UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q

 

x

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

 

For the quarterly period ended: September 30, 2016

 

OR

 

¨

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

 

Commission file number:    333-191004   

 

Citizens Independent Bancorp, Inc.

(Exact name of registrant as specified in its charter)

 

Ohio		31-1441050
(State or other jurisdiction of		(I.R.S. Employer Identification Number)
incorporation or organization)

 

188 West Main Street, Logan Ohio		43138
(Address of principal executive offices)		Zip Code

 

	(740) 385-8561
(Registrant’s telephone number, including area code)
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 x         No ¨

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).

 

Yes x         No ¨

 

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

 

Large accelerated filers   ¨ Accelerated filer ¨ Non-accelerated filer ¨ Smaller reporting company x

 

Indicate by check mark whether the registrant is a shell company (as defined in Exchange Act Rule 12b-2).

 

Yes ¨         No x

 

As of November 10, 2016, the latest practicable date, 691,287 shares of the registrant’s no par value common stock were outstanding.

 

 

CITIZENS INDEPENDENT BANCORP, INC.

FORM 10-Q

For the Nine Month Periods Ended September 30, 2016 and 2015

 

Table of Contents

 

	Page
PART I – FINANCIAL INFORMATION	3
ITEM 1 – Financial Statements	3
Consolidated Balance Sheets as of September 30, 2016 (unaudited) and December 31, 2015	3
Consolidated Statements of Income (unaudited) for the three and nine month periods ended September 30, 2016 and 2015	4
Consolidated Statements of Comprehensive Income (unaudited) for the three and nine month periods ended September 30, 2016 and 2015	5
Condensed Consolidated Statements of Changes in Shareholders’ Equity (unaudited) for the nine month periods ended September 30, 2016 and 2015	6
Consolidated Statements of Cash Flows (unaudited) for the nine month periods ended September 30, 2016 and 2015	7
Notes to the Consolidated Financial Statements	8
ITEM 2 - Management’s Discussion and Analysis of Financial Condition and Results of Operations	26
ITEM 3 - Quantitative and Qualitative Disclosures about Market Risk	37
ITEM 4 – Controls and Procedures	37
PART II – OTHER INFORMATION	38
ITEM 1 - Legal Proceedings	38
ITEM 1A – Risk Factors	38
ITEM 2 - Unregistered Sales of Equity Securities and Use of Proceeds	38
ITEM 3 - Defaults upon Senior Securities	38
ITEM 4 - Mine Safety Disclosures	38
ITEM 5 - Other Information	38
ITEM 6 - Exhibits	38
SIGNATURES	40

 

PART I – FINANCIAL INFORMATION

Item 1 – Financial Statements

 

CITIZENS INDEPENDENT BANCORP, INC.

Logan, Ohio

CONSOLIDATED BALANCE SHEETS

 

		(Dollars in thousands)
		(unaudited)
		September 30, 2016				December 31, 2015
ASSETS
Cash and cash equivalents
Cash and amounts due from depository institutions		$	3,741			$	5,307
Federal funds sold			6,300				4,064
Total cash and cash equivalents			10,041				9,371
Securities available for sale			9,029				14,013
Other investment securities			859				859
Loans held for sale			229				-
Loans			149,889				149,231
Allowance for loan losses			(1,954	)			(2,078	)
Net loans			147,935				147,153
Premises and equipment, net			3,776				2,977
Accrued interest receivable			277				285
Other real estate owned			22				238
Other assets			8,752				8,899
TOTAL ASSETS		$	180,920			$	183,795
LIABILITIES
Deposits
Noninterest bearing		$	31,859			$	26,116
Interest bearing			126,463				136,209
Total deposits			158,322				162,325
Borrowed funds			2,203				2,569
Accrued interest payable			560				759
Other liabilities			926				783
TOTAL LIABILITIES			162,011				166,436
SHAREHOLDERS’ EQUITY
Cumulative preferred stock of no par value; 100,000 shares authorized, 0 shares issued and outstanding			-				-
Common stock of no par value; 2,000,000 shares  authorized, 745,667 shares issued and 691,287 shares outstanding at September 30, 2016 and 721,998 shares issued and 667,618 shares outstanding at December 31, 2015			14,964				14,296
Common stock warrants outstanding; 0 warrants issued and outstanding as of September 30, 2016 and 119,003 warrants issued and 67,985 outstanding at December 31, 2015			-				108
Retained earnings			10,924				10,112
Treasury stock, at cost, 54,380 shares at September 30, 2016  and December 31, 2015, respectively			(6,590	)			(6,590	)
Accumulated other comprehensive income (loss)			(389	)			(567	)
TOTAL SHAREHOLDERS’ EQUITY			18,909				17,359
TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY		$	180,920			$	183,795

 

See notes to consolidated financial statements

 

 

CITIZENS INDEPENDENT BANCORP, INC.

Logan, Ohio

CONSOLIDATED STATEMENTS OF INCOME

(Unaudited)

 

		(Dollars in thousands, except per share data)
		Three Months Ended								Nine Months Ended
		September 30,								September 30,
		2016				2015				2016				2015
INTEREST INCOME
Interest and fees on loans		$	1,940			$	1,953			$	5,817			$	5,788
Interest and dividends on investment securities			52				80				150				313
Interest on federal funds sold			9				8				26				21
TOTAL INTEREST INCOME			2,001				2,041				5,993				6,122
INTEREST EXPENSE
Interest on deposits			174				219				523				691
Interest on borrowed funds			31				84				100				274
TOTAL INTEREST EXPENSE			205				303				623				965
NET INTEREST INCOME			1,796				1,738				5,370				5,157
Provision for loan losses			-				-				-				-
NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES			1,796				1,738				5,370				5,157
NONINTEREST INCOME
Service charges			103				124				300				311
Net gain on sale of securities			-				20				15				168
Net gain on sale of loans			13				-				24				-
Net gain (loss) on sale of other real estate owned			47				255				213				211
Credit card income and fees			91				88				268				261
Other			83				111				296				235
TOTAL NONINTEREST INCOME			337				598				1,116				1,186
NONINTEREST EXPENSE
Salaries and employee benefits			786				792				2,450				2,367
Net occupancy and equipment expense			201				219				629				695
Other real estate owned expense			10				32				83				92
FDIC insurance expense			39				56				157				182
Legal and professional fees			60				235				289				433
Data processing			93				86				274				273
Advertising			35				56				144				153
Examinations and audits			58				81				222				237
Directors fees			54				60				165				171
Other operating expenses			307				475				977				1,157
TOTAL NONINTEREST EXPENSE			1,643				2,092				5,390				5,760
INCOME BEFORE INCOME TAXES			490				244				1,096				583
Income tax expense			144				67				284				155
NET INCOME		$	346			$	177			$	812			$	428
Basic earnings per common share		$	0.50			$	0.27			$	1.20			$	0.67
Diluted earnings per common share		$	0.50			$	0.26			$	1.20			$	0.66

 

See notes to consolidated financial statements

 

 

CITIZENS INDEPENDENT BANCORP, INC.

Logan, Ohio

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(Unaudited)

 

		(Dollars in thousands)
		Three Months Ended
		September 30,
		2016				2015
Net income		$	346			$	177
Other comprehensive income (loss), net of tax:
Unrealized net holding gain (loss) on securities available for sale, net of income tax of $44 and $36 for the three month periods ended September 30, 2016 and 2015, respectively			86				69
Reclassification for gain recognized on sale of securities available for sale, net of income tax of $0 and $7 for the three month periods ended September 30, 2016 and 2015, respectively			-				(13	)
Other comprehensive income (loss)			86				56
Comprehensive income		$	432			$	233

 

		Nine Months Ended
		September 30,
		2016				2015
Net income		$	812			$	428
Other comprehensive income (loss), net of tax:
Unrealized net holding gain (loss) on securities available for sale, net of income tax of $97 and $56 for the nine month periods ended September 30, 2016 and 2015, respectively			188				108
Reclassification for gain recognized on sale of securities available for sale, net of income tax of $5 and $57 for the nine month periods ended September 30, 2016 and 2015, respectively			(10	)			(111	)
Other comprehensive income (loss)			178				(3	)
Comprehensive income		$	990			$	425

 

See notes to consolidated financial statements

 

CITIZENS INDEPENDENT BANCORP, INC.

Logan, Ohio

CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY

(Unaudited)

 

		(Dollars in thousands)
		Nine Months Ended
		September 30,
		2016				2015
Balance at beginning of period		$	17,359			$	14,837
Exercise of common stock warrants - 23,669 shares in 2016 and 49,145 shares in 2015			560				1,124
Issuance of common stock - 0 shares in 2016 and 33,175 shares  in 2015			-				771
Issuance of common stock warrants - 119,003 warrants in 2014			-				-
Net income			812				428
Other comprehensive income (loss)			178				(3	)
Balance at end of period		$	18,909			$	17,157

 

See notes to consolidated financial statements

 

CITIZENS INDEPENDENT BANCORP, INC.

Logan, Ohio

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

 

		(Dollars in thousands)
		Nine Months Ended
		September 30,
		2016				2015
CASH FLOWS FROM OPERATING ACTIVITIES
Net income			812				428
Adjustment to reconcile net income to net cash provided by (used in) operating activities
Depreciation and amortization			232				217
Deferred income taxes			283				155
Investment securities amortization (accretion), net			38				104
Provision for loss on other real estate owned			15				-
Change in cash surrender value of bank owned life insurance			(83	)			(11	)
Net (gain) loss on sale of other real estate owned			(213	)			(211	)
Net (gain) loss on sale of investment securities			(15	)			(168	)
Net (gain) loss on sale of substandard loans			(56	)			-
Net (gain) loss on disposition of premises and equipment			67				29
Net (gain) on sale of loans			(24	)			-
Proceeds from sale of loans			1,592				-
Loans originated for sale			(1,797	)			-
Net change in:
Accrued interest receivable			8				(9	)
Accrued interest payable			(199	)			(421	)
Other assets			(145	)			(58	)
Other liabilities			143				303
Net cash provided by (used in) operating activities			658				358
CASH FLOWS FROM INVESTING ACTIVITIES
Purchases of available for sale securities			(1,000	)			(3,084	)
Proceeds from maturities of available for sale securities			2,191				2,928
Proceeds from sale of available for sale securities			4,040				14,418
Proceeds from sale of substandard loans			651				-
Purchase of bank owned life insurance			-				(3,000	)
Net change in loans			(1,399	)			(1,983	)
Proceeds from sale of other real estate owned			436				1,053
Purchases for construction of new brance			(868	)			-
Purchases of premises and equipment			(230	)			(114	)
Net cash provided by (used in) investing activities			3,821				10,218
CASH FLOWS FROM FINANCING ACTIVITIES
Net change in deposits			(4,003	)			(9,840	)
Payments on borrowed funds			(366	)			(1,238	)
Proceeds from issuance of common stock and warrants			560				1,238
Net cash provided by (used in) financing activities			(3,809	)			(9,840	)
Net increase in cash and cash equivalents			670				736
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD			9,371				16,633
CASH AND CASH EQUIVALENTS AT END OF PERIOD		$	10,041			$	17,369
Supplemental Disclosure of Cash Flows
Cash paid during the period for:
Interest		$	822			$	1,386
Supplemental Schedule of Noncash Investing and Financing Activities
Transfer of loans to other real estate owned		$	22			$	150
Short term debt converted to common stock		$	-			$	656

 

See notes to consolidated financial statements

 

CITIZENS INDEPENDENT BANCORP, INC.

 

LOGAN, OHIO

Notes to the Consolidated Financial Statements

 

NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

 

Nature of Operations

Citizens Independent Bancorp, Inc. (the Bancorp), a bank holding company for The Citizens Bank of Logan (the Bank), collectively referred to as the “Company” is engaged in the business of commercial and retail banking services with operations conducted through offices in Hocking and Athens Counties, Ohio. These communities and surrounding areas are the source of substantially all the Company’s deposit and loan activities. Secured loans are secured by business assets, consumer assets, residential real estate, and non-residential real estate. The majority of Company income is derived from commercial, real estate, and retail lending activities and investments. Other financial instruments, which potentially represent concentrations of credit risk include deposit accounts in other financial institutions and federal funds sold.

 

In October 2012, the Bank entered into publicly available Consent Orders with the Federal Deposit Insurance Corporation (FDIC) and the Ohio Division of Financial Institutions (DFI) (collectively referred to as the Orders), which required the Bank to take a number of actions. In October 2015, the Orders were lifted and the Bank entered into a Memorandum of Understanding (MOU) with the FDIC and DFI. Significant among the ongoing required actions was the development of a capital plan resulting in the Bank meeting and maintaining its level of Tier 1 capital as a percentage of its total assets at a minimum of 8.00% and its level of qualifying total capital as a percentage of risk-weighted assets at a minimum of 11.50%. The Bank was also required to obtain approval from the FDIC and DFI prior to the payment of any dividends. In August 2016, both the FDIC and the DFI released the Bank from the MOU without restriction. The Bank is no longer required to seek prior approval of any dividends.

 

On July 5, 2011, the Bancorp entered into a memorandum of understanding (the FRB 2011 MOU) with the Federal Reserve Bank of Cleveland (the FRB). The FRB 2011 MOU prohibited the Bancorp, without prior approval of the FRB, from: declaring or paying cash dividends, taking dividends or any other form of payment representing a reduction in the Bank’s capital, incurring, increasing, or guaranteeing any debt, or purchasing or redeeming any shares. On August 18, 2016 the FRB released the Bancorp from the 2011 MOU without restriction. Bancorp may declare and pay cash dividends, take dividends or any other form of payment representing a reduction in the Bank’s capital, incur, increase, or guarantee any debt, or purchase or redeem any shares as approved by the board of directors without prior approval of the FRB.

 

Basis of Financial Statement Presentation

These consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (GAAP) for interim financial information and with instructions to Form 10-Q and Article 8 of Regulation S-X.  Accordingly, they do not include all of the information and footnotes required by GAAP for annual year-end financial statements. In the opinion of management, all adjustments considered necessary for a fair presentation, have been included and are of a normal, recurring nature. Operating results for the nine month period ended September 30, 2016 are not necessarily indicative of the results that may be expected for the year ending December 31, 2016.

 

The accounting and reporting policies of the Bancorp and the Bank conform to GAAP and to general practices followed within the banking industry.

 

The consolidated balance sheet as of December 31, 2015 has been extracted from audited financial statements included in the Company’s 2015 filing on Form 10-K. Certain information and footnote disclosures normally included in financial statements prepared in accordance with GAAP have been omitted. These financial statements should be read in conjunction with the financial statements and notes thereto included in the Company’s December 31, 2015 Form 10-K.

 

 

Information is presented in these notes with dollars expressed in thousands, unless otherwise noted or specified.

 

Principles of Consolidation

The consolidated financial statements include the accounts of Citizens Independent Bancorp, Inc. and its wholly-owned subsidiary, The Citizens Bank of Logan. All significant intercompany transactions and balances have been eliminated.

 

Common Stock Warrants

In June 2014, the Company issued warrants to purchase 119,003 shares of common stock in connection with the issuance of common stock in the stock offering campaign. These warrants entitled the holder to purchase the Company’s common stock at 90% of the prior month’s closing book value. Valid for a period of two years, the warrants expired June 25, 2016. Allocated value of these common stock warrants was based on the Black Scholes methodology. A total of 74,687 of the 119,003 total warrants issued were exercised.

 

Recent Accounting Pronouncements

In May 2014, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) No. 2014-09, “Revenue from Contracts with Customers (Topic 606).” The core principle of the guidance is that an entity 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. The core principle will be achieved using a five step process. In August 2015, the FASB issued ASU No. 2015-14, “Revenue from Contracts with Customers (Topic 606)” which amends the effective date for the Company from January 1, 2017 to January 1, 2018. The adoptions of ASU No. 2014-09 and ASU No. 2015-14 are not expected to have a material impact on the Company’s consolidated financial statements.

 

In February 2016, the FASB issued ASU No. 2016-02, “Leases (Topic 842).” This standard requires organizations to recognize lease assets and lease liabilities on the balance sheet and disclose key information about leasing requirements for leases that were historically classified as operating leases under previous generally accepted accounting principles. This ASU will become effective for the Company for interim and annual periods on January 1, 2019. Management is currently evaluating the potential impact of ASU No. 2016-02 on the Company’s consolidated financial statements.

 

In June 2016, the FASB issued ASU No. 2016-13, “Financial Instruments - Credit Losses: Measurement of Credit Losses on Financial Instruments (Topic 326).” This standard replaces the incurred loss impairment methodology in current GAAP with a methodology that reflects expected credit losses and requires consideration of a broader range of reasonable and supportable information to inform credit loss estimates. The amendments in this update require a financial asset (or a group of financial assets) measured at amortized cost basis to be presented at the net amount expected to be collected. The new Current Expected Credit Losses model (CECL) will apply to the allowance for loan losses, available-for-sale and held to maturity debt securities, purchased financial assets with credit deterioration, and certain off-balance sheet credit exposures. Entities will apply the standard’s provisions as a cumulative-effect adjustment to retained earnings as of the beginning of the first reporting period in which the guidance is effective. This ASU will become effective for the Company for interim and annual periods on January 1, 2020. Management is currently evaluating the potential impact of ASU No. 2016-13 on the Company’s consolidated financial statements.

 

NOTE 2 - EARNINGS PER COMMON SHARE

 

Earnings per common share are net income available to common shareholders divided by the weighted average common shares outstanding during the period. The factors used in the earnings per share computation for the three and nine month periods ended September 30, 2016 and 2015 follow: 

 

 

		(Dollars in thousands, except per share data)
		Three Months Ended
		September 30,
		2016				2015
Net income		$	346			$	177
Weighted average common shares outstanding			691,287				663,521
Basic earnings per common share		$	0.50			$	0.27
Total shares and warrants			691,287				670,680
Diluted earnings per common share		$	0.50			$	0.26

 

		Nine Months Ended
		September 30,
		2016				2015
Net income		$	812			$	428
Weighted average common shares outstanding			679,673				638,807
Basic earnings per common share		$	1.20			$	0.67
Total shares and warrants			679,673				647,751
Diluted earnings per common share		$	1.20			$	0.66

 

NOTE 3 - INVESTMENT SECURITIES

 

The amortized cost of securities and their approximate fair values are as follows:

 

		(Dollars in thousands)
		September 30, 2016																December 31, 2015
		Amortized Cost				Gross Unrealized Gains				Gross Unrealized Losses				Fair Value				Amortized Cost				Gross Unrealized Gains				Gross Unrealized Losses				Fair Value
U.S. government securities		$	-			$	-			$	-			$	-			$	1,005			$	-			$	-			$	1,005
U.S. government federal agencies			2,242				6				-				2,248				6,571				3				(39	)			6,535
State and local governments			2,763				164				-				2,927				1,774				9				-				1,783
Mortgage backed securities			3,836				30				(12	)			3,854				4,745				4				(59	)			4,690
Total		$	8,841			$	200			$	(12	)		$	9,029			$	14,095			$	16			$	(98	)		$	14,013

 

 

The following is a summary of contractual maturities of securities available for sale as of September 30, 2016:

 

		(Dollars in thousands)
		Securities available for sale
		Amortized Cost				Fair  Value
Amounts maturing in:
One year or less		$	250			$	251
After one year through five years			2,532				2,543
After five years through ten years			1,239				1,275
After ten years			4,820				4,960
Total		$	8,841			$	9,029

 

Expected maturities will differ from contractual maturities because issuers may have the right to call or prepay obligations with or without call or prepayment penalties.

 

During the first quarter of 2016, the Company sold available for sale securities, U.S. Treasury and Agencies, totaling $4.0 million with a weighted average yield of 1.00% and weighted average maturity of 1.9 years. The net realized gain on these transactions was $15 thousand. In August, 2016 the Company purchased a $1 million taxable municipal bond at a 4.25% yield, due December 2030.

 

Investment securities with a carrying amount of approximately $2,068,000 and $2,848,000 were pledged to secure deposits as required or permitted by law at September 30, 2016 and December 31, 2015, respectively.

 

Information pertaining to securities with gross unrealized losses at September 30, 2016 and December 31, 2015, aggregated by investment category and length of time that individual securities have been in a continuous loss position, follows:

 

		(Dollars in thousands)
		Less than 12 months								12 months or greater								Total
		Fair Value				Gross Unrealized Losses				Fair Value				Gross Unrealized Losses				Fair Value				Gross Unrealized Losses
September 30, 2016
U.S. government federal agencies		$	-			$	-			$	-			$	-			$	-			$	-
State and local governments			-				-				-				-				-				-
Mortgage backed securities			315				-				875				(12	)			1,190				(12	)
Total		$	315			$	-			$	875			$	(12	)		$	1,190			$	(12	)
December 31, 2015
U.S. government federal agencies		$	4,981			$	(39	)		$	-			$	-			$	4,981			$	(39	)
Mortgage backed securities			3,115				(28	)			1,388				(31	)			4,503				(59	)
Total		$	8,096			$	(67	)		$	1,388			$	(31	)		$	9,484			$	(98	)

 

 

As of September 30, 2016, the investment portfolio contains unrealized losses of mortgage-related instruments issued or backed by the full faith and credit of the United States government or are generally viewed as having the implied guarantee of the U.S. government. As management has the ability to hold debt securities until maturity, or the foreseeable future if classified as available for sale, no declines are deemed to be other than temporary.

 

Management evaluates securities for other than temporary impairment at least on a quarterly basis, and more frequently when economic or market concerns warrant such evaluation. Consideration is given to (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, and (3) the intent and ability of the Bank to retain its investment in the issuer for a period of time sufficient to allow for any recovery in fair value.

 

NOTE 4 - LOANS AND ALLOWANCE FOR LOAN LOSSES

 

The following table provides information on the activity in the allowance for loan losses by the respective loan portfolio segment for the periods indicated:

 

		(Dollars in thousands)
		Three Months Ended								Nine Months Ended
		September 30,				September 30,				September 30,				September 30,
		2016				2015				2016				2015
Allowance at beginning of period		$	1,991			$	2,414			$	2,078			$	3,869
Provision for loan losses			-				-				-				-
Charge-offs:
Commercial			52				21				125				1,443
Real estate			-				-				-				42
Consumer			18				35				89				94
Total charge-offs		$	70			$	56			$	214			$	1,579
Recoveries:
Commercial			24				25				53				64
Real estate			1				1				3				1
Consumer			8				3				34				32
Total Recoveries			33				29				90				97
Allowance at end of period		$	1,954			$	2,387			$	1,954			$	2,387

 

 

The following table presents the recorded investment with respect to loans and the related allowance by portfolio segment at the dates indicated:

 

		(Dollars in thousands)
		Collectively Evaluated								Individually Evaluated								Total
		Allowance for loan losses				Recorded investment in loans				Allowance  for loan losses				Recorded investment  in loans				Allowance for loan losses				Recorded investment in  loans
September 30, 2016
Commercial		$	1,022			$	75,415			$	481			$	4,234			$	1,503			$	79,649
Real estate			191				43,011				26				394				217				43,405
Consumer			217				26,723				17				112				234				26,835
Total		$	1,430			$	145,149			$	524			$	4,740			$	1,954			$	149,889
December 31, 2015
Commercial		$	1,479			$	80,293			$	150			$	1,854			$	1,629			$	82,147
Real estate			196				42,993				44				408				240				43,401
Consumer			209				23,683				-				-				209				23,683
Total		$	1,884			$	146,969			$	194			$	2,262			$	2,078			$	149,231

 

As part of its monitoring process, the Bank utilizes a risk rating system which quantifies the risk the Bank estimates it has assumed when entering into a loan transaction and during the life of that loan. The system rates the strength of the borrower and the transaction and is designed to provide a program for risk management and early detection of problems. Loans are graded on a scale of 1 through 8, with a grade of 4 or below classified as “Pass” rated credits. Following is a description of the general characteristics of risk grades 5 through 8:

 

5 – Special Mention - The weighted overall risk associated with this credit is considered higher than normal (but still acceptable) or the loan possesses deficiencies, which corrective action by the Bank would remedy, thereby reducing risk.

 

6 – Substandard - The weighted overall risk associated with this credit (based on each of the Bank’s creditworthiness criteria) is considered undesirable, the credit demonstrates a well-defined weakness or the Bank is inadequately protected and there exists the distinct possibility of sustaining some loss if not corrected.

 

7 – Doubtful - Weakness makes collection or liquidation in full (based on currently existing facts) improbable.

 

8 – Loss- This credit is of little value and not warranted as a bankable asset. Accordingly, the Bank does not carry any loans on the books that are graded 8 – loss, instead these loans are charged off.

 

The Bank’s strategy for credit risk management includes ongoing credit examinations and management reviews of loans exhibiting deterioration of credit quality. A deteriorating credit indicates an elevated likelihood of delinquency. When a loan becomes delinquent, its credit grade is reviewed and changed accordingly. Each downgrade to a classified credit results in a higher percentage of reserve to reflect the increased likelihood of loss for similarly graded credits. Further deterioration could result in a certain credit being deemed impaired resulting in a collateral valuation for purposes of establishing a specific reserve which reflects the possible extent of such loss for that credit.

 

 

The following tables present the risk category of loans by class of loans based on the most recent analysis performed at September 30, 2016 and December 31, 2015.

 

Commercial Credit Exposure

Credit risk profile by credit worthiness category

 

		(Dollars in thousands)
		Commercial								Commercial
		Mortgage								Other
Category		09/30/16				12/31/15				09/30/16				12/31/15
Pass		$	62,955			$	61,612			$	10,652			$	12,123
5			849				984				164				186
6			4,425				6,686				604				557
7			-				-				-				-
Total		$	68,229			$	69,282			$	11,420			$	12,866

 

Consumer Credit Exposure

Credit risk by credit worthiness category

 

		(Dollars in thousands)
		Residential								Consumer								Consumer								Consumer
		Real Estate								Equity								Auto								Other
Category		09/30/16				12/31/15				09/30/16				12/31/15				09/30/16				12/31/15				09/30/16				12/31/15
Pass		$	43,096			$	42,690			$	12,460			$	10,049			$	12,890			$	11,999			$	1,469			$	1,512
5			-				373				-				59				-				38				-				-
6			309				338				-				7				16				18				-				-
7			-				-				-				-				-				-				-				-
Total		$	43,405			$	43,401			$	12,460			$	10,115			$	12,906			$	12,055			$	1,469			$	1,512

 

Loans evaluated for impairment include loans classified as troubled debt restructurings and non-performing commercial, real estate, and consumer loans. The following table sets forth certain information regarding the Bank’s impaired loans by class, segregated by those for which a specific allowance was required and those for which a specific allowance was not necessary for the periods indicated:

 

 

		(Dollars in thousands)
						Unpaid
		Recorded				Principal				Related
		Investment				Balance				Allowance
September 30, 2016
With no related allowance recorded:
Commercial mortgage		$	1,170			$	1,229			$	-
Commercial other			121				121				-
Residential real estate			294				295				-
Consumer equity			-				-				-
Consumer auto			37				37				-
Subtotal			1,622				1,682				-
With an allowance recorded:
Commercial mortgage		$	2,980			$	3,048			$	459
Commercial other			600				600				22
Residential real estate			394				395				26
Consumer equity			113				113				17
Consumer auto			-				-				-
Subtotal			4,087				4,156				524
Total		$	5,709			$	5,838			$	524

 

						Unpaid
		Recorded				Principal				Related
		Investment				Balance				Allowance
December 31, 2015
With no related allowance recorded:
Commercial mortgage		$	1,324			$	1,886			$	-
Commercial other			38				37				-
Residential real estate			315				316				-
Consumer:
Equity			-				-				-
Auto			89				90				-
Subtotal			1,766				2,329				-
With an allowance recorded:
Commercial mortgage			997				1,100				150
Commercial other			-				-				-
Residential real estate			408				409				44
Consumer:
Equity			-				-				-
Auto			-				-				-
Subtotal			1,405				1,509				194
Total		$	3,171			$	3,838			$	194

 

 

The following tables present the average recorded investments in impaired loans and the amount of interest income recognized on impaired loans after impairment by class for the periods indicated:

 

		(Dollars in thousands)
		No Related								With Related
		Allowance Recorded								Allowance Recorded								Total
						Total								Total								Total
		Average				Interest				Average				Interest				Average				Interest
		Recorded				Income				Recorded				Income				Recorded				Income
		Investment				Recognized				Investment				Recognized				Investment				Recognized
Three Months
Ended September 30, 2016
Commercial:
Mortgage		$	898			$	3			$	1,805			$	18			$	2,703			$	21
Other			122				1				300				-				422				1
Residential real estate			297				3				396				1				693				4
Consumer:
Equity			-				-				113				1				113				1
Auto			43				1				-				-				43				1
Other			-				-				-				-				-				-
Total		$	1,360			$	8			$	2,614			$	20			$	3,974			$	28
Three Months
Ended September 30, 2015
Commercial:
Mortgage		$	1,049			$	1			$	1,057			$	11			$	2,106			$	12
Other			35				-				-				-				35				-
Residential real estate			225				3				474				5				699				8
Consumer:
Equity			66				1				75				-				141				1
Auto			111				1				-				-				111				1
Other			-				-				-				-				-				-
Total		$	1,486			$	6			$	1,606			$	16			$	3,092			$	22

 

 

		(Dollars in thousands)
		No Related								With Related
		Allowance Recorded								Allowance Recorded								Total
						Total								Total								Total
		Average				Interest				Average				Interest				Average				Interest
		Recorded				Income				Recorded				Income				Recorded				Income
		Investment				Recognized				Investment				Recognized				Investment				Recognized
Nine Months
Ended September 30, 2016
Commercial:
Mortgage		$	962			$	6			$	1,442			$	27			$	2,404			$	33
Other			80				1				150				-				230				1
Residential real estate			304				11				401				5				705				16
Consumer:
Equity			-				-				56				1				56				1
Auto			58				2				-				-				58				2
Other			-				-				-				-				-				-
Total		$	1,404			$	20			$	2,049			$	33			$	3,453			$	53
Nine Months
Ended September 30, 2015
Commercial:
Mortgage		$	3,464			$	26			$	2,301			$	33			$	5,765			$	59
Other			51				1				66				-				117				1
Residential real estate			230				7				452				14				682				21
Consumer:
Equity			38				5				114				-				152				5
Auto			108				4				-				-				108				4
Other			-				-				-				-				-				-
Total		$	3,891			$	43			$	2,933			$	47			$	6,824			$	90

 

 

The following tables summarize information relative to loan modifications determined to be troubled debt restructurings (TDRs) during the periods indicated:

 

						(Dollars in thousands)
						Pre-Modification				Post-Modification
		Number				Outstanding				Outstanding
		of				Recorded				Recorded
		TDRs				Investment (1)				Investment
Three months ended September 30, 2016
Commercial mortgage			10			$	2,499			$	2,499
Residential real estate			-				-				-
Consumer:
Equity			-				-				-
Auto			-				-				-
Other			-				-				-
Total			10			$	2,499			$	2,499
Three months ended September 30, 2015
Commercial mortgage			1			$	309			$	309
Residential real estate			3				211				211
Consumer:
Equity			-				-				-
Auto			-				-				-
Other			-				-				-
Total			4			$	520			$	520

 

						Pre-Modification				Post-Modification
		Number				Outstanding				Outstanding
		of				Recorded				Recorded
		TDRs				Investment (1)				Investment
Nine months ended September 30, 2016
Commercial mortgage			11			$	2,511			$	2,511
Residential real estate			-				-				-
Consumer
Equity			1				113				113
Auto			-				-				-
Other			2				88				88
Total			14			$	2,712			$	2,712
Nine months ended September 30, 2015
Commercial mortgage			2			$	478			$	478
Residential real estate			5				377				377
Consumer
Equity			-
Auto			6				40				40
Other			-				-				-
Total			13			$	895			$	895

 

(1)

– Pre-modification balance is calculated using the loan balance on the day prior to modification as TDR.

 

A modification of a loan constitutes a TDR when a borrower is experiencing financial difficulty and the modification constitutes a concession. The Bank offers various types of concessions when modifying a loan. Loan terms that may be modified due to a borrower’s financial situation include, but are not limited to, a reduction in the stated interest rate, a reduction in the face amount of the debt, a reduction of the accrued interest, temporary interest-only payments, or re-aging, extensions, deferrals, renewals, and rewrites. In mitigation, additional collateral, a co-borrower or a guarantor may be requested.

 

 

During the three month period ended September 30, 2016, loans were modified by either a reduction in interest rates or a change in the contractual maturity date of the note. Seven loans were modified with reduced interest rates and the amortization of three loans was modified.

 

During the nine month period ended September 30, 2016, loans were modified by either a reduction in interest rates or a change in the contractual maturity date of the note. Ten loans were modified with reduced interest rates, the amortization of three loans was modified, and the contractual maturity date of one loan was extended.

 

During the nine month period ended September 30, 2015, four loans were modified with reduced interest rates, the contractual maturity date of three loans was extended, and five loans had the rate reduced and the amortization period extended. A single note was converted to interest only, with a balloon payment at maturity.

 

Loans modified as a TDR may already be on nonaccrual status and partial charge-offs may have, in some cases, been taken against the outstanding loan balance. The allowance for impaired loans that have been modified as a TDR is measured based on the estimated fair value of the collateral, less any selling costs, if the loan is collateral dependent or on the present value of expected future cash flows, discounted at the loan’s original effective interest rate. Management exercises significant judgment in developing these determinations.

 

There have been no loans, which were modified as a TDR within the previous twelve months that have subsequently defaulted as of September 30, 2016.

 

The following table presents the loan portfolio by class summarized by aging categories, at September 30, 2016 and December 31, 2015:

 

		(Dollars in thousands)																								Recorded
																										Investment
		30-59				60-89				>90																>90 Days
		Days				Days				Days				Total								Total				and
		Past Due				Past Due				Past Due				Past Due				Current				Loans				Accruing
September 30, 2016
Commercial:
Mortgage		$	649			$	271			$	678			$	1,598			$	66,631			$	68,229			$	14
Other			1				-				3				4				11,416				11,420				-
Residential real estate			221				94				-				315				43,090				43,405				-
Consumer:
Equity			19				-				-				19				12,441				12,460				-
Auto			78				18				14				110				12,796				12,906				4
Other			4				3				-				7				1,462				1,469				-
Total		$	972			$	386			$	695			$	2,053			$	147,836			$	149,889			$	18
December 31, 2015
Commercial:
Mortgage		$	628			$	433			$	196			$	1,257			$	68,025			$	69,282			$	-
Other			11				-				-				11				12,855				12,866				-
Residential real estate			449				33				-				482				42,919				43,401				-
Consumer:
Equity			23				-				-				23				10,092				10,115				-
Auto			138				17				-				155				11,900				12,055				-
Other			2				9				-				11				1,501				1,512				-
Total		$	1,251			$	492			$	196			$	1,939			$	147,292			$	149,231			$	-

 

 

The following summarizes by loan class, the loans on nonaccrual status at September 30, 2016 and December 31, 2015:

 

		(Dollars in thousands)
		September 30,				December 31,
		2016				2015
Commercial:
Mortgage		$	1,014			$	1,334
Other			3				3
Residential real estate			1				3
Consumer:
Equity			-				-
Auto			9				10
Other			-				-
Total		$	1,027			$	1,350

 

NOTE 5 – BANK OWNED LIFE INSURANCE

 

In 2015, the Bank invested in whole life insurance contracts on the lives of ten current officers who have provided positive consent allowing the Bank to be named beneficiary of these insurance contracts. One insured employee has since left the bank, and an existing policy on a former employee is also in place. These policies are recorded at their cash surrender values which are presented in the consolidated balance sheets in “Other Assets.” Those policies covering current officers are split dollar policies, providing one year’s salary to a deceased employee’s estate. These policies feature variable crediting rates and are expected to produce an average yield of about 5.50%, on a fully tax equivalent basis.

 

NOTE 6 – BORROWINGS

 

As of February 9, 2015, the Company renegotiated a portion of the $5.0 million note payable due December 29, 2015. An interest only note (Note B) for $1.6 million, due August 4, 2021, with a fixed interest rate of 6.00%, and 28,675 shares of the Company’s common stock were exchanged for $2.3 million of the original $5.0 million note. The remaining $2.7 million (Note A) of the original $5.0 million note continued unaltered, earning a fixed rate of 8.00%, due December 29, 2015.

 

In September 2015, the Company made a $1.0 million principal payment to Note A from available funds at the Bancorp level. In November 2015, the Bank requested permission from the FDIC and DFI to pay a one-time dividend to the Holding Company for the purpose of retiring Note A. In December 2015, permission was granted, the dividend was paid, and Note A was retired.

 

In April, June, and July, 2016, proceeds from the sales of OREO properties held at the Bancorp level were applied to the remaining Note B, reducing the balance by $193 thousand.

 

(Dollars in thousands)

Description

Balance of Loan as of  09/30/16

Interest Rate

Frequency of Payments

Status

Maturity  Date

Loan 1

$

444

4.75

%

Monthly

Amortizing

11/21/2019

Loan 2

$

307

4.25

%

Monthly

Amortizing

6/25/2019

Loan 3 (Note B)

$

1,452

6.00

%

Monthly

Interest Only

8/4/2021

 

NOTE 7 – EMPLOYEE BENEFIT PLANS

 

The bank has a qualified noncontributory defined benefit pension plan, which covers certain employees. The benefits are primarily based on years of service and earnings.

 

 

The following table presents the components of the net periodic pension cost of the defined benefit plan.

 

		(Dollars in thousands)
		Three months ended September 30,								Nine months ended September 30,
		2016				2015				2016				2015
Net periodic pension cost:
Interest cost on projected benefit obligation		$	14			$	14			$	42			$	42
Expected return on plan assets			(20	)			(11	)			(59	)			(33	)
Net amortization of deferral of (gains) losses			18				17				55				51
Net periodic pension cost		$	12			$	20			$	38			$	60

 

NOTE 8 – FAIR VALUES OF FINANCIAL INSTRUMENTS

 

Fair value is defined as the exchange price that would be received to sell an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. Accounting guidance also establishes a fair value hierarchy that prioritizes the inputs to valuation techniques used to measure fair value. The hierarchy gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (Level 1 measurements) and the lowest priority to unobservable inputs (Level 3 measurements). The three levels of the fair value hierarchy under this guidance are described below.

 

Level 1 - Valuation is based on quoted prices in active markets for identical assets or liabilities that the Company has the ability to access at the measurement date. Level 1 assets and liabilities generally include debt and equity securities that are traded in an active exchange market. Valuations are obtained from readily available pricing sources for market transactions involving identical assets and liabilities.

 

Level 2 - Valuation is based on inputs other than quoted prices included within Level 1 that are observable for the asset or liability, either directly or indirectly. The valuation may be based on 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 asset or liability.

 

Level 3 - Valuation is based on unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities. Level 3 assets and liabilities include financial instruments whose value is determined using pricing models, discounted cash flow methodologies, or similar techniques, as well as instruments for which determination of fair value requires significant management judgment or estimation.

 

A financial instrument’s categorization within the valuation hierarchy is based upon the lowest level of input that is significant to the fair value measurement.

 

Accordingly, investment securities available for sale and loans held for sale are recorded at fair value on a recurring basis. Additionally, from time to time, the Company may be required to record other assets at fair value on a nonrecurring basis, such as impaired loans and other real estate owned. These nonrecurring fair value adjustments typically involve application of lower of cost or market accounting or writedowns of individual assets.

 

The following describes the valuation techniques used to measure certain financial assets and liabilities recorded at fair value on a recurring basis in the financial statements.

 

Investment securities available for sale - Fair value measurement is based upon quoted prices, if available. If quoted prices are not available, fair values are measured using independent pricing models or other model-based valuation techniques such as the present value of future cash flows, adjusted for the security’s credit rating, prepayment assumptions, and other factors such as credit loss assumptions. Level 1 securities include those traded on an active exchange, such as the New York Stock Exchange or traded by dealers or brokers in active over-the-counter markets. Level 2 securities include securities issued by government sponsored entities, mortgage backed securities, and municipal bonds. Level 3 securities include those with unobservable inputs. Transfers between levels can occur due to changes in the observability of significant inputs.

 

 

Loans held for sale - Loans held for sale are carried at fair value. These loans currently consist of one-to-four-family residential loans originated for sale in the secondary market. Fair value is based on the committed market rates or the price secondary markets are currently offering for similar loans using observable market data.

 

The following are assets and liabilities that were accounted for or disclosed at fair value on a recurring basis:

 

		(Dollars in thousands)
						Fair Value Measurements Using
						Quoted Prices in				Significant
						Active Markets				Other				Significant
						for Identical				Observable				Unobservable
						Assets/Liabilities				Inputs				Inputs
		Fair Value				(Level 1)				(Level 2)				(Level 3)
September 30, 2016
Assets:
Securities available for sale:
U.S. government securities		$	-			$	-			$	-			$	-
U.S. government federal agencies			2,248				-				2,248				-
State and local governments			2,927				-				2,927				-
Mortgage backed securities			3,854				-				3,854				-
Total securities available for sale		$	9,029			$	-			$	9,029			$	-
Loans held for sale		$	229			$	-			$	229			$	-
December 31, 2015
Assets:
Securities available for sale:
U.S. government securities		$	1,005			$	1,005			$	-			$	-
U.S. government federal agencies			6,535				-				6,535				-
State and local governments			1,783				-				1,783				-
Mortgage backed securities			4,690				-				4,690				-
Total securities available for sale		$	14,013			$	1,005			$	13,008			$	-

 

The following describes the valuation techniques used to measure certain financial assets and liabilities recorded at fair value on a nonrecurring basis in the financial statements.

 

Impaired loans - The Bank does not record loans at fair value on a recurring basis. However, from time to time, a loan is considered impaired and an allowance for loan losses may need to be established. Loans for which it is probable that payment of interest and principal will not be made in accordance with the contractual terms of the loan agreement are considered impaired. Once a loan is identified as individually impaired, management measures impairment. As of September 30, 2016, the fair value of substantially all of the impaired loans was estimated based on the fair value of the collateral. When the fair value of the collateral is based on an observable market price or a current appraised value, the Bank records the impaired loan as nonrecurring Level 2. When an appraised value is not available or management determines the fair value of the collateral is further impaired below the appraised value and there is no observable market price, the Bank records the impaired loan as nonrecurring Level 3. Those impaired loans not requiring an allowance represent loans for which the fair value of the expected repayments or collateral exceed the recorded investments in such loans.

 

 

Other real estate owned (OREO) - OREO consists of real estate acquired in foreclosure or other settlement of loans. Such assets are carried on the consolidated balance sheet at the lower of the investment in the real estate or its fair value less estimated selling costs. The fair value of OREO is determined on a nonrecurring basis generally utilizing current appraisals performed by an independent, licensed appraiser applying an income or market value approach using observable market data (Level 2). However, if a current appraisal is not available, the original appraised value is discounted, as appropriate, to compensate for the estimated depreciation in the value of the real estate since the date of its original appraisal. Such discounts are generally estimated based upon management’s knowledge of sales of similar property within the applicable market area and its knowledge of other real estate market-related data, as well as general economic trends (Level 3). Upon foreclosure, any fair value adjustment is charged against the allowance for loan losses. Subsequent fair value adjustments are recorded in the period incurred and included in other noninterest expense in the consolidated statements of income.

 

The following are assets and liabilities that were accounted for or disclosed at fair value on a nonrecurring basis:

 

						(Dollars in thousands)
						Fair Value Measurements Using
						Quoted Prices in				Significant
						Active Markets				Other				Significant
						for Identical				Observable				Unobservable
						Assets/Liabilities				Inputs				Inputs
		Fair Value				(Level 1)				(Level 2)				(Level 3)
September 30, 2016
Assets:
Impaired loans
Commercial mortgage		$	3,691			$	-			$	-			$	3,691
Commercial other			699				-				-				699
Residential real estate			662				-				-				662
Consumer equity			96				-				-				96
Consumer auto			37				-				-				37
Total impaired loans			5,185				-				-				5,185
Other real estate owned
Residential			22				-				-				22
Commercial			-				-				-				-
Total other real estate owned		$	22			$	-			$	-			$	22
December 31, 2015
Assets:
Impaired loans
Commercial mortgage		$	2,171			$	-			$	-			$	2,171
Commercial other			38				-				-				38
Residential real estate			679				-				-				679
Consumer equity			-				-				-				-
Consumer auto			89				-				-				89
Total impaired loans		$	2,977			$	-			$	-			$	2,977
Other real estate owned
Residential			15				-				-				15
Commercial			223				-				-				223
Total other real estate owned		$	238			$	-			$	-			$	238

 

 

The quantitative information about Level 3 fair value measurements for financial assets and liabilities measured at fair value on a nonrecurring basis is as follows:

 

		(Dollars in thousands)
		Fair Value				Valuation Technique		Significant Unobservable Input		Range
September 30, 2016
Impaired loans
Commercial mortgage		$	3,691			Appraisal of Collateral		Appraisal Adjustment		Up to 11%
Commercial other			699			Appraisal of Collateral		Appraisal Adjustment		Up to 3%
Residential real estate			662			Appraisal of Collateral		Appraisal Adjustment		Up to 4%
Consumer:
Equity			96			Appraisal of Collateral		Appraisal Adjustment		Up to 15%
Auto			37			Appraisal of Collateral		Appraisal Adjustment		*
Other real estate owned
Residential			22			Appraisal of Property		Appraisal Adjustment		*
Commercial			-			Appraisal of Property		Appraisal Adjustment		*
December 31, 2015
Impaired loans
Commercial mortgage		$	2,171			Appraisal of Collateral		Appraisal Adjustment		Up to 6%
Commercial other			38			Appraisal of Collateral		Appraisal Adjustment		*
Residential real estate			679			Appraisal of Collateral		Appraisal Adjustment		Up to 6%
Consumer:
Equity			-			Appraisal of Collateral		Appraisal Adjustment		*
Auto			89			Appraisal of Collateral		Appraisal Adjustment		*
Other real estate owned
Residential			15			Appraisal of Property		Appraisal Adjustment		*
Commercial			223			Appraisal of Property		Appraisal Adjustment		Up to 45%
						* There are no related allowances for these classifications

 

The following methods and assumptions were used to estimate the fair value disclosures for other financial instruments as of September 30, 2016 and December 31, 2015:

 

Cash and cash equivalents - The fair value of cash and cash equivalents is estimated to approximate the carrying amounts.

 

Other investment securities - Other investment securities consist of restricted equity securities in the Federal Home Loan Bank (FHLB) and are carried at cost. Because there is no market, the carrying values of restricted equity securities approximate fair values based on the redemption provisions of the FHLB.

 

Loans - The fair value of loans is calculated by discounting estimated cash flows using current rates at which similar loans would be made to borrowers with similar credit ratings and for the same remaining maturities. The estimated cash flows do not anticipate prepayments.

 

Management has made estimates of fair value discount rates that it believes to be reasonable. However, because there is no market for many of these financial instruments, management has no basis to determine whether the fair value presented for loans would be indicative of the value negotiated in an actual sale.

 

Accrued interest receivable and payable - The carrying amounts of accrued interest approximate fair value.

 

Bank owned life insurance - The fair value of bank owned life insurance approximates the cash surrender value of the policies.

 

Deposits - The fair value of deposits with no stated maturity, such as noninterest bearing and interest bearing demand deposits, regular savings, and certain types of money market accounts, is equal to the amount payable on demand at the reporting date (that is, their carrying amounts). The fair value of certificates of deposit is based on the discounted value of contractual cash flows. The discount rate is estimated using the rates currently offered for deposits of similar remaining maturities.

 

 

Borrowed funds - The carrying amounts of borrowed funds which mature within 90 days approximate their fair values. The fair values of other borrowed funds are estimated using discounted cash flow analysis that applies interest rates currently offered on similar instruments.

 

Off-balance sheet instruments - The fair values of commitments to extend credit and standby letters of credit are estimated using the fees currently charged to enter into similar agreements, taking into account the remaining terms of agreements and the present credit standing of the counterparties. The amounts of fees currently charged on commitments to extend credit and standby letters of credit are deemed insignificant, and therefore, the estimated fair values and carrying values are not shown.

 

The estimated fair value of the financial instruments is as follows:

 

										Fair Value Measurements Using
										Quoted
		(Dollars in thousands)								Prices in
										Active				Significant
										Markets				Other				Significant
										for Identical				Observable				Unobservable
		Carrying				Fair				Assets/Liabilities				Inputs				Inputs
		Amount				Value				(Level 1)				(Level 2)				(Level 3)
September 30, 2016
Financial assets:
Cash and cash equivalents		$	10,041			$	10,041			$	-			$	10,041			$	-
Investment securities			9,029				9,029				-				9,029				-
Other investment securities			859				859				-				-				859
Loans held for sale			229				229				-				229				-
Loans, net			147,935				154,492				-				-				154,492
Accrued interest receivable			277				277				-				-				277
Bank owned life insurance			3,403				3,403				-				3,403				-
Financial liabilities:
Noninterest-bearing deposits		$	31,859			$	31,859			$	-			$	31,859			$	-
Interest-bearing deposits			126,463				127,885				-				127,885				-
Borrowed funds			2,203				2,203				-				2,203				-
Accrued interest payable			560				560				-				-				560
December 31, 2015
Financial assets:
Cash and cash equivalents		$	9,371			$	9,371			$	-			$	9,371			$	-
Securities available for sale			14,013				14,013				1,005				13,008				-
Other investment securities			859				859				-				-				859
Net loans			147,153				149,355				-				-				149,355
Accrued interest receivable			285				285				-				-				285
Bank owned life insurance			3,320				3,320				-				3,320				-
Financial liabilities:
Noninterest bearing deposits		$	26,116			$	26,116			$	-			$	26,116			$	-
Interest bearing deposits			136,209				137,174				-				137,174				-
Borrowed funds			2,569				2,569				-				2,569				-
Accrued interest payable			759				759				-				-				759

 

 

The carrying amounts in the preceding table are included in the consolidated balance sheets under the applicable captions. No derivatives were held by the Company for trading purposes.

 

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

 

Forward-Looking Information

 

Certain statements contained in this quarterly report are not historical facts, including but not limited to statements that can be identified by the use of forward-looking terminology such as “may,” “will,” “expect,” “anticipate,” or “continue” or the negative thereof or other variations thereon or comparable terminology, and are “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. Actual results could differ materially from those indicated in such statements due to risks, uncertainties, and changes with respect to a variety of market and other factors. The Company assumes no obligation to update any forward-looking statements.

 

Management’s Discussion and Analysis as of September 30, 2016

 

Overview. Citizens Independent Bancorp. Inc. (Holding Company, Bancorp, we or our) was organized under the laws of the State of Ohio in 1994 as the bank holding company for The Citizens Bank of Logan (Citizens Bank or Bank) under the Bank Holding Company Act of 1956, as amended. Bancorp and the Bank are sometimes collectively referred to herein as the Company. Holding Company is headquartered in Logan, Ohio, and offers a broad range of financial services through Citizens Bank, an Ohio chartered commercial bank. The Bank is currently regulated by the Federal Deposit Insurance Company (FDIC) and the Ohio Division of Financial Institutions (DFI). Holding Company is regulated by the Federal Reserve Bank of Cleveland (FRB).

 

Citizens Bank is engaged in the business of commercial and retail banking. The Bank’s primary market area is Hocking, Fairfield, and Athens Counties, Ohio. The Bank serves this market through three full service locations, which include the Bank’s main office located at 188 West Main Street, Logan, Hocking County, Ohio. The Bank maintains drive-up facilities, as well as ATM equipment at all branches. In a cost saving project, the Bank is presently constructing a new full service branch. This branch will consolidate a full service facility and a limited service location, both of which will be closed with the opening of this new branch. The principal economic activities in the Bank’s market area include manufacturing, the service sector for local universities, tourism, construction, healthcare, retailing, and food services. The Bank grants residential real estate, commercial real estate, commercial and industrial, and consumer loans to customers primarily located in the Bank’s footprint of Hocking, Athens, and Fairfield counties.

 

In October 2012, the Bank entered into publicly available Consent Orders with the FDIC and the DFI (collectively referred to as the Orders), which required the Bank to take a number of actions. In October 2015, the Orders were lifted and the Bank entered into an MOU with the FDIC and DFI. Significant among the ongoing required actions was the development of a capital plan resulting in the Bank meeting and maintaining its level of Tier 1 capital as a percentage of its total assets at a minimum of 8.00% and its level of qualifying total capital as a percentage of risk-weighted assets at a minimum of 11.50%. The Bank was also required to obtain approval from the FDIC and DFI prior to the payment of any dividends. In August 2016, both the FDIC and the DFI released the Bank from the MOU without restriction. The Bank is no longer required to seek prior approval of any dividends.

 

On July 5, 2011, the Bancorp entered into a memorandum of understanding (the FRB 2011 MOU) with the FRB. The FRB 2011 MOU prohibited the Bancorp, without prior approval of the FRB, from: declaring or paying cash dividends, taking dividends or any other form of payment representing a reduction in the Bank’s capital, incurring, increasing, or guaranteeing any debt, or purchasing or redeeming any shares. On August 18, 2016 the FRB released the Bancorp from the 2011 MOU without restriction. Bancorp may declare and pay cash dividends, take dividends or any other form of payment representing a reduction in the Bank’s capital, incur, increase, or guarantee any debt, or purchase or redeem any shares as approved by the board of directors without prior approval of the FRB.

 

Management’s Discussion and Analysis is intended to provide shareholders with a more comprehensive analysis of the issues facing management than can be obtained from an examination of the financial statements alone. This analysis should be read in conjunction with the consolidated financial statements and related footnotes and selected financial data elsewhere in this filing.

 

 

 

The Bank’s profitability, as with most financial institutions, is significantly dependent upon net interest income, which is the difference between interest received on interest earning assets, such as loans and securities and the interest paid on interest bearing liabilities, principally deposits and borrowings. During a period of economic slowdown, the lack of interest income from non-performing assets and additional provision for loan losses can greatly reduce profitability. Results of operations are also impacted by noninterest income, such as service charges on deposit accounts and fees on other services, income from lending services, as well as noninterest expense, such as salaries and employee benefits, occupancy expense, professional and other services, and other expenses.

 

For the nine months ended September 30, 2016, the Company earned net income of $812 thousand or $1.20 per share, compared to net income of $428 thousand or $0.67 per share for the nine months ended September 30, 2015.

 

Key items affecting the Company’s results for the first nine months of 2016:

 

·

Net interest income increased by $213 thousand period-over-period for the nine months ended September 30, 2016 from the nine months ended September 30, 2015. A $129 thousand decline in interest income was offset by a $342 thousand decrease in interest expense.

·

Noninterest income decreased by $70 thousand to $1,116 thousand for the nine months ended September 30, 2016 from the nine months ended September 30, 2015. The period to period decrease can be attributed to a decline of $153 thousand in gains on the sale of securities, partially offset by an increase of $61 thousand in other income resulting from the third quarter purchase of a BOLI policy and a gain of $24 thousand on the sale of loans.

·

Noninterest expense decreased $370 thousand for the nine months ended September 30, 2016 in comparison to the nine months ended September 30, 2015, totaling $5.4 million in 2016 and $5.8 million in 2015.

·

Non-performing loans were lower by $0.3 million at September 30, 2016 relative to December 31, 2015, totaling $1.0 million and $1.3 million, respectively. The period-over-period activity primarily consisted of the pay-off of three credits totaling $773 thousand and the upgrade of one credit totaling $191 thousand, offset by the downgrade of four credit totaling $709 thousand.

·

Gross loans increased $0.7 million, or 0.4%, to $149.9 million as of September 30, 2016 from $149.2 million as of December 31, 2015. The increase results from loan originations of $23.0 million offset by $22.3 million in principal reductions received during the first nine months of 2016. Non-performing loans made up $1.0 million of these principal reductions.

·

Deposits were down $4.0 million from year end balances to $158.3 million as of September 30, 2016 from $162.3 million as of December 31, 2015.

·

Shareholders’ equity of the Company increased $1.6 million, or 8.9%, to $18.9 million as of September 30, 2016 from the December 31, 2015 equity position. This increase was due to net proceeds from the exercise of outstanding common stock warrants totaling $668 thousand, net income of $812 thousand, plus an increase of $178 thousand in accumulated other comprehensive income resulting from the recognition in equity of an unrealized gain on the Company’s available for sale investment portfolio during the first nine months of 2016. Leverage Capital and Total Capital at the Bank were 9.06% and 13.50%, respectively, as of September 30, 2016 and 8.23% and 13.14%, respectively, as of December 31, 2015.

 

Comparison of Results of Operations for the Nine Months Ended September 30, 2016 and September 30, 2015

 

For the nine months ended September 30, 2016, the Company earned net income of $812 thousand, a $384 thousand increase from the $428 thousand net income reported for the nine months ended September 30, 2015. The increase in profitability can primarily be attributed to a $213 thousand increase in net interest income relative to the first nine months of 2015 and a decrease in noninterest expense of $370 thousand, only partially negated by a decline in noninterest income of $70 thousand. Federal income tax provisions were $284 thousand for the first nine months of 2016 versus only $155 thousand during the comparable period in 2015.

 

Distribution of Assets, Liabilities, and Shareholders’ Equity

For the nine months ended September 30,

 

		(Dollars in thousands)
		2016												2015
		Average Balance				Interest				Yield / Rate				Average Balance				Interest				Yield / Rate
Interest-earning assets:
Loans receivable (1), (2), (4)		$	146,651			$	5,817				5.29	%		$	142,517			$	5,788				5.42	%
Securities (3)			9,270				124				1.78	%			24,272				287				1.58	%
Fed funds sold			11,247				26				0.31	%			12,306				21				0.23	%
FHLB stock			859				26				4.04	%			859				26				4.04	%
Total interest earning assets			168,027				5,993				4.76	%			179,954				6,122				4.54	%
Noninterest earning assets			12,602												16,178
Total assets		$	180,629											$	196,132
Interest-bearing liabilities
Interest bearing deposits			127,301				523				0.55	%			148,144				691				0.62	%
Other borrowings			2,370				100				5.63	%			5,346				274				6.83	%
Total interest bearing liabilities			129,671				623				0.64	%			153,490				965				0.84	%
Noninterest bearing liabilities			31,349												23,433
Total including non-interest bearing demand deposits			161,020				623								176,923				965
Other noninterest liabilities			1,415												2,778
Total liabilities			162,435												179,701
Shareholders’ equity			18,194												16,431
Total liabilities and shareholders’ equity		$	180,629											$	196,132
Net interest income; interest rate spread						$	5,370				4.12	%						$	5,157				3.70	%
Net interest margin											4.26	%											3.82	%
Average interest-earning assets to average interest-bearing liabilities											129.58	%											117.24	%

 

⁽¹⁾ Loan fees are immaterial amounts

⁽²⁾ Non-accrual loans are included in average loan balance

⁽³⁾ Interest income for tax-exempt securities is not calculated on a tax-exempt basis

⁽⁴⁾ Loans receivable includes loans held for sale

 

Interest income for the nine months ended September 30, 2016 was $6.0 million, a $129 thousand, or 2.1%, decrease from that earned during the nine months ended September 30, 2015. The yield on earning assets increased 22 basis points to 4.76% for the nine months ended September 30, 2016 from 4.54% for the nine months ended September 30, 2015. Interest income earned from the loan portfolio increased $29 thousand, or 0.5%, to $5.8 million for the nine months ended September 30, 2016 from $5.8 million for the nine months ended September 30, 2015. The increase in interest income from the loan portfolio can be attributed to an increase in average loan balances of $4.1 million, or 2.9%. The yield on loans decreased 13 basis points to 5.29% for the nine months ended September 30, 2016 relative to the 5.42% earned for the nine months ended September 30, 2015.

 

 

Interest income from the investment portfolio declined $163 thousand, or 56.8%, to $124 thousand for the nine months ended September 30, 2016 from $287 thousand for the nine months ended September 30, 2015. Average assets for the securities portfolio declined $15.0 million and the yield increased by 20 basis points. Securities sales during the nine month period ending September 30, 2016 totaled $4.0 million at a weighted average yield of 1.00% and a weighted average maturity of 1.9 years. Securities sales during the nine month period ending September 30, 2015 totaled $14.4 million and purchases were $3.1 million. Securities gains recognized during the first three quarters of 2015 were $168 thousand.

 

Interest expense for the nine months ended September 30, 2016 was $623 thousand, a $342 thousand, or 35.4%, decrease from the $965 thousand in interest expense for the nine months ended September 30, 2015. Interest expense for deposits declined $168 thousand, or 24.3%, to $523 thousand for the nine months ended September 30, 2016. Average balances of interest bearing deposits decreased by $20.8 million, or 14.1%, to $127.3 million at September 30, 2016 from $148.1 million at September 30, 2015.

 

Interest expense for other borrowings was $100 thousand for the nine months ended September 30, 2016 and $274 thousand for the nine months ended September 30, 2015. In February 2015, the Company issued $656 thousand of common stock, retiring a like amount of debt, and reducing the interest rate on a portion of the remaining debt. Principal payments reduced the average outstanding debt to $2.4 million as of September 30, 2016 from $5.3 million as of September 30, 2015.

 

Net interest margins continue to be under heavy pressure as higher yielding loans reprice downward, are refinanced at lower rates, or are paid off early. During the first nine months of 2016, loans totaling $13.7 million have repriced at a net decrease of 13 basis points, mostly due to the downward repricing of commercial loans offsetting the increased rates of home equity loans repricing from their initial teaser rates. The Bank has continued to drive the composition of the loan portfolio towards variable rate loans and shorter maturity fixed rate loans as protection against rising interest rates. Although striving to originate conforming residential mortgage loans, management is retaining a larger percentage of these mortgage loans in-house rather than selling to the secondary market. The loan mix resulting from holding these typically variable rate loans in the portfolio will depress the net interest margin in the short term, but should be additive as they begin to reprice. The loan portfolio currently consists of 69.7% variable rate loans. The Bank has reduced interest rates paid on a large group of deposit accounts and continues to monitor certificate of deposit rates relative to our peers. Effects of these deposit cost initiatives are now being felt.

 

Comparison of Results of Operations for the Three Months Ended September 30, 2016 and September 30, 2015

 

For the three months ended September 30, 2016, the Company earned net income of $346 thousand, a $169 thousand increase from the $177 thousand net income reported for the three months ended September 30, 2015. Net interest income increased $58 thousand (3.3%) during the third quarter of 2016 versus the third quarter of 2015, noninterest income decreased $261 thousand, and noninterest expense decreased $449 thousand. Federal income tax expense of $144 thousand in the third quarter of 2016 was $77 thousand (114.9%) greater than that recorded in the third quarter of 2015.

 

 

Distribution of Assets, Liabilities, and Shareholders’ Equity

For the three months ended September 30,

 

		(Dollars in thousands)
		2016												2015
		Average Balance				Interest				Yield / Rate				Average Balance				Interest				Yield / Rate
Interest earning assets:
Loans receivable (1), (2), (4)		$	146,944			$	1,940				5.28	%		$	144,070			$	1,953				5.42	%
Securities (3)			9,108				43				1.89	%			19,050				71				1.49	%
Fed funds sold			11,090				9				0.32	%			14,038				8				0.23	%
FHLB stock			859				9				4.19	%			859				9				4.19	%
Total interest earning assets			168,001				2,001				4.76	%			178,017				2,041				4.58	%
Noninterest earning assets			12,733												15,952
Total assets		$	180,734											$	193,969
Interest-bearing liabilities
Interest bearing deposits			126,152				174				0.55	%			143,964				219				0.61	%
Other borrowings			2,223				31				5.58	%			4,975				84				6.75	%
Total interest bearing liabilities			128,375				205				0.64	%			148,939				303				0.81	%
Noninterest bearing liabilities			32,128												25,222
Total including noninterest bearing demand deposits			160,503				205								174,161				303
Other noninterest liabilities			1,450												2,757
Total liabilities			161,953												176,918
Shareholders’ equity			18,781												17,051
Total liabilities and shareholders’ equity		$	180,734											$	193,969
Net interest income; interest rate spread						$	1,796				4.12	%						$	1,738				3.77	%
Net interest margin											4.28	%											3.91	%
Average interest-earning assets to average interest-bearing liabilities											130.87	%											119.52	%

 

⁽¹⁾ Loan fees are immaterial amounts

⁽²⁾ Non-accrual loans are included in average loan balance

⁽³⁾ Interest income for tax-exempt securities is not calculated on a tax-exempt basis

 

Interest income for the three months ended September 30, 2016 was $2.0 million, a decrease of $40 thousand or 2.0%, from that earned in the three months ended September 30, 2015. The yield on earning assets improved 18 basis points to 4.76% for the three months ended September 30, 2016 from 4.58% for the three months ended September 30, 2015. Interest income earned from the loan portfolio decreased $13 thousand, or 0.7%, for the three months ended September 30, 2016 relative to the three months ended September 30, 2015. The decrease in interest income from the loan portfolio can be attributed to the decrease in average yield of 14 basis points for the three month period ending September 30, 2016 compared to the three month period ending September 30, 2015.

 

 

Interest income from the investment portfolio declined $28 thousand, or 39.4%, to $43 thousand for the three months ended September 30, 2016 from $71 thousand for the three months ended September 30, 2015. Average assets for the securities portfolio declined $9.9 million and the yield increased by 40 basis points. During the third quarter of 2016, a $1.0 million taxable municipal bond, due in 2030, was purchased at a yield of 4.25%.

 

Interest expense for the three months ended September 30, 2016 was $205 thousand, a $98 thousand, or 32.3%, decrease from the $303 thousand in interest expense for the three months ended September 30, 2015. Interest expense for deposits declined $45 thousand, or 20.5%, to $174 thousand for the three months ended September 30, 2016. Average balances of interest bearing deposits decreased by $17.8 million, or 12.4%, declining to $126.2 million at September 30, 2016 from $144.0 million at September 30, 2015. The Company continues to trim the public deposits by offering competitive, but not exorbitant, deposit rates.

 

Interest expense for other borrowings was $31 thousand for the three months ended September 30, 2016 and $84 thousand for the three months ended September 30, 2015. In February 2015, the Company issued $656 thousand of common stock, retiring a like amount of debt, and reducing the interest rate on a portion of the remaining debt. Principal payments reduced the average outstanding balance for the quarter from $5.0 million as of September 30, 2015 to $2.2 million as of September 30, 2016.

 

Noninterest Income. Noninterest income, which consists primarily of fees and commissions earned on services, such as deposits, credit cards, and ATMs that are provided to the Bank’s customers, and to a lesser extent, gains on sales of OREO and other repossessed assets and other miscellaneous income, decreased $70 thousand, or 5.9%, to $1,116 thousand for the nine months ended September 30, 2016 from $1,186 thousand for the nine months ended September 30, 2015. The period-over-period decrease in noninterest income can primarily be attributed to a $153 thousand decrease in gains recognized from the sale of available for sale securities during the first nine months of 2016 versus the first nine months of 2015. The following is a discussion of other significant period-over-period changes in other material noninterest income categories:

 

·

Income from service fees decreased $11 thousand, or 3.5%, to $300 thousand for the nine months ended September 30, 2016 from $311 thousand for the nine months ended September 30, 2015. The decrease was due to a $59 thousand period-over-period decrease in revenue from the Bank’s overdraft protection product, resulting from a change in the way we process overdrafts. The Bank is currently evaluating strategies to recapture lost fee income.

·

Sales of OREO properties generated gains of $213 thousand for the nine months ended September 30, 2016 compared to gains of $211 thousand recognized on the sale of OREO properties during the nine months ended September 30, 2015. During the first nine months of 2016, the Company sold 13 properties with a carrying value of $223 thousand versus 8 bank properties with a carrying value of $815 thousand last year.

·

Other income increased $61 thousand, or 26.0%, during the first nine months of 2016 to $296 thousand. The increase is primarily attributable to a gain of $56 thousand realized on the sale of three substandard, nonaccrual loans with a carrying value of $595 thousand, as well as increased earnings of $71 thousand from Bank Owned Life Insurance policies purchased in September 2015 on key management figures for the purpose of offsetting employee benefit costs. Offsetting this increase was a decline of $50 thousand in mortgage broker commissions.

 

For the three months ended September 30, 2016, noninterest income decreased by $261 thousand, or 43.7%. The period-over-period decrease in noninterest income can primarily be attributed to a decrease of $208 thousand in gains recognized from the sale of OREO and other repossessed properties and reductions of $20 thousand and $21 thousand in gains on the sale of available for sale securities and service charge fees. The following is a discussion of other significant period-over-period changes in other material noninterest income categories:

 

·

Income from service fees decreased $21 thousand, or 16.9%, to $103 thousand for the three months ended September 30, 2016 from $124 thousand for the three months ended September 30, 2015. The decrease can be attributed to a $26 thousand period-over-period decrease in revenue from the Bank’s overdraft protection product, due to a change in the way we process overdrafts. The Bank is currently evaluating strategies to recapture lost fee income.

 

·

Sales of OREO properties generated gains of $47 thousand for the three months ended September 30, 2016 compared to gains of $255 thousand recognized on the sale of OREO properties during the three months ended September 30, 2015.

·

There were no transactions or gains from the sale of investment securities during the third quarter of 2016 versus $20 thousand in gains for the three months ended September 30, 2015.

·

Other income declined $28 thousand, or 25.2%, during the three month period ending September 30, 2016 to $83 thousand. The change can primarily be attributed to an increase of $20 thousand in earnings from Bank Owned Life Insurance policies purchased in September 2015 on key management figures for the purpose of offsetting employee benefit costs, offset by a declines of $34 thousand in mortgage broker commissions.

 

Noninterest Expense. Noninterest expense, which consists primarily of personnel, occupancy, equipment, and other operating expenses, decreased $370 thousand, or 6.4%, between the nine month periods ended September 30, 2016 and September 30, 2015. The decrease is primarily attributable to changes in only a few categories. The following is a discussion of significant period-over-period changes for other material noninterest expense categories:

 

·

Salaries and employee benefits expense increased by $83 thousand, or 3.5%, to $2.5 million for the nine months ended September 30, 2016 relative to the nine months ended September 30, 2015. Nearly all of the increase is attributable to the addition of two senior level employees to enhance our lending and loan processing capabilities. An additional new employee has brought a service formerly outsourced to a third party back into the Bank.

·

Net occupancy and equipment expense decreased by $66 thousand, or 9.5%, during the nine months ended September 30, 2016 relative to the same period of 2015. Most of the savings are due to the closing of an unprofitable in-store branch in September 2015.

·

Expenses on other real estate owned were $9 thousand lower for the nine months ended September 30, 2016 relative to the period ended September 30, 2015. Other real estate owned balances averaged $25 thousand for the nine months ended September 30, 2016 versus $432 thousand for the nine months ended September 30, 2015, resulting in lower maintenance and preservation costs.

·

Legal and professional fees have fallen $144 thousand for the nine month period ending September 30, 2016 to a total of $289 thousand versus $433 thousand for the comparable period in 2015. Litigation and foreclosure activity has declined for the 2016 period as reflected in the lower levels of OREO properties and non-performing assets.

·

Other operating expenses for the nine month period ending September 30, 2016 is $180 thousand less than for the comparable period ending September 30, 2015. This decrease was driven by the 2015 write-down of $80 thousand in worthless, discarded assets in addition to $119 thousand in additional expenses related to the closing of an unprofitable branch. During the nine month period in 2015, we wrote-off stock received as collateral in a 2012 loan foreclosure. Previously valued at $100 thousand, the carrying value of the stock was written down to zero. Increases of $23 thousand in employee training related costs for the 2016 year to date period were partially offset by savings of $65 thousand in temporary and seasonal employee costs as well as employee acquisition costs.

 

Noninterest expense, which consists primarily of personnel, occupancy, equipment, and other operating expenses, was down $449 thousand, or 21.5%, for the three month period ended September 30, 2016 compared to the same period for September 30, 2015. The decrease is primarily attributable to drops in both legal fees and other expenses. The following is a discussion of significant period-over-period changes for other material noninterest expense categories:

 

·

Salaries and employee benefits expense fell by $6 thousand, or 0.8%, to $786 thousand for the three months ended September 30, 2016 relative to the three months ended September 30, 2015. Staffing levels did not change significantly for the two periods in question.

·

Net occupancy and equipment expenses decreased by $18 thousand, or 8.2%, during the three months ended September 30, 2016 as depreciation expenses decreased by $7 thousand and branch lease payments declined by $9 thousand as a result of a branch closing.

 

 

·

Legal expenses were $175 thousand, or 74.5%, less for the three months ended September 30, 2016 relative to the same period ended September 30, 2015. Charges related to a since dismissed lawsuit accounted for $48 thousand of the difference and savings attributable to the way we collect on past due and nonperforming accounts were $56 thousand. Balances of OREO properties fell from $376 thousand at September 30, 2015 to $22 thousand at September 30, 2016, with a resulting savings in legal expenses.

·

Other operating expense for the quarter ending September 30, 2016 were $168 thousand less than for the quarter ending September 30, 2015. Expenses related to branch closures totaled $149 thousand during the third quarter of 2015 and $25 thousand during the third quarter of 2016. The company realized savings of $38 thousand in temporary and seasonal employee costs and employee acquisition costs when comparing the third quarter of 2016 to 2015.

 

Provision for Loan Losses. The Company establishes an allowance for loan losses through charges to earnings, which are shown in the consolidated statements of income as the provision for loan losses. Through the provision for loan losses, an allowance is maintained that reflects management’s best estimate of probable incurred loan losses related to specifically identified loans, as well as the inherent risk of loss related to the remaining portfolio. In evaluating the allowance for loan losses, management considers various factors that include loan growth, the amount and composition of the loan portfolio, (including non-performing and potential problem loans), diversification, or conversely, concentrations by industry, geography, or collateral within the portfolio, historical loan loss experience, current delinquency levels, the estimated value of the underlying collateral, prevailing economic conditions, and other relevant factors. Loan charge-offs are recorded to this allowance when loans are deemed uncollectible, in whole or in part. Impacting the provision for loan losses in any accounting period are several factors, including the amount of loan growth during the period broken down by loan type, the level of charge-offs during the period, the changes in the amount of impaired loans, changes in risk ratings assigned to loans, specific loan impairments, credit quality, and ultimately, the results of management’s assessment of the inherent risks of the loan portfolio.

 

Management considers the current allowance for loan losses at September 30, 2016 adequate to cover loan losses based on its assessment of various factors affecting the loan portfolio, including the level of problem loans, overall delinquencies, business conditions, estimated collateral values, and loss experience. No provision for loan losses was recorded in either of the first three quarters of 2016 or 2015.

 

A further decline in local and national economic conditions, or other factors, could result in a material increase in the allowance for loan losses, which could adversely affect the Company’s financial condition and results of operations.

 

Changes in Financial Condition from December 31, 2015 to September 30, 2016.

 

Overview, Total assets decreased $2.9 million to $180.9 million on September 30, 2016 from $183.8 million on December 31, 2015.

 

Loan Portfolio. Gross loans increased $0.7 million, or 0.4%, to $149.9 million as of September 30, 2016 from a balance of $149.2 million on December 31, 2015. The increase is the net effect of new origination activity totaling $23.0 million, and $22.3 million in principal reductions for the first nine months of 2016. Principal reductions also included net loan charge-offs of $124 thousand. A single loan of $38 thousand was transferred to OREO at its fair value of $22 thousand. The new originations were primarily commercial mortgage loans ($6.8 million or 30.2%) and consumer mortgage ($4.3 million or 19.3%). Total consumer lending, including consumer mortgage, was 65.5% of originations during the nine month period ending September 30, 2016. The emphasis on consumer lending is part of a strategic initiative to re-balance the loan portfolio to be more equally weighted between commercial and consumer loans. This trend is expected to continue for the remainder of 2016 and is incorporated into the 2016 budget. As of September 30, 2016, total consumer loans, including consumer mortgage loans, totaled 46.9% of gross loans versus 45.0% of gross loans at December 31, 2015.

 

 

		(Dollars in thousands)
		September 30,				December 31,
		2016				2015
Commercial		$	79,649			$	82,147
Real estate			43,405				43,401
Consumer			26,835				23,683
		$	149,889			$	149,231

 

The Company’s loan portfolio represents its largest and highest yielding assets. The fundamental lending business of the Company is based on understanding, measuring, and controlling the credit risk inherent in the loan portfolio. The Company’s loan portfolio is subject to varying degrees of credit risk. Credit risk entails both general risks, which are inherent in the process of lending, and risk specific to individual borrowers. The Company’s credit risk is mitigated through portfolio diversification, which limits exposure to any single customer, industry, or collateral type. Typically, each consumer and residential lending product has a generally predictable level of credit losses based on historical loss experience. Home mortgage and home equity loans and lines generally have the lowest credit loss experience, while loans secured by personal property, such as auto loans, are generally expected to experience more elevated credit losses. Credit risk in commercial lending can vary significantly, as losses as a percentage of outstanding loans can shift widely during economic cycles and are particularly sensitive to changing economic conditions. Generally, improving economic conditions result in improved operating results on the part of commercial customers, enhancing their ability to meet their particular debt service requirements. Improvements, if any, in operating cash flows can be offset by the impact of rising interest rates that may occur during improved economic times. Declining economic conditions have an adverse effect on the operating results of commercial customers, reducing their ability to meet debt service obligations.

 

To control and manage credit risk, management has a credit process in place to ensure credit standards are maintained along with strong oversight and review procedures. The primary purpose of loan underwriting is the evaluation of specific lending risks and involves the analysis of the borrower’s ability to service the debt as well as the assessment of the value of the underlying collateral. Oversight and review procedures include the monitoring of portfolio credit quality, early identification of potential problem credits, and the aggressive management of problem credits. Executive management has implemented and continues to focus on the following measures to manage credit risk in the loan portfolios:

 

1)

Reviewed all underwriting guidelines for various loan portfolios and have strengthened underwriting guidelines where needed;

2)

Evaluated outside loan review parameters, engaging the services of a well-established firm to continue with such loan review, addressing not only specific loans but underwriting analysis, documentation, credit evaluation, and risk identification;

3)

Increased the frequency of internal reviews of past due and delinquent loans to assess probable credit risks early in the delinquency process to minimize losses;

4)

Aggressively seeks ownership and control, when appropriate, of real estate properties, which would otherwise go through time-consuming and costly foreclosure proceedings to effectively control the disposition of such collateral;

5)

Aggressively obtaining updated financial information on commercial credits and performing analytical reviews to determine debt source capacities in business performance trends; and

6)

Engaged a well established auditing firm to analyze the Company’s loan loss reserve methodology and documentation.

 

Allowance for Loan Loss (ALLL). The ALLL represents management’s estimate of losses inherent in the loan portfolio. The allowance is actively maintained to ensure future earnings are not impacted by credit losses. Reserves are based on historical loss analysis, assessment of current portfolio and market conditions, and any identified loss potential in specific credits. Reserve levels are recommended by senior management on a quarterly basis and approved by the Board of Directors.

 

 

The ALLL is composed of a reserve to absorb probable and quantifiable losses based on current knowledge of the loan portfolio and a reserve to absorb losses, which are not specifically identified, but can be reasonably expected.

 

Following the guidelines set forth in GAAP, Interagency Policy Statements on the Allowance for Loan and Lease Losses, and all other relevant supervisory guidance, the adequacy of the ALLL is ensured by applying consistent methods of identification, analysis, computation, documentation, and reporting.

 

The Bank’s ALLL has two components, the general reserve and the specific reserve. Included in the general reserve is the environmental reserve.

 

The general reserve is calculated by applying annualized net loan losses taken during a 36 month rolling look back period to the current loan portfolio, less any loans considered in the specific reserve analysis. To reflect the variations in risk of different loan products, the portfolio is segmented by collateral type, borrower type, and underwriting process.

 

The specific reserve is the calculated impairment of all loans classified as impaired, with a minimum outstanding principal balance of $100,000. A loan is classified as impaired when it is probable that the Bank will not be able to collect all amounts due according to the loan agreement’s contractual terms. All loans classified as TDRs are also evaluated in the specific reserve. Impairment is measured based on one of the three following methods:

 

·

Present value of expected future cash flows discounted at the loan’s effective interest rate;

·

Loan’s observable market price; or

·

Fair value of the collateral if the loan is collateral dependent.

 

The environmental reserve allows management to consider qualitative or environmental factors that are likely to cause estimated credit losses to differ from historical loss experience. The Bank’s environmental reserve considers 11 risk factors which are evaluated as minimal, low, moderate, or high risk. As the overall risk level of the environmental factors increases, the proportion of the loan portfolio held in reserve also increases. Risk factors considered in the analysis are:

 

·

Lending experience, with particular attention paid to new lenders;

·

Exceptions to loan policy;

·

Rate of total portfolio delinquency;

·

Growth rate of loan portfolio;

·

Exposure to commercial loan concentrations;

·

Exposure to “watch list” loans;

·

Consumer sentiment;

·

Local economic conditions;

·

Regulatory risk;

·

Unemployment, with particular attention paid to local unemployment; and

·

Vintage risk, with particular attention paid to underwriting procedures at time loans were made.

 

Deposits. The Company’s primary source of funds is customer deposits. The Bank offers a variety of deposit products in an attempt to remain competitive and respond to changes in consumer demand. The Company relies primarily on its high quality customer service, sales programs, customer referrals, and advertising to attract and retain these deposits. Deposits provide the primary source of funding for the Company’s lending and investment activities and the interest paid for deposits must be carefully managed to control the level of interest expense.

 

The deposit portfolio decreased $4.0 million, or 2.5%, to $158.3 million as of September 30, 2016 from $162.3 million as of December 31, 2015. Noninterest bearing deposits increased $5.7 million, relative to December 31, 2015, as a result of the reclassification of interest bearing accounts which no longer met the criteria to earn interest. Both savings and DDA/NOW accounts declined during the period relative to December 31, 2015. Savings declined by $0.1 million and DDA/NOW accounts fell by $6.4 million, in addition to the reclassification decrease. Much of the decline in transaction deposits was a shift to MMDA which increased by $0.8 million (2.0%) over the same period. Certificates of deposit increased nominally, in line with the Bank’s pricing strategy of setting competitive interest rates, but not necessarily the highest deposit rates in our market. This strategy contributed to a 20 basis points decrease in the average cost of deposits during the first three quarters of 2016 versus the first three quarters of 2015. Management expects these disintermediation driven reductions in cost to continue in 2016 as premium deposit rates are no longer offered by the Bank.

 

 

Other Borrowings. Borrowed funds totaled $2.2 million as of September 30, 2016, a $366 thousand, or 14.3%, decrease from the December 31, 2015 balance. The borrowings consist of three loans to the Bancorp from outside creditors. The loans must be repaid from Bancorp cash. As of September 30, 2016, Bancorp’s cash position was $486 thousand.

 

During the first quarter of 2015, Bancorp was able to renegotiate a substantial portion of the debt due December 29, 2015, achieving terms more favorable to Bancorp. A portion of the $5.0 million note totaling $2.3 million was exchanged for 28,675 shares of Bancorp common stock and a new $1.6 million note with a more favorable interest rate and a maturity date of August 2021.

 

Management is engaged in the sale of the remainder of the OREO property held at the Bancorp, which will provide additional liquidity to meet required debt servicing payments. The Bancorp is also reviewing other borrowing avenues to ensure there is adequate cash to meet debt servicing needs.

 

Other Borrowings

(Dollars in thousands)

Description

Balance of Loan as of  09/30/16

Interest Rate

Frequency  of  Payments

Status

Maturity Date

Loan 1

$

444

4.75

%

Monthly

Amortizing

11/21/2019

Loan 2

$

307

4.25

%

Monthly

Amortizing

6/25/2019

Loan 3 (Note B)

$

1,452

6.00

%

Monthly

Interest Only

8/4/2021

 

No FHLB borrowings were outstanding as of September 30, 2016 or December 31, 2015. The Bank had an approved FHLB line-of-credit of $51.0 million as of September 30, 2016. In addition, the Company has collateralized federal fund lines of $8.7 million with the FRB and $1.0 million with Great Lakes Bankers Bank. Neither line was drawn upon as of September 30, 2016. The FHLB line is secured via the pledge of mortgage loans totaling $76.9 million, the Federal Reserve federal fund line is secured via the pledge of $12.0 million of automobile loans, and the Great Lakes Bankers Bank line is unsecured.

 

Federal Income Taxes. The Company, in December 2014, recaptured the $5.1 million deferred tax asset allowance account, which had been established in 2012 as a write-off of the Company’s deferred tax asset position. As a result of recapturing this allowance account, the Company is now subject to reporting federal income tax expense. For the nine month period ended September 30, 2016, the Company recorded income tax expense of $284 thousand versus $155 thousand for the nine month period ended September 30, 2015. At September 30, 2016, the Company has a deferred tax asset related to a net operating loss carryforward of approximately $4.7 million.

 

Concentrations of Credit Risk. Financial institutions such as Citizens Bank generate income primarily through lending and investing activities. The risk of loss from lending and investing activities includes the possibility that losses may occur from the failure of another party to perform according to the terms of the loan or investment agreement. This possibility is known as credit risk.

 

 

Lending or investing activities that concentrate assets in a way that exposes the Company to a material loss from any single occurrence or group of occurrences increases credit risk. Diversifying loans and investments to prevent concentrations of risks is one way a financial institution can reduce potential losses due to credit risk. Examples of asset concentrations would include multiple loans made to a single borrower and loans of inappropriate size relative to the total capitalization of the institution. Management believes adherence to its loan and investment policies allows it to control its exposure to concentrations of credit risk at acceptable levels. The Bank’s loan portfolio is concentrated geographically in central Ohio. Management has identified lending for non-owner occupied residential real estate as a lending concentration. Total loans for income generating property totaled $30.0 million at September 30, 2016, which represents 20.0% of the Company’s loan portfolio. Management believes it has the skill and experience to manage any risks associated with this type of lending. Loans in this category are generally paying as agreed without any unusual or unexpected levels of delinquency. The delinquency rate in this category, which is any loan 30 days or more past due, was 3.5% at September 30, 2016. Management has also identified sub-prime loans (less than a 660 credit score) and unsecured loans as concentrations. As of September 30, 2016, loans to sub-prime borrowers totaled $10.1 million (6.7% of total portfolio), with 3.2% of these credits 30 days or more past due. In addition, unsecured loans totaled $3.8 million as of September 30, 2016, or 2.5%, of the loan portfolio, with a delinquency rate, which is any loan 30 days or more past due, of 0.3% at September 30, 2016.

 

Liquidity and Capital Resources. The Company’s primary source of liquidity is its core deposit base, raised through the Bank’s branch network, along with wholesale sources of funding and its capital base. These funds, along with investment securities, provide the ability to meet the needs of depositors while funding new loan demand and existing commitments.

 

Cash provided by operating activities was $658 thousand for the first nine months of 2016 and $358 thousand for the first nine months of 2015. The adjustments to reconcile net income to cash provided by or used in operations during the periods presented consist primarily of accrued interest payable, net gain on sale of other real estate owned, other assets, other liabilities and adjustments related to loans originated for sale.

 

The primary investing activity of the Bank is lending, which is funded with cash provided from operating and financing activities, as well as proceeds from payment on existing loans and proceeds from sales and maturities of investment securities.

 

In considering the more typical investing activities, during the first nine months of 2016, $4.0 million of cash was generated from sale of investment securities and $2.2 million was provided by the combination of maturity, pay-downs, or calls of investment securities.

 

Financing activities consumed a net total of $3.8 million of cash balances during the nine month period ended September 30, 2016, due to the drop in deposit account balances during the same period. Proceeds from the issuance of the Bancorp’s common stock totaled $0.6 million.

 

For the first nine months of 2016, total deposits were down $4.0 million, or 2.5%, versus December 31, 2015 as the Company continues to de-emphasize large, collateralized, public fund deposits. For the same period in 2015, total deposits were down $9.8 million. For additional information about cash flows from the Bank’s operating, investing, and financing activities see the consolidated statements of cash flows included in the consolidated financial statements.

 

Item 3 - Quantitative and Qualitative Disclosures About Market Risk.

 

There are no matters required to be reported under this item.

 

Item 4 - Controls and Procedures.

 

Bancorp’s management carried out an evaluation, under the supervision and with the participation of its Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of the Company’s disclosure controls and procedures as of September 30, 2016, pursuant to Exchange Act Rule 13a-15. Based upon that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that the Company’s disclosure controls and procedures were effective as of that date, in timely alerting them to material information required to be in the Company’s (including its consolidated subsidiary) periodic SEC filings.

 

There have been no changes in the Company’s internal control over financial reporting that occurred during the Company’s fiscal quarter ended September 30, 2016 that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.

 

 

FORM 10-Q

Quarter ended September 30, 2016

PART II - OTHER INFORMATION

 

Item 1.	Legal Proceedings.
	There are no matters required to be reported under this item.
Item 1A.	Risk Factors.
	There has been no material change in the nature of the risk factors as set forth in the Company’s Annual Report on Form 10-K filed for the year ended December 31, 2015.
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds.
	There are no matters required to be reported under this item.
Item 3.	Defaults upon Senior Securities.
	There are no matters required to be reported under this item.
Item 4.	Mine Safety Disclosures.
	There are no matters required to be reported under this item.
Item 5.	Other Information.
	There are no matters required to be reported under this item.
Item 6.	Exhibits.

 

Exhibit No.		Exhibit
3.1		Amended and Restated Articles of Citizens Independent Bancorp, Inc. incorporated by reference to Exhibit 3.1 to the Company’s Registration Statement on Form S-1, filed September 5, 2013 (Registration No. 333-191004).
3.2		Amended and Restated Regulations of Citizens Independent Bancorp, Inc. incorporated by reference to Exhibit 3.2 to the Company’s Registration Statement on Form S-1, filed September 5, 2013 (Registration No. 333-191004).
31.1		Certification of Chief Executive Officer pursuant to Rule 13a-14(a)/15(d)-14(a) of the Securities Exchange Act of 1934, as amended, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

 

31.2		Certification of Chief Financial Officer pursuant to Rule 13a-14(a)/15(d)-14(a) of the Securities Exchange Act of 1934, as amended, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
32.1		Certification of Chief Executive Officer pursuant to 18 U.S.C. 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
32.2		Certification of Chief Financial Officer pursuant to 18 U.S.C. 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
101		The following financial information from Citizens Independent Bancorp, Inc.’s Quarterly Report on Form 10-Q for the quarterly period ended September 30, 2016 formatted in Extensible Business Reporting Language (XBRL): (i) the Consolidated Balance Sheets, (ii) the Consolidated Statements of Income, (iii) the Consolidated Statements of Comprehensive Income, (iv) the Condensed Consolidated Statements of Shareholders’ Equity, (v) the Consolidated Statements of Cash Flows and (vi) the Notes to the Consolidated Financial Statements.

 

 

Citizens Independent Bancorp, Inc.

 

SIGNATURES

 

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

 

	CITIZENS INDEPENDENT BANCORP, INC.
	(Registrant)
Date: November 14, 2016	/s/ Daniel C. Fischer
	Daniel C. Fischer
	President and Chief Executive Officer
	/s/ James V. Livesay
Date: November 14, 2016	James V. Livesay
	EVP and Chief Financial Officer