale – These assets are presented at the estimated present values that management expects to receive when the properties are sold, net of related costs of disposal.

 

Core deposit intangible – This intangible asset represents the value of the relationships that Hometown had with its deposit customers. The fair value of this intangible asset was estimated based on a discounted cash flow methodology that gave appropriate consideration to expected customer attrition rates, cost of the deposit base and the net maintenance cost attributable to customer deposits.

 

Other assets – The fair value adjustment results from recording additional deferred tax assets related to the transaction. Otherwise, the carrying amount of these assets was deemed to be a reasonable estimate of fair value.

 

Deposits – The fair values used for the demand and savings deposits that comprise the transaction accounts acquired, by definition equal the amount payable on demand at the acquisition date. The Company performed a fair value analysis of the estimated weighted average interest rate of the certificates of deposits compared to the current market rates and recorded a fair value adjustment for the difference when material.

 

Federal Home Loan Bank advances and Other borrowings – The fair value of Federal Home Loan Bank advances and other borrowings are estimated based on borrowing rates currently available to the Company for borrowings with similar terms and maturities.

 

Securities sold under agreement to repurchase – The carrying amount of securities sold under agreement to repurchase is a reasonable estimate of fair value based on the short-term nature of these liabilities.

 

Subordinated debentures – The fair value of subordinated debentures is estimated based on borrowing rates currently available to the Company for borrowings with similar terms and maturities.

 

Other liabilities – The carrying amount of these other liabilities was deemed to be reasonable estimate of fair value.

 

 

 

Note 4: Securities

 

The amortized cost and approximate fair values of securities classified as available-for-sale were as follows:

 

 

 

Maturities of available-for-sale debt securities as of June 30, 2019:

 

 

The book value of securities pledged as collateral, to secure public deposits and for other purposes, amounted to $6,292,193 and $24,943,176 as of June 30, 2019 and December 31, 2018, respectively. The approximate fair value of pledged securities amounted to $6,371,216 and $24,374,187 as of June 30, 2019 and December 31, 2018, respectively.

 

Realized gains and losses are recorded as net securities gains. Gains and losses on sales of securities are determined on the specific identification method. Gross gains of $172,327 and $3,183 and gross losses of $124,064 and $10,388 for the six months ended June 30, 2019 and June 30, 2018, respectively, were realized from the sale of available-for-sale securities. The tax effect of these net gains and losses was $10,135 and ($1,837) for the six months ended June 30, 2019 and June 30, 2018, respectively.

 

 

The Company evaluates all securities quarterly to determine if any unrealized losses are deemed to be other than temporary. Certain investment securities are valued at less than their historical cost. These declines are primarily the result of the rate for these investments yielding less than current market rates, or declines in stock prices of equity securities. Based on evaluation of available evidence, management believes the declines in fair value for these securities are temporary. It is management’s intent to hold the debt securities to maturity or until recovery of the unrealized loss. Should the impairment of any of these debt securities become other than temporary, the cost basis of the investment will be reduced and the resulting loss recognized in net income in the period the other-than-temporary impairment is identified, to the extent the loss is related to credit issues, and to other comprehensive income to the extent the decline on debt securities is related to other factors and the Company does not intend to sell the security prior to recovery of the unrealized loss.

     

Certain investments in debt and equity securities are reported in the financial statements at an amount less than their historical cost. Total fair value of these investments at June 30, 2019 and December 31, 2018, was $25,714,110 and $70,434,596, respectively, which is approximately 27% and 82% of the Company’s investment portfolio.

 

The following table shows gross unrealized losses and fair value, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position at June 30, 2019 and December 31, 2018.

 

 

 

 

 

Note 5: Loans and Allowance for Loan Losses

 

Categories of loans at June 30, 2019 and December 31, 2018 include:

 

 

Classes of loans by aging at June 30, 2019 and December 31, 2018 were as follows:

 

 

 

 

 

Nonaccruing loans are summarized as follows:

 

 

The following tables present the activity in the allowance for loan losses based on portfolio segment for the three and six months ended June 30, 2019 and 2018:

 

 

 

 

 

 

The following tables present the recorded investment in loans based on portfolio segment and impairment method as of June 30, 2019 and December 31, 2018:

 

 

 

 

The allowance for loan losses is established as losses are estimated to have occurred through a provision for loan losses charged to income. Loan losses are charged against the allowance when management believes the uncollectability of a loan balance is confirmed. Subsequent recoveries, if any, are credited to the allowance.

 

The allowance for loan losses is evaluated on a regular basis by management and is based upon management’s periodic review of the collectability of the loans in light of historical experience, the nature and volume of the loan portfolio, adverse situations that may affect the borrower’s ability to repay, estimated value of any underlying collateral and prevailing economic conditions. This evaluation is inherently subjective as it requires estimates that are susceptible to significant revision as more information becomes available.

 

The allowance consists of allocated and general components. The allocated component relates to loans that are classified as impaired. For those loans that are classified as impaired, an allowance is established when the discounted cash flows or collateral value of the impaired loan is lower than the carrying value of that loan. The general component covers nonclassified loans and is based on historical charge-off experience and expected loss given default derived from the Bank’s internal risk rating process. Other adjustments may be made to the allowance for pools of loans after an assessment of internal or external influences on credit quality that are not fully reflected in the historical loss or risk rating data.

 

Included in the Company’s loan portfolio are certain loans acquired in accordance with ASC 310-30, Loans and Debt Securities Acquired with Deteriorated Credit Quality. These loans were written down at acquisition to an amount estimated to be collectible. As a result, certain ratios regarding the Company’s loan portfolio and credit quality cannot be used to compare the Company to peer companies or to compare the Company’s current credit quality to prior periods. The ratios particularly affected by accounting under ASC 310-30 include the allowance for loan losses as a percentage of loans, nonaccrual loans, and performing assets, and nonaccrual loans and nonperforming loans as a percentage of total loans.

 

A loan is considered impaired when, based on current information and events, it is probable that the Bank will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement. 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. Impairment is measured on a loan-by-loan basis by either the present value of expected future cash flows discounted at the loan’s effective interest rate, the loan’s obtainable market price or the fair value of the collateral if the loan is collateral dependent.

 

 

Groups of loans with similar risk characteristics are collectively evaluated for impairment based on the group’s historical loss experience adjusted for changes in trends, conditions and other relevant factors that affect repayment of the loans.    

 

The following table summarizes the recorded investment in impaired loans at June 30, 2019 and December 31, 2018:

 

 

 

The following table summarizes average impaired loans and related interest recognized on impaired loans for the six months ended June 30, 2019 and 2018:

 

 

At June 30, 2019, the Bank’s impaired loans shown in the table above included loans that were classified as troubled debt restructurings (“TDR”). The restructuring of a loan is considered a TDR if both (i) the borrower is experiencing financial difficulties and (ii) the creditor has granted a concession.

 

In assessing whether or not a borrower is experiencing financial difficulties, the Bank considers information currently available regarding the financial condition of the borrower. This information includes, but is not limited to, whether (i) the debtor is currently in payment default on any of its debt; (ii) a payment default is probable in the foreseeable future without the modification; (iii) the debtor has declared or is in the process of declaring bankruptcy and (iv) the debtor’s projected cash flow is sufficient to satisfy the contractual payments due under the original terms of the loan without a modification.

 

The Bank considers all aspects of the modification to loan terms to determine whether or not a concession has been granted to the borrower. Key factors considered by the Bank include the debtor’s ability to access funds at a market rate for debt with similar risk characteristics, the significance of the modification relative to unpaid principal balance or collateral value of the debt, and the significance of a delay in the timing of payments relative to the original contractual terms of the loan. The most common concessions granted by the Bank generally include one or more modifications to the terms of the debt, such as (i) a reduction in the interest rate for the remaining life of the debt, (ii) an extension of the maturity date at an interest rate lower than the current market rate for new debt with similar risk, (iii) a reduction on the face amount or maturity amount of the debt as stated in the original loan, (iv) a temporary period of interest-only payments, (v) a reduction in accrued interest, and (vi) an extension of amortization.

 

 

The following table presents the carrying balance of TDRs as of June 30, 2019 and December 31, 2018:

 

 

The Bank has allocated $949,930 and $901,086 of specific reserves to customers whose loan terms have been modified in TDR as of June 30, 2019 and December 31, 2018, respectively.

 

There were no TDRs for which there was a payment default within twelve months following the modification during the three months ending June 30, 2019 and 2018. A loan is considered to be in payment default once it is 90 days contractually past due under the modified terms.

 

As part of the on-going monitoring of the credit quality of the Bank’s loan portfolio, management tracks loans by an internal rating system. All loans are assigned an internal credit quality rating based on an analysis of the borrower’s financial condition. The criteria used to assign quality ratings to extensions of credit that exhibit potential problems or well-defined weaknesses are primarily based upon the degree of risk and the likelihood of orderly repayment, and their effect on the Bank’s safety and soundness. The following are the internally assigned ratings:

 

Pass: This rating represents loans that have strong asset quality and liquidity along with a multi-year track record of profitability.

 

Special mention: This rating represents loans that are currently protected but are potentially weak. The credit risk may be relatively minor, yet constitute an increased risk in light of the circumstances surrounding a specific loan.

 

Substandard: This rating represents loans that show signs of continuing negative financial trends and unprofitability and therefore, is inadequately protected by the current sound worth and paying capacity of the obligor or of the collateral pledged, if any.

 

Doubtful: This rating represents loans that have all the weaknesses of substandard classified loans with the additional characteristic that the weaknesses make collection or liquidation in full, on the basis of currently existing facts, conditions and values, highly questionable and improbable.

 

Risk characteristics applicable to each segment of the loan portfolio are described as follows.

 

Real estate-Residential 1-4 family: The residential 1-4 family real estate loans are generally secured by owner-occupied 1-4 family residences. Repayment of these loans is primarily dependent on the personal income and credit rating of the borrowers. Credit risk in these loans can be impacted by economic conditions within the Bank’s market areas that might impact either property values or a borrower’s personal income. Risk is mitigated by the fact that the loans are of smaller individual amounts and spread over a large number of borrowers.

 

 

Real estate-Construction: Construction and land development real estate loans are usually based upon estimates of costs and estimated value of the completed project and include independent appraisal reviews and a financial analysis of the developers and property owners. Sources of repayment of these loans may include permanent loans, sales of developed property or an interim loan commitment from the Bank until permanent financing is obtained. These loans are considered to be higher risk than other real estate loans due to their ultimate repayment being sensitive to interest rate changes, general economic conditions and the availability of long-term financing. Credit risk in these loans may be impacted by the creditworthiness of a borrower, property values and the local economies in the Bank’s market areas.

 

Real estate-Commercial: Commercial real estate loans typically involve larger principal amounts, and repayment of these loans is generally dependent on the successful operations of the property securing the loan or the business conducted on the property securing the loan. These loans are viewed primarily as cash flow loans and secondarily as loans secured by real estate. Credit risk in these loans may be impacted by the creditworthiness of a borrower, property values and the local economies in the Bank’s market areas.

 

Commercial: The commercial portfolio includes loans to commercial customers for use in financing working capital needs, equipment purchases and expansions. The loans in this category are repaid primarily from the cash flow of a borrower’s principal business operation. Credit risk in these loans is driven by creditworthiness of a borrower and the economic conditions that impact the cash flow stability from business operations.

 

Consumer: The consumer loan portfolio consists of various term and line of credit loans such as automobile loans and loans for other personal purposes. Repayment for these types of loans will come from a borrower’s income sources that are typically independent of the loan purpose. Credit risk is driven by consumer economic factors (such as unemployment and general economic conditions in the Bank’s market area) and the creditworthiness of a borrower.

 

The following tables provide information about the credit quality of the loan portfolio using the Bank’s internal rating system as of June 30, 2019 and December 31, 2018:

 

 

 

The above amounts include purchased credit impaired loans. At June 30, 2019, purchased credit impaired loans comprised of $3.1 million were rated “Substandard”.

 

 

For loans amortized at cost, interest income is accrued based on the unpaid principal balance. Loan origination fees net of certain direct origination costs, are deferred and amortized as a level yield adjustment over the respective term of the loan.

 

The accrual of interest on loans is discontinued at the time the loan is 90 days past due unless the loan is well-secured and in process of collection. Past due status is based on contractual terms of the loan. In all cases, loans are placed on nonaccrual or charged off at an earlier date if collection of principal or interest is considered doubtful.

 

All interest accrued but not collected for loans that are placed on nonaccrual or charged off is reversed against interest income. The interest on these loans is accounted for on the cash-basis or cost-recovery method, until qualifying for return to accrual. Loans are returned to accrual status when all the principal and interest amounts contractually due are brought current and future payments are reasonably assured.